Breakingviews

Exclusive: Ditching CEO won’t save US utility deal

By Rob Cox The author is  a Reuters Breakingviews columnist and a Northeast Utilities customer. The opinions expressed are his own.

Northeast Utilities made an offering at the altar of the regulatory gods. The New England utility parted ways with the executive who headed its biggest division, Connecticut Light & Power, over its poor handling of two storms that left millions of customers without power for weeks. Investors seemed to think that will help it gain approval for a $4.7 billion takeover of rival NSTAR. Their optimism looks misplaced.

In an interview with Reuters Breakingviews, Connecticut’s Commissioner of the Department of Energy and Environmental Protection, Dan Esty said Governor Dan Malloy’s administration is determined to insert itself into the merger approval process, even if that means introducing and fast-tracking special legislation.

“There are important questions that need to be vetted for the people of Connecticut” before this deal is approved, Esty told Reuters Breakingviews. “The state needs to know how the merger will impact ratepayers and what lines of accountability will be drawn.”

That’s a stark change from the state’s earlier line. Connecticut’s Public Utilities Regulatory Authority had previously decided it had no jurisdiction over the deal, which was announced a little over a year ago, leaving final approval to utilities regulators in Massachusetts. That was before Hurricane Irene and a snowstorm on Halloween weekend left millions of customers of Connecticut Light & Power, NU’s primary subsidiary, without power for more than a week.

CL&P’s planning, response and communications are now the subject of numerous investigations by the state and local authorities. The company failed to meet a handful of deadlines for restoring power. On Thursday NU accepted the resignation of CL&P’s Butler, who had become the public face of the company’s failings during the outages.

It’s easy to see why that news warmed investors’ hearts and gave NU shares a 1.8 percent lift Friday. By removing the man in charge of the bungled performance of CL&P, the monopoly can argue that it is accountable to its customers and local regulators.

Music gods again divert EMI’s destiny

By Jeffrey Goldfarb The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The music gods have meddled again with EMI’s destiny. In the minds of financiers and industry wags, the union of the British music group – home to the Beatles and the Beastie Boys – with U.S. rival Warner Music was just a matter of time. But the star-crossed match has been knocked off course again by the sale of EMI’s two divisions to Sony and Vivendi’s Universal Music.

EMI’s path to this point has been torturous. An overleveraged buyout in 2007 led to seizure of the music company by lender Citigroup earlier this year. The bank, a reluctant owner, appeared to have a quick way out when billionaire Len Blavatnik acquired Warner soon after. The logic for a deal is nearly as compelling as it was when the two companies first tried to merge in 2000. EMI and Warner remain the runts among the four majors, complement each other geographically and present cost-cutting opportunities.

Yet Universal, the world’s largest music company, and number-two Sony have bold plans of their own. With twice as much revenue as Warner but about the same operating margin, Universal needs cost reductions to capitalize on its scale. Though it’s paying a rich seven times EBITDA through March for EMI’s recorded music business, it expects about $160 million of annual savings. Taxed and capitalized, those should cover over half the $1.9 billion purchase price.

For Sony’s part, taking control of EMI’s music publishing business for $2.2 billion would vault it to the top spot in the sector. It would also leave the rival BMG partnership established by private equity firm KKR and German media group Bertelsmann still lacking the anchor asset it had been seeking to give it serious clout.

Still, EMI’s fate is not quite sealed. Citi made sure Universal assumed all the regulatory risk on the deal. Though Universal plans to sell 500 million euros of assets, U.S. and European trustbusters will still have plenty of questions. In some countries, the enlarged Universal would control over 40 percent of the market; in the United States, it would have about a 38 percent share. The competition review may take a year or more. This isn’t necessarily the day the music died for Warner and EMI.

Previous version incorrectly stated revenue comparison in third paragraph

When is a merger-of-equals really a takeover?

By Rob Cox The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

When is a merger-of-equals really a takeover? One easy way to tell is when the top brass get rich and undeserved paydays. There’s probably no better live example than the just-delayed sale of Massachusetts electric utility NSTAR. Its top five executives could feast on as much as $50 million in severance and change-of-control payments despite labeling their deal as one of mutual control for both sets of shareholders. As regulators probe the union more deeply, investors may want to do the same.

It’s no surprise NSTAR wanted to describe selling out to rival Northeast – the company behind Connecticut’s recent crippling power outages – as a merger instead of a takeover. Given their huge local monopolies, electric companies are highly regulated and politicized creatures. NSTAR has 1.4 million captive customers in the greater Boston area.

These sensitivities explain why the companies used a variation on the verb “merge” 29 times when announcing the all-stock deal. Each company will contribute seven directors to the board. NSTAR Chief Executive Thomas May retains the same role in the combined company while his counterpart at Northeast, Charles Shivery, will become chairman.

But while all this makes it sound like a merger, it’s not. The terms of the transaction give NSTAR’s existing owners shares equal to around 44 percent of the new entity. That constitutes a change of control, according to NSTAR’s proxy documents, thereby triggering accelerated payouts of benefits and other goodies for named executive officers.

For May alone, this comes to $8.3 million. What’s more, the deal includes so-called “double-trigger” agreements that pay out as much as $50 million if the five senior employees are terminated after two years. In the context of executive pay gone wild, this may not sound like an aberration. Oil driller Nabors recently paid $100 million in severance to Chairman Eugene Isenberg merely to surrender his CEO title.

But equity investors normally receive a premium when handing control to a buyer. NSTAR’s deal was struck at parity. That effectively means NSTAR’s executives will exploit a change-of-control premium that their shareholders were denied.

De Beers buyout adds polish to Anglo American

By Quentin Webb The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Taking full control of the world’s top diamond producer will add extra polish to Anglo American. The miner’s agreement to buy the Oppenheimer family out of De Beers was rewarded with a 1 billion pound ($1.6 billion) boost to its market cap on Nov. 4. At $5.1 billion, the price tag seems reasonable. But there’s more to the share-price boost: the deal is also another step towards a more straightforward Anglo – making it a more attractive merger partner.

Anglo will take its holding in De Beers from 45 percent to 75-85 percent, depending on whether the diamond miner’s third shareholder, the government of Botswana, exercises its rights to buy a quarter of the Oppenheimer stake. Factoring in about $1.1 billion of debt, the deal gives De Beers an enterprise value of at least $13.8 billion, or about 5.9 times this year’s EBITDA, assuming EBITDA in the second half matches the $1.18 billion made in the first.

European metals and mining firms trade at about 5.2 times forward EBITDA, but De Beers surely merits a big premium, since it has as much in common with, say, jeweller Tiffany’s (trading on 11.9 times) as a steelmaker. And like so many other deals, this one is partly predicated on China’s rising wealth: a bigger middle class equals more brides demanding diamond rings.

Anglo should also be able to save on central costs and procurement, and share more mining know-how. Some investors are doubtless also relieved at this sensible use of cash, coming just as the company prepares for an unwelcome multi-billion-dollar windfall in Chile, where the state’s copper giant is exercising an option to muscle into Anglo’s operations.

It fits well with Anglo’s long-running move to simplify itself, with $3.3 billion of divestments of late in areas such as zinc. And the more straightforward Anglo gets, the more attractive it could be if, say, rebuffed suitor Xstrata ever decided to make another pitch at a merger or takeover.

The Oppenheimers will plough the proceeds into new Africa-focused investments outside diamonds. For them, diamonds were not quite forever. But Ernest Oppenheimer’s involvement in the industry began in 1902. A century and a decade is good enough going.

P&G deal partner probe proves shorts aren’t nuts

By Jeffrey Goldfarb The author is a Reuters Breakingviews columnist. The opinions expressed are his own.Skeptical investors who went nuts over Diamond Foods may not be so crazy after all. More than a third of the snack food company’s shares were out on loan in late September in anticipation of the company’s planned December purchase of the Pringles brand from Procter & Gamble. That’s indicative of interest from short sellers, who questioned Diamond’s accounting. Now, the company is undertaking an internal investigation, putting the $2.6 billion deal on hold.

Diamond’s expansion plans excited shareholders. Its soaring stock price, which hit an all-time high of over $92 six weeks ago, reflected a heady enterprise value of more than 14 times pro forma EBITDA, including Pringles, for the 12 months to July 31. But the odd timing of certain payments made to suppliers – big enough amounts of money to potentially make the company’s results look materially different – piqued the interest of the shorts and other observers, including Breakingviews.

Deeper analysis turned up more curiosities at Diamond. Trade receivables have been growing faster than sales, which in theory can be a worrying trend. Investor presentations use charts that are at best sloppily compiled to exhibit the company’s growth. Diamond failed to provide a clear explanation for its upward revision to merger-related costs. Then, even after acknowledging some possible fuzziness, the company repeated the same description in a later statement.

The company for the most part initially dismissed the concerns. And only a month ago, more than half the 13 analysts Thomson One records following Diamond recommended its shares as a “buy” or a “strong buy.” None rated the company “underperform” or “sell.” Representative of the group was Jefferies, which on Oct. 10 considered concerns over the grower payments “unfounded,” upgraded Diamond to a “buy” and set a $94 price target, against a close of around $74 the previous trading day.

Word nevertheless filtered up to Diamond’s audit committee. The company postponed the Pringles deal this week and news of its accounting probe has pushed the shares down under $52 apiece. Even if nothing untoward turns up, Diamond might still be inspired to improve its delivery of information. Either way, it calls attention to the value provided by the salty side of investing. At least the company is listening to the short-selling messengers, not shooting them.

Less, not more, better for New England utilities

By Rob Cox The author is a Reuters Breakingviews columnist, and a Northeast Utilities customer. The opinions expressed are his own.

The moneyed folk inhabiting the Connecticut environs of hedge fund town Greenwich wield plenty of power. But many of them have lately been powerless. For the second time in barely more than two months, a huge swath of the two million captive customers of Northeast Utilities – which covers territory from the Constitution State up through Western Massachusetts and into New Hampshire – have spent too many days without electricity.

In an echo of the financial crisis, it turns out that better risk management and stronger regulation of the utility could have made the fallout much less bad. This raises serious questions about Northeast’s competence – and whether it should be allowed to complete a $4.7 billion takeover of Massachusetts utility NSTAR.

The first blow was Hurricane Irene in August. Then came a once-in-a-generation pre-Halloween blizzard. Both were highly unlikely and unpredictable events, utilities argue, so when uprooted trees and snow-heavy branches took down power lines, the responsibility lay mainly with God.

But giving Northeast, specifically its Connecticut Light & Power subsidiary, a pass is like absolving Lehman Brothers <LEHMQ.PK> of any blame for its demise in 2008. Like financial firms, utilities need to manage risks. And they have it relatively easy: much of the task simply involves clearing overhanging trees and other hazards from power lines.

Yet according to regulatory filings, CL&P slashed its maintenance spending by a whopping 26 percent from $130 million in 2008 to just $96.5 million last year. Put simply, that meant one in every four trees that could have been trimmed was left hanging.

The utility showed the same kind of tin ear as some banks, too. Even as customers still faced a week without electricity after Irene struck, CL&P boss Jeff Butler suggested any restoration costs should be covered by increasing electricity rates – when Connecticut’s power is already the most expensive in the continental United States. Butler later backtracked. But this week he suggested the weekend snowstorm came without warning – words he was again forced to eat.

Sprint’s antitrust pitch hedges against DoJ miss

By Reynolds Holding The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Sprint’s antitrust pitch hedges against a swing and a miss by the U.S. Justice Department. The third-largest mobile operator has said it just wants to help the feds squelch AT&T’s $39 billion takeover of T-Mobile USA. But its separate lawsuit suggests a lack of confidence in Uncle Sam’s arguments. Though a court hearing on Monday showed the case faces hurdles, it may give Sprint insurance in case the government stumbles.

Judges generally look askance at competitors’ suits to block mergers. Antitrust law doesn’t protect rivals from harmful competition, the Supreme Court has ruled, unless it’s clear their injuries would also damage consumers. Merely filing a suit can appear self-serving and undercut a company’s arguments, and legal fees are costly. That’s why most firms let the DoJ do the heavy lifting and cheer from the sidelines.

Sprint, though, says stepping in frees it to make clearer legal points and give DoJ technical support about the industry. The latter may be harder to accomplish after a judge’s ruling on Monday denied the company access to AT&T documents already given to the government. Sprint also notes that the more lawsuits AT&T faces, the tougher a settlement — and consummation of the deal — will be.

But court documents suggest another reason. Justice argues that the merger would cut competition, curb innovation and raise prices. Sprint, on the other hand, says the deal would block smaller rivals from offering cutting-edge handsets, reaching roaming agreements and accessing backhaul services, which tie a central network to remote sites. Both results could harm consumers. But the first might benefit Sprint if higher prices gave it a competitive edge. The second would limit its market.

Antitrust-law experts critical of the DoJ‘s argument say Sprint’s is legally much stronger. They also say the stock market agrees. When the government announced its lawsuit on Aug. 31, Sprint’s stock jumped substantially. That’s a surprising reaction to a move that was intended to keep the mobile industry generally from boosting prices.

Sprint says the government’s case is very strong. That the company felt compelled to make its own arguments in a rare lawsuit may be telling nonetheless. With AT&T’s play for T-Mobile threatening to create a wireless behemoth, there’s a lot at stake for Sprint. Little wonder that it wants to have its own say in court.

Apax misses with HIT disposal

By Quentin Webb The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Mattel’s $680 million purchase of HIT Entertainment, the company behind kids’ characters Bob the Builder and Thomas the Tank Engine, brings a sorry tale of private equity ownership to a close. But uniting Bob with Barbie does not necessarily mean they’ll live happily ever after.

With HIT, Apax Partners seems to have fallen short as a builder of businesses and a financial engineer. HIT is worth less, and enjoys lower revenues, than at its 2005 buyout. Sales were 148 million pounds in financial 2004, its last year as a public company, or about $236 million at current exchange rates. Now they stand at about $180 million. The current deal values HIT at about 60 million pounds less than in 2005 — although HIT’s stake in a TV channel is still to be sold, which could help narrow that gap.

In 2005, with the buyout boom in full swing, Apax over paid. It went in at 14.6 times historic EBITDA, versus an exit at 9.5 times. It also put too much debt on the business, forcing it into negotiations with lenders last year. Strategically it misfired too, dabbling with in-house toy-making, and probably overestimating the potential for Bob, whose star was already waning. Newer shows, like Rubbadubbers, sunk sadly into obscurity. DVD sales, a key revenue source, are also under pressure.

From Mattel’s point of view, the price tag looks more palatable. Japanese rival Tomy paid 11 times historic EBITDA for U.S. toymaker RC2 earlier this year, for example. There is also strategic logic for the new combination. Mattel already makes the non-wooden toys for Thomas & Friends, by far HIT’s strongest set of characters. Moreover, its clout with big retailers like Wal-Mart should ensure toys based on HIT characters get better shelf space.

But it’s not without risks. Mattel is a company that has forged its reputation making toys. HIT’s skill lies in creating characters, making shows and licensing products. Judging kids’ tastes is as much an art as a science. Synergies between the two, meanwhile, look thin. It is too early to write the fairytale ending.

Blocking a deal isn’t always best antitrust answer

By Rob Cox The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Blocking mergers is the bluntest tool in an antitrust watchdog’s armory. That’s what the U.S. Justice Department is trying with AT&T’s ambitions to acquire T-Mobile USA. But as the case of Live Nation Entertainment shows, aborting deals isn’t always necessary to foster competition – extracting concessions can work instead.

The $1.5 billion group was created by the early 2010 union of TicketMaster, the largest ticket seller in the United States, with the leading concert promoter. The creation of such a vertically-integrated beast scared consumer groups – even rock’n’roll tough guys like Pearl Jam and Bruce “the Boss” Springsteen sang foul.

But a funny thing happened on the way to Live Nation’s predicted market domination. It never actually materialized. That much is apparent to the company’s stockholders. Since hitting a post-crisis peak north of $16 soon after the merger closed, the stock has lost about half of its value.

In approving the deal, the DOJ set some important conditions. Among these, Live Nation was required to license its ticketing technology to a nascent rival, AEG. It was also prohibited from retaliating against venues that worked with competitors.

At the time, opponents of the merger considered these insufficient. Clearly investors today think differently. Since August, when AEG went live with its new ticketing site, Axs – led by the former chief executive of TicketMaster – shareholders have clipped a quarter out of Live Nation’s share price.

In addition to competitive threats, Live Nation appears to have set itself back by misjudging the market. While Lady Gaga still manages to attract hordes of little monsters to big arenas, consumer preference may be moving toward smaller venues. To wit, Radiohead played the relatively tiny Roseland Ballroom in New York this week – not Madison Square Garden.