Breakingviews

Loss of Bhattal may signal Nomura retreat

By John Foley The author is a Reuters Breakingviews columnist. The opinions expressed are his own Nomura has lost its top banker, and with him its chances of becoming a globally relevant investment bank. Jesse Bhattal, who helped broker the Japanese group’s purchase of Lehman Brothers’ Asian and European businesses, has retired less than a year after being promoted to president of the wholesale bank – essentially everything outside Japan. At best, Nomura will muddle through. At worst, this marks the beginning of a slow retreat.

Bhattal would most likely have left the bank in April, according to people familiar with the situation. That he didn’t last that long suggests the relationship had become frayed. Bhattal had pushed hard to make Nomura leaner, including a $1.2 billion programme of cost cuts announced in November, after Nomura reported its worst quarterly loss since 2009.

The next question is whether the bankers beneath Bhattal stick around. They include his most likely successor, Asia chief Philip Lynch, and Europe-based business heads William Vereker, Tarun Jotwani and Benoit Savoret. The signs aren’t good. All three came with Bhattal from Lehman. And as Bhattal was the first non-Japanese executive on Nomura’s management board, the impression will be that he failed to win over domestic vested interests.

Either way, Nomura has problems aplenty. Its European business is loss-making; its U.S. arm more successful but tiny. Nomura ended 2011 as the world’s 16th biggest investment bank by fees. And it lost market share: the bank’s haul was 35 percent lower than in 2010, while the global fee pool shrank by just 6 percent, according to Thomson Reuters data. The recent threat of a credit downgrade, while shared with other banks, would be a severe blow to Nomura, whose low rating already puts its trading arm at a disadvantage in dealing with counterparties.

The irony is that there’s nothing “wrong” with Nomura as an investment bank. It has no big exposure to euro zone debt, or rogue traders. It had already begun to shed capital-intensive private equity assets, and its core Japanese franchise has been performing strongly. But faced with falling markets, higher capital requirements, and the surprising resilience of bulge-bracket rivals like Citi and Morgan Stanley, the dice are loaded against it.

Private equity skewered by Romney-bound arrows

By Jeffrey Goldfarb

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

Private equity is caught in the crossfire. Rivals for the Republican nomination for the U.S. presidency are leading a full-blown assault on front-runner Mitt Romney’s track record at Bain Capital. The attacks won’t stop Romney, but the collateral damage could hurt the buyout industry.

Only two months ago, KKR kingpin Henry Kravis warned his fellow buyout barons to beware the barrage. If Romney becomes the nominee, “they’re going to describe us all as asset strippers,” he said. But “they” were supposed to be the Democrats. Not even Kravis anticipated friendly fire.

Romney, to an extent, invited the onslaught. To burnish his economic credentials, he put forward an unsupportable claim about job creation during his time at Bain. But that doesn’t justify the absurd spectacle that has unfolded. Newt Gingrich, who once advised private equity firm Forstmann Little, claimed that Bain “looted” companies. Jon Huntsman, whose family’s publicly listed chemical business agreed to an ultimately unsuccessful $6.5 billion leveraged buyout in 2007, jumped on the bandwagon. So did Texas governor Rick Perry, even though his state’s teachers – whose retirement fund board he appoints – have invested in Bain funds.

Moreover, the GOP en masse has helped thwart repeated efforts to make buyout firms pay a fairer tax rate on a big chunk of their profits. And while Republicans in Congress took less money related to private equity than Democrats between January 2007 and June 2011, they still pocketed some $6.5 million, according to research firm MapLight.

The rhetoric is unlikely to derail Romney’s chances of taking on President Barack Obama in November’s election. The populist anti-private equity message from GOPers could, however, have staying power. For one, it gives fresh fodder to the Occupy crowd. It also will make it harder for Republicans to defend the industry when debates such as the one over taxing carried interest are rejoined in Congress.

Apple ties Cook into Jobs’ boots – at a price

By Robert Cyran 

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

Apple has tied Chief Executive Tim Cook into Steve Jobs’ boots – albeit at a high price. The maker of functional but expensive gadgets now has a $376 million CEO retention plan to match. Cook deserves much after standing in for Jobs, and Apple needs continuity. But in future the board can pay Cook a bit more like the company’s late co-founder.

As the board admitted, the award to Cook – a tidy 1 million restricted shares – was essentially plucked out of the air. Yet it would be hard to reason a way to a number. Cook ably replaced the ailing Jobs on three occasions before eventually becoming CEO. While running the near-$400 billion Apple is probably the most exciting job in tech, Silicon Valley rivals would love to get their hands on Cook. And with Jobs gone, the company needs to hold onto his top lieutenants, among them Cook and Jonathan Ive, the newly-knighted British chief designer.

Cook’s award – already worth almost $50 million more than the official figure, which uses Apple’s share price last August – isn’t only hefty, it also serves its purpose. Half of the stock vests in five years’ time, the other half in 10 years. And Cook will lose unvested shares if he leaves the company for any reason except death or disability.

Yet from now on, the board doesn’t need to pay Cook over the odds. Consider Jobs’ pay history. Apple gave him 20 million options and a $90 million Gulfstream jet in 2000. They would be worth about $16 billion to his heirs now, had he not exchanged them – along with a lesser batch of options received in 2002 – for a smaller quantity of restricted stock in 2003.

Critics thought the 2000 grant, in particular, excessive. Other than the two sets of options, however, Jobs received only $1 a year for more than a decade. The board can justify a higher annual sum for Cook, if he can help sustain the trajectory that made Apple the most valuable company in the world briefly last August and brought an all-time high share price during Monday’s trading. But the grant is designed to lock in the CEO’s services, and the company shouldn’t need to pay up again.

GDP-linked debt could make finance safer

By Edward Hadas The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The financial crisis showed that there are serious problems with the architecture of all of the main investment types. A new instrument – bonds with payments that vary with GDP – could prove a happier medium.

Consider the weaknesses in the current set-up. The real return of ordinary fixed-interest securities can be savaged by inflation. Besides, these bonds lure borrowers to take on too much leverage in good times, while making default more likely in recessions. Inflation-linked debt, as the name implies, protects investors from increases in the cost of living. But they offer almost no exposure to economic expansion. Equities provide growth, but are altogether more risky.

Nominal GDP forms a far superior base for investment. It captures both inflation and real growth, so brings the advantages of inflation-linked bonds and equities. As a national measure, it is less variable and more predictable than the corporate profits which underlie share prices, but grows roughly as fast as them over time. And because nominal GDP is exactly as cyclical as the economy, it is less likely than any fixed-payment arrangement to make borrowing either too tempting or too burdensome.

Robert Shiller, the economist who has promoted the concept, suggests an instrument he calls the “trill” (crediting the name to co-author Mark Kamstra). A trill would pay an annual coupon equivalent to one-trillionth of the previous year’s GDP (about $14 in 2012, for the United States).

Corporates as well as sovereigns could issue GDP-linked debt. As with any market instrument, investors would decide how much they were willing to pay for the anticipated stream of payments. As with stocks, both the payment and the price could and would change. As with bonds, the failure to pay the dividend would have all the dire consequences of default.

Some “trills” have been issued, but only by countries that have already defaulted. Indeed, there has been some talk of “GDP-kickers” on restructured Greek debt. To succeed, bond investors would have to be willing to give up some nominal certainty for the sake of a real guarantee. Traders and asset managers would have to develop new pricing models too. But GDP-linked bonds could serve issuers and investors well, while showing that the past years of financial crisis can bear good fruit.

Fiat may find Chrysler deal is ticket out of Italy

By Rob Cox

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

Italy is a global leader in fashion, food and art but comes up short on multinational corporations. That’s likely to change as Fiat plots a full takeover of Chrysler. Going global, though, comes at a price: Fiat’s Agnelli family may need to put pragmatism over sentimentality and move its headquarters from Italy.

Fiat is already becoming less Italian. This marks the first year the company is not a dues-paying member of Confindustria, the federation of Italian employers. Just a couple of years ago, when Fiat’s chairman led Confindustria, this would have been unthinkable. Chief Executive Sergio Marchionne withdrew Fiat largely to forge its own destiny with labor unions.

But the bigger catalyst for Fiat’s global graduation lies ahead. The launch of the Fiat-engineered fuel-efficient Dodge Dart allowed Fiat to raise its stake by five percentage points to 58.5 percent this week. Buying the remainder of Chrysler from a trust established to fund healthcare costs for retired UAW workers comes next, but will be far trickier.

The two sides are supposed to work out a deal in the first quarter of 2013. Though negotiations have yet to begin, they’re already far apart on price. Moreover, even if Fiat could snag a valuation in line with the price it paid for a 16 percent stake last year, it would cost around $3.3 billion. But given Fiat’s debt is nearly 6 billion euros – dwarfing its market value of 4.8 billion euros – that would be tight.

That suggests the best option would be to offer a combination of equity, with some cash, to the UAW trust as part of a full merger. The net present value of synergies that could be squeezed out – estimated by Breakingviews at some $17 billion – might also appeal to the trust. But it’s hard to imagine it would want its primary asset to be in Italian stock.

Fat cats have little to fear from Cameron curbs

By Edward Hadas The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

All those in favour of “grossly excessive pay rewards”, raise their hands. No takers? All right, how about everyone who approves of “a few at the top” receiving “rewards that seem to have nothing to do with the risks they take or the effort they put in”. Still no one?

That is hardly a surprise. But almost universal condemnation – now backed by these tough words of the UK prime minister and his Treasury chief secretary – does not translate into lower pay for the corporate elite.

Those at the top are certainly not suffering. IDS, an incomes consulting group owned by Thomson Reuters, the parent of Breakingviews, reported that directors of top UK companies received an average 49 percent pay increase last year. That followed a 55 percent rise in the previous year. In stark contrast, the average worker managed a 4.5 percent gain over two years.

Those receiving, and awarding, the high pay are unlikely to plead guilty to social injustice. They will say that they are merely participating in an Anglo-American trend that started in the 1980s. They’re right about the pay acceleration.

Economists Carola Frydman and Raven Saks Malloy calculate that median inflation-adjusted pay for the top three executives in U.S. companies rose only 5 percent between the 1930s and the 1970s, and by 55, 126 and 125 percent in each of the next three decades.

But no one has provided a full explanation for the shift upward, or for bosses’ real-value pay cuts between 1940 and 1949, from 24 to 17 times average earnings. Government policies – war-related curbs in the early 1940s and financial deregulation in the 1980s – probably played a role. Many explanations, however, end up with an unsatisfactory invocation of mysterious social forces.

Yahoo’s gain is eBay holders’ pain

By Robert Cyran The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Yahoo’s gain is probably eBay shareholders’ pain. The Internet company has nabbed Scott Thompson, the head of eBay’s PayPal division, as its new chief executive. That’s good for Yahoo, but less so for eBay’s owners. The auctioneer’s payments business is a gem that could grow faster on its own. Thompson’s walk suggests such a split isn’t coming any time soon.

PayPal has grown rapidly and in the most recent quarter accounted for almost 40 percent of eBay’s revenue. But with more than 100 million regular users, further expansion will increasingly need to come from payments unrelated to eBay and even to the Internet. For example, PayPal is moving into services allowing people to use their phone numbers or swipe cards at terminals in brick-and-mortar stores. Retailers would surely be more receptive if PayPal were free of any connection to eBay, a potential rival for them.

Investors have a more concrete reason to clamor for a split, too. PayPal is set to produce about $2.2 billion in EBITDA this year, by analysts’ estimates. Payments giant Visa’s enterprise value is slightly more than 10 times its estimated 2012 EBITDA. PayPal probably deserves a premium because of its much faster growth. Put it on a 12 times multiple, and the division should be worth some $26 billion.

The rest of eBay should generate about $4 billion of EBITDA this year, and UBS estimates that’s worth about $22.5 billion in enterprise value. Add eBay’s net cash of about $1.5 billion, and the company’s equity value ought to be around $50 billion. With a current market capitalization of $39 billion, eBay is trading at a more than 20 percent discount to the value of its parts.

Logically, Thompson might have stuck around had the company been seriously considering a value-enhancing split. He would have had a chance to run his own show and have a big payday without taking a risk on the uncertainty and painful drama surrounding Yahoo.

Investors knocked nearly 4 percent off eBay’s value in Wednesday morning trade. Maybe they are concerned that eBay is losing a talented manager. But an explanation at least as likely is that they are disappointed that the company, which has hinted in the past that a split could make sense eventually, isn’t in any hurry at all.

U.S. shale exuberance may need to be tempered

By Christopher Swann The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

France’s Total and China’s Sinopec kicked off 2012 with $4.5 billion of deals with Chesapeake Energy and Devon Energy, respectively, to drill for U.S. shale oil and gas. Vast resources and technology in America should keep attracting foreign buyers. But the reaction by Ohio officials after several earthquakes suggests political risks will intensify.

Worries over hydraulic fracturing, or fracking, have been steadily rising. In spring 2011, Britain suspended the deep-excavation practice near Blackpool after minor tremors. The quake in Ohio, which prompted the state to suspend drilling at five wells, could be the start of a bigger setback. Until now, there has been only token resistance in Ohio. The weekend’s seismic movements threaten to galvanize the kind of public discontent that has been gathering strength in New York and Pennsylvania.

It also comes less than a month after a report from the Environmental Protection Agency offered the first tentative evidence that the fracturing process itself, rather than merely the careless disposal of waste fluids, can contaminate groundwater supplies.

Global energy companies may consider such hazards routine. After all, Total faced a complete ban on fracking at home. Political risk is an integral part of oil exploration. Exxon Mobil’s modest payout for the nationalization of its Venezuelan assets, less than a seventh the sum it was seeking, is another stark reminder. By comparison, the United States still looks a relatively safe place to invest. And shale drilling stands a good chance of being proven safe when conducted properly.

Still, greater public opprobrium over fracking and stricter government oversight both look likely in 2012. Such threats may not be fully reflected in the racy sums overseas buyers are willing to fork out for U.S. shale assets. Chesapeake’s latest sale in the Utica formation fetched a rich $15,000 an acre for largely unproven reserves. Prices are up from recent deals in Texas and North Dakota, with per-acre prices between $8,000 and $11,000.

Such asset inflation indicates that wide-eyed profit-seeking is trumping any fear of political risk. Big spenders would be wise to temper their exuberance.

Investment banking dreams may die in 2012

By Margaret Doyle The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Will there be fewer investment banks at the end of 2012? Brutal market conditions forced almost all wholesale banks to cut costs and jobs in 2011. New regulations will force further shrinkage simply to generate acceptable returns. Unless the market picks up soon, smaller players may conclude they’re better off out of the game altogether.

Banks cut thousands of jobs from their wholesale divisions in 2011, as revenues collapsed amidst the euro zone crisis. And new regulations will halve average expected return on equity (ROE) across global investment banks in 2012 to 8.3 percent, according to analysts at JPMorgan, well below the 13 percent needed to cover their cost of equity.

To reach that required return, banks have to shrink further. Even factoring in further headcount reductions of up to 20 percent and a 5 percent cut in non-compensation costs, returns would still be too low. To reach a 13 percent ROE, banks will have to slash pay too – by a hefty 23 percent per head on average, JPMorgan reckons.

Those cuts will not just remove fat, they will also undermine revenue. The most vulnerable banks are those that are already sub-scale. JPMorgan analysts estimate that 2011 revenue at Royal Bank of Scotland, UBS and Societe Generale will be barely half that of industry leaders Goldman Sachs and Deutsche Bank. Nomura too, faces a tough call – its investment bank is losing money in Europe, while the threat of a ratings downgrade could undermine its counterparty status.

No one is yet contemplating quitting – publicly, at least. Nomura reckons that its capital strength and liquidity position will allow it to gain from euro zone turmoil. UBS’s new chief executive, Sergio Ermotti, insists its smaller investment bank is essential to its private bank.

However, there are signs of retreat. The UK government, RBS’s major shareholder, made clear in December that it wants to shrink the investment bank faster. And SocGen has installed its chief financial officer at the head of its investment bank, suggesting a tighter focus on costs.

Refiner’s credit crunch augurs wider pains

By Kevin Allison The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Lenders have frozen a $1 billion credit line at Petroplus, Europe’s biggest independent oil refiner, which speaks for 4.4 percent of the region’s total capacity. The loss-making Swiss group relies on the borrowing facility to buy crude, and may be forced to close production within days if it can’t find a new source of funds.

European rivals might be able to raise prices if a poor outcome for Petroplus speeds reduction in refining capacity, but low margins are likely to remain a widespread problem.

Refiners have been dealt a succession of blows since the financial crisis. First, the recession battered demand for oil products. Now, with another European recession looming, new refining capacity commissioned during the boom years is coming online. Left unchecked, UBS estimates these new facilities, mainly large-scale, low-cost refineries in the Middle East and Asia, will drive global capacity utilisation below 80 percent by 2015. That’s too low for an industry with high fixed costs. Getting to a more sustainable 85 percent would require shutting about 5 million barrels per day (bpd) of refining capacity over the next four years.

Petroplus’s 667,000 bpd of production capacity would make a useful dent if all five of its refineries shut down permanently. But even if the company sinks, the plant won’t necessarily disappear. Besides, the company said on Tuesday it intended to continue talks with its banks. France, meanwhile, has promised to do “everything it can” to help the group keep its French operations open. And Petroplus’s better facilities would probably attract buyers in the event of a fire-sale or bankruptcy.

Even if the Petroplus plant were decommissioned, European refining economics would remain challenging. Rivals’ valuations pose questions, too. The sector has underperformed the MSCI World Index by 19 percentage points this year. Yet less distressed independents, such as Finland’s Neste Oil and Greece’s Hellenic Petroleum, still trade on about double U.S. refiner Valero Energy’s three times EV/EBITDA multiple – and they don’t benefit from Valero’s access to cheaper WTI.

The woes of Petroplus might give struggling rivals a temporary shot in the arm. But the broader issues – depressed demand, excess capacity and volatile oil prices – are far from company specific.