Breakingviews

Repsol nearly pricing in the worst

By Fiona Maharg-Bravo

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

How bad could it get for Repsol in Argentina? The Spanish oil and gas company has just had the bulk of its 57 percent stake in YPF expropriated by Buenos Aires. It’s far from clear whether Repsol will be properly compensated. Which way it goes could make big difference to its market value.

Calculator: Repsol value after the YPF grab

Repsol says YPF is worth at least $18.3 billion, based on a simple formula enshrined in YPF’s bylaws. On this assessment, if a third party buys more than 15 percent of the company, it must launch an offer for the rest of the shares that values YPF using the highest price-earnings ratio attained in the previous two years, multiplied by earnings in the last 12 months. YPF then would be worth $46.55 a share, more than double the current quote of $19.50.

But it’s pretty unlikely Repsol will get as much. The price at which it is compensated will be decided by a government tribunal in Argentina. If Buenos Aires ends up paying the current (depressed) market price, the hit to Repsol would be 3.1 billion euros relative to values at Jan. 27 before talk of expropriation began. Subtract this from Repsol’s market value before Argentina began its saber rattling in January, and Repsol should be worth around 19 euros a share.

But that’s not all. Repsol sold a 25 percent stake in YPF in two blocks to the Petersen Group, an Argentine vehicle owned by the Eskenazi family. As part of the sale, it loaned the group 1.54 billion euros, backed by YPF shares. The rest was loaned by a syndicate of banks that have priority over Repsol’s vendor loan. The Petersen Group relies on dividends from YPF to service the loans, and a default cannot be ruled out. Assuming this happens, and Repsol receives shares which it can then sell at market prices, the hit to Repsol would be another 813 million euros.

Temasek tinkering could put StanChart in play

By John Foley

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

Could Temasek’s tinkering put Standard Chartered in play? The Singaporean fund’s recent reshuffle of its bank assets has revived talk about its 18 percent stake in the UK-based emerging markets lender. Now might be a good time to find a new owner.

Rival banks have long eyed StanChart. It spans Asia and Africa, but lacks exposure to slow-growing European markets or U.S. subprime mortgages. It’s conservatively run, too: loans were equivalent to just 76 percent of deposits in 2011. Moreover, there are signs Temasek is open to offers. It issued a bond exchangeable into StanChart shares last year. And an old idea of guiding StanChart into a merger with Singapore’s DBS seems to have fizzled; DBS is now chasing other deals, with Temasek’s blessing.

Potential buyers are many. U.S. banks like JPMorgan or Wells Fargo should be attracted to StanChart’s exposure to emerging market trade. Australia’s ANZ and Japan’s Mitsubishi UFJ are aggressively targeting new markets. Even a Latin American aspirant like Brazil’s Banco Itau may take a look.

Leaving aside the potential clash of cultures, not many could pull it off. StanChart’s attractive portfolio – and some bid speculation – mean its shares trade on a higher multiple of book value than most prospective suitors.

Second, local regulators may be chary of allowing already-big banks to expand further. And while StanChart isn’t yet labelled as a globally significant bank, or “G-Sifi”, as part of a bigger lender it probably would be, which would see its return on equity crimped by an additional capital buffer.

Int’l Power does well to get better buyout from GDF

By Quentin Webb

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

International Power’s independent directors have done a decent job in securing a better buyout from GDF Suez. It’s not that easy to extract a big premium when a bidder is already a 70 percent shareholder. But the terms of the original tie-up helped, as did GDF’s evident keenness to take full control of the emerging-markets focused power generator.

Last year’s complex shares-and-assets tie-up secured GDF effective control but left unfinished business. GDF can now afford to take full ownership without hurting its balance sheet too much, while Europe’s crisis must have erased any doubts about re-focusing on fast-growing countries where power demand is surging. That divergence probably also helps explain an outperformance in International Power’s shares; GDF probably wanted to move before that gulf widened further.

Still, any bid before August required the approval of International Power’s independent directors. They sensibly rejected GDF’s 390 pence opening gambit as too low. True, GDF is not usually a hostile bidder, but that standstill agreement gave the target board a bit more power, as did some other terms such as a higher threshold for any delisting.

At 418 pence a share, the new and agreed 6.8 billion pound ($10.8 billion) offer is 7 percent higher. Investors will also keep a dividend, which wasn’t previously specified. Factor in recent bid speculation, and the premium moves closer to that in a standard takeover – even though GDF was already in the driving seat. GDF reckons the rumour mill really got going in late February and estimates a 21 percent premium to the undisturbed price. But the first reports appeared a month earlier: go back that far, and it looks like 26 percent.

In earnings terms, too, the buyout looks robust. Analysts polled by Starmine expect International Power to earn about 0.31 euro cents a share this year, valuing the buyout at about 16.4 times earnings – roughly 50 percent above its median 10.9 times over the past decade. It also beats the 11.8 times current-year earnings on which Europe’s utilities trade – although the sector is full of duller outfits. Factor in wobbly markets, and International Power shareholders look to have been served well.

Ducati could rip it up with VW

By Quentin Webb

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

Skoda cars and MAN trucks, meet your potential Volkswagen stablemates: 186-mph superbikes. No-one walks into a showroom after a cheap family car and screeches out on a blood-red Italian motorcycle. But Audi’s ambitions to buy Ducati would make some sense for VW’s luxury marque. And even with an appropriately macho price tag, the deal could pay off if Audi turbo-charges Ducati sales in emerging markets.

Motorbike valuations are in a different league to the big automakers. A deal at 875 million euros, the high end of earlier reports, would value Ducati at more than 1.8 times 2011 sales and 9.3 times EBITDA. That’s below U.S. peer Harley-Davidson, which fetches 3.1 times sales. But it’s far above VW itself, which trades at just 0.3 trailing sales and 5.5 times EBITDA.

Nor are there big cost savings. Maybe some engine know-how can be shared, and Ducati should be able to buy raw materials and borrow money more cheaply, among other things. But Audi clearly can’t reap the huge savings that come from combining carmakers – where similar-size vehicles can be built using common platforms, engines and parts. Still, Audi might persuade some dealers to stock both two- and four-wheelers, as happens with arch-rival BMW.

The sale could yet fizzle out. Ducati’s main owner, Italy’s Investindustrial, now says talks with VW are no longer exclusive, which doesn’t sound promising. But any successful deal would be tiddling for Europe’s largest carmaker, whose operating profit hit 11.3 billion euros last year.

And perhaps Ducati’s celeb-endorsed bikes are best understood as a leather-clad version of all the other luxury brands that are storming the emerging world. In that case, VW’s experience, connections and marketing nous could be a big help. In China, for example, VW is among the biggest foreign players. Audi sold a record 90,000 cars there last quarter. Ducati’s Asian sales leapt 75 percent last year, but were still just 11 percent of the total.

3D printing deal enhances sector depth illusion

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

Making physical items from digital files is a hot technology – maybe too hot if the market reaction to the acquisition of privately held Objet by Stratasys is any guide. Despite few synergies and an odd poison pill, the buyer’s shares rose nearly 25 percent, mainly on potential revenue synergies. But the future isn’t quite here yet.

A 3D printer takes digital blueprints or scans and recreates them one very thin layer at a time. The process is already quickly encroaching in product areas like replacement teeth and prototypes for new goods. That explains why the top lines of both Minneapolis-based Stratasys and the Israeli Objet are growing faster than 25 percent. But it’s the idea of upending the field of manufacturing to create custom items one at a time without having to worry about shipping costs that makes such technology truly exciting.

Stratasys, and its chunky acquisition, make it the biggest and most attractive way for investors to play the sector. The $600 million price seems fair. Objet accounted for 43 percent of the combined company’s sales last year and a roughly similar amount of income, and will wind up with 45 percent of the combined equity. Moreover, management reckons it can slash up to $8 million in costs and up to $4 million in taxes annually. Those are worth about $75 million to shareholders today.

That doesn’t explain the nearly $180 million increase in the market value of Stratasys following the announcement. Investors seem to think uniting the knowledge of working with different materials and strengths in separate areas – for example, Objet in medical devices and Stratasys in manufacturing prototypes – will make the sum worth considerably more than the parts.

That perception could be distorted. There are many competitors in this fast-growing field, and new ones are springing up. Even Stratasys management didn’t seem to expect the reaction. The company enacted a temporary poison pill to ensure activist investors couldn’t blow up the deal, even though Stratasys was already trading at a heady 30 times estimated 2012 earnings. The growth of 3D manufacturing is no illusion but the market appears to be enhancing the reality.

Qatar plays merger-maker at Glencore-Xstrata

By Una Galani

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

Qatar is playing merger-maker for Glencore-Xstrata. The Gulf state’s sovereign wealth fund has already proved it can act as a successful arbitrageur in M&A situations. It hasn’t revealed its intentions for the 5.5 percent stake in Xstrata built in the two months since Glencore agreed to merge with the Anglo-Swiss miner in a $90 billion deal. But the bold $2.7 billion investment could be another win.

The fund’s track record in special situations has improved. Interventions in UK retailer Sainsbury and London Stock Exchange in 2007 both backfired. But when Qatar bought 10 percent of European Goldfields last year and offered the cash-strapped miner cheap financing in return for warrants over more of the company, its interest teased out a premium bid for the entire company – and a quick buck for Qatar. The emirate is also in the money on the Volkswagen shares purchased when the car group was trying to marry with Porsche in 2009.

Qatar is doubtless betting that Glencore will raise its offer for Xstrata. Institutions that hold at least 8 percent of Xstrata shares are holding out for more, and Qatar’s stake potentially gives these naysayers more leverage over Glencore to bump up the terms. The deal can be blocked by just 16 percent of Xstrata shareholders because Glencore can’t vote its own 34 stake when the deal is put to a scheme of arrangement. Qatari opposition would almost certainly kill the deal.

In reality, the situation is more probably nuanced. Qatar wouldn’t want to get a reputation for being difficult by voting down a deal. Equally, Glencore would doubtless be keen to get it on board as a supportive long-term investor.

Qatar may have paid an average price of 1,144 pence per share for its stake, based on the average price of Xstrata shares in the last two months. Xstrata shares currently trade at 1,098 pence. But if Glencore ups its proposed share exchange ratio only to 2.9 from the current 2.8, Qatar could be more than made whole at current share prices.

Lloyds forced disposals inch towards quasi-auction

By George Hay

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

Lloyds Banking Group’s enforced branch sale is no longer a one-horse race. Back in December, the UK bank entered into exclusive talks with the Co-operative Group to sell 632 branches it was ordered to offload by the European Commission before 2014. A new offer from start-up rival NBNK probably doesn’t kickstart a hot bidding war. But it’s still good for Lloyds.

NBNK’s reappearance is well-timed. In December, the thinking was that the Co-op deal would be tied up by the end of March. But Co-op, whose bank has about 3 percent of the UK current account market, has taken longer than expected to pass through regulatory and financial hoops in order to pull off its proposed 1.5-2 billion pound deal.

In the meantime, a transaction has got easier for NBNK to swallow. Lloyds had planned to jettison 30 billion pounds of deposits but some 70 billion pounds of loans in any deal. Now it will transfer 20-30 billion pounds of each, enabling bidders to avoid a huge funding gap, and requiring only 1.5-2 billion pounds of capital instead of more than 3 billion pounds. NBNK’s latest proposal also offers Lloyds’ investors something different: by allowing them to take shares in the new entity rather than cash, bulls can participate in any upside.

As auctions go, it’s fairly lukewarm. NBNK needs to do a deal to preserve its existence. But the Co-op’s focus on its members makes it unlikely to start a bidding war. And as long as it can overcome its regulatory difficulties, Co-op’s existing retail banking presence still leaves it firmly in the driving seat – the government, itself a Lloyds shareholder, would much prefer the combined entity to have over 6 percent of the market.

NBNK has two trump cards. One is that it could use its extra headroom and capacity for synergies to spend 1.5 billion pounds buying the UK assets of National Australia Bank which, in tandem with the Lloyds assets, create an entity with the required market share. The other is that if Co-op can’t deliver then it will be the only bidder left standing.

Oaktree IPO gets marked to Howard Marks

 By Jeffrey Goldfarb

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

Oaktree Capital’s initial public offering was marked to Howard Marks. In the run-up to Wednesday night’s share sale, the outspoken co-founder of the debt-focused private equity firm made clear that accumulating assets would never be his top priority. Public investors, who have been conditioned to prize management fees from investment firms like Oaktree that have gone public, took the message to heart.

Underwriters, led by Goldman Sachs and Morgan Stanley, could only unload about four out of five Oaktree shares on offer. They sold at the bottom end of the firm’s price range. And then the market whacked them another 5 percent when trading started. That may reflect the Los Angeles-based firm’s guiding philosophy that clients, not shareholders, come first.

This was clearly spelled out in the deal’s prospectus as Oaktree’s first risk factor, among some 40 pages of them. Marks and co-founder Bruce Karsh stated unequivocally that Oaktree might not always think bigger is better. In 2001-02, they returned $5 billion to investors in their distressed debt funds. The warning wasn’t merely historical or boilerplate. Oaktree’s assets under management declined 9 percent last year, to $75 billion.

The problem with the firm’s promise to prioritize performance over scale is that it hasn’t delivered on that front lately. Though Oaktree is generally considered one of the best in the business, distributable earnings fell 23 percent last year. And returns in four of its last five distressed debt funds started before 2011 have underperformed its own long-term aggregate of 22.9 percent.

That still may have been less of a concern than Oaktree’s lack of size ambition. After Blackstone floated at the top of the cycle in mid-2007, its publicly traded units tanked during the financial crisis. That led to a revised private equity valuation pitch favoring the industry’s captive and steady fees over lumpier investment profits, or the so-called “carried interest.”

Coty will need to up its Avon game

By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.Coty is going to need a bigger ring. Avon Products has rejected its $10 billion marriage approach, and the company this week hired a formidable new chief executive, Sheri McCoy. That rams home the point that Avon would rather go it alone than sell itself short. A new Breakingviews calculator shows just how much bigger Coty’s proffered engagement ring could be.

Coty, the maker of fragrances like Baby Phat, indicated it was willing to pay $23.25 a share, a 20 percent premium over Avon’s beaten-down stock price the Friday before the offer was made public. Avon’s shares have traded much higher even in the past year. The emergence of another possible suitor – privately-held U.S. investment firm Richmont Holdings, whose founder tried to take over Avon in the 1980s, is interested, according to Fortune – could mean even more pressure on Coty to raise its bid.

A lot depends on how big an equity check Coty can write for a deal that would look a bit like a leveraged buyout. Suppose it can scrape together $5 billion between its wealthy owners, the Reimann family, and banker Byron Trott’s connections, who include Warren Buffett. Then assume Coty could borrow a fairly hefty 5.5 times Avon’s $1.4 billion of estimated 2012 EBITDA, increased by potential synergies at 5 percent of the smaller Coty’s $4.5 billion of annual revenue. That’s $8.7 billion of total debt. That would allow Coty to hike its offer to just over $27 a share, doubling the premium to 40 percent.

Even that might not be enough to turn the heads of Avon’s directors. The juicier premium would still fall short compared to other deals in the beauty sector, based on the deal’s enterprise value-to-EBITDA ratio.

If Coty got into a bidding war, more equity or an even more aggressive debt ratio could allow it to raise its price. But it might not find that to be worth it. Initially, the company was considering being acquired by Avon rather than the other way around – a move that would have reversed it into a U.S. stock exchange listing. Coty may yet find that its most promising wedding party includes public equity markets, not private ones.

Facebook’s defensive Instagram M&A raises red flag

By Robert Cyran The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Facebook’s defensive purchase of Instagram raises a red flag. Online photos are supposed to be a core Facebook competence. Paying $1 billion for the popular picture-sharing app may boost the social network in mobile. But paying over the odds for revenue-free rivals is usually the hallmark of anxious, mature firms – not a growth company seeking to go public at a $100 billion valuation.

It’s impossible to say exactly what Facebook gets for the oodles of cash and stock it is handing over to Instagram, founded just two years ago by Kevin Systrom and Mike Krieger. Traditional metrics don’t apply – Instagram is just embarking on an actual business plan, and the firm was worth just $20 million a year ago. What it does have are lots of users – more than 30 million – and super-fast growth. More than 1 million more users signed up in 12 hours for its new Android app last week.

Facebook is clearly acquiring the firm for other reasons. People are spending an increasing amount of time connecting via their mobile phones. This shift is worrying for the formerly desktop-focused Facebook, whose own prospectus warns of the risks to its business of an increasingly mobile Internet. Most smartphones use operating systems made by Apple and Google. If Facebook doesn’t run well on these phones, rival social networks such as Google + could get a leg up.

Buying two-year-old Instagram could help give Facebook the whip hand. It hopes to use the experience it is gaining to “build similar features in our other products.” Instagram has figured out the easiest way to date of putting pictures on the web, and how to capture the attention of mobile users. These are valuable skills and tools in Facebook’s fight against other social networks.

What’s worrying for potential Facebook investors is why Mark Zuckerberg and his merry hackers couldn’t produce their own version of Instagram. He says this is a one-off. “But providing the best photo-sharing experience is one reason why so many people love Facebook and we knew it would be worth bringing these two companies together.”

The precedent is worrisome, though, if it means every time a startup encroaches on one of Facebook’s presumed strengths it will need to take out its pocketbook to defend its turf. That’s hardly a robust justification for a lofty valuation.