Breakingviews

Asian conglomerate owners owe Heineken a toast

By Wayne Arnold

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

Fraser and Neave’s shareholders may wind up raising a glass to Heineken. The Dutch brewer’s $6 billion bid for their Tiger beer venture, Asia Pacific Breweries, should catalyze the independent directors of the Singapore drinks and property group to consider a full-blown breakup. Even after F&N’s recent stock run-up, its pieces are worth some 20 pct more than the whole.

Thai beer mogul Charoen Sirivadhanabhakdi got the party started with his $3 billion purchase of Singapore bank OCBC’s stakes in F&N and APB. That gives Charoen a roughly 17 percent interest in APB, but little chance of wresting control from Heineken. By shaking up F&N’s ownership, though, Charoen kicked Heineken into launching its bid to buy F&N’s 40 percent of the venture. The punch bowl now passes to F&N’s board, which has turned to Goldman Sachs for advice. Judging by Goldman’s work for Kraft, McGraw-Hill and other firms that have recently broken themselves up, it’s easy to see where this is going.

The numbers make a compelling case for F&N splitting and selling non-core assets. Heineken’s bid values F&N’s share of the beer business at $4.1 billion. F&N’s stake in its Malaysia-listed food and drinks unit is worth another $1.2 billion. A handful of other interests in private food and beverages firms in the region are worth about $1.3 billion if valued on the same multiple of earnings as the public company. All told that’s around $6.7 billion for F&N’s consumer businesses.

On top of that, the group has substantial property holdings in Southeast Asia. At a roughly 15 percent discount to stated book value, these are worth another $6.1 billion. All told, that gives an enterprise value of some $13 billion. Subtract net debt of around $2 billion and the company’s total assets should be worth around $11 billion, or S$13.5 billion – equivalent to around S$9.50 a share.

That’s almost 20 percent higher than the current share price – and some 50 percent above where the stock traded before Charoen fizzed things up. And that’s before the company has even tried to negotiate a higher offer from Heineken. Presented with a chance to split the company into its components parts, shareholders would be crazy not to respond with a resounding “bottom’s up.”

China Inc not letting politics get in way of M&A

By Rob Cox

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

China Inc isn’t letting politics get in the way of M&A. The upcoming conclave of China’s Communist Party, a once-a-decade changing of the guard, was supposed to hold back the global ambitions of state enterprises, at least temporarily. But CNOOC’s $15.1 billion bid for Canada’s Nexen suggests that’s not happening.

The 18th party congress is expected to convene in the fall to select new leadership. Seven of the nine seats on the all-powerful standing committee of the politburo are up for grabs. The two continuing members, Xi Jinping and Li Keqiang, are widely presumed to replace Hu Jintao and Wen Jiabao as China’s president and premier, respectively. Xi is also likely to become general secretary of the Communist Party.   The next-most powerful body, the politburo, will see many of its two dozen members rotate. Ditto the central committee, which includes over 300 full and alternate members. All these changes will mean new people manning the red phones that connect party leaders to the heads of China’s most important ministries, regulatory agencies and state-owned enterprises.

Bankers and investors have, as a result, been bracing for a slowdown in Chinese deal-making. The logic is that an ambitious executive would be foolhardy to propose a risky transaction that might soon be frowned upon by new masters somewhere up the chain of the country’s inscrutable power structure.

CNOOC’s agreement to buy Calgary-based Nexen goes against that rationale. While smaller than the company’s eventually withdrawn bid for U.S. oil group Unocal a few years ago, it will be the largest ever full-blown foreign takeover by a Chinese company if it’s approved. Perhaps learning from the controversy over its Unocal effort, CNOOC is making big efforts to pitch the benefits of the deal to Canadian authorities, too.

In the run-up to a possibly tumultuous transition of power, such a big deal is a bold move. It brings China’s outbound announced M&A volume to $38 billion so far this year, 72 percent more than last year, according to Thomson Reuters. Though other sectors feature in much smaller deals, the bulk of that is in energy. China’s oil and gas champions are on the hunt for resources everywhere. Maybe, at least as seen from Beijing, even in a political season there’s no such thing as a bad energy deal.

Risk appetite set for brutally hot Spain vacation

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

Global markets are being shaken out of their laid-back summer. Risk appetite faces an unpleasantly hot and long vacation in Spain’s provinces. Stocks, commodities and the euro are likely to suffer. Yet again the dollar, yen and safe-haven bonds will win.

For the last two months, euro worries and stocks had decoupled. The sense was that the euro zone could be propped up and global growth stimulated. A rout of risky assets on July 23 leaves both assumptions evaporating.

The immediate catalyst for volatility is the suggestion that several of Spain’s provinces will follow Valencia and seek support from Madrid. A short-selling ban on Spanish stocks reeks of panic. Elsewhere in the euro periphery, reports that the International Monetary Fund is washing Greece off its hands are unsettling. But so long as Greece has a government that isn’t giving up on meeting austerity targets, Europe is unlikely to abandon it.

Spain and Italy are the more acute worries. The yield on Spain’s 10-year debt is at 7.4 percent, Italy’s at 6.34 percent, having overtaken Ireland’s last week. Regionally and nationally Spain’s economy remains in fiscal distress. Spanish debt is rising far too fast, by 68 billion euros – more than 7 percentage points of Spain’s falling GDP – in just one year, to 72 percent of GDP. After the recently agreed European support for banks, additional external assistance for Spain seems certain to be necessary, even if the next crunch refinancing is a couple of hot months off.

Until there’s clarity about how Spain is to be supported, markets will play out well rehearsed defensive moves. The euro is likely to continue its not unwelcome slide, breaking below $1.20. Stocks and commodities, which have risen to two-month highs despite global growth fears, look set to be stewed. A retreat below the sub-1300 early June S&P 500 low would seem a minimum.

The dollar, yen and safe-haven bonds again look like the beneficiaries. The U.S. 10-year Treasury now yields just 1.4 percent, its lowest since the 1800s. That makes it less likely the U.S. Federal Reserve will print money again to drive Treasury and mortgage yields down: euro fear is doing the job. And in the absence of that, the correction in risk assets may be steeper.

U.S. housing poised to boost economy

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

The U.S. housing sector is poised to boost economic growth. While existing home sales fell 5.4 percent in June from May, other indicators suggest a recovery is under way. A flip to a positive impact after dragging on GDP for five years will give lawmakers a chance to change distorting housing market policies.

Despite the short-term decline, existing home sales last month ran 4.5 percent faster than in June last year. More encouraging, the median sale price increased 7.9 percent year-on-year. Home buyers and their lenders should gradually regain confidence that their investments will be sound.

Home construction activity seems to be running ahead of the housing market itself, as permits and starts in June were both up around 20 percent on the previous year. However the National Association of Homebuilders’ confidence index, while sharply higher in June than May, is still well below housing boom levels, so optimism is still appropriately contained.

The housing slump sliced more than one percentage point off real GDP growth in 2007 and 2008. But the sector’s impact turned positive in the last quarter of 2011 and residential investment added 0.42 percentage point to annualized growth in the first quarter this year. If the year-on-year growth in housing starts is a reasonable proxy for the increase in residential investment since the second quarter last year, then a rough calculation suggests housing could contribute as much as 1.5 percentage points to annualized second-quarter GDP growth. That could mean the economy expanded more than many economists expect. Continuing housing growth should also make a sizeable dent in unemployment.

President Barack Obama’s re-election campaign may draw comfort from this trend. But the policy implications should also be clear. Housing policy – not just bad bank lending – helped inflate the bubble which, upon bursting, triggered the recent financial crisis.

A variety of recent initiatives to support the market will need to be wound down. Government guarantees for home loans through finance giants Fannie Mae and Freddie Mac and other channels need a comprehensive rethink. So does the tax subsidy on mortgage interest. Major changes need perhaps a decade to be phased in. With a recovery taking hold, early 2013 looks like the right time to start putting plans in place.

Chinese MBO boomlet may take necessary breather

By Wei Gu

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

Chinese management buyouts may fizzle on Wall Street. A regulatory probe, short-seller allegations, and a profit warning sliced 60 percent off New Oriental Education in the past two days. Though depressed stocks may make it cheaper for U.S.-listed Chinese companies to take themselves private, a spike in financial – and perhaps legal – costs may halt the buyout trend.

True, falling share prices may make founders keener than ever to go private. Not only is the takeover price lower, it’s getting pricier to maintain their U.S. listings. Law firms have launched class-action lawsuits against Chinese companies. Legal and compliance costs are surging after a spate of scandals. Litigation insurance premiums have gone up about four times in the past two years, according to one banker.

The slowdown had already started. ShangPharma’s $176 million management buyout on July 6, backed by U.S. private equity group TPG, was the only new deal announced since late May. In the first five months of the year 11 deals had been announced, according to Roth Capital Partners. The success rate hasn’t been very high. Since April 2010, only 14 of the 34 go-private deals announced by U.S.-listed Chinese companies ever closed. 

Financing appears to be the biggest hurdle. Banks are now demanding high interest rates, up to 20 percent a year, for bridge loans, according to a person involved in those deals, to compensate for the heightened legal risks. The underlying businesses have also deteriorated. New Oriental’s revelation of a Securities and Exchange Commission probe came along with a profit warning.

Moreover, new accounting woes and a general global market retreat have dimmed hope for listing arbitrages. Private equity funds assisting founders with MBOs planned to delist undervalued companies from one market, say New York or Singapore, and relist them in Hong Kong or mainland China at better prices. That’s becoming harder to pull off. Hong Kong IPO volumes tanked nearly 90 percent in the first half compared to 2011, according to Thomson Reuters. 

U.S. student debt on scary trajectory

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

U.S. student debt is on a scary trajectory. New statistics from the New York Federal Reserve show just how steep it is. Education loans are piling up at an unsustainable rate and delinquencies are rising despite the slowly improving American economy. Instead of trying to tackle the problem, Washington’s policies continue to exacerbate it.

Student loans in the United States have surged to $900 billion from $360 billion in just seven years. Even as the U.S. housing bubble inflated between 1999 and the start of 2006, mortgage balances didn’t grow that fast. The bursting of that bubble triggered the worst recession since the Great Depression. Sure, the numbers were considerably larger. But there’s enough student debt to cause trouble – more than auto loans or credit card debt, for example.

And people are struggling to make their payments. The Fed’s numbers show that a startling 12 percent of borrowers aged 40 to 49 are at least 90 days behind. That’s a demographic that should be in the prime of their careers and free of such stress. The unemployment rate for that group is probably under 7 percent, according to Bureau of Labor Statistics data, significantly below the national average of 8.2 percent. Moreover, though joblessness has declined from its late 2009 peak of 10 percent, most age groups are experiencing higher rates of student loan delinquencies.

The implication is that even as the U.S. economy slowly improves, many Americans will continue to struggle under the weight of borrowing that was supposed to bring them qualifications and well-paid jobs. Most of the loans are backed by taxpayers, raising the prospect of huge writeoffs for the government down the road. But instead of working out how to curb the growth of the loans, policymakers continue to subsidize student borrowing. Just this month, President Barack Obama signed legislation to keep the cost of education loans at a below-market 3.4 percent.

Making further borrowing ultra-cheap is the wrong medicine. At the recent growth rate, Americans’ student debt will exceed their credit card and auto loan balances combined within five years. With incomes growing only slowly, something will have to give.

China investors get wise to a new four-letter word

By Wei Gu

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

China investors have a new four-letter word to decry. Really it’s an acronym: VIEs, for “variable interest entities.” These are the structures used by nearly half of all Chinese firms listed on the Nasdaq to get around restrictions at home. A new Securities and Exchange Commission probe of New Oriental Education may sound their death knell. In the end, that’s probably best for investors – and for China. 

These loopholes were designed to let Chinese companies active in certain sectors – such as the Internet and education – list abroad without running afoul of rules against foreign ownership. Under this arrangement, the listed entity effectively draws up a contractual agreement with the Chinese company through some complex arrangements that mimic, but do not constitute, a direct equity stake. These structures have created all sorts of grey governance areas and famously figured in a recent spat between Yahoo and Alibaba.

New Oriental Education appears to have triggered the SEC probe by taking the VIE structure to another level of control by its founder. The company said on July 11 it had changed the shareholding structure by consolidating all the equity interests in New Oriental China, its VIE, under founder Michael Yu. While the company argued this strengthened its corporate structure, it also clearly gave Yu more power. Investors responded by marking the stock down some 3 percent.

But the bigger hit came Tuesday when the company, alongside a profit warning, revealed an SEC investigation into the matter. Investors freaked out and sliced 30 percent off the stock. Scrutiny by the U.S. regulator into VIEs is long overdue. About 97 of the 230 Chinese companies traded in New York use this structure, according to Macquarie, despite the risk that they offer American investors little protection from, say, the founder of a company absconding with valuable assets. That happened when online gaming company Gigamedia tried to sack the owner of its Chinese license.

True, closing the VIE loophole might make it harder for future Chinese companies to access overseas investors. But that may provoke two beneficial outcomes over the long run. First, it might convince Beijing to relax its rules on the kinds of companies foreign investors can own. Second, it could entice Chinese companies to simply work harder to list at home, which ought to help deepen China’s capital markets. In the meantime, though, it looks like more pain for investors in Chinese companies listed abroad.

U.S. senators show manipulation double standards

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

Not for the first time, there are double standards on display in the U.S. Senate. During Federal Reserve Chairman Ben Bernanke’s testimony on Tuesday, lawmakers loudly denounced bank skullduggery to fix Libor rates. Then came demands for Fed action to create U.S. jobs. The latter is at least clearly legal, but it’s still manipulation – and it has far more potential to damage markets for the long term.

Barclays traders’ false London Interbank Offered Rate quotes represented both profit-maximization by traders and institutional attempts to improve the market perception of Barclays by lowering one proxy for its cost of funds. The senators missed this distinction. It matters because the second rationale for dodgy Libor quotes, condoned by UK authorities by some accounts, is a step toward the policy intervention some senators are so keen on.

And it is consistent with the deliberate manipulation that central bankers in the United States, the UK and elsewhere have been undertaking since the crisis erupted, if not before. This has involved many tactics, from direct purchases of government and mortgage bonds by the Fed, to simply maintaining short-term interest rates near zero, far below the level of inflation, as Bernanke’s Fed has done. On Tuesday he seemed ready to try more such interventions if U.S. economic growth remains weak.

While Libor ostensibly governs aspects of $500 trillion or more of derivatives contracts, it has proved hard so far to identify major market consequences of the false quotes submitted – though they could emerge. Action by central banks like the Fed, by contrast, has artificially reduced borrowing rates for governments including the United States that owe trillions of dollars and pushed down the cost of U.S. mortgages, for example. At the same time it has made safe returns hard to come by for pension funds and other investors. It’s no coincidence that S&P Dow Jones Indices reckons companies in the S&P 500 Index face record underfunding of their pensions and other retirement benefits.

These consequences, extending over the whole economy for several years, surely far exceed the impact of a few spivvy Libor traders. The argument for Fed intervention carried weight for many in the heat of the crisis. But to help the economy return to a healthier, less distorted state, the senators would now do well to complain as vigorously about further official market rigging as they do about the unofficial variety.

Euro bank union should spur fatter capital buffers

By Hugo Dixon

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

The move towards euro zone bank union should spur fatter capital buffers. As the region inches towards creating a collective safety net for its lenders, it will focus on reducing the cost to taxpayers. After all, there are no votes in telling German citizens they need to bail out rotten banks in other countries.

The planned 100 billion euro bailout of Spain’s lenders is already concentrating minds. As part of that deal, Madrid will be required to “bail in” subordinated bondholders. The European Central Bank even suggested haircutting senior bondholders, although governments eventually decided not to go that far, according to a report in WSJ. That’s a welcome volte-face by the central bank. Only last year, it strenuously opposed inflicting losses on senior bondholders of Irish banks, fearing this would provoke contagion.

If a bank goes bust, there is always the risk of a domino effect. Even if it is rescued but its bondholders are haircut, other banks could be denied access to funding and also go bust. Hence, the temptation to bail out lenders without inflicting losses on bondholders. But such an approach will be politically untenable in a banking union.

One way forward is to copy the UK and require lenders to issue a minimum amount of bail-in debt, which could either be haircut or converted into equity if a bank got in trouble. It would constitute a second buffer on top of equity capital. One advantage of identifying debt in this way when it is issued is that bondholders would then have no reason to be surprised if they ended up with losses. The contagion would therefore be minimised.

The UK has decided that the two buffers combined – equity plus bail-in debt – should be 17-20 percent of banks’ risk-weighted assets. That’s roughly two or more times the minimum equity capital level agreed under the new global Basel III accord. The European Commission has so far hesitated following suit, merely noting that if banks held bail-in debt equivalent to 10 percent of risk-weighted assets taxpayer losses would be limited. As the euro zone embarks on the long road to banking union, it should turn that into a requirement.

Yahoo tackles existential problem with engineering

By Rob Cox

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

Yahoo is tackling an existential problem not with a philosopher king, but an engineer. The internet grab bag has hired Marissa Mayer, one of the few females to rise up through Silicon Valley’s geek hierarchy, to be its next chief executive. She’s certainly qualified – and no doubt itching – to become CEO of something. But Yahoo’s manifold problems won’t so easily be solved by rewriting computer code.

That’s not to take away from Mayer’s many accomplishments. As Google employee number 20, she knows Yahoo’s biggest nemesis better than just about anyone. While there, she was either intimately involved in, or responsible for, a variety of products, from the core search business and Gmail to its efforts to provide local content and Google Maps.

She has also been a Google evangelizer, speaking at conferences and bringing a touch of estrogenic glamour to a company founded by two roller-hockey-playing boy engineers from Stanford overseen by a chairman whose dating history has provided fodder for Silicon Valley gossip websites. Her years as the nerd queen in a complex full of men bodes well for her ability to retain and recruit the hacker set to Yahoo.

The riddle she must solve, though, is not easily deciphered from the Javascript on Yahoo’s home page. Is Yahoo a tech company or a media and marketing business? The last CEO, Scott Thompson, tried straddling both. He was a marketing guy in engineering drag: he even lost his job for embellishing his computer science credentials. Mayer has the engineering cred, but it’s not clear she has the marketing chops. Keeping acting CEO Ross Levinsohn to complement her skills would be wise.

At least Mayer should be better able to focus on solving the enigma of Yahoo’s raison d’etre. The thorny sale of a big chunk of China’s Alibaba is now on a trajectory to bring in some $7 billion. A similar arrangement awaits to be struck with Yahoo Japan. Combined, these two stakes appear to make up a majority of Yahoo’s $19 billion of market capitalization.