Breakingviews

Shell pays up for a foothold in Mozambique gas

By Kevin Allison

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

Shell is paying a full price to gain exposure to promising natural gas prospects off the Eastern coast of Africa. The oil group’s $1.6 billion offer for Cove Energy represents a 70 percent premium to the AIM-listed energy explorer’s undisturbed share price. Cove may be tiny, but its assets are attractive. With more than $11 billion of cash on hand, Shell can easily afford it. If Asian gas prices stay high or Cove’s exploration projects deliver, this small but highly priced deal may be worth the bother.

Cove’s main attraction is an 8.5 percent stake in an as yet undeveloped gas find off the coast of Mozambique. The field is thought to contain between 15 trillion and 30 trillion cubic feet of recoverable gas. Take the average of those two figures, and the purchase price equates to about $4.60 per barrel of oil equivalent, according to Bernstein Research – or $4.10/boe, excluding cash on the balance sheet. That’s roughly double the average of $2.30/boe that Shell has forked out for other gas explorers recently.

Overpaying is overpaying, regardless of how big or small the deal is. But Cove thinks the Mozambique assets alone could be worth up to $1.6 billion, based on optimistic assumptions about the field’s gas reserves and the size of the export capacity from the field. Crucially, it also assumes that Asian buyers keep paying dear prices for gas. The region may be short of liquefied natural gas (LNG) now, and oil-linked Asian contracts should keep a floor under prices. But that dynamic could change by the time the Mozambique supplies come onstream near the end of the decade – especially if U.S. companies win approval to build big LNG export hubs.

Still, Cove’s other exploratory tracts in Mozambique, Kenya and Tanzania could always come good. Part of Cove’s premium price can also probably be justified by lower costs – a big LNG export facility should be cheaper to build and operate in Mozambique than in Australia, where Shell is also investing heavily in gas. Shell can also arguably get more out of Cove’s assets than other putative buyers who lack its gas know-how, financial clout, and marketing savvy. It’ll take some luck, but the deal might just end up looking very clever.

UPS could be bidding against itself for TNT

By Christopher Swann and Quentin Webb The authors are Reuters Breakingviews columnists. The opinions expressed are their own. TNT shareholders are waiting for a much bigger buyout package. There’s good reason for the Dutch parcel service to expect UPS, its American suitor, to sweeten its bid of 4.9 billion euros, or $6.3 billion, given the huge synergies that would probably result from the union. But with rivals FedEx and DHL inhibited in varying ways, TNT investors may not get the bidding war they’d like.

UPS hasn’t unwrapped the expected cost savings from acquiring TNT. Stripping out expenses would be relatively easy, though, given UPS’ formidable presence in Europe. And the opening offer suggests it would retain a large slug of these benefits for itself.

But for now at least, UPS is bidding against itself – and it could stay that way. FedEx has a negligible 3 percent market share in European delivery, a third of what UPS claims, according to HSBC. That would make it harder for FedEx to extract synergies of a similar magnitude. As a result, Barclays estimates FedEx savings from a tie-up with TNT at just $240 million. Taxed and capitalized, this amounts to about $1.8 billion. UPS is already offering TNT a premium of $1.9 billion, meaning FedEx shareholders wouldn’t necessarily cheer a competing offer.

What’s more, FedEx has a weaker balance sheet. UPS may have been deliberately taking advantage of this fact with its all-cash offer. Matching the 9 euros a share bid in cash would take FedEx’s net debt to three times operating cash flow including leases, according to HSBC, against a multiple of just two times for UPS.

Deutsche Post DHL, meanwhile, faces a different kind of obstacle. Acquiring TNT would create a titan with a 33 percent market share in Europe – almost four times larger than nearest rival UPS. Though there could be divestiture workarounds, antitrust authorities would quickly descend on any such proposal.

A rival bid can’t be ruled out, of course. FedEx, for example, may calculate that the risk of being totally outgunned in Europe warrants paying over the odds. Still, TNT investors are expecting at least 9 percent more right now. As it stands, it’s not obvious their shipment will come in.

GM’s former finance arm better suited for IPO

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

GM’s ormer financing arm would be better off waiting for an opening to launch a much-delayed stock offering rather than selling itself. Sure, the business now known as Ally Financial would fit well with several banks – or even its previous owner. And the U.S. Treasury, which pumped $17 billion into Ally and owns about three-quarters of it, wants its money back. But the troubled mortgage division, ResCap, may give some pause. And Ally is too big to swallow easily.

The company’s $112 billion of global auto loans are enticing. For example, TD Bank’s low loan-to-deposit ratio prompted it to buy Chrysler Financial in 2010. TD’s major Canadian rivals are similarly challenged as are U.S.-based Regions Financial, PNC, BB&T and Wells Fargo.

But large-scale finance deals are scarce. Capital One’s $9 billion acquisition of ING Direct is the biggest unassisted deal since before the crisis. And the Federal Reserve signaled last week it would put any deal over $2 billion in assets under the microscope. The extra time required to seal the deal – and the prospect it could be nixed – may be deterrent enough.

Ally would be almost three times the size of the ING deal. It’s probably worth $25 billion, assuming it were to sell for 1.3 times its $19.3 billion book value – midway between TD’s near-book value purchase of Chrysler Financial and the 1.6 multiple GM paid in 2010 for AmeriCredit.

Buying just Ally’s assets might circumvent the Fed. But paying a slight premium for net assets of the North American outfit would require $68 billion, according to KBW. A bank could dip into its cash and securities to raise the money, but with liquidity rules still unclear, the prospect is less likely. If one did, Ally’s remnants would essentially be in wind-down mode, with much of the sale proceeds used to pay creditors.

AT&T board lets CEO off hook for bad call

By Jeffrey Goldfarb The author is a Reuters Breakingviews columnist. The opinions expressed are his own. AT&T’s board has let its chief executive off the hook for his bad call. Randall Stephenson’s total compensation fell to $22 million last year from just over $27 million in 2010. That’s a light slap for the badly botched bid to buy T-Mobile USA from Deutsche Telekom. AT&T had to take a $4 billion charge for the break fee related to the deal’s collapse. Though complicit directors factored the monetary costs into their decision, they didn’t hold Stephenson properly accountable for failure.

The T-Mobile takeover plan scrapped by regulators unquestionably took its toll. In 2010, AT&T’s free cash flow was atop its target range and earnings per share surpassed it. Last year, free cash flow settled back into the middle of its range while EPS barely scraped the bottom. Even had the T-Mobile costs been excluded, earnings would have fallen short of target. And while on a longer, three-year horizon, AT&T’s total shareholder return of 9 percent outperformed the broader market, it was near the bottom of its own self-described peer group. That all suggests T-Mobile proved a bigger distraction for AT&T management than even the hefty immediate costs imply.

AT&T tried to blame Washington for the torpedoed deal – and it may even have a point where tight spectrum rules are concerned. But shareholders shouldn’t get too distracted by that excuse. Stephenson and the company’s directors led AT&T into antitrust battle without sufficient ammunition. With say-on-pay on the ballot at this year’s annual shareholder meeting, investors can show their displeasure about the repercussions for that decision – and should.

Alibaba $2.5 bln buyout looks opportunistic

By Wei Gu

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

Jack Ma may have failed to buy back a stake in his e-commerce group Alibaba from U.S. partner Yahoo, but he has at least found a fallback plan. Ma has offered $2.5 billion to take his Hong Kong-listed unit, Alibaba.com private. The premium, 46 pct to the company’s last price before the deal was announced, is decent, and minority investors have no better options. But it still looks opportunistic.

Alibaba.com shares closed just two percent below the offer price of HK$13.50 a share after the announcement, suggesting investors aren’t spoiling for a fight. No-one else can bid given Alibaba.com’s 27 percent free float, and the company said it won’t offer a better price for at least a year. Sluggish fourth-quarter revenue doesn’t bode well for a quick turnaround. And there is not a big enough shareholder to block the deal single-handedly.

Minority shareholders aren’t toothless. They can veto the buyout with 2.7 percent of the total outstanding votes, or 10 percent of the public shareholders. They have some reason to seek a better price, since the shares are 80 percent below their 2007 highs. Hong Kong tycoon Richard Li’s failed battle to take his telecoms group, PCCW, private in 2009 shows that buyouts by management and founders aren’t always a sure-fire success.

Ma’s offer looks like a bet that Alibaba.com’s business woes are temporary. He may be right. The division is to some extent suffering from a setback in global demand and tight credit conditions at home. China still has huge potential for business-to-business e-commerce, which is in its relative infancy, and Alibaba is a giant in the market.

The risk is that Ma will dent his track record with the capital market. He is offering no more than the initial public offer price in 2007. That matters because Taobao, the real crown jewel of the parent Alibaba group, has long been mooted as a big future IPO. Many investors hoped Ma would inject it into Alibaba.com one day. They may now be reluctant to pay up next time he comes calling.

Apple needs more than a good lawyer in China

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

Apple has no problem getting Chinese consumers to desire its products, as a near-riot outside its Beijing store showed in January. But the U.S. tech giant has been beset by problems. As well as a rolling trademark battle, which has resulted in iPads being taken off the shelves in some cities, Apple’s market share is slipping, and the factory conditions at some of its Chinese partners are being questioned. It needs a new strategy.

Despite strong demand, Apple has so far held the Middle Kingdom at arm’s length. One in eight dollars of Apple’s revenue came from China in its fiscal 2011, yet only five of its 300 stores globally are there. That leaves room for rivals to grow. Apple’s smartphone market share in China was 7.5 percent by the end of 2011, down from 10.4 percent in the third quarter.

Step one should be to distribute more cleverly. The six-month delay in making the iPhone 4S available to its Chinese customers after the U.S. release looks too long. Yet instead of adding channels, Apple is pulling its tablets from unauthorised merchants including Amazon.com’s Chinese site. It halted iPhone 4S sales after overwhelming demand.

Striking a deal with China Mobile, the country’s biggest mobile carrier, would help. It currently relies on China Unicom, which reaches just 10 percent of mobile users. If the iPhone could reach a third of China Mobile’s existing 120 million high-paying customers, it could boost projected earnings per share by up to a quarter in 2013, according to Morgan Stanley.

Tighter control of suppliers is another must. Not owning any factories in its most important manufacturing base has left it vulnerable to criticism over working conditions – particularly at its biggest supplier, Foxconn. The Fair Labor Association said it has uncovered “tons of issues” at the manufacturer’s plants.

Apple could do worse than buy a stake in Foxconn, dipping into its $98 billion cash pile. It has enough funds to buy Foxconn’s parent, Hon Hai Precision, three times over. For Apple, which doesn’t normally own its suppliers, it would be a departure. But doing so would ensure it has a bigger say over its supply chain. Without some new thinking, Apple is unlikely to realise China’s vast potential.

Why 100 pct FDI could save India’s Kingfisher

By Jeff Glekin

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

The Kingfisher saga has dragged on for too long. Mounting debts and deteriorating service levels are bringing the Indian airline, majority owned by Vijay Mallya, the flamboyant liquor baron, to the brink. New investors are in short supply. A proposal to allow foreigners to buy up to 49 percent of the company does not go far enough. If the government is serious about saving the airline, why not go the whole hog and allow 100 percent?

Kingfisher, which until this year was India’s second largest airline, hasn’t turned a profit since it was founded in 2005. In the quarter ending December 2011 revenue also started to fall. That’s no surprise; the firm is so strapped for cash it has had to cancel flights. Net debt stands at $1.3 billion. Staff are not being paid and tax bills remain outstanding – adding a further $477 million to what it owes, according to Kotak Institutional Equities. Shares in Kingfisher have dropped almost 60 percent since the beginning of last year, shrinking its market value to around $270 million.

Banks, which took a 29 percent stake in an earlier debt-for-equity swap, are unwilling to restructure loans further until fresh equity is found. But there is no sign of the guardian angel Mallya has long promised. In any case, investing small sums of equity will only keep the business ticking over until it runs out of cash again. Only a complete overhaul which reduces its interest expense, clears all outstanding payments and cuts operating costs will give it a chance of survival. That could take well over $1 billion – although the banks might be prepared to cut the money owed them if there was a serious equity injection.

An investor of this scale would become by far the largest shareholder, diluting Vijay Mallya’s holding to a minority stake. That might not be a bad thing. He has run the business himself without a full time chief executive until last year. He takes a large share of responsibility for the company’s state.

The airline’s last hope may be to attract a foreign airline, say from the Middle East, with deep pockets. But If foreign firms are to save Kingfisher, they are sure to drive a hard bargain both with Mallya and with the Government. 100 percent ownership is a good place to start the negotiations.

Citi, BofA prove too big to punish harshly

By Agnes T. Crane

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

Sticking it to Uncle Sam should attract harsh punishment. But the fines Citigroup and Bank of America will pay – $158 million and $1 billion respectively – to settle claims they defrauded the U.S. government look easily handled. Citi has even admitted fraud in its dealings over home loan insurance. A ban from participating in the government’s mortgage insurance programs would be a better deterrent. But unfortunately, Washington needs big banks too much.

BofA’s alleged misdeeds are still murky since its settlement was conveniently wrapped up in the broader $25 billion deal between federal and state enforcers and big mortgage servicing banks over so-called robo-signing transgressions. But the complaint against Citi offers a brutal account of the drive for profit squashing quality control. The Federal Housing Administration ended up insuring shoddy Citi mortgages that, in some cases, were in default within six months.

Federal insurance programs rely to a large extent on banks’ good faith in delivering mortgages that genuinely meet the required standards. Citi’s admission that it failed to do this came only after someone blew the whistle last year. It was a breach of the government’s trust and it has cost taxpayers money.

The penalties for ripping off the government usually go beyond dollars and cents. Yet Citi’s fine, in particular, is hardly crippling. And BofA has already set aside enough money to cover a good chunk of its settlement. A temporary ban on doing business with the FHA, on the other hand, would deliver more punch and show others in the industry that Washington won’t tolerate abuses of its largess.

Yet that’s unlikely to happen. The FHA, once a niche player focused on low-income housing, now backs about a third of new mortgages including super-sized ones for wealthy home buyers. The market for FHA-qualified mortgages runs $25 billion a month. While Citi has only a 2 percent share, BofA is the largest player with more than 26 percent, according to FTN Financial, using mortgage servicing as a proxy for origination activity. Booting offending banks out of the government’s program could make mortgages even harder to come by.

French banks face tough 2012 after rocky 2011

By George Hay

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

Last year wasn’t much fun for France’s two largest banks. After a relatively benign first half, the euro zone crisis hit BNP Paribas and Société Générale with a vengeance: their shares finished the year down 38 and 58 percent respectively, while the cost of insuring their debt tripled. For good measure, the European Banking Authority forced them to raise capital.

Full-year results bear the scars. Both banks saw top-line income fall by around 3 percent as they embarked on deleveraging. Returns dipped below the cost of capital. BNP did a better job of protecting its bottom line – net income was down 23 percent compared to SocGen’s 39 percent – and it is still paying a dividend, contrary to its smaller rival. But both banks are feeling the pinch from shrinking investment bank revenues, asset disposals and provisions on Greek sovereign debt now reaching 75 percent.

Yet if everything else was set fair, both BNP and SocGen could roll with the punches. BNP has already done almost a third of its programme to cut risk-weighted assets by 75 billion euros, and its investment bank’s reliance on flighty dollar funding dropped by 57 billion euros in the second half. SocGen has reduced its dollar funding by almost the same amount. Both lenders have already hit their EBA capital targets, while the combination of three-year liquidity from the European Central Bank and an expanded collateral pool has removed fears a French bank could fall over.

This year may prove just as rocky as last year for the French banks – albeit for different reasons. France’s GDP will grow by a meagre 0.5 percent, according to the government forecast, while the threat of a Greek disorderly default doesn’t do much to boost confidence.

But the real concern is within France itself. The election of uber-favorite socialist candidate François Hollande to the country’s presidency in May could be a cause for worry. He is campaigning against the “faceless finance” he wants to “subjugate”, and advocates a UK-style split between retail and investment banking. As for incumbent Nicolas Sarkozy, he has started to unilaterally bring in a tax on financial transactions. So BNP and SocGen may have to stay in restructuring mode a bit longer than planned.

Would President Romney sell Uncle Sam’s GM stake?

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

Mitt Romney may be unsure which hat to wear when it comes to General Motors. In a Detroit News article this week, the Republican presidential candidate exhorted President Barack Obama’s administration to offload Uncle Sam’s holding in the automaker, which reported fourth-quarter earnings on Thursday. That may be Political Romney’s take, but selling now would leave taxpayers with a hefty loss. That’s a hit Private Equity Romney would surely avoid.

Romney is right that governments should try not to hold long-term positions in private companies. So if the U.S. government were to sell its 32 percent of the Detroit automaker immediately, that would superficially satisfy Romney’s belief in free-market capitalism.

But at Wednesday’s closing share price, doing so would leave taxpayers shouldering a $14 billion loss on their GM investment – almost a third of what Presidents George W. Bush and Barack Obama poured in to keep the company on the road. Not only would crystallizing that loss offend Romney with his private equity background. It’s also a sure bet that Romney the presidential candidate would have pounced on it as evidence of Obama’s fiscal irresponsibility.

Of course, it’s not quite the same as a private equity investment – price shouldn’t trump everything else. The U.S. government invested in GM, Chrysler and hundreds of banks to keep them afloat, not to make a profit. Even so, it isn’t hard for the government to explain why it’s OK that it still holds a significant stake 15 months after GM went public.

Executive pay aside, officials have not interfered with the automaker’s business; the fact that its investment has largely been a non-issue for months speaks to that. And the Treasury has proved adept at getting out of other bailout positions relatively quickly and at a profit – just the kind of responsible approach Romney advocates. That should give non-partisans comfort that the GM stake is receiving the same treatment.

There’s also a reasonable case that GM’s market value will rise over the next year or more as it continues working on its turnaround, especially in its loss-making European operations. If Romney finds himself in the Oval Office next year and he’s able to sell the GM stake at a profit, both his political and private equity personas will find it hard to resist taking the credit.