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.

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.

Deloitte caught in Diamond Foods’ glare

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

Deloitte can’t seem to avoid the spotlight. Just a few months ago, it became the first of the Big Four accounting firms to be publicly shamed by their U.S. regulator for past failings. And now another client, Diamond Foods, has admitted to botching two years of financial reports. Deloitte could be headed back into the spotlight.

The world’s largest accounting and consulting firm has examined and signed off on Diamond’s numbers since the onetime walnut-grower collective went public in 2005. The snack food company said earlier this month that it logged a total of $80 million of payments incorrectly in the fiscal year ended July 31, 2011, and in the current year. When asked by Breakingviews last September to explain to which period one set of payments applied, a company official said it was “somewhat of a blur.” It’s not an answer that inspires much confidence in the company’s audited figures.

Diamond has tried to draw a line under the matter. The company’s own investigation blamed failures in internal controls for the mistakes, and Diamond replaced its chief executive and chief financial officer. But if past accounting scandals are any guide, more problems could surface that embarrass not just the company’s officials but also, potentially, its auditor.

Aside from the grower payments, there was a curious increase in the estimated cost of its now-dead deal to buy Pringles that was never fully explained. The firm’s capital expenditures may also need clarification. Between August 2010 and February 2011 Diamond announced plans to spend a total of nearly $60 million on three plant expansions. In two of the cases, the expected costs look high compared with the price tags for previous investments at the same plants and the third contained little detail. Diamond provided Breakingviews with additional information, and the company and its auditor may be able to further explain the figures.

Deloitte could have to, one day, especially considering its recent history. After the firm, which declined to comment, was given a year to improve its quality controls and failed, the Public Company Accounting Oversight Board went public last October with an inspection report that is typically kept private. The PCAOB also has been toughening up enforcement in general, including stinging Ernst & Young with a $2 million fine earlier this month, the board’s largest ever.

When Diamond said in December it expected to finish its internal accounting probe by February, one Wall Street analyst considered the news to be a sign the company’s auditor must be standing by its work. “Deloitte’s silence is golden,” he wrote. As it turns out, he might have done better to interpret the silence as deafening.

UPS love letter validates TNT’s earlier break-up

By Quentin Webb

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

UPS’s 4.9 billion euro ($6.4 billion) love letter validates TNT Express’s recent divorce. The U.S. parcel service has admired its smaller Dutch peer for years, and proposed just before Valentine’s Day. TNT is thinking about it. But clearly its 2011 split from PostNL, the dowdy domestic mail business, is finally achieving the desired effect.

While traditional postal services struggle with email and upstart competitors, the express industry – rapid international deliveries, courier services, and parcels – has fared better. But the sector still cries out for consolidation, because zipping packages worldwide is a scale game. Hence last year’s TNT-PostNL separation, under pressure from activist investors.The newly single TNT made a clear bid target: sizeable in Europe, but globally lagging UPS, FedEx, and Deutsche Post’s DHL, and struggling to make money in Brazil and China.

UPS’s 9 euros-a-share all-cash bid may look first class, pitched at an outsize 43 percent premium to TNT’s previous close. It values TNT at 10.4 times the 470 million euros in EBITDA that Nomura estimates it will make in 2012. UPS trades at 9.8 times current-year EBITDA and FedEx at just 6.1 times, Starmine data shows.

But TNT is right to drag its feet. The offer is still a 5 percent discount to the shares’ first close post the demerger. Investors weary with the weak performance of TNT shares since the separation will not be easily appeased.

Big synergies, based partly on combining ground and air fleets, could justify UPS going higher. Barclays Capital reckons it could reap $451 million in annual gains if it gets TNT’s margins up to its own. Taxed and capitalised, these are worth perhaps $3.4 billion – against the $1.9 billion premium currently on offer. But disposals to appease antitrust regulators may pare back the value creation to something less stratospheric: on BarCap’s figures, UPS already has 23 percent of Europe’s international express market, and TNT 16 percent.

Congratulations Google, you’re now a conglomerate

By Robert Cyran The author is a Reuters Breakingviews columnist. The opinions expressed are his own.Congratulations Google, you’re now a conglomerate. U.S. and EU antitrust authorities have cleared the search firm’s $12.5 billion purchase of Motorola. Its foray into manufacturing phones and tablets might open new markets – or simply amount to a vital means of defending its core advertising business. Whatever the case, on Wall Street, diversification like this usually merits a valuation discount.

Sure, the purchase of Motorola helps protect Google’s intellectual property. The cellphone maker’s several thousand patents shore up the walls protecting Google’s Android operating system from software and hardware rivals alike. But the company has made it clear from the start that its purchase wasn’t only about intellectual property – it was also about making gadgets.

This is partially defensive. If Motorola’s devices work well with Google’s own efforts in social networking, payment systems or games, it could blunt the threat of Facebook. Moreover, while Google’s attempts at creating phones of its own have been largely underwhelming, there’s potentially a big financial carrot if it can turn around loss-making Motorola. Apple has shown that hardware can generate 35 percent margins when partnered with the right software, design, marketing and content.

Yet Google’s hardware push smacks of diversification. Some on Wall Street are even starting to view the company as something of a conglomerate. The best way to figure out the worth of a company with multiple operations is to use a sum-of-the-parts analysis. To wit, in a recent research report, Barclays Capital figures Google’s search and hardware operations will be worth about 15 percent more than Google’s current $197 billion market value based on expected cash flows.

While Barclays uses the analysis to show why it thinks the shares are undervalued, it suggests investors are already attaching a “conglomerate discount” to Google. That’s typical, and very often justified, at companies like General Electric that embrace diversification. The worry is they poorly allocate capital among their diverse operations, are difficult to manage and are hard to understand. It’s also why breakups of companies from Kraft Foods to McGraw Hill and Fortune Brands have been welcomed by investors.

It will be a long time before anyone suggests Google needs to break up. But until the group run by Larry Page convincingly shows how combining Internet search and gadgets under one roof creates a better business, investors can be forgiven their skepticism.

Kellogg rescues P&G from over-cleverness

By Rob Cox The author is a Reuters Breakingviews columnist. The opinions expressed are his own. “Half the cleverness, none of the risk” makes an apt cereal-box slogan for Procter & Gamble’s sale of Pringles to Corn Flakes-to-Froot Loops giant Kellogg. By offloading the chips business for $2.7 billion in cash, P&G swaps a complex structure that, while it would have saved on payments to the tax man, put the consumer giant’s corporate finance competencies to a severe test.

And what may be P&G’s loss looks like Kellogg’s gain. While the cereals group is plunking down 15 percent more in cash than Diamond Foods had originally agreed to pay in new stock, the accompanying cost savings more than justify the premium. In a nutshell, this is a reasonable outcome, not least because P&G emerges with a valuable lesson the rest of Corporate America would be wise to observe.

The Kellogg deal makes it easy to see why P&G was tempted by a more complex transaction with Diamond last year. After paying taxes of as much as 48 percent of the value of the deal, P&G will bring in as little as $1.4 billion from the Pringles sale. Accepting a lower offer of $2.35 billion from Diamond would have avoided handing over a big slice of shareholders’ booty in the form of capital gains. Rather than the earnings per share gain of as much as 65 cents it predicted from the Diamond deal, P&G predicts it will reap a 50 cents-a-share gain from the Kellogg arrangement.

As in life, however, there’s no free lunch in the snack foods business either. The so-called “reverse Morris trust” structure required P&G shareholders to elect to receive Diamond stock. And as catalogued and brought to light by Breakingviews, Diamond’s finances turned out to be pretty nutty. The salty snacks purveyor last week came clean on about $80 million of bad accounting and replaced its chief executive and chief financial officer.

Despite having used this structure before, P&G clearly failed to adequately crunch the details on its Pringles partner. The scale of Diamond’s revelations suggests P&G, its accountants and advisers at Morgan Stanley and Blackstone missed, or simply chose to ignore, some warning signs. That should be a lesson to all companies contemplating serving up another firm’s equity to their own shareholders.

Alibaba and Yahoo could live unhappily ever after

By Wei Gu

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

Talks on Alibaba buying back Yahoo’s stake in the Chinese e-commerce giant seem to have faltered. Valuation, structure and financing appear to be the key roadblocks. With more strain added to the unhappy relationship, Yahoo and Alibaba need to rebuild trust before heading back to the negotiation table.

Founder Jack Ma wants to take back control of Alibaba. Relations with the U.S. group soured due to an earlier spat over its payment unit Alipay, and Yahoo’s attempt to appoint more directors at the Chinese company. Ma was trying to buy the bulk of Yahoo’s 43 percent stake in a complex transaction worth up to $9 billion.

Disagreement over valuation appears to be the main challenge. Yahoo is holding out for a better offer, saying Alibaba’s value has increased during the discussions, according to people close to the matter. But putting a price on a stake in a private company that has grown some 30-fold over seven years is certainly not easy, especially if trust has broken down between the partners.

The structure of the deal also looks a bit too smart. Under the details of the deal being talked about, Alibaba would inject up to $6 billion of cash and $3 billion of assets into a new subsidiary. The idea is to make the transaction tax-free for Yahoo. One snag is that Yahoo may be eyeing assets that Alibaba doesn’t yet own, such as some businesses in the United States. Another is that the Internal Revenue Service may deem it a sale anyway, which would be taxable, as opposed to a tax-free asset-shuffling.

A tough financing market adds more uncertainty. Alibaba was looking to borrow $4 billion from a group of six to seven banks, but had to cut the size of its debut loan to $3 billion, according to Reuters. The loan market is tight, as many European banks are cutting lending activity in Asia.

Why the league-table bonanza at Glencore-Xstrata?

By Quentin Webb

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

How many banks does it take to put together a friendly, all-share merger – and one that’s been on the cards for years anyway? If the companies are Glencore and Xstrata, the punchline is seven – plus a lone banker acting as go-between. And despite the abundance of expensive wisdom informing the negotiations, this mega mining deal clearly needs wider shareholder support.

To be fair to Glencore, the commodity trader is using only using two key banks – Citigroup and Morgan Stanley. That’s pretty much the minimum for multi-billion dollar transactions today. But Xstrata has five – Deutsche Bank, JPMorgan, Goldman Sachs, Nomura and Barclays Capital.

To be sure, any big deal is complicated. And you’d expect Xstrata to need more help: it is selling out to its biggest shareholder and must be seen to be crafting a fair deal. But it still seems a bit much. Barcap’s role as “equity adviser” stands out. There’s no significant financing required, whether in debt or equity, and the two companies are already semi-merged thanks to Glencore holding a 34 percent founding stake in its target. Moreover, Deutsche and JPMorgan are playing the additional role of UK corporate broker – a specialist service focused on relationships with core investors.

Still, ties between corporations and their advisers are long term. It’s not unheard-of for CEOs to appoint banks as a reward for past services or to keep them sweet for future mandates. Even if the actual involvement and cash fees are low, the engagement brings all important league-table credit and bragging rights.

Gamesmanship over rankings is unedifying, but does it matter much? After all, it’s hard to get too worked up about the sanctity of league tables. A huge line-up could hurt shareholders’ interests if independent research was silenced, or a counter-bidder couldn’t find funding and advice. But several big investment banks remain unconnected to the deal, so such worries look surmountable.