By Chris Hughes

LONDON, April 30 (Reuters Breakingviews) – Unilever (ULVR.L: Quote, Profile, Research) (UNc.AS: Quote, Profile, Research) is breaking some of the basic rules of corporate finance. Investors, being keen on financial logic, aren’t impressed.

The Anglo-Dutch consumer goods giant is offering to pay $5.4 billion for a 22 percent stake in Hindustan Unilever (HLL.NS: Quote, Profile, Research), lifting its holding in its Indian subsidiary to 75 percent. The first rule violation is to offer a premium for additional shares in a majority-owned business. But Unilever had no real choice, since Indian stock market rules mandate a minimum price in such situations.

The high price exacerbates the second violation – buying expensive shares in another company rather than buying back its own cheaper stock. Unilever trades on a forward price-earnings multiple of 20. Its bid for Hindustan Unilever values the stock at 34 times forecast earnings.

There’s more. Here is a multi-billion dollar transaction with no synergies. And the deal isn’t even a route to 100 percent ownership. Unilever wants to keep the subsidiary’s listing, to protect the profile that goes with being one of the top Indian blue chips.

Unilever’s market capitalisation is $127 billion. It could probably spend only about $4.7 billion to buy back and retire 110 million shares without hurting its credit rating. After taking the cost of debt into account, the financial engineering would boost per share earnings more than the Hindustan Unilever transaction.

For Unilever, the difference is small – added accretion of maybe a percentage point or so. But corporate managers have previously danced to the tune of share buyback vigilantes, who have no patience with any amount of financial inefficiency.

Common sense is less precise but more helpful. Unilever has no better way to buy structural growth in emerging markets. Sure, in theory Unilever shareholders could buy that growth themselves by using the proceeds of a buyback to purchase Hindustan. But they would not get the closer ties and goodwill created in this important market. Those synergies are probably worth the $1 billion premium. Let common sense prevail.

CONTEXT NEWS

- Unilever has launched an offer for shares in Hindustan Unilever, the consumer group’s listed Indian subsidiary, with a view to raising its stake from 52.48 percent to 75 percent.

- The offer is 600 rupees per share, a premium of approximately 29.5 percent over the mandatory floor price required under Indian regulations, 26 percent to average share price over the last month, Unilever said. If fully subscribed, it will cost 292 bln rupees.

- Hindustan Unilever distributes brands includes Lux, Lifebuoy, Pond’s, Vaseline, Lakmé, Dove, Sunsilk, Brooke Bond, and Knorr.

- For previous columns by the author, Reuters customers can click on <HUGHES/>

(Editing by Edward Hadas and David Evans)

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

The regulation of pay in Europe marks an unwelcome watershed in post-crisis financial reform. European Union lawmakers on Thursday finally approved rules to cap bank bonuses relative to base salaries. Regulating for competition or financial stability is one thing. Intervening in how people are paid is quite another.

Full details of the proposals are yet to emerge. Broadly, all EU banks and foreign banks operating in member countries will only be able to pay bonuses of more than 100 percent of base salary if they have 66 percent shareholder support. Even then, the maximum ratio will be 1:2.5, and only if banks choose to pay a portion of the bonus in deferred stock or contingent capital.

Among its flaws, this puts banks out of kilter with other sectors. Take miner Rio Tinto. It appointed a new finance director just as the EU’s bonus caps were being disclosed. This is a big job with a base salary of 800,000 pounds. But the annual and deferred bonuses together are worth 3.3 times base pay.

Europe hopes the move will bring down bankers’ pay. It may. But the reality is that the labour market’s response to existing bonus curbs has been to demand higher fixed salaries. Competitive pressure has made it hard for banks to resist this. Increasing the relative contribution of fixed pay undermines all the good incentives embedded in short- and long-term bonus structures that reward good performance and claw back payouts when misdemeanours emerge. That’s why this policy could hurt shareholders far more than employees.

Sadly, these arguments are now largely academic. But bank management and investors must now ask how this situation arose. The answer is that the industry failed to engage effectively. Banking has a genuine problem with excess pay and excess risk taking. But banks and bankers have been slow to acknowledge this and offer solutions. True, Deutsche Bank’s Anshu Jain made lower remuneration a key message in his strategic review. But that was only in September and the industry is still awash with provocative pay deals.

The banks should have admitted the need for change and come up with their own ways of channelling more of their profit to capital, shareholders and taxpayers. Ineffective self-regulation invariably leads to bad top-down regulation in the end.

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

By Chris Hughes

LONDON, Feb 19 (Reuters Breakingviews) – If Europe wants to
hard wire excess pay for bankers, it is going the right way
about it. Proposals to set a maximum ratio of bonuses to salary
are so manifestly counterproductive that it’s hard to believe
they have gained almost unstoppable momentum among European
Union members. Bad policy is what happens when weak management
in the financial industry collides with the politics of envy.

Investment bankers are overpaid. The rewards in banking are
still way beyond those available in other industries. This is
partly because investment banking is an oligopoly: a handful of
big global firms control the pathways of international finance.
It’s also because the business enjoys an indirect taxpayer
subsidy in the form of bailouts when things go wrong. And in
some parts of finance – notably advising on deals – clients will
pay top whack to have the very best person on their side.

But capping bonuses is not the answer. It would make matters
worse. Such a policy would cause further inflation in base
salaries – a phenomenon already under way following post-crisis
curbs on cash bonuses. And cutting handouts relative to base pay
means there would be less deferred compensation to be clawed
back in future if trades blow up or bad behaviour is discovered.

Fixing the problem of excess pay requires lowering banks’
excess returns. After paying their employees, banks’ main
expense is servicing equity capital, the cushion against losses
provided by shareholders. If banks hold more capital, the cost
of providing investors with a decent return would leave less to
distribute as bonuses. This process has already started, though
shareholders need to be more muscular. So-called living wills,
which should make it possible for banks to fail safely, will
help remove the taxpayer subsidy. Where competition is weak,
governments should legislate to increase it – or impose higher
taxes.

Britain is lobbying hard against the EU’s proposals.
Unfortunately, perceived self-interest in protecting the City of
London, twinned with the prevailing scepticism about the UK in
the rest of Europe, render it a weak advocate. Banks have also
singularly failed to make a credible counter proposal. The
result will be precisely the opposite of what was intended -
more cash for bankers.

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CONTEXT NEWS

– Bankers’ bonuses could be pegged at no more than their
annual salaries if European Union lawmakers and member states
reach agreement in key talks on Feb. 19.

– Reuters: EU seeks deal on fixed-salary cap for bankers’
bonuses [ID:nL6N0BI7A7]

RELATED COLUMN

Wrong again [ID:nL3E8FD7ME]
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(Editing by Peter Thal Larsen and David Evans)

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Liberty Global’s $23 billion offer for Virgin Media marks a turning point in post-crisis deal finance. This cable-TV mega-merger has most of the hallmarks of the pre-crisis boom. The target’s shareholders are being paid partly in their own cash, which will be extracted from Virgin Media through some ambitious financing operations. Leverage may not be pushed up to pre-crisis highs, but this is still a big moment.

By any standards, this is a punchy deal. Liberty has agreed to give the Nasdaq-listed company’s shareholders $6 billion in cash and a 36 percent stake in the combined group. The exit enterprise value is $23.3 billion. At 8.5 times Virgin Media’s projected EBITDA for 2013, that’s expensive, although not out of line with Liberty’s own valuation.

The declared $180 million of annual synergies don’t come close to covering the 24 percent premium to Virgin Media’s pre-deal market value. Taxed, capitalised and adjusting for one-offs these are worth only about $1.2 billion. Liberty’s investors will hope that further savings can be found from the additional buying power for both content and set-top boxes.

Liberty will refinance Virgin’s current debt and gear up with 5 billion pounds ($7.9 billion) of new debt. A little under half of this will be a high-yield bond, with the rest coming from new loan financing. It’s a massive slug of issuance for a non-investment grade firm and the overall the effect will be to take leverage from about 3 to 4 times EBITDA.

The new debt will fund about $3 billion, or roughly half, of the cash that will be paid to Virgin shareholders. Post-completion, Virgin will be held as a ring-fenced entity, with its own debt. Its leverage will increase, as it funnels dividends up to its parent, which will help finance the planned $3.5 billion of share buybacks for Liberty shareholders, including former Virgin investors.

The precise cost of all this debt hasn’t yet been determined. But Liberty must be hoping that it will be cheap enough that, in combination with the synergies, its return on investment on what is effectively a Liberty-sponsored leveraged buyout will be acceptable.

It’s ambitious stuff, making it hard to see a rival bid surfacing. Possible interloper Vivendi is tied up with other deals. Private equity firms could conceivably raise the same financing, although the sizeable share ticket would be hard to match, and they would lack synergies. But if Liberty’s financing gets away, private equity will be inspired to do similar.

By Chris Hughes

DAVOS, Switzerland, Jan 25 (Reuters Breakingviews) -
G oogle’s (GOOG.O: Quote, Profile, Research) mantra, “Don’t be evil,” sounds so easy. But
businesses, including the search giant, have struggled with
avoiding harm while aspiring to do good. Executives gathered at
the World Economic Forum in Davos see a simple logic: comporting
themselves in socially beneficial ways can hurt financially in
the short term, but must be good for business over time.
Immediate conflicts, however, could make that promise difficult
to uphold.

The pressure to change comes from society. In banking, it’s
because taxpayers rescued the banking system. A financial firm
that devises complicated structures to help clients minimise tax
bills is going to find itself vilified by the media. Tax
structuring is, in theory, a perfect post-crisis business for
banks: it requires no capital and is highly profitable. But it
doesn’t pass a socially useful test and can damage the brand. On
balance, that makes a decision to exit easy.

Banks with big, capital-intensive commodities operations
face a similar quandary. These units may serve a useful purpose
by helping corporate clients hedge certain costs. But the same
resources may also be utilized to help hedge funds speculate on
prices and potentially exacerbate a squeeze on vital products
like wheat, increasing food costs in a way that may not benefit
society. A bank can’t easily cherry pick its clients.

It’s not just a banking problem. Consumer-goods businesses
are particularly vulnerable to changes in popular sentiment. But
strict application of an evil-mitigation strategy could lead to
some aggressive portfolio pruning. It’s one thing to dispose of
an obesity-fuelling snacks business when it is mature and
low-growth. But if it’s the hot thing in emerging markets, the
company may be tempted to justify keeping the business for
shareholders’ benefit.

The traditional corporate approach was to offset “evil” by
handing money to charities or doing good works, like giving
employees a day off to plant trees to counter environmental
impact. It’s laudable that chieftains in Davos are earnestly
grappling with a holistic approach to making a positive impact.
But they may find managing evil easier than avoiding it
altogether.

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To feel good again, the world’s financial elite need a growth catalyst like the Internet. America’s shale gas revolution fits the bill. Ask delegates at the World Economic Forum in Davos for their 2013 outlook, and that simple idea features in most answers. It may only surface as a passing reference in conversations around the Swiss ski resort. But in the echo chamber of Davos, the notion that shale gas is a reason to be bullish has become common wisdom.

The argument is familiar. As fracking – the technique to extract gas from shale – takes off, that benefits satellite businesses that serve the industry. That stimulates the broader economy. What’s more, shale lowers energy costs, benefiting American industry by lowering expenses. Factor in a healthier housing market, and you have the makings of a durable recovery in a region accounting for about a quarter of the global economy.

In one form or another, this thesis is being touted by corporate executives, bank bosses and politicians navigating the icy byways of this mountain village. It’s easy to see why. This year, the WEF takes place when the world is more composed than it has been for ages – the acute phase of the sovereign debt crisis is past, yet there is no exuberance either. Masters of the universe feel things are looking up, but they’re mindful of latent risks.

Shale supplies grounds for reasoned optimism. Lower energy prices thanks to abundant natural gas in the United States saved $107 billion, or $926 per household, last year, according to research by IHS. The boom has created 1.7 million jobs already.

But it’s a big leap from this to believe shale will lead a global recovery. Shale is still a small element of the overall U.S. economy. The U.S. oil and gas sector is only 1 percent of GDP, according to Credit Suisse. While it brings advantages, it is more of a mini stimulus than a saving grace, which would require the side effects of shale to be both large and entirely positive. In reality, only a handful of industries – like petrochemicals or fertiliser – will enjoy game-changing benefits.

Then again, maybe the details of the shale thesis aren’t so important. The assurance expressed among business leaders and their entourages in Davos may be misplaced. But confidence, even one derived from gas, can be self-perpetuating. Let them keep believing.

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

Heathrow spent more than 36 million pounds on improving its snow defences after the chaos in 2010. The result? More bad publicity for London’s hub airport when this winter’s first blizzards hit. Heathrow’s operational upgrades have failed to address the fundamental problems it faces.

The latest debacle – with pictures of stranded passengers sleeping on terminal floors – underscore Heathrow’s core difficulty. The airport normally runs at near-full capacity. So there is no slack when things go wrong.

Two years ago, Heathrow struggled to clear snow from runways while its airlines had difficulties de-icing planes. This time, investment in advanced snow ploughs helped keep the airport operational. But there were still problems with de-icing the planes. Critically, there were cancellations because poor visibility necessitates greater intervals between flights. With no extra runway capacity, Heathrow’s only option was to ground flights.

The best way of managing this problem would be to lower customer expectations. The message would have to be conveyed loud and clear. The price of running lots of flights in “ordinary” weather is inevitable disruption when snow hits. Unfortunately, Heathrow’s recent investment has only raised expectations. Even when passengers were forewarned of cancellations this weekend, many still turned up hoping for the best or at least seeking – quite rationally – to grab pole position in the queue when flights resumed.

A second solution is to build a third runway while exercising the discipline to utilise only some of the extra capacity to meet day-to-day demand. But the current government has blocked the idea of extending the west London site, although it faces continued pressure from the business lobby to change tack.

The radical option is to operate the existing infrastructure at lower capacity. This would give Heathrow a cushion against disruptive events. True, it would risk a damaging knock-on effect for London and the UK economy. But the severity of that outcome would depend on whether passengers modified their behaviour and used London’s other less-crowded airports. Public policy could play a role in improving the local alternatives. The business impact on Heathrow, meanwhile, could be mitigated by charging airlines more.

It’s hardly an attractive solution – but it is the most economically realistic.

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

Greg Coffey’s retirement at 41 from Moore Capital marks the end of the big personality era in hedge funds. The macro trader’s success was based on drive, personality and talent, plus the usual hedge fund ingredients – luck, leverage and high management and performance fees. His luck ran out at GLG Partners when the Lehman crisis hammered his illiquid positions. Clearly, something else has gone at Moore Capital.

Coffey’s personality was famous in the industry. He demanded a cup of coffee be delivered to his desk at the same time every day, even if he wasn’t in. There are also possibly apocryphal stories about his wrath towards cleaners who moved the carefully arranged mini-bottles of vodka on his desk. His personality attracted clients and other talented traders and the quirks went along with an intense trading style.

He also had an eye for privately-held emerging market assets that delivered colossal returns when they went public. But exposure to illiquid assets became a big problem when the crunch came. Coffey moved to Moore Capital, leaving GLG equity incentives on the table.

Moore acquired Coffey’s dedication and talent, which was deployed on more liquid strategies. The intensity came too: he sometimes turned over almost his entire portfolio in a day. Still, something has happened to make Coffey call it a day. In September, he made a 9 percent monthly return, erasing year-to-date losses to leave his fund flat. Rather than a sense of victory, Coffey felt that was a good moment to leave, according to a person familiar with the situation.

It’s not clear why Coffey’s drive has gone. Perhaps the reported $700 million of net worth de-motivated. Maybe Moore wasn’t the right environment. But the hedge fund world is becoming more institutionalised, with more emphasis on asset gathering and compliance. And less on big characters like Coffey.

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

BAE Systems needs a new chairman. Dick Olver’s management of the attempt to merge the UK defence group with EADS was poor. He has also presided over a sustained period of share-price underperformance. After eight years on the board, he should make room for fresh talent.

It is easy to see why BAE pursued a tie-up with EADS. The enlarged group could have won bigger contracts, reaped cost savings and gained buying power. OK, so it was unexpectedly stiff opposition from Angela Merkel that ultimately killed the deal. But the difficulty for Olver is that he led BAE into a project with shaky foundations. BAE’s own shareholders were doubtful. Invesco, with 13 percent, was incensed by a perceived strategic U-turn. The UK-based fund manager went public in its push-back campaign – a clear sign that relations with the board had broken down. Privately, other big shareholders echoed its concerns.

In M&A, it is the chairman’s job to anticipate, manage and win over potentially sceptical investors. Not only did Olver fail, he should have known better. Comparisons with Prudential and G4S are apposite. Ambitious plans by both companies foundered on the reaction of their own investors; and the chairmen left in the wake of the reversals. While Olver couldn’t have made BAE’s top investors insiders on the deal, there are ways of softening up shareholders up for big strategic moves. And if that really was impossible, he is still culpable for failing to limit the damage once the EADS talks deal leaked.

Olver would be in a stronger position if BAE’s operating and share-price performance was better. But, as Invesco notes, its price-earnings ratio is low both historically and relative to peers. The stock has underperformed the FTSE-100 for the last three years. And Olver was in the chair when BAE overpaid for two big acquisitions in 2005 and 2007. From here, BAE faces flat revenues at best. Its progressive dividend policy looks uncomfortable.

A new chairman would provide a chance to repair investor relations, take a fresh look at strategy and give new impetus to BAE’s efficiency drive. Olver is likely to retire in 2014 anyway. The board should accelerate his succession.

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

BSkyB shares should start to reflect the chance of a second bid from News Corp. Ofcom, the UK media watchdog, has confirmed that Rupert Murdoch’s media group is a suitable lead shareholder in the satellite broadcaster despite the phone-hacking scandal in News Corp’s UK newspaper business. The clarification removes a potential obstacle to it taking full control of the business.

Ofcom excoriates Rupert’s son James for his mishandling of the phone-hacking affair, detailing management failings as late as December 2010. His conduct was “ill-judged” and “fell short” of what was expected of him. Ofcom also fails to endorse James’s account of what he did and didn’t know about the scandal, saying only that there was no convincing evidence to contradict his version of events.

The Ofcom verdict clearly vindicates the BSkyB board’s decision to demote James from chairman to non-executive director in April. Without that switch, Ofcom may well have forced his exit or stripped BSkyB of its broadcasting licence. Crucially, however, Ofcom is content to allow Sky to continue broadcasting with James on the board.

There are still risks in a new bid for Sky. Ofcom might change its mind if it gets new information from criminal cases relating to phone hacking, or from the forthcoming Leveson report into UK media standards. Even if News Corp gets over these hurdles, any new bid would reignite the political firestorm in Britain against the Murdoch empire.

But News Corp has long coveted full control of BSkyB and may well decide to move before the next UK general election, due in 2015. The current government could have blocked it on grounds of reduced media choice but seemed prepared to approve the deal before the hacking scandal broke. Dissenting voices in the ruling coalition government came from the junior Liberal Democrats, but they are a weakened political force. The 2015 vote, meanwhile, could see the election of a new, Murdoch-hostile, Labour administration.

The planned demerger of News Corp’s publishing businesses, due to complete next year, will put helpful additional distance between the broadcasting core and the troublesome UK print business. The Murdoch empire has the firepower it needs to complete the buyout, which is worth $12 billion at the current share price, and probably retains the ambition. It might well strike back.