Breakingviews

Quest board cleverly squeezes more out of MBO

By Robert Cyran

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

Quest Software’s directors have come up with a canny plan to squeeze more money out of a buyout offer backed by Chief Executive Vincent Smith. They were put on the defensive in March when Smith, who owns a third of the enterprise software company, teamed up with private equity shop Insight Venture Partners for a lowball bid. But independent board members managed to level the playing field by offering Dell an option to acquire a 19.9 percent stake in the firm if Smith didn’t support its superior bid. That bagged shareholders a 12 percent bump in the purchase price.

Management buyouts don’t always work out so well for investors. Take the case of retailer J Crew two years ago. Its boss, Millard “Mickey” Drexler, talked to private equity firms for weeks without informing his board, who approved the resulting sweetheart offer from TPG and Leonard Green Partners without conducting an auction. And the subsequent go-shop provision suffered a big flaw – Drexler was a big shareholder and appeared reluctant to work with other potential bidders.

Quest Software’s Smith acted more admirably, informing the board when first approached. Still, the private equity shop’s $23-a-share offer had the inside track. Smith’s stake meant he could swing a vote. Moreover, his interests aren’t necessarily the same as other holders. A strategic bidder wants to run the company, while Smith could keep his job if the firm were bought by private equity.

Granting Dell the option to acquire a 19.9 percent chunk of stock – the most allowed without a shareholder vote – effectively neutralized Smith’s ability to sway the outcome. This encouraged the computer company to lob in a higher bid of $25.50 a share. Insight and new partner Vector Capital quickly trumped this with a $25.75 offer.

There’s still a chance that Dell could put in a higher bid – or that another firm could enter the frame. But even if the gavel comes down at the current price, the directors’ clever wheeze has already squeezed out 12 percent more for investors. Granted, threatening to dilute shareholders should never be done lightly. Nonetheless, members of other boards, who have a legal obligation to achieve the best outcome for shareholders in a takeover, should take note.

KKR gets rich prescription for top-of-market LBO

By Robert Cyran and Quentin Webb The authors are Reuters Breakingviews columnists. The opinions expressed are their own. KKR has found the right formula to exit Alliance Boots, its top-of-the-market drugstore deal. Walgreen’s two-stage acquisition of its European rival should more than double the investment KKR and its partners made at the peak of the leveraged buyout frenzy. What the U.S. drug chain’s investors will get for their money – as much as $16.2 billion – is harder to fathom.

The first stage sees Walgreen pay about $6.7 billion in cash and stock for 45 percent of Boots. The firm’s ownership is currently split fairly equally between KKR funds, Boots Executive Chairman Stefano Pessina and outside investors. Pessina, who will become a Walgreen director, takes proportionately more stock than the financial investors.

Two and a half years on, Walgreen can buy the rest of the company for about $9.5 billion at current share prices. Assuming the second stage completes, and considering a minority stake in a Swiss firm that is excluded from the current deal, KKR should make about 2.2 times its original investment in dollar terms. That’s pretty good for a boom-year deal, especially in the cut-throat world of European retail. If Walgreen stock rises, the ultimate return could be higher.

The benefits to Walgreen shareholders from supporting a risky cross-border acquisition aren’t as obvious. With a $26 billion market cap, Walgreen is currently valued at an enterprise value of about six times EBITDA, and paying a multiple almost twice as high for Boots. The hefty price tag might make sense if promised synergies – up to $150 million over the first year and $1 billion by the end of 2016 – ever arrive. The after-tax value of these would be about $5 billion today.

Yet the two firms have little overlap. Since workers can’t be cut, the initial savings will come from wrangling better prices from suppliers. Most of the benefits further down the road come from selling more goods and best practices, for example, selling Boots’ skincare products in Walgreen stores, and sharing advice on how to run loyalty reward programs. These sorts of gains are easy to talk about and very hard to deliver.

Of course, Walgreen can choose not to proceed with the second part of the deal should reality not live up to promises. But investors’ skepticism – they sliced nearly $2 billion off its market value on the announcement – is justified.

Xstrata shareholders should say no

By Chris Hughes

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

Xstrata shareholders should vote down the $45 million three-year retention package awarded to Chief Executive Mick Davis to seal the miner’s tie-up with commodity trader Glencore. Sure, the merger would collapse, but that’s a price worth paying.

In 2011, Xstrata paid Davis $14.3 million in salary and bonuses plus a long-term incentive plan (LTIP) that delivers an estimated $9.8 million if the miner meets performance targets. If Xstrata merges with Glencore, the Xstrata board thinks an extra $15 million a year is required to keep Davis loyal, taking his total annual package to around $40 million during the integration phase.

This would put Davis’s pay well above his peers. Marius Kloppers at BHP Billiton was paid $7.7 million in 2011, plus a $3.3 million LTIP. Cynthia Carroll at Anglo American got about the same, although more tilted to the LTIP. Rio Tinto’s Tom Albanese got $3.9 million plus a $3 million LTIP. Sure, these figures reflect individual performance, and Albanese waived his annual bonus. But their maximum potential pay was still well below that of their Xstrata counterpart.

Davis’s retention is effectively insurance against the damage the merged “Glenstrata” would suffer if he quit. He might well leave. M&A often gives executives itchy feet. And Davis’s job will have some big challenges, like managing Glencore’s powerful CEO, Ivan Glasenberg. Davis has form too – he quit BHP Billiton shortly after its founding merger. And he’ll have made millions on vesting options.

It’s also true that the company could suffer without Davis at the top. Squabbles between Glencore and Xstrata staff about the allocation of capital to “their” sides of the business could become toxic, other Xstrata people may leave, and the potential synergy of melding Glencore’s trading nous with Xstrata’s mining assets may be lost.

World’s new air giant taking off at turbulent time

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

Get ready for the world’s largest airline to take off this week. But don’t look north or east – the globe’s most valuable carrier is set to be South American. Chile’s LAN Airlines is on track to finally consummate its marriage to Brazilian rival TAM this Friday, almost two years after announcing the tie-up. But the promise of greater regional integration has fueled big expectations that economic headwinds will make difficult to meet.

Investors eager to buy into a promising Latin America growth story have pushed TAM shares up by more than a third since the deal hit in August 2010. That values the firm at $3.6 billion – a pricey bump for LAN, whose shares have risen by just 10 percent. But at $12.5 billion the combined airline will be worth almost double Ryanair, 50 percent more than Delta and around 15 percent more than Air China.

The new airline, to be called LATAM, is enticing for several reasons. There’s not much overlap. LAN gets access to Brazil, the region’s largest airline market, while TAM gains from its partner’s far larger cargo business. And LAN is growing fast: executives expect passenger traffic to grow by 14 percent this year. That should boost its already solid performance: LAN cranked out a 16.8 percent EBITDA margin last year, handily surpassing Delta’s 9 percent.

But economic growth is slowing across Latin America. Brazil’s crowded airline industry is struggling to cut capacity. In fact, TAM’s bosses have already signaled a problem with seat capacity, estimating a 2 percent decline this year in available seat kilometers, a key metric. Meanwhile, LAN’s cargo business is facing increased competition as European rivals redeploy planes from their home markets to a healthier Latin America – the company expects growth in available tonne kilometers to be 5 percent this year, a fifth of its 2010 level.

Combined, that makes it harder to achieve the sales growth that was supposed to account for most of the $700 million in synergies promised from the deal. LATAM may well start life as the world’s most valuable carrier. But it might not retain the title for long.

Chesapeake gets pistol-whipping from shareholders

By Robert Cyran and Christopher Swann

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Chesapeake Energy has gotten a pistol-whipping from shareholders. The besieged U.S. gas giant’s owners voted overwhelmingly against directors who were up for re-election and the board’s executive pay plan, while favoring a slew of investor proposals to improve Chesapeake’s governance. It’s hard to see how boss Aubrey McClendon can keep running this circus.

McClendon tried hard to placate investors ahead of the annual meeting on Friday with a series of half-measures. Chesapeake agreed to ditch four loyalists from the nine-strong board. Newcomers will be named by the two largest shareholders, including Carl Icahn, and will be far harder to push around.

And the firm pulled out stops both big and small to suck the air out of the shareholder revolt. Hours before the meeting, the Oklahoma-based group announced the sale of pipelines and related assets for more than $4 billion, to partner Global Infrastructure Partners, in an attempt to assuage concerns over the firm’s liquidity. And the formerly press-friendly company relegated the media to watching a news feed of the meeting.

None of these measures worked. The executive pay plan was backed by less than a third of shareholders. Nearly all voters – 97 percent – backed supermajority voting for directors, making it easier to kick them out. The only directors up for election, Burns Hargis and Richard Davidson, were forced to tender their resignation after receiving scant votes. Finally, investors voted to reincorporate Chesapeake in Delaware, making it easier to amend company bylaws and mount board challenges.

Though McClendon until recently ran Chesapeake as a personal fiefdom, at this stage it’s hard to see how he can remain even in a straitjacketed role. Shareholders were already calling for his head. The results from today’s annual meeting are the corporate equivalent of riots in the street – with the fury pointed directly at McClendon’s debt-fueled empire building and the conflicted intertwining of his personal interests with those of shareholders. With such anger, it’s hard to see how he can govern at all.

Qatar play for EFG Hermes stokes backlash in Egypt

By Una Galani

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

Qatar’s move on EFG Hermes is provoking a backlash. The Gulf emirate’s play for key assets of the region’s preeminent investment bank has prompted a rival consortium, notably backed by billionaire Naguib Sawiris, to declare an interest in buying it outright. The Qatari deal was approved last week by shareholders, but in the current volatile situation anything can happen.

The possible bidding war highlights the rising Egyptian concerns over the country’s financial relations with Qatar. The rival Planet consortium promises to “prevent the breakup of a flagship Egyptian multinational” and is counting on regulatory intervention.

EFG shareholders support the deal that will give state-backed QInvest control of 60 percent of the firm’s investment banking business, with an option to buy the rest. That prevents EFG opening its books to Planet, which wants to see them before launching a formal bid. So far its mooted offer, at a 23 percent premium to the last closing price, still undervalues the bank.

Unless the regulator disagrees with the valuation of the QInvest deal, or minority shareholders challenge it, lawyers say there is no legal basis to stop the EFG tie-up with Qatar. Yet in Egypt’s fast changing political environment, and considering this would be the country’s first hostile takeover, people close to the bank concede anything could happen.

Planet’s pledges to keep EFG whole, and Egyptian, play into wider fears over Qatar’s influence in post-Mubarak Egypt. EFG’s co-chief executives were known to be close to the former regime, and they face accusations of illegal share dealing. Qatar, on the other hand, has noticeable ties to the Muslim Brotherhood, which dominates parliament and has a strong chance of taking the presidency.

Carlos Slim may drive KPN to poison

By Quentin Webb

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

Carlos Slim may drive KPN to poison. The Dutch telecoms group wants to dodge what it sees as a takeover-on-the-cheap from the world’s richest man. Slim is hoping to nab a near-28 percent stake at eight euros a share. KPN’s response is to wax lyrical about its standalone potential, and drop heavy hints about a possible German tie-up that’s been talked about for a decade. But counterpart Telefonica does not seem ready to trade.

Sticklers for corporate governance, look away now: KPN may buy time with poisoned pills.

Slim’s America Movil has already amassed a 5 percent stake in KPN and is offering to buy more shares until June 27, up to a maximum 27.7 percent. That has concentrated minds at KPN HQ. The company decries Slim’s opportunism and now says it will explore “strategic options” for E-Plus – its biggest overseas operation and Germany’s third-biggest mobile operator.

KPN says merging E-Plus with a rival could yield valuable savings – synergies that analysts hope would have a net present value of 3.5 to 4 billion euros. That only points in one direction: Telefonica’s O2 Germany. Antitrust concerns would probably nix a rival deal with the larger Deutsche Telekom or Vodafone. Even a German marriage between the offspring of the Dutch and Spanish parents might prompt some detailed scrutiny from trustbusters.

The problem is, debt-laden Telefonica has other ideas. The Spanish company is eager to conserve cash and is thinking about part-floating O2 Germany. What’s more, it denies talking to KPN about buying E-Plus – although of course that does not rule out other forms of collaboration. In any event, any combination looks both complex and some way off.

Douwe Egberts listing has to create its own buzz

By Quentin Webb

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

Sara Lee’s coffee spin-off must create its own buzz. Investors need to believe the unit, officially known as “D.E Master Blenders 1753”, will benefit from a sharper focus and strong leadership.

This unusual cross-border divorce is the last big step in dismantling Sara Lee, the U.S. group once simply called Consolidated Foods. Thomson Reuters Starmine data show large European food and drink companies trade at roughly 15 times current-year earnings, or enterprise values of about nine times EBITDA. Averaging those multiples suggests an equity value of roughly 4.2 billion euros for D.E, based on Kempen forecasts.

Half or more of Sara Lee’s shareholders are U.S. index trackers, private investors and others who cannot or will not keep the D.E stock doled out in late June. Some may already be selling out of Sara Lee. So new owners must come forward.

At first glance, the story is no better than lukewarm. The biggest slice of sales, 43 percent, comes from retail customers in wobbly Western Europe. Weak margins spoil a big presence in Brazil. And 49 percent of overall revenues come from roast and ground coffee. It will disappoint amateur baristas to hear this is lower margin, and slower growth, than instant coffee or “single-serve” pods – such as those in Nestle’s hugely successful Nespresso machines or D.E’s own Senseo system, for longer drinks.

It doesn’t help either that European stock markets are wilting, and initial public offerings elsewhere have foundered. Still, new investors are intrigued and, barring a market collapse, Sara Lee seems determined to push ahead. Spin-offs are usually more resilient to market sentiment than flotations anyhow.

Mike Lynch should try to buy Autonomy back

By Chris Hughes

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

Mike Lynch should try to buy Autonomy back. The software entrepreneur sealed a superb deal for shareholders when he sold the Cambridge-based firm to U.S. tech giant Hewlett Packard Co in October. But the marriage isn’t happy. Lynch was meant to be leading HP’s efforts to scale up the business. Instead, he’s leaving to do acquisitions of his own. It would make sense if Autonomy was on his list of targets.

Last summer, HP may have looked like a suitable parent for Autonomy. Lynch himself had taken the business from nothing to annualised revenue of $1 billion in the second quarter of 2011. Scalability wasn’t in doubt. HP’s new chief executive, Léo Apotheker, was a software guy who wanted to move away from the challenged core business of computer hardware. The 64 percent premium on offer showed a commitment to turbo-charging Autonomy’s performance.

But the new family has turned out rather dysfunctional. HP shareholders blew a big raspberry at the overpriced deal. The board replaced Apotheker. Autonomy staff left too. That was to be expected given the cash deal had provided a decent exit on their stock. But HP’s big-company bureaucracy and “hardware culture” was another factor, according to a person familiar with the situation.

Meg Whitman, Apotheker’s successor, has backed the strategic logic of buying Autonomy. But she will need to work very hard now to bring harmony, let alone satisfactory returns on the investment. Licensing revenue has proved very disappointing lately, HP says. Mass defections by Autonomy staff would see the debilitating loss of institutional know-how, albeit with the clarity of HP’s culture becoming dominant.

The best thing for all concerned may be for HP to dispose of the business. HP’s stock has already taken a hit. The cultural mismatch may never be resolved. Big gaps are appearing in Autonomy’s development expertise. HP seems to have other priorities.

Hot infrastructure auctions drive down returns

By Quentin Webb

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

The market for infrastructure assets is heating up. Yield-hungry investors are keen on large, predictable businesses in the less rickety bits of Europe. So auctions like E.ON’s sale of its German gas pipes run pretty hot. Even if the bets are less extravagant than during the credit boom, returns will suffer.

The 3.2 billion euro price tag for E.ON’s “Open Grid Europe” doesn’t look hair-raising: it’s in line with book value, and about 10 times EBITDA. Low-cost debt helps: Macquarie’s infrastructure fund, which teamed up with a Canadian money manager, Abu Dhabi’s sovereign fund, and a German insurer, got banks to stump up 2.2 billion euros or so of cheap loans, ahead of a likely bond sale.

Nonetheless, robust auctions tend to mean higher prices. To win, Macquarie had to fight off three other serious consortia. Rivals and sector-watchers reckon the Macquarie group paid at least 200 million euros more than the next bidder, and question how it will achieve its target 10-percent plus internal rate of return from the investment.

Of course, business plans differ, although regulators probably limit a buyer’s wiggle room. Macquarie may also be more optimistic about an eventual exit price. And today’s low-yield world is undoubtedly compressing return expectations for all investors, not just in infrastructure.

Still, lower anticipated returns also reduce the margin for error. Like Vattenfall’s sale of its Finnish assets late last year, the E.ON disposal is a reminder of how much cash is chasing assets. That appetite comes both from infrastructure funds and from other enthusiasts for long-term investments, such as stewards of pensions and petrodollars.