Breakingviews

Comcast deal extends content’s precarious reign

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

Content’s reign in TV Land is secure for now but maybe not for long. As media moguls gather for their annual Sun Valley confab, U.S. cable operator Comcast struck a deal to sell its minority stake in A&E Television Networks to its partners for $3 billion. That implies a healthy valuation of over $19 billion, all the more impressive given the fight elsewhere that represents the industry’s future.

Feuds between program creators and distributors have become as ugly as the one in “Hatfields & McCoys,” the hit May mini-series on A&E’s History Channel. Just Wednesday, Nickelodeon, MTV and other Viacom channels were yanked from DirecTV’s 20 million customers as the two sides squabbled over how much the satellite-TV operator should pay to carry them.

These battles have grown more intense as cable networks fight for higher fees from distributors. The likes of Comcast and DirecTV have long been hampered in such negotiations because they’re the ones who must face the customer backlash when desired channels disappear from the lineup or bills rise. The latest scrap with Viacom suggests a tipping point of sorts. Its Nickelodeon kids channel is one of the most valuable on the dial. But audiences have tumbled, emboldening DirecTV to take a harder line.

By contrast, ratings for many of A&E’s channels are improving. “Hatfields & McCoys” was the most watched non-sports program ever broadcast on ad-supported cable. That helps explain why the 15.8 percent stake in A&E secured $1 billion more than where Comcast pegged it at the end of March. Based on SNL Kagan’s 2012 estimates, the deal with Disney and Hearst valued A&E at 15 times 2012 cashflow.

It’s true Disney owns the ESPN sports hub, which commands 20 times the price that the average cable network does per customer. That gives it significant leverage in negotiations with carriers for all its channels. But the heady growth of fees also isn’t sustainable. In the decade through 2011, so-called affiliate revenue increased on average 10.7 percent annually to nearly $27 billion, according to SNL Kagan. For the next four years, that rate is expected to slow to 6.4 percent. Content is still king, but uneasy must lie the head that wears the crown.

Intel deal closes circuit to faster chips, growth

By Robert Cyran The author is a Reuters Breakingviews columnist. The opinions expressed are his own.Intel has found a way to close the circuit on faster growth. Next-generation chips are cheaper, quicker and require less electricity. But toolmakers haven’t spent the sums necessary to make the switch. Intel’s $4.1 billion investment in ASML should remove such bottlenecks.

The clever deal has multiple components. First, Intel will give the Dutch company $1 billion over five years for research and development into the production of 450-millimeter wafers and extreme ultra-violet lithography. These should cut costs and make chips more powerful. Intel also will buy a 15 percent stake in ASML in two increments, for a total of $3.1 billion.

The risk is shared and both sides have plenty to gain. ASML locks in an important customer. It also can now develop new tools without diluting shareholders. The company will return to existing investors the cash raised from the new equity. Intel, meanwhile, gets stock with potential upside and recoups some R&D costs with equipment discounts. There are tax savings from deploying cash trapped overseas. And because any new ASML machines are available to all chipmakers, the deal sidesteps antitrust worries.

More importantly, Intel reckons the arrangement will accelerate the deployment of new-wave microprocessors by up to two years. Making more chips per silicon wafer and cramming more circuits on them reduces Intel’s manufacturing costs and shrinks capital expenditure. Intel estimates the present value of converting to larger wafers at around $10 billion.

Such changes are complicated so Intel may be too optimistic about the savings. But its manufacturing expertise is well-established. It’s safe to assume Intel will be the first to take advantage of any new ASML tools, giving it an edge. If it can produce more powerful chips than, say, AMD and sell them for less, it will help sustain its monopoly-style profits and margins.

Moreover, smaller chips need less juice, a growing selling point for both servers and cellphones. Intel has yet to make any serious inroads into mobile. Nearly all manufacturers use designs from ARM Holdings. By forcing the industry to play to its strengths, however, Intel could just muscle its way into this lucrative market.

Central bank stimulus won’t solve the crisis

By Ian Campbell

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

Following another weak U.S. jobs report, fear abounds. The sense is that the global economy is teetering and central banks can’t do much more. The point is that in the developed world they should not do more. Monetary policy risks becoming harmful if pushed further.

Mario Draghi, the President of the European Central Bank, hinted at the limits of policy on July 5. The interest rate doesn’t work so well when demand for credit is lacking, he said. In other words, you can create pools of cheap money but you can’t make nervous borrowers drink. Nor did it seem that he was thinking of other spurs, such as quantitative easing. It’s “not obvious there are measures that could be effective in a highly fragmented area”.

The hard truth is that Draghi is ill-placed to stimulate growth in the euro zone. Confidence is the problem. The ECB cannot resolve a crisis of insolvent and uncompetitive states locked in a union with solvent and competitive ones. Only politicians can do that. Then the growth horses might drink.

The Bank of England is trying, but it’s hard to imagine the newly launched 50 billion pounds of quantitative easing, taking the total to a colossal 375 billion pounds, will do much for growth. Of course, the BoE could emulate the U.S. Federal Reserve and buy mortgage-backed securities. But UK house-buyers might still be reluctant to drink.

In emerging economies, central banks are far from the end of the stimulative line. China has just cut its lending rate to 6 percent; Brazil is now down from 12 percent last summer to 8.5. Emerging economies can and will ease further, profiting from falling global inflation. But that helpful fall in inflation could itself be undone if the West chooses to push harder on the monetary string. Further QE would push up bonds, commodities and equities, pleasing financial markets – but driving up oil prices and hurting consumers.

Supreme Court gives shot in arm to Obamacare M&A

By Robert Cyran

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

Expanding health coverage to more than 30 million Americans remains politically contentious. But the Supreme Court’s decision not to overturn the law means that it’s here to stay. The increased number of covered patients is a lucrative opportunity for insurers that helps justify juicy merger premiums. That’s the logic behind WellPoint’s pricey $4.5 billion bet on Amerigroup. More deals are likely.

Amerigroup is one of the biggest providers of managed care for Medicaid, the government program covering poor patients. Medicaid already accounts for 24 percent of the average state’s budget, according to the National Association of State Budget Officers. So getting costs under control is a necessity. Encouraging patients to emphasize preventive care rather than make trips to the emergency room can yield big savings – and Amerigroup takes a chunk of that.

With Medicaid’s budget expected to reach $587 billion in 2014, and only about a fifth of these patients currently in managed care, the opportunity is obvious. But the new law effectively supercharges growth, making at least 7 million people eligible for Medicaid in the states where Amerigroup operates.

WellPoint is paying up to grab this opportunity. At 23 times estimated 2012 earnings, the company is baking in a lot of growth. Moreover, the $125 million of estimated annual synergies over three years are only worth about $650 million currently when taxed, discounted and capitalized. That’s just half the $1.3 billion premium. Yet investors sent WellPoint’s stock up 3 some percent on the news.

Expected growth may explain that. But the synergies are probably a lowball estimate – it’s notable that WellPoint said there were “at least” $125 million. Throwing in too high a figure might encourage regulators and lawmakers to bargain harder. The combined company may also have more heft in negotiations with hospitals and the like.

Duke CEO sucker punch a value lesson for investors

By Christopher Swann

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

Leadership is supposed to have its privileges. So naming the chief executive was a prize electric firm Progress Energy demanded when selling itself to larger rival Duke Energy. In return they accepted a tiny premium. That Progress’ man Bill Johnson lasted only hours in his job is a reminder to investors never to sacrifice value for the prestige of getting the top job.

When Jim Rogers, Duke Energy’s veteran chief executive, consummated his takeover of Progress in January 2010 he joked with analysts about arm-wrestling his successor as leader of the combined company. He noted that Johnson, a powerfully built former Penn State football player, was likely to win any such battle of strength. When it came to the power struggle, however, Rogers lost no time in slamming his rival.

This was an unequal match. After the merger Duke, whose shareholders owned 63 percent of the new firm, controlled 11 of the board’s 18 board seats. Former Progress directors understandably feel aggrieved at this unexpected act of aggression. One, John Mullin, described it as “one of the greatest corporate hijackings in U.S. business history.” At the time the Progress board accepted a tiny 4 percent takeover premium, modest even by the standards of the electric sector.

The ousting of Johnson is hard to explain in anything other than Machiavellian terms. True, one of Progress Energy’s nuclear reactors in Florida is having some costly technical problems. Still, such mishaps are not unheard of and should not disqualify Johnson from leading the combined group. Rather it seems that Rogers and his entourage were unwilling to play second fiddle.

Nobody comes out of this looking good. Anyone negotiating with Rogers in the future is likely to be extra cautious. Those who handled Progress’ side of the deal end up seeming hopelessly naïve.

New mortgage seizure plan is the nuttiest idea yet

By Daniel Indiviglio

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

A California county’s new plan to seize underwater mortgages from investors may be the most dangerous housing market intervention yet. If it catches on, bondholders could face billions in losses – and taxpayers, too, if local authorities start targeting loans backed by the federal government. That would whack up mortgage costs and may leave Washington as the only lender.

The plan is simple enough. San Bernardino county wants to invoke existing eminent domain laws to seize mortgages that are bigger than the current value of the homes they’re lent against. That’s a radical departure from the way eminent domain is usually deployed – to commandeer land for public use, such as to build a road.

The county would then sell the loans to a fund called Mortgage Resolution Partners. The deal is a no-brainer for all concerned: the investment group makes a profit on the safer new mortgages – to qualify, borrowers have to be current on their payments. The homeowners get a loan that’s now worth less than their home, so also end up with some equity. And the local politicians look smart and may win some extra votes.

But that doesn’t allow for the true cost of the program. Assume it’s implemented across the country and includes not just private-label mortgages, as is the case in San Bernardino, but the far larger market of those backed by the U.S. government. That opens up the scheme to a large chunk of the $1.2 trillion-worth Americans owe on their mortgages above the current value of their homes, according to Zillow’s first-quarter Negative Equity Report.

That would cause enormous losses for bondholders and taxpayers alike. At the extreme, private investors would probably abandon any intentions of financing a private mortgage market in the future, leaving the U.S. government as the only entity willing to shoulder the risk.

What if Barclays hadn’t lowered Libor submissions?

By Hugo Dixon

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

What if Barclays hadn’t lowered Libor submissions? The bank certainly reduced its vulnerability by submitting lower rates in the midst of the crisis. But what would honesty have cost? Would Barclays have secured funds from Middle East investors, avoided nationalisation and protected its bosses’ bonuses? No one knows, but the timeline is suggestive.

After Lehman Brothers went bust in September 2008, most smart market participants realised that the published Libor rate was not giving an accurate picture of borrowing costs. The UK government also knew this and was keeping a tab on the health of Britain’s banks by looking at other measures. So it’s possible that Barclays’ decision to cut its Libor submissions at three key moments in the autumn of 2008 had no effect on the course of history.

However, it is clear that Barclays was worried about being seen to be an outlier – as a result of submitting rates at which it thought it could borrow that were higher than the competition’s. The government also appears to have asked questions about this, indicating that it might have been concerned. What’s more, there were good reasons for anxiety. The whole financial world was blowing up while Barclays itself was gobbling up part of the Lehman Brothers carcass.

Barclays originally tried to buy the whole of Lehman before it went bust – a manoeuvre wisely blocked by the UK Financial Services Authority. But the UK bank did acquire Lehman’s U.S. operations after bankruptcy for a song, announcing the deal on Sept. 17.

The next day one of the Barclays staff responsible for submitting Libor rates told his manager that he planned to put in a one-month U.S. dollar submission of 4.75 percent – according to the FSA report into the rate-rigging scandal. After that conversation, he cut it to 4.5 percent. This was still 50 basis points above the next highest submission. Would Barclays have been able to proceed with the Lehman deal if it had been even further outside the pack?

Chinese IP awareness, sown by West, bruises Apple

By Wei Gu

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

Apple just got gently bruised in China. The U.S. gadget-making giant can easily afford the settlement it has agreed to use the iPad name in China. And a new lawsuit over Snow Leopard poses little threat. Still, the Middle Kingdom is increasingly alert to such things as trademarks and patents. Western multinationals wanted that, but Apple’s experience shows it may increasingly cut both ways.

The $60 million settlement with Proview Technology (Shenzhen) is a rounding error for Apple, which had $110 billion of cash at the end of March. Yet it is significant by Chinese standards. Already, Apple is facing another suit from Jiangsu Snow Leopard Everyday Chemicals over the use of part of its name for Apple’s operating system, according to China Business News. The Chinese firm is only asking for $80,000 in damages, but it’s a trend that might eventually get expensive – or at least annoying – for Apple and other Western firms.

China accounted for a fifth of Apple’s sales in its latest reported quarter. It hardly registered a few years back when the spat with Proview started. That might explain why the Silicon Valley firm wasn’t perhaps as thorough as it might have been in making certain it had dealt with the right Proview group company and fully secured the iPad name.

The irony in the situation is that Western firms, including the likes of Microsoft, are the ones that pushed hard for China to toughen up its intellectual property rules. It seems they have unleashed something of a beast, though as yet nothing on the scale of the litigiousness of the United States. The country saw the fastest growth in the number of international patent filings last year, up by 33 percent, according to World Intellectual Property Organisation. Chinese telecommunications company ZTE overtook Japan’s Panasonic to become the world’s top filer of international patents in 2011.

All that said, China remains a haven for piracy despite having strengthened its laws to comply with World Trade Organisation rules. The U.S. government claims that, on average, 20 percent of consumer products in the Chinese market are still counterfeit, and American companies lose more than $1 billion a year to piracy. That means there’s plenty of room for Western firms to benefit from tougher enforcement. But Apple’s settlement is a reminder that they need to do their homework to make sure they aren’t too often on the receiving end.

Will Microsoft learn through self-flagellation?

By Robert Cyran

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

Will Microsoft learn from self-flagellation? The software giant squandered shareholder treasure for years to break into internet services, gaming and consumer electronics. Writing down the $6 billion it blew on aQuantive in 2007 should mark a turning point where Microsoft at long last returns to its knitting and focuses on enterprise. Thankfully for its shareholders, there are glimmers that this may already be happening.

The purchase of the internet ad agency was ill-timed, overpriced, and poorly thought out. Google’s purchase of DoubleClick a month earlier had set off a land grab for similar firms by the likes of Yahoo and advertising conglomerate WPP. Microsoft, late to the party, paid more than twice what aQuantive had been worth a month prior. Microsoft didn’t have the traffic or the advertisers to make the purchase pay off. The massive charge it is taking merely recognizes what has been long apparent: the deal was a dog.

That brings up a broader point. Microsoft’s efforts to expand beyond the enterprise customer and the PC have fared poorly. The firm’s online services division, which contains the aQuantive business, search engine Bing and MSN, had an operating loss of $1.4 billion in the first three quarters of its current fiscal year. The entertainment division that produces the Xbox has done somewhat better, earning $637 million, or an 8 percent margin, over the same time. But Microsoft spent heavily for years on the game console. It has yet to recoup these losses, much less earn a satisfactory return on investment.

Microsoft’s results in the enterprise and PC spaces, however, are different indeed. Its Windows and Windows Live division earns 65 percent operating margins, as does its Business division. The company’s Server and Tools segment has 38 percent margins.

Microsoft may finally be getting the message. Sure, paying $8.5 billion for Skype last year and $1.2 billion for social networking firm Yammer doesn’t exactly imply a conservative mind-set. But at least Skype can be plugged into its enterprise offerings. And Yammer is aimed squarely at business users. Ditto its recently unveiled tablet, “the Surface”. Microsoft’s record in hardware is mediocre, as the Zune illustrates. But the tablet’s key selling points are its keyboard and its Office compatibility. This was clearly designed to appeal to businesses.

Diamond’s exit leaves Barclays at a crossroads

By George Hay

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

Bob Diamond has left the building. One day after penning an epic 1,900 word letter to staff pledging to stay at Barclays, the interest rate fixing scandal has forced the UK bank’s chief executive to quit. His is a hard act to follow. And in replacing Diamond, the board faces a critical strategic decision.

If Barclays is to remain an all-singing universal bank, it may well decide it needs an investment banker who knows the UK market – someone like Bill Winters, the previous head of JPMorgan’s London office, or Colm Kelleher, of Morgan Stanley. Since half of the bank’s profit and three-quarters of its assets in 2011 came from Barclays Capital, the investment bank that Diamond built up from the mid-1990s, this may be the most likely course.

But if the board decides to ask what Barclays could or should be, the answer is less clear-cut. The bank should take this opportunity to examine a partial or even total separation of the investment and retail sides.

The investment bank has struggled recently while new rules on capital buffers make it harder to grow returns. Return on average equity in 2011 was only 6.6 percent, miles off the stated 13 percent target, and reliance on volatile investment banking has long led shares in the whole entity to trade at a book-value discount to peers.

Even if the plan is only to focus more on the retail side, the board could signal the change by making a very different kind of appointment. Antony Jenkins, who currently leads Barclays’ retail operations, would be a candidate. Such a change would fit with the trend towards more nationally-focused retail banks clearly seen at Royal Bank of Scotland. It could still be good for investors too – the UK retail arm of Barclays made a 15 percent return on equity in 2011, ahead of BarCap’s 10.4 percent.