Agenda-Setting Financial Insight.

Feb. 25 2013 5:04 PM

Apple's Halo Loses Shine in Investor Fight

Apple and its lawyers come off amateurish.

Photo by TIMOTHY A. CLARY/AFP/Getty Images

No one looks too good in Apple’s fight with David Einhorn. The Greenlight Capital founder scored a legal point, but better governance wasn’t his main objective. Apple comes off amateurish. The California Public Employees’ Retirement System, despite worthy shareholder-friendly aims, seems careless. The Securities and Exchange Commission also missed a trick.

The general bumbling leaves Einhorn least blemished. He wants Apple to issue preferred stock to his own specifications, and doesn’t like a provision the company planned to put to shareholders at Wednesday’s annual meeting that would have made it impossible for the board to do so, at least without shareholder approval. So he sued to block the vote based on Apple’s combining of the issue with several others. He won – but not on the merits of his “iPref” idea.

Apple, presumably thanks in part to its lawyers, ends up the worst for wear. Chief Executive Tim Cook called Einhorn’s lawsuit a “silly sideshow,” but the SEC’s rules make clear companies can’t combine separate matters into one vote. Even without legal certainty – the judge acknowledged the issue has received scant court attention – the simple and safe, not to mention gracious, move would have been to untether the proposed changes when the issue came up, even if it meant delaying them. Other companies are now surely scouring their proxy statements for similar transgressions.

Then there’s Calpers, which gave full-throated support to Apple. That’s understandable in a sense because the package of measures included majority voting for directors as well as ending the board’s ability to issue preferred stock without shareholder approval. Good governance could be threatened, however, if companies bundle dodgy proposals with sound ones – not to mention the questionable message sent by neglecting SEC rules.

The regulator perhaps isn’t blameless either. Apple filed its proxy statement in December. As the judge noted, SEC inaction doesn’t mean it has approved anything. Yet Apple, with its $420 billion market value, is the largest company under the watchdog’s jurisdiction, so a degree of scrutiny is merited.

Either way, the end result is a distraction for shareholders, who now must wait to vote on desirable changes and figure out how to unbundle, in a different sense, Einhorn’s legal victory from his preferred stock idea. It all takes more shine off Apple’s halo.

Read more at Reuters Breakingviews.

Feb. 21 2013 5:02 PM

Southeast Asia's Growth Could Lead to Credit Curbs

Southeast Asia’s heady debt-fuelled growth is beginning to resemble the unsustainable mid-1990s boom. But authorities are shy to raise interest rates as doing so could attract more overseas capital, stoking inflation and financial instability. Direct curbs on credit and capital flows may prove more attractive.

Growth is strong across the region. Thailand’s GDP jumped almost 19 percent from a year earlier in the final quarter of 2012. Malaysia and the Philippines saw better-than-expected expansion of 6.4 percent and 6.8 percent in the same period, respectively. Growth in Indonesia has been above 6 percent in five years out of the past six. Singapore is at full employment.


The rising credit intensity in these economies may not be as pronounced as in China; nonetheless, it is a cause for concern. On average, commercial credit as a proportion of GDP for the region’s five largest economies – Indonesia, Malaysia, Singapore, Thailand and the Philippines – is approaching the pre-1997 crisis peak of 75 percent, according to Breakingviews calculations.

There’s no immediate inflation threat. Besides, countries like Thailand, Malaysia and the Philippines haven’t had a decent investment boom in a long time. The desire to prolong the party – and the fear of attracting more overseas capital — explains the reluctance to raise the domestic price of money. Bank Indonesia has left its policy interest rate unchanged for a year; Malaysia’s central bank last raised rates 22 months ago.

But doing nothing is risky. So policy makers are likely to reach for a different set of tools. Central banks could increase the pace at which they sterilize capital inflows by buying low-yielding foreign-currency assets and selling high-yielding domestic bonds. The fiscal cost of this strategy is a small price to pay for ensuring financial stability. More direct controls on capital inflows are also possible, especially if rising wages feed into inflation expectations.

But before that, the authorities will try to curb credit supply by raising reserve ratios and bank capital risk weightings. The answer to a property mania is to tighten loan-to-value norms, shorten repayment periods and dissuade foreign buyers; Singapore has tried them all.

Ultimately, though, the dams offer only temporary reprieve against waves of global liquidity. A few more years of credit-fuelled growth will make the repeat of a 1997-type crisis a distinct possibility.

Read more at Reuters Breakingviews

Feb. 19 2013 3:06 PM

Offices Depot and Max Lucky to Have Each Other

Uniting the purveyors of U.S. pens, paper clips and printer toner is obvious

Photo by PATRICK HERTZOG/AFP/Getty Images

Office Depot and Office Max are lucky to have each other. Uniting the U.S. purveyors of pens, paper clips and printer toner is about as obvious as it gets in M&A. The potential synergies could be worth more than the market value of the two companies combined. As the internet ravishes retail, at least this corner can cling to life by merger.

Consolidation is overdue. The encroaching power of the likes of Amazon and Target has been evident for years. Office Depot and Office Max are also good partners. Plenty of nearby stores could be closed and their own suppliers squeezed. Based on past deals, savings of about 2.6 percent of revenue, or some $450 million a year in this case, look realistic, Sanford Bernstein analysts wrote in a prescient note on Friday, ahead of weekend reports of the two companies being in talks.


These costs cuts, taxed and capitalized, would be worth $3 billion to shareholders. That's an impressive sum given the two companies were only worth around $2.1 billion combined before the merger talks were reported. Investors initially added another $400 million on Tuesday as they anticipate details on a possible all-sharer combination.

Office Max is on target to generate a net margin of just 0.9 percent in 2013, according to the average estimates of analysts collected by Thomas Reuters. Office Depot is seen struggling to eke into positive territory. Revenue at the top three chains is forecast to stagnate, but online competition could be harsher as other specialty retailers like Blockbuster, Circuit City and Borders learned. While Office Max and Office Depot might together slow the decline, their industry is still bound to die a death of a thousand paper cuts.

Read more at Reuters Breakingviews.

Feb. 15 2013 3:13 PM

Herbalife: The Ultimate Financial Plaything

Carl Icahn has joined investors Bill Ackman and Dan Loeb in the war over the nutritional supplements seller

Photo by Stephen Dunn/Getty Images

Herbalife has become the ultimate financial plaything. Carl Icahn cemented the status by joining uppity investors Bill Ackman and Dan Loeb in the war over the nutritional supplements seller. One idea of his is for Herbalife to go private - again. The controversial business model and rich cash flow make it easy for Wall Street to keep imprinting fresh narratives on the company.

The renewed batting around of Herbalife began last April when another agitator, Greenlight Capital’s David Einhorn, raised questions about whether the “distributors” of Herbalife weight-loss powders and vitamins actually sell them to other customers or mainly consume them personally. The shares swiftly tumbled from over $70 apiece to $46.


Then Ackman, founder of Pershing Square Capital, came along at the end of 2012 with his $1 billion short thesis about the company being a doomed pyramid scheme. That pushed the stock well below $30.

Third Point’s Loeb gave the market something else to think about. He said Ackman was trotting out a tired, old bogeyman about multi-level marketing and that government action against Herbalife was unlikely. Loeb pointed to a $950 million stock buyback plan as a reason to buy.

Icahn, the fourth activist to weigh in on Herbalife, disclosed a 13 percent stake on Thursday, sending the shares up initially about 14 percent. The 76-year-old billionaire, whose personal animosity toward Ackman blew up in spectacular fashion last month live on CNBC, reckons Herbalife is ripe for a leveraged buyout.

It’s an idea as old as Ackman’s skepticism. Private equity firm J.H. Whitney took Herbalife private in 2002 after the founder’s tabloid-fodder death sent the shares plunging. About two years later, Herbalife returned to the public markets, minting Whitney a fortune. In 2007, the firm tried to repeat the trick, but shareholders shot down the $38-a-share buyout offer.

For a company whose business is hard to comprehend and which operates in a constantly challenged gray area, it’s easy to alter perceptions. Its stock is 80 percent more volatile than average, according to Thomson Reuters. The many varied and confident opinions about Herbalife seem to have equally powerful influence. That’s why it’s so important for these multi-millionaire investors to get in the last word.

Read more at Reuters Breakingviews

Feb. 14 2013 2:40 PM

Heinz Deal Gives Taste of New Buyout Secret Sauce

While growth at Heinz is usually as slow as its ketchup flows, the cash still pours out quickly

Photo by Justin Sullivan/Getty Images

Heinz ketchup is giving markets a taste of private equity’s new secret sauce. Buyout firm 3G Capital is swallowing the condiment king for $28 billion with Warren Buffett’s help. In the past, such mega-LBOs required multiple firms to work. With so-called club deals all but dead, the Heinz takeover shows the new way forward.

Only six weeks ago, the group of Brazilians behind both Anheuser-Busch Inbev and 3G, which owns Burger King, made the pitch to Heinz. The U.S. icon quickly saw the benefits of the more globally-minded Jorge Paulo Lemann and his other fellow Gs, named for the Brazilian Banco Garantia they started together. While growth at Heinz is usually as slow as its ketchup flows, the cash still pours out quickly. Moody’s expects the company to generate about $450 million of free cash flow for the year ending April 30.


Even so, 3G would have been hard-pressed to pull off anything of this scale alone. Lemann enlisted his old Gillette board pal Buffett with a transaction perfectly suited to his burger, shake and value-investing appetite. Berkshire Hathaway is putting in the same $4.5 billion of equity as 3G. The Oracle of Omaha’s conglomerate also could reap a 9 percent dividend from some $8 billion of preferred stock he’s acquiring in the deal.

The arrangement is similar to one being used by Michael Dell to buy his eponymous PC maker. Instead of assembling a roster of private equity firms, as was the norm in the pre-crisis buyout boom, Silver Lake Partners and Dell turned to Microsoft for additional funding. And Dell kicked in some cash from his MSD investment vehicle to go along with his 14 percent stake in the company.

Despite how cheap it is to borrow, more creative pairings probably will be needed if more big public companies are to go private. Buyout firms are understandably reluctant to band together after their investors balked and regulators pried into clubby relationships. Berkshire Hathaway and Microsoft aren’t the only companies with hoards of cash they’d like to put to work. Teaming up with private equity might turn out to be a combination that works as well as ketchup on a Whopper.

Read more at Reuters Breakingviews

Feb. 13 2013 12:24 PM

Comcast Ad-Libs on Winning NBC Universal Script

Comcast shares are up by over 70 percent since the first part of the NBC Universal deal closed in January 2011

Photo by Justin Sullivan/Getty Images

Comcast has smartly ad-libbed on an already winning script. Back in 2009, the U.S. cable operator engineered a complex, multi-step deal with General Electric to buy NBC Universal. It has now smoothly accelerated and slightly rejigged the acquisition of the 49 percent of the TV and film group it doesn’t own for $16.7 billion. With the financial side of things now sorted, Comcast boss Brian Roberts must prove he’s the right owner.

The transaction cements the chief executive’s media mogul ambitions. Roberts arranged to buy the owner of Universal Studios and CNBC after a failed hostile bid for Walt Disney. Comcast valued the original 51 percent it acquired at $13.8 billion, partly by contributing its own channels, accepting the obligation to buy half GE’s remaining stake in 2014.


Instead - perhaps betraying a touch of impatience - Comcast and GE have improvised. The newly negotiated purchase cost looks close to what the original mechanism would have produced, according to a Breakingviews calculator from 2009 adjusted for the earlier denouement and slightly faster growth in NBC Universal’s operating cash flow than expected. Comcast is valuing the media enterprise at about nine times EBITDA, assuming growth continues at a similar pace, roughly where Barclays pegs Disney.

NBC Universal’s cash flow won’t fund the deal as it might have done had Comcast waited longer, but the $4 billion-plus of cash it had accumulated as of Sept. 30 will help. So too will the low interest rates at which Comcast can borrow - not to mention $2.7 billion of financing help from GE, which can now hasten its own restructuring plans.

In total, Roberts is draining essentially all of the $11 billion of cash on Comcast’s year-end books to pay for the deal, and it now falls to him to demonstrate his media credentials. Early returns are good. The NBC broadcast network topped U.S. ratings last fall for the first time in a decade. Despite the pricey cost of broadcasting the London Olympics, the company didn’t lose money on the deal as expected. And Harry Potter has worked his magic at NBC Universal’s theme parks. Comcast shares are up by over 70 percent - better than rivals and the broader stock market - since the first part of the deal closed in January 2011.

Even so, it isn’t clear NBC Universal’s entertainment networks like USA will command higher fees for cable carriage the way sports-intensive channels have. Advertising revenue remains highly unpredictable, as does the film business. And Comcast’s cable peers in recent years have jettisoned media operations after shareholders fretted that value got lost within a conglomerate structure. Roberts may be putting away his engineering hat for now, but it could come in handy again some day.

Read more at Reuters Breakingviews.

Feb. 12 2013 3:58 PM

G7 Only Adds to Global Currency Confusion

The G7 endorsed a “domestic” orientation of monetary and fiscal policies

Photo by ASIF HASSAN/AFP/GettyImages

The G7 has spoken about the troubled foreign exchange markets, and the world is marginally less secure for it. In Tuesday’s four-sentence statement, the finance ministers and central bankers of the world’s leading economies managed to ignore the problem of inadvertent competitive devaluations, contradict themselves and make an empty promise.

The G7 endorsed a “domestic” orientation of monetary and fiscal policies. That pleases the United States, Japan and the UK, all of which are pumping vast quantities of money into the economy in the as-yet vain hope that companies and households will spend and invest enough of the new funds to push GDP growth up and unemployment down.


But the endorsement misses the point. While domestic policymakers may see the cheaper dollars, yen and pounds as no more than a welcome by-product of their stimulus efforts, other trading partners - including the euro zone - see a cross-border flow of monetary pollution. They will take no comfort from the commitment to continue not to care about the international consequences of domestic policies.

To move within a single sentence from an endorsement of “market-determined exchange rates” to a pledge “to consult closely in regard to actions in foreign exchange markets” is remarkable even by the standards of diplomatic double-speak. The real meaning is, “We cannot agree on anything but irrelevant platitudes”.

After the vagueness, it is hard to take much comfort from the final promise, to “cooperate as appropriate” in dealing with “excessive volatility and disorderly movements in exchange rates”. If the 20 percent devaluation of the yen against the euro since November is not deemed excessive, the bar for “appropriate” must be set quite high.

True, finance ministers can’t promise or do much about currencies if central bankers don’t play along. And there’s a good case that the recent talk of an impending currency war is exaggerated in the first place. Roughly similar perma-loose policies almost everywhere need not be globally disruptive. But that argument may overestimate the wisdom of politicians and traders - who immediately sent the euro soaring up 0.5 percent against the dollar. If the G7 statement is finance ministers’ best response to the supposed threat of war, then everyone should hope that currency peace returns soon.

Read more at Reuters Breakingviews.

Feb. 11 2013 3:13 PM

Dell LBO Objectors in Tight Corner

Analysts expect Dell to generate $4.6 billion of EBITDA in the coming year

Photo by Joe Raedle/Getty Images

Objectors to the founder’s $24.4 billion leveraged buyout of Dell are in a tight corner. The likes of Southeastern Asset Management are right that Michael Dell and Silver Lake Partners have made a lowball offer. Yet it’s at a respectable 25 percent premium, and the company’s shares haven’t topped the $13.65 per share deal price in months or Southeastern’s $23.72 per share valuation in years.

Dell’s net cash, its finance business at book value and the cost of recent acquisitions, which Dell says are doing well, add up to almost $13 a share, as Southeastern points out. That’s practically the whole of the LBO price, yet it ignores the value of Dell’s server and PC business and most of its IT consulting. Those businesses may be in decline, but they are not worthless.


Or look at it this way. Analysts expect Dell to generate $4.6 billion of EBITDA in the coming year. After capital expenditure, estimated interest costs following the buyout and taxes, the company will probably churn out more than $2 billion in free cash flow. That’s an impressive return on the buyers’ roughly $6 billion of equity - much more than sufficient to compensate for the risk of a continued slide in the PC business.

Southeastern is justified in worrying that the role of the founder and largest shareholder will deter rival bids, despite the board’s efforts to use independent advisers and allow a period to find a buyer at a higher price. Industry rivals might want to pick off some Dell units, but most likely not the whole. And without Michael Dell’s willing involvement, it is probably too big a bite for private equity funds. Moreover, short-term investors betting on the sale - who perhaps now hold a quarter of all Dell’s shares - will mostly vote for the bird in hand if the alternative is the stock returning to earth with a thud.

Southeastern’s other ideas require patience. For instance, a big special dividend financed by debt would still leave shareholders with a period of high leverage and potential earnings volatility before they have as much in their pockets as the buyout price. Yet returning about $4 billion to investors over the past two years via buybacks and a recent dividend has not done anything to persuade public investors of Dell’s charms.

Investors have had time to understand Michael Dell’s turnaround plan, but Dell’s shares traded at no more than about $11 apiece in the months before buyout rumors surfaced in early January. Not enough shareholders seem to be persuaded it’s worth waiting around. More optimistic owners like Southeastern, with its 8.5 percent stake, could be in a position to force the price higher. But barring a major surprise, it looks as though alternatives to the LBO provide too little certainty to match up.

Read more at Reuters Breakingviews.

Feb. 8 2013 1:46 PM

Slowing U.S. Snail Mail Could Speed Innovation

The Postal Service is halting Saturday deliveries to save money

Photo by Justin Sullivan/Getty Images

Slowing U.S. snail mail could speed up innovation. The Postal Service is halting Saturday deliveries to save money. That won’t cover its $5 billion annual losses or plug its pension hole. Even so, it’s an opportunity for Uncle Sam to hasten corporate and individual technology adoption. Over time, further shrinking the USPS should have broader economic benefits.

One of the postal service’s biggest problems, for example, is being forced to deliver mail to all U.S. states and territories at prices that must be approved by a federal regulator. These might be financially viable in big cities, but not in all rural areas. Some 4.2 million households are in such isolated areas and many lack either a computer or broadband Internet access – or both.


A $250 tax credit would allow each household to buy a cheap PC, costing taxpayers $1 billion in total. Hooking them up with decent Internet access will cost more, but at least it wouldn’t have to start from scratch – the Federal Communications Commission is already working on it. If Uncle Sam plowed an extra $2.5 billion a year into that project, it could have a broadband network up and running by 2018, four years earlier than the FCC’s target.

That would spread online access for everything from paying bills to magazine subscriptions – and should spur businesses to up their game. America’s banks, for example, still lag European rivals on same-day free money transfers. They could also cut back on paper statements and bills, as could other service providers like utilities. That will reduce their costs as well as being good for the environment, as less paper and gasoline is spent.

There are broader benefits, too. Fast, reliable Internet access would improve these Americans’ ability to communicate with the rest of the world and put more information at their fingertips. That means more educational and career opportunities. That could boost their earnings, their spending power and even their happiness if it improves talk time with out-of-town relatives or helps them find love on a dating website.

The sort of private sector innovation that America loves to brag about could surely fill whatever holes a smaller USPS creates – and probably create more jobs in the process.

Read more at Reuters Breakingviews.

Feb. 7 2013 4:46 PM

Apple and Einhorn Could Both Use Cleaner Design

Apple has proposed several changes to its articles of incorporation ahead of its shareholder meeting later this month

Photo by Kevork Djansezian/Getty Images

Apple and David Einhorn could both use some of the iPhone maker’s famed simplicity. The $430 billion technology company has combined three governance fixes better considered separately. Also a bit unwieldy is an idea from the boss of hedge fund firm Greenlight Capital to unlock value at Apple. A sleeker approach makes more sense.

Preferred stock lies at the heart of the spat uncorked on Thursday. Apple has proposed several changes to its articles of incorporation ahead of its shareholder meeting later this month. One is a clearly positive shift to majority voting for directors. Another is a largely administrative, though sensible, move to attach a par value to Apple’s common stock.


The third change would prevent Apple’s board from issuing preferred stock without shareholder approval. Calpers, the $243 billion California pension fund and governance champion, supports the whole package. That’s no surprise, since governance advocates worry that directors can use a blank check for pref issuance to deter takeovers. Einhorn, though, wants Apple to consider issuing preferred stock. He has initiated a legal effort to force Apple to break the package into three separate shareholder votes, claiming U.S. public company rules require this.

Legalities aside, the cleanest response would be for Apple to comply. Greenlight says the company has ruled that out. Either way, Einhorn could also streamline his own approach. He’s right that Apple shares look cheap, particularly considering its $137 billion cash pile and over $40 billion of annual cash accumulation. But his idea, floated last year, of distributing preferred shares carrying a fixed dividend yield as a way to crystallize more value may not be the most user-friendly place to start.

A more straightforward initial effort could be to push Apple to pay a much larger regular stock dividend than the smallish payout it has started making. If that doesn’t enhance the company’s value, other ideas could be considered. If Einhorn’s preferred shares then looked attractive enough, shareholders could still vote for them even if Apple’s proposed changes are all enacted.

The company’s design guru, Jony Ive, keeps busy masterminding the uncluttered look and feel of Apple’s gadgets and software. His boss Tim Cook and shareholders like Einhorn might benefit from a similar mindset in the boardroom.

Read more at Reuters Breakingviews