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.

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.

Bristol-Myers and Astra make fat bet on obesity

By Robert Cyran

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

Bristol-Myers Squibb and AstraZeneca have made a fat bet on obesity. The U.S. and UK drug giants are teaming up in the $7 billion purchase of Amylin Pharmaceuticals. Seven times estimated sales is a hefty price to pay for a biotech whose main drugs face stiff potential competition. But Amylin’s focus on diabetes, a sadly expanding market across the globe, makes this a healthier financial endeavor.

The deal is a bit complicated. Bristol is paying $5.3 billion for Amylin’s equity and another $1.7 billion to cover debt and obligations associated with the biotech ending a joint venture with Eli Lilly. In a follow-on transaction, AstraZeneca will pay $3.4 billion for half the profits and losses from Amylin’s drugs.

The rationale is simple. The world is getting fatter. And while the United States and UK are near the forefront of the trend, developing countries such as China and India are rapidly catching up. This has health consequences. The number of patients with diabetes has more than doubled since 1980 to about 350 million, according to a study last year in the Lancet medical journal.

Yet Amylin hasn’t lived up to all of its backers’ hopes. Sales of the company’s lead drug, which is derived from the spit of the Gila lizard and has the happy side effect of reducing patients’ weight, have grown slowly. The recent introduction of a weekly version should help. But skeptics will point out that firms ranging from Novo Nordisk to Sanofi to GlaxoSmithKline have similar drugs in development or already on the market.

So why are Bristol and Astra paying roughly seven times estimated 2013 sales for the money-losing biotech? Similar firms with products on the market trade at about five times. The fact the two pharma firms already have a partnership devoted to diabetes helps. Plugging Amylin in should result in some cost synergies, and the two firms might be able to do a better job selling lizard spit. But the biggest factor in favor of the deal is time. Amylin’s drugs are unlikely to face cheap generic competition for the foreseeable future. Meanwhile, diabetes will continue expanding relentlessly. That gives plenty of time for the purchase to grow into its valuation, and perhaps become a sweet deal.

Glenstrata wobble another blow for M&A bankers

By Quentin Webb

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

The collapse of Glencore-Xstrata would be a $130 million blow to mergers and acquisitions bankers. Nine banks would lose most of that fee pool, and league-table standing too, if investor pressure nixes the $26 billion Xstrata buyout. Even in a merger boom, that would hurt. But it’s particularly painful in a thin year for deal-making.

The long roster of advisers always looked rich for mining’s most obvious deal. Now the banks may go nearly empty-handed, since their fees tend to be heavily dependent on a successful deal. Xstrata’s five banks stood to make as much as $80 million for financial advice and broking, while the quartet representing Glencore could have made $50 million. This comes shortly after another disappointment for the bulge bracket: KKR’s partial exit of Alliance Boots, Europe’s biggest buyout, for which the private-equity giant relied on the advice of one boutique.

M&A advisers are sunny-side-up types. Big companies are swimming in cash and need new ways to grow, the mantra goes. And beaten-down stock markets make targets cheap. That means more deals like Mexican billionaire Carlos Slim’s recent swoop on European phone companies should be on the way. Investment banking executives hope the same: after all, M&A is a prestigious business that promises big payday without eating up precious capital – and can generate plenty of revenue for other bits of the bank.

Alas, those hopes have foundered on Europe’s debt crisis. At just over $1 trillion, global M&A volumes in the first half of the year are down 25 percent on the same period in 2011, preliminary tallies from Thomson Reuters show. If Glencore-Xstrata collapses, the year’s biggest “deal” to date will be the Spanish government’s rescue of Bankia. That hardly shows a thriving market.

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.