Breakingviews

Nixing China’s oil bid may create Canada discount

By Christopher Swann

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

Canada is at risk of slapping a national discount on its resources sector. Investors reckon there’s a roughly one-in-four chance that the country’s politicians will block a $15.1 billion offer by China’s CNOOC for local energy company Nexen. Takeovers by state-owned companies raise tricky questions. But hoisting the national flag over a company of little strategic importance risks further alienating outside investors.

When state-owned oil giant first unveiled its bid on July 23, investors expected little Canadian resistance. Since then, however, doubts have crept in. Nexen shares are now hovering about 10 percent below CNOOC’s cash offer of $27.50. Though that’s still well above the pre-bid level of $17.30 to which Nexen shares would probably return if the deal was blocked, the market is no longer taking approval for granted.

Part of the anxiety stems from Prime Minister Stephen Harper’s insistence that market access should run both ways. Canada’s Bank of Nova Scotia, for example, has been waiting a year for official go-ahead to purchase a minority stake in China’s Bank of Guangzhou. Cabinet members – and the country’s spying agency – have also expressed concerns about selling to state owned companies which might harbour sinister political motives. And Canada has form in spurning foreign buyers: two years ago, it blocked BHP Billiton’s $39 billion takeover of Potash Corp., the world’s largest fertilizer company.

But buying Nexen hardly gives the Middle Kingdom control of Canada’s energy output. The company is the nation’s 24th largest pumper of oil, according to Macquarie, and about three quarters of the Nexen’s resources are outside Canada. Blocking the takeover would also raise tricky policy questions: is Canada singling out Chinese buyers, or would it also object to the trio of Indian state companies that recently lodged a $5 billion bid for Canadian oil sands currently owned by ConocoPhillips?

Hoisting the flag over Nexen would be bad news for investors in other Canadian mid-sized drillers – including Talisman Energy and Celtic Exploration – that are seen as potential foreign targets. Canada has said it needs $640 billion over the coming decade to fully exploit its energy reserves. Rebuffing its most enthusiastic investor seems especially foolish.

BBA ouster is right first step for Libor reform

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

So, farewell then, the British Bankers’ Association. The UK financial lobby group has signalled that it will not kick up a fuss should it lose its integral role setting and overseeing the London Interbank Offered Rate, or Libor. After a damaging global scandal in which it was revealed that banks routinely tried to fiddle the interest rate benchmark for trillions of dollars of international contracts, it’s an encouraging sign that reform will not be piecemeal.

It should come as no surprise that the BBA’s role is in jeopardy. The outrage that greeted the scandal shone a spotlight on the shortcomings of the Libor-setting process, which involves bankers submitting daily best estimates for 150 rates based on different maturities and currencies, overseen by a committee of more bankers. Martin Wheatley, the UK regulator due to report on the issue on Sept. 28, gave an indication of his thinking back in August: He described the current system as neither independent, robust, nor transparent.

It seems Wheatley won’t pull his punches. He could have meekly fallen into line with other recent attempts at reform, which generally looked to add non-bankers to the BBA committee in charge of Libor. With the BBA out of the picture, that role would probably either pass to a public body or to a more credible private group with stronger public sector oversight.

Yet even if Wheatley did deem Libor’s existing governance adequate, the benchmark would probably still have to change. That’s because he is also reviewing whether to base the rate on actual trade data rather than banks’ best estimates. If market data is to be used, that will in turn raise questions about how to set Libor when actual transactions don’t happen, as occurred during the financial crisis of 2007-2008.

The most critical calls for Libor’s future will be how to incorporate market data, whether there should be fewer rates overall, and how to diversify the rate-setting away from its traditional London base. Whatever package of reforms the UK regulator proposes will need strong global support, perhaps including the backing of the Financial Stability Board which represents some two dozen governments. Hopefully, Wheatley’s proposed Libor reforms will all be as robust as his expected ouster of the BBA.

Who will run Murdoch’s grand newspaper spinoff?

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

With a key British regulatory judgment concerning News Corp’s satellite broadcaster BSkyB cleared last week, Rupert Murdoch can focus on cleaving his newspaper empire. Critically for investors, that means it’s time to pick a leader. Wall Street Journal boss Robert Thomson appears in pole position, though his appointment would spark an editorial chain reaction of its own.

Whoever runs Spinco (the least-disparaging name used by its future employees) will have one of the hardest jobs in media. The Times of London hasn’t covered its costs for decades. The New York Post is a perennial cash sinkhole. Inside a vast conglomerate, the profitability, or lack thereof, of some papers was relatively inconsequential. To attract investors to a standalone print business, the red ink can’t flow so freely. In its last fiscal year, the publishing arm saw operating income drop 31 percent.

A chief executive with demonstrable news business nous might have the credibility to hack away at costs. That probably explains why the name of Murdoch confidant Thomson is making the rounds in New York and London media circles.

Thomson’s experience reshaping the financial broadsheet Murdoch overpaid to acquire four years ago, plus six years as editor of The Times, give him unmatched understanding of the assets and a gravitas with staff that no other News Corp executive exhibits. While Tom Mockridge has led News International since Rebekah Brooks left last year, he hasn’t worked at the Journal, which presents the most promising global opportunity for the separated company.

That’s especially important in the face of potentially renewed competition from the New York Times, where Mark Thompson, the former BBC director general with extensive battle scarring from tangling with Murdoch, has arrived as the new president and CEO.

As chief of a newly public company, of course, Thomson would need to relinquish editorial duties, kicking off a game of journalistic musical chairs. The guessing over who will lead the Journal is already in full swing internally, with editors Gerry Baker and Alan Murray seen as potential candidates. Wrenching changes at the Times might also lead to changes there.

iPhone 5 will live up to the hype – in time

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

The iPhone 5 will live up to the hype – in time. Apple sold 5 million of the new handset, or about $3 billion worth, during its three-day debut. That fell short of Wall Street’s whisper number, which was up to twice as high. Yet the latest sales outpaced those of its predecessor and the company couldn’t meet demand. Supply-chain glitches and map-app hysteria won’t derail Apple’s smartphone train.

Apple sold 4 million of its last phone, the 4S, on its opening weekend in October last year, and 1.7 million of the previous iteration 16 months earlier. Though investors fixate on these openings, they aren’t as indicative as the Hollywood box-office premiere tallies they’ve come to resemble. Apple shares tumbled 2 percent on Monday, knocking about $13 billion off the company’s market value.

Despite missing the early expectations, the iPhone 5 is destined to be a blockbuster. Most stores quickly sold out. The wait for online orders is up to four weeks. The phone is still only available in nine countries, though 30 more will be selling it soon. There’s also plenty of market share to be snatched from struggling Nokia and Research In Motion.

The real problem for now is that Apple just can’t make enough. Manufacturers of hit gadgets routinely encounter the problem. Sourcing screens, processors and memory is difficult even for a company with Apple’s fastidiousness and clout. The more cutting edge the components and the greater the demand, the more likely the supply chain will hiccup. Apple, however, overcame similar short-term problems in 2010 with both iPhones and iPads.

It only goes to show just how fanatical Apple’s customers are. Some were camping outside stores a week in advance for the iPhone 5. Many fans shrugged off the frenzied backlash against Apple’s replacement for Google Maps and critics saying the phone offered only incremental improvements.

The iPhone makes up about half the company’s total sales – expected to be about $156 billion for the fiscal year ending in September – and a greater proportion of its profit, so there’s a lot riding on sorting out production. But with Tim Cook – regarded as one of the best in corporate America at handling logistics and an executive with a history of fixing similar problems – there’s really not much cause for concern. It won’t be long before the iPhone 5 is delivering many happy returns.

Spain looking to cut corners on bank bailout

By George Hay

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

Spain remains intent on cutting corners on its long-awaited bank bailout. The country has been promised up to 100 billion euros to recapitalise its ailing lenders. It’s looking worryingly like it will try everything to minimise the headline number. The country’s government obviously doesn’t get that it must be conservative to be credible.

The current assumption is that Spain will take around 60 billion euros, according to a senior Spanish banker. That has to make up for the capital shortfall created by transferring around 130 billion euros of toxic assets, at a big discount, from the worst lenders to a new “bad bank”. The numbers look to be based on 261 billion euros of losses on overall Spanish loans, offset by existing provisions and likely profit over the next few years, and a requirement for the banks to end up with at least a 6 percent core Tier 1 ratio.

These loss assumptions, which come from consultant Oliver Wyman’s sector-wide study in June, aren’t ridiculous. They assume an overall 16 percent loss on loans, including a 47 percent loss on developer loans. But they still may not be conservative enough. Instead of an 80 percent loss rate on undeveloped land, as assumed, the true figure could be closer to 100 percent. Throw in a few other assumptions from a ’worst case’ scenario – such as the prohibition of deferred tax assets as capital – and the capital shortfall may amount to 87 billion euros, according to JPMorgan research.

Then there’s the actual discount applied. The 60 billion euro hole implies a 55 percent discount on the assets sold to the bad bank. This is hefty, but may not be enough to banish lingering concerns that things could get worse. For every extra 10 percentage point in the discount, another 13 billion euros of recap money would be needed, according to JPMorgan. Assume a 65 percent haircut on top of the stiffer loss assumptions, and Spain would need all 100 billion euros already earmarked.

Why is Spain trying to dodge those hard facts? It may be that Prime Minister Mariano Rajoy’s government does not want to increase its debt to the euro zone. But a more negative view would be that Rajoy is being his usual self. When dealing with banks, he has consistently shown a preference for a piecemeal approach, instead of going for comprehensive solutions. But if investors now take yet another Spanish bank bailout with a pinch of salt, it will make it harder for Spain to turn the corner.

Real estate wave helps an IPO avoid tech wipeout

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

A real estate wave helped an initial public offering avoid a tech wipeout. Newly listed shares of Trulia, an online property listing service, popped by over 40 percent in their debut on Thursday. That defies the dire dot-com market evidenced by the likes of Facebook and Groupon. The U.S. housing recovery is a good story but Trulia is also still hitched to the Web.

For the first time in years, home prices, new construction and completed residences are slowly increasing across America. The rebound is helping many boats rise. Since the start of the year, Home Depot shares are up 43 percent, those of paint maker Sherwin-Williams have gained 67 percent and builder Lennar have rocketed 87 percent.

Trulia benefited, too, by associating itself with the housing market instead of the tech sector. More home sales mean more traffic on its site, more ads from movers to mortgage brokers and more realtors paying to have their picture and phone number pop up next to a new listing. The company’s first-half sales grew by nearly 80 percent from a year ago.

But the company’s financials reveal its true pedigree. Trulia is valued at about nine times the revenue it should be able to generate this year based on its January-to-June performance. That’s a tech multiple, not anything found in the bricks-and-mortar world of housing. It also has never turned a profit in seven years of existence, a foundation on which only a web IPO could be built. If Trulia can’t swing into the black soon, investors could move the shares into the shabby tech neighborhood.

BSkyB should start to build in new bid premium

By Chris Hughes

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.

South Africa platinum crisis not over yet

By Kevin Allison

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

South Africa’s platinum crisis isn’t over yet. A pay deal struck by Lonmin will, if it holds, end a violent six-week strike that has claimed 45 lives. That’s good for the workforce. And it solves an immediate, potentially existential problem for the world’s third-biggest platinum producer. But it sets up other big challenges for Lonmin and the industry. The big wage hike will hurt already weak margins. And the response may only encourage further strikes.

The pay deal was a surprise. Lonmin’s shares opened 9 percent higher in Johannesburg on Sept. 19. Earlier this week, the two sides seemed far apart. But several weeks of shut production and no wages, along with police raids on mining villages at the weekend, seem to have forced the issue. The miners have agreed to go back on the clock in return for a pay rise of up to 22 percent, plus a signing bonus.

The next few days should tell whether the agreement sticks. Lonmin’s employees are due to return to work on Thursday, though in reality it will probably take longer to know whether the deal has support.

Even if the settlement holds, the consequences for Lonmin and the industry may still be painful. Lonmin’s higher-cost operations meant it was only just breaking even on its mines before the labour unrest began. Worker pay is 60 percent of the company’s cost base, according to Nomura. Six weeks of disruption will force the company to spread its fixed costs over fewer ounces of mined material, hurting mining margins further. If platinum’s recent price rally fades as concerns over supply ease, that will also challenge the industry’s economics.

Lonmin may have had no choice but to agree to a big wage bump. What started as a local labour dispute turned into a national emergency after 34 workers were killed by South African police in August. Nevertheless, Lonmin has publicly blinked in the face of pressures that started well outside the standard labour relations channels. Lonmin’s shares pulled back, trading just 2.5 percent higher by midday in London on Sept. 19. That seems a fair reflection of the extent to which the benefits of resolving this tragic situation may come at a significant cost.

Goldman’s Mr. 25 Standard Deviation hard to follow

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

Goldman Sachs’ Mr. 25 Standard Deviation was a Wall Street rarity. Despite an outlandish 2007 characterization of the crisis – “We were seeing things that were 25-standard deviation events, several days in a row” – that raised concerns he didn’t understand fat-tail risks, David Viniar played a big role saving his bank from the mortgage rout and was the blue-moon banker who succeeds as a chief financial officer. He’ll be a tough act to follow.

Viniar led the call for Goldman to cut its U.S. residential mortgage positions in December 2006. That helped keep the firm stable financially, even if it didn’t stop the reputational damage that still endures. The highly paid Viniar also was one of the few calm voices during the depths of the financial meltdown in 2008.

His origins from Goldman’s structured finance department make his success all the more unusual. Recent attempts to move investment bankers into the finance department have been disastrous. Erin Callan couldn’t cope with the deteriorating conditions at Lehman Brothers. Merrill Lynch used the CFO position as a career stepping stone. Stan O’Neal served a stint as part of his grooming to be chief executive. It didn’t help him or the Thundering Herd avoid the subprime meltdown. Neither did O’Neal’s own choice for the job, equities banker Jeff Edwards.

Though his way with words was occasionally worrisome – another gem was describing trading as “prop with a client overlay” – Viniar brought crisis experience to the CFO’s office. During Goldman’s near-demise in 1994, he was in charge of funding, and was deputy CFO amid the 1998 collapse of Long-Term Capital Management and its fallout. His replacement, Harvey Schwartz, is no slouch either.

He’s a member of Goldman’s risk committee, sat on the company’s business ethics review committee in 2009 and the financial crisis must count as relevant on-the-job training. That’s no guarantee, however, that a trader like Schwartz – he’s co-head of the securities arm – will make a good CFO. He’ll at least have Viniar around for advice. Goldman’s putting him on the board. If Schwartz can handle his predecessor peering over his shoulder, it’ll make the big shoes easier to fill.

Markets sagely dismiss China’s anti-Tokyo tantrums

By Wayne Arnold

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

Investors aren’t particularly bothered by China’s anti-Tokyo protests. While smashed cars and shuttered factories are worrying, the two countries have more to lose in trade and investment than to gain from tit-for-tat reprisals. Companies that are big in China like Nissan may suffer in the short-term, but Japan Inc. has more to fear from U.S. Federal Reserve chairman Ben Bernanke than from Beijing.

Judging by the two country’s stock markets, you wouldn’t guess a dispute over uninhabited islands north of Taiwan had caused the world’s second-largest economy to explode in anger against the third-largest. Japan’s stock market lost only 0.4 percent on Sept. 18, the yen rose, and the cost of insuring Japanese sovereign debt climbed only slightly. China arguably looks the victim: the Shanghai market is down about 3 percent this week. But even that is a trifle when compared with its 17 percent decline in the past year.

China might seem to have the economic advantage: it’s Japan’s largest export market, accounting for 18 percent of Japanese exports. And China is a crucial part of Japan’s supply chain – Chinese subsidiaries of Japanese companies sell 23 percent of their production back to Japan. Some Japanese companies have also come to depend on China for sales growth. Nissan sells more than a quarter of its vehicles in the country, its largest market.

But any move to punish Japan would likely prove, as Beijing’s mouthpiece the People’s Daily has observed, a double-edged sword. Chinese imports from Japan are largely capital goods such as steel, heavy equipment and industrial robots, which are difficult to substitute. Japan is China’s third-largest foreign direct investor and fourth-largest importer. And while China may be a key supplier, rising costs have been driving more Japanese companies to shift elsewhere.

It’s possible that the protests will flare up into a bigger conflagration. But a bigger threat to both economies may be the $40 billion-a-month barrage of cash Bernanke has vowed to blast into the global economy every month until the U.S. job market improves. That’s likely to sink the U.S. dollar, reducing returns on China and Japan’s foreign reserves, and put pressure on exports. Investors are betting Bernanke’s bazooka is the only weapon that will be fired.