Tuesday, 19 February 2013

Nik Stanojevic: Capital discipline revisited



Back in January we wrote about a ‘new normal’ in capital discipline within publicly listed companies. We said that the corporate sector might be less likely to go on an acquisition/capex binge, and that listed companies may thus be less likely to overextend themselves than past cycles, at least for a while. This should also lengthen capex cycles which would be positive for investors.

Since then a number of large, high profile deals have been announced including Dell, Heinz, American Airlines, NBCU and Virgin Media. So where does this leave our thesis?
  • The $24.4bn proposed takeover of Dell does not contradict the view. Founder Michael Dell and Silver Lake partners are planning to take Dell private which all else equal should be positive for public markets.
  • Berkshire Hathaway and 3G Capital’s potential $27bn all cash takeover of Heinz will leave publicly listed Berkshire with plenty of cash. Berkshire currently has cash less debt of around $124bn and CEO Warren Buffet is famously against leveraging up for acquisitions. With Heinz’ pricing power and stable growth, this is the kind of transaction which could make a good return for the buyers.
  • The US Airways all share combination with American Airlines announced last week has been known about for some time as AA went through chapter 11 bankruptcy and restructured its cost base. Leverage for the combined company will not change substantially as both companies had similar pre-deal leverage levels.
All this is encouraging with a private equity buyout, a purchase out of cash reserves and a genuine all share merger which did not significantly change leverage for either company. However, as in the past the telecoms sector puts a slight dampener on things.

Comcast (a US cable operator) will see net debt of $30bn increase to around $47bn with its proposed $17bn all cash purchase of the 49% of NBCU (a content company) that it does not already own from GE. Leverage will increase with Net-debt-to-EBITDA expected (by analysts) to go from 2.0 to c.2.3x. However, this is relatively comfortable for a telecoms services company, although it is no longer particularly low. Investors were happy with the inexpensive price paid and analysts expect the deal to be accretive to earnings.

Liberty Global’s (a US listed cable company with mostly European networks) proposed $23bn purchase of Virgin Media (a UK based cable company) should not increase leverage significantly, but only because Liberty will increase its share capital by 55% to fund around 60% of the acquisition (Liberty’s leverage is already reasonably high). Liberty Global’s shareholders may be disappointed that the deal will be dilutive to earnings due to the issue of new shares.

So what conclusions to draw? Of the five large transactions announced in the last two weeks, none have increased leverage substantially and none strike us as large, top of market empire building, and value destructive (although Liberty/Virgin Media might qualify as empire building). So far so good.

Nik Stanojevic
Divisional Director - Research

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