private equity, buyout groups, Vodafone

Private equity set for mega-cap splurge?

12.05.2006

by Simon Nixon

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Cash sloshes around the City

So what is to be done with it? Expect it to be poured into ever bigger deals

How much longer before private equity makes a bid for a real giant, such as Unilever or Vodafone? The world’s biggest buy-out is still KKR’s acquisition of RJR Nabisco for $31bn (£26bn) back in 1989. But I’d be surprised if this record wasn’t broken soon. That could create some interesting opportunities for investors.

True, companies such as Unilever at £40bn and Vodafone at £100bn are probably too big a mouthful even for a private-equity consortium bid. Buyout groups can’t put more than 20% of a fund into one deal and banks will typically only lend $3 for every $1 of equity. So even the latest giant funds can’t write cheques for more than about $8bn. Their best option might be to team up with a trade buyer. A recent rumour linked US telecom group Verizon and Spain’s Telefonica with a break-up bid for Vodafone.

The numbers certainly stack up. UBS reckons Vodafone trades at a 25% discount to the sum of its parts. The mobile-phone group grew rapidly in the bubble years, thanks to several headline-grabbing deals by former boss Chris Gent. But most of Gent’s deals destroyed value and his successor, Arun Sarin, was left to pick up the pieces. He’s already sold the troubled Japanese division and may be about to sell the US division too. Even so, that’s still not likely to close the discount.

Similarly, Unilever’s first-quarter results were a dismal affair, with sales up just 2%, dashing hopes that new boss Patrick Cescau had engineered a turnaround after a year in the job. Unilever’s problems are both cultural and structural, with little evidence to support its claim to reap economies of scale from being in both food and household goods. Collins Stewart reckons it would be worth 30% more if it was broken up.
Could a bid emerge? The conditions are certainly propitious. Private equity has more cash sloshing around than it knows what to do with. Blackstone and TPG recently raised monster funds of more than $10bn; KKR last week raised $5bn – three times its target – for a new fund listed in Amsterdam. And private equity will be desperate to spend this money so that it can start collecting its juicy 2% management fees.

What’s more, buyout groups are struggling to find targets among the small and mid-caps – their usual hunting ground. Mitchells & Butlers, HMV, ITV and Associated British Ports have all seen off private equity-backed bids in the last few weeks. Vulnerable companies are shoring up their defences by doing the things that private equity does – selling non-core businesses and piling on debt. And investors are refusing to sell out cheap. The only stocks that still look reasonably priced are the mega-caps.

Don’t trust the analysts

So Robert Tchenguiz failed in his bid for Mitchells & Butlers. No surprises there. What is a surprise, though, is how little the shares have fallen back. At 477p, they stand over 20% higher than before news of his interest broke. Yet at the time, not one analyst thought the shares were worth anything like this much. In fact, the average price target in January was 403p – whereas now it stands at close to 500p.

Now even if you allow for the fact that Mitchells & Butlers has reported some sparkling results since then and that the bid encouraged the board to be more open about its prospects, this is still a poor show by the analysts. Nor is it an isolated example. When Saint-Gobain launched its surprise hostile bid for BPB last year, the average price target for the plasterboard maker was 535p. Yet analysts still complained that the French group’s initial bid was too mean at 750p. BPB was eventually sold for 780p.

But really to see the uselessness of price targets, look at the London Stock Exchange. When Deutsche Börse launched its 530p bid in December 2004, its offer was well above any analysts’ price target. Eighteen months and three failed bids later, and the shares stand at close to 1,300p. No amount of improved trading can explain that rise. The market simply wasn’t valuing the business properly.

The moral of the story? Treat analysts’ price targets with a pinch of salt.

Tories: still clueless

The Tories may have had a great couple of weeks – but after my meeting with a senior shadow cabinet minister this week, I don’t think anyone should be counting their chickens. On all the pressing economic issues – pensions, taxes, nuclear power – the party remains worryingly clueless. But I suspect the issue that could really trip it up is planning. This lies at the heart of many of Britain’s economic challenges – our housing shortage, our lack of decent infrastructure, our energy shortages. Even if the Government gives the go-ahead to new nuclear-power stations, it’s not clear that they will ever get built under existing planning rules. The snag is that core Tory voters are affluent people with nice houses who worry that if the rules are relaxed, someone will come along and ruin their view. The test of whether the Tories have really changed – and are fit for office – will be whether they can square this circle.