Breakingviews

Amazon hedges against the rise of the machines

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

Is Amazon hedging itself against the rise of the machines? That’s one way to explain the kooky $775 million purchase of Kiva Systems. Either that or the online retailing giant’s founder Jeff Bezos has a robot fetish. It’s not clear what the deal offers Amazon shareholders. Automating Amazon’s warehouses makes sense. But buying Kiva droids, rather than their maker, seems the more rational approach.

There’s no doubt that Kiva’s orange robots have a big place in the future of supply chains. And after the initial outlay of $15 million for a giant warehouse, throwing in a few Kiva borgs helps to slash operating costs and speed the handling of goods. This explains why Kiva is growing roughly 80 percent annually, with sales approaching $150 million last year according to analysts.

Amazon undoubtedly needs some help – the company’s net margin was less than 2 percent last year as fulfillment costs rose 58 percent. Automation helps reduce these costs. Fewer workers need to be hired and items can be shipped faster, which means items can be sent by truck rather than pricier planes. It may also increase capital efficiency if warehouses can handle more items or inventory turnover quickens.

Yet it’s not obvious that Amazon needed to buy the cow when it could just purchase the milk. Kiva already sells lots of robots to companies ranging from Gap to Staples. For $775 million, Amazon could buy a lot of robots without the hassle of running a company that’s peripheral to its core business of selling apparel, books, music or toys. Instead, it’s paying five times estimated sales for what looks like a distraction.

There may be a strategic advantage to Amazon owning Kiva. While the company says it will continue to sell its robots to other firms, there may be ways to tailor the systems to fit best with Amazon’s warehouses and systems, giving it a leg up on online retailing rivals. But Kiva has plenty of rivals trying to build better robots that would gladly fill any void in the market. The machines may one day rise, but there’s no assurance Amazon’s pricy bet will.

Cisco’s John Chambers falls off the M&A wagon

By Robert Cyran The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Cisco’s John Chambers has fallen off the M&A wagon. Less than a year ago, the networking giant’s chairman and CEO, in an unusual mea culpa to employees, forswore big deals and promised discipline. Now, Cisco is shelling out $5 billion for NDS Group, a pay TV software firm. But this acquisition might just deliver justifiable returns and fit nicely with Cisco’s revised strategy.

Cisco had a long history of overstretching prior to last year’s shift. The company’s deals had transferred oodles of Cisco cash to other firms’ shareholders, hurting Cisco’s valuation and leaving the firm sprawling and a struggle to manage. That distracted executives from core businesses in routers and switches, which were under attack from rivals like Juniper Networks and Huawei. Profit warnings ensued with alarming regularity.

Chambers’ pivot a year ago – which included shuttering some operations, selling others, and focusing on fewer businesses – generated quick returns. The firm’s value has risen by more than $15 billion since last April, as investors have regained confidence in Cisco’s commitment and ability to protect its cash-cow businesses.

So the NDS transaction has naturally stoked concerns that Chambers has returned to his bad old empire-building ways. Indeed, with assumed debt the deal amounts to Cisco’s largest takeover since it spent $7 billion on Scientific Atlanta in 2006.

Yet aspects of this deal should calm concerns. Video is one of the five areas that Cisco is focusing on. And NDS software should fit well, allowing protected content to be delivered to Cisco’s set-top boxes and other devices over the web. The returns look reasonable too. NDS had operating profit of $127 million in the second half of 2011. If the firm keeps its current trajectory of revenue growth and costs for the next three years, and manages to find synergies equal to 10 percent of NDS’s costs, the return on investment would be close to 10 percent. That’s certainly better than the minimal interest Cisco’s cash is earning in the bank, and probably above its cost of capital.

These factors may make the acquisition worthwhile. True, there are risks. The world of video is quickly shifting, and big acquisitions often are difficult to digest – as Cisco’s past problems suggest. Perhaps the greater danger is that one reasonable deal whets an appetite for a return to more dealmaking. Chambers needs to avoid any such relapse.

Youku-Tudou price pop not only about synergies

By Wei Gu

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

Investors are hooked on Internet video portal Youku’s plan to merge with smaller rival Tudou. The companies’ combined market capitalisation swelled by $1.5 billion after the unveiled merger. Cost savings of $50 million to $60 million a year only partly explain it. Other factors may include a squeeze on short sellers, a re-rating of the sector, and hopes that an enlarged Youku could itself be a bid target.

Synergies offer some justification for the 45 percent increase in the combined companies’ value. Youku and Tudou could cut costs by sharing some content, and using their search functions to link to each other’s sites. Youku sees annual cost savings of up to $60 million, compared to their total content costs of $140 million in 2011. Those could be worth up to $600 million in present-value terms.

There may be revenue synergies too, but it is hard to see where these will come from. While the two companies will merge their ownership structure, the two user-facing sites will remain separate.

What of the remaining $900 million increase? A short squeeze may have played a part. Short-sellers have targeted U.S.-listed Chinese companies after scandals like the deep accounting irregularities at forestry company Sino-Forest. Concerns over unusual, cross-border holding company structures also weigh on the sector. The surge in the companies’ shares will have left some short-sellers scrambling to cover their positions as the shares surged.

Then there is the hope of more deal activity. An enlarged Youku-Tudou could itself be a target. It would be a relatively small potato, with just 3 percent of China’s online advertising market. Their current combined market cap of $4.8 billion is a 10th of that of diversified Internet player Tencent, which is pushing aggressively in the online video market. Youku’s combined knowhow in online video technology and content may be attractive to those deep-pocketed diversified players.

Splitting AT&T CEO and chairman roles a no-brainer

By Robert Cyran

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

Randall Stephenson’s botched plan to buy T-Mobile USA came with a $4 billion tab. The board didn’t see fit to hold him fully accountable. But shareholders can have their own say – and should vote to strip Stephenson of his chairman title and install an independent.

The lumps suffered from the failed $39 billion deal may not be an especially big sum. After a tax benefit, it amounts to less than two months of free cash flow – and AT&T’s market value has actually gone up since the transaction was first announced amid a broader stock rally. Even so, AT&T shareholders would be better off with the funds used to pay the break fee in their company’s coffers than Deutsche Telekom’s.

Stephenson got a mere slap for the misadventure, which also bore additional cost in the form of at least six months’ worth of management distraction. His total compensation for 2011 fell by less than a fifth to $22 million from just over $27 million in the previous year, despite AT&T’s middling performance on various targets such as earnings per share or cash from operations.

Shareholders now have an opportunity to step in where the board opted not to. Another way to make Stephenson responsible – and establish an extra safeguard against another T-Mobile-like misstep – would be to separate the two seniormost roles at AT&T. It’s true the board already has several measures in place to protect investors. For example, Stephenson is the only manager on the board and most important committees are made up solely of independent directors.

But it is simply good governance to separate the two roles. And plenty of challenges lie ahead for AT&T. Accumulating spectrum and shoring up the company’s network to service accelerating data demand are chief among them. Leaving Stephenson to focus on these significant matters and bringing in an independent chairman to run the board would make AT&T all the better. Shareholders missed chances to split the chairman and CEO roles in 2006 and 2009. They shouldn’t let it pass them by again.

Glencore faces fight to land $5.5 bln Viterra deal

By Kevin Allison

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

Ivan Glasenberg seems to like difficult deals. The chief executive of commodity trader Glencore is still trying to win over shareholders in Xstrata to a proposed $90 billion merger with the miner. But he is potentially also in the market for a smaller but no less challenging acquisition, of Canadian grain handler Viterra.

Agriculture is a growing part of Glencore. Buying Viterra would make strategic sense. The assets are attractive, and the expected liberalisation of Canada’s wheat market in August means a deal would be opportune. As with Xstrata, the apparent logic would be to shunt the target’s production through Glencore’s global trading machine, giving the firm more scope to exploit commodity market inefficiencies around the world.

The mooted price seems about right. Glencore is proposing a possible offer in the region of $5.5 billion, the Sunday Telegraph reported. Add net debt and that would represent an enterprise multiple of about 9.3 times expected fiscal 2012 EBITDA, based on Reuters consensus estimates. That’s broadly in line with other recent agriculture deals.

But if Glencore proceeds, it may find it hard to avoid being bid up in an auction. The planned ending of the Canadian Wheat Board’s seven-decade monopoly on wheat and barley marketing has piqued international interest in the sector. Cargill, with about 13 percent of Canada’s breadbasket, might relish the opportunity to roll up its biggest rival. It would also probably be able to extract more synergies from a deal than Glencore, whose existing agricultural portfolio lies outside Canada.

A still bigger challenge is politics. While a transaction would be worth only about 13 percent of Glencore’s current market value, it would be material in other ways – roughly doubling Glencore’s revenue from agricultural commodities and giving it 45 percent of Canada’s grain deliveries, along with a significant chunk of the related infrastructure. Less than two years since Canada’s government blocked BHP Billiton’s hostile takeover of Saskatchewan’s Potash Corp, agricultural resources appear to be as touchy a subject as ever. If Glencore has a relative advantage, it may only be that it is seen as a less problematic buyer than rivals.

Icahn targets given red alert by Dynegy debacle

By Christopher Swann The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Carl Icahn’s reputation already precedes him when he turns up to agitate. Now a court-appointed official has shredded a retooling at Dynegy, where the uppity investor meddled and installed directors. Companies on the receiving end of his tactics, like CVR Energy, have all the more reason to spurn Icahn.

Once a $13 billion powerhouse, Dynegy’s equity is now worth a mere $70 million. The 76-year-old raider-cum-activist has played a significant role in the latest step of the downfall, ever since he helped block a $600 million leveraged buyout by Blackstone at the end of 2010. With a stake of nearly 15 percent, he is the largest shareholder – and responsible for two of Dynegy’s six directors.

Icahn, along with hedge fund Seneca Capital, helped persuade investors that a gas-price revival would reinvigorate the heavily indebted company. As prices kept tumbling, ever more desperate measures were attempted. A restructuring at the end of 2011, after Icahn’s appointees joined the board, shifted lucrative coal-fired assets beyond the reach of bondholders, in a move that up-ended the conventional capital structure. A court examiner slammed the maneuver as a “fraudulent transfer” and recommended that Icahn’s representatives – along with other non-officer members – be removed from the board.

The debacle won’t help Icahn’s broader cause. His shake-up efforts typically involve byzantine deal structures and hardball tactics. Take, for example, his latest target, CVR Energy. Icahn says the $2.3 billion oil refiner should sell itself. Not only does he plan to nominate a full slate of directors, but he lobbed in a takeover bid of his own that includes fiendishly complex contingent value rights. In the last couple of years, he has tried similarly inventive ploys at Commercial Metals, Clorox and Lions Gate – only to eventually walk away.

Other investors may get burned in these situations, but Icahn doesn’t always leave empty-handed. His fund achieved returns of 35 percent in 2011, a year when peers were down about 5 percent on average, according to Hedge Fund Research. But this latest episode at Dynegy provides a red alert for management and shareholders elsewhere. And the more skeptical they become, the less effective Icahn’s antics will be for him.

M&A lawyers lob stones at Goldman from glass house

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

M&A lawyers tossed stones at Goldman Sachs from a glass house. Debate over how the bank played both sides of the El Paso sale to Kinder Morgan drowned out other hot topics at this week’s dealmaker jamboree in New Orleans. Bankers and chief executives took beatings over other conflicts of interest, too. For an event organized by and for mainly attorneys, however, there was surprisingly little self-reflection.

Topics like investor activism, especially with Bill Ackman in attendance, and dodgy lawsuits also were on the docket. But like highway rubberneckers, no one could resist the deal wreck laid bare in a Delaware ruling last week. One panel’s moderator even tried actively to steer the conversation away from the case, but failed.

There was plenty of outrage to go around the Big Easy’s Roosevelt Hotel. Goldman, Morgan Stanley and El Paso Chief Executive Douglas Foshee all drew fire for their roles, but the sharpest criticism from Merger Gras revelers was reserved for the Goldman banker who held a $340,000 investment in Kinder Morgan.

Who would have dreamed to ask whether the lead adviser from the firm helping the seller held an investment in the buyer, one lawyer asked. Well, he might have had the good sense to come forward on his own, responded another.

From there, it went downhill for the outnumbered bankers. Lawyers revisited last year’s controversial Del Monte case and the subject of staple financing. There was also a suggestion that perhaps a second bank brought in to “cleanse” another’s conflict should never get paid with fees contingent on closing.

But the legal eagles avoided the subject of their own potential conflicts. Strict ethics rules and client checks often prevent them. But with so many lawyers and so many deals, mega-firms can find their own conflicts questioned, as occurred, for example, in the case of hostile target Airgas. Multiple bidders can make matters messier still. M&A lawyers can’t be too careful about tracking their own investments. And their deal advice isn’t beyond reproach.

Fortune 500 plays tough for home-court advantage

By Reynolds Holding

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

U.S. companies are playing tough for home-court advantage. Weary of fighting shareholders in multiple states, the Fortune 500 is forcing M&A lawsuits into its preferred forum, Delaware. But investors deserve a say in the matter. As the hot-button issue plays out before judges, deal-making lawyers and bankers will give it a hearing at their annual New Orleans confab this week.

Mergers invite lawsuits now more than ever. Companies were sued by investors in almost 95 percent of transactions last year, according to a study by two law professors.

Many such claims no longer land in Delaware, the legal home to most of corporate America. The state’s courts retain a pro-management reputation while judges elsewhere have handed shareholders surprising victories. Last year’s conflict-of-interest lawsuit against JPMorgan and others, filed and won in Illinois, is a case in point.

States fight for the revenue and prestige of hearing corporate cases, often by being slower to throw them out or by awarding more fees to attorneys, the professors found. That competitive spirit may also help explain why, a month after insisting that Delaware can be plaintiff-friendly, the state’s Chancery Court chief, Leo Strine, awarded a record sum of around $300 million to the lawyers who represented a challenge to the Grupo Mexico and Southern Copper transaction.

Shareholders are suing in multiple states over the same deal in hopes of hitting pay-dirt. Oracle, for one, hit back against such opportunistic redundancy. The California-based technology company changed its bylaws so investors could sue only in Delaware. A federal court struck down the change, but hundreds more companies have adopted similar amendments – and are being challenged.

Browne’s North Sea idea is more than nostalgic

By Kevin Allison

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

Buying into Fairfield Energy, the North Sea-focused UK oil producer, would be a fitting move for John Browne. In the 1980s, when some of Fairfield’s most attractive assets were first being developed, the ex-BP boss was managing the Forties oil field off the coast of Aberdeen. But Browne’s interest in Fairfield, reported by the Sunday Times on Feb. 26, is likely to be more than just nostalgic. Fairfield specialises in mature oil fields that no longer interest the big majors. With oil prices likely to remain high for some time, and opportunities to buy unwanted acreage increasing, the deal has sound commercial appeal.

North Sea oil production is in long-term decline – peak output was in 1999. But there are still plenty of barrels waiting to be extracted. New seismic technologies, advances in horizontal drilling and other so-called ’enhanced oil recovery’ techniques mean even picked-over fields can be cajoled into giving up more of the black stuff. For oil majors, this is often not worth the hassle. With huge new volumes required to boost production significantly, the likes of Shell and BP have bigger fish to fry. But it creates opportunities for smaller players. Both Shell and BP have sold acreage to Fairfield since it was set up in 2005. And BP is still flogging North Sea gas assets it put up for sale last year after the Gulf of Mexico oil spill.

Fairfield and its backers clearly believe that the business model has legs. A planned flotation in 2010 would have valued the whole company at $1.3 billion but investors including Warburg Pincus, the U.S. private equity group, wanting to retain a 60 percent stake. In January last year, Fairfield’s shareholders injected an additional $150 million to help it develop its assets. Since then the group has struck development deals on several properties.

Oil prices have also risen since the IPO was abandoned, so Browne and Riverstone must expect to pay more for a piece of Fairfield than they would have two years ago. The key danger is that they become too confident about the price of the black stuff, and overpay for assets that could prove less accessible than is hoped.

Shell pays up for a foothold in Mozambique gas

By Kevin Allison

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

Shell is paying a full price to gain exposure to promising natural gas prospects off the Eastern coast of Africa. The oil group’s $1.6 billion offer for Cove Energy represents a 70 percent premium to the AIM-listed energy explorer’s undisturbed share price. Cove may be tiny, but its assets are attractive. With more than $11 billion of cash on hand, Shell can easily afford it. If Asian gas prices stay high or Cove’s exploration projects deliver, this small but highly priced deal may be worth the bother.

Cove’s main attraction is an 8.5 percent stake in an as yet undeveloped gas find off the coast of Mozambique. The field is thought to contain between 15 trillion and 30 trillion cubic feet of recoverable gas. Take the average of those two figures, and the purchase price equates to about $4.60 per barrel of oil equivalent, according to Bernstein Research – or $4.10/boe, excluding cash on the balance sheet. That’s roughly double the average of $2.30/boe that Shell has forked out for other gas explorers recently.

Overpaying is overpaying, regardless of how big or small the deal is. But Cove thinks the Mozambique assets alone could be worth up to $1.6 billion, based on optimistic assumptions about the field’s gas reserves and the size of the export capacity from the field. Crucially, it also assumes that Asian buyers keep paying dear prices for gas. The region may be short of liquefied natural gas (LNG) now, and oil-linked Asian contracts should keep a floor under prices. But that dynamic could change by the time the Mozambique supplies come onstream near the end of the decade – especially if U.S. companies win approval to build big LNG export hubs.

Still, Cove’s other exploratory tracts in Mozambique, Kenya and Tanzania could always come good. Part of Cove’s premium price can also probably be justified by lower costs – a big LNG export facility should be cheaper to build and operate in Mozambique than in Australia, where Shell is also investing heavily in gas. Shell can also arguably get more out of Cove’s assets than other putative buyers who lack its gas know-how, financial clout, and marketing savvy. It’ll take some luck, but the deal might just end up looking very clever.