Breakingviews

iPhone anniversary marks triumph over crisis

By Robert Cyran

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

Apple rolled out its iconic iPhone five years ago, just as Bear Stearns subprime hedge funds sounded the alarm on a systemic trauma. Financial woe often impedes development. But the iPhone is proof that innovation can defy the odds and overcome hard times.

The advance of technology is hard to stop. R&D budgets do get slashed in downturns. The growth rate of patent filings has slowed during the recent crisis. But companies that don’t invest, or that do so poorly, can suffer. Research In Motion and Nokia learned the lesson all too well. Their market values have plummeted over 90 percent since mid-2007.

More importantly, desired products, whether new plastics in the 1930s or smartphones now, tend to thrive regardless of the economic climate. About 40 percent of Dupont’s revenue in 1937 came from products introduced during the Great Depression. Almost 60 percent of Apple’s sales are now generated by the iPhone.

Apple’s focus on high-end customers hasn’t hurt. Even reduced disposable income at a certain level still leaves plenty left over for a new bauble. But the iPhone offers value for the considerably less affluent, too. It replaces digital cameras, personal organizers, guidebooks, dictionaries, satellite navigation systems and music players. That list isn’t inclusive and is bound to grow.

The contrast with the financial crisis is a stark one. Apple’s market value has increased by about $430 billion since the iPhone was introduced. The device represents a majority of the company’s sales and an even greater proportion of profit, and has contributed greatly to the popularity of the iPad. That makes it safe to ascribe a healthy amount of the gain to the iPhone.

Brazil’s richest man overpromises, underdelivers

By Raul Gallegos

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

Brazilian billionaire Eike Batista is swiftly falling from favor. His flagship oil company OGX lost 25 percent of its value Wednesday after massively cutting the output expectations of some key oil wells. Batista is a savvy salesman and wheeler-dealer but his failed promises are building up rapidly. Investors smartly no longer take him at face value.

Brazil’s richest man sold the market on his EBX group of loss-making companies mainly on the strength of his promises. He pledged to turn EBX into a world-class energy conglomerate, with stock market listings of subsidiaries including a record-breaking oil explorer, a leading Colombian coal miner and a major shipbuilder in Brazil, to name just a few of his dreams.

But these companies are not yet producing coal or christening new ships. OGX just began pumping oil this year. And it now appears to be falling short of its lofty goals. On Tuesday the group cut output projections for its offshore Tubarao Azul field to 5,000 barrels a day from about 20,000.   Batista has vowed to multiply the wealth of those who invest with him but has so far mainly destroyed it. After Wednesday’s plunge, OGX has a market value of $9.8 billion, merely a third of its 52-week high in late February. The OSX shipbuilding unit has also seen similar declines since going public in 2010.

Investors are finally losing faith in the Batista gospel. Lowly public shareholders that bought into the various listed companies are already licking their wounds while A-list investors, such as General Electric and Abu Dhabi, which bought into EBX this year, are farther away from turning a profit. Just last week Batista sold half of his unlisted AUX gold mining company to an undisclosed investor for $2 billion. With a skeptical market, monetizing further assets will be tricky.

Batista seems to be getting the message, to a point. He has surrendered the chief executive title at OGX to one of his lieutenants, arguing new leadership can guide the company through its production phase, but he remains chairman. Just how this will enhance the company’s ability to deliver or reassure investors after continued disappointments is a mystery.

Barclays’ board should replace Bob Diamond

By Peter Thal Larsen The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Barclays’ chief executive has become a liability. A $450 million regulatory fine imposed after bank employees attempted to rig key interest rates has tarnished Bob Diamond’s track record. Added to previous controversies over tax and pay, it undermines his attempts to revamp the UK bank. Though Diamond has been an asset to Barclays for most of his 16-year career at the lender, the bank will find it hard to move on while he is in charge.

It is less than seven months since Diamond argued that banks should “serve a social purpose and meet a real client need”. Subsequent events have exposed the gap between his words and Barclays’ actions. In February, the bank’s use of aggressive tax avoidance schemes prompted the UK government to take the highly unusual step of retrospectively changing the law. In April, Barclays’ decision to award Diamond a hefty bonus for 2011 – even though he admitted the bank’s performance was “unacceptable” – prompted a shareholder protest.

The fines levied by global regulators – including the largest-ever penalty imposed by the UK’s Financial Services Authority – are even more serious. Emails showing traders’ casual attempts to manipulate interbank borrowing rates reinforce the widespread public perception of banks as venal and immoral. Worse, the misdemeanours took place at Barclays Capital, the investment banking unit Diamond built up and oversaw until he took the top job at the bank in 2010. It is hard to reconcile such behaviour with his famous rule that the bank has no place for employees who behave like “jerks”.

On their own, the fines do not constitute a hanging offence. Other banks are also under investigation over alleged manipulations and could yet face even bigger financial penalties. In time, Barclays’ decision to co-operate with the probe and seek an early settlement may look prudent. But in the context of past missteps, Diamond’s credibility with regulators, politicians, customers and investors is so low the board should replace him. 

Diamond is a charismatic leader who built a global investment bank almost from scratch. Partly as a result of his efforts, Barclays was able to avoid accepting government capital in 2008. But the crisis has altered banks’ position in society, while regulation is changing the industry’s scale and focus. Diamond’s leadership skills, while valuable during the boom, are less well suited to a period of retrenchment.

Replacing Diamond will not be easy. Any new CEO would need clout with regulators and politicians, as well as a deep understanding of investment banking, which still accounts for half Barclays’ pre-tax profit and two-thirds of its assets. But there are credible candidates: former JPMorgan investment banking co-head Bill Winters is one. Naguib Kheraj, the ex-Barclays finance director and former CEO of JPMorgan Cazenove, is another.

Murdoch deal is a non-core disposal – not a split

By Rob Cox The author is a Reuters Breakingviews columnist. The opinions expressed are his own. After Brangelina or bananas split, two more or less equal halves remain. To suggest that News Corp is doing anything similar with its plan to hive off the print publishing businesses sounds more like wishful journalistic thinking than clear arithmetic. The Printco’s value amounts to less than 6 percent of the media conglomerate’s market value. 

The newly spun-out publisher may punch above its weight in influence, what with the Wall Street Journal, Times of London, New York Post, The Australian and HarperCollins book publisher stuffed into its portfolio. And from a public relations perspective, these have been the activities – specifically the UK newspapers – that have generated all of the mostly nefarious headlines for News Corp and its 81-year old owner Rupert Murdoch over the past year. 

But from the point of view of shareholders, detaching Printco amounts to little more than the disposal of a non-core asset. The business, which Nomura calls “Bad News,” will produce net income of about $362 million in the coming fiscal year. That’s just around 11 percent of the profit Nomura anticipates from the core entertainment business, which includes the Fox broadcast and cable networks, satellite television and 20th Century Fox film studio. 

That still overstates Printco’s importance in value terms. From 2011 to 2014, the company’s compound annual growth rate in net income will be a negative 21 percent, Nomura reckons. Fold in the overhang of legal liabilities from the phone-hacking scandal and it’s hard to see how investors could value those earnings at more than eight times, or around $2.9 billion, little more than half what News Corp paid for the Journal’s parent company, Dow Jones. 

Relative to the empire’s $53.4 billion market capitalization, Printco amounts to about 5.4 percent of the total value. Since Murdoch’s plan to separate the business emerged earlier this week, investors have ascribed nearly $5 billion of additional value. That’s not because they see value in “splitting” News Corp. It’s appreciation for the overdue jettisoning of an unwanted liability.

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.

MPS capital plan only solves immediate crisis

By George Hay

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

Monte dei Paschi di Siena has bowed to the inevitable. Italy’s third-largest bank always looked a good 1.5 billion euros short of capital to pass the European Banking Authority’s stress tests. That’s exactly the amount the Italian state will now pump into the Tuscan lender.

The good news for MPS’s battered shareholders is that the state funds are not in the form of equity. At two-thirds of the bank’s market capitalisation, the amount required would have been highly dilutive.

The bad news is that the state funds will be in the form of hybrid debt. One problem is that these new instruments will probably not count as proper core equity under new Basel III capital rules. Another is that the state will need to charge a hefty coupon to comply with Brussels state aid rules, hurting MPS’s already slim earnings. Finally, MPS already has 1.9 billion euros of similar “Tremonti bonds”, bestowed by Italy’s ex-finance minister in 2009.

As such, the newly-enlarged 3.4 billion euros of state bonds – call them “Monti bonds” – are a stopgap solution. The bank says it will pay back 3 billion euros by 2015. In the same period it will cut 10 percent of its branches and 15 percent of its workforce, and at some point raise 1 billion euros of Basel III-compliant capital.

That’s unlikely to be great for the MPS foundation, the public body which has already seen its stake in the bank diluted from 50 percent to 36 percent. The financially stretched foundation probably won’t be able to participate in the capital increase, further shrinking its stake. Scarce dividend payments and job cuts will further undermine MPS’s traditional role bankrolling Sienese culture and society.

Barclays’ Libor penalty goes beyond the financial

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

Barclays’ reputation has hit a new low. The UK bank on June 27 received a 290 million pound fine from UK and U.S. regulators for trying to rig the London Interbank Offered Rate (Libor). The UK element is the biggest fine the Financial Services Authority has ever handed out.

The popular post-crunch perception of universal banks is that ordinary retail customers suffer from the fast and loose antics of traders in the investment bank. Over the course of an extraordinary 44-page document, the FSA largely stacks up that stereotype in Barclays’ case.

To re-cap, Libor is the rate off which most retail and investment bank transactions, including $554 trillion of interest-rate derivatives, are priced. It is based on submissions by a host of lenders, and these are then crunched by Thomson Reuters. The FSA says Barclays, and potentially other banks, tried to manipulate the rate for the benefit of their trading desks.

The regulator has exposed a severe systems failure at Barclays Capital, the investment banking unit. Derivatives traders and those submitting Libor bids should have been divided by so-called Chinese walls. Instead, between 2005 and 2009, 14 traders submitted 257 requests to try to rig the rate in their favour. The FSA’s report shows they were brazen about it. One trader “begs” a submitter to put in a low Libor submission. The submitter responds: “I’ll see what I can do”. When hearing a submitter will be in late, another knowingly exclaims, “Who’s going to put my low fixings in?” And yet another pledges, “when I write a book about this business your name will be written in golden lights”. The submitter responds, “I would prefer this not (to) be in any book!”

Barclays Chief Executive Bob Diamond was in charge of Barclays Capital when these abuses took place. He was responsible for the culture. Unnamed senior executives are indirectly implicated by the FSA in the misleading Libor submissions. And no Chinese walls were put in until December 2009.

In Diamond’s favour, other banks are likely to be brought to book, and there is no evidence the attempted manipulation actually worked. He can blame wrongdoing on a small team at the bottom of his organisation.

China’s U.S. home loan risks being a subprime idea

By Robert Cyran

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

China Development Bank appears to be toying with a subprime idea. The Asian firm is considering lending U.S. homebuilder Lennar $1.7 billion to construct two housing projects, according to the Wall Street Journal – one of them on a polluted man-made island in an earthquake zone. It has all the hallmarks of globally distorted economic incentives forcing yield-starved investors to take risky bets they don’t understand.   Real estate investing can be tricky for any bank. And converting Treasure Island, a former naval base near San Francisco, into housing isn’t straightforward, due to the competing governmental, environmental and seismic issues. But a good rule of thumb holds that the further afield a project, the greater the danger that the lender is getting out of its depth.   Of course, the projects have potential. The timing looks promising, as they could be investing at, or near, the bottom for housing. Average home prices actually rose 1.3 percent in April, according to the S&P/Case Shiller index. These projects won’t be finished for a decade or more, by which point markets could once again be sizzling. San Francisco has few spaces as well placed geographically as these two for big developments. And China Development Bank isn’t completely naïve – it has increasing amounts of experience investing in countries ranging from Australia to Pakistan.

Yet it’s worthwhile pondering why exactly a financial arm of the Chinese state is thinking of investing in building U.S. homes. After all, this foray hardly fits in with the bank’s original goals of building infrastructure in the Middle Kingdom and promoting strategic industries.

Perhaps the most salient reason stems from China’s policy of favoring exports. At about 3 percent of GDP, the current account surplus is a fraction of what it once was. But the country still has massive amounts of cash to invest overseas. Meanwhile, U.S. monetary policy has resulted in ultra-low interest rates. With U.S. 10-year Treasuries at 1.6 percent and set to remain around that level for some time, bankrolling complex construction projects starts to look unhealthily tempting by comparison.

Split wouldn’t fix all News Corp’s shortcomings

By Quentin Webb

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

Spinning off News Corp’s scandal-hit publishing arm won’t solve all Rupert Murdoch’s problems. The media mogul is preparing to drop his long-held resistance to a break-up, according to a report in his own Wall Street Journal. Outside investors will approve on strategic and financial grounds. But with the Murdoch family retaining a firm grip on both parts, governance remains troublesome. That will make it hard to insulate News Corp’s broadcasting and movie operations from Britain’s phone-hacking furore.

Spinning off the publishing unit, which houses HarperCollins books as well as newspapers such as the Times of London and the Australian, makes strategic sense. The division requires too much management attention while accounting for a small proportion of its parent’s $49 billion market cap. Its operating margins are less than half the wider group’s 16.6 percent; operating income of $458 million in the nine months to March was little more than 10 percent of the group total.

There’s financial merit too. These are fissiparous times: Kraft, Sara Lee, ConocoPhillips and others have already carved themselves into businesses that focus on doing fewer things better, and which investors can assess more easily. In theory at least, better stock-market valuations follow.

But there are limits to what a separation would achieve. News Corp’s dual-share structure means the Murdoch family’s 12 percent economic interest comes with effective control, thanks to 40 percent voting rights. That arrangement would apparently continue in both arms post-split.

Moreover, Murdoch will retain direct influence over both arms, probably as chairman. Politicians and regulators will question whether the separation is more than cosmetic. A separate listing might make it easier in time for the family to sell down its stake in publishing. Even so, the reputational damage in Britain could take years to repair. A split might help News Corp persuade regulators it should be allowed to keep its 39 percent stake in BSkyB. But resurrecting a full buyout of the UK satellite operator looks a long way off.

Murdoch all but erases discount he inflicted

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

Rupert Murdoch has all but erased the discount he inflicted on his media conglomerate. When scandal struck News Corp last year, a Breakingviews calculator found the company trading around 30 percent below the sum of its parts. The possibility of splitting the company in two, confirmed on Tuesday, may complete an improbable run to close the gap.

The phone-hacking affair at the company’s British tabloids exacerbated the “Murdoch discount.” This special breed of conglomerate markdown took hold because of the octogenarian mogul’s affinity for newspapers despite their low margins and lack of growth and his undisciplined approach to acquisitions.

But the misdeeds have sharpened News Corp’s focus. In the past year, the company has increased its dividend and announced $10 billion of stock buybacks. After Murdoch’s son, James, was sidelined, Chase Carey, Murdoch’s right-hand man, took a more prominent role and considered shareholders who don’t bear the family name.

News Corp still trades at a discount to peers like Time Warner and Walt Disney. But the market’s valuation now more closely adheres to the sum of its disparate parts, according to an updated Breakingviews analysis using divisional profit forecasts by Barclays and comparable valuation data from Thomson Reuters.

Put the company’s cable operations, including Fox News, on a multiple of nine and they’re worth nearly $30 billion. Earnings from its studio, producer of films like “Prometheus,” and its U.S. Fox broadcast network, home to hit shows like “Glee,” are more unpredictable, but should be valued at over $13 billion together. Sky Italia and various private holdings add about another $4.5 billion. Stakes in publicly traded companies including BSkyB contribute almost $9.5 billion more.

The publishing unit, which includes HarperCollins and the Wall Street Journal, is worth a mere $2.5 billion. But the idea it might be spun off added 8 percent to News Corp’s market value on Tuesday, bringing it to nearly $53 billion. Ignoring the unprofitable digital unit and stripping out net debt of almost $5 billion, the company’s pieces should add up to more than $54 billion, or just about 4 percent more than where they trade. In a way, the scandal may have been the best thing to happen to News Corp.