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Source : www.loicharari.com
May 2010
Contents
4 6 6 9 Has the time come to spin off or demerge? Salutary spin-offs Merger and spin-off cycles Mergers & spin-offs: different situations, different economies
11 Spin-off: the changing face of M&A in developed countries 14 Corporate spin-offs: best-case scenario 14 Three reasons to have a spin-off cycle 17 SG Cross Asset Research spin-off screening tool 17 Sector analysis 18 Results 19 Conclusion - back to focusing on the core 20 Sector review 21 Aerospace & Defence - Only few spin-offs expected 23 Air transport - Ripe for takeovers rather than spin-offs 25 Automobiles - Emerging players are changing the game 27 Banks - Focusing on their core business 30 Capital goods - Focus on core business is the key 34 Construction, Motorways & Building Materials - Companies already focused on sub segments 36 Food products - No spin-offs on the agenda 38 Food & Staples Retailing - Expand in emerging markets or spin off unprofitable assets? 40 General Retailing - Difficult to survive 42 Hotels, Restaurants & Leisure - Still fragmented 44 Household & Personal Care - More consolidation than spin-off 46 Insurance - Changing regulatory rules 48 Luxury goods - No spin-offs to expect 50 Media - Already well split between sub-sectors 52 Metals & Mining - Trend moving from consolidation to spin-off 54 Oil & Gas - Oil leaders ready to spin off non-core assets 56 Pharmaceuticals - Big is beautiful but for how long? 58 Real Estate - Spin-off of industrial groups would be beneficial 60 Software & IT Services - Offshore factor dominates IT services 62 Telecom Equipment - Many spin-off options 64 Telecom Services - Spin off foreign businesses? 66 Utilities - Many assets for sale
Report completed on 5 May 2010 Thanks to Nicolas Harari for his assistance in preparing this report.
May 2010
China
g k in lo o s re a s a are h nie pa rowt com in g ern and st p We ex to
India
Russia UK
Japan Eurozone
Profitability
Source: SG Cross Asset Research
To finance part of their acquisitions with debt, companies will face competition from sovereign debt. Therefore, one of the solutions would be to divest part of their non-core assets through spin-offs to fund future growth. For some sectors, this should be fairly easy to do, whereas in other sectors, there is nothing to sell and competition from emerging companies will also have to be tackled. In the chart below we show our view of sector spin-off potential.
Sector view of spin-off potential
Emerging markets development: growth Air Transport 93% Household & Personal Care Luxury Goods 83% Consolidation Aerospace Automobilles & Pharmaceuticals 73% Components Food & Staples Retailing Food products Telecom Services 63% Hotels, Restaurants & Leisure Software & IT Services Media 53% Real Estate General Insurance Retailing 43% and competition
Oil & Gas Telecom Metals & Construction, Equipment Mining Motorways & Building Materials Banks
33%
Low
Diversification
May 2010
In company terms, we have highlighted 27 companies which could at some stage decide to spin off certain businesses. Among the names mentioned, a portion has already announced that they are thinking of spin-offs, whereas others could be forced to do so by their shareholders if their stock performance starts to disappoint.
Our 27 stock selection
Company name Sector Country Reco Currency Target Price (loc cur) Price (loc cur) 4/05/10 Sales Market Cap (lc m) (lc m) 2010e P/E Return on EPS Growth 10e Equity 10e 09-10e
EADS Finmeccanica Hochtief Philips Saint-Gobain Siemens PPR Repsol-YPF Statoil Carrefour Metro Henkel ArcelorMittal BASF SE ThyssenKrupp Vivendi Bayer AG ALCATEL Ericsson Motorola Inc Deutsche Telekom E.ON Enel Commerzbank Royal Bank of Scot. ING Group Munich RE
Capital Goods Capital Goods Capital Goods Capital Goods Capital Goods Capital Goods Consumer Durables & Apparel Energy Energy Food & Staples Retailing Food & Staples Retailing Household & Personal Prod. Materials Materials Materials Media Pharmaceuticals & Biotech Technology Hardware & Equ. Technology Hardware & Equ. Technology Hardware & Equ. Telecommunication Services Utilities Utilities Banks Banks Insurance Insurance
France Italy Germany Netherlands France Germany France Spain Norway France Germany Germany France Germany Germany France Germany France Sweden US Germany Germany Italy Germany UK Netherlands Germany
Sell Hold Hold Buy Buy Buy Buy Hold Buy Buy Hold Buy Buy Buy Hold Buy Hold Hold Buy Hold Buy Hold Buy Sell Hold Buy Buy
EUR EUR EUR EUR EUR EUR EUR EUR NOK EUR EUR EUR EUR EUR EUR EUR EUR EUR SEK USD EUR EUR EUR EUR GBP EUR EUR
12 10 61 30 47 92 121 18 165 45 43 43 37 54 26 22 52 2.2 100 6.5 10.8 29 5.1 3.6 0.55 9 125
13.85 9.6 62.27 25.48 37.26 73.09 102.75 143.6 36.88 46.76 40.07 29.57 44.6 24.76 19.93 47.17 2.39 7.1 9.88 28.19 3.96
11303.1 5547.3 4358.9 25125.3 19114.4 66819.1 13006 21621.5 25993.3 15153.8 7139 46156.3 40959.6 12738.7 24499.7 39007.1 5540.2 16421.4 43081.1 56408.2 37237.3 7072.8 31505.5 26361.1 21161.5
17.1 9.8 22.8 14.7 15.4 12.8 13.8 9.9 9.1 13.6 15.6 16.8 10.6 10.2 43.7 8.9 13.7 58.9 13.2 29.2 12 8.5 7.2 nm nm 7.4 9.1
6.1 8.6 8 7.8 8.3 15.9 7.7 10.7 23.5 15.4 16.5 14.2 8.9 18.8 4 10.3 13.6 -2.9 12.2 5.5 9.8 15.3 15.4 -5.4 0.2 na na
271.8 -7.5 12 141.6 85.7 9.5 19.4 68.2 30.5 -26.3 43 43.2 92.1 46 144.7 4.4 18.2 117.3 88.5 nm 5.2 6 19.1 79.4 33.9 289.1 -3.1
17.71 898.785* 91836.4 68161.9 14039.7 90745.9 57800 45212.1 27588.2 32015.2 15233.4 22134.2 64048.9 77523.3 58594
1760* 457889.7
* Production ** Total income *** Operating income Source: SG Cross Asset Research
May 2010
Salutary spin-offs
The recent economic crisis has undermined the concept of consolidation, as huge losses from over-expensive acquisitions have revealed the risks facing large corporations implicated in M&A deals. As we exit the recession, there is once again a growing buzz around potential M&As and increasing interest for spin-offs. Companies are seeking opportunities, waiting for signs of recovery while also benefiting from low interest rates and healthy balance sheets (see Marc Teyssiers SG Cross Asset Quant Research report Training your computer to find potential M&A candidates published 2 March 2010). And, with anaemic western economies, these companies may now be looking for acquisitions opportunities specifically in emerging markets where they believe future growth lies. But, what can be learned from history?
Spin offs and Demergers Maturing via restructruring Expansion via external growth to acquire leadership Growth via Internationalization Start-up phase:
Industry's birthinacountry
Source: SG Cross Asset Research
A solution to tackle this situation could be to become even larger via acquisitions, although in some cases, this could create monopolistic situations. But, most of the time, a company with numerous activities sends a blurred image to external financial analysts and its own shareholders. Indeed, it is particularly complex to value a company with varied core businesses. An activity requiring heavy investments with growth rates near to zero mixed with an activity generating strong growth but overdrawn will inevitably make company strategy more opaque. A spin-off involves the creation of an independent company from an existing part of another company through a divestiture, such as a sale or distribution of new shares. Spin-offs (which represented only 16% of M&A deals in 2007/2008) clearly equate to strategy which pushes companies to concentrate their financial resources on the core business. History tells us that this option is the best way to create shareholder value.
May 2010
12000 10000
Third wave
8000
First M&A wave Second wave
Number of M&As
Source: Nelson series, Thorpe series, FTC Broad series, M&A Domestic series and from 1984 Thomson Financial, Real S&P 500 Stock Price Index compiled by Schiller
When mergers create a monopolistic situation, the legislator can become less supportive (as was the case with the Sherman Act, followed by the Clayton Anti-trust Act in 1914 and the Tax Reform Act in 1969). In 2010, we could see a similar situation arise in the financial sector as we believe the US administration could decide to downsize banks. We could also see countries specifically aiming to protect their industries and their national champions. The recent proposals from Lord Mandelson, the UKs business secretary, to review UK takeover laws following the bid from Kraft on Cadbury is a good example of this. Indeed, political impetus could adjust regulations with the intention of putting a halt to excessive consolidation. Moreover, the recent warning from Warren Buffet following Krafts bid for Cadbury reminds predators that shareholder interests should come first. Overpaying for major acquisitions is no longer acceptable. Logically, this would suggest that we have entered the spin-off phase.
May 2010
50
10000 40 8000
28
26 20
22
30
30
20
19
20
11 7
13
10
On a complementary side with no clear market trend, a spin-off is a way for companies to differentiate, to push valuations higher than their direct competitors, as fund managers tend to favour focused companies with clear strategies. Logically, a spin-off enables a better valuation of a company thanks to clearer visibility on accounts. Ideally, each spun-off entity would obtain an optimum valuation and, therefore the valuation of the whole is greater than the sum of its parts. While synergies could be expressed as 1 + 1 = 3 (a very simplified expression of the reason behind M&A transactions), a spin-off could, similarly, be expressed as 2 = 1 + 1 (+ 1) (with (+1) reflecting the premium that could be gained from better legibility/transparency of company accounts). In summary, after a market crash, companies tend to focus on value creation and profitability. As a result, we generally see more spin-offs at that time. But, this requires a certain amount of market stability. It seems that 2010 could see a strong spin-off phase. Already several deals have been announced not only in the US but also in Europe (see part 2).
Volatility trend of the S&P (VIx)
100
80
60
Spin off?
40
20
Spin-off wave
May 2010
60%
40%
20%
0% 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
Thus, during the Asian financial crisis over a decade ago, unaffected European and American multi-national companies seized the opportunity of devalued Asian currencies and low valuations to expand through M&A deals. Now, a role reversal is taking place as the healthy balance sheets of Asian firms are bringing about a number or cross-border M&A deals in Europe and the US. In the early 2000s and up until recently, we saw strong signs of expansion in the eurozone and in eastern European economies. For Q1 10, Europe remained weak in terms of M&A activity.
M&A volume in the European Union
800 Value of deals in bn$ 600 Number of deals 4000 4500
400
3500
200
3000
0 1Q 2007 2Q '07 3Q '07 4Q '07 1Q '08 2Q '08 3Q '08 4Q '08 1Q '09 2Q '09 3Q '09 4Q '09 1Q '10
2500
May 2010
Growth in Emerging Markets relative to advanced economies has created a very long M&A cycle. This new trend, pushed forward by strong international competition, is noticeable in the M&A world. Some important deals are now taking place in emerging countries and particularly in Asia which is seen as the growth market of the next decade. Hence we just saw Prudential bidding for the Asian insurance operations of AIG, the troubled insurance company.
Low rates Low Gearing + high Cash flow Low level of consolidation Bullish GDP growth forecast Possibility of restructuring
XX XXX XX XXX XX
XXX XXX X X X
XXX XXX X X X
X X XXX X XX
Recently, we have also seen interest from companies in emerging countries to develop in more mature markets. This is clearly linked to the new economic cycle which reflects the rapid development of emerging companies and their valuation premiums compared to western companies.
Previous and current business cycle
Previous economic cycle
Interest rates rising
Yuan revaluation?
Market Stress
Market stress
Interest rate cuts + fiscal stimulus
Capex
For example, Chinas outbound foreign direct investment has been facilitated lately by Chinese policy measures. The government is publicly boosting Chinese international investment appetite by easing and decentralising regulatory procedures but also by broadening firms foreign investment financial channels. Further motivation lies in the growth
10 May 2010
drivers needed at home. China has high demand for resources such as iron, oil, cement, timber for infrastructure projects, and housing as well as production for domestic and foreign consumption. Since the start of the economic crisis, Chinese firms have acquired significant positions within the worlds largest companies. China has 47 companies listed in the FTs 2009 global 500 list, and Chinese cross-border investment amounted to of $170 billion in 2008. This is a tremendous amount of money for a country supposedly lagging in foreign investment terms, and media coverage has created concerns that Chinese firms may be attempting to buy up the whole world! Thus, in 2009, Chinese purchases of US businesses jumped 300%, reaching $3.9bn. China is rebalancing its growth model, as the country is shifting from an economic model with growth that had been sustained for 30 years by producing goods for export, to a model that is gaining increased significance beyond domestic borders. This new model is driven by attractive valuations abroad, but also because the Chinese know that they can no longer rely on expanding economies of scale. This could come to a halt however, due to recent tension between the Peoples Republic of China and western corporations.
Anheuser-Busch InBev Beiersdorf Carrefour Diageo Ericsson Inditex LVMH Nestl Nokia Renault Telenor Unilever Volkswagen
Source: SG Cross Asset Research
ABB Atlas Copco BHP Billiton Lafarge Holcim Saipem Schneider Siemens Technip Veolia Environnement Xstrata
Spin-off criteria
USA Europe Emerging Comments
XX XXX XXX
XX XXX XXX
XX X X
Diversified companies in Europe and US will favour spin-offs Weak performance in the US and Europe favours spin-offs Need for value creation
Investors are also likely to insist that companies adopt a cautious approach to expansion, considering that these companies are still recovering from losses and the pain suffered during the recession. The only M&A deals likely to be rewarded by investors will be the safer kind, that is to say deals in line with core businesses and objectives, carried out at attractive valuations and that are at least partly paid for in cash.
12
May 2010
120
110 105 100 95 90 0 100 Duration (days) 200 300 400 500
80 0 50 Duration (days) 100 150 200 250 100
90
On the left graph, we present the performance of newly-traded spin-offs in the US from 1996 to 2007. Most US-domiciled spin-offs file a Form 10-12B with the SEC. Therefore, we used the SEC website to constitute our sample. Then, we compared the relative performance of the different spin-offs to obtain the average spin-off price trend throughout its lifecycle. We then compared each value with the S&P500 performance over the same period and compiled the results to obtain this curve. On the right graph, we picked 2008 spin-offs with market capitalisation greater than USD 1 bn and studied their performance over 250 trading days. We used the same method to compile this chart but, our sample being smaller, we compared each stock to its respective sector: an example being Suez Environment relative to the MSCI World Utilities.
May 2010
13
the past 15 years, spin-off companies have created employment independently of the business cycle. Most of the new jobs were created during the first four years after the demergers. The same analysis of the parent company is a much more complex exercise owing to scale, but it is clear that management is likely to be more efficient in focusing its energies on one core business rather than on a broad range of different types of business lines.
Evolution of spin-off workforce through time
35% 30% 25% 20% 15% 10% Average 5% 0% 1 3 5 7 9 11 13 Median
% Job-destroying companies
% Job-creating companies
In developed economies, spin-offs are favoured when restructuring and lay-offs are difficult to justify. When unemployment is high, it is difficult to justify an acquisition, particularly as it may prove to be more difficult to achieve efficient restructuring. As we are still forecasting a high level of unemployment in the next two years in developed countries (with a peak at the end of 2010), M&A activities with cost synergies will likely be difficult to achieve. On the contrary, a spin-off tends to create jobs and value for shareholders. The point is that the level of employment was exceptionally high during the last M&A cycle at that time and allowed companies to restructure. But since then, the increase in the unemployment rate has made restructuring more difficult than ever. As an example, in Japan, although interest rates have been very low for a number of years, and companies have been generating high levels of cash flow, we did not see the development of a major M&A cycle as it has always been difficult to restructure in this country, particularly with the ever-present issue of steadily increasing unemployment.
Employment/Population ratio (bureau of labor statistics)
14000 12000 10000 8000 6000 4000 2000 0 1948 1958 1968 1978 1988 1998 2008 Number of M&As Employment / population ratio 66 64 62 60 58 56 54 52 50
14
May 2010
-0.2
If we consider the figures overall, we can see that, in developed countries, there is a high level of concentration in most industries.
Concentration
Top 5 by sales Household & Personal Care Aerospace Pharmaceuticals Food products Food & Staples Retailing Automobiles & Components Software & IT Services Telecom Equipment Telecom Services Oil & Gas
Source: SG Cross Asset Research
Top 10 88% 77% 72% 68% 67% 67% 59% 60% 67% 74%
Top 5 Top 10 by market capitalisation 73% 53% 48% 59% 52% 47% 56% 52% 43% 41% 90% 76% 75% 75% 71% 71% 69% 67% 64% 59%
64% 49% 43% 48% 48% 44% 41% 40% 45% 52%
Following the last wave of mergers and depending on the sector, we estimate that there are 5% to 30% of company assets to divest or spin off. The high level of concentration and the lack of restructuring possibilities owing to high unemployment prompts us to think that spin-offs will make a strong contribution to economic growth thanks to the two factors mentioned above.
May 2010
15
Oil & Gas Telecom Metals & Construction, Equipment Mining Motorways & Building Materials Banks
33%
Low
Diversification
Diversification measured by an efficiency ratio (sales/market cap.). We look at below-average ratios compared to the sector and the size of the company. For the second part of the document, we have crossed these two criteria on the main companies of each sector, in order to have a broad view of the results. However, in the list provided in the table overleaf, we focused only on companies followed by our analysts. Profitability measured by below-average Return on Equity ratio compared to the sector.
Three-year underperformance versus peers. Behavioural finance shows that market reaction to news is at times excessive, creating high volatility as markets are pushed above or below fundamentals before reverting. The psychology behind the overreaction to unexpected or dramatic news based on empirical evidence reflects inefficiencies. Based on these inefficiencies we can conclude that the market reaction tends to overweight recent news and events. Therefore, we will focus on a three-year timeframe and concentrate on companies
16
May 2010
which could spin off activities which are then likely to generate higher-than-average returns after being hived off. Testing these three criteria suggests that the first is the most important, so we focus on these in our quantitative screening for the sector-by-sector review. But, to determine the final list from the companies followed by our analysts, if the criteria match, we consider the company to offer the potential for a spin-off. Logically, we have eliminated stocks where there are no non-core assets to divest.
Results
The table below gives a list of 27 companies highlighted by our screening that are covered by SG analysts and could be considered as having potential spin-off candidates. Note that, in some cases, our sector analysts do not believe the companies flagged are in the mood to consider spin-off possibilities in the short term.
Our 27 stock selection
Company name Sector Country Reco Currency Target Price (loc cur) Price (loc cur) 4/05/10 Sales Market Cap (lc m) (lc m) 2010e P/E Return on EPS Growth 10e Equity 10e 09-10e
EADS Finmeccanica Hochtief Philips Saint-Gobain Siemens PPR Repsol-YPF Statoil Carrefour Metro Henkel ArcelorMittal BASF SE ThyssenKrupp Vivendi Bayer AG ALCATEL Ericsson Motorola Inc Deutsche Telekom E.ON Enel Commerzbank Royal Bank of Scot. ING Group Munich RE
Capital Goods Capital Goods Capital Goods Capital Goods Capital Goods Capital Goods Consumer Durables & Apparel Energy Energy Food & Staples Retailing Food & Staples Retailing Household & Personal Prod. Materials Materials Materials Media Pharmaceuticals & Biotech Technology Hardware & Equ. Technology Hardware & Equ. Technology Hardware & Equ. Telecommunication Services Utilities Utilities Banks Banks Insurance Insurance
France Italy Germany Netherlands France Germany France Spain Norway France Germany Germany France Germany Germany France Germany France Sweden US Germany Germany Italy Germany UK Netherlands Germany
Sell Hold Hold Buy Buy Buy Buy Hold Buy Buy Hold Buy Buy Buy Hold Buy Hold Hold Buy Hold Buy Hold Buy Sell Hold Buy Buy
EUR EUR EUR EUR EUR EUR EUR EUR NOK EUR EUR EUR EUR EUR EUR EUR EUR EUR SEK USD EUR EUR EUR EUR GBP EUR EUR
12 10 61 30 47 92 121 18 165 45 43 43 37 54 26 22 52 2.2 100 6.5 10.8 29 5.1 3.6 0.55 9 125
13.85 9.6 62.27 25.48 37.26 73.09 102.75 143.6 36.88 46.76 40.07 29.57 44.6 24.76 19.93 47.17 2.39 7.1 9.88 28.19 3.96
11303.1 5547.3 4358.9 25125.3 19114.4 66819.1 13006 21621.5 25993.3 15153.8 7139 46156.3 40959.6 12738.7 24499.7 39007.1 5540.2 16421.4 43081.1 56408.2 37237.3 7072.8 31505.5 26361.1 21161.5
17.1 9.8 22.8 14.7 15.4 12.8 13.8 9.9 9.1 13.6 15.6 16.8 10.6 10.2 43.7 8.9 13.7 58.9 13.2 29.2 12 8.5 7.2 nm nm 7.4 9.1
6.1 8.6 8 7.8 8.3 15.9 7.7 10.7 23.5 15.4 16.5 14.2 8.9 18.8 4 10.3 13.6 -2.9 12.2 5.5 9.8 15.3 15.4 -5.4 0.2 na na
271.8 -7.5 12 141.6 85.7 9.5 19.4 68.2 30.5 -26.3 43 43.2 92.1 46 144.7 4.4 18.2 117.3 88.5 nm 5.2 6 19.1 79.4 33.9 289.1 -3.1
17.71 898.785* 91836.4 68161.9 14039.7 90745.9 57800 45212.1 27588.2 32015.2 15233.4 22134.2 64048.9 77523.3 58594
1760* 457889.7
* Production ** Total income *** Operating income Source: SG Cross Asset Research
May 2010
17
18
May 2010
Sector review
Below, we present a series of two-page sector analyses of spin-off possibilities. In each case, the first page contains:
A sector data/valuation table and a chart showing sector performance. A brief overview of industry trends. A chart showing the top ten companies ranked by market capitalisation.
The second page contains: Our sector map, using just two of the three spin-off criteria: sales/market cap and sales:
In the top right-hand section of the map are located many companies that have historically been active in M&A deals and probably now have assets to sell. Basically the theory is that when sales are substantial and the sales/market cap ratio is high, the sales are not fully valued and the company probably has assets to spin off. In this area, we find many conglomerates and/or groups which made major acquisitions in the past, thus inheriting non core assets. The top left-hand section shows industry leaders with generally solid positions in their core business and few non-core assets.
The bottom left-hand section shows growth companies generally medium-sized companies with low market cap in relation to their sales.
On the bottom right, we present what we call doldrum companies which generally have a high market caps but relatively low levels of sales.
After this map, we have our analysts fundamental view on the prospects of spin-offs in their sector and we conclude with a list of the key potential spin-off candidates in the sector, based on their coverage, when there is one. We used MSCI World indexes to constitute our samples. In the Sector Valuation table, the Median and the Total lines are calculated from the entire sample and include companies from geographical areas which are not displayed in the table.
May 2010
19
Sector performance
MSCI World Aerospace & Defence MSCI World
110
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
10
20
30
40
50
60
70
80
20
May 2010
SG view
Sector map
Industry Leaders
Sales BOEING EADS (PAR) UNITED TECHNOLOGIES LOCKHEED MARTIN NORTHROP GRUMMAN GENERAL DYNAMICS HONEYWELL INTL. BAE SYSTEMS RAYTHEON 'B' FINMECCANICA BOMBARDIER 'B' S/M* THALES ROLLS-ROYCE GROUP L3 COMMUNICATIONS SAFRAN ITT GOODRICH PREC.CASTPARTS ROCKWELL COLLINS SINGAPORE TECHS.ENGR. COBHAM Growth CAE
companies
Doldrums
In recent years (2006-2008), the focus for European companies was on expansion into the US market, not only because of its size, but also as a hedge against the eight-year depreciation of the US dollar. Given the state of the M&A market, transactions are likely to be confined to smaller bolt-on acquisitions. Aerospace companies have tended to acquire small businesses over the past few years, and this should continue. In shareholding structures where the state has true power as a shareholder and/or client, spinoffs may end up being a political decision. However, overall many groups appear to have a fairly low efficiency ratio as shown in our map above. Among the groups followed by SG analysts, we believe that spin-offs could be a solution for companies like Finmeccanica or EADS which failed to deliver performance and are not focused enough.
Finmeccanica: The group has identified the Transport and Energy activities as non-core. Transport
has been subject to an IPO with the retention of a 40% stake. Energy is poised either for an IPO or for a stake to be sold to an industrial partner in the medium term.
EADS: The Airbus and non-Airbus businesses are run as distinct entities but a recent initiative has
been to integrate the support functions. The group is dominated by Airbus which perhaps leaves the non-Airbus activities undervalued in the depressed valuation of the overall group. A partial IPO of either the Airbus or non-Airbus activities would give a better valuation for each part.
Stocks to watch
Company Country Reco Target Price (loc cur) Price loc cur) 04/05/10 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
EADS Finmeccanica
France Italy
Sell Hold
EUR EUR
12 10
13.85 9.6
42584.5 18662.7
11303.1 5547.3
17.1 9.8
6.1 8.6
271.8 -7.5
May 2010
21
Sector performance
MSCI World Airlines 170 MSCI World
13.5 NA NA NA 20.7
0.13 NA NA NA NA
140
110
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
22
May 2010
SG view
Sector map
Industry Leaders
Sales
ALL NIPPON AIRWAYS QANTAS AIRWAYS SOUTHWEST AIRLINES SINGAPORE AIRLINES CATHAY PACIFIC AIRWAYS IBERIA
S/M*
Growth companies
RYANAIR HOLDINGS
Doldrums
There have been some significant steps in the consolidation of the European airline sector in recent years, including Air Frances acquisition of KLM in 2004 and Lufthansas acquisition of SWISS (consolidated in 2007). Lufthansa now has a number of pending acquisitions: Brussels Airlines, Austrian Airlines and BMI. Merger talks are also ongoing between British Airways and Iberia. If all these deals go through, the top three players will control 72% of the traffic of the Association of European Airlines (compared with 48% in 2000). This sector was identified last month as the most likely to consolidate. Our efficiency map shows that European leaders are not well valued, but spin-offs could be difficult as Airlines is a global business and companies are already focusing on their core business. Consequently, we do not see any potential spin-offs in this sector. However, we believe that in relative terms, Lufthansa and Air France are the two companies which should restructure their business.
May 2010
23
Sector performance
MSCI World Automobiles & Components 170 MSCI World
3.77
140
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
20
40
60
80
100
120
140
160
24
May 2010
SG view
Sector map
Industry Leaders
Sales TOYOTA MOTOR HONDA MOTOR DAIMLER (XET) NISSAN MOTOR BMW (XET) DENSO JOHNSON CONTROLS RENAULT BRIDGESTONE SUZUKI MOTOR MICHELIN AISIN SEIKI MAZDA MOTOR S/M* FORD MOTOR PORSCHE AML.HLDG. (XET) PREF. FIAT PEUGEOT
MAGNA INTL.'A' DAIHATSU MOTOR GOODYEAR TIRE & RUB. FUJI HEAVY INDS.
Growth companies
HARLEY-DAVIDSON TOYODA GOSEI BORGWARNER NGK SPARK PLUG STANLEY ELECTRIC
*S/M: Sales / Market capitalisation; Source: SG Cross Asset Research
YAMAHA MOTOR
Doldrums
Big was beautiful for carmakers until recently when groups like General Motors understood it was no longer possible to maintain so many different brands. GM is trying very hard to slash costs and to sell non-core assets; however, this is less feasible in the current economic environment. For example, Sichuan Tengzhong was unable to complete the Hummer acquisition in February 2010. The M&A model shows that there could be a wave of sector deals in 2010 but mostly among manufacturers. For the manufacturers, we see almost no big mergers but some spin-offs may be possible. We also expect aggressive development in Asia, especially China. For example, Zhejiang Geely Holdings Group, a Chinese carmaker, is completing the Volvo acquisition. We believe two companies could spin-off some assets, Renault and Peugeot. Fiat announced on 21 April the spin-off of the groups industrial units by year-end. The new company, Fiat Industrial SpA FI - will be the majority owner of the agricultural and construction equipment manufacturer, CNH; the truck maker, Iveco, and the engine producer Fiat Powertrain Technologies FPT Industrial & Marine activities. Fiat SpA will remain the parent company of the other units, which comprise the auto activities, the components and FPT auto. Stock price jumped by 9.3% the day of this announcement. Renault: To reduce net financial debt of close to 6bn, we believe that the group will have to sell some assets, such as properties, and, in a much bigger move, its 20% stake in Volvo AB (trucks) worth around 3bn. There are no obvious links between Renault and Volvo AB, except limited partnerships in small trucks. Peugeot SA does not need to make disposals to rapidly improve its financial situation. However, our view is that a deconsolidation of Faurecia (57%-held component supplier) could take place via acquisitions made using share swaps, reducing Peugeots stake from a majority to a minority shareholding. At 1.4bn end-2009, Faurecias net debt currently represents most of Peugeot groups debt (2bn).
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (lc) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
France France
Buy Buy
EUR EUR
34 43
22.63 35.58
52400 35200
5133.8 10523.3
9 15.5
5 3.6
166.3 119
May 2010
25
Sector performance
MSCI World Banks 140 MSCI World
3.77
110
50
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
20
40
60
80
100
120
140
160
180
200
26
May 2010
Higher capital needs should result in a re-prioritising towards core businesses. The need to prioritise capital generation will have a number of consequences: 1) businesses which are lacking in scale or which have structurally low profitability will be de-emphasised; 2) with capital demands increasing under Basel 3, some banks may decide to withdraw entirely from some businesses in order to focus their capital resources on core business areas, leading to some retrenchment towards domestic/home markets vs international operations; 3) competition in many businesses will be lower, further enhancing pricing power and market share of the biggest players; and 4) the diversification profile of some banks will worsen in the near term, leaving them more exposed to the macroeconomic outlook for domestic economies.
SG view
Sector map
Industry Leaders
Sales
WELLS FARGO & CO UNICREDIT COMMERZBANK (XET) CREDIT SUISSE GROUP N GOLDMAN SACHS GP. MORGAN STANLEY INTESA SANPAOLO NORDEA BANK BBV.ARGENTARIA ROYAL BANK CANADA NATIONAL AUS.BANK COMMONWEALTH BK.OF AUS. TORONTO-DOMINION BANK WESTPAC BANKING BK.OF NOVA SCOTIA S/M* DEXIA
Growth companies
AUS.AND NZ.BANKING GP. STANDARD CHARTERED US BANCORP PNC FINL.SVS.GP. BANK OF NEW YORK BLACKROCK MELLON
KBC GROUP
Doldrums
the state of the Commercial Property markets. Commerzbank must pay back over 17bn of the silent stake provided by the German states Soffin fund, which supported the Dresdner acquisition and credit crisis costs. This will require a combination of capital raisings and possible further asset sales, although the scale of the task appears daunting, increasing the likelihood of some form of debt/equity swap. Dexia must sell Crediop, Dexia Sabadell and Dexia Banka Slovensko within three years.
May 2010
27
ING must sell its Insurance activities via a trade sale or IPO, divest ING Direct US, ING
Investment Management and Inter-Advies by the end of 2013. Given the size of the overall ING insurance operations (24.6bn embedded value), the company is likely to run a dual track, and weigh its options, either doing an IPO or selling various operations. In our opinion, the Benelux and US operations are too large to be sold to trade buyers, each with reported embedded values of 7-8bn. However, we believe there would be significant interest in the leading franchises ING operates in various emerging markets.
Royal Bank of Scotland is being forced by the EU to sell RBS Insurance, the RBS/Natwest
branches, William & Glyns, Global Merchant Services and RBS Sempra (partly complete) by 2013.
Revised business models may lead to more businesses being put up for sale
In addition to these forced sales, revised business models prompted by regulatory reform may precipitate asset sales. AIB intends to sell its Polish business, its MIT stake and its UK banking businesses in order to reach the Irish regulators demands in relation to equity Tier 1 capital even before the new Basel 3 rules are decided. Although there has been some political support in the US for the break-up of the largest financial institutions, this does not appear to have found international support. Hence, the wholesale break-up of Universal banks into their constituent Commercial banking and Investment banking parts does not seem likely at the present time. There also has been some pressure on banks to reverse some of the unbridled expansion from the pre-crisis period, e.g. Unicredit, where operations in 22 emerging European economies is seen by many as an unfocused approach which has left the group with limited distribution capacity as it seeks to rebuild its capital base.
UBS: Although UBS is now well capitalised post the difficulties it faced throughout the crisis,
should it fail to turnaround its US Wealth Management business, this could be yet another asset put up for sale. However, the bank remains focused on rebuilding its integrated Wealth Management/Investment banking Group rather than moving back to its pure Private Wealth Management roots.
proposals pass relatively intact, a number of banks with significant minority interests may need to increase these stakes to avoid being penalised from a capital perspective, and stakes in financial companies (e.g. Barclays 20% stake in Blackrock) may also need to be sold, increasing opportunities for investors to participate.
Stocks to watch
Company Country Reco Local Currency Target Price Price 04/05/10 (loc cur) (loc cur) 09 Sales (m) Market Cap P/E 10e Return on (m) Equity 10e EPS Growth 09-10e
nm nm 7.4 13.1
May 2010
29
Sector performance
MSCI World Capital Goods 160 MSCI World
3.77
130
70
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
markets (primarily in dollar-pegged currencies). Schneider, for example, plans to transfer around 250m of purchases per annum to low-cost countries (LCCs).
Relocation of production and R&D centres to regions outside Europe, primarily to LCCs. Closing and relocating plants to developing countries, which is a costly process. On the
whole, although the expansion of emerging markets should boost sector growth in the medium term, European companies could find their margins squeezed. New rivals of global scale are set to emerge.
Top ten companies (by market cap)
GENERAL ELECTRIC SIEMENS (XET) 3M ABB 'R' CATERPILLAR EMERSON ELECTRIC MITSUBISHI PHILIPS ELTN.KONINKLIJKE SCHNEIDER ELECTRIC HUTCHISON WHAMPOA 0
Source: SG Cross Asset Research
in $bn
50
100
150
200
250
30
May 2010
SG view
Sector map
Industry Leaders
Sales GENERAL ELECTRIC
MITSUI
ITOCHU
Growth companies
INGERSOLL-RAND
Doldrums
Sector consolidation could mark time in several regions, as new emerging market rivals arrive on the scene and become more aggressive in international markets, putting additional pressure on prices. We have identified three main potential spin-offs in this environment: General Electric, Philips, and Siemens, which are all diversified. However, their sound balance sheets mean they do not have to make this tough decision. Most of them will probably prefer to remain diversified and make acquisitions in non-euro countries. Thus, leaders, such as Siemens and ABB, are likely to continue external growth in emerging markets.
Siemens: The groups strategy is to focus on its three core sectors (Industry, Energy and
Healthcare). As a result, two of its current divisions could be put up for sale in the medium term: 1) SIS (4,686m sales, 90m in earnings in 2009): SIS is a provider of IT services which generates one-third of its sales internally. SIS will also be carved out (put into a separate legal entity), which makes possible an exit (via sale or IPO) in the medium term. 2) Hearing aids (sales of 700m): The business has a significant break-up value (probably worth >2bn). A disposal would highlight management's willingness to continue to streamline the portfolio and dispose of non-core businesses. But given the business is highly profitable (margins of around 20%), this would have a slightly dilutive impact on margins (-10bp) and EPS (-0.7%). Finally Siemens could also exit from its Mobility business. The transport business is isolated within Siemens and holds back the overall margin and growth profile of the group.
Philips: The group has had a very active portfolio streamlining strategy over the past 10 years. We
believe that the sale of the Television business (2009 sales 3.1bn, EBIT losses -180m) is the last necessary step in the groups strategic repositioning. Fixing the Television business is difficult given structural pricing pressure and rising competition. As a result, this business is holding back the companys growth profile, depresses group margins and, in our view, explains the stocks below average earnings rating (10% discount to the European Capital Goods sector on 2010e EV/EBITA).
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Philips
Netherlands
30 92
25.48 73.09
25640.2 73752.1
25125.3 66819.1
14.7 12.8
7.8 15.9
141.6 9.5
Siemens Germany
May 2010
31
Sector performance
MSCI World Chemicals MSCI World
110
NA
50 2005 2006 2007 2008 2009 2010
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
10
20
30
40
50
60
32
May 2010
SG view
Sector map
Industry Leaders
Sales
AIR LIQUIDE LINDE (XET) SUMITOMO CHEMICAL ASAHI KASEI TORAY INDS. PPG INDUSTRIES MONSANTO SYNGENTA DSM KONINKLIJKE AGRIUM YARA INTERNATIONAL PRAXAIR SHIN-ETSU CHEMICAL AIR PRDS.& CHEMS. SOLVAY ORICA MOSAIC ECOLAB POTASH CORPORATION OF SASKATCHEWAN Growth NITTO DENKO WACKER CHEMIE (XET) K + S (XET) GIVAUDAN 'N' SIGMA ALDRICH NOVOZYMES
*S/M: Sales / Market capitalisation; Source: SG Cross Asset Research
S/M*
companies
Doldrums
Over the past three years, chemicals companies have started refocusing on their core business, for instance divesting plastics (see Dows last deal) or selling pharma (see Solvay), in order to improve efficiency. The best example comes from the gas business where the refocus is almost complete. On the other hand, this is not the case for the other businesses. Of the top 10 leading chemical companies by sales, only three BASF, Dow, and Du Pont are listed standalones, while five are the chemicals operations of oil majors and two, LyondellBasell and Ineos, are privately-held. In this industry, some deals are already taking place, e.g. Air Products for Airgas and CF for Terra (Yara made an attempt).
BASF has said it will look to sell Styrenics again; however, apart from this, it is hard to imagine
BASF SE
54
44.6
57800
40959.6
10.2
18.8
46
May 2010
33
Construction, Motorways & Building Materials Companies already focused on sub segments
Sector valuation
Sector Market. Cap lc m P/E 10e P/BV 09 Dividend Yield 09 LT Interest rates
200
Sector performance
MSCI World Construction & Engeneering MSCI World
3.77 3.08**
170
140
3.99
110
1.29 NA
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
positions looks set to continue. Potential opportunities are becoming scarcer and the gap between the majors and non-majors is widening. However, the current crisis has prompted several cement majors to put some assets up for sale, which could provide opportunities for medium-sized players to catch up. In the cement segment, the focus is likely to be on emerging markets, primarily India, China and Africa. In aggregates, opportunities are mainly to be found in the developed world: the value of a quarry depends on its rarity and there is very little environmental pressure in emerging markets.
Top ten companies (by market cap)
VINCI (EX SGE) SAINT GOBAIN HOLCIM 'R' LAFARGE CRH BOUYGUES ACS ACTIV.CONSTR.Y SERV. ASAHI GLASS HEIDELBERGCEMENT (XET) DAIKIN INDUSTRIES 0 5 10 15 20 25 30 35
in $bn
34
May 2010
SG view
Sector map
Industry Leaders
Sales VINCI (EX SGE) BOUYGUES HOCHTIEF (XET) CRH LAFARGE HOLCIM 'R' FLUOR ACS ACTIV.CONSTR.Y SERV.
HEIDELBERGCEMENT (XET) LEIGHTON HOLDINGS ASAHI GLASS DAIKIN INDUSTRIES JS GROUP JACOBS ENGR. URS MASCO SNC-LAVALIN GP. ASSA ABLOY 'B'
S/M*
Growth companies
VULCAN MATERIALS
QUANTA SERVICES
IMERYS
JGC
Doldrums
GEBERIT 'R'
The rationale for consolidation in the construction and building materials sectors varies greatly depending on the segment and the specific features of the trade concerned. As a result, the degree of domination must be assessed based on geographic criteria. The worldwide consolidation process is more advanced in building materials than in construction and this is likely to remain the case in the coming years. Based on our screening, some companies expanded outside their core business during the last M&A cycle and could now be tempted to refocus. The economic crisis had a strong and direct effect on companies making them more vulnerable. This situation could push diversified groups like Saint-Gobain, or Hochtief to refocus on their core business.
Hochtief: At the end of 2009, Hochtief had planned to launch an IPO of its concessions business which is mainly minority stakes in several airports. The IPO was cancelled as market conditions were not good enough for the company to obtain a price attractive enough. Hochtief could at some point try to get some value out of its concession business. Saint-Gobain announced the disposal of its Glass packaging unit in 2007. The economic crisis
delayed the sale as the business is generating large cash flows and the company does not want to sell it cheap. Nevertheless, we expect the disposal to take place this year or next.
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Saint-Gobain Hochtief
France Germany
Buy
EUR
47 61
37.26 62.27
38615.1 17972.7
19114.4 4358.9
15.4 22.8
8.3 8
85.7 12
Hold EUR
May 2010
35
Sector performance
MSCI World Food Beverage & Tobacco MSCI World
140
110
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
20
40
60
80
100
120
140
160
180
200
36
May 2010
SG view
Sector map
Industry Leaders
Sales NESTLE 'R' JAPAN TOBACCO ARCHER-DANLS.-MIDL. UNILEVER CERTS. PEPSICO KRAFT FOODS PHILIP MORRIS INTL. ANHEUSER-BUSCH INBEV COCA COLA WILMAR INTL. KIRIN HOLDINGS BRITISH AMERICAN TOBACCO ALTRIA GROUP GENERAL MILLS DIAGEO SABMILLER KELLOGG CONAGRA FOODS SARA LEE HJ HEINZ PERNOD-RICARD REYNOLDS AMERICAN CAMPBELL SOUP MEAD JOHNSON NUTRITION LORILLARD FOSTER'S GROUP ASSOCIATED BRIT.FOODS IMPERIAL TOBACCO GP. DANONE HEINEKEN S/M*
Growth companies
Doldrums
The top 10 ranking shows that there are already significant sector leaders, and the sector includes a multitude of sub-segments. It does not make sense for groups to merge if they do not share common interests. Conversely, spin-offs could be seen as a solution to focus solely on core assets. Unsurprisingly, Unilever would appear to be a good candidate for a spin-off given its wide range of businesses. However, the company has decided to do otherwise. Over the past three years, it has implemented a program called One Unilever, for which the main goal is to locally merge the three operational management teams in Food, Personal Care and Household Care. That way every country has only one management and one headquarter for all the groups activities. This strategy has proven to be efficient so far, hence a split would not make sense. Other diversified groups like ABF are well placed on our Sector Map, but not many diversified groups are part of the Food products sector.
May 2010
37
Food & Staples Retailing Expand in emerging markets or spin off unprofitable assets?
Sector valuation
Sector Market. Cap lc m P/E 10e P/BV 09 Dividend Yield 09 LT Interest rates
Sector performance
MSCI World Food & Staples Retailing 140 MSCI World
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
50
100
150
200
250
38
May 2010
SG view
Sector map
Industry Leaders
TESCO Sales WAL MART STORES CVS CAREMARK COSTCO WHOLESALE SEVEN & I HDG.
Growth companies
COLRUYT
CASINO GUICHARD-P WESTON GEORGE SAINSBURY (J) DELHAIZE GROUP MORRISON(WM)SPMKTS. METCASH
Doldrums
LAWSON FAMILYMART
*S/M: Sales / Market capitalisation; Source: SG Cross Asset Research
OLAM INTERNATIONAL
A key focus for development has been eastern Europe where Metro is a clear pioneer and leader and Asia, with China still considered to be the Holy Grail. The market potential of these regions and the investments that European retailers have already made in these countries stand to make them long-term sources of growth. The majority of Europe's food retailers are still heavily exposed to western Europe, and the US retailers to North America; however, Tesco, Carrefour and Metro buck this trend with extensive overseas business. The model has been for profitable domestic markets to finance emerging markets expansion. We saw Casino spin off its real estate portfolio two years ago. Now, we consider whether a geographical spin-off would be possible for a company like Carrefour. For its part, Metro has many assets to sell.
Carrefour (Buy, TP 45). We have believed for some time that Carrefour will be the most successful turnaround in the sector after the 3.1bn of cost savings are delivered in 2012e. In the event of failure, Carrefours main shareholder, Blue Capital (50/50 Bernard Arnault and Colony Capital) would push for a partial break-up (sale of non-G4 operations), in our view. Our conservative sumof-the-parts valuation gives 50, i.e. 43% upside from the current level. Metro (Hold, TP 43). Metros management has made no mystery about several potential
disposals: 1) Kaufhof (German Department stores) is considered non core, i.e. on sale. Recently, the Metro CEO was cited in the Financial Times (30/03/10) as saying that the assumption of Kaufhof being sold to a private equity company in 2010 could be realistic. The value of this asset is based on its 50% store ownership. 2) IPO of Consumer Electronics: Metro is the European leader in Consumer Electronics delivering the Best in Class top line and margin. It clearly announced that going public is a mid-term goal. 3) REAL (Food Retail): although less likely today, as Metro recently published encouraging top-line and margin improvements for the division, management has made clear that if REAL was not back at a 2-3% EBIT margin in 2012, the asset would be sold.
Stocks to watch
Company Country Reco Target price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Carrefour Metro
45 43
36.88 46.76
91836.4 68161.9
25993.3 15153.8
13.6 15.6
15.4 16.5
-26.3 43
May 2010
39
Sector performance
MSCI World Retailing MSCI World
130
100
70
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
10
20
30
40
50
60
70
40
May 2010
SG view
Sector map
Industry Leaders
Sales HOME DEPOT TARGET BEST BUY LOWE'S COMPANIES SEARS HOLDINGS AMAZON.COM STAPLES MACY'S PPR YAMADA DENKI TJX COS. PENNEY JC KOHL'S KINGFISHER INDITEX GAP HENNES & MAURITZ 'B' LI & FUNG LIMITED BRANDS NORDSTROM MARKS & SPENCER GROUP JARDINE CYC.& CARR. S/M*
Growth companies
FAST RETAILING LIBERTY MDA.INTACT.'A' BED BATH & BEYOND SHERWIN-WILLIAMS AUTOZONE ESPRIT HOLDINGS RAKUTEN
Doldrums
PRICELINE.COM
*S/M: Sales / Market capitalisation; Source: SG Cross Asset Research
UK companies, which are not a homogenous group, have seen some spin-offs in the past (Kesa Electricals). Administrators were appointed at many retailers from 2008 onwards including Woolworths, MFI, Zavvi, Land of Leather and Sofa Workshop. Some of the brands were sold, either to management or a third party, which usually involved closing part of the store portfolio. As such they should continue to exist, even if only online (e.g. Zavvi and Woolworths). Nevertheless, some capacity has disappeared. The trend to specialise itself will probably continue as retailers seek to improve profitability following the competition of distribution through internet. PPR is probably the most complex stock to analyse in the retail sector. Management has developed several business areas (retail luxury, lifestyle), and the group now resembles a conglomerate. This aspect should lessen in the future as the group focuses on personal equipment by selling all retail banners in 3-5 years. However, for the time being, investors may have difficulty seeing which areas of value creation should yield the best returns and the best upside potential for the shares. We believe there are two: the repositioning of the Gucci brand (+20/share) and the value created by future acquisitions. In our SOP we estimate the value of retail assets at 3.7bn.
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
PPR
France
Buy EUR
121
102.75
16930.3
13006
13.8
7.7
19.4
May 2010
41
Sector performance
MSCI World Hotels Restaurants & Leisure 140 MSCI World
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
10
20
30
40
50
60
70
80
90
42
May 2010
SG view
Sector map
Industry Leaders
Sales MCDONALDS
STARWOOD HTLS.& RSTS. WORLDWIDE APOLLO GP.'A' H&R BLOCK ORIENTAL LAND
Growth companies
ICTL.HTLS.GP. SHANGRI-LA ASIA GENTING SINGAPORE
TIM HORTONS
WHITBREAD
Doldrums
It has become increasingly difficult to expand organically in Europe because of regulations and high real estate prices, making acquisitions a prized source of growth. The main hotel groups have therefore made many acquisitions (Accor with Dorint in Germany, Hilton with Stakis and Scandic, etc.), as this is a rapid way of rounding out regional coverage and facilitating brand development. The recent emergence of specialised investment funds could kick-start hotel development, but barriers to entry remain strong, and financing is currently extremely rare in the sector. The long-term potential in Europe and other regions looks high however.
Accor: Accor, one of the main hotel groups, has decided to spin off its non-hotel operations in order to focus on the hotel market, and reveal additional value as Vouchers are expected to trade at a clear premium to Hotels (our DCF valuation for vouchers gives a prospective EBITDA of 13.2x).
We think that: 1) The two future stocks combined offer considerable upside over the next 12 months (29.5 for hotels and 22.5 for the prepaid services division based on the net debt split announced by the group on 24 February 2010); and 2) Meanwhile, Accor could announce favourable news, including perhaps further asset disposals in line with its asset-right strategy which is at the root of the operating issues facing the hotel entity. Also, Accor is likely to IPO its share in Casino group Lucien Barrire (49% of shares) in H2 10e, which could be worth between 400m and 500m, plus a 220m debt impact.
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales(m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Accor
France
Buy EUR
53
43.32
7296.6
9766.8
28.1
9.2
10.7
May 2010
43
Sector performance
MSCI World Household & Personal Products 140 MSCI World
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
Scale issues are striking for A&P spending on media agencies (the biggest cost line in personal care) and for raw materials purchases from suppliers (the biggest cost for household care).
Critical mass is needed and constantly growing due to retailers current scale in addition to a continued shift towards more local concentration and geographical diversification.
Top ten companies (by market cap)
PROCTER & GAMBLE L'OREAL COLGATE-PALM. RECKITT BENCKISER GROUP KIMBERLY-CLARK BEIERSDORF (XET) AVON PRODUCTS KAO HENKEL (XET) CLOROX 0
Source: SG Cross Asset Research
in $bn
20
40
60
80
100
120
140
160
180
200
44
May 2010
SG view
Sector map
Industry Leaders
L'OREAL KIMBERLY-CLARK HENKEL (XET) COLGATE-PALM. KAO RECKITT BENCKISER GROUP AVON PRODUCTS ESTEE LAUDER COS.'A' BEIERSDORF (XET) SHISEIDO S/M* Sales PROCTER & GAMBLE
Growth companies
CLOROX
Doldrums
ENERGIZER HDG.
Sector consolidation remains on the agenda for both the personal care and the household sub-sectors, but now there are fewer listed targets (after the takeover of the The Body Shop and the minority buyout of Clarins), particularly when it comes to targets free of a controlled shareholding structure. The primary hurdle to consolidation in the HPC industry is the scarcity of decent-sized companies. That said, the deteriorating environment creates more opportunities but not necessarily at more affordable prices. In this environment, Henkel appears to be one of the few diversified companies in this sector. However, at the moment, management does not seem keen to divest unless it finds an acquisition in its own area of expertise. We believe the main players will wait for big conglomerates to refocus on fewer core businesses and dispose of appealing assets or brands (as was the case with LOral, when it acquired YSL Beauty from PPR, or Reckitt Benckiser, when it acquired BHI from Boots the Chemist). For several conglomerates, personal, household or healthcare businesses are small relative to their own size, and as such are often considered to be non-core. However, these businesses would offer an attractive fit and strengthen the portfolio of focused HPC groups.
Henkel announced in 2009 the sale of some of its business including the do-it-yourself (DIY) line of adhesives, office and houseware products, including Duck brand products. If Henkel follows this trend, in order to continue to focus on its core activity, a major spin-off is conceivable by splitting one of its three main businesses: Adhesive Technologies, Laundry & Home Care and Cosmetics. Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Henkel
Germany
Buy EUR
43
40.07
14039.7
7139
16.8
14.2
43.2
May 2010
45
Sector performance
MSCI World Insurance 150 MSCI World
120
90
60
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
Balance sheets have recovered quickly from low levels seen early in 2009 as the entire business is under mark to market.
While the European Commission will be the final decision-maker in the solvency II process, Thomas Steffen, who heads the German insurance industry supervisory authority, has stated that he would not object to delaying the introduction of Solvency 2 to 2013 from 2012. He points to the challenges for small- and medium-sized players, which might come under severe pressure. We have probably heard the worst about the potential impact of Solvency 2 on the industry (300bn in capital requirements for the industry, of which roughly 80bn for UK, or 50bn for Germany or France). The first signs of regulatory easing are appearing: grandfathering, review of the liquidity premium, ongoing discussion on intangibles.
Top ten companies (by market cap)
BERKSHIRE HATHAWAY 'B' ALLIANZ (XET) AXA METLIFE GENERALI ZURICH FINANCIAL SVS. MANULIFE FINANCIAL PRUDENTIAL FINL. MUENCHENER RUCK. (XET) GREAT WEST LIFECO 0
Source: SG Cross Asset Research
in $bn
10
20
30
40
50
60
70
46
May 2010
SG view
Sector map
Industry Leaders
Sales
METLIFE
MANULIFE FINANCIAL TOKIO MARINE HOLDINGS PRUDENTIAL FINL. ALLSTATE GREAT WEST LIFECO SWISS RE 'R' POWER FINL. HARTFORD FINL.SVS.GP. TRAVELERS COS. SUN LIFE FINL.
S/M*
Growth companies
CHUBB
Doldrums
The global insurance industry landscape has been radically modified as a result of the financial crisis. The biggest change concerns AIG, the worlds largest insurance company by premiums, which is now no bigger than a mid cap. AIGs collapse is a unique opportunity for the strongest players to pick and choose assets. The largest assets have now been sold (ALICO and AIA) but smaller pieces are still for sale. The insurance assets of ING (see Banks) are also on the table. We are confident we will see dynamic M&A in the medium term following the AIG deals. Insurance companies will emerge from the crisis either weaker or stronger. The stronger ones, i.e. those who did not need to call on the market during the crisis, should be best-placed to take advantage of M&A opportunities over the next 2-3 years. The biggest players are probably the best placed to consolidate the market and therefore take advantage of the current M&A environment via financial flexibility. The impact of Basel 2 and 3 on banks also may trigger a good pipeline for Bankinsurance assets to be sold (see ING).
Muenchenen Ruck: The insurer long has been saying that splitting insurance activities from reinsurance activities would create more value for shareholders. We doubt that management will finally decide to go through with this, although a spin-off of Ergo, the primary business, would not be irrational in this period. Stocks to watch
Company Country Reco FV (loc cur) Price 04/05/10 (l c) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Munich RE
Germany
Buy
EUR
125
107.2
4213.9
21161.5
9.1
na
-3.1
May 2010
47
Sector performance
MSCI World Textiles Apparel & Luxury Goods 170 MSCI World
140
110
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
10
20
30
40
50
60
48
May 2010
SG view
Sector map
Industry Leaders
LVMH NIKE 'B' ADIDAS (XET) VF RICHEMONT LUXOTTICA YUE YUEN INDL.HDG. POLO RALPH LAUREN 'A' THE SWATCH GROUP 'B' COACH PUMA RUDOLF DASSLER(XET) SOT. HERMES INTL. NISSHINBO HOLDINGS ASICS BURBERRY GROUP BILLABONG INTERNATIONAL GILDAN ACTIVEWEAR S/M* Sales
Growth companies
Doldrums
Sector consolidation remains on the agenda for the luxury goods sector given that: 1) entry barriers are high, as establishing a global brand takes time; 2) acquisitions help round out a product portfolio or improve geographical coverage; and 3) this industry is still relatively fragmented, although a closer analysis by product or distribution segment highlights contrasting situations. The luxury goods sector can already be considered a global market given the balanced breakdown of its sales. However, this is somewhat misleading as an analysis by customer nationality appears more meaningful in order to get past the problem of tourist flows.
May 2010
49
Sector performance
MSCI World Media MSCI World
130
100
70
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
Client needs. The ability to service clients on a global basis has gradually become critical in
some sub-sectors. The consolidation process seen over the last two decades in the advertising agencies sector (and potential Aegis/Havas tie-up) is, therefore, likely to be replicated in some marketing services activities. In particular, market research should see steady consolidation (started with TNS/WPP), driven by the main agencies or marketing services groups.
Sub-sector maturity. In markets that are already very segmented, such as magazine
publishing, acquisitions are the main way of gaining additional penetration, either in the Consumer or B2B fields. Given the highly diverse nature of the Media sector, we have used a market capitalisation ranking (30 March 2009). On this basis, the top 10 global Media & Entertainment companies are clearly dominated by US groups.
Top ten companies (by market cap)
WALT DISNEY COMCAST 'A' TIME WARNER DIRECTV 'A' VIVENDI THOMSON REUTERS NEWS CORP.'A' VIACOM 'B' BRITISH SKY BCAST.GROUP OMNICOM GP. 0
Source: SG Cross Asset Research
in $bn
10
20
30
40
50
60
70
80
50
May 2010
SG view
Sector map
Industry Leaders
Sales WALT DISNEY COMCAST 'A' VIVENDI TIME WARNER DIRECTV 'A' DENTSU THOMSON REUTERS VIACOM 'B' WPP OMNICOM GP. BRITISH SKY BCAST.GROUP PEARSON MCGRAW-HILL PUBLICIS GROUPE VIRGIN MEDIA MEDIASET WOLTERS KLUWER JUPITER TELECOM. SHAW COMMS.'B' DISCOVERY COMMS.'A' JCDECAUX SCRIPPS NETWORKS INTACT. 'A' CBS 'B' DISH NETWORK 'A' LAGARDERE GROUPE S/M* CABLEVISION SYS. NEWS CORP.'A'
Growth companies
SES FDR (PAR) EUTELSAT COMMUNICATIONS
Doldrums
The main "traditional" consolidation driver (i.e. the search for cost savings) has limited crossborder relevance in the Media sector, mostly due to local cost dynamics. For commercial TV, there are strong potential cost-savings synergies from merger operations on the domestic market, but margins depend on the local context (multichannel players vs single channel players, cost inflation etc). As the degree of consolidation is high, we do not see any major move and the same applies for spin-offs. Following the Time Warner spin-off of AOL, only Vivendi now appears to be a good candidate for spinning off the telecom business. The spin-off process has already begun with the disposal of Universal which should be complete by H2 10. This is clearly a favourable asset reshuffle and there may be more ahead. However, while the group's structure lends itself very well to potential spin-offs (discount to SOP, diversified portfolio, no tax liabilities), its effective strategy focuses on gaining fuller control of its main activities, except when local specifics favour continuing a market listing (Maroc Telecom, Activision Blizzard). The SG Media team therefore deems the odds of a spinoff as rather low.
Stocks to watch
Company Country Reco Target price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Vivendi
France
Buy EUR
22
19.93
27588.2
24499.7
8.9
10.3
4.4
May 2010
51
Sector performance
MSCI World Metals & Mining 290 MSCI World
3.77 3.08**
230
170
3.99 1.29 NA
50 2005 2006 2007 2008 2009 2010 110
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
The top 10 companies represented 30% of world steel production in 2008. The market is still fragmented, with the top 20 steel producers representing 45% of total production. ArcelorMittal clearly dominates the steel industry and is four times bigger than its closest competitor. The top 10 mining companies are clearly diversified. Industry fragmentation varies depending on the business segment: in iron ore, the top 10 companies represent 97% of world production vs 71% for coking coal, 54% for copper, and 49% for aluminium.
52
May 2010
SG view
Sector map
Industry Leaders
Sales BHP BILLITON RIO TINTO XSTRATA ANGLO AMERICAN
BARRICK GOLD NEWMONT MINING TECK RESOURCES 'B' EURASIAN NATRES.CORP. GOLDCORP ERAMET
Growth companies
AGNICO-EAGLEFRESNILLO MINES ELDORADO GOLD
ANTOFAGASTA KINROSS GOLD KAZAKHMYS CLIFFS NATURAL FORTESCUE METALS GP.RESOURCES NEWCREST MINING YAMANA GOLD
Doldrums
Contrary to spin-off activity, there may be ongoing consolidation in the sector. Greater industry consolidation (especially vertical integration) is becoming increasingly important and may receive growing attention as corporate activity continues. As some markets become oligopolies, many producers seek the benefits from concentrations critical influence on price.
Synergies albeit at a limited level: in our view, M&A-linked synergies in the mining industry are
usually modest, as they are limited to cuts in E&P and capex spending through project prioritisation within expanded exploration portfolios (historically -20%). However, we question consolidators leeway to trim development costs against the current backdrop of expansion cost overruns and delays. Indeed, the mining industrys ability to reduce cost bases through mergers is generally limited, as such reductions imply geographical/portfolio overlaps that conflict with the search for risk diversification.
BHP Billiton: In 2004, BHP Billitons former CEO Chip Goodyear was quoted as saying that
more had to be done to convince investors of the value of the oil & gas division. He stressed that if this failed, management would come up with an alternative. We believe BHP Billiton remains committed to high returns and its differentiating petroleum unit, and that a spin-off may no longer be on the horizon.
ThyssenKrupp announced the reorganisation of its operating segments into two divisions in
order to: 1) adapt to further deteriorating economic conditions, 2) increase the groups efficiency, and 3) increase flexibility for M&A measures (disposals, restructuring, JVs). We are of the view that TK is unlikely to spin off its steel divisions as it considered doing in FY00.
ArcelorMittal is likely to maintain its iron ore and coking coal activities within the group to fully
ArcelorMittal ThyssenKrupp
37 23.5 26
8.9 29.4 4
May 2010
53
Oil & Gas Oil leaders ready to spin off non-core assets
Sector valuation
Sector Market. Cap lc m P/E 10e P/BV 09 Dividend Yield 09 LT Interest rates
170
Sector performance
MSCI World Oil & Gas MSCI World
110
NA
50 2005 2006 2007 2008 2009 2010
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
54
May 2010
SG view
Sector map
Industry Leaders
Sales
SUNCOR ENERGY IMPERIAL OIL OCCIDENTAL PTL. HUSKY EN. BG GROUP ENBRIDGE CENOVUS ENERGY CANADIAN NATURAL RES. APACHE ENCANA
HESS
S/M*
TRANSCANADA
Growth companies
XTO EN. WOODSIDE PETROLEUM EOG RES.
Doldrums
TALISMAN EN.
The sector is already very concentrated. There was a big consolidation wave when oil prices plummeted in 1998-99. Majors are so big now that we believe consolidation would create companies that would be too big and make it difficult to sustain growth. Many oil companies are looking to improve shareholder value via divestment of non-core assets:
Statoil: The Board of Directors unanimously agreed in February to consider a new ownership
structure for the energy and retail business (E&R), with a stock-exchange listing currently viewed as the most likely solution in the fourth quarter of 2010 at the earliest.
Repsol-YPF issued a press release with and without Gas Natural, signalling a possible medium-term withdrawal from its c.30%-owned subsidiary. Thus, Repsol-YPFs debt which currently stands at 10,928m (14,654m including preferential shares) could be reduced to 4,905m (or 8,453m including the preferential shares) if Gas Natural is excluded. Repsol-YPF is a diversified oil company with upstream, downstream LNG and Gas Natural businesses. Total also could potentially spin off its specialty chemical division, which would resemble the
groups strategy when it successfully spun off Arkema four years ago.
ConocoPhillips has announced it will cut its stake in Lukoil by half. It currently owns 20% of
Lukoil, a stake worth $9.4bn, which means that it may be selling c.$4.7bn in shares.
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Spain Norway
Hold Buy
18 165 58 49
May 2010
55
Sector performance
MSCI World Pharmaceuticals 140 MSCI World
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
20
40
60
80
100
120
140
160
180
200
56
May 2010
SG view
Sector map
Industry Leaders
JOHNSON & JOHNSON PFIZER NOVARTIS 'R' ROCHE HOLDING SANOFI-AVENTIS MERCK & CO. ABBOTT LABORATORIES GLAXOSMITHKLINE ASTRAZENECA ELI LILLY ASTELLAS PHARMA DAIICHI SANKYO MITSUBISHI TANABE PHARMA FOREST LABS. SHIRE PERRIGO SHIONOGI UCB MYLAN S/M* EISAI BAYER (XET) Sales
BRISTOL MYERS SQUIBB TAKEDA PHARM. NOVO NORDISK 'B' ALLERGAN CHUGAI PHARM.
Growth companies
Doldrums
We see the diversification approach of the industry falling into three main categories: 1) Big Pharma diversifying into new businesses and geographies; 2) Big Pharma shedding non-core businesses and focusing on fewer geographic regions; and 3) Specialty care companies expanding globally. We have seen an increase in M&A activity as some majors have been unable to replace blockbusters and grow new business lines and markets quickly enough. We note that for most recent deals in Europe, the market did not appear to penalise the acquirer for significant premiums, provided the deals were accretive. This could make the trend a net positive for investors. We see the Big Pharma model continuing for some time, although in an adapted form. The industry has been focusing on improved R&D productivity, restructuring to drive operatingmargin improvements and searching for growth opportunities via new blockbusters, diversification and emerging markets, with M&A a theme throughout.
Bayer: Management staying the conglomerate course, but nothing can be ruled out over a
longer time period. Our quantitative model shows Bayer as a leading candidate for spin-off deal. This comes as no surprise as the groups presence in healthcare, chemicals and crop science has often given rise to speculation about a break up. Indeed, pharma peers Sanofi-Aventis, Novartis and AstraZeneca have all spun off their non-core businesses in the past. However, current Bayer CEO Werner Wenning has been a staunch defender of the current model, and CEO designate Dr. Marijn E. Dekkers has publicly committed to stick to the conglomerate path. It would likely be much easier for Bayer to divest units than to invest the proceeds from such a deal into new businesses. Hence, a spin-off transaction does not appear imminent, but cannot be ruled out over a longer time period.
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Bayer AG
52
47.17
32015.2
39007.1
13.7
13.6
18.2
May 2010
57
Sector performance
MSCI World Real Estate MSCI World
100
NA
40 2005 2006 2007 2008 2009 2010
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
10
15
20
25
30
35
40
58
May 2010
SG view
Sector map
Industry Leaders
Sales
SWIRE PACIFIC 'A' CHEUNG KONG HOLDINGS NEW WORLD DEV. ANNALY CAPITAL MAN. HENDERSON LD.DEV. VORNADO REALTY TST. CITY DEVELOPMENTS CAPITALAND S/M* WHARF HOLDINGS EQUITY RESD.TST.PROPS. SHBI KERRY PROPERTIES
Growth companies
BOSTON PROPERTIES HCP PLUM CREEK TIMBER STOCKLAND SINO LAND VENTAS
Doldrums
This map shows property developers (high sales, low capital intensity) and pure rental businesses (low rent, high capital intensity). Real estate sectors could benefit from the determination of certain industrial groups to refocus on their core business and therefore we could have more spin-offs such as Mercialys which was previously part of the Casino group. The sectors renewed appeal should last over the next few years.
The development of funded pension schemes should benefit long-term investment vehicles that offer good visibility on cash flow and underlying asset values. Even in the event of a real estate crisis, investors can reasonably expect property values to rise over the long term in line with local economic growth.
Institutional investors are likely to switch increasingly to real estate assets in the wake of the
general disenchantment with equities. Listed real estate companies, which represent more liquid investments than direct real estate holdings, stand to benefit from this trend. The sectors renewed appeal should lead to an increase in the number of players. The introduction of new investment vehicles could help to match demand for real estate equities. Although we do not expect any major move in the industry, demerging is a possibility even for the Small & Mid Caps. A few weeks ago Liberty International announced it was demerging its portfolio of central London properties from its regional shopping centres, as the company reported a narrowing in pre-tax losses in 2009. It has planned to complete the demerger by May. Liberty International will then be renamed Capital Shopping Centres.
May 2010
59
Sector performance
MSCI World Software & Services MSCI World
140
110
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
50
100
150
200
250
300
60
May 2010
SG view
Sector map
Industry Leaders
ORACLE SAP (XET) EBAY VISA 'A' MASTERCARD CA YAHOO NINTENDO Sales MICROSOFT
GOOGLE 'A'
S/M*
ACTIVISION BLIZZARD ADOBE SYSTEMS PAYCHEX AUTODESK CITRIX SYS. COGNIZANT TECH.SLTN.'A' INTUIT BMC SOFTWARE
Growth companies
Doldrums
DASSAULT SYSTEMES
Software companies and IT Services companies are priced differently by the market. Hence, the main Software companies are located on the left side of our Map, as they are better priced, and the main IT Services companies are on the right. In our view, M&A activity is also likely to continue in the IT services sector, with larger players taking advantage of low valuations. The main motivations are to increase the client base, acquire operational capacity such as low cost resources, and gain business expertise. We believe the consolidation trend will continue to focus on offshore. However, following the HP-EDS merger, we cannot rule out the possibility of another mega consolidation in the sector driven by market-share dynamics. IT Services goal to become one-stop shops could continue to push major vendors to acquire small companies. Furthermore, we believe that cross-border consolidation will increase as offshore vendors, such as Indian companies, focus on acquiring business. As these companies already have strong positions in the US, we believe their next targets likely will be European. Given the emergence of cloud computing, the major technology shift in the industry for the next ten years, we believe the industry could move back to a semi-integrated model, providing customers with an all-in-one offering, including hardware, software and services. In our view, companies would better protect their profitability in the IT industry by adopting this approach and partially lock in their customers. Against this backdrop, hardware companies actively would continue to acquire software companies, e.g. IBM, Cisco and HP's strategy over the past few years, while software vendors would acquire hardware companies, e.g. Oracle's acquisition of Sun Microsystems. In the Services sector, some companies such as Indra or Sopra have a hybrid model, offering both proprietary software solutions and traditional services activities. For example, Sopra, a mid-cap French company, will spin off its software division Axway in Q3 10.
May 2010
61
Sector performance
MSCI World Technology Hardware & Equipment MSCI World
140
110
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
50
100
150
200
250
300
62
May 2010
SG view
Sector map
Industry Leaders
Sales INTERNATIONAL BUS.MCHS. APPLE CISCO SYSTEMS HEWLETT-PACKARD NOKIA TOSHIBA DELL FUJITSU NEC
CANON
ERICSSON 'B'
Growth companies
KEYENCE
TDK NIDEC MURATA MANUFACTURING HARRIS AGILENT TECHS. HOYA SANDISK NETAPP JUNIPER NETWORKS NIPPON ELEC.GLASS AMPHENOL 'A'
WESTERN DIGITAL
Doldrums
In a depressed sector, some leaders are looking for a new strategy. Motorola is already thinking of a full spin-off after several quarters of losses from its handset business unit, whereas groups like Alcatel-Lucent and Ericsson are fighting to keep a leading position in their business. We believe that any further consolidation is likely to continue to be driven by companies exiting certain markets and/or regions. In addition, larger manufacturers may still acquire smaller manufacturers to gain access to specific technologies and/or customer lists. We do not anticipate any major acquisitions or mergers between larger companies.
Alcatel-Lucent The company has been through a huge reorganisation which has included a
large number of asset sales. However, we believe that there is now little to sell and that the company will be forced to focus on its existing businesses rather than acquisition or selling further assets. There has been speculation about a potential merger of Alcatel-Lucents mobile business with that of Nokia Siemens, but we believe that an American/Finnish/French/German group would be too complex to even contemplate.
Ericsson After a flurry of purchases in the fixed line business a few years ago, Ericsson has not
made any recent acquisitions recently. We believe that the company has little intention of acquiring large new companies but is interested in bolt-on acquisitions. Given its very large cash pile, further small acquisitions could well be on the horizon.
Motorola The company has announced its intention to split the business, and keep the handset
business with the other businesses spun off. However, we believe that the handset business still has major hurdles to overcome and so this spin-off still represents a difficult challenge for the company, particularly as it is struggling to make a credible comeback in the market.
Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
117.3 88.5 nm
May 2010
63
Sector performance
MSCI World Telecommunication Services 140 MSCI World
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
Mergers between incumbents appear difficult to achieve due to political roadblocks and the lack of obvious synergies between what essentially remain local businesses.
In-market consolidation faces regulatory hurdles. The local dominant players will not be in a position to make acquisitions due to anti-trust concerns. Moreover given the increasing risk aversion towards emerging markets, European operators are unlikely to use their balance sheets to expand their footprint. Given the country-based nature of the industry, it is not surprising that large GDP countries are overrepresented. Most of the companies in the table below have been in the top 10 throughout the last decade as consolidation has enabled them either to reinforce their domestic presence or to expand internationally.
Top ten companies (by market cap)
AT&T VODAFONE GROUP TELEFONICA VERIZON COMMUNICATIONS NTT DOCOMO INC NIPPON TELG. & TEL. FRANCE TELECOM DEUTSCHE TELEKOM (XET) TELSTRA SINGAPORE TELECOM 0
Source: SG Cross Asset Research
in $bn
20
40
60
80
100
120
140
160
180
64
May 2010
SG view
Sector map
Industry Leaders
Sales AT&T
KDDI TELECOM ITALIA SPRINT NEXTEL BT GROUP SOFTBANK TELSTRA KPN KON BCE TELENOR TELIASONERA QWEST COMMS.INTL. ROGERS COMMS.'B' SINGAPORE TELECOM SWISSCOM 'R' TELUS PORTUGAL TELECOM SGPS TELE2 'B' CENTURYTEL NII HDG. CROWN CASTLE INTL. AMERICAN TOWER 'A'
*S/M: Sales / Market capitalisation; Source: SG Cross Asset Research
S/M*
Growth companies
BELGACOM
Doldrums
We have seen many changes in this sector in the past 10 years with many mergers in Europe, but also some spin-offs, for example O2 bought by Telefonica. Vodafone changed its strategy following Chris Gents departure in mid-2005, divesting noncore assets. Now it appears that Deutsche Telecom is considering listing its US subsidiary.
Deutsche Telekom's (Buy, TP 10.8) US mobile operation T-Mobile US is currently experiencing operational difficulties (revenue decline driven by market share losses at the high end to competitors AT&T and Verizon). While management is committed to turning around this situation in 2010, we believe there are realistic scenarios for the medium to long term where the company could consider a partial sell-off in the form of a partial IPO or a trade sale of a stake to an industrial partner. One scenario, against our own expectations, is that management is unable to turn around the asset in 2010. We believe the likelihood of a strategic solution would rise significantly in this case in early 2011. However, even if operating trends stabilise, there is a question mark over the return on capital achievable by T-Mobile US during the inevitable longer-term move to a next-generation (4G) network. While this is more a 2012-13 story for T-Mobile US, a partnership with (selling a stake to) an industrial company, preferably one with access to the required radio spectrum, would make sense. Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
Deutsche Telekom
10.8
9.88
64048.9
43081.1
12
9.8
5.2
May 2010
65
Sector performance
MSCI World Utilities 170 MSCI World
3.77
140
80
* Median and Total are calculated from the entire MSCI World Sector Index, ** German LongTerm Interest Rate, Source: SG Cross Asset Research Data as of 4 May 2010
66
May 2010
SG view
Sector map
Industry Leaders
Sales EDF
FORTUM CLP HOLDINGS HONG KONG SNAM RETE GAS AND CHINA GAS IBERDROLA RENOVABLES HONG KONG ELECTRIC
*S/M: Sales / Market capitalisation; Source: SG Cross Asset Research
Growth companies
FIRSTENERGY
Doldrums
Some of the large utilities have indicated they want to sell off assets. We believe the market will pay particular attention to this theme given the increasing difficulty of obtaining financing. We estimate the value of assets up for sale at around 30bn. Some assets could be listed on the stock market. The sale of assets will naturally come under close scrutiny as the programmes are carried out. We believe asset divestments could create potential for rerating depending on the price obtained.
Example of assets up for sale
Company Divestment programme Period
E. ON the company has already sold some assets (hydro generation to Verbund, generation
assets to EnBW, Thega). One of the remaining assets for sale is E.ONs US business, LG&E in the Midwest.
Enel the Italian company has launched the process to IPO its renewable energy arm, Enel
Green Power. We think this company (worth 10-13bn) could attract a lot of interest and help Enel to reduce its debt pile by year end.
EDF The group may sell its distribution network in the UK. The value of the regulated assets is 3.6bn with non-regulated assets valued at c.200m. We think EDF may sell these assets only if it obtains a premium. Stocks to watch
Company Country Reco Target Price (loc cur) Price 04/05/10 (loc cur) 09 Sales (m) Market Cap (m) P/E 10e Return on Equity 10e EPS Growth 09-10e
29 5.1 55
28.19 3.96 41
8.5 7.2 21
6 19.1 -9.5
May 2010
67
68
May 2010
May 2010
69
IMPORTANT DISCLOSURES
Accor Aegis Group plc Air France-KLM Air France-KLM ALCATEL American Water Works American Water Works American Water Works Anheuser-Busch InBev Anheuser-Busch InBev Banco De Sabadell Banco De Sabadell BANK OF AMERICA Barclays Barclays Barclays BASF SE BBVA BG Group Boeing Carrefour Carrefour Casino Casino CFAO Deutsche Bank Deutsche Telekom Dexia EADS EADS EDF EDF EDF Enel Enel Enel Enel Faurecia Faurecia Faurecia Finmeccanica Finmeccanica Finmeccanica France Tlcom Gas Natural SDG Gas Natural SDG Gas Natural SDG Gas Natural SDG Gas Natural SDG ING Group Lafarge Lafarge Lafarge Lafarge LVMH Metro Nokia Novartis AG Peugeot Citroen PSA Peugeot Citroen PSA PPR PPR Prudential Repsol-YPF Saint-Gobain Saipem Sanofi-Aventis Santander Santander Schneider Schneider Socit Gnrale Sopra Group TELEFONICA SA TELEFONICA SA TELEFONICA SA SG is acting as financial advisor in its demerger project. SG acted as joint bookrunner of Aegis' convertible bond issue. SG acted as joint book runners to Air France-KLM inaugural bond issue. SG acted as joint bookrunner in the issue of senior unsecured bonds convertible into new shares and/or exchangeable for existing shares of Air France KLM (OCEANE) SG acted as joint bookrunner in the issue of bonds convertible into new shares and/or exchangeable for existing shares of Alcatel Lucent (OCEANE) SG acted as co-manager in American Water Works' equity raising. SG acted as co-manager in the secondary offering of American Water Works shares by RWE SG acted as co-manager in the secondary offering of American Water Works shares by RWE and in the capital increase of American Water Works. SG acted as co-manager of Anheuser-Bush Inbev's senior bond issue SG acted as joint bookrunner of Anheuser-Busch Inbev's bond issue (4% 26/04/18 EUR). SG acted as joint bookrunner in the Banco De Sabadell's senior bond issue. SG acted as joint bookrunner in the Banco Sabadell's covered bond issue (3.125% 20/01/14 EUR). SG acted as co-manager in Bank of America's secondary offering. SG acted as Co-manager of Barclays plc's bond issue. SG acted as co-manager in the Barclays senior bond issue. SG acted as co-manger in Barclays' senior high grade bond issue. SG acted as joint bookrunner in the BASF's senior bond issue (TAP) (5.125% 09/06/15 EUR). SG acted as joint bookrunner in BBVA's covered bond issue (3% 09/10/14 EUR). SG acted as Joint Bookrunner in the BG Group's senior bond issue (3.375% 15/07/13). SG acted as co-manager in the Boeing's senior high grade bond issue. SGSP is managing a liquidity contract on behalf of Carrefour SG is a long-standing banker of Carrefour as well as the Halley Family SG acted as bookruner in Casino's exchange offer. SG is acting as Dealer Manager for Casino's tender offer. SG acted as joint-global coordinator, joint-lead manager and joint-bookrunner in CFAO's IPO. SG acted as Joint bookrunner in the Deutsche Bank covered bond issue. SG acted as co-manager in Deutsche Telekom's high grade senior bond issue. SG acted as joint bookrunner in the Dexia's senior bonds issue (5.375% 21/07/14). SG acted as joint bookrunner in the EADS's senior bond issue (4.625 12/08/16 EUR). SG is mandated lead arranger of the loan granted to Republic of Brazil to finance the acquisition of helicopters from EADS Group. SG acted as joint bookrunner in EDF's bond issue (4.625% 26/04/30 EUR). SG acted as co lead manager in the EDF bond issue to retail customers (4.5% - 2014). SG acted as joint bookrunner in EDF's senior bond issue (4.625% 11/09/2024 EUR). SG makes a market in Enel warrants SG acted as senior co-lead manager of Enel right issue SG is participating in a medium-term bank loan to Enel Rete Gas for the operation of disposal by Enel of its majority stake. SG acted as bookrunner in Enel's senior high grade bond issue (4% 14/09/16 EUR, 5% 14/09/22 EUR, 5.625% 14/08/24 GBP, 5.75% 14/09/40 GBP). SG was sole bookrunner and sole global coordinator for the placement of Faurecia's shares. SG was acting as global coordinator, lead manager and bookrunner of the rights issue of Faurecia SG acted as global coordinator, joint bookrunner and joint lead manager in the issue of bonds convertible into new shares and/or exchangeable for existing shares of Faurecia (Oceane). SG makes a market in Finmeccanica warrants SG acted as joint bookrunner in the Finmeccanica's senior bond issue. SG acted as co-manager in the Finmeccanica's senior unsecured HG bond issue. SG acted as joint bookrunner of France Telecom's bond issue (3.875% 09/04/20 EUR). SG acted as passive bookrunner in Gas Natural's bond issue SG acted as Bookrunner and Mandated Lead Arranger in the acquisition financing of Union Fenosa by Gas Natural SG acted as financial advisor to Mitsui in the purchase from Gas Natural of natural-gas-fired power stations in Mexico SG acted as joint bookrunner in the issue of GAS NATURAL's senior bond (5.25% 09/07/14 EUR & 6.375% 09/07/19 EUR). SG acted as joint bookrunner in Gas Natural's senior bond issue (3.375% 27/01/15 EUR ; 4.125% 26/01/18 EUR ; 4.5% 27/01/20 EUR). SG acted as co-lead manager in the ING's rights issue. SG acted as joint bookrunner of the rights issue of Lafarge SG acted as joint bookrunner in Lafarge's bond issue (5.5% 16/12/19 EUR). SG acted as joint bookrunner in the Lafarge senior bond issue (7.625% 24/11/16 EUR). SG acted as joint bookrunner in the Lafarge's senior bond issue (7.625% 27/05/14 EUR). SG acted as joint bookrunner in the LVMH's senior bond issue. (4.3275% 12/05/14 EUR) SG acted as joint bookrunner in the Metro's senior bond issue. SG acted as co-Manager of in NOKIA 's senior unsecured bond issue. SG acted acting as joint bookrunner in Novartis' senior bond issue. SG was acting as global coordinator, lead manager and bookrunner of the rights issue of Faurecia SG acted as global coordinator and joint book runner in the issue of unsecured bonds convertible into new shares and/or exchangeable for existing shares of PSA Peugeot (OCEANE). SG acted as joint bookrunner of PPR's senior bond issue. SG acted as joint-global coordinator, joint-lead manager and joint-bookrunner in CFAO's IPO SG will act as Co-lead Manager in Prudential PLC announced right issue SG acted as joint dealer manager for a Repsol's bond exchange offer. SG acted as joint bookrunner in the Saint-Gobain's senior bond issue (6% 20/05/13 EUR). SG makes a market in Saipem warrants SG acted as joint bookrunner in the SANOFI-AVENTIS' senior bond issue (3.5% 17/05/13 EUR & 4.5% 18/05/16 EUR). SG acted as joint bookrunner of Santander's covered bond issue (3.625% 06/04/17 EUR). SG acted as joint bookrunner in the Santander's covered bond issue (3.875% 27/05/14 EUR). SG is acting as financial advisor to Alstom for the acquisition of Areva T&D. SG acted as sole manager in the Schneider Electric's senior bonds issue. SG issues no recommendation on Socit Gnrale's own financial instruments. SG holds between 10% and 20% of Sopra SG is acting as joint bookrunner in Telefonica's senior bond issue. SG acted as joint bookrunner in Telefonica's senior bond issue (3.406 24/03/15 EUR). SG acted as joint bookrunner in the Telefonica's senior bond issue (5.496% 01/04/16 EUR).
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Thomson Thomson Total UBS Unicredit Group Unicredit Group Unicredit Group Veolia Environnement Vivendi Vivendi Vivendi Volkswagen (Pref.)
SG is one of the banks of Thomson. SG holds between 5% and 10% of Thomson as a result of its trading activites SG acted as exclusive financial advisor to Total for a disposal project. SG acted as joint bookrunner in the UBS' covered bond issue. SG makes a market in Unicredito warrants SG acted as co-lead manager in Unicredit's rights issue. SG acted as joint bookrunner in the Unicredit's subordinated bond issue (8.125 10/12/49 EUR). SG is acting as financial advisor to CDC for the merger of Transdev with Veolia Transport. SG acted as financial advisor to Vivendi for the disposal of its stake in NBCU AG acted as joint bookrunner of Vivendi's senior bond issue (4% 31/03/17 EUR). SG acted as joint bookrunner in Vivendi's bond issue (4.25 01/12/16 EUR & 4.875 02/12/19). SG is acting as co bookrunner for Volkswagen's right issue
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