Panta Capital

As expected in our 02-Jun-09 entry, the European Commission has today both approved the proposed acquisition of Austrian Airlines by Lufthansa AG, and the State Aid. This means that now all green lights have been given for the acquisition, and Austrian Airlines' shareholders will receive the EUR 4.49 cash per share.

After Oracle Corporation agreed to buy Sun Microsystems (JAVA) on 20-Apr-09 for $9.5 cash per share, the closing of the deal remains subject to both US DoJ and EC competition approvals. Given the presence of significant competition from various participants in every market where both Sun and Oracle operate and compete, we strongly believe that both regulators will ultimately approve the deal.

However, timing risk exists on Oracle's statement that it will be able to complete the transaction before the end of the summer: First, Oracle announced on 26-Jun-09 that the US DoJ requested additional information regarding the transaction and that it expected to be able to resolve the antitrust issues in approximately 8 weeks (i.e. before the end of August). Secondly Sun and Oracle filed their merger application with the EC on 30-Jul-09, indicating a provisional deadline for a Phase I decision on 03-Sep-09.

From both the DoJ and EC's perspective there is an increased unlikelihood of a late August/early September closing of the deal: 1) Given that most DoJ antitrust review processes last about 3 months from the date of the request for additional information, we would find an end of September decision more likely than Oracle's aggressive end of August indication.
2) Given a) the complexity of the vertical issues of a Sun-Oracle combination; b) the number of questions that will be raised by European competitors and programmers surrounding the licensing of Java and MySQL; and c) the current European holiday period, there is a strong possibility that the EC might launch a Phase II decision, adding a possible extra 90 trading days to the timetable.

We believe that ultimately the deal will close, in a worst case scenario by the end of 2009, and would be buying more if/when Sun's share price falls towards/under $9 per share levels (or 5.6% merger spread) on regulatory delay announcements.

On 16 July 2009, Tandberg ASA (TAA NO - TADBF.PK), the Norwegian videoconferencing company, was rumoured again to have received an expression of interest from a private equity firm. This rumour follows last August's announcement that Tandberg was approached by a PE player. We believe that the PE player in question is Silver Lake Partners, a $10bn technology specialty fund, which is re-evaluating the deal it abandoned last year when the financing fell through: an acquisition of Tandberg would create significant synergies for Silver Lake, which already owns Avaya (a world leader in enterprise telephony) and are in the process of buying Nortel Enterprise Solutions. An addition of Tandberg to Silver Lake's portfolio would create a major player in the communication equipment market.

Despite its 10% share price appreciation to NOK 124 since the rumoured interest, Tandberg is still trading at a discount to both its own trading history and to Polycom (PLCM), its closest competitor:
1) Tandberg has on average been trading at a 12 month forward EV/EBIT multiple of 13.5x since 1999. At a NOK 124 share price, Tandberg is trading at a 2010 EV/EBIT of 10.5x, a 20%+ discount vs its historical average multiple.
2) TAA’s multiple is currently at a 5-10% discount to PLCM’s (compared to a historical 2% discount): we believe this is unjustified as:
o    Back in 2006-early 2007, PLCM’s premium valuation was due to the numerous profit warnings and other bad news from TAA. Naturally investors chose to invest in PLCM and avoid TAA.
o    Since the start of 2008 the valuation premium/discount has been in the low single digits. PLCM’s larger potential market and cross selling opportunities diminish as convergence in the end market gathers pace. Thus it would make sense that PLCM’s premium valuation will be eroded as this opportunity set shrinks.
o    Stronger historical sales and EPS growth for TAA:  TAA 27% 5-year CAGR sales growth versus PLCM’s 15.3%, and TAA 21.1% 5-year CAGR EPS growth versus PLCM’s 18.6%.
o    TAA, with considerably higher margins, is forecast to grow faster than PLCM.

Given Tandberg's attractive stand-alone valuation and its exposure to the structural growth story of video conferencing equipment, Panta Capital recommends to go long Tandberg (hedged with either the Norwegian OMX Nordic 40 Market Index or with Polycom) under the NOK 120/share level, and receive the bid optionality for free.

Please contact Panta Capital to receive a full Tandberg analysis.

On 24 July 2009, Thomson SA (TMS FP) said it had signed a balance sheet restructuring agreement with the majority of its creditors. The agreement stipulates 1) a 45% cut in its gross senior debt (from EUR 2.83bn to EUR 1.55bn) by converting it to equity in form of a EUR 350m rights issue,  EUR 528m notes redeemable in shares ('NRSs') and Disposable Proceeds Notes ('DPNs'); 2) the renegotiation of terms of the remaining gross debt with longer payment maturities and conditions more compatible with its repayment capacities (the first significant EUR 1050m maturity doesn't come before 2016 as where before a EUR 1444m maturity was approaching in 2012); and 3) redemption of all the super subordinated debt securities for a maximum of EUR 25m. With the agreement currently approved by a majority of creditors, the restructuring has eliminated the risk of bankruptcy and brings Thomson's net gearing around 2x. This allows Thomson for breathing space for the short and mid term and allows it to work on its position as world leader on several of its activity segments (DVD, set-up boxes).

Although there has been lot of analyst focus on the massive extent to which shareholders will be diluted, we believe that even in a pessimistic case of dilution, it is attractive to go long Thomson under €0.70 a share. Assuming full dilution of existing shareholders and applying a discount of 20% to its peers trading at 1.0x EV/Sales 2010 -stemming from doubts about the sustainability of its business model (eg structural downtrend of DVDs), we achieve a price of €0.7, with further upside to come from 1) Thomson achieving better than expected prices for its divested businesses (more than €300 for businesses which generated €1.1bn turnover in 2008);  2) narrowing of Thomson's peer valuation discount; 3) Thomson's decision to redeem a portion of up to 34% of its NRSs;  4) participation of current shareholders  in 100% of the €300m rights issue and €75m in the issue of the NRS.

Although we want to point out that risks still remain like 1) achieving unsatisfactory prices for the divested businesses; 2) not receiving restructuring approval from all its creditors and 3) stock sale overhang from debt holders disposing of their converted equity holdings, we believe that over the medium term, Thomson should come out as a healthy business ready to focus on profitable activities, with considerable upside for its equity valuations.

As anticipated by Panta Capital in its 18-Jun-09 analysis, Wessanen announced today it had amended its EUR 250m credit facility, increasing its net debt to consolidated EBITDAE to 4x in 2009 and to 3.5x in the first half of 2010. Under the original facility, net debt was allowed to exceed 3x consolidated EBITDAE for a limited period only and not allowed to exceed 3.5x. At 01-Mar-09, Wessanen reported a net debt to EBITDAE ratio of 3.2x.

Although we feel that this might put increased time pressure on Wessanen to generate a sale of its US business before 30-Jun-10, we believe that this news removes the debt covenant breach risk before the actual US sale. With Wessanen rumoured to have between 10 to 15 interested parties for its US distribution business, we think it is on track to a successful exit from its US operations.

Begbies Traynor Group plc (BEG:LN), the independent UK corporate insolvency firm, has seen a 50%+ share price drop from its 200p Aug-08 high. Although analyst concern has been expressed on a slowdown of its Corporate Finance/Taxation activities (15% of total revenues), we believe this concern is exaggerated, given that Insolvency constitutes more than 80% of the company’s revenues. Although no real hard catalyst exists on the Begbies buy case, demand for its insolvency services and news flow on a rise in insolvencies would act as share price drivers: insolvency numbers are expected to remain high into 2010. Note that during the 1990's recession, new insolvencies continued to rise well after the fall in GDP. In 1992, corporate insolvencies peaked at 30,000 or 1% of active companies. With 25% more businesses around, and a more structurally driven recession, the expected peak could well be above 40-45,000 (compared to 21,850 in 2008) and could contribute to significant growth for Begbies for several years to come (taking into account a normal 2-3 year timescale for completion of an insolvency case). At the current 100p, Begbies trades at x9.8 2010 consensus earnings, which seriously undervalues a high-growth/high-margin business with earnings growth north of 20% a year. Conservatively we would expect earnings to grow more than 15% going into 2010. 

Today Centennial Communications (CYCL US), which is in the process of being acquired by AT&T for  USD 944m or USD 8.5 cash per share offer, saw a 9.6% drop from USD 8.12 to USD 7.35 on the back of no news. The acquisition has already been approved by CYCL shareholders and remains subject to HSR (USA) and FCC (USA) approval. On 02-July-09, AT&T informed the market that they expect completion and regulatory approvals during the third quarter of 2009. With clearances expected -with or without imposed divestitures or asset swaps- by September/October, we believe that the 14-Jul-09 share price drop represents a (short-term) buying opportunity as the merger spread widened out from 4.6% (annualised 22% return -assuming latest end-Sep 09 closing) to 16% (annualised 75% return). We believe that the intraday drop could  have been triggered by regulatory fears and/or margin calls or merger arbitrage fund liquidation(s) (similar liquidation  driven sell-offs as seen in the Anheuser-Busch, Genentech, Puget Energy merger situations). Although we feel there is regulatory risk in Puerto Rico where AT&T and Centennial will control approximately 40% of the wireless market share with America Movil (AT&T has 23% voting control) having another 25% share.  However with five carriers on the Island (AT&T, Sprint Nextel, America Movil, T- Mobile, Open Mobile),  the Puerto Ricon wireless market will remain a competitive market . Nevertheless, if there would have to be concessions offered, AT&T would be open to divesting the Puerto Rico wireless operations (CDMA) if necessary, as the most attractive Centennial properties for AT&T are the mainland U.S. wireless (GSM) operations.
Given that the merger spread has been stable between 1 and 5% for the last 6 months (reflecting the regulatory risk), we recommend to play the technical anomaly and buy CYCL around USD 7.4, and playing the temporary narrowing of the 16% merger spread.

As anticipated in our 02-June blog, Centrica has come up with a GBP 8.45 a share cash offer for Venture Production on 10-Jul-09. The offer was made after Centrica secured the additional 5.4% stake from 3i Group to bring its ownership in Venture to  29%. Although we feel the offer is highly opportunistic - and hence was almost immediately rejected by the Venture board as substantially undervaluing its business- we feel that there is a good chance Centrica's offer might be succesful, given that the offer is subject to receiving valid acceptances in respect of, or otherwise acquiring, such number of Venture Shares as to give it an interest of over 50% of the fully diluted ordinary share capital of Venture. Given its ownership of 29%, Centrica's bid would be succesful if it achieves acceptances of 21% out of 71% (or less than 1/3 of the Venture shares Centrica does not yet own): although Venture's management owns about 10%, the Venture shareholder base is fairly liquid, with funds like Legal & General who own 4.36% and almost entirely consisting of index tracker funds who will be more inclined to accept any (even opportunistic) offer.  

Although Centrica stated that it would not raise its 845p offer (stating it was its final offer) and Venture management will do its best to fight off the offer, we believe there is a chance –albeit smaller- that Centrica would pursue a friendly deal and might increase its 845p offer.  Hence we recommend buying Venture shares under the 845p bid level.

With Hermes (RMS FP) trading at a 100%+ premium to the luxury goods sector, mainly supported by the largely unsubstantiated takeover speculation, Hermes stock is again highly vulnerable to a re-rating which could be driven by the speculative appeal to vanish.  Similar to what happened mid-07 and early-09, we expect the unjustified take over premium to phase out and the large premium to sector average to compress in the short term. Ideally to start shorting around EUR 105-110 levels, and take profit around 75-85 levels.

Although probably one of most resilient business models in luxury goods sector, valuation is extremely stretched for a low-double digit earnings/sales growth profile:
o    Hermes trades at an excessive 100%+ P/E premium to the luxury goods sector
o    This compares with a long-term historical forward P/E premium of 30-40% to luxury peers
o    Although Hermes’ profile proves to be late-cyclical and its products’ price points are within the highest of the luxury, recent observations start pointing to a slow-down in top- end luxury sales’ growth: RMS has lowest exposure to emerging markets’ customers from Russia/Middle East/ China (24% of sales vs sector average of 29%), the main current luxury sales’ growth driver. RMS exposure to more slowing markets as Japan (29% vs 23% sector) is among the highest in the sector.

Current pricing and 50% rise since early March-09 (compared to CAC40 rise of 20% since early Mar-09) is mainly driven by renewed take over speculation which seems very unrealistic to materialize in the short/mid term:
o    Family partnership (72% of voting rights/capital) publicly stated it was not willing to sell anytime soon and is well decided to keep its investment
o    Presence of poison pill (“Loi Breton”): Articles of Association delegate special powers to Executive Management to issue share purchase warrants and carry out capital increase
o    The emphasis of the company’s control has been put on the transition to the next generation with the appointment of 6 members from the 6th generation to the management board, replacing the 5th generation members, who now number 5 on the board. This is in addition to the appointment of 3 members of the 6th generation to the supervisory board.
o    The company is structured as “Societe en Commandite par Actions” (limited partnership): a structure which concentrates most operating decisions within the hands of the families and whereby the CEO can only be appointed by the families.
o    “Loi Dutreil”: shareholder agreement whereby the families can benefit from a rebate on wealth tax if they keep the stocks for a minimum of 6 years (i.e. until 2011)
o    Any shareholder who reaches 0.5% (and subsequent 0.5% increments) of Hermès’ capital or voting rights must reveal its position to the management, or lose their voting rights. So far, nobody has disclosed any such positions.
o    If families would need the cash, they could easily re-leverage to raise special dividend, as currently the company has net cash position of €0.5bn. If they would leverage up to 2* Net Debt/EBITDA (cfr PPR at 2.8x), they could distribute up to €1.6bn to all shareholders (about €1.2bn to the family alone).
o    Financials do not work for the 3 parties (LVMH, Richemont and PPR) who have been rumoured in the last 18 months to be building stakes and/or looking at Hermes. Luxury sector has become more rigorous since early 2000, with transaction multiples coming down: early 2000 transactions were typical at 2.5-3.5x sales, while recent transactions have been done at average 2x sales (RMS currently at 6.4x sales), displaying the higher (capital return) discipline of the sector.
At 34x ’08 guidance earnings and 22x EBIT, any premium over current price offered is dilutive for both LVMH and Richemont. After its Apr-07 PUMA acquisition, PPR is highly leveraged at 2.8x with BBB- credit rating. A cash acquisition of Hermes would increase PPR’s net leverage to 5.5-6x, making such an acquisition highly improbable.
o    At a road show with Merrill Lynch, Hermes’ CFO reinstated even if LVMH would offer double of current share price, they wouldn’t sell (highlighting deeper conflict between Hermes and LVMH).

Up to end-May, we were uncomfortable to put Hermes as a consensus short call because of the possible short squeeze (understood that currently 20% of float is on borrow) on possible CAC40 index inclusion, given limited FF of the company: however with the 28-May-09 Euronext Expert Committee ruling against RMS inclusion, we feel that risk is temporarily gone and with Hermes further market outperformance, we feel comfortable now to put on the Hermes short.

Find here a full Panta Capital Analysis on the Hermes short idea.

On 22 April 2009, Koninklijke Wessanen NV announced its plans to look into exiting its US distribution and branded businesses. (constituting 60% of group sales and 40% of its EBIT).  On 10 June 2009, Wessanen communicated it was in an 'orientation' phase to determine the sale price of its US businesses. On 15 June 2009, Wessanen announced on 15 June 2009 that it discovered accounting irregularities in its US branded business.

Wessanen fell 25% of 67c to EUR 2.6 after its accounting irregularity announcement and is currently trading at a 20-30% discount to both US food distributors and European/US food manufacturers. We see significant upside if Wessanen were to dispose its US activities to the likes of United Natural Foods, Nash Finch or a PE house, who all have displayed acquisitive interest in this cash generative, consolidating food(service) landscape. After such a disposal to take place in 2H09, we believe Wessanen could become a pure play European branded natural/organic foods high margin company, which could be interesting for the likes of Unilever or other food groups, wanting to gain further exposure to the growing organic/natural foods market.

Investment Valuation
We believe getting in under EUR 2.5 a share is an attractive risk-return proposal, given the downside trading SOTP valuation of EUR 2.4 (obtained by applying a 0 valuation for the US branded business where the accounting irregularities were found AND applying a 20-25% peer discount valuations for its other European/US food distribution and branded production businesses) and an upside US distribution sale  scenario valuation of  EUR 3.5 a share (obtained by sale price of US distribution in line with lowest exit multiple of food distribution deals and a 0 valuation for the US branded business).

Find here a full Panta Capital Analysis on Wessanen.