Markets live chat transcript for the chat ending at 12:05 on 28 Nov 2007. Participants in this chat were: Paul Murphy (PM) Neil Hume (NH)
PM: Welcome to Markets Live
PM: Sorry we are late — just deling with irate readers
PM: dealing even
PM: certain investment bank
PM: neil is with me
PM: raring to go
NH: yep back in the chair
NH: lets start with Rank
NH: VP wants to know if there is any RAW
NH: and of course there is
PM: Smell’s rank does it this RAW
NH: been lurking around for a weeks
NH: first the facts
NH: shares have motored this morning
NH: heavy volumes – over 15m traded already
PM: Goodness, just looking at the price
PM: te former Tank up 6.5p at 90p
PM: rise of 7.8%
NH: two pieces of RAW info in the market
NH: first we have the stakebuilding story again
PM: Details?
NH: HSBC is supposed to be in the market buying stock for Genting, the Malaysian gaming operator that acquired Stanley Leisure last year
NH: apparently Genting have been building the stake for a while and could be ready to declare a notifable holding
NH: but of course if they have been buying on a CFD they won’t have to
NH: and then we have this story about Harrah’s, the Las Vegas gaming company
NH: think it was in one of the Sunday papers
PM: ???
NH: it runs along the lines of this
NH: Harrah’s was going to sell a significant portion of London Clubs International (LCI) to Rank in return for a stake of around 28 per cent
PM: right…
PM: Sounds a tad complicated
NH: and don’t forget Harrah’s is in the process of being taken over by two PE firms itself
PM: Of course. But how do you rate these rumours Neil?
NH: well its not from 
NH: more like a 
PM: ok — degree of caution then
NH: but the thing to note today is the volume
NH: its is heavy
NH: but Rank has been oversold in recent days
NH: from what I am hearing this morning the mid cap index as a whole is due a bounce
NH: and that’s because a big quant fund has finished unwinding a big sell trade
NH: and that is helping the price of a few names this morning
PM: Ok — thanks for that
PM: 
PM: Moving on — since youve had a couple of days off — why dont we put you on the spot
PM: Explain johnson services for Nick below
NH: right, here goes
PM: Come on !
PM: explain!
NH: first, the rumours about a bid from Industri Kapital are way, way, way wide of the mark
NH: spent a lot of time last week checking them out
NH: seems they looked or were approached by bankers to take a look and declined
NH: they might be interested in buying some businesses from JSG but not the whole thing
NH: on top of that there has been a technical situation developing
PM: Oh yeah
NH: one or two of the big CDF houses jacked up the margin on JSG to 90% in recent days
NH: these forced a lot of people to sell
NH: the selling reached a climax yesterday morning
PM: I bet it did
NH: when the shares hit 30p
PM: Quite extraordinary
NH: now, the point to note here is that there is huge bull position in the stock waiting for a bid
NH: that is never going to happen
NH: but one thing that could happen if the company does not sell any businesses is that it will need a rights issue, and probablyt a deeply discounted one
PM: I’m just looking at the chart — this stock has fallen from 250p level a the begining of Oct!!!
PM: What a mess
NH: certainly is
NH: but JSG is not alone in being rocked by CFD brokers upping margin
NH: it is happening in a number of stocks
NH: we believe that Robert Bonnier was forced to sell a large chunk of his holding in SCI enteratinemtn yesterday to cover a margin call in another of his stocks
NH: Artillium
NH: margin here gone up to 60%
NH: in fact the margin on SCI has probably gone up
NH: because no one seriously believes anyone is going to bid for the company at a reasonable price
PM: Thats v v interresting
PM: So some of the CFD houses are happy to kill their customers
PM: Captive audience
NH: there’s nowhere else they can get the leverage
PM: Interesting that they have suddenly done this now — not as tho vol has suddenly jumped in the last week or so
PM:
NH: right, time to put Paul on the spot about China
PM: Well — yes Jezzman — everyone has tended to ignore China recently cos of the stress over here
PM: But last night’s 1.2% fall – -to about 4800 puts the Shanghai composite 20% below its peak
PM: Given the speed with which that has happened — does that quality as a formal “crash” i wonder??
PM: This being China, 20% is bugger all, of course
PM: Simply retraced the previous month’s gains
PM: As for Hang Seng read over — i just dont know anymore
NH:
NH: well it does not seem to have affected the London market today
NH: after a jittery opening
NH: market has found its feet
NH: FTSE 100 currently up 31 points at 6,171.5
NH: and that’s despite a poor performance from the mining sector
PM: That rally has happened in the last half hour or so — the rally
NH: apparently Goldman Sachs are telling clients to sell the miners because a bear market rally is on the way
PM: really?
PM: What is a bear market rally, when its at home?
NH: a
PM: ah right — understand that
NH: anyway Goldman are saying put the money into the banks
NH: not the bank
NH: but a banking stock
PM: World turned upside down — switch from miners to banks
NH: that has helped Barclays for example, which is up 15.5p at 539p
NH: that said
NH: banks also being helped by this Citigroup rumour
PM: What’s the story there?
NH: here it is
NH: y David Altaner
Nov. 28 (Bloomberg) — Citigroup Inc. got a surprise call
from a well-known investment banker suggesting a merger with
Bank of America Corp. after Charles Prince stepped down as
chief executive officer, the Wall Street Journal reported,
citing a person familiar with the situation.
The informal approach was at once dismissed by Citigroup
and no talks took place, the newspaper said.
An unidentified Bank of America spokesman said the
company hasn’t authorized an approach by any investment banker
to any company in the past six weeks, according to the
Journal.
Citigroup got a tentative approach from Bank of America
several months ago, the newspaper said, adding that an
unidentified Citigroup representative wouldn’t comment.
It’s unlikely that Citigroup’s board would favor such a
merger because recent events have shown that the bank is
already cumbersome enough and a combination would make it more
so, the newspaper added.
PM: bloomberg take on WSJ tale
PM: Should mention btw for Nick below — there is life beyond Bloomberg. Honest
PM: So board of Citi rejected the informal approach out of hand
PM: they are not exactly in the position to negotiate a merger at the moment are they
NH: no
NH: and I don’t see how this fantasy deal would ever have got past the regulators
NH: still an interesting talking point
NH: as is UBS
NH: shares up 5% at the moment
NH: and SWF stake building time
NH: that’s right hot on the heels of the Citi investment
NH: surprise, surprise, rumours that another SWF is looking to take a stake in UBS
PM: Hmm
NH: actually its the Chinese
NH: hang on its the Ruskies
NH: no, no, no its the Arabs
PM: 
PM: Norway is comkpletely out of this game you know
NH: actually we have been debated the Citi cash injection
NH: and whether it is a good deal
PM: Oh, dont start
NH: on the face of its the couponn looks steep
NH: but there are a number of varibales to consider
NH: bsb
NH: we have got some stuff to put up
NH: we broadly agree with you
NH: right everyone, get a cold towel and wrap it round your head because this is complex
PM: Both barrells???
NH: right, Paul let the readers have it
PM: Firstly, this is a mandatory convertible. It’s NOT DEBT (obviously as it qualifies as tier 1 capital). An 11% coupon may sound high but if one considers what this structure actually is then it should become apparent that this is not high.
This deal is best thought of as a forward issue of equity with a minimum maturity of just over 2yrs and a max of just under 4yrs. Citi is effectively guaranteed that it will be issuing the holder(ADIA) common stock at a premium to last night’s closing of between 4% and 21%. Taking this into account and given that the current div yield of the stock is over 7%, this no longer looks such a bad deal.
I have valued the structure:
(i) what we know:
- $7.5bn face
- 11% coupon
- mandatory conversion (“purchase contract settlement dates”) of Mar 15 2010, Sep 15 2010, Mar 15 2011 and Sep 15 2011.
- “Strikes”: stock closed last night @ $30.7 but let’s assume to start with that this deal is priced off $31.83 as this is the “lower strike”. With the stock price <= $31.83, Citi will issue 235,627,500 shs (ie at most $7.5bn of stock). stock price >= $37.24 Citi will issue 201,390,000 shares. The number of shares issued varies between these two “strikes” such that ADIA receives $7.5bn worth of stock ie par. This is otherwise known as a 100/117 mandatory.
(ii) assumptions:
- Citi div’s are flat for the life of the structure @ $2.16.
- credit spread for Citi is 0 (5yrs is actually L+90 but this has a minimal impact on the theoretical value (TV) so we’ll give Citi the benefit of the not inconsiderable doubt).
- “skew” is 10vol’s; ie we will price the put at 51 vol and the call @ 41 vol (this looks to me to be in line with where options are currently quoted).
- that the mandatory, rather than having a variety of different strikes from £31.83 up to $37.24 over the 4 “settlement dates” is in fact just one strike of $37.24 with a March 2010 expiry.
(iii) valuation:
On the basis of these assumptions above, Citi have issued a structure for $7.5bn that is worth $7.18bn (ie 95.75% of par). If I value the Sep 2011 mando’ using the same criteria as above then the TV is 99.60 (ie are issuign something worth almost $7.5bn).
(iv) conclusions:
This is NOT necessarily expensive financing for Citi. I get TV for the longest dated mandatory to be 100. If the strikes are staggered over time the TV climbs. For example the TV of the mar 2010 structure above using 7 skew and a 10% premium rather than 17% (ie $35.00 upper strike rather than $37.24), is effectively par. Also, if Citi cut the dividend by 5% each year during the life of the structure the TV of the Mar 2010 structure goes up by 1pt.
PM: Got that?
PM: I.m not 120% convinced on his reading of the skew tho
NH: nor me!!!
PM: Point here is that the financial press have been taken to task by the blogosphere — as bsb refers to below
PM: We dont know what we are doing — which is undoubtedly true
PM: We are just publishing a post on this on the AV home page
PM: My boring piont is that the cheapest way Citi could have repaired its balance sheet would have been to cut the divi
PM: But it obviously does not want to do that
PM: cant do a regular right — cos tht would simply be raising cash from sharehodlers and then sending it straight back to them
PM: Which would be daft
NH: but I suppose the wider point here is that the Citi deal could be seen as a template for other banks in need of a capital injection
PM: Well yes — but i still find it extraordinary that this is treated as “good” news
PM: Buy the banks — this is as bad as it gets???????
PM: But how about when RBS come out with their capitial raising
PM: Will that be a doubled good time to buy the banks??
NH: good question
NH: RBS Tier 1 capital is just over 4%
PM: remember that Citi note — beware the uber leveraged three
PM: RBS, barclays, deutsche
NH: and there are a few brokers pushing the line that Barclays Tier 1 capital is not as high as it seems
PM: Super Siv — thanks for keeping the quality up here
PM: Quoting Lear
NH: here’s the stuff a broker sent me on Barc yesterday
NH: Their Tier 1 ratio has been met by the GBP400m profit on
the buy back, and GBP1.3bn of new capital (non-equity Tier one -
reserve capital instruments and preference shares).. all of
which implies MUCH stronger growth in RWA than we had
aniticipated. This will further unnerve the market.
NH: We hear reckon Equity Tier 1 is 4.7%, our
banks guys are trying to work thro the detailed maths, but
basically there’ll be further inquisition as to what the
unexpected rate of RWA growth comes down to.
PM: That’s v interesting
PM: Other point is that there is no longer consensus on what measure of core capital is the best to use. Tier 1 is being widely ignored at the mo
PM:
PM: hey, nick — dont rush. Its good for charts
PM: Anyway — let’s move on
PM: Shall we go to pubs — or is too early for you Neil?
NH: no
NH: sector very lively this morning
PM: What’s going on??
NH: we should ask Mark Brumby at Blue Oar
NH: he seems to have all the answers
PM: Ah BlueOar securities — is that name a Eton reference or something
NH: nah, Oxbridge
PM: Ah, ive only got an Open University degree
NH: before Mr Brumby starts asking for investigation into this morning’s share price movements
PM: Call the police!
NH: we can tell him they are down to a note from one of his rivals
NH: Merrill Lynch
NH: pushing the line that the sector is seriously oversold
NH: that tradinig remain resillient
NH: and that rising costs can be passed on to customers
NH: top picks are Punch Taverns and Greene King
NH: Punch shares currently up 12.5p at 854p
PM: Hmm. interesting — anything youwant to paste?
NH: yep
NH: Trading remains resilient, scope for further price increases
Since our last pub pricing report (JDW continues to lead on price, 24 May 2007),
the pub sector has been de-rated by c35%. We feel that this fall is overdone
especially given the resilient trading from pubs reporting in recent weeks. Pub
pricing remains solid and even if the brewers pass through some of the raw
material price increases to the pub retailers, we believe that the end consumer is
fairly elastic in terms of absorbing extra costs. It is also worth remembering that
raw materials are a relatively small proportion of the overall cost of beer.
NH: Pub sector has defensive merits
The absolute spend in the on-trade for alcoholic drinks has risen every year since
1964 apart from only once in 2003 where it fell by 0.4%, highlighting the strong
defensive qualities of the sector. This is particularly important considering that
current DCFs are now discounting negative long term growth forever, an unlikely
scenario given that on-trade absolute spend continues to increase.
NH: Punch sees highest price rise across managed estate
Our analysis of the Q3 2007 CGA data suggests that Punch Taverns saw its
managed pub prices rise by 2.1% (qoq). On a Moving Average Total (yoy) basis,
Punch was second only to JDW rising by 7.2%, although this may be more to do
with estate mix following the disposal of Spirits discounting pubs than genuine
price rises. Out of the tenanted operators, Marston’s pushed through the highest
quarterly price rise Q3 2007 of 1.0%. On an MAT basis, Marston’s has seen the
highest price rises in all quarters this year.
NH: Punch and Greene King still top picks
On our current forecasts Punch is trading on a cal 2008 PER of 9.2x, leaving
Punch the cheapest stock in the sector on this metric. Greene King trades on a
cal 2008 PER of 10.7x. GK remains an attractive asset backed group with
potential to release value from its property at some point.
PM: BTW we shouldnt be too mean to Brumby — he send out a very entertaining note each morning.
NH: we shouldn’t
PM: prefer to stay on his email list
NH: we were just surprised by the line he took on the Punch stories over the weekend
PM: sure — we can assure him this M&B/Punch stuff was not a hedge fund ramp
NH: we are still trying to get to the bottom of what punch are playing at
PM:
PM: What else is moving this morning??
NH: Compass, the contract caterer
NH: up 22p at 311.25p – a gain of 7.6%
NH: that follows the release of annual results
NH: Now, the stock has been drilled since French rival Sodexho issued a profits warning a couple of weeks back
NH: Sodexho were forced to reduce earnings guidance because of rising raw material prices
NH: a lot of people thought Compass would follow suit.
NH: indeed, its shares were off about 5% yesterday
PM: and in the event the figures are fine
NH: yep
NH: pretty good
PM: so what are the highlights?
NH: well, I suppose the thing that catches the eye is the improvement in operation margins
NH: up from 4.4% to 5.1%
NH: EPS has come in at 15.0p vs our forecasts group around 14.4p;
NH: and PBT £442m vs forecasts of around £436m
PM: So everything ahead of expectations
PM: and what about the outlook statement
NH: well, that addresses head on the concerns about food price inflation
NH: “food price inflation is well understood and being acted upon”.
PM: So they are well on top of it
NH: seems that way
NH: I suppose the only quibble one can have with these results is that they are all about improving margins through cost cutting
NH: while that is admirable the top line needs to grow
NH: and compass is not cheap
NH: Trades on a prospective PE of 15.9 against 14.8 for Sodexho
PM: any analyst comment???
NH: This is from Oriel Securities
NH: Compass reports full year pre tax profits of £442m ahead of expectations (Oriel forecast – £ 430m). Operating profits up 24% in constant currency
• Dividend increased by 7%
• Upbeat statement: encouraging start to the year and excited about the prospects for
profit growth
• Seeing food price inflation of 4-5% but food price inflation is not new and is being acted upon
• These are strong figures and an encouraging statement; Compass is a defensive play inuncertain times
• Shares valued on prospective P/E of 16.7 times and a dividend yield of 3.9% With the outlook for further margin progress the shares have solid attractions as a 2/3-year
recovery play. BUY
NH: and this comes from Panmure Gordon
NH: Tasty dividend increase, we move from SELL to HOLD
The results were very much as expected with 5% organic growth and margins
improved 70bps to 5.1%. We believe the 7% increase in the dividend is
significant as it sends the message of a continuing optimism over the outlook
despite fears of margin pressure from food inflation. Having reached our
target price we have moved our recommendation from Sell to Hold. We prefer
higher growth more predictable revenue stories elsewhere in the sector.
NH: The group’s financial model looks like 5-6% organic growth and maybe 10-20bps of margin increase leading to c10% pbt growth for the foreseeable future.