ft.com/alphaville

Markets live chat transcript for the chat ending at 12:13 on 3 Mar 2008. Participants in this chat were: Neil Hume (NH) Helen Thomas (HT)

NH: good morning and welcome to Markets Live

NH: Alphaville’s daily musings on the markets

NH: and I am in control this week

NH: because Paul arbitrarily decided on Friday to take the week off

NH: to do

NH: and I quote

NH: “some DIY shit”

NH: rather him than me

NH: would rather come into work than put shelves up

NH: anyway, I will be joined by a variety of guests this week

NH: and today Helen Thomas has kindly agreed to join me

HT: morning

HT: yes, we’ve been abandoned

HT: Paul’s gone all Property Ladder on us

HT: and before we get going a quick stat

HT: July 26, 2007 - the first day of Paul Murphy’s summer holiday. The FTSE loses 3.2 per cent in its worst one-day sell off for four years.

March 3, 2008 - the first day of Paul Murphy’s impromptu week off. The FTSE down 1.5 per cent.

Coincidence? We think not.

NH: yep, the market is looking a rocky this morning

NH: FTSE 100 currently down 84.9 points at 5,799.4

HT: been as low as 5,777.7

NH: quite a grizzly session on Wall Street, Friday

HT: Dow lost over 300 points

HT: and that weighed on Asian markets overnight

HT: [caveat - except China]

NH: and London this morning

NH: and it’s the banking sector that is leading London lower

NH: some pretty big falls

NH: HBOS down 34.5p at 569p

HT: had a disasterous run since the figures last week

NH: A&L off 25p at 538.5p

NH: RBS 16.2p lower at 368.75p

Barclays (BARC:LSE): Last: 459.50, down 17.75 (-3.72%), High: 467.50, Low: 456.25, Volume: 24.81m

HT: nasty

NH: seems the sector has been spooked by rumours coming out of Switzerland this morning

HT: what are they?

NH: that UBS are going to take further write downs and they will be large

NH: the speculation was so intense that trading in UBS shares were temporarily suspended earlier this morning

NH: and there was also a bearish note on UBS from their Swiss rival Credit Suisse this morning

NH: With the capital increase and transparency about risks, it is possible to get an assessment of potential value in UBS: In our
report we separate out the capital required for the ongoing business and that allocated to the realisation of the ‘problem’
portfolio of subprime and other troubled assets, terming this a ‘good bank/bad bank’ approach to this analysis.
• Further writedowns appear likely and could be large: On the basis of a straightforward ‘mark to ABX’ approach, the
writedowns implicit in market movements so far this year are around SFr6.2bn, which is the number we have used for our
central case estimates. Taking more pessimistic assumptions in order to estimate what losses could be incurred in actually
selling this portfolio, however, would give a figure closer to SFr15.5bn.
• Downgrading EPS numbers to reflect conservative assumptions. We have downgraded our 2008 and 2009 EPS estimates to
reflect a conservative set of assumptions for the operating environment. We have downgraded 2008E EPS by 5% on an exwritedowns
basis and by 37% (to SFR3.31) with writedowns, and downgraded 2009E EPS by 9%.
• Even including large potential writedowns, we think there is still value here: Even using a valuation of the ‘good bank’ based
on highly unfavourable assumptions (such as a 2008E 11.0x PE for the private banking business), and assuming writedowns
larger than our worst-case assumption, we would get a fully diluted fair value of SFr43 per share. On more reasonable
assumptions we reach a new price target of SFr57 (from SFr 67 previously) and maintain our Outperform rating

NH: anyway, that has all contributed to bad price action across the sector

NH: this sector cannot hold on to rally

NH: was looking at RBS earlier

NH: this stock hit 427p ahead of its results last week

NH: and look at it now

NH: and this is not the first time a rally has comprehensively failed

NH: the technical picture in the banks is still as unappealing as ever

HT: right - gloomy

HT: anything else to say on the banks??

NH: a few things

NH: results from HSBC

NH: which I will come to a minute

NH: But before that, just wanted to chat about RBS

NH: as Citigroup has reiterated its sell rating

HT: they really don’t like RBS do they

NH: no

HT: what are they saying?

NH: pretty much what they have been saying for months

NH: that RBS has a weak balance sheet

NH: Citi also forecasting earnings is impossible

NH: as RBS have not provided any info on the division of spoils from the ABN Amro acquisition

NH: here’s the note

NH: Leverage remains our key concern — Operational trends were somewhat mixed
across the group in 2007 but generally in line with expectations. However, we
believe that the share price will be unable to post a sustainable recovery until the
issue of excessive balance sheet leverage is addressed. Our estimate shows that on
a proportionally consolidated or ‘look through’ basis RBS has a tangible equity:
asset ratio of 1.1% and a core equity Tier 1 ratio of 4.0%.

NH: Balance sheet repair hampered by write-downs — RBS disclosure on financial
exposure leaves a number of lingering concerns. We expect additional write-downs
of £1.1bn to be taken in 2008E and £0.7bn in 2009E. Although we continue to
view this as a secondary concern for the group, we believe it is far too early to
conclude that we have seen the worst. Further market-related write-downs
potentially reduce the pace of organic capital rebuild.

NH: Lack of disclosure reduces earnings visibility — A complete lack of useful
disclosure on the proportional impact of RBS’ share of ABN makes forecasting
underlying earnings difficult. However, we currently view earnings as less important
than the balance sheet and believe that the high level of leverage and slow initial
rebuild of capital will prevent a re-rating from taking place.

We retain a Sell (3M) recommendation and 350p price target — We have cut
2008E EPS by 2% but are leaving our 350p price target unchanged. This implies a
2008E price to book multiple of 1.8x our 2008E tNAV per share of 193p. Although
RBS currently trades on a 2008E PE of 6.3x, this rises to 7.5x on a normalised
capital basis.

NH: NH: We do not believe that the full year 2007 results have moved the RBS
investment debate on to any great extent. A key problem is that a lack of
relevant disclosure on the ABN acquisition leaves us unconvinced by
management projections.

Although the company has stated that it expects its
capital ratios to rebuild organically over the next few years, we fear that this is
based on an optimistic view of the economic outlook. If conditions remain
difficult in the credit markets, then it seems unlikely that RBS will
meaningfully correct what we continue to view as an over-leveraged balance
sheet position.

Alternative options include asset sales, balance sheet shrinkage
or capital raisings. None of these options appear attractive for shareholders and
with no signs of a significant improvement in capital market conditions, we
continue to maintain a negative stance. We retain our Sell (3M)
recommendation on an unchanged price target of 350p.

HT: RBS made themselves rather unpopular with their disclosure last wee

HT: and Citi don’t believe Sir Fred Goodwin’s pledge

HT: that he will pay down debt through cashflow

NH: No

NH:

HT: right moving on from RBS

HT: How’s Bradford & Bingley performing

NH: before that, just getting some flashes through from Warren Buffet

NH: *BUFFETT SAYS BERKSHIRE INSURING MUNICIPAL BONDS AT 3.5%
*BUFFETT SAYS OFFER TO TAKE BUSINESS FROM RIVALS REJECTED
*BUFFETT COMMENTS ON BOND INSURANCE :BRK/A US, MBI US, ABK US
*BUFFETT COMMENTS ON FIXED-INCOME INVESTMENTS :BRK/A US
*BUFFETT COMMENTS ABOUT POSSIBLE DEALS IN CNBC INTERVIEW
*BUFFETT SAYS BERKSHIRE GETTING CALLS ON LARGE PORTFOLIIOS

NH: does not look good

NH: seem to remember the market rallying on this Buffett plan

HT: look at the market

HT: we’re about to breach three figures

HT: down 99.3

NH: could get messy this afternoon

NH:

NH: right. let’s get back to the banks

NH: and B&B

NH: shares down 14p at 211p

NH: why are you so interested???

HT: just saw them whiz up on Friday

HT: on the back of the Lloyds/HBOS bid rumours

HT: half expected to see a story in one of the Sunday papers

HT: but nothing came

NH: actually I reckon there was too Friday’s move than meets the eye

NH: as Sheik notes below

HT: go on

NH: As you said the shares whizzed up on Friday

NH: one minute they were doing nothing, the next there were up 18%

NH: I think they closed around 8% higher

NH: now I reckon this was all down to short covering

NH: but the bears weren’t buying back positions because they were really worried a bid might emerge

NH: no, they were being forced to do so because their prime brokers have been cranking up margin/collateral on short positions

HT: really? do we have any evidence for this

NH: no, just rumours from the market

NH: : but it makes sense

NH: if you can’t put up the increased margin, the position has to be closed

NH: even if it is profitable

NH: and it does not matter what the rest of the market is doing at the time

HT: and on Friday it was falling, quickly

NH: anyway, I have got hold of a list of the most shorted stocks in the UK from the very helpful people at Dataexplorers

NH: should give us and idea where there could be other unexpected spikes

NH: This one is for the FTSE 100

NH: the figures quoted below at % of market cap on loan

NH: A&L 22%

NH: Persimmon 16.4%

NH: Carphone 16%

NH: Liberty International 14.9%

NH: Sainsbury 14.5%

NH: London Stock Exchange 13.5%

NH: Kingfisher 13%

NH: United Utilities 12.8%

NH: this one is for the FTSE 250

NH: again the figures quoted below at % of market cap on loan

NH: HMV 36%

NH: Inmarsat 25%

NH: Carpetright 22%

NH: CSR 20%

NH: DSG International 19.6%

NH: Helphire 19.5%

NH: B&B 19.4%

NH: Debenhams 19.1%

NH: Signet 19%

NH: Trinity Mirror 19%

NH: actually if anyone is interested DataExplorers have a very interesting blog on short selling situations

NH: you can find it at

NH: http://shortstories.typepad.com/globalequities/data-explorers-short-port.html

HT: thanks for that

HT: right, I suppose we should have a look at the HSBC figs

NH: Good idea

NH: they seem to have gone down well

NH: stock currently bucking the weak market trend

NH: up 5.5p at 771.5p

HT: what are the highlights?

NH: well, the figs appear to be bang in line with expectations

NH: PBT was $24.2bn up 10%

NH: DPS to $c90 +11%

NH: at the divisional level

NH: the US Household business, which is exposed to all the sub prime toxic waster, made a $2.3bn loss in H2

NH: But this was offset by strong Asia and HK (up +40 and +42% respectively, excluding the paper gain on HSBC’s Chinese associate investments)

NH: Loan impairments in Personal Financial Services (PFS) were +79% to $11.7bn.

NH: Writedowns in the investment bank were $2.1bn FY (v $925m Q3), which includes monoline credit exposures.

NH: So, basically no new shocks in the figs

NH: pretty much in line

NH: although the outlook statement is fairly upbeat

NH: “The fundamentals of HSBC are very strong. The deleveraging of the financial system clearly plays to HSBC’s strengths, given our conservative balance sheet and international presence. There can be few banks in the world that are better positioned to withstand market turbulence and grasp strategic opportunities. We will continue to focus HSBC on the parts of the global economy that promise the best prospects for higher growth over the long term. We will continue to invest for profitable growth in line with our strategy, and we will do so while maintaining HSBC’s financial strength, which is at the heart of our success.”

HT: some interesting wording in there

HT: We will continue to focus HSBC on the parts of the global economy that promise the best prospects for higher growth over the long term

HT: sounds like HBSC might be preparing to give into some of the demands from Knight Vinke

NH: and what demands they are

NH: did you see the piece in the Sunday Times this weekend about selling Household

HT: yes - hang on

HT: THE shareholder activist Knight Vinke has presented Stephen Green, chairman of HSBC, with four options to sever ties with HFC, its troubled American banking business.

The proposals have been made in a series of private meetings between Eric Knight, who heads the activist-investor group, and Green, ahead of HSBC’s full-year results, which are due to be published tomorrow.

These results will show record profits of $24billion (Pounds 12billion) for HSBC, but they will be scarred by the bank’s huge exposure to America’s sub-prime mortgage crisis.

Knight believes that each of his four solutions would “build a firewall” around HSBC’s future exposure. The bank has been one of the largest losers from America’s mortgage meltdown, having lent money to thousands of homeowners with poor credit histories.

The most dramatic of the four options involves HSBC walking away from HFC, leaving its bondholders with $150billion of debt.

Knight Vinke says bondholders have no recourse to HSBC, although analysts say such a measure would badly damage the bank’s reputation in America.

HT: Green has conceded that he wants to draw a line under HFC’s mortgage business, but he has not put a timescale on it.

Its American arm has cost it more than $11billion this year from its exposure to stretched American consumers.

In the last two years the write-offs that have stemmed from HFC have topped the $14billion price it paid for Household International five years ago. HFC formed the largest part of this acquisition. Knight called it a “catastrophic strategic error”.

Knight’s second solution involves HSBC asking HFC’s creditors to help restructure its $150billion debt. This could involve asking them to undertake a debt-for-equity swap. HSBC could also swap its own $15billion interbank loan with HFC into equity or write it off.

If this move is successful, HFC would still operate as a subsidiary, but HSBC would have no on-going liability. It would allow HFC to carry on as a subsidiary company, but on a stand-alone basis with no further support from its parent.

Knight believes that if HSBC does walk away from its loan to HFC, it will quickly claw back the loss from a rapid rise in its share price. By shedding its American business, the majority of the group’s earnings would come from growth markets in Asia and Hong Kong, and this would give it a significantly higher market rating.

The third solution, according to Knight, is “for HSBC to recapitalise HFC by injecting between $10billion and $15billion in cash or writing off its existing inter-company loan, and then selling the business”.

The fourth option involves recapitalising HFC and then demerging it into a stand-alone quoted company.

Green has been looking hard at the options for HFC. Last Friday he reconfirmed his strategy to move away from mature markets when he sold 400 bank branches in France to Banque Populaire for $3.2billion.

Aside from the troubles in the bank’s American mortgage business, HSBC is expected to unveil a huge surge in impairments on its unsecured loan book. Across the group, total bad debt charges are expected to stretch to $16billion -a 50% rise on last year.

HSBC’s profits have been boosted by the sale of its Canary Wharf headquarters building in London, and big gains on some of its Chinese holdings.

The bank’s stakes in Chinese insurance group Ping An, and the Bank of Communications have been marked up by more than $1billion. It is also expec ted to announce board changes.

NH: Interesting stuff

HT: got any comment on the results??

NH: this is from Alex Potter at Collins Stewart

NH: Remains a safe haven. Results above consensus

NH: Headline results look good
HSBC reported PBT of $24.2bn (+10% yoy) on revenues up 25% yoy, more than 5% above our and market expectations, we believe. EPS was ahead of expectations at $1.65 (CS: $1.62 and consensus $1.52), driven by the revenue beat. The dividend was raised 11.1%, in line with expectations.

NH: Impairments and write-downs broadly in line
Total impairments were reported at $17.2bn. US consumer finance provisions were $11.7bn, nearly double last year’s level. The mortgage services portfolio is now down to $36.2bn (from $49.5bn at end-06, $41.5bn at Jun-07 and $38.9bn at Sep-07). The rate of run-off does appear to have slowed in 4Q07 but this is little real surprise. Management does also make some cautious comments about asset quality deteriorations in wider areas of the US consumer finance portfolio (branch-based loans, auto and other) so we can assume 2008 will also show elevated impairment levels. Write-downs were just $2.1bn, which is less than RBS and Barclays and a relatively good number, in our view.

NH: HK was the standout performer
This region reported pre-tax profits of $3,330m in 1H07 then $4,009m in 2H07 (and this usually see seasonal slowdown in second half). We believe there was some exceptional items in this number but, in line with StanChart last week, this is a very strong performance.

NH: Funding and capital strength show through again.
Loan growth was 13%, deposit growth 22% (to over one trillion dollars). Loan-deposit ratio is 89.5% (i.e. surplus liquidity to the tune of $115bn). The Tier 1 ratio is 9.3% (in line), well above most other UK peers
■ Estimates to rise, remains relative safe-haven
We believe consensus will rise after these results. HSBC is at the low-end of its historic valuation range and 9.3x trailing earnings is cheap in absolute terms. This bank continues to show capital strength, earnings diversity and surplus liquidity – it remains a safe haven

NH:

NH: staying with the banks

NH: we have had results from Close Bros this morning

NH: and anyway hoping for news of a radical shake up at the merchant bank are going to be very disappointing

NH: and remember the backdrop to this

NH: Close Bros shares tanked on Friday after the company said it was no longer in takeover discussions

NH: that news saw the stock fall 12%

NH: and they have fallen a further 38p to 621p this morning

HT: ouch

NH: and also remember Andy Stewart’s Cenkos was going to offer £10.25 a share

HT: urgh - but wasn’t that subject to financing

NH: we will come to that later

HT: what’s wrong with morning’s figures

NH: well

NH: On the strategic level, Close have looked at number of options – selling businesses, gearing up the balance sheet ect

NH: and they have rejected them all

NH: this bank is SO conservative

NH: their new plan seems to be to incentivise staff better

HT: inspired

HT: this morning’s results won’t have helped that

NH: here are the key parts from the statement

NH: STRATEGY REVIEW
During the offer period, the board, together with its financial advisers,
undertook a review of the group’s strategy to identify the best options for
delivering shareholder value.

NH: In this review, five main options were evaluated: the sale of the whole group; a
break-up and separate sale of each of the divisions of the group; sale of one or
more of the divisions; a return of capital to shareholders based on an increase
in gearing; and finally, further development as an independent broadly based
financial services group.

The first option, the sale of the whole group, offered shareholders an
opportunity to crystallise significant value with the least execution risk. As a
result it was fully pursued but no firm, fully financed, offer was forthcoming.

NH: The second, total break-up option was rejected because, in the judgement of the
board and its advisers, this option carried extremely high execution risk and
was unlikely to yield a better financial result for shareholders.

The board concluded that the third option, the sale of one or more of our
divisions, was equally unattractive. In light of current market volatility, it
was felt that it would not be possible to establish competitive tension in any
business auction or reach close to fundamental value of any one business. The
board also considered it unattractive to reduce the overall size of the group,
at a time of considerable financial uncertainty and volatility.

The group is well capitalised and soundly financed with a strong balance sheet.
This is an important strength which provides both resilience and flexibility in
the current environment of reduced liquidity in the credit markets. Nonetheless,
the board considered the option of gearing up the balance sheet and returning
cash to shareholders. The board was not happy to increase the fundamental risk
profile of the group at this juncture, nor did it wish to restrict the
availability of capital to fund growth in the bank or attractively priced
acquisition opportunities of the sort current market conditions are expected to
provide. However, it will continue to keep the group’s capital structure under
review.

NH: For all these reasons the board came to the clear conclusion that it was in the
best interests of all shareholders that Close Brothers should continue to grow
and develop as a broadly based financial services group. The board reviews its
group strategy and structure on a regular basis.

THE WAY FORWARD
In the light of the events of the last few months it is important to reaffirm
our strategy. This remains clear and consistent: actively to manage our
distinctive, diverse, specialist and soundly financed businesses with a view to
generating growth in profit, dividends and long term shareholder value. We
believe strongly in the Close Brothers business model which has delivered good
value to shareholders over the long term.

NH: We have some specific actions planned to enhance profit growth. These will
include:

* More rigorous capital management.
* Being more proactive in shifting capital from one division to another in
response to growth opportunities.
* Adjusting the risk profile of the group in the light of future growth
opportunities.
* Increasing the number and size of acquisitions of businesses both in the UK
and internationally. We have both the ambition and resource to do this and,
as expected in current market conditions, we are seeing an increasing number
of acquisition opportunities at attractive valuations.
* Bringing a greater focus on costs at all levels.

We have always relied on the motivational effect of equity and for some time we
have been considering whether existing remuneration arrangements, particularly
for key management in our divisions, are effective to deliver the right business
performance and behaviour and have sufficient retention effect. Recent events
have highlighted the need to implement incentive arrangements which link reward
to future increases in business value, provide significant staff retention
incentives and provide “currency” to enable businesses to attract new employees.
We are well advanced in the design of new equity type incentive arrangements.

HT: that’s not going to enough to appease shareholders

NH: nope

NH: and one imagines there must be some hedge funds on the share register now

HT: what about the numbers?

NH: they look to be below estimates.

NH: and they did not include £5.5m in advisory fees for the potential sale of the business.

NH: and the outlook statement is pretty bearish

NH: but the fact that takeover talks ended had nothing to do with the company

HT: well they would say that

NH: and the idea of selling Winterfloods rejected because of the current market environment

NH: right, got a few bits of comment

NH: this is from Merrill Lynch

NH: Stripping out this exceptional the result missed our estimates by 7%. Asset management was inline, securities were slightly ahead; the miss mostly came from corporate finance that was 34% behind and the banking division that was 6% behind. The outlook statement talks about challenging conditions that are likely to affect business in securities and corporate finance.

NH: On corporate developments, the company states that it received no “firm, fully
funded” proposal for the whole firm, and decided to reject any sale of divisions.
The company discusses strategy, but has also rejected any return of capital, in
spite of the Group’s significant excess.

NH: Instead, Close seems to be looking to improve the businesses is owns operationally, whilst maintaining the same portfolio of businesses, and aim to speed up acquisitions.
Our initial response to this is one of disappointment; however we will listen to the
company’s more detailed presentation on this topic at the analysts’ meeting with
interest.
We will review our numbers post the meeting and retain our Neutral
recommendation.

NH: and this is from Landsbanki

NH: Close Brothers has reported interim results today for the six months to
January 2008.

Close has reported interim results which provide more disclosure but include
some restatements of prior figures. PBT of £69.8m was down 29% with
underlying contributions from asset management and corporate finance down.
Adjusted EPS was 35.1p – down 5%. The interim dividend is up 13% to 13.5p.
Strategy

NH: A strategy review looked at five options: a sale of the whole group; a
break-up and separate sale of each of the divisions of the group; sale of
one or more of the divisions; a return of capital to shareholders based on
an increase in gearing; and finally, further development as an independent
broadly based financial services group.

However, there has been no firm, fully financed offer. Total break-up was
rejected as unlikely to realise value for shareholders. The sale of one or
more divisions was rejected in light of market volatility. Close doesn’t
want to gear up at present to facilitate a return to shareholders but the
capital position remains under review.

NH: So it will carry on as a group but with more rigorous capital management and
will be more proactive in shifting capital from one division to another to
capture growth opportunities. It will adjust the risk profile of the group
in the light of future growth opportunities and says that it will increase
the number and size of acquisitions of businesses both in the UK and
internationally. Finally, it will bring a greater focus on costs at all
levels.

The future looks to rely on better allocation of capital to capture growth
but includes a greater focus on acquisitions which may further limit the
potential return of capital to shareholders.

Outlook
The outlook statement notes difficult market conditions are likely to
continue to affect business in the Securities and Corporate Finance
divisions. It also expects that raising new funds and attracting new assets
to be difficult. Nonetheless, management expects a solid second half
performance from its banking businesses and expects the current trading
performance for the group as a whole to continue into the second half.

HT: think the analysts are being rather kind

NH: me too

NH: they have run a strategic review and the conclusion

NH: let’s carry on as before

HT: if in doubt, stand still

NH: so shareholders can look forward to another 5 years of a stagnating share price

HT:

NH:

NH: right, quite a few questions below

NH: inclduing some good points on Xstrata

NH: interesting post from DLC adviser

NH: points out that any side deal would fall underRule 16 of the Takeover Code, which prohibits special deals with any shareholder.

NH: and that Xstrata’s adviser would have to be able to say that the arrangement is fair to all shareholders.

NH: still there are more things to worry about in this deal

NH: seems to have reached a real impasse

HT: not sure this is just negotiating tactics by xstrata any more

HT: could be real issues

HT: was just trying to look something up - but FT internet connection appears to have died

NH: shares down 69p to £38.94

HT: do you have problems neil?

NH: what generally or with IT

NH: feels like we are working on a dial connection today

HT: well both - I meant IT but feel free to share

NH: which is very possible

HT: what were the xstrata results like?

NH: they seem to be broadly in line with expectations

NH: although some brokers seem to grumbling that they have fallen a touch short

NH: Revenues was US$28.5 billion, up 12% YoY

NH: Group “Underlying” EBITDA was US$10.9 billion, +7.2%

NH: Net income US$5.5 million, +13.5% YoY

NH: EPS “Underlying” US$5.60, +12.2% YoY

NH: Total DPS declared US$0.50, up 20% YoY

HT: who’s unhappy then?

NH: the mighty Merrill Lynch

NH: they are saying everything has undershot apart from the divi

NH: here’s some comment from Merrill

NH: The impact of mining industry inflation and CPI impacted EBIT by a total of $481
million. In particular, further price increases were experienced in South Africa,
Argentina and Chile, primarily for energy, fuel and contractor labour. Profits were
also negatively impacted by the weaker US dollar against most of Xstrata’s
operating currencies, reducing earnings by $457 million. Together these two
factors took away some 70% of the US$1.3 billion in positive price impact.

NH: Outlook “Expect impact of US slowdown on Chinese GDP growth and emerging
market demand for commodities including metals to be muted… robust growth in
global demand for commodities into the medium term.”
Vale bid - “Discussions with Vale are ongoing and may or may not lead to an offer
for Xstrata.”
Our price objective on Xstrata is GBp4650. We take as a base a peer based
valuation of 12x 2008 EPS, the middle of previous sector trading ranges of 10-
14x. Then we apply a 30% takeover premium based on premiums paid in
previous transactions in the resource sector. We believe this is appropriate given
company statements indicating that they are in advanced bid discussions with
Vale (CVRD) of Brazil.

NH:

NH: FX trader wants to know if we have any comment on EADS and the US air force tanker win

NH: must admit I saw the EADS move but was concentrating on Cobham

NH: which will supply the refueling equipment

NH: shares up 4p to 186.5p

NH: and that’s seemt to be about right

NH: Merrill reckons the contract worth 3p to Cob

HT: neil’s hunting out the note

HT: stand by I suppose for a slew of protectionist sentiment from the presidential candidates

NH: sorry the email is SO slow today

NH: Lotus notes

NH: running on Window on a dell machine. it does not get any worse than that

NH: Cobham on EADS tanker – worth up to $1bn in sales
Cobham supplies much of the flight refuelling system for the KC-45A tanker,
which was awarded to Northrop Grumman late on Friday evening. The initial
contract is for 4 prototype aircraft, but there is a requirement for up to 179 aircraft
over the next 15 years. Allan Cook, Cobham CEO, commented in The Sunday
Times that this would be worth about $1bn of sales to Cobham.

NH: Worth 3p per share on fundamentals…
$1bn of sales over 15 years is about £33m per year – assuming 10% margins and
10 times EBIT, this is worth about 3p per share on a fundamental basis and would
boost medium term EPS by about 1.5-2%.

NH: but maybe 10p+ from a strategic perspective
However, this is probably the death-knell for the Boeing 767 tanker programme
and with it GE’s (formally Smiths) air-refuelling contract. Cobham has supplied
over 95% of all the western refuelling systems and we would expect that they are
in an excellent position to win on the remaining 250-350 aircraft requirement from
the US, irrespective of whether Airbus or Boeing (or anyone else) build the
aircraft, and the other 100 or so potential refuelling aircraft required in the rest of
the world. Given that the total market is about 3 times the value of the initial 179,
we believe that this order could be worth over 10p per share for Cobham.

NH: Buy – Price objective 220p
We are not changing near term numbers and are reiterating our buy, with a price
objective of 220p. The company reports FY 2007 results on Thursday, which we
believe will be strong and we expect the company to give a robust outlook.

HT: thanks for that

NH: and I also have a Citi note on EADS

NH: Congratulations due: The Northrop / EADS team beat Boeing to provide the US
with 179 air tankers worth c$35-40bn. We est. the direct value of the contract
could be worth €0.7/share for EADS, adding 4% to the share price. However,
other potential benefits could add further value including subsequent US
tanker contracts; improved tanker export opportunities; more $-based
manufacturing; aftermarket opportunities; and extending the commercial life of
the underlying A330 aircraft platform. We expect EADS shares to bounce 5-
10% today but we would sell into that rally.

NH: Recent FX moves outweigh the tanker upside: FX moves can be transitory and
we don’t adjust our earnings on a weekly basis. On 29 Feb we cut our EADS
‘09E EPS by 14% and ‘10E EPS by 7% but we assumed a forward $/€ rate of
$1.45 in those years. Today’s forward rate is $1.49. If we were to adjust for this
it would take 14% of our 2010E EPS (assuming no offsetting cost savings).

NH: Growing risks to the cycle: Slowing air traffic growth; falling airline profitability;
tougher financing environment for aircraft; peaking lease rates; significant risk
of order deferrals / cancellation; and slowing new orders. From 2008E to 2010E
civil aerospace represents c60% of EADS sales.
 EADS cash flow risks: EADS’ faces major CF challenges over the next 3 years,
although advances on the tanker will certainly help. The challenges are lower
deposits on civil aircraft, higher wkg cap due to the A380 ramp up, the material
risk of vendor financing, and the fact that EADS will spend €2-3bn of the
provisions it made for problem contacts / restructuring in the next 2-3 years.

HT: right - are we done here?

HT: any raw market info?

NH: not that much

NH: been looking at a couple of situations

NH: one is Expro International

NH: on Friday the company announced it had received a very preliminary approach

HT: Expro - oilfield services co

NH: personally I am not sure how preliminary the approach

NH: we were hearing rumours of a £13.75 a share bid

NH: the stock spiked 10% and then bang statement out

NH: which said

HT: have got it here

HT: EXPRO INTERNATIONAL GROUP PLC

Expro International Group PLC (”Expro”, the “Company”) notes the recent movement
in its share price and confirms that it has received a very preliminary proposal
which may or may not lead to an offer for the Company. The preliminary nature of
the proposal is such that there can be no certainty that any offer will be
forthcoming or as to the terms of any offer.

A further announcement will be made when appropriate.

NH: now, these statements take a list and hour half to get up on the wires from scratch

NH: but this one came out as soon as the share moved

NH: so this was ready cooked and ready to go

HT: so you think they had it pre-prepped

NH: all signed off by adviers, board members etc

NH: now we had a story in the paper on Saturday that Candover is the bidder

NH: Candover was of couse one of the underbidders for Abbot Group

NH: presonally I think this could start a bidding war

HT: who else might be interested?

NH: well, Expro is market leader in its niche - does a lot of deepware stuff and provides tools that help oil companies get more out of there fields

NH: the other big name in this area is schulmberger

NH: although there last big acquisition in Europe was a disaster

NH: that was Sema - took huge write downs on it

NH: Haliburton could also be interested

NH: as could First Reserve, who acquired Abbot

NH: got a good note from Phil Lindsay at ABN Amro

HT: 3i?

NH: Expro received a ‘very preliminary approach’ on Friday. The weekend FT reported that Candover (who lost out on Abbot Group)
had made the approach, but we would not be surprised to see others enter the fray, both private equity and potential trade
buyers. First Reserve are incredibly active in this space (currently in the process of acquiring Abbot Group and announced the
largest ever oilfield services buyout just two weeks ago of CHC US$3.7bn cash). However, First Reserve did sell Power Well
Services (PWS) business to Expro in summer 2006 and this could have a bearing. 3i were the other private equity originally in
the running for Abbot. In terms of trade buyers, potential interested parties could be European majors (Saipem/Aker), US
majors (Schlumberger, Baker or GE, who acquired Sondex in 2007) or closer to home, we do not rule out AMEC, given its strong
net cash position and willingness to do a deal. In terms of valuation, previous sector deals have been struck at 9-12x EBITDA or
20-30x earnings. At Friday’s close (1259p) the shares trade at 24.5x Cal 08 and EV/EBITDA of 9.4x.

NH: . We think any deal would
have to be struck at a premium to current share price and at the top-end of range of previous sector deals given a) Expro’s
niche leading market positions, b) its strong existing technology offering and c) its strong technology pipeline including the
potentially transforming AX-S technology

NH: This would suggest a broad range of 1400-1500p, the caveat being the ‘very early’
stage of the offer with no certainly of an offer being made. However, we think the situation could get quite competitive. Clearly,
we see a strong read across for rest of sector given M&A’s increasing prevalence in this market and would highlight Wood (2008
PER 17.9, EV/EBITDA 10x) and Hunting (2008 PER 16.5x, EV/EBITDA 8.4x) as potential prey

HT: so agrees with you

NH: yep

NH: Expro shares currently off 46p at £12.13

HT: any more RAW?

NH:

NH: not really fresh, but this rumours that Centrica might be looking at Drax

NH: we flagged up it up last week

NH: and a few analysts have been looking at it

HT: and their conclusion?

NH: well, Cazenove does not think it stacks up

NH: says Drax is too expensive

NH: and there is a threat of government windfall tax on free C02 in the budget

NH: here’s the full note

NH: Drax’s share price rose 13% last week, outperforming the European utilities index by 14%. According to Bloomberg, this was due to speculation that Centrica [CNA.L, CNA LN, 323p, In-line] would bid for it. We believe this to be unlikely and borne out of a misinterpretation of comments Centrica’s management made at an analyst presentation on the 21st February.

NH: In our view, Centrica would be unwilling to pay a premium to the current share price. Centrica was part of consortium that bid £2.075bn bid for Drax in October 2005 and was rebuffed by Drax’s management. On our calculations an EV bid of £2.075bn, is equivalent to around 510p/ share. This is without adjusting for the £592m which Drax has returned to shareholders since listing at the end of 2005. We consider that Drax’s fundamentals have worsened since 2005 due to a doubling of coal prices and a tightening of the CO2 trading scheme

NH: In addition, we believe that any bid for Drax ahead of the Budget on 12th March would be extremely brave given the threat of a government windfall tax on free CO2 permits. On our calculations Drax’s free CO2 permits account for 39% of 2008E EBITDA. With Drax due to publish results for the year ending 31 December 2007 tomorrow (4th March), we expect the market’s focus to move away from M&A and back to the fundamentals of the business. The numbers themselves should contain few surprises as the company published a detailed trading statement on the 18th December. We are expecting EBITDA of £506m (£583m), EPS of 92.2p (126p), final ordinary DPS of 9.4p (9.1p) and a final special dividend of 8.2p (32.9p). We believe that the consensus forecast for EBITDA is £505m.

NH: The main areas of interest are likely to be:
Exposure to rising coal prices Over the last year, month ahead API2 coal prices have more than doubled from $70/ tonne to $148/ tonne. We currently assume a long term delivered price to the power station of $100/ tonne which is equivalent to an API2 price of around $85/ tonne. Although the forward curve suggests that coal prices will ease with 2012 coal trading at $113 tonne, this would still suggest around £160m p.a. increase in Drax’s coal costs by 2011.
UK electricity prices: Despite the steep increase in coal prices, forward dark green spreads have proved resilient due to the strong UK electricity price. Drax may talk about the drivers behind the strength in prices and how sustainable they are.

NH: View on Ofgem’s windfall tax proposal: Drax may use the results presentation as an opportunity to discuss Ofgem’s proposal on a potential windfall tax on the power companies. Drax is the most affected by any tax which tries to reclaim the value of the free CO2 permits given to power generators in Phase II of the Emissions Trading Scheme (ETS). On our calculations Drax’s 9.5m free permits p.a. account for around 39% of its market cap.

Refinancing: Drax may provide an update on its plans to financially restructure the Group in order to increase balance sheet efficiency. Drax had initially planned to refinance in H2 2007, but given the credit markets decided that it was an inopportune time. We doubt that Drax will be particularly keen to increase its financial leverage given the potential volatility in its profitability from changes in commodity prices and the risk of a windfall tax.
Recommendation and Valuation
Drax’s valuation is extremely sensitive to quite small changes in assumptions. Our base case valuation is 525p assuming a long term electricity price of £46.5/ MWh and API2 coal price of $85/ MWh. If we were to use $113/ tonne as our long term coal price and keep our power price assumption unchanged our fair value estimate would fall to 272p. On the other hand if we were to increase our long term electricity price assumption to £56.5/ MWh (the current 09/10 price) then it would raise our fair value estimate to 686p (18% upside from the current share price). In our view, British Energy [BGY.L, BGY LN, 565p, Outperform] would offer substantially more upside in a high electricity price environment. Our fair value for British Energy is 715p using a long term electricity price of £46.5/ MWh. If we were to use £56.5/ MWh, then our fair value would rise to 1,008p/ share (78% upside from the current share price).

HT: I was just booted out by my delightful computer

NH: me too

NH: system is grinding to a halt and on the day of Pearson results too

HT: no comment

NH: Pearson shares down 19.5p at 646.5p at the moment

NH: right Helen has been completely booted otu and has given up

NH:

HT: I’m back - Neil’s now gone

HT: which is unfortunate as he had more to say

HT: Murphy sabotage entirely possible

NH: hang on

NH: i’m back

NH: just want to look at HBOS again

NH: shares heading south

NH: down 6% at 567p now

NH: shares were at 700p before the numbers last week

NH: some brokers pinning this morning’s weakness on a note from UBS

NH: A tough operating environment likely to get tougher
HBOS FY07 results were broadly in-line. However, it finds itself in the unfortunate position of
being exposed to the majority of the market’s current areas of concern: Commercial property &
mortgages, private equity gains, a high level of wholesale funding & post the results concerns
over the quality of treasury assets. In the short-term these are likely to continue to weigh on the
g.roup’s share price. Treasury disclosures bigger than expected but majority has low credit risk
HBOS’ relatively comprehensive treasury asset disclosure is useful & should be applauded
despite the short-term volatility it has caused in the share price. We do believe that eventually
the market will move to differentiate between mark-to-market losses and cash losses although
we may still be some 6-12 months away from this. In the meantime mark-to-market concerns
a.re likely to continue to weigh Funding moving increasingly short-term
With a retail loan to deposit ratio of 160% (177% at a group level) HBOS remains heavily
dependent on wholesale funding. With term funding markets still difficult we believe the group is
currently funding its loan growth much more short-term than it would like. There will naturally be
a limit as to how much the group will want to shorten its funding duration & we suspect that if
f.unding markets do not normalise in Q3 then volume growth will be pulled back aggressively. Valuation: Still facing big challenges
Our 08 EPS forecast are largely unchanged & sit some 10% below consensus. Our SOTP
valuation indicates a fair value of £6.50. We maintain a Neutral rating.

NH: not as exciting as I thought it might be

HT: thanks

HT: any more?

NH: there is a bear stearns note on HBOS as well, but I think we have put too much analyst stuff up this morning

NH: just time for a quick FTSE 100 check

NH: down 95.5 points at 5,788

NH: so that’s it for today

NH: we have managed to succcessfully negotiate a session without Paul

HT: just about

NH: before we go, Tom Braitwaite has just pinged over an interesting email on Sports Direct

NH: and the upshot is that the buyback programme may have to stop soon

NH: Sports Direct International plc (’the Company’) was notified on 3 March 2008 by
Michael James Wallace Ashley that he continued to hold 410,400,000 ordinary
shares of 10p each in the Company but that by reason of the reduction in the
number of ordinary shares in issue with voting rights he was now interested in
71.53% of such shares.

NH: Tom says once it gets to 75% it must stop

NH: this is because of free float rules I think

NH: must have 25% free float to be listed on the main market

NH: i suppose he could go over and switch the listing to Aim

NH: which I suppose you could not rule out

HT: bit of come-down

HT: a further come-down rather

HT: are we done?

NH: yep, think so

NH: we will see if Javier fanices a turn on ML this week

NH: see u tomorrow

HT: bye all