Markets live chat transcript for the chat ending at 12:01 on 25 Nov 2008. Participants in this chat were: Paul Murphy (PM) Neil Hume (NH)
PM:
Morning, welcome to Markets Live
PM:
This FT Alphaville’s daily markets chat.
PM:
Neil is here with me – on time, tech-ed up.
PM:
Sort of
PM:
We are patting ourselves on the back this morning…
PM:
Having given everyone firm advice on Friday afternoon to “buy” financials, we are not looking pretty darn smart!
NH:
Even if we say so ourselves.
PM:
Yep, FT Alphaville said: “The worst is over. Buy financials”
PM:
Reiterated that yesterday morning. Our only note of caution was about the miners, where we suggested the bottom could yet be three months away.
PM:
We see deep embedded value and we’ve been happy to share that with the readers.
PM:
Surprised to see the market’s overall reaction on both sides of the Atlantic tho
NH:
Murph, you just can’t openly lie to the readers – and expect them to believe it.
NH:
They’re not going to think: “Oh, Murph gave us the buy signal yesterday. Shame I missed it. Must pay more attention to ML.”
PM:
Oh, I thought that was what columnists do. Find a bandwagon and then convince yourself that you’ve been driving it for weeks.
NH:
I think that used to be possible – in the pre-digital age. Not now tho.
PM:
So when we come up with some idea on here and then it pops up as a fresh comment idea elsewhere, that’s just coincidence is it.
NH:
Almost certainly.
PM:
Anyway, we are going to develop a model portfolio on here – long short. Readers will be invited to flip the recommendations and we can see who makes money.
PM:
Meanwhile, we will assess ourselves against a suitable benchmark – the CIC
NH:
Er, I can’t find that on reuters. Index? Credot Omdistroe; et Commercial ??????
PM:
No! – China Investment Corp – the Chinese sovereign wealth destruction vehicle.
NH:
Ah, the SWD – a good choice, except that they’ve been so so bad it’s a bit like playing against a dreadful penny share.
PM:
Yes yes.
PM:
PM:
Anyway, better roll back and explain to new readers why we said “sell the miners” yesterday – just as the Footsie was heading to the moon. – reload the bear.
PM:
What’s happened Neil?
NH:
We got a deal break
NH:
and it’s a big one
NH:
BHP has walked away from the Rio
NH:
much to the surprise of just about everyone
NH:
esp Rio
NH:
actually, what BHP has said it is that it no longer believes the deal would be in the interest of shareholders
NH:
: and just look at the damage it had done to Rio
NH:
stock down 870p
PM:
NH:
or 35%
PM:
whoa
NH:
at £15.79
PM:
that could finish off a few merger arbs — if indeed they were playing
NH:
indeed, any surivors of the great de-leveraging could have been wiped out by ths hit
PM:
that’s a huge huge fall
PM:
What’s going on?
NH:
debt
NH:
it is all about debt
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and Rio has lots of debt
NH:
around $40bn
NH:
that’s against a market cap of £14.6bn
PM:
No — that cant be right
NH:
well it is
NH:
although to get Rio’s real market cap, one has to add the value of its Aussie listed shares
NH:
and they are worth £11.5bn
NH:
but even so, this company is now in a bit of a pickle
NH:
and note that one of the reason BHP gave for walking away was the prospective level of debt of the combined company
NH:
and whether it could generate enough cashflow to service the debt
NH:
RIO CDS are out at 800bps this morning
NH:
but a word of caution here – apparently they rarely trade
PM:
So all this debt cam efrom the Alcan deal, no?
NH:
yes
NH:
and the market is awash with speculation that Rio will need to raise at least £9bn via a cash call
NH:
and of course there were rumours in the Aussie press yesterday
PM:
saying Rio had been in China recently sounding out potential investors
NH:
that’s right
NH:
and look at some of the flashes coming out of China this morning
NH:
CHINALCO MAY SEEK BIGGER RIO STAKE, SOME EXECUTIVES CONSIDERING 49.99 PERCENT – VICE PRESIDENT
PM:
49.99%????
PM:
think they might be confused
PM:
try 29.9%
NH:
OK, try this
NH:
RTRS SAYING CHINALCO WANT 15% OF RIO
PM:
Of course they could buy 49.9 per cent — and then offer to buy the remainder
NH:
well, they certainly need to average down
PM:
They paid how much????????
NH:
£60
NH:
that’s not a typo
PM:
dear me
NH:
they paid £60 a share for 12% holding in Rio
NH:
cost $14bn
NH:
one hell of expensive insurance contract
NH:
they want to block this deal remember
PM:
Shall we talk a bit more about theese debt levels at Rio
NH:
OK
NH:
and valuation
NH:
market seems to be saying, you have a lot of debt Rio
NH:
so you should be valued on a similar rating to Xstrata
PM:
which is ?
NH:
around 3.6 times spot based prospective earnings
PM:
Doesn’t that seem a bit on the low side?
NH:
well, people do have that view
NH:
they say given the size and spread of Rio’s ops
NH:
perhaps something around 4.5 times 12 months spot is more appropriate
NH:
that would equate to a share price of £20
NH:
but the debt is a really worry here
NH:
Look, Rio has net debt of $38bn
NH:
$8.9bn has to be repaid by October next year
NH:
now, given that it has an undrawn credit line of $4.6bn, it needs to find $4.3bn
NH:
However, the much biggest problem for Rio is 2012, where $10bn comes due
NH:
So you can see why people think a rights issue might be needed, particularly if the global economic outlook remains bleak
NH:
and this morning’s statement leaves investors in no doubt that BHP is battening down the hatches and preparing for the worst
NH:
now just a couple of weeks ago their point man on the deal Calderon was telling investors, that BHP was still bullish on China
NH:
and the decline in the metals prices was overdone
NH:
but that view has changed
NH:
BHP no has “concerns about the continued deterioration of near term economic conditions
NH:
“the lack of any certainty as to the time it will take for conditions to improve and the risks that these issues imply for shareholder value
NH:
actually those comments have knocked the rest of the mining sector
Kazakhmys (KAZ:LSE): Last: 220.00, down 9.75 (-4.24%), High: 230.00, Low: 198.00, Volume: 1.82m
Antofagasta (ANTO:LSE): Last: 407.50, down 23.25 (-5.40%), High: 429.00, Low: 387.25, Volume: 2.09m
Eurasian Natural Resources Corp (ENRC:LSE): Last: 244.75, down 12.25 (-4.77%), High: 263.00, Low: 227.50, Volume: 1.15m
Lonmin (LMI:LSE): Last: 812.50, down 42 (-4.92%), High: 860.00, Low: 789.00, Volume: 576.94k
Vedanta Resources (VED:LSE): Last: 515.00, up 4.5 (+0.88%), High: 518.00, Low: 470.75, Volume: 1.36m
NH:
actually there was another bit of bearish news in the statement for the mining sector
NH:
taking a large charge against their nickel ops down under
NH:
2.1bn impairment charge
NH:
citing significant deterioration in the nickel market
NH:
and the dramatic fall in demand
PM:
Do you think BHP might come back with another offer??
NH:
Well, never say, never
NH:
but reading this morning’s statement I just don’t get that impression
NH:
BHP are making it pretty clear that the divestments they would have to make in iron ore and coal
NH:
would completely undermine the economics of the deal
NH:
basically, BHP are saying that it would struggle to find buyers for these operation because of the Le Crunch
NH:
and even if they did, the price would not be acceptable
NH:
so until the world economy is back on the rails
NH:
this deal is dead
NH:
for the time being
PM:
but just for the record
PM:
when could they come back??
NH:
well, I guess it would be 12 months
NH:
from the date the deal lapses
NH:
and I imagine what will happen is that BHP will not respond to the EU objections to the deal
PM:
Unless of course the chinese bid before hand
PM:
right
PM:
what about BHP shares
PM:
where are they trading
NH:
they have had a big move on the upside
NH:
up 167p to £11.48
NH:
a rise of 17%
NH:
the view on BHP is relief that they will not be taking all this debt on
NH:
and hopes that it could restart a buyback
NH:
mind you did see how much this deal has cost BHP
NH:
$450m over the course of the 18 months that this deal has been rumbling on
PM:
that’s v v high — for the bidder, that fails
PM:
right time for some analyst comment
NH:
OK
NH:
This is from Michael Rawlinson at Liberum
NH:
In a shock move and after what has been over a year of activity BHP Billiton has walked away from the Rio Tinto offer.
NH:
They cite the uncertain macro outlook as the primary driver behind the decision and
specifically cite the high debt burden in RIO and “our ability to achieve fair divestment values in the required time frames could contribute to the cost and the risk of the transaction.” Our views post the BHPB call:
specifically cite the high debt burden in RIO and “our ability to achieve fair divestment values in the required time frames could contribute to the cost and the risk of the transaction.” Our views post the BHPB call:
Why break? In short we see this is a combination of 1) ‘bottling it’ as regards the cycle and some genuine concerns about debt levels 2) having gravely misread from the outset the complexity of the anti-trust issue, the EU process in particular. We note Eurofer’s comments that economic slow down is being used as a face saving exercise by BHPB.
NH:
EU key? BHPB deny that the complexity of the EU process was the overriding factor in this decision. However, we would guess the EU’s desire for divestments in iron ore and coking coal possibly before the closing of the transaction to credible “strong third players” was the nail in the coffin, in particular the desire for them to see RIO/BHPB’s dominance in iron ore pellets broken.
RIO balance sheet fears overdone? RIO has net debt at c.$38bn with a big refi in October 2009 of $8.9bn. Facility C in the Alcan package is undrawn to the tune of $4.6bn, implying RIO needs $4.3bn from FCF or disposals to make its refi by 2009. If the 2009 refi isn’t a worry in our view, the Oct 2012 refi is a bigger issue at $10bn. RIO has debt covenants that kick in at 4.5x EBITDA so they are comfortable on this in our view.
NH:
Regarding BHPB, the combined pro-forma net debt coverage ratios for RIO/BHPB are similar to those of Anglo – not sufficient reason to walk away in our view.
BUY RIO here? At the time of writing BHPB was up 15% and RIO down 38%. This means RIO is now much cheaper on a PER basis (3.9x versus BHPB’s 7.5x) and at parity on EV/ EBITDA of 3.6x. For those with a positive bias on the cycle RIO is the clear leveraged play. It also remains a target – with strong deal rationale underpinning. BHPB is a safer bet, but already has the premium rating in the sector it deserves.
NH:
We are not sure if this deal is dead for ever – most likely it is. In the even it isn’t we think it will be one year before BHPB can re-launch an offer, unless the deal is agreed. Of course BHPB can come into the market and buy RIO shares (as hinted in their release) – but a remote possibility in our view.
Bad news for the sector, and not good for either management team. This move by BHPB has been taken by the broader market as bad news for the cycle (watch actions not words). As the recriminations start, we would expect to see Tom Albanese under pressure though BHPB’s team have also miss-stepped.
PM:
So
PM:
on that reading the debt position does not look too bad
PM:
they have got a year to refinance what $4.3bn
??
PM:
a lot can change in a year
NH:
true and miners are pretty cash generative. this could be a touch overdone
NH:
this is from MF Global
NH:
Tobias Wiener
NH:
Investors need to focus on the EV ratio and not the equity ratio. You could make
actually a massively bearish case if you take the historical EV exchange ratios between the two Groups and focus on the low point of that ratio (which was around 0.61x). At the moment the exchange ratio on an EV basis is around 0.93, so the EV would have to fall by 35%, implying that the Rio Tinto share price could fall by as much as 60% from here. THAT SAID, this ignores the potential of metal prices bouncing back and a stronger US$ also having a positive impact on costs for Rio Tinto. SO if you take the historical EV exchange ratio (of 0.81) between the two stocks you would probably get a better indication for now.
actually a massively bearish case if you take the historical EV exchange ratios between the two Groups and focus on the low point of that ratio (which was around 0.61x). At the moment the exchange ratio on an EV basis is around 0.93, so the EV would have to fall by 35%, implying that the Rio Tinto share price could fall by as much as 60% from here. THAT SAID, this ignores the potential of metal prices bouncing back and a stronger US$ also having a positive impact on costs for Rio Tinto. SO if you take the historical EV exchange ratio (of 0.81) between the two stocks you would probably get a better indication for now.
NH:
This would then imply a fall of c20% in the Rio Tinto share price from last
nights close assuming that BHP Billiton stays at the current level. So this would then point to a fair value on the basis of that exchange ratio of around 2,000p. A new fair exchange ratio would then be 2x based on the equity;
nights close assuming that BHP Billiton stays at the current level. So this would then point to a fair value on the basis of that exchange ratio of around 2,000p. A new fair exchange ratio would then be 2x based on the equity;
NH:
The focus now needs to be on the US$ and hence the metal prices. If you believe that there will be a bounce back in metal prices then Rio Tinto will be more geared to this than it is the case for BHP Billiton. If not, then you really should stay away from Rio Tinto for now. Having said that, investors at this point in time seem to ignore the benefits of a stronger US$ on costs, which is not insignificant.
NH:
Rio Tinto itself said that 50% in the fall of metal prices tend to be offset by lower costs. Remember most of the miners produce in countries such as Australia, South Africa and Chile, where a stronger US$ reduces local costs significantly. Most LME based metal prices now trade at or below the marginal cost of production from which they normally tend to bounce back. The fear now, however, is that the marginal cost of production would have to fall back as well, so that prices will fall more than so far anticipated. We would say that although a risk the market ignores the positives from lower costs;
NH:
The stock’s valuation appears attractive on the face of it, but the higher debt matters. We price our new target price for Rio Tinto at 2,000p on the basis of the historical EV ratio, which would price the stock at 6x 09E P/E (using marginal costs of production for the price assumptions).
NH:
This sounds attractive against the historical lows, but then we investors should note that if the stock falls back to its historical low on a sales multiple basis, the stock could fall significantly more. As said, it all depends on metal prices or on how quickly the Group gets rid of its debt from here.
ON RIO CASH CALL SPECULATION, SEE COMMENT BELOW
NH:
PM:
thanks for all that
NH:
OK, let’s move on from this boring little mining deal
PM:
if you get bored with us here, we recommend this CNBC vid
NH:
That’s Mario Bartiromo been duped by Sacha Baron Cohen
PM:
She should have realised when “Prince Alwaleed” started toaking about Mr Vikram at Citigroup.
PM:
very funny, but very embarrassing for the money honey
NH:
and Mr, keep on dancing, Prince, the artist formerly known as the CEO of Citigroup
NH:
here’s a little taster
NH:
courtsey of dealbreaker
NH:
Oh, and he told a little story about meeting his “good friend Sandy Weill” in Paris one night, at which time Sands told him, “Prince, I am sorry [for the whole Chuck Prince situation].” Though the Other Prince is “a good man, a gentleman, frankly speaking, the destruction of wealth was his fault.” But no more! “We’ve spoken enough about Chuck Prince. Let’s talk about Mr. Vikram. Let’s give him some time. He’s a man of strong will, he’s a man of vision.” No more about Chuck Prince. No more! One more word about Chuck Prince and I will shut you down, Maria. One more word!
Update: Charlie Gasparino “wouldn’t trust what [Alwaleed] says when it comes to Vikram” because what he said about Chuck Prince “wasn’t classy,” and “not a good moment for The Prince.”
NH:
recommended viewinig that
NH:
and it could really be a spoof
NH:
The Price is sitting in front of a camel and two race horses
NH:
with rose tinted spec on
NH:
and some serious bling in his hand
NH:
and at the end of the interview there is some outragous flirting with Maria
PM:
NH:
right correction to something I wrote earlier
NH:
the name of the MF analyst is Tobias Woerner
NH:
Wiener is someone who lives in Vienna or also a schnitzel
NH:
apologies for that
NH:
obviously thinking schnitzel
PM:
NH:
PM:
Back to the theme of other people who are following our bullish market call – even James Montier is towing the line now
NH:
From SocGen – Albert Edwards’ mate?
PM:
Yep
PM:
The inexorable march down the road to revulsion is throwing up some truly incredible investment opportunities. BAA-rated corporate bonds are now yielding the highest level since the 1930s – as Ben Graham said, corporate bonds “should be bought on a depression basis”. Even in aggregate terms, equity markets are offering reasonable value. From a bottom-up perspective, great companies are available at bargain basement prices. Will I be early? Almost certainly yes. But as Jeremy Grantham noted recently, “If stocks are attractive and you don’t buy and they run away, you don’t just look like an idiot, you are an idiot”.
PM:
Actually, this is rather good. Here’s the rest of the summary.
PM: