Less than a month ago we were being asked to believe, according to market rumour, that 3G, the notoriously frugal Brazilian investor, was planning on bidding for SABMiller. Now the market rumour, having been sparked by an entry on a little-known Brazilian blog, is that 3G is limbering up to practise its cheese-paring expertise on Diageo, the second of the three global drinks groups.
I suggested at the time that the only reason to hold SABMiller’s shares was if you believed a bid would emerge, otherwise avoid. They are now two quid lower. I feel much the same about Diageo. The shares sell on such a high multiple, at a time when the company is hitting headwinds in some of its most important markets, that the price can be justified only if a bid emerges.
There is one complicating factor. If 3G were to embark on a leveraged buyout, at the sort of premium it would have to pay for Diageo, market capitalisation just shy of £50 billion, it would be the biggest such deal in history (the recordholder, of a Texan energy company just before the financial crisis hit, came to grief last year.)
This is not 3G’s style. Earlier deals, such as for Heinz and Kraft, have not seen it put in too much of its own money.
The Diageo story has the Brazilians teaming up with the third global player — and the largest — Anheuser-Busch InBev. There are several reasons why this looks implausible. It would be a huge stretch and, analysts believe, would require ABI to cut its dividend. There is the option to reduce the cost by disposals from Diageo, such as Gleneagles, already on the market, and the wine business, but not by much.
There is no obvious compelling logic to combining spirits and beer, where ABI is concentrated; indeed, some distributors might react negatively. It would be an immensely complex task and, if ABI does want to get into spirits, it is likely to do so on a more measured scale at first. The combination would probably hit regulatory problems in the American beer market, too.
Diageo’s latest trading statement revealed sales struggling in emerging and developed markets. The shares, up 119½p at £18.80, sell on 20 times earnings. Avoid, unless you are convinced a bid is coming.
Earnings multiple for 2015 20 times
My advice Avoid
Why There seems little prospect of a bid, despite ill-founded rumours, while the multiple the shares are on looks hard to justify otherwise
It is always disappointing to see a company withdrawn from the market while in the early stages of a recovery programme, but the 160p offer for Phoenix IT from Daisy, announced late last month and forecast in this column in April, looks the best outcome for investors.
It also looks inevitable. Toscafund, which helped to bring Daisy to the stock market, has 29 per cent of Phoenix and clearly is backing the offer, representing 19 times earnings.
Phoenix fell foul of the typical weakness of software providers, an over-enthusiastic booking of revenues. There was a £14 milion hole in the books. Steve Vaughan arrived as chief executive, implementing a three-year turnround strategy. The results for the year to the end of March show a return to profit after those one-off losses, although revenues are still falling. There is no dividend.
Mr Vaughan, therefore, has stabilised the business, but a return to revenue growth will be difficult. The shares, up ½p at 157p, were below 90p last summer. For Daisy shareholders, the deal looks a good one, adding to its portfolio of products, although any acquisition is a risk. Phoenix shareholders should take the cash.
Cost of Daisy offer £135m
My advice Accept offer
Why Outcome is about as good as investors can expect
Drax is an odd business to get your head around and probably is not one for the unsophisticated investor. Profits are wildly variable — as are dividends, as the company’s policy has been to pay out half of earnings to shareholders.
Much of the reason for holding the shares, then, has been the hope that one day Drax, which operates one giant power station using coal and biomass and generates about 8 per cent of the UK’s electricity, will attract the attention of one of the bigger energy groups. This hasn’t happened yet and in today’s low-price energy environment it is hard to see it happening soon.
The main driver of profits is the gas price, which governs what the company can get for the power it generates, and this has been relatively low. Drax sells ahead much of its output and is reliant on what the market will offer and its view on the future cost of energy.
The latest trading statement shows that the market does not expect much short-term increase in the price. Drax has now sold forward almost all of this year’s output and about 40 per cent of 2016’s, at prices below £50 per megawatt hour. This means that forecasts for earnings of about £190 million this year are pretty well nailed down, but it does not suggest much significant improvement for next year, although this is so far ahead as to be almost impossible to predict. This year’s forecast dividend suggests a forward yield of little more than 1 per cent. The shares, up 1¼p at 376¾p, offer little appeal unless you expect a sharp rise in energy prices or that takeover approach to emerge.
Forward price for 2015 £49.9/MWh
My advice Avoid
Why Earnings and dividends highly erratic
And finally . . .
Ashtead has results in a week’s time and a note from Jefferies has been totting up the reasons why the outcome should be favourable. The equipment rental company has 85 per cent of its business in the United States and a track record of gaining share in the highly fragmented market there, which is worth $36 billion. It focuses on smaller kit and enjoys high rates of utilisation. Some competitors have spoken of late of a slight softening in the market, but this is down largely to the energy sector, to which Ashtead has little exposure.
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