Marriage and Divorce Corporate Style (Part 2)

And Vodafone PLC

Hindu wedding courtesy Wikipedia 

Bumi PLC 

In 2010, the financier Nat Rothschild invested the funds of a cash shell, Vallar PLC, that had raised 700 million pounds via an Initial Public Offering, in Bumi PLC. The Indonesian industrialist Bakrie family exchanged 29% of their company, PT Bumi Resources, for a 29.9% stake in Bumi PLC. Bumi Resources owned majority stakes in 2 large coal-mining companies, 2 coal mining exploration companies and 87% of BRM, a non-coal mining company. All are incorporated in Indonesia. And Bumi PLC bought 85% of Berau Coal from another Indonesian industrialist for $1.6 billion.  

Rothschild and the Bakries were each left with 29.9% of Bumi PLC. Rothschild and Nirwan Bakrie became Co-Chairmen of the PLC. The happy marriage did not last long. The price of coal slumped, Bumi PLC lost $319 million in 2011 and the shares, which had been listed at 1,000p, fell to 254p when they were suspended 24 April 2013. By then Rothschild had accused the Bakries of irregular payments and loans at Bumi Resources, and further financial irregularities at Berau Coal. Both Rothschild and Bakrie resigned. The irregularities are said to total the suspiciously rounded figure of $1 billion. This suggests they are large but presently unquantifiable. 

The Australian (13 March 2013) reported that the Bakries' Bumi Resources, 29% owned by Bumi PLC, had sold down its stake in BRM, the non-coal miner, from 87% to 45%. If true, this would be a pre-emptive advance on a divorce settlement. 

The Bakries want to cancel their participation in Bumi PLC in exchange for recovering their shares in Bumi Resources plus a payment of $278 million. Bumi PLC would then be left with an 85% share in the loss-making coal miner, Berau Coal. The Bakries are the most powerful business family in Indonesia and one of their members, Aburizal Bakrie, has declared his candidacy for next year's Presidential election. This February the Bakries emerged as the victors of a proxy fight with Rothschild. Shareholders supported their candidates for the Board, including the Bakrie ally Mr Samin Tan as chairman. Bumi PLC owns nothing outside Indonesia. 

On 9 May 2013, Bloomberg reported that Nat Rothschild said his tie-up with the Bakrie brothers to form Bumi was a “terrible mistake". He regretted taking advice from Ian Hannam, the former JP Morgan investment banker, in the lead-up to the creation of Bumi.

"He said it was the best deal he had ever seen in his life,” said Rothschild. Nothing like blaming someone else for your mistake. With the shares suspended, the UK shareholders in Bumi PLC face a disappointing outcome. 

 What went wrong?

Nat Rothschild, who has specialised in resource-based assets, saw an opportunity. China was buying vast quantities of coal, Indonesia has vast quantities of coal and he wanted part of the action. But to do so he required a well-connected Indonesian partner already in the coal business and the Bakries seemed to be the perfect in-laws. The Bakries wanted to expand their interest in coal. They had tried and failed to buy Indonesia's third largest coal miner, Berau Coal. And Rothschild, with $1.1 billion in the bank, was a very well endowed bride.   

The price of coal then collapsed, falling 32% between January 2011 and December 2012. Bumi PLC made big losses and its shares collapsed in value (graph from Yahoo, Bumi PLC in blue, the FTSE 100 in green, click to enlarge):

 

The Bakries want a quickie divorce, leaving the other shareholders with the loss-making Berau Coal.

The Indonesian ways of doing business, governance and business ethics do not coincide with the UK's. Bumi PLC has only a minority stake in Bumi Resources, and Bumi Resources does not own 100% of most of its subsidiaries. This gives the companies' managers leeway to make deals that are in the interests of the controlling shareholder.

With all Bumi's assets in Indonesia, it was inevitable that the Indonesian Bakries would take effective control of Bumi PLC if they so wished. 

From both Bumi and TNK-BP (see 8 May article), the investor can draw some conclusions: 

1. Where assets are held in a joint venture in emerging markets (EMs), the local partner wields control.

2. London listed companies that operate only in EMs are not going to behave like companies whose management and main assets are in developed markets. Many EM companies have listed in London in the last decade, and many a UK investor has lost money in them.

3. EMs and resource companies are a toxic mix for the UK investor. Expectations are pumped up by City investment bankers and brokers, who are eager to win big fees. The hype - emerging market, China's demand for energy, the rising price of coal - is passed on by journalists, who are caught up in the unwarranted enthusiasm. But the people and government of the EM country naturally believe the resources that are dug up or pumped out of their ground belong to them. The risk of losing money in these companies is very high.

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Vodafone PLC

Evolution of the mobile phone, courtesy Wikipedia

When management report the results and performance of their company based on EBITDA (earnings before interest, tax, depreciation and amortization), you know they are hiding something. In the case of Vodafone, they hide the annual multi-billion pound impairments for assets they bought at vastly inflated prices. In just the last 4 years, Vodafone has written down its assets by 18.2 billion pounds in addition to over 30 billion in depreciation. After tax profits, for those same years, amount to 26.7 billion pounds. And 18.9 billion of that is not even managed by Vodafone - it comes from the company's associates, principally from its 45% share of Verizon Wireless.

Verizon Wireless is Vodafone's one outstanding success as an investor. In 1999, Vodafone reached an agreement with Bell Atlantic (now Verizon Communication) to establish a joint wireless business to serve the United States. Wireless is now the biggest mobile phone operator in America. Verizon holds 55% and Vodafone 45% of Wireless's equity. Management control is firmly in the hands of Verizon.

The marriage, despite its commercial success, has not been an easy one. Just a year into the marriage and it was rumoured that Vodafone wanted to buy out Verizon's share in Wireless. That same year, Wireless announced it would use a technology that would not be compatible with Vodafone's, though the pair made up the squabble. In 2004, Vodafone said that as both partners wanted all of Wireless, they were at an impasse. In 2005 Verizon retaliated by blocking dividend payments from Wireless, believing that this would force Vodafone into a divorce. This unhappy state of affairs lasted for 6 years. In 2012, Verizon needed Wireless's dividend as much as Vodafone and the cash began to flow. But Verizon still wants to divorce Vodafone. It is dangling $100 billion under Vodafone's nose. The shares have jumped:

Graph courtesy of Yahoo, click to enlarge.

What would Vodafone be worth without its share in Wireless?

Making sense of Vodafone's profitability is a Herculean task. Working through the thicket of accounting adjustments, I have made some heroic assumptions about the notional profitability of Vodafone without Wireless. The following excludes impairment charges, profit and loss on the sale of assets and foreign exchange translation gains and losses. To remove legacy items, I have used actual capital expenditure to replace the significantly higher depreciation and amortization charges each year.

Vodafone adjusted profit ex Wireless 2012 2011 2010 2009   4 YEARS EBITDA 14474 14670 14735 14490 58369 Less Capex 7852 8640 6975 6968 30435 less interest 1932 429 1512 2419 6292 NOTIONAL PROFIT PRETAX 4690 5601 6248 5103 21642 Tax at 24% 1126 1344 1500 1225 5194 NOTIONAL PAT 3564 4257 4748 3878 16448     Notional Earnings per share 7.3p 8.7p 9.7p 7.9p 8.4p

Wireless is carried at 35 billion pounds in Vodafone's balance sheet and the notional return on equity, once Wireless is removed, is 10%. Net debt is a manageable 27 billion pounds, or 35% of equity.

70% of Vodafone's revenue is from Europe and revenues are stagnating. The only market that is currently growing is India, which accounts for less than 10% of revenue. Although earnings are static these last 4 years, it is reasonable to assume that earnings could grow at about the rate of inflation, say 3% annually. I have used a discount rate of 10.8%. On this basis, my valuation model values Vodafone without Wireless at 67p a share. At this price, Vodafone would be on a notional PE of 8 and yield 6.2%.

$100 billion net proceeds for the sale of Wireless translate to 133p a share, giving a combined value of 200p. This compares to Vodafone's current share price of 191p.

There are significant uncertainties:

1. The potential tax bill on the sale of Vodafone's share in Wireless is variously estimated at 30 billion pounds (Societé General) to $5 billion (Citibank), were Verizon to pay $100 billion for the shares of Wireless.

2. Vodafone has a history of spending huge sums on assets and then writing them down. What is to stop Vodafone's management from throwing away a sizeable part of the proceeds from a Wireless sale on overpriced assets? This would greatly reduce the value of the Wireless sale to Vodafone's shareholders.

3. Vodafone and Wireless combine their purchasing power to reduce costs. The impact of a break-up on Vodafone's cost structure is not known.

4. Vodafone is in dispute with the Indian tax authorities that could cost it, including interest and fines, up to 2.4 billion pounds.

5. Vodafone's share price jumped 24% from a 12-month low of 154p in December to 191p on speculation of a sale of Wireless. If the sale does not proceed, the share price could fall steeply.