Dealreporter Flash in Securities Lending Times

16 June, 2015 - 2:51 pm UTC

by Adnan Siddique

Cevian’s game plan for ABB

Dealreporter’s Adnan Siddique, CFA, discusses the latest European pre-event ideas: Swiss industrial conglomerate ABB Ltd and Italian constructor Salini Impregilo.

Activist investor Cevian Capital would have made detailed preparations before taking its 3.1% position (view) in Switzerland-based multinational ABB Ltd [VTX:ABBN]. Dealreporter takes a close look at Cevian’s game plan for ABB, including the possibility of a demerger of its power and automation business.

The investment in ABB is a typical Cevian bread and butter industrials deal but on a much larger scale. Previous and ongoing investments include Metso [HEL:MEO1V],ThyssenKrupp [ETR:TKA] and Volvo [STO:VOLV]. Most previous campaigns have been highly successful for Cevian but notably Bilfinger [ETR:GBF] is proving resistant to a turnaround. Cevian first appeared on Bilfinger’s share register in 4Q11, adding to its stake over time. Yet nearly four years and whole scale management and board changes later, the stock price is around half of what it was at the time of the initial investment.

Despite Cevian’s highly concentrated portfolio, it is going to be severely restricted if it wants to purchase more stock and gain greater influence over the company as it did in Bilfinger. In ABB, Cevian is going active on a CHF 49bn market cap company and its stake would have cost around CHF 1.5bn. This could amount to nearly 15% of Cevian’s c.EUR 10bn (view) assets under management. In preparation for this and prior to investing, Cevian is likely to have gained considerable fellow shareholder support.

The primary shareholder in ABB is Investor AB with 9.3% and is controlled by the influential Wallenberg family. Investor AB Chairman Jacob Wallenberg is vice chairman of ABB. It’s unlikely that Sweden-based Cevian would take such a high stakes gamble on ABB without first having engaged the Swedish family. Other major shareholders are Blackrock (3.0%) and Norges Bank (1.9%). Blackrock made headlines in April when CEO Larry Fink’s annual letter (view) criticised the role of activist investors. However, Fink made a distinction between short-term activists and others who “take a long-term view and have pushed companies and their boards to make productive changes”. Cevian is known for its long-term engagement with company management teams and clearly fits into Fink’s approved type of activist. Norges Bank has become increasingly active (view) in its ownership and holding management to account. It has recently mentioned inquiring about mining conglomerates “hiving off coal mining from their other activities”. Norges may well be open to Cevian’s plan.

What could be Cevian’s plans for ABB? The company does seem to be underleveraged at 0.3x. ABB has roughly maintained this target ratio since FY12 but is low compared to other large cap peers. Philips [AMS:PHIA] on 2.3x, Schneider Electric [EPA:SU] 1.3x, Siemens[ETR:SIE] 1.2x, Emerson Electric [NYSE:EMR] 0.7x, and Atlas Copco [STO:ATCO] on 0.5x. An obvious strategy would be to lever up and pay out a special dividend or extend its current two-year USD 4bn buyback programme. ABB increased dividends from CHF 0.12 per share in FY05 to CHF 0.72 in FY14 – an impressive compound annual growth rate of 22%. If it increased leverage to 1.0x it could pay out USD 3.9bn, which works out to USD 1.74 (CHF 1.63) per share, or a yield of 7.7%.

Another option is a demerger of ABB’s high growth automation franchise business from the power unit. A split was mentioned in the press in April. Cevian has often pushed for operational optimisation in its portfolio companies. ABB CEO Ulrich Spiesshofer has already said his focus is on operational improvements and integrating previous acquisitions, so additional scope for Cevian-led efficiencies must be beyond what ABB has already planned. Cevian has an awful lot of break-up experience having engineered separations at Metso, Cookson, ThyssenKrupp and reportedly pushed for disposals at G4S[LON:GFS] and Volvo.

The automation division benefits from a large installed asset base and branding. Separating the unit into a rare pure play automation business could be very attractive to investors. However, management may disagree. The 1Q15 press release highlighted from the outset that “collaboration drives large combined power and automation orders” (view), and the CEO emphasised that ABB “won key projects due to our combined power and automation offering”. The crux of the issue comes down to the value of synergies between the two operations and the sum-of-the-parts (SOTP) discount in the valuation – which is greater? Supporters of a demerger will have to successfully argue that the SOTP discount, after including the all the costs of separation, exceeds synergies.

Nordea Investment Management (0.57%) CIO Mathias Leijon was reported (view) to have called for a break-up in April. With support from Cevian and potentially other investors, combined with a sympathetic new chairman (view), a demerger could be possible.

Salini Impregilo lock-up expiry

A massive chunk of locked-up shares owned by private Italian construction group Salini Costruttori in Salini Impregilo [BIT:SAL] expired last week, and may have a bearing on the previously stated aim of international M&A. The 360-day lock-up on 61.7% of Impregilo ended on 11 June (view).

Pietro Salini, the head of both Costruttori and Impregilo, was quoted by newspapers in August 2014 as seeking out international acquisitions. There have been no takeovers since then by Impregilo, but if acquisitions are still on the agenda for Salini, he has potential expansion choices through both the Costruttori and Impregilo vehicles.

Costruttori’s stake has a market value of EUR 1.2bn. It is unlikely Construttori will give up control of Impregilo particularly after a year-long and bitter takeover battle against the Gavio family. Salini could instead sell up to 11.6% in Impregilo and remain in control, raising around EUR 225m at market prices to contribute towards Costruttori growth.

Another option is to acquire through Impregilo. The company had EUR 360m net debt and EUR 430m trailing EBITDA as of 31 March 2015, meaning it could raise a further EUR 715m if it increased trailing leverage to 2.5x. Further financing could be raised via an equity issuance, as it previously did in June 2014 in a 9.96% floatation (view). Impregilo could potentially issue a further 23% or 114m shares at current prices and still enable Costruttori to be a 50.1% shareholder. Given the market cap of EUR 1.93bn and shares outstanding 493.79m, this implies Impregilo could issue new shares at around EUR 3.18 each, raising EUR 360m and assuming there’s no discount. Adding this onto financing raised from increasing leverage, Impregilo could have a warchest of over EUR 1bn.

The above is an extract from Dealreporter’s Europe Flash, which is published twice weekly on www.dealreporter.comThe Europe Flash combines proprietary insights and commentary with raw data from stock exchange flings, transcripts, analyst reports and news stories, producing short and long-term actionable pre-event ideas.