Thu, 14 Feb 2013
Five stats from the market and the stories behind them. This week: Berkshire's stake in a $28 billion deal, Avon's not-so-pretty 1% sales growth, and more.
Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five: Five stats from the market and the stories behind them.
Joining me, as always, with the numbers is Morningstar markets editor Jeremy Glaser.
Jeremy, thanks for being here.
Jeremy Glaser: Thanks, Jason.
Stipp: So, what do you have for the Friday Five this week?
Glaser: We're going to look at $28 billion, 26%, minus 0.6%, $16.7 billion, and finally 1%.
Stipp: $28 billion is the elephant size price tag on Heinz. Berkshire Hathaway, in partnership with another group, making that purchase. That news came out on Thursday. What's our take on the deal?
Glaser: This is not an enormously surprising deal in a couple different ways. This is the kind of company that Buffett obviously likes. It's a relatively stable consumer packaged goods company, strong brands. It's the kind of business that you could see him really being able to wrap his head around, and it hasn't been a secret that he has been looking for acquisitions--that he is sitting on this big pile of cash. He knows that there are opportunities. He's said that he has gone after a few deals that have fallen through. So, we shouldn't be shocked to see a deal of this size come from Berkshire.
But some of the terms of it are a little bit different than we have come to expect from him. He is partnering with a private equity firm from Brazil called 3G Partners, and the deal is going to be structured so that a lot of his investment is actually going to be in preferred shares that are going to yield a hefty 9%. I think this shows that he is able to really throw his name and his weight behind these deals to get really preferential terms in order to get boards to agree to the buyout. So, that 9% that he will get on those preferred shares looks a lot better than almost 0% he is going to get if the cash is just sitting there.
Our analyst Gregg Warren, who covers Berkshire, thinks that the price may be a little bit high. They are certainly not getting a big bargain on Heinz. But he expects that because of the yield on these preferred shares and the way it's structured that Berkshire will still come out ahead, but we still need some more details there to see if the valuation is just a little bit too lofty.
Stipp: Also in deal news, an airline merger is going to result in 26% market share for that new company. It seems like a pretty high number, but does this really change the long-term story for this beleaguered industry?
Glaser: The combination of U.S. Airways and AMR, which is the parent of American Airlines, was probably one of the worst-kept secrets in the airline industry. We've heard rumors of this deal ever since American entered into bankruptcy. U.S. Airways has been pushing really hard to get this merger done. And it finally came to fruition this week.
It's going to be a deal that values the company at around $10 billion to $11 billion. Like you said, they are going to have 26% of market share in the U.S. That's going to be the largest carrier by traffic. And it's a hope that the consolidation in the industry and that by becoming a bigger player in the industry, they are going to be able to keep their costs down, maintain their pricing power, and be able to build that economic profit over time, which is something that's eluded airlines for quite some time.
I think the verdict on this will probably end up being mixed. The mergers that we've had so far have resulted in a more rational environment. Pricing has looked reasonably strong, even though a lot of those increases or attempted increases didn't stick. There hasn't been a ton of new domestic capacity coming online, which is something that always tends to drive those prices down over time. But it's still not a slam dunk.
Basili Alukos, who is our airline analyst, doesn't think this [merger] all of a sudden makes these great moaty companies that are going to be able to fend off competition. There is still going to be low-cost competition. There still are relatively low barriers to entry if new people wanted to try to come in. Low switching costs between the airlines--frequent flier points aren't enough to keep people within a single airline.
So, this is a step in the right direction. In terms of consolidation, 82% of domestic capacity will be in those four biggest carriers. So, it helps that rationalization. But on its own, you can't say that the airline industry is now totally in clear skies and that we are going to see great profitability in the coming future.
Stipp: Negative 0.6% refers to the GDP growth decline for their recent report. This is obviously negative, it's not good news, but how bad is that number?
Glaser: This is not good for Europe. No one expected to see growth in the eurozone this quarter. There was broad consensus that they were going to see another decline. But this was sharper than expected, and somewhat worryingly, there was weakness in Germany and in France and in other really core countries that were expected to be a little bit stronger and help prop up the peripheral countries like Spain and Greece that had much weaker growth--again as expected.
This just shows how difficult the problems in Europe are. Even if the ECB has been able to calm the bond markets a little bit and we're not in a moment of immediate crisis, we still have a very serious growth crisis there. It's not clear what's going to happen, how Europe is going to be able to get back to growth. The expectations are that for Germany this will be a very mild trip into negative territory and that their powerful exports and low unemployment rate will help get [Germany's] GDP rate up.
But in the peripheral countries, if they don't see growth, it's going to be that much more difficult to solve some of these problems. Eventually, bondholders somewhere along the line are going to have to take losses in order to really stem the crisis. We just haven't seen that happen yet. We just keep kicking that can down the road, and if growth continues to look weak, it's going to get more and more difficult to actually solve these underlying problems. This is a story that we've said is going to go on for years. It is going on for years. And this lack of growth is going to be a big component of that.
Stipp: $16.7 billion refers to a deal finishing up sooner maybe than we expected. That's between Comcast and NBC. What's the story behind that?
Glaser: When Comcast bought out the 51% of NBCUniversal, GE had some put options that they would be able to sell the other 49% back to Comcast, and that ended up happening sooner than most people expected. Comcast stepped in, said they really wanted to take control of the entire business because they are looking to invest in it. They are looking to continue to grow it. They're spending a lot of money on theme parks, in particular, also in programming, to try to really leverage that asset in a way that it is able to continue to grow for them.
But what is almost more interesting about this deal is from the GE standpoint. Daniel Holland, who covers GE for us looked at this and said it's another sign of … good capital allocation from General Electric's management team. They're going to take this money and instead of maybe using it on a splashy acquisition or for something like that, they're going to return a lot of it to shareholders through increased share buybacks. And they continue to be focused on good organic growth, on making those tuck-in acquisitions that are going to keep their core businesses growing, while getting out of some of these peripheral businesses that just don't make a lot of sense for them to be in and just aren't a great use of capital.
So, I think that's a good sign for GE's shareholders. It's a good sign for Comcast shareholders, too, that they are going to have this business that they bought at a fair price. They got the rest of it at a fair price, and they will be able to invest in it and have some use for cash there. So, this does look like it's a winning situation for all involved.
Stipp: 1% is the year-over-year growth rate for Avon. It doesn't seem like a really good number, but the market seemed to like it. What does our analyst think, though?
Glaser: The market was happy, because [this 1% growth] was a sign that … Avon was starting to turn around. This has been a challenging year for Avon. They have been under pressure on a lot of different fronts, and there were some good underlying numbers. In Latin America, there was 7% growth, with Brazil looking particularly strong, and that's an area of intense focus for investors as a potential growth vector for Avon.
But North America still looks pretty bad, and margins still continue to be a problem. Profitability was a big issue. Our analyst Erin Lash does think that it's a company that still has some good intangible assets. It still has a decent brand and can really tap these networks of entrepreneurial women to continue to grow their business, but it's not going to be an easy road, and one quarter that looks a little bit better probably isn't a sign that the turnaround is complete. It's going to be a difficult process and one that's going to take some time.
Stipp: Lots of deal news and numbers this week, Jeremy. Thanks for taking us behind the data.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.