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Markets not live, Monday 13th January 2020

Is Pennon cutting the wastemen? The Sunday Telegraph says it is:

SOUTH WEST WATER owner Pennon is preparing to flush out buyers in the £4bn sale of its bin collection and incinerator arm after fending off a swoop by one of the world’s biggest private equity funds.

Investment bankers from Morgan Stanley and Barclays are understood to have been appointed to sell Viridor, which burns rubbish to generate energy, amid frenzied buyout interest. City sources said that US private equity titan KKR attempted to jump start proceedings with a knockout bid for Viridor. The move is understood to have shocked a slew of interested parties queuing up to land one of Britain’s most sought-after investments of 2020.

No statement from Pennon and a hard no-comment from the flacks this morning. That might mean KKR’s interest is dead or dormant following a rejection (note the approach reportedly came “early last year”), which history tells us is enough to pacify the Takeover Panel into allowing silence. Note also that Pennon announced in September that it was doing a strategic review so it might be argued that the possibility of a breakup had been flagged to investors. Also, Pennon’s previous admitted publicly a few years back to having received offers for Viridor. Still, given £4bn would be nearly 90 per cent of Pennon’s current market cap, it’d be nice to get some on-the-record clarity. 

Here’s RBC Capital Markets:

Implied valuation of Viridor – Within our current 875p Price Target for PNN we value Viridor at ~£3.2bn, however taking into account newer near-term growth projects, namely the recently announced ERF with Grundon Waste Management in West Sussex, alongside further opportunities in plastics recycling, we believe a ‘live’ fundamental Viridor valuation is closer to ~£3.5bn. This implies a premium of ~12.5% on sale of the asset, which would be ~10% positive to Pennon’s share price, despite the fact that the share price has already performed strongly post the strategic review announcement in September.

Implications for remaining Water business – A £4bn valuation for Viridor implies a trading premium to RAB of ~15% for the water business (which compares to SVT and UU at 20% and 7%, respectively). Any sale of Viridor would also likely lead to the market assuming a higher probably of M&A falling on the regulated UK water asset where the RCV currently sits at ~£3.5bn for March 20E.

Use of proceeds – A key point would be what Pennon would do with the funds following a sale of Viridor with no significant investment required in the water business outside of the PR19 plan, as such it may be that some of this is given back to shareholders in the form of a special dividend. We estimate debt outside of the water company in PNN is £1.7bn, and hence net proceeds (depending on tax implications) could be up to £2bn, and ~450p/sh, which could need to be returned to shareholders.

And Credit Suisse:

We note that the company has most of its Energy from Waste facilities up and running. One—Avonmouth—and also a plastics recycling facility are under construction. Once these are commissioned in FYmar22E, underlying EBITDA (i.e. consolidating Viridor’s share of EBITDA) would be £274m. The asset would become highly cash flow generative if assuming no growth capex (£175-200m p.a. cash flow), albeit it would have exposure to the merchant EFW pricing and implicitly future waste volumes in the UK and internalisation of landfill tax rates.

Such a multiple —14.6x EV/EBITDA—would be above those at the peak of the last cycle in 2007, when Biffa and Cory achieved c9.5-11.3x. It would, however, be below the c20x we calculate for Riverside in mid-2018 (>£1.5bn EV on a c£70-75m EBITDA) reflecting lower contract pricing and likely higher merchant risk.

We expect that there would be few operational synergies for either a financial or trade buyer. Most of Viridor’s value is in large discrete assets with some pricing power. It does not have intensive exposure to collection or municipal contracts. And we expect that the scope for cost-out would be low. We would, however, see scope for farm-downs of some of the EfWs and project finance to help bring forward cash flows.

Implied multiples: We value South West Water at a 16% premium to March 2021 RAB and Viridor at £2.5bn (c9.5x EV/underlying EBITDA once all assets are complete). Putting £4bn on the Viridor valuation would imply 14.6x EV/EBITDA and +c350p/share upside. It would put Pennon on c1,050p; just c4% above where the shares closed at on Friday.

Spirent, the network testing and analytics thing, has a full-year trading update that flags EBIT of $91m to 93m, 10 per cent above consensus. Sales are essentially in line at $503m, up 5.5 per cent year on year, so it’s a margin beat. EBIT margins of circa 18 per cent to 18.5 per cent are up about 2 percentage points year on year. No explicit guidance on 2020 but there’s a new medium term target to grow revenue by mid-single digits.

Here’s UBS:

The company hasn’t clarified whether this was due to gross margins or opex at this stage, but either way we believe has likely been due to strong cost management in the business. Also positively, the beat has followed through into cash with year-end cash of $183m vs. UBSe $172m. We also note that the company has called out ‘strong order growth for our Lifecycle Service Assurance solutions in the last quarter’ – something that should help revenue in 2020 – and states that it enters 2020 with a strong order book. … Currently, consensus assumes almost 6% growth in FY20E and EBIT of $91m (17% EBIT margin) and we believe the margin strength following through to FY20E will likely see consensus EBIT rise 5-10% for FY20E.

Scrap HS2 and nationalise Flybe! That’s the kind of take we can expect from the end of the shoutier business commentariat after Sky News reported overnight that the UK’s preeminent and only regional airline’s in discussions to secure extra financing. EY on standby to handle the potential administration, Kleinman says. Company has no comment.

Would nationalisation of Flybe be that silly an idea? It already provides essential high-speed links between the capital and Manchester, Leeds and Birmingham, which HS2 might manage by 2040, as well as connecting the likes of Campbeltown, Wick, Newquay and Tiree, none of which is well served currently by high-speed rail.

A Virgin consortium bought Flybe’s operating assets for £2.8m in January, taking on £40m of high-yield and junior debt for the purchase, with a further £20m bridging loan used to avoid a cash crunch and £80m of credit dangled once the deal was complete. So, let’s guess at £140m of current borrowings. Buying that lot out at par would be 0.17 per cent of HS2’s current estimated cost of £78bn. It makes sense, sort of! Though whether public ownership would add any competency to the operational management of Flybe following decades of haplessness is a much bigger question. 

Anyway, here’s a nice picture of Flybe’s former CEO Saad Hammad with Spirit of Liberum, a jet named on honour of its house broker.

Elsewhere! Credit Suisse has a big note out on European insurers. Here it is in chart form:

And in text form (including, regrettably, the word “insuretech”).

We believe Property & Casualty names are still attractively valued despite outperforming in 2019, but we downgrade three life insurers owing to less attractive risk-reward and higher regulatory headwinds. We downgrade Just Group (new TP 55p from 60p) and St. James’s Place (new TP 900p from 940p) to Underperform (from Neutral) and NN Group (new TP €37 from €40) to Neutral (from Outperform). …

We think the threat of insurtech disruption to life and retail P&C insurers may be greater than for commercial P&C (re)insurers given the more complex nature of commercial risks, fewer threats from non-insurance ecosystems and the potential for commercial (re)insurers to engage with new technology (e.g., IoT and autonomous cars).

Otherwise on the sellside, Bank of America likes BAE Systems. Upgrade to “buy”, price target 720p and added to the Europe One list. That’s part of a bigger aerospace and defence thing that’s very pro war. Says Thales and Leonardo both “sit in deep-value territory,”

Further escalation in Gulf tensions can support re-rating of EU Defence sector and underpins US/Saudi defence spending. Conservative UK election victory removes risk to Saudi exports and supports budget, France/Germany growing budget allocation. … Improved outlook on M109, the Conservative majority in UK election and the recent escalation in tensions in the Middle East provide a mid-term re-rating opportunity in our view.

William Hill, the bookmaker best known for having its logo above many thousands of vacant shops, says FY 2019 ebita beats expectations and its CFO has resigned. Guide is for £143m to £148m against a £130m consensus. Better than hoped margins on sports betting and possible breakeven in the US. Here’s Peel Hunt on the US side:

The strong wagering growth is clearly a positive. Disciplined ‘investment’ implies a lid on marketing spend from which we infer tough competition and possible constraints on growth; we are less sure this is positive.

The departure of CFO Ruth Prior is “a material negative,” Peel Hunt adds. (Ms Prior’s moving to private equity with materials testing company Element Materials Technology and has a 12 month notice period.)

After significant management change William Hill needs to demonstrate it can hold onto its best people. … The largely new operational top management team may feel that it has not been trying to fix William Hill for long, but clearly some investors have lost patience. Today’s trading statement has the potential to pique a little more interest in a story where not only online, but also the US have the potential to go materially right. The perennial regulatory risk remains. We reiterate our Buy rating and 250p target price.

Over in Europe, Casino’s up a tad on a single-sourced Reuters report that Aldi might pay €750m for Leader Price, the French retailer and financial experimentation lab’s hard-discount fascia. Previous reports had pinned the likely price at €400m. A sale was widely predicted following Casino buying out Leader Price’s master franchisee a few weeks ago, which took about half the stores back under its direct control. Analyst Bruno Monteyne of Bernstein has questions:

[F]or the Casino valuation we need to know (A.) how much Casino had to pay to buy back the franchisees and (B) how much of that purchase price is for real estate that has been sold by Casino in recent years. Those 2 adjustments in themselves could well bring the net receipts down to less than half the reported purchase price. In addition we need to consider the unwinding of special balance sheet constructs: … Casino has found ways to put certain debt and inventory off balance sheet. Selling Leader Price may unwind some of those constructs causing a further drag. Taking also into account possible working capital moves, the net change to the balance sheet from this disposal could be close to zero. That would not be a bad achievement: zero impact is better than ongoing cash losses in this struggling part of the business.

Bernstein also takes a moment to retread its previous (excellent) research on how Casino structured its Leader Price franchise network. In short, Casino kept 51 per cent ownership of profitable franchised stores but only 49 per cent of the unprofitable ones, meaning it could book 100 per cent profits from the former and zero per cent of losses from the latter. “Losses disappear and profits are doubled,” says Mr Monteyne. “Management reports of group ebitda are therefore materially inflated by those franchisee ownership structures. Upon selling Leader Price, those ‘management reporting’ profits will disappear, negatively impacting valuations.”

What else is there? Pound’s back below $1.30 on grim GDP data for November, which raises the possibility that Carney’s welcome present to Andrew Bailey will be a 0.5 per cent base rate. Aston Martin’s all over the place post the FT story late Friday about China’s Geely and F1 magnate Lawrence Stroll holding talks about providing salvage money. Sky News then reported over the weekend that Chinese battery maker CATL might take a stake, which a CATL flack denied. Oh, and a German payments processing company chose 23:04 local time on Friday to announce some routine c-suite turnover.

What are we missing? Tell us below.

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