A Quick About-Turn

  • Not-so-desirable inner city living
  • Slums in the sky
  • Not all ‘cash’ is cash
  • In the mailbag

In yesterday’s Port Phillip Insider we warned about the slowing mergers and acquisitions market.

We said it was a clear warning sign that stocks are on a knife edge.

Well, to prove that there’s no such thing in the financial advisory business as a consistent view, today we’ll issue you another warning.

This time it’s to warn you about the dangers of the red-hot and rampaging mergers and acquisitions market!

Hold on for the ride. Tally-ho!


Overnight, the Dow Jones Industrial Average fell 8.01 points, or 0.05%.

The S&P 500 fell 4.28 points, or 0.21%.

In Europe, the Euro Stoxx 50 index dropped 29.23 points, for a 0.99% fall.

Meanwhile, the FTSE 100 fell 0.32%, and Germany’s DAX index lost 0.74%.

In Asian markets, the Nikkei 225 index is down 111.22 points, or 0.67%. China’s CSI 300 is down 0.73%.

In Australia, the S&P/ASX 200 index is 7.84 points lower, or 0.15%.

On the commodities markets, West Texas Intermediate crude oil is trading at US$47.87 per barrel. Gold is trading at US$1,245 per ounce.

The Aussie dollar is worth 71.9 US cents.

Not-so-desirable inner city living

Before we return to the exciting and lucrative world of mergers and acquisitions, as a suburbanite, it was impossible for your editor to read the following story without a smile crossing his face.

From Bloomberg:

The maximum mortgage a borrower can get in “high density postcodes” has been cut to 70% of the value of the property from 80%, Macquarie says in note to mortgage brokers.

But how can that be possible?

Isn’t inner city living the ‘done thing’?

Aren’t the inner city areas the most desirable and in-demand places that anyone can live in?

After all, surely that’s why the previously ‘pancake’ Southbank skyline in Melbourne is now a near mirror image of the CBD.

When your editor first graced (or sullied, depending on your view of our presence here) these shores in 1996, the tallest buildings in Southbank were the HWT Tower and IBM Centre.

At a non-nose-bleed-worth 26 stories, they were dwarfed by anything the CBD had to offer…but towered above pretty much everything else on the south side of the Yarra.

Today, it’s a different story. Towers fill the sky on Southbank. They’re mostly residential, from what we can guess. And we’d also imagine they are mostly landlord and tenanted properties.

That’s the impression we’ve gained from seeing ads over the years extolling the benefits and rewards of buying and letting inner city apartments.

But now, we can assume that things aren’t looking good for inner city and high density area properties. Our guess is that the market has already begun to turn on the banks.

We can’t for a minute imagine that the banks would pre-empt ‘frothiness’ in the housing market by slowing down lending in advance of a downturn.

That the market has already turned appears to be evident in the recent financial reports from the major Aussie banks. Each advised that they are increasing their bad debt provisions.

We won’t gloat too much. We’re sure there are problems in the suburbs and exurbs, thanks to enticing ‘house and land’ deals.

But who’d have thunk it? Inner city types have looked down their noses towards the suburbs for years. They’ve tut-tutted that people should live so far away from the centre of town, in those ghastly McMansions.

Yet, it turns out that the first among many casualties of the crashing Aussie housing market will be those who thought inner city living would be their protection in the (to them) unlikely event of a house price crash.

Not so. It seems.

Slums in the sky

On a side note, we’ll be curious to see how long it takes for areas like Melbourne’s Southbank to turn into a new breed of slum living — slums in the sky.

It probably won’t take that long. All it needs is a sustained economic downturn, vacant dwellings, and a combination of landlords who don’t want to spend money on improvements — and tenants who don’t care about the upkeep — and you have a recipe for a decline into slum-like living.

No wonder Macquarie is tightening the reins on lending in high density suburbs.

Not all ‘cash’ is cash

Anyway, back to the world of M&A. That’s mergers and acquisitions to you.

Bloomberg reports:

After weeks of rumours, German-pharmaceutical and agrichemical company Bayer confirmed it had made an all-cash $62 billion bid for the American biotechnology company Monsanto.

So much for our fears of a slowdown in the M&A market. This is a US$62 billion mega-deal. Surely, that’s proof that this market isn’t done with yet.

As we stare at the glass of water in front of us…and squint…we’d bet money on it being half empty.

Far from this multi-billion dollar deal making us rethink our position on the markets, it reinforces our thinking.

How so?

For one, it’s right there in the quote. According to the report, this is an ‘all-cash’ deal.

That’s pretty neat. You know those Germans, always saving. But to have saved US$62 billion in order to fund a takeover, that’s impressive.

Of course, that’s not quite the extent of it. In this context, ‘all-cash’ means that shareholders of Monsanto Co [NYSE:MON] will receive cash of US$122 per share.

Monsanto shares closed last night at US$106 per share.

That’s a big discount to the proposed takeover price. So, what does that tell you? It tells you investors aren’t convinced the deal will go through.

If the market was super bullish about it, the Monsanto share price would trade somewhere near (or even above, if they thought Bayer may have to stump up more cash) the takeover price.

There’s a reason for that. First, this may be an all-cash deal for Monsanto shareholders, but it’s not an all-cash deal from Bayer AG’s [XET:BAYN] perspective.

A quick glance at the company’s balance sheet shows why. At the end of the 2015 financial year, Bayer had 1.8 billion euros (US$2.1 billion) in cash. That’s far short of the US$62 billion Bayer needs to fund the takeover.

How does it plan on raising the cash in order to pay in cash?

Easy. According to Dow Jones Business News:

Bayer said it would finance the deal — the largest foreign corporate takeover effort ever by a German company — with a combination of debt and equity, including a share sale worth around 25% of the total transaction value. That means the company would launch a capital increase of approximately $15.4 billion, Chief Financial Officer Johannes Dietsch said.

If 25% of the transaction is coming from new equity, that still leaves the company US$46.6 billion short. The US$2.1 billion in the bank would help, but it wouldn’t make much of a dint.

What about cash flow? That could help. But Bayer’s 4.1 billion euro profit for 2015 is already reflected in the balance sheet. It will take the company until early 2017 to register that much profit.

The only other option is to finance the rest of the transaction from debt. And assuming that Bayer would like to keep some cash in the bank to cover ongoing expenses, it’s safe to assume Bayer will need to raise the full US$46.4 billion in debt.

That’s a big chunk to add on to current short term debts of 2.8 billion euros, and long term debts of 16.3 billion euros.

But what the heck. Interest rates are low. Bayer’s 1.875% 2021 corporate bonds are currently priced to yield 0.57%. Granted, that’s for a smaller bond issue of 750 million euros.

Remember, Bayer will need to issue debt for around US$46.4 billion. Even so, if it can secure the debt for a similar yield, the annual cost to Bayer would ‘only’ be around US$265 million.

That’s less than it’s paying in interest now (752 million euros last year) on its current outstanding debts, which are around one-third the size of this prospective debt issue.

It’s no wonder Bayer’s management feels fine about putting the company into ‘hock’ for a mega-takeover.

Of course, the question is whether Bayer really will be able to raise that much debt…and whether they’ll be able to do so at the price (interest rate) they’d like.

The chart below shows what the bond market thinks of Bayer’s expected demand for debt. The yield on the 2021 bonds has soared from 0.25% two weeks ago, to 0.572% today:

chart image

Source: Bloomberg
Click to enlarge

Not all mega deals happen at the top of the market. Many happen as the market rises; after all, that’s why, and how, the market rises.

But as the bull market duration continues, and as companies become more desperate to grow, they take ever more desperate measures. Overpaying for an acquisition is one sign of desperation.

We’ll continue to watch takeovers as they’re announced…and as they collapse. It should be fun.

In the mailbag

Subscriber Tav writes:

I’ve been reading your publications for a couple of years now, had a go at investing and lost a sh** [Ed voice: ship?] load, thanks Kris and Woolworths, but I’ve learned a lot I think since then.

I know you guys are apolitical but it is election time, so I was wondering. Since I’ve heard no policies on money from any political party, what policy on finance would everyone at Port Phillip Publishing create?

I’d create a flat 15% tax rate for every one and attract foreign business to our shores.

I’m sure it’s more complicated than that though.

Love to hear your policy.

Tav, don’t undersell yourself. It doesn’t have to be that complicated.

In fact, seeing as you ask, it’s quite simple. Here’s how my tax policy would work. Get ready for it: What’s mine is mine, and what’s yours is yours.

That’s it. Tax is theft. It’s the expropriation of private property by the government. There is no excuse for it.

And those who try to come up with elaborate tax policies, which always involves deciding how much of someone else’s money the government should take, should stop and listen to themselves.

Imagine the following scenario if you will. You’re sat in a room, with your money on the table in front of you. Sat on the other side of the table are two people. Only they are allowed to talk, while you must remain silent.

Their topic of conversation? How much of your money they plan to spend on various things. By the time they’ve finished divvying up your money, about 30% of it remains.

How would you feel about that? Would you feel calm and relaxed? Would you feel content that two strangers ‘knew’ better how to spend your money than you?

No need to reply, we’re just asking.

But if you would like to reply, answers on the back of a postcard to letters@portphillipinsider.com.au.