The Investment Column: Banking on Santander is too risky

Stock Exchange needs a deal to impress; Chips are down at Invensys and it's a big gamble

A weak, demoralised British force is about to surrender to a confident, swelling Spanish empire. Today is the final day as an independent entity for Abbey National, the UK's sixth-largest bank, which is to become a satellite of the Spanish banking giant Banco Santander Central Hispano. Abbey's army of 1.7 million small shareholders have this choice: back their new rulers or sell up.

Santander shares will be in the post next week. Those who had fewer than 2,000 Abbey shares will be able to sell their Santander holdings through Abbey branches without foreign exchange charges. And then, early next year, Santander itself will list in the UK, meaning its shares will trade easily and in sterling. Despite the nationalistic coverage of the takeover, shareholders need make a decision only on financial grounds.

First, an apology. Our last advice on Abbey shares was to sell. We said that "at 490p a share, the numbers simply don't stack up for a foreign" bidder. Abbey shares are 639.5p now.

For Santander's existing shareholders, the Abbey deal destroys a lot of value in the short term. In the long term it tilts the bank away from the emerging markets of South America, with effects that are harder to measure. It improves the group's credit quality (meaning it can borrow money more cheaply) but, while risky, the Americas do offer long-term growth in a way that cannot be said of the UK.

The basis of our sell recommendation was a lack of faith in Abbey's management. The bank continues to lose market share, particularly in mortgages where it has struggled to create competitive deals.

What Santander thinks it has identified is the root cause of Abbey's woes: a terrible IT system. There is a lot in its thesis (the information Abbey holds on its customers is scattered across the organisation, squandering marketing opportunities) but it is most likely overblown. The real advantage that Santander will have is that the shock of a takeover will make it much easier to shake up ineffective working practices and improve efficiency, but while a radical overhaul is necessary it is fraught with danger.

Santander has successfully integrated a string of Latin American banks, and the region has stabilised after the currency crises of earlier this decade, suggesting strong lending growth is possible over the long term in countries such as Mexico and Brazil. Santander is a much more appealing investment prospect than Abbey because of this growth potential. But as you can see from our chart, it is also heavily exposed to the mortgage market in Spain, where worries about an over-heated housing market are similar to in the UK.

Valued at probably 13 times next year's earnings, Santander shares do not look cheap enough to bear these risks. Cash those Santander shares.

Stock Exchange needs a deal to impress

The London Stock Exchange, is still the largest exchange in Europe. But capital markets are consolidating, and LSE cannot stand by as its competitors become larger, more efficient and more innovative. It is already less profitable than its two main European competitors, Deutsche Börse and Euronext. Yet LSE shares are priced at a premium because, since it so patently needs to do a deal, it is a prime takeover candidate.

Clara Furse, LSE's chief executive, claims to be open to an alliance beneficial to customers and shareholders, but investors are weary of waiting.

They will not have been calmed by yesterday's half-year results, which were uninspiring. Revenues grew by just 5 per cent. Fees from share trades were up 12 per cent but income from companies whose shares trade on the exchange fell by 11 per cent. The AIM market has taken off like a rocket, but fees from companies on AIM are not as high. Stripping out a £5m windfall from selling its City headquarters, the LSE's profits actually fell, held back by the costs of investing in the derivatives trading system it must have to catch up with rivals. A pay-back from this investment is highly uncertain.

The company is extending its electronic trading platform, Sets, into the small-cap arena, but many firms bypass this system altogether, trading directly on market-makers' own electronic platforms which are not only cheaper but often offer more competitive spreads. In short, LSE needs better systems if it is to attract more business to counter dull equity markets.

Yielding only 1.5 per cent, the shares look far too expensive to buy. The imperative to do a deal means existing holders should await developments.

Chips are down at Invensys and it's a big gamble

It has ever been thus at Invensys. The engineering conglomerate (mashed together in the merger of BTR and Siebe in 1999 and picked apart through a series of fire sales of assets since then) posted disappointing sales from almost all its businesses yesterday but said that most "leading indicators" were pointing in the right direction. In other words, good times are just around the corner.

The company makes goods for industry, ranging from factory control systems to railway signalling equipment. The leading indicators it was talking about were forward orders from key customers, while there were also tangible gains from efficiency programmes across the group. In all, operating profits met targets.

Invensys refinanced £2.7bn of debt in the spring, but it has not cast off the fear that another fundraising will be needed, despite modestly improved cash generation in the remaining businesses. There was a share price wobble last month, when several heavyweight brokers decided a deeply discounted rights issue was a possibility.

To be certain of avoiding that, Rick Haythornthwaite, the chief executive, needs to deliver his promised "improving year-on-year trend" in the second half, and then some. He is desperate to move on, but needs to make sure he leaves some unequivocal green shoots behind to safeguard his (still good) reputation. That focus in itself justifies hanging on to the stock if you have it. For the rest of us, Invensys shares are gambling chips, little more.

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