Jeremy Warner's Outlook: Olivant throws in the towel on the Rock

Ryanair's O'Leary warns on profits; Punch tilts at Mitchells & Butlers; China's velvet-glove approach to Rio
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The Independent Online

And then there were two. Luqman Arnold's Olivant has repeatedly threatened to withdraw from the three-horse race for Northern Rock, so last night's hissy fit may be just more brinkmanship designed to wring a more accommodative deal out of the Government. Yet for the time being, we must assume Olivant is out for good, leaving just Sir Richard Branson's Virgin and the company itself in the running.

Mr Arnold's withdrawal does not presage well for the other two's chances of making a go of it. Olivant is quitting because it has determined that, by the time the Government has had its pound of flesh, there won't be a viable enterprise left, or at least not one that it is worth sinking £800m of fresh equity into.

Under the Treasury's plans, Northern Rock's ability to write new business or win more deposits will be severely restricted at least until the taxpayer is completely off the hook for any remaining exposure. This is justified on two counts – first as a way of answering complaints from rivals over unfair state subsidy, and secondly as a supposed way of being ultra-safe with the taxpayers' interests.

Under the plan to refinance the Bank of England's loans with bonds, a special-purpose vehicle will be established into which the great bulk of remaining, uncommitted, mortgage assets will be placed. This will essentially be put into run-off until the bonds are paid back and the Government is thereby released from any remaining guarantee.

Olivant's concern is that the book will be so depleted by the time this process is over that the business will be as good as defunct. Obviously, neither of the other two parties entirely agree with this analysis, or they too would have withdrawn.

They also harbour hopes that some of the proposed restrictions could be lifted as the ship begins to right itself. All the same, it's going to be bloody, with swingeing job losses and no certainty of a viable business at the end of it. Shareholders might reasonably wonder whether they'll get more out of a nationalisation with compensation than an enforced private sector run-off.

Ryanair's O'Leary warns on profits

Matilda told such dreadful lies, it made one gasp and stretch one's eyes ... (Hillaire Belloc). Michael O'Leary, chief executive of Ryanair, has been crying wolf about this, that and the other for so long now, it is tempting to write off his latest apocalyptic warning about economic calamity and its likely consequences for the airline industry as just another case of alarmist blarney. This time he predicts "the perfect storm", which has become the most repeated cliché in the English language to describe a cocktail of negatives. Is he right to be so pessimistic, either for his own company or the airline industry as a whole?

In the past, Mr O'Leary's gory predictions have tended to be so much hot air, designed to knock down expectations only to better them, or perhaps deliberately intended to deter potential low-cost rivals hell-bent on challenging his position in the market. It was only a few years back that he was saying most low-cost operators wouldn't be able to withstand a $50-a-barrel oil price. Yet even at $90 a barrel, the industry is proving surprisingly resilient.

This time around, Mr O'Leary doesn't just predict "a deep, dark, recession", he would actually welcome one, which he says would both blow away the competition and put paid to green taxes, a doubling of landing charges at Stansted and other "luxury" ideas of the years of plenty. In any case, if fuel prices remain at their present inflated levels, then profits next year could halve, Mr O'Leary said.

Load capacity is already down 2 per cent for January and Mr O'Leary is predicting a 1 per cent fall for the next six months as a whole. That could translate into a much steeper decline in yields, or average fares per passenger. Curiously, there is a mismatch between this gloomy prognosis and Mr O'Leary's plans for his own company, where aircraft orders which cannot easily be wriggled out of commit Ryanair to expanding capacity by around a fifth per annum for at least the next five years.

Nor do his predictions tally with what the full-service airlines are saying. British Airways said last week it saw no let up in strong demand for long-haul premium travel. And there's the rub, for there is obviously a world of difference between long-haul business-class traffic and what the low-cost airlines do, which is short-haul leisure.

If there is a worldwide recession, BA and other full-service airlines will suffer alongside everyone else. Yet for the moment, it is short-haul leisure which is suffering most acutely from the downturn, and perhaps in particular, the relatively immature eastern European markets which Ryanair has been aggressively expanding into. So perhaps this time, we should believe Mr O'Leary. Like Belloc's Matilda, he may indeed be about to be burned alive.

Punch tilts at Mitchells & Butlers

Were it not for the disaster of the "unhedged" hedges, Roger Carr, chairman of Mitchells & Butlers, wouldn't have given yesterday's merger proposal from Punch Taverns so much as the time of day. He would have rejected it out of hand. As it is, he's in no position to reject anything. Management has been too humbled by the events of the past six months for such dismissive bravado.

Even so, this is hardly a compelling proposition. Punch may come free of the calamity of an exercise in financial engineering gone wrong, but its shares have performed just as poorly as Mitchells & Butlers since the summer, with the smoking ban eating deep into the earnings of its estate of old-style, largely tenanted pubs.

Despite the fall in the M&B share price, Punch is still on a lower rating than its would-be merger partner. The deal is therefore dilutive to its own shareholders even after taking account of synergies.

The Punch approach certainly demonstrates nerve and ambition, yet it is also opportunistic and there is, in truth, little doubt about which of the two companies has the stronger business, and therefore the greater underlying value.

Mitchells & Butlers is virtually all managed houses, with a considerable unrealised freehold asset value and relatively good protection through established food revenues to the smoking ban-induced downturn in beer sales.

M&B shareholders would be perfectly justified in sacking the management for its ineptitude over the loss-making hedges, but they shouldn't be so daft as to sell the company at an undervalue, either to Punch or anything private equity might be able to cobble together.

China's velvet-glove approach to Rio

Chinalco's stake-building in Rio Tinto represents all the concerns the West has over sovereign wealth fund investment writ large. What I hadn't realised when I wrote about this subject last week is that the Chinalco chairman, Xiao Yaqing, is also a recently elected member of the Communist Party Central Committee of China.

This position places him right at the centre of Chinese public policy and explodes the idea, which Mr Xiao touted last week, that this is in its entirety a commercially driven endeavour divorced from wider national interests.

I'm not saying there is no commercial interest whatsoever. Part of the cleverness of using Chinalco is that there is some sort of a commercial case that can be made for its diversification internationally into the extractive industries. Had it been Baosteel, one of Rio's largest Chinese customers, it would have looked too obvious. So it was Mr Xiao sent in to scupper BHP Billiton.

The Chinese have chosen the softly-softly approach to getting their way rather than the iron fist. They are attempting to play by Western rules, or at least in a manner which doesn't directly contradict them. Yet this state-determined capitalism is no less alien or worrying for its velvet glove.