Jeremy Warner's Outlook: If overseas pension funds are so keen to buy BAA, how come our own are so keen to sell?
Chancellor's free market rhetoric; UBS trader decides to go it alone
Tuesday 06 June 2006
As Goldman Sachs and Ferrovial mull their options, the question which has bothered me from the start of this epic City bid battle remains as pertinent as ever: if Goldman Sachs, Ferrovial and their overseas backers think it worth paying well north of £9 a share for BAA, how come the stock market won't value the company in the same way?
As long as there is the possibility of a higher bid from one or both of the consortia, the shares will trade above that level. Both bidders were engaged in eleventh-hour talks last night in an attempt to secure the BAA board's recommendation. In effect there was an auction taking place, with everyone apparently preparing to work through the night. But if the bidders had decided to walk, the shares would have slumped back down to around the £8 mark, perhaps lower still.
Remember, neither of these consortia gains any synergies from acquiring BAA. Under both proposals, the company would be run as a stand-alone enterprise. They are bidding only for the earnings stream and assets as they currently exist and might be developed.
Moreover, the other partners in both consortia are in the main big pension fund investors of the type which in the past would have owned their stakes in BAA through the normal mechanism of the stock market. There is no logical reason why BAA would be worth more to them than it is to most ordinary stock market investors.
The same point can be made about virtually all private equity bids; if private equity is prepared to bid such and such, then it must think the assets worth a great deal more. The implication is that the stock market has in some way mispriced the company.
This mismatch between valuations is accounted for only partly by the fact that such bids are mainly debt financed, which has the effect of making the equity more high risk. Investors that take on that risk hope that ultimately they will be compensated by a higher return. Ergo, they are prepared to pay more than the value the market assigns.
Another reason is that stock market liquidity in itself causes high volatility in the the value of the shares. At any one time, BAA will have an array of different types of investor on its share register, each with their different appraisals of risk and expectations of return.
As a monopoly utility with a predictable revenue stream, BAA makes an almost perfect investment for pension funds. Yet these days, UK pension funds own little more than 20 per cent of the stock. They may even be outweighed by hedge funds and other short-term traders, many of which will be recent investors in the stock and whose only interest is in selling to the highest bidder.
Still, there is plainly something rotten in the system that overseas pension schemes find it so much more attractive to hold British infrastructure assets than our own pension schemes. If BAA is such a perfect hedge against against long-term pension liabilities, how come there aren't any British funds involved in the bidding consortia?
One reason may be that few are big enough to take on such risk. Another might be that they simply lack the imagination. But perhaps the most powerful is the perverse effect of solvency regulation, which forces pension schemes to classify all equity as the same high risk asset that ought to be replaced by low risk bonds as soon as opportunity presents. Never mind that shares in BAA are in all probability lower risk than many forms of corporate debt.
Two conclusions seem worth drawing. One is that British pension funds need to find better ways of grouping themselves together to ensure that secure, relatively low risk, long-term assets of the type BAA represents, remain in UK ownership for the benefit of UK citizens, perhaps by taking these assets out of the publicly quoted sector altogether, as Ferrovial and Goldman Sachs propose.
Another is that UK pension funds need to find more precise ways of grading their equity holdings, so that particularly low risk forms of equity such as BAA are treated for solvency purposes differently from less predictable corporate assets. As it is, it seems only too likely that another important UK asset, together with the rewards it generates, will disappear into largely foreign hands.
Chancellor's free market rhetoric
Nobody should doubt the Chancellor's sincerity or determination in wanting to prepare Britain for the challenge of competition from China and India. He's also right to lambast Europe for burying its head in the sand over the demands of globalisation. The recent outbreak of what the Chancellor calls "economic patriotism" - or unwillingness to allow cross-border takeovers - demonstrates how far Europe still has to travel to make the single European market a reality.
In hammering home this message to the president's dinner at the CBI last night, Mr Brown was preaching to the converted. To this audience, it was all motherhood and apple pie. Yet as ever, the Chancellor speaks with forked tongue. He preaches the virtues of free markets while at the same time cluttering them up with an ever growing burden of regulation and taxation.
The British economy has fared well under this Chancellor, and its growing reliance on high value-added services for growth and prosperity seems to make it particularly well placed to weather rapid industrialisation in the developing world.
Yet few would argue that Britain has become relatively more competitive during this period. To the contrary, productivity growth has remained pedestrian and many older industries have declined badly. Most independent assessments of competitiveness put Britain further down the rankings than it was when Mr Brown came to power.
In general business investment and in transport and utilities, Britain has slipped further behind leading competitors. What's more, the Government's determination to tax more heavily and spend the proceeds in the public sector has made the economy as a whole less efficient.
As a proportion of GDP, Britain now has one of the heaviest tax burdens anywhere in the developed world. Indeed, the economy's capacity to absorb ever rising levels of taxation without being brought to a complete standstill is a marvel to us all. We can only hope it doesn't encourage the Chancellor to believe he can tax even more.
Thankfully, Britain does not suffer from the more overtly protectionist leanings of some of our European partners. As Mr Brown points out, such policies are a strategy of despair. By protecting existing jobs and industries, governments only discourage the creation of new ones. Both capital and labour resource gets stuck in uneconomic activity. Yet the problem the Chancellor has got is that too often his social ambitions are in fundamental conflict with his free market rhetoric.
UBS trader decides to go it alone
Another hedge fund might seem the last thing we need, yet the one being set up by Jon Wood, head of proprietary trading at the Swiss bank UBS, promises at least to bring some excitement to the markets.
Mr Wood has been practising his own particular style of arbitrage and hedge-fund management for many years now, but while at UBS, with its myriad connections and interests, there would always have been restrictions on what he could get his teeth into for fear of stepping on someone's toes or offending some client.
He's known as an aggressive and activist enough investor already, so goodness knows what we can expect once he's let off the UBS leash. Some $500m of an expected fund of up to $5bn will come from UBS itself, so the bank retains a stake in his money making prowess without the sometimes explosive downside of actually having him on board.
A case in point was the bizarre legal action Mr Wood launched against the Scottish financier Sir Tom Hunter, which ended up backfiring badly when the judge branded Mr Wood an unreliable witness. It doesn't seem to have damaged him, though. He's not due to launch until September, yet already he's raised $3bn.
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