Jeremy Warner's Outlook: Mittal makes his final pitch, but he still won't find a welcome at Arcelor, which fights on

The bears have it - but only for now; BAA's final defence may tilt at windmills
Click to follow
The Independent Online

We'll have to await the board meeting on Sunday to know for sure what the Arcelor response to Lakshmi Mittal's revised takeover bid might be, but no prizes for guessing the outcome; unless Arcelor's chairman, Joseph Kinsch, has unbeknown to the rest of us experienced some kind of blinding flash on the road to Damascus, he'll again be giving Mr Mittal the old two fingers.

The Arcelor board decided right at the outset that the Indian-born steel baron was a bad lot and between themselves made a secret pact that if it came to it, they would all go down with the ship. This is not a takeover battle destined to end in friendly agreement, notwithstanding the fact that the two companies make an excellent fit.

By raising the terms to give an 18 per cent premium to the Arcelor share price, and by offering 50 per cent more cash, Mr Mittal has addressed the valuation issue. The offer reasonably reflects the buoyant profits recently announced by Arcelor.

He has also gone as far as he's ever likely to in answering corporate governance concerns. There's now to be only one class of capital, with the Mittal family shareholding reduced to less than 50 per cent of the combined group. In practice, the Mittal family will still have control, but it is less than the absolute control of the first bid.

Yet still the Arcelor board will resist. In Luxembourg, where the company is based, Arcelor is regarded as a national champion and a vital part of the country's economic health. If Mr Mittal is allowed to breach the walls of the citadel there's no knowing what might happen. Heaven forbid, decisions will get taken for commercial reasons, without regard for national sensitivities or the priorities of local employment.

So what are Mr Mittal's chances of success? Regrettably, I am going to have to duck the question, for the truth is that it is impossible to know. Arcelor's share register is opaque to the point of total obscurity. It is impossible to know where the balance of power might lie.

Are the majority essentially Arcelor cronies, where strings can be pulled to ensure rejection, or is Arcelor these days owned more by mainstream international investors whose only concern is shareholder value? The answer to this question will determine the outcome.

The bears have it - but only for now

The stock market correction of the past week is as sharp a reminder as they come that share prices are as much determined by psychology as fundamentals. As far as the latter is concerned, virtually nothing has changed over the past week.

US inflation for April came out a little worse than Wall Street had expected, leading investors to think that interest rates might have to rise for longer and by more than previously thought, but other than that there was little else that could be seen as fundamentally changing the outlook. So why did markets become so spooked?

Equities virtually the world over have enjoyed a spectacular run since they hit bottom shortly before the invasion of Iraq in March 2003. As the good times roll, investors become ever more oblivious to risk, and in their search for a decent return they start to invest in assets thought highly dangerous in more risk averse times.

The phenomenon is sometimes referred to by Wall Street investment bankers as "reaching for yield". In this particular cycle, investors may have been even more careless than usual, in that central bankers flooded the world with excess liquidity post the terrorist atrocities of 11 September so as to keep the economic wheels grinding. Much of this excess has found its way into asset prices.

Yet paradoxically, as markets go ever higher, investors also become increasingly nervous. The analogy here is with a mountain climb. The first pitches seem easy, emboldening the climber to go beyond the point of no return. Then on looking down and realising how far he's come, he gets nervous and loses his footing.

What happened this week in markets was that investors all of a sudden remembered that there was such a thing as a business cycle and that higher interest rates can generally be relied on to bring it to an end. Economic cycles don't just peter out and die of old age. Instead they are murdered by central bank tightening.

Up until now, the tendency has been to believe that China and India have in some way altered the picture, allowing the world economy to keep growing for longer than it might otherwise. Rapid industrialisation in these regions has had some hitherto quite unusual effects. Commodity and oil prices have taken off, usually the precursor to a period of more generalised inflation, but because of the rapid expansion of industrial capacity, the price of goods has stood still or deflated.

This process has to end some time, especially if much of the growth is being fed by an unsustainable consumer boom in the US. The question is whether the bears are right in believing that moment may already have arrived. It is virtually unprecedented for share prices to keep rising into the certain prospect of an economic downturn, so if you believe that inflation is coming back and that interest rates will need to rise further to choke it off, then you would be a seller.

That view finally gained the upper hand this week, and asset prices have adjusted accordingly. Yet the bulls, and I still count myself among them, haven't been entirely vanquished.

Valuations are if anything on the low side right now; that too would be highly unusual if we were about to enter a bear market and could only really be justified by the prospect of a severe earnings squeeze. Few corporate leaders foresee such a calamity. A buying opportunity then? Perhaps not quite yet. There's still a lot of nervousness out there. Yet the cycle isn't yet at an end. The developing regions of the world have too much of an interest in keeping it going. I'm sticking to my view that the FTSE 100 will end the year higher.

BAA's final defence may tilt at windmills

As I have pointed out before in this column, BAA, the airports operator, is in the peculiar position of having to battle a bid that may never be made. OK, so there is a real offer on the table from Ferrovial of Spain and its partners, but for the time being it is too low to be credible. If this was the final offer, it would fail even if BAA did nothing at all. This week's correction in the stock market hasn't markedly altered this position.

Doing nothing, however, is not an option, for under the Takeover Code, BAA must issue final details of its defence before Ferrovial is required to make its final offer. Were BAA to maintain a snooty disdain, the risk is that Ferrovial would come back with something that was credible and BAA would be powerless to respond. It's not about to take that risk. A full on defence is being prepared which will probably be announced some time next week.

The centre piece is a big capital return, yet there are other reasons for holding on too. This week the Civil Aviation Authority added a little more flesh to the bones of its five year review of BAA charges. For obvious reasons, press reports chose to focus on the regulator's warnings about excessive leverage. Buried within the statement, however, was news of a quite considerable regulatory concession. Commercial revenues - mainly from airport shopping and car parking - will in future be subject to 10-year review, rather than the previously existing five years.

What this means is that should BAA exceed the regulator's assumptions on these revenues, the excess will no longer be subject to clawback after five years, but only after 10. This further underpins BAA's already excellent growth prospects. Expect a robust defence document with plenty to keep shareholders happy. Yet like Don Quixote, BAA may find itself only tilting at windmills. There's every possibility Ferrovial will never make a credible bid.

j.warner@independent.co.uk

Comments