Jeremy Warner's Outlook: Poor performance and high pay is rightly proving a deadly combination for US bosses
Megacaps have their attractions too; Ratan Tata weighs his options on Corus
Thursday 04 January 2007
Corporate trends that begin in the US generally wash up on these shores a year or two later, so FTSE 100 chief executives should perhaps take note of the public sacking yesterday of one of America's most high-profile bosses, Bob Nardelli, chairman of the home improvements retailer Home Depot.
Mr Nardelli has not been sacked merely for poor performance. His main offence was that he combined a progressive loss of competitiveness with a truly heroic level of pay - one that makes the much complained-of excesses of our own senior executives look peanuts by comparison. Outstanding performance perhaps deserves outstanding pay. Poor performance and outstanding pay is a deadly combination which is claiming the scalps of growing numbers of American CEOs.
A similar story lay behind the recent ousting of Hank McKinnell at Pfizer. The backdated-options scandal has meanwhile spawned a mass of sackings where performance has failed to mitigate against the crime.
As I say, we can expect this to become a growing feature of the UK scene too as progressively more intolerant investors act against poorly performing managements. A sign of the new activism was last summer's removal of Charles Allen as the chief executive from ITV.
Still, at these rarefied heights, it can pay to be fired. Mr Nardelli walks away with an estimated $210m as his reward for failure. That much the US still hasn't managed to get right. The cost to investors of extricating themselves from a poorly performing CEO is still likely to be extreme.
Megacaps have their attractions too
The big picture story in UK equities last year was the performance of the mid-caps. Driven largely by takeover speculation, the FTSE 250 rose by an astonishing 27 per cent, putting it more on a par with the stellar performance of emerging-market tigers than the big-cap FTSE 100, which recorded a much more pedestrian 11 per cent rise.
What's more, most of the rise in the FTSE 100 was accounted for by the index's smaller stocks. The megacaps, with market values of £30bn or more - BP, GlaxoSmithKline, HSBC and so on - basically went nowhere. After more than two years of relative underperformance, could this be their year?
A plausible case for it is made by Roger Cursley, chief equity strategist at Investec Securities. He was badly wrong about equity markets last year, with an end-year forecast for the FTSE 100 of 5,500. His mistake was failing to anticipate the bid fever that gripped the mid to large caps (anything under £30bn) and their consequent outperformance. Had his forecast been confined only to the megacaps he would have been broadly correct.
Now he's banking on a big catch-up in the valuation of the UK's largest companies. So confident is he that this will take place that he's pencilled in one of the more bullish forecasts for the FTSE 100 for the coming year. To achieve the year-end number of 6,750 he anticipates, he seriously needs the megacaps to outperform, particularly as he's also anticipating some abatement in the merger mania which last year energised smaller company share prices.
He may well be right about this. The big-caps have become neglected territory in the scramble to spot the next takeover target. Most of them are beyond the reach of private equity and are also already too powerful in their respective markets to allow for meaningful consolidation. So takeover fever has largely passed them by.
Yet with their big, relatively secure, cash flows and undemanding ratings, they perhaps deserve more. Certainly, their relative undervaluation is becoming a growing cause for concern among investors. Managements may not welcome this kind of attention, for it puts them under intense pressure to perform. Yet this too could be a galvanising influence this year, forcing hitherto complacent managements to apply the wealth of new tools now available for improving corporate efficiency.
We are already seeing some of this at Vodafone, whose share price is belatedly responding to a management now apparently determined to cut flab and, through outsourcing, improve operational performance. The megacaps have also borne the brunt of the equity divestment being undertaken by maturing final-salary pension funds. That process too may be reaching its cyclical conclusion.
I'm not sure it would yet be wise to bet on a fully blown investment rotation into the mega-stocks, yet, in an uncertain world, they have clear defensive characteristics which may provide an attractive haven. Property and infrastructure were last year's two stock market glamour sectors, if that is not a contradiction in terms. There's a good chance that this year it will be very large companies, with big cash flows and reasonable growth potential. Think GlaxoSmithKline and Vodafone, and you would have it about right.
Ratan Tata weighs his options on Corus
The will-he, won't-he guessing game over whether Ratan Tata, chairman of India's Tata Steel, will raise his bid for Corus is once against reaching fever pitch. Indian press reports quote "authoritative banking sources" in support of the story that he's already in effect decided to raise to 550p a share, and will announce this new offer at some stage in the next two weeks.
In the sense that this is the sort of number he'll have to offer credibly to outbid the Brazilians, these stories are self-evidently correct. Whether Mr Tata has already decided to take the plunge is rather more doubtful. Rarely has that wonderful quote from the former White House spokesman, Larry Speakes, seemed more apposite. "Those who talk don't know what is going on and those who know what is going on won't talk."
In the end, it will, I suspect, come down to a rather lonely decision by Ratan Tata. He'll already have a number in his mind which is the maximum he and his advisers think Corus is worth to Tata Steel, but, even if that number is 550p a share, it doesn't necessarily mean he'll offer it. As Mr Tata is only too well aware, whatever he does the Brazilians are almost certain to outbid him. Backed by a hot-to-trot Goldman Sachs, CSN's Benjamin Steinbruch is determined to have Corus, almost regardless of price.
Strategically, it is worth more to him than to Tata. Corus is, moreover, the only Western steel company he can buy for cash, thereby remaining in the driving seat of the steel goliath that emerges. Almost anything else and he would have to cede control. If Mr Tata is only going to get outbid, what's the point in him upping the ante? Well, there's always the satisfaction of forcing the rival to overpay.
On the other hand, there would be little competitive advantage to Tata in performing such a service to the hedge funds. The two companies are largely confined to their own domestic markets and are not head-to-head competitors.
The big difference between the two offerors is that for Tata this is not a make-or-break deal. Tata Steel's prospects are excellent whether it buys Corus or not. Already, massive increases in steel capacity are planned in India to cater for extraordinarily strong domestic demand.
What's more, Tata Steel is only a comparatively small part of an extensive business dynasty, with interests as diverse as automobiles, hotels, IT services and chemicals. Personally, I've never entirely understood the logic of buying Corus when there is such a wealth of growth opportunities in Tata's own backyard where the money might more profitably be applied. One of these is India's retail revolution, where Mr Tata has known ambitions now being actively discussed with possible foreign partners, including Britain's Tesco.
For all kinds of reasons, Ratan Tata would love to buy Corus. Shareholder value is perhaps the least of them. Yet the house of Tata won't be broken if he fails and he may considerably damage himself if he ends up paying a silly price. Will he raise one more time? I'm afraid I fall into the category of those who don't know. The only person who does for sure, Ratan Tata, is for the time being not saying.
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