Jeremy Warner's Outlook: Stelios weighs options as easyJet nosedives

<preform>Marks & Spencer; Microsoft/SAP</preform>
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The Independent Online

Profit warnings come in threes, or so the old City saw has it. Ray Webster, chief executive of easyJet is already sitting on two in the space of a month. A third and the pilot's seat will begin to feel like there's a fire burning beneath it. Everyone knows the budget airline industry is heading for a bloodbath as overcapacity drives fares ever lower. Just how gruesome will become apparent this winter, and perhaps sooner.

Profit warnings come in threes, or so the old City saw has it. Ray Webster, chief executive of easyJet is already sitting on two in the space of a month. A third and the pilot's seat will begin to feel like there's a fire burning beneath it. Everyone knows the budget airline industry is heading for a bloodbath as overcapacity drives fares ever lower. Just how gruesome will become apparent this winter, and perhaps sooner.

Easyjet will be one of the handful of survivors. Of that we can be sure. But in the meantime it is encountering plenty of turbulence. The mark down in the share price which accompanied yesterday's profits warning was punishment for Mr Webster's failure to be sufficiently candid with the market at the time of profit warning number one a month ago.

Then, he complained of the damage that "unprofitable and unrealistic" pricing was doing to the business but declined to put any numbers on it. Yesterday, he was more specific, suggesting that fares would fall 10 per cent this summer. That means the airline will struggle to make much more than the £52m profit it achieved last year. With another month's trading under its belt, conditions have also worsened still further.

Mr Webster is not alone in ringing the alarm bells as often as he has. Over at Ryanair, Michael O'Leary has been even more graphic in his Armageddon-like predictions of what is in store. The difference is that he takes the reaction of the markets with a shrug and tells them to live with it. In any case, the O'Leary strategy is as much an attempt to scare the pants rival start-up budget carriers who have had the effrontery to try and nibble away at Ryanair's market than frighten investors. In some senses, easyJet is playing the same game.

The two dominant players in the low-cost market have everything to gain from killing off their competitors before they have had the chance to get a decent summer season tucked under their belts to tide them over the cash flow problems they will hit this winter.

The joker in the pack, at least for easyJet, is its founder and former chairman, Stelios Haji-Ioannou, who is sitting there with a 41 per cent stake and is watching it shrink in value by the day. Most of the other Stelios ventures, from internet cafés to budget cinemas have been a flop. He would like nothing better than to take his airline private again and prove how wrong the City was ease him out in the first place. Could he raise the finance? Apax for one might be willing to back Stelios again, and with the shares now significantly lower than they were when floated four years ago, the company would be a steal on its present valuation. Fasten your seatbelts for some major turbulence.

Marks & Spencer

When Philip Green started sounding out the City a little while back about its appetite for a Marks & Spencer bid, it was made clear to him that any such endeavour would only be acceptable if shareholders were left with a share of the upside. City institutions were said to be fed up with selling businesses to Mr Green, only to look on enviously as the retail entrepreneur proceeded to make huge sums of money out of them. It wasn't going to happen again.

The upshot is that Mr Green's opening gambit would give M&S shareholders 25 per cent of the equity of the bidding company on top of the 290p to 310p cash offer. Having had a few days to think about it, the institutions are now not at all sure they want Mr Green's paper after all. Under the structure as proposed, Mr Green would still be getting too much of the upside, some complain, while others worry about corporate governance and whether they'd really want to own shares in a company run by Mr Green in tandem with a substantial, privately owned retail empire.

After Friday's apparently bruising encounter between Mr Green and Stuart Rose on the Baker Street pavement outside M&S's London headquarters, would they want anything to do with Mr Green at all? For M&S staff, it must have been much the most exciting thing to have happened in years - pure theatre - but for some in the City it seems like reckless and extreme behaviour. I'm willing to bet Mr Green already regrets it.

Provided the cash is good enough, the upside can go fish, some institutional shareholders now say. No wonder the Green camp is at sixes and sevens as to what its next move should be. Do shareholders want stub equity or don't they? And if they don't, can Mr Green summon up sufficient finance for a straight cash take out? Mr Green is reported to be perfectly happy to make an all cash offer. Indeed, it is said that the City has positively played into his hands by being so dismissive of the stub equity offer. Now he's free to do what he wanted to all along, and take M&S wholly private.

Yet I'm not convinced this is what's going on. For Mr Green, the stub equity is a vitally important part of the entire offer. Financing the bid is going to be a lot more difficult and costly in the absence of an equity component. Without the backing of the M&S board, it may even be impossible. Mr Green could conceivably go hostile on the terms as they presently exist, but I doubt his bankers would allow him to go much higher without the limited due diligence he's asking for.

To go hostile would also require what Mr Green would call "proper" money - £50m to £60m just for the privilege of the banking facilities being on call, never mind whether they are actually used. Even for Mr Green, that's a lot of money to place on the gambling table. He'd want near certainty to do so. Unfortunately, there can be no such thing in a hostile bid.

Assuming Mr Green decides to go further, mix and match would therefore seem the most likely approach, with shareholders being offered either a mix of cash and stub equity or straight cash, the unwanted equity being underwritten in the City and among Mr Green's considerable fan club. Even then, it's one hell of a hill Mr Green has to climb.

Many institutions regard the stub equity terms as a rip off that give most of the value in the company to Mr Green. Yet Mr Green thinks of the £1bn of his own money he's putting up for equity in the new vehicle as "risk capital". The institutions should be glad he's prepared to risk so much of it, is his view, for it will require the payment of some mighty dividends before he gets his money back. Everyone would share in this dividend bonanza if and when it comes, so it is wrong to think of the terms as disadvantageous. The gulf that separates these two ways of thinking about the same thing could scarcely be wider. It doesn't pay to underestimate Mr Green, but even he will struggle to close it.

Microsoft/SAP

At first glance, the idea of Microsoft, the world's largest software company, merging with SAP, the number three, would seem so obviously anti-competitive that it's a wonder the two ever thought it remotely possible. Competition regulators are already crawling all over Microsoft's near monopoly of desktop operating system. SAP, a German based software house sometimes referred to as Europe's answer to Microsoft, has even been responsible for some of the legion of anti-trust complaints itself.

Yet in fact the two are in largely distinct areas of the software market. SAP's most direct competitor is Oracle, not Microsoft. SAP's speciality in the back office software that services large companies and governments is quite different from the desktop functions that drive Microsoft. SAP is more wholesale than retail. It is almost a separate species. Even so, Microsoft would have struggled to achieve a regulatory free ride. Its expansion into a whole new market would have been viewed with extreme suspicion by the anti-trust authorities in both Europe and America.

Add to that the complications of integrating two such culturally different organisations, and it's not hard to figure out why the talks came to grief. Still, it's symptomatic of just how mature a company Microsoft has become that it could consider engaging in a consolidating mega-merger. Strange to think how quickly this industry has evolved. It is still only twenty years since Microsoft floated on the stock market as the scion of a hot new industry.

jeremy.warner@independent.co.uk

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