There is no such thing as a merger of equals and, for all National Grid's protestations to the contrary, yesterday's deal with Lattice boils down to a straightforward takeover. As well as owning 57 per cent of the combined business, National Grid will also appoint the majority of the executive board of directors, including the chief executive. Despite all this, the Grid has got away without paying a premium. The price offered in shares for the operator of Britain's gas pipeline network is less than its regulatory asset value.
That does not necessarily mean that the Lattice chairman, Sir John Parker, has sold his shareholders down the river. The 11 per cent rise in the Lattice price yesterday reflects the improved growth prospects that its shareholders should enjoy when they swap their stock for shares in the more highly rated National Grid. Moreover, there is a high degree of cross-share ownership between the two companies, making the issue of who pays whom a premium less central. For Lattice, the deal neatly solves the problem of where to find a new chief executive, the previous incumbent having left abruptly.
However, the two companies are not forking out £60m in advisers fees simply to find a new man to run a low-growth gas network. Nor are they really doing it for the £100m in cost savings to be had by merging their UK gas and electricity networks and closing down one head office. What this deal is really about is creating a national champion with a large enough balance sheet to stride out and conquer the rest of the world, starting with the US, where the Grid has already spent £9bn buying up other electricity businesses. The management of National Grid Transco has already begun thinking about the next mega-deal in the States before regulatory approval for this merger has been obtained.
It makes a change for someone other than the Germans to have their sights set on world domination and a useful side-effect of yesterday's deal will be to make Lattice and the Grid indigestible, even for the likes of RWE and E.ON. But when companies start bulking up simply for the sake of bulking up even further alarm bells should ring. The Grid's diversification experience to date has not been an unqualified success. Its US strategy has so far paid off, unlike that of ScottishPower, but its foray into the Latin American telecoms market has been nothing short of disastrous. Many Lattice shareholders would prefer to have their excess capital paid back than invested on their behalf in foreign adventure. Still, the now obligatory break fee is not big enough to be a significant deterrent to potential party poopers, and while this is not a merger that will have the City rocking in the aisles, nor is there sufficient reason for opposing it.
ITV Digital's collapse
Keith Harris, chairman of Seymour Pierce, former City investment banker, and chairman of the Football League, cannot be much of a poker player. He seemed to think Carlton and Granada were bluffing when they said they would liquidate the company if the League refused to negotiate down the value of its contract to acceptable levels. He was wrong. The League should never have signed up to ITV Digital, a start-up with an uncertain future, in the first place, and it has been naïve in the way it has dealt with the gathering crisis.
As they stand, the rights are hardly worth anything, and while Carlton and Granada may eventually be held legally liable for the débâcle, it will probably take years of litigation to see a payback. Silly little League. As for ITV, it now seems inevitable that heads will roll over the affair. Michael Green, chairman of Carlton, wants out anyway. His counterpart at Granada, Charles Allen, would by contrast have to be carried out in a box, but it may yet come to that. ITV Digital has been a monumental failure all round and, in the meantime, the core ITV product seems to be fast disappearing down the pan. Someone needs to get a grip. Will Mr Allen be given a second chance to prove himself? It will be interesting to see. He's a tough and resilient operator, but the City is an unforgiving place.
Interest rates on hold
Heavy hints over the weekend from Sir Edward George, Governor of the Bank of England, that UK interest rates won't be rising any time soon are welcome for any number of reasons. The economic recovery, if there is one going on at all, is still fragile. House prices and consumer spending have been roaring away, and there were some signs of a recovery in business confidence too. But that was before Gordon Brown's Budget last week, which has put a dampener on everything.
Business has taken another gigantic hit while for working people, there is the thought of all that extra national insurance kicking in next year to take the wind out of the consumer boom. Many companies will deal with the looming rise in employers' national insurance contributions by abolishing the annual pay rise. In any case, few of us are likely to feel better off next year. All in all, the economy needs an interest rate rise like a hole in the head right now.
All of which helps explain why equity prices remain so subdued. The City consensus was that there would be some sort of a bounce back in the stock market this year, albeit not a huge one, but early summer has arrived and the stock market remains as flat as a pancake. Indeed, if you look at the charts, you see that equities are about the same level as they ended 1998 at, nearly three and a half years ago. The theory, widely propounded then, that equities were in for a prolonged and turbulent period of sideways trading is being proved correct.
Stock market valuations ultimately depend on how much money investors think companies can make, and how quickly. At the top of the bull market, valuations reached extreme levels amid the general euphoria, and some pundits started to talk quite seriously about how the new economy miracle had made equities as risk free as bonds. The over-investment and indulgence of that period has yet fully to work its way out of the system.
But there's more to it than that. In many cases, price-earnings ratios are still extremely high by historic standards, this in the belief that corporate profits will eventually bounce back making valuations look more normal again. What if they don't? Bill Gates once said that profit was not a natural state for companies, by which he meant that in a perfect market, profit is always competed away. In the real world, that's never going to happen, since without profit there would be no enterprise. Even so, in today's deregulated, global markets, profit is proving much harder to come by than it was.
Eventually, of course, both recent and future productivity gains will come to industry's rescue. The new economy wasn't all mirage. In the US in particular, above average productivity gain has continued unabated right through the business downturn. There have also been some deep cuts in capacity across some industries. Recent IT advances should allow for some substantial productivity gains to start kicking in from the middle of the decade onwards. Whether any of this will readily or quickly translate into resumed corporate earnings growth remains to be seen, but whatever the longer-term outlook, now's not the time to be raising interest rates.Reuse content