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Even Billionaires Do Dumb Deals
In some ways, debt has never looked so good. This may sound strange given over-indebtedness arguably led to the financial crisis and continues to impede economic growth in the developed world, despite what Keynesian propagandists tell you. But from the viewpoint of investors and businessmen who aren't over-leveraged, debt is dirt cheap now and banks are more than willing to lend. Buying cheap assets with inexpensive debt, possibly unhedged in depreciating currencies such as the yen, makes a lot of sense. But only if it's done right.
Which brings us to the world's largest retail acquisition this year and Thailand's biggest ever takeover: 7-eleven operator CP All's US$6.6 billion deal for cash-and-carry wholesaler, Siam Makro. CP All is controlled by Thailand's richest man, Dhanin Chearavanont, reputedly worth more than US$14 billion. The largely debt-financed deal looks silly on many levels. Asia Confidential is going to pick it apart, but in a bit of a twist, also look at what type of deal should have done. In addition, we're going to offer some possible lessons for you from the Thai billionaire's mistakes.
The world's largest retail takeover YTD
First to the details of the deal. CP All agreed to buy the 64% stake of Siam Makro's major shareholder's for 787 baht a share, a 15% premium on the company's prior day's close. The same offer will be made to Siam Makro's remaining shareholders. Members-only Siam Makro has 57 cash-and-carry wholesale stores and posted earnings of 3.6 billion baht (US$123 million) last year, a 37% increase on the previous year. Its share price had already surged 53% this year before the takeover offer.
The price paid for Siam Makro is 53x last year's earnings or 44x this year's consensus earnings. On another widely used valuation metric, enterprise value (EV) to earnings before interest, tax, depreciation and amortisation (Ebitda), the multiple paid is 32x for 2013.
These multiples are the largest paid for any major retail takeover over the past 15 years. It values Siam Makro above US$100 million per store. By way of comparison, Costco - which many regard as the world's best retailer - is valued at close to US$70 million per store, with arguably more valuable property on its books.
The deal will be heavily debt-financed. Deducting the net cash on the balance sheets of CP All and Siam Makro means that Chearavanont will need about US5.6 billion in debt to finance the US$6.6 billion acquisition. CP All has flagged that the debt will be in U.S. dollars and possibly Japanese yen, though fully hedged. This will reduce the interest costs but limit any currency volatility issues.
If you assume financing costs of 6%, interest costs will be close to 50% of operating profit. In my experience, the 2x interest coverage here (operating profit/interest costs) is very low, with most deals requiring 2.5x at a minimum.
Interestingly, the bridging loan required for the acquisition is so large in a Thai context that one of the deal's financiers, Siam Commercial Bank (SCB), had to get regulatory approval to exceed a limit on lending to a single company (SCB already has a relationship with the parent of CP All, CP Group). I'm sure that questions about Thai bank lending standards will come soon enough...
Ego overruled numbers
Let's then take a look at the positive aspects of the deal:
· CP All will now become Thailand's largest retailer by a distance. Forecast sales of 349 billion baht will be 2.5x larger than Thailand's second biggest retailer, Tesco Lotus. This will give CP All a certain scale and the potential to squeeze suppliers and cut costs (merger synergies in financial parlance). That said, the two companies operate in very different formats, one in convenience, the other in cash-and-carry. This will limit the synergies, with supplier overlap of less than 10%.
· Chearavanont actually knows Siam Makro very well, limiting potential downside surprises from the deal. He jointly founded the company in 1988 but had to sell his original stake after the 1997 Asian crisis.
· Domestic demand in Thailand appears to be on an upswing, which will help retailers such as Siam Makro. The government seems committed to continued stimulus to fuel this domestic demand.
· The debt financing is very cheap in a Thai and Asian context. Putting the debt in U.S. dollars and possibly yen is smart and hedging the debt will limit currency fluctuations (note that un-hedged debt burnt many Thai corporates during the Asian crisis).
· Siam Makro could expand outside of Thailand into China and South-East Asia. CP All has expressed its ambition to expand beyond Thai borders but has been stifled by 7-Eleven brand owner, Japan's Seven & i Holdings. CP All could use Siam Makro to realise its ambitions.
· There could also be monetisation of Siam Makro's extensive property portfolio. It owns the land and buildings for 50 of its 57 stores. These are carried at book value of 13 billion baht, but will be re-valued post transaction to 69 billion baht.
In my view though, the negative aspects of the deal far outweigh any positives:
· The price paid is exorbitant, any way that you cut it. Credit Suisse estimates that CP All's Ebitda will increase 37% while its net income will rise by just 1% (due to interest costs) and the company's invested capital (the cash invested by shareholders and debtholders) will jump 430% due to increased goodwill (the price above book value that one company pays for another). This assumes minimal cost synergies and some property portfolio monetisation. If these estimates are right, Ebitda returns on capital will be just 8.6% while net income returns will be close to nothing.
· But the Credit Suisse estimates assume that Thailand's economy continues to improve. That's a big assumption given the perilous state of the world's economies, which Thailand is still dependent on. Not to mention the ever-present political risks in Thailand where leaders usually don't last a year (the current one has, which is unusual). Let's assume the worst (as dealmakers should do) and Siam Makro's earnings fall 50%. This would send prospective returns into deeply negative territory. And interest costs would be roughly 1x operating earnings, which would guarantee a mammoth equity raising.
· The company has been very vague on synergies which doesn't augur well. Research suggests that during takeover deals, cost synergies are often over-estimated. I'm not sure what the research says when synergies aren't even outlined!
The question then is why Thailand's richest man has done a deal where the risks would seem to outweigh any potential rewards? It's hard to say, but I'd guess that ego and/or sentiment may have overruled the hard numbers which would have undoubtedly been crunched by the billionaire's offsiders. It wouldn't be the first time that this has happened.
As an aside, I had to laugh at the reaction of investment bankers to the deal. Referring to the potential cost synergies, expansion plans and possibly property monetisation, The Financial Times quoted a banker involved in the deal as saying:
"On a standalone basis, it might look expensive. If you look at the broader scheme of things, it is a fair price."
More broadly, other investment bankers are heralding the comeback of mergers and acquisitions (M&A) in Thailand. Citigroup's head of Asian M&A, Colin Banfield, told Reuters:
"After a decade-long slumber, Thailand's M&A scene has burst into life over the last 12 to 18 months and is now one of the most vibrant and interesting M&A markets in the Asia-Pacific region.
Personally I am spending more time in Thailand now with our local clients than at any time since the Asian Crisis back in 1997-1998."
Good on you, Colin. No offence to my friends in the investment banking industry, but investment bankers wouldn't know value if it kicked them in their behinds. And they ultimately care only for one client's interests: their own.
What should have been done
It's easy to criticise a deal, but harder to think of ways that it could've been done better. But let's give it a go:
1. The obvious mistake made is paying too higher price for the company. So what would have been the right price? Well, it would have made much more sense if Ebitda returns on invested capital were in the mid-to-high teens, based on conservative assumptions. Critics might argue that you would never be able to get Siam Makro at much cheaper prices. But I say that's rubbish and it's only recently that it's traded at exorbitant prices.
2. A corollary of this is that any deal should be examined using worst case scenarios. It clearly wasn't in this case. If the returns are still potentially good under worst case scenarios, then the odds are overwhelmingly in your favour. The odds for CP All here are instead stacked against it.
3. I would have got all of the debt in yen-denominated terms and unhedged. This may seem risky to some because currency volatility on debt makes forecasting possible returns on a deal more problematic. But if you're as confident as I am about yen depreciation from here, it would be worth the risk.
Lessons for the average investor
More generally, there are some lessons from this particularly case study which are applicable to investors and businessmen alike:
1. A deal or investment is only as good as the price you pay. Price determines returns. It's all that matters.
2. Never let ego or emotion determine a deal. Let the numbers do the talking.
3. Never base a deal on the good times continuing. Assume the tide turns and see if the deal still stacks up.
4. Debt should be used cautiously as it is the undoing of many entrepreneurs and investors. But if you can use cheap debt to buy cheap assets, it could well be worth pulling the trigger.
5. Billionaires can do dumb deals. Learn from the dumb deals as well as from the better deals.
This post was originally published at Asia Confidential: http://asiaconf.com/2013/04/27/billionaires-do-dumb-deals/
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Reminds me of Robert Campeau.
Just like Campeau was the high-water mark of a previous debt tsunamai and marked the hubris of ego-addled over-reach, this dude will probably be a global economic Icarus reference point in retrospect.
Oh well, at least his banker advisers will be OK.
CP Group have also purchased a Chinese Insurance company for 11,2 billion USD. This is the largest single FDI in China to date. CP seem to have deep pockets. They were also looking to purchase Birdseye in the UK last year for over GBP 1,2 billion. tannin is the richest man in Thailand according to Forbes Asia rich list.
or is that thieves .... mmm yah!
in a world of theives , the only final sin is stupidity .... HST
To billionaires power and ego are more important than money ... call them a dumbass and you cut them.
looks more like an over confident bet on a forex play. he offered way too much to entice a no brainer sale with money that will soon be worth not much making everyone smile. the sellers get cash today to reinvest. the buyer gets a very good asset he may end up not paying very much for at all. it is a real ballsy move that looks risky today but final judgement will be made tomorrow.
Billionaires didn't make their money; the Government did it for them.
At ZIRP all sorts of deals enter the possible.
Once ZIRP ends and interest rates rediscover reality, a multistore consumer store deal is going south will be the least of anyone's worries. Lots of "smart" money will become "no" money.
I didn't see the corruption budget factored in anywhere.
Almost EVERY billionaire eventually has a ROYAL F-up. Undoubtedly, it is the ego factor to blame...EVERY TIME...!! Money cannot lengthen one's DICK
Smilin' Bob disagrees...
http://www.blogcdn.com/www.aoltv.com/media/2009/06/smilingbob1.jpg
Right! Now if I had a billion dollars I would assure you, beyond a moment's doubt that I would not fuck it up. No way Jose. Not in a quad fud trillion aeons, and I double-dog dare ya to say otherwise.
Anyone want to give me a billion and prove me wrong?
one billionaire to watch is Soros; but does he do what he says?
Look at this as example of a guy who said one thing and apparently does the opposite :
Mark Zuckerberg's Political Group Is Trashing Obama And Obamacare And Promoting Wildlife Oil Drilling
Read more: http://www.businessinsider.com/mark-zuckerberg-political-group-promotes-oil-and-gas-2013-4#ixzz2RgMjRZRp
The biggest business success can get the swelled head and think he can do anything if he listens to his own bullshit (publicity).
In this case it looks like he wanted back a company he lost in the Asian crisis in 1997 and didn't care what he paid for it.
If the yen and dollar drop fast enough he may wind up ok. But if massive devaluation happens in 2 of the world's most important currencies what does that mean for the baht and business conditions?
Easy. The billionaire will share his wealth with the Thais so they can continue to go shopping at his stores. /sarc
I'm so glad to read that Thailand is on the up and up. Makes me feel really warm and fuzzy about the US economy.
In other news .. people in Bangladesh are rioting. They get paid 7 cents a day to produce garments and now a factory collapsed killing and hurting many. No health care to speak off. They lost their limbs which they require to .. you guessed it .. earn that 7 cents per day to live off.
I hope that Thai billionaire will loose the stores a 2nd time because of his ego.
Chances are the buyer did not amass 14 Billion in net worth by being a stupid ass.
Most certainly, dummies do not amass $14B fortunes, but the point of the article is that even bazillionaires do dumb deals, and for some reason, retail chains seem to attract big egos. Maybe it's because they are so visible to the general public.
For a recent home-grown example, I offer you JCP....but there is a long list of vanished retail chains to ponder.
First water then cash, it floods a lot in the land of many smiles.
That real estate is VERY expensive. Plus "you ain't building Costco in Thailand." haven't been to Bangkok in 25 years so imagine it's changed a lot. Did find that undiscovered beach tho...one of the highlights of my life. South Thailand is one of the most beautiful places on earth. Just watch "the Man with the Golden Gun" if you want to discover it. Besides everyone knows the best retailer in the world is Amazon. "they already own the future" and it ain't the mammoth footprint on the property. That model has wiped out every City in the United States save two or three.