Elis/Berend­sen: well pressed

Financial Times USA - - COMMENT -

Like cor­po­rate uni­forms in one of its laun­dries, Berend­sen has en­dured some rough and tumble. Its shares have landed in a pile, down 30 per cent over a year. See­ing that, French ri­val Elis qui­etly had a word, look­ing to pick up the UK com­pany on the cheap. Berend­sen said no.

What has hurt Berend­sen’s shares has been down­ward earn­ings re­vi­sions due to issues with its UK busi­ness, which gen­er­ates about a third of group rev­enues. An­a­lysts worry about how much this will cost to fix. The Elis bid would not solve the prob­lem.

Yes­ter­day, Elis de­cided it has had enough of pri­vate chats. It went public with the terms of its sec­ond of­fer from May 16, of £4.40 cash per share plus 0.426 Elis shares for each one of Berend­sen’s. Ex­ec­u­tives there had qui­etly folded that one away, per­haps be­cause it was only 7 per cent above an ear­lier bid from late April. The lat­est of­fer prom­ises €40m of an­nual cost cuts. Those sav­ings, taxed and cap­i­talised, would not cover the pre­mium to be paid. An ini­tial 30 per cent surge in Berend­sen’s shares, shy of the the­o­ret­i­cal bid price of £11.72, faded quickly.

One rea­son for the mar­ket’s doubts could in­volve the buyer’s own fi­nances. Elis al­ready car­ries net debt equiv­a­lent to three times its for­ward earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion. Com­bin­ing with Berend­sen would not lower this lever­age ra­tio. Given that, the abil­ity of Elis to pay more looks lim­ited. On top of this, con­sider that Berend­sen al­ready has its own plans to spend con­sid­er­ably more than oper­at­ing cash flow for the com­ing three years. That means the UK com­pany will also need more cap­i­tal, be­yond any cost cuts, to cover the neg­a­tive free cash flow.

This deal would stretch the fi­nan­cial fab­ric of Elis too far. Judg­ing from the French com­pany’s fi­nan­cial his­tory, it does not have enough cash flow to China’s charm of­fen­sive with for­eign in­vestors is run­ning up against a $9tn block. In­ter­na­tional in­vest­ment in the coun­try’s vast on­shore bond mar­ket ac­counts for just 1 per cent of the to­tal. A re­cent yield curve in­ver­sion in gov­ern­ment debt of­fers fur­ther rea­son to steer clear.

Nor­mally, rates on longer-dated sovereign bonds ex­ceed those on short, to com­pen­sate in­vestors for ex­tra risk. But yields on Chi­nese fiveyear debt are higher than 10-year.

Such an anom­aly of­ten hints at fears about growth and in­fla­tion. In China the driv­ers ap­pear more var­ied and less omi­nous. A bull mar­ket sup­ported by mone­tary stim­u­lus has flipped as Bei­jing cracks down on the use of bor­rowed money for meet both Berend­sen’s needs and its own. Both com­pa­nies have plenty to iron out be­fore any deal can go ahead. in­vest­ment by rais­ing short-term rates. Tech­ni­cal fac­tors are also at play: five-year bonds are less liq­uid that 10-year bonds, so price moves can be more ex­treme.

This is the first time such an in­ver­sion has been seen since Na­tional In­ter­bank Fund­ing Cen­ter records be­gan in 2010. China’s bond mar­ket might be the third largest in the world but it is young. Cap­i­tal re­stric­tions and ex­clu­sion from global bench­marks make its bonds a mys­tery to many.

En­thu­si­asts point to good yields. In­vestors can earn 3.6 per cent in fiveyear Chi­nese sov­er­eigns, com­pared with 1.8 per cent in US Trea­suries and 0.3 per cent in UK gilts. Quo­tas and li­cens­ing re­quire­ments have been lifted, mak­ing it eas­ier for for­eign­ers to buy these sov­er­eigns. A new plan, Bond Con­nect, agreed this week should sim­plify mat­ters by re­mov­ing the need for an on­shore trad­ing ac­count.

China wants to pro­mote the ren­minbi as an in­ter­na­tional cur­rency. But over­seas in­vest­ment in its bonds will stay lim­ited un­til they are in­cluded in a big global in­dex. This is years, not months, away.

Un­til then, the yields are not high enough, given con­cerns about China’s spi­ralling debt, its cur­rency weak­ness and the pos­si­bil­ity of two US rate rises this year. Ap­ply a cur­rency hedge on five-year debt and dol­lar in­vestors earn just 2 per cent a year. China’s bond mar­ket may be big but in­vestors can still af­ford to ig­nore it.

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