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After the revelation of government concerns left the proposed BAE-EADS merger up in the air like a hot air balloon with no place to land, BAE’s (LSE:BA.) single largest investor fired off some shots, any one of which could cause enough shareholder concern to blow a hole in the deal and bring it crashing to the ground.
Investec Perpetual owns 13.3% of BAE. As it has carefully examined the deal in terms of what it does for investors, Investec has “significant reservations” about the value of the merger. It called the proposal “illogical“. Investec has had ongoing problems with BAE’s acquisition policies and is currently concerned about the long-term value for shareholders.
Strategic benefit – Investec said that it can find no strategic benefit in the merger deal, at least for BAE shareholders, unless it is diversification. Investec pointed out that there are a lot of ways for shareholders to diversify without a BAE merger. Reading between the lines, Investec is saying, “Leave the diversification up to us. That’s what we do.”
Privileged Position – Investec suggests that BAE is likely to lose its “unique and privileged position” with the US Department of Defense. This has been a concern throughout the entire negotiations, and is a highly likely scenario. Investec raised the concern that there is nothing significantly beneficial about the deal to offset the loss of US DOD business.
Direct Impact on BAE Shareholders – Investec calculates that the 60-40 merger ratio does not benefit BAE shareholders because it does not reflect BAE’s superior earning stream and the strength of its relationships with its customers. Neither has there been any dividend guidance on the proposal beyond 2013. This is an issue because BAE’s current yield is 5.9% whilst EADS’ is 2.3%. No forward looking guidance for BAE investors leads to speculation that BAE investor yields could be diluted as a result of the merger.
Growth Potential – Although BAE has been promoting the potential for growth as a benefit for the deal, Investec is rightly concerned that “While growth is important, it should not be at the expense of cash flow and returns, which are even more important drivers of long term value creation.” (BTW, in case you haven’t noticed, nearly every merger proposal touts growth as a benefit, when often it is just the bait on the hook.)
Victim of Politics – Additionally Investec foresees that the investment of the French and German governments could adversely affect the future commercial growth of the company by prioritizing the influence of political considerations ahead of shareholder value.
Detrimental Dual Listing – Investec believes that the proposed dual listing concept is not appropriate for this merger and will have a three-fold negative impact on shareholders. They believe that it will “impede synergies, divide share trading between two markets, and deprive the new group of the benefits of a single deep pool of liquidity.”
It remains to be seen how other investors will respond to Investec’s insights. Given the “piling on” of concerns over the weekend and today, it is not likely that the deal will close before 10 October. It is, however, likely that the government will allow an extension for the negotiations. Nonetheless, the potential for the merger to happen seems to be growing dim.
BAE shares continued to slide today, dropping 3.00 pence from Friday’s close.
