3rd November 2009
- This troubled European bank could hold a tasty profit opportunity
- Another twist in the National Express saga
Dear subscriber,
Welcome back. This week I want to take another look at the saga of National Express, which has more twists and turns than a cheap soap opera. Plus I'll be looking at an alternative way of playing our Sun Micro trade.
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But first, there's an interesting opportunity arising in Dutch financial giant ING (NA: INGA). This is definitely one to stick on our watch list
How to profit from ING's break-up woes
Most of you will be familiar with ING Direct the bank with the orange life jacket logo that used to pay a decent rate on your savings. But you may not have realised that ING is one of Europe's largest financial conglomerates.
I use the term conglomerate, because ING is not just a bank but also an insurance (or in technical terms, bank-assurance) group more or less like Lloyds and Scottish widows, although in this case the bank / insurance split is 50:50, not 90:10 like Lloyds.
Bank assurance companies were fashionable in the 90s, as managers of dominant banks in small countries, unable to grow any more through grabbing extra market share, instead diversified into related sectors. The theory was that synergies could be achieved by pushing a whole range of financial services to clients.
But these synergies never materialized. The few institutions that tried the approach, such as Credit Suisse and Winterthur, decided to split up a while ago. So ING is one of the last bank-assurance groups left.
Why ING's downfall was the opposite of Northern Rock
Last year ING ran into trouble, and had to be bailed out due to a $25bn portfolio of Alt-A mortgages it held in the US. The irony is that ING was very successful in raising deposits through its ING Direct subsidiary, but couldn't actually write mortgages fast enough against these deposits. So it chose the easy option and bought mortgages instead, which unfortunately turned out to be of dubious quality. I call this ironic, because it's exactly the opposite of what happened to Northern Rock and HBOS. These two were writing mortgages at a very speedy rate, but couldn't get enough deposits to cover them and so were forced to rely on wholesale markets.
Anyway, last week ING announced a €7.5bn rights issue which will be used to repay 50% of the €10bn bailout money it received from the Dutch government. It will also split its insurance arm from its banking unit via an IPO or a sale, and its ING Direct operation in the US will also be disposed of.
As you've probably noticed, there's been a flurry of cash calls in the banking sector all across Europe. What makes this different is the double whammy of a large rights issue which will put pressure on the share price, alongside a demerger move which should unlock quite a lot of value for the shareholders.
The strategy
The strategy here is very simple. The sum of the company's parts should be worth more than the company itself. So if you get in at the right time which is when the stock is under pressure from the rights issue you should be able to make some decent money in the next few months.
ING has a market cap of around €18bn. When it announced the rights issue and demerger plan, it also reported it had made a net profit for the third quarter of €750m (€500m from insurance and €250m from banking). That gives you a price / earnings ratio of below 10 (I'd prefer not to give an exact figure here, because quarterly results can be particularly volatile). The insurance stub has a book value of €13bn, which means the implied valuation of the bank is roughly €5bn.
Other factors worth noting are that Tier 1 capital (a key measure of a bank's strength), rose to 9.7% from 9.4% last quarter; and that a few investment banks upgraded the stock on the back of the news, citing ING's attractive valuation.
The plan should be approved by the 18th November, at which point the date for the rights issue should be announced. No date was given for the demerger of the insurance stub, but the restructuring process is expected to end in 2013.
My feeling is that the rights issue is the priority for now. Once that's over, ING will focus on the spinoff. I expect that a few buyers could be found for the insurance part in a short time frame (perhaps a few months). For example, Italian finance group Generali has been looking for acquisition targets for quite a few years now.
We won't buy yet we'll wait first for the details and dates of the rights issue. For now, I reckon our first entry point for the stock could be around €8-8.50 per share, but hopefully it could be less once the issue is underway. It's very difficult to put a target price on ING as financial assets are notoriously opaque and hard to value, but it could easily be above €12 per share (market permitting, of course). In any case, we'll be returning to this one very shortly, once we know more.
Using options to trade Sun Micro
Last week a reader asked me if we could play Sun Micro (US: JAVA) using options (for the original tip, see Events Trader issue 12). The answer is yes.
As you know, the European Commission has to block or clear the takeover by the 19 January. This means that we have to focus on call options with January expiry and an $8.00 or $9.00 strike (remember, Oracle has offered $9.50 for Sun Micro).
Unfortunately Sun Micro is not a widely traded stock which also means the range of traded options is limited. I checked on both Bloomberg and Yahoo Finance, and could only find a $9 strike for January, trading at $0.26.
The maths on this trade is quite simple. If you buy the option at $0.25 or $0.26, you could double your money if the deal goes through, but only lose the premium if the deal falls through. What makes this trade attractive is that the deal has a much better than 50% chance of being completed.
However, I have a feeling that an $8 January strike will also become available later on, as expiry approaches. This strike is the one you should focus on. It should cost around $0.60 with the stock at these levels, which would mean you can make $0.90 with I reckon an 80% probability, but can only lose $0.60. Alternatively you can play the $7.50 strike which costs $1.30 (it's in the money), but in this case you stand to lose more than you'll gain if the merger fails.
I'd point out that this is just another way to get exposure to this trade. If you are already holding the company's shares, I'd keep them just now, and think carefully before you increase your exposure to this trade. However, if you don't already hold a position in Sun Micro, this is certainly a good way in for more adventurous investors.
The latest turn in the National Express drama
This transport group is giving us more twists and turns than your average episode of Coronation Street or East Enders. Last week's big news was that the potential merger with Stagecoach had collapsed.
Both Stagecoach and the Cosmen family (who own around 18% of National Express) blamed the management team for this failure. In particular Stagecoach said that it could have completed the merger in a short time as all the due diligence had been done in September when the Scottish company was the junior partner in the CVC-Cosmen bid.
We should soon have further news on details of the National Express rights issue, which is now the only option left for the company. It needs this highly dilutive issue to be completed before 2009, or else it will breach the banking covenants on its existing loans. If the rights issue is complete, the banks will renegotiate some of the term of its loans in National Express's favour, extending the loan maturity.
Again, let's sit and wait for now. The best possible outcome would be the news that the UK rail franchises have been withdrawn while the issue is underway this would provide us with an excellent entry point.
Just before you go, I also wanted to draw your attention to the sale of Gatwick Airport by airport operator BAA. BAA is a highly leveraged group, and the £225m loss suffered on the sale of Gatwick was worse than it had expected. Now, BAA is planning to refinance £1bn of debt next March, but I reckon the company has the potential to become an interesting distressed play in the future. I'll keep an eye on it for now, but this may be one that we'll be returning to in the next few months.
As usual I welcome your questions and comments just e-mail me at eventstrader@f-s-p.co.uk.
Riccardo Marzi
Events Trader
Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Some shares recommended may be denominated in a currency other than sterling. The return from such shares may increase or decrease as a result of currency fluctuations. Please seek independent personal advice if necessary.
One investment idea above is using options where any profit depends on the potential price increase of an underlying security. The potential loss is predetermined and limited to the premium amount paid, and can be as much as 100% of the premium initially paid for the call.
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Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Editors or contributors may have an interest in shares recommended.
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