Orkla and Mecom

If there’s one British name which nearly every Norwegian is by now familiar with it’s David Montgomery, former editor of The Sun and News of the World, CEO of the Mirror Group and, since 2000 founder and executive chairman of Mecom Group, the AIM-listed media acquisitions and development vehicle. Since Mr. Montgomery agreed to purchase Orkla Media from Norwegian conglomerate and national institution Orkla at the end of June, the self-styled media tycoon has been the catalyst for hundreds of column inches of debate over the ethics of selling national publications to foreign proprietors, the fate of the country’s press, and most recently, whether the deal is going to go through at all.

Norwegians can be forgiven for all the drama. Montgomery’s proposed million Euro acquisition has not been smooth by any account; more mixed still have been the messages both Mecom and Orkla have been sending out over the past month. At first Mecom’s ownership of Orkla Media – whose empire is spread across Norway, Sweden, Denmark, Finland, Lithuania, Poland, Ukraine, and Germany, making it the fifth largest media conglomerate of the Nordic region – seemed like a foregone conclusion. On June 28, Orkla made a simple announcement of the sale in a press release, stating financial details were still under negotiation. “Mecom’s offer for Orkla Media is financially attractive for Orkla shareholders,” said CEO of Orkla Dag Opedal. “Furthermore, the solution is satisfactory with regard to the other goals that were set for the process. Based on an overall assessment, this is therefore the best solution for both Orkla shareholders and Orkla Media.”

Less than a week later, on July 3, Orkla announced that the sale would be for 7 billion Norwegian Kroner (about £614 mln), and that the parent company would be taking a 15% share and one seat on the board of the newly formed Mecom Europe conglomerate, which was to be headquartered in Oslo and run by existing Orkla Media Managing Director Bjoern Wiggen. Orkla Media would be valued at 7.5 billion Norwegian Kroner “after adjustments for cash and other financial capital”. Mr. Montgomery announced his plans to raise the money through a combination of debt and equity, giving the new entity a “leveraged buyout structure”. The deal was supposed to complete and sign last Monday on the evening of July 17, with a press conference planned for the next morning.

It’s at this point the deal began to look uncertain; that press conference never took place. The parties announced that lawyers were still finalising the deal, and that the agreement was “large and complicated, with many elements to be put into place.” Nevertheless, Orkla Media director Stig Finslo was confident; “We will finalise the agreement,” he said. Danish newspaper Berlinske and Norway’s largest financial daily Dagens Naeringsliv reported soon after that Mr. Montgomery was having trouble raising even half the money required for the acquisition, with several previously committed funds having gone weak on the deal. Orkla’s Chairman – and Norway’s richest man – Stein Erik Hagen announced from his holiday break that “we’re still following the timeframe we set up.”

This weekend came confirmation of the problems associated with the deal however as Mr. Opedal caught a plane together with a lawyer and an accountant from the company to meet Mr. Montgomery and try to iron out the problems. On Saturday, Mr. Hagen then made a surprise announcement to Dagens Naeringsliv that Orkla had a back-up plan if the deal with Mecom fell through. “We have a plan B, but I don’t wish to disclose the details,” he said.

In yet another about-turn, the mood yesterday evening after this weekend’s talk was suddenly more upbeat. “(Mecom and Orkla) have worked through the whole weekend on a possible agreement,” Mecom’s spokesman Eric Cameron told the Norwegian news wires just after six London time. “The talks have mainly taken place here and have been productive, but it is too early to say when we will reach a decision. It will take as long as it takes.”

The question is then, what’s going on and even more presciently, is this deal going to happen at all? Certainly, there are members on both sides that desperately want it to go through. For Mr. Opedal, who has been chief executive of Orkla for less than a year, this is just the kind of lucrative international deal he has been looking to make his mark with since he took over from his short-lived predecessor, the more conservative Finn Jebsen. It is widely cited inside Orkla that Mr. Opedal is the company’s next  Jens Heyerdahl, the entrepreneurial and dynamic former Chief Executive who from 1979 until 2001 turned the company around dramatically from a medium-sized mining operation into a full consumer-goods and specialist metals manufacturer. Selling to Mecom would be a savvy move: it would give Opedal a substantial amount of money to pursue his own vision for Orkla while at the same time retaining a minority – but still valuable – share in a profit-hungry European media enterprise.

Orkla media currently operates at a 7 – 8 % profit margin; it is Mr. Montgomery’s hope that he can turn this around to 15% in fairly swift order. The problem for Mr. Opedal if he were to pursue this himself would be in harming the very close relationships with unions which Orkla has enjoyed since it’s days in the mining business. What’s more, this deal flies very well with the traditonal corporate philosophy of the organisation – “ownership is more important than structure” is a frequently cited maxim inside the company’s walls in Skoeyen, Oslo.

For Mr. Montgomery of course is the chance to own one of the largest European media conglomerates in the world, and firm up positions in Germany since his controversially-received acquisitions of Hamburg Morgenpost and Berliner Verlag earlier this year, and at a comparatively low valuation (analysts have put previous valuations on Orkla Media at well over £700 mln). Battling unions is not shy territory for the former Murdoch employee either.

Perhaps most presciently of all, the deal works as mutual back scratch: both Mr. Opedal and Mr. Montgomery are young Chief Executives out to prove that they can make a mark not only in their own industries but on an international playing field. Mr. Montgomery has almost entirely ignored the UK newspaper market since founding Mecom. This accounts too for the apparent strategic discrepancy in Mr. Hagen’s statement made on Saturday and the more affirmative ones consistently made by Mr. Opedal. If both entrepreneurs wish to close this deal, they will have to quickly.

The issue seems to be almost unequivocally one of cash. In March this year, Mecom suspended its stock and announced a rights issue to raise £145 mln at 50p per share. Two months later, it had only managed to get together £70 mln at 48p per share.

The suspension of the stock remained on grounds of plans of a “major acquisition”. The previous acquisitions of the German dailies were majority partnered by American private equity firm Veronis Suhler Stevenson, since Mecom blew most of its cash on the £200 mln acquisition of Dutch LMG from Telegraaf Media Groep. If Mr. Montgomery cannot borrow or raise sufficient cash then, what are the options? This was most likely the issue on the table this weekend.

A potential solution which Mr. Opedal may have offered Mr. Montgomery is for Orkla to loan Mecom the money itself; assuming Mecom can front up half the cash, borrowing 3.5 bln Norwegian Kroner (about £307 mln) at a standard corporate bond rate of 8%, Orkla Media would still yield (albeit slight) annual profitability of £10 mln with current revenues of 8.7 bln Norwegian Kroner (about £763 mln) until Mr. Montgomery can raise the cash to pay off the loan.

If he hit his projections for doubling the profit margin, the company would be in very healthy financial shape, even without paying off the loan. This deal is about personal interest and politics as much as it is the bottom line, which is why perhaps it has been so adamantly presented as the latter. All that remains to be seen is whether the two chief executives at the front of it can pull it off in time. This will prove the first valuable test for both their ambitions.

Too cheap?

Philips Electronics’ announcement this morning that it is buying back 1.9 billion EUR of its own stock after the price fell on the announcement that quarterly profits were off 69% may signal confidence but it should not yet be misconstrued as a signal to pick up the shares.

Although operating profits more than doubled this quarter to 367 million EUR and sales were up 10%, the figures do not look quite so bullish when set aside the most recent yearly financials: at the end of 2005 operating profits were off more than 30% and sales had fallen by nearly half that; in addition, catch-up with end-of-year 2004 numbers is still some way off.

Rather, what this signals is just how difficult  it is to make money in the overcrowded and brand-dominated markets – and in particular the semi-conductor market – in which Philips operates. At first glance a P/E of 10 seems to be pretty cheap for the proprietor of the successful LG brand and more broadly speaking for a company in the heavily traded tech sector right now, and one almost understands CFO Sivignon’s announcement that the valuation is “attractive” – until, that is, one looks closer at the earnings.

2004, the big year so far for Philips, was most notably marked not by a substantial increase in product sales or even a sharp spike in gross margin on products sales (both of which grew steadily), but by a dramatic uplift on interest earned from equity holdings. This is a wary form of income for a business where market share and brand dominance is everything.

Philips’ sale of its stake in digital map maker Navteq last year – which trades at twice the valuation of the former – was a necessary move, but it is up to Sivignon once again now to prove to shareholders that he can effectively invest the cash in R&D and marketing to offer a substantial threat to goliaths such as Sony, Siemens and Texas Instruments, all of which trade at a minimum of one and a half times the price and all of which focus heavily on the former two departments. CEO Gerard Kleisterlee’s 3 billion EUR plus acquisitions binge this year may be expanding the size and scope of the company, but unless that expansion is paying off in terms of profit margins derived from product sales – rather than short term bets – it’s a meaningless indicator of the long-term prosperity of the company. 

It’s the age-old rule of quality of earnings. In a sector where depreciation of unsold goods is about as high as it gets, and where brand loyalty is as flighty as the next new new thing (as evidenced by LG’s sharp wake-up call on July 11), Philips’ focus on strengthening product quality and innovation and perception of product quality and innovation needs to defined more clearly before the shares look cheap. Spending some of these billions in development and marketing must follow next.

Slovenia

The EU's formal announcement today of Solvenia's inclusion in the European currency fold may look like just another natural step in the direction of long-planned regional growth - and indeed this is exactly the kind of low-profile way EU party members want to make it appear - but the addition of the former Yugoslavian member state is one of the most significant moves in Europe in a long time. For a formerly volatile political hotbed, Slovenia's economy appears to be in remarkable shape: with a GDP per capita income of 12,000EUR at a real growth rate of 3.8% and with national deficits of less than 1.7% of GDP, the country has weathered only recently acquired independence better than most. This is partly due to exceptional trade relations with Europe, and partly due to the country's unique geographic positioning and fair natural resources: at the intersection between the Balkans, central Europe and the Mediterranean Slovenia has been able to benefit off increased European demand for raw materials, in particular raw material assembly on the cheap.

Most significantly for Europe, however, Slovenia posesses all the economic indicators that buck the negative macroeconomic trends the continent wishes to try and steer clear from as her transatlantic neighbours seem barely able to cope. Increasing privatisation in the country has led to a decline in inflation by two hundred basis points over the past two years (when Slovenia's acquisition of the European currency was first formally proposed), unemployment is falling sharply and privatisation of state assets is aggressively being undertaken with relative ease. In addition to this, Slovenia's unique cultural and political relationships with the Ukraine and Russia give Europe economic front-door access to investment in a wider oil-rich Eastern European economic region.

Most pertinent of all, however, is Slovenia's import and export market: with over two thirds of trade concentrated with mainly Germany, France and Italy, and just under 3% of trade with the United States, she makes for the perfect "New Europe" model.

EU legislators know that if they can only get another few "Slovenias" on board, they stand a chance at curbing global inflationary trends while simultaneously accessing growth markets in politically neutral ways; something Uncle Sam has never been able to fulfill in one sweep. The accession of the European currency in Slovenia is both significant and timely.