Crunch Time At Cable & Wireless

Published in Company Comment on 26 March 2012

We look at what the company's suitors might offer.

Shareholders in Cable & Wireless Worldwide (LSE: CW) should find out this week if one or both of Vodafone (LSE: VOD) and Tata Communications (NYSE: TCL.US) will table a formal bid. Or possibly not, as the weekend press speculated that both potential bidders might seek an extension to Thursday's "put up or shut up" Takeover Panel deadline.

Apparently the bidders are frustrated by the reticence of C&W's management to provide information. If that's the case, I imagine large institutional shareholders in C&W will soon read the riot act: the best chance long-suffering shareholders have of recouping value in the ailing telecoms firm is if a bid crystallises.

Who dares wins

And if one or both of the suitors does declare their hand, then that must surely spell the end of C&W. Weakened by three profit warnings and two changes of CEO in the past 12 months, and a share price that had fallen by 75% before Vodafone's bid emerged, the company's board could scarcely put up much of a fight.

Nor does new CEO Gavin Darby have much ammunition in the form of his new strategy, which is to prioritise cash flow, refocus capital expenditure on higher return projects, reduce operating costs and simplify an overly complex business structure. That's all good stuff, but it smacks of a long haul. If neither bid materialises, shareholders face the prospect of the shares returning to languish in the sub-20p region.

He may also lack the motivation. With a £600k "change of control" payoff and an even larger prospective gain from his shares, Mr Darby would be quids in if the company is sold.

Vodafone

Vodafone was forced to go public on its interest in mid-February. With a £7bn cash pile, it could swallow C&W's shares with ease -- but digesting the business post-merger might be more cause for indigestion.

Its interest is thought to centre around C&W's UK fixed-line network. Vodafone already buys capacity from C&W, as well as competitors such as BT (LSE: BT-A), to supplement the so called "back-haul" part of its network that connects mobile masts to the internet. As mobile communication becomes more data intensive, this is vital and expensive infrastructure. Buying C&W's network would generate serious savings.

Vodafone is also said to be attracted to C&W's client list that includes 70 of the FTSE 100, the police, NHS and BBC. As consumer markets are becoming saturated, it is aiming to grow its enterprise segment.

And thirdly, Vodafone could possibly make use of C&W's tax losses to reduce its own tax bill in the future. In theory this is legitimate, but the details could cause give rise to a lot of wrangling with the tax man and, according to City AM, some of Vodafone's board are concerned at the reputational implications. The company has previously been targeted by the UK Uncut campaign and is vulnerable to adverse public sentiment.

Some analysts think that Vodafone's current management are "gun shy" and would walk away from a bid battle if Tata makes a formal offer.

Tata

The Indian company, whose activities are more akin to C&W's, certainly looks serious. It is understood to have arranged a $2bn (£1.25bn) syndicated loan to finance a cash bid. Part of the Tata conglomerate, which successfully bought and turned around Corus and Jaguar Land Rover, Tata Communications is 25% owned by the Indian Government and is listed on the Bombay and Indian national stock exchanges, with ADRs listed in New York.

It is supposed to be mainly interested in C&W's international subsea cable network, which links 150 countries and is a heritage of C&W's more illustrious past. Tata has a substantial subsea network itself, which it plans to expand to Latin America, and combined with C&W's it would be a premium global asset.

Tata may ascribe more value to C&W's UK enterprise relationships than Vodafone, giving it a European base. And with Corus and Jaguar under its belt, the group shouldn't blanch at the prospect of turning around C&W's performance.

What's it worth?

C&W was trading at around 20p before Vodafone's announcement, a market cap of £560m compared with its £2.5bn in March 2010. Analysts then spoke of a bid in the £700m-£900m range, (25p to 32p), a minimum 30% premium to the pre-declaration price.

But the shares have risen substantially since Vodafone's and Tata's interest emerged and are now trading around 36p, a market cap of about £1bn.

So a bidder would likely have to offer well over that now. Charles Stanley analyst Tom Gidley-Kitchin has speculated that an offer would need to be priced around 45p to get C&W board support. That chimes with the fact that one top three shareholders is believed to have paid an average 40p per share for its stake: getting out with a small premium would seem to be a good result.

Indeed, it corresponds to my own thinking. Having got in much cheaper, I was happy to cash in at a small profit and eliminate the risk of the bid interest evaporating. Longer-suffering shareholders may understandably have more patience.

Of course, a bidding war between the two interested parties could see offers going much higher. But Tata's loan may be a clue to the upper limit of bids. With the loss-making company's balance sheet quite stretched, it may not be willing to spend more than the 44p a share its $2bn loan represents.

Divide and conquer?

It may also be significant that Vodafone and Tata are mainly interested in different parts of the business. Might they, I wonder, collaborate: one party bidding with a pre-agreed sale of assets to the other? It's an intriguing thought.

Before Vodafone's bid, Investec valued C&W on a sum-of-the-parts basis at £2.5bn, 90p per share. That includes £1bn for the UK network and customer base, £650m for the subsea network, £350m for its data centres and £500m for its tax losses.

By joining forces, the bidders could make a knock-out blow that captures that value, turning a substantial profit while leaving C&W's shareholders relieved and satisfied.

I'm happy to be out of the situation, but those shareholders still in should be feeling better about things than at any time over the past 12 months.

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> Tony has shares in Vodafone.

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Comments

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apprenticeDRL 26 Mar 2012 , 8:28pm

I also averaged down just before the bids were announced (pure luck). I have held for the bids and am keeping my fingers crossed. Hopefully we will know later in the week.

drfuzz 27 Mar 2012 , 9:58am

Pretty good analysis with which I generally agree.

Despite being initially quite bearish on the takeover price, I'm still holding half my initial holding (having sold the other half at 37p straight after the deadline extension). The reason I'm still holding half is Tata - as you point out the fundraising they are discussing implies around 45p per share. I suspect any upside will come from a Tata bid and think the max we'll see is 50p. I wouldn't be surprised to see VOD do a kick in the teeth and offer below current market price. There's also the risk that Tata doesn't make a bid for whatever reason - I've heard the Indian government are not so keen - so there's still a moderate chance nothing will materialise. Hence the reason for selling half at 37p, a price I would have bit your hand off for about 3 months ago!

I've never bought in to the investec sum of the parts valuation. CW was trading at 20p before the speculation for a reason.... the company itself wrote down its assets to the tune of 600m in the interims (while this was mainly intangibles, some of it was the network too). Hardly suggests there's huge hidden value in there to me!

LastChip 27 Mar 2012 , 1:05pm

Forgive me drfuzz, but I think you're missing the point.

It's not about whether there's hidden value on the balance sheet. In a sense, that's almost immaterial, although it will always have a bearing. It's more about a ready made International data communications platform.

As I've written in the past, phone companies will need exponentially more and more capacity to meet growing user demands. Video for example, is notoriously data intensive and actually, cable/land-line is a poor and inefficient medium for transmission.

You can't build a transatlantic (and I think in CWW's case, a transpacific) data highway overnight. It's time consuming and financially very expensive, not to mention the political hoops to jump through. And that's (IMHO) where the value lays.

Vodafone can reasonably predict their growing demands over (say) the next five years. They also know that whoever controls the data highways, will always have a competitive advantage over those who don't. All the political rhetoric in the world won't stop that.

To some degree, they're probably mindful of over paying for wireless licences in the past. But then in hindsight you could argue; did they? Without those licences, they wouldn't be the company they are today and they are in a similar position with requiring the backbone that CWW can supply on a plate.

So in essence, it's my view that this deal is far more valuable to them than people realise. At least, that's what I'm banking on ;-)

Levant1 27 Mar 2012 , 6:54pm

C&W joined up the Empire and was a mighty company now laid waste by incompetent British management.

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