Monday, May 31, 2010


A reverse merger (“RM”) is a non-traditional method of going public. Instead of hiring an underwriter to market and sell the company’s shares in an initial public offering (“IPO”), a private operating company works with a “shell promoter” to locate a suitable non-operating or shell public company.1 The private operating company then merges with the shell company (or a newly-formed subsidiary of the shell company).2 In the merger, the operating company shareholders are issued a majority stake in the shell company in exchange for their operating company shares.3 Post-merger, the shell company contains the assets and liabilities of the
operating company and is controlled by the former operating company shareholders.4 The shell company’s name is changed to the name of the operating company, its directors and officers are replaced by the directors and officers of the operating company,5 and its shares continue to trade on whichever stock market they were trading prior to the merger.6 Hence, the operating company’s business is still controlled by the same group of shareholders and managed by the same directors and officers, but it is now contained within a public company. In effect, the operating company has succeeded to the shell company’s public status and is therefore now public.

RMs have been around for years but have recently regained popularity. Closed RMs totaled 46 in 2003, 168 in 2004, 179 in 2005,7 and 69 through the first half of 2006.8 Notwithstanding this resurgence, RMs should be viewed critically. Although RMs are often pitched as IPO substitutes, they provide neither a large infusion of equity capital nor share liquidity, the two primary benefits of an IPO.9 This Article proceeds as follows: Part II describes the principal features of an RM, including the origin of shell companies, RM deal structure, and legal compliance. Part III takes a critical look at RMs arguing that comparisons to IPOs are misleading and, for many companies, irrelevant. Part IV discusses why companies nonetheless undertake RMs. Part V briefly discusses RMs involving special purpose acquisition companies (“SPACs”). Part VI states a brief conclusion.

To read the full report: REVERSE MERGERS

>POLAND BANKS: From Wrestling to Merging (CITI)

1Q10 Results In-Line — Our universe of seven Polish banks reported an aggregate 1Q10 net profit of ZL1,976m (+45% yoy, +22% qoq, +3.7% vs. CIRA estimates and +2.3% vs market consensus as reported by PAP). Despite high provisioning on retail loans (+34% yoy, -26% qoq), 1Q10 aggregate provisions came in 8% below our estimates. On the other hand, non-interest income came in 3% below our estimates driven by weak fees (partly due to a lower-than-expected recovery in investment fund fees).

Increased Competition in 2010 — Polish banks are abandoning strategies that concentrated on product niches and are embracing a universal banking strategy. This coupled with growth plans announced by some smaller players (e.g. Meritum Bank and Bank Pocztowy) is likely to lead to increased competition as more banks will sell a full range of products, while demand for banking services is expected to remain muted. This trend may negatively affect margins and revenues and presents a risk to our top-line growth forecasts.

More M&A in 2011? — Given increased focus on capital and funding globally in the sector, foreign players that find it difficult to accomplish their objectives in terms of growth or profitability of their Polish operations may consider engaging in M&A, either as an acquirer or a seller. M&A activity can be also triggered by financial problems of parent banks, as was the case with BZ WBK. Given Pekao’s expressed interest in M&A and PKO BP’s declaration to keep its options open, we analyse possible merger scenarios. Generally we expect consolidation to have a
positive impact on profitability longer-term.

Upgrading on Weakness — Following recent share price correction and due to attractive valuations we upgrade four Polish banks. Our top picks are PKO BP (1L rating maintained, TP ZL49, Tier 1 14.0%, only 24% of loans in FX) and Pekao (upgraded to 1L from 2L, TP ZL179.5, Tier 1 18.4%, only 27% of loans in FX). For investors with a higher risk appetite we recommend buying BRE (upgraded to 1M from 2M, TP ZL279) and BZ WBK (upgraded to 1M from 3M, TP ZL222). We upgrade ING BSK to Hold (2M from 3M, TP ZL809) and maintain our Sell rating on
Bank Millennium (3M, TP ZL4.70) and Kredyt Bank (3M, TP ZL16.9). We change our target prices to reflect our revised estimates and roll forward of our valuatio ns.

To read the full report: POLAND BANKS


What's New — We are cutting our target price to €31 from €34.60, maintaining the ‘Sell’ (3S) code. The value of PAH is no longer linked to the operating performance of the Porsche core operations (simply an associate). Instead it is dominated by the Rights issue due to happen before June 30th 2011 to allow repayment of Tranche 1 of Porsche’s December refinancing, and the Merger with VW, which will need to happen shortly thereafter. Investors now rightly focus on PAH Prefs on the basis of whether they are a cheap/expensive way into VW Prefs. As of today, one cannot fully define the Exchange Ratio, but our analysis suggests that at any price above €32 they are currently a more expensive way to own New VW than buying VW shares directly.

Why so?? — The merger of the two companies is based on values, not share prices, so the number of VW shares available to PAH Pref holders does not change once valuations and liabilities are determined. However the PAH share price determines the potential Rights issue price. We assume a PAH Rights at market, so as more PAH shares are created with a lower price, the eventual exchange ratio will fall, but this is not a linear relationship. At the current price of VW Prefs (€70), only below €31 do Porsche Prefs begin to look a more attractive entry point

Assessment of Liabilities still the critical factor — We make ‘central case’ assumptions about the imponderables among the liabilities of Porsche SE — notably the tax and litigation issues that can’t be fully calculated. This includes options tax/options unwind and litigation liabilities of a total of €3bn. €1bn more value within Porsche offers a 4-5% upside in the value Pref holders achieve on exchange, and boosts the family ownership of New VW by nearly 1%.

Risks — We will be wrong about our low-end assessment of the Porsche share price if we have judged the unquantifiable liabilities too harshly. We do not see failure to complete the merger as a risk to our negative view: in that event we see the value as resting between €20 and €28, with VW shares the only material asset of the rump company, and much of its dividend income required for debt service. We make only detail changes to forecasts with this note.

To read the full report: PORSCHE AUTOMOBILE

>Is this the ‘BRICs Decade’?

The last decade saw the BRICs make their mark on the global economic landscape. Over the past 10 years they have contributed over a third of world GDP growth and grown from one-sixth of the world economy to almost a quarter (in PPP terms). Looking forward to the coming decade, we expect this trend to continue and become even more pronounced.

The last decade saw the ‘arrival’ of the BRICs story. Here, we take a look at the next chapter—at how the BRICs and their relationships with the rest of the world will change in their second decade. We expect many of the trends we have already seen to continue and become even more pronounced. Our baseline projections envisage the BRICs, as an aggregate, overtaking the US by 2018. In terms of size, Brazil’s economy will be larger than Italy’s by 2020; India and Russia will individually be larger than Spain, Canada or Italy.

In the coming decade, the more striking story will be the rise of the new BRICs middle class.
In the last decade alone, the number of people with incomes greater than $6,000 and less than
$30,000 has grown by hundreds of millions, and this number is set to rise even further in the next 10 years. These trends imply an acceleration in demand potential that will affect the types of products the BRICs import—the import share of low value added goods is likely to fall and imports of high value added goods, such as cars, office equipment and technology, will rise.

In the past decade, BRIC equity markets outperformed significantly because the strong growth of these economies surprised many and the BRICs themselves came into focus. At the same time, valuations were low relative to many major markets in 2000. Now that the BRICs story is better known, expectations are higher and the valuation gap is much smaller, the same degree of outperformance seems much less likely, even if the BRICs deliver solid returns.

To read the full report: BRIC'S DECADE

>Telecom Regulatory Authority of India (Trai) has proposed new regulations for telecom service

Telecom Regulatory Authority of India (Trai) has proposed new regulations for telecom service providers with regard to the much awaited announcements on allocation of 2G spectrum charges, M&A guidelines, spectrum sharing/trading and universal license fee. The authority has prescribed a cap of 8 MHz for all service areas and 10 MHz in Delhi and Mumbai for GSM services. However, operators will have to shell out one-time fees for spectrum over the contractual limit of 6.2 MHz for GSM and 5 MHz for CDMA operators. Mergers and acquisitions
will be relaxed to make it easier for telcos to buy out one another as long as the combined entity does not command more than a 30% market share in revenue or subscriber terms. Trai has proposed to replace the 900 MHz band spectrum with 1800 MHz band spectrum at the time of renewal of license in order to re-use the former for 3G services. The regulator has expressed a desire to have uniform licenses fees across all telecom licenses and service areas. It has proposed to bring it to 6% by FY14 in a phased manner.

New Spectrum Management Policy – Spoilsport for incumbents According to the latest Trai recommendations, the amount of spectrum required in GSM is 6.2 MHz for most areas in the country, 8 MHz for districts having cities with a population of 1 million or more and 10 MHz for metro service areas of Delhi and Mumbai.

Similarly, for CDMA, not more than 5 MHz is required in the whole of the country except in metro service areas of Delhi and Mumbai where 6.25 MHz of spectrum will be required. Trai has suggested charging a one-time fee for holding 2G radio spectrum in excess of 6.2 MHz. The fee will be linked to the price of the ongoing auction of 3G spectrum. The worst affected companies will be Bharti Airtel, BSNL, Idea Cellular and Vodafone Essar. If the recommendations are implemented in the current form it would be hugely negative for the overall telecom industry. The overall outgo to the government on account of one-time spectrum fees could be to the tune of Rs 10,000 –12,000 crore.

However, it also said that 4.4 MHz of start-up spectrum that new entrants hold will be enhanced to 6.2 MHz for no additional cost, which favours new entrants.

The priority for granting spectrum would be:

a. Licensees who have received the initial start-up spectrum and met eligibility conditions for grant of additional spectrum up to 6.2/5 MHz will be given top priority. The inter-se priority for such operators, subject to meeting the eligibility norms, would be the date of application for additional spectrum

b. Licensees who have been assigned the committed spectrum but are waiting to get additional spectrum up to the maximum permissible limit will be next in priority.

To read the full report: TRAI


Over the years the two wheeler sector has played a key role in a country like India where majority of population lives in rural or semi-urban areas without adequate transportation facilities. The Indian two wheeler market with an annual domestic sale in excess of 9mn units is 2nd largest globally and accounts for 75% of the total domestic automobile industry sales volume and that clearly demonstrates the popularity of two wheelers among the Indian consumers. After facing a slowdown in FY08 and FY09, the two wheeler industry made a remarkable come back in FY10 and we are optimistic about growth prospects in FY11E. Current retail demand is quite robust and this, coupled with new launches and players' focus on volume generating 100cc segment, would be the main growth driver for the industry in FY11E. Volumes in FY10 grew at a significant pace and on that high base in FY11E industry volumes are expected to grow though at a relatively moderate pace. We expect the domestic two wheeler volumes growth rate to come down from 26% in FY10 to 15% in FY11E. Due to relatively lower base and new launches, we expect players like Bajaj Auto (BAL) and TVS Motor (TVS) to outperform the industry volumes growth rate in FY11E. On the other hand, Hero Honda (HH) is expected to underperform on back of enhanced competition and relatively much higher base. We have an ACCUMULATE rating on all three stocks with preference for BAL and TVS.

Volume growth to come down but remain decent in FY11E
After a substantial volume uptick in FY10, we expect the industry to return to a relatively moderate growth path in FY11E. We expect the demand momentum for two wheelers to continue in FY11E but the rate is likely to be lower than FY10. Robust retail demand, new product launches and lower base effect of 1HFY10 would be the main volume driver in FY11E. However, the relatively higher base of 2HFY10 and absence of one time factors (FY10 had the effect of VIth Pay Commission, farmers loan waive-off etc) will restrict the growth rates to a moderate level, we opine. Accordingly we expect the two wheeler volumes to grow by 15% in FY11E versus 26% growth recorded in FY10.

New launches would remain crucial
New launches over the next 6-12 months would be critical for maintaining the growth in FY11E. Successful product launch generally tends to expand the overall market thereby leading to a robust and higher growth for the industry. With overall two wheelers demand drivers in place; new launches would play a significant role in FY11E to achieve our industry volume growth expectation of 15%. Recent new launches like Pulsar135LS, Twister and Jive would aid industry
volume growth over the next six months.

To read the full report: 2 WHEELER INDUSTRY