A new advisory science has been born this year in Europe: how to launch and defend hostile bids. The aggression and free-flowing finance are straight out of America, but the old continent’s politics add an extra level of difficulty. The latest landmark battle, following the struggles for Telecom Italia, Gucci and Société Générale, is raging in the French oil sector. TotalFina’s raid on Elf Aquitaine, and Elf’s counter-attack, highlight once again the primacy of politics in shaping French business. The battle also provides Europe-wide lessons for the M&A tactical manual.
TotalFina versus Elf is firmly stuck in a Parisian courtroom. Bidder and defender have both appealed against the regulatory approval given to the adversary’s actions, and rulings are due by mid-October. Thereafter, the market will have a short period to pick the winner. Elf was the first to resort to the law; it did so because it desperately needed to buy time. Its defence plan, thought up by Morgan Stanley, Goldman Sachs and Lazard Frères, was proving difficult to sell to institutional investors. But so cunning was TotalFina’s raid that the defence advisers, now privately pessimistic about their chances, had few options.
A link-up between France’s two oil powers has been rumoured recurrently throughout the 1990s. As in other globalized industries, critical mass and merger synergies are in vogue. The combined firm would rank behind only Exxon-Mobil, Royal Dutch/Shell and BP-Amoco-Arco in turnover. The two bosses, Thierry Desmarest of TotalFina and Phillipe Jaffré of Elf Aquitaine, lunched together regularly. Jaffré claims they did not substantively discuss a merger.
Then, on July 3, TotalFina attacked, launching an all-share offer for Elf, then valued at €42 billion. The offer, advised on by CSFB, Paribas and Merrill Lynch, was cheap: Elf is now trading above the value of the four-shares-for-three exchange bid. The proposed annual synergies were low at €1.2 billion over three years. They were to be achieved, said chairman and chief executive Desmarest, “in a manner respectful to the social policies that we are committed to”. That meant 2,000 fewer jobs at French sites, through voluntary and natural reductions. “You know how it is in France,” shrugs an investment banker involved in the deal.
The modest synergies, which Elf attacked in its rejection of the offer, gave Desmarest maximum flexibility to form his own strategy once in charge of the combined company. The all-paper bid at a low premium preserved a large stake for TotalFina’s own shareholders, and kept the company’s financial powder dry for future investments and possibly acquisitions. And, conveniently, the share offer allowed TotalFina to use pooling-of-interest accounting rules, meaning the company would not have to book billions of francs in depreciation costs for goodwill.
Before launching the bid, Desmarest approached the French finance ministry and the office of prime minister Lionel Jospin, to inquire whether the government would use its golden share in Elf Aquitaine to veto the acquisition. But Desmarest knew the government likes to see a French national champion emerge – as manifested by its tolerance of BNP’s bid for banking rivals SG and Paribas. In the last days before the bid, Desmarest received political blessing.
On July 5, Elf’s defence advisory team found itself in difficulty. The leaders among the advisers were the brothers Yoel and Michael Zaoui, respectively of Goldman Sachs and Morgan Stanley. The group of investment bankers knew each other well, says an Elf adviser from Lazard Frères: “We see each other on every single deal in France.” But seldom have they been made to struggle so.
The defenders studied three main options. The first was just to say no, and offer a stand-alone commercial plan. “Nobody thought it was a viable option that would bring more value to shareholders,” says the source at Lazard. “The merger has some logic to it, there are synergies, and it is the fashion to be a big company.”
Few companies retain their independence, once bid for. The most common outcome in takeover battles everywhere is victory for a white knight. Elf’s defence team spent until mid-July studying every candidate in the industry, analyzing the government’s likely view of foreign acquirers, and taking secret soundings.
An M&A specialist in the Elf camp says: “A white knight didn’t seem to be on the cards quickly, because of the position of the government with its golden share. None of the potential suitors was sufficiently confident about the golden share. And none of these companies was willing to fight the French government in court.” Each possible rescuer had its own disadvantage: ENI, with which Elf has held past merger discussions, is 37% owned by the Italian state, which didn’t want to be involved in a corporate struggle against the French state. Elsewhere in Europe, Repsol was too small, BP was still digesting two huge mergers, and Shell was busy with restructuring. The advisers believed Chevron of the US had no hope of getting the golden share waived.
With nearly two weeks up, the bankers were scrambling to build a defence against the bid, which Elf’s management viewed as a sly attempt to buy it on the cheap during the quiet of summer. The only option left was a pacman defence: a counterbid for TotalFina. The teams worked around the clock to formulate and launch it by July 18. “It is an investment-banking miracle that we’ve been able to put this thing together,” says an adviser to Elf: “But we always knew that pacman was a difficult strategy to sell.”
The great disadvantage of a pacman manoeuvre is that it acknowledges your adversary’s case for a merger. An M&A specialist at Morgan Stanley says: “You implicitly recognize some of the merit in the bid; however, you believe there is more value to be achieved if you structure it in a different way.” You can contrast yourself only through your offer to shareholders, your industrial plan, or the appeal of your boss.
In contrast to TotalFina, Elf’s €50 billion offer for its rival included €13.4 billion in cash, backed by an €18 billion loan facility: the latest in a series of monster international acquisition financings. “We knew investors like leverage, and they like cash. Everyone was very conscious about Telecom Italia,” says the Lazard source – whose firm was involved in that earlier defence.
However, high leverage is less of a winner among shareholders in oil corporations than is the case with telecoms operators. Oil companies’ cashflow depends on the price of crude – a variable whose depths have repeatedly been unforeseen.
The Elf camp’s analysis is that even if crude sank to $12 a barrel, pre-tax earnings would still cover net interest 7.6 times. But among investors, the leverage tactic has at best proved a neutral selling point during the past two months.
Elf’s problem in shaping an industrial plan was that TotalFina had left its commercial options so open. Elf could only contrast itself by pinning its colours to a particular mast. The advisers boldly chose a strategy driven by financial value-creation, but which went against the industry consensus.
The plan is to spin off the combined chemicals interests of Elf and TotalFina. The defence advisers’ analysis was that the full-range chemicals business and the more profitable oil business would be worth more on their own than in a conglomerate. Synergies between the two businesses are limited to petrochemicals, which account for only 20% of the combined firms’ chemicals operations.
But confusingly, the defence plan proposes to sell petrochemicals too, because clientele, R&D, and other aspects are more integrated with other chemicals operations than with oil refining. Even more confusingly, the opposite holds true at operational sites in Belgium, where a different solution would be applied.
The TotalFina camp argues the complex scheme was cooked up by number-crunching investment bankers, and stood at odds with the earlier thinking of Elf chairman Jaffré. The Elf camp claim Jaffré had privately intended to spin off chemicals in the long term anyway. Jaffré has repeatedly done his best to convince international fund managers of the scheme’s merits, but he has run up against the third issue in any pacman contest: who rules?
Investors prefer Desmarest, an oil man with two decades’ experience at Total. Jaffré is seen, slightly harshly in view of his record at Elf, as a technocrat typical of the French elite, a treasury civil servant supported into the Elf job by his political protector, former prime minister Edouard Balladur.
In late 1998, both Elf and Total were eyeing up Belgian oil company Petrofina. Bankers from Goldman Sachs and Lazard, representing Elf, complained to Petrofina’s largest shareholder, the Belgian financier Albert Frère, about the size of Total’s offer – in their view, well over a fair valuation.
“You don’t get it,” Frère rebuked them: “The point is not the price. It is that whichever company wins[Petrofina] will later win the other.”
Jaffré didn’t heed the prophecy, continuing to focus on internal cost-cutting at the expense of external strategy in a rapidly changing sector. It seems that the clearest lesson to be learnt from Elf’s travails is that in M&A, passivity is perilous. Marcus Walker
