In February 2023, Teck Resources, a Canadian mining group with a capitalization of €18 bn, announced its intention to demerge its metals assets (mainly copper mines) from its steelmaking coal assets, which would therefore be listed separately. As the metals assets are capital-intensive in the medium term, it was planned that 90% of the cash flow from the coal assets would be taken (in the form of royalties) by the new metals group over a period of 5 years to finance its development.

Teck, which had reported sales of €12.7 bn and net income of €3 bn in 2022, had sold its oil sands assets a few months prior to the announcement of this demerger project, which was therefore intended to enable the separate listing of “pure” assets clearly identifiable by investors. The split was prompted by the different dynamics of the two asset classes:

• copper and base metals are growing fast, with high capital expenditure requirements. The dynamic is driven by energy transformation and the need for copper for electrification;
• steelmaking coal is mature and generates substantial cash flows. It should be pointed out that steelmaking coal or coking coal, which accounts for around 15% of coal mined worldwide, is not used to fuel coal-fired power plants, which use thermal coal representing the remaining 85% of coal produced.

These profiles lead to very different valuation multiples (almost double!). Keeping assets within the same group without synergies between them leads to a conglomerate discount[1] applied by investors (the stock market value being much lower than the sum of the parts). It has to be said that the cash flows from steelmaking coal meet the investment needs of copper; and it's not unwarranted for investors not to appreciate this type of internal circulation of flows which is imposed on them.

At the same time as this operation, Teck announced its intention to abolish, after a period of 6 years, the multiple voting rights mechanism which gave de facto control of Teck to the Keevil family. In 1969, the Keevils created A shares representing 1.5% of the total number of shares, each with 100 voting rights, whereas the remaining shares, the B shares, have only one voting right per share! So, with 0.8% of the capital, the Keevil family holds 33% of Teck's voting rights. No pun intended, but tech companies who also subscribe to this type of structure haven't invented anything.

Financial analysts were unanimous in pointing out that the demerger, combined with the eventual elimination of multiple voting rights, could make it easier for different investors to acquire each of the businesses. They estimated a potential 60% rise in the share price once the operation was completed.

A few weeks after this announcement, in April 2023, the Anglo-Swiss mining group Glencore, with a market cap. of €60 bn, made an unsolicited proposal for an alternative transaction to the project presented by Teck. Glencore wanted to merge with the entire Teck group, then immediately split the resulting Teck-Glencore group into 2 new entities, one focused on metals production and commodities trading, the other on coal (thermal and steel).

The proposed merger parity represents a substantial premium (22%) for Teck shareholders on the basis of pre-announcement stock market prices, valuing it at €22 bn, ... but:

• This was an all-stock transaction, so value creation for Teck shareholders would largely depend on price trends, and therefore on the equity stories of the two new groups. As for the coal assets, the story to be told is complicated by the fact that the new group would integrate Glencore's thermal coal, which is a deterrent for investors (many investors are unwilling, or even unable, to invest in thermal coal for power generation, which is highly polluting and can be substituted by gas or renewable energies). Steelmaking coal, on the other hand, is an essential and currently non-substitutable product.
• Furthermore, even if certain guarantees are given, the transaction does entail the loss of Teck's Canadian identity, something the Keevil family has always fought against, hence the historical voting rights structure.

The Board (with the support of the controlling family) rejected this proposal, pointing to the absence of a competitive process, the inopportune timing (value creation from the initial separation project not achieved, copper projects too little advanced), the execution risk, the scarecrow represented by thermal coal and Glencore's presence in oil trading.

The rejection of the deal by Teck's management opened the door to a more targeted offer for its steelmaking coal division. Teck reports that several unsolicited bids are materializing. Following a more competitive process, in November 2023 Teck announces the sale of its steelmaking coal business for around €8 bn to Glencore (77%), Nippon Steel (20%) and Posco (3%).

With the acquisition of Teck's steelmaking coal, Glencore has achieved its primary objective of making its coal division more “respectable”, and has made it possible to eventually spin off this asset. It's true that when you're responsible for the emission of 433 Mt CO2 in 2023, i.e. more than France or the UK each, the subject is not totally neutral, even if most of Glencore's shareholders are not, by construction, proselytizers of the environmental cause.

Hence last August's announcement of the indefinite postponement of plans to spin off this coal division, reflecting either less pressure from ESG issues, or a certain opportunism that should come as no surprise in a group with its roots in trading.

^[1] For more on conglomerate discounting, see chapter 42 of the Vernimmen.

Morningstar regularly publishes a barometer of active and passive management performance over different time horizons. We have chosen the 10-year horizon, which we feel is the most relevant, as it most often alternates between bullish and bearish market phases. The results are not encouraging for active equity managers, unless they specialize in the Chinese market:

Of all equity funds, only 17% of active funds beat their passive counterparts after 10 years of performance ending in 2023. This is true irrespective of the geographical region of investment. And this proportion is steadily declining, having exceeded 22% in 2014.

However, active managers shouldn't throw themselves into the Seine, the Thames or the Main. 17% is better than management left to pure chance, which would be 0.1% over a 10-year period. And above all, it's the active managers who make the market's composition evolve between the different stocks. Otherwise, a market made up solely of passive investors would be content to reproduce the same structure and weightings every day. By this yardstick, Casino and Atos would still be members of the CAC 40, each worth several billion euros, whereas they are currently penny stocks!

If the statistics seem to encourage you to invest in passive funds, we can only hope that not all investors will do so! But rest assured, the market will naturally develop its antidote. Indeed, if the proportion of passive funds were to approach 100%, the market would become less efficient, allowing active funds to find more undervalued, performance-generating assets that passive funds would miss out on. As a result, active funds would once again outperform passive funds, leading to a rebalancing of their respective shares.

With Simon Gueguen, lecturer-researcher at CY Cergy Paris University

When a company suffers an operational shock, the goods or services it provides to its customers are often affected. For example, their quality or availability may be degraded. The company's place in the value chain is threatened, particularly if its customers can easily change supplier. The article we present this month[1] is an empirical study which shows that companies affected in this way increase the payment terms granted to keep their customers. And companies further up the value chain facilitate the operation by granting payment terms themselves, so that a flow of customer receivables is organized to the affected company. This mechanism is explained by a common interest in not losing downstream customers due to a transitory shock.

The sample studied covers the period 2003-2019. It is derived from the merging of two databases concerning companies based in the USA, one comprising accounting data and the other customer-supplier relationships in value chains. One of the strengths of this study is that upstream effects are measured not only on direct suppliers, but also on suppliers of suppliers, and so on. As is often the case in studies of this kind, natural disasters are used as an operational shock. These disasters have the merit (for the researcher, that is!) of being exogenous and a priori uncorrelated.

The empirical study shows that the trade receivables ratio (relative to sales) of affected companies increases by 2 percentage points after the shock. Out of around 100,000 observations, this increase is highly significant. The most plausible explanation is that this increase is voluntary and intended to retain customers. What's more interesting is the effect observed on trade payables: they also increase, by 8 percentage points relative to cost of sales. When this is translated into dollars, it can be seen that the delays obtained almost exactly cover the delays granted, so that these two effects have a statistically zero cumulative impact on the cash flow of the company affected.

In the sample as a whole, less than 6% of suppliers are located in the same disaster zone as the affected company. The increase in receivables cannot therefore be explained by the fact that suppliers are subject to the same shock. More likely, they are seeking to help their customers cope with the shock, thanks to a flow of lead time that is passed down the value chain.

To confirm this idea, the authors look at the substitutability of the goods and services provided by the affected company. To this end, they use substitutability indicators developed in a study published in 2014[2]. When substitutability is high, the risk of losing customers is high. In this case, the affected company grants even more lead times, and obtains more from its suppliers, which corroborates the idea of voluntary trade receivables.

Finally, the authors look at cases where the affected company's suppliers have difficulty in obtaining financing. The flow of trade receivables cannot be set up. Obtaining lead times up the value chain appears to be a necessary condition for using trade receivables as a shock absorber.

There are two main lessons to be learned from this study. The first is that companies subject to an operational shock increase the lead times granted to their customers in order to compensate for the deterioration in goods and services rendered. This result is not trivial: in the event of a liquidity shock, companies reduce their lead times. In the case of natural disasters, the desire to retain customers outweighs the need to absorb the liquidity shock.

The second idea concerns the value chain. The affected company's suppliers are aware of the need to increase lead times in order to avoid a break in the chain and a drop in sales. Trade receivables flows are therefore an effective tool for stabilizing value chains in the event of an operational shock.

[2]   G. Hoberg, G. Phillips et N. Prabhala (2014), Product market threats, payouts, and financial flexibility, Journal of Finance, vol. 69, pages 293 à 324.

Company A has consolidated EBITDA of 100 and consolidated net bank and financial debt of 8 times this EBITDA.

Company B generates EBITDA of 20 in its parent company accounts and has net bank and financial debt of 3 times this EBITDA.

A buys B, which was independent, for 12 times its EBITDA in cash. What is A's bank and financial debt as a percentage of its consolidated EBITDA after this acquisition?

After the acquisition of B by A, the EBITDA of the new group will be the sum of the EBITDAs, i.e. 100 + 20 = 120. Consolidated net debt will be the sum of the net debt of A and B, plus the price paid by A to acquire B in cash which is 12 x 20 – 3 x 20 = 180, leading to a net debt of 8 x 100 + 3 x 20 + 180 = 1040, i.e. 8,7 times consolidated EBITDA, which is really a lot!

No another question. Assume now that A which owns B, sells B for 12 times its EBITDA in cash. What is A's bank and financial debt as a percentage of its consolidated EBITDA after this sale?

After the sale of B by A, the EBITDA of the new group will be the consolidated EBITDA of A minus that of B, i.e. 100 - 20 = 80. Net debt will be A's consolidated net debt minus B's corporate debt, minus the price of B sold in cash which is 12 x 20 – 3 x 20 = 180, i.e. 8 x 100 - 3 x 30 - 180 = 560, i.e. 7 times consolidated EBITDA, which is still a lot!

Regularly on the Vernimmen.com Facebook page^[1] we publish comments on financial news that we deem to be of interest, publish a question and its answer or quote of financial interest. Here are some of our recent comments.

 Vivendi, or the lenders who applaud a demerger with both hands 

As a general rule, a demerger that reduces the diversity of a group's businesses is not well received by lenders, since their level of risk increases with the concentration of activities that results from a demerger. Indeed, the cash flows generated by each division of a group are naturally pooled within the group that combines them to service the latter's debt. Once split into independent entities, cash flows are naturally no longer mutualized, and the lenders of each of these now independent divisions can only rely on the cash flows generated by each division to service the debt allocated to it in the demerger.

As a result, lenders have long reserved the right to obtain early repayment of their loans/bonds at face value, or even slightly more, in the event of a demerger (or even in the event of a simple announcement).

When a phase of sharply rising interest rates pushes the value of bonds well below par, the subsequent announcement of a demerger is a godsend for lenders, who suddenly see the value of their bonds approaching par, despite a below-market rate of return on these loans. This is exactly what has been happening for several months with Vivendi bonds. A year ago, before any announcement of the demerger project, the 2016 bond maturing in 2026, yielding 1.875%, was quoted at 94.3% of par, due to a market rate of 4.10%. The bond is currently trading at over 99%, in anticipation of redemption at par by the end of the year, when the demerger is scheduled to take place. For a bond investor, a price increase of 7% in one year, including coupon, is considerable for a BBB-rated bond.

The demerger candidate must refinance its debts, i.e. negotiate with banks to take out loans that will be used to prepay the bonds. These bank loans are then allocated between the various entities to be demerged. Only when the demerger is complete can the demerged entities issue bonds to repay the bank loans set up as bridging loans. For Vivendi, this involves €2,750 million.

^[1]  Like it here