The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Peter Thal Larsen
LONDON, Oct 5 (Reuters Breakingviews) - Welcome back! At Breakingviews we love nothing more than a big deal, and this week the M&A gods delivered. Some thoughts on the $55 billion takeover of Electronic Arts EA.O below, plus other highlights from the past seven days. As always, email me with feedback or tips. And if you’re not already a Breakingviews subscriber, sign up for a free trial here.
OPENING LINE
“In the book ‘Trump: The Art of the Deal’ the future U.S. president counsels wannabe business titans to never settle for less than they want. Big Pharma CEOs appear to have taken that lesson to heart in negotiations with the White House.”
Read on: Big Pharma prevails in art of the drug deal.
FIVE THINGS I LEARNED FROM BREAKINGVIEWS THIS WEEK
Almost half of large UK businesses do not have insurance against a cyberattack.
Berkshire Hathaway’s BRKa.N cash pile has doubled in five years.
China’s $108 billion Zijin Mining 601899.SS is almost as valuable as BHP BHP.AX and Rio Tinto RIO.AX.
Indian spending on artificial intelligence in the past decade was just 9% of China’s.
More than 5% of Americans with car loans are behind on repayments.
ARABIANS AT THE GATE
For private equity investors, the 2007 acquisition of TXU has become a case study in reckless exuberance. Early that year a group of buyout barons led by KKR and TPG clubbed together to pay $45 billion for the Texas utility, including debt. The deal relied on excessive leverage: the consortium borrowed almost four-fifths of the headline sum. It was badly timed, as credit markets froze up shortly after the announcement. And the investment case rested on a bet on rising gas prices which went badly wrong. Seven years later, the company filed for bankruptcy.
As of this week, though, TXU is no longer the largest leveraged buyout in history. The $55 billion offer for computer games giant Electronic Arts by a consortium led by Saudi Arabia’s Public Investment Fund smashes that dubious record. The inauspicious benchmark raises two questions: are we facing a new wave of mega buyouts, and are the new barons making the same mistakes as before?
In some ways it’s surprising that TXU held on to the high score for so long. In early 2007, companies in the S&P 500 Index had a combined value of around $13 trillion. Today, the constituents of the U.S. benchmark are worth roughly four times as much. Buyout firms like Blackstone BX.N and KKR KKR.N oversee much larger funds. So, a $45 billion buyout should be less remarkable than it was 18 years ago.
The EA deal differs in other ways, too. For one, the buyers are borrowing less than half the headline sum. Granted, their $20 billion loan is still large, representing a hefty 7 times EA’s expected EBITDA this year. But the PIF and its co-investors – Silver Lake and Jared Kushner’s Affinity Partners – are stumping up $36 billion of equity, including the PIF’s existing 10% shareholding in EA. The Saudi fund is likely to own the majority.
This structure suggests limited scope for similar deals. The PIF’s total portfolio is worth more than $900 billion, and it had previously earmarked $38 billion for gaming investments. Yet EA alone will probably account for about 2% of its fund. Even a giant sovereign investor cannot make many such concentrated bets on private companies. Besides, the deal runs counter to the PIF’s stated mission of boosting investment in Saudi Arabia.
Will this buyout produce better results? That’s also far from certain. A back-of-the-envelope calculation suggests the buyers could earn a 10% internal rate of return after five years – roughly half the figure private equity investors aim for. Maybe artificial intelligence will supercharge EA games like “FC” and “Battlefield”. Perhaps the PIF has other objectives. But Silver Lake must be hoping that EA will not replace TXU as the set of initials that private equity buyers would rather forget.
CHART OF THE WEEK
Hong Kong’s real estate market is down more than 30% since 2021. Yet most banks in the financial hub have so far avoided big losses. That’s in part because the Hong Kong Monetary Authority clamped down on lending when interest rates were low. The result of this real-life stress test will resonate far beyond the Chinese territory.
THE WEEK IN PODCASTS
Since the beginning of last year, Reuters Commentator-at-Large Hugo Dixon has been making the case for Western countries to use $300 billion of frozen Russian assets as backing for a loan to Ukraine. Now EU leaders have endorsed the idea. On The Big View this week, Hugo explained how it works, and why it’s so urgent.
Donald Trump is doing his utmost to undermine the independence of the Federal Reserve, including by trying to fire Governor Lisa Cook. On this week’s Viewsroom, Gabriel Rubin and I debated what the Trump administration is trying to achieve – and what could go wrong – with Aimee Donnellan and Jonathan Guilford.
PARTING SHOT
What do you get when you combine a company with no revenue, 15,000 acres in Texas, a former U.S. energy secretary, and dreams of building nuclear-powered data centres? The answer: about $15 billion. That’s the value investors put on Fermi FRMI.O following its stock market debut this week. When we look back on the artificial intelligence frenzy, I suspect this will be one of its defining moments.
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Hong Kong has worked hard to prevent a leveraged property bubble https://www.reuters.com/graphics/BRV-BRV/zjpqoleowpx/chart.png
(Editing by George Hay; Production by Oliver Taslic)
((For previous columns by the author, Reuters customers can click on LARSEN/peter.thal.larsen@thomsonreuters.com))