BY CHRISTOPHER THOMPSON

Electric-car maker Tesla is worth an eye-popping $540 billion despite a puny 0.8% global market share. It’s an opportunity for boss Elon Musk to use the company’s hyped-up stock to merge with an old-line business, just as AOL did with media titan Time Warner 20 years ago amid the dot-com bubble. Mercedes-Benz maker Daimler is the best fit.

Analysts’ earnings projections for Tesla in 2021 have fallen by nearly one-fifth since their peak in August 2018, according to JPMorgan. Yet the company’s shares surged almost sevenfold in 2020 alone, most recently boosted by its coming addition to the S&P 500 Index. Musk’s company is worth more than the next four most valuable global automakers combined, led by Toyota Motor, while producing only around 500,000 vehicles annually against more than 10 million in 2019 at Toyota and Volkswagen.

Speaking at a conference in December, Musk himself seemed open to the idea of a deal with another carmaker. Tesla’s existing aspirational customer base might best suit a luxury marque. And one with a low-voltage electric-vehicle strategy could allow Musk to add most value.

U.S. rivals Ford Motor and General Motors hardly fit the former criterion. Europe’s VW, meanwhile, is all-in on EVs. BMW might be Tesla’s most obvious fossil-fuelled counterpart, but family ownership probably rules out a takeover.

History shows the difficulty of buying any big Japanese company, while a supercar producer like Lamborghini, which VW may soon offload, would be too niche. One name remaining is $74 billion Daimler, the world’s biggest-selling luxury carmaker, whose shares have trailed the benchmark STOXX Europe 600 Auto index over the past 5 years.

Tacking on a largely combustion-engine business would dilute Tesla’s pure-play EV credentials. And Musk would have to grapple with the constraints of a German governance structure. But adding Daimler could increase Tesla’s global car output around fourfold. And the German group’s deep foundations in Europe and China, the two biggest battery-vehicle markets, would reinforce Musk’s electric offensive. Daimler even had a small stake in Tesla for a time.

There’s a kicker, too. Under U.S. stock-exchange rules, Tesla would only need shareholder approval if it increased its outstanding shares by 20%. At Tesla’s equity value, Musk could theoretically snap up a target worth $100 billion or more. With a luxurious 40% premium, he could buy the Benz empire without even asking permission.

First published Dec. 3, 2020

BY LAUREN SILVA LAUGHLIN

U.S. airlines need more than a little help. The “Big Four”— Delta Air Lines, American Airlines, United Airlines and Southwest Airlines – have been pleading for additional bailouts as Covid-19 continues to crimp travel. More cheap money is an option. But consolidation would also help, and probably leave taxpayers – if not consumers – better off. In 2021, the big carriers will shrink from four to three.

Airline mergers aren’t easy. Unionized workforces that rank pilots based on seniority, for example, make it hard to mash companies together. And competition regulators don’t like it when too much power ends up in the hands of too few players, though U.S. antitrust authorities have permitted some industries, such as mobile telephone operators, to concentrate to just three players.

But consolidating makes financial sense. Most other countries have a single flag carrier implicitly or explicitly backed by the state. America doesn’t, but pandemic bailouts have made the Big Four quasi-government-owned, giving the public a stake in their future. And merging hasn’t worked out too badly for consumers so far. Ticket prices adjusted for inflation have halved since 1995, when America’s skies were awash with carriers, according to the Bureau of Transportation Statistics.

American, which has lapped up $13.5 billion in taxpayer cash, is in the worst position. The Texas-based carrier has $25 billion of net debt, roughly 6 times its forecast EBITDA for 2022, according to Refinitiv estimates that assume three-quarters of sales return in two years. United is next but with debt levels only half as daunting.

Yet 2022 is a long way off. If revenue rebounds only 70% while costs remain stable, American’s EBITDA plunges to just $335 million – not a crazy assumption given the expected long-term impact on corporate travel and airlines’ outsize operating leverage. That jeopardizes interest payments.

A deal may be better for taxpayers than restructuring. One between American and a rival might mean ditching routes. Shareholders of the healthier partner may balk at taking on added problems. But cheap government funding could help.

And regulators also have a history of turning blind eyes to competition concerns during a crisis, such as in 2008 when JPMorgan bought Bear Stearns and Bank of America scooped up Merrill Lynch. If the alternative is bankruptcy, a merger stamped by the government can’t be ruled out.

First published January 2021

BY LIAM PROUD

Christian Sewing has had a surprisingly good year, but 2021 will be harder. The chief executive of 17 billion euro Deutsche Bank will most likely have to abandon his medium-term profitability target. Reviving a merger with rival Commerzbank is the most logical Plan B.

A pandemic-fuelled trading boom, relatively low loan losses and heavy cost cuts have helped Sewing in 2020. Deutsche’s shares are up 17% in 2020, while the Euro STOXX Banks Index is down 45%.

In 2021, however, it will become clear that Sewing’s targeted 8% return on tangible equity for 2022 is out of reach. It would require Deutsche to generate 24.5 billion euros of revenue, according to Breakingviews calculations based on Sewing’s own cost targets and analysts’ estimates for loan losses. Even if investment banking income holds steady – which is unlikely as volatility fades – the rest of Deutsche would have to grow at a 1.1% average annual rate. Analysts expect the top line to shrink instead.

Sewing’s alternatives are limited. There will be little fat left to cut by 2022, since he has pledged to reduce costs by one-quarter from 2018’s level, and exited businesses such as equities trading.

Dusting off the aborted 2019 Commerzbank deal would help. A merger could generate 2.9 billion euros in annual savings, based on the 12% of combined expenses targeted in the recent Caixabank and Bankia merger. Add that to the two banks’ forecast net income, and the new group’s ROTE would reach 7% in 2022, according to Breakingviews calculations based on Refinitiv data. A solo Deutsche would churn out just a 3.1% return that year, analysts reckon.

Sewing’s cleanup makes his bank a more appealing partner than in 2019, when the lenders called off talks citing execution risks and capital requirements. Deutsche has shed 27 billion euros of risk-weighted assets through its bad bank and should finally generate a profit in 2021. European regulators have also made it clear they won’t necessarily raise capital requirements after mergers.

Finally, Commerzbank’s equity value has slumped since early 2019. Assuming a 30% acquisition premium, Deutsche shareholders would own 70% of the new bank, versus 60% in early 2019, giving them more of the upside. Sewing’s revamp might not deliver the hoped-for returns. But at least it’s making Deutsche fit for a deal.

First published Oct. 28, 2020

BY KAREN KWOK

Nothing makes a blockbuster like superheroes improbably matching up on-screen to take on teams of baddies. The same dynamic could apply to the real-life movie business. If Iron Man and Thor can lock arms, why not a cinema chain with a streaming giant like Netflix, Walt Disney or Amazon.com? Bundling subscriptions with theatre access might serve as a key differentiator.

Cinemas have been reeling from forced closures during the pandemic, delays of big movies, and the threat of online entertainment providers. Shares of AMC Entertainment,Cineworld and Cinemark, the three biggest chains, tanked in 2020. AMC’s woes meant it had to agree to let movies go from theatres to online much sooner.

The streaming giants are engaged in trench warfare as Walt Disney, Apple and AT&T aim for a slice of Netflix’s dominant market share. Consequently, Reed Hastings’ company is expected to see revenue growth slow to 18% in the next fiscal year, down from 24%, analysts polled by Refinitiv estimate. In the latest example of rising competition, AT&T’s Warner Bros will release its 2021 slate simultaneously in both theatres and on HBO Max, its subscription service.

Taking over a cinema chain could aid marketing efforts by offering an extra avenue beyond the couch for the increasingly original content Netflix and others are championing. Upselling subscribers to premium prices with theatre access can also be a lever to dislodge shared plan accounts. Amazon can even use theatres to reinforce other e-commerce services like lockers for pickups, and to test innovations like virtual reality.

It would come at a steal. Cinemas are worth half of what they were at the start of 2020: AMC and Cineworld together own over 1,770 theatres, and in mid-December were valued at $450 million and $1.2 billion, respectively, while the top U.S. chain, Cinemark, with 533 locations, was worth$1.9 billion. They’re rounding errors next to $1.6 trillion Amazon or $2.2 trillion Apple.

Hollywood arguably will need physical theatres more than ever as it prepares a post-pandemic rollout of its stockpiled big-ticket films. More than half of Americans surveyed by EY said they were more likely to stream movies that had been released in cinemas. That’s a validation of box office power that should whet the M&A whistles of the streaming giants.

First published December 2020

BY LIAM PROUD AND JENNIFER HUGHES

HSBC Chief Executive Noel Quinn has the right idea, but he’s going about it too slowly. In 2021, a lagging share price may force him to turbocharge his pivot towards the more lucrative Asian business. Selling the bank’s U.S. retail network and spinning off its ring-fenced UK unit would help.

Like his predecessors, Quinn is freeing up capital to invest in Asia by cutting elsewhere – specifically HSBC’s U.S. operations and European investment-banking business.

Yet between him taking charge in August 2019 and mid-December 2020, the bank’s shares had fallen by a third; rival Standard Chartered was down a quarter over the same period. At a multiple of 0.7 times expected tangible book value, HSBC was trading at a 16% discount to global rival Citigroup in mid-December. It was valued at a premium when Quinn stepped up.

Time to accelerate the strategy. Though HSBC is already cutting roughly a third of its U.S. retail branches, offloading the unit would be cleaner. The division’s $21 billion in consumer loans implies a tangible book value of $1.6 billion, based on the capital typically carried by other U.S. retail banks. Citigroup would be a logical buyer, if regulators approved.

A more radical move would be to spin off HSBC’s UK retail and commercial unit. Local ring-fencing rules mean that its roughly $300 billion of deposits are effectively trapped in the country, where they mostly fund local mortgages and business loans. Handing shares in the business to HSBC investors would create a stand-alone unit which could participate in any future bank consolidation in Britain. On the same multiple of tangible book value as UK rival Lloyds Banking Group it would be worth $15 billion.

Jettisoning American and British businesses acquired during HSBC’s westward expansion in the 1980s and 1990s would focus investors’ attention on its operations in Asia, which in 2019 generated an adjusted return on tangible equity of 15.8%. The region would then account for more than half of HSBC’s risk-weighted assets, compared with around two-fifths in June. In theory, a higher valuation should follow: regional peers like DBS trade at a premium to tangible book value. Quinn’s pivot to Asia needs a shot in the arm. The best way for him to achieve that will be to lop one off.First published December 2020

BY OLIVER TASLIC

Big Tech will go shopping for computer games in 2021. Alphabet-owned Google and Amazon.com are trying to muscle into the $175 billion industry by letting people play games on any screen for a monthly fee, much like Netflix did for television. But as the streaming giant showed, success depends on exclusive content. Acquisitions will be the fastest way for the tech giants to reach the next level.

Amazon’s Luna gaming service and Google’s Stadia let the companies’ vast data centres do the technological heavy lifting involved in running a game. That allows internet-connected players to stream high-end titles on low-end hardware, dispensing with pricey consoles like Sony’s PlayStation and Microsoft’s Xbox. Broadband speed is still a major issue: at its highest resolution, Stadia’s recommended network speed excludes about a quarter of British households. But improving infrastructure and the arrival of super-fast 5G connections should help.

The bigger question is what subscribers will play. Microsoft has not been afraid to splash out to improve its subscription service, dropping $7.5 billion on “Fallout” publisher ZeniMax Media in September. Sony, meanwhile, recently spent over $200 million on “Spider-Man” developer Insomniac Games. The more content Sony and Microsoft add to their subscription services, the more likely gamers are to stick around. Global gaming M&A reached $11.1 billion in the first nine months of 2020, according to PitchBook data, more than in the whole of the previous year.

Google and Amazon have yet to make any major purchases, preferring to fill their services with third-party games that are available elsewhere. With combined cash reserves of almost $140 billion, they could in theory afford any target, including industry heavyweights like Electronic Arts and Take-Two Interactive, valued at $40 billion and $22 billion respectively in mid-December. However, it would make little financial sense to limit established games like EA’s “FIFA” soccer series to a single platform. A more realistic target might be a publisher with a history of developing compelling single-player games, like $7 billion Square Enix, maker of the “Final Fantasy” series. Buying individual studios rather than sprawling publishing houses would also make sense.

Any major acquisition by a Big Tech company would likely draw regulatory scrutiny. If Netflix is any guide, though, buying engaging content will be vital to being crowned gaming king.

First published December 2020

BY GINA CHON

Microsoft still has a shot at going viral without TikTok. The software giant lost out on the chance to buy the video app after its Chinese owner was forced to sell on national security grounds. But a better fit may be gaming chat service Discord, valued at about $7 billion according to TechCrunch. It’s a cheaper, and less politically fraught, way for Microsoft to chase new users.

By trying to acquire the U.S. assets of TikTok, Chief Executive Satya Nadella showed where his firm’s ambitions lie. TikTok would have given the $1.6 trillion Microsoft a social network of younger-skewing adherents. Owner ByteDance decided to instead sell a 20% stake to Oracle and Walmart in a deal that values TikTok at around $60 billion. In September, Microsoft bought ZeniMax Media, owner of popular game “Doom,” for $7.5 billion.

Discord offers some of what Microsoft missed out on. Its users chat in topic-based channels – called servers – by text, voice, video and pictures, all of which can be public or private. In June, the network co-founded by former game developer Jason Citron had over 100 million monthly aficionados, twice the number it had a year earlier. That’s around one-seventh of TikTok’s global users, but roughly the same as Microsoft’s Xbox Live gaming service.

There’s more overlap than with TikTok too. As well as gaming, Discord is gaining ground in education, where teachers and students use it for remote learning and study groups. Discord arguably looks like a consumer-facing version of Microsoft’s Teams messaging service. It also makes money through subscriptions rather than advertisements, which puts it closer to Microsoft’s own model. With $138 billion in cash, Microsoft can easily afford Discord.

Not that it needs a deal. Analysts already expect the software giant to grow revenue more than 10% for the next three years according to Refinitiv. And chasing consumers brings its own perils. Discord had to do damage control after white supremacists used its platform to plan a rally in Charlottesville, Virginia, in 2017. Social networking isn’t for the faint hearted. If that’s where Nadella’s desires lie, though, Discord may not be a bad way to gratify them.

First published Dec. 9, 2020

BY JENNIFER HUGHES

Most chief executives like to think big and Charles Li has been no exception. The outgoing boss of the Hong Kong Stock Exchange built a link with mainland China that handles large trading volumes every day and tried and failed to buy his London rival for $39 billion. That legacy and a spate of recent deals across the industry might tempt his replacement. It would be better to resist any such urges and focus on shoring up the company’s strengths.

In the decade under Li, Hong Kong Exchanges & Clearing solidified its position as a gateway to the People’s Republic. With a $63 billion market value in mid-December, it was jockeying with CME to be the world’s most valuable trading hub. Competition is rising for HKEX, however, as Shanghai and Shenzhen lure the sorts of startups that traditionally considered heading southward to sell their shares. The danger is that the next Tencent doesn’t reach Victoria Harbour.

Sizeable acquisitions will be tough and financially ill-advised for HKEX, though. Even as Nasdaq branches into regulatory technology with its $2.8 billion deal for Verafin and the London Stock Exchange aims to wrap up its $27 billion takeover of data provider Refinitiv, the Hong Kong bourse could be stymied from any similar M&A efforts because of its board’s close ties to Hong Kong’s Beijing-backed government.

A new chief would do well to devote energy and capital to fixing the outdated HKEX technology while also expanding further beyond equities into bond trading and derivatives. A focus on improving creaky systems, including the one that registers shares, and tackling its relatively high trading costs would carry significant expense. Its rival-beating 74% pre-tax profit margin will be squandered, however, if competitors woo more issuers and investors.

HKEX cannot escape its geography or the politics that cloud Hong Kong’s future. But those aspects are also what differentiate it from most of its peers. And the city’s position as a financial hub is riding to a large degree on the exchange’s success. The bold choice for the next CEO will be to resist the appeal of empire-building and instead doing what it does best, only better.

First published December 2020