November 20, 2001
Article 24 of 35
European Markets
The Wall Street Journal Europe
Page 18
(Copyright (c) 2001, Dow Jones & Company, Inc.)
PARIS -- Four times a year, French stock market officials meet behind closed doors to eject companies that no longer make the grade in the CAC-40 index and to name the firms that will replace them.
This October, people in the know say, they decided to give it a miss. In a way, it's understandable.
If they had met as usual, some big names like insurer AXA SA and luxury retailer LVMH Moet Hennessy Louis Vuitton may have been unfairly penalized for lost business after the autumn's tragic events. Both stocks lost about 30% within weeks of Sept. 11, though they have bounced back since then.
But insiders say the market officials may shuffle their selection list in January, if not before. And when that happens, there may be some surprises.
Such as? How about Alstom SA being let out the back door while Vinci is ushered up the red carpet?
That would be bad news for trains-to-turbines company Alstom, whose decimated stock is inching up as bargain hunters warm to the company again. Alstom shares have lost nearly two-thirds of their value since June after the company encountered financing and order problems.
Another firm asked to leave the CAC-40 party, low-voltage electrical equipment supplier Legrand SA, gave up 12% of its value the month after news emerged of its impending expulsion from the index basket.
Why? Companies on the exclusive list are must-buys for index-driven funds; stocks that aren't don't have that built-in advantage.
"Index funds will have to sell (Alstom shares)," explained James Stettler, an analyst at Dresdner Kleinwort Wasserstein.
Shares in contractor and construction company Vinci -- which now boasts a market capitalization of 5.4 billion euros compared with Alstom's 2.7 billion euros -- should, on the other hand, have some significant upside potential if they pass muster. Orange, for example, shot up more than 20% three weeks after its imminent CAC-40 entry was announced.
Mighty Alstom, which evolved from a union of the power and transportation activities of France's Alcatel and the U.K.'s General Electric Co., has long been a symbol of French pride and power. It makes sleek TGV trains that slice through the French countryside, subway cars, cruise ships and power stations.
But Alstom made several big-time blunders this year, overleveraging itself in some key areas, and it failed to come clean with the market early enough.
It all started with power. Last year, news leaked that one of the company's gas turbine lines had faults, prompting the company to set aside 1.6 billion euros of provisions against potential customer compensation. Alstom made more than half of its 24.5 billion euros in revenues for the year ended in March 2001 from power products.
Then in September, key customer Renaissance Cruises went belly up and brought Alstom stock crashing down.
The reason? Alstom said it provided vendor financing to Renaissance for eight ships -- a common practice in capital-intensive industries but a gamble in unsure times.
Alstom reckons its maximum exposure is 684 million euros -- much higher than original analysts' estimates of 200 euros-500 million euros. At least one analyst calculates a worse-case scenario of 1.6 billion euros in exposure.
"They've said they can manage the situation," said Chris Heminway, an analyst at Lehman Brothers, on the Renaissance issue. "But in a company like this, where does the next accident come from?
Try transport, which kicks in another 22% of revenue.
In November, Alstom confirmed quality problems with some trains it sold to U.K. customers.
Management declined to provide more details, but did disclose first-half debt of 2.05 billion euros -- up 26% from 1.63 billion euros earlier. That pushed its debt-to-equity ratio up to 95%, or 40 points above its debt-to-equity ratio on March 31.
Martin Skanberg, who manages the SEB Investment Fund, believes true net debt levels -- including financing, provisions and its full liability exposure -- are closer to 5 billion euros; HSBC pegs the company's debt-to-equity ratio at 143%, by its own criteria.
Other bad news, in the wake of Alstom's first-half results: The company may not meet its 2003 6% operating margin target -- plus provisions of 110 million euros for the Renaissance ships -- if it stops there.
That's unlikely, given slowing demand for power equipment and cruise ships, a bruised reputation, and a U.S. economy teetering on recession.
As a result, Alstom stock hit bottom earlier this month, at an all-time low of 12 euros, putting the company's market capitalization at 2.7 billion euros -- in small-cap territory and at the bottom of the CAC pile.
Expulsion from the CAC would, therefore, "not be a surprise," said a Paris-based analyst. And the damage would be "double -- on the day of the announcement and on departure day," he said. Nearly 30% of Alstom's shares are held by North American investors. Alstom management declined to comment.
Late afternoon Monday, Alstom shares fell 1%, or 14 European cents, to 13.80 euros.
While Alstom was being ravaged, Vinci was chugging along and snapping up far less sexy -- but safer -- investments like carparks and tollroads.
Those sorts of cash cows only account for about 8% of revenue, but bring in a whopping 60% of profits.
Vinci's other major businesses are construction and roadworks, which bring in 41% and 31% of revenue, respectively. Vinci's overall revenue rose by only 3.6% in the first half of this year, but maybe that's what investors want right now: steady and reliable growth -- and no surprises. Net profit, however, was up 31%, leading 11 of 12 banks to recommend Vinci as a buy.
"Organic growth of 3% in this environment isn't bad," said a Paris-based analyst.
Unlike Alstom, luck seems to be on Vinci's side.
In August Vinci made a bid for airport operator TBI PLC when air travel was already showing signs of slowing but later dropped the deal through a legal loophole. And week before last Vinci snapped up automotive assembly machinery maker TMS.
"We will remain relatively untouched by the crisis if we seek businesses with recurring revenue," Vinci's chairman, Antoine Zacharias, said.
Vinci said it has heard speculation about an imminent entry into the CAC. "We meet the criteria," a company spokesman said. "Our liquidity is growing, we have a 65% float and ours is the second-best performing (French) stock since July 2000."
Late afternoon Monday, Vinci shares were up 2.9%, or 1.85 euros, at 65.90 euros.
There are clearly other candidates for the CAC-40: luxury-goods maker Hermes International, for example, has a market capitalization just above Vinci's.
But if Alstom exits, the CAC selection committee may want another big industrial group to make up the weight.