Wall Street Journal 08_04_2020

B12| Wednesday, April 8, 2020 THE WALL STREET JOURNAL.

Auto Deal Spreads Alluringly Wide

Fiat Chrysler-Peugeot is one of many mergers offering prospect of huge but uncertain gains

For some, the second quarter is a period that can make or break the year.

DAVID PAUL MORRIS/BLOOMBERG NEWS

Social distancing has been good

forSamsungso far. But the com-

pany’s prospects depend on the

state of the global economy after it

emerges from shutdown.

On Tuesday, the world’s largest

maker of memory chips and smart-

phones delivered better-than-ex-

pected preliminary results for last

quarter: sales up 5% from a year

earlier, operating profit up 3%.

There is no breakdown of the earn-

ings—full results will be released

later—but demand for memory

chips for servers probably helped

overcome the presumed lockdown-

related hit to smartphone and con-

sumer-electronics sales. Semicon-

ductors accounted for half of

Samsung’s operating profit in 2019.

Demand for servers from cloud

services has picked up as more

people work from home, play

games and buy goods online. Mem-

ory-chip prices in the first quarter

were up in the low single digits

from the quarter before, according

to market-research firm Trend-

Force. And memory-chip manufac-

turing is highly automated, helping

maintain supply through business

disruptions.

But more-challenging times could

lie ahead. Smartphone sales may

worsen: The U.S. and Europe didn’t

go into lockdown until the last

month of the quarter. That could

weaken demand both for memory

chips and for displays, another im-

portant segment for Samsung.

And while more people working

from home has temporarily boosted

demand for servers, an economic

slowdown could weaken it longer

term. The looming uncertainty

threatens spending on technology

infrastructure. Half the chief infor-

mation officers surveyed by Morgan

Stanley late last month said they

have cut information-technology

budgets by an average of 2.6%.

Startups, big customers of cloud

computing, have already seen re-

duced funding. Samsung’s $77 bil-

lion cash pile will probably allow it

to weather the crisis better than

most, but the boost from today’s re-

mote working and learning might

not last forever. —Jacky Wong

Working

At Home

Is Helping

Samsung

But more-challenging

times could lie ahead

patched over with an influx of stim-

ulus money, but investors shouldn’t

expect the fallout to end there.

The continuing surge in unem-

ployment will also likely lead to a

decline of patients with private

health insurance, which typically re-

imburses hospitals at far higher

rates than do Medicare and Medic-

aid. State budgets will be strained

as the economic damage mounts,

and both publicly traded and non-

profit hospitals also tend to rely on

debt financing, which adds to the

challenge.

The uncertainty makes it unlikely

that hospitals will be comfortable

investing in new equipment in the

near term.HCA Healthcare,afor-

profit, publicly traded company

which manages nearly 200 hospitals

nationwide, said in January that it

expected capital spending on the

order of $4 billion to $4.2 billion

this year, but announced on March

20 it was putting those plans on

hold. It is reasonable to assume

that hospital systems with smaller

balance sheets will follow suit.

Stocks with business models at

risk have sold off but still fetch

fairly high valuations.Intuitive

Surgicaltrades at nearly 43 times

last year’s adjusted earnings.

Stryker shares go for about 30

times. Those valuations made sense

in a stable, predictable world. But

the longer hospitals are swamped

with Covid-19 patients, the more

likely these stocks are to go under

the knife —Charley Grant

HCAHealthcare

IntuitiveSurgical

Stryker

Share-priceperformance

Source: FactSet

10

–60

–50

–40

–30

–20

–10

0

%

Jan. April

Buying Fiat Chrysler stock without cover is a very risky play given consumer lockdowns.

NAM Y. HUH/ASSOCIATED PRESS

HEARD

ON

THE

STREET

FINANCIAL ANALYSIS & COMMENTARY

Hospital operations have been

thrown for a loop recently. Health

care should be prepared for major

disruption as a result.

For years, hospitals and large

physician practices had a steady,

predictable stream of sales and

profits. The coronavirus disaster

has scrambled that dynamic. Hospi-

tals across the country have sus-

pended elective procedures to help

cope with a surge in Covid-19 pa-

tients. Elective procedures can in-

clude anything from nonessential

cosmetic fixes, such as a rhino-

plasty to more serious surgeries

like hip replacement.

That has hurt medical technology

stocks:Strykerwithdrew its 2020

organic sales growth and earnings

per share guidance on March 31.

Boston Scientificlikewise warned

Thursday that procedure volumes

plunged in March and will affect

sales and profit.

It isn’t just patients and de-

vice company shareholders that

stand to lose. The longer hospi-

tals defer such procedures, the

more red ink they will face. The

short-term revenue shortfall may be

On paper, it is a sensational

time to invest in companies about

to be bought out. In practice, even

the best-laid merger plans are up

in the air.

A popular investment strategy,

risk arbitrage, involves betting on

the gap or “spread” between a

takeover offer and the stock mar-

ket value of the company being

taken over. Following last month’s

market meltdown, spreads on the

auto industry’s biggest deals are

mouth-wateringly wide.

The value ofFiat Chrysler,for

example, is less than half that of

its merger partnerPeugeotonce

dividends and other distributions

agreed by the auto makers are fac-

tored in. If the companies com-

plete their 50-50 merger on the

terms agreed last December, Fiat

Chrysler’s shareholders will get

half the combined company by

providing just 31% of the equity. It

should be a no-brainer to buy Fiat

Chrysler’s stock and cover the po-

sition by selling Peugeot’s short.

This apparent pricing anomaly

didn’t exist even a month ago.

But there is a problem: Inves-

tors can’t short Peugeot right now.

The stock trades on the Paris ex-

change, and the French market

regulator banned short selling for

30 days in the heat of the selloff

last month. Given that the merger

isn’t due to complete until early

next year, following a lengthy anti-

trust review, buying Fiat Chrysler

stock without cover is a very risky

play given consumer lockdowns.

Then there is the thorny ques-

tion of whether the deal math will

have to be revisited. Both compa-

nies agreed to pay their sharehold-

ers a €1.1 billion ($1.2 billion) divi-

dend for 2019. In the economic

shutdown, such payouts seem like

a bad idea. On Friday, both compa-

nies postponed their annual gen-

eral meetings, and thus their divi-

dend decisions, until June.

A bigger question concerns the

€5.5 billion special dividend due to

Fiat Chrysler shareholders before

completion. Depending on how

badly this year pans out, this also

might seem unwise—in which case

the way the transaction’s benefits

are split could look very different.

Fortunately, the companies won’t

need to address this until the end

of the year, by which time the

scale of the current economic cri-

sis should be clearer. However, all

this uncertainty means that entic-

ing deal spread is at this point lit-

tle more than a spreadsheet fic-

tion.

In other cases, the question of

whether a merger will happen is

open. In January, car-parts supplier

BorgWarnermade an all-stock of-

fer forDelphi Technologies. Then,

last week, BorgWarner accused

Delphi of breaching the terms of

their agreement by drawing down

a $500 million credit facility in full.

If Delphi doesn’t correct the situa-

tion, its suitor claimed the right to

call off the engagement. Delphi

stock plunged, opening a gap for

arbitragers.

Most extreme isNavistar Inter-

national. In January, minority

shareholderVolkswagen. offered

$35 a share for the stock it doesn’t

already own. Having traded at a

premium to the offer for all of

February, the stock closed at

$16.69 on Monday. If the deal goes

ahead on existing terms, investors

will more than double their money.

Navistar may be worth a gam-

ble: Volkswagen will eventually

want control, and the spread may

have been blown out of proportion

by hedge-fund deleveraging. But

this game needs to be played with

extreme caution. The old arbitrag-

ers’ world of small, fairly certain

gains has given way to one of po-

tentially huge but uncertain ones.

—Stephen Wilmot

Samsung’squarterly

operatingincome

Source: S&P Global Market Intelligence

Note: Latest quarter is preliminary;

1 trillion won=$823 million

20

0

5

10

15

trillion won

2015 ’16 ’17 ’18 ’19 ’20

A Season of Trouble for the Economy

Spring is supposed to be the

season of renewal, not just in na-

ture but for many businesses. That

will make the blow to the economy

from the new coronavirus crisis

even heavier.

Economic data often give the

impression that U.S. business is a

steadily moving thing, but that

isn’t entirely the case. Rather, dif-

ferent parts of the economy wax

and wane in a regular way

throughout the year. During the

holiday shopping period in Novem-

ber and December, for example, re-

tailers register a jump in sales. The

government and other data provid-

ers use statistical methods to sea-

sonally adjust for such swings and

better capture the economy’s un-

derlying trend.

Take away those seasonal ad-

justments and the second quarter,

more than any other time, is when

the economy really surges. Con-

sider real estate, where the spring

selling season would now typically

be under way. In the second quar-

ter of last year, the National Asso-

ciation of Realtors’ pending home-

sales index, which is based on

when home sales go into contract,

was on average 2.6% higher in the

second quarter than in the first on

a seasonally adjusted basis. But

take away that seasonal adjust-

ment, and it was 32% higher.

Similarly, the second quarter is

when spending on construction

surges as work on building every-

thing from houses to bridges picks

up. Construction spending in the

second quarter of last year was flat

on a seasonally adjusted basis with

the first quarter, according to the

Commerce Department, but with-

out that adjustment it was up 20%.

There also is a great deal of sea-

sonal job growth in the second

quarter, including workers who get

hired on for summer work such as

line cooks in beach town restau-

rants and housekeepers in resort

hotels. From March to June of last

year, the leisure-and-hospitality in-

dustry added 30,000 jobs on a sea-

sonally adjusted basis, according to

the Labor Department, but 1.13 mil-

lion without seasonal adjustment.

It all adds up to a lot. Without

seasonal adjustment, gross domes-

tic product grew at a 13.6% annual

rate in the second quarter of last

year, according to the Commerce

Department, which compares with

a seasonally adjusted 2%.

It might be tempting to look at

incoming data on a not-seasonally

adjusted basis and conclude that

the reality isn’t as bad as adver-

tised. When in July the Commerce

Department reports that GDP con-

tracted massively, for example, one

might think it wasn’t as bad as it

might have been. But that would

be getting it wrong because the ab-

sence of activity that usually oc-

curs in the second quarter will

cause a lot of damage.

That will be particularly true for

those businesses and workers that

depend on the second-quarter

surge. For some of them, it is a pe-

riod that can make or break the

year. For some of them, even in a

best-case scenario, in which the vi-

rus has been contained by the start

of the summer and the economy

starts to regain its footing, the

lost season could mean losing ev-

erything.

—Justin Lahart

Medical Tech Stocks Face a Swoon

OVERHEARD

“You’ll shoot your eye out!”

One reason the plot of “A Christ-

mas Story” works so well is that it

is centered on a familiar maternal

instinct. Unlike obviously dangerous

products like the Red Ryder carbine

action 200-shot range model air ri-

fle Ralphie covets, many supposedly

safe products turn out not to be. A

group of researchers found the

presence of female board directors

made it much more likely that com-

panies do something about that.

According to “The Influence of

Female Directors on Product Recall

Decisions” by Kaitlin Wowak,

George Ball, Corinne Post and Da-

vid Ketchen, medical-prod-

uct companies with fe-

male directors recall

products with high sever-

ity issues 35% faster than

those that don’t have females.

The paper looked at 4,271 re-

calls between 2002-2013 reported

by the Food and Drug

Administration by 92 publicly

traded companies.

Recalls became more efficient

as the number of women on the

board rose. The greater degree of

caution is even starker when the

danger is more of a judgment call.

Companies with female directors

announce 120% more recalls in-

volving low severity issues than

those with all-male boards.

Put another way, executives

are less likely to triple dog dare

their boards to keep a potentially

dangerous product in

stock when at

least one of

their members

is a woman.

MGM/EVERETT COLLECTION