Pirelli has been under the spotlight since the beginning of the past week.
The company, which is among the main players in the global tyre industry and leader in the high-end segment of the sector, has been characterised by a reorganisation of the shareholders structure. Rosneft, the biggest oil producer of Russia, has become the largest investor of the group paying a consideration of roughly €500M (or €12 per share) for the 13% of Pirelli. The participation is held through a stake of Camfin, which is a holding company that backs Pirelli.
Market reaction to the deal
Market reaction has been extremely negative so far: Pirelli is down more than 9% this week, below the psychological level of €11 per share.
Let us try to understand why market reaction has been so adverse. We identified two main drivers of the downward spiral: on the one side, it is due to Russia – Ukraine turmoil; on the other side, the speculative appeal of the stock has disappeared.
Indeed, even though markets seem to have already perceived the riskiness of the situation (that we covered last week, there is still the threat of sanctions for Russian companies, in particular for state-owned corporations as Rosneft.
The second reason, which we deem to be more reliable, relates to the end of speculations about Pirelli as a potential target for M&A.
First of all, it is necessary to quickly describe the very complex shareholders structure of the tyres maker. Marco Tronchetti Provera, the chairman and CEO of the group, controls Pirelli through Camfin, an investment vehicle that holds approximately 26% of it. Camfin was 40% owned by the Italian manager; the other relevant shareholders (before the announcement of Rosneft deal) were Clessidra (a private equity fund), and the two Italian major banks. Of course, Clessidra has had an exit strategy from day 1: there was an agreement according to which a buyer for the stake must have been found by 2017, ensuring a profit to the fund.
The situation was already known in June 2013, but the most impacting rumours had started at the end of January 2014. In fact, according to a news reported by the Financial Times, the private equity arm of Goldman Sachs, along with Tronchetti Provera, were thinking about taking the company private. The businessman, however, said that he had not received any offer nor he was going to co-buyout Pirelli, on the same day in which the story was published. Nonetheless, there were still some rumours and the shares were still above €12 two weeks later.
With the entrance of Rosneft, all the speculations have disappeared, since the industrial investor seems to be there for long-term strategic cooperation. This last point can actually be, on the opposite, a positive factor for the future of the firm. In fact, the two companies have already worked together: Pirelli tyres are marketed in Russia through a commercial agreement with the oil producer; moreover, the two companies may be investing together on synthetic materials for tyres; finally, the entrance of a strong partner can help in giving stability to the firm governance.
The analysis of the stock
Going to markets, we found that Pirelli has been trading at premium compared to its closest competitors recently. The two main reasons that we have considered to justify the premium are:
1) Business specific factors and competitive advantage
2) Speculations about a potential bid to buyout the company
The company is focused on the premium market, which should encompass higher margins. Moreover, in a stagnant European automotive market, high-end consumers are still an important source of revenues. After that, Pirelli is geographically diversified, with a strong presence in emerging markets that, despite a slowdown of growth, are still a factor for the future potentially.
However, still coherent with what we have said so far, we believe that speculation has been the main driver, in particular in the short-term. It is also relevant to stress that the current upward trend has started just before June 2013, when the arrangement with Clessidra was announced. Anyway, we think that, as the main driver of short-term growth for the stock has disappeared, the upside potential must be considered to be smaller than before.
In the medium to long term, however, there is a number of positive factors that will be probably priced by markets: in particular, once Russian turmoil will have calmed down, it will be realised that the strategic investment of Rosneft will give an enormous chance to further penetrate the Russian market to Pirelli. Moreover, the oil company may even decide to increase its stake, assuming also a future exit of Tronchetti Provera from the company in the next years.
Finally, just to give a look also to the stock graph, we would like to highlight the following:
The stock is clearly oversold; also some technical indicators, like Bollinger Bands, outline an extreme situation. However, it does not necessarily mean that there will be a rebound of the price in the next days. Indeed, by giving a look to volumes (essential to confirm the strenght of a directional movement), we can appreciate that they have been 2-3x the 25 days moving average: some “fast money” investors seem to have clearly lost interest in the stock and they have probably exited (or even reversed) the position. We think that, in such situation (high volatily, different factors involved), it is very risky to take a position on the stock for the very short term. Giving general levels, if 10.81 will resist, it will be a good signal for market; nonetheless, we need to bear in mind that Pirelli is extremely exposed to general confidence of markets right now, being linked to Russia. So, 10.35 – 10.20 will become a very important level in case of bearish break with volumes.
The very last thing is about an arbitrage that may have arisen: Pirelli has two classes of shares listed, the ordinary shares and the non-voting shares. We know that the spread between the two should be influenced by the probability of a takeover (a bidder is interested in voting shares): as a consequence, it may significantly fluctuate. Given the entrance of Rosneft, the probability of an external takeover has shrunk in the short term, thus the spread should have diminished. Nevertheless, Pirelli Rsp (the non-voting shares) are very illiquid compared to ordinary shares: consequently, the price may have not reacted efficiently.
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