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Heidelberger Druckmaschinen: Sell on manroland Merger News Strength

Several German media have been reporting that Heidelberg Druckmaschinen AG (HDD GY), the German based number one global offset printing press maker, is considering a merger with manroland AG, the privately owned global number two player. Although not confirmed by either company, the reports have been mentioning that both companies have hired investment banks to advise on a potential deal, and that the talks have been triggered by Allianz, which owns 65% of manroland and 12% of Heidelberg.

Although such a deal would make perfect sense from a (cost) synergy point of view, there are significant number of obstacles for any value creating merger scenario:

1) Competition approval: If a manroland-Heidelberg Druck merger would be announced, we would be highly sceptical of US and European regulatory approval for such a combination, given that the tie-up would create a company with 65% of the (global) global sheet-fed printing market.
2) Hard cost savings potential: Although a merger would realize significant value by overlapping job cuts, we believe that such cost savings would be less easy to achieve after Heidelberg received a €645m government loan guarantee in August 2009 (i.e. 50% guarantee of a €300m KfW state-owned bank loan and 90% guarantee of a € 550m bank loan). A transfer of the guarantees to a new merged company structure would require the approval of the governments, who are particularly sensitive to job cuts, and could prevent the realization of significant (job cuts) cost savings value. Cost savings will need to be realized on top of the low-hanging fruit restructuring and cost cutting activities which Heidelberg has already achieved.
3) No solution for the structurally declining business: With the gradual shift away from traditional print media advertising to non-print (internet), the offset printing market is in structural decline: the commercial printing equipment market did not grow in the last boom cycle, and further declines will happen even if the next upcycle is ready to start. A combination of 2 entities in this market will not solve this situation, but will result in a combined entity that will face tougher pricing environments and further margin pressure.
4) Merger exchange ratio highly likely to be less advantageous for Heidelberg: With Allianz expected to be the main driver behind the merger process and a 65% shareholder in manroland and a 13% holder in Heidelberg Druck, we believe that Allianz will favour more beneficial merger terms for manroland than for Heidelberg.
5) A merger scenario does not remove the need for rights issue: Although the new financial package that Heidelberg signed with the German governments/banks prevented its immediate bankruptcy, the group continues to stack up losses and bleed cash (expected 2009 year end net debt of €760m on 2009E EBITDA of 41m). We believe that manroland -being private equity owned- carries an equally large net leverage.

We, hence, recommend investors to short Heidelberger Druck on manroland merger news driven share price strength.

Disclosure: Short HDD GY