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Rolls-Royce: Capital expenditure cut is result of a no big deals policy, says Nils Pratley

June 20, 2014

Nils Pratley



Has Rolls-Royce, every politicians' favourite engineering powerhouse, run out of ideas? The engine-maker has never before conducted a share buy-back; now it will spend pounds 1bn on its own shares. For good measure, it pledged to the City yesterday that capital expenditure - worth about 5% of revenues last year - will fall to 4% over the next three to five. What's going on?

Not quite as much as it might appear. This is not a case of City short-termism overwhelming long-term investment.

There is a perfectly good reason why capex, expressed as a percentage of revenues, will fall. The big spending on factories to produce the latest engines for wide-bodied aircraft has been made, and sales should accelerate from about 2017. Thus it would be a surprise if capex did not fall. Spending on research and development, which is only part of Rolls-Royce's overall capex bill, should continue as before. The company has not changed character.

What has happened, though, is that management has bowed to shareholders' wishes to give up dreams of big acquisitions. In January it was revealed that Rolls-Royce had been in talks with Finnish group Wartsila, a purchase that would have been worth about pounds 8bn. The strategic appeal was obvious: it might have solved the perceived problem that Rolls-Royce is underpowered in marine engines.

Yet it became clear that shareholders were not keen on reopening talks with Wartsila. A deal would have been a case of too much, too soon. Rolls-Royce has never splashed so much on a single purchase; a rights issue would have been needed; and a euros 2.4bn (pounds 1.9bn) deal, Rolls-Royce's biggest, to buy Daimler out of a joint venture in reciprocating engines in Germany is already in train.

Whether or not chief executive John Rishton now shares shareholders' views on Wartsila, he has decided the deal is definitively dead. "No material acquisitions," are planned he says, thus the decision to direct the proceeds of the sale to Siemens of a gas turbine business towards a share buyback.

The no-big-deals policy looks correct for now. Rolls-Royce has usually performed best when it has concentrated on organic investment and invention, albeit with a few smaller bolt-on deals on the side. That is the 20-year winning formula via which Trent engines have grabbed half the global market in wide-bodied aircraft. The magic has to be repeated elsewhere, such as boats, but you can't blame shareholders for insisting that Wartsila carried too many uncertainties.



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Source: Guardian (UK)


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