SEPTEMBER 2012
SEVENTH EDITION
MAGAZINE London Study Trip 2012
Bringing back big bond business 14
Chinese Currency Controls 28
Crouching Tigers, Hidden Lions 24
FinanceLabs favourite YouTube films 8
and much more...
EDITORS
NOTE
W
elcome to this special edition of FinanceLab Magazine. This issue of FinanceLab Magazine is issued in connection with FinanceLab London Study Trip and written by Study Trip contestants. We start of in the city of our destination, The City; as The 2012 Olympics has come to an end, the first article reveals that UK has more in common with ancient old Greece than just athletics and sports games, namely indebtedness. In an interview with Nick D’Onofrio, managing partner at North Asset Management, the next article gives you key insights on how to make it in the asset management business. Furthermore, the article reveals how North Asset Management has profited from arbitrage opportunities in the European market. Staying in Europe, the next article explores the tough environment for IPOs in Europe by analyzing the market conditions and evaluating the performance of the most recent IPOs. While the market for IPOs is suffering, bond deals are flourishing; the next article explains how current macro environment has benefitted the bond market and brings an overview of recent debt issues. As is turns, the ma-
jority of firms who have issued bonds during the past two decades have used the funds to help finance acquisitions. Thus, the next article explores the M&A market in 2012. As we take a look at the current macroeconomic environment, we take a further look at the US, as we argue that the economy is considerably better off than the indebted euro zone countries. Moving to emerging markets, we look at the Asian Tigers and the slowly, yet steadily, emerging African Lions. Looking further into the by far largest economy out of the Asian Tigers, China, we explore the currency control as we take a look at how the government of China has a strong grip around the renminbi. Turning back to the western markets, we look at recent trends in sales and trading as we analyze the upside potential in equities from a recovery in Europe. Afterwards we take a look at Basel lll and analyze the implications of increased capital requirements. Lastly, we round up this issue of FinanceLab Magazine by moving onwards from public to private. Here, we look at the private equity market as we investigate how the private equity market has been affected by the current financial crisis.
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ABOUT EDITORS
Rune Randrup-Thomsen Sarah Louise Hansen
PROOF READER
Naja Hannibal Ottosen
LAYOUT
Frederik Ploug Søgaard
CONTRIBUTORS
Ole-Bjørn Kolbæk Merit Fatima von Eitzen Rasmus Ditlevsen Jon Rustemi Kaznelson Jens Bech Petersen Kasper Vinther Olesen Tomas Rosales Johan Riis Madsen Mikael Petersen
Mads Axel Schønberg Kevin Hellegård Nielsen Marie Leth Christensen Fabian Berg Jørgen Bråten Nordby Farina Ria Nordam Bastian Aue Kasper Olesen
CONTENT From the Olympus to the UK Nick D’Onofrio, North Asset Management The five biggest IPOs in Europe in 2011 and the uncertainty dominating the IPO market Bringing Back Big Bond Business M&A transactions in 2012 The Global Debt Crisis - Why America is different Crouching Tigers, Hidden Lions Chinese Currency Controls Private equity take-overs Trends in sales and trading Basel III
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FinanceLab is a network and interest organisation aiming to improve financial competences among students through networking, education and hands-on experience. FinanceLab is represented at several universites in Denmark such as Aarhus School of Business, Copenhagen Business School, Aarhus University, University of Copenhagen, Technical University of Denmark, Aalborg University and Niels Brock. Visit FinanceLab.dk
As London Bridge stood in all its pride and glory, few people realized that UK has adopted more than just a few cultural events and traditions from indebted Greece.
From the olympus to the uk BY MARIE LETH CHRISTENSEN
T
his summer London is hosting the Olympic Games. The Games, however, are not the only Greek influences hitting the UK hard presently. The European debt crisis with Greece as its frontrunner is quickly catching up on the British economy. June statistics show that financial stability is deteriorating in the UK, and British GDP is contracting. Will the Olympic Games help boost growth or will they only worsen government finances? The fight to restore growth and decrease debt will continue long after the Olympic battles have ended.
resilience, through higher capital levels and stronger funding structures, have provided some insulation from strains in the euro-area, progress in building capital is slowing and UK bank’s fundIn the Financial Stability Report from ing costs remain high - partly due to June 2012, the Bank of Eng“While the Olym- investors’ concerns land writes “the outlook for about potential financial stability has dete- pic battles will end future losses. Esriorated, particularly in light of mid-August this timates from the heightened uncertainty about year, the fight to Bank of England how, and when, euro-area suggest contarisks will be resolved”. Major restore growth and gion in Spain and British banks do not have large de-crease debt con- Italy could cost UK exposures towards the weakest banks up to GBP tinues” European sovereigns, but their 100bn. While diverexposures towards non-bank sification generates private sec-tor borrowers in many of risk, diversification benefits ex ante. It these countries are significantly larger. also generates contagion ex post. SpeWhile past efforts by UK banks to build cific UK banks that are most exposed
Towards financial instability
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to the Euro-zone crisis include Barclays and the bailed-out Royal Bank of Scotland according to a note published by Credit Suisse in June. In the event of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) leaving the Eurozone, Barclays faces losses of GBP 30bn. and RBS of GBP 22 bn. according to the Credit Suisse note.
The gloomy economy At the same time as threats of spreading contagion from Greece through Spain and Italy to the UK remain high, the British GDP is contracting. As London is celebrating at the Olym-pics opening ceremony, the economic outlook is gloomy. According to the Office for Nation-al Statistics, British GDP contracted by 0.7 percent in 2012 Q2. The drop of 0.7 per cent in the second quarter of 2012 is the third consecutive quarterly contraction in UK GDP. Total output has now declined by 1.4 per cent over the last three quarters in the UK. All four of the main sectors in the UK economy have contracted between the first and second quarters, with con-
struction providing the largest negative contribution to growth. Causes of the drop in growth stem from many sources, such as an extra public holiday to celebrate Queen Elizabeth’s Diamond Jubilee in June, as well as government spending costs and the euro-zone crisis.
ered a significantly contributing factor to the current Greek sover-eign debt crisis. At this backdrop it is worth pondering whether the UK Olympics will prove a good investment in infrastructure or a contributing factor to worsening government finances and further spur the downturn in the UK economy.
Fighting the deficit
Challenges ahead
While athletes are fighting each other in the Olympic arena, British Prime Minister David Cameron is fighting to reduce the UK government’s deficit and improve its finances. Elimi-nating Britain’s structural budget deficit during the next five years in order to strengthen or maintain investor confidence is a central political goal for the government. However, the British economy is due some kind of boost over the coming months. Production looks set to rebound from the hit from the extra public holiday, and ticket sales and visitors’ spending during the Olympics may boost growth. Only time will tell whether the net effect of hosting the Olympics, will be positive or negative for the UK. The Olympic Games held in Athens in 2004 are generally consid-
Clearly, challenges lie ahead. Most Western economies are struggling with high and increas-ing debt levels, China’s growth is stagnating India and Brazil have lost momentum and Rus-sia is overly dependent on high energy prices. Renowned economist Nouriel Roubini fears that because Western problems are due to insolvency, and not illiquidity, policy tools are rap-idly becoming ineffective and useless. Roubini’s views are supported by several leading economists. Thus while the Olympic battles will end mid-August this year, the fight to restore growth and decrease debt continues.
REal GDP Growth pct.
Quarter on quarter
6,0 Quarter on same quarter one year ago
4,0 2,0 0,0 -2,0 -4,0 -6,0
20
07 20 Q3 07 20 Q4 08 20 Q1 08 20 Q2 08 20 Q3 08 20 Q4 09 20 Q1 09 20 Q2 09 20 Q3 09 20 Q4 10 20 Q1 10 20 Q2 10 20 Q3 10 20 Q4 11 20 Q1 11 20 Q2 11 20 Q3 11 20 Q4 12 20 Q1 12 Q 2
-8,0
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By exploiting the dislocations both between markets, North Asset Management profits from the arbitrage opportunities in the European market
Asset management interviews series
Interview: Nick D’onofrio
By Bastian Aue & Kasper Olesen
north asset management
T
his is the first installment in a series of articles based on interviews with successful money managers. In July 2012, we talked to Nick D’Onofrio, managing partner at North Asset Management, in their offices in Knightsbridge, London. In 2002 Mr. D’Onofrio and several colleagues of his from Morgan Stanley in London decided to set out on their own. The decision to start a fund was motivated both by the attractive opportunities they saw in the market at the time and by entrepreneurial drive. Over the decade that North has existed, its funds have received several awards for its impressive performance, including the 2011 EuroHedge Award in the Global Macro category and a Barron’s ranking of 32 out of the 100 best performing hedge funds in the world in the period from 2006 to 2009. Intending to obtain information about the industry that would be interesting to students of finance, we talked to Mr. D’Onofrio about the investment approach of North Asset Management and about what it takes to work in a macro hedge fund.
The Investment Approach
both having potentially a large upside without much downside risk.
The company’s flagship macro fund, MaxQ, is focused on Europe and a few other countries. It primarily trades FX and interest rate derivatives on the short end of the yield curve. Specifically, the portfolio manager tries to identify market dislocations and future trend reversals by assessing factors including fundamentals, the extent to which they are priced into rates, and the feed through effects of public policy on inflation. The fund looks for such dislocations both between markets – such as FX vs. interest rates – and across markets – such as Czech interest rates vs. German interest rates.
When asked about what characteristics allow his fund to profit from such opportunities, Mr. D’Onofrio mentioned size, focus, and ability to trade tactically. Of these, the advantages of moderate size are closely related to both focus and to the ability to trade tactically.
An example of a recent trade mentioned by Mr. D’Onofrio that profited from such dislocations was going long the spread between German and Czech rates, which had narrowed beyond what was justified by fundamentals and historical patterns. Another example was going long the spread between the premiums on Austrian CDS and Belgian CDS which, given the state of Belgian public finances and politics, should be wider than it was. The attractiveness of these trades was augmented by the asymmetry of their expected payoffs,
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It is difficult for the large funds and other institutional investors to make meaningful profits from trades in small and illiquid markets. This, in turn, means that these markets are under-analyzed, leaving opportunities for focused funds, such as MaxQ. In order to benefit from this situation, the fund, of course, has to stay relatively small. It plans to do so by continuing its past practice of closing the fund to new investments whenever it approaches £1 billion. Moderate size also allows the fund to move quickly in and out of positions. Recently, the fund has been positioned to benefit from a worsening of the European crisis, but has managed to shield itself from the sharp reversals caused by policy initiatives by tactically modifying or reversing its exposure in expectation of intervention.
What it takes The rising profile of hedge funds over the last couple of decades has inspired an increasing interest in working in the industry among students, despite the career uncertainty involved. However, the competition for positions is intense, and it is not always clear what it takes to get hired. We asked Mr. D’Onofrio what he looks for when he is assessing a prospective employee. He responded by highlighting four traits that he looks for: a sincere interest in markets, an ability to think critically, a degree of humility, and solid quantitative skills.
First,
the prospective employee needs to be sincerely interested in following and understanding markets and
current affairs. If this intellectual curiosity is absent, it is unlikely that the candidate will be able to acquire the necessary analytical depth needed to identify the market dislocations and trend reversals that North Asset Management profits from.
Second, the candidate needs to
be able to think critically. This encompasses two related skills; 1) the ability to disentangle an overwhelming amount of information, cut through to the key issues, and infer a concise hypothesis, 2) the ability to question prevalent beliefs and hold unpopular opinions.
Third, a degree of humility is re-
mility allows one to continuously question the validity of one’s inferences, thus reducing the likelihood of clinging too long to loss-making positions.
Fourth, the increasingly sophisti-
cated methods and strategies employed by the hedge fund industry make quantitative skills a big comparative advantage. It is possible to work in a hedge fund without a PhD in physics, but, as Mr. D’Onofrio says, “one has to be comfortable with numbers and quantitative models.” For more information about Nick D’Onofrio and North Asset Management see www.northasset.com
quired, in that one acknowledges if one’s analysis is incorrect when new evidence contradicts it. This kind of hu-
Moderate size also allows the fund to move quickly in and out of positions
“...one has to be comfortable with numbers and quantitative models”
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Some of FinanceLabs
If you find yourself laughing after watching these films, you’ve propably passed the
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FinanceLab nerd test
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Bankers’ Song - We Didn’t See It Comin
Baby Got WACC
Brokeback Bankers
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The 5 biggest IPO’s in Europe in 2011
The IPO market is not all bad news; Glencore International PLC managed to raise USD 10bn in May making a dual listing on London and Hong Kong stock exchanges.
By Rasmus Ditlevsen & Jon Rustemi Kaznelson
...and the uncertainty dominating the IPO market Introduction
T
he European IPO market in 2011 was split into two distinct periods. The first two quarters of 2011 continued the positive trend of 2010, whereas the last 2 quarters saw a dramatic decrease in global IPO activity, mainly due to the debt cri-
Euro debt crisis and volatile market is hampering the success and realization of one IPO after another.
sis stretching throughout Europe. The amount of capital raised in 2011 fell 19% from USD 36.7b to USD 29.7b, however the numbers of deals actually saw an increase of 6% from 252 deals in 2010 to 266 in 2011. Even though these numbers might reveal a pan-European economy in trouble, much has improved since 2009 - capital raised increased at a tremendous 396% from
2009 to 2010 and numbers of deals rose 306%. The following will give a brief overview of the European IPO market as well as the largest recent IPOs in Europe. The five biggest IPOs in Europe in 2011 (by capital raised) were all executed within the first half of 2011 reflecting the overall trend of the market.
Source: Ernst & Young Global IPO Trends 2012 Despite the economic conditions and the related uncertainty, some companies found a good window to go through with the IPO. For instance, Glencore International PLC managed to raise USD 10bn in May making a dual listing on London and Hong Kong stock
exchanged, which is becoming more common as companies need to be flexible and keep an open mind towards funding. The uncertainty that the debt crisis in Europe brings to the IPO activity is
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clearly reflected in the VIX index below, or alternatively referred to as the “fear index” (see graph). When the VIX index is above 20% it becomes much harder to make a successful IPO due to the volatility in the market.
“The pipeline of firms waiting to go public remains high. Both issuers and investors are being far more cautious, particularly in light of the difficult current market conditions. They are just waiting for the global market to stabilize and concerns over global growth to dissipate before they decide to become active again.”
“
By investing in the lumbering, deficit (Maria Pinelli, Global Strategic Growth Markets Leader at Ernst & Young) ridden, and low-growth giant you would actually have avoided the huge drops in stock value
“
Source: Yahoo Finance The five companies from the below table revealed that there was a possibility to find an appropriate window where they could go public. The VIX index clearly shows how different the 2 periods of 2011 were. Looking forward, the trend towards the end of the year is relatively positive, where the VIX index is showing signs of a down20% turn in market volatility, to a more IPO friendly level.
The challenge of finding a window of IPO opportunities Retrospectively, the VIX index has been flirting with the 20% line through most of the first half of 2011. Given these circumstances it might not come as a surprise that
2011 was the year where a new record was set, namely the one for most withdrawals or postponed IPOs. So what risk did these 5 companies face when they decided to go public? Increasing volatility and lower investor confidence
result in an increase in perceived risk. In the book-building phase this means the investors want to see a discount in the pricing, i.e. higher volatility implies a higher discount demanded. Using years of strategic thinking, optimization
Last year's stock price development
10% 0% -10%
Glencore
Bankia
JSW SA
-20% -30% -40% -50% -60% -70% -80%
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Banca Civica
Nomos Bank
STOXX Bloomberg 600 European 500 index
and efficiency improvement before the five companies went public ultimately needs to be reflected in their valuation. This requires flexibility and speed, which is the key to success. These tough circumstances have fostered a new approach towards IPOs; whereas before it was seen as a sign of weakness to be in the pipeline for several months without bringing the deal to the market – now its just good business. The uncertainty that dominated the market activity hopefully returns to a steady state at some point. In order for
the market to return to a steady state, historical IPO cycles shows that it takes a few successful IPOs with solid returns after the listing to rebuild investor confidence. The general consensus in some parts of 2011 was leaning towards the perception that the IPO asset class was high risk relative to returns – where it should be a normal part of a diversified investors portfolio. If it takes a few successful deals to give the IPO market a much-needed push, how have these 5 companies performed (see graph)? Looking at the last 52 weeks, which gives fairly good indication of post
IPO performance, Glencore is down 13.17%, Bankia is down 67.65%, JSW SA is down 7.52%, Banca Civica is down 34.6% and Nomos Bank is down 5%. The STOXX Europe 600 price index – which represents large, mid and small companies across the European region – is up by 13.64% and the Bloomberg European 500 Index is likewise up by 12.39%. Even though there should be made no final conclusion on the basis of these numbers, they indicate that these IPOs did, so far at least, not break the IPO cycle.
“The five biggest IPOs in Europe in 2011 were all executed within the first half of 2011 reflecting the overall trend of the market”
Looking forward In the first few weeks of 2012, optimism returned for IPO prospects with the London IPO of Ruspetro and a spate of IPOs launching in the US, including the much-scrutinized Facebook IPO. This reflects some easing of the tough market conditions that plagued the end of 2011 and has been further boosted by the rally in stock market indices around the world in early 2012. Continued volatility is the theme for 2012, as Europe continuously tries to solve its debt problems. There is no
quick fix to the ever-growing debt crisis, which greatly impacts the IPO market. For Q1 2012 9 IPOs were withdrawn, demonstrating that the IPO market is still impacted by uncertainty in the global economy. The European IPO market suffered once again during Q2 2012 with a 68% decline to just USD 915m via 46 IPOs (only 2% of global capital raised this quarter) compared to USD 2.9bn raised via 39 deals in Q1 2012. The weakness of the IPO market reflects not only the tough market conditions but also the number of companies that postponed their IPO plans by 6-12 months following the challenging market conditions in the second half of 2011.
Whilst we expect market volatility to continue into 2012, there will be periods when market conditions will be favorable for IPOs. In this climate, companies will have to ensure that the groundwork is completed well in advance so they can be opportunistic should an IPO window open. Other lessons learned in 2011 include the need for selling shareholders is to be realistic about company valuation and to ensure that the business is supported by a compelling equity story to attract potential investors. Even with these lessons learned and great caution, the 5 biggest IPOs in Europe in 2011 showed how difficult the current environment is.
“Whereas before it was seen as a sign of weakness to be in the pipeline for several months without bringing the deal to the market – now its just good business”
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Bringing Back Big Bond Business BY KASPER OLESEN & TOMAS ROSALES
W
ith a USD 9.8 billion debt issue in May, United Technologies Corporation (UTX) stressed the attractiveness of debt issuance
given current market conditions. The deal is the biggest bond deal since Pfizer’s (PFE) 2009 $13.5 billion bond deal and comes at a time when corporate bond volumes top. Figure 1: 10 year nominal U.S. Treasury rate
The largest single deals in history UTX, the maker of diverse products as Carrier air conditioners, Black Hawks, and Pratt & Whitney engines used the bond issuance to help finance its USD 16.5 billion acquisition of Goodrich Corporation, an aerospace manufacturer. With expected ratings of A2 by Moody’s and A by Standard & Poor’s (S&P), UTX sold bonds at record-low coupons, luring bond buyers away from the turmoil in Europe. Investors happily greeted the new bond deal, and UTX garnered USD 38 billion of bids in the six-part USD 9.8 billion offering, making the UTX deal the most demanded corporate bond deal in history. The six-part deal featured four fixed rate tranches consisting of USD 1 billion of three-year notes at a credit spread of 80 basis points, USD 1.5 billion of five-year notes at a spread of 105 basis points, USD
2.3 billion of ten-year notes at a spread of 135 basis points, and USD 3.5 billion of thirty-year notes at a spread of 173 basis points over comparable maturity Treasury securities (see Figure 1). The company also sold two floating rate tranches with the eighteen month and three year tranches pricing at 27 and 50 basis points over the London interbank offered rate (LIBOR). Acquisitions were similarly the driving force behind the largest ever U.S. bond deals, when the rival drug makers PFE and Swiss Roche Holding (RH) in 2009 acquired Wyeth (a USD 68 billion deal), a healthcare company, and Genentech (a USD 47 billion deal), a biotech corporation, respectively. RH and PFE bonds obtained Aa1 and Aa2 ratings from Moody’s and AA- and AAA from S&P, respectively, placing them well above the UTX rating. Being the largest in history the RH offering was a six-part deal with four fixed rate tranches amounting to enormous USD 12.25 billion. Maturities were similar to the UTX deal but credit spreads of 335 basis points over 14/42
Treasuries for the 3-year and 5-year notes, 345 basis points for the 10year notes, and 365 basis points for the 30-year notes, were higher than today. In addition to this, Treasury rates are also lower now. RH also sold floating rate tranches with one year and two year tranches pricing at 100 and 200 basis points over the LIBOR. The five-part PFE issue offered three, six, ten and thirty years fixed-rate bonds with coupons ranging from 305 to 345 basis point more than comparable Treasuries, and two-year floating rate notes priced at 195 basis points over the three-month LIBOR. A worldwide glance at the largest debt issues introduces three telecoms to the all-time high of bond deals (see Table 1). France Telekom (FTE) comes in second after RH with its USD 16.3 billion 2001 offering, Deutsche Telekom (DT) comes in third with its USD 14.5 billion 2000 offering, and the now bankrupt WorldCom (WC) is fifth in between PFE and UTX with its USD 11.9 billion 2001 deal. Proceeds mainly helped alleviate the large debt loads many big telecoms had acquired. The refinancing was mostly due to several investments in expansion or modernization of the large carriers, such as the bidding on 3G network auctions for DT, and expanding/buying international networks for FTE. Over a period of just one year, the telecom companies each broke records for debt issuances at the time. It seemed investors favored the debt, as all three companies were met by massive demand, with FTE being in highest demand.
Company
Year
Size
Primary Reason
(USD billion)
Tran-‐ ches
Rating
(Moody’s/S&P)
Treasury Spread (10 years fixed)
Roche
2009
16.5
Acquisition (Genentech)
6
Aa1/AA-‐
345
France Telekom
2001
16.3
Refinancing (int. network)
6
A3/A-‐
285
Deutsche Telekom
2000
14.5
Refinancing (3G auctions)
8
Aa2/AA-‐
-‐
Pfizer
2009
13.5
Acquisition (Wyeth)
5
Aa2/AAA
325
WorldCom
2001
11.9
Refinancing
3
A3/BBB+
255
United Technologies
2012
9.8
Acquisition (Goodrich)
6
A2/A
135
Kraft
2010
9.5
Acquisition (Cadbury)
4
Baa2/BBB-‐
188
Ford
2001
9.4
Refinancing
5
A3/BBB+
300
GlaxoSmithKline
2008
9.0
Share repurchase
4
A1/A+
173
General Electric
2008
8.5
Refinancing
3
Aaa/AAA
200
Table 1: the largest bond deals in history. References: see below. They got offers of about USD 25 billions for their original plan of selling 7-8 billions, and as such doubled the scale of their issuance to the USD 16,3 billions. Favorable conditions bypassed high credit risk and skepticism towards the sector for all telecoms. FTE, WC, and DT all offered short-term tranches of 2, 3 and 5-year maturities with coupons as different as the 5.5% floating rate of FTE, 125 basis points above the LIBOR, to DT’s of 7.7% on their dollar 5-year maturities. With the longer-term tranches of 10 and 30-year maturities, FT, DTE, and WC all indicated the credit risk of buying the debt. Coupons went as high as 8.3% for DT’s and WC’s 30-year maturities, 260 ba-
sis points over the 30-year comparable Treasury security. FTE similarly had a spread of 315 basis points over the 30year Treasury.
Current market conditions favor debt issuance With treasury yields and central bank rates in free fall (even down to negative digits for some!) current market conditions favor high-grade debt issuance. Alas, not surprisingly, corporate bond volumes were historically high in the first six months of 2012 with first-
quarter issuance the second highest on record. Companies are seen jumping into the market to get financing plans out of the way with low coupons, even though broader markets are shunning risk. Each maturity is at the low end of earlier pricing guidance, indicating strong demand. Investors appear with a robust demand though insurance companies and the like are discouraged from buying because of low yields. They could sit on their hands for a few weeks or months, waiting for yields to go back up. However for the historical records, UTX brought back big bond business.
Info With its 13.5 billion bonds issue Pfizer was behind one of the largest bond deals in the past few years. The capital raised was used to finance the acquisition of Wyeth. The low interest rate environment yields the perfect opportunity for companies to minimize their debt overloads. An example hereof is Deutsche Telecom who issued 14.5 billion in bonds to refinance their debt. 15/42
LIBOR stands for London Interbank Offered Rate is the rate offered for a short-term loan between banks in London. The Danish counterpart is the CIBOR (Copenhagen Interbank Offered Rate), both common benchmarks for short-term borrowing. Credit Ratings Top layers of Moody’s and S&P’s ratings systems (in descending order) are Aaa, Aa1, Aa2, Aa3, A1, A2, A3 and AAA, AA+, AA, AA-, A+, A, A-, respectively.
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M&A
transactions
in 2012 By Johan Riis Madsen & Mikael Petersen
W
hen exploring the most Now, this was supposed to be an article recent history of the larg- on the biggest deals of 2012. So what est M&A deals one theme has 2012 offered so far? In terms of deal keeps reappearing, phar- size we are far from the level of the past maceuticals. The five largest deals in years with few transactions in double 2011 were all within life science and digits billion USD. However, the trend predominantly between pharmaceuti- of health care domination seems unimcal manufacturers. Among them were paired. Again the top deals so far are all some true mega-deals headed by Ex- in the pharmaceutical sector, however press Scripts paying Medco share- UPS is expected to close its acquisition holders USD 29 billion and Johnson & of Dutch based TNT, which will conJohnson acquiring Synthes for stitute the more than USD 21 billion. In highest val2010 the 5 biggest deals were “The trend is crystal ued deal of all health care related with the clear - if it’s big, it’s 2012 so far. exception of one. The biggest pharmaceuticals” Within pharwas Sanofi-aventis taking over Genzyme in a deal valued at maceuticals over USD 20 billion. In 2009 we have the picture was no different. Pfizer led seen an attempted hostile takeover of the way with the astonishing USD 68 the American biotech company Illumina billion acquisition of Wyeth. Merck & Co by the Swiss health care giant Roche. and Schering-Plough followed with their The initial offer from January of USD 5.7 USD 41 billion merger. No need to say billion representing a premium of 64% that 2008 was the same with at least the over Illumina’s market cap was turned five biggest deals all within health care. down. Finally, in April USD 6.7 billion The trend is crystal clear ”if it’s big, it’s was offered and subsequently turned pharmaceuticals”. down. Roche decided to abandon the offer with the questionable reasoning
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that they no longer believed in the technological potential of Illumina. Roche has in the meantime been involved in the successful takeovers of Genentech and Ventana Medical Systems. One big deal this year reached signing in April. The American generic pharmaceutical manufacturer Watson Pharmaceuticals acquired its European competitor Actavis for an amount of USD 4.3 to USD 5.9 billion depending on the financial performance of Actavis. Watson has already been expanding by acquiring Australia-based Ascent Pharmahealth for USD 393 million in cash in January. Watson CEO Paul M. Brisaro commented on the strategic rationale: “The acquisition of Actavis will create the third largest global generics company, substantially completing Watson’s expansion as a leading global generics company. Actavis dramatically enhances our commercial position on a global basis and brings complementary products and capabilities in the United States”. It seems that economies of scale were major value drivers in this deal as it has been in many previous
The five largest deals in 2011 were predominantly between pharmaceutical manufacturers Express-Scripts’ CEO, George Paz (right) and Medco’s CEO, David Snow in one of the largest Another trend breaker in M&A deals in the the M&A market was the past few years energy, mining & utilities sector deals within the sector. Watson has stated that it expects to save USD 300 million due to cost synergies in the next three years. The synergies are mainly expected in the areas of research & development, selling and general expenses.
veals a combined value of USD 415 billon of announced deals in 2012. As of today, some of the expected deals are uncertain or pending, however, among them could likely be a giant transaction in the energy, mining & utilities sector with Glencore and Xstrata merging together. The deal has a value of approxi-
Although the pharmaceutical industry seems on the rise, the glo- ““Economies of scale were bal M&A activity does not reveal major value drivers in this this across the board. In fact, the market size has decreased by deal as it has been in many roughly 30% as compared to Q1 previous deals within the 2011. The market suffered its fifth sector” consecutive quarterly decline with only the European region showing quarterly increases. The U.S. market mately USD 53 billion and would create went down sharply to 54% compared to one huge company with massive market Q1 2011; (Energy, mining & utilities ac- power. Glencore aims to virtually control counting for over a quarter of deal total the entire value chain of the industry – amount in Q1 2012). The M&A index ranging from extraction to transport and of the Centre for European Economic sale of the commodities. The combined Research confirms the data as its indi- future annual revenues are estimated to cator declined to the lowest level since be around USD 210 billion. August 2009. The reason for such weak performance is largely ascribed to the Another such giant deal – and again in still unresolved European debt crisis the energy, mining & utilities sector – is and the associated uncertainty it brings the acquisition of El Paso by American to the markets with a potential conta- Kinder Morgan, which was completed gion effect that could struck the world in May for USD 37.4 billion. A key stramarket. Nonetheless, M&A activity re- tegic motive behind the deal was the 19/42
addition of 44,000 miles of natural gas pipelines from El Paso, as CEO Richard Kinder explained. His company thereby managed to grow to the fourth largest energy supplier in North America. Furthermore, the same sector records high value transactions with Sesa Goa taking over Indian Sterlite Industries for USD 10 billion and Apollo Global Management buying EP Energy Corporation, in a USD 7 billion deal. It appears that not only the pharmaceutical but also the commodity sectors escape the downward trend in M&A activity. Energy, Mining & Utilities make up 27.5% alone in global market share. Other prominent M&A cases in 2012 were seen in the Google Motorola deal and when Sumitomo Mitsui, Japans third largest bank, acquired RBS Aviation capital, an aircraft leasing company of the RBS group. Despite these and several smaller transactions, the overall market clearly shows that the commodities and pharmaceutical sectors dominate current M&A activities.
With an unemployment rate stuck around 8.3% it doesn’t seem as if Helicopter Ben can stop worrying any time soon.
THE global debt crisis:
Why America is different
By Fabian Berg & Jørgen Bråten Nordby
LUCKY FOR THE US, THE STRONG DOLLAR IS OFFSETTING THE HEAVY DEBT BURDEN. 20/4220/42
I
t has been almost four years since the default of Lehman Brothers Sep 15, where the world experienced the peak of the biggest financial crisis in modern history. The burst of the American housing bubble led to global economic and financial turmoil. What initially started with reckless lending From an economic perspective there are policies in the market for personal and good reasons to be worried, especially mortgage loans in the US eventually considering the lackluster recovery on caused the huge securitized debt mar- the labor market. FED, unlike the ECB, kets to dry up with gigantic losses for has a dual target; to keep inflation close private investors and banks. Four years to 2% and to maximize employment. To later, this has developed into a debt lower borrowing costs for households problem at a country level with all eyes and businesses and stimulate employnow turned towards Europe. The intro- ment growth, the FED has slashed the duction of the EUR made it possible for target rate to 0.0-0.25%, and pledged countries such as Spain, Greece, Por- to keep rates exceptionally low until late tugal and Italy to raise wages and costs 2014. This has not been enough. Fed while borrowing cheap money thanks to has also been forced to use quantitative strong credit quality of countries such easing (QE). The first round, QE1 (Nov as Germany. Lately, the world has to a 2008-Mar 2010) focused on buying back mortgage backed securities (USD large extent only been focused “the debt burden in the US 1.25 trillion) and treasuraround these ies as well as is to a much larger extent countries and debt issued finding a solution justified by the economic by Freddie to save the Euro Mac and Fancycle” zone and the rest nie Mae (USD of the world from 300 billion). a series of national defaults. It almost seems like the world has forgotten the elephant in the Thereafter the Fed announced QE2 room; the US has a larger debt burden (Nov 2010-Jun 2011) where they than the euro zone countries combined bought USD 600 billions worth of longand the budget deficit peaked in 2009 term treasuries to further keep interest at 10.1% of GDP compared to 6.2% for rates on long-term treasuries low. When the euro zone. So why are investors still economists started to worry about inflaunder the impression that the U.S is in tion the Fed responded by introducing better shape than some of the largest Operation Twist in Sep 2011 and it was recently extended to the end of this economies in the Euro zone?
The Federal Reserve’s work towards US economy recovery
year. By selling short-term and buying long-term treasuries, this form of financial intervention will not increase the Fed’s total assets. Despite all unconventional methods from the Federal Reserve the real economy has not yet responded as desired. They are still stuck at an unemployment rate of 8.3%, where the observed decrease in the unemployment rate is largely due to a reduction of the labor force. If the labor force had been the same as pre the financial crisis, the unemployment rate would be as high as 11% clearly illustrating the lack of result from Fed’s unprecedented expansionary monetary policy. After all this arguing of the grim situation in the United States we still think it is in better shape than debt infested countries in Europe.
Why the US is different The US has one major advantage: the dollar! Even though the net result of the Euro crisis is unfortunate for the US economy, and the strong dollar weighs on exports, the current turmoil in the Euro area has further strengthened the Dollar’s position as a “safe haven”. The current economic environment has boosted demand for treasuries, as the USD (together with JPY) is the only currency offering enough liquidity. Consequently, the US borrowing costs are at the lowest since the early 18th century
Budget deficit 4 2 0
%
-2
US yearly deficit 2000
2001
2002
2003
2004
2005
2006
2007
2009
2010
2011 Euro zone yearly deficit
-4 -6 -8
-10 -12
2008
years
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meaning the US can refinance itself at a very low cost despite of its enormous debt burden. That is not the case for the highly debt burden euro zone countries such as Italy and Spain which currently have to settle with refinancing rates as high as 7%. Even considering euro zone aggregated the borrowing cost is higher than in the US as indicated by an EFSF 10y bond recently traded between 50-100bps above the US 10y Treasury yield. Regardless of the cheap refinancing a large fraction of international economists have pointed out the fact that the debt is still building up, and even if they get cheap funding they must at some point start paying down on their debt. This is obviously a good point and something US politicians need to take into
consideration. In the near term however there are very few expecting the faith in the dollar to disappear. The USD is still 62% of global FX reserves (excl. China)
The median age in the US is 36.9 years, while the median age in Italy, Spain and Greece is 44.3, 41.5 and 42.2 respectively. According to macroeconomic theory the average person will follow “US’ attempted economic the same consumption and production pattern throughout his/her life. recovery has advanced
further than that of the troublemakers in the Euro zone” according to the IMF’s latest data, an increase from 60% in 2010. Another important point is the difference between the demographic picture in the U.S and the Euro zone countries.
Early in her life she will consume more than she produces, while in the intermediate part she will produce more than she consumes before she retires and once again consumes more than she produces. Accordingly, a country’s debt situation should to a large extent depend on the demographic distribution of the country, because its inhabitants varies between borrowing and saving for its soci-
35,00 Euro Area
30,00
Germany
25,00
Ireland
20,00
Greece
15,00
Spain
10,00
2012M07
2012M04
2012M01
2011M10
2011M07
2011M04
2011M01
2010M10
2010M07
2010M04
2010M01
2009M10
Portugal 2009M07
0,00 2009M04
Italy
2009M01
5,00
USA
*)The Euro Area yield is the aggregated Euro Zone and not the EFSF ety, hence a large debt can be justified if a large share of the citizens are yet to enter the workforce. These people will transform from a cost into a value-creating asset, which implies that they will create more than they produce in the foreseeable future. The current age distribution in the U.S clearly shows that a large proportion of the population belongs to this age group, hence the debt burden in the US is to a much larger extent justified by the economic cycle. The Euro zone countries on the other hand are at the stage in the economic cycle where they actually should save
money, because a large fraction of their inhabitants will soon disappear from the labor stock. On top of arguments above, the US’ attempted economic recovery has advanced further than that of the troublemakers in the Euro zone. US GDP is increasing and even if the growth is rather slow, the country is gradually recovering. The private sector is also in a good position after reducing their debt level markedly from the peak. The money that has been, and still is, thrown into the US economy, can create the jobs
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that will help the US take advantage of the growing labor force it will get during the next decade and that is an opportunity none of the other indebted countries have.
i
Spain: Age distribution (%)
USA: Age distribution (%)
100+ 90-94 80-84 70-74 60-64 50-54 40-44 30-34 20-24 10-14 0-4
100+ 90-94 80-84 70-74 60-64 50-54 40-44 30-34 20-24 10-14 0-4
Female Male
10
5
0
5
10
The real economic factors still have to recover In conclusion, there are still some issues that need to be solved. The growth that is stimulated from monetary action and quantitative easing must exceed the inflation created by the printing of money and unemployment has to de-
15
Female Male
10
5
0
crease drastically. If this fails, they can risk that the economic interventions push the U.S economy into an even deeper crisis. As a consumer driven economy, the puzzle is complicated; the high percentage of unemployment keeps the consumption low, while the consumption related industries cannot hire more workers before they experience an increase in consumption. The recent boost in the oil and gas sector could be part of the solution, and help put off some of the pressure on the con-
5
10
sumer industry, but there is still a lot of ground to cover. In other words, the U.S economy is far from saved, but it still looks a lot brighter than Italy and Spain these days. The Fed still has time to provide monetary aid, and hopefully the economic recovery will occur before the financing cost skyrockets.  
inve
INVESTMENT CAMP 2012
TENTIONS IN Y M T B U WHO DO TO THOSE IGHT BACK F T O N L IL IW RISE BUT I WILL TOP QUER THE N O C L RISIS IL IW ANCIAL C IN F N W O E PEOPLE PD C M N A TA S IN L F IL T IW BOU HISTORY A E H T ... E IT R W E I SET OFF R O F I WILL RE E B T S AND JU T AT WE’LL MEE T INVESTMEN
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2
CAMP 201
Opening for registrations soon!
Emerging markets
“With its heavy reliance on commodity prices, the Lion might not continue to roar”
Crouching Tigers, Hidden Lions
BY MERIT VON EITZEN & OLE-BJORN KOLBAEK
A
sia and Africa in the struggle for profit generating equity investments in an uncertain economic climate - a comparative macro-analysis with an overview of inherent risk and growth opportunities.
The IC’s in BRIC’s and the rest of the tigers An overarching ambiguity characterises Asia, the region is composed of exceptionally diverse national economies. The economy of Asia comprises more than 4.2 billion people (60% of the world population) living in 46 different states. Asia is the largest continent in the world by a considerable margin, and it is rich in natural resources, such as petroleum, rice, copper and silver. Manufacturing in Asia has traditionally been strongest in East and Southeast
Asia, particularly in the China, Taiwan, South Korea, Japan, India, the Philippines, and Singapore. Japan and South Korea continue to dominate in the area of multinational corporations, but increasingly the PRC and India are making significant inroads.
spectively. From August 2011 onward, global risk aversion surged in response to escalating turmoil in the euro area. In Asia this caused a large withdrawal of foreign equity investments, plunges in regional stock markets, share currency depreciations. So far capital flows to Asia have rebounded throughout 2012, Asian domestic defollowing the sharp enmand has generally “Business is on the trenchment in portfolio remained strong durrise in Africa and equity flow last year. ing the turmoil in the advanced economies, the early bird will Strong economic and buffering the impact of catch the worm” policy fundamentals the weakening exterhave helped buffer nal environment. Camost of the region’s pacity deployment has remained high, economies against the global financial and regional labour markets have been crisis, by limiting adverse financial martight on the back of strong employment ket spillovers and better tolerating the growth and steadily rising real wages. impact of deleveraging by European Domestic demand has benefited from banks. However, growth in Asia slowed the continued easing of macroeco- markedly in the last quarter of 2011, nomic policy across most of the region. mainly due to the weak external deGrowth in the Asia region is expected mand. Export growth has lost momento gain momentum over the course of tum across the region, both for elec2012, and is currently projected at 6 tronics and non-electronic goods. The and 6.5 percent in 2012 and 2013, re- level of exports to the European Union 24/42
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has fallen considerably below trend, while exports to the United States have recovered to their long-run trend after the global financial crisis. Meanwhile, the regions trade surplus continued to shrink in the last quarter of 2011. This development was highly influenced by China. Another downside risk for Asia is renewed escalation of the euro debt crisis. Although Asian economies on average rely less on euro area and UK banks than other regions, these banks nonetheless have a substantial presence in several Asian economies. They are important sources of credit in two ways 1) direct lending, including in the area of trade finance, to private sector agents in the region, through cross-border transactions and lending by local subsidiaries and branches; and 2) indirectly, through their role in the wholesale funding of regional banks, particularly in Hong Kong SAR, Korea, Singapore, and Taiwan Province of China. While developments in the euro area continue to represent the most important source of risks for Asia, the region also faces two other risk factors. First is a hard landing in Mainland China. Even though a low probability event, a sharp correction in e.g. Chinas real estate market represents an important downside risk. Moreover, although conserva-
tive mortgage loan-to-value ratios and The rise of the Lion?! healthy bank balance sheets might buffer the banking system to some extent, Africa is a highly unstable continent. the likely tightening of financial condi- Political will, financial markets, growth tions and associated corporate sector rates, and democracy have been flucdistress would tuating heavily. However, result in a signifi“The region’s poli- the last 10 years have cant slowdown cymakers now face shown a modification of of the Chinese this pattern with impreseconomy. IMF the difficult task of sive growth led primarily estimates sugadjusting the amount by foreign direct investgest that in this ment , . Chinese, Indian scenario, output of insurance needed and Saudi firms have in China could to support stable, invested heavily in the fall to as much as continent, which has 4 percent below noninflationary led to greatly improved baseline after two infrastructure. The congrowth.” years, with likely struction of roads is ususubstantial trade ally the price big invesand financial spill-overs to the region, tors have to pay to get their investment especially Hong Kong SAR, Indone- through. The improved infrastructure sia, and Singapore. Second concern is eases business growth by providing booming commodity prices. A shock to means of export and access to wider commodity prices could create a diffi- markets. Especially agriculture is a field cult trade-off between inflationary pres- in which investment takes place on a sures and budgetary risks from energy remarkably large scale. In Ethiopia, an and food subsidies. Overall, the region’s Indian company has bought a rural area policymakers now face the difficult task at the size of southern Sweden . Comof adjusting the amount of insurance pared to 10 years ago foreign aid has needed to support stable, noninflation- risen from $20b to $30b whereas FDI ary growth. has increased by $35b from $20b to $55b. The peak of the inflow of capital was in 2008 where the continent saw an inflow of approximately $75b . The global economy has been slacking. Global economic gloom has not altered the Asian consumerism and the shopping malls are still booming.
In the rise of The Lion, large-scale infrastructural projects are paving the way for economic growth
As the African economies are expanding, the agricultural sector is prospering in Africa.
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In spite of promising growth prospects, the uncertainty in the commodity markets and the debts crisis in the euro zone might end up putting the Asian tigers to rest.
Little to no growth has been the common parameter of the western economies, and the expectations to the BRIC countries are low. According to the IMF the economies of Africa are projected to have growth rates between 5%-10% . It is no wonder some African economies are referred to as lions – a clear reference to the Asian Tigers, an expression created when they started developing 20-30 years ago . A major concern with the stability of the African growth rates, is how strongly correlated they are with the global commodities market, especially oil and minerals . An example of this is Zambia where half the GDP derives from cobber. Sub-Saharan Africa can be divided into three groups:
1. OEC – Oli Exporting Countries
with an estimated growth rate of 7-8% despite unstable oil prices. These countries however are prone to high inflation and fluctuating fuel prices.
2. MIC – Middle Income Countries
who have been hit heavily by the financial crisis and the following credit crunch since these economies are relatively closely linked to the western economies. The expected growth rates in this group are around 3-4%. Growth in this group is driven by consumption, and FDI in the minerals sector.
3. LIC – Low Income Countries
have been excluded from the financial turmoil the last few years. They are all, except from Ethiopia, estimated to have growth rates of 6-7% in 2012 and 2013 . This cluster is particularly vulnerable to fluctuations on the global food market. East African economies are relatively independent of commodity prices, and have proven able to generate growth without the presence of major reserves of natural resources. Africa is no longer dependent on the Western world to buy its goods. Over the last 20 years export to BRIC countries has risen from ap-
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proximately 1% to about 20%, and it is expected that this figure will increase to 50% before 2030. The group of African countries with these characteristics consist of Kenya, Tanzania and Uganda in the east, and Côte d’Iviore, Ghana and Cameroun in the west. When it comes to production and the potential of local and regional sales a variety of economical factors come in to play. Naturally, private income must be on a level where consumers are able to consume goods and services, but still low enough to compete with Asian manufacturing. As an investor in Africa there is a range of challenges, namely the rule of law, protection of private property, and political/economical stability. Business is on the rise in Africa and the early bird will catch the worm. 34 out of 46 governments have made it easier to start and run a business over the last year . The rise of democracy, less corruption, and a growing private sector has provided greater stability and growth, but African economies still struggle with comparatively high corruption rates and lack of
responsible government. When making a strategic decision on whether to invest in the developing world a careful country-level analysis will be required. Political stability, an open economy, and a diversified private sector seem to minimize the influence of corruption , . Naturally, an investor or provider of credit will be more willing to enter a project if the project is guaranteed relative rule of law and clear protection of private property. The lack of skilled labour is also a problem, and the mortality rate and expected longevity lessens the incentives to invest in human capital. Statistics from WHO suggests that longevity in the before mentioned countries is rising at a dramatic rate. It has been estimated that the 1b African population will double over the next 40 years with the majority of the population in the working age. It is imperative that the companies and governments are able to provide education and jobs or political instability could become an issue. Compared
with Europe and Asia where the median age is 40 and 30, respectively, in the median age in Africa is merely 20 years. This represents a huge potential for the continent and is quite similar to what happened in Asia 30 years ago. This situation paves the way for enormous productivity potential but also a boom in consumer demand. However, it also presents a risk: vast numbers of young adults seeking a future is like financial gearing in an LBO – it multiplies both good and bad performance! The growth in Asia seems almost unstoppable. India and China are moving in on the traditional tuft of tech savvy countries like Japan and South Korea. The new brands are spreading globally. Still production in South East Asia is hard to compete with, since labour cost and capital inputs are cheap. Given global demand does not suffer too grim a downfall – namely western demand – this should keep the money flowing with growth rates around 6.5%. On the risk side are European bank credit in the
region, the Chinese real estate market, and booming commodity prices. The path towards growth and stability that the African continent in large has endeavoured upon is still unclear in direction, and investments must be tracked carefully. With an expected growth spanning from 3 to 8 percent, an unexploited market, and booming consumer demand, opportunities exist. In this market the major risk factors are inflation, food prices, and the difficulty of handling corruption. With the population getting richer and endorsing technologic advancements innovation is one side of the African medal – the other being basics like agri-business, infrastructure, food processing, and electricity. The lions are on the move and investors hunting for long-term high returns should consider joining the pack.
These colourful notes does not merely reflect a mean for exchange of goods, but a complex currency of a country who has its mind set on eating its cake and having it too.
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Hong Kong Exchange Square is not only a financial nerve centre. It also serves as a currency laboratory for Government of China.
China’s Exchange Rate and Capital Controls – a new era for the Renminbi!
By Jens Bech Petersen
C
hina’s exchange rate and capital controls have without doubt been some of the the most heavily debated topics during the last decade. The topic was more or less omnipresent throughout the corporate, academic and political spheres – and with good reason! Given the country’s size, China’s policies on exchange rate and capital controls have a major influence the global economy, capital markets as well as the ability of companies to hedge risk and move capital across borders. In terms of currency controls, very few people will be surprised to learn that China indeed does keep a firm grip on currency flows in and out of the country. One cannot simply move money in and out of China; especially not when the transfer involves the Chinese national currency – the Renminbi (RMB). Similarly, the government has also put heavy restrictions on the cir-
culation of foreign currency within China. However, the severity of the capital controls is highly dependent on whether the currency flows are associated to the current or the capital account.
Current account? Capital account? Same same, but different… The obvious question is of course why it matters whether items are related to the current or the capital account. Generally speaking, the current account is related to trade and in the case of China this includes items such as the sale of goods, provision of services, interest payments and repatriation of dividends. As long as the activities are conducted in
28/42 28/42
compliance with Chinese law, neither foreign nor Chinese companies will face many difficulties in transferring money in and out of the country or exchanging RMB to foreign currency and vice versa. For Chinese companies the receipt of foreign exchange can be retained or sold to financial institutions permitted to engage in such business, whereas foreign companies may convert any RMB profits into foreign exchange through certification obtained from the State Administration of Foreign Exchange (SAFE).
Mainland Chinese entities do not run out of cash, and on the other hand it is not straight forward to hedge the currency risk. Similarly, investors face a tough challenge to gain direct exposure to the RMB or Chinese capital markets. While such problems can only truly be solved through a freely convertible RMB, the Chinese government has already initiated measures that partly may solve the problem.
From Hong Kong with RMB!
Meanwhile, the foreign exchange controls on the capital account items are far stricter. In broad terms, any transaction that aims at creating capital will Due to its position as a global finanbe regarded as a capital account item. cial center and strong legal framework, Examples of such items include equity Hong Kong has time and again served investments, foreign direct investment as laboratory for China’s finance and (FDI), derivative deals and loans. For- currency policies. This was also the eign companies can obtain approval case in 2003 when the Chinese govfor FDI through SAFE and thereby in- ernment sought to develop an offshore ject capital into their China entities, but RMB-market as part of the currency’s the process is notoriously cumbersome internationalization process. and it normally takes two “Investors or three months before RMB transactions began face a tough in 2004 with an arrangethe capital can be put into use. The whole process that allowed Hong challenge to ment only becomes more arduKong banks to develop an ous when the capital to be gain direct ex- offshore deposit market for injected comes in form of posure to the RMB that allowed individuRMB and may in fact exals and companies to hold RMB or Chi- RMB in Hong Kong. Three tend the total time frame by another month! later the Chinese nese capital years government took another markets.” Regulations are similarly major step in liberating its tough for Chinese citizens capital account when it and companies that wish to move their allowed companies to issue RMB decapital out of China - not to mention if nominated debt in Hong Kong – the the capital is earmarked for investments so-called “Dim Sum bonds”. Although in capital markets. In fact, neither for- this marked a major step towards makeigners nor Mainland Chinese citizens ing the RMB convertible, it was still a can freely invest in each other’s capi- very strenuous process to transfer the tal markets. Foreign investors seeking offshore RMB into Mainland China. In exposure to Mainland Chinese mar- fact, due to the stringent capital conkets can only succeed by applying for trols, the Chinese government had Foreign Qualified Institutional Investor developed two parallel markets for the (QFII) status, Renminbi Foreign Quali- RMB; the onshore CNY market and the fied Institutional Investor (RQFII) sta- offshore CNH market. tus or alternatively invest through entities that already possess such permits. In this regard another milestone was Mainland Chinese citizens will have to achieved in 2009, when a pilot scheme go through the Qualified Domestic Insti- was started to allow cross-border trade to tutional Investor (QDII) scheme. be settled in RMB. Initially, this scheme only included Shanghai, Guangzhou, Evidently, these restrictions pose some Shenzhen, Zhuhai and Dongguan inserious problems for foreign companies side China and Hong Kong, Macau and and investors alike. On one hand capi- the ASEAN countries abroad. However, tal movements relating to the capital ac- the scheme was gradually expanded count have to be well planned so that and in 2012 China allowed all of its
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provinces to conduct cross-border trade in RMB with the rest of the world as long as the Chinese company had an approved import/export scope on its business license. The RMB cross-border settlement scheme became complementary to the bilateral currency swaps that China has signed with selected partner countries since December 2008. Essentially, these swap agreements allow foreign governments to offer local importers RMB financing when purchasing Chinese goods. Among the countries that already entered into these RMB swap agreements are Japan, Russia, Singapore, Australia, Hong Kong and Brazil. In combination the bilateral currency swaps, the cross-border trading scheme and the offshore RMB-market has allowed companies to find support for a wide range of RMB related financial services. In addition, Hong Kong’s offshore market also allows investors and financial institutions to gain exposure to RMB capital markets and financial products. Besides a US Dollar settled non-deliverable CNY forward market, Hong Kong also offers deliverable USD-CNH forwards, swaps and foreign exchange options. The interest rate risk can be managed through CNH interest rate swaps or alternatively through crosscurrency swaps that under normal circumstances provide higher liquidity. Hypothetically, this means that companies and institutions with access to both Mainland Chinese and the Hong Kong capital markets potentially may benefit from the interest differentials. Moreover, outside of Mainland China, the CNH can actually be traded with very few restrictions. So, doesn’t this imply that the RMB is almost freely convertible? And how about risk management? Aren’t companies perfectly capable of hedging their RMB currency exposure? If the two markets could be treated as one, it would imply the existing of an arbitrage opportunity that could dictate the law of one price. But the CNY and CNH often do not trade at the same rates! So what is missing…?
Ideally, a country’s central bank would like to be able to (1) fix a country’s exchange rate, (2) allow a free capital flow and (3) lead an independent monetary policy. However, in praxis this is hardly possible and the central bank will have to forfeit one of these three items. While countries such as the United Kingdom and United States of America largely have relinquished their exchange rate controls to maintain free movement of capital and an autonomous monetary policy, the Chinese government has chosen to sacrifice the free cross-border flow of capital to retain control over its exchange rate and money supply. The impossible trinity also highlights the connection between China’s recent moves to lessen capital controls while expanding the daily trading band of the RMB. China may be at a point where it needs to ease its capital control in order to facilitate a more efficient distribution of capital. A prime example in this regard is the country’s overheated real estate market, where considerable
400 350 300 250 200 150 100 50 0 jan/04
maj/05
okt/06
feb/08
jul/09
nov/10
apr/12
aug/13
Figure 1: Value of the People’s Republic of China’s Outbound Foreign Direct Investment stock China's Foreign Exchange Reserves 3.400 3.200 3.000 2.800 2.600 2.400
0 Ju l/1 0 Se p/ 10 N ov /1 0 Ja n/ 11 M ar /1 1 M ay /1 1 Ju l/1 1 Se p/ 11 N ov /1 1 Ja n/ 12 M ar /1 2 M ay /1 2
/1 ay
M
ar
/1
0
2.200
M
amounts of Chinese investors have put their savings due to the lack of a feasible alternative. Allowing Chinese companies and individuals to invest more freely abroad could not only help China to deflate some of its domestic asset bubbles, but could also deliver some of the much needed capital for struggling western economies like the ones of Europe.
Two’s Company, Three’s a Crowd
Value of China's Outbound FDI
Billion US Dollars
“Allowing Chinese companies and individuals to invest more freely abroad could not only help China to deflate some of its domestic asset bubbles, but could also deliver some of the much needed capital for struggling western economies like the ones of Europe.“
n/ 10
Thus, as long as the cross-border arbitrage can be based on current account items such as trade and profit repatriation, companies and institutions can with relative ease move RMB across the Chinese border and potentially take advantage of the spread between the two markets. Nevertheless, the cross-border arbitrage becomes rather difficult to implement when a transaction relates to China’s capital account. As already
When China regained control over Hong Kong back in 1997, it implemented a “one country, two systems” policy to allow Hong Kong to function as gateway to the outside world. Similarly the Chinese government seems to be implementing a “one currency, two markets” approach for the RMB. But why does it have to be so complicated? Why bother to establish offshore RMB hubs? Wouldn’t it be more feasible simply to remove the capital controls? The answer to these questions can be traced back to what economists have dubbed “The Impossible Trinity”.
Ja
Again the issue relates back to China’s stringent capital controls. Even though the divergence between the CNY and CHN will be limited by companies and financial institutions, as these have a natural incentive to buy RMB in the cheapest market and sell them in the priciest. However, since transactions only can be conducted on the background of approved corporate activity, there is no clean-cut arbitrage relation between the two markets.
mentioned, under normal circumstances it takes two or three months for a foreign company to inject new capital into a Mainland China entity and the process may potentially be extended by another month when the capital to be injected comes in the form of offshore RMB. Likewise, investors have to undergo a similarly cumbersome process when funds are transferred through the QFII and RQFII schemes.
Billion US Dollars
The Great (Capital Control) Wall of China
Figure 2: Foreign Exchange Reserves of the People’s Republic of China 30/42 30/42
USD/CNY Exchange Rate in 2012 6,40 CNY per US Dollar
Furthermore, if Chinese investors and enterprises were less constrained with regards to outbound investments, the People’s Bank of China – China’s central bank – would be less dependent on buying US government bonds and could thereby more easily diversify its holdings into other asset classes.
6,38 6,36 6,34
In fact, this process may already have 6,32 begun, as China’s stock of outbound invest6,30 ments continues to increase (see figure 1) while its foreign exchange reserves slowly 6,28 are starting to decline (see figure 2). This 6,26 development has so far been accompanied Jan/12 Feb/12 Mar/12 Apr/12 May/12 Jun/12 Jul/12 by two percent depreciation of the USD/ RMB exchange rate since the beginning of Figure 3: Development of the 2012-exchange rate between the US Dollar and May 2012 (see figure 3). In addition, the Renminbi second quarter of 2012 marked China’s first quarterly Balance of Payments deficit since 2000, which in praxis means that more money is leaving the country than entering (see figure 4). ital flows in and out of China will be less turn into a win-win situation for China, While the process of liberating the constrained in the near future. Looser but also for the global community as a country’s capital account has been capital controls and a less constricted whole. rather slow, it seems imminent that cap- RMB exchange rate may in fact not only
China's Balance of Payments 250
Capital & financial account balance 200
150
current account balance Overall Balance
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50
0
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Figure 4: Balance of Payments for the People’s Republic of China
It requires a whole lot more than the ability to count when trying to convert your currency into RMB.
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Trends in sales and trading By Mads Axel Schønberg & Kevin Hellegård Nielsen
Although the European stock market got a good head start in the first six months of 2012, the investor sentiment has gone gloomy.
T
he purpose of this article is to look at possible future trends in trading, with a main focus on the European area. The possible trends will be based on a scenario, which will be further elaborated later in the article. Based on the scenario we will emphasize assets, areas and sectors that look interesting given the scenario is going to unfold. The beginning of 2012 was good for investor’s, especially investors long in equities. The Stoxx 600 index tracking European stocks was up by app. 11 % on its top on the 16th of March. But since then all increases were rolled back and the Stoxx 600 index was at its lowest point this year down by app. 4 % year to date at the 4th of June. The major factor for these declines is the current debt crisis in Europe. Its causing nervous markets, which to some extend has an effect on all asset classes. Investors are leaving risky assets – like equities and high yield bonds – to seeks towards safe heavens. Currently, the American dollar is the most attractive and it has increased significantly during the last months, but also government bonds in Germany and Denmark has interest. The question is “What’s going to happen now?”
A pessimistic scenar“The European markets have to regain io could be financial trust in the Euro area, stocks generstress in a larger extend thereby fueling the very than seen so far. This ally took a heavy empty “Euro-tank” tocould lead to another wards a recovery (albeit recession, which will beating from the it might be a slow one, have a large impact on market during the it is a recovery). For especially the Europethe Euro area to attract debt crisis” an economies. A more investors it probably positive scenario is that needs support from European leaders will US, China and EM so succeed to encapsulate the ongoing that exports to these areas will increase. debt crisis and thereby calm the finan- This will not only increase the conficial markets; this could lead to an eas- dence in the Euro area but also help to ing in banks credit standards, which will start the recovery. There is off course help start a recovery. There are factors several risk factors combined with this pointing towards both scenarios, but scenario, which is more likely to happen the scenario that will be used in the rest on mid- to long-term than on short- to of this article is leaning towards a posi- mid-term. tive future and will be further explained below. With the positive scenario in mind, the current market would seem to be at an The scenario is built upon certain posi- attractive level to buy more risky assets tive factors to take place. First it is vital such as stocks, corporate bonds and for the Euro area that the current debt covered bonds in the financial sector. crisis is being contained and controlled Nonetheless, this article will focus on to avoid it wreaking more havoc on the stocks. Euro currency and the Euro collaboration. One way to do this is to give the As previously stated, the stock rally in ESM more money, now they got the the first two months of 2012 was rolled mandate which gives even more reason back at the end of the second quarter. to raise capacity and the ECB should be Compared to the past 5 years, the Stoxx given a reason to provide more support 600 Index is still down with roughly 35 i.e. unleash QE. Second, the financial %, while the S&P 500 in the same pe32/42
The outlook depends heavily on whether Christine Legarde and the rest of the Troika are able to solve the current debt issue in the euro zone.
Stoxx 600
S&P 500 0,1
-0,1
16
23
-S
ep -D -20 0 e 09 c- 7 -M 20 a 0 01 r-2 7 -J 00 24 un- 8 -A 20 0 u 16 g- 8 -N 20 o 0 08 v- 8 -F 20 03 eb 08 -M -20 a 09 26 y-2 -J 00 18 ul- 9 -O 20 0 10 ct- 9 -J 20 0 a 04 n- 9 -A 20 p 1 27 r-2 0 -J 01 u 19 n- 0 -S 20 1 e 12 p- 0 -D 20 1 e 06 c- 0 -M 20 29 ar 10 -M -20 1 21 ay- 1 -A 20 1 u 13 g- 1 -N 20 o 1 05 v- 1 -F 20 1 e 29 b- 1 -A 20 pr 12 -2 01 To 2 da y
0
-0,2 -0,3 -0,4 -0,5 -0,6
riod is down with merely roughly 12 %. In addition, the EUR-USD currency-pair has moved in favor of the dollar-native investor thus giving those investors an extra possible upside to an investment in European assets. Based on the above, the more risky European assets could be a favorable long position to investors. This is especially because stocks at the moment are highly correlated with macro economic factors, causing healthy, well-functioning companies to get dragged down along with the rest of the market, and therefore they become relatively cheaper. Especially equities would be a preferable asset class to invest in, since it is generally outperforming other asset classes in a recovering or growing economy. Also the European stocks generally took a heavy beating from the market during the debt crisis, though bank stocks probably were hit the most. Hence, the stocks of the Euro area might be at fa-
vorable to pick up at the current level. Though investors should be cautious when buying individual stocks or sectors, while not all have managed equally well on their way through the crisis. Investors should look to companies which have a fundamental healthy base of operations and have taken the necessary means to slim and trim the company enough to endure the crisis but still have retained the ability to keep pace or more with a recovery. Given the recovery in the scenario expected to be at a slower pace, investors should be expecting longer-term investments which emphasizes that the fundamentals are ought to be solid. In addition, these companies and sectors should preferable have product or service prices varying with the inflation beside being of a more durable or necessity based, which would strengthen the longer term investment. It is still important to stress that diversification is still important both cross assets classes, sectors and geo33/42
graphic locations.
-0,7
In the light of the debt crisis investors would also want to take the debt of the company into account. It is vital to look for companies who hasn’t indebted itself to survive the crisis but have kept a level in accordance to pre-crisis levels or to engage in sound investments. There are off course several risk factors associated with the scenario stated above. First of all its based on a believe in European politicians being both willing and able to encapsulate the debt crisis and solve the problems accompanying the crisis. Furthermore, current macro numbers shows a slowdown in the American recovery and Chinese growth. With this being said, the European area still looks interesting in the long run, both because a lot of healthy companies has been dragged down by factors that may not be relevant for the company.
BASel III By Farina Ria Nordam
H
igher Common Equity Capital Requirement of Basel III and its impact on the Commercial Banks’ capital structure and Risk Taking – Author Farina Ria Nordam Capital Regulation, according to PwC’s Annual Global CEO Survey, is the most important factor influencing changes in financial institutions. Moreover, it is the second largest threat after economic uncertainty. Capital Regulation has long been discussed among regulators, experts, scholars and financial practitioners. Basel II’ excessive and more detailed regulation RWAs, for example, has been claimed to be one of the sources of recent financial crisis. Basel II has also been criticized for requiring banks to increase their capital, when risks rise. Consequently, this might cause them to decrease lending precisely when capi-
tal is scarce, potentially aggravating a financial crisis (pro-cyclicality effect of the accord). It is due to the fact that the judgements of PD tend to underestimate risks in good times and overestimate them in bad times. Thus, one of the main issues in the banking sector is “how much and what kind of bank regulation is optimal?”.
Basel Accords’ Capital Ratio The Basel Accords, “Cooke Ratios”, that tend to maintain enough capital to absorb losses without causing systemic problems and to create an equal playing field internationally, has undergode some improvement under Basel I II, 2.5 – and recently III – to find the “optimal
Source : Basel III No Achilles’ spear 34/42
capital regulation ratio”. As a reaction to recent financial crisis, BIS increases a combination of higher minimum tier 1 capital requirement (common equity), a broader ratio of RWA, and adds leverage and liquidity standards through Basel III proposal. Understanding the importance of holding Minimum Regulatory Capital Requirement (MRCR), Nordam and Kontic (2011) calculated and illustrated the MRCR of the US Commercial Banks (with around 6453 institutions data pooled from FDIC) from period 1992 to 2011 (quarterly based) . They found evidence that MRCR held by the commercial banks in US are in excess of the minimum capital requirement of 8%. This is particularly evident among commercial banks with assets less than 100 M USD. This evidence supports some
experts’ argument that “economic capital” is more important than the regulatory capital in running the business.
Impact of Higher Common Equity Ratio on the Commercial Banks’ Capital Structure and Risk Taking The finding on MRCR leads to the following part of analysis of how the implementations of higher common equity ratio from 2% to 7%. (incl. capital conservation buffer) will affect the Commercial Banks’ Capital Structure and Risk Taking”. In the discussion of Optimal Capital Structure, Modigliani-Miller theorem is one of the core theories in modern corporate finance optimal capital structure theories. The theory was introduced with the assumptions that organizations are in a perfect capital markets with perfect information where there are no taxes, transactions and bankruptcy costs and individuals can borrow at same interest rate as organizations. The capital structure of financial institutions is determined mostly by the same departure point from the frictionless world of M&M that determine the capital structure of any other kind firm facing market imperfections, i.e. taxes, expected cost of financial distress, transaction costs and signalling behaviour and agency problems arising from asymmetric information between shareholders and creditors and between owners and managers. However, banks differ from other ordinary firms in two important aspects that affect their capital structures. Firstly, the presence of the regulatory safety net (i.e. deposit insurance) that protects the safety and soundness of banks is likely to lower bank capital. Harding et al, Merton (1977) shows that banks have an incentive to decrease capital-to-asset ratios and to increase assets risk. As a result the risk of default is increased and wealth from the deposit insurance system is extracted. Nordam and Kontic (2011) also found evidence that bank’s high leverage level is motivated by the tax-shield inherited in debt. Secondly, the regulatory capital requirements raise the capital of some banks.
Thus, the main topic to be discussed in this article is the impact of the higher common equity requirement on the commercial banks’ capital structure and risk taking. The major concern on the regulatory attempts to raise bank capital ratio is that: “it will drive banks to seek out more risky investment” The criticism can for instance be deducted from William McDonaugh vice chairman of First National Bank of Chicago who says that: “... the proposal could lead banks to take on riskier business to compensate for the lower returns they would almost assuredly get by having to maintain more capital”. In line with this quotation Nordam and Kontic (2011) also find evidence that higher CAR and ROE are not positively correlated with the earnings of US commercial banks with assets less than 100 M USD. Meanwhile, a contradicting result was found among the US commercial banks with assets more than 1 B USD . This finding has been supported by experts, e.g. Koehn and Santomero (1980), Keeton (1988) and Kim and Santomero(1988). Using utility maximization models they show that an increase in the required equity-to-asset ratio might either increase or decrease the portfolio risk chosen by a bank. If equity is relatively expensive, riskaverse bank owners may choose to increase its exposure to risky assets (with higher expected return) to gain a higher return on its free capital. Alternatively, the bank will liquidate its risky investments and move to safer investments, thereby decreasing the expected return on the overall investments. In contrast, a recent article by Keeley and Furlong, shows that the previous studies using such a framework are internally inconsistent and the models cannot be used to support the conclusion that “higher bank capital ratio can lead to great risk-taking” . Through the state-preference model used by Keeley and Furlong (1989), they analyze how the portfolio and leverage decision of an insured bank that maximizes its current value (the market value of its equity). The same result is found by Nordam and Kontic (2011) in observing the quarterly data from the US Commercial Banks from 1990s to 2011. In the project, they found evidence that higher
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CAR will make the banks decrease their risk taking. The problem with maximizing shareholder value in a bank is that commercial banks’ have illiquid assets that are strongly correlated and pro-cyclical with the economy. As a result, a small decrease in asset value can erode shareholders equity in a highly leveraged commercial bank. Compared to a relative to a highly leveraged commercial bank, shareholders of a bank with strict capital requirements will have a higher return on equity in “bad times”, while a lower return on equity in “good times”. However, this signifies that commercial banks have to own more of the downside risk, as commercial banks have to reduce the risk of default by creating cushions at its own expense. This creates an incentive for commercial banks – especially the ones that are “too big to fail” – to increase their leverage – and consequently, rely on explicit and/or implicit government guarantees to protect them from the downside risk – rather than acquire equity. As a result, commercial banks may be more willing to satisfy higher required return on equity than the following downside risk with more equity. Understanding the commercial bank’s shareholders and its manager’s strong incentive to prefer high leverage due to the higher ROE, regulators increase capital requirements to diminish the consequences and social costs with a high dividend payout, debt overhang and moral hazard problem. As a result, one can argue that an increase in capital requirements has the potential to make the commercial banks’ less pro-cyclical and more efficient in downturns. Hence, the impact of the application of Basel III higher capital requirement will affect US banks and European peers differently (JP Morgan, 2010). It is presumed that European Banks are less capitalized and there will be larger need for them to transform current assets into both longer term maturities and of higher quality. Furthermore, higher capital requirements have also been criticized for intensifying pro-cyclicality problem within the economy by forcing the commercial banks to reduce their balance sheets (i.e. deleveraging) in order to comply with the new capital regulations.
In a recent case the group chairman of HSBC BANK Douglas Flint criticized Basel III and its increase in capital requirements. He argued that 1% increase in capital requirements would diminish the banks’ lending capacity with approximately 100 billion pounds . This statement was further embraced by the chief executive of Barclays bank who argued that even the current capital requirement level at 10% is too high and should be decreased in order to increase lending capacity.
In conclusion,
Higher Capital Requirement of Basel III proposes by Basel Committee should be understood as the “good intention” of the regulatory agency to limit the risk exposure of the government and taxpayers that stand behind it. However, in order to reach the goal of financial regulation a symbiotic co-operation with financial institutions like moral hazard on the “safetynet” provided by the regulators should be diminished. Although higher capital requirement intended to create a stable and reliable financial system, regulators will continue to face difficulties regulating the more complex and intertwined financial system. Even though the Common Equity Ratio has doubled in its ratio
from 2% to 4.5% (see diagram), some experts argued that it ought to be increased proportionally higher to be able to absorb alike recent losses. It is also important to bear in mind that upon the implementation of the Basel III, debt will remain the major funding source for commercial banks. Consequently, the government should start to think how to deal with “too big to fail” financial institutions so that they are not become “too big to regulate” institutions. In general the writer agrees with other scholars that more common equity is a competent tool to overcome the recent solvency and liquidity crisis, undervaluation of new equity financing and will be the first step in striving for an optimal capital structure of the economy. However the writer believes that to make the proposal effective, the whole financial system needs to be reformed. So that the new Basel Accord implementation purpose to decrease risk taking (to avoid systemic risk) and create a sound and reliable financial system can be achieved. Earlier government subsidies by rewarding debt financing i.e. through tax benefit and deposit insurance (and penalizing equity financing) had benefited managers and existing shareholders. Such subsidies should be reduced
“Private equity take-overs”
A new normal in the Private Equity industry? By Mads Ingeman Pedersen & Ragnar Stoknes Hafting
T
he days where a well-structured leveraged buyout (LBO) could generate returns in the triple digits might remain a thing of the past as the private equity industry today is struggling with increasing takeover premiums and tight credit markets. Up until 2007, the Private Equity industry was associated with gigantic transactions of tens of billions and extraordinary returns. Today the story has changed. Following the financial crisis and the problems in the euro zone the capital markets have dried up and
LBOs have become more expensive. As such both the number and size of private equity takeovers have declined dramatically the last couple of years. Today, there are far fewer ‘quick wins’ in the industry as compared to 10-20 years ago. The generation of returns has increasingly become a function of the ability of the fund and company management to excel operationally and not a question of financial restructuring or buying cheap and selling dear. For instance, the Boston Consulting Group (2012) has estimated that in order to generate an IRR of 25% in the current market conditions, portfolio companies 36/42
if equity capital requirement is to be further increased. However higher capital requirement implementation should also take into consideration “the opportunity cost” of lending declining or asset liquidation as the most frequent steps taken by the banks increasing their reserves. It is due to the fact recent financial crisis have made investment and risk taking within banking industry to diminish. Additionally even though Basel III has tried to deal with this pro-cyclical problem of the regulation through i.e. Credit Valuation Adjustment (CVA), Conservation Buffer and/or Countercyclical Capital Buffer, regulators still need to realize the complicated application of these tools especially in identifying the state of business/economic cycle and consequently point of enactment. At this level of analysis the writer will rest the “ex-post” impact of the Basel III Accord of higher capital requirement (common equity) on the commercial banks’ capital structure and risk taking to other students or scholars to elaborate upon its implementation in the near future.
“With such a high stake the necessity of this investment turning out profitable is critical to the performance of Blackstone’s portfolio” must deliver an annual growth in EBITDA of 11%. This tougher environment is reflected in the relative amount of which the private equity industry accounts for global takeover volume. In the first half of 2007 the private equity industry accounted for 18%. Since then takeover volume has been slashed to a mere level of 7% last year. Consequently, as fewer deals are carried out and the competition for attractive takeover targets has increased. At the end of 2011, PE funds held roughly USD 900 billion in non-invested equity. Not only do PE funds hold a lot of dry powder they also face stern competition from strategic
At a mere USD 26 billion The Blackstone Group acquired Hilton, an international hospitality group, in October 2007.
buyers with excessive cash levels on their balance sheet looking for acquisitive growth opportunities. As a result of fewer attractive investment opportunities and increased competition, the biggest players are forced into the middle market, thereby pushing out many of the small and medium firms. Secondly, exits have become increasingly difficult due to the market turmoil. An example of this is a decline in number of IPOs, which in USA has dropped from an average of 311 per year during 19802000 compared with 120 per year during 2001-2009. On top of this, investors show bad appetite for new stocks. This has increased the risk for the mega funds as public offerings are often regarded as the traditional exit strategy for their investments. Summing up, the private equity industry is today not flush with as many ‘quick wins’ as was the case 10-20 years ago and the generation of excess returns nowadays involves operational excellence to a far greater extent than before. Nevertheless, despite the challenges that the industry is facing it is still an attractive place to invest as the toughened environment effectively has created a shake-out of less-performing funds.
Case study: Blackstone’s 2007 takeover of Hilton Worldwide As mentioned above, the private equity industry has taken a radical turn in the post-crisis era. This is reflected in both the number and the deal size of the PE takeovers after 2007. Looking closer at the 15 all time largest PE deals, interestingly, 13 of them are clustered in 2006-2007 according to BusinessInsider. Interesting is number
9 on the list, namely the USD 26 bil- terest payments. This restructuring had lion public-to-private buyout of Hilton creditors slash their claims by roughly Hotels by Blackstone in October 2007. USD 4 billion, while Blackstone conThis transaction effectively made Black- tributed USD 800 million of new equity stone the majority owner of Hilton’s glo- to buy back debt at a discount. This bal operations spanning nearly 3,500 helped strengthen Hilton’s cash flows hotels totaling over 575,000 rooms in a time when the hotel industry exacross 79 countries today. As for the perienced a general decline. Accorddeal details, the enterprise valuation of ing to some analysts, Blackstone could USD 26 billion equates to roughly 14.5 have been forced to sell Hilton assets to times EBITDA at the time. Further, the cover its roughly USD 900 million in inacquisition was financed with USD 20 terest payments (The Wall Street Jourbillion of bank debt necessitating an in- nal, 2008). Secondly, at the time of the vestment of USD 6 billion by Blackstone acquisition, Chris Nassetta was as the - by far their largest equity investment CEO given considerable trust in deliverat the time. With such a high stake the ing on a number of key strategic initianecessity of this intives among them reanimatvestment turning out ing and knitting together a “Not only do PE profitable is critical fragmented, rather sleepy to the performance funds hold a lot of organization; of accelerof Blackstone’s port- dry powder they also ating growth, particularly folio. This had the and of bolsterface stern competi- overseas; financial crisis hit ing the profitability across Blackstone espe- tion from strategic Hilton Worldwide’s range of cially hard as Hilton buyers with exces- hotel brands. According to experienced a 30% sive cash levels on The Deal Pipeline, this refall in EBITDA when turned the company’s 2011 the economy turned their balance sheet” EBITDA to its 2008, all-time south. According to high, level (The Deal PipeThe Deal Pipeline, line, 2011). a magazine covering the deal sphere in private equity and M&A, this made As the typical life of a PE-investment Blackstone’s billion dollar equity invest- is often projected to 5-6 years and the ment plunge by 70%. As such, was Hilton investment will pass the 5-year it not for the fact that Blackstone had mark next month, it will be interesting negotiated an attractive loan-package to see whether Blackstone will press with the USD 20 billion being bor- the IPO-button later this year or wait rowed covenant-free; Hilton Worldwide for more favorable market conditions. could very likely have been seized by Something however might suggest that its lenders at this point. Nevertheless, market conditions are not that gloomy the company’s management has along at the moment: Their closest American with Blackstone created somewhat of competitors, Marriott and Starwood, a strategic turnaround both financially trade at 13.9x and 13.8x respectively – and operationally. Firstly, Blackstone close to the 14.5x EBITDA multiple at has restructured Hilton’s balance sheet which Blackstone acquired initially. with a restructuring of the original USD 20 billion debt load in order to meet in37/42
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Søgaard er formand for Financelab og er en af initiativtagerne til konkurrencen. Han byder velkommen til deltagerne og giver dem en kort ”market briefing”. Det vil sige en orientering om begivenheder, der kan få betydning for udviklingen på dagens marked. ”Konkurrencen er dog bevidst lagt på en dag uden de helt store begivenheder i finansmarkedet. Det er gjort, så det er de deltagere, der er bedst til at bruge de analytiske redskaber, der vinder”, fortæller Frederik. ”Release the bulls” råber han ud til forsamlingen. Konkurrencen er nu i gang. Deltagerne i dag har alle deltaget i de tradingkur-
ser, der blev holdt i foråret. Vinderne ved hver af disse kurser er de 15, der er her i dag, og de er dermed de bedste af de 200 oprindelige deltagere. Skal finde de bedste af de bedste ”Today is about finding the very best of the best”, som Wayne Walker siger. Han er underviser på trading-kurserne og har flere års erfaring med aktiemarkedet efter at have arbejdet som trader tidligere i sin karriere. Han har store forventninger til deltagernes kunnen, og sammen med sin kollega Ole Quistgaard er han dommer ved konkurrencen
AF SAJEEV SHANKAR / FOTO CASPER BALSLEV
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