All posts by Amanda Gomez

Introduction

Introduction

BY ANTONY CURRIE

The world needs to make some burning decisions in 2020. That’s why this year’s Breakingviews Predictions book is entitled “Turning up the heat: a pivotal year for profit, politics and the planet.” If that sounds like overreach, paired with a cliché, so be it. Humanity is at something of a crossroads.

Start with politics. The pro-democracy protests in Hong Kong continue and may prompt the People’s Republic of China to act. UK Prime Minister Boris Johnson, fresh from a stunning election victory, will push ahead with Brexit, even if it means the dissolution of Great Britain. Meanwhile, American voters will return to the ballot box in November to either send to the White House one of the many Democrats still running for president or, assuming he survives impeachment, reelect President Donald Trump. The choices made in each instance will have ramifications for years, perhaps a generation.

Next, as our cover photograph of fires raging in the Amazon suggests, comes global warming. This is supposed to be the year when the almost-200 governments which signed the 2015 Paris accord make good on commitments to curb greenhouse-gas emissions. It does not look promising, based on the disappointing outcome of a United Nations climate-change confab in December. Failure to act risks sparking more of the devastating wildfires that have raged recently across Brazil, California and Australia. These, along with more floods and droughts like those seen from India to Nebraska to Iran, will have an immense impact on economic activity in the short- and long-term.

Despite all this doom and gloom, we begin our book with some positive predictions. On climate, for example, the rising need to act will spur shareholders to take bolder stances with some of the major greenhouse-gas emitters – and their supply chains. And what would scream Federal Reserve independence from climate-change-denying Trump more than for Chairman Jay Powell to take the central bank into the Network for Greening the Financial System? There’s an opportunity here for bankers, too: The M&A adviser who adds climate issues to her repertoire will find receptive clients.

Green deals won’t be the only ones being struck, though. Expect a rare 11-digit leveraged buyout to be unveiled in Asia in 2020 – even as fears grow elsewhere about private-equity financing. There may even be another big merger contemplated between carmakers, with BMW-Daimler as our top pick. The 30th anniversary of German reunification brings some welcome relief to struggling Commerzbank and Deutsche Bank in the form of fees from helping eastern German entrepreneurs prepare for retirement.

And, as always, we indulge in a bit of fantasy corporate finance: Blackstone boss Steve Schwarzman will reunite his firm with BlackRock – unless Goldman Sachs Chief Executive David Solomon beats him to it.

Elsewhere, look for Indian Prime Minister Narendra Modi to pull a rabbit out of his hat to bolster the economy. Watch as Twitter and Square CEO Jack Dorsey becomes the anti- Facebook hero. And we even imagine how welcome a return of inflation would be – in modest amounts, of course.

There will also be fiery trouble ahead. The continuing tensions in Hong Kong are likely to burn investors. Bankers to the ultra-wealthy are in danger of stoking a superprime bubble. Russia and South Africa will both disappoint markets. And serial defaulter Argentina is heading back for another round of bond restructuring that could scorch the sovereign-debt market.

We also make space for some lighter-hearted observations. A mix of new standards, sustainability and short-term stimulus will help Tokyo benefit from hosting the Olympic Games. The most important job for companies to fill will be the one that fills jobs. And beware the peak of the subscription economy.

Predicting the future is a risky business – and we often get singed for sticking our necks out. Last year we asserted that Japan would be the stealth threat to the global economy in 2019. Unless well-cloaked, we were wrong. And the market debuts of Lyft and Uber did not affect Tesla’s scarcity value at all.

But when we prognosticate correctly, the stakes are high. Voters did indeed give Mauricio Macri the boot as Argentina’s president. And we laid out why write-downs were in the immediate future for SoftBank’s Vision Fund: The colossal failure of WeWork to launch an IPO became Exhibit A. For 2020, we’re doubling down on that one and pushing for an activist to take on SoftBank boss Masayoshi Son.

Whether or not we succeed on that call and others, our main goal is to provide thought-provoking financial analysis of the biggest topics in global finance, business, technology, markets and economics. Continuing to do so is one prediction we can guarantee.

First published Jan. 6, 2020

IMAGE: REUTERS/Bruno Kelly

Contents

FIRED UP

Hotter inflation is the best surprise to hope for

Jay Powell has golden chance to avow independence

Green laggards face war on multiple fronts

Wall Street finally gets some capital satisfaction

Look out for Narendra Modi’s big economic surprise

Jack Dorsey adds third job as anti-Facebook hero

RAINMAKERS

Asia Pacific is primed for its next 11-digit LBO

The hottest new car model is a Daimler-BMW deal

M&A bankers will turn climate risk into clients

BlackRock is Wall Street’s object of fantasy M&A

Deutsche, Commerz get 30-year reunification bonus

An ever-drier world will unleash investment flood

FLAMING OUT

Investors will rue their Hong Kong risk appetite

Buyout barons’ debt machine will blow a gasket

Wealth managers will inflate superprime bubble

French lottery IPO may be as good as Macron gets

Disney will lose its magic touch

PLAYING WITH FIRE

American election to test Wall Street’s nerves

South Africa heads for year of living dangerously

Italy and Germany will unite on EU tech taxes

Investors warming to Putin’s Russia will go cold

Johnson’s big win unlocks Brexit black box

Taiwan will widen U.S.-China schism in 2020

A Canadian breakup is back on the table

SPARKS FLYING

Wanted: bold activist to take on Masayoshi Son

Tencent is next in Western cross-hairs

Argentina debt do-over is even chancier than usual

ECB feuding will have a new front in coming year

Margrethe Vestager will open tech’s walled garden

ALTERNATIVE ENERGY

Tokyo brings home the Olympic gold in 2020

Gaming’s strongest opponent will be regulation

Peak subscription economy approaches in 2020

Underdog will take home Japan’s casino jackpot

A health craze for 2020: Chinese medicine

HR nous will make or break tech-driven ambitions

Hotter inflation is the best surprise to hope for

Fired up

The death in December of Paul Volcker, former chairman of the U.S. Federal Reserve and famed inflation-fighter, is a reminder that galloping price increases used to be a problem. In recent years, though, inflation has largely gone missing. Its return in 2020 would be an unexpected bright spot.

Not, of course, the kind of inflation Volcker countered with tough monetary policy in the early 1980s, when annual price increases topped 10% in America. Or the debilitating 50% annual rate in Argentina as of October. But there’s a lot to be said for modest price gains.

The failure of U.S. price pressures to gain much momentum, starting with wages, is a head-scratcher given the tight labor market evinced by an unemployment rate of a mere 3.5% in November. The country’s consumer price index rose 2.1% in the year to November. That metric clears the central bank’s 2% symmetrical target but doesn’t make up for long periods of much weaker inflation since the financial crisis.

In turn, this contributes to low interest rates, which in the past decade or so have changed the financial world. Central bankers like New York Fed President John Williams like to talk about “r-star,” the real interest rate that’s natural for a healthy economy. Economists think the theoretical r-star has become lower than it used to be thanks to aging populations, lower productivity growth and other factors. Add weak inflation, and the nominal interest rate matching r-star is also low.

That’s why the Fed’s target rate is far lower than the historical average, in the 1.5%-1.75% range. In Europe and Japan, key policy rates are less than zero. That’s a huge challenge for pension funds, some targeting long-term 7%-plus annual returns on their often-underfunded portfolios, insurance companies seeking safe investments, and risk-averse savers. It’s also problematic for banks trying to lend profitably.

It’s hard to find hints of a resurgence in inflation. True, the impact of President Donald Trump’s tariffs could push prices up. But globally the International Monetary Fund, for example, is more worried about the reverse – even if BlackRock, the giant asset manager, thinks inflation risks are underappreciated. Maybe the best hope for a resurgence of manageable inflation is that the consensus is largely dismissing the possibility. Otherwise, there’ll be more painful adjustments to a new, low-interest rate future.

First published Jan. 2, 2020

IMAGE: REUTERS/Darren Ornitz

Jay Powell has golden chance to avow independence

Fired up

BY ROB COX

Federal Reserve Chairman Jay Powell is channeling Groucho Marx when it comes to climate change. The U.S. central banker seems to be following the comedian’s quip that he would “refuse to join any club that would have me as a member.” But there are good reasons for Powell to see sense and nudge the Fed into the Network for Greening the Financial System in 2020.

Founded two years ago, this 50-plus global group of central banks and other regulators wants to focus the financial sector’s mind on environmental and climate risks and encourage the industry to support the switch to a greener economy. Trying to keep the planet from frying is a noble cause and even hydrocarbon-dependent countries, like the United Arab Emirates and Canada, have sent emissaries to figure out how global warming will impact banking supervision and macro-financial policy.

Fed Governor Lael Brainard said in November the U.S. central bank was in discussions about how it might participate in the network. But there is no good official reason why it hasn’t already signed up. Some at the Fed worry that tackling climate change is a diversion from its mandate of maximizing employment and ensuring price stability. And Powell told Congress in April that climate risks don’t “fit neatly” into his financial stability duties. Neatness hasn’t, however, prevented the Fed from past diversions.

That leaves an impression the true motive for aloofness is a reluctance to tangle with President Donald Trump, who is pulling the United States out of the 2015 Paris climate accord. If this is the reason, Powell is doing a disservice to America’s financial institutions, which are among the world’s largest. It deprives them of some of the best practices agreed to by the body’s members, while cutting them out of their formulation altogether.

Joining the network would have the added benefit of broadcasting the Fed’s independence from political interference. Powell has cut rates even though the U.S. economy is relatively healthy and yet still gets bashed by Trump. Taking the central bank into a multilateral dialogue on an issue that Trump once called a “hoax” might defuse criticism that the central bank has been too malleable on interest rates. Brickbats will fly anyway. Better to do the right thing come what may.

First published Dec. 19, 2019

IMAGE: REUTERS/James Lawler Duggan

Green laggards face war on multiple fronts

Fired up

BY GEORGE HAY AND ANTONY CURRIE

Climate-change slowcoaches are heading for a smash. Fossil-fuel producers, steel companies, carmakers and other big greenhouse-gas emitters have so far faced only limited pressure from their owners for action on climate risk. That’ll change in 2020.

Despite increasingly frantic calls from scientists to limit global warming to 1.5 degrees Celsius, companies and investors have had grounds to hang back. An International Energy Agency business-as-usual scenario has oil demand still growing during the 2030s. Even engaged governments have only set very long-term carbon emissions goals.

That narrative is shifting. Shareholders have until now mostly needled companies like BP, Glencore and Royal Dutch Shell for extra detail on global-warming risks. They’re getting pushier. Climate Action 100+, a group of 370 investors with $35 trillion in assets, will soon place more stringent demands on individual companies, including going after directors and supply chains. Activist hedge fund TCI, run by Christopher Hohn, is already doing it.

Meanwhile, the pension and insurance funds that hand out mandates to asset managers are slowly mobilising the trillions of dollars they have in passive investments with BlackRock and Vanguard, which have been chastised by think tank InfluenceMap for underwhelming shareholder engagement. The United Nations’ new Net-Zero Asset Owner Alliance includes big hitters like Allianz and CalPERS. Hiro Mizuno, chief investment officer of Japan’s $1.5 trillion Government Pension Investment Fund, is already awarding work based on environmental, social and governance concerns. Last year BlackRock’s passive foreign equities mandate for GPIF nearly halved.

Crucially, climate risk will increasingly feature in shorter-term analyses of company valuations. A U.N.-supported research project backed by Principles for Responsible Investment estimated that the world’s 10 biggest oil companies, including Exxon Mobil and Total, would lose a third of their value if markets repriced their shares now to anticipate tough policy pushbacks, such as carbon pricing by 2025.

That’s starting to create the kind of noise that wakes up more traditional shareholder activists and short sellers. The prospect of some governments using the fifth anniversary of the 2015 Paris climate accord to add some teeth to their green commitments will push more than a few laggards towards the ditch.

First published Dec. 18, 2019

IMAGE: REUTERS/Daniel Munoz

Wall Street finally gets some capital satisfaction

Fired up

BY ANNA SZYMANSKI

It’s tough to pity the likes of JPMorgan, Bank of America and Goldman Sachs. But Wall Street giants with more than $700 billion in assets have barely benefited from the regulatory rollbacks bestowed on smaller peers and other industries by President Donald Trump’s administration and the Federal Reserve. But the central bank will finally give them some satisfaction in the next few months.

Sadly for the them, they won’t suddenly be allowed to cut their overall capital levels. Instead, they’ll get some relief from tweaks to the short-term lending market known as repo.

This usually arcane part of the business hit the headlines in September when repo rates jumped more than fourfold to around 10%. It wasn’t even sparked by an actual crisis. Large banks exacerbated the spike, though, by not exchanging reserves – basically a form of cash – for treasuries. Postcrisis rules were a big part of the reason why.

Technically, treasuries are treated the same as cash for many capital requirements for lenders, like the liquidity coverage ratio. But Fed Vice Chair Randy Quarles has said that many banks feel regulatory pressure to favor reserves. Ultimately, the two aren’t interchangeable: A client wanting to borrow $1 billion when the repo market is closed isn’t going to accept U.S. government bonds.

The Fed is likely to alleviate this by creating a permanent standing facility, presumably run by Lorie Logan, head of the New York Fed’s market operations. Banks could get cash from the Fed in exchange for high-quality assets like treasuries almost any time on a business day. That ought to persuade their repo desks to hold more treasuries, rather than hoarding reserves, and thus make a bit more money. It could also allow banks to reduce the amount of reserves they hold to satisfy their so-called living-will liquidation plans; the eight largest players currently have nearly $800 billion set aside as a precaution and could cut that drastically, the New York Fed reckons.

The facility would need some deft handling, from determining both the firms and assets allowed, to setting the right borrowing rate: too high, and it creates a stigma; too low and the Fed ends up running the entire market.

Those ought to be manageable. Granted, it wouldn’t be quite the regulatory relief the banks have been hoping for. But it would be welcome nonetheless.

First published Dec. 9, 2019

IMAGE: REUTERS/Carlo Allegri

Look out for Narendra Modi’s big economic surprise

Fired up

BY UNA GALANI

The good days are coming: India’s Prime Minister Narendra Modi needs to jump-start the economy to keep that 2014 campaign promise. Months into a second term, GDP growth of 4.5% is about half the pace ideal for its 1.3 billion people. Modi surprised markets in good ways, and bad, before. Here’s how he might do so again.

A crisis of confidence is crippling the private sector, which is hobbled by $200 billion of bad debt, and isn’t investing as demand weakens and businesses adjust to new rules on everything from sales tax to insolvency. If India Inc is now acutely aware of the costs of corruption, the pendulum of fear has swung too far. Industrialists once willing to back large infrastructure projects are now risk-averse.

One big problem is unpredictable policymaking that has seen companies abruptly stripped of key licences or whacked with costly new contractual terms. Prashant Ruia, whose Essar Group lost its steel asset through a new bankruptcy regime to ArcelorMittal, told the audience at Breakingviews’ Predictions event in Mumbai on Dec. 6 that fixing regulatory risk is key to revival.

Another sentiment lift can come from privatising businesses like Air India, an indebted globetrotting reminder of India’s inefficiencies. Modi’s earlier attempt failed. Getting it right this time would send a message that New Delhi is serious about reform. Outlining a roadmap to other selloffs would help too, Sunil Mehta, non-executive chairman of Punjab National Bank said at Mumbai Predictions.

To kick start consumption, meanwhile, direct transfers of cash into people’s bank accounts or a big spending plan on roads can’t be ruled out. The government could risk the ire of the bond market to raise the funds by relaxing the fiscal deficit beyond a target of 3.3% by March 2020 to over 4%.

A more radical option is to devalue the rupee, says Shankar Sharma, co-founder of securities firm First Global. By making Indian goods more competitive, it would boost net exports. Most of the 200-strong audience predicted in a Breakingviews poll that India may choose a combination of these measures to kick start the recovery.

Modi’s past economic surprises haven’t all worked out: Demonetisation, the shock 2016 withdrawal of bank notes, dealt a massive shock and probably contributed to the current slowdown. Investors should brace themselves for the year ahead.

First published Dec. 9, 2019

IMAGE: REUTERS/Brendan Mcdermid

Jack Dorsey adds third job as anti-Facebook hero

Fired up

BY GINA CHON

Jack Dorsey will add another line to his resume in 2020. The Twitter boss banned political ads and did more than Mark Zuckerberg to prevent the silencing of Hong Kong protesters. Dorsey, who also runs payments firm Square, fared surprisingly well in Washington hearings, too. His style will turn him into the anti-Facebook hero.

Dorsey is an unlikely political darling. He comes across as awkward and soft-spoken. But he has also been more up-front with U.S. lawmakers than his social-media rivals about toxic content and his platform’s confusing terms of use. It’s a contrast with both Zuckerberg’s tin-eared talking points and the technical wonkiness of Sundar Pichai, who now runs Alphabet as well as its biggest business, Google.

Twitter has also been more decisive than rivals about resolving controversies, including political ads. While Facebook and Google’s YouTube are tying themselves in knots over restrictions, Dorsey in October announced Twitter was simply banning political ads altogether. While President Donald Trump’s campaign manager criticized the decision, it hasn’t sparked much blowback from other Republicans and it drew applause from Democrats.

That move followed another politically popular decision on Hong Kong. In August, Twitter decided to stop running ads from state-controlled media entities, including Beijing-backed outlets. Facebook, which generated about $5 billion in revenue from Chinese advertisers in 2018 according to Pivotal Research, has run Xinhua ads about this year’s protests in Hong Kong, while YouTube hosted similar China Global Television Network shows.

Square, meanwhile, has been building its cryptocurrency capabilities without drawing political backlash, whereas Facebook has put its Libra digital-currency project on hold after a global regulatory outcry.

Political pressure on social networks will increase as the November 2020 presidential election approaches. Dorsey may find he has earned a third important job as a thorn in the side of his larger, more compromised rivals.

That’s if he’s even around: After a trip to Africa in November he tweeted that he would spend three to six months living there in 2020. There are opportunities for Square in African markets, but Dorsey’s absence could hurt Twitter if it gets caught in an election firestorm. That said, a move to another continent is one way to get a breather from an interminable, and probably nasty, campaign.

First published Dec. 20, 2019

IMAGE: REUTERS/Chris Wattie

Asia Pacific is primed for its next 11-digit LBO

Rainmakers

BY ALEC MACFARLANE

It is shaping up to be a big year for buyouts in Asia. There’s over $250 billion of capital committed to private equity in the region, according to research outfit Preqin. KKR plans to raise a fund that would be bigger than its flagship U.S. one. Cheap debt is also available from Japan to Australia, making a mega-deal all the more likely.

Jumbo Asian LBOs are rare. Bain led the biggest one a couple of years ago, an $18 billion acquisition of Toshiba’s memory-chip business. The region’s only other 11-digit buyout, according to Dealogic data, was Singapore’s Global Logistics Properties. With so many companies controlled by tycoons, governments or entrenched boards, it has been a tougher part of the world for private equity to crack.

Overall conditions are improving for buyout barons, however. Interest rates keep falling. Banks are generally willing to lend more. Debt markets in Europe and the United States, often offering looser covenants, are opening to Asian deals. Ageing owners without clear succession plans are warming to private equity. And conglomerates such as Panasonic have been increasingly willing to sell off big businesses.

There are also plenty of listed companies with solid cash flows and modest borrowing which fit the buyout profile. A rough-and-ready screen for ones with a market capitalisation of over $10 billion, at least $1 billion in EBITDA and net debt equal to no more than that measure of earnings churned out some tantalising theoretical prospects. Among them are Japanese chocolatier Meiji and advertising giant Dentsu. Chinese appliance maker Haier’s publicly listed units could also be a target if a mooted take-private of the parent company fails.

At the decidedly larger end of the spectrum, there is Woolworths and 7-Eleven operator Seven & I. The Australian supermarket chain would cost upwards of $40 billion, including a takeover premium.

Using $20 billion of debt, or a robust 6.5 times the EBITDA forecast by analysts for its next financial year, would mean scrounging up another $20 billion. That would take at least four buyout shops and additional co-investors, such as sovereign wealth funds, to write the full equity cheque. It’d be a stretch, for sure, but given the amount of money sloshing around Asia Pacific, even that kind of deal has entered the realm of the possible.

First published Dec. 23, 2019

IMAGE: REUTERS/Aly Song

The hottest new car model is a Daimler-BMW deal

Rainmakers

BY CHRISTOPHER THOMPSON

Daimler and BMW should quit fumbling around the backseat. Faced with slumping global demand for their pricey cars, merging would reap synergies worth more than the 13 billion euros in annual savings they’re currently targeting. As Peugeot and Fiat Chrysler Automobiles consummate their marriage in 2020, the German heavyweights will model one of their own.

Analysts forecast almost no sales growth over the next two years for cars. And luxury brands’ winning streak – premium car demand has grown above global demand each year since 2009, according to Jefferies – is coming to an end due to a Chinese slowdown. Even in the Middle Kingdom, upmarket vehicle sales hit 11% of the total, in line with the global proportion.

Ola Kaellenius and Oliver Zipse, bosses of Daimler and BMW respectively, are feeling the strain. Together with incoming European Union fines for dirty fleets, Daimler, worth 53 billion euros, plans to save 1 billion euros in staffing costs by 2022 and accelerate its transition to electric vehicles. BMW, worth 48 billion euros in mid-December, is seeking 12 billion euros in total savings by then to offset higher technology spending.

The Fiat-Peugeot deal suggests an alternative. The Germans already cooperate in mobility services and autonomous vehicles. And there are additional financial benefits. The Italo-French combo is seeking to save about 2.4% in combined operating costs. Applying the same proportion to Daimler-BMW would result in savings worth 38 billion euros – assuming a 28% tax rate and 9 billion euros in restructuring costs – to shareholders today. But given their greater overlap in products and geographies they could probably achieve synergies worth twice that much.

BMW’s controlling Quandt family has a strong independent streak and might not take kindly to having significant Chinese carmakers as shareholders. Together, Geely and BAIC Motor own a combined 15% of Daimler, although that could rise to 20%. Again, they can look to Fiat, where the Agnelli family will emerge as the largest shareholder in the group. Assuming a nil-premium merger, Stefan Quandt and his sister, Susanne Klatten, would hold nearly 17% of “BMDaimler”. The Chinese would be diluted to around 12%.

True, German unions would howl at the prospect of potential job losses. But given the financial and industrial logic in a stagnant market, the Fiat-Peugeot playbook will be scrutinised heavily in Stuttgart and Munich, where Daimler and BMW are respectively based, in the year ahead.

First published Dec. 18, 2019

IMAGE: REUTERS/Lucy Nicholson

M&A bankers will turn climate risk into clients

Rainmakers

BY ANTONY CURRIE AND CHRISTOPHER THOMPSON

The looming $46 billion merger of France’s Peugeot and Fiat Chrysler Automobiles may go down as one of the first major corporate tie-ups driven by climate risk. Yet the novelty will quickly wear off as chief executives wake up to the financial impact of global warming. That gives climate-conscious advisers an edge.

Investment bankers spent little time on green issues in 2019 – or before. Lazard boss Ken Jacobs has said environmental, social and governance concerns may play a role in deals, but reckons they are “not a factor yet.” He’s mostly right. Of the 39 transactions worth over $10 billion announced up to Dec. 10, only Fiat-Peugeot counts. The Italian-American carmaker could avoid a potential $2 billion in European emissions fines in part by teaming up with its French rival, Jefferies reckons, and ease industry problems like overcapacity and low margins.

Others may follow suit. Carbon-intensive sectors like steel, cement and airlines are grappling with the prospect of higher prices or even a tax on carbon, incentivizing a shift to cleaner energy. Royal Dutch Shell in 2019 bid for Dutch renewables utility Eneco, which instead agreed a 4.1 billion euro sale to a consortium led by banking-to-energy conglomerate Mitsubishi Corp. Chevron, ConocoPhillips and even climate laggard Exxon Mobil may similarly need to buy their way to a greener future.

Avoiding bad deals is equally important, even if climate due diligence virtually never happens, as one veteran banker told Breakingviews. Drought in the Colorado River basin could drain up to a fifth of defense group Raytheon’s revenue, yet received no mention in its $120 billion merger with United Technologies. BB&T’s $28 billion acquisition of rival U.S. lender SunTrust ignored potential flooding in Florida and the southeast United States. As such risks materialize, climate-conscious advisers can more convincingly pitch their services to CEOs.

Green bankers are admittedly a rare breed. Former UBS investment-banking boss Jeff McDermott set up Greentech Capital Advisors to work on clean energy a decade ago, and in December agreed to sell to Nomura. Erstwhile Lazard dealmaker Tony O’Sullivan and Baker McKenzie climate lawyer Martijn Wilder recently founded Pollination. As climate concerns rise up the corporate agenda in 2020, more Fiat-style mega-deals are possible. That’ll give Lazard’s Jacobs and other fast-moving rivals more ways to rake in fees.

First published Dec. 19, 2019

IMAGE: REUTERS/Maria Alejandra Cardona

BlackRock is Wall Street’s object of fantasy M&A

Rainmakers

BY JOHN FOLEY AND ROB COX

Steve Schwarzman has one big regret. In 1994 the Blackstone boss sold a stake in some funds that later became BlackRock, the $7 trillion asset manager run by Larry Fink. Schwarzman describes the sale as “a heroic mistake.” It’s not too late to fix it.

Yet he might not be alone in coveting the investment manager. The stability of BlackRock’s earnings has won it the respect from investors that its Wall Street peers, such as Goldman Sachs, covet. It fetches 16 times the next 12 months’ forecast earnings, according to Refinitiv, compared to 9 times for the investment bank and money manager helmed by David Solomon.

Today, BlackRock serves opposite ends of the market from Blackstone and Goldman Sachs. Fink’s company houses two-thirds of its assets in exchange-traded and passively managed index funds. Blackstone’s $545 billion of private equity, real estate and other investments, managed for wealthy clients and institutions, are active. Ditto most of the $1.5 trillion Goldman oversees.

Yet all are hungrily eyeing the middle. BlackRock’s fees from easy-to-trade products are under pressure amid tough competition, so Fink is growing alternative investments like private equity. Blackstone is eyeing more retail money – so it’s perhaps no wonder Schwarzman says he often pictures the two together. As for Goldman, it’s somewhere in between but looking to grow at both ends, having entered consumer financial services with its Marcus electronic bank and Apple credit card.

Valuation has always been the obstacle, though needn’t be for much longer. Blackstone’s shares had risen around 85% in 2019 by mid-December, helped by a restructuring that let passive funds like BlackRock’s buy shares. The $63 billion buyout firm even trades at a higher multiple of 2020 earnings, after a decade of trading at a discount. Goldman is only a couple of billion dollars larger than BlackRock, which was worth $78 billion in mid-December. Mathematically, a merger of equals is doable.

Fink has little reason to contemplate such a deal for now. But at 67, and an oft-cited contender to lead the Treasury under a Democratic president, succession is a live topic. One of the candidates to replace him, Mark Wiseman, was fired in December for having a relationship with a subordinate. Fink shouldn’t be surprised to see a pitchbook with his company’s name on it do the rounds on Wall Street in the year ahead.

First published Dec. 23, 2019

IMAGE: REUTERS/Lucas Jackson

Deutsche, Commerz get 30-year reunification bonus

Rainmakers

BY LIAM PROUD

Germany’s big lenders suffer from high costs in an overbanked market offering customers abundant access to credit. But Commerzbank and Deutsche Bank will get a small but welcome boost from an unlikely source in 2020: the generation of entrepreneurs who founded businesses after reunification in 1990.

October 2020 will mark 30 years since the Soviet-backed German Democratic Republic rejoined the Federal Republic of Germany as a single country. It was a rough transition for workers at former state-owned companies in the East: they had to compete on the open market with more competitive rivals, and a stronger currency made their products more expensive than previously.

Amid the chaos, however, entrepreneurship soared. Historian Michael Fritsch calculates that the self-employment rate in the East was just 1.8% in 1989, but had almost tripled to over 5% two years later. By the end of the decade it was almost 10%. 

Success stories include tech-services firm Comparex, founded in Leipzig in 1990 and now part of Switzerland’s $3 billion SoftwareONE. There’s also sparkling wine maker Rotkaeppchen-Mumm Sektkellereien, previously a state-owned group bought out by management in 1993, whose revenue was 1 billion euros in 2018. Many of the companies founded or taken private in the 1990s are part of what Germans call the Mittelstand, or small- and medium-sized companies.

So what does that have to do with Commerz and Deutsche? It’s all about age: An entrepreneur who was, say, 40 in 1990 would now be 70 and thinking about retirement. A 2017 Commerzbank study found that 39% of Mittelstand companies with at least 2.5 million euros of annual revenue expected a change of management within five years.

Corporate financiers are hoping that many heirs would rather sell or merge the family business than take over, for example, a slow-growing manufacturer at the end of an economic cycle. That would mean deals, and therefore fees for bankers.

It might not be a lifesaver for the lenders: just under one-tenth of the companies Commerzbank surveyed had over 100 million euros of annual sales. Still, interest rates are falling and Germany’s economy is slowing, hurting banks’ bottom lines. In 2020, they’ll be grateful for any help they can get.

First published Jan. 3, 2020

IMAGE: REUTERS/Fabrizio Bensch

An ever-drier world will unleash investment flood

Rainmakers

BY ANTONY CURRIE

The global water crisis is getting worse. By 2030 humans will be using 56% more than is sustainable, according to new research out later in January from the World Resources Institute, a climate think tank. Luckily, investors and companies are investigating some solutions.

The WRI reckons it’ll cost $1 trillion a year to fix the problem, almost half of which is required to boost water supply, with the rest going towards managing demand. Buyout shop KKR is hoping to do its part, announcing in December that it would invest alongside specialist fund XPV Water Partners to develop wastewater-treatment solutions.

It’ll be hard to solve the crisis without addressing farming, since the industry accounts for around 70% of global water use and the same proportion of the WRI-calculated sustainability gap.

Encouragingly, a fix would soak up only 38% of total investment. Trouble is, it can take three or more years for water and other sustainability projects to pay off for farmers, points out Continuum Ag, an agriculture consulting firm set up by Iowa farmers. Yet many eke out a living from season to season. The companies who buy farmers’ goods therefore need to help.

Some are already doing so, like brewer Anheuser-Busch InBev and Mars. The confectioner recently helped Pakistani smallholder farmers cut water use by a third over three years, while increasing their income by a similar amount. On a larger scale, such projects lend themselves to green-bond financing, as PepsiCo showed with a $1 billion deal in October. Some of the proceeds will go towards smarter water use, including for farmers.

Shareholders, meanwhile, are targeting slower-moving companies. A coalition managing $6.5 trillion is haranguing fast-food providers like McDonald’s to force their suppliers to up their game. That pressure will increase in 2020. A number of discussions are underway involving investors, companies and a couple of governments, with goals ranging from setting science-based targets to corralling big water users to publicly set more ambitious targets.

Others, meanwhile, see a big investing opportunity. UBS Global Wealth Management, with $2.5 trillion in assets, has identified water scarcity as one of its top longer-term investment themes. That came after some three-quarters of the 3,400 high-net-worth clients it recently surveyed tagged clean water and sanitation as the most pressing issue facing the world.    

Ignoring water risks can drain earnings. Salt and potash supplier K+S lost 11% of quarterly revenue from lost production as last year’s German drought prevented it from shipping out its wastewater. Meanwhile, investing in solutions can return several times the principal, the United Nations, among others, has calculated. More big players are starting to notice. There’s a flood of money looking to flow into action, and the WRI’s startling new data should help unleash that. But it’s a race against time.

First published Jan. 6, 2020

IMAGE: REUTERS/Mike Hutchings

Investors will rue their Hong Kong risk appetite

Flaming out

BY JEFFREY GOLDFARB

There is relative optimism about Hong Kong reflected in its stock market. That’s hard to reconcile with past and present realities. It also doesn’t bode well for the future.

The city’s benchmark indicator of equities has lagged the S&P 500 Index since violent anti-government protests started in June. Nevertheless, the slide has been less severe than during the Asian financial crisis some two decades ago or the deadly SARS breakout that followed. As of mid-December, the Hang Seng Index was down less than 7% from its July apex. That’s modest when compared with peak-to-trough falls of more than 50% during each of the previous two calamities.

The main Hong Kong index includes more mainland companies than it used to, with such notable additions as Chinese tech titan Tencent. However, more locally skewed indices and stocks – including subway operator MTR, cosmetics retailer Sa Sa International and conglomerate Jardine Matheson – have held up comparatively well through more than six months of turbulence that drove the city into recession.

Clashes are likely to persist. Even under an optimistic scenario laid out by political risk consultancy Control Risks, any de-escalation would be temporary and underlying tensions “would not fully revert to pre-crisis levels.” That’s a bad omen for tourism, shopping and property prices.

The former British colony’s fortunes are also tied to China’s economy, which has been roiled by the volatile trade war being waged between Washington and Beijing. Progress in the negotiations has been slow, and any significant breakthrough looks distant. Under a newly passed law, the United States will now decide each year whether Hong Kong is “sufficiently autonomous” to qualify for special treatment on trade matters.

Any downward turn for buoyant U.S. stocks also would weigh on Hong Kong equities. The cyclically adjusted price-to-earnings ratio developed by economist Robert Shiller, which smooths out the profit for S&P 500 constituents over a decade, has been running at over 30 times. The level was breached only twice before, ahead of the 1929 crash and the dot-com bubble bursting. Likewise, the MSCI Hong Kong Index in late November was trading at a higher multiple of expected earnings than its long-term trend line, according to UBS. Investors will come to rue their risk appetite.

First published Dec. 19, 2019

IMAGE: REUTERS/Jorge Silva

Buyout barons’ debt machine will blow a gasket

Flaming out

BY NEIL UNMACK AND ANNA SZYMANSKI

Private equity looks set for a tricky ride in 2020. And it will be thanks to ructions in the $1 trillion market for bonds backed by the leveraged loans that finance many deals struck by Henry Kravis’s KKR and David Rubenstein’s Carlyle, for example. A weaker economy will make investors wary of buying these so-called CLOs and force vehicles to curb lending. That means higher borrowing costs, and probably fewer takeovers – though some industries and regions, such as Asia, will buck the trend.

Collateralised loan obligations, to give them their full name, hoover up over 70% of the loans buyout shops often use to finance their deals. They slice and dice these loans into tranches offering higher returns for riskier cuts. The U.S. CLO market has more than doubled since 2012 to over $650 billion. JPMorgan reckons the amount of outstanding CLOs should top $1 trillion next year. But this securitisation bonanza is starting to sputter.

It’s all about the arbitrage – or lack thereof. CLOs work when cash flows from the underlying loans exceed payments to the CLO noteholders, leaving annual returns of 15% or more for the lowest-ranking tranches, and fees for managers. But fears of a U.S. recession and general economic skittishness have made investors demand higher returns for some CLO debt. If yields rise much higher, the CLO new-issue machine is likely to grind to a halt.

Downgrades could also be a problem. The rating models that govern CLOs allow them to account for loans at face value. But the moment a CLO holds more than a certain percentage of assets rated CCC, typically 7.5%, managers have to value them with current market prices, which are usually far below par. If enough companies are downgraded, and the CLOs’ assets sufficiently devalued, income from loans is diverted to repay senior bondholders, cutting off lower-ranking investors.

The situation already looks quite fragile. A combination of high company debt and a stagnating global economy mean the share of loans in U.S. CLOs rated B-minus, one level above CCC, is nearly 20%, twice the level before the 2008 crisis, according to Standard & Poor’s. UBS analysts expect the average U.S. CLO CCC exposure to reach 11% in 2020.

The effect could be doubly bad. Investors in lower-ranking CLO tranches will take steep losses, sapping appetite for new deals. Meanwhile, existing CLOs will be less able to lend to lower-rated companies, driving up borrowing costs. That raises the risk of the dealmaking debt machine blowing a gasket.

First published Dec. 19, 2019

IMAGE: REUTERS/Mike Segar

Wealth managers will inflate superprime bubble

Flaming out

BY LISA JUCCA

The world’s biggest banks are stirring up a new lending frenzy. More than a decade has passed since loans to subprime homebuyers went bad. Now UBS and other private banks are cranking up credit to uber-rich clients. This superprime bubble will bring higher returns and risks, too.

A global transparency push forced the wealth management industry to kick the lucrative habit of hiding clients’ assets from tax authorities. Now rock-bottom interest rates are making it harder to deliver positive returns. That’s putting pressure on fees and squeezing profit margins.

In an attempt to boost revenue, wealth managers are extending more loans to successful entrepreneurs and their offspring. Total lending revenue at top private banks grew 8% annually in the two years to mid-2019, according to Tricumen, a consultancy.

UBS’s private bank had extended $176 billion to wealthy clients at the end of September. That’s equal to 7% of the $2.5 trillion in assets it looks after. New global wealth management co-head Iqbal Khan, who previously cranked up lending at rival Credit Suisse, looks set to go further. Some executives reckon private banks could comfortably extend credit worth up to 15% of the assets they manage.

Lending to people who are already rich appears relatively low-risk. So-called Lombard loans, which are secured against a portfolio of securities lodged with the private bank, are typically the safest. Gross margins on such loans tend to be less than 100 basis points, says consultancy Capco. Banks can charge twice as much for fancier collateral such as real estate or shares in unlisted companies, and even more for credit backed by art, yachts or wine. However, private bankers will sometimes reduce rates to win a bigger mandate – or lock in an investment-banking client.

Even though wealthy borrowers can generally repay the loan, accidents do happen. When Steinhoff International revealed a massive accounting fraud in 2017, the likes of Bank of America and Citigroup suffered losses on 1.6 billion euros of loans secured against shares owned by Christo Wiese, the South African retailer’s former chairman.

Such lending is safer than risking big fines by helping money launderers or tax dodgers. And by rights it ought not to have the potential to blow up the entire financial system like the subprime crisis did. Such comparisons, though, can breed a false sense of security, and complacency. That means this bubble has further to inflate – and will leave a mess when it pops.

First published Dec. 30, 2019

IMAGE: REUTERS/Arnd Wiegmann

French lottery IPO may be as good as Macron gets

Flaming out

BY CHRISTOPHER THOMPSON

There are some benefits to having a former investment banker as president. Shares in La Française des Jeux rose by up to 18% on their debut after the government-controlled national lottery made its stock market debut in a listing championed by Emmanuel Macron, the ex-Rothschild banker who now occupies the Elysee Palace. But resurgent protests and a national strike will make it harder for him to flog other state assets in the coming year.

The biggest French retail stock offering since the global financial crisis was a success for around 500,000 domestic punters who saw their cut-price shares jump by almost a fifth. The state and its advisers, however, will face charges of underpricing the country’s showpiece privatisation by leaving around 600 million euros of value on the table.

In truth, the FDJ soufflé may yet deflate. A market capitalisation of around 4.3 billion euros means the company trades at a heady 22 times expected earnings for next year. That’s a hefty premium to Greek peer Greek Organisation of Football Prognostics, which is valued on a multiple of 15 despite higher expected sales growth, according to Refinitiv data.

The successful initial public offering should whet investors’ appetite for the sale of other French assets, much as the British government offloaded telecom and gas holdings in the 1980s. Top of the list is the government’s 51% stake in Aeroports de Paris, which Macron wants to use to start an innovation fund. Shares in the 18 billion euro manager of the Charles de Gaulle and Orly airports have crept back up after suffering a selloff in May, when France’s constitutional court approved plans for opposition politicians to ballot for a referendum on the idea.

Yet hostility to privatisations has hardly gone away. Parisian bankers speak of the “social issues” overshadowing a sale of ADP, including a national strike planned for December. One of the likely beneficiaries of a selloff is Vinci, the French infrastructure company which already owns 8% of ADP and would probably buy more. The operator of French highway toll booths is a frequent target of “gilets jaunes” protestors.

The ADP ballot is well short of the threshold needed to force a national vote on the issue. And Macron can point to a fruitful lottery IPO. But French bankers hoping their former colleague will push more lucrative business their way may be disappointed.

First published Nov. 21, 2019

IMAGE: Daniel Leal-Olivas/Pool via REUTERS

Disney will lose its magic touch

Flaming out

BY JENNIFER SABA

Walt Disney Chief Executive Bob Iger rarely puts a foot wrong. In his 14 years in charge he has bought properties like Star Wars and the Avengers, and while he paid a high price in the auction of assets from Twenty-First Century Fox, at least he won. Expectations are therefore high for his next magic trick: creating a video-streaming product to rival Netflix. This feat may be beyond him.

An eye-popping 10 million people signed up for Disney+ on its first day out of the gate in November, a number that added $18 billion to Disney’s market capitalization within hours of disclosing it. Disney’s stock was in mid-December trading at 26 times 2020 forecast earnings, according to Refinitiv, having overtaken Apple and Google owner Alphabet’s multiple during 2019. Iger wants up to 90 million subscribers by September 2024 – by which time he says he will no longer be chief executive.

Is that growth feasible? It’s pretty much what Netflix did, times two. Reed Hastings’ streaming pioneer went from just under 10 million subscribers in 2008, which included by-mail DVD rental, to 44.3 million five years later. Apply that same rate of growth to Disney and it would be just halfway towards Iger’s upper target. And that’s already faster than Facebook’s growth in monthly active users between 2009 and 2014 for a product which, unlike Disney+ and Netflix, is free to use.

Granted, Disney has advantages its rivals didn’t, like name recognition and splashy content including Yoda and animated works from Pixar. And it’s cheap at $6.99 a month, about half the price of Netflix. That too, though, is a problem. Disney effectively hopes to grow at twice the speed of Netflix in its early days, but at half the revenue per user that Hastings’ service gets today. A slew of rival offerings from companies like Comcast’s NBC Universal and AT&T-owned HBO will make it tough to raise prices.

That suggests Disney investors are already living in “Fantasia.” Netflix, with an enterprise value of $136 billion in mid-December, is valued at around $860 per user. Take half that rate and apply it to 90 million subscribers, and Disney’s digital service ought to be worth around $40 billion five years from now. Yet the company’s market capitalization has increased roughly $50 billion since details of Disney+ started to emerge in April. The return to earth promises to be anything but magical.

First published Dec. 19, 2019

IMAGE: REUTERS/Mario Anzuoni

American election to test Wall Street’s nerves

Playing with fire

BY JOHN FOLEY

The following imaginary conversation between two Wall Street bankers was overheard in the changing room of Park Avenue’s elite Racquet and Tennis Club.

Jordan: So, the head of our family office is starting to get a bit antsy about 2020. I know 2016 was uncomfortable, but this time is something else. It’s all tax the rich and shut down Wall Street. I feel like the market rally’s running out of steam, and Democrats are just out to punish anyone who’s made it. What are you hearing from your people?

Patrick: You worry too much. Donald Trump’s a shoo-in. Sure, he’s the least popular president to run for re-election in history and only the third to be impeached. But the economy, or I should say the consumer, is doing great. Housing starts are on a roll and impeachment is DOA in the Senate. Oh, and it’s hard to dislodge a president after just one term if the economy is fine. Remember that Jimmy Carter had kicked off a recession, and George Bush Sr. raised taxes.

Jordan: Right. All the same, you’ve got to be a bit nervous about what happens if the Republicans win, and he keeps on down this trade-war road. Last year our guys were forecasting global GDP growth of 3.6%, and now it’s more like 3%. In real money that’s about $400 billion down the drain – with hardly any actual tariffs. And the budget deficit is going up during the best of times. That’s totally contrary to what we learned in Econ 101 at Harvard.

Patrick: Relax, everyone knows he’ll strike a deal with the Chinese. If they don’t fold before the election, they’ll give in afterwards when they realize Trump’s got another four years to turn the heat up. Plus, worst-case scenario is that growth takes a hit. That’s when Jay Powell and the Federal Reserve will step in. They’ve got it covered. Bigly.

Jordan: Ok, but just bear with me. What if he loses. I just looked this morning and Elizabeth Warren and Bernie Sanders were right up there for the Democratic nomination. I mean, my teenage kids love Bernie, but this idea that capitalism is broken is bad news for markets, for dealmaking, and, you know, for people like us.

Patrick: Yeah, I hear you. Do you really think Bernie or Warren has a chance, though? Even if Trump flames out, I’m banking on the three B’s – Biden, Buttigieg and Bloomberg. Joe Biden’s an old hand – ok, maybe too old – who’s not going to rock the boat. Pete Buttigieg is a Harvard man and former McKinsey guy. As for Mike, well, I am still a bit sore about the way he dropped his membership here. But really, there’s no better man for the job.

Jordan: Don’t get me wrong – I love Mike as much as anyone – notwithstanding that whole brouhaha when he quit the club. Lots of Republicans I know would flip for him. But he’s nowhere in the race right now.

Patrick: Maybe. Don’t bet against an establishment billionaire though. He’s already spent more on TV ads in swing states than any candidate ever. And if Biden can’t go the distance, or things go down to the wire when the Dems pick their candidate at the convention in Milwaukee, he’s got a definite shot.

Jordan: How so?

Patrick: Think of it this way. It’s a super-crowded field. Usually we know by Super Tuesday in March who’s leading the pack, but that might not happen this time because the party’s so divided. If it’s all still up for grabs by the time the convention happens in July it’s all down to those 760-odd so-called superdelegates – you know, the party elites and so on. They changed the rules so they don’t vote in the first round this time unless there’s an obvious winner already. If there isn’t, they wade in and we go to a brokered convention.

Jordan: Oh yeah, a brokered convention. Remind me?

Patrick: Basically, that’s where anything could happen. It’s a bunch of horse trading where people can switch their support and there’s another vote for the nomination. Everyone always predicts there’ll be one and it never happens, but this time could be different. If the delegates want someone closer to the center, that’s when Bloomberg could emerge as the dark horse. Or Amy Klobuchar or Buttigieg – someone centrist, maybe from the Midwest, who can win those states Hillary Clinton lost.

Jordan: Hmm. And if he doesn’t? What’s the plan if Warren or Sanders come out on top? I tell you, Bernie makes me nervous. He’s angrier than my wife was the day I got her that Peloton.

Patrick: Come on, dude. Being POTUS isn’t like being the candidate. Even Liz and Bernie, when they realize how much of the economy relies on finance, they’ll change their tune. And either way, they can’t do squat if the Senate remains divided. You can also bet that Jamie Dimon and a bunch of other moderate corner-office guys will be working to get them onside. The best thing about having an inexperienced POTUS is you can help mold their views.

Jordan: I guess. I feel like I heard that somewhere before. Anyway, I’ve got to split.

Patrick: See you at Buffy’s thing this weekend in Bridgehampton.

First published Dec. 30, 2019

IMAGE: REUTERS/Brendan McDermid

South Africa heads for year of living dangerously

Playing with fire

BY ED CROPLEY

President Cyril Ramaphosa is running out of time to salvage South Africa. A flatlining economy and soaring debt-servicing costs are squeezing public spending. The obvious option is to shrink bloated state firms like power utility Eskom. That will provoke trade union protests and strikes, which may dent the economy. A failure to press ahead will be worse in the long run.

South African government bond yields are relatively stable, at around 8.4% for 10-year debt, but Pretoria’s debt pile is growing. The government expects it to hit 80% of GDP in 2023 from the current 69%, including borrowing by Eskom. That will push up debt-servicing costs. In 2020, South Africa will spend more on interest payments than healthcare for the first time in the post-apartheid era.

Ramaphosa’s fiscal wiggle room would be bigger if he could turn around troubled state-owned companies. His first test is South African Airways. True, the debts of the perennially loss-making airline are only $1.5 billion, less than 1% of total public debt. They also pale against Eskom’s $30 billion debt pile. But unlike Eskom, which supplies 90% of South Africa’s power, SAA can go bust without taking down the $360 billion economy.

Unions have opposed cuts to the airline’s 5,000-strong workforce. Yielding ground would weaken Ramaphosa for the more important fight over Eskom, which is teetering on the brink of bankruptcy and struggling to keep the lights on. The government is willing to take a chunk of the utility’s debt onto its books. But it also wants to split the company into three to improve efficiency, possibly as a stepping stone to privatisation. Eskom bosses also reckon they need to axe 16,000 jobs, a third of the workforce. That would trigger sustained and violent protest.

Blackouts due to sabotage or strikes would hurt the economy. But caving in to unions would carry even greater long-term costs. Without a profitable Eskom to invest in a stable power supply, billions of dollars in investment pledges will lapse and the economy will further atrophy. Ramaphosa’s leadership of striking mine workers in the 1980s played a central role in collapsing the apartheid economy and ending white-minority rule. His battle with unions in 2020 will decide the country’s next chapter.

First published Nov. 29, 2019

IMAGE: REUTERS/Siphiwe Sibeko

Italy and Germany will unite on EU tech taxes

Playing with fire

BY LISA JUCCA

Ursula von der Leyen is starting on the defensive. Despite her ambition to overhaul the European Union, the new European Commission president is unlikely to persuade Italy and Germany to set aside their differences on common banking rules any time soon. A plan to tax technology giants offers a better chance for the traditional EU rivals to find some common ground.

Among her long list of promises, the former German defence minister has pledged to complete the euro zone’s half-baked monetary union. To enable lenders to operate freely across the 19-nation currency bloc, member states first need to agree to common deposit insurance, as well as a fund to handle the cost of bank failures.

Rome and Berlin are in opposite corners. German leaders want Italy to reduce financial risks, including its $2.5 trillion public debt, before signing up to measures that could see euro zone taxpayers share the cost of a future crisis.

Meanwhile, Italian officials object to Berlin-backed suggestions that euro zone sovereign bonds should carry different levels of risk when calculating bank capital requirements. Stripping Italy’s public debt of its current risk-free status would hit domestic lenders, which are large holders of the securities. That might accelerate an Italian debt blowup.

Messy politics in both countries will hamper any compromise in 2020. Italian Prime Minister Giuseppe Conte’s coalition is fragile and under constant attack from eurosceptic leader Matteo Salvini, the likely winner of any election. Meanwhile, German Finance Minister Olaf Scholz, who championed a recent plan to create a common deposit backstop, has become less influential after losing out in a recent vote to lead his Social Democratic Party.

It thus makes sense for von der Leyen to change tack. A more promising idea is a plan to impose a 3% levy on the revenue of global tech companies such as Facebook and Amazon. That would help redress an imbalance which the commission says allows digital players to pay an effective 10% corporate tax rate, against 23% for brick-and-mortar rivals. The project needs to overcome opposition from small low-tax states like Ireland – and faces fierce criticism from President Donald Trump.

But France, Italy and Germany all like the idea. While banking union remains elusive, the tech tax could unite the euro zone’s biggest adversaries.

First published Dec. 19, 2019

IMAGE: REUTERS/Francois Lenoir

Investors warming to Putin’s Russia will go cold

Playing with fire

BY DASHA AFANASIEVA

A thaw is coming early this Russian winter. Inbound retail and technology investments are hints of improvement in the business climate, and fresh sanctions fears have eased off. But these bright spots won’t save the G20 country from economic stagnation in 2020.

The owner of U.S. retailer TJ Maxx acquired 25% of Russian low-cost clothing retailer Familia for $225 million in November, the first big Western investment since Washington and Brussels imposed sanctions over Russia’s annexation of Crimea in 2014. New York-traded search engine Yandex may float its ride-sharing business, part-owned by Uber Technologies, in 2020, Reuters reported. Bank VTB Capital expects Russian companies to raise more than $10 billion through equity listings over the next year – a big improvement on $484 million raised in 2018, according to Refinitiv data.

Yet investors should be wary. For one thing, existing sanctions are not going away. And Russia’s economy is still stuck in a rut with growth forecast below 2% in the coming years after a 2.3% expansion in 2018. President Vladimir Putin’s plans to spend billions of dollars enhancing business conditions, infrastructure, healthcare and ecology have been slow to take off. They also merit healthy scepticism. Business conditions are hardly friendly when – as one example – Michael Calvey, the American head of one of the country’s biggest buyout funds, is under house arrest over a dispute relating to a portfolio company.

Russia is protected from much scrutiny by chaos elsewhere. With military action in Ukraine and Syria, Putin has perfected a foreign policy along those lines, and the same goes for business. U.S. lawmakers are too busy with the Democrats’ efforts to impeach President Donald Trump and their election in November 2020 to enact major new sanctions – a worry for Russian businesses as recently as last summer. Washington’s trade fights with China and the European Union also serve as distractions that are welcome in Moscow.

Investors can find chunky yields in Russia, particularly if they are happy to own stakes in companies that are tools of Putin’s government. Gazprom, for instance, brought shareholders a total return of around 75% in the year to mid-December partly thanks to a new bumper dividend policy. Some may find that worth the risk. But if they are warming to Russia more generally, they are likely to feel chills again.

First published Jan. 2, 2020

IMAGE: Alexander Zemlianichenko/Pool via REUTERS

Johnson’s big win unlocks Brexit black box

Playing with fire

BY PETER THAL LARSEN

Britain will soon know what Boris Johnson’s pledge to “get Brexit done” actually means. The UK Conservative Party secured a large parliamentary majority in Thursday’s general election. That will allow Britain to quit the European Union three and a half years after voters narrowly opted to leave. The prime minister’s policy ambitions, however, remain a black box.

The result is an overwhelming vindication of Johnson’s decision to campaign on a single repetitive promise. His government’s hefty majority will ensure Britain leaves the EU at the end of January. It should also make it easier for Johnson to secure a trade deal with the remaining 27 countries by the end of 2020, a tight deadline he says he will not extend. That’s because Johnson will no longer be captive to the eurosceptics in his party, who dream of turning Britain into a lightly-regulated capitalist nirvana. If the prime minister opts for a closer alignment with the EU, it will be hard to stop him.

Markets reflect the hope that Johnson will have the authority to push through a softer version of Brexit. The pound was up almost 2% against the U.S dollar. Soaring stocks will deliver a short-term feel-good factor. Foreign investors who fretted about Labour Party leader Jeremy Corbyn’s hard-left agenda will decide that their money is once again secure in Britain.

Yet what Johnson plans to do with post-Brexit Britain is a mystery. His decision to campaign to leave was famously motivated by personal ambition. His election campaign was largely free of policy ideas, beyond vague promises to hire more nurses and police, and a pledge to prop up ailing companies.

He will also face high expectations, particularly among former Labour voters in the north of England. Leaving the EU will still inflict long-term economic damage and any blame will fall squarely on Johnson and his government. Meanwhile, a strong election performance by the Scottish Nationalist Party will revive pressure for a new independence referendum north of the border. Johnson will get Brexit done. It’s still not clear that voters will be glad he did.

First published Dec. 12, 2019

IMAGE: REUTERS/Hannah McKay

Taiwan will widen U.S.-China schism in 2020

Playing with fire

BY ROBYN MAK

Keep a close eye on Taiwan in 2020. Its significance is set to grow amid shifting supply chains. Anti-Beijing sentiment also has been gaining traction in the United States. Both dynamics herald deeper ties between Taipei and Washington, bolstering the case for a controversial bilateral trade deal.

The $560 billion economy is an unlikely beneficiary from U.S.-China tension. While other Asian export powerhouses grapple with slowing demand, Taiwan recently nudged up its GDP growth forecast for 2020, to 2.7%. Rising domestic investment should help, boosted by local manufacturers moving operations back home from mainland China.

Moreover, American companies are buying more from Taiwan. In the first half of 2019, for example, U.S. tariffs diverted over $4 billion of office machinery and communications equipment orders to the island, according to a UN report. The likes of Microsoft and Alphabet’s Google are among those stepping up investments there.

Against this backdrop is growing American antagonism towards the People’s Republic, which considers self-governed Taiwan a renegade province. President Donald Trump signed a veto-proof bill effectively supporting anti-government protesters in Hong Kong. Soon after, the U.S. House of Representatives roundly passed a bill that condemns the crackdown on Chinese Muslims in Xinjiang.

Taiwan is next on the legislative agenda. The Taiwan Allies International Protection and Enhancement Initiative Act calls for the United States to reduce engagement with countries whose actions have undermined Taiwan. Under President Tsai Ing-wen, who faces an election in January, and her independence-leaning Democratic Progressive Party, eight countries have broken diplomatic relations with Taiwan in favour of Beijing. The U.S. proposal also calls for bilateral trade talks.

That will provoke Chinese President Xi Jinping and could even derail already-fragile U.S.-China negotiations. But there is a strategic rationale for a trade agreement with Taiwan.

American giants such as Apple and Qualcomm rely on Taiwanese components. Manufacturing export orders from the United States reached some $150 billion in 2018. And while companies including TSMC are leading the charge for next-generation semiconductors, China is catching up quickly. A deal may help Tsai defend the industry, and ultimately reduce her economy’s dependence on the mainland. But it also means Taiwan is destined to be a flashpoint.

First published Dec. 18, 2019

IMAGE: REUTERS/Tyrone Siu

A Canadian breakup is back on the table

Playing with fire, Uncategorized

BY ROB COX

Something disturbing happened Saturday on the platform of the Place-des-Arts metro stop in Montreal. As a woman of South Asian descent was boarding a train with a Domino’s box in her arms, a man slammed it from her hands, sending the pizza melting onto the subway floor. She called after the man, who had bleached yellow hair. He flipped her the bird, scrambling toward the exit. Her face registered astonishment, then fear. “I’m sorry, but do you know that man?” No, she replied, shaking. “Never seen him before.”

The incident was surely racially motivated, at least in part. It was shocking not just for its randomness, but for having occurred in Canada, a country which has led even other liberal democracies in its openness to the world and to immigrants and refugees. On the same day, Canada’s best-known hockey commentator, Don Cherry, suggested that new arrivals should spend a few dollars buying the red poppies worn to commemorate Remembrance Day. Two days later, Cherry was sacked as a host of “Hockey Night in Canada.”

A couple of anecdotes don’t define an entire nation, of course. But it’s hard not to see a reflection of the current divided state of Canada.

It’s a larger debate that could one day threaten the country’s cohesion. Taking control of immigration is one of the demands coming from supporters of “Wexit” – the withdrawal of western provinces, in particular energy-rich Alberta and breadbasket Saskatchewan. The far bigger beef, however, is economic. In part, that relates to the federal government’s approach to global warming under Prime Minister Justin Trudeau, who is leading a minority government for a second term. It’s a disagreement that democratic countries will increasingly need to tackle, often in tandem with migration.

Canada has seen divisions like this before. A move for Quebec’s independence was only narrowly defeated in a referendum in 1995. And the question has cropped up in Alberta periodically since the region became a province in 1905, usually in connection with energy policy and taxation. During local boy Stephen Harper’s decade as prime minister, Albertan separatism was muted. It has come back under Trudeau. A third of Albertans think the province would be better off separate, according to an Ipsos poll released last week, up from 25% scarcely more than a year earlier.

The main issue is Canada’s approach to energy, or more specifically the tar sands of Alberta, which the provincial government says represent the third-largest oil reserves in the world, after Venezuela and Saudi Arabia. The sands employ 140,000 people and generated royalties of C$2.6 billion in the 2017-18 year. What’s less good about them, however, is their high cost of extraction, which combined with the expense of transport arguably makes tar sands the world’s least efficient large-scale energy resource.

That’s before what economists call the externalities. To extract bitumen from the sands, processors effectively melt the earth with boiling water and chemicals, creating toxic residues. The National Resources Defense Council argues: “From extraction to waste storage, every step of the tar sands oil production process wreaks havoc.”

Consequently, the province produces 62 tonnes of carbon dioxide equivalent per person, according to 2019 World Population Review statistics cited by Canada’s Global News. That compares to roughly 17 tonnes per Saudi Arabian subject or 16 tonnes per American citizen. By that measure, an independent Alberta might be the world’s biggest polluter per person.

That’s not deterring Peter Downing, who heads Wexit Canada, which he hopes to turn into a political party. Downing, perhaps Canada’s answer to Brexiteer Nigel Farage, says the group should gain political support beyond Alberta, in Saskatchewan, Manitoba and parts of British Columbia. He says the party “is basically going to be the Bloc Quebecois of the west but it does a little more damage.” While the francophone Quebec still commands 26% backing for separation according to the Ipsos poll, rising support for Wexit other than in Alberta is really only noticeable in Saskatchewan, at 27%, up from 18% a year ago. Manitoba and BC just aren’t into it, for now.

Conscious of the rift in his province, Alberta Premier Jason Kenney last week created a “fair deal panel” to study ways to reclaim powers from Ottawa. These could include taking Alberta out of the Canada Pension Plan, creating a provincial police force, and fighting back against the Trudeau government, including its regulation of the energy sector and foot-dragging on the construction of the Trans Mountain pipeline expansion.

Kenney says he is a federalist. Keeping Western anger at Ottawa and the so-called “Laurentian elites” of Toronto and Montreal from boiling over – while also not alienating the country’s two most populous provinces, Ontario and Quebec – won’t be easy, though.

Downing’s response to Kenney’s panel on the VoteWexit Facebook page, which has 265,000 followers, suggests the difficulty that lies ahead: “Trudeau is set to DESTROY Alberta. Kenney is set to STUDY and STALL for the next 6-months. Only separation SOLVES the problem.”

Ultimately, the debate comes down to where Canadians see their economic future. When resource extraction is deemed the enemy of a warming planet, how will the industry and the country prosper? A government that wants to cut out fossil fuels will have to find economic answers that ease the transition – maybe reversing the majority view in Alberta and Saskatchewan, per Ipsos, that the provinces don’t get their fair share from the Confederation.

For a nation of just 38 million people occupying the world’s second-largest land mass after Russia, maintaining a vibrant economy in a warmer future in which the oceans encroach on coastal land almost certainly means encouraging immigration. That’s already a source of division, illustrated by the Montreal metro incident, but it could become much bigger.

It may sound far-fetched to suggest newish countries like Canada, or its southern neighbor, could break into smaller sovereign pieces. But the consequences of climate change will present existential challenges that could easily drive even friendly neighbors apart. Keep an eye on Alberta.

First published Nov. 12, 2019

IMAGE: REUTERS/Amber Bracken