ECB

Week in Review: Animals galore!

The theme of this week’s post is animals! We have animal spirits are driving even more M&A activity, this time in the hotel industry. We see a fundamental divide between the hawks and doves in monetary policy, between those who want to see less monetary stimulus and those who want more. Finally, there is a tale about the mythical unicorns, the start-ups that are valued at over $1bn before even being public listed!

Hotels are getting in on the action!

A Marriott flag hangs at the entrance of the New York Marriott Downtown hotel in Manhattan, New York November 16, 2015. Marriott International Inc will buy Starwood Hotels & Resorts Worldwide Inc for $12.2 billion to create the world's largest hotel chain with top brands including Sheraton, Ritz Carlton and the Autograph Collection. REUTERS/Andrew Kelly

  • What happened? After the last few weeks were dominated by headline-making ‘megadeals’ in the beer, tech and pharmaceutical industry, it was the hotel industry’s turn; Marriott International approached Starwood Hotels & Resorts with an offer of $12.2bn to acquire them. However, the deal is not yet done as the door is still open for other hotel chains to propose an even better offer.
  • What’s going on behind the scenes? The hotel industry is known to be widely dispersed; the combined firm would be the largest hotel company in the world but would still only have a global market share of 7%. Nonetheless, growing in scale is highly significant as Marriott hopes to gain greater bargaining power against the internet booking companies of Expedia and Priceline who together control 61% of the market, and a greater ability to compete with the likes of Airbnb who have intensified the competition that the hotel companies face. Finally, this deal is perfectly in line with Marriott’s strategy of international diversification because they are already steadily opening one new hotel in China every fortnight but through the acquisition of Starwood who sell over 20% of their rooms in Asia, they can dive straight into the Asia-Pacific markets where incomes are rising fastest.
  • Why is this important? The hotel sector had been particularly quiet in the first half of this year, even when most of the sectors were seeing large amounts of M&A activity going on but within a fortnight, that changed dramatically. Firms such as Accor, the French hotel group and Travelodge, the budget UK hotel chain, were quickly immersed in deals before this bumper transaction was announced. Ultimately, it highlights that in the face of disruptive innovation and pressures from their distributors, firms must adapt and M&A is one way to do that. Only time can tell if that is a sufficient answer.

Are unicorns even real?

Jack Dorsey

  • What happened? Of course unicorns exist! No, we don’t mean the mythical horned creature, we mean the tech firms that have managed to amass a valuation in excess of $1 billion. However, one purported unicorn, the payment processing company of Square Inc, didn’t nearly as well as it hoped when it had its initial public offering last week. Its shares priced at $9, well below its indicated price range of $11-$13.
  • What’s going on behind the scenes? In its previous private fundraising round, Square had been valued at $6bn and if the IPO had gone according to plan, it would have been worth as much as $4.2bn but alas, its public valuation at debut was just a meagre $3.2bn. When we consider why the firm was valued at such a discount relative to its private valuation, there are many reasons. The most important factor to consider is almost always the fundamentals; behind all the optimism about its status as a unicorn, Square is still a loss-making financial services company and although its year-on-year adjusted revenue growth rate is high at over 70%, it is on a downward trend. In fact, in an competitive industry where there are at least 5 other unicorns, it is clear that the market has deemed Square as being simply not unique enough to command such a high price.
  • Why is this important? On the whole, tech IPOs have done rather poorly this year; there have been less than 30 tech IPOs in the US this year, the least since 2009 and there is good reason for this. Investors are suspicious of the high valuation that privately listed companies have received, as it is not clear how strong the fundamentals of the firm are and what terms private investors have been given by private tech firms. With unicorns being as illustrious as they are, just as with the mythical creatures, it seems that August’s market correction has made investors sceptical of the unicorns.

Hawks and doves
ECB president Mario DraghiJanet Yellen testifies before the House Finance Committee in the Rayburn House Office Building November 4, 2015

  • What happened? More and more evidence is accruing to suggest that the ECB and the Fed are going to change their monetary policy stance in December. The big sticking point is that the changes are almost certain to be in the opposite direction to one another.
  • What’s going on behind the scenes? The US is coming off the back of a strong jobs report in October where there was a record low level of unemployment and according to the minutes of the Fed’s October meeting, many members on the board support the view that the conditions for a Fed rate hike “could well be met”. In direct contrast, ECB President Mario Draghi echoed his famous call to “do whatever it takes” to save the Euro in 2012, by announcing that he “will do what we must to raise inflation as quickly as possible” after months of near-zero inflation rates and a paltry growth rate in Q3 for the Eruozone. As such, December looks set to be the month when the Fed finally abandons its rockbottom Fed funds rate with a hawkish rise but also when the ECB makes dovish moves to bolster its €1.1tn quantitative easing programme.
  • Why is this important? A change in the monetary policy for the two biggest economies in the world would individually be enough to attract the interest of most economists but the fact that they are set to occur in the same month and with a difference in direction has added a whole new element into the mix. This is most plain to see in currencies and bonds where the dollar is surging to a seven-month high against the Euro whilst the sovereign debt spreads on two year Treasury notes against their G7 equivalents has reached almost 80 basis points, the greatest since 2007.

Other News:

  • There were significant developments in the fight against ISIS, in the aftermath of the Paris terror attacks that killed at least 129 people and injured more than 300 others. French President Hollande declared war on ISIS and launched an air offensive in Syria against known ISIS strongholds in retaliation. Meanwhile, the US continued to launch air strikes against and claimed to have killed the leader of IS in Libya. Finally, calls have been made to restrict the flow of Syrian migrants into Europe and the US, in fear of letting in would-be ISIS terrorists.
  • Walmart reported positive results last week as its stocks rallied and its sales in its domestic stores were slightly higher in the third quarter but despite this, profit was down by 11%, owing to the poor performance of the international stores. In particular, sales at Asda were down 4.5% due to fierce competition from the discount retailers who have seen their market share double in the past 3 years.
  • The Japanese economy fell into recession in the third quarter as it saw a slight contraction of 0.8% at an annualised rate that added to Q2’s contraction of 0.7%. This is a severe disappointment for Japanese Prime Minister Shinzo Abe whose efforts to eliminate deflation and revitalise economic growth through fiscal and monetary stimulus have clearly been in vain. Fortunately, the underlying reason for the contraction was simply a sharp decline in inventories, as private consumption had actually grown by 2.1% at an annualised rate, suggesting this ‘technical recession’ isn’t nearly as bad it seems.

Week in review: A sinking feeling

In this section, we provide a comprehensive look at the week’s top stories, examining all the important parts of the story from the immediate details to the critical factors lying below the surface. 

IPOs losing their buzz

1961 Ferrari SpA 250 GT SWB California Spider, picnMastercard and Visa logos are pictured on credit cards in New York, Wednesday, August 31, 2005. Photographer: Daniel Acker/Bloomberg News.

  • What’s happened? Following the great success of the equities market last year which saw a bullish run, the record-breaking Alibaba flotation and a slew of lucrative bio-tech IPOs, the equity-listing market appeared to show significant signs of weakness this week. For example, First Data’s IPO of $2.65bn, which was the largest US IPO this year, performed abysmally as it was launched at the price of $16 a share that was already below the expected range of $18 to $20 and it ended up trading at a further discount on its debut. Similarly, in markets worldwide, IPOs are being put on hold as the IPOs for Digicel, a Caribbean telecoms group and Albertsons, an American grocers, were cancelled whilst  the UK-based Acacia Pharma have delayed a planned flotation.
  • What’s behind this story? The IPO market as a whole been struggling throughout the year as shares that floated in 2015 have been down by 5% on average and over half are below their issue price. It has been factors such as a slowing China, uncertainty over the timing of the Fed’s impending rate hike and pessimism about the recent Q3 earnings season that has caused investors to seek  to minimise their risk by eschewing IPOs and companies are responding in kind by delaying their IPO until more favourable conditions return. In fact, it was exactly this equity volatility that CEO of Digicel Denis O’Brien cited as his reason for abandoning plans for what would have been one of the largest IPOs this year this year at $1.7bn.
  • This is yet another sign of the major economic factors at play that have been dominating the minds of investors for months, creating a dampener on the performance of equities. Nonetheless, the Ferrari IPO also showed that even if investors have become more risk-averse, investors are still up for a good deal when presented to them; valuing the company at $9.8bn through its sale of 7.2m shares at $52 apiece, the luxury car-maker’s share price rose even further before closing at $55 at the end of its debut day.

The mystery of Chinese growth data

Chart: China key activity indicatorsRenminbi banknotes are placed on a bank staff's table in a bank in Lianyungang, east China's Jiangsu province on August 11, 2015. China's central bank on August 11 devalued its yuan currency by nearly two percent against the US dollar, as authorities seek to push market reforms and bolster the world's second-largest economy. CHINA OUT AFP PHOTO (Photo credit should read STR/AFP/Getty Images)

  • What’s happened? The Chinese statistics bureau releasing data reporting that the Chinese economy had grown at an annualised rate of 6.9% during Q3, which marked yet another fall on its growth rate in previous quarters.
  • What’s behind this story? There are suspicions arising from the release of this data as it seems too perfect. Beating expectations of 6.7% growth rate from a Bloomberg poll, it implies that China is on track to achieve its full-year growth target of 7%. This comes despite other statistics from China’s economy painting an even worse picture as industrial production grew by just 5.8% in September which was close to the 6-year low that was seen in March but it was allegedly robust consumption that prevented the headline growth rate from being any worse as retail sales rose by a better-than-forecast rate of 10.9%. To what extent is the Chinese government manipulating the data? Who knows.
  • Why is this important? Economists naturally expect China to slow down due to structural reasons such as a shrinking labour force and the end of “catch-up growth” as China completes the transition from a rural to industrial economy but the multi-million question is whether it will be hard or smooth landing. Cyclical factors at the same time are also dampening Chinese growth prospects such as weakening demand for Chinese exports and an oversupply of housing so it creates even more uncertainty about whether the Chinese government can do enough to nail this landing as it has been trying hard to stimulate the economy via cuts to the headline interest rate on top of fiscal stimulus.

To “do whatever it takes”

Mario Draghichart: Eurozone

  • What happened? This week, Mario Draghi made clear the European Central Bank’s readiness to deploy more monetary stimulus; he explicitly pointed out that the “size, composition and duration” of its QE programme was subject to review in December and it would act to further boost to the Eurozone economy should the slowing emerging markets have a severe impact. For the time being though, the ECB is set to continue its current QE programme of €60bn monthly asset purchases in mostly government bonds until at least September 2016.
  • What’s behind the story? The ECB’s significant monetary stimulus has had mixed success it seems. For one, it has helped to improve the condition of European credit markets by encouraging banks to ease credit conditions on loans to businesses as a survey of European banks by the ECB has shown. On the other hand, economic data from the Eurozone continues to be weak with sluggish growth in form of industrial production in the eurozone falling in August by 0.5% as well as anaemic inflation with consumer prices actually falling by 0.1% in September. This gives justification for why the ECB may be looking to expand their current €1.1tn bond-buying programme and reduce the deposit rate of -0.2% even further.
  • Why is this important? This whole ordeal highlights the divergence in monetary policy around the world; whilst the ECB is looking to increase its monetary accomodation, just across the channel, the Bank of England is set to tighten its monetary policy within just a few months and the central bank for the world’s largest economy, the Fed, is in a similar situation. This has big implications for capital markets with capital being so internationally mobile and will thus have a big effect on equity prices. It also highlights the effects that persistently low oil prices have had because although it may have had some limited effect in boosting consumption, it has also created the spectre of deflation that has entered the ECB’s cross-hairs.

The future of the European Investment Banking industry

Tidjane Thiam, chief executive officer for Credit Suisse Group AG, speaks during a Bloomberg Television interview at the bank's headquarters in Zurich, Switzerland, on Thursday, July 23, 2015. Credit Suisse reported second-quarter net income that beat analyst estimates even as profit from investment banking fell in the months before Thiam took over. Photographer: Chris Ratcliffe/Bloomberg *** Local Caption *** Tidjane Thiam

  • What’s happened? Having hit hard times recently, two of Europe’s major players in the global investment banking industry have announced drastic measures in order to keep afloat. Credit Suisse, with their new chief executive Tidjane Thiam, announced equity raising plans of $6.4bn and outlined a schedule to restructure their investment bank, ultimately leading to it being shrunk by 20%. Meanwhile, Deutsche Bank, who also recently appointed a new chief executive of John Cryan, made plans to dramatically turn around the business by replacing its outdated technology, shedding its labour force and revamping its asset and wealth management divisions as well as splitting its investment bank.
  • What’s behind this story? Both are struggling under the current economic climate as their main strength has traditionally been fixed income which is currently doing abysmally. For Credit Suisse, revenue from fixed income sales and trading was down 42% year-on-year which helped to drive down their net revenues by 20% whilst Deutsche Bank is expected to make its first loss in 4 year on the basis of such weak performance of the division. As long as the weakness in fixed income continues which is being driven by both structural factors such as risk aversion and cyclical factors such as greater aversion to risk, so too will the weak performance of these banks persist.
  • Why is this important? As highlighted by this FT article, over the past decade, there has been a significant reversal in the fortunes of European investment banks; from 14 of the world’s 20 largest banks being European, that number has more than halved to just 5. If the plans to shrink the European investment banks go through, Europe will have even more of a diminished presence in the global investment banking industry and that would be a great loss due to their socio-economic role in acting as an intermediary between savers and borrowers and in making markets more liquid.

In other news:

  • Mark Carney controversially entered the UK’s EU referendum debate by claiming that Britain has been the leading beneficiary of the EU’s four freedoms of capital, labour, goods and services and in his eyes, this has allowed the UK to enjoy one of the fastest per capita growth rates in the G7 over the last four decades. As the governor of the Bank of England, a politically independent central bank, some have argued that he has overstepped his remit but that emphasised that he was not offering a “comprehensive assessment of the pros and cons” of EU membership.
  • The Canadian general election concluded with Justin Trudeau, leader of the Liberal Party, being elected as the new Canadian Prime Minister, ending Stephen Harper’s decade-long reign. The son of a former Canadian Prime Minister, Trudeau has been elected on a strong mandate with 40% of the popular vote and a majority in parliament but he faces a tough challenge as the economy is gripped in a recession. Nonetheless, Trudeau believes he has the answer as he has made bold promises such as a pledge to  run three consecutive deficits in order to fund infrastructure spending.
  • Valeant had a stressful week as it was accused of accounting fraud by incorporating the financial results of Philidor, a specialty pharmacy that it bought the option to acquire in 2014, into its own financial report, leading to claims that it has been artificially raising its revenue. Although executives at Valeant have denied the allegations, the damage has been done as Valeant shares lost 25% of their values over the following 2 days and there is now growing concern over Valeant’s business model which is dependent on buying the rights to “under-priced” drugs and then quickly raising their prices due to the threat of new drug laws. There is a sinking suspicion that this whole charade has been maliciously created as it was a company called Citron that released the report making such claims and it has come to light that Citron was shorting Valeant stocks, causing them to profit massively from the debacle.