Gravitas Spark CrowdFunding

Tag: debt

  • What Returns Can Investors Expect In A Private World?

    What Returns Can Investors Expect In A Private World?

    Well, I can’t promise you a future with a beachfront property in “Gaza Lago”. In fact, in the world of investing there are no guaranteed returns. As promised in our recent Private Portfolio Thoughts newsletter, I wanted to address expectations as to what long-run returns a private investor should be looking for in a portfolio of private assets.  First, let’s take a look at ‘industry standard’ expectations based on global historic data compiled by research house, Pitchbook. Of course, these are just averages and no doubt are ‘skewed’ by supra-normal returns for a small number of successful funds in each asset class. However, the table below gives an approximate guide to expectations over various time horizons and types of investment.

     

    The Spark focus is probably towards the top of this table summarising 5-year and 10-year returns for private equity (PE) and early-stage investing through venture capital (VC). However, if we strip out debt and real asset products the double-digit (%) performance picture is pretty similar across the board for private assets. The annual rates of return (IRR) implied by the performance of these private assets (in aggregate) are 13.4% over 5-years and 12.5% over 10-years.

    Let’s be more conservative and suggest that portfolios of private assets after 10 years SHOULD have grown in value at a rate of 12%. In real terms (and compounding those rates of return) that equates to an initial investment of €10,000 growing to €31,000 over 10 years. For context, a fund with publicly listed equities would be expected (by financial planners) to generate 7% returns per annum and thus turn €10,000 into €19,600. Of course, the extra return earned by the private asset portfolios is the compensation required by investors for the higher risk exposure(reduced liquidity, business failure) compared to the shares of large established businesses trading every day. These return numbers (based on history) can be described as “hurdle” rates which investors are expecting to match or beat in order to justify putting their capital at risk over long periods of time. So, let’s apply some hurdles to our world of very young companies (VC) and small businesses (private equity).

    We know that the industry standard in more mature private capital investment strategies is looking to turn €10,000 into something north of €30,000 over 10 years. We might describe this as an expectation to generate 3x your initial investment amount. Arguably, for higher risk investments in our earlier-stage world, investors could expect/demand an even higher return for their portfolios. If investors wanted 4x returns or €40,000 after 10 years that equates to a 15% annual return which is what private equity strategies have achieved(see table). So, that expectation is not unreasonable. But…. how realistic is it in a high risk portfolio of mainly early-stage business failure? We should touch on the key ‘push backs’ we get from investors who are wary of investing in start-up businesses or smaller private equity deals. The following are the most common perceived wisdoms….

     

    “80-90% of start-ups fail”

    “ Exits are more difficult as IPO markets for smaller companies have struggled”

    “I can just buy publicly listed equities and earn similar returns”

     

    There is an element of historic truth to all these statements but I’m going to use the most dangerous words in the investing lexicon by stating “this time it’s different”. First, the history of start-up failure should take into account the characteristics of older vintages of businesses. Let’s think about old economy businesses investing heavily in premises, equipment, overseas expansion facilities, logistics etc. These are, in most cases, “sunk costs” in capital-heavy businesses. Inevitably, if the business gets into trouble these ‘assets’ are not just worthless but can have an actual negative value due to ongoing liabilities/leases, maintenance costs, security, insurance etc. Now, think about many of today’s “asset light” businesses leveraging digital infrastructure and building value through the experience of the founders/team, the data gathered by the business and the development of relationships with clients and partners.

    These businesses don’t have the same level of sunk costs/liabilities (as old economy businesses) which can swamp the value of the operational “franchise”. Instead, the value within a business which might not be meeting growth targets can be recognised by a third party and lead to another form of exit which doesn’t involve liquidation. In the Spark portfolio we have seen a number of businesses acquired by third parties in the same sector in exchange for shares in the acquiring company. These shares clearly have a value and also change the traditional calculations around start-up failure.

    In the world of debt/credit one of the key financial terms/metrics is historic “recovery value”. In main street terms, this is the typical expected percentage of the debt which can be recovered when a business fails in a particular sector. You will see such sector recovery data displayed as a percentage of the debt ie 20 cents, 30 cents in the dollar. So, in the world of start-ups there is normally no debt and the equity in the business is a complete ZERO in the case of struggle or failure. But, now that’s not quite the case. If an acquiring business is offering a share exchange then the “recovery value” could by 20-50% of the original investment. And, the reason for ‘value’ being found in the business is the experience of the acquired team, the database and client relationships. This is happening on a far bigger scale elsewhere.

    Ever heard of the term ‘acqui-hiring”? This refers to a situation in which a company acquires another company primarily for its talented team or employees, rather than its products, technology, or other assets. In an acqui-hire, the acquiring company may not be interested in continuing the acquired company’s business or product, but rather wants to bring the talent into its own organization. Now, here’s another bit of jargon monoxide…. ever heard of CVC? Well, you know what venture capital (VC) does but there’s a subset of the VC ecosystem called Corporate Venture Capital(CVC). This form of VC funding is in reality larger corporations investing in smaller businesses whose franchises/technology could ultimately be relevant and value-creating for the parent company.

    So, you might think Sequoia, Index Ventures, Tiger Global and Andreessen Horowitz are the kings of VC investing. Now, think again. Amazon, Google, Microsoft and Nvidia are hugely active in the VC funding space. As an illustration, Nvidia deployed $1 billion in 50 VC funding rounds in 2024 alone. Furthermore, Google has acquired a whopping 222 start-ups over the years, and in 2023 the “Magnificent 7” tech stocks participated in 208 VC deals. So, the IPO market might not be as start-up friendly as in the past but Big Tech certainly is stepping up to the plate as a new and highly active exit event option.

    Of course, there will always be those investors who believe they can earn approximately similar returns to private asset strategies by choosing a selection of publicly listed companies. Yep, the likes of Domino’s Pizza, Paddy Power, Apple and Nvidia tick those boxes but there’s also an assumption investors will avoid the temptation of selling while on the multi-decade rocket ride. However, the more significant point is about business failure. Think it’s only start-ups?  Sixty years ago the average life-span of a company in the S&P 500 was over 50 years. Today, it’s less than 15 years! By 2027, almost 75% of companies who were quoted in the S&P 500 in 2016 will have disappeared (Source: McKinsey). Not for the first time, I’d suggest it’s worth a read of the excellent The Future is Faster Than You Think to grasp how fast business and technology leadership is changing.

    We can’t forecast the future. However, we should recognise that the world of start-ups today has changed dramatically. As a final illustration, start-up funding was traditionally populated by a majority of consumer-focused businesses – think retail, textiles, manufacturing, food, fashion etc.  The term “B2C” would be used to describe these business-to-consumer companies. Well, that’s changed too. Certainly, for Spark. A whopping 70% of funding deals completed by Spark have been business-to-business (B2B) opportunities. It should also be noted that our vetting process turns away approximately nine in every ten opportunities. Arguably, we are selecting the top decile of quality in the opportunity universe. No doubt we will get it wrong along the way, but this is still a robust risk starting point. And, it’s not the only starting point…

    The purpose of this article is to set the scene for a follow-up piece on how these structural shifts can impact the average private portfolio and future expectations using sample portfolios and outcomes. But always remember…. if I could truly forecast the future, “Gaza Lago” might personally have an entirely different meaning and location.

  • A World Losing Control Of Truth….

    A World Losing Control Of Truth….

    You know that feeling. No control, just watching helplessly. On a personal level, I observed the devastating wildfires in Los Angeles from afar via Google Maps and X(itter) but was updated on the ground by my son dangerously close to events on the UCLA campus. Evacuation to San Diego was his fortunate escape while the estimates of fatalities and rebuild costs continue to climb. Sadly, the losses are not just in the physical world of lives and properties. Truth has also been scorched by the partisan politics of the US. Incoming President Trump and his oligarch allies have been quick to blame political incompetence for the fires and deflect from the urgency of the climate crisis. A cursory look at Xitter and other online channels reveals waves of misinformation on lack of water and firefighting resources, saving smelt fish(yep), DEI /woke policies (open season it seems) and even funding Ukraine as the ultimate source of blame. Now, for a few stubborn facts:

    No rain in Los Angeles (LA) since May 2024

    Highest summer temperatures in LA ever

    Land/vegetation is the second driest on record – UCLA research suggests 25% drier than average

    Strongest seasonal Santa Ana winds in 14 years (up to 150 kph)

    That lethal combination of extreme heat, bone-dry fuel and tornado-like winds are climate change driven. Fires are nothing new for California, but the change in wind/heat patterns has dramatically increased the intensity of the fires and the speed-of-spread when they occur. However, the extent of climate denial deflection at the highest US political leadership levels is amply demonstrated by the words of the incoming Trump nominee for Energy Secretary, Chris Wright, at his Senate confirmation hearing just this week: “I stand by my past comments…..the hype over wildfires is just hype”. Not for the first time, the world of finance will have its say too. In particular, the exit of insurance companies and house protection coverage for residents of LA, West Virginia, Florida and Texas is probably more instructive than the internet warriors in their underpants shrieking about political mismanagement, conspiracy theories or super-powered immigrant arsonists.  Credibility and truth are inextricably linked and the biggest bully of them all is flexing its truth-seeking muscles….

    We have written in recent days about debt markets constraining the actions of autocrats in the geopolitical world. However, in the financial world there are increasing words of worry from some very credible players about a credibility gap emerging. So, without bamboozling with jargon, let’s flag two financial facts.

    *Interest rates around the world are either falling or stabilising at lower levels than 18 months ago.

    *Bond yields which usually track interests rates are not falling, or even stabilising. Longer term yields in the UK, Japan and US have broken free of their relationship with interest rates and are rocketing higher.

    This divergence of trajectories for interest rates and bonds is HIGHLY unusual. So, what’s happening? Well, debt and bond markets do track interest rates set by the central banks….normally. But, in this instance, credibility or credit has come into play on two fronts. First, central banks like the Fed and Bank of England are facing increased scrutiny in their battle to tame inflation. Second, government bonds track the credibility of sovereign governments – their ability to confront or tell the truth. And that’s a problem now. Nobody believes current UK government policies are able to deliver growth and not many believe Trump’s tax cuts and tariffs menu will tame inflation. Bluntly, there are increasing fears in financial circles that the Fed has lost control of the most important financial market in the world: the US Treasury market. Again, truth and credibility (not denial) are critical to attract risk capital, insurance, investment etc.

    Finally, we should note the warning in President Joe Biden’s farewell address to the nation this week. Critics might argue his presidency wasn’t bold enough, even cruel enough, but his departing words might resonate with those who read President Dwight D. Eisenhower’s farewell speech warnings in 1961 about the dangers of the “military-industrial complex”. Biden points to an oligarchy of “extreme, power, wealth and influence” in a “tech-industrial complex” which wields a very modern weapon to serve their own interests. The tacky million dollar Trump inauguration donations and spineless abandonment of content moderation by the tech oligarchs could be mistaken as the source of bitterness for an ousted president but I’ve a feeling the following statement will be revisited by historians as a prescient warning:

     

    “Americans are being buried under an avalanche of misinformation and disinformation, enabling the abuse of power. The free press is crumbling [or] disappearing. Social media is giving up on fact checking. The truth is smothered by lies told for power and for profit…. Meanwhile, artificial intelligence is the most consequential technology of our time, perhaps of all time.”

     

    I’ve got some bad news. That “avalanche of misinformation” is just the start, and the reference to AI is key. It feels like every funding round at the moment is attached to “AI-agents”, bots who will carry out the mundane content generating tasks of human workers. In fact, one in every two dollars of VC funding in the US right now is going to AI. The number globally is 37% (Source: CB Insights). However, let’s think about that ‘army’ of bots to be unleashed on the future of work and communications. First, know that an estimated 50% of all online traffic right now is bot generated. Yep, that’s bot created content, bot engagement, bot dissemination….. the whole false fly-wheel effect. Now, imagine a vicious circle of billions of bots, content pieces and false engagement. Then think false content.

    You will hear more about “Dead Internet Theory” in 2025. It started out as a peripheral online conspiracy theory claiming the internet has been taken over by artificial intelligence(AI). Viral posts, engagement rankings, traffic stats etc all have a whiff of AI-bot promotion these days but there’s worse to come. The sheer volume of misinformation coming our way via AI-agency bots could kill online platforms’ utility value. Even this week, using Xitter was an exercise in dodging the underpants brigade + bots and finding real true information on the LA fires. And, now the chat is Elon Musk will be buying Tik Tok. A change of commercial control perhaps, but the reality at a higher communications level is more existential. We could lose control of not just the internet, but truth itself.

     

    “You can’t handle the truth!!”  – Colonel Jessup, A Few Good Men.

     

     

  • Does Europe Have Whatever It Takes?

    Does Europe Have Whatever It Takes?

    This is tricky. Here goes… I’m going to sound like Boris Johnson for a moment. Relax. No Greg Wallace, Master Chef or “middle-class women of a certain age”. More like the Middle Ages, and a stunning personal discovery this week that, before counterparties sign off a private investment in Germany, a public notary must read every single word out loud. Yip, not a banana-straightener but for a venture capital investor this week that meant “12 hours and counting” for a Series A investment document to be read out loud in front of founders and investors. In person. It sort of feels like Germany has missed out on a few productivity hacks since the Gutenberg printing press arrived in 1439. Meanwhile, European leadership is in disarray as the French government collapses, Germany’s industrial base struggles and the UK paddles alone in its own faeces-filled waters. It is difficult to ignore the “Europe is Donald Ducked” chorus growing louder by the day. And yet, I believe Europe can change course for the better. First, let’s identify a few key problems…

    Actually, why don’t we turn to the man who rescued Europe once before. Back in 2012 Mario Draghi as President of the European Central Bank (ECB) declared that “the ECB is ready to do whatever it takes to preserve the euro”. Remember the “PIIGS” who struggled in the crosshairs of European debt crisis traders for weeks? Well, Portugal, Ireland, Italy, Greece and Spain have more than survived that credit (or credibility) crisis. In fact, this week Greece was able to borrow at cheaper rates than France. Stunning. And perhaps, that should be Europe’s inspiration. Greece was a mess. Not now. However, the same Mario Draghi in his 400 page EU Competitiveness report is telling us Europe is in a mess and that “without action, we will have to either compromise our welfare, our environment or our freedom”.  Draghi sees the following challenges:

     

    1. Productivity: European GDP growth has lagged the US by 0.5% every year since 2000. Interestingly, demographics (population growth) has played its part in that too. How about building that wall? Maybe not.
    2. Innovation: There are no leading technology companies in Europe. Draghi identifies a “middle tech” trap where Europe seems happy to be in “the peloton” rather than lead. Indeed, outside the information and communications technology sector, European productivity growth matches and often beats US competition.
    3. Finance: Draghi bemoans the lack of joined-up thinking and fragmentation in the area of debt financing and regulation. Think about those hoarse notaries and the 1,330 banks servicing Germany. Then know that Canada has just 93 banks.
    4. Security: Draghi deals with a number of distinct challenges in his report but I have lumped them together as almost existential threats: defence(war), climate crisis (decarbonisation) and industrial dependence(China).

     

    There’s a danger these challenges are perceived as nothing new. Arguably, the outbreak of a full scale European war is the only really new challenge of recent years. The other challenges have been slow-moving train wrecks over a decade or more. However, the point to be made is, like our climate crisis, Europe is running out of time. As always, I try to use data to tell a story and here are a few standout numbers which have crossed my desk in recent weeks:

     

    *In the 1950s to 1970s period European investment in innovation equated to 4% of GDP. That percentage is now 0.5%.

     

    *Venture capital investment in Europe is 6 times lower than the US.

     

    *71% of all current funding for AI globally is in the US. Europe accounts for just 14% of global AI investment.

     

    *The performance gap between US and European stock markets this year is over 21%. That’s the biggest performance divergence since 1976. In fact, US stock markets now account for 65% of global stock market capitalisation but with just 26% of global GDP.

     

    *According to Bank of America research, US to European equity valuations have risen to 3.6x in November, an all-time record. This ratio has DOUBLED in 8 years, and is 3 times the historic average.

     

    *The US stock market has outperformed Europe in 12 out of the last 15 years.

     

    *There are more than 270 regulatory bodies involved in digital networks in the EU today.

     

    *The EU has 34 mobile network operators. China has four, and the US three.

     

    If the list above feels a bit “money” oriented there is good reason. If investment, performance, valuations and growth gravitate to one economic region the knock-on effect is significant for competing regions like the EU. Stripe didn’t even bother starting out in Ireland. The Collison brothers went straight to California. It’s not just start-ups. One of Europe’s homegrown fintech stars, Revolut, is about to IPO but co-founder and CEO, Nikolay Storonsky, has said the US will be their public listing home as London “can’t compete”. Not surprisingly, CB Insights are saying 40% of the world’s AI companies (and talent) are located in the US.

    It’s not just a money tale – those stats above about regulators and network fragmentation are massive hurdles to companies competing for investment capital based on growth. You don’t need a notary to grow GDP. However, like Greece and Ireland in the recent past, it is possible to be ‘forced’ into survival strategies which may require pain. As an illustration, the decision of VW to close manufacturing plants in Germany for the first time in 87 years might only be the start of bad news for the 100,000 VW workers striking in protest. Now for some better news, and a bit of European inspiration…

    Europe has proven already it has whatever it takes to win the battle of the skies. In a truly pan-European collaboration project, Airbus has emphatically emerged as the dominant aircraft manufacturer on this planet. Even before Boeing’s troubles, Airbus was racing towards 60% global market share and currently is winning the market for large single-aisle planes on an 80/20 basis. The European champion of the skies has been beating Boeing for 5 consecutive years and has an order backlog of 8,600 planes. This is the inspiration and illustration of European collaboration. Now look to the skies again.

    War is a tragic European fact of life in Ukraine. However, battles for survival can bring innovation. WW2 was the catalyst for Europe to invent radar, penicillin and jet engines. Today, you might consider the 200 Ukrainian companies currently manufacturing Unmanned Aerial Vehicles (UAVs). Yep, drones are the future and Elon Musk has had the temerity to suggest US F-35 jet fighters are “already obsolete”. If Musk is right and “Future wars will be drone wars” then Europe is the epicentre of UAV innovation. Interestingly, Germany’s start-up AI software company, Helsing, has focused on drones and jet-fighters and is now manufacturing its own attack weapons. These drones are armed and don’t need pilots or GPS, it’s all AI. And, Helsing is already valued at $5 billion.

    Our other survival battle is climate. And Europe can lead. One of the key drivers of productivity and valuation divergences over the years has been energy costs. An auto factory or chemical plant in Europe can typically pay $500m to $1 billion more for its power supply…. each year. Electrification is not just the decarbonised future, it is European industrial survival. While Europe might be stuck in a “middle-technology” trap it might be the US and China who remain wedded to cheaper fossil fuel options. Draghi’s analysis envisages Europe spending €3-4 trillion on electrification, or about 25% (!) of EU GDP over the next 10 years.

    Investment/spend is critical to innovation, and Europe right now looks like it is losing out in the energy race. So, we must hope a power crisis breeds innovation opportunity in electrification and perhaps gives Europe a head start over more complacent rivals. In fact, one of my favourite stats this week emerged in the decarbonisation space. A research paper from University of Chicago and Wharton estimates the total carbon burden of US corporates is $87 trillion. That’s 1.3 x the market capitalisation of US companies in 2023, and starkly demonstrates payment for damages caused by greenhouse emissions would bankrupt corporate America.

    Adversity forcing dramatic shifts in industrial policy and investment capital could ultimately be Europe’s saviour. Furthermore, we should look east to see how countries and cultures free themselves from government and regulatory over-reach. Poland is now, per capita, as rich as Japan or Spain. Its military is arguably the strongest in Europe, and its GDP has grown by 3.5x since 1990. Quietly Poland is becoming a tech and innovation hub. And, behind that drive is a STEM graduate pipeline ranked 4th in Europe between 2013 and 2019. That will only accelerate as Microsoft invests $1 billion, Google builds an R&D centre and a talent brain drain now moves into reverse. Inspiring stuff.

    It can be done. However, it might need a further crisis to prompt Europe’s leaders to commit to ‘whatever it takes’ to survive and lift itself out of decades of decline. And… the data and vibes suggest we are close to that moment.

     

     

  • Four Huge Trends For Your Private Portfolio

    Four Huge Trends For Your Private Portfolio

    I scared a few people last week. Apologies. Then again, you could be a public servant or journalist in the US today and be referred to as “the enemy within” by the bookie’s favourite for the Oval Office. Or, how about being a lifetime Tory party member faced with the extremist choice of “KemiKaze” Badenoch or “Honest Bob” Jenrick as your next leader? Better still, put yourself in the shoes of the Tory tactical masterminds who ‘traded’ leadership votes and eliminated their own likely winning candidate, Jimmy “Dimly” Cleverly. Breathe, just breathe slowly. We can’t promise an end any time soon to populist buffoonery but in the real world big changes are afoot. Four developments, in particular, caught the eye this week and highlighted future opportunities for those building new businesses or investment portfolios.

     

    Electricity: If $150 billion of hurricane damage in Florida doesn’t focus climate crisis minds I’m not sure what will. Indeed, there is an encouraging reality check beginning to filter into financial discussions. Just this week the Washington Post ran a story about the cost of extreme weather exerting further strain on an already challenged Federal government’s fiscal position($35 trillion debt). Of course, moving away from fossil fuels to electricity is already set to be the greatest financial shift ever experienced by the global economy – $275 trillion to be invested in the transition by 2050(Source: McKinsey). So, the following statistics really hit home. They are sourced from the International Energy Agency (IEA) and flag the recent growth of electricity use being twice as fast as the growth of energy demand. However, the future is about to turbo charge that relationship. Between now and 2035 electricity usage will outpace energy demand growth by a factor of 6x. Yep, that’s electric vehicles (EVs), AI chips, data centres all doing their future thing. Another way of looking at this shift is that this 6x electricity acceleration equates to the entire energy demands of Japan (4th biggest GDP in world) being added EACH year to global electricity usage.

     

    Banking: In the old days it was banks that provided loans, or credit. Now, every second ‘growth’ headline in investment markets is referencing “private credit”. So, what is it? It is quite simply lending by private pools of capital(not banks), usually sitting within large investment firms. The original “Barbarians at the Gate” were private equity firms who used debt to buy out big companies. Today you might read about Blackstone buying software Smartsheet for $8 bilion. Back in 1988 it was KKR buying RJR Nabisco for $25 billion. Historically, the debt part of the ‘leveraged’ buy-out came from banks. Now the Barbarians (private equity) want to do the banking (debt) too. In the last 12 months there have been 14 different partnerships announced between banks and private credit(debt) firms. Most recently, Citibank announced a partnership with private equity/credit giant, Apollo Global. Amazingly, this relationship turns banking orthodoxy on its head – Citibank’s investment bank will source the deals and Apollo will provide the money/debt. Bankers turned deal makers, deal makers turned bankers. Wowzers. Note, if the Barbarians are now keen to provide debt funding to companies, then they must see opportunity and excellent returns. Current estimates of the size of the market indicate private lending assets (AUM) currently at $1.5 trillion growing to $2.7 trillion by 2027 (Source: Prequin).

     

    Life Sciences: Despite the anti-elite denial of science prevalent in the social media and political spheres, the incredible speed-to-discovery of vaccines seen during Covid-19 is set to continue. However, with a little AI twist. Arguably, AI won its first Nobel Prize in recent days. From The Japan Times….

     

    “The recent awarding of the Nobel Prize in chemistry is an incredible vote of confidence in the potential for artificial intelligence to transform the way medicines are invented by using AI to illuminate and manipulate proteins, life’s most basic building blocks. The Royal Swedish Academy of Sciences honoured University of Washington professor David Baker and two scientists from Google DeepMind, CEO Demis Hassabis and senior research scientist John Jumper.”

     

    Yep, AI machine-learning cracked the code to predicting protein structures with Google scientists right in the middle of it all. Meanwhile the Nobel Prize for Physics went to the “Godfathers of AI”, Geoffrey Hinton and John Hopfield, who developed the tools which power the neural networks underpinning today’s AI boom. Now, think about the Nobel tradition of rewarding decades of research and recognition. Then think about chemistry protein discovery work barely 2 years old and not one, but two, Nobel prizes. Simply astonishing.

    Nuclear Power: It’s not just gold hitting all-time highs. Uranium mining stocks are flying too. Let’s face it, the news flow in nuclear power has been hard to miss. Japan has just re-started a 47 year old nuclear reactor at the Takahama nuclear power station. Amazon is pumping $500 million into nuclear capabilities, and Google has entered an interesting deal with Califormia start-up, Kairos Power. Google has committed to buying nuclear power generated by multiple small modular reactors(SMRs) built by Kairos. And, one for the nuclear history buffs – the infamous Three Mile Island nuclear power station will be restarted in a $1.6 billion deal struck between Microsoft and the energy utility, Constellation. Again, AI is the power demand trigger for these moves. And, mining stocks sitting on uranium reserves might just be the wrong price (low) if a Big Tech AI race goes nuclear on many levels.

    So, there’s four thoughts or trends which are very much part of our future. You might spot AI as the common factor across a lot of these developments but that’s possibly not the only private opportunity. There seems to be some enormous shifts happening in traditional sectors like infrastructure, materials, banking, power and chemistry. The good news is that there are lots of private companies plugged into these transition sectors right now and many will need funding (debt or equity) in the years to come. If that sounds like a private portfolio-building strategy then you’d be right. It’s time to take a private dip. Even better, we might be able to help you very soon…..

     

     

  • Betting On Small Can Really Win

    Betting On Small Can Really Win

    Please, no political bets. The headline is absolutely not referring to the UK Prime Miniature. The 14-year Conservative Party mission to shrink public services, business investment, critical trading relationships, institutional integrity and individual standards of public behaviour is ending in electoral wipe-out. Time for new beginnings, even small ones. As I read about UK ‘global leadership’ (with China) in a potential 9,000 millionaires leaving the country before the end of this year, I’m thinking more about generational change and down-sizing shifts in wealth creation strategies. That might seem strange in a world of mega-trillion tech companies but wealth works across different types of assets and for different generations. First a couple of size observations.

    An interesting chart this week from Private Equity/VC research data house, Pitchbook, showed smaller private equity(PE) funds outperformed bigger ones over a 10-year time horizon. In the best performing quartile of funds the performance gap was a whopping 6.7%. In real money terms, the returns of small funds were one third higher than the bigger funds. Here’s the chart:

     

     

    Clearly, the challenge of earning high returns with massive pools of money runs into the problem of a smaller opportunity set. In other words, big funds can only deploy capital in bigger companies and miss out on opportunities with smaller (probably faster growing) companies. However, funds as they become bigger can also suffer from strategy “drift” as pressure to deploy capital forces funds into other sectors, geographies, vintages, styles etc. As a classic illustration of this challenge, look no further than the ARKK innovation fund managed by Cathie Wood. Back in 2021, a big winning bet on Tesla and other innovative companies by the ARKK fund attracted billions of investor dollars. However, since then, the fund has cratered in value by 59% while the funds which track the Nasdaq tech index are up 37%. Big can sometimes be painful. Of course, new strategies can help diversify risk for investors and five headlines caught my eye this week:

     

    Blackrock Muscles Into Private Assets Market For Wealth Clients – Bloomberg

    Andreessen Horowitz plans to launch a private equity fund  –  Fortune

    Carlyle and KKR beat rivals to win $10bn Discover Financial loan portfolio – Financial Times

    Private Credit Is Trouncing Private Equity So Far This Year – Wall Street Journal

    Watford FC Sells Digital Equity Tokens – Techopedia

     

    So, the giant manager of publicly listed assets is looking for private assets, the venture capital giant wants private equity, the private equity monsters are going for better returns in private credit (loans) and Elton John’s former club is looking for digital equity. Got all that? Probably not, but, if we think about Elton and the music business 20 years ago then you’re witnessing a similar generational shift in investment/wealth products. Investors, as individuals or as families, are increasingly looking to invest in private assets, not just publicly listed companies or funds. There is also an additional trend we should be watching. Private investors are now organising themselves in syndicates or family office structures and the latter segment is sitting on enormous pools of wealth. Try these for size:

     

    *Family offices currently manage circa $10 trillion of investments. Compare that to the higher profile hedge fund industry which manages $6.5 trillion.

     

    *There are currently 15,000 family offices operating and actively investing globally.

     

    *Now, for the banger. In the next 20 years there will be a seismic transfer of wealth from “Baby Boomers” to the next generation. Current estimates of this generational wealth transfer exceed $80 trillion.

     

    So, this investor base of family offices will have new principals and new ‘purpose’. Apart from asset growth , tax structuring, succession planning and philanthropy, it is increasingly likely these investors will be ‘values driven’, and possibly less interested in the buy-and-sell 5-year cycles of private equity and venture capital funds. In this writer’s view, a massive pool of patient purposeful capital is poised to disrupt the traditional way companies are funded. And, for smaller companies and smaller investors this should be considered a win without any need for Gambling Commission scrutiny…..

  • Buying Privately Begins To Work Out

    Buying Privately Begins To Work Out

    So, Adam Neumann wants to buy WeWork out of bankruptcy, and Don Poorleone is apparently a billionaire again. Yep, the Donald’s social media platform, Truth Social, has cracked a $7 billion valuation by moving from the private market to listing on a public market, the Nasdaq exchange in this instance. Amazingly, this valuation is based on annual revenues of barely $3 million and operating losses of almost $50 million. That doesn’t work for me but perhaps a Trump Bible (oh Lordy) is needed or a quick chat with Adam Neumann. Remember Adam tried to list WeWork publicly via IPO  in 2019 with a $47 billion valuation. After a nano-second of Wall Street scrutiny that valuation and IPO was pulled, Adam was removed and we eventually had to wait until 2021 for a $9 billion listing to happen. Today, WeWork is a zero. Such is life in the racy world of high-ego IPOs but there’s a positive aspect to these two shame-free deals. A healthy financing market needs buy-out and IPO activity to pick up. In particular, private markets where we focus our efforts need to see exits via buy-outs and IPOs. Happily, recent developments in both areas are encouraging and involve more credible leaders. Let’s see what’s really working.

    Sticking with IPOs as a signal of good funding health, Californian AI play, Astera Labs, rocketed up 72% on its Nasdaq debut on March 20th giving it a $9.5 billion valuation. Social media platform, Reddit, followed suit the next day with a 48% IPO bump up and a matching $9.5 billion market capitalisation. These significant post-IPO spikes in value will bolster the confidence of others considering IPOs, and boost exit valuations. As always, confidence is critical to funding activity and a giddy IPO ‘shop window’ always helps the mood. However, regular readers will know the ‘Big Daddy’ driver of financial markets is the cost of money (or investment capital). Here too, there is increasing giddiness and activity.

    Funding costs(or interest rates) reflect two things: central bank interest rates and then the extra bit (the ‘spread’ in financial jargon) added on to reflect the commercial and economic cycle risks. Well, you might be aware that central banks in most advanced economies have stopped hiking interest rates and have signalled potential rate cuts. However, the investment markets have already started to cut their add-on bit (spreads) which is a really big deal. Consider the following headlines:

     

    Junk Issuers Rush To Refinance With Spreads Lowest Since 2022 – Bloomberg

     

    Investors Pour Money Into US Corporate Bond Funds At Record Rate – Financial Times

     

    Junk Bond Sales In Sterling Surge At Fastest Pace Since 2021 – Bloomberg

     

    The term ‘junk’ refers to higher risk borrowers and is relevant to our risky world of start-ups and private equity. The headlines point to a stampede by investors to lend( through debt/bonds) to higher risk companies. In the US alone, corporate bond funds have attracted $22.8 billion of investment in the first quarter of 2024. So, this combination of greater debt availability and all-time-high equity markets attracting IPOs is the perfect environment for increased traditional private equity buy-out activity (using debt and equity). The year 2023 was one to forget for private equity deals but check out the following encouraging developments in recent weeks:

     

    Private equity firms Advent International and CVC Capital have joined forces to make a €2 billion bid for UK-based Partner in PetFood (PPF).

     

    US private equity firm Bright Path Sports Partners has bought a 40% stake in Ipswich Town football club for £105 million.

     

    Canadian private equity house, Brookfield, is looking to buy a $3 billion stake in Australia’s second largest telco, Optus.

     

    Grant Thornton US is going to sell a majority stake to private equity firm, New Mountain Capital.

     

    Switzerland-based Partners Group has launched a $12 billion private equity secondary strategy fund.

     

    Clearly, this mix of firms from different parts of the world are spotting opportunity. It is worth pointing out one more factor potentially in private equity thoughts. The headlines have been full of stories about technology sector domination of stock markets, AI euphoria and the concentration of investor expectations in a small group of US tech names, aka the “Maginificent 7”. However, with perfect timing, the Financial Times this week has highlighted “US small-cap stocks are suffering their worst run of performance relative to large companies in more than 20 years”. In fact, since 2020 small caps on average have risen by 24% compared to a 60% move by larger companies. That divergence in performance equates to a significant ‘discount’ valuation opportunity for anyone looking to buy smaller companies. So, what happens next?

    It is reasonable to expect more buy-out activity of smaller companies which, in turn, will raise expectations and valuations in early-stage companies. The trickle-down effect of buoyant public equity markets and greater access to cheaper debt will certainly attract institutional investment capital. And, the good news is that private investors can benefit too by building a diversified portfolio of early-stage companies. Even better, Spark’s Private Portfolio investors can invest in our first ever buy-out deal of an established profitable business in the coming weeks. Yep, profitable. Call it the difference between ‘working’ and WeWork. That really is the truth, and we’d even swear on a Trump bible to that.

  • Take Your Pension Or Portfolio To Another Level

    Take Your Pension Or Portfolio To Another Level

    Fizzle sticks! There goes another billion dollar ‘unicorn’ I didn’t back. Sound familiar? This week’s news that Ireland’s Cubic Telecom has entered the ‘unicorn’ club thanks to a €473 million investment from Japan’s Softbank should focus financial planning minds. In particular, we should focus on two things very familiar to readers of these pages. Firstly, speed. The business world is moving faster and faster. Secondly, technologies are rapidly merging and compounding value.

    Just over a year ago, Cubic Telecom was reporting annual sales(Sept 2022) of circa €30 million with its connectivity software installed in 10 million vehicles. Yep, €30 million not €300 million. So, what prompted Softbank to enter into discussions for a 51% stake purchase on a valuation multiple of 31x the previous year’s revenues? One could hazard a guess that speed of growth was one consideration, given installations of its software have ramped up to 450,000 vehicles per month and are expected to go ‘exponential’. Also, one suspects the compounding of a number of technologies is beginning to drive traction. Cubic is at the fortunate intersection of the Internet of Things(IoT), 5G connectivity, electric/battery powered vehicles (EVs), cloud computing and Artificial Intelligence(AI). We need to start thinking about multiple technologies compounding at speed rather than focusing on one technology advance, and it’s not just Ireland illustrating these two themes.

    All the gloomy headlines this year have put us all in a strange place. And, awkwardly so for financial advisors who possibly went into ‘bunker’ mode. I have been asked to look at 3 different pensions in the last week where returns to date were hovering at just over 3%. That’s actually less than you’d earn on risk-free US Treasuries currently. However, the killer data point is that the tech-heavy index, the Nasdaq 100, is up 48% year-to-date. Oh, and despite all those war headlines and oil worries from Russia/Ukraine and the Middle-East, the energy sector is DOWN year-to-date. Even Germany which is staggering into recession boasts a stock-market (DAX) hitting all-time highs and returning 18% gains this year. Note, the DAX is definitely NOT filled with tech names. However, the Nasdaq is telling us lots of technology from energy storage(Tesla) to cloud(Microsoft) to AI(Google) are emerging at the same time. Just yesterday, Google showed us a new AI bot, Gemini, and its market value jumped by $85 billion over the day. That’s the equivalent of Citibank’s market capitalization after 211 years in existence. Just one day. It feels like wealth creation cycles are shrinking.

    Latest reports suggest the AI team at French start-up, Mistral, are raising funds again. Recall that this crew of AI gurus raised over $100 million 6 months ago with no product, no business or revenues. Just a PowerPoint presentation deck. Now the team have a product (large language model(LLM) for Generative AI) and want to raise more than $300 million. The current valuation level for Mistral is ….. reported to be over $2 billion. Six months. However, before we go all dollars dreamy, note that the hard yards and years are still the norm. For example, Cubic Telecom started up back in 2005. At a higher level, consider it took Microsoft 44 years to hit the trillion dollar market value mark, Apple 42 years, Amazon 24 years and Google 21 years. Keep those tech and time thoughts and let’s move to the other end of the business life spectrum.

    We have already referenced pensions, but for many investors these are vehicles for a variety of funds investing in a mix of blue chip publicly listed company shares and their debt(bonds), government bonds, possibly some real estate and a bit of cash. Given the fast-moving tech world we live in, it is increasingly apparent that investors’ pensions or savings portfolios should allocate a small portion of monies(5-10%) to early-stage companies. Pensions are not the ideal vehicle(for the majority of people) for these investments, but the good news is that the government provides incentives with a similarly attractive taxation impact.

    For years, starting with BES schemes and then evolving into the current EIIS funding initiatives, government has encouraged private investor capital to support employment and growth for early-stage companies by offering tax rebates against income generated in the year of investment(s). That rate of rebate has been a standard 40% but is due to change. More on that later but first, let’s briefly explain the mechanics of EIIS.

    If a company is eligible for EIIS investment it will typically be introduced to private investors in three ways. Note, not all companies qualify for EIIS treatment eg. financial trading businesses are not eligible. Companies which do qualify, offer shares through the following:

     

    • Direct Investment: The investee company offers its shares directly to investors. These direct investment opportunities are typically offered to small groups of investors known to the company’s founders or its financial advisors, and not made public.

     

    • EIIS Funds: These funds are managed by financial intermediaries/brokers and request lump sums up front from private investors. The capital raised is then deployed across EIIS investment opportunities. The up-front sums can be significant(> €10,000) and the managers will charge annual fees.

     

    • CrowdFunding Platforms: A platform like Spark (or Seedrs or Crowdcube in UK) will give thousands of signed-up investors access to 12-15 fundraising campaigns by EIIS qualifying companies each year. The business model of these platforms is different to a fund. The investors do not pay any up-front lump sums or fees. Investors can invest as little as €250 in each EIIS investment with NO commissions, and NO management fees. Instead, Spark and other platforms only charge the companies a fee(and only if successful). One other variation on this is Angel Networks, or syndicates, which invest as opportunities arise. However, the entry level investment size (€5,000 – €10,000) and lead times are not for everyone.

     

    So, after paying for your shares, those shares will sit in a broker account, or a fund, or in a nominee account(independent of platform). The company will then apply for EIIS certification from the Revenue. On receipt of this notification, investors will get a certification confirming same which can be filed with the Revenue to offset taxes paid in that year.

    What sort of people could this interest? The income which qualifies for tax rebates includes employment income, rental income, dividends and ARF distributions. The amount of income which can avail of EIIS has been increased from €250,000 to €500,000 in a single year under new rules to come into effect in January 2024. Also, note the investment must be for a minimum of 4 years. The new rules in the Finance Bill also have broken the standard 40% rebate rate into different bands which we have summarised in a previous article as follows:

     

    • 50% for businesses that ‘have not operated in any market’;
    • 35% for a business in its first EIIS fundraise within 7 years of its first sale;
    • 20% for a business in its second or subsequent EIIS fundraise;
    • 20% for a business expanding into new markets or regions; and
    • 30% for investments via a ‘Qualifying Investment Fund’, of which there is only one in Ireland.

     

    Quite apart from introducing potential confusion, the ‘core’ or standard EIIS rebate of an equity investment will now be reduced from 40% to 35%. On a more positive note, the 50% relief for early-stage pre-operating companies could be very interesting for Ireland and Irish investors. It won’t have escaped your attention that the trillion dollar tech club is entirely US based. That can be attributed to deeper capital markets and Silicon Valley tech leadership but could Ireland be a leader now? I’m thinking three big areas where the Irish ecosystem is quietly building real scale and a pipeline of early-stage opportunities. Here we go:

    Medical Technology/Bio-pharma: 14 of the 15 biggest MedTech players have significant operations including critical R&D functions in Ireland. Also, 12 of the biggest global pharma players are there too. That ecosystem is beginning to deliver a fly-wheel effect of training, management, success, entrepreneurial juices and world-class innovation.

    Cleantech: Irish engineering and construction companies are already leveraging their experience of executing huge hi-spec projects for tech giants like Microsoft and Intel, and global life sciences companies. These Irish companies are now key players in the build-out of EV battery gigafactories, data centres, clean energy manufacturing plants, pharmaceutical plants and chip manufacturing facilities all over the world. It is highly likely this hi-tech project expertise will generate new innovations and young companies to drive the cleantech revolution.

    Artificial Intelligence(AI): The creator economy is a $250 billion monster with all the major players from Google to LinkedIn to Meta/Facebook positioning their European HQs in Ireland. It is clear the creator economy is in the cross-hairs of AI and one can expect the Silicon Docks of Dublin to spin out a number of AI innovations. In fact, Spark will be bringing an exciting AI play to investors very soon.

     

    Furthermore, or a bit further afield, we should note interesting developments in Europe. Spark as a newly regulated entity with EU ‘passport’ will be looking at potential investment opportunities and encouraged by the latest data from Atomico’s “State of European Tech 2023” report:

     

    • Investment levels in European tech has reached $45 billion which is up 18% on 2020. Every other region is down over the same period.

     

    • Europe’s talent pool has grown from 750,000 to 2.3 million in the last 5 years. And, in 2023 Europe was a net beneficiary of people moving from the US to Europe. How Trumpy….

     

    • Europe now has 4,000 growth stage tech companies.

     

    • Europe (not just Mistral) can compete in AI globally. In fact, Europe has more resident AI talent than the US (120k vs 112k).

     

    There will be early stage investment opportunities in a faster world. And, frankly, waiting for IPOs could be a long way off. Thanks to huge private investment pools, companies like Stripe, Shein and OpenAI can stay private for longer, or forever. In the US alone, 70% of early stage/VC funding comes from pension funds and educational endowments. Europe has a bit of catching up to do; only 20% of funding comes from institutional sources. But….. on a contrarian view, this presents an opportunity for European and Irish private/individual capital to step into the gap and seize opportunities that typically might have gone straight to institutional/professional players. So, instead of fizzle sticks maybe think about sticking some funds into one of the EIIS access vehicles referenced above. As always, we recommend a portfolio-building approach, spreading your risk in smaller amounts across 8-10 investments per year. See the table below as a quick summary of what might work for you:

     

     

    Finally, if it’s speed and technology you’re looking for, then a 3-minute sign up process on the Spark platform is a pretty slick start to your early-stage investing journey.

     

  • Night Of The Living Debts

    A former boss of mine used to marvel at the typical information bias of editors and readers of the broadsheet version of the Financial Times (FT). Of the thirty-odd pages in the daily must-read for finance professionals, all bar the back two or three pages were devoted to equities. My boss’s point was that that the debt and currency markets were quantums bigger and ultimately far more influential than stock markets. I was reminded of this overnight as various market commentators and media outlets breathlessly gushed about yet another huge move in stock markets around the world.

    For this writer, last night’s 1000 point upwards move by the Dow Jones share price index was almost irrelevant. What caught the eye was the emerging significance of the asset class usually confined to the back pages of the FT – debt. In a previous article, “Other People’s Money”  back in July 2019, we cautioned readers about business models, and even countries, overly dependent on the daily funding/kindness of strangers. Furthermore,  we specifically warned that “these companies struggle for survival when markets take fright and all providers suddenly decide they would rather hold onto their liquid funds until volatility recedes”.

    Well, this is a “fright” moment for capital markets and that sucking sound you hear is not a gurgling Texan oil well but capital swiftly draining from riskier parts of the markets. Let’s start with oil, or rather shale oil. The dramatic escalation of production in Saudi Arabia and subsequent collapse in oil prices is threatening the survival of many US shale oil players who have borrowed via the high yield (junk) bond markets. More than two-thirds of these companies are now trading at distressed levels in junk bond portfolios. This is not good news for these oil companies or their bankers.

    US banks will be watching high yield indices as nervously as they watched mortgage-backed securities (MBS) indices back in 2008. The mighty Bank of America has seen its share price crater by a third in less than three weeks. That’s worrying but not fatal. However, in Italy, a country now in total shut-down mode, one wonders how an already fragile national banking system will cope with a shock hit to funding flows. Recall that all banks and insurance company business models are dependent on other people’s money to carry out their daily operations. It can become very ugly if daily funders suddenly take fright. Just ask Robinhood.

    Fintech has been receiving great press on these pages and elsewhere but it is not a one-way bet. A real crisis can expose weaker fintech platforms. Robinhood has had a number of trading outages in the past week which has frustrated users wishing to buy or sell shares on its investment platform. If this wasn’t worrying enough for its customers there have been reports that the company maxed out its $200 million credit line in February when market volatility first struck. The company has reassured the market that liquidity has been restored but this will hardly keep its army of 10 million users in “merry men” mood. Expect more news there.

    Of course, the news is already full of stories on airlines struggling to keep empty fleets airborne. Note many airlines use other people’s money when they lease aircraft. This has been a rapidly growing sector of the debt securities market and Ireland is the global leader and IP capital of this funding model. We have written previously about our caution on leasing models predicated on airlines benefitting from a national “backstop” from governments. The rationale is that countries would be unwilling to restrict/shut off their airspace by defaulting on leasing debts. Let’s just say public health systems have just zoomed to the top of most government funding queues in the Covid-19 crisis and difficult choices may lie ahead. The potential impact of Covid-19 at a national level could cause defaults in sovereign debt markets too.

    Lebanon has already defaulted on its bonds over the weekend. Turkey and Brazil worry lots of observers, and Japan had already experienced a GDP decline of 6% BEFORE Covid-19 struck. It’s early days yet but there is no doubt debt stories are migrating towards the front pages of the FT.  As always, when the funding tide goes out naked bad behaviour can reveal itself at the corporate level.

    The hospital operator NMC Health is a blue-chip name in the FTSE 100 but it looks like investors will now be screaming blue murder. The company has kindly informed the market it has discovered it has an extra $2.7 billion of debt its board never even knew about! That more than doubles the debt burden of the company and probably ensures a fraud investigation. Meanwhile, Boeing has had a bad 12 months already but its bankers were happy last month to provide it with a $14 billion credit facility to assist it through production and delivery delays on its troubled 737 Max aircraft model. Those same loan syndicate banks might be a little bit queasy to hear Boeing plans to draw down on the entire $14 billion by Friday…

    None of this is good for creditor confidence. Hence, our caution about companies’ dependent on other people’s money. Those kind people might just take fright when the back pages of the FT become the main story and naked corporate bodies wash up on the shore.

  • Top 10 Trends To Watch For 2020

    The end of the calendar year, and the decade, means readers should brace themselves for a bombardment of articles with all manner of forecasts and predictions for 2020. As always, many will be spectacularly wrong given human beings are particularly awful at forecasting. However, in the world of financial trading the trend is often your profitable friend. More importantly, trends can be evidenced with hard data. On that basis we thought it might be helpful to identify a mix of financial and geopolitical trends which are already established but will continue to impact business owners and investors for the forseeable future. Here’s our Top 10 with the usual health warnings:

    • Debt: Global debt has just topped the $250 trillion mark according to the International Institute of Finance (IIF). It’s rather scary to think that in the ten years since the credit crisis of 2008-2009 the world has piled on another $70 trillion of debt. This debt mountain is incredibly sensitive to rising interest rates. Hence, central banks led by the Fed have had to abandon attempts in 2018 to return interest rates to more normal levels. Central banks are now stuck in a Japan-style debt trap with additional credit creation achieving less and less stimulatory impact on economies. Now, frustrated and worried central banks are pressuring politicians to introduce fiscal policies to break out of this stagnation spiral. Unfortunately, politics at a global level is increasingly polarised.
    • Democracy: Levels of income inequality not seen since the 1930s presents the potential danger of history repeating itself. Democracy is under pressure. The Freedom House think tank published a report in 2018 highlighting that year as the 13th in succession where democratic freedoms were in decline. A total of 68 countries witnessed a tightening of civil liberties and political rights whereas only 50 countries registered progress in these areas. As 2019 comes to a close the strong-arm tactics of Trump, Putin, Xi, Orban, Erdogan and Prince MBS do not provide reassurance that authoritarian trends will reverse any time soon.
    • ESG: There is grounds for optimism that businesses and investors see “doing good” as a prerequisite for wealth creation. It almost sounds like common sense but the ESG investment framework covering Environment, Social and Governance factors is gaining traction rapidly with $30 trillion worth of investments now employing ESG metrics in their investment processes. That $30 trillion number will grow and standardised metrics to measure and audit ESG will be the next challenge for business and investor alike.
    • Trade: President Trump is now saying phase 1 of the China-US trade negotiations might not conclude until after the 2020 US elections. Who knows what will come out of Trump’s mouth next but expect 2020 to again be dominated by trade tensions in the EU with Brexit, and in Asia-Pacific with China. The rise of populist politics and trade protectionism are the two sides of a no-win economic confidence trick. Closer to home, Boris Johnson’s bombastic certainty of concluding trade deals with Europe by the end of 2020 will be particularly painful to watch unravelling.
    • China: The most important macro story apart from debt in the world today is China. It’s arguably the engine of growth which services the planet’s debt. By the end of this year Chinese consumers will have purchased goods worth more than $5 trillion, exceeding that of the original consumption super power, the US. So, financial markets will now have to pay much closer attention to the role of Chinese consumer confidence in the global economy. Think of how many decades financial research and trading teams have agonised every first Friday of the month for the US Non-Farm Payrolls. Get ready for Sunday night China economic reports but before that keep an eye on bond default newsflow. There have been four or five relatively significant blow ups in recent weeks, even involving State Owned Enterprises (SOEs). Do not underestimate the potential impact on consumer confidence if the all powerful state can’t save its own.
    • Tech Tension: Technology has been a dominant driver of markets since the credit crisis. Some companies now have user bases which would be in the top 3 populations of the world if they were sovereign states. Think Facebook and Alipay with 2.5 billion and 1 billion users respectively. As Microsoft and Apple’s combined market value now exceeds that of Germany’s entire stock market at $2.25 trillion it is tempting to think this is a high water mark for tech valuations. Two developing stories/trends suggest the tech sector could meet some growth challenges. First, Facebook’s power and abdication of responsibility on publishing false information to huge numbers of people is moving towards a 1911 moment. That date is neither a typo nor hyperbolic. For the historians, that’s the year when the Standard Oil refinery monopoly was broken up. Second, the rise of ESG is ultimately not compatible with corporate deference and fear of China’s wrath. The recent China anger incidents involving the NBA, Apple and Google suggest corporates may have to decouple from Chinese internet and broadcasting platforms. Yes, the internet could splinter and anyone following the Huawei case with fears over 5G security might be forgiven for thinking a “net split” is not just a possibility but inevitable.
    • Content is King: Even with a potential internet split, original content continues to be the critical asset for every media platform on the planet. We mentioned monopolies earlier but has anyone noticed that Disney has quietly assembled a portfolio of content assets with enormous power? Even before Star Wars opens in cinemas, Disney has accounted for $1 in every $3 spent in cinemas in 2019! The battle for content has exploded to unsustainable levels with almost 500 originally scripted TV shows produced this year. In 2012 that number was less than 300. And the costs are rocketing. One statistic we read recently was that for each $1 of a Netflix subscription the user was receiving $1 billion of content. It’s not just entertainment content. Think about the $5 billion valuation of Manchester City implied by the recent private equity investment made by Silver Lake Partners from Silicon Valley. Live sport is hot but $5 billion for a franchise which can’t fill its home ground…?
    • Energy: Climate change is for some top hedge funds now a critical factor in every investment selection. The climate crisis headlines multiply each week and this means continued pain for fossil fuel investors. Apple’s valuation is now bigger than the entire US Energy sector. Furthermore, for fossil fuel dependent economies like Saudi Arabia and Russia it is striking that their levels of sovereign interference have increased in recent years in the likes of Yemen, Syria and Ukraine. There is a suspicion that this projection of international power is an attempt to disguise significant structural weakness.
    • AI: We have been inclined to highlight the risks/areas to avoid but Accenture tells us there is a $14 trillion opportunity in AI across 16 industries in the years out to 2035. Health, finance, logistics and agriculture all look particularly suited to AI innovation and it is striking to see an out-of-favour sector like finance now attracting the largest chunk of venture capital money via European fintech.
    • Inflating Value: And that leaves us finally with another potential positive albeit it is difficult to argue this trend is established just yet. However, we can include this in our list with a speculative health warning! For years, value investing has been clobbered in performance terms by growth and momentum investing strategies. Yes, it might be difficult for oil to make a come back but other commodities could bounce back sharply if inflation picks up. Whisper it very gently but there is data/evidence to support wage inflation picking up in Europe. Wages are growing at the fastest pace in a decade and Europe remains the largest trading bloc in the world. A stronger Europe would be a very positive development. No doubt, investors stuck in value strategies will be watching hopefully for an end to their performance misery. The rest of the world should hope for the same too.

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  • Debt Works Until It Doesn’t

    WeWork was the IPO that didn’t happen. Now we are about to find out how the combination of excessive debt and a loss of market confidence can obliterate equity valuations. WeWork’s largest shareholder, Softbank, is going to bail out its own original investment of $10.5 billion with an injection of up to $5 billion in new capital.

    The zinger for readers and Softbank’s investors is that the latest ‘survival’ valuation of WeWork will be circa $8 billion; yes, that’s half what Softbank will have invested in total. Wowzers. Was it just a month ago we were told by WeWork’s bankers that the equity was worth $47 billion? Indeed it was. It turns out there was a little flaw in the IPO plans. WeWork had built up liabilities(leases) or long-term debts which amounted to another $47 billion number. Debt or “other people’s money” is perfectly fine to employ in building a business and funding growth but when it’s a very large amount of money then the confidence of those other people is everything.

    Unfortunately, WeWork’s IPO filing documents highlighted a business that was not only losing billions of dollars but was extremely light on detail as to how those losses could be stemmed in expansion mode. Once the IPO failed to happen and raise additional capital, events turned ugly as landlords, banks, service providers etc began to take steps to protect their exposures on concerns about a potential cash crunch just months away. There is a temptation to view the WeWork implosion as an extreme case study in excessive leverage meeting funding realities. The more sobering truth is that WeWork may not be such an extreme example. You see, this debt thing can be quite popular when interest rates are unnaturally low; arguably, capital is almost free until it isn’t. Just ask the IMF.

    In recent days the IMF has been sounding the alarm on the huge rise of debt issuance in an ultra-low interest rate environment. Their concerns were focused on the corporate sector rather than governments who are enjoying negative rates on $15 trillion of debt. The IMF analysis stated that up to 40% of the $19 trillion(!) of debt owed by companies is now at risk of default if there is a global economic downturn. The world’s most powerful banker, JP Morgan’s Jamie Dimon, says there is a recession ahead but not now. This writer does not feel comforted by this stay on calamity and is rather struck by a number of developments which suggest that “confidence” is slipping.

      • Fund Management Liquidity:

    The high profile blow up of Woodford Investments is keeping fund administrators very busy in Dublin, London and Luxembourg as people who should know now realize they haven’t a clue whether investments in funds really are liquid ie the end of day prices reported by these fund administrators are actually achievable. Investors in funds at Woodford, H20, Lime Asset and GAM have found out too late. Other investors are vulnerable too.

      • Bond Fund Liquidity:

    The IMF examined a sample of 1,760 bond funds or 60% of the $10.6 trillion invested globally in these type of assets. They used the worst monthly redemption flows experienced since 2000 to stress test the funds. Alarmingly, the IMF reckons almost one-sixth of these funds would struggle to repay investors at month-end ie liquidity constraints would require more time to sell/realise funds.

      • Corporate Bankruptcies:

    Despite super-low interest rates there has been a marked increase in corporate casualties as banks possibly try to move before Jamie Dimon’s recession prediction materialises. Thomas Cook might be the high profile name of recent weeks but watch out for a more serious situation in the energy sector. Not unlike WeWork’s aborted IPO signaling some pain to come in the real estate sector, the failure of Saudi Arabia’s oil monster IPO, Aramco, to attract sufficient market interest highlights some real stresses in the energy sector. By August this year, there have been 26 bankruptcies in the US oil and gas sector. Expect that number to grow significantly as a massive $240 billion of debt is due to mature in the US oil sector by 2023 according to ratings agency Moodys.

      • Winners and Losers:

    The market is beginning to differentiate its treatment of debt across sectors. Take an example closer to home. Irish franchises built on junk bonds, Ardagh and Digicel, are perceived very differently by global institutions. It is incredible to think that Ardagh in the packaging sector is one of those fortunate companies in Europe which is enjoying negative yields on its debt while Digicel’s bonds in the struggling telco sector are yielding double-digit percentages. Suffice to say double digits is not a good look but can also be a good guide as to the market’s perception of a company or a sector’s prospects of refinancing highly leveraged balance sheets. As mentioned earlier, confidence is everything. Watch the energy sector closely.

      • Macro is Key:

    It is interesting to see what are the key macro drivers for equity markets at the moment. Note these markets are close to all-time highs. If you thought it was fundamentals driving markets you’d be wrong. London macro analytics gurus, Quant Insight, are seeing all the major benchmark indices driven by macro regimes/factors. Dig a little deeper with their analytics and there’s another interesting nugget. The most significant macro factor for developed markets in Europe and the US is corporate credit(bonds) but in emerging markets, the story is more nuanced. Emerging markets are very correlated with central bank support(QE) and inflation. This could suggest leverage is a bigger problem in emerging markets where corporate debt has tripled in 10 years to $2.78 trillion. The repayment profile for emerging market corporates is also a worry; 80% of the debt is due for repayment within five years.

    WeWork didn’t work for many investors in the end. Debt works for lots of businesses as they grow but high levels of debt require high confidence from ‘other people’.  Little things can become quite significant triggers on market confidence. The problem for investors and fund administrators is that a confidence shock can and will generate rapid risk shifts that can destroy equity, wealth and even entire franchises. Current debt levels are too high to ignore and the bond markets will inevitably ‘earn’ respect if not interest.  We write regularly about “other people’s money” for good reason and we always liked the words of former Clinton advisor, James Carville:

    “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

     

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