Gravitas Spark CrowdFunding

Tag: finance

  • Risk Warning: Trust, But Verify…..

    Risk Warning: Trust, But Verify…..

    On the fifth check of my passport at Paris’s Orly airport I did wonder. Will trust die before our planet dies? Both are under severe threat and, yet, I’m hopeful. Let’s take a look at three particular examples of widely-held mistrust where recent developments might challenge the negativity. First, some history. Ronald Reagan’s signature phrase in nuclear disarmament talks with the Soviet Union was derived, ironically, from an old rhyming Russian proverb: Trust, but verify. Of course, it was tough to trust the Kremlin but technology, in the form of satellite imagery, was the critical verification tool. These days it’s technology which is not trusted but could also be the solution.

    We have previously written about global payments processing as possibly the biggest ‘network’ yet to platform and join social media and cloud computing in the multi-trillion dollar wealth creation club. However, the payments opportunity starts with technology mistrust. Bitcoin is flying high but the cryptocurrency ecosystem is still widely mistrusted by consumers, governments and regulatory authorities. Stripe famously ceased processing Bitcoin payments on its platform back in 2018. Now, it’s all change. Stripe is bringing back crypto payments, this time with a stablecoin. The USDC stablecoin to be accepted by the platform will be pegged to the US dollar ie it tracks the US dollar value. More critically, the technology which underpins the security and verification of these currency assets is blockchain. On so many levels this is a huge verification moment for digital currencies and the software blocks used to build them. Now, for some more building…..

    The 2022 CHIPS and Science Act was a Biden administration attempt to reinvigorate the US manufacturing base by attracting huge factory construction projects. Scepticism was rife, given the Trump toddler promised ‘infrastructure week’ every week but never delivered. Well, let’s verify. First, the US government has paid out more than half its ear-marked $39 billion of incentives to companies planning to invest in manufacturing facilities. The corporate follow-through has been extraordinary – microchip manufacturers and their suppliers have announced $327 billion of investments over the next 10 years. Micron alone is planning a $100 billion project in Syracuse, NY. That’s a nationwide 15x leap in construction spend on these type of facilities and will capture 20% of the global chip manufacturing market by 2030. Currently, that number is zero. But what about our planet and other targets with Zero (Net)?

    Let’s face it, the push back on global sustainability and ESG targets is worrying. We often write that money talks and the following headlines paint a picture of worrying reversal:

     

    Flows to European ESG exchange traded funds halve in first quarter –  Financial Times

     

    US Fund Managers With ESG Mandates Have Worst-Ever Outflows – Bloomberg

     

    Clearly, this is not good news. However, we should be careful not to equate fund flows with commitment to climate change targets. For example, the banking sector in recent decades could be described as the ultimate counterparty requiring ‘trust, but verify’ checks on their behaviours and risk management. So, with the global financial crisis barely 15 years in the rear-view mirror, how did genuine ESG investors feel about this week’s staggering headline?

     

    Western banks in Russia paid $800m in taxes to Kremlin last year –  Financial Times

     

    Yep, that was the tax bit. The profits according to the FT were over $3 billion. Trust, but verify indeed……ESG investors can rightly ask how are those “S” and “G” policies going in these shame-free and profit-full banks? Answers on a post card to Kyiv please.  Before we all blow a complete gasket, let’s finish with some more wind but a bit more climate positivity. And, no, it’s not a Trump legal challenge. But it could ultimately rhyme by starting badly, and then ending with a positive reality check.

    First, the severity of the storms and tornados sweeping through the Midwest heartland of the US this week are truly frightening. However, there’s a bigger financial storm brewing further south. An excellent article in The Lever this week highlighted the plight of Louisiana homeowners struggling to insure their houses while 12 insurance companies have failed, and 12 others have left the state. Almost one in five Louisiana residents lost their homeowner insurance last year. The crisis is climate caused. Global insurance giant, Swiss Re, in a recent report stated that natural disasters now cost the United States $97 billion a year.

    In Florida, the climate denial Governor, Ron De Santis, might be kissing the Trump ring again but home insurance rates jumped 42% last year and coverage from big players, AAA and Farmers Insurance, has been pulled from the market before hurricane season. Unsurprisingly, Florida for-sale housing inventory has jumped 57% in 12 months. Leaders in denial-mode face a wave of voters, mortgage banks, pension funds and Wall Street analysts giving them the ultimate verification check on climate crisis. The critical shift is that investment capital has checked, and is already fleeing.

    Trust me, that seismic capital flight will force leadership change and action. Verification…..pending.

  • Welcome To Growing Sports Opportunity

    Welcome To Growing Sports Opportunity

    “Sports is now no longer a hobby for rich guys” was the introductory quote in this week’s Fortune magazine profile of ex-Goldman Sachs dealmaker Gerry Cardinale. The day before, it was the turn of an earlier Gravitas name-drop and breakfast ‘buddy’, Todd Boehly, to appear in Forbes magazine. One owns AC Milan, the other Chelsea FC – both former investment bankers. Two articles in two days….hmmm. Curiosity tweaked, I did a bit more reading and my sense is that sport as a business has evolved significantly and is staring down the barrel of a seismic technology shift. Let’s start with evolution.

    In a week when Taylor Swift becomes music’s first billionaire on personal performances and song-writing alone (Source: Forbes) we are reminded of the increasing value attributed to exclusive entertainment. Sport is a form of entertainment but the lines between showbiz and professional sport are beginning to blur. Swift’s attendance at her boyfriend’s Kansas City Chiefs games might have helped NFL TV viewing figures but that’s a superficial coincidence and misses the critical building blocks required to create wealth in sport these days. One could easily presume that the huge growth in value of sports franchises in recent years can be attributed to simply more (and wealthier) buyers than there are available suitable selling franchises. Yes, Saudi Arabia’s sovereign wealth fund(PGA golf, Newcastle Utd),  the UK’s richest man Jim Ratcliffe of INEOS(Man Utd) and Wall Street’s finest (Boehly, Cardinale etc) are buying assets but, to use a property analogy, they are developers not real estate landlords/traders. These purchases are not about spotting undervalued assets to trade, but are all about building franchise value across the entire operation.

    Gerry Cardinale’s RedBird has merged sport and entertainment in investments across football (AC Milan), media (LeBron James’s Spring Hill), Formula 1( Alpine Racing team with Ryan Reynolds) and stadium hospitality(Legends Hospitality) and he’s a believer in layering event expertise on top of sporting excellence:

     

    “Sports is a multibillion-dollar live event entertainment business, and you have to bring relationships and multidisciplinary skill sets across a range of activities to be able to get these things done”

     

    The formula for modern sports ownership needs deep pockets and is focused on three key areas:

    Brand:  The on-boarding of multi-year sponsors requires relationship and story-building skills.

    Infrastructure: Building world-class stadiums, training grounds and player rosters.

    Rights: Expertise and finance skills in the area of media rights are critical in modern sport.

     

    Clearly, investment in the product (arenas, players) builds the brand and leads to the showbiz discussions where audience and finance are the key leverage points. It is no accident that the owner (Boehly) of the LA Dodgers and Chelsea FC is also the owner of Hollywood’s Golden Globes awards event and Oscar-winning film production company A24. Boehly also was once a bond trader for Guggenheim which brings a world-class grasp of financing and risk. So, should we be surprised that it was he who structured the richest individual sports contract in history for the LA Dodgers’ signing of baseball star, Shohei Ohtani? The deal is worth $700 million but Ohtani has agreed to be paid only $20 million of the package until 2034, then the balance over the next 9 years to 2043. Meanwhile, the Dodgers press conference introducing the deal and their new star drew an audience of 70 million and sold more jerseys in 48 hours than Lionel Messi did when going to Miami’s soccer franchise.

    Phasing payments over decades is only one side (liabilities) of the balance sheet evolution of sport. On the assets side of the franchise balance sheet, the LA Dodgers back in 2014 signed a 25-year broadcasting rights deal with Time Warner Cable for…..$8.4 billion. Now consider that Boehly and his Eldridge investment vehicle bought the Dodgers two years earlier for $2 billion. Smart business, but there’s another smart thing in the Eldridge investment approach. The sports and media portfolio of Eldridge holds more than 100 companies and includes Bruce Springsteen’s song catalogue as well as betting site, DraftKings. Yes, for those using Spark’s EIIS Private Portfolio service, the risk-sensible ‘portfolio approach’ is music to our ears. Now, let’s hit the senses with five more data points before we tackle the technology revolution coming.

    • The average Gen Z consumer is spending $56 per month on streaming subscriptions (Spotify, Netflix etc)
    • Netflix has done a $5 billion deal over 10 years for the live broadcasting rights to wrestling franchises, WWE and UFC, owned by the TKO Group.
    • Investment firm, Sixth Street, is the first to launch a sports team from scratch – the 14th franchise, Bay FC, in the US national women’s soccer league.
    • NBC’s streaming service, Peacock, paid $110 million in January to broadcast a single NFL play-off game between the Miami Dolphins and the Kansas City Chiefs. That works out at $1.8 million per minute of game action.
    • Legal sports betting in the US reached $119 billion in 2023 (Source: American Gaming Association).

     

    That Peacock-NFL streaming experiment annoyed plenty of sports fans but did draw a world-record live sport streaming audience of 27.6 million (Source: Nielsen). And, there’s a simple reason why the NFL risked fan fury and tried out new broadcasting tech. Streaming (via internet) is set to pass out cable viewership at some point this decade. This is a monster media technology shift. It means that the existing sports broadcasting giants like Fox, Sky, ESPN, Time Warner etc will be battling the likes of Apple, Amazon, Peacock and Netflix for live sports media rights. Please remember not that long ago Netflix said they had no interest in live sports broadcasting rights. Well, they do now and shocked everyone with the WWE deal. So, more buyers…..and then you do wonder what happens next to the value of sports broadcasting rights, particularly as live sport betting in its infancy in the US goes stratospheric? However, be wary of ‘build it and they will come’ expectations and strategies despite Sixth Street success in little more than 12 months. Note the various skillsets employed by the new sports investment giants – brand building, player and facilities investment, finance/media expertise and use of AI powered datasets. Also, recall that Formula 1 has no facilities or stadia. In essence, it is a travelling event circus. The success of Netflix’s “Drive to Survive” fly-on-the-wall series was the audience and brand build.

    Interestingly, I am currently involved in two sports finance projects and, in both cases, the ‘story’ and the product/people will likely be the key value drivers. It is increasingly apparent that both these elements – brand and product build – require planning before any financing comes into play. Not every story can rely on Hollywood stars like Ryan Reynolds and Rob McElhenney in Disney’s “Welcome to Wrexham”. Watch carefully as sport and web streaming services grow commercially closer and you never know, opportunities might appear closer to home than even Wrexham. Oh, and this is not our first sporting call. We did suggest watching back in 2019….

    “No Netflix, no WAG nor streaming device can generate the social capital of watching sporting thrills and greatness in real time. So, for those with an entrepreneurial bent get thinking. There’s a strong possibility governments and private investors will sit up and take notice of the rich returns available in sport in a low returns world. Sport loves a crowd and one would be confident that equity crowdfunding will equally love a sports story. Tell it soon with the data and, as they say, if you’re not in you can’t win”

     

  • How To Trade A Trump Win

    How To Trade A Trump Win

    The financial text books and academia will tell you that stock markets tend to reflect investor views 6 to 9 months ahead of events. In financial ‘jargon monoxide’ it is said that stock markets ‘discount’ future events or, in main street terms, it’s a bet. It should also be said that this is real investment money taking a view. Bluntly, opinions are cheap, even worthless. So, when I read the frequent headlines about poor polling numbers for President Biden and a likely November election win for ‘The Accused’, Donald J Trump, my instant reaction is to check the ‘money view’. Polling responses are ‘free’ and we are now entering into that critical stock market focus period of 6-9 months ahead of a significant macroeconomic event. Real money should be starting to show its teeth and the latest financial indicators might surprise.

    The Trump policy manifesto, aside from staying out of jail, is focused on four key messages for the GOP cult.

    1. The US is the largest importer in the world – the US Office of Trade Representative puts the annual import figure at $3.2 trillion (in 2022).  Trump has proposed a 10% across-the-board tariff on all imported goods which would have a seismic impact on all parts of the US economy and instantly add to inflation pressures.
    2. Immigration: Trump plans the detention and deportation of millions of undocumented immigrants while the economy is in full employment. This is another potential inflationary stimulus.
    3. As an undisguised (but curiously skirted around by US media) fan-boy of Orban and Putin, the Trump policy line is to cut off Ukrainian funding support and force a settlement with Russia. The implications for front line European nations like Poland, Finland and Estonia are enormous.
    4. Fossil fuels: Trump has made clear that the climate change crisis and sustainability initiatives of the Biden administration will be reversed, keeping the oil and gas industry happy….and paying into Trump-related coffers.

     

    That’s the plan. And, the polls say Trump will win. However, financial markets don’t seem to believe it, or follow that probability with the obvious trades. Allow me to illustrate the point with a few trading examples.

    Firstly, the import and immigration shockers in Trump’s policy golf bag should not just impact inflation but should also really spook the most important and intimidating market in the world – the bond market. And frankly, it’s not looking too fussed. The bond market and the Fed are still thinking – and trading – inflation (with the odd wobble like last week’s report) is on a glide path to 2-3% and will be accompanied by 3-6 interest rate cuts by the Fed going into 2025. For context, the global bond and debt markets are three times the size of the headline grabbing stock markets which dominate the first 29 pages (of 32) in the Financial Times. As we always say, the cost of money(rates) drives the prices of all financial assets. But, let’s humour the stock market followers…

    Agent Orange seems pretty keen to throw Ukraine and NATO under the bus. So, one would have thought Poland would be terrified of being abandoned by the US while it acts as temporary home to 3 million Ukrainian refugees. In fact, a macro commentator who I hold in high esteem has recently asked the question as to how long before Poland requests or sources its own nuclear weapons for location on its sovereign territory? Terrifying stuff, but again financial markets are more sanguine about the Trump threat. Poland’s stock market – tracked by the $EPOL exchange traded fund (ETF) – was the best performing major country-specific stock index in 2023 – up an almost tech-like 50.8%. Furthermore, Poland’s benchmark index is chugging along at chirpy 3% gain year-to-date in 2024. And, Warsaw is not the only place defying the US polling forecasts.

    Germany is not without its challenges but it has surpassed Japan as the world’s 3rd largest economy. This economic feat has been powered by the most formidable export engine ever seen and, again, would be hugely threatened by a Trump across-the-board 10% tariff on any company exporting to the US. Guess what? Germany’s stock market is hitting all-time-highs. Note, this is not even a country specific phenomenon. The US tech sector might be grabbing all the AI headlines but Europe’s own exporting superstars, nicknamed the “GRANOLAS” by Goldman Sachs, are absolutely flying and don’t seem to be catching any of this Trump (head)wind either. Clearly, investors are not betting on exporting chaos for these companies. In fact, we recently highlighted financial market excitement and the tech-like performance of these 11 companies in our new Private Portfolio Newsletter:

    More strikingly, the Granolas have matched the 63% gain achieved by the US-based Magnificent 7 since January 2021, and paid out much higher dividends. Whoodathunk!! For the curious, and those holding pharma and medtech startups, here are the 11 names: LVMH, ASML, SAP, Nestle, Novo Nordisk, L’Oreal, Sanofi,  GSK, Roche, Novartis and Astra Zeneca.

    Finally, climate and science denial might be very good news for the US oil and gas industry. However, even an almost-broke Trump knows that money talks. So, check out the US Oil & Gas sector represented by the exchange-traded-fund (ETF) known by the ticker “$XOP”. Stunningly, in a Ukraine crisis dominated energy market the US oil and gas sector has inched upwards by barely 4% since the beginning of 2023. For context, one could have earned a higher return by buying a risk-free US Treasury bond over the same period. In fact, US oil production levels are ironically rocketing toward 14 million barrel per day levels under Biden, or as “Honest Don” – no seriously he suggested this name – would say “like never before seen in history”. Go figure, or quiz the GOP!

    That’s real money, investing (or not) in real outcomes in 6 to 9 months’ time and offers certain investors the biggest trading opportunity of a lifetime. The financial instruments referenced above are clearly trading at the ‘wrong prices’ if Trump is set to win the 2024 US Presidency in November. The ‘MAGA Trump Trade’ involves buying inflation-protection bonds (TIPs), buying oil and gas stocks, selling German and Polish stocks and exiting any property funds sensitive to increased inflation and higher interest rates. However, there is one tiny catch. You have to believe the polls and Trump. And….. remember neither has any money.

     

     

     

     

  • Fintech Is The Forgotten Network Card To Play

    Fintech Is The Forgotten Network Card To Play

    Brexit has delivered a win. There, I said it. Now, before you all head off to lobby on my behalf for a co-anchor slot on GB News with the Moggster, Bad Enoch and the Rishibot, there’s a distinct possibility I could be clutching at correlation rather than causation. However, the numbers – for a change – are real. According to KPMG’s bi-annual report, Pulse of Fintech, last year was a tough year for global fintech with funding levels hitting a 6 year low. The UK did not escape the bear market as its $12.3 billion of new investment represented a 34% drop. But….the UK remains, by far, the capital of European fintech and ranks second globally behind Silicon Valley. For global context (and Nigel Farage cartwheels), UK-based fintechs attracted more funding in 2023 than France, Germany, China, Brazil, India and Canada combined. That feels like winning to me but also prompted thought on networks and London’s global positioning in the financial ecosystem.

    London is blessed with an enormous talent and innovation pool thanks to centuries of being the dominant global financial centre and a time zone which straddles the Americas and Asia. This global positioning means there is a bigger and more realistic point to be made than Brexit. It is striking to me that when a country is in the middle of a political, institutional and trading meltdown there is a sub-sector of economic activity which defies the gloom. Fintech might have suffered investment flight in 2023 but the resilience of UK fintech in the midst of a national mental health event points to the recovery of a structural story we have written about many times before.

    It’s a network story but it has had to play second-fiddle to two much ‘hotter’ networks in recent times. Social network platforms (quasi-relationship processors!) are now bigger than sovereign nations – billions spend hours of screen time with Facebook, Instagram, YouTube, Tik Tok etc. And yes, Meta may have picked the wrong name but its share price is at all-time-highs. Also, this week we got another blow-out pulse-check on the hottest network story of recent times; Nvidia’s leading role and 400% y-o-y growth in supplying AI-capable chips for data centres. The computer/digital processor network now lives in the cloud powered by a rapidly growing network of data centres operated by Amazon, Google, Microsoft, Apple etc. However, this week we were reminded that the global financial network is the biggest beast of all and still searching for next-generation financial processing. In the vast field of fintech covering regulation, cybersecurity, analytics, flashboy trading, execution algos, insurtech and blockchain the Big Daddy of them all is payments, call it financial processing.  And this week, we saw some big payments developments.

    First, US bank Capital One announced it is buying Discover Financial Services in a $35 billion deal. At first glance this looks like Discover’s credit cards were the target and, indeed, the combined card operation would create the No.1 US credit card company, passing out JP Morgan and Citigroup. But, no, what caught my eye is that Discover also operates a payments network. Furthermore, Capital One CEO, Richard Fairbank, said that by adding Discover, he could start building “a payments network that can compete with the largest payments networks and payments companies,” a reference to Visa and Mastercard, which dominate the industry. To put the card deal in context, the $35 billion deal is not even a tenth of Visa’s $550 billion market value which is fast catching up on Nasdaq poster-child, Tesla. It’s not just traditional banks like Capital One eying up payments networks. Closer to home, there was an interesting private deal announced.

    UK digital bank, Monzo, is reported by the FT to be close to completing a £350m funding round with a £4 billion valuation. So far, so unremarkable. After a bit more reading, two things struck a chord. First, little Monzo now has a whopping 9 million customers, with 2 million coming aboard in 2023. That’s quite the banking network build and I wasn’t the only one intrigued. Apparently, the lead investor in this round is Google’s very own investment wing, CapitalG. Note Monzo is a banking service which includes payment processing but guess who is the processor behind Monzo? Stripe. And, Stripe wasn’t the only hot payments fintech I was reading about this week.

    When Mario Gabriele of the Generalist newsletter flags a disruptor company I usually pay attention. This week he did a deep dive on Australian payments fintech, Airwallex. It’s not in Stripe’s league – they raised $6.5 billion in 2023 –  but Airwallex has just raised $160m at a $5.6 billion valuation supported by 100,000 corporate customers (including SHEIN, Qantas, Canva) generating $80 billion of annual volume and $400m in revenues. The service offers payouts in 150 countries in 46 currencies, is executed by a couple of clicks and costs markedly less than traditional financial institutions. Once again, the issue of costs and tolls charged by traditional financial intermediaries looks like a key ‘win’ for fintech disruptors, and even traditional banks like Capital One. Check out the words of their own CEO, Fairbank (perfect name when you think about it);

     

    “Owning a network allows us to deal more directly with merchants rather than a network intermediary…..We create more value for merchants, small businesses and consumers and capture the additional economics from vertical integration.”

     

    That network word seems important. Arguably, there already exists a disruptive network and it’s already worth a trillion dollars. Yes, the blockchain-powered cryptocurrency, Bitcoin, traded back to the $50,000 mark in recent weeks and put the total value of the currency at $1 trillion. Of course, the recent decision of US regulators to allow funds (ETFs) invested in Bitcoin to trade on public exchanges like the NYSE is a further validation for this particular ecosystem. However, Bitcoin’s connectivity to the merchants, consumers and businesses which Fairbank covets is still very limited. What is not in doubt is the size of the global digital payments market which is, per Statista, going to exceed $15 trillion by 2027. The good news for fintech disruptors and start-ups is that reducing the “tolls” on these money flows can be a quicker route to profits than other sectors.

    In Europe, just two of the ten most valuable venture capital (VC) backed companies are making profits. Interestingly, both are fintechs –  Revolut(neobank) and SumUp (mobile merchant payment hardware). Clearly, route-to-profitability is an increasing focus of investors as higher interest rates bring tighter funding conditions. However, investor interest in payments networks appears strikingly robust. Check out the following recent funding deals:

    • UK-based Kriya secures £50m funding boost to supercharge B2B payments revolution – TechNews 180
    • Valar Ventures backs Berlin fintech, Monite, with $6 million – CB Insights
    • Colombian payments startup, Bold, secures $50m in Series C funding, led by General Atlantic – HUBFX
    • Payment orchestrator, Navro, raises $14m Series A from Bain Capital and Motive Partners – Dealroom

     

    The truth is that payments funding has ‘only’ seen a 30% fall in funding activity compared to wider fintech funding collapses of 50-70%. So, perhaps my Brexit blurt was too impetuous and the stronger logic attaches to London’s critical positioning in the payments ecosystem. There goes my GB News career but I’d rather you keep an eye on the forgotten third giant network – payments. And, now you know there are 15 trillion reasons why.

  • The Value Of Good Times Revisited

    The Value Of Good Times Revisited

    My first year on this planet was the first for humanity on the moon. A good year but no memory of it. Probably my earliest happiest memory was lying on the floor playing with Airfix toy soldiers in a Waterloo battle scene at Christmas time as Simon & Garfunkel’s ‘The Boxer’ played on my parents’ hi-fi. Happy times, and always grateful for plenty more over the following decades. However, last week another ‘good times’ feeling was prompted by the radio belting out “The Boxer”, quickly followed by a news update on another lunar expedition. Yep, it was Japan’s turn to visit the moon but also a reminder of how much I loved living in Tokyo in the ‘90s. Good years, many memories. I won’t be visiting there any time soon but the memory-jog from the East could be timely. Japan might just be about to revisit its own good times…..

    The main stock market index in Tokyo, the Nikkei 225, recovered to a 34-year high this week. That’s a positive headline but doesn’t escape the fact that the Japanese stock market has only returned to index levels last seen when I first landed in Japan. However, there’s a lot more going on than headlines highlighting 34-years of zero wealth creation. In fact, I’d almost use the word ‘progress’. Progress might not sound like a big deal to readers, and I might have shared that very same view until I came across a fascinating piece of data in the Financial Times(FT) in recent weeks. Thanks to the Google AI tool, Ngram Viewer, one can explore language usage trends over time by searching millions of books, documents and other text sources.

    According to the FT’s John Burn-Murdoch, usage in the West of English, French and German words for “progress, advance, future, rise and improvement” have been in decline since a few years after Apollo 11’s daring touch-down on the moon. Meanwhile, usage of the words for “threat, worry, caution, risk and caution” have increased significantly to suggest a multi-decade cultural shift to risk-aversion, or ‘safetyism’ which is being used a lot these days in AI discussions. Indeed, a recent excellent David McWilliams podcast with Burn-Murdoch explored this potential connection between culture, language and growth. For Japan, this analysis must genuinely resonate. After decades of trying to unwind huge debt levels in its financial system, and persuade its ageing population to spend, there are interesting developments which point to a significant cultural shift.

    Leaving aside the ambition to be only the 5th nation in history to successfully ‘soft’ land on the moon, Japan is flexing its ‘progress’ and ‘advance’ muscles further afield. How about the daring move by Nippon Steel last September to buy iconic US industrial asset, US Steel, for $14 billion? Or Softbank swooping for Ireland’s Cubic Telecom in a €473m deal pre-Christmas? Perhaps the even bigger deal is the incoming capital landing on the island nation. Last April we wrote about Warren Buffett buying up significant stakes in Japanese sogo shosha, 150-year old industrial trading houses, described by Buffett himself as “a cross-section of not only Japan, but of the world”. In some ways, Japan is the beneficiary of a global China de-coupling. Indeed, its trading houses could be considered a new de-risked staging post to access the Asian middle-class; a cohort which will account for a stunning two thirds of the global total by 2030. And….Buffett is not the only financial guru revisiting Japan.

    Steve Cohen, has opened a Tokyo office of his Point72 hedge fund and US private equity player, Ares Management, has announced plans to do the same in 2024. Ken Griffin’s Citadel, the most successful hedge fund in history, has also decided to reopen its Japan office. So what’s the deal? Well, when an iconic Japanese industrial giant like Toshiba agreed in September 2023 to a $14 billion sale to local private equity firm, Japan Industrial Partners (JIP), that was a very big deal. Not the size, but the business cultural signal. Typically, underperforming companies on the Japanese market have stubbornly rebuffed shareholders’ demands for maximizing returns on invested capital. In fact, the Japanese authorities have frowned upon the unfettered threat of Anglo-Saxon-style unsolicited takeover bids. Without the threat of takeovers, Japanese companies, in aggregate, have displayed the following unique features:

     

    • Japan’s listed companies sit on enormous cash piles amounting to almost 45% of their market capitalization. That’s about three times what UK or US companies hold (Source: IMF)
    • Prior to Covid-19, Bloomberg reported that total cash held by Japanese companies on their balance sheets had reached 90% of Japan’s $5 trillion GDP.
    • 40% of companies listed on the Tokyo Stock Exchange finished 2022 with net cash holdings equal to more than 20% of their equity. (Source: Carlyle)
    • 50% of companies listed in Japan are trading below the value of the assets on their balance sheets. In financial valuation terms this is expressed as a price-to-book ratio of less than 1x. (Source: Schroders)

     

    So, cash is king. But, in a super-low interest rate Japan, un-deployed cash is killing investment returns. This is reflected in so many companies trading on valuation multiples less than 1x price-to-book, but is now poised for a shake-up. The Tokyo Stock Exchange (TSE) has formally instructed all listed companies whose price-to-book ratio is less than 1x to raise their multiple above 1x, or risk being de-listed. One way to do that is to reduce the book value in the ratio by handing cash back to shareholders. The TSE has published a “name and shame” list and this is raising investor expectations of better governance and deployment of capital. In fact, more than 50% of Japanese companies have increased their cash dividends to shareholders in the last year. Sounds like Warren, Ken and Steve have their eyes on the ball. And, if you like ball games, then Japan is making waves there too..

    Shohei Otani from Iwate Prefecture has just signed a $700 million contract with the Los Angeles Dodgers baseball franchise. This is the biggest individual contract signed in history, in any sport, and it feels like ‘a moment’ for Japan. I sense other moments too. Tokyo’s stock exchange has just passed out Shanghai in market value and regained its place as Asia’s biggest equity market. And, it’s not just investment capital coming to Japan. Back in the mid-1990s tourist numbers were just over 3 million. That number had rocketed to over 30 million before Covid struck. Anecdotally, Japan seems to be on so many ‘bucket lists’ as the last advanced economy which is truly a different experience for travellers. Also, thanks to its price stagnation problem over the last 30-years Japan is presenting far better relative value attractions than its “pricy” reputation. Of course, value is a huge factor in financial markets so my final Japan revelation might surprise.

    We mentioned earlier that Japan’s stock market has only just returned to levels last seen in 1990. In other words, the long-run multi-decade returns on Japanese assets (on average) have been close to zero. However, the annual valuation “bible” published by Nobel Prize winner, Eugene Fama, and Kenneth French has just thrown up an amazing bit of data. Japanese stocks which qualify as value stocks (low valuation ratios like Price-Earnings, Price-Book etc) have compounded returns at 6.5% annually in the period 1990 to 2022. In a global market recently dominated by Big Tech and “Magnificent Seven” turbo-charged valuations and share price gains this is a timely reminder of Warren Buffett’s super-power, TIME, and his focus on value for long-run returns. For investors today, the investment question should always address value but also… timing. Right now, watching these moments, I’m wondering is it Japan’s time for good times again?  It certainly has a fighting chance.

    “In the clearing stands a boxer
    And a fighter by his trade
    And he carries the reminders
    Of every glove that laid him down”      –    Simon & Garfunkel

  • What’s The Score For ’24?

    What’s The Score For ’24?

    It’s that time of year again to pause, reflect and hope to do better in future. Unless, of course, you’re the Conservative Party in the UK or the Republican Party in the US and ‘the race-to-most-nasty’ is the leadership badge of shame soon to be re-spelt with a ‘Z’. Back in the do-better world, a review process can help shape future efforts. So, let’s do a quick check on our four multi-year investment themes we identified almost a year ago in “Four Pictures To Develop This Year”.  First, we will remind ourselves of what was written, and then score/review how things developed for AI, Housing, Corporate Credit and Cleantech/Batteries. We kick off with the biggie….. Artificial Intelligence (AI):

    “The excellent database resource, Our World in Data, shows annual corporate investment in AI doubling from circa $80 billion in 2019 to over $160 billion by mid 2021. More specifically, the explosion of interest in generative AI (ChatGPT, DALL-E etc) has seen VC investment increase by 425% to $2.1 billion since 2020”

    Review: Well, at the half-way stage of this year, 18% of global venture(VC) funding went to AI, clocking a total of $25 billion(Source: Crunchbase). Furthermore, with the tech-heavy Nasdaq index gaining almost 50% this year, Nvidia reaching a trillion dollar market cap and OpenAI hitting an $85 billion private market valuation, it is not hard to identify AI as the single biggest positive driver of investment markets this year. Of course, the trajectory of the cost of money (interest rates) also helps with the confidence bit, but we have written before that November 17 has more than one revolutionary connotation. As of this year, the night of November 17th will be remembered for the $200 billion swing in value between Google and Microsoft in a matter of hours, and entirely driven by the relative success or failure of their respective cloud computing divisions. The AI revolution is in full swing and will continue into 2024

    While the cloud has become the housing proxy for AI, what about our own housing markets? A year ago we were concerned:

    “Of course, rising interest rates don’t just impact companies. The biggest item on an individual’s balance sheet is likely to be a house and as interest rates rise, so do mortgage rates. The push/pull effect of higher interest/mortgage rates can reduce the price of the assets being purchased, in this case houses rather than growth companies…… indicates a more difficult 2023 for a number of major housing markets.”

    Review: Arguably, this theme did not play out in a significant way, unless you were Chinese. Bluntly speaking, the doomsday predictions of housing crashes in the US, Australia, Canada and the UK just did not materialise. However, house prices are somewhat softer in many markets. The St Louis Fed has said median house prices in the US are off 10%. Even the UK with its dysfunctional government, and one Prime Minister(Liz Truss) having a good go at crashing the property market all by herself, has seen price slippage of just 1% (Source: Halifax). The key flaw in the doomster arguments was that most people kept their jobs. Major economies in a state of full employment was not expected as the “vibecession” never turned into a recession. And, if recession is avoided then there’s another asset class which has dodged a bullet; corporate debt/credit. Here’s what we feared….

    “In real world terms, the knock–on effect of tighter funding conditions will begin to reveal themselves in 2023 as companies with challenged balance sheets/indebtedness – aka ‘zombies’ – move into distressed territory.”

    Review: As a proxy for corporate stress you’d expect high yield bond (lower quality debt) spreads to have risen through the year. But no. They’re actually at their lowest since April 2002. However, we’ve had a few big bankruptcies through the year – Silicon Valley Bank, WeWork, Diebold Nixdorf, Rite Aid, Van Moof, and even Birmingham City Council. By June UK bankruptcies were up 40% on the year before. According to S&P Global, in the first 10 months of this year 561 companies sought bankruptcy protection in the US. That’s more than any year since 2010, except for the Covid-19 hit in 2020. So, I’d give us a pass mark on this but feel there’s another year of stress ahead. In particular, commercial real estate as an asset class is going to witness some very painful write-downs and outright collapses. Check out the recent travails of Austrian billionaire, Rene Benko, and his $25 billion property empire, Signa, for a very current case study.  However, not all building is in trouble….

    “In some ways, the best proxy for the planet’s race towards reducing fossil fuel dependence is the enormous investment currently being ploughed into production facilities for batteries to power a generational shift to electric vehicles(EV). China in 2020 accounted for 75% of global battery production capacity but that’s going to change. Europe intends to up capacity 5-fold by 2030 and the US isn’t just home-shoring semiconductor manufacturing.”

    Review: Like AI, I think this gets us pretty good marks. The cleantech and energy storage(battery) revolution is in full flow. McKinsey reckon $6.5 trillion will be spent every year on capital expenditure/building facilities which, in the words of the latest Cop-out 28 text, will “transition away from fossil fuels”. We did say catch up was required by Europe and the US in battery manufacture, but arguably the US has accelerated faster. Thanks to ‘Bidenomics’ and the IRA Act the US is seeing capital investment in manufacturing reach levels not seen in four decades. According to MIT, cleantech investments in the 12 months to July 2023 hit $213 billion, and was mostly allocated to EV battery manufacturing, renewable energy and green hydrogen infrastructure. No wonder the old-economy barometer, the Dow Jones Index, just hit an all-time-high level of 37,000 points. More amusingly, Trump whisperer, Maria Bartiromo, on Fox Business was forced to say “the economy is doing much better than most people understand.”  Wonder how that misunderstanding developed, Maria?

    So, there’s a temptation to stick with the same four themes for 2024, but in the spirit of Christmas we’d like to give a bit more. The bonus good news is that Christmas might also be easier on the waistline in the coming years. Yes, AI has stolen many of the headlines this year but there’s a 100 year old company in Europe breaking records too. Denmark’s Novo Nordisk is now the most valuable company in Europe with a $437 billion market capitalisation thanks to its insulin product, turned weight-loss miracle drug, Wegovy. This semaglutide-based drug is a game-changer for up to 750 million people living with obesity. However, there might be even bigger break-through treatments to come. And, it’s all about BIOLOGY.

    We are entering the world of gene editing spearheaded by CRISPR technology. Get used to that term. CRISPR stands for Clustered Regularly Interspaced Short Palindromic Repeats. It is a component of bacterial immune systems that can cut DNA, and has been repurposed as a gene editing tool. Only this week we were reading that the FDA has approved two ground-breaking cell-based gene therapies, Casgevy and a new one, Lyfgenia, for treating sickle cell disease (SCD) in patients aged 12 and older. Notably, Casgevy is the first FDA-approved therapy utilizing CRISPR.

    Now, think about healthcare spend being almost 11% of global GDP, or $11-12 trillion. The prospect of biology rather than pharmacology being used to eliminate various life-changing diseases is mind-blowing. Furthermore, as the first attempts to regulate AI emerge let’s open our minds up to the probability that these massive new computing powers can save decades of research time. So, as a final thought, perhaps 2024 will deliver a break-through global healthcare solution through the combination of AI and biology. Just imagine, our health becoming your wealth…. I definitely think that would score well.

  • And You Thought Only The Bots Did Comebacks…

    And You Thought Only The Bots Did Comebacks…

    As pantomime season approaches, it almost explains why most of the Conservative Party front bench are off the front pages. Unless, of course, you’re new Home Secretary, James Cleverly, and a wee bit envious of the coverage given to Nigel “I’m A C…….. Get Me Out Of Here”. Poor James, affectionately known in the corridors of Westminster as “Jimmy Dimly”, has been caught not once but twice using expletives in awkwardly public circumstances. However, if we are looking for real awkward stuff, consider the board of OpenAI. It has been quite the week. The board room coup and firing of CEO Sam Altman last weekend shocked the AI world and threatened to incinerate $90 billion of corporate value in OpenAI. However, a whirlwind four days later we were on to our fourth CEO, a potential 600 resignations out of 700 personnel, thousands of worried start-ups built on OpenAI’s flagship ChatGPT model and a potentially costless acquisition by Microsoft. Anyway, the fourth CEO happens to be Sam Altman who seems to have had the comeback of comebacks. So, all is back on track? Ehhh… not quite.

    The details as to what was the exact cause of the original board room bust up are not yet clear. But… the general gist of things is the tension between executives wanting to develop AI at break-neck speed and board members worried about the risks involved with super powerful models capable of Artificial General Intelligence(AGI). The advance hidden in the AGI acronym is the ability of a machine to reason and think, potentially in a superior way to a human being. Now, AGI(vs AI) was supposed to be some way off on development timelines, but reading between the lines something has spooked the members of the OpenAI board. The existential threat of out-of-human-control technology is a genuine fear but there are two key drivers as to why the “growth” champions want to keep moving, and fast:

    The Stakes: At a corporate and sovereign level, the risk of your competitors or geopolitical rivals gaining a lead in AI has huge market and political power implications. If someone gets a sufficiently big technological lead, you could be corporately or literally dead.

    The Incentives: We saw this week the incentive to be ahead in AI. The company nobody had ever heard of 6 months ago, Nvidia, released its Q3 results. Expectations were sky high evidenced by the market giving it a current market value of more than $1.2 trillion. And, yet it still beat expectations with its data centre chips (AI) revenues up 279% year-on-year and exceeding the sophisticated forecasting models of Wall Street’s finest by a whopping $2 billion.

    So, this tension between technology risk and technology development/growth is going to dominate AI discussion and regulation in the coming years. We have already seen the Biden administration put in place an Executive Order on AI safety and security, and Europe’s AI Act is imminent. However, these attempts to mitigate risk might lead to another comeback by a technology closely connected to another Sam.

    Unfortunately, Sam Bankman Fried faces Federal incarceration and won’t be restored any time soon to the helm of crypto platform FTX. Indeed, this week another platform founder in the space Changpeng Zhao or “CZ” of Binance was convicted of money laundering, fined $4 billion, stepped down from his executive role and narrowly avoided a prison sentence. Those are the bad headlines in the crypto world and could cause readers to miss the bigger picture. The reality is that one of the huge risks of AI is fraud, caused by deep fake imagery, false ID and misrepresentation. Now, crypto can help. Well, not crypto or cryptocurrencies because they are applications/digital assets. However, they are built on a really powerful technology, blockchain. And, blockchain technology is really good at ID verification, security and transparency/ traceability. Clearly, this could help with fears over AI and, like Nvidia, blockchain technologies could be a way to play or track the opportunity in AI. As always, we like to follow the money for evidence of our thinking. So, consider the following…..

     

    • Bitcoin is up 130% this year.
    • PayPal has launched a US dollar stablecoin ie a digital currency layered on to blockchain technology.
    • For those that giggled at NFT madness and wealth destruction, note Disney has launched its own NFT market platform in recent weeks.
    • And if you thought nobody wanted to read about their crypto wealth destruction, you might be surprised to hear that crypto exchange, Bullish, has just acquired industry publication, Coin Desk.
    • Blockchain.com just raised $110 million with a $7 billion valuation.
    • Blockchain payments firm, Fnality, in London just did a funding round for $95 million backed by Goldman Sachs.

     

    The funding rounds in particular indicate significant capital seeing a future for blockchain. Indeed, AI and its risks look like they are driving a faster blockchain comeback than investors expected. If the OpenAI rumours of a big AGI breakthrough are true, then the risk genie is truly out of the bottle and blockchain is on for a BIG comeback.

     

  • Get Ready For The Cloud Wars

    Get Ready For The Cloud Wars

    When the value of just two companies changes by $200 billion in a matter of hours I usually take a closer look. That can even happen when “Married At First Sight”, and not Gaza, has brought you to the point of giving up on humanity. More Gaza later. For now, let’s revisit the events of October 24th. Despite the glow of its recent 25th birthday, Google’s quarterly earnings results failed to impress investors and the subsequent share price dive clipped the guts of $75 billion off the value of the Mountain View tech giant. In contrast, investors were excited by the update on the same night from the world’s second most valuable company, Microsoft, as investors rushed to buy shares and added a cool $125 billion to the valuation of the Seattle tech giant.

    The only word on any traders’ lips that evening in New York was ‘cloud’. More specifically, the revenues earned by the critical data storage and processing architectures which support all our personal and business digital apps and services. The ‘cloud’ is where big tech has leveraged its scale and offered enormous computing power to live and work your digital existence. However, these apps and services are now feeding off a new digital super-power – Artificial Intelligence(AI).

    Generative AI with its large language models(LLMs) and enormous data learning appetites have turned the cloud into a battle field fought by the big three – Microsoft, Google and Amazon. And, the cloud is flying – not quite literally but Microsoft’s Azure cloud business revenues are rocketing at 29% annual growth rates. Google’s cloud business was perceived the ‘loser’ last week with a growth rate of just….. 22%. You get the picture – the cloud is big money, but it’s also really all about AI. Revenues earned by cloud services (powered by data centres) are a proxy for measuring who is winning the AI ‘war’. Let’s be very clear Google and Microsoft have lots of other revenue channels but there is no doubt that the $200 billion shift in valuations between the two giants was entirely driven by the cloud, and by AI. Still sceptical? Allow me to expand on this thread…

    Remember Mistral? Yep, that was the company with 4 guys who raised $120 million with no business and no revenues. Just a PowerPoint presentation. Well, that was 4 months ago. And, now they’ve reportedly raised another $300 million. This time they can actually demonstrate a proprietary large language model(LLM) built with 7 billion parameters for AI training. Yes, built… in 4 months. In valuation terms, Mistral is already a ‘unicorn’ – a startup worth more than $1 billion. If you thought this was merely VC excitement about ‘disruption’ then think again. It feels like the world is still figuring out which of emerging disruptors (with new AI models) or big tech (with its massive proprietary data head start) will win the modelling wars. However, big is still beautiful in investors’ eyes.

    Check out all the gloomy headlines – inflation, painful interest rate hikes, war, recession. You’d think stock markets would be cratering. And, you’d almost be correct. If you strip out the share price performance of just 7 technology companies – aka the “Magnificent 7” – then global equities are probably in negative territory for 2023 so far. Now, think about what is driving Apple, Microsoft, Tesla, Google, Facebook, Nvidia, and Amazon who, on AVERAGE, have rocketed in value by 80% this year. For this writer, it is clear these 7 companies possess the best databases on the planet and are in pole position to train AI models to do whatever they want. Some are happy to use 3rd party models like OpenAI’s ChatGPT or Anthropic’s Claude and the investment monies are still flowing fast.

    Microsoft has already put $10 billion into OpenAI and the latest reports of funding activity suggest OpenAI’s valuation has jumped from $20 billion to $85 billion….in 8 months. Amazon is putting $4 billion into Claude but, as we have illustrated, there are about 200 billion reasons and counting to be in this race. We can’t forecast the future but it is worth remembering that this is AI in its infancy, or to put it another way, at its worst.

    I had the genuine pleasure of chatting to “the Oracle of AI”, Jim Dowling, who presented at an IIBN business event last week. He’s usually based in Sweden and, uniquely, is that country’s only resident lecturer in Deep Learning. It was fascinating to hear him talk about “emerging reasoning” in some of the very large AI models and how lots of well-known businesses are using his company, Hopsworks, to re-configure their data architecture for pending AI applications. What was less fascinating was my estimate that probably 75% of the questions from the audience were fixated on deep fakes, misinformation, AI ‘hallucinations’ and cheating on…. homework. I know, how do we sleep at night!

    Now, recall my earlier words that these early building stages are seeing AI ‘at its worst’. Then just repeat one word to yourself, quite a few times. GAZA. As a species we seem to be perfectly good at bringing ourselves to the brink of World War III or demonstrating barbaric behaviours which, on reflection, didn’t quite end with Ghengis Khan or the Inquisition. Bluntly, we can do far better and AI could help – think of education, the unbanked, healthcare, medicine, energy, decarbonisation, urban planning or agriculture. You know, all the bits to do with living. Of course, all important things must have governance and guardrails. How many unapproved foods, drugs or banks do you know? So, get ready for more of the following:

    Biden Executive Order Imposes New Rules For AI – ABC News

     

    The excellent Tech Brew newsletter gives a good summary in the following bullets:

     

    • The directives in the order cover everything from housing discrimination to bioweapons, and aim to address AI at each stage of development.

    • Developers must share safety test results with the government, and various agencies will work on developing standards designed to mitigate threats from AI-created biological weapons and deceptive deepfakes.

    • The order includes a regimen of new privacy research and rules that aims to better govern how developers use information they collect on users.

    • A section of the order homes in on algorithmic discrimination; it calls for guidance to landlords, federal contractors, and welfare programs on reducing bias in any AI tools they use, as well as new guidelines for the Department of Justice to probe this type of discrimination and more rules around AI’s use in the criminal justice system.

    • The general consumer protection section focuses mostly on developing standards for AI’s use in healthcare and education.

    • The order calls for a report on AI’s impact on the workplace, and lists directives for working with allies to implement AI standards internationally.

     

    Meanwhile, over the other side of the pond……

     

    UK, US, EU and China sign declaration of AI’s ‘catastrophic’ danger – The Guardian

     

    Hosted by the British government this week, twenty-eight governments signed up to the so-called Bletchley declaration on the first day of the AI safety summit. One can understand the British government’s eagerness to exhibit some form of responsible stewardship given the stunning revelations coming from the ongoing Covid-19 inquiry in Westminster. An “unfit” Prime Minister surrounded by “f*ckpigs and morons” administering a staggeringly incompetent response to a global pandemic is truly a review for the ages. And a relative reminder of AI’s infancy and humanity’s ability to be……. ehhh…..almost inhuman, or non-human.

    So…..GAZA or AI? My money (and clearly a lot of investment capital) is on cloud wars potentially delivering a better humanity. Keep watching, and hoping. It will be worth it.

  • Government NOT Making It EIISy For Startups?

    Government NOT Making It EIISy For Startups?

    In the investment world of benchmarks and relative performance, portfolio managers will tell you every year is a tough year. World going thrillingly gang-busters? Gotta keep pace. Risk, slowdown and volatility? Don’t blow up, survive. Arguably, for startup businesses and founders dependent on external funding support there is a similar dynamic in play.

    In the giddy years, if your investment story isn’t ‘shiny’ enough you can be starved of capital which is diverted to other sectors. Then, in tougher more cautious funding environments like the last 12 months, you’re possibly juggling slower sales cycles and slower funding rounds and decisions. Worse still, no decisions. Uncertainty is a decision and business killer. And, we have no shortage of uncertainties fuelled by inflation, rocketing interest rates and geopolitical powder kegs in Ukraine and the Middle East. Now, smaller businesses and investors must deal with a fresh uncertainty coming from perhaps a surprising source, our own government.

    The last US President to close out a global geopolitical proxy war was Ronald Reagan but he’s also famous for his disdain of government over-reach. In a 1986 press conference he said, “The nine most terrifying words in the English language are ‘I’m from the government and I’m here to help.’” Arguably, these words might resonate with businesses and investors currently wrangling with the latest Finance Bill and its changes to EIIS rules for equity investors and investee companies. Firstly, an easy-to-understand flat rate of 40% income tax rebates for Irish resident investors in qualifying Irish startup businesses has been chopped up into 5 different bands. The different bands, to come into effect on January 1st 2024, are 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%. Clearly, this reduces the incentive to invest rather than increases the incentive with what could be considered particularly poor timing. We would highlight three key pre-existing factors as challenges for businesses seeking investment capital:

     

    • Higher interest rates: Remember our reference to capital chasing the “shiny” things? Well, interest rates rocketing to 5% are forcing all asset classes to increase their attractiveness by offering better returns. Think deposit rates, mortgage bonds, corporate bonds and other lower risk options to earn returns. They are all upping incentives/yields while the government is seeking to make startup investment less “shiny” or easy.

     

    • Financial Conditions: The Goldman Sachs research team tracks the broader financial climate and looks at lending patterns, terms, spreads, credit trading etc Its view on euro-area financial conditions is that they haven’t been this tight since the Great Financial Crisis (GFC) in 2008-2009. This means businesses must search harder for investment, endure tougher terms and possibly find new banking channels unless your choice is….

     

    • Irish Banks: A senior Dublin legal eagle only recently told me that the banks are effectively ‘not open’ for any additional risk on their books before year end. True or not, the banking choices for SMEs are extremely limited as Nat West(Ulster) and KBC have pulled up sticks in Ireland and followed Rabobank and Danske Bank into retreat to their higher margin core markets.

     

     

    The recent memories of Covid-19 and the pitiful take-up of the government’s Credit Guarantee Scheme (just 12% of funds used by April 2021) hint at a limited banking system which isn’t massively interested in the SME sector. As a reminder, the government was guaranteeing 80% of the €2 billion in loans under this Credit Guarantee Scheme but it seems even a 20% share of the risk was too much for the Irish banks. But, also be mindful that 99% of active enterprises in the state are SMEs and account for 70% of employment. Of course, there are other institutional sources of capital.

    In the US 70% of venture capital comes from pension funds and educational endowments. In Europe, you’d be lucky if that number even reached 20%. So, despite the fabulous efforts of Ireland’s state funding agency, Enterprise Ireland, the role of private investors is critical in supporting early stage businesses. It is true that European government agencies and EU institutions(eg Horizon 2020, EIC) play a significant part and these latest EIIS changes in the Finance Bill are part of a broader harmonization of state aid. However, harmony works both ways.

    Due to limited competition and regulatory constraints, smaller Irish businesses are experiencing a much more difficult banking and funding environment than their European peers. In those circumstances, one would hope that European and Irish policy makers were encouraging private capital to fill the institutional and bank funding holes. Complicating simple tax treatments is not a good start and, to add to decision paralysis, there is a critical question outstanding in the new EIIS rules.

    The 50% rate applied to investments made in companies “not operating in any market” is leaving many people, both founders and investors, in the startup world scratching their heads. For us, we need to clarify the “not operating” phrase. Does this mean companies not generating revenues yet or is this demarcation geared towards companies in earlier risk stages like R&D, pre-API-type development phases? These are the questions which, left unanswered, will delay business funding and investment. Fatally, in some cases.

    Now, to finish on a more upbeat note. This writer, as a long-time analyst of investments and their returns, has always been wary of treating tax rebates as a means of re-setting your starting point. In other words, if EIIS of 40% is applied, your €1,000 investment cost only €600 post your tax rebate. In my world of valuations and RETURNS the more critical point was that your investment value remained €1,000. So, in a 35% EIIS rebate world the return of your €1,000 in subsequent exit value would amount to just shy of a 54% return. If that €1,000 becomes €2,000 that’s a greater than 3x return, irrespective of whether you started with a €600 or €650 cost. That broad quantum of outcome should still keep investors very interested in startup investing. However, as we hit GFC levels of funding tightness, the government may not be able to magic up more banks but it could certainly incentivise more private investors to support the 99%. Kinda like what governments used to say they do.

  • We Are All Start-Ups Now!

    So, it’s The Great Lockdown then. That’s the name given to this crisis period by the IMF and I’m hoping there’s another Isaac Newton out there. Well, not quite. Newton famously developed humanity’s knowledge of calculus, light refraction and gravity while quarantined during the Great Plague of 1665. Right now, behind the global public health priority of a CV-19 vaccine, the world is in urgent need of a gravity-defying economic plan. Newton’s falling apple suggested what goes up must come down. The task today is to figure out how a Lock-Down transitions to, hopefully, an Open-Up in the coming months. The laws of gravity and economics are challenging to say the least.

    Let’s start with a few numbers. How much are we really down? The IMF reckons global GDP in 2020 will shrink by a higher percentage (3 %) than any period since the Great Depression. That’s even more than the nadir of the credit crisis in 2009. In dollar terms, January IMF forecasts of 3% growth this year have in a matter of weeks seen $5.2 trillion worth of activity evaporate from those 2020 expectations. The IMF think the ultimate cost through 2021 could be closer to $9 trillion – that is the equivalent of Japan and Germany’s economies disappearing. Here are a few other numbers which hint at the scale of the gravitational pull on economic recovery:

    • Commodities: The IEA is forecasting oil demand for 2020 to fall by more than 9 million barrels per day (!). In April alone that number will fall by 29 million barrels per day. In effect, global economic activity/consumption has returned to 1995 levels. Good news for the climate but catastrophic for nations dependent on exporting commodities.
    • Banks: Ireland might escape the worst GDP implosions likely to hit Italy and Spain but a quick check of bank share prices in Ireland gives some clues as to the scale of capital destruction. The combined market valuations of AIB, BOI and IPTSB amount to just over €4 billion, or just over 20% of the combined book value of these banks ie the market is discounting €16 billion of capital at risk of wipe-out. Then, factor in a 2020 Irish government budget surplus of €2 billion vaporizing into an estimated €19 billion deficit. That’s another €21 billion we might not have in 2021.
    • Corporate Debt: Back in 2009 a critical factor in capital destruction was the amount of leverage in the banking system. We have written frequently about the risks of being dependent on “other people’s money”. Fast forward to 2020, and it is clear companies across the globe have feasted on ultra-low interest rates and loaded their balance sheets with debt. The Institute of International Finance estimated corporate debt levels among non-banks had rocketed to $75 trillion by the end of 2019. That figure was $48 trillion at the end of 2009.

    Yes, the numbers are quite scary. However, the intention of this article is not to frighten but rather to highlight the difference between two competing emergencies. Governments and central banks everywhere have moved swiftly to address the immediate cash flow issues of citizens and companies experiencing a collapse in income and revenues. The longer term issue is how creditors and debtors deal with damaged balance sheets and the need for additional capital to “Open-Up”.

    The Lockdown is a cash flow emergency. The Open-Up phase will probably be phased and slow. The entire world from universities to airlines will need capital buffers to navigate a possibly very changed world. Bluntly, the capital destruction estimated/discounted in the forecasts summarized above suggests too many capital-hungry mouths to feed. Previous years’ financial performances by established corporates may not be a helpful guide to the future. Companies will have to be realistic with their projections and tell their story very well. The risk profile for many sectors has endured a meteor strike and, in a sense, business models will have to be rebuilt, or in start-up terminology, pivot.

    Yes, the Great Open-Up will be a capital event without precedent.  We are all start-ups now.