10.27.2020
Irony Overload

Headline of the day, from Bloomberg:

Fraud Prevention Firm Goes Bankrupt After CEO Charged With Fraud

Street View
Lenders are putting the screws to mall owners laid low

Lenders are putting the screws to mall owners laid low by the events of 2020, The Wall Street Journal reports today.  As nationwide mall valuations have fallen as much as 75% and tenant revenues have slowed to a trickle, time is running out on forbearance and rent breaks, setting the stage for a raft of contentious negotiations and workouts

For instance, creditors for a Saks Fifth Avenue location in Miami’s Dadeland Mall are foreclosing on the owner, a subsidiary of Hudson’s Bay Co. following a missed mortgage payment in April that has yet to be repaid.  The owner “is disappointed that in the context of a global health crisis the lenders would choose litigation over cooperation but understand the background and continue to diligently pursue an amicable solution,” a Hudson Bay spokesperson told the Journal

Unsurprisingly, tenant-versus-landlord disputes have found their way into the courts, as owners attempt to extract rent while retailers look for legal authority to break their leases. “Every step of the way, everyone is fighting with each other to see who will take the loss,” Jim Costello, senior vice president at Real Capital Analytics, tells the Journal.  

Some mall tenants are taking the initiative and hitting the bricks. At its annual investor meeting last Thursday, apparel retailer Gap, Inc. unveiled a three-year plan that included slashing its North American store count by 350 locations (equivalent to 30% of its total footprint), including 200 over the next year.  “Most of the closures we have going forward [are] going to be in malls,” chief operating officer Shawn Curran noted, while CEO Mark Breitbard lamented that: “we’ve been overly reliant on low-productivity, high-rent stores.”

Of course, mall struggles are hardly confined to the United States.  Bloomberg reported Friday that Goldman Sachs is set to take control of the Blanchardstown Centre mall in Northwest Dublin from owner Blackstone, as rent collections have dropped to as low as 25% during recent pandemic-addled months. 

Then, too, the current retail migration looks to help ensure higher costs for mall owners, who typically work under co-tenancy clauses bestowing rent relief on inline tenants in the event that multiple anchor tenants vacate a property, to compensate the holdovers for lost revenues resulting from declining foot traffic. 

A report from Green Street Research last Wednesday attempted to quantify the implications of widespread mall vacancies, finding that, within the best-in-class “A” mall category, about one-third of total box locations are not only vacant but are still looking to identify their next occupant.  

As anchor tenants depart and more malls go dark, capital expenditures needed to help generate future revenues look set to rise in tandem.  Green Street estimates that redevelopment cost reserve requirements (defined as the funds needed to bring two anchor tenants per mall over the next ten years, along with the equivalent of one anchor every ten years thereafter) for “A” and “B” malls now stands at roughly 15% and 18% of net operating income, respectively, roughly double their pre-coronavirus levels.  

In addition, the analysts expect that more intense competition for high-quality tenants will necessitate higher up-front incentives from landlords. So-called tenant allowances, inducements which fund expenses like store build-outs, will rise to a projected 7% of industry NOI from the current 5%. Overall, Green Street projects that those additional costs, in tandem with virus-related earnings declines, will increase total capex reserves for “A” malls to 32% of annual NOI, up from a prior estimate of 27%.

With costs rising and revenues remaining under pressure, might industry distress yet spur wider problems?  In mid-October, analysts at Barclays relayed that nearly one-third of the mall loans within commercial mortgage-backed securities they cover are already in delinquency or default. 

Someone has to pay.

Recap Oct. 27

Stocks failed to bounce following yesterday’s notable selloff, as the S&P 500 fell another 30 basis points to extend its two-day loss to 2.1%. Treasurys were bid across the curve as a record $54 billion two-year auction went smoothly, while gold ticked to $1,910 an ounce and WTI crude rebounded to $39.50 a barrel.  The VIX popped above 33 for its best finish since Sept. 3. 

- Philip Grant

10.26.2020
No Man is an Island

A 24-hour tour? From the Los Angeles Times:

A dispute between bond king Bill Gross and his next-door neighbor over a $1-million outdoor sculpture has devolved into police calls to their Laguna Beach mansions, multiple legal actions — and allegations that the billionaire investor blared the “Gilligan’s Island” theme song on a loop at all hours to annoy his neighbor.

If things escalate further, “Baby shark” would presumably be the nuclear option. 

Postmodern Monetary Theory
How low can it go?

How low can it go?  This morning the Turkish lira traded above 8 to the dollar for the first time.  For comparison, less than 6 lira equaled a buck at the beginning of the year, while the exchange rate stood at just 3.5 lira per dollar at the time of a failed coup against President Recep Erdogan in the summer of 2016.  

Government inaction stands as the catalyst for the latest selloff: Last week, the Central Bank of the Republic of Turkey (CBRT) opted to keep its benchmark one-week repo rate unchanged at 10.25%, defying market expectations of a 175 basis point hike and spurring the latest round of lira weakness.  

Raging inflation helps put the FX market’s concerns into context. Thus, year-over-year CPI growth registered at 11.8% in September, the 11th consecutive double-digit increase.  Other measures suggest an even more rapid clip.  Data from the Inflation Research Group finds that prices rose at a 3.61% sequential pace between August and September, nearly four times higher than the 0.97% figure supplied by the Turkish Statistical Institute. 

While easy monetary policy in the face of raging inflation and pronounced currency weakness may strike some as counterproductive, Erdogan himself espoused this economic philosophy in July 2019: “As far as I’m concerned, the most important reason behind high inflation is high interest. If you don’t bring down high interest rates, then high inflation will not come down.” The CBRT, under the leadership of finance minister and Erdogan son-in-law Berat Albayrak, dutifully cut the key rate to as low as 8.25% in May from 24% 11 months earlier. 

“If you look at the policies, (they have) become very hard-headed. And frankly trying to make something logical out of the irrational has become difficult,” Angus Blair, investment banker-turned-professor at the American University of Cairo, told CNBC on Oct. 15. 

While the lira’s value evaporates, a series of regional and international disputes further muddy the waters.  Turkey is currently at odds with fellow North Atlantic Treaty Organization member Greece over disputed territory in the eastern Mediterranean,  and is facing the prospect of U.S. sanctions for purchasing Russian S-400 missiles and for its role in the Azerbaijan vs. Armenia conflict. Erdogan took the opportunity to taunt Uncle Sam over the weekend: "You don’t know who you are dancing with. Whatever the sanctions are, don’t be late. Do it. . . We are not a tribal state, we are Turkey.”  

Then, too, a dispute with France over perceived anti-Muslim bias spurred a call from Turkey’s President to boycott French goods. Erdogan yesterday also opted to advise French President Emmanuel Macron to consult mental health professionals: “He needs to get himself checked out.”  In response, France recalled its ambassador from Turkey. 

As inflation rages and the lira spirals, Turkey’s foreign-currency cache has dwindled to dangerous levels.  Gross FX reserves fell to $42.8 billion as of Oct. 16, down from $80 billion at the beginning of the year and the lowest level since late 2005.  Further declines could prove problematic, as Moody’s downgraded Turkey’s sovereign credit rating to junk in September, warning that “external vulnerabilities are increasingly likely to crystalize in a balance-of-payments crisis.”  In a subsequent downgrade of a dozen Turkish banks, Moody’s analysts speculated that “capital controls and restrictions on foreign currency outflows” could be in the cards.  Erdogan offered a nonchalant response to the Moody’s’ warnings: “Do what you want to do, your ratings are of no importance.”

Meanwhile, the head of another emerging market mainstay looks to take a page from Erdogan’s monetary policy-playbook.  On Friday, Mexican President Andres Manuel Lopez Obador weighed in on the Central Bank of Mexico’s next policy move, following an easing cycle that took the overnight rate to 4.25% from 8.25% in August 2019: “Interest rates are still high. The Bank of Mexico is lowering them, but it has to go even lower for people to want to take out loans.” A hotter-than expected CPI over the first two weeks of October (measured prices rose 4.09% from a year ago, higher than all but two economist estimates) appeared not to figure into AMLO’s calculus. 

Recap Oct. 26

Stocks came for sale, as the S&P 500 lost nearly 2% while the VIX ripped higher by 18% to 32.5, its most elevated finish in nearly two months.  Treasurys were well bid, with the yield on the long bond falling five basis points to 1.6%, while WTI crude sank to $38.5 a barrel.   Gold held near $1,900 an ounce.

- Philip Grant

10.23.2020
The Far Side
The more, the merrier?

The more, the merrier?  As the credit markets have enjoyed a dramatic recovery from their spring depths, deal flow has exploded with junk bond supply exceeding $359 billion so far this year, nearly $40 billion above the prior full-year record established in 2012. That issuance barrage includes some eye-catchingly speculative deals.  

Bloomberg reported Tuesday that acquisition financing accounted for roughly one-third of leveraged loan volume so far this month, up from 13% in September. Recall that new loans used to finance dividend recaps (i.e., payouts to the issuer’s private equity sponsor) registered at $15.8 billion in the third quarter, the most since the beginning of the Trump administration (Almost Daily Grant’s, Oct. 5).  

Now comes the next phase of the cycle: So-called pay-in-kind toggle bond offerings, which allow issuers the option of paying interest with additional debt, instead of cash, are making a triumphant return, the Financial Times reports today.  

Perhaps unsurprisingly, private-equity players figure prominently in the PIK issuance spree. Notable pending transactions include a pair of $500 million, five-year notes floated by Apollo-owned Aspen Insurance and Platinum Equity-backed Multi-Color Corp. Roughly half and virtually all deal those proceeds, respectively, are earmarked for dividend payouts to the p.e. sponsors.  

Other, more traditional p.e.-backed deals are seeing issuer-friendly price changes.  For instance, Bloomberg reports that the term loan issued to finance KKR’s purchase of single-B-rated 1-800 Contacts saw pricing tighten to a 6.75% premium over Libor, some 100 basis points lower than the initial projection.  Subordinated loan deals have also appeared, with more than $2.1 billion in second-lien syndicated loans coming to market in the first 19 days of October, already the highest full-month total since July 2018. 

From an investor’s perspective, the calculus can be relatively simple: “Capital is widely available and remarkably cheap. Plus, in a world without growth, M&A becomes increasingly important,” Michael Terwilliger, a portfolio manager at Resource Credit Income Fund, told Bloomberg Tuesday. 

The erosion of legal protections for creditors further muddies the waters. A Monday report from Moody’s found that the percentage of so-called high-yield-lite bonds (i.e., those with no restrictions on dividend payouts and/or additional debt incurrence) registered at 39% and 41% of all junk bond deals across September and August, respectively, far above the historical average of 28%. 

According to Bain’s 2020 Global Private Equity report, the median deal multiple on leveraged buyouts reached a record 11.5 times Ebitda in the third quarter of 2019, up from less than 10 times Ebitda in 2007.  With higher prices, comes an extra dollop of debt.  Per Bain, some 75% of leveraged buyout transactions carried net debt greater than six times Ebitda at year-end, up from about 60% with six or more turns of debt in 2007.  Those figures are also flattered by the increasing use of so-called Ebitda add-backs, or credit for hypothetical future cost savings.  Strip out those friendly assumptions, and even more p.e.-sponsored entities would cross that six times threshold. 

Those high-debt deal structures feature in the broader data.  According to Moody’s latest B3 Negative and Lower Corporate Ratings List published on Oct. 15, the B3N list (comprising companies rated the equivalent of single-B-minus or lower, along with a negative ratings outlook) stood at 394 as of Sept. 30, topping the 291 stressed entities at the peak of the last cycle in 2009. As a proportion of total issuers, the ratio of B3N issuers stands at 26.1%, matching the worst levels of 11 years ago. Moody’s reports that roughly 70% of all credits within the B3N universe are p.e.-backed.  

While wide-open capital markets have helped keep debt-saddled issuers going through a brutal economic contraction, the bill will eventually come due.  In an interview with Bloomberg television last Thursday, Jim Zelter, co-president and chief investment officer of credit at Apollo, noted that this year’s debt issuance spree may carry severe consequences in coming years: “I suspect many companies were in a rush for liquidity and they added a lot of debt to make sure they got through the troubled period. But when they turn around in 2021 and 2022, they’ll find themselves having just way too much debt.” 

How might one profit from a potential p.e. pile-up?  See the May 29 and July 10 editions of Grant’s for a pair of ideas. 

Recap Oct. 23

Treasurys bounced following their recent selloff, with the 10- and 30-year yields falling to 0.84% and 1.63%, respectively. Stocks rebounded from a mid-day dip, with the S&P 500 finishing a bit higher to narrow its weekly loss to 50 basis points.  WTI crude slipped below $40 a barrel, gold held at $1,904 an ounce, and the VIX dropped 2% to 27.5 

- Philip Grant

10.22.2020
Spinning Wheel
Top of the heap no more.

Top of the heap no more. International Business Machines Corp. reported third quarter earnings on Monday, including $17.56 billion in revenues.  That’s down 2.6% from a year ago and 3.1% sequentially and the weakest result since the first quarter of 1997. 

While $2.58 in headline earnings per share was down 4% from a year ago, a series of salutary one-time adjustments spruced up that figure, which was 27% above the $1.89 per share derived from generally accepted accounting principles.  Even those GAAP results were flattered by a meager 7% corporate tax rate.  In 1985, when then-dominant IBM commanded a 6.4% share of the market cap-weighted S&P 500 (a record single-stock concentration until this year), Big Blue paid out 44% of its bottom line in taxes. 

With three quarters of its 2019 revenue base (the information technology infrastructure hardware, software and sales units) under pressure thanks to widespread adaptation of the cloud, you can’t say that IBM is sitting on its heels.  After completing a $34 billion acquisition of open source software provider Red Hat in July 2019, the company announced Oct. 8 that it will spin off its legacy managed infrastructure services unit.  CEO Arvind Krishna explained: “This will accelerate our growth strategy and better position IBM to seize the $1 trillion hybrid cloud opportunity.” 

That rationale is understandable, as the I.T. services unit, which includes the soon-to-be-spun-off division, endured a 6.1% revenue decline in 2019.  The move earned the rousing approval of Mr. Market, as shares closed higher by 6% on the day of the announcement, but good days for the bulls have been few and far between.  Since a bearish analysis in the Feb. 21 edition of Grant’s, IBM shares have lost 21% after accounting for dividends, compared to a 5% gain over the S&P 500. 

While shedding that growth albatross is seemingly a positive step, other concerning signs abound.  For instance, IBM’s global business services (i.e. management consulting) revenue registered just $4 billion, down 5% from a year ago, a concerning sign as the division should be largely inured against the cloud craze. Even the 19% top-line expansion from the cloud unit was well below the 30% year-over-year revenue growth logged in the second quarter.   

Analysts remain circumspect, with six Wall Street analysts rating IBM shares “buy” while 12 judge the stock either a “hold” or “sell.” Following Monday’s earnings report, Keith Bachman of BMO Capital Markets wrote that “underlying business conditions remain weak such that patience will be required, particularly since the spin-off is a year away,” while Bloomberg Intelligence’s Anurag Rana concludes that the flagging top line “may not see any dramatic improvement until the second half of 2021 at the earliest.” 

Then, too, efforts to bolster cloud unit growth haven’t come cheap, as IBM coughed up fancy valuation for Red Hat (10 times revenues, 53 times Ebitda and a 63% premium to the target’s pre-bid closing price). That’s pushed single-A-rated IBM’s net leverage to 2.9 times consensus 2022 adjusted Ebitda, up from 1.5 times Ebitda prior to the deal announcement and 2.0 times net leverage for the median single-A-rated corporate issuer, according to a September analysis from Moody’s.  IBM’s net leverage can be expected to drift still higher, if form holds. Thus, Street consensus currently calls for $18.8 billion in adjusted Ebitda next year, down from a $20 billion 2021 Ebitda guesstimate a year ago. 

Perhaps most concerningly, fast-deteriorating cash generation has further hampered management’s efforts to turn the ship around.  IBM generated just $1.1 billion in free cash flow in the third quarter, far below the $2.3 billion analyst consensus and well short of the $1.5 billion in dividends paid out over the same period.  

Might IBM be facing an extended stay in corporate stagnation purgatory?  Bernstein analyst Toni Sacconaghi noted Tuesday that while CEO Krishna thinks IBM can grow “mid-single digits” by 2022 following the I.T. spin-off, organic revenue declined 6% in the third quarter from a year ago and has fallen by a meaty 11% so far this year. Such a massive top-line turnaround “seems ambitious given that IBM management stated that 70% of its revenues were largely unaffected by the pandemic” in the third quarter.  Bernstein “continues to believe that IBM’s normalized growth rate today is -1%,” and “might be 0% to 1% post its spin-out.” 

The slog continues. 

QE Progress Report

The printing press is heating up anew, as Reserve Bank credit jumped to $7.11 trillion, up $65 billion from a week ago.  That pushed the three-month growth rate of interest bearing assets at the Fed to 7.5% from 4.9% a week ago, even as the year-over-year comparison continued to edge lower, reaching 80.2% growth this week compared to 81.1% on Oct. 15.  

Recap Oct. 22

Rates were routed once more, as Treasurys came under pressure across the curve again with the 30-year yield rising to 1.68%, its highest since mid-March. Stocks caught a moderate bid, with the S&P 500 finishing 60 basis points in the green to narrow its loss for the week so far to less than 1%.  Gold pulled back to $1,907 an ounce, WTI crude crept up toward $41 a barrel, and the VIX slipped 2% to 28. 

- Philip Grant

10.21.2020
Gig 'em

Here’s Uber Technologies CEO Dara Khosrowshahi, speaking at a Wall Street Journal conference yesterday about California’s new AB-5 labor law, which obliges Uber and its peers to classify drivers as employees rather than independent contractors, thus allowing them to receive health insurance and other routine benefits: 

We are looking at all our options. We will do our best to operate in California…Where in California we will operate is a question mark, and the size and scale of business will be a big question mark. 

The executive went on to identify one option to deal with the AB-5 scourge: Aggressive price hikes. Khosrowshahi added that, were Uber forced to abide by the law, prices for California riders could jump by 25% to 100%. “These are not made-up estimates,” he added.

Might this episode be shining a spotlight on fundamental flaws in the ride-share business model?  See the Nov. 1, 2019 edition of Grant’s for more. 

Maalox from the Bottle, Inc.
As the Middle Kingdom turns:

As the Middle Kingdom turns:  Let’s review the latest with China’s largest and the world’s most precariously-leveraged property developer, China Evergrande Group (3333 on the Hong Kong Exchange).   

Evergrande, which dabbles in electric vehicles, movie theaters and life insurance in addition to its core business, continues to wheel and deal as it contends with a fearsome debt load of $120 billion (of which $5.8 billion comes due within in the next two months). The company is haggling with banks over a HK$11.4 billion ($1.5 billion) three-year, senior secured loan to refinance an $HK8 billion loan coming due next month, Bloomberg reports today. 

Last week, Bloomberg noted that the developer was in negotiations with lenders as it “explor[es] various ways to repay” an HK$18 billion convertible bond. Apart from full repayment, launching a tender or exchange offer are reportedly up for consideration. 

A recent fundraising effort was less than encouraging, as last week Evergrande raised $555 million through a stock sale of 260.7 million shares at HK $16.50 apiece.  That was downsized from an initial target of 490 million shares at HK$16.50 to HK $17.20 a share, equivalent to $1.1 billion at the high end of the price range. 

The prospect of an imminent cash crunch briefly loomed large last month, following news of an Aug. 24 letter purportedly from Evergrande to regional authorities in Guangdong warning of systemic risks including cross-defaults in the event it is unable to secure permission to list its shares in mainland China by Jan. 31. Failure to list by that deadline would trigger some RMB 130 billion ($19 billion) in repayments to investors, equivalent to nearly all of its cash and cash equivalents as of June 30. Evergrande, which decried the letter as fabricated, managed to come to a deal with those investors a few days later, successfully kicking the can down the road. 

Fake letter or not, might government assistance indeed be forthcoming?  Bloomberg reported last Friday that company insiders believe the Chinese government “may roll out measures to support some developers either by the end of this month or early next month,” with debt swaps among the likely remedies. 

That doesn’t mean that the powers-that-be are going to take it easy on Evergrande, which carries net leverage of 11 times Ebitda, nearly twice the second-most encumbered Chinese developer and triple the industry average. Recall that the Chinese government is set to debut its “three red lines” rules for property developers next year, introducing balance sheet caps including debt-to-asset ratios below 70%, net gearing below 100% and short-term debt no greater than cash reserves (Almost Daily Grant’s, Oct. 13). Companies which fail these tests (like Evergrande) will be barred from growing liabilities for one year. 

Then, too, Reuters reports today that authorities imposed more onerous rules than had been expected at a meeting last month.  In addition to the aforementioned balance sheet restrictions, developers will also need to provide financing information covering not only bank loans and bond issuance, but also less conventional forms of funding like off-balance sheet arrangements and securitization of accounts receivable. 

“The government is monitoring everything now, unless you want to cheat, but they will be able to tell from your monthly figures,” said a senior executive at one of the developers in the pilot scheme.

Anne Stevenson-Yang, co-founder of J Capital Research, described Evergrande thusly in the June 2, 2017 edition of Grant’s: “It is a company that would send most financial managers running for their blood-pressure pills.”

Better get those beta-blockers ready. 

Recap Oct. 21

Selling pressure in the Treasury complex pushed the 10- and 30-year yields to 0.82% and 1.63%, respectively, the highest for each since June.  Stocks finished slightly lower with the S&P 500 giving back about half of yesterday’s 50 basis point advance, while the VIX slipped below 29. WTI fell 4% to $40 a barrel following a smaller than expected weekly inventory drawdown, while gold climbed to $1,927 an ounce. 

- Philip Grant

10.19.2020
Fluff and Fold

A pair of Bloomberg headlines, concerning Brazilian President Jair Bolsonaro:

From Oct. 7:

Bolsonaro Declares Brazil Corruption-Free and Ends Carwash Probe

And from Oct. 15:

Bolsonaro Ally Resigns After Covid Cash Found in Underpants

From Here to Eternity
One from the unintended consequences files:

From the unintended consequences files:  The Financial Times reported over the weekend that Federal Reserve higher-ups are considering beefed-up regulation to combat risks associated with the current low-and-lower interest-rate regime.  

Boston Fed president Eric Rosengren told the FT that “if you want to follow a monetary policy. . . that applies low interest rates for a long time, you want robust financial supervisory authority in order to be able to restrict the amount of excessive risk-taking occurring at the same time.”  Neel Kashkari, president of the Minneapolis Fed, added: “I don’t know what the best policy solution is, but I know we can’t just keep doing what we’ve been doing. As soon as there’s a risk that hits, everybody flees and the Federal Reserve has to step in and bail out that market, and that’s crazy. And we need to take a hard look at that.”

A pullback in market interventions may be one way to limit moral hazard. Thus, a report last Thursday from the Congressional Oversight Commission recommended that the Fed wind down its Secondary Market Corporate Credit Facility (SMCCF) bond purchase program initiated during the teeth of the spring panic, explaining that: “Given the Federal Reserve’s success in buoying corporate bond markets and recognizing that primary market investment-grade corporate bond rates are now below pre-pandemic levels, the Commission does not believe that further secondary market corporate bond purchases through the SMCCF are necessary.” 

Indeed, this year’s severe economic shock has visited no lasting damage on financial assets, with the stock market near record highs and credit spreads not far removed from their pre-virus levels, while year-to-date junk bond issuance reached $351 billion on Friday according to Bank of America, some $30 billion above the prior high-water mark set in the 12 months of 2012.  

To be sure, animal spirits are percolating: This morning, Caa1-rated satellite communication concern Ligado Networks (née LightSquared) managed to sell a total of $3.85 billion in first- and second-lien three-year secured debt at 15.5% and 17.5% coupons, respectively, allowing the company to forestall a potential return to bankruptcy (Ligado’s exit financing, a first-lien term loan due in December, fell as low as 48 cents on the dollar in March).  The offering is pay-in-kind, meaning the company will provide interest in the form of additional debt, rather than cash. 

As the Fed’s monetary exertions have reached unprecedented heights during the crisis-wracked 2020, there is every reason to expect more of the same when trouble strikes next. After speculating that the recession may already be over in a speech today, vice chairman Richard Clarida nevertheless declared that “additional support from monetary – and likely fiscal – policy will be needed.”

The seeming convergence between fiscal and monetary policy stands as a singular feature of the current monetary epoch, as exploding federal deficits ($3.1 trillion in the 12 months through September, more than double the prior record set in fiscal 2009) coincide with ballooning Reserve Bank credit at the Federal Reserve, as the central bank currently buys about $80 billion in Treasurys per month, net of reinvestments. Randal Quarles, Fed vice chair for supervision, offered some eye-opening candor in that regard last Wednesday:

It may be that there is a simple macro fact that the Treasury market being so much larger than it was even a few years ago, much larger than it was a decade ago and now really much larger than it was even a few years ago, that the sheer volume there may have outpaced the ability of the private market infrastructure to support stress of any sort there.  

Will there be some indefinite need for the Fed to provide — not as a way of supporting the issuance of Treasuries, but as a way of supporting a functioning market in Treasuries — to participate as a purchaser for some period of time?

It sure seems that way. 

Recap Oct. 19

Stocks came under heavy pressure with the S&P 500 losing 1.6% and finishing near its worst levels of the day, leaving the broad index up 6% so far this year.  The Treasury curve steepened a bit with the 30-year yield climbing two basis points to 1.55%, while gold held at $1,905 an ounce and WTI crude remained near $41 a barrel.  The VIX jumped above 29 to approach a five-week high.

- Philip Grant

10.14.2020
19 Herbs and Spices

Who said American ingenuity is a thing of the past?  Fast food player Jack in the Box is taking orders on its website for a chicken-scented facemask.  Free on a first-come, first-serve basis through Oct. 23, the offering comes with the descriptive tagline: “Smells Like Chicken, Wears Like Mask!”    

Rejected taglines include: “Looks Like Chicken, Tastes Like Mask.” 

Maul of America
It's gone from bad to worse for commercial landlords.

It’s gone from bad to worse for commercial landlords. According to data from the CBRE Group, third quarter asking prices for ground-floor retail rents in Manhattan dropped 12.8% from a year ago, marking the 12th consecutive sequential decline.  Concurrently, new leases and renewals plunged 30.8% over the 12 months through September, while ground-floor availabilities rose 8.1% sequentially to 254 units, the highest on record going back to the 1990s. 

"The recent influx of closed storefronts along the main shopping corridors and the introduction of new, heavily discounted offerings will continue to put downward pressure on average asking rents in the coming months," CBRE concluded.

Are the Big Apple’s woes representative of broader pain for mall operators and their investors?  The spring cessation of commerce is having a lasting impact on malls and other retail outlets, which were already flagging as the bug bit thanks to intense online competition from the likes of Amazon.com.  Let’s review:

An investor group is trying to block Paris-based commercial real estate operator Unibail-Rodamco-Westfield (owner of the Westfield malls in London and San Francisco) from undertaking a dilutive rights offering, instead advocating for an effective divestiture of the Westfield portfolio, for which the parent company coughed up $22 billion in June 2018.   

Mr. Market has given that deal the side-eye, with Unibail’s market cap having since been cut to $6.7 billion from $30.5 billion over that two-plus-year period. The company also toted a leverage ratio of more than 10 times trailing Ebitda coming into the coronavirus crisis. 

Meanwhile, a stateside operator looks set for the restructuring chopping-block. CBL & Associates Properties, Inc. announced yesterday that it will not make a scheduled interest payment on its $300 million in outstanding senior unsecured 4.6% notes due 2024, starting the clock on a 30-day grace period that would be followed by an event of default.   

CBL, which owns and operates a portfolio of malls and other retail properties across the Southeast and Midwest, also pushed back the deadline for its planned Chapter 11 bankruptcy filing to Nov. 2 from today, as it continue to haggle with lenders  under a restructuring support agreement signed in August.  The company said that it "is continuing collaborative negotiations with its senior, secured lenders and noteholders to attempt to reach a consensual arrangement with both parties."

Then there’s Brookfield Property REIT, the mall-focused subsidiary of Brookfield Property Partners.  On Sept. 22, CNBC reported that Brookfield’s retail division will lay off some 20% of its workforce.  In an email to staff, CEO Jared Chupaila explained that the move wasn’t made lightly: “While many companies were quick to implement furloughs and layoffs at the onset of the pandemic, we made the conscious decision to keep all our team employed while we gained a better understanding of its longer-term impact on our company.” 

Anecdotal evidence suggests more drastic measures are underway.  Trepp reporter Daniel McNamara noted on Twitter the next day that “Brookfield is handing the keys back” on a $90 million loan backed by a 384,111 square foot mall in Florence, Ky.  Shares in BPY are down about 25% after accounting for dividend reinvestment since a bearish analysis in the Nov. 29, 2019 edition of Grant’s

Operators will soon have some tough choices to make.  Barclays analyst Ryan Preclaw tells CNBC today that he expects some 16% of U.S. mall space will need to be repurposed for residential use, fulfillment centers or other purposes, an endeavor which leads to valuation write-downs of between 60% to 90% on the recycled properties.  Financial bloodletting is well underway: The Barclays team relays that some 30% of the mall loans within commercial mortgage-backed securities they cover are already in delinquency or default. 

The calendar is no friend either. A report from Morgan Stanley earlier this week finds that roughly half of all mall-based specialty retailer leases are up for renewal within the next four years, bad news for landlords as the raft of vacancies will ensure that tenants enjoy a far stronger negotiating position. “The good news for malls is that they should emerge much stronger post rationalization, but the bad news is every mall REIT needs to rationalize a portion of their portfolio,” Morgan Stanley concludes. 

QE Progress Report
Reserve Bank credit (i.e. the sum total of interest bearing assets at the Fed) jumped $26 billion to $7.045 trillion, a four-month high.  That pushed the three-month annualized growth rate to 4.9% compared to 1.1% last week, though the year-over-year comparison continues to dwindle, with growth now at 81.1% compared to 82.7% a week ago. 
Recap Oct. 15

Stocks erased most of their early losses with the S&P 500 climbing back to the cusp of unchanged, leaving the broad index within 3% of its early-September highs. Treasurys stayed put with the 30-year yield finishing at 1.51%, while WTI crude held near $41 a barrel and gold edged higher to $1,911.  The VIX ticked to a one-week high near 27. 

- Philip Grant

Almost Daily Grant's will resume on Monday

10.13.2020
Take the Red Line
A clearance sale with Chinese characteristics:

A clearance sale with Chinese characteristics:  China Evergrande Group, (3333 on the Hong Kong exchange) announced it will sell 490 million shares in a so-called top-up placement at a 13% discount to this morning’s closing price, using the midpoint of management’s provided range. The move would raise just over $1 billion, as the world’s most encumbered property developer – with net debt equivalent to a cool 11.2 times trailing Ebitda – tries to clean up its balance sheet.  

“The placement should tide them through,” Kerry Goh, chief investment officer at Kamet Capital Partners, comments to Bloomberg. “But I don’t think $1 billion is sufficient for them to be able to pare down their large debt. This is just sending a signal to buy some time from creditors to work out the capital structure through the sale of assets or fundraising.”  Evergrande watchers won’t have to wait long for the next financial litmus test, as the company is set to offer RMB 2 billion ($300 million) worth of five-year onshore debt later this week. 

Evergrande managed to escape a major liquidity scare in late September, coming to an agreement with private investors to keep their shares in a company business unit and forego some $13 billion in contractually-owed payments, a move which Breakingviews described as “another miraculous escape” for the developer and its founder Hui Ka Yan.   “The agreement solves the core issue of Evergrande, which is liquidity concern,” added Raymond Cheng, a property analyst at CGS-CIMB Securities. Mr. Market agreed, as the stock price jumped nearly 20% while the benchmark 2025 8 3/4 dollar bonds rallied to 80 cents from 75.

Meanwhile, the company’s fall sales blitz continues apace, as unprecedented base discounts of up to 30% have helped spur an active “Golden Week” season.  Evergrande announced Friday that it had made some RMB 142 billion in contracted property sales from Sept. 1 through Oct. 8, over 70% of its sales goal for the crucial two-month period.  However, the discounts are taking a toll, as those figures equal an average selling price of RMB 8,627 per square meter, down 11% from August levels. 

Time will tell if that discounting strategy will be enough, as nearly half of Evergrande’s RMB 836 billion debt load was scheduled to fall due in the next year as of June. “We are skeptical of the company’s willingness to deleverage given its poor record of adhering to its plans over the years,” CreditSights analyst Luther Chai told the South China Morning Post last Friday. 

Late this summer, Chinese authorities rolled out a trio of new restrictions on property developer balance sheets, including capping debt-to-asset ratios at 70%, net gearing at 100% and short-term debt lesser than or equal to cash reserves.  Firms that fail the “three red lines guidance” test, like Evergrande (which sported a bloated net gearing ratio of 199% and cash equal to less than half of short-term maturities as of June 30), are barred from expanding their liabilities for a year. 

Then, too, Evergrande’s successful efforts to dodge short-term catastrophe haven’t mollified its heretofore-patient lenders. Bloomberg reports that “several” of its largest creditors are cutting their exposures to Evergrande, while a quartet of large banks instructed branches to cease offering new unsecured loans to the developer.  Instead, “large state-owned lenders will only consider new financing for the developer if it’s linked to specific projects with ample collateral and risks that are segregated from Evergrande as a group.” 

The bond market continues to express its own doubts, as single-B-plus-rated Evergrande’s dollar-pay senior secured 8 3/4 notes of 2025 trade near 77 cents on the dollar for a 1,545 basis point spread over Treasurys.  For context, the single-B-rated component of the Bloomberg Barclays High Yield Index currently sports a 454 basis point option-adjusted spread over Treasurys.  

This avatar of the Chinese economic miracle first caught the eye of Grant’s in the June 2, 2017 issue, which speculated that Evergrande would one day reside in the history books alongside “Bank of United States” or “Hindenburg.”  For an update to that analysis, as well as a review of the broader implications of a longer slowdown in China’s property market, see the Oct. 2 edition of Grant’s

Recap Oct. 13

Apparently, stocks only mostly go up, as the S&P 500 fell by 65 basis points to snap a five-session winning streak and leave the broad index higher by 8.7% year-to-date.  Treasurys were well bid, with the long bond yield falling six basis points to 1.51%, while gold lost nearly 2% to $1,895 an ounce and WTI held near $40 a barrel.  The VIX rose 4% to 26, building on yesterday’s resilience in the face of a ripping stock market.

- Philip Grant

10.12.2020
PPP Guard

Here’s longtime NBA columnist and hall of famer Peter Vecsey on Twitter today:

Props to the [Los Angeles] Lakers, the first team to come away with a title and a small business loan in the same season.

Interest Rate Lockdown
Prognosis: more negative.

Prognosis: more negative.  The phenomenon of nominal interest rates below zero was virtually unprecedented in the 4,000 years of financial history prior to the current cycle, according to financial historians Sidney Homer and Richard Sylla, but that was then.  As of today, $16.16 trillion in global debt is priced to yield less than nothing, up from less than $8 trillion in March and not far off from the $17.04 trillion peak in August of 2019.  In terms of sovereign debt, Austria, Germany and Switzerland are paid to borrow at maturities as long as 15, 30 and 50 years, respectively. 

Those figures grow far larger when accounting for the measured rate of inflation.   Strategists at J.P. Morgan wrote last week that the total stock of developed nation sovereign debt sporting a negative real yield now stands at $31 trillion.  That’s double the reading of two years ago, and equivalent to 76% of total developed nation sovereign debt, up from 57% in 2017.    

Recent commentary from a trio of European nations indicates that the sub-zero debt stack may set new records sooner rather than later.  Let’s review: 

First up, Norway, where the benchmark policy rate currently stands (or crouches) at 25 basis points.  Norges Bank governor Øystein Olsen kept the door open for a negative interest rate policy (NIRP) in a speech last Tuesday: “The possibility of further reducing the policy rate has not been ruled out.”  A move to (or below) zero “may. . . be appropriate in periods of severe financial market turbulence and sharply rising risk premiums.”

One of Olsen’s Polish counterparts went a step further. In an essay on the Radio Maryja website, National Bank of Poland monetary policy committee member Eryk Lon argued in favor of NIRP if consumer sentiment deteriorates. The central banker noted that “such a move wouldn’t even be anything strange given current conditions.”  Indeed. The NBP’s current policy rate is 10 basis points. 

Then there’s the Bank of England, which has also set a 0.1% policy rate.  Unsatisfied with the results of the lowest rate in its 326 year history, the venerable institution appears to be clearing the groundwork for its own foray into the negative rate ether, asking commercial banks today (in tandem with the Prudential Regulation Authority) to assess their ability to operate under a NIRP regime.  “A negative policy rate could have wider implications for your firm’s business and your customers,” PRA chief Sam Woods said in the letter.  Experience has borne that out, as Europe’s Stoxx Banking Index now trades at just 0.38 times book value, down from 0.81 times book at the end of 2013, six months before the European Central Bank took its deposit rate below zero for the first time.

As the ECB’s NIRP experiment drags along into a seventh year, results are wanting, with eurozone headline CPI inflation advancing at an average 0.9% annual clip over the past six years, compared to 1.6% in the September 2008 to Sept. 2014 epoch. 

The evident solution: More of the same.  In an interview with The Wall Street Journal, ECB president Christine Lagarde indicated that more monetary support would be forthcoming in the event of more pandemic- and lockdown-induced economic pain: “We are prepared to use all the tools that will produce the most effective, efficient, and proportionate outcome.” 

Some of Lagarde’s colleagues are openly advocating for an escalation of the NIRP regime from the current record-low minus 50 basis point deposit rate. ECB executive board member Philip Lane had this to say in a separate Journal interview: 

The value of a rate cut is still there, and we look at it all the time. It’s perpetually looked at. We reject the idea that we are at the lower bound. We think, overall, a rate cut would still be working the way other rate cuts have worked. 

The economics of a rate cut remain. We think the rate cuts up to now, including last September’s, have worked in the way intended; they pass through into lower lending rates, into more credit volumes and so on. In terms of effectiveness, we think the asset purchases have a bigger impact on the yield curve now. But the option of going lower remains part of our policy guidance.

Issuers have duly taken note of the ZIRP era, as the 37 government members of the Organization for Economic Co-Operation and Development borrowed some $11 trillion in the first five months of the year, up 70% over the last five years, on average.  More broadly, the Institute of International Finance found in an April paper that total global debt rose to $255 trillion at year-end 2019.  That’s equivalent to 322% of worldwide output, and some 40 percentage points higher than its 2008 level.

Recap Oct. 12

Another bull rampage saw the S&P 500 and Nasdaq 100 gain more than 1.5% and 3%, respectively, as each index closes in on their respective high-water marks set on Sept. 2.  Treasurys went nowhere with the 30-year yield holding at 1.55%, while gold edged higher to $1,928 an ounce and WTI crude slipped back below $40 a barrel.  The VIX managed to finish in the green just above 25, bucking the rally in stocks. 

- Philip Grant

10.09.2020
Moment of Hen
Many happy returns?

Many happy returns? After a nine-month hiatus, state-owned oil behemoth Petróleos Mexicanos (a.k.a. Pemex) enjoyed a successful foray in the bond market yesterday, selling $1.5 billion in five-year dollar-pay notes, priced-to-yield 6.95%. That compares to initial coupon projections of a 7.5% to 8% on a $1 billion offering size. The issuer-friendly terms were most welcome for Pemex. “They have refinancing needs, so absent more government support they do need to raise money,” Shamaila Khan, head of emerging-market debt at AllianceBernstein, tells Bloomberg.

Government support is a key selling point for Pemex’s creditors. Left-leaning populist President Andrés Manuel López Obrador (AMLO) has made returning Pemex to national glory a central plank of his platform, routinely criticizing the market-based reforms undertaken by his predecessor, which included introducing foreign competition into Mexico.  In July 2019, AMLO awarded Pemex the contract to build a 340,000 barrel per day (bpd) capacity refinery in his hometown of Tabasco, as the front-runner supplied both a lower bid and quicker construction timetable than the foreign competition. 

More fundamental changes may be in store. Bloomberg reported Sept. 22 that AMLO “will consider tweaking his predecessor’s energy reform if his goals of strengthening Pemex. . . can’t be met under current laws.” 

Indeed, the status quo doesn’t seem to be working. On Sept. 29, Bloomberg noted that Pemex’s gasoline market share has slipped by 13% during the 21 months in which AMLO has been in power, compared to a 4.5% market share loss in the preceding 35 months. 

Meanwhile, the long-term production decline from 2004’s peak output of 3.4 million barrels per day (mbpd) continues apace thanks to steady depletion at the offshore Cantarell field (long one of the world’s largest). July production registered at just 1.54 mbpd, the lowest output figure since the 1970s.  Budget Committee Chair Erasmo Gonzalez told Bloomberg in early September that Pemex is now targeting 1.86mbpd in output next year, down from a prior 2.07mbpd goal and increasingly distant from AMLO’s pre-election promises to oversee 2.6mbpd by 2024. 

That long-term decay is exacerbated by an abrupt output downturn at the Ku-Maloob-Zaap field, currently Mexico’s most bountiful (Almost Daily Grant’s, June 7, 2019). Output in the Maloob field plunged to 276,000 bpd in July according to IHS Markit, down 30.8% from a year ago.  

The events of 2020 have further sullied what was a less-than pristine balance sheet. As of June 30, net financial debt of $106 billion, along with a further $65 billion in pension liabilities, while second quarter Ebitda of $858 million was down more than 80% from a year ago. The company is on track to burn cash for a tenth straight year, posting a cool $82.5 billion in aggregate negative free cash flow from the beginning of 2010 through June 30 of this year.   

On April 17, Moody’s cut its rating on Pemex debt to junk at Ba2 (equivalent to double-B), joining a similar verdict from Fitch and officially sending Pemex’s more than $50 billion of dollar-pay marketable debt into the “fallen angel” category.  The timing of those downgrades is less than ideal, as Pemex may need to return to the bond market sooner rather than later. 

Analysts at Bloomberg Intelligence noted Sept. 15 that the company’s $1.6 billion cash balance as of June 30 represents just over 10% of short-term financial debt.  Since a bearish analysis in the March 23, 2018 edition of Grant’s, Pemex’s 6 3/4% bonds due 2047 have seen their spreads widen to 699 basis points from 390. Over that period, five-year credit default swaps have jumped to 573 basis points from 193 basis points. Despite catching downgrades from all three rating agencies this spring, Mexico’s sovereign CDS have barely budged, last changing hands at 118 basis points compared to 114 in March 2018. 

Might a hypothetical future Pemex bailout further pressure Mexico’s sovereign credit profile? AMLO appears unconcerned. An anonymous source explained the President’s thinking to Reuters on Sept. 22: “He said the free market is like ‘a fox guarding the hen house’ and that what we need to do is have the regulators and the government give the market to the state companies so that they can run the market.”

Recap Oct. 9

Another banner day for the bulls, as the S&P 500 jumped nearly 1% to wrap up the week almost 4% higher.  Gold also caught an aggressive bid, jumping 2% to $1,938 an ounce, while WTI pulled back to near $40.5 a barrel.  Treasury yields finished little changed with the long bond settling at 1.57%, and the VIX fell to 25, down 5% on the day. 

- Philip Grant

10.08.2020
Vertigo Integration
Is Uncle Sam coming for big tech?

Is Uncle Sam coming for big tech?  The House Antitrust Subcommittee released a report Tuesday calling for extensive restrictions on the likes of Amazon, Facebook and Google parent Alphabet.  

Recommendations include legislation limiting big tech’s ability to own business lines separate from their legacy online operations, as well as amending merger laws to assume that any big-tech acquisition is anti-competitive unless the parties can demonstrate the deal “is necessary for serving the public interest.”  

A draft response from Republicans on the committee termed the report “a thinly veiled call to break up” the tech giants.  Congressman Ken Buck (R-CO) said: “I think it’s clear that there will be a bipartisan effort to make reforms in the antitrust area,” adding that: “If I was one of the tech companies I would see this week of Democrat and Republican responses as very concerning because there is clearly a bipartisan conclusion that these companies are acting anticompetitively.”

As for implementation, one lawmaker offered a relatively prompt timeline. In an interview with CNBC on Tuesday evening, Rep. Pramila Jayapal (D-WA) predicted that “significant legislation” would be forthcoming in the next three to six months. 

Amazon came up for particularly intense scrutiny, as the report contends that the e-commerce behemoth actually boasts market share as high as 74% in various product categories, nearly double the 39% domestic online retail share reported by the company.  

“Amazon functions as a gatekeeper for e-commerce,” the report claims, wielding “monopoly power” over third-party vendors who use the site.  In particular, “the investigation revealed that the dominant platforms have misappropriated the data of third parties that rely on their platforms, effectively collecting information from customers only to weaponize it against them as rivals,” echoing an April report from The Wall Street Journal. For context, Amazon’s take of third-party sales accounted for 19% of total revenue in the 12 months ended March 31, while outside vendors account for well over half of physical gross merchandise sales on the platform.  

It seems that Amazon did itself no favors over the course of the 16-month Congressional inquiry. The report added that the company “displayed a lack of candor” in its interactions with the committee. 

***

One thing’s for sure, Mr. Market has demonstrated every faith in the ongoing dominance of big tech.  As the below chart from Goldman Sachs demonstrates, Facebook, Amazon, Apple, Microsoft and Alphabet have accounted for more than 100% of the S&P 500’s year-to-date return, as that quintet has risen 39% in 2020 while the other 495 components have lost 1%.  


 
That exceptional performance has vaulted big tech to the cusp of uncharted territory.  Facebook, Amazon, Apple, Alphabet and Microsoft currently account for 22.2% of the S&P 500 market capitalization, near the heaviest five-stock index concentration since at least 1970.  The top dog, Apple, commands a 6.5% in the broad index, topping the 6.4% record established by IBM back in 1985.  Apple bulls hope that past is not prologue, as Big Blue managed compound annual revenue and net income growth of 1.3% and 1.1%, respectively, over the next 34 years, well below the average annual 2.6% rise in the CPI during that period.

Perhaps instructively, big tech C-suites were less than bullish as the market enjoyed its spring rebound. Thus, Vincent Deluard, director of global macro strategy at StoneX Group, finds that Nasdaq 100 insiders sold $10.4 billion of shares in the second quarter, up 171% from a year ago, while insider purchases fell 67% from last year, to $35 million. 

As for Amazon specifically, the law of large numbers looms as the company attempts to build on its runaway success.  For the bear case on the house that Bezos built, see the June 26 edition of Grant’s

QE Progress Report
Reserve Bank credit (the sum total of interest bearing assets at the Fed) footed to $7.02 trillion this week, marking the 21st straight weekly reading near the $7 trillion line.  The three-month annualized growth rate stands at 1.1%, while year-over-year growth fell to 82.5%, down from 87% on Sept. 10. 
Recap Oct. 8

Another day, another well-bid stock market as the S&P 500 rose nearly 1% to leave the broad index higher by 3% for the week so far. Treasurys finished a bit stronger, with the 30-year yield ticking to 1.56%. Gold rebounded to $1,898 an ounce, WTI crude pushed above $41 a barrel for the first time since mid-September, and the VIX slipped toward 26.  

- Philip Grant

10.07.2020
Debtors Delight

Instructive bond market action Down Under:  Yesterday evening, Australia’s Treasurer Josh Frydenberg presented a budget to parliament anticipating an A$214 billion ($152 billion) deficit in the fiscal year ending June 30, equivalent to 11% of gross domestic product, as the country tries to climb its way out of its coronavirus-related economic hole. The economists’ consensus calls for an 8% unemployment rate by year end, a figure which would represent a 22-year high.

Australia’s sovereign creditors, already under the yoke of “yield-curve control” (the ReserveBank of Australia has established a 25 basis point ceiling on debt out to three years), reacted to the news of runaway deficits with something less than alarm.  The yield on three-year government bonds sank to a record-low 12 basis points, down from 16 basis points on Tuesday. The 30-year bond yield, which is not under the yoke of yield-curve control, stayed little changed at 1.77%. 

Trickled Pink
The fiscal stimulus saga continues apace in the nation's capital,

The fiscal stimulus saga continues apace in the nation’s capital, as President Trump tweeted yesterday evening: “If I am sent a Stand Alone Bill for Stimulus Checks ($1,200), they will go out to our great people IMMEDIATELY.” That’s a change from roughly eight hours prior, when POTUS declared: “I have instructed my representatives to stop negotiating until after the election.”  Naturally, those conflicting tweets sent asset prices into spin cycle. 

As the political class continues to bicker and markets gyrate, our monetary mandarins strike a consistent chord.  Fed chair Jerome Powell seemingly addressed the fiscal powers-that-be in a speech yesterday: “The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.” 

By Powell’s reckoning, the more the better: “At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship. . . even if policy actions ultimately prove to be greater than needed, they will not go to waste.”  

“He’s become a broken record,” Diane Swonk, chief economist at Grant Thornton, tells The Wall Street Journal. “There is nothing all that new in the message, but the urgency is getting greater.”   

From an output perspective at least, there is good reason for concern.  As Bianco Research notes today, Wall Street economists now expect fourth quarter GDP to expand at a 3.6% annualized rate, a solid figure in normal times but far below the 11.5% fourth quarter estimate seen on June 11, as the U.S. economy wrapped up its worst quarter on record with a 31.4% sequential annualized contraction.  

Then again, existing programs, like the $2 trillion-plus CARES Act signed in March, have pushed government red ink to previously unimaginable levels.  A striking chart, posted on Twitter yesterday by Bianco Research co-founder and eponym Jim Bianco, puts this year’s exertions into historical context:


 

This afternoon’s release of the minutes from the Sept. 15-16 meeting of the Federal Open Market Committee laid out one argument for returning to the fiscal well : “Participants viewed fiscal support from the CARES Act as having been very important in bolstering the financial situations of millions of families, and a number of participants judged that the absence of further fiscal support would exacerbate economic hardships in minority and lower-income communities.”

Of course, Mr. Market hasn’t waited for Congress. Instead, ultra-loose monetary policy has seemingly done the trick, as evidenced by euphoric price action in stocks and speculative corners of the bond market since the spring. 

One constituency seems to be faring pretty well in this pandemic-plagued 2020. The Financial Times relays some striking data, courtesy of UBS’s recently published annual report documenting the richest of the rich. The Swiss bank finds that the billionaire cohort had amassed a record $10.2 trillion of wealth as of July, topping the prior high-water mark set in 2017 and well above the $8 trillion logged in April. 

The report puts it this way: “When the storm passes, a new generation of billionaire innovators looks set to play a critical role in repairing the damage.”  Investment from tech-oriented billionaire investors, the report argues, “has the potential to help bridge financial social and environmental deficits.”

Or, perhaps, the opposite. 

Recap Oct. 7

Stocks raced higher with the S&P ripping nearly 2% to close within 4.5% of its Sept. 2 high-water mark, while Treasurys gave back some of yesterday’s feverish late rally with the 30-year yield rising to 1.58%.  WTI crude fell below $40 a barrel following an unexpected weekly inventory supply build, while gold slipped back below $1,900 an ounce and the VIX retreated toward 28.  

- Philip Grant

10.06.2020
Group Therapy
Last week, Japanese telecom upstart Rakuten, Inc. rolled out its new 5G plan

Last week, Japanese telecom upstart Rakuten, Inc. rolled out its new 5G plan featuring aggressively cheap pricing at ¥2,980 ($30) a month.  That’s well below the ¥8,000 or more monthly rate on offer from rivals NTT Docomo, KDDI and SoftBank Corp. for full service data plans. 

“Charges have been set aggressively, to underpin cost competitiveness,” commented research analysts at Citigroup. “We think the firm is likely therefore to be able to play to its competitiveness in winning a share of net adds in 5G.”

That salvo may accelerate a price war which was already taking shape. Incoming Japanese Prime Minister Yoshihide Suga is pressing carriers to lower their user fees, as Tokyo phone and data usage prices are two to three times higher than rates in Paris and London, for instance.  To that end, SoftBank Corp. has indicated it will accede to the PMs wishes, according to a report today from daily newspaper Sankei Shimbun

Mr. Market didn’t like the sound of that, as SoftBank Corp. shares fell to a fresh 52-week low last Wednesday, off 23% from their October 2019 levels. SoftBank Corp., is the formerly wholly-owned subsidiary of Masayoshi Son’s conglomerate-cum-hedge fund SoftBank Group Corp.  After IPOing a portion of the cash-generating telecom unit in December 2018, SoftBank Group sold some $12 billion in the telecom operators shares last month, lowering their stake to 40% from 62%. 

That sale is just one of many from SoftBank Group this year, as the conglomerate has already announced some $94 billion in asset sales, according to estimates from The Wall Street Journal, well in excess of the $43 billion in sales announced earlier this year. On Sept. 18, SoftBank unloaded its money-losing Brightstar wireless services unit to a private equity buyer, while larger  deals include the pending $40 billion cash-and-stock sale of Arm Ltd. to Nvidia Corp. and pieces of its mammoth Alibaba stake, as well as $15 billion in T-Mobile U.S., Inc. shares following the completed merger with Sprint Corp.  Then, of course, there was that disposal in SoftBank Corp., described in Grant’s last year as the conglomerate’s “most relevant, majority-owned, cash-generative business.”  We can now scratch “majority owned” from that description. 

In lieu of those positions, SoftBank reportedly has a better idea. CNBC’s David Faber reported last week that another round of unusual options activity, including $200 million in call options across various Nasdaq 100 mainstays, had all the hallmarks of Masa Son’s outfit: “A number of sources in the derivatives markets on major trading [desks are] noting that significant call buying, and they all point to SoftBank as being behind it.”  Recall that in early September, SoftBank reportedly spent some $4 billion in tech company call options, a move which followed the purchase of about $10 billion in common shares of FAANG-type names. 

SoftBank’s move to dial up portfolio risk comes as Masa Son expresses continued frustration with his firm’s perceived valuation discount. Though shares have enjoyed a 157% surge from their March nadir to ¥6,913 per share, that’s barely half the company’s ¥12,973 “shareholder value” self-estimate made on Aug. 11.   

Might Son et al. be trying to set the stage for what would be, by far, the largest corporate takeover in history? “The firm seems to be selling off assets rapidly and is considering the sale of its ARM holdings earlier than initially planned,” SMBC Nikko Securities analyst Satoru Kikuchi wrote last week. “Given the scale of its buyback operations, we think delisting via management buyout is a possibility.”

Such an outcome would yield an interesting capital structure, as a management-led buyout would require a further $80 billion in financing, an anonymous source estimated to Bloomberg.  For context, SoftBank showed some $102 billion in net debt as of June 30, equivalent to 5.5 times consensus Ebitda for the fiscal year ending March 31, 2022. 

The May 17, 2019 edition of Grant’s concluded that: “Absent a path to solid profitability for its numerous unicorns, SoftBank is leveraged to the goodwill of capital markets – and [as it relates to its mammoth Alibaba position] to the People’s Republic of China.” 

Epitome of the cycle?  You bet. 

Recap Oct. 6

A Trump tweet declaring that no additional fiscal stimulus is forthcoming before the election sent stocks into sharp retreat, as the S&P 500 finished 1.5% lower on the day.  Treasurys symmetrically reversed early losses as the 10- and 30-year yields fell to 0.74% and 1.54%, respectively, while gold dove nearly 2% to $1,890 an ounce.  WTI crude managed to hold above $40 a barrel, and the VIX climbed to 29.5. 

- Philip Grant

10.05.2020
Lite Headed
The health of corporate America is on the upswing,

The health of corporate America is on the upswing, at least according to investor sentiment regarding leveraged loans, or tradable bank debt issued by speculative-grade borrowers.  A portfolio manager survey conducted by S&P Global’s LCD unit last week found that respondents now expect loan defaults to top out at 6.6% in the middle of next year, down from an anticipated peak of 7% to 8% surveyed in March.  Fitch Ratings likewise offers an improved assessment, now penciling in a 2021 default rate of 7% to 8% from a prior 8% to 9% forecast range.  

That projected improvement follows an impressive price recovery, as the LSTA Leveraged Loan Index has clawed nearly all the way back to unchanged for 2020, having erased the harrowing 12.5% decline in March.   

The sharp rebound has helped to reopen funding markets, as issuance jumped to $87 billion in the third quarter, up 60% sequentially, while some $16 billion in deals are expected to price this week alone, according to Bloomberg.  The ratio of issuer friendly “price flexes” to such moves favoring investors approached 16 to one in the third quarter, by far the highest disparity since at least 2016.  Opportunistic issuers are making sure not to miss their chance:  new loans used to finance dividend recaps (i.e., payouts to the issuer’s private equity sponsor) footed to $15.8 billion in the third quarter, the busiest such period since the first quarter of 2017.  

Improving sentiment has brought echoes of cycles past.  Bloomberg reported Friday that Cerberus Capital Management has formulated a triple-A-rated securitized debt product comprising triple-B-minus-rated commercial mortgage backed securities, in a move recalling the infamous collateralized debt obligations of the last cycle (see the March 23, 2007 edition of Grant’s for a preview of that pileup).  Some 9% of all commercial mortgage debt which has been bundled into bonds was delinquent at the end of August, according to data from Trepp. 

As investors and issuers alike celebrate the apparent return to business as usual, the events of 2020 continue to take a toll on broad corporate health. In a separate report last week, LCD relays that some 33% of all outstanding loans are from issuers rated single-B-minus (“adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments”) or worse as of Sept. 22, up from 23% a year ago.  While the unpleasant events of 2020 figure prominently in that deterioration, its worth noting that the downgrade-to-upgrade ratio for institutional loans reached three-to-one in the second half of 2019, the worst such showing since 2009.

The ubiquity of so-called covenant-lite documentation adds another wrinkle to the dirty shirt. As data from S&P suggest, widespread adaptation of borrower-friendly legal structures (accounting for about 80% of the loan market, compared to 17% in 2007) have adversely impacted default recovery rates:

The cohort of [restructured cov-lite loans] issued after the credit crunch — the 2.0 incarnation — remains thin, at just 39 observations. However, the data indicate that these loans have underperformed cov-lite 1.0 loans, with an average recovery of 59%, versus 77% for those issued prior to 2010. These 39 loans had an average debt cushion [meaning debt that is subordinated to loans] of roughly 15%, vs. 32% for 2004-2010 cohort.

Importantly, the post-crisis cov-lite proliferation coincided with a secular boom in leveraged loans.  Thus, the loan market grew at a 10.2% compound annual rate from 2010 to 2019, nearly triple that of junk bonds.

Then, too, rising debt levels among speculative-grade corporate borrowers ensure heavy burdens in coming years.  A brand new report from Moody’s finds that U.S. junk-rated companies now sport a record $1.41 trillion in debt maturing between 2021 and 2025, up 19% from the 2020 to 2024 period measured only a year ago. Leveraged loan and revolver maturities account for $903 billion of that sum, up 20% from the year-ago figure.  

Recap Oct. 5

A rout in Treasurys, as the back end of the curve was hammered with the long bond jumping 10 basis points to 1.57% while the 2- vs 30-year spread reached 142 basis points, testing the multi-year highs set in early June.  Stocks caught another bid with the S&P 500 gaining 1% to leave the broad index up 5.5% year-to-date, while WTI crude ripped back above $39 a barrel and gold rose to $1,918 an ounce.  The VIX finished at 28. 

- Philip Grant

10.02.2020
Not All Heroes Wear Capes
The City that Never Sleeps received a rude awakening yesterday evening,

The City that Never Sleeps received a rude awakening yesterday evening, as Moody’s downgraded its general obligation bond rating by one notch, to Aa2 from Aa1, affecting some $38.7 billion in debt. The rating agency also downgraded NYC’s $4.5 billion in appropriations debt to Aa3 from Aa2, while maintaining a negative outlook on both.  

The rationale is no secret, as the pandemic and lockdown-related economic consequences “will likely be amongst the most severe in the nation and require significant fiscal adjustments,” Moody’s said. A spokeswoman for Mayor Bill de Blasio contended in response that the administration has a “strong record of fiscal management.” 

One thing’s for sure, de Blasio’s management has been strong for those on the city payroll. Citing data from Chicago-based budget watchdog OpenTheBooks.com, The Bond Buyer relays that more than 114,000 NYC employees made $100,000 or more in 2019, a 50% uptick in such six figure annual payouts from three years earlier. 

Of course, that growth in high-paying headcount is now in danger of reversing.  Hizzoner announced 22,000 layoffs at the end of August, a move which was since put on pause as the Mayor attempts to secure permission from Albany to borrow funds to cover operating costs, a move which is prohibited by laws put in place following the city’s brush with financial disaster in the mid-1970s. In July, de Blasio projected the fiscal 2021 budget stands at $87 billion, down from a projected $95 billion in January. Even with those cuts, the anticipated shortfall for the next two years stands at $9 billion, while the city doesn’t anticipate a return of tax revenues to pre-pandemic levels until 2024. 

The grim state of city real estate is front-and-center for those fiscal woes. According to Miller Samuel and Douglas Elliman Real Estate’s third quarter market report, Manhattan’s unsold residential inventory ballooned to 9,319 listings, up from 7,352 last year and equivalent to 20.3 months’ worth of supply, vs. 8.6 months’ supply a year ago. That’s the highest figure since 2009 for each metric. 

Then, too, improvement on the commercial side has been painfully slow. According to data from CBRE Group, only some 10% of Manhattan office workers were back at their desks as of Sept. 18, only slightly better than the 6% to 8% occupancy rate in July.  Nationally, returnees number roughly 25%, while Dallas and Los Angeles have seen 40% and 32% shuffle back to the office, respectively.  Overall, private sector employment in the city fell to 3.44 million in August, down 603,000 from a year ago. The city unemployment rate stands at 16%, double the national average. 

Mr. Market, trailing Grant’s, is gradually taking notice of these not-exactly hidden woes. NYC’s general obligation 4% bonds due 2050 have slipped to 111.5 cents on the dollar from 116.25 cents at the time of Grant’s July 24 bearish analysis pushing the tax-equivalent yield to 2.6% from 2.09%. The November elections loom large, as New York’s political class eagerly awaits the prospect of a federal bailout which would presumably follow a Biden victory and Democratic Senate majority.

***

More broadly, the cash crunch faced by municipalities nationwide stands as its own risk to the nascent economic recovery. According to this morning’s reading of September non-farm payrolls, state and local government employment fell to 5 million and 13.7 million, respectively, down from 5.2 million and 14.5 million in September 2019.  

As state and local governments are required to balance their budgets and lack Uncle Sam’s handy access to the Federal Reserve printing press, the prospect of further bloodletting across municipal payrolls appears likely.  During a recent Economic Policy Institute teleconference, Moody’s Analytics chief economist Mark Zandi projected that the aggregate state and local governments budget shortfall could approach $500 billion by fiscal 2022, along with an additional 3 million lost jobs over the next 12 to 18 months.

Investors seem to be taking note of these grim developments, as Refinitiv Lipper finds that municipal bond mutual funds absorbed a $775 million outflow for the week through Wednesday, the first such withdrawal since May. 

Meanwhile, one high-profile politician looks outside the box as they attempt to get their city back on its feet. For instance, Chicago Mayor Lori Lightfoot donned some interesting garb at a press conference yesterday rolling out Halloween trick-or-treating rules: 


  
Feel better yet, muni investors?  

Recap Oct. 2

Stocks came under pressure with the S&P 500 losing 70 basis points, though the broad index managed a near 2% advance for the week and currently sits higher by 4% so far this year.  Treasurys saw more softness with the 30-year yield rising to 1.47%, while gold pulled back to $1,907 an ounce and WTI tumbled to $37 a barrel.  The VIX rose 2% to 27.5. 

- Philip Grant

10.01.2020
Boob Job
Nudie magazine Playboy announced today

Nudie mag Playboy announced today that it will go public via a merger with blank-check “SPAC” Mountain Crest Acquisition Corp. at a $415 million valuation. Once the deal receives regulatory approval, Playboy will trade on the Nasdaq under the ticker PLBY.  As CNBC’s Leslie Picker notes, the new company will feature an all-male board of directors. 

Due diligence? They probably read it for the articles. 

Party Crashers
The Commodity Futures Trading Commission

The Commodity Futures Trading Commission and Southern District of New York today announced charges against the BitMEX exchange for illegally offering crypto derivative contracts and for failing to conduct anti-money laundering checks. The filing explained:

BitMEX touts itself as the world’s largest cryptocurrency derivatives platform in the world with billions of dollars’ worth of trading each day. Much of this trading volume and its profitability derives from its extensive access to United States markets and customers.

Nevertheless, BitMEX has never been registered with the CFTC in any capacity and has not complied with the laws and regulations that are essential to the integrity and vitality of the U.S. markets.

The Hong Kong-headquartered company has long been at the vanguard of crypto, offering customers up to 100 times leverage on certain crypto futures. 

For more on recent developments in crypto-land and their implications, see the center section in the brand new edition of Grant’s

Neutral Zone Infraction
The gnomes have been busy.

The gnomes have been busy. Yesterday, The Swiss National Bank announced it spent CHF 90 billion ($98 billion) intervening in currency markets over the first six months of the year in a bid to keep a lid on franc appreciation against the euro as well as the dollar.  Bloomberg notes that that six-month figure represents a larger currency intervention than the past three years combined.  

To hold down the franc, the SNB buys euros then diversifies into dollars and other currencies, buying, amongst other things, U.S. stocks. As of June 30, 2020, the SNB held $118.3 billion in American equities, including, for instance, $4.6 billion worth of Amazon, $6.3 billion of Apple and $1.1 billion in Home Depot.

Those accelerating efforts have had limited success. The venerable “swissie,” which has long served as a currency safe haven, reached a five-year high of 1.05 to the euro in May (the lower the cross, the stronger the franc), since easing a bit to 1.09 but still much stronger than the 1.21 per euro rate last seen in mid-2018.  

There is more where that came from, as a statement from the bank last week explained:

The SNB’s expansionary monetary policy is necessary to ensure appropriate monetary conditions in Switzerland and to stabilize economic activity and price developments. . . In view of the fact that the Swiss franc is still highly valued, the SNB remains willing to intervene more strongly in the foreign exchange market.

In a further effort to discourage FX inflows, Switzerland “boasts” the lowest policy rate in the world at an eye-watering minus 75 basis points. With the powers-that-be hesitant to dive deeper into the negative rate abyss, currency price suppression stands as the next-best option.

SNB chairman Thomas Jordan made the argument at a speech to the International Monetary Fund in July: 

Even though we still have scope for further interest-rate cuts, the fact remains that one cannot lower interest rates indefinitely. For this reason, interventions in the foreign exchange market, in which we buy foreign currencies and sell Swiss francs, also play a central role in our policy mix.

Those open-market exertions are having an impact in at least one respect. The SNB’s balance sheet now stands at CHF 950 billion as of Aug. 31, equivalent to nearly 150% of 2019 nominal GDP.  That compares to 33% and 49% ratios of central bank assets-to-trailing output for the U.S. and eurozone, respectively. 

A bubbly domestic housing market is part and parcel of the SNB’s efforts to beat back unwanted currency gyrations. UBS’s Swiss Real Estate Bubble Index jumped sharply in the second quarter towards bubble territory, as falling incomes from the pandemic and lockdowns contrast with a 4% jump in owner-occupied home prices versus the second quarter of 2019, the biggest such gain in seven years. That helped push price-to-annual rent and price-to-household income ratios to near 33 times and seven times, respectively, up from about 31 times rent and 6.3 times income five years ago.  

The Sept. 19, 2014 edition of Grant’s proposed a speculation in three-year call options on the Swiss/euro exchange rate, figuring that the SNB would eventually be forced to abandon its financial Maginot Line of a 1.2 franc-to-euro exchange-rate established in fall 2011.  That hypothesis indeed came to pass in January 2015, sending the CHF/EUR cross plunging to as low as 0.97 and generating handsome profits for those derivative contract-holders. 

Might the preconditions for a sequel to that 2015 FX regime change already be in place? For context, at the time of that analysis, the SNB held assets equivalent to 83% of output, or just over half of today’s relative balance sheet footings. 

QE Progress Report
Reserve Bank credit (i.e., the Fed’s sum total of interest bearing assets) ticked to $7.01 trillion, a $15 billion decline from last week’s reading. That pushed the three-month annualized growth rate to minus 2.5%. As the calendar is now beginning to lap last fall’s “not-QE” balance sheet growth, the year-over-year uptick fell to 84.5% from 87% two weeks ago. 
Recap Oct. 1

Stocks caught another bid, with the S&P rising 60 basis points to close within 6% of its Sept. 2 peak, while Treasurys held steady after yesterday’s selloff with the long bond holding at 1.46%.  Gold rose to $1,911 an ounce, its best finish in nearly two weeks, while WTI tumbled below $39 a barrel.  The VIX erased early losses to end the day near 27. 

- Philip Grant

09.29.2020
Material World
When diamonds aren't forever:

When diamonds aren’t forever: The contentious-and-potentially-busted $16.2 billion merger between jewelry giant Tiffany & Co. and French conglomerate LVMH (which would have been the largest on record within the luxury goods industry) continues to boil and bubble. 

The would-be acquirer announced on Sept. 9 that it was walking away from the deal on account of pressure by the French government. Tiffany filed suit with the Delaware Court of Chancery the same day to hold its partner to the existing terms.

Yesterday evening, LVMH filed a countersuit citing a pandemic-related “material adverse effect” (MAE) on Tiffany’s business operations, language which would allow LVMH to break its agreement.  As the filing noted, TIF logged a $45 million operating loss in the first six months of the year compared to a $345 million profit in the first half of 2019, while LVMH described its former target's prospects as “dismal.”  The filing continues: 

For instance, Tiffany paid the highest possible dividends while the company was burning cash and reporting losses. No other luxury company in the world did so during this crisis. There are many examples of mismanagement detailed in the filing, including slashing capital and marketing investments and taking on additional debt. 

LVMH also got personal, accusing Tiffany’s management of acting in their own financial self interest in order to jam the deal through. Noting that CEO Alessandro Bogliolo would score a $44 million payout if the deal were to be consummated, LVMH icily observed: “His golden parachute is equivalent to Tiffany’s losses in the first half of 2020.” 

“LVMH’s specious arguments are yet another blatant attempt to evade its contractual obligation to pay the agreed-upon price for Tiffany,” countered chairman Roger Farah this morning. 

Delaware Chancery Court is set to hear the case in January, but Mr. Market is hedging his bets.  TIF shares changed hands at $116 at day’s end, below LVMH’s initial $120 a share bid last fall, let alone the $135 a share price that the sides agreed upon in November 2019.

***

Others are similarly turning to MAE clauses to escape deals after having second thoughts. In June, Simon Property Group (the largest shopping mall operator in the U.S.) sued mall developer Taubman Centers in an effort to back out of a $3.6 billion merger agreement that was signed in February.  Notably, Simon accused Taubman of violating the merger agreement (despite the fact that it was the acquiree who sued to halt the deal) for renegotiating a credit facility with lenders to provide liquidity in exchange for “a secured interest in certain unencumbered assets.” That agreement, Simon contends, would “substantially reduce [Taubman’s] financial and operational flexibility.”  A trial date in Oakland County Superior Court is set for Nov. 16. 

Coronavirus-related MAE claims are about to get their first legal test across the pond as well. Last week, Payment processing firm WEX, Inc. went to trial in hopes of escaping an agreement to buy a pair of travel-payment businesses eNett and Optal, for $1.7 billion, after having announced in June it was terminating the deal as the pair suffered “a disproportionate effect” from the pandemic and lockdowns.  The target companies, subsidiaries of Siris Capital Group and Elliott Management-owned Travelport Worldwide, filed parallel claims in the U.K’s Commercial Court of the Business and Property Courts of England and Wales, setting the stage for a landmark ruling in the U.K. as to whether the events of 2020 are grounds to back out of a merger agreement.  

Might the MAE-inspired legal battles augur a more extended slump in deal activity? The pandemic has certainly taken a toll.  According to data from Mergermarket, worldwide M&A activity registered at $902 billion (inclusive of pending deals) in the first half of the year, down 53% from a year ago and the lowest total since 2010. Concerningly, the most recent full-month data aren’t looking much better: Global completed deal volumes plunged 65% in August compared to a year ago, according to Goldman Sachs, while completed deal volumes in the U.S. collapsed by 78% from August 2019. 

Recap Sept. 29

Stocks came under moderate pressure, with the S&P 500 slipping 50 basis points to give back a portion of yesterday’s advance, while key commodities diverged with gold jumping back over $1,900 an ounce and WTI crude slumping toward $39 a barrel.  Treasury yields went nowhere, as usual, and the VIX remained near 26.  

- Philip Grant

09.28.2020
Pop Up Video
Deal of the day:

Deal of the day:  Big Hit Entertainment, the record label behind Korean boy-band BTS, priced an initial public offering at KRW 135,000 ($115) per share (the top end of its range) for a total valuation of $4.1 billion, which would be South Korea’s biggest IPO in three years.  The institutional tranche of the offering was reportedly oversubscribed by a cool 1,000 times. 

As that chart-topping debut demonstrates, it’s a good time to go public.  Stateside, some $95 billion worth of IPOs have debuted so far this year, already closing in on the full-year post-2000 issuance record of $96 billion established in 2014. 

The deal frenzy has opened the door for all sorts of inventive structures, as so-called special purpose acquisition vehicles, or SPACs (a.k.a. “blank check” companies) have proliferated, raising more than $41 billion in the year to date through Thursday, more than the last 10 years combined.  Up next, “SPACs of SPACs,” as Bloomberg reports that Boston based Easterly Partners is planning a $100 million fund to invest in the blank check funds.  

Red Baron
A headline-grabbing win for Uber

A headline-grabbing win for Uber Technologies, Inc., as a London court ruled that the ride share giant is “fit and proper” to conduct operations in the city.  The decision beats back a challenge from regulator Transport for London (TfL), which declined to renew Uber’s license last fall following revelations of a spate of unauthorized drivers using fraudulent identification photos. 

It was, however, an incomplete victory, as the court granted an 18-month license, well short of the five-year maximum authorization. As a TfL spokesperson explained, the company remains on something akin to double-secret probation: “This 18-month license with a number of conditions allows us to closely monitor Uber’s adherence to the regulations and to swiftly take action if they fail to meet the required standards.”

Then, too, today’s victory removes only one legal roadblock in London, as the U.K.’s top legal body continues to deliberate over the company’s reliance on independent contractor status for its drivers, allowing Uber to avoid paying health insurance and other benefits, a battle which is also playing out in California and other jurisdictions (Almost Daily Grant’s, Sept. 15).  Britain’s Supreme Court is expected to deliver its ruling as soon as October.  

“If the Supreme Court says that Uber’s drivers are workers, and not genuinely self-employed as Uber maintains they are, drivers will be entitled to holiday pay, the national minimum wage and certain other entitlements,” Joseph Lappin, partner and head of employment at U.K. law firm Stewarts, tells the Financial Times. “I suspect that Uber will lose in the Supreme Court. [In that case], Uber’s costs would swell.”

Fever Pitch
The good times are here again for the private equity industry,

The good times are here again for the private equity industry, at least if the reappearance of so-called dividend recapitalizations is any indication.  Thus, Bloomberg reports that some $8.6 billion worth of such dividend recap deals (in which funds are used for payouts to a company’s private equity promoters) have been priced this month through Sept. 18. That’s equivalent to about 25% of total loan deal volume and already the busiest full month period for such recap deals in an even three years. 

While p.e. looks to capitalize on the stirring post-March recovery in asset prices, some question the self-reported performance benchmarks which have underpinned the industry’s marketing efforts. Ludovic Phalippou, professor of finance at Oxford’s Saïd Business School, argued in a mid-September online event with the Securities and Exchange Commission that the p.e. industry’s heavy use of subjective and easy-to-game metrics, most notably the internal rate of return (IRR), provide investors with a misleading picture of risk and return.  

Citing documents from p.e. giant Apollo Global Management touting a 39% IRR over the last 30 years, Phalippou dryly retorted: “A $1 billion investment earning 39% annually over 30 years would be worth $20 trillion. And $20 trillion is the GDP of the United States. I think we would have noticed.” 

For a closer look at p.e. through the years, along with a way to profit from a reversal in the torrid current conditions, see the July 10 issue of Grant’s

Recap Sept. 28

A bull rampage saw the S&P 500 rise more than 1.5%, as the broad index now sits higher by nearly 4% this year so far and has closed to within 6.5% of its Sept. 2 high-water mark.  The Treasury curve steepened a bit with the 30-year yield ticking to 1.42%, while gold jumped 1% to $1,888 an ounce and WTI crude rose to about $41 a barrel.  The VIX gave back early gains, holding near 26. 

- Philip Grant

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