April 1 – April 7, 2016 – the janus observer

The virtuous cycle of Chinese real estate development. Global liquidity trap. What’s driving the China M&A boom?

In an effort to ease readability and to assist with navigation of the weekly posts I have updated the format this week. I am removing the featured articles/themes from the introductory paragraph – so there may at times not be an introductory paragraph, rather I will get right into Headlines (article links with a headline of what the article is about), followed by Briefs (currently featured as the “other items” section), Special Reports, Graphics, Featured (the featured themes/articles from the week), and will conclude with the Other Interesting Articles. Happy readings.

Headlines

FT – Ireland: define normal 3/31. Ireland just issued a bond with a term of 100 years, denominated in euros and yielding 2.35%.
FT – China reverts to ‘grid management’ to monitor citizens’ lives 4/3. Reminds me of George Orwell’s book 1984.
WSJ – Staples Finds New Use for Its Stores: Office Space 4/3. Bottom line, too many formats no longer need as much space.
Bloomberg – Brookfield Said Close to Raising $10B for Infrastructure Fund 4/5. If you have several billion dollars, where do you find yield these days?

Briefs

The Economist did an interesting piece on how Venezuela is resembling Zimbabwe 15 years ago.

“The IMF predicts that inflation will be 720% in Venezuela this year, a figure Zimbabwe hit in 2006. By 2008 Zimbabwe was racked by hyperinflation so crippling that beggars who were offered billion-Zimbabwe-dollar bills would frown and reject them.”
“Suppliers, rather than giving goods away at the official price, prefer to sell them on the black market.”
In the case of a tanker of subsidized gasoline, “you can sell the cargo legally in Venezuela for $100, or drive across the border to Colombia and sell it for $20,000. The pitifully paid border police will be easy to square.”
“By the most overvalued official exchange rate, ten bolivares are worth one American dollar. On the black market, the same dollar fetches 1,150 bolivares. Zimbabwe abandoned its worthless currency not long after monthly inflation hit 80 billion percent in November 2008.”

Konrad Putzier of The Real Deal illustrated the growing cash piles of private real estate funds and their lack of placement opportunities.
- “As of March, private real estate investment funds worldwide had $231 billion in aggregate dry powder – or capital commitments from fund investors ready to be spent – according to research firm Preqin. That’s the highest figure in history and a 10% increase since December.”
- “Dry powder has grown in part because fund managers are having an increasingly difficult time finding profitable investments – not just because they are raising huge sums from investors.”
- “In a year-end Preqin survey, 56% of fund managers polled said they see finding attractive investment opportunities as their biggest challenge – far ahead of raising funds (27%).”

According to Mark Benioff, founder and chief executive of Salesforce, “There are going to be lots of dead unicorns.” The following is from Attracta Mooney’s article in the Financial Times.

2015 was the year of the unicorn, 2016 may be the year of the dead unicorn (private companies with valuations in excess of $1bn).
In late 2013 there were 39 unicorns (a phrase introduced by Aileen Lee, founder of Cowboy Ventures – a venture capital firm), now there are 156 globally “with a cumulative valuation of $550bn, according to CB Insights.”
Interesting thing is growing investment amounts by non-traditional VC investors, specifically large money managers like Fidelity and BlackRock. So called “crossover investments in private technology companies rose 51% last year, to more than $40.9bn across 800 deals, CB Insights data show.”
While crossover investments still make up a small portion of the VC funds in private companies, the question is whether the investors in these fund managers are equipped for VC investing? “58 tech start-ups suffered “down rounds” since the start of 2015.” Not to mention the lack of liquidity in these investments.

Apparently there is No Mercy Rule for the Natural-Gas Market. Spencer Jakab of the Wall Street Journal elaborates.

Natural gas goes through two primary seasons, an “injection season” when gas is put into storage during the warmer months of the year and a “withdrawal season” when gas is drawn down for use during the winter months for heating and the like.
Well two things have happened, 1) record amounts of gas is being produced, and 2) it’s been a lot warmer than usual during the winter months.
“The problem is that there is so little room to put gas between now and November. On Thursday, with one week to go in withdrawal season, the amount in underground storage was at an all-time record of 2.47 trillion cubic feet, some 52% higher than the five-year average. That is a whopping trillion cubic feet more than a year ago.”
“Last year, so much excess gas was produced in the following seven months that storage reached its theoretical limit. If this year is like 2015, then storage might be full by the middle of August. Gas would have nowhere to go, and producers would have to “shut in” production or sell it for nearly nothing until heating demand appears.”

Think corporates have been buying back a lot of their stock? You were right. Joseph Ciolli, Lu Wang, & Oliver Renick from Bloomberg bring some clarity to this hunch.

“The biggest source of fresh cash in American equities isn’t speculators or exchange-traded funds – it’s companies buying their own stock, by a 6-to-1 margin.”
Companies have “executed about $550 billion of buybacks last year, according to data compiled by S&P Dow Jones Indices. That compares with a net $85 billion of deposits by customers of mutual and exchange-traded funds, the biggest gap since 2012.”

Peer-to-peer lenders in China are creating risks that resemble the former subprime-housing risk in the U.S., Esther Fung and Lingling Wei elaborate in the Wall Street Journal.

“Peer-to-peer lenders, who raise money from investors and then lend it out at higher interest rates, made 924 million yuan ($143 million) in down-payment loans in January, more than three times the amount made in July, according to Shanghai-based consultancy Yingcan.”
“Agents say these loans can attract annual interest rates of up to 24%.”
“Trying to reduce housing inventory by encouraging individuals to increase borrowing is a dangerous experiment. Enormous risks are lurking behind the surging property prices in first-tier cities.” – Ming Zhang, a senior economist at the Chinese Academy of Social Sciences, a government think tank.
“Industrywide, nonperforming loans rose to 1.67% of total loans last year from 1.25% in 2014, according to official data. But analysts estimate the true ratio this year could be 8% or more. In the U.S., 14.6% of subprime loans made in 2005 defaulted, according to the Federal Reserve Bank of Chicago.”

Ed Crooks of the Financial Times highlighted how the US oil and gas sector is going through a reboot to survive.

“Steven Woods of Moody’s, the credit rating agency, says the entire US oil industry is under financial stress with prices at today’s levels.”
“At $40, the industry doesn’t work. Companies can’t earn an adequate return on capital.” – Mr. Woods
“The number of rigs drilling for oil and gas in the US has dropped 77% since September 2014, falling a further 14 last week to 450, the lowest level since the data were first collected in 1940.”
“To stabilize total US production and stop it falling, oil would need to be about $40 to $50 a barrel, he adds. To go back to the boom years of 2012-2014, when the US was adding about 1m barrels a day of additional supply every year, oil would need to be more than $80.”
“The shale revolution will not be reversed; in fact, the technology is continuing to advance. But every revolution needs to be followed by a period of consolidation, and this one is no different. The high-growth period of the industry’s history is over, perhaps for a long time.”

Tom Randall of Bloomberg illustrated the scale of Wind and Solar investments relative to Fossil Fuels of late.

“Government subsidies have helped wind and solar get a foothold in global power markets, but economies of scale are the true driver of falling prices: The cost of solar power has fallen to 1/150th of its level in the 1970s, while the total amount of installed solar has soared 115,000-fold.”
“Just since 2000, the amount of global electricity produced by solar power has doubled seven times over. Even wind power, which was already established, doubled four times over the same period. For the first time, the two forms of renewable energy are beginning to compete head-to-head on price and annual investment.”

In case you haven’t heard about the ‘Panama Papers,’ the Economist does a good job of explaining what they are and why they matter.

“The International Consortium of Investigative Journalists (ICIJ) this weekend went public with its findings that the firm (Mossack Fonseca) had, wittingly or unwittingly, helped clients evade or avoid tax, launder money or mask its origins. More astonishing than their methods, which are well known, was the scale of activity and the people involved. The 2.6 terabytes of data are thought to contain information about 214,500 companies in 21 offshore jurisdictions and name over 14,000 middlemen (such as banks and law firms) with whom the law firm has allegedly worked.”

Hannah Kuchler of the Financial Times covered Facebook’s plan to expand its live streaming service.
- Here is a link from the horse’s mouth.
- Just imagine how much content Facebook is going to put out in the near future. “Live is like having a TV camera in your pocket. Anyone with a phone now has the power to broadcast to anyone in the world.” – Mark Zuckerberg, founder and chief executive of Facebook.
- This is a game changer. Think the Kardashian’s get too much play, you ain’t seen nothing yet.

Special Reports

Bloomberg – The World Is Getting Fatter and No One Knows How to Stop It 4/6
Federal Reserve Bank of St. Louis – Thrivers and Strugglers: A Growing Economic Divide
- “To our surprise, age is the strongest predictor of balance sheet health, even after accounting for race and education… An American born in 1970 is projected to have 40% less wealth over their lifetime than an American born in 1940. Clearly, some larger economic and social forces are underway, reshaping economic opportunity in the U.S.”
Sydney Morning Hearld | Huffpost – World’s Biggest Bribe Scandal 3/31
WSJ – The Secret Money Behind ‘The Wolf of Wall Street’ 4/1

Graphics

The Real Deal – Private real estate funds have a record $231B to spend – but few places to put it.

Wall Street Journal – No Mercy Rule for Glutted Natural-Gas Market.

Financial Times – US oil and gas sector reboots to survive.

Bloomberg – Wind and Solar Are Crushing Fossil Fuels. Investment in Power Capacity, 2008-2015 (Source: BNEF, UNEP)

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Price falls keep China’s property developers grounded. Ben Bland. Financial Times. 4 Apr. 2016.

Seeking an example of the credit boom in China fueling property developments that maybe should not be undertaken? Look no further than Hong Kong developer Goldin Properties’ Goldin 117 a $10bn project in Tianjin (30 minutes by high-speed train from Beijing).

Founder Pan Sutong (also the individual who had $13bn wiped off his paper fortune in a single day due to stock market girations) and China Cinda Asset Management “one of the state-run ‘bad banks’ with a mission to lend to distressed companies” are putting in Rmb9bn ($1.4bn) each recapitalize the project.

“Anne Stevenson-Yang of China-focused research house J Capital, argues that the use of government-backed funds to support Goldin is symptomatic of the wider misallocation of capital weighing upon China’s economy.”

“It’s a miniature picture of what China is all about, demonstrating scale in order to capture more financing. China’s asset management companies and banking establishment are dedicated to maintaining the value of their collateral because if they allow it to drop and they have to mark their real estate holdings to market, it would be a disaster for banks, depositors and cities.” – Ms. Stevenson-Yang

Because “Chinese banks are reluctant to continue lending to ambitious and overstretched developers,” the “government is pushing asset managers such as Cinda to extend more credit to ailing companies and has proposed allowing Chinese banks to swap debt in struggling enterprises for equity.”

“The government is using its financial arms to provide further guarantees to the real estate sector and other industries that are plagued by overcapacity. It’s setting a bad precedent and there is a very big risk of moral hazard because developers know that, in the end, the government will bail everyone out.” – Zhu Ning, a professor at the Shanghai Advanced Institute of Finance

The global liquidity trap turns more treacherous. Scott Minerd (global chief investment officer at Guggenheim). Financial Times. 5 Apr. 2016.

“…when monetary policy is the only game in town, negative rates are likely to beget even more negative rates, creating a perverse cycle with important implications for investors.”

“There is a strong argument that when rates go negative it squeezes the speed at which money circulates through the economy, commonly referred to by economists as the velocity of money.”

“The empirical data support this view – the velocity of money has declined precipitously as policymakers have moved aggressively to reduce rates.

A decline in the velocity of money increases deflationary pressure. Each dollar (or yen or euro) generates less and less economic activity, so policymakers must pump more money into the system to generate growth.”

Recall Kevin Wilson’s article: Japanese Policy Failure Means Disaster For Us All from the March 5 – March 10 post.

“As consumers watch prices decline, they defer purchases, reducing consumption and slowing growth. Deflation also lifts real interest rates, which drives currency values higher.“

“The Bank of Japan and the European Central Bank are already executing massive quantitative easing programs, but as their balance sheets expand, assets available to purchase shrink.”

“The BoJ now buys virtually all of the Japanese government bonds that are issued every year, and has resorted to buying exchange traded funds to expand its balance sheet.”

China’s M&A boom – Money bags. Economist. 2 Apr. 2016.

Subheader: China’s global investment spree is fueled by debt

“Chinese firms with little international experience and lots of debt have emerged as the biggest buyers of global assets. They have announced nearly $100 billion in cross-border M&A deals this year, already more than their $61 billion of foreign acquisitions last year.”

What is being missed are the motivations. General theories are concern over the Chinese economy or a pending yuan devaluation; however, what it really comes down to is that foreign acquisitions are a cheap (relative to what’s available in China) source of growth.

“Chinese buyers, by and large, are far more indebted than the firms they are acquiring. Of the deals announced since the start of 2015, the median debt-to-equity ratio of Chinese buyers has been 71%, compared with 44% for the foreign targets, according to The Economist’s analysis of S&P Global Market Intelligence data. Cash cushions are generally also much thinner for Chinese buyers: their liquid assets are roughly a quarter lower than their immediate liabilities. The forbearance of their creditors makes these heavy debts more bearable in China than they would be elsewhere. But the Chinese buyers are financially stretched, all the same.”

“Chinese banks see lending to Chinese firms abroad as a safe way of gaining more international exposure. The government has encouraged them to support foreign deals. As long as the firms to be acquired have strong cash flows…”

“For the buyers, there are two strong financial rationales for the deals…

“First, debt-funded buyouts can actually make their debt burdens more tolerable. Take the case of Zoomlion, a construction-equipment maker with 83 times more debt than it earns before interest, tax, depreciation and amortization. It wants to buy Terex, an American rival with debt just 3.5 times larger than its earnings, for $3.4 billion. Even if the purchase consists entirely of borrowed cash, the combined entity would still have a debt-to-earnings multiple of roughly 18, a marked improvement for Zoomlion.”

“Second, Chinese buyers know that one key financial metric works to their advantage: valuations in the domestic stock market are much higher than abroad. The median price-to-earnings ratio of Chinese buyers is 56, twice that of their targets. In effect, this means they can issue shares domestically and use the proceeds to buy what, from their perspective, are half-price assets abroad.”

“…so long as their banks and shareholders are willing to stump up the cash, Chinese companies see a window of opportunity.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Saudi Arabia Plans $2 Trillion Megafund for Post-Oil Era: Deputy Crown Prince 3/31

Bloomberg – Norway Frees Wealth Fund to Add $17 Billion in Real Estate 4/4

CoStar – REITs Reverse Course on Investment Strategy, Become Big Net Sellers 4/6

FT – China group seals record trove of M&A deals 3/31

FT – Hong Kong’s retail sales drop hardest in 17 years 3/31

FT – What is the Petrobas scandal that is engulfing Brazil? 3/31

FT – Anbang chairman Wu Xiaohui’s ‘wings clipped’ by regulators 4/1

FT – Even oil barons are giving up on fossil fuels 4/2