Monday, 15 April 2013

Re-capitalisation arbitrage . . . and some gold

Monday mornings always come with many questions. A weekend's worth of reading can often leave me puzzled about economies and markets. At least we get some solid data during the day including Chinese GDP, IP and retail sales just to provide something to go on with.

Readers of this blog know that I have been watching very closely the action in the M&A space, with much of my focus being on translating cheap capital into returns via acquisitions. My theory has always been that if you can borrow at X% and return nX% then you're ahead in this ultra low financing environment. What I didn't consider was that Private Equity would take this opportunity to raise debt for the sole purpose of paying a dividend to investors (namely themselves). There's nothing wrong with this type of behaviour in general. The capital cost arbitrage between debt markets and real business often can push owners to add gearing over time. The trouble here is that the debt is raised not on under-geared businesses, but rather on businesses who's balance sheets are already at the upper end of their financing limits. The FT quotes the example of UK business Pets at Home. In February KKR which bought it in 2010 for £955m, added £135m in new debt, raising total debt to about five times the company’s EBITDA. I don't know whether the pet retail sector will hold up, but I do know that the buffer now available to that company is limited. It strikes me that an excuse such as the IPO markets are still not buoyant enough to correctly value a business is somewhat disingenuous. The total amount of such refinancing in Europe was €2.3bn in 1Q13 and $7.6bn in the US. When these companies finally come to market via IPO canny investors should look very carefully a the debt coverage and terms associated with outstanding bonds . . . being an equity investor may mean you're at the back of a longer line than you think in terms of getting access to returns on your capital.

My experience of Asian junk debt markets is limited to restructuring of various credit structures after the 1997 Asian debt crisis. As another facet to the refinancing dodecahedron it suddenly seems very strange to me that people would like to re-enter the world of mirky balance sheets in countries not always known for the rule of law when it comes to protecting investors. So far this year the Asian junk market has raised $18.1bn and is on course to smash all records. Chinese property developers who paid 13.5% for money in 2010 now can finance at 8.875%. The Bank of Ceylon, a Sri Lankan state-run lender, raised $500m last week. These are the consequences of insanely low government bond rate; the risk differential is fast evaporating. I could rattle off a raft of now defunct companies who did similar things in Asia in the mid 90's only to disappear by the end of 1998. Some will survive, but the bond buyer needs to understand that rarely will failed companies in Asia be wound up with an eye to returning capital in a correct sequence. In summary ask yourself if 8.875% seems like a reasonable return on a company that you hadn't even hear of 6 months ago and had in fact been paying nearly 5% more only 2.5 years previously . . . a split second in the world of bond investing.

Gold is now officially in a bear market as it slips below 20% from its' highs. To listen to various commodity analysts you'd think that inflation was dead and that they'd predicted the gold bubble all along. Of course the only thing that's moved down fasted than gold is gold equities who have long been  a refuge for those wanting to own the metal but either unwilling or unable to hold commodities directly. As I've said before gold equities spend most of their time disappointing investors whether it be through production reports, bad management or mines that suddenly become unprofitable. 

Maybe it was better that I stuck to watching another kind of gold over the weekend. The Amstel Gold race was as usual thrilling; perhaps not as great as Paris Roubaix for drama, but nonetheless exciting to the very end. 

When Roman Kreuziger kicked clear at the bottom of the Cauberg for the last time it was all over. Gilbert resplendent in the world champion's stripes just didn't have the legs to bridge the gap as his earlier problems had taken too much out of him. 

Thanks for the notes regarding my vertigo. The dizziness has not returned for 5 days now, so I remain hopeful that it was a virus. I should have blood test results this week and I've booked myself in for a full physical at the end of the month including the the treadmill heart lung show. Perhaps I can get a better idea about my oxygen capacity (VO2 max) and heart rate limits so I can input them into my Garmin 800 for a better picture of my cycling efforts. In the interests of science I'm going to take some photos and post some data which might shed some light on how the pro's assess themselves.


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