Friday 29th April 2016
NEWS TICKER: Central bank policy is still dominating the trading agenda, even though most analysts believe that the Fed will, if it does move, move only once this year and will raise rates by a quarter of a percent. The statement of the US FOMC was terse and most likely signals extreme caution on its part, though there is a belief that hawkish voices are rising in the committee. The reality is though that the US economic growth story is slowing. Many think the June meeting will spark the uplift. Let’s see. The US dollar is continuing to lose ground across the board after data showed the US economy expanded at its slowest pace since the second quarter of 2009, according to the BEA, which FTSE Global Markets reported on last Friday. GDP increased at a 0.5% annualised rate - versus an expected 0.7% - after rising 1.4% in the fourth quarter of 2015 as personal consumption failed to boost growth in spite of low gasoline prices. Central bank caution makes sense in that context, however timing will be sensitive. If the central bank moves in the autumn it threatens to unbutton the presidential elections; but the reality is that mixed data will emanate from the US over this quarter which will make a June decision difficult. It’s tough being an FOMC member right now. The Bank of Japan meanwhile signalled its intention to stay the course this week with current policy, which discombobulated the markets. The Japanese markets were closed today for a public holiday, so it won’t be entirely clear if the market will suffer for the central bank’s decision. Certainly if fell 3.61% yesterday and is down 5% on the week. so the omens aren’t great. Of course, the pattern that is well established of late is that as the market falls, the yen appreciates. The yen was trading at 107.14 against the dollar last time we looked, compared with 108 earlier in the session, having at times touched 111/$1 yesterday (the lowest point for more than 18 months) The month to date has seen a rise in both the short term and long term volatility gauges. Coinciding with the rise, Nikkei 225 Index Structured Warrant activity has also significantly picked up. Nikkei 225 Structured Warrants showed increased activity with daily averaged traded value up 33% month-on-month. The Nikkei 225 Index Structured Warrants had significant increase in trading activity year-on-year with total turnover up by 6.8 times. – ASIAN TRADING SESSION - Australia's ASX 200 reversed early losses to close up 26.77 points, or 0.51%, at 5,252.20, adding 0.3% for the week. The uptick today was driven by gains in the heavily-weighted financials sub-index, as well as the energy and materials sub-indexes. In South Korea, the Kospi finished down 6.78 points, or 0.34%, at 1,994.15, while in Hong Kong, the Hang Seng index fell 1.37%. Chinese mainland markets were mixed, with the Shanghai composite dropping 7.13 points, or 0.24 percent, at 2,938.45, while the Shenzhen composite finished nearly flat. The Straits Times Index (STI) ended 12.42 points or 0.43% lower to 2862.3, taking the year-to-date performance to -0.71%. The top active stocks today were SingTel, which gained 0.26%, DBS, which declined 1.03%, NOL, which gained closed unchanged, OCBC Bank, which declined 1.00% and CapitaLand, with a 0.63% fall. The FTSE ST Mid Cap Index gained 0.60%, while the FTSE ST Small Cap Index rose 0.49%. Structured warrants on Asian Indices have continued to be active in April. YTD, the STI has generated a total return of 1.3%. This compares to a decline of 4.9% for the Nikkei 225 Index and a decline of 6.3% of the Hang Seng Index. Of the structured warrants available on Asian Indices, the Hang Seng Index Structured Warrants have remained the most active in the year to date with Structured Warrants on the Nikkei 225 Index and STI Index the next most active – FUND FLOWS – BAML reports that commodity fund flows went back to positive territory after taking a breather last week, supported again by inflows into gold funds. “The asset class is currently the best performer, with year to date % of AUM inflow at 15%, far ahead of all other asset classes. Global EM debt flows reflected the bullish turn of the market on EMs, recording the tenth consecutive week of positive flows. On the duration front, short-term funds recorded a marginal inflow, keeping a positive sign for the last four weeks. The mid-term IG funds continue to record strong inflows for a ninth week. But it looks like investors have started to embrace duration to reach for yield, as inflows into longer-term funds have recorded a cumulative 0.8% inflow in the past two weeks,” says the BofA Merrill Lynch Global Research team – GREEN BONDS - Banco Nacional de Costa Rica is the latest issuer with a $500m bond to finance wind, solar, hydro and wastewater projects. The bond has a coupon of 5.875% and matures on April 25th 2021. Banco Nacional will rely on Costa Rican environmental protection regulations to determine eligible projects. This is the fourth green bond issuance in Latin America, according to the Climate Bonds Initiative (CBI). Actually, Costa Rica is one of the global leaders in terms of renewable energy use. In the first quarter of 2016 it sourced 97.14% of its power from renewables. Hydro's share alone was 65.62%. – SOVEREIGN DEBT - After coming to market with a 100 year bond last week, the Kingdom of Belgium (rated Aa3/AA/AA) has opened books on a dual tranche bond; the first maturing in seven years; the second in 50 years, in a deal managed by Barclays, Credit Agricole, JP Morgan, Morgan Stanley, Natixis and Société Générale. Managers have marketed the October 22nd 2023 tranche at 11 basis points (bps) through mid-swaps and the June 22nd 2066 tranche in the high teens over the mid of the 1.75% 2066 French OAT – LONGEVITY REINSURANCE - Prudential Retirement Insurance and Annuity Company (PRIAC) and U.K. insurer Legal & General say they have just completed their third longevity reinsurance transaction together, further evidence that longevity reinsurance continues to be a vehicle for UK insurers seeking relief from pension liabilities exposed to longevity risk. “This latest transaction builds on our relationship with Legal & General and solidifies the platform from which future business can be written,” explains Bill McCloskey, vice president, Longevity Risk Transfer at Prudential Retirement. “It's also a testament to our experience in the reinsurance space and our capacity to support the growth of the U.K. longevity risk transfer market.” Under the terms of the new agreement, PRIAC will issue reinsurance for a portion of Legal & General's bulk annuity business, providing benefit security for thousands of retirees in the UK. PRIAC has completed three reinsurance transactions with Legal & General since October 2014 – VIETNAM - Standard & Poor's Ratings Services has affirmed its 'BB-' long-term and 'B' short-term sovereign credit ratings on Vietnam. The outlook is stable. At the same time, we affirmed our 'axBB+/axB' ASEAN regional scale rating on Vietnam. The ratings, says S&P, reflect the country's lower middle-income, rising debt burden, banking sector weakness, and the country's emerging institutional settings that hamper policy responsiveness. Even so, the ratings agency acknowledges these strengths are offset by Vietnam's sound external settings that feature adequate foreign exchange reserves and a modest external debt burden. The country has a lower middle income but comparatively diversified economy. S&P estimates GDP per capita at about US$2,200 in 2016. “Recent improvements in macroeconomic stability have supported strong performance in the sizable foreign-owned and export-focused manufacturing sector (electronics, telephones, and clothing). This strength will likely be offset by weaker domestic activity as the impetus to growth stemming from low household and company sector leverage is hampered by weak banks and government enterprises, and shortfalls in infrastructure. We expect real GDP per capita growth to rise by 5.3% in 2016 (2015: 5.6%) and average 5.2% over 2016-2019, reflecting modest outlooks for Vietnam's trading partners. Uncertain conditions in export markets and the slow pace in addressing government enterprise reforms, fiscal consolidation, and banking sector resolution add downside risks to this growth outlook – RUSSIA - Russia's central bank held interest rates steady at 11% today, in line with expectations, although it hinted that if inflation kept on falling it would cut soon. Last month, the bank held rates steady, warning that inflation risks remained "high" and that the then oil price rise could be "unsustainable." However, the decision came at a time of renewed hope for Russia's beleaguered economy and the country's oil industry with commodity prices showing tentative signs of recovery. The central bank noted that it "sees the positive processes of inflation slowdown and inflation expectations decline, as well as shifts in the economy which anticipate the beginning of its recovery growth. At the same time, inflation risks remain elevated." Yann Quelenn, market analyst at Swissquote explains: "The ruble has continued to appreciate ever since it reached its all-time low against the dollar in early January. At that time, more than 82 ruble could be exchanged for a single dollar note. Now, the USDRUB has weakened below 65 and even more upside pressures on the currency continue as the rebound in oil prices persists. The outlook for Russian oil revenues is more positive despite the global supply glut. Expectations for increased oil demand over the coming years and the fear of peak oil are driving the black commodity’s prices higher – MARKET DATA RELEASES TODAY - Other data that analysts will be looking out for today include Turkey’s trade balance; GDP from Spain; the unemployment rate from Norway; mortgage approvals from UK; CPI and GDP from the eurozone; CPI from Italy; and South Africa’s trade balance – FTSE GLOBAL MARKETS – Our offices will be closed on Monday, May 2ndt. We wish our readers and clients a happy and restful May bank holiday and we look forward to reconnecting on Tuesday May 3rd. Happy Holidays!

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Sale of the Century

Tuesday, 01 July 2008
Sale of the Century Private equity money swooped into the retail arena during the last few years, snapping up crown jewels across the world. By last year it had almost become a sport for predatory banks and financial houses. Fronted by hard nosed retail operators with turnaround track records, financiers tried to woo disgruntled shareholders with the promise of a premium price for their stakes in return for the opportunity to take the helm and turn high street under performers into consumer stars. That was then; this is now. Have crashing consumer confidence, woeful high street sales and the cold chill of a debt freeze put an end to the age of the mega-deals? Mark Faithfull reports. http://www.ftseglobalmarkets.com/
Private equity money swooped into the retail arena during the last few years, snapping up crown jewels across the world. By last year it had almost become a sport for predatory banks and financial houses. Fronted by hard nosed retail operators with turnaround track records, financiers tried to woo disgruntled shareholders with the promise of a premium price for their stakes in return for the opportunity to take the helm and turn high street under performers into consumer stars. That was then; this is now. Have crashing consumer confidence, woeful high street sales and the cold chill of a debt freeze put an end to the age of the mega-deals? Mark Faithfull reports.
RETAIL IS IN fact a relative newcomer to the private equity portfolio. Traditionally viewed as a high risk sector, open to the vagaries of consumer tastes and with limited international expansion opportunities, the market was left largely to founding families and listed company status. That was until the last few years when, in many markets, consumer spending went unchecked and continued upwards and upwards unabated, regardless of a worsening economic picture in the wider world. At the same time retailers began to flex their muscles outside their home markets, brands began to travel dramatically and the Far East began to open up as a fledgling consumer market; and although small it showed a particularly refined (nay obsessive) interest in high end luxury products.

What has followed is a series of mega-deals. Just a few of the high profile highlights include KKR fronting the purchase of US toys retailer Toys ‘R’ Us and Texas Pacific Group buying venerable US department store group Neiman Marcus and Australian household name Myer. In Europe footwear retailer Kurt Geiger was snapped up by Graphite, in the UK Debenhams flipped through the hands of private equity for vast profits, while Cortefiel in Spain has predicated growth on its equity backing. Moreover, Icelandic predator Baugur has moved in to buy a string of, predominantly British, retailers. Last year private equity finance backed the biggest deal of them all; the purchase of the merged Alliance and Boots operations to create a European pharmaceutical powerhouse. Even Sainsbury’s was circled by equity houses although it managed to repel any and all advances.



There have been many more deals. The reasoning behind the majority of them has been very similar: despite the consumer boom, at any given time a number of retailers tend to be struggling or underperforming, either as a result of lethargic or unfocused management teams or because the retailer has failed to adapt to declining sales in its traditional retail channel. That’s the downside. The upside? Well, retail offers any number of attractive attributes. For one, it is one of the most cash-generating sections of the economy. Two, buyout groups like companies with substantial assets, and most retailers own at least some of their valuable property freeholds. Three, private equity companies like businesses with steady income streams, and (with seasonal peaks and troughs taken into account) retailers’ cash tills ring all year round.

Private equity money has flowed into those businesses where the financial team believes that the company’s woes are in part of their own making, where the retail niche is under-exploited and often where property is part of the play. Get the formula right and fortunes can be made. At least, up until the middle of 2007 when consumer spending in several key markets including, notably, the US, the UK and Ireland, and Spain began to fall off a cliff and the cost of debt (when it could be found) began to spiral upwards. “It is only in the past few years that private equity has really had an appetite for retail,” reflects Henry Jackson, chief executive and managing director of London-based Merchant Equity Partners, which he joined from Deutsche Bank where he headed up the German bank’s European consumer and retail group. “Those companies have had some very successful transactions and we have seen a period when companies have been sold at ten or 11 times earnings. I think we will now see much less activity from private equity and in broad terms a lot less interest.”

Jackson’s company specialises in the retail field and has continued to invest in retail opportunities. In October 2006 it bought the retail arm of struggling UK kitchens and bedroom furniture retailer and distributor MFI Group and in March of this year it snapped up French furniture retail chain BUT from Kesa Eletricals for €550m. “We target companies with potential, but they need to be of scale. They need to matter,” he says. “Valuation is very difficult in retail. Certainly we look for good returns but there is no doubt that retail is at the high risk end.”

Nowadays, following that extended bull run of consumer spending in the opening years of this century, that level of risk appears to be putting equity money off any move onto the high street. In the first five months of 2007 over €25bn of private equity money exchanged hands in the retail sector, almost two thirds of the total retail deals for the period. The first five months of this year have seen that total plummet by an order of magnitude to just €2.4bn, representing a paltry 15% of deal totals. In comparative periods the sector fell from the most active for private equity deals to fourth.

In May this year Bridgepoint Capital became the first private equity house to buy back debt from a UK portfolio company when it bought €13m of the €240m of debt used to finance the €455m management buyout of UK clothing chain Fat Face from Advent International. Nonetheless, others remain positive about the role of private equity, despite the current downturn. Jón Ásgeir Jóhannesson, the controversial executive chairman of Icelandic operator Baugur Group, has snapped up a host of retail names with a focus to date on the United Kingdom. A hybrid company, Baugur started off by running its own grocery retailing operations in Iceland but by using venture capital soon sought bigger markets in which to target retailers it felt were punching below their weight. In a back story, behind the scenes Jóhannesson has been reportedly dogged by financial investigations by the Icelandic authorities for what he claims are politically motivated reasons and to date nothing has stuck.

Like Jackson, Jóhannesson is undeterred by the current downturn and Baugur has been linked with an audacious bid for Saks Fifth Avenue, in which it already has an 8.5% stake. While he will not be drawn on what would represent the standout deal of 2008, he does admit that the US is of interest but dismisses the notion that the weak US dollar is part of the appeal. However, Jóhannesson says that he sees “some interesting value around” and that “it will be an interesting year”. Jóhannesson typically looks for management teams to invest in their own operations and “to take part in what we are doing”. Previously Jóhannesson has been drawn to UK retailers, in part because of the thriving UK high street and in part because he felt that the market contained a number of clear underperformers. Now he says that Baugur is seeking “something that has the potential to travel across markets”.

Online sales have held up better than store sales in the opening phases of the consumer slow down and Jóhannesson says that he is increasingly keen on retailers with a strong internet presence. “A lot of our focus is on e-commerce,” he says. “I strongly believe it will be a big part of our business quite soon. We are researching and spending a lot of money on it and some of our businesses are already doing 45% of their business online.” Jackson concurs and reflects of the previous MFI management team (MEP’s initial purchase): “As the UK market leader, not to own kitchens online was a big mistake. After our first year in charge we have focused on our online activities.”

However, not everyone agrees that e-commerce is the only maxim. Anselm van der Auwelant, the charismatic Belgian CEO of Spanish retailer Cortefiel Group, asserts that the dramatic expansion of the fashion retailer would have been impossible without private equity money and that physical stores still form the backbone of the company’s future growth.“There are two financial partners plus the retail operation in our agreement and the business plan remains all about growth,” says Auwelant. An instinctive retailer at heart Auwelant believes that growth potential in emerging Europe and Asia remains strong and that physical stores rather than the internet also remain the best route to market. “To me the internet is the shop window but I still believe nothing can replace the real experience. E-commerce is a bit like sex, nothing beats the real thing.”

Despite soaring year-on-year internet retail sales, the polarisation in retail performance is also about more than online versus in-store sales. The internet may be holding up better than the high street but the real split in consumer outlook comes in western versus eastern markets. China, India, Russia, south east and sub-continental Asia and central and eastern Europe are suffering few if any of the consumer crises of their west European and US counterparts and little wonder that the biggest private equity deal of the year to date has been the acquisition of Turkish supermarket group Migros Turk by BC Partners and Turkven for €1bn.

However, entry into the emerging markets through the private equity route is increasingly difficult, with no shortage of domestically produced cash waiting in the wings in the emerging market. Consequently, most would-be investors will probably be forced to team up with local, family run businesses and to use their investment to grow the businesses organically and through local acquisitions; making the prospect of a quick in and out remote. Yet it is not all bad news. Initial skepticism from the retail sector about the motives of private equity buyers, notably whether they would simply be asset strippers or experts at polishing a business up for the short term while damaging it for the longer run, has largely proved unfounded.

Bernie Brookes, CEO of Australian department store stalwart Myer, points out that in a consumer downturn the rigours of private equity can in fact revitalise operations. Brooks heads up one of Australia’s most venerable retail names and his department store group was extracted from conglomerate Coles Myer in June 2006 when Texas Pacific Group led a management and family buyout. “Myer represented about 10% of Coles Myer Group turnover and got about 10% of the time,” he reflects. “We introduced a 100-day plan, a turnaround phase from 2006 until 2010 and then a growth phase to 2014. We intend to move from 58 stores to 80-plus and we have reinvested in stores, in our people and in 2009 we will have a state-of-the-art flagship in Melbourne.”

Indeed in Australia a report published in May has challenged the view that private equity takeovers will continue to wane in the current climate, after a surge in private equity takeovers of high-profile Australian retailers in recent years, including Myer, Godfreys and Repco. Rather, the report argues that the high cost of credit is pushing private equity firms to restructure their deals rather than miss out altogether. The PricewaterhouseCoopers (PwC) retail outlook report also predicted that while there would be fewer deals involving companies at the top end of the market in the next 18 months, the focus would shift to mid-cap deals. “There’s still plenty of equity in the market, with 70% of private equity funds remaining uninvested. However, due to the credit crunch, new deals need to be structured with 6% more equity,” says PwC corporate finance partner Greg Keys.

What retailers also often offer is an attractive real estate portfolio, with the potential to unlock capital through sale and leaseback. John Hoffman, shareholder representative at RREEF Printemps, which owns Italian department store group La Rinascente and French retail group Printemps, reflects: “We wouldn’t look at a deal that didn’t involve a property play. That is part of what makes it stack up.” Tough times might just be the time to make a foray into the retail arena, reckons Henry Jackson. “In a downturn capital expenditure has to justify the investment against the leverage,” he says. “What private equity does is put discipline back into the business and in the current climate that is no bad thing.

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