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Building BRICS for my new Bank
There has been a high level of change within the UK domestic banking industry given the rise of firms such as TSB, Aldermore Bank, VirginMoney and Metro Bank. Now we might be observing a similar move within the international financial institution industry. Historically the IMF and World Bank have dominated funding and lending agreements to troubled nations. Notably during the 1980’s Latin America debt crisis and most recently during the 2010/11 Eurozone bailout endemic.
In reaction, Brazil, Russia, India, China and South Africa have come together by creating a new $100bn development bank and emergency reserve fund. The aim of the arrangement is to assist developing countries with short-term liquidity, diversify lending sources and ultimately lower global financial risk by distributing leverage more evenly. The bank’s head office will be in Shanghai, China with the 1st president from India.
Impact
There is hope the new bank will work similar to China’s soft power influence within Africa and South America. Contractual relationships and agreements that assist both parties with no underhand clauses. The most obvious benefit is the increase in the number of players in the industry to compete with organisations such as the IMF, World Bank and Paris Club. Possibly allowing less stringent borrowing conditions and fairer in-house voting measures. A promising alternative to our current Western dominated platform that better represents the global economic balance.
After all, competition promotes improved consumer welfare with lower ‘prices’ and more choice right? Not too bad for developing countries who need lower borrowing rates for much needed infrastructure and development investment.
@CapitalMoments
Bag yourself a Worldie!
Yes, here I am with yet another football-economics analogy however do not fret, this short post may actually earn you some money. After reading a Financial Times article and economic reports from Goldman Sachs and PwC I was intrigued to understand not only how economics can be applied to the FIFA World Cup but also how could I profit from the game.
Now, after reviewing the odds from the Oddschecker website and based on the enhanced Paddy Power 8/1 offer for Brazil to win the World Cup I have created a model to ensure if any of 8 teams win, you are guaranteed a minimum total return of 38%*. You too will be able to benefit from the glorious World Cup winners gone – all you need is internet access, an email account and some risk affinity.
Allocating an initial start up cost of £75 across the 8 teams and based on their odds to win the World Cup, I have distributed a percentage of the total stake to each team to ensure a return as long as 1 of the 8 teams wins the final in Rio de Janeiro. You can replicate the model with a different total stake as long as the weightings across each team are the same and you place your bets with the identical odds.
Apologies to any patriotic fans who have their hopes pinned on England winning but you can either lose money on watching England win or win money watching them lose. A win-win situation either way.
@CapitalMoments
Disclaimer Please be aware if neither of the 8 selected teams win the World Cup you stand to lose your total stake.
*Not taking into account reinvestment risk
Sources: Goldman Sachs, PwC, Financial Times, Paddy Power, Oddschecker
Mr. Carney, are we there yet?
Remember those never-ending school trip journeys to obsolete locations, the long drives on the double decker peering through the windows snacking on your school trip lunch? The same question to my teachers always arose -“Are we there yet?”
It seems to be same the question is being raised to Mark Carney, the Bank of England Governor, regarding the eventual base interest rate hike. The base rate provides the benchmark to price other interest-linked instruments and products. We are now experiencing strong consumer confidence and surging house prices, rising variables that can often lead to a credit bubble. In April, UK house prices rose at an annual rate of 6.7% and 17% in London. Conventional economic theory would suggest a rate rise is required in a world of bubbling asset prices and a full flow recovery.
Why is Mr. Carney delaying the rise for so long? There are a myriad of factors such as pending political elections and the long-term stability of UK’s growth. Is UK growth story in the gripping centre piece nearing climax or are still waiting to flick from the trailers to the opening scene? I’ll skip further analysis of our current situation and instead examine the response once we finally arrive at Thorpe Park for the school trip. Investigating the real ramifications on lives for people like my younger, older siblings and I when interest rates finally do bite.
Students
It may not seem to have much effect but an increase in interest rates could strongly impact students indirectly. Students may accrue lower pocket money from Mum & Dad PLC as higher monthly mortgage repayments eat into their income. On the upside however students may have more holiday spending money on their summer trips to Ibiza, Ayia Napa and Zante or more equally buy even more online clothes and goods from America and China. This is assumed as typically, increased interest rates are often followed by currency appreciation and therefore cheaper imports. In simple terms, more €/$/¥ for your £’s.
Graduates
Those graduating once interest rates finally do rise may suffer initially. At higher costs of borrowing, firms may decide to invest less. Labour, often the most expensive factor of production, could be the first to go resulting in lower recruitment. It could become harder to secure the coveted “graduate job”. It may not be completely lost in the long term, as firms adjust to the new credit environment and revert back to their prior recruitment strategies.
Young Professionals
The obvious impact would be regarding young professionals paying rent/monthly mortgage repayments and those saving for their first home. If we use the following example, young newly-wed professional couple looking for a two-bed in London. Currently, examining market rates, they may be able buy home using a variable-rate mortgage charging 3.99% annually. For a 2 bedroom home for £250,000 this equates to minimum monthly mortgage repayments* of £831.25, if we assume due to a marginal rate rise, the variable mortgage rate increases to 4.5%. Our young Kimye couple will now face minimum monthly mortgage repayments* of £937.50. A minimal expansion of 0.5% costs the couple an extra £106.24 per month, a large impairment given such a slight increase. Again, the rate rise could also be beneficial, especially savers. Those locked into long term rent tenant agreements will not feel the effects straight away. Allowing time to offset higher future costs by investing their savings in higher interest rate products for that dream first home.
Capital Allocation Change?
Under conventional economic theory – higher rates imply lower levels of lending. Levels of lending may fall but allocation efficiency should improve. In our current era of cheap money with low borrowing costs, money has flowed to a number of zombie firms. Firms that in a normal economic environment would suffer and eventually shut up shop have been allowed to continue business due to easy access to capital.
Higher rates will therefore incentivize and boost lending to businesses with strong long-term plans and ambitions. Result? It could mean there is more capital available for young people to invest in their ideas and businesses. Students, graduates and professionals are often those with risk taking affinity and the least amount of responsibility. Young people may stand a better chance to launch businesses in the ex-QE environment. Therefore indirectly an interest rate rise may implicate the youth, the change of capital allocation may help directly boost young business ideas and activities, a disguised blessing.
@CapitalMoments
* Mortgage repayments cover initial lump sum amount & interest accrued.
Sources: BBC, Nationwide, Halifax
AstraZeneca – Pfizer, cutting costs or leading the way in British Science? by Harry Archer @harryarch_
The proposed merger of US drug giant, Pfizer and UK/Swedish pharmaceutical company AstraZeneca is one that has been met with a plethora of reactions. Some have argued that it will improve the way that drug companies deliver value for their shareholders. Other, more speculative views, have suggested that Pfizer is only interested in the merger to cut costs and to use the UK as a tax base to increase its profits.
Firstly, lets take a more optimistic view of the effect that this proposed mega-merger will have on the economy. The primary factor to consider is the jobs that will be created in the UK science and research sectors. This will provide employment opportunities for UK residents in highly skilled and well paid roles, which will reduce unemployment and possibly increase the long term productive potential of the economy. Increased investment in research and development can only be a positive…
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The most lucrative game in football
Before you read on ask yourself the following two questions. Would you rather be an unused substitute in the Champions League Final or score the winner in the Championship Playoff final? then ask yourself this which club would you rather own – the runner up in the Champions League Final or the Championship Playoff final winners?
This Saturday 2 football finals will be played, both having monumental levels of importance for different reasons. Firstly and in the eyes of the majority more importantly, the Champions League Final will be played between the two Madrid rivals – Real and Athletico. Who will be crowned the best team in Europe? Secondly we have the Championship playoff final between Derby and QPR to see who will be the third promoted club to the Premier League alongside Burnley and Leicster. Congratulations to all 4 clubs and the best of luck in their respective games…
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A Beautiful Game
After enjoying a weekend watching my favourite team win the FA Cup, my mind quickly turned towards next season and the possible transfer targets. Furthermore upon reading a Mourinho interview where he outlined some of his potential summer buys I was interested to understand how managers plan transfer market strategies. Therefore I’ve decided to post a blog incorporating another football analogy with an enlightening economic lesson. Some of you may be aware of two things:
1. The impending World Cup and transfer market dealings that come afterwards.
2. Game theory, a behavioural economic theory based on strategic decision making amongst rational agents. A theory told superbly by the Russell Crowe film – A Beautiful Mind on economist John Nash’s life.
Now to our transfer market problem. Let’s assume we have two teams, Arsenal and Chelsea who have a similar problem – to buy a striker(s). Both teams have a budget of £50m and two strategic choices, they can:
A. Bid for two alternative strikers, costing £17.5m each.
B. Bid for Benzema of Real Madrid for £30m.
Given their budget, each team aims to maximize their payoff(savings) given the cost of the player(s). Payoff (P) = 50-X. Where X = cost of player(s).
We also have two further assumptions based on demand & supply.
1. If one team bids for Benzema and the other for an alternative, the price of the alternative strikers increases. This happens because other club teams understand there is lower supply of quality strikers and therefore increase their price – from £17.5m to £22.5m each.
2. If both teams bid for Benzema, his value increases, simply on the assumption a higher demand for a good or service increases the price. Benzema’s value rises from £30m to £40m.
What does this mean for our model?
Now, you can also see the cumulative payoffs for each set of choices.
Using the payoff function described, above where P=50-X, each team payoff is illustrated in left(Arsenal) or right(Chelsea) dependent on the value X, e.g. if both teams buy 2 alternative strikers, Arsenal payoff = P = 50m – (17.5m x 2) = £15m. Simple enough right?
We can clearly see the dominant strategy for Arsenal and Chelsea is to bid for Benzema, that is bidding for Benzema always yields the highest individual payoff(savings) irrespective of the other team’s decision. If both teams bid for Benzema, we fall into Nash Equilibrium where neither player sees it advantageous to change their strategy unless the other player also does so.
Arsenal [A], Chelsea [A] – £30m saved
Arsenal [B], Chelsea [A] – £25m saved
Arsenal [A], Chelsea [B] – £25m saved
Arsenal [B], Chelsea [B] – £20m saved
It is also apparent that the Nash Equilibrium solution is not optimal, if both teams co-operate and bid for two separate alternatives, they will both accrue savings of £15m, a co-operative strategy that saves the highest amount for both teams £30m cumulatively.
What seems odd is from this simple economic model, we find a solution where both teams may actually do better by working together! That is, by not bidding for Benzema, Arsenal and Chelsea save more money and can buy more players.
Now I know this model relies on certain assumptions of player values and the probability of the strategy choices. It also omits variables such as player exchanges, future expected performance impact and most importantly. The assumption Arsene Wenger and Josè Mourinho will be willing to co-operate.
I still hope it provides a simple lesson on how economic methods and techniques can be used in a fun and simple way to partially solve everyday problems.
@Capital Moments
City boys facing UEFA FFP fine
Yesterday, Manchester City were handed a £50m fine under UEFA’s financial fairplay policy. The sanction also included a 21 player squad size restriction for the 2014/5 Champions League season. Further conditions of the sanction are to be revealed this week however City have decided to appeal and will await the the UEFA panel’s final decision. If still in disagreement, City can lodge their case to the Court of Arbitration for Sport in Lausanne, Switzerland.
What is FFP really?
The UEFA Financial Fair Play regulations govern all clubs involved in UEFA competition (CL or Europa League). The regulation provisions were agreed in September 2009 by the Financial Control Panel spearheaded by Michel Platini. The aim was to implement regulation that prohibits “financial doping” and provide policies that promote football clubs as sustainable businesses. Ultimately in pure numbers, the policy stipulates that the break-even deficit(loss) for a club in 2013/14 season should not fall above €45m(taking into account the past three income reporting periods).
Now examining a football club like business, a club can accrue income from two primary sources, competition and commercial. Competition income strongly depends on match-day ticket sales and competition prize money. Income determined by a team’s performance on the pitch. Commercial income can also generate large swathes of funds, possibly from TV revenue or merchandising. Manchester United for example generate merchandising revenue by corporate sponsorship of their team kit and training ground. They also have foreign partnerships in the world’s two biggest economies, US & China. Clubs incur costs predominantly from player acquisitions and wages. The problem with a football club is whether it should it be allowed to spend more than income without a claim to tangible and intangible assets (debt+equity). Would a firm such as Tesco be allowed to continually accrue losses if the amounts were only accounted for by a sole owner? Now this is where UEFA FFP regulation takes effect.
Clubs such as PSG & Manchester City continue to play russian roulette, practically placing huge bets on their future earnings to collaterise their current expenditure. City have received close to £1bn of Abu Dhabi investment since 2008. All despite cases such as Leeds, Rangers and Portsmouth, clubs who have all fell foul of financial prudence and suffered the consequences. Now we saw what happened in the financial sector when such reckless behaviour occurred. It poses the question as to why is there is no precedence within the football sphere to stop this.
Future Impact
Although the punitive action on City currently seems extreme, will it really be enough to influence the European juggernauts to renege on the excessive spending. Will it impact the demand for foreign club ownership, like the NBA, football club ownership in England is particular attractive, with 11 of the 20 Premier League teams currently owned by foreigners. How will they react if they’re unable to pump limitless cash into UEFA teams? Will we finally see a leveling of the playing field? I do hope so being an Arsenal fan.
And will the clubs really take future rulings more seriously if UEFA continues to hand out sanctions rather than ban clubs from competing. I remember when I was younger and constantly being told by my Mum she was going to take my sister and I to eat out after school. Consequently once we arrived home we’d be eating rice and stew for dinner.
Lesson? Continual promises given by ‘policy makers’ have less or no credibility when the policy makers fail to live up to them. They ultimately impact expectations and decision-making, if no-one believes they’ll get kicked out the CL for exorbitant expenditure then there is no reason for them to stop spending. A scenario similar to expectations regarding central bankers and their monetary policy. If policy makers say they’ll raise rates when unemployment reaches 7%, then when its does, they renege. It would be more difficult to depend on future central banker statements because they have less credibility.
Overall, it seems the UEFA FFP has been set out with good intentions however it faces an uphill task to ensure execution and compliance amongst UEFA club participants especially in light of legal loopholes.
@CapitalMoments
Sources: BBC, Deloitte, UEFA Club Licensing & FFP Regulation document (Edition 2010)
Barçelanced Economy
With so much pressure on the UK to move away from debt fuelled growth, What would the ideal balanced economy constitute of? How much economic growth should be attributed to investment, exports or consumer spending. These are powerful questions of which I will attempt to answer using a football analogy. Also as a teaser before my UEFA FFP blog later this week. I will use the 2008-2011 Barcelona team as an example, & measuring economic growth to the number of Champions League titles for simple subjective analysis.
Gross Domestic Product = Investment + (Exports-Imports) + Consumer Spending + Government Spending
Investment – Economies must invest in education, innovation and technological progress that allows for improvements in long term growth. Just like an economy, a football must invest adequately, investing youth football and culture of play that promotes creativity and expression. Barça has done this well, exemplified by the fact Barça has the highest number of academy graduates playing professional football in Europe.
Current account balance – Countries should attempt to have balance with regards to imports and exports, becoming too independent on either can leave at country at severe risk when currency rates or other economies move adversely. Comparatively a football team shouldn’t buy or sell key players too frequently in order to maintain independence and stability to a team, Barcelona have done this, in the period examined only buying an average of 8 players including loan signings.
Consumer Spending – Once again, a country that spends too much and therefore saves too little worsens their ability to allow investment throughout the economy, ultimately becoming credit amourous however it must also ensure there is spending to drive growth and provide incentive for firms to produce and invest. Likewise a club that spends too much on wages will cripple it’s ability to invest in youth and acquire new players but too little and it will not be able to attract and hold on to the players that will allow the team to be successful. In 2010-2011 income statement Barça spent 61% of income on wages, a commendable figure compared to competitors such as Man City, who spent 113% of income on wages and made an astounding £194m loss.
Overall the analogy should provide some partial evidence to suggest too much of one thing is never good. As the below examples further show:
Arsenal – Too much investment at period of time crippled the ability of team to blend youth and experience adequately. 0 CLs 2008-2011
Real Madrid – Extreme buying and selling of key personnel, the overhaul of the team from Robben, Sneijder & Hunterlaar to players such as Benzema & Ronaldo. A strategy causes problems for stability and sustainability. 0 CLs 2008-2011.
Man City – Excessive spending on wages and acquisitions between 2008-2011 detracts the ability to harmonise team style and ultimately disrupts a football club’s longterm investment structure. Points I will assess further in my next post.
The best success for an economy similarly to an successful football team is to allocate adequate proportions on the different elements of economic growth without being too dependent on any ingredient.
Please note I have left out Government Spending for ease of analysis and evaluation.
@CapitalMoments
Sources: BBC, CNN, Forbes, Deloitte
Seplat Petroleum – A Simple Surveillance
This week, as part of a @CapitalMoments overview, myself and Josh have decided to cover the IPO of Nigerian oil and gas firm Seplat Petroleum Development Company PLC, the 2009 merger of Chairman Dr. ABC Orjiako’s Shebah Exploration and Production and CEO Austin Avuru’s Platform Petroleum Limited. The firm has listed 25% free float shares on the LSE, pricing at £2.10 per share giving a market capitalization of £1.14bn. The offer has raised just over £300m, providing the needed finance to repay $48m debt to Maurel & Prom. BNP Paribas & Citigroup were among the bookrunners for London’s biggest oil industry IPO since 2011.
Now, I know you’re expecting the rest of the review to include Seplat’s potential dividend yields, equity valuations and pricing ratios however I want my readers to be able to easily apply this simple technique to any firm they may have an interest in. Therefore I’ll be using the most straightforward breakdown. SWOT analysis.
Strengths
The firm’s strongest quality in comparison to other domestic players has to be their strength of corporate governance and management. The company adheres to strict international CSR standards with reputable investment in education, healthcare and training in the local Delta region. A strong framework of transparency and accountability yielding impressive results, daily oil production has quadrupled in 4 years and revenue increased 40% from 2012 to 2013. Their prudent firm policy and recent IPO will provide capital for higher investment, allowing the firm to fund further deals and strengthen their horde of assets after recent acquisitions from international oil producers such as Royal Dutch Shell PLC and Chevron Corp.
Weaknesses
Although it may seem advantageous to acquire many oil producing blocks within the Niger Delta region, over-investment could turn into a fatal experiment. Investing in a volatile resource such as oil and gas and at time when the Nigerian economy is still very dynamic may mean current forecasts and predictions could prove incorrect. A measured and cautious investment approach is advised. The underlying risk of local instability cannot be ignored also. Shell, a world leader in the industry, lost close to $1bn due to oil theft within the Niger Delta region, no firm will be invisible to the brute of the region’s militants.
Opportunities
The Petroleum Industry Bill, which is still currently being drafted could transform Seplat’s fortunes. The legislation may possibly grant exclusive access of new onshore oil blocks to local producers. If passed, the PIB will provide a great springboard for the firm to provide power for the country’s electricity market. Another great opportunity is the relative infancy of Nigeria’s infrastructure and industrial sector. Resources in crude oil could revolutionise the transport space and petro-chemical market, particularly for an expansive country heavily dependent on fertilizers in the agricultural sector.
Threats
In the world context, the shale gas boom could have dire consequences on exports to both the world’s two largest economies. US & China now hold 1780 cubic feet of shale gas and 80bn barrels of shale oil reserves collectively. A global change that could severely dampen the firm’s future export potential, especially given Nigeria’s oil exports to US accounted for 6.6% of domestic GDP in 2011. In addition the merits of issuing shares on the LSE may be a downfall, the bullish equity run in the UK may falter once interest rates finally rise in the next few years, which could hamper further investment initiatives for the firm.
Summary
Overall, the picture seems fairly balanced. In the short to medium term, the firm may have to overcome turbulence arising from global geopolitical and macroeconomic risk and possible local turmoil. In the long term however the positive externalities of good governance could thrust the firm as the market leader for providing oil and gas to Nigeria’s burgeoning domestic power industry. Conditional dealings in Seplat’s shares started in London today and unconditional trading in London begins April 14 so if you’re looking for a long term 10 year investment, this may just be it!
Sources: IMF, EIA, Seplat
@CapitalMoments
LEKANOMICS 