Green or Green – Growing ESG Importance in the Private Equity Industry

I. ESG in the PE industry

In 2004, the then-UN general secretary Kofi Annan wrote a letter to 50 CEOs in the financial industry, urging them to further integrate sustainability into capital markets. This was the beginning of the PRI (Principles for Responsible Investment). Today, over 2,000 funds have signed the United Nations-supported PRI, up from 1,300 in 2013. The signees now have a combined $82 trillion AUM. PRI consists of six principles centred around the idea that long-term value of investors is best secured when investing into targets that are aware of the importance of ESG (Environmental, Social and corporate Governance).

During its transition from alternative investment option to mainstream way of investing, the private equity industry has also become increasingly concerned with ESG. This involves recruiting ESG-dedicated specialists, having higher sustainability requirements on potential targets and integrating ESG into every aspect of the daily operations of their portfolio companies.

“Poor ESG is indicative of a poorly run business, and for positive change to be really effective it must be driven by organizational culture,” Adam Black, Coller Capital Head of ESG said recently. A newly conducted ESG report by his firm shows that 89% of responding General Partners (GPs) are following and have formal ESG Policies, while the same percentage of responders say that ESG awareness require a special set of skills.

CFA UK has now responded to this demand by launching a four-level certificate in ESG Investing to stay up-to-date with recent developments and to integrate ESG capability more thoroughly into working life. Candidates will be able to take the exam in December 2019, and over 500 candidates have as of now already signed up to complete the course, showing that the interest in ESG is high both for employers and employees in the financial industry.

II. How ESG is integrated in recent deals

In the Private Equity industry, ESG is becoming an important part of the decision-making process for investments. According to a research by BCG, among 343 firms from 5 sectors, companies with strong ESG ratings get higher marginal return on the long term. 85% of the limited partners surveyed by Private Equity International strongly emphasized on responsible investment.

In 2017, the world’s largest pension fund (Japan’s Government Pension Investment Fund) with AUM of over 1.5 trillion announced their strategy to incorporate ESG factors as a top priority, and to allocate 10% of the general funds to sustainable investments. New Zealand Super Fund has announced a huge divestment of their investments in fossil fuel projects valued at $950M. Bain & Company’s report, based on a sample of 450 PE-led exits in Asia-Pacific region, shows that the median multiple on invested capital was higher for deals with social and environmental impact.

The evolution of ESG is not without difficulties: How should we appreciate, rate and rank ESG factors in a company? Which factors are more relevant for each sector? Certainly they are different: A company in the agriculture segment would not have the same ESG issues as a company in the energy production sector.

ESG Rating agencies such as Vigeo Eiris, ISS ESG and Sustainalytics have been created. Classic rating agencies and audit firms are also trying to fill this market (Bureau Veritas, SGS), and a globally shared standard could be the next thing we expect.

According to Deloitte Sitra and FVCA, a PE firm can be defined based on its current status of ESG maturity and role of impact into four categories.

III. What is the future for ESG in PE?

Cerulli Associates’ director said : ”We are in the beginning stages of adoption, with many firms just starting to build their ESG integration processes.” The development of Private Equity firms focusing on ESG is positive for the world’s ESG challenges, as private equity firms have influential and financial capabilities to create social responsibility through environmental improvement and social projects, while increasing returns for their investors.

However, it is still too early to conclude on whether this impact commitment and the ESG influence in Private Equity investments are creating value for investors although the current situation does look promising, looking at the Bain & Company sample of 450 APAC PE exits where the multiples for ESG deals were significantly higher than for other deals. According to the research firm Cerulli Associates, one “significant” challenge that asset managers are facing currently is the lack of ESG data. This is confirmed by Deloitte “there is enough information available, but concrete procedures are missing or they are still emerging.”















Super Fund’s $950m fossil fuel divestment an “aha” moment for NZ economy



Coca-Cola takes plunge into coffee with 3.9 billion-pound Costa deal

On the 31st of August 2018, Coca-Cola (NYSE:KO) announced that it had reached a definitive agreement to acquire the U.K. Coffee-shop leader Costa for 3.9 billion pounds ($5.1 billion). This brave acquisition is a turning point for both companies.            

The Coca-Cola Company 

The buyer is The Coca-Cola Company, one of the biggest beverage company in the world. Its portfolio is extremely wide, including around 500 brands based in more than 200 countries.          
The firm was founded in 1892 in Atlanta, Georgia in the United States. The Coca Cola’s product was designed in 1886 by Dr John Stith Pemberton. A trade secret protects its recipe from the 20th century.    
The successful marketing campaigns are the major drivers of brand triumph. Indeed, they have a powerful impact on pop culture and society as a whole.

Coca Cola six-year financial performance        

74.1% of the turnover of Coca Cola is achieved at the international scale with more than 30 worldwide production sites. In the last quarter release of 2018, Coca Cola showed an increase of EBITDA Margin reflected by a reduction in Operating Costs. Despite a reduction in EBITDA by -2.94 % and Revenue by -7.64 %, EBITDA Margin in 2018 was 40.11 %, above the company average.

The beverage company expanded the range of its product by bringing other soft drinks such as Fanta or Sprite in its portfolio.   
Nowadays, Coca-Cola aims to reduce the amount of sugar and the environmental impact caused by traditional drinks. Therefore, Coca-Cola strives to achieve those goals through the acquisition of additional organic and artisanal beverage companies.        

As a result, the acquisition is a clear signal that it is diversifying away from the sugary and carbonated drinks on which it has built its name. It is the most significant acquisition of Coca-Cola in eight years, pushing it into direct competition with Starbucks, Nestlé and JAB Holdings in the international coffee market.

About Costa Limited        

The seller is Costa Coffee. It is a British private multinational coffee company established in 1971 by the Costa Family (Bruno and Sergio Costa) as a wholesale operation supplying roasted coffee to caterers and traditional Italian coffee shops.  The company is headquartered in Dunstable, Bedfordshire (UK).        
Costa Coffee is the largest coffeehouse in the UK, with a market share of 39%. It was initially acquired by Whitbread PLC, the UK largest hotels, restaurants and coffee shops operator for £19m in 1995 when it had only 39 shops.     
Nowadays, Costa Limited is running a coffee shop business internationally and specifically within the UK with around 2,400 retail outlets in the UK and over 1,400 stores in 31 global markets.

For several years, Whitbread was under pressure to spin off Costa from the rest of the business as an independent company but resisted the desire and waited for the right time. Indeed, Whitbread concluded that a straight sale would lead to a more profitable option. Associates emphasized the fact that the spin-off option would have led to smaller yields and might have taken around 2 years to produce comparable returns.

For Whitbread, the acquisition provokes a new period in its 276-year history that will be spearheaded by its Premier Inn hotels and complimentary restaurant brands such as Beefeater and Brewers Fayre. 

Costa Coffee five-year financial performance  

Costa’s revenue swelled at sturdy rate of 7.5% to £1,292m in 2017 (up from £1,202m in 2016). It also announced a hefty return on capital of 46.0%.

M&A in the coffee market heats up with entry of Coca-Cola        

The coffee industry has become a fast pace growing sector of the international beverage business. The worldwide coffee market is worth between $80 billion and $100 billion.
According to Statista, the US is the largest market on a global scale, with consumers spending $12.5 billion on coffee in 2017.

Numerous beverage companies have been acquiring companies to expose themselves to prospective markets.  
For instance, Nestle acted in the same way as Coca-Cola by acquiring smaller niche producers, Blue Bottle Coffee and Chameleon Cold Brew. The Swiss food company also paid $7.2 billion to establish an alliance with Starbucks with the aim of selling its coffee products outside the US company’s coffee shop, extending its Nescafé and Nespresso portfolio with Starbuck’s brand. Likewise, the U.K.-based food-and-coffee chain Prêt A Manger has been bought by JAB, Reimann family’s investment company for $2 billion earlier this year. Formerly, JAB had acquired high end coffee companies such as Peet’s Coffee & Tea in 2012 for an estimated £1 billion, Caribou Coffee in 2013 for $340 million, Nordic Coffee in 2015 for $300 million and Krispy Kreme in 2016 for $1.4 billion. The merger of Dr Pepper Snapple and Keurig Green Mountain for $18.7 billion also occurred previously this year. Therefore, Costa was the sole acceptable coffee chain available for a potential buyout in the market.

These decisions are explained by the desire of diversification, exploring new opportunities and penetrating new markets and businesses. Indeed, soft drink has always been a disintegrated sector without having strong positions in the coffee industry. 

The trend of “health-consciousness” has become the company’s priority. This move might lead to a reduction in the consumption of sugary and fizzy drinks.
The expansion towards Asia is another priority due to the fact that the coffee culture is growing at a fast pace. According to GlobalData, retail sales of hot drinks in China will hit $34.2bn by 2022. A few acquisitions are going along. Indeed, Costa itself acquired Yueda on October 2017, a Chinese coffee chain and Starbuck announced a deal with e-commerce giant Alibaba with the goal of extending its delivery services within the country in August 2018.

Buyer’s rationale of the deal

  • Coca-Cola buys Costa to fill in the final piece of the puzzle: Coffee Expertise

“Hot beverages are one of the few remaining segments of the total beverage landscape where Coca-Cola does not have a global brand. Costa gives us access to this market with a strong coffee platform” said Coca-Cola President and CEO James Quincey. Indeed, this big deal will help Coca Cola to further expand beyond soft drinks and move into the hot drinks sector. Costa provides new capabilities and expertise in coffee to Coca Cola.       
However, this coffee expertise might cause friction with Starbucks, which already forged strong ties with Coke. Indeed, this acquisition might spark a burden in the Starbucks marketplace.

Coca Cola will benefit the vast coffee vending business of Costa Coffee counting more than 8 000 Costa Express machines worldwide, located in convenience stores, cinemas, and offices. This business strategy will enable Coca Cola to expand its existing offerings. However, Coca-Cola does not have any experience in running a retail format. Therefore, it plans to let the existing management handle that part of the business. Moreover, this coffee expertise will also help Coca Cola’s customers.  In effect, the Coca-Cola president and CEO, James Quincey said “it’s the right thing to do to serve our consumers with more of the drinks they want, which in turn helps our customers”.
Overall, the acquisition of Costa Coffee will give Coca-Cola a competitive advantage through strong expertise across the coffee supply chain, including sourcing, vending and distribution.

  • Coca Cola’s long-run diversification scheme

Nowadays, the new generation is becoming health conscious, sugary drinks and junk foods are no longer part of the youth’s daily routine. Health organizations are raising awareness about the negative health effect of sugary beverages. Governments are also discouraging businesses by putting into practice severe measures such as “sugar taxes” to restrain their production.       
Overall, the consumption of sugary drink is dwindling swiftly at a global scale (estimated around 11% in 2018). Coca Cola and its competitors are facing this problem together and strive to shift their approach by reaching alternative beverage marketplaces. A previous M&A deal of $3.2 bn involving Pepsi and SodaStream is a typical example.    
Therefore, the world’s biggest producer of soft drinks is seeking for alternatives in the hot beverage segment in order to offset the unfavorable trends in consumer preferences who shifted from sugary drinks to healthier ones.

Despite the fact that Coca Cola has always been a flagship company, the firm lost its fizz over recent years. Coca Cola has made a lot of attempts such as expanding its fruit juice portfolio and striving to launch a naturally sweetened version of its flagship coke named “Coca-Cola Life”. However, all these attempts were not successful enough to regain momentum in the marketplace. This is reflected by a decrease in Coca-Cola’s sales since 2012. Therefore, one smart acquisition was the only way for the Atlanta-based company to help their revenues and margins revive.
This was the moment when the “Coca Cola and Costa Coffee deal of $5.1 bn” headline came up in the news. This move was designed to penetrate the profitable hot beverage marketplace as well as raising synergies by combining the Costa’s established coffee-selling platform with Coca-Cola’s astounding marketing expertise and global reach.

  • Synergies opportunities

Coca-Cola expected revenue synergies through the sale of the seller’s products added to its distribution network. Moreover, cost synergies could also be generated by centralizing ingredient purchasing and production reflected on a reduction in SG&A costs.

Seller’s rationale of the deal

·      Whitbread passes on Costa’s Chinese challenge to Coca-Cola

Although Costa has penetrated a lot of geographical markets, the company is interested in the Chinese market to guide its global expansion in order to compete with its US rival, Starbucks.  
China GDP projected to exceed $15 trillion by 2021 from $11 trillion in 2014, is a major driver for the company growth with a meaningful increase in its middle class.
Furthermore, the per capita coffee consumption in China is significantly higher than in the US which may lead to a revenue growth from the region.       

The intention of Costa Coffee is to augment the number of its store in the country from their current 449 to approximately 1,200 by 2022.
Coca-Cola will be essential for achieving this goal by using its financial power. Indeed, while there was little doubt behind Whitbread’s plans to expand Costa internationally it has delegated the enormous task of breaking into new markets against more established competition, to a more fitting owner, Coca Cola who has the resources needed to drive Costa to the lead of coffee on the international scale.

  • Costa Coffee is using Coca Cola’s well-established reputation to expand itself

The coffee shop chain is determined to realize its strong potential overseas. The combination of an international super-brand and the UK’s biggest coffee chain will ensure continued product development, greater market share and potentially enormous and rapid growth expansion overseas.        
The sale to Coke offers intriguing possibilities for the Costa name to appear in new formats, such as chilled variants, and reach a wider audience through Coca-Cola’s well-established distribution network. While Costa is “ubiquitous in the UK, the business has “plenty of opportunity to expand internationally, as Whitbread had been doing” says Patrick Mitchell-Fox, senior business analyst.                        
With operations in many markets, Coke would be well placed to facilitate international expansion further and take Costa Coffee to the next level.

  • Tremendous returns received by the shareholders

Whitbread shareholders will receive a majority of the proceeds of the £3.8 billion deal, taking into account the £100 million of costs. Also, Whitbread plans to lower its debt and address its pension deficit.       
It is worth mentioning that the net debt and the deficit were already shrinking. Indeed, Whitbread’s pension deficit was at £289 million at the beginning of March, £136million lower compared to last year. Net debt reached a pinnacle of £910 million in 2016 but fell to £833 million beginning of March. The Gearing is relatively low, with a ratio of Net Debt/ EBITDA equal to 1.

Deal structure        

According to Alison Britain, CEO of Whitbread said: “It’s been a very fast transaction, there was no auction process”.           

The sale was a cash and debt-free deal valuing Costa Limited Business at $4.15 billion (after transaction costs), with Whitbread’s financial debt and pension fund staying with Premier Inn (the hotel chain owned by Whitbread PLC).

During the 2018 fiscal year, (ending March 1, 2018) the revenue of the company is £1.3 billion and EBITDA of £238 million GBP. This is an equivalent of $1.7 billion in revenue and $312 million in EBITDA.        
This involves a 15.7x EBITDA multiple (or 16.4x if we take into account the total enterprise value of $5.1 billion). When Analysts compare the ratio EV /EBITDA of 16.4x to the 13.0x multiple that Nestlé paid for Starbucks’ market rights in mid-2018, they conclude that a hefty premium is paid by Coca-Cola.      

Nicholas Hyett, an equity analyst at Hargreaves Lansdown, commented: “£3.9 billion is an undeniably rich valuation and likely far better than Costa could achieve as an independently listed company, valuing its earnings higher than those of the robust Starbucks, and Coca-Cola is one of the few companies in the world that could justify the valuation”. Indeed, Coca Cola is paying up to 70% premium. Coca-Cola will acquire all issued and outstanding shares of Costa, the wholly owned subsidiary of Whitbread. This M&A deal is planned to be somewhat accretive the first year, which might however be impacted by the purchase accounting (not much in terms of cost synergies).

Two reasons can justify such a premium.

  • The first reason is the desire to circumvent a bidding war with a set of private equity firms that were informally initiating conversations with Whitbread.
  • The second reason is the potential operating synergies generated following the acquisition with Coca-Cola already using a lot of coffee and caffeine in its production chain and with Costa Limited providing the firm with exceptional experience in the field. Besides, Coca-Cola will have the opportunity to make the most of Costa’s retail chain to enhance its worldwide distribution of drinks.

Market Reaction     

The shares of Whitbread climbed to almost 20% following the deal announcement.
Alison Britain, CEO of Whitbread, mentioned that the acquisition reflected growth potential for the company. This has been reflected through an increase of the shares by almost 20% and closed at 14.3% higher following the news of the deal which analysts said was priced at 16.4 times Costa’s latest annual earnings.   
However, the share price of Coca-Cola has been impacted in a negative way. The share price decreased by 0.4% following the deal announcement. This small impact might be explained by two opposite reasons.

  • On the one hand, the acquisition is a good move and helped the company to diversify its product range and attract a new type of health-conscious customers.
  • On the other hand, investors are a skeptic to the fact that Coca Cola will not embrace the retail experience, crucial in the coffee business, which might result in a decrease in profitability. Starbuck, an expert in their approach of building customer relationship and delivering high-quality service, will be a burden for Coca-Cola who usually communicates information simply through advertising ads.

The consequences in the long-term

Whitbread managed to please their resentful shareholders that have been waiting patiently for it to segregate Costa, soothing them through the “substantial premium” received by the shareholders.   
The coffee chain owns the financial support required in order to operate on a worldwide scale and Coca-Cola acquires a brand that diversifies its portfolio, which possesses a platform essential for the company to raise global growth.            

Nevertheless, this acquisition may arise an issue. Indeed, the absence of Costa will make the Whitbread portfolio less diversified, which make Whitbread vulnerable compared to the large hotel players such as InterContinental Hotels Group, Marriott, Accor. Therefore, we may raise the following question:  Could Whitbread become a takeover target?


Rothschild & Co was the unique financial adviser to the buyer the Coca-Cola Company. Coca Cola already had previous experience with the British-based elite boutique which advised the major deal of the 2015 merger of three major bottlers valued at $31 billion at the time. However, Whitbread decided to involve a few banks to advise the deal. Indeed,
Goldman Sachs, Morgan Stanley and Deutsche Bank were all sharing a piece of the pie. Clifford Chance was the legal counsel to The Coca-Cola Company, while Skadden, Arps, Slate, Meagher & Flom were its tax consultant. Slaughter and May acted as legal advisor to Whitbread.

Author : Charles Zeitoun


Markets reaction over Covid-19 outbreak – Insight on pandemic and corona bonds

The world economy is falling into recession as the virus outbreak involves more countries, but as the IMF chief economist Gita Gopinath points out, this is not like a normal recession.

This health system crisis and the drastic governments’ actions as the self-isolation and forced quarantine are strongly affecting the global real economy.

These actions have created a global slowdown of the economy and diffuse uncertainty, which will cost the global economy $ 1tn in 2020, according to what discussed during the World Economic Forum. As the real economy faces recession, financial markets crash and report worst performances since the 2008 financial crisis. Central Banks worldwide are taking important actions to try bring a little calm.

On Thursday 19thof March Christine Lagarde, president of the ECB, has launched a new “bazooka”: the PEPP, Pandemic Emergency Purchase Program consisting in €750bn bond-buying, claiming that “Extraordinary times require extraordinary actions”, a “whatever it takes” kind of statement. Similar plans were made by the Federal Reserve, which has pledged to provide a $700bn stimulus package and has brought interest rates close to zero from the 1.50% at the beginning of the year.

Markets reaction

The entire stock market is being heavily hit with European and US equity indices at the top of the black list, following the path of the virus spread. Eurostoxx 50 has lost 33.34% in the last 30 days while the S&P 500 about 24%. It took a breathtaking 19 trading sessions for the Dow to fall by at least 20% from its record high last February, a drop that meets the commonly used definition for a bear market. That’s the fastest such slide from peak to trough since 1931. It took 16 trading days for the S&P 500 from its record peak to enter a bear market, the fastest such reversal since 1933. The Nasdaq Composite Index also slid into a bear market in those 16 days, the fastest such decline on record. The pummeling would have been even worse if not for several robust, although short-lived, rallies that were fueled by hopes that the government might come up with a financial antidote that would prevent the fallout from the coronavirus outbreak from becoming as bad as it is now.

The industries which had the worst losses have been Oil & Gas Production, Hotel and Tourism, Airlines. The latter was strongly hit with a -62%. Giants like Ryanair and Delta Airlines have been forced to stop almost 100% of their flights due to cross-border bans and planes workload close to 0% due to quarantine and have dropped by 46% and 63% respectively in the last 30 days. Another huge fall is the one of the cruises industry with Carnival Corporation (the world’s biggest cruises company) which has lost more than 70% of its market value in the last few weeks.

On the commodities side, oil prices fell to below $25 per barrel on Friday. Brent and U.S. crude have both collapsed about 40% in the past two weeks weighed by the spread of the virus causing huge decrease in demand due to the low level of consumption and the collapse of coordinated output cuts by producers from the Organization of the Petroleum Exporting Countries (OPEC) and others including Russia. Big Oil & Gas stocks like Exxon in the US and Eni in Europe are facing huge losses, almost halving their market value in the last month.

This week, gold fell from $1,590 to $1,455 before recovering around $1,500. The fall is approximately 8.4 in percentage terms, which is very high compared to average weekly movements. The coronavirus has increased volatility in all asset classes with the equity class’s daily movement of 6% being common nowadays. Precious metals too have seen massive intraday movements and virus-related panic have forced investors to raise cash by selling gold and silver. This situation should not be surprising: investors should look at the history of 2008 crash where the same situation was playing out. In the mad dash to raise cash, sometimes even the safest of safe-haven assets get liquidated. During the heightened crisis of 2008 credit crunch, gold was getting liquidated along with S&P 500 but in Oct-Nov, gold prices started bottoming out in spite of S&P 500 still declining. Once the worst part of panic subsided, gold commenced a new bull market which eventually led prices to all time high.

On the currencies side, must be noticed the unprecedented 4% fall of the British Pound in violent trading week. The UK currency hit a low of $1.1463, having closed the previous day at $1.2050. The dollar extended its gains on Wednesday and hit new multi-year highs against both the Australian and New Zealand dollars, as companies and investors worried by the coronavirus outbreak rushed to the world’s most liquid currency. Markets have crumbled this month as investors liquidated nearly everything for cash driving up the dollar’s value and the cost of borrowing the greenback abroad. The U.S. dollar was last up nearly 0.5% against a basket of currencies, after hitting an almost three-year high in earlier trading on Wednesday. It has gained more than 5% over the past two weeks. Export exposed currencies fared particularly badly versus the greenback. The Australian dollar sank to a fresh 17-year low of $0.59215 on Wednesday, while the New Zealand dollar hit a decade low of $0.5850 cents. Only perceived safe-haven currencies managed to hold their ground against a strengthening greenback with the safe-haven yen up around 0.2% to 107.42 yen while the Swiss franc up by a similar magnitude to $0.9598 francs.

Last but not least, the bond market is living, as the other asset classes, a turbulent and unique moment in its history. US treasury yields have far breached the 1% level threshold falling again on Friday capping off a wild week for the bond market. The yield on the benchmark 10-year Treasury note fell 18 basis points to about 0.93%, while the yield on the 30-year Treasury bond dropped 24 basis points to 1.52%. Bond yields move inversely with prices. On the other side of the ocean instead Germany’s 10-year yield climbed sharply to minus 0.26% at one point, the highest in two months, while UK 10-year gilt yields leapt to 0.7%. The pressure was even more intense in riskier eurozone government bonds. Italy’s 10-year yield surged to 2.78%, the highest in more than a year. In early March, Italy was able to borrow for a decade at roughly 1%.

In this dramatic framework, the good news is that the stock market remains in far better shape than it was during the last financial crisis since the S&P 500 is still nearly worth four times higher than it was at its low point 11 years ago. The bad news is the same government toolbox that helped resuscitate the economy back then may not prove to be a cure for the economic ills caused by the biggest pandemic in a century. While during the financial crisis central banks lowered short-term interest rates (especially the ECB dropped them to 0%) helping to create a virtuous cycle as consumers spent more, this time protecting people’s health is requiring the economy to go into “hibernation” for what could be just a few weeks or could turn into many months until an effective vaccine against COVID-19 is found. After all, consumers can’t spend when they are being ordered to stay home as much as possible.

“Those numbers that in the past would say, ‘OK, you’re definitely at a bottom,’ don’t mean that right now because there hasn’t been evidence that’s taken place,” said Willie Delwiche, an investment strategist at Baird. “It’s extreme markets becoming more extreme, so then your boundaries of what’s extreme need to change with it.”

While the financial world is trying to catch up with this unexpected situation, some debt instruments have been brought to the fore as possible solutions to the crisis and will be discussed in the insight of his article.

Equity indexes performances: S&P 500 (blue), Dow Jones (red), Stoxx 50 (yellow) and FTSE 100 (green)

Pandemic bonds

Very discussed financial instrument during these days is the World Bank’s pandemic bond, a special security designed to make payment to poorer nations whenever a pandemic outbreak reaches certain criteria; countries eligible for payout are 76 countries under the World Bank’s International Development Association.

Pandemic bonds are a particular type of insurance linked securities or catastrophe bonds, also called CAT bonds: they are event-linked debt instruments created by the insurance and reinsurance industry, with the aim of selling insurance risk in capital markets.

CAT bonds are composed of a debt instrument and a call option: if the linked catastrophic event takes place during the life of the instrument, investors lose their principal and interests, while the funds are used by the issuer to pay the arising claims.

The classic structure usually involves the creation of a single purpose reinsurer (SPR), which issues bonds to investors and invests the relative proceeds in short-term securities (government bonds or AAA corporates) held in a trust account. The principal can be partly guaranteed or fully at risk; in the first option the relative tranche is protected, at the occurrence of the event the repayment can be delayed or not completely lost. The majority of CAT bonds, however, are fully at risk: if the event is large enough, the investor loses the whole amount.

To compensate for the risk taken, a premium/higher-than-average coupon is paid to investors, in addition, to immunize from the interest-rate risk, the fixed return on the securities held are swapped for floating return (based on widely accepted interest rate benchmark).

An emission of this kind took place in July 2017, covering six viruses likely to cause a pandemic, including coronavirus. The aim was to provide financial support to the Pandemic Emergency Financing Facility (PEF), created by the World Bank to channel funding to developing countries facing the risk of a pandemic. The emission was in response to the Ebola outbreak in Africa between 2014 and 2016, the goal was to transfer the economic risks of a disease outbreak from under-developed countries to financial markets.

The 5-year note is divided in two tranches for a total size of $320m. Investors are aware and ready for losses, since last week the World Health Organization (WHO) has declared the covid-19 outbreak has reached pandemic proportions. However, some conditions (which differs from tranche to trance) set by the World Bank have to be met: the outbreak needs to last more than 12 weeks and cause more than 2.500 fatalities. In addition, it takes 84 days after the first WHO “situation report” on an epidemic to the funds to be transferred.

Investors holding the riskier tranche, B, are set to lose the full principal of $95m; whereas tranche A investors can lose a maximum of 17 per cent of the total investment, $225m.

The conditions set are very discussed for several reasons: they are considered too stringent, e.g. when the second Ebola outbreak in 2018 killed 2.200 people in the Democratic Republic of Congo, nothing has been transferred because the outbreak didn’t reach 20 death in a second country. A second objection regards timing and it is brought by public health experts who believe that the funds availability will be too little to help poor countries.

Investors who have chosen to buy pandemic bonds were mainly driven by two reasons: they offer a much higher yield than other fixed income products (Class A: 6.5% plus 6-month US dollar Libor rate; Class B: 11,10% plus 6-month US dollar Libor rate). Secondly, this asset class is not linked to stock market performance therefore was seen a good opportunity for diversification; however, DBRS Morningstar cautioned “the current coronavirus outbreak is showing that the valuation of pandemic bonds is highly correlated with the performance of global financial markets when it matters most”.

There is no public information on who precisely the investors are because they were privately placed but they are mostly based in Europe and US.

Corona Bonds

Another very discussed instrument is the coronavirus or simply “corona” bond: the Italian prime Minister Giuseppe Conte has proposed the issuance of corona bonds as a European common response to the difficult economic circumstances the EU is facing.

In fact, the roots of the discussion are to be found in 2011, sovereign debt crisis: when northern European countries, such as Germany, the Netherlands and Austria refused to join their debt with riskier countries, Italy, Greece and Portugal, issuing debt together. However, the current situation appears different as the covid-19 is giving a shock to the entire system and measures need to be more coordinated and consistent to protect the eurozone.

ECB member and governor of the Bank of Portugal, Carlos Costa, suggests a bond issuance characterized by maturity of several decades and the proceeds would only be used to deal with the economic consequences of the virus. Regarding the amount some German economists suggest the joint bond issuance should amount €1tn.

The issuing institution of corona bond has to be a European Institution, that will likely be the European Stability Mechanism (ESM) or the European Investment Bank (EIB).

Coronabonds still need to be fully discussed but given the different circumstances, the arguments used in 2011 no longer regard moral hazard, as the proceeds would be used to cover the spending due to the virus outbreak, affecting the whole region.

Authors: Silvia Monge, Mirko Filice


























Leveraged Buy-Outs: Why do some of them fail?

In 2007, at the peak of the real estate bubble, Blackstone Group invested $6.5bn equity in Hilton Worldwide. Soon after the transaction, the economy plummeted, and it seemed as the group could not have chosen worse time, especially when Lehman Brothers and Bear Stearns – Blackstone’s partners – fell apart. The story took a significant u-turn as the Hilton re-listed in 2013, transforming doomed-to-spectacularly-fail into one of the most profitable private equity deals ever. After 11-years of relationship, Blackstone finally „checked out” from Hilton realising $14 billion of profit.

Even though the Blackstone Group managed to triple its initial investment, the very same period brought losses to others. In the era of mega-buyouts (2005-2007), a consortium led by Kohlberg Kravis Roberts & Co. (KKR), Texas Pacific Group (TPG Capital), and Goldman Sachs acquired the largest electricity utility in Texas, then known as TXU for $48bn. In 2007, the investors were betting on rising natural gas prices giving its coal-fired plants a significant advantage. What happened soon after the acquisition, was the exact opposite – U.S. shale gas revolution tumbled the natural gas prices. Today known as Energy Future Holdings, the company filed for Chapter 11 in 2014. The biggest deal in history, left Energy Future Holdings with $40bn debt, and even Warren Buffet himself ended up losing nearly $900mln throughout the investment.

What these two deals have in common, is the form of their financing: leveraged buyout.

What is an LBO?

A Leveraged Buy-Out (or LBO) is a form of acquisition that implies a significant amount of debt as a mean of financing. The sole purpose is to increase the financial leverage by reducing the equity capital in an acquisition. In order to do so, a holding company is created with one aim: holding financial securities. The holding company borrows money to buy a company, generally called “target”. The holding company has to pay interest on the debt and also pay back the principal with the cash flows generated by the target.

The following figure depicts the framework of an LBO:

There are two main strategies in order to maximize the Internal Rate of Return (IRR):

 1) Buy and Hold (B&H): Before the subprime crisis, investors were investing in companies without really looking to be involved in their growth rate. It is a form of passive investing, where PE funds are building a diversified portfolio where they only have to wait on their returns.

 2) Buy and Build (B&B): After the crisis, financial sponsors have adapted their strategies, particularly developing an interest for having a goal of going public with their target companies. Buy and Build is strategy-related with a long-term vision, thus involving a closer relationship between target management and sponsors, creating real synergies.

Why do some of them fail? 

As simple as it may look, the leveraged buyout is a transaction that requires specialized knowledge and involves technicalities, that cannot assure positive outcomes. There exists a number of reasons for LBO failures, which differ due to transactions’ diverse nature. The following are characteristics that accompanied the greatest failures in LBO transactions:

  1. financial distress of a company;
  2. the obligation to refinance debts in order to avoid a company going bankrupt;
  3. breach of an agreement;
  4. the capital loss exceeding the initial investment from financial sponsors;
  5. unexpected departure of top management;
  6. the size of a target company.

For the purpose of this article, we have decided to discuss how the size of a company can influence the success of an LBO transaction, focusing on the situation in France.   

Recently, the SME market has constituted a main target for LBO transactions, as it involves smaller investments and lower risk. The main threat comes from the lack of knowledge of LBO transactions, potentially leading to the failure of the buy-out (by not following the business plan or by confronting different visions). According to BPIFrance, mid-caps are constituting an ideal target for LBO activity, through realizing the best financial performances (having a margin rate of 25% vs 20% for SMEs), being more established internationally (with an average of 5 subsidiaries abroad), and more diversified (31% of mid-cap firms are acquiring holdings in other companies), but they are not infallible. However, failure in this market exists as well. According to Souissi (2013), breaches of covenants are more present in Midcaps than SMEs, the former having an average of 46%  breaches. But Midcaps are more targeted by covenants than SMEs. So regarding large corporations we can wonder if they are too powerful for LBOs.

The real issue with large corporations is refinancing, which means reporting the debt, and the risk. Risk is strongly linked to the banks, and considered more important nowadays, even if the “too big to fail” effect still exists, and can give some ways of pressure. Moreover, banks tend to issue loans more quickly for a significant amount, which implies a bigger leverage effect, and an increase of loans for larger corporations (8.1% in June 2019 YTD. Source: Banque de France).

Number of companies in 06/2019Amount issuing for loans (in €bn) in 06/2019Variation (in %) 06/2018 vs. 06/2019
Mid Cap6,451280.2+4.0
Large Cap284146.7+8.1

Following this pattern, the “Haut Conseil de Stabilité Financière” (HCSF) decided to set (in July 2018 and for a minimum of 2 years) a limit of 5% of the equity capital for any loan exceeding 300 million of euros issued by a large corporation in France. This preventive measure is established in order to avoid a large and risky concentration on systemic banks such as BNP Paribas, Societe Generale, Credit Agricole, that are covering 95% of the credit outstanding.

From the perspective of a financial structure, things have drastically evolved. Not only has the debt ratio decreased, the financial structure has also changed, leading banks to refuse the financing of Term Loan B (or “in fine”) and its limit of 30%. Now the tendency for them is to focus on the first main amortized Term Loan A:

Example of a Balance Sheet of a target in an LBO transaction (after the subprime crisis)

AssetsLiabilities & Equity
Value of titles

Financial fees  
·Equity Capital  (minimum 50%)
·Senior debt (maximum 50%)
– Term loan A (70%) on 6 years
– Term Loan B (30%) on 7 years Debt Mezzanine (0 to 10%)
Debt Mezzanine (0 to 10%)
Source: Quiry and Le FUR Vernimmen 2016

LBO transactions now require more equity into the financial consolidation in order to satisfy the financial sponsors.

The European Central Banks, being aware of this tendency, did not hesitate to act and established the “ECB Guidance on leveraged transactions”. In this set of new rules, it is stated that banks issuing loans to companies with a ratio Debt/EBITDA above 4x should improve their risk management and surveillance system. It is therefore of great importance that the selected target company in an LBO is capable of generating strong cash flows along with having a solid business model.

Can we really understand the failure of LBOs?

It is not clearly possible to identify and say how to avoid the failure of LBO transactions, but some key factors can be identified. The financial structure of the debt plays an important role in a buy-out. Finding the right amount between debt and equity in order to decrease the risks for the actors is essential, especially by respecting the covenant set into the LBO. As explained, banks are changing their financing model following the crisis, by limiting the amount of debt issued at the amount of the Equity capital, focusing on the first term loan amortized.

Private Equity firms are using their resources, their connections with other firms, their risk management and their network to be involved in the growth of the target company. However, all those resources are limited, and according to Steveno (2005), top managers are themselves deciding alone on which pieces of information are given to financial sponsors.

Nowadays, financial sponsors tend to hold LBO targets for a longer amount of time, but as the last phase approaches, the visions from sponsors and top managers are less innovative and centered mainly around the maximization of the IRR rather than realizing the strategy of the company.

Authors: Qitong Sun, Joanna Przadka, Nicolas Chedeville, Erik Steineger and Nikolas Schmitte





QUIRY, Pascal; LE FUR, Yann.Pierre Vernimmen Finance d’entreprise 2016, Chapitre 50 -Les LBO, en ligne, Edition Dalloz, 2016, p1015-1032







The birth of a true Apple Watch competitor

Google has struck a $2.1bn deal to buy fitness-tracking pioneer Fitbit, in order to team up to take on Apple’s fast-growing wearable-tech business. Google announced the acquisition in November 2019, and the deal is expected to go through in early 2020 following the Fitbit shareholders’ approval of the third of January. Could this mean we’ll finally see an actual Apple Watch competitor?

About Fitbit

Fitbit Inc., incorporated on March 26, 2007, is an American provider of health and fitness devices headquartered in San Francisco, California.

Its products include activity trackers, wireless wearable technology devices that measure data such as the number of steps walked, heart rate, quality of sleep, steps climbed, and other personal metrics involved in fitness. The company also branched into smartwatches to keep pace with rivals Apple and Samsung.

One of the main strengths of Fitbit is its platform that combines connected health and fitness devices with software and services, including data analytics, motivational and social tools, personalised insights and virtual coaching through customised fitness plans and interactive workouts.

Since 2010, Fitbit has sold almost 100 million devices worldwide and has over 28 million active users. The company is amongst the leading companies in the wearable market, which includes well-known firms such as Apple, Xiaomi, Huawei and Samsung.

Number of Fitbit devices sold worldwide from 2010 to 2018
Number of active users of Fitbit from 2012 to 2018

From 2010 to 2015, Fitbit’s revenues increased from just over 5 million U.S. dollars to more than 1.8 billion U.S. dollars. In the years following this rapid expansion, the company has experienced a period of decline, with its total revenue figure decreasing to 1.5 billion U.S. dollars in 2018. Forecasts suggest that total shipments of wearable electronic devices will reach 220 million units in 2019 as Fitbit looks to regain its footing within the growing industry.

About Google

In 2014 Google released Wear OS, a Google’s Android operating system version designed for smartwatches, but the Mountain View giant had decided not to make the hardware itself, leaving that to third-party manufacturers.

Google’s strategy however seems to have changed in the last year. In January 2019, the tech company bought some of Fossil’s smartwatch technology and hired some of the engineers who created it. The move prompted speculation that we would finally see a Google Watch soon, confirmed by an official statement regarding the Fitbit buyout:

“Over the years, Google has made progress with partners in this space with Wear OS and Google Fit. But we see an opportunity to invest even more in Wear OS as well as introduce Made by Google wearable devices into the market.”

Rick Osterloh, Senior Vice President of Devices and Services at Google.

About Google’s purchasing offer

Fitbit is Google’s biggest acquisition in consumer electronics since it paid $3.2bn for smart home company Nest in 2014.

With its offer of $7.35 a share, Google has rekindled investor interest for Fitbit. After a $20 initial public offering in June 2015, Fitbit had reached its highest price of $47.49, followed by a sharp decline during the past four years until a $2.99 per share price. The announcement of the Google acquisition in November has pushed the share price up to $7.14 with a subsequent decrease to $6.64 due to the Fitbit’s disappointing quarterly results.

Fitbit’s stock price since 2015 IPO


Google has greatly expanded its hardware portfolio in recent years to include Pixel smartphones, smart speakers, Nest thermostats and security cameras, and various entertainment devices. But it never released its smartwatch to rival Apple directly despite the fact that Wear OS has some advantages over Apple’s technology.

Launched in March 2014 Wear OS had more than a one-year head-start over Apple Watch and it is also a cross-platform system, working nicely with both iOS and Android devices, differently from Apple Watch.

Specifically, what Fitbit can give to Google, besides its hardware technologies and expertise, are its 28 million active users, and a 12-year history of selling more than 90 million of units, with a smartwatch market share of 11.3%, third place after Apple 47.9% and Samsung 13.4%.

On the other side, Fitbit stands to gain a lot too. What Google can offer is in fact a solid and tested operating system, able to perform well with both Android and iOS devices, backed by necessary resources and capabilities to further develop and improve it like the other big players such as Apple.

Furthermore, what Google does, better than any other company operating in the wearable sector, is Artificial Intelligence. Google Assistant is, in fact, without any doubts, much more developed than Apple’s Siri. That’s really important when talking about a device with a screen that’s typically around an inch and a half to make the device more user-friendly, avoiding the use of the small and uncomfortable touchscreen.

Privacy concerns

Politicians and privacy campaigners have called for Google’s $2.1bn deal for Fitbit to be blocked, over fears that the search giant will feed its growing healthcare business with the data of the 27 million people who use Fitbit fitness trackers.

The takeover, if it is passed by regulators, will give Google access to a huge amount of heart rate, activity and sleep data which it could use to create a new range of personalised health services. Worried about this scenario, both privacy and antitrust advocates have asked the Federal Trade Commission to block the purchase, arguing that health data are “critical” to the future of the digital marketplace.

“Google should not gain control of Fitbit’s sensitive and individualised health data that can be integrated with data from its current services to entrench its monopoly power.”

Several groups including the Open Markets Institute, Public Citizen and the Electronic Privacy Information Center.

It is clear indeed that through its vast portfolio of internet services, Google knows more about us than any other company, owning a huge amount of user data. The nature of the data (health) that Google would rise after Fitbit takeover has attracted the attention of the regulators, particularly sensitive to data protection and usage nowadays.

On its side, Google did not say whether Fitbit data would be used to inform other Google products, and privacy advocates fear that the data collected will not be ringfenced but will instead be used for a variety of applications across the company and also utilised to allow Google moving further into the healthcare sector.

This is not only the strategy of the Mountain View firm but strong trend affecting many of the large technologies companies such as Apple and Amazon, eager to disrupt the healthcare industry, which represents more than the 18% of the US gross domestic product.


Sell side: Qatalyst

Buyside: Lazard

Author: Gian Pietro Bellocca



Wall Street, New York. On February 19, at the closure of the stock market, Tesla has reached the highest valuation since the company’s listing in 2010:  $917.42 per share. A new outstanding record for Elon Musk’s creature, a company that has a tormented and turbulent history, but which, in good or bad times, has always attracted the interest of supporters and detractors.

Just a few weeks before (January 21), the company that has revolutionized the car market has topped $100bn of market value for the first time, capping a dramatic rally that has seen its share price rise 125% in the past three months. At that level it is worth more than Volkswagen, the world’s biggest carmaker by volume.

This is not the first time that Tesla’s stock is protagonist of extreme bullish runs, but this time it seems to be different than in the past, when sudden rises have been followed by drastic plunges. Maybe a true turning point has been reached, for a company that just few months ago was on the verge of collapsing (in May 2019, in fact, Musk told Tesla employees that the company would have run out of cash in about 10 months unless “hardcore” cost-cutting efforts were made). 

From its inception, the electric car maker has always lived a difficult financial situation – burning billions of dollars and being very far from profitable. The margins realized on the sales (Tesla’s cars are mainly positioned in luxury and sport categories) have never been enough to counterbalance the production issues and huge R&D costs, much of which were allocated to the development of autonomous driving vehicles. Nonetheless, Tesla’s brand has become known as a symbol of ultimate technological development worldwide, and one that has built a group of loyal customers that some critics confuse with fanatics.

Despite weak financials, Tesla’s stock has had relatively high valuations with much higher multiples with respect to the carmaker’s competitors in the past, mainly because of future growth and profitability expectations that quarter after quarter looked more and more distant from being realized. 

This until the third quarter of last year, when the company reported extremely positive earnings reaching $1.86 EPS (i.e. Earning per Share) vs -$0.42 EPS expected by market consensus. From there on, the stock price has started its unbelievable rise, reaching and now breaching, the $100bn market cap milestone, which marks a moment of vindication for Elon Musk, who will have the option to buy about 1.69 million shares at about $350 each if the market capitalization remains above this threshold over a six month period (a payout worth more than $370 million before taxes at the current stock price). 

Tesla has just released another better than expected earnings report for the last quarter of 2019.

Here’s how the company performed against the expectations:

  • Earnings: $2.14 adjusted vs. $1.72 per share expected (an increase of 7% YoY)
  • Revenue: $7.38 billion versus $7.02 billion (an increase of 2% YoY)

The main reasons for this positive performance can be identified by the following drivers:

  • Production
  • Deliveries
  • Cash position

Tesla has decided to focus on Model 3 production which has reached a 42% increase YoY with respect to a 29% decrease YoY for Model S, whose demand has never been very high during the year with respect to the lower positioned Model 3 (Model S is priced at about $75k vs $40k for Model 3). The company has been able to start Model 3 production in Gigafactory Shanghai in less than 10 months from breaking ground and has already begun the production ramp for Model Y in Fremont, which may give further boost to sales in the following year.

Source : tesla.com

An even greater achievement for the electric car maker has been the increase in deliveries. For Model 3 they have increased by 46% YoY, confirming the increase of demand and the improved capability of the company to fulfil these orders especially in Europe and in the Chinese region. 

From the financial point of view, the most important achievement for Tesla is the cash position. Quarter-end cash and cash equivalents increased by $930M (+17%) QoQ to $6.3B, driven by positive quarterly free cash flow of $1.0B. Capital expenditures increased sequentially due to investments in Gigafactory Shanghai and Model Y preparations in Fremont. As stated in Outlook of the Tesla’s Update File, the company expects “positive quarterly free cash flow going forward” and above all that the “business has grown to the point of being self-funding”, instilling trust in all investors concerning one of the main drivers for companies’ valuation.

Another great performance has been delivered by the Energy Business, less known but as much important as the automotive one. Energy storage deployment reached an all-time high of 530 MWh in Q4, which included the first deployments of Megapack, the new commercial scale 3 MWh integrated storage system that is preassembled at Gigafactory Nevada as a single unit. Since the introduction of this product, the level of interest and orders from various global project developers and utilities has surpassed company’s expectations. In 2019, Tesla deployed 1.65 GWh of energy storage, more than what has been deployed in all prior years combined.

After all these positive results many analysts have now changed their valuation of the stock, some increasing the target price to $800 per share and being confident that the company is finally on the right path towards becoming what it’s supposed to become from the beginning: a world changer. 

The future of the company has a much better outlook but will depend on greater efficiencies in production, on differential improvements to self-driving technology, on moving into the world’s largest automobile market, and on long-term orientation. Tesla has a substantial competitive advantage with respect to “traditional” car makers which have only recently begun to heavily invest in the electric segment (e.g. Volkswagen’s investment amounts to ~$40bn). For this reason, a lot of Tesla’s future performance will also be conditioned by how quick and effective the competition will be in terms of catching up on performance, technology and convenience.

A lot can be said about Tesla, but the results speak for themselves – this is not a traditional company. Its mission is not to sell cars, or even to sell batteries, it goes much further. Its mission is to anticipate the future, a much better future, and to make it easier for us to think about how to get there. Will it really accomplish this extremely challenging purpose? Is this the beginning of a new era for automotive world with Tesla leading the way? Who knows, maybe only Elon Musk does…

Author : Mirko Filice

Sources :


These last months have been characterized by an increasing importance of the role of the Repurchase Agreements in the financial markets. The rate linked to it has never been this fundamental thus attracting the attention of the entire financial world. Much attention was attributed to the unprecedented spike of Repo rates in September. Market participants are now constantly looking at central bank’s moves and trends in order to understand the wealth of markets. Central banks around the world, and the Federal Reserve (Fed) in particular, planned to double Repo intervention to avoid cash crunch in response to concerns of a jump in short-term borrowing costs. In September 2019, the interest rate for the overnight money market jumped to 10%. Banks were not inclined to lend out capital for the Fed’s target interest rate of 2%. Therefore, the Fed answered to the cash crunch by financing the Repos, which gave the 2% interest on these short-term loans in order to bring the interest rate down and to pump the cash into the market.

  1. Introduction to the REPO market

The Repo (repurchase agreement) is a money market instrument set by central banks that concerns one party – usually banks – lending out cash in exchange for an equivalent value of securities. This market helps companies which own a lot of securities but are short on cash to cheaply borrow money. More technically, the Repo (Repurchase Agreement) is a type of short-term borrowing for dealers in government securities, which involves a dealer selling government securities to investors, on an overnight basis, and buying them back the following day at a higher price. This requires one party lending out cash in exchange for the same value of securities as collateral. The exchange permits the party that own securities to borrow cheap cash and the other party to earn a small amount of interest while taking negligible risk. The differential in the price is the overnight interest rate (repo rate). The longer the term of the repo, the highest probability that the collateral securities’ value will fluctuate before the repurchase and the business activities will impact the repurchases ability to fulfill the contract. Therefore, the counterparty credit risk is the primary risk involved in repos; in loans the creditor bears the risk that the debtor will not repay the principal, but repos as collateralized debt reduce total debt. These agreements are beneficial for both parties as the repo price is bigger than the value of the collateral.

There are different types of repos. The most common agreement is the third-party repo in which a clearing agent manages the transactions between the buyer and the seller protecting both interests. The clearing banks hold and value the securities and ensures the seller receives the cash and the buyer transfers funds and deliver the securities at maturation. However, the clearing banks do not know act neither as matchmakers nor as brokers. The third-party repos account for more than 90% of the Repo market, which held approximately $1.8 trillion in 2016.

Another type is the specialized delivery repo which requires a bond guarantee at the beginning of the transaction and upon maturity. The last type of repo is the held-in-custody one in which the seller receives cash holding it in a custodial account for the buyer.

Central banks repurchase securities from private banks at a discounted rate which is known as repo rate, which is set by the central banks themselves. This allows governments to control the money supply in the economy managing funds. If repo rates decrease, the banks are encouraged to sell securities to the government in exchange for cash, which in turn increases the money supply, while an increase in the repo rates discourage banks in reselling securities decreasing the money supply in the general economy.

Its increasing importance is given to the fact that the Repo is used to raise short-term capital, facilitates central bank operations and ensures liquidity in the secondary debt market increasing money supply available in the market. Moreover, hedge funds borrow cash in the repo market to fund leveraged investments on a cost-efficient basis and also borrow securities to allow them to take on short positions stopping asset bubbles from developing. This is important for injecting market liquidity and driving price through arbitrage and trading. Investors also borrow securities in the repo market to sell short to hedge their investments against the movements in securities prices.

  1. REPO rates September spike

If we analyse Repo trading volume from October 2017 to January 2020, we see an increase from $772bn to $1093bn, with a spike in September registering $1196bn total volume traded.

This came in an environment characterised by a decline in the importance of the Repo market, accounting from the 33% of GDP in 2008 to 17% of the GDP in September.

This is primary linked to the demand for cash that went on increasing as liquidity was needed by financial institutions. Demand for cash exceeded supply, and the Fed had to intervene through the expansion of its balance sheet.

In July, the Congress agreed to make the US Treasury borrowing more through the issuance of Treasuries, and consequently the repo market reversed as cash held by US Treasury increased.
Because of the cash crunch affecting markets, in September, Repo rates increased from 1.89% – 1.95% average rate to 10%, which was four times higher than the prior week.
The Federal Reserve responded to the turmoil by expanding its balance sheet and highly injecting liquidity in the repo market. In mid October, the FED increased the overnight repo liquidity disposal from $75bn to $120bn daily. The central banks did not only intervene in the short term but also expanded the two-week liquidity disposal for repo from $35bn to $45bn.
The purpose of this massive unconventional intervention was to backstop against unusual spikes in repo rates thus affecting global markets and cash availability.
Even though some experts saw this move by the FED as a way that could potentially be used also in the future to control interest rates, the American institution warned that this intervention will not be a frequent measure but available when needed.

Source: tradingeconomics.com – Federal Reserve
  1. Causes of the spike

The sudden increase in rates was due to a cash crunch affecting markets, but the real rationale behind this is still unclear. Many could be the reasons, but the ones more directly related are the quarterly tax payments, the settlement of treasury debt and Liquidity Coverage Ratio rules.

Firstly, on September 16th there was the cut off for quarterly tax payments, where the money was taken from companies’ accounts and deposited in treasuries. At the same time, $78bn of treasury debt settled.

Moreover, reserves balances were lower than normal. After the Fed terminated its quantitative easing program in 2014, it tried to shrink the system’s reserves to a normalized level – minimum level of reserves is estimated to be $1.2-1.3 trillion. According to data from the Fed, total reserves edge closer to these levels.

Lastly, under Basel III Regulation new balance sheet requirement arose, as the LCR Liquidity Coverage Ratio rule – requiring to hold a buffer of liquid assets – keeping either reserves or cash availability high for the central bank at all times in order to keep banks solvent. After the 2008 financial crisis, central banks started to require higher reserves in order to decrease risk of default and avoid Fed intervention.

  1. Alternative: Foreign exchange derivatives

Even though liquidity has been restored and injected in the market, some experts claim that the FED intervention through repo rates adjustment did not calm the Money Market because some liquidity has been taken from the FX swaps market.

A foreign exchange derivative – also known as FX swap – consists in an exchange of currency between two parties that have long or short positions in different currencies. The agreement consists of swapping principal and interest payments on a loan made in one currency for principal and interest payments of a loan of equal value in another currency. One party borrows currency from a second party as it simultaneously lends another currency to that party. In 2008, the Federal Reserve System made this particular swap available to emerging countries.

In the case of the United States, FX swaps contracts allow a non-US entity to exchange non-dollar cash flows for dollar cash flows. As written by Claudio Borio, Robert McCauley and Patrick McGuire “A key finding is that non-banks outside the US owe large sums of dollars through these instruments. The total is of a size similar to, and probably exceeding, the $10.7tn of on balance-sheet dollar debt.”

FX swaps are technically equivalent to borrowing and lending in the cash market with the difference that they do not appear on the balance sheet and their existence stays unknown by outsiders.
If we look at the numbers, the dollar repo in earlier november was at 190 bps, T-bills at 150 bps and ¥/$ FX swap at 230 bps for a synthetic yen-dollar repo. In this scenario, dealers and brokers have an incentive in terms of return to lend dollars in the FX swap market rather than the domestic money market.

  1. How FED is going to intervene in the Money Market in the future

The FED tried to increase reserves in the banking system and intervene on liquidity shortages also through $60bn monthly purchases of Treasury bills from mid-October.

The overnight lending facility injection by the FED further expanded in December, as repo rates and volatility in general usually increase at the end of the year. Investors and analysts feared a repetition of the 10% spike of September, but thanks to a massive FED intervention, markets did not panic and rates were under control. On December 31, the US Central Bank provided $25.6bn in overnight funding with maturities throughout January.

This intervention was prompt and successful, the liquidity is still circulating in the markets and this shows that the central bank could effectively manipulate liquidity injections readily available for financial institutions and players when needed.

The Fed is currently trying to decrease its intervention on the repo market but still wants to keep rates low to avoid spikes in rates as happened in September.

At the beginning of February the New York Federal Reserve decreased the marginal cost of funding from 1.60% to 1.59%, it was surprising to see how heavily market participants reacted to this news, showing a highly sensitive demand from market participants that submitted $59bn in bids for the central bank’s offering. 

It is known that the demand for short-term funding remains high in the market but the central banks has clear the willingness to cut the size of its interventions. A new plan has been published by the Federal Reserve lowering the overnight lending facility from $120bn to $100bn and the two-week facility from $30bn to $25bn to go back to March 2019 supply levels.

What is coming next? The problem now is that the Repo market has been distorted via the central bank’s interventions and in the future, new rate jumps could happen.

Authors: Elena Paparcone and Arianna Brasiliani






















The EU setting the pace for sustainable finance across the world

During 2019, issues related to sustainable finance have gained momentum throughout the world (Goldman Sachs pledging to invest more than $750 billon in ESGs by 2030 in December 2019) but especially in Europe and more precisely in the EU. This issue has indeed become the cornerstone of EU policy. The EU Green Deal demonstrates the extent to which sustainable finance is becoming an increasingly crucial issue.

The rise in awareness of sustainable finance in the EU stems from long before the EGD in 2019. Indeed, a major interest has been centered around sustainable finance for the past years. This is demonstrated by the 2016 creation of the High-Level Expert Group on Sustainable Finance. This group includes about 20 senior experts in all domains and one of its main aims is to help the EU protect the stability of the financial system against environmental risks.

The European Green Deal, set forth in December 2019 in order to make the EU climate neutral by 2050, takes a step further for green finance and displays a proactive approach. For example, in Q1 of 2020, the Commission has planned to launch a public consultation on a renewed sustainable finance strategy that will be presented in Q3 2020. Most importantly, the Commission is trying to aim homogenization. Indeed, its main aim is to establish an EU Green Bond Standard and examine how it can increase both public and private finance for green and sustainable investments. The investment plan of the EGD is expected to mobilize at least €1 trillion of sustainable investments needed for the transition to a climate-neutral economy.

All these moves have demonstrated the EU’s will to be a prominent actor in this domain. Following the cooperation put in place between the EU and the IMF to support sustainable development in 2019, Managing Director of the IMF, Kristalina Gerogieva drew attention to the avant-garde role of the EU played in sustainable finance: “We appreciate the EU’s leadership on sustainable development for all. We have a history of working together in building strong economic institutions to improve economic performance and the livelihoods of people in our partner countries. This Agreement will deepen our collaboration and help us do more together, especially where it matters the most — in low-income countries and fragile states.”

Throughout this statement, we can understand that the EU has not only made it its will to reform the domain of sustainable finance within the continent but also at a larger and more international level.

In his book Norms over Force: The Enigma of European Power, Zaki Laidi mentions that the EU can never be a superpower, however it is and can potentially be a “normative power”. This denomination can be used in the case of the Green Deal but also the development of the European Green Bond Market. Indeed, the EU’s normative bodies expressed their desire to monitor and regulate more its green bond market.

The European Commission decided in December 2019 to adopt new legislation concerning green, or also called sustainable, bonds. When issued, the issuers of the bonds need to declare the percentage that is environmentally friendly. The deal will especially be classifying the bonds in 3 categories: from the least green type to the greenest one. The EU has, therefore made significant efforts in order to establish an EU green bond standard and taxonomy for the mentioned products. Any member state of the EU will need to apply the framework implemented by the Council, aiming to create a more homogeneous market for green financial instruments. These taxonomy requirements will need to be fulfilled by 2021 by the EU member states as well as financial market participants in the EU. All these efforts are made to make the EU green bond market mature and improve the credibility of green bonds at a broader scale.

Sustainable investing across the world

Sustainable investing across the world

Europe is doubtlessly a very dynamic market for green bonds and green financial instruments, and the growth has been exponential for the past years. For example, in 2008, there were few actors in the European green bond market, indeed, it mainly concerned States and investment banks. However, in 2018, 145 entities issued green bonds in Europe, representing a third of those in the world. The EMEA region has therefore made headways in terms of volume compared to all other geographic regions. For example, in 2019, EMEA accounted for more than 74% of volume in global green and ESG loans. It is safe to say that most of these loans are emitted by countries in Europe and more precisely countries of the EU.

As a leader in sustainable finance, the EU has made the pledge not only to be a normative power that regulates its own market, but it has taken the initiative to set the tone on a worldwide scale, as demonstrated by the cooperation with the IMF. Europe was the first to step on the ground of the nascent market of green bonds and it intends to stay.

Authors: Oumaima Sadouk, Edoardo Castangia












Analysing the DAX in Germany’s economy

The link between a country’s economic health and the behaviour of its stock index, specifically the performance of the index during periods of decreasing economic growth has always been an intriguing topic. Accordingly, the aim of this article is to illustrate the role of the DAX in the German economy and how the index moved in comparison to the country’s well-being.

Germany has a current GDP of $ 3.95 trillion as measured by nominal gross domestic product. Being the World’s fourth largest economy, following the US, China and Japan, some say that the country has flourished over the last 12 years. Contrary, to the years before 2008 where the country struggled with modernization costs of Eastern Germany and unemployment rates higher than 10%. Its chancellor Angela Merkel strengthened the country’s economic position by successfully pushing through stimulus efforts and tax cuts in the past decade.  Similarly, the country’s leading index, the DAX, has steadily increased and more than doubled in value since 2008. However, as history has shown, the DAX and Germany’s economy do not seem to be as closely related as one might initially infer. Although the index was pushed down during longer times of recession such as the bust of the dot.com bubble in 2002 and suffered during the financial crisis in 2008, German stocks have suggested robust performance during times of smaller recessions. 

 Graph 1: DAX performance during times of recessions since 1990

An analogical development can be analysed when looking at the development of the DAX and the German Economy in 2019. According to Claus Michelsen, head of forecasting and economic policy at the German Institute for Economic Research (DIW Berlin), the country would enter its first official recession in six years, mainly due to a cooling export sector. Although Germany only narrowly avoided that scenario with a minimal GDP growth of 0.1 percent in Q3 of 2019, the DAX performance, shrugged off all bad news and maintained a healthy growth development. As results in the following graphs show, while Germany’s GDP has shown signs of weakness over the last 2 years as growth rates turned negative in July 2019, the country’s most valuable companies have continued to exhibit extremely low volatility and a constant growth rate of 17.58% in 2019.   

    Graph 1: DAX performance since 2017    

Graph 2:  German GDP Growth Rate quarterly since 2017

Global political uncertainty affects German exports

Heavily relying on international trade, Germany is the world’s third-largest exporter, led by sales of the automotive industry, machinery, chemicals and electronics. In 2018, the country shipped $1.557 trillion worth of goods around the globe, which reflected a 7.4% gain from 2017 to 2018. However, as of September 3, 2019, the Federal Republic only exported $752.7 billion worth of goods in the first 6 months of 2019, dropping -6.1% compared to the same period one year earlier. 

This is a clear indicator that at the centre of Germany’s latest economic cooling is the struggling export sector. It has been mainly hurt by a slowdown in China due to consistent concerns over a prolonged trade war. Despite the fact that President Donald Trump and Chinese leader Xi Jinping have entered a “Phase 1” agreement based on “mutual respect and equality”, many economists argue that several further steps need to be taken in order to ensure a sustainable global relief. Additionally, the US hit Germany more directly by imposing record tariffs on the EU of $7.5 billion in response to its subsidies for European aircraft maker Airbus.  A second factor that negatively influenced Germany’s export rates is the UK’s exit from the European Union. As the general election in December has helped Boris Johnson to gain a needed majority in the House, the Conservatives are set to finalize their departure. 

On top of that, a sharp decline in the car industry, which has been disrupted by new emissions rules and the shift to electric vehicles, has further put the German economy under stress. Only due to a surprising rebound, as German exports rose to 4.6% in September, Germany avoided a technical recession. As a revive in trade to other EU countries, the UK and US offset a decline in China and provided a boost to the export-focused economy. Carsten Brzeski, economist for Germany at ING admitted that “today’s trade date leaves analysts somewhat scratching their heads.” (November, 2019) Particularly strong growth in the Netherlands and Belgium, as well as 6.9% increased exports to the US upheaved Germany at the last minute. Nevertheless, GDP figures are still expected to show another shrinkage. 

The DAX and its performance in 2019

The DAX, which was created in 1988 with a starting value of 1000 points consists of the 30 largest German companies by market capitalization (calculated using the XETRA-prices). The companies are traded on the Frankfurt Stock Exchange and have different legal requirements to fulfil in order to enter the German index. As one can see in Graph 1, the DAX has increased by around 26,02% from 10.580,19 points on January 2nd, 2019 to 13.337,11 on December 27th, 2019. Among the top gainers in 2019 were the usual suspects such as Bayer, Adidas or RWE. The pharmaceutical and production sector withstood the struggling exports and continued to show robust growth throughout the year. However, major automotive companies such as BMW, Daimler or VW were heavily affected by the trade war and the shift to green energy. In fact, almost all transport-related stocks experienced a rough year and had to deal with a negative performance. 

How can the DAX perform well, despite the German economy struggling?

According to an analysis made by STOXX, part of the Deutsche Börse Group, the DAX mostly showed a strong performance during short periods of technical recession in the German economy. An example can be taken from the years of the latest European debt crisis, specifically during the technical recession lasting from Q4 2012 to Q1 of 2013 in Germany (see Graph 3).

Graph 3: German Recessions and corresponding Dax performance (1991-2014)

Therefore, it can be inferred that there are factors other than Germany’s economic situation that influence the DAX. A very basic point that has to be clear, to understand the relationship between Germany`s leading index and its economy, is that the DAX`s performance is based on the stocks of the companies listed in it. Thus, the development depends on the demand and supply of the company’s stocks, which is influenced by the past and present performance of those companies and especially depends on the expectations regarding the future performance of those companies. 

While the past and current health of a business can be analysed using the company’s financial reports; expectations about the future performance are opinions that are influenced by many other factors. We can subdivide these into economic, political, and other factors. Examples of economic factors that influence the DAX could be the forecast for GDP growth in Germany. But also the global GDP growth rate is relevant since over 75% of the DAX companies’ revenue is generated outside of Germany. Political factors could be the outbreak of a war, rising populism or trade tensions. While other factors could- for example- be natural disasters. Along with these factors, the amount of alternative investments, such as bonds or other asset classes, influence the stock market in a way that, for example, investment opportunities with a better risk/return ratio incentivise investors to pull capital out of the equity market and rebalance their portfolios. Next to future expectations and its influencing factors, there are also psychological and behavioral aspects influencing the stock market, the “irrational exuberance” of investors selling, because “everyone is selling” or buying because “everyone is buying”.

We can conclude that, while the German economy is one of the factors influencing the DAX, if the companies (or at least the majority of the thirty companies) perform well and/or are expected to do so in the future regardless of the macro-economic situation, a positive development of the DAX, even during weaker economic situations is understandable. 

What factors explain the development of the DAX in 2019

In 2019 several major circumstances are widely considered as drivers of the DAX´s good performance. 

Firstly, an economic factor, which also affected the number of alternative investments, are the measures the ECB took to stimulate the European Economy. One concrete example was the ECB ́s deposit facility rate reduction from -0.40% to -0.50% in September 2019. With this measure, the European Central Bank aims to stimulate commercial banks to enhance more borrowings by decreasing their willingness to lend their money to the Central Bank. Hoping to stimulate consumption and investment behaviour of individuals and companies and thereby, boost the economy. This can be considered a reason for the German stock index`s great performance, as individuals and companies may well to prefer to invest their money (or consume) than to save it on their bank account, where inflation and negative interest rates decrease their fortune. Additionally, the ECB reintroduced its Quantitative Easing programme (open-ended government bond-buying of 20 billion euros monthly) starting from November 2019, which can lead to a price-increase of government-bonds bought by the ECB and lower their yields. Consequently, the equity market becomes a more attractive market to invest in. Moreover, Q.E. also lead to increased money supply in the European market, which again enables cheaper lending for banks and improves borrowing interest rates for companies and individuals. To summarize, the ECB contributed to the DAX`s robust growth in 2019 with its low interest rates and its Quantitative Easing programme in three main ways: It made saving unattractive, it made government bonds more expensive, lowering their yield and enabled more investments and consumption since the borrowing of money become “cheaper”.

Secondly, some analysts consider the increase in stock buybacks of companies listed in the DAX as a pillar for the DAX.  Stock buybacks (or share repurchases) are considered an alternative to dividends, especially in the US. One effect of stock buybacks is an increase in earnings per share (assuming profit stays the same) and the return on equity since fewer shares are outstanding. This can make a stock appear more attractive and by that also lead to further purchases, increasing the stock’s price. Although there are no specific numbers released for all share repurchases of DAX companies in 2019, the trend also seems to be increasing in Germany: Having reached its maximum since 2008 of around 8,4 billion euros in 2018 (shown in Graph 4, also including equity buybacks in the MDAX) and the year 2019 starting with the announcement of a 6 billion US-Dollar equity buyback in the next two years by the DAX-company Linde plc.

Graph 4: Share buyback volume (DAX and MDAX)

Thirdly, it was often reported throughout the year markets have been positively affected by the investor’s belief and president Trump’s announcements that a “phase one deal” between China and the US will be reached soon. The deal which has been confirmed by officials on Friday, December 13th and was signed on Wednesday, January 15th in the White House by Trump and Liu He, Vice Premier of the People’s Republic. 

Finally, one factor which has had a positive effect on the DAX towards the end of 2019 is, that after two weak quarters in the third quarter of 2019, 17 of the 30 companies have increased their EBIT in comparison to the third quarter of the year 2018. Also, only ten have experienced a decrease, despite the German economy just narrowly avoiding a recession. In total, the 30 companies listed in the DAX can show an increase in their EBIT of 3,5% in Q3 19, compared to the same period of the previous year. 

Future Outlook

For 2020, Germany’s central bank, the Bundesbank, forecasts a GDP growth of 0,5% in Germany and the Deutsche Bank (DB) predicts the DAX being at 14000 points at the end of 2020. However, there are also economists criticising factors that have influenced the DAX-performance in 2019 and claiming that these factors contribute to the DAX being overvalued. For example, Professor Jürgen Stark, a German economist who was a member of the Executive Board of the European Central Bank from 2006 to 2012, claims that the ECB measures lead to “bubbles” in the stock, real estate and bond markets. As a result, he fears that there will be a correction in these prices at some point in the future. Additionally, Prof. Stark states that the highest global debt-load in peace times is also at least partially caused by the ECB measures.

Next to ECB ́s negative base rate and its Quantitative Easing programme, also the stock buybacks are not free from discussion. Some experts argue that they are used to improve financial ratios (that are often linked to managers numeration), making the stock seem like a better investment and consequently lead to an artificial rise in the stocks price. Also, the claim that there are superior investment opportunities for companies, for instance investing in machines or research, that will generate more sustainable value for shareholders in the future than share repurchases remains persistent.

In a final conclusion, it can be said that the economic situation in Germany only partly influences the Dax, especially during “short” technical recessions a simultaneous increase in the DAX is possible. Therefore, considering the factors listed above, it is not a surprise that the DAX was able to perform well in 2019. Nevertheless, some long-term effects of certain measures taken in 2019 by the ECB cannot be predicted adequately just yet and will remain open to discussion in the future. 

Authors: Constantin Caspar, Karl-Friedrich Flick


LVMH’s breakfast at Tiffany’s with the bill of $16.2 billion

LVMH Group will acquire Tiffany & Co, an American jeweler known for engagement rings and white diamond necklaces, for $ 16.2 billion with $135 per share, the biggest deal in luxury industry. 

About the Buyer: LVMH Moët Hennessy Louis Vuitton

The buyer of this deal is LVMH Moët Hennessy Louis Vuitton, the world’s leading high-quality product group, which recorded revenues of €12.5 billion in the first quarter of 2019, with an increase of 16% against previous year.

LVMH is a French international luxury goods group. The group was founded in 1987 as a result of the merger of Louis Vuitton and Moet Hennessy. Moet Hennessy was formed in 1971 by the merger of champagne maker Moet & Chandon and cognac maker Hennessy. Its businesses are divided into wine and spirits, fashion and leather, perfume and cosmetics, watches and jewelry, retail and hotels. The company has about 70 brands and more than 3,950 stores worldwide. It produces distilled and sparkling wines from different regions, as well as whiskey. The fashion and leather business groups include Louis Vuitton, Fendi, Donna Karan, Loewe, Marc Jacobs, Celine, and Edun. It specializes in perfumes, cosmetics, and skincare and offers a range of brands such as Dior, guerilla, and Kenzo. The watch and jewelry industry is divided into two parts: high-quality watchmaking, jewelry, and high-quality jewelry. Its selection of retail operations is based in Europe, North America, Asia, and the Middle East.

In millions of EUR

About the seller: Tiffany&Co 

The seller is Tiffany&Co, a holding company that operates through its subsidiary companies. The Company’s principal subsidiary, Tiffany and Company (Tiffany), is a jeweler and specialty retailer. 

Founded in 1837 by Charles Lewis Tiffany and John B. Young in Brooklyn, Connecticut, as a “stationery and fancy goods emporium”, the store initially sold a wide variety of stationery items and operated as “Tiffany, Young, and Ellis” as of 1838 at 259 Broadway in Lower Manhattan.

The Company’s segments include Americas, Asia-Pacific, Japan, Europe and Other. Through its subsidiaries, the Company designs and manufactures products and operates TIFFANY & Co. retail stores around the world, and also sells its products through Internet, catalog, business-to-business and wholesale operations. The Company also sells timepieces, leather goods, sterling silverware, crystal, stationery, fragrances, and accessories.

Tiffany’s merchandise offerings include an extensive selection of jewelry (92% of worldwide net sales in fiscal 2018), as well as timepieces, home and accessories, and fragrances.

In millions of USD

Buyer’s rationale of the deal: 

  • Consolidate U.S market as well as getting a strong presence in America  

Louis Vuitton leather factory was announced to open last month in Texas. The goal of the Paris-based brand’s newest factory is straightforward: in its own words, the new manufacturing hub will help Louis Vuitton “to meet the ever-growing demand for Louis Vuitton products in America.” As the Wall Street Journal put it, the new factory is part of Louis Vuitton’s larger strategy of “selling luxury goods to the masses without lowering prices.” Besides, acquiring Tiffany helps the group to grow its smallest business, give it a bigger share of the lucrative U.S. market and expand in jewelry, the fastest-growing sector in the luxury goods industry. LVMH’s latest American endeavor gives the ability to “hedge against the risk of trade disputes between the U.S. and European Union”, under the watch of President Donald Trump. 

  • Get access to the core expertise and well-known brand in the jewelry industry  

The jewelry is reported to grow 7% since this year and is rated as one of the fastest-growing sectors in the luxury industry. Since LVMH’s acquisition of Bulgari, its sales have been doubled and sustain LVMH’s organic growth in the jewelry world widely. 

Acquiring Tiffany aligns with LVMH’s ambition to actively pursue its market share growth target by constantly monitoring markets and remaining highly selective in its allocation of resources. 

For LVMH, the deal will give the world’s largest luxury goods company a more prominent name in fine jewelry and make it a leading company in the U.S. The deal also comes as demand for diamonds globally is going through a resurgence.

By getting access to the core expertise and strong and established brand brought by Tiffany, LVMH can build a more modern and adapted portfolio than LVMH currently proceeds to better serve the millennials in the booming luxury market in the next years.  

Besides, the deal is also projected to increase LVMH’s market share up to 20% in the jewelry sector as much as its primary competitor Richemond, which holds Cartier under its name. 

Seller’s rationale of the deal:

  • Increase innovation of the product under the LVMH environment and sustain long-term development 

Tiffany has been criticized for its lack of innovation during recent years compared with its major competitor: French luxury brand Cartier, which invests more in young consumers. Cartier’s parent company Richemont’s jewelry business is headquartered in Switzerland, and its operating margin is about twice that of Tiffany. Tiffany logged 10 quarters of either flat or negative same-store sales growth between the fourth quarter of 2014 and the third quarter of 2017. The deal could allow Tiffany to update its products and help it to grow overseas.

Bernard Arnault, the chief executive officer of LVMH, has handled a number of other luxury brand acquisitions, including the acquisition of Italian jewelry brand Bulgari and he expected to help Tiffany in expanding beyond the Americas.

  • Get a grip of opportunity in China 

Tiffany has also been fluctuating with the global diamond industry for some time, and demand for jewelry has declined. But jewelry sales have begun to rebound, thanks to the strong U.S. economy, China’s strong demand to buy diamonds for themselves and more from millennials in China, according to consulting firm Bain & Co.

China is reported to be the world’s largest luxury goods consuming market. Tiffany currently only has 35 stores in China and benefits from the strategy to rely on Chinese consumers going abroad. With the rally between the U.S and China Trade war, this strategy may no longer apply ,and Tiffany now is losing its presence in mainland China as a result of the lack of marketing.

From Tiffany’s perspective, we can see the access to capital, global and high luxury expertise is likely to boost Tiffany’s transition considerably.

Deal structure  

LVMH will buy Tiffany & Co. for $135 a share, a deal that would value the company’s overall stake at $16.2 billion. Including net financial liabilities of $700m, that would give Tiffany an implied enterprise value of $16.9bn, making LVMH’s biggest-ever acquisition and largest deal in luxury history. 

The deal represents a 37.0% premium to the deal price of $98.55 per share on LVMH’s last trading day, October 25, 2019. This also reflects a 12.5% increase over LVMH’s initial offer of $120 per share on October 28, 2019.

Since LVMH first made its $120-a-share offer on October 28, 2019, Tiffany’s shares have jumped to $130 immediately after the initial announcement and have stayed well above the $120 mark ever since. This implies that investors are betting on the fact that an improved offer from Louis Vuitton or a rival bid will be made on Thursday, November 21, amid rumors that LVMH has been granted access to confidential financial information by Tiffany & co. Tiffany’s shares rose 3.1 percent to $127.18 after the speculation.

At the suggestion of Goldman Sachs and Centerview Partners, Tiffany’s board has sought to keep it a secret since it was first approached by LVMH. The directors did not comment publicly on the value of the $120 offer, advising shareholders not to act. Talks with LVMH have been accompanied by discussions with other potential suitors as part of a review of strategic options, but no one seemed ready to make a better offer. They backed LVMH’s $135-a-share offer on Monday morning.

The deal values the 321-store luxury jeweler at 16.6 times EBITDA for the year to January 31, 2019. It will also trade at 27.8 times earnings, or $4.86 per share for the year ending Jan. 31, 2020, according to consensus estimates.

This is very much in line with LVMH’s own forward price/earnings ratio of 27.0 for the full year 2019, which is slightly higher than Richemont, meaning that LVMH is effectively offering a full price for Tiffany.

LVMH will use the bond markets to finance its biggest-ever acquisition, raising some new debt facilities, including an $8.5bn bridge loan, a $5.75bn commercial paper support line and a €2.5bn revolving credit facility. These debt arrangements will later be refinanced by LVMH through a bond issue. Nevertheless, the impact on LVMH’s overall debt leverage remains limited. The French group’s EBITDA for FY19 is estimated to exceed 14 billion euros. 

Market reactions & Expectations in long-term 

On Monday evening, Tiffany’s shares closed at $133.25, just below their offering price. This clearly means that investors now believe the buying will continue. However, conditions remain on the deal, including formal approval by Tiffany shareholders at the general meeting and regulatory approval, including antitrust. The process could take months and is expected to be completed by mid-2020. Still, investors welcomed the offer: LVMH’s shares rose 1.5% on Monday. The deal should have a slightly stronger impact on LVMH’s earnings per share in 2020 when its net debt to EBITDA ratio will be close to 0.9 times.

 LVMH Share Price – 18/12/2019
Tiffany Share Price – 18/12/2019

The acquisition would give LVMH a 20 percent share of the global jewelry market, “very close” to Richemont. Given Tiffany’s U.S. sales (44 percent), LVMH’s U.S. sales will rise from 23 percent to 26 percent.


Citi and JP Morgan Chase acted as financial advisors, and Skadden, Arps, Slate, Meagher & Flom LLP served as legal counsel to LVMH.
Centerview Partners LLC and Goldman Sachs Co. LLC acted as financial advisors, and Sullivan & Cromwell LLP served as legal counsel to Tiffany.

Author: Gaochang Tian


Silicon Valley Meets Sports: Silver Lake takes a Stake in Champions League Football Club Manchester City

Silver Lake Partners just bought a $500 million stake (10% of the equity shares) in the owner of Manchester City, at a valuation that makes the English football team one of the most expensive sports franchises on the planet.

Silver Lake is one of the world’s largest tech investors with over $43 billion in assets under management including stakes in Alibaba Group, Dell Technologies and Tesla. On Saturday 23th of November, the Silicon Valley private-equity firm officially took a 10% stake in City Football Group (CFG) – owner of the English Premier League powerhouse – in a deal that values the team at $4.8 billion.

source: KPMG Football Benchmark, May 2019

The CFG’s majority owner is Sheikh Mansour bin Zayed Al Nahyan, a member of Abu Dhabi’s royal family. Since buying the team in 2008, he has spent hundreds of millions of dollars on world-class players, and renowned manager Pep Guardiola, in order to build one of Europe’s premier teams and the world’s fifth-highest revenue-generating soccer club in the 2017-18 season. CFG has also managed to expand its footprint by acquiring other football clubs worldwide such as Chinese third-tier side Sichuan Jiuniu, adding up to investments in the US, Japan, Australia, Spain and Uruguay. The group is also in talks to take over Indian Super League team, Mumbai City FC.

source: KPMG Football Benchmark, May 2019

CFG will leverage on the $500 million cash injection from the transaction to continue its expansion strategy, by growing globally through further acquisitions of football clubs and the planned construction of a stadium in New York City. From Silver Lake’s view, the deal is part of its plans to gather sports, media and entertainment groups that attract the attention of millions of consumers globally. Its investments also include mixed martial arts franchise UFC, talent agency group Endeavor (represents leading athletes such as Serena Williams and Novak Djokovic), the Miss Universe pageant and the Madison Square Garden Company. Silver Lake intends to hold its stake for about a decade, but according to sources close to the firm, the PE house could opt to exit through an IPO or a sale to another private investor.

Silver Lake had approached other major football clubs, including Chelsea, finally landing on the bid to Manchester City. The technology-focused firm was attracted by the multibillion-dollar prices paid for football media rights by broadcasters and internet streaming groups. 

While the big clubs still make most of their money from broadcasting rights and merchandising, they are looking for ways to use technology to sell privileged access to fans. Some have developed apps providing exclusive content such as player interviews, short documentaries, press conferences and even match highlights. Manchester City took a taste of the potential value of behind-the-scenes content last year when it partnered with Amazon’s Prime Video streaming service for an eight-part documentary charting the path to its 2018 title win.

Moving to the challenges, some experts blame Silver Lake has not closed a good deal, choosing a strange time to enter the football business. According to Enders Analysis report published last month, the media rights market is weakening; last year’s auction for Premier League domestic rights saw a 10% decline in the total paid by broadcasters. An increasingly common trend sees fewer people choosing to pay to watch football on TV in Italy, the UK and France. Media companies jumped into the live events as one of the remaining ways to bring in advertisers, who are increasingly shifting online. It is a crucial time for clubs to diversify their revenue sources, focusing on matchday and commercial revenues. In order to boost the latter, many European clubs are looking to expand their global footprint and worldwide fanbase

Other criticism on the deal emerged relating to CFG’s sky-high valuation assessed by Silver Lake, seen as excessive compared to its peers in the sports industry. As of July, Man City was ranked 25th, with a value of $2.69 billion on Forbes list of most valuable sports teams. But the new stake brings the club all the way up to No. 2, thereby exceeding the New York Yankees valued at $4.6 billion, but just behind the Dallas Cowboys which are No. 1 with a valuation of $5 billion. However, this new valuation is much higher than the previous one because it includes the other assets of CFG. In addition, Silver Lake acquired preferred-shares in the transaction, which demand a premium, so the real valuation may be lower according to specialists.

Critics however support the idea that Silver Lake over-valuing Manchester City is just an effect of a potential bubble floating on the football industry, made up by inflated transfer prices (players are treated as assets by sports clubs) and excessive investors’ euphoria. Man City’s rival Manchester United is listed on the New York Stock Exchange, and had a market capitalization of $2.75 billion before rumors of the Man City deal. The acquisition lit a spark under Man Utd’s shares, which jumped up to 14% on Wednesday. 

Time will reveal if Silver Lake, one of the most successful private equity firms in the world, has grasped a great opportunity that will generate value for its investors, support its transversal expansion to sports and entertainment, while backing the growth of one of the major sport houses globally or if, instead, it has simply overpaid a stake in a sports club, facing risks posed by negative trends in its industry.


The Birth of a Giant: FCA-PSA merger

Nowadays, it is very challenging and strenuous to be a globally prosperous automaker. For this reason, major players of the sector are trying to merge to maximize shareable costs. Examples of this could the devising new propulsion technologies, such as electric powertrains and competing with tech firms on alternative transportation methods such as connected cars and autonomous vehicles.

Hence, many of the contemporary automakers have merged with competitors or are considering doing so. The structure of the automaking industry is being heavily reshaped: The Renault-Nissan-Mitsubishi alliance is currently in the process of collapsing, Ford and VW are attempting to dissolve any merger discussion and GM is trying to entangle its European division more solidly in the European market by merging it with regional automakers. Currently, the biggest merger announcement regards the potential consolidation of  FCA and PSA. 

The hypothesized merger between FCA and PSA doesn’t represent the first attempt of the Italian automaker. FCA had previously speculated about a consolidation with the French carmaker Renault. This merger failed in June after FCA declared a strong interference from the French government, which owns 15% of Renault.

The current merger arrangement between FCA and PSA is on a constructive and encouraging path to be realized. PSA would profit greatly by effectively taking over the Jeep brand and receive continuous and direct access to the North American market with its valuable and voluminous pickup-truck and SUV end-market. 

Besides, FCA does not own any pure electric or autonomous drive technology which could play a significant role in the next future. Thus, the merger between the two players will not target the general market gaps but rather will focus on assorted and embedded problems within the existing conventional carmaker traditions. This was an additional reason why the speculated merger between FCA and Renault fell apart.

The announcement of the possible merger has been published on October 30th, with the approval of the PSA’s board. The formula agreed on is a 50/50 share-swap, and the creation of  a new automotive company. In the end, who is buying who?

Figure 1: Share movement comparison of FCA and PSA after the merger announcement. 

FCA’s stock rose more than 17% from the day before the announcement, while PSA plumbed to almost 9%. Considering the share price of FCA on the 1st November, PSA is paying a $3.9 premium for the Italian-American-Dutch group. FCA has also declared that it will pay a special dividend prior to the acquisition amounting to $5.5 billion, which means $3.5 per share, or  more than 20% of the current share price. 

By summing up all this data is reasonable to state that FCA’s shareholders are the real winners of the operations, while PSA would almost be facing most of the market risk. 

The merger, carried out under a Dutch parent company, will greatly impact the shareholder structures of FCA and PSA, as well as their respective voting rights.

The governance of the new company would be balanced between the contributing shareholders, with the majority of the directors being independent. The Board would be composed of 11 members, of which 5 nominated by FCA (including John Elkann as Chairman) and 5 nominated by Groupe PSA (including the Senior Independent Director and the Vice-Chairman).

The Chief Executive Officer would be Carlos Tavares for an initial term of five years.

It is proposed that the by-laws of the new combined entity would provide that FCA’s loyalty voting program will not operate to grant voting rights to any single shareholder exceeding 30% of the total votes cast. Additionally, there would be no carryover of existing double voting rights which would accrue after a three-year holding period starting from the completion of the merger.

A standstill of 7 years and a 3-year lock-up period  would be applied to the shareholdings of EXOR N.V., Bpifrance Participations SA, DFG and the Peugeot Family, with an exception made for the last one , which would be allowed to increase its shareholding by up to 2,5% during the first 3 years following the closing, through Bpifrance Participations and DFG.

Figure 2: Possible shareholder structure of the new company

The value creation from the deal is mainly derived from the synergies created by more efficient resource allocation. The majority of the $4.12 billion estimated synergies are supposed to be achieved in the following 4 years. The new company will generate total  revenues for $188 billion and will sell 8.7 million vehicles per year, overcoming General Motors and Volkswagen in terms of sales volume.The technological synergies would also be relevant and are projected to be between €3 and €6.6 billion in the long run. 

Surely this deal will face different obstacles, due to uncertainties on multiple fronts, such as the  political implications of the deal.

From a political standpoint it is renown that FCA already faced a certain degree of opposition when, months before, it had approached PSA’s French rival Renault for a possible merger discussion, which was subsequently terminated due to the decision by the French government to walk away last June.

The French government is Renault’s biggest shareholder, with a stake exceeding 15%, and thus had a relevant size to oppose the deal’s development. However, in the PSA case, the French government possesses the same amount of shares as the Peugeot family and Dongfeng, which represents a mitigating factor according to analysts. Furthermore, the French government  declared its support to the deal’s logic and the size of the NewCo which will be able to able to protect workers’ interests.

The logic of the deal itself is a point of uncertainty. Comparing it with the previous merger attempt between FCA and Renault, the deal with PSA presents a stronger logic and thus, has a greater chance of succeeding. 

The newly formed  entity would allow Peugeot to diversify its geographical presence, penetrating the  US and Latin America markets, at the same time, it would mitigate FCA’s risk of regulatory financial backlash by granting access to PSA’s power-train technology at a highly competitive cost.

The likelihood that the merger will actually take place is growing day by day. On November 25th, Reuters announced that both FCA and PSA have produced an internal communication, stating that more than 50 people are working towards the finalization of the mergers. 

Excluding any unexpected turn of events, the new automotive behemoth will see the light of day within the next few months. The good prospects are confirmed by the willingness of the two parts to sign a memorandum of understanding within the 20th of December, in order to give a more precise direction to the deal. 

As everybody knows, there is no gain without pain. General Motors did not stand by looking, suing  FCA for presumed corruption with the American union “United Auto Workers”. We will see in the next few weeks how this is going to affect the deal and the values proposed for it . For now, it seems that  the road is open for the real game-changer of the decade in the automotive sector.

Authors: Leo Paus, Mattia Lorenzo di Lilla, Federico Felice Intini