Giant deal in the pharmaceutical sector: Bristol-Myers Squibb buys Celgene

Last 6th January, US drug manufacturer Bristol-Myers Squibb (NYSE:BMY) and Celgene Corporation (NASDAQ:CELG) announced that they have entered into a definitive merger agreement under which BMY would have acquired Celgene for an equity value of approximately USD 74bn.

The board of the two firms welcome the acquisition which will imply that Bristol-Myers Squibb’s shareholders will own about 69 percent of the merged company, while Celgene’s owners account for the remaining 31 percent. After the merger, the company will have nine blockbuster products with sales exceeding USD 1bn annually. The companies also see “significant growth potential” in the core areas of oncology, immunology, inflammation and cardiovascular diseases.

Celgene stock price decline on drug’s sluggish sales

Celgene is a biotechnology company based in New Jersey with around 8’000 employees. The firm develops, discovers and commercialises medicines for inflammatory disorders and cancer. Celgene had a troubling year 2017 as the stock price declined 37 percent from October to September. In the same year, the firm decided to abandon a late-stage Crohn’s disease drugs as well as two clinical trials along with it. Also, during the period the firm encountered lawsuits associated with its patents which suggested possible jeopardies in revenue. The firm had a troublesome 2017 missing its revenue expectations for the last two quarters and disappointing sales for the drug Otezla. Bad sentiment and business continued in 2018 as the shares lost nearly 40 percent in value during the year. Lately, the stock price has been trading 39.5 percent under its 52 week-peak value and changed 13.94 percent from the 52 week-bottom stock prices.

Figure 1: Celgene Stock price’s slump in 2017

The buyer’s rationale of the deal

The deal creates a new pharma company with numerous blockbuster cancer drugs and many enhanced strengths to respond to the competition in the immunotherapy market. In fact, the competition has grown as Mercks’s rival treatment Keytruda has gained market share in the lung cancer treatment which is the most lucrative oncology market. Giovanni Caforio, chairman and chief executive officer of BMY explains that: “Together with Celgene, we are creating an innovative biopharma leader, with leading franchises and a deep and broad pipeline that will drive sustainable growth and deliver new options for patients across a range of serious diseases”. The acquisition creates a firm with nine drugs, each of them generating more than USD 1bn in annual sales, as well as a large pipeline of treatments which expect the potential peak sales of USD 15bn. Some analysts claim that the acquisition will address the importance for Bristol-Myers to diversify from immunotherapy with the opportunity to generate enhanced margins, strong combined cash flows as well as robust EPS accretion. Mark Alles, Chairman and Chief Executive Officer of Celgene explains that: “For more than 30 years, Celgene’s commitment to leading innovation has allowed us to deliver life-changing treatments to patients in areas of high unmet need. Combining with Bristol-Myers Squibb, we are delivering immediate and substantial value to Celgene shareholders and providing them meaningful participation in the long-term growth opportunities created by the combined company”. Furthermore, he adds that: “Our employees should be incredibly proud of what we have accomplished together and excited for the opportunities ahead of us as we join with Bristol-Myers Squibb, where we can further advance our mission for patients. We look forward to working with the Bristol-Myers Squibb team as we bring our two companies together”.

Figure 2: The greatest pharmaceutical deal summarised in key points

The largest healthcare deal ever: a financial overview

According to data elaborated by Bloomberg, Bristol-Myers Squibb takeover of Celgene Group values the target at USD 88.8bn, including net debt, even surpassing the Pfizer’s acquisition of Warner-Lambert, a deal occurred in 1999 for a total value of USD 87.14bn in stocks. With a forecast of achieving annual cost synergies of USD 2.5bn by 2022 and generating future earnings of over $6 per share, the Bristol-Myers acquisition became the largest pharmaceutical deal in history.

This transaction has been financed by a bridge loan of USD 33.5bn, the second highest US bridge loan recorded in the healthcare sector: Bristol has obtained fully committed debt financing from Morgan Stanley Senior Funding and MUFG Bank, while, on the other hand, JPMorgan Chase and Citi served as Celgene’s financial advisers.

Figure 3: Top deals in Pharma consolidation (Deal value: $B)

One of the most relevant aspects of this deal, for Bristol-Myers Squibb, is access to a promising experimental CAR-T therapy. Celgene, indeed, acquired in 2018 Juno Therapeutics in a USD 9bn takeover deal: Juno Therapeutics is a biopharmaceutical company specialized on CAR-T cell therapy, a cancer therapy in which a patient’s own immune cells are genetically engineered to make them attack specific proteins on cancer, and infusing them back into the patient. CAR-T could become a highly profitable market over the next four years, with an estimated growth at a CAGR of 63 percent within 2023. Therefore, Bristol-Myers through this deal will have the potential for growth especially in oncology diseases, meanwhile taking advantage from the CAR-T market expansion.

Specifically, Bristol-Myers acquired Celgene through a cash-and-stocks deal, in which Celgene stockholders will receive one Bristol-Myers share and $50 cash for each Celgene share held. According to the boards of the two Companies, the deal, which they hope to finalise in the third quarter of 2019, will represent a 53 percent premium to the average closing price of Celgene shares over the past 30 days.

Besides this, the takeover is expected to generate 3 main financial benefits:

Strong Returns and immediate EPS accretion. The transaction’s internal rate of return is expected to be well in excess of Celgene’s and Bristol-Myers Squibb’s cost of capital. The combination is expected to be more than 40 percent accretive to Bristol-Myers Squibb’s EPS on a standalone basis immediately after the finalisation of the deal.
Strong balance sheet and cash flow generation to enable significant investment in innovation. With more than USD 45bn of expected free cash flow generation over the first three full years post-closing, the Company is committed to maintaining strong investment grade credit ratings while continuing its dividend policy for the benefit of Bristol-Myers Squibb and Celgene shareholders.
Meaningful cost synergies. Bristol-Myers Squibb expects to realize run-rate cost synergies of approximately USD 2.5bn within 3 years.

However, the days following the merger’s announcement showed a negative market reaction: investors indeed rewarded Celgene’s shares at a limited extent of 22 percent to $81.28, while shares in Bristol-Myers fell over than 16 percent to $45.1, that is USD 11bn of capitalization in less than 2 days (from USD 86.4bn to USD 76.5bn).

According to Brian Skorney’s words, senior research analyst at Robert W. Baird & Co., “this deal has not been driven by enthusiasm or excitement on either end”: Celgene investors were not thrilled after the deal, and Bristol investors were less than enthused. In this respect, Mizuho Securities USA after conducting a quick survey of about 100 clients, concluded that Bristol investors think the Company is overpaying for Celgene, therefore not approving the acquisition. This could be a possible justification for the slipping of Bristol’s shares.

Figure 4: Bristol-Myers Squibb share price trend

Figure 5: Celgene Group share price trend

What drives M&A in the Pharma industry?

The approval of US tax reform in late 2017 led to speculation that merger-and-acquisition activity would soon surge among pharmaceutical companies, due in part to tax-cut benefits accruing to sellers. In the first quarter of 2018, indeed, there were 212 deals in the sector worth more than USD 200bn. Bristol-Myers takeover follows a spree of tie-ups in the healthcare industry over the past four years: Japan’s Takeda last year has won shareholder approval for its USD 58bn megamerger with Shire, and a month ago GlaxoSmithKline announced it was buying Tesaro, a cancer-focused US biotech, for USD 5.1bn. According to some senior investment bankers who presented at the Forbes Healthcare Summit in NY last November, 2019 will be another active year for live science M&A deals, particularly in the biotech, payer, outsourced services and healthcare IT arenas.

Thomas Sheehan, head of global healthcare investment banking at Bank of America Merrill Lynch, stated that we are in a “biotech bubble” which is difficult to predict how long it will last.

We showed in the chart below the climb of the number of M&A transactions implemented in the pharma industry over the last 20 years.

According to this graph, we can point out that the pharmaceutical industry probably sees more M&A activity than any other industry, both in the number of deals and the amount of money spent on mergers-and-acquisitions operations. There are two main key drivers which justify the large amount of M&A activities in this industry:

Lowering R&D expenses. Most companies can no longer afford to carry out R&D to find innovative drugs: today, a company needs to invest between USD 2bn and USD 4bn per year in R&D to have a meaningful portfolio of drug development programs. In the long-term, only companies with revenue of US 10bn or higher can afford to have a substantial drug development program. The growing cost for the development of a new pharmaceutical drug drives large pharmaceutical companies in using M&A to exploit innovation sources outside of Big Pharma.

Capture synergies by scaling up. Pharma companies adopt such transactions in order to implement strategic changes: expanding their pipelines, broadening their product portfolios or reducing their investment costs.

In conclusion, deal-making is a fundamental tool to implement game-changing strategic moves to build companies fit to master future challenges, but M&A is essential for pharma companies also to get access to innovation, to prune business portfolios and to streamline operations in manufacturing.

Authors: Giovanni Cola, Edoardo Hähnel

Sources:

THE RISE OF GREEN ECONOMY, A NEW CHALLENGE FOR MANAGERS AND A NEW OPPORTUNITY FOR INVESTORS

Introducing the Green Economy

Investors have always looked at various elements for their investments in order to make the best choices and historically it was mainly a matter of returns. Responsible investments began in the 1960s as a social criterion, with investors excluding stocks involved in tobacco production or in the South African apartheid regime. For a long period of time, investors believed that ethical investments were reducing returns due to their nature. At the time, philanthropy was not known to be profitable. Furthermore, M. Friedman argued in the 70’s that the cost of behaving ethically would reduce returns.

However, due to the growing fears concerning climate change and new research (in particular Moskowitz’s in 1988) on the topic, Environmental, Social and Corporate Governance (ESG) factors became three leading criteria investors started looking at. ESG investing was given a shot in the arm when United Nations introduced the Principles on Responsible Investing (PRI) in 2006. The PRI has been signed by more than 2000 companies all over the world, including the main financial institutions such as Goldman Sachs, JP Morgan, Morgan Stanley or BlackRock and representing around $10.4 trillion out of the overall $89.6 trillion worldwide assets under management as of April 2018. The signatories have to commit to six voluntary principles such as, the incorporation of ESG issues into investment analysis and decision making and to increase disclosure about their environmental standards, their supply chains and their treatment of employees. ESG investing was even given a further push thanks to the Sustainable Development Goals (SDGs), a collection of 17 goals divided into 169 targets, set by United Nations in 2015 and to be achieved by 2030.

The same mainstream has been reached by Green Bonds, an investment solution that allows investors to generate profits while taking care of the planet’s health.

ESG investing

Nowadays many investors look at ESG factors to incorporate them into the investment process alongside with the traditional analysis. As you may have understood, now the approach to ESG investing is segmented into Environmental, Social and Governance factors. But those are only the three main criteria, whereas there are also subcategories for all of them. Regarding the Environment it could be divided into: climate change, natural resources, pollution & waste and environmental opportunities. The Social aspect mainly focuses on human capital, diversity, product liability, consumer protection and animal welfare. While Corporate Governance covers management structure, transparency, business ethics and employee relations.

Those factors can then be included in the investment process in two ways. Firstly, the “best in class” approach, focalizing into companies which within a sector have the best practices in term of sustainable development. Therefore, companies that are either polluting less or are having better social relations compared to companies in the same sector. Secondly, the “best in universe” approach, grouping companies that have the best sustainable development practices regardless of their sector of activity.

A growing trend

During the past years we saw heavy inflows into ESG investments and an increasing demand for those (Social Responsible Investments, SRI, rose by 33% between 2014-2016, up to $8.72 trillion). According to various studies, this is just the beginning and it can be explained by three main reasons.

Firstly, as mentioned above, the world is changing. Investors are getting more and more aware of climate change and its implications. According to a survey of Morgan Stanley, millennials are two times more likely to invest in companies targeting social or environmental goals compared to the overall population. Furthermore, global sustainability challenge is introducing new risk factors for investors and may force them to re-evaluate their traditional investment approach preferring an ESG one. Secondly, because investors are changing. Quoting a study made by Accenture, in the next decades there should be a wealth transfer of $30 trillion from baby boomers to 90 million millennials, which should likely be translated into roughly $20 trillion put into ESG investing. And lastly, thanks to the evolution of data and analytics on this topic available in the market. Better data and transparency from the companies will allow ESG investors to have accurate and precise information for their investment process.

A new approach for financial returns

As mentioned in the introduction, the main issue of ESG investing was the fear of lower returns, although some studies have proved the opposite. A recent MSCI study showed how companies with solid ESG practices have a lower cost of capital, lower volatility, and less bribery, corruption and fraud, in contrast to companies with poor ESG practices. The latter having higher cost of capital as well as higher volatility.

The graph above shows an analysis of the MSCI Emerging Market ESG Leader Index and the MSCI Emerging SRI Index returns compared to MSCI Emerging Markets Index. We can see that Companies with higher ESG ratings are usually associated with higher profitability, lower tail risk and lower systematic risk.

In order to invest in the right companies, asset managers are relying on more and more ESG rating agencies. Moreover, as the general demand is increasing, ESG indexes such as the Dow Jones Sustainability Index, the FTSE4Good Index, Bloomberg ESG data or the MSCI ESG Indices are rising in inflows.

Green Bond

A new initiative

Among the other market players, there is a non-profit organisation managing to mobilise a huge amount of money for climate change solutions. Its name is “Climate Bonds Initiative”, and the declared strategy is “to develop a large and liquid Green and Climate Bonds Market that will help drive down the cost of capital for climate projects in developed and emerging markets; to grow aggregation mechanisms for fragmented sectors; and to support governments seeking to tap debt capital markets”. By having a look its website, it is possible to figure out how its activities look like. Firstly, it manages the “Climate Bond Blog”, which is essentially a journal of record for relevant bond issuance including also some important industry updates, as well as drawing up a report concerning global outstanding bonds. The second workflow is related to developing trusted standards. The aim of these standards is to lead investors when making the right choice in order to tackle climate changes. Lastly, they provide policy proposals in the attempt to harmonise the work between governments, finance and industry.

At this point, someone could ask why there was the necessity to give birth to such a specific organisation. The answer lies in the overpowering rise of the abovementioned securities known as “Green Bonds”. These are issued by financial institutions, governments or companies allowing investors to receive their own returns but at the same time to contribute financing climate and environmental projects, and there is nothing else more right to do. In order to be labelled as Certified Green Bond, a security must undergo a strict process, at the end of which an Approved Verifier submit an assurance report to confirm that the bond meets the Climate Bonds Standard’s requirements. However, the Climate Bonds Standard Board has the final word. Certifications can be split in Pre-Issuance and Post-Issuance Certification, and they are available for asset related to specific sectors, currently including Solar Energy, Wind Energy, Geothermal Energy, Marine Renewable Energy, Water Infrastructure, Low Carbon Transport & Low Carbon Building. Nevertheless, other assets related to different sectors can be published after being approved by the Climate Bonds Standard Board. After the Post-Issuance verification, issuer’s duties are not over, since it is asked to provide the Climate Bonds Secretariat with annual reports with the purpose of keeping the compliance with the requirements.

2018 figures

Since their inception, Green Bonds have represented an unstoppable phenomenon that has seen the greatest global institutions as major players. The first socially-responsible fixed income security (€600m) has been issued in 2007 by the European Investment Bank, followed one year later by the World Bank, which issued the first Green Bond in history (€400m).

From 2008 on, a great work has been done in order to enhance the process, achieving relevant results. If we have a look again at a document from Climate Bonds Initiative, the 2018 Green Bond Market Summary, we can find some interesting figure that can help us understanding why last year has been exceptional concerning the green economy. Global green bond issuance reached $167.3bn in 2018, a figure that represents a 3% increase on 2017. Specifically, there have been 1,543 green bond issues from 320 issuers from 44 countries. The largest single green bond has been issued by Belgium with €4.5bn. USA has occupied the top spot in the bond issuance rankings for countries, followed by China and France. These three countries have already been ranked in the same positions in the previous years, and put together they have accounted to roughly $80bn issued in 2018. Consequently, it is easy to understand why the largest global issuer is an American company (Fannie Mae, $20.1bn), and the second one is Chinese (Industrial Bank Co, $9.6bn).

Source: Climate Bond Initiative – 2018 Green Bond Market Summary

In addition, also Emerging Markets are playing a key role in the sector. With the contribution of Supranational Development Banks, EM accounted to the 31% of the total issuance. Obviously, China leads the group with 78% of EM’s issuance. Thanks to the introduction of the ASEAN Green Bond Standards, issuer from Thailand and Indonesia joined the market, with the latter becoming the first sovereign bond issuer from Asia in March 2018. On the European side instead, Poland, Iceland, Lithuania and Slovenia have been the major contributors.

Source: Climate Bond Initiative – 2018 Green Bond Market Summary

Outlook 2019

Fortunately, also the outlook for 2019 seems to be positive according to Moody’s Investors Service. Indeed, the rating company has forecast green bond issuance to increase up to $200bn globally, representing a year-on-year growth of c.20%. The driving factors will be the increased use of the United Nations’ Sustainable Development Goals (SDG), as well as the “heightened commitment to addressing climate change”. Moreover, not only just an overall increase is expected, but also a consistent diversification in terms of sector, region and use of proceeds. Lastly, the fact that it will be easier to qualify a project as green is going to be beneficial for the growth of the sector as well.

However, not only Green Bonds market is about to explode in 2019, but also Social and Sustainability Bonds are pushing to reach a recognised position. With the birth of the SDG frameworks in 2018, investors are now able to decide where to channel their money to bonds financing green projects or to those financing social ones. According to CBI, Sustainability Bonds issuance has risen up to $21bn, a figure representing a 114% growth over 2017. Considering these trends, it is reasonable to point out that 2019 will be the year of a great consecration.

It’s just the beginning

The investors’ change of mindset is shifting the world from a sole return-driven perspective to a more ethical and sustainable way of investing. This process is clearly helped by the implementation of new regulations by the United Nations and financial institutions. This is taking time and energy; and there is still a lot to do. As a study of PIMCO illustrates, although a lot of companies have a high level of awareness of the SDGs, only few are setting quantitative targets, letting us think that many are struggling to translate well-intentioned resolutions into action.

A key challenge is to develop an agreed set of performance indicators that shows a company’s target and progress. This would be extremely important for investors, in order to compare the SDG contribution of companies. We encourage financial institutions and private investors to do so and to keep on making investments in a more responsible way (obviously with the objective of delivering returns).

Is all this going to lead to a permanent change in investors’ mentality or are we just witnessing a fancy, but temporary, trend?

Authors: Federico Giorgi, Thomas Bauzon

Supervisor: Carmen Alvarez

PART I – What happened in 2018? Bain & Company “Global Private Equity Report 2019”

1. PE funds produced another impressive surge in investment value in 2018, capping the strongest five-year stretch in the industry’s history. Fierce competition and rising asset prices continued to constrain deal count (i.e. the number of transactions fell by -13%, to 2,936 worldwide) with total buyout value jumped +10% to $582bn supported by a strong growth of public-to-private transactions which globally reached their highest value since the previous take-private boom in 2006–07.

2. Despite the steady pace of investment, PE dry powder has been on the rise since 2012 and hit a record high of $2tr at year-end 2018 across all fund types and $695bn for buyouts alone. The build-up of excess capital is putting pressure on PE firms to find deals, but the good news is that buyout firms hold 67% of their dry powder in funds raised over the last two years, meaning the recent deal cycle is clearing out the older capital and replacing it with new.

3. The stiff competition and high multiples (i.e. 10.9x was the average EV multiple for North American buyouts in 2018) that made it challenging to find deals in 2018 also made it a great time to exit. With 1,146 transactions valued at $378bn, exit activity came in a smidgen lower than in 2017, but the total was still a strong contributor to a historic five-year stretch that has produced unprecedented distributions for investors. There was clearly some urgency on the part of GPs to sell assets, as signs of economic weakness pile up. The median holding period for buyouts fell last year to 4.5 years, after edging down slowly from a peak of 5.9 years in 2014. PE funds continued to attract an impressive amount of capital in 2018, although the pace fell off from 2017’s record-breaking performance. GPs raised $714bn from investors during the year (i.e. the third-largest amount ever) bringing the total since 2014 to $3.7tr. LPs remain committed to what has been their best-performing asset class (i.e. 90% of all institutional investors say they intend to maintain or increase their PE allocations).

4. After several years of heavy stock market volatility around the world, buyout funds continued to outperform public equity markets in all major regions, over both short and long time horizons. At the same time, buyout returns in the current cycle have not been as robust as they were in the previous cycle. As the overall PE industry has matured and become more competitive, the outsize returns that GPs could once earn on a large pool of undervalued assets are harder to find. Yet, top-performing funds still exceed the industry average by a relatively wide margin.

SOURCES

Global PE report 2019 – Bain & Company https://www.bain.com/contentassets/2792a2cbcdcf4e94acfddc077a85c5ea/bain_report_private_equity_report_2019.pdf

US monetary policy influence on an increasingly globalised economy

From Quantitative Easing to Tightening Policies

On Tuesday 16^th December 2008, following the recession, the Federal Reserve lowered its benchmark interest rate to a range of 0 – 0.25%. The central bank also implemented the Quantitative Easing, which consists in purchasing US Treasuries and mortgage-backed securities to increase liquidity and stimulate the economy with new printed money.

In December 2015, based upon a better economic backdrop, Janet Yellen as Chair of the Fed, began a tightening policy. Since then, the Fed has raised the interest rates by 25 basis points 9 times, rising from 0 – 0.25% to a range of 2.5 – 2.75% in only 3 years. Since Jerome Powell succeeded to Yellen as Chairman of the Fed, his increasing confidence in the US economy, based upon accelerating inflation and a solid economic backdrop, allowed the Fed to raise the interest rates 4 times in 2018. While the Fed had signaled it would probably raise rates twice in 2019 and twice in 2020 to finally reach 3.5-3.75% in 2020, a dovish January Fed meeting changed expectations as it seemed the central bank would be more patient than expected regarding a future rate increase.

Figure 1: Federal Reserve’s funds rates increasing over time

Source: Macro Trends

Borrowers taking cautious stances

Since the tightening policy began in December 2015, signs of rising inflation, pushed the central bank into a more hawkish direction, raising the rates by 2.25% in 3 years. A moderate rising inflation is indeed an indicator that the economy is doing well, and it paves the way for salary increases but also interest hikes. Higher rates allow a better yield for savers, but it also means consumers and business will face higher costs when they want to access credit. Even more worrying, with US incomes still relatively flat, higher interest rates mean many homeowners with flexible-rate mortgages may be unable to repay their loans. This was one of the causes for the subprime crises: people took on mortgage debt at a very low interest rate thinking they would be able to reimburse it, but when the rates increased, they found themselves with not enough liquidity to pay back their interests on debt and lost a major part of their savings. And not only…

Bond holders see their prices fall…

A tightening monetary policy is a negative news for investors who see the price of their bonds fall. Interest rates and bond prices have an inverse relationship; meaning if one goes up, the other goes down. Therefore, if the interest rates increase, the value of a bond will decrease. The reason for this is that new bonds can now be issued at a higher yield and will therefore give a higher return than the bonds which are already on the secondary market pushing the demand for the existing bonds down together with their price.

“If the Fed is buying Treasuries, investors have to go further out the risk spectrum in search of returns,” said Subadra Rajappa, head of US interest rate strategy at Société Générale. “So, if the Fed is unwinding QE then the reverse should be happening. It should be negative for credit spreads and equities”.

…and so do equity holders

It seems the market wasn’t prepared to switch to quantitative tightening as US stocks had their worst December since 1931. The S&P 500 Index fell 15.7% between December 3^rd and December 24^th, when it reached its lowest point of the month. The Dow Jones Industrial Average fell 15.6% entering the correction zone.

Equities usually underperform during tight monetary policy periods. The higher the interest rates, the easier for investors to find low risks investment with high yields, such as bonds. As risk appetite is restricted, equities sell-off drives stock markets prices lower. On the other hand, higher interest rates environment impacts investor confidence that the economy is growing strongly enough for the corporations to offset the impact of higher borrowing costs.

Figure 2: S&P 500 (blue) and Dow Jones (red) Indexes falling for the month of December

The impact on the Yield Curve

The Yield Curve is a graphic representation of the interest rates at different maturities for a given credit quality. The most common yield curve compares different maturities of the U.S. Treasuries. The tightening policy of the Fed controls short-term interest rates but has very little impact on the long-term. Therefore, the Fed monetary policy has a crucial impact on the Yield Curve. As shown on the graph below, as short-term interest rates rise, the spread between the short-term and long-term maturities diminishes, which causes a flattening of the yield curve over the years. Concerns rose around the flattening of the yield curve as it means investors do not expect to get a higher yield for long-term investments than for short-term investments even though long-term ones are riskier. In other words, it means investors expect an economic slowdown in the future.

Figure 3: US Treasury Yield Curve

Source : Guru Focus

The flattening Treasury yield curve has also raised concerns as it paves the way for a future inversion. An inverted yield curve is an interest rate environment in which long-term debt securities have a lower yield than short-term debt securities. It means that investors expect their return to slow down in the future, hence, an inverted yield curve has often been seen as an anticipator of a recession, as it has been historically observed twice and both times it was the case. The Fed takes into account inflation, economic growth and unemployment when voting for a rate hike, however it may also take into account the yield curve and pause hikes if it were to flatten further or possibly inverts.

Figure 4: The visual representation on the inverted and the normal yield curves

Source : Forbes

The impact on Emerging markets

Fed’s U-turn from Quantitative Easing (QE) to Quantitative Tightening (QT) is pretty significant for emerging markets (EMs).

As already said above, following the financial crisis, the Fed injected liquidity into the market aiming to ease financial conditions and borrowing costs by increasing demand for relatively safe assets. As a consequence, prices rose, and interest rates fell (this is the supposed effect of a QE).

Central banks across EMs followed suit, to allow non-financial corporations to get cheaper debt, consequently, private credit across EMs ballooned. Now that central banks are holding their current portfolios of bonds until maturity and selling the assets on their balance sheets to the market (QT), that private credit has started to shrink (Figure 5). Given that “credit creation has been the most important driver of asset prices for decades” as credit creation has pulled back, economies have tumbled.

Figure 5: Private sector credit creation started falling

Source : National Central Banks

EMs have strongly been affected by this unwinding for two main reasons:

They binged the most on the giant pool of cheap money in the years since the crisis
As the Fed started shrinking its balance sheet, as observable on the appendix 1, the supply of global dollars will also shrink making it more expensive. The dollar rally in 2018 worsened currency crises in the economies with large dollar-denominated debt (Appendix 2).
Higher interest rates in US means higher returns for dollar-denominated banking accounts that increase investors’ demand for dollars consequently making the USD more expensive vs other currencies (Appendix 3).

Appendix 1: Fed’s balance sheet, showing a steep increase after the 2008 crisis and now starting to decrease

Source : Bloomberg

Appendix 2: the huge evolution of the Chinese debt in US dollars value, representative on the EMs debt trend

Source : IMF data, Tradingview representation

Appendix 3: Balance sheet roll off is supportive for the Dollar

Source : CitiFX, Bloomberg

Authors: Noa Lachkar, Greta Pontiglio

Supervisor: Lorenzo Bracco

Small investment bank boutiques cash in on mega M&A deals

(On the right side is Simon Warshaw and on the left side is Michael Zaoui)

While it’s normal that big name players take mega deals in M&A market, small investment bank boutiques in London have shared a bigger slice of the pie than ever before, and, many times, some of them are beating big names.

Robey Warshaw, a Mayfair based investment bank boutique with merely 13 members, had a market share of 20.4% and an announced deal volume of about $65.6 billion through 1H2018 in the UK M&A market, according to the Bloomberg Global M&A Market Review 1H2018, overcoming giants such as Bank of America Merrill Lynch ( UK market share19.1%, deal volume: $61.6 billion), Goldman Sachs (UK market share: 18.8%, deal volume: $60.6 billion) and Rothschild (UK market share: 18.4%, deal volume: $59.2 billion) etc.. Interestingly, Robey Warshaw had only 3 deals to achieve a deal volume as high as $65.6 billion, comparing to an average of approximately 30 deals for other top-10 investment banks on this list (as shown in the table). With an average deal size of $21.9 billion,Robey Warshaw beat almost every company on this criterion.

Another mega-deal investment bank kiosk is Zaoui & Co. Established in 2013 by Morocco-born brothers, Michael Zaoui and Yoël Zaoui, Zaoui & Co had 12 employees in 2015, of which only 7 were bankers. It is worth noting that both brothers held a senior role in major investment banks: Michael was the head of M&A division at Morgan Stanley and Yoël at Goldman Sachs. Although the company was not on the top 20 deal-maker list in the 1H2018 report, which is mainly due to a lack of large deals and a nearly 60% shrink in French M&A market, according to Michael Zaoui’s interview with Financial News, it showed a strong performance in 2014 and 2015, only two years after it was incorporated. In 2014, the company advised GlaxoSmithKline PLC (“GSK”) to acquire 36.5% of stake in Consumer Healthcare Joint Venture of Novartis AG (“Novartis”) for $13 billion. There are other transactions involved which push the total amount to $57 billion. The deal was closed on 1st June 2018. In the same year, Zaoui brothers also advised a major merger in the manufacturing industry, helping Lafarge and Holcim to form LafargeHolcim, now the industry’s biggest player. The transaction involved is about €40 billion. Different from Robey Warshaw, which mainly puts its focus on the UK M&A market, Zaoui & Co. has broader geographical coverage. It has been developing its market in France, Italy, and Switzerland and also working on deals in Israel, according to the Financial News.

Comparing to the similar size UK kiosk advisors (another name often used for investment bank boutiques), which often have deals with transaction volume between $10-300 million, these two investment bank boutiques had an eye-catching performance, often with multi-billion deals. Reason? Their owners were superstars in big-name investment banks long before building their own businesses. Robey Warshaw has a team with Sir Simon Robey, Philip Apostolides, and Simon Warshaw. Sir Simon Robey was the former co-head of global M&A at Morgan Stanley, while Mr. Apostolides also held a senior investment banking role at the same bank. Mr. Warshaw was the former head of investment banking at UBS, according to FT source. Michael Zaoui was a colleague of Simon Robey in Morgan Stanley for many years; even now, their offices in Mayfair are merely a few hundred meters away. While both were co-head of global M&A in Morgan Stanley, Simon Robey focused more on the UK deals while Michael on continental European ones. This is correspondent to the different geographical exposure and strategies of Robey Warshaw and Zaoui & Co now. The former did the most of deals in the UK while the latter focuses primarily on continental Europe. Yoël Zaoui had spent about 25 years in Goldman Sachs and left as the head of the global M&A before founding the company with his brother in 2013. There is “fantasy football team” of London’s leading merger & acquisition advisers on the wall in Zaoui & Co’s boardroom, drawn up by a financial journal, according to EveningStandard. In goal is Karen Cook. The right full-back is Simon Robey. At right center is Richard Gnodde. Occupying the two striking positions are Michael and Yoel Zaoui. When all-star players team up, no wonder they can hit the goal that even big banks cannot.

Robey Warshaw and Zaoui & Co. are just two typical examples of investment bank kiosks. LionTree Advisors LLP (example transaction: Liberty Global’s acquisition of Virgin Media, $23.3 billion) and many others are advising multi-billion deals with just a few bankers in the office. Nonetheless, M&A advisory was never a labor-intensive industry. Thanks to their structure, top tier boutiques can generate an incredible amount of profits with small teams. Zaoui & Co, for example, earned an approximate £17.3 million turnover and an £8.6 profit. Between these two numbers is an administrative expense of £6.4 million, and employee cost was more than £5.3 million for a total of 13 staffs. In conclusion, with a strong network of the top management and an experienced team loaded with talents who worked for big banks, these firms have proven the ability to win the trust from big clients and play a leading role in the most relevant deals in the market.

Autor: Yintao Hu

Sources:

Financial News, Sahloul F., 28 Sep. 2018 “Zaoui brothers back in black after European M&A bounce” url: https://www.fnlondon.com/articles/zaoui-brothers-back-in-black-after-european-ma-bounce-20180921

Financial News, Clark P., 8 Oct. 2018 “Deals dry up for Vanity Fair cover stars Zaoui & Co” url: https://www.fnlondon.com/articles/deals-dry-up-for-vanity-fair-cover-stars-zaoui-co-20181008

Financial Times, Murphy H., 4 Jan. 2018 “Robey Warshaw pays out more than £60m to founders” url: https://www.ft.com/content/ae701f18-f14c-11e7-ac08-07c3086a2625

Evening Standard, Blackhurst C., 4 Sep. 2015 “Michael Zaoui: The Ronaldo of investment bankers with $150 billion of deals in the back of the net” url: https://www.standard.co.uk/business/michael-zaoui-the-ronaldo-of-investment-bankers-with-150-billion-of-deals-in-the-back-of-the-net-a2927466.html

US-China Trade War Effect on the EU

Back in March we introduced and briefly discussed Trump’s intention to impose tariffs on steel and aluminum goods. In less than a year those trade disputes escalated in a trade war, impacting not only the two involved countries but also other trading partners, including the EU. The disaffection versus international institutions has been driven by their inability to include the weakest parts of the population from feeling the benefits of the globalization process. While globalization has triggered economic growth and substantial real income growth in developing countries, the middle class of developed nations has not experienced the same benefits, leading to a decrease in purchasing power and a rise in protectionist sentiment.

The main idea behind Trump’s rhetoric was to reduce the large trade surplus China has with the United States. Trump previously described the widening deficit, which Washington has said is around $100 billion wider than Beijing reported, as “embarrassing” and “horrible”. China and the EU were among those expressing their concerns regarding steel and aluminum tariffs and have threatened the US with applying a number of countermeasures. Jean-Claude Juncker, President of the European Commission, announced that the union will engage in a collective response with other countries affected by American measures and expressed EU’s intention to draft a list of retaliation tariffs amounting to $3 billion.

Since then, Trump’s actions have shaken the very foundations of global trade, with billions of dollars worth of goods from the EU, China, Mexico and Canada. The protectionist measures imposed by the American president have escalated into a full-fledged trade war between China and the US. An economic showdown between world’s largest economies does not look great for anyone and the EU’s manufacturing and industrial sectors are largely affected. Clearly, those sectors are monumental for Germany – the world’s fourth largest industrial nation.

Potential Paradigm Shift?

As the US is escalating the trade war, it will be more difficult for China to accommodate American demands. There are few effective ways for China to retaliate without hurting its long-term development. An alternative would be to open up to the world’s largest economy to the EU. Thus, there is an expectation of a possible collaboration between China and the EU, given that China accepts the longstanding demands of the EU on better market access and give-and-take approach. Within this scenario we would observe a paradigm shift in terms of US-China economic relations. The EU Commission currently maintains a neutral stance towards Chinese exports. So, the result would largely depend on whether EU chooses to align with the US to protect its market from the Chinese market or maintain the neutral policies. By maintaining the neutral stance, EU could substitute the US and China in each other’s markets to an extent. Given that US does not hit the EU directly and EU maintains a neutral stance, potential gains for EU industries are relevant for the motor vehicles and aircraft sectors as well as other sectors combining over $200 billion altogether.

Germany’s GDP Growth

In the third quarter of 2018, German output contacted for the first time since 2015 and this helped push the euro zone growth down to just 0.2%. This weakness is expected to continue in 2019, with the German GDP Growth rate revised down from 1.8% to 1% due to the global economic slowdown. Furthermore, the euro zone does not have the economic backdrop to increase rates, since the ECB ended its net asset purchases in December. Therefore, the benchmark rate is likely to remain the same, making it harder for the EU to offset the effects brought about by the trade war.

The main factor contributing to this contraction is the German auto industry. German car production decreased by 7.4% quarterly and this subtracted 1% from expansion in the industrial production and 0.3% from Germany’s GDP growth. The reason for this decrease comes partially from the new environmental standards for passenger cars, as producers could not make the vehicles as quickly as they desired.

Another reason for the Germany’s GDP slump might be China’s economic slowdown as China is one of Germany’s largest trading partners. China is facing economic issues arising domestically due to financial instability and externally given the trade tensions with the US. In October, China’s financial team went into overdrive with ten meetings within two months and Vice-Premier Liu He’s team was under pressure to resolve problems caused by the trade war that slowed the country’s growth. China’s economy officially grew only 6.4% on YoY basis in the fourth quarter, its slowest rate since the global financial crisis. A lack of growth in investments and consumption is the main driver of this lackluster performance.

Weakness In The Car Industry

Back in June, Germany’s Daimler cut its 2018 profit forecast, while BMW stated it was looking at “strategic options” because of the trade war. Thus, the companies sparked fears of earnings downgrades in the auto industry. Daimler stated that import tariffs on cars exported from the United States to China would hurt sales of its Mercedes-Benz cars, resulting in slightly lower EBIT for the year. Morgan Stanley’s analysts added that Daimler will not likely be the only Original Equipment Manufacturer (OEM) to reduce its guidance. Other OEMs are exposed to similar trends in various degrees.

Daimler’s rival BMW, which also exports from the United States to China and Europe reaffirmed the profit forecasts, adding that these would largely depend on unchanged global political conditions.

“Within the context of the current discussion concerning additional tariffs on international trade, the company is evaluating various scenarios and possible strategic options”.

European Central Bank’s Hard Work

Mr. Draghi of the ECB and Mr. Weidmann of the Bundesbank seem to agree that the policy should be normalized without delay. This suggests that the ECB remains determined to end net asset purchases by the end of 2018. Still, German exporters are vulnerable to the slowdown in external demand and the risk of trade tensions between Europe and the United States.

So, what should the ECB focus on? The Quantitative Easing program launched in 2015 with the intention to reduce the risk of deflation has come to an end last December. The key EU Inflation Rate rose above the ECB’s target of close to but below 2% for 2018, making it harder to justify an extension of the QE program.

The ECB held its benchmark refinancing rate at 0 percent on October 25th and said it would stop to make net purchases under the asset purchase programme at the end December 2018.

This situation has changed in the past months as the effects of the Trade War have been felt on both the real economy and financial markets globally. The sharp slump in energy prices, a contraction in Exports and finally Consumer Sentiment drifting lower from high levels have consistently reduced Inflation and GDP Growth expectations for the EU Area. As a result, it is highly improbable that Mario Draghi will be able to follow through on ECB plans towards normalization in the short term. The continued reinvestment of the proceeds from bond redemptions will be necessary to provide stimulus to the European economy for the years to come. Moreover, ECB should use the forward guidance to thrust back market expectations over the key interest rate rise – something which would weaken the euro and further loosen the financial conditions. The ECB’s next moves largely depend on the upcoming levels of inflation and economic activity, which are linked to politicians’ ability to solve trade disputes and restore confidence.

Trade War Detente

China and the US have agreed to not impose new tariffs up until March, when a definitive agreement is expected to be reached. Furthermore, China’s Ministry of Finance removed the 25% tariffs on American-made cars and 5% on specific car parts for three months. This shows the willingness of both sides to cooperate and work towards a larger trade deal, but only time will tell whether this willingness will convert into a desirable outcome. As commentators pointed out, any positive cooperation including negotiation or even talking would help settle the markets, while continuing tensions will instigate investors to withhold their money.

Even if according to the United States Trade Representative several outstanding issues remain, the possibility of an expedited trade deal has helped stabilize the markets in the last weeks.

The Dow Jones Industrial Average gained 163.08 points (0.7% increase) to 24,370.24 – its highest level since December 13.

The upcoming elections of 2020 in the US oblige Trump to find an agreement in order to maintain his electoral base and increase his probability of reelection. According to reports from various sources, US officials are willing to grant China sizeable concessions in further negotiation rounds to reach an agreement before the deadline. It is unknown if this is enough to restore confidence in the system and the first test is expected in few months on the other side of the Atlantic Ocean. In May there will be the elections for the European Parliament, with Eurosceptic Parties gaining ground thanks to the widespread economic malaise exacerbated by the Trade War. The March meeting proves to be essential for all the parties involved, making extremely hard to forecast future upcoming events.

Authors: Nikita Borzunov, Mario Stopponi

The website and the information contained herein is not intended to be a source of advice or credit analysis with respect to the material presented, and the information and/or documents contained in this website do not constitute investment advice.

The Race has started for European PE firms to join the $100bn Club!

By Ascanio Rossini

The race to become Europe’s first $100bn private-equity firm is accelerating as the recent fundraising boom shows. Europe’s largest investment firms, including Ardian, Partners Group and CVC Capital Partners, are closing in on $100bn in AuM after raising some of their largest-ever funds in recent years and launching new investment strategies in areas such as infrastructure, credit and real estate. Their rapid growth from single-fund PE shops to multi-strategy asset managers comes as the asset class has matured from a cottage industry 20 years ago to one attracting hundreds of billions of dollars annually from some of the world’s largest institutional investors.

Keeping Pace

The rapid growth of these firms also raises questions about whether firms are expanding their teams and building out the infrastructure sufficiently to keep pace with their growing assets. Money flooding into the asset class in Europe is concentrating in the hands of fewer firms, much like the U.S. market. New York-based Blackstone, for example, manages nearly $500bn, ranking it as the largest firm by assets.

Paris-based Ardian, established in 1996 as the captive private-equity arm of French insurance conglomerate AXA, leads the pack of European managers closing in on the $100bn mark.

Ardian now manages $82bn on behalf of its investors (more than double of what it managed in 2013), but is seeking an additional $25bn in new cash across its various investment strategies, including a flagship buyout fund and a global secondary fund, as well as vehicles focused on North American buyouts, private debt and European infrastructure.

Meanwhile, Ardian’s Swiss rival Partners Group, Europe’s largest listed private-equity firm, has turned itself into a fundraising machine after switching its investment focus a decade ago from backing private-equity funds to making direct investments. The Swiss firm now manages $78bn.

London-based CVC, the former owner of Formula One, is another candidate that could join the $100bn club, although perhaps a bit later than the others. The firm managed some $69bn in assets as of Sept. 30 after collecting €16bn in 2017 for the largest buyout fund ever raised by a European private-equity manager.

Increasing assets under management by moving into new markets means PE firms stand to enrich themselves by boosting the fees they receive from investors. Buyout shops typically make cash by taking a slice of profits from successful investments as well as by charging a 2% fee on the money they manage. The decision to move into different investment strategies has prompted a mixed reaction from some investors. Some see it as an opportunity to put large sums of money to work with a manager they know and trust; others as an excuse to increase the money they make in fees.

Increasing Staff

To keep pace with the growth in assets, many of the largest European firms are expanding into new geographies and ramping up the number of staff they employ. Partners Group for example, employs more than 1,000 executives globally; nearly double the 560 workers Ardian has on its payroll.

Investment firms, including Neuberger Berman’s Dyal Capital Partners and Goldman Sachs’ Petershill unit, buy stakes to gain a cut of the fees firms charge and the profits from their deals.

Bridgepoint, which has recently moved into credit and manages small-cap funds, became one of the first major buyout shops in Europe to strike such a deal when it sold a chunk of itself to Dyal Capital in August.

The continuing flood of capital flowing toward Europe’s buyout giants comes with a risk. Firms will have to be careful to ensure they don’t raise more money than they can prudently spend, as dry powder in Europe reached a record of €220bn as of Q4 2018, pushing asset prices up to an all-time high in 2018.

“This is the kind of environment—marked by too much money chasing too few deals – in which investors should emphasise caution” said Howard Marks (OakTree Capital co-founder).

Sources:

PE News – https://www.penews.com/articles/the-race-is-on-for-europes-firms-to-join-the-100-billion-club20190121

PE Insights – https://pe-insights.org/the-race-to-be-europes-first-100bn-private-equity-firm/

FN News – https://www.fnlondon.com/articles/the-race-to-be-europes-first-100bn-private-equity-firm-20190122

Escp Europe Finance Society