The London Brief - December 31st, 2020
The London Brief
December 31st, 2020
2020 was a turbulent year. It started with the coronavirus. Markets took a sharp dive in March. Then came highly politicized responses to its control with the very idea of science being questioned. But by the end of the year, we had several vaccines for the virus, the potential for less Twitter volatility under a new President and even a Brexit deal.
Although coronavirus mutations and lockdowns will still dominate the news in the near-term and we end the year with much misery, the 2021 narrative should start to move from viruses back to next generation technologies. For instance, China’s EHang Holdings piloted a two-seater air taxi in Seoul flying through its downtown for 10 minutes. Australian start-up AMSL launched an electric air ambulance that transports patients from remote communities straight to the hospital. DeepMind utilized AI techniques to identify 30,000 novel molecules with desirable properties for pharmaceutical development. The first wave of a new class of anti-ageing drugs began testing. It works by removing certain cells that suppress normal mechanisms of cell repair as we age.
Hopefully next year we will fly higher as things normalize and a new American president attempts to radiate a more optimistic message than what we’ve seen over the last four years. This month’s brief will give my outlook for 2021, talk about the top five books that I read in 2020 and survey this month’s M&A trends.
U.S. IPOs raised $178 billion of new capital outpacing the $167 billion in real dollars issued during the dotcom bubble in 1999. Bitcoin reached new highs rising to 29,000 from 5,000 at the mid-March low. Doordash soared 86% and AirBNB rose 113% on the first days of trading. Neither company is profitable. I lost track of the number of Tesla wannabes that listed through SPACs. Much like 1999, retail investors are focused on trendy tech-based companies. Tesla is up almost 7x this year and has a $600 billion valuation. Investors borrowed against their investment portfolios pushing margin balances to a record. The head of allocation at Grantham, Mayo, Van Otterloo noted, “We are seeing the kind of craziness that I don’t think has been in existence, certainly not in the U.S., since the Internet bubble.” This wealth has not been spread evenly. According to Ed Wolff, an economist at NYU, half of American households do not own stock. The wealthiest 10% control 84% of the value of these shares.
Negative signals are obscured by liquidity. G5 M2 is up 18%. Public liquidity is growing 50%. The supply of USD is up 20%. Fiscal deficits are above 10%. Yet the excess yield of equities versus bonds is actually higher than in January. The head of Barclays cash equities said, “You have this maestro up in the front that’s conducting the orchestra. And until they stop, the music is going to keep playing.” According to the Institute of International Finance (IIF), global debt is now $273 trillion, with most debt in developed markets and China, where central banks monetize it. This number excludes unfunded liabilities like pensions and medical care, which in the U.S. alone totals $50 trillion. Overall global debt is probably around $450 trillion or 4.5x GDP and the global value of financial assets is probably around $400 trillion. G5 central banks have balance sheets over $30 trillion. Emerging markets, however, still have to restructure debts and reconstruct. EM debt is $29 trillion, only marginally higher than 2015. Foreign currency debt ex-China is only $4 trillion, and China is at $2 trillion. Inflation expectations have risen with ten years up 20 basis points over the month. But yields would have to rise from 95 bps to 200 bps before there is a positive real return, in which case equities will retain their relative attractiveness.
Some believe yields could go up if the Treasury has to offer higher yields to entice borrowers to buy $1.8 trillion of Treasuries next year. Currently the Fed has been buying shorter-dated Treasuries allowing the market to soak up the long-end at positive spreads. While there should be demand from Japanese investors and pension funds, if the Fed does not buy longer-dated Treasuries itself, the government may be forced to pay up to sell its long-dated debt. This could become a headwind for equity markets as global risk tends to be priced off of the ten-year. A U.S. led backup in yields is a tail risk that will grow in the latter part of the year”, said JPM’s Head of Global FX. But the head of bonds at PGIM Fixed Income is a sceptic about the case for higher yields saying, “People think the U.S. is the central market, but look around and it’s on the fringes. It’s a low-rate world, and Treasury yields already look too high.” Europe and Japan are negative rate markets. If U.S. yields start to rise, yield-starved investors in other markets should soak up that demand.
Another risk is that as we get to the back half of 2021 with vaccines rolling out and life normalizing, fiscal policy could turn into a headwind with the withdrawal of $2 trillion in public spending. Monetary tools may contract (Macquarie estimates are $3.5 trillion down from $9 trillion). However, these numbers are still small relative to the amount of global debt and global asset values.
This period reminds me a lot of the 1998-2002 period. In that instance the exogenous shock was not a virus, but the Russian debt and East Asian financial crises. This led to turmoil in financial markets and the Fed ended up supporting the banks. With concerns also over Y2K, the Fed led a loosening cycle which culminated in the dotcom bubble in 1999. The peak of this for me was when Razorfish acquired a company called Ice Cube creating a $20 billion Internet advertising behemoth that made little revenue let alone profits. After the Y2K issue passed without incident, the Fed started on a tightening cycle that then caused a 40% peak to trough decline in equities.
However, we currently seem to be more in the 1999 phase and certainly not in the tightening period. I suspect that with coronavirus still raging until at least the middle of next year, there will continue to be high rates of unemployment leading to continued loose monetary and fiscal conditions that will continue to provide a tail wind for markets and probably create Ice Cubed: The Sequel. As we get closer to the end of the year and normality leads to sharp spike in growth and lower unemployment, we may see more concern around inflation and rates, and the ride could get bumpier. Fed-watching will be important.
Top Five Books for 2020
I try to do a lot of reading each year and these were the most influential and interesting books I read in 2020. It’s kind of like a Bill Gates list, but he does a much better job than me.
The Road to Conscious Machines by Michael Woodridge. Woodridge is a professor of computer science at Oxford and gives a comprehensive history of artificial intelligence and its false starts starting from Alan Turing. Besides explaining in layman’s terms the many words you hear from AI companies but don’t know exactly what they are talking about, he catches you up with the problems AI is currently facing and why the Singularity is not coming anytime soon.
Deep Work by Cal Newport is a self-help book written by a professor of computer science at Georgetown. When Bill Gates described his first meeting with Warren Buffett, someone asked them what the most important thing in life was and apparently both said, “focus” at the same time. This book tells you why and gives a lot of helpful tips. We are in a world of constant distractions, but only when we are most focused and disciplined can we deliver our best work.
The Last Lion: Visions of Glory, 1874-1932 is the first book of three written on Winston Churchill by the late William Manchester. This is considered to be the best of the three. It’s very well-written and his research is exhausting. He brings this volatile and history-moving period alive. And his description of the complicated character of Churchill is fascinating. Its long length makes for suitable for lock-down reading. What struck me is how much news there was in Churchill’s time. During that period there were financial crises, wars, rival economic systems and a lot of innovations that led to immediate change (like armoured vehicles, rocket science, energy innovations, communications, cryptography, etc. – often created from wars). Our period is characterized by central bank and fiscal policy coordination, one economic system in capitalism, far fewer wars (the only conflicts this year were the Nagorno-Karabakh War and the Tigray Conflict; I’ll let you figure where those occurred) and technology change that is actually more gradual than back then. Its puts modern day life in perspective.
Out-Innovate by Alexander Lazarow is about some of the companies outside of Silicon Valley that are creating and establishing new businesses. Silicon Valley dominates start-up investing, while emerging markets get little VC funding. Even in the U.S. about 60% of start-ups are outside the West Coast but only get 40% of the funding. But there are now 1.3 million technology start-ups globally and many of them are now in the frontier, emerging markets and China. As a result, the future is likely to be different as successful entrepreneurs in these frontier areas encourage other entrepreneurs to innovate and create alternative ecosystems to Silicon Valley. The book is the most interesting when it describes many companies and unicorns you have probably have not heard about before.
Finally, I put down a fiction book called A Gentleman in Moscow by Amor Towles. In a year that was not so uplifting, it was nice to read a book that was. It’s about an aristocrat who is imprisoned in the Metropol in Moscow at the start of the Russian Revolution. It illustrates that often hardship and negative circumstance can lead to purpose and emotional discovery.
Deal volumes are down about 6% from the prior year down to $3.5 trillion according to data provided by Bloomberg. But two-thirds of those came from July. Buyers flew drones to do locational due diligence and executives remoted in from quarantined locations. It took time for executives to get acclimated to the new M&A environment, but everyone seems to be all guns blazing now. $1.3 trillion of deals occurred just in the last quarter alone. Year to date, European deal activity rose 6% to $1.2 trillion and Asia was up 13% to $1.3 trillion.
European bank consolidation continued. Bloomberg News talked about the discussions in bank boardrooms to get around the negative interest rates, shrinking workforces and unprofitability. The slump in European banks has created a new sense of urgency. Banking regulators and executives want change. Liberbank and Unibanca announced a merger at month-end, and there are several more on the horizon.
JP Morgan’s head of Nordic M&A thinks Scandinavia’s biggest surge in takeovers will continue into 2021. EQT offered to buy Swedish pharmaceutical company Recipharm AB for $2.1 billion. There was a bidding war over Norwegian property firm Entra by two rival Swedish property players.
The Times reported that bankers are preparing for a boom in UK M&A in 2021. Citi’s head of M&A says their backlog is 2.5x more this year than last. Companies see the end of the virus crisis given the vaccine, they are looking to improve their competitive position, interest rates are low and British firms remain cheap for overseas acquirers given sterling’s fall over the past few years. As an illustration, AstraZeneca bought Alexion in a $39 billion deal. And Electronic Arts made a $1.2 billion counterbid for Codemasters, which develops and publishes video games specializing in the development of racing titles. Take-Two had originally been looking to take the company private.
Technology M&A continued to generate large transactions. S&P made a $44 billion deal to acquire IHS Markit, a provider of data and services for the financial industry. The combination would create a data powerhouse. GlobalWafers made a bid for Siltronics in a $4.5 billion deal. Siltronics manufactures silicon wafers. Cisco bought U.K. cloud company IMImobile Plc for £543 million pounds. It designs tools that help companies keep track of and interacting with users. They plan to add this to its customer relations software.
Private equity activity continues its strength. Thoma Bravo bought RealPage in a $10.2 billion deal. RealPage is a real estate software maker. Vista Equity Partners acquired Pluralsight for $3.5 billion. Blackstone bid for Signature Aviation in a £3.5 billion deal; they may face competition for the asset from GIP. Blackstone and the Lim family made a $524 million bid to buy Soilbuild, a property owner in Singapore.
Idemitsu made an offer to buy out the minorities of its 50.1% subsidiary Toa Oil in keeping with Japan’s corporate reform efforts around subsidiaries.
Gilead Sciences offered $1.4 billion for German hepatitis maker MYR GmbH and Boehringer Ingelheim spent €1.2 billion or NBE-Therapeutics as pharmaceutical consolidation continued. Some M&A practitioners think pharmaceutical companies have generated some goodwill given the vaccines and could pursue more controversial deals next year.
Diamondback Energy acquired two rivals for $1.4 billion to expand its position in the Permian in all-stock deals. QEP Resources was bought for $555 million and Guidon was bought for $862 million. Stem Peak Energy and Stem announced a $1.35 billion deal in the energy space. Most of these are stock deals in keeping with the tough outlook for oil and gas companies in the face of climate change policies.
In other activity, Huntingdon Bancshares acquired TCF Financial for $6 billion. Lockheed Martin acquired Rocketdyne for $4.4 billion. The deal will Lockheed a larger stake in the competitive space and hypersonic area. Aphria acquired Tilray in a $1 billion cannabis deal. Orange made an offer to buy out minority shareholders in its Belgian subsidiary for $752 million. The listing had not attracted much investment due to liquidity and the price point was opportunistic post-COVID.
We are now in Tier 4 lock-down, so far avoiding inner London’s Tier 5 fate, which really sounds a lot like Tier 3 back in May. Similar to the large number of electric and hydrogen- oriented SPACs, it’s hard to keep up. Another record many may have missed is that Hurricane Iota was the 30th named storm this year, breaking the record for named storms. For only the second time, letters of the Greek alphabet were used instead of names after the Roman alphabet-based list ran out. I’m not sure what happens when we run out of Greek letters. Hopefully those SPACs pay off and we don’t get to that point.
Have a safe and prosperous Happy New Year and hopefully see you (rather than Zoom you) in 2021!
 Viktor Shvets, Macquarie Research