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The London Brief - March 31st, 2021

The London Brief March 31st, 2021 Christies auctioned the NFT, “Everydays” from the “First 5000 Days” for $60 million. This was a unique token by the digital graphic artist Beeple. NFTs stand for ‘non-fungible token’. Each NFT is coded to have a unique ID and other metadata that no other token can replicate. This gives originality and scarcity. NFTs are used for Tweets, one-of-a-kind cat images and “punks”. But what they all have in common is their use of blockchain technology, which is a decentralized ledger that tracks the ownership and transaction history of each NFT. Nowhere is blockchain technology more prevalent than in cryptocurrencies. Is the World Moving to Bitcoin? Bitcoin is gaining increasing market acceptance. Aker Solutions, an establishment company with a long history said, “We will use Bitcoin as our treasury asset. We will build and invest in projects and companies in Bitcoin’s ecosystem. Our home game is industrial applications. But we also believe nicely designed user interfaces will enable new applications wherever transactions happen. I am particularly interested in micropayments and how they may allow us to avoid usernames, passwords, and our personal data being monetized with, an often without, our knowledge or consent.” Citigroup’s Global Perspectives and Solutions group issued an interesting report on Bitcoin in March with some interesting data. · 36% of SMEs are accepting Bitcoin according to HSB · There is $536 million of Bitcoin volumes in South Africa and Nigeria according to Reuters · There is $20 billion a day in OTC Bitcoin trading according to Hacker Noon · There were $500 billion of crypto volumes in the first three weeks of 2021 according to Coindesk · There are 11,798 terminals that allow for the purchase of Bitcoin and sale of cryptocurrency for cash They noted people like Bitcoin’s borderless and decentralized design; its lack of FX exposure; its speed; its cost advantage in moving money; security of payments; and traceability. Most of the Bitcoin network is enabled by satellites so it’s censorship resistant. There is a growing trend of companies following in Aker’s footsteps. Burger King in South America and Germany have apps that accept Bitcoin. KFC offered a Bitcoin Bucket for online customers. The Lightning Pizza Initiative allows you to buy Domino’s in Bitcoin. The American Cancer Association has a Cancer Crypto Fund which accepts Bitcoin. Wikileaks accepts donations in Bitcoin. Amazon’s game streaming platform, Twitch, accepts Bitcoin. Overstock partnered with a global crypto exchange to allow online purchases in Bitcoin. Through BitPay, AT&T offers a payment option for customers for their phone service. Microsoft offers users a top-up for games in Bitcoin. The Dallas Mavericks allow the use of Bitcoin for game tickets and merchandise. MicroStrategy and Tesla put some of their corporate cash into Bitcoin. PayPal announced in October 2020 that it would allow U.S. account holders to buy, sell and hold cryptocurrencies and use it to shop with 26 million merchants (although these are still settled in fiat currencies). African money transfers in Bitcoin jumped 55% in August 2020; the reason is that people have difficulties obtaining U.S. dollars and there are weak local currencies. Visa said it would start settling transactions with Bitcoin partners. After the U.S. Capitol attack on January 6th, Bitcoins worth $500,000 were dispersed to 22 virtual wallets most of which went to right-wing organizations and individuals. Jonathan Levin of Chainalysis says, “Bitcoin is the first global payment system that’s accessible to anyone in the world.” There are several concerns including capital efficiency, insurance and custody. No government interference also means no government backing. If an institution goes down your money is lost. Bitcoin has also been hacked. CoinCheck in 2018 was subject to $487 million of altcoin being stolen in a hacking theft. Mr. Dox in 2011 led to 800,000 Bitcoins being stolen. Tether is a stable coin backed by Bitcoin meant to help create fractional banking, however there were concerns about its sources of funds and it was described as a ‘doomsday machine’. While freeing money from government control sounds good, I think going to a Bitcoin world is like re-visiting the gold standard, which was essentially a tight money system. I’m not sure if Elon Musk and Chamuth Palihapithiya realize that in a tight money system their companies would probably not trade at the high multiples they do to give them the wealth and media heft to promote Bitcoin. And there’s the rub. A bet on Bitcoin is an anti-system bet that central bankers and governments are going to print money forever and obliterate its value. However, the Treasury market is not saying that. Taper Tantrums The 10-year U.S. Treasury bond sharply lifted the last week of February. Good reasons for the move were rising 2025 forward rates in line with 2% inflation. The Fed has an ‘outcome-based policy’ which allows the market to set the bond price. A rising yield curve should be a good thing as inflation would signal growth and economic recovery from COVID. If it overshoots potential inflation the Fed can step in, but Treasuries pricing in pre-COVID yields does not seem unreasonable. This could impact market valuations particularly those names trading at high multiples of revenue, but it’s not the Fed’s job to provide puts for crazily optimistic market values. One odd effect of recent monetary policy has been the ‘supplementary leverage ratio’ (SLR), which requires big banks to fund themselves with equity worth at least 5% of assets. Because the central bank has been buying bonds with newly created cash from the March 2020 cash shortage, there is now an abundance of dollars. When the Fed buys assets in the secondary market, it does not pay the pension fund with electronic money it creates as only banks can hold this ‘reserve’. Instead, the pension fund gets a deposit in its bank and the bank gets the ‘reserve’ from the Fed. The bank ends up bigger with a new asset and a new liability. The same thing happens when the Fed buys Treasuries from the government. In the case of the stimulus checks, there is an expansionary impact as the government sends these checks to households and the banking system grows. To give some scale in numbers, in 2020, JP Morgan grew from $2.7 trillion to $3.4 trillion as deposits rose 35%. The Treasury general account at the Fed grew from $350 billion in March 2020 to $1.3 trillion on March 11th. The infusion in cash has meant that the federal-funds rates between banks and the secured lending or ‘repo market’ have approached the zero bound. This could impact money market funds and force them to ‘break the buck’, where they return less than what people put in. The second effect is the SLR which states that banks must have equity worth at least 5% of their assets. The Fed has given them an exemption which expires at the end of March. But banks have threatened to turn away new deposits. Another way a bank can shrink its balance sheet is by selling assets to investors. This is part of what has caused the Treasury sell-off in late February. One solution is to allow for an expansion of the ‘overnight reverse repo facility’. Currently counterparties can only post $30 billion there; the Fed may raise this to $80 billion. Banks balance sheets could then shrink. Currently, there are large short positions in Treasuries, one of the most significant on record. Jamie Dimon earlier in the month advised to sell Treasuries. I think the spread widening pressure ebbed at the end of the month as continued issues with coronavirus forestalled bets on inflation and higher yields, but during the spring and summer time expect continued testing of Treasury levels with a view the 10-year settles around the 2% mark. The Evolving Antitrust Debate Potential FTC Chair Patricia Slaughter gave a press conference announcing a multilateral working group to ensure that future merger reviews address expansive and perhaps additional theories of harm. They will look at pharmaceutical deals to look at the effects of innovation. They will consider whether a company has engaged in price fixing, reverse payments and other regulatory abuses in their review. However, at a spring ABA conference later in the month Representative Ken Buck talked about the subcommittee’s work on a congressional antitrust bill. He mentioned that they are looking at several smaller bills rather than a comprehensive omnibus bill. Most of the legislation focuses on big tech, but they may focus on the pharmaceutical industry as well. It’s too early to opine on whether a substantive change will occur on antitrust merger reviews. In one sense there is a desire to bring more cases and challenge, but the regulators are governed by pre-existing law and it doesn’t look like any big-bang legislative changes are coming due to a lack of unanimous support by Democrats and the ongoing use of the filibuster by Republicans. There is the possibility of rulemaking by executive order, but that might not withstand judicial review, so it’s unclear whether Biden wants to go this way. A good indicator (but only partly) is the Willis Towers/Aon deal. The DOJ staff seems to be pursuing a 3 to 2 theory on the basis of national global accounts for insurance along with Australia and other smaller jurisdictions. It will be interesting if a case is actually brought. But I say only partly on the basis that there are precedents like the Office Depot/Staples land Sysco/U.S. Foods which were successfully challenged by the DOJ. This deal would only be an extension of prevailing antitrust theory. Regulators also have good legal grounds to challenge certain deals in the healthcare data and defence industry such as a recent case filed yesterday against Illumina in their takeover of Grail, which does cancer testing. But would deals be blocked on more far-reaching vertical issues or due to very small overlaps on a general lack of innovation? This remains to be seen, but without a real change of law I’m a bit sceptical. Mergers and Acquisitions Investment banks are set to have their best quarter ever making more than $30 billion in fees. Of course, this was before several of them lost a lot of money lending to a dodgy family office called Archegos, which had to throw in the towel. Still, by the end of March global deal-making hit $1.4 trillion. “We expect an uptick in M&A as financing is cheap and valuations are high. Fundamentals are better and corporate earnings are stronger as the COVID-19 vaccine is rolled out. This is all spurring confidence,” said Conor Hillery co-head of IB for JPM in EMEA. The co-head of UBS banking Javier Oficialdegui said, “The reality is that the current level of market activity is astounding. Activity has been strong across the board.” Investment banks have made $4.7 billion in fees from SPACs this year. In terms of deal activity this month, Canadian Pacific is merging with Kansas City Southern in a $25 billion deal. This is the first merger between two Class 1 railroads in over two decades. The strategic rationale involves nearshoring and last year’s trade deal between the U.S., Canada and Mexico. In the insurance sector, Chubb made an unsolicited approach for Hartford in a potential $24 billion deal. This was rejected but Hartford may be starting an auction as AIG, Allianz and others have also been rumoured to be interested. Rogers made a bid to buy Shaw Communications in a transformative bid for the Canadian telecom sector for over C$24 billion. Canadians pay some of the highest mobile bids in the world and Shaw’s Freedom brand helped bring down prices by about 18%. I’m expecting a colourful review, although ultimately the deal is about 5G investment and there are potential solutions to fix the anticompetitive problems. In Asia, Jardine Matheson bought in the minorities of Jardine Strategic for $5.5 billion in a deal that highlighted egregiously poor corporate governance. This promises to be one of the biggest test cases for appraisal rights ever and the first one for Bermuda. In private equity, Blackstone made a proposal to Crown for A$8 billion. The company is in the midst of licensing reviews after some money laundering concerns in NSW for Chinese high rollers. Apollo bought Michaels in a $3 billion deal showing that physical retail isn’t dead yet. They then bought in the Athene, their insurance subsidiary, in a stock deal. Blackstone and Starwood bought Extended Stay America for $3.5 billion. Several minority holders have complained about the price in that deal. Roche bought Genmark for $1.8 billion to expand its product offerings. Amgen bought Five Prime Therapeutics for $1.8 billion as it seeks to augment its pipeline. This continues a theme of big pharma buying pipeline (unless proposed FTC Commissioner Slaughter gets in the way). Over in China, Wise Road private equity bought MagnaChip Semiconductor in a $1.4 billion deal. Wise Road looks like a front for Chinese purchases of semiconductor technology. The deal seems high risk as the U.S. has leaned on allies to block semiconductor technology transfers and this one seems to be in that camp. An article in Korea also highlighted the potential damage to its semiconductor industry if the deal went through. Perhaps the deal is not so wise. Infrastructure deals continue to be active. Tilt was bought for NZ$2.8 billion in a landmark deal. The valuations paid for the renewable portfolio blew most expectations away. Digital Colony bought Boingo Wireless in a $854 million deal. Macquarie and a consortium bought Vocus for $3 billion. Immofinanz made a bid for S Immo as musical chairs continue to be played in the Austrian and East European property sector. The Dolans continued their quest to destroy the Knicks, this time by merging Madison Garden Entertainment with MSG Networks. End Note For the two Canadian deals (Rogers for Shaw and Canadian Pacific for Kansas City Southern), instead of reading the typical analyst reports, I was fortunate to have two interesting biographies available: Relentless by Ted Rogers andRailroader: The Story of Hunter Harrison. Rogers built up a cable empire, carrying along a lot of det and negative free cash flow for years not too dissimilar perhaps to a lot of the current stories in technology, AI and SPACs where we see a noticeable lack of free cash flow as companies build themselves up to scale. The introduction of precision railroading by Hunter Harrison transformed the rail industry and despite publishing a few manuals on his techniques, none of the other managements could implement his theory until Harrison actually took the helm four separate times, his last time on an oxygen machine. If Evan Greenberg, the CEO of Chubb, prevails in his quest to buy Hartford Financial Services, I can read The AIG Story about his father. Hopefully there will be a lot more deal flow and more biographies to come. Happy Easter. Omar Sayed Cobham, Surrey

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