Category Archives: economics

Warren Buffett’s bid for Unilever (ULVR)

February 21, 2017 By in economics, mergers and acquisitions, Uncategorized Tags: , , , , Leave a comment

(Note:  ULVR is an Anglo-Dutch conglomerate with what is for Americans a very unusual corporate structure.  I’m using the London ticker.)

Late last week word leaked of a takeover offer Kraft Heinz (KHZ)–controlled by Warren Buffett and private equity investor 3G Capital–made for Unilever.  Within a day, KHZ withdrew its offer, supposedly because of a frosty reception from the UK government.  Not much further information is available.  In fact, when I checked on Monday evening as I was writing this, there’s no mention of the offer or its retraction among the investor releases on the KHZ website.  Press reports don’t even seem to acknowledge that Unilever is one set of assets controlled by two publicly traded companies.

In any event, two aspects of this situation seem clear to me:

–Buffett’s initial foray with 3G was Heinz, where the Brazilian private equity group quickly established that something like one out of every four people on the Heinz payroll did absolutely no productive work.  Profits rose enormously as the workforce was trimmed to fit the actual needs of the company.

Buffett subsequently joined with 3G in the same rationalization process with Kraft.

For some time, achieving stock market outperformance through portfolio investing has proved difficult for Berkshire Hathaway.  Tech companies are basically excluded from the investment universe; everyone nowadays understands the value of intangibles, the area where Buffett made his reputation.

The bid for ULVR shows, I think, the Sage of Omaha’s new strategy–acquire and rationalize long-established, now-bloated firms in the food and consumer products industries.

Expect a lot more of this, with any needed extra financing likely coming from Berkshire Hathaway.

–the sitting pro-Brexit UK government is showing itself to be extremely sensitive to evidence that contradicts its (questionable) narrative that Brexit is good for the UK.  That seems to me to not be true in the case of UVLR.

Sterling has fallen by 15% or so since the Brexit vote, creating problems for firms, like UVLR, which have revenues in sterling + euros but costs in dollars.  Since the Brexit vote, and before the revelation of the bid, UVLR ADRs in the US had underperformed the S&P 500 since last June by about 20 percentage points.  Yes, UVLR has been a serial laggard, but most of the recent stock price decline can be attributed, I think, to the currency decline brought about by Brexit.

The idea that a venerable British firm would fall into American hands, with layoffs following close behind, appears to have been more than #10 Downing Street could tolerate.

That attitude is probably also going to remain, meaning that weak management teams in the UK need not fear being replaced–and that Buffett will likely have to look elsewhere for his next conquest.

 

 

the French election?

February 14, 2017 By in Brexit, economics, government economic policy, Strategy, Uncategorized Tags: , , , , Leave a comment

French elections

As I mentioned yesterday, there’s at least some chance that control of the French government will fall in the Spring to a party that vows to:

–leave the euro,

–engineer a depreciation of the newly-resurrected French franc and

–repudiate euro-denominated French national debt.

This is not just like Brexit, since Brexit didn’t involve government refusal to repay previously incurred financial obligations.  It’s way worse.  This is more like Argentina or Cuba.

Sounds crazy, but so did Brexit and so did Trump.

What to do?

…particularly since it’s hard for me to figure the chances of any of this happening, and I no longer know that much about French stocks.

Two lines of thought:

–avoiding being hurt, and

–trying to make money.

Both will be brief, since I don’t know enough to say any more.

avoiding being hurt

Currency depreciation would have effects much like what’s happened in Japan during the Abe administration.  National wealth and the standard of living of ordinary citizens could take a substantial beating.  Export-oriented industries would thrive.

It’s likely that French companies would have a more difficult time raising money in global capital markets, if France refuses to honor its existing euro-denominated debt.  Companys’ repayment of debt not denominated in francs would become more costly.

Knock-on effects:  my guess is that Italy wouldn’t be far behind France in leaving the euro.  The currency union would likely end up being Germany plus bells and whistles.

The way bond investors are now taking defensive measures is by selling their French government-issued euro bonds for German issues, giving up 0.4% in annual yield to avoid a potential currency loss.

We, as equity investors, can do something similar now, by avoiding non-French multinationals with large exposure to the French economy.  If we want to/need to have some French exposure, it should be in companies that will benefit from possible devaluation–that is, firms with costs in France but revenues elsewhere.  Here the performance of Japanese stocks should be a good guide, except that I’d avoid French companies with a lot of foreign debt.

trying to make money

I consider betting on future political developments to be a dubious enterprise.  If Marine Le Pen makes an unusually good showing in the first round (of two) in French voting in April, and if the French market sells off sharply on that result, I’d be tempted to look for beaten down French multinationals, on the thought that Le Pen would lose in the second round.  I’m not sure I’d actually do anything, but I’d be willing to think about it.  This would imply beginning to study potential purchase candidates, or a suitable ETF, now.

 

 

 

a French sovereign debt default?!?

February 13, 2017 By in Brexit, currency effects, currency markets, Frexit, Uncategorized Tags: , , , , , , Leave a comment

First there was the surprise Brexit vote in the UK, after which sterling plunged.

Then there was the improbable victory of Donald Trump in the US presidential election, which sent the dollar soaring.

Now there’s France, where the odds of a far-right presidential victory by the Front National have improved.  A competing right-of-center candidate, former frontrunner François Fillion, has been hurt by allegations that his wife and children did little/no work in government jobs he arranged for them (with aggregate pay totaling about €1 million).

If Marine Le Pen, the FN leader and standard bearer, were to win election in May (oddsmakers now give this about a 1 in 12 chance), her victory might conceivably snowball into a similar sea change in the National Assmebly election in June.  Were the FN to win control of the legislature too, the party says it will leave the euro and re-institute the franc as the national currency.  In addition, it intends to, in effect, default on €1.7 trillion in French government bonds by repaying the debt in new francs, at an exchange rate of 1 Ffr = 1 €.

Improved prospects for Ms. Le Pen–plus, I think, President Trump demonstrating he means to do his best to keep all his campaign promises–have induced a mini-panic in the market for French-issued eurobonds.  Trading at a 40 basis point premium to similar bonds issued by Germany as 2017 opened and +50 bp in late January, they spiked to close to an 80 bp premium last week.

my take

At this point, the conditions that would trigger a French exit from the euro and its refusal to honor its euro debt instruments seem high unlikely.  Still, the possibility is worth thinking through, since the financial markets consequences of Frexit would likely be much more severe than those of Brexit.

More tomorrow.

 

 

 

 

 

 

 

should the US dollar be strong or weak?

February 9, 2017 By in economics, government economic policy, Uncategorized Tags: , , Leave a comment

This is the question President Trump purportedly called his adviser, Michael Flynn, to ask at 3am one recent morning.  Flynn, to his credit, said he didn’t know.

Perhaps the genesis of the inquiry is the odd position Mr. Trump has put himself in of criticizing Germany (and by implication the EU as a whole) for damaging the US by having a currency that’s too strong while berating China for damaging us by doing the opposite.

It may also be economists’ comments that the Republican Congressional proposal to introduce a value added tax on imports could trigger a sharp appreciation in the dollar, thereby making exports from the US that much less attractive.

What is the best strategy for the US?

First of all, we should recognize that there’s no generally accepted economic framework that deals with currency.  There are lots of theories for particular aspects of currency relationships, but no one go-to theory.

Also, the US is in the unusual position of being the only universally accepted reserve currency, making the US is in effect the banker to the world.  So rules that apply rigorously to others may not, for good or ill, hold so firmly for us.

 

In 30+ years of dealing with foreign currencies as an equity investor, I think the issue can be summed up in practical terms to the question:  “If this country were a person, would I feel comfortable lending money to him?”

The factors that have meant the most to me are:  political stability, the rule of law, growth-oriented government policies, no excessive government debt, prudent government spending, and no restrictions on being able to repatriate my funds.  All other things being equal, mild appreciation of the foreign currency would be nice.  But I would trade that away in a nanosecond for assurance I wouldn’t have a currency loss.

All this implies that the value of a country’s currency isn’t determined by a deliberate currency policy.  Instead, it’s the result of overall conditions for doing business in that place, and of the effectiveness of government in providing a backdrop conducive for corporations to locate there.

One instructive recent example of what not to do:  massive government-engineered currency depreciation has been the cornerstone of Abenomics in Japan.  The main results so far have been to revive the fortunes of near-obsolete manufacturers, while retarding innovation and inducing an epic fall in the standard of living of ordinary citizens.

My advice for Mr. Trump?   Press forward on tax reform and infrastructure spending.  Establish meaningful vocational training to replace the VA-like stuff we have now.  Don’t try to weaken the dollar; that’s a recipe for disaster.

 

Trump and the big banks

February 7, 2017 By in Banks, economics, Federal Reserve, government economic policy, Uncategorized Tags: , , , , , 3 Comments

banks and their social function

Banks aren’t ordinary corporations.  In addition to being private, for-profit organizations, they also carry out important social economic functions.  They’re the primary instrument the government uses to carry out national money policy.  Through letters of credit, they also underpin the workings of the international trade of multinational firms that is increasingly important for economic growth.

This is why the major banks are considered “too big to fail.”

bank failures

US banks have been on the brink of failure twice during the past hundred years–in the late 1920s and in 2007-09.  Both times this has been the result of rampant speculative financial market activity coupled with reckless lending, both driven by the search for earnings per share growth.

Glass-Steagall, and its repeal

In the 1930s, Washington enacted legislation, including the Glass-Steagall Act that barred the banks from non-banking activities (like brokerage, proprietary trading and investment banking).  The new laws ushered in a period of relative stability for the banks that lasted until the late 1990s, when their intense lobbying succeeded in getting Glass-Steagall repealed.

(An aside:  yes, the banks manufactured periodic crises through imprudent lending to emerging economies–the Walter Wriston-led binge of the 1970s being a prime example–but these were relatively tame in comparison.)

Less than ten years later, many big banks were broke.  World trade had come to a standstill as manufacturers refused to accept banks’ guarantees that shipped merchandise would be paid for (the worry was that the guaranteeing bank would file for bankruptcy while the goods were en route, reducing the shipper to being an unsecured creditor).  The deepest peacetime period of world economic decline since the Great Depression began.

This, in turn, spawned Dodd-Frank, the 21st century equivalent of Glass-Steagall.

repeal again?   so soon?

While it took more than half a century for the memory of the Depression to fade enough for Congress to consider removing restrictions on bank activity, we’re now less than a decade away from the 2007-09 collapse.

Despite this, despite campaigning on an anti-establishment platform, and despite warning that Hillary Clinton should not be elected because she would be a creature of the big banks, during his first few days in office Donald Trump is proposing to restore to the big banks the tools of self-destruction they have wielded to devastating effect twice before.

How odd.