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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
Campus for Finance New Years Conference 2015
Topic: Cheap money, easy borrowing, tough investment
Jaime Caruana, General Manager, Bank for International Settlements (BIS).
The world is still recovering from the consequences of the 2007-2009 financial crisis. Thesituation remains complex, and those who say that they clearly understand what is going on, eitherlying or just dont have enough information at hand.
BIS invests in high-quality assets. Therefore, the appetite for risk is low because of the influence ofworld Central Banks decisions. As a result, return on investment is low as well.
Trends in the EU market:
1. Performance dispersion
Commodities prices decline. Winners: Sri Lanka, Philippines, Romania, Thailand, India,Ukraine, Pakistan, Bulgaria, Cambodia. Losers: Venezuela, Norway, Ecuador, Columbia,New Zealand, Australia, Chile, Iceland, Canada, South Africa, Denmark, Mexico.
EU and Japan are barely moving
Most Emerging markets (EM) are slowing down
2. High debt overhang: banks are deleveraged, but economies are not. Globally debt ofhouseholds, non-financial corporations and government combined has increased from 210% ofGDP at the end of 2007 to around 235% of GDP (it is more than 20%).
US dollar denominated credit to borrowers outside US
SourceL McCauley, McGuire and Sushko (BIS 2014); data as of Dec 2014
Public debts grew by 40% globally, while the private sectors debt has seen a decline of 5%.
The public debt remains high; however, companies and households are deleveraging. That
means that they are paying off their previous debts instead of spending more. In case of EMpublic debt was kept under control but the debt of firms and households exploded.
Non-bank
borrowers
Banks
Bond
investors
US borderBanks
Bond
investors
1.0 trillion
1.3 trillion
2.7
3.8
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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
No deleveraging in aggregate. In aggregate, funds are available as well as cheap.
The Federal Reserves flow of funds data show that nonfinancial corporate business inthe US held $1.9 trillion in bank deposits, money market funds, bonds and mutualfunds at end-September 2014.
The same source shows that internal funds (mostly after-tax profit and depreciationexpenses) at $1.8 trillion exceed capital spending at $1.7 trillion.
In the euro area, nonfinancial corporations showed a profit share of gross value addedover 24% but an investment share of less than 22%.
In the US and Europe, junk bonds and leveraged banks debt have never been moreavailable and cheaper.
All this suggests structural rather than financial impediment investment.
3. Eurozone economy is stuck with easy money and fairly weak investment. This means that itis getting harder for investors to allocate assets in their portfolio to maximize return on Investment.
Long and global view
What has to be done and taken into consideration?
1. Better integrate finance into global economy:
Financial cycles are the key focal point to real economy. Currently the debt piles up and itresults in financial system deterioration. The role of finance and financial cycles is oftentimesunderestimated. The same goes to long-term costs of the short-term expedients.
Monetary policy sets leverage price in currency and influences risk-taking. That is caused bythe following boom of misallocated resources and obscured weakness in productivity. Therefore,there is a gap between financial and real risk-taking.
2. Invest in real economy:
Financial boom obscured a general decline in productivity growth in advanced economies.
Booms are financed by banks headquartered in countries not experienced in that (e.g.Germany, CH)
Slow productivity growth forms basis for the raise of pay and living standard)
Advanced economies: nominal investment in equipment is below the trend. Newtechnologies are not being installed.
Investment is not so weak.
There are two approaches to risk (leverage): bank-driven and asset management-driven.
Within asset management-driven approach the move to capital markets implied it is positivedevelopment. However it has the following issues: first, asset managers are influenced by ranking;second, liquidity. Liquidity is a key component for real global economic growth support. But it is notclear if liquidity will be there. However, interest rates hike is projected in the medium-run,concluded top executive.
Summary and Conclusions:
Recognize benefits of easy money decline.
Costs and risks taking lead to the rise of debt and distortions although they are country-
specific. Symmetrical monetary policy needed. Counter boom in a real sector needed against that in
financial sector.
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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
Investing in the low Interest Rate Environment, Panel Discussion
1. Tamaz Georgadze (TG), Weltsporen2. Thomas Groffmann(TGr), COO of BlackRock3. Prof. Markus Leippold (ML), Zurich University
4.
Prof. Hans-Peter Burghof (HB), Hohenheim University
TG: Interest rates will remain low for a considerable time. Approximately 10 years.
ML: there is no indication of interest rates hike because of savings overhang and low productivity.Large amount of money goes to the stock market to support dividend-paying companies.
Nowadays it is very hard to diversify globally due to the assets interconnection. The demand forETFs goes up which, thereby, increases correlation between various asset classes. In essence, ETFschanged the market.
TGr: Investment horizon and expected return are becoming the most primary factors. 69% savings
in savings account are held in cash (in Germany) => no opportunities for the capital markets.
Inflation in UK remains around 0.5%. There will be no change in Bank of England monetary policy.
ML: The maturity term for US bonds is 5 years. Fed will not make any haste in interest rates hike.Unemployment rate for unskilled and young people remains high.
TGr:EUR/USD is forecast to go down which is good for European exporters. The problem of lowinterest rates in Europe is complicated by diversified policies and growth rates among Europeanmember states. That is contrary to the US, where the policy is uniform nation-wide.
It will take a long while till the rates will improve. We are expecting that the US economy will growfurther. Hence, there is a high probability that dollar will rise further this year.
HB: What is good for the US might be unhealthy for Europe. That is, shall low interest rates remain
at all-time low, the classic banking model will be destroyed.
The capital is currently exported from Germany. Deposit banks have to set negative interest rate
which will cause bank runs and system destabilization => systemic risk. In particular, Central Bank
of Switzerland has negative interest rate.
If banks dont make any changes to their business models German banks in particular then
bank runs across Europe will be inevitable in the upcoming decade.
ML: There is not enough production capacity among European companies. This makes no space for
the money inflow, so new economic and business models need to be introduced.
TGr: ETFs are cost effectiveand cheap instruments in such environment. Individuals and investors
now need to get advice from professionals on how to invest the money. One of the ways to diversify
is to select the ETFs to buy. Derivatives and swap-based ETFs could be considered as an option.
TG: There is a problem of failing oil prices. It is good for real economy. However, it creates hurdles
for monetary policy which is not working properly the key interest rates are well below target
levels => investment is subdued. E.g., the Netherlands have high interest rates due to high taxes.
HB: It is currently hard to believe in ratings. Market is fundamentally inefficient. Europe is exposed
to political risks (as such, election in Greece and geopolitical tensions between Ukraine and
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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
Russia). ECB believes that interest rates have to be the same everywhere in EU. However, it is not
the way for Eurozone economy recovery given the difference of economic model among EU
members.
Why should not ECB lock into large-scale asset purchases program?
HB: deflation is wrong term in the context of Euro area. Inflation of 2% all over Europe does not
mean the price stability.
ML:inflation is not healthy way out for Southern Europe. There is no discipline among EU Central
Banks, so they will not be able to run unprecedented bond-buying program.
TG:Due to subdued inflation and absence of growth the debt burden will become unbearable for
the borrowers. Quantitative Easing (QE) alone is not enough to spur growth in Europe due to
structural problems in Eurozone economy and low productivity growth.
David Blumer, Head of EMEA, BlackRock
Investor poll takeaways
1. Europeans remain downbeat about their financial futures. The Club Med countries arefeeling least positive.
2. Efforts to encourage financial advice are needed.3. With over half of all household assets held in cash, Europeans need to take greater strides
towards investment.4. Funding Europes ageing society is an important need. 50% of Europeansare not saving for
retirement. Less than half know what they need to save.5. Key message how to take greater financial control. Europeans believe this would involve
putting something aside managing their debts and having cash safety net. But this willrequire governments and industry to better educate servers.
Smart investorshabits
1. Save and invest more.2. Make retirement as priority.3. Actively invest for income.4. Recognize the need to spread assets => diversification. As such, if 60% of savings held in
cash, it is not a diversification at all.5. Take advice from professionals.
Economic growth and monetary policy across the globe are diverging.
The year 2015 will be return of volatility. This requires investors to recognize, mitigate and
hedge risks.
Tightening of financial conditions is expected in UK and US. Risk-free rates in EU will stay
low for longer. The cost of mistakes will increase. Thus, investment strategy needed.
This year US, EU and Japan are recommended to be considered as investment
opportunities.
US. We expect Fed tightening in 2015 but in a gentle way. Cyclical and low beta stocks will
be key beneficiaries of that. USD will keep on strengtheningand the US economy will enjoy
sustainable recovery.
EUis low-flying plane. This year EU might a subject to occasional near-death experience as
well as large potential for upside surprise through potential QE.
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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
Japan. Key theme Abenomics. The reasons for Japan to be a good story for 2015 are the
following: Bank of Japan (BoJ) buys equities and large pension fund will double investment
allocations into equity stocks. Additionally, Japanese equities have cheap valuations.
However, watch out for air pockets (turbulence, high volatility)
Investors are searching for yield. It becomes more difficult to be fixed income investor.
More and more investors take private debt and go into more illiquid instruments. One has
to make sure to be able to stomach illiquidity.
Few bargains today in the global markets. Russia is a bargain due to cheap valuations. But
due to uncertain environment it is very risky investment. US valuation is quite expensive,
but it is still somehow below the average. China also looks attractive and, no doubt, is good
long term investment. Nevertheless, one has to be patient and be ready for numerous
storms on the way of their structural reforms implementation.
Lower commodities prices beneficiaries are also recommended to be tracked from the
buying prospective.
Investment ideas for the 2015
Equities
Japanese and EU equities
US cyclical stocks (if Fed tightens)
Fixed Income
Hard-currency Emerging Market debt
US Treasuries
Contrarian
Natural resources equities as a hedge if US dollar strength fad.
Alternative investments
Income paying real real-assets (e.g., property, infrastructure), but make sure to get
compensated for illiquidity
Trends in Cross-Border M&A
Alexander Doll, CoHead of Barclays, Germany
There are three types of M&A: hostile, friendly and reluctant.
EMEA accounts for 28% of global volume ($304 bln). In terms of the deals size and transactions
amount industrial sector in Germany took the lead.
EMEA into Americas 19%
Americas into EMEA 16% with largest cross-border volume flows.
M&A was assumed as Foreign Direct Investment (FDI)
Overall M&A activity is well below historical levels in relation to FDI
Germany $900 bln (15%)
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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
USA - $4500 bln (15%)
China - $900 bln (15%)
M&A Financing
Globally:
83% was paid by cash. Cash is King in a global basis, 8% by stocks, 9% by debt.
Germany:
95% was paid by cash, 5% by stock, 0% by debt.
Acquisition premia in 2014
Global 29%
Germany 26.4%
77% of M&A volume was provided by financial investors.
Low interest rate policy triggers leveraged buyouts (LBOs). We will see more deals like these closed
in 2015.
The Americas is responsible for 50%+ of M&A volumes, while Europe has seen a decline. In EMEA,
only 1-2 out of 10 M&A deals are closed. Why does this happen? I dont know.
Cross-border deals with German involvement
Historically US inbound M&A flows exceeded those from the States by roughly 40%. 2014 markeda new high and raised the game with the Sigma-Aldrich being one of the largest US acquisition out
of Germany.
The largest deals: German acquirer/US Target
* 55|25 63|25 74|16 74|30 75|29 42|14 49|21 78|21 92|25 50|13 78|27
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Acquirer DeutscheTelekom
Adidas BASF Siemens Fresenius K+S SAP SAP DeutscheTelekom
Bayer Merck
Target CingularWireless
Reebok Engelhard
DadeBehring
Holdings
APPPharmac
euticals
Morton Sybase Success-factors
MetroPCSCommuni
cations
Conceplus
Sigma-Aldrich
Value($m) 2,480 4,311 5,400 6,814 5,623 1,675 7,111 3,739 6,806 1,136 16,989
*Total # of transactions|# of transactions that reported transaction value
0
10
20
30
40
50
60
70
80
90
0
500
1000
1500
2000
2500
3000
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Transaction volume, $bn (right axis)
Average Transaction value in $m
Source: Dealogic, Barclays presentation
The largest M&A deals volume. German Acquirer/US Target
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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
The largest deals: US acquirer/German Target
* 130|61 116|48 113|43 170|56 112|39 86|27 108|30 143|32 104|28 85|33 118|33
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Acquirer Rockwo
od
Specialists
Providenc
e Equity
Partners
Goldman
Sachs
Goldman
Sachs
JC flowers Liberty
Global
BlackR
ock
Liberty
Global
General
Motors
McKess
on
ADM
Target Dynami
t Nobel
Kabel
Deutschland
Property
Portfolio(Karstadt
Quele)
Property
Portfolio(Allianz)
Hypo
RealEstate
Holding
Unitym
edia
Allianz
(5%)
Kabel
Baden-Wurtem
berg
GMAC-
SAICAutomoti
veFinance
Celesio WILD
Flavors
Value($m) 2,703 2,533 5,416 3,329 1,782 5,247 2,930 4,481 4,200 7,062 3,126
*
Total # of transactions|# of transactions that reported transaction value
US companies make more M&A deals but in a smaller scale rather than Germany. US companies
acquire mostly medium-size firms.
Why M&A is important?
Strategic / M&A dialogue serves many business areas of IBD
Access to key decision makers on highest board level
1. DCM/Leveraged Finance
Bonds
Syn. Loan
Bridge Financing
2.
ECM
IPO
Capital inc.
Convertibles
3. RSG
FX hedging Interest hedging
Commodity
0
5
10
15
20
25
30
35
0
100
200
300
400
500
600
700
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Transaction volume, $bn (right axis)
Average Transaction value in $m
Source: Dealogic, Barclays presentation
The largest M&A deals volume. US Acquirer/German Target
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4. Corporate Bank
Transaction services
Trade Finance
Credit cards
M&A Revenue Contribution
M&A as % of total bank revenues
US banks 1-4%;
EU Banks 0.25-2.5%
Adv. Specialists 39-52%
Banking is in the heart of strategic decision.
Strategic Importance
M&A importance cannot easily be pinned down to pure P&L contribution
Strategic dialogue serves as door opener and angle for other investment banking products
A whole package of event-driven products can be offered to support M&A transaction
(financing, risk solutions, etc.)
Verizon Case Study
Source: Barclays presentation
M&A activity is expected to rise in the year 2015. Availability (more targets and different
dimensions) and cross-dealing(deals between industries) are projected to be among major trends
in M&A activity.
Bridge
financingM&A
Bond
financing
RiskSolutions
ECM
Verizon has agreed to
acquire the remaining
45% stake in Verizon
Wireless Stake for
Vodafone
$120 billion Financial
Advisor to Verizon
Barclays
Verizon
$61 billion Bridge
Facility
Joint Lead Arranger and
Bookrunner
Barclays
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Alexander Yalygin, Financial Analyst, KIT Finance Ltd.
Cheap Money A Take on Current M&A Activity
Dr. Wolfgang Fink, Co-CEO Goldman Sachs, Germany & Austria
The GS Economic View
Overall positive growth outlook despite persisting macto concerns over Eurozone, US Tapering
and Emerging Markets Growth cooling.
Top 10 Themes for 2015 (herein more details)
1. A Broadening Recovery:
- US recovery remains strongest anchor of global growth
2. Developed Market Divergence Lives on
- Europe and Japan fail to march US growth
3. The New Oil Order
- Sharp decline in oil prices and its consequences
4.
Low Inflation and no fight against it
- Slack remains large and wage pressure slows to return, and commodity disinflation flows
5. The Dollar Bull Market
- Broad-based USD Strength
6. Central Bank Interest Rate Policies
- Divergence in Rate Policy
7. Chinas umpy Downshift Continues
- Further decrease in potential and actual growth
8. EM: More Relief, More Polarization
- Fight between disinflation leading to growth and commodities causes crisis
9.
The Low Volatility World and its Challenges- Lower Market Volatility may persist but low liquidity means ongoing temporary spikes
10.Living in a Low Return World
- Entry point matter more with flatter yield
Source: Bloomberg, GS Research as of 02 Jan 2015
Equity market valuationsremain favorable. P/E is trading around historical average. Risk
premiais still very high. It is a strong case for equity as an asset class.
M&A volumes are close to pre-crisis period, but not in EU, where one may observe large gaps.
>85% of M&A deals involve corporates.
Organic growth perspectives are subdued. Particularly in Europe, GS earnings growth forecastcomparatively flat.
Earnings Growth (%)
GS Research Consensus
2014E 3.2 4.0
2015E 6.2 12.3
2016E 6.0 11.0
2017E 8.0 11.1
2018E 6.0 8.1
http://www.gsalumninetwork.com/s/1366/images/editor_documents/research/2014/top_ten_market_themes_for_2015.pdfhttp://www.gsalumninetwork.com/s/1366/images/editor_documents/research/2014/top_ten_market_themes_for_2015.pdfhttp://www.gsalumninetwork.com/s/1366/images/editor_documents/research/2014/top_ten_market_themes_for_2015.pdfhttp://www.gsalumninetwork.com/s/1366/images/editor_documents/research/2014/top_ten_market_themes_for_2015.pdf8/21/2019 Campus for Finance 2015 Summary
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94,7102,7
113,5
162,3
219,8
0
50
100
150
200
250
2010 2011 2012 2013 Current
ActivistCapita
l($bn)
44
59 63
82
191
2010 2011 2012 2013 Current
to deploy on an increasing number of campaigns
Main driver for the difference between GS Research and Consensus are GS earnings estimates
below consensus for Oil & Gas Companies(following the sharp decline in energy prices) as well
as Financials.
CEO Confidence remains positive and markets rewarded those who have acted. One day
indexed stock price reaction to buyers 1% (in the year 2014).
Activists is here to stay running an increasing number of campaigns
Recent Examples for Break-up/Spin-off campaigns
Company Activist Proposed Transaction Status/Outcome
DOW Third Point Spin-off petrochemical business Nov-14: Dow agreed to add fourindependent directors to its board. Two ofthem Third point nominates
Cliffs CasablancaCapital
Spin-off Bloom Lake mine Jul-14: Casablanca gained majority onboardNov-14: Ceased Bloom Lake operationsas no buyer was found
Ebay Carl Icahn Spin-off PayPal Sep-14: Ebay announced plan to spin-offPayPal in 2015
DARDEN Starboard Value Break-up into several operating
companies and REIT
Jul-14: Darden Restaurant sold to Red
Lobster ChainOct-14: Starboard value took over entire
12-member boardSource: Goldman Sachs presentation
Summary of Key Trends Driving M&A Activity
1. Deal composition has shifted towards corporate activity (e.g. AActavis; TAllergan, V
$66.4bn, DNov14)
2. CEOs focusing on strategic M&A (e.g. AMerck; T- Sigma-Aldrich; V$16,4bn; DSep14)
3. Cross-border M&A US companies targeted by European firms (e.g. AGE; TAlstrom; V
$17,1 bn; D- May14).
4.
Active shareholder engagement (e.g. AVolkswagen; T- Scania; V$9,1bn; DFeb14)
Notations: A Acquirer; TTarget Company; VTransaction Value; DTransaction Date.
Activists have access to increasing amounts of capital
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Outlook for the year 2015
1. Supporting macroeconomic conditions(positive trigger):
Cheap money, low cost of financing, limited perspective of organic growth, attractive equity
valuation levels.
2.
Regulation(questionable issue):Large regulatory hurdles and Fed rate hikes.
3. Geopolitical uncertainty(negative factor)
Middle-East unrest, Russia & Ukraine conflict
Eurozone uncertainty: upcoming elections in Greece and UK.
4. Increasing volatilityis expected.
The Future of Monetary Policy. Panel Discussion.
Takeshi Shirakami(TS), Bank of Japan
Prof. Christoph Kaserer(CK), TUM
Joahim von Schorlemer(JvS), Royal Bank of Scotland
Peter Muller(PM), Bayer AG
What is the current state of monetary policy in EU?
TS: Eurozone economy is losing momentum. Deposit rate is (-0.2%). Headline deflation does not
vary considerably.
Low inflation and low interest rates trigger M&A activity and support consumption.For the next few months we might see interest rates decline because of oil price slid.
CK: Interest rates are close to zero level. This undermines investment activities. The cost of money
is very low, which stands for decreasing price of risk. Government and corporate bonds buying will
pose risk for EBC balance sheet.
JvS: Government spending is limited right now. ECB has the one mandate handling inflation. The
monetary policy of ECB may result in investors squeeze: poor will become poorer and rich people
richer.
PM:Back in 2013 when Cyprus crisis occurred, the head of ECB supported euro by phrase ECB will
save single currency whatever it takes. Strengthening euro was beneficial for exporters in the short
term. Now it is not anymore. At the same time Eurozone experiences structural problems:
1. In many companies capacities are not utilized or the money is invested in non-competitive
environment.
2. Financial regulation is very complex and unclear.
Is it deflation or natural process in EU?
TS: ECB should take into consideration the whole Eurozone economy to decide on monetary policy.
Banking sector, in particular, is much safer in low interest rates environment.
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CK: Eurozone is in sclerotic situation right now. There is no belief in free market. The major
problems are economic and fiscal policy as well as inefficient government spending in
infrastructure. Interesting that in Japan one cannot turn around monetary policy instruments.
Recommendations for ECB:
1.
Go for QE: buy debt assets
2. Benefit from other economic policies support.
Japan has identical situation to EU low interest rates. In case of Japan there is uncertainty about
Abenomics. But Japan is doing better because they have a framework coordination and complex of
measures in monetary policy.
JvS: The yields are low. We pay a lot to have euro.
PM: Interest rates should stay low for a long time. Such countries as Italy, Spain, Portugal and
Greece need that. They are not ready for inflation and rate hikes.
Is ECB well-prepared for the future in the medium- and long-run?
TS: Independently ECB is not ready for that. Unfortunately, other economic policies do not work for
ECB. Its weighing on ECB plans to reach target level of inflation of 2%.
CK: Now it is not the time for ECB to unveil QE program. It will relieve government intensions for
structural reforms.
What about Exit strategy? What time will be needed for that?
CK: around 25 years.
Will the Euro survive?
CK: Politically it is impossible. In particular, there is a massive movement against Euro in Italy.
Some countries will exit EU.
TS: Euro has so-called Teenager issue. It needs to grow up.
JvS: There is unrest situation and were some mistakes made:
Some success, but no progress in Greece;
Underutilization of capacity. It accounts for 60% of GDP growth (compounded measure)
PM: Technically there is no way out. Monetary union does not provide the money for exit. All EU
countries are in the same boat and they have to agree on something to resolve existing problems.