TheChek News Flow

Requirement to share some excess profits seen as dangerous precedent

South Korean chipmakers have expressed alarm at tough conditions revealed this week for companies taking advantage of a $39bn US federal fund designed to encourage advanced chip manufacturing in America.

Of particular concern is a requirement for companies to share some of their unexpected excess profits with the US government, according to a clause in commerce department guidelines unveiled this week for applications for funds from the Chips Act, passed by Congress last year.

The new subsidies are aimed at building a leading edge US semiconductor industry as part of efforts to counter China, but South Korean chipmakers such as Samsung Electronics and SK Hynix are worried about the implications as they plan to build plants in the US and still rely heavily on their chipmaking operations in China.

Seoul’s former trade minister Yeo Han-koo said the clause about excess profit-sharing seemed “problematic”, calling it an “unprecedented move charting a new territory that we haven’t seen in recent years”.

“Many companies may cry out on this. It may set a worrisome precedent for other countries who may follow suit,” he told the Financial Times.

The commerce department said companies that received more than $150mn would have to return some money to the government when they made returns that surpassed original projections by an agreed threshold. Samsung and SK Hynix said they were reviewing the 75-page guidelines, but declined to comment further.

The safeguards have been put in place to ensure the subsidy programme is not abused as chipmakers prepare to submit their applications. Samsung is building a $17bn foundry in Taylor, Texas, while SK Hynix is planning to build an advanced chip packaging plant in the US.

“We’re perplexed by these unexpected conditions. We’ve never seen anything like this for state incentives,” said an industry executive. “It is unclear how they will calculate excess profits. They want to take some of our profits when the business is booming but they won’t return our money when the industry is in a downturn. This will be a key point of contention.”

Yeo cautioned that the profit-sharing scheme would have huge ramifications for the industry. “It is a complex matter how to define excess profits. This will give the regulator a huge discretionary power in implementing it, while companies will be incentivised to set the threshold higher,” he said.

South Korean chipmakers have been caught up in growing US-China tech rivalry as Washington’s curbs on technology transfers threaten to weaken their competitiveness in China. Under the Chips Act, they are required not to expand capacity in China for a decade in order to receive federal funding.

The chipmakers are now awaiting details of the “guardrails” that have made them rethink their exposure to China. SK Hynix’s Wuxi plant in eastern China accounts for nearly half of its Dram memory chip production, while Samsung’s plant in Xian takes up about 40 per cent of its Nand flash memory output, according to analyst estimates.

“Now that Pandora’s box is open, this will deepen Korean chipmakers’ anguish over their future investment plans,” said Lee Jae-min, a law professor at Seoul National University and an expert in international trade disputes. “They will be worried that their sensitive R&D and financial information will fall into the hands of a foreign government.”

DAX:

MDAX:

SDAX:

Push by three agencies comes amid fears imports flowing from UAE and Turkey are fuelling war in Ukraine

The US has launched a renewed crackdown on countries and individuals helping the Kremlin evade western sanctions amid growing fears Russia is fuelling the war in Ukraine by funnelling imports through countries such as the United Arab Emirates and Turkey.

The push by the US Treasury, commerce and justice departments, details of which were first obtained by the Financial Times, comes as western allies increasingly believe Turkey and the UAE, as well as countries in central Asia and the Caucasus, have emerged as the weak links in their efforts to isolate Russia both economically and militarily.

“Those who attempt to prop up Putin’s war machine by evading our export controls and sanctions will be held accountable,” Matthew Axelrod, assistant secretary of commerce for export enforcement, said in a statement.

Elizabeth Rosenberg, the assistant Treasury secretary for terrorist financing and financial crimes, said at a closed event on Thursday that the UAE was also a “country of focus” for the US.

Rosenberg said that UAE companies exported more than $18mn worth of goods to “US-designated Russian entities” between July and November of 2022. She added that $5mn of that was “US-origin, US-export controlled goods to Russia”, including “semiconductor devices, some of which can be used on the battlefield”.

“These types of figures are the basis for our engagement with the private sector, so that we can clarify the consequences of violating sanctions and export controls, discuss high-risk activity, and act when necessary,” she said.

As part of their effort, the three US agencies issued a “compliance note” on the “use of third-party intermediaries or transshipment points to evade Russian- and Belarusian-related sanctions and export controls”.

This includes a list of “red flags” businesses should be looking out for in terms of potential sanctions evasion, singling out specific states including China, Armenia, Turkey and Uzbekistan that western allies say are commonly used as “transshipment points” in order to “illegally redirect restricted items to Russia or Belarus”.

“The UAE recognises its critical role in safeguarding the integrity of the global financial system,” an official from the Gulf state said. “The UAE takes this responsibility extremely seriously, and has clear and robust processes in place to deal with sanctioned entities.”

Irish group says switch to Wall Street makes sense as bulk of its business is in America

The world’s largest building materials company CRH is planning to move its listing from London to New York in a fresh blow to the UK’s capital market.

The company, which has a market capitalisation of close to £30bn, is the latest UK-listed company to embark on a move to New York. Last year, Ferguson, the plumbing and heating products supplier, left the FTSE 100 after moving its primary stock market listing to Wall Street. Flutter, the world’s largest publicly traded gambling company, is also considering a US listing.

Earlier this week, the Financial Times reported that Shell’s top executives explored moving the Anglo-Dutch energy group to the US.

CRH said on Thursday that it would recommend to shareholders a switch of its primary listing to the US in 2023. It said that North America now represented about three-quarters of earnings, and would be a key driver of future growth. 

“Our exposure to this market is likely to increase further driven by substantial increases in infrastructure funding, a renewed drive for the onshoring of manufacturing activity and significant levels of under-build in the residential construction market,” CRH said.

Analysts said a move to the US would lead to a higher share price for the company and allow the group greater exposure to investors in its key market. UBS said the shift to a US listing could lead to a “multiple re-rating given US peers trade on roughly 25x [price to earnings] vs CRH on 13x”.

Shares in CRH jumped more than 9 per cent after the news.

The company has had a London primary listing since 2011, but also has a secondary listing in Dublin, where it is headquartered. The company said it would consult shareholders on moving the primary listing to the US but did not say what the plans were for Dublin.

Asked about the move on Thursday, David Schwimmer, CEO of the London Stock Exchange, said: “If companies are going to make decisions when most of their business is in the US, that, sort of is what it is.”

The London market has been hit by a wave of takeovers and take-private deals in the tech sector that risk further stripping it of large listed companies, including Kape Technologies, Aveva, Micro Focus and cyber-security company Avast. Some companies are also choosing to list their shares in the US, particularly the tech sector, to access deeper pools of capital and a broader range of analyst and specialist financial services.

CRH works on large construction projects across Europe and the US, including the construction of London’s Crossrail line and the HS2 railway line in the UK.

Recent retracement of stock market gains highlights uncertainty on rates and potential economic pain

Much has been made of the speculative fervour that underpinned the gains in equity markets at the start of the year. After a challenging 2022, there was sharp rebound in riskier assets with investors seemingly taking a more bullish view of the world, particularly on the path of interest rates.

But beneath the shift, there were signs that the foundations of the “fear of missing out” rally might have been shakier than it initially appeared. They help explain the recent retracement of gains and why there are reasons for caution now.

Rather than being driven by stickier investments in traditional equities or funds, much of the rally was underpinned by factors such as the covering of short positions and a frenzy in US options activity.

In January, there was surge in the buying of call options, effectively bets that pay off when a stock or an index reaches a certain level and an investor can buy the underlying security. Such purchases constituted much more than the average daily number of trades in US equities in January.

This derivative trading amplified the upswing in underlying assets as dealers bought and sold positions to ensure a market-neutral stance. Yet as markets rallied, more of the contracts started “moving into the money” by surpassing their strike price and the opposite effect played out. Dealers were forced to unwind positions in underlying assets as options were exercised, sparking volatility and adding to the broad equity sell-off.

The lack of conviction in a renewed bull market for stocks was also evident in the broader flow of investor funds. Global equity buying meaningfully slowed at the start of the year.

Using flows into exchange traded funds as a proxy for shifts in positioning, it is clear that any money that has been deployed this year has largely gone into under-owned exposures.

Investors have reduced allocations to US equity ETFs so far this year to fund increases elsewhere. European equity ETFs attracted their largest inflows in a year in January and a further $4.8bn was added in February, though Europe remains under-owned after last year’s outflows compounded selling in previous years.

But such a flow from US-based investors into Europe doesn’t tend to be sticky or euro hedged; it can reverse at the first sign of relative underperformance.

Upside surprises in economic data could be seen as justification for the shifting style preference away from the quality-tilted US stock market towards value-orientated Europe equities, which benefit from a more positive growth environment.

Yet that data means market pricing for rate cuts by the Federal Reserve, the European Central Bank and the Bank of England that accompanied the start-of-the-year stock market rally was misplaced. The surprising resilience of economies, particularly in Europe, tilts inflation risks to the upside, raising the odds of higher-for-longer policy rates.

Despite ongoing hawkish guidance by central banks on monetary policy, expectations of an easing of rates next year have not changed that much, setting up another reckoning for riskier assets. Especially outside Europe, money has chased parts of the market that are most vulnerable to rate rises yet did not participate in the February sell-off, including consumer discretionary and technology stocks.

Of course, animal spirits are a hard force to fight when mixed with ample liquidity. Investors have stockpiled cash, with nearly $5tn held in US money market funds globally, while the growing balance sheets of the People’s Bank of China and Bank of Japan are further offsetting monetary policy tightening by their peers.

However, signs of sustained price pressures in Japan suggest the BoJ may have to shift tack on monetary policy while the unleashing of cash reserves is probably contingent on the economic backdrop remaining supportive — an increasingly unlikely outcome as past and future rate rises take effect.

This still-precarious position for equities makes a case for staying invested in value parts of the market. Investors are also rightly eyeing rising opportunities in fixed income. Global bond and credit ETF flows have outpaced equity buying year-to-date as a result.

All in all, inflation risks remain, monetary policy paths are uncertain and recessions may be needed to bring inflation back to 2 per cent targets. While equity price action looked as though the bulls were in the driving seat to start the year, an abundance of uncertainty and potential economic pain is starting to feed through to market pricing with more to go.

Integration was difficult but the deal itself had always been misguided

Since it was founded by former UK policeman Nick Ogden, Worldpay has been passed at great cost between a series of owners. Now, more than a quarter of a century later, the payments processor’s fortunes are back in its own hands.

US financial technology group FIS last month announced plans to spin off Worldpay just four years after paying $43bn for the group in a deal now seen as the high watermark for the consolidation then gripping the payments industry.

On paper, the deal had a logic: uniting FIS, which delivers payments process technology to banks, with Worldpay’s customer base of merchants, including retailers, would create a powerhouse in the fast-growing sector.

The admission by FIS, which took an almost $18bn writedown on Worldpay, is not just the latest case of buyers’ remorse over a company that was created in a wave of mergers and whose owners over the past two decades have included buyout firm Bain and fintech group Vantiv. It has also forced a reckoning over the industry’s mantra that scale must be prized at all costs.

“There was peer pressure to create these payment conglomerates . . . this should never have happened,” said Dan Dolev, an analyst at Mizuho.

Current employees at the company who spoke to the Financial Times on condition of anonymity said the two businesses were ultimately incompatible.

Scale, scale, scale

The payments industry had rapidly changed in the years before FIS bought Worldpay.

Big, slow-moving, incumbents were being scared into action by the growth of online shopping, declining cash usage and disruptive new companies such as Square — now known as Block — that pioneered portable, branded point-of-sale terminals allowing small businesses to take card payments more cheaply.

The older payment companies fought back to win market share and add capabilities, gambling on spending enough money to repel the upstarts.

The fundamental idea behind a wave of mergers — that began in 2019 when US payments processor Fiserv agreed to buy rival First Data for $39bn — was to establish a quasi-oligopolistic payments network as a moat against competition.

FIS’s takeover of Worldpay was the next big deal to follow, then came Global Payments’ acquisition of TSYS for $21.5bn and finally Worldline’s deal to buy Ingenico for €7.8bn.

All of the big players bought the ability to serve both merchants and banks. But the difficulties getting a huge payments merger right are shown in the diverging fortunes of the two biggest deals.

For Fiserv the addition of Clover — a rival to Square that was owned by First Data — gave it access to one of the biggest payments trends of the past few years: portable, branded point-of-sale terminals for small businesses, which make for the most profitable customers.

Worldpay, however, lacked similar access so was left vulnerable to the kind of disruption that had spurred mergers to begin with.

“Pre-acquisition Fiserv and FIS were incredibly similar companies — the Coke and Pepsi of legacy fintech. But Worldpay and First Data had very different product, client profiles, that largely explain why one deal worked well and one did not,” said a senior FIS employee.

Dolev at Mizuho said that the big mistake for FIS and Worldpay, both of which declined to comment, was combining in the first place, as integrating the companies was always going to be difficult.

“The original sin was . . . the board of FIS I believe felt obliged to get themselves a merchant acquirer” in response to the First Data deal, he said.

Structural problems were exacerbated, say analysts, by Worldpay moving too slowly in response to changing customer needs during the coronavirus pandemic.

“A lot of merchants, especially small businesses, overnight had to find an online way to sell stuff because everyone was quarantined. [Worldpay] in the US was just too slow to react to those demands. They were very corporate America, and that slowness led to a lot of small merchants finding solutions elsewhere,” said Dolev.

“The Worldpay business would have struggled through the past 18 months with or without the merger,” said the senior employee.

FIS claims it extracted $1.65bn in annual revenue and cost synergies from the deal. However, the decision to split was a clear admission it had failed to sustainably combine the two businesses.

It was also an acknowledgment that Worldpay might now be better off outside FIS and that money matters less than the removal of fetters.

As FIS chief executive Stephanie Ferris said in announcing the spin-off: “The separation from FIS will allow Worldpay to pursue a more growth-oriented strategy.”

Peter Keenan, chief executive of payments fintech Apexx Global, said that although the argument in favour of scale remained valid “there is a point where it becomes a law of diminishing returns, go beyond a certain point and you lose agility, which damages you more”. 

There was also a fear that FIS was holding back Worldpay due to internal conflicts pitting its traditional bank clients against the merchants, according to several analysts.

“Worldpay was interested in following the likes of Stripe, who are getting into the issuing business as well to allow merchants to issue cards . . . arguably this competes with banks, which are the bread and butter of the FIS client base. It wouldn’t be surprising if there were some friction between the two sides of the business,” said Zilvinas Bareisis, an analyst at Celent.

Jack Henry, a smaller rival that remained independent during that wave of dealmaking, has done better than most by focusing on its core business of serving only banking clients.

Its stock is the second-best performer among its peers, up 34 per cent since 2019 when the race to scale up accelerated. Only Fiserv did better as its stock is up about 60 per cent during the same period, while Global Payments is up only 15 per cent and FIS is down 35 per cent.

The hope is that an unshackled Worldpay will now be free to challenge the newcomers as well as hunt for bolt-on acquisitions that can help it make up the lost ground. Some analysts have suggested that it could try to acquire a point-of-sale company such as Toast, shares of which are down 50 per cent from their 2021 IPO price.

The market is likely to look favourably upon a leaner and more focused Worldpay as it will be better placed to compete and grow, according to analysts. Meanwhile, FIS will also be free to deepen its ties with its banking clients.

The two separate groups — FIS and Worldpay — will have new leadership. Charles Drucker, who is highly regarded in the industry, is coming back to lead Worldpay, having left when it was sold to FIS. Ferris is stepping into the top job at FIS, having been chief financial officer at Vantiv.

Ferris has said the two companies will continue to work together but the real test will be less their ability to collaborate and more how quickly the two can grow apart.