TheChek News Flow

Diversifications into cyber security are tricky for defence investors to assess

The Ukraine war has revived the threat of conventional conflicts for developed nations. That has boosted the defence sector, in which Airbus participates. But the interest the Toulouse-based group is reportedly taking in the cyber security and big data arm of Atos is incongruous. Cyber warfare is a different activity to the physical sort.

The French software group is the kind of vendor that acquirers like: distressed. But there is a further incongruity in talk of Airbus buying a minority stake in the Evidian division of Atos. It would hardly be material to the aerospace group.

Defence and space activity makes up just over a quarter of Airbus’s top line, though its separate helicopters unit has defence exposure, too. Within defence and space, the software businesses — within connected intelligence — make up an even smaller part.

Diversifications into cyber security are tricky for defence investors to value, as BAE’s purchase of Detica illustrated. Competence and cash flows are harder to assess than in military hardware.

Building jets is Airbus’s main activity. In the nine months to September 2022, this accounted for more than 90 per cent of group operating profits. Airbus has dabbled in software previously via its Skywise project, with US partner Palantir. Not much has come of this so far, says Jefferies.

Perhaps Airbus boss Guillaume Faury believes stake building could pave the way to a purchase of Evidian. Atos chief executive Rodolphe Belmer may have resigned last year because the board resisted a trade sale and favoured a demerger.

Atos has already entertained at least one offer for Evidian. A bid led by consultants Onepoint valued Evidian at €4.2bn, which Atos rejected. That looks low compared with an estimate from Citi of €4.6bn including net debt and pension liabilities.

In its current form, the software group is burning cash flow at an average of €385mn annually through 2025, according to S&P Global estimates. There is a danger Airbus would help fund a rescue if it becomes embroiled with Atos. That would please the French government but harm shareholders.

Private equity group offers minimum annual return of 11.25% with $1bn backstop to entice endowment

One of the largest endowments in the US is making a $4bn investment into Blackstone’s flagship private real estate investment trust, in a move intended to shore up confidence in a $69bn fund that put limits on investor withdrawals last year after suffering heavy redemptions.

The University of California’s endowment, which manages more than $150bn of assets, said on Tuesday that it would make the investment in the Blackstone Real Estate Income Trust, or Breit, at its current net asset value. That means it is taking a large position at the same valuation as the fund’s more than 200,000 existing investors.

However, Blackstone has promised a minimum annual return of 11.25 per cent for six years and is providing a $1bn backstop if the fund does not achieve that target. In exchange, the endowment has agreed to lock up its capital in the fund until 2028, while paying higher overall fees if the vehicle performs well. Other investors do not benefit from the same arrangement.

The investment was a “validation” of Breit’s investment portfolio and performance, said Blackstone chief executive Stephen Schwarzman.

In November, Blackstone limited investor withdrawals from Breit after breaching monthly and quarterly limits on redemptions, an announcement that cast doubt on the future expansion of the fund and prompted a sharp slide in the New York-based private equity group’s shares. Breit has grown quickly in recent years and accounts for a fifth of the group’s fee-based earnings, according to analysts.

Blackstone shares were up nearly 2 per cent at midday in New York following the announcement. The company’s stock price has plunged more than 40 per cent over the past 12 months.

After the restriction was put in place last year, Jagdeep Singh Baccher, chief investment officer at the University of California, reached out to Blackstone to propose making a large direct investment in the fund. On December 8, Singh spoke to Blackstone president Jonathan Gray to propose the investment.

“We consider Breit to be one of the best positioned, large-scale real estate portfolios in the US, managed by one of the world’s top real estate investors,” said Singh. “This is an opportunity that comes only through strong, trusted partnership.”

While the university will be buying common shares in Breit, it will then move the investment into a strategic venture it has created alongside Blackstone.

Its $4bn investment will be combined with $1bn in shares Blackstone already owns in Breit and moved into a separate fund that carries a performance fee above an 11.25 per cent hurdle rate.

Blackstone would receive a 5 per cent cash performance payment on any returns in excess of that hurdle rate, the group said in a statement.

Those fees would be on top of Breit’s costs for all investors, including the University of California. Investors pay a 12.5 per cent performance fee to Blackstone above a 5 per cent annual hurdle.

If the fund performs poorly and does not achieve an 11.25 per cent annual return, Blackstone will return fees to the university until it receives its guaranteed return. If the fund were to fall in value, or earn minimal returns, Blackstone risks forfeiting the $1bn of shares, according to two people briefed on the agreement.

Blackstone said the investment was advantageous to the firm and its shareholders. It said it would make money on the investment if Breit returned an annualised return of at least 8.7 per cent over the next six years.

The university has agreed to hold its investment in Breit for a minimum of six years and then will have the ability to redeem its interests over a two-year period beginning in 2028. This contrasts with the monthly liquidity Blackstone offers the fund’s other investors, who can redeem up to 2 per cent of the fund’s overall assets a month, or 5 per cent per quarter.

The university’s investment comes as other investors continue to redeem from the fund.

In December, US investors sought to redeem 3 per cent of their overall assets in the fund and 5 per cent of all investors sought redemptions, according to sources familiar with the matter.

However, because of Blackstone’s restriction of withdrawals, just 0.43 per cent of Breit’s net assets were redeemed in December.

In a communication sent to Breit investors, Blackstone called the new investment a “win” for existing shareholders because it would increase the “balance sheet flexibility” of the fund and add capital during what “we believe is an opportune deployment period”.

The company also said the investment should bolster fees paid to the firm and its common shareholders.

Brussels initiative is part of European response to fallout from Beijing’s ditching of strict pandemic restrictions

The EU has offered free Covid-19 vaccines to China to help Beijing contain a mass outbreak of the illness following its decision to end strict nationwide pandemic-related restrictions.

The offer was made in recent days ahead of a meeting of EU health ministry officials on Tuesday, said European Commission officials, speaking under the condition of anonymity. The initiative is part of efforts by health commissioner Stella Kyriakides to arrange a European response to the prospect of a wave of infections after Beijing ditched its so-called “zero Covid” policy.

“Commissioner Kyriakides has reached out to her Chinese counterparts to offer solidarity and support, including public health expertise as well as through variant-adapted EU vaccine donations,” said one official. Beijing has yet to respond to the offer, the person added.

China has relied on its domestically produced Sinovac and Sinopharm vaccines and has yet to deploy western vaccines using mRNA technology at large scale. The World Health Organization on December 21 said China’s current vaccination coverage was insufficient.

Its domestic vaccines require three doses to prevent severe illness in vulnerable people.

Two doses only provided 50 per cent protection for people over 60, Dr Mike Ryan, WHO head of health emergencies, told a press conference.

“That’s just not adequate protection in a population as large as the population of China. In such a large population, with so many people in a vulnerable setting, with that coverage, we really have to focus on vaccination.”

Only 40 per cent of over-80s have had three doses, according to WHO data.

By contrast, in the EU, 83 per cent of the adult population is fully vaccinated and more than 1.7bn doses have been delivered. Contracts have been concluded with eight vaccine developers, providing as many as 4.2bn doses.

However EU member states have surplus stocks due to large orders of vaccines under long-term contracts with manufacturers. These could be shipped to China, the EU officials said.

Kyriakides is seeking a meeting with pharmaceutical companies to adjust the contracts within the next few weeks after complaints from member states that they are spending money on drugs that are destroyed.

Meanwhile some EU countries have insisted that travellers arriving from China after January 8, when restrictions are lifted, must provide evidence of a negative Covid test or of their vaccination status.

France, Spain and Italy have all said they would bring in controls as they fear the spread of as yet unidentified new variants. However, Kyriakides has called for co-ordinated action. Member state officials last week opted not to call for China-specific measures since coronavirus is now endemic in the EU. They meet again on Tuesday and there is a meeting of the Integrated Political Crisis Response emergency mechanism on Wednesday.

China’s mission to the EU insisted on Sunday that the country had good vaccination coverage. “More than 3.4bn Covid-19 vaccine doses have been administered on the Chinese mainland, with over 90 per cent of the population fully vaccinated and over 92 per cent of the population received at least one dose,” it said.

It said Chinese tourists did not pose any threat, pointing out that the European Centre for Disease Prevention and Control considered Covid-19 screenings and other measures on travellers from China “unjustified”.

“Tourist destinations across the world can’t wait to welcome Chinese tourists as cross-border travel searches soar in China,” China’s mission to the EU added.

Long-delayed reckoning comes after falling markets hit both management and performance fees last year

Global asset managers are facing a long-delayed reckoning in 2023 as falling assets force them to cut costs and make tough decisions about where to invest for growth.

Revenues were down across the industry last year, after a record 2021, as falling markets across almost all asset classes hit both management and performance fees. In the US, total assets in mutual and exchange traded funds dropped 17 per cent between the start of 2022 and the end of October, the most recent figures available from the Investment Company Institute showed.

At the same time, most money managers are under pressure to find money to upgrade their technology and win new customers. As a result, they are squeezing personnel costs through hiring freezes and bonus cuts in the hope of avoiding mass job losses. Consultants also reported a sharp uptick in requests for advice on “efficiencies”.

“There has been a lot of complacency. A lot of players now really need to get their act together,” said Markus Habbel, a partner at Bain who focuses on the sector. “If you don’t have scale, it is getting tougher.”

While the initial reaction to this past year’s turmoil has largely been generic belt-tightening measures and small across-the-board cuts, industry analysts predict that the coming year will require more strategic decisions.

“The temptation is to take a little bit off everything. In reality it doesn’t move the dial,” said Julia Hobart, partner in the wealth and asset management practice at Oliver Wyman. “Managers will need to decide what they will and won’t focus on. Big structural changes will need to be made to take costs out of the business.”

Jeremy Taylor, who heads Lazard Asset Management’s UK-based business, added: “What does an asset manager do as revenues go down? You tend to do less of what hasn’t worked over the past three to five years and put greater scrutiny on things that haven’t grown . . . you don’t give up on any scale product.”

In fact, the stronger asset managers are keen to press for gains while their weaker rivals are making cuts. “We continue to invest through the market cycle into long-running trends that are strategic priorities for us, including sustainable investing, alternatives, active management and exchange traded funds,” said Patrick Thomson, chief executive for Europe at JPMorgan Asset Management. “If you invest significantly into those trends through a downturn, it puts you at an advantage where others may have to cut back.”

Many asset managers are hopeful that bond funds, which saw big price drops and massive outflows as interest rates rose, will start to recover in 2023. “This is a mixed blessing for asset managers because you’re going to see flows come out of other higher-margin asset classes to lower-margin fixed income,” said Tom Mills, who analyses the sector for Jefferies, the boutique bank.

Some asset managers also predict the downturn will accelerate the shift by clients from traditional mutual funds and brokerage accounts to newer ways of investing, including ETFs, separately managed accounts and model portfolios.

“Whenever there are super shocks in the market, people make big changes to their portfolios. This is when people do deferred maintenance,” said Martin Small, who heads BlackRock’s US wealth advisory business and is the incoming chief financial officer. “In US retail markets, there is a move from brokerage accounts to fee-based advisory, that means more model portfolios and more ETFs.”

Asset managers spent 2021 and early 2022 snapping up providers that specialised in private markets and alternative investments, but dealmaking largely dried up amid the market turmoil. Share prices in the sector are sharply down: the S&P Composite 1500 Asset Managers index has dropped 23 per cent since the start of the year. Sellers are reluctant to accept those prices and potential buyers are not willing to pay more.

Philipp Koch, head of McKinsey’s European asset management practice, thinks continued pressure on costs might change the calculus, particularly in the second half of 2023. “Some players may conclude their business models are no longer sustainable and entertain more creative solutions for consolidation and M&A,” he said. “Most asset managers were on the buyer side . . . there were very few sellers — that might change.”

The pressures may simply be too much for some longtime players. “Whenever there’s a downturn, if it is a deep downturn, the players with weak hands get flushed out,” said Cyrus Taraporevala, who just stepped down as chief executive of State Street Global Advisors. “That’s just normal.”