TheChek News Flow

A deal would bring the genetics testing company on to public markets at a value of about $4bn

A blank-cheque company backed by Richard Branson’s Virgin Group is in talks to merge with 23andMe, in a deal that would vault the genetics testing start-up on to public markets.

The merger with Sir Richard’s special purpose acquisition company, VG Acquisition, could value 23andMe at about $4bn, according to two people briefed on the discussions. A deal could be reached within weeks, the people said, although the talks could still fall apart.

23andMe would be the latest high-profile company to go public through a Spac, as the euphoria in US markets has encouraged celebrities, politicians and dealmakers to sponsor blank-cheque vehicles.

Sir Richard has experience with the Spac dealmaking process after one of his companies, Virgin Galactic, went public in a deal with Social Capital Hedosophia, the vehicle set up by former Facebook executive Chamath Palihapitiya. The space tourism company is among the most successful Spac deals to date, with its shares trading at about $50. 

VG Acquisition raised $480m in October to acquire and publicly list a consumer-facing business that would expand Virgin’s brand in the US. Shares in the Spac are trading at close to $14.

23andMe pioneered direct-to-consumer genetic testing but has recently turned its attention to the potential to use its genetic research database — the largest in the world — for drug discovery. People who have taken the tests often opt to share their data for research and take assessments so their genes can be compared with the state of their health. 

Last year, the company began clinical trials of a cancer drug as part of its partnership with UK drugmaker GSK. It also licensed its first drug candidate to Spanish dermatology drugmaker Almirall in early 2020. 

23andMe has a history of battling with US regulators, who were initially concerned about allowing patients to access information they might not understand. It then pivoted to focus on genealogy, before returning to genotyping for certain diseases, such as assessing whether people have genes that heighten the risk for breast cancer. 

Recent concerns about privacy — particularly after online DNA databases were used to long-unsolved crimes — appear to have damped sales of consumer genetic test kits. Last year, 23andMe laid off 100 employees, or about 14 per cent of its staff.

Sequoia Capital, the venture capital group, is one of the largest investors in 23andMe, which has reportedly been valued at more than $2.5bn by private backers.

23andMe and a representative for Sir Richard declined to comment. Bloomberg first reported on the discussions.

Online-forum punters have exploited a quirk to push up some unloved stocks. The risk is that investors start believing the share prices imply real-world prospects.

Wall Street can’t take its eyes off once-unloved stocks such as GameStop GME +124.43% and BlackBerry, which are rocketing due to a kind of betting game played by online forum users. The real risk is that investors start to believe something deeper is going on.

The past year has seen a boom in individuals buying stocks through retail online platforms such as Robinhood. More and more, they seem to be coordinating their moves on sites such as Reddit’s WallStreetBets, placing wagers on firms that are under attack by professional speculators like hedge funds. At Tuesday’s close, GameStop, once a popular target for short sellers, was up almost 3,700% over six months.

There are two main causes of big market moves. The healthier one is when new information comes to light about a company, an industry or the economy at large, and financial assets are repriced to reflect it. The other is when market participants buy or sell in a rush, often because they suddenly need to protect their finances—in which case asset prices don’t convey much useful information.

The latter is at play now. Hedge funds’ short bets have been unsettled, forcing them to buy back the stocks to limit their losses. Also, punters have been using options contracts to prop up their targets. Such instruments can amplify even small market moves, because they force banks to take the other side and then hedge the risk by buying the actual underlying stocks. It can create a feedback loop: Those stocks then go up, and the value of the options tied to them increases even more, forcing banks to hedge further, and so on.

Reddit users haven’t shied away from the technical nature of the price moves, correctly crediting it for their success. But market gyrations caused by bottlenecks in financial plumbing don’t tend to last. The 2018 carnage unleashed by option-driven low-volatility strategies can attest to that. Eventually, there aren’t any forced buyers left. The losses are usually limited in scope.

But often, if something goes up, people have an uncanny ability to convince themselves there is a nontechnical reason for it, creating a self-sustaining narrative. Reddit forums contain some insightful analyses of the value of these companies. After all, perhaps GameStop was somewhat undervalued.

The dot-com bubble of the late 1990s lasted so long partly because many individual investors truly believed innovative business models would eventually justify crazy prices. They weren’t just buying to sell higher. Until recently, high technology-company valuations have mostly been restricted to large solid firms with proven stories, but there are signs of that changing—Tesla and its imitators notably demand faith. While many Reddit users know they are playing a game, they could end up igniting blind enthusiasm for a wider raft of small, unprofitable companies.

So far, Mr. Market seems aware that GameStop’s share price is a meaningless number driven by financial quirks. If he stares at it too long, though, there is a danger that he will start to see real-world prospects.

Biden Freezes U.S. Arms Sales to Saudi Arabia, UAE

The administration is reviewing weapons transactions approved by former President

BREAKING NEWS

The Biden administration has imposed a temporary freeze on U.S. arms sales to Saudi Arabia and the United Arab Emirates as it reviews billions of dollars in weapons transactions approved by former President Donald Trump, according to U.S. officials.

EDF/nuclear: cold fusion

French group has warned it needs another £500m before Hinkley Point C is operational

Britain and nuclear power have never really fused. Reliance on foreign builders left would-be plants stranded when first Toshiba and then Hitachi pulled the plug. Now EDF, the French state-owned energy group, has warned it needs another £500m and six months before Hinkley Point C is operational. 

EDF has already busted earlier budget estimates. The latest, pinned on Covid-19, brings the cost of the nuclear power station in Somerset to about £23bn. It will start generating power in mid 2026. Extended deadlines on a 10-year duration imply inflated costs — 3 per cent annually based on indexed gilts — and six months without income. That hits EDF’s bottom line, compressing its expected internal rate of return by 200-300 basis points to slightly more than 7 per cent. Spooked investors pushed the shares down 4 per cent.

Bad for EDF, but neither can UK taxpayers afford a Gallic shrug. The public purse is no longer on the hook for £2bn of debt, which it had originally guaranteed. But in order to make the venture profitable the UK has agreed to top up power prices to ensure Hinkley’s backers receive £92.50 per MWh — over double the average power cost of the past decade.

Consumers will shoulder an annual £10-£15 of this on their bills, according to earlier government estimates. But numbers move all the time. The National Audit Office forecast of the cost of guaranteed power prices rose from £6bn in October 2013, when Whitehall began negotiating the deal, to £30bn in March 2016.

Nuclear requires a long period for profitability. It also lacks offshore wind’s economies of scale and quickly produced turbines. Government, however, remains enamoured: openly applauding the diversity nukes offer and (more quietly) relishing the jobs it brings through the entire supply chain.

Two years ago, then business and energy secretary Greg Clark revealed the government considered taking a one-third equity stake in the Welsh project that Hitachi quit. That would have sent spinal frissons through older Tories who, under Margaret Thatcher, wrenched the state out of utilities. Ironically, Britain’s newest energy plant could see government reverting to older industrial models.

Bearish bets unwound as US exuberance crosses the Atlantic

It is a measure of dysfunctional markets that day traders delivered a bigger return for Pearson shareholders within 90 minutes than John Fallon ever managed in seven years as chief executive.

An early morning pile-on lifted shares of the textbook publisher by nearly 20 per cent to their highest since July 2019. Had the long-rumoured private equity bid approach finally arrived? It appears not. Instead, Pearson was one of a handful of companies to catch the secondary effects of stonk-mania, the US-led fashion among retail investors for using collective brute force to soak up liquidity and pressure short-sellers into closing their bets.

Cineworld and Petrofac caught the same bug, as did J Sainsbury. A cinema chain, a refinery engineer and a grocer have little in common other than being among the most heavily shorted stocks on the London market, with Financial Conduct Authority data showing 8 per cent or more of their total share capital out on loan.

It is too easy, however, to write off these moves as a direct consequence of investment gamification via internet message boards and commission-free trading apps. Stock markets remain a niche pursuit for Britons, who have free access to many other forms of legal gambling, and the social media chatter on Wednesday gives no hint of a cross-border mob assembling that would have the heft to move FTSE 100 stocks. Yet more than 6m Pearson shares changed hands within the first three hours, about treble the daily average.

Instead, events on Wall Street appear to have triggered a broad and undifferentiated risk-off trade among hedge funds. Very few will have direct exposure to the likes of GameStop, a flagship investment for the day trader armies. But after Melvin Capital Management required a bailout for being on the wrong side of the GameStop trade, fellow hedge funds are facing higher borrowing costs and more constraining volatility metrics.

Do not expect much sympathy for the short-sellers. They make convenient villains, particularly on the internet forums that set the current mood. Yet in a market powered largely by algorithms and technical signals, the bears play a valuable role in improving corporate transparency and accountability. Financial incentives have helped expose numerous frauds, from Enron and Wirecard to NMC Health, as well as putting pressure on countless other companies to clean up their operations.

It is hard to know exactly how much credit to give the amateur trader armies for each day’s gyrations. Nevertheless, their involvement is making life more difficult for the investor class working hardest to keep markets honest, which is an unfortunate unintended consequence.

Something’s Brewin

Asset managers may be in an entirely different line of business from commodity miners but they are often blown about by the same winds, writes Jamie Powell.

While returns in mining are heavily determined by the mood swings of commodity markets, asset managers are also beholden to the general feelings of the market. If they are happy, the managers do well. If they have woken up on the wrong side of bed during a global pandemic, less so.

It is no surprise then that investors tend to take a dim view of both sectors, often placing low double-digit multiples on profits, even if a particular business is doing rather well. Brewin Dolphin is a perfect example.

A first-quarter update from the London-based asset manager on Wednesday showed funds under management rising by 8 per cent to a record £51.4bn, with fee revenue following. Yet its shares rose just 3 per cent in early trade. A valuation of nine times 2021’s estimated operating profit suggests scepticism as to whether this feat can be repeated.

Reading the results, there is some justification for this. Net inflows over the quarter contributed only 8 per cent to the £3.8bn of growth in managed assets, suggesting a business still struggling to attract clients even in boom times for markets.

Part of the problem, no doubt, is that wooing clients with good coffee and smart suits does not work quite as well over Zoom. But it is difficult to ignore wider structural issues — asset managers such as BlackRock have mopped up clients over the past decade, thanks to lower fees. And, though not yet such a force in the UK, the rise of exchange traded funds could bring further fee pressure and potential outflows.

The case for caution is easy to make, but it is also hard to argue that Brewin Dolphin is really struggling. Total wealth management assets are up 43 per cent over the past decade, according to S&P Global data — hardly a sign that clients are fleeing in their droves. Further margin improvements from the company’s new focus on investment advice could also help profits.

Brewin Dolphin may not be the cheapest UK-listed asset manager (that accolade goes to Charles Stanley which trades at just four times operating profits if you subtract its cash), but for a business with a loyal client base it feels like a bargain. If investors continue to disagree, it is fair to speculate that a larger competitor looking to diversify might start circling the ship.