Ralph Lauren Has a $1.8 Billion Department Store Problem
Ralph Lauren greets the crowd after presenting his
Discounting is killing its operating income
One of the biggest factors behind Ralph Lauren’s RL -0.40% sales problem has been department stores’ ongoing slump and inability to lure shoppers inside.
The fashion brand, which this week announced a $400 million comeback plan that will reportedly include closing 50 stores and cutting 1,000 jobs, gets 24% of its annual sales from department stores, with Macy’s M -1.07% by far its biggest account.
That means $1.8 billion of Ralph Lauren’s annual sales come from stores like Macy’s, Nordstrom JWN -1.74% , and Belk, which are all struggling with quarter after quarter of declining same-store sales, creating a domino effect on the fashion brand.
Macy’s last month reported comparable sales (including shops it licenses to outside brands) fell a worse-than-expected 5.6% in the first fiscal quarter, for their fifth straight decline as the department store blamed “the uncertain direction of consumer spending.” And Nordstrom did only slightly better.
So it’s easy to see why some many Ralph Lauren items end up at clear-out stores like TJX’s TAX -0.05% T.J. Maxx, where they sell for far less, which over time ruins a brand’s cachet on top of yielding lower top-line sales.
CEO Stefan Larsson said at Ralph Lauren’s first-ever analyst day this week that heavy discounting is leading the company to reduce shipments to wholesalers like department stores, with revenue in that wholesale channel set to fall by a double-digit percentage in 2017.
Larsson, who steered the comeback of Gap Inc’s GPS -2.02% Old Navy brand a few years ago, is putting department stores on notice that he won’t let their problems devalue his company.
The CEO told investors on Tuesday that shoppers will spend money on apparel but only if it is “exciting” and that “exciting isn’t selling a generic product with more and more discounting.” Kohl’s KSS -1.71% CFO, Wes McDonald, whose store sells Ralph Lauren merchandise, rang a similar note last month when he bemoaned an overall lack of “excitement” in fashion nowadays.”
But rather than sit back and watch the Ralph Lauren label wind up 80% off at a discount store, Larsson is planning to shorten production times to react more quickly to fashion trends and overhaul the supply chain to avoid overproduction, a problem exacerbated when department stores can’t sell his brand’s merchandise.
In the end, Ralph Lauren is not turning its back on Macy’s and its rivals. Without specifying how, Larsson said his company would work with those chains. Still, it’s easy to see why he would want to reduce his dependence on a retail channel that is shrinking with few signs of a turnaround.
Weekly Market Update: Caution Abounds Ahead of FOMC, Brexit Vote
Global markets were volatile this week as risk assets first recovered from the let-down of last week's May US jobs report and then succumbed to global jitters as funds rotated into fixed income. The ongoing oil market recovery propelled both WTI and Brent firmly back over $50 early in the week, helping boost the broader energy sector. Solidifying belief that the Fed will need to hold off on rate hikes at least little bit longer has helped gold and silver prices reach one month highs as well. In a widely anticipated speech on Monday, Fed Chair Yellen said nothing at to upset the apple cart, and there is a sense that a Fed rate increase in September is emerging as the new favorite view, although July is still touted as a 'live' meeting as well. The dollar arrested its decline without testing the lows seen in early May. Mid-week the DJIA and S&P500 approached but did not hit new all-time highs, as Brexit fears and interest rate jitters took over and pushed risk assets lower. For the week, the DJIA gained 0.3%, the S&P slipped 0.1%, and the Nasdaq fell 1%.
Treasury prices soared globally as panicky investors plowed into fixed income assets this week. The toxic combination of negative interest rates at the Bank of Japan, the ECB, and several other European central banks, fear of Brexit, and deep uncertainty about Fed rate hikes have fostered an extraordinary low yield environment. On Friday, the yield on the German 10-year bund sank to an all-time low of 0.025%, and some analysts suggested it could go to zero soon. Yields have fallen so far that more than $10 trillion of government debt worldwide is now trading with negative yields - Bill Gross took to Twitter to call the huge pile of negative-yielding sovereign a "supernova that will explode one day." The Japanese 10-year benchmark yield touched a record low of -0.15%. The 10-year UST yield fell as low as 1.649%, while the 30-year yield is at its lowest point since February 2015, at 2.45%, further flattening the yield curve to levels not seen since 2007. The 2-year/10-year UST spread has sunk below 90 bps, driving big losses this week in US financial stocks. Bond market analysts commented that the sustained level of demand for US Treasuries at this week's 10- and 30-year reopenings largely appeared to be driven by foreign buyers desperate for yield.
Some better US jobs data helped balance the narrative of a slowing labor market that emerged after last week's dire May payrolls report. The April JOLTS survey - Fed Chair Yellen's preferred gauge of US labor market health - saw an all-time high of 5.8 million job openings, up slightly from 5.76 million openings at the end of March. April hires fell to 5.1 million, slightly lower than the previous month's 5.3 million, while the key quits rate fell to 2.0% from 2.1% prior. Meanwhile, the jobless claims data showed the number of Americans filing for benefits unexpectedly fell in the week ended June 4th. Initial claims fell much more than expected, while continuing claims dropped 77,000 to 2.10 million, the lowest level since October 2000.
The annual US-China bilateral summit in Beijing saw tough rhetoric from both sides, with economic concerns taking a back seat to the tense situation in the South China Sea. Chinese officials blamed tensions in the South China Sea on the provocations of "certain countries for their own selfish interests." Secretary of State Kerry responded that China's plans to set up an air defense identification zone in area would be "a destabilizing act." Relations were smoother on the economic front, but there was still some tension. US Treasury Secretary Lew said good progress was made in currency talks and said China appeared committed to moving in an orderly way to a more market-oriented exchange rate. Lew pressed China to keep reforming bloated industrial sectors, especially steel, and told his Chinese counterpart that offloading excess capacity on the rest of the world was damaging global markets. Chinese officials stressed that Lew's critique only told half the story, as China's steel overcapacity resulted largely from the post-crisis stimulus plans, which themselves contributed to more than half of global growth in the 2009-11 period, helping lessen the impact of the Great Recession.
The China May trade report held good news and bad news for the world's second-largest economy. The bad: exports in dollar-denominated terms tanked 4.1% y/y, more than double April's 1.8% decline and slightly worse than estimates. The good: imports declined a mere 0.4% y/y, much improved from April's 10.9% slide and way ahead of expectations for a 6% decline. Softening global demand was clearly responsible for the worse exports component, while the ongoing recovery in commodities pricing and demand dovetailed nicely with the surprisingly robust imports component. In yuan terms, the trade report looked more positive, with exports up 1.2% y/y and imports 5.1% higher. The divergence with the dollar figures reflected the interruption of CNY's long-term appreciation trend against the dollar. Chinese Premier Li Keqiang once again reiterated this week that Beijing will be able to keep the yuan at a reasonable equilibrium level over the long term.
In Japan, the second and final reading of Q1 GDP confirmed the economy averted a technical recession, though concerns remain that the impact of Kumamoto earthquake could plunge the country back into contraction in the second quarter. Key components were better, with private consumption adjusted slightly higher to +0.6% from the preliminary +0.5%, and capex spending much improved to -0.7% from -1.4% in the preliminary. Skeptical analysts are quick to note that the data included an extra Leap Year day, and growth would have been slower if adjusted for that impact.
The referendum on the UK's further membership in the European Union is only two weeks away and a handful of polls this week have indicated the race is still too close to call. Three polls on Monday showed the 'stay' and 'leave' camps within a few points of each other, and the undecided camp remains in the double digits. Then on Friday an online poll from the Independent showed the 'leave' vote rising to 55%, further weakening the pound sterling. The pound continues to suffer from the heightened level of uncertainty, with GBP/USD dropping back toward 1.4200, for its lowest levels since late April. Last week there were reports that the ECB and the Bank of England were making provisional plans to provide liquidity guarantees for markets in the event of a vote in favor of Brexit, and this week BoE Chief Carney said that the Fed and BoJ are also looking to coordinate responses in case of excessive market volatility. In Parliament, a caucus of MPs in favor of remaining in the EU (totaling 454 MPs versus 147 in the 'leave' camp) is reportedly developing a plan to use their majority in the Commons to delay Brexit and keep UK within the single market because the 'leave' camp has refused to spell out what relationship it wants the UK to have with the EU in the future.
Three central banks around the Pacific Rim tinkered with their policy positions this week. The Bank of Korea surprised markets by cutting its seven-day repurchase rate by 25 basis points to 1.25%. The BOK statement expressed concern with rising household debt, slowing inflation, weakening consumption and declining exports. Analysts expect more BOK cuts are possible. The Reserve Bank of Australia signaled it was in no rush to cut interest rates again (it eased policy at the prior meeting) and kept the cash rate on hold at a record low 1.75%. The RBA acknowledged the recent recovery in trade, stating that exports and "areas of domestic demand" are expanding above trend. In New Zealand, the RBNZ kept on hold at 2.25%, while post-decision comments from Governor Wheeler indicated another rate cut was still built into projections. The statement emphasized inflation would strengthen, reflecting accommodative monetary policy, higher fuel and commodity prices, and a weaker NZD.
In M&A news, Westlake clinched a deal to acquire Axiall Corp, with the latter agreeing to be acquired for $33/share in cash. The deal values Axiall at $3.8 billion. The combined company will be the third-largest chlor-alkali producer and the second-largest PVC producer in North America, with expected combined pro forma revenues of $7.6 billion. Polycom received a competing acquisition offer to its deal with Mitel Networks. According to a Polycom filing, an unidentified private equity firm offered $12.25/share in cash, valuing the company at $1.66 billion. Back in April, Mitel agreed to acquire Polycom for $3.12/share in cash and 1.31 Mitel common shares for each share of Polycom. Weisman Group offered to acquire Ashford Hospitality Group for a $20.25/share, in a deal valued at $1.48 billion.
Investment opportunities in the autonomous vehicle space
Rob Toews is jointly pursuing degrees at Harvard Business School and Harvard Law School. He is the co-founder of SHFFT.
As companies race to bring autonomous vehicles (AVs) to market, investment activity in the space is heating up.
General Motors made headlines in March when it paid over $1 billion for Cruise Automation. A few weeks later leading venture capital firm Andreessen Horowitz entered the space, announcing investments in two early-stage autonomous startups, Comma.ai and Dispatch.
Most recently, secretive AV startup Zoox raised a massive $250 million funding round, making it Silicon Valley’s newest unicorn. These and other recent deals point to a growing investment frenzy as AVs get closer to mainstream commercialization.
The AV investment landscape is complex. It includes both hardware and software players and features competitors ranging from early-stage startups to large publicly traded corporations. This article will provide a primer for those interested in the rapidly evolving AV space.
Hardware
Vehicles
The first and most obvious layer of the AV ecosystem is the vehicle itself. The capital investment and manufacturing expertise required to produce vehicles at scale largely preclude early-stage entrants from being active here. Even large, deep-pocketed technology companies investing heavily in an autonomous future — e.g. Google and Uber — seem unwilling and unlikely to become car manufacturers themselves.
The most probable outcome therefore seems to be that traditional car manufacturers will continue to mass-produce vehicles in the autonomous age. It is unclear whether this manufacturing role will continue to be as profitable for these companies as it has in the past. As value creation in transportation shifts toward high-tech components and software, manufacturers of the cars themselves may become an increasingly commoditized, low-margin business.
Virtually every traditional car manufacturer has by now begun to invest in autonomous vehicle capabilities. Those with particularly interesting autonomous programs include GM, Volvo and Mercedes-Benz. (While Tesla manufactures cars, it is more appropriately considered a technology company.)
Lidar sensors
Lidar is one of several types of specialized sensors that allow AVs to interpret their environment. Lidar sensors give the vehicle a precise three-dimensional awareness of its surroundings by projecting lasers in all directions and measuring the time they take to rebound, a process analogous to radar (the word Lidar is a portmanteau of “light” and “radar”).
Given how critical these components are for overall AV functionality, the market for Lidar sensors will be enormous. A handful of startups have recently emerged that specialize in their production.
Two key dimensions of these sensors are their size and their cost; the company that can harness Moore’s Law to drive both of these down the fastest will have a huge advantage. The Lidar sensors that Google used for its initial AV prototypes reportedly cost $80,000, an impracticable price point for the mass market.
The current market leader in Lidar production, Velodyne, priced its most recent sensor at $500. Velodyne, a privately held company based in California, has yet to take any venture funding.
Another California-based Lidar startup that has attracted positive attention recently is Quanergy. Quanergy has announced that its sensors will cost only $250 and have no moving parts. The company has established relationships with a handful of large OEMs but has yet to bring a product to market.
Cameras
Like Lidar sensors, cameras help AVs understand their environment and maneuver accordingly. Though less precise than Lidar, cameras offer the significant advantage of being able to detect color—important when, for instance, identifying traffic lights and signs.
The dominant player in AV camera production is a publicly traded Israeli company named Mobileye. Mobileye has high-profile supplier contracts with a number of auto manufacturers including Tesla.
Computer chips
Perhaps the most important piece of AV hardware is the computer chip that serves as the vehicle’s “brains.” These chips take inputs from the vehicle’s various sensors and, based on complex software algorithms (discussed further below), enable the vehicle to operate autonomously. As with microprocessors in personal computers, these components sit at the very center of the overall system’s functionality.
Given the enormous computing power demanded, AVs will require state-of-the-art microprocessors. The established chipmakers that have long dominated the microprocessor market — Nvidia, Qualcomm and Intel — seem poised to leverage their existing expertise to succeed with AV chips. All three companies have signaled that autonomous technology will be a strategic priority moving forward.
Of the three, Nvidia is arguably taking this opportunity seriously and investing most heavily in it. Investors have taken notice, with the company’s stock trading near an all-time high.
Software
While the hardware described above is essential, AVs are able to act intelligently, or autonomously, because of their software. There are several different key types of AV software to be aware of.
It is worth noting that the divide between hardware and software companies, while helpful as a framework, is not entirely clean. Some hardware companies — e.g. Mobileye — also provide software to analyze their sensor data. Likewise, some companies classified below as software players also offer hardware as part of an end-to-end autonomous solution.
Mapping and localization
The first category of software critical to AVs is mapping and localization.
In order to effectively navigate, an AV must have a detailed and up-to-date map of its surroundings and must know where on that map it is located. Creating and continually updating such a map database is a massively challenging exercise.
The two biggest players specializing in digital worldwide map database creation are HERE and TomTom. Each of these companies has attracted significant investment attention — no surprise, given that maps will be a key strategic asset for the AV industry.
A coalition of German automakers including Audi, BMW and Daimler recently acquired HERE for around $3 billion (outbidding Uber, among others).
TomTom, a publicly traded company based in Amsterdam, has faced acquisition rumors for years by suitors including Apple; to date the company remains independent. Apple, Uber and Bosch all have partnerships to use TomTom’s data.
Meanwhile, other AV players — notably Google and Uber — are seeking to build mapping capabilities themselves, while a handful of smaller startups are also tackling this challenge.
Cybersecurity
As vehicles become increasingly connected to the Internet, other vehicles and surrounding infrastructure, cybersecurity will become an increasingly prominent concern. In an important warning of the potential dangers of connected vehicles, white-hat hackers last year remotely took control of a Jeep Cherokee and cut its transmission.
Entrepreneurs and investors are becoming active in AV cybersecurity. As examples, Tel Aviv-based Argus Cyber Security raised $26 million in Series B funding last year, auto electronics maker Harman paid $72.5 million for cybersecurity startup TowerSec in March, and newcomer Karamba Security raised $2.5 million in seed funding in April. More competitors will no doubt emerge soon.
Fleet operations and management
As the autonomous age dawns, many predict that private car ownership will become obsolete, replaced by shared AV fleets that individuals summon only when needed. The task of managing these fleets and optimizing their routes will be an immense challenge requiring complex software solutions.
Startups already beginning to tackle this challenge include RideCell, which in early April raised $11.7 million from BMW and Khosla Ventures. Given its strategic positioning and its commitment to autonomous technology, it seems safe to assume that Uber will invest and compete vigorously here.
AV artificial intelligence / machine learning
The central technological breakthrough at the core of the entire AV concept is the vehicle’s ability to conduct advanced and adaptive decision-making itself based on all the data at its disposal. Artificial intelligence software enabling vehicles to “think” in this way is the most important and technically demanding AV technology category of all. A handful of companies are seeking to build such solutions.
Some of these companies focus solely on software; to go to market, they will look to partner with, or be acquired by, hardware manufacturers. One prominent example is nuTonomy, which recently announced a partnership with the Singapore government to deploy driverless taxis there by 2018. nuTonomy, an MIT spinout, raised a $16 million in Series A funding in March.
Other companies are building machine-learning software integrated with hardware in order to offer a comprehensive autonomous system. Included in this group are auto manufacturers such as Tesla but also many promising startups. Cruise Automation, recently acquired by GM, is one well-known example.
Another noteworthy startup is George Hotz’s Comma.ai. Comma.ai is building aftermarket “kits” consisting of sensors, computers and software that allow customers to convert existing cars into AVs. The company aims to bring these kits to market for under $1,000 by the end of 2016.
Other startups tackling this ambitious challenge include Zoox, Peloton (focused specifically on long-haul trucking fleets) and Nauto, among many others currently in “stealth mode.”
Conclusion
The landscape of AV companies in these early days of the technology is fluid and fast-changing. Established auto manufacturers, large technology companies and scrappy start-ups are all fiercely competing to win in the AV ecosystem.
A wave of M&A activity, partnerships and consolidation seems likely as AVs move toward commercial availability. One thing is certain: There will be massive opportunity for profit as the autonomous vehicle market takes off in the coming years.
In the words of angel investor Tikhon Bernstam, one of Cruise’s earliest backers: “You’d be hard-pressed to lose money investing in this space right now because there is going to be tens or even hundreds of billions in M&A and IPOs going forward. Cruise at $1 billion may look very cheap one day
IMF sounds warning on China’s corporate debt
Shawn Donnan in Washington and Tom Mitchell in Beijing
China’s corporate debt risks sparking a bigger crisis if the authorities fail to tackle it, the International Monetary Fund has warned.
It is the latest red flag over China’s ballooning debt, which rose to a record 237 per cent of gross domestic product in the first quarter on the back of massive lending designed to boost economic growth.
That has put the subject to the fore of this year’s annual IMF review of the Chinese economy with a team from the Fund set to conclude its latest monitoring mission on Tuesday.
“Corporate debt remains a serious — and growing — problem [in China] that must be addressed immediately and with a commitment to serious reforms,” said David Lipton, the IMF’s number 2 and the leader of its latest mission, which ends on Tuesday.
Speaking in Shenzhen, where then-paramount leader Deng Xiaoping kicked off China’s experiments with capitalism more than three decades ago, Mr Lipton pointed to the potential risk to the global economy.
“We have learned over and over in the past 20 years how disruptions in one country’s economy and markets can reverberate worldwide,” he said, citing the global “spillovers” from last year’s turmoil in Chinese markets.
He warned that efforts to address China’s corporate debt load — which at 145 per cent of GDP was “very high by any measure” — had seen only “limited progress”.
“With the rapid increase in credit growth in 2015 and early 2016, and the continued high rates of investment, the problem is growing. This is a key fault line in the Chinese economy . . . And it is important that China tackles it soon,” he said.
Zhou Xiaochuan, governor of the People’s Bank of China, has long warned of the dangers of the corporate debt build-up, according to people familiar with the central bank’s deliberations.
In May the official People’s Daily newspaper picked up the theme, running a front-page interview with an unidentified “authoritative figure” who warned that soaring debt levels could trigger a “systemic” financial crisis.
China has since launched a series of initiatives to whittle back the bad debt sitting on banks’ balance sheets, including securitisation and debt-for-equity swaps — although Mr Lipton echoed analysts who see these as having limited resuts and doing little to eliminate bad debt from the overall financial system.
Zhang Tao, deputy governor of People’s Bank of China, speaking at a financial forum in Shanghai on Sunday, signaled a willingness to let zombie companies die. “Any industry that lacks the mechanism to elevate winners and eliminate losers can’t develop in a healthy and sustainable way,” he said.
He said an orderly system would be put in place for failed financial institutions: “We will permit financial institutions to go bankrupt in an orderly way, restructure those that need restructuring, shut those that need to be shut, and strengthen market discipline.”
Mr Lipton highlighted the state-owned enterprises, which he said were responsible for 55 per cent of the corporate debt pile despite representing 22 per cent of economic output and which “are essentially on life support”.
“In a setting of slower economic growth, the combination of declining earnings and rising indebtedness is undermining the ability of companies to pay suppliers or service their debts,” Mr Lipton warned. “Banks are holding more and more non-performing loans [and] the past year’s credit boom is just extending the problem.”
While concluding the issue is “manageable”, he warned that a recent IMF estimate that put the potential losses for China’s banks from bad corporate loans at 7 per cent of GDP was a conservative estimate that excluded exposures in the “shadow banking” sector.
The risk was also that if the problem wasn’t dealt with speedily it could grow into a large crisis. “Company debt problems today can become systemic debt problems tomorrow,” Mr Lipton said. And “systemic debt problems can lead to much lower economic growth, or a banking crisis. Or both.”
HNA Hospitality Group declares no participation in acquisition Of AccorHotels Group
In response to the recent groundless reports, claiming that "AccorHotels attempts to join forces with HNA to counter Jin Jiang Hotels", HNA International Hotels & Resorts Management Co., Ltd. ("HNA Hospitality Group") issued the following statement:
As of now, HNA Hospitality Group neither has discussed with French AccorHotels Group on the equity acquisition, nor plans to have such discussion. Relating reports are false.
As a global leading hotels group, HNA Hospitality Group is on the mission to establish a Chinese hotel brand. At the same time, HNA Hospitality Group actively fulfills a company's responsibilities in the society, with the dedication in creating a healthy market environment for the hotel industry with stakeholders, including the government, investors, industry peers, and customers.
HNA Hospitality Group has always been cautious with investments, following industry standard business codes and company work rules strictly, and will not participate in hostile bidding with any projects.
HNA Hospitality Group reserves the rights to pursue any legal rights available should any individual or company discuss project acquisition in the name of HNA Hospitality Group without authorization.
HNA Hospitality Group declares the statement hereby.
Mooted Smith & Nephew bidder Medtronic boosts coffers with tax case win
Medtronic (NYSE:MDT), the Dublin-headquartered medical devices group long tipped as a prospective acquirer for its British peer Smith & Nephew (LON:SN), has freed up cash after winning a legal battle over tax, the Financial Times reported. The report said USD 3bn of cash which was held in Puerto Rico will be released as a result.
Medtronic, whose operational headquarters is in Minnesota, USA, has played down talk of any tax-inversion deal and management has forecast a USD 1.5bn potential acquisition spend for the year, the report noted.
Smith & Nephew has a GBP 10.4bn (USD 14.8bn) market cap.
The original report appeared in the Financial Times, page 22
Financial Times
Monsanto Turns Back Bayer Again
German company is aiming to seal a deal that would form the world’s largest supplier of crop seeds and chemicals
Bayer AG’s bid to buy Monsanto Co. for more than $60 billion has hit an impasse that could pose a challenge for the blockbuster agriculture tie-up.
Bayer has offered to buy the U.S. seed giant for $62 billion including debt, or $122 a share, which Monsanto last month rejected as too low.
In an effort to bring Monsanto to the negotiating table, Bayer in recent days sent the company a letter saying it has lined up financing for the deal and is confident any regulatory obstacles can be overcome, according to people familiar with the matter.
It sought access to detailed business information, known as due diligence, which Bayer said could lead to a higher offer. Bayer didn’t increase its bid.
Monsanto, which considered the proposal little changed, responded by refusing to grant such access until Bayer raises its bid, the people said. Monsanto also told the German company that in addition to more money, it needs clarity on other matters including regulatory risks before agreeing to a deal, the people added.
Companies frequently engage in sometimes-tense negotiations before agreeing to combine.
Monsanto shares declined as much as 2% Friday afternoon after The Wall Street Journal reported on the stalemate. They recovered somewhat and closed at $109.20. Bayer shares earlier closed down 2.5% at €88 ($99) in European trading.
Bayer aims to seal a deal that would form the world’s largest supplier of crop seeds and chemicals and follow a brisk round of consolidation in the industry. St. Louis-based Monsanto, which failed last year in its effort to buy Swiss rival Syngenta AG, has indicated it is open to a deal with Bayer but hasn’t detailed terms it would accept.
The deal would combine Monsanto, the biggest seed provider with a leading position in biotech crop development, with Bayer, which has a robust lineup of pesticides but a smaller presence in major crops like corn and soybeans. Rivals Dow Chemical Co. and DuPont Co. are pursuing their own combination and Syngenta is working toward a $43 billion sale to China National Chemical Corp.
Bayer has secured more than $60 billion in debt financing for the deal from a handful of banks, people familiar with the matter have said. It would have to assume about $8 billion in Monsanto debt.
Bayer has also faced pushback from its own shareholders. The German company’s stock traded at roughly €100 before its bid surfaced last month, and the decline from that level is a sign some shareholders oppose the combination or worry Bayer will pay too much.
Others worry the tie-up would leave Bayer—a hybrid health care and agriculture giant—too exposed to crop-price swings.
After outlining its plan for the deal in late May, Bayer executives spent two weeks meeting with investors in Germany, the U.K. and the U.S. to pitch them on its merits.
“We have on social media the nice term ‘shit storm’ to summarize what the immediate feedback was,” Liam Condon, head of Bayer’s agricultural division, told the company’s staff in a meeting this week. Bayer filed a transcript of the meeting with U.S. securities regulators.
Some investors said they have come to see the long-term merits of a merger between the companies.
“What this does is undoubtedly make [Bayer’s] current crop-protection business much stronger,” said David Moss, head of European equities for F&C Management Ltd., part of BMO Global Asset Management.
As Bond Yields Tumble, Junk and Gilts Shine
The European Central Bank boosts its asset-buying program, pushing returns lower. Corporate issuance soars, but sovereigns suffer.
The hunt for yield got a little harder after the European Central Bank dived into the Continent’s corporate credit markets, pushing returns even lower last week.
But there are still strategies for investors looking to make a buck. Sterling-denominated debt that has sold off in the run-up to the United Kingdom’s European Union referendum on June 23 could rebound if the country opts for continued membership, as seems the most likely outcome. The high-yield, or junk-bond, market also still looks attractive.
European debt markets have rallied strongly since March, when the ECB announced that it would increase the size of its asset-purchase program to 80 billion euros ($90.38 billion) a month from €60 billion, and would widen the scope of eligible assets in June to include nonfinancial investment-grade credit.
The purchase program is the ECB’s latest initiative designed to spur inflation and economic growth. Analysts estimate that the central bank could splurge as much as €10 billion a month on corporate debt, but in reality the figure is likely to be closer to €4 billion to €5 billion.
The rally shows little sign of abating, and yields are hitting record-low levels. (When bond prices rise, yields fall, and when bond prices fall, yields rise.)
This compression in yield is most evident in the market for sovereign debt. On Friday, the yield on German sovereign bonds with a 10-year maturity fell to a puny 0.02%. But that still seems comparatively rich compared with Swiss government debt of a similar duration, which yields minus 0.45%. U.K. 10-year sovereign bonds, or gilts, yielded 1.23%, also a record low.
Yields aren’t plunging just in Europe. Sovereign yields are at lows, or flirting with lows, in the U.S., Japan, and Australia. It is difficult to see value anywhere in the sovereign spectrum.
Low interest rates in Europe’s corporate debt markets are great news for companies seeking to reduce their borrowing costs. Investment-grade credit issuance has rocketed in the past three months, as companies look to take advantage. Issuance in the first five months of 2016 was €226 billion, putting European markets on track for their biggest year of issuance. In 2014 and 2015, average issuance was only about €120 billion.
Companies have been able to sell issues with meager returns. Unilever (ticker: UN) sold €300 million of bonds due in 2020 with a 0% coupon and a yield of just 0.08%. Sanofi (SAN.France) and Allianz (ALV.Germany) have also successfully offered zero-coupon issues.
Since March, some 30% of investment-grade issuance has priced with a yield lower than 1%, according to an analysis by Goldman Sachs. In the same period last year, the figure was 11%. “The only direction for European yields in an environment with no inflation is down,” says Vincent Juvyns, global markets strategist at J.P. Morgan Asset Management.
His favorite space is European high yield. “It is the only market where the ECB won’t stimulate,” Juvyns says. “It is where investors will be pushed to” as they search for yield. He likes the fact that the sector recently has seen more rating upgrades than downgrades, and that it has almost no exposure to energy.
EUROPEAN HIGH-YIELD DEBT has attracted more new issues, but not to the same extent as investment-grade. Issuance in May was €6.1 billion, more than twice the €2.4 billion in the same month in 2014, but just a fraction of the €58.3 billion in investment-grade. The sector has returned more than 3% in 2016 to date.
Uncertainty surrounding the U.K. referendum later this month—and the threat of a further decline in the value of the British pound, in particular—appear to have created a trading opportunity. Sterling-denominated bonds of companies that have both euro and sterling instruments with the same maturity “have dramatically underperformed” since February, according to an analysis by research firm CreditSights.
There are 21 investment-grade credits that have sterling and euro senior bonds. Among them, sterling-denominated bonds underperform by around one percentage point. The list of issuers includes Bayerische Motoren Werke (BMW.Germany), Daimler (DAI.Germany), Investor (INVE.A.Sweden), and Telefonica (TEF).
“We see that spread as an uncertainty premium,” says Tomas Hirst, European credit strategist at CreditSights. “It is large enough that we don’t think it is a random trading pattern.” If the U.K. votes later this month to remain part of the EU, “that gap could well close,” he says, offering a healthy return for fixed-income investors.
For investors, the best way to get exposure could be through exchange-traded funds like iShares Euro Corporate Bond Large Cap UCITS (IBCX.UK) or iShares Core Euro Corporate Bond UCITS (IEAC.UK).
Pension Funds, Keep It Simple: U.S. Stocks for the Long Run
Pension consultants’ advice has often been misguided, emphasizing everything but U.S. stocks.
Dear Pension Trustees Everywhere: Do you ever experience feelings of self-doubt or guilt, brought on by acting on bad investment advice? Are you concerned about your fiduciary responsibility to your beneficiaries? You should be.
Most of you have been taken in by pension consultants—members of a fairly new profession who have track records that mostly are short and bad.
They advise big investors like you, and also wealthy individuals, charitable endowments and similar institutions, on how they should allocate their money among many possibilities: stocks, bonds, private equity, real estate, gold, commodities, emerging markets, and other small markets.
Have you noticed that since the stock market selloff in 2008, these folks have consistently advised clients that they reduce exposure to U.S. stocks? Their advice has been consistently wrong, as the tough-to-beat Standard & Poor’s 500 hit new highs last year.
They also have advised you to redefine the word “risk.” No longer is it the chance of permanent loss of capital. Now the consultants say it is volatility—the amount your portfolio bounces up and down in good years and bad—and they say it should be avoided by creating a broadly diversified portfolio of all possible investments.
Naturally, you have hired more consultants to balance your investments and manage the ones you don’t understand.
Shame of the Cities
Pension consultants’ advice has contributed mightily to the insolvency of cities, states, municipalities, and corporations unable to meet their pension obligations because of poor investment returns on their pension funds.
Let’s consider pension funds, looking at each 20-year period—roughly the typical career length of a policeman or fireman–on a rolling basis over the past 50 years. That is, we’ll look at 20 years, starting in 1965, then 20 years starting in 1966, and so on.
Returns on investment in the S&P 500 stock index for each period have fluctuated between 8% and 12%. Each period contained some bad years, but there were always more good years and they outweighed the bad results for every 20-year stretch.
While the actuarially assumed rate of return for most public pension systems is approximately 7.5%, the stock market has managed to climb the proverbial wall of worry and offer superior returns, compared to virtually all available alternatives—if you stayed fully invested in the index for the full 20 years.
You could look it up on the first page of Warren Buffett’s Berkshire Hathaway (ticker: BRKA) annual report, where he presents the S&P 500’s record over the past 51 years. Any way you slice these numbers in 20-year increments, the basic result is the same. Each rolling 20-year period produces returns adequate to maintain fully funded actuarial values for defined-benefit pension funds.
If there is a drawback, it’s that some of you will lose your jobs, because two or three professionals could direct money to index funds, versus the hundreds of employees who currently manage large funds.
Home-Grown Success
In addition to being wrong, the consultants’ advice to cut or avoid exposure to U.S. stocks seems gratuitously unpatriotic to some.
The object of this article, however, is not to impugn your motives, but to try to get you to objectively evaluate the data–the U.S. stock market’s compelling record over the past 50 years. Instead of relying on consultants who seem to view the world through their broken rearview mirrors, you have the opportunity to look forward at what is likely to work best, and then act accordingly.
How did our money-management industry so cleverly manage to avoid the U.S. stock market? A cynic might think it had something to do with fees or wanting to emulate the inimitable David Swensen, who has managed Yale’s highly diversified endowment for the past 30 years. The Yale model would seem to be another shining example of that old saying about fads: “What the wise man does at the beginning and the fool does at the end.”
A far more realistic model would be the Tampa, Fla., firefighters and police officers pension fund, run by Jay Bowen and featured in these pages a few weeks ago (“Consider Investing With Rip Van Winkle,” April 23). Bowen has strictly stuck to owning quality bonds and shares of great companies. He uses a high-quality, long-term balanced approach, relying on high-quality bonds for income and stability, and common stocks for growth and capital gains. Typically, the fund holds 50 to 70 stocks. Since 1974, it’s generated a compound annual return of 11.8%; its common stocks returned 14.5%. This compares quite favorably with the S&P’s 12.1% total return in the same time frame.
While the stock market is near all-time highs and employment is at supposedly acceptable levels, this has been a timid economic recovery and joyless bull market.
It’s important to note that the stock market is a leading indicator. Business investment is at very low levels. Currently, the only net new money coming into stocks is from companies themselves—buying their own shares. That will change eventually.
What happens when a roaring bull market gets started? Animal spirits rise. Companies conclude they need to earn more to justify their rising stock prices, which in turn would help fund underwater pensions. Then we are off to the races again. The stock market is huge, relative to private equity, collectibles, gold, etc. And so, we could easily see a bull market, a few more funded pensions, and rising economic activity, as political fears subside and economic greed takes over.
Here is a prediction. A gigantic market move to the upside is coming, as investment committees assess their costs and reach the conclusion that the stock market is their best and only hope to meet their obligations.
You public pension trustees, whose funds own such a high percentage of American business, should make a better effort to hold down your controllable costs. Some of you are raising Cain about the compensation of the senior managers of the companies in which your funds are invested. You should also pay attention to what you are paying for others to manage the funds’ money.