When diamonds aren’t forever: The contentious-and-potentially-busted $16.2 billion merger between jewelry giant Tiffany & Co. and French conglomerate LVMH (which would have been the largest on record within the luxury goods industry) continues to boil and bubble. 

The would-be acquirer announced on Sept. 9 that it was walking away from the deal on account of pressure by the French government. Tiffany filed suit with the Delaware Court of Chancery the same day to hold its partner to the existing terms.

Yesterday evening, LVMH filed a countersuit citing a pandemic-related “material adverse effect” (MAE) on Tiffany’s business operations, language which would allow LVMH to break its agreement.  As the filing noted, TIF logged a $45 million operating loss in the first six months of the year compared to a $345 million profit in the first half of 2019, while LVMH described its former target's prospects as “dismal.”  The filing continues: 

For instance, Tiffany paid the highest possible dividends while the company was burning cash and reporting losses. No other luxury company in the world did so during this crisis. There are many examples of mismanagement detailed in the filing, including slashing capital and marketing investments and taking on additional debt. 

LVMH also got personal, accusing Tiffany’s management of acting in their own financial self interest in order to jam the deal through. Noting that CEO Alessandro Bogliolo would score a $44 million payout if the deal were to be consummated, LVMH icily observed: “His golden parachute is equivalent to Tiffany’s losses in the first half of 2020.” 

“LVMH’s specious arguments are yet another blatant attempt to evade its contractual obligation to pay the agreed-upon price for Tiffany,” countered chairman Roger Farah this morning. 

Delaware Chancery Court is set to hear the case in January, but Mr. Market is hedging his bets.  TIF shares changed hands at $116 at day’s end, below LVMH’s initial $120 a share bid last fall, let alone the $135 a share price that the sides agreed upon in November 2019.

***

Others are similarly turning to MAE clauses to escape deals after having second thoughts. In June, Simon Property Group (the largest shopping mall operator in the U.S.) sued mall developer Taubman Centers in an effort to back out of a $3.6 billion merger agreement that was signed in February.  Notably, Simon accused Taubman of violating the merger agreement (despite the fact that it was the acquiree who sued to halt the deal) for renegotiating a credit facility with lenders to provide liquidity in exchange for “a secured interest in certain unencumbered assets.” That agreement, Simon contends, would “substantially reduce [Taubman’s] financial and operational flexibility.”  A trial date in Oakland County Superior Court is set for Nov. 16. 

Coronavirus-related MAE claims are about to get their first legal test across the pond as well. Last week, Payment processing firm WEX, Inc. went to trial in hopes of escaping an agreement to buy a pair of travel-payment businesses eNett and Optal, for $1.7 billion, after having announced in June it was terminating the deal as the pair suffered “a disproportionate effect” from the pandemic and lockdowns.  The target companies, subsidiaries of Siris Capital Group and Elliott Management-owned Travelport Worldwide, filed parallel claims in the U.K’s Commercial Court of the Business and Property Courts of England and Wales, setting the stage for a landmark ruling in the U.K. as to whether the events of 2020 are grounds to back out of a merger agreement.  

Might the MAE-inspired legal battles augur a more extended slump in deal activity? The pandemic has certainly taken a toll.  According to data from Mergermarket, worldwide M&A activity registered at $902 billion (inclusive of pending deals) in the first half of the year, down 53% from a year ago and the lowest total since 2010. Concerningly, the most recent full-month data aren’t looking much better: Global completed deal volumes plunged 65% in August compared to a year ago, according to Goldman Sachs, while completed deal volumes in the U.S. collapsed by 78% from August 2019. 

Stocks came under moderate pressure, with the S&P 500 slipping 50 basis points to give back a portion of yesterday’s advance, while key commodities diverged with gold jumping back over $1,900 an ounce and WTI crude slumping toward $39 a barrel.  Treasury yields went nowhere, as usual, and the VIX remained near 26.  

- Philip Grant

A dubious achievement for European banks today, as the Stoxx 600 Banks Index fell to its lowest level since 1988.  With a 45% year-to-date decline (that compares to a 14.5% drop for the broad Stoxx 600 Index), the gauge sits 61% below its June-2014 levels when the European Central Bank rolled out its negative interest rate policy, and a cool 85% off its high-water mark reached in April 2007.

While European banks gasp for air, financial institutions Down Under celebrate a friendly governmental edict.  This morning, Australia’s Treasurer Josh Frydenberg announced an overhaul of so-called responsible lending obligations, a move which Bloomberg describes as “effectively end[ing] a decade of ever-increasing regulation for the banks.”  

Among the changes:  In order to remedy, as Frydenberg put it, “excessive risk aversion which has built up and restricted the flow of credit,” banks will no longer be obliged to conduct due diligence regarding whether a loan is suitable for a given applicant. Instead, that responsibility will now shift to the borrower from the lender. 

Mr. Market liked the sound of that. In response, the VanEck Vectors Australian Banks ETF jumped 9% and now sits 35% above its March nadir.

Where to next? As the potent post-March rally in stocks and bonds has shown signs of fatigue, investors have been heading for the hills of late, at least according to fund flows from benchmark products. 

Thus, domestic equity funds lost $25.8 billion in assets during the week ended Sept. 23 according to data from Bank of America and EPFR Global, the third-largest weekly outflow on record. Last Friday, the Invesco QQQ Trust Series 1 ETF, which tracks the Nasdaq 100 Index and sports $128 billion in assets, saw a $3.5 billion outflow, the largest one-day loss since October 2000.  

On the bond side, investors pulled $4.86 billion from high-yield funds over the week ended Sept. 23, the largest migration since March, while BlackRock’s iShares National Muni Bond ETF, the largest municipal bond ETF with some $18 billion in assets, saw a $150 million outflow yesterday, also the biggest since March. 

While investors pare back their bets in stocks and bonds, the so-called risk free corner of the market remains in deep freeze. The MOVE Index, which measures Treasury market volatility, slumped yesterday to its lowest reading on record going back to 1992.  Over the past six weeks the 10-year yield has shuffled between 0.64% to 0.75%, while the 30-year yield has remained in a 1.32% to 1.52% band over the same period. 

Of course, risk averse punters seeking shelter in the currently-inert Treasury market must contend with a different problem: Namely, the determined efforts from the Federal Reserve to stoke inflation, and losses on a real basis to government bondholders.  On Aug. 27, chairman Jerome Powell introduced the concept of symmetrical inflation targeting, or allowing measured prices to rise at more than 2% for sustained periods prior to any policy tightening in response. 

Those hoping to earn interest on their cash shouldn’t expect much help from Washington. As The Wall Street Journal documents today, Congress appears to be on board with the scheme, judging by Powell’s reception during testimony in front of the House and Senate this week:

Lawmakers who have in the past raised concerns about allowing higher inflation didn’t press Mr. Powell over the changes or raise any objections this week.

In fact, a pair of congressmen offered effusive praise for the plan to tolerate higher inflation: “I am not at all exaggerating when I say this new framework is the most important thing that has happened to monetary policy – indeed, in economic policy – in 40 years,” declared Rep. Denny Heck (D., Wash.) on Tuesday. The move is “great news,” added Rep. Trey Hollingsworth (R., Ind.). Addressing the chair, Hollingsworth effused: “I really appreciate you doing that and I think it’s going to be a positive for the Fed and for the American economy going forward.”

In other words: Great quarter guys. 

Stocks caught a strong bid with the S&P 500 rising 1.6%, though the broad index still marked its fourth straight weekly decline to leave year-to-date gains at 2%. Treasurys held still, gold slipped to $1,866 an ounce and WTI crude remained at $40 a barrel. The VIX sank nearly 8% to 26.5.  

- Philip Grant

“Price stability” is so last year.  Instead, so-called average inflation targeting is now the monetary law of the land. Fed chair Jerome Powell described the new policy epoch in his Aug. 27 “Jackson Hole” conference virtual speech: 

Our new statement indicates that we will seek to achieve inflation that averages two percent over time. Therefore, following periods when inflation has been running below two percent, appropriate monetary policy will likely aim to achieve inflation moderately above two percent for some time. . . We will steadfastly seek to achieve a two percent inflation rate over time.

Chicago Fed president Charles Evans appeared to try and shift the goal posts yesterday, stating: “We could start raising rates before we start averaging two percent [inflation]. It’s still -- we need to discuss that.”

Yet, vice chairman Richard Clarida said the following during an interview with Bloomberg Radio this morning:

We’re not going to even begin to think about lifting off, we expect, until we actually get observed inflation -- and we measure it on a year-over-year basis, equal to two percent.

Forget forward guidance.  How about present guidance? 

Bankrupt NPC International, Inc. announced last week that it is seeking $725 million for its portfolio of Wendy’s and Pizza Hut restaurants that it looks to sell off while under court protection. NPC filed for Chapter 11 on July 1, saddled with $903 million in debt (or well more than the hoped-for sales price) thanks to a 2018 leveraged buyout. 

Pizza Hut and Wendy’s are less than thrilled with NPC’s plan.  The Wall Street Journal reported yesterday that the pair each filed objections with U.S. Bankruptcy court for the Southern District of Texas expressing concerns over the sale and asking for a greater hand in vetting potential bidders. Pizza Hut’s petition laid out the argument:

Without Pizza Hut’s consent to a change of control, the debtors will not be selling an operating Pizza Hut franchise, but brandless leasehold interests and personal property, resulting in lower sale proceeds and diminished returns to the debtors’ creditors.

John Hamburger, president of the Restaurant Finance Monitor, tells Grant’s that he anticipates the Wendy’s locations should generate brisk demand (even from the company itself, which has the right of first refusal on all sales). In any event, financial flexibility will be front and center: 

Wendy’s would prefer that NPC’s stores be split into smaller franchisee groups.  They don’t want another high-leverage franchisee that lacks the cash to remodel stores or develop new restaurants. 

Meanwhile, Pizza Hut parent Yum! Brands has indicated no particular willingness to buy out NPC’s restaurants, with CEO David Gibbs declaring on its second quarter earnings call, that Yum! is “committed to the asset-light model.” Pizza Hut has struggled markedly during the lockdowns, posting a 10% year-over-year comparable store sales decline in the second quarter. 

The credit markets are getting more optimistic on privately-held NPC, which has seen its first-lien term loan rebound to 74 cents on the dollar from just 37 cents in April. Yet Hamburger notes one detail that could complicate the transaction, while simultaneously shining a light on wider industry dynamics: 

When NPC bought 140 Wendy’s locations in 2017, they agreed to remodel 90 by 2021 – an obligation which now falls to the next owners.  Banks are unlikely to be as aggressive as they were pre-Covid in terms of extending credit, and so would-be buyers will probably need lots of equity.

More broadly, NPC’s plight underscores years of pressure on the franchisee business model, which has borne the brunt of declining traffic in tandem with rising labor costs in recent years, while the franchisors have themselves thrived. At year-end 2019, the S&P Restaurants Index traded at 28 times trailing earnings with an enterprise value of 17.3 times Ebitda, far above the 21 price-to-earnings and 13.5 times EV-to-Ebitda ratios sported by the S&P 500 on Dec. 31. 

Interestingly, Hamburger points out that the quick-serve business model has thrived of late and franchisees are currently flush with cash. However, several recent tailwinds are set to abate:

Quick-service restaurant franchisees took loans, which has yet to be resolved (either paid back or converted to grants), and rent deferrals, to be paid back by year-end or 2021.  Banks which write loans have deferred principal and even interest. That will have to get back on an amortization schedule, and franchisors deferred remodeling and developing commitments.  That will need to be worked into the cash flow equation.  

The key question: Might the franchisors, who have long collected royalties without direct exposure to a rugged operating environment, end up on the hook for some or much of franchisees’ capital needs?  

Restaurant Brands International, Inc. a frequent Grant’s pick-not-to-click and avatar of the asset-light business model, exemplifies Mr. Market’s potential for a change of heart.  Since the most recent bearish Grant’s analysis on Aug. 29 of last year, shares are down 28%, far worse than the 11% decline in Carrol’s, RBI’s largest franchisee, over that period. Meanwhile, double-B-rated RBI now sports a bloated balance sheet featuring net debt of 5.8 times consensus Ebitda estimates for 2021.  For context, the median double-B-rated credit carries 3.8 turns of net leverage, according to data from Moody's. 

Note:  The emailed edition erroneously reported QSR's leverage ratio at 9.6 times.  The corrected version now appears on this website. 

Stocks were flattened as the S&P 500 lost 2.3% and finished near the lows of the day, as the broad index has now lost nearly 10% from its Sept. 2 high-water mark.  The Treasury complex finished little changed, as a hefty $53 billion auction of five-year notes priced at a record low 0.275%. Gold was hammered again, falling to a two-month low of $1,860 an ounce, while WTI remained near $40 a barrel. The VIX jumped to 29, up 8% on the day. 

- Philip Grant

The Securities and Exchange Commission and Department of Justice separately announced insider trading charges this afternoon against Yinghang “James” Yang, a senior index manager at S&P Dow Jones, along with his friend and alleged co-conspirator, sushi restaurant manager Yuanbiao Chen.  Details of the allegations, from the SEC press release: 

Between June and October of 2019, Yang and Chen repeatedly purchased call or put options of publicly traded companies hours before public announcements that those companies would be added to or removed from a popular stock market index that Yang helped his employer manage.

Bringing new meaning to the term: Index arbitrage. 

As the pandemic and lockdowns continue to crimp the world economy, central banks across the Old Continent look to respond with an extra dose of the dual pillars of post-2008 monetary policy: ever-lower interest rates and more ambitious forays into financial markets. Now follows a review of recent happenings.

Last week’s minutes from the most recent Bank of England policy meeting included hints that negative interest rates could be on the way, as the Monetary Policy Committee was briefed on how negative rates “could be implemented effectively, should the outlook for inflation and output warrant it at some point during this period of low equilibrium rates.”  The BoE declared it will “begin structured engagement on the operational considerations” related to negative rates during the fourth quarter. 

Some observers believe that the move below zero is now a fait accompli. “The more [the BoE] talks about this option the more it looks as if it has all but made up its mind,” Allan Monks, economist at J.P. Morgan, commented to the U.K. Telegraph on Friday. 

It’s a notable change in tack for BoE governor Andrew Bailey, who succeeded the Brookfield Asset Management-bound Mark Carney six months ago.  Asked about the prospect of sub-zero rates in March, he replied: “It’s not an area I would want to go to.”  That was then.  The BoE’s next meeting is scheduled for Nov. 5. 

Of course, negative rates are old hat across the Channel, with the European Central Bank taking its benchmark deposit rate below zero in 2014 and cutting it to a record-low minus 50 basis points last fall.  The excursion below zero has evidently done little to revive dormant inflation, as core CPI rose just 0.4% in August from a year ago, down from a 1.2% annual rate in July. That’s the lowest reading on record going back to 2001. 

Rather than force rates deeper into negative territory, the monetary mandarins consider further ramping up asset purchases. The Financial Times reports that the European Central Bank is conducting “a sweeping review” of its Pandemic Emergency Purchase Programme (PEPP), “as debate is intensifying on the [governing] council over whether it should start drawing up plans to wind down the PEPP or consider expanding it further.”

The PEPP, which was initially slated to buy €750 billion ($878 billion) worth of corporate and sovereign bonds in March and expanded to €1.35 trillion in June, allows the ECB to bypass prior restriction on buying speculative-grade debt and accumulating more than one-third of a given country’s sovereign debt stock. The program, which has some €823 billion in remaining capacity as of last week, is scheduled to run through June of 2021.

Total assets at the ECB footed to €6.48 trillion as of last week.  That’s up 38% from a year ago, well below the 87% year-over-year jump in Reserve Bank credit at the Federal Reserve over that period. However, the ECB has been far more aggressive relative to the size of the underlying European economy, as balance sheet holdings stand at 49% of 2019 nominal GDP for the euro area. By comparison, Reserve Bank credit equates to about 33% of U.S. output following that spring shopping spree. 

The powers that be at the ECB have no compunction about taking that figure higher.  Speaking to French and German parliaments today from Frankfurt, president Christine Lagarde declared that she is “not at all aligned with this idea of the exhaustion of the toolbox.” Transitioning from mechanic to military analogies, Lagarde reiterated: “Has the ECB fired its last cartridges? No, not at all, not at all. We can find answers to help economies.”  

Meanwhile, Sweden’s Riksbank, the world’s oldest central bank, recently commissioned Wall Street behemoth BlackRock to conduct an assessment of its own corporate bond-buying scheme, which began on Sept. 1 and is scheduled to run through June. The consultant’s findings are shrouded in mystery, as reporters from Bloomberg received the following response to a request for information: 

[The Riksbank] sent a heavily redacted document consisting of 19 pages. “The Swedish corporate bond market exhibits a number of singularities when compared to other Anglo-Saxon markets,” the document showed. Almost everything else was blacked out.

Some were less than pleased with the lack of candor. “It becomes a black box, run by the Riksbank, with highly unclear working methods and motives,” comments Andreas Halldahl, head of Swedish fixed income at Storebrand Asset Management. “It only brings more uncertainty and destroys another market that worked just fine without them.”

Stocks took a fall on the last official day of summer, with the S&P 500 losing more than 1%, though the broad index managed to finish well off its worst levels of the day.  Similarly, the VIX rose to 27.5, a 6.5% advance on the day but far below its intraday peak of 31. 

Treasurys caught a bid with the 30-year yield slipping to 1.42%, while a strong rally from the greenback helped put the hurt on the commodity complex, with gold, WTI crude and natural gas clobbered by 2%, 3.5% and 10%, respectively. 

- Philip Grant

Fast-growing and money-losing cloud company Snowflake, Inc. enjoyed a blockbuster public debut yesterday, as shares went skyward from their $120 a share IPO price, which was already upsized from a projected $85 a share.  SNOW shares finished the day at $254 a share, giving the company a $71 billion market capitalization, and the $319 a share intraday peak valued SNOW’s equity at a cool $88.4 billion.  

Not only is that orders of magnitude above the $12 billion valuation achieved in the most recent private funding round conducted all the way back in February, but it tops the company’s own best case scenario.  Thus, Snowflake’s S-1 filing explains that the company: “Believes the addressable market opportunity for our Cloud Data Platform is approximately $81 billion as of January 31, 2020” (hat-tip to a friendly ADG reader).  

As Die Hard villain Hans Gruber quipped (in misquoting Plutarch): “When Alexander saw the breadth of his domain he wept, for there were no worlds left to conquer.” 

Now youse can’t leave. The continuing saga of H2O Asset Management, the London-based subsidiary of French bank Natixis SA with £20 billion ($25 billion) under management, is once again front-and-center.  At issue: Several funds managed by the firm offer investors daily liquidity (meaning the ability to quickly redeem their investments) while allocating a material portion of assets to highly illiquid debt securities. 

Recall that In June 2019, Morningstar suspended its rating on H2O’s Allegra Fund, precipitating some £3 billion in withdrawals over the next three days. 

Recent weeks have brought further bad tidings. On Aug. 28, French regulator Autorité des Marchés Financiers sent a letter to H2O ordering the manager to freeze three bond funds on account of “valuation uncertainties on the significant exposure of these funds to private securities.” In the regulator’s judgment, hard-to-sell assets are rife across that trio of funds, accounting for as much as 35% of Allegro, as well as up to 30% of the Multibonds Fund and 25% of H2O’s Multistrategies Fund.   

To try and remedy the situation, H2O will “side-pocket” the assets in question, meaning shunt them away to a separate entity, allowing investors to maintain daily liquidity from the existing pool of more liquid positions. Unfortunately for those investors, there is a lot less to withdraw.  Through the first seven months of the year, the three funds posted losses of 37%, 35% and 64%, respectively. 

Specific culprits are hard to identify, a Sept. 1 report from Fitch Ratings explained:

The private assets that drove the H2O fund suspensions are not readily identifiable, as the funds are not required to publish statements of portfolio holdings on a monthly basis. The most recent publicly available information is from the funds’ 2019 annual reports and indicates small exposures to private assets, hedge funds managed by H2O, defaulted Venezuelan sovereign bonds and subordinated bank capital instruments.

Another detail that raised regulatory alarm: The H2O funds close affiliation with oft-sued German entrepreneur Lars Windhorst, which was first reported by the Financial Times last year. H2O disclosed in a letter yesterday that it has applied haircuts on Windhorst-linked debt securities by some 60%, while one of the Windhorst-backed companies, Chain Finance, has yet to repay a €500 million ($590 million) bond more than a month past its August 11 maturity date.  H2O owns roughly 77% of that issue, per Bloomberg. 

Other curious details appeared today. The FT reports that the asset manager utilized a series of “a loose network of minor brokerages” as counterparties in order to shift its exposure to troubled Windhorst-linked debt instruments, an “unusual” arrangement for such a large firm.  H2O used the entities, which included “a mysterious company [named] ‘Merit Capital’ that H2O refuses to identify,” to conduct so-called buy-and-sell-back transactions. 

Following last summer’s revelations, H2O told investors that it had sold a material chunk of the illiquid debt instruments in question. Instead, the manager apparently used its network of lesser-known brokerages to hold the bonds in question for a predetermined period, allowing H2O to avoid breaching caps on illiquid securities which apply to open-ended funds in the U.K. 

Analysts at Bloomberg Intelligence write today that “we suspect delays and further write-downs are likely” before the situation is resolved.  The episode may continue to haunt parent company Natixis.  B.I. notes that H2O accounted for nearly 20% of total asset-management fees in 2019 despite making up less than 3% of total AUM as of June 30.  

Mr. Market seems to have rendered his own judgement:  At the end of 2017, Natixis sported a €20.7 billion market cap and traded at 117% of book value, a hefty premium to the 83% price-to-book ratio then commanded by the Stoxx 600 Banks Index.  Today, Natixis is valued at just €6.9 billion, equivalent to 40% of book and in-line with its peer group.
 

Stocks absorbed a moderate selloff with the S&P 500 falling nearly 1% to trim gains for the week-thus-far to 0.5%, while Treasurys caught a slight bid with the 30-year yield settling at 1.43%.  Gold slipped to $1,954 an ounce, WTI rose to $41 a barrel, and the VIX rose to 26.5. 

- Philip Grant

A slow motion financial accident in the Middle East?  Turkey’s economy continues to flash danger signs as the lira’s slide continues apace, falling to an exchange rate of nearly 7.5 to the dollar this morning.  That compares to 6.8 in early August, 5.6 lira to the buck in January and just over 3 in the summer of 2016, prior to the failed coup against president Recep Erdogan.  

The Central Bank of the Republic of Turkey (under the direction of finance minister and Erdogan’s son-in-law Berat Albayrak) has, perhaps counterintuitively, acceded to the president’s demands for looser monetary policy despite the weakening lira, cutting the one-week repo rate to 8.25% from 24% over the 10 months through April. Inflation has hotted up accordingly, with CPI rising by 11.8% year-over-year in August, the 10th straight month of double digit price increases. 

The lira’s downward drift is especially alarming, as it comes despite Turkey selling down its cache of foreign currencies in an effort to support its own. Gross FX reserves slipped to $44.9 billion as of Sept. 4 according to the CBRT, down more than 40% so far this year and the lowest since 2005, when nominal GDP footed to $501 billion compared to $774 billion in 2019. 

The rating agencies have taken notice. On Friday, Moody’s downgraded Turkey’s sovereign debt rating to B2 (five notches into junk territory) from B1, while maintaining a negative outlook.  The rating agency didn’t mince words: “Turkey’s external vulnerabilities are increasingly likely to crystallize in a balance-of-payments crisis.”   Moody’s writes that, after accounting for required reserves and foreign-exchange liabilities, net reserves “are now close to zero.”  

While some $44 billion in commercial bank reserves parked at the CBRT could help repay maturing external debt, “such a situation would increase the risk that the government impose restrictions to safeguard its scarce FX assets,” i.e., capital controls. Then, too, with the CBRT holding a $53 billion net short FX position in the swap market, up from $30 billion in March, “all the commercial banks’ reserves at the central bank are insufficient to cover this short position if the swaps were not rolled over.”   

Perhaps most concerning, Moody’s concludes: “The country’s institutions appear to be unwilling or unable to effectively address these challenges.” 

By way of response, Erdogan went the casual dismissal route, declaring of Moody’s Saturday: “Do what you want to do, your ratings are of no importance.”

As the political class keeps calm and carries on, foreign investors hit the bricks, withdrawing a record net $7 billion from local debt markets in the first half of the year while the ratio of non-Turkish ownership in the stock market has fallen below 50% for the first time since 2004.

The citizenry, too, is voting with their pocketbooks.  The Turkish Ministry of Trade reports that gold imports footed to $15 billion over the first eight months of the year, up 153% from the comparable period in 2019.  A dispatch today from The Wall Street Journal notes that average daily trading volume at the Grand Bazaar in Istanbul jumped to 4,500 pounds upon reopening from its coronavirus hiatus in June, a 10-fold increase from the baseline level.

“I’ve been at the Bazaar for 20 years and I had never experienced that,” Ozgur Anik, general manager at Ozak Precious Metals AS, tells the Journal of that surge in activity. “When gold prices are at [a] record high, people normally sell their gold. This time, they keep buying more.” 

A bull stampede to start the week, as the S&P 500 jumped 1.3% to leave the broad index higher by nearly 5% so far this year.  Treasurys finished little changed with the 30-year yield settling at 1.42%, gold rallied nearly 1% to $1,967 an ounce and WTI crude held near $37 a barrel.  The VIX closed below 26 for the first time in two weeks. 

- Philip Grant

Headline of the day, from the Financial Times:

Central banks will win the tug of war in markets.

A scalding corporate financing environment is allowing all manner of enterprises to tap public equity markets, as the volume of U.S. initial public offerings approached $19 billion in July according to Bloomberg. That’s the most active month since September 2014, which featured the debut of Chinese e-commerce behemoth Alibaba Group. “This is the busiest summer [on record], bar none,” Ashley MacNeill, Morgan Stanley’s co-head of technology equity capital markets for the Americas, told Bloomberg on Aug. 24. 

With stocks remaining near record highs and up smartly in this pandemic plagued 2020, a pair of tech-focused entities are set to grace the domestic public markets with their presence:

Cloud data firm Snowflake, Inc. filed its amended form S-1 with the Securities and Exchange Commission on Tuesday, disclosing plans to sell 28 million shares for between $75 and $85 each, with a midpoint price valuing Snowflake at $22.3 billion. For context, the company raised $479 million in February at a $12.4 billion valuation. 

Snowflake, which was founded in 2012, has enjoyed brisk top-line growth with revenues ($242 million in the six months ended July 31 from $105 million over the same period in 2019) and has caught the eye of blue-blooded investors Berkshire Hathaway and Salesforce Ventures, which have each agreed to buy $250 million worth of class A shares at the IPO.  

That fast-expanding top line has yet to translate into profitability, with the company reporting a $171 million net loss over the six months through July 31, little changed from the $177 million loss in the comparable period last year, while stock based compensation rose to $39 million from $34 million. 

Another tech unicorn looks set to join the public ranks, as yesterday, video game software developer Unity Software, Inc. filed its own amended form S-1 to sell 25 million shares to public investors at a range of $34 to $42 a share, valuing the company at just over $9 billion using the midpoint of that range. That’s up from a $6 billion valuation in a private fundraising round in May 2019.  

Much like its presumptive public peer Snowflake, Unity Software boasts sturdy top-line growth and persistent red ink, as revenues footed to $351 million in the six months through June, up from $253 million in the same period last year, along with net losses of $54 million and $67 million, respectively.  Stock-based compensation expense rose to $22 million from $15 million in the first half of 2019. 

Both Snowflake and Unity, which was founded in 2004 in Denmark and reorganized as a Delaware-based corporation in 2009, will be classified as “emerging growth companies” under the 2012 Jumpstart Our Business Startups Act (JOBS Act).  As the Unity filing spells out, the designation is a helpful one for these “emerging” eight and 16-year-old concerns, allowing for:  

[An exemption from] auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002.  

Reduced obligations with respect to financial data, including presenting only two years of audited financial statements and only two years of selected financial data.

Reduced disclosure obligations regarding executive compensation in our periodic reports, proxy statements, and registration statements.

An exemption from compliance with the requirement of the Public Company Accounting Oversight Board regarding the communication of critical audit matters in the auditor’s report on the financial statements.

Meanwhile a more newfangled enterprise looks to make its own public debut across the pond, with less auspicious results.  One-year old concern Guild Esports, which is co-owned by English soccer legend David Beckham, announced in a statement yesterday that it is preparing its IPO on the London Stock Exchange at a £50 million ($64 million) valuation. 

More ambitious plans were reportedly thwarted. The Financial Times noted Tuesday that Guild had previously attempted to debut at a £100 million price tag earlier this year, eventually scaling back its goals after “tak[ing] into account market volatility and discussions with investors and advisers in recent months.”

Perhaps London needs its own JOBS Act. 

Correction: 
A pair of price-and-time errors in yesterday’s edition:  August auto sales came to a seasonally adjusted annual rate of 15.2 million according to J.D. Power, up from 8.8 million in April and 12.2 million in May. The cited 17 million SAAR figure was from August of 2019.  In addition, steel prices peaked at $940 a ton in summer 2018 (not summer 2019), falling to between $550 and $600 a ton in the summer and fall of 2019. 

A renewed round of selling pressure forced the S&P 500 to reverse early gains and settle near session lows with a 1.75% loss, while Treasurys caught a bid with the 10- and 30-year yields slipping to 0.68% and 1.43%, respectively.  A surprise build in weekly crude oil inventories helped push WTI crude back to $37 a barrel, and gold ticked slightly lower to $1,950 an ounce. 

- Philip Grant

A cyberattack has forced the temporary closure of BancoEstado, one of Chile’s largest depositories. 

Technology news site ZDNet reports: “While initially, the bank hoped to recover from the attack unnoticed, the damage was extensive, according to sources, with the ransomware encrypting the vast majority of internal servers and employee workstations.”

It’s not the only recent example of bitcoin-seeking hackers wreaking havoc on financial infrastructure.  Last week, New Zealand’s NXZ exchange suffered four straight days of electronic assaults, including an offshore denial of service attack on Friday morning that compelled the exchange to remain closed. The Kiwis are bringing in the big guns to investigate, with NXZ declaring that it was working with “national and international cyber security partners. . . to address the recent cyber-attacks.” 

Martin Boer, director of regulatory affairs at the Institute of International Finance, offered this assessment to the Financial Times: “A sophisticated [cyber] attack — the suspicion is that it does come from a foreign, state-backed adversary.”

Everything must go.  Property giant China Evergrande Group Ltd. (3333 on the Hong Kong exchange) announced a month-long sales promotion that includes base discounts of 30% on all residential real estate, along with other incentives that could push savings to 43%. Its largest such price concession since the company began offering biannual sales in 2011, Bloomberg reports. 

The pressing need to book sales is understandable. Evergrande sports a whopping 12 turns of leverage, triple the industry average and nearly double that of the next-most encumbered Chinese property developer, Sunac China Holdings Ltd.  A pandemic-related earnings hit has exacerbated the problem, as total profits over the first six months of the year fell to RMB 6.54 billion ($980 million), a 56% drop and the third straight decline over that January to June period. For context, nationwide property sales registered at RMB 8.1 trillion in the first seven months of this year per the South China Morning Post, down 2.1% from a year ago. 

The company has paid lip service to cutting down its debt burden, announcing a plan this spring to reduce leverage by RMB 150 billion annually over the next two-plus years, but progress on that front has been wanting. Total debt stood at RMB 835 billion as of June 30, up 4% from its year-end level, while the gearing ratio (meaning net debt to equity, inclusive of minority stakes) rose to 199% from 159% on Dec. 31.  Analysts at Bloomberg Intelligence guesstimate that gross margins could drop below 21% next year, compared to 25% in the first six months of 2020.

For its part, Evergrande’s management remains upbeat in the face of daunting challenges: “We’re confident that total debt, net debt and net gearing will all substantially decline by year end,” declared CEO Xia Haijun on last week’s earnings call. To that end, the property giant cut its forecast investment in its money-losing electric car business (how’s that for synergies?) to RMB 29 billion from RMB 45 billion. A sense of urgency bordering on desperation colors the c-suite’s optimism. In announcing sales targets of at least RMB 100 billion across the crucial selling months of September and October, chairman Hui Ka Yan termed the initiative “a military order.”  

Then, too, the maturity schedule presents its own hurdles. Evergrande has some $19 billion in dollar-denominated bonds coming due between 2021 and 2025, according to Bloomberg, as well as an HK$8 billion ($1 billion) term loan due on November 30 this year.  

Despite single-B-plus-rated Evergrande’s extensive debt load and relatively front-loaded maturity schedule, yield-hungry bond investors have taken recent news in stride. After falling below 60 cents in March, the developer’s dollar-denominated 8 3/4 senior secured notes of 2025 have snapped back to their pre-coronavirus levels at 85 cents on the dollar while the 6 1/4% senior secured dollar pay notes due next year are hovering near par.

Might Evergrande serve as an avatar for the precariously leveraged Chinese economy, which features total banking assets of $43.8 trillion as of June 30, equivalent to one-half of 2019 global GDP? An Aug. 17 paper from the National Bureau of Economic Research concluded that “a 20% fall in real-estate activity could lead to a 5% to 10% fall in GDP, even without amplification from a banking crisis, or accounting for the importance of real estate as collateral.” 

For an early look at Evergrande and the Chinese economic miracle, see the June 2, 2017 edition of Grant’s. 

Stocks were clobbered with the broad S&P 500 and Nasdaq 100 Indices falling 2.8% and 4.8%, respectively, with each gauge finishing at the lows of the day.  Oil also came under heavy pressure with WTI sliding to $37 a barrel and Brent crude below $40 for the first time since June. Gold edged higher to $1,939 an ounce, Treasurys were bid with the 30-year yield falling four basis points to 1.43%, and the VIX rose a relatively modest 3% to near 32.

- Philip Grant

A new report from Colliers International finds that Manhattan’s August office vacancy rate jumped to 11.8%, the highest since 2013 and up from 11% in July. 

That figure appears set to rise further. Colliers reports that the total Manhattan office sublease market jumped by 1.3 million square feet in August, building on a 1 million square foot increase in July.  Subleases now account for 23% of available office space in the borough, the highest ratio since the 2010 financial crisis aftermath.  That’s despite a seasonal tailwind, as sublease activity traditionally wanes in August before picking up after the Labor Day holiday. The jump is also concerning in that, as most office leases run between six and 10 years, demand declines often manifest in short-term subleases before transitioning to outright vacancies. 

With the pandemic dragging into a month six and New York’s politicians seemingly in no hurry to end the quasi-lockdowns, large tenants look to downsize. Bloomberg reported last week that hedge fund York Capital is looking to sublet some 20,000 square feet of its space in the prestigious General Motors building on Fifth Avenue, while J.P. Morgan executive Daniel Pinto disclosed in a CNBC interview that the investment banking division’s 60,000-strong staff will rotate between stints at the office and working from home, a switch that he “believe[s] will be more or less permanent.”  J.P. Morgan was long the largest office tenant in Manhattan prior to WeWork’s rapid ascent in 2018. 

Other banks look set to follow suit. Fox Business reports today that Morgan Stanley and Goldman Sachs are similarly preparing for 50% onsite staffing until “well into next year,” while employees at UBS were told that a return may not come before April of next year.  

While the coronavirus presents a plausible catalyst for the moves, other considerations may factor in. “It’s a cost-saving measure," Dick Bove, a senior research analyst at Odeon Capital Group LLC, tells Fox Business. "The ultimate result of keeping people home is they can get rid of real estate."

It’s not just Wall Street that is looking to slim down its physical footprint in New York. In a filing with the Department of Labor on Monday the 478-room Hilton Times Square declared it was “permanent closing” after the hotel shut on a temporary basis in March and furloughed employees. For its part, owner Sunstone Hotel Investors may yet be keeping its options open, as a spokesperson told The Wall Street Journal that that filing language means only that layoffs are expected to last more than six months. 

While overall asking rents held mostly steady across Manhattan office buildings in the second quarter, the rush for the exits is already pressuring prices in select neighborhoods: According to Cushman & Wakefield, asking rents for retail space in the midtown section of Fifth Avenue fell 30% from a year ago. Meanwhile, one-bedroom apartment rental prices slipped by 10.9% year-over-year in August according to the Zumper National Rent Report. 

While New Yorkers have long been known for their healthy self-regard, the city that never sleeps is objectively a key cog in the national commercial real estate machine. Statista pegs the Manhattan office market alone at 526 million square feet as of the end of the second quarter, representing roughly 13.5% of the 3.9 billion square feet worth total office space in the U.S., per the CBRE’s 2020 Real Estate Market Outlook. For comparison, the entire New York metro area population (spanning the five boroughs and sections of New Jersey, Connecticut, Long Island and the Hudson Valley) stands at an estimated 20.3 million according to the Census Bureau, or just over 6% of the nationwide total. 

It’s not just the Big Apple that is facing a painful work-from-home reckoning. This afternoon, tech company Pinterest announced it has terminated its 490,000 square foot preconstruction lease near its current headquarters in San Francisco, choosing to cough up an $89.5 million break-up fee rather than go forward with the project.  

Clearly, that broad-based pain is no good news for the banks that finance commercial real estate.  J.P. Morgan Chase & Co., for instance, set aside a $10.5 billion provision for credit losses in the second quarter, up nearly 10-fold from last year’s credit loss provision. According to Fitch Ratings, the median credit loss provision among regional banks with between $50 billion and $100 billion in assets rose five-fold from a year ago in the first six months of 2020.  

Besides making a reservation with U-Haul, how might one position for the prospect of prolonged economic pain in Gotham?  The July 24 edition of Grant’s features a pair of ways to potentially profit. 

Stocks were trounced to the tune of 3.5% on the S&P 500 and 5.2% on the Nasdaq 100, sending those indices to their lowest closes since last Wednesday and last Tuesday, respectively.  By contrast, the yield curve remained under control as Treasury yields barely budged.  Gold fell $7 to $1,937 an ounce, WTI crude ticked to near $41 a barrel, and the VIX (which recently crept higher in advance of today’s pullback) jumped 26% to near 34. 

- Philiip Grant