The new James Bond film out last week may have received splendid reviews, but it has also made Hugh Hendry of Eclectica Asset Management nervous.
James Bond movies have, he says, “an uncanny knack of mirroring reality.” Witness The World is Not Enough, which was released in 1999. It featured as its central character an anarchist terrorist seeking to wreak havoc on global capitalism. “Sound familiar?” asks Hendry.
Then look at this year’s release, Casino Royale. It is all about gambling (specifically poker) and could be said to be mirroring the high-stakes games being played out in markets around the world. Most investors are happily betting that the US economy will have a good 2007, that profits will keep rising and world share prices will do the same, despite the huge range of evidence to the contrary.
The derivative markets, where traders bet on the price of an underlying asset, have gone berserk. Globally they have almost quadrupled in size since 2000, while the credit-derivatives market alone is growing at an annual compound rate of over 100%. Do all the holders of these contracts really understand all the risk involved? Given how fast the market has expanded, you have to wonder.
Anyone who doesn’t find all this speculation worrying might stop to remember that Casino Royale is a remake. The first, spoof version came out in 1967, around the time of the Dow Jones’s Sixties peak. Following the ensuing bear market, it took the average investor 25 years to make back the real value of his of her portfolio. Consider yourself warned.
The highest stakes of all are being played for in the private-equity sector. Suddenly nothing looks too big or too complicated. James Harding, business editor of The Times, last week mentioned meeting a private- equity dealmaker who said he had taken a “casual look” at buying British Airways. The next day we heard an approach had been made for Qantas by Macquarie and Texas Pacific. Qantas shares leapt 15% to a record of $5.
There’s a huge amount of money sitting in private-equity funds and we are now at the point where there is too much cash chasing too few opportunities. The result? The dealmakers are considering betting on increasingly risky purchases.
The man who looked at BA stopped looking because it was going to be too expensive, but that might not be the case for long: when you feel confident and your wallet’s always full of cash you stop looking for value after a while.
Still, none of this means there isn’t money to be made over the next few months. Global interest rates aren’t rising sharply enough for the buyout boom to be stopped in its tracks any time soon. And while it carries on, private investors must do what they can to make money from the folly of others. The question for us is simply, what’s the next target? How mad can the market go? Well, clearly BA will now be looked at again, something the market has already recognised — BA shares rose over 2% after news of the Qantas bid came out.
City analysts have worked out that if there were a bid for BA on similar terms to Qantas it could go for more than 700p a share (it is now trading at 490p).
Away from airlines, Hendry points me in the direction of telecoms, and Vodafone in particular. Eclectica looked at the numbers for Vodafone a few months ago, when the shares were a bit cheaper than now, and wondered what the big private- equity companies might do if they were looking to buy it.
They figured that after using all the company’s possible cashflow to raise more debt, selling its 45% stake in US telecom firm Verizon as well as other stakes in companies such as China Mobile, you could get Vodafone for not much more than £11 billion — in effect a price/earnings ratio of between 2 and 4 times.
The Vodafone share price has risen since, but the point remains — in the current climate it could make a perfectly reasonable investment. The shares also yield 5%, which should provide some comfort to investors should the private-equity sector not immediately agree.
Analysts at Axa say that Telenor and Swisscom also meet private-equity criteria and Eclectica makes a good case for Deutsche Telekom. An adventurous buyer could, they say, borrow against the business as much as possible, sell its American arm, dispose of surplus property and end up getting the core company “for nothing”.
You might think it unlikely that anyone would do this — and a year ago it was — but if the private-equity business has got to the point where it is buying airlines, why on earth would it be adverse to getting into the likes of Vodafone and Deutsche?
First published in The Sunday Times 26/11/2006