The vultures of the financial world are circling, hoping for rich pickings as the global money flood turns to drought.
According to the Financial Times, wages for experts in ‘distressed debt’ are rising as investment banks and hedge funds prepare themselves for the next slump.
Reuters reports that recruitment company Michael Page has “about 172 global debt and structure finance jobs on offer”. That’s “as many as for corporate finance and mergers and acquisitions.”
So is the era of exuberant M&A about to give way to sell-offs and asset-stripping?
Investment banks are readying themselves to profit from a wave of European companies going to the wall, as rising interest rates make it harder to stave off bankruptcy.
How do the banks make money from distressed companies? There are two main ways.
One way is from the lucrative fees investment banks can charge for advising their struggling clients on how to restructure their debt, dispose of their assets or put themselves up for sale.
The second, more risky, but generally more profitable way, is for the banks to buy assets at dirt cheap prices from these “distressed” companies and then sell them once markets have recovered.
Reuters points out that hedge funds such as Polygon have benefited in the past from trading in the debt of distressed companies such as power generators Drax and British Energy. “These funds bought debt at a fraction of their value when the companies were unprofitable in 2002 and 2003, only to sell it at as high as four times its value when the businesses recovered.”
Opportunities look set to arise in Europe partly because new laws in Germany and Italy make it easier for companies to enter Chapter 11-style bankruptcy. This buys a struggling firm time to attempt to restructure its business (with the help of the aforementioned investment banks, of course) and return to the land of the living.
And with eurozone interest rates rising at a time of lax lending standards and record debts, the credit cycle looks set to turn. As the FT puts it, “the corporate default rate has fallen to such low levels that most observers believe the only way now is up.”
Unsurprisingly, Goldman Sachs has been “the most aggressive recruiter of late”. The investment bank has recruited Lachlan Edwards, previously head of restructuring at Rothschild. Mr Edwards’ previous cases have included restructuring former rail services firm Jarvis and German retail group Karstadtquelle.
Goldman also hired leading US restructuring lawyer James Sprayregen, whose cases have included United Airlines and TWA, last month.
Goldman Sachs is something of an expert in debt restructuring and complex financial products. As Lila Rajiva points out in this week’s issue of MoneyWeek, “risky derivatives now account for more than two-thirds” of Goldman’s revenues. So should investors hoping to take advantage of rising bankruptcies snap up Goldman shares?
Maybe not. If the credit cycle does turn, Goldman’s appetite for risk may leave it more exposed than most to the downturn. Subscribers can read why MoneyWeek believes the time has come to sell shares in the investment bank by clicking here: Why it’s time to sell Goldman.
In any case, the vultures may be better off looking to the UK, rather than on the continent. National Statistics reported earlier this week that 2005 was a record year for UK company profitability. The net rate of return for private, non-financial companies came in at 14.4% – the highest since records began in 1965.
But as we all know, what goes up, must come down. And while oil firms and companies in the services sector maintained a strong performance into the first quarter of this year, manufacturers saw returns slump to 6.6%, the lowest quarterly performance in three years.
Continued rises in raw material and energy costs have hit manufacturing firms hardest – and times are only set to get harder.
The oil price is at near-record levels in New York, trading as high as $75.40 a barrel of crude yesterday, not far off the $75.85 seen in May. And Societe Generale is predicting that oil prices could hit $83 a barrel this summer, ahead of what is forecast to be another active hurricane season. With the world also worrying about stand-offs in Iran and North Korea, this figure doesn’t seem unrealistic to us by any manner of means.
A recent report by accountancy firm BDO Stoy Hayward predicted that the soaring oil price would result in the number of UK business failures rising by 13% to 2,134 this year.
Rather than buying into potentially risky vulture firms, you might be better off buying into the one sector set to benefit from the high oil prices that are hurting everyone else. A few issues ago MoneyWeek economist James Ferguson outlined why he believes the oil majors are still a great buy. You can read his piece by clicking here: How to profit from soaring oil prices.
Turning to the wider markets…
The FTSE 100 fell back, closing down 56 points at 5,826 on Wednesday. Trading volumes were low, with 2.8bn shares changing hands. High street bank Alliance & Leicester was the main loser, down 6% to £10.84 on news that French predator Credit Agricole has dumped plans to bid for the group. For a full market report, see: London market close
Over in continental Europe, the Paris Cac 40 lost 62 points to 4,921, while the German Dax fell 103 to close at 5,625.
Across the Atlantic, US stocks slid, as unexpectedly strong employment data and surging oil prices increased fears of further interest rate hikes. The ADP national employment index showed that private sector jobs rose by 368,000 last month, the biggest since ADP records began in 2001. Factory orders were also far higher than expected in May, rising 0.7% against forecasts for a 0.1% rise. The Dow Jones Industrial Average fell 76 to 11,151, while the S&P 500 closed 9 points lower at 1,270. The tech-heavy Nasdaq dropped 37 to 2,153.
In Asia, the threat of higher US rates weighed on stocks once more. The Nikkei 225 fell 202 points to 15,321, led by exporters.
This morning, oil was flat in New York, trading at around $75.20 a barrel. Brent crude was a little lower, trading at around $73.80.
Meanwhile, spot gold was a little lower, trading at $623.40 an ounce, after rising as high as $630.40 on Wednesday amid uncertainty over North Korea. Silver edged lower, to trade at around $11.33 an ounce.
And in the UK this morning, Halifax reports that house prices fell by a whopping 1.2% in June, suggesting that lower levels of mortgage approvals are feeding through to prices.
And our two recommended articles for today…
Why the dollar has to fall
– The dollar has held firm over the past few weeks, but there are plenty of signs that it is on the verge of falling lower, say Andrew Selsby and John Robson of RH Asset Management. To find out what to look out for – from the price of gold, to decisions made in Beijing – click here: Why the dollar has to fall
What’s more likely – stagflation or depression?
– Are we about to see a return to the 1970s? The US is involved in a controversial war, oil prices are soaring, the Federal Reserve is hiking rates – it’s no surprise that many analysts are experiencing a strong sense of déjà vu. But as Mike Shedlock points out in Whiskey & Gunpowder, there are also some huge differences between now and then. To find out why we could be looking at a repeat of a much more worrying period of history: What’s more likely – stagflation or depression?