Tapping the infrastructure boom
With billions of dollars of spending slated for new infrastructure in emerging markets over the next decade, investment managers are keen to take a slice of the cake. For example, Russia has pegged $185 billion for pipelines and ports to facilitate the export of commodities. The CEE is looking to spend $25 billion on a trans-European road and rail network, and Brazil has allocated some $100 billion across a range of sectors to support telecoms, engineering and construction, and transportation. But tapping this opportunity is far from straightforward.
Philippe Guigny, senior emerging markets manager at CAAM, which has just launched an Indian infrastructure equity fund, says that infrastructure investment is now a key theme for governments. “In resource-rich countries we are always looking at those sectors anyway because these are the drivers of growth for emerging markets and underpin natural resource exports. Asia, Eastern Europe and Latin America are all taking measures to enhance their infrastructure but we think there is more potential in Asia as the population is so much bigger.”
China and India in particular have already attracted a lot of interest, but direct investment in this space is not for the novice. Trusted Sources, an independent research firm, has recently published two reports in collaboration with consultancy Urandaline, to examine the impact and the scope for investment, of infrastructure modernisation in China and India.
“India is more interesting for investors because you can go direct or there a large number of companies available, from cement companies, such as Ambuja Cement and ACC, to manufacturers of railway rolling stock such as Siemens India,” says Lawrence Brainard, chief economist at Trusted Sources. He points out that India is way behind in its infrastructure spending, and therefore has a political imperative to address it. “They also need to draw on the private sector in a way that the Chinese don’t.”
Patience required
Almost US$500 billion is budgeted for infrastructure spending in India’s 5-Year Plan budget to 2012, and one third of this is expected to come from private firms. But Brainard warned that this would test the country’s political flexibility and the patience of potential investors.
“For direct investors the most important judgement is the political judgement. Power is one of the most politicised sectors in India, so there are tariff controls. As an investor this means this is only a good opportunity if you are able to manage the political risk.” And only a handful of Indian companies have the political contacts to get things done, he believes.
Most private direct investment has to be done in the form of a Public Private Partnership (PPP), and therefore adequate legal documentation and the choice of partner is crucial. “As a foreign investor, you will be in a partnership with a state or federal entity so it’s critical that you think about how those interests are balanced,” he says.
“With the railways, which is a huge monolithic industry, you would also want a big local partner with clout. You need to think about the leverage of the local parties.” Indian Railways, which owns a lot of the prime real estate in cities, has failed to develop its sites due to internal feuding, with a plan to build budget motels at terminals becoming bogged down by bureaucracy and infighting.
The port sector is less politicised, with the minor ports competing with each other to attract investment, and 30-year licences on offer to private operators: “So one of the best opportunities for direct investors is to go into one of these developments,” says Brainard. But he adds that it is essential that the state government commits to connectivity – that is, ensuring there is the road and rail access to get the freight out.
“The problem is that the notion of Indian infrastructure is so sexy now, there is more money than projects, which has pushed down the rates of return. There are too few good projects.” He says that with something like the metrorail projects, which are being done on a PPP basis, there is strong competition because this is viewed as a long-term opportunity – the winning groups hope to use it as base from which to expand.
Jonathan Fenby, director of China research at Trusted Sources, says it is a similar story for China, where sub-contractors will be needed for huge projects. “The emphasis at the moment is on getting foreign investors into sectors where the Chinese lack the technical know-how,” he explains. “They are now trying to move up the value chain because places like Vietnam and Bangladesh can undercut them on cheap labour.”
Sectors of particular interest include railways, energy, seaports and inland waterways, and water and waste management, as these lag behind what is required both to meet consumer demand and to keep industry moving forward. However, Fenby warns that political constraints are evident as powerful interest groups seek to protect their turf.
Coal by wire
For example, Chinese railways are very inefficient with lots of stopping services and single tracks. This has made it difficult to convey coal from the coalfields in the north to the booming coastal cities. “China is currently a net importer of coal because it has been quicker and easier to import coal from overseas than to bring it through the interior,” said Fenby. “This has led to a move to build power stations at the coal mines with the aim of transmitting the electricity over long distances to where it is needed – what they call ‘coal by wire’. But that needs a massive improvement in the electricity grid and there is no Energy Ministry.” A proposal to set one up was opposed by the big power generators.
Similarly, a proposal at the National People’s Congress in March to set up a central transport ministry will not include the railways due to powerful vested interests within the Ministry of Railways. Fenby believes that the ambitious network expansion plans unveiled by the Ministry of Railways will be insufficient to meet the demand from passenger and freight that is envisaged over the coming decades, but suppliers of signalling equipment, rolling stock, sleepers, and steel might be worth a look.
Bureaucratic wrangling is also accentuating a water crisis in China, with approximately a dozen ministries and government departments involved in water policy. On a positive note, the sea ports were deregulated and decentralised 15 years ago and foreign investors have gone in. “The question now is whether this can be applied to inland waterways, as Central and Western China could be opened up by making the Yangtze River a modern transport hub,” Fenby says.
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Infrastructure becomes electric
Not so very long ago, infrastructure investment was a sleepy little backwater populated predominantly by Canadian pension funds and Australian banks. Considered too arcane for mainstream investors, and a lot less interesting than those exciting whiz-bang mortgage-backed securities, the infrastructure specialists were left to their own devices.
A few years ago this all started to change as European asset managers woke up to the opportunities provided by the privatisations of old state assets in Eastern Europe and the redevelopment of ageing infrastructure in the West. This year the story is all about infrastructure needs in emerging markets – and following the implosion of the credit derivatives market, real assets suddenly look a lot more appealing.
Christophe Nagy, manager of Edmond de Rothschild Asset Management’s new
Infrasphere fund, sees infrastructure as a defensive investment, which benefits from long-term relatively visible trends in both emerging and developed countries. “These companies may also have guaranteed returns on assets or index-linked tariffs, and that’s a significant advantage in the current environment as inflation becomes more of a concern,” he says.
Returns squeeze
Infrastructure is said to have performed well in the 1970s against a backdrop of stagflation, and with the big US pension funds such as CalPERS and CalSTRS planning allocations, the flows are expected to keep on coming. But this rise in interest has begun to squeeze returns at the top end of the direct market, as the stiffer competition is making it harder for the biggest funds to secure the high returns of yesteryear. Whereas $2-3 billion was once considered a sizeable fund, the largest direct funds are now weighing in at $7-8 billion, forcing teams to scour the globe and bid aggressively for deals in auctions.
Steve Jacobs, global head of infrastructure asset management (IAM) at UBS, believes that these mega funds may not get invested very quickly as they are forced to focus on the biggest, headline deals, and there aren’t that many of them out there. “We want a meaningful but manageable-sized fund that we can get invested quickly,” he says. “In our core fund we are targeting OECD investments because we want to mitigate the regulatory, legal and economic risks and OECD countries have transparency over the economy and a proven rule of law.”
The most recent investment is a 28 percent stake in Saubermacher Dienstleistungs, an Austrian waste management company. UBS’s stake will produce an IRR of over 15 percent, and allows UBS to take an active role in developing the business. Vincent Gilles, head of infrastructure AM, EMEA at UBS, sees strong growth opportunities for Saubermacher as Central Europe is binning more, so the company will benefit from the EU directive to treat more waste by 2012.
“People will increasingly have to pay to get rid of their rubbish, and you can make money out of recycling the components of some household appliances,” he says. “Saubermacher has a refuse derived fuel strategy to take advantage of this – for example, when oil is over $80 a barrel it’s economic to make fuel by burning plastic bags.” Gilles sees the best opportunities in mid-sized cities in Eastern Europe: “There is no point going up against the big French companies when it comes to auctions in the major cities.”
Around UBS’s core fund it is planning a number of satellite, regionally-focused funds, of about US$500 million in size. As well as a MENA fund, coming in September, Jacobs says UBS is bullish on China and Latin America, but it won’t do ‘me too’ funds.
UBS already controls a full-service domestic bank in China, so is aiming to launch a direct infrastructure fund in 2009, with a sector bias. “We will look to take a quality operational local partner and we will offer something quite different from the rest of the marketplace,” Jacobs promises.
UBS also has an interest in a large Brazilian bank, which invests in infrastructure, and is hoping to leverage this towards the back end of 2009. “There is a lot of demand for Latin America due to the commodity-driven boom. We’ll be focused on green-field sites,” says Jacobs.
Style drift
But it is not just direct investment that has taken off in the last 12 months. A raft of infrastructure equity investment funds have also launched – not surprising perhaps, as direct investment requires a significant amount of industry expertise and the ability to manage operational risk. But Jacobs believes that such funds are at the risk of style drift: “Either they don’t have the experienced teams or they lack the deal flow, so you get funds investing in shipping, airlines or lotteries – that might be allied to infrastructure, but they don’t pass the simple test of an economic downturn.”
Christophe Nagy’s fund is strictly infrastructure, and focused on industries that are relatively uncoupled from the business cycle; operating natural monopolies; or in sectors that are highly regulated, such as infrastructure management, production or concessions. The maintenance and construction businesses, which are subject to greater variation in their orders, or shorter contracts, are excluded.
Nagy tries to strike a balance between electricity, transport, and water and gas, to offset interest rate effects and the commodity impact. “Water, gas, and waste management are stable but also subject to movements in long term interest rates,” he explains. “But transportation, which is very cyclical, performs well when rates go up. Adding the two together hedges the interest rate sensitivity and mitigates commodity exposure.”
He is currently keen on the transmission theme in the US, warning that it needs to ramp up its investment or face the prospect of power shortages in many areas: “By 2015 it could be very serious. They need to reinvest, but depending on the state, there are different regulations and you have to be very careful at picking the right states.”
Check the contract
A real understanding of the regulations and drivers in each market is crucial, especially as contracts can vary. Jacobs warns that wind farms can be over-priced in America but offer value in Europe. “Gas storage is the same – in Europe you can get long-term contracts but in America they might only run for two or three years, so it is less of an infrastructure play.”
Philippe Guigny, senior emerging markets manager, CAAM, which has just launched an Indian infrastructure equity fund, says that investors also need to think hard about the portfolio mix, as some investments, like energy, deliver more quickly than others. “Valuations need to be looked at on a stock specific basis as expectations are sometimes too high and may not be realised. Investors should also scrutinise the types of contract that companies are securing.”
Some companies work on a cost-plus basis so that they are not exposed to rises in input prices – this means that whoever has commissioned the project agrees to bear any increase in the cost of materials and energy. Conversely, some Indian and Korean companies working on infrastructure projects in the Middle East have seen their margins squeezed as energy and materials prices have risen.
He is also wary about some of the new Chinese railway stocks that have attracted attention, such as China Railway Group, China Railway Construction and China Communications Corp. “The Chinese have long term plans for their railways but these stocks are relatively expensive,” he says. He prefers the electricity generating companies in Brazil, and Asian companies which are benefiting from the construction boom in the Middle East, such Korean desalination stocks.
Nagy adds that you can still pay a premium for the visibility on earnings of the developed market companies. “But surprisingly you can buy Chinese highway stocks at 15x earnings, which is cheaper than those in Europe, and they will grow at 15-20 percent earnings. So on a P/E to growth basis these are much cheaper than their European counterparts.” He suggests that this may be because there is still some reluctance from investors to go into this area. “But they are listed in Hong Kong so they have visible earnings, and it is high quality infrastructure.”
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When Private Goes Public
The credit crunch has had a surprisingly positive impact on the UK-based managers ploughing the specialist furrow of applying private equity techniques to quoted equities. As well as the fall in equity valuations, which has led to reduced entry prices, the decline in the availability of credit for corporate borrowers means that investors like SVG Investment Managers, Acuity Capital and 3i QPE receive a positive reception from quoted companies in need of expansion capital.
“We have seen more cyclical opportunities coming on to our radar screen over the last six months,” confirms Bruce Carnegie-Brown, managing partner of 3i Investments, the adviser to 3i Quoted Private Equity Ltd. “There are some obvious sectors where rates are depressed at this point in the cycle, such as financial services, software, real estate and credit businesses.”
When the 3i QPE fund was conceived 15 months ago, the market was a lot stronger than it is today, he adds. “We are trying to find 10 investment opportunities that for one reason or another have been neglected, or are undervalued by the market. And we believed those opportunities existed 15 months ago. The credit crunch has created more volatility, and a number of companies have seen a reduction in their market value, for a variety of sentiment reasons not necessarily supported by underlying trading. And of course many of the things that might previously have got funded in the debt markets are now coming to the equity markets.”
M&A activity
Adam Steiner, head of research, public equities, at SVG Investment Managers, says the mega buy-out market is still closed as banks are unable to syndicate loans, but smaller deals below $1 billion are continuing, as banks can do these on a solo basis. He is upbeat about the prospects for M&A activity in the small and mid-cap arena and sees private equity playing a significant role. “The high funding levels of private equity firms and the reduced availability of debt means that equity will represent a greater proportion of these deals,” he points out. In addition, as prices have come down, private equity groups can afford to put in more equity.
But Acuity’s Judith Mackenzie, who will manage the upcoming Real Active Management Fund, stresses the importance of doing your homework on stocks that have de-rated badly: “Sometimes that’s completely warranted because they have messed up badly and the fundamentals have been wrong in the first place, but more often it’s because of a relatively naive management team who haven’t been well-versed by the broker as to what the market wants. Yet the fundamentals of the company tend to be quite strong.”
Steiner says that SVG looks for a small number of companies that create a lot of value. “It’s a seven month process to research companies, and we analyse the company’s customers, suppliers and competitors, as well as using industry experts to undertake ad hoc research.” A strategic advisory board will also look at a prospective investment and give its view.
In terms valuations, Steiner says that traditional asset managers will look at P/E ratios and compare those with a company’s peers. “We don’t really do that. Instead we look at buy-out models and try to work out how much money we would make if we took the company private. We also look at transactions done in the sector and what P/E multiple they were done at.” Cash flow yield is also important as this attracts buyers for companies in the mid-market buy-out space.
Unlocking value
Once the company is in the portfolio, Mackenzie says that the assistance provided by Acuity might include identifying acquisitions or partial disposals, but she expects to have about 10 to 15 stocks where not too much needs to be done: “The company may just be unrecognised by the market, so it might need a few tweaks like a new investor alongside ourselves, or a new broker. It’s about looking for unlocked value and finding out where the trigger points are going to be over the next 12 to 18 months.”
Steiner adds that SVG will speak to the company management regularly, and help them improve the value of the company. “For example, if they need to make an acquisition and do a fund-raising, we will put some of the money in to help them place that fund-raising. We will also help them find better non-executives, and will urge them to introduce private equity style incentive schemes for management if they create value for investors.”
3i’s Carnegie-Brown says that this more intensive investment approach can offer companies an appealing alternative to delisting after a disappointing or bruising experience on the AIM. “Delisting is quite hard to do. If you’ve brought your company to the market and then delist it within two or three years, then institutional investors get pretty ticked off,” he warns.
“Also, if you delist and go private, you are essentially putting yourself up for auction and there is a risk that the winner will have a different business plan than the one you envisaged. But if you’ve got someone who is interested in minority positions and committed to keeping the company quoted, it’s a much more benign and supportive model. We can help the management team drive the business the way they want to go.”
He cites the example of Jelf Group, a UK insurance broking and wealth advisory business aiming to be a leader in the consolidating regional commercial insurance sector. It has made 15 acquisitions over the last two years and QPE has helped finance five of the most recent of these. Also supportive is the fact that with its previous investments in asset management and insurance brokers, 3i has already accumulated a range of skills and expertise in this area.
Exit strategies
When the time comes to exit an investment, Carnegie-Brown says there may be several options such as selling to a private equity firm or trade buyers, or back into the market. “But the idea is to keep the company in the portfolio for a meaningful period of time. It’s a constraint on private equity funds because they need to return cash to shareholders to show the value they’ve created, but with this you can see the value at any time.”
The average investment period is expected to be about five years, and 3i QPE is looking at a number of other investments in the UK, France, and Germany. “The Nordics are also interesting because they have an international perspective and it’s a strong region for 3i,” says Carnegie-Brown. “But there are more opportunities coming out of the UK because the concepts are generally better understood.”
If you want to read more about how this approach differs from traditional asset management, and where managers are finding opportunities in this space, please visit:
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A question of perception
When is an emerging market no longer an emerging market? Is it when it attains investment grade status? Or is it more philosophical, more abstruse than that? For specialist debt investors like Jerome Booth, head of research at Ashmore Investment Management, it’s a rather specious issue.
“You don’t go from being an emerging to a developed market because your creditworthiness improves,” he says. “That’s a total myth. You go from being an emerging market to a developed market because the investor base allows you to deteriorate your creditworthiness if you want.” For example, Romania recently joined the EU, and is therefore viewed as becoming “developed” but is heading for a 14% current account deficit this year. “There is no way that they would be allowed to get away with that if they were an emerging market. It is about risk perception,” Booth argues.
Booth says that the credit crunch, triggered by the implosion of sub-prime securitised debt, has put the real value of unleveraged emerging market paper into perspective. “No one ever bought Brazil without thinking it was risky – including Brazilians. But I believe Brazil has a lower default risk than Italy over the next 10 years. If Italy does leave the euro, one of the obvious ways to do that is to translate all the bank accounts into new lira, which would be an active default.”
Booth argues that corruption is not just an emerging market phenomenon but in emerging markets, the risk is priced in. For Booth, this is one of the fundamentals of investing in this space: “Where we see political and macroeconomic developments impacting asset prices, we can use our expertise. But where the domestic investor base doesn’t even think about their country’s own sovereign risk, that is not an emerging market, and our skills won’t add any value.”
This is also why he sees the credit crunch having an important impact on asset allocation – it’s a case of rethinking the map. “Pension funds will have to accept that in the next 15 years emerging markets will be much more important, but they are still massively under-represented in institutional portfolios.” Booth wants to see institutional investors allocating some 35% of their portfolios to emerging markets, across asset classes. “This isn’t just peripheral any more. This is a wake up call for asset allocators – maybe they shouldn’t be buying so many US Treasuries or US and European corporates.”
Corseted currencies
The current opportunity in emerging market debt revolves around the anticipated appreciation of emerging market currencies against the dollar, and this has led to high inflows into local currency paper over the past year. “A lot of the emerging markets have got semi-pegged exchange rates, or there has been restrained appreciation, and like a corset, that has forced a lot of the dollar’s weakness against the euro,” says Booth.
He expects to see greater currency appreciation in the next 12 months as emerging markets try to get inflation under control. “The US needs to be realistic about what is possible,” he warns. “You can’t expect these countries to appreciate their currencies without selling dollars and that’s going to be painful. But there comes a point where you don’t want to be throwing good money after bad.”
Some two-thirds of foreign capital flows into emerging market debt is going into the $3 trillion local currency sovereign bond market at present. But there is also a growing sub-segment of corporate debt, worth some $2 trillion. The longer-standing hard currency sovereign debt market is worth about $1 trillion, but doesn’t offer great value, according to Stuart Culverhouse, chief economist at Exotix, a broker for frontier market securities.
“Up until the credit crunch, spreads had narrowed across most emerging market hard currency debt so there was less value there. That reflected better fundamentals and liquidity conditions,” he says. “Since the credit crunch, these have widened out a little but not as far as developed high yield or investment grade corporate credit, so this is still not seen as offering great value. For example, you are looking at 7% to 8% yields for low ‘B’ rated credits in Sub-Saharan African countries and people would generally expect more from these markets, such as 10% to 12%.”
Some investors have instead sought to add value by picking up some of the new corporate issuance which has come onto the market recently. At the start of the year, corporate issuance was down, but in Q1 this rebounded, especially out of Russia. “Those deals were interesting, but with some reservations,” says Claire Husson, portfolio manager and research analyst in emerging markets debt at the Franklin Templeton fixed income group.
She adds that corporate debt from former state-owned enterprises often offer an interesting credit risk premium, but a number of financial issuers weakened following the credit crunch, and are now coming back at attractive levels. “This is the sector where we see the highly leveraged names and this is where the risk could erupt,” she warns.
New issuers
Although she has some exposure to corporates, Husson favours a mix of sovereign debt from established and new issuers in frontier markets in Africa and Central Asia. In the past 12 months new issuance has come from sovereigns that don’t necessarily need to borrow, such as Georgia and Gabon: “They are coming to market to access relatively cheap financing, and by doing so, expect to raise the profile of their industry and banks, thereby stimulate the economy. That has been an interesting development in Africa and Central Asia,” she says.
Husson believes that these small upcoming economies, who want a piece of the globalisation pie, tend to be much more prudent than people might expect: “They make strong efforts to disclose their financials and are improving their corporate governance. They are also fine-tuning their loan systems so that potential creditors have some recourse in the event of default.”
But Booth says Ashmore prefers to invest in these markets via real assets, through its Global Special Situations Fund, or originating its own transactions in is Emerging Market Corporate High Yield Fund. “Traditionally the Special Situations Fund was distressed debt, but now a lot of it is private equity,” he says. “Over the last 10 years the average rate of return on exited deals has been 37 percent, and that is all non-leveraged. And because it is event-driven it has not been impacted by the credit crunch at all.”
He expects these assets to be supported by a flow back of funds from emerging markets investors who have traditionally put money abroad. But he concedes that it is not easy to get access to the good deals – a constant refrain for Western investors hunting for real asset investments in emerging markets.
“A lot of money is chasing the infrastructure deals but in a lot of cases the spreads are very unattractive,” he says. “To get the really high rates of return you need to have a strong relationship with decision-makers in emerging markets going back years.” He says the fact that Ashmore specialises in emerging markets has proved advantageous in terms of getting deal flow.
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Forever Blowing Bubbles
June 11, 2008 at 3:17 pm (Asia equity markets, Commodities, Macroeconomic commentary, UK equity markets) (bubbles, buy to let, China, Commodities, contrarianism, dotcom, miners, SVG, UK, value investing)
This time it’s different – the plangent refrain of the investor suffocating in a bubble. Ah, what bliss it is to recall the golden days of the dotcom era, when we thought the mini-scooter-driven party would never end. We would all be commuting to work via the internet and downloading our memories into cyberspace in a kind of Neuromancer-meets-Facebook “mash up”.
Now we look back and scoff at the delusions of our younger selves. What on earth were we thinking? Boy, we were really stupid 10 years ago! We forgot to ask important questions like: What does this company do? And: How will it make money? Thank goodness the commodities super-cycle is nothing like that.
And just why is it so different? Because China and India are industrialising like crazy, of course! Who could pass up that opportunity? Hmm, well let’s just run a slide rule over that shall we?
Tony Dalwood, head of public equities at SVG Investment Managers, believes that mining stocks and other natural resources plays, which have run up on the back of the commodities boom, are heading for a fall. “Value investing has underperformed because commodity stocks like the miners have got ahead,” he says. “The market is focusing on cyclical peak earnings, but miners are heading for a problem when returns normalise.”
Panic and crisis
Adam Steiner, head of research, public equities, at SVG adds: “The investment time horizon of hedge funds and traders is microscopic compared to pension funds, and the markets are now very momentum driven. In moments of panic and crisis no one is using valuation to pick stocks – they just churn their portfolios to try and keep up to date. They don’t want to be underperforming the market at the end of the quarter.”
He argues that resources companies are “grotesquely overvalued” – mining is a cyclical industry and is generating the highest returns it ever has, but as costs go up and more capacity comes on stream this won’t continue. “Whenever you have a bubble there is always an argument that this time it is different,” he says. “People are pointing to the impact of China, but the increase in the oil price is not completely accounted for by that. To pretend the demand for resources is in no way influenced by the global economic cycle is crazy. If oil goes to $200 a barrel then the average US driver has to spend 10 to 20 percent of their income on petrol. So you have to ask – if everyone in China owns a car, how will they afford to drive it around? High commodity prices in themselves slow global growth.”
He adds that the population of China is only three and a half times that of the US, and the majority are peasants in the north and west. So the Chinese economy will only become two or three times bigger than that of the US and it will take a long time to get there. “You also have to keep in mind that a lot of China’s growth has been financed by US debt.” That is, consumers withdrawing equity against their homes to keep spending – something they are unlikely to be doing much of in the foreseeable future.
The commodity gurus argue that prices are supported by years of under-investment, which has created a pinch point – miners can’t get the stuff out of the ground fast enough, so prices keep increasing. But when new capacities come on stream, shouldn’t prices correct to more realistic levels, especially if the US is in the doldrums? So investors have to ask themselves: How far do we want to ride this boom? You can bet the chartists are hunkered down over their models right now trying to call the peak.
Buy-to-let blow up
Steiner is also worried about the horrors that may lie ahead for the UK, especially if the buy-to-let boom turns out to be the UK’s very own sub-prime meltdown. “The banks have only written down their lending impacted by the US so far, not their UK lending losses,” he argues. “That will come if we have a nasty house price plunge. For the last few years there has been a very strong tailwind that has helped retailers, banks and property, but that has now gone into reverse, and it is likely to be a headwind for another three to five years. The issue will become – how are banks going to make money now? The ratings will recover but the earnings won’t.”
SVG takes a contrarian approach and is focused on companies not at the peak of the cycle – particularly, telecoms, pharmaceuticals, software and media companies. Steiner says that pharma stocks are interesting as they are “off the scale cheap” – some 40 percent below their 20 year average. “All the arguments for pharma – such as the ageing demographics – remain intact, but they have been hit by the FDA tightening up its approvals process and the market is fretting over near-term fears.”
He adds that media is “mind-blowingly cheap” because of fears that if the economy does turn down, media will do badly. SVG is focusing on business-to-business companies such as DMGT and the WPP agency, which is more diversified, and therefore less cyclical than people seem to think. “This is the exact inverse of 1998 to 2001,” he argues.
It’s an interesting idea – that TMT will ride again after a speculative bubble in commodities goes pop. M&A activity in the small and mid-cap telecoms and software sectors has been brisk in the last couple of years, with strong private equity interest. “A lot of small and mid-cap deals are happening and they have raised a decent amount of money,” says Steiner. Telecoms has now re-rated a little, but SVG believes there is further to go. Perhaps it’s time to dust off that mini-scooter and drive back into the TMT market again.
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