Time to stop these water sports

This wasn’t how it was supposed to be. When water floated (as the ads cringingly put it 20 years ago) the monopolies were to be controlled by a combination of regulation and comparison, putting the weaker of the 10 privatised water businesses under pressure to shape up.

It worked until the managements got bored with running water and splashed out on silly acquisitions. Then the private equity mobs moved in, picking off the prettier companies and replacing equity with debt. The result is that the industry is fading from financial view – the  accounts for Thames Water Utilities, for example, are quite hard to find.

Now Severn Trent may become the next to be taken private. Only United Utilities (now effectively stripped back to North West Water) and little Pennon of the original 10 would remain as publicly listed companies. A league table of two is meaningless, and as the sector shrinks, the scrutiny provided by stock market analysts disappears.

That leaves regulation. Companies agree a capital base on which their returns, and hence their charges, are calculated. Paying a 30 per cent premium to this, as the consortium suggests for Severn Trent, should be financial folly. Yet previous private buyers who did so have cleaned up, helped by wholesale replacement of equity by debt. Thames, for example, had borrowed 78 per cent of its regulatory capital value at its March 2012 balance sheet date

The regulator, Ofwat, fixes prices for each five-year period. The preliminary skirmishes for the next round are starting, so expect ritual cries of poverty from the companies – Thames’s beggar’s sore is the proposed £10bn tunnel under the river. Somehow, though, they do better than they expected (brilliant management, of course).

This bid approach threatens to give the game away, providing Ofwat’s newish chairman, Jonson (“Stop”) Cox a reason for hard water regulation. He may also be spurred by the abrupt departure of Regina Finn, the chief executive he inherited. She had the temerity to talk about competition. The companies are not sorry to see her go.

If the bidders persist – and no bid for a water company has yet failed -  Mr Cox should tell the industry that the gearing and gaming has gone far enough, and it’s time for the captive customers to benefit instead. That may be painful for us Severn Trent shareholders in the short term, but the bidders are not the only ones who like this low-risk long-term investment.

Very co-operative

Don’t tell the Co-operative Group about boardroom diversity. With a nurse, a farmer, a retired telecom engineer, and five female directors out of 20, they’ve got it. They’ve also got it in the neck from Moody’s, and this week S&P has joined in, changing its view of Co-op group credit from stable to negative. Not encouraging for the FT’s 2012 winner of “Europe’s most sustainable bank” award.

The 20 must now decide which bits of the Co-op empire must be jettisoned to keep the bank aloft. The insurance business is already going; fortunately, insurance is almost fashionable again, but it won’t be enough. The funeral parlours made £60m last year, and it’s undoubtably a growth industry, while pharmacy (£28m) would also help a little.

The trickier question is whether to “burden share” (as the euphemism has it) with the lower ranks of creditors. Bottom of the heap are £80m of preference shares, whose next payment is due at the end of the month. The prices of a further £310m of subordinated bonds have also slumped this week on fears that interest payments might be deferred indefinitely. It’s all something of a challenge to this unique branch of financial biodiversity: just how co-operative must we 20 be to be the Co-op?

Merv the poster boy

Mervyn King may never decorate as many student walls as Che Guevara (Castro’s first central bank president) but his reputation, widely trashed last year, is already past its nadir, as the UK economy twitches back into life just in time for his retirement party. Were it possible to invest in BitKings, they would look rather better value than those shiny new Carneys, where the gloss will surely come off once the QE junkies have to go cold turkey.

This is my FT column from last Saturday

 

Netting the rewards of longtermism

It was a great week for longtermism, now that Paul Walsh and Alex Ferguson can sit back, relax and compare notes. The most striking common feature of this odd couple is to note how long it took before the businesses they ran really started taking off. Sir Alex went four years before ManU won the first trophy on his watch, while the Diageo share price gave up most of its early gains during Mr Walsh’s first six years. The patience of fans and investors since then has been hugely rewarded.

Unfortunately, those looking for ways to spot the next Diageo, or even to see what made Paul run will not find much guidance in the way he was rewarded. The plan that covered much of his tenure was put in place in 2004, and is the usual impenetrable mix of salary, annual bonus and so-called long-term incentives. The long term here is defined as three years. Yet when it comes to building global brands, whether whisky or football, persuading people that consuming your product will somehow say how fashionable/wealthy/exciting they are, three years merely puts the idea into the customers’ heads.

A CEO whose eyes are fixed on a three-year horizon would look at the scale of spending required, consider the damage that would do to profits, and decide that launching the project was something to leave to his successor. Us shareholders will not begrudge Mr Walsh the £11m he earned last year, when the value of the business has doubled since 2009 to nearly £50bn, but so many schemes like his have merely rewarded executives for mediocrity that it was surely something more than the incentive plan that made his 13-year tenure such a success.

Supermarket blues

Justin King, another longtermist, is in a better position than his competitors to moan about taxes. Unlike CEOs at other supermarket groups, J Sainsbury  is not looking for an excuse for poor performance. It’s raising profits, dividend and margins, but Mr King worries that the likes of Amazon will eat his lunch. Not that they are better retailers, you understand, but because they have neither bricks and mortar nor checkout girls to look after.

Higher business rates on the bricks and National Insurance payments for the girls have taken twice what the Chancellor dished out with his cut in corporation tax and, as Mr King couldn’t resist adding, those competitors don’t seem to pay much of that, either. So far, this attack on conventional stores has not caused him to rethink the business model – on the contrary, much of Sainsbury’s planned £1 billion of capital spending is to go into convenience stores, located on those very high streets which are under threat.

However, as he did not say, there are far too many shops in Britain. It may not be pleasant to see the life sucked out of your local shopping parade by the mega-malls and the internet, but that is the way we live now. The harder question for the supermarkets, as Tesco signalled last month, is whether all that expensively-acquired real estate on the edge of town is an asset or a liability. Even the longtermist Mr King will be gone before we see the answer to that.

We wus wrong

Capital Economics have got quite a lot right with their post-crisis forecasts, as they are quick to claim. But they got inflation seriously wrong. Since January 2006, the Consumer Price Index measure has risen by 24.5 per cent. They expected it to have risen by just 7.5 per cent. What went wrong? They explain that they didn’t see the rise in VAT and energy prices or the fall in sterling.

Some of us would say that a compound rate of 3.6 per cent is pretty good going for the inflation-prone UK economy, and that a falling pound is always the way to bet, but Capital’s economists have the expertise, and they’re sticking to their guns. “We still do believe that a recovery in productivity growth will bring down labour costs and core inflation.” So that’s a recovery with no rise in labour costs, after years of suppressed wages? It’s a point of view…

This is an uncensored version of my Saturday FT column

 

Pension fund snaps up Kodak legacy

Dear Kodak Pensioner: we can’t pay your benefits this month, but here’s a big box full of assorted camera films for you to swap for something to eat. Well, perhaps not. Kodak’s bankruptcy last year was a shocking demonstration of how a disruptive technology can destroy big, well-established businesses if they don’t see it coming, but the failure has at least forced its executives to show some brain activity.

Kodak has sold its legacy film manufacturer to its British pension fund. Instead of a financial claim on a bankrupt company, the fund will own a business. While it may not be a very exciting business, the chairman of the fund believes there is “a very high chance” of sufficient cash flow to keep up the payments to pensioners. Presumably, he hopes they will fade away faster than the business itself.

Whether he’s right or not, it’s a better solution than the last resort of the Pension Protection Fund, which offers only basic benefits for failed schemes, as thousands of UK Coal pensioners are about to discover to their cost. In addition to retaining control, the Kodak trustees will be employing their assets productively. Instead of supplicants, they will be shareholders.

This defies the conventional wisdom on pension schemes, where the baleful combination of legislation and actuarial mumbo-jumbo has driven trustees to sell shares and buy “risk-free” government bonds. Rising bond prices equal falling yields, which means lower discount rates for actuarial calculations of future liabilities. This bumps up the present value of those liabilities, forcing companies to buy still more bonds..

While there is some logic to this for an individual scheme, the schemes as a whole can only meet their liabilities if the capital is employed productively, something governments generally struggle to do. Under the current rules, cash drains from companies to meet the demands of their own schemes, which in turn dare not make the riskier, long-term investments which produce future growth.

A few companies have broken out of this vicious circle. Diageo poured £500 million of whisky stocks into its fund, while Dairy Crest used 20,000 tonnes of cheese to plug its deficit. Generally, though, it takes a corporate crisis to force some imaginative thinking about paying for pension liabilities, as Kodak’s snappy solution demonstrates.

Iain’s winter warmer

Iain Duncan Smith would like those of us oldies who can afford it to get a warm glow from our winter fuel allowance by giving it up. He’s even pointed out how to do it. Well, every little helps when it comes to government spending, but this is desperation, not sensible policymaking. We recycle much of the money anyway; whisky drinkers who prefer their central heating internal pay about £140 of the £200 allowance straight back in duty and VAT.

The allowance is the legacy of a particularly cynical piece of Brownian crowd-pleasing, along with free TV licences for the even olders, and now the pleasant surprise has faded, we’ve come to expect it every year. Even Ed Milliband has noticed, and dared to suggest that it might not be sacrosanct. Still, those who don’t need it should think twice about helping the government kick its £2 billion-a-day spending habit. Better to give £200 to charity, which will spend the money much more efficiently, while you claim tax relief on the donation. That’ll teach ‘em.

Keeping the lights on

“When the energy crisis hits there will be three possible casualties, the government of the day, the consumer, and the investors who have funded the UK government’s radical energy policy. Whilst no doubt there will be plenty of pain to go around, investors should be under no illusions that the government will seek to protect itself and the consumer (aka the electorate) by heaping most of the financial pain on to investors.”

Thus brokers Liberium Capital in another scary assessment of the slow-motion train crash that is UK energy policy. As they point out, the managements at Centrica (British Gas) and SSE have already noticed, and are scaling back investment. Along with Drax (importing wood-chip from America to look green) the brokers reckon the risk in these utilities is growing and urge investors to “limit exposure”. That’s “sell” in English.

This is an updated version of my column from Saturday’s FT

it’s only money, after all

The E500 note is one of the many mysteries surrounding the birth of the euro. For whom, exactly, was the equivalent of $600 or £400 designed? No other significant currency is available in a form that allows £1m-worth to be comfortably carried in a briefcase, and which is effectively non-negotiable in everyday use.

The Spanish used to dub the notes “Bin Ladens”, because everybody knew they existed, but nobody had never seen one. Now BoA Merrill Lynch’s Athanasios Vamvakidis has proposed a rather scary way to use them to solve – or at least dramatically reduce – the euro-crisis. The E500 notes in issue add up to about E290bn, one-third of the face value of all euros in circulation. The European Central Bank estimates that two-thirds of those E500 notes are used as a store of value (rather than as a medium of exchange).

We can guess whose value they store – the UK’s Serious Organised Crime Agency estimates that 90 per cent of the E500 notes in Britain are held by criminals. Curiously, the outstanding proportion of the notes in the eurozone is falling slightly, which suggests that the smarter villains are moving into other stores of value. Perhaps they have also thought of Mr Vamvakidis’s idea. He suggests that the ECB call in the whole lot, and that beyond a certain date in the near future, the notes should become worthless. Anyone handing in a bulging briefcase before that date could be asked to reveal just which casino they got so lucky in, before being allowed to deposit the cash.

Understandably, the ECB will admit to no such plan, but after the tarring and feathering of big depositors in Cypriot banks, it’s not quite as whacky as it sounds. Until now, the pain of the west’s banking crisis has been borne by innocent taxpayers, but as it goes on, others will be forced to “burden share” (as the official language puts it). Quite a few of the legitimate holders of wads of E500 notes were on the other side of the trades which busted the banks in the first place, getting bankrolled for some ambitious property deal, for example. The argument that they should repay some of their debt to society would be music to the ears of desperate governments everywhere. If, say, one-third of the notes are not presented in time, the ECB’s liability would be cut by a very handy E100 billion. Oh Mr Vamakidis, what have you started?

Nostalgia corner

During the best days of the Thatcher administration, Britain’s public finances were in such fine shape that there were plausible projections of magnificent Budget surpluses, which would mean no new government stock issues, and early redemption of those outstanding. The traders in the gilts market fretted that there would be nothing left for them to trade (although few of them went so far as to suggest that they would then go and do something more useful instead).

It never happened. Governments can always find ways to spend other people’s money, because that’s why most politicians go into the trade in the first place. Since then, the policy of successive administrations has been rising financial incontinence. Yet the Bank of England’s quantatitive easing has mopped up one-third of the national debt, driving up gilt-edged prices to levels that nobody would pay with their own money. So are the dealers happy now? Er, no. Their market is drying up, after all, but for completely different reasons. There’s just no pleasing some people.

No sexism, please

Tut tut, Jock Miller. Melrose Industries, the engineering business he built after tiring of retirement, is one of six FTSE100 companies without a woman on the board. Aside from four (shortly to be three with Glenstrata) butch miners and Croda International, Melrose sticks out as the least politically correct of Britain’s biggest companies. Vince Cable is not amused, and is again muttering about quotas, even though few successful female executives want them. Never mind that there’s no convincing correlation between share performance and gender balance, or that Melrose has delivered a stellar performance in a workaday sector. Presumably, with a couple of women on board, it would have been even better. Or not.

This is an updated version of my Saturday FT column

http://www.ft.com/cms/s/0/a5fd3f98-a361-11e2-8f9c-00144feabdc0.html#axzz2QW9if3wO

Arrgghviva!

And a happy Easter week from Aviva. What do you mean you didn’t have much of one, after the dividend cut? You should have been keeping warm with the 2012 annual report. If reading it doesn’t make you hot under the collar, then you’re probably past claiming on your Norwich Union life policy.

The document is marginally shorter than About a Boy, and about as comprehensible. Skip to page 104, where rem. com. chairman Scott Wheway is pleased to present his report, and admits that “we got it wrong” on pay. In future, he says, “underpin” metrics will more closely align rewards with “shareholder experience.” Well, that would be a first. Shareholder experience at Aviva has been horrible. The shares are the same price as they were four years ago, and less than half what they cost in 2006.

You wouldn’t spot that from Mr Wheway’s report. Its best joke is the award of £607,302 to finance director Patrick Regan from his long term incentive plan. Aviva may be a life assurance company, but the long term here is just three years. The shares have gone nowhere, but he’s still worth 69.83 per cent of the 2010 LTIP award.

It’s going to be different from now on, Mr Wheway tells us, but his 14 pages of charts, acronyms and targets ensure that complexity is the enemy of comprehension. Normal mortals will continue to struggle to see why the executives are all so well paid, but don’t worry about Mr Regan. He earned £1,533,269 last year, and should be meet his “stretch” target, he’d get £3.6m under the next LTIP.

Aviva is having a good clearout of the board, with nine departures and three arrivals (along with a plea for a couple of female non-execs) so we must hope that the newcomers make a better fist of things than the last lot. They could hardly do worse: the bull market which has seen insurance shares soar has quite passed Aviva by. For shareholders who can face reading these accounts, that will grate even more than the presumption that a very decent salary isn’t enough to get the executives to do more than turn up.

Short circuit

“Building the plane while flying it” makes a great headline for an analyst wanting to be heard in a noisy world. It’s rather more attention-grabbing than “We’re worried about this company’s depreciation policy”, even if that’s a better summary of Espirito Santo’s view of APR Energy.

APR brings power to the people – that’s portable electrical power, anywhere in the world. Renting out massive mobile generators is a great cash flow business, but real profits depend on how long the kit lasts. The accountants have tied themselves up in knots trying to work out the answer; Espirito don’t claim to have found it, but they note that APR has changed its policy – again.

In 2011 it was stretched from a maximum of 12 years to 15, and now the whizzy new dual-fuel turbines are expected to last even longer, depending on the intensity of use. Espirito interprets this to mean up to 22 years, which is pretty heroic for a relatively new technology. A long depreciation does wonders for short-term profits, but if the turbines don’t last, APR could suffer a nasty electrical fire.

Risky business

Nathan Bostock is, we’re told, tough and competent. As head of risk at RBS for the last four years, he’s needed to be tough, and in wangling a promise of preferment to resist being head-hunted by his old mate at Lloyds, he proved he was competent. Now he’s getting his reward, promotion to finance director.

Fair enough, you might think. Not so fast, suggests Anthony Fitzsimmons at risk specialists Reputability. Since Mr Bostock knows the weaknesses in the system, and has been the boss of everyone in the risk department, the move means “potentially lethal behavioural and organisational risks”.

It’s pretty rough if a successful risk manager can’t advance any further because he knows too much, and given the way risk was essentially ignored by the previous RBS management, it’s surely helpful to have a CFO who knows a bit about the subject. However, it would reassure us shareholder-taxpayers if Mr Bostock’s replacement was an outsider.

Of course it couldn’t happen here…

How many people does it take to start a bank run? The conventional answer is two: one to draw the money out, and another to form the queue. Actually, you don’t need anyone present at all, since the money can disappear through the wall while the bank is physically closed. The truth of this will be tested, possibly to destruction, when (if) the banks in Cyprus finally re-open some time next week. It will not be a pretty sight.

As any fule kno, banking is about confidence, and the Cypriot authorities have managed to destroy it at a stroke with their reverse bank raid. Even now the reverse raid has itself been reversed, to be levied only on those accounts containing more than E100,000, the damage is done. Few will weep for the Russian oligarchs getting a haircut on their funds, but those in the middle of a house move, or with a down payment on a substantial contract, may face ruin. Not every six-figure deposit is the result of some shady deal in a sunny place.

Cyprus seems small and far away, but nothing that the European Central Bank, the IMF or the EU now promise can push the toothpaste back into the tube. Whatever  they say, bank deposits are now considered a fair target for “burden sharing”. As Willie Sutton famously replied when asked why he robbed banks: “Because that’s where the money is.”

Could it happen here? You bet. The ghastly arithmetic underlying last week’s Budget shows that, at best, Britain is travelling less fast in the wrong direction. We may already have passed the point where the state’s debt can be brought under control by conventional means, as the deadweight cost of servicing it stifles the growth needed to pay it down. In that event, there are only three ways out: inflation, taxation or confiscation. The first is proving rather harder to establish than many of us thought. The second is reaching the limits of practicality. The third is now a reality, albeit – so far – only on the biggest deposits.

If bank deposits do become a legitimate target, there’s not much the ordinary citizen can do. Moth and rust doth corrupt the treasures you lay up for yourself, but the state can simply take them away. While that million euros flown out to our boys in Cyprus could fit into a briefcase, thanks to the E500 note, there’s no sterling equivalent, and even the £50 note is barely negotiable. You need space to store £20 notes, but at least savers could make a start with the must-have accessory of the week, a mattress with a built-in safe.

Not even half-baked

Budgets come along so frequently nowadays that the previous one is still grinding through parliament. Or not. Mercifully, the Lords have flattened George Osborne’s “shares for workers’ rights” plan. This proposal, for workers to swap their employment rights for £2,000-worth of shares, popped out of  the Osborne headline generator last autumn. As Lord (Gus) O’Donnell put it: “If an employer is offering this, they are probably the kind of employer that you do not want to go near. If an employee accepts it, it is probably because he doesn’t really understand what he’s doing.” There’s a strong case for allowing freedom of contract for the smallest firms, since today’s employment law allows a single rogue employee to threaten such businesses, but to call this proposal half-baked is an insult to bakers.

‘ello ‘ello

If George Osborne needs cheering up, he could reflect that things could be worse. His opposite number in France, Jerome Cahuzac, has quit because police analysts believe a 13-year-old recording discovered on a voicemail is Mr Cahuzac discussing his secret bank account in Switzerland. He was a plastic surgeon at the time (as suitable a training as any for a budget minister, you might say)  specialising in hair transplants. He’s now (or was) in charge of the Hollande crackdown on tax evasion, and the recording comes from an anonymous political opponent, who leaked it. Mr Cahuzac denies that it’s him. Suddenly, dealing with Ed Balls doesn’t seem quite so bad.

This is an updated version of my Saturday FT article

http://www.ft.com/cms/s/0/534b2eaa-92e9-11e2-b3be-00144feabdc0.html#axzz2OY7hLc7z

 

Another euro triumph

I think this just about sums up the general view of the Cyprus disaster.

How many Euro decision-makers are unemployed as a result of the crisis? How many Euro decision-makers who have since retired have lost any pension entitlements? But now the citizens of Cyprus are having their savings plundered by the Troika. The shamelessness seems to have no bounds. It is not even a strategy that will deliver the outcomes they have defined. The elites go from one blunder to the next and meanwhile all the key economic targets continue to deteriorate (like employment growth etc). And even the irrelevant targets that are the obsession of the elites also move in the opposite direction to that intended. If it wasn’t so tragic it would be the comedy of the century.

Bill Mitchell‘s blog: How to wreck another country

http://bilbo.economicoutlook.net/blog/?p=23094