Buying bonds can damage your wealth. Buying junk bonds…well, what does it say on the label? The buyers of the bonds issued last September by Phones4u have learned just how damaging these things can be, as the price went from £100 to £12 in a matter of days. As Joseph Cotterill noted, this was a Wile E Coyote moment, since the signs had been there for months that not all was hunky-dory at P4u.

Perhaps for the first time, the bondholders are reading the prospectus for the senior bonds and the accompanying pay-in-kind notes. These are peculiarly dangerous instruments: instead of a cash coupon, you get more and more notes, until the wonderful day when all the rolled-up paper is redeemed. Or, as in this case, not. Trading at £85 in August, they are now standing at, er, £3.

Like many P4u employees, the holders can’t see the funny side of the decision of the company’s owners, BC Partners, to pull the plug. BC is laughing all the way to the bank, since the proceeds of the bond offers went to finance a dividend which repaid the whole of its investment. In the private equity trade, this is called a “dividend recap”, replacing the owners’ capital with new debt. In this case, it took P4u’s debt from 2.2 times ebitda to 4 times, a level that leaves no room for error (and little cash for investment).

The network companies sensed financial weakness. They saw the chance to grab a fatter slice of the mobile pie, and (almost) all’s fair in love and business. O2 abruptly cancelled its contract in January. BC wrote off the value of the post-recap equity in May, when the long engagement of Carphone Warehouse and Dixons (a P4u retailer) was finally consummated. When Vodafone announced that it could live without P4u, the game was up and the company collapsed.

The bondholders are, understandably, trying to salvage something from the wreckage, mulling turning their useless debt back into new equity. They are also reaching for their lawyers. Should the management have hung up earlier to preserve cash? Did BC know, or at least suspect, more than the long list of risk factors disclosed in the prospectus?

There’s many a billable hour here, but the real moral of the tale is that too many bonds in today’s climate offer miserable yields for potentially catastrophic risks. And does anyone read the small print?

How to keep the lights on

The boffins at National Grid must hope that Britain ‘s Indian summer lasts all the way to March. Those of us who believe that weather tends to balance out over time (remember the soaking spring?) suspect that there’s a price to pay this winter.

Even before the unplanned closure of four geriatric nuclear stations, Grid’s own forecast is for the margin of capacity over demand to fall below 7 per cent, and to little more than 2 per cent in 2015/16. Its novel solution is to call for volunteers; companies will be paid not to take juice at peak periods, either shutting down or making do with their own stand-by diesel power.

This power costs both the companies and the environment dear, but it reflects the desperate measures needed to keep the lights on. We’re here as a result of the cat’s-cradle of EU directives, successive government green initiatives, and the resulting reluctance of anyone to commit to new build.

A paper from the Global Warming Policy Forum, a climate-sceptic pressure group, spells this out in grim, if not exactly novel, detail. It recommends speeding up shale gas development, delaying compliance with the EU’s emissions directive and scrapping the carbon price floor, a levy that has the peverse effect of making it cheaper to burn coal than gas.

This is typical of the unintended consequences of an energy policy run by two political parties with opposing views on how to do it. Coming soon: so-called smart meters. Not so smart, since they don’t tell the washing machine to switch on only when the price of power drops to a level you’ve set. One day. maybe, but until then we must just hope that the weather bill for our everlasting summer doesn’t come in next winter.

This is my FT column from last Saturday

There’s an awful lot of iron ore in Australia. South America, too. The problem has been getting it out and shipping it to China, and such was the scale of its building boom that the price went from $25 a tonne in 2004 to $170 in 2010.

BHP, Rio Tinto and Vale grew fat on the profits. The money that was not wasted on empire-building acquisitions went into more production and now the first law of commodities – today’s shortage is tomorrow’s glut – has kicked in. The price is tumbling, and at $82 a tonne, is the lowest in five years.

Goldman Sachs’ Christian Lelong calls it the end of the iron age. The extra production out of Austalia is still cranking up, while the Chinese seem to have enough empty buildings for now, thanks. The miners have destroyed their profitability by overinvesting, as they always do.

It could get a lot worse. Capital Economics is forecasting $70 next year, uncomfortably close to its cost estimates of $50-$60 a tonne for Aussie ore delivered to China. The miners believe that the expensive Chinese mines will close, but this process may be too slow to stop the slide. Ivan Glasenberg, the boss of Glencore, is whistling cheerfully that the commodities supercycle is not dead, if only his competitors would stop ramping up production.

He’s the expert, and he can take comfort from Goldman’s distinctly mixed forecasting record, particularly with shares. In this case, though, Mr Lelong’s analysis looks pretty deadly.

You do what, exactly?

Johnathan Turrall is not a happy bunny. He’s a small entrepreneur frustrated at the behaviour of banks, and he has written to the FT to complain. In his case, Bank A turned him down as a customer because of fears about money laundering. There’s a happy ending, of sorts, in that he admits that Bank B has agreed to run the account for MetaLair, his nascent company.

MetaLair, in case you were wondering, is developing a “double spending proof fully centralised exchange mechanism enabling trustless exchanges between blockchains” [their italics]. Mr Turrall and Sussex University hope it could be the first decentralised cryptocurrency exchange.

Suddenly, you can see why Bank A might be apprehensive. Its money laundering people have probably heard of bitcoins but, like the rest of us, have only the vaguest idea of what they are. They might have read about how convenient bitcoins’ anonymity is for those who dislike audit trails or other forms of inspection of their activities. In short, it’s easy to see why they might not rubber-stamp MetaLair’s application.

This is surely symptomatic of a wider problem for banks dealing with small businesses. Start up a home-made jam business, and describing it to the bank is a piece of cake, so to speak. Explain that you’re developing a decentralised cryptocurrency exchange, and the small business department is already struggling.

Since the significant companies of the future will look more like web-based information businesses than purveyors of specialist foods, this is something of a roadblock to British prosperity and employment.

Bankers working in M&A, watching tech mega-deals being done without them, are learning the hard way that they need to understand this stuff. If the commercial banks really do want to develop the giants of tomorrow, their small business people will too.

Exam question

Here is a Bank of Scotland note. Sir Walter Scott is on the front and the Brig o’Doon on the back. It promises to pay the bearer five pounds, signed by order of the board by Dennis Stevenson as Governor. Candidates are invited to assess this note as a store of value and a medium of exchange, choosing one of the following answers:
a) at parity with Bank of England £5 note
b) at small discount (not acceptable to taxi drivers)
c) at small discount to Reserve Bank of Zimbabwe $1 trillion note
d) none of the above – hold and hope to operate a bear squeeze
Prize for the first correct answer: the Stevenson fiver.
Candidates are reminded that Lord Stevenson of Coddenham was Governor from 2006 to 2009, when he retired following, ahem, a reconstruction.
This is my FT column from Saturday

The last time the FTSE100 Index was at today’s level, St Tony was in Number 10, boring old stocks like Unilever and Diageo were being dumped in favour of exciting new businesses like Freeserve and Dimension Data as the dotcom boom reached its apogee, and War Loan cost £70.

Government stocks were hardly more popular than “old economy” shares, but those who ditched the dotcommers and put their money into long-dated gilts (war loan is about the longest) have had a wonderful time.

They have avoided the heart-stopping plunges of two bear markets, enjoyed a guaranteed income of around 5 per cent and seen their capital gain. Lending to the British government has never been so agreeable.

Forecasting is always hard (especially for the future) but one thing is sure: it won’t be as agreeable over the next 14 years. Treasury 4.25 per cent 2027 yields 2.5 per cent. War loan at £90 yields 4 per cent, to reflect its shrunken relative size and the possibility of repayment at £100 if that suited the UK government.

Far more likely is the prospect of the state issuing much, much more paper, and since it must have the money, it will do so whether the market wants the paper or not. The Labour government was obliged to pay more than 15 per cent for 20-year money in 1976. This cycle turns slowly, but a bear market in gilts is surely the next big move.

The yield on the FTSE100 is 3.4 per cent, and even during the worst financial crisis in much more than 14 years, the total dividend payout of its constituents did not fall. When share prices go down, rising dividends provide a cushion of sorts. When bond prices go down, there’s nothing to ease the pain.

Heathrows go on and on

When the British Airports Authority was privatised in 1987, it was plain to all but those involved that the move turned a public sector monopoly into a private sector one. The then chairman argued with a straight face that there was plenty of competition – from Schipol and Charles de Gaulle airports. It took almost 20 years for the Office of Fair Trading to notice, panicked into referring BAA to the Competition Commission by a takeover bid for the company.

Another eight years on, and few would argue that splitting Gatwick (and Stansted) from Heathrow was a mistake. But for the sheer press of humanity, Heathrow is a much less miserable experience, and maintaining the competitive pressure is surely Gatwick’s best argument for hosting London’s next runway.

It is also Howard Davies’s best argument for ditching Boris’s fantasy island: if built, it would destroy Gatwick and Stansted (Heathrow would close to help pay the £1,000-plus per head of the UK population needed to build it). The old BAA monopoly would be restored, more powerful than ever.

There is something about grands projets which causes common sense to fly from the politicians’ minds. While everyone can agree that investment in infrastructure is a fine thing, finding prospects of sufficient size to make a difference and which are worth doing is hard. Neither HS2 nor the Thames supersewer adds up convincingly.

Crossrail seems like a rare successful example on track to complete inside a (generous) £15bn budget. Its success has raised the pressure to find something else, anything else, to exploit the project management expertise that it has created.  Boris island wasn’t the answer.

Their Cup runneth over

When sorrows come, they come not single spies, but in battalions, as the beleaguered top brass at Tesco have found out. Not only another profit warning and a slashed dividend, but the Carbuncle Cup for its new supermarket at Woolwich.

Still, there’s consolation, of sorts. Tesco cannot possibly win it next year, when the excrescence of Land Securities’ Walkie-Talkie will be finished, and thus eligible for the prize. A fire hazard to those below it on sunny days, its footprint is too small for its ambitions, so it gets fatter as it goes up (and up). If beauty is in the eye of the beholder, this is the ugliest new building I’ve seen since the now-demolished post-war horrors along London Wall.

This is my FT column from Saturday

You are Chris Gibson-Smith, chairman of the London Stock Exchange. Is your top priority a) to ensure a fair fight between buyers and sellers of stock, or b) to look after the interests of shareholders in the companies listed? The LSE is in the middle of a well-flagged, and generally well-received, rights issue to pay for a sensible acquisition – a fine opportunity to show how efficiently capital can be raised on the exchange, at a reasonable cost to the shareholders.
Pricing such issues demonstrates the investment banker’s art. After all, much can happen between the fixing of the price and the moment the shareholders must choose whether to pay up. The LSE’s experts decided that offering three new shares for every 11 was the right proportion, at a price of £12.95 a share.
This ridiculously complex piece of maths raises £963m, to go towards the $2.7bn purchase price of Russell Investments. Unfortunately, not all the proceeds flow to the company. For all that erudite advice, and taking the risk that on September 25, all the shareholders turn the share offer down, the advisers (eight banks plus assorted hangers-on) are charging £25m.
There is a risk, of course, but the new shares are priced at a stonking 30.1 per cent discount to the market price immediately before the announcement on August 22 – this, you will recall, for a fund-raising that had been well signalled beforehand and thus priced-in by the market.

In order for the underwriters to be obliged to take the stock, markets everywhere would have to go into free fall in the next four weeks. If you wanted insurance against such an unlikely event, you could buy it cheaply with FTSE options. Even if shares did collapse far enough to discourage some LSE shareholders, it’s absurdly unlikely that none would subscribe, so the underwriters would be released from at least some of their obligations.

This level of costs, for this level of risk, is commonplace. It’s a blight on the London Stock Exchange, and when the LSE itself fails to take a golden opportunity to do something to break this monstrous cartel, it provides the answer to the question above. Mr Gibson-Smith is retiring after a hugely successful 11 years, but this is not his finest hour.

Dangerous mortgages

Martin Wheatley is having a lovely time at the Financial Conduct Authority. The banks “constantly surprise” him with their capacity for poor behaviour (where has he been?) and almost every day Tracey, his scary-sounding director of enforcement and financial crime, finds someone else to fine.

This week the Royal Bank of Scotland was dunned for £14,474,600 (after the 30 per cent discount for coming quietly) for not selling mortgages properly. Apparently, RBS hadn’t pressed the borrowers on affordability, and some advisers even expressed views on the path of interest rates. Goodness, we can’t have that. Only bankers and financial journalists should be allowed to pontificate on such an important matter. Whatever next: advisers discussing house prices?

It’s a comfort to learn that (so far) these shocking failings have not caused “widespread detriment” to customers. Still, can’t be too careful, and naughty RBS failed to deal with the problems when the FCA’s predecessor regulator first raised them.

Well, the fine should teach them better behaviour, except that RBS is 81 per cent owned by the taxpayer. So one arm of the state is effectively paying £11,724,426 to another.

How the EU works

Alas poor Doresa and Milena, your sojourn in space may be brutally short. These two satellites, part of the European Union’s madcap attempt to duplicate GPS (£4bn and counting up, rather than down) have been dumped in a low trajectory by their Russian-made rocket. From a satellite’s point of view, this is not good news.

The Galileo project, a sort of Common Agricultural Policy in space,  is already six years late, and if it does complete in 2020, as is now planned, will join a crowded field of navigation systems. The UK government sensibly opposed the whole idea, but its criticism became more muted after British firms won much of the work building the system. Wonderful thing, the European Union.

AO World has changed the world of domestic appliance retailing. If your fridge-freezer dies, you can have the new model of your choice installed before the frozen pizzas start to melt. The company is a demonstration of how to marry the internet to state-of-the-art delivery. It’s hardly surprising that investors loved the story, scrambling over themselves to get stock when it came to market in March.

And yet…there are limits to the need for next-day delivery of cookers or washing machines, and a brilliant analysis by Shore Capital suggests AO is well over them. Michael Stewart calculates that if the company eventually sold every single domestic appliance bought in Britain, the shares at 267p would still cost 22 times earnings. But this is one tough market. As he puts it: “The consumer has limited brand loyalty, price competition is incredibly high and demand is elastic.”

Unfortunately for the bulls, this is just the half of it. The other half is the sort of product insurance that the banks used to add to their loans until they admitted mis-selling and paid £15bn in compensation  (and counting). AO doesn’t break out its profits from product protection, so Mr Stewart has tried to do it for us. He notes that AO has 150 people in a call centre devoted to selling protection, and his back of the envelope calculation says they generated one-third of the company’s latest profits.

Such point-of-sale insurance is almost always bad value. Accusations of mis-selling are never far away and appliances break down so rarely. AO has amitions to take its impressive business model across the Channel, but others like Amazon have similar ideas and depper pockets. The investors who failed to get any shares at 285p in the float can have as many as they like at 267p now, but it’s easy to see why they aren’t rushing in.

Balls up for CGT changes

If you don’t like the capital gains tax regime, then don’t worry. There will be another one along if you’re patient. This tricky tax has been a playground for chancellors ever since it was introduced half a century ago, and finding a fair, stable system has eluded them all.

It makes sense to tax short-term gains as income, since one looks much like the other. But last weekend my colleague John Lee reported how he will pay 28 per cent on the gain from his 40-year investment in Pochin’s (his saga reads like a financial version of Apollo 13 – successful lift-off, near-disaster, and an improvised rescue). This is less a tax on a gain than a capital levy through inflation, and is manifestly unfair.

The previous CGT regime had allowed for this, tapering the tax to reflect the time the investment was held. When one private equity boss pointed out that this meant he was paying a lower rate of tax than his cleaner, the government panicked. Rather than simply strecthing the taper to make things fairer, it imposed the current regime.

Now Labour, casting about for something which sounds business-friendly, is is looking at the subject again. The shadow chancellor likes the idea of long-term investment, so if he gets the chance, might bring back the previous regime – a Labour government design, after all – which cut the tax on long-term gains. Besides, get-rich-quick invites taxation, while get-rich-slow suggests building something of lasting value.

Let’s be more refined

Diesel should be cheaper than petrol, but it’s years since it was, thanks to the rise of diesel cars and oil refineries set up to maximise petrol output decades ago. Refining is a grim, almost profitless business, thanks to the shale boom and ban on crude exports from the US, so it was a surprise this week to see ExxonMobil preparing to spend $1bn beefing up its plant in Antwerp to produce more diesel.

As refineries close across the continent, Exxon plans to be (almost) the last man standing. Antwerp will also help its other plants across Europe stay open by taking their heavy fractions. It’s a real, long-term investment. Don’t expect Esso’s diesel to get any cheaper, but at least that irritating price premium should eventually disappear.

This is my FT column from Saturday

Tempted by the latest IPO? Then lie down until the feeling goes away. London’s new issues market is in danger of becoming a racket. Prospectuses are frequently published only after conditional dealings have started; banks or brokers whose analysts might be expected to take a robust view are brought on board, thus silencing criticism, while any prospective investor asking awkward questions risks being cut out of the issue.

The process has become less transparent, not more. Competition was supposed to drive down fees, but the evidence shows the opposite, and in some recent IPOs a significant portion of the flotation proceeds has gone to the advisers. One finance director who negotiated a lower price from bank A was asked by bank B to accept the tariff in return for better terms on some future deal. Some of the real clunkers can only have got away by those in charge warning potential buyers that they might not see the next (better) offer.

So who are the villains of this particular piece? Not all private equity companies have behaved badly, but a disconcerting number of the real dogs at flotation have been done over by the PE boys. They are overstocked with businesses they expected to sell years ago, before the bear market got in the way. Some of those businesses have been sold to other private buyers en route, with equity replaced by debt at each transaction.

Nobody is forced to buy new issues. Anyone tempted to do so should ensure that there’s a published prospectus, and that the business has been trading in its current shape for more than just a year or two. Then look at who’s selling in the offer. Ignoring this market completely may mean you miss the odd nugget, but it saves sifting through all that low-grade ore.

Pricey floorcovering

It’s hardly surprising that Philip Harris is reluctant to give up the carpet business. The 71-year-old knows almost nothing else, and this week rescinded his earlier proposal to leave the chair at Carpetright, arguing that 71 no longer looks old to him.

The puzzle, though, is why so many outside shareholders (his family owns a fifth of the stock) are also clinging on. Carpetright is nothing like as successful as Lord Harris’s previous venture, Harris Queensway, which made his fortune. Carpetright sales hit £475m in 2007, when EY (as it’s now called) made him entrepreneur of the year, and it’s been increasingly threadbare ever since.

The last dividend was more than three years ago, and there’s red ink all over the accounts. Yet the shares refuse to reflect this depressed reality, and actually perked up on this week’s horrid trading news. At 511p Carpetright is valued at £346m, but last year’s £448m of sales yielded just 4.7p of “underlying” earnings per share. If the housing market is picking up, it hasn’t picked up Carpetright’s carpets.

When EY was giving Lord Harris his award, earnings hit 46p a share, supporting a 33.9p dividend. Perhaps the company’s exciting new luxury vinyl tiles and lovely soft polyprop carpets will bring those days back, but it’s a distant prospect, and time is not on Lord Harris’s side, however young he feels.

Joy for jobsworths

Ooh, goody, a brand new boondoggle. The Chinese are prepared to lob in a spare $100bn as starting capital for “a new global financial institution“, and 22 other countries with too much money want to join the proposed Asian Infrastructure Investment Bank.

The first aim is to finance a rail link from Beijing to Baghdad (a sort of iron silk road) but the real attraction is to found an institution which isn ‘t controlled by the smug western bankers and bureaucrats who dictate policy at the World Bank and International Monetary Fund.

These boondoggles are easy to start, quickly sprouting their own secretariats, conferences and cushy jobs for cronies of the founding governments. The Paris-based OECD shows that stopping them is another matter. It sails on long after performing any useful function, as does the United Nations Industrial Development Organisation, or UNIDO, to which the only response is: Oh no we don’t.

This is my FT column

Q. How do you attract the attention of a Missouri mule? A. Hit it briskly over the head with a length of 4×2 planking. Last week saw the simultaneous publication of two indices of inflation, pointing in opposite directions. The second question might be: which measure do you think the Bank of England’s Monetary Policy Committee prefers?

The Consumer Prices Index is up by a barely-discernible 1.5 per cent in a year, while the Central Statistical Office’s measure of house prices is 9.9 per cent higher. The divergence is not new, but it’s horribly large and persistent. Other house price measures tell much the same story: if you live in the south east and own a house, you’ll be feeling clever and slightly smug. Own one in London, and you’ll be insufferable (up 18.7 per cent).

The Governor of the Bank of England could  impose a 21st century version of hire purchase controls, to limit the numbers of high loan-to-value mortgages  that a bank can offer, but it’s likely to be even less effective than they were. Moreover, in his brief tenure he’s proved anew that forecasting is always difficult, especially for the future. After indicating unchanged interest rates for years to come, he ignored rapidly falling unemployment when it didn’t fit his projections. Now, belatedly, he’s suggesting that rates may rise in the autumn.

To which the only response is: get on with it. Today’s near-zero Bank Rate was set five years ago when we seemed to be on the brink of the economic abyss. Now we’re in an old-fashioned asset boom for shares, art, collectables and, of course, property. The CPI may indeed stay stuck for a year or two, especially if there’s a full-blown price war in the supermarkets, but cheap food hardly helps when buying a home anywhere near the jobs is beyond so many people.

As last week’s contrasting figures show, the MPC is not paying attention. The boss may be from Alberta rather than Missouri, but he still appears to need the application of the equivalent of a 4×2 plank.

Free the 90 per cent

Over 700 militant free-marketeers occupied Guildhall last Wednesday, to boost the Thatcher-inspired Centre for Policy Studies’ attempt to free the workers (sic). Its chairman, Maurice Saatchi, had a simple message (he specialises in simple messages): abolish corporation tax for small companies, and capital gains tax for their shareholders.

As any fule know, this is shockingly expensive, costing £10.5bn next year, according to the CPS. Ah, but the jolt such radicalism would give the economy means that by 2018/19, the liberated labourers in soaraway small companies would have paid so much more tax that the exchequer is actually better off.

The timescale may be heroic, but releasing small companies (90 per cent of the total, defined in the Companies Act as those with fewer than 50 employees) from corporation tax would undoubtably boost their expansion. A CPS survey found that big companies are almost as unpopular as big government, and the measure would have the agreeable side-effect of allowing the taxman to focus on avoidance at the multi-nationals. Release the very smallest companies from the quagmire of employment legislation as well, and this could be a winner.

Crowded out

When both buyers and sellers think they’re getting a rotten deal, it’s a sure sign of a deeper malaise. So it is in banking, where depositors get little or nothing, and business borrowers are either refused or charged ruinous rates.

Banks are supposed to match those with cash to those wanting it, but reserve requirements, high fixed costs and an inability to judge the borrowers’ credit are combining to produce this market failure. Into the gap is, increasingly, stepping peer-to-peer lending and last week Santander, one of those big banks, clinched a partnership with Funding Circle, a P2P website.

Zopa, which claims to be Britain’s biggest, has now lent over £500m, while newcomer Archover is a “crowdlender” which believes it can survive on a gross margin of just 1 per cent. The banks never really liked lending to small businesses because it was too much trouble to understand them. If this trend continues, they won’t have to.

This is my FT column from Saturday

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