Scent of light

There are many tasty dishes that are simple to prepare. However, the ingredients are extremely important, as is the correct combination of them. The same applies to the stock markets. Below are the ingredients for a tasty and healthy dish. With few calories and potentially some capital gains.

1/4 of dramatic geopolitical event whose peak has passed

1/4 of nice strong inflation, from transient factors

1/4 clap of solid consumer savings and a pipeline of strong infrastructure investment

1/4 interest rates normalising and a robust financial system

Supportive governments, as much as required.

Mix everything well, no rush. Dramatically increase lower wages before baking.

Take care to burst any “growth” bubbles that arise during baking.

Serve with depressed traditional market valuations, on a bed of fresh recession and stagflation fears.

It should be doused with something sparkling and young, like post-pandemic, vintage 2020 or 2021 spending appetite.

Taste possibly after Macron’s victory and before the dividend wave coming in May.

Enjoy.

CardYes, CardNo

An experienced friend of mine has expressed his perplexity about Nexi’s performance. After reaching €18 per share, the stock has halved in a few months, with constant and worrying weakness. Anyone who knows the market well, knows that prolonged phases of weakness can hide serious problems, and so he wondered if there might be something rotten in the stock.

Intrigued, we took a look at the company. An in-depth analysis would require more time, particularly on a sector that is extremely popular with the market and as such, ignored by us.

What emerges from our initial analysis is that:

1) The weakness of the stock seems to reflect the weakness of the sector. Below is the chart showing Nexi, Worldline, Adyen and Paypal at one year. Adyen and Paypal belong to a different league in terms of quality, but we see that they too have been subject to strong derating.

2) At the beginning of the year, the company was showing a considerable premium to its direct peers as seen below. Today the premium has partially reduced.

3) Nexi has a number of expiring lock-ups ahead of it which could create a substantial sales flow over the next 12 months. Below is a mirror showing that 136m shares in lock-up have already been released since January.

4) The company’s guidance released in conjunction with its Q4 results indicates that it is struggling to meet its targets, which in turn perhaps indicates an increase in competitiveness in the sector.  Below are the changes in EPS estimates for 2022 and 2023 in recent months. Couple this with valuations that at the start of the year reflected a lot of positivity about growth and substantial, though to date unceremonious, debt, and you can understand why some have reduced exposure

Today the company is worth around 10x 2023 EBITDA (EV/EBITDA) in line with its direct peers (companies like Adyen and PayPal have different characteristics and deserve premium valuations over Nexi). The valuation of the stock and the sector cannot be considered expensive today and its rerating or derating will be linked to whether or not earnings growth is confirmed. Given the assumption that digital transactions increase earnings growth will depend in the short term on competitive pressures in the sector and, a little further down the line, on any risks from technological change. As in all bubbles, first comes the massive and seemingly incomprehensible derating and then, gradually, the problems emerge. We believe that stocks related to bubble issues should be treated with great caution because the adjustment process usually takes years, not months. The same optimism that creates bubbles then leads to a glut of players, acquisitions made at optimistic prices, regulatory attention and stimulus for technological change. And it often goes from being shamefully expensive to shamefully cheap.

CardYes, CardNo(2)

We country managers find the digital payments sector quite complex. There are so many players and roles. Issuer, acquirer, gateway, processor… Only apparently there are large unassailable players. In reality, excluding issuers (VISA and etc) the other roles are vulnerable. An example comes from the small Adyen that in a few years has become a colossus, a cut above the rest, thanks to a faster and more efficient software and an intelligent strategy.

Then there is another problem. And this also concerns issuers. The future of payments is not necessarily tied to the debit/credit card circuit. Merchants do not like interconnection costs and technology is improving. ACH (automated clearing house) and BNPL (Buy Now Pay Later) models are interesting alternatives with some shortcomings. Blockchain circuits such as cryptocurrencies could also be an alternative, although they also present some problems, of cost and speed. However, things could change quickly.

In conclusion, we are not sure that securities such as VISA or Adyen itself, leaders in their respective markets, deserve extremely generous valuations as they do today, given the many risks in the sector.

Goodbye plush toys?

We grew up with the idea that the democratic world was well organised. Entrusted to capable and responsible men and institutions. Balanced and fair. That governance was fair and well defined. But this is not the case. The level of incompetence, ignorance, inefficiency and dishonesty is staggering. Many of the international institutions that claim so much credibility are in fact inept and useless hulks, at the mercy of economic and political interests. In such a context, it is not surprising that organised greed in the form of corporations/businesses prevails, controlling the ganglia of power and the very lives of billions of people.

The only glimmer of light for today’s democracy is to analyse its alternative: autocracy. This renders the current defects of democracies meaningless, however imperfect, is the only adequate organisational form. It must be improved to make it sustainable. A democracy that does not represent the demands of the majority of citizens, inevitably leads to nationalistic regurgitation. We have seen this recently in the USA, as well as in Europe and elsewhere. Economists such as Stiglitz, Krugman and Korten, who saw risks to democracy in an excessively savage capitalism, have often been sidelined. Today they are being re-read and reappraised.

It cannot be denied that globalisation has had positive effects. Thanks to it, much of the poverty in emerging countries has been eradicated (see graph above) and the average age of life has risen considerably. However, its exaggeration has had a cost for the West that is now proving excessive, particularly for the weakest and most numerous, as can be seen in the two graphs above. This cost has risked plunging the West into the darkness of autocracy. To open a long period of stalemate in the path of progress, like the Middle Ages. However, Covid and the Ukrainian invasion have opened a new phase. A necessary and inevitable phase of deglobalisation. It will bring manufacturing, investment and jobs back to the West. The losers will be the autocracies in the emerging countries, the large Western corporations that sell (and produce) in the emerging countries, and the large and small traders who profit greatly from the fat margins associated with imports from the emerging countries. Europe, like the US, has allocated large funds to help emerging countries, for their economic and democratic development. The opportunities for Western corporations will have to go hand in hand with the democratic development of the countries where they invest.

In November 2019, the book “Meeting Globalization’s Challenges”, a collection of pieces by distinguished economists on the topic of globalization, was published. The introduction was left to Christine Lagarde, then General Director of the IMF, one of the most influential and most criticised international institutions. It is precisely her introduction that is a sweetened re-presentation of the narrative offered in the 1990s and early 2000s about the goodness of globalisation. There are several references to papers of dubious quality and transparency showing that globalisation does not lead to job losses in the West. More transparent, however, but highly questionable, is the description of how re-training and social safety nets would protect the weakest in the West from globalisation. While admitting several errors, Lagarde, inevitably, still in 2019 defended the IMF position, written by the US years under the dictation of big corporations, the primary beneficiaries of globalisation. We know that propaganda does not only exist in Russia.

One of the pieces in the book belongs to Nobel laureate Paul Krugman, one of the exponents of sustainable capitalism. Here the economist acknowledges his mistake when, in the 1990s, he supported the process of globalisation, defending it against the accusations of those who said it would increase social inequality and impoverish the West. In fact, globalisation soon turned into what some economists dubbed ‘hyperglobalisation‘, responsible between 1998 and 2005 for the loss of 10% of the manufacturing workforce in the West, over 10 million people. This number has continued to rise until today, with damage to the social fabric of the West and its supply chain.

Political Europe today is finally united. The atrocities in Ukraine and, before that, China’s lack of transparency linked to Covid, have shaken public opinion and politics. Corporations are also realising that the pursuit of short-term profits can create major problems in the long run. Today there is total alignment. Hyperglobalisation is over and we are moving towards a path of substantial domestic investment, which will create jobs and support wage developments and purchasing power. Some corporations will suffer, but then they will regain in the West some of the growth they have lost in emerging countries. Countries like China, India and the Middle East, which have implicitly approved of the massacres and violation of sovereign territory in Ukraine, will be affected by this shift in perspective.

Today, Europe has a trade deficit with China of over USD 300 billion.  These are not just useless teddy bears or acrylic blouses, but much of it is advanced machinery (see graph on the right). Much of this will have to be produced in the West in future.

The lights of the Renaissance now seem to prevail over the shadows of the Middle Ages. If this is the case, we can look forward to years of good growth in Europe, the reabsorption of debt accumulated during the Covid era, fiscal and political union. On the other hand, we should say goodbye to disposable T-shirts and plush toys. With significant benefits for the environment.

Optical illusions

A lot works sinusoidally. We would say everything, when there are human beings involved. The market teaches us this on a daily basis. Last weekend the hope for a ceasefire in Ukraine seemed to grow. This weekend it seems to be shrinking. Fears, albeit remote, of Russian use of tactical nuclear warheads or chemical weapons are re-emerging in the newspapers. The success of the Ukrainian army is being questioned. Putin’s determination to continue the war, as he himself stated during the recent pro-war demonstration in Moscow, seems certain. The willingness of the Chinese to support the Russians, veiled by Xi in his video call with Biden on Friday, seems dangerous.

In reality this is not the case.

Pere Borrell del Caso – Escaping Criticism, 1874. Oil on canvas. Collection Banco de España, Madrid

What we see today is a tug-of-war in view of an agreement that is just a few lines away from being signed. Putin needs to save face. Russia demands the neutrality of Ukraine (a huge step backwards from the “denazification and demilitarisation of the country”), the recognition of Crimea as part of Russia and the recognition of the two regions of Luhansk and Donetsk as independent states. Ukraine accepts neutrality, but does not recognise the expropriation of Crimea or the independence of the two republics. Moreover, expropriation by force can never be accepted as a matter of international principle. Moreover, thousands of lives would have been sacrificed for nothing. So an agreement on the independence of the Crimea (which its population would approve in a referendum, as has happened in many countries in the past) and a form of boosted autonomy for the two republics is likely. Finally, war damage. Here the tug-of-war is tight, but they will be granted against a relaxation of sanctions. We believe that Russia cannot politically afford to continue the war to the bitter end. That is why it is important to make it look like it can, to have more strength in the negotiations. Moreover, the conquest of Mariupol and thus of access to the sea from Crimea to Russia is crucial. Its return can be bargaining material at the agreement table. As for China, it does not want to weaken Putin’s position now that he is negotiating. But it certainly exerts pressure for a cessation of hostilities. China absolutely must avoid being cut off from the West, a West that already seems inclined to do so (see previous article). The confirmed news that China has denied spare parts for aircraft to Russia goes in this direction. The market relief offered on Thursday by the Chinese government expresses strong unease and growing concern.

We cannot say how long it will take but we believe a ceasefire is close. And the last days before the ceasefire will be the days when Russian forces launch their last and fiercest attack. This phase has already begun.

Putin will save face. He will probably sell the war damage to be paid as aid for the friendly country devastated by Nato pressure. However, gradually the truth will come out. In the meantime the Russian population will be dramatically affected, even though many of the sanctions will be lifted in the coming months. This could lead within a couple of years to Putin’s departure, not unlike the departure in 1999 of Boris Yeltsin. A departure apparently voluntary, but in reality obligatory. This should mark the beginning of recovery for this huge country and its unfortunate population, which has not benefited from global growth for the past 25 years. The graph opposite shows the GDP growth of China and Russia over this period.

As for the recession that many expect, we believe it is very unlikely. If you watch TV you can see the damage to the economy in European countries. The media creates a lot of anxiety. This damages aggregate demand. However, we can’t help but notice how the removal of covid restrictions leads people to go out and spend. Spring has started and this trend will increase. Temperatures are rising and the price of natural gas will fall. Oil supply remains plentiful, its price reflecting speculation. Finally, in the wake of this anxiety, which also grips institutions as always, new fiscal policies will be implemented and will manifest their benefits well after the end of the war. The only (apparently) positive thing circulating is that ECB rates will not rise. Here too we disagree. Rates will go up soon, fortunately.

Ultimately, we believe that any downturn in the market can be a good opportunity to increase exposure to equity, particularly the value component, which is the most affected in this phase as it is generally more linked to economic growth. This is always within the framework of a balanced allocation, which takes due account of the risk profile of the product/investor and respects diversification, which must always be significant.

Dear Mr Cheicheiar,

Dear Mr Cheicheiar,

I’m a 10-year-old boy. When I was born, my grandfather gave me some of his Telecom Italia shares. Savings shares which, my grandfather told me, always give a dividend that could help me pay for my studies one day. But I would like to buy a PlayStation.

Grandpa bought them almost 20 years ago for his old age, but when he told me about it he made a strange expression.

I don’t know much about stocks, but I like them. Dad is crazy about them and spends his Sundays reading the financial papers. Mother doesn’t seem happy. She’d rather go to Ikea or Zara.

Dad told me that the shares Grandpa gave me are no good. He says Grandpa is old and doesn’t understand much about stocks. Dad says that Grandpa’s shares have gone down so much and that I’d better sell them and buy apple. This made me very sad. Also because it seems that what I have left is not enough to buy a PlayStation.

Grandpa says the company makes us talk on the phone. With Mum, Auntie Ginetta, and Auntie Assuntina. And it also lets us watch Disneyplus, which I really like. All this, Grandpa says, for the monthly cost of a lunch at the deli down the street. I really like the stuffed peppers they make there.

I think that’s good. Talking to the aunts and watching Disneyplus all you want for the monthly cost of stuffed peppers, ice cream and a barley water drink sounds good to me. Dad replies that Tim doesn’t make money at these prices though, but they can’t raise them because of Mr. Regulator. I didn’t quite understand who he is, but I think he’s a bad guy, because he punishes good companies.

Dad says that the only ones who make money are the bosses at Tim. They stay for a short time and make millions. I wish daddy was the boss of Tim.

Daddy then says that you, Mr Cheicheiar, want to buy Tim by paying much more than it’s worth now. So much so that I’d get the money for the PlayStation. I’m not sure why you’re doing this, but I’m glad. It’s good.

At the same time, the current boss of Tim, Mr Alessio, and his friends who run the board with him, say that the company is worth almost five times what it is now and almost three times what you offered, Mr Cheicheiar. But if it’s worth so much, why is it that if I sell it I can’t even buy a PlayStation for it? I don’t really understand the difference between price and value. For the PlayStation, the two values seem to coincide.

I asked Dad why anyone would say the bid is low even if it’s twice the price I can sell the stock for today. He didn’t answer me.

Grandpa then told me yesterday that the boss of Tim decided not to pay a dividend to my savings shares otherwise he would pay tax on them. Apart from the fact that Grandpa says that paying taxes is the right thing to do in order to keep hospitals and the police functioning, I wonder if the head of Tim is lowering his salary in order not to pay taxes. Of course this gentleman is strange. Even stranger than Mr. Regulator.

I, Mr Cheicheiar, would be very happy if you bought Tim and made a lot of money. I’d still be talking to my aunts who I love. And I would buy a PlayStation.

Sincerely

Ukraine and China

Edvard Munch “Anxiety” (1894)

As the bombings tear apart Ukrainian cities, the media tammy continues, creating anxiety and volatility. We believe the market is now afraid of two events. The first is an extension of the conflict to NATO. The second is that sanctions will be extended to China, which is guilty of helping Russia. In the first case, talking about asset allocation does not make much sense, whereas it would make sense to start making arrangements to move to the mountains or the cellar. In the second case, recession would be certain. As we have already said, although mistakes are always possible, we believe the first scenario to be very unlikely because of the consequences it would bring. We also believe the second scenario, which would see a China with negative economic growth that would in turn bring risks to the stability of the Chinese regime, is unlikely. In China, citizens give up democracy in exchange for the journey to prosperity. Today, however, wealth is concentrated on a minority and it is Xi Jinping’s goal to redistribute it. A recession would weigh on the weakest (who are also the most numerous and the most angry).

If the likelihood of the two events recedes over time, we believe the market can slowly return to normal. Oil and gas will gradually fall and so will commodities. And equities, particularly value stocks, would recover. Even if the conflict were to become chronic.

If there is a credible ceasefire in the near future, the readjustment would be rapid. But we realise that a certain amount of optimism is required to assume this, an element that we do not lack today…

Cybersecurity and paranoia

Our IT has decided that a Russian-originated cyber attack is imminent and that we must further strengthen our security. This is the slightly paranoid air that now circulates in the environment and we, although hesitant, comply. The damage, though remote, would be too great otherwise. We would not be surprised if tobacconists and perfume shops started installing cybersecurity programmes and processes.

Atos, an IT consultancy that we have mentioned several times and which is going through a difficult transition phase (it recently came out with yet another profit warning), has a division called BDS. The acronym stands for big data and cybersecurity. This division is considered one of the leaders in cybersecurity and is clearly the first choice of the thousands of customers of Atos’s other divisions. The BDS division has sales of around 1.5bn EUR and has been valued at 3 to 4bn EUR. It recently received an initial bid from Thales of 2.7bn EUR, which was rejected.

We value the BDS division on the basis of what THALES offered. If we also value the Atos infrastructure division at 50% of where the market is (i.e. only 0.1x sales), the digitalisation division at a 40% discount to where the market is (i.e. 1x sales) and subtract the modest debt, the stock would be worth around €60 per share. With cautious assumptions. Today it is worth only 25. If you want to invest in the growing fear of cyber war, poor, scrappy Atos seems to be the quality value player with one of the most attractive risk/benefit profiles on a global basis.

Europe, now or never

A different world

Party over?

Grey gold

Ignorant options

Fëdor de guerra

The year of the orange blossoms