Thursday 22 March 2018

Market jitters as China tries to pull off a soft landing

Chinese president Xi Jinping wants the renminbi to become a global reserve currency
Chinese president Xi Jinping wants the renminbi to become a global reserve currency
Richard Curran

Richard Curran

Can the Communist Party of China, rulers of the world's second-largest economy, engineer what Fianna Fail couldn't - the proverbial soft landing?

News of a 2pc devaluation of the Chinese yuan during the week sent shock waves through global currency and stock markets. The Chinese stock market has already seen significant share price falls, which have had to be stemmed through direct intervention.

The economy is still growing - but not as quickly as it was. That slowdown created fears of a stock market and property bubble. Some investors began to worry that China was about to take a "great leap backward".

As the world's second-largest economy, its fortunes have a very wide global reach. The sudden 2pc devaluation in the currency temporarily raised more concerns that an even bigger drop was on the way.

However, the reality is more complicated than that - and it may not be such bad news. In 2008, in the wake of the financial crisis, the Chinese devalued their currency, which made their goods cheaper in markets such as the US, at a time when the American economy was struggling. Uncle Sam was not pleased, and there has been much criticism that China has been artificially keeping its currency low in recent years.

Now the US economy is growing and the Chinese economy is slowing down. All the Chinese did during the week was yield to a little bit of market pressure and let the currency drift down by just over 2pc.

That makes their goods cheaper in America, which could dampen US exports. We may have seen the share prices of companies such as Burberry fall by 3.5pc during the week, because it won't sell as many handbags in China, but the real economic action is farther afield.

The Chinese move will dampen the chances of the US opting to increase interest rates in the coming months. The rationale is that slower US growth caused by a cheaper yuan would reduce the Fed's ability or need to raise interest rates in the short-term.

The Chinese want their currency to be used more widely and take its place on a global stage (see Alan Duffy, below). They realise that will entail letting the currency find its own market level more freely. Last week's devaluation was a toe in the water that has given the Chinese a little bit of a competitive edge while not yielding to full market pressures.

China is becoming a victim of its own success. The cost of doing business there is rising, which is affecting economic growth.

Irish consumers could benefit slightly given the amount of stuff we buy from China, from toys in Smyths to electronic gadgets. Meanwhile, Irish exports to China are relatively small, but we have high hopes, especially in the food area.

As long as Chinese household incomes keep rising, that potential will remain. The real danger is that the Chinese economy is actually slowing down more rapidly than we realise, and the Chinese government knows something that global markets don't.

A sudden crisis in China would have wider implications, holding back growth in the global economy, and would seriously affect an exporting economy like ours.

The question is, do you have confidence that Xi Jinping and the boys - unlike Bertie Ahern and Brian Cowen - can avoid turning a boom into a bust?

Capvest may have to dig deeper to get One51

It certainly looks like game on at One51. The timing of Capvest's takeover approach for the company was particularly interesting. It comes as One51's balance sheet is being bolstered by a €50m to €60m cash dividend from its investment in NTR, and after it just completed the acquisition of a majority stake in a plastics business in Canada.

The Canadian deal was described by One51 management as "transformative", and investors put in €22m in new equity just last autumn.

One question now is whether Capvest is attracted to both parts of One51's business mix.

Management at One51 have completely streamlined the business in recent years, selling off assets and paring back its sprawling boomtime portfolio to two divisions - environmental services and plastics.

As a private equity firm, Capvest could see potential in both divisions - or it could see value in a break-up. The approach for One51 has been friendly so far, with little sign of things going hostile.

But it isn't easy to manage a friendly takeover of a company with such a huge shareholder base. Lots of people in different circumstances need convincing.

No shareholder has more than 10pc. The share register at One51 is extremely varied, with older co-op investors sitting on losses from massively-priced share placings during the boom. In October 2007, One51 raised equity at €5 per share. Last September it raised money at 90c.

Some of the shareholders nursing losses may be happy to take a cheque at €1.80 or a little higher at €1.95. Other individual investors who bought in at lower levels - including Larry Goodman, Lochlann Quinn and Dermot Desmond - might be tempted by an offer at these prices.

It might be easier for them to sell their shares to Capvest if they have bought in a much lower average price. But others might feel like sticking it out for the long haul, given that the group has been through the pain and has now finally got its house in order.

The trade in One51 shares last week (where 19.6 million were sold at €1.85 in two tranches) suggests there will be pressure on Capvest to go higher.

Capvest doesn't look like getting a deal that will get majority ownership over the line at €1.80. The question is, how high might it have to go? And is it prepared to do that?

Of course, the bidder doesn't have to get 100pc or even 80pc acceptances, because One51 is not a listed company. In fact, Capvest has signalled that it would be quite happy to have a number of existing shareholders remain on board.

The approach values the business at around €280m, or eight times earnings before interest. It's a pretty good valuation. But that doesn't appear to allow for any of the real growth potential from the Canadian plastics business, which practically doubles the size of that division and presents some solid opportunities in North America.

One51 grew its revenues last year by €26m to €276m prior to acquiring the Canadian operation. It has modest borrowings and is finally poised for real growth after years of mopping-up operations.

Don't rule out Seamus Fitzpatrick's Capvest getting it in the end - but a lot of One51 shareholders will want to make him pay for it.

It's Gubu time for Nama bonds and Irish banks

Nama and the aftermath of the banking crisis took a Gubu-style turn during the week when it emerged that Michael Noonan has written to the property agency, suggesting it pay more in interest on bonds held by Irish banks than is allowed for in their contract.

Irish banks hold around €10.8bn in these Nama bonds, and the state agency pays an annual coupon equal to the six-month Euribor rate. That is what it says in the contract. But the Euribor rate now looks like heading into negative territory. It is currently only 0.46pc.

Noonan is worried that if it turns negative (which means the banks would pay Nama), the bonds will no longer be acceptable as collateral with the ECB. This in turn could create problems for Irish banks, who Noonan wants to see lend more money into the economy.

So, post-banking crisis logic says keep paying out interest on the bonds, even though it isn't in the contract, just for the wider good of the banking sector.

And are the banks applying the same logic to their cash-strapped customers?

Not exactly. Imagine if they slashed interest rates beyond what they were obliged to in loan contracts because it would be best for the economy as a whole.

Nama paid out around €85m last year on other subordinated bonds that are linked to the overall financial performance of the state agency.

The banks are collecting if Nama does well, and if money markets go in Nama's favour, the banks are going to collect anyway.

The sums of money are relatively small on these bonds. If the six-month Euribor stayed at 0.46pc, the payout would be around €60m.

If it hit negative territory, that should save Nama more than €60m in a year.

In the context of Nama's scale, it doesn't seem like a lot of money.

In the context of running public services or building badly needed social housing, €60m is not to be sniffed at.

It does feel as if banks are on a win-win, just as bank bondholders were in the crash.

Unfortunately, the fortunes of the State and the banks are still inextricably linked in a relationship that is more damaging to the taxpayer than to the banker.

Sunday Indo Business

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