4th August 2009
A summer update on some of our favourite stories
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Welcome back - I trust that most of you are now enjoying a well-deserved summer break so rather than launch into a brand new trade, I'm going to update you on some significant events in three of our ongoing trades, or situations we are monitoring.
Tier 1 securities a good week for Barclays and HSBC
This week is crucial for our tier 1 banking securities, as all the major UK banks report their first half earnings, which could have a big effect on them. The chances of a major bank being nationalised now seem pretty remote, which is a very positive development for the tier 1 securities in the event of nationalisation, tier 1 holders could expect significant losses, or even be wiped out.
If results for the banking sector are good, then it's quite possible that while share prices could react immediately, the tier 1 could lag. This could create the opportunity to purchase some high-yielding tier 1 securities after the issuer has announced its results.
It's only the start of the week, but so far, the news has been positive. Barclays and HSBC reported strong results yesterday. Barclays' results in particular were stunning, with profits up 10% on last year, mainly down to its investment banking division, Barclays Capital. First half profit came in at £1.89bn, of which £1.05bn was down to the BarCap unit.
Impairment and other provisions came in at £469m. Most important of all, the bank cut its leverage to 22 times capital from 32 times last year. Its tier 1 capital ratio (an important measure of a bank's financial strength) will rise to 8.8% from 5.6% at the end of last year, after the sale of its Barclays Global Investors unit to BlackRock is completed.
HSBC was a similar story. Net income came in at $3.35bn after setting aside $14bn for provisions against bad loans. Investment banking here provided a $6.3bn boost to operating profit.
Why I'm optimistic on Lloyds and RBS too
Lloyds will report tomorrow, and RBS on Friday. As you know, Lloyds and RBS are the sickest of the lot, so they'll be under a lot of pressure to report a set of good numbers to show that the bailout they received is starting to work. I'm quite bullish on those two banks, because the government already insured most of their dodgy loan books for a fee a few months ago, so I don't think they will be required to take further write downs that lead to losses. If you add in the fact that the interest rate margin (that's the difference between the interest paid to depositors and that charged to borrowers) is at its widest in years, boosting profits, then the picture could be quite positive.
Lloyds could also benefit from a factor that people seem to have forgotten. The mortgage market is far less competitive than two years ago, and this also means higher margins for the banks. The credit crunch has forced all of the most aggressive competitors (Northern Rock and Bradford & Bingley) out of the market.
Over in the US, Goldman Sachs, JP Morgan and Morgan Stanley in the investment banking sector, have already demonstrated just how profitable the death and retrenchment of their rivals has been for them.
RBS is more exposed to international banking and commercial lending so it could feel the benefit of the recent rebound in the pound's value and the renewed appetite for risk which has caused the prices of more risky loans (of which RBS has plenty) to climb. RBS is also more exposed to investment banking, and the same factors that applied to Barclays and HSBC could also benefit RBS, which could be the biggest surprise of the lot.
Next week, after the dust has settled and we know all the results, I will suggest a few more Tier 1 securities that I believe represent good value in terms of risk / reward.
What's happening to General Motors and the Motors Liquidation Company?
As you probably know, a couple of weeks ago I was puzzled by the statement posted on the website of Motors Liquidation Company (the old GM) saying that "none of the publicly-owned stock or bonds issued by the former GM are or will become securities of the new GM". So I decided to call the company to ask for clarification on this statement plus a couple more things.
This follows a summary of my chat with the investor relations.
1) I asked her why in the restructuring plan it was clearly stated that unsecured bondholders would receive 10% of the new GM plus 15% in warrants, yet now their website seemed to have a contradictory statement saying that any old GM securities will not be converted in new GM stock.
She confirmed that the original plan is correct, and that she would look into the statement posted on the website and see if it needs amending. The unsecured bondholders will eventually receive a form that will allow them to convert their holdings into securities of the new GM later on, when the restructuring process is more advanced.
2) I asked her if she could give me more information on the terms of the warrants.
She replied saying that nothing has been decided yet and that the terms will be decided by the restructuring plan once it is approved.
3) I asked her if there's any possibility that the remnants of the old GM could be worth less than 0; and if that is the case, then could the payment to the bondholders be less than the 10% plus warrants?
She could not answer my question. But this point is not as far fetched as it might sound, as sometimes the legacy costs connected with a struggling business exceed the value of the assets. For example, Rover was sold the Phoenix consortium by BMW for -£400m (ie BMW gave £400m in loans and financial commitments to the buyers just to get rid of the company).
So the unsecured bondholders will be entitled to receive 10% plus warrants in the new GM as expected. Meanwhile, the restructuring process is still in its infancy and has not yet decided much, so everything is still in play.
Until something clearer emerges, I will also assume that the value of the old GM is 0, so that we do not complicate matters further. I doubt that the liquidation value of the rest of the business could be negative, so maybe extra recovery value could come from that side too.
One last thing, the US incentive scheme known as "cash for clunkers" has run out of cash. It ran through its $1bn in allocated funds which was expected to last until October in a matter of days. Now the administration could decide to extend it and put some more money into the scheme. This means that the underlying demand for cars is there, and once the economy recovers we should see sales bouncing back to a more normal level around 13-14m units (from 17m before the crash and 10m cars a year now).
National Express
National Express has rallied by more than 25%, and is now trading at around 340p, up from 267p when we first discussed the stock and concluded that it was still too early to play. However, this is against a backdrop of a FTSE 100 which has rallied 11% over the past few weeks, to hit 4,600 from a monthly low of 4,127.
The main problem with the stock was the potential loss of the other rail franchises, which contributed more than 50% of the group's turnover. On this front, no news has emerged. As parliament is now in recess, and the government on holiday, I don't expect any significant announcement relating to the rail franchises until at least the beginning of September.
The other main development on the stock was the news that CVC and the Spanish Cosmen family (owners of 19% of NEX already) have submitted a cash bid that is conditional on the company keeping the other two rail franchises. No indicative price for the tender offer was given. Stagecoach is also party to this bid and could buy part of the company from CVC and the Cosmen if the bid succeeds. If a cash bid is launched then no rights issue will be needed.
This news basically confirms my hunch that the company is interesting and undervalued. NEX has a stable and viable business and generates cash. But unfortunately, now everything hinges on the government's decision on the remaining two rail franchises. If the company keeps them, then it's quite likely that NEX will be subject to a bid. But if it is stripped of the franchises, then a rights issue will be necessary and the stock could fall quite sharply.
I reckon it's worth waiting for the government decision. If NEX keeps the franchises, we'll review the situation and perhaps try to play it using a risk arbitrage strategy. Otherwise, if the government strips the company of the rail franchises, then be ready to buy on the dips and double up once the rights issue is under way.
The upside in the stock if there is a bid could be quite limited, while the downside could be more dramatic. I do not think the proposed bid is going to be generous and I do not expect it to be 10-15% higher than the current price. The Cosmen family already owns 19% of NEX equity and to me this looks like a cheeky attempt to buy the company on the cheap.
If I was the transport minister I would definitely revoke the other two rail franchises. This would set a tough precedent for other rail companies and could even prove a vote winner with a general public which has become very angry with public bailouts.
As usual I welcome your feedback , please e-mail me at eventstrader@f-s-p.co.uk with your comments, ideas and suggestions.
Riccardo Marzi
Events Trader
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