Category Archives: Financial arcana

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The death of the banana republic

US-based banana producer and importer Chiquita, the world’s largest banana company, is almost certain to be bought by a Brazilian consortium, after the collapse of its attempted tax-dodge reverse takeover of Irish-based banana importer Fyffes.

In some ways, this is an entirely normal business story.

It features the collapse of the easy, painless [1] tax revenues that the US government could once reliably collect from US-based multinationals’ overseas ventures, as companies move their formal registration and a couple of dozen accountants and lawyers to low-tax jurisdictions like Bermuda, Ireland and the Netherlands whilst keeping management control in the US. It features the growing importance of Brazil’s highly competent and often highly cash-rich middle class, whose flagship was Brazilian-controlled InBev’s takeover of Budweiser brewer Anheuser-Busch.

But that isn’t the whole of it.

The full story takes us back to the tail-end of the 19th century, when advances in shipping made it viable, for the first time, to ship bananas from South America to urban consumers in the northern US.

The United Fruit Company, founded in 1899 by the merger of banana pioneers in Boston and New York, owned and operated plantations in the Caribbean and Central America, and introduced refrigerated sea transport to provide New Yorkers and New Englanders with the freshest fruit.

The UFC [2] found itself building complex logistics networks in countries that had previously lacked any real communications capacity. And as the US became the world’s leading power, and US consumers became richer and hungrier for bananas, the UFC found itself far richer than any of the governments that nominally ruled the Central American countries where it traded [3].

Which is how the term ‘banana republic‘ was coined. Even before WWI, the UFC controlled telecoms and postal networks in Guatemala, Honduras and Costa Rica. With politicians in the company’s pockets, it dominated the US banana trade. It kept costs low by dispossessing peasants of their lands through crooked legal systems, and then employed them as cheap labour on the grounds that serfdom was mostly better than starving to death.

If this sounds familiar, then you’re probably aware of the history of British India.

The main difference between the United Fruit Company and the East India Company is that the former never even required a show of US military force to protect its interests. The implicit threat was so clear, it never needed to be carried out. Besides, bribes are cheaper than wars.

So why am I blethering on about the United Fruit Company? Well, in 1990, it was renamed to Chiquita Brands International. The same one mentioned above. That’s right: the ultimate US imperialist multinational, the inventor of the banana republic, is about to be bought by South Americans.

In the long run, all empires fall and all companies collapse. And often enough, it’s the people they oppressed who take over. The East India Company brand is now owned by an Indian business. There’s nothing new under the sun, and so on.

But I don’t think I’ve seen a quicker shift from colonial corporate power to re-appropriation than Chiquita.

[1] For US consumers and the US economy in general. I’m sure US CEOs were deeply pained.
[2] The best wrestling abbreviation coincidence since Pandas vs Hulk Hogan.
[3] There is some extremely good development economics work on this; this paper is a great start.

A Qantas of solace

Qantas announced its financial results today. Predictably, they were a car crash (Qantas still hasn’t had a plane crash [*], but they’re definitely a crash). $646 million operating loss, and $2.6 billion in one-off write-offs from revaluing the company’s aircraft fleet. No rock and roll fun.

Fiddling and burning

As Qantas CEO for the last six years, and about as many restructuring programs, much of the blame has fallen on Alan Joyce. “Alan Joyce is to Qantas what Caligula was to the Roman Empire”, said independent Senator Nick Xenophon, who never met an exaggeration he didn’t love.

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Qantas CEO Alan Joyce chairing a board meeting

And it’s true: while he hasn’t yet made his horse a board director, Joyce’s strategy has been something of a disaster. His approach to a long-term structural weakening in Qantas long-haul, combined with an epic boom in domestic demand, was to ignore the former (leaving the long-haul airline with a fleet of fuel-guzzling 747-400s, highly-efficient-when-full-but-hard-to-fill A380s, and senescent 767s up to the end of 2013), and deal with the latter by starting a price war with its only real domestic rival, smaller, lower-resourced, lower market share Virgin Australia. Although at least the domestic airline’s ageing planes were replaced with efficient new 737-800s.

Under Joyce, Qantas’s investment has been focused on expanding pan-Asian short-haul budget airline Jetstar, which has had modest success in Australia and Singapore, less success in Japan, embarrassment in Vietnam, and dismal failure to even get an operating license everywhere else (including Hong Kong, for which the airline bought six brand new A320s that have been sitting idle). Much of the failure has been due to Qantas’s and Joyce’s failure to understand the Asian operating environment, where the perception that the airline is controlled by local partners is vital to local regulators.

More recently, as long-haul became predictably loss-making, the airline has slashed services, cancelled further A380 deliveries, life-extended 747-400s up to the point where they’ll be welcomed in museums on decommissioning, postponed 787 deliveries (despite the fact that, due to Boeing’s program delays, the airline is due an exceptionally good price on its 787s), made no effort to lease 777s in order to decommission 747-400s, and negotiated a codeshare with its biggest international rival that hands over most of its long-haul services out of most Australian cities.

And rather than attempting to either blitz or alleviate Qantas’s troubled relationship with staff and their unions, Joyce ratcheted the tension up to maximum, closed the airline for a day to hold a lockout, and then stuck a band-aid over the wound.

So, yes, Joyce has been inept. But what about the environment he’s facing?

They can’t be better than us, so they must be cheating

A lot of cant is talked about this, partly because local airlines in rich-people countries are very good at placing PR stories in the media, and partly because it’s the only area where rich-people country airlines and airline staff have aligned incentives. The general story is that it’s grossly unfair that airlines like Qantas are losing out, because their rivals in less-rich-people countries are “government sponsored foreign airlines with unlimited piles of cash”.

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A highly subsidised government-controlled airline stealing Qantas’s passengers

Anyone using this lie should be banned from aviation commentary. It is a bullshit excuse used to defend the incompetent management & overpaid staff of legacy airlines in rich-people countries from profitable foreign rivals.

Looking at airlines that could be considered Qantas’s competitors, Emirates is immensely profitable; it does not have any state subsidy. Singapore Airlines and Air New Zealand, both major shareholders in Virgin Australia, and Cathay Pacific are all slightly less profitable, but also unsubsidised. The remaining foreign government-controlled airlines that run on subsidy are basket cases that can’t fill their seats anyway: Malaysian Airlines, Air India, Alitalia.

The alleged indirect subsidies that critics like to pretend Qantas’s rivals receive are also illusory. Yes, fuel is cheaper in Dubai than it is in Sydney. But the economics of long-haul air travel are such that you have to refuel every time you land, so a Qantas flight that goes Sydney-Dubai-London has exactly the same fuel cost as an Emirates flight that does the same. It’s also true that company profits are taxed less in Dubai than they are in Australia, but you need to be making a profit in the first place before anyone taxes it.

The problem is, if you are an airline with new planes, new IT systems, and staff recruited on current contracts, you have a hell of a cost base advantage over an airline which doesn’t. This is highlighted by, um, Jetstar and Virgin Australia, never mind the foreign rivals. The foreign rivals also have the advantage of being on the way between somewhere and somewhere (with the exception of Air New Zealand, which really doesn’t).

The “cheating” narrative exists, of course, because it’s a first step in the one cause that unites unions and management everywhere: extorting money from the taxpayer to preserve unviable business models. Once you’ve established the trope that it’s unfair of Emirates and Cathay Pacific to steal all of Qantas’s international passengers using their home advantage, a subsidy to ‘level the playing field’ is a logical next step. To the current Australian government’s credit [**], it doesn’t so far seem to be showing any signs of playing ball.

Portrait of the CEO as a doomed man

Alan Joyce said in the results statement, “We expect a rapid improvement in the Group’s financial performance – and a return to Underlying PBT profit in the first half of FY15, subject to factors outside our control”. Note that ‘factors outside our control’ here means whatever he wants it to, like Humpty Dumpty. And note that he has said variations on this theme at almost every results announcement so far.

Etihad CEO James hogan
Etihad CEO James Hogan

Things should be less terrible for the airline going forward. The various doomed attempts to forge new Asian carriers seem to have been dropped; Qantas has addressed some of the terrible usage patterns of its international fleet (no longer leaving $300m aircraft parked up in London for 20 hours a day), 2,500 of the 5,000 layoffs in February have actually been made; and the write-off to aircraft values will save about $200m a year in depreciation charges. If not quite profit, that would seem to be enough to keep the airline’s loss manageable given its cash in the bank.

But while Qantas’s future is reasonably secure, Alan Joyce’s surely can’t be. The results today were greeted with near-universal incredulity that he hadn’t been sacked already, given the sheer number of times he’s come forward with another round of sorry apologies, another insane unworkable Asian solution, and failed to save money on the core business. He’s a hate figure for the airline’s staff and the Australian public.

So why hasn’t he been, then? There are two possible alternatives:
1) As with the sacking of BP CEO Tony Hayward following the Deepwater Horizon disaster, there is no point in bringing in the untainted CEO until the worst of the disaster is over. Joyce’s head needs to roll, but this might as well happen in six months when the current cost-cutting program is complete and it’s time to make longer term strategy decisions again; or
2) Australian business is utterly nepotistic and corrupt, with supine boards made up of drinking buddies who cosily tolerate each other’s incompetence no matter how gross.

We’ll see which it is over the next 12 months. Meanwhile, if I were the chairman at Qantas, I’d offer the Australian CEO of Abu Dhabi carrier Etihad, James Hogan, all of the money in the world and total free reign over all decisions to come home and repeat some of the magic he worked out in the desert.

[*] Fatal or hull-loss accident since the start of the jet era.
[**] Given the current Australian government’s performance at literally everything else, you have no idea how much this pains me to say.

$27 million a year is a bargain price to buy a government

It’s been Good Times Online as Crikey gets hold of a copy of News Australia’s detailed management accounts for fiscal year 2012-13 (I’ve uploaded a copy here, since the Crikey version, hilariously, is paywalled).

As a way of demonstrating its commitment to journalism, News has threatened to sue anyone who reports on the topic. The fact that The Australian loses $27 million a year (almost as much as the Guardian, despite being a barely-read Canberra local paper rather than a major global news organisation) has been noted as particularly hilarious.

If you try and frame The Australian as a newspaper in the traditional sense, of using content to sell readers to advertisers, then the level of fail here is baffling. News is a private company, not a charitable trust dedicated to furthering the cause of journalism. The continued existence of The Australian (and the continued employment of its coterie of gibbering morons at an average wage of $174,000) is a mystery.

But I don’t think that’s what’s going on. The News Australia accounts show that the actual value in News Australia comes from its pay-TV businesses.

News Australia’s profit for FY12-13 was $367 million. Its share of profit from pay-TV (Foxtel, Fox Sport and Sky New Zealand) was $230 million. Add in REA (which runs realestate.com.au)’s $146 million profit, and you’re already above total group profit. The newspapers in total – even including the profitable regional tabloids – contribute less than nothing [*].

That breakdown isn’t entirely fair, since it ignores $75 million of parent company costs – which are mostly, but not wholly, newspaper focused – and also $40 million of amortisation costs related to the Foxtel stake (whose accounting treatment I don’t understand). But it makes clear where the financial heart of the business lies, and it’s not in dead trees, or even their digital equivalents. It’s in having a monopoly on pay-TV delivery in Australasia.

Hell, it’s probably the only business of any real worth in the whole of News Corporation, since its assets outside Australia now consist solely of dead-tree businesses.

What are the ongoing risks and opportunities for pay-TV? Well, the biggest opportunity is in gouging people out of even more money for it, and the biggest risk is that people stop subscribing to it. Both of these depend mainly on government: the more draconian copyright legislation is, the more stringently it is enforced, the harder it is for you to just get things from Netflix and iTunes, the more crippled the ABC is, and the slower your broadband Internet is, the more value Foxtel has.

So that’s what The Australian is for. When you’re defending $230 million of annual profit, paying $27 million a year to shape the opinions of Very Serious People in Canberra regarding copyright law, competition law and telecoms policy isn’t a bad investment at all.

[*] per pages 3, 13 and 14 of the accounts. These are complicated by the fact that stakes in the various businesses changed over the year, with some some Fox Sports revenue counting as operating income and some as income from investments.

Only sentimentalism could have saved the Australian car industry

There is much wailing and gnashing of teeth over the news that Toyota will follow its fellow foreign-owned carmakers GM Holden, Ford and Mitsubishi in ending car assembly in Australia. But at least from an economic point of view, there shouldn’t be.

The basic problem for the Australian car industry has nothing to do with unions or pay rates, despite the government’s outrageous lies to the contrary. It’s far simpler than that. Australia is a country of 23 million people, with a new car market of just under a million a year, while car manufacturing is an industry with massive economies of scale where the most efficient factories have annual production levels of more than half a million a year.

Less than half as many cars per worker…

Nissan Motor Manufacturing UK in Sunderland, which is famed for being one of the most productive plants worldwide, is about to increase production from 500,000 to more than 550,000. To knock out those half a million cars, NMMUK employs 6,000 people, and supports around 23,000 jobs in the UK supply chain. So that’s about 80 cars per worker (labour is not the whole story, but it’s a tolerable proxy, and accurate job data is easier to find than full input cost data at plant level).

Toyota Australia employs 2,500 people to produce 100,000 cars year, which is about 40 cars per worker. In the rest of the industry (as of now-ish, before Ford and Holden begin their shutdown), 1200. So carmaking in Australia employs 6600 people directly, for a total of 220,000 cars per year, or about 33 cars per worker (as you might have expected, Holden and Ford are less efficient than Toyota).

Scaling the supply chain in line with NMMUK employment (i.e. assuming Australian suppliers are as inefficient as Australian carmakers) would suggest that about 25,000 supply jobs will be lost when the Australian industry shuts down. Scaling it in line with Nissan output (i.e. assuming Australian suppliers are just as efficient as UK suppliers), you’d assume about 10,000 jobs will be lost.

…and 21,000 jobs, not hundreds of thousands

Data from IBISWorld suggests the actual number of jobs in the industry at risk is about 15,000, somewhere in the middle. So the total number of job losses when the car industry shuts down, including knock-on effects, will be about 21,000 [*]. This is roughly equivalent to the number of public servant jobs the federal government is currently cutting.

(the number of Australians in employment is 11.6 million, as of December 2013; the number of unemployed Australians is 716,000).

These 21,000 jobs are being lost because the Australian car market isn’t large enough to support an efficient domestic carmaking industry, even if every single car Australians bought were manufactured domestically. A large, remote, resource-rich and wealthy island of 23 million people has more productive uses of time and resources than subsidising industries that require greater scale than can possibly be achieved domestically, and where we’ve never excelled at exporting. Economically speaking, we would do better to buy new cars from South Korea, import second-hand cars from Japan, redirect the labour and capital involved towards things we are good at, and spend the subsidy money on things that we actually need.

But whence will come the V8 Supercars of the future?

Economics isn’t the whole story. It’s possible that having a carmaking industry is so important to Australia’s wider culture and self-image that it is worth protecting, whether by direct taxpayer subsidy or by higher import tariffs (which are a tax on everyone who buys a car, whether it is domestic or foreign-made). If Australia agrees as a society that this is the case, then continuing to subsidise carmaking is a completely legitimate decision – just as is the case for the large subsidies that go to farmers.

But if you think that the car industry has closed because wage rates are too high, you are wrong, and you believe the toxic bullshit the Liberals are seeking to peddle in order to erode everyone’s employment conditions. If you think that the decision to stop subsidising inefficient lossmaking industries will cost Australia money, you are wrong, and you believe the economically illiterate bullshit Labor is seeking to peddle in order to bash the Liberals. The only grounds on which to support a domestic car industry are sentimental grounds.

[*] Wider estimates of up to 200,000 job losses have been published in various ‘newspapers’. These are lies.

Why the G4S Olympics screw-up proves that outsourcing is good

Everyone seems very upset about the fact that private security firm G4S has not delivered as many guards as contracted to police the white elephant that is Sports Day 2012, with many people suggesting it’s an example of why outsourced contracts are terrible . I’m not sure they should. Let’s rewind on what’s happened here…

G4S was contracted by the London Organising Committee of the Olympic and Paralympic Games (LOCOG) to deliver 2,000 security guards, as part of total security staffing of 10,000 people. The requirement for private security was increased to 10,400 out of 23,700 in December 2011 for reasons that were left obscure at the time, but can be presumed to be down to some combination of fear of imaginary terrorists and the desperate need to prevent people bringing in off-brand merchandise.

The company agreed to the increase, having its existing GBP86m contract value increased to GBP284m. It then carried out 100,000 job interviews over the following six months for staff, but failed to find enough people available at the right time and willing to take the work. Eventually, it had to admit that it had massively screwed up by taking on a near-impossible task, was not able to meet the 10,400 requirement, and LOCOG (presumably with government help) has instead brought an unspecified number of police and 3,500 soldiers  in to make up the shortfall.

While detailed contractual arrangements for the G4S deal haven’t been published, people familiar with LOCOG say that its Olympics contracts generally contain two separate contractual penalty elements: 1) payment by results, so if you don’t deliver, your pay is scaled back; 2) reimbursement for the costs of getting someone else to finish the job if you can’t.

So we can reasonably assume, in the absence of evidence to the contrary, that G4S is getting its pay scaled back and paying for the police and soldiers to step in. There’s a standard rate of GBP55 per hour at which cops are billed out to festival organisers; while I’m not sure the Army makes itself available for hire on quite the same basis [*], the soldiers presumably should command something similar.

This double hit – less pay and much higher costs, offset by much smaller savings on wages for the staff that haven’t been hired – is reflected by G4S’s statement to the London Stock Exchange last Friday, in which the company said it expected to make an overall net loss of GBP35-50 million on the Olympics contract. According to FT Alphaville, the total profit for G4S if everything had gone according to plan would only have been in the region of GBP10m, or 4% of the revenue from the deal. In the best-case scenario for G4S, 96% of the GBP284 million paid by LOCOG to the company would have have been paid out in costs [**].

Net result:

1) Sports Day will still be going ahead with a full security contingent;

2) the net cost to LOCOG of the deal will be lower than if G4S had delivered, because of the impact of the penalty clauses;

3) the police and the army will also get decent reimbursement from G4S, so the taxpayer will win out to an even greater degree;

4) G4S will make a significant outright loss on the LOCOG contract, which is at least four times the size of the profit it would have made had everything gone well.

Had security staffing been carried out directly by LOCOG, there’s little reason to assume it would have gone appreciably better. G4S is probably the organisation in the UK with the most experience in recruiting security people for events, and this is one hell of an event; if the task were easy, they wouldn’t have stuffed it up so badly. Unlike G4S, LOCOG has a million other tasks to focus on to the same deadline, and no direct experience of recruiting security people.

LOCOG perhaps could have made the cops and the army part of the original plan – but then the taxpayer would be paying the full billing rate, rather than having G4S picking up the tab. Or it could have massively raised wages for everyone (including the people already hired, not just the extra people at the margin – I’m fairly certain this is why LOCOG and G4S didn’t go down that route once problems arose) – but again, the taxpayer would then be paying the full rate for everything.

In other words, the risk of failing to deliver on the contract was successfully transferred from the taxpayer to the private sector, without being significantly elevated. For just 4% margin, G4S was willing to assume the entire financial responsibility for the staffing project. The consequences of the epic failure fell entirely on their shareholders, and not on the taxpayers.

Conclusion:

The outsourcing model [***] has won the day, and the wicked private capitalists are the only ones to lose out. Hurrah!

[*] although I suppose this could be one way to offset the impact of military cuts in future.

[**] the only reason to take such a low margin on such a high-risk contract is as a loss-leader, with the whole world watching G4S’s performance as a contractor. Which has admittedly happened, although not quite as planned.

[***] when combined with tough contracts that have decent enforceable penalty clauses. Without them *cough*Metronet*cough*, it’s a terrible model and people who use it should be horsewhipped.

The future of News: from one oligarch to the next?

In the wake of a punch to the face from phone-hacking-Leveson-scandalous-British-naughtiness, and a kick to the balls from shrinking print revenues, News Corporation is contemplating splitting its TV assets from its print ones.

The plan would be to remove the newspaper drag from the share price, and hopefully bypass some of the regulatory fallout from News International’s behaviour. In Australia, that’d mean the Foxtel, FoxSports and Sky stakes going into ‘Good News’, and the papers, magazines and book publishing (HarperCollins) going into ‘Bad News’.

An obvious problem here is that Bad News would be, well, bad news.

The analysts at Nomura have worked out what the historic and forecast income statements would be for both demerged companies. They’re projecting that, despite the newspaper division halving in profit (EBIT) in 2012, future profit declines will only be in the region of 5% a year – and that global newspaper division (including digital) revenues will show slight overall growth. Nomura values the print company worldwide at around US$3-4 billion.

To me, that sounds optimistic. 2012 is going to be particularly awful for the newspaper division because it’s the financial year after the cash cow of the News of the World was killed, sure. Nonetheless, looking at Fairfax’s position, the Guardian’s position, News Limited’s announced cuts in Australia, the Times and Australian’s massive losses, and the ongoing march of often free, often superior (albeit seldom both) online news sources, growing sales even at the rate of inflation seems like a pipedream.

Supposedly, the WSJ’s finances are in a better state than most of the other titles, because people actually pay for business information online. The four remaining sensational big city tabloids in the group – the UK Sun, New York Post, Sydney Daily Telegraph and Melbourne Herald Sun – likely still make money, since they were never reliant on classified advertising. But the Times and the Australian are reported to lose vast sums annually, despite the imposition on both of draconian paywalls which very few people have taken up, and which mean that they form no part of the online conversation.

(the Times recently started a Tumblr for some of its opinion content, in a desperate attempt to maintain some kind of relevance to the outside world…)

Now, Rupert Murdoch is 81, and his children show absolutely no interest in taking over the print business. And Bad News would be a publicly traded company with shareholder obligations.

When you’re a vehicle for an oligarch to promote his corporate interests to politicians, in the way Mr Murdoch has used his papers for the last 50 years, bunging tens of millions of dollars a year into a respectable-opinion-leading project like the Australian or the Times can get you results far in excess of your investment: tax reliefs, exemptions from competition laws, broadcasting licenses, etc.

But once you break the link with the corporation that benefits from the regulatory corruption, lose the oligarch to retirement/senility/Old Father Time, and lose the ability to shape national conversation by excluding your pieces from most modern forms of sharing and discussion, then really, what’s the point?

So the only way for the Times and the Oz to survive is to be sold to some kind of oligarch who’d benefit from their advocacy. In London, you can barely throw a stick and not hit some overseas billionaire or other, so that should be easy enough.

In Australia – now, who might be interested in buying a voice in the national conversation? Who easily has the money to continue publishing the Australian, tearing down the paywall, making it into perhaps (if Fairfax’s desperate plans are followed through) the only free source of premium news and commentary in the country? Who has a conveniently close ideological position to the one the Australian is already pushing? And who’s just been rebuffed in her attempt to gain control of a couple of newspapers whose readers and editorial staff are completely opposed to her ideological position?

Gina for the Oz. You read it here first!

Being for the retirement of Mr Hartnett

So, you’re a lifelong civil servant. You’re quite competent, and you’re amazingly good at tolerating people who aren’t, especially your political ‘masters’. You’ve spent over 30 years in the service, and you’ve risen to be in charge of collecting tax and that.

You’re well aware that a lot of companies are headquartered in the UK, that it costs them a grand and a few Ryanair flights a year to be headquartered in Ireland where there’s hardly any tax at all on foreign earnings instead, and so any company that makes the majority of its money outside the UK is only not sodding off to Ireland because the boss quite likes his office on the Thames/being among the London advisory community/and so on. But that this isn’t necessarily worth billions of squillions of squids.

So, given that the government’s official ethos is “we’re OK with people getting filthy rich, as long as they pay their bills”, rather than “fuck everybody we don’t like TO DEATH”, you come to deals with people, under which the UK gets shedloads of tax money, far more than if the companies in question had just fucked off to Ireland, and nobody has to fuck off to Ireland.

Then, you get a disastrous recession, caused more by the governing ethos that both parties have shared for 20 years than anything else – and which you’ve bought into wholly, as did everyone except for some marginal cranks (no, shut up, as did everyone except some marginal cranks). And it all goes to ratshit, and the incoming government declares war on the public sector.

What better to do than to a) strongly encourage you-as-lifelong-public servant to quit now; b) smear you to fuck as a FATCAT PUBLIC SECTOR SALARY PERSON, even though the pension difference is vastly less than the enormous lifetime paycut you accepted for working in the public sector in the first place?

It’s not quite fair to view the current UK scenario solely as an excuse to fuck over people who work in the public sector. It’s also massively fucking over people in the private sector, but they have to meekly take it because FINANCE IS GOD. Thanks to Mrs Thatcher, as played convincingly by Corinna Harfouch, that’s the perceived medicine for everything. “Oh, you’re poor? Well, we’ll stop helping with your rent and your dole, then you’ll be less poor”. < - FACT | SATIRE -> “Oh, you’ve got cancer? Well, here’s my asbestos-themed cigar bar; also, this lady in heels will kick you in the genitalia whenever you care. After all, you wouldn’t want to bring kids into such a world”.

(I lied with the Harfouch resemblance. At lest Mrs G got the “not wanting to bring kids into such a world” part).

But yeah. Everything’s fucked. Dave Hartnett devoted his life to making the best job of public service, for paymasters who haven’t (at least yet) been hanged. Until and unless we hang them, we owe him that deal, just as much as we owe everyone else who rejected easy private sector money in order to do hard stuff for crap money with the sole benefits being a smile on your face and a tolerable pension.

Why credit ratings weren’t important in the Thameslink deal

I’ve not abandoned this blog – just, whilst struggling with painful paid work on the kind of social media and consumer goods marketing work I tend to post here (it’s rewarding and worthwhile paid work, but whilst working on it for pay I’m not so keen to blog on it for no money), most of what I post tends towards the political, so I tend to post it on Liberal Conspiracy. If you’ve missed out, my work for LC is here. I’m also on Twitter a lot, and am slightly disturbed to see from my tweet figures that I’ve written more than a book’s worth of Tweets. Oh, and also I was blogging as part of my MA course – I should really repost those blogs here.

However, this current topic is definitely unsuited to any of those media. Roger Ford, who’s probably the best railway journalist working in the UK at the moment (sorry Nick!) writes a great technical column in Modern Railways magazine, and sends out a monthly email based on his work for the mag. But although he’s a brilliant rail industry writer, he’s not a great finance industry writer. And so he’s fallen for an insiduous and silly myth spread by the Telegraph’s Alistair Osborne in this piece.

The last UK government put out a tender for 1,200 new train carriages to be built for the Thameslink project, which links southeast London and its commuter belt with north London and its commuter belt via upgraded lines running from London Bridge to St Pancras via Farringdon. The tender didn’t specify any British-built content for the trains, and was won by Siemens with trains that will be built in Germany rather than Bombardier with trains that would’ve been built in Derby. Siemens bid cheaper than Bombardier, and the government wasn’t allowed to take British jobs into account because a specification of British jobs wasn’t part of the invitation to tender.

This created anger, especially as Bombardier used the announcement as a catalyst to announce that it’d sack two thirds of its contract staff and 25% of its permanent staff in UK train-building, because it doesn’t have any UK train orders after it’s finished building new London Underground trains. Europhobics used it as an opportunity to attack the EU’s anti-corruption rules; more sensible people used it as an opportunity to attack the previous government for failing to specify British jobs (as would’ve been allowed by EU rules) in its invitation to tender.

Which is fair comment. A related question, though, is why – as the biggest supplier of trains to the UK railway network over the last five years – is why Bombardier couldn’t outbid Siemens to the contract. Osborne’s claim was that this was a reflection on Bombardier’s credit rating relative to Siemens. Siemens’s debt is rated at A+ by Standard & Poor’s, compared with Bombardier’s BB+ rating, and the contract was to provide the trains on a leasing basis rather than to buy them outright. He says that because it costs Bombardier more to borrow (credit ratings are basically like individual credit scores, so A+ means you get a cheaper loan than BB+), it would’ve cost Bombardier 1.5% more than Siemens per year in interest costs to supply the trains than Siemens, so no bloody wonder Siemens won.

However, this is rubbish. Neither Bombardier nor Siemens bid on their own. Bombardier teamed up with Deutsche Bank, services outsourcing company Serco, PFI investment company Amber Infrastructure and SMBC Leasing for its bid. Siemens teamed up with PFI investment company InnisFree and private equity company 3i Infrastructure. In neither case would the train manufacturer have put up the money for the trains – in Bombardier’s case it would have been SMBC (which has an A+ rating, befitting its position as one of Japan’s least bankrupt banks), and Siemens’s case, it would have been its own corporate finance division (A+) plus 3i Infrastructure (BBB+). For the Bombardier consortium, the money would have been borrowed against SMBC’s account; for the Siemens consortium, it would have been borrowed against Siemens’s account – they would both have had an A+ credit rating.

So, in other words, the Bombardier consortium and the 3i consortium would have had the same financing costs. The only difference is that, had the bid been successful, Siemens’s credit rating and ownership of a finance company would have allowed it to take a higher proportion of the profits. The difference between Bombardier and Siemens based on credit rating is that Bombardier wouldn’t have been able to take an additional slice of the profits based on the financing part of the project, and therefore had to bring in an external partner for the financing. But that’s about how the profits from winning the bid are shared, not about the cost of delivering the trains.

The same EU rules that ban the government from choosing Bombardier because it’s designed and built in Derby also ban the bid from being awarded on a cross-subsidy basis from companies’ finance arms compared to their building arms. In other words, Siemens’s assessment of the cost of building the trains had to be on the same basis as Bombardier’s, and it wasn’t allowed to pretend that the trains were cheaper and offset that money on the basis of any financing that its finance company did. So there’s no sane reason why this should have made the Bombardier consortium’s bid more expensive than the Siemens bid.

In short, either Siemens overbid (presumably because it was desperate to keep a foothold in UK rail, having lost most major recent contracts to Bombardier), or Bombardier underbid (either because it thought the government would somehow dodge the EU rules and pick the British-based trains, or because it couldn’t really be bothered and was looking for an excuse to cut Derby anyway). The financing problem is not important.

Friends don’t let friends buy gift cards

Australia’s worst book retailing chain, RedGroup (parent of Borders and Angus & Robertson) went into administration yesterday. There are a few reasons for this:

1) RedGroup was a highly indebted private equity portfolio company;
2) Australian retail spending has been weak-ish in general for the last year or so;
3) Books have been particularly hard-hit by consumers switching to online retail from overseas;
4) This is exacerbated by an extremely silly law which bans wholesalers and retailers importing books from overseas, instead forcing them to pay exorbitant local publisher prices;
5) According to pinch-of-salt-worthy rumours, the chain wasn’t very well run. Certainly, it didn’t provide a very enjoyable retail experience.

So, it’s the kind of story that was prevalent in the UK in the late 2000s: a retailer which isn’t massively successful but was making just-about-tolerable money gets bought and heavily leveraged by a private equity company. Then the market takes a turn downhill, the new owners can’t cut costs enough to make up for the downturn, and the company can’t make enough profit to pay the debt – so the administrators get called in and the shareholders lose all their money. On the plus side, at least the shareholders who lost all their money on the deal were greedy private equity zillionaires.

But since the Australian media has been denied an ‘OMG THIS IS AN OUTRAGE!!!’ story from ripped-off shareholders, it’s managed to dig one up from consumers instead, about RedGroup gift cards not being honoured by the administrator. Well, no – of course they aren’t. Indeed, he’s being very generous in their case.

When a company goes into administration (Australian and UK law are fairly similar here), the administrator is required to run the company in the interests of its creditors – the people to whom it owes money – until he has worked out a longer-term plan for the company’s future. If he can sell the business as a going concern once the debts are out of the way, this will normally generate the most value for creditors.

In this case, RedGroup’s creditors are its banks, the Australian Tax Office, its landlords (because the stores have multi-year leases), its suppliers (because publishers are paid in arrears), and the people who hold RedGroup gift cards (because they represent a commitment for RedGroup to give you goods of a certain value on a certain future date).

If the company is unable to pay all of its debts, some of these creditors take priority over others, because their debts are legally enforceable against the assets of the business. Usually, these secured creditors are the banks and the ATO (under certain circumstances). So the administrator’s job is to come up with the best way of minimising the loss to the company’s creditors in total, while also ensuring that secured creditors are the first to be repaid. It’s likely that RedGroup is in this position: otherwise, its management would have been unlikely to bring in the administrator in the first place.

This means that if Penguin’s MD were to turn up at RedGroup’s head office saying “you haven’t paid us for books in months, give us some money now!”, then the administrator would tell him to go away until the administration process is complete. Penguin will get its share of the remaining assets once the secured creditors have been paid off, but as an unsecured creditor it won’t get anything until then.

The administrators of collapsed UK music retailer Zavvi applied this same approach to gift voucher holders: they were treated as unsecured creditors, and – along with other unsecured creditors – are likely to get back 10-20% of the face value of their debt. However, RedGroup’s administrator has been more generous to voucher-holders than Zavvi’s.

Borders or A&R gift card holders also have the right to lodge an unsecured claim, but the administrator has said that they can instead fully redeem their card as long as they are spending twice its face value (i.e. if you buy $40 worth of books, you can pay with a $20 gift card and $20 in cash or card). This is offered as a gesture of goodwill, but presumably reflects the administrator’s belief that the chain will be worth more if he does this – both because it’ll keep up cashflow in the short term, and because it’ll tarnish the brand less than if cardholders had been offered cents on the dollar years down the line.

The difference in administrator behavior is most likely because Borders and A&R are likely to continue to exist in some form or other, whereas Zavvi pretty much wasn’t (it was a newish brand, and it moved from ‘precarious’ to ‘ruined’ after its main supplier went insolvent a month before Christmas and therefore couldn’t supply it with stock). But if the administrator ends up concluding the finances look really nasty, this could all change – so if you’ve got a voucher and you value a half-price trip to the bookshop, then now’s the time to use it.

What’s the conclusion, apart from ‘don’t borrow money against assets that won’t cover your interest payments, duh’?

Well, for individuals, no matter how unimaginative you are, how mercenary your nieces and nephews are, or indeed any other concerns of any kind whatsoever, don’t buy gift vouchers. Would you spend $50 on unsecured, 0% interest bonds sold by a highly indebted company struggling to stay afloat in a massively competitive market? No, nor would I – and that’s exactly what purchasers of gift vouchers are doing.

There’s a policy conclusion as well, which is that retailers shouldn’t really be allowed to issue gift vouchers – they’re effectively a license to print money, granted to institutions that (jokes about the financial crisis aside) are far less regulated and far more likely to go under than banks are. That can’t be a good thing, for anyone in the system.

If retailers do want to have a gift card scheme, they should be obliged to lodge all money earned from the sale of gift cards with a third party, completely detached from the assets and liabilities of the business, and only released when the gift card is redeemed against goods. I suspect, since it doesn’t mean Free Cash Now, such a scheme would be significantly less popular among retailers than the current setup…

It’s a Jolly Fun Bank Quiz

It being Sunday, or Monday, or one of those kind of days, and this being a Journal of Record [*], I thought I’d put out the kind of quiz that only my readers could answer.

What do the following UK-headquartered banks:
* HSBC
* Lloyds Banking Group
* Standard Chartered
* RBS

…have in common with no other UK-headquartered retail banks?

[*] I’m almost embarrassed to say that this blog is being archived by the British Library. I actually have no idea what the hell 25th century historians of the 21st century will do – well, I recognise half of my readers believe they’ll occasionally venture out of their caves and wonder why the outside world still makes their skin blister or similar. But right now, every humanities undergrad thesis candidate is delighted to find a neglected text to use for their work – in 2500, this crap will be (and, in terms of proportion of utter shite to “survives”, actually will be) available for an undergrad thesis. In which case, hello 2500 person, I hope they’ve genetically engineered girls to look like Natalie Portman, gizza shout if you’ve got a time machine, OK?