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.

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.

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…

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?

During the Korean War, Congress enacted an excess profits tax meant to keep military contractors from, well, profiteering. In its infinite wisdom, Congress defined excess profits as anything above what a company had been making during the peacetime years 1946-1949.

Boeing was mostly a military contractor in those days (Lockheed and Douglas dominated the passenger-plane business), and had made hardly any money at all from 1946 to 1949. So pretty much any profits it earned during the Korean conflict were by definition excess, and its effective tax rate in 1951 was going to be 82%…

It being 1951, Boeing instead sucked it up and let the tax incentives inadvertently devised by Congress steer it toward a bold and fateful decision. CEO Bill Allen decided, and was able to persuade Boeing’s board, to plow all those profits and more into developing what became the 707, a company-defining and world-changing innovation.

(I’ve deleted some of his sarcastic commentary about how a government enacting a similar measure today would be described, so that mine sounds cleverer.)

Not a single trading team from Tullett Prebon, the London-based broker which told employees they cold move abroad for tax reasons in one of the clearest signals of an exodus from London has moved, almost a year after the offer was made. It is the second development in a week that suggests fears over core talent leaving the City were overblown.

So *nobody at all* at Tullett thought that they would be better off paying less tax to work somewhere that wasn’t in London.

I suppose some people might argue that although not emigrating, Tullett’s brokers are working-to-rule and deliberately ensuring they aren’t eligible for big bonuses, because they’d rather have 100% of nothing than 50% of a lot. This doesn’t seem entirely convincing, given the personality traits of the trader-y types that I’ve encountered…

However, the funding shortfall threatening the public-private partnership (PPP) to build 78 new Waratah suburban trains for Sydney CityRail services is an exception. The NSW government did a good job in managing risks for this deal, and it’s at risk of having to stump up extra taxpayer’s cash for reasons nobody can blame it for not foreseeing.

On the plus side, even if the government does have to step in, it’s unlikely the NSW taxpayer will lose much. The biggest loser is likely to be Downer, the train’s builder, which is exactly where the blame should lie. Unfortunately for the NSW government, the deal is arcane enough that the press and the opposition can easily claim otherwise.

Why is PPP a good idea?

PPPs have become popular worldwide as a way of funding new rail rolling stock programmes because of the transfer of risk they involve. Under traditional contracts, a government agency buys some trains from a private contractor, who builds them and hands them over to the agency when they’re built, with the agency paying to maintain them until they’re no longer economic to repair. Under a PPP, the agency agrees with a private contractor that the contractor will provide it with working trains for a fixed time period, with repair and maintenance work carried out by the contractor.

The advantage of a traditional deal is that it’s straightforward. The disadvantage is that it sets up a terrible incentive structure. The manufacturer’s best option is to promise the lowest possible upfront cost, then deliver as many trains as possible as soon as possible, even if they won’t reliably last for their design life, so they can win the contract and get paid. The government’s best option is to take the lowest bid and accept as many trains as soon as possible, even if they won’t reliably last for their design life. So both sides have a good motive to agree to underspecified trains that will cost more in the long term. Not just in actual maintenance money but also in disruption, which is the absolute killer: a half-hour delay to a morning commuter train carrying 800 passengers costs the NSW economy over $10,000 in lost work hours.

The last trains procured in NSW under a traditional contract were the Tangara sets in the late 1980s and early 1990s. They’ve suffered from reliability problems throughout their working life, partly because the manufacturer built them down to the minimum spec, and partly because RailCorp specified cheaper components in the design than the manufacturer recommended. The first trains procured under a PPP, on the other hand, are the Millennium trains. Now, these also arrived late and suffered from initial reliability problems – but crucially, the manufacturer paid for the delays, and now that the trains are in reliable service, the manufacturer will pay for all future maintenance to keep them running.

The PPP approach for train procurement has also worked in Melbourne, as well as in countless successful projects in Europe, North America and Asia.

So what’s gone wrong on the Waratah project, then?

Well, first of all, as with almost every new rolling stock project in the world ever, the engineering side of the project is running late. Integrating multinational suppliers’ work has taken longer than expected, and the trains have encountered unexpected problems when they’re actually run on RailCorp’s rails. This is the consortium’s fault for not managing the project well enough, and for not pricing risks and delays into the original contract.

So Reliance Rail – the legal entity that’s providing the trains to RailCorp – is liable for a sizeable compensation bill that will wipe out its profit (Reliance’s main shareholder, Downer EDI, has already written off its entire equity investment in the consortium). This is exactly the point of doing a PPP – the private sector partner is paying for its failures, and the NSW taxpayer isn’t. Hurrah! And this would have been the end of the story, but for some complicated financial engineering…

Reliance is a company created solely to buy Waratahs from Downer EDI, and provide them to RailCorp with Waratahs. When the project was launched in 2006, Reliance raised a total of $274m from its shareholders (Downer, AMP, and, erm, RBS and Babcock & Brown), and $1.9bn in AAA-rated bonds. It also got its bankers (NAB, Westpac, Sumitomo and Mizuho) to pledge another $357m in debt financing that would be drawn after 2012 if required – effectively, an overdraft facility to cover the possibility of overruns.

From the point of view of everyone involved at the time, this was a fine deal. Reliance had enough cash to pay Downer to actually build the trains, and a guarantee of getting its hands on extra cash from the banks if its funding obligations ran ahead of delivery-based payments from the NSW government. NSW could see that Reliance had easily enough funding to deliver the trains and compensate for overruns. The bondholders had super-safe AAA bonds. And the banks’ overdrafts would have been on the same investor-friendly terms as the bondholders.

Unfortunately, the deal also involved one of the more surreal bits of the pre-GFC financial system. Reliance paid two large insurance companies – XL (now Syncora) and FDIC – to insure its debt. In other words, if Reliance were to go bust – say, because it spent all its capital and was completely unable to deliver any trains, or because NSW underwent a Communist revolution and refused to honour any private sector contracts – then XL and FDIC would make sure Reliance’s bondholders and bankers were repaid. This guarantee is how Reliance managed to get its bonds rated as AAA (‘almost totally safe’) despite being exposed to some operational risk.

You might be wondering why it was cost-effective for insurance companies to take on financial risks by insuring loans, rather than simply getting banks and bondholders to accept slightly riskier terms in exchange for higher interest payments. At the time, it was universally accepted that the logic was simply based on different risk appetites for different types of investor, with enormously clever computer models backing this up.

As it turned out, the actual reason was that the insurance companies had massively cocked up – they hugely underestimated the chances of defaults on the private-sector loans they made (mostly in US real estate. Yes, subprime mortgages again). And when the real estate companies whose bonds they were guaranteeing went bust, the insurance companies took the hit. So Syncora and FDIC are now both in serious financial trouble, and may become insolvent.

Who loses, and what can we do about it?

The insurance crisis doesn’t matter from the point of view of Reliance’s bonds: they’ve been sold, and the insurers’ failure is the bondholders’ problem. The same is true with the shareholders’ money. Reliance has $2.2bn in real money, and it will cover the vast majority of the project’s cost.

But it does matter for the overdraft: the bankers say that without the AAA rating that the insurance would have provided, their agreement to provide the extra $357m is null and void. So there is a danger that in the final stages of the roll-out, before the company starts receiving regular payments from RailCorp, it will run out of cash. This is what’s driving front-page headlines about ‘rail crisis goes off track’.

It’s the job of the opposition and the press to talk this up into a major disaster, with “$2.6 billion project in jeopardy and NSW taxpayer on the hook” headlines. But in truth, it isn’t a major disaster at all.

The insurers aren’t bust yet, and may not actually go bust at all – in which case, the banks will have to provide the overdraft. Even if they don’t, the bondholders will lose far more money if the contract collapses than if they agree to let the provider of the completion funding take precedence over their bonds (in other words, ensuring that if the company did go bust, the $357m would be paid before any of the bondholders are paid). So there’s a strong incentive for everyone in the private sector to work things out.

But let’s assume the worst financial scenario happens, and the NSW government ends up deciding to guarantee the $357m itself rather than see the introduction of the trains delayed until everyone’s sued everyone else to death. Reliance would pay the government back with interest over the life of the contract. The only risk to the NSW taxpayer would be if the project went so badly wrong that even with the $357m overdraft, the company was unable to bring the trains into service. This doesn’t look likely, considering the level of delays and the reported engineering quality of the trains so far.

A government bailout defeats some of the point of a PPP, in that NSW now has a financial interest in ensuring Reliance can pay its debts. But on the other hand, the private sector has already lost $274m (the value of shareholder equity in Reliance, which has been wiped out), and would lose still more if the final project went so wrong that the company did collapse (the $1.8bn in bonds). Even if NSW does end up having to underwrite some of the debt, this will still be a better deal for taxpayers than a traditional purchasing model.

This makes sense. Since I was working as a drinks industry reporter getting on for ten years ago, I’ve been saying Fosters should flog off the beer business. They’re a combination of a global premium wine company, a low-margin domestic beer business, and one mysteriously popular global beer brand – which, oddly enough, has almost entirely disappeared from their home turf. Being a global wine distributor, while providing a global beer company with a global brand, and an opportunity to distribute their other brands into Australia, was always going to be a better call.

I’d always taken a British take on ‘appropriate buyers for CUB’, on the basis that Heineken (formerly Scottish & Newcastle) owned the EU rights. Obviously, that would’ve been a good fit. But I’d forgotten the fact that the USA is the world’s largest beer market, that Foster’s is a popular import brand in the USA (”throw another shrimp on the barbie”, etc), and that Miller owned the US rights to the brand.

Meanwhile, SABMiller – which, like Kraft Foods, is part-owned and heavily cash-backed by Altria (= Phillip Morris) in a desperate attempt to stop all their shareholders’ money going to compensate lung cancer victims – has fallen way behind Anheuser-Busch Inbev in the “being a serious global brewer” stakes.

A leading position in a mature but profitable beer market (yes, oddly enough, selling beer to Australians is popular. See: selling crack in Baltimore; selling expensive houses in Mayfair) is nice from a cash-generation point of view. And for some utterly mystifying reason Foster’s is a much-loved beer brand everywhere except Australia, and as brand promotion becomes global it’s becoming important to have the rights to your most important assets, rather than having them owned by some comedy convict jokers [*].

So if the news is true, then it’s a good call on SABMiller’s part, as well as a bloody relief to Fosters Group (who’ll presumably have to rename themselves to ‘Australian Wine Company’ or a made-up name like Geadeo or something). And some kind of deal with Heineken to sort out the global rights would probably also be sensible.

And no, none of my alcoholic drinks market wisdom would have made the slightest difference to share-tippery at any point ever. If you want to make money on markets by thinking you know more than people about fundamentals, horse-racing is still a better bet. Stock analysts are still voodoo-merchants; my skills are only worthwhile if you actually want advice on what to do if you’re trying to market grog.

[*] dear the Australian Department of Immigration and Citizenship: I don’t believe that all Australian businessmen are comedy convict jokers. As the owner of an official certificate of being an Australian Businessman, I take Australian business very seriously. And mentioning Alan Bond and John Elliott at this point would be deeply unfair, and the fact that Mr Elliott used to own CUB isn’t even slightly relevant.

But if I was in serious financial trouble, and I owned a money tree, but I couldn’t afford to harvest the money tree due to my serious financial trouble, then I’d sell someone the rights to the next harvest of my money tree. Then, I might be able to do the following money tree harvest myself. At a worst case, the money tree’s money crop hasn’t just rotted on the branches.

So I’m genuinely perplexed about the weird machinations that mean we’re not going to get another Bond movie until forever. What incentive have MGM’s management got to not sell the rights to make a new Bond (which will make copious quantities of money, unequivocally) to someone with dollars, rather than sitting around making nothing until they go painfully bust?

I suspect it’s an accounting / US law / principal-agent problem, but would appreciate guidance from anyone who either knows, or can come up with a vaguely sensible reason for MGM’s management to do what they’re currently doing…

At that point, the American liabilities are ringfenced, and BP can continue to do as it does in the North Sea, Asia and Africa, bringing quantities of money that are undeniably copious, albeit less large than its shareholders pre-spill might have hoped.

At that point, British and Chinese BP shareholders are perfectly safe in their holding of the company. But what happens to American shareholders? Is there a mechanism by which the US government could appropriate US-held BP shares, and is it an ‘unprecedented, practically war’ thing or a ‘yeah, we do this’ thing if so?

…which brings the technical question: is there any divergence between movements in BP shares on the LSE, and BP shares on the NYSE? That would be an interesting indicator, if so…