Vinamilk-ing the Cow

What is an excellent stock in a downturn? One that combines attractive returns stemming from being part of a country’s growth story, part of the non-cyclical sector of an economy, and being run by excellent management. Vinamilk is one such stock. Vinamilk is a major component of the VN Index (Ho Chi Minh’s stock exchange), Asia’s best performer this year after surging 17%. Their share price stands at VND104,000, having returned in one year 78%. Vinamilk’s current market capitalization is around VND86,687,000,000,000 (US$2.8 billion) with a 5-year dividend growth of 45%.

Vietnamese dairy market is fast-growing, with a CAGR of 12% from 1997 to 2013. There is increasing demand for nutritional products as more Vietnamese enter the middle classes. Vietnam’s government have also taken strategic decisions to develop the country into a dairy production powerhouse. There is no other country in South-East Asia with the combination of government support, abundant water, solar energy, and fertile land.

Is Vinamilk a cash cow?

Since its founding in 1976, Vinamilk has established itself as Vietnam’s strongest company by building the largest distribution network in Vietnam in order to easily access customers and leveraging its network to introduce innovative products to the domestic market as well as for export. Vinamilk produces powdered milk, condensed milk, instant coffee, yogurt, soy milk, ice cream, cheese and Vfresh fruit juices. Major export markets include the Middle-East, Australia, Cambodia, the Philippines, USA, Canada, Russia, Turkey, Thailand and South Korea. Exports accounted for $180 million out of US$1 billion revenue in 2012. Vinamilk’s distribution network boasts around 174,000 retail sales points across rural, urban, coastal and mountainous Vietnam – a decisive factor in the success of this consumer goods producer. Additionally, Vinamilk's main competitors are Dutch Lady Vietnam - a division of Friesland Foods, Nestlé Vietnam, Abbott, Mead Johnson, Friso and Nutifood. Vinamilk have had to outcompete foreign milk, often preferred to domestic products, in order to become the number one dairy producer in the Vietnamese market. They have done so by focusing on new products rather than attempting to gain traction with products that other companies have yielded success from. One example is Vinamilk’s introduction of their yogurt and ice cream products in 1993, which saw people lining up to purchase them to help Vinamilk reclaim their investment outlay in three months. Vinamilk also introduced the first powder milk plant in Vietnam in 1987. They are building two dairy processing factories in Binh Duong province which will be operated by robots – cutting edge technology developed in conjunction with the Dutch Campina company. These innovations have enabled Vinamilk to be the leading dairy producer in Vietnam by sales volumes and revenue since 2008 – they have a 31% market share of powdered milk and a 75% share of the overall dairy goods market. Furthermore, Vinamilk, as a privatised state-enterprise, has strong links with the Vietnamese government – having contributed hefty amounts of corporate tax (US$120 million in 2012) and set up many community initiatives such as a fund providing 50,000 poor children across the country with two bottles of milk daily for free in order to combat malnourishment of children under the age of five to under 15% by 2015. Perhaps a signal of its excellent operational efficiency is Vinamilk being the only Vietnamese business to have any realistic chance of being in Forbes’  2013 list of the 50 best publicly traded companies in Asia, coming off the back of their 2010 Forbes Asia Best Enterprise Award for being among the Top 200.

The food and consumer products industry is non-cyclical and a major draw for investors, particularly in emerging markets where there is expected to be a large increase in the middle class. Vietnam’s sovereign wealth fund, State Capital Investment Corporation, own 45% of Vinamilk whilst its CEO and Chairwoman Mai Kieu Lien is heavily incentivized by owning 0.3% of the company. Meanwhile foreign investors hold around 49% of Vinamilk’s shares with major investors being F&N Dairy Investments of Singapore (9.5%), Deutsche Bank (6%), local private equity fund Dragon Capital (5%), Vinacapital (2.5%), and New Zealand dairy company Miraka (2.2%). The strength of the foreign investors is a testament to their belief in Vinamilk’s growth potential and operational efficiency.

In addition, CEO and Chairwoman, Mai Kieu Lien is also a major draw for investors and a key strength of the company. She was included in a list of Asia’s 50 powerful businesswomen. Since her inception, Vinamilk have doubled their revenues and become one of the largest businesses in Asia with revenues of US$1 billion. Mai Kieu Lien has focused on long-term planning, creativity to continue producing new products and training talented managers.

Vietnam's most successful export - in more than one way

Vinamilk’s future is very bright and expected to contribute to capital gains as well as dividend increases in its share price. Vinamilk has the most modern production lines in Vietnam, ensuring quality and hygiene. They have also signed an enterprise agreement with Microsoft to obtain technical support for technology in their plants. In 2012, the US$75 million Miraka milk powder plant in New Zealand, owned by Miraka Limited and in which Vinamilk have a 19% stake, went operational. The plant has the capacity to produce 32,000 tonnes of powdered milk a year. It is Vinamilk’s first overseas investment and part of Vinamilk’s long-term strategy to become one of the world’s 50 largest dairy producers by 2017 with annual revenues of US$3 billion. To aid in reaching their target of annual revenues of US$3 billion by 2017, they are investing in building two high-tech plants (to equal a total of eleven plants nationwide) at a cost of US$200 million. One plant will be in Binh Duong province with a capacity of 400 million litres of fresh milk annually, whilst the other plant will be built in Vietnam-Singapore Industrial Park to focus on producing high-quality powdered milk (Dielac) with annual capacity of 54,000 tonnes a year. The Binh Duong plant is expected to be the biggest in South-East Asia. It is hoped that by 2017, Vinamilk’s current liquid milk production will double, yogurt products will increase by 30% and powdered milk by 125%. Other components of Vinamilk’s strategy include buying more farmland to build new farms as well as expanding existing farms in order to supply more input materials to meet Vinamilk’s production capacity demands. The company is aiming to expand the number of cows it owns to 30,000 by 2019. In addition, Vinamilk’s strategy includes diversifying product lines to meet increasing consumer demand of all sorts of dairy products, continued expansion of its extensive distribution networks, and manufacturing Vinamilk branded products in Australia and New Zealand (where the cost to produce a litre of fresh milk is lower than in Vietnam due to excellent natural conditions for raising cows and modern production technology).

With such compelling leadership vision from Mai Kieu Lien as well as overall growth in the Vietnam dairy market and well-chosen investments for their future, I would bet on Mai Kieu Lien to continue leading Vinamilk’s dominance of their domestic dairy market and to increase their exports. Hold this stock for the long-term and great rewards could be reaped.

 

Banking on Metro

UK retail banking is a mess; bereft of adequate customer service and lacking innovation the major banks – RBS, Lloyds Banking Group, Barclays, HSBC and Santander – are ripe to be challenged. The major banks have experienced sluggish growth and high operating costs due to a succession of acquisitions that have not yet been fully integrated. Furthermore, the retail banking market in the UK is very highly concentrated, with 88% of the market’s retail deposits taken by the top six banks. This contrasts sharply with Germany where the top seven banks have a 68% market share and the USA where the top eight banks have 35% market share.

Enter Metro Bank. Founded in 2010, it now has 15 branches, 100,000 customers and assets of £800 million. They survived tough initial scrutiny from the Financial Services Authority in 2010 in order to be allowed to establish a bank that could take retail deposits. Metro Bank’s competitive advantage is its simplicity – they have just one current account as well as a single computer system that handles all its customers’ accounts and details in order to provide staff with a holistic view of its customers. The concept of beauty in simplicity also extends to Metro Bank’s stores; they all adhere to a strict criteria of being located near transport hubs, being corner sites with around 4,000 square feet, and have ceiling-to-floor windows to create an engaging and transparent customer environment. Their 15 branches need to attract around £25 million retail deposits each in order to lend profitably, which can be obtained with just around 8% of the local retail banking market around each branch. For 2011, Metro Bank reported £33.1 million in losses, largely due to increased investment in store openings. Metro Bank will probably continue to make losses in 2012 and 2013. However, it is important with this investment to emphasize the positives and long-term potential. Since January 2012, they have increased their deposit base by 310% to £530 million and grown their lending to £150 million, a 400% growth. They also now provide around 6,000 mortgages – just three years after launching. A recent agreement signed with MasterCard to provide Debit and Credit MasterCard services with its current accounts also signals rising potential. Metro Bank have set a target of opening 200 branches in London by 2020 with calculated assets of £10.7 billion, assuming same ratios of assets to branches – this goal seems well within their grasp considering their growth story thus far. Metro Bank plan to float on the London Stock Exchange (LSE) around June 2014, which means there is ample time to assess this investment opportunity.

People are often key to a successful business – it is a oft-repeated phrase that in this case may be a considerable advantage. Metro Bank are chaired, and founded, by Vernon Hill – an entrepreneur with extensive experience founding and expanding Commerce Bancrop in 1973 from Philadelphia to throughout the eastern coast of the USA with assets of US$50 billion and 500 offices. Vernon Hill’s first foray into retail banking received many awards for its retail banking and customer service and was acquired by Toronto-Dominion Bank in 2007 for US$8.5 billion. Vernon Hill’s shrewd business judgments are not just confined to retail banking, having co-partnered with US Restaurants Inc to operate 40 profitable Burger King restaurants in downtown Philadelphia as well as developed Site Development Inc into a real estate development firm with experience developing over 1,000 shopping centers and retail sites in the USA. Furthermore, Metro Bank CEO Craig Donaldson has extensive local retail banking experience having started on Barclays’ graduate development scheme before working in management roles at HBOS, Natwest, Halifax and RBS. Additionally, key investors in Metro Bank are property magnates who value stable investments – Richard LeFrak and the Reuben brothers, as well as renowned fund manager Fidelity. In June 2012, the company also announced the end of a £126 million capital raising, which bagged funds from Moore Capital and billionaire investor Steve Cohen. It is therefore evident that the key people have the right experiences to make Metro Bank successful - and major investors also seem to think so.

love at first sight? 

I would argue that the retail and business banking industry in the UK is ripe for a new challenger, such as Metro Bank. Such a challenger also has the full support and blessings of the UK Government and financial regulatory authorities. In 1980, just 60% of the UK adult population had a bank account and now 94% do. The number of services that a bank sells to a typical customer has also risen dramatically with banks cross-selling current account customers various other products including credit cards, personal loans, mortgages, insurance and investment products. Moreover, technology has enabled retail banking to become more cost-efficient and done without need for customers to come to their local branch. Advances in information technology have driven down the cost of processing and the introduction of cash machines and internet and smartphone banking has driven down the costs per transaction. However, while the focus has been on product expansion, there has been less of a focus on the core element of retail banking – customer service and personal relationships. This is the focus that Metro Bank is banking on. In fact, contrary to other banks, they want their customers to come into their branches.

In an era of less sexy risk-taking, retail and business banking is due to play a more significant part in the universal bank’s EBITDA. The financial crisis reversed dominant trends in the UK retail banking market – trends such as reckless balance sheet growth due to fierce competition as opposed to a focus on innovation to differentiate from competitors. The financial crisis also induced low interest rates, reduced competition and a shortfall in the supply of credit. Shortage of credit in the UK is particularly sharp at 15% of GDP compared to 2.5% in the USA and 3% in the Eurozone. This is a ripe environment for new market entrants. In this environment economies of scale is no longer the primary source of domination – improved margins attached to core retail banking products is creating an opportunity for smaller entrants to differentiate by innovation. Politically, the government and opposition both want more competition in UK retail banking in order to help meet the credit needs of households and small businesses. This is backed by the EU’s demands that RBS and Lloyds Banking Group sell assets as the price for requesting state aid. Metro Bank in particular are aligning their product offering with what the customers want in the post-financial crisis era – a recent survey shows that retail depositors place high value on branches and service levels, conveniently located branches, longer service hours, and bank ethics. Metro Bank aims to attract busy London customers with late opening hours and high levels of customer service in conveniently located branches for commuters. The lack of a legacy for Metro Bank also allows them to build without constrains such as political pressures, historical mistakes, the need to integrate technology from mergers (roughly one-third of incumbent banks’ operating costs), and existing union agreements that do not allow incumbent banks to easily change banking work hours. These benefits will allow Metro Bank to enjoy a significant cost advantage once they get over their initial high cost-income ratio. They may ultimately be able to compete strongly on price and to offer services with lower charges – a major source of customer dissatisfaction. That is why I will be banking on Metro. 

A Mid-sized Telecoms Company That Rings True!

Portugal Telecom (PT) look like a great long-term investment this year, both for exposure to emerging markets and investment in the non-cyclical telecommunications sector within a eurozone periphery country displaying economic recovery. PT stock is currently trading at €4.1370 per share on the Lisbon stock exchange, with a 52 week range of €3.0030-€4.4620, a P/E ratio of €14.8704, earnings per share of €0.2700, and market capitalization of €3,600,500,000. PT’s share price has also risen steadily by 32% since June 2012. Investing in PT at this point would conform to Warren Buffett’s investment philosophy that “Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised.”

PT's future of fibre optics?

Recent consolidation in the telecoms industry suggests there will be further consolidation in the next few years. The German telecoms market is highly fragmented with several regional operators. The UK’s Vodafone is interested in acquiring Kabel Deutschland, Germany’s biggest cable operator that provides phone and internet services to over 8 million households, for €10 billion – completion of the deal would provide Vodafone with its own broadband lines as they currently spend €300 million a year on leasing lines from Deutsche Telekom. Similarly, private equity owned French cable operator, Numericable, is looking to purchase Vivendi’s telecom operator SFR – Numericable is the only national cable operator in France and the leader in high-speed fixed optical fibre cable access whilst SFR is France’s 2^nd largest mobile operator. In Portugal too mobile operator Optimus announced a merger in January with cable operator Zon to create the second largest firm in their telecommunications market. Also in the UK, BSkyB have announced their €229 million acquisition of O2, the UK broadband business of Spain’s operator Telefonica - the deal adds 500,000 new subscribers to its 4.2 million base and makes BSkyB the second largest broadband provider in the UK. Late February also saw a €19 billion bid from US market leader Liberty Global for the UK’s Virgin Media, which has been notified to the European Commission due to competition concerns – the merger would strengthen multi-product offerings spanning fixed line, mobile phone, internet, and television. It would be reasonable to suggest that PT may be part of this consolidation.

Internally, Portugal Telecom have many strengths that would appeal to investors. PT is the largest telecommunications company in Portugal, with 100.4 million customers in 2012 and EBITDA of €2.269 billion. PT owns PT Comunicações, the largest landline operator in Portugal. PT owns Telecomunicações Móveis Nacionais (TMN), the largest mobile phone operator in the country. PT also owns 25% of Páginas Amarelas, the publisher of the Portuguese Yellow Pages, and PT PRO, one of the largest shared services companies in Europe. One aspect of PT that would appeal to investors is their significant presence in emerging markets, particularly China, Macao, East Timor, Guinea-Bissau, Cape Verde, Mozambique, Namibia, Angola, Kenya, and Sao Tome and Principe. Some of PT’s foreign holdings include:

·         Brazil - 25% stake in one of Brazil’s largest telecom companies, Oi;

·         Angola - 25% stake in Unitel, 40% in Multitel (internet access and data provider), and controlling stake in ELTA, Angola’s telephone directory company;

·         Mozambique – Owns directory company - Listas Telefonicas de Mocambique, owns Teledata (ISP and data);

·         Cape Verde – 40% stake in CV Telecom, 60% stake in Directel;

·         Sao Tome and Principe – 51% stake in Companhia Santomense de Telecomunicações;

·         Namibia - Through a 75% owned investment holding company Africatel, PT holds a 25.5% stake in Namibian mobile company MTC;

·         East Timor – 41% stake in Timor Telecom;

·         Macau – 28% stake in CTM.

Despite a difficult European macroeconomic environment, PT managed to increase their number of customers in Portugal in 2012 by 3.4%, the number of business and corporate mobile users in Brazil by 14%, and the number of customers in Africa and East Timor by 16%. Data accounts for 34% of PT’s revenues and they have sought to consolidate this revenue stream through investing in cloud computing – Cloud PT – as well as in partnerships with Oracle, SAP, Cisco, Fujitsu and EMC. PT also boast an excellent 52% of non-voice revenues. In another way, PT show that they are a very innovative telecommunications company. PT has an advanced fibre-to-the home network in Brazil and cover 46% of Portuguese households and businesses with this FTTH. In February, PT further advanced their innovation by teaming up with small British ecommerce company, Powa, to create devices that allow businesses to take card payments by smartphone – the first in Europe. Powa, a competitor to Square, hope that their device, small card readers that connect via Bluetooth to the smartphone, will be available in Q3 2013. Powa’s device differs from Square, which concentrates on new users to card payments and utilizes swipe technology, as it targets existing users through banks and telecoms companies and has security clearance to handle chip and PIN which is widely used in Europe. Powa’s device takes a small licensing payment on top of the card fee, which is split with PT.

Mobiles for all!

Portugal, as a periphery country within the eurozone that took a bailout from the EU, is experiencing economic recovery. Buying into PT, one of the Lisbon Stock Exchange’s largest companies, therefore also means buying into exposure to Portugal’s economic recovery, which is being driven by renewed confidence in their corporate sector. While Portugal’s economy is still likely to be in recession during 2013 and with unemployment set to reach 19%, there is still much for Portugal’s government to do before they are truly recording positive growth. Yet the Portuguese 10-year government bond yields have fallen from around 15% in January 2012 to 5.9% currently, which intimates at heightened international market confidence in Portugal’s economy.

Therefore, there are many reasons to favour an investment in Portugal Telecom stock right now. Combine the above factors with PT’s annual habit of dividends of around 16% and a stock price around €4, makes this a favourable investment. Speculation abounds that China Mobile, the world’s largest mobile phone operator by number of customers, is interested in investing in PT due to its African and Brazilian exposure as well as comparatively low valuation, and there is an opportunity to possibly capitalize on a fast rising stock too this year.

A Dutch Auction?

For those unfamiliar with the concept of a Dutch auction, it is one in which the auctioneer begins with a high asking price which is lowered until a participant bids for the auctioneer’s price or a predetermined reserve price is reached. Much the same is happening with the European Union’s budget deficit limit as various member states threaten to flout the rules, lead by the Dutch.

Despite being one of the Eurozone’s keenest proponents of budget deficit limits at prior European summits, the Netherlands have decided to make no attempt to rein in its projected 2013 budget deficit under the agreed limit of 3% of GDP. The Dutch economy shrank by roughly 1% in 2012 and is expected to contract a further 0.5% in 2013. The Netherlands’ budget deficit is also expected to be 3.3% of GDP in 2013. The 3.3% budget deficit is mainly due to the nationalisation this month of failing bancassurer SNS Reaal in which the Dutch government provided a €1.1 billion bridge loan and €1.9 billion recapitalization. This projection has influenced the Government’s decision not to pursue further austerity measures, such as budget cuts or tax rises, to meet the 3% limit. However they will likely back further austerity measures in 2014 when the budget deficit is estimated to be 3.4% of GDP.

The government’s decision not to pursue further austerity measures this year is largely due to the Dutch economy being hit by a drop in consumer spending. Household spending has dropped to the same level as in 2001, house prices are falling and contributing to a less liquid housing market, real wages have fallen, and value-added tax has been increased from 19% to 21%. Unemployment has also risen to 6.4% and pension funds have announced premium increases to meet their coverage ratios.

EU coming down on its member states

A secondary reason is that the Dutch government is a coalition of centre-right Liberal and centre-left Labour parties and is effectively governing with a minority as they do not have a majority in the Dutch upper house Senate. They are therefore not keen to institute budget cuts and tax raises in the Netherlands, especially as the country has experienced three such periods since 2010, which decreased government spending by €46 billion or 7.1% of GDP.

Theoretically, the European budget commissioner can impose penalties on countries that violate the agreed limit. However, the Dutch believe that they will not be fined this year as they have taken effective action against their long-term structural budget deficit. The only country to request a delay in meeting the 3% budget deficit limit, and who have not received EU economic aid, is France. Portugal, Greece and Spain have all received one year delays to comply with the limit. However there are many other EU countries seeking delays to implementing the budget deficit limit.

On a bigger picture, some say that the worsening outlook in the Netherlands suggests a policy of growth through austerity is failing. In my opinion, austerity measures are not going to bring the European economies out of the crisis – it’s akin to giving cigarettes to a lung cancer patient. Austerity means lower real incomes, pensions, and minimum wages, and this translates into less income from consumption and less economic activity. This leads to a vicious cycle of a higher budget deficit and higher taxes. The EU and its member states should not be attempting to curb their budgets – that is for when the Eurozone is on a true upswing in the boom/bust cycle. Instead they should be focusing all their efforts on reducing unemployment, which would raise productivity, European competitiveness, and overall incomes, translating into a healthier budget deficit, higher consumption, and higher economic growth.   

A Japanese Twist in the Natural Gas Saga

Japan has just announced that it has been the world’s first nation to extract natural gas from frozen methane hydrate off their coast. Methane hydrate is sometimes called clathrates or fire ice and is a frozen ‘cage’ of methane and water molecules. This announcement suggests that Japan may soon have their own shale gas revolution to rival the USA. The announcement is also likely to worry international oil companies who are targeting Japan as a key market for their products in the next few years. Although other countries are examining methods to exploit methane hydrate deposits, they have been less invested in their efforts due to an abundance of easier energy sources, in particular the large shale deposits in the USA and China and the oil sands in Canada. What has incentivised the Japanese to push for their own “clathrates gas revolution” is the higher cost of LNG prices contributing to a rising trade deficit that the new government under Shinzo Abe is trying to arrest as well as exposing its major power utilities companies, such as Tokyo Electric Power Company and Kansai Electric Power, to massive financial losses.

Powering Japan's future?

Currently, Japan is heavily reliant on imports for its energy needs, especially after the Fukushima Nuclear disaster of 2011. They are the largest importer of LNG in the world and currently pay about US19/mmBtu for their imports. This is about five times the US Henry Hub natural gas price of around US$3.70/mmBtu. Several IOCs with large shale gas production in the USA have applied for export licences and are building LNG terminals in order to meet demand in North Asia. Therefore, this recent development could be particularly worrying to them, as they will have the infrastructure to export natural gas to Japan by 2015. It has been estimated that there are around 1.2 trillion cubic metres of methane hydrate off the shore of Japan, equivalent to 11.5 years of Japan’s natural gas consumption. Yet, it could take until 2016 or 2017 until Japan have built economies of scale and improved offshore drilling technology to the level to make extraction of natural gas from methane hydrates economically profitable.

However there are environmental concerns with extracting methane hydrate. Drilling for undersea methane hydrates could have an impact on earthquake-prone areas, a particular concern for Japan.

If Japan is able to produce economically profitable methane hydrates in the next few years they will have a large reserve of natural gas to reduce their dependency on imports. This could bode ill for the natural gas market by decreasing prices worldwide and in particular force international oil companies to accept lower revenues despite a huge outlay on initial natural gas infrastructure. It will be interesting to see how Japan’s “clathrates gas revolution” compares to the US’ “shale gas revolution”. 

Is this the year for Merger Arbitrageurs and M&A?

The last five years has been a torrid time for the mergers and acquisitions market, and in turn for those investors seeking merger arbitrage opportunities. What do firms such as Touchstone Investments, Twin Securities, and Tyrus Capital have in common? They are all merger arbitrage specialists – funds who aims to profit from the spread between a target group’s share price after a takeover announcement and the closing price at completion of the deal. Several large funds scaled back their merger arbitrage operations during the financial crisis as deal activity dried up and their ability to borrow was curtailed. The lack of competition means merger arbitrage funds can make high double-digit returns in a couple of months even from mainstream deals. Therefore, I would investing in a merger arbitrage fund ahead of the expected recovery in M&A activity.

M&A deal volume peaked in 2007, just before the financial crisis, at US$4.1 trillion. Deal volume then experienced a sharp decline and in 2012 deal volume was $2.2 trillion after a more optimistic first half of the year due to high projected growth rates in emerging countries. The fact that the European bond markets rebounded in late 2012 and the USA did not default on its debt should augur well for M&A in 2013. The Dow Jones Industrial Average also topped 14,000 for the first time since 2007 last month.

Mergers & Acquisitions have started strongly this year. Some of the deal activity includes:

·         Sinopec’s acquisition of a 50% interest in some of Chesapeake’s oil and gas properties in the Mississippi Lime Shale formation for US$1.02 billion cash. The valuation is notable for falling short of expectations as Chesapeake are a company that are having to sell due to large debt problems and are looking like a forced seller.

·         $11 billion merger between bankrupt AMR Corporation (parent of American Airlines) and US Airways Group.

·         Liberty Global’s $23.3 billion purchase of UK cable operator Virgin Media.

·         Michael Dell’s deal along with partners Silver Lake private equity firm and Microsoft to take Dell private for $24.4 billion in the biggest leveraged buyout since the financial crisis.

·         Heinz is under a $28 billion bid from Buffett’s Berkshire Hathaway, 3G capital backed by Brazilian billionaire Jorge Paulo Lemann (who led leveraged buyout of Burger King in 2010). Berkshire and 3G will contribute $4bn of equity each, and Berkshire will buy another $8bn to $9bn of preferred stock paying a 9 per cent coupon. The bid values Heinz at $28bn, including $5.1bn of net debt, and is subject to shareholder and regulatory approval. In addition to the buyers’ cash, JPMorgan and Wells Fargo have committed debt financing of $14.1 billion for the deal.

The US Federal Reserve has held benchmark interest rates at 0.25% for over four years and the European Central Bank has held interest rates at 0.75%. Trillions of dollars have been injected into US, European and Japanese economies in an effort to kickstart them. Additionally, markets are liquid and stable. Investors are also moving assets out of cash and are searching for high-yielding and riskier assets. This is a market ripe for M&A activity.

Yet if the market is going to continue to derive interesting opportunities for merger arbitrage investors, then a few developments are necessary.

·         Cash-rich corporates are conserving their mounds of cash. As of 1^st October 2012, corporations globally were sitting on a record $1.5 trillion of cash and their balance sheets have never been stronger. However, corporates are facing a “use it or lose it” conundrum where investors are pressuring cash-rich companies, such as Apple, to either use the funds for acquisitions and increase capital expenditure or pass it over to the shareholders either through share buybacks or dividends. I suspect that companies are starting to “use it” and will continue to do so as cash-rich corporates can cherry pick underleveraged companies at attractive prices in the current environment.

Time to pop a bottle?

·         M&A activity typically lags 12 months behind the stock market pick-up and 18 months behind corporate CEOs’ confidence. Business confidence has been improving since Q4 2012 as worries about the eurozone debt crisis and a potential slowdown in China’s growth have subsided. Therefore, we may be seeing M&A activity catching up with stock market and corporate CEO sentiment.

·         The environment right now is earnings accretive for M&A. There is a record spread between the free cash flow and the earnings yield. Additionally, the low corporate bond yields on offer is rendering debt-financed M&A activity especially appealing.

·         Many companies’ market capitalisations are trading below replacement value and this is above the historical average – 28% of the European market is trading below replacement below which is well above the average of 14%. Therefore, buying is abnormally cheap compared to building a company in the current environment. With such attractive equity market valuations M&A activity should be around the corner.

·         In 2012, 10% of all global M&A activity involved international companies acquiring US targets. This trend is expected to continue in 2013 as companies in developed countries with relatively slower-growth – Australia, Canada, Japan, Europe – seek opportunities in the USA with its better growth. Companies from emerging countries, such as China and India, are also attracted by the US recovery – Chesapeake’s sale of assets to Sinopec is one such example.

·         There is a discrepancy between M&A activity in the USA and Europe. Banks have resumed lending in the USA whereas in the Eurozone banks are still not lending. M&A activity will receive a pick-up if the EU can get their banks to restart lending.

The only likely detractor from an M&A recovery in 2013 will be heightened regulatory scrutiny, particularly in the case of cross-border deals. Yet, much of M&A activity is psychological. The deals in 2013 thus far would have helped to raise confidence that the worst of the financial crisis is over. Whether merger arbitrage investors are able to open that bottle of Pernod-Ricard Perrier-Jouet will depend on whether companies buy into the confidence and keep on spending.

Ethanol RIN-Sanity

As climate change becomes a hotter topic, various governments have taken steps to introduce renewable energy sources into their domestic consumption. The problem with ethanol is that while it is a viable energy source, it also courts controversy by affecting corn prices in developing countries and subsequently world food prices. Nonetheless in 2007, the US government introduced the RINs market to facilitate the use of more biofuels (typically ethanol or biodiesel) in the USA. The 2007 Energy Independence and Security Act had set levels for various types of renewable fuels that have to be blended with US gasoline and diesel fuel, with the required levels of biofuels increasing steadily from 2008 until 2022. By 2022, 35 billion gallons of ethanol and 1 billion gallons of biodiesel fuel are to be blended with U.S. motor fuel. 

The mechanism to ensure the required levels of blending are reached is the Renewable Identification Numbers (RINs) and the US Environmental Protection Agency (EPA) oversees them. RINs are actually just a 38-digit identification number. RINs also have expiration dates. RINs have their own value to reflect the changing economics of blending biofuels with gasoline and diesel fuel. RINs are issued at the point of biofuels production or import and then the RINs must be reported to the EPA. When biofuels are sold, the RINs are transferred too. The refiners, importers and blenders that buy the biofuels and RINs must then blend a portion of their gasoline or diesel fuel with the biofuels. After the biofuels are blended into the gasoline or diesel fuel, the refiner, importer or blender sends the RINs to the EPA to evidence compliance with their company’s Renewable Fuel Standards (RFS). In years when biofuels blending exceeds the required level in the industry as a whole, as has happened with ethanol in the past couple years, the excess RINs that are generated can be used to offset blending shortfalls in future years. These excess RINs can be sold or bought by other refiners and blenders to use as credits against their Renewable Fuel Standards. The alternative is for the current owners of the RINs to hold them to use in future years. This system allows refiners and blenders to buy excess RINs when their costs of blending are higher than the cost of purchasing the RINs. In the past few years, the ethanol industry has produced more ethanol than required and therefore excess RINs have been issued. A swap market has also developed for RINs.

A Bright Future for Speculators but not for American Families

Since January 2013, ethanol RINs have gained 1,400% due to oil refiners and fuel blenders worrying they will be unable to meet their ethanol blending mandates with physical supply. Prices are 110 cents per ethanol RIN, up from 5 cents per ethanol RIN at the end of 2012. On the supply side, high corn prices and weak petrol demand in the USA has forced some ethanol refiners to shut down plants. US ethanol production is estimated to be around 12.3 billion gallons in 2013, which would be insufficient to meet the EPA’s requirements for this year. This year the EPA requires blending 13.8 billion gallons of corn-derived ethanol with gasoline and diesel fuel. However, currently most fuel wholesalers sell their petrol blends with 10% ethanol content and combined with US gasoline and diesel fuel demand remaining flat at 134 billion gallons this year, this means that demand of 13.4 billion gallons of ethanol will fall below the requirements of the EPA. Therefore ethanol supply has tightened at the same time as demand has weakened for petrol and increased for RINs as speculators enter the secondary market to exploit profit opportunities with demand likely to grow. Furthermore, cash-rich international oil companies have been buying excess RINs from blenders and refiners to ensure compliance with the RFS, all of which has increased the likelihood that the “blendwall” is nigh – the time when the maximum amount of the US petrol pool has been blended with 10% ethanol.

It is likely that RIN prices will continue increasing due to a variety of factors:

·         Only a small minority of cars in the USA can burn ethanol blends with greater than 10% ethanol content;

·         The refineries and blenders are still developing the equipment to provide higher blends than 10% ethanol content;

·         US gasoline and diesel fuel consumption, and consequently, demand is in long-term decline;

·         The 2007 Energy Independence and Security Act already fixed the required levels of biofuels to blend with gasoline and diesel fuel for every year until 2022 – there was no room for flexibility in setting these levels.

Therefore as there is a 10% cap on the ethanol content and falling demand for petrol consumption, meeting the RFS is only possible by purchasing RINs. Thus entering the RIN market looks attractive at least for the remainder of 2013. It is easy to trade RINs – one merely has to register with the EPA and create an individual account on the EPA’s Central Data Exchange. Higher RIN prices are also boosting the price of gasoline for retail consumers as ethanol is a mandated component for retail gasoline, so speculating on gasoline prices is also an attractive proposition.

However, in the longer-term we must watch for developments that could alter the fundamental support for RIN prices:

·         A more rapid expansion of ethanol blending with petrol of 15% ethanol content would expand the “blendwall” and reduce demand for ethanol RIN credits to meet the RFS;

·         Lobbying Congress to renegotiate the RFS would reduce the mandated levels for biofuels and so would also reduce the demand for ethanol RIN credits.

Is there a Gold Flush?

The gold market has recently been declared by several banks, including Goldman Sachs and Credit Suisse, to be at the end of its decade-long bull run. However I contend that it is a time to buy gold. With gold prices currently at US$1574 an ounce, this is near the low point in 2012.

There are several reasons that the aforementioned banks feel gold’s decade-long bull run has come to an end. Gold’s bull run coincided with the introduction of gold exchange traded funds (ETFs) that were launched in 2003. These gold ETFs offered investors a relatively low cost and easily tradable method of holding physical gold. The way they work is that the ETF buys physical gold and then issues shares that investors can buy and trade on an exchange. Collective ETF gold holdings globally are 2,491 tonnes – larger than all but two central banks, the USA and Germany. However since January of this year, ETFs have sold 140 tonnes of gold. The sell-off is partly due to broader negative sentiment towards gold as investors become more confident in the global economy and put their money into riskier assets such as equities. As investors grow more confident in the US and Chinese economies, they are shifting their allocations to equities. The Dow Jones Industrial Average surpassed its previous record high set in October 2007 by closing at 14,253 last week. Furthermore, regulatory filings reveal that George Soros and Louis Bacon have sold portions of their gold ETF holdings in February. As ETFs have become a major force in the physical gold markets, their recent sell-off could accelerate a dip in gold prices.

How can it be worth-less?

The ETF gold sell-off is also a surprise, when compared to previous periods of gold price weakness when ETF holdings showed investors stuck with the metal. The simultaneous fall of gold ETF holdings and the price could reflect the activity of a few hedge funds selling their gold investments. Yet it is also worrying that despite the US’s failure to avert signing budget cuts into law, gold has remained at its low price. Perhaps it is because there is less fear of unbridled inflation or a collapse in the USD’s value. Even on the Comex futures bets on falling gold prices is at the highest level since 2000. Moreover, the latest 5% drop in gold prices in the past two weeks due to uncertainty of the duration of the US Federal Reserve’s asset purchase programme has made the 50-day moving average price of gold fall below its 200-day moving average, intimating little support for the metal. Furthermore, with the US and Asia showing stronger economic activity, investors are opting for assets that benefit from GDP growth, pay interest or dividends. The gold sell-off may also have longer term roots. Gold soared from a low of US$253 in 2001 to a high of US$1920 in 2011. Many suggest that from a long-term perspective, the decade-long bull ran has rendered gold substantially overvalued both in absolute and relative terms.

In the last few years, the metal has failed to show any strong signs of a directional trend, typically trading within a range of $1570 to $1850. There are several explanations for the ETF sell-off that may be positive for gold. Perhaps there is a shift in the type of investors that allocate a proportion of their assets to gold in ETFs. The investors were generally individual investors and institutions such as pension funds or insurance companies that were more inclined to hold their gold during times of trouble as they were driven by longer-term considerations such as the need to hedge against currency debasements and unexpected inflation. However, it could be that gold ETFs, like many other asset classes, are becoming popular with shorter-term traders as well as long-term investors. Therefore, the recent sell-off of gold could be a short-term trend rather than an inflection point in the gold price trajectory. China’s launch of its first gold ETFs this year should also help increase demand for gold in 2013. As China, along with India, are the two largest physical markets for gold worldwide, the demand from these two players can have a major influence on the gold price. As China’s economy propels more of their citizens into the middle-class, their consumption of luxury items made of gold will likely increase. The Indian Rupee has also strengthened since the beginning of 2013, which should make gold more affordable for price-sensitive Indians. The patterns of demand for physical gold is also shifting with many other emerging markets in the Middle-East and South-East Asia now accounting for a higher proportion of gold demand. It is also emerging market central banks that are increasing their gold reserves as a hedge against inflation eroding the value of their substantial USD reserves.

The ranging of gold prices in the past few years between $1570 and $1850 suggests that perhaps gold has finished its bull-run. Yet it does not mean that the gold price will suddenly spiral downwards. On the contrary, if gold is trading within a range, we are near the bottom of the range signalling a good time to buy gold. The combination of strong physical demand growth for gold in emerging markets as well as the scarcity of gold should ensure that prices are supported within this range in the coming years. Therefore, I recommend taking a long position on gold and buying into an ETF, such as SPDR Gold Shares, and wait to sell at around $1800-1850.

Asian Invasion into US Collateral Loan Obligations

Collateral loan obligations (CLOs) are a form of securitisation where leveraged loans from multiple corporate loans are pooled together in a special purpose vehicle (SPV). Leveraged loans are those loans extended to companies that already have considerable amounts of debt – as these loans are at higher risk of default, they cost the borrower more in interest. The SPV then issues bonds that are sold to investors in several different tranches with varying levels of rights to collateral and the payment stream. There are typically AAA rated (generally 64% of the total investment), AA, BBB, mezzanine, and equity (10% of total investment) tranches. CLOs are popular as arbitrage conduits that generate equity returns through leverage by issuing debt that is around 10 times their equity contribution. An alternative type is the market-value CLOs that are less leveraged, around 4 or 5 times, but that allow managers greater flexibility than the more tightly structured arbitrage CLOs. CLOs are typically rated by the major ratings agencies – Moody’s, S&P, Fitch. CLOs also enforce several covenant tests on the collateral managers covering areas such as minimum rating, industry diversification, and maximum default basket. The attraction of CLOs is that it makes it easier for companies to borrow by allowing banks to transfer loans they originate, as well as the risks attached to the loans, to institutional investors.

In 2006 and 2007, CLO volumes were roughly US$190 billion. CLO volumes dipped to negligible amounts in 2009 and 2010, before a resurgence in 2011 and 2012 during which US$70 billion of CLOs were recorded. In the current low-yield environment, the CLO market is making a comeback. The yield in a CLO rated BBB or in the equity tranches is much higher than in similar rated fixed income instruments. In particular, Asian investors, who have felt less of a sting from the financial crisis and who are cash-rich, are driving demand for CLOs as they seek higher yield. The keenest investors seem to be North Asian insurers struggling with high guarantees on their historic business, such as Sompo Japan Insurance, Tokio Marine, and KB Life Insurance. Already in 2013, we have seen 18 deals of around US$9 billion in January and US$6.5 billion of issuance in February. The market is expected to reach US$75 billion by year end. The typical client in the CLO market is also diversifying away from merely US investors with North Asian investors seeking more sophisticated asset classes. It is an important trend to take advantage of the US market for leveraged loans - worth around US$1 trillion – especially as in 2012 50% of new leveraged loans originated by banks were purchased by CLOs.

CLOs are safer than other forms of securitisation that had infamous roles in the subprime mortgage crisis and subsequent credit crunch. CLOs are a first derivative securitisation as the underlying assets are leveraged loans. However, CDOs are a second derivative securitisation as the underlying assets are other securitisations such as mortgage-backed securities, SME-backed loan securities, and CDOs. Therefore it is easier to evaluate a CLO portfolio than a CDO portfolio. In addition, trustees typically report every month to investors on the collateral, underlying credits, payment waterfall and the net asset value (NAV). Additionally, out of 41,120 tranches of CLOs rated by Moody’s from 1996 to 2012, only 32 tranches or 0.8% hit event of default and suffered losses on the principal investment at maturity. Therefore, CLOs had a low default rate before and during the financial crisis. 2013’s bullish prospects for US corporate credit, transparency in the underlying assets, good track record, and the added yield offered by CLOs are all factors that make purchasing CLOs attractive this year.

However there is one caveat. Regulation has impacted the CLOs market, which has ensured that the US market will see stronger growth than in Europe. Article 122a of the EU Capital Requirements Directive and the Dodd-Frank Act have both incorporated the concept of risk retention which require the CLO manager to retain at least 5% of the total size of the CLO until maturity. The rule in the Dodd-Frank Act does not come into effect in the USA until 2015, but there are attempts to exempt CLOs from the risk retention rule. Conversely European CLO is low as European banks have been unwilling to comply with the risk retention requirement due to low leveraged loan issuances in Europe as well as potentially high liability spreads across the different tranches of a CLO. Therefore, it is likely that demand will dampen for US CLOs if they are not made exempt from the risk retention rule.

Greek Stoicism

Zeno of Citium, the founder of Stoicism, promoted maintaining a balance of the mind so that errors of judgment did not occur and consequently manifest destructive emotions. After six straight years of recession, Greece is in need of just such stoicism to walk the tightrope between withdrawal from the Eurozone and staying within the monetary union’s relative prosperity.

Greece were the recipient of the biggest bailout in world history, a massive €240 billion from the troika of the EU, IMF and ECB. Continued funding from the Troika has built credibility.

However, Greece faces many challenges this year which could still result in a Greek default on its debt. If not that drastic an ending, such challenges will ensure ample opportunities to buy Greek bonds at high yields that could net profits like $500 million of US hedge fund Third Point last year.

Greece’s economy has wobbly foundations. Unemployment is at 26% and projected to hit 30% by June this year. 33% are living below the relative poverty line in Greece – meaning they earn less than €7,100 per annum. Greek GDP is also set to shrink by 4.5% this year, meaning that it has shrunk by 25% cumulatively since 2007. In addition, even after billions of euros in cuts, the Greek economy is in such a dire state that it is unable to absorb long-term reforms to kickstart economic growth. In order for the economy to function again, it is estimated that Greece will have to be absolved of at least 50% of its debt. Their current debt is 180% of its GDP. Despite these worrying signs, Greece will need to meet the expectations of international creditors who are keeping insolvency at bay.

Greece recently received €34 billion of rescue loans in December 2012. However, the trickledown effect will ensure that it takes a long time to reach the people. Critical steps to ensure Greece remains within the eurozone and on the pathway to recovery are:

·         There is a risk that the fragile Greek government coalition will not survive social rest in 2013 that could be exacerbated by the inevitable implementation of €9.2 billion in cuts this year. They will have to survive if Greece is to remain within the Eurozone.

·         Germany is set to elect its new government in September. Once a new government has been elected, they will be able to set the tone on whether an official writedown of Greece’s immense €340 billion debt burden is endorsed.

·         Clampdown on tax evasion – this is a major problem, particularly the ability of the wealthy elite to use their political influence to evade taxes. Tax evasion is estimated to cost the Greek government €30 billion annually in lost revenues.

Contemporary Greece - An Athens or Sparta?

·         Overhaul its current tax administration (condition of Troika funding) -  Greece attempted to collect overdue tax had a target of €2 billion in 2012, yet the government only raised €1.1 billion. It is also estimated that Greece has unpaid taxes of €55 billion, roughly 30% of their GDP. Tax reforms were announced in February 2013 that will further squeeze middle-class taxpayers by expunging tax exemptions for insurance premiums and interest on mortgage payments, increasing annual property taxes, and introducing a 20% capital gains tax for stock trading. Annual incomes of up to €25,000 will be taxed at 22%, whilst incomes over €40,000 will be taxed at 42%.  The corporate tax rate will increase from 20% to 26%.

·         Successfully complete privatisations – The government needs to raise €2.6 billion this year from sales of state-controlled companies. If revenues fall behind the target set by the Troika, the shortfall will have to be made up through immediate spending cuts. State-owned gas trader DEPA has been the subject of a €1.5 billion bid from Gazprom.

·         Attract foreign direct investment – in particular the Troika made it a condition of funding that the big four banks – National Bank of Greece, Eurobank, Alpha Bank, Piraeus Bank – attain foreign investment in them. However, they together hold negative equity of about €8 billion, which is a disincentive for investors to inject fresh capital as they are not willing to pay for pre-existing losses. Thus far, few fund managers and hedge funds have shown interest in buying shares in Greece’s big four banks. Without investment from foreign investors, the banks will be fully nationalised by the Hellenic Financial Stability Fund (the administrators of the Troika’s bailout money).

·         Tourist season begins in June – income is badly needed to be brought into the ailing economy.

To date Greece has managed to rein in its government spending and the Greek citizens must now also accept the pain of these cuts to allow a government to have the longevity to see out this period of recession. Private companies have cut monthly salaries to the minimum wage of €580 per month by renegotiating contracts with their employees. Meanwhile the government has capped the majority of public sector salaries at €5,000 per month. However the upside to the approximately 35% decrease in Greek wages over the past two years is that several multinational companies see Greece’s labour as highly competitive relative to other European countries. Companies such as Coca Cola Hellenic, Unilever and Procter & Gamble are either transferring production from other countries to Greece or planning increased output this year. Furthermore, the 10-year Greek government bond yield dropped below 10% for the first time in more than two years in February 2013, whilst Athen’s stock market has rallied 120% since June 2012. These are signs that, with some Greek stoicism, the Greek government can navigate through these difficult terms and chart the path towards economic recovery within the Eurozone. 

Bonding over Dim Sum

Dim Sum bonds are bonds denominated in Chinese RMB and issued outside China, typically in Hong Kong. Dim Sum bonds provide exposure to yuan-denominated assets to foreign investors, as China’s capital controls currently limit foreign investment flows in mainland Chinese debt. Issuers of Dim Sum bonds are usually corporations from China or Hong Kong, however there are many foreign companies that also issue them. Dim sum bonds can be issued as either retail bonds settled in RMB or synthetic bonds settled in other currencies such as EUR or USD. Retail bonds must be approved by the People’s Republic of China (PRC) Central Bank and PRC National Development and Reform Commission (as regulator of foreign debt) and only institutions in China and Hong Kong are allowed to issue them. Retail bonds must have a registered prospectus to enable retail investors as well as institutional investors to buy into them. Proceeds from retail bond issues also must be taken back into the PRC and cannot remain in Hong Kong or elsewhere. Synthetic bonds do not require any PRC or Hong Kong approval.

The China Development Bank was the first to issue dim sum bonds in July 2007. This nascent bond market has seen further growth since then and especially as a currency play for foreign investors seeking to take advantage of RMB appreciation. Hopewell Highways Infrastructure issued the first synthetic dim sum bond in July 2010. McDonalds were the first non-financial overseas company to issue dim sum bonds in September 2010. Many multinational issuers have issued synthetic dim sum bonds including the World Bank, Unilever, BP, Volvo, and Caterpillar. There has even been an issuance requiring an islamically structured dim sum bond issue by Khazanah. More recently in November 2012, China Construction Bank became the first Chinese bank to issue a one billion yuan dim sum bond in London. Furthermore, growth in dim sum issuance has been exponential from 36 billion yuan issued in 2010, 131 billion yuan in 2011, 265 billion yuan in 2012, and an expected 350 billion yuan in 2013.

Expectations for 2013 are highly positive for the Dim Sum bonds market. Bond prices and yields have an inverse relationship and companies have had to issue their bonds at higher yields to compensate for a more uncertain yuan as a result of PRC Central Bank’s policies that targeted the yuan’s appreciation. However, these yields have had the positive effect of attracting investors to the dim sum bond market with average interest paid on corporate dim sum bonds around 4.25%, comparing favourably with US corporate bonds with the same maturities yielding 3.95%. Additionally, 2013 looks to be a better year for RMB trading, with an expected 3.5% appreciation. Investors in dim sum bonds would therefore earn both the yield plus any yuan appreciation. That the PRC Central Bank keeps the yuan within a narrow trading range also provides more security to investors by reducing the risk of sudden currency moves wiping out bond returns.

Tighter Bonds this year?

The attractiveness of the dim sum bond market will also be helped by statistics suggesting the end of the Chinese economy’s two-year slowdown. China’s economy grew by 7.8% in Q4 2012 and the CSI300 index of Shanghai and Shenzhen listed stocks rose 33% since the beginning of December 2012. The pool of yuan deposits held in Hong Kong bank accounts is also at 624 billion yuan and dim sum yields are more attractive than the average yield for other Asian bonds. Just this week, speeches from the PRC’s incoming leaders Premier Li Keqiang and President Xi Jinping, committing to liberalizing the economy and exchange rates as well as the RMB strengthening to a 19-year high against the USD at 6.20 yuan is spurring Chinese companies to increase issuance of dim sum bonds. Furthermore, February 2013 has been the busiest month for corporate dim sum bond issuance since March 2012, with 7.5 billion yuan raised.

It is not just Chinese companies that make up the issuers; foreign companies are also getting in on the act. In fact in Q1 2013, Russian companies have issued more dim sum bonds than Chinese companies, emphasizing the dim sum bond market’s appeal as a cheap source of funding for emerging market borrowers. Yields have become less competitive for investment-grade multinationals, yet it has made dim sum bonds an increasingly attractive alternative for lower-rated borrowers, even after accounting for the costs of swapping RMB raised into USD or EUR. Yet investment-grade multinationals desiring to expand in mainland China would consider issuing dim sum bonds due to their cost of funds averaging around 3%, which is roughly 3.5% lower than their average 6.5% funding cost for a two-year RMB loan from a mainland Chinese bank. This is a strategy followed by several of the multinationals, including McDonalds, who tapped the dim sum bond market to fund expansion in the mainland Chinese market where they themselves own the majority of their restaurants.

There are a few reasons to be cautious about the dim sum bond market. It is a nascent market and there can be liquidity problems when investors are looking to sell their bondholdings to buyers. There are also many investors who prefer to buy RMB directly to gain exposure to China. Furthermore, investors are concerned that many dim sum bond issuers are not rated by credit rating agencies such as Moody’s, S&P, and Fitch. Yet, this is improving with 70% of dim sum bonds issued by companies with credit ratings, up from 48% in 2011. In addition, rumours that the PRC’s new leadership will open up the mainland Chinese bond market, with the allure of higher yields, would divert investment flows from the offshore RMB market. The mainland Chinese RMB bond market has outstanding volumes of 24 trillion yuan.

However the dim sum bond market is not expected to be affected – after all, it affords greater flexibility and transparency than any potential access to the mainland Chinese bond market. The dim sum bond market is also expected to continue to expand as long as there is a surplus of RMB deposits offshore (namely in Hong Kong). These deposits are inevitably going to continue to expand, with the result that dim sum bonds become even more widely issued and traded in the years ahead.