Langton Capital – 2019-11-07 – PREMIUM – Pizza Express, Bread, Merlin, McDonald’s etc.:
Pizza Express, Bread, Merlin, McDonald’s etc.:
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A DAY IN THE LIFE:
Drinking vessels have been around for four or five thousand years and, putting the scooped-out sheep’s heads to one side, they’ve not evolved much in shape for perhaps a half of that period.
Which does rather beg the question as to why glassware is now sometimes thinner at the bottom than the top because, whether this is a Peroni glass or a medium latte in one of the country’s better-known coffee shops, it can make drinking a somewhat risky enterprise.
I mean the centre of gravity is nearer the top than the bottom. At least when the glass is full and, let’s think about this, is that a good idea?
I mean you wouldn’t give even a plastic glass (if it were full of blackcurrant or beetroot juice and was hovering over an ‘autumn mist’ i.e. beige carpet) to a toddler so why give a similarly shaped vessel to someone who may try to balance it on a wobbly table?
And don’t get me started on handles that are too small to get your finger into. On to the news:
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BOOK REVIEW: WHEN GENIUS FAILED – ROGER LOWENSTEIN (II of II): Mr Lowenstein’s book remains a cautionary tale for those using the past to predict the future. See also Part I (on 5 Nov). 7 Nov 2019:
The glory years:
• LTCM returned 28% before fees in 1994. It was fast becoming a fund conceived by geniuses, run by geniuses, for geniuses. What could go wrong?
• Very little in the short term, as it happens. The fund returned 59% gross of fees in 1995. It only lost more than 1% in any month once in its first 2yrs.
• In 1996, the fund raised another $1bn. In that year, it made 57% before fees.
• In 1997, the fund made ‘only’ 13% before fees. The partners began to think that they had too much capital to remain nimble.
• Rob Merton and Myron Scholes won the Nobel Prize for economics in 1997.
The signs (apparent more clearly with hindsight):
• LTCM believed in normalised risk, in normal distributions. Economist Eugene Fama said ‘life has a fat tail’.
• LTCM models assumed the market has no memory. A tossed coin doesn’t, so the market shouldn’t – but it does.
• Robert Merton was evangelical in his beliefs. He did not believe that speculation and irrational behaviour should exist.
• The firm was putting too much faith in VAR (Value at Risk). It makes heroic assumptions re causality, correlation etc. Lowenstein said VAR was a lighthouse that drew ships onto the rocks.
• Returns, though they looked spectacular at 57% on equity, may have been as low a 1% on total investments including derivatives.
• The firm had $5bn of equity by 1997 but perhaps as much as $1.25tn in gross exposure to markets including derivatives ($140bn ex-derivatives). This implies leverage of 250x.
• LTCM was ‘an insurer of financial risks’. But history suggests that it was to get its premiums wrong.
• The company left its fees in the fund. Management borrowed $100m to invest.
The earth moves:
• In July 1997, the Thai Baht fell LTCM did well. Equity was up to $7bn and the company paid back around $2.7bn of it to redeem external investors, often against their will. This was to prove ironic.
• The fund broke even in Oct & Nov 97. For the year as a whole, it made 25%. The partners now owned 40% of the fund (some $1.9bn of $4.7bn)
• Russia looked worrying but LTCM continued to sell volatility. It forgot that markets can remain irrational longer than you can remain solvent.
• In January 1998, partner Larry Hilibrand had $500m in the fund and John Meriwether had perhaps $250m.
• Its model said the odds were 10 to the power 24 that it would lose all of its capital in a year. It’s model was to prove to be wrong.
• The fund was still up 3% in April. But it lost 6.7% in May, its worst month ever. The record didn’t last long as it lost 10.0% in June. Leverage was still 31x.
• Russia defaulted in mid-August.
The centre of the inferno:
• Spreads rose and there was a dash to quality. At the end of August, LTCM lost 15% of its capital in one day. The fund was down to $2.9bn.
• The partners rang around for a capital injection. Would-be investors had been throwing money at them a year earlier. Investors (including Buffett) said no.
• Margin calls led to more sales and the appetite for risk disappeared.
• The fund lost $277m on Thursday 27 August but made $128m the following day. It still managed to lose 45% of its capital on the month. Lower equity numbers actually increased leverage. It was up to 55x.
• Counterparties were chasing for cash. The fund lost money for the first 12 trading days in September. In the week to 15th, it lost half a billion dollars.
• Equity was down to $1.5bn. The fund wanted $4bn. Goldman Sachs said no. Warren Buffett went on holiday to Alaska for a fortnight.
• By Monday 21st, the Fed was leaning on Goldman Sachs, Merrill and JP Morgan to step in. On the Tuesday and Wednesday, negotiations continued. Equity in the fund was down to $555m.
• A deal was struck. The partners would be wiped out and fired. They had an hour to decide. The deal was sweetened to allow the partners to keep 10% of the recapitalised fund but, as they were personally geared, they still took massive hits.
• Goldman Sachs drove home the knife. Ex-partners would not be shielded from investor lawsuits and their remaining money would be locked in for 3yrs.
• The money was ‘honestly lost’. Nobody went to jail. But the adage remained true, beware elegant mathematical models
• No public money was involved in the bailout. The Nobel-prize winning partners denied that their models were wrong, John Meriwether moved on and treated it like a bad trade.
• The consortium of banks that now owned LTCM lost a further $750m in the next two weeks. The original equity was below zero. Overall, the fund made 10% in its first full year.
• The industry managed to shrug off calls for greater regulation. Derivatives were not curbed. The lessons re leverage linked to illiquidity were not learned and, more than 20yrs later, we are still kidding ourselves if we claim to understand risk
• Mr Lowenstein appears as a talking head in this Horizon documentary – http://watchdocumentaries.com/trillion-dollar-bet/
GENERAL NEWS – PUBS & RESTAURANTS:
• Langton commented yesterday that one of the things it was waiting for was news re Pizza Express’s refinancing – and it didn’t have to wait long.
• Pizza Express owner, Chinese investment company Hony Capital, is to buy back £80m of its unsecured bonds, which are trading at less than a quarter of their face value. The original owners of the bonds will take a nasty capital hit.
• Pizza Express is reported to have appointed advisers Houlihan Lokey and Kirkland & Ellis to explore options. It is possible that bondholders could have (and could still) wrest control of the company from its equity owners in the event of a refinancing. If Hony is prepared to put enough new money in, then it could prevent this from happening.
• Hony has offered to buy back the bonds at between 20% and 40% of their face value, per the FT. Some £465m of the group’s external debt matures in 2021 with the remainder due to be repaid or refinanced in 2022 (all numbers at face value). The group additionally has debt owing to its shareholders in addition to the equity capital outstanding.
• Pizza Express reports that LfL sales in the UK & Ireland fell by 1.1% in the quarter to end-September. Revenues were broadly flat.
• Though the company did not comment, restaurant costs, impacted by business rates and wage increases, are thought to be rising by between 3% and 4% on a LfL basis. With LfL sales in decline and discounting still and issue, margins would therefore still be falling, and further restructuring is possible, indeed likely. Were a CVA to take place, it would be the largest in the restaurant market to date. This would likely require a split between the UK and Chinese operations and further write-downs in both equity and debt values before landlords could be persuaded to cut the group a deal. Advisors etc will make millions.
• Pizza Express is effectively describing the entire UK market when it says its business in this country has been impacted by ‘a number of market and macroeconomic factors, including fragile consumer confidence given ongoing uncertainty around Brexit.’
• Sky reports that Luke Johnson, the former chairman of failed cake chain Patisserie Valerie, has hired bankers to prepare a sale of Bread Holdings, the owner of Gail’s, another bakery group. Sky mentions a figure of £150m although work carried out by ourselves and others suggests a much lower figure. The operator has 50 leasehold sites and a bakery. To value such units at nearly £3m a pop seems a little ambitious.
• Rumours that Patisserie Valerie was to buy Bread circulated nearly two years ago. Following that, a sale of Bread ‘at £200m’ was talked about just before Patisserie Valerie collapsed amid claims of incompetence, fraud and dishonesty. EBITDA at Bread Holdings fell from £9.7m to £8.1m in the last set of accounts it lodged with Companies’ House.
• Bread’s valuation of perhaps 18-19x is therefore implied at £150m. This seems out of line. Bread said in its accounts ‘the wholesale market is very competitive [and] the retail bakery market also remains very competitive’. Mr Johnson told the Sunday Times re the failure of Patisserie Valerie in which investors lost all their money that ‘the stress made me physically ill – I suffered a series of debilitating infections and was on antibiotics for weeks.’
• Brewer Innis & Gunn has launched a funding campaign on Seedrs aimed at raising £3m for a new brewery.
• Moody’s has reported that McDonald’s decision to fire CEO Steve Easterbrook is credit negative ‘because it comes at a time when McDonald’s aims to maintain the momentum of its Velocity Growth Plan around the world, which Easterbrook initiated and for which he has been a key driving force.’
• Moody’s says that McDonald’s new boss, Chris Kempczinski, who currently reportedly does not own any shares in the company, has an operating experience ‘both at McDonald’s and within the restaurant industry, [that] is somewhat limited and will likely pose some challenges as he takes the reins of the company on a global basis.’
• German Doner Kebab, based in Scotland, reports same-store sales up 49.6% with kebab sales in its 36 sites reaching £1m per week.
• Bloomin’ Brands announces it is exploring strategic options, including a sale. CEO David Deno said ‘Despite this continued progress, we believe the current stock price does not reflect the value of the company.’
• Diageo releases its last limited edition Game of Thrones themed spirit. Six Kingdoms is a Mortlach Single Malt Scotch Whisky Aged 15 Years and is the ninth and final GoT spirit.
• Japanese brewer Kirin is facing pressure from one of its largest shareholders, UK-based Independent Franchise Partners (FP), who are pushing for the company to focus on making beer and ditch the ‘unrealistic hope’ that it can thrive as a cumbersome conglomerate.
• UKHospitality has teamed up with Bidfood to release its Food Service Management Market Report, finding that in 2018, the UK’s FSM sector saw turnover reach £10.9bn. Dr Andrew Kemp MBE FIH, Group Sales and Marketing Director at Bidfood commented: ‘We are encouraged this year to see contract catering, and the hospitality sector in general, rise above the political uncertainty that has been haunting us, and to read of a buoyant and confident industry with the right mindset and ambition to continue playing its crucial role as an engine of growth for the UK economy’.
• The new chief executive of Gaucho has announced plans to launch a new ‘socially and environmentally responsible’ concept in the steak restaurant group’s original site.
• Harvey Nichols has rolled out Plant Pops, a new vegan snack.
• Boparan Restaurant Group has announced it will open its sixth Slim Chickens site in Bristol later this month.
• Admiral Taverns has grown its pub estate past 1000 sites, following the purchase of 137 venues from Marston’s for £45m.
• Belu has won the Sustainable Restaurant Association’s Food Made Good award for its free water filtration system in restaurants. The group seeks to reduce restaurant’s reliance on single use plastic bottles.
HOLIDAYS & LEISURE TRAVEL:
• A survey by Unite union finds two thirds of former Thomas Cook Airlines staff have not secured any form of employment six weeks after the company collapsed. The study found that 42% secured interviews in the airline sector but this hasn’t been transformed into jobs.
• New York City forecasts 1.308m UK visitors for 2019, up from 1.259m the year prior and set to reach 1.346m in 2020.
• The Guardian reports at least three Ryanair Boeing 737s have been grounded due to cracks between the wing and fuselage. Ryanair is the latest carrier to be affected by faults in the ‘pickle fork’ structure, which has sparked an urgent grounding of 50 planes globally since 3 October.
• The National Transportation Safety Board (NTSB) has released a report identifying software flaws in an Uber self-driving vehicle that struck and killed a woman in Arizona last year. The report also revealed Uber’s autonomous test vehicles were involved in 37 crashes over the prior 18 months.
• Airbnb will review and verify all seven million properties listed on its platform after reports of false or misleading details being published on the home sharing site.
• Uber shares fell up to 9% on Wednesday as early investors gained the ability to cash out following the end of a lock-up period. The drop mirrors Beyond Meat, which fell 22% last month on the day its lock-up expired.
• The UK betting industry announces five safer gambling commitments just days after UK gambling firms lost nearly £1.2bn in value due to MPs recommending curbs on online casino games. The commitments have been devised by the betting firms, with their development being facilitated through the Senet Group.
• The five pledges, which will be independently monitored and publicly reported on, are to: Prevent underage gambling and protect young people. Increase support for treatment of gambling harm. Strengthen and expand codes of practice for advertising and marketing. Protect and empower our customers. Promote a culture of safer gambling.
• Merlin has partnered with China Media Capital to build a Legoland resort near Shanghai. The resort should open in 2023.
FINANCE & ECONOMICS:
• The IFS says that high borrowing promises by both the Tories and Labour means the next government is set to break rules on spending. Rising debt will ‘burden future generations’.
• Sterling down at $1.2847 and €1.1612. Oil lower at $61.75. UK 10yr gilt yield off 5bps at 0.73%. World markets mixed, Far East mixed in Friday trade.
• Brexit & politics:
o Tory campaign off to a poor start, Labour loses Tom Watson.
o BBC Politics Live guest labels Jacob Rees Mogg a ‘deluded relic’ following his comments re the apparent lack of common sense viz Grenfell.
o Cons Andrew Bridgen says the above isn’t victim blaming, says Rees Mogg is clever and that’s why he likes to see him in a position of power.
o Tory candidate suggesting benefit claimants should be ‘put down’ still to stand. Facebook and Twitter posts from the distant past being pored over by both sides.
o Tory leader in Wales Alun Cairns resigns over claims he supported a colleague (Ross England) who had been accused of sabotaging a rape trial by victim blaming & calling into question the victim’s sexual history. Both men are standing as Tory candidates in Wales.
o FT letters suggest Tory Party dominated by white, male, English nationalists. A ‘whitelash’ was reportedly one of the driving forces behind Donald Trump’s election in the US three years ago.
START THE DAY WITH A SONG:
Yesterday’s song was If You Tolerate This Your Children Will Be Next by Manic Street Preachers. Today, who sang:
It was fun for a while,
There was no way of knowing
Like dream in the night
Who can say where we’re going
RETAIL WITH NICK BUBB:
o Sainsbury: The 15% fall in interim underlying PBT is said to be in line with guidance, “due to the combined impact of the phasing of cost savings, higher marketing costs and tough weather comparatives”, but Sainsbury still expect these impacts to unwind in the second half and highlight the “positive momentum in Grocery market share and sales performance, driven by a strong customer response to lower prices and our new value brands”.
o Halfords: Ahead of today’s interims (for the 26 weeks to Sept 27th), the Halfords share price has been pretty weak, as if another profit warning was expected, but the 15% fall in first half underlying PBT is said to be in line with expectations (with Retail LFL down by 3.8%) and full-year guidance is maintained. There is even a small acquisition in Motoring Services: Tyres on the Drive. However, Halfords have said that the final dividend will be reduced and that next year’s dividend will be rebased to 12p (versus last year’s 18.6p)…
o Howden: If the trade kitchen joinery business Howden was ever going to disappoint, given its exposure to big-ticket spending, you’d think it might have been in October (which is the most important trading period for the company), but today’s update flags that sales were “robust” and that Howden is on track for full-year expectations