Longhorn Investment Team Weekly Insight: Final Four Edition (4/6/19)

What’s up gang! We know March Madness is coming to an end, and we had each of our members create an algorithm to predict the correct outcome of the NCAA tournament. It didn’t work. Anyway, lets dive into the news.

Trade War is Down to the Wire

Trade cannot play its full role in driving growth when we see such high levels of uncertainty.

Roberto Azevêdo, WTO Director General

In the World Trade Organization’s press release last week:

  • Global GDP growth expected to slow from 2.9% in 2018 to 2.6% in 2019 and 2020
  • Estimate of 2018 trade growth is lowered to 3.0% from early September estimate of 3.9% (WTO’s lowest forecast in 3 years)

““The U.S. has a point when it comes to IP theft concerns” – China

Larry Kurdlow, White House Economic Advisor

A possible concession from China in the realm of IP theft – a key point of contention in the current trade dispute – was all investors needed to hear. The S&P posted its second straight week of gains.

Is this information really actionable? Not really, while its good for the two countries to have an open dialogue, many questions such as the Huawei investigations remain unanswered. Moreover, actions speak louder than words, and Kurdlow’s statement came the day after a Chinese official was charged for trying to bring a thumb-drive loaded with malware onto Trump’s Mar-a-Logo resort.

March Job Report Comes in Clutch

The US added 196,000 jobs in March. Wages increased 3.2% year-over-year.

People expected 170,000 new jobs and 3.4% yoy wage growth.

Compare the March data to February (only 33,000 new jobs) and things are looking up as investors can still cling to employment data as a sign of a healthy US economy despite lower consumer confidence, retail data, and that yield curve situation…

Oh yeah, the yield curve! Remember how if long-term bonds have higher yields than short term bonds, investors pee themselves? Well that ominous cloud has subsided to a degree, as the yield curve returned to a relatively flat, but positive slope.

The Middle Market Has More Bandwagoners Than Duke Did

“Investment bankers across Wall Street are tripping over themselves, and sometimes each other, to win business advising smaller companies on deals – assignments they would’ve scoffed at two years ago” – The Wall

What do investment banks do?

A lot of stuff, but it’s common for them to facilitate mergers and acquisitions, or the buying and selling of businesses. For the purpose of simplicity, let’s assume all investment banks are primarily focused on M&A to make money (usually through a % fee based on the size of the transaction).

Big banks are shifting from fewer big marlin deals to lots of small tuna deals.

Yes, M&A in the fisheries market is booming. Just kidding, that was really an analogy. Let me explain. After 2008, there was a big recession so lots of companies consolidated, causing a boom in big time deals. Follow the recession with a decade of low interest rates and then a tax cut, and you see another wave of big time deals (CVS+Aetna, Disney+Fox, Amazon+Wholefoods).

What changed?

  • M&A activity for transactions over $2 billion has slowed down recently as tax cut savings have worn off.
  • Banks are turning to the middle market (companies that make between around $10 million to $500 million a year in revenue) for more and more business. M&A are extremely common among middle market companies, which presents the perfect opportunity for big banks that already lend to these businesses to cross-sell their M&A advice to middle market clients.

Why is that?

  • Middle market companies are frequently purchased by private equity shops. Private equity firms are companies that just buy other companies and flip them; it’s not complicated or anything. Right?
  • Middle market companies are commonly family-owned. Sometimes founders can’t get their kids to act as successors to the business, and acquiring talented employees is generally difficult as a family-owned business. This creates situations where owners are more likely to just sell their business.
  • Smaller companies are way more likely to create truly disruptive innovations. Big companies are bad at innovating, but they have the money to just buy the innovators when they’re small.

Anyway, big mergers are like the marlins and middle market deals are the tuna…

…and its tuna season, baby!

Why it matters for banks: Big investment banks like Goldman Sachs and JP Morgan are moving into a space crowded with regional banks that already specialize in the middle market. With middle market companies accounting for roughly a quarter of total revenue generated in the US, it’s no wonder banks are turning more and more to mid-size clients.

Why it matters for the middle market: A TD Bank survey found that 68% of middle market banks expect to undergo M&A in the next 2 years. The National Center for The Middle Market furthers 60% of middle market businesses are relying on inorganic growth as part of their strategy.

Because M&A can make or break a company, it’s crucial that they receive top notch advice from getting the right price on the deal to ensuring that the companies integrate properly to create synergies.

Other News:

Upcoming IPOs we forgot to mention last week: SpaceX, WeWork, Palantir, and iHeartMedia. iHeartMedia just announced their IPO which they are using to exit the bankruptcy they filed for last year. iHeartMedia’s bread and butter is podcasts. They claim to have 275 million US listeners per month on their platform. For context, Spotify claims to have 207 million global monthly users.

Lyft stock shorts were the most expensive bearish bet in the US stock market on Wednesday. In other words, investors clearly think it’s overvalued, driving up the price of put options contracts. It gets juicy – Lyft just accused one of their underwriters, Morgan Stanley, of marketing investment vehicles to short their shares. This could be a violation of lock-up agreements, contracts that prevent early investors from selling shares immediately after the IPO.

Verizon introduced 5G networks in parts of Chicago and Minneapolis, making them the world’s first commercial 5G provider. 5G will enable download speeds 10x faster than LTE. South Korea will be unveiling their 5G networks shortly, and you may have it in the top right of your screen as early as 2020.