It’s remarkable how people have become so eager to huddle together for comfort over each little market tremor. Last week, for example, one US leveraged buy-out had to be put to the banks rather than financed in the bond market, and the dollar/yen moved by 2, count ’em 2 yen. Every day I received calls asking me if this was The Big One.
Since I’m not the reassuring type, I told everyone that yes, our incomes and capital are going to die humiliating, disfiguring, painful, and prolonged deaths. Oddly, this seemed to make them feel better. I have noticed the same effect after evangelical church services I’ve attended (as a guest).
However, I did add that those humiliating, disfiguring, etc deaths aren’t going to come right away. Nothing much happens in the summer, unless you count the occasional start of a world war. Financial crises prefer to come in the autumn or early spring.
Of course this “repricing of risk”, as they call it when people are losing money, suggests opportunity, and last week revealed two sets of potential trades, one for the longer term, and one for the next several months.
Let’s first look at a currency position. Back in March, I suggested that the hysteria of the moment about the yen carry trade was so overdone that the right thing to do was to fade the action, as we scholars say. Borrow yen against dollar, and, in particular, euro assets. That worked out reasonably well, with the yen declining significantly against the higher yielders. One important player in that trade was Mrs Watanabe, the shorthand name for the Japanese housewives who control the country’s retail investing capital.
The retiring Japanese vice finance minister for international affairs, Hiroshi Watanabe, would reassure visitors that Mrs Watanabe was a cool customer. She would not panic and unwind her yen short/high yielder long position. Privately, though, the officials were worried that, as the yen sank and her position grew, any reversal would be politically and financially messy. They are concerned about banks exposed to the yen carry risks, but are terrified of the prospect of an angry Mrs Watanabe.
In the Street, credit people had been telling me that while the US subprime mortgage market might be a $50bn concern, the yen carry trade was growing into a $500bn concern. When, they wondered, would the Japanese authorities try to stop it from getting bigger.
Last week we found out the answer. It’s now.
The yen’s reversal and subsequent rise last week, which came before it reached the 125 to the dollar level, was not triggered by any official intervention. Rather, it was made clear to the larger players, and the public, that the ministry did not want to see any further inflation of this bubble.
The fundamentals for a stronger yen are there, in the current account numbers, industrial competitiveness, and a lot of cheap equities.
So buy the equities, unhedged for currency risk, and own the currency.
Mr Watanabe’s colleagues and his successor, Naoyuki Shinohara, do not want a repeat of the 1998 yen/Russia/LTCM crisis, and would provide liquidity, that is to say, yen, to help forestall a disastrous unwind. They have also provided a marker on how far they will allow the yen to weaken, helpful if you’re long.
The yen strength was also connected to the US credit market weakness, both symptoms of risk aversion. And this created a set of tactical trades in the US leveraged buy-out world.
Specifically, you could do worse than to buy First Data stock in anticipation of a successful closing of the KKR-sponsored acquisition of the company. The deal is set to close in the third quarter at $34 a share. At times last week, the stock was trading more than $2 a share below that level, on the assumption that credit markets are over and we’re all going to hell.
Weaker credit markets probably are going to kill or forestall some marginal deals, but the First Data buy-out is not going to be one of them. Dan Ilany at Bear Stearns, says: “To me the risk of First Data unwinding is near zero. There are commitment letters [from the banks] and this does not have a financing contingency in it. If there is a change in the business fundamentals for First Data, a [material adverse change] clause would be invoked, but the odds of that happening are negligible.”
So you could get a 20-25 per cent annualised return, on the basis of the recent stock weakness, by being a post announcement risk arb on a very liquid stock. You can repeat the trick with other deals where the LBO sponsors have locked in their financing by paying for commitment letters, which are put options on the deal debt. Assuming the to-be-LBO’d underlying businesses are stable.
It’s an ill wind . . .