Saturday, December 23, 2006

Equity premia and the debt-junkies from Macquarie

Are the private equity moves so much discussed in the press of late – the proposed $11 billion takeover of Qantas is an instance – a consequence of equity premium issues?

In short, if equity is relatively expensive way of financing firms – that relies on excessively risk-averse investors - does this mean there is a market opportunity to substitute debt for equity? The case for this type of substitution is bolstered by the fact that, as with negative gearing, interest costs are tax deductible which reduces some of the pressure to meet debt repayments. It is further encouraged by the huge fees merchant banks enjoy from raising the debt for private entrepreneurs, from arranging 'asset-stripping' sales and from eventually re-floating privatized firms as public companies. Many of these fees are payable even if debts are not eventually repaid – in the case of the Qantas sale some analysts believe Macquarie could earn up to $500 million in total fees from this deal.

It seems to me extremely dangerous, in a macroeconomic sense, for firms to be acquiring extra debt as a way of gearing up to avoid moves by private equity to gain control. This is so because I believe the equity premium is not a sign of irrational investor behavior but, rather, is a consequence of the notion that in real markets returns are distributed with very long tails – disasters and stock market slumps such as the 1987 slump do occur and investors are right to be cautious about them. With this in mind, when such slumps do occur, the costs of the leveraged buyouts will fall on the shareholders of the banks that are providing the vast amounts of credit necessary to fund them. Moreover, attempts by the RBA to offset such risks by trying to dampen down credit markets through higher interest rates will leave us all worse-off.

I am not a finance expert but retain enough knowledge to retain an interest in these issues. I note that better informed monetary authorities such as the RBA do likewise.

On the specific Qantas deal, methinks, Qantas CEO Geoff Dixon should extract the digit and, if he can, continue working on the job of building a growing national carrier – a job that his shareholders have paid him (and Margaret Jackson) large amounts to do. Given Australia’s geography Australia needs (and can sustain) a strong vigorous national carrier – not a protection-reliant monopoly run by a bunch of financial engineers. Opportunities to build a strong, growing business are not improved by turning Qantas into a highly geared flunkey of the financial cowboys at Macquarie who don't produce anything. In addition, Dixon’s claims to preserve for its future owners the monopolized privileges that Qantas has enjoyed for decades are disgraceful.

The real failings in the Australian markets are not in our capital markets but in the market for executive skills. Qantas has self-evidently had poor executives without imagination and with the inability to do anything for Australia’s national airline than to propose flogging it off to a bunch of debt-reliant financial spivs.


Brenda Rosser said...

Two things to keep in mind. First, that capitalism is now dominated by financial rather than non-financial corporations. Secondly, that these so-called 'private' companies - those being taken over by private equity trusts - are actually public in nature. They operate in a social and economic environment that has been created by our Governments and paid for by the general public. Laws of contract, public subsidies, Government-sanctioned trading monopoly status, corporate law, patents. They use our roads, our courts, our communication and transport networks. Most of Government regulatory structure is there to promote trade and provide legitimacy to many corporate practices that wouldn't hold up on closer examination. (Bob Brown's Wielangta win this month is the latest example).

It is not appropriate, in fact it's dangerous, to have such large institutions lying outside of public scrutiny.

Our civil and human rights begin with a truthful examination of our current economic system.

"You begin to ask the question, 'Who owns oil? You begin to ask the question, 'Who owns the iron ore? You begin to ask the question, 'Why is it that people have to pay water bills in a world that is two-thirds water?...I'm not talking about communism...communism forgets that life is individual. Capitalism forgets that life is social, and the kingdom of the brotherhood is found neither in the thesis of communism nor the antithesis of capitalism. It is found in a higher synthesis that combines the truths of both."

Martin Luther King

individual voluntary arrangement said...

# does this mean there is a market opportunity to substitute debt for equity? #

If there is, can you let me know asap! I could do with a trade like that!!!

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