Brexit Is a Lehman Moment for European Banks
bloomberg.com
bloomberg.com
Lets see how the story will unfold.
You left it unstated that Facebook is now worth $283bln more than Ford. So, yes, the video looks silly for crying wolf back in 2007.
But I'm at a loss to draw the correct conclusion from this. Is it rational that Facebook is now worth 6x as much as Ford?
CREATING THE PRODUCT: Facebook's engineers provide the framework, but each day's content is created free of charge by 1.5 billion active users. That's great for profit margins! At Ford, cars don't get built unless the company buys steel, glass, tires, etc. and pays workers to put it all together. That really squeezes margins.
GENERATING DEMAND: Facebook's users share content and invite their friends to join, at no cost. Media companies beg to play in Facebook's ecosystem. By contrast, Ford needs to spend billions on advertising to get people excited about cars.
OBLIGATIONS TO CUSTOMERS: Facebook has a modest-sized fraud and security team that keeps everything tidy. They do heroic work, but there aren't 50,000 of them. At Ford, the requirements for inspections, safety tests, recalls, legal settlements when vehicles go bad, etc. are vastly larger.
OBSOLESCENCE: Ford has $58 billion invested in plant and equipment. Every day, those factories get a little closer to being obsolete. Ford must constantly either raise cash or reinvest profits to keep its factories competitive. That means less free cash for shareholders. By contrast, Facebook has just $8 billion invested in server farms, beautiful headquarters, etc. Its asset-maintenance burden is vastly less -- and should stay that way forever.
MAKING MONEY: Ford's net income zigzags all over the place, jolted by lots of market/economic issues. Net income was down last year; historically it's ranged from $11 billion to sizable losses. Facebook's net income totaled $3.7 billion last year and is climbing at a very snappy rate. 35% a year? Doubling? Still hard to tell, but it keeps going up.
Put all those factors together, and Facebook is a growth stock with a pretty straightforward path to making its business hum. Ford is a cyclical stock that may have already posted its peak profits. Ford may be a bedrock part of the U.S. economy, but that doesn't always get you a lot of love in the stock market, for reasons above. Yeah, Ford has $150 billion in revenue a year and Facebook had just $18 billion. But markets value companies on their growth prospects. I've got no trouble believing that Facebook's overall opportunity to make money is 6x better than Ford's.
Businesses that rely on and grow from network effects, die from them too at an even faster rate. A scandal or rival product could take FB to zero. Some would say that history tells us it is FB's inevitable outcome. I know some believe that it can't happen and the FB is "the last social network" but that sounds a little bit like bubble participants claiming "this time its different".
The warning signs of FB rising were apparent for years, but the News Corp managed MySpace did nothing to curb its rise.
As such, Facebook takes all the profit from social media advertising, and can set its own prices and dictate terms to its customers. Ford can afford to do no such thing.
If Ford were the only auto maker in the world, it would be a far more lucrative investment.
ExxonMobil is just oil. WalMart is just department stores. Visa is just credit cards. All those companies have top-20 valuations. It's possible to come up with a doomsday scenario for any industry ... but by and large, once they get really big, they tend to persist in some form.
It is only this year that internet advertising is projected to match TV advertising spend. TV advertising has been around ~50 years, and before that we have another ~100 years of print advertising to learn from.
From those historic precedents we can see that advertising is a huge, huge market. It is true that something could surpass internet advertising as the best way to spend that money, but I don't see any viable candidates (I'm including mobile & VR ads in "internet").
AdBlockers - of course - accelerate the trend of the money in the "internet" category going to players like FB where they control the delivery mechanism (ie, deliver ads in a mobile app, where an ad blocker can't reach it on most platforms).
To me, Google and FB's PE ratios are sensible, taking into account current profits, continuing growth in the short and medium term, and uncertainty in the long run.
Your "Creating the Product" and "Generating Demand" elements synergise off one another. Facebook has considerable network effects, and those network effects stimulate content, but break the chain, or boil-off customers (see "The Evaporative Cooling Effect"), and the feedback's strongly negative all the way down. MySpace imploded quite rapidly. Google's G+ had some traction initially, but worked exceptionally hard to drive off its strongest fans. Those who are slower to learn (/me raises hand) are only now being convinced of our error.
But "Obsolescence" is the big one. Ford's plant degrades from the inside, and the rate of amortisation of manufacturing equipment is fairly well known. Innovation in automobiles peaked in the 1920s, though it's arguable that there were additional spurts in the 1970s (largely around economy), 1990s (quality and electronic controls), and now a possible shift to hybrid or electric vehicles, though those remain tiny portions of the entire market (highly visible, but still tiny by either unit count or, slightly less so due to much higher per-unit costs, currency marketshare).
Ford, along with other US automakers was blindsided when a very modest amount of market innovation, toward more efficient vehicles, hit in the 1970s. That was an exogenous obsolesence function.
Facebook and other technologies face this all the damned time. As I've slowly realised, the cost of provisioning technology hardware falls by an order of magnitude per decade. The rate is much slower for software, but there's far more capable, far more modular software rising up all the time. You can actually see this progression going back to the dawn of electronic computing, with IBM owning the market in the 1950s and 1960s, then a cascade of first minicomputers (DEC, Wang, Sun), then micros (PCs), then laptops, now handhelds, coming along at roughly 10-year intervals.
Software's taken a while to catch up.
Facebook had roughly 1/10 the hardware cost profile of Google (though growth of the Web may have increased that). Scaling out a startup now is largely a solved problem. Revenue model is harder -- but you need far less revenue.
The other problem Facebook (and any other tech player) faces is that their own codebase becomes liability. For every table-based desktop site (say, Hacker News), that existing site layout (and perhaps much the technology underpinning it) actively impedes movement to mobile or tablet devices. I've had long arguments with designers of sites who insist on pixel- and point-based font sizing, rather than em and rem, and then screw up with low-contrast sites to boot.
(HN's own fonts are barely readable for me on a 10" tablet, and no, mobile extensions don't help.)
Further, "Making Money" for Facebook has been exceptionally reliant on both easy-money Federal Reserve policies, and lending and banking regulations favouring Silicon Valley style investments. A tremendous amount of advertising is itself financial services, electronics, and other startups (I'm basing this off of Google's advertisers which I'm familiar with from other sources, but suspect FB's profile is similar). That ads money could well dry up damned quickly.
Tech companies have the problem that as the money dries up so does their tech workforce. Look at the salaries reported to have been offered to Yahoo's top tech talent (if you can't offer appreciating stock, you've got to bleed money). Lose programmer interest, and again there's a downward cascade of talent and capabilities, and some of the negative feedbacks start dominating.
I worry that I see it as over-hyped because of my discomfort in the future it proposes. Its valuation represents the market's belief in what I feel is a very dark future.
So, a slightly more optimistic way of looking at it is that investors think that other investors think that there's a dark future ahead, but may not believe so themselves. It's quite possible that no one really believes in that particular dystopian future, but everyone thinks that everyone else does.
It's fairly easy to imagine monetisation strategies that could be pretty negative in the long term.
Blackmail me based on private conversations?
Resell my photo uploads to shutterstock?
Charge the intelligence agencies $1k per user for a backdoor to my encrypted FB chat messages?
They could become the whole internet. In many places they already are. This is a very sad future for someone who sees the internet as a tool of human liberation and direct connection.
I don't care so much about them selling our information. It's worthless even to me. These other things are much more subtle and valuable.
Or, as we used to called it in my day, not actually socializing.
Digital is a nice way to keep touch or contact new people, but bad replacement for physical socializing. Of course it's also easier and needs far less commitment, courage and empathy, and you can't beat that for people...
https://finance.yahoo.com/news/number-active-users-facebook-...
That video is fantastic.
Italy for example is imploding on $300 billion in bad debts, which is likely to send their economy into a Spanish style depression. That's going to sink a lot of European banks. Deutsche Bank's lead economist is already calling for a $150 billion EU bank bailout. They're going to need something more like $500 billion as the financial picture gets worse in Europe in the next few years.
Finland as another example is in a nearly decade long soft-depression, and is likely to abandon the Eurozone as their situation will continue to drift and erode.
Countries like Sweden, Denmark, the Netherlands, and Norway, now have among the most indebted households on earth based on debt to income ratios. The mortgage debt accumulation going on there can't continue indefinitely.
Spain and Portugal have barely begun to pull out of the last recession, when a new one is inbound. Greece is still a hobbled mess.
Countries like France and Germany that are center to Europe's economy, have had zero growth for nearly a decade. Germany's ability to continue to bail out other parts of Europe, is now at an end.
It's far more likely Deutsche Bank will be quasi-nationalized, than not at this point. The next few years will be worse, rather than better.
The liquidity requirements introduced after Lehman should be sufficient for banks to sustain another Lehman scenario but you could imagine an even more severe stress.
They let Greece go bust rather than the Landesbank.
However Deutsche Bank is a private company. It's still likely to be kept alive, but it's not as certain.
It more a case they may have to bail out Greece rather than letting it default and take out the Landesbank.
A lot of the problems could be prevented by the German controlled ECB easing monetary policy and aiming for say 2% inflation rather than the present 0%.
European institutions are largely determined by "every member gets something", not economic size.
In this example, the Governing Council of the ECB has 25 members, two of which are German.
It is "first among equals" in the sense that no country has more members and few have as many, but what you're insinuating is factually wrong.
When it comes to any European organization, just assume that each member country has one vote and you'll always be very close to reality.
http://www.bloomberg.com/news/articles/2016-02-12/deutsche-b...
As others have pointed out, the German government would probably be ready to bail them out if they ever ran into trouble, though that would likely be a painful process for existing common shareholders.
[1] https://twitter.com/matt_levine/status/742800372473946112
Edit: For a more complete analysis of DB's capital position, they have published Moody's report on their credit. [2] I don't see much in there that would suggest DB was insolvent, but they do seem to be having some difficulty reorganizing their business.
[2] https://www.db.com/ir/de/download/Moody_s_on_DB_26_May_2016....
A falling share price doesn't impact the bank's capital ratios. It does impact however its capacity to raise more capital if required, which is not a good thing.
A bank has assets, the money you lent the bank (through your deposit) is invested in a mortgage, backed by a property. You will ultimately get your money back. but it is a timing issue (and therefore liquidity), not a solvency issue.
Madoff just paid a dividend or phony appreciation to investors based on money deposited by new investors -- except for the money he stole it was a closed system with no return generated.
He also concentrated his efforts on courting a relatively insular community (religious Jews) via trusted community figures to avoid awkward questions.
Thats usually a sign of a scam -- banks don't send your priest/rabbi/community leader to hawk CDs. But there are many hustles (Ponzi schemes, pyramid schemes, and various savings clubs) that are common in ethnic and religious communitiesand apread via word of mouth.
On one side of the range, the consulting firm, which has no assets, and which value is a pure function of future earnings.
On the other extreme you have an investment fund where the value is purely a function of the value of the assets which are all liquid financial assets. You don't buy the fund at a premium, otherwise you might as well buy the underlying assets yourself.
A bank is somewhere between the two. It has what should be a reasonably reliable accounting value since at the end of the day, all of its assets are financial assets that can be sold and aren't highly specialised like a factory or a hotel building is. But on the other side a large part of the value is not just the balance between assets and liabilities. It has additional earnings (fees, trading activities, etc).
Most banks hold a decent amount of highly specialized, illiquid debts that have no active market and could reasonably be compared in terms of liquidity to real estate or capital goods.
And no, there are no line in an IFRS balance sheet for "human capital".
[edit] and on your second point, I don't think I agree. You will pretty much always find a buyer for financial assets. Unless they are so rotten that no one thinks they are worth what you have them in your books for (which may be the case for some Italian banks).
Where I think you are right to be careful with banks is with the size. If you need to wind down a massive international bank, you need to find buyers for a awfully large amounts of assets, and that will likely damage their value.
Yeah, we are on the same page, it was just a little nit as it seems weird to me to state that future revenues are the "pure" base for valuation when future is informed by current. Just semantics though.
> You will pretty much always find a buyer for financial assets. Unless they are so rotten that no one thinks they are worth what you have them in your books
At the right price you will find a buyer for anything. I was speaking to your point about liquidity, which is not about price of the asset, but about the quantity of interested buyers and the ease of structuring and executing a transaction with a buyer.
But size is a problem. When you have 2 trillions $ of assets to sell, even if they are simple vanilla mortgages, it will be a buyer's market.
Not sure what your objection is. The function is something like V = 3 * r, where V is the value of the company and r is the annual revenue. Boom, pure function.
I would term the difference "operating value", the extent to which the entity is valuable because of what it does vs what it owns.
Software companies are interesting because they fall in the middle, somewhat like banks.
Most banks are more in the middle than you might think. BofA for example, is valuable in large part due to its customer relationships and brand.
You're right that a pure holding company with no brand and "operations value" is just the book (accounting) value of its assets.
As I said before the DB/Snapchat comparison is apples to oranges when you compare balance sheets, but both metrics (market cap, "valuation") are decent proxies for the magnitude and direction of the "true" value of the company.
EV in it's simplest form is Mkt Cap less Cash plus Debt. Just b/c a company isn't public doesn't mean the value of the equity is unknown.
If you buy the equity of a $100M company that has $90M in Net cash then you really are only paying $10M for it. Likewise, if the company had $1B in Net debt then you are paying $1.1B for it. Theoretically, DB could issue $10B of debt and buyback $10B of equity tomorrow and that reduces their mkt cap dramatically (their regulators wouldn't be too happy about it, though).
My point is that Banks use leverage so mkt cap is NOT a decent proxy of the value of the bank. When you compare valuation of 2 companies using Market Cap for 1 or the other (or both) is VERY misleading, especially when you have one that has a business model that uses leverage.
also, Snapchat has both an EV and Mkt cap.
You practically need a PhD in finance to value these things, with all the preferences, participation multiples, board seats，drag-along and pro rata rights, etc attached to these shares...
Market cap is a good way to think about what the total value of a company's stock is, but a leveraged (indebted) company may have some of its "company value" "owned" by bondholders as well. EV is the total value, whereas MC is just the shareholders' part.
So, how come people are purchasing equity without paying any attention to debt?
I understand how different classes of shares may be equivalent in scenarios where a company is successful, but very different if it is failing. I also understand that the market has established a price for 0.01% of a company, and not necessarily a price for a much larger share.
That said, on Hacker News, subjects like company valuations seem to be discussed in terms that are more consistent with economics than what you typically hear from students of finance.
Perhaps the bigger issue is that when banks get to such a low level of equity relative to debt, they have no cushion to absorb losses. Once the equity hits zero, they become insolvent and that's when the Lehman comparison becomes very valid.
So are private Silicon Valley valuations.
IMO, even the most libertarian government would not allow a normal insurance company take on so much leveraged potential liability without at least a disclosure to the consumer that says, "Hey, this company probably can't payout the policy you just bought from them." Yet somehow it's okay for financial instruments? IMO, Dodd-Frank should have forced financial institutions to calculate their overall liability on derivitives as part of their capital requirements. This would never happen though, as they trade so rapidly most banks probably don't even know at any given time what would happen to their derivitives liability if the market swung wildly, either up or down.
We're going to have another 2007 again, for sure. I have no idea when, but we did not solve the underlying problem at all.
I think the technology is there to make it happen automatically. It's a deterministic system. The problem is the lack of political will to do so, which is appalling and leads to situations like Brexit and Trump.
http://www.welt.de/finanzen/article156924408/Deutsche-Bank-C...
Or the slightly more sensationalised English version:
http://www.zerohedge.com/news/2016-07-10/deutsche-banks-chie...
Comparisons to $UNICORN are irrelevant. If DB melts down, 2008 will look like an inconsequential stutter.
'Worth' as defined by 'what someone is willing to pay'?
Saying Snapchat is 'worth' 17 billion euros is completely and utter nonsense.
EDIT: As noted below in the comments, LinkedIn was bought for 26 Billion in cash by Microsoft.
You need to look at the big picture here. Young people aren't watching TV. Ad spend by the likes of P&G, Nike, and the auto industry is still largely on TV. Also, Silicon Valley largely hasn't been able to capture brand advertising -- the spend on billboards, sports stadium advertising, etc vs. direct-response like Google AdWords. Ask anyone in the industry， they'll tell you direct-response spending is a drop in the bucket compared to spend on brand advertising.
Now, tell me, one the ad industry wakes up and realizes how absurd it is to dump billions of ad spend onto a platform with rapidly declining viewership (linear TV), where is all that ad spend going to go?
Maybe a communications platform that's used heavily by young people (great for advertisers), to send pictures and short videos (ads?) to each other in a playful, unhurried manner?
I don't know whether that's worth $20 billion or whatever its "valuation" is, but these dumb cheap shots against ad supported tech company valuation need to end. These platforms are as big as like, several big TV networks combined in viewership, with about 100x better ad targeting. How isn't that worth billions?
ad blockers
http://news.microsoft.com/2016/06/13/microsoft-to-acquire-li...
Is there general agreement that the US government acted effectively in this matter, not just for bankers, but for society as a whole?
However, arguably the bank bailouts could have had much better terms for the taxpayer - most of the upside was realised by bank shareholders who were not wiped out, rather than the taxpayer who bore the risk.
For comparison, Warren Buffet also recapitalised some banks in the depth of the crisis, demanded and got long-term warrants that paid out truly humongous amounts of money once bank shares rose back to pre-crisis levels. Tax payers - in comparison - got a few percent of interest rather than adequate compensation for the risk they bore.
More on the Snapchat side, than the DB side.
In fact, due to liquidation preferences in the term sheets Snapchat's true valuation (i.e. the point at which investors actually lose money) immediately post investment, according to basic math, is $0.
http://www.visualcapitalist.com/chart-epic-collapse-deutsche...
I think it's an important differentiation.
The underlying dynamics of the two companies are quite different, and I'm not sure their "worth" can be directly compared.
One is worth a lot to the granny taking out cash from her pension fund, the other is worth a lot to the advertisers wanting to cash in on the cloud social services.
Snapchat valuation is nonsense.
Central bank balancec sheet vs inflation expectation http://www.zerohedge.com/news/2016-07-05/central-bank-death-...
Comparing a Banks market cap to Snapchat? You can't take this seriously. I thought more of Bloomberg.
https://pbs.twimg.com/media/CbBMXbTWAAAl-PG.png
It's another league. That could cause a x10 times Lehman. Too big to fail. If DB falls, the rest of the world follows suit...
Another pearl from the article:
> If the rot isn't stopped soon, Europe will have found a novel solution to the too-big-to-fail problem -- by allowing its banks to shrink until they're too small to be fit for purpose.
Really? and what about the derivatives exposure?
A confirmed bankruptcy of Deutsche Bank would be followed by the collapse of 10s of banks, not in a day but maybe few weeks. Quick enough for unleashing the biggest financial armageddon in the western world.
> there will be no systemic risk to the global banking establishment [...]
Are you sure? on June 30th the IMF said exactly the contrary: "Deutsche Bank Poses Greatest Risk to Financial System"
http://www.nasdaq.com/article/deutsche-bank-poses-greatest-r...
or in a simple pic:
http://cf.broadsheet.ie/wp-content/uploads/2016/06/risks.jpg
Stop doing that.