Hard-hit online lender CAN Capital makes executive changes

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BoE stress tests: all you need to know

The Bank of England has released the results of its latest round of its annual banking stress tests and its semi-annual financial stability report this morning. Used to measure the resilience of a bank’s balance sheet in adverse scenarios, the stress tests measured the impact of a severe slowdown in Chinese growth, a global recession […]

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Zoopla wins back customers from online property rival

Zoopla chief executive Alex Chesterman has branded rival OnTheMarket “a failed experiment”, and said that his property site was winning back customers at a record rate. OnTheMarket was set up last year, aiming to compete with Zoopla and Rightmove, the UK’s two biggest property portals. It allowed estate agents to list their properties more cheaply […]

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Asia markets tentative ahead of Opec meeting

Wednesday 2.30am GMT Overview Markets across Asia were treading cautiously on Wednesday, following mild overnight gains for Wall Street, a weakening of the US dollar and as investors turned their attention to a meeting between Opec members later today. What to watch Oil prices are in focus ahead of Wednesday’s Opec meeting in Vienna. The […]

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Banks, Financial

RBS emerges as biggest failure in tough UK bank stress tests

Royal Bank of Scotland has emerged as the biggest failure in the UK’s annual stress tests, forcing the state-controlled lender to present regulators with a new plan to bolster its capital position by at least £2bn. Barclays and Standard Chartered also failed to meet some of their minimum hurdles in the toughest stress scenario ever […]

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Archive | November, 2016

China: Fear of a deflationary spiral

Posted on 30 November 2014 by

YIWU, CHINA - SEPTEMBER 28: (CHINA OUT) A toy dealer checks informations at the Small Commodity market on September 28, 2007 in Yiwu of Zhejiang Province, China. According to reports, retailers in the UK are set to import 375,000 tonnes of toys from China this year amid fears of made-in-China products, nearly 5 percent increase from 2006. Figures with the British Toymakers Association shows that about 85 per cent of toys sold in Britain are made in China. (Photo by China Photos/Getty Images)©Getty

A toy dealer in Yiwu, a centre for the trading of small commodities. Many manufacturers are having to accept reduced prices

The 600,000-square-metre China Commodity City in Yiwu city, often referred to as “Walmart on steroids”, is one of the world’s largest wholesale markets.

Traders from the Middle East, Russia and Africa come to the market in eastern Zhejiang province to browse a staggering array of products from umbrellas to buttons to refrigerator magnets commemorating every city in the world – many made in one of the small factories dotted around the city’s fringe.

    But as the holiday season approaches, Guo Wei, factory manager at China Zhongsheng Crafts Co, which makes plastic Christmas trees for export to the US, the UK, Australia and Japan, is struggling to cope. For some products, the company is even selling below cost.

    “Sales revenue is holding up OK, but when it comes to prices, customers want them lower and lower. They all say the economy isn’t good,” said Ms Guo. “Some of our own products aren’t profitable any more but we still make them to keep our customers happy.”

    Cheaper Christmas trees may sound like good news for western consumers. But falling prices in China pose a rising threat to economies across the globe, many of which are grappling with their own issues of weak demand and troublingly low inflation.

    After a decade in which rapid growth and investment gobbled up China’s enormous output, many of its factories – like those in Yiwu – are finding it difficult to shift stock. Demand at home and abroad has been stalling, leaving many industries with chronic overcapacity, especially in basic commodities like steel, glass and cement. For many, the only answer is to keep cutting prices.

    The result is reflected in China’s official statistics, which show that so-called producer prices have been in outright deflation for nearly three years. Perhaps even more worrying,
    consumer prices have dropped to a near five-year low of 1.6 per cent on an annual basis in October. “You think there’s a problem in the eurozone? There’s a far bigger problem in China,” says Albert Edwards, strategist at Société Générale.

    China is the world’s top exporting nation, and the main trading partner with dozens of countries. As its manufacturers drop prices to increase sales, the impact is being felt across the world, from the factory floor to the shop shelf. With policy makers in many economies – Europe and Japan especially – worried about falling prices, China’s own ability to boost inflation is becoming a key part of the puzzle. As George Magnus, an economic adviser to UBS, puts it: “The rest of us need Chinese deflationary pressures like a hole in the head.”

    Optimists say China is unlikely to tip into the kind of stubborn deflationary spiral that has dogged neighbouring Japan for two decades and is dominating the policy debate in Europe. Growth, for now at least, remains above 7 per cent a year, making it an important engine of global demand.

    But in a possible sign of rising concerns about disinflation, the People’s Bank of China cut interest rates in November for the first time since 2012.

    “It’s a clear indication of how heavy deflationary pressure in China can be these days,” said François Perrin, head of China equities at BNP Paribas Investment Partners.

    For over a decade, China has faced accusations of exporting deflation. In 2002, Haruhiko Kuroda – then a Japanese finance ministry official, now head of the Bank of Japan – warned in the Financial Times that China’s entry into the World Trade Organisation would add a “powerful deflationary force” to the global economy.

    Just over a year later, the US Federal Reserve published a discussion paper entitled: “Is China exporting deflation?”, but it concluded that the Chinese economy was “too small” to have an impact. A decade on, China’s place in the global economy has been transformed, both as a supplier of goods and a source of demand for raw materials. The Chinese slowdown has been a key factor in falling commodity prices, such as oil, which sank to a four-year low last week.

    The drop in global energy costs is feeding through to weaker inflation
    everywhere, but many see China’s current bout of disinflation as a symptom of deeper problems that are unique to the world’s second-largest economy: chronic overcapacity, insufficient demand and faltering growth. All are side effects of a top-down system where cosseted state enterprises are reluctant to retrench and local governments are engorged with easy credit.

    The country has a long history of excessive development across industries, from solar panels and shipbuilding to steel and chemicals. Many companies in these sectors are now on life support and are increasingly reliant for funding on China’s vast shadow banking system, where “non-bank institutions” sell wealth management products that offer high returns on investments regarded – rightly or wrongly – as underwritten by the state. Even the downturn in the housing market can be attributed to the burden of oversupply in many cities.

    Last week, government researchers put a figure on wasteful spending. By their calculations, $6.8tn has been squandered on “ineffective investment” – such as needless steel mills, ghost cities and empty stadiums – since the start of the 2009 stimulus launched to buffer China from the global financial crisis.

    Overcapacity is largely the result of pressures on local governments. The performance of local officials has long been evaluated based on gross domestic product, creating an incentive to maintain production even at unprofitable factories. Excess capacity has unfortunate consequences: falling prices undermine corporate profitability and lead to stress in the banking system. Local officials lean on banks to relax lending standards for companies that would otherwise be forced to close down. Unprofitable manufacturers pile on ever more debt but avoid bankruptcy and maintain production, adding more downward pressure on prices.


    The central government has pledged to stop measuring officials’ performance mainly based on GDP, but this change will take years to trickle down to lower levels of government.

    Deflation has also fuelled the build-up of risk in the financial system. Cut off from bank finance, companies in oversupplied industries, especially privately owned ones, pay exorbitant interest rates in the shadow banking system. Falling prices at the factory gate make the burden of that growing debt even heavier, raising the risk of defaults.

    Overcapacity is not just a local problem: sinking prices for Chinese-made goods affect costs globally. Before the financial crisis, that helped drive a consumer boom in the west. But now excess supply risks worsening the problem of falling prices in developed economies.

    Eswar Prasad, economics professor at Cornell University, says: “Disinflation and weak demand growth in China could have adverse spillover effects on other countries grappling with even more severe versions of these two problems.”

    Deflation inflicts a dual blow on an economy. It increases the burden of debt in real terms, something that China, which Standard Chartered estimates has a debt-to-GDP ratio above 250 per cent, can ill afford.

    Falling prices can also hold back consumption, as people delay purchases in expectation of even cheaper prices. But as China tries to shift its economy from credit-fuelled investment towards consumer-driven growth, it needs its citizens to go shopping.

    In the scenario of higher spending, China’s policy makers could do very little, at least until the prospect of outright deflation becomes a more serious risk.

    “Cheaper commodities benefit consuming countries which drive global demand,” says Fred Neumann, chief Asia economist at HSBC.

    If prices continue to tick down, Beijing has several options for generating demand. But as central bankers in Japan and Europe have found, stirring inflation with monetary policy is no mean feat when dealing with years of excess credit growth. Many analysts expect further rate cuts and more targeted easing measures for some sectors. This could support consumer spending and reduce the debt burden on companies.

    But there are questions about the impact of rate cuts on the broader economy. Lower borrowing costs will largely benefit hulking state-backed companies, helping them to keep going even if they are not economically viable.

    Rate cuts could also signal the status quo will be preserved, which “might give the market an impression that the new government once again uses credit easing to stimulate growth”, said Lu Ting, chief China economist at Bank of America Merrill Lynch.

    Under President Xi Jinping and Premier Li Keqiang, China has laid out a path towards comprehensive reform designed to introduce real market forces. But there has been little to show for it. “I think the majority in policy circles still talk about reform in a positive way,” says Zhang Zhiwei, economist at Deutsche Bank. “The question is about timing and how to do it.”

    Until then, China’s economic model remains reliant on the trusted drivers of growth – credit-fuelled investment and exports. However, both are under increasing strain. Credit growth has been explosive in recent years since the financial crisis, while weak global growth means that the export engine is stalling, and driving down prices.

    The worry is that China decides to take the nuclear option to fan inflation at home: currency devaluation. A sharp drop in the value of the renminbi could boost exports, and help use up excess capacity; it would also offset the drag of weaker commodity prices. But raising import prices would be bad news for Chinese consumers, as would higher input costs for manufacturers.

    Analysts say the chances of a devaluation are still slim, but growing. “I don’t think this is likely, but the weaker Chinese data gets, the greater the pressure on policy makers to go for the easy option of devaluation,” says Mr Neumann. “Should China opt to depreciate its exchange rate, this would be a game changer.”

    Such a move could prove disastrous for efforts elsewhere, notably Europe and Japan, to fight deflation. China is the world’s top exporter to the EU, meaning that a significant drop in the price of its goods would put fresh downward pressure on already very low inflation trends in the eurozone.

    But the aggressive expansion of the BoJ’s quantitative easing programme has raised the stakes. The yen has tumbled to a record low against the renminbi, while South Korea has put the market on notice that it is watching the Japanese currency closely. If the BoJ sparks a regional currency war, China may not be able to remain neutral.

    “If you’re trying to crush a credit bubble, which the Chinese are, the last thing you need is a rapid appreciation in the exchange rate,” says SocGen’s Mr Edwards. “Economically, China doesn’t have a lot of choice. It’s just an inevitability, and Japan is the straw that broke the camel’s back.”


    Corporate debt

    Historic default fails to clean up financial sector

    In March, solar-panel maker Chaori Solar failed to meet an interest payment on its bonds, marking China’s first default of the modern era.

    Investors expected a wave of corporate bankruptcies and defaults to follow, which would have damaged confidence but would have cleared away some of the excess capacity that has been pushing prices down. Raising the potential for corporate failures was expected to lead to more rational pricing of risk, as investors began to realise not everything was underwritten by the state.

    Reality has proved rather different. Fears that injecting too much risk into the system too quickly would close the window for refinancing companies have overridden expectations. Regional authorities were also afraid of playing host to corporate failures.

    Instead, local government officials prevented companies from going bust by strong-arming banks into making new loans. Defaults failed to emerge, while non-performing loan rates at large banks – although rising – have remained extremely low.

    Chaori bondholders were ultimately bailed out by a state-owned bad bank in October. Huarong, another of China’s bad banks, also rescued those invested in “China Credit Equals Gold #1”, a trust product that had teetered on the brink of default in January. In both cases, the bailout was largely kept quiet, leading to assumptions of state-directed assistance.

    There have been attempts at shaking up the status quo and introducing more market forces into the economy. Many large state-owned enterprises have this year announced restructuring or asset spin-offs. Sinopec recently sold a $17.4bn stake in its gas station business, Citic Group is injecting $37bn of assets into its Hong Kong-listed arm, while China’s three mobile operators are exploring a stake sale of their pooled towers business.

    But these measures remain piecemeal, and are in many ways simply experiments at the margins of the economy.

    Market rout as oil fall hits energy groups

    Posted on 28 November 2014 by


    Shares in the world’s biggest energy groups have tumbled in a market rout as plunging oil prices put at risk billions of dollars of investment and jeopardised future supplies of crude.

    The sharp slide in the price of Brent oil after Opec’s decision not to cut output triggered warnings that oil companies would cut as much as $100bn of capital spending in response, imperilling the US shale bonanza and threatening much Arctic oil exploration.

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    Meanwhile oil’s fall continued to play havoc with the currencies of oil exporting countries, especially Russia. At one point on Friday, the rouble slid to a record low.

      Leonid Fedun, vice-president of Lukoil, Russia’s second largest crude producer, told the Financial Times that Opec was trying to turn the US shale oil “boom” into a “bust” for smaller producers.

      He compared the surge in North American shale to the dotcom and subprime mortgage booms, and said Opec’s objective now was “to get small producers with large debts and low efficiency to pack up and leave the market”.

      Opec said on Thursday that it was leaving its output ceiling of 30m barrels a day unchanged, prompting a swift 8 per cent drop in the oil price, which was already down by nearly 40 per cent since mid-June. Brent fell $2.80 on Friday to $69.78, a four-year low.

      The move showed that Saudi Arabia, Opec’s largest producer and effective leader, had decided to relinquish its traditional role of balancing the oil market by increasing or reducing output, letting prices do the job instead, analysts said.

      “We cannot overstate what a dramatic and fundamental change this is for the oil market,” said Mike Wittner, senior oil analyst at Société Générale.

      Friday’s brutal sell-off in the US and across Europe hit shares in the oil majors, the big oil services companies that supply them, as well as the smaller explorers most exposed to the plunge in crude. ExxonMobil fell 4.3 per cent, Chevron 5.4 per cent and oilfield services group Halliburton 11.1 per cent. They recovered slightly by the close.

      But the slide could bring relief for motorists. In the UK, the Petrol Retailers Association said it could trim the average price of petrol, currently 122.6p per litre, by another two pence over the next couple of weeks.

      The price fall has sent a chill through the US shale sector, which had driven US oil production to its highest level in more than three decades. Analysts at Tudor Pickering Holt, the energy investment bank, warned that, with US crude at or below $70, “no basin is safe” from cuts in drilling activity. WTI, the US benchmark, is currently trading below $67 a barrel.

      The Bakken shale of North Dakota and the Mississippian Lime region of Oklahoma would be among the regions bearing the initial brunt of the slowdown, they said.

      The critical factor determining the pace of the slowdown will be the debt levels of the US independent oil and gas companies that have led the shale boom. With oil at $70, exploration and production companies will cut back spending on new wells to prevent their debt burdens rising.

      In depth

      Living with cheaper oil

      Oil refinery

      Latest news and comment on the global economic and political consequences of tumbling oil prices

      Further reading

      Wood Mackenzie, the energy consultancy, said if Brent stayed below $75-80, US shale oil supplies could be reduced by 0.6m b/d by the end of 2015.

      Other high-cost sources of oil, such as Canadian oil sands, could be affected. Andrew Leach of Alberta University said that production of bitumen by mining was typically only viable at over C$50 per barrel, the current market price. He added: “If we see sustained low prices [for conventional oil] some oil sand projects will have to stop.”

      Arctic exploration could also be hit if crude stays low. Mr Fedun told Bloomberg he did not expect the development of oil reserves in the Arctic on a significant scale to happen within his lifetime.

      Oswald Clint of Bernstein Research warned that the response would be similar to 2009, when non-Opec capital expenditure, excluding acquisitions, fell by 16 per cent or $100bn after the oil price plunged from record highs.

      Falling oil prices, meanwhile, are driving down expectations for global inflation, putting additional pressure on central banks to step up economic stimulus programmes.

      Inflation in the eurozone returned to a five-year low of 0.3 per cent in November as energy prices in the currency bloc slipped. Eurozone government debt rallied in the wake of Friday’s reading, sending yields in countries including Germany and France to record lows as investors focused on the possibility of a government debt purchasing programme by the European Central Bank to boost inflation.

      In the UK, yields on longer term 30 year bonds also hit a record low of 2.66 per cent on Friday.

      Additional reporting by Elaine Moore and Jonathan Guthrie


      Letter in response to this report:

      Oops . . . there goes the sovereign wealth fund / From Julian McIntyre

      Europe Inc: Light amid the gloom

      Posted on 27 November 2014 by

      BRUSSELS, BELGIUM - OCTOBER 24: A woman walks past the European Commission building on October 24, 2014 in Brussels, Belgium. Alongside criticism from outgoing European Commission president Jose Manuel Barroso on the UK's stance on EU immigration and a plan to quit the European Court of Human Rights, the UK has now been told to pay an extra £1.7bn GBP (2.1bn EUR) towards the EU's budget because its economy has performed better than expected. (Photo by Carl Court/Getty Images)©Getty

      Making strides: a woman walks past the EU flag in Brussels. The European Commission is set to play a more active role in boosting investment

      The mood music from the eurozone has changed once more into a relentlessly minor key. Economists worry that the region is about to slip back into recession. Mario Draghi, president of the European Central Bank, warns of the dire impact of deflation. Academics suggest Europe has lost any competitive advantage over faster-growing rivals. Even Pope Francis is worried, telling MEPs in Strasbourg on Tuesday that the continent was now like “a grandmother, no longer fertile and vibrant”.

      But through the macroeconomic gloom peeks a more positive picture. Europe’s multinationals, flush with cash, are starting to flex their healthy balance sheets in acquisitions and overseas expansion. Even the continent’s smaller companies are showing signs of life.

        “From a corporate credit perspective, we believe that macroeconomic concerns are overstated,” says Gareth Williams, economist at Standard & Poor’s.

        This is not to underestimate the strength of the headwinds facing Europe’s companies. Growth in the region is anaemic, at best. This month the pace of recovery slowed to its lowest level in almost a year and a half, with a poll of purchasing managers suggesting that activity would remain weak in the months ahead. Meanwhile inflation is running at 0.4 per cent, well below the ECB’s target of below but close to 2 per cent.

        Even the well-known macroeconomic negatives have a flipside, however. Ignacio Galán, chairman and chief executive of Iberdrola, Spain’s largest power utility, says that although low inflation means most companies have very little pricing power, it has made bosses’ lives easier in other ways. “In certain situations [low inflation] can provoke a more stable situation in terms of wages reducing,” he says. “In the past, high inflation means that we are forced to have difficult negotiations at this level.”

        Deflation is also one of the few ways for peripheral Europe to regain competitiveness within the eurozone. “Within a monetary union a country cannot devalue its nominal exchange rate to regain lost competitiveness,” argues Dirk Schumacher, a Goldman Sachs analyst. “A decline in the price level relative to other countries is therefore the only option left to reduce its real exchange rate.”

        Other macroeconomic developments are more unequivocally positive.

        At the beginning of the year, the loudest complaints from business leaders concerned the price of energy and the euro. In March the European Round Table (ERT) of Industrialists, the influential lobby group of 50 chief executives and chairmen of Europe’s leading multinationals, warned that the region’s high energy costs and strong currency risked derailing its recovery.

        Euro and energy advantage

        Now both trends are going in the right direction. The euro has fallen 4 per cent on a trade-weighted basis since its 2014 high in March, and 11 per cent from its May peak against the US dollar. Meanwhile Brent crude, the international oil benchmark, has fallen about 37 per cent from its June peak and traded around $72 a barrel on Thursday.

        “It is undeniable that a lower oil price and a lower euro is a positive. It has got to be a windfall for the European economy,” says Paul Watters, head of corporate credit research at S&P.

        Given that nearly half of listed European companies’ sales are overseas, UBS estimates that a 10 per cent fall in the trade-weighted euro results in a boost of about 6 per cent to European earnings.

        Falling energy costs and improved foreign exchange earnings are also playing out against a backdrop of easy money, at least for Europe’s multinationals. On this front, issues that had dogged the market as recently as 18 months ago have all but disappeared. For instance, Myriam Durand, Europe, Middle East and Africa managing director for corporate finance at Moody’s, says concerns about the “refinancing wall” of maturing corporate bonds that European companies were going to hit have evaporated.

        “The refinancing issues that we had been really worried about have largely been taken care of and the corporate world is sitting on large cash piles,” she says.

        Smaller companies have also been able to take advantage of easier borrowing conditions. The Moody’s Liquidity Stress Index, which falls when liquidity improves and rises when it weakens in a universe of non-investment grade companies, dropped to an all-time low in August of 10.7 per cent, compared to its peak of 18.8 per cent in December 2012.

        The western European leveraged loan market is back to its pre-crisis peaks – volume stands at $251bn this year, up nearly a quarter from 2013 and the highest year-to-date volume since 2007. Meanwhile, there were twice as many initial public offerings of European companies in 2013 than in 2012, according to Dealogic, and deal volume this year, at €30bn, is three times higher than the whole of 2013.

        Banks in a better place

        The conclusion of the ECB’s asset quality review and stress tests of banks should also result in further relaxation of lenders’ caution.

        “Now that we’re through the comprehensive test, hopefully that will strengthen market confidence in the banking system, and banks will also feel more confident to lend,” says James Watson, director of economic affairs at BusinessEurope, the Brussels-based lobby group. Industrialists agree. “In the past few months a lot of things have been done in Europe that are positive,” says Mr Galán. “The banking union is a very important step.”

        Even the lack of access to bank lending during the financial crisis, it can be argued, has had positive effects, with small and medium-sized enterprises reducing their
        over-reliance on banks and diversifying their funding sources.

        While the improvement in smaller companies’ borrowing conditions should not be overstated, large corporates have benefited from years of rock-bottom interest rates in the public debt markets, and are now sitting on fat cushions of cash. Investment, though, is still stagnating despite being much needed to maintain depleted capital stock as well as develop new projects.

        “I don’t think there is any company CEO who likes to keep cash on the balance sheet if there are good investment opportunities,” says Vittorio Colao, chief executive of Vodafone and a member of the ERT. He blames bureaucracy for muzzling investment rather than the lack of attractive projects.

        Although shareholders still seem unwilling to pressurise chief executives to spend the cash on their balance sheets, mergers and acquisitions have picked up, fuelled by cheap financing as well as plump cash balances. European dealmaking, according to Deloitte, has doubled from $300bn in the first nine months of 2013 to more than $600bn in the same period of 2014. Nearly a third of loan issuance in the primary European loan market this year has been acquisition-related – the largest quarterly total since the financial crisis.

        Even if companies continue to hold on to their cash, there are hopes that the European Commission will play its part in boosting investment. Jean-Claude Juncker, commission president, on Wednesday presented a €300bn investment programme for the next three years to the European Parliament. Although the amount of new public funding will be limited, corporate Europe has welcomed the move, as well as the restructuring of the commission.

        “There is a real need in Europe for a growth agenda, which is what I am expecting from the new European Commission,” says Michel Combes, chief executive of Alcatel-Lucent, the French telecoms equipment maker. “The new architecture of the commission will be extremely powerful . . . and I think [it] clearly understands what is at stake.”

        Benoît Potier, chairman of the ERT as well as chief executive of Air Liquide, says: “The organisation of this commission is along the lines more or less of what we suggested . . . breaking the silos that we had in the past.

        “The glass is still half full at this stage rather than a glass which was half – if not more – empty.”

        Whether growth in Europe picks up, its multinationals have already diversified beyond the region in a trend exacerbated by the financial crisis. Morgan Stanley expects the share of European corporate revenues generated within developed Europe to fall to 46 per cent in 2014 from 71 per cent in 1997, and the heads of Europe’s multinationals insist their performance is no longer so dependent on the region.

        Vodafone, says Mr Colao, is “based in Europe, but not European in terms of the prevalence of customers or markets”, for example.

        From this perspective, the fact that the US has recovered faster than Europe is a growth opportunity. “Long term we still have a very healthy portfolio of [investment] opportunities, some of them in Europe but the rest being in the more dynamic economies – the US, China and the Middle East,” says Mr Potier. Iberdrola’s Mr Galán adds: “Almost two-thirds of our business [is] outside the EU in emerging countries or countries that are growing very fast like the US.”

        Expansion expectations

        And the demand outlook for Europe’s goods is still encouraging. “Looking at a sample of manufacturing purchasing managers’ indices for 19 major economies shows that 14 are still reporting expansion,” says S&P.

        This is not to obscure the many challenges that Europe’s businesses face. These include relentless competition both for export markets and inward investment. Europe’s share of global foreign direct investment, 40 per cent in 2007, had fallen to just 20 per cent by 2012. Accounting for nearly 600 of the world’s top 2,000 listed companies by market capitalisation a decade ago, it now represents fewer than 400.

        Low, or non-existent, growth in domestic markets will pose long-term problems and changes in behaviour forced by the financial crisis – such as hoarding cash – may well prove permanent rather than temporary. But it is easy to miss the good stories amid the pessimism that characterises much of the macroeconomic debate.

        “Europe as a single economic bloc has great strengths as a market and as a place to produce. It is the duty of companies to underline that what Europe needs is scale, lower regulation and more harmonised regulation,” says Mr Colao.

        “I am a fundamental optimist about Europe getting our act together, and the richness of the skills we have in Europe is a good basis to start from.”


        Energy: politicians and business play catch-up

        Analysts suggest the emerging markets and leading eurozone economies benefit more from the fall in the oil price – which dipped under $72 a barrel in trading on Thursday – than the US and Japan.

        According to UBS, a $15 decline in the price of a barrel of oil adds 0.25 percentage points to eurozone growth after one year, with
        energy-dependent Germany
        getting a slightly bigger benefit. Reduced oil prices lower input and energy costs for companies and lift consumers’ spending power, hopefully leading to a rise in demand.

        More than 27 per cent of listed European companies’ earnings could be hurt by falling commodity prices, given that the oil and gas sector makes up 12 per cent of profits and a quarter of capital expenditure in the region. But consumer-tilted sectors, which represent nearly a third of profits, will benefit.

        However, Europe has been caught on the wrong end of radical shifts in energy prices as the shale gas and oil boom in the US has taken off, sharply reducing costs for its companies. Balancing the demands of sustainability, affordability and security of supply is placing policy makers in a dilemma. In Germany, for example, a decision to exit nuclear power and move to renewables has created a supply shortfall and resulted in a rising reliance on dirty coal-fired power stations.

        Meanwhile, the European Round Table of Industrialists, a lobby group, calls for shale gas exploration to be allowed “under appropriate oversight” and for a genuine single market in energy, with a single regulator.

        “Energy is crucial
        for the European industrial renaissance, [and] absolutely required is energy union – [the] same taxation, same levies, cleaning up the tariffs that we pay, which the Americans are not,” says Ignacio Galán, chairman and chief executive of Iberdrola

        Nyrstar parts ways with chief executive

        Posted on 26 November 2014 by

        Nyrstar CEO Roland Junck talks on February 7, 2013 during a press briefing to announce Belgian-Australian zinc giant Nyrstar NV's results for the year 2012 in Brussels. AFP PHOTO / BELGA / ERIC LALMAND -- BELGIUM OUT -- (Photo credit should read ERIC LALMAND/AFP/Getty Images)©AFP

        Roland Junck

        Nyrstar is looking for a new chief executive after the world’s largest zinc producer abruptly parted company with Roland Junck, shortly ahead of an investor vote to approve a refinancing package.

        Julien de Wilde, chairman, said Nyrstar’s board had concluded it needed a different leader for a “new phase of execution”. The Belgian group is investing heavily in redeveloping smelters and refineries as part of a strategy initiated under Mr Junck.

          The immediate departure of Mr Junck, chief executive since 2009, follows recent stakebuilding in Nyrstar by Trafigura, one of the world’s largest commodities trading houses.

          Mr de Wilde told the Financial Times the decision to find a new chief executive was not linked to Trafigura’s becoming an investor. “No investors have had [anything] to do with the decision,” Mr de Wilde said.

          Trafigura has said the stake of at least 15 per cent that it has amassed in Nyrstar since last month is a financial investment, although analysts have speculated that it may also give the trading group clout to try to gain marketing rights for a share of Nyrstar’s metals output. At the moment Nyrstar sells its zinc to Noble, another trading house.

          Many trading houses are trying to become more vertically integrated, in a response to declining profit margins in their traditional role as a link between producers and customers.

          Nyrstar raised €600m via a rights issue and bond in September, using the proceeds to pay down some debt and invest in its downstream facilities, with the largest project an expansion of Port Pirie, an Australian smelter.

          “We have the strategy and we have the funding,” said Mr de Wilde. “Now it is a question of accelerating . . . the board decided that it would be better if we did that with another chief executive.”

          Mr de Wilde said he hoped a successor to Mr Junck could be found quickly. “Sometimes you do not have, at moment X, Mr X readily available,” he said.

          Heinz Eigner, chief financial officer since 2007, has taken over as acting chief executive.

          Shareholders in Nyrstar have to vote next week on a change of control clause related to the debt refinancing. Mr de Wilde said he expected support from the shareholder meeting, required under Belgian corporate law.

          Trafigura declined to comment on Mr Junck’s departure. Shares in Nyrstar were flat at €2.75 in Brussels.

          Thomas Cook hits travel stocks

          Posted on 26 November 2014 by

          Travel stocks missed out on a wider, miner-led rally in London on Wednesday after the sudden resignation of the chief executive of Thomas Cook unnerved the sector.

          After Harriet Green, who drove the recovery of the tour operator from near-collapse, announced her immediate departure, shares in the company slumped 19 per cent to 111.6p and the bottom of the mid-cap FTSE 250.

            Thomas Cook also trimmed its guidance for the full year, saying it expected growth in the 12 months to September 2015 to come “at a more moderate pace”. It noted that geopolitical uncertainty was damping demand, with weakening consumer confidence in Europe also taking a toll.

            “Investor concern is that Ms Green has left too soon and that the company transformation may be at risk,” said Rebecca O’Keeffe, head of investment at Interactive Investor.

            “Comments that her ‘work was complete’ conflict with other statements in their results that there is still ‘more to do’.”

            Credit Suisse cut its rating on Thomas Cook’s stock from “outperform” to “neutral”, saying: “The outlook commentary is balanced but cautious as the company note it expects more measured [earnings] growth plus highlights winter trading and extra cost pressures . . . We lower our 2015 and 2016 earnings before interest and taxation forecasts by 10 per cent and 13 per cent [respectively]”.

            As traders read across from the news, Tui Travel was among the biggest fallers on the FTSE 100, down 0.8 per cent at 443p. EasyJet was caught in the downdraft, turning around from its recent gains which related to lower crude prices. The stock drifted 0.5 per cent to £15.52.

            Overall, the main London index rose 0.3 per cent to 6,749.06, a rise of 18 points, with the rally underpinned by resurgent base metal stocks as risk appetite continued to improve on global markets.

            London’s best single gainer was Antofagasta, up 4.2 per cent at 764p. Anglo American gained 0.7 per cent to £13.39.

            Defensive stocks were lower in line with the more confident mood. Admiral Group, the car insurer, fell 0.7 per cent to £12.14 while United Utilities slid 0.8 per cent to 907½p.

            The bull case for European equities

            Posted on 25 November 2014 by

            European equities are not an obvious buy for US investors, who see their own economy forging ahead, corporate earnings beating expectations and a stronger dollar.

            Yet with company earnings for the eurozone not as bad as expected, some believe the sector is now undervalued, creating pockets of opportunity in the continent.

              Analysts at Barclays believe European equities could rally “significantly” if the European Central Bank embarks on full-blown quantitative easing, which they believe is not yet priced into stocks. They predict European markets, not including the UK, will grow at the most rapid rate of any other major market next year with a total return of 18 per cent, compared twith just 5 per cent in the US and 9 per cent for global and emerging markets.

              Jack Ablin, chief investment officer at BMO private bank, is optimistic QE can help the eurozone.

              “QE was effective in the US and if we see the ECB act, that should be cause for optimism,” he says, estimating that developed world equities trade at a 25 per cent discount to the US market.

              Yet the big problem for US-based investors is the dollar. The euro has fallen 9 per cent against the US currency since July – a trend that analysts are overwhelmingly forecasting will continue, as the Federal Reserve tightens interest rates next year while the European Central Bank talks of easing monetary policy further.

              US and European shares jointly enjoyed a bull run in the first half of this year, but started to decouple in early summer when fears of deflation hit the eurozone. The S&P 500 has risen 15 per cent over the past year, while the MSCI EMU Index is up 3 per cent in absolute terms – but down 4 per cent in dollar terms.

              Some US investors are hedging the currency exposure. Alan Ruskin, an analyst at Deutsche Bank, says fund managers that do hedge are doing so more than usual when buying European equities. Dale Winner, manager of the Wells Fargo International Equity Fund, hedges the currency risk for part of his portfolio and has been adding to European industrials he thinks will benefit from the falling euro – in particular companies that are cutting costs and trading cheaply such as Germany’s Siemens, Holland’s Akzo Nobel and Italy’s Prysmian.

              Others are buying products that take the currency risk out of the equation. The most popular exchange traded funds this year include the WisdomTree Europe Hedged Equity, which saw some of its largest daily net inflows in November, according to data from

              Some believe European equities have further to rise than the euro has to fall, making them still worth buying even without a hedge. A rule of thumb investors use is that a 10 per cent fall in the euro against the dollar boosts earnings per share for European companies by 10 per cent.

              T Rowe Price’s head of equity, Bill Stromberg, told investors last week that while the world was “very bearish” on Europe, companies had been cutting costs to put themselves in a good position to outperform if earnings surprised on the upside.

              “If there’s a whiff of GDP growth we think you’ll see really good earnings growth in Europe that could surprise on the upside, and stocks are cheaper there, so we would own some Europe as a really good hedge for some potential good news,” he said.

              The current European reporting season has been reasonably upbeat, with third-quarter earnings expected to be 12.1 per cent higher than a year ago, despite only a marginal 0.3 per cent increase in revenue over the same period.

              Shares in European telecoms groups such as Vodafone, Deutsche Telekom, France’s Orange and Telecom Italia have responded well to an unexpectedly strong run of results, while car manufacturers such as Volkswagen and PSA Peugeot Citroën were also positive. ThyssenKrupp, the German steel and elevator group, ended a three-year run of multibillion-euro losses with a return to net profit and the promise of a dividend for investors.

              Some fund managers are selecting stocks in Europe that are more likely to benefit from a stronger dollar.

              “Going into 2015 the currency move will be the biggest factor,” says Gerd Kirsten, a European equity manager at Deutsche Bank.

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              “The big currency moves mean big support for exporters, especially those that export to the US. We find a lot of dollar beneficiaries on the consumer side, in healthcare, industrials and machinery companies.”

              Top stocks in his flagship European fund, the DWS Top Europe, include Novartis, Anheuser-Busch InBev and Roche.

              “If you compare it on a global scale Europe is probably the cheapest region you can get,” he adds.

              Éric Mijot, a strategist with Amundi Asset Management, says: “If deflationary risk sets in, valuation levels will certainly be downgraded, as will profits – a sort of double penalty. However, if these risks abate, the opposite will occur – a double bonus.”

              American bulls in charge

              Posted on 24 November 2014 by

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              When the US led the world into a catastrophic financial crisis six years ago, few expected the country to be the first to surge out of the mess it had created. But that is what happened. While others remain in the doldrums, US markets power ahead in an unambiguous bet that the American economy can grow even if others suffer a recession.

              The S&P 500 has more than trebled since it hit rock bottom after the crisis; it has sailed on for three years without once suffering a fall of as much as 10 per cent; it has done this on the back of economic performance most Americans find terrible; and yet sentiment remains firm that the rally can continue.

                Richard Bernstein, a New York-based investment analyst, said: “We said in 2009 we were probably entering one of the biggest bull markets of our careers, and I think we still are. If you look around the world, it’s very hard to find too many economies that are getting better. In the US, the absolute growth rate is not so strong, but in many aspects the economy is actually improving.”

                The logic pushing investors into US stocks is ineffable. Vinny Catalano, of Blue Marble Research in New York, puts the case succinctly: “The main drivers for the bull markets have been strong earnings, interest rates being extraordinarily low and a significant amount of liquidity. That money has got to be invested somewhere. The music is playing and you have to dance.”

                But the extent of the turnround when compared to the rest of the world suggests that things may have been taken too far. In early 2008, the total value of European stock markets briefly exceeded US market capitalisation by more than $1tn. Now, Corporate America is worth almost $10tn more than Corporate Europe. Since March 2009, the US S&P has outpaced the developed world’s stock markets by 87 per cent and emerging markets – which had surged before the crisis – by 89 per cent.

                Meanwhile, the dollar is enjoying a long upswing while yields on US debt remain historically low, even after the Federal Reserve has ended its quantitative easing programme. That suggests strong confidence that the US will avoid inflation, even as investors are braced for the Fed to start raising interest rates.

                Once feared, the prospect of higher rates is now greeted by investors as a sign of returning normality. As Mr Bernstein says, bear markets usually happen not when the Fed raises rates but when it raises rates too much. When worried this is about to happen, the bond market signals its fear by raising short-term rates above long-term rates – something that is far from happening at present.

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                The strengthening dollar, bolstered by higher US rates, encourages foreign investors to buy US stocks, as they can gain from the currency if the underlying equity market goes off the boil. But it also creates a problem. A stronger dollar directly weakens the value of US companies’ overseas earnings, which have dropped from a third to a fifth of total earnings since the dollar hit its low during the crisis. As John Higgins of the London-based Capital Economics puts it: “While the dollar’s recent strength may partly be a reflection of the relative health of the US economy, it is arguably a reason to be more cautious about the prospects for US equities.”

                Stocks are already priced on the assumption that the US is to reign supreme. They look expensive compared to their own history, and very expensive compared to other countries’.

                The S&P now sells at a multiple of 27 times its average earnings over the past 10 years. This is well above its 10-year average and roughly where it was on the eve of the credit crisis in 2007. Every other major developed market has a long-term price/earnings multiple below its historic average, according to Research Affiliates. The US looks more expensive because it has many tech companies, which command higher multiples, but the gap is wide and stark.

                A further issue with valuation concerns profits. S&P 500 companies’ earnings per share are at a record and gained more than 10 per cent on an annualised basis in the third quarter. But those profits were buoyed by QE, which enabled financial engineering such as borrowing to buy back stock. Companies also enjoyed the high and perhaps unsustainable profit margins that come from cost-cutting, low interest expense and a compliant labour force. Earnings before interest, tax, depreciation and amortisation are still not back to their 2007 peak. Revenues have been far slower to recover than earnings – even if they did grow at a clip of more than 5 per cent in the most recent quarter, once energy companies are excluded.

                That means earnings owe much to profit margins, which are now at historic highs and tend to be cyclical. That they have stayed high throughout the post-crisis period probably reflects stubbornly low wage growth; the US economy is not growing fast enough to give workers much negotiating power. Indeed, some equity analysts say their chief concern is a return to healthy wage growth. That would be good for Main Street but not for Wall Street.

                US companies are buying back their own stock at a record rate. So far this year, more than 90 per cent of their announced earnings has gone back to shareholders, either through buying back shares or as dividends – suggesting executives see few promising investment opportunities. Indeed, the biggest buyer of US stocks, by far, is US corporates. Buybacks swamp the total invested by mutual funds and pension funds combined, as companies such as Apple, Intel and Boeing, often under pressure from activists, reduce the number of their shares outstanding.

                Finally, much of the “buy US” enthusiasm rests on a view that the Fed is out of kilter with other central banks. The European Central Bank is talking of speeding up its attempt to stimulate inflation, the Bank of Japan has stepped up its own bond purchases, and the People’s Bank of China has surprised investors by cutting rates – while the minutes from the latest Fed meeting suggest that the bank is gearing up to raise rates next year. All of this should keep funnelling money into the US.

                But if this does pan out, the risk that the US – already expensive – continues charging upwards until it becomes overheated seems very real. As Rob Arnott of Research Affiliates puts it: “The flight to safety brings money into this economy, propelling markets higher. So there are lots of reasons. That doesn’t mean that the market is a buy, it just has been fuel for rising markets and it doesn’t tell us when this merry-go-round stops.”

                Perhaps it is the almost uniform confidence in the US that is most worrying. The closest approach to a correction this year, when a spasm in the bond market last month led to a 9.8 per cent dip in the S&P 500, came after a few data points suggested the US economy was weakening. Evidently, many were overexposed to the notion of strong US growth.

                The strength of the consensus worries even self-confessed dollar bulls, like Marc Chandler of Brown Brothers Harriman.

                He says: “I’m just finishing up a huge business trip that took me through the US and Europe and Asia, and I’ve not met a single money manager who’s not bullish on the dollar, not bullish on US stocks or not bullish on the divergence story. What could go wrong is not that something goes wrong in Europe or Japan, but that the shine goes off the US side of the story.”

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                Investors keep trimming inflation hedges

                Posted on 20 November 2014 by


                Inflation has become the dog with no bite during the era of aggressive central bank policies, casting uncertainty over portfolios meant to safeguard against climbing prices.

                For years, conventional wisdom on Wall Street dictated that slumbering interest rates and the massive expansion of balance sheets by the likes of the US Federal Reserve would ignite inflationary pressure. Instead, inflation is running below target in most of the largest economies including the US, which Thursday reported no change in consumer prices between September and October. In Japan and the eurozone, signs of disinflation are mounting.

                  These facts challenge a trend sparked by quantitative easing. Alarmed by central banks’ experiments in monetary policy, investors sought inflation protection via commodities and inflation-linked bonds and derivatives.

                  Commodities are headed for their fourth consecutive year of losses, with the Bloomberg Commodity Index down 7 per cent so far in 2014. Gold – a classic haven from inflation – sits well below its peak at $1,180 per ounce. Inflation-linked bonds in the US, UK and eurozone signal no significant risk of sharply rising consumer prices.

                  “We are in a secular moment of low inflation due to technology and energy innovation, and that could last for three to five years,” says Rick Rieder, chief investment officer of fixed income at BlackRock.

                  He believes US inflation will remain low and below historical norms, but worries that a lack of aggregate demand in Europe and Japan could well result in disinflation affecting their economies.

                  So far this year investors have pulled $17bn from commodity index products tracking baskets of futures from oil to cotton, more than double the outflows in all of 2013, according to Barclays estimates. Exchange traded funds backed by gold have dumped 4m troy ounces of bullion as prices gave up gains for the year, Bloomberg data show.

                  James Steel, a precious metals analyst at HSBC, says: “We had a lot of buying between 2008 and 2012 in the gold market based on the likelihood that quantitative easing . . . would eventually trigger inflation. As that is patently not the case, this inflation hedge money has come out of the market.”

                  A broad index of US Treasury inflation protected securities (Tips) has generated a total return of nearly 5 per cent this year, while long dated holdings are up some 15 per cent according to Barclays Indices. Nevertheless, the iShares Tips bond exchange-traded fund has seen $466m of outflows this year, according to

                  The asset management group Pimco has tens of billions of dollars invested in both commodities and inflation-linked bonds. Nic Johnson, a Pimco portfolio manager, thinks “now is a pretty attractive time” to add inflation protection.

                  Mr Johnson is of two minds about the two asset classes, however. “We don’t expect a meaningful bounceback in commodities,” he says, citing factors such as the slowdown in oil demand growth.

                  He calls Tips “cheap”, saying the market is mistakenly assuming the Fed will fail to meet its inflation objectives. “We expect incrementally higher inflation as you move further in the economic cycle,” he says.

                  Since the end of October, $146m of money has flowed back into the iShares Tips ETF, suggesting some believe a buying opportunity exists. The market has rebounded sharply from 2013’s year of negative returns that sparked a $7.9bn outflow from the sector.

                  The risk, however, may be a market that remains cheap for much longer than investors think.

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                  Richard Gilhooly, a strategist at TD Securities, says the US inflation market is experiencing a further washout after 2013 was a negative year of performance for an asset class established in the late 1990s.

                  “Investors can look at the long term, but one issue with Tips is that they haven’t been around that long and have suffered from a lack of liquidity and manipulation due to the Fed’s QE policy,” he says.

                  Tips at least pay a yield to investors. Commodities do not, and in fact holding futures can eat into returns when prices of futures markets slope upwards – as they currently do in oil, gold, corn and cotton.

                  “We’re generally looking for strategies where we’re not just sitting around waiting for inflation to materialise to get returns,” says Christian Busken, director of real assets at Fund Evaluation Group, an investment consultant to endowments and foundations. “That’s kind of the case with commodity futures – it’s sort of this insurance policy against inflation spikes.”

                  commodities graphic

                  Virgin group: Brand it like Branson

                  Posted on 05 November 2014 by

                  Virgin data

                  Sir Richard Branson is a mass of contradictions. A man who often appears shy, yet has built a brand around his charisma. Someone who vaunts his social conscience, but who lives as a tax exile on Necker island. A fervent environmentalist, who wants to send wealthy
                  travellers into space.

                  One of the biggest inconsistencies is that his public persona – that of an entrepreneur running a multifarious business empire – does not reflect reality. In fact, Sir Richard manages very little. His Virgin Group owns stakes – few of them majority ones – in a vast range of businesses, but as an investor rather than a manager. Indeed it most resembles a huge “family office” with a portfolio run by professional investment managers and the profits channelled – via a number of trusts and a network of holding companies – to
                  the Branson family.

                    The crash of the Virgin Galactic spacecraft on Friday and the death of one of its pilots strike at the heart of the contradictions of the Virgin empire, contradictions which show that it is less robust than it might appear.

                    “Richard is interested in what is happening in the investment portfolio, but doesn’t run any of the businesses in it,” says Josh Bayliss, chief executive of Virgin Group Holdings, which manages Sir Richard’s investment portfolio and the Virgin brand. “His attention on a day-to-day basis is not on the operational aspects of the businesses.”

                    Of the about 80 businesses which bear the Virgin name, spanning sectors from travel, transport, leisure, entertainment, telecoms and media, less than half have direct stakes held by Virgin Group. Virgin companies made £15bn in revenues in the past financial year, but these bear little relation to the value or performance of the holding company. VGH owns 27 per cent of the 12 largest Virgin companies by revenues.

                    And those
                    group companies
                    are not even
                    the most significant holdings in its investment portfolio.
                    Virgin Money, which is only the 12th largest Virgin company by revenue, accounts for 15 per cent of the portfolio, with Virgin America at 10 per cent, followed by Virgin Active, Virgin Atlantic and Virgin Mobile France.

                    VGH makes a significant amount of its money not from cash flows from its investments – particularly since a number of large Virgin businesses do not turn a profit – but from the fees it charges companies for lending them the Virgin name. The Branson family’s wealth, therefore, is dependent on the value of the Virgin brand which is intimately linked to Sir Richard himself.

                    “Every day that Richard gets older the issue of the Virgin brand becomes a bigger one because so much of it is tied to him,” says Jez Frampton, chief executive of Interbrand, the brand consultancy.

                    Since 2005, Sir Richard, 64, has stepped back from day-to-day running of Virgin Group Holdings, to focus on his charitable activities and space tourism.

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                    With Virgin Galactic, he hoped not just to send people into space, but also harness his personal brand and that of the Virgin name to boost franchising opportunities, especially in the US.

                    For Galactic’s business model, Virgin followed a well-worn route. The group’s favoured start-up model relies on private investment for financing, with generally a co-investor sharing equity, and therefore the financial risk, often with a large amount of debt to the parent company loaded on to the balance sheet, a model it has followed at most of its businesses since the group’s brief but painful experience as a London-listed company in the 1980s.

                    So far, Virgin says, Galactic has sucked in up to $600m of investment, $380m of which was provided by
                    Aabar, Abu Dhabi’s state investment agency. The Aabar money has now been spent, but Virgin says its partner is not expecting a swift return on its money nor pressing for an exit.

                    The structure of the Virgin Group allows cross-subsidisation of its different businesses. Now that Virgin Galactic has burnt through the Aabar investment it is being financed from cash held by VGH itself. Virgin will not confirm that this has diluted Aabar’s equity, suggesting that the bulk of the additional financing is in the form of debt. Mr Bayliss says Virgin is not seeking an additional equity injection from Aabar, nor a new equity partner for the venture.

                    Space dream

                    Sir Richard has vowed to continue testing spaceships and seems to have no plans to abandon Galactic. The commercial launch was scheduled for next year, which seems ever more unlikely, but on Wednesday the company told the Financial Times that only 3 per cent of the about 700
                    people who had signed up for a ticket by paying a $20,000 deposit or the $250,000 full fare had asked for a refund.

                    If Sir Richard did decide to abandon Galactic, repaying Aabar’s $380m investment, the $89m in advance ticket sales and the hit to its own balance sheet of $220m-plus, would not be overwhelmingly onerous for the group, given VGH’s portfolio is valued at more than £5bn. Continuing with it, though, is a rather different matter.

                    Virgin data

                    Because VGH is run like a private equity company the question is how secure are the cash flows to bankroll Galactic and other Virgin businesses, which are at varying stages of development and profitability. How long can VGH sustain the cash drain?

                    Sir Richard told the FT last month that the group was “in the strongest position it’s ever been in”, “cash-rich” with no net borrowings. It is also pressing ahead with the initial public offering of Virgin Money, which owns the “good bank” assets from failed UK mortgage lender Northern Rock, and of Virgin America, the US airline in which it has a 22 per cent stake, lodging its prospectus with the Securities and Exchange Commission on Monday.

                    Virgin America only returned to profit in 2013. Its listing – which the owners hope will value the airline at up to $1bn – will allow the repayment or conversion into equity of at least $650m of related-party debt plus the accrued interest on it – owed to Virgin Group and its co-investor, Cyrus Capital, a distressed debt fund manager.

                    Virgin says the bulk of the cash proceeds will remain in the business to finance future growth, but it will nevertheless provide VGH with some useful cash in hand.

                    In the private equity world, such financial arrangements are not unusual before an investment is exited. But as no interest has been paid on the debt on Virgin America’s balance sheet since its start-up in 2007, it is difficult to assess the profitability of the business.

                    VGH does not disclose the amount of cash in its portfolio, although it says there are “several hundreds of millions of dollars” available. The group’s value relies on the capital appreciation of its investments. But its income is made up of a share of dividends and cash flows from those investments, including service on the debt it lends down the network of holdings, the proceeds of refinancings, sales or listings and the revenue stream from licensing the Virgin name.

                    There is nothing illegal about Virgin Group Holdings using cash or its stakes in other Virgin companies to support other branded businesses. But it makes it difficult to assess their genuine sustainability, and may skew management decisions – to the detriment of minority shareholders – if cash is needed

                    another part of the portfolio.

                    Damaged goods

                    An even bigger question hanging over VGH and the other companies bearing the Virgin name is what damage last week’s fatal crash
                    will do to the value of the

                    Interactive timeline

                    Virgin: 44 years of brand-building

                    Virgin Empire

                    Richard Branson’s golden touch has helped him grow a mail-order record service into a global conglomerate of 80 Virgin-branded companies. He has juggled spaceships, mortgages and video games, and now ranks seventh on the Forbes UK billionaires list. Forty-four years after Mr Branson opened the first business, Virgin Group’s net worth is now estimated at £5-5.5bn.

                    Virgin America has been explicit on the subject: “The ‘Virgin’ brand is not under our control, and negative publicity related to the Virgin brand name could materially adversely affect our business,” it warns in its IPO prospectus.

                    Sir Richard had hoped Galactic would have a “halo effect” on the rest of the company. The risk is that it will have the opposite impact and threaten
                    the value of the brand upon which the

                    whole edifice depends.

                    Mr Bayliss says that royalties – income from allowing companies to use the Virgin brand name – have increased substantially in recent years and their weight in the overall VGH investment portfolio has risen accordingly. Revenues from the brand, which are mainly licensed by Virgin Enterprises, now amount to about £120m a year. The brand is valued on a discounted cash flow basis at roughly £1bn, and it thus accounts for a significant proportion of VGH’s overall value of £5-5.5bn.

                    Virgin has focused most of its expansion plans in North America in recent years and had hoped to use the Galactic operation as a way to grow the appeal of the brand in a country where
                    Sir Richard has struggled to raise his profile.

                    “[Sir Richard] is quite well known in New York because of Virgin Atlantic but once you get beyond there, he’s not,” says Mr Frampton of Interbrand.

                    Mr Bayliss argues that the Virgin brand stands on its own two feet.

                    “If you rebranded Virgin Atlantic as, say, Cloud Airways, they would pay less in royalty fees, but strategically and operationally the business would continue to do the same things, although without the benefits of the ‘Virgin’ name,” he says. “In the UK it’s more true than anywhere else that Richard contributes to the [Virgin] brand perception. But it’s a very very mature diverse brand which stands for different things in different markets.”

                    It is a moot point whether the Galactic crash will combine with previous failed attempts to boost the Virgin brand in North America and reduce the potential growth of VGH’s royalties income.

                    Although it has had to lower the price it hoped to raise from Virgin Money, VGH says the crash has had no impact on the valuation range suggested for its Virgin America IPO. And is aware of the need to sustain the brand’s value.

                    “Over the past seven or eight years, since Richard has been less hands-on, it has been a very significant focus for us to build equity in the brand beyond Richard,” says Mr Bayliss.

                    The Virgin founder
                    has always been a dreamer who likes taking big risks. But with Galactic, the danger is that those risks undermine the structure that underpins the dreams – and finances the risks.

                    Additional reporting by Cynthia O’Murchu