May 31, 2020

Let animal spirits lead us out of this slump

written by Lisa Eason

So the rebuilding begins. The total lost output from lockdowns globally is forecast to be about $9 trillion (£7.2 trillion) over 2020 and 2021. Given such epic damage to economies, there is no time to be lost. The recovery must start right now.

Despite the dreams of those who think we need ever more state intervention, big government is not the answer. The world has plenty of private capital looking for a home since interest rates are turning negative in more countries, potentially including Britain.

Across the world, governments have initiated at least $14 trillion of stimulus. They have done enough pump-priming. As ever, this liquidity has overflowed into asset prices. While stock markets are generally overvalued and far too bullish, the remarkable bounces in share prices since March are at least encouraging investors to be hopeful.

Since the pandemic took hold, the London Stock Exchange has shown the true value of being quoted. According to the broker Peel Hunt, there have been at least 57 equity raisings by public companies carried out at short notice, via institutional placings, as a response to the pandemic. They have raised more than £8bn, all of which has been injected into businesses — none has gone to selling shareholders. Most of these calls have been from companies that are fundamentally sound but need cash for short-term working capital purposes, or to take advantage of opportunities because of exceptional circumstances.

It is difficult for private companies to access such large sums at short notice, and this should stand as a significant selling point to those considering taking their businesses public.

Private equity is a larger provider of capital to business than ever. Many private equity portfolios are suffering thanks to the closure of their companies’ operations or collapses in demand. The business model for leveraged buyouts is to gear up the balance sheet of the acquired company with bank debt.

Vulnerable firms that have entered this downturn with borrowings of three, four or even five times annual underlying earnings will be struggling. Some will go bankrupt and some will be recapitalised by their private equity owners — with perhaps some debt write-offs. It can be complex for private equity owners to save investee companies if the particular fund is exhausted.

There has been talk that reform of private equity is needed, in areas such as tax treatment of carried interest or the treatment of interest on borrowings. Now is not the time for government to alienate providers of capital — Britain will need all the support it can get to keep industry going and preserve jobs and exports.

In theory, distress investors should be rubbing their hands with glee at the corporate mayhem. A small group of specialist funds tend to buy companies out of insolvency. It is a fairly high-risk/high-reward game, but the experts can do very well. There are likely to be many failing companies in the coming months that will need turning round. A crisis such as this exposes existing weaknesses, and a fair proportion of the worst-hit businesses need to be swiftly merged, restructured or allowed to fail. The pandemic is an excellent justification to change leadership.

My favourite industries, hospitality and travel, have been hit very hard. I’ve been an active investor in both for decades. Some observers are suggesting they will shrink dramatically, and that the “new normal” will involve consumers going out and travelling far less, with social distancing a permanent feature of life. I passionately hope such pessimists are wrong. These trades employ at least three million in Britain and provide forms of pleasure, such as holidays and eating out, that are central to the enjoyment of life for millions.

Humans are social creatures. We will adjust to Covid-19 over time and the overly fearful attitude of many will dissipate. As a society and an economy, we need to regain our confidence.

To suddenly reject thousands of previously viable businesses, and thereby see the destruction of perhaps hundreds of thousands of livelihoods, is tragic and unnecessary.

There is really only one quotation you need in such circumstances. General Ferdinand Foch said during the battle of the Marne in the First World War to General Joseph Joffre: “Hard-pressed to my right; my centre is yielding. Impossible to manoeuvre. Situation excellent. Attack!”