Buying the Dip - Entertainment One

 Share Price: 163 ½ p – Target (short term 185p)

Overview

ETO fell 17.8% today as the company disclosed that a potential buy-out would no longer occur.

Price Action

1. ETO share price; c.185p.  FTSE100; c.6,000.
2. ETO share price; c.165p.  FTSE 100; c.5,100-5,400
3. ETO indicates their intention to proceed with buy-out talks (share price rises c.30p).
4. Take-over talks fall through, share price slips.

Price action follows a logical trend with the exception of point 4.  ETO holds a beta value of 1.29, pricing them at a 10% discount to the theoretical price.  Assuming the wider market has risen c.9% on August lows (c.5, 400 to c.5, 900), ETO historically would have risen (9 * 1.29 = 11.61%) producing a preliminary target of 185p. 

Fundamentals

To underscore price action irregularities, fundamental information goes further in suggesting a retrace is due.  Peel Hunt are expecting pre-tax profits of £42m putting ETO on a forward PE of c.7.5 (PE c.11 on EPS metric) versus a PE of 16.04 for the sector.  Although ETO have historically traded at a PE of c.12, this contrast weighs on upside potential.  

Despite a declining retail market, diligent management has positioned ETO to benefit from broader exposure to digital distribution channels.  Investment in content has been a core positive - personal observation has seen ETO work hard to secure a steady stream of new opportunities. 

After turning down 'various buy-out offers' (on grounds that they didn't 'reflect ETO's value') the company intends to expand via acquisition.  Alliance Films is rumoured to be a target (Patrice Theroux, head of ETO's films operation spent 18 years at Alliance and attempted a management buy-out in 2006).  Having followed ETO for well over a year I have come to view ETO as a well managed firm and thus have faith that aggressive expansion is the most effective strategy at this stage. 

A Few Passing Thoughts....

In the last week, Germany and as of this morning Italy, have both comprehensively failed in meeting targets set for their bond auctions.

Germany was unable to sell 39% of it's €6bn 10yr issue (with the ECB not surprisingly picking up the rest).  The bonds sold at a 2% annual yield.

http://uk.reuters.com/article/2011/11/23/uk-markets-bonds-bunds-idUKTRE7AM0SL20111123

Italy failed in a different way.  Although they managed to find buyers for €10bn worth of 6 month paper, they will compensate investors to the sum of 6.5%.  This is double the yield from a month earlier.

http://uk.reuters.com/article/2011/11/25/uk-italy-bonds-auction-idUKTRE7AO0EN20111125

A few passing observations on this situation:

1.)  Factors I highlighted in my previous article do indeed spell trouble. 
2.)  Equity indices are approaching a 10 day losing streak.
3.)  Confidence in Germany is now starting to fade.
4.)  In this climate, tapping investors for money is like drawing blood from a stone.  No wonder yields of 2% didn't attract buyers.
5.)  The Eurozone crisis worsens and politicians are still vacant.

The articles I've included above make for some interesting, albeit depressing reading. 

Next time I write, I'll try and find a positive element to focus on.

Crisis Hits Core

It appears I am not alone in deriving anxiety from current market conditions but from a qualitative perspective I ask the question; do current equity index levels price in debt market trends?  In my view, no.

To elaborate, earlier this year (in August) markets worldwide tanked due to fear of debt contagion and a double dip recession (see older posts).  At the start of October, the MSCI World Index hit a trough of 1072 marking a 22.6% drop on a high of 1385 seen in May.  This movement correlated with rising panic over systemic threat from debt ridden peripheral Euro zone nations.  In my view, recent bond market movements confirm the fears of August's speculators.  The spotlight (for the time being) turns from Greece and shines with greater intensity on Spain, Italy and now France.  Let's take a look at the spreads: 

(Above: French 10yr Government Bond Yield, Source: Bloomberg.com)

(Above: Italian 10yr Government Bond Yield, Source: Bloomberg.com)

(Above: Spanish 10yr Government Bond Yield, Source: Bloomberg.com)

With the exception of the French 10yr notes, Italian and Spanish securities have historically moved broadly in negative correlation to global equity markets.  The reason for this is they are increasingly being seen as 'risk on' positions.  The fact that French Bond movement is now starting to adopt a similar pattern spells trouble.  It undermines integrity in an AAA rated security which by definition should be a safe haven.  The previous post outlines troubles France is facing. 

So why do these numbers warrant my bearish mid-term view on global equities?  Starting with Italy, the key figure markets are watching is 7%; the point of no return.  History shows indebted nations have required a bailout when the 7% mark is breached.  This was the case for Portugal, Greece and Ireland.  As I've discussed earlier, the ECB cannot afford to bailout Italy.  Even with the recent decision to leverage the EFSF to €1tn, the fund would still be €0.8tn short.  The repercussions of an Italian default are somewhat elusive but this would most likely involve the demise of the Euro and drastic reformation of the EU.  For the rest of the world it almost assures another recession.  While Spanish yields sit at c6.5% this is of course similar concern to Italy.

Based on this analysis, where do I believe equity markets should be priced at this point in time?  To continue on with the examination of my home market, I'll base my answer on the FTSE100.  In conjunction with the MSCI index, the FTSE100 also bottomed out at the start of October briefly breaching 4,800.  Given the threat is now realised rather than merely feared, I don't believe we are too far off seeing at least 5,000 in the next couple of weeks although a lot will rely on whether ECB action can continue to push down European bond spreads.  On a more positive note, market researchers are slightly more positive about the chances of another global recession with many predicting a modest slip back into the red as a likely outcome.  As has become customary over the previous year, sentiment (and seemingly with it, the entire world) is likely to change over the next couple of weeks so for the time being, I eagerly watch. 

Market Report - France

Apologies for having not updated the site in a while.  I was recently required to construct a market report on France which I thought may be of interest to some of my readers:

Overview

The French economy was reported to have expanded by an encouraging 0.4 percentage points in Q3 (QonQ) on Tuesday, having experienced a 0.1 percentage point contraction on the previous three readings.  This compares to a 0.2 percentage point expansion across the currency bloc. 

In an effort to balance public favour with an essential requirement for French austerity, the same Nicolas Sarkozy who marched into a European Finance minister’s meeting Brussels in 2007 proclaiming ‘France would postpone its commitment to balancing it’s budget by 2 years’ has recently attempted to reinvent himself through adopting unspecific plans to raise €65bn through tax hikes and budget cuts over the next 5 years.  Economists say there is no visible growth strategy in place to counter these cuts.  This move is largely thought to protect France’s AAA credit rating which Moody’s currently has under review.  On November 7 the government unveiled its second austerity plan in three months.  This one promises an extra €7bn in 2012 on top of the €11bn announced in August at an emergency meeting.  Despite these cuts, a report by the Lisbon council on Tuesday said France’s inability to make rapid adjustments to its economy should be ringing alarm bells for the Euro zone.  It ranked France 13^th out of 17 for its overall health, including its growth potential, employment rate and consumption, and 15^th for its progress on economic adjustments, particularly on reducing its budget deficit and keeping a lid on unit labour costs.

‘Analyst sentiment predicts France is likely to slip back into a mild recession by the end of the year’ a comment from ING Economist Carsten Brzeski states.  A senior EU official highlighted the important contribution France must offer over the next month if the Euro zone is to be protected:  “Between now and December 9^th [date of next European Summit], Germany has to decide what it is prepared to put on the table to save the euro and others, especially the French, have to show how far they are willing to go to meet Germany’s requirements.”

Financial Markets

French equity markets have been hit particularly hard since the start of August, primarily due to vast Banking sector exposure to Greek debt ($51.3bn).  While the threat of a double dip recession looms large, the CAC40 has increasingly been leveraged to European systemic risk.  A 50% voluntary write down on privately held Greek government debt offered French Banks temporary relief to plummeting share prices.  BNP Paribas rose c.20% on the news but has since retraced to support at €0.30 per share (down from a high of €0.60 in February).  Other French banks have followed suit reflecting investor concern for Greek debt exposure.

On Tuesday 15^th, French sovereign bond yields triggered alarm bells as bearish sentiment began to weigh in on the concern that European debt contagion (and the ineffectiveness of European politicians to solve the crisis) was starting to have an influence on the safety of French debt.

At market close, 10 year French Bond yields sat at 3.71%, a euro-era high.  "It's a confidence crisis," said Elwin de Groot, a senior market economist at Rabobank Nederland in Utrecht, Netherlands. "Investors have no confidence that the euro zone can solve its problems. They will look for the most safe place they can store their money, which is Germany. Everything else is suffering."

Market Overview 27/10/11 - 'The Plan'

On Thursday 27th October, markets worldwide rallied strongly on news that a 'comprehensive package' was established, designed to protect the Euro zone from the vast systemic threats currently knocking on the door of the global economy.  I for one am delighted with this progress and thrilled to be writing on more positive terms for the first time in a while.  Before we get to the charts, let's take a look at the headlines:

• Banks to take a 'voluntary' (forced) write down of 50% their exposure to Greek debt.
• EFSF to be leveraged to the value of €1tn (NB - Not the €1.8tn needed to support Italy in the event of a default.)

The Economist Newspaper offers further detail (albeit rather critical) on the leverage of the EFSF:

"Unfortunately the euro zone’s firewall is the weakest part of the deal (see article). Europe’s main rescue fund, the European Financial Stability Facility (EFSF), does not have enough money to withstand a run on Italy and Spain. Germany and the European Central Bank (ECB) have ruled out the only source of unlimited support: the central bank itself. The euro zone’s northern creditor governments have refused to put more of their own money into the pot. 


 Instead they have come up with two schemes to stretch the EFSF. One is to use it to insure the first losses if any new bonds are written down. In theory, this means that the rescue fund’s power could be magnified several times. But in practice, such “credit enhancement” may not yield much. Bond markets may be suspicious of guarantees made by countries that would themselves be vulnerable if their over-indebted neighbours suffered turmoil.

Under the second scheme, the EFSF would create a set of special-purpose vehicles financed by other investors, including sovereign-wealth funds. Again, there are reasons to doubt whether this will work. Each vehicle seems to be dedicated to a single country, so risk is not spread. And why should China or Brazil invest a lot in them when Germany is holding back from putting in more money?


Together, these schemes are supposed to extend the value of the EFSF to €1 trillion ($1.4 trillion) or more. Sadly, that looks more like an aspiration than a prediction. And because the EFSF bears the first losses, its capital is at greater risk of being wiped out than under a loan programme."  (Full article here) 


This was where the news had greatest impact:"

Above:  Equity Indices in Europe open strongly and continue to gain momentum over the next 24 hours. 

The Euro breaks through 1.4 against the dollar and support forms just under 1.42.

Banks with exposure to Greek debt encounter huge gains.  Soc Gen up c20% yesterday.

Risk on currencies such as the CAD and AUD strengthened as investors exited 'safe havens.'

Outcome of European Summit (pt.2/?)

So, 8 days have passed and once again our European 'leaders' convene.  As I predicted last week, today's summit returned little progress towards finding a solution to the many problems now facing the Euro zone (and as a result, the global economy).  To emphasise on the all too familiar 'kicking the can down the road' demeanour governors appear to be adopting, it has been announced that final decisions will now be deferred until a second summit on Wednesday 26th (stay tuned for pt.3)

Given nothing was achieved this weekend, lets take a snapshot glance at what was discussed:

• Sarkozy backed down to German opposition to use unlimited European Central Bank funds to fight the crisis.  (As a result, the Euro zone may turn to emerging economies for bond market support.)
• It probably wouldn't hurt at this stage to examine an updated perspective of the developing relationship between Germany and France.  Last week the world observed progression as signs of collaboration emerged.  This week, we witness the French bullied out of their ideas.
• Italy comes under pressure to produce a more 'convincing' plan to implement structural reforms within its domestic economy.  Berlusconi to call a cabinet meeting on Monday morning to discuss measures to boost growth.  
• (Excuse my petulant interruption but is this to say that every option to stimulate growth in Italy hasn't already been reviewed by this stage!?)
• Merkel said only two options remained on the table for leveraging the €440 EFSF and neither involved drawing on the ECB. 
• Officials said the emerging solution would combine using the EFSF to provide partial guarantees to buyers of new Italian and Spanish bonds, while also creating a special purpose vehicle (read the at_best analysis on the Special Purpose Vehicle here) to attract funds from major emerging countries that could guarantee bonds in the secondary market (Source: Reuters.) 
• Broad framework drafted for recapitalising European banks - €100-110bn support, €46bn of which was already put aside for bank support in the EU/IMF bailout programs for Ireland, Greece and Portual - the market wanted a figure of around €200bn, instead they got c.€60bn.
• Discrepancy continues as to the value banks must accept on Greek debt write downs.  Banks are citied to have offered 40%, governments are apparently demanding 60%, market consensus is 50%.

So what next?  Monday morning's futures point modestly towards the red which tells me the market had already anticipated much of this disappointment.  It's likely to be a roller coaster ride until Wednesday which in my view will result in further procrastination.  With the Euro hovering at exorbitant highs against the USD, I see huge fundamental downside for those willing to place shorts on little being accomplished this coming week.

Who Owes What?

Continuing on with the contagion theme, this illustration offers a visual plan of the crisis and those participants who stand to lose out if action isn't taken soon.

Mapping the European debt crisis - to enlarge, Click Here (Source: zerohedge.com)

I believe this supports my view that placing short term pressure on France and Germany is undoubtedly progression, but any conjured solution will fail to address the long term problem.