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Musk’s Conveniently Timed $46.5bn Twitter Tilt




Here’s why “funding secured” is rising fast on Twitter’s trending list: Elon Musk has outlined how he might be able to pay for control of the microblogging website that has become his personal Moby Dick.

The $46.5bn in financing commitments put together by Morgan Stanley involve a whole heap of debt. There’s a $6.5bn term loan, a $3bn secured bridge loan, a $3bn unsecured bridge loan, a $500m revolving facility and a $12.5bn margin loan secured against Musk’s Tesla shares. The Tesla CEO also promises to kick in $21bn in equity.

Musk’s filing also confirms (explicitly, rather than in annoyingly twee riddles) that he’s “exploring whether to commence a tender offer to acquire all of the outstanding shares”. A reminder that because Twitter has adopted a poison pill it’d be irrational for Musk to buy shares that are tendered, so for the moment the threat looks like a lobbying tool or possibly a chaos engine.

Nevertheless, revealing the funding package hours after blockbuster results from Tesla adds a wrinkle to the story. There’s an interconnectedness to Musk’s corporate universe that’s excited analysts including Morgan Stanley’s own Adam Jonas, who has written at length about the extrinsic value of “The Muskonomy”:

The margin loan to fund a Twitter bid requires a pledge of nearly 59mn Tesla shares, or about 85 per cent of Musk’s total stake. His remaining unpledged stock is worth about $25bn at current prices so if sold, and allowing for an overhang discount, there would be just enough to cover the cash component of the offer. It’s a big ask.

But such calculations ignore a big event looming in the Muskonomy: the final payout from Tesla’s 2018 bonus scheme. Musk’s last awards will unlock shortly, assuming board approval, and will carry a five-year selling lockup.

Each of the three tranches due Musk give him the right to buy 8.4mn Tesla shares at $70, a more than 99 per cent discount to the prevailing market level. So, based on a $1,061 share price at pixel time, Musk could buy Tesla stock worth $25.4bn for about $588m. Factor in those shares and the margin loan financing looks a bit less onerous.

Tesla’s forecast-shredding Q1 numbers overnight, and resultant 8 per cent share price rise, are therefore usefully timed. But are they everything they appear?

For a lively perspective, here’s Neil Campling. Mirabaud’s head of technology research has never been a fan of Tesla, which sets him apart from approximately half of the 54 sell-side analysts to publish on the stock.

Campling’s tearing down of the automaker’s forecast-busting Q1 numbers begins with a simple question: why were everyone’s margin estimates so wrong?

Tesla’s simplified explanation is that anywhere around 10% to 15% of their cost structure is exposed to raw materials. They have been experiencing increases in costs in general, and also on raw materials “for a number of quarters now” – as you’d expect (as everyone else has). That pace picked up in Q1 and will increase further in Q2. Their caveat is that, in some cases, “there are contracts with suppliers, and then as those contracts expire, we have to renegotiate them, so that there can be a lag. In some cases, our contracts do directly reflect movement in commodity prices or raw material prices, but the timing in which that Tesla pays for that has a lag associated with that as well, based on the contract.” Nothing rocket science in that – although actually it is a reminder that Tesla don’t hedge for these exposures/risks (hold that thought…). The CFO explains that “because it’s quite an unprecedented situation of raw material movement and all of these various lags and uncertainty around renegotiating contracts. They try and make sure all the prices and cost increases “align and the company can remain financially healthy”. So how can Tesla successfully navigate this when every other company on the planet can’t?

There’s an answer of sorts: Warp, Tesla’s in-house enterprise resource planning software. Warp replaced SAP as Tesla’s ERP system in 2012, having reportedly been built in under four months. It has since grown from a tool for production planning into a central megabrain for managing everything from the group’s e-commerce sales and customer service to over-the-air software updates.

This kind of “amazing, first-of-its-kind, best-of-breed” software might be worth billions if spun out yet Warp has never even merited a mention in a Tesla filing, says Campling. Drawing a parallel with Star Trek’s fictional physics, he “can’t help but wonder if there are more than one kind of Warp Drive that are science fiction and the stuff of dreams.”

We have rampant inflation everywhere. There are logistics issues, labour issues and component sourcing headaches the world over, hitting even the largest corporate company on the planet (Apple). And yet Tesla has net profits up 50% QoQ on flat volumes and increased costs. But, despite the higher input costs, and no volume uplift somehow, they manage to reduce COGS. GAAP auto gross-margins reached 32.9% and, for the first time, exceeded 30%. (And this is even more remarkable given it is based on delivering cars with pricing set at lower ASPs from previous quarters). Tesla has said factories are likely to continue to run below capacity through the rest of 2022. You’d have thought that would negatively impact their margins. The Shanghai factory’s manufacturing and operations director told state-run media this week that the plant only has enough inventory for one week’s production. Let’s just remember – Tesla is seeing record delivering, record gross margins, record profit margins, record output, record profitability. Amazing.

Some might call it incredible. But then, what is there about the Muskonomy that isn’t?

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The Fed Owes the American People Some Plain-speaking





This week financiers’ eyes have been firmly fixed on the Federal Reserve. No wonder. On Wednesday the US central bank raised rates at the most aggressive pace for 22 years, as Jay Powell, Fed chair, finally acknowledged the obvious: inflation is “much too high”.

But as investors parse Powell’s words, they should spare a thought for a central bank on the other side of the world: the Reserve Bank of New Zealand.

In recent years, this tiddler has often been an unlikely harbinger of bigger global trends. In the late 20th century, for instance, the RBNZ pioneered inflation targeting. More recently, it embraced climate reporting ahead of most peers.

Last year, it started tightening policy before most counterparts. And this week it went further: its latest financial stability report warns of a “plausible” chance of a “disorderly” decline in house prices, as the era of free money ends.

Unsurprisingly, the RBNZ also said it hopes to avoid a destabilising crash. But the key point is this: the Kiwi central bankers know they have an asset bubble on their hands, since property prices have jumped 45 per cent higher in the last two years and “are still estimated to be above sustainable levels”. This reflects both ultra-low rates and dismally bad domestic housing policies.

And it is now telling the public and politicians that this bubble needs to deflate, hopefully smoothly. There is no longer a Kiwi “put” — or a central bank safety net to avoid price falls.

If only the Fed would be as honest and direct. On Wednesday Powell tried to engage in some plain speaking, by telling the American people that inflation was creating “significant hardship” and that rates would need to rise “expeditiously” to crush this. He also declared “tremendous admiration” for his predecessor Paul Volcker, who hiked rates to tackle inflation five decades ago, even at the cost of a recession.

However, what Powell did not do was discuss asset prices — let alone admit that these have recently been so inflated by cheap money that they are likely to fall as policy shifts.

A central bank purist might argue that this omission simply reflects the nature of Powell’s mandate, which is to “promote maximum employment and stable prices for the American people”, as he said on Wednesday. In any case, evidence about the short-term risk of asset price falls is mixed.

Yes, the S&P 500 has dipped into correction territory twice this year, with notable declines in tech stocks. However, the American stock indices actually rallied 3 per cent on Wednesday, after Powell struck a more dovish tone than expected by ruling out a 75 basis point rise at the next meeting.

And there is no sign of any fall in American property prices right now. On the contrary, the Case-Shiller index of home prices is 34 per cent higher than it was two years ago, according to the most recent (February) data.

However, it beggars belief that Powell could crush consumer price inflation while leaving asset prices intact. After all, one key factor that has raised these prices to elevated levels is that the Federal Reserve’s $9tn balance sheet almost doubled during the COVID-19 pandemic (and has expanded it nine-fold since 2008.)

And, arguably, the most significant aspect of the Fed’s decision on Wednesday is not that 50bp rise in rates, but the fact that it pledged to start trimming its holdings of mortgages and treasuries by $47.5bn each month, starting in June — and accelerate this to a $90bn monthly reduction from September.

According to calculations by Bank of America, this implies a $3tn balance sheet shrinkage (quantitative tightening, in other words) over the next three years. And it is highly unlikely that the impact of this is priced in.

After all, QT on this scale has never occurred before, which means that neither Fed officials nor market analysts really know what to expect in advance. Or as Matt King, an analyst at Citibank, observes: “The reality is that tightening hasn’t really started yet.”

Of course, some economists might argue that there is no point in the Fed spelling out this risk to asset prices now, given how this might hurt confidence. That would not make Powell popular with a White House that is facing a difficult election, Nor would it help him achieve his stated goal of a “soft” (or “softish”) economic landing, given that consumer sentiment has wobbled in recent months.

But the reason why plain speaking is needed is that a dozen years of ultra-loose policy has left many investors (and households) addicted to free money, and acting as if this is permanent. Moreover, since the Fed has repeatedly rescued investors from a rapid asset price correction in recent years — most recently in 2020 — many investors have an innate assumption that there is a Fed “put”.

So if Powell truly wants to emulate his hero Volcker, and take tough measures for long-term economic health, he should take a leaf from the Kiwi book, and tell the American public and politicians that many asset prices have been pumped unsustainably high by free money.

That might not win him fans in Congress. But nobody ever thought it would be easy to deflate a multitrillion dollar asset price bubble. And the Fed has a better chance of doing this smoothly if it starts gently and early. Wednesday’s rally shows the consequences of staying silent.

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Nasdaq Tumbles 5% in Sharpest Fall Since 2020





Wall Street’s Nasdaq Composite tumbled 5 per cent on Thursday in its steepest decline since the market tumult of 2020, marking an abrupt reversal from a powerful rally in the previous trading session.

The Nasdaq, where many of the leading US technology companies are listed, fell as much as 5 per cent in early afternoon trading in New York, the heaviest intraday drop since September 2020.

The blue-chip S&P 500 index also suffered heavy selling, sliding almost 4 per cent. Every major sector was in the red, with economically sensitive industries including consumer discretionary, technology and financial companies among the biggest fallers.

The S&P has declined 13 per cent this year as prospects of higher borrowing costs and sustained high inflation have threatened corporate profits. The Nasdaq is down more than 20 per cent.

US government bonds also faced an intense bout of selling pressure, sending the yield on 10-year Treasury notes soaring 0.18 percentage points to 3.1 per cent per cent.

The sharp reversal after a buoyant performance for US stocks and Treasuries in the previous session comes as leading central banks withdraw crisis-era stimulus measures at a time when concerns over global economic growth are mounting.

The Federal Reserve, the world’s most influential central bank, raised its main interest rate by 0.5 percentage points on Wednesday in its biggest increase since 2000, as it attempts to tame intense inflation. Jay Powell, the Fed chief, sent a strong signal that the US central bank is likely to raise rates by the same amount at it next two meetings.

However, in a sign of the headwinds facing global economies, the Bank of England on Thursday warned the UK will slide into recession this year as higher energy prices push inflation above 10 per cent.

“This is really the sum of all our fears” about the UK economy, said Roger Lee, head of UK equity strategy at Investec. “Growth forecasts have been downgraded, inflation expectations have been upgraded and interest rates are still going up.”

At the same time, many of the companies that thrive on optimistic consumer sentiment have faced sharp declines in their share prices as the war in Ukraine and rapid price growth weigh on investor confidence.

Shares in Shopify, the Canadian ecommerce platform that helps brands and retailers open online stores, fell by almost 17 per cent on Thursday after revenues of $1.2bn for the first quarter came in $38mn below analysts’ expectations. The company’s stock has fallen by around 70 per cent this year.

In Europe, Zalando, one of the continent’s largest pure-play ecommerce retailers, on Thursday said full-year sales and profits would be at the lower end of a previously-forecast range, sending its shares down more than 10 per cent.

Chief executive Robert Gentz said the company was “adjusting to the lower levels of demand that we are seeing” but that the longer-term structural trend towards ecommerce remains intact. His comments follow a profit warning on Wednesday from UK fast-fashion retailer Boohoo.

Meanwhile, in currencies, the dollar index, which measures the greenback against a basket of six others, rose 1.2 per cent on Thursday. Sterling slumped more than 2 per cent against the dollar to $1.23, its weakest level since June 2020.

Reporting by Adam Samson, Naomi Rovnick, George Steer and Ian Johnston in London, Eric Platt in New York and Hudson Lockett in Hong Kong

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Tankers of Russian Oil a Prime Target for Western Sanctions





Earlier this month Boris Johnson, the British prime minister, grabbed headlines by travelling to Kyiv to demonstrate his solidarity with Volodymyr Zelensky, the Ukrainian president.

It was eye-catching, tub-thumping stuff. But if Johnson wants to support Ukraine against Russia’s invasion, he now should make a symbolic visit to a closer destination: the headquarters of Lloyd’s, the world’s largest insurance marketplace, in the City of London.

Thus far, the insurance industry has attracted little public scrutiny compared with banks, in relation to the west’s sanctions against Russia. No wonder: most politicians (and voters) have only limited awareness of the sector’s complex but crucial role in finance and trade.

But the industry matters deeply now. If the British government, along with its EU and US counterparts, were to demand that insurance companies stop protecting tankers carrying Russian oil, it would be another potent weapon in western efforts to squeeze Moscow.

To understand why this matters, consider current oil flows. In recent weeks, rising outrage about Russian aggression has prompted some western companies, such as Shell, to self-sanction by (belatedly) refusing to touch Russian oil. And the Biden administration has also imposed an oil embargo, albeit one that has mostly symbolic value.

But that has not stopped exports. “The movement of Russian crude by tanker ship was just over 3m barrels per day in February and March, but more than 4m bpd in the first 17 days of April,” as Anette Hosoi and Simon Johnson, two economists, note in a recent paper.

This is partly because the EU has not imposed an oil and gas embargo, prompting Josep Borrell, EU foreign policy chief, to lament in early April that “since the start of the war, we’ve given [Russian president Vladimir Putin] €35bn, compared to the €1bn we’ve given Ukraine to arm itself”.

But non-western countries such as China and India are also gobbling up the black stuff, at an accelerating rate. “India has been ramping up its imports massively — there has been a fivefold increase [since the invasion],” says Florian Thaler, co-founder of OilX, an oil analytics company. This helps explain the unexpected rebound in the rouble: funds are flooding into Moscow’s coffers, as the oil price rises.

One way to counter this would be to introduce an EU embargo. That might yet happen, although it remains highly contentious. However, it would not stop non-EU countries from accelerating their own purchases, since “China and India are not easily deterred” by western appeals, as Thaler notes.

That might change if sanctions were placed on the trading companies that handle oil or the banks that finance these trades. However, another option is to look at tankers. Right now they carry about three-quarters of all Russian oil exports, according to Thaler — and almost all the oil that flows to India. Even China is heavily reliant on tankers, notwithstanding two pipeline links to Russia.

More than half of recent oil shipments from Russia have been carried on tankers belonging to companies headquartered in Greece, according to data compiled by the Institute of International Finance. Most of the rest carry Russian, Chinese, Scandinavian and Singaporean flags.

This means that one way for the west to reduce the tanker flow would be to ban EU ships from touching Russian crude. Another more effective tactic that would hit non-EU vessels would be for the British government to prevent the Lloyds Marine and Aviation syndicates from insuring fleets that carry Russian oil; and for the UK, EU and US to ban the provision of property and indemnity insurance, via mutual industry clubs.

This would not halt all traffic, since “there is always an element of sails without insurance”, Neil Roberts head of marine and aviation at the Lloyds Markets Association told British politicians last week. The tale of Iran shows how inventive traders can exploit loopholes.

But most nation states will not deal with uninsured fleets, and it would be tough for shipping groups to find alternative coverage quickly. As Roberts notes, 95 per cent of the global fleet uses P&I insurance, and London provides 80 per cent of war coverage.

So will this tool be deployed? It is not clear. Self-sanctioning is already occurring with new insurance contracts. But the insurance companies say they cannot legally withdraw existing contracts without a direct government order, and complain that the current situation is dangerously muddled. “I draw a parallel with Italy in 1935 [after the invasion of Abyssinia], when there were sanctions put on an aggressor state, but there was confusion as to whether or not they would put sanctions on oil, and they therefore failed,” Roberts told the UK parliament.

Moreover, insurance executives are quietly lobbying against any draconian move since they fear it would damage the status of the City. Maybe so.

But the reality is that unless Russia’s energy exports are reduced, Putin’s coffers will remain reasonably full. And while an EU embargo would hurt (if it ever materialised), it would not be comprehensive. For that reason, it is time for western leaders like Johnson to look hard at those insurance weapons — even if Lloyds and P&I contracts are not as telegenic as a walkabout with Zelensky in Kyiv.

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