15th March 2020

Blog – 10th March 2020

10th March 2020

Austrian politician Klemens von Metternich (1773 – 1859) penned the phrase “When Paris sneezes, Europe catches a cold.”

In the 20th century the phrase was popularised and amended to ‘When America sneezes, the world catches a cold’ reflecting the increased industrial dominance of the land of the free and the home of the brave.

Here we are in the 21st century and we may indeed have a further iteration of von Metternich’s initial thought – ‘When China sneezes, the world stops.’

The COVID-19 proliferation is a worrying yet expected event. Microbiologists and virologists have been warning about a global viral outbreak for years. Not if, but when. And so we find ourselves on the brink of a more restrictive and economically damaging period as governments and health authorities around the world grapple with rapid infection rates and, sadly, increased rates of mortality when compared with the familiar benchmark of seasonal influenza.

As one of us walked with ease through a normally packed late Friday afternoon Terminal 5 at London’s Heathrow Airport last weekend, the reduced number of travellers and activity was immediately apparent. If this is reflected throughout wider society with further travel restrictions, lockdowns, supply chain disruptions and a temporary reduction in available fit and healthy personnel within the workforce, the economic damage will be significant and lasting.

And if that wasn’t enough, the oil market has plummeted on the back of an anticipated reduction in demand due to decreasing economic activity which in turn has sparked a price war to the bottom as Saudi Arabia floods the world with cheap oil. And as we know, cheap oil is great until the prospect of deflation starts to creep into the economic picture.

Conversely, should Saudi Arabia convince some of its fellow suppliers to cut production and raise the price of oil back to $50+ then we might expect inflation to rear its ugly head once again. But there is more…

The recent and sharp downward stock market movements are not, in our view, a direct result of COVID-19. The viral outbreak was merely the catalyst in triggering a very necessary correction in what had become a vastly over-valued global equity situation fuelled by 10 years of very cheap money.

With interest rates around the world near or at historical lows depending on where you are, the only investable areas to realise a decent return over time was either a hard asset like property or the equity markets. And the flood of cheap money encouraged by governments around the world following the crash of 2008 has inflated property and equity values to record levels. Indeed, the world’s debt levels have never been higher.

In our own work regarding equity pricing levels and actual economic performance within the top global pharmaceutical businesses, our Future Market Value model revealed a number of companies were operating with a calculated expectation level based on future performance of more than 50% of the share price. In other words, less than half of the total share price reflected current economic performance. In many cases, companies would have to double the achieved economic profit just to keep pace with the expectations of the market. Clearly something was amiss – a mismatch between the equity price and performance.

The ongoing problem which will manifest itself in the coming months given the expected reduction in economic activity and the decline in equity markets will be liquidity. Companies and individuals with large debt piles will find debt servicing more expensive as banks increase charges to cover defaults from highly leveraged corporate failures along with lower revenues and/or returns. Equally, investors who took out loans to buy equities may find themselves ‘under water’ as equity values drop and loans are called in. The price of money and thus the charge for capital will increase.

Without doubt, there will be significant and high-profile failures in the world of football. The current economic picture as we have reported many times is not good. Indeed, based on current evidence, the Premier League clubs are heading for record economic losses for the 2018-19 season.

Given that football matches are increasingly being played behind closed doors at the time of writing, the lower divisions in English football will find life very tough indeed if a crowd ban is applied. Matchday income forms a substantial proportion of total annual revenue for the nation’s smaller clubs.

To us, it seems unlikely that internationally cosmopolitan Premier League club owners will offer further financial assistance to a largely loss-making English Football League club cohort given that they already provide £140m in solidarity payments, according to the Premier League website.

Therefore, EFL club owners will be compelled to dig deep financially to get their clubs through a difficult period of time, however long it may be. But the balance of probability tells us that some owners will also be affected by wider economic events and may find that the money originally allocated to shore up the football club will have to be diverted to their core business. Inevitably the football club will suffer, the family business perhaps less so.

For those clubs whose owners are more financially fortunate but still rely on loans and debt to operate, the capital charges are likely to increase putting further pressure onto the balance sheet and reducing the ability of the club to achieve economic profit. Again, we expect balance sheets to further deteriorate as they reflect reduced income and constrained circumstances. At the time of writing just 9 of the 44 clubs which make up the current Premier League and Championship cohort have achieved an overall economic profit over the most recent 5 years of accounts. A sobering perspective if ever there was one.

We have featured our concerns previously but it would appear that recent and unfortunate events have now conspired to create an incredibly difficult road ahead. The problem is, of course, that the journey has already started with the recent failure of Bury FC. As we said at the time, we expect more to follow. Unfortunately, they will…


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