June 2016 Newsletter



Miércoles, 12 Julio 2017 00:00

The diamond industry and De Beers´ new mine

De Beers, the world’s largest diamond company, marked the opening of its Gahcho Kué mine in September 2016. Located 280 kilometers northeast of Yellowknife, near the Arctic Circle, the mine is expected to produce around 54 million carats of rough diamonds over its 12-year lifetime.

It’s estimated it will contribute $5.2 billion to the Canadian economy until 2028, according to a socio-economic impact report prepared by De Beers. Another reason why the mine's opening is important is the fact that two of the country's major diamond operations are approaching the end of their productive lives. Gahcho Kué, although smaller, is expected to offset the production drop-off.

The mine, one of the world’s 10 biggest diamond mines, is the sixth precious rocks operation opened in Canada in the almost 19 years the country has been producing diamonds.

It is a turning-point for one of the world’s oddest industries. The diamond business gained its sparkle around 1866, when a farmer’s son picked up a glistening pebble on the bank of the Orange river in South Africa. For most of the next 150 years, De Beers would dominate the global market. Success depended on manipulated supply and skilfully cultivated demand.

Much has changed since then. De Beers can no longer control the market. Though it is the biggest producer by value, it accounts for only a third of global sales, down from 45% in 2007. It faces many uncertainties, from synthetic diamonds to changing relationships with polishers and cutters. Its loosening grip is reflected in increased volatility: its sales fell 34% in 2015, before bouncing back by 30% last year. Meanwhile the source of the demand that drives sales—the link between diamonds and love—looks weaker than it used to.

diamond production

Diamonds had been rare before 1866; the South African finds threatened to send prices plunging. Rhodes founded De Beers to consolidate the area’s mines and to restrict sales. By his death in 1902, the firm accounted for 90% of the world market. More discoveries were made in the 20th century, notably in Siberia in the 1950s, Botswana in the 1960s and Australia in the 1970s. But De Beers kept tight control of supply, both by owning mines and by buying diamonds from others.

But by the 1990s De Beers’s grip had started to loosen. The Argyle mine in Australia left the De Beers cartel in 1996, fed up with the giant’s terms. New discoveries in Canada, a civil war in Angola and the collapse of the Soviet Union all made supply harder to manage, meaning that more diamonds were sold outside the cartel. Concern that diamond sales were financing African conflicts threatened the gem’s image. In 2000 De Beers said it would no longer control the market so strictly, but sell instead to vetted buyers. Legal settlements in America and Europe followed, barring the company from monopolistic behaviour.

The limits of De Beers’s power have been revealed in the past two years. Demand slumped in China in late 2014, prompting retailers to buy fewer polished diamonds. Companies that cut and polish stones became weighed down by excess inventory. But the tools De Beers once used to use to prop up prices were no longer at hand. There are legal restrictions on the share of excess diamonds it may buy. Because it controls just one-third of the market, any production cuts have limited effect on total supply. In fact, the firm may even have made matters worse. Contracts with its customers sometimes encourage them to overpurchase—if they turn down too many of the stones De Beers offers them, they risk being allocated a smaller share in future.

There are signs of recovery. Bain estimates that rough-diamond sales rose by 20% in 2016. De Beers is becoming more flexible, easing rules for buyers of its stones. More frequent reporting of its sales should help investors understand the business. It also signals to competitors—without engaging in collusion—when the market is deteriorating, enabling them to adjust accordingly.

But a long-term risk looms over the industry: one day young couples may no longer want diamonds at all. They are a “Veblen good”, as items that gain their value solely from their ability to signal status are named, after Thorstein Veblen, an economist who wrote about the spending of the rich. For Veblen goods, the normal law of supply and demand does not hold: higher prices support demand, rather than suppressing it. If a big gap opens up between the number of diamonds offered for sale and the number of people willing to buy them at high prices, diamonds could suffer a big, sustained fall in value and the entire business could cease to make sense.

Complicating matters, those who do want a diamond now have an alternative. Synthetic diamonds have been available for decades, but only recently has the process become cheaper and the result more refined. In 2015 a company called New Diamond Technology made a ten-carat polished diamond of excellent quality, an unprecedented feat. Sales of synthetic diamonds are thought to amount to just 1% of the rough-diamond market. But synthetic-diamond sellers are appealing to young shoppers’ concerns for social and environmental causes—Diamond Foundry, backed by Mr. DiCaprio, boasts that its products are “as rock-solid as your values”.

Miércoles, 12 Julio 2017 00:00

Patent Box

The so-called Patent Box is a fiscal regime that reduces the taxable income of corporate income tax, on the amount of income that comes from the assignment and / or transfer of intangible assets.

Many countries offer tax advantages for revenues derived directly or indirectly from patents or similar. One of these countries is Spain, whose fiscal exemption is 60% of net income; the reduction is applied to the net income obtained (income minus expenses), although the transferor entity is required to have invested at least 25% of the cost of the transferred assets; In addition there are no time limits in its application.
With this, the legislators aim to encourage investments in R D i with the additional benefits they entail and to attract or retain human talent.

On the other hand, the company values R D i results by assigning them to third parties and applies to the assignment of use or exploitation, so that ownership of the asset is not lost. In addition, it is compatible with the use of other R D i deductions.

The complex departure from these exceptions is that you have to be very well prepared to identify and prove the accounting accuracy of what you intend to integrate for the deduction and rigorously meet the requirements to identify that it is susceptible to be conceptualized.

The different global legislations may or may not have this type of incentive and not looking outside of Europe, it is true that countries like Belgium or Malta have better deductions, although it must be remembered that being in those countries carries an additional expense structure, that in order to make it profitable, it has to compensate for recurring expenses that are lower than the tax savings.

And finally, the different legislations contemplate different concepts of what can be included in what we have here called patents or similar, such as certificates of supplementary protection, rights to the development of new plants or food or medicines or software or data listings, ... Also in some cases they require reinvestments in more R D i ...

Martes, 11 Julio 2017 00:00

Whatsapp´s Corner

During the last years, the use of whastapp has been extended to send messages and occasionally, or frequently, draw a smile. We want to do the same from this corner, while using this tool to send some business messages.

This situation that appears in the picture below, sent by a medical friend, has its point of grace and can be a common situation when the entrepreneurs and professionals undertake certain risks, conveying that in general, if we are less experienced the risk is greater.


 - Relax Santi, it´s only a small cut with the scalpel, don´t be nervous...

 - Hey doctor, my name is not Santi

 - I know, Santi is me!

Depending on each job or activity, there will surely be many times when we are prepared to face new situations or situations that we do not practice frequently or situations where we have made a slip in the past. So rest assured, if we are effectively able to go to the next challenge, let's go with determination and calm.

In the example of the ophthalmologist, it´s most probably a person with good preparation, at least six years of a demanding career and in this case with practices, later studies, in Spain the famous MIR, experience in hospitals and clinics and assistance to other surgical interventions with other professionals.

If this doctor is not at ease he will not perform his job well. He has to be concentrated, not to operate on the healthy eye and must remember what has been learned and experienced. And he must be decisive, if the scalpel is not applied decisively, the incision will be wrong and may bring fatal consequences.

Either way, there is always a first time. It is inevitable and neither fear nor recklessness help.
But for the most fearful people, in this case, both the patient and the doctor himself, they should let themselves be advised by professionals with long experience who know the matter and how to react to the situation they face, a council. Sometimes not all eyes are the same, and for example, the curvature of the cornea of ​​the right eye is different from that of the left eye and as it does not calibrate well when the instrumentation is changed in an intervention of the two eyes ... as a bad intervention.

Therefore, honesty in the preparation, in the capacity for analysis, in the methods used and in being effectively concentrated, are essential to carry out a good execution.

Martes, 11 Julio 2017 00:00

The Due Diligence

One of our colleagues at our International network GCG, Mr. Bart Steenmeijer from Marktlink Fusies & Overnames B.V. from Holland, recently wrote an article about some interesting conclusions extracted from their experiences in due diligence (DD) processes (study based on 25 cases). We at CLOSA Investment Bankers, did a similar study (based on 100 cases) some years ago with very similar results.

In this summary, we detail some of the main issues that CLOSA obtained:

  • 8% of possible transactions failed because of the due diligence conclusions. That means that after the DD, a large majority, 92 % of the cases, were approved in a sales and purchase agreement.
  • Price (in terms of Enterprise Value), including earn out agreements issues (which includes reconsiderations of the forecasts), changed in 29% of the deals (4 cases upwards) and usually it was less than 5% of the total amount agreed upon. The analysis of the EBITDA is without any doubt the most frequent controversial element when the price is changing.
  • Net financial position (cash and debt) changed in 12% of the cases, normally because some debt is kept out of the balance sheet statements.
  • The most relevant issue was reps and warranties. 49% of the deals closed had a modification of the previously expected amount to be guaranteed. It is significant that labour issues were part of almost 62% of the cases, followed by legal and tax misunderstandings. But it is true that in several cases, seller or buyer didn´t make a previous work about reps and warranties and they were waiting for the due diligence report.
  • Issues regarding balance sheet figures appeared in 38% of the cases. Generally, with small amendments lower than 5% and mainly related to the inventory.
  • The interpretation of minimum working capital required were changed in 21% of the cases and always in minimal figures.

Here is a list of the most common issues in the reviewed DD investigations:

  • Derogation with regard to profit development / achieving forecasts
  • Woking capital
  • Labour contracts
  • Margin EBITDA pressure
  • Debt position
  • Inventory and inventory records

Legal contracts (e.g. change of control clauses)

Martes, 11 Julio 2017 00:00

Is the entrepreneur born or created?

According to a study by Prof. Wadhna of Duke University, the answer is: 54% of today´s entrepreneurs were the first to start a business in their family and 48% had precedents. Therefore, being born, having seen it at home, is very important in almost 50% of cases. If you see love at home, logically, you will try to pass it on to the next generation.

But it is also created. Anthony Tjan, in Harvard magazine, and with a sample of thousands of entrepreneurs, highlights the factors that determine the ultimate success:

  • Passion has a genetic component, but it must also be seen as a good example in education. Einstein said that examples are not the best way to educate, but rather the only way.
  • Here school education is basic because, according to Coral, until the age of 20, temperament is molded and the character is formed, and until the age of 30 we learn with sufficient depth.
  • The most difficult thing in our current society, to get out of the comfort zone.
  • Pablo Cardona, in his book The Keys to Talent, says that great leaders always talk about luck, when in fact it is an attitude - to hear others - and know how to surround themselves with good people, in a personal and professional sense.

After this empirical data we see what is the translation to Spain:

  • Africans say that whoever educates is the tribe. Gary Becker, a Nobel laureate in economics in 1992, talked a lot about this and, for example, showed that in the bosom of large families are born infinitely more entrepreneurs than in single-parent and unstructured families.
  • It costs a lot to leave the comfort zone. In 1975, expenses for food, alcoholic beverages, tobacco, clothing, footwear and hospitality accounted for 55% of income and today they account for only 30% ... And today one can live very well.
  • Failure is tremendously penalized both legally and socially. The Mediterranean culture forgives everything except business failure, in contrast to the Anglo-Saxon

We are going in the opposite direction even though everyone believes that a lot is being done in this regard. Let's go to Asia or to the USA where we will really see what is entrepreneurship and how the mentioned conditions meet there.

Reliable data on the success and failures of start-ups are not known. Perhaps, the most solvent, also from Harvard University, points to only 1 in 60.

In recent years, a new form of entrepreneurship called search fund has appeared. It consists of searching for a company for a while (maybe up to 2 years) and acquiring it. Meanwhile, a group of investors finance this work very humbly. In this way, there is already a first filter that guarantees that the person has the traits of entrepreneurship.

To finish, an aphorism: good money comes from customers, bad money from investors. So why don´t we help entrepreneurs more? Assessing their contribution to society, structuring more favorable legislation, etc. They are the ones who really generate wealth.

Michael Porter, one of the best management thinkers, wrote about strategy and was/is taught in every major MBA in the world. He is considered the Godfather of strategy and his model, which describes the Five Forces that determine competitive power in a business situation, has been very influential in this area for more than two decades. But how relevant is his work in today´s changing world?

Porter argues that the goal of the strategist is to understand and cope with competition. When competition is considered, it is important to look at direct competitors, but also contemplate broader competitive forces against which the company is fighting for profits. The Five forces that should be considered include:

  • Supplier Power: how easy it is for suppliers to drive up prices
  • Buyer Power: how easy it is for buyers to drive prices down
  • Competitive Rivalry: the number and capability of your competitors
  • Threat of Substitution: ability of your customers to find a different way of doing what you do
  • Threat of New Entry: the ability of people to enter your market

Porters 5 Forces

According to Porter, strategy is “the creation of a unique and valuable position, involving a different set of activities” and is based on competitive difference.

Some argue that strategy has changed and new priorities should be considered today when performing industry analysis:

  • Stable versus dynamic markets: while Porter´s framework suggests that markets are stable and so positioning oneself is enough to survive over time, in dynamic markets one has to think about where to compete and then how. It is not just about being different but also to develop purpose, innovate more in terms of business models, trajectories and customer experiences.
  • Power shift to customers: today businesses are focusing more on customers, not just in terms of serving them best but are also considered a guiding star. Porter doesn´t give customers much importance in his model.
  • Blur boundaries in today´s markets: strategic opportunities might be to move across sectors and geo boundaries or to even fuse them together. So for example, communication becomes media which becomes entertainment which becomes sports…It is not just about being different, cheaper or better but out-thinking others.
  • Big is not always best: the old thinking was that companies win through scale by generating more revenue and more power but they addressed homogenous markets with undifferentiated products and services. Some of today´s winners succeed with better visions and ideas, focusing on niche and highly relevant customers- small agile and smart.

There is no question that Porter´s five forces is a robust framework that is at the heart of what constitutes a strategy. It is a tool that should allow one to understand the current industry´s dynamics and major trends. In fact, no one can deny that his framework helped shape modern-day strategy but taken as it is, it might appear outdated in the light of the social era.

Jueves, 06 Abril 2017 00:00

Warning Light from China

Signs emerged that China´s effort in boosting its economy might be reversing, which could affect global investors.

During much of 2014 and 2015, China´s growth seemed to be slowing so the country enacted a concerted effort in 2016 to stimulate its economy. It encouraged its banks to lend more money to companies within China and the Chinese government increased its spending on infrastructure projects. Since China largely contributes to world demand for commodities, this boost led to an increase in metal prices (price of iron ore almost doubled since December 2015). Now, it seems as though China has started to withdraw that support (in order not to overheat the economy) by moderately increasing interest rates and imposing new restrictions on borrowing to buy property.

Jueves, 06 Abril 2017 00:00

Europe is on a good run

The Eurozone´s business activity hit its highest record in 6 years early March 2017, according to IHS Markit. The data suggests that the first quarter could be Eurozone’s best for economic growth in six years and, given that activity accelerated in March, it’s reasonable to expect that this momentum will continue into the second quarter. Strengthening demand within European countries (e.g. consumer spending), especially in France and Germany, is one main reason for the increased activity. Particularly good news for Europeans is that job growth has improved to the fastest level in almost a decade.

Consequently, Eurozone stocks have now outperformed US stocks since the start of the year as investors integrate the improved economic data into stock prices.

Jueves, 06 Abril 2017 00:00

Amazon is on a mission

Amazon announced on March 28 that it´s buying Souq.com, the largest ecommerce retailer in the Middle East, expanding thus its retail empire. Souq was founded in 2005 as an auction site, like Ebay, but rebranded in 2011 to become more like Amazon, an online marketplace. The acquisition was not easy as Emaar Malls, a major Dubai-based shopping mall operator, tried to outbid Amazon at the last minute.

While we do not know the exact price, amazon´s purchase is apparently the biggest-ever technology acquisition in the Middle East and shows in fact that companies worldwide are aiming at expanding in the affluent regions of the Middle East with the examples of Tesla and Apple in the UAE.

Jueves, 06 Abril 2017 00:00

2017 M&A Predictions

With Brexit continuing to work itself out, many of President Donald Trump´s policies still unclear, and questions around global growth, it is still hard to predict how this year might unfold.

There´s hope that 2017 will pick up where 2016 left off, which was the third best year on record for M&A although activity dropped by 23% year-over-year but with 4,951 mergers and an annual total of 3.6 trillion $.

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Despite of the challenges, many advisors are foreseeing an M&A boom as many companies face poor organic growth opportunities forcing them to consider acquiring rivals or expanding into new territories, regardless of higher valuations. Since the recession in 2008, companies have been hoarding cash but many want to spend it now. According to FactSet, S&P 500 businesses held more than $1.5 trillion in cash in the third quarter of 2016, a 7.6 percent year-over-year increase. Commercial banks also have money to lend, while private equity firms want to spend.

On another hand, the M&A sector will be affected by how fast interest rates will rise. Although the Federal Reserve raised rates, hardly anyone is expecting a large spike and so companies won´t feel a material impact if interest rates rise gradually.

Also, many expect that the deal making themes of 2016 will continue, in particular, the flow of capital from Asia to Europe and Europe to the US. Large Asians companies such as ChemChina, HNA Group (China) and Asahi (Japan) showed increased interest in Europe and thus helped offset a sharp slowdown between European companies. In turn, European multinationals went to the US in order to escape a slower regional growth and take advantage of a more reliable US market. Some examples are Bayer and Danone.

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Finally, it looks like the tech industry could lead the way. It has been the most active sector, with particular focus on internet tech-enabled services, financial technology and healthcare IT. The year 2016 resulted in 612.9 billion $ in global tech deals according to Dealogic, and experts are predicting private equity interest on tech and big players looking to remain competitive in the market as sectors converge. Some of the biggest deals we witnessed last year include Microsoft´s acquisition of LinkedIn for 26.2 billion $ and Didi Chuxing´s acquisition of Uber China for 7 billion $.

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