Uniting Gamesters

BWIN’s on-going search to “create shareholder value” seems to be moving on with the announcement that it “has entered into preliminary discussions with a number of interested parties regarding a variety of potential business”. A previous post on a number of the main players in the European gambling sector highlighted that William Hill and Paddy Power were speculated to be potential bidders for all or parts of BWIN, a European online gaming firm with a concentration of approx 25% of revenues from Germany. Now press reports speculate the potential interested parties include the Canadian firm Amaya, who purchased PokerStars/Full Tilt earlier this year, and Playtech, a software gaming firm that are “seeking transformational M&A opportunities to take the business to the next level”.

Commentators raised an eyebrow about the speculated 45% premium on offer (from before discussions were reported) given BWIN’s operating metrics and the uncertainty over the key German market. Speculation involving Playtech focussed on their recent debt raising which brings their cash-pile to around €700 million. Playtech’s shareholders may not be too pleased if their new strategy moves too far away from the very profitable software business, particularly considering the alternative of continuing with their generous special dividends. Taking on businesses such as BWIN, or even another speculated target like Ladbrokes, is a far cry from what made Playtech such a star.

In fact, the best performer in the sector (in fact the only name that’s in positive territory!) is the reinvigorated Betfair under Breon Corcoran (see previous post on Betfair) as can be seen below (they also have cash to spend on potential M&A).

click to enlargeShare price YTD selected betting stocks

This is a fascinated sector that is in the midst of considerable change. Although I have no financial interest in the sector, I am an intrigued bystander. Bring on the next development.

Will the climate change debate now move forward?

The release of the synthesis reports by the IPCC – in summary, short and long form – earlier this month has helped to keep the climate change debate alive. I have posted (here, here, and here) on the IPCC’s 5th assessment previously. The IPCC should be applauded for trying to present their findings in different formats targeted at different audiences. Statements such as the following cannot be clearer:

“Anthropogenic greenhouse gas (GHG) emissions have increased since the pre-industrial era, driven largely by economic and population growth, and are now higher than ever. This has led to atmospheric concentrations of carbon dioxide, methane and nitrous oxide that are unprecedented in at least the last 800,000 years. Their effects, together with those of other anthropogenic drivers, have been detected throughout the climate system and are extremely likely to have been the dominant cause of the observed warming since the mid-20th century.”

The reports also try to outline a framework to manage the risk, as per the statement below.

“Adaptation and mitigation are complementary strategies for reducing and managing the risks of climate change. Substantial emissions reductions over the next few decades can reduce climate risks in the 21st century and beyond, increase prospects for effective adaptation, reduce the costs and challenges of mitigation in the longer term, and contribute to climate-resilient pathways for sustainable development.”

The IPCC estimate the costs of adaptation and mitigation of keeping climate warming below the critical 2oC inflection level at a loss of global consumption of 1%-4% in 2030 or 3%-11% in 2100. Whilst acknowledging the uncertainty in their estimates, the IPCC also provide some estimates of the investment changes needed for each of the main GHG emitting sectors involved, as the graph reproduced below shows.

click to enlargeIPCC Changes in Annual Investment Flows 2010 - 2029

The real question is whether this IPCC report will be any more successful that previous reports at instigating real action. For example, is the agreement reached today by China and the US for real or just a nice photo opportunity for Presidents Obama and Xi?

In today’s FT Martin Wolf has a rousing piece on the subject where he summaries the laissez-faire forces justifying inertia on climate change action as using the costs argument and the (freely acknowledged) uncertainties behind the science. Wolf argues that “the ethical response is that we are the beneficiaries of the efforts of our ancestors to leave a better world than the one they inherited” but concludes that such an obligation is unlikely to overcome the inertia prevalent today.

I, maybe naively, hope for better. As Wolf points out, the costs estimated in the reports, although daunting, are less than that experienced in the developed world from the financial crisis. The costs don’t take into account any economic benefits that a low carbon economy may result in. Notwithstanding this, the scale of the task in changing the trajectory of the global economy is illustrated by one of graphs from the report, as reproduced below.

click to enlargeIPCC global CO2 emissions

Although the insurance sector has a minimal impact on the debate, it is interesting to see that the UK’s Prudential Regulatory Authority (PRA) recently issued a survey to the sector asking for responses on what the regulatory approach should be to climate change.

Many industry players, such as Lloyds’ of London, have been pro-active in stimulating debate on climate change. In May, Lloyds issued a report entitled “Catastrophic Modelling and Climate Change” with contributions from industry. In the piece from Paul Wilson of RMS in the Lloyds report, they concluded that “the influence of trends in sea surface temperatures (from climate change) are shown to be a small contributor to frequency adjustments as represented in RMS medium-term forecast” but that “the impact of changes in sea-level are shown to be more significant, with changes in Superstorm Sandy’s modelled surge losses due to sea-level rise at the Battery over the past 50-years equating to approximately a 30% increase in the ground-up surge losses from Sandy’s in New York.“ In relation to US thunderstorms, another piece in the Lloyds report from Ionna Dima and Shane Latchman of AIR, concludes that “an increase in severe thunderstorm losses cannot readily be attributed to climate change. Certainly no individual season, such as was seen in 2011, can be blamed on climate change.

The uncertainties associated with the estimates in the IPCC reports are well documented (I have posted on this before here and here). The Lighthill Risk Network also has a nice report on climate model uncertainty which concludes that “understanding how climate models work, are developed, and projection uncertainty should also improve climate change resilience for society.” The report highlights the need for expanding geological data sets beyond short durations of decades and centuries which we currently base many of our climate models on.

However, as Wolf says in his FT article, we must not confuse the uncertainty of outcomes with the certainty of no outcomes. On the day that man has put a robot on a comet, let’s hope the IPCC latest assessment results in an evolution of the debate and real action on the complex issue of climate change.

Follow-on comment: Oh dear the outcome of the Philae lander may not be a good omen!!!

Same old guff

Now that the US hurricane season is over without any material events, I had a quick look over a few transcripts of conference calls in the specialty insurance and reinsurance sectors to see if there was any interesting comments on where the market is going.

Nearly everybody claims to be mitigating the challenging market conditions by ducking & diving between business classes whilst keeping their overall underwriting discipline. The softness in the reinsurance market has spread into the insurance market, albeit not to the same extent. The reality is that results continue to be flattered by reserve releases, low loss activity and improved loss trends. Market realities are slowly being reflected in ROEs which are coming down to the low double digits.

Nearly all of the reinsurers are claiming to be the winners in the structural changes in the “tiering” of the market whereby cedants are reducing their reinsurance spend and concentrating that spend amongst a select group of reinsurers. Everybody has special relationships and the gravity defying underwriters! That same old guff was the typical response in the late 1990s.

The only interesting comment that I could find was from the ever colourful Ed Noonan of Validus who, after claiming that not everybody is as disciplined as they claim (he was talking about the large generalist reinsurers), said the following:

“It’s unfortunate because the market has had such strong discipline for the last decade. There are no magical segments that are beautifully priced, and the idea that a well-diversified portfolio poorly priced risk makes sense is an economic capital model-based fantasy.”

The last sentence reminds me of one of my favourite quotes from Jim Leitner of Falcon Management that “there is no real diversification in owning a portfolio of overvalued assets“.

My view is that few economic capital models in the insurance market which are currently being used to allocate capital to business classes are taking such arguments seriously enough and most are likely over-estimating the benefit of diversification across soft or under-priced portfolios.

 

Judicious Volatility

The market has a tendency to take an extreme position, either everything is on the up or the sky is about to fall in. Well, fear is the flavour of the markets these days and that’s no bad thing given where we have come from. Still it’s annoying to hear the media full of hysterical noise on Ebola, the Middle East, Europe, Japan, Russia, oil, end of QE, deflation, etc. Hopefully, we’ll start to get some more considered arguments on what the medium term economic and earnings outlook may look like. Vitaliy Katsenelson had a nice piece on thinking through the effects of a few scenarios. Hopefully, the end of the happy-clappy market (it will likely not go easily and may well return before long) will lead to some more thoughtful pieces like that.

For now though, the smell of fear is in the air and the graph below on the ups and downs in the S&P500 show that the recent volatility is not even near correction territory (i.e. greater than 10% fall). In fact, we really haven’t had a proper correction since late 2011. As to whether this volatility will turn into a correction, I have no idea (I suspect it might take a while yet but it will get there).

click to enlargeS&P500 ups and downs

The graph below shows that the high beta stocks as measured by the Powershares high beta ETF (SPHB), as you would expect, have been hit hard here compared to the S&P500 and the low volatility ETF.

click to enlargeS&P high beta ETF

It will be interesting to see how the market develops over the coming weeks. Earnings, particularly guidance for Q4, will likely play a large part it how it plays out.

On the debate about whether historically high earnings can continue, McKinsey had an interesting article recently on the earnings and the market. The graph below from McKinsey illustrates the increased important of technology, pharma, and financials in the higher profits.

click to enlargeMckinsey Share of S&P500 profits

Spending time looking for thoughtful arguments on the impact of macro-economic, demographic and social pressure in today’s world on these sectors is a better way to understanding the medium term direction of the market. As McKinsey says “assessing the market’s current value ultimately depends on whether the profit margins are sustainable”. The rest is really just noise, best ignored or viewed from a distance.

TRIB Follow-up: D’OH!

Well, I have to put my hands up on this one, my timing couldn’t have been worse with TRIB off about 20% since this post. Reading it back, you can see that I knew I was going against my instincts and it shows the result of indiscipline on my part.

The analysts all revised their estimates in early September to take account of delays in product take-up – revenue and EPS are estimated at a tad over $27M and 0.19 respectively for Q3. Although my estimates agree on EPS, I think revenue could miss & come in below $26.5M. Add in the uncertainty on the impact of Ebola on African revenues (approx. 12% of total revenues are from Africa in HIV segment), the push out to H2 2015 for the target commercial launch of the cardiac troponin test (assuming FDA approval), the continued selling by the shareholder(s) who has been selling down through the 20′s and beyond.

All in all, this is one to own up to as a badly timed call. My risk management allowed me to only establish a small position so it’s not a disaster and I’m not beating myself up (too much!!). Ironically, TRIB is trading now around where the level my original post targeted. However, I don’t have the conviction to follow this one down. I’ll see what is said at the earnings call next week before I decide what to do but I’m not positive short term in today’s market (which I welcome as a dose of reality is needed).

Longer term TRIB may still be interesting as the main points of my assessment still hold. But as Yra Harris said “if you’re right at the wrong time, you’re wrong“. Well, hands up, I was wrong on TRIB.