More on Europe

I recently read an investor letter discussing the historical correlation between global mobility of capital and the propensity of banking crises.  It concluded the easier it is for money to move (physically or electronically), the more likely a financial crisis.  As soon as people think their institution or country is in danger, they move their money elsewhere and the problem is exacerbated.

This is currently happening in Europe.  Capital is fleeing the already insolvent peripheral countries (Greece, Portugal, etc.) to the core countries (Germany, Switzerland, UK) in a flight to safety.  In actuality, this trend is worsening their stance and banking systems.  A hedge fund manager framed it nicely saying, “Greece is like a business whose revenue base is declining (GDP), who generates revenue through receivables (taxes), who collects only a fraction of those receivables, and who has a huge fixed expense base that it can’t cut without enraging customers (the voters).  This is not sustainable, and definitely not a business you want to lend money to.”

At some point in history most countries have been overly optimistic, borrowed too much, got carried away, and weren’t ready when things deteriorated.  However, there is one risk specifically unique to Europe scaring many investors, including myself: redenomination risk.  What happens if the Euro falls apart?  What if certain countries leave and not others?  What currency will your investment be denominated in?  What will that currency be worth relative to the dollar?  Is there a way to hedge this?

Redenomination is scary, possible, and maybe even probable.  So what's an investor to do?  My best advice is to 1) study the language of each legal document to understand the ramifications of a currency change and 2) be careful when crafting new documents.  As detailed in my previous post, Catalus is now actively seeking European investments.  We are working to understand and mitigate redenomination risk, rather than letting it eliminate potential excellent opportunities.  I’ve included some articles below on the topic.

Banks Ponder Scenarios if Countries Drop Euro

Banks Struggle With Euro Contingencies

An EU Currency Breakup Would Be Unlike Any Other
Banks Prep for Life After Euro
Time to Think the Unthinkable on the Euro

Also, to review interesting investor letters like the one I refer to at the beginning of this post, visit the Neo-Alpha Blog.  

Entering Europe against the Grain

Like the entire financial community, Catalus has been watching European developments with horror and skepticism.  Unlike most of the financial community, we believe that where there is uncertainty there is also opportunity.  It appears that most European banks have restricted or discontinued lending until stability is restored, which means that our type of capital could start to play a larger role in financing growth, acquisitions, and recapitalizations.

Catalus, of course, differentiates between the Continent's countries.  We view the UK and Germany as the most desirable, with Greece and Eastern nations trailing further behind.  For us, the specific company, opportunity, and deal structure is far more critical than the "bucket" within which it falls.  Our focus will remain on existing cash flow and/or hard assets.  In a newly originated deal, our minimum investment will be $10 million (~7.5 million Euro), however it could be less for traded bonds or loans.

No one knows how things will end up in Europe.  It is probable that it will struggle for a number of years to come and possible dramatic changes will be made to how the Euro zone is structured and governed.  Certainly there are countless risks.  Nevertheless, as of today we are updating our website and online profiles to include European investments.  Although we may be getting in a bit too early, we believe in the end Europe will prevail and emerge as a stronger global competitor.

Catalus will start an online campaign to generate European deal flow.  We will be actively searching for companies looking to borrow money and for intermediaries (investment bankers, deal brokers, lawyers, accountants, and others) that can help make an introduction.  If you are in the market, we would love to hear from you at marek@cataluscapital.com.