Good Afternoon. In today's newsletter, we dive into a range of economic and market insights, from the nuanced dynamics of proportional unemployment to the strategic maneuvers of corporations like Newmont Corp and Apple Inc. We'll analyze the evolving landscape of the Canadian credit market, the impactful merger between Discover Financial and Capital One, and the critical U.S-China semiconductor rivalry. Additionally, we spotlight growth equity's role in today's finance sector and challenge our readers with a thought on the Internal Rate of Return (IRR). Join us for a concise exploration of these pivotal topics shaping our economic and financial world.
ECONOMIC UPDATE
PROPORTIONAL UNEMPLOYMENT; WHAT DOES IT MEAN?
After hitting record lows in 2022, unemployment seems to be trending negatively. The unemployment rate has risen by 0.8 percentage points since April 2023. While this may not seem significant, after diving deeper into the data, there are a few insights to uncover.
Oddly enough, Canada posted a net increase in jobs over the last year, so why has unemployment increased? This can partially be attributed to record population growth, as over 369K international workers joined the labor force. However, only 182K successfully secured a job, resulting in the remaining workers being counted as looking for work and unemployed.
The other half of the equation revolves around students. In fact, over half of the gain in unemployment is a result of post-secondary graduates and other students being unable to find work according to RBC. While this is normal during a labor market slowdown, it does leave the population in a particularly vulnerable place during an uncertain economic environment, especially as individuals that are just starting their career.
Note that the quality of posted jobs has also decreased, as employers seek to cut labor. There was a gain of 37.3k jobs in January, but full-time employment declined by 11.6k positions, which indicates that part-time jobs are responsible for this increase. This reduces the average income earned and the proportion of underemployed workers.
Overall, the softening Canadian labor market seems to be unable to keep up. While companies are still adding new positions, they don’t seem to be accommodating the rise in people interested in obtaining employment. Further, they seem to be shifting their focus from full-time to part-time employees, which is a bearish signal for the short-term future of the economy.
Newmont Corp
Following its acquisition of Newcrest in 2023. Newmont is based in the United States with headquarters in Colorado and operational plants spread across continents. In regard to their operation Newmont predominantly focuses on gold and copper, but they also mine other metals such as silver and various materials.
Despite generating a revenue of 11.8bn in FY 2022 Newmont saw a net loss of 2.47 billion. This net loss coupled with recent announcements by the company regarding plans to trim dividends has scared investors and caused the stock to trend to a 5-year low.
While typically viewed as a negative move, the dividend cut might signal a strategic shift for Newmont. It may provide them with the financial flexibility to pursue strategic acquisitions and reposition themselves for sustained relevance in the long term.
Although the stock may not experience the rapid growth of junior mining companies, it can offer a more stable, long-term hedge against the volatility of other investments, particularly amid ongoing economic uncertainty, both in the near future and beyond.
Apple Inc (NASDAQ: AAPL)
Apple’s shares are down 10% since the beginning of the year and on a 7-day losing streak. The market’s reaction can be attributed to a recent series of bearish reports following disclosure of a disappointing forecast for the March quarter, and a publication from Counterpoint Research indicating that Apple experienced a 24% decrease in iPhone sales in China, the world’s second-largest economy, during the first six weeks of 2024 compared to the same period in 2023. The report also noted a 7% decline in overall smartphone sales during this timeframe. Additionally, the European Commission issued Apple a $2 billion fine for “abusive App Store rules'' concerning music-streaming providers. More anxiety was induced when Goldman Sachs removed Apple from its U.S Conviction List after 274 days, which contains the bank’s 20 to 25 most differentiated buy ideas across their U.S stock coverage.
Some analysts say that Apple’s cult following and sticky product switching costs will prevent a further downward trend, but others attribute the stock’s future to what the infamous investor Warren Buffet does with his shares of the company.
MARKET TREND
CANADIAN BANKS SHAKE UP CREDIT MARKET WITH RISKY BUSINESS
In an era where financial stability is paramount, Canadian banks are making significant moves in the credit market with an innovative approach: Synthetic Risk-Transfer Tools (SRTs). These financial instruments, reminiscent of the complex securities that preluded the 2008 financial crisis, are gaining momentum, highlighting a strategic pivot in risk management and regulatory compliance.
The Essence of SRTs
At the core of SRTs lies a simple yet profound mechanism: they enable banks to transfer the credit risk of loans to private investors. This transfer occurs without selling the actual loans, akin to keeping a valuable Pokémon card while paying a friend to assume the risk of loss or theft. In the financial world, this means banks continue to own their loans, from corporate to mortgages, but share the potential financial burden with investors for a fee.
Canadian Banks' Strategic Shift
The landscape of Canadian banking has witnessed a dramatic transformation with the adoption of SRTs. The volume of synthetic securitizations has surged to $86.6 billion from $40.3 billion over the past two years, a testament to the sector's adaptation to regulatory pressures. This shift is primarily driven by enhanced capital requirements imposed by Canadian regulators, mandating banks to bolster their reserves relative to the risk profile of their loan portfolios.
A Global Perspective: Learning from Neighbors
The financial tumult following the downfall of notable banks in 2023, including Silicon Valley Bank and Signature Bank, prompted a stringent regulatory response from the FDIC, with capital requirements soaring by up to 20%. This move aimed at reinforcing the banking sector's resilience has inadvertently fueled the adoption of Credit Risk Transfer (CRT) transactions, setting a record in the process.
Implications and The Road Ahead
The embrace of SRTs by banks is not without its implications. While ostensibly mitigating risk and circumventing capital constraints, this strategy could potentially amplify banks' leverage, echoing the precursors to past financial calamities. The critical balance between regulatory compliance and financial innovation is more precarious than ever, underscoring the need for vigilance and prudent risk management.
For those keen on delving deeper into the intricacies of these regulatory frameworks and their impact on the banking sector, exploring the Basel Endgame rules could provide valuable insights into the governance of capital requirements in the United States.
In Conclusion
As Canadian banks navigate the complex terrain of credit risk and regulatory mandates through the use of SRTs, the financial landscape is witnessing a remarkable evolution. The strategic shift towards these synthetic instruments underscores a broader trend of innovation and adaptation in the face of regulatory challenges. However, it also serves as a reminder of the need for cautious optimism, as history's lessons loom large over the horizon of financial innovation.
INDUSTRY UPDATE
U.S & CHINA AT WAR; SEMICONDUCTORS AT THE PINNACLE OF THIS RIVALRY
War on Innovation: China vs US
The US-China technology war continues to escalate across multiple fronts, particularly in the semiconductor and cloud computing sectors, affecting global tech dynamics significantly.
What’s currently happening/history?
The ongoing US-China technology war marks a critical phase in the geopolitical rivalry between the world's two largest economies. The conflict spans several sectors, with a particular focus on semiconductors and cloud computing. The United States has imposed stringent export controls aimed at limiting China's access to advanced semiconductor technology, essential for modern electronics and military applications. In retaliation, China has banned purchases from certain American chipmakers and introduced export controls on critical raw materials like gallium and germanium, crucial for chip manufacturing.
What is this causing?
These restrictions have intensified global supply chain disruptions, affected global tech development, and pushed both nations towards technological self-sufficiency. The battle over semiconductors has also led to a broader conflict involving cloud computing and AI, with the US attempting to restrict China's access to advanced cloud technology and infrastructure critical for AI development. Despite these efforts, Chinese firms have found ways to circumvent restrictions, showcasing the difficulty of controlling access to technology in a globalized world.
Why is this an issue?
The technology war between the US and China raises concerns about the fragmentation of the global technology ecosystem, potentially leading to a divide in tech standards, supply chains, and internet governance. Such a divide could slow down global innovation, increase costs for consumers and companies, and worsen geopolitical tensions. Moreover, the focus on technological supremacy risks overshadowing critical cooperation on global challenges such as climate change, cybersecurity, and pandemic response.
Personal opinion/Future outlook
In conclusion, the US-China technology war is a complex issue with far-reaching implications. While national interests drive current policies, the long-term prosperity of both nations—and indeed the global community—depends on finding common ground and mutual respect in the realm of technology and beyond. It underscores the critical intersection of technology and geopolitics, and while efforts to safeguard national security and protect intellectual property are valid, the escalating tit-for-tat actions may ultimately harm global technological progress and economic stability. Moving forward, it is imperative for countries globally to find pathways for cooperation and communication, ensuring that technological advancements serve as a bridge rather than a barrier. The future should ideally see a balance between competition and cooperation, fostering an environment where innovation thrives and contributes to global well-being.
MERGER AND ACQUISITION
DISCOVER FINANCIAL TAKES CAPITAL ONE TO NEW DOMESTIC HEIGHTS
Transaction Details
On February 19, 2024, Capital One Financial Corporation executed a strategic acquisition of Discover Financial Services via an all-stock transaction valued at $35.3 billion. The merger agreement specifies a share exchange ratio of 1.0192:1, with Capital One shares exchanged for Discover Financial shares, representing a 26.6% premium over Discover’s closing stock price as of February 16, 2024.
Overview of the IPO
Target (Discover Financial)
Discover Financial Services is a prominent digital banking and payment services entity, offering a suite of products through its subsidiaries. Its portfolio includes credit card loans, private student loans, home equity loans, and deposit products. Discover has various subsidiaries deemed the Discover Global Network, enabling a global payment and banking solutions framework.
Acquiror (Capital One)
Capital One operates as a diversified financial service holding company, delivering a wide array of financial products to consumers, small businesses, and commercial clientele. The company leverages digital channels, branch networks, Cafés, and other distribution channels to offer its services. They have several subsidiaries globally and rank as the third-largest credit card issuer.
Strategic Rationale
The acquisition of Discover by Capital One propels the latter to the position of the sixth-largest bank in terms of domestic assets, with a portfolio valued at $625 billion. Capital One processes transactions through the Visa and Mastercard payment networks, where a portion of all credit card revenue is paid to Visa and Mastercard. In contrast, Discover operates its own payment network, acting as both a card issuer and payment processor, thereby retaining all transaction proceeds in-house. The merger of these two financial service giants allows Capital One to capitalize on Discover's in-house payment processing network, while Discover benefits from Capital One's extensive consumer base. This strategic consolidation leads to a
range of horizontal and vertical implications, injecting competition into various sub-sectors of the financial service industry and potentially reshaping the competitive landscape.
Industry Commentary
The strategic acquisition of Discover Financial Services by Capital One Financial Corporation signifies a pivotal consolidation within the financial services sector, highlighting the critical role of digital transformation and the pursuit of integrated payment processing capabilities. By merging Discover's unique in-house payment network with Capital One's vast consumer base and digital-first strategy, the move not only propels Capital One into a significantly enhanced competitive position but also promises diversified growth opportunities through a comprehensive portfolio of financial products. This merger, indicative of the industry's evolving dynamics, underscores the potential for more efficient operations, cost savings, and the delivery of competitive rates and innovative services to consumers and small businesses. However, it also raises important considerations for regulatory scrutiny and the competitive landscape, suggesting a trend towards further consolidation in the industry as entities strive to match the scale and capabilities of this newly formed powerhouse, thereby reshaping the future of financial services in the digital age.
CAREER SPOTLIGHT
GROWTH EQUITY EXPOSE
Description
Growth equity centralizes around investing in relatively mature companies that are positioned for drastic expansion and growth. Such investments can be used for various growth plans including acquisitions, scaling up operations, and market expansion. Growth equity investments usually are minority stakes of around 15% - 30% and have a holding period of 3 to 5 years
Growth equity vs Private equity
Growth equity investments are commonly minority investments in earlier stage companies and help the target company expand rapidly. Private equity investments are geared towards more mature companies and private equity firms are heavily involved in controlling the operations of the target company since they acquire the entire company or own a majority stake
Desirable Academic Background
Business degree, finance and accounting courses, finance clubs
Review the career progression tree below to grasp a brief understanding of what your path through growth equity might entail
Ideal Certifications
- CFA is helpful unless you have banking experience.
Queen’s Alumni
- Matthew Ferreira – Growth Equity at Blackstone
- Taylor Durand – Growth Equity at Blackstone
- Kyle Johnson – Growth Equity at Permira
- Adam Carnicelli – Growth Equity at General Atlantic
Potential Career Transitions:
- Private Credit
- Private Equity
- Venture Capital
Day in The Life
- Varies depending on size of firm, deal flow, and specific role responsibilities
- Similar to private equity professional
- Calling different management teams and founders
- Majority of day spend working on Valuation models to determine returns on the investments
- Due diligence into potential sectors to source deals
Key Skills
- Valuation, market research, client relationship management, teamwork, interpersonal, networking
Type of Person That Would Suit Growth Equity
- Hard working, creative thinking, competitive, team driven, detail oriented, quantitatively adept
Type of interview to Expect
- Mix of behavioural and technical
- Basic finance technical, technical questions tailored to early-stage companies
- Examples:
- If company doesn’t have earnings, how would you value it?
- What metrics/multiples would you use for early-stage companies?
- Can you pitch a potential investment and why?
- How would you communicate and approach conversations with owners to learn more about their businesses?
RECRUITING QUESTION
What does Internal Rate of Return (IRR) measure in financial analysis?
IRR measures the rate at which Net Present Value (NPV) is equal to 0. It can be used in capital budgeting to estimate the profitability of potential investments or projects.
How is IRR used in the decision-making process for investment projects?
IRR is used as the minimum rate of return for a project/investment, meaning any investment with a lower rate of return than the IRR will result in a loss, and any rate above the IRR will lead to a profit.
Describe the process of calculating the IRR for an investment. What is the main mathematical characteristic of IRR in the context of Net Present Value (NPV)?
To find IRR, set NPV equal to 0 and solve for the discount rate from there. This will give you a return rate that results in an NPV equal to 0.
b. Suppose the following cash flows for a project:
Using the provided cash flows find the Internal Rate of Return of the project? To find the IRR utilize this equation:
CF1 +(1+r)/CF2 =0
−100+(1+r)/110=0
100(1+r)=110
1+r=1.1
R=0.1or10%
Utilizing the IRR formula, it can be calculated the IRR given the provided cash flows is 10%.
