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The Latam Pink Tide: takeaway from a field trip

https://bondvigilantes.com/wp-content/uploads/2022/10/1-the-latam-pink-tide-takeaway-from-a-field-trip-1024×576.pngThe political landscape in Latin America…

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The political landscape in Latin America over the past 18 months – from Boric in Chile to Petro in Colombia more recently – has changed to varying degrees but only in one direction: to the left. Some have coined the change the pink tide, others the pink wave. I like the image of a pink tide, slower but mightier than a wave. This pink tide may expand in a couple of weeks if Brazil’s presidential election sees Lula winning, in what is expected to be a tight second round against incumbent Bolsonaro. I am just back from a two-week research trip in Latam (Mexico, Chile, Peru and Colombia) where I met with several corporate bond issuers and local investors and I came back with a mixed view. On the one hand, policy risk has materially increased and the business environment has changed in some countries. On the other hand, I find value in Latam corporate bonds in US dollar relative to other regions of emerging market debt.


Source: M&G, Wikipedia Oct 2022, countries with members of Sao Paulo Forum ruling parties (Pink) and  non-Sao Paulo Forum ruling parties (blue)

From a fundamental standpoint, businesses in the region are in decent shape even though policy risk has already impacted some of them. Utilities have seen credit metrics deteriorating recently, but the starting point is strong in terms of balance sheets. The oil and gas industry benefits from high oil prices but is vulnerable to tax and environmental regulation, notably in Colombia. The demand outlook and market imbalance for key metal-based commodities should provide support for miners in general but Chinese GDP – as a key demand driver – remains a question mark. In the retail space, profits have been impacted by margin erosion due to input cost inflation but top-line numbers continue to stay strong, sustained by consumption. Refinancing risk is moderate and Latam HY default rates are expected to be low-2% in 2022, and moderately higher next year. In terms of valuation, Latin American corporate bonds in US dollar offer a spread of 480bps over US Treasuries – a wide level not seen in 6 years (excluding the pandemic). In 2016, default risk was much higher after the region got caught in a wide-spread corruption scandal originating in Brazil and credit metrics were weaker too. Political risk has increased in many countries in the region but one may argue that the increases in geopolitical risk elsewhere – e.g. Eastern Europe, US-China – are more lasting and worrying changes for asset prices in the medium to long term.

Here is my takeaway on the four countries I visited, how the business environment has changed (or not) with the pink tide, and the implications for bond investors.

Mexico

  • Probably where the macro outlook is the most stable. Leftist president Lopez Obrador (“AMLO”) is very popular in the country – notably thanks to its elderly population’s pensions and the perceived fight against corruption – whilst not so popular with the business community. Strong consumption is driving the economy and most companies I met have strong top-line growth. However, higher input cost has had an impact on businesses that are unable to pass through the entire cost inflation to end clients (margin erosion) or those which are prevented do so by regulation in the energy sector (working capital needs are elevated on lagged payments of subsidies). The Russia/Ukraine conflict in Europe and the US-China geopolitical tensions are all seen to benefit Mexico in the way of US nearshoring.
  • Inflation, like elsewhere, is a question mark. The government expects 3.2% next year but this is well below economist forecasts of mid-4. Banxico continues to keep a high premium over US rates and the Mexican Peso has been stable and outperforming many other peer currencies this year. The current administration, despite its left-leaning rhetoric, is actually praised by investors for its fiscal sustainability. Both deficits and debt levels are low, and the government’s 2023 budget proposal is unlikely to put fiscal stability at risk.
  • State-owned Pemex continues to be the “elephant in the room” with tight liquidity and an insolvent balance sheet that requires a constant lifeline from the government, despite this year’s elevated oil prices. Local investors think the AMLO administration will provide support at any cost. Going into the next presidential election in 2024, there is a wide expectation that the left (Morena party) will stay in power and back Pemex whatever it takes.

Chile

  • For decades, everyone forgot that Chile was located in South America. The business district of Santiago does look modern, but other areas of the city nonetheless still have visible signs of the 2019 unrest in which over a million people protested against social inequality. The election of a young (now 36 year-old) left-wing President in 2021, Gabriel Boric, paved the way for a referendum to change the 40-year-old Chilean Constitution. Too controversial, the new Constitution was rejected in September 2022 by over 60% of voters. Since then, the leftist government has lost a lot of political capital and locals expect another – more sensible – Constitution should be presented within 24 months.
  • Chile’s economy relies much on the mining industry and most of the key players I met reiterated the importance of China for copper (50% of global demand). Marginal copper demand should also come from India and Asia ex-China in the future, driven by electric vehicles and renewables. The outlook is even brighter for lithium (the country has the world’s largest reserves) which displays an impressive demand outlook (2021 was +50% yoy; YTD 2022 +40% yoy; min 25% per year until 2025) on the back of electric vehicle sales in China and Europe. Both copper and lithium miners are facing risk of increased royalties with the proposed tax reform.
  • The non-mining sectors have experienced various trends. In retail, margins have been under pressure due to input cost inflation, but businesses are generally solid with strong balance sheets, and they benefited from both higher spending from early pension withdrawals and a strong rebound in consumption after Covid. The telecom sector is unique in Latam in the sense that it is the most disrupted in the region – too many players and an inability to increase prices have resulted in weaker credit profiles over time (e.g. VTR). Utilities are impacted by the fact that Chile is a net oil and gas importer and most companies have shown working capital pressure with impacts on credit metrics.

Peru

  • Lima is not Santiago. Roads are noisier, streets are busier, and Lima felt overall livelier (day and night). Politics too. As of late August, in average a new minister has been named every six days since ex-teacher and unionist Pedro Castillo became president in July 2021. Castillo’s reputation varies from “poor” to “bad” in the business community. More surprising though, it seems that the population blames the president for high inflation. Although higher prices impact most countries around the world, food is a very large item in the inflation basket in Peru and the weak Peruvian sol is only amplifying the effect.
  • The mining sector (10% of GDP and 60% of exports) is carefully monitoring upcoming policy impacts. For instance, the government is trying to force miners to put on payroll most of their contractors (a measure that happened in Mexico last year and had a small impact) and royalties will go up in copper mining. Similarly to Chile, miners have seen cost inflation across the board in Q2: explosives, transportation, steel. However, unlike Chile, electricity prices are competitive because Peru produces (and exports) gas. In the third quarter, inflation has seen a slowdown.
  • I also had the opportunity to meet with local Peruvian pension funds. The mood was rather bleak. Partly because pension withdrawals over the past couple of years (as a source of income for households during the pandemic) halved pension funds’ asset under management. But also because there was a general sense of resignation about Peru’s political outlook. Castillo has faced two impeachment proceedings since he took office – both failed, but corruption allegations continue, and political stability is never granted.

Colombia

  • The most recent addition on the Latam pink map (before Lula in Brazil?), former guerrilla fighter Gustavo Petro became Colombia’s new president in June 2022. Petro is a more seasoned politician than Castillo in Peru and more experienced than Boric in Chile. He appointed in August a market-friendly Finance Minister (José Antonio Ocampo) and quickly introduced an ambitious (and ever-changing) tax reform proposal with a new oil and gas export tax (allegedly abandoned), the non-deductibility of royalties, a corporate income tax surcharge of 10% (increased from the 5% proposed at the time of my trip) for oil and gas and financial institutions, as well as higher income tax on wages of more than 10 times the minimum wage, amongst other measures.
  • The oil and gas sector is at the centre stage of Petro’s proposal for a couple of reasons. First, Colombia is a net oil exporter and majority state-owned company Ecopetrol accounts for 12% of the country’s revenue. Increasing taxes on the sector in the current oil price environment is an effective way to raise budget revenues. Second, there is also an ideological argument. Petro campaigned for a sustainable transition of the Metals and Mining and Oil and Gas industries. For that purpose, he made a very controversial appointment with Irene Vélez as Minister of Mining and Energy: a philosopher and doctor in political geography, she has close to no experience in mining and energy. Following the announcement by the government of restriction on fracking and limitations on new concessions or permits for oil explorations, credit spreads of oil and gas issuers (including Ecopetrol) widened significantly.
  • I also met a large utility firm in Bogota, and they were not spared either by policy change. The government recently changed tariffs to Consumer Price Index (CPI) from Producer Price Index (PPI) and the previous government had already prevented the Foreign Exchange market pass through for transmission assets, which is a problem for utilities that had funded their assets with long-term USD bonds on the assumption that their revenues were USD-linked.

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EY Eyes Comeback for Biopharma M&A

EY noted that the total value of biopharma M&A in 2022 was $88 billion, down 15% from $104 billion in 2021. The $88 billion accounted for most of the…

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A recent trickle of mergers and acquisitions (M&A) announcements in the billion-dollar-and-up range suggests that biopharma may be ready to resume dealmaking this year—although the value and number of deals isn’t expected to return to the highs seen just before the pandemic.

2022 ended with a handful of 10- and 11-figure M&A deals, led by Amgen’s $27.8 billion buyout of Horizon Therapeutics, announced December 13. The dealmaking continued into January with three buyouts announced on the first day of the recent J.P. Morgan Healthcare Conference: AstraZeneca agreed to acquire CinCor Pharma for up to $1.8 billion, while Chiesi Farmaceutici agreed to shell out up to $1.48 billion cash for Amryt, and Ipsen Group said it will purchase Albireo Pharma for $952 million-plus.

Biopharmas generated about $88 billion in M&A deals in 2022, down 15% from $104 billion in 2021. The $88 billion accounted for most of the $135 billion in 124 deals in the life sciences. The number of biopharma deals fell 17%, to 75 deals from 90. The other 49 deals totaling $47 million consisted of transactions in “medtech,” which includes diagnostics developers and companies specializing in “virtual health” such as telemedicine. [EY]
EY—the professional services firm originally known as Ernst & Young—recently noted that the total value of biopharma M&A in 2022 was $88 billion, down 15% from $104 billion in 2021 [See Chart]. The $88 billion accounted for most of the $135 billion in 124 deals in the life sciences. That $135 billion figure is less than half the record-high $313 billion recorded in 2019, including $261 billion in 70 biopharma deals.

The number of biopharma deals fell 17% to 75 deals from 90. EY’s numbers include only deals greater than $100 million. The other 49 deals totaling $47 million consisted of transactions in “medtech,” which includes diagnostics developers and companies specializing in “virtual health” such as telemedicine.

We expect this to be a more active year as the sentiment starts to normalize a little bit,” Subin Baral, EY Global Life Sciences Deals Leader, told GEN Edge.

Baral is not alone in foreseeing a comeback for biopharma M&A.

John Newman, PhD, an analyst with Canaccord Genuity, predicted last week in a research note that biopharma companies will pursue a growing number of smaller cash deals in the range of $1 billion to $10 billion this year. He said rising interest rates are discouraging companies from taking on larger blockbuster deals that require buyers to take on larger sums of debt.

“We look for narrowing credit spreads and lower interest rates to encourage larger M&A ($50 billion and more) deals. We do not anticipate many $50B+ deals that could move the XBI +5%,” Newman said. (XBI is the SPDR S&P Biotech Electronic Transfer Fund, one of several large ETFs whose fluctuations reflect investor enthusiasm for biopharma stock.)

Newman added: “We continue to expect a biotech swell in 2023 that may become an M&A wave if credit conditions improve.”

Foreseeing larger deals than Newman and Canaccord Genuity is PwC, which in a commentary this month predicted: “Biotech deals in the $5–15 billion range will be prevalent and will require a different set of strategies and market-leading capabilities across the M&A cycle.”

Those capabilities include leadership within a specific therapeutic category, for which companies will have to buy and sell assets: “Prepared management teams that divest businesses that are subscale while doubling down on areas where leadership position and the right to win is tangible, may be positioned to deliver superior returns,” Glenn Hunzinger, PwC’s U.S. Pharma & Life Science Leader, and colleagues asserted.

The Right deals

Rising interest and narrowing credit partially explain the drop-off in deals during 2022, EY’s Baral said. Another reason was sellers adjusting to the drop in deal valuations that resulted from the decline of the markets which started late in 2021.

Subin Baral, EY Global Life Sciences Deals Leader

“It took a little bit longer to realize the reality of the market conditions on the seller side. But on the buyer side, the deals that they were looking at were not just simply a valuation issue. They were looking at the quality of the assets. And you can see that the quality deals—the right deals, as we call them—are still getting done,” Baral said.

The right deals, according to Baral, are those in which buyers have found takeover targets with a strong, credible management team, solid clinical data, and a clear therapeutic focus.

“Rare disease and oncology assets are still dominating the deal making, particularly oncology because your addressable market continues to grow,” Baral said. “Unfortunately, what that means is the patient population is growing too, so there’s this increased unmet need for that portfolio of assets.”

Several of 2022’s largest M&A deals fit into that “right” category, Baral said—including Amgen-Horizon, Pfizer’s $11.6-billion purchase of Biohaven Pharmaceuticals and the $6.7-billion purchase of Arena Pharmaceuticals (completed in March 2022); and Bristol-Myers Squibb’s $4.1-billion buyout of Turning Point Therapeutics.

“Quality companies are still getting funded one way or the other. So, while the valuation dropped, people were all expecting a flurry of deals because they are still companies with a shorter runway of cash that will be running to do deals. But that really didn’t happen from a buyer perspective,” Baral said. “The market moved a little bit from what was a seller’s market for a long time, to what we would like to think of as the pendulum swinging towards a buyers’ market.”

Most biopharma M&A deals, he said, will be “bolt-on” acquisitions in which a buyer aims to fill a gap in its clinical pipeline or portfolio of marketed drugs through purchases that account for less than 25% of a buyer’s market capitalization.

Baral noted that a growing number of biopharma buyers are acquiring companies with which they have partnered for several years on drug discovery and/or development collaborations. Pfizer acquired BioHaven six months after agreeing to pay the company up to $1.24 billion to commercialize rimegepant outside the U.S., where the migraine drug is marketed as Nurtec® ODT.

“There were already some kind of relationships there before these deals actually happened. But that also gives an indication that there are some insights to these targets ahead of time for these companies to feel increasingly comfortable, and pay the valuation that they’re paying for them,” Baral said.

$1.4 Trillion available

Baral sees several reasons for increased M&A activity in 2023. First, the 25 biopharma giants analyzed by EY had $1.427 trillion available as of November 30, 2022, for M&A in “firepower”—which EY defines as a company’s capacity to carry out M&A deals based on the strength of its balance sheet, specifically the amount of capital available for M&A deals from sources that include cash and equivalents, existing debt, and market cap.

That firepower is up 11% from 2021, and surpasses the previous record of $1.22 trillion in 2014, the first year that EY measured the available M&A capital of large biopharmas.

Unlike recent years, Baral said, biopharma giants are more likely to deploy that capital on M&A this year to close the “growth gap” expected to occur over the next five years as numerous blockbuster drugs lose patent exclusivity and face new competition from lower-cost generic drugs and biosimilars.

“There is not enough R&D in their pipeline to replenish a lot of their revenue. And this growth gap is coming between 2024 and 2026. So, they don’t have a long runway to watch and stay on the sidelines,” Baral said.

This explains buyers’ interest in replenishing pipelines with new and innovative treatments from smaller biopharmas, he continued. Many smaller biopharmas are open to being acquired because declining valuations and limited cash runways have increased investor pressure on them to exit via M&A. The decline of the capital markets has touched off dramatic slowdowns in two avenues through which biopharmas have gone public in recent years—initial public offerings (IPOs) and special purpose acquisition companies (SPACs).

EY recorded just 17 IPOs being priced in the U.S. and Europe, down 89% from 158 a year earlier. The largest IPO of 2022 was Prime Medicine’s initial offering, which raised $180.3 million in net proceeds for the developer of a “search and replace” gene editing platform.

Another 12 biopharmas agreed to SPAC mergers with blank-check companies, according to EY, with the largest announced transaction (yet to close at deadline) being the planned $899 million merger of cancer drug developer Apollomics with Maxpro Capital Acquisition.

“For the smaller players, the target biotech companies, their alternate source of access to capital pathways such as IPOs and SPACs is shutting down on them. So how would the biotech companies continue to fund themselves? Those with quality assets are still getting funded through venture capital or other forms of capital,” Baral said. “But in general, there is not a lot of appetite for the biotech that is taking that risk.

Figures from EY show a 37% year-to-year decline in the total value of U.S. and European VC deals, to $16.88 billion in 2022 from $26.62 billion in 2021. Late-stage financing rounds accounted for just 31% of last year’s VC deals, down from 34% in 2021 and 58% in 2012. The number of VC deals in the U.S. and Europe fell 18%, to 761 last year from 930 in 2021.

The decline in VC financing helps explain why many smaller biopharmas are operating with cash “runways” of less than 12 months. “Depending on the robustness of their data, their therapeutic area, and their management, there will be a natural attrition. Some of these companies will just have to wind down,” Baral added.

M&A headwinds

Baral also acknowledged some headwinds that are likely to dampen the pace of M&A activity. In addition to rising interest rates and inflation increasing the cost of capital, valuations remain high for the most sought-after drugs, platforms, and other assets—a result of growing and continuing innovation.

Another headwind is growing regulatory scrutiny of the largest deals. Illumina’s $8 billion purchase of cancer blood test developer Grail has faced more than two years of challenges from the U.S. Federal Trade Commission and especially the European Commission—while Congress acted last year to begin curbing the price of prescription drugs and insulin through the “Inflation Reduction Act.”

Those headwinds may prompt many companies to place greater strategic priority on collaborations and partnerships instead of M&A, Baral predicted, since they offer buyers early access to newer technologies before deciding whether to invest more capital through a merger or acquisition.

“Early-stage collaboration, early minority-stake investment becomes increasingly important, and it has been a cornerstone for early access to these technologies for the industry for a long, long time, and that is not changing any time soon,” Baral said. “On the other hand, even on the therapeutic area side, early-stage development is still expensive to do in-house for the large biopharma companies because of their cost structure.

“So, it is efficient cost-wise and speed-wise to buy these assets when they reach a certain point, which is probably at Phase II onward, and then you can pull the trigger on acquisitions if needed,” he added.

The post EY Eyes Comeback for Biopharma M&A appeared first on GEN - Genetic Engineering and Biotechnology News.

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IMF Upgrades Global Growth Forecast As Inflation Cools

IMF Upgrades Global Growth Forecast As Inflation Cools

The International Monetary Fund published its latest World Economic Outlook on Monday,…

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IMF Upgrades Global Growth Forecast As Inflation Cools

The International Monetary Fund published its latest World Economic Outlook on Monday, painting a slightly less gloomy picture than three and a half months ago, as inflation appears to have peaked in 2022, consumer spending remains robust and the energy crisis following Russia’s invasion of Ukraine has been less severe than initially feared.

But, as Statista's Felix Richter notes, that’s not to say the outlook is rosy, as the global economy still faces major headwinds.

However, the IMF predicts the slowdown to be less pronounced than previously anticipated.

Global growth is now expected to fall from 3.4 percent in 2022 to 2.9 percent this year, before rebounding to 3.1 percent in 2024.

The 2023 growth projection is up from an October estimate of 2.7 percent, as the IMF sees far fewer countries facing recession this year and does no longer anticipates a global downturn.

Infographic: IMF Upgrades Global Growth Forecast as Inflation Cools | Statista

You will find more infographics at Statista

One of the reasons behind the cautiously optimistic outlook is the latest downward trend in inflation, which suggests that inflation may have peaked in 2022.

The IMF predicts global inflation to cool to 6.6 percent in 2023 and 4.3 percent in 2024, which is still above pre-pandemic levels of about 3.5 percent, but significantly lower than the 8.8 percent observed in 2022.

“Economic growth proved surprisingly resilient in the third quarter of last year, with strong labor markets, robust household consumption and business investment, and better-than-expected adaptation to the energy crisis in Europe,” Pierre-Olivier Gourinchas, the IMF’s chief economist, wrote in a blog post released along with the report.

“Inflation, too, showed improvement, with overall measures now decreasing in most countries—even if core inflation, which excludes more volatile energy and food prices, has yet to peak in many countries.”

The risks to the latest outlook remain tilted to the downside, the IMF notes, as the war in Ukraine could further escalate, inflation continues to require tight monetary policies and China’s recovery from Covid-19 disruptions remains fragile. On the plus side, strong labor markets and solid wage growth could bolster consumer demand, while easing supply chain disruptions could help cool inflation and limit the need for more monetary tightening.

In conclusion, Gourinchas calls for multilateral cooperation to counter “the forces of geoeconomic fragmentation”.

“This time around, the global economic outlook hasn’t worsened,” he writes. “That’s good news, but not enough. The road back to a full recovery, with sustainable growth, stable prices, and progress for all, is only starting.”

However, just because the 'trend' has shifted doesn't mean it's mission accomplished...

That looks an awful lot like Central Bankers' nemesis remains - global stagflation curb stomps the dovish hopes.

Tyler Durden Tue, 01/31/2023 - 14:45

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Nike Escalates Design Battle Against Lululemon

The sportswear giant is accusing lululemon of patent infringement.

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The sportswear giant is accusing lululemon of patent infringement.

The Gucci loafers. The Burberry  (BBRYF) trench coat. When it comes to fashion, having a unique design is everything. This is why brands spend millions both creating and protecting their signature looks and the reason, as in the case of Adidas  (ADDDF) , extricating a brand's design from creators who behave badly is a costly and difficult process.

There is also the constant effort to release new styles without infringing on another group's style. This week, sportswear giant Nike  (NKE) - Get Free Report filed a lawsuit accusing lululemon  (LULU) - Get Free Report of infringing on its patents in the shoe line that the Vancouver-based activewear company launched last spring.

After years of selling exclusively clothing, accessories and the odd yoga mat, lululemon expanded into the world of footwear with a running shoe it dubbed Blissfeel last March. These were soon followed by training shoe and pool slide styles known as Chargefeel, Strongfeel -- all three of the designs (including a Chargefeel Low and a Chargefeel Mid design) have been mentioned in the lawsuit as causing "economic harm and irreparable injury" to Nike.

Nike's History Of Suing Lululemon Over Design

The specific issue lies in the technology used to build the shoes. According to the lawsuit filed in Manhattan federal court, certain knitted elements, webbing and tubular structures are too similar to ones that had been used by Nike earlier.

Nike is keeping the amount it hopes to receive from lululemon under wraps but is insisting the company infringed on its patent when releasing a shoe line too similar to its own. Lululemon had previously talked about how its shoe line "far exceeded" its leaders' expectations both in terms of sales and ability to expand.

In a Q1 earnings call, chief executive Calvin McDonald said that the line "definitely had a lot more demand than we anticipated."

Nike has already tried to go after lululemon through the courts once before. In January 2022, it accused the company of infringing on six patents over its at-home Mirror Home Gym. As the world emerged out of the pandemic, lululemon has been billing it as a hybrid model between at-home and in-person classes. 

The lawsuit was also filed in the U.S. District Court in Manhattan but ultimately fizzled out.

When it comes to the shoe line lawsuit, Lululemon has been telling media outlets that "Nike's claims are unjustified" and the company "look[s] forward to proving [their] case in court."

Lululemon

Some More Examples Of Prominent Design Battles

In the fashion industry, design infringement accusations are common and rarely lead to high-profile rulings. While Nike has gone after the technology itself in both cases, lawsuits more often focus on the style or pattern on a given piece.

Shein, a China-based fast-fashion company that took on longtime leaders like H&M  (HNNMY)  and Fast Retailing  (FRCOF) 's Uniqlo with its bottom-of-the-barrel pricing, has faced numerous allegations from smaller and independent designers over the copying of designs -- in some cases not even from fashion designers but artists painting in local communities.

"They didn't remotely bother trying to change anything," U.K.-based artist Vanessa Bowman told the Guardian after seeing her painting of a local church appear on a sweater on Shein's website. "The things I paint are my garden and my little village: it’s my life. And they’ve just taken my world to China and whacked it on an acrylic jumper."

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