Here’s a radical idea — fire all the CEOs of Stoxx 50 companies in Europe and replace them with a single president, who will serve as the highest-ranking corporate officer at each firm, with full responsibility for their stewardship.
Of course, that’s never going to happen — if only because the president would only be able to spend seven days a year at every company. But Citigroup strategist Jonathan Stubbs says it’s what needs to happen if the share prices of Europe’s 50 biggest companies — combined market cap of €2,800bn — are ever to recover.
Mega-caps have suffered a decade of negative returns, with little respite:
This dismal performance has been driven by less-than-exciting growth prospects and limited fund flows into equities — compared with the boom times of the late 1990s.
So here’s is the dilemma, says Stubbs:
Mega-caps have too much equity in our view, €2.8 trillion at the last count. For this “lump” of capital to outperform, or to re-rate, there needs to be a lot of money behind the trade. But, nobody wants to buy European equities at the moment.
We believe mega-caps face slow death unless big capital flows return to equities (don’t hold your breath) or unless they can deliver a strong pick-up in collective growth (unlikely). Else, they would likely outperform in an equity market down 30-40%, but this scenario would be a hollow and costly victory.
And this is where the president comes in:
The President is needed. And I can assure you that the primary role of the President will not be to run better businesses; these companies are generally well run already. The primary function of the President will be to run smaller companies. Given the correlation between market cap and rating, this looks to be a sensible strategy. I promise to materially shrink the equity base of the Stoxx 50 over the next couple of years. This compares to a 12% increase in Stoxx 50 share count since 2006.
Now, there aren’t many CEOs who will voluntarily shrink their business. The ‘bigger is better gene’ is embedded in their DNA. But given the lack of demand for European equity, Stubbs says CEOs are now responsible for driving demand for their shares:
They can do that by running better businesses and/or by buying their own equity and running smaller (and better) businesses. Our analysts believe that some megacap companies could “eat themselves”, ie buy back all outstanding equity within 5-6 years if so minded.
And they really need to be aware that debt/equity arbitrage — using debt to buy back equity– is back on:
All companies must at least be aware of the “size and price” that the bond market is willing to lend to them. If recent experience is anything to go by then, the answer is that mega-caps can raise a lot of cheap funding relatively easily. The biggest companies are likely to get the best price on funding. Warren Buffett has a strong view on this, as evidenced during the Kraft takeover of Cadbury (more debt please). This is already having an influence on corporate behaviour.
Clearly some companies already get it.
For example, Nestlé has combined cash and funded growth-seeking deals with aggressive share buybacks. Closer to home, Vodafone is slowly retreating from its empire building, and on a smaller scale Next has continued with its aggressive buyback programme.
And that makes sense with corporate debt so cheap and free cash flows so high — for non-financial mega-caps they are forecast to reach 9 per cent next year.
But much more is needed if mega-caps aren’t to suffer another 10 years of underperformance.
Stubbs reckons de-equitisiation (along with emerging markets exposure) will be the key theme to watch in equity markets over the next few years. He could be right.
Related link:
Hold fire before supporting Buffett’s equities theory – Tony Jackson