Weekly Reads - April 24, 2023
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Leverage buyouts might be the next asset class to face mass declines with rising interest rates and recent subpar returns souring investors on this popular investment alternative .
Ever since the financial crisis of 2007-2008, leveraged buyouts have benefited from low-interest rates and growing popularity. Low rates have helped bail out poor investments and turn good investments into great ones. In 2022 the venture capital market and public markets declined as interest rates rose and economic sentiment worsened. Surprisingly buyouts have become more popular as investors got suckered into the promise of higher and more reliable returns. Unfortunately, according to this article, private equity funds have underperformed public indices since 2006 due to higher prices, fees, and excessive leverage. The growing popularity of buyouts has killed the asset’s performance with more investors raising the prices for deals leading to overall underperformance. This is likely to continue with the SEC in 2021 recommending letting more US investors into venture capital and buyouts. It’s clear that buyouts and venture capital are no longer “alternative investments” hitting the mainstream and are opening these asset classes to more competition. Competition typically breeds lower returns and investors in these asset classes might be in for a rude awakening in the next few years. If returns decline in these alternative asset classes, we could see an influx of capital back to public markets which would be a boon for the public equity space.
Big oil’s influx of cash from rising oil prices could spark a wave of industry consolidation helping big oil companies deliver volume growth as oil prices and earnings decline heading into 2023.
The recent oil super-cycle has left big oil companies flushed with surplus cash. The largest oil companies are generating free cashflow yields in the mid to high teens compared to just super-cycle four percent for the general index. Some of this excess cash has been used for buying back outstanding shares by as much as 8% in aggregate and paying down $87 billion in debt. With lower oil prices and earnings slated for this year after a record 2022 the big oil companies could use their remaining cash stockpile for acquisitions to help deliver stronger volume growth to help offset decline in prices. The big oil companies have cut back spending on the exploration and development of new resources so even in a lower-price oil environment these companies will continue to generate a ton of cash. This cash could help these giants expand their operations in new and existing oil-rich basins via acquisitions of smaller peers that traded at a significant discount. In our opinion, it is likely M&A will be kept to a minimum with many of the big oil giants preferring share buybacks with capex spending rising to help start new projects. After cleaning up their balance sheets and regaining shareholder confidence large M&A deals might be too risky for these oil giants who still bear scars from the last oil super cycle.
Apple’s app store economics are being upheld by the court system after the Epic lawsuit put into question the long-term sustainability of Apple’s exclusive control over the distribution of iPhone apps .
On Monday the Ninth Circuit Court of Appeals upheld Apple’s exclusive control over the distribution of apps rejecting the attempt from Epic Games to skirt developer fees on the Apple app store. Epic Game’s lawsuit focused on how Apple’s app store has become an illegal monopoly that stifles innovation and competition while generating billions in revenue. Epic started this lawsuit after having its popular game Fortnite dropped by the app store after Epic tried to find a way to evade developer fees. These fees range from 15%-30% on subscriptions and digital items which is a large portion of Epic’s revenues. Both courts believed that the Apple app store could not be considered a monopoly with alternatives like Android available. Despite the conclusion of this lawsuit, Epic is still planning to proceed with an antitrust lawsuit against Google’s play store with similar allegations to the Apple case. With a precedent now in place it might be even more difficult for Epic to win its follow-up lawsuit against Google and change the business models of these platforms.