May 31, 2019–President Trump Nukes USMCA As He Starts a Trade War With Mexico. Is Canada Next?
Carl Icahn Launches Activist Campaign On Occidental. Is the Anadarko Deal At Risk?
China Digs In Its Heels As It Threatens To Restrict Rare Earth Exports. What Happens Next?
T-Mobile and Sprint Look To Land DOJ Approval For Their Merger. What Are They Proposing?
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.
Julian: Welcome investors to Episode 16 of the Absolute Return Podcast. I’m your host Julian Klymochko.
Mike: And I’m Mike Keslering.
Julian: Today is May 31st, 2019, a lovely Friday. We got some pretty major market events to discuss this week. Off the top the main thing happening in the market is it seems like Trump is starting what could turn out to be another trade war. He effectively nuked the USMCA, that new potential trade agreement by starting a trade war with Mexico, implementing tariffs and we’re really going to get into that and see if there’s any implications for Canada. Some activism, Carl Icahn launched an activist campaign on Occidental. Because he is actually against the Anadarko deal and the financing that they had along to get that deal done. But is the deal at risk? We’ll talk about that. China digs in its heels as it threatens to restrict rare-earth exports. What happens next with the ongoing us-china trade war and lastly T-Mobile and Sprint look to land DOJ approval for their merger. What are they proposing and are they likely to get it?
What’s better than one trade war? Two trade wars. President Trump starting another one with Mexico with a recent tweet that he is imposing a five percent tariff on all goods from Mexico beginning June 10th, just in less than two weeks here and if the administration determines that Mexican authorities have not done enough in response in what the US is looking for, is Mexico to curb migration from Mexico and South American countries into the U.S., they’re looking for Mexico to really clamp down on that and if Mexico does not do enough here the, tariffs automatically jumps to 10% on July the 1st. Furthermore continues rising in 5% increments at the start of each subsequent month until it reaches 25% by October 1st and this is a pretty serious claim by Trump here and it was really a surprise announcement that came out of nowhere and effectively shocked everyone. Even, you know, people within the administration. I heard Robert Lighthizer was in fact against this recent tariff implementation by Trump.
And what the negative effect that these tariffs could have? They could undermine a key economic relationship that has been in place for decades. There’s in this new agreement, the US-Mexico-Canada agreement. USMCA, also known as You-Smacka, it’s putting it in jeopardy and this USMCA was supposed to be a replacement for NAFTA. Effectively a new NAFTA that was going to be ratified by each country over the next few months. These tariffs really strike at the heart of that and could put that potential deal in jeopardy. The major US industries that are going to suffer the hardest, it’s pretty much Detroit’s automakers. They were going to be punished here. Because they spread their supply chains across North America since NAFTA was implemented decades ago. What happens when they build an auto, it can effectively go back and forth between US and Mexico a number of times before it gets completed and each time it goes back and forth, if there’s tariffs well then you know the cost to the consumer just effectively skyrockets.
Some market action within 30 minutes of Trump’s tweet on the tariff implementation, the Mexican peso actually fell 1.7 percent compared to the US dollar. US bond yields are also plunging, and I believe the Dow finished down almost 400 points this week. I mean today had finished I believe down 355 points even more over the week and I think we’ve had about five weeks in a row of negative market performance off probably north of six to seven percent off the 52-week high of the market. So, market participants not liking all this static and drama on the trade front. What are your thoughts on what’s going on here with the second trade war?
Mike: Yes, so to add some context so Trump is applying the tariffs under the emergency powers that he invoked earlier this year regarding the Mexican border. And so really the Trump administration is combining trade policy and border security, which are typically separate issues and so the emergency powers have never in the history of the presidency being invoked to impose tariffs. Which is you know quite highly unusual. The other aspect is that typically the Constitution actually states that Congress is responsible for trade policy. So, this is really just a way for Trump to get around a democratically controlled Congress and enact some trade policies on Mexico. But it really just shows that no agreements within the Trump administration are safe with regards to any of the trade policies and as you had mentioned earlier that this was opposed by some of his aides, most notably as you had mentioned Robert Lighthizer and the Treasury secretary Steve Mnuchin and so really, they had been looking for the Trump administration to kind of hold back, let this new Mexican government settle in. But this is the complete opposite of what Trump has done and what you’re also seeing is that if for example Larry Kudlow, one of his advisors that is very free-trade focused. He’s actually out of office on getting a hip replacement and so you know some of the members of his group that are in his ear, you know that are very free trade are just absent right now and so that’s maybe having a little bit of an impact.
Julian: Yeah, they weren’t there to talk him off the ledge and had this knee-jerk reaction that really isn’t all that smart. I wanted to get into context of some of the numbers behind the trade between Mexico and the US. So last year the U.S exported 265 billion dollars worth of goods to Mexico and this is in fact more than China, Japan and Germany combined in terms of the US exports. The import side U.S imported 347 billion in goods from Mexico. So significant trading partners here.
Interesting that accomplished businessman, multi-billionaire and politician, Michael Bloomberg wrote an opinion piece effectively ripping Trump apart on this new trade war that he is starting, and I just wanted to reiterate some of the quotes that Bloomberg stated here.
“President Donald Trump’s approach to trade policy had set new benchmarks of incoherence and irresponsibility even before his threat to impose escalating tariffs on imports from Mexico. But this latest maneuver takes the cake. The administration plans to harm businesses north and south of the border and to impose additional new taxes on US consumers, not to remedy a real or imagined trade grievance, but to force Mexico to curb migration of the U.S.” And he continues, “from the start Trump’s failure to understand that trade is a matter of mutual advantage combined with his contempt for international rules and norms has threatened the global economic order that the U.S designed and built. His latest decision suggests Trump’s willingness to gamble with the country’s prosperity and that of one-time friends and allies is greater than previously supposed”. And he finishes it off with, “the prospects for a global trade and output were already uncertain. Now Trump is risking not just a slow and steady reduction in investment thanks to hate and anxiety over trade, but a sudden collapse and confidence that could royal financial markets and bring on an outright recession. It’s increasingly urgent that Congress curb this president’s ability to conduct a potential ruinous trade policy.” And I 100% agree with Bloomberg here. He hits the nail on the head, this certainly is potentially ruinous trade policy. You saw by the market action today, bond yields hit new lows. There’s flight to safety and risk assets, markets tanking. So, it’s really confusing you know why Trump is pursuing this ill-advised second trade war with a trusted trading partner, after he already got them to make changes on trade on the USMCA agreement.
Mike: And trade policy is a very complex issue and what you know what I’m thinking is that you know Trump is looking at in a very simplistic way that if you impose these tariffs, production will shift back to the US for you know auto manufacturing for example and it’s not as easy as just you know snapping your fingers and all of a sudden, all the production and jobs come back.
Julian: Yeah, these supply chains have been built over decades and you really just can’t move on that quickly without significant cost to companies and ultimately at the end of the day as we’ve been saying on these trade wars along and tariffs, it’s the US consumer who ends up paying that. The other sort of head-scratcher here is Trump is pretty much fascinated with the stock market. So, when he’s implementing policies that will clearly tank the stock market and he’s really not taking that into account, it really makes you wonder does he lack basic understanding in economic principles?
Mike: Well and that’s the thing is that he’s made the announcement, I believe they wouldn’t come into effect until June 10th. I don’t think it would be out of character for him to completely reverse course after seeing the market go down a few days.
Julian: Yeah yeah, I don’t doubt about that. But we’ll continue to monitor this second trade war and hopefully things simmer down, but we’ll see.
Perhaps my favorite activist investor Carl Icahn goes after Occidental. Is this Anadarko deal now at risk? Well what happened was Carl Icahn, he’s taken a big stake in Occidental worth one point six billion or five percent of the company. He launched a legal attack by suing Occidental Petroleum just on Thursday. Arguing that the oil company paid way too much to acquire Anadarko Petroleum. Which we discussed many times on this podcast. They had a bidding war with Chevron Occidental did in order to win that Anadarko deal. Not only was the purchase price quote sky high according to Icahn in his lawsuit, but the financing cost, he was also unhappy with. He considered these astronomical as well. Called the takeover of Anadarko quote “misguided” and that it raises very real questions about the competence of Occidental’s management and the board. Talking about the financing, Icahn took particular issue with Occidental’s agreement with Warren Buffett. This preferred share financing that Buffett underwrote to finance the Anadarko takeover, it was a 10 billion preferred stock and warrant deal. Icahn called this financing quote “extraordinary and unnecessarily expensive financing”.
Icahn also said that transactions showed the inexperience of Occidental CEO, Vicki Holub in M&A. It’s a funny quote from him, he says “a 90-minute deal negotiation with one of history’s canniest investors is no place to gain M&A experience”. At least if you care about protecting your stockholders, this is what Icahn’s lawsuit said. Rather than plunking down tens of billions of dollars on Anadarko, Icahn argue that Occidental should instead put itself up for sale. What are your thoughts on the octogenarian activist on this Occidental deal?
Mike: Yeah, I guess so take a look at from the logic of both of their arguments. So, the logic phase argument seems to be quite sound, it’s that this is a transformative acquisition and that shareholders should have a say in this through a vote. I don’t think you can really argue that. But because of the Buffet deal there really isn’t a way of him blocking the deal. From that side it just seems like a Hail Mary for him to convene a special meeting to elect a new board and then try to block the deal. But that’s a very low probability and you’d mention that he owns about five-is percent of the company. But he would need 15 percent of shareholders to convene a special meeting and, so you know the probability of that is quite low. But on the other side management’s defense of choosing a deal structure that avoided a shareholder vote is that Anadarko’s board was reluctant to recommend a deal with a vote attached. Which is fairly rational and so because of this, their options were either to raise their bid and hope that Anadarko would be, that would satisfy their board or increase the cash portion to avoid a vote and they obviously chose this. But that defense of their rationale would assume that acquiring Anadarko was their only option and as you had mentioned, Icahn believes that they should try at the very least they should try to push through this acquisition as fast as possible and then immediately sell the company. Which you know whether that’s the correct route to go is debatable.
Julian: Yeah, I think that ship has sailed. They’re going to take a long time to integrate Anadarko operations into their own and so in terms of M&A; on Occidental, they’ll kind of be out of the market for a number of years. So, it’s weird to see Icahn going against them there. The other two key aspects I wanted to touch on, the Anadarko deal is going to close at least I think there’s a high probability. The merger arbitrage spread is still relatively wide. I think it’s about 10% annualized. So, you can get a pretty decent double-digit annualized return on that merger arbitrage spread.
Then commenting on the vote side of Occidental, initially what happened was, Occidental was issuing more than 20% of their shares to buy Anadarko and New York stock exchange rules indicate that if you’re crossing the 20% share issuance threshold, that shareholders do get a vote. Anadarko, their board of directors didn’t like that. Because it just added one more hurdle to Occidental’s bid. Occidental wanted to take down some of these hurdles. So they got the Buffett investment to restructure their bid to get around that shareholder vote, and so many shareholders are pretty angry and upset, because they are initially stated that they’re going to get a vote, but then they got that taken away from them after that bid was rejigged and so you know unfortunately I guess we’ll see who’s right, is that the shareholders and that Occidental is overpaying or is it Occidental’s management and board who thinks this is a transformational deal that’s going to lead to growth and shareholder value. I guess it’s to be seen.
More news on the trade war front here with China digging in its heels, as it threatens to restrict rare-earth exports. Chinese media this week reported that the country is considering cutting exports of rare earth metals and rare earth metals are critical elements for industries such as electric car manufacturers, it’s used in the batteries. Obviously, you need these to manufacture Tesla’s and other electrical vehicles. China accounts for 70% of the world’s supply of rare earth metals. We discussed I believe on last week’s podcast that rare earths aren’t in fact all that rare. They are somewhat plentiful, it depends on which rare earth you’re discussing. But that being said China has such high market share. Because many other countries didn’t want to get in the business of producing rare earths, just because it’s so environmentally destructive. That’s some of that dynamic how China accounted for such a large portion of the total global market. Because they definitely have far lower environmental standards than most other countries worldwide. Australia and the US are the second and third largest producers of rare earths respectively. The US is only operating rare earth mine, it’s in California. It sends whatever it mines to China to be processed, just because the US lacks its own processing capabilities.
Talking about some companies that could potentially be affected by this, if it was in fact implemented. You have your electric car manufacturers such as Tesla is one, General Motors and even wind turbine manufacturers like General Electric. This rare earth export restriction would also hurt oil refiners and chemical companies in fact, since rare earths are used to process crude and fuels like gasoline and diesel. I see this as a shot across the bow from President Xi and China just trying to hit back on Trump and the US after Trump’s late latest salvo on Huawei and increased tariffs that he recently implemented. What are your thoughts on this escalation and hostilities between China and the US?
Mike: Yeah, I guess first of all, I do see this as somewhat of a short-term crisis. As mentioned you know the rare earths are not, you know they aren’t very that rare. But it would just be ramping up production in other areas of the world, which would take some time. But over in the long term there is a solution to this problem. But I did want to just provide a little bit of historical context for this is, China actually last reduced their export quotas in 2010. Which resulted in prices going up about 500 percent. This was in reaction to some Japanese relations and what ended up happening, that was in 2010. In 2014 the World Trade Organization, the WTO, they ruled that it was an illegal move with regards to international trade. But what the problem was is that that was four years out and, so you still had the effects of that export quota in the intervening time. Looking at it this time, currently prices have gone up about you know ten percent or so. So not nearly as much of an effect and in terms of that, it’s actually not enough of an increase to really entice a bunch of production to come in at a higher price point, right? But really like I mentioned this is kind of a short-term issue. Right now, US companies, it’s estimated that they have a cushion of inventory that could last three to six months. So, it does supply a little bit of a cushion there.
Julian: Escalating hostilities here, not good for either countries economy’s nor the corporate champions nor any businesses in those countries. So, it’s unfortunate to see. Hopefully that you know the countries can come to the table and sort some of this stuff out. But for now, we’re just really seeing escalating trade tensions with a sort of tit-for-tat dynamic between China and the US and you’re really starting to see much much more negative economic data out of China. So, I’m somewhat surprised that they’re digging in their heels here. It’s only a matter of time where economic growth starts to drop precipitously. You’re really seeing it in the Chinese export numbers, where they’re really tanking and exports from other Asian countries such as Thailand, Taiwan are really just taking off. Like increasing double digits while China is decreasing double digits. Economists believe that should start to flow through the National GDP numbers of China.
So, my opinion kind of remains and that the U.S is winning this trade war. You can see on the relative economic performance, the U.S continues to chug along with Q1 GDP growth of north 3%. China’s GDP growth really missing expectations and the lowest it’s been in, I believe 27 years. You can tell by the relative market performance. I mean the US markets are down, they’re down 6 to 7 percent off their highs. But Chinese markets are down significantly more than that. Take it as a scorecard. My view the US is winning. Hopefully at some point China can see that. I think the U.S is trying to force them to see that and ultimately it should be just a matter of time. But hopefully you know cooler heads prevail here and they can come to some sort of agreement.
Moving on to some M&A news. Some serious developments in the T-Mobile and Sprint potential merger. They’ve had this deal going through all the regulatory approval process for quite a while and effectively the last remaining approval is a nod from the DOJ. That’s the Department of Justice who looks at this from an antitrust perspective. The T-Mobile and Sprint deal, the major concern on the regulators is this is a four to three merger. Effectively it’s taking four players AT&T; Verizon, T-Mobile and Sprint and then once T-Mobile and Sprint merge, there’s only going to be three major players and whenever you have that type of four to three consolidation, regulators can get you know fairly concerned about too much market power on those providers and potentially consumers being taken advantage of oligopoly on the pricing, lack of competition etc. What’s happening here is the Department of Justice wants T Mobile and Sprint to sow the seeds of a fourth national Mobile competitor outside of anyone else in the game right now. In order to garner this antitrust approval and ultimately close the deal. This is in addition to Sprint selling their prepaid business Boost Mobile and interesting there is that a rumored bidder for Boost is actually Internet giant Amazon. Amazon maybe looking to get into the prepaid wireless game there.
T-Mobile and Sprint are considering to divest some air ways to win DOJ approval of this twenty-six points five-billion-dollar merger. A proposal that’s already attracted interest from cable heavyweights Comcast and charter. DOJ officials met just a couple days ago with both Comcast and Charter over their possible interest in these airwaves or spectrum that the merged entity could divest in order to bring the DOJ on side and ultimately bless this deal such that they can close. So, if this actually happens, you’d have a AT&T, Verizon, a merged T-Mobile and Sprint as the number third then perhaps we’ll see Comcast or Charter get big into the wireless space. What do your thoughts on this deal dynamic here?
Mike: Yeah so first with regards to the Boost Mobile sale is, it’s looking like it could be in the range of three billion dollar asking price for the unit.
Julian: Pocket change for Amazon.
Mike: Exactly and so yeah there are reports that Amazon is interested. I mean to be fair Amazon is interested in pretty much any getting into any vertical right now. So, they’ll kick their tires on anything of this scale. So, you wonder you know what the actual interest is in it. But as well you have to wonder whether T-Mobile and the new T-Mobile would even be willing to sell to Amazon. As Amazon is a very well capitalized player, it would be effectively inviting them into your industry. Which you know could be bringing in a very formidable competitor.
Julian: Another disruptive competitor of which T-Mobile has long been you know that sort of disruptor in the mobile space.
Mike: Absolutely and you can see why the DOJ would be very keen on bringing in a well capitalized competitor such as Amazon and as well whether it be Comcast or Charter, that’s obviously a very good solution from the DOJ’s perspective. My only question with regards to the divestiture of the spectrum or the airwaves by T-Mobile is would this be lower quality spectrum of their choosing that they would divest or how would that process work exactly?
Julian: It’s tough to say where the exact concerns on the DOJ with respect to the spectrum would be. I think they just pretty much look at market shares and want to make sure that this fourth Wireless competitor or whatever has a good shot at competing. I know that one of the reasons T-Mobile wanted to acquire Sprint was their real treasure trove of 5G, 5G spectrum for next generation wireless. I know T-Mobile is really keen on that. In addition to the massive potential synergies between combining Sprint and T-Mobile, I’ve heard present value of those synergies or cost savings being as high or even greater than twenty billion dollars. So that really puts this twenty-six point five billion merger in perspective. Because it’s just so accretive to per share value just given all the cost savings available to a joined T-Mobile and Sprint.
Mike: So, what you’re thinking be that because of these you know very large synergies and all the other benefits of the merger, that would outweigh the fact that they would be bringing in a fourth competitor that is likely to be well capitalized?
Julian: Yeah, its a good point and it certainly is a risk for T-Mobile and Sprint here. I think Sprint doesn’t have a choice. Because they cannot survive on their own. I think if Sprint were to go it alone, absent a recapitalization I think they might have to file for a bankruptcy in relatively short order. T-Mobile was certainly you know kicking ass and taking names in the wireless space. They could do a lot better with Sprint and I think you know when push comes to shove, and you look at the benefits and the costs, those synergies and larger entity having another thirty percent market share, that’s likely to outweigh a potential strong new fourth competitor. Especially a competitor that’s new to the business.
Mike: And when you look at it from the regulator’s standpoint, I mean either the companies agree to these terms and have a command entity that will then create a fourth competitor, or they walk away, and one of two situations happens. Either Sprint continues to that they actually turn it around and continue on as a fourth player or like you mentioned, they end up declaring bankruptcy and then those assets are bought by another player. So, it’s kind of a win-win for the DOJ.
Julian: Yeah, another option, I mean we saw it recently with the Time Warner deal is that they wanted to close its sale to AT&T. Time Warner wanted to close and DOJ in fact sued them to block the deal. The companies fought the DOJ in court and won, which was a black eye on the Department of Justice and I don’t think they’d want to see a crushing defeat like that. When they go to court they really got to be very confident that they’re going to win. Ultimately on this deal, it seems like the parties are pretty close to striking an agreement here. I’m pretty sure Justice Department doesn’t want to go back to court after suffering a pretty embarrassing defeat with Time Warner just a year or two ago. So, I think ultimately this deal will close and it’s looking like Charter and/or Comcast could get big into the wireless space.
And that’s it for Episode 16 of the Absolute Return Podcast. You can hear more as always on www.absolutereturnpodcast.com, check us out on iTunes. If you enjoy it, leave us a review and we’ll chat with you next week. Cheers.
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