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MARCH 2013

By Matt Evans

Prime Minister Camerons vision for Britains future

On January 24th, Prime Minister David Cameron of Britain delivered a highly anticipated speech at the World Economic Forum in Davos, Switzerland. His vision for the future of the U.K. within the European Union was the topic of discussion. Backed by his moderate-right Conservative Party, Cameron perceives Britain as an independently global force, inhibited by its active membership within the European Union. He maintained that, should his Conservative party win the coming election, he will be intent on bringing Britains EU membership to a referendum in five years time. Although Cameron does not favor a centralized political and fiscal union (Britain remains on the pound and has no intention to adopt the euro), his goal is not to secede from the EU entirely. (This is mainly because the U.K. would be forced to surrender its globally influential voice through the EU, where many affairs directly affecting the U.K. are discussed.) Ideally, Cameron simply wishes to renegotiate the conditions of British membership, a problem-causing precedent should members of any type of group agree to inclusion only after their uniquely-designed conditions have been approved. Newly reignited talks to reduce the British Rebate are amid several factors motivating Cameron to take such action. Since 1984, the U.K. has received a rebate on their contribution to the EU budget, originally sanctioned to reflect the U.K.s small agricultural sector at a time when roughly 80% of the EU budget went to farmers. The current British Rebate of 3 billion places the nations net contribution below that of France, whose president, Franois Hollande, has outspokenly supported the EU presidents proposal to cut Britains rebate by 1 billion (805 million). In addition to Camerons adamant resistance to such a cut, he has struggled to achieve a freeze in the EU budget, threatening to exercise Britains veto in the event that negotiations elicit a deal Cameron finds bad for Britain. An argument however is to be made for a European Union with multilevel membership, whereby nations not in the European Monetary Union (EMU) could chose to assume a validated role of lesser participation, yet still realize the benefits of structure and regulation. This concept is what Cameron envisions for a more competitive, open and flexible Europe, although the U.S., Britains largest trading partner next to China, has persuaded against such a change. Cameron has captured support from many of Britains prominent economic leaders, including the heads of the London Stock Exchange, who were included on a list of 56 business icons championing Camerons position in a letter to The Times of London. Sir John Major, Prime Minister until 1997, believes the EU has poisoned British politics for too long. However, many skeptics are concerned that years of debate over the U.K.s membership in the European Union would dissuade foreign investors during this time of an already-troubled British economy. Unfortunately for Cameron, criticism for drastic economic and political change has arisen in consideration of Britains economy having contracted 0.3% at the years end, tripling analyst estimates. The economy is 3.3% smaller than its level five years ago, and is dangerously close to entering a third recession since that time. Prior to these published results, the Cameron and George Osborne, Chancellor of the Exchequer (Secretary of the Treasury), defended their austerity plan to reduce the deficit, despite consistent disapproval from the International Monetary Fund. Asleep at the wheel is how a representative from the opposing Labour Party described the government. At Britains recent levels of GDP, substantial growth and the realization of budgeting expectations are required to create an environment in which a Conservative win in the next election is even a possibility.

British Prime Minister David Cameron

CURRENCY WARS Guilherme Baiardi

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MARCH 2013


By Guilherme Baiardi
When Brazilian Finance Minister Guido Mantega coined the term Currency Wars over 2 years ago, he was referring specifically to the expansive monetary policies adopted by the U.S through the Feds Quantitative Easing programs. The excess of available cash was making American investors look elsewhere to invest their money, after all, with treasury yields at historic lows, the investors were hungry for anything that paid more than 1-2% a year. This money flooded developing economies (including Brazil), making their currencies artificially strong and consequently impacting their export dependent domestic industries. The Real, for example, reached a minimum of 1.55 BRL/USD (down 62% from its 2008 peak) as it saw significant relative strength during this period due to the devaluation of the Dollar brought by the Fed-induced increase in the money supply. China was already known to manipulate their own currency, but having some of the most important developed economies doing it, albeit indirectly through QE, brought a whole new level of attention to the issue. The currency wars, however, eventually left the spotlight as the situation in Europe worsened, and growth stalled in many of the developing economies. The issue came back with a bang in November, when then Representative and Liberal Party President Shinzo Abe ran for the position of Japans Prime Minister. His political platform was based on strong Quantitative Easing, that is, the printing of money to buy Japanese Government securities, with the final goal of pushing down the treasury yields and decreasing lending costs for the population. By doing so, he expected to kick start the Japanese economy out of a two decade long period of stagflation (zero to negative GDP growth and deflation). By the same time, it became clear that Mr. Abe would probably win the election, and markets started a run on the Yen that effectively lasted until late February. Abes monetary policies, even though they are primarily targeted at boosting internal consumption, have put tremendous downward pressure on the Yen. The mere suggestion of a new surge of similar activity in countries such as the U.K has made countless leaders stand up and protest in international forums, chief amongst these, the recent G20 meeting in Moscow. Given the sudden alarm over Abes policies, let us look at them a bit more carefully. Abes primary actions were directed at the Bank of Japan, which has historically emphasized its independence from the executive branch. The banks inflation target had already been reluctantly placed at 1%, and as soon as he took office, Mr. Abe made sure that that target was raised to 2%. This would not be as significant if not for the QE type policy implemented to enforce it. By increasing the availability of cheap money, Abe was anticipating an increase in consumption and consequently inflation. In anticipation, and later in reaction to these policies, the Yen, which was at 77.97 /$ in October, rose to 93.41/$ as of the 22nd of February. This has improved Japans exports, as many of its export-based companies (especially electronics and auto companies) were suffering as a result of an expensive Yen. These measures, together with the excess cash flooding the Japanese domestic market has led to the Nikkei 225 stock index skyrocketing over the last five months, having been up 32% since October. Abe, however, is not done. The Prime Minister has implied

Brazilian Finance Minister Guido Mantega

in his speeches that more easing is on its way, but the international community is increasingly worried about whether he will indeed carry out his promises. In the G20 meeting this past week, global financial leaders committed themselves to preventing currency manipulation, but the body has very little power over the monetary policies of individual countries. Abe has recently said that he was not planning an expansion of his program and that the G20 should not be as critical as they are of his program, as his goal is not to artificially devalue his currency. There is truth to this argument, since Quantitate Easings main objective is to push down interest rates, and the eventual devaluation of the Yen is just a collateral effect of this measure. It has, however, given a strong incentive for central banks throughout the world to adopt these policies, as their short term results are anything if not desirable. In a recent Board of Governors meeting in the UK, the measure was proposed, but voted down by its members. However, the simple suggestion of it is a good indication that more discussion is on its way. With that being said, Europe looks as a likely target if not for QE-like monetary policies, then for some form of currency manipulation. Following the rebound from the economic crisis that has been plaguing European debt markets for over two years, the Monetary Union has seen renewed demand for its currency, with the Euro undergoing strong revaluation since January. Given the very delicate situation of several of its economies, and the peripheral European economies strong reliance on export based industries to even attempt an economic rebound, the European Central bank finds itself in a delicate situation regarding monetary policy. The ECB will be meeting on the 7th of March to discuss this, and lowering the value of the Euro will definitely be one of the topics on the table garnering attention from the Governors. Just when we though the Currency Wars had subsided, the issue comes rushing back into the economic spotlight. With new rounds of QE around the world, China still being accused of blatant currency devaluation and the emerging economies being forced to take measures to protect their currencies, the FX markets are undoubtedly going to the center stage of future monetary policy.
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MARCH 2013



By Teddy Xiong
rather than theft prevention. This has led to the development of Contran 245, a piece of legislation that would require car manufacturers to fit tracking devices on all vehicles sold in Brazil either during production or via retrofitting. The law has repeatedly been delayed and gone past deadlines, but sentiment in the telematics industry is cautiously optimistic that the government could implement the law in the first half of 2013. Last June, the government began live testing the implementation idea, with every vehicle manufacturer in Brazil participating. Multiple manufacturers have begun talking to consulting firms on how to best implement the technology within their models, with some projecting towards full implementation in Q2 2013. What this means for Ituran Iturans Brazilian division has grown its subscriber base to nearly 250,000, having recovered roughly 21,000 vehicles at a total value near $600 million according to one of their sales directors. However, only 14% of the 2.3 million cargo trucks in Brazil are fitted with the tracking systems to prevent robberies, leading to nearly 13,000 incidents of cargo theft every year. This low penetration rate represents a significant growth catalyst for Ituran even before the implementation of Contran 245. Just a side note: Why is the normal theft rate around 1%, but theyre at nearly 10% of their subscribers? Seems a bit fishy. Additionally, last April, Ituran announced that it had entered into an agreement with General Motors Brazil and one of its majority-owned subsidiaries to offer to provide anti-theft services and products in every Chevrolet car produced in Brazil. Individuals do not have to activate the service component (and thus do not have to pay the subscription revenues), but they must have the security system pre-installed. Last year, Chevy sales amounted to 643,000 vehicles in Brazil, nearly the size of Iturans total subscriber base. Although the company would only profit from customers who utilize the recurring service, even a 15% take rate would amount to nearly 100,000 extra subscribers, indicating very strong growth prospects. Summary Overall, Ituran is market leader poised to capture a significant portion of growth in the fast-developing Brazilian market. With the impending passing of Contran 245 and its already announced agreement with General Motors Brazil, Ituran has strong catalysts ahead of it, not including growth in any other geographic segment. Additionally, to further sweeten the deal, Ituran pays out a dividend of at least 50% of its net income annually, implying a dividend yield of roughly 8%. With a stable dividend flow for conservative investors and rosy growth prospects for more aggressive investors, Ituran represents a win-win for any equity investor.

Company Background Ituran Location and Control is an Israeli-based company that provides a variety of location-based products and services using their advanced tracking technologies. The majority of their revenues come from their stolen vehicle recovery (SVR) services, and other businesses include their fleet management services, personal location services, concierge services, and GPS/radio-frequency products. Much of Iturans SVR and automatic vehicle location (AVL) sales go to insurance companies that encourage or require customers to subscribe to AVL services or purchase vehicle location products in order to decrease their own costs of business. The company has 653,000 total subscribers at the end of Q3 2012, including a net subscriber growth of 14,000, the highest net growth in ten quarters. Excluding currency effects and a onetime gain relating to a sale of a segment last year, operating profit grew nearly 15% year-over-year. Geographically, the company operates a monopoly in Israel where they earn roughly 50% of their revenues, and they are developing an increasing presence in Brazil where they earn roughly 40% of their revenues. This thesis focuses on the growth of Iturans Brazil businesses, especially in light of Contran Law No. 245. Car Theft in Brazil Brazil has one of the worlds highest passenger theft rates at nearly 100 per 10,000 cars. Annual statistics show that more 400,000 vehicles are stolen annually, or roughly one every 78 seconds. Thieves steal cars for parts disassembly, whole-car cash sales, and use in organized crime. Together, this has amounted to $8 billion in annual losses due to vehicle theft and another $1 billion from stolen cargo. Immobilizers have been become a very effective means of preventing theft, but lately car thieves have opted towards carjacking instead. As a result, car insurance plans that provide theft coverage can be prohibitively expensive for individuals given the higher likelihood that insurance companies would payout. Nevertheless, auto sales in Brazil have increased every year since 2002 and have more than doubled since 2007 to 3.8 million last year, implying that the fast developing Brazilian economy and its consumer base have not let the high rate of asset loss deter them from obtaining the classic prestige symbols that cars represent. Contran Law No. 245 In response to the evolving strategy of car thieves, the Brazilian government has opted to focus on stolen vehicle detection
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MARCH 2013
draw negative attention until it was too late. The fallout from this incident has been monumental. Federal scrutiny with several investigations has been occurring over the past year. JP Morgan has been busy repairing its image, ousting several key players and executives, including Iksil, Martin-Artajo, and Chief Investment Officer Ina Drew. The board doled out many pay cuts, and Dimons compensation was slashed by 50% from the previous year for 2012 from roughly $23 million to $11.5 million. Finally, it launched its own internal investigation headed by Chief Financial Officer Mike Cavanagh. This investigation, after extensively reviewing records such as over one million e-mails, resulted in a 50-page report recently released to the public, citing lax supervision and risk control as primary reasons for the debacle. Steps have been taken to reduce the likelihood of similar future incidents, such as stricter risk measures and more narrow valuation range requirements. JP Morgan, despite this highly publicized trading loss, has churned out strong performance, with record profits for three consecutive years. Perhaps the true area of concern should not lie with JP Morgan, but with the government. Despite recent regulations in response to the global financial meltdown, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010, it appears that there are still weaknesses in the system and potential disasters like the one JP Morgan experienced looming in the future; perhaps an effective solution will require greater risk control mechanisms for Wall Street to prevent another London Whale incident in the near future.

By Karan Parekh
In May 2012, the tempest in a teapot that JP Morgan CEO Jamie Dimon described took Wall Street by storm. With an estimated $6 billion lost, JP Morgan was forced to reshuffle management positions, launch an internal investigation, and repair public image in what otherwise had been a time of recovery. What caused this large loss for JP Morgan? What steps have been taken to correct it? Who is the London Whale. The London Whale, Bruno Iksil, was a credit derivatives trader for JP Morgan in the London office. Iksil had a reputation for riskheavy trades that often ended in large profits for JP Morgan during his history with the company. He was rumored at times to even single-handedly have moved the index with some of his actions. Although Iskil had historically enjoyed consistent success, much of the blame fell on him in this debacle. Iksil engaged in CDSs (Credit Default Swaps), a complex type of insurance that hedges against changes in credit markets or loan defaults. He bet big on a large basket of investment grade credit default swaps known as CDX IG 9 in order to hedge against corporate debt that JP Morgan already had positions in. This was essentially a bet that investment grade bonds would not default. However, JP Morgan then hedged against its own bet, and began taking such large positions that it shifted the market; other investors saw this and, seeing opportunity, they bet against JP Morgan. When European financial worries spiked again, CDX IG 9 rose in value, and JP Morgan lost a great deal of money because of its large positions. Of course, the transactions occurring were complicated in nature. But how could JP Morgan overlook the risks it was taking that amounted to such a large loss? Firstly, Iksils boss, Javier Martin-Artajo, encouraged the transactions and pushed him to persist despite initial losses. Furthermore, Iksil made purchases at high valuations. JP Morgan does have a valuation control group, but the control group checks valuations by setting valuation ranges; if purchases are made in between these ranges, which often were very broad, they do not draw red flags. In this risk management error, Iksil made purchases at the high end of the spectrum, but did not

Resilient or Vulnerable?
By Matt Parmett
The safety of municipal debt has been scrutinized as American cities, counties, and states have grappled with budget issues over the past several years. Since 2010, there have been 31 municipal bankruptcy filings, with the most notable filings coming from Jefferson County, Alabama and San Bernardino, California.[1] While some of these bankruptcies have been highly publicized, especially in the context of the European debt crisis, experts disagree on the severity of the threat of widespread municipal bankruptcy. For many local and state governments, default carries serious consequences: aside from bondholders swallowing losses on debt holdings, governments may not be able to fully cover their public expenses. What is a municipal bond? Municipal bonds are issued by governments to raise money for project and public expenses. For example, a city may issue municipal debt to finance the construction of a bridge or sports arena. Debt financing is often used to offset the burden that major projects place on the municipality's taxpayers.

JP Morgan CEO Jamie Dimon

Story continued on page 6, Ituran

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MARCH 2013


Merger Modeling and LBO Modeling March 23rd, 2013 (Saturday)

Sponsored By:

Overview This intensive workshop is designed to develop an understanding of merger consequences and leveraged buyout analyses through actual hands-on construction of both an M&A model and an LBO model. Each participant will build their own interactive M&A model and LBO model to better understand the dynamics of merger consequences and leveraged buyout analyses. The completed products allow for a dynamic evaluation of (1) whether or not a company should acquire a competitor or sell itself (merger consequences analysis) and (2) whether or not the company is a strong LBO candidate. Specifically, participants will construct and analyze the following: Merger Consequences Analysis (morning) - Transaction summary detailing sources and uses of funds - Earning impact, including accretion/dilution analysis and synergies analysis - Purchase price allocation Leveraged Buyout Analysis (afternoon) - Transaction summary detailing sources and uses of funds - Pro forma income statement and cash flow schedule - Debt schedule with repayments, pro forma debt balances, iterative interest expense calculations - Returns analysis to the financial sponsor **Credit Suisse will be providing free lunch** Learning Methodology Through practical examples, the lectures will discuss theories, approaches and applications of modeling. Personal one-on-one assistance will be available to answer questions and give guidance while participants are working on computers. Target Audience This intensive one day workshop will benefit students interested in: - Working at a private equity firm or dedicated leveraged buyout firm - Working at an investment bank in their M&A, leveraged finance or financial sponsors group - Working at a venture capital firm or hedge fund potentially making LBO investments - Enhancing the learning experience in finance and transaction analysis NOTE: The workshop will take place in a computer lab. You can use computers in the lab or bring your computer. If you have a MAC, it is recommended you run Windows (via Parallels, VMware or Bootcamp). How to Register Registration Link:; Class code: 4DDD5C Class Details: 9am-5pm on March 23rd (Saturday) at JMHH 375 Cost: $40 About Training the Street Training The Street (TTS) offers state-of-the-art, instructor-led courses in financial modeling and corporate valuation. Founded in 1999, TTS is the worlds leading financial learning services company offering targeted and customized training courses to corporate and academic clients. * Modeling classes are optimized for Office 2010, 2007, 2003 and earlier versions.

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Preparing Financial Professionals for Success

WHARTON UNDERGRADUATE FINANCE CLUB Ituran,story continued from page 4

These bonds differ from corporate bonds in several ways. First, interest earned on municipal bonds is often tax-exempt. Tax-exempt municipal bonds generally have lower listed yields than comparable corporate bonds, but can often yield more than corporate bonds when the tax savings is taken into account. For example, at a tax rate of 30%, a $100,000 municipal bond yielding 5% will make an investor $5,000 in tax-exempt interest, while a $100,000 corporate bond yielding 7% will only pay $4,900 in interest ($7,000 * (1 - 0.30)). Municipal bonds are generally classified according to their method of repayment. Revenue bonds are repaid specifically from revenues earned by the project which they finance. For example, the revenues from a sports stadium might be used to repay a revenue bond. General Obligation (GO) bonds, on the other hand, are backed by the full faith and credit of the issuer and can be repaid with any revenue of the municipality (including taxes). Revenue bonds can be riskier than GO bonds because repayment depends on the cash flows of the resulting project. The Muni Crisis: A Myth, or Reality? In 2010, well-known analyst Meredith Whitney, claimed that undisciplined state budgets would cause a financial collapse on the scale of the 2008 meltdown.[2] Whitney anticipated that the gap between municipalities' spending and revenue would present a large default risk to municipal bondholders. As we have seen on the national stage over the past several years, it is hard for governments to alleviate budget issues through spending cuts or revenue (tax) increases. Recently, Illinois delayed a $500 million bond issuance due to a debt rating decrease resulting from the state's inability to pay the entirety of its pension obligation.[3] Whitney believed that this phenomenon would occur in most

MARCH 2013
states, making it hard for governments to raise money and pay off their debts. As a result, governments would have to declare bankruptcy, and debt holders would be forced to take losses on their bond portfolios. In the years since 2010, however, the municipal bond market has not deteriorated with the severity suggested by Whitney's prediction. Bloomberg observed that such a crash is "far from the case. Despite those bankruptcies, and even though fewer muni bonds are now insured than before the financial crisis, investor demand points to unshaken confidence."[4] According to Bloomberg, states have been able to increase tax revenues, decrease the size of their budget gaps, and increase their ability to service debt. Experts also tend to disagree with Whitney's analysis. Alexandra Lebenthal, CEO of well-known municipal bond specialist Lebenthal & Co., observed that in 2012 57% of municipalities are in a more favorable financial position than they were in 2011.[5] To better balance their budgets, state governments have restructured expenses associated with public pension plans. Most importantly, investor demand for municipal bonds has remained strong, and tax-exempt yields have outperformed aftertax yields of comparable corporate bonds. Although investors and analysts have speculated that the municipal bond market would collapse and trigger another financial crisis, pessimistic predictions seemed to rely heavily on the extrapolation of trends observed in Europe during the European debt crisis. Interest rates, investor demand, debt rating upgrades (particularly in California), and a continuous stream of new municipal debt issuances suggests that the public sector debt markets are still strong. A major risk looms, however, as the markets await the increase of interest rates when the Federal Reserve scales back its interest rate intervention through Quantitative Easing.

Kevin Goldfarb Editor-in-Chief
Vice President of Financial Analysis

Shruti Shah
Managing Editor

Jasmine Azizi & Alejandro Villero

Assistant Editors

Questions or comments? Please send your suggestions to

Guilherme Baiardi, Tony Murphy, Matt Parmett & Teddy Xiong

Senior Financial Analysts

Charles Bagley, JeonKang,Karan Parekh &Matt Evans

Financial Analysts
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