It May Shine, But it is Not Gold

In this report we will summarize the plight of the European Crises as of May 6th, 2012. ● The biggest borrowers are over reliant on revolving credit, and they happen to be countries in Europe. (Similar to Municipal Bonds) ● ECB has no equivalent to the US Treasury Bonds, Notes, and Bills. ● The European Sovereign debts are funded by European banks, Sovereign Wealth Funds (SWF), International Monetary Fund (IMF), and other Qualified Institutional Buyers. At this moment in time the European Sovereign Debts are defaulting at an alarming rate. The bondholders are requesting money from two sources, while shunning the ISDA and the Credit Default Swaps (CDS). ● LTRO = First source of liquidity is the European Central Bank (ECB), which just gave the ECB Banks a little over a Trillion Euros at an interest rate of 1%. This was two different offerings of the LTRO. ● International Monetary Fund (IMF) = Second source of financing of the various European Sovereign Debts requires certain austerity measures.

● Finally the Credit Default Market and the ISDA are being shunned by a number of European countries for a number of reasons ranging from counterparty risk to a blatant request to end speculation. The money circulates between the individual governments and their respective banks. If there is a default in the Sovereign debt, then the individual bondholders may go bankrupt. That means the banks may go bankrupt; therefore, they are not lending money to corporate banking or private banking clients. The big losers are the customers of European banks who are not getting any credit lending. Now in this day and age everybody is reliant on credit for both sales and production. In other words customers buy on credit, and manufacturers produce on credit. Cost of the credit is going to rise as the banks stop lending out of fear that yet another Sovereign European Nation may default. (Kindly refer to the footnote on WACC) IMPACT ON THE EURO If the current trend continues, then we can not only forecast (Discounted cashflow analysis WACC) a decline in the European stock prices due to the increase in cost of capital, we can also assume there will be a subsequent macro decline in European GDP. Thus leading to a declining Euro against the dollar. IMPACT ON THE GCC ECONOMY OF THE PEG TO DOLLAR The local economy can benefit from the strength of the US Dollar against the Euro. Suddenly European products and services will become relatively cheaper. The weaker currency might be the macro solution for the European Debt Crises.

I would like to qualify that last statement by saying that would depend on the state of mind of the leaders of the individual companies. For example, if they are oriented towards growth and mass manufacturing, then they will benefit from the weaker currency. However if they are shortsighted and they begin cutbacks and closing manufacturing facilities, then they might miss the opportunity that the weaker Euro will present. The problem with some European entrepreneurs is that they do not understand mass production or capturing market share. For example, Ferrari has an absolutely inefficient business model specifically in a recessionary environment. They are not oriented for mass production; therefore, they can not reap the benefits of a weaker currency. Furthermore their business model excludes them from making consistent spare part sales, which is the lifeblood of the auto industry. In an age of IMF austerity measures, their customers might be scrutinized for merely driving one of their cars. In my humble opinion this is the quintessential issue at the crux of our analysis of the future prospects of the Euro. Will the European industry adopt a more competitive stance, or will they wither away like the old monuments in Greece. The key is about a cultural change that invites innovation and creativity. It’s about capturing the imagination of students and investors. At this juncture on May 6th, 2012, I am sad to report that a dark cloud of socialism is growing over the continent. It is a fluid situation as the election results of both France and Greece are about to be announced. We recommend that our readers stay vigilant and stay tuned.

Khalid I Natto Chairman & CEO The KIN Consortium

Email: khalid@kinconsortium.com Work: 009665 686 100 43 Website: http://www.kinconsortium.com
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NEWS ARCHIVES: http://www.kinconsortium.com/tnp.html Footnote: The Valuation Model that should be used to evaluate the impact on European stocks is WACC:

Definition of WACC: 'Weighted Average Cost Of Capital A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk. The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:

Where:
Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt

V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate

Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using the formula: NPV = Present Value (PV) of the Cash Flows discounted at WACC. Investopedia explains 'Weighted Average Cost Of Capital - WACC' Broadly speaking, a company’s assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances. A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm. Read more: http://www.investopedia.com/terms/w/wacc.asp#ixzz1u4JGwXZO