Outlook: The bottom may be close but don't expect a rapid bounce

Energis end game Ê
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The Independent Online

Most City money managers think the London stock market is approaching the bottom. On a number of yardsticks, valuations are starting to look reasonable again. The world economy is still weak, but it is plainly not yet going down the drain. Investors are worried and sickened by recent losses, but there is no blind panic. So is it time to be dipping a toe back into the equity markets once more? The City would love everyone to say yes. Unfortunately, it's not working out that way.

The mood is still black, disillusionment with equities is almost total, and despite stock markets at five-year lows, the bargains are not yet obvious. The time to buy is when the blood is running in the gutter or, to use another old cliche, when the last bull turns bearish, and we are not there yet. Indeed, right now it's incredibly hard to see where the buyers might come from. The life assurers are sellers of equities to shore up solvency margins, the pension funds are sellers of UK equities to go into bonds and overseas stocks, while the retail investor is nowhere to be seen.

The only obvious buyers are companies themselves, but when cash is king, even they are reluctant to commit. You never know when you might need the money. To find a mood as bleak as this one, you have to go back to the bear market of the mid-1970s. Is there anything that might turn it? Over the next two weeks, three quarters of the S&P 500 report quarterly figures. Against the backdrop of recent accounting scandals, nerves are at breaking point. What further skeletons are going to come rattling out of the cupboard? We all know that during the boom, earnings expectations became wildly exaggerated. The fear is that reported earnings were grossly inflated too, not just at Enron and WorldCom, where there was a fraudulent deception, but across the whole water front of corporate America and beyond.

In the new order of financial rectitude that now rules, chief executives and finance directors will be judged by their conservatism with the numbers, not their ability to meet market expectations. Dubya has offered corporate America an amnesty period to come clean. As a consequence, we can expect profits to be heading south in a major way over the next few weeks.

This would be fine if a solid base from which to rebuild were to be established. Everything seems to conspire against hitting the bed rock. During the good times, companies boosted their profits by taking pension holidays. That's all gone. Instead, companies are being forced to fund growing pension deficits.

Bill Gates, chairman of Microsoft, once said that profit was not a natural state for companies. What he meant by this is that in a perfect market, profit would be constantly competed away. The moment one company established a profit, others would pursue it until it disappeared. It hasn't happened with his own company. Globalisation and technology has been less successful in breaking down local monopoly and protections than they might have been. However, there is a great deal more international competition than there used to be, undermining the ability to raise prices. At the other end of the spectrum, the biggest corporate cost, labour, is continuing to rise steeply. Somewhere in the middle, profits are getting progressively squeezed.

Pursuit of shareholder value used to be the most important part of a chief executive's job, and it was the cause of much that went wrong. Today the priorities are changing. Any profit generated goes to pay the workforce, the bankers, and if there's still anything left once they've taken their helping, it goes into investment. Shareholders are no longer at the top of the pecking order. A seismic shift in the corporate landscape is under way. After a prolonged period in which corporate profits have taken a progressively larger share of GDP, in Britain and the US, it's started to go the other way again. For equities, it can only be bad news, and rather supports the view that even if we are approaching the bottom, it's going to be awfully difficult to bounce back off it.

The FTSE 100 is now nearly 40 per cent off its peak. That doesn't mean it is yet good value.

Energis end game

Energis seems fast to be slipping away from the group of venture capitalists who have been trying to buy its UK telecoms business. Instead, the group's 16 member banking syndicate has all but decided to go it alone. In order to secure unanimity for such a high-risk approach, Royal Bank of Scotland, the lead bank, has had to resort to strong arm tactics. Smaller banks have been warned that existing debt will be subordinated to any new debt if they fail to shoulder their share of any refinancing. The RBS approach involves providing an extra £150m on top of the £750m of outstanding loans.

On the upside, the RBS plan would mean that none of the banks would have to recognise the Energis liability as a bad debt provision. The venture capital bid, by contrast, involved the banks taking a £290m hair cut. By sticking with the existing management, the banks keep the Energis débâcle at bay and out of their bad debt provisions. There's quite a bit of this going on among the big banks at the moment, which rather leads you to wonder how reliable the surprisingly low bad debt provisions being reported by banks really are.

Presumably any number of suspect loans are being shepherded in the same way, allowing RBS and others to keep profits rising despite the business downturn. The hope is that Energis can be made to soldier on for long enough to allow the telecoms bust to come to an end, or the loans refinanced in a less painful way than was being proposed by the venture capitalists.

In any case, in order to bolster the credibility of their approach, the banks are planning to bring in Archie Norman, the former Asda boss, to front the company. For Mr Norman, this is a crafty change of horses. Up until a couple of weeks ago, he was to have headed up the venture capital solution. The ethics of the switch are one thing, but it will also involve Mr Norman in performing a not inconsiderably intellectual somersault, since the performance assumptions required to make the banking solution work are a good deal more heroic than the venture capital ones.

What makes Mr Norman think that a management that succeeded in wiping out all of Energis's shareholder value by linking the company's borrowing facilities to unachievable performance targets is worth risking his reputation for is anyone's guess. Still, he's no doubt being heavily incentivised, so what does he care.

It is not yet entirely over for the venture capitalists. In recent days more than £100m of Energis debt has mysteriously been put up for sale in the debt market. Were they to buy this debt, Apax and Carlyle would be able to block the RBS solution and secure a place back at the negotiating table. For them, the game is not yet entirely over. Unfortunately, for those still left in the equity and the bonds, the game finished a long time ago. Whatever the outcome, there will be nothing left for them by the time the bankers have had their pound of flesh. For David Wickham, the chief executive, and his finance director, William Trent, it's really quite an achievement. The City won't easily forget it, either.

jeremy.warner@independent.co.uk

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