OUTLOOK : Rates below double figures will be a triumph
Friday 03 February 1995
The Bank of England, foiled in its Scrooge-like hopes of a miserable Christmas for retailers, does not want to see the present buoyancy of manufacturing spreading to householders, boosting spending in a potentially inflationary way. Eddie George, the Governor of the Bank, said last month that a stitch in time saves nine. He meant that if the upward movement starts early the cycle is bound to peak at a lower rate than it would otherwise have done. What he and the rest of us have to guess - because the Go vernor and the Chancellor are as much in the dark about it as anybody - is how much lower and what would the peak have been in an unreconstructed world in which politicians continued to keep interest rates down until too late?
The average of past interest rate cycles is a movement of 6 percentage points from peak to trough, which would take rates to 11.25 per cent this time round. Clearly, much has changed in the aftermath of the 1990 recession. Inflation is far lower, while fiscal policy is tight compared with most past recoveries. And, of course, interest rate strategy has changed for the better.
But the consensus in the markets that the peak is no more than a percentage point above today's new level is based on an all-too-eager readiness to believe that changes in behaviour can be both complete and instantaneous.
There is still a very real possibility that rates will rise very near to 10 per cent. If the tax giveaway is as great as everyone expects in the next Budget, they might, by rights, have to go higher still. In reality, anything even fractionally below double figures will represent a triumphant break with the past.
Wellcome should forget search for white knight It is early days yet but Wellcome's search for a white knight looks an increasingly desperate affair. Even a 19 per cent upswing in pre-tax profits to £738m was insufficient to persuade the market that the company is worth any more than the £10.25 a share Glaxo is offering. As far as the stock market is concerned, this is already a done deal. The board's opposition is largely an irrelevance.
One after another potential rivals are ruling themselves out. There are still some left with the $15bn of firepower it would take to outbid Glaxo - Merck is one - but it is hard to see why they should take the plunge. Wellcome would clearly prefer a bidder that would allow the company a degree of continued independence. It would, however, be naive to think anyone would pay that amount of money just to allow Wellcome to play around in the back yard.
Any takeover is bound to involve rationalisation. By talking to rivals, even before Glaxo made its bid, Wellcome implicitly recognised the consolidation taking place in this industry. Wellcome was always going to get dismembered. The existence of a substantial shareholder, the Wellcome Trust, which wants to sell out, meant it could never take the active role in the process of change in the pharmaceuticals industry.
Glaxo's position is in a way unfortunate. It looks like the rapist. Certainly that is how Wellcome would like it to be seen. But the reality is that whoever ends up with Wellcome will go through exactly the same slash and burn process.
For Glaxo, however, this is not merely a cost-cutting exercise. It is a considered and bold approach to the two revolutions taking place in pharmaceuticals. One is the shift in market power from producer to purchaser, requiring dramatic changes in organisation and marketing. The other is in science and technology. Gone are the days when drugs were stumbled upon by accident and the mechanism by which they work discovered later. Today the mechanism comes first and the drug is designed against it. According to Glaxo, Wellcome by itself would be incapable of sustaining the sort of research facility that success in pharmaceuticals requires.
Wellcome owes it to its shareholders to explore all available opportunities. On the other hand, to give preference to an American bidder over Glaxo is unlikely to be in the company's, or Britain's, best interests. The sooner the search for that illusory white knight is exhausted and the serious discussion on how to go forward together begins, the better.
So-so evidence on money for old rope Is nothing sacred in the City any more? It seems not. Not so long ago the idea of some busybody government regulator daring to investigate the way that the City organises its activities would have been regarded with horror, bordering on outrage. Since Bi g Bang, and the Lloyd's nightmare, however, all that has gone by the board. Everything, including time-honoured custom and practice, is now fair game. The future of the rights issue, a central plank in the UK system of corporate finance, is again in the frame.
There is plenty of prima facie evidence that the system of paying comissions for underwriting share issues - though it has stood the test of time - is potentially anti-competitive, and imposes unnecessary costs on firms seeking to raise new equity capital.
Whether this would justify Sir Bryan Carsberg, director-general of the Office of Fair Trading, ordering a Monopolies and Mergers Commission investigation, as reports suggested yesterday, is another matter. He has been canvassing opinions from vested interests, including merchant banks, brokers and fund managers. On his files, if he needed supporting evidence, is a report from Paul Marsh, a distinguished professor at London Business School, which suggests institutions are earning excess profits from their underwriting activites.
Alas for those who like a good scare story, the chances that Sir Bryan will trigger an MMC enquiry look slim. Sir Bryan recognises a complex issue when he sees one. He also has, by regulator standards, an unusual amount of common sense. He knows that a reference is not necessarily the best way to get to grips with this particular thorny issue. A better outcome could be to publish a high-profile report, and - if overcharging is demonstrated - let market forces determine whether changes are needed.
Nobody would deny that underwriting costs are an important part of the wider, highly political, debate about the cost of capital in this country. Is the established method of raising capital by rights issues cost-effective and fair? The evidence is so-soat best.
International comparisons show that the rights issue method is not that expensive. The administrative costs of the American alternative, general market placements, are higher. But this does not alter the impression that the fees, and notably the underwriting charges, are excessive. Privately, big institutions that sub-underwrite these issues admit it is mostly money for old rope. But if fundamental change is desired, then the only way to achieve this would be to scrap pre-emption rights. The merest hintof this is sure to provoke ferocious opposition across a wide front.
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