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Impact of the Internet Age on the Economics of Business

Patrick A. McNutt

w w w . P a t r i c k m c n u t t . c o m

Outline of Presentation

Economic

Realism 2010

• Paradigm shift

• FDI and Creative

Industries

Investment Clinic

• Structured Finance,

Innovation &

Technology

• Investment Signals

There is a Paradigm Shift in

Economics: Greater Role for FDI

Old paradigm GDP = C + I + G + (X – M) still used in macro-models

Old economy FDI = retained profits

New economy FDI = asset-seeking FDI (low cost locations) and efficiency-seeking FDI

(information and communications)

New paradigm GDP = X + FDI + (G + C)

Cross-border FDI capital flows

Since 1990: Cross-border capital flows have been rising at an annual rate of 10.7%, adjusted for inflation and exchange rates.

From 1980 – 1990 annual rate of 4.3%

MENA has witnessed YOY average increase of 95% due to global demand for petrochemical products.

Explain the increase

Information has created connected markets allowing key suppliers of capital to supply across borders and across currencies:

Example: DIFX and world portfolio funds or QSTP

100% foreign ownership or China-Egypt

Intra-Regional FDI Flows

Top 5 FDI Recipients 2005-2009

UAE, Turkey, Egypt, Saudi Arabia, Morocco

FDI Flows to MENA [inc Turkey]

13.4% share of Developing World FDI

FDI Stocks as % Real GDP (average adjusted)

Middle East [inc Turkey]: 11.9%

North Africa: 24.8%

Example of ‘Classic’ FDI Targeted

Industries

Chemicals and chemical products

(Bahrain)

Telecommunications (Kuwait)

Hotels and restaurants (Saudi Arabia)

Yarn spinning mills (Turkey)

Amusement and recreation (Dubai)

Connected markets

Connected markets exist because of the

Internet:

global

markets are now locally controlled…..data warehouses, IT processing, international brokerage, supply chain management, technology transfer, information-sharing.

What are the consequences?

Global growth is increasingly driven by

Emerging Market [EM] economies.

Key EMs are China, Russia and India

Emergent debt is still supported by strong economic fundamentals.

More Governance: Example: IAIGC

Membership, zero customs duties under

Greater Arab Free Trade Area

Information and Communication Will Define the Opportunities

Information is now a commodity with positive costs.

Communication costs are falling.

Information processing = risks + mixed signals

OPPORTUNITIES

Hybrid portfolio of PE and HF focusing on distressed opportunities.

Strong global growth has come with falling capital costs and a wider use of quants to reduce credit risk.

FDI = investment in transfer of technology, IPRs and technology licensing agreements.

Key Drivers of investment opportunities

.

Pressure on EM currencies and exchange rates:

EM currencies to continue fluctuation against US$ and Euro.

Global outsourcing and local restructuring:

Focus on exposure to core products – energy, utilities, materials, equipment suppliers.

Real interest rate policy in Key EMs:

Negative: Impact on confidence of investors to

Central Bank money as store of value.

Positive: Appreciating currency.

Real Time Information Flow

Non-traditional FDI:

Not ‘bricks and mortar’

Business

Strategy:

’Trade in

Tasks’

Mobile

Capital:

‘Trade in e-

Funds’

Resources

&

Materials:

‘Trade in

Scarcity’

FDI & New Economy

Between 1980-1998, US, EU and Japanese companies signed 9000 strategic technology alliances: New economy companies with costless entry

Churning equilibrium: goes beyond traditional

FDI of bricks & mortar’ to FDI as ‘information bridge’ in technology and information flows.

Information is a tradable resource for the distribution of technology and innovation with FDI potential.

Example of New Paradigm

:

Trade co-operation

Increased Intra-nation trade: only 25% of Asian exports go outside Asia.

US, EU and Japan share of global economy is falling [60% in 2009] and expected to approximate 50% in 2020.

More co-operation and technology transfers: FDI

~

Chinese-Egyptian Business Council 2006 or

Singapore-China Trade Mission 2009

New Paradigm Recommendations for

FDI flows

Strategic exposure to Key EMs

with currency regime linked to US$ with rising inflation with rising commodity prices exposure to high yield corporate bonds prefer credit over equities prefer equities over government bonds

New Geo-political order

Emerging markets: young population, technology transfer, creative industries, and

FOREX reserves:

EMs, GCC, MENA, ASEAN and BRIC

More FOREX Non-dollar Assets and the role of US $.

EMs’ Equity markets: High P/E due to high GDP growth = Flows of FDI as purchase of shares.

Post-Internet Age

since 1988 (arrival of home

PC and www URL)

‘virtual’ investment

FDI and Creative Industries

EU Benchmark

2010:

8% GDP

Innovation &

Technology

Infrastructure

2015:

Greater than

8% GDP

Creative Industries:

EXAMPLES

Virtual surgery or High-Tech Tourism

Smartphone technology or Telcos

Prime Brokerage or Portfolio Fund

Management

New FDI

Investment Opportunities

Understand the ‘information bridge’ in the

Template for FDI Investment

Asset-seeking FDI = Case C

Efficiency-seeking FDI = Case B

Market-seeking FDI = Case A

Template: Case A: Virtual surgery

Telerobotics =

Internet &

Information

Processing

Virtually assisted microsurgery

Virtual

Environments

Bio-sential crops

Next generation antibiotics

Template Case B: Smartphone

Technology

Handset

Manufacturers

Networks

Devices

OS

Apps

Smartphone

Transformation

Template Case C: Prime Brokerage

TRADES

Brokerage accounts

Hedge

Funds

Privileged Information

Investment Clinic

Investment Cycle

Monetary policy does not work

Information

Signals

Moral hazard embedded in risk analysis

Information Processing

Data availability in the cloud

Virtualisation of both product and process

Example: (i) IT infrastructure delivered as a service

(ii) Convert data into strategy and insight

(iii) 50% increase on average in Business expenditure on information processing equipment and software since

1990s

Mismatch in Risk Signals

Weightless companies

Mismatch in Risk Signals

New

Technology of

Structured

Finance

Information

Processing and

Innovation

Weightless virtual companies

Weightless companies: $x invested in physical assets, $y invested in sales & capitalisation:

Yahoo, Microsoft, Apple, Google…………….???

$y >> $x

Market Panic

Analyst advice: Strong SELL to SELL

Consensus: HOLD

Panic as Consensus ‘Sell’ and Price Falls

Deviation of Equity values from Fundamentals

Investment Signals

Macro economic trends moving towards intra-nation trade and exchange rates as policy tool. Case

I EMs and ASLEEP economies to account for 50% of world trade and

30% of world exports by 2015.

Case II production drives demand in oil and core scarce resources.

Micro economic trends with technology transformations. Case

III vertical handset manufacturers transform to horizontal computer markets. Case IV global insourcing with mobile workforce.

Case V increased mobile banking and e-purse payment methods.

S&P 500: 40% of revenues from foreign sales.

50% of world’s equity capital is now outside the US.

Nascent bubble in EMs depends on sustained growth in China: 10% of

World GDP.

Case I

Concluding……..

What lies ahead in brokerage:

FDI/Macro Trends?

Today

Tomorrow

What lies ahead in brokerage:

FDI/Micro Trends?

Today

Tomorrow

Private Equity: Prognosis

• Herding and Panic

• Virtualisation and absence of scarcity in resources

Information

Processing

Weightless companies

• Latest technology

• Signals v company fundamentals

• Geo-politics

• Ease of trade ease of entry v

Intra-Regional

Virtual Trade

Prognosis for FDI

Markets remain irrational longer than you remain solvent: short term investors ‘rent’ rather than ‘own’ shares

Long term investment in Asia as they decouple from US and EU as Asia bouyed by increasing domestic demand

Low Communication

Costs But High

Governance Regulations

EU Mifid Directive with brokers beholden to prove best deal for clients in creative industries

Strategic Trade Alliances like Egypt-China and China- Singapore with investment opportunities

Predict an Information Overload!!

THANK YOU

‘’do not wait for the stream to stop before crossing it’’

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