Soft landing doubts creep in

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Good morning, and happy CPI day, when investors gather around the campfire and tell how Paul Volcker slew inflation with his bare hands, and swap tales of ex-housing core services. Email us your financial ghost stories: and

Markets are a bit less sure of themselves

The inflation forecasters we follow are sounding unsure about today’s January CPI numbers. Their job is especially hard this month, between methodology changes, start-of-year price increases, less volatility in cars and more volatility in airfares. Consensus calls for inflation to reaccelerate: a 0.4 per cent month-over-month increase in core inflation. That would leave six-month annualised core inflation near 5 per cent.

Markets are unsure, too. There has been a big, fast change in interest rate expectations. Coming into February, the narrative was: “Disinflation is here, hallelujah!”. Futures markets were pricing in a rates peak of 4.9 per cent and, after some cuts, ending the year at 4.4 per cent. Now, with the jobs market roaring and some scary Fedspeak, the new peak is 5.2 per cent, and the year-end rate is 4.9 per cent:

Line chart of Where markets expect US rates to be in December 2023, % showing Two whirlwind weeks

Until recently, 2023’s winners have been last year’s dunces: growthy stuff, bitcoin, Ark Innovation ETF (Arkk), profitless tech, highly shorted stocks like Carvana — all things that thrived under easy money. But as soft landing doubts have multiplied, this is reversing. Goldman Sachs’ profitless tech index is down 11 per cent from its peak on February 2, for example. The recent increase in rate volatility (dark blue line below) corresponds with the end of growth’s outperformance year-to-date (light blue):

You can see soft landing doubts worming into European stocks, too, where cyclical value stocks predominate. As we noted yesterday, European stocks’ months-long streak of outperforming US equities broke in mid-January (light blue below), and did so even before recent weakening in the euro:

This looks like consolidation, says Matthew Palazzolo, a strategist at Bernstein — that is, investors taking gains in an equity market that’s had false starts before. But Palazzolo added that growing anxieties about a US soft landing may well lie behind “profit-taking in a more cyclical Europe that’s more levered to an improving economy”.

So markets are feeling shakier about a soft landing, because the economy keeps throwing up surprises. No one is terribly sure what happens next.

Such trepidation makes sense. But remember, if we have a soft landing, rates are not headed back to zero; that will probably only happen in a deep recession. If rates go to say, 2 per cent, that is still a much harder world for the most speculative stocks. For big, profitable tech companies, on the other hand, it would be just fine. If today’s CPI report points to a soft landing, it makes sense to own Alphabet, but not Arkk. (Ethan Wu)


As a rule, I have a lot of confidence in capitalism and markets. Then I read something like this:

US-based financial technology group FIS has said it will spin-off Worldpay, the payments business it acquired for $43bn just four years ago, after it failed to successfully integrate the two companies. Formally known as Fidelity National Information Services, the company acquired Worldpay in 2019 to create one of the largest providers of financial infrastructure that underlie the bank payments sector.

In 2019, the management and board of FIS, which sells technology that helps banks process payments, thought it was a good idea to pay $43bn, mostly in stock, to buy Worldpay, which sells technology that helps merchants process payments. This was a premium of 13 per cent over Worldpay’s market value, which was already elevated due to merger speculation in the payments space. Paying that premium was justified by the expectation of $700mn in annual revenue and cost synergies. The company put a present value of $11bn on those synergies.

Yesterday, the company announced that it was taking a $17.6bn writedown of goodwill associated with the acquisition. This is a little odd because, according to FIS, all of the targeted synergies, and much more, were achieved. As of the beginning of 2022, the company reported it had achieved $500mn of operating expense savings and $750mn in revenue synergies. FIS also said it had achieved $400mn of non-operating cost synergies, which I assume means lower financing costs. It smashed its original synergy target by at least $550mn; therefore the synergies’ present value is, presumably, much greater than $11bn.

It appears, then, that something has changed such that FIS is willing to reverse the deal and lose the large associated revenue and cost synergies. What is it?

Here’s a snippet from the 2019 press release announcing the deal:

This combination greatly expands FIS’ capabilities by enhancing its acquiring and payment offerings and significantly increases Worldpay’s distribution footprint, accelerating its entry into new geographies . . . 

“Scale matters in our rapidly changing industry,” stated Gary Norcross, chairman, president and chief executive officer, FIS. “Upon closing later this year, our two powerhouse organisations will combine forces to offer a customer-driven combination of scale, global presence and the industry’s broadest range of global financial solutions.”

Yesterday’s press release announcing the spin-off talked about “strategic and operational focus”, but the main issue is capital structure. The current FIS CEO, Stephanie Ferris, said on a call with investors yesterday that:

The pace of disruption in payments is rapidly accelerating, requiring increased investment for growth and a different capital allocation strategy for our Merchant business . . . 

A separation . . . enables FIS and Worldpay to implement different capital allocation strategies . . . FIS will be in a better position to balance return of capital to shareholders with organic investment and complementary M&A. We remain committed to our investment-grade ratings, conservative capital structure and growing dividends . . . 

The separation from FIS will allow Worldpay to pursue a more growth-oriented strategy . . . a return to more consistent M&A and a capital structure that does not require an investment grade rating . . . 

 . . . it is expected that FIS and Worldpay will maintain a close commercial partnership to deliver critical capabilities . . . we did realise a lot of cost synergies bringing [Worldpay] in. I think we know what those are, we would enter into as many commercial relationships as we can to not have as many dis-synergies. We think the dis-synergies are fairly manageable.

In 2019, the payments industry was changing very quickly, which required scale. In 2023, the payments industry is changing very quickly, which requires nimbleness. In 2019, the synergies would create many billions in value. In 2023, losing the synergies is “fairly manageable”. What is going on here?

The synergies are not all that will be lost. There are sunk costs, too. The bankers on the deal were paid $93mn, but that is small potatoes compared to the $2.7bn in “acquisition, integration and other” costs FIS recorded from 2020 to 2022. At least $1.3bn of that is Worldpay integration costs, and possibly more, depending on how you want to allocate things such as severance and data centre consolidation expenses. From the point of view of FIS investors, all that money is simply gone.

Ferris’ comments about commercial partnerships and other forms of efficiency suggest that the two companies will be able to preserve some of the synergies. But this does nothing to ameliorate the grim picture, because if it’s true, it would have been possible to achieve much of the cost savings and higher revenue without doing the deal in the first place. To put it another way: either tens of billions in synergy value are going to be lost in the spin-off, or the value of the synergies was wildly overstated in the first place. It can’t be both.

It may well be true that, despite the lost synergies, the spin-off will create billions in net shareholder value, relative to where the combined company is today. Presumably this is why the activist investors DE Shaw and Jana Partners got involved in FIS. But that implies that the original deal was an epic mistake.

Industries change. Maybe the merchant payments space is indeed so competitive now that Worldpay will have to invest much more heavily, more heavily than FIS could have anticipated in 2019. And maybe that means the aggregate value of the two companies will be greater after a separation, because growth investors will pay up more for Worldpay now, and value investors will pay up more for FIS. But note, again, that the fast-changing competitive landscape was an important justification for the deal in the first place. In 2019, fast-growing rivals Square and Stripe had been around for a decade.

The lesson here for investors is an old one: M&A is very risky. Here is a company that did a huge deal, promised big synergies, invested a lot of money and management time in achieving them, said that it did achieve them, and reversed the deal a few years later anyway. This can only make sense if either the combination is so value-destroying that the tens of billions worth of synergies FIS achieved are not worth keeping, or those synergies were never really worth all that much.

Boards and executives have strong incentives to do deals. The target’s leaders get their shares bought at a premium and their contracts bought out. The buyer’s management gets to run a bigger company, meaning more money and more power. They also have the pleasing experience of having done something transformative, rather than sitting there watching a good company do its thing. The advisers on either side — bankers and lawyers — get huge fees only if a deal is done. Whatever their intentions, everyone involved has lots of reasons to exaggerate the benefits of M&A and downplay the risks.

FIS has a new CEO, a new CFO and a new independent chair since the deal was done. This represents a degree of accountability. But ultimately, FIS investors paid the price. It was their money.

One good read

“Consultancies and outsourcers . . . know less than they claim, cost more than they seem to, and — over the long term — prevent the public sector developing in-house capabilities.”

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