Daniel Lacalle

Kleptocracy, value creation and the opportunity for Spain

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This article was published in El Confidencial on January 19th 2013

“This threat of cronyism and patronage is not a threat. I think it’s a promise ” John Gage

“I do not worry if there are useless people in this organization, what worries me is if the useless are proactive.” This sentence comes from a senior executive with whom I had the pleasure of working for many years, and it encapsulates the biggest risk facing the ‘brand Spain’ after the recent embrace of optimism courtesy of the fall in sovereign risk premium. Now Spain faces its own acid test.

When I read that the image of our country is unfair, I always say how lucky we are that the scandals coming out every day in the national press are barely mentioned in the international media.

Honestly, all these appalling stories that I read every day create an excellent opportunity for the country to carry out a real change and take advantage of these periods of euphoria to clean the image of “oligarchy without oil” that we have, and we have built ourselves, with the acquiescence or indifference of a large majority in the lost decade of “take the money and run”, because oligarchic corruption always left something for everyone, and as such was tolerated. They call it “kleptocracy”, but it’s much more than that because it permeates to many entities, public and private. It is a way of understanding the responsibility of each individual resetting our threshold of what is “acceptable” by using our favourite sentence: “The opponent is worse”. Until it explodes.

At the moment we have some optimism from investors and those are the environments to combat cronyism and lay the foundation for a change in mentality .We give ourselves pats on the back saying that everything is solved, but this happens every January, as shown in the graph below (courtesy of Mirabaud). Minister De Guindos commented rightly that “markets are neither well now, nor bad before”

Market matters. Because Spain has debt everywhere, and it has to be refinanced. As I have said many times, if we do not want financial scrutiny, we should not be heavily indebted. Now we have to accept the rules and prove ourselves worthy of the trust of those who lend us money. Or go bankrupt.

The 2013 fiscal cliff

Severing corruption is only one step. Political risk affects creditworthiness, investment in the country and compresses the multiples of listed companies because there is no real long-term investing. Only short term speculation.

To attract investment, Spain will need to show a positive, reliable and predictable investment environment. But in this sense Spain has fallen again, unfortunately, in its ranking at the Heritage Index of Economic Freedom 2012. An institutional problem that can be solved … Because it has been done before. But it’s not a single problem. It is part of the cost of the “oligarchy without oil”. The other part is the “see if no one notices” approach to economic figures, as we saw a couple of years ago.

There is a rumour that the Spanish tax revenue figures have been “improved”, by advancing the 2013 corporate tax of big business and delaying pending refunds. If this is true, it is bad news.Unfortunately it is a very typical practice of certain countries of the European Union.

If Spain has met the revenue target of the budget, but the deficit is around 7% or more … Then the problem lies in expenses. Maintaining expenses that continue above the 2007 “bubble peak” levels is a huge bet, and one that is impossible to finance with deficits above 5% of annual GDP.

But the risk is that as we reach the second half of 2013 building up a fiscal cliff similar to the U.S. one, and face a need for adjustments between 1.5 and 3% of GDP to meet the minimum requirements of the EU.

It is true that in many forums 2012 is viewed as a year of transition in which the country has been unable to show the true effects of the measures implemented. But 2013 does not offer excuses. We can not chalk it up to the cost of debt, to Germany, to hedge funds or the Anglo-Saxon press.What the State achieves in 2013 will be its own success or failure.

From the companies’ perspective: delivery, value creation and corporate governance.

The first step has been relatively easy. Listed companies have seen their shares rise while bond yields fell. It’s like the effect of throwing a stone into the water, it looks like a big change, but the liquid content is the same.

At least now, unlike in 2009-2011, companies are aware of the risk that the bond yield move is temporary and are using the credit window to issue bonds (BBVA … issuing mortgage-backed bonds with ten year maturities). And with excellent demand. There are signs of confidence because, for the first time in five years, the vast majority of listed companies come to investors with a track-record of having fulfilled their commitments to divest, and lower unaffordable dividends, instead of justifications of under-delivery. An important difference.

In addition, earnings estimates no longer seem more false than a Walt Disney movie. Unfortunately, consensus estimates remain high by 12-15% – and at least the communication departments should know it before we see a “feast of profit warnings” in the third quarter.

So far the reduction of debt of Spanish companies has been relevant. The State debt reduction is yet to be seen. But de-leveraging has been achieved mainly through asset divestments and cutting investments. Now comes the hard part. To improve gearing increasing free cash flow. Let us not forget the the fact that the Ibex remains the most indebted index in Europe.

Corporate governance is essential to strengthen the recovery of stocks. Cronyism, investment-by-committee, debt and lack of meritocracy mean low multiples for stocks in any country. It is called “black-box discount”. Large companies should undertake a major restructuring and stop having managers that are budget consumers, not value creators . To dramatically increase the proportion of stock compensation compared to fixed salary would be a differentiating factor.

The alignment between the interests of managers and minority shareholders will dictate again who performs better or worse. Not 200 page corporate responsibility reports full of platitudes that are not met. The first rule is not to become state agencies. Oligarchy without oil.

For several years many companies have forgotten that their duty is to create value-economic value added, not to hide and justify themselves with “the crisis”.

We are in the period pre 4Q results that we used to call a “death row channel”. Waiting for delivery. If companies and the country beat their targets, drastically cut cronyism, and create value, Spain will emerge from this downward spiral. If not, you’ll see that the country finds someone to blame someone-foreigner, of course.

Justifying mistakes and failures as “small”, “already discounted” or “they do not understand us” is not acceptable. It’s delivery time. We did it after the Latin American crisis. I do not know why we would not be able to do it now.

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