Blain’s Morning Porridge 14th June 2023:  Buying 3% of the AI Market for $100mm and Night of Living Dead CoCo Zombies part 7

“They are the Bastard Offspring of Deranged Regulators and Desperate Banks..”

A 4 week old French AI has achieved a first funding round value of $240mm and that’s as cheap as chips (literally). Meanwhile, AT1/CoCo zombie bonds return from the grave of bad financial ideas, confirming Blain’s mantra: The Market Has No Memory!

It’s Joy Unlimited across markets after US inflation came in as expected y’day. Stocks boomed. Today stocks will likely get a further lift when the Fed “skips” an interest rate hike this month. Fed Head Jerome Powell’s comments at the press conference will be parsed for any details or direction on what the Fed is thinking.

However, all that is dwarfed by the news a four-week old French AI start-up called Mistral AI just raised a record $105mm in a first round financing – valuing the company at $240mm. It’s a record first round financing in Europe…. It tells us a lot about market mood. And it might just be the best tech deal ever….

Fair credit to them. As the rest of us were still asking silly questions to ChatGPT, and dreaming about all the money AI investments are going to make us, three French chaps actually did something. No doubt they opened up an empty pack of Gauloises to scribble down a plan for something incredibly clever, which they took to funders – who loved it.

The 4 week-old venture – which has written its business plan in French to ensure no one in the Anglo-Saxon world will be able to understand or steal its IP – attracted money from France’s state investment bank, BPI and others including ex Google boss Eric Schmidt. It will apparently compete with OpenAI ad DeepMind.. but in French. Yay.

A few weeks ago I predicted the first AI Diamond Unicorn would be founded by three men and a dog.. and although I don’t know if any dog is actually involved, the three French chaps behind Mistral are ex DeepMind and Meta – their plan is to build a “generative AI”.

Here’s the real issue: Apparently there are less than 100 people on the planet with the kind of expertise required to write large language models, the core of generative AI. Paying $105 mm for three of them might just prove to be the business deal of the millennium, or it might just be froth. Time will tell.

Meanwhile, in a galaxy far, far away…. CoCos/AT1 zombie bonds return…. again

Big News in the Bank capital market is the return of CoCo AT1 additional capital bonds. Spanish bank BBVA has reopened the market with a new Euro 1 bln deal callable in 2029. It carries price-talk of 8.75% which sounds attractive, but is not without significant risk – whatever the bank analysts tell you. Yield hungry investors are tumbling over themselves to buy it – the book is apparently 3 times oversubscribed.

Whoa…

One of Blain’s Key Market Mantra’s is “The Market Has No Memory”.

That phrase was famously coined at a Euromoney Global Borrowers conference back in the mists of time when the Treasurer of GE rounded on the Eurobond market. One of his deals the year before had gone badly wrong – mispriced and mistimed, and the market was full of comments that GE would struggle to come back to market. Just a few months later, GE was the market’s darling again, prompting the observation the market has no memory. (Question for younger readers – have you ever heard of General Electric Capital Corporation…? Thought not.)

Sure enough, the market seems to have forgotten what happened to luckless Credit Suisse AT1 Investors just a few months ago.

When the failing bank was fed into the ravenous maw of UBS by the Swiss regulator, its $16 bln of Additional Tier 1 (AT1) capital was written down to Zero, prompting fury and calls of foul from investors. They’d made a fundamental due-diligence mistake – not reading the prospectuses or understanding what could happen to them ahead of equity holders being hit.

Funnily enough, back in January this year (well before Credit Suisse sank) I wrote a comment on AT1 CoCo issues: CoCos and AT1 – cheap or still dangerous?

I must have been prescient:

“AT1s/CoCos remain far more equity like than debt-like. The risks are largely equity risks – that a sudden liquidity event hitting a bank, triggering a run or collapse in the ability of the bank to fund itself, could very quickly consume capital or cause regulators to declare it “non-viable” triggering a write down of the AT1 (or conversion into worthless equity).

Such a liquidity event may come from cybercrime, fraud, or conventional sources such as increasing loan delinquency – which is likely to happen if rates are rising. Or it may come from a major fund going bust on the back of some event, trigger a systemic hit on its lenders’ balance sheets.

There are multiple reasons why things could still go to rack-shit in a heartbeat across the banking industry. The threat may be less than in 2007/08, but it’s not negligible. You need to understand the capital structure, the risks it covers, and the ability of the bank to manage these risks. And all banks are different..

And never forget, when an investment bank tells you complex financial instruments are cheap and you should buy them, you first thought should be how long and wrong they are…”

Following the collapse of Credit Suisse I wrote another comment on AT1s: CoCos, AT1s – Proved Right at Last

In it I reminded investors of another critical Blain’s Market Mantra: “CoCos are an inspired investment choice if your objective is own all the downside, no upside and less return than equity with much greater risk.” 

I rest my case on CoCos..

Five Things To Read This Morning

WSJ                 European AT1s Are Back, Baby

BBerg              Goldman Sees India Holding Its Own Even If China Stocks Rebound

BBerg              Berlusconi’s Death Puts Italy’s Future in the Hands of Two Women

FT                    El Nino’s arrival spells out the stark choices on climate

FT                    US Junk loan defaults surge as higher interest rates start to bite

Out of time, and think I shall go for a swim…

Bill Blain

Morning Porridge