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November 24th, 2021

Quid Games

Quid Games, a new Netflix serial, features an island country filled with noble ideas and aspirations planned and implemented in a Benny Hill like script.  A series of recent UK anecdotes catches one’s attention.  Climate change initiatives in electric vehicles, solar power and wind turbines have received attention and funding as have initiatives to close traditional power generation facilities.  Coordinating the total power needs with the new alternatives and the shutting of the old sources has not been a priority.  For the recent Climate Change Summit in Glasgow, 250 electric cars were madeavailable to the delegates. Unfortunately, sufficient chargers were not available in Glasgow, so generators had to be brought in to charge the cars. Large shallow water wind turbine farms have been installed, as have acres of solar panels to provide power whilst simultaneously shutting many natural gas plants. Recent light winds and cloudy days have led to enormous shortages of power causing three unforeseen consequences:  1) The price of power has more than tripled, causing utilities to abrogate fixed price contracts with customers and forcing factories to shut during uneconomic peak hour pricing  2)  The UK is now burning the most coal in nine months to meet the shortfall and  3) PM Boris Johnson’s climate change initiatives have lost credibility. Similar issues portend problems for home heating this winter.

​The UK is suffering supply shortages like the rest of the world, but Brexit has added its own unique twist as many European citizens who worked in the UK have departed.  For example, there are 150,000 pigs awaiting slaughter due to a skilled butcher shortage. The government has now announced 800 new six-month visas for butchers, and due to the bottlenecks that now exist, the government has established a “private storage aid” to store carcasses for six months while inventory is cleared. This Strategic Porcine Reserve will be closed when enough pigs fly out the door. Recent entanglements such as the suspension of Northern Ireland Secretary of State Owen Paterson, fishing quota fights in the English Channel and Amazon threatening to ban UK Visa cards are news. Some of these are the normal claptrap of political life while others are the direct, unforeseen consequences of Brexit as Britain is no longer protected by the EU cap on card fees nor by prior quota agreements.

The UK serves as the canary in the coal mine for what is occurring in the U.S. The recent censure of Rep. Paul Gosar is our proxy for Owen Paterson. California’s green initiatives have led to the shutdown of refining capacity and power generation in the state while not coordinating the transition versus actual power demand. Consequently, random brownouts and expensive power are now the norm in California and gasoline has reached $6 per gallon, almost double the U.S. average. Government regulation and the pandemic have led to severe supply shortages as the national logistics system is stifled.  Worsening the situation are new rules that restrict or prevent truckers, the key to the solution, from working. As in Britain, inconvenience will not be the only consequence as states are now rationing product and those that are less fortunate will suffer this winter.  Perhaps the largest consequence of federal spending, the pandemic, and supportive Fed monetary policy is inflation, a challenge not seen in four decades.

We are seeing 20% plus increases in many inputs at our portfolio companies and some north of 50%. Comments that the inflation is transitory, meaning brief, are already past the point of being credible. Price increases are being passed to customers at levels not seen since the 1970’s.  The Dollar Tree stores which have priced all items at $1 for 35 years just permanently raised all prices to $1.25. Thus far, interest rates, which underpin the valuations we see today, are not reflecting actual inflation due to the Fed’s actions.  As tapering is completed, rates may begin to reflect the economy. As a living fossil, I have the benefit of experiencing the last inflation period, in the 1970’s. My student loan package consisted of two layers; one capped at 7% by the government and the junior layer that floated at the Prime rate plus three hundred basis points. The day I was admitted to graduate school, Prime was at 8%, slightly above the government cap on the first layer.  Two years later, when I graduated, the prime rate hit 20.50% making the rate on my loan 23.50%.  I lived on a yoga mat, rather than buy a bed, for the first four months of my job in order to retire much of that debt. Stagflation may not hit us as hard as it did in the seventies, but the Fed has a scarcity of tools to avoid it.  Managing a private equity portfolio in a higher inflation environment is an exercise in agility as margin management requires nimbleness amid the rapid movement of interest rates, as seen above, can deplete cash flow and crush multiples. 

I’m Rob Morris and I approved this blog.

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