Restructuring makes Germany attractive bet

Serious Money: Despite some weakness on the back of high oil prices, European equities have been having another good year. Serious Money has previously touched on the paradox of economic gloom accompanied by rising stock prices.

More than one English-speaking observer has been seen to shake his head in bafflement at the sight of French equities, at their most recent highs, reaching 10 per cent plus gains for the year to date. But even Germany, long a favourite equity market of this columnist, has not been too far behind.

Market movements at the broad index level always conceal at least as much as they reveal. The CAC 40 index for the French market, for example, has been boosted to a considerable extent by the influence of the oil giant, Total.

Oil stocks, of course, have been having a good run of late for very obvious reasons. Other individual stock names would include the stellar performance of Vinci, a stock I wish I owned.

The German story has received more publicity, mostly because of the howls of protest from German politicians about the behaviour of capitalist "locust" investors. These hedge funds and private equity groups have been demonised in Germany for persuading companies to become more profit-oriented.

But from the point of view of the investor, the catalysing effects of the locusts have been dramatic. Barely a day goes by without an announcement from a German company about restructuring. And the penny has dropped for investors, as can be seen from the performance of indices like the Dax 30.

Many components of the Dax are becoming less German by the day. Indeed, the national identity of many of Europe's most famous corporate names is becoming less clear. Of course, this has always been true, to an extent at least. How Irish is CRH? Its HQ may be domiciled in Ireland, it is a big part of the ISEQ index, but the bulk of its money-making activities have long since taken place far from these shores.

If the presence of global companies has long been a feature of the European investment scene, what is new is the extent to which globalisation is accelerating the trend for local indices to be dominated, effectively, by non-local companies. And that's not just exclusively companies that operate overseas. Many firms that operate within a domestic sphere find that global influences are growing.

Competition is an obvious point here of course but it is also the fact of being quoted that is important. Once in the public domain, companies are held up by investors to standards that are set on a global stage.

If you don't perform at least as well as your global peer group - even if they are not competitors - the markets will punish your share price.

The paradox of weak economies and strong markets is also explained by the size of the equity markets.

In the UK, we moved from talking about the FT30 share index to the FTSE 100 back in the 1980s. The UK's style of capitalism means that it has a big quoted equity market, the second or third largest worldwide (depending on how the Nikkei is doing).

Note that we are still using a 30-share index in Germany as the benchmark and a 40-share index in France. Many of the companies in these indices are good businesses that are well run and offer attractive returns to shareholders. Europe's well-known problems simply mean that there just aren't very many of them.

If Europe were to restructure in a meaningful way, we would see the investment potential rise considerably. When US investment banks first came to London in the 1980s, many of the well-paid bankers believed that Europe was just a big open-air industrial museum, ripe for corporate restructuring along the lines that had just taken place in many areas of the US economy. Some of those bankers departed as quickly as they arrived, disappointed that nobody wanted to pay them fees for all that restructuring advice.

Twenty years later, things are once again beginning to stir and some of those investment bankers are back. They have been snapping up German property, industrial companies and distressed debt. The common theme among these disparate asset classes is that they are all mispriced, all way too cheap.

True, they are not at quite such bargain basement prices as before, but I still believe that there are many good deals still to be had. The idea of Germany as a serious place to put your money still causes many, perhaps most, investors to experience cognitive dissonance. If I knew how to do it, I would package up some German real estate assets and sell them to property hungry Irish investors. The story, for me, is compelling.

One significant area of the market that still looks more local than global is the financial services sector. Most banks have some global operations and have to compete domestically with overseas players but it remains true that Europe is still dominated by European banks with strong domestic franchises. This too could be about to change.

European bank restructuring is a very old idea. Those 1980s investment bankers would have included banks (and insurance companies) in their list of potential fee-generators (sorry, customers).

But there have been enough deals in Europe over the last year or two - think Abbey and Santander, HVB and UniCredito, ABN AMRO Italy and BBVA Italy - for me to start thinking that something, finally, is up. If the game is truly on we can expect some non-European banks to get involved as well (think of all of those old rumours about Citigroup and Barclays).

Anybody agreeing with me that restructuring is inevitable will have more European banks than usual in their portfolios.

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.