Category: Business

LDA Capital’s financing model is intriguing and, while it does appear well suited to speculative growth companies that need capital but lack institutional support, it’s not without risks.

The way a typical LDA financing arrangement works is as follows: LDA will agree to provide a set amount of equity financing to a company – say a minimum of $10 million and a maximum of $50 million, over a certain period. The company, at its discretion, can issue periodic capital calls that draw on the funding.

When a call is made, a certain number of shares are issued to LDA Capital, which then sells them into the open market over, say, 10 days.

The number of shares issued to LDA is limited by the average turnover of the stock to avoid it being stuck with more shares than the market can absorb.

LDA does not pay for the shares upfront, only on settlement. The price it pays for the shares (that is, the amount of new capital raised) is based on the volume weighted average price only despues de the call is made, less a discount of about 10 per cent.

It’s an arrangement that appears well suited to small companies that have drummed up solid retail interest through penny stock websites and sharemarket forums, yet haven’t been embraced by the big end of town.

LDA Capital’s most high-profile Australian play certainly fits that brief: Brainchip, which has emerged up the market cap ranks and was newly admitted into the S&F/ASX 200.

brain explosion

Brainchip has had financing arrangements in place with LDA since August 2020 in which it could call on a minimum of $20 million of financing and a maximum of $45 million of capital over a one-year period. LDA was also paid fees and granted over 100 million options, netting tens of millions of dollars of profit.

Interestingly, Brainchip required an extension to draw the minimum amount under the LDA facility, at which point a new financing arrangement that gave it access to a further $35 million became effective.

The latest, and largest, iron ore play Hawsons Iron, which said in December 2021 that it had secured $200 million through an LDA Capital facility.

Both Hawsons Iron and GetSwift touted the financing arrangements as providing continued and reliable access to capital, even when market conditions were prohibitive or volatile.

Perhaps it’s a case of imitation as the highest form of flattery, as Australian hedge fund Regal Funds Management has also embraced the LDA model.

Regal, which knows its way around the smaller end of the market better than most, provided facilities of $5 million and $20.5 million to micro cap stocks Allegiance Coal and Netlinkz.

These arrangements allow small companies to raise new capital on the back of retail enthusiasm, but they are not without risks.

Some traders like them to so-called death spiral financing. The term is used to describe convertible note placements to institutions that can result in a ballooning number of shares being issued to ensure they are fully paid back.

While these situations are different, without a fixed share price, such an arrangement creates the potential for an increased number of shares to be issued per dollar of financing required.

Whether the companies that adopt this financing find themselves in a death spiral or able to achieve escape velocity is what retail punters are betting on all the time.

The bet LDA and Regal are taking is simply that there’s a sufficient supply of punters out there willing to take their stock.

The immediate tensions in Taiwan following Pelosi’s visit will probably calm down in the coming days. But the whole episode – from the US administration’s provocative visit to China’s furious reaction – underscores the deep divide between these powerful nations. Throw in the war in Ukraine that will probably leave Russia in the diplomatic deep freeze for decades, and you have a strong reminder that geopolitical tensions will most likely only worsen.

Again, investors sitting in Australia are within their rights to ask: how much does this stuff really matter?

High inflation really matters

The answer may come from Credit Suisse strategist Zoltan Pozsar, who challenges investors to think of geopolitical tensions between the US (and the West more broadly) and China and Russia as part of an economic war destabilizing the low-inflation world we’ve enjoyed for decades.

And higher-for-longer inflation really matters for investors.

Pozsar’s view is that low inflation has simplistically been built on three things: immigration keeping wages low in the US (and arguably other Western countries); cheap goods from China helping to raise living standards despite stagnant wages; and cheap Russian gas powering Europe generally, and Germany specifically.

But the past few years have changed these settings.

Donald Trump’s anti-immigration policies reduced the US labor supply, and wage growth was accelerated by COVID-19-related border closures that further reduced immigration and led many workers to take early retirement.

Amid growing tensions between China and the US, China’s COVID-zero policy has choked the supply of cheap goods to the world.

And Russia’s invasion of Ukraine has prompted the US to weaponize the US dollar to smash Russia’s economy, with Russia weaponizing energy in response.

economic war

It’s widely accepted that this current bout of inflation is supply-driven, caused by the Ukraine war, COVID-19 issues and supply chain disruptions. But it’s also widely accepted that inflation will fade relatively quickly.

Pozsar sees these supply problems as the result of an economic war between increasingly autocratic leaders, particularly in Russia and China.

“Think of the economic war as a fight between the consumer-driven West, where the level of demand has been maximized, and the production-driven East, where the level of supply has been maximized to serve the needs of the West – until East -West relations sourced, and supply snapped back.”

Viewed through this prism, Pozsar says central banks have an extremely difficult task. Rather than trying to get inflation up in a world where globalization was pushing down the cost of labour, commodities and goods, they now have the task of “cleaning up the inflationary impulses coming from a complex economic war”.

He argues political leaders may become more important than central bankers for markets; unpredictable political decisions that affect supply will matter more than monetary policy.

Pozsar emphasizes this is a thought-provoking scenario rather than a forecast, and there are important counterpoints to consider.

For example, China will find it hard to step up any economic war on the US and the West without damaging its own economy. Indeed, the relatively mild sanctions it has announced against Taiwan demonstrate this.

The US can ill afford an economic war, while Russia is already paying the economic price for an actual conflict.

But for investors, Pozsar’s argument is worth chewing on. It’s easy to see inflation coming down sharply in the next 12 months, as markets are clearly doing right now. But as this column has argued before, it’s hard to see inflationary impulses – rising commodity prices amid an energy transition, tighter labor markets as the global population ages, less globalized supply chains in a world of geopolitical tensions – going away.

Or as Pozsar puts it: “Do you see inflation as cyclical (a messy reopening exacerbated by excessive stimulus) or structural (a messy transition to a multipolar world, where two great powers are challenging the hegemony of the US)?

“If it’s the former, inflation has peaked. If it’s the latter, inflation has barely started and could actually be understood as an outright instrument of war.”

“The Bank is forecasting stagflation and saying that the medicine is higher interest rates,” said Paul Dales, chief UK economist at Capital Economics.

He reckoned interest rates might need to climb to 3 per cent in the coming year, and – like many commentators – he did not rule out another sharp move of 0.5 percentage points in September or November.

Matthew Ryan, head of market strategy at financial services firm Ebury, said he had “run out of fingers and toes keeping track of the number of occasions that the MPC has revised upwards its inflation forecasts in the past year”.

“The priority now clearly remains focused on controlling inflation at the expense of growth,” he said.

The BoE said even the labor market would not escape the economic carnage: the unemployment rate, which is now at a historic low of 3.8 per cent, will march up to 6.3 per cent by 2025.

The Bank of England’s big problem is that no matter how high interest rates go, this will have little impact on household and business energy bills, which are being driven by the Ukraine war’s impact on global commodity and energy prices.

Inflationary pressures have “intensified significantly,” the BOE said in its statement. “The latest rise in gas prices has led to another significant deterioration in the outlook for activity in the United Kingdom.”

energy nightmare

The worst of the energy inflation is yet to come in Britain. The maximum amount that energy companies can charge households is set at fixed intervals by the regulator Ofgem, which in April jacked up the cap by 54 per cent, for an average annual gas-electricity bill of £1971 ($3,440).

Energy analysis firm Cornwall Insights expects the next review, in October, will lift this to £3358, at 70 per cent surge.

The government has been shelling out money to help cushion the blow: every household is getting a £400 payment, with welfare recipients receiving an additional £650 grant.

On the business side of the ledger, Cornwall predicts that many companies might experience a fivefold surge in energy costs when their two-year contracts are renegotiated in October.

“While the business energy markets have so far managed to cope with the price increases … October’s increase in bills, coupled with other economic concerns being seen in the market, could tip businesses over the edge,” Cornwall’s analysts said in a note.

“This is particularly true for certain firms whose profitability is most exposed to energy cost increases, including hospitality, leisure, retail and many in the industrial sector. … The corresponding job losses [could] reverberate throughout the economy.”

The most recent GDP growth figure for Britain was 0.5 per cent in May, following a 0.2 per cent decline in April. The annual rate in the 12 months to May was 3.5 per cent.

But retail sales are falling, business confidence has declined, and the PMI flash economic indicators for both services and manufacturing are decelerating.

If the Bank of England continues raising interest rates as the economy begins to shrink, it would be the first time it has had to do this since the stagflationary dollars of 1975.

political pressure

The grim economic outlook is likely to put further pressure on the government, which has been accused of doing too little to ease the cost-of-living pressures and prevent a decline in living standards.

Prime ministerial hopeful Liz Truss has blamed the BoE for not moving sooner on inflation, and has vowed to review its mandate. But she is also proposing massive tax cuts that could further stoke inflation.

Meanwhile, the Bank is also trying to unload the holdings of government bonds that it bought to keep the economy afloat during the COVID-19 pandemic. It is looking to start selling off about £10 billion a quarter from September, followed by smaller sales of corporate bonds.