Paulo Leitao Mercurio Capital Ltd Business Mathematics Made

Paulo Leitao Mercurio Capital Ltd Business Mathematics Made Simple 1

• (15 -20 minutes presentation) • Overview industrial production in different countries • Capital Intensive (high Capex) – the basics • Cost of equity • Conclusion • Q&A (20 -25 minutes) • Ask for footnotes 2

§ Natural resources make a country rich. § Capital intensive sectors are old-fashioned. § Investors can make more money in digital economy than in heavy industry. § Germany is very successfull with their industrial and manufacturing sector. § UK economy will never have a strong industrial sector. 3

Some numbers. . . § UK auto industry exports more cars than it imports. Last time this happened: 1976 § UK place in world Industrial production 1895: § 1 st (15%) § UK place in world Industrial production 2015: § 9 th (2. 3%) § Labour force in manufacturing: § China: 100 million § UK: 2. 3 million § UK industrial success stories: § Automotive § Food & Drink § Pharmaceutical § Semiconductors § Aerospace and defense 4

Comparison between Germany and UK industrial sector weight on GDP § Germany’s industrial sector weight on GDP: 29, 1% (25, 1% industry, 4% construction) § UK’s industrial sector weight on GDP: 21% (14, 6% industry, 6, 4% construction) This difference in numbers. . . GDP difference impact between 25, 1 and 14, 6: £ 192 billion* Jobs: 612. 000 extra jobs** Would make the UK 5 th largest in World GDP, from 6 th*** * UK GDP 1. 832 trillion X 10, 5% (25, 1 -14, 6) = 192 billion **(Labour fource 31 million X 18, 8% industry related jobs) * 10, 5% *** World Bank, United Nations, CIA Wold Factbook data 5

Fact or Fiction? § Everything is produced in China, nothing is produced in the UK. § UK industrial components are often buried somewhere in an end-consumer product, with final assembly in China. § Industrial units are big polluters of the environment. § Potentially a fact. § “EU red tape” hinders and limits UK businesses. § The Manufacturers Organisation (www. eef. org) manifesto includes campaigning to stay in the EU. § Public cash help doesn’t make a difference when financing industrial “high risk” projects. § Government “Business Finance Partnership” program has helped create £ 5 of lending for each £ 1 of government guarantees*. § There’s financial resources competition between different sectors of the economy. § Potentially a fact. Finance and construction seem to be linked, seeking “low risk” investments rather than industrial “high risk”. § “Continental style” of capitalism provides better ecosystem for long-term industrial investments. 6 § Anglo-Saxon style of capitalism led industrial production for most of last century (UK, USA). § *https: //www. gov. uk/government/publications/business-finance-partnership-activity-report

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§ High Capex – low Opex/Low Capex – high Opex § Liquidity premium (business plan and business model lack of flexibility) § Sensitivity to country/national risk 8

Liquidity Premium Square root to payback and/or breakeven in years: (Initial investment – salvage value) Country Risk Premiums Economist Intelligence Unit Country Risk Reports (score system): Standard & Poors Sovereign 10 -year yields 10 -year Sovereign bond yield 9

40 35 Licensing Build Operation 30 Return Risk 25 20 15 10 5 0 1 2 3 4 5 6 7 8 9 Time 10

§ Project is the guarantee, not the company’s balance sheet or the director’s equity. § Locking the Risk: § Income streams Futures § Interest rates Swaps § Currency forwards § Long term offtake contracts (5 to 20 years). 11

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§ Return needed to keep the equity in the company § Intrinsic Risk & External non-controllable variables § Business Risk + Liquidity + Country Risk § Main challenges with Equity: Not visible (not cash/accounting cost) Measured indirectly (Mkt multiples, Quantitative Methods, Benchmarking, Ungeared Beta, etc) For private companies, more difficult to measure 13

Cost of Equity (Required Rate of Return) 70 60 Seed Build 50 TIO 40 Startup 30 Early Growth 20 10 “T” - Technology “I” - Implementation “O” - Operation Late Expansion IPO Event driven Mature 0 1 2 Present value 100 3 4 20% 120 10% 110 5 6 20% 144 8% 119 7 8 20% 173 6% 126 9 10 20% 207 4% 131 11 12 Time Future value 207 131 Purely financial dynamic: time sensitivity 14

Years 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Licensing Business Premium Build Business Premium Start Up Uncertainty EXIT Sweet Spot BP BP BP Liquidity Premium LP LP LP Country Premium CP CP CP BP BP BP CP CP CP 15

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What are the ingredients of a successful industrial project decision making? Capital Budgeting Operational logic Investment logic & capital structure Management Go/No. Go decision & “Design freeze” 17

§ Natural resources make a country rich. § Capital intensive sectors are old-fashioned. § Investors can make more money in digital economy than in heavy industry. § Germany is very successfull with their industrial and manufacturing sector. § UK economy will never have a strong industrial sector. 18

§Mercurio Capital Ltd §www. mercurio-capital. com § Follow us on Twitter! (Business Mathematics) https: //twitter. com/Mercurio. Capital § Linked. In Group (Business Mathematics Made Simple) 19