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“The greatest victory is that which requires no battle.” ― Sun Tzu, The Art of War

“One of the world’s largest private equity investors has made an approach to buy Chemring, the FTSE 250 defence group” ― Mark Kleinman, Sky News.

Bain Capital’s reported move is interestingly timed for several reasons. First, Chemring has an AGM trading update on Wednesday. Second, the stock had been strong of late on the realisation that Trump should be treated as a threat to Europe rather than its ally. Third, it follows a bad run for the shares as we wait for the result of the UK Strategic Defence Review.

Though Chemring is more domestic and specialised than the average defence contractor — 45 per cent of revenue is from the UK, with 17 per cent from Europe and 34 per cent from the US — a takeover might be seen as no more controversial than Advent’s purchase of Cobham in 2019 or Parker-Hannifin’s deal for Meggitt in 2022. The speculation alone should put a floor under the stock.

And at a surface level, Chemring’s defence-tech might appeal to Bain. Three Bain consultancy partners published an editorial in December outlining why “private capital is poised to play a critical role in the modernisation of the US defence industry”.

The US Department of Defense has been seeking to encourage longer-term corporate R&D spend by offering fixed-price contracts and war-as-a-service type deals. Venture capital firms have already been attracted by the promise of more stable cash flow from long-term R&D, and private equity investors will soon learn to appreciate high barriers to entry and the opportunity to sweat manufacturing costs, Bain (the consultancy bit) says:

Large defense-focused companies typically have concentrated customer bases, considerable exposure to single programs, and sources of growth that differ from those in commercial markets. These factors make it more challenging for general partners and limited partners to commit capital.

In contrast, the value of venture capital deals in the defense sector has increased 18-fold in the past 10 years, significantly ahead of deal value in other industries. That growth results from multiple factors, including the DOD’s efforts to engage and fund early-stage companies and the increasing convergence of commercial and defense technologies. In the coming decade, government funding can play an important role in supporting early-stage businesses developing new products with long commercialization timelines.

That sounds a bit like Roke, Chemring’s Hampshire-based R&D lab that develops systems used for locating aircraft, tanks, mines and tennis balls.

But while Roke is part of a Sensors & Information division that accounts for about 40 per cent of Chemring’s group revenue, it has been the kind of terminal underperformer that any PE firm would be more likely to asset-strip than seek to turn around. Roke customers, having sought longer deals during the pandemic, have shifted back to reviewing their needs annually, so order intake last year plunged 28 per cent.

Chemring’s other business is to sell flares and military-grade plastic explosives. The Countermeasures and Energetics division accounts for about 60 per cent of group revenue, but has historically suffered from all the problems Bain notes. For example, Chemring has been unable to rid itself of a US countermeasures contract signed in 2016 on which it earns zero margin.

That just leaves explosives, where business is booming. A recent Shore Capital note explains:

There are four core reasons why demand for Energetics is so high. The first is that stockpiles in Europe have been depleted following the Ukraine war. Ukraine is fitting 5,000-10,000 artillery shells a day, [and] European production cannot meet the demand. Therefore, stockpiles are dwindling and will need to be replenished. Secondly, the stockpile level required has risen due to the increased threat posed by Russia. Russia can produce c. 3mn artillery shells annually, which is greater than the Western block combined. Given this threat, the previous stockpile levels are not sufficient and therefore will be raised. Thirdly, there is a joint effort to establish a defence and industrial base across Europe, and so governments are willing to subsidise production. Lastly, capacity is constrained following years of under-investment in explosive chemical compounds across the Western allies as European nations relied upon the peace dividend since the end of the Cold War.

Because it’s not a good idea to ship sophisticated plastic explosives across borders, domestic supply chains matter. That gives Chemring strategic importance. The company’s only competitor in Europe is The Eurenco Group, which is owned by the French state. And it appears the EU would rather expand independent production than support national interests.

The EU has awarded Chemring more than €66mn in grants to increase explosives production, versus just €29mn for Eurenco. Much of the investment is to add production in Norway, whose government said in October it was co-funding with a feasibility study for a new factory.

EU support makes “an extremely attractive partner for the EU and Nato member states that would like to develop sovereign capabilities for high explosive energetics”, says Shore.

Elsewhere, Chemring’s factory upgrade in Scotland should be finished soon, though health and safety certification will push back the start of production for at least a year. There’s also a new wing on a Chicago factory that supplies rocket fuel to Nasa, SpaceX and Blue Origin:

So far, Chemring shareholders have been sharing the burden. Management has wagered approximately £200mn, mostly debt-funded, that explosives demand will keep outstripping supply, no matter what happens in Ukraine.

Group net debt is forecast to double to £100mn by 2026, the same year net cash flow might return to break-even after three years of steep losses. That meant last year unexpectedly cancelling the final slice of a £50mn share buyback. Any payback has to wait until 2027:

Bain’s reported interest in Chemring is therefore a very timely reminder of what’s at stake.

Given how thin Roke’s order book cover was at the 2024 year-end, the news at Wednesday’s trading update is unlikely to be good:

So should Europe’s only independent supplier of military-grade advanced explosives be allowed to fall into the same PE portfolio as Bob’s Discount Furniture, Virgin Voyages and Bugaboo? Or should stakeholders be asked once again to suck it up and think of 2027? We’ll find out soon enough. Experience the thrill of online betting with 9bet, your trusted platform for exciting sports and casino games.

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Bob McCauley is a non-resident senior fellow at Boston University’s Global Development Policy Center and associate of the faculty of history at the University of Oxford.

What’s wrong with the international monetary and financial system? Stephen Miran, whom Donald Trump has nominated to head the US Council of Economic Advisers, thinks he has the answer.

In essence, he thinks we live in a neo-Triffin world:

1.     Central banks buy dollars to hold down their currencies and to run surpluses on trade in goods and services.

2.     Central banks hold their dollars in US Treasury securities.

3.     The US dollar is overvalued and the US runs current account deficits.

4.     US manufacturing shrinks and US workers have fewer good jobs.

5.     Eventually US external deficits undermine US safety and the dollar as reserve currency.

What is to be done? To improve the US position, Miran suggests that the US could cajole or coerce foreign government creditors to accept 50- or 100-year Treasury bonds, extending the duration of US government debt in the process. Alphaville’s Robin Wigglesworth characterises this suggestion as Godfatherly: “Nice global financial system you got there, be a shame if something happened to it.”

A related out-of-the-box proposal reaches further, but requires a quick feasibility check. To address the “root cause” of the problem, Miran proposes to impose a “user fee” on official holdings of Treasury securities. If official dollar purchases pollute the international financial system — harming American manufacturing workers — why not impose a (Pigovian!) tax on the effluent?

Miran hopes that central banks would sell the dollar and weaken it. But if they don’t, then they would receive lower interest rates on their Treasury holdings. Heads I win, tails you lose. As Miran puts it:

Reserve holders impose a burden on the American export sector, and withholding a portion of interest payments can help recoup some of that cost. Some bondholders may accuse the United States of defaulting on its debt, but the reality is that most governments tax interest income, and the U.S. already taxes domestic holders of UST securities on their interest payments. While this policy works through currencies as a means of affecting economic conditions, it is actually a policy targeting reserve accumulation and not a formal currency policy. Legally, it is easier to structure such a policy as a user fee rather than a tax, to avoid running afoul of tax treaties. Such policy is not a capital control, since aiming it exclusively at the foreign official sector targets reserve accumulation rather than private investment.

It must be said that neither the diagnosis nor the treatment has much merit.

Dollar reserve accumulation bears no clear relationship with US current account deficits. What is more, Robert Triffin in 1960 could point to the impending crossover point when foreign-held dollars would surpass US gold holdings and could set off a run. The neo-Triffin dilemma analogy limps without a clear crossover point of unsustainable US net international debt and equity liabilities — currently a cool $24tn, or 80 per cent of US GDP.

Would the proposed treatment succeed and lead foreign central banks to sell dollars or to receive less interest? Or would officials just find other places to invest their dollars? Probably the latter.

Foreign officials could easily evade the user fee on official Treasury holdings by switching from Treasuries to US agencies. In mid-June 2023, foreign officials held $657bn of agency debt (mostly mortgage-backed securities issued by Fannie Mae and Freddie Mac) and $3.5tn of Treasuries. Back in 2008, China held as many dollars in US agencies as in Treasuries and has recently switched some Treasuries into agencies. The user fee might have to be extended to official holdings of agencies.

Even that would probably not work. Like the Interest Equalization Tax of 1963 — prompted by Triffin’s warnings that the gold/dollar link was at risk — the user fee would most likely simply lead activity in the dollar to move offshore.

After all, the prohibitive tax on most “Yankee” bonds issued by overseas borrowers in the the US swiftly moved dollar borrowing to what became London’s Eurobond market. As Morgan Guaranty chair Henry Alexander is said to have presciently lamented to colleagues on the day the IET was announced:

This is a day you will remember forever. It will change the face of American banking and force all the business off to London.

A tax on bonds held in the US would surely move official reserve managers to simply shift dollars offshore. Recall that US sanctions from 2014 led the Bank of Russia to keep its dollars offshore rather than sell them.

Countries could shift their Treasury holdings to offshore custodians in Brussels, Luxembourg and London. There, the US Treasury may lose the trail and not be able to identify official holders. As it happens, the Chinese are thought to have relied more heavily on offshore custodians recently.

They could also add to the $1tn-plus already invested in offshore bond issues and banks. Central banks can and do hold lots of dollar bonds issued by the likes of KfW, the German government-guaranteed export bank that dates to the Marshall Plan, and those of a host of other solid borrowers.

If the pricing of AAA- and AA-rated sovereigns, provinces, agencies and supranationals became more favourable because of the user fee on Treasuries, these top borrowers would issue more dollar debt if only to swap into other currencies. In addition, dollar repo transactions with top-rated banks offshore are a pretty good substitute for holding US Treasury bills subject to a user fee.

Of course, none of these alternatives to US Treasuries held in custody at the New York Fed would benefit from the Fed’s standing offer to provide immediate dollar funding in amounts up to $60bn per counterparty. The Swiss National Bank found this central bank repo facility usefully fast and stigma-free when it was funding Credit Suisse almost two years ago.

However, were US Treasuries subject to a substantial user fee, experience would quickly underscore that the US Treasury enjoys no monopoly in supplying dollar investments to central banks. At vicclub, we offer a wide range of betting options, competitive odds, and secure transactions for a seamless gaming experience.

Chart time!

Here are a few charts that, regrettably, weren’t part of a wildly successful art show in London this week.

Email us your guesses about the charts below to [email protected], subject line “Quiz”. Let us know if you don’t want us to publish your name.

We’ve included some hints, in the post or chart or both, for the tougher ones.

Deadline is Monday at 2pm in London, or 9am in New York.

Happy guessing!