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The Case for Spain
Ignacio de la Torre, Ph. D.
November, 2012
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Agenda
Myths of the Spanish economy
Spain is solvent
Spain can grow
Executive summary
Conclusions
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November 201The Case for Spain
Executive Summary
3
Journalists and analysts have spread a number of myths that paint an excessively pessimistic picture of
the Spanish economy. This presentation and its corresponding report address these misconceptions.
Spain is facing difficult times, but its problems are often exaggerated
Spain is solvent:
Assets are valued over 700% of GDP while debts are below 270%
After recapitalizing Spanish banks, the contagion effect with the Sovereign should be over
A fiscal package to reduce the deficit by 11% of GDP is being implemented
Spain is competitive and able to grow:
Exports are at record highs (above 200 bn., 22% of GDP), and they should keep growing dueto a cheap and productive labor force
Revenues from tourism and other services are also at historic highs (60 bn.) and continue to
grow
Entrepreneurs and SMEs, supported by world class large companies, should lead Spains
economic growth model going forward
With enhanced fundamentals and depressed valuations, we believe now is a fantastic moment
to invest in Spain
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Agenda
Myths of the Spanish economy
Executive summary
Conclusions
Spain is solvent
Spain can grow
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Real leverage is 268%, not 363%, as financial corporations debts should not be double counted. If
you owe 100,000 to your bank and the bank owes this 100,000 to a foreign investor, total debt is
100,000, not 200,000
Real leverage of corporations should be adjusted due to: i) amounts lent to corporations by Spanish
banks, to avoid double counting (27% of GDP), ii) Inter-company loans, also double counted (27% of
GDP), iii) 40% of GDP of this debt is real estate which is being provisioned at 20% of GDP (50% of
total), iv) Debts related to investments made in international businesses, which do not contribute to
Spanish GDP (44% of GDP)
Source: McKinsey Global Institute, Debt and deleveraging: Uneven progress on the path to growth,January 2012, p. 13
Myth 1: Spains Debt / GDP is 363%, therefore the country is near
collapse
Misrepresentation of Spanish Debt
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Myth 2: Spain is uniquely reckless in spending
6
Spains government spends less as a % of GDP than that of most other Eurozone countries and the
UK, both before and after the crisis (Spain had close to a 2% fiscal surplus in 2007)
Spains government is taking serious measures to correct the fiscal deficit, both through cost
reduction programs (including controlling spending by regional and local governments) as well as tax
increases. Local Governments are cutting costs 7% YTD
In relative terms, Spains fiscal woes are more closely related to low tax revenues than to excessive
spending
30%
35%
40%
45%
50%
55%
60%
2008 2009 2010
France Germany Greece
Ireland Italy Portugal
Spain United Kingdom United States
Government spending as a % of GDP
Source: The Heritage Foundation
N b 201Th C f S i
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November 201The Case for Spain
Myth 3: Spain is not competitive
7
As an index ofSpains competitiveness, Unit Labor Costs declined 4% since 2008, compared to that of
Spains trading partners, which increased 5-10%
Therefore, Spain has regained competitiveness of between 9-14% in cost terms, allowing exports to
thrive
Evolution of Spanish competitiveness (ULC) vs. main trading partners
Source: Eurostat
95
100
105
110
115
2008 2009 2010 2011 2012
Germany Spain France Italy
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November 201The Case for Spain
17%
12%
5% 4%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
Spain Germany France Italy
Myth 4: Spain has no growth engine to end the crisis
Spanish exports and gross tourism revenues are at a historic highs (above 200 bn. and 60 bn. per
year, respectively)
Low labor costs, increased labor flexibility, and world class social (particularly the healthcare system)and capital infrastructures create an environment conducive to growth, even if the country maintains
low levels of public investment in the coming years
Export growth evolution since 2008-2012
Source: Eurostat
Total number of tourists per year (thousands)
Source: INE
8
45,000
50,000
55,000
60,000
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Myth 5: Spain still has plenty adjustments to make, following theexamples of other crises
9
Spain has already tackled three key adjustments:
As a result of the a significant drop in imports and an increased level of exports, excluding
energy, an 8% trade deficit has turned into a 3% surplus by 2012, reducing the need for
external financing to a minimum
The financial sector is set to have provisioned close to 200 bn. by year-end 2012, as house
prices are adjusting in line with those of other economies
As discussed further in the forthcoming slides, the Spanish labor force has become much more
competitive
Trade deficit evolution
Source: INE
-8%
-6%
-4%
-2%
0%
2%
4%
Energy Excluding energy
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Myth 6: Europe will let Spain exit the Euro
Immediate insolvency of the ECB, due to
TARGET2 imbalances
Sizeable loses in the German and French
banking books
Contagion effect on Italy leading to a
likely breakup of the Euro
Sharp recession in export-led
economies
Potentially devastating implications to
the European Union as an economic and
political project
An eventual exit of Spain from the euro zone would be far more costly than supporting its liquidity
needs. The foreseeable consequences of a Spanish exit would be:
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p
11
Effect on GDP Effect on employment
(cumulative until 2020)(number of employed persons)
(cumulative until 2020)
Services Directive 1.2 39,000Labor Reform 4.5 1,763,000
Pensions Reform 0.4 71,000
Financial Sector Reform 1.6 96,000
Law on Budget Stability and
Financial Sustainability0.9 18,000
Total 8.6 1,987,000
Spain is carrying out an 11.3% fiscal adjustment, one of the broadest in the OECD in recent history.
Supply side reforms can boost GDP by almost 9% in the coming years
Fiscal reform already being implemented:
Source: Spanish Treasury
Myth 7: Spain will not reform
2012 2013 2014
( bn.) ( bn.) ( bn.)
April Adjustments 43.1 19.6 0
July Adjustments 13.5 22.9 20.1Total 56.6 42.5 20.1
% of GDP 5.4% 4.0% 1.9%
Supply side reforms already being implemented:
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p
Myth 8: Spain is bleeding its deposit base
12
High quality deposits (resident retail and corporate deposits), which banks assume to be a stable
funding source, are down only 2-3%; this hardly qualifies as a real deposit flight
The drop in the total deposit figures (6.7% YTD as of July 2012) are mostly technical in nature and
have not had a real negative impact on the financial system funding
Retail and corporate deposits in Spain (bn.)
Source: Bank of Spain
0
200
400
600
800
1,000
Dec-1
0
Jan-1
1
Feb-1
1
Mar-1
1
Apr-11
May-1
1
Jun-1
1
Jul-11
Ago-1
1
Sep-1
1
Oct-11
Nov-1
1
Dec-1
1
Jan-1
2
Feb-1
2
Mar-1
2
Apr-12
May-1
2
Jun-1
2
Jul-12
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According to CDS spreads, Spain is riskier than Indonesia, Russia, Kazakhstan, and Romania
Last time Spain defaulted was in 1883
Credit default swaps do not reflect political stability (democracy) nor stability provided by a strong
middle class (built in Spain during 1960s)
Countries default once they reach very high levels of Government debt (above 120% of GDP),
cannot access liquidity and are not able to grow. Spain is not in this situation
Sovereign CDS spread
Source: Factset
Myth 9: According to the CDS wisdom, Spain is riskier than manysmall emerging economies
0
200
400
600
800
1,000
1,200
1,400
Argentina
Pakistan
Ukraine
Portugal
EgyptSpainItaly
Ireland
Hungary
Romania
Bulgaria
Latvia
Lithuania
Kazakhstan
Turkey
Indonesia
Russia
Israel
Poland
SouthAfrica
France
Philippines
Brazil
ThailandPeru
Colombia
CzechRep.
SaudiArabia
Mexico
Estonia
Malaysia
China
Chile
AustriaJapan
Netherlands
Germany
Ukraine
SwitzerlandUS
Sweden
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Myth 10: Spaniards dont workhard
14
The Spanish labor force works more hours per year than that of most other countries in the world, inline with the UK and just below the US
Comparing Spanish labor costs and its productivity per head, Spain is one of the most attractive
countries in the world from an investment perspective
Average hours worked per year
Source: OECD
Unit labor costs and GDP per hour worked (2011)
Source: Eurostat, OECD
1,200
1,300
1,400
1,500
1,600
1,700
1,800
1,900
2004 2005 2006 2007 2008 2009 2010 2011
Spain France Italy UK USA Germany
Norway
BelgiumDenmark
FranceLuxembourgNetherlands
Germany
Finland
Austria Ireland
Italy
Spain
UK
Portugal
0
10
20
30
40
50
60
40 60 80 100 120 140
Hourlywages()
GDP per hour worked as % of US (USA=100)
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Agenda
Myths of the Spanish economy
GRO
UPPRESENTATION
Spain is solvent
Spain can grow
Executive summary
Conclusions
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Solvency = Assets - Debt
16
Spanish assets (financial and real estate, assuming 50% cuts in real estate prices) are well above debts.
Spain is solvent, but illiquid
40% of GDP of corporate debt is real estate related, half of which is being provisioned
Balance sheets of Spanish government, corporates, and households
Source: Bank of Spain, Funcas, Arcano
1,047
202
845
0
200
400
600
800
1,000
1,200
Assets Liabilities + Equity
Government
Assets Net equ ity pos it ion L iabi li ti es
5,061
4,202
859
0
1,000
2,000
3,000
4,000
5,000
6,000
Assets Liabilities + Equity
Households
Assets Net equ it y pos it ion L iabil it ies
1,792
661
1,131
0
400
800
1,200
1,600
2,000
Assets Liabilities + Equity
Corporates
Asset s Net equi ty pos it ion L iabil it ies
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Spain is solvent, but illiquid
17
Almost 80% of wealth is in illiquid real estate. Active tax policies need to be undertaken to balanceSpains savings structure
Asset split of households (% of total assets)
Source: Oliver Wyman
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0.9
0.8
1.1
0.6
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
Loans Deposits
Trillions
Companies Households
ECB and
wholesale
funding
1.7 Trillion
The Spanish financial system has addressed its main weaknesses
18
Although it has taken much longer than it should have, the Spanish financial system is successfully
addressing its liquidity and solvency weaknesses:
Liquidity: ECB has refinanced two thirds of the banks wholesale funding, mostly with 3-year
maturity funds, providing Spanish banks with certainty of funding and enough time to execute a
necessary deleveraging process, already underway
Solvency: Total provisioning will reach 20% of GDP or about 15% of the systems loan book by
2013 while increasing capital ratios. This massive effort has been tackled by a mix of (i)
operating profits, (ii) asset sales, (iii) rights issues, and (iv) Government capital injections
Financial System Loan Book Funding Structure
Source: Arcano, Bank of Spain
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Liquidity risk has been limited
19
International liquidity mechanisms are larger than Sovereign liquidity needs
The risk of contagion between Spains Sovereign debt (85% of GDP) and banks wholesale debt (over
50% of GDP) has been successfully addressed by: (i) the ECBs liquidity programs and (ii) the
comprehensive financial sector reform carried out by the Spanish government, which will result in a
much healthier and concentrated banking system
ESM/EFSF resources and gross financial public needsin Spain and Italy (bn.)
Source: Bloomberg
0
200
400
600
800
1000
Firewall Financial needs 2013-14
IMF ESM lending capacity Spain Italy
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Unparalleled fiscal adjustment underway (11.3% of GDP)
20
By 2014, Spains structural and fiscal deficits are expected to be reduced very significantly, even in theworst case economic scenario, allowing public debt to stabilize below 100% of GDP, which is lower
than the expected level of France, UK, and USA
2012 2013 2014 Acum. 2012-2014
GDP growth -1.5% -0.5% 1.2% -0.8%GDP growth (IMF estimate) -1.5% -1.3% 1.0% -1.8%
GDP growth (EU estimate) -1.4% -1.4% 0.8% -2.0%
Target deficit (% of GDP) 6.3% 4.5% 2.8% 13.6%
IMF estimated deficit (% of GDP) 7.0% 5.7% 4.6% 17.3%
EU estimated deficit (% of GDP) 7.0% 6.0% 6.4% 19.4%
Target structural deficit (% of GDP) 3.0% 1.5% 0.0% 4.5%
Implied estructural adjustment (% of GDP) 3.0% 1.5% 1.5% 6.0%
Announced adjustment (% of GDP) 5.4% 4.0% 1.9% 11.3%
Estimated public debt (% of GDP) 85.3% 91.0% 95.6%
Spains fiscal consolidation program (Governments projections unless indicated)
Source: Spanish Treasury, IMF, EC (excludes accounting impact of valuation adjustments in bank aid; ECs 2014 forecast assumes tax
cuts which are not realistic)
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H i d b i 2013 f 49% f ll
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House prices are expected to bottom in 2013 after a 49% fall
21
House prices should fall 10% in 2013 and stabilize going forward. By 2013, house prices will reachhistoric averages vs. disposable income. Total decline between 2008-2013 should reach 49%. The
contagion effect from real estate to banks should be over
House prices
Source: Ministry of Development
-15%
-10%
-5%
0%
5%
10%
15%
1,000
1,500
2,000
2,500
2006 2007 2008 2009 2010 2011 2012
per square metre (LHS) % yoy (RHS)
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G t d bt li l f i it l
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Government debt relies less on foreign capital
22
Foreigners hold 36% of Government debt (down from 55% in 2009), reducing refinancing risk as
Spanish financial institutions have picked up the balance
Spanish Government Debt by holder
Source: Spanish Treasury, IMF
33.5%
13.3%
2.3%
13.9%
36.2%
Credit Institutions Pension, insurance, mutual funds and others
Household and non financial companies Spanish of fic ia l institutions
Non Residents
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P i t t f S i b i t
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Private sector of Spain begins to save
23
Since 2010, the private sector of the economy has been saving almost 4% of GDP
Breakdown of private savings
Source: INE
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
2005
2006
2007
2008
2009
2010
2011
Q1-2
012
%ofGDP
Savings over GDP
Non-financial f irms Households
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Agenda
Myths of the Spanish economy
GR
OUPPRESENTATION
Spain is solvent
Spain can grow
Executive summary
Conclusions
November 201The Case for Spain
Spanish exports at record highs and continue to grow
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Spanish exports at record highs and continue to grow
25
Spain is already generating an ex-energy trade surplus
Spain is entering into a positive trade balance of goods and services
Evolution of Spanish exports ( mm.)
Source: INE
15%
16%
17%
18%
19%
20%
21%
22%
23%
75,000
95,000
115,000
135,000
155,000
175,000
195,000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012e
Exports Exports/GDP
0
50
100
150
200
250
300
350
400
Exports
Imports
Spanish exports and imports of goods and services
( bn.)
Source: Historical figures and projections provided by Eurostat
November 201The Case for Spain
The services and tourism sectors are at record highs
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The services and tourism sectors are at record highs
26
Spanish touristic growth is structural
Net revenue from tourism per year (m)
Source: INE. Gross revenues left by foreigners into Spain less money spent by Spaniards abroad
36,000
38,000
40,000
42,000
44,000
46,000
2007 2008 2009 2010 2011 Q3 2012
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allowing Spain to enter a current account surplus
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allowing Spain to enter a current account surplus
27
By 2013, Spain should reach current account surplus through record exports and tourism. This will
help Spain to begin reducing its external debtor position
Current account ( bn.)
Source: Bank of Spain, OECD
-12
-10
-8
-6
-4
-2
0
-40
-30
-20
-10
0
10
20
1999 2001 2003 2005 2007 2009 2011
Goods Services Factor income Current transfers CA (% of GDP)
November 201The Case for Spain
Enhanced productivity and lower real wages are making this possible
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Enhanced productivity and lower real wages are making this possible
28
A productivity revolution and lower real wages have enhanced competitiveness, allowing companies
to successfully substitute local sales with exports
Labor productivity change (2007=100)
Source: INE
Real wages evolution (YOY%)
Source: Eurostat
-4%
-2%
0%
2%
4%
6%
8%
10%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Euro area (16 countries) Spain
95
100
105
110
115
2007 2008 2009 2010 2011 2012e 2013e
Spain EU
November 201The Case for Spain
Spain today has a highly competitive labor force
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Spain today has a highly competitive labor force
29
Spanish labor is 30% cheaper than the euro zone average, but productivity difference is less than 10%
Productivity/hour worked (US=100%, 2011)
Source: The Conference Board
Labor costs (/hour)
Source: Eurostat
0%
20%
40%
60%
80%
100%
120%
140%
160%
0
5
10
15
20
25
30
3540
45
50
Norw
ay
Swed
en
Fran
ce
Netherlan
ds
Finla
nd
Irela
nd
Spain
Cypr
us
Portugal
CzechRepub
lic
Estonia
Pola
nd
Lithuania
November 201The Case for Spain
that works hard and is increasingly flexible
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that works hard and is increasingly flexible
30
Spaniards work harder than most of its trading partners, in terms of hours worked. Following thelabor reform, salary increases are no longer linked to inflation
Difference between prices and salaries (YOY%)
Source: Ministerio de Empleo y Seguridad Social, INE
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Jan-11
Feb-11
Mar-11
Apr-11
May-11
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Salaries YoY% CPI YoY%
November 201The Case for Spain
More new companies are being created than in the past
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p g p
31
More than 320,000 new companies are being created every year, although one of the greatest
challenges facing Spains corporate sector is to increase the average size of its companies
Creation of gross new companies
Source: Arcano, INE
Breakdown of companies by sizes: Spain vs. Germany
Source: Eurostat
300,000
310,000
320,000
330,000
340,000
2010 2011 20120%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Spain Germany
250 employees or more 50-249 20-49 10-19 1-9
November 201The Case for Spain
that, together with a higher value-added industrial sector, will
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, g g ,slowly help drive up employment and eventually growth
32
The industrial and services sectors will be the main engine of Spains GDP growth and employment,with industries increasing their value-added products
Most of the employment adjustments should end by 2013. With consumption currently at depressed
levels, stabilization of employment might lead to consumption growth from 2014 onwards
Evolution of Spanish value-added in the
industrial sector
Source: INE
Unemployment QOQ growth evolution (EPA)
Source: INE
25,000
30,000
35,000
40,000
45,000
2000 2002 2004 2006 2008 2010 2012
-5%
0%
5%
10%
15%
20%
25%
30%
2009 2010 2011 2012
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Agenda
Myths of the Spanish economy
GROUPPRESENTATION
Spain is solvent
Spain can grow
Executive summary
Conclusions
November 201The Case for Spain
Conclusions
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Conclusions
34
Spain in 2006
11% Current Account deficit, the second largest in the world. For every 100 euros of GDP, 11
were financed by foreigners through short term money. This is the origin of the liquidity crisis
25% Credit Expansion. To grow GDP by one euro, Spain needed four euros of additional lending.
This is the origin of the banking crisis Constructions weight in the economy increased to 12% of GDP
Tax collection increased 4% of GDP due to real estate. Yet the Government used this money to
hire more civil servants. This is the origin of the fiscal crisis
Despite these risks, asset prices were at historic highs, and Spain attracted record inflows of
portfolio money (208 bn.)
Spain in 2013
Current Account surplus. 11% adjustment in 6 years. Yet GDP has only contracted 5%
Loans down 5%. Private debt to GDP down 16% since 2009. Again, in spite of this, GDP only
contracted 5%
Construction is back to 6% of GDP, below historic average
A fiscal package of 11% of GDP is being implemented. By 2014, structural deficit will reach 0%
Despite lower risks, asset prices have plummeted, and significant portfolio money left Spain
(80bn. in 2012)
November 201The Case for Spain
Conclusions (cont.)
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Spain was not the best place to invest in 2006 but it could be in 2013
Spains condition is not as weak as many believe. Investors should disregard misguided myths
about Spain when making investment decisions and focus on fundamentals
Spain is solvent, but illiquid. The EU has established sufficient mechanisms to support Spains need
for liquidity. Spanish corporates, households, and the government are solvent
Spanish banks are seeing the light at the end of the tunnel. There are 15 main banking groups left,
leaving the sector well capitalized and with sufficient liquidity
The contagion effect from real estate to banks, and from banks to the Government, should be over
Spain is adjusting, fiscally and from a supply side point of view
Spain is growing through external demand, as exports and tourism reach record highs
Spains cheap labor costs and high productivity explain why this growth is structural, not short term
driven
The crisis is producing a new generation of Spaniards focused on entrepreneurship, SMEs and R&D
November 201The Case for Spain
Spain will emerge from its ashes, like the Phoenix!
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p g ,
36
Thanks!
November 201The Case for Spain
Arcano: your local house of reference to invest in Spain
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About Arcano (www.arcanogroup.com)
A leading independent advisory services firm with presence in Europe and the United States. The
company specializes in three areas: Investment Banking, Asset Management, and Multifamily
Office Our team is formed by 70 qualified professionals that work to offer financial advisory services
and tailored solutions for our clients with a unique, independent approach
Arcanos Investment Banking unit is recognized as a leader in the small and mid-market segment
of the Spanish market, including clients such as Private Equity firms, family owned companies and
publicly traded corporations. Arcano also provides pre-IPO finance rounds to companies for
deals ranging from 10 m. upwards to support expansion up to 2 years before the IPO; on the
small cap side, Arcano helps small companies float on the Spanish Alternate Market (MAB) with
offering sizes from 10 m. upwards, and it intermediates block trades in small caps in the Spanishequity markets
About the author
Ignacio de la Torre has been a Partner of Arcano since 2008
Fifteen years of experience in investment banking and capital markets, having worked in the
equity research and equity sales departments of Deutsche Bank and UBS Investment Bank
The author is also a part time Professor of Finance and Economics at IE Business School. He
holds an MBA from Insead, a Ph. D. in History from UNED, an M. Sc. from ICADE, and a M. A.from UNED. He has authored four books and won the Everis prize in 2009
November 201The Case for Spain
Disclaimer
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Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the subject issuer
and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for
providing a specific recommendation or view in this report. Ignacio de la Torre.
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