We got lucky as Mr.Market quickly recognized the value in this stock. Sold 66% of this stock and there is still a little bit of further upside.
Thursday, May 12, 2011
Saturday, January 29, 2011
This week focus is to learn from Sir John Templeton
I will add 10-15 links of various interviews of John Templeton. It is good advice to read and get insights from these interviews. It is incredible based on this inteview, John Templeton was able to see mortgage crisis way before. Some quotes I like
- To be successful you need to keep changing your ideas and some times more than once a year. You should still have the same frame work but ideas need to be changed. This is the same lesson once peter cundill said about he was not flexible enough. Personally I was doing lot of net nets from last two years but I need to move on because net nets do really well when economy is in recovery mode
- "I have observed in 92 years that the people who are most diligent in working do live many years longer than those who are lazy," Sir John says.
- Do the Opposite of the Crowd: My job was being paid by wealthy families to help them choose stocks and bonds. And my results were much better when I was working from here than from Manhattan, Radio City and Rockefeller Center. I had good results in New York. But when I came here, I had better results. The secret, I think, is that in order to buy stocks at a bargain price, you have to do the opposite of the crowd. When you're going to the same meetings with the other people in Manhattan, it's hard to be different.
- Templeton does not base on his investment choices based on country growth prospects. His decisions to allocate money are dependent on where he can find the lowest valuations. He thinks there are many opportunities in the United States.
- At 84, he says one need to be industrious, he is more busier, enthusiatic, happier, joyful than ever in his life. Post world war II, most of the investment ideas are in Japan. Japan was 1/10 of the price of similar businesses. One of the basic principles to buy where ever it is cheaper and this is only when one is selling. People were selling in Japan after world war.
- Couple of days when hitler invaded poland. There were 104 companies that went below 1 dollar a share. John templeton asked to buy everything that is selling for less than a dollar and 37 of them are in Bankruptcy. He says those are the best of all. One outstanding once was missouri pacific railway, it gotten down to 12 cents a share. Railroads come back in war. He got 40 times what he paid for.
- 1/3 of the time all my investments are wrong. So please do not worry you can still make around 13% in the long run
- Benjamin Franklin is one person who has influenced him the most
- When there are no bargains, the key investment strategy in this environment is to go long on 10 well managed solid stocks and short on 10 that are in similar industries that do not posses the qualities of favorite
10.
- If we are increasingly humble about how little we know, we may be more eager to search
- Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria
- The four most expensive words in the English language are "this time it's different"
- Investments are different, if you go to 10 doctors they prescribe the same medicine, if you go to 10 engineers, they prescribe to build in similar way and if you go to 10 investment specialits and if they all prescribe the same stock, you need to stay away from it
- Stock price fluctuations are proportional to the square root of the price. When your method becomes popular, switch to an unpopular method. Stay flexible. No asset or method is forever. In the long run, stock index prices fluctuate around the EPS trend line
- Templeton's tip for bond investors: Focus on countries that have both trade and budget surpluses. Russia and Canada fit the bill.
- In 2003 "Every previous major bear market has been accompanied by a bear market in home prices. ... This time, home prices have gone up 20%, and this represents a very dangerous situation. When home prices do start down, they will fall remarkably far. In Japan, home prices are down to less than half what they were at the stock market peak." Sir John adds, "A home-price decline of as little as 20% would put a lot of people in bankruptcy.
http://www.sirjohntempleton.org/articles_details.asp?a=9
http://www.lanczglobal.com/SirJohnInterview.htm
http://www.charlierose.com/view/interview/5555
http://chinese-school.netfirms.com/Sir-John-Templeton-interview.html
http://chinese-school.netfirms.com/abacus-Sir-John-Templeton-interview.html
http://www.gurufocus.com/news.php?id=82503
http://www.youtube.com/watch?v=EjINZszzYDs
http://www.sirjohntempleton.org/articles_details.asp?a=14
- To be successful you need to keep changing your ideas and some times more than once a year. You should still have the same frame work but ideas need to be changed. This is the same lesson once peter cundill said about he was not flexible enough. Personally I was doing lot of net nets from last two years but I need to move on because net nets do really well when economy is in recovery mode
- "I have observed in 92 years that the people who are most diligent in working do live many years longer than those who are lazy," Sir John says.
- Do the Opposite of the Crowd: My job was being paid by wealthy families to help them choose stocks and bonds. And my results were much better when I was working from here than from Manhattan, Radio City and Rockefeller Center. I had good results in New York. But when I came here, I had better results. The secret, I think, is that in order to buy stocks at a bargain price, you have to do the opposite of the crowd. When you're going to the same meetings with the other people in Manhattan, it's hard to be different.
- Templeton does not base on his investment choices based on country growth prospects. His decisions to allocate money are dependent on where he can find the lowest valuations. He thinks there are many opportunities in the United States.
- At 84, he says one need to be industrious, he is more busier, enthusiatic, happier, joyful than ever in his life. Post world war II, most of the investment ideas are in Japan. Japan was 1/10 of the price of similar businesses. One of the basic principles to buy where ever it is cheaper and this is only when one is selling. People were selling in Japan after world war.
- Couple of days when hitler invaded poland. There were 104 companies that went below 1 dollar a share. John templeton asked to buy everything that is selling for less than a dollar and 37 of them are in Bankruptcy. He says those are the best of all. One outstanding once was missouri pacific railway, it gotten down to 12 cents a share. Railroads come back in war. He got 40 times what he paid for.
- 1/3 of the time all my investments are wrong. So please do not worry you can still make around 13% in the long run
- Benjamin Franklin is one person who has influenced him the most
- When there are no bargains, the key investment strategy in this environment is to go long on 10 well managed solid stocks and short on 10 that are in similar industries that do not posses the qualities of favorite
10.
- If we are increasingly humble about how little we know, we may be more eager to search
- Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria
- The four most expensive words in the English language are "this time it's different"
- Investments are different, if you go to 10 doctors they prescribe the same medicine, if you go to 10 engineers, they prescribe to build in similar way and if you go to 10 investment specialits and if they all prescribe the same stock, you need to stay away from it
- Stock price fluctuations are proportional to the square root of the price. When your method becomes popular, switch to an unpopular method. Stay flexible. No asset or method is forever. In the long run, stock index prices fluctuate around the EPS trend line
- Templeton's tip for bond investors: Focus on countries that have both trade and budget surpluses. Russia and Canada fit the bill.
- In 2003 "Every previous major bear market has been accompanied by a bear market in home prices. ... This time, home prices have gone up 20%, and this represents a very dangerous situation. When home prices do start down, they will fall remarkably far. In Japan, home prices are down to less than half what they were at the stock market peak." Sir John adds, "A home-price decline of as little as 20% would put a lot of people in bankruptcy.
http://www.sirjohntempleton.org/articles_details.asp?a=9
http://www.lanczglobal.com/SirJohnInterview.htm
http://www.charlierose.com/view/interview/5555
http://chinese-school.netfirms.com/Sir-John-Templeton-interview.html
http://chinese-school.netfirms.com/abacus-Sir-John-Templeton-interview.html
http://www.gurufocus.com/news.php?id=82503
http://www.youtube.com/watch?v=EjINZszzYDs
http://www.sirjohntempleton.org/articles_details.asp?a=14
Thursday, January 27, 2011
Sold -1-800-Flowers @2.85 - 54% in 4 months with annualized return of 162%
Today I sold 1-800-flowers at 2.85. We bought this on sep 27 for 1.85, a 54% gain in four months. There might be further upside but I am happy with this return. We cannot hold these cigar butts for a long time. With out a strong competitive advantage in the business, we need to get out of it. After further research, I was not too comfortable with the management team also.
Tuesday, January 25, 2011
Bought Cache @ 3.99
Company (Cache Inc – Bought at $3.99, 52 wk range – 3.86 – 7.25, P/B – 0.81, Market cap - $51MM)
Profile: Cache owns and operates more than 270 women's-apparel specialty stores. The company's stores are concentrated in large metropolitan and suburban areas across the United States, often in shopping malls. Merchandise sold includes sportswear, eveningwear, and various accessories. The company purchases approximately 98% of the goods it sells from domestic vendors and about 2% from foreign investors
Story: The story is very simple. This company currently valued at $51 Million. It has $25MM cash and $2.23MM debt. Basically 50% in cash. So the business is selling for Enterprise value of $29MM. Before 2008, it used to trade close to $18 dollars. The average cash flow was close to $1.00 from 2002 excluding 2008, 09, 10 and average earnings was close to 60 cents. Obviously they did not do well in last three years in this market. Will it do well in next three years – I do not know. We all know how competitive a retail business is. This is not a good business but selling very cheap. I think the downside risk is very low
Catalyst: Why suddenly interest in this company. Most of you might not know who Seth Klarman is - but he is a legend in value investing. Michael Price is guru of Seth Klarman. He owns 15% of the stock. Recently company started deleveraging. In a recent call, the CEO was excited to reduce their inventory. They are not madly expanding and they are closing unprofitable stores. The best part was that there are more than 25% of stores that are coming up for lease renewals. I think they will renegotiate some of them and close the unprofitable ones. What Michael Price can bring to the table is – he will make sure the management does not squander cash and might bring a potential deals to the table
Upside / Downside: If it generates $1:00 cash flow like what it did historically, its value should be $10 with P/E 10 multiple. With additional $2:00 in cash, it should trade close to $12. Obviously the downside is close to $2:00 in cash. Do I think will it trade it at 12:00 in next 1 yr? Maybe not. Will it trade at $8:00 - $12:00 in 3-5yrs, yes I think it is possible. Please note that this is again not a good business but it has cheap valuation. You should not invest more than 1%-2% of your portfolio. Group of cheap companies will do fine in the long run and one should never concentrate in one single stock
Profile: Cache owns and operates more than 270 women's-apparel specialty stores. The company's stores are concentrated in large metropolitan and suburban areas across the United States, often in shopping malls. Merchandise sold includes sportswear, eveningwear, and various accessories. The company purchases approximately 98% of the goods it sells from domestic vendors and about 2% from foreign investors
Story: The story is very simple. This company currently valued at $51 Million. It has $25MM cash and $2.23MM debt. Basically 50% in cash. So the business is selling for Enterprise value of $29MM. Before 2008, it used to trade close to $18 dollars. The average cash flow was close to $1.00 from 2002 excluding 2008, 09, 10 and average earnings was close to 60 cents. Obviously they did not do well in last three years in this market. Will it do well in next three years – I do not know. We all know how competitive a retail business is. This is not a good business but selling very cheap. I think the downside risk is very low
Catalyst: Why suddenly interest in this company. Most of you might not know who Seth Klarman is - but he is a legend in value investing. Michael Price is guru of Seth Klarman. He owns 15% of the stock. Recently company started deleveraging. In a recent call, the CEO was excited to reduce their inventory. They are not madly expanding and they are closing unprofitable stores. The best part was that there are more than 25% of stores that are coming up for lease renewals. I think they will renegotiate some of them and close the unprofitable ones. What Michael Price can bring to the table is – he will make sure the management does not squander cash and might bring a potential deals to the table
Upside / Downside: If it generates $1:00 cash flow like what it did historically, its value should be $10 with P/E 10 multiple. With additional $2:00 in cash, it should trade close to $12. Obviously the downside is close to $2:00 in cash. Do I think will it trade it at 12:00 in next 1 yr? Maybe not. Will it trade at $8:00 - $12:00 in 3-5yrs, yes I think it is possible. Please note that this is again not a good business but it has cheap valuation. You should not invest more than 1%-2% of your portfolio. Group of cheap companies will do fine in the long run and one should never concentrate in one single stock
Thursday, January 20, 2011
Lessons learned from my 32 bagger - GGP - General Growth Properties
Finally I sold my General growth properties last week. I bought it around 67 cents and finally sold it around 21 dollars. As many of you know that General growth propertie is second biggest mall owner is US. It has liquidity problem in 2009 and the stock tanked from 60 dollars to 67 cents. While I was searching for deep value, I found GGP. When Bill Ackman explained that it will go to atleast 15 dollars, stock started rallying.
Here are few learnings
- you will always find buyers for good business
- In a restructuring game, hedge fund titans like Bill Ackman can really change the game. He really helped the stock price by not selling this cheaply to Simon propery group
- you could also buy the bonds (probably was a safer route). I did not use that strategy
- Finally patience and it almost tanked 50% couple of times and you need to have a strong stomach
- Understand the valuation so that you don't need to sell when it is a two bagger or 3 bagger and wait until it reaches if fair value
- Only when there is a lot of uncertainity in market, you will find good values
I am totally spoiled now and I hope I will find atleast a 10 bagger in next 5 years
Here are few learnings
- you will always find buyers for good business
- In a restructuring game, hedge fund titans like Bill Ackman can really change the game. He really helped the stock price by not selling this cheaply to Simon propery group
- you could also buy the bonds (probably was a safer route). I did not use that strategy
- Finally patience and it almost tanked 50% couple of times and you need to have a strong stomach
- Understand the valuation so that you don't need to sell when it is a two bagger or 3 bagger and wait until it reaches if fair value
- Only when there is a lot of uncertainity in market, you will find good values
I am totally spoiled now and I hope I will find atleast a 10 bagger in next 5 years
Monday, January 3, 2011
Bought SKX at 21.80
Skechers - 01/04/11
Summary
- Skechers designs and markets Skechers-branded contemporary footwear for men, women and children under several unique lines. Skechers operate 235 retail stores and 40 international stores. Core consumers are style-conscious 12 to 24 year-old men and women attracted to our youthful brand image and fashion- forward designs. Skechers best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Brand recognition is an important element for success in the footwear business. Skechers basically designs shoes and outsource all their manufacturing to china using third party vendors
Latest Story Line:
Recently the stock price tanked from $44 to $20.57 as of yesterday in the last six months. Its market cap is 1.0B and Enterprise value of $731MM. It recently fell pretty hard due to its inventory problems and market believes that its recent “Shape UP” line could be fad. There are even couple of lawsuits that their advertising is false. Recently Nike did not even design shape ups thinking it is fad.
The most important question whether this is a short term problem or fundamentally much deep rooted problem. Before we answer this question, let’s look at the DNA of this company.
Skechers was started in 1992 by Robert Greenberg. Let’s look at the career of Robert Greenberg (Career: Talk of the Town, 1962–1969, owner; Wig Bazaar, 1965–1968, owner; Wigs 'n Things, 1968–1970, owner; Europa Group, 1970, owner; Europa Hair, 1971–1974, owner; Wild Oats, 1974, importer; Removatron, 1977, investor; Roller Skates of America, 1979–1983, owner; L.A. Gear, 1983–1992, CEO; Skechers USA, 1992–, CEO).
Obviously plenty of experience in Hair Products and Shoes. Both of them have a touch of fashion and fickle minded customers. To provide some ammo to the shorts, the earlier business he started was L.A.Gear (which capitalized on the aerobics craze of the 1980’s.). By 1990, L.A.Gear had $820million in sales and no.3 retailer behind Nike and Reebok. It took a loan amount of $360MM from a consortium led by Bank of America and one of the covenants stated that if L.A.Gear lost money in any quarter they would pull the line. Obviously they lost money in one quarter and the rest is history and it filed for BK in 1998. In a way this is good as he obviously learned his lesson as Walter Schloss said in Rule no.16 - “Be Careful of leverage as it can go against you”. The good part is that he has plenty of experience in Shoe business and he has learned his lesson related to leverage. No wonder, SKX has $249 MM in cash without any debt.
If you look at Shoe industry, it is very sensitive to fickle mindedness of the customers. As a value investor why would you bet on this kind of business unless it sells very cheap. Obviously the recent hot product “Shape Ups” could be real disaster but if you ignore this product, it was still selling close to $1.5B in revenues in the last two years. I think the core earnings are in line and even if you assume they do not make a penny on shape up’s, they have strong operating leverage going forward.
It recently started going into two most populous countries in the world (China and India) and also in Brazil. International whole sale business is up by 26% for Q3 and 36% for the first 9 months. Most of the subsidiaries had double digit growths for the first 9 months. They currently have 43 stores in Asian Region and point of sales to 375. Let’s look at last quarter numbers. Sales were $554MM. Domestic whole sale is 56%, International whole sale is 22% and Retail is 20%. The domestic retail grew by 14% and international retail grew by 52% Even if you assume that 25% ($500MM) from toning sale is zero value add, still the stock looks cheap. You also get a free option for BRIC/toning play/retail improvement in 2011/12. They just opened 4 Skechers stores in Mexico.
Obviously we cannot compare these three businesses but let’s look at a few numbers for SKX, Nike and Crocs.
Skechers
P/B – 1.12
P/S – 0.52
P/E (TTM) – 6.25
Forward P/E – 8.75
Nike
P/B – 4.41
P/S – 2.2
P/E (TTM) – 21.75
Forward P/E – 17.18
Crocs
P/B – 4.16
P/S – 2.04
P/E (TTM) – 29.93
Forward P/E – 18.46
I think even though they messed up these designs and the inventory is bloated, if you have long term horizon this should do fine. It has lot of other designs. I think they could easily get to $2.0B in sales in next three years and have a margin of 5% - 7% and this could earn up to $100MM - $140MM. . I think this would mainly come from growing internationally. Currently 22% of sales are coming from international sales and this could go easily up to 40% sales. With a $249MM in Cash and this could easily grow to $300MM by Q2’10. Then the enterprise value will be close to $700MM and a potential earnings yield of 14% - 17% on Enterprise value in next 2-3 yrs.
Obviously lots of assumptions go into this estimate but here are few things that can throw a curve ball into these estimates.
Design failures
Unable to pass the increased cost of goods due to inflation
Most of the manufacturing is in China and with strong renminbi, this could be an issue
Currency Translation
If you look beyond four quarters, I think this should do well unless they really mess up their process but without any debt and potential strong international expansion, I think it will be a decent business with intrinsic value between $32 - $36.
But for next two quarters, you will see plenty of bad news when they start writing off their inventory.
You should have a strong stomach to hold this business. But with longer time lines and you can make decent money on the wall-street short sightedness.
Summary
- Skechers designs and markets Skechers-branded contemporary footwear for men, women and children under several unique lines. Skechers operate 235 retail stores and 40 international stores. Core consumers are style-conscious 12 to 24 year-old men and women attracted to our youthful brand image and fashion- forward designs. Skechers best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Brand recognition is an important element for success in the footwear business. Skechers basically designs shoes and outsource all their manufacturing to china using third party vendors
Latest Story Line:
Recently the stock price tanked from $44 to $20.57 as of yesterday in the last six months. Its market cap is 1.0B and Enterprise value of $731MM. It recently fell pretty hard due to its inventory problems and market believes that its recent “Shape UP” line could be fad. There are even couple of lawsuits that their advertising is false. Recently Nike did not even design shape ups thinking it is fad.
The most important question whether this is a short term problem or fundamentally much deep rooted problem. Before we answer this question, let’s look at the DNA of this company.
Skechers was started in 1992 by Robert Greenberg. Let’s look at the career of Robert Greenberg (Career: Talk of the Town, 1962–1969, owner; Wig Bazaar, 1965–1968, owner; Wigs 'n Things, 1968–1970, owner; Europa Group, 1970, owner; Europa Hair, 1971–1974, owner; Wild Oats, 1974, importer; Removatron, 1977, investor; Roller Skates of America, 1979–1983, owner; L.A. Gear, 1983–1992, CEO; Skechers USA, 1992–, CEO).
Obviously plenty of experience in Hair Products and Shoes. Both of them have a touch of fashion and fickle minded customers. To provide some ammo to the shorts, the earlier business he started was L.A.Gear (which capitalized on the aerobics craze of the 1980’s.). By 1990, L.A.Gear had $820million in sales and no.3 retailer behind Nike and Reebok. It took a loan amount of $360MM from a consortium led by Bank of America and one of the covenants stated that if L.A.Gear lost money in any quarter they would pull the line. Obviously they lost money in one quarter and the rest is history and it filed for BK in 1998. In a way this is good as he obviously learned his lesson as Walter Schloss said in Rule no.16 - “Be Careful of leverage as it can go against you”. The good part is that he has plenty of experience in Shoe business and he has learned his lesson related to leverage. No wonder, SKX has $249 MM in cash without any debt.
If you look at Shoe industry, it is very sensitive to fickle mindedness of the customers. As a value investor why would you bet on this kind of business unless it sells very cheap. Obviously the recent hot product “Shape Ups” could be real disaster but if you ignore this product, it was still selling close to $1.5B in revenues in the last two years. I think the core earnings are in line and even if you assume they do not make a penny on shape up’s, they have strong operating leverage going forward.
It recently started going into two most populous countries in the world (China and India) and also in Brazil. International whole sale business is up by 26% for Q3 and 36% for the first 9 months. Most of the subsidiaries had double digit growths for the first 9 months. They currently have 43 stores in Asian Region and point of sales to 375. Let’s look at last quarter numbers. Sales were $554MM. Domestic whole sale is 56%, International whole sale is 22% and Retail is 20%. The domestic retail grew by 14% and international retail grew by 52% Even if you assume that 25% ($500MM) from toning sale is zero value add, still the stock looks cheap. You also get a free option for BRIC/toning play/retail improvement in 2011/12. They just opened 4 Skechers stores in Mexico.
Obviously we cannot compare these three businesses but let’s look at a few numbers for SKX, Nike and Crocs.
Skechers
P/B – 1.12
P/S – 0.52
P/E (TTM) – 6.25
Forward P/E – 8.75
Nike
P/B – 4.41
P/S – 2.2
P/E (TTM) – 21.75
Forward P/E – 17.18
Crocs
P/B – 4.16
P/S – 2.04
P/E (TTM) – 29.93
Forward P/E – 18.46
I think even though they messed up these designs and the inventory is bloated, if you have long term horizon this should do fine. It has lot of other designs. I think they could easily get to $2.0B in sales in next three years and have a margin of 5% - 7% and this could earn up to $100MM - $140MM. . I think this would mainly come from growing internationally. Currently 22% of sales are coming from international sales and this could go easily up to 40% sales. With a $249MM in Cash and this could easily grow to $300MM by Q2’10. Then the enterprise value will be close to $700MM and a potential earnings yield of 14% - 17% on Enterprise value in next 2-3 yrs.
Obviously lots of assumptions go into this estimate but here are few things that can throw a curve ball into these estimates.
Design failures
Unable to pass the increased cost of goods due to inflation
Most of the manufacturing is in China and with strong renminbi, this could be an issue
Currency Translation
If you look beyond four quarters, I think this should do well unless they really mess up their process but without any debt and potential strong international expansion, I think it will be a decent business with intrinsic value between $32 - $36.
But for next two quarters, you will see plenty of bad news when they start writing off their inventory.
You should have a strong stomach to hold this business. But with longer time lines and you can make decent money on the wall-street short sightedness.
Monday, October 25, 2010
Warren Buffett hired Todd Combs, 39, to manage some of Berkshire Hathaway's portfolio
FORTUNE -- Today, a large Berkshire Hathaway mystery lifted when a Greenwich, Conn., hedge fund, Castle Point Capital Management, quietly advised its investors that the fund's managing partner, Todd Anthony Combs, would leave to join Berkshire at the end of the year.
Behind that simple fact is a big story: Combs, a mere 39, will with this move become the leading contender to eventually succeed Warren Buffett as manager of Berkshire's billions in investments.
The word "investment" is key to that last sentence. As chairman of Berkshire, Buffett has two jobs: He runs the business as CEO, and he manages Berkshire's huge investments in securities. It is the investment job for which Combs is the leading contender.
Buffett's hiring of Combs at least partially satisfies a commitment Buffett made to Berkshire's shareholders more than threes year ago in his 2007 annual letter, published in March that year. Buffett said were he to die "tonight," the company would have three outstanding candidates in the CEO half of his job. On the investment side, however he conceded that good candidates were not lined up in the wings.
http://money.cnn.com/2010/10/25/news/todd_combs_berkshire.fortune/index.htm
Behind that simple fact is a big story: Combs, a mere 39, will with this move become the leading contender to eventually succeed Warren Buffett as manager of Berkshire's billions in investments.
The word "investment" is key to that last sentence. As chairman of Berkshire, Buffett has two jobs: He runs the business as CEO, and he manages Berkshire's huge investments in securities. It is the investment job for which Combs is the leading contender.
Buffett's hiring of Combs at least partially satisfies a commitment Buffett made to Berkshire's shareholders more than threes year ago in his 2007 annual letter, published in March that year. Buffett said were he to die "tonight," the company would have three outstanding candidates in the CEO half of his job. On the investment side, however he conceded that good candidates were not lined up in the wings.
http://money.cnn.com/2010/10/25/news/todd_combs_berkshire.fortune/index.htm
Sunday, October 17, 2010
Bought Shanda interactive Entertainment - SNDA @ $40.20
Shanda Entertainment is one of the largest operators of online games in China through Shanda Games. In 2009 it spun off Shanda Games for $1B in an IPO. This is capitalizing on china’s exploding online gaming market. As part of its growth strategy, the company in 2009 acquired 51% of ringtone provider Hurray! Holding Co. -- later renamed Ku6 Media Co. -- in a deal valued at $46.2 million. Then, in 2010 Shanda and Ku6 completed an asset swap: Ku6 acquired 75% an online audio business of Shanda in exchange for about 415 million newly issued shares of Ku6, while Shanda acquired Ku6's recorded music and wireless value-added services businesses for some $37 million in cash. The deal is part of Shanda's use of proceeds from the 2009 spinoff and IPO of its games unit.
Shanda has unique model. It includes a venture capital fund that invests in fledgling independent game studios, and taps the full potential of promising new games by leveraging the firm's management expertise and gaming platform. This strategy can be particularly effective in expanding and refreshing the game portfolio, to keep its large gamer community "hooked" to the Shanda platform. Currently, the company offers 33 multiplayer and casual games on its website, with another 28 games in the pipeline.
Shanda is also into online literature, online video and other media related businesses.
Competitors: The main competitors are Tencent and NetEase. Currently there is talk that Shanda is lagging behind the competitors as Shanda is dependent on few aging games for the bulk of the revenue.
What can go wrong with this stock?
- Mismanagement of cash due to bad acquisitions. Currently we have not seen anything like that
- If Chinese market crashes, the stock price might temporarily gets depressed but we have strong downward protection with $25 cash
- Accounting Fraud is one other biggest concern for us. We have seen more of that in smaller Chinese companies but not in large companies
Why do you invest in technology stocks and it is not deep value investing ?
- We do not go with conventional definition of deep value. We have strong downside protection with more than $20/share cash. Currently the stock price is close to $40.
- In technology and some businesses, sometimes the future is not very clear but we know that they have valuable digital assets. Even if you put $0 value for all those assets, still it damn cheap selling for less than 4 times EV/EBITDA. The value of online games is just $42.
- Shanda Literature and online video has the potential to be huge. They recently came up with Chinese version of kindle. They also get their revenue from ring tones
(Recent Excerpts from an interview from Mason Hawkins on Shanda Entertainment. Very respected Value investor. Thanks Value investor insight)
We wouldn’t expect a company with “Chinese” and “Internet” in its business description to have a value-priced stock. Why do you consider that the case with Shanda Interactive?
- KS: Shanda Interactive is a leading online entertainment media company in China, basically providing the platform for players of online games created by its publicly traded and 70%-owned subsidiary, Shanda Games. They run more than 30 online games, the blockbuster being Legend of Mir II, a multi-player online role-playing game akin to Activision Blizzard’s World of Warcraft. The business model varies, but for the most part the network’s 100 million registered users can start playing any given game for free, but they then pay to upgrade their capabilities or powers to advance further into the game. Shanda’s stock got hit earlier this year after they tweaked Legend of Mir II so that it was easier to just buy new powers than have to earn them, which turned some hardcore players off. Usage went down and they had to revise earnings expectations, which sent the stock in January from almost $60 to less than $40. We saw that as a temporary problem they will work through, so that gave us an excellent buying opportunity. On a consolidated basis, Shanda Interactive has cash on its balance sheet worth 65% of its current market cap, so obviously whether value is created or destroyed going forward has a lot to do with how they spend that cash. We like that the CEO, Tianqiao Chen, owns more than 40% of the company and has his entire net worth invested in it. He also has a clear eye on increasing shareholder value and has spent more money in the past two years on share repurchases than on anything else by far. At one point he issued convertible debt with a strike price of $35 and used the proceeds to buy back stock at an average of $28 per share
How cheap do you consider the shares today, at a recent price of $40.90?
- KS: The current market value is around $2.7 billion and they have nearly $1.9 billion in net cash, so the enterprise value is only about $800 million. We estimate the company will make $270 million in free cash flow over the next twelve months, so the multiple of that on an EV basis is only about 3x. That makes no sense to us for a company with 35%-plus operating margins, an attractive network effect, a sticky revenue model, and still-vibrant growth prospects in an underpenetrated market. We value Shanda Games on its own at $11.25 per share [versus a current market price of around $5.80], which assumes a 7x multiple of free cash flow (after cash) for a business that should grow at least at a low-teens rate. That valuation translates into roughly $42 per share in Shanda Interactive value. There’s another $20 per share in cash
- at the holding company level. On top of that is the “rent” Shanda Interactive receives from Shanda Games for access to
- its online network – at 17x free cash flow, that’s worth another $10 per share. That brings our intrinsic value estimate for the holding company to more than $70 per share. If we’re right about management investing the cash wisely, that could easily turn out to be conservative.
Shanda has unique model. It includes a venture capital fund that invests in fledgling independent game studios, and taps the full potential of promising new games by leveraging the firm's management expertise and gaming platform. This strategy can be particularly effective in expanding and refreshing the game portfolio, to keep its large gamer community "hooked" to the Shanda platform. Currently, the company offers 33 multiplayer and casual games on its website, with another 28 games in the pipeline.
Shanda is also into online literature, online video and other media related businesses.
Competitors: The main competitors are Tencent and NetEase. Currently there is talk that Shanda is lagging behind the competitors as Shanda is dependent on few aging games for the bulk of the revenue.
What can go wrong with this stock?
- Mismanagement of cash due to bad acquisitions. Currently we have not seen anything like that
- If Chinese market crashes, the stock price might temporarily gets depressed but we have strong downward protection with $25 cash
- Accounting Fraud is one other biggest concern for us. We have seen more of that in smaller Chinese companies but not in large companies
Why do you invest in technology stocks and it is not deep value investing ?
- We do not go with conventional definition of deep value. We have strong downside protection with more than $20/share cash. Currently the stock price is close to $40.
- In technology and some businesses, sometimes the future is not very clear but we know that they have valuable digital assets. Even if you put $0 value for all those assets, still it damn cheap selling for less than 4 times EV/EBITDA. The value of online games is just $42.
- Shanda Literature and online video has the potential to be huge. They recently came up with Chinese version of kindle. They also get their revenue from ring tones
(Recent Excerpts from an interview from Mason Hawkins on Shanda Entertainment. Very respected Value investor. Thanks Value investor insight)
We wouldn’t expect a company with “Chinese” and “Internet” in its business description to have a value-priced stock. Why do you consider that the case with Shanda Interactive?
- KS: Shanda Interactive is a leading online entertainment media company in China, basically providing the platform for players of online games created by its publicly traded and 70%-owned subsidiary, Shanda Games. They run more than 30 online games, the blockbuster being Legend of Mir II, a multi-player online role-playing game akin to Activision Blizzard’s World of Warcraft. The business model varies, but for the most part the network’s 100 million registered users can start playing any given game for free, but they then pay to upgrade their capabilities or powers to advance further into the game. Shanda’s stock got hit earlier this year after they tweaked Legend of Mir II so that it was easier to just buy new powers than have to earn them, which turned some hardcore players off. Usage went down and they had to revise earnings expectations, which sent the stock in January from almost $60 to less than $40. We saw that as a temporary problem they will work through, so that gave us an excellent buying opportunity. On a consolidated basis, Shanda Interactive has cash on its balance sheet worth 65% of its current market cap, so obviously whether value is created or destroyed going forward has a lot to do with how they spend that cash. We like that the CEO, Tianqiao Chen, owns more than 40% of the company and has his entire net worth invested in it. He also has a clear eye on increasing shareholder value and has spent more money in the past two years on share repurchases than on anything else by far. At one point he issued convertible debt with a strike price of $35 and used the proceeds to buy back stock at an average of $28 per share
How cheap do you consider the shares today, at a recent price of $40.90?
- KS: The current market value is around $2.7 billion and they have nearly $1.9 billion in net cash, so the enterprise value is only about $800 million. We estimate the company will make $270 million in free cash flow over the next twelve months, so the multiple of that on an EV basis is only about 3x. That makes no sense to us for a company with 35%-plus operating margins, an attractive network effect, a sticky revenue model, and still-vibrant growth prospects in an underpenetrated market. We value Shanda Games on its own at $11.25 per share [versus a current market price of around $5.80], which assumes a 7x multiple of free cash flow (after cash) for a business that should grow at least at a low-teens rate. That valuation translates into roughly $42 per share in Shanda Interactive value. There’s another $20 per share in cash
- at the holding company level. On top of that is the “rent” Shanda Interactive receives from Shanda Games for access to
- its online network – at 17x free cash flow, that’s worth another $10 per share. That brings our intrinsic value estimate for the holding company to more than $70 per share. If we’re right about management investing the cash wisely, that could easily turn out to be conservative.
Saturday, October 16, 2010
Scary stuff about China and Japan bubble
One of the very good interviews I read about China and Japan. I need to validate this info with my friends in China and Japan. Very logical interview, though I do not agree few points but still very interesting info. Thanks Contrarian Edge
An interview with Vitaliy Katsenelson, Chief Investment Officer, Investment Management Associates, Inc., and author of Active Value Investing. Profiled in Barron’s in September 2009, Vitaliy, who was born in Murmansk, Russia, and moved to the U.S. in 1991, from 2007 to 2007 was an adjunct faculty member at the University of Colorado at Denver’s Graduate School of Business.
TCR: What our readers are looking for is a better sense of China and Japan, both of which are very important in the context of the global economy. As we have to start somewhere, let’s start with China.
Today the conventional wisdom is that somehow the Chinese economy is better managed than its competitors, very similar to how people viewed Japan in the 1970s and 1980s. Back then people were absolutely convinced that Japan was the superior country with superior policies and that its economy was unstoppable. We all know how that ended.
So, let’s start there. Is China’s system better than everyone else’s? Is it really possible the Chinese economy can keep steamrolling along?
VK: A few months ago, I watched a movie about Ayn Rand and it talked about how Americans in the 1930s looked at the Soviet Union’s flavor of managed economy as being superior to the American version of capitalism. At the time America was just coming out of the Great Depression, so that view made a lot of sense. So in the short run, and especially after the ugly side of creative destruction has paid us a visit, the grass of managed economy may look greener.
So when we look at China, the conventional wisdom says that the government is very, very smart, and therefore they can do a very good job in steering the economy in the right way. Chinese government may have the best intentions, its leaders may have IQs of 250 each on a bad day, but it is impossible to centrally manage an economy of China’s size.
I am a big believer that in the boxing match between a visible and an invisible hand, though the invisible hand may lose a few rounds, it will win the match every time. Last century we had the most amazing economic experiment take place when after World War II, Germany was split into two countries with different economic and political systems. But they were the same people, with the same language and culture, separated by a wall. We know how that story ended.
Of course, for a time, having government control over the levers of the economy can have advantages. For example, by taking prompt action, the Chinese government was able to pull the economy out of the recession remarkably fast, basically by fire-housing the stimulus package that was equivalent to 12% GDP. That’s the advantage. The only problem is that these kinds of short-term advantages come with long-term, painful consequences.
For example, when you have a huge government presence in the economy, you also have a huge bureaucracy, and bureaucracy brings corruption. This is one of the reasons why China is rated so poorly on Transparency International’s annual corruption rating. Corruption breeds misallocation of capital, because the capital flows not to the best use, but it basically flows to whatever the political connection or whatever the bribe is directed to.
In addition, when you have a government-managed economy, it creates excesses. China has huge excesses in the industrial sector, as well as in commercial and residential real estate. We see plenty of evidence of these excesses, but they are likely to be much greater than we can measure today as they are covered up by robust economic growth. The true magnitude of these excesses will come to the surface once the economy slows down.
TCR: In essence, you’ve got a relatively small group of individuals who are making big decisions about China’s economy and where production should be, in what sectors, etc. If history is any guide, that really can’t last, yet many people seem to think it can. That said, China’s economy has certainly done remarkably well in the global economic crisis. In fact, according to their government, their GDP is almost back to where it was pre-crash. Why?
VK: Sure, the growth you see today in China is there, but it’s not a sustainable growth. It’s not a growth that you’ll see a few years from now. That is an important point for readers to understand.
TCR: Why is it not sustainable?
VK: Because the growth is being induced by government spending, by a misallocation of capital.
I’ll give you an example. The vacancy rate on commercial real estate in China is fairly high, but they still keep on building new office buildings because they think they will always grow. So therefore as long as they keep building, that activity will be registered as growth, until they stop. And when they do stop, they’ll drown in overcapacity, and they won’t be building new skyscrapers for a very long time.
TCR: We read that note you sent about the South China Mall, which is pretty stunning. It’s the second largest mall in the world but is mostly empty.
VK: That’s right. But as outrageous an example as the South China Mall is, there’s an even more outrageous example – namely that the Chinese built an entire city, Ordos, in Inner Mongolia for 1.5 million residents and it is completely empty. These are classic examples of the sort of excesses going on in China.
TCR: The equivalent of building bridges to nowhere, but on a very large – Chinese – scale.
VK: Exactly. There are no shortcuts to greatness. As long as they keep building new bridges, the economic numbers will register that there is growth, but at some point the piper will have to be paid, and these projects have a negative return on capital.
TCR: It seems the Chinese are following the script Japan used to dig itself out of its postwar doldrums, deliberately keeping their currency low in order to build an economy on the back of low-cost manufacturing. But that game inevitably has to end – already we see more and more things being made in Indonesia, Pakistan, India, and so forth. If China loses the manufacturing core of their economy, won’t they be in big trouble?
VK: Well, once you move manufacturing to other countries, it’s very difficult to get it back. So you could probably argue that China will maintain its manufacturing advantage for a while.
The problem with China is pretty much same as with any bubble. Though it may have had a solid foundation under it, it is simply a good thing taken too far. If you look at the railroad bubble in the United States, the country did need railroads, but we built too many.
The same thing happened with the technology bubble in 1998. The Internet was transformative to our economy, no question about it. But, again, it was taken too far.
There are some other countries that are lower-cost producers than China, but they probably can’t do it on the same scale that China can. But my point is that China is just a good thing taken too far, and if you add government involvement and corruption into the mix, you will get a bubble that is taken a lot further than you would normally expect.
One way of thinking about it is that the actions taken by the Chinese government, especially after the recent global recession, have basically supersized the bubble that was already forming.
TCR: Their government is sort of a holdover from a largely bygone era when many nations were communists, so isn’t it true that they need to maintain some fairly strong forward momentum, otherwise they could run into some political problems? Is that why they were so quick to unleash the massive stimulus or encourage their banks to lend an amazing amount of money? You have a chart showing those loans amounted to 29% of GDP in 2009. What kind of quality of lending can that be?
VK: Let’s try to understand why the Chinese government did the things they did. As everyone knows, the Chinese economy grew at a very high rate for a long period of time. When the global economy slowed down, their economy slowed down as well (though official numbers did not show it). The Chinese government is extremely concerned about the economy slowing down because that is likely to lead to political unrest. A lot of that potential friction comes because a lot of people moved from villages to the cities. China has an almost nonexistent social safety net system. So people who lose jobs don’t complain, they riot.
So, yes, the Chinese government is afraid of political unrest, and therefore they quickly released a tremendous amount of stimulus into the economy, then followed it up with encouraging bank loans equal to 29% of GDP in 2009, a huge increase. When you infuse this much debt into an economy, it’s impossible to have good capital allocation decisions. While the economy is growing, the bad debt won’t be so apparent, but it certainly will be when the economic growth slows.
A good analogy might be that when you analyze a credit card company that is growing very, very fast, and that has opened new accounts, you don’t see the bad debt because that debt is covered up by new loans. The true nature of the past lending decisions only becomes obvious when the company’s growth falls off.
One way to think about the Chinese economy is by comparing it to the bus in the movie Speed with Keanu Reeves and Dennis Hopper. In the movie, a bus was wired with explosives that would blow up if the bus’s speed dropped below 50 miles an hour.
Since China is manufacturer to the world, that manufacturing business comes with a lot of fixed costs. Factories, equipment need financing, and they are mainly financed by debt – another fixed cost. The high level of fixed costs doesn’t afford China an economic slowdown, but when it happens, the consequences will be dire. High fixed costs are great when revenues are rising as income grows at a faster rate than sales. But they are devastating to profitability when sales decline: costs decline at a slower rate than sales and you start losing money, fast.
TCR: Interestingly, there’s clearly a slowdown in the U.S. and Europe, China’s two biggest markets, so you would assume that China’s export industries would have suffered a fairly sharp decline since the go-go days before the crash. That has to be putting pressure on their growth. How important to the Chinese is it that the U.S. and the European economies recover and Western consumers get back into the game?
VK: I think a return of U.S. and European consumers is extremely important to the health of the Chinese economy. Some analysts think China’s internal demands can overcome the demand decline from U.S. and European consumers, and I think it is possible in the long run. But in the short run, I don’t think that’s possible. Let me explain the reasons for that.
Chinese consumers represent one-third of a 5-trillion-dollar economy. If you look at the size of the U.S. and European Union together, they are equal to a 30-trillion-dollar economy, and the consumers there constitute about two-thirds of those economies.
So on the one hand, you have U.S. and European consumers representing 20 trillion dollars in purchases, versus Chinese consumers at about 2 trillion dollars. In other words, U.S. and European consumers are 10 times the size of the Chinese consumers. As a result, a very small change in consumption in the U.S. and Europe has to be overcompensated by a huge increase in consumption in China, and that is going to be very difficult to do, especially considering that the Chinese currency is kept at artificially low levels. That, of course, diminishes the purchasing power of the Chinese consumer. Over time the Chinese consumer will play a larger role in the economy, but it’s going to take a decade, not months – not even a few years.
TCR: You’re pretty bearish on the outlook for China; do you have a theory about what might trip them up? What’s the thing that readers should be watching for that would suggest things are starting to unravel?
VK: It’s very difficult to know exactly what’s going to be the straw that breaks the camel’s back. It could be a slowdown in the Japanese economy, or a double-dip in the U.S., or some other factors that are not apparent to us today. It could be just the simple fact that the Chinese government is trying to put the brakes on the economy and mistakenly does too much.
I don’t trust government-reported statistics, thus I’d watch numbers that the Chinese government is less likely to fudge: electricity consumption, which was down during the global recession, same-store sales of American fast food restaurants in China, tonnage of goods shipped through railroads, and, though they may lag, sales by American and European companies in China.
TCR: If you look at inputs like copper imports and even copper stocks in Shanghai, by all appearances China is at least pretending that it’s business as usual. In fact, I think in August they imported 22% more refined copper than they did the year before. But if this is just to build bridges to nowhere, then it supports the idea that this is not going to be sustainable.
VK: That’s right. That is the problem with looking at this kind of data, because a lot of it is going to building things that have a negative return on capital. Therefore, you look at the data and the data does not really tell you that much – until it does. Because, basically, it’s the government’s involvement that is driving a lot of the demand.
You can make the same argument that the U.S. economy was doing great in 2004, 2005, 2006, despite the obvious problems in real estate and its financial system. Likewise, a lot of people said great things about what was going on in Japan in the late ‘80s. Of course, the U.S., and Japan before it, were experiencing huge real estate bubbles that few saw as being a problem, until they were.
There was an article in the Wall Street Journal a couple of weeks ago talking about a Chinese state-owned enterprise that operated salt mines, but now it’s building office parks. Those are kind of the signs you start seeing in an economy in the late stages of a bubble, where a state-owned enterprise starts building real estate projects because it’s almost like you can’t lose money doing this. But one thing that makes predicting the end of this bubble very difficult is the amount of firepower the Chinese government has. The government can drive this bubble further than a rational observer would expect.
TCR: Because they’ve got so much in the way of reserves?
VK: Because they have a significant influence over the economy. Chinese government can force banks to lend and can force companies to borrow and spend (or build).
TCR: On the topic of real estate, I was speaking to a very well-off Chinese friend recently who had bought a very expensive apartment in Beijing. When I asked him about buying at bubble prices, he commented that it really didn’t matter. The money was almost irrelevant, given the status that came from having an apartment in that particular part of town. He said it was very good for his business and that he didn’t really plan on using it very much. It was an interesting perspective, how he saw real estate.
VK: In the same way that everyone in the United States decided they “must” own a house, this belief was reinforced by continuously rising house prices. You can see how big a problem this became in big cities such as Beijing and Shanghai where the affordability ratio is horrible, so the property-value-to-income ratio in Beijing is pushing 15. In Shanghai it is over 12. If you look at the national average, it is over eight times.
TCR: Can you explain that ratio to our readers?
VK: You get the ratio by taking the property value and dividing it by annual disposable income.
Basically, if you spent all your money, after you paid your taxes, just to pay off the mortgage, it would take you 14 years – which means you didn’t pay for food, electricity, etc.
This ratio is important because it helps put the scale of the Chinese real estate bubble in its proper context. In Tokyo, at the peak of the massive Japanese bubble, the ratio stood at nine times. In Beijing it’s already 14 times. In Shanghai it’s over 12 times. The national average for China is pushing 8.2 times right now. So housing affordability is very, very low, and the housing prices are extremely high.
Here is another interesting piece of data: property investment in China in 2009 was 10% of GDP, up from 8% in 2007. In Japan, at the peak of its bubble, it did not exceed 9%; in the U.S. it never exceeded 6%.
A recent study found that 64.5 million apartments basically don’t use electricity because they are empty. Chinese people buy those condos, and they don’t rent them. Similar to new cars in the U.S. when taken off the lot, in China an apartment is worth less once rented out. So they just keep them unoccupied with the hope to flip them, and you know how that story ends.
TCR: Yes, after Japan’s real estate bubble collapsed, prices in the major cities fell by about two-thirds and have rebounded only very little from the post-crash lows.
If a lot of Chinese lost a lot of money in real estate, one has to assume they’re going to be very unhappy. I recall a conversation with another Chinese man who lives in the States half a year and in Beijing half the year. When I asked him about the real estate bubble in China, his comment was, “Well, the government would never let it fall,” and he said the same thing was true of their stock market. To put it mildly, he had an inordinate amount of faith in the Chinese government’s ability to prop up bubbles.
VK: As you can tell from my accent, I was born in Russia and spent half of my life in Soviet Russia. From my direct experience, the Russian propaganda machine was very, very powerful, and so many people believed how smart the leaders were and that they could do nothing wrong.
China is not that much different from Russia in that respect. Due to the government’s control of the media, the average citizen has been brainwashed into thinking of the government with respect. They has led to an unconditional belief that the Chinese government walks on water, that the laws of economics are somehow suspended when they touch things (except they also did a fine job convincing not just their own citizens but the West as well). Sure, they have a greater control of the economy, but at the long-term cost we talked about earlier. That’s point number one.
Point number two can be understood by asking why people are buying those apartments, why are they buying this real estate? In part it is because if they put money in the bank – where the government basically sets the rates on savings accounts and the checking deposits – they are getting very little interest on their savings. Therefore they look at real estate as basically a form of savings.
Some analysts will argue that it can’t be a bubble because of the lack of leverage, given that in China you have to put 30%-40% down when you buy an apartment. It is a large down payment. But think about how much wealth will be destroyed when real estate prices decline – and that in itself could trigger a serious crisis in China because it would destroy a lot of wealth, and that could lead to political unrest. So that would be very important psychologically and for the political stability of the Chinese economy.
TCR: What would typically trigger the end of this real estate bubble?
VK: To some degree, a real estate bubble is like a Ponzi scheme. As long as there is an incremental buyer, prices keep going up, but at some point everybody who wants to buy a house has bought a house, so when an incremental buyer is not there, the prices start declining and then it becomes self-feeding. It’s very difficult to time the end, but there is always an end.
TCR: What about commercial real estate?
VK: If you look at commercial real estate, it’s often one subsidiary that is borrowing money from another subsidiary to put a down payment to build or buy a building. And a lot of times land is used as collateral. As land prices decline, so the loan-to-value ratio can jump through the roof very quickly when real estate prices collapse.
TCR: Talk a little about the renminbi. The Chinese government has been making noises about possibly allowing it to rise against the dollar, but from a practical standpoint, can they actually afford to let that happen?
VK: They could let it rise on a very gradual basis, but they absolutely cannot allow it to rise very rapidly because that would quickly diminish the value of the foreign reserves. But there is a conundrum. When the Chinese economy bursts, there is a very good chance the renminbi will actually depreciate, because you are going to have a flight of capital leaving China. So right now you may argue that China’s currency is too cheap, but during the crisis it’s probably going to get cheaper.
TCR: What’s your general sense about how much longer they can keep the game going before they collapse? And is collapse the right word?
VK: I really don’t know. In the case of Japan, their government basically ran out of chips. I think the Chinese government still has enough chips to keep the bubble going awhile longer. These bubbles usually last longer than the reputation of the person who predicts their demise.
TCR: Do you think it will occur within a decade?
VK: I think so, yes. GMO became famous for predicting the Japanese bubble collapse, but they started predicting it in 1986, so they were “wrong” for a while because it actually burst in 1989-1990. The point being, these bubbles typically last longer than you would expect, but it’s going to burst.
TCR: Let’s talk for a minute about some of the potential implications of a bursting Chinese bubble. There are some fairly obvious ones, like Chinese real estate, but there are a lot of somewhat less obvious consequences, for example the hit this would cause to the Australian economy because its export sector depends heavily on China.
VK: China has been responsible for a very large portion, if not all, of incremental demand for commodities in recent years. If you’re talking about copper, about oil, or pretty much all the industrial commodities, China was responsible for a very large portion of the demand. When the economy slows down and the bubble bursts, then the demand for those commodities will decline dramatically.
It’s going to impact economies that benefitted tremendously from China’s ascent, so Australia will be impacted, Russia will be impacted because oil prices will decline and Russia is basically a commodity-driven nation. Brazil will be impacted. Any economy you can think of that benefitted from China’s ascent will get hurt from its descent as well.
Let me clarify this. I’m not saying that China will cease to exist or that it’s going back to the stone-age – I’m saying there is a bubble and it’s going to burst. It’s going to go through readjustments.
TCR: But it will be a serious crisis.
VK: The bubble burst will have significant consequences.
TCR: So you’d be cautious on sort of base commodities.
VK: Yes. But also think about industrial goods. Getting commodities out of the ground, building empty shopping malls, ghost towns, and bridges to nowhere requires a lot of equipment. Industrial goods companies benefitted tremendously from Chinese demand. In the past, those were very cyclical companies, and it seems like this time they almost didn’t have a normal cycle. They declined but then came back very fast because the demand came back very fast, and a lot of that demand came from China.
TCR: And what would you invest in, are there any opportunities you see?
VK: Unless you short stocks, it’s very difficult to see an opportunity in a Chinese downturn. As a portfolio manager, I look at it as a risk, and I say, all right, what can I do to immunize my portfolio from that risk. I have very little exposure to commodities and industrial stocks, and very little exposure to countries that will get hurt from China’s bursting bubble – the countries we mentioned, like Australia, Brazil, Russia, etc.
TCR: Canada would have to be on that list.
VK: Yes, very true.
TCR: Let’s talk briefly about Japan. Bud Conrad, our chief economist, has done a lot of looking at Japan and concludes that it’s basically past the point of no return. What are your general thoughts on the implications of that country tipping back into a serious crisis? After all, it’s a very big economy, and so that would have to have a big impact on the world.
VK: Japan’s story is very simple. The economy slowed down in the 1990s. To keep the economy growing, the government lowered taxes and increased government spending, sending budget deficits up. In order to finance those deficits, the amount of government debt has tripled.
The only reason they were able to finance that debt was because over 90% of the government debt was purchased internally; therefore, thanks to Japanese interest rates declining from 7.5% to 1.4%, the government was able to dramatically increase the amount of debt without the total borrowing costs going up.
Today, Japan is one of the most indebted nations in the developed world, and its population demographics are horrible because every fourth Japanese is over 65 years old. There’s no immigration into Japan, and the population is aging rapidly, and the savings rate went from the middle teens to quickly approaching zero.
TCR: So there is less demand for Japanese government bonds.
VK: Yes, exactly. With the demand for Japanese bonds declining, they are going to have to start shopping their debt outside of Japan, and the second they do, they’ll realize that no rational buyer would buy Japanese debt yielding 1.4% when they can buy U.S. debt or German debt with yields double that.
So the Japanese are going to have to start paying high interest rates, and they can’t afford that, because one-quarter of the tax revenues already goes to servicing their debt. If their interest rates were to double to just 2.8%, it basically wipes out the funding for the country’s Departments of Defense and Education. So this is a situation where they go from deflation to hyperinflation, because they’re going to have to start printing money to be able to keep paying off their debt, so this is the case where they are going just from one extreme to another.
TCR: Their economy has been hugely helped by their trade surplus, but their trade surplus has been going down steadily, in no small part because China has been stealing market share.
VK: Exactly. A lot of manufacturing went to China from Japan, so that hurt the economy too.
So when you ask me about what could trigger Chinese problems, well, you know, Japan is still a big trading partner for China, so Japan’s decline would impact China as well, and vice versa.
TCR: We have heard a lot about Japanese demographics. That seems to be an intractable problem.
VK: Recently I heard that the Japanese were considering trying to solve their demographic problems by allowing immigration from China to Japan. I almost fell off my chair when I heard that, because there is a lot of animosity between the two countries. They love each other as much as Armenians love Turks, so it’s very difficult for me to see that happening just because of the cultural issues going on.
TCR: And it seems that the tensions are actually getting much worse.
VK: Too true. But the key point is that Japan is past the point of no return. It’s like the Titanic has already hit the iceberg and you know it’s going to sink, you just don’t know just how long it will take to go down. That’s basically what is taking place in Japan.
TCR: Sticking with that metaphor, it seems like people need to begin donning life jackets and edging toward the nearest lifeboat.
So we’ve got some serious issues with Asia, which obviously will have some global implications. How does this tie back to the U.S.? Our take has been that – at least on a short-term basis – when things start to come unglued, it will benefit the U.S. as a purported “safe harbor,” but then people will begin to realize that if two out of three of the world’s biggest economies can fall, so can the U.S.
VK: In the short run, it may benefit the U.S. dollar because the value of currencies is relative, right? As my friend Barry Pasikov says – the U.S. dollar is valedictorian in summer school. So if people are afraid of Japan, afraid of China, they would be running towards the U.S. currency. By the way, the Japanese currency made a 15-year high recently suggesting what could be the trade of the decade.
I’m a value investor, so I generally don’t spend much time on currencies, but I think this is a case where shorting Japanese yen makes a lot of sense.
http://contrarianedge.com/2010/10/14/shadow-over-asia/
An interview with Vitaliy Katsenelson, Chief Investment Officer, Investment Management Associates, Inc., and author of Active Value Investing. Profiled in Barron’s in September 2009, Vitaliy, who was born in Murmansk, Russia, and moved to the U.S. in 1991, from 2007 to 2007 was an adjunct faculty member at the University of Colorado at Denver’s Graduate School of Business.
TCR: What our readers are looking for is a better sense of China and Japan, both of which are very important in the context of the global economy. As we have to start somewhere, let’s start with China.
Today the conventional wisdom is that somehow the Chinese economy is better managed than its competitors, very similar to how people viewed Japan in the 1970s and 1980s. Back then people were absolutely convinced that Japan was the superior country with superior policies and that its economy was unstoppable. We all know how that ended.
So, let’s start there. Is China’s system better than everyone else’s? Is it really possible the Chinese economy can keep steamrolling along?
VK: A few months ago, I watched a movie about Ayn Rand and it talked about how Americans in the 1930s looked at the Soviet Union’s flavor of managed economy as being superior to the American version of capitalism. At the time America was just coming out of the Great Depression, so that view made a lot of sense. So in the short run, and especially after the ugly side of creative destruction has paid us a visit, the grass of managed economy may look greener.
So when we look at China, the conventional wisdom says that the government is very, very smart, and therefore they can do a very good job in steering the economy in the right way. Chinese government may have the best intentions, its leaders may have IQs of 250 each on a bad day, but it is impossible to centrally manage an economy of China’s size.
I am a big believer that in the boxing match between a visible and an invisible hand, though the invisible hand may lose a few rounds, it will win the match every time. Last century we had the most amazing economic experiment take place when after World War II, Germany was split into two countries with different economic and political systems. But they were the same people, with the same language and culture, separated by a wall. We know how that story ended.
Of course, for a time, having government control over the levers of the economy can have advantages. For example, by taking prompt action, the Chinese government was able to pull the economy out of the recession remarkably fast, basically by fire-housing the stimulus package that was equivalent to 12% GDP. That’s the advantage. The only problem is that these kinds of short-term advantages come with long-term, painful consequences.
For example, when you have a huge government presence in the economy, you also have a huge bureaucracy, and bureaucracy brings corruption. This is one of the reasons why China is rated so poorly on Transparency International’s annual corruption rating. Corruption breeds misallocation of capital, because the capital flows not to the best use, but it basically flows to whatever the political connection or whatever the bribe is directed to.
In addition, when you have a government-managed economy, it creates excesses. China has huge excesses in the industrial sector, as well as in commercial and residential real estate. We see plenty of evidence of these excesses, but they are likely to be much greater than we can measure today as they are covered up by robust economic growth. The true magnitude of these excesses will come to the surface once the economy slows down.
TCR: In essence, you’ve got a relatively small group of individuals who are making big decisions about China’s economy and where production should be, in what sectors, etc. If history is any guide, that really can’t last, yet many people seem to think it can. That said, China’s economy has certainly done remarkably well in the global economic crisis. In fact, according to their government, their GDP is almost back to where it was pre-crash. Why?
VK: Sure, the growth you see today in China is there, but it’s not a sustainable growth. It’s not a growth that you’ll see a few years from now. That is an important point for readers to understand.
TCR: Why is it not sustainable?
VK: Because the growth is being induced by government spending, by a misallocation of capital.
I’ll give you an example. The vacancy rate on commercial real estate in China is fairly high, but they still keep on building new office buildings because they think they will always grow. So therefore as long as they keep building, that activity will be registered as growth, until they stop. And when they do stop, they’ll drown in overcapacity, and they won’t be building new skyscrapers for a very long time.
TCR: We read that note you sent about the South China Mall, which is pretty stunning. It’s the second largest mall in the world but is mostly empty.
VK: That’s right. But as outrageous an example as the South China Mall is, there’s an even more outrageous example – namely that the Chinese built an entire city, Ordos, in Inner Mongolia for 1.5 million residents and it is completely empty. These are classic examples of the sort of excesses going on in China.
TCR: The equivalent of building bridges to nowhere, but on a very large – Chinese – scale.
VK: Exactly. There are no shortcuts to greatness. As long as they keep building new bridges, the economic numbers will register that there is growth, but at some point the piper will have to be paid, and these projects have a negative return on capital.
TCR: It seems the Chinese are following the script Japan used to dig itself out of its postwar doldrums, deliberately keeping their currency low in order to build an economy on the back of low-cost manufacturing. But that game inevitably has to end – already we see more and more things being made in Indonesia, Pakistan, India, and so forth. If China loses the manufacturing core of their economy, won’t they be in big trouble?
VK: Well, once you move manufacturing to other countries, it’s very difficult to get it back. So you could probably argue that China will maintain its manufacturing advantage for a while.
The problem with China is pretty much same as with any bubble. Though it may have had a solid foundation under it, it is simply a good thing taken too far. If you look at the railroad bubble in the United States, the country did need railroads, but we built too many.
The same thing happened with the technology bubble in 1998. The Internet was transformative to our economy, no question about it. But, again, it was taken too far.
There are some other countries that are lower-cost producers than China, but they probably can’t do it on the same scale that China can. But my point is that China is just a good thing taken too far, and if you add government involvement and corruption into the mix, you will get a bubble that is taken a lot further than you would normally expect.
One way of thinking about it is that the actions taken by the Chinese government, especially after the recent global recession, have basically supersized the bubble that was already forming.
TCR: Their government is sort of a holdover from a largely bygone era when many nations were communists, so isn’t it true that they need to maintain some fairly strong forward momentum, otherwise they could run into some political problems? Is that why they were so quick to unleash the massive stimulus or encourage their banks to lend an amazing amount of money? You have a chart showing those loans amounted to 29% of GDP in 2009. What kind of quality of lending can that be?
VK: Let’s try to understand why the Chinese government did the things they did. As everyone knows, the Chinese economy grew at a very high rate for a long period of time. When the global economy slowed down, their economy slowed down as well (though official numbers did not show it). The Chinese government is extremely concerned about the economy slowing down because that is likely to lead to political unrest. A lot of that potential friction comes because a lot of people moved from villages to the cities. China has an almost nonexistent social safety net system. So people who lose jobs don’t complain, they riot.
So, yes, the Chinese government is afraid of political unrest, and therefore they quickly released a tremendous amount of stimulus into the economy, then followed it up with encouraging bank loans equal to 29% of GDP in 2009, a huge increase. When you infuse this much debt into an economy, it’s impossible to have good capital allocation decisions. While the economy is growing, the bad debt won’t be so apparent, but it certainly will be when the economic growth slows.
A good analogy might be that when you analyze a credit card company that is growing very, very fast, and that has opened new accounts, you don’t see the bad debt because that debt is covered up by new loans. The true nature of the past lending decisions only becomes obvious when the company’s growth falls off.
One way to think about the Chinese economy is by comparing it to the bus in the movie Speed with Keanu Reeves and Dennis Hopper. In the movie, a bus was wired with explosives that would blow up if the bus’s speed dropped below 50 miles an hour.
Since China is manufacturer to the world, that manufacturing business comes with a lot of fixed costs. Factories, equipment need financing, and they are mainly financed by debt – another fixed cost. The high level of fixed costs doesn’t afford China an economic slowdown, but when it happens, the consequences will be dire. High fixed costs are great when revenues are rising as income grows at a faster rate than sales. But they are devastating to profitability when sales decline: costs decline at a slower rate than sales and you start losing money, fast.
TCR: Interestingly, there’s clearly a slowdown in the U.S. and Europe, China’s two biggest markets, so you would assume that China’s export industries would have suffered a fairly sharp decline since the go-go days before the crash. That has to be putting pressure on their growth. How important to the Chinese is it that the U.S. and the European economies recover and Western consumers get back into the game?
VK: I think a return of U.S. and European consumers is extremely important to the health of the Chinese economy. Some analysts think China’s internal demands can overcome the demand decline from U.S. and European consumers, and I think it is possible in the long run. But in the short run, I don’t think that’s possible. Let me explain the reasons for that.
Chinese consumers represent one-third of a 5-trillion-dollar economy. If you look at the size of the U.S. and European Union together, they are equal to a 30-trillion-dollar economy, and the consumers there constitute about two-thirds of those economies.
So on the one hand, you have U.S. and European consumers representing 20 trillion dollars in purchases, versus Chinese consumers at about 2 trillion dollars. In other words, U.S. and European consumers are 10 times the size of the Chinese consumers. As a result, a very small change in consumption in the U.S. and Europe has to be overcompensated by a huge increase in consumption in China, and that is going to be very difficult to do, especially considering that the Chinese currency is kept at artificially low levels. That, of course, diminishes the purchasing power of the Chinese consumer. Over time the Chinese consumer will play a larger role in the economy, but it’s going to take a decade, not months – not even a few years.
TCR: You’re pretty bearish on the outlook for China; do you have a theory about what might trip them up? What’s the thing that readers should be watching for that would suggest things are starting to unravel?
VK: It’s very difficult to know exactly what’s going to be the straw that breaks the camel’s back. It could be a slowdown in the Japanese economy, or a double-dip in the U.S., or some other factors that are not apparent to us today. It could be just the simple fact that the Chinese government is trying to put the brakes on the economy and mistakenly does too much.
I don’t trust government-reported statistics, thus I’d watch numbers that the Chinese government is less likely to fudge: electricity consumption, which was down during the global recession, same-store sales of American fast food restaurants in China, tonnage of goods shipped through railroads, and, though they may lag, sales by American and European companies in China.
TCR: If you look at inputs like copper imports and even copper stocks in Shanghai, by all appearances China is at least pretending that it’s business as usual. In fact, I think in August they imported 22% more refined copper than they did the year before. But if this is just to build bridges to nowhere, then it supports the idea that this is not going to be sustainable.
VK: That’s right. That is the problem with looking at this kind of data, because a lot of it is going to building things that have a negative return on capital. Therefore, you look at the data and the data does not really tell you that much – until it does. Because, basically, it’s the government’s involvement that is driving a lot of the demand.
You can make the same argument that the U.S. economy was doing great in 2004, 2005, 2006, despite the obvious problems in real estate and its financial system. Likewise, a lot of people said great things about what was going on in Japan in the late ‘80s. Of course, the U.S., and Japan before it, were experiencing huge real estate bubbles that few saw as being a problem, until they were.
There was an article in the Wall Street Journal a couple of weeks ago talking about a Chinese state-owned enterprise that operated salt mines, but now it’s building office parks. Those are kind of the signs you start seeing in an economy in the late stages of a bubble, where a state-owned enterprise starts building real estate projects because it’s almost like you can’t lose money doing this. But one thing that makes predicting the end of this bubble very difficult is the amount of firepower the Chinese government has. The government can drive this bubble further than a rational observer would expect.
TCR: Because they’ve got so much in the way of reserves?
VK: Because they have a significant influence over the economy. Chinese government can force banks to lend and can force companies to borrow and spend (or build).
TCR: On the topic of real estate, I was speaking to a very well-off Chinese friend recently who had bought a very expensive apartment in Beijing. When I asked him about buying at bubble prices, he commented that it really didn’t matter. The money was almost irrelevant, given the status that came from having an apartment in that particular part of town. He said it was very good for his business and that he didn’t really plan on using it very much. It was an interesting perspective, how he saw real estate.
VK: In the same way that everyone in the United States decided they “must” own a house, this belief was reinforced by continuously rising house prices. You can see how big a problem this became in big cities such as Beijing and Shanghai where the affordability ratio is horrible, so the property-value-to-income ratio in Beijing is pushing 15. In Shanghai it is over 12. If you look at the national average, it is over eight times.
TCR: Can you explain that ratio to our readers?
VK: You get the ratio by taking the property value and dividing it by annual disposable income.
Basically, if you spent all your money, after you paid your taxes, just to pay off the mortgage, it would take you 14 years – which means you didn’t pay for food, electricity, etc.
This ratio is important because it helps put the scale of the Chinese real estate bubble in its proper context. In Tokyo, at the peak of the massive Japanese bubble, the ratio stood at nine times. In Beijing it’s already 14 times. In Shanghai it’s over 12 times. The national average for China is pushing 8.2 times right now. So housing affordability is very, very low, and the housing prices are extremely high.
Here is another interesting piece of data: property investment in China in 2009 was 10% of GDP, up from 8% in 2007. In Japan, at the peak of its bubble, it did not exceed 9%; in the U.S. it never exceeded 6%.
A recent study found that 64.5 million apartments basically don’t use electricity because they are empty. Chinese people buy those condos, and they don’t rent them. Similar to new cars in the U.S. when taken off the lot, in China an apartment is worth less once rented out. So they just keep them unoccupied with the hope to flip them, and you know how that story ends.
TCR: Yes, after Japan’s real estate bubble collapsed, prices in the major cities fell by about two-thirds and have rebounded only very little from the post-crash lows.
If a lot of Chinese lost a lot of money in real estate, one has to assume they’re going to be very unhappy. I recall a conversation with another Chinese man who lives in the States half a year and in Beijing half the year. When I asked him about the real estate bubble in China, his comment was, “Well, the government would never let it fall,” and he said the same thing was true of their stock market. To put it mildly, he had an inordinate amount of faith in the Chinese government’s ability to prop up bubbles.
VK: As you can tell from my accent, I was born in Russia and spent half of my life in Soviet Russia. From my direct experience, the Russian propaganda machine was very, very powerful, and so many people believed how smart the leaders were and that they could do nothing wrong.
China is not that much different from Russia in that respect. Due to the government’s control of the media, the average citizen has been brainwashed into thinking of the government with respect. They has led to an unconditional belief that the Chinese government walks on water, that the laws of economics are somehow suspended when they touch things (except they also did a fine job convincing not just their own citizens but the West as well). Sure, they have a greater control of the economy, but at the long-term cost we talked about earlier. That’s point number one.
Point number two can be understood by asking why people are buying those apartments, why are they buying this real estate? In part it is because if they put money in the bank – where the government basically sets the rates on savings accounts and the checking deposits – they are getting very little interest on their savings. Therefore they look at real estate as basically a form of savings.
Some analysts will argue that it can’t be a bubble because of the lack of leverage, given that in China you have to put 30%-40% down when you buy an apartment. It is a large down payment. But think about how much wealth will be destroyed when real estate prices decline – and that in itself could trigger a serious crisis in China because it would destroy a lot of wealth, and that could lead to political unrest. So that would be very important psychologically and for the political stability of the Chinese economy.
TCR: What would typically trigger the end of this real estate bubble?
VK: To some degree, a real estate bubble is like a Ponzi scheme. As long as there is an incremental buyer, prices keep going up, but at some point everybody who wants to buy a house has bought a house, so when an incremental buyer is not there, the prices start declining and then it becomes self-feeding. It’s very difficult to time the end, but there is always an end.
TCR: What about commercial real estate?
VK: If you look at commercial real estate, it’s often one subsidiary that is borrowing money from another subsidiary to put a down payment to build or buy a building. And a lot of times land is used as collateral. As land prices decline, so the loan-to-value ratio can jump through the roof very quickly when real estate prices collapse.
TCR: Talk a little about the renminbi. The Chinese government has been making noises about possibly allowing it to rise against the dollar, but from a practical standpoint, can they actually afford to let that happen?
VK: They could let it rise on a very gradual basis, but they absolutely cannot allow it to rise very rapidly because that would quickly diminish the value of the foreign reserves. But there is a conundrum. When the Chinese economy bursts, there is a very good chance the renminbi will actually depreciate, because you are going to have a flight of capital leaving China. So right now you may argue that China’s currency is too cheap, but during the crisis it’s probably going to get cheaper.
TCR: What’s your general sense about how much longer they can keep the game going before they collapse? And is collapse the right word?
VK: I really don’t know. In the case of Japan, their government basically ran out of chips. I think the Chinese government still has enough chips to keep the bubble going awhile longer. These bubbles usually last longer than the reputation of the person who predicts their demise.
TCR: Do you think it will occur within a decade?
VK: I think so, yes. GMO became famous for predicting the Japanese bubble collapse, but they started predicting it in 1986, so they were “wrong” for a while because it actually burst in 1989-1990. The point being, these bubbles typically last longer than you would expect, but it’s going to burst.
TCR: Let’s talk for a minute about some of the potential implications of a bursting Chinese bubble. There are some fairly obvious ones, like Chinese real estate, but there are a lot of somewhat less obvious consequences, for example the hit this would cause to the Australian economy because its export sector depends heavily on China.
VK: China has been responsible for a very large portion, if not all, of incremental demand for commodities in recent years. If you’re talking about copper, about oil, or pretty much all the industrial commodities, China was responsible for a very large portion of the demand. When the economy slows down and the bubble bursts, then the demand for those commodities will decline dramatically.
It’s going to impact economies that benefitted tremendously from China’s ascent, so Australia will be impacted, Russia will be impacted because oil prices will decline and Russia is basically a commodity-driven nation. Brazil will be impacted. Any economy you can think of that benefitted from China’s ascent will get hurt from its descent as well.
Let me clarify this. I’m not saying that China will cease to exist or that it’s going back to the stone-age – I’m saying there is a bubble and it’s going to burst. It’s going to go through readjustments.
TCR: But it will be a serious crisis.
VK: The bubble burst will have significant consequences.
TCR: So you’d be cautious on sort of base commodities.
VK: Yes. But also think about industrial goods. Getting commodities out of the ground, building empty shopping malls, ghost towns, and bridges to nowhere requires a lot of equipment. Industrial goods companies benefitted tremendously from Chinese demand. In the past, those were very cyclical companies, and it seems like this time they almost didn’t have a normal cycle. They declined but then came back very fast because the demand came back very fast, and a lot of that demand came from China.
TCR: And what would you invest in, are there any opportunities you see?
VK: Unless you short stocks, it’s very difficult to see an opportunity in a Chinese downturn. As a portfolio manager, I look at it as a risk, and I say, all right, what can I do to immunize my portfolio from that risk. I have very little exposure to commodities and industrial stocks, and very little exposure to countries that will get hurt from China’s bursting bubble – the countries we mentioned, like Australia, Brazil, Russia, etc.
TCR: Canada would have to be on that list.
VK: Yes, very true.
TCR: Let’s talk briefly about Japan. Bud Conrad, our chief economist, has done a lot of looking at Japan and concludes that it’s basically past the point of no return. What are your general thoughts on the implications of that country tipping back into a serious crisis? After all, it’s a very big economy, and so that would have to have a big impact on the world.
VK: Japan’s story is very simple. The economy slowed down in the 1990s. To keep the economy growing, the government lowered taxes and increased government spending, sending budget deficits up. In order to finance those deficits, the amount of government debt has tripled.
The only reason they were able to finance that debt was because over 90% of the government debt was purchased internally; therefore, thanks to Japanese interest rates declining from 7.5% to 1.4%, the government was able to dramatically increase the amount of debt without the total borrowing costs going up.
Today, Japan is one of the most indebted nations in the developed world, and its population demographics are horrible because every fourth Japanese is over 65 years old. There’s no immigration into Japan, and the population is aging rapidly, and the savings rate went from the middle teens to quickly approaching zero.
TCR: So there is less demand for Japanese government bonds.
VK: Yes, exactly. With the demand for Japanese bonds declining, they are going to have to start shopping their debt outside of Japan, and the second they do, they’ll realize that no rational buyer would buy Japanese debt yielding 1.4% when they can buy U.S. debt or German debt with yields double that.
So the Japanese are going to have to start paying high interest rates, and they can’t afford that, because one-quarter of the tax revenues already goes to servicing their debt. If their interest rates were to double to just 2.8%, it basically wipes out the funding for the country’s Departments of Defense and Education. So this is a situation where they go from deflation to hyperinflation, because they’re going to have to start printing money to be able to keep paying off their debt, so this is the case where they are going just from one extreme to another.
TCR: Their economy has been hugely helped by their trade surplus, but their trade surplus has been going down steadily, in no small part because China has been stealing market share.
VK: Exactly. A lot of manufacturing went to China from Japan, so that hurt the economy too.
So when you ask me about what could trigger Chinese problems, well, you know, Japan is still a big trading partner for China, so Japan’s decline would impact China as well, and vice versa.
TCR: We have heard a lot about Japanese demographics. That seems to be an intractable problem.
VK: Recently I heard that the Japanese were considering trying to solve their demographic problems by allowing immigration from China to Japan. I almost fell off my chair when I heard that, because there is a lot of animosity between the two countries. They love each other as much as Armenians love Turks, so it’s very difficult for me to see that happening just because of the cultural issues going on.
TCR: And it seems that the tensions are actually getting much worse.
VK: Too true. But the key point is that Japan is past the point of no return. It’s like the Titanic has already hit the iceberg and you know it’s going to sink, you just don’t know just how long it will take to go down. That’s basically what is taking place in Japan.
TCR: Sticking with that metaphor, it seems like people need to begin donning life jackets and edging toward the nearest lifeboat.
So we’ve got some serious issues with Asia, which obviously will have some global implications. How does this tie back to the U.S.? Our take has been that – at least on a short-term basis – when things start to come unglued, it will benefit the U.S. as a purported “safe harbor,” but then people will begin to realize that if two out of three of the world’s biggest economies can fall, so can the U.S.
VK: In the short run, it may benefit the U.S. dollar because the value of currencies is relative, right? As my friend Barry Pasikov says – the U.S. dollar is valedictorian in summer school. So if people are afraid of Japan, afraid of China, they would be running towards the U.S. currency. By the way, the Japanese currency made a 15-year high recently suggesting what could be the trade of the decade.
I’m a value investor, so I generally don’t spend much time on currencies, but I think this is a case where shorting Japanese yen makes a lot of sense.
http://contrarianedge.com/2010/10/14/shadow-over-asia/
Tuesday, October 5, 2010
Picked up some Visteon@57
I have picked up Visteon today at 57. I think this is no brainer. If you want to read the detailed analysis, please read it here. The entire credit goes to Ryan from Cushman Capital. Excellent Analysis.
Brief Business Description:
Visteon Corporation is a global Tier 1 supplier of automotive products to original equipment manufacturers (OEM’s). Visteon is a market leader in each of its three core product groups: climate, electronics, and interior systems. Visteon is geographically diversified and is not overly reliant on any one particular OEM. The company’s three largest customers are Ford, Hyundai/Kia, and Nissan/Renault (which make up 29%, 27%, and 9% of the company’s revenues respectively).
Opportunity Overview:
Visteon’s shares are currently trading on a “when issued” basis at roughly 3x 2011 EBITDA, and after backing out the company’s significant ownership in high growth subsidiaries, we believe the core Visteon business trades for roughly 1.5x EBITDA. Given Visteon’s multiple internal and external catalyst’s, highly attractive absolute valuation and the outsized spread between the company’s “when issued” shares and the already depressed valuation’s of its global competitors, we think that the stars are aligning for bargain hunting investors to generate spectacular returns of 30%+ in a short period of time with relatively low risk. Keep in mind that this isn’t “your father’s” Visteon, as the company will exit bankruptcy permanently improved and completely transformed, offering investor’s both a 1) quick, high-return, relatively risk-free arbitrage and/or 2) an inexpensive way to play any upturn in - or at least the stabilization of – global auto sales and economic activity in general.
The idea here is simple. As Visteon exits chapter 11, the near to medium-term upside will likely be driven by a combination of 1) a couple of imminent, high probability catalyst’s that should force the market to assign this company with a much more appropriate valuation on an absolute basis and relative to its peers and 2) various operational and financial enhancements that the company recently undertook while in bankruptcy should continue to yield visible and increasingly positive operating results for the foreseeable future.
Our expectation is that the initial roughly 30%+ will come almost instantaneously (within a month or so) as 1) the stock begins to trade regular way 2) equity analysts initiate coverage and 3) various institutional and index funds that have been unable to purchase the stock up until this point (due to restrictions on purchasing company’s in Ch. 11), begin buying in droves. Notably, the return assumption above assumes that upon re-emergence the company trade’s at an incredibly non-demanding multiple of 3.75x EBITDA or, to put it another way, in line with the cheapest automotive suppliers within the industry as a whole. Keep in mind that we think this estimate is very (almost unjustifiably) conservative given that on average Visteon’s peers tend to be considerably more levered, and typically possess both lower EBITDA margins as well as less attractive long-term growth prospects.
http://www.sumzero.com/postings/3190/guest_view
Brief Business Description:
Visteon Corporation is a global Tier 1 supplier of automotive products to original equipment manufacturers (OEM’s). Visteon is a market leader in each of its three core product groups: climate, electronics, and interior systems. Visteon is geographically diversified and is not overly reliant on any one particular OEM. The company’s three largest customers are Ford, Hyundai/Kia, and Nissan/Renault (which make up 29%, 27%, and 9% of the company’s revenues respectively).
Opportunity Overview:
Visteon’s shares are currently trading on a “when issued” basis at roughly 3x 2011 EBITDA, and after backing out the company’s significant ownership in high growth subsidiaries, we believe the core Visteon business trades for roughly 1.5x EBITDA. Given Visteon’s multiple internal and external catalyst’s, highly attractive absolute valuation and the outsized spread between the company’s “when issued” shares and the already depressed valuation’s of its global competitors, we think that the stars are aligning for bargain hunting investors to generate spectacular returns of 30%+ in a short period of time with relatively low risk. Keep in mind that this isn’t “your father’s” Visteon, as the company will exit bankruptcy permanently improved and completely transformed, offering investor’s both a 1) quick, high-return, relatively risk-free arbitrage and/or 2) an inexpensive way to play any upturn in - or at least the stabilization of – global auto sales and economic activity in general.
The idea here is simple. As Visteon exits chapter 11, the near to medium-term upside will likely be driven by a combination of 1) a couple of imminent, high probability catalyst’s that should force the market to assign this company with a much more appropriate valuation on an absolute basis and relative to its peers and 2) various operational and financial enhancements that the company recently undertook while in bankruptcy should continue to yield visible and increasingly positive operating results for the foreseeable future.
Our expectation is that the initial roughly 30%+ will come almost instantaneously (within a month or so) as 1) the stock begins to trade regular way 2) equity analysts initiate coverage and 3) various institutional and index funds that have been unable to purchase the stock up until this point (due to restrictions on purchasing company’s in Ch. 11), begin buying in droves. Notably, the return assumption above assumes that upon re-emergence the company trade’s at an incredibly non-demanding multiple of 3.75x EBITDA or, to put it another way, in line with the cheapest automotive suppliers within the industry as a whole. Keep in mind that we think this estimate is very (almost unjustifiably) conservative given that on average Visteon’s peers tend to be considerably more levered, and typically possess both lower EBITDA margins as well as less attractive long-term growth prospects.
http://www.sumzero.com/postings/3190/guest_view
Monday, October 4, 2010
Arbitrage Spreads
Reuters has excellent website which provides you arbitrage spreads. Based on Seth Klarmans interview, there are a lot more values in spin off's, post BK and merger arbitrage. My quest for learning has only increased. I will continue to post any possible links to these items.
http://www.reuters.com/finance/deals/arbitrageSpreads
http://www.reuters.com/finance/deals/arbitrageSpreads
Excellent write up on Visteon by Average odds investing
Hat tip to mwhitman for doing all the heavy lifting
Thesis:
The Visteon Corporation is a classic post reorg/special situation with a large margin of safety and substantial near-term upside potential.
Brief Business Description:
Visteon Corporation is a global Tier 1 supplier of automotive products to original equipment manufacturers (OEM’s). Visteon is a market leader in each of its three core product groups: climate, electronics, and interior systems. Visteon is geographically diversified and is not overly reliant on any one particular OEM. The company’s three largest customers are Ford, Hyundai/Kia, and Nissan/Renault (which make up 29%, 27%, and 9% of the company’s revenues respectively).
Opportunity Overview:
Visteon’s shares are currently trading on a “when issued” basis at roughly 3x 2011 EBITDA, and after backing out the company’s significant ownership in high growth subsidiaries, we believe the core Visteon business trades for between 1.5x and 1.7x EBITDA. Given Visteon’s multiple internal and external catalyst’s, highly attractive absolute valuation and the outsized spread between the company’s “when issued” shares and the already depressed valuation’s of its global competitors, we think that the stars are aligning for bargain hunting investors to generate spectacular returns of 30%+ in a short period of time with relatively low risk. Keep in mind that this isn’t “your father’s” Visteon, as the company will exit bankruptcy permanently improved and completely transformed, offering investor’s both a 1) quick, high-return, relatively risk-free arbitrage and/or 2) an inexpensive way to play any upturn in – or at least the stabilization of – global auto sales and economic activity in general.
The idea here is simple. As Visteon exits chapter 11, the near to medium-term upside will likely be driven by a combination of 1) a couple of imminent, high probability catalyst’s that should force the market to assign this company with a much more appropriate valuation on an absolute basis and relative to its peers and 2) various operational and financial enhancements that the company recently undertook while in bankruptcy should continue to yield visible and increasingly positive operating results for the foreseeable future.
Our expectation is that the initial roughly 30%+ will come almost instantaneously (within a month or so) as 1) the stock begins to trade regular way 2) equity analysts initiate coverage and 3) various institutional and index funds that have been unable to purchase the stock up until this point (due to restrictions on purchasing company’s in Ch. 11), begin buying in droves. Notably, the return assumption above assumes that upon re-emergence the company trade’s at an incredibly non-demanding multiple of 3.75x EBITDA or, to put it another way, in line with the cheapest automotive suppliers within the industry as a whole. Keep in mind that we think this estimate is very (almost unjustifiably) conservative given that on average Visteon’s peers tend to be considerably more levered, and typically possess both lower EBITDA margins as well as less attractive long-term growth prospects.
http://aboveaverageodds.wordpress.com/2010/09/24/investment-analysis-the-visteon-corporation-vstnq/
Thesis:
The Visteon Corporation is a classic post reorg/special situation with a large margin of safety and substantial near-term upside potential.
Brief Business Description:
Visteon Corporation is a global Tier 1 supplier of automotive products to original equipment manufacturers (OEM’s). Visteon is a market leader in each of its three core product groups: climate, electronics, and interior systems. Visteon is geographically diversified and is not overly reliant on any one particular OEM. The company’s three largest customers are Ford, Hyundai/Kia, and Nissan/Renault (which make up 29%, 27%, and 9% of the company’s revenues respectively).
Opportunity Overview:
Visteon’s shares are currently trading on a “when issued” basis at roughly 3x 2011 EBITDA, and after backing out the company’s significant ownership in high growth subsidiaries, we believe the core Visteon business trades for between 1.5x and 1.7x EBITDA. Given Visteon’s multiple internal and external catalyst’s, highly attractive absolute valuation and the outsized spread between the company’s “when issued” shares and the already depressed valuation’s of its global competitors, we think that the stars are aligning for bargain hunting investors to generate spectacular returns of 30%+ in a short period of time with relatively low risk. Keep in mind that this isn’t “your father’s” Visteon, as the company will exit bankruptcy permanently improved and completely transformed, offering investor’s both a 1) quick, high-return, relatively risk-free arbitrage and/or 2) an inexpensive way to play any upturn in – or at least the stabilization of – global auto sales and economic activity in general.
The idea here is simple. As Visteon exits chapter 11, the near to medium-term upside will likely be driven by a combination of 1) a couple of imminent, high probability catalyst’s that should force the market to assign this company with a much more appropriate valuation on an absolute basis and relative to its peers and 2) various operational and financial enhancements that the company recently undertook while in bankruptcy should continue to yield visible and increasingly positive operating results for the foreseeable future.
Our expectation is that the initial roughly 30%+ will come almost instantaneously (within a month or so) as 1) the stock begins to trade regular way 2) equity analysts initiate coverage and 3) various institutional and index funds that have been unable to purchase the stock up until this point (due to restrictions on purchasing company’s in Ch. 11), begin buying in droves. Notably, the return assumption above assumes that upon re-emergence the company trade’s at an incredibly non-demanding multiple of 3.75x EBITDA or, to put it another way, in line with the cheapest automotive suppliers within the industry as a whole. Keep in mind that we think this estimate is very (almost unjustifiably) conservative given that on average Visteon’s peers tend to be considerably more levered, and typically possess both lower EBITDA margins as well as less attractive long-term growth prospects.
http://aboveaverageodds.wordpress.com/2010/09/24/investment-analysis-the-visteon-corporation-vstnq/
Sunday, October 3, 2010
Insights from Mohnish Pabrai's annual meeting
Pabrai Funds Annual Meeting
Chicago Illinois
September 25th 2010
Prepared Comments:
The meeting started with an overview of how the fund has performed. Since the fund was started in 2001, it has returned 15.1% annually compared to -1.5% for the S&P 500.
$100,000 invested in the fund in June of 2000 would be $408,000 today.
Mohnish’s goal is to beat the index by 3% annually.
This past summer 3 interns worked part time on the checklist 2.0. They identified mistakes by great investors that resulted in a permanent loss of capital and analyzed why the mistakes occurred. They looked for commentary by the fund managers on these mistakes. They found that these investors almost never discussed their mistakes.
The biggest mistake was an investment in AIG by the Davis Fund which resulted in a $2 billion loss for the fund.
Mohnish said that the checklist is a great weapon in the Pabrai Funds arsenal.
Mohnish then went through one winner and one loser in the portfolio.
The worst investment during the period was Ternium which was actually sold at a small gain.
The winner he discussed was Teck cominco. This is the best investment the fund has ever made. The Pabrai Funds made an 8x return in only 3 months. Mohnish invested because they have some of the lowest cost mines in the world. The reason they were so cheap was because of a liquidity mismatch on the balance sheet. It had a large amount of debt coming due in a year. Mohnish felt that if they weren’t able to refinance the debt that they could sell assets piecemeal because of their highly diversified operations. In the worse case, the company would be worth a lot even in reorganizations because its book value was so high.
Question and Answer:
How Long did you follow Teck Cominco before buying?
Mohnish said he spent less than 5 days researching Teck because there were so many bargains at this time. Teck had a very solid moat because it was the lowest cost producer. To find Teck he looked at industry cost curves and paid attention to the lowest cost producers. The most important question to figure out was the liquidity mismatch.
Thoughts on Fairfax?
He doesn’t discuss current holdings.
Why don’t you discuss current holdings?
If investors get in the habit of discussing their investments they may end up suffering from commitment bias. If they constantly talk about how great a company is, they may suffer from a bias that could impair their judgment.
What are your views on position sizing?
His allocation policy changed in 2008 to reflect slightly elevated investment risks of his investment baskets and prior mistakes. If he has 10% positions it’s very hard to recover from a mistake. He discussed his new allocation framework with Charlie Munger who disagreed at first. After Mohnish explained it further, Charlie agreed that Berkshire Hathaway has achieved success with a more diversified portfolio. Mohnish talked about basket bets. When the risk is slightly elevated he will buy a basket of companies with small weightings. For example, he said he is currently researching companies in Japan. If he ends up buying companies there, he will buy a basket of companies each with small weightings in the portfolio. He said stocks there are very cheap.
Please read the rest here. Thanks Guru Focus
http://www.gurufocus.com/news.php?id=108213
Chicago Illinois
September 25th 2010
Prepared Comments:
The meeting started with an overview of how the fund has performed. Since the fund was started in 2001, it has returned 15.1% annually compared to -1.5% for the S&P 500.
$100,000 invested in the fund in June of 2000 would be $408,000 today.
Mohnish’s goal is to beat the index by 3% annually.
This past summer 3 interns worked part time on the checklist 2.0. They identified mistakes by great investors that resulted in a permanent loss of capital and analyzed why the mistakes occurred. They looked for commentary by the fund managers on these mistakes. They found that these investors almost never discussed their mistakes.
The biggest mistake was an investment in AIG by the Davis Fund which resulted in a $2 billion loss for the fund.
Mohnish said that the checklist is a great weapon in the Pabrai Funds arsenal.
Mohnish then went through one winner and one loser in the portfolio.
The worst investment during the period was Ternium which was actually sold at a small gain.
The winner he discussed was Teck cominco. This is the best investment the fund has ever made. The Pabrai Funds made an 8x return in only 3 months. Mohnish invested because they have some of the lowest cost mines in the world. The reason they were so cheap was because of a liquidity mismatch on the balance sheet. It had a large amount of debt coming due in a year. Mohnish felt that if they weren’t able to refinance the debt that they could sell assets piecemeal because of their highly diversified operations. In the worse case, the company would be worth a lot even in reorganizations because its book value was so high.
Question and Answer:
How Long did you follow Teck Cominco before buying?
Mohnish said he spent less than 5 days researching Teck because there were so many bargains at this time. Teck had a very solid moat because it was the lowest cost producer. To find Teck he looked at industry cost curves and paid attention to the lowest cost producers. The most important question to figure out was the liquidity mismatch.
Thoughts on Fairfax?
He doesn’t discuss current holdings.
Why don’t you discuss current holdings?
If investors get in the habit of discussing their investments they may end up suffering from commitment bias. If they constantly talk about how great a company is, they may suffer from a bias that could impair their judgment.
What are your views on position sizing?
His allocation policy changed in 2008 to reflect slightly elevated investment risks of his investment baskets and prior mistakes. If he has 10% positions it’s very hard to recover from a mistake. He discussed his new allocation framework with Charlie Munger who disagreed at first. After Mohnish explained it further, Charlie agreed that Berkshire Hathaway has achieved success with a more diversified portfolio. Mohnish talked about basket bets. When the risk is slightly elevated he will buy a basket of companies with small weightings. For example, he said he is currently researching companies in Japan. If he ends up buying companies there, he will buy a basket of companies each with small weightings in the portfolio. He said stocks there are very cheap.
Please read the rest here. Thanks Guru Focus
http://www.gurufocus.com/news.php?id=108213
Saturday, October 2, 2010
Thursday, September 30, 2010
Recent pick Analysis
One of my friends recommended me to start writing detailed analysis on my picks so that one understand my thought process. Here is the analysis of a recent pick
Nobody likes discretionary income retailers these days in this tough economy. How much would you pay for a company that does online retailing who earns close to $30MM EBITDA and $25MM free cash flow? I would say 7 times EBITDA on a conservative basis which is $210MM. Here is a simple stat for conservativeness – At the end of Aug, the average digital ecommerce retailer is traded at 17.3X times EBITDA
If I say that this is a market leader in that category, One of the major three major players, taking market share from others with strong brand/moat (good share of mind) , has very low cap-ex requirement compared to other retailers, how much would you pay conservatively pay? 10-12 times EBITDA -$300- $360MM.
The best part is they made $58MM EBIDTA when the economy was doing well with bloated expense line. Even if the economy picks up slightly they could make $40MM conservatively. With a 10 multiple they could easily be $400MM market cap. Additionally they have launched another category and this could exceed the major category in next few years, could potentially launch new products using this great platform
Will this be a deal if this whole company is selling for less than $120MM and an enterprise value of close to $155MM, 5xEBITDA? I am talking about 1-800-Flowers. 1-800-Flowers is the leading flower gift shop. This provides flowers, plants, gift baskets, gourmet foods, confections, balloons and plush animals perfect for every occasion. It offers best of both worlds - exquisite arrangements from top floral artists and hand delivered same day and flowers shipped overnight from its Fresh Growers collection. It also has another line of business Bloomnet - international floral service which provides a broad range of quality products and value added services designed to help professional florists grow their business profitably.
"Gift Shop" also includes gourmet gifts such as popcorn and specialty treats from the Popcorn Factory; cookies and baked gifts from Cheryl Co; premium chocolates and confections from Fannie May(r) confections brands and Harry London; wine gifts from Ambrosia(r) and Geerlings&WadeSM; gift baskets from 1-800-BASKETS.CO M(r) (www.1800baskets.com) and DesignPac(r) gifts as well as Celebrations(r) (www.celebrations.com), a new premier online destination for fabulous party ideas and planning tips
The company grew its revenue from $498.4MM to $668.0MM from FY05 to FY10. The revenues are divided by consumer floral (54%), Gourmet Food and Gift Baskets (36%), BloomNet Wire Service (9%).
Historically management has made some bad decisions but they are getting their act together in the last two years. They divested noncore business and paid off $70MM of debt in the last two years. It still has $45MM in long term debt. It has recently launched 1-800-BASKETS, which is picking up lot of pace. It has also reduced its operating expenses by $50MM. Reduced salaries by 15%, Consolidated its IT infrastructure, moved to Virtualized customer platform. This company is not perfect. It takes bonuses based on its EBITDA, not the metric I like to take it on. It took a good will charge of $85MM in 2009 which implies historically made bad acquisitions. This year, management was granted 257,500 options at a strike price of $3.5.
Very few times Mr. Market will provide a market leader with a decent moat, which has a potential to expand, launch new categories with low capex selling at cigarbutt price. Can you imagine how tough for someone to start something like 1-800-Flowers. How much capital one needs to spend on branding to get the share of the mind. Can you provide value to these intangibles? Look beyond the numbers. 50% of the customers are repeat customers and they attract more 9MM customers per year. How many businesses have this kind of stickiness?
Do you think one of the competitors like FTD or Tele Flora would like to buy this at 10-15 times EBITDA? I am sure they would love to. Not the least we have couple of value investors who could put them on the line if necessary which include Royce & Associates, Tocqueville Asset Mgmt.
To statistically minded friends, here are some numbers
Revenues ($MM)
2005 - 498.4
2006 - 584.8
2007 - 725.7
2008 - 739.2
2009 - 714
2010 - 668
Adjusted EBITDA ($MM)
2005 - 21.7
2006 - 18.1
2007 - 57.2
2008 - 57.1
2009 - 36.5
2010 - 29
Nobody likes discretionary income retailers these days in this tough economy. How much would you pay for a company that does online retailing who earns close to $30MM EBITDA and $25MM free cash flow? I would say 7 times EBITDA on a conservative basis which is $210MM. Here is a simple stat for conservativeness – At the end of Aug, the average digital ecommerce retailer is traded at 17.3X times EBITDA
If I say that this is a market leader in that category, One of the major three major players, taking market share from others with strong brand/moat (good share of mind) , has very low cap-ex requirement compared to other retailers, how much would you pay conservatively pay? 10-12 times EBITDA -$300- $360MM.
The best part is they made $58MM EBIDTA when the economy was doing well with bloated expense line. Even if the economy picks up slightly they could make $40MM conservatively. With a 10 multiple they could easily be $400MM market cap. Additionally they have launched another category and this could exceed the major category in next few years, could potentially launch new products using this great platform
Will this be a deal if this whole company is selling for less than $120MM and an enterprise value of close to $155MM, 5xEBITDA? I am talking about 1-800-Flowers. 1-800-Flowers is the leading flower gift shop. This provides flowers, plants, gift baskets, gourmet foods, confections, balloons and plush animals perfect for every occasion. It offers best of both worlds - exquisite arrangements from top floral artists and hand delivered same day and flowers shipped overnight from its Fresh Growers collection. It also has another line of business Bloomnet - international floral service which provides a broad range of quality products and value added services designed to help professional florists grow their business profitably.
"Gift Shop" also includes gourmet gifts such as popcorn and specialty treats from the Popcorn Factory; cookies and baked gifts from Cheryl Co; premium chocolates and confections from Fannie May(r) confections brands and Harry London; wine gifts from Ambrosia(r) and Geerlings&WadeSM; gift baskets from 1-800-BASKETS.CO M(r) (www.1800baskets.com) and DesignPac(r) gifts as well as Celebrations(r) (www.celebrations.com), a new premier online destination for fabulous party ideas and planning tips
The company grew its revenue from $498.4MM to $668.0MM from FY05 to FY10. The revenues are divided by consumer floral (54%), Gourmet Food and Gift Baskets (36%), BloomNet Wire Service (9%).
Historically management has made some bad decisions but they are getting their act together in the last two years. They divested noncore business and paid off $70MM of debt in the last two years. It still has $45MM in long term debt. It has recently launched 1-800-BASKETS, which is picking up lot of pace. It has also reduced its operating expenses by $50MM. Reduced salaries by 15%, Consolidated its IT infrastructure, moved to Virtualized customer platform. This company is not perfect. It takes bonuses based on its EBITDA, not the metric I like to take it on. It took a good will charge of $85MM in 2009 which implies historically made bad acquisitions. This year, management was granted 257,500 options at a strike price of $3.5.
Very few times Mr. Market will provide a market leader with a decent moat, which has a potential to expand, launch new categories with low capex selling at cigarbutt price. Can you imagine how tough for someone to start something like 1-800-Flowers. How much capital one needs to spend on branding to get the share of the mind. Can you provide value to these intangibles? Look beyond the numbers. 50% of the customers are repeat customers and they attract more 9MM customers per year. How many businesses have this kind of stickiness?
Do you think one of the competitors like FTD or Tele Flora would like to buy this at 10-15 times EBITDA? I am sure they would love to. Not the least we have couple of value investors who could put them on the line if necessary which include Royce & Associates, Tocqueville Asset Mgmt.
To statistically minded friends, here are some numbers
Revenues ($MM)
2005 - 498.4
2006 - 584.8
2007 - 725.7
2008 - 739.2
2009 - 714
2010 - 668
Adjusted EBITDA ($MM)
2005 - 21.7
2006 - 18.1
2007 - 57.2
2008 - 57.1
2009 - 36.5
2010 - 29
Monday, September 27, 2010
Bought FLWS @1.85
1-800-FLOWERS.COM, Inc. (1-800-FLOWERS.COM) is engaged in providing flowers and plants, gift baskets, gourmet foods, confections, balloons and plush stuffed animals. Its BloomNet (www.mybloomnet.net) international floral wire service provides a range of products and value-added services designed to help professional florists. The 1-800-FLOWERS.COM, Inc. Gift Shop also includes gourmet gifts, such as popcorn and specialty treats from The Popcorn Factory (www.thepopcornfactory.com); cookies and baked gifts from Cheryl&Co. (www.cherylandco.com); chocolates and confections from Fannie May Confections Brands (www.fanniemay.com and www.harrylondon.com); gourmet foods from Greatfood.com (www.greatfood.com); wine gifts from Ambrosia (www.ambrosia.com or www.winetasting.com or www.Geerwade.com), and DesignPac Gifts (www.designpac.com). In January 2010, the Company announced that it has completed the sale of its Home and Children's Gifts business to PH International, LLC.
Negative: What can go wrong on this stock
- Double dip will drop the stock prices by 50%. This is not an essential commodity
- Slightly higher debt than a typical
- History of bad acquisitions and bad corporate management
Positive:
- Valuation: Cheap, Industry leader selling for less than 5 times depressed EBITDA.
- Paid of $60MM debt in last two years
- Started 1-800-baskets
Purchase Price: $1.85
Fair Value: $3.50
Negative: What can go wrong on this stock
- Double dip will drop the stock prices by 50%. This is not an essential commodity
- Slightly higher debt than a typical
- History of bad acquisitions and bad corporate management
Positive:
- Valuation: Cheap, Industry leader selling for less than 5 times depressed EBITDA.
- Paid of $60MM debt in last two years
- Started 1-800-baskets
Purchase Price: $1.85
Fair Value: $3.50
Saturday, September 25, 2010
Thursday, September 23, 2010
Sold DLIA
Sold DLIA for 2.10. Not bad for a 30% annualized return. The reason why I sold DLIA is it could become a value trap. It continues to bleed and the only end game for this is some one else to buy. The more I read about retail industry, the more it is clearer that it is very tough to invest in this with chaning fashions.
Saturday, June 12, 2010
Fascinating video about Quants
This is a fascinating video of Quants. Why should we bother about quants. We all know that every model is based on historic data. We also know historic data does not capture every possible scenario. This will only provide more opportunities for people like us where we are patient and take opportunities when they come by
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