Why I am short First Solar

(The following is an extract from Bronte Capital’s client letter. I thought it deserved wider circulation. It also provides grist to Felix Salmon who described shorting – and in the context by implication me – as socially useless. I think that was harsh – but not necessarily in this case. I will write an article in the future on socially useful short selling.)

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Case study: our short on First Solar

Investing in technology stocks has lots of traps for neophytes – and by-and-large we are neophytes so we do not do very much of it. We however spend a lot of time thinking about it primarily because we are scared of what technology can do to other businesses. (The demise of many low-tech newspapers provides a good demonstration of why – as investors – we should think about technology.)

Technology offers value creation like few other industries. In Australia Cochlear has created enormous value and improved the world. It can literally plug a bionic ear into someone's brain-stem and get them to hear. And the stock has paid about 20X – which is better than anything in our portfolio. Many of the biggest fortunes were made in technology. But technology – and specifically technological obsolescence has thrown many a fine company to the wolves. Palm for instance is likely to go bankrupt even though the concepts it pioneered are in everyone's pocket.

We do however have a framework to hang around our (limited) technology investments. A technology, to be a really great investment, must do two things. It must change part of the world in a useful way – a big part of the world is better of course – but you can be surprisingly profitable in small niches. And it must keep the competition out.

In technology the competition is remorseless. In most businesses the competition might be able to do something as well as you – and it will remove your excess profit. People will build hotels for instance until everyone's returns are inadequate but not until everyone's returns are sharply negative. Even in a glutted market a hotel tends to have a reason to exist – it still provides useful service. And someday the glut will go away so the hotel will retain some value.[1] In most businesses the game is incremental improvement. If you get slightly better you can make some money for a while. If the competition gets slightly better you will make sub-normal returns until you catch up.

In technology the threat is always that someone will do something massively better than you and it will remove your very reason for existence. Andy Grove – one of the most successful technologists of all time (Intel Corporation) – titled his book “Only the paranoid survive”. He meant it.

If your technology is obsolete the end game is failure – often bankruptcy. Palm will fail because Palm no longer has a reason to exist. If we wait 20 years Palm will be even more obsolete – but the hotel glut will probably have abated. Nothing left in Palm is likely to have any substantial value. Businesses that produced plenty now, produce nothing then.

Surprisingly, changing the world looks like the easy bit. Plenty of companies do it. The problems are in keeping the competition out. Only a few do that (Microsoft, Google are ones that seem to). Hard drive makers changed the world (they allowed all that data storage which made things like digital photography and internet multi-media possible). But they never made large profits – and they trade at small fractions of sales.

The limited technology investments we have are not driven by any real understanding of the technology. Sure we try – but if you ask us how to improve the laser etching on a solar panel then we will not be able to help. The driver of our investment theses in almost all cases is watching the competition.

A simple example is Garmin. We have a small short position in what is a very fine company. Garmin – once a small avionics company - led the mass-marketing of satellite navigation and allowed John – without stress – to find his son's Saturday sports game. Sat-nav it seems has saved many marriages and meant that school sports teams do not run short players because dad got lost.

Garmin has over a billion dollars cash on the balance sheet – and that cash represents past profits. It has changed the world – and thus far it has been well remunerated.

The only problem is that they can't keep the competition out. Nokia has purchased a mapping company. Iphone now has a Tom-Tom app, downloadable for $80 in Australia. Soon sat-nav will be an expected application in every decent mobile phone. Google has mapping technology too and will embed it into their android phone. Eventually the maps will be given away because people might book hotels using their sat-nav device whilst they are travelling. [It is darn useful to know where a decent hotel with a spare room is when you are on the road.]

Garmin has a great product. They have improved my world. The only problem is that they can't sell their product at any price that competes with “free”. Garmin's business is going the same direction as Palm. Bankruptcy however is only a remote possibility – they have a billion dollars on the balance sheet and unless they do something really stupid on the way down they will remain a profitable avionics business.

Is it fair that Palm is facing bankruptcy? Or that Garmin is being displaced? We don't think so – but then capitalism is not necessarily moral or fair – but it does produce goods and services quite well. We don't invest on the basis of fair – we invest to make you good returns.

The solar industry – and the possible failure of the good

First Solar is a company that improved the world. It drove the cost of production of solar cells to quite low levels and made utility-scale solar farms viable with only modest subsidies. There are some places where solar is now viable without subsidies.[2]

Our biggest short position though is First Solar – a company we have little but admiration for. There is a distinct possibility that First Solar's business will fail in the same way as Palm or Garmin. It won't be fair – but fairness has nothing to do with it. Like Garmin it probably won't go bust because it has a billion dollars in liquid assets on the balance sheet – assets which represent past profits.

Moreover we suspect that First Solar's profits are about the same as the rest of the industry put together. The stock still trades with a high teens trailing price-earnings ratio – a fading growth stock. It hardly looks like a failure. It is a strange conclusion to come to. So we should explain how we got there. To do that we need to explain how a solar cell works.

How a solar cell works

To make a solar cell you need three things.

1). A substance which is excited (i.e. spits off electrons) when a photon hits it.

2). A layer which separates the electrons. This layer is usually a “semiconductor” which means that electrons go through one way and cannot go back.

3). Something at the back which conducts the electrons away.

Thin film versus wafer

Traditional solar cells were made with a semiconductor ingot cut to a thin sheet. On one side it was “doped” with a substance that kicks out electrons. The other side was laced with wires to conduct the electrons away. This was expensive.

There were generally two types of ingot – monocrystalline – where the wafer structure was perfect or near perfect and polycrystalline which had visible crystals in the wafer. Monocrystalline wafers are primarily used for computer chips (where atomic level imperfections are problematic) and are expensive.

Polycrystalline silicon is cheaper. For most large-scale uses polycrystalline wafers were sufficient. These have about a 17 percent conversion rate – which means that 17 percent of the photon energy that strikes them is turned into electricity.

The ingot itself was a substantial part of the cost of a photovoltaic cell. Polycrystalline ingot used to sell for $450 per kg.

First Solar (and others) developed a process for making solar cells with considerably less semiconductor material. They have a Cadmium Telluride process which vapor-deposits semiconductor at atomic level thickness and comes up with a cell that is now exceeding an 11 percent conversion ratio.

This company is a technological wonder. Glass goes in on one end of the manufacturing process and comes out as solar cells at the other with next to no human intervention. Labour is used only when it comes to putting frames around the glass and for similar tasks.

This was revolutionary – it made cheap solar panels and hence made possible commercial scale plants like this 1.4 megawatt roof installation in Germany. This is enough to supply a few hundred households – not earth shattering – but a complete revolution in the solar industry.

We can think of few companies which have pushed a technology so far and with such high environmental benefits. Companies like this will allow us to maintain a modern lifestyle whilst addressing greenhouse issues.

Still for all the benefits of First Solar’s cells, they are inferior in many important ways to a polycrystalline cell. Their efficiency is lower – which means you do not get as much solar energy off the constrained roof space. Secondly, whilst they save a lot on the semiconductor part of the manufacturing process they have to use more glass, more wires etc to generate the same amount of solar electricity. Each cell generates less electricity too so inverters, connectors, installation all cost more with thin film. Thin film also degrades over time. First Solar warrants their performance over their lifetime – but with the warranty being for lower levels of performance in the second decade of operation (google the Staebler-Wronski effect for a non-trivial explanation). Thin film does however have some advantages in low light - keeping a slightly greater proportion of their peak capacity.

Indeed the main advantage of thin film is cost – and that cost advantage has been driven by the cost of the semiconductor component. After all ingot did cost $450 per kg.

That cost advantage made First Solar absurdly profitable – and they used that profit to grow into a behemoth. Revenue has grown from $48 million to over $2 billion. Gross profit (before selling and administrative costs) has grown to over $1 billion. We do not want to tell you how far the stock ran for fear of invoking insane jealousy. This stock would have made Berkshire Hathaway shareholders jealous.

But remember – all of that was predicated on a cost advantage (almost all other things being inferior). And that cost advantage is predicated on expensive semiconductor material.

Competition cometh

To make money in technology you need to do two things. Firstly you need to change the world (which First Solar clearly did) and secondly you need to keep the competition out. Alas very few businesses manage the second trick.

The competition came in a couple of forms. Firstly it came from Applied Materials. Applied Materials, or AMAT (as the company is known) is the most important company in the world you have never heard of. It is the dominant maker of capital equipment that goes into semiconductor factories and it is thus the company that – more than any other – provides the kit to keep Moore’s Law active.

AMAT has tried competing head-on with First Solar in the thin-film space. AMAT developed the vapor deposition equipment that made large-screen LCD televisions possible. This entails deposition in large sheets (5.6 square meters) which are then cut down into several large screen TVs. An imperfection in the vapor deposition shows on the TV as a bad pixel.

AMAT appropriated this technology for solar. The silicon semiconductor is not as efficient as First Solar’s Cadmium Telluride technology – and it is equally subject to the Staebler-Wronski effect, however they can do much larger panels than First Solar (with comparably lower wiring, inverter and balance of system costs). AMAT’s thin-film business could do some damage to First Solar – but it is unlikely to kill it. (Indeed AMAT appears to be de-emphasizing that business for the reason discussed below.)

Far more important have been developments in the wafer business. AMAT (often the protagonist) has developed wire saws for cutting wafers thinner and thinner. They are now 80 microns thick. These wafers are so thin that they flutter down in air and break if held on their side. AMAT will of course sell the whole kit for handling these wafers – including laser etching material and other steps in the manufacturing process. Much less semiconductor is needed in the wafer business.

But worse – the price of ingot has fallen – and spot prices are now $55 per kg – which is a lot less than $450. The cost of ingot is still falling. First Solar’s advantage is entirely dependent on the fact that they use much less semiconductor than wafers – an advantage that disappears entirely as wafer prices fall. At that point all of First Solar’s many disadvantages will shine through.

We are trying to work out the cost-structures of the polycrystalline manufacturers – but it looks to us that the extra glass and other balance of system costs that First Solar panels have are getting close now to completely removing the advantage of low semiconductor material usage.

If that happens though, First Solar is toast. It probably won’t file bankruptcy because it has so much in past profits to fall back on – but it will be every bit as obsolete as a Palm organizer is now or a Garmin car navigation system might be in five years.

We do not wish failure on First Solar – and if we are right it could not have happened to a nicer company (no irony intended). Capitalism is not fair – and technology investment is particularly unfair.

We don’t make money from fairness. We make money from getting the business analysis right and betting on (or against) the right business – and in this case we are betting against the most successful company in a massively important growth industry.

If we are right (and we think we are) then we will make money from the demise of a company that has much improved the world. We like to think our business is noble. And it is sometimes – but in this case we can see why people dislike short-sellers. Their opinion however is not our business.

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[1] Unfortunately the hotel is usually mortgaged – and the value often reverts to the debt holder.

[2] One way amuses us greatly. Walmart started putting solar cells on the rooftops of many of their super-centers in the Southern United States. They did this originally because of implicit subsidies. However the test centers showed something quite interesting. Good solar panels turn quite a lot of the energy hitting the rooftop into electricity which is conducted away. That energy does not wind up as heat in the building – and the cooling load of the building went down. The rooftop solar installation may not have been justified by the electricity output alone – but combined with lower cooling bills it worked a treat. [Addendum. This footnote is anecdotal from good source rather than published... many people have asked us about it - and a few have said they have heard this sort of thing before but they would like hard data... I apologize as I am unable to provide...]

A Jim-the-Realtor video

Jim the Realtor is a fabulous feed on the Southern Californian residential (and small-scale commercial) real estate market – its directions and its intricacies.

This video is one of his best ever.  It is 9 minutes long and in his usual monotone. 

I wish it were three minutes shorter because I recommend you watch it to the end.  The last two minutes are intriguing. 

 

 

Explanations sought.

 

 

 

John

Repo 105’s antecedents: Ken Lewis

I agree with Felix Salmon that the former Lehman staffers who defend Repo 105 are psychopaths – certifiably insane.  They state (as if this justifies it) that …

The only people who would worry about using an old trick to reduce leverage from 13.9 to 12.1, are “yappers who don’t know anything.”

For those that don’t know Repo 105 was a sale and repurchase agreement by which Lehman parked about 50 billion in assets (presumably assets they did not want to discuss) overnight via a repo transaction so they would not appear on the balance sheet. 

By now anyone who does not realize that sort of accounting legerdemain is unacceptable is (a) entirely out of touch with reality and (b) self aggrandizing on a magnificent scale.  Both are signs of mental illness.

But unfortunately the Lehman executives do have one point.  Repo 105 type balance sheet faking was “an old trick” and well known to anyone who cared to read balance sheets (very) carefully.*

Let me take you back to 2006 and Bank of America.  Pages 94 and 95 of the 2006 Annual Report show (amongst other things) the average total assets by quarter from the fourth quarter of 2005 to the fourth quarter of 2006 inclusive.  Here are the numbers:

(US dollars - millions)	Q4 2006	Q3 2006	Q2 2006	Q1 2006	Q4 2005
Average total assets	1,495,150	1,497,987	1,456,004	1,416,373	1,305,057

Now lets extend this table by including period end assets.  You can find the data here (see page 4 for both fourth quarters and third quarter, and page 4 here for the first and second quarters). 

(US dollars - millions)	Q4 2006	Q3 2006	Q2 2006	Q1 2006	Q4 2005
Average total assets	1,495,150	1,497,987	1,456,004	1,416,373	1,305,057
End period total assets	1,459,737	1,449,211	1,445,193	1,375,080	1,291,803
end period less average assets	-35,413	-48,776	-10,811	-41,293	-13,254

 

You will notice that the end period assets were always lower than the average assets.  Moreover it was not obvious unless you really looked because the quarterly earnings releases did not include average assets (but you could work it out because they stated return on average assets). 

It was not just 2006 either – this had been happening for a while.  Bank of America was parking its assets off balance sheet at the end of every quarter for some time and had been obscuring the fact. 

Counterparties

If Bank of America wanted to shove the assets off balance sheet someone (credit worthy) needed to be found to house the assets overnight.  There are not that many parties credit worthy for $50 billion or more of overnight repos. 

Well – being an obsessive reader of bank accounts I found the counterparty.  It was MUFJ.  If you wish to you can show – the same way that MUFJ had end period assets higher than average assets and that the differences and timing roughly match.  Someone had to assist BofA in its financial legerdemain and we know the counterparty.

Once – through an interpreter – I asked senior MUFJ executives about this.  Any nuance in the answer was lost in translation. 

So back to Repo 105

Repo 105 is fraud.  Its a lie to investors and rating and regulatory agencies.  It was also fraud when BofA did it.  But both Lehman and Ken Lewis compartmentalized it as OK.  And it was not the fraud that undid them – it was the overweening arrogance that thought this was alright.  The same overweening arrogance that made Ken Lewis think it was alright to pay a big premium to close for Merrill Lynch (and later force mass dilution of BofA common shareholders). 

But the chief executive (or other executive) who thought this was alright was probably certifiable.  Just as certifiable as the Lehman execs who Felix rightly chastises. 

Do we want to prosecute?

There is a big debate in the blogosphere as to whether anything in the Valukas Report rises to the level of prosecution.

I suspect in a vacuum it does.  But this was a collective insanity every bit as mad as the poisoning craze written about Charles Mackay.  Mass insanity does lower moral culpability and it takes an extraordinary person to stand up to it. 

Besides – if we are going to slap Erin Callan’s wrists in handcuffs then we are going to have to do the same to Ken Lewis and probably have to extradite the top-end of the Japanese establishment who were the counterparties. 

I do not want to go there – and I do not think it would be constructive.

 

 

John

Disclosure:  Long a lot of Bank of America – surprising given this post I guess. 

*It is my burden to read balance sheets like this and to remember details four years later. 

My tipper on Astarra

Tipping the authorities off about Astarra required – as I said – no special genius on my part.  I was tipped by a blog reader who noticed that the Astarra investment committee claimed Charles Provini as a member whilst Provini was the CEO of Paradigm Asset Management.  I have written extensively on Paradigm Asset Management (see here for a decent summary). 

Anyway my tipper has now revealed himself.  He is Dominic McCormick – the chief investment officer of Select Asset Management.  Dominic insists his team deserves any credit.

Dominic (and presumably his team) had many of the issues with Astarra nailed by the time he tipped me off.  I worked out a few more.   

I reported the story to the Sydney Morning Herald who did not think they had enough evidence to run the story.  [They printed nothing until much later.]

Later I worked a few more things out and using connections ensured that the whole story landed directly on the desk of Tony D’Aloisio (the head of our securities regulator). 

Dominic found about half a dozen red flags with Astarra.  He has since listed them in this article without revealing that he was my original tipper.  Dominic’s article shows clearly that there were plenty of reasons not to invest in Astarra – and these reasons are valid reasons to be wary even if you have no strong basis to allege fraud.

The problems are wider than either Dominic or I anticipated.  For instance we knew nothing of ARP Growth – and that may be the most seriously impaired fund of the lot.  It is also the only fund on which I am willing to determine – absolutely – involved fraud.  (I have two wildly different sets of accounts for ARP Growth - at least one of those accounts must be fraudulent.)

The rest of the issues with Astarra I will leave in the capable hands of our regulator and perhaps the class action lawyers.  I want to get back to making money for our clients.

 

 

John

Barclays: do you employ these psychopaths?

Felix Salmon directs us to a blog post in which former Lehman executives (possibly safely employed by Barclays) talk about the Valukas report. 

http://blogs.reuters.com/felix-salmon/2010/03/17/repo-105-like-whatever/

Felix rightly describes these people as psychopaths. 

I am not going to further roast these executives – I just want to know how much of this culture infected Barclays. 

It remains a source of amazement to me that Barclays came out of the crisis so well.  Sure they got a (real) bargain buying Lehman’s US Broker-Dealer.  But they were hardly Snow White and their leverage levels were way higher than Lehman.  Moreover the crash-or-crash-through attitude of Bob Diamond would not have been out of place at the most aggressive (failed) hedge fund.  [The first post on this blog that got more than 30 readers was on Barclays – and – unlike many of my early posts – it looked very good for a while – but less good in the long run.]

Barclays is here and prospering so my pre-crisis view of the investment banks (that Lehman and Barclays would be the troubled ones) did not turn out precisely right.

 

John

PS.  Sorry for the absence of posts – but I was busy walking from Mallacoota to Wonboyn and there were no people, phones, internet or stock quotes.

A little follow up for people who want to reinterpret what Buffett said… oh – and a stock reason for looking at all of this…

There are a few comments on the blog that annoy me.  One for instance is repeated below:

A review of the transcript will show that Buffett believes that: a) the legislation must focus on cost, in order to achieve the goal of universal coverage. This has nothing to do with socialized medicine; b) he believes a broader political consensus is required. Everyone is entitled to the their opinion, but not to someone else's.

Buffett clearly said he was for universality of health care.  He would – if given no other choice – vote for the current bill.  Universality – unless someone else has worked out how it happens – involves a person who can’t pay (or possibly won’t pay) being covered by other people.  That can happen via the tax system or via some kind of forced levy on other people.  But it necessarily involves the (partial) socialization of medicine.

He implies however – though does not say so directly – that universality (necessarily involving some socialization of costs) – could be a disaster if costs are not controlled.  I will go further and say that it will be a disaster if costs are not controlled.  Australia has spent the last twenty years on measures that control costs (with considerable success).  In the UK – but to a much lesser extent in Australia – those measures include queue rationing of some services.  Queue rationing known here as “hospital waiting lists” was for a long time one of the dominant issues in State politics.  Queues are less of an issue now than (say) ten years ago – but if you run the expression “hospital waiting lists” through Google News you will still find that it is a political issue.  Anyone who tells you that you can have universal coverage without some queue rationing is lying.  A decent part of the system however is working out what procedures must take place quickly and what procedures can safely wait a while.  In Australia some people are in pain whilst on waiting lists. 

Buffett states clearly that controlling costs will not be done with a bill that pleases everybody.  There are $2.3 trillion of costs – and every bit of those costs has a constituency.  He wants a real analysis of medical spending effectiveness.  He wants experts – and he points favorably at Dr Gawande.  Dr Gawande focuses on things that involve medical incomes (including the use of the Doctor’s pen to order tests and specialist treatment). 

He notes that medical employees as a percent of population are low in the US compared to other jurisdictions and yet medical expenditures are high as a proportion of GDP.  Some of this must be expenditure that does not go to medical staff (he points directly at medical kit).  But some of it must be the incomes of the participants are high relative to the rest of the population.  [Simple math here – less employees – more cost – so more cost per employee.  And I know kit is part of that equation… but kit expenditures are simply not large enough to make up the difference.  And most of the rest of the cost of a doctor is the doctor’s income.]

Buffett does not prescribe how you would crush medical costs as he suggests – but he notes that other countries have done it with universal coverage, providing more doctors, more nurses and more consultations.  He thus thinks it is possible (though politically terribly difficult).  He specifically thinks that this cannot be done by consensus (despite the comment repeated above) because a bill that pleases everyone can’t deal with costs.  [I added – though Buffett did not say – that that implies that the bill cannot be bipartisan.  In the current context that means a filibuster process – though Buffett did not say that either.  Still if there is a way for a non-consensus medical bill which provides universal coverage and cuts costs to be bipartisan show me and I will stand corrected.]

I doubt Buffett – as the world’s second richest man – would find queue rationing acceptable for himself – but that discussion never came up.  If you want to accuse him of hypocrisy go ahead.  When my wife damaged her knee in a skiing accident we queue jumped using supplementary private health insurance.   So accuse me of hypocrisy too.

Buffett obviously knows that a system that radically cuts costs but has the government meet some of those costs will necessarily involve rationing.  He is not a fool.  He just never said how the rationing should take place – preferring to leave that discussion to experts.  That way though he could sound reasonable and friendly whilst proposing reforms that will radically reduce some peoples’ incomes and somewhat limit access to medical care.  And that I guess is Warren Buffett to a tee.  He sounds all genial – but underneath is one of the most hard-headed men you will ever come across.

Why I am interested

This is actually a hard headed investment blog.  And Buffett is right.  Medical reform which does not control costs will be a disaster.  He is also right to finger medical kit.  The current bill does not address costs – so it is not the time to think about this – but some medical kit companies trade at nose-bleed valuations because they can sell growing amounts of high tech kit at high margins.  (Intuitive Surgical is a good example.) 

I am an irregular short-seller of stock in even the finest companies.  When America finally gets serious about controlling medical costs some of these stocks will be fantastic shorts – simply because controlling costs means reducing some people’s incomes and some corporate profits.

And – that is enough reason to take the partisan glasses off and look entirely rationally a the problem.  This bill does not give me a good reason to short Intuitive Surgical.  From the perspective of Warren Buffett however that is why it is not a good bill. 

 

John 

 

Follow up: 

Namazu  - the provider of the comment that annoyed me - suggests we might be arguing over the meaning of socialized.

I think that is probably a fair comment... it is not a word Buffett used.

I consider the mixed market system of Australia partially socialized. By far the bulk of medical costs are picked up by government and are shared through the tax system - but it looks quite different to the UK.  [My UK friends also prefer the Australian system…]

Still – a system where by far the bulk of the costs are picked up by government and shared through the tax system meets my definition of socialized.  [Though people who say keep government hands off Medicare might have a different view…]

Still in many categories (for example pharmaceuticals) the Australian government is effectively the monopoly buyer - and it uses that power to reduce costs. That is a KEY part of the story as to how costs are reduced in almost all other countries.

And yes - it does crush incomes of doctors and corporate profits. 

Warren Buffett on Obama’s health reforms

Warren Buffett did one of his regular (extended) interviews with CNBC.  I think he appreciates the charm and attention from Becky Quick – even enough to get up at 5am and go to the steakhouse turned TV studio.  Most of these interviews are Buffett repeating his wholesome (and oft repeated) wisdom.  However he often comes up with a piercing analysis of something topical.  Today it was health care.

We (the US) have a little over 2.5 doctors per thousand.  Much of the world has over 3 doctors per thousand.  We have 11 nurses per thousand – much of the world has more.  We have three beds per thousand – much of the world has 6 or 7 beds per thousand. 

Having said this he points out that costs as a proportion of GDP are considerably higher than the rest of the world.  He then points out some statistics (for example infant mortality) where the US does worse than some other developed countries.  Importantly he points out that these costs are a passed onto other sectors of the economy.  He did not describe them as a “tax” on the rest of the economy – but that is what he meant.

He describes the situation as a “tape-worm” strangling American productivity and he is for health care reform but particularly health care reform that controls costs.  He would – in the absence of other choice – vote for the current bill.  That however is – in his case – very qualified support for the current bill.

The health-care part of the interview is worth watching.

 

 

In the interview he refers (favorably) to an article in the New Yorker by Atul Gawande which compares medical costs in high cost locations and low cost locations.  Dr Gawande describes health care driven by entrepreneurial doctors in an environment of over servicing.  I think the money quote in Gawande’s article is this:

Most Americans would be delighted to have the quality of care found in places like Rochester, Minnesota, or Seattle, Washington, or Durham, North Carolina—all of which have world-class hospitals and costs that fall below the national average. If we brought the cost curve in the expensive places down to their level, Medicare’s problems (indeed, almost all the federal government’s budget problems for the next fifty years) would be solved. The difficulty is how to go about it.

I have written about health care before (but I think Buffett says many things better).  Though in summary the costs of American health care is higher because:

1. America pays its doctors more than other countries (indeed substantially more than other countries)
   
2. There is less control on pharmaceutical expenditure and other medical kit (and Buffett notes that Americans spend a lot on medical kit), 
   
3. There is more hospital and health care administration – especially insurance operating - expense than other countries (although anyone who follows the bureaucracy of the National Health might think otherwise), and
   
4. There is more litigation and insurance expense than in other countries (though Buffett did not play up this aspect of cost comparisons).

I would love a decent breakdown of those things.  Unless however the costs are addressed health care reform will ultimately be an economic failure. 

And that is roughly how Buffett thinks about the Obama reforms.  The current health care bill provides universality of health care – but does not address the fundamental cost issues. 

That however is very difficult.  As Buffett puts it – the current health care bill is about $2.3 trillion annually.  And every one of those $2.3 trillion has a constituency.  Moreover that constituency is organized and are effective lobbyists.  Buffett thinks that there is simply no way to do an effective cost reduction health care bill by consensus.  That is hard to disagree with. 

As he puts it:

Everyone of those dollars is going to somebody and they are going to yell if that dollar becomes 80c or 90c. 

I thought he was being generous.  If American doctors were paid like Australian doctors my guess is those dollars would not become 85 cents.  More like 60 cents or less.  The squealing here was intense – but even after all that trimming doctors remain pretty well paid.  But you can’t get rich doing general practice and even specialist medicine is a ticket to the upper-middle class not to dynastic wealth. 

What allows Australia to pay so little for doctors is a monopoly buyer (the Government) actively suppressing their income.  It is little surprise that doctors do not in general support that bit of the reform agenda.

What ultimately Buffett was saying was that proper health care reform does not and cannot get broad agreement – and hence must be done with the expenditure of significant political capital.  He never says it – but I think he thinks that this would be a good time for the Democrats to outlast a filibuster.  Triangulating Democrats have their place – but not here.

Buffett thinks that if this is not done medical care will remain a growing parasite (“a tape worm”) for the rest of the American economy.  He supports an aggressive and interventionist solution.

Still – if you follow his numbers he thinks the savings are probably 4% of GDP.  The ambitious number in my original post was somewhat larger.  He is probably right on that too.

 

 

John

 

PS.  One of the more amusing things about this interview is Joe Kernan making an ass of himself.  Buffett is clearly saying that – correctly done – socialized medicine will improve the competitiveness of American industry (though the current bill is not a solution to costs).  This is anathema to Kernan’s oft-stated ideology – and Kernan repeatedly tries to restate Buffett’s position to suit his own ideological view rather than Buffett’s clearly enunciated position.  Becky Quick proves again that she is the heavyweight on that show and I can see why Buffett does appreciate her (intellectual) charms.

In which Paul Krugman proves he is an academic snob who argues from his prejudice rather than the data

Felix Salmon has a lovely post where he picks apart the news values of the Wall Street Journal – including picking apart differences between the front page of the WSJ and the online version. 

From this Paul Krugman argues that the New York Times rather than the Wall Street Journal is likely to wind up as the only national US newspaper (at least if the US does wind up with a single national newspaper). 

Frankly, there was a time when I thought the Journal was better on business/economic news than the Times. But no longer; and it’s not just things like referring to the estate tax as the “death tax” in news stories. Overall, coverage is getting cruder, with more tendency to report opinions as if they were news, and substitute prejudices for real analysis.

And this bad news is good news. There’s a pretty good chance that we will end up with only one great national newspaper. And I know which paper that should be …

Krugman’s prejudice matches mine.  I prefer reading the New York Times. 

But one of the things Paul Krugman does better than most is argue from data or a testable model – but he lapsed badly here.  Below are the top 15 newspapers in the US by circulation now and two years ago.  [The sources are revisions to the relevant Wikipedia page.]

 

No paper has – in this data – maintained circulation.  For most papers the fall has been catastrophic.  (The effects of falling circulation on pulp pricing is background to my next post…)

Nonetheless, it is pretty hard to see disaster or even the “great recession” in the Wall Street Journal numbers.  I gather of late that the fully paid circulation of the Wall Street Journal is rising again – albeit slowly.  None of this says that Rupert did or did not overpay for Dow Jones but Paul Krugman’s argument from prejudice rather than data about the New York Times possibly becoming the nations largest newspaper because of editorializing is – well – hogwash.

What sells the news?

Paul Krugman gives his view of what sells the news.  It is a view that fits the vision of the Gray Lady quite well: a clear distinction between news pages and editorial pages, facts supported by data etc.  That is also how I want my news presented.  However the evidence that that sells the news is quite thin.  Whatever Rupert did to the WSJ Journal (that which Felix Salmon and Brad Delong rail against) appears to be working. 

More generally opinion dressed up as news, especially when it panders to the prejudice of your readers or viewers works seems to sell really well.  A while back I gave a quarterly series of operating profits (in millions) for Fox Cable Networks – a business dominated by Fox News.  Here they are again: 197, 262, 211,194, 249, 275, 282, 284, 289, 337, 330, 313, 379, 428, 429, 434, 495.

There are few businesses with growth in operating profits without substantial capital expenditure that look anything like that.  Well Fox News gets even better (at least from the perspective of a News Corp shareholder).  The latest number is was $604 million operating profit for the quarter ended 30 December 2009. 

I am not a newspaper guy – but I have watched for long enough to form a supported opinion – which is that opinion and prejudice sell media – especially when they back the readers’ opinion and prejudice.*  It is respectable to present an alternative viewpoint – but only if it is a caricature – something weakly presented to rile the audience – but only till they pick it apart and make themselves feel smug.  The lightweight Alan Colmes – the token Fox News Liberal – and the equally lightweight Miranda Devine – the conservative for the Sydney Morning Herald fit this bill. 

Rupert knows this – and his news outlets all blur opinion and fact.  If his audience is left-leaning he will blur from that side (he once owned the Village Voice) and he knew enough to leave its politics alone.  He is (obviously enough) more comfortable with right-wing media markets (with a special love for “working class tories”) – but again – it might just be that is where the big markets are… 

Krugman however insists on wonkish articles arguing closely from data.  Those articles are like eating spinach.  Reading them is good for you but you would rather have ice cream.  But sometimes – as he did this time – he lets his prejudice out and argues like the Liberal equivalent of Fox News.  His prejudice matches mine – and I love him for it.  I suspect it also increases his value as an author.  Advice to Paul: get it wrong more often and ask for a pay rise.

 

 

 

John

*Local newspaper guys – who know far more about this than I ever will – say that what sells newspapers is local relevance.  All politics is local (but the internet is global).  Readers like to see pictures of themselves and their schools and teachers and articles about their roads and public transport. 

Submission to the Cooper Review of Superannuation

I have written a submission to the Cooper Review of Superannuation (that is privatized social security) in Australia. 

You can find it here. 

The submission is entirely about asset security issues – that is can you be assured that the assets are really there?  This is (obviously) of concern to people charged with looking after the (entire) retirement savings of tens of thousands of Australians.  However I have also found it is a very useful conversation to have with anyone recently finding themselves in possession or care of many millions in financial assets.  [If you run a small family office managing financial assets after you have (for instance) sold the family business then you should probably read it.]

The issues covered are broker and custodian failure (think Lehman failing and not returning assets to the clients) and also simple theft or misplacing of assets. 

Under normal circumstances this would normally be (very) dry reading.  However the events of the last two years have driven home the relevance. 

Weekend edition: an old Astarra marketing leaflet – and some comment on Astarra’s very peculiar asset base

The Astarra funds were amongst the top performing sold retail in Australia. 

According to the advert below it is because of market timing.  Shawn Richard knew when to go to cash. 

This suggests that his asset base was highly flexible – able to be converted into large licks of cash on market turns.

He says (in the picture) and I quote:

People ask me all the time how we do it.

To me it’s simple…  why be fully invested in a deteriorating asset class?  Investors don’t pay me to invest in cash, they pay me to get out of assets at the right time.

I believe that every asset class should be treated from an absolute return philosophy.  If that means higher cash weighting for a short time then so be it. 

Shawn Richard, Chief Investment Officer

Now if it was easy to shift Astarra funds to cash then it should be easy now.  Alas Peter Johnston in an article in Investor Daily suggests otherwise:

AIOFP chief executive Peter Johnston said he disagreed with [the administrator’s plan of liquidating the funds] and that the AIOFP intended to voice its opinion on the matter.

"Because these assets of hedge funds are off-market assets ... if there's a fire sale, in other words if the administrator wants to get in there and just wants to wind it up in a bloody-minded sense, you're going to find they run the risk of devaluing the assets," Johnston said.

"We just disagree with their strategy. So we intend on voicing our opinions on this because they don't have any experience in dealing with hedge funds at all.

These are very peculiar assets.  They can be liquidated in response to a market turn – but they can’t safely be liquidated in response to a court order.

Enough said.