A gem from Jim the Realtor.
PS. Even the title is not original - it was purloined from the comments.
Thursday, January 27, 2011
Monday, January 24, 2011
What to do with Fannie and Freddie
There are a bunch of ideologues out there with solutions to the Fannie and Freddie situation. They argue that government intervention has to end and then propose a system with a permanent role for government. It is not just nonsensical - it is usually in the interest of some large financial institution. All they want is Frannie out of their part of the business. They like government subsidies in the rest of their business.
Anyway I have the free market solution to the Fannie and Freddie situation - and - I hate to say it - it is dead obvious.
Answer: raise Frannie’s pricing.
At the moment there is nobody doing conforming mortgages except Fannie and Freddie. Indeed there is almost nobody doing mortgages of any kind except Fannie and Freddie. If the free market wants the business they can have it. (They just don't want it at this sort of interest rate spread - and I don't blame them.)
All the government need to do is tell Frannie to raise their price a little each quarter. Currently they charge 20-25bps for guaranteeing mortgages. (The free market won’t take credit risk at that price.) So it is entirely open to the FHFA (and hence the Treasury) to tell Fannie and Freddie to raise their prices by 5bps. The government will get paid better for the risk they are taking (and what free market ideologue will disagree with that) and the private sector can compete if they want to.
I doubt the free market will. But then in a quarter or two Frannie can raise their pricing by another 5 bps. And a quarter or two later Frannie can raise by another 5bps.
At some stage you will get to a level where the private sector chooses to compete. Frannie should not set its price competitively though. In another quarter they should raise the price another 5bps. And in another quarter they should raise again.
Over time Frannie will become non-competitive. It will shrink simply because bankers and mortgage brokers do not bring it business. And so Frannie is put into market chosen run-off and the business is effectively privatized.
You can do the same thing with Frannie's portfolio - you could ask them to raise their internal revenue exectations on any mortgage they buy by 5bps. They might buy less - they may not. Don’t limit the size of the portfolio: raise the profitability of the portfolio. When another quarter elapses raise spreads by another 5bps. Eventually of course the private sector won’t bring Frannie business - and so Frannie will shrink.
If you want the government to keep supporting the housing market (an object of policy it seems) then you just slow the rate of price increase down. Do 5bps per half rather than 5bps per quarter - or even 8bps per year for a slow exit.
Over time the government will make a full exit from the mortgage business. Along the way the taxpayers recover as much money from Frannie as possible.
If you look at my long series on Fannie and Freddie and compare my model predictions to current results you will notice that the credit losses are lower than my projections. The revenue however is much lower than my projections. The lower projected revenue has been a government choice: the Government has been forcing Frannie to charge lower spreads to support the housing market.
This is so obvious it is painful: if you want to remove the subsidy remove the subsidy. If you want to do it slow do it slow.
So why can’t anyone see it?
Every proposal for the government to get out of Fannie and Freddie is in reality a proposal for the government to get out of only a bit of Fannie and Freddie.
For example: if you are a business that likes managing interest rate risk you want Fannie and Freddie out of the interest rate risk management business but you want them to stay in the credit risk management business. You would prefer the government take the risks that you don’t want. And moreover you would prefer they took it at the lowest possible price.
The worst proposal out there (much worse than doing nothing) comes from Phil Swagel and Don Marron. They propose that the government exit the interest rate risk management business (the only business at Frannie that never lost money) and allow ten or so new competitive companies with government guarantees to compete with each other to sell government guarantee of credit risk. That means that credit risk (the risk that blew up the system) will be priced as close as possible to zero with the government wearing the downside. I can't see that Swagel and Marron learnt anything from the crisis.
But Swagel and Marron are an extreme variant of the typical proposal. Everyone’s proposal involves getting Frannie out of their business whilst leaving subsidies (preferably increasing subsidies) in the parts of the value chain they don’t compete in. Every proposal is thus about maximizing profits of some financial institution whilst sticking those risks that they don't want to the government.
Are you surprised?
John
Disclaimer: Every proposal out there is conficted. I am too. I own defaulted preference shares in Frannie on my own behalf and on behalf of my clients. A proposal that allows Frannie to maximize revenue on their way to oblivion is in my interests. But then I only get paid if taxpayers get back 100c in the dollar plus penalty interest and fees. And from the perspective of a US taxpayer it is hard to see what is wrong with that. You exit Fannie and Freddie and it does not wind up costing anything.
Anyway I have the free market solution to the Fannie and Freddie situation - and - I hate to say it - it is dead obvious.
Answer: raise Frannie’s pricing.
At the moment there is nobody doing conforming mortgages except Fannie and Freddie. Indeed there is almost nobody doing mortgages of any kind except Fannie and Freddie. If the free market wants the business they can have it. (They just don't want it at this sort of interest rate spread - and I don't blame them.)
All the government need to do is tell Frannie to raise their price a little each quarter. Currently they charge 20-25bps for guaranteeing mortgages. (The free market won’t take credit risk at that price.) So it is entirely open to the FHFA (and hence the Treasury) to tell Fannie and Freddie to raise their prices by 5bps. The government will get paid better for the risk they are taking (and what free market ideologue will disagree with that) and the private sector can compete if they want to.
I doubt the free market will. But then in a quarter or two Frannie can raise their pricing by another 5 bps. And a quarter or two later Frannie can raise by another 5bps.
At some stage you will get to a level where the private sector chooses to compete. Frannie should not set its price competitively though. In another quarter they should raise the price another 5bps. And in another quarter they should raise again.
Over time Frannie will become non-competitive. It will shrink simply because bankers and mortgage brokers do not bring it business. And so Frannie is put into market chosen run-off and the business is effectively privatized.
You can do the same thing with Frannie's portfolio - you could ask them to raise their internal revenue exectations on any mortgage they buy by 5bps. They might buy less - they may not. Don’t limit the size of the portfolio: raise the profitability of the portfolio. When another quarter elapses raise spreads by another 5bps. Eventually of course the private sector won’t bring Frannie business - and so Frannie will shrink.
If you want the government to keep supporting the housing market (an object of policy it seems) then you just slow the rate of price increase down. Do 5bps per half rather than 5bps per quarter - or even 8bps per year for a slow exit.
Over time the government will make a full exit from the mortgage business. Along the way the taxpayers recover as much money from Frannie as possible.
If you look at my long series on Fannie and Freddie and compare my model predictions to current results you will notice that the credit losses are lower than my projections. The revenue however is much lower than my projections. The lower projected revenue has been a government choice: the Government has been forcing Frannie to charge lower spreads to support the housing market.
This is so obvious it is painful: if you want to remove the subsidy remove the subsidy. If you want to do it slow do it slow.
So why can’t anyone see it?
Every proposal for the government to get out of Fannie and Freddie is in reality a proposal for the government to get out of only a bit of Fannie and Freddie.
For example: if you are a business that likes managing interest rate risk you want Fannie and Freddie out of the interest rate risk management business but you want them to stay in the credit risk management business. You would prefer the government take the risks that you don’t want. And moreover you would prefer they took it at the lowest possible price.
The worst proposal out there (much worse than doing nothing) comes from Phil Swagel and Don Marron. They propose that the government exit the interest rate risk management business (the only business at Frannie that never lost money) and allow ten or so new competitive companies with government guarantees to compete with each other to sell government guarantee of credit risk. That means that credit risk (the risk that blew up the system) will be priced as close as possible to zero with the government wearing the downside. I can't see that Swagel and Marron learnt anything from the crisis.
But Swagel and Marron are an extreme variant of the typical proposal. Everyone’s proposal involves getting Frannie out of their business whilst leaving subsidies (preferably increasing subsidies) in the parts of the value chain they don’t compete in. Every proposal is thus about maximizing profits of some financial institution whilst sticking those risks that they don't want to the government.
Are you surprised?
John
Disclaimer: Every proposal out there is conficted. I am too. I own defaulted preference shares in Frannie on my own behalf and on behalf of my clients. A proposal that allows Frannie to maximize revenue on their way to oblivion is in my interests. But then I only get paid if taxpayers get back 100c in the dollar plus penalty interest and fees. And from the perspective of a US taxpayer it is hard to see what is wrong with that. You exit Fannie and Freddie and it does not wind up costing anything.
Thursday, January 13, 2011
Skepticism and wealthy investors
I know a rich bloke who is usually pretty switched on who is a private investor in Black Light Power.
That is - at least to my eyes - a very strange thing to invest in. Firstly the company seems to have identified the mysterious “Dark Matter” in the universe. Moreover this provides a miraculous source of power (through machines that are small enough to be used as the power source for a car). Finally they claim to have demonstrated this motor almost two years ago.
I should quote their web page executive summary:
Moreover the board of Blacklight Power look clever enough (even if I have not bothered to check their CVs).
Besides, the company claims to have demonstrated a 50 kilowatt “hydrino engine” as early as 29 May 2008.
If this is the case then it would be fairly easy to demonstrate now - and they would easily be able to sell a 5 percent interest in the company for $1 billion plus. So they would hardly need to be door-knocking merely middling rich investors.
Wikipedia has some detail on the Blacklight Power controversy. (Even that relatively small Wikipedia article is subject to over 1000 edits which suggests promoters and skeptics at war.)
I will side with the skeptics on this one - and if it were a listed company I would short it.
I am not sure that Blacklight will ever solve the world’s problems.
I can't drawn any conclusions on this one not found in the various Wikipedia edits - in my (possibly incorrect) view they have demonstrated something somewhat less valuable: if you market arrant nonsense with wild-get-rich-quick claims to sophisticated investors enough of them will give you enough money to make it worthwhile.
I guess we knew that already.
John
PS: I wonder if the converse marketing result is true: If you market modest truths you will be thought of as smart but possibly boring and shown the door. Comments on that would be nice.
PPS: Wikipedia suggests - without citation - that Blacklight has raised $70 million. Maybe they have found the risk-loving investors I was moaning about in the last post.
Finally - if you want a stronger view than mine go to the website of Professor Park (Physics, Maryland). Search for Mills (the name of the CEO). You will get the idea.
That is - at least to my eyes - a very strange thing to invest in. Firstly the company seems to have identified the mysterious “Dark Matter” in the universe. Moreover this provides a miraculous source of power (through machines that are small enough to be used as the power source for a car). Finally they claim to have demonstrated this motor almost two years ago.
I should quote their web page executive summary:
• BlackLight Power, Inc. is the inventor of a commercially competitive, nonpolluting new primary source of energy that forms a prior undiscovered form of hydrogen called “hydrino” which is very likely the identity of the dark matter of the universe.
• Proprietary electrochemical reactants or solid fuels undergo reaction to cause hydrogen to form hydrino with energy released as electricity or heat, respectively. The net energy released from this "BlackLight Process" may be two hundred times that of combustion of the hydrogen fuel with power densities and performance comparable to those of batteries and conventional central power plants, respectively.
• Water can be used as the stored hydrogen, generated on demand by electrolysis using less than 1% of the electrical output. With the elimination of fuel and fuel infrastructure costs, the operational cost of BlackLightPower generators is likely to be very inexpensive. Moreover, the process does not give rise to pollution, green-house gases, or radiation as conventional systems do.
• The Company has developed three systems for producing electricity powered by forming hydrinos: one electrochemical and two thermal systems. A CIHT (Catalyst Induced Hydrino Transition) cell generates electricity directly from hydrogen. But, unlike a conventional hydrogen fuel cell, the cost is forecast at $25 per kW compared to thousands per kW for a fuel cell. This is in part due to the CIHT cell’s electrical energy released per hydrogen being over 200 times greater, and the CIHT materials being inexpensive. Moreover, fuel cells can’t use water as the source of hydrogen, since their product is water. For CIHT, no fuel infrastructure is required to provide on-site power allowing the CIHT cell to be autonomous.
• BlackLight Power is focused on advancing CIHT technology to produce power to ultimately sell directly to consumers under power purchase agreements. Rapid dissemination at nominal historic cost is expected by deploying many autonomous distributed units that circumvent the huge barriers of entry into the power markets such as developing and building massive billion-dollar power plants requiring enormous thermally-driven mechanical generators with their associated power distribution infrastructure. This is especially advantageous in emerging markets.This sounds to me like arrant nonsense. But hey - my friend has invested in them and when I express skepticism he tells me he will rub it in when he is a BLP billionaire.
Moreover the board of Blacklight Power look clever enough (even if I have not bothered to check their CVs).
Besides, the company claims to have demonstrated a 50 kilowatt “hydrino engine” as early as 29 May 2008.
If this is the case then it would be fairly easy to demonstrate now - and they would easily be able to sell a 5 percent interest in the company for $1 billion plus. So they would hardly need to be door-knocking merely middling rich investors.
Wikipedia has some detail on the Blacklight Power controversy. (Even that relatively small Wikipedia article is subject to over 1000 edits which suggests promoters and skeptics at war.)
I will side with the skeptics on this one - and if it were a listed company I would short it.
I am not sure that Blacklight will ever solve the world’s problems.
I can't drawn any conclusions on this one not found in the various Wikipedia edits - in my (possibly incorrect) view they have demonstrated something somewhat less valuable: if you market arrant nonsense with wild-get-rich-quick claims to sophisticated investors enough of them will give you enough money to make it worthwhile.
I guess we knew that already.
John
PS: I wonder if the converse marketing result is true: If you market modest truths you will be thought of as smart but possibly boring and shown the door. Comments on that would be nice.
PPS: Wikipedia suggests - without citation - that Blacklight has raised $70 million. Maybe they have found the risk-loving investors I was moaning about in the last post.
Finally - if you want a stronger view than mine go to the website of Professor Park (Physics, Maryland). Search for Mills (the name of the CEO). You will get the idea.
Wednesday, January 12, 2011
Swashbuckling versus risk: a comment on marketing small hedge funds
Laurence Fletcher wrote a piece in Reuters about how some hedge funds are losing their sex appeal. Only a minority of rich clients want a swashbuckling fund - one that has high returns (and maybe higher risk) and takes high profile bets (such as Paulson’s bet against subprime AAA securities or even more famously - Soros’s bet against the pound).
To some extent he is right. For example (and I could choose many examples) Dan Loeb at Third Point is getting older. Third Point may be named after a surf break - but Dan is surfing less than he used to. He is not getting fat but he is no longer Mr Pink - the doyen of the yahoo chat boards and the man with the encyclopaedic knowledge of small cap stock promotes and frauds and the scumbags behind them. Moreover Third Point now occupies two levels of a Manhattan skyscraper - he has staff and responsibilities and guess what - 30-40 percent returns in 2010. [I am not sure that Dan ever admitted to being Mr Pink. He has however admitted to sharing many of Mr Pink's opinions.]
Most of Third Point’s clients don’t want Dan to be Mr Pink or even associated with someone like that. They want him to be the suited well-staffed machine that Third Point has become. One thing I did not comment on in my review of The Ackman-MBIA book is how potential clients of Bill Ackman’s thought his obsession with MBIA was a negative. Some would invest provided Ackman actually dropped his obsession. I am not sure whether David Einhorn has the same trouble - but David Einhorn has a knack I wish I could emulate - he can say the most contentious things and seem reasonable and moderate when he says it. (I think that is partially because he looks so preternaturally young.)
Laurence Fletcher is also right about the business of marketing a new hedge fund. The institutions are very powerful. On our trip to America (to market Bronte) we met lots of people who would be very useful clients if we wanted to increase our fund size from 750 million to 3 billion. We met very few people who would invest in a new fund.
And this is a real problem if you have a strategy which is low risk (meaning negligible chance of true blow-up) but which does not scale well above a few hundred million under management. In that case you can’t get to $500 million - and if you get there you don’t want to grow - making the institutions and funds-of-funds doubly useless.
If Laurence Fletcher is right - and there are a bunch of clients who are willing to bet on a swashbuckling fund they are not looking very hard. I have met more than a few bright ambitious and swashbuckling types. Recently for instance Kerrisdale Capital (two guys below 30 sitting in some dingy office in NYC) put out a detailed report on China Education Alliance (NYSE:CEU) - a Chinese for-profit education company listed in America. This included hiring private investigators in China to investigate their activities and produce videos (posted on YouTube) which supported their thesis that the company was (their suggestion) a complete fraud. It had the right effect too - the stock has more-than-halved since the Kerrisdale Capital research and I am sure the very few (adventurous) clients Kerrisdale had did pretty well out of that one. Kerrisdale’s actions are every bit as swashbuckling as Mr Pink.
Now if Kerrisdale wants to scale their business beyond a few hundred million under management they will have - by the nature of the business - to become a little less out-there. They may have to turn into Dan Loeb. (If they still get over 30 percent returns as Third Point did last year I am sure the clients won’t complain too much.)
Felix Salmon’s comment on the Laurence Fletcher piece misses the point of startup funds. Felix wonders why - if people want higher returns - they don’t just lever themselves into hedge funds (and implicitly he thinks the high returns of some hedge funds of yore came from putting the capital entirely at risk). This assumes (falsely) that risk-return is a continuum. Putting 10 percent of your capital into put options over China Education Alliance and then publishing your analysis is not a deadly strategy - you could lose 10 percent pretty rapidly or make 30 percent or much more - and given the research on CEU was so convincing it was likely to be extraordinarily profitable. I don’t know Kerrisdale’s returns (I have never asked) but if they got 35 percent doing that sort of thing during 2010 I wouldn’t describe it as “risky” but I would describe it as “swashbuckling”. I would also note that it is impossible to scale beyond even relatively small size (100 million would be a limit for that sort of investment strategy). Sure you might get 35 percent by leveraging into a bunch of 12 percent return hedge fund strategies as Felix suggests - but my guess is the risk would be considerably higher.
At Bronte there are parts of our strategy that scale more or less forever. (We could manage billions.) And parts of our strategy (incidentally the parts on which we are doing well) probably top-out at a few hundred million. Its the same problem faced by a bunch of smaller funds (many of the managers of which are readers of my blog).
I don’t know the potential clients that Laurence Fletcher was talking to. I wish I did (and if they would contact me I would be thrilled). If they want unconventional funds they are not going to find them in gleaming offices lined with modern art in NYC. They will find them in some dingy little office or outside the New York/London financial centers altogether. And they are going to have to do a little work because otherwise they are going to have to fall into Felix Salmon’s mistake and implicitly confuse high returns with high risk (by asking why not just lever into conventional hedge funds). There are high-return strategies you can employ when small which are not very high risk. The strategies however are often difficult to scale and potential clients have to work out whether they make sense and whether they should commit capital.
One reason why the institutions don't invest in small funds is that the due diligence for a small fund is as hard (or harder) than the due diligence for a large fund. That is - they think - the adventurous client's burden.
John
PS. It's just not good enough to just buy small hedge funds. When you don’t understand either (a) the custody or (b) the strategy don’t do it - otherwise you are going to wind up investing in an Astarra or a New World Capital Management. Of these the first requirement - custody - is by far the most important. If the fund has genuine third parties holding the assets and doing asset valuation at least the returns are real. Once you have assessed custody - and only after you have assessed custody - do you make your decision on strategy.
PPS. This is not a recommendation for Kerrisdale. The only thing I know about Kerrisdale is the work they did on CEU. I met them. Smart, young, ambitious and more than a little out there. Potential clients will have to do the work I described in the last paragraph - I did not do it for you.
PPPS. Of course potential clients should make the same assessment of Bronte too.
To some extent he is right. For example (and I could choose many examples) Dan Loeb at Third Point is getting older. Third Point may be named after a surf break - but Dan is surfing less than he used to. He is not getting fat but he is no longer Mr Pink - the doyen of the yahoo chat boards and the man with the encyclopaedic knowledge of small cap stock promotes and frauds and the scumbags behind them. Moreover Third Point now occupies two levels of a Manhattan skyscraper - he has staff and responsibilities and guess what - 30-40 percent returns in 2010. [I am not sure that Dan ever admitted to being Mr Pink. He has however admitted to sharing many of Mr Pink's opinions.]
Most of Third Point’s clients don’t want Dan to be Mr Pink or even associated with someone like that. They want him to be the suited well-staffed machine that Third Point has become. One thing I did not comment on in my review of The Ackman-MBIA book is how potential clients of Bill Ackman’s thought his obsession with MBIA was a negative. Some would invest provided Ackman actually dropped his obsession. I am not sure whether David Einhorn has the same trouble - but David Einhorn has a knack I wish I could emulate - he can say the most contentious things and seem reasonable and moderate when he says it. (I think that is partially because he looks so preternaturally young.)
Laurence Fletcher is also right about the business of marketing a new hedge fund. The institutions are very powerful. On our trip to America (to market Bronte) we met lots of people who would be very useful clients if we wanted to increase our fund size from 750 million to 3 billion. We met very few people who would invest in a new fund.
And this is a real problem if you have a strategy which is low risk (meaning negligible chance of true blow-up) but which does not scale well above a few hundred million under management. In that case you can’t get to $500 million - and if you get there you don’t want to grow - making the institutions and funds-of-funds doubly useless.
If Laurence Fletcher is right - and there are a bunch of clients who are willing to bet on a swashbuckling fund they are not looking very hard. I have met more than a few bright ambitious and swashbuckling types. Recently for instance Kerrisdale Capital (two guys below 30 sitting in some dingy office in NYC) put out a detailed report on China Education Alliance (NYSE:CEU) - a Chinese for-profit education company listed in America. This included hiring private investigators in China to investigate their activities and produce videos (posted on YouTube) which supported their thesis that the company was (their suggestion) a complete fraud. It had the right effect too - the stock has more-than-halved since the Kerrisdale Capital research and I am sure the very few (adventurous) clients Kerrisdale had did pretty well out of that one. Kerrisdale’s actions are every bit as swashbuckling as Mr Pink.
Now if Kerrisdale wants to scale their business beyond a few hundred million under management they will have - by the nature of the business - to become a little less out-there. They may have to turn into Dan Loeb. (If they still get over 30 percent returns as Third Point did last year I am sure the clients won’t complain too much.)
Felix Salmon’s comment on the Laurence Fletcher piece misses the point of startup funds. Felix wonders why - if people want higher returns - they don’t just lever themselves into hedge funds (and implicitly he thinks the high returns of some hedge funds of yore came from putting the capital entirely at risk). This assumes (falsely) that risk-return is a continuum. Putting 10 percent of your capital into put options over China Education Alliance and then publishing your analysis is not a deadly strategy - you could lose 10 percent pretty rapidly or make 30 percent or much more - and given the research on CEU was so convincing it was likely to be extraordinarily profitable. I don’t know Kerrisdale’s returns (I have never asked) but if they got 35 percent doing that sort of thing during 2010 I wouldn’t describe it as “risky” but I would describe it as “swashbuckling”. I would also note that it is impossible to scale beyond even relatively small size (100 million would be a limit for that sort of investment strategy). Sure you might get 35 percent by leveraging into a bunch of 12 percent return hedge fund strategies as Felix suggests - but my guess is the risk would be considerably higher.
At Bronte there are parts of our strategy that scale more or less forever. (We could manage billions.) And parts of our strategy (incidentally the parts on which we are doing well) probably top-out at a few hundred million. Its the same problem faced by a bunch of smaller funds (many of the managers of which are readers of my blog).
I don’t know the potential clients that Laurence Fletcher was talking to. I wish I did (and if they would contact me I would be thrilled). If they want unconventional funds they are not going to find them in gleaming offices lined with modern art in NYC. They will find them in some dingy little office or outside the New York/London financial centers altogether. And they are going to have to do a little work because otherwise they are going to have to fall into Felix Salmon’s mistake and implicitly confuse high returns with high risk (by asking why not just lever into conventional hedge funds). There are high-return strategies you can employ when small which are not very high risk. The strategies however are often difficult to scale and potential clients have to work out whether they make sense and whether they should commit capital.
One reason why the institutions don't invest in small funds is that the due diligence for a small fund is as hard (or harder) than the due diligence for a large fund. That is - they think - the adventurous client's burden.
John
PS. It's just not good enough to just buy small hedge funds. When you don’t understand either (a) the custody or (b) the strategy don’t do it - otherwise you are going to wind up investing in an Astarra or a New World Capital Management. Of these the first requirement - custody - is by far the most important. If the fund has genuine third parties holding the assets and doing asset valuation at least the returns are real. Once you have assessed custody - and only after you have assessed custody - do you make your decision on strategy.
PPS. This is not a recommendation for Kerrisdale. The only thing I know about Kerrisdale is the work they did on CEU. I met them. Smart, young, ambitious and more than a little out there. Potential clients will have to do the work I described in the last paragraph - I did not do it for you.
PPPS. Of course potential clients should make the same assessment of Bronte too.
Tuesday, January 11, 2011
Some Logitech feedback and China macro
Thanks for the comment - email and otherwise on the Logitech post.
The first comment (made fairly consistently) is that the core assumption (peripherals are dying) is wrong. My response: cables are not dead either. My laptop is still connected to my kindle (for charging) via a USB Micro. So what - I now have a box full of cables in the attic and another one at work. I can't imagine myself buying another one for a while.
You can buy a USB Micro cable (buy it now) on Ebay for USD1.50. A USB Cable at Radioshack is $9.95. Selling them for 6 times cost is very fat margin - it was the raison d'etre of Radioshack - a place you went when you needed a cable now. Lots of stores. One close to you. Even small declines in the demand for cables changed the economics of Radioshack.
In five years time we will need mice like we need USB cables. (Irregularly - and you will already have a drawer full of the critters.) The decline of Radioshack will be mirrored in the peripheral makers unless they can find something else to do.
The second set of comments - more concerning from a short's perspective - is that they are finding something else to do. The best stories are about music - people selling high end speakers to go with their computer. Some of this stuff is pretty groovy. Logitech make the (hands down) best ear-buds in the world: Ultimate Ears. That is never going to be a mega-hit product because there are not many people who are up to getting their ears cast by an audiologist for form-fitting (screw in) ear-buds at $1000 a pair. But top-end products like that allow you to develop technology for a mass market.
My guess is that memory on mobile devices (especially phones) gets cheaper and more plentiful we will use phones at much higher sound-quality than the iPods of yore. Improved sound quality will drive demand for higher-end headphones. Maybe not Ultimate Ears - but at least a product that sells for more then a hundred dollars.
I was surprised how few people commented on the Chinese macro angle. To me that was the most important observation.
John
The first comment (made fairly consistently) is that the core assumption (peripherals are dying) is wrong. My response: cables are not dead either. My laptop is still connected to my kindle (for charging) via a USB Micro. So what - I now have a box full of cables in the attic and another one at work. I can't imagine myself buying another one for a while.
You can buy a USB Micro cable (buy it now) on Ebay for USD1.50. A USB Cable at Radioshack is $9.95. Selling them for 6 times cost is very fat margin - it was the raison d'etre of Radioshack - a place you went when you needed a cable now. Lots of stores. One close to you. Even small declines in the demand for cables changed the economics of Radioshack.
In five years time we will need mice like we need USB cables. (Irregularly - and you will already have a drawer full of the critters.) The decline of Radioshack will be mirrored in the peripheral makers unless they can find something else to do.
The second set of comments - more concerning from a short's perspective - is that they are finding something else to do. The best stories are about music - people selling high end speakers to go with their computer. Some of this stuff is pretty groovy. Logitech make the (hands down) best ear-buds in the world: Ultimate Ears. That is never going to be a mega-hit product because there are not many people who are up to getting their ears cast by an audiologist for form-fitting (screw in) ear-buds at $1000 a pair. But top-end products like that allow you to develop technology for a mass market.
My guess is that memory on mobile devices (especially phones) gets cheaper and more plentiful we will use phones at much higher sound-quality than the iPods of yore. Improved sound quality will drive demand for higher-end headphones. Maybe not Ultimate Ears - but at least a product that sells for more then a hundred dollars.
I was surprised how few people commented on the Chinese macro angle. To me that was the most important observation.
John
Monday, January 10, 2011
Logitech and a divergence into days payable outstanding, Dell, Apple, and macroeconomic conditions in China
Stableboy Selections (a blog I should read more often) provides us with a fairly simple case for shorting Logitech. After joking about their domicile (Apples Switzerland) he points out the obvious - laptops are replacing desktops - pads and phones are replacing both of them. Logitech sells peripherals. The new technology (along with things like Google speak-to-search) will reduce the need for peripherals. Peripheral sales should fall year-in-year-out - they have done so at Logitech.
Eventually this suggests Logitech will look like Radio Shack - a company that got rich selling cables for your computer and TV and eventually shrunk into (near) oblivion. The first of two bottoms (in the stock at least) was marked by The Onion doing a mock interview where the CEO could not figure out why they were still in business.
If the desktop is doomed so are its peripherals - and along with my absurd collection of cables (firewire anyone) I now have a collection of mice, keyboards, video-cams and the like. My shop is my attic.
Given Logitech trades at a trailing PE of 22 it looks like an attractive valuation-business obsolescence short.
Alas if this business were as easy as ripping off other people’s ideas we would all be rich. So I went to work reading Logitech’s accounts. There are some upsides - first and foremost is Google TV (“the most important product launch in our history”). I am not sure Google TV is getting much traction (but they have a really complex remote control to sell and even that will become another Android app). More notably they had a really good quarter - enough of a good quarter that it spelled "turnaround". Just as The Onion marked a bottom in Radioshack I was worried that Stableboy would mark a (the?) bottom in Logitech.
I just could not work out why peripherals would have a good quarter. And if it was a good quarter I could not figure any reason why sales should start motoring upward. The trend towards lower peripherals sales plain - and the company's contrary prediction is strange. However the company does predict turnaround.
My first reaction was that the company was channel-stuffing. (Increasing the speed at which you deliver to just-in-time retail can produce sharply rising sales at the expense of annoying your customers and sharply falling sales next quarter.) Channel-stuffing would have been a great short thesis (and Stableboy hints at it) but it does not look supported by the data. Days receivable rose - but only in proportion to sales. (They rose from $260 to $305 million - both 47 days.)
Inventory turns dropped (why I do not understand). But what really jumped out at me was that payables rose to 90 days from 71 days. This company was not paying its suppliers. Ninety days outstanding almost destroyed David's Holdings (as per my last blog post). Its a pretty big tell - or so it seems to someone who is used to the 35 days of retailers.
But alas 90 days is not so startling. Apple is at 80 days at the end of year (and has been higher). Dell is at 81. And the disease is widespread - for instance the Japanese optical companies (Canon, Nikon) are at 80-90 days.
Dell is particularly instructive. The company collects its cash in advance from customers and runs on negative working capital. The business has always been funded by borrowing from suppliers. Its just that the scale of the loan has increased with monotonous regularity. Days payable outstanding was 56.1 days a decade ago - then 66.9, 69.4, 71.3, 73.4, 74.8, 77.1, 80.1, 71.8 and 81.2 days. Dell just screws its suppliers a little bit more every year. It shows more cash generation than is real. It makes itself look better than it actually is.
Ultimately this is bad business practice. It stresses suppliers - it costs them money chasing you up. It builds distrust. Yet Apple does it - and the reason is obvious. Because it can. Apple has power and it is not afraid to (ab)use that power.
By contrast Cisco (a company which tries to keep its supply chain sweet after an infamous supply chain stuff up) is under 20 days.
Macroeconomic conditions in China
This leads me to the real point of this post. The macroeconomic conditions in China are changing dramatically. Labor shortages are a serious problem. We are beginning to see press stories about difficulties in getting things produced and companies bringing production back to the USA. What this presages is a change in power between the Western giants and their Chinese manufacturers. Apple behaves badly because it can - but that power probably does not exist in the long run for Dell or Logitech and the loans that these companies have taken from their suppliers (loans that are a meaningful part of their cash balance in some cases) are going to have to be repaid.
It is logical when you think about it. Inflation in the US is 1 percent plus or minus 2 percent. Its probably over 10 percent in China. Slow payment thus benefits the Americans relatively little but costs the Chinese counterpart a lot. Chinese inflation and labor shortages should cause supply chains to speed up.
Cisco, Samsung and other companies that have kept the supply chain sweet should be fine. Apple should be fine too - its bills to suppliers are trivial compared to cash balances or profits.
But hey - we did short some Logitech. It really is not so good for them. 90 days really is a problem - even if they don't know it yet. Their business practice stinks and it will come back and bite them. And it will bite many other companies too.
John
(All days payable numbers sourced from Factset.)
Eventually this suggests Logitech will look like Radio Shack - a company that got rich selling cables for your computer and TV and eventually shrunk into (near) oblivion. The first of two bottoms (in the stock at least) was marked by The Onion doing a mock interview where the CEO could not figure out why they were still in business.
If the desktop is doomed so are its peripherals - and along with my absurd collection of cables (firewire anyone) I now have a collection of mice, keyboards, video-cams and the like. My shop is my attic.
Given Logitech trades at a trailing PE of 22 it looks like an attractive valuation-business obsolescence short.
Alas if this business were as easy as ripping off other people’s ideas we would all be rich. So I went to work reading Logitech’s accounts. There are some upsides - first and foremost is Google TV (“the most important product launch in our history”). I am not sure Google TV is getting much traction (but they have a really complex remote control to sell and even that will become another Android app). More notably they had a really good quarter - enough of a good quarter that it spelled "turnaround". Just as The Onion marked a bottom in Radioshack I was worried that Stableboy would mark a (the?) bottom in Logitech.
I just could not work out why peripherals would have a good quarter. And if it was a good quarter I could not figure any reason why sales should start motoring upward. The trend towards lower peripherals sales plain - and the company's contrary prediction is strange. However the company does predict turnaround.
My first reaction was that the company was channel-stuffing. (Increasing the speed at which you deliver to just-in-time retail can produce sharply rising sales at the expense of annoying your customers and sharply falling sales next quarter.) Channel-stuffing would have been a great short thesis (and Stableboy hints at it) but it does not look supported by the data. Days receivable rose - but only in proportion to sales. (They rose from $260 to $305 million - both 47 days.)
Inventory turns dropped (why I do not understand). But what really jumped out at me was that payables rose to 90 days from 71 days. This company was not paying its suppliers. Ninety days outstanding almost destroyed David's Holdings (as per my last blog post). Its a pretty big tell - or so it seems to someone who is used to the 35 days of retailers.
But alas 90 days is not so startling. Apple is at 80 days at the end of year (and has been higher). Dell is at 81. And the disease is widespread - for instance the Japanese optical companies (Canon, Nikon) are at 80-90 days.
Dell is particularly instructive. The company collects its cash in advance from customers and runs on negative working capital. The business has always been funded by borrowing from suppliers. Its just that the scale of the loan has increased with monotonous regularity. Days payable outstanding was 56.1 days a decade ago - then 66.9, 69.4, 71.3, 73.4, 74.8, 77.1, 80.1, 71.8 and 81.2 days. Dell just screws its suppliers a little bit more every year. It shows more cash generation than is real. It makes itself look better than it actually is.
Dell however is a declining business. Apple which is clearly not declining does it too.
Ultimately this is bad business practice. It stresses suppliers - it costs them money chasing you up. It builds distrust. Yet Apple does it - and the reason is obvious. Because it can. Apple has power and it is not afraid to (ab)use that power.
By contrast Cisco (a company which tries to keep its supply chain sweet after an infamous supply chain stuff up) is under 20 days.
Macroeconomic conditions in China
This leads me to the real point of this post. The macroeconomic conditions in China are changing dramatically. Labor shortages are a serious problem. We are beginning to see press stories about difficulties in getting things produced and companies bringing production back to the USA. What this presages is a change in power between the Western giants and their Chinese manufacturers. Apple behaves badly because it can - but that power probably does not exist in the long run for Dell or Logitech and the loans that these companies have taken from their suppliers (loans that are a meaningful part of their cash balance in some cases) are going to have to be repaid.
It is logical when you think about it. Inflation in the US is 1 percent plus or minus 2 percent. Its probably over 10 percent in China. Slow payment thus benefits the Americans relatively little but costs the Chinese counterpart a lot. Chinese inflation and labor shortages should cause supply chains to speed up.
Cisco, Samsung and other companies that have kept the supply chain sweet should be fine. Apple should be fine too - its bills to suppliers are trivial compared to cash balances or profits.
But hey - we did short some Logitech. It really is not so good for them. 90 days really is a problem - even if they don't know it yet. Their business practice stinks and it will come back and bite them. And it will bite many other companies too.
John
(All days payable numbers sourced from Factset.)
Tuesday, January 4, 2011
How dope smokers with the munchies at 2AM almost destroyed the number three wholesale grocery distributor in Australia
I have a post coming about days payable outstanding (DPO) in by various mega-corporation - and the uses and abuses of corporate power. However before that I have to tell a story - the details of which have probably been embellished in my memory - but which mixes high finance with marijuana, chocolate biscuits and the munchies. It all happened twenty years ago - so the story has had time to embellish.
Anyway you need a bit of background.
There are two dominant grocery market chains in Australia - Woolworths and Coles. The latter is now owned by Wesfarmers. These chains have enormous market power - far more than say Wal-Mart in the US because the concentration here is so high.
These chains own their own distribution businesses.
When I first started investing seriously there was a third-player distributor in most states of Australia. The third player in the biggest state (New South Wales) was David’s Holdings - owned by John David. I met John David once - he was a very nice man. He was also ambitious. He wanted to consolidate all the number three players - something that was probably necessary if the third player was to survive.
So David raised some of the necessary capital by listing his company. He then one-by-one purchased the wholesalers in the other states.
But he did not raise enough money by simply listing. He started to raise money by playing around with payment terms. After all a wholesaler turns over an enormous amount of merchandise on margins that are below 2 percent. If a wholesaler is vehement about collecting from their customers rapidly (30 days or less) and starts paying its suppliers slowly (60 days or more) it can generate a lot of cash - a free loan if you will from the suppliers.
And that is what John David did. Payments to suppliers became increasingly tardy - and DPO edged towards 80 days. (By contrast well Wal-Mart DPO is 35.7, Tesco is at 34.3, Wesfarmers is at 35.7 and Woolworths is at 30.8). Suppliers might not like it - but it generated Davids a large cheap float - and kept the third-force in wholesaling alive.
Woolworths however kept growing and kept destroying mom-and-pop corner grocery stores. It was awfully difficult staying open as an independent against the large chains. And every time one of those stores closed Davids lost volume. And when it lost volume it lost the float associated with that volume. Negative working capital employed in a business is wonderful until your business shrinks.
David’s - which had levered itself up for its acquisition spree - dealt with this cash drain the only way it could - which was to allow payment terms to blow out even further. Now Davids was operating above 100 DPO.
Woolworths however smelt blood. It started using its wholesale operations to supply third parties - mom and pop stores, shops at gas stations and the like. These shops were reluctant to go to Woolworths because - well frankly - Woolworths was the enemy. But some left and David’s had to increase its DPO even further.
Now enter Arnotts. Arnotts is the dominant biscuit maker in Australia. It is now owned by Campbell’s soup and is one of their best assets. Arnotts however have a biscuit which figures above all others in the Australian psyche - the Tim Tam. The Tim Tam is a desperately rich biscuit - beloved by teenagers and twenty-somethings and an iconic part of getting fat in Australia.
They are sold by gas stations (open all night) at ridiculous markups - a couple of dollars a pack being a common mark-up. And the only person that buys them at 2am is someone who has the munchies. (Irrational hunger - known colloquially as the munchies - is a side-effect of smoking marijuana.) And Tim-Tam’s at 2am are the mainstay of the (overpriced) grocery shop attached to an all-night gas station. They are an important product.
And Arnotts, sick of David’s tardy payments, supplied David’s with their entire product range except Tim-Tams.
This annoyed the gas stations who would put signs up on the vacant area where the Tim-Tams should be - saying “supplier out of stock”. This convinced some gas stations to shift their supplier to the enemy - the dreaded Woolworths. At least they could get Tim-Tams.
This drove David’s almost bankrupt. The stock plummeted (it traded as low as 40c). Eventually it sold itself in distress to a South African group (Metcash) who injected enough capital to fix the DPO problem.
And so in my memory we almost lost the third biggest grocery wholesaler in Australia because dope-addled kids with the munchies could not buy chocolate biscuits.
And I learnt to watch DPO as an important indicator of corporate health.
Till next time.
John
Anyway you need a bit of background.
There are two dominant grocery market chains in Australia - Woolworths and Coles. The latter is now owned by Wesfarmers. These chains have enormous market power - far more than say Wal-Mart in the US because the concentration here is so high.
These chains own their own distribution businesses.
When I first started investing seriously there was a third-player distributor in most states of Australia. The third player in the biggest state (New South Wales) was David’s Holdings - owned by John David. I met John David once - he was a very nice man. He was also ambitious. He wanted to consolidate all the number three players - something that was probably necessary if the third player was to survive.
So David raised some of the necessary capital by listing his company. He then one-by-one purchased the wholesalers in the other states.
But he did not raise enough money by simply listing. He started to raise money by playing around with payment terms. After all a wholesaler turns over an enormous amount of merchandise on margins that are below 2 percent. If a wholesaler is vehement about collecting from their customers rapidly (30 days or less) and starts paying its suppliers slowly (60 days or more) it can generate a lot of cash - a free loan if you will from the suppliers.
And that is what John David did. Payments to suppliers became increasingly tardy - and DPO edged towards 80 days. (By contrast well Wal-Mart DPO is 35.7, Tesco is at 34.3, Wesfarmers is at 35.7 and Woolworths is at 30.8). Suppliers might not like it - but it generated Davids a large cheap float - and kept the third-force in wholesaling alive.
Woolworths however kept growing and kept destroying mom-and-pop corner grocery stores. It was awfully difficult staying open as an independent against the large chains. And every time one of those stores closed Davids lost volume. And when it lost volume it lost the float associated with that volume. Negative working capital employed in a business is wonderful until your business shrinks.
David’s - which had levered itself up for its acquisition spree - dealt with this cash drain the only way it could - which was to allow payment terms to blow out even further. Now Davids was operating above 100 DPO.
Woolworths however smelt blood. It started using its wholesale operations to supply third parties - mom and pop stores, shops at gas stations and the like. These shops were reluctant to go to Woolworths because - well frankly - Woolworths was the enemy. But some left and David’s had to increase its DPO even further.
Now enter Arnotts. Arnotts is the dominant biscuit maker in Australia. It is now owned by Campbell’s soup and is one of their best assets. Arnotts however have a biscuit which figures above all others in the Australian psyche - the Tim Tam. The Tim Tam is a desperately rich biscuit - beloved by teenagers and twenty-somethings and an iconic part of getting fat in Australia.
They are sold by gas stations (open all night) at ridiculous markups - a couple of dollars a pack being a common mark-up. And the only person that buys them at 2am is someone who has the munchies. (Irrational hunger - known colloquially as the munchies - is a side-effect of smoking marijuana.) And Tim-Tam’s at 2am are the mainstay of the (overpriced) grocery shop attached to an all-night gas station. They are an important product.
And Arnotts, sick of David’s tardy payments, supplied David’s with their entire product range except Tim-Tams.
This annoyed the gas stations who would put signs up on the vacant area where the Tim-Tams should be - saying “supplier out of stock”. This convinced some gas stations to shift their supplier to the enemy - the dreaded Woolworths. At least they could get Tim-Tams.
This drove David’s almost bankrupt. The stock plummeted (it traded as low as 40c). Eventually it sold itself in distress to a South African group (Metcash) who injected enough capital to fix the DPO problem.
And so in my memory we almost lost the third biggest grocery wholesaler in Australia because dope-addled kids with the munchies could not buy chocolate biscuits.
And I learnt to watch DPO as an important indicator of corporate health.
Till next time.
John
Monday, January 3, 2011
The party is not over in Australia
Mike Shedlock has declared the party to be over in Australia for about the fifth time.
He is dead right that the Australian economy is a party and that it will end.
He is wrong that it is over now. The property market is more illiquid than usual. It has got illiquid a few times (and essentially flat) and every time it has I have thought that we were in Wile-E-Coyote country. (You know the type - the Coyote has run off the cliff - but he has not looked down - and only when he looks he starts to fall.) It just never fell.
The beaches are crowded and people are still buying lots of $6 ice-cream cones. You still meet plenty of people who are purchasing houses for more than can afford whilst driving his-and-hers BMWs.
I have thought the party was going to end for a while. (Like Mike Shedlock I am wanting to run fast from this bubble.) But early is wrong.
I have done very nicely with my offshore money. I have managed to keep up with the Australian dollar and then some. For that I am thankful. It would have course been easier to just buy Aussie bonds.
Oh well...
He is dead right that the Australian economy is a party and that it will end.
He is wrong that it is over now. The property market is more illiquid than usual. It has got illiquid a few times (and essentially flat) and every time it has I have thought that we were in Wile-E-Coyote country. (You know the type - the Coyote has run off the cliff - but he has not looked down - and only when he looks he starts to fall.) It just never fell.
The beaches are crowded and people are still buying lots of $6 ice-cream cones. You still meet plenty of people who are purchasing houses for more than can afford whilst driving his-and-hers BMWs.
I have thought the party was going to end for a while. (Like Mike Shedlock I am wanting to run fast from this bubble.) But early is wrong.
I have done very nicely with my offshore money. I have managed to keep up with the Australian dollar and then some. For that I am thankful. It would have course been easier to just buy Aussie bonds.
Oh well...
Friday, December 17, 2010
Looming excess capacity in getting you smashed and Chinese statistics
A few years ago I travelled by local transport (mostly boats along the Mekong) from Saigon to Siem Riep. I traveled with my wife and my then seven year old son. Hotels ranged from about a dollar a night to 170 dollars a night. (We splurged at the Victoria Chau Doc which felt like the best hotel I had ever stayed in - but probably was only in contrast.)
We hired locals to show us what they did for fun - which largely revolved around cock-fighting and any other form of gambling they could find and moonshine. They even bred fighting fish for gambling.
I sipped (small amounts of) moonshine and watched Cambodian soldiers play poker and boules.* The soldiers left their machine guns in a pile whilst they gambled. They would not let me photograph them because they were on duty. (They had machine guns - so I went along with that request.)
The moonshine was bad. Really bad. Kill-people sort-of-bad. Drinking it in quantity would be like having your brain smashed around a gold brick and then twirled with some slightly rotten pineapple chunks. It told me that the real game in alcohol in developing countries is to get people off the (literally) poisonous once-distilled moonshine and get them onto double or triple distilled stuff that comes in bottles. The biggest selling liquor label in the world used to be Johnny Walker Red Label. Now it’s Bagpiper - a genuine Indian whiskey. Bagpiper is one of the few liquors I would argue saves lives. The alternative is moonshine and with regular and sometimes very large death-tolls.
In China they didn’t take to whiskey like the Indians. Instead they drink Baijiu. The alcohol is usually sold as a wholesale ingredient - and blended under lots of brand names. The commercially made (and multiple distilled) grain alcohols will be displacing moonshine for years to come. There is good quality growth there.
Which brings me to China New Borun (BORN). BORN is a controversial stock floated on the US exchange earlier this year. It had reputable brokers backing the IPO. [The prospectus is part of my holiday reading!]
The prospectus tells us that edible alcohol is sold by grade (A, B, C) with A grade being more refined and hence tasting better. This company produces B and C grade with increasing focus on the B grade. Absolut Vodka it is not - but whatever - it is likely far better than the vat of rice and rotten pineapple by the Tonle Sap I tried. Here is what the company says about its production.
In China the numbers can bamboozle you - but I am not used to talking about 380 thousand tons of edible alcohol. That will supply an awful lot of drunks. I was trying to work out just how many - but the text of the prospectus does not make clear whether they are talking about metric tonnes or US short tons** as would be measured in America. (The spelling is different - so I would normally go with the spelling - except that China would measure this in metric and some diagrams later in the prospectus are specifically labelled as “metric tons”.)
And here is the diagram that was labelled “metric tons”. It purports to show edible alcohol consumption in China. They mean grain based stuff sold into the Baijiu market.
Lets take the 2012 estimate. 7.3 million tonnes of alcohol per annum. That is 7.3 billion kilograms of alcohol per annum. That is of course on top of the moonshine, wines, beers and imported spirits that the Chinese drink. (The growth in this chart must be moonshine replacement.) This is a lot of alcohol even for 1.3 billion people. It is more alcohol than the Chinese drink according to WHO statistics. Indeed it suggests that the Chinese are as drunk as the Russians (something that casual observation of culture makes you think is unlikely).
There is just over a quarter of a kilogram of alcohol in a (standard 700ml) bottle of Absolut Vodka. So this represents say 29 billion bottles of vodka. One company - China New Borun - is - according to its prospectus - responsible for about 1.2 billion of these bottles.
By contrast, the biggest selling liquor labels in the world (Bagpiper, Johnny Walker Red) sell about 20 million bottles (ahem: cases) each. China New Borun claims to be an absolute global behemoth in the business of getting people smashed. (Even with the bottles-cases correction China New Borun is a global behemoth in getting people stewed.)
Of course all the consumption in this note - and China New Borun's capacity - represent 2012 estimates. Maybe - like everything else in the world - the Chinese are building excess capacity in getting people pissed, legless, bladdered, trashed and otherwise off-the-wagon.
Lesson of all this: there are either a lot of drunks in China or the statistics are wrong. Maybe there are a lot of drunks in China and the statistics are wrong. Maybe the statistics are compiled by the drunks. Maybe the excess alcohol capacity is supplied by drunks. Whatever - when it comes to statistics and China you need to take them with a good stiff glass of Baijiu. If the statistics are in a prospectus trying to sell you stock - take two glasses of Baijiu. If that does not work - resort to moonshine.
John
*The French left baguettes, boules and train-tracks. The train-tracks have since been converted to bamboo railways.
We hired locals to show us what they did for fun - which largely revolved around cock-fighting and any other form of gambling they could find and moonshine. They even bred fighting fish for gambling.
I sipped (small amounts of) moonshine and watched Cambodian soldiers play poker and boules.* The soldiers left their machine guns in a pile whilst they gambled. They would not let me photograph them because they were on duty. (They had machine guns - so I went along with that request.)
The moonshine was bad. Really bad. Kill-people sort-of-bad. Drinking it in quantity would be like having your brain smashed around a gold brick and then twirled with some slightly rotten pineapple chunks. It told me that the real game in alcohol in developing countries is to get people off the (literally) poisonous once-distilled moonshine and get them onto double or triple distilled stuff that comes in bottles. The biggest selling liquor label in the world used to be Johnny Walker Red Label. Now it’s Bagpiper - a genuine Indian whiskey. Bagpiper is one of the few liquors I would argue saves lives. The alternative is moonshine and with regular and sometimes very large death-tolls.
In China they didn’t take to whiskey like the Indians. Instead they drink Baijiu. The alcohol is usually sold as a wholesale ingredient - and blended under lots of brand names. The commercially made (and multiple distilled) grain alcohols will be displacing moonshine for years to come. There is good quality growth there.
Which brings me to China New Borun (BORN). BORN is a controversial stock floated on the US exchange earlier this year. It had reputable brokers backing the IPO. [The prospectus is part of my holiday reading!]
The prospectus tells us that edible alcohol is sold by grade (A, B, C) with A grade being more refined and hence tasting better. This company produces B and C grade with increasing focus on the B grade. Absolut Vodka it is not - but whatever - it is likely far better than the vat of rice and rotten pineapple by the Tonle Sap I tried. Here is what the company says about its production.
We currently own and operate two facilities: one in Shouguang, Shandong Province and the other in Daqing, Heilongjiang Province. Our Shouguang facility has an annual production capacity of 160,000 tons of corn−based edible alcohol (90,000 tons of Grade B edible alcohol and 70,000 tons of Grade C edible alcohol). Our Daqing facility currently has an annual production capacity of 100,000 tons of corn−based edible alcohol (70,000 tons of Grade B edible alcohol and 30,000 tons Grade C edible alcohol). We are constructing an additional 120,000 tons of capacity (all Grade B edible alcohol) at our Daqing facility, currently expected to commence commercial production in December 2010. According to the Frost & Sullivan Report, we are the largest privately−owned corn−based edible alcohol producer operating in Shandong Province and Heilongjiang Province. Our Daqing facility is licensed to build up to 330,000 tons of production capacity of edible alcohol. Based on data from the Frost & Sullivan Report and our knowledge of our industry, we believe we will be the largest producer of corn−based edible alcohol in China, in terms of current known production capacity, following complete development of the Daqing facility.
In China the numbers can bamboozle you - but I am not used to talking about 380 thousand tons of edible alcohol. That will supply an awful lot of drunks. I was trying to work out just how many - but the text of the prospectus does not make clear whether they are talking about metric tonnes or US short tons** as would be measured in America. (The spelling is different - so I would normally go with the spelling - except that China would measure this in metric and some diagrams later in the prospectus are specifically labelled as “metric tons”.)
And here is the diagram that was labelled “metric tons”. It purports to show edible alcohol consumption in China. They mean grain based stuff sold into the Baijiu market.
Lets take the 2012 estimate. 7.3 million tonnes of alcohol per annum. That is 7.3 billion kilograms of alcohol per annum. That is of course on top of the moonshine, wines, beers and imported spirits that the Chinese drink. (The growth in this chart must be moonshine replacement.) This is a lot of alcohol even for 1.3 billion people. It is more alcohol than the Chinese drink according to WHO statistics. Indeed it suggests that the Chinese are as drunk as the Russians (something that casual observation of culture makes you think is unlikely).
There is just over a quarter of a kilogram of alcohol in a (standard 700ml) bottle of Absolut Vodka. So this represents say 29 billion bottles of vodka. One company - China New Borun - is - according to its prospectus - responsible for about 1.2 billion of these bottles.
By contrast, the biggest selling liquor labels in the world (Bagpiper, Johnny Walker Red) sell about 20 million bottles (ahem: cases) each. China New Borun claims to be an absolute global behemoth in the business of getting people smashed. (Even with the bottles-cases correction China New Borun is a global behemoth in getting people stewed.)
Of course all the consumption in this note - and China New Borun's capacity - represent 2012 estimates. Maybe - like everything else in the world - the Chinese are building excess capacity in getting people pissed, legless, bladdered, trashed and otherwise off-the-wagon.
Lesson of all this: there are either a lot of drunks in China or the statistics are wrong. Maybe there are a lot of drunks in China and the statistics are wrong. Maybe the statistics are compiled by the drunks. Maybe the excess alcohol capacity is supplied by drunks. Whatever - when it comes to statistics and China you need to take them with a good stiff glass of Baijiu. If the statistics are in a prospectus trying to sell you stock - take two glasses of Baijiu. If that does not work - resort to moonshine.
John
*The French left baguettes, boules and train-tracks. The train-tracks have since been converted to bamboo railways.
Wednesday, December 15, 2010
Fish and chips in Kiama
I am back in Australia after my trip to the USA and I am taking a few days break. Its lunch time – and I have been reading the annual report of a once highly valued internet company* whilst I wait for the heat to die down. It is too hot to stay at the beach – but I am cool from my most recent dip in the Pacific Ocean. I can hear waves crashing on the shore.
I write to make an observation – one for all the currency speculators out there. We stopped for a meal on the way South. South of Sydney (hence with cooler water) is the unfashionable part of the New South Wales coast. A beach-town cafe in decidedly middle class Kiama – and without water views is now as expensive as a cafe on the Upper West Side of Manhattan. (The fish and chips are better in Kiama though.)
Some of this price level is due to wage structure – but most of it is new. Australia is just expensive and getting more so – and the Central Bank (justifiably) feels the need to raise interest rates. Australia is now a very expensive place to visit and I do not recommend it except for the very wealthy.
It's hard to call the end of the Australian bubble – but the boom and prices have gone far beyond rational. I don't see what breaks it other than an end to the Chinese construction boom. These prices are the downside of being China's coal and iron ore mine. In America I saw no obvious inflation between trips. On the South Coast of New South Wales I can't say the same thing.
If you are an Australian and you are not in the process of shifting 25 percent of your asset base offshore you are probably remiss. And if you are a currency speculator liking the carry on Australian government bonds then it has been a great trade but I hope you get to the exits early.
Meanwhile you can enjoy ordinary ice-cream cones in small coastal towns at US $5.30 each.
John
*There is a blog post in that internet company – but it will have to wait for the new year. I want to talk to management to hear their side of the story first.
I write to make an observation – one for all the currency speculators out there. We stopped for a meal on the way South. South of Sydney (hence with cooler water) is the unfashionable part of the New South Wales coast. A beach-town cafe in decidedly middle class Kiama – and without water views is now as expensive as a cafe on the Upper West Side of Manhattan. (The fish and chips are better in Kiama though.)
Some of this price level is due to wage structure – but most of it is new. Australia is just expensive and getting more so – and the Central Bank (justifiably) feels the need to raise interest rates. Australia is now a very expensive place to visit and I do not recommend it except for the very wealthy.
It's hard to call the end of the Australian bubble – but the boom and prices have gone far beyond rational. I don't see what breaks it other than an end to the Chinese construction boom. These prices are the downside of being China's coal and iron ore mine. In America I saw no obvious inflation between trips. On the South Coast of New South Wales I can't say the same thing.
If you are an Australian and you are not in the process of shifting 25 percent of your asset base offshore you are probably remiss. And if you are a currency speculator liking the carry on Australian government bonds then it has been a great trade but I hope you get to the exits early.
Meanwhile you can enjoy ordinary ice-cream cones in small coastal towns at US $5.30 each.
John
*There is a blog post in that internet company – but it will have to wait for the new year. I want to talk to management to hear their side of the story first.
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