Tuesday, July 26, 2005

Moschip Semiconductor (listed on BSE)

My friend had asked me to do some research on this company. I think I finally somewhat understood how off balance sheet activities can make the financials look better or worse than they actually are. For this company, the entire income is off the income statement.. And in the process, I found this section on moneycontrol website where one can search for block deals for any scrip..

· Company Description: The company is in ASIC (application specific integrated circuits) space. It has a wholly owned subsidiary: Moschip USA. The product design and software development is done by MosChip India. The software is licensed to MosChip USA, which subcontracts the manufacturing and sells the chip through its distribution network. The entire revenue from sale of products is thus in MosChip USA. MosChip USA pays a license fee to MosChip India, which is linked to the gross margin on the products designed and developed by MosChip India.

· Complicated Capital Structure and Reported Financials: The capital structure of the company is complicated. The company acquired Moschip USA and Varsity using its shares. On the balance sheet, these acquisitions are accounted of as investments. The financials on BSE are for Moschip India. As such, the sales, income and share count associated with the investments is not on the BSE reported financials. So we don’t really know the consolidated financials of the company, which is critical, as all the sales are recorded by Moschip US. Economically though, as the subsidiaries were acquired using Moschip shares, any economic benefit from these subsidiaries will accrue to Moschip shareholders at some point of time.

· Critical drivers of stock price: Seems like there are two critical drivers of the company’s performace: (a) How fast does the company topline grow overall? (b) What is the revenue and profit sharing mechanism between the US subsidiary and its Indian counterpart? While this does not impact the financial outlook of the consolidated company, a higher royalty payment to the Indian subsidiary would increase the EPS reported to BSE.

Relied on prospectus filed in Feb 04 to get some of the numbers like cash and debt.

· Share count. Before the offer last year 30.64 million. After the offer, additional 3.34 million. GDR listing, additional 9.5 million shares. Total today should be about 43.5 million shares

· EV: 43.5 mn shares * 45 = Rs. 1957.5 mn market cap. As of 1Q:04 Moschip US has 30 mn. debt. Moschip India had 14 mn cash, Moschip US had 3 mn cash. So Enterprise value = Rs 1970.5 mn.
· Revenues: Don’t know Moschip US revenues. Need to approximate.

Method 1: Consolidated sales for 9 months ended 31/12/03 were Rs 94.6 million. Annualizing the consolidated sales, we come up to Rs 120 million in sales in the year ended 31/03/04. Moschip India sales were 3.8 mn during the 9 month period. (Business Standard article says the company’s revenues were Rs 12.63 crore in 2004 – pretty close).

Between the year ended 31/03/04 and 31/03/05, Moschip India sales went up 5.03 times. If it was all due to increased sales by Moschip US, and not increase in royalty payment rates from Moschip US to Moschip India, then sales companywide grew 5.03 times. This would imply consolidated 31/03/2005 sales were 120*5.03 = Rs 603 million

1Q:06 revenues for Moschip India grew 129%. If this is again companywide, and assuming similar growth throughout the year. FY 2006 sales would be around Rs 1200 million.

So EV/Sales would be 1970.5/1200= 1.64x
Risk: We don’t know whether Moschip India revenues are increasing because of increased sales companywide, or increased payments by Moschip US to Moschip India on the same revenue base.

Method 2: Sales increase in 2004 were 20%. In 2003, it was 25%. If it was 25% for FY2005, sales were 120mn*1.25 = 150 mn. If it is same for FY06E, sales next year would be 150*1.25 = Rs 187.5 mn. On that EV/sales = 1970.5/187.5 = 10.5x

· Conclusion: Blended EV/sales by the two methods is (10.5+1.64)/2 = 6.07x. For a company growing at 25%, this would be steep multiple to pay. For a company growing at 100%, this would be a bargain. I don’ t know what the growth rate is for this company.

· Company is saying that they will become cash positive this qtr, and EPS positive by year-end – that is great. It is these kinds of companies whose shares run up.
· The company has survived for a long time, including the telecom bust.
· The commitment of the management seems to be there – same CEO since inception.
· The company is hiring - http://www.assureconsulting.com/indiajobs/showjob.php?id=1426, 4 software engineers and ASIC engineers. Engineering strength in 2004 prospectus is 57.

· This company doesnt seem to have any patent. That is very surprising. Prospectus says – “The company is in product development, initially it was in IP”.
· These type of companies are very order driven – no predictability in revenues. There might be substantial variation in revenues from one quarter to next. Because revenues were so high in 1Q:06, they might be depressed in the next qtr.
· No clue about how good the technology of the company is, and who its customers are. As such, we are clueless really to what might be happening.
· About 100 employees – still a small company. But it has great ambitions. Acquired two companies in last 5 years through stock issuance.

· The company issued GDR? Listed at Luxembourg exchange? WHY – This is a very small company? Who bought this GDR?
· What is the profit sharing fundamental between the company and its subsidiary in the US?
· Many bulk deals for Moschip in the last week or so. Why this sudden interest in the scrip? Marshall Wace is a hedge fund – holding period typically less than 7 days – they will sell the stock soon. My former boss (Mike Seargent) is the CEO of its US operations. http://news.moneycontrol.com/stocks/marketstats/blockdeals_query.php

· Got R RamMohan Rao as director on June 4, 2003 – IIM-B ex Chairman.

Friday, July 22, 2005

China revaluing yuan

The news of the day was definitely China looseining the dollar peg (though not by a lot). This should lead to appreciation of yuan, and cause dollar to depreciate. This shouold help inch the 10 yr bond yields up as Chinese lower their appetite for US treasuries (why keep money in a weaker currency). Housing mousing should start cooling off a little bit...

When I was out of the markets, they went up, despite the London bomb blasts which killed 56 people. When I am back in, markets went down, despite the bomb blasts in London which apparently killed no one.. Microsoft has lowered guidance for next year, Google has missed on EPS.. That should be bad news for the market tomorrow

Thursday, July 21, 2005

Earnings going through the roof

I think I made an intelligent decision to move back into the market the other day. Coming into the day, more than 85% of the 104 companies in the S&P 500 that reported earnings either met or beat expectations, according to data compiled by Bloomberg. And finally, it is corporate earnings and price momentum that determine the movement of individual stock prices, and the indices on the aggregate.

GM came in weak today, but that is company specific. While Intel and Yahoo missed analyst expectations, Amgen had an absolutely monstrous quarter. It must be remembered that for Intel and Yahoo, analysts have been ratcheting their expectations up all quarter.

Then Greenspan made positive comments about the economy, and oil inventories came out larger than expected, and the indices ended up positively. After close Washingtom Mutual, Allstate and Qualcom have reported big qtrs - that should be awesome tomorrow...

Wednesday, July 20, 2005

Indian markets - Cable and satellite.. Zee Telefilms

As I continue learning about the US cable and satellite industry, it looks like these are amongst the best businesses to be out there. While the content business (TV and movies) is very hit-dependent, the distribution business is subscription based. As such, there is a lot more predictability to the revenues. And I think this has implications for India.

Whether the Indian economy is growing or slowing down, consumers who have experienced cable service would continue to subscribe to a pay-tv provider (cable or satellite), as long as they can afford it. Because the alternative - Doordarshan - is so plain awful. So, as consumer incomes increase and video penetration increases in India, the cable and burgeoning satellite providers should see massive subscriber growth.

India currently has a dominant state network - Doordarshan, that is free off the air. That is the only channel that one can get for free. For the other channels, one needs to subscribe - till now mostly to a cable provider. Cable distribution in India has so far been heavily fragmented, controlled in many cases by criminal elements. The only big cable-tv provider in India is Siti Cable, owned by Zee TV. It is only now that satellite companies are starting to roll out plans for the Indian market.

As the cable distribution business has been fragmented, it has had a few implications: (a) Under-investment in cable network. (b) Bad customer service (c) Local monopolies within cities, implying prices that vary sharply in different zip codes. If there were to be an alternative, it might gain significant market share. Two alternatives are beginning to emerge on the Indian horizon: Satellite distribution, and Reliance Infocomm.

Satellite distribution has an obvious advantage over cable - low capital expenditures. Once a satellite is up in the sky, it can cover the entire country. The other major expenditure involved is in subsidizing the equipment (dish, receiver) in each subscribers home. But these equipment costs also follow Moores law (after all most of the equipment costs lie in silicon chips). And when subscriber additions reach a certain volume, equipment costs fall even more rapidly. Thus, this is a business with a high operating leverage, i.e. high margins for the marginal subscriber. And presuming that satellite distributors would be companies with bigger balance sheets (a satellite's cost of build, launch and insurance is roughly $250 million) and superior management than the local cable provider, customer service is where satellite companies can get a big leg up.

But Reliance Infocomm would have an even more powerful weapon, besides strong balance sheet and superior management, if it were to launch video service in India. That is the bundle. Having one bill for the land-line, mobile, Internet access and video servicess is a powerful motivation for a lot of consumers to switch from one company to other. And normally, the consumers would get a discount if they buy all the services from one company than if they purchased the services separately. But as Reliance doesnt seem ready to launch video service for a couple of years, we would focus back our attention on cable vs satellite companies..

There are a few other factors which we should take into account:
(a) Prasar Bharthi has ruled that their cannot be exclusive agreements between distributors and content providers (Star, Sony etc.). That basically reduces pay-tv distributors to a commodity channel. If viewers can see the same content on cable and satellite, the only reason to prefer one over other would be price, and maybe customer service.

What I need to figure out though is that whether Prasar Bharti has regulated the pricing at which content providers can provide their programming to the distributors. Because if it hasn't, distrbutors might be able to squeeze some savings, if they have a sufficiently large reach. This would imply that the bigger the cable or satellite company is (in terms of number of subscriers), the better it is for it.

(b) India is booming in the urban areas, agricultural incomes are stagnant. As such, incremental subscriber growth is more likely to come from urban areas than rural. Cable is dominant here, indicating satellite would have a rough time penetrating this market.

(c) Hyper-competition: There are many satellite companies that are planning to launch service in India. Only a couple will survive. It is important to identify which. Star can leverage NewsCorp expertise in DirecTV, BSkyB and Sky-Italia. Who are Zee's partners?

Zee seems to be betting on distribution - both cable and satellite - which is great. I think I need to study this company more. But the equity has moved from Rs 140 to Rs 175 in the last 10 days, since I thought about it..

Saturday, July 16, 2005

The week that confounded everybody..

This was a week when almost nothing could go wrong - inflation remains tame, growth remains robust, consumer confidence remains high, oil drifts lower, and companies beat earnings estimates handidly. S&P now sits at 4 year high. I haved moved back all my cash back into S&P and small cap funds. So, these and emerging market funds are where I am invested in.

Right now I am a momentum person. Trying to time the market perfectly - which apparently no one has been able to do. What is the harm in trying anyway - I would learn something in the process.

Friday, July 15, 2005

Valuation of companies - setting up DCF correctly

There are hundreds of ways a DCF can be constructed - many of which are inaccurate, or don't capture issues like dividends and share repurchases correctly. The most accurate model that I have been able to come up so far, is as follows (the difference is in step c):

a) Calculate Free Cash Flow for each of the forecast years = Cash flow from operations - capex. As this would include cash flow from equity affiliates and cash outflow to minority interests, we do not need to account for them separately.
b) Calculate Unlevered Free Cash Flow = Free Cash Flow + Interest.
c) Calculate Unlevered Free Cash Flow/dil. share for each of the forecast years.
d) Calculate the Present Value, discounting using WACC. This is the Enterprise Value per share. If calculating one year price target, it is the two year out Unlevered FCF from which the forecast series to be discounted should start.
e) Subtract Net Debt/share. If calculating a one year price target, use next year forecasted net debt. Net debt = Long term debt - cash - net debt attributable to minority interests.
f) Add in value of investments accounted to by fair method and cost method/share.

That's it - we have the share price.. Simple!!

The crucial step is step (c) - I haven't seen any analyst do that. But if we don't, then share repurchases in outer years get modeled incorrectly. What is done by other analysts (and hitherto by me) is to go directly from step b to step d. And then subtract net debt, add fair value investments, and divide the resulting number by next year estimated dil. share count to come up with share price.

However, this is incorrect. For if share repurchases are being modeled in outer years, and we use next yr share count to calculate share price in the last step, it doesnt capture the decrease in number of shares that happens in outer years. While unlevered cash flow does go up (because as cash is used to buy back stock, net debt goes up, and so deos the tax shield provided by debt), the full impact of reduced share count doesn't get captured..

Maybe that is why DDM (Dividend discount model) is a better model to value companies.. But then in DDM, you have to make companies that dont pay any dividends to also pay dividends... Which has its own set of problems (what is the payout ratio etc..)

Thursday, July 14, 2005

S&P allures?

It was less than 2 weeks back that the markets were fretting about slowing growth in the world, and bond yields had gone below 3.95%. I was then thinking about going into high yield funds. Now, the mood seems upbeat - definitely since the London blasts!! Bond yields are back above 4.1%, and no one expects Fed to pause next time. Most of the companies that have reported numbers have beaten estimates - looks like both Apple and AMD will open up tomorrow after their results after the close today..

Amongst all the madness, there are finally just two drivers of a stock : Earnings revisions and price momentum. That is, the stock should beat consensus EPS numbers consistenly, or it should have wind behind its back. If both happen, we have a winner. If none happen, the stock won't work over the long term. If either one happens, a decision needs to be made.. Does this apply to the broader stock market?

What is the market telling us currently? Is it dangerously complacent, or we are living in one of those times when historical precedents lose their wisdom. Like after 1971, when US went off the gold standard and money supply increased in the system. Now we might be having a similar situation, with easier cross-border capital flows.

Vega Asset Management lost roughly $700 million in June - because the traders there bet on rising US treasury yields. Seems like everyone is being challenged mentally.

Does oil hold as much influence as it did in 1970's? The current rally in oil prices in not OPEC driven, it is market driven. So high oil prices are a result of economic growth in the world - if expectations of growth increase, oil prices would rise, which would temper those growth projections, which should cause oil prices to fall down. But oil has settled at higher and higher prices, which would indicate that markets are able to absorb higher oil prices now, while maintaining the growth..

Inflation numbers are out tomorrow. They should tell something...

Tuesday, July 12, 2005

S&P Multiple, and stock vs bond yields

So we had a third gain in a row after the London blasts. Briefing.com cites two reasons: (a) S&P is trading at 18.8x earnings, which puts its yield at 5.3% higher than bond yields at 4.1%. (b) Forecast for YoY earnings growth rate for 2Q has come down to 7.5%, below 8.8% at the beginning of quarter in April. And the market is reacting to the fact that reported earnings are always 2-5% higher than consensus.

(a) I read somewhere, maybe in "Stocks for the long run", that stocks yielded higher than bonds before World War II, then the relationship inversed. The prevalent thinking was that stocks being a riskier investment should yield higher than bonds. Many investors shorted stocks at that time thinking that they are overpriced, and lost their shirt. Are we again entering an era when stocks would yield higher than bonds? Maybe before World War II, capital movement was more free than it was for the next 50 years (human movement was definitely more free - no passports et al) , are we entering that phase again?

(b) Where is this fact of earnings growth being 2-5% higher than consensus coming from? I though stock analysts either overshoot or undershoot - there cannot be an always statement.

Should I go into the market, should I not? With dollar being as strong as it has been, wouldn't Dell, Intel, Cisco etc get hurt?

Sunday, July 10, 2005

Current Asset allocation..

Currently I am invested 60% cash, 40% emerging markets. After the London blasts, markets have moved up approx 2%. Does this point to resilience, or is this the final 10% of a bull market that I shouldn't try to catch? YTD, I am up 3.65%, vs flat for S&P.

What are the reasons I have seen for low interest rates in the US, and other places? Here is a list:

a) China, Japan, Korea et al buying US treasuries. But then why is EU debt yield so low? Somebody is clearly buying EU treasuries too
b) Better cross-border movement of capital has removed ineffeciencies, lowering cost of debt worldwide
c) Increased integration of India and China would keep wage growth and cost of producing goods low worldwide, leading to lower inflation worldwide (and hence lower bond yields)
d) Depression is an offing - this is a classic case of yield curve inversion.

I think it is fair to say that when yield curve gets flatter, retail banks get killed (they borrow on short end of the curve, and lend on long, and make money on the carry trade). To avoid getting killed, they should curail lending, which due to the money multiplier effect would be negative for economic growth. But if the game is on for grabbing market share, the banks might not curtail lending even if it hurts immediate profits.

Excess savings in the world?

Businessweek has on its cover this article on "World is awash in savings glut". What I cant figure out is this - how can there be a net savings glut in the world. If I sell someone something for $50, then my balance increases by $50, and the other person balances decreases by $50. So net savings in the world is 0. Maybe what they are saying is that the world has net positive savings vis-a-vis US. (They do say it at places in article, but still the feeling that one gets is that net savings in world is +ve) I dont know how economists calculate global savings, maybe I should figure it out.

If there is a net savings surplus globally, I strongly suspect that there can be only two reasons:

a) Asset inflation: Do savings include asset price increases? If the price of my home has jumped from $100 to $150, and that $50 unrealized gain is included in savings, then the problem is one of asset inflation. So I need to figure out whether these unrealized gains are included in calculating the savings.

b) Money multiplier effect: We all know the money multiplier effect the banks create. Similarly, there is a money multiplier effect when I borrow from my banks for house loans and credit card company. Are the global savings netted for debt? If not, then the problem is not of high savings, but one of low interest rates.

Now asset inflation can also be linked to low interest rates. Due to removal of ineffeciencies in the world financial markets, cost of money might have gone down globally. Question is: how much?

What exactly is the 2 line conclusion of the 10 page article of businessweek. That Americans are consuming a lot of imports, while the rest of world is not consuming American products. Instead it is investing in America. That is keeping interest rates down in the US. And because the world is not consuming, the interest rates in other countries have been held low by central banks.

I guess the best situation for the world is if Americans reign in their consumption, while the rest of world increases its consumption.

Friday, July 08, 2005

London blasts - Summarizing the risks for the US equity markets...

Before the open, it looked as if the US indices would have steep losses during the day, with S&P futures indicated down 17 points before the open. At close, all the three indices (S&P, DOW, Nasdaq) were up. One would have expected that with oil still at $60 and Hurricane Dennis building up in the Atlantic, the blasts would cause the S&P to have double digit losses and the DOW to have triple digit losses. That was however, not the case.

This resilience by the US markets in the wake of terrorist attacks might indicate that the underlying fundamentals are stronger than thought (by me). Or maybe, there is too much money in the world chasing too few investment opportunities, which jumps at any asset that falls in value. So I thought it would be instructuve to prepare a list of the biggest risk factors that might cause the the US equity markets to move down:

1) Slowing year-on-year earnings growth due to higher 2004 base.
2) Historically high profit margins for corporates - Reversion to the mean would lead to lower profits
3) Market trading at around its long term average of 15-16x (I need to figure out exactly how much, as even a 1x multiple swing indicates 6% swing in values)
4) Interest rate tigheting by Fed, and the narrowing yield curve. Inverted yield curve has historically been a harbinger of depression, though Greenspan thinks that is not the case this time.
5) Huge US budget and trade deficits - with associated long-term implications of dollar weakening
6) Oil prices at $60
7) Housing bubble - the current economic expansion has largely been driven by consumer spending, which in turn has been driven by higher income effect due to appreciation in home values. If the housing market to have a sharp correction, things could become ugly for the broader market.
8) (Now) Terror Risk

Separately, Bank of England kept its benchmark rate unchanged at 4.75%. With Euro weaker to dollar since the beginning of year, some investors have been predicting that the European banks don't need to cut rates to spur growth on the continent. Maybe that is what the Bank of England thought. I should look at the minutes of the meeting when they come out.

Also of news of personal interest, Deutsche Bank decided to sell part of its asset management business, after Citigroup got out of CAM a couple of weeks back by selling it to Legg Mason. Guess it is not a good idea to be employed by an asset management business owned by an investment bank. Lets see what happens to Morgan Asset Management and Merrill Asset Management, Goldman seems to be doing great in its asset management business.

Friday, July 01, 2005

Fed hikes another 25 bps - Not the time to invest in bond funds

As expected, the Fed Open Market Committee (FOMC )raised the Fed fund rate by 25 basis points. More crucially, it signalled continued tightening down the road, and not a relaxation, as some investors were expecting. The result was a loss of over a 100 points for the DOW after the FOMC announcement came out at 2:30 pm.

The Fed indicated that while long-term inflation remains under control, near-term inflation concerns remain elevated. This increase in Fed funds rate might slow housing , which has been an area of concern, if 10 yr and 30 yr yields rise. (See Greenspan's comments: http://gaurav1.blogspot.com/2005/06/alan-greenspans-comments-on-housing.html) 10 yr yield actually fell by 2 bps today after FOMC announcement, indicating further tighetening of yield curve. The current economic expansion has been largely driven by consumer and not by business. Consumer wealth has largely been driven by higher home values, and home equity lines against these values. Any significant decline in home values might thus have a extremely negative impact on overall economic growth. The best hope here, I guess, is to have a soft landing in home prices.

I had discussed a couple of days back whether this is the time to invest in high yield bond funds.
(See http://gaurav1.blogspot.com/2005/06/time-to-move-to-high-yield-bond-funds.html). I think it is better to wait and watch. If Fed keeps increasing the short term-rates, long term-rates might follow suit (so far they haven't).