Wednesday, October 25, 2006


The Economist has a really good article on the Arab World in its current issue, found here.

In this, the Economist makes one very interesting point. It says (but not in as many words) - "The mistake that the US made after 9/11, that it clubbed all the terrorists together. However, Al Qaeeda is vastly different from Hamas or Hizbullah. Al Qaeeda has a more global agenda, while the concerns of Hamas and Hizbullah are more local." Failure to differentiate between various terrorist organizations has also led to a failure in prioritizing as to which organization to deal with first. Trying to take them all at the same time is now proving burdensome for USA.

Politicians are often criticized for being not idealistic and too compromising. Here, Bush tried to lay out a very idealistic version of his policy - "We are against all terrorism". And it has backfired. Should one conclude that good politics would always call for chosing amongst the lesser evils (minimax, or minimize your maximum losses) ? In this case, for instance, USA could have ranked Al Qaeeda as its number one target, and Hizbullah somewhere down the order. This would have implied that USA continue maintaining relations with Syria (USA clubbed Syria in its Axis of Evil in 2002 for supporting Hizbullah).

Wednesday, October 18, 2006

The Motorola blow up

Motorola blew up today. Down 10% after-market. It is down 15% since hitting $26.30 on Friday. What were my mistakes:

a) There is something called a price-target, which I did not have. I think now I will formally put a price target against all stocks that I buy. And maybe use the Citigroup grid to help in my thinking. If a stock goes up to that price target, it is time to sell.

b) I have been looking at Nokia for this past month, and how cheap it has become compared to Motorola, as MOT kept rising and NOK kept falling. Before today, MOT was trading at 19x, while Nokia at 16x. I never acted though.

Is it time to sell Motorola? I guess the share gains game that they have been playing for the last 2 years is now over. So unless Motokrzr helps them start regaining market share, their 2007 year-on-year comps are going to be very tough. So if they are growing as fast as overall market in 2007, they should command the same multiple as Nokia, which is trading at 15.9x vs MOT at 17.3x, at MOT's after-market price of $23. So MOT can fall another $1, which is not that bad. So I guess risk-reward is again in favor of owning MOT shares.

There are 2 concepts that I will formally drill down in my brain from here:
a) Price target of a stock - i.e. when is it time to sell
b) Risk - reward, what is the upside vs what is the downside.

DRC: What is the price target. Considering that it will generate about $2/sh of FCF, the stock is currently trading at 9.5% FCF yield. At $26.67, the stock will have a 7.5% FCF yield. So I will go with a $27 price target. The stock's total return is about 27% from here.

Saturday, September 30, 2006

From here..

I predicted correctly that oil prices could fall in Sep to $60, and so the markets will move up. The wrong bet i made was that I moved into emerging markets - thinking they are a high beta play on US markets. Well, it turns out that Dow is near an all time high now, while the emerging markets funds have moved hardly at all.

It is actually not that surprising. I had feared as much when I bet on emerging market funds last month. There were two reasons for my fear. First, emerging markets actually benefit from a high price of oil and other commodities, as that it what they export primarily. So buying them for a falling oil price doesn't make sense. Second, the funds that I bought were actively managed funds, and not index funds. Any manager worth his money has been overweight oil stocks over the last 3 years, so a fall in oil prices was bound to hurt.

I am still afraid of investing in the US markets. It almost seems that the bullishness that gripped the market in May has returned. A big surprising rally has already happened in the last 2 months, since the day Bernanke went to Congress in July and gave his sanguine testimony. Could there be a further year-end rally? Yes, and no. Oil prices have fallen, but one reason is seasonality. If winter is normal and demand for heating oil is high, inventories would fall and prices rise.

I guess I will hold on to Motorola. The company is gaining market share world wide, and once they stop their stepped up investments in distribution in India and China, their margins could move up.

Dresser Rand is more tied to oil prices. The stock has moved down about 8% since when I bought it, but its FCF yield is 10%, which is great. I actually dont know how to think about industrial companies across business cycles, so this is risky.

The stocks that are interesting at this time.

a) Sprint - A broken company with severe merger intergration issues with Nextel. At 5x EBITDA, this wireless company is cheaper than the wireline telcos, which is insane. Question is: How does Sprint merge two disparate technologies in EV-DO and I-Den? Is the merger itself fundamentally flawed, unlike Cingular-ATT Wireless, which both used GSM. Sprint has been broken for 8 months now, so maybe I will wait for this quarter earnings, where they could lose subscribers, before moving in.

b) Yahoo - Another broken company. Have had a series of misses this year - pushed out search algorithm deployment, lowered their 3Q06 guidance. 40% of Yahoo revenues come from the real estate and financial services vertical, which could be more prone next year. The stock is pretty much dead for the rest of the year, and 2007 could see a slowing US economy. But search algorithm fix should be around the corner now. Besides, advertising continues to move online, and as long as Yahoo maintains its market share, things should turn out well.

Monday, August 28, 2006

Why markets could spike in the next 3 months.

These days, most investors appear bearish. People are worried about slowing growth and/or rising inflation, and extremely circumspect that the Fed can pull off a soft landing. That is possible. One can look at fundamental reasons (slowing housing market, tapped our consumer, energy inflation feeding into core inflation, rising inflation expectations - at least in University of Michigan survey) etc etc to feel gloomy about the future of the world.

However, the sequence in which events unfold will have as much bearing on what events actually ultimately unfold. That is, if inflation slows before growth stalls, the stock market reaction would be very different than if growth were to stall before inflation softens.

In this context, perhaps the single biggest factor that will determine the direction of the stock market over the next 3 months could well be the next 3 weeks of the hurricane season. Let us explore this thesis in more detail below:

A) Hurricane season: Oil prices have remained at elevated levels in the last couple of years on geopolitical concerns, and the extensive damage caused by prior year hurricanes in the Gulf of Mexico region. So far this year, the hurricane activity has been quiet - only 3 named hurricanes so far vs. 10 last year. The period from Mid-August to Mid-September is the peak season for hurricane activity, of which one week has already passed. If, and this is a big if, this season were to pass without any major incidents in the Gulf of Mexico reason, oil prices would be headed down sharply - towards $65, and maybe $60.

For, a quiet hurricane season would help in two ways. First, it would remove some of the supply disruption risk in the current oil prices. Investors will suddently realize that massive oil inventories have built up over last year to sufficiently address demand. Second, it would give the oil infrastructure that is still out in the GOM region one additional year to recover from the battering it received from Katrina and Rita. This additional supply would further depress prices.

While posing headline risks, I don’t think the nuclear standoff with Iran would result in a oil trade embargo for 3 reasons. First, China and Russia would not support it. Second, even Iran would not want not to reap benfits of $70 oil. The last time Iran had an oil embargo in 1952 (imposed by Great Britain), the country did face severe economic difficulties. Iran would posture and get maximum concessions out of the UN, or the UN will slap some sanctions on Iran, but I doubt Bush administration would risk $90 oil in an election year when Republican prospects look shaky. If Bush does something on Iran, it will be in 2007.

B) The Fed Moves: One can safely assume that the Fed will not raise rates in September just 6 weeks after it stopped raising rates. August core CPI reading of 0.2% bolsters this case. If oil prices were to start falling in mid-September because of no hurricane season impact, it would give the Fed reason not to raise rates in its next meeting in October. For the Fed will argue (in October) that a falling housing market is curbing demand and reducing inflation, and falling energy prices are further restraining inflation.

C) Stock Market Reaction: If oil prices were to fall, helping the Fed remain firm in its stance, markets would rally. For investors would become less worried about consumer demand in the all-important holiday season, and a hope of Goldilocks might emerge again.

This is not to say that it will be an clear signal for 2007 - falling US housing market, resetting ARMs, falling US dollar etc - pose their own risks. But, till Thanksgiving, we could get a 8%-10% rally, simply if the hurricane season were to leave us unharmed.

Thursday, August 10, 2006

5 types of bad mergers (from Cramer)

1) Getting out while the getting is good: an M&A motivate by a seller who simply wants to exit the company, example: Sprint's (S) purchase of Nextel,
2) Don't just stand there, do something acquisitions: here a company doesn't know what to do, so it buys something, example: E-Bay's (EBAY) acquisition of Skype,
3) Panic and overpay acquisition: a company worried about slowing, borrows money to buy a company, example: EMC's (EMC) purchase of RSA Security (RSAS),
4) Two drunken sailors acquisition. Two underperforming companies try to combine, example: Alcatel (ALA) and Lucent (LU),
5) Napoleon complex: when a little company tries to buy a much larger company, example: Boston Scientific (BSX) vs. Johnson & Johnson (JNJ).

Saturday, August 05, 2006

From GS Chief Economist

1. Let's step back a bit from all the near-term excitement for a minute. As the housing market turns down, the US economy is in the most vulnerable position since 2000. Then and now, the private sector -- households and businesses taken together -- was running huge financial deficits. Then and now, the bubble that had driven the deficit in the first place was bursting. Then and now, the necessary spending adjustment was likely to depress private sector demand (relative to trend) by several hundreds of $billions. This is why we have been expecting a fundamental downshift in growth in the course of 2006, which now is clearly underway.

2. But I think there is one important difference compared with 2000. This is that the current slowdown is consumer led, while the 2000-01 downturn was business led. A consumer led slowdown -- even a big and fundamental one -- tends to be gradual because consumers try to maintain their standard of living if given half a chance, whereas businesses slash spending first and ask questions later when the going gets tough. So while the total size of the adjustment is similar, I suspect it will play out over a longer period of time than it did in 2000-2001. I expect sluggish domestic demand for a multi-year period, but not the steep descent we saw in late 2000/early 2001. In the current environment, a recession is possible if there is an outside shock (energy is an obvious candidate), but it's not the base case.

3. In our forecast, the slowdown does imply that the current inflation pressure -- and it's looking much more like genuine pressure following the upward revisions to the compensation numbers last Friday -- will abate in 2007, opening the door to significant rate cuts. These cuts are an integral part of our base case of no recession next year. We expect a fed funds rate of 4% by the end of 2007.

4. But doesn't this mean the Fed has to pause/stop next week? That's clearly the market's view post the payroll numbers, though we are still holding steadfast as some of the last remaining members of the flat earth society. The ball is now in the Fed's court if they want to change expectations over the weekend -- and frankly there are some good reasons for them to do so:
a) I think the message that the Fed will take away from the employment report is that the economy has slowed from an above-trend to basically a trend pace, but not that we are on the cusp of a real downturn. Payrolls are growing at a pace very close to trend and the guts of the household survey are stronger than the 0.15pp increase in the unemployment rate would suggest. Meanwhile, average hourly earnings have accelerated to a 4.4% annualized pace over the last 6 months, and unit labor costs are picking up.
b) If the FOMC really believes its own forecast -- and it's their forecast, not ours or anyone else's that matters -- the economy still needs more restraint. They expect the economy to grow at its 3% long-term trend and the unemployment rate to stay stable over the next 18 months. So in their forecast, hardly any "slack" opens up that would push down inflation over time. Unless they are happy with a core PCE deflator of 2.4% yoy and unit labor costs at 3.5% yoy (that's the likely Q2 figure following last Friday's GDP revisions), that means higher rates are needed under the assumptions of their forecast.
c) In the Handbook of Good Central Banking, you can argue that now is the time for one additional hike. The inflation data have been bad, and there have been some questions about Bernanke's resolve. Why not use this to signal that inflation is your first priority, and thereby inoculate yourself against possible upside inflation surprises in coming months, which are very possible. After all, there is a reason why most Fed rate cycles have ended with one last move that ultimately turned out to be unnecessary.

5. If they decide to pause, the statement is likely to be fairly similar to its predecessor and might even retain the sentence that "[t]he extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information." Given the recent inflation and labor cost data, I think no hike and an all-clear is very unlikely.

6. Market views. No strong views on the direction of rates -- the medium-term outlook is bullish for bonds as the economy is slowing and inflation should tend to ebb (our 10-yr note yield forecast remains at 4.5% in early 2007), but I think there is considerable risk of a near-term correction as things decelerate more gradually than the market is discounting. The big issue is getting the timing of the eventual Fed rate cuts right. Since it's hard to be sure, options may be the way to go -- especially at the current still-low volatility levels. In equity land, I still like the idea of being short growth, housing, and the consumer. All these trades have stalled in recent weeks as the markets have moved towards pricing a soft landing. I suspect that view could come under renewed pressure in coming months.

Friday, August 04, 2006

State of Markets - Aug 4

The Fed Meets in another 3 days, and after today's job numbers, it is almost a certainty that the Fed will pause in its interest rate campaign. This will cause the markets to run up today, as they have over the last 2 weeks. It was a bad miss on my part - I moved out of the markets in May just before they started melting, which was smart. But I failed to re-enter when they were low. Trading makes sense only if one can do both the things right - sell high and buy low. If one does only one of these, results would be lower than in a buy-and-hold strategy. But what should I do now ?

Are equity markets a good place to be now? Lets look at the positives:
a) low P/E ratios - 14x forward P/E
b) Presidential cycle - stocks are weakest in the second year of US Presidency, and Congress elections should be over in the next 3 months.
c) A potential fourth quarter rally, which should start in another month.

What are the negatives?
a) A weakening US dollar - as soon as the weak job reports came out today, the dollar weakened significantly. This in itself could have a number of ramifications, including:

i) Commodity prices rising up again, as they are inversely correlated to the dollar. This could support oil prices at these high levels, cutting into consumer spend.
ii) This could make US bonds less attractive to foreigners, pushing bond yields up. (Parenthetically, I am unable to understand why Chinese sell all these goods to the US, take this huge money that comes into their economy, and reinvest in US bonds. For if their principal starts eroding because of devaluation of US Dollar, their central bank will show losses in its forex reserves).
iii) It could hurt export oriented economies such as Japan, Korea etc, and hit their stock markets. It would hurt Indian software exporters such as Infy, Satyam. And that could hurt US markets, as happened in May. Or will it? Is US market dependent on what happens internationally?
iv) Even if the US market rallies, the returns are lower because of dollar weakness.
v) On the positive side, dollar weakness helps US exporters, which is good.
vi) Could this dollar weakness and yuan's peg to dollar cause China to crack up? If dollar weakens => yuan goes down => Europe and Japan pressure on China mounts => China revalues yuan => China slows => demand for commodities goes down, which offsets increase in commodity prices due to dollar weakness. Could China do a soft landing? If China does not break the peg, it is a big problem.

b) The yield curve is now firmly inverted. The Fed has stated in the past that the yield curve has lost its predictability in forecasting recession. If that it true, it is fine. If it is not, and there is a recession, markets would turn down later.

My lessons:
a) Never bet against the Fed. They are smarter than I am. More importantly, the ball is always in their court, as to whether they want to act or not.
b) If I am able to sell high, I should also buy low to make money. Otherwise buy and hold is the best strategy

Strategy going forward:
a) There would be no company news in the next month, as the earnings season is over. So news will be dominated by geo-political events and hurricane stories, which is negative At the same time, many people who had jumped out of the market would be itching to move back in.

b) Is it a good strategy to invest in the broader stock market, or buy individual stocks now? I would prefer later, as the risks are known.

Thursday, June 22, 2006

State of the financial markets - June 22

How should one play the financial markets going into the next 2-3 months?

Lets start with the US markets. The key here is the direction the Fed takes in its interest rate tigtening campaign. Two scenarios are possible:

A) Inflation readings keep coming high, so the Fed keeps on increasing rates beyond 5.5%. This would cause markets to go down - in the US and abroad.

B) Fed stops at either 5.25% or 5.50%. This would likely cause the US markets to move up. And as all asset classes have recently become correlated with the US markets, this would also push up commodities, emerging markets (for most of whom commodities are the main exports) etc.

This would also cause the dollar to start weakening against the Euro and Yen - where the central banks have indicated that they could raise the rates soon. As commodity prices are inversely related to dollar, this would cause them to go up, further pushing up commodities and emerging markets. So the world markets best hope is that Fed stops.

However, if prices of commodities start rising, inflation expectations are going to start to creep up again. Also, a weaker dollar would increase import prices, further fueling up inflation concerns. These could be offset by slower growth in US in the coming months due to the past Fed rate increases, which take effect with a lag. If Fed stops raising rates but US economy keeps its strong trajectory, then inflation would again raise its head tomorrow, prompting rate increases. So the best hope for world markets is that Fed stops, and the US economy slows sufficiently (which would reduce demand for commodities and imports) so that inflation remains contained.

To the extent that a weaker dollar hits export oriented Japan, Nikkei might take a hit (which could bring emerging markets down). However, if the dollar decline is smooth rather than abrupt, it is possible that the incipient economic growth and domestic consumption in Japan is able to offset weaker exports. It would enable the Japanese central bank to raise rates - which is essential for the long-term health of that country. How does that impact the so called carry trades is a billion dollar question.

Could the past 10 day rally have been predicted? The rally started the day futures started pricing in a 100% probability of rate increase on June 29th. The US economy grew at 5.8% rate in 1Q06. Add in 3.6% inflation, and the nominal growth rate was 9.4%. To the extent some of it carried over in 2Q06, the earnings numbers are going to be beat estimates - as has been shown by all brokerages, Fedex etc. So if I had an earnings calendar with me, I might have been able to play it. But what now?

The Fed meets next week on June 29th, July 4th is a 4 day weekend, and after that the CPI report that will be out around July 9th would again enchant everyone. Considering that interest rate futures are not pricing in a 100% probability of rate increase in August, the markets might again stall till these futures price in a 100% probability. This time however, corporate earnings announcements might act as a buffer. Lets see how this plays out.

Thursday, June 01, 2006

Is it a good time to buy Indian stocks - Not really!

Recently, the Indian market has suffered a rather painful correction for anyone who was invested there. And now there is a dilemma for investors: Is this the bottom, or is there more to go?

The Indian story is unique in certain aspects. First, it is driven in a large part by domestic consumption (unlike investment and exports as in China). Second, high commodity prices are not the primary cause behind the prosperity of the last few years (unlike Middle East and Brazil, where commodity exports make up a big chunk of the economy). As such, even if US economy slows and commodity prices soften, the Indian growth story should remain untouched to a large extent.

But when we talk about stocks, things are a bit different. For stocks are impacted not only by underlying fundamentals, but also by liquidity flows. And that is where the concern lies.

Currently, foreign investors are key players in the Indian markets, through various emerging market funds and hedge funds. And so, if the foreign investors were to yank money out of these emerging market funds, these funds would be forced to sell securities that they hold, including Indian securities. So while the Indian story is different, it is clubbed together with other emerging markets for investment purposes. So where goes the emerging markets, so will go India.

And so the key question becomes - are the US, European and Japanese investors going to withdraw money at a rapid clip out of the emerging market funds?

I doubt whether anyone knows the answer to that question for the next two months. The next Fed meeting is on June 29th. Till that time, I think the US market is going to get conflicting reports on where inflation and economic growth are headed. So while there will be a lot of volatility in the US markets, there will not be in any direction.

After June 29, the focus will shift to when the Bank of Japan raises its short-term rates. It could happen anytime between July and September, which would create another uncertainty in the markets. So I think that investing in Indian stocks would remain a risky proposition at least till July. But the growth story exists in India - between January and March 2006, the economy grew at 9.3%. So when the time is right, stepping into the market could produce a number of winners. That time is, however, not now.

Wednesday, May 24, 2006

Where do US markets go from here?

I think the US markets will not go anywhere till 29th June - the day of the next Fed meeting. Till then, I think there are 2 issues that will prevent US markets from going up:

a) Commodity prices: If commodity prices go up, inflation fears heat up. If they fall, a lot of emerging markets indices go down (as many are leveraged to commodity prices - see brazil), which heighten the uncertainity in US markets.

b) Inflation fears: If economic data is stronger than expected, inflation fears heat up. If it is weaker, economic slowdown concerns hit the market.

Best thing that could happen is, Fed leaves the interest rates unchanged, and inflation does not shoot up due to lagged effects of past monetary tightening. But that can only be understood in retrospect by historians.

If Fed stops raising rated next month, there will be a section of the bond market that will worry that Mr. Bernanke has gone soft on inflation in pursuit of growth. So 10-yr yields might rise in anticipation of this higher inflation. So equity markets could still get hurt.

Thursday, May 11, 2006

Quotable quotes

1. "Ati ka bhala na bolna, ati ki bhali na choop.. Ati ka bhala na barasna, ati ki bhali na dhoop", or The middle path is often the best path. - Kabirdas

2. An intelligent person has a unique theory of life. A wise person knows that there are various theories of life, that one theory cannot fit all, and that different theories assume significance at different points of time. Sometimes, Quantum mechanics helps explain nature, and sometimes Einstein's Relativity, and the two need not sync with each other*.

3. Tit for tat is the best economic philosophy in competitive situations. It is also the best one socially. In other words, do unto other (person) what the other (person) does to you.

4. The more I practice, the luckier I get - Anonymous

5. Stay Hungry, Stay Foolish. - Steve Jobs

6. Either things will happen for the good, or they will happen for the bad, so why worry.

7. It is not right to say that things have happened for good when they have happened for bad - slowly but surely it obfuscates the ability to perceive truth.

8. You get what you ask for - Gandhi

9. "When you want something, all the Universe conspires to help you achieve it" is true only under special conditions.

10. You can be a bull, or you can be a bear, but there is only one way to be correct.

11. Happiness is a state of mind, and not a state of being (or existence).

* As physicists say often, one of Quantum mechanics or Einstein's relativity is wrong - they cannot both be correct at the same time.

Tuesday, April 04, 2006

Risks to the Indian Financial Markets

The Indian Markets continue to surprise even the most ardent bulls. Surely there is growth, and surely there is a huge middle-class population that is discovering the joys of spending for the first time. But the march of the BSE Sensex from 10,000 to 11,000 in 25 odd trading days, and then the march from 11,000 to 11,600+ in 3 trading days has been unexpected, to put it mildly. Will this be a case of the higher they rise, the mightier they fall? Is there so much liquidity in the Indian markets currently - Reliance recently raised $1.3Bn from domestic investors for its Reliance equity fund, $1.3 billion is close to 1 day trading value on the Indian bourses - that the markets have become entirely liquidity driven?

Here, I list a few near-term events that could cause the Indian markets to correct sharply. Others are welcome to chip in.

A) Political elections: Currently, there are state assembly elections scheduled in Tamil Nadu, Kerala, Assam (already on) and West Bengal within the next few months. Predicting the Indian elections is at best, a guessing game (In 2004, psephologists widely predicted that BJP would win the national elections by a wide margin on back of 'India Shining' campaign, only to see it lose. Recall the Sensex plunged by over 10% that day of May 17, 04). Still, surprises in Kerala and West Bengal - which are the bastion of Communist parties (a key coalition partner at the centre) - could result in some interesting dynamics at the centre.

B) Increase in Japanese Interest Rates: Japan has been a very big investor in India, so an increase in interest rates there, as has been indicated by the Japenese Central bank, could have a negative impact on the Indian markets. One could, however, also argue that an increase in Japanese interest rates signals a confidence by the bank in Japanese economic recovery, which could turn out to be a big positive for the Indian economy in the long run. Similarly, higher interest rates in US and Europe could make foreign investors look at their own countries than to India.

C) Failed Monsoons: Agriculture contributes nothing to the Indian growth story - the 8% GDP growth number is all off services and manufacturing. But a failed monsoon will have wide repercussions for India - estimates range from 35% to 60% of the population as still dependent on agriculture. Rains normally arrive in late May.

D) Terrorist attacks: Within India, terrorist attacks have so far been taken in stride. Outside India, London attacks did not deter the markets worldwide. So unless there is a major geo-political crisis (Iran, Iraq?) that suddenly increases the risk profile of investors world-wide to go up sharply, this would be a non-event.

Tuesday, February 21, 2006

The Conundrum around interest rates

There is one question that is prominent in the minds of anyone who takes even a passing interest in the affairs of Wall Street. And it is this – How long and how much would Mr. Ben Bernanke, the new Federal Reserve Chairman, continue to raise the Fed Funds rate? The concern is legitimate, for the supply of money in the economy, which the Fed attempts to control through the Fed Funds rate, determines to a large extent the potential growth that American economy can exhibit in the coming year.

The Fed Funds rate is the rate that the Federal Reserve charges to lend money to its member banks. If the rate is low, member banks would have incentive to borrow money at a cheaper rate and lend it to their borrowers at a higher rate and pocket the difference (called the carry spread). The borrowers, in turn, would take more loans (perhaps to construct that extra plant, or buy an extra house) when they have to pay lower rates. As such, the Federal Reserve lowers Fed Funds rate when it perceives that the economy is slowing down and might perhaps go into a recession. On the other hand, the Fed increases rates when it feels that the economy is expanding at a faster rate than necessary (which might lead to inflation).

Following the Internet bubble burst in early 2000 and 9/11, the Fed dropped interest rates to historic lows of 1% in a succession of rate cuts by 2003. As the economy strengthened and gained momentum , the Fed started increasing rates beginning June 2004. In a succession of 14 rate hikes of 25 bps each, the Fed funds rate has climbed from 1.00% to 4.50%. It is widely perceived that Mr. Bernanke would increase the rates once more when he chairs the first meeting of the Fed since he took over from Mr. Alan Greenspan. But are there more rate increases after this, or will Mr. Bernanke be satisfied with the state of the economy and leave it at that?

That would most likely depend on the inflation numbers that the Fed measures going forward. While growth is important in an economy, it is even more important to contain inflation. For the biggest reason behind the economic expansion in US in the last 2 decades has been the ability of the Fed to control inflation effectively. Low inflation gives visibility to consumers and businesses visibility into wages and prices. As such, they are willing to take increased risks.

Measuring inflation is, however, not straightforward. Different measures of inflation, such as CPI (consumer price index), WPI (wholesale price index), GDP deflator etc. might give different pictures. Then again, these measures might include items (such as food prices and energy prices) that are more volatile, which might cause inflation numbers to be erratic month to month (Economists try to circumvent these problems by looking at inflation ex food and energy). The Fed also at various other metrics such as the rate of unemployment, capacity utilization etc to get a sense of inflation.

Most of the inflation numbers are currently benign. That makes the bulls argue that the Fed might stop raising rates after the next one. They point out that the economy grew at a mere 1.1% in the fourth quarter of 2005. Consumer spending was flat year on year in the all important holiday season. The house market has started cooling. With so many Americans depending on the home equity lines of borrowing to finance their spending over the last few years, any further increases in rates might cause the consumer to throttle back further, pushing the economy down, maybe into a recession.

Bears, however, contend that the various inflation measures systematically underestimate the real inflation in the economy. They also point out that the rate of unemployment is currently running at 4.70%, which is much higher than the normal rate of 5.0%. As such, it is very likely that wage pressures start building up in the economy (i.e. employees start demanding higher wages). And while the economy might have grown at 1.1% in fourth quarter, it is expected to rebound to 3%+ growth in the current one. They also point out the impact that high oil prices might have on core inflation.

The equity markets have remained range-bound in the last year and half, with the Dow Jones oscillating between 10000 and 11000 during this time-period. If the Fed decides to stop raising rates, the markets might move higher. But then, corporate profits have grown in double digits in the last 15 quarters – the longest streak that the US economy has had since World War II. Besides, this economic expansion has been driven by consumer spending and not business spending. The consumer is currently heavily indebted, the savings rate actually fell below at one time last year. Perhaps the consumer might slow down even if the Fed stopped raisi! ng rates, and business spending might not pick up enough to fill the gap. If that were to occur, one might not see the Dow crossing its all time high of 11, 722 hit on Jan 14, 2000 anytime soon.

Monday, January 30, 2006

The hype on Rediff

Disclaimer: This is not investment advice. Consult your investment advisor before making a decision.This could be factually incorrect. Author does not hold position in the stock, but could have a vested interest in seeing the publication of this article. This represents the author's fair opinion of the company, which might be completely incorrect. Author might not have any financial, accounting or valuation background. Again, contact your investment advisor.

These days if Jim Kramer as much breathes the name of a stock on Mad Money (CNBC) - the stock runs (or tanks) depending which side Kramer is on. He mentioned Rediff earlier this week, as a play on India, on Jan 24. Not surprisingly, the stock has jumped - about 35% since that day. So is Kramer speaking out of his hat, or is there some sane reason behind his bullishness?

Rediff was first (or amongst the first portals) that were launched in India in the late-90s. Most of them, such as, flamed out with the dot-com bust. Amongst the survivors, Rediff and Indiatimes are the biggest Indian portals. Rediff enjoys a very strong brand recognition amongst Indians - this writer has lived in US for 3 years and still visits Rediff, as do almost any other Indian that he knows. This has been achieved without heavy advertising spending - in contrast to Indiatimes. Indiatimes, owned by Bennett and Coleman (publishers of Times of India - the largest read Indian English daily), has been "cross-promoted" on an entire page in the Times of India every day for the past 7 years. And still, it lags Rediff in rankings.

On Alexa, is ranked globally as the 132nd most visited web site.〈=none&page=2#. Rediff is the top-ranked Indian website - ahead of Google India (though there are a large number of Indians who go directly to Google US) and it closest competitor Indiatimes (ranked at 301). Yahoo India does not get ranked seperately. Does that smell gold? Not necessarily. Rediff ranks ahead of such websites as Monster, Best Buy and Netflix. Mere high internet rankings are not enough to translate into a high market cap or oodles of cash flow.

Rediff's ADS trade under the ticker symbol REDF. Each ADS is equal to 1/2 share.

Basic Shares outstanding - 14.39 million
Shares underlying Options - 520.8K equity shares at weighted average price of $8.29, or $8.29/2=$4.15 per ADS (As each ADS = 1/2 equity share). This adds another 261K share, at current price of $19.78 per ADS.

So, Diluted shares outstanding - 14.65 million

Current REDF ADS price - $19.78
Equivalent REDF share price = $19.78*2 = $39.56

Market Capitalization = $39.56 * 14.65 million = $580 million. The company has essentially no debt, so its Enterprise value (EV) is $580 million

Besides a web portal, Rediff also publishes two weekly newspapers: Rediff USA and India Abroad. Of the $12.6 mn revenues reported in 2004, $6.6 mn. were from the portal, while $6.0 mn. were from the newspapers. The Online business grew 53% each year over the last 2 years, while the publishing business remained essentially flat.

This year, the online business has accelerated. If we annualize the revenues reported in first 2 quarters of 2005 (Rediff has a March year end), the online business is set to show a 75% increases in revenues, from $6.6 million in 2004 to approximately $11.5 million in 2005. If it grows at 75% next year, we are looking at a revenue of $20 million for the web business in 2006. Add $6 million in publishing revenue (assumed flat), and total sales in 2006 will be $26 million.

Rediff has consistently made losses. This year, it will barely be profitable. As such, we use an Enterprise Value/Sales ratio to get a sense of Rediff's valuation. Rediff is trading at EV/06E Sales multiple of 22x ($580/$26) - which is expensive. Note that this multiple is on sales - 25% of which will come from a no-growth publishing business. Could this steep multiple be justified?

If one recalls the euphoria surrounding Chinese Internet stocks (Baidu, Sina, Alibaba etc) over the past two years, it would seem logical to get bullish on Rediff - the biggest Indian Internet portal. But Baidu and Sina are the top 10 ranked sites globally - Rediff is 132. is expected to have $237 million in revenue in 2006. The company has a current market cap of 1.23 billion. Currently, it has a net cash position of $188 million. So it trades at an EV/Sales ratio of 4.4x. Besides, the company is profitable - 06E consensus EPS is $1.07 for a P/E ratio of 21.7x.

Maybe Rediff has a much brighter growth curve ahead of it than Sina. And then, News Corp acquired Myspace for $580 million when it had piffling revenues. Yahoo, Google and other big media companies are aggressively buying web properties. Rediff targets a particular demographic - and an increasingly important one at that. It might be a good acquisition target. But will any acquirer be willing to pay $580 million?

Lets look at Myspace. Myspace was the fifth most trafficked site in the US when News Corp bought it, and is the 13th most trafficked site globally. Its growth has been explosive, from a virtually nothing 2 years ago, to over 13 billion page views per month today. Rediff, on the other hand has merely increased from 400 million page views to 600 million page views over the same time period. Over this time, Rediff has constantly ranked below 100 in the list of most trafficked properties, indicating that a lot of the growth has come simply due to the widening reach of the Internet.

And this is perplexing. The biggest Indian portal is not showing any explosive growth in its page views. This company, which has been existence for close to a decade, will barely touch merely $20 million in revenue in 2006. Over this decade, Rediff's management has done a few acquisitions, including the publishing assets, a calling card business (which was sold - why did a Internet portal invest in a calling card business in 2001 when lond distance prices were in free fall is mysterious, only to sell it off in 2 years at a mere 16% of the price paid?) etc. In the meantime, other India focused websites - such as privately held - have been able to monetize their product more effectively.

One would argue that Internet penetration in India is rising exponentially, which might justify Rediff's valuation. But we do not see it in Rediff's numbers. Quarter-over-Quarter in 2005, growth in Online revenue is flat. There are still not enough users in India to cause massive shift of ad dollars to the Internet. Maybe they will come in 2 years, in which case the stock is 2 years ahead of its time.