Om Shanti Om in Beijing Olympics

In the women rhythmic gymnastics event, the Israeli team choreographed the last 60 second or so of their last routine on "Dhoom Taana" from Om Shanti Om. They finished 6th. Very strange indeed!!

In 2004 Olympics, China won 73 medals and India won 1. In 2008 Olympics, China won 100 and India 3. Indian Olympics is a much higher growth story (growth of 200%) compared to a maturing Chinese story (growth of only 40%). Giving a 200x multiple to India's 3 medal count (there is a huge runway of growth left) and a 6x multiple to low growth China medal count story (this is a cyclical peak due to home country advantage, besides how much more can they go to), we come to a valuation of 600 for both. India has finally caught up with China!!!!

Freddie Mac

It seems Freddie Mac is going out of existence soon. For a $2bn market company (as of now, when stock has fallen another 20% after being massacred throughout the week), how does it raise $10 bn? Bush administration is going to be forced to do something dramatic just before it bows out of the White House.

I just saw the fight that really launched HBO (and the cable TV industry) in 1975 on ESPN. Thriller in Manila - the fight between Ali and Frasier - was the first live telecast using satellite. Gerald Levin was the brain behind this. He was also the CEO of Time Warner 25 years later when it merged with AOL - the largest M&A deal ever.

A Verizon takeover of Vodafone

A speculation here. The biggest M&A deal in the world of the next 4 years is going to be a Verizon takeover of Vodafone. Verizon might then divest its landline business and become a global wireless operator - somewhat on the lines of what Vodafone did to Mannesmann at the beginning of the century.

It all boils down to Verizon Wireless - in which Verizon owns 55% and Vodafone owns 45%. It is probably the best wireless operator in the world with a churn of sub 1.2% and is a crown jewel. Because of the way Verizon has manipulated the situation, Vodafone's stock has become relatively undervalued, while Verizon has become relatively overvalued.

Here is why. A lot of telecom investors are focussed on dividend yield and free cash flow yield. Verizon controls the board of Verizon wireless and it has argued against Verizon Wireless paying a dividend to its parents to reduce its leverage for years. This works fine with Verizon. It consolidates Verizon Wireless, so the consolidated cash flow statement includes all of Verizon Wireless's cash flow (including Vodafone's piece of it). So the free cash flow calculated using cash flow statement overstates Verizon's free cash flow power. Besides, as debt reduces at Verizon Wireless, it makes consolidated leverage at Verizon look better (if one forgets to count minority interest as debt).

Vodafone has no such luck. It carries Verizon Wireless as an investment on its balance sheet. Because it doesn't receive any dividend from VZW, its cash flow statement doesnt include any benefit from VZW, and so its free cash flow is understated. Whatever free cash flow Vodafone generates today, it is from its properties other than VZW, and it is from this that it is paying out its dividend.

So on a free cash flow yield basis, Vodafone is cheap. A big cause of it is VZW. Verizon can capture this discount. Pound has started weakening, and if it continues to weaken further as UK falls off, UK takeover targets will become attractive in the next 3-4 years. Someday, Sprint will get its act back in US and it will become difficult for VZW to grow by churning Sprint subs. Growth in US wireless through domestic M&A will be difficult - after Alltel, there is hardly anyone of scale left to acquire. VZW will spend 2-3 years integrating Alltel. That is when Verizon will pounce on Vodafone.

Oil, dollar and interest rates

I had thought in April that commodities will weaken as Fed ends its interest rate cut campaign, because that will support dollar. http://gaurav1.blogspot.com/2008/04/time-to-short-commodities.html. That didn't happen. Then I thought that probably Fed needs to hike interest rates to make dollar strong to kill commodities.

What has happened is different. Expectations on Europe have changed from rate increases to rate cuts. So the expected interest rate differential between dollar and Euro has narrowed, strengthening the dollar and weakening commodities. A valuable lesson. Relative interest rates are more important than absolute interest rates in the forex market, and by extension commodities.

There is a clear linkage between credit crunch and commodities through interest rates and forex moves. A lot of people think these are two seperate problems. They are not. All these demand-supply theories on commodities are BS in the short run, and not enought to explain oil prices going up from 100 to 145 in 3 months.

This is another evidence of the point made by Charles Kinderberger in "Manias, Panics and Crashes" - asset deflation moves from asset class to asset class and country to country - often through capital market linkages. Oil price spike caused by credit crunch has made sure that emerging markets weaken significantly.

Commodity crack-up..

Commodities are cracking - finally. If it becomes a deeper slump over the next 24 months, there are going to be lots of issues with industrial companies and banks that are heavily exposed to steel, cement and other commodity companies. The swing factor for a lot of these commodities is China, and I have no clue about what is happening there.

In the immediate term, commodity stocks might fall a lot and start pricing in a very pessimistic scenario. One of the key learnings of the last 9 months is - nothing goes down forever. So there might be a quick trade here. But there is a global slowdown/recession, it is spreading, and high commodity prices dont fit in well with a theory of global slowdown. I think inflation is going to turn into deflation over 24 months. So need to be careful with commodities.

Sold out Aban at a loss of 30% - there are much better oil drillers available cheaply now with lower leverage, higher exposure to deepwater drilling, and better corporate governance. This stock didn't rally when oil was moving up in May June because Indian markets fell, and hasn't rallied since when Indian markets have gone up in July-August, because well oil has been falling. Now when Indian markets fall again, and their fall this time will have nothing to do with oil, this stock can crack up further. For a highly leveraged company, its stock price is paramount to its survival.

Why will India markets fall again? They have been rallying since RBI apparently surprised the markets with more tigheting than the markets bargained for - because oil is falling. Interest rates and inflation are high and they are not coming down for the next 5 months, and all you need is 5 months to turn the cycle decisively. Earnings estimates are way out of whack for all Indian companies.

Catching the bottom

Barrons has this excellent reason for why no one can catch the bottom...

"THERE'S A REASON THAT STOCK PRICES ALWAYS BOTTOM BEFORE the economic news turns for the better -- and it isn't all about the "wisdom of crowds" working its information-processing magic in the crucible of the market.

It happens partly because a struggling market, in its impatience, tries to anticipate the turn so often, with bottle-rocket rallies, that eventually it turns out to be right.

It's easy to tell the false dawns from the real ones, of course. Just wait a year or two, and it'll be clear in retrospect. Divining it in real time and anticipating the anticipatory is a good deal tougher."

The risk is volatility

In financial theory, volatility of an asset class is considered as a proxy for its investment riskiness. The risk is captured in the discount rate. So, to value on asset, the formula is

V = Sum of {C(i)/(1+r)^i}, i = 1 to infinity, where

V is the value of the asset,
i is the year,
C(i) is the cash flow in year i,
and r is the discount rate, calculated as

r = r(f) + Beta * {r(m) - r(f)}, where
r(f) is risk-free rate,
Beta is associated with volatility,
and r(m) is the market return

This way, rising volatility increases discount rate, reducing the value of asset.

However, it ignores the impact volatility has on cash flows - the numerator of the equation above. The incidents of the last few months makes me believe that volatility impacts not only the denominator by increasing discount rate, but also the numerator by impacting cash flows.

Take the instance of Indian IT companies. Last year they were hit because rupee appreciated suddenly. They took on derivative positions, in some cases excessively. So, this year, they are getting jacked when rupee is depreciating. Last year, Indian importers didn't take forward cover, thinking rupee will appreciate forever. This year, they are getting hit.

The point is - volatility makes decision making difficult. If oil price rises to $145, should an airline hedge or not? Should a steel maker plan to massively expand capacity today or not - when there are some tentative signs that China is slowing? If people say that they will not make a decision till volatility subsides, that itself hurts overall growth. One man's savings is other man's income.

So, more than oil prices etc, I think it is volatility itself that will restrain global growth. The animal spirits are sagging - India and China had their share in the last few months and now it is Brazil's and Russia's turn - and they are essential for any boom to continue.

The bull and bear dilemma

Alan Greenspan starts his article in FT today with the following sentence - "The surprise of recent months is not that global economic growth is slowing, but that there is any growth at all". That is precisely the reason why bulls and bears alike are being challenged.

For, when one puts on the bear hat, one can argue that credit destruction should have caused things to fall apart. Unfortunately for bears, that hasn't happened. Amongst all the doom and gloom, US is still growing at a snail pace. China still continues to grow - and it was the reason given behind the commodity price spike.

So, should one then become a bull? If the once in a century credit crunch results in just a 20% decline in equity markets, why should one ever not be in equities? To that, the bears will argue - just wait and watch. The real destruction will start now as China and India slow, and capital to western financial institutions becomes scarce.

There are various dilemmas in investing right now:

a) Should one invest for quarters? Suppose a stock like Bharti falls to 14x PE today when it is growing at 20%+. I can say with reasonable confidence that the next 12 months are going to be fairly good, and the next earnings report will be solid. I dont know what happens after that -competition heats up, inflation hits rural India causing subscriber addition to slow down etc. Should I buy for the next qtr? The risk is that the stock doesnt recover in the next 12 months. Or for that matter PSU banks. Chances that they report good numbers over the next 9 months is good, after that who knows. How should one think about investing when next qtr might be good but 2 year out might be bad?

b) Should one buy stocks that would be the last to fall? Stocks like Colgate, P&G etc? If things dont fall apart, one will end up making money in these - their multiples have also compressed, although not that much. And if things become really bad, one wouldnt lose much (hopefully)

c) Should one invest on reversion to the mean? The amazing thing of last few months is - whatever has fallen has come back, and whatever has risen has fallen back. Banks fall, then rise, then fall again, then rise. Commodites were going one way, now are going the other way. India was going down, Brazil was going up - in the last month Brazil is down 20% and India is up the same. The risk with this is - one never knows when the mean reversion happens. People were shorting oil at $120 in May, they would be only even now. Besides, what is the mean? Still, this is worth exploring.