Friday, January 30, 2009

Philip Morris International - a currency play

There are only two stocks I own today. PM is one of them. Unfortunately it has become one giant currency play of dollar versus all other currencies. The stock is listed in dollars. Against that, 45% of EBIT is in Euros (Even Trichet was forced to comment at Davos that Euro won't disintegrate - remember Milton Friedman said Euro won't survive its first recession - now we shall see), 10% is in ruble (crashing), another 10% from Ukranian hryvnia and turkish lira (crashing even more), 25% in Sterling, Polish Zloty, Latam currencies, Indonesian rupiah, Aussie dollar, Saudi Riyal and Egyptian Pound (most of them are weak), and 10% in Yen (the only saving grace).

It is unlikely that PM will show any EPS growth in 2009, or even in 2010. If dollar continues its rampage, especially against the EM currencies  (and I think it will) we can even see -10% EPS in 2009.  So, should I sell? 

I would have sold this, but I am trying to test a theory of long-term investment with this stock. It is this:

a) Forget EPS growth. There are hardly any companies that will show EPS growth in the next couple of years (except Amazon of course). If one can be convinced that the EPS of a company is not going to collapse like that of a steel company,  one needs to look at some other things. I am pretty sure that PM's EPS won't get cut in half, so I am looking at these other things. 

b) The most important of these other things is - does the company have the financial capacity to do some deals that will help it solidy its moat, so that whenever the tide turns three four five six years away, it is in a dominant position.  PM has a very strong balance sheet. Can it take advantage of the situation that unfolds in 2009 to acquire competitors in Russia or Indonesia or LatAm who might face trouble? 

c) Purchasing power parity: Yes all the EM currencies are depreciating against the dollar today. But doesn't it imply that there is one year of 10%-20% type inflation out there in all these countries somewhere in the next five years, in which PM's EBIT will jump by 25% in one year in EM countries and take care of some of the lost EBIT of previous years (and no, EM currencies need not depreciate further in that high inflation year - if it is just high inflation and not hyperinflation). Besides, if there is a non-zero probability of hyperinflation in US, it definitely is non-zero everywhere else. 

Suppose Euro crashes and is replaced by another currency. There will be upheavel, revolution, war etc etc. At the end of it all, it is unlikely that we get an Ipod for $99 in US and $29-equivalent in Europe. One big reason why pound had to fall at some time last year was - everything was just so expensive in London vs Paris or New York. 

If one believes that all currencies, including dollar, are risky because of what central banks and governments are doing, then the best defense is not bonds or even gold - it is stocks. After all, companies can raise prices to offset steep depreciation of currencies. But one needs to be very careful. A lot of companies will go bust - especially companies running asset-liability currency mismatch. One needs to buy stocks of companies that will not only survive the recession, but will take advantage of their immense balance sheets to snap up competitors on the cheap. So the M&A track record of management is very important going forward. 

I think this is one big reason why Buffett wrote that open letter in Oct, where he said that he is buying stocks because of the policies he expects governments worldwide to take.  

One right question to ask is - what is true EPS of PM if all currencies were trading on PPP basis. Because remember, last year's EPS of $3.34 benefitted from dollar depreciation against the Euro and EM currencies in 1H08 - which one can argue was also excessive. So, some of dollar appreciation against EM currencies is just a return to normality. 

Timing wise, one can argue that I should sell today and buy close to that time when we are close to inflation.  But I need to test my theory with some stock, and I have chosen this one. 

The other problem with PM is - cigarettes are the easiest things to tax, and don't the governments need tax revenue. 

So lets see how this turns out. 

Monday, January 26, 2009

Val Thorens and Skiing

Just back from a week-long ski trip at the highest ski resort in Europe (in the French Alps). This is the largest linked ski area in the world. And it is simply amazing.  

An even more amazing thing (for me) - I didn't see one Indian or Chinese in my week there. I can't remember any other time in my life that I didn't see even one Indian or Chinese for an entire week. 40% of the world's population had only one representative - me - at the resort. 
Now I haven't travelled that much to exotic locations to be sure. But from what I have read or heard - that even in the remotest jungles of Africa one can always find a Gujju hotelier - Val Thorens seems to have escaped the imagination of the Gujju entrepreneur.  

To be fair, I heard "Tu Roop ki Rani" from "Roop ki Rani Choron ka Raja" (that really bad movie of the early 90's) on the French Radio. Where Indians haven't reached, Bollywood has. It was bizarre to hear this song (of all) amongst all the other French songs playing on radio. 

The best thing that will happen because of Slumdog is - execs at Disney, NBC and Viacom who invested in Indian entertainment industry can go to their bosses and justify their investment because of the potential blockbuster resturns. Fox Searchlight has again hit the jackpot of the foreign Indian movie market - Slumdog, Namesake, Water etc are all Fox Searchlight distributed.  

Fox incidentally reports the highest operating margins of any studio (high teens vs high single digits for Paramount or Warner). There is probably something in the DNA of a movie studio - much like there is  something about the DNA of a bank (even though they are all going to 0 this time) - that can make one stand head and shoulder above the rest.  

Wednesday, January 14, 2009

Fama on Bailouts

The blog world is indeed exploding. Even Fama and French have started writing a blog. At this rate, students can sit at home and get free tution. 

Fama has written an essay yesterday on Bailout and Stimulus Plans.  In this, he talks about the equation Private Investment = Personal Savings + Corporate Savings + Government Savings. This equation implies that fiscal bailouts end up displacing something else, so fiscal bailouts don't really end up helping much. 

The question that arises in my mind is - how is Central Reserve Bank printing money included in this equation? If population at large doesn't have a problem with Fed printing money, then US government savings might go up just by printing money. That implies that fiscal stimulus financed by printing money is great - as long as people don't have a problem with it. Now this doesn't sound right, so I must be missing something. 

Also, does this equation take into consideration the financial considerations that exist in real world? For e.g. if govt issues bonds today to finance spending, it sells the bond to some investor. The investor buys the bond in his bond portfolio. The riskiness of his bond portfolio goes down because it has larger proportion of  government securities. So he/she could lever it up just a bit more than is possible with a portfolio that has all private sector bonds. This creates lending capacity in the system, which could be given to private sector borrowers. So, while government borrowing displaces private sector borrowing, is the ratio 1:1? Does Savings = Investment really hold at all times, or is there a timing mismatch? 

This is all getting a bit confusing. 

This is an excellent article by some Aussie Prof: Bernanke an expert on the Great Depression?

Take Satyam into Bankruptcy and Sell It

Indian government is balking at writing a 1000 crore cheque to bail out Satyam - as it rightly should be. Satyam is a pack of lies - it is probably operating at 40% utilization rate - which means that 10-20K employees anyway need to be laid off just to right size the company. Paying them salaries using taxpayers money even for couple of months would be completely unjustified - what has happened is sad, but let's not compound one mistake by committing other.  

If Deepak Parekh is planning to wait for the correct financials of Satyam to be prepared before deciding what to do, he will be waiting 12-24 months. 2009 is the year when IT industry is going to take it to the chin. Even till last qtr, Citi, Merrill, MS, GS and UBS were increasing their technology spend year on year. That is not going to happen this year. The easiest vendor for anyone to cut is going to be Satyam.  

The best idea for all of Satyam's stakeholders is here.  Even its creditors will recover something. Bankruptcy is a good idea for dead companies - creative destruction and reallocating capital of failed companies is an important concept of capitalism. 

Their is one hope for the the Indian IT industry - Barrack Obama and his plan of digitizing healthcare and investment in broadband access. Digitizing healthcare records appears a problem that is tailormade for offshoring. The obvious caveat is - Obama's priority is to create jobs in US and not India.  

Changing the objectives

I had set four areas of study for myself two years ago (outlined in the title of the blog). The time has come to evaluate how much I achieved, now that 2008 is over and 2009 has started.

(a) Stock Markets: A+ 
(b) Learn French: D+
(c) Social Entreprenurship: F- 
(d) Middle East politics and Islam: D-

This is my focus for next 2 years (till Dec 2010):
(a) Markets 
(b) Learn French 
(c) Geography of Russia and Middle East - this is the new area of study

Bernanke's Speech

Bernanke gave a speech yesterday at LSE. Noteworthy are his remarks on Quantitative Easing in Japan and what Fed is doing, Fed's expanding monetary base and the shrinking money multiplier. Inflation is not a concern today because the money multiplier has fallen below 1. When it turns back, it might be an issue. The big question is when that turn happens. I don't think it turns as easily as some people are expecting (the second half 2009 recovery crowd) - if righting economic cycles was that simple, there wouldn't be any poverty in the world and all of us would be rich and happy. 

Also note his remarks on substituing public balance sheet for private balance sheet. What it also implies is that the portfolio of investors is changing - from more risky private securities to less risky public securities - though the change in composition is slow. This was an important consideration for Minsky - but something that doesn't get its due importance amongst economists.

Wednesday, January 07, 2009

How the sale process of Satyam should be

Prof Verma suggests that Indian govt needs to step in the next 24 hrs. I agree. I also have an idea on how the sale process should be. 

Satyam is going to have huge legal liabilities going forward, and will be forced to fight costly litigation. It already has a dispute with Upaid, and events of today will give Upaid lots of ammunition. Any buyer would need to take into account these legal bills to put a value on Satyam. Most likely Satyam doesn't even have 53000 employees. If the buyer puts too low a value on Satyam, shareholders will be unwilling to sell out. The process will drag out - in the meantime employees and customers will run away and the company's value will get drastically reduced. The longer this drags out, the worse it is - for all the stakeholders involved. 

A better option would be:  the government steps in, and runs an auction for only the employees and the customer contracts. Whatever value it receives + whatever assets Satyam has (buildings etc) go into an escrow account, from which the legal bills are paid, and shareholders receive any money that is left (after two or three years).  This is equivalent to taking Satyam into bankruptcy (like Lehman) and selling its employee platform (to Nomura or Barclays in case of Lehman). The stock can in the meantime continue trading, like stocks of bankrupt companies keep trading in the US (even WaMu trades today), where investors can bet on the recovery value post the legal costs and other liabilities.

The alternative is - the government steps in and tries to run a sale, but that cannot happen till we have proper audited accounts. An audit can take 2-3-4 weeks. In the meantime customers and employees start deserting. By the time a sale process starts, buyers are putting Rs 20 value on Satyam, shareholders are unwilling to sell, more employees and customers leave, and the company goes into a negative spiral. 

Infosys or Wipro should approach the government with this proposal. There is tons of money to be made if the transaction is structured to isolate the legal risks. 

Raju should get prosecuted under Sarb-Ox

India has its Enron. Satyam has imploded. Satyam is listed on NYSE. Will India extradite Raju to US? 

As I metioned couple of days ago, Grantham is bullish from a seven year perspective. But there is a survivorship bias inherent in that statement - one needs to figure which companies will survive and which won't. The Satyam fiasco illustrates this. As Buffett says, When the tide goes out, we find who is swimming naked. That time is here - some companies are not going to survive next year. 

Petrochem is bleeding

Lyondell Basel files for bankruptcy. Kuwait calls of K-Dow (Dow JV) five days before it is scheduled to close, complicating Dow's acquisition of Rohm and Haas. Hexion-Huntsman can't merge because the combined company will go bankrupt. 

But Reliance stands tall in India. Am I missing something about Reliance? This is going to be a very interesting quarterly report from Reliance. 

Quote of the day from Jim Grant: Treasuries now offer return free risk.

Tuesday, January 06, 2009

Bringing down the House

I was in Goa last week, and went to one of the newly opened casinos. Invariably, on the blackjack table, the subject of Bringing Down the House came up, and how a group of MIT students made money counting cards in Las Vegas. One of my friends had a different take on it. He thought that the casinos had sponsered the book to fool those who have a high opinion of their intelligence into believing that they could make money off casinos. It is definitely one of the most compelling conspiracy theories that I have heard - more compelling than Nasa faking the moon landing in 1969 or USA carrying out the 9-11 itself to get an excuse to attack Iraq and Afghanistan. 

Interestingly, there weren't a lot of slot machines on the casino ship, unlike Vegas, where one finds slot machines beginning from the airport itself. The manager of the casino gave us a simple logic. While slot machines have a assured and high ROI, it is primarily the old that play the slots. The casino going demographic in India is very new and primarily young, so it doesn't make sense to have a lot of slot machines. In a few years, if the casinos start seeing an influx of more older people, they would also have more slot machines. 

The casino was actually quite good. I was expecting a seedy joint with five six tables, with foul mouthed gangsters smoking grass all around. The ambience was more like that of a small newly opened Atlantic City casino - it was definitely better than the Trump Taj Mahal (on that note, India should patent the name Taj Mahal) . It is backed by the home minster of Goa, which is not surprising.  Who else can open a casino in India, where normal residential towers take five years to complete.  

Washington Post series on AIG

Washington Post has done a three-part series on AIG Financial Products Unit. It is quite long, but worth a read.  Fascinating stuff on the ultimate black box company that existed.   

Everyone is bullish

Ain't it surprising? It is almost as if the turn of the calendar has confined the banking crises to history. I can understand if Jeremy Grantham says that stocks are cheap from a seven year view. But that means two things for lesser mortals:

a) That we will be able to hold stocks for seven years through thick and thin. 
b) That we will be able to identify which companies will survive and which ones will buckle. There is a survivorship bias in Grantham's statement. 

The bullish argument is basically this: Stocks are down 50%. Government will save everything. Let's buy. 

To be fair, this is the first time in over a year that stocks, credit and commodities are priced in line with each other. Over the first 9 months of 2008, equities and commodities were painting a completely different picture than what credit markets were saying.  Now, that is not the case. The latest equity market rally has come in the backdrop of credit markets rallying since Dec 16, when Fed said that it will print money and buy MBS. 

This is a good paper on the history of banking crises, just in case one gets too bullish. We are still in the middle of one.