Verizon Wireless and Vodafone

I am sticking by the prediction I made one year back - that the biggest M&A deal over the next four years will be a Verizon takeover of Vodafone. By 2010 end, Verizon Wireless will be levered at 0.5x debt/EBITDA. There is hardly anything left in US to acquire. VZW can't expand abroad under the partnership agreement with VOD. The best thing would then be for VZ to acquire Vodafone and become a global wireless operator.

No sell side analyst talks about it - this is completely original.

Disclaimer: Own Vodafone

Cinemark Holdings

I had purchased Cinemark (CNK) at $8.90 at the end of April when Swine flu broke out in Mexico. 20% of CNK's EBITDA comes from LatAm (mainly Brazil and Mexico), so the fears were justified at that time.

1H09 has been spectacular for US theater exhibitors with box office gross up approx 13% yoy. In 2H09 though, they will face difficult comps from The Dark Knight, which was released in July 2008. And come 1H10, they will face difficult comps from a great 1H09. So the question is - what should one do? Here is a list of the +ves and -ves:

+ves

• Dividend yield of 6.5%, FCF yield of 12% are good. This is not a declining biz - volume (attendance) is up high-single digits this year. That might fluctuate yoy and might be -ve next year, but it doesnt look like this industry is in secluar decline.
• 3-D might really happen. If Avatar is a big success, it might just change the dynamics of the entire industry. Dreamworks is quite bullish on 3D. 2010 might not be a down year if 3D takes off in a big way.
• There was a lot of concern over the past few years that DVD's will destroy the theatre industry. Investors were afraid that if the studios are able to collapse the time gap between theatrical release and DVD release of a movie, consumers will prefer to buy a $20 DVD than spend $40 for a family trip to the movie theatre. After this year, theatres might have more negotiating power against the studios.
• Cinemark seems a better operator than Regal or AMC - its attendance growth/screen is constantly higher than Regal and AMC.
• 2Q earnings might be above consensus because of higher attendance growth translating into better margins. Real and MXN strengthening would help - offset by the biz lost in these markets because of the flu.
• Hey, it is an emerging market play :)

-ves

• Difficult comps.
• Company levered at 3x Net Debt/EBITDA. If 2010 is a down year, and investors extrapolate that down year into the future, then the company might be forced to do something on its capital structure - like cut dividend or raise equity. Regal has cut its dividend.
• Studios might turn up the pressure on theatres to shorten the DVD release window now that they are in real trouble because of falling DVD sales
• Studios are cutting on their movie slate. It is possible to have a higher box office gross with fewer releases (like 2Q09) - but one never knows.
• Maybe consumers get bored of 3D by 2010. So it turns out to be all capex with no returns. Though after watching Monsters vs Aliens in 3D, my reaction was - I don't mind paying a bit extra for the 3-D experience.

I think I am going to hold on till earnings.

1H09 Performance

It has turned out to be quite good in the US portfolio - what with markets going up and not. 10% YTD in 2009 (indices are up 1%-2%). I am now 10% below the peak in Oct 2007. I am playing it conservatively - these are my savings after all. The biggest money losers since Oct 2007 have been the UltraShorts (SKF and SMN). If I do a sleight of hand and convert dollars to INR - my currency of consumption - than I am up 10% or so in the past 2 years. A lot of people told me in June 2007 to convert dollars into Rupees as Rupee was at 40 on its way to 30. So I can justifiably claim I have generated some alpha for myself.

I will now start running a proper portfolio for the Indian markets too. Kotak Securities has such a bad user interface that I never bothered to do anything systematic. Sometimes, the interface doesn't work during market hours. Then, they calculate profit and loss from the cost basis and not on YTD basis, so it is quite a task to figure out YTD performance. Most frustratingly, they link the brokerage account to my bank account from which money gets debited or credited for each transaction - so it is extremely difficult to figure out the average invested amount over a period of time itself. As a result, I have multiple brokerage accounts, and I have no idea of my IRR.

A Bollywood superstar's blog

My friend Ed who has been on a world tour for the past one year has finally penned his much anticipated entry on his blog here. Maybe I will see him dancing behind Kylie Minogue in Blue.

Unaccustomed Earth

I have been reading this book of short stories by Jhumpa Lahiri. All of them are similar, and after a point of time uninteresting. That doesn't mean I have stopped reading the book. But then I have read Surendra Mohan Pathak's novels till the very end a large number of times, so it is more a comment on my stupidity than on her brilliance.

When 2009 began, I decided that I will reduce my reading of financial and business fiction/non-fiction. As I read WSJ, FT, blogs, earnings, 10-Ks and Qs as part of work, I felt I need to diversify away my reading at home.

Time to take stock at the mid-point of the year. Books read so far in 2009:

1) Kite Runner

2) Shantaram

3) Freedom at Midnight - this is a real gem

4) Is Paris Burning?

5) Bankers who broke the world - finance history - can't avoid it.

6) Unaccustomed Earth - almost over

Long CTSH, Short INFY

Cognizant has historically gone 10%-20% faster than Infy, and continues to do so - if we go by the guidance of the two companies for 2009. Till last year, its stock used to trade at substantial premium to Infy. Since then, the differential collapsed. In the last two weeks, Infy has been trading at 10% premium to Cognizant. My guess is - Indian markets are on a tear and are pulling Infosys India stock along, so INFY ADR is duly obliging. However, Cognizant is not listed in India. So CTSH doesn't have something similar pulling it forward. 

Whatever factors impact Infy will impact Cognizant to the same degree. If tech spending recovers, Infy will benefit, and so will Cognizant. Rupee appreciation hits both. US protectionism hits both. Amongst the Indian outsourcing companies, CTSH probably does the best quality of work - if one were to go by the number of IIM grads that chose CTSH over INFY, Wipro or TCS. 

Cognizant has grown faster than Infy in the past, and it will grow at least 10% faster than Infy in 2009. I think CTSH will again start trading at a 10%-20% premium to Infy after another 2 quarterly reports. Infy will report next in mid-July, Cognizant in August. So probably by Oct Nov is when CTSH will reassert its premium. 

CTSH Long, INFY Short

My first long short in my personal account. Lets see how it works. Portfolio right now:

a) PM - This is my fav play on EM currencies. 

b) CNK - Bought when Swine Flu hit Mexico last month and the shares swooned. Is the content cycle in 2010 as good as the one this year? Probably time to exit after 2Q results, which are going to blow out consensus. I actually like this company - they seem to execute better than AMC and Regal.  

c) TWC - 11% FCF yield ex the tax benefits. Cable video gross margins are going down + they need to market to compete against DTV - unemployment is a concurrent indicator for cablecos and telcos. But if wireline telco companies can generate lots of cash when they lose 10% lines each year, I am sure cable can with 1%-2% sub loss. 

d) VNV, UZG - debt securities of Viacom and US Cellular

e) VWO - Vanguard emerging market fund. This is the beta. 

It is an extremely defensive portfolio (55% cash) with hardly any cyclicals - too bad for me. Probably it is another 5 years before I figure out how to price commodities, and I am in no hurry.  

Return of the Friedmanites..

Suppose commodity prices keep going up. The closed mines will open up as soon as selling price crosses their cost of production. However, because demand would not have come back to the same degree, their production will go into inventories - unless the cost of production also moves up so that the mines remain unprofitable. That would require some giant scheme so that the general price level in the world economy goes up. In particular, wages need to go up, which doesnt seem likely looking at the state of world affairs.

So, production goes into inventories. There are no end buyers. Do prices go down, or bulls keep arguing that China will take care of the inventories in a year? Does dollar weakness keep commodity prices high which leads to stockpiling of inventories. 

The key to inflation is not output gap. It is commodity prices, at least in emerging markets like India. The last year was the year of Keynesians. I think Friedmanites are going to get an opportunity to strike back very soon. How exactly we get inflation - I am not very sure. Investors are taking Libor + 50bps funding provided by the brokers to take a flyer on everything risky.   

Stagflation!!

If emerging market stocks run another 20%-30% from here, I am pretty sure oil will follow. The same logic that investors are using to bid up asset prices - liquidity from the Fed - can and is being used to bid up oil prices. 

The thing is - there is no theory to figure out what the price of a commodity should be. For stocks, one can use DCF or some other intellectual justification. What should one use to figure out the price of oil? Supply is more than demand today. So should oil fall to $50 or $40. Why not $10? An economist will say - well the price of oil should be such that demand is met over the next few years and oil exploration companies are able to earn their cost of capital. If oil companies make excess profits, than price of oil is high. Needless to say, this logic has zero practical applicability. 

Markets are open right now for both equity and debt, and the Fed will be hoping that investors calm down a bit. Because if they don't, by their very actions, investors will cause inflation to happen. It might not happen in US as much where commodity prices are not a big part of CPI, but it will definitely happen in emerging markets like India. 

Revenue Shortfalls and EPS beats

SocGen confirms in Barrons what I was suspecting. While companies were beating EPS estimates in 1Q, they were falling short on revenue projections - i.e. margins were expanding. So margins were expanding between 2003 and 2008 when there was expansion, and margins are expanding now when there is contraction. That is not possible beyond a couple of quarters. 

The next fall in the markets is going to come either from revenue/earnings shortfalls in 2Q (July), or if something happens in the commodity/currency complex (oil goes above 80 if dollar keeps falling). People are bullish and afraid to miss out on the wonderful 2010, and it is unlikely that a couple of bad macro data points are going to derail the optimism for the time being. 

So, we need to enjoy while it lasts, with a firm eye on the exit door. 

S&P expresses concern over UK AAA - so pound strengthens!!

Dollar weakens. Because investors are now concerned about US debt. But wait a sec - the concern has been expressed today on UK, not US. It is very strange.

Gold is strong when markets are strong because dollar weakens, and strong when markets are falling apart as a safe haven. Seems like gold is going to cross $1100 this year.  

Sensex goes up by 17%

Even on Sunday, after hearing the election results, I thought markets will go up by 5%-7%. This is a shocker, and to some extent indicates the illiquidity of the Indian market. I am sure there are some sellers of Bharti above 1000. 

I am looking for some studies which show which other indices went up by 17% in a day, and under what conditions. Yesterday, after Sri Lanka ended a 25 year war, its index was up 7%. If I remember correctly, Taiwan was up 13% over 2 days at end April, when the Chinese govt allowed mainland companies to buy shares on the island. India is an extremely high beta market - that is the main lesson to be drawn from this episode. 

Hindustan Lever & Procter & Gamble India

HLL (Hindustan Unilever) has decided to go for pricing to retain market share in soaps and oral care (toothpastes). HLL made a very interesting comment - in times of low commodity prices, new small competitors come up. I guess smaller competitors dont need to invest as much in working capital during times of lower commodity prices, so they become more aggressive. 

I am pretty sure that what has started in soaps and oral care will slowly spread to other categories - investors wont get price increase, volume increase as well as margin expansion in these companies.

P&G has a listed company in India - Procter and Gamble Health and Hygiene - through which they sell Whisper and Vicks. They also have a 100% subsidiary, through which they sell everything else. There seem to be serious corporate governance issues here - at a time when media costs are falling for all other FMCG companies, this company has a huge jump in media costs on no new product launches. The same is true for employee costs. I guess P&G India is booking its costs in the listed company, so that they can depress the share price and then delist it at a later stage.

Lords of Finance

"Lords of Finance - The Bankers who Broke the World" by Liaquat Ahamed is the best book on the 1920's-1930's financial markets that I have read so far. Now I haven't read a lot about this time period, so it doesnt say much. But it is definitely better than "1929" by Galbraith in giving a context to the whole episode. Highly recommended. 

It was the gold standard which caused the recession to become a depression, as countries couldn't expand credit fast enough to fill the gap left by private sector deleveraging. As soon as US went off the gold standard, dollar depreciated against gold and other commodities (Jim Rogers is right when he says commodities went up in the 1930's, but that was after a huge plunge happened in early 1930's. And it was linked to dollar devaluation). As soon as prices started going up, industrial production went back up - including in mining. And that led to new discoveries of gold itself. 

Michael Milken has written a very good article in Tuesday's WSJ on the importance of capital structure. This is a very good line: "History isn't a sine wave of endlessly repeated patterns. It's more like a helix that brings similar events around in a different orbit"

Deflation continued

Continuing the deflation post from yesterday, there is a big difference between consumer price inflation and wholesale price inflation right now in India. CPI is running in high single digits, while WPI is close to 0. This implies firms are increasing margins - which is what FMCG analysts are factoring in their EPS growth projections. I don't think this can last long. In each FMCG category, there will be an upstart who will try to use price cuts to expand market share, which will force the biggies to react. Lets see.

The key is oil prices

I have been looking at various consensus S&P EPS projections for 2010. Depending on which analyst it is, EPS is going up from $45-55 in CY09 to $60-$70 in CY10. Almost everyone assumes oil prices will be $70-$80 next year, up from $50 this year.

The bull argument for oil is - credit crunch has made new supplies difficult. So when global growth resumes - coupled with the natural field decline each year - the excess oil inventory and supply will be taken care of soon. And, it is a good inflation hedge. 

What was unusual between 2003-2007 was that not only did global growth happen, but it lasted for a long time. For the oil bulls to be correct, not only should global growth occur, but it should continue for some period of time. If growth were instead turn out to be erratic - which is what I think is more likely - productivity improvements and climate change pressures might ensure that the time taken to work off the excess inventory and supplies is more than just a couple of years.  Oil companies and national governments are still doing capex - it is down but not to 0. 

Deflation and Indian FMCG stocks

Buying stocks with pricing power in a deflationary environment - especially when they are priced on deflationary EPS - might be the best hedge against an eventual return of inflation.  

Like a lot of people, I have been trying to figure out the inflation-deflation conundrum. On the one hand, the output gap (capacity utilization in US less than 70%) will suggest producers will find it hard to stick any price increases. On the other hand, if Fed and other central banks keep using this logic to print money ad infinitum, then at some point of time inflation will become a monetary phenomenon. 

Now what I am pretty sure of is that inflation will go up in India and other emerging markets before it goes up in US. Last year, Indian rupee depreciated by 25% and inflation is a staggering 0%. That would have been a very startling outcome for anyone before 2007. In 2008, rupee appreciated by 15%, and inflation was 10%. Now it is the reverse. That tells us how powerful the inflationary surge was in 2007-08, and how powerful a deflationary environment exists today. 

In the next 4 months, we are going to pass through probably the highest deflationary numbers in India. It was from March-April 2008 onwards that the big spikes in oil and other commodities came, so yoy inflation numbers are going to trend negative. A lot of FMCG companies increased prices early last year to take care of the increase in commodity costs. Some of these companies have already reduced prices on some products (paints, soap etc) and others might follow suit in the coming months.

What I have found quite strange in analyst projections is - volume growth and margin expansion is supposed to offset the impact of reduced prices, so that EPS growth in CY09 is same as CY08. That is very unlikely. FMCG, tobacco etc have price elasticity less than one. Companies are better off in a moderately high inflation environment than in a 0% inflation environment. 

Also, last year stockists and dealers were keeping increasingly higher inventories as they expected prices to go up - so last year's volume growth was a bit inflated. That dynamic has likely reversed and will remain so at least for the next few months. 

Indian FMCG stocks trade at very high multiples (Nestle is 30x, HLL is 25x etc). So, a reduction in EPS estimates might hit both on bottomline and multiples. 

So (a) Indian FMCG stocks might see a leg down as EPS growth expectations are revised downwards due to deflation, (b) Indian economy will again see 5% type inflation - probably in the next 12 months itself, (c) FMCG companies have pricing power (d) As inflation comes back, EPS growth expectations will go up, and (e) If Coke USA with 7% long-term EPS growth can command a 13x-14x multiple, then Nestle India with 12%-15% EPS growth can deserve a 20x multiple. 

Now it is possible that companies really deliever on the EPS growth expectaion due to margin expansion. Or that even if they miss, stocks don't fall at all. But if they do, then it might be a very good time to buy some of the FMCG stocks. 

I am assuming that India can grow at 3%-5%.

GS employees to make 25% more this year

Compensation benefits up 18% to $4.7bn, while employee strength down by 7%. Enjoy the benefits of a steeper yield curve and the largesse from AIG. 

Is the company paying dividends on its prefs? Preferred dividends are down qoq - total prefs outstanding are $16.5 bn and dividend paid is only $155 million. In 1 month in Dec 2008, pref dividend payout was $248mn - now that was probably too much.  

A Surreal April

It is playing out like April 2008. From middle March onwards, we get a huge rally. Wells Fargo comes out with huge numbers. Are we going to get a repeat of "Sell in May and Go Away?"

Bottom or Top

Who cares - there are ample opportunities to make money whichever way indices move from here.

 

I think inflation is going to be an issue much faster than what anyone expects. See what the IMF is doing. Politicians are convinced now that printing money is not going to have any side effects. Everyone missed the credit crunch, and everyone is going to miss inflation when it happens.