Category Archives: economics

Graff Diamonds yanks its proposed Hong Kong IPO

May 30, 2012 By in China, Gold, Hong Kong, Industry Analysis, Luxury goods, Retail, Stock ideas Tags: , , , , , , , , Leave a comment

fuses blown

Bad day in New Jersey.  Yesterday was the first super-hot day of the late spring, with temperatures approaching 100 degrees Fahrenheit.  Creaking power infrastructure reacted in the way we’re unfortunately becoming accustomed to.  It collapsed.  No power for most of our neighbors, no internet or cable TV for us.  Hence the late post.

Graff

According to Bloomberg, the plug was pulled on the Graff Diamonds offering less than two days before the stock was supposed to debut.

I can’t say I was shocked, for several reasons:

–Hong Kong has been pummelled especially badly by selling emanating out of the EU, where another flight to safety by equity investors is in full flower.  It looks almost like last summer.  (Where did they get all the stock?)

–Chow Tai Fook Jewellery (HK: 1929) came public late last year and is now trading at about 2/3rds of the IPO price.  True, 1929 sells mainly chuk kam pure gold jewelry and knickknacks, not diamonds.  But the market is the same–China.

–TIF, whose main problems appear to me to be in the US, nevertheless also reported a deceleration in its China business last quarter.

–I suspect that retail investors in Hong Kong–always important in that market–were especially badly burned by the Facebook IPO.  IF US retail investors got 5x-10x what they expected, Hong Kongers could have gotten double that size.  Hong Kong is a market of veteran stock market participants, so they’ll shrug off their bad treatment by underwriters quickly.  But if I’m correct, they’re still licking their wounds.

–I haven’t tried to locate a copy of the Graff Diamonds prospectus.  My experience is that in Hong Kong these documents weigh a ton, but don’t contain anything like that amount of information.  Besides, they’re not supposed to be available in the US until after the offering.  Media reports do bring up two potentially worrying issues, however.

Apparently, a mere 20 customers make up 50% of revenues.

A large chunk of the IPO proceeds were said to be earmarked for buying diamond inventory from the company’s founding family.  I’d want to know how this inventory is being valued–and how many months’ (years?) sales this represents.  I’d also want to know how the acquisition of the gigantic gems Graff is famous for will proceed from now on.  Does the Graff family act as exclusive agent for the company?  …is the family paid a commission for acquisition?

a paucity of demand

When the IPO was pulled, the underwriters had orders for only half the shares intended to be offered by the company.  In a healthy offering the books would be, say, 5x covered.  A “hot” offering might have books 10x covered.  In Hong Kong, which operates under different rules than the US, 100x isn’t unknown.

my thoughts

In the current economic environment, Graff Diamonds was always going to be a tough sell, especially with the family wanting 25x earnings for its shares.  I think FB did much more to suck the life out of this offering than most brokers would be willing to admit, however.

“What Workers Lose by Staying Put,” Enrico Moretti in the Wall Street Journal

May 29, 2012 By in economics, employment Tags: , , , , , , , , 2 Comments

The New Geography of Jobs

“What Workers Lose…” is an article in the Weekend Edition of the WSJ, adapted from Dr. Moretti’s recent book (which I haven’t read) The New Geography of Jobs.  Dr. Moretti was born and grew up in Italy, but now teaches economics at Cal Berkeley.

The thrust of the article is that Americans are unusually mobile in search of work, in contrast with Continental Europeans, who seldom stray from their birthplace.  Dr. Moretti believes that this flexibility is an economic virtue–not necessarily a surprise, given his own career.

His observation is interesting because it runs so counter to the views of prominent 20th century European literary and social critics, who look on American willingness to move as evidence that we’re rootless, soulless wanderers who have no sense of belonging.  Even worse, we eat at McDonalds, vacation at Disneyland and use disposable pens!  That’s all evidence, in their minds, that we’re an inferior brand of humanity–which, by the way, finds its highest and purest expression in the stay-at-home residents of whatever their native country is (read: themselves).

More important from a stock market point of view, the article sheds some light on the problem of the current high level of unemployment in the US.  And it offers a policy prescription for helping to alleviate it.

cyclical or structural?

The key unemployment issue, to my mind, is whether the current high level is

–a cyclical phenomenon, that is, a function of the slow economic rebound from the Great Recession, or

–a structural one, meaning that the unemployed don’t have the skills needed to qualify for jobs in today’s world.  If so, unemployment won’t just go away.

White House and Capitol Hill vs. the Fed

Politicians in Washington seem to adhere to the former view, which, conveniently for them, means that no legislative action is needed.  Time, patience and continuing low interest rates will solve the problem.  The Fed is in the latter camp (where, for what it’s worth, I am, too).  Structural unemployment requires retraining programs, plus continuing unemployment benefits until workers gain skills needed to compete successfully in the job market.

JOLT
The Fed points to the Labor Department’s Job Openings and Labor Turnover (JOLT) studies.  The latest report, from the end of March, shows the private sector has 3.7 million+ unfilled job openings.  Washington replies that workers are trapped in their home towns by houses the can’t sell because the mortgage exceeds the house value.

What does Dr. Moretti bring to the discussion?

He says:

–”willingness to relocate is a large factor in American prosperity”

–”the financial return for geographical mobility keeps increasing”

–the willingness to move is very strongly related to education level.  45% of college graduates will likely move to find better jobs before they’re 30 years old, vs. 17% of high school dropouts.  Dr. Moretti cites research by Prof. Abigail Wozniak of Notre Dame who says education explains most of the willingness to move.

Why the huge difference?

The less educated:

–have less information about the possibility of good work elsewhere

–may lack the skills needed in high-paying jobs

–don’t have the savings needed to finance the trip and support themselves while they look for a job.

Example:  the Motor City, 2009

Dr. Moretti cites the example of Detroit in 2009. Unemployment there was 18%.  Unemployment in Iowa City, 500 miles away, was 4.5%–basically meaning Iowa City firms were crying for workers of all stripes.  But high school dropouts in Detroit didn’t budge.

a policy recommendation

Dr. Moretti suggests that in high unemployment areas government unemployment benefits include vouchers that cover part of the expense of moving to find work.  This doesn’t address the lack-of-marketable-skills problem, but it does address the lack-of-cash one.  Such a program–already being implemented in a small way for workers whose firms have been hurt by foreign competition–would have two benefits.

It would help shift workers who were willing to move to places where they could find work.  And, by starting to drain the pool of unemployed in high unemployment areas, it would make the job search there somewhat easier.

two kinds of structural

All of the commentary–at least all that I’ve seen–about structural unemployment is concentrated on the long-term issue that many young men leave the US school system unequipped to compete for the best-paying jobs.  They’re prime candidates to be chronically unemployed.

Dr. Moretti’s insight is that while we can’t educate these men overnight, we can make them more mobile with the stroke of a pen.  We may also find that removing the structural rigidity of no-money/no-information does much more to relieve unemployment than we might imagine.

capital flight and brain drain (II): Greece

May 22, 2012 By in capital flight/brain drain, economics Tags: , , , , , , , Leave a comment

what would Greek exit from the Eurozone look like?

I mean what happens in general terms, not the nitty-gritty details of how a sovereign debt default and currency devaluation would be put into place.

Several things would occur, I think:

1.  Greece would stop making principal and interest payments on its sovereign debt and open negotiations with creditors for new, more favorable, terms.

2.  The country would force conversion of all cash held by Greek citizens or Greek companies into a new currency–call it the drachma.

3.  Greece would prevent reconversion of drachmas into foreign currency.  It might ban citizens from holding foreign currency outright, for example.  It would certainly make it illegal for anyone to transport foreign currency in and (especially) out of the country.

4.  It might institute a crawling peg (a specified daily weakening of the exchange rate) or some other mechanism for continuing devaluation of the drachma vs. the €.

how would Greek citizens react?

This default/devaluation path is well-defined.  Look at Mexico in the early 1980s as an instance.  Knowing the roadmap far in advance, what can Greek citizens do to defend themselves against loss of wealth?  Again, the moves are pretty standard:

–move cash holdings to a bank outside of Greece

–raise cash locally–either by selling assets or by borrowing from a local bank (in the hope that your debt will subsequently be devalued)–and move that out of the country, too

–emigrate.

Businesses would presumably be thinking of similar measures.  In addition, they would likely begin to drag their feet on paying for stuff bought from Greece, while accelerating payment deadlines for Greek customers.

what about investors?

They do pretty much the same.  They extract cash.  They stop making new investments.  Yes, they study what they might like to buy once devaluation occurs, but otherwise they sit on their hands.

taking a very long time…

…makes the situation worse.  While uncertainty remains high, an increasing number of citizens are likely to make and execute capital flight plans.  And the flow of new investment in the country drops to a trickle.  So the country sits in neutral and idles.

effects on the rest of the EU?

I perceive a sharp difference between the local reaction to debt problems in Italy and Spain, on the one hand, and Greece, on the other.

I think the former two have made it clear they accept responsibility for their weak economic situation and are taking action to fix their problems as quickly as they can.  In contrast, Greece seems to me to believe that its sovereign debt is basically an EU problem.  Its strategy appears to be to implement no reforms and instead bargain for ever better terms.

If that’s an accurate representation, one could argue that the contagion effects–the adverse impact on Spanish and Italian bond markets–of Greece leaving the Eurozone (and, presumably the EU) shouldn’t be severe.

In an investment world dominated by short-term chart-oriented traders, however, I don’t have a lot of confidence other investors will see things my way.  I certainly wouldn’t want to bet the farm that I’m right.

capital flight and “brain drain” (I): what they are

May 21, 2012 By in capital flight/brain drain Tags: , , , , Leave a comment

a Guatemalan airline

I got my first practical exposure to the phenomenon of capital flight when I started to work on Wall Street.  It came from a creative colleague at work who gave me a prospectus to read for a bond issue from a Central American airline.  Kind of like a puzzle, he asked me what I thought was unusual.

I had no idea what was going on…

…until he pointed out four things:

–the company was family-owned,

–it bought planes outright rather than leasing them (a much more expensive way of operating),

–it would sell perfectly serviceable planes when they were two or three years old and replace them with brand-new ones, plowing all the firm’s cash flow into this effort (again, very inefficient), and

–the planesalwaysspent the night in foreign airports, mostly in the US.

On the surface, this behavior seems crazy.

But think about it.  Most of the family wealth was tied up in the planes; they spent most of their time outside the country.

Perfect in case of a sharp change in the political winds.  And not obvious enough a move to catch the sitting government’s eye.

The airline was the family’s vehicle for capital flight (no puns intended).

two sides of one coin

“Brain drain” is the term coined in the UK for emigration of its highly skilled and educated citizens to the US after World War II.  It has become synonymous with the flight of human capital in general.

The term “capital flight” typically refers to the flight of financial capital.

why does capital flee a country?

Three main reasons:

–political repression, actual or feared

–limited economic prospects in the home country

–high taxes, either on current earnings or on accumulated wealth.

examples

politics

In the early 1980s, China announced it would not renew the UK lease on Hong Kong.  Therefore, the colony would revert to Chinese rule in 1997.  The UK then said it would not grant citizenship to anyone in Hong Kong (because they wouldn’t like the harsh UK climate).  So Hong Kong citizens began to look for other places in the Commonwealth to obtain passports and shift their wealth.

economic prospects

Emigration from Europe to the US post-WWII is a prime example of this phenomenon.  New Zealand or the Australia of twenty years ago might be others.

taxes

There has been a steady flow of people out of high-tax states in the US like California and New Jersey into neighboring areas like Nevada and Pennsylvania, where levies are lower. For decades, Ireland has attracted multinational corporations by offering very low tax rates.  One of the planks in the electoral platform of Mr. Hollande, the new head of government in France, was to raise income taxes on yearly earnings of over €1 million to 75%.  Reportedly, real estate agents in the UK have seen a surge in interest in London residences from French buyers.

fighting capital flight:  closing the borders

Generally speaking, there are two ways to stop capital flight/brain drain:  fix the problems that are causing the flight, or forcibly prevent capital from leaving.

Practically speaking, then, there’s only one way–closing the borders.

For financial capital, a government does this by limiting the amount of foreign currency a holder of the domestic currency can buy, or the amount of local currency he can transport out of the country.

For human capital, a country can restrict the ability of citizens, or their families, to leave.  In addition, a potential emigrant has to have someplace to emigrate to, which can make this issue a lot more complicated.

Tomorrow:  the situation in Greece.

 

 

 

 

 

a quick look at DIS

May 15, 2012 By in earnings conference calls, economics, Stock ideas, Strategy Tags: , , , , , Leave a comment

a little history

I became reacquainted with DIS in late 2009 when the company bid for Marvel Entertainment, which I had been a shareholder of for a couple of years.  Several things struck me about DIS that made the investment case more compelling than I expected:

1.  A new chairman, Bob Iger, was steadily reenergizing a company that had suffered for years under complacent and bureaucratic management, as happens with many mature firms.

2.  Although the price being paid, $4 billion, seemed pretty full to me, I knew Marvel would benefit from DIS’s stronger distribution.  And I also saw that Mr. Iger wanted to build the attractiveness of the Disney brand to boys, so Marvel had an “extra” value to DIS.

3.  The theme parks were suffering from the Great Recession.  I thought results would gradually improve as the economy recovered, first through an increase in foreign tourists, then through a return of US vacationers.

4.  Wall Street didn’t like the Marvel deal, which made DIS even cheaper.  So I bought some more.

I ended up selling most of my DIS stock about a year ago, soon after it popped above $40 a share.  Two reasons:  the stock was up a lot, and I worried that possible strikes by the NFL and/or NBA players would dent the profits of ESPN, which is DIS’s dominant business.

I’ve still kept my eye on DIS, which has been a market outperformer even after my sale.  The media reports of strong theme park business in 2Q12 (ended March 31st) when the company reported results last week caught my eye.  So I thought I’d take a closer look.

Here’s what I found.

DIS’s 2Q12 results

Excluding unusual items, earning per share were up 18% year on year, at $.58 vs. $.49 in 2Q11.

parks and resorts

Disney cruise line bookings were up 30% yoy.

Domestic theme park attendance was up 7% yoy, with spending per person up 5% in addition.

Occupancy in park hotels was up 2% yoy at 82%.  Room rates were up by about 5% as well.

Disneyland set a new 2Q attendance record.

The strength in the domestic theme park business comes from two sources:

–foreign tourists, especially from Latin America and Asia, and

–reviving interest from in-state residents in California and Florida.

Out of state domestic visitation to the parks was about flat, yoy.

Operating income from the worldwide Parks and Resorts business was up 53% yoy at $222 million.  The comparison is skewed by the closing of Tokyo Disneyland last year after the mid-March nuclear reactor accident in Japan, combined with a $15 million business interruption insurance payment made in the current quarter.  Ex these factors, the theme park business was probably up a bit over 20%.

To me, the most encouraging news is that residents of two of the areas hardest hit by the domestic housing crisis–southern California and Florida–are starting to come back to the Disney parks.

studio entertainment

Currently, this business is a tale of two movies.  John Carter, which may have made a $100 million loss, is certainly the main reason Studio Entertainment operating results dipped into the red by $84 million in 2Q12.  The other is The Avengers, which reportedly cost $220 million to make but which has had box office of over $1 billion in the first three weeks.  So 3Q12′s results in this segment will doubtless be eye-popping.

consumer products

Avengers-related merchandise sales are going much better than DIS had planned for.  A change of actors appears to have even breathed back life into the Hulk.

media networks

This segment is two-thirds of DIS’s operating income and is driven mostly by ESPN.  Changes in affiliate contracts and the differences in  timing/number of sporting events make year-on-year comparisons particularly hard for an outsider to interpret.  The reported you gain in operating income is 13%.  DIS says an apples-to-apples comparison would be more like half of that.

my thoughts

I find the implications for the US economy in DIS’s results to be encouraging–and consistent with what other companies who appeal to a broad range of Americans are saying.

DIS shares aren’t expensive.  They’re trading at 15x the Wall Street earnings consensus of $3.00 a share for fiscal 2012.  Trend growth is probably around 15% a year.  My guess is that they’ll be mild outperformers over the year ahead, with their best relative showing coming in uncertain days like these.

 


 

 

Follow

Get every new post delivered to your Inbox.

Join 100 other followers