Update on the WYNN Macau IPO in Hong Kong

WYNN (I own the stock) has just filed an 8-k and amendments to its Hong Kong information package.

The company is now going to float 25% of its Macau operations, up from 20%, and expects to receive proceeds of up to US$1.6 billion rather than the US$1 billion it has previously forecast.

The top end of the pricing range is just over HK$10.   A first-day close of HK$13 or so would mean a market value for Wynn Macau of about US$8 billion, or just about the entire current market capitalization of the parent, WYNN.

Maybe American investors think that Hong Kong valuations of Macau are wildly overoptimistic.  Maybe they think the right price for Wynn operations in Las Vegas is zero (yes, the company may be flirting with breakeven in Nevada, but you’d think there will be a pickup in 2010 or 2011).  It could also be they just haven’t connected the dots yet–and maybe they never will.

It will be interesting to see how events play out.  For what it’s worth, I don’t think the first of these possibilities will turn out to be right.  Our next clue will come when Sinopharm starts trading.

It’s where stocks are going that counts…(ll) an illustration

Monsanto–up 650% from 2004-2007

Background

In 2004, I was managing a number of growth stock portfolios when a broker called me and my co-manager to say one of his firm’s better analysts was beginning to recommend Monsanto (MON).

The story was simple, but powerful.  The “old” Monsanto, a chemicals conglomerate, had broken itself up into three parts:  pharmaceuticals, agricultural chemicals and basic chemicals.  The agricultural chemicals business retained the Monsanto name.

The attraction of the “new” MON was its dominant position in genetically engineered seeds.  This business looked as if it could grow in a number of different directions–new products, new variants of existing products, new geographical areas–at a very rapid rate (20%+ annually) for, say, ten years.  The stock was not well-known.  Its virtues had been obscured while it was part of the bigger entity.  It was also cheap.  And growth investors like us were just beginning to find out about it.  In other words, this was a classic, open-ended, growth stock situation.

MON did have some warts.  The conglomerate’s top management, which went with the pharma business, attempted to insulate itself from potential environmental cleanup claims in the basic chemicals business by structuring the breakup so liability would fall on MON before them.  Also, MON’s main moneymaker, Roundup (glyphosate), had gone off patent and was being attacked by generics.

My colleague and I researched the stock for a couple of weeks–really learning the company would take a year or more of steady work, though–and bought the stock at about $19 a share (I’ve adjusted the price for a subsequent 2/1 split).

MON quickly rose to $22, as more growth stock investors established positions.   At this point, my co-manager, a value investor at heart, decided that we should sell.  Her reasoning was that we had a 16% profit, that the stock was now overvalued, and that we could consider repurchasing it when it fell to $20–as it surely would.

I was strongly opposed to selling, given that I thought the stock could double or triple, so we did nothing.

(By the way, this kind of short-term trading maneuver, which depends on the other guy being the “dumb money” who will allow you to repurchase at a lower price, invariably backfires with growth stocks.  The seller ends up either having to repurchase at a much higher price, or misses out altogether on the bulk of the stock move.

There’s a matter of prioritizing, as well.  All of us, professional or not, only have a limited amount of high-quality thinking time that we can devote to finding and monitoring investments.  I think we should focus that time on what we hope will be big long-term winners, not on trying to exploit short-term market volatility.)

The stock did drop to $21 but then immediately reversed course and rose to $30.  At that point, my co-manager and I had a more emphatic version of the $22 discussion, but we did nothing.

Some months later, MON had risen to $52-$53, as the company announced a steady stream of good operating news.  I had just about convinced myself that as a stock MON had achieved almost all the outperformance it was going to, when I was visited by a health care analyst who was relatively new to our firm.

He was beginning to look into MON, which he considered to be substantially undervalued (remember, the stock had almost tripled in less than two years).  By this time, MON was talking about seeds that would produce plants that would not only resist insects or drought, but would also contain extra amounts of healthy substances, like omega-3 fatty acids.  Relative to drug stocks–other companies with important patents and earnings that don’t ebb and flow with the overall business cycle–MON’s earnings looked really good to him. And, again relative to other health care-related issues, the stock didn’t look expensive.

The new analyst thought MON could reach $70.  I wasn’t convinced, even though I knew the analyst was a careful researcher and had good judgment.  Maybe I was also looking in the rear-view mirror at the profit MON had made for my clients.  In any event, I sold the stock.

If you’re looking at a chart of MON, you know what happened next.  The stock went to $70.  Then, in a market worried about the business cycle–and therefore more favorably disposed to earnings not dependent on it–Congress passed biofuel legislation encouraging farmers to grow more corn.  That’s MON’s main crop.  The stock doubled again, to $140.

Lessons for a growth stock investor Continue reading

It’s where stocks are going that counts, not where they’ve been (l)

It’s not where they’ve been…

It’s easy for anyone, including professional investors, to become paralyzed into inaction by sharp recent price rises, either of the market as a whole or of individual stocks.  Every once in a while, at market tops (in other words, about once every four years), this is the correct stance.  Most of the time, though, it’s not.

Our current situation is a case in point.  The S&P 500 is up 60% from the lows in March.  It’s up 18%, year to date.  Economically sensitive stocks have doubled or tripled off the lows.  Highly financially leveraged firms that seemed on the brink of disaster last winter can be up 5x, or even 10x, from the absolute bottom.  But unless you can somehow go back in time and transact at those prices, the have limited relevance to our investment situation today.

You may regret not having bought, or be patting yourself on the back for having had the courage to act.   Neither emotional state of mind will necessarily help you in your role as an investor, which is to make money from this point on.

(I think it would be instructive, however, to go back and review what pundits were saying about the market at any time from April or May on.  I’m confident that at every point you would find commentators saying the market had gone “too far, too fast,” and was “due for a pullback.”  Their advice?  “Wait for a correction.”  This is what the consensus always says in the early stages of a bull market.  And it’s always wrong.  If you want more information on this topic, look at my posts from March and April.)

The only relevant investment question is “What comes next?”

…it’s where they’re going that counts.

The stock market is a futures market.  The most important questions are always:

what are future profits likely to be–either for the market as a whole, or for sectors or individual stocks you may be looking at?

how much of that is reflected in today’s stock price?

what doesn’t the consensus not yet understand, or what is it not yet looking at?

Where are we now?

I read a research report recently whose summary was, in effect, we’re six months from the bottom and two years from the top.  This conclusion is a variation on the typical four-year inventory/interest rate/election cycle that has been a rough and ready timing tool at least since the Second World War.  The idea is that the stock market goes up for 2 1/2 years, more or less, and then down for 1 1/2.

I don’t whether the precise timing will hold in this cycle, but I do think the spirit of the remark is correct.

We’re way past the panic of March, when investors were convinced (by stunning congressional ineptitude, in my opinion) that Washington lacked the skills to fix the financial crisis.  We now are beginning to get confirmation from other economic indicators of what stocks (a powerful leading indicator themselves) have been telling us for a while–that the recession has just about run its course and that corporate profits are about to rise substantially.

What we haven’t yet begun to do is to make meaningful estimates of what corporate profits are likely to be for 2010 and beyond.  In a way, I think investors as a whole are stuck in the error of looking backward rather than forward.  Perhaps taken aback by the magnitude of the stock market decline, the consensus seems to be unable to imagine the good things that can happen next year and the year after that.  Remember, the S&P would need to rise almost another 50% to reach the last high-water market of 2007.

Who knows whether we’ll reach the 2007 market highs in the US in the current cycle.  On the one hand, it’s hard to imagine the financial stocks, which were such a big part of the market then, playing the same role this time around.  In fact, the previous cycle leaders are most often non-factors for a long while from that point.  On the other, technological and communication innovation is blazing along at a torrid pace.  And, of course, the steep decline we’ve had in the dollar (more to come, I think) make the old highs a less daunting target in local currency terms.

In any event, the economic environment is likely to be supportive for stocks for the next two years or so. I can imagine two main scenarios.  You can probably imagine more (post them as comments, if you like).  Mine are:

1.  plain vanilla The overall market rises 10% per year in 2010 and 2011, which would have the S&P 500 a bit above 1300 by the end of the period.  Overweighting of economically sensitive sectors makes a few percentage points of outperformance possible.  Returns would be much better than those on bonds or cash.

2. late Seventies redux The overall market meanders in a trendless way, making little progress over the next two years.  This general result disguises powerful underlying sectoral movements, both positive and negative, that more or less cancel each other out in the market aggregate.  My guess would be that tech, materials, energy, entertainment all outperform substantially.  Staples utilities, financials are all left behind.  Eventually consumer discretionary joins the positive column.  The net result is that substantial outperformance is possible.  (The key statistic of the second half of the Seventies, in my opinion, is that the smallest 100 by market capitalization of the S&P 500 outperformed the index by at least 25 percentage points each year.)

Sinopharm: the latest Hong Kong IPO; good news for WYNN and LVS

The Hong Kong IPO market is alive and well.  Sinopharm, the largest drug distributor on the mainland, came public yesterday.  The offering, which raised HK$8.73 billion, was almost 600x oversubscribed, according to Bloomberg.  The stock was priced at the top of the range, on a 2010 price earnings multiple of 25x.

I have no opinion about the merits of Sinopharm.  It sounds like a great story and may well turn out to be the superior long-term winner that the market expects it to be.  But 600x oversubscribed means animal spirits are running high in the Hong Kong market and suggests that the timing of the IPOs of the WYNN and LVS Macau casinos couldn’t be much better.

What makes a Hong Kong IPO different; upcoming issues from WYNN and LVS

Generic IPO stuff

Any initial public offering has certain general characteristics:  an offering document, a selling syndicate, an underwriting group (which may, or may not, take ownership of the deal from the issuer),…

Underwriters and potential buyers, usually institutions, do a ritual dance around the topic of making firm indications about how many shares they want to buy.  The underwriters want to figure out what the real demand for the stock is, but they also want to create “buzz” by being able to say early in the offering period that the books are covered (that is, they have firm bids for all the shares being offered) by 3x, 5x or some larger number of times.

Bidders, for their part, often try to get a larger allocation of a “hot” issue by asking for many times the amount of stock they actually want.  In most markets, there’s no cost, other than possibly getting the underwriter annoyed or possibly getting stuck with a gigantic amount of unwanted stock if the IPO flops, for really inflating your order.  In Hong Kong, things are different, though.

How they do it in Hong Kong

In Hong Kong, the traditional rule of thumb is that a new issue is only successful if it goes up 30% or more from the offering price on the first day of trading.  Up less than that, it’s a failure.  Here’s why:

Hong Kong has a very high level of retail interest in IPOs.  And it has an unusual solution to the overbidding problem.  Applicants for IPO stock have to deposit enough funds with the underwriters to pay for all the stock they bid for, not just the amount they expect to be allocated.  In other words, if the IPO is “hot” and 30x oversubscribed, the bidder who wants 1,000 shares of a HK$1.00 stock will ask for 30,000 shares and make a HK$30,000 deposit.

You can put up your own money or have your broker arrange a loan.  Suppose the cost of this is 1% of the amount deposited (interest income from the deposits goes to the company being IPOed).  That amounts to 30% of the value of the stock you stand to receive.  Hence, the 30% rule.

Upcoming gaming IPOs will answer Macau questions for Americans

Two American casino companies, WYNN and LVS, are in the process of IPOing their interests in Macau through offerings in Hong Kong.  The WYNN IPO roadshow is slated to start on September 21st, with listing on October 9th.  The company is proposing to sell a 20% interest in its Macau subsidiary for what the market seems to expect will be US$ 1 billion.  The LVS offering will come later in the year.

It will be very interesting to see how they are received.  Two issues:

1.  Will one IPO get a higher valuation than the other? Both are looking for money to fund expansion in Macau.  But their overall corporate financial conditions are quite different.  LVS, an operator of convention-oriented properties, was caught by the financial crisis in the midst of simultaneous expansions in Las Vegas, Macau and Singapore.  WYNN, although it pressed ahead with completion of the Encore expansion of its Las Vegas Wynn Resort, has charted a much more conservative course.  This is doubtless because Steve Wynn, king of the high-roller market, lost control of his previous company, Mirage, during a prior downturn in the US industry.  It seems to me that LVS wants the IPO proceeds to keep the wolf from the door; WYNN wants to make sure it spends enough on maintenance and upgrades so it doesn’t take on the worn and tired look most of its competitors are beginning to sport.

2.  How will they stack up against the Pacific-based competition?  Arguably, the American companies have a more sophisticated product and experience with operations in a competitive marketplace.  The Macau government, it seems to me, wants WYNN and LVS to succeed and to act as a counterweight to the influence of the local operators.  And the less than pristine reputation of some of the other operators should make it more difficult to lure management talent away from any American gaming company.

On the other hand, the competitive situation can be sticky for everyone in a market where weaker competitors shift from trying to make money to trying to get their capital back out of an unwise investment.  And it’s never been clear to me how much of a reputational discount there is imbedded in the prices of the already-listed Hong Kong gaming stocks.

We’ll know soon!