Sands China (1928:HK): first day trading not so good

Sands China (ticker: 1928) made its debut on the Hong Kong stock market this morning. The stock opened at HK$9.35, but quickly dropped to HK$8.78 before rallying.  It closed at HK$9.32, down 10.1% from the IPO offering price, on volume of about 340 million shares.

Worries about the fate of Dubai World rocked smaller world markets late last week.  That certainly didn’t help Sands China.  But it seems to me that the poor showing is, as much as anything else, a signal that a long string of IPOs in Hong Kong has finally reached the point of draining the market of so much liquidity that all the buyers’ money is going into IPOs, with nothing left to bid stock prices higher.

This is part of the natural evolution of the IPO cycle.  What typically happens from this point on is that the IPO flow gradually diminishes, as issuers realize they can only get their stock sold at prices much lower than they had envisioned.  They decide to wait for a better time, instead.

As to Sands China itself, it’s important to remember that the IPO proceeds of US$2.5 billion, less the underwriters’ fees, go to the seller of the shares, the parent company LVS.  So the IPO itself shows investor commitment to Macau and stabilizes the finances of the parent, but does not provide money for the completion of the Sands China Cotai expansion.

LVS did announce last Friday that the project–which consists of 6,000 room under three hotel brands–Shangri-la, Traders and Sheraton–is fully financed and is being restarted.  Where does the money come from?  US$500 million from LVS, US$600 million from a previously issued Sands China convertible bond, and US$1.75 billion in project financing–US$300 million more than had been committed when the project was originally launched.

What do I think about Sands China and Wynn Macau?  There is considerable local skepticism that the Las Vegas model of upscale resorts with entertainment, fine dining and gaming is transferable to Macau.  If it indeed is, these two companies will be the ultimate winners in this market.

My guess is that the Las Vegas model can take its act on the road.  I also think, admittedly without overwhelming evidence, that the Macau government wants this to happen and will tilt the playing field a bit in Sands China’s and Wynn Macau’s favor to help the process along.  Maybe a better way to say this is that Macau will ensure that the playing field is level even though the two firms are foreign.

Also, one of the peculiarities of capital-intensive industries is that they go through cycles of shortage and glut of productive capacity–in this case, hotel rooms and casino floor space.  In the upcycle, however, I think the firms with state-of-the-art capacity get most of the new business and those with older plant tend to lose market share and begin to gradually fade away.

Another complication with Sands China is the suggestion in its name that the company will open casinos elsewhere in China, Hainan Island, for example, as the LVS chairman has already expressed a desire to.

I think there’s no rush to buy either stock.  But they’re certainly issues to monitor closely to see how new capacity is received in Macau and how/whether market share shifts toward the Americans.   This is a question of timing and price paid.  I’ve already decided that they’re both companies whose stock I’d like to own at some point.  As with their parents, I think Wynn Macau is the more conservative choice–if one can call any casino “conservative” these days–and Sands China the more aggressive one.

Dubai World wants to reschedule debt: what’s going on

The Dubai World situation, as it stands now

On Wednesday, Dubai government-owned conglomerate Dubai World announced it intends to ask creditors to postpone maturities on Dubai World’s debt until at least May 30, 2010.  The heavily debt-laden company intends to use the time to restructure itself.

In the grand scheme of things, where the world financial crisis has already seen trillions of dollars of value erased from global banks’ balance sheets, Dubai World is not much more than a drop in the bucket.  No one seems to know exactly how much the company owes to others, but the largest estimates remain below $100 billion (though not by much).

Why creditors should be worried

There are several disturbing aspects to Dubai World for its creditors:

1.  The announcement comes after repeated assertions by Dubai that the situation was completely under control.  Recently, for example, the government has consistently responded to enquiries about a $3.5 billion sukuk of Dubai World property subsidiary Nakheel that matures in the middle of next month by saying that it would be paid in full when it came due.

2.  The announcement coincided with the start of Eid al-Ahda (a religious holiday commemorating Abraham’s willingness to sacrifice his son Isaac) and the beginning of the UAE national day celebrations, so that no further information will be available for several days.  Whether Dubai intended this or not, it employed a trick often used by poorly-managed, troubled companies, of announcing information just before a weekend or holiday, in order to avoid having to elaborate–and in hopes of “burying” the press story so that no one notices.

3.  Press reports suggest Dubai made the Wednesday announcement before consulting creditors.  If so, that would be most peculiar.  And no banks have come forward that I’m aware of to say everything’s basically ok.

4.   As other financial problems involving sharia-compliant debt over the past year or so have illustrated, there are no established conventions governing their status in restructuring or liquidation.

5.  Ambiguity also extends to bank lending in the Middle East, much of which appears to have been done on a “reputational” basis–that is, because of the borrower’s perceived status or wealth–rather than after careful study of pertinent financial documents.

6.  In addition, in cases of monarchy like Dubai, the line between public money and private money is sometimes blurred.

7.  It’s also unclear how much financial support the United Arab Emirates, the federation of which Dubai is a member, will provide for Dubai overall, and to Dubai World in particular.

What should be worrying the stock markets

Emerging markets contagion?–not so much, especially with oil prices above $70 a barrel.

Serious problems in developed stock markets?  Maybe if this were happening a year ago, but I think that markets will properly size the Dubai problem (i.e., understand it’s small) in short order.

Worries about banks with exposure to Dubai?  Maybe.  For HSBC and Standard Chartered, Dubai exposure appears to be small.  Could Dubai lead to general sukuk fears–and thus to the assumption that any bank with sukuk exposure is a risk?  Could happen, but if so I think this would present a buying opportunity.

Downward pressure on stocks?  Yes, but not for the reasons you might be thinking of.  Big investors in Dubai-related sukuks may find themselves in worsened financial straits if money is not repaid on time–as it appears now it won’t be.  They may have other obligations they can’t now meet without selling other holdings.

Monday’s trading will be more revealing about how much the market’s psyche has been damaged by the Dubai World announcement.  My guess is that it won’t be a particularly big deal–but then again, I’m a growth investor, that is, an inveterate optimist.

Thursday and Friday aren’t telling, since Wall Street was closed for Thanksgiving on Thursday and worked with reduced staffs for Friday’s abbreviated trading.  Even looking at Friday, though, the US market sold off initially, bounced back during the day and sold off again–as one would have expected–before the close.  Short-term traders understandably haven’t wanted to hold net long positions over the weekend.  However, selling didn’t approach the early-day lows, which is a positive sign, to me anyway.  I’d imagined that the market might breach them just before the close and the day at new lows.  That would imply heavier selling on Monday.

See also my update of December 1st.

Jewelry sales: Tiffany’s October quarter

TIF is a truly remarkable company

It’s the only consumer name I can think of that’s been able to bring its brand to cover progressively more down-market without destroying its image.  The iconic Blue Box holds a leading share worldwide in sales of “statement” jewelry items retailing for over $50,000 each.  The typical BB, however, houses a silver pen, a glass pitcher or whatever else the average purchase price of well under a thousand dollars will buy.

For TIF, no one seems to mind.   For almost everyone else who has tried to achieve the same kind of brand extension, no trace, no sign remains of them on the main shopping streets of major cities.

TIF is strong in the US and in Asia, where the fact that it’s an American company is a positive.  The company is making gradual inroads in Europe as well, but there the going has been slower.  There, traditionalists regard TIF as an upstart. They also seem to believe that luxury goods from outside Europe don’t have the sophistication of domestic products.

Third quarter earnings were just about flat, year on year…

after adjusting for unusual items.  At $598.2 million, sales were above the company’s expectations, and down only 3% vs. the year-ago quarter.  Same store sales were down 6%, a much smaller decline than in the first half of the year.  Each month in the quarter was better than the previous one.  This pattern has continued into November.  As a result of the continuing recovery in sales, TIF has raised its full year earnings guidance.

…although they’re not quite as good as they seem.

Pre-tax earnings from operations were down 17% year on year.  The difference between that figure–which is an improvement in operations compared with the first half–and breakeven is the tax rate.  Third-quarter results were taxed at 22% vs. 32% in the year-ago period.

What happened?  The (too) simple, but enough for us, explanation is this:  at the beginning of each year a company estimates what its full-year tax rate will be and applies that to each quarter’s earnings.  During the October quarter TIF got favorable tax rulings that meant the rate would be a few percentage points lower than it had thought.  As it’s supposed to do, TIF made the entire year-t0-date adjustment by lowering the third quarter rate.

A revenue breakout

Americas (mostly US)   $303.5 million    51% of total

Pacific    $225,8 million     38%

Europe    $188.9 million     11%

What the company said

Europe:  overall sales were up 16%, comparable store sales were up 9% (the difference shows how fast TIF has been expanding there).  This was a lot better than expected.  Business is showing sequential improvement.

Pacific:  ex Japan, overall sales were up 18%, comps up 9%.  China, Australia and Singapore are going from strength to strength; Hong Kong, Korea, and Malaysia are improving.

Japan, where the large majority of TIF’s current Asian business is done, continued weak, with no recovery in sight.  Why?  poor economy, national disenchantment with luxury goods, TIF’s brand positioning.

Dragged down by Japan, TIF’s overall Asian sales continue to improve but were up only 2%, and comps down 3%.

Americas: US sales are also improving month by month.  Overall sales were down 9% for the quarter, comps down 10%.  Comps at the flagship store in NYC, helped by tourist spending, were down 8%, about the same experience as all NY-vicinity stores had.  For what it’s worth, CA was relatively soft, FL relatively strong.  Hawaii and Guam, boosted by tourism were up for the quarter.

The greatest revenue declines were at the high end.  This was a decline in number of items purchased, not selling prices.

Catalog and online were up in October.

Improving comps are a function both of improving demand and of the “anniversary-ing” of the financial crisis-induced falloff in sales.  In other words, starting around September, current sales are no longer being matched against strong, pre-crisis results from the prior year.  Last year’s sales are beginning to show crisis-related weakness.

My thoughts:

The regional information confirms what other companies have been saying. That is:

–China is already more or less back to normal.  The rest of the Pacific ex Japan is following suit.

–Japan is weak

–the US is weak, but slowly recovering.

The question I see with the stock–which I owned for years during the Nineties–is that the real bright spots for TIF,  Pacific ex Japan and Europe, together make up less than a quarter of company sales.  Japan, another quarter or so of sales, could be a drag for years to come.  Let’s say these two factors offset one another for the moment (eventually, the positive side will be more important, though).

If so, the investment focus should be on the US.  There’s no doubt in my mind that TIF remains a dominant force in domestic jewelry sales.  The investment issues are:  how fast will demand recover, and, given that the stock is within 20% or so of its high before the financial crisis, how much is already priced into the stock.  My first reaction would be to look for a company outside luxury goods, or one with less exposure to US+ Japan.



It’s hard to stay ahead of a bull market–or so they say

Conventional wisdom among equity portfolio managers is that it’s relatively easy (maybe easier) to get outperformance vs. an index during a bear market than a bull market.

In a down market, the companies that are in the most highly cyclical industries–like manufacturing, construction, property, or consumer durables–and the firms that are the most structurally fragile (operations or finances) get pummeled the worst.  So a very simple strategy–stay away from them–usually works well.  You may lose money, but it will be nothing like what will happen to people in the “bad” areas.

In the typical up market, however, almost everything goes up.  And sometimes the weakest companies go up the most, at least for a while (see my post on the behavior of “near-death experiences” in a bull market).  There are two reasons I can see for this “rising tide” behavior:

1.  when managers of the largest portfolios realize that the worst is over for stocks and a new bull market has begun, their first priority is to work down their cash reserves and become fully invested as fast as possible.  The best way to do this is to buy shares of the most liquid (read: largest capitalization) companies.  You may not be in a first-class seat on the bull market train this way, but at least you won’t be left standing on the platform watching it pull out of the station.  Basically, then, for a while the main stocks in most industries go up.

(An arcane footnote:  Sometimes investors are “trapped” in small cap stocks if liquidity dries up.  There just isn’t enough volume to sell an institutional-sized position.  If you show even, say, 10% of what you own on the market, even if you take precautions to do this slowly and as secretly (that could be an inside joke) as possible, professional traders will soon work out what you’re doing.  They’ll assume (correctly) that you want to sell all you hold, and the stock will crater.  Until the market turns, your best (and probably only) option is to continue to hold.  Anyway, when a bull phase begins, the market in stocks like this will begin to clear.  But their first move may be to go down on high volume as formerly trapped investors finally escape.  This is usually a great chance to buy.)

2.  The market is typically rapidly rotational, both from industry group to industry group and from high-quality to low-quality within industries.

Why is this?  “Don’t chase!!” is one of the first lessons any rookie portfolio manager learns.  Don’t buy stocks that have already had strong upward movements.  What should you do instead?  Reconcile yourself to the fact that you’ve missed the opportunity in a certain area.  Sit down and figure out what is likely to move next and buy that. Don’t help your more astute (at least for now) rival exit from positions whose run of outperformance is almost over.  If all the biggest names in an attractive industry have run already but the smaller haven’t, buy the smaller.  If the most leveraged have run but the less leveraged haven’t…  Again, given a little time almost everything goes up.

Another crosscurrent:  the next step for the managers in paragraph 1. who have succeeded in becoming fully invested is to reshape their portfolios into what they believe is a more advantageous position.  At first, they’ve bought big stocks across the board.  Now, they start to shift some of that money into smaller, harder-to-buy, names.  Their action creates a drag on stocks whose previous good performance has partly been due to their buying and gives a lift to shares they are in the process of purchasing.

For these reasons, the argument goes, a bull market resembles a clearance sale at a department store.  There are few trends, if you can call them that, that persist for more than a couple of months.  This makes it impossible to position a portfolio so that it achieves consistent outperformance.

This time’s an exception

So far in 2009, the S&P 500 is up 25.1%.  Looking at the index sectors, however, shows very clear patterns.  For example:

IT                 +53.2%

Materials  +43.7%

Consumer discretionary    +  34.2%.

On the other hand,

Telecom       -1.1%

Utilities        +1.4%

Staples      +13.7%.

The performance differential has been in the same direction but even to a greater extreme since the market bottom in March.  What I’ve found really striking about this bull market so far is the sharp separation between winning and losing sectors.  The “bad” sectors have been especially bad.  There have been few periods of more than a couple of weeks where they have shown any signs of relative strength.

How can this time be so different?

1.  individual investor behavior.  According to Investment Company Institute (the fund management trade association) data, individuals have made massive new commitments of money to bond funds since the stock market bottom, while taking a neutral/negative stance toward domestic stocks.  This despite record low bond yields.  So it has been bond managers, not stock managers, who have been scrambling to get new inflows of money invested quickly.  Domestic stock managers are more than likely eyeing weak positions as possible sells to meet redemptions.

2.  “pent-up” demand is missing.  US economic upturns have traditionally been led by vigorous consumer spending, even in advance of new job creation.  Outlays have been focused on–although not limited to–housing-related areas, construction and consumer durables.  The current recession has occurred at the end of, and because of worries about further financing of, a period of massive over-buying in all these areas.  The epicenter of the problems has also, unusually, been the US.  As a result, we haven’t seen enough demand for second- and third-tier firms to prosper.  And the lack of consumer power has exposed structural problems in some areas that would go unnoticed in a more upbeat environment.

What do I think?

On a personal level, I’m not too disturbed so far by the US stock market’s break with the patterns of the past, since the stocks and mutual funds I hold have turned out to generally have been in the right places.  On the other hand, it puts me somewhat on edge to realize that we are sailing in uncharted waters, where the maps of history are not of great assistance.

Actually, now that I’ve written it, I recognize that my last sentence is not quite correct.  The US market–world markets, in fact–have been marked over the past 15 years or so by broad conceptual movements that have gone to great excess and then reversed themselves.  There were the internet stocks of the second half of the Nineties, followed by the massive updraft of value issues just after the turn of the century, and then the housing/financial boom.

If there’s a theme to what’s going on now, it’s probably a negative one–safe havens from the US/UK financial meltdown.  I don’t think we’re in anything close to bubble territory, though.

I’m perplexed by the flight to bonds, mostly because rates are so low.  I kind of surprised myself by making my recent argument that WMT, with a current dividend yield higher than a five-year Treasury bond (note?), is a much better alternative than a Treasury security.  Why is no one–other than Warren Buffett, whose portfolios have added large amounts of WMT recently–interested?

While it’s true that during the Lost Decade of the Nineties in Japan, the dividend yield on the Topix index was above the JGB coupon for years and years without any interest in stocks by domestic investors, they all knew that Japanese companies are run for employees, not shareholders, and one bad day in the market could wipe out their yield advantage.  The extensive cost-cutting and continuing layoffs surely show that there’s no comparison between the two situations.

Three useful ideas…

…not just the musings of the section above.

I think that at some time, utilities, telecom staples and health care will have their day in the sun.  But if I had to guess, that won’t be until the Fed begins to raise interest rates late next year.  So there’s no rush.

Sometimes, the market makes a big-concept anticipatory move up or down and then pauses as it waits for events and begins to sort out the wheat from the chaff.  We may be in that second situation now.  If so, the market may do no more than provide a stable platform from which strong-earnings companies launch themselves higher.

In the US, we’re used to being the middle ring of the circus.  This time, it’s more like we’re on the sidelines selling popcorn.  So if we focus only on the internal domestic economic situation, we may not be able to see the important forces of global economic growth emanating from abroad.

 

 

DELL (II): a company in transition

In its heyday, DELL, as now, assembled and sold desktops and laptops, primarily to business and government but also to consumers.  The desktops were utilitarian, the laptops not particularly stylish and a bit heavier than others.  But all DELL’s products were serviceable and they were cheap.

DELL’s advantages…

DELL had several advantages over its competition:

1.  it dealt directly with the end consumer, assembling machines to order.  So it had virtually no finished goods inventory

2.  component manufacturers suffered from chronic overcapacity.  So their prices were generally falling.  DELL took delivery of parts on the day a machine was assembled and sold, rather than having a finished machine sitting on a shelf for three months before purchase.  This gave the company a several percentage point cost of goods advantage over rivals.

3.  competitors were weak.  IBM wasn’t sending its best and brightest to make PCs.   A Jobs-less AAPL was drifting.  Compaq was very inefficient, as was HP.  HP then compounded its problems by hiring Carly Fiorina–a marketer with little manufacturing experience–and acquiring Compaq.

4.  DELL uses a negative working capital business model.  That is, customers pay for their DELL computers at present on average 36 days earlier than DELL pays its suppliers and workers for making the machines.  Also, DELL receives payment for warranty or other service contracts in advance.  When short-term interest rates were higher than now, DELL could earn hundreds of millions of dollars in interest income on these “floating” balances.

..where did they all go?

What happened is this:

1.  component making became more sophisticated and expensive.  Suppliers consolidated or dropped out of the business.  Chronic overcapacity abated.  We now appear to be entering, if anything, a period of component shortage.

2.  IBM sold its PC-making business to Lenovo.  Jobs returned to AAPL.  Fiorina was shown the door at HPQ, which promptly hired a veteran manufacturing manager, Mark Hurd, from NCR.  Acer and ASUS emerged as global players in the PC market with low-cost netbooks.

3.  Consumer tastes shifted from heavy and clunky to smartphones, netboooks and sleeker Macs.  DELL didn’t adjust, although it’s trying to do so now.

4.  Vista arrived, causing consumer disenchantment with MSFT-driven computers and encouraging businesses to stay with Windows XP.

5.  The Great Recession developed.  Not only did this reduce demand, but it lowered short-term interest rates to almost nothing, all but erasing DELL’s once significant interest income.

Not all the issues were external, however.

6.  DELL’s quality control and customer service, at least in its consumer business, slipped badly.

Where to from here?

Michael Dell, the company founder, returned to the helm to right a troubled ship in early 2007.

His initial goals were to reduce manufacturing costs and increase production efficiency, in order to raise margins and reverse a sharp slippage in the effectiveness of the company’s negative working capital model.

DELL has also been trying to rationalize product lines (fewer models) and simplify product design.  To this end, it is increasingly turning away from its own manufacturing plants and using contract manufacturers.

I’ve read that Mr. Dell also at least initially wanted to expand the company’s consumer device offerings.  But I can see no specific evidence of this desire in company documents on the website.  And in any event, it seems to me that this market–which is now iPhone, iTouch, Blackberry, Android, netbook–has pretty much run away from DELL.

(By the way, I’ve found the company website much more open and accessible than it was a few years ago, when it was impossible, even as a professional investor, to arrange to get on the company’s email alert list.  The new reporting format this year is also a big step up in delivering relevant investor data.)

International expansion is another theme.

So to is creation of a much larger service business, so that DELL can have more recurring revenue and be less dependent on the PC replacement cycle with large enterprises and government entities.  Hence, the $4 billion (cash) Perot Systems acquisition, which has just closed.

A tough row to hoe

To sum up:   DELL appears to have decided to  start down the same path that IBM began to tread in the late Nineties and onto which HPQ turned two years or so ago.  This seems to be the natural evolution of the IT business–from hardware to software and services.  Two big issues for DELL:   it’s a little late to the game, and the competition is not only ahead of it in this move, but also much less concentrated than DELL is on enterprise and government PCs and servers (about 80% of the company’s business).

Progress so far is hard to assess

This is partly due to the recession itself, partly to DELL having to try to restructure the corporate house during an economic tornado.   I’m not sure how the reorganization is faring, but then I’m not an expert on DELL.  But I didn’t get the sense from listening to last week’s conference call that professional Wall Street tech analysts have a much better idea than I do.  So maybe lack of communication from DELL also plays a part.

Do we as investors need to know?…probably not.

In a case like this, the relevant investment question is:  do I need to know this information, or can I make a decision about the stock without it?  Here, my guess is it’s unlikely that we’ll get strong earnings acceleration from ongoing cost-cutting.   If anything, we may get further unusual losses.  So restructuring is probably a neutral or a mild negative.

Things probably can’t get any worse in the consumer business, since results are close to zero now and DELL seems determined to protect margins at the expense of incremental sales.  Public will go its own counter-cyclical way.   Half of small and medium business customers have already upgraded to Windows 7.

Therefore, the next big potential lift to earnings, I think, will come as and when enterprise customers start to buy new PCs again.  This is unlikely to happen before yearend–and possibly not before the middle of next year.  So my conclusion on DELL  is the best course of action is to watch and wait.

One more post

I have one more post to do on DELL–an analysis of its negative working capital situation and what constraints it potentially places on the company.  It will be out in the next day or two.

The Sands China IPO has priced–at the low end of the range

The Macau subsidiary of LVS, Sands China Ltd., priced today in Hong Kong.  The good news is that the IPO was fully subscribed.  The less good news was that it priced at the bottom of the range.

The “low” pricing, at 13.5x anticipated earnings for next year, is understandable, for two reasons:

–the high end would have Sands China trading at a substantial p/e premium to Wynn Macau, which is, I think, a better-run company, and

–Wynn Macau itself is trading at about 20% below its October 9th high, and almost 10% below its IPO price.

Trading for Sands China starts on November 30th.

Here’s a link to my original Sands China post.