Monthly Archives: March 2011

a look at Tokyo Electric Power (TEPCO), JP: 9501

March 31, 2011 By in Asian economic development, economics, Industry Analysis, Japanese development, Utilities Tags: , , , , , , 2 Comments

“9501” says a lot

Unlike systems using letters to form ticker symbols for stocks employed in many Western markets, Japan has four-digit numbers that identify the stocks traded in that country.

The initial number indicates a company’s sector.  The 9000 companies are in the Service sector.

The second number is the firm’s subsector or industry.  The 9500 companies are Utilities.

The third and fourth numbers form a pair.  Firms are ranked in order of their importance in the industry (or at least their importance when the code numbers were initially given out), with “01” at the top.

So 9501 is the designator for the biggest and most important utility in Japan.  That’s TEPCO.

Foreign investors coming to Tokyo (other than those from Korea or Taiwan, which have similar number codes) might scratch their heads at Japanese ticker symbols.  But does a system where stocks can be designated “HOG” or “LUV” have a right to criticize?

As recently as the 1980s, the power of the “01” was immense.  Industry leading firms were magnets for the most talented university graduates.   The stock market invariably awarded the industry “01” the highest price-earnings multiple, regardless of relative growth rate or asset value, making it easier for these companies to raise equity capital if need be.

post-earthquake

I can’t imagine ever buying TEPCO again (I held tons of Japanese utility stocks in the late 1980s—that’s another story, though, having to do with a since changed electricity price setting mechanism).  So I haven’t done–and have no intention to do–the work I’d need to give an investment opinion.  What follows are observations rather than analysis:

1.  Japanese stocks are subject to maximum daily fluctuation limits, both up and down (don’t ask what the rules are).  The idea is that this gives panicky investors time to get their emotions under control so they don’t sell at crazy-low prices.  In my experience, however, wherever they’re in force the limits have the opposite effect.  There’s nothing like a day or two where your stock goes limit down with no trade–and all you can do is watch–to bring panic to never before experienced heights.  TEPCO had three such days in a row.  So the stock lost two-thirds of its value before anyone had a chance to get out.

2.  It’s not clear to me that TEPCO would be able to raise new capital from non-government sources if it operated in a market like the US.  But it doesn’t.  It’s possible that the Japanese government will pressure banks and insurance companies to provide funds.

3.  TEPCO is part of the industrial grouping (or keiretsu–another long story) led by the Mizuho Bank.  Group companies may feel a special obligation to lend support.

4.  There have been rumors that the Japanese government itself will make a large capital injection.  Since regulatory negligence seems to have been a contributing factor to the nuclear reactor disaster, this makes sense to me.  Certainly, the country has to replace the lost electric power somehow.

5.  The CEO of TEPCO has reportedly been hospitalized, suffering from a number of maladies.  It’s possible that Mr. Shimizu actually is sick.  But a company-announced hospital stay is also a ritual Japanese way for firms to sack unwanted executives.  The disappearance in January 2010 of Hirohisa Fujii as finance minister in the current administration after losing a power struggle to Ichiro Ozawa is a very recent example.

I think we’ll find that this “hospitalization” is the first step in a reorganization of TEPCO’s operations.  Interested investors should watch to see who’s appointed.

Are Chinese walls around bank credit analysts porous?–Yes, say Profs.Ting Chen and Xiumin Martin

March 30, 2011 By in Banks, Industry Analysis, securities markets, Securities regulation, stock market Tags: , , , , Leave a comment

the authors

Ting Chen is a professor at Baruch College, City University of New York.  Xiumin Martin is a professor at the Olin Business School, Washington University of St. Louis. Together, they authored an extremely well-done article entitled “Do Bank-Affiliated Analysts Benefit from Lending Relationships?”, published in the February issue of the Journal of Accounting Research. (Thanks to Neil Schoenherr of the Olin School’s Office of Public Affairs for providing me with a copy.)

the study

The Chen/Martin paper analyzes what happens when a company makes an initial loan from a banking conglomerate that also has a brokerage arm. In theory, the bank’s credit analysis department keeps all loan-related information confidential—even from other parts of the bank.  The Chen/Martin conclusion is that in practice this doesn’t happen at all. Instead, their evidence strongly suggests that this confidential information ends up  in the hands of the equity securities analysts who cover the borrowing companies for the bank’s affiliated brokerage houses. It also makes its way into their published equity research.

conclusions

The main takeaways from the article are:

    • The accuracy of earnings estimates by bank-affiliated equity securities analysts of a company that is a bank loan customer improve significantly after the company takes out its first loan with the bank.
    • The increase in accuracy is greater if the company is small and information about it is not easily available.
    • Estimates also become better when the company is likely to report bad news, when it’s considered a high credit risk, or when the bank insists on covenants in the loan.  All these areas are, of course, ones that credit analysts would zero in on. In addition to this, however, covenants are of particular note.  They’re restrictions on company activity that the borrower agrees to have written into the loan documents—like that it will maintain a certain minimum level of working capital. What makes them important here is that the borrower must submit periodic financial reports demonstrating that it is not in violation of any. This gives the bank’s credit department a continuing stream of fresh financial and operating data about the borrower.
    • In the case where the loan comes from a syndicate of several banks, the improvement in earnings estimates only shows up with securities analysts employed by the lead arranger, that is, the bank that does the credit analysis and gets the covenant reports.
      • A somewhat wider statement—the improvement in earnings estimate accuracy shows up only with the bank-affiliated analyst, none of his competitors.  This suggests that the impetus for this improvement doesn’t come from publicly available information.
        • Also, the increase in earnings forecasting accuracy for the bank-affiliated analyst applies only to his estimates for the company borrowing from his bank, not the rest of his coverage in the same industry. Here, I think the authors want to establish that the source of the analyst’s inspiration is not some industry-wide development or information gleaned from another company in coverage. How so?  …because there’s no evidence of such insights in his analysis of other companies.  The result can be read in another way, however.  To me, it’s very striking that the analyst doesn’t learn from the information.  It’s even possible that the analyst doesn’t really know why his new-found information is correct, but rather only that it is.  …Hmm.

          earlier work in the same vein

          As the authors point out, this study follows on earlier academic work that suggests that information gathered by credit analysts makes its way into:

          –trading in credit default swaps,

          –the positioning of bank-affiliated mutual fund complexes, and

          –the merger and acquisition section of the bank’s investment banking arm.

          Why don’t borrowers complain?

          One possibility is that, until this article at least, affected companies didn’t realize what has been going on. As the authors suggest, the companies may feel any allegations of illegal activity would be hard to prove.  And, of course, the company may actually benefit, through a higher stock price, from the securities analysts efforts to publicize it. Or they might regard the information leakage as one more cost of getting a loan, something that’s part of the price of entry.

          Where’s the SEC?

          Due to “lack of staff,” this kind of thing is a potential violation that the agency “rarely” looks at.

          my thoughts

          I have two:

          –this is an unusually well thought out and persuasive analysis. 

          –welcome to the real world.

          4Q10 TV numbers from SNL Kagan: better than 3Q10, but not good

          March 29, 2011 By in Current Market Thoughts, Entertainment, Industry Analysis, internet, Technology, Utilities Tags: , , , , , , , Leave a comment

          4Q10 TV subscriber numbers

          The June 2010 and September 2010 quarters were tough to take for the cable, telco and satellite TV industry, which lost a total of 335,000 net subscribers over the six months.

          A complex set of interacting factors produced this result:

          1. The stock market’s biggest worry is that some—mostly younger—viewers are unplugging from traditional cable/satellite and substituting a basket of (cooler, but also cheaper) streaming services like Netflix and Hulu instead. That certainly is happening, but the extent isn’t clear.
          2. Recession has caused some viewers to cancel service to save money.
          3. For some years, cable companies have steadily been losing market share to telco-offered TV services at cheaper, introductory rates. A portion of these switchers subsequently cancel service at the end of the first year, as the telco rates revert to higher prices.
          4. Some over-the-air viewers shifted to cable/telco/satellite as the US made the switch from analog to digital TV broadcasting in the June quarter of 2009. A percentage of these viewers have figured out that they can get the reception they want (actually often a better picture) using an over-the-air digital antenna. They are switching back to over-the-air viewing as their cable/satellite contracts run out.

          The December quarter was a bit better. According to industry guru SNL Kagan, cable+satellite+telco added 65,000 net new subscribers over the three months. That compares with losses of 119,000 and 216,000 subs during the prior two quarters. Two reasons for the better numbers: the economy is improving; most people who adopted cable as a temporary measure while they figured out digital have already cancelled service, so this headwind is abating.

          Not everything is rosy, though. Traditional cable subscribership continues shrink at a steady, and possibly accelerating, pace. The figure of 526,000 subscribers lost during the December quarter only looks good against the much greater defections seen during the middle of the year. For 2010 as a whole, cable lost 2.2+ million subs and has dipped under 60 million viewers.

          Also, according to SNL Kagan, the number of occupied housing units rose at a faster rate during the period than the number signing up for cable/satellite. In other words, a decreasing proportion of people establishing new residences signed up for these video services.

          Will cable lower prices to retain customers? I doubt it. For one thing, it’s a matter of conjecture whether, say, a 10% across the board price cut would persuade anyone to stay with cable. However, such a measure would definitely mean a 10% loss of revenue—and perhaps double that percentage as a loss of profit.

          Fighting the net neutrality battle is a better way to go. Ironically, it’s the cable companies’ provision of high-speed internet service that allows people to unplug from cable video offerings. If cutting prices is too risky, the logical route for the cable firms to follow to combat unplugging is to attempt to impede their streaming rivals’ access to the bandwidth they need to deliver their services, or charge them a lot for it. Streaming services, in their turn, should argue that the cable firms are quasi-monopolies who have a social obligation to allow equally high-speed access to all for a nominal fee. This battle will ultimately be decided in Washington.

          My thoughts

          I believe we’re only in the early adopter phase of a switch from traditional cable to streaming services. I understand that special factors may have led to large net losses of video service subscribers in the middle of last year. But I don’t take any particular encouragement from the “rebound” of the December quarter.

          On the other hand, I remember thinking during the ATT breakup of the early 1980s that the regional Bells would not be able to survive for long. If someone had told me then that they would only be reaching the end of the profit road for their basic fixed-line business thirty years later, I would have thought they very crazy. Yet, the fixed-line business has fought a successful war of attrition for that long. And the Baby Bells have been done in, not by lower-cost fixed-line rivals, but by wireless, a new technological development. Although I’m inclined to look longer and harder at the streaming services providers, my guess is that value investors will find the cable firms to be fertile fields for investing for decades to come.

          The June 2010 and September 2010 quarters were tough to take for the cable, telco and satellite TV industry, which lost a total of 335,000 net subscribers over the six months.

          A complex set of interacting factors produced this result:

          1. The stock market’s biggest worry is that some—mostly younger—viewers are unplugging from traditional cable/satellite and substituting a basket of (cooler, but also cheaper) streaming services like Netflix and Hulu instead. That certainly is happening, but the extent isn’t clear.
          2. Recession has caused some viewers to cancel service to save money.
          3. For some years, cable companies have steadily been losing market share to telco-offered TV services at cheaper, introductory rates. A portion of these switchers subsequently cancel service at the end of the first year, as the telco rates revert to higher prices.
          4. Some over-the-air viewers shifted to cable/telco/satellite as the US made the switch from analog to digital TV broadcasting in the June quarter of 2009. A percentage of these viewers have figured out that they can get the reception they want (actually often a better picture) using an over-the-air digital antenna. They are switching back to over-the-air viewing as their cable/satellite contracts run out.

          The December quarter was a bit better. According to industry guru SNL Kagan, cable+satellite+telco added 65,000 net new subscribers over the three months. That compares with losses of 119,000 and 216,000 subs during the prior two quarters. Two reasons for the better numbers: the economy is improving; most people who adopted cable as a temporary measure while they figured out digital have already cancelled service, so this headwind is abating.

          Not everything is rosy, though. Traditional cable subscribership continues shrink at a steady, and possibly accelerating, pace. The figure of 526,000 subscribers lost during the December quarter only looks good against the much greater defections seen during the middle of the year. For 2010 as a whole, cable lost 2.2+ million subs and has dipped under 60 million viewers.

          Also, according to SNL Kagan, the number of occupied housing units rose at a faster rate during the period than the number signing up for cable/satellite. In other words, a decreasing proportion of people establishing new residences signed up for these video services.

          Will cable lower prices to retain customers? I doubt it. For one thing, it’s a matter of conjecture whether, say, a 10% across the board price cut would persuade anyone to stay with cable. However, such a measure would definitely mean a 10% loss of revenue—and perhaps double that percentage as a loss of profit.

          Fighting the net neutrality battle is a better way to go. Ironically, it’s the cable companies’ provision of high-speed internet service that allows people to unplug from cable video offerings. If cutting prices is too risky, the logical route for the cable firms to follow to combat unplugging is to attempt to impede their streaming rivals’ access to the bandwidth they need to deliver their services, or charge them a lot for it. Streaming services, in their turn, should argue that the cable firms are quasi-monopolies who have social obligation to allow equally high-speed access to all for a nominal fee. This battle will ultimately be decided in Washington.

          My thoughts

          I believe we’re only in the early adopter phase of a switch from traditional cable to streaming services. I understand that special factors may have led to large net losses of video service subscribers in the middle of last year. But I don’t take any particular encouragement from the “rebound” of the December quarter.

          On the other hand, I remember thinking during the ATT breakup of the early 1980s that the regional Bells would not be able to survive for long. If someone had told me then that they would only be reaching the end of the profit road for their basic fixed-line business thirty years later, I would have thought they very crazy. Yet, the fixed-line business has fought a successful war of attrition for that long. And the Baby Bells have been done in, not by lower-cost fixed-line rivals, but by wireless, a new technological development. Although I’m inclined to look longer and harder at the streaming services providers, my guess is that value investors will find the cable firms to be fertile fields for investing for decades to come.

          investing in stocks outside your own country: the Vale example

          March 28, 2011 By in Basic Concepts, Current Market Thoughts, economics, emerging markets, Foreign markets, Portfolio management Tags: , , , , , , , , , Leave a comment

          Still at spring training. So far, the Mets have beaten the Braves (five Atlanta errors) and lost to the Cardinals.

          Investing in a foreign country

          In my experience, one of the most difficult (and expensive) things to learn about investing outside your home country is that what you consider to be self-evidently and commonsensically true about the characteristics of good investments there isn’t necessarily so in someone else’s market. Instead, the rules that govern each market are the product of that nation’s legal framework, its shared social norms and the risk preferences of the dominant investors there (be they local or foreign), as well as the objective characteristics of the companies that are publicly listed.

          The situation is made more difficult because we’re all, at least initially, not consciously aware of our deepest presuppositions about our own market. We don’t think to ask anyone in a new market what the rules of the game are, either, because we assume they’re the same as ours. And the people in the new market that we might ask are, like ourselves, probably not consciously aware of the assumptions they share with their fellow local investors.

          Take the US and UK markets, for example. Superficially, the two are very similar. They have the same general language, same general legal system, same general accounting conventions. One is the former colony of the other. They are political allies. Everyone talks about Anglo-American capitalism as being different from the Japanese or continental European varieties.

          Yet the two markets are quite different.

          For example:

          –Americans “know” that debt is a cheaper form of capital than equity; British investors “know” the reverse.

          –The letter of the law is paramount in the US. In the UK the spirit of the law is more important. If some one can figure out a way to exploit imprecise wording in a contract to achieve an advantage, he’s likely lionized in the US. In the UK, he’s vilified.

          –UK investors prefer to own the stocks of mature companies that generate free cash flow, pay rising dividends and have low price-earnings multiples. US investors are pretty evenly split between such value investors and growth advocates, who prefer younger, faster-growing firms that are cash flow users, not generators, and pay no dividends. US individual investors are prepared to pay very high PEs for stocks in the latter class.

          How does one learn these rules? Mostly through experience—and through being aware that it’s important to be on the lookout for them speeds up the process immensely.

          At the present time, there’s an interesting instance of “local ground rules” in progress, one that will go a long way toward fleshing out the rules of investing in Brazil, a potentially important emerging market. Here it is:

          Vale, a large, publicly listed company in Brazil, is one of the world’s most important miners and exporters of iron ore. Iron ore is the main raw material used to create blast-furnace steel, the type of steel used to make automobiles. Vale’s most important customer is the steel industry in China.

          Although Vale is happy to remain a miner/exporter, the current Brazilian government isn’t content with the current state of affairs. According to a recent Financial Times article, it wants Vale to integrate forward by investing in steel mills in Brazil and so it can produce steel for export in its home country. Vale is refusing.

          The government’s response? …to force the current Vale CEO out of office, in the hope of replacing him with someone willing to adhere to the government’s wishes. As I see it, the government’s reasoning for its action is not that becoming a producer of steel, in direct competition with its largest iron ore customer, will be good for Vale or its shareholders. The rationale is that it will be good for Brazil.

          It isn’t clear yet whether the government will get its wish.  I suspect that if I knew more (read: anything) about the Brazilian legal system, I’d have found tha there’s a deep-seated belief that natural resources really belong to the citizenry as a whole, that private companies don’t own natural resource deposits in the same way they do other assets.  And that idea is the basis for the government’s request.  If so, this might imply other industries might be immune from these tactics.

          But every country has investment issues like this.  In Korea, for example, if a company is seen to be making “too much” money, it has been asked to make a “voluntary” contribution to some government-sponsored research project.  In Japan, the banks were never intended to make money; they were intended to gather national savings to make cheap loans to export-oriented companies.  Recently, we’ve learned that yoghurt-production is a key b in France, and thus not subject to foreign takeover.  For a decade or so, US oil companies were legally barred from charging market prices for the oil they brought to the surface.  And the US has massively protected/subsidized the domestic auto industry for as long as I’ve been a professional investor.

          My private belief is that these quirks end up being bad for the capital markets anyplace they’re enforced.  They result in inefficient allocation of capital.  And that results in lowe price earnings multiples for stocks in the affected industries.

          In a practical sense, however, there’s nothing any single investor can do about the local house rules  …other than to be aware they exist, lurking under the surface, everywhere–and take appropriate protective measures.

          the Mets’ financial problems: lessons for stock market investors

          March 27, 2011 By in Basic Concepts, Industry Analysis Tags: , , , , , , , , 1 Comment

          I’m writing this on Saturday morning, just before heading out to see a Mets spring training game in Florida.

          the Mets

          Yesterday’s New York Times has a front-page article (I’ve tried to link the article but I’m sending this from a Starbucks and I’m finding the NYT search function is awful!  Sorry.  3/28:  here it is.) detailing the Mets’ current financial troubles. It states that the Mets lost $10 million in 2009 and $50 million in 2010. The paper expects the club to lose another $50 million in 2011. My guess is that this last figure will prove much too low.

          Another aspect of the Mets’ bottom line is that the losses come after including the yearly payment to the club of $60 million for broadcast rights to games. That payment comes from the cable network SNY, which is also owned by the Wilpon family. Whether the figure represents a subsidy to the Mets or a shifting of value away from the club isn’t clear to me. The only figure I have for comparison is the one from the $1 billion lawsuit filed against the Mets by the Madoff trustee. The court papers say the Mets bought back broadcast rights from Cablevision in 2003 for under $10 million a year.

          Where does the NYT‘s information come from? The article doesn’t say, but I presume the source is one or more of the approximately half-dozen parties now poring over the Mets’ financials in preparation for possible bids to buy a stake in the baseball team.

          According to the article, current ownership’s projections call for the team to be back in the black by a healthy amount by 2015. To me, that sharp reversal of current form would be a prodigious feat of management skill, even if the Madoff litigation weren’t hanging over the club.

          As a life-long Mets fan, I feel a horrible temptation to begin a litany of the shortcomings I perceive in the way the Mets have been managed over the past decade. But that’s not my point, and the ballgame is calling.

          My post of a year ago

          About a year ago, I wrote a post about the Mets, saying I believed they were in far deeper financial difficulty than was commonly thought. I had assembled some figures, like the Mets’ payroll, ticket sales and concession revenue. I knew something about the interest and principal payments due on the bonds issued to finance CitiField construction. But getting hold of the bond offering documents, which aren’t easy to find, proved beyond me. And, of course, I didn’t have anything like the data that prospective bidders are being furnished with. Also, I’m basically a lazy person when no money is on the line.

          Why was I convinced that the Mets had financial troubles? The club’s behavior had changed—in a way that was totally at odds with their previous behavior but was entirely consistent with the hypothesis that the club faced a serious revenue shortfall.

          IThe Mets had made a trademark of spending lavishly on free-agent baseball talent. They didn’t always spend wisely, as $24 million for Luis Castillo or $39 million for Oliver Perez will attest to, but they always spent a lot. Two off-seasons ago, however, the club altered that behavior drastically. Yes, the Mets did sign Jason Bay. But despite the fact they desperately needed pitching, they ignored all the available pitchers. That may have been the prudent way to go, but my point is that the Wilpons had never acted that way before.

          Time passed. The club’s pitching woes worsened. Yet the Mets were reluctant to pursue pitchers whose price tags would be less than $1 million in yearly salary. These may not have been the best arms in baseball, but they were better than what the Mets had on the roster. There were also leaks of the Wilpons’ dissatisfaction with the performance then general manager Omar Minaya, whom the Mets were supposedly reluctant to let go because he had a $3 million buyout clause in his contract (if these sories are true, and the Wilpons’ evaluation of Mr. Minaya were accurate, then the decision to keep him on the payroll for another year was lunatic, but that’s another story).

          Significance for stock market investors

          If you watch companies carefully enough, you’ll discover that they have personalities, just like individual people do. There are some actions you come to expect of a management team, and some that you’ll come to think are completely out of character.

          I think this kind of qualitative observation is extremely important to do, especially for growth companies. While a company acts within what you understand its personality to be, you get little data other than more confidence that you have typed the firm correctly.

          But when a company acts out of character, you almost always have very significant information. And you have it—positive or negative—far in advance of when the reasons for the change become apparent in the company’s financial results.

          If you can put yourself in the place of the company’s CEO and ask yourself, “Why would I be doing this?”, you will in all likelihood get insights into corporate strategy—and therefore into potential earnings surprises—far ahead of Wall Street analysts who are focusing mostly on what results will be over the coming three months. This will give you time to either add to positions or exit gracefully before reported earnings make the new state of affairs evident to all.