slumping casino stocks

a China-related selloff

In yesterday’s trading in New York, MPEL, a pure play on Macau casinos, fell steadily during the day end ended down 9.3%.  WYNN, down more than 10% intraday, closed with a loss of 7%+.  LVS, which had fallen almost 8% during the afternoon, closed down 5.3%.  MGM, the third Las Vegas/Macau conglomerate–but a company with other issues–shed a “mere” 3.3% of its value.

That was just a warmup act for Hong Kong overnight.  Wynn Macau fell more than 17% overnight and Sands China 14%.  The “best” of the Macau casino performers among Hang Seng stocks was SJM Holdings, which lost 8.4%.

All these issues have given up about a third of their value in the past couple of months–although almost all remain strong year-to-date outperformers.

Why?

The ostensible reason is that growth in China may be slowing–maybe even to the point where, at the bottom, the country will be posting only a 5% GDP advance in a year or two.  Casinos weren’t the only decliners on this worry.  TIF fell almost 7% yesterday, after having been down over 10% intraday.  In contrast, Signet Jewelers, which has only US and UK operations, rose slightly.

my thoughts

It seems to me that there’s no rational basis for the declines.  Affluent Americans haven’t stopped buying at TIF, for example, despite the fact that the US economy is barely north of zero.  Quite the opposite.  Jewelry comps throughout the industry are at 10%+–and rising.  So I don’t see the logic to the argument that because affluent Chinese citizens will have “only” 20% more income next year rather than being up 35%, their consumption patterns will change markedly.

Two caveats:

Bad markets aren’t rational.  They’re emotional.  In hindsight, they may make little sense.  But that’s cold comfort if you get run over by a runaway locomotive barreling down a track where nothing logically should be.

The depth of these declines has got to suggest to a growth investor like me that I might be wrong in my assessment of future earnings.

what to do

A value investor would add to his positions.

A growth investor who owned none of these stocks would buy a little–and then watch for a while.  A growth investor like me, who has a large enough holding in this sector already, tries to take the point of view of the seller to try to discover what he knows that I don’t.

On that score, I’m coming up empty so far.  For me, then, the best course is to stay on the sidelines.

The next important data point will be the release of September Macau gaming revenue by the SAR government, possibly over the coming weekend.

 

tablets as online retail magnets

tablets as online money machines

Yesterday’s Wall Street Journal has an article about tablets and online spending.  Its conclusions:

–9% of online shoppers own tablets and half use them to shop.

–conversion rates (that is, the percentage of site visitors who actually buy something) for tablet users are typically 4%-5% vs. 3% for PC or cellphone users.  One site mentioned reported a whopping 10% conversion rate from tablets.

–tablet users spend 10%-20% more than PC or cellphone users when they buy.

–tablet users don’t like apps.  They use browsers to visit retail sites.

–retailers are starting to tailor their sites to make them more enticing to tablets.  This means more slideshows and videos.  Because virtually all tablets are iPads this implies using alternatives to Adobe Flash.

A bit of arcana:  a huge amount of web design time and effort goes into designing attractive buttons on websites (strange, but true).  All of that needs to be revamped so buttons are big enough for fingers to use them.

my thoughts

Retailers don’t seem to know why tablet-wielding visitors are so much more attractive customers.  That they are seems to be enough to spark a website gold rush to attract them.

It may be that tablet owners are more affluent than the general online population.  That might explain the higher average purchase.  On the other hand, the article mentions that QVC, which doesn’t attract a wealthy demographic, is particularly enthusiastic about its tablet business.

It could be that, because they’re instant-on and portable, tablets encourage impulse purchases.  That might explain the higher conversion rate.  If so, the tablet edge should vanish as solid state memory laptops, like the MacBook Air or ultrabooks become more common.  Given that the latter two are significantly more expensive than tablets, that may take some time, however.

(By the way, conversion rates are a bit more complicated than bigger-is-better.  It’s generally agreed that a conversion rate below 1% is bad and that 5% or higher is unusually good.  But if traffic is directed to your site through search engines, the cost of keyword purchase has to be factored in as well.)

It’s also possible that there’s something addictive about the tablet experience, sort of like that way people spend a lot more when they use a credit card than when they use a debit card.  If so, big spenders may end up getting unsolicited gifts in the mail of tablets with retailers’ catalogs and URLs pre-loaded.

investment implications

It seems to me this phenomenon is a mild positive for AAPL, but nothing to run out and buy the stock for.  For retailers, the quality of their websites may become more crucial in their sales efforts.

Anyone with a Flash website may find his popularity diminished–although I understand this is a much bigger problem in Europe than elsewhere.

This isn’t a positive for ADBE, but it remains to be seen how significant a negative it is.

what if this is a bear market…and not just a wicked correction?

standard definitions

Commentators often use sound-bite definitions for economic and stock market phenomena.  For example,

–a recession is two successive quarters of year-on-year GDP decline.

–a correction is a short, counter-trend, fall in stocks of 5%-10%.

–a bear market is a fall in stock prices of 20% or more.

The virtues of these definitions are that they’re brief and unambiguous.  On the other side of the coin, brief and unambiguous doesn’t represent real life that well.

adding complexity, but also relevance

There’s a time aspect to corrections and bear markets.

A correction typically lasts a few weeks.  That’s because it’s normally a valuation issue–that “animal spirits” have pushed stock prices higher than near-term earnings can comfortably support.  Short-term traders sell, but intend to repurchase in short order, hopefully at somewhat lower prices.

Bear markets, on the other hand, come in two types.  Both anticipate–and ultimately reflect–widespread economic weakness that will last for a year or so.  The garden variety is a consequence of governments’ countercyclical fiscal and money actions when economies are about to overheat (too bad Mr. Greenspan forgot about this part of his job).

The really deep ones come from one-time shocks to the system.  In the past, these have been “external shocks,” like huge oil price rises.  The most recent is the self-inflicted wound of the financial meltdown.  As we experienced in 2007-2009, these ones are deeper and longer.

for the record…

…I don’t think we’re in a bear market–at least not in the world outside the EU (where stocks have already lost over a third of their value since May).

I think we’re in an unusual situation of correction in world markets, complicated by the EU situation.  In brief, the EU hoped to get away with not rebuilding its banks’ strength after the losses they took in the financial crisis, but hiding them instead.  They figured they could free-ride on the economic coattails of China and the US instead and use worldwide growth to mend.

Then the Greek crisis came.  And, instead of addressing the fact their gamble had failed, EU governments have spent the last year with their heads in the sand, letting the problem get worse.

why bring this up now?

EU stocks have lost over a third of their value since May.  US stocks are down by almost 20% (the “magic” bear market line).  Metals prices are crashing.  Stocks have been extremely volatile.

Monday morning I saw a lot of crazy stuff when I turned my computer Monday morning.

–European markets were down 5% intraday.

–Hong Kong-traded Ping An Insurance (I own it–ouch!) had lost another 8%+.  It was down by 25% in three days on rumors that HSBC was about to sell a portion of its holding (so what, I say).

–AAPL lost $10 in early trading in a rising US market on a report out of Taiwan that orders for iPad components from Hon Hai for the December quarter were lower than expected.  It turns out the orders, if they are indeed being lost at Hon Hai, are most likely going to a new iPad factory that’s opening in Brazil in December. It could equally be that AAPL is preparing for iPad3, which would be a bullish sign, I think.  But, noooo. Traders took the most bearish interpretation.

The world isn’t 5% better one week, 6% worse the next, and 7% better the week after that.  Economic processes don’t change that fast.  Human emotions do, however.  And the extremes of emotion we’re seeing now typically signal significant turning points in market behavior.  Hence the title of this post.

what to do

My best guess is that we continue to move sideways in markets ex the EU until European governments address their banking crisis.  They markets probably rally.  But that may not be for a while, so don’t bank on that.

I think the best strategy is to use days of crazy selling as a chance to buy stocks that are being irrationally sold down.  Be very picky, though.  Look for high quality names where you’re very confident about the fundamentals.  And don’t bet the farm on a single stock.

On September 6-9, for example, I bought INTC, because I saw it was trading at under $20 a share, or less than 9x earnings, and with a dividend yield of 4.3%.  As/when it reaches $24, I have to decide whether I keep it.

if it’s a bear market, then what?

Then markets are not turning up again until maybe next summer.  And, if past form holds true, we’ll see at least one more downdraft in stock prices–maybe another 10% from here, more in economically sensitive stocks and in emerging markets securities (even though the emerging economies themselves may be fine).  That will come as government statistics and company reports show economic activity dipping into negative territory.  Yes, world stock markets may have begun discounting this possibility.  But, ex the EU, they’re barely begun to, in my view.

As much as it cuts against the grain of my growth stock temperament, it seems to me it’s worthwhile thinking about asset allocation and how you’d act if a more ursine mood begins to make itself evident on Wall Street.  My portfolio is betting against this, but it never hurts to think about what happens if you’re wrong.

 

 

 

 

 

what is a roll-up?

definition

Roll-up is the name commonly used to describe the process of buying up and merging small participants in a highly fragmented industry.

characteristics

The acquirer is most often a financial buyer, typically a private equity firm, rather than the operating management of a company in the industry in question.

The companies acquired are typically relatively small–and of sub-optimal size, in economic terms.

They are most often privately held, and owned by individuals who don’t have a sophisticated awareness of the value of their firms–either as stand-alone entities or as part of a larger combination.  As a result, purchase prices can be small single-digit multiples of yearly sales.

examples

Industries in the US that have been rolled-up include:  radio stations, auto dealerships, funeral homes, independent radio and TV stations, billboards, taxi walkie-talkie radio systems (i.e., Nextel).

why do this?

The two basic aims of a roll-up are to achieve large size relative to other competitors in the industry, and to grow to economically optimal size in absolute terms.  Doing so allows the roll-up to:

–lower administrative overheads,

–cut capital spending by sharing plant and equipment,

–negotiate lower prices and/or better payment terms with suppliers,

–offer a wider array of services to customers,

–create and market a brand name–with the increase in unit profits that this will bring,

–have units mutually support each others’ sales efforts,

–focus competitive activity at firms outside the roll-up.

profit sources

I’ve already mentioned that:

–the target companies can usually be bought very cheaply, and

–economies of scale and simple improvements in general management can boost profitability a lot.

In addition:

–better access to credit can reduce borrowing costs,

–the target firms can be more highly leveraged financially (= more debt) as part of a larger unit, and

–the rolled-up company will likely be IPOed, allowing the private equity company to cash out at least several times its purchase price.

why an IPO?

Two reasons, other than extra profits  …one good reason, one bad:

–the private equity company is likely funding the roll-up with money from institutions or high net worth individuals.  These investors will expect their capital + profits to be returned after, say, five years.

firms that carry out roll-ups typically have little hands-on experience running businesses, and not much detailed knowledge of the rolled-up industry.  They’re good at basic general management and at creating a capital structure with a lot of debt in it to boost returns on equity.  I think they realize they’re better off exiting the roll-up before some crucial issue arises that requires industry knowledge to solve.

 

question from a reader: the merger of Alpha Natural Resources and Massey Energy

the question
24.149.88.16

I listened to a debate recently on the merits of small commodity companies
acquiring larger ones. The company in question was Alpha Natural Resources purchasing much larger Massie Coal.
Can a smaller commodity company like ANR actually make the investment finacially feasible when they bought a company that was already foundering?
I enjoy your blog greatly!

my thoughts

At the outset, you should be clear that, although I’ve done extensive research in natural resources over the years, I don’t know much about the coal industry. So personally I don’t know enough to want to buy ANR stock.  But I can see several issues a buyer might want to explore.

background

ANR, which has private equity roots, was formed in 2002 to buy assets from Pittston Coal and has since growth by acquisition.  Its largest purchase to date is Massey Coal, a 2000 spinoff from Fluor.  It bought Massey in June 2011 for about $1 billion in cash plus just over 100 million shares of ANR stock, worth $5 billion+ at that time.

By revenues, both are roughly equal in size.  Mine output seems to be similar as well, with 5/6 thermal coal for power generation and 1/6 higher-value coking coal for blast furnace steel making.

Massey is the owner of the Upper Big Branch Mine in West Virgina, which experienced the worst domestic coal mining disaster of the past forty years on April 5, 2010.  A methane gas explosion there killed 29 miners.

Since the Massey takeover, ANR shares have lost about 60% of their value.  Part of this is due to general selloff of commodity stocks on worries about economic slowdown, part to former Massey shareholders cashing in their profits, part to ANR’s announcement in September that sales volumes will be lower than expected.

merger issues

My experience is that there are two types of risk in a merger like this:

–Are Massey’s safety problems confined to this one mine, or has that company been cutting corners to increase profits of other mines as well?  Certainly, industry gossip may provide clues.  But until ANR actually analyzes the Massey properties one by one in detail, it won’t know for sure.  Aside from the human issue, the question is whether ANR will have to make substantial capital investment to get the Massey mines functioning properly.  In other words, are the Massey properties actually less profitable than they appear to outsiders?

–Does ANR have the management depth to run an enterprise twice its former size.  It may be able to rely on the former Massey management.  But suppose they just refuse to do what ANR wants?  Sounds silly, but culture clash is a significant risk.  The risk going in is much higher when there’s evidence of badly-run operations.

In addition, is the ANR management composed of deeply knowledgeable and experienced coal miners?  …or is it basically a financial company doing a “rollup,” that can make generic efficiency improvements but entrusts the actual operation of the business to others?  I don’t know.

–One positive thing.  The combination was done mostly for stock.  So increased financial leverage isn’t a risk.

specific questions

A quick look at Value Line shows that ANR achieves only about half the operating margin of the VL coal industry.  Why?

My guess is that coking coal may be as much as a third of ANR’s profits, although only about 1/6 of volumes shipped.  At least some of that goes to China.  If so, have recent profits been inflated by flooding and transport problems in Australia?  How long will that advantage last?

more on “discounting”

discounting

“Discounting” is the jargon that Wall Street uses to describe the process of factoring changes in consensus beliefs about future happenings into today’s stock prices.  I’ve outlined the basics of discounting in an earlier post.

fundamental vs. technical analysis

Fundamental analysis, the study of company-specific and economy-wide economic and financial information, and technical analysis, the study of charts, can be seen as two approaches to discounting.  In the first case, researchers try to figure out what information is most important for making a security’s price go up or down, and then actively search for relevant data.  In the second, investors study chart patterns as a way of figuring out what fundamental analysts are doing and then riding on their coattails.

the internet

The internet has changed the amount, quality and cost of information in dramatic fashion. For example:

–When I was building an international equity investing organization for a major financial institution in the early 1990s, it cost about $300,000 a year in today’s dollars to get access to all corporate SEC filings.  The data came on microfiche and was available about six weeks after the documents were filed.  Today, the information is free on the SEC’s Edgar website; documents are available the instant they’re filed (companies do this electronically).

–Thanks to regulation FD (Fair Disclosure), company presentations are routinely webcast and are available through the company website.  Typically, they’re archived for at least a year.  True, breakout sessions at conferences, small group meetings or one-on-ones aren’t, but these mostly serve to fill in the blanks for analysts not familiar with a firm.  Companies may sound like they’re revealing new information, but they’re not.

–A Bloomberg terminal still costs $30,000-$50,000 a year, depending on its capabilities.  But discount brokers offer most of what an individual investor needs to their customers on their websites for free.

discounting and Greece

Discounting isn’t a one-time event.  It’s a process.

1.  For one thing, what’s painfully obvious to a seasoned observer or an industry specialist may only dawn on the average investor a considerable time later.

2.  Also, bad news that relates to a specific event is typically not fully discounted until the event occurs–no matter how far in the future that may be.  The financial crisis in Greece is a good example.

A year ago, a new administration in Athens revealed that the country had been falsifying its national accounts for many years.  Greece had taken in less in taxes and also spent a lot more than it had ever revealed.  How so?  Its membership in the EU had allowed it to borrow much more than it could ever repay.

For at least six months, it has been clear that either the rest of the EU will be forced to pick up the tab and let Greece remain in the EU, or that Greece will default and lose its EU membership.  In default, holders of Greek sovereign debt would lose most of their money.  But, since that’s mostly big EU banks which might need government bailouts as a result, the effect is basically the same.  EU taxpayers ultimately foot the bill.

Over recent months, however, EU stock markets–and the financials, in particular–have been subject to periodic waves of selling, driving prices ever lower, as investors express their fears about Greece.  …despite the fact that in general terms everyone has already read the closing chapter of the story.

This pattern of discounting the same news over and over again is typical.  It begins in denial (inadequate discounting) and may end in despair (overdiscounting), the same emotional pattern that shapes a bear market.  While bear markets end in a whimper sometimes, however, discounting that anticipates a discrete event usually involves a final selling bout as the event actually occurs.

Over the weekend, the G-20 seems to have given the EU an ultimatum to resolve the Greek crisis quickly.  We’ll see tomorrow how the markets react.

the current selloff

concrete signs of slowdown are emerging

A few days ago, Rio Tinto, the giant Melbourne/London mining conglomerate, said some Western customers (European?) are asking the company to delay shipment of contracted amounts of industrial metals (how this works financially is an interesting, semi-complex topic, but irrelevant here) .  FedEx announced this week that orders for airfreight shipment to the US, the EU and Japan are losing momentum as customers opt for slower and cheaper ways of getting their products into retail outlets.

In other words, for the first time in two years +, some firms are beginning to worry about having too much inventory and to work it down.  In one sense, this isn’t good.  But it had to happen eventually.  And the equity markets have been discounting this development since July.  After all, FDX has lost a third of its value in the past three months; RIO has been clipped by 37% over the same span.

So this is not really news.  And as FDX said, customers’ hair isn’t on fire.  They’re just being a little cautious.

the real problem is in the EU

There, a modern version of the Iliad, sans Helen, seems to be playing out, with France and Germany taking the role of Troy and, well …Greece in the role of Greece.

In a nutshell:  the EU let Greece in about a decade ago, even though it didn’t really qualify, giving it unrestricted access to EU credit.  Greece promptly borrowed (and spent) a gazillion times what it could ever repay, funded ultimately by the ever hapless financial institutions of Germany and France.  Greece says it’s sorry and will change its ways–but is actually doing very little. It seems instead to be milking the situation for the best possible terms for default, or perhaps just for more time at the EU credit trough–which, I guess, is what almost anyone would do in their situation.

On the other hand, German politicians are on the horns of a dilemma.  They either fund a Greek bailout, in which case they’re tossed out of office, or they let Greece default and destroy their banks.  And they’ll be thrown out of office again.  So they don’t want to act, either.  Arguably, this is also their best strategy (short of actually doing their jobs and fixing things).

Having endured this stalemate for about a year, the nerve of European investors seems to me to have finally cracked.  They’re selling anything not nailed down in a classic panic.  The rest of the world is being dragged along for the ride.

If there’s silver lining to this, financial market panic may provide the political cover the EU needs to stop procrastinating and begin to act.

three stock market scenarios

I’ve sketched this out in a little more detail in Current Market Tactics this month and last.

I have three targets for the S&P over the coming year, depending on economic circumstances:

nothing wrong (hah!)     1350

muddling through          1170

recession ahead             1000.

I still think that muddling through is by far the most likely outcome.  If so, 1170 would be the central tendency around which Wall Street will revolve.  Panic aside, if an investor thought he would need a 7% return in order to be induced to take the risk of owning stocks, then he should be a buyer at an index level of 1090.  That’s about 3.5% below yesterday’s close.  Below that any selling, which I already regard as overdone, would enter into another, higher, level of craziness.

The main item on our wish list should be market stabilization.

what to do

My thoughts haven’t changed very much.

When we get to the other side of the current storm, I think the winners will be firms with Asian exposure, participants in technology-based change and companies that serve the affluent.  At some point it will be right to trade your TIF in for WMT (I own the first but not the second), but not anytime soon.

If you can force yourself to get out from under your desk and witness the carnage, look for ways to upgrade your portfolio.  When selling starts, it may be rational at first and the weakest stocks get sold off first.  But then the selling often takes on a life of its own.  When panic sets in and the bad-stock ammunition runs out, good stocks get thrown out the window at crazy prices as well.  Why?  That’s all that’s left to sell.  No other reason.

My stocks got really whacked on Thursday, so I guess I’ve got to think that we’ve entered the latter phase.

Under the desk (or the bed) is sooo much more comfortable at a time like this, but my experience is that you’ve got to force yourself to at least analyze what’s going on.

If you can’t do this, or if you know you’d just do things you’d regret later–and you know your psychological makeup better than I do–find a good book.

By the way, in my view the current selling has nothing to do with year-end mutual fund housecleaning.

discounting

I want to add something about the discounting mechanism, but I’ll save that for Sunday.