Monthly Archives: February 2011

China’s trans-Colombian railroad proposal: good for Latin America

February 16, 2011 By in Balance of Payments, China, economics, emerging markets, Strategy Tags: , , , , , , , 1 Comment

Railroad Tycoon

Sid Meier’s Railroad Tycoon has always been one of my favorite video games.  I wasn’t particularly good at it (it took too much time), but the idea was to build a corporate railroad empire in the US during some period in history.  In addition to laying your own track and building your own depots and stations, you could also own the raw materials providers that depended on rail transport, as well as the processing plants that turned these inputs into finished goods.  You could also buy out your competitors’ empires by astute stock market dealing.

Sino-Colombian projects

Someone high up in the Beijing government must also be a Sid Meier fan.  The president of Colombia, Juan Manuel Santos, in an interview with the Financial Times, says that his country is in advanced talks with China about constructing a 130-mile rail line running through Colombia connecting the Atlantic and Pacific coasts.  Combined with a new port to be built on the Atlantic side, the project would serve as an alternative to the Panama Canal.

Talks are farther along than this on another Sino-Colombian project, which would expand the Pacific port of Buenaventura and build another 450 or so miles of track that would speed the flow of Colombian coal to the Pacific, and to China in particular.

what’s at stake

What does Colombia gain from such deals?  …in the first instance, modern infrastructure and access to the Pacific Basin to market its natural resources (most of its existing rail capacity reaches toward the Atlantic), without much spending of its own (Colombia’s idea is to use build-operate-transfer concessions, in which China will make the capital outlays in return for the right to operate the ports and rail lines for a specified period of time).

And China?  …goodwill; access to Colombian coal; the possibility of extending the rail network into Venezuela, where it is developing extensive oilfields; a way to get around the potential bottleneck caused by restrictive work practices at the Los Angeles area ports.

more

Is there more?  Yes.

Much as a generation ago foreign firms used the UK as a jumping off point for the rest of the EU, Colombia may play the same role for China in the Americas.  One could see a reverse flow to the natural resources traffic that would be headed to Asia–components shipped from China to Colombia for final assembly, to be sent from there to the rest of Latin America–and potentially to the Us and Canada as well.

For its part, Colombia is worried about catching the “Dutch disease,” meaning the economic distortions that excessive reliance on natural resources creates.  With about half its citizens living below the poverty line and per capita GDP not much higher than China’s, Colombia would welcome the economic oomph that being China’s entrepôt to the Americans would bring.

where the US stands

Politically, the US may consider stronger China-Colombia ties to be a blow to its prestige.  On the other hand, Washington is one of the biggest catalysts behind China’s moves.  I don’t mean the AFL-CIO’s success since 2006 in blocking a bilateral trade deal with Colombia (which would result mostly in Colombia dropping its taxes on goods exported from the US–go figure that one out!), however.

Just as it did with Japan a quarter-century ago, Washington is vetoing any direct investment from China on “national security” grounds, effectively preventing Beijing from spending its huge dollar holdings on anything other than more Treasury bonds.  China is also interpreting (correctly, in my opinion) the unwillingness of Washington to tackle the three largest sources of government spending–the military, Medicare and Social Security–as evidence the US has no real commitment to preserving the purchasing power of the dollar.  So Beijing shouldn’t have a particularly high investment hurdle to beat–just not losing money would be enough–in considering projects like those in Colombia.

what should an investor do?

From an investment point of view, I don’t think there’s any need to rush out today and buy Colombian stocks (I don’t even know in practical terms how open the market, soon to merge with Chile’s and Peru’s bourses, is to foreigners).  But that country seems to  me to be the clear long-term winner from these developments.  It may well also be that one or more of the Chinese port companies, which I think are attractive on their present merits, will end up with a significant Colombian exposure.

Skandia Life: we’ve made money on private equity

February 15, 2011 By in Private equity Tags: , , , , , Leave a comment

Who says insurance companies don’t have a good sense of humor?

the Skandia Life study

The Financial Times reported today that Skandia Life has done a proprietary study that “proves” its investments in private equity have made money for the company, even from purchases made during the wildest days of the middle of the last decade–when loans were flowing like water and everything not nailed down was being bid for at very high prices.

Despite this, Skandia concludes that its private equity investments earned it “between six and 14 per cent per year” better than publicly traded equities (which would likely have lost some money during the period).  The print newspaper article said the margin of outperformance was “between 0.8 and 1.5 per cent,” a set of figures that the FT apparently subsequently changed.  I don’t know which is correct.  (I’ve looked for the study on the internet but have been unable to find it.  So all I have to go on is the FT newspaper and website.)

the study’s assumptions

To get the Skandia results,  you have to make a number of (heroic) assumptions.  They include:

1.  that the private equity people who sold Skandia its deals worked for free.  That is, they collect no fees and have no carried interest.

2.  that estimates of the current values of the companies bought, which are made by the private equity firms doing the buying, are fair and accurate.  There was apparently a “third party” check on the figures,  presumably by the investment banks who were paid by the private equity firms to line up and help finance the deals.

3.  that the highly leveraged acquisitions of poorly-performing companies are no riskier than buying, say, a stock index ETF, so no adjustment to returns for”extra” risk needs to be made.

are they believable???

How likely are any of these suppositions?  In New York they say…”If you believe this, I have a bridge you might be interested in buying.”

The icing on this comedic cake is the answer to the question, “What financial professional could possibly have approved this study and endorsed its dubious results?”    …why, the guy in charge of giving Skandia Life’s money to private equity, that’s who.

In the thrust and parry of bureaucratic infighting in large companies, I can see why someone might call for a justification for making private equity investments at the top of the market to be made.  And I can see how a study like the FT writes about might have been the response.  What I don’t understand is why the authors would want it made public in any form.

On the other hand, maybe they didn’t.

 

 

 

 

insider trading and ETF stripping

February 14, 2011 By in ETF stripping, Securities regulation, Trading Tags: , , , , 2 Comments

insider trading

Over the past couple of months there has been a constant drip, drip, drip of news conferences by the SEC on the topic of its ongoing investigation of insider trading.   Most have been to announce arrests of hedge fund-related professionals accused of this white-collar crime.  The “timed release” nature of the news flow has several objectives that I can see:

–it unsettles as yet uncaught lawbreakers, perhaps causing them to make foolish mistakes that will make their apprehension easier,

–it discourages anyone tempted to trade on confidential company information,

–it burnishes the reputation of the SEC as guardian of the securities markets, and, of course,

–it keeps unflattering stories, such as the one that the agency’s own financial statements have chronically failed to meet minimum government standards, off the front page.

ETF stripping

One the of the latest SEC announcements involves something new to me–ETF stripping. What is it?

The securities exchanges and their regulators maintain continual computer surveillance of public market trading, both of securities and derivatives.  They look for unusual patterns in volume or price movement that may indicate insider trading.   For example, three days before a merger announcement, trading in near-term call options of the target firm spikes to 5x normal volume; or the day before a surprisingly bad earnings report, puts for the stock of the company in question do the same thing.  Such deviations from the norm ring alarm bells and prompt the regulators to investigate who was trading and why.

According to the SEC, one way traders on inside information have been able to outwit this surveillance has been by buying shares in a sector ETF that contains their target stock, and shorting all the other names the ETF contains.  They end up owning only the name they want to.  But they don’t show up on the regulators’ screens as owning the target stock at all.  Instead, they’re seen as holding an index security (the ETF) and a bunch of short positions.

my thoughts

I have several thoughts:

–Most traditional investors can’t short stocks.  For those who can, there’s a very good chance that clients would notice and question the synthetic construction of a long position through ETF stripping.  So the SEC is talking about hedge funds here.

–Hedge funds would presumably piece the trading out to several brokers so that no one counterparty sees the entire picture.

–ETF stripping would be particularly hard to find if it were done by the trading desks of brokers, particularly those who act as intermediaries for ETFs and are constantly buying and selling both ETFs and their component securities.  Trading costs would be the lowest for such brokers, as well.

–There’s no reason to go to the trouble of ETF stripping other than to try to evade regulatory scrutiny.  So the practice seems to me to be a two-edged sword.  On the one hand, the chances of being detected are lessened.  On the other hand, the ETF stripper is like the burglar caught in the bank after hours with safe-cracking tools.  If caught, he can’t claim he’s there by accident.

–I can’t imagine the SEC figured this out by itself.  Instead, I presume the agency learned about ETF stripping through an arrested inside trader who offered information in exchange for a lesser sentence.

It will be interesting as this story develops to see how widespread the practice has been.

 

Wynn Resorts’ 4Q10: spectacular results from Wynn Macau

February 13, 2011 By in Casinos, China, Current Market Thoughts, earnings conference calls, emerging markets, Entertainment, Hong Kong, Industry Analysis, Stock ideas Tags: , , , , , , , , , Leave a comment

the results

WYNN reported 4Q10 and full year 2010 earnings results after the market close in New York on February 10th.

On February 1st, the company announced it would release its figures on February 24th, but a week later moved the date up to the 10th.

(I read this as signalling that the results were extremely good and WYNN was worried about their somehow leaking out in the intervening two weeks.  I appear to have been the only one to do so, however, since the stock traded flat on the two days before the conference call.)

Wynn reported revenues of $1237.2 million for the December quarter, up 52% year on year.  Earnings were $114.2 million, or $.91 per share.  That compares with  loss of $5.2 million or -$.04 per share in the closing three months of 2009.  Wall Street analysts had been estimating $.66, so the actual number was over a third higher.

Interestingly, the stock initially sold off by several percent in the aftermarket Thursday night, both before and after an upbeat conference call.  Stock price weakness continued in early-morning Friday trade.  Selling abated quickly, however, and WYNN ended the day up 7.45%.

the details

Macau

As I pointed out on January 5th, the Macau market experienced record gambling business in the December quarter.  Wynn Macau also gained market share, implying–at least in part–that it was unusually “lucky” during the period (what casinos report as revenue is not the amount bet by customers but the (small) portion of that figure that the casino wins).  In that post, I said I thought quarter on quarter revenues might be up by a third, and that (like any other well-run company) WYNN would encourage its accountants to find ways to tamp down the windfall gain.

As it turns out, 1128 reported revenues of $912.1 million, up 36% quarter on quarter.  Win percentage at high-stakes baccarat, the staple of the Macau market, was 3.15% of the amount bet for 1128 during the December period vs. 2.88% in the third quarter.  (WYNN thinks a normal range for that percentage to be from 2.7% to 3.0%.)

Yes, 1128 did increase its reserve for bad debts by $11 million but its operating income still rose from $124.5 million in the September quarter to $214.5 million in the December period.  (That’s what operating leverage is all about.)

Las Vegas

Slow recovery continues.  Convention business is gradually coming back.

But there’s still a glut of hotel rooms in Sin City, a fact that is holding room rates down.  CityCenter and the Cosmopolitan, the last venues to open in a flurry of capacity expansion, added almost 10,000 new rooms, or 15%, to the total on the Strip in a little more than a year.  Ouch!  That’s especially bad for the Las Vegas casino companies because their properties have been built with the idea of generating  half the firms’ operating revenue from being resort hotels, not from gambling.

So in Las Vegas, WYNN remains cash flow positive but earnings negative. For the December quarter, WYNN had an operating loss of $13.4 million.  At least that’s better than a year ago, when the red ink crested on the operating line at $56.7 million.

2011 to date

–Macau continues to boom, with the market growing by about a third, year over year, in terms of casino “win” in January.  1128’s win percentage for the quarter to date, however, has dropped from its recent highs to an unusually low 1.9%–meaning the company’s gaming profits aren’t much better than flat for the month v.s 2010.

That’s just a fact of life when dealing with high rollers, and has no investment meaning.  Nevertheless, this is the likely reason 1128 has sold off by 20% or so in Hong Kong over the past few weeks.

WYNN clearly thinks that the best is yet to come, as transportation links with Hong Kong and the mainland are improved.

–Chinese New Year was good for WYNN.  It produced the biggest night in the history of the Wynn Resort in Las Vegas, with table win of $16 million +.  And it yielded one-day casino win in Macau of $46 million +.

–In contrast with Macau, WYNN’s casino win percentage is Las Vegas is unusually high at the moment.

–1128 is planning to add two more to its current roster of ten junket operators (who bring groups of high-rollers to the casino) during the spring.  It hopes to receive final permission before summer to begin construction work on its new $2.5 billion casino in the Cotai section of Macau.  That would mean opening in early 2015.

the stocks

1128’s current market capitalization is HK$96 billion.  WYNN’s ownership interest in 1128, therefore, is worth about US$9 billion.  Wynn itself, which has outperformed 1128 by about 10% over the past year, has a market cap of just over $16 billion.  In simple terms, this means investors are paying $7 billion for:  the company’s Las Vegas operations, the royalties/management fees WYNN receives from 1128 and exposure to possible new ventures outside of Macau.  My guess is that this works out to cash flow return of 5% or so, assuming Las Vegas breaks even on the operating income like this year.

I hold both, with about a 3:1 ratio of WYNN:1128.  My overall holding is big enough that I’ve been forcing myself to sell bits and pieces just to control risk.

Neither stock is exactly undiscovered.  Still, I think that both will be at least mild outperformers of their markets in the year ahead.  If both stocks traded in the US, growth investors would gravitate toward 1128 and their value counterparts would tend to select WYNN.  The latter might even short 1128 to get “pure” exposure to the parent company.

The reality, though, is that the two trade in different markets (see my post on this topic), with different investment preferences and knowledge bases.  So the either/or strategy has risks that are not obvious.  In particular, it’s possible that 1128 could get caught up in a general asset shift away from emerging economies toward developed ones.  I don’t see that yet with 1128, and I don’t expect it will happen, but it’s possible.

My only useful thought in this regard is that a negative market reaction to 1128’s current run of bad casino luck in 1Q11 could present a buying opportunity.  I think that’s happening now with 1128.  Given that Wall Street analysts and US investors don’t seem to assimilate this kind of information very quickly (look at how badly they missed 4Q10 eps), the same may occur with WYNN when the 1Q11 earnings report comes out.

Activision’s 4Q10: a reprise of 4Q09

February 11, 2011 By in Current Market Thoughts, earnings conference calls, Entertainment, Industry Analysis, internet, Stock ideas, Technology, Video games Tags: , , , , , , , Leave a comment

the results

Activision reported fourth quarter and full year 2010 results after the market closed in New York on Wednesday. On a non-GAAP (Generally Accepted Accounting Principles) basis, the firm earned $.53 a share–in line with Wall Street analysts’ expectations–vs. $51 in the year ago quarter.  For the full year, GAAP earnings per share were $.34 vs $.09 in 2009.  On a non-GAAP basis, eps were $.79 vs. $.69.

On a GAAP  basis, however, ATVI reported an operating loss in the vicinity of $400 million for the closing three months of the year–the second time in a row they’ve accomplished this “feat.”

The company issued initial (non-GAAP) guidance for 2011 of $.70 per share in earnings, or about an 11% year on year decline (more on this below), which was lower than analysts’ preliminary guesses of a flat earnings year.  (Some are also saying that ATVI is guiding to earnings of $.07 a share for the March quarter, which would be below analysts’ estimates of $.10.  I don’t think that’s right, though, since the $.07 includes $.02-$.-3 of restructuring charges.  In other words, ATVI guidance is for earnings of $.10 per share for March.)

ATVI also announced that its board of directors had authorized a 10% increase in the dividend to $.165 per share and a $1.5 billion share buyback.

The shares were down about 7% in the aftermarket.   As I’m writing this, in the early afternoon of February 10th, ATVI shares are down about 10% on very heavy volume.

the details

1.  Bobby Kotick has developed feet of clay.  The CEO of ATVI has had a well-deserved reputation for quickly focusing his firm on new trends and deftly cutting his exposure to the old without taking big losses.  No more.  For the second year in a row, ATVI is taking a gigantic writeoff related to the Activision side of the business.

Elements of the writeoff are scattered around in different accounting categories, however, including some costs that will only be recognized in 2011, so I find it difficult to figure out exactly how big the current damage is.  $400 million + is the best I can do.  Unlike last year, when management blithely ignored the loss completely in the conference call, there were at least a few passing references to it Wednesday night.

What’s happening?  ATVI’s financials suggest that, ex Call of Duty, the Activision side of the house continues to be deeply in loss. That got the former Activision-side top brass fired a year or so ago.   After posting a large deficit ex CoD again in 2010, new management has decided to:

–stop making new versions of Guitar Hero and concentrate on digital downloads to the title’s waning fan base,

–shut down True Crime,

–not launch a new Tony Hawk game this year (no more, ever?).

ATVI will also be laying off 500 employees.  This will leave the Activision part of ATVI with Call of Duty, the Bungie team that’s developing a new MMO, and some niche products like Cabelas hunting games, that make money.

2.  Blizzard is doing fine–better than fine, actually.

–Non-GAAP operating income, at $850 million, was up 53% year on year. 

–World of Warcraft has over 12 million subscribers globally.  Blizzard’s new partner, NetEase, is making it easier to get permission from Beijing to introduce new WoW software to China. 

–WoW: Cataclysm sold 4.7 million units during its launch month in December.

–Starcraft II has sold almost 4.5 million units, as well.

–Blizzard has also been talking about a new WoW-like game it is developing, code name: Titan.

3.  Call of Duty is, too.

–Despite pre-launch worries that Call of Duty: Black Ops could never surpass the success of the 2009 entry in the game series, CoD: Modern Warfare 2, the number of players of Black Ops during its first three months is about 50% higher than for MW2.

–First-day downloads of the initial expansion pack for Black Ops (just launched) were 25% higher than for the comparable release for MW2.

4.  ATVI will be announcing a mystery new gaming initiative at Toy Fair today.

5.  New releases for 2011?  Will there be any?

–There’ll certainly be one for Call of Duty. But ATVI is (sensibly) unwilling to project that it will meet the lofty sales standards of Black Ops. Other than that, the current-year cupboard may be pretty bare.

–There’s no word from Blizzard on (the now long-awaited) Diablo III. All we know is it’s not ready for beta testing yet.  A 2011 launch has not been ruled out.

–Heart of the Swarm, the Zerg entry in the Starcraft II series, is certainly a 2012 event (if then).

–The Bungie MMO definitely won’t debut this year.

–On the bright side, there won’t be self-inflicted losses from Guitar Hero et al. But worries the new Blizzard launches could be pushed back into 2012 are the main reason for ATVI’s conservative earnings guidance.

why the big selloff in the stock?

1.  Some investors may be throwing in the towel.  ATVI has been a severe underperformer over the past two years.  Another huge writeoff and prediction of a down earnings year in 2011–especially when most other firms, video game and otherwise are posting surprisingly good results–may have been more than many investors are able to take.  Some professional investors who use mechanical rules for buying and selling, in an attempt to keep emotion out of their decisions, may also have been forced by them to divest.

2.  Has Bobby Kotick lost the magic touch?  I thought the Activision division problems had been fixed last year.  It’s distressing to see that it has required another year of large losses to get management to smell the coffee.  Odder still, ATVI has been much more aware than its rivals about the threat from casual and mobile games.

3.  It’s also possible that ATVI’s juvenile attempt to divert investor attention from the writeoffs by not mentioning them is undermining investor confidence in management’s integrity and competence.

where to from here?

ATVI is a stock I’ve been consistently wrong about, so maybe you should skip this part and make up your own mind without my two cents. 

First of all, the company has about $3 a share in cash on the balance sheet, and no debt.  It is generating cash flow from operations, principally from Blizzard, of about $1.15 a share.  That level of cash generation can probably continue indefinitely.  True, there may not be a new mega-hit like Starcraft II in 2011, but there won’t be Guitar Hero, Tony Hawk or True Crime to pile up offsetting red ink.  And MMOs, a field Blizzard leads, are the future for serious gamers.

Assume a current stock price of $11 and subtract the $3 in cash.  The remaining $8 is equal to about 7x cash flow.  If the current level of cash flow is sustainable–and I think it is–the stock is cheap.  It’s the equivalent of a bond that yields 15%.  If this were a different industry, or if ownership weren’t so concentrated in Vivendi’s hands, a takeover bid would be a good possibility.  I don’t think that’s likely here, though.

The big question is whether there’s anything in ATVI’s future that could make it less cheap than it is today.  A new Bungie MMO, a big increase in the number of WoW subscribers, new online moneymaking opportunities for Starcraft or Call of Duty are all possibilities that come to mind.  Also, in time, and with more forthright communication, management may win back investor trust.  In addition, at some time before the end of summer, focus will turn to 2012, which could be a year with two or three big new releases.

I can easily imagine circumstances–and again I have been as cold as ice with this stock–where ATVI is trading 20% higher than it is today six months from now.  Like almost any value stock, however, the “what” is easier to figure out than the “when.”