A reader had two questions about yesterday’s post, which I figured it would be easier to answer here than simply in a comment.
The big attractions of emerging economies to an equity investor are the possibility of very rapid economic growth for the country and of finding future titans of world industry as infants. The two standard paths of gaining exposure to these markets are: to invest directly or to buy a developed-world multinational with significant presence in the economy in question.
Some emerging markets aren’t open to foreigners. For those that are, the most important thing to realize, I think, is that there is typically little local support for stocks. There are usually no pension funds or other local institutional investors (because there are no pensions and residents aren’t wealthy enough to afford financial products like insurance). Local citizens don’t have enough money to be able to own stocks. As a result, emerging market performance ends up being heavily dependent on foreign inflows and outflows.
Foreign flows can be very cyclical. When developed market investors are feeling confident, inflows to emerging markets are typically very large. When they’re scared, outflows are the order of the day. Because there’s little local buying power, these outflows invariably cause sharp price declines.
Right now, oil-exporting emerging markets are being hurt very badly by the declining price of crude. investors are also worried that emerging markets-based companies may have borrowed excessively, in US$, during the past few years of easy credit. Such debts were a big factor in the crisis in emerging Asian markets that started in 1997. In fact, today’s developments in Russia sound a lot like what happened in Malaysia in the late 1990s.
Yes, emerging market will eventually settle out. I don’t think we’re anywhere close to that point, though.
rent vs. buy
Take Adobe. Say you’re a web designer who wants to start a business on your own and that you want to use Adobe tools.
Buying a Creative Suite package to get started used to cost $2,500 – $3,000. That’s a lot.
Many people would do one of two things:
–bite the bullet and buy, but never, ever upgrade; or
–find a bootleg copy on Craigslist for $200 or so. Yes, it would probably stop working after six months, but it was cheaper than getting an “official” copy.
How many people took the second route? I don’t know …but probably a lot. I once heard Bill Gates estimate that 40% of the small business users of Office in the US were using counterfeit copies
Adobe has now gone over to a rental model. $50 a month gets you access to the Creative Cloud version of all the Adobe tools. The same sort of thing for photographers–$10 a month for Photoshop + Lightroom, vs. $600 to buy (Amazon is selling the last disk version of Photoshop for $1500).
–the move from buy to rent changes a big one-time capital expenditure by a small business customer into an affordable monthly operating expense. If users stay subscribers for at least five years, Adobe gets more money from rental than from a sale.
–Just as important, matching the tool expense more closely with customer cash flows is bringing a whole bunch of former illegals into the fold
–the company may also be attracting casual photography users who would never before have contemplated using Photoshop, but for whom $10 a month isn’t a big deal
–subscriber growth has continually exceeded consensus expectations.
The rental model isn’t exactly new. It has been used for all sorts of equipment for years, from copiers to burglar alarms to colonoscopes.
What surprises me is that Wall Street has been so slow to figure out that the rental model works for software, too. Yes, in the early days, the accounting looks ugly. In fact, the faster the transition to rental goes, the uglier the income statement looks. Development expenses remain the same, but instead of chunky sales revenue, the company only shows subscription payments for that month. But professional analysts should be able to see past that. My guess is that they miss completely the bootleg copy phenomenon.