internet companies vs. state-owned enterprises in China

Recently Beijing announced it wants to take equity positions in the major internet companies in China and place Communist Party officials on their boards of directors.

What’s going on?

I see two general possibilities.

Some background first.

Deng’s economic reform

In the late 1970s, Deng Xiaoping realized that the Chinese economy was too big to be controlled through central planning.   To grow it had to adopt Western economic (but not political) methods.  So he began to allow the market, not doctrinally-correct political cadres, to dictate the direction of expansion.

A major issue he faced in doing so was that, say, three-quarters of Chinese industry was owned by the state.  These companies were rudderless, and hopelessly inefficient–but they employed tons of people.  If large numbers lost their jobs all at once, the ensuing social instability might threaten the rule of the Party.  Therefore, economic progress had to be tempered by the need to avoid this outcome.  And this in a nation without sophisticated macroeconomic tools to control the pace of growth.

The result over three+ decades has been a Chinese economy that lurches between boom and bust, depending on the temperature in the state-owned enterprises.  The strategy has generally been successful, I think, with the state-owned sector now representing less than a third of China’s overall output.

possibilities

–China’s internet companies have become large enough that their actions, intentional or not, can accelerate the speed at which state-owned companies shrink.  So they need to be monitored much more carefully than in the past.  This is the benign interpretation, and the one which share prices suggest the market has adopted

–China’s internet companies have become large enough to generate “creative destruction” in large enough amounts to threaten the economic control over China exercised by the Communist Party itself.  If this is the case, then the oversight over domestic internet conglomerates will be much more draconian than the consensus expects.  That would presumably result in considerable PE contraction for the firms being controlled.

My guess is that the first possibility is much more likely to be the case.  But I think we should watch the situation closely for new hints about Beijing’s intentions.

the curious case of Toshiba and the Mitsui keiretsu

The Financial Times, now owned by the Nihon Keisei Shimbun (the Nikkei)–and which should therefore have a particularly sharp insight into goings on in corporate Japan, had an interesting article the other day about Toshiba.

Toshiba is facing possible bankruptcy and potential delisting from the Tokyo Stock Exchange as a result of the disastrous performance of its nuclear power business.  To avoid this fate, it has decided to sell its flash memory business, which is a world leader in this important class of semiconductor devices and owns essential intellectual property for their manufacture.

The Japanese government is intervening in the matter, with the aim of ensuring that this important asset remains in Japanese hands.  What is distinctly not happening, as pointed out in an FT article two days ago, is any aid being offered by other members of the Mitsui industrial group.  This is very unusual.

background

At the core of Japanese economy in the first half of the twentieth century stood a number of powerful industrial conglomerates, called zaibatsu, which emerged from the samurai culture of shogun-era Tokyo.  The zaibatsu were outlawed after WWII for their role in Japan’s participation in that conflict.  But their dissolution was in name only.  The groups continue to exist in substance but were referred to as keiretsu.

One of the principal features of the keiretsu is mutual assistance in times of trouble.

For example,

Some years ago, Mistubishi Motors tried to buy its way into the US car market with a “0-0-0” financing campaign.  That meant zero down, a zero interest rate on 100% financing, and no loan repayment for the first year.  As it turned out, there was also a fourth zero–no credit checks.  And very large number of buyers (if you can call them that) simply made no payments when the time came.  They continued to drive the cars until they were repossessed.  Mitsubishi Motors as a whole, not just the US subsidiary, was faced with financial failure as a result.

What happened?

The other members of the Mitsubishi group injected hundreds of billions of yen into the auto company so that it remained afloat.  I remember speaking about this at the time with the chairman of Mitsubishi Corp, the group’s trading company.  He was deeply unhappy about having to invest in the auto arm of the group, and knew that this made no economic sense, but felt that his honor demanded that he do so.

today

Fast-forwarding to today and Toshiba     …not a peep from other Mitsui group members.

There may be something unusual about Toshiba.  More likely, the zaibatsu concept, a vital aspect of the samurai culture, may have finally passed its best-by date.  Interesting, too, that this should come while a descendant of the samurai is the prime minister.

Chinese economic growth

China, the largest economy in the world (by Purchasing Power Parity measurement), reported 1Q17 economic growth of 6.9% earlier today.  The best analysis of what’s going on that I’ve read appears in the New York Times.

The bottom line, though, is that this is a slight uptick from previous quarters–and good news for the rest of the world, since one of the big factors that is driving growth is exports.

Traditionally, the first question with Chinese statistics has been whether they attempt to represent what is happening in the economy or whether they’re the rose-colored view that central planning bosses insist must be shown, whatever the underlying reality may be.

I think this is a much less worrisome issue now than, say, ten years ago.  But in addition to greater faith in statisticians, we also have other useful indicators about the state of China’s health.  They’re all positive:

–As I wrote about a short while ago, demand for oil in China is rising.

–Last week, port operators reported an activity pickup, led by exports.

–And Macau casino patronage, which bottomed last summer, is showing surprising increases–with middle class customers, not wealthy VIPs, in the vanguard.

While I think that consumer spending in the US is probably better than recent flattish indicators would suggest (on the view that statistics are catching all of the pain of establishment losers but much less of the joy of new retail entrants), my guess is that increasing export demand for Chinese goods is coming from Continental Europe.

More tomorrow.

Shenzhen Connect starts next week

…on December 5th.

That’s according to the Hong Kong Exchanges and Clearing Limited (HKEX), whose Stock Exchange of Hong Kong subsidiary signed an agreement with its Shenzhen counterpart on rules for Shenzhen Connect last month.  The agreement was just approved by mainland Chinese regulators.

what is Shenzhen Connect?

It’s a mechanism that allows investors in Hong Kong to buy or sell Shenzhen-listed stocks, up to a specified (but large) total daily limit.  It also allows China-based investors to buy and sell Hong Kong-listed stocks through the Shenzhen Exchange.

The start of Shenzhen Connect trading follows the successful establishment of a similar arrangement between Hong Kong and Shanghai, called Stock Connect, a little more than two years ago.

significance?

In a practical sense, Shenzhen Connect and Stock Connect together end the closed nature of the Chinese stock market.  Doing so is an important economic objective of Beijing.  It’s another step down the road to dismantling the central planning and control that has characterized Chinese socialism since WWII.

rising Shenzhen shares?

Will this signal a boom in Hong Kong interest in China-listed shares?  I don’t think so, but it will be interesting to watch and find out.

Stock Connect, which opened the Shanghai stock market to foreigners wasn’t such a big deal, in my view.  That exchange is dominated by state-controlled banks and by stodgy old industrials headed mostly by state functionaries with no idea of how to run a profitable business.  Beijing will protect the banks but is content to let the  gradually wither and die.  So I didn’t see any rush to be the first foreigner to arrive in 2014.

The Shenzhen Exchange, on the other hand, is home to much more entrepreneurial firms, with little or no official state involvement.  So, in theory, yes, I might want to participate.

A big roadblock for me, though:  I have no idea whether I can trust the financial reports that companies issue.

Two ways to find out: listen carefully to what local players say and do; and visit the companies that sound interesting, interview the managements–and then watch to see how what they say matches up with operating results and what the financials report.

Even then, my experience is that you may not be safe.  Years ago, I visited a small Hong Kong manufacturing company at the urging (I didn’t need much) of a friend.  The firm told me a fabulous story of its success making computers for children.  I went back to see the management some months later.  They didn’t recognize me as a person they’d spoken with before.  This time they told me an equally dollar-sign-filled story, but this time they were an auto parts firm.  Whoops.

I’m not willing/able to put in the effort required to understand how the stock market game is played in Shenzhen.  So, Shenzhen Connect won’t tempt me away from the sidelines.

 

 

developments in Macau gambling

Today’s Election Day.  Be sure to vote.

I think the results of the presidential election may have far-reaching effects on the US economy and stock market, with a Trump victory being especially bad.  But that’s a topic for another day.

 

There are three recent developments of note in the Macau casino gambling market, one whose recent decline I badly underestimated:

–after peaking at a monthly gambling win of MOP 30.7 billion (US$3.8 billion) in February 2014 and beginning negative year-on-year comparisons that June, the market finally bottomed in June 2016.   Win for that month was MOP 15.9 billion (US$2 .0 billion); yoy comparisons turned positive in August.  An obvious plus.

–18 marketing employees of Australia’s Crown Resorts were detained in China last month.  Their crime appears to be offering., while in China, larger-than-permitted inducements to Chinese high rollers to visit Crown Resorts properties in Australia.  Since Crown also has casino operations in Macau, however, it’s not 100% clear that this is the issue.  A similar situation occurred in 2015, when marketers for casinos in Korea offered illegal inducements in an effort to get high rollers to visit.  For the moment, at least, this has marketers for Macau erring on the side of caution.

It’s unclear whether this is good or bad for casino operators.  Running VIP gambling operations is all about controlling the cost of the rebates and amenities needed to get high rollers to commit to visit a casino and gamble a specified (large) amount.  In the past, Crown has initiated price competition in this arena.  At one point, the Macau government stepped in to set a cap on allowable rebates.  Whatever Beijing’s motivations, it may be having the same effect now.

–profits at existing Macau casinos generally have been surprisingly strong.  That’s both because of non-casino attractions like restaurants, shows and shopping, and the continuing strong evolution of a non-VIP market.  Two exceptions:  the Ho family legacy casinos and companies like Wynn Macau, which are opening substantial new capacity.  Contrary to what one might expect,new offerings are not immediately drawing gamblers looking for novelty.  Instead, the Macau experience has been slow but steady progress to full utilization, achieving that goal, say, a year after opening.

One other point:  Macau has been marching to its own drummer in stock market terms over the past couple of years, driven by the course of casino win.  That’s likely to continue   …but it will probably be a positive rather than a negative in 2017.  So Macau may act as a refuge in a time of choppy global markets.

(Note:  I own shares in Wynn Macau (HK1128) and Galaxy Entertainment (HK0027), as well as a tag end of a former Sands China (HK1928) position that I’ve mostly sold (and am not inclined at present to rebuy.))

 

current Japanese inflation? ..there is none

Deflation means that prices in general are falling.  If this is the case, it’s better to put off buying new things for as long as possible, until they’re 100% absolutely needed.  That’s because anything you buy today will be cheaper tomorrow.

After a while, non-consumption becomes a habit, and an economy stagnates.

Conversely, in an inflationary environment, everything is more expensive tomorrow than it is today.  So consumers buy in advance.  In addition to things they need, they may also purchase items they have no intention of consuming.  They may think that keeping physical objects which they can later resell is a better way of preserving or enhancing purchasing power than keeping savings in the bank.

Japan has been in a deflationary economic funk for over a quarter century.   When Shinzo Abe became Prime Minister of Japan in late 2012, he decided to attack deflation as a way of boosting economic growth.  He had a plan that has become famous for its three “arrows”:  a massive depreciation of the yen, large-scale government deficit spending, and corporate/regulatory reform.  Each of the three should have been enough by itself to spark inflation.

The expense of the plan has been enormous, both in terms of the loss of international purchasing power of yen-denominated assets and in increased national debt.

The result after close to four years?   ….as the Tokyo government reported last week, no inflation at all.

How can this be?

From its outset, I’ve believed that Abenomics would be unsuccessful.  I thought the stumbling block would be corporate reform.  The earliest evidence that would indicate I would be wrong would, I thought/think, take the form of an effort to remove the legislative barriers to reform that the Liberal Democrats in the Diet had installed after the deflationary crisis had already begun.  So far, for all practical purposes there’s been nada.  So I continue to be convinced that corporate leaders will resist any changes to the status quo, aided as they are by the Diet’s removal of any levers to force reform from the outside.

Of course, any inflation-induced oomph to consumption won’t last forever.  People and institutions adjust. If nothing else, consumers run out of storage space for the extra stuff they’ve bought.  They then have to throttle back their spending   …or rent a storage unit  …or contemplate a McMansion.

What’s surprising to me, however, is that the same reluctance to spend–although perhaps not to the same degree–is evident in both the US and in Europe.  We might figure that the austerity approach of EU countries wouldn’t exactly spur consumers on.  But the lack of inflation and the paucity of mall-storming or website-crashing consumption in the US after eight years of extraordinary stimulus seem to argue that the overarching economic theories about how to induce inflation are incorrect.

Demographics as the cause?

 

the Hanjin Shipping bankruptcy

Last week Hanjin Shipping (HS), a subsidiary of the Korean Hanjin Group, one of that country’s big industrial conglomerates, filed for bankruptcy.

Korean chaebol conglomerates, their analogue of the Japanese zaibatsu/keiretsu, have traditionally been highly financially leveraged, at least in part on the assumption–again along Japanese lines–of unlimited financial support from the nation’s banks.

I decided long ago that there wasn’t enough payoff for me as investor to spend the time it would take to understand the ins and outs of Korean economic politics.  So I don’t know know why HS was allowed to enter bankruptcy, or whether an effective rescue will ultimately be mounted by the Seoul government.  (The Financial Times says that the chairman of the Hanjin Group is going to inject $90 million into HS and that another $90 million in government loans is being made available, but that this falls short of the $500 million+ HS needs just to pay for unloading cargoes already on its ships.)

The bankruptcy itself seems to have occurred, whether by design or not, in a way that is creating maximum chaos for HS customers:

–HS ships are not being allowed to dock at their destinations, since ports are not likely to be paid docking fees.  Nor are HS ships already in port being unloaded, since dock workers are unlikely to be paid for their work, either.  So cargo in transit is effectively trapped on HS ships.

–some ships have already been seized by creditors, at least partly because HS didn’t take standard legal measures to prevent this

–the move comes close enough to the holiday selling season in the US to be threatening some domestic merchants’ efforts to stock their shelves

–the bankruptcy may disproportionately affect other South Korean chaebols, since HS handles 40% of Samsung Electronics’ exports and 20% of LG’s

Temporary supply chain disruptions aside, the HS bankruptcy is unlikely to do much to address worldwide shipping overcapacity. The ships themselves will continue to exist, although they will doubtless end up in the fleets of financially stronger owners–either third parties or a restructured Korean shipping industry.  What I find most striking about this is the lack of advance planning.