The Ten IPO Commandments

Friday, May 25th, 2012

Via Nic Colas of ConvergEx Group

There’s been a lot of hand-wringing about busted Initial Public Offerings of late, but the process itself is hardly rocket science.  Like Tolstoy’s comment about families, every “Happy” IPO is essentially the same, while every miserable one is different in its own way.  There are rules to the successful IPO, and today we offer up Nic Colas’ manual, a step-by-step checklist for investors to assess if an offering is on track.  From maintaining the illusion of scarcity to managing company and investor expectations, the road from salesforce “teach-in” to final pricing is narrow but well-marked.

I spent the better part of a decade as a senior U.S. equity research analyst at Credit Suisse in the 1990s, covering the auto and auto parts sector.  This was in many ways the heyday of the equity research function at large investment banks, largely because analysts were so deeply involved in capital markets transactions as well as mergers and acquisitions.  In my nine year run I did a variety of lead and co-managed Initial Public Offerings as well as secondary equity issuances for the likes of Chrysler, General Motors, Budget and Dollar Thrifty Rent-a-Car, Goodyear Tire, Ducati, as well as a variety of lesser-known auto aftermarket parts companies and foreign automakers and suppliers.

The process of raising capital in U.S. equity markets has changed very little in the last decade – far less than other parts of the market such as electronic trading.  Companies still choose bankers based on formalized pitch meetings with positioning and valuation discussions.  Analysts do play a smaller role at the front end of the process, but their buy-in is every bit as critical during the marketing of the deal.  And equity salesforces still have an important position in the workflow, pitching the investment merits of the company at hand to first get a meeting and then an order from a long-only or hedge fund client.  Issuing stock is still a basically a specialized house-to-house search for appropriate owners, setting market expectations for near term performance, and getting the equity story out in a consistent and accurate manner.

At the same time, mistakes still happen in even the most well established business processes, as we have seen over the past week.  No need to “Name names” here, because it is not the point of this note to rewarm the leftovers of an already well-publicized failure.  Rather, as I watched the drama unfold in all its can’t-look-away-from-the-car-accident glory, it occurred to me that the wounds of the past week were somewhat self-inflicted.  There are rules to doing an Initial Public Offering.  By and large, investment banks follow these “Commandments” to the letter.  But when they don’t, well, that’s when someone loses an eye.

As I reminisced about the various transactions I witnessed during the 1990s, I started to jot down what I realized are the unwritten, but critical, rules to a successful public offering.  They apply reasonably well to both IPOs and secondaries.  And – conveniently – there are ten of them.

Our “Ten IPO Commandments” are as follows:

1)      Create The Illusion of Scarcity.  The biggest challenge to a successful stock offering is to convince the base of buyers that there is much more demand than supply.  Raising the price range of an offering a good sign.  Increasing the number of shares is much more problematic and requires a “Measure twice, cut once” approach.  It is, after all, a signal that the sellers – who are almost always better informed than buyers – think the price of the offering is compellingly attractive versus their knowledge of the company and its prospects.
2)      Maintain a Consistent and Improving Narrative about the Business.  For an IPO, there is a fairly long window between when you FedEx the initial documents to the Securities and Exchange Commission and the pricing of the deal.  Months, in fact.  Investors’ initial contact with the company comes when they read that initial filing.  From that point on, they want to see and hear an improving story about the business and its prospects.  If that means keeping expectations and commentary about the business modest at first, so be it.  Trajectory is everything.
3)      Make Management Available To Investors.  Chairmen/women and Chief Executive Officers rarely achieve those positions without a healthy dose of self-esteem.  And they often bridle at being quizzed about their company by investors who know much less about the business than they do.  Fair enough, but it is part of the process and investment bankers need to deliver that message and get the most senior people to travel on the roadshow.  My most memorable experience with rocks-star management was Lee Iacocca, the former Chairman of Chrysler, and a bigger-than-life personality.  The key to making sure he was happy on the roadshow was to simply book the biggest hotel meeting space in all the major cities on the agenda.  We called him “Sinatra” and he enjoyed the nickname.  And he was happy to go anywhere and meet anyone after selling out the big rooms.  Investors appreciated that, and I believe they cut the company a lot more slack over time because they had seen Sinatra up close and personal.
4)      Talk to your fellow underwriters.  The best capital markets officers I worked with always maintained an open dialog with their fellow lead and co-manager counterparts.  More information about how the market hears a story is always helpful.  And yet certain investment banks have a reputation for keeping things very close to vest.  Caveat emptor there.
5)      Know Who is Buying.  “Building a book” is the tough part of any stock offering. How much is “Real” – legitimate orders from institutions who want to own the stock – and how much are “Flippers?” Sadly for many capital markets desks, buy-and-hold institutions now trade far less than faster-moving hedge funds.  As deals heat up, customers will try to leverage their importance to the day-to-day trading operation of the underwriters in return for better a allocation.
6)      The IPO is Just the “First Date.”  Many companies think of the IPO as the end of a long journey, which may have started in a dorm room or a garage and ended by ringing a buzzer or a bell.  But for investors, that sound is the beginning of their involvement with the company.  No matter how great the business model or convincing the management team might be, the goal posts have shifted.  Bottom line – as a company, want your IPO to work on day one, week one, and month one.  It will pay dividends when you come back to the capital markets.  And, trust me, you’ll be back.
7)      Know Who is Selling.  No matter how carefully constructed the deal book might be, some significant portion of the accounts will be sellers.  The underwriter needs to have a home for those shares (see Commandment #5).
8)      Retail Is Different.  Most equity offerings allocate 20-30% of the deal to what investment banks call “Retail.” This term connotes individual investors, but can also mean smaller institutions.  If the business is consumer-focused, it will be at the higher end of the range, since these buyers are thought to be customers as well.  And retail is considered “Sticky” money, less likely to sell into any initial stock price pop.  The relationship, however, cuts both ways. A poorly executed IPO stands the chance to alienate customers and damage the company’s brand.  All of which means retail-heavy stock offerings need to be especially well run.
9)      Bankers – Manage Your Client.  The best bankers I have worked with over my career had one thing in common: they established themselves as a financial expert with their clients and never let go of that position.  This is not an easy thing to do, but the reason bankers add value to the process of raising capital is not their ability to socialize or play golf or feign enthusiasm for a company in a pitch.  Their value is that they know more about the intersection of business analysis and capital markets than the clients they serve.  If the client comes to feel that they know more about the process than their bankers, and is allowed to act on that impulse, you can turn out the lights and head home.  The deal isn’t going to work.
10)   Don’t be Afraid to Walk Away.  This applies to both buyers and bankers alike.  The stock market in the U.S. is open from 9:30am to 4:00pm every day.  If you are unsure about the deal, you can still buy it the next day, or the next week, or the next month.  The illusion of scarcity is just that.

And for my hustling banker friends, a story to close out this note…

The most stressful 24 hours of my professional career occurred when I found out a company I was working to take public had inadvertently hired a senior person with falsified credentials.  I took the information to the head of equities, a tough as nails West Point grad.  He immediately called the head of the firm and said the deal was off unless the individual with the fake resume was removed from the transaction.  This was a courageous move, for the deal was extremely high profile and we were the lead manager.  No one argued.  I never saw the fellow again.  I think he is a potato farmer somewhere.

Tags: Auto Aftermarket, Automakers, Capital Markets Transactions, Colas, Credit Suisse, Electronic Trading, Equity Research Analyst, Goodyear Tire, Initial Public Offerings, Investment Banks, Investment Merits, Investor Expectations, Issuing Stock, Last Decade, Managing Company, Mergers And Acquisitions, Rocket Science, Secondary Equity, Step Checklist, Thrifty Rent A Car
Posted in Markets | Comments Off

Emerging Markets Diary (October 25, 2010)

Saturday, October 23rd, 2010

Emerging Markets Diary (October 25, 2010)

Strengths

• China has been supportive of small and medium-sized private companies engaged in equity financing this year, as the Shenzhen Stock Exchange, where most of these smaller deals occur, has raised a record $33.6 billion via initial public offerings this year. This volume is triple last year’s total and higher than the $24.1 billon raised in Shanghai, where mega state-owned companies typically list.
• Thanks to robust external demand for electronics and auto parts, Thailand’s exports rose more than expected to 21.2 percent in September from a year earlier, despite an appreciating local currency.
• China’s GDP expanded by a slightly faster-than-expected 9.6 percent year-over- year in the third quarter, despite policy tightening on real estate and local financing vehicles, as well as power cuts to meet carbon reduction targets.
• Sales of steel billets, long products, and metalware in Russia soared by 47 percent in the third quarter on the back of the seasonal uplift in construction works. Housing volumes approved for construction in 2011-15 exceed those of the previous 2006-10 program by one third.
• ASUR’s passenger traffic in the third quarter rose 10 percent year-over-year. However, the reported EBITDA (earnings before interest, taxes, depreciation and amortization) margin declined to 43 percent from 61 percent, due to changes in accounting standards.
• Brazil’s unemployment rate in September declined to 6.2 percent from 6.7 percent in August, well below market expectations. While the trend is a positive development from an economic recovery point of view, we will monitor whether falling unemployment translates into higher wage claims, which would be worrisome for inflation expectations.

Weaknesses

• China unexpectedly raised both one-year lending and deposit rates by 25 basis points to 5.56 percent and 2.5 percent, respectively, to better anchor inflation expectations and prevent economic overheating in anticipation of further hot money inflows as a result of additional quantitative easing in developed countries.
• The Philippines posted a fiscal deficit of $31.7 billion pesos in September, from a surplus of $1.3 billion pesos in August, driven by an 8.7 percent year-over-year decline in revenue and a slower 3.6 percent decline in expenditure.
• Poland’s Central Bank is expected to raise interest rates next week after inflation accelerated faster than expected in September, reaching its 2.5 percent policy threshold. Since 1998, each of the three tightening cycles began at the Central Bank meeting immediately after the inflation target was met.
• The outcome of the Brazilian presidential election (the second round will be held on October 31) may have an impact on the fortunes of the country’s utilities players. While some, such as Cemig and Copel, are operated and governed at a regional level, where the current governments are supportive of higher tariffs, others such as Eletrobras are governed by federal authorities. The expectations are that the government of Dilma Rousseff would be more consumer-friendly while a government of Jose Serra would be more pro-business.

Opportunities

• Does Fed easing always lead to an emerging markets rally? Examining the historical relationship, BCA indentified two regimes:

1) In the early 1990s, emerging market share prices were negatively correlated with the Fed funds rate. Low interest rates in America drove capital to emerging markets, where growth was robust;

2) Whereas from 1995 until very recently, emerging market equities were positively correlated with U.S. interest rates. Global growth conditions were improving and U.S. interest rates rose in recognition of a firmer economic environment.

Ultimately, if global growth disappoints, emerging markets will likely be hurt regardless of the Fed’s liquidity boost. But if global growth is firm, emerging market prices should resume their uptrend even when U.S. interest rates rise.

• Even though emerging market equities have rallied around 30 percent from the low reached in late May, the ongoing trend has the potential to continue now that industrial production in these developing countries, a critical driver for market returns, has superseded its 2007 peak whereas equities have not responded in the same magnitude.
• China’s total subway length may more than double in the next five years according to construction plans from major cities because of the government’s role in promoting urbanization and consumption. Although 1,014 kilometers of subway lines were already in operation in 11 cities in China as of 2009, subway capacity either per capita or per unit area is still well below the global average, with Shanghai and Beijing representing 62 percent of increased subway length since 2006. Railroad construction and equipment companies should benefit going forward.
• Indonesia has received $52.9 billion of investment commitments from Japan over the next 15 years to fund the country’s 44 infrastructure projects ranging from construction of ports to power plants.
• Although India’s sugar production this year is expected to increase to 24.5 million tons (up 30 percent year-over-year), tighter supplies from Brazil (due to adverse weather conditions and poor infrastructure) have been supportive of sugar prices that are up 16 percent month-over-month in September.
• Brazil’s federal tax revenue in September reached R63.4 billion vs. R62.7 billion in August and compared with R51.5 billion in September 2009 – a sign of better tax discipline and economic recovery that should lead to improvement in the country’s finances.
• Grupo Banorte of Mexico announced its intention to acquire Bank Ixe, with a stronghold in Mexico City. Banorte has long been rumored to be an acquisition target by a number of foreign players eager to expand in Mexico, but the bank had communicated its desire to remain independent. The acquisition of Ixe provides a stronger platform for growth in the country despite Ixe’s relatively small size (around 1.5 percent market share in loans).
• Cencosud (a retail group from Chile) is to acquire Brazilian supermarket chain Bretas, which currently operates 62 stores and three distribution centers in Brazil. This is a further sign of the Chilean retailer’s expansion on the continent. Following this acquisition, Cencosud will derive nearly 20 percent of consolidated sales from Brazil.

Threats

• The Czech government proposed to implement a 25 percent tax on free carbon dioxide credits allocated to power generation companies. The new tax will be effective in 2011 and 2012. The proceeds from this tax will be used to offset the negative impact of higher solar energy generation volume.
• Just two weeks after raising a tax on foreigner’s investments into Brazilian fixed income securities (from 2.5 to 4 percent), the authorities raised the tax again, this time to 6 percent in order to stem the appreciation of the real. It remains to be seen if this measure will prove effective in light of Brazil’s highest real interest rates in the world. Concurrently, the authorities in Colombia and Chile indicated that they will not follow Brazil’s example in discouraging inflows into their countries, both of which are also struggling with appreciating currencies.

Tags: Accounting Standards, Asur, Basis Points, Billon, Brazil, BRIC, BRICs, Carbon Reduction, China, Construction Works, Ebitda, Economic Recovery, Emerging Markets, India, Inflation Expectations, Initial Public Offerings, Market Expectations, Metalware, Passenger Traffic, Private Companies, Reduction Targets, Russia, Shenzhen Stock Exchange, Steel Billets, Unemployment Rate, Uplift
Posted in Brazil, China, India, Infrastructure, Markets | Comments Off

The Emerging Markets IPO Frenzy (Mobius)

Wednesday, August 4th, 2010

This article is a guest contribution from Mark Mobius, Vice-chairman, Franklin Templeton Investments.

Privatization of state-owned enterprises has been a key catalyst in unlocking the market potential of emerging economies. Personally, I believe that listing on stock exchanges or allowing market forces to work can ensure greater efficiency in effective resources deployment.

In recent years, we have seen a rise in initial public offerings (IPOs) in emerging markets (EM) as EM companies begin to recognize the advantages of going to the market to raise capital in order to expand and grow. At the end of 2009, emerging markets IPOs represented about 70% of all global IPOs, as compared to about 20% in 2000.[1] During 2009, the amount of IPO money raised in emerging markets rose steadily. Total funds raised were about US$87 billion. [2]

The flood of emerging markets IPOs was also largely fuelled by excess liquidity in the global markets. There has been a dramatic increase in the money supply in the U.S., China and other countries. As a result of the current low interest rate environment and less attractive growth prospects in developed countries, investors look to emerging markets to seek better yields for their cash.

Although the large amount of IPOs in the market is a reflection of emerging markets’ strength, this huge pipeline may also put downward pressure on the markets as money could be diverted to new issuances, away from existing shares in the market.

In general, institutional pension funds’ exposure to the emerging markets asset class averages around 3% to 8% of their portfolios.[3] From a pure market capitalization perspective  I think that they are severely underweight in the asset class, as emerging markets stocks account for more than 30% of the world’s total market capitalization.[4] We anticipate seeing some shift of institutional allocations to this asset class. Consequently, we believe institutional investors could fuel further demand for emerging markets equities.

However, I have a note of caution for investors who are chasing IPOs and short-term gains. Not all listings are created equal. There is generally a lot of promotion surrounding all new listings. Therefore, it is important to conduct your due diligence and evaluate the stock based on its fundamentals with a long-term investment perspective.

I learned one important lesson during my early days before entering the fund management industry when I made some personal investments. Prior to my Templeton days, I bought into Mosbert Holdings, which was listed in Hong Kong in the 1970s, without proper due diligence and at the advice of a friend. It turned out to be one of the largest cases of fraud in Hong Kong and I lost my investment.

Thus, when it comes to the IPO markets, the key is research. Do your homework on the individual IPO with regards to its respective merit and fundamentals before making an investment decision. Some IPOs issue shares at attractive valuations and this is where good companies can be purchased. And then there are also instances where some may be trading at excessive valuations. On the positive side, IPO companies can also offer new and exciting investment opportunities and broaden the existing investment universe. Market liquidity also improves as a result.

It is always important to have your eye on the long-term horizon when you are making any investment decision and not to be led by the opportunistic promotion of IPOs which often accompanies such issues. IPOs tend to come to the market when the issuers of those shares think the price they can get is high. So buyer beware!

[2] Source: Dealogic, as of April 2010.

[3] Source: Pensions & Investments, as of Jan 6, 2010.

[4] Source: WEF, as of March 2010.

Copyright (c) Mark Mobius, Franklin Templeton Investments

Tags: Class Averages, Downward Pressure, Dramatic Increase, Emerging Economies, Emerging Markets, Excess Liquidity, Franklin Templeton Investments, Global Markets, Growth Prospects, Initial Public Offerings, Institutional Investors, Institutional Pension, Interest Rate Environment, Ipo Frenzy, Ipo Money, Mark Mobius, Money Supply, State Owned Enterprises, Stock Exchanges, Total Market Capitalization
Posted in China, Markets | Comments Off

Emerging Markets Diary (July 26, 2010

Sunday, July 25th, 2010

Emerging Markets Diary (July 26, 2010)

Strengths

• Taiwan’s unemployment rate dropped to 5.2 percent, the tenth consecutive monthly decline thanks to a continued strong recovery in exports.
• Thailand’s exports in June surprised on the upside with a 46 percent year-over-year growth and a 4 percent month-over-month, lending resiliency to its economy despite political turmoil.
• China is planning to spend 5 trillion renminbi through 2020 to promote its alternative energy industry, which may add 1.5 trillion renminbi in industrial production to the nation’s economy and create 15 million jobs annually.
• Chinese airline passenger traffic rose 23.2 percent from a year ago in June to 21.8 million, the fastest pace since August 2009.
• Turkish banks’ year-to-date loan growth was 15 percent, according to the banks’ regulator. The growth was driven by mortgages (up 16 percent) and general consumer loans (up 19 percent). Non-performing loans have declined by 4 percent so far this year, easing the cost of risk and boosting profits, another positive trend.

• The improvement in relations between Russia and the United States is reflected in a marked pick-up in bilateral trade. U.S. trade in goods with Russia through the first four months of the year rose by 27.4 percent, to $8.48 billion, according to the Commerce Department.

Weaknesses

• Chinese car dealers have shown signs of weakening pricing power and introduced incentives to promote sales. Average selling prices of locally made passenger cars in China declined by 2.08 percent year-over-year in June.
• The Russian gas extraction tax is set to increase 10-15 percent next year, reports Russian newspaper Vedomosti. Based on the Finance and the Economy Ministries’ proposals, this could increase the bill to $5.3-$6.6 billion next year from $2.9 billion this year.

Opportunities

• A major contributor to weak performance of Chinese domestic stocks so far this year has been massive initial public offerings (IPOs), which divert liquidity away from the secondary market. In fact, equity capital raised in China’s domestic market over the last 12 months is approaching the 2007 peak, according to BCA Research. This is more than twice the U.S. and three times that of developed Europe. Although it may have been of the government’s own accord to expedite IPOs in order to forestall asset bubbles, poor market performance only discourages fundraising activity in the future. With the completion of China’s last mega bank IPO, anticipation of decelerating equity financing going forward may help sustain the ongoing rebound in Chinese stocks.

• Going back to 1990, the average gain for the MSCI Emerging Markets Index in a new bull market has been 57 percent for the first year. The average gain the following year has been a much more modest 9 percent. Citi posits that in the excitement of the first year, equity markets rebound first and stay well ahead of earnings; the following year markets have to wait for earnings to catch up before moving higher.

Threats

• Government policy uncertainty might linger in China before new central leadership officially takes over in 2012, as the incoming and outgoing administrations continue to debate and maneuver for power according to their own visions and agendas for the Chinese economy over the next decade.
• Standard & Poor’s is reviewing Hungary’s credit rating for possible downgrade after the collapse of talks with the International Monetary Fund (IMF). Without an IMF program in place, Hungary is likely to face higher and more volatile funding costs, which could weigh on its financial sector, public finances and economic growth, according to the rating agency.

Tags: Airline Passenger, Bilateral Trade, Chinese Airline, Commerce Department, Consumer Loans, Decline Thanks, Domestic Stocks, Economy Ministries, Emerging Markets, Gas Extraction, Initial Public Offerings, Loan Growth, oil, Passenger Cars, Passenger Traffic, Political Turmoil, Renminbi, Resiliency, Russia, Russia And The United States, Russian Gas, Turkish Banks, Unemployment Rate
Posted in China, Energy & Natural Resources, Markets, Oil and Gas, US Stocks | Comments Off

India’s Focus on Investor Protection

Monday, April 19th, 2010

Email this article | Print this article

India’s Mumbai Stock Exchange

Week Ended: April 16, 2010

India’s financial sector watchdogs have demonstrated their independence time and again. For example, the country’s central bank, the Reserve Bank of India, was one of the few central banks that chose to break from prevailing global loose monetary policies. India’s other regulator, the Securities and Exchange Board of India (SEBI), which is equivalent to the Securities and Exchange Commission (SEC) in United States, has also come a long way in asserting itself. Established in 1992, SEBI has been making systemic reforms aimed at better corporate governance, deeper capital markets and more satisfied investors.

SEBI’s primary goal has always been investor protection. Its recent efforts to abolish entry and exit loads—sales charges paid by mutual fund investors—has significantly brought down investing costs. SEBI’s recent listing regulations have balanced the interests of minority shareholders with those of promoters intending to delist companies. It has also offered guidelines for enhanced disclosures and mandatory grading of Initial Public Offerings (IPOs). Real estate IPOs, for example, are required to reveal complete ownership details of land banks and report market-determined asset values.

The regulator has also been gradually raising India’s corporate governance standards. A decade ago, SEBI managed to implement the disclosure of quarterly financial results amid huge resistance. Recently, it required the semiannual disclosure of balance sheets, in efforts to limit the scope of any “creative accounting.” SEBI has also asked companies to increase the weight of independent directors on their boards as part of its efforts to create checks and balances. These checks are meant to improve auditor oversight following an accounting scandal that surfaced at a leading technology company early last year.

Developing capital markets has been a high priority for SEBI. About a decade ago, SEBI streamlined security transactions by eliminating the need for investors to hold shares in paper form. This was followed by their push to have exchanges implement online trading capabilities. To improve liquidity and price discovery, it recently introduced short selling and is now enhancing securities lending mechanisms that enable this. SEBI has also proactively introduced new asset classes and exchanges to enable broader capital market participation.

Despite its accomplishments, SEBI still has a lot of unfinished work. For example, the liquidity in India’s capital markets is significantly lower than expected. In addition, SEBI—which currently spurs product innovation—could arguably be better served to leave that function in the hands of the exchanges themselves, and focus on the task of regulating its markets.

Sunil Asnani
Research Analyst
Matthews International Capital Management, LLC

Tags: Accounting Scandal, Asset Values, Bank Of India, Central Banks, Checks And Balances, Corporate Governance Standards, Exchange Board, India, Initial Public Offerings, Investor Protection, Land Banks, Minority Shareholders, Mumbai Stock Exchange, Mutual Fund Investors, Ownership Details, Quarterly Financial Results, Reserve Bank Of India, Sales Charges, Securities And Exchange Board Of India, Securities And Exchange Commission, Systemic Reforms
Posted in India, Markets | 2 Comments »

Emerging Markets Highlights (February 28, 2010)

Sunday, February 28th, 2010

Emerging Markets

Strengths

• Taiwan’s GDP grew 9.2 percent year-over-year in the fourth quarter of 2009, exiting a recession which started in late 2008. Not only were exports and investment on the rise, but private consumption registered the strongest quarterly increase in the last 20 years.
• Thailand’s fourth quarter GDP rose 5.8 percent from a year earlier, accelerating from a 2.7 percent contraction during the third quarter. The change came as private consumption and government spending more than offset still anemic investment constrained by political uncertainty.
• January wireless data for Brazil indicated net additions of 1.6 million and a 16 percent year-over-year increase in total subscriber base. Vivo accounted for 43 percent of new subscriber additions, followed by Claro (América Móvil) with 25 percent and Telecom Italia Mobile with 24 percent. Brazil wireless penetration currently stands at 92 percent compared with 76 percent in Mexico, 116 percent in Argentina, 98 percent in Chile, 81 percent in Colombia and 68 percent in Peru.
• Unemployment in Brazil rose to 7.2 percent during January, up from 6.8 percent in December due to a seasonal effect but was better than the market expected.
• According to Troika Dialog metals and mining analysts, Russian gold mining companies boast output growth that is among the highest on the global landscape, while appearing attractive on valuation grounds.

Weaknesses

• Initial public offerings launched by Chinese companies in the U.S. during the fourth quarter declined 4.8 percent on average in the first month of trading. The loss deteriorated to 6.7 percent for IPOs in January and February, the longest slump in five years, as investor continued to trim risk exposure and sentiment remained weak.
• Results from Brazilian toll road operator Companhia de Concessões Rodoviárias (CCR) came in weaker than anticipated due to higher costs.
• Murray and Roberts, the largest engineering firm from South Africa, provided a murky outlook for its operations. While the company was positive about its long-term outlook, its short-term future is foggy—particularly with respect to operations in the Middle East.
• Price expectations for residential buildings in Czech Republic remain stagnant even after a significant recession, according to Citi research. The chart shows realized prices significantly below offer prices, while expectations from a business survey point to further weakness.

Opportunities

• Expanded urbanization and regional development are expected to be confirmed as a major policy focus in China in the upcoming annual plenary session of the National People’s Congress. Supportive policies may be created to empower local governments to develop infrastructure and attract capital because of the role urbanization plays in promoting consumption. Indeed, even global luxury brands have spread their presence beyond coastal China into second- and third- tier cities to position for tomorrow’s growth.

• As uncertainty related to global policy actions in both the developed and emerging worlds continues to rise, Russia could become a spot of relative stability, according to Bank Credit Analyst research. The chart shows that equity valuations are still low compared with the emerging market universe.

Threats

• Domestic sugar prices in China have been on the rise so far this year as drought in southern China affected cane production. There are also news reports about labor shortages, especially in the Pearl River Delta area where some migrant workers chose not to return to work after the Chinese New Year because of unattractive wages compared with inland regions. There could be inflation going forward if these developments persist.
• Although an announcement of higher bank reserve requirements in Brazil had been expected, some market participants may view it as ambiguous with respect to the impact on the banks’ top and bottom lines. We do not expect a detrimental impact on the profitability of Brazil’s banks because they will still be earning interest on the reserves at the SELIC rate—the overnight lending rate set by Brazil’s central bank.
• Political tensions in Turkey have escalated this week following new arrests related to an alleged 2003 military coup against the ruling Justice and Development party. The uncertainty related to the outcome of a likely referendum on controversial judiciary reform may also contribute to further market volatility.

Tags: Brazil, Ccr, Chinese Companies, Contraction, Emerging Markets, Engineering Firm, Fourth Quarter, Global Landscape, Gold Mining Companies, Initial Public Offerings, Political Uncertainty, Private Consumption, Quarter Gdp, Quarterly Increase, Risk Exposure, Russia, Seasonal Effect, Subscriber Base, Telecom Italia, Telecom Italia Mobile, Toll Road, Troika Dialog
Posted in Brazil, Infrastructure, Markets, Outlook, US Stocks | Comments Off

Boom and Burst: Don’t be fooled by false signs of economic recovery. It’s just the lull before the storm

Monday, August 24th, 2009

Andy Xie is a former Morgan Stanley economist now living in China; The following is from the South China Morning Post:

The A-share market is collapsing again, like many times before. It takes numerous government policies and “expert” opinions to entice ignorant retail investors into the market but just a few days to send them packing. As greed has the upper hand in Chinese society, the same story repeats itself time and again.

A stock market bubble is a negative-sum game. It leads to distortion in resource allocation and, hence, net losses. The redistribution of the remainder, moreover, isn’t entirely random. The government, of course, always wins. It pockets stamp duty revenue and the proceeds of initial public offerings of state-owned enterprises in cash. And, the listed companies seldom pay dividends.

The truly random part for the redistribution among speculators is probably 50 cents on the dollar. The odds are quite similar to that from playing the lottery. Every stock market cycle makes Chinese people poorer. The system takes advantage of their opportunism and credulity to collect money for the government and to enrich the few.

I am not sure this bubble that began six months ago is truly over. The trigger for the current selling was the tightening of lending policy. Bank lending grew marginally in July. On the ground, loan sharks are again thriving, indicating that the banks are indeed tightening. Like before, government officials will speak to boost market sentiment. They might influence government-related funds to buy. “Experts” will offer opinions to fool the people again. Their actions might revive the market temporarily next month, but the rebound won’t reclaim the high of August 4.

This bubble will truly burst in the fourth quarter when the economy shows signs of slowing again. Land prices will start to decline, which is of more concern than the collapse of the stock market, as local governments depend on land sales for revenue. The present economic “recovery” began in February as inventories were restocked and was pushed up by the spillover from the asset market revival. These two factors cannot be sustained beyond the third quarter. When the market sees the second dip looming, panic will be more intense and thorough.

The US will enter this second dip in the first quarter of next year. Its economic recovery in the second half of this year is being driven by inventory restocking and fiscal stimulus.

However, US households have lost their love for borrow-and-spend for good. American household demand won’t pick up when the temporary growth factors run out of steam. By the middle of the second quarter next year, most of the world will have entered the second dip. But, by then, financial markets will have collapsed.

China’s A-share market leads all the other markets in this cycle. Even though central banks around the world have kept interest rates low, the financial crisis has kept most banks from lending. Only Chinese banks have lent massively. That liquidity inflated the mainland stock market first, then commodity markets and property market last. Stock markets around the world are now following the A-share market down.

By next spring, another stimulus story, involving even bigger sums, will surface. “Experts” will offer opinions again on its potency. After a month or two, people will be at it again. Such market movements are bear-market bounces. Every bounce will peak lower than the previous one. The reason that such bear-market bounces repeat is the US Federal Reserve’s low interest rate.

The final crash will come when the Fed raises the interest rate to 5 per cent or more. Most think that when the Fed does this, the global economy will be strong and, hence, exports would do well and bring in money to keep up asset markets. Unfortunately, this is not how our story will end this time. The growth model of the past two decades – Americans borrow and spend; Chinese lend and export – is broken for good. Policymakers have been busy stimulating, rather than reforming, in desperate attempts to bring growth back. The massive increase in money supplies around the world will spur inflation through commodity-market speculation and inflation expectations in wage setting. We are not in the midst of a new boom. We are at the last stage of the Greenspan bubble. It ends with stagflation.

Hong Kong’s asset markets are most sensitive to the Fed’s policy due to the currency peg to the US dollar. But, in every cycle, stories abound about mysterious mainlanders arriving with bags of cash. Today, Hong Kong’s property agents are known to spirit mainland-looking men, with small leather bags tucked under their arms, to West Kowloon to view flats. Such stories in the past of mainlanders paying ridiculous prices for Hong Kong flats usually involved buyers from the northeast. In this round, Hunan people have surfaced as the highest bidders. The reason is, I think, that Hunan people sound even more mysterious. But, despite all this talk, the driving force for Hong Kong’s property market is the Fed’s interest rate policy.

Punters in Hong Kong view the short-term interest rate as the cost of capital. It is currently close to zero. When the cost of capital is zero, asset prices are infinite in theory. At least in this environment, asset prices are about story-telling. This is why, even though Hong Kong’s economy has contracted substantially, its property prices have surged. Of course, the short-term interest rate isn’t the cost of capital; the long-term interest rate is. Its absence turns Hong Kong into a futile ground for speculation, where asset prices increase more on the way up and decrease more on the way down.

When the Fed raises the interest rate, probably next year, Hong Kong’s property market will collapse. When the Fed’s policy rate reaches 5 per cent, probably in 2011, Hong Kong’s property prices will be 50 per cent lower.

Andy Xie is an independent economist.

Boom and burst
Don’t be fooled by false signs of economic recovery. It’s just the lull before the storm
Andy Xie
South China Morning Post Aug 24, 2009

(h/t: Barry Ritholtz, The Big Picture)

Tags: Andy Xie, China Morning Post, Chinese Society, Commodities, Credulity, False Signs, Government Policies, Initial Public Offerings, Living In China, Loan Sharks, Local Governments, Lull Before The Storm, Market Sentiment, Morgan Stanley, Opportunism, Ormer, Resource Allocation, Retail Investors, South China Morning, South China Morning Post, Speculators, State Owned Enterprises, Stock Market Bubble, Stock Market Cycle
Posted in Markets | Comments Off