Bulls and Bears: Tales of the Zoo

The 1981-2 Malaysian tin market fiasco

2008-07-09T07:36:00.000-07:00

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It is interesting to read about another speculators' attempt to control a particular segment of the commodities market, given all the heated arguments recently about how much oil price dynamics are being driven by futures speculation.

This attempt was in 1981 and ironically it wasn't long after the Hunt Brothers' failed attempt to corner the silver market. The Malaysian government(!) was the main protagonist, and its objective was decidedly altruistic: to support tin prices to "protect the national interest" (Malaysia was the world's largest tin miner).

Then, there was actually a global organisation, made up of tin consumer and producer countries, to maintain tin prices. This was known as the International Tin Council (ITC); it acted on behalf of the various members to buy up surplus tin stocks to maintain the price at a steady level. New substitutes for tin had emerged within its traditional applications: the advent of aluminium containers, the use of protective polymer lacquers inside cans, and increased recycling by industry, had all caused the demand for tin to stagnate considerably in the early 1980s. In 1981, the ITC consumer members rejected producer demands for higher prices. The Malaysian government, on advice from a Swiss commodities broker Marc Rich, then unilaterally commenced secret operations to buy tin futures on the London Metal Exchange (LME) from July 1981 till early 1982.

Initially the operations succeeded in supporting tin prices, which rose sharply from <7000 GBP/ton to nearly 9000 GBP/ton within 8 months. The tin price did not rise more because traders on the LME were short-selling on the other end. But cracks began to appear, as the natural consequence of rising prices was rising supply; in addition, the US announced its intention to sell part of its 200,000 ton stockpile in November 1981 --- which drew more short-sellers.

It was around this time that the Malaysian/Swiss partners switched tactics from a price-support operation (through buying futures) to attempting to corner the tin market through making spot purchases of physical tin for cash. This would, hopefully, squeeze the short-sellers into paying much higher prices when they would find no tin to cover upon contract expiry. But the switch in strategy dramatically increased the stakes, because as opposed to only needing to post 10% margin for futures, the cornering operation's spot buying needed 100% cash for immediate settlement. Then all this physical tin needed insurance and storage --- additional costs. Where did the money come from? Loans from state-linked banks Bank Bumiputra and Maybank of course --- another example of the many legendary shady interlinkages between industry and government in Malaysia.

It turned out that the people who got squeezed were the aspiring cornerers themselves. Those who had sold short futures contracts did indeed find it hard to locate tin to deliver as settlement day approached. This created a crisis on the LME, with traders facing the prospect of default and ruin. As the short squeeze loomed in February 1982, the LME changed its rules --- it declared that traders who failed to meet sales contracted could pay a fine --- 120 GBP/ton --- instead of supplying physical tin, meaning short sellers could avoid paying steep premium to the cornerers, which could have been >1000 GBP/ton. There was a collapse in tin prices following the ruling, culminating in massive losses for the Malaysian/Swiss partners. At the same time, tin supplies continued to come from the US stockpile while tin users began reducing stocks due to high prices and a continuing global recession.

The subsequent price collapse from 9000 to 7000 GBP/ton within a month due to the rule change cost the partners a paper loss of >500M RM even as they were stuck with 50000-60000 tons of tin in physical stock that they had never meant to keep long-term. Worse was to come, as fast falling tin prices forced the ITC (the earlier-mentioned tin cartel) to begin massive intervention to protect the artificially high floor price until it too ran out of funds in 1985, defaulting on 900M GBP(!) loans and triggering another tin price collapse.

Ultimately, thousands of Malaysian mine workers were laid off and hundreds of mines closed due to the collapsing tin prices that rendered many mining operations no longer viable. The "good intentions" of the Malaysian government had boomeranged cruelly back on itself, and from the mid-1980s onwards tin would no longer be a key export for Malaysia that it had been for decades extending back to British colonial rule as an indirect result of the 1981 fiasco. For bystanders it was a lesson not to interfere in or manipulate normal operations of the market and attempt to go against the fundamentals of demand/supply. For the Malaysian government and Dr Mahathir (the cornering operational plans and political support went up to the highest levels), it reinforced their belief that the West was not to be trusted --- in 1986 when the scandal was finally publicly admitted by the Malaysian government, on persistent allegations by opposition leader Lim Kit Siang, Mahathir defended the intervention by contending that only "massive cheating in the London Metal Exchange" had deprived the government of profits from its trading (the LME defended itself by asserting that the exchange was required by its own rules to block an apparent attempt to corner the market).

There was an accompanying scandal following the 1982 fiasco where the Malaysian government scrambled to find funds to cover back the loans it had taken from the state-linked banks to finance its cornering operations, which involved the use of Employee Provident Fund (EPF) pension money to play the local stock market. That is another story for another day. A key lesson from the 1981-2 fiasco, together with the similarly ill-fated Hunt Brothers' silver corner around the same time, is the wild card of exchanges making rule modifications in response to extreme market conditions that can instantly crush any market manipulation operations. Tin or silver were relatively small markets. It is hence difficult to imagine someone attempting to manipulate the oil markets, for example, with its infinitely bigger liquidity on top of wild losses should the exchange decide to tweak its rules again if it should perceive market irregularities. Who says you can't change the rules?

References:
(1) M Way -- Mahathir's Economic Legacy (Jom K.S.)

Crash stock: L & M

2008-04-11T06:24:00.000-07:00

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I decided to research and document the history of this company/stock after reading an online discussion about a certain prominent member of the local property industry and his version of his involvement with L&M in the 1990s. Its history is chequered, and the more I read, the more intrigued I became. It is the perfect example of a political stock gone wrong.

L&M was a prominent structural engineering firm in the 1970s and 80s, and listed on the then SES (predecessor of SGX) in 1983. L stands for Paul Lim, M for Richard Mulholland; they were the two prime drivers of L&M as it continued to expand market share into the 1990s, when they started to diversify into property development and investments. When Guthrie GTS mounted a takeover of L&M Group Investments in the early 1990s, it was a local construction giant with overseas projects in ASEAN and Asia turning over >$200M per year. Profits were razor-thin though, at about $1-2M per year. Nonetheless, the founders exited the scene with good money as new management came onboard and a new chapter began.

The insipid earnings performance continued under Guthrie for the next few years, even as turnover continued to grow to >$400M by 1995. Share price accordingly hovered around the $1 mark, though during the great bull run of 1993-94 it reached nearly $2. Then in late 1995 ownership changed hands again.

In the 1990s the kingpin of ASEAN was Indonesia. Under President Suharto the system of patronage, later derided as crony capitalism, was booming, and Indonesia was minting millionaires out of those with close ties to the ruling elite. Singapore was a natural destination for these rich Indonesians to park their wealth. A 1996 Asiaweek article details the companies that became Indonesian vehicles then:

As seen in the table, L&M was acquired by an Indonesian consortium led by Johannes Kotjo, former CEO of the Salim Group, with Bambang Trihatmodjo - the elder son of President Suharto - also being one of the shareholders. The buy-in price was close to $4 --- a level that would never be seen again.

There was much hope that the Suharto ties would bring big fat contracts from the Indonesian government, but earnings post-acquisition never really took off and the effect was that share price soon went south to half the acquisition price by 1997. That was still not too bad because the emerging markets of Asia were firing on all cylinders then, and the general market was buoyant and relatively forgiving, especially towards market darlings with strong political links (and hence growth prospects, it was assumed). In early 1997 the Soeryadjaya family took over control of L&M, with the former owners exiting at a big loss. Next better (Indonesian) player.

You have to say that the Soeryadjayas, they who lost the Astra empire in the early 90s, really seem to be cursed with bad luck. The troubles at L&M really began, as with so many other construction/property companies at that time, with the 1997/98 Asian financial crisis. For years, L&M had been operating on high leverage; by 1997 its short-term loans equalled equity funds and interest expense was nearly half of operating profit. Thus when the Asian currencies took severe haircuts during the crisis the balance sheet liabilities suddenly ballooned.

The company faced problems refinancing its loans, which it kept having to extend month by month. To compound its issues on hand, it faced legal suits and claims during this period for certain overseas construction projects amounting to tens of millions of dollars. In 1998, it was forced to make provisions and writedowns amounting to $50M, and wound down its property and infrastructure division. In mid-1999 the company appointed an advisor to restructure its loans; there were questions whether the company could continue as a going concern. The share price sank to below 25 cents at the bottom (1998).

True to its past history, the market fortune of the stock, in contrast to its actual operational performance, did a revival again in late 1999. Again, its revival was tied to political developments in Indonesia. Abdurrahman Wahid was the new Indonesian President, and the Soeryadjayas had long had business ties with him. By fair means or foul, L&M was chosen as the company to develop and manage Cybercity in Jakarta, Indonesia's answer to Malaysia's Cyberjaya, Hong Kong's Cyperport (under Richard Lee's Pacific Century), and of course USA's Silicon Valley. L&M was poised to become the top IT and Internet infrastructure player in Indonesia. Those who have been through the dot-com mania of 1999-2000 would understand the impact of such a possibility on investors' imaginations, even when the company involved was still in the midst of a loan restructuring process. The stock jumped from $0.60 to $1.50 in 3 months to January 2000, as even veteran investors started to buy into the idea of it being the beneficiary of Indonesian political connections both current and future. This was further reinforced by the entry of Bambang Sukmonohadi as a shareholder; Bambang was then Vice-President Megawati Sukarnoputri's father-in-law. Rumours swirled of Microsoft, Lucent, Singtel, PCCW joining L&M in the Cybercity development, further reinforcing investor optimism.

Unfortunately the dot-com mania ebbed at the turn of the millenium, and with it the plans for Cybercity mysteriously died away. There had been some stock sales by insiders in the meantime. However, the company managed to keep itself in the public eye over the next 1-2 years, with the announcement of deals many of which never materialised: plans to list L&M's geotechnical division; plans to buy Singapore-listed Van Der Horst, Presscrete, Link Islands and Malaysia-listed Mitrajaya that were all later cancelled; several agreements in Indonesia, including a joint venture to promote and build a mass rapid transit transport system in Jakarta, a letter of intent to supply and purchase sea sand (from Indonesia to Singapore); acquisition of infrastructure assets of Van der Horst (this one materialised). In the midst of all this, it was indeed impressive that the company still found time to make losses of $30M in FY00 and then follow up with an even more impressive loss of $70M in FY01.

By 2001, despite all the huffing and puffing by the enterprising and publicity-savvy L&M management, the share price had dropped to $0.20 under the weight of the bone-crushing losses. With its financial situation rapidly deteriorating and credit facilities tightening, the company found it difficult to deliver on existing contracts as it was unable to pay workers. By 2003, the company had undergone a series of recapitalisation exercises that ballooned its outstanding shares. By then, the company had run up a shattering total loss of $200M over 2000-03. By 2004, L&M was trading at 1 cent as it entered into one of its last placement/debt restructuring exercises that saw outstanding shares balloon to nearly 9 BILLION shares. In 2005 the stock was suspended and the suspension has not been lifted since. The company's profitable assets have since been taken over (eg. geotechnical/piling assets by CSC) and it is difficult to see shareholders recovering any significant value back from the company from here, even if it undergoes an RTO.

The company started from a strong position in a strong industry in the early 1990s, and had luminaries like Albert Hong (venerable chairman of RSP Architects) sitting on its board. It then degenerated into a heavily politicised stock under the Indonesians, and its operations never fully recovered from the Asian crisis. Speculators were attracted to its multi-bagging ability that often happened in short spurts (1995, 1999-2000) as well as the political connections associated with its key shareholders; however circumstances have developed such that political stocks have come in for the worst mauling simply because the crony capitalism practised by Indonesia has toned down (mind you, it has never disappeared) after Suharto was overthrown. Companies that hope to profit from economic rent-seeking and do not focus enough on core competencies and operating leanness can easily lose focus; similarly stocks that are based on concept but have little grounding in real profitability will eventually crash to earth.

References:
(1) Shareinvestor.com archives on L&M

Crash stocks: The Plastics Stocks

2008-02-15T20:44:00.000-08:00

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I highlight the plastics sector in this article to illustrate the folly of long-term buy-and-hold without regular monitoring and assessment of industry dynamics, or even the simpler approach of cutting loss or taking profit at certain cut-off points. The failure to identify the cyclical nature inherent in a particular sector, coupled to a stubbornness in refusing to exit before it is too late, can lead to heavy underperformance in a bull market and hence great frustration.

This is a convenient sector to track because I follow the sector through my self-created Plastics Sector Index started in mid-2006. By then the sector was already accelerating into its declining stage. But even then, from a starting index of 100, the sector has plunged another 40% through the 2007 market bull and the subsequent bear to hit just above 60 today. For comparison, the STI was up ~35% over the same period, while outperforming sectors/themes like oil&gas and China are up over 60% (according to two other tracking indices I created). Be a patient buy-and-hold investor in the wrong sector and you will be disgusted at the stock market and more justifiably, at yourself.

The boom in the plastics sector started in mid-2003 and lasted till early 2005. That they were among the first stocks to charge up in the bull run gives credence to the sector timing view that technology stocks are among the early movers in an economic recovery.

Indeed, the plastics sector had been growing revenues and profits consistently even as early as from 2002 onwards, which probably caught fund attention when the global rebound began in earnest in mid-2003. They were riding on the trend of electronics manufacturing being outsourced to Asia, a structural shift which had already seen a major wave of re-ratings on SGX-listed EMS (electronics manufacturing services) companies in 1999/2000 along with major M&A deals; the action moved to plastics moulders in 2003-05.

The main sector leaders were Fu Yu, Meiban, Sunningdale, Hi-P, First Engineering. Fu Yu made plastic parts for HP and also Chinese handset companies; Meiban served HP and Dyson; Sunningdale made plastic automotive parts; Hi-P moulded for a diversified customer set and also did downstream contract manufacturing; First Engineering did high-precision components for HP, hard-disk drive OEMs and automotive suppliers. Over 1.5 years from mid-2003 to end-2004, these companies doubled or tripled in price as institutional funds piled in.

I have this plastics sector report from Kim Eng in August 2004 at the height of the boom, and its views were typical of bullish brokerage views of the sector at that time. I quote: "Despite rising uncertainty in the electronics industry" (yes, the industry was already stagnating then), Kim Eng was positive because (1) the outsourcing trend; (2) "it is the material of choice in many products, replacing others such as metal and glass"; (3) "Plastic is playing a more important part in product differentiation" (whatever that means); (4) "Plastic component makers are becoming contract manufacturers and capturing the additional value added in the manufacturing process". Generally, it then set price targets of 15-20X trailing, or even forward PE, on these companies. Typical of brokers to fan the flames of bullishness when the going is smooth.

How, then, to explain the collapse since mid-2005? Obviously, the fundamentals in the form of earnings drove the collapse. Examining one layer deeper, and consolidating the reasons offered by the various plastics companies since then explaining their profit drops, we find that there was a simultaneous confluence of: drop in demand leading to pricing pressure from customers, buildup in plastics manufacturing capacity leading to excess, and a rise in raw material costs due to continually rising oil prices (plastics is a petrochemical product). Individual companies faced further company-specific problems that exacerbated the dire industry plight for them: for example, Fu Yu faced a meltdown of the domestic China handset makers which were some of its main customers, and later ran into management problems; Hi-P's main customer Motorola went downhill after failing to follow up on the success of its Razr handphone; Sunningdale merged with another moulder Omni Mould and then found it hard to cope with integration and excess capacity.

The developments described above lend credence to the view that when it rains, it pours, and thus we should never try to catch a falling knife where sectors or individual companies are concerned (but markets are another matter). Capacity excesses take a long time to work themselves out, and the markets can punish the sector leaders mercilessly in a death spiral: first a PE de-rating as institutional funds sense that the sector has peaked and start to exit, then further price fall as earnings drop continuously, finally a fall below NTA (net tangible assets) as the slide continues (a stock trades justifiably below NTA if its return on equity is too low).

Today Fu Yu is trading at sub-20 cents, a fifth of its peak, and faces investigations for management indiscretions. Hi-P is also trading at about a fifth of its peak as profit margins have halved over each of the last two years. Meiban seems to have recovered in earnings but due to sector PE de-rating remains at a third of its peak. Sunningdale trades at half its NTA; at its peak it was trading at 2-3 times NTA. First Engineering had the best ending: it got acquired at $1.00, just a third off its peak at ~$1.40. There is still no respite for the sector: even if the excess moulding capacity has resolved itself or if individual company managements have embarked on new and more effective positioning strategies, the end demand from the Western economies does not look like picking up anytime soon as the sub-prime crisis continues to exact its toll.

References:
(1) Kim Eng report Aug 04: Plastic Rules

The Bretton-Woods Currency System and Its Collapse

2008-01-17T06:57:00.001-08:00

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Currency systems have always been one of the cornerstones of world finance; this has become even more apparent in recent years with globalisation and its accompanying trade and financial liberalisation as pushed mainly by the West. With free capital flows into and out of countries, whether local currencies are fixed or freely floating determines the actions that central banks have to take to maintain status quo, as well as the kinds of stress on the system and its stability. Emerging markets suffered badly due to incompatibility of currency systems versus their ability to manage capital flows in 1997-98.

My writeup details the development of the Bretton-Woods currency system after World War 2, and its subsequent collapse more than 20 years later. It gives a perspective on the difficulty of maintaining status quo on the international currency markets.

In the 19th and early 20th centuries gold played a key role in international monetary transactions. The gold standard was used to back currencies; the international value of currency was determined by its fixed relationship to gold; gold was used to settle international accounts. This was the classical gold standard. Supplementing the use of gold in this period was the British pound as a reserve currency. The implication of the gold standard and full convertibility was that exchange rates were fixed, and tended to be self-stabilising: under trade deficits a country's gold reserves would be depleted with corresponding decrease in money supply (since it had to be backed by gold) and importing power would decline, while the lowering of prices would boost exports; thus the deficit would be rectified.

After World War 2, the Bretton Woods conference was convened to structure the international economic framework for the future. One of the key items was the global currency system. Exchange rate stability was a prime goal; however the classical gold standard could no longer be used because gold production was not sufficient to support burgeoning world trade. What emerged was the "pegged rate" currency regime. Members were required to establish a parity of their national currencies in terms of gold (a "peg") and to maintain exchange rates within a "band" by intervening in their foreign exchange markets (ie. buying or selling foreign money). This was somewhere in between pure fixed exchange rates and pure freely-floating rates.

In practice, the world's currencies were pegged to the main reserve currency, now the US dollar, with the latter then pegged to gold at the rate of US$35 per ounce of gold. The US dollar therefore became the key currency of the Bretton Woods system and most international transactions were denominated in dollars from then on. A key reason for this arrangement was that post-WW2, the US dollar was the only currency strong enough fundamentally to meet the rising demands for international liquidity. It was also running a huge balance-of-payments (BOP) surplus; thus, maintaining the Bretton-Woods system necessitated reversal of this BOP flow to meet international dollar shortage. The Bretton-Woods system was highly advantageous to the US which would use the convertible financial system in a system of triangular trade as follows: it would trade (at a tremendous profit) with developing nations, expanding industry and acquiring raw materials. It would use this surplus to send dollars to Europe, which would then be used to rebuild their economies, and make the United States the market for their products. This would allow the other industrialized nations to purchase products from the Third World, which reinforced the American role as the guarantor of stability.

The Bretton-Woods system functioned very well for over 20 years. But it was founded on a contradiction. The system would continue to operate while the mass of US dollars circulating in the rest of the world was backed by gold held in the US. But the very expansion of the international economy tended to increase the need for international liquidity in the form of US dollars. That is, the more the global economy expanded, the shakier became the relationship between the dollar and gold.

In the 1960s, the dollar overhang—the difference between the dollars in international circulation and the value of the gold backing held by the US—began to grow as a result of increased US investment abroad and military spending (eg. the Vietnam war). The growth of the Euro dollar market (please read up yourself) also meant that growing amounts of financial capital were now able to move around the world outside the control of governments; capital controls to maintain incumbent fixed exchange rate regimes (as under the Bretton-Woods system) would not be effective (a tenet of economics is that it is impossible to balance a fixed exchange rate regime with open capital flows).

By 1968, the attempt to defend the dollar at a fixed peg of $35/ounce, the policy of the Eisenhower, Kennedy and Johnson administrations, had become increasingly untenable. Gold outflows from the U.S. accelerated as its balance of payments swung towards zero, a massive reversal from the post-WW2 years. By the early 1970s, as the Vietnam War accelerated inflation, the United States as a whole began running a trade deficit (for the first time in the 20th century). In 1971, as financial assets continued to flee the US and the US economy showed signs of a tailspin, President Nixon finally announced, in August, that the US was unilaterally removing the gold backing from the dollar, effectively spelling the end of the Bretton-Woods fixed-rate system centred on the dollar.

The removal of the gold backing from the US dollar was rapidly followed by the abolition of fixed currency relationships globally and the lifting of restrictions on the movement of capital throughout the 1980s. The demise of the gold standard and global fixed exchange rate regime has been blamed for a series of ensuing currency crises. In 1987, differences between US and German authorities over interest rate policies directly contributed to the October stock market collapse. The decade of the 1990s saw the sterling crisis of 1992, followed by the turbulence in bond markets in 1994 and the Mexican bailout of 1994-95. Then came the Asian crisis of 1997, followed by the Russian default of 1998. Many of these were precipitated by countries managing their own pegs that turned out to be overvalued. Under the Bretton-Woods system, their currencies would have been pegged to the US dollar whose value would be backed by gold; value was assured. But then again, the Bretton-Woods system had also met its demise due to internal instabilities as described above. It just goes to show the dynamism of international finance, and why it is important to evolve one's views, beliefs and positions with time.

References:
(1) When the Bretton Woods system collapsed
(2) Wikipedia: Bretton-Woods System

The 1980s US Savings and Loan Crisis

2007-08-23T08:05:00.000-07:00

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In the midst of a (temporary?) respite from the subprime crisis that enveloped global financial markets in panic over the last two weeks, I find it an appropriate time to look back at a similar crisis that the subprime issue is often compared to: the US savings and loan crisis of the 1980s. There are indeed some parallels that can be drawn between the two.

In the US, savings and loan institutions (also known as S&Ls or thrifts) have existed since the 1800s. They originally served as community-based institutions for savings and mortgages for the conservative residential mortgage sector, surrounded by legislation put in place in the 1930s to promote home ownership. Hardly a likely candidate to cause what became known as the biggest financial scandal in the US.

But things change. Between 1960 and 1980 that environment changed out of recognition. Particularly in the 1970s, the interest rate market became increasingly volatile as inflation soared. Mandated to offer a low interest rate that they could offer to depositors, the S&L industry lost its competitiveness for funds with commercial banks and securities markets, leading to lesser amounts of money available for mortgage lending.

Deregulation in the early 1980s removed the abovementioned deposit interest rate ceilings, increasing the competitiveness of S&Ls in sourcing for depositor funds. A new problem was brewing: by raising their cost of funding, margin pressure was created on the income generated by their mortgage loans. What was worse, the liabilities (deposits) were short-term, while the assets (mortgage loans) were long-term, typically fixed-rate interest --- a so-called asset-liability mismatch.

Between 1980 and 1982, regulators, industry lobbyists and legislators put together various legislative and regulatory mechanisms to postpone the threatened insolvency of the sector in the hope that interest rates would quieten down and S&Ls would be able to engineer themselves back into profitability. The approach was to loosen S&L capital restrictions, while offering S&Ls new freedom to extend their activities into potentially lucrative (and therefore risky) areas --- which planted the seeds for the next crisis.

S&Ls were allowed to sell their mortgage loans and use the cash generated to seek better returns. In particular, S&Ls began to both lend to real estate developers and to invest in real estate, construction and service companies. In key regions, such as Texas and Florida, S&L lenders competed with other lenders such as commercial bankers to fuel a real-estate boom. And yet, the traditional risk management skills of mortgage lenders, where credit risk is relatively low and predictable, and property and collateral prices relatively stable, did not equip most S&Ls to venture into the strongly cyclical commercial real estate market. A mismanagement of investment risk, driven by greed for high yields, characterise both the S&L crisis and the current sub-prime crisis.

The mid to late 1980s saw the long-term impact of such risk mismanagement. A series of US regional crises, triggered by collapses in the oil, property and farming sectors, acted to realise the credit and investment risks now embedded in S&L portfolios. For example, the oil-price inspired boom of the early 1980s in Texas was faltering, and by 1987 its oil and real estate sectors were in deep recession. A similar process of increasing rates of default and falling collateral values remorselessly undermined S&L asset around the US, right through until 1992.

Realising the threat of insolvency facing many S&Ls, from 1986 onwards, politicians and regulators struggled with a series of measures to fund the restructuring of the industry, but these failed to match up to the scale of the problem. Much of the restructuring was accomplished through encouraging mergers and acquisitions between S&Ls. Public awareness of the enormous scale of the S&L crisis continued to be relatively muted into the late 1980s, surprisingly, until 1989 when a new Act was passed that substantially restructured US financial industry regulation and belatedly recognised that US taxpayers would end up paying much of the bill for the S&L fiasco.

Regulators began to act aggressively to close down S&L institutions, though it quickly became clear that the situation in the S&L industry was even worse than had been imagined. In 1989 and 1990 the S&L crisis reached its height in terms of public expense, with total bailout expense (taxpayers' money) estimated in the hundreds of billions. It contributed to the large budget deficits of the early 1990s, and the resulting slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990-1991 economic recession.

The episode is a prime example of the dangers of deregulation, especially for financial institutions. With the withdrawal of regulatory oversight coupled with mismanagement, there is great potential for excessive risk-taking. It also illustrates how formalistic reporting of the financial condition of S&Ls was deliberately selected by interested parties to cover up the true economic extent of the unfolding disaster, truly a risk-reporting failure on a grand scale.

References:
(1) US Savings and Loan Crisis
(2) Wikipedia: Savings and Loan crisis

Bull Stock: Ho Bee

2007-05-08T17:58:00.000-07:00

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The property boom in Singapore is well-established by now, with all developers' share prices enjoying buoyant valuations not seen since probably the mid-1990s boom. Among these, those with well-defined market positioning have outperformed: among these, Capitaland as the easily identifiable market leader and its asset light-enabling REITs approach has done extremely well, as well as SC Global with its ultra high-end developments, but easily the best outperformer these few years (in terms of share price) has been Ho Bee, which has risen from being the smallest pure-play developer in the late 1990s-early 2000s to the verge of becoming a property heavyweight in the local market. The key reason for its success: one word --- Sentosa.

The company was a relatively new arrival to the SGX, listing in late 1999 at $0.48. Since its inception in 1987, it had been undertaking miscellaneous residential (condominium and landed) projects in Singapore, with the odd industrial development (interestingly, recently they have been expanding their industrial landbank again). Under founder Chua Thian Poh, the company also ventured into property development/investment in prime districts of central London in 1996, disposing of most of these investments at good profits by the late 1990s/early 2000s.

Nothing exciting, for they were considered small fish in the Singapore property market; property development after all was a capital intensive business, and it was conventional wisdom that the bigger the better. In fact, the company's share price tanked straight after listing, and remained in the doldrums for the next 3-4 years at between 15-30 cents, below NTA of ~40 cents; as were the rest of the property players in a depressed property market. It was worth noting however, that while the bigger players like Capitaland and Wing Tai went into the red at the turn of the millenium, Ho Bee remained profitable, albeit less so.

Another development was worth noting, with the benefit of hindsight. In December 2003, Ho Bee successfully tendered for two plots of land for residential development in Sentosa Cove, Sentosa Island. One of these eventually materialised into the first condominium development on the Sentosa waterfront district, The Berth by the Cove; the other contained the first terrace houses, The Berthside. The units in these two developments were snapped up by 2005.

It is worth exploring the pessimism surrounding Sentosa at the time of the property tenders in late 2003. The macroeconomic environment of course, was tentative; sentiment had bottomed with the SARS crisis just half a year earlier, and the stock market had barely recovered (of course, nobody knew then it was preparing for a multi-year bull charge). Zoom in to individual district level: Sentosa was perceived to be a declining tourist resort, with the only commercial attraction nearby being the new Harbourfront retail mall (aka World Trade Centre). In 2002, Sentosa's management authority had embarked on a ten-year strategic plan to rejuvenate Sentosa, but the fact that most mainstay property developers avoided the December 2003 tenders reflected the lack of their belief that this masterplan could succeed.

The extent of the pessimism was reflected in the ~$200 psf ppr for the terrace parcel, and the $350 psf ppr for the condominum parcel. For comparison, the recent Sentosa Cove acquisitions (for condo development) by Ho Bee: the Waterfront Collection (Dec 06) and the Seaview Collection (Mar 07) were transacted at $900 psf ppr and $1300 psf ppr respectively; how times have changed! Selling prices for Sentosa condominiums are now projected at north of $2000 psf.

The whole rejuvenation of sentiment surrounding Sentosa has been driven by two hot property themes that are somewhat inter-related: the rise of "waterfront living" and the development of the Sentosa IR. Real estate often seems to elicit an emotional resonance within many people, which accounts for the vast disparity in property prices across areas in close proximity. Successful marketing of a certain lifestyle associated with the property can stir these emotions, and this is what has happened with the idea of the waterfront lifestyle which has captured the imagination of foreigners and affluent locals alike. While areas like Meyer Road claim good sea views, Sentosa developments (especially landed properties) can claim true proximity to the ocean --- just a few steps away. The success of developments at Marina Bay (The Sail) and at initial developments at Sentosa perpetuated the positive feedback process. For this, Chua Thian Poh should be credited for his foresight and conviction in the value of Sentosa as a residential area.

In mid-2005 the Singapore government announced plan to develop two "IRs" (aka casinos) by the end of the decade, and eventually it surfaced that Sentosa would be one of the locations. One wonders if the Sentosa IR had been in the political backburner all along; after all the Sentosa masterplan had been drafted in 2002, to develop the Sentosa-Harbourfront precinct as a world-class integrated leisure and lifestyle destination. Indeed, Vivocity was probably conceived before the IR announcement, but with the impetus of the formal Sentosa IR decision, there was now a buzz around the region, with new entertainment outlets springing up in the form of St James Powerstation and talk of a regional cruise hub developing around the cruise terminal. Meanwhile, the Harbourfront commercial developments by Keppel packed in new prestigious tenants like Merrill Lynch, and residential developments across the bay from Sentosa, ie. Carribean, captured strong demand. District 4 had become THE place to be (see developments at Harbourfront).

Hence, perhaps Ho Bee's success in bottom-picking Sentosa had been a combination of foresight, that intangible known as luck, and connections (its chairman also headed the Chinese Chamber of Commerce). The government's conviction to develop the precinct was probably apparent quite early, though not the detailed plans. That may have been enough to bet on Sentosa in late 2003.

And so Sentosa boomed, and with it, Ho Bee, and along with it, the share price. It is as simple as that, though the company also developed other prime properties in districts 9/10/11. The company is now developer of more than a quarter (totalling >1M sq ft land area) of the allocated residential space on Sentosa Cove, as it built on its momentum following its successful 2005 launches and continued adding to its Sentosa landbank at increasing prices. The fully sold Sentosa projects and future launches can be seen on its website.

The company is now considered one of the larger mid-tier property players at >S$1.5B market capitalisation. At $2.36 last count, the share price has done a near eight-bagger over 3 years. Its FY07 profit is expected to run into several hundred million dollars as it books the profit on its earlier Sentosa developments. Supernormal profits for good property acumen, indeed.

References:
(1) Sentosa Masterplan projects
(2) Ho Bee IPO prospectus 1999
(3) Shares Investment Issue 256 report on Ho Bee

Crash stock: Acma

2007-03-16T08:04:00.000-07:00

(P.S: Sorry for any disturbances the advertisements above may have caused you)
Acma is one of the oldest listed companies on the SGX, being listed in the then-SES in the late 1960s. Its original business was in the manufacture and distribution of home electrical equipment such as refrigerators and air-conditioners; when this became unprofitable due to uncompetitive cost structures, it diversified into various businesses and ventured into post-communist Russia in the 1990s. Eventually, its principal activities included various distinct segments including: (i) manufacture, sale and service of home electrical equipment; (ii) distribution of communications equipment; (iii) M&E contracting servies for buildings; (iv) trading. Its glory years were in the mid-1990s, when revenue reached S$500-600M with net profit reaching $50-70M. It reached over $10 at its peak, split and still traded in the region of $4 then; it enjoyed institutional ownership with substantial holders in foreign pension funds and insurance funds (AIA); it was part of the FTSE Singapore Index. It was a semi-blue chip.

The purpose of this writeup is to illustrate firstly, how bad corporate strategies and dilution of corporate energies can lead to the demise of a hitherto sterling corporation; secondly, the perils of doing business in emerging markets; the last issue will be left till the last paragraph.

In retrospect, the hastiness to build a platform for recurrent earnings, combined with bad timing, led to the downfall. Over 1995-97 the company put in an aggregate capital expenditure of >$200m (mainly financed by borrowings), equal to its equity, mostly in expansion in Russia through acquisition of food businesses (it became the sole franchisee for Delifrance, KFC, Pizza Hut, Haagen Daas under its new food segment) and then Russian property (shopping centres etc). Another big expansion project was its development of its plastics and tooling business which it grew by pure acquisitions to 8 factories by 1998 spreading across to Malaysia, China, Latvia, Slovenia and Mexico. The learning curve in so many new industries probably contributed to its eventual troubles, but undoubtedly the key trigger was the Russian sovereign debt default in 1998 and the subsequent devaluation of the rouble by 30-40% within a year. The Russian economy would not recover for the next 4-5 years following the debacle and meanwhile Acma's Russian operations suffered writedowns and business decline. In 1998 alone, the company wrote down ~S$90M in investments, followed by another S$25M the following year. That was about half its equity. As late as FY01 the company had to write off S$20M worth of bad receivables in its badly declining Russian operations.

Then in 2000, the company announced that it would convert itself into an internet company, planning to spin off or close down existing non-internet operations. It had stakes in six Internet sites which it claimed it planned to list within a year or two; these stakes were built up mainly through acquisitions: Russianscientists.com (website for hiring or placement of Russian engineers and scientists), Propertybuyer.com (a joint venture with property giants Far East Organization, FCC and Wing Tai), Acmabooks.com (online bookstore), Conduit (NZ-based online retailer of IT goods), Wiredhub (engineering and communications hub for broadcasting) and Netlearner (online learning). That led to some excitement, but as we all know now, the dot-com collapse happened pretty soon after. It was one hell of a bad timing on the part of management, and a desperate measure to regain market attention, which caused it to tank even further, as well as diluting management focus. Eventually, the company had to make "provisions for costs relating to the rationalization of the Group's internet businesses" (ie. another set of investment writeoffs).

Over 2001 till now, the group has been loss-making. It appears that from a case of extraordinary losses in 1998 (due to the Russian rouble debacle), corporate provisions and writeoffs relating to its various diversified investments had become recurring items on the P&L statement. In Russia, it discontinued its restaurant operations, as well as consumer plastics and car garage operations. In Australia and Singapore it shut down switchboard factories and electronic distribution companies. It also eventually had to scale down its tooling and plastic moulding operations, shutting down plants in Malaysia and Mexico after years of sustained losses with no turnaround in sight. And the last few years were bull years! What is strange is that all the troubles had been originated with the poor decision-making of a long-time management led by Quek Sim Pin, which had helmed the group so well in the 1990s as it became seen as an investment-quality stock.

It appears that the company is still struggling with its high gearing up to this day, even after an astonishing 7:2 rights issue in late 2001 at the then-heavily discounted rights exercise price of 9.5 cents, which contributed to mass investor confusion and anger at having to put out additional funds to recapitalise the company and bail it out from its various imprudent investments.

A look at some figures to get a perspective of the degree of shareholder value destruction: in 1993 the group's market cap was worth S$900M; even when the 1993 super-bull had abated, the group's market cap was still in the region of S$500-600M in the mid-1990s. Today it is worth under S$50M. That's a drop by more than 10 times, proceeds from rights issue notwithstanding.

Now for the last lesson. Acma was one of Oei Hong Leong's investments; OHL is known as the man with the Midas touch and there are many who ape his purchases. But the media tends to publicise his successes (Natsteel, Jurong Engineering), but his investment losses are obviously less newsworthy, thus leading to the public perception of his infallibility. China Strategic, OHL's investment vehicle, bought into Acma in mid-2000 and continued accumulating through the year as the group announced their Internet ventures. By the next year or two China Strategic had sold out at huge losses. Probably it cost him several million dollars. But the proportion of these losses to his overall fortune must have been insignificant, compared to many investors who appear to have bet big-time with him, using him as their confidence shield and averaging-down justification, and lost a big part of their money as a result. Thus it is that we should use "guru buying" as a guide, but never a sole justification, for buying or holding.

References:
(1) Shareinvestor.com archives on Acma

The story of Yeo Hiap Seng

2007-02-13T06:17:00.000-08:00

(P.S: Sorry for any disturbances the advertisements above may have caused you)
The story of Yeo Hiap Seng in the mid-1990s is a study in two issues: one, that family businesses seldom last beyond three generations ("the first generation builds, the second preserves, the third destroys"), and two, the debilitating effects of a large corporate acquisition.

Yeo Hiap Seng had its humble beginnings in China's Fujian province, started at the turn of the century by family patriarch Yeo Keng Lian. After moving to Singapore in 1935, the family set up a sauce factory. Despite stiff competition from other players such as Tai Hua Food Industries, Sinsin Food Industries and Woh Hup Food Industries, the Yeos grabbed market share with a strong distribution network, in particular capturing a large section of the soft-drink market by catering for Chinese tastes. It eventually emerged as the largest food and beverage group in Singapore after F&N. In 1987 Alan Yeo, part of the second generation and head of the company since it went public in 1969, was named Singapore's Businessman of the Year. The clan was praised for being "a superb example of a family-controlled business" that others could emulate. Soon Yeo was appointed chairman of the Trade Development Board (TDB) and invited to join the boards of government-linked companies like Keppel Bank and Neptune Orient Lines. (Incidentally, the Businessman of the Year award has jinxed quite a few award winners, such as the Thakral family, Patrick Ngiam of IPC, Sim Wong Hoo, Lee Ah Bee of Amtek, the Phua brothers of HTL).

In 1989, YHS and Temasek Holdings bought Chun King, an American manufacturer of canned Chinese food, from Nabisco, then selling assets after a leveraged buyout, for $52M. It signalled the entry of YHS into the largest consumer market in the world -- the US. Almost twenty years later, a similar Temasek-linked attempt to crack the US market would be made by another company --- Osim --- in what is now familiar to most market watchers.

Some things never change. Underestimation of the difficulties of digesting a large acquisition, coupled with the problems of securing a beachhead on an entirely new market, appear to have remained eerily similar across two decades. Of the Chun King acquisition, an analyst dissected the issue: "It was a mistake right from the beginning. Nabisco had the food retailing muscle to carve out shelf space in the highly competitive U.S. market. But not YHS. It didn't understand the market and the resources needed to back up products." It appeared that Chun King did not have the economies of scale and distribution clout that makes a business like that profitable. Another reason was that the company's products -- canned Chinese food --- had lost much of their appeal in the US due to social trends, where even the smallest towns now had take-away Chinese restaurants.

In the four years following the acquisition, Chun King posted losses totaling $36M. In 1994 the parent wrote down Chun King's value -- taking a $25 million charge. In 1995, YHS announced the sale of some Chun King assets for $10 million, marking an ignominious exit from the US market.

In the end, the US fiasco brought down more than the bottom line: the Yeos splintered. In 1994, a group of Yeos, led by Alan Yeo's nephew Charles, began attempts to push out Alan as chairman. Its reasons: the Chun King fiasco, his inability to choose a successor and alleged autocratic leadership and bad management. In retrospect, this was just a family feud waiting to happen: by the 1990s, there were 6 families under the Yeo clan, with about 50 members, and it was claimed that too many family members interfered with the running of the company, and expected to be consulted on every major decision. Power struggles were inevitable, since everyone felt they had a right to the family fortune.

To protect his job, Alan Yeo dissolved the family holding company, fragmenting the Yeos' controlling stake in YHS. The reason was that as long as his supporters' stake, totalling 18%, were tied up in the family investment block YHS Holdings, they would be considered the minority because the opposing Yeo group controlled the other 21% in the YHS Holdings stake (which thus controlled 39% of Yeo Hiap Seng). His fragmented 18% stake could then be combined with other supporters' stakes to gain majority control of Yeo Hiap Seng over the rival Yeo group, whose fragmented 21% stake might be smaller in comparison. It was under such circumstances that the Ngs were brought in as outside support. The Ngs of Far East fame, under Ng Teng Fong, then among the richest men in Singapore.

But with the Yeo investment block split, it became possible for an outsider to divide and conquer. Eventually, Alan's allies sided with Charles instead and ruled YHS. Alan Yeo was replaced as CEO by an outsider --- the first time a non-Yeo had assumed the mantle --- and Ng Teng Fong's son, Robert Ng, took over as chairman in 1995. And so a dynasty ended, with Far East controlling Yeo Hiap Seng to this day.

And for general interest, one should appreciate the reasons why Yeo Hiap Seng was such an attractive target. For one, the brand equity of the Yeo's brand of tea and juice was immense in Asia, and the group's Pepsi bottling franchises in Singapore and Malaysia were valuable. But the big attraction for tycoons like Ng laid in its $400 million in assets, in particular the four-hectare $300-million site of its factories in Bukit Timah which had been rezoned for housing. Whoever controlled YHS would make a lot of money building condominiums on that site (Alan Yeo had been thinking of doing that after resolving his family feud before he was trumped by the Ngs). In 1995, YHS became the subject of a struggle for ownership between the Ngs and Quek Leng Chan, one of the richest men in Malaysia, who coveted YHS for similar reasons. The Ngs prevailed in the end. It probably didn't matter anymore to the Yeos by then (though they probably had a windfall through their remaining stakes as YHS shares were bid up by the Ngs and the Queks).

References:
(1) Asia Inc article Oct 1994: Yeo Hiap Seng feud
(2) Asiaweek 1995 article: Tea for Two - Battle for a Great Name and Address

A tale of investing on the Singapore market: Mossie

2007-01-04T07:16:00.000-08:00

DanielXX's intro: I was surfing around for some backgrounding on the 1993 Singapore bull market to do a writeup and happened to chance upon this article by Mossie, as shown below. I believe this is the same Mossie who was a well-respected fundamentally-inclined forumer on the Shareinvestor forum in the early 2000s, but is less active online nowadays. It is a very illuminating article on one veteran's travails of trading stocks on the SGX and is especially relevant in the current heady market climate in providing a greater perspective of things. It more than satisfies my original purpose of writing on the 1993 bull market; it spans the entire 1990s (when I was still studying) and describes the evolution of both the markets and the writer's market investing philosophies.

The article appears in a forum "Singapore Way of Life" (you could also check out its investors' forum) and the direct link to Mossie's article is here. As I did not obtain permission to copy the article from the site (not sure how to), my advance apologies to Mossie if it's not ok by you; just let me know and I'll remove it immediately.

MY STORY – by Mossie
01 April 2006

Introduction

One night I woke up screaming, “SELL, SELL…” The Market has overtaken even my sleeping hours. My wife made a joke of it the next morning but I knew something was not right. Except, I didn’t know what it was.

Six years has passed since that fateful night. In between, the Market took and thankfully, gave back everything I had: my house, my car, and my family. More importantly, it revealed a lot about of my greed, my fears and myself. Those lessons have stayed with me ever since.

I hope to share my lessons with you. Hopefully, you will not make the same mistakes I did.

THE BEAR ATTACK

I have never seen the likes of it before. The ST Index fell from a high of almost 2,000 points in May 1997 to 800 points in Sept 1998. A drop of 1,200 points and the bloodbath lasted a full fifteen months. Worlds came apart. Fortunes, which took a lifetime to build, were wiped out in 12 months.

I was not spared. The Asian crisis took away my business, my house and car. My business floundered, and what sources of cash inflow I had dried up. By May 1998, my assets, including the house were “forced” sold and all I had left was the CPF savings accumulated through 12 years of contributions.

When has bought me to this low point of life?

The foremost answer was I had mistaken a bull market for brains.

Years 1990 to 1993

I graduated from university in 1988 and I started my stock trading in 1990. Up to that point, I have never lived through a recession in my working life. Having lived through a string of 6 to 7% growth rates for a few years, I began to take for granted that strong GDP growth rates would be with us forever. Hence, I was totally unprepared for what was to come in the form of the Asian crisis. The mother of all bull markets came along in 1993. That further made me more complacent into believing that bull markets were my destiny in life.

My methodology of investing in stocks was non-existent. I relied on tips from friends and brokers. Swept along with the upward momentum in stock prices, it was easy to make money. Small trades soon gave way to bigger trades as I got bolder.
When “contra” profits piled as the market surged higher, I thought I was a genius and leveraged my trades with bank overdrafts. Bigger profits piled up and I begun to believe I was really a genius. By the end of 1993, I must have made half a million dollars. I was becoming arrogant. Mixing arrogance with the brashness of youth, I thought I was invincible. It was a dangerous mix and a major cause for my eventual down fall.
Success breeds success. It’s not what you know but whom you know, or so I was mistakenly led to believe. I would arrange to get myself associated with professional fund managers who were part of the syndicates to ram stock prices upwards. When they bought, so did I. When they told me to sell, I did. When they told me to cut losses to move to another counter. I blindly followed.

I was mistakenly led to believe it was the easiest money making formula in the world. All I had to do was to follow what “smart” money does, make the money, and then spend that money on these fund managers on gifts and alcohol to ensure that they will continue to look after me.

Methodology? What methodology? Fundamentals of stock investing, what fundamentals? I mistakenly believed then, that it was more important to grease the palms of my “guru’ who told me “what” to buy than asking the all important “why”. I was totally dependent on handouts in the form of tips, rumours and recommendations. I had no knowledge of investing of my own. I was like the mindless dog lapping up the handouts given by my masters.

Years 1994 to 1996

Through the influence of friends, I applied what I learnt from contra in the stock market to the property market. From 1994 to 1996, I was part of syndicate that would pool our borrowed funds together and speculate on property. The cycle repeated itself. Except, my ego by now has expanded 10 fold!

We would get our hands on choice units of property launches because one of the members of the syndicate owned a housing agency. Before the ink on the sales option could dry, we would flip the options for a profit. The property market in 1995 was just about to reach boiling point. Finding buyers was not difficult. We had a stream of Indonesians and Hong Kong nationals making a beeline to Singapore. Most of them were taking advantage of Singapore’s attractive immigration policies, especially for those who wanted to be business immigrants. One of the conditions of seeking Permanent Residency was to invest $1m in a business or buy a property. Most of them bought properties and that inflated the property bubble further.

In hindsight, I was sadly lulled into believing that I was a genius for making lots of money at such a young age. The reality was that I was an empty vessel making lots of noise. I was just plain lucky to be around at the right place and the right place. I wasn’t a genius. I had not invented anything that improved the lives of millions. I was a just a plain old speculator jockey that rode up a general uptrend in the stock and property markets. It was my own arrogance that led me to believe that I was smart. I had mistaken a bull market for brains.

THE PAIN

The Asian crisis struck in 1997. The cause of the crisis was not specific to what Asians did or didn’t do. It was simply the correction of a very extended bull cycle exacerbated by over borrowing by all sectors of the economy. Punters like me over borrowed to buy shares and properties. Companies borrowed too much to chase over-valued assets like land. Too many golf courses were built. For every dollar of capital, three dollars or more were borrowed against it.

For me, the day of reckoning came in May 1998. It was the month I received notice that my house was going to be forced sold. I had borrowed close to seven figures from banks to support my leveraged lifestyle and my business. When interest rates surged, I had no means to keep up with interest payments. The situation was made worse when my business floundered when I made certain guarantees to suppliers. The bank called on the guarantee and I had to liquidate all my assets to meet the call. My world caved in.

Whatever I owned, my portfolio of shares, my semi-detached house in District 10 and my turbo driven Volvo had to be sold. To put a roof over my head, I had to move back to live with in-laws after the sale of my house. The glorious emperor really had no clothes after all.

In the end, I had nothing to show for my twelve years of working life. Whatever all the trading profits I made in 1993, it was given back to the market from 1995 to 1997. Whatever profits I made in speculating in properties in 1995 to 1996 were lost in 1997.

THE BUS TRIPS

After my debts were paid off, I was left with fund accumulated in my CPF, little cash, no job, no car, no house, a jobless wife, two crying babies and lots of time. But since I was living with in-laws, I could not loathe around the house. I would put up a brave point, wore a long sleeve shirt and maintained the impression that I still had a job. My pride demanded that.

But where could I go to spend my day? I would spend a lot of my initial jobless period on the bus. I would sit on the bus and followed the bus on the routes around Singapore. The buses were air-conditioned and it didn’t require much capital in the bus fare. It was interesting to see sights of Singapore I have never seen. The scenery was always changing and that took the boredom out of the day.

I would always have someone to talk to at the Bus interchanges as I shared a coffee with the Bus drivers and those inspectors that maintained the schedules. Most importantly, it slowly removed my depression to know that the average man on the street had harder battles to fight than I did. I saw how they struggled to survive and they did it with great dignity.

Eventually, it became to dawn on me that I could either wallow in my self-pity, continue to ply the bus routes for the rest of my life or I could put yourself to study how to invest properly. I decided on the latter.

Over the latter half of 1998, I put myself under a strict regime of self-study. I devoured every resource material on the Asian crisis. One of the sites I visited regularly was Nouriel Roubini's Global Macroeconomic and Finanacial Policy Site.. From there, I also understood more about the interplay of the economic business cycles on different classes of assets (Bonds, stocks, and commodities). I make more comments on this in the section Investment Clock.

I also gave myself to the study of Technical Analysis. I read Edward and Magee’s “Technical Analysis of Stock Trends” cover to cover because I wanted to recognize accumulation patterns by “Smart Money”. I needed to understand how syndicates set themselves up to ram prices by accumulating stocks during quiet spells in the market.

Knowing how “Smart Money” worked, they would corner the market over a long period of time when no one was interested in the market. Their eventual aim would be to ram up prices when the bull market resurfaces. Always, the “Dumb Money” or the faceless crowd would succumb to the herd instinct and left holding the proverbial baby. I needed to recognize accumulation and distribution patterns so as not to get caught by “Smart Money” as they sold. Technical Analysis provided the tools.

To understand the operating of the herd instinct and how not to succumb, I read, “Contrarian Investing: Buy and Sell When Others Won’t Make Money Doing It” by Anthony M. Gallea. From there, I learnt that crowd behaviour is usually wrong. To succeed in the stock market, I must behave in the opposite fashion. That is, fear when there is greed all around and be greedy when there is fear.

For Fundamental Analysis, I read both books by Peter Lynch. They were “One Up On Wall Street” and “Beating the Street”. I learnt from these two books that it was possible for the average man to beat the professionals at the game. This was achieved by, first, having an understanding and a love for business. Second, by being observant of great products and after some homework, invest in them.

Lynch mentioned coming across stocks like Nike at the shopping malls. In our context of stocks listed in Singapore, it could be Tiger Balm (Haw Par Healthcare), GP Batteries. In the Hong Kong context, it could be Giordano, Esprit and so on.

I also learnt that what mattered most was not only must the business economics be sound, but that the Management of the Company has to be capable to deliver growing earnings consistently over time. Buying stocks with cheap Price Earnings Ratios, low Price to NTA or high Cash per share is not enough to spur me to invest. The company must be able to convert capital into sustainable earnings growth over time.

APPLYING THE LESSONS LEARNT AND THE SUBSEQUENT BULL MARKET

After reading, studying and reviewing my every trade I made in the last year and a half, my mistakes became clearer to me. For one, I did not have a methodology. I depended on handouts from friends and brokers. I saw the market as a place to gamble, not a place to invest in companies. I never did any homework on the company I speculated in.

I allowed emotion to rule me by succumbing myself to crowd hysteria. I allowed prices to condition my mind. When prices moved up accompanied with high volumes, I would GET ALL EXCITED and pile in as well, hoping that the momentum will move me along. Worst, I chased prices. When prices fell to the lowest levels, I failed to buy because I was swept along in the pessimism.

By 1998 following the burning of Indonesia, prices in the market have fallen to levels not seen in the last ten years. Companies with viable businesses had fallen to depressed prices. Stocks like Inchape Marketing were even trading below their cash per share. Tan Chong International fell to HK12cts, way below the value of the motor franchise.

Having read volumes about the stock markets, I knew that I had a golden opportunity before me. Should I be buying when there were extreme levels of fear pervading? Did viable business like DBS justify being at their lowest levels historically? I knew I had to buy. But sadly I had no money.

At about Sept 1998, my lucky break came. The CPF liberalized the use of CPF funds. I turned to my wife and asked her for permission to pool our CPF Funds to buy the market. She replied with an emphatic, “Are you mad?!??” I could understand her anxieties. The last thing she wanted was another encounter with Mr. Market.

I had to convince her that I was a reformed man. To her credit, she was prepared to have confidence in me again provided that I showed her that I have done my homework in the stock I wanted to buy. With that mandate, I set myself to work again.

Coincidentally around that time, the Government announced that there were plans to put together a multi-modal transportation system. In other words, they wanted to integrate the bus and rail (MRT) operations to eke out greater efficiencies.

I knew how bus operations worked. Don’t forget, I spent a lot of time during the initial months of unemployment sitting around bus stations and drivers. I knew the cash flow nature of the business and I was convinced that such a business was a cash-generating machine. This became my first principal in investments: BUY BUSINESSES you understand.

By that time, I was so familiar with bus operations that I knew some major statistics by the back of my hand. For example, Singaporeans took five million trips on the bus and trains a DAY! I also knew from observation that the greatest profits were earned on the feeder routes around the satellite towns. (Hence, the need for multi-modality. MRT lines bring people to people centres and the feeder buses distribute them to the outskirts.)
This leads me to my second principal: DO YOUR HOMEWORK. I dug out all the Annual Reports of DELGRO, SBS and TIBS and I read voraciously all the newspaper cuttings surrounding these companies. I even went to the extent of digging out the Government White Paper on Multi Modal Transport and tried to digest the logic behind the Government’s intentions. From the Annual Reports, it confirmed that the business was positively generating cash and that valuations were cheap. If you have a chance to see the company at work, do so. Nothing beats visually inspecting the workings of the business.

This leads me to my third and most important principal. Buy into stocks or industries that will be undergoing CATALYTIC CHANGES that the market had not yet noticed. Don’t buy into a cheap company for the sake that it is cheap. Cheap companies can remain cheap forever. But buy into a cheap company that was going to embark on positive changes that will enhance the profits.

For the bus companies, the CATALYTIC change that was about to happen was the change in Government operations. Bus operators will be allowed to run rail operations. That would have the effect of bolstering their cash flows and increase operating efficiencies. The Government’s intentions were splashed across the major newspapers but no one noticed. The prices hardly budged when it was announced.

Currently, the companies undergoing catalytic changes are in the business of Supply Chain. Specifically, companies like TeckWah and Mentor Media are doing roaring businesses and it’s reflected in the earning results. The catalyst: major acceleration towards outsourcing by MNCs as a result of the emergence of IT, e-commerce, efficient transportation services and so on.

Needless to say after all that work, I convinced my wife that I was a changed man. I got her blessings and I set about to buy all three bus companies from October/November 1998 onwards. But never did I expect the Bull market of 1999 to return so quickly that it did, and with such ferocity. My three bus companies moved along with the market liquidity and I made back all I had lost from the previous years.

There are countless opportunities existing in the stock markets that are about to face catalytic changes we can exploit. But it needs the determination and instincts of a hound dog to sniff them out. Thankfully, the playing field has been made more level with the Internet and the freer flow of information. Gain knowledge, for knowledge is KEY to your success.

INVESTMENT CLOCK

The key understanding from studying the Investment Clock was realising that that macroeconomics determined the tidal shifts in the direction of liquidity. At certain phases of the boom bust or economic cycle, it is best to sell everything and take a holiday. Likewise, at certain phases of the cycle, it’s safe to load up and be engaged. At times commodities, bonds and stocks out-perform one another.

I never understood The Investment Clock during the years 1993 to 1997. When the property and stock markets were at boiling because of availability of cheap credit and liquidity, I should have avoided them and stay in cash.

Just as it is important to understand how the moon affects tidal movements in the sea, direction of interest rates sets the tone for the markets.

CONCLUSION

What I have shared in these pages are just my lessons from my journey from losses to recovery. I hope they have been useful to guide as you navigate your way through these treacherous waters called the Stock Market.

But please note, my suggestions here are not the only way. There are many other ways to successful investing. There are also a lot of other areas I have not mentioned for the sake of brevity. For example, I have not talked about risk management (an important area) or planning. Maybe, if there is interest, I will share my thoughts on that.

For now, it leaves to wish one and all, “HAPPY INVESTING".

The early-1990s Singapore residential property boom

2006-11-11T20:55:00.000-08:00

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Nowadays, not a day passes without the papers reporting bullish news of prospective property deals; some argue that the residential property market is in the beginning of a new secular boom that could spread to the lower-end housing markets while others are significantly more cautious and cynical. In both camps the comparison is inevitably done with the property bull market of the early 1990s, when this asset class reached speculative heights and ultimately became a bubble that was pricked by consecutive blows of government regulatory measures and regional political trouble.

The fundamental case for property investing in the early 1990s was predicated on the rise of Singapore domestic demand. With economic stability and increased purchasing power built up over preceding years, it was time for asset enhancement in the 1990s. Young Singaporeans were being urged to marry and population control and immigration policies were being revised, adding to the demand for housing. Households were becoming increasingly double-income, increasing the purchasing power for big-ticket items. CPF balances were rising in-step with incomes, providing the financing means for purchasing expensive private property.

The sentimental case for property investing had been built up over the years. Since independence, the government had been promoting home ownership as a crucial tenet of nation building, and a huge majority of Singaporeans (~80-90%) owned the apartments they stayed in (mainly HDB). Hence increasingly over the years, property was seen as a good investment as prices were well-supported by the abovementioned government stand towards home ownership, the scarcity nature of Singapore property (the supply side), and perceived continued economic growth and stability (the demand side). Demand also trended towards more expensive private housing as people strove to upgrade their lifestyles. Many fellow Singaporeans will remember the Singapore dream built on the material five Cs: career/cash, credit cards, car, condominium, country club membership. Hence snob appeal and social aspirations accounted for an additional component of property demand meant for consumption.

Property as a comparative investing instrument was superior to other asset classes. There were few avenues for the less-educated to put their money: bonds had never been an Asian mass-market instrument, there was mass distrust of stocks due to their volatility (the market had shot up in 1993 and then dived back down in 1994), and money deposit rates were low. This also meant that housing loan rates were low (6% or less) and hence money was cheap. The unique standing of property as the only main investment instrument that could draw on the bulk of CPF funds enhanced its appeal; people tended not to think of it as "real money".

Given the above factors, property purchasing for consumption and investment soon turned into speculative buying. Stories of people buying an apartment for $500,000 and selling it for $700,000 a year later were part of the popular folklore. One apt description was that "people are buying property like groceries". This, of course, refers to the particular segment of property sales known as sub-sales, where people buy a property and then sell it off even before completion --- the most direct measure of speculative activity. At the height of the mania in the mid-1990s, there were the much-publicised midnight queues preceding condominium launches and the peaking of the highly reliable contrarian index known as the "market/coffeeshop auntie/uncle - buying, selling and recommending property" indicator.

All segments of the residential market were booming, including newbuilds, resales, public (HDB) and private housing (condominiums). From 1986 to 1996, the private residential price index rose by about 440%. About two-thirds of this gain was in the early 1990s up to 1996. See below for a graphical representation. There was a big merry-go-round as sellers became buyers of other properties, whose sellers then sourced for new residences. Over 1992-2002, 58% of the 3-million population changed homes. Among private homeowners, it was almost 70%. This created an upward spiral of property prices that was exacerbated by the speculative elements.

In 1996 the government introduced regulations to cool property speculation, which included heavy taxes on profits made from property sold within three years of purchase --- a measure targeted at property speculators. It had to end somewhere. Rocketing property prices were increasing the costs of living, driving some citizens out of Singapore and decreasing its long-term business competitiveness. The private residential property market prices collapsed; the end of the bull market was confirmed by the 1997-98 Asian financial crisis that destroyed foreign demand drivers from the ASEAN region. With the exception of a minor mini-rally in 2000, private housing prices had dropped 30-40% by 2003, since they peaked in 2Q96. The HDB resales market was better although it was never to reach the heights of 1996, primarily because the government was careful about its impact on ordinary, less well-off Singaporeans.

Still, the damage had been done. The term "negative equity" is used to describe a situation where the difference of the investment's market value and the debt incurred in financing it is negative --- a predicament that many Singaporeans have been stuck in. The plunge in residential-property prices also had an impact on private consumption - fewer owners were able to withdraw equity from their homes to borrow against the increase in value to finance other consumption. As a result of heavy investments in property, Singaporeans are asset-rich and cash-poor, even counting their CPF retirement money. It is an example of how investments based on solid fundamentals can turn into speculative buying egged on by peer pressure to "make money while it lasts"; when the primary driver is sentiment and liquidity rather than fundamentals, it can be prone to sudden drying of liquidity that causes prices to plunge. In this case, the reversing of government policy towards controlling asset inflation just happened to be the catalyst that caused the U-turning of residential property prices. Even if it had not taken place, the hit would still have been suffered in the 1997 Asian financial crisis. It was a disaster to happen, and as always, it was one that was precipitated by human envy and greed, in my view.

References:
(1) Global Property Guide: Singapore
(2) The Star, May 2002: Curbing the property craze
(3) Asia Inc, Nov 1993: The Boredom Bubble
(4) Asiaweek, 1996: Testing Times
(5) FEER, Jul 2003: Singapore's housing glut

Personalities: Jim Rogers

2006-11-02T07:12:00.000-08:00

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In recent years Jim Rogers appears to have come to prominence. The main reason is the rise of commodities as an asset class, a trend he had predicted in the late 1990s. It would pay for us Singaporeans to know him as well; he might well be moving his family to Singapore! This was reported in the press recently; he wants to stay close to where the action is --- Asia, the world's growth engine for the new century (as seen by him).

He is best known for being the co-founder of the global macro hedge fund Quantum Fund together with the more famous George Soros. The fund started in early 1970, and Rogers left in 1980 a multi-millionaire and semi-retired; he now manages his own money. He was the research point-man for the fund. So it is clear that he is a fundamentals guy, and given the sweeping investment approach of Quantum, he tends to operate along the lines of big-picture macroeconomic analysis in picking assets to invest in. That means he takes a broad global perspective for good countries to invest in, betting on whole industries (ie. buy the leading sector stocks) or on the country itself. He takes the short side as easily as the long, but does seem to be partial to two asset classes: equities and commodities.

The Rogers investment approach is typically oriented towards betting on secular trends, as opposed to short-term changes. Rogers himself admits that he is the world's worst trader. Such a heavily fundamentals-based approach in global macro investing is rare, and to do it well involves being constantly in touch with the various social, economic and political facets that will have a bearing on the various asset class valuations. Indeed, it requires hard work to the point of obsession, and the ability to think independently from the herd --- a contrarian mindset. Indeed, Jim Rogers reads widely, and travels widely, in order to get a broad perspective of things, as first-hand as possible.

Besides being a co-founder of Quantum, Jim Rogers is primarily known for two other things: travelling around the world on a motorbike over two years (starting 1990) where he experienced the various countries first-hand, and his late-1990s bullishness on commodities which led him to devise the now-well known Rogers International Commodities Index that tracks all key commodities. He has written a book on each of these two topics ("Investment Biker" and "Hot Commodities" respectively). He was probably one of the first to see the structural changes the commodities asset class would experience due to the rise of China, a country he liked very early on and in which he continues to be maximum bullish now (which is why he wants to relocate to Asia and desires his infant daughter to learn Mandarin). Commodities is right up his alley: it is governed by the laws of demand and supply, probably more than any other asset class, and cannot be manipulated easily over the short-term, and even more impossibly over the medium/long-term --- an ideal ground for the well-researched, well-reasoned fundamental analyst.

It would be exciting to have him in Singapore. For such a well-travelled and famous investment personality to choose Singapore as his home (and probably his base for conducting his investment activities) would be one hell of an endorsement indeed.

References:
(1) Money Masters of Our Time (by John Train)

The 10 worst stock market crashes in U.S. History

2006-10-03T07:17:00.000-07:00

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In the midst of the three-year bull market that everybody around the world has been enjoying, it is worth getting a perspective of the kind of losses that are possible on the stock market. Most of the 10 crashes below happened over more than one year rather than in short durations (such as the 1987 Black Monday) but were no less painful for those involved. In fact, slow deaths are often more painful. The ranking and data were obtained from a financial article on About.com titled "Worst Stock Market Crashes" written by Dustin Woodward, and considers only those stock market crashes after 1900. A trivial noted by the author: 6 out of the top 11 crashes started in either September or November.

Some personal notes about the crashes:
1) It is interesting to note that all but two of the 10 most severe crashes happened in the early part of the 20th century, which suggests that either the economy has acquired more sophisticated self-correcting mechanisms or that the Federal Reserve's economic management has worked well in recent times.
2) 5 of of 10 have been in periods leading to war, during war and even after war (1919-21), with another (2000-02) at least partly due to imminent and limited war (terrorist, Iraq). Political problems weigh heavy on the market more than anything else.
3) Two of the four most severe crashes have been linked to the Great Depression, and there was a whole 2 decades where a secular bear haunted the economy. This is the kind of long-term gloominess that can kill off the spirit of the last bulls.

For those who think this is an inauspicious article, read no further.

10th Worst Stock Market Crash: 2000 - 2002
Key events: Tech bubble bursting, September 11th terrorist attack

Date Started: 1/15/2000
Date Ended: 10/9/2002

Total Days: 999
Starting DJIA: 11,792.98
Ending DJIA: 7,286.27
Total Loss: -37.8%

9th Worst Stock Market Crash: 1916 - 1917
Key events: US being drawn into World War 1

Date Started: 11/21/1916
Date Ended: 12/19/1917

Total Days: 393
Starting DJIA: 110.15
Ending DJIA: 65.95
Total Loss: -40.1%

8th Worst Stock Market Crash: 1939 - 1942
Key events: World War 2, attack on Pearl Harbor

Date Started: 9/12/1939
Date Ended: 4/28/1942

Total Days: 959
Starting DJIA: 155.92
Ending DJIA: 92.92
Total Loss: -40.4%

7th Worst Stock Market Crash: 1973 - 1974
Key events: Vietnam war, Watergate scandal

Date Started: 1/11/1973
Date Ended: 12/06/1974

Total Days: 694
Starting DJIA: 1051.70
Ending DJIA: 577.60
Total Loss: -45.1%

6th Worst Stock Market Crash: 1901 - 1903
Key events: Assassination of President William McKinley; a severe drought causing alarm about US food supplies

Date Started: 6/17/1901
Date Ended: 11/9/1903

Total Days: 875
Starting DJIA: 57.33
Ending DJIA: 30.88
Total Loss: -46.1%

5th Worst Stock Market Crash: 1919 - 1921
Key events: Followed a post war boom, bursting of the first big tech bubble- the automobile sector (but after bottoming, this decade saw tremendous growth in the stock market and the economy, often called the roaring twenties)

Date Started: 11/3/1919
Date Ended: 8/24/1921

Total Days: 660
Starting DJIA: 119.62
Ending DJIA: 63.9
Total Loss: -46.6%

4th Worst Stock Market Crash: 1929
Key events: End of the roaring twenties, and kicked off the Great Depression

Date Started: 9/3/1929
Date Ended: 11/13/1929

Total Days: 71
Starting DJIA: 381.17
Ending DJIA: 198.69
Total Loss: -47.9%

3rd Worst Stock Market Crash: 1906-1907
Key events: The "Panic of 1907" due to a credit crunch in New York, as well as gloom due to President Roosevelt's antitrust drive

Date Started: 1/19/1906
Date Ended: 11/15/1907

Total Days: 665
Starting DJIA: 75.45
Ending DJIA: 38.83
Total Loss: -48.5%

2nd Worst Stock Market Crash: 1937-1938
Key events: Legacy of Great Depression, war scare and Wall street scandals

Date Started: 3/10/1937
Date Ended: 3/31/1938

Total Days: 386
Starting DJIA: 194.40
Ending DJIA: 98.95
Total Loss: -49.1%

Worst Stock Market Crash: 1930-1932

This is the grand daddy of them all. Investors lost 86% of their money over this 813 day beast. This market crash combined with the 1929 crash, makes up the Great Depression.

If you had $1000 on 9/3/1929 (beginning of the 4th worst crash, it would have gone down to a whopping $108.14 by July 8th, 1932 (end of the worst crash) or an 89.2% loss. To recover from a loss like that, you would have to watch your portfolio go up 825%! The full recovery didn't take place until 1954, 22 years later!

Date Started: 4/17/1930
Date Ended: 7/8/1932

Total Days: 813
Starting DJIA: 294.07
Ending DJIA: 41.22
Total Loss: -86.0%

References:
(1) About.com: The 10 worst stock market crashes in US history
(2) BBC News- Bear Markets: Wall Street's Worst

Bull Stock: Venture Group

2006-09-18T08:29:00.000-07:00

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If there is such a thing as a defensive tech stock, the first one on the SGX that should come to mind is Venture Group, formerly known as Venture Manufacturing. Although I have written on this before in my HotStocksNot blog (see article link), it was purely on grounds of excessive valuation in context, not on fundamentals. In terms of critical mass, track record and management pedigree, Venture is widely acknowledged as world-class.

Venture Manufacturing was incorporated in 1984, and only listed on the SESDAQ in mid-1992 on FY91 topline and bottomline of ~$80M and <$5M respectively. For all practical purposes, it is worth tracking its progress starting from 1989, when the company acquired significant mass with the merger/acquisition of Multitech Systems Pte Ltd and Technocom Systems Sdn Bhd.

An investor holding Venture Manufacturing from its IPO (~$0.30) till now would have had multiplied his money by ~160 times, taking into account all splits (original shares outstanding of ~65M versus current 270M shares outstanding). At its peak in 1999-2000 during the tech boom, the lucky IPO investor would have multiplied his capital by 400 times, if he had cashed out at $30. That is the kind of return which has made Venture one of the Singapore stock market's best performing stocks of the 1990s.

As always, a steady earnings track record earns (pardon the pun) the stock the right to such prodigious multibagging. Over 1989-2000, the topline and bottomline grew at an almost straight upward trajectory; the CAGR (compounded annual growth rate) for topline was ~45% while bottomline(profit after tax) was 70%. Even while the rest of the electronics world suffered from the post-binge effects in 2001-03, the group continued to grow profit and sales at phenomenal rates until it began to slow down in 2004 (and since then). By then, it had annual sales of >$3B and profits of ~$200M.

The key underlying trend that has propelled Venture Manufacturing's rise is outsourcing. Specifically, it is the outsourcing of manufacturing (high volume, low profit operations) by various electronics OEMs over the 1990s. In the early Eighties, contract manufacturing, as this model is known, was still in its infancy; however by the late 1990s it was a US$100 billion a year industry (and projected to grow 25 to 30 percent annually over the next five years.... ultimately it didn't pan out). The industry was an offshoot of the rapidly rising PC and peripherals industry, that would form what is now known as the technology sector. Although traditional preference at most OEMs was to manufacture products in-house to ensure quality control, surging demand for PCs in the early Nineties, together with growing sophistication of electronic equipment, led smaller OEMs to outsource their simplier, more labor-intensive tasks and spill-over work to contract manufacturers, while they concentrated on the higher value-add, upstream design and engineering processes. The arrangement proved so successful that larger electronics companies such as IBM, HP and Compaq soon began shipping out work to industrial outsourcers. Buildup of critical mass at contract manufacturers such as Venture allowed them to progress beyond mere product assembly, to providing a host of services to OEMs, including process design and testing of products. In addition, some contract manufacturers (in particular, Venture) worked with OEMs in the actual design of new products (the ODM model).

Before the rise of China, Singapore was a big beneficiary of this trend, thanks to a longstanding openness to direct foreign investment as well as strong hard (logistics, communications, supporting industries) and soft (skilled and relatively cheap manpower, legal) infrastructure. It already had a track record in being the hard disk drive manufacturing capital for the world, and hence was a natural choice. The key customer for many Singapore contract manufacturers was Hewlett-Packard, which had had a strong Singapore presence for decades, and which moved aggressively to contract out production in the 1990s --- it farmed out so much work to Singapore that it created a market for local contract manufacturers. Venture's CEO, Wong Ngit Liong, was himself a HP alumnus.

Venture Manufacturing rode this trend throughout the 1990s, together with several other local contract manufacturers that would come to dominate the Singapore electronics manufacturing industry. What set Venture apart was its high profit margins, one of the best in the business. While other local manufacturers were operating on sub-5% profit margins (pre-tax), Venture was consistently achieving 7-10% margins. The key was that it provided high value-add --- the ODM model was adopted for many products, where the company also designed most of the products it manufactured, allowing higher prices to be charged. It was possible due to the company's diverse, low-volume product mix. At the same time, the company also provided supply chain management services, what it called e-fulfilment ---- another value-add. Although it was not the biggest local contract manufacturer by sales in the late Nineties (that honour belonged to Natsteel Electronics), it was probably the most profitable.

Oldtimers will remember the flurry of takeovers of local electronic contract manufacturers during the wild last few years of the old millenium, which hollowed out the local manufacturing scene. NatSteel Electronics, JIT Holdings, Li Xin Industries, and Omni Industries were acquired by bigger, global contract manufacturers like Flextronics, Solectron, Celestica, keen to build mass (in a period where revenue seemed more important than profits --- inspired by the dot-coms) at irrationally exuberant valuations (~30-40X PE) which now looks like perfect timing by the founders who cashed out. By virtue of its abovementioned ability to maintain high profit margins, Venture opted out and chose to go on its own. From the share investor's point of view, it may have been the wrong move; however one can hardly argue with the results. As the big contract manufacturers foundered in the wake of the dot-com crash, the company's earnings growth remained strong. However, since valuations for electronics contract manufacturers have since gone down as people realised that the earnings streams were not as defensive as first thought(it was originally conceptualised that a tech industry downturn should benefit contract manufacturers, as OEMs look to outsource more work to help cut costs), Venture's PE has been re-rated downward successively despite its sterling earnings track record post-crash and now looks further in trouble because its profitability also appears to be slowing down. Nevertheless, it is one of the truly world-class technology companies around, with a global manufacturing footprint and strong design capabilities making it a strategic partner to companies like Cisco, HP, Philips..... maybe Creative can give it a fight for top Singapore tech stock? Just joking.

References:
(1) Forbes article: Singapore Fling
(2) CFO Asia Feb 1999: The Man with the Midas Touch
(3) Businessweek Jul 04: Singapore's Venture Shows The Big Guys Another Way

Personalities: Maynard Keynes

2006-09-05T09:07:00.000-07:00

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Those who have studied Economics would know John Maynard Keynes; his magnum opus, the General Theory of Employment, Interest and Money, set the foundations for modern macroeconomics, otherwise known as Keynesian economics. At the same time, a less-known fact is that he was an accomplished hedge-fund manager.... at least, the scope of his operations, which involved long and short various asset classes spanning currencies, stocks, bonds, commodities qualified him for this term, although the phrase hedge fund would be invented only decades later.

People love underdog stories, such as Albert Einstein who rose from a clerk to pioneer the theory of relativity; however Keynes was never an underdog. Born with a silver spoon, he was consistently brilliant throughout his academic years in Eton, then Cambridge, where he was also invited to join the then fashionable and highly exclusive secret societies within these academic institutions which admitted the greatest intellectuals within them. It was there that Keynes entered into homosexual relationships; it was fashionable among intellectuals then to believe that women were inferior in mind and body and hence love of young men was ethically better and more enriching. Later in his life Keynes turned straight and married a woman.

A brief description of Keynes' mainstream career as an economist. He was adviser to the British finance department during World War 1, where he argued against forcing Germany, the eventual loser, to pay excessive war reparations .... which was ultimately ignored and which eventually led to German disillusionment and the rise of Hitler. His greatest work, the General Theory of Employment, Interest and Money challenged the economic paradigm when published in 1936, introducing the previously unthinkable idea of running government budget deficits to jump-start a depression economy ---- which eventually, when adopted, arguably ended the Great Depression of the 1930s (though some argue World War 2 did it). As a key negotiator post-World War 2, he was instrumental in creating a new currency order (fixed exchange rates, gold standard) and also in setting up of the World Bank and the International Monetary Fund --- legacies which have lasted till today.

As a fund manager Keynes' record branched along two avenues. Firstly, he oversaw an endowment fund for Cambridge which showed a brilliant record over ~20 years --- from 1928 to 1945, despite taking a massive hit during the Depression, the fund produced a very strong average increase of 13% compared with the general market in the United Kingdom declining by an annual average of 0.5%. The approach generally adopted by Keynes with his investments can be described succinctly as

1. A careful selection of a few investments ie. concentration, not diversification;
2. Buy-and-hold (for several years if need be) until either they have fulfilled their promise or it is evident that they were purchases on a mistake;
3. A balanced investment position, i.e. a variety of risks in spite of individual holdings being large, and if possible opposed risks --- an understanding of minimising portfolio risk even before Harry Markowitz's portfolio theory in the 1960s.

These principles may be a result of experience and distilled thought processes from his earlier speculatory experiences in his hedge fund and personal portfolio (described below), because his supervision of the endowment fund started long after his first forays into the markets.

Keynes had created what was essentially a hedge fund in 1919 with his broker in 1919 comprising of fund contributions from various friends, after speculating in stocks and currencies for ~4-5 years (let's see... he started speculating only around the age of 30!); he managed the hedge fund while also speculating separately with his personal portfolio. Given his training and career as an economist, it was natural that he adopted top-down macro positions in his asset allocations in both his hedge fund and his personal portfolio, dabbling in various asset classes --- European and US currencies, commodities, equities. It appeared that his earnings were quite cyclical, being wiped out to the brink three times --- at the start of his hedge fund (in a currency bet that turned sour), during the Great Depression (mainly commodities whose prices dived), and in an abrupt bear market in 1937-38 (in stocks); however he made big money in between. In his hedge fund and personal portfolio he used leverage aggressively to magnify bets; even the greatest economist cannot predict market turns consistently, and Keynes might have been too confident of his intellectual prowess in his liberal use of leverage.

Yet Keynes recognised the impreciseness of the stock market. He compared the stock market to a newspaper-sponsored beauty contest in which the prize was to be awarded to the participant who guessed which of the photographed faces would be judged to be the most beautiful. Essentially, to quote him: "It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which opinion genuinely thinks the prettiest. We have reached the third degree, where we devote our intelligences to anticipating what average opinions expect the average opinion to be. And there are some who practise the fourth, fifth and higher degrees." This leads to the "castle-in-the-air" theory of stock-picking as described in Burton Malkiel's "A Random Walk Down Wall Street", where one estimates what investment themes/situations are most likely to capture the attention of the investing public. This was Keynes' most famous insight on the stock market.

References:
(1) Wikipedia article: John Maynard Keynes
(2) Hedge Hogging (by Barton Biggs)

Personalities: Hetty Green

2006-08-16T07:36:00.001-07:00

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Investment and finance has somehow, always been a profession associated with men. Perhaps it is the general stereotype that men are better with numbers, or that aggression, a trait atypical of women, is a prerequisite in the industry. The best known woman investor lived more than 100 years ago, and she was hardly a typical woman.

Hetty Green was born in Massachusetts in 1834, to a relatively wealthy family. She acquired her financial knowledge early, spending much of her youth with her father and grandfather, learning about financing and business. In 1865, at the age of 31, she received a $5M inheritance when her father passed away. At the time, women were thought to be incapable of managing money, so such assets would typically be held in a trust managed by a man. Hetty struggled against the establishment and eventually was able to gain control over her inheritance.

A main reason why Hetty Green's name has survived through the ages was her eccentricity, in particular her miserliness. Her fortune grew to tens of millions, but it was almost impossible to pry a single penny from her grasp. Hetty would purchase a newspaper for 2 cents, then resell it after she read it. Every day, she wore the same long black dress, only buying new clothes when her outfit became threadbare. The most extreme example of her miserliness was when Hetty's son, Ned, injured his leg in a sledding accident. Not wanting to pay for a doctor, she attempted to take care of Ned herself ...... Ned developed gangrene and the leg had to be amputated.

As a result of her miserly and eccentric reputation, as well as her strange appearance, Hetty Green came to be known as the "Witch of Wall Street". However, she was a successful businesswoman who was a peer with the best male financiers of the time. On several occasions the City of New York came to Hetty in need of loans to keep the city afloat, most particularly during the Panic of 1907; she wrote a check for $1.1 million and took her payment in short-term revenue bonds. At her death in 1916 she owned about 6,000 pieces of real estate across forty-eight states, including railroads, theaters, cemeteries, hotels, office buildings, and the mortgages to nearly six hundred churches; the total worth was estimated at $100-200M --- billions in today's dollars, and undoubtedly making her the richest woman in the world at that time save for royalty.

Unsurprisingly, Hetty Green was a value investor. As she said, "There is no secret in fortune making. All you have to do is buy cheap and sell dear, act with thrift and shrewdness and be persistent." Green did not seek investments that would promise quick returns but instead invested conservatively and with the long-term in mind. Before deciding on an investment, she would research as much information on it as possible. In addition to buying government bonds, Green primarily invested in railroads and real estate in places like New York, Chicago, and St. Louis. Hetty Green liked real assets, and was neither speculative, nor ultra-conservative. The railroads that Hetty owned were in an exciting growth industry in her days.

Her specialty was buying when everyone else was panicking. Hetty did not borrow, she maintained significant liquid assets, and she knew the value of stocks and bonds. At that time, the stock market was not as regulated as it is now --- margin requirements were minimal -- people could get huge amounts of leverage by buying stocks almost entirely with borrowed money. When crisis arose, cash was king. Hetty Green had both the means and knowledge to profit. For instance, days after the end of the Civil War, she bought Civil War bonds that everyone thought were worthless, soon doubling her net worth. Later, during the Panic of 1907, when a string of banks failed and the stock market crashed, Hetty was buying with both hands.

On retrospect, it was not such a great investment performance. She transformed $5 million (her inheritance) into more than $100 million over the course of 51 years. If we assume she generally didn't spend her principal and rarely paid taxes, then she really only made about 6% a year. This makes sense, considering that she held a lot of cash and bonds. But it doesn't compare well with the stock market's long-term returns or the even higher returns investors can achieve with value stocks. If she had made 10% a year, she would have died with about $650 million rather than $100 million. If she had made the 20% returns that some value investors like Buffett have achieved, she would have been worth almost $55 billion. Rather, she was infamous, more for her eccentricity and frugality. Perhaps one lesson to learn from her is to be careful with one's expenses and to let the money compounding magic work for oneself. Of course, it would help to have several millions to start with.

References:
(1) Wikipedia article: Hetty Green
(2) Motley Fool article: The Witch of Wall Street
(3) National Women's History Museum: Hetty Green

Crash stock: Ipco

2006-07-22T06:41:00.000-07:00

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Ipco is probably one of the more colourful stocks on the SGX. However, it is also one of the greatest destroyers of shareholder value over the last ten years. A shareholder buying in at $5/share in 1993 before the start of the 1994 bull surge would be left with <$0.10/share today (assuming he had not exercised a rights issue in 1997) --- a reverse 50-bagger over 13 years excluding opportunity costs.

The evolution of Ipco since its listing in 1993 may be divided into three stages: from 1993-99, 1999-2004, and finally 2004-now. The shareholding structure of the company, and its main business operations, underwent major changes through each of these stages.

The company was founded in the 1970s and at time of listing, its major shareholders were an Australian-listed group, Leighton group, and Malaysia-based Promet, an infrastructure, maritime engineering and construction group which was a stock market darling during its time --- veteran investors would be familiar with it. Ipco was involved in infrastructure, construction and oilfield services/equipment, and given its linkages with Promet it quickly became a hot stock during the bull run in late 1993-94, hitting a peak of $10 or ~25X trailing PE. However, a normalisation of market sentiment drove the price downwards to around $2 by 1996. The company was still profitable in its core operations, deriving S$7M profit on nearly S$300M revenue in 1996, although earnings growth was patchy.

The 1997 Asian financial crisis hit the company badly, a blow from which I believe it was never able to recover since. Most construction companies were hit, given that the heavily-leveraged property developers across Southeast-Asia bore the brunt of the currency shock. Over 1997-1999 Ipco accummulated losses of over S$100M. Promet itself was troubled due to its property commitments and in 1999 pared down its Ipco stake from >70% to <10%. Ipco's share price had dived to 60-70 cents by 1999, albeit having had an 8-for-10 rights issue in late 1997 (which apparently sparked a huge short-term spike to >S$3).

The second stage began with an Indonesian businessman Purwadi taking charge, and the landmark event being an amazing share issue of 650 million new shares valued at US$0.20 a share (existing share capital had been 70 million shares) for the purchase of a toll operator Spring Sun International which owned a stake in two China toll roads. Today it would be known as a reverse takeover. However, the seller appeared not exactly keen to hold on to the Ipco shares, as there was a subsidiary agreement to sell back the shares to Purwadi in stages subsequently. It appeared to be a way for Purwadi to gradually consolidate shareholding control over Ipco, except that he couldn't: according to "regulations" he was unable to hold more than 25% at any time, which of course meant he would probably place these shares out to the market eventually. Strangely, a steady flow of market news and imminent deals cultivates the speculative instincts in traders, and Ipco's share price surged from $1 to $4 within the space of one month in April 2000 (a move contrary to the market trend, given that the dot-com bubble burst in that month), then retreated even more quickly back to $1 within the next few weeks. There is reason to believe the stock had been cornered.

The deal eventually went through but Purwadi had rescinded his offer to buy back the shares. He was lucky, for Ipco languished at ~10-20 cents, way below the original issue price of US$0.20. Anyway, the SSI seller, Hi-Way Investments, probably eventually offloaded its huge stake in mid-2002 at a loss. But it had also, in turn, probably screwed Ipco in its own way: operating losses were actually incurred on the toll roads over the next two years, and eventually Ipco sold off its SSI stake at a S$80M loss, a 40% loss on its initial investment (which admittedly cost no money, but destroyed shareholder value through massive dilution). Ipco had somehow managed to contrive a deal where all parties were made to feel that they had lost big-time.

In-between, there were so many miscellaneous deals here, there, everywhere that the minority shareholder must have been bedazzled. There were oil-and-gas deals in Thailand which ended in litigation, new share placement deals (again!) to acquire an explosives company (never went through), and attempted listing of a subsidiary Insitu (also never went through). Finally, under new management in 2004, Ipco decided enough was enough, and restructured yet again, selling off all its core infrastructure and construction assets and acquiring yet another set of assets, comprising stakes in companies doing electronics , property, oil and gas, gas supply, located in Malaysia, China, USA, Singapore (confusing, but in alignment with the company's "culture"). This is the third stage. It is still evolving, and I shall not go into it further because I have already covered it in a Hotstocksnot article on Ipco recently.

One thing cannot be denied, and that is the speculative nature of the stock, which has made it a traders' favourite. It is interesting to note that starting 1994 when Ipco had its first price spike, it had had one every 3 years, in 1997, then in 2000. Since then, it has not had any real price surges of note. Traders, however, still believe in it.

But for what? It is a prime example of a management being distracted by too much dealflow and attempting to capitalise opportunistically on the stock market to grow the firm (through new share placements to finance acquisitions), but instead losing focus and missing the forest for the trees. Most importantly, it continually compromised the minority shareholders. This was especially apparent in the SSI deal. Those who believe they can still ride on the stock when it recovers might end up being trampled by the vagaries of its management.

References:
(1) Various issues of "Shares Investment"

The 1980 silver corner

2006-07-09T04:34:00.000-07:00

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A corner is a situation where an investor/group of investors secures a large proportion of the outstanding amount of assets on which he forces, or squeezes, those short on the asset to pay a disproportionately high price. Coined in the days of the 19th-century robber barons, it is a vivid description of the quandary faced by shortists who panic to cover: "he that sells what isn't his, must buy it back or go to prison" (courtesy Daniel Drew). The silver corner of the late 1970s-1980 was probably one of the last attemmpted corners.

The protagonists were the Hunt brothers, specifically Nelson Bunker and William Herbert Hunt, two of the fourteen children of the Texas oil magnate H. L. Hunt, who was the richest man in the United States when he died in 1974. Of the two, Nelson Bunker Hunt was the main driving force.

In 1970 Nelson Bunker Hunt decided to invest in silver to hedge against inflation, which was clearly rearing its head. At the same time, silver provided a safe haven to individual investors, in the face of a risky international situation in the forms of Vietnam and the Middle East. The price of silver was then $1.50/oz(ounce). The form of accummulation was via silver contracts which the Hunts had every intention of accepting delivery: by 1974 they had accummulated silver contracts totaling 55 million oz or about 8% of the world's silver supply at that time; they took delivery of all the silver. By the spring of 1974 silver had risen to over $6/oz amid talk of the attempted silver corner.

At this point it is useful to understand the silver market. There are three primary markets for silver: the ornamental market which serves jewelry and silverware; the investor segment which concerns silver bars and coins; and the industrial part which includes photographic film and paper (the main), computer components, brazing alloys, pharmaceuticals and alternative energy applications. The industrial sector generates the biggest demand for silver, while the investor segment, the smallest. Although the world was churning out new silver from the mines all the time, world demand was about double that (new annual production of 245 million oz vs annual demand of 450 million oz in 1974). In that year, of the estimated 700 million ounces of silver in supply, only about 200 million ounces was available for delivery against futures contracts. Supply was tight, and the Hunt brothers realised that if they could take on a partner to resume purchases of silver, the price would rocket upwards, as those short on silver (ie. the sellers of the silver contracts) would have to scramble to find new silver for delivery.

The partner was needed because the Hunts, despite their wealth, were now a little short on cash by then. It also takes a lot of courage to attempt a corner on one's own; better to spread the risk. In 1978 they found their partners in two Saudi sheiks, formed an investment group called International Metal Investment, and resumed their silver contract purchases in 1979 on the CBOT (Chicago Board of Trade) and the COMEX (Commodities Exchange of New York). In the fall of 1979 the silver price doubled from $8 to $16/oz in only two months. Other syndicates with big money behind them started buying silver, as momentum took on a life of its own. The COMEX and the CBOT started to panic; in late 1979 the warehouses of the two exchanges only held 120 million oz of silver. By then, the Hunt brothers held 40 million oz of physical silver in Switzerland and 90 million oz of bullion they jointly owned through International Metals. International Metals had contracts on another 90 million oz due for delivery that March from the COMEX. The Hunts were looking ready to suck all the available deliverable silver out of the US exchanges.

Then the exchanges started to modify the rules of the game. CBOT changed the rules and stated that no investor could hold over 3 million oz of silver contracts and the margin requirement were raised; those holding above 3 million oz. had to liquidate the excess. The market interpreted this move as a sign that a silver shortage was imminent, and pushed up prices to an astronomical $34 by end-1979. Then in January 1980 the other exchange, the COMEX, changed their rules to only allow 10 million oz. of contracts per trader; excess to be liquidated. The Federal Reserve supported the rules modification of the two exchanges. It was analogous to a casino telling the professional gambler that only a certain portion of his chips were now exchangeable for cash. And such an abrupt rules change against a speculator might have inspired Dr Mahathir's moves during the Asian financial crisis to impose capital controls to halt the tide; it makes one wonder what moral authority the West had in criticising the Malaysian PM for his "draconian" measures, when they had set a precedent in 1980.

When the market realised that the financial authorities would resort to drastic measures to stop any silver cornering attempts, the price began to slide. As the Fed kept on raising interest rates (a move to curb overall inflation: see "1970s Bear Market"), it had two effects: it made the US dollar strong and hence silver cheaper (in US$ denomination), and it made credit expensive. The combined effect was to make it difficult to borrow more money against the Hunts' silver holdings (rapidly depreciating in collateral value) to buy even more silver to hold up the price.

By mid-March 1980 silver was down to $21/oz. By end-March the Hunt brothers ran out of cash to top up their margin calls. On March 27th, a day known as Silver Thursday, the price of silver collapsed by 50% from $21 to $11 in one day, as the market realised the Hunts were now being forced to sell their silver. And so started a downward spiral.

The collapse of the silver market meant countless losses for speculators. The Fed eventually came in and got a group of banks to provide a billion-dollar loan to the Hunts, with their oil assets as collateral. Nevertheless, in 1988 Bunker Hunt declared personal bankruptcy, as the family's fortunes declined following the debacle. In 1988 the Hunts were convicted of conspiring to manipulate the market.

The most interesting thing about this episode that emerged in its wake was that members of the two commodities exchanges had just as much at stake as the Hunts, because they were short the futures contracts. If the corner had succeeded, these were the guys that would have been financially killed. Was there a conflict of interest when they formulated the rules changes that eventually killed the Hunts' silver corner? The answer is very clear. Often people take the moral high ground with a secret agenda.

After the Hunt debacle, silver fell into a deep swoon -- falling to about $3.50 in the 1990s. It is interesting that some investors such as Warren Buffett, George Soros and Bill Gates have taken on significant silver positions. They might have seen some undervaluation given the strong utility provided by this precious metal, as described above.

References:
(1) H.L. Hunt's Boys and the Circle K Cowboys
(2) The Hunt Brothers: by Kevin Kerr
(3) The Hunt Brothers and the Silver Bubble: from StockandNews.com

The 1970s gold bull market

2006-06-21T09:30:00.000-07:00

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Among all metals gold retains a mystical quality, with centuries of its symbolic value behind the common perception of it being the ultimate currency. This perception means that the metal retains its real value well; one would expect its price to be relatively stable. However, in times of crisis and inflation when there is a flight to quality, gold's qualities as the ultimate inflation and currency hedge (inversely correlated to the US dollar) plus its safe haven characteristics come to the fore.

The pressure for a revaluation of gold had been building up throughout the first few decades of the twentieth century. For a long time global paper currencies operated on the gold standard, meaning that they were backed by gold reserves; paper currency was fully convertible to an equivalent amount of gold at the appropriate rate, which meant the gold price was fixed. Up till 1944 it was fixed at US$20 per ounce, then under the Bretton Woods agreement it was revalued to US$35/ounce. But as gold demand continued to rise and its gold reserves dropped due to its rising trade deficit, the US faced increasing pressure to revalue its currency downwards (in terms of gold) by the end of the 1960s. In the end, President Nixon closed the "Gold Window" in 1971, ending the dollar-gold convertibility, and leading inevitably to "floating" of the world's currencies (because there was no longer an intermediary -- gold --- to which currencies' values could be fixed, hence they could trade against each other freely to find their true value). Given that the price of gold had been artifically held back via agreements before this move, it was like the opening of a dam to release the water behind. By the end of 1974, Gold had soared from US$35 to US$195 an ounce.

The mid-to-late 1970s was of course, the stagflation years where annual inflation rates were as high as 15%, partly due to cost-push inflation caused by the rise of the OPEC cartel. The last commodities bull before the current one was during then; commodities are the best inflation hedge, and chief among them was gold, partly because of nervousness about a possible collapse of the global financial system (still adjusting to floating rates) causing a flight to safety. Despite attempts to keep gold prices down by sales of gold from the US Treasury, and aided by a drop in the US dollar's exchange rate against its main trading partners, the price of gold doubled to US$400 in the space of one year in 1979, then doubled again to US$850 by early 1980.

Anyone vested in gold in the early 1970s would have seen his investment rise >2000% within the space of a decade. Hindsight, of course, is 20/20, but while the super-inflation in the late 1970s could not have been foretold, the reformation of the dollar-gold convertibility regime in 1971 would have suggested a strong catalyst to buy into gold for the astute investor. Without an artificial peg to gold prices (to the US dollar), and given the difficulties faced by the US Treasury in maintaining the regime prior to Nixon's repudiation of the long-held policy, the demand-supply dynamics that were released into play drove gold prices inexorably upward.

As it was, 1980-81 marked the high point of gold prices for the next 2-3 decades. Gold and commodities went into a long swoon as the world went into a golden period of low inflation and high growth. As money flowed back towards equities, gold prices fluctuated between US$250-400 (rarely above). That is, until 2006, when it recently touched US$700/ounce before retracing amidst the global commodities correction.

References:
(1) The Privateer Gold Pages
(2) Wikipedia entry: Gold

Personalities: Jesse Livermore

2006-06-06T07:30:00.000-07:00

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The greatest trader that ever lived, they call him. I use the figure of the bear (see above) because he made his name shorting the market crashes of 1907 and 1929. More than the money that he made, it was the way he made them and lost them --- several times over --- and the immortalisation of his trading philosophies in the classic "Reminiscences of a Stock Operator" that mark him as one of the greats.

According to the book, written by Edwin Lefevre in the persona of Larry Livingston which was a pseudonym for Jesse Livermore, the man himself started his trading career at the age of fifteen, after he ran away from home to escape a life of farming his father wished him to have. He then began his career by posting stock quotes at a brokerage in Boston, where he first learnt about stocks and honed his ticker-tape reading skills, enabling him to read and predict price movements and tendencies. In the next several years, he made his money at the bucket shops (a kind of gambling outlet allowing margin trading on stocks), and then devoted his energies towards trading in legitimate markets, first on the stock exchange and then moving on to commodities as well. His life was filled with ups and downs; his big money was made in the market collapse of 1907 and Black October in 1929, which made him $3M and $100M(!) respectively, but in between he lost most of his fortune in commodities and a sideways trading market, and subsequently after 1929 again lost most of his trading capital in a depression market. He declared bankruptcy several times in his trading career, and committed suicide in 1940, having lost confidence in his abilities and suffering from depression. A sorry end to a great speculator.

I guess the ups and downs only added to the romanticism of his life story and enhanced his status in the eyes of professional traders (somehow). His teachings and trading philosophies, learnt through hard experience, are probably standard traders' rules nowadays: trend-following, buying and holding in a bull market, industry analyses, following the leaders, identifying pivot points, and of course, risk management. Speculators before him had practised some of these ideas, but he probably formalised these philosophies and profited greatly from them like no other before him, by sheer application on the markets.

One should really go and read the abovementioned classic (Reminiscences of a Stock Operator) to get a full view of his ideas and their evolution. Below are probably some of the most important ones:

- The greatest amount of money is made following the major trends - not in the day-to-day fluctuations of a stock or in a particular commodity. A useful piece of advice for the day-traders of today, from one of the all-time great speculators. "The courage of your convictions and the intelligent patience to sit tight" (in this sense he shares a certain similarity of spirit with Warren Buffett).

- While his tape-reading skills were still important, they were not as important as studying the fundamentals of each company and the credit conditions of the stock market and the economy; such studies served him well in his bear raid during the Panic of 1907 where he observed tightening of credit conditions and the bankruptcy of a number of businesses and Wall Street brokerages

- Always average up; buy more of what shows you a profit, and sell off if the price is not behaving right (ie. goes down). This is consistent with his view of trend trading and cut loss. "Always sell what shows you a loss and keep what shows you a profit".

- Do not depend your analysis solely on "insider information.", or more generally, trust your own analysis and do not rely blindly on other people's advice however convincing and knowledgeable they are. He learnt this from personal experience, most significantly in a cotton trade where he reversed his original position on the advice of an expert and consequently suffered huge losses.

- The need to continuously evolve in the stock market. Thus he was able to switch from the bucket shops to the exchange, and continuously evolve new philosophies and trading styles from his observations. He also learnt to trust his instincts (a point also emphasised, incidentally, in "The Zurich Axioms").

The 1920s to 1930s were probably some of the most treacherous times for speculators. Having thrived on one crisis (Black October 1929), Livermore then probably misread the severity of the crash and made bad calls leading to his last bankruptcy and his eventual depression and suicide. Perhaps this is the final lesson for traders: be ready to admit defeat rather than go all out .... the nature of the market might have changed.

References:
1. Marketthoughts.com: On Jesse Livermore And His Legacy
2. Wikipedia entry: Jesse Livermore
3. Wisdom of Jesse Livermore
4. Reminiscences of a Stock Operator (Edwin Lefevre)

Crash Stock: ACCS

2006-05-26T06:30:00.000-07:00

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With the admission of guilt of ACCS founder and former CEO Victor Tan to charges of fraud as announced in the papers today, the corporate scandal of ACCS that first erupted in February 2005 and brought the high-flying stock to the pits comes to a close. The company was once a stock market darling worth S$800M in market capitalisation but today trades at less than one-eighth that value.

In early February 2005 ACCS was trading at 85 cents, a trailing PE of 25 times. Since its IPO in 2002, it had displayed stellar performance, showing near doubling of revenues and net profits every year till then. It had the backing of the investors with the Midas touch -- 2G Capital. Its business captured the imagination of investors and traders alike --- its rapidly expanding after-market maintenance services for mobile phones captured two popular themes: the regional outsourcing story and the mobile phone theme. Its subsidiary, DMS (in the business of phone distribution), was on the verge of listing, which would bring its parent exit gains. It is amazing, on retrospect, that within one week the whole world would come crashing down.

On 18 February, the company made a late-night announcement that it was ceasing its AMS (after-market services) for Nokia in several countries, spooking the market despite company assurances ("just pricing issues") and concurring analyst reports ("impact on financials minimal, maintain target prices"). One learns to respect the movement of the market; it behaved in a volatile manner on heavy volume despite these assurances and four days later the bomb dropped --- the Commercial Affairs Department announced that it was launching an investigation into ACCS, which subsequently admitted to overstating revenue in the previous quarter "in relation to one particular contract in Singapore with a customer of the company", and cancelled its listing of DMS. In the wake of CAO and Citiraya the market was sufficiently alarmed to bring it to below 40 cents, or half of its early-February valuation. Even a stellar set of FY04 results announced around the same time, showing another year of revenue and profit doubling, wasn't much help --- investors no longer knew what to trust.

The stock was a journalist's dream in the next few months, for all the wrong reasons. In March it attracted a suitor in Singpost who proposed to take an eventual 30% stake, but this was called off after much publicity about how Singpost's chairman's and director's (Tommie Goh) ACCS holdings presented a conflict of interest. The forced selling of Victor Tan's ACCS stake (ostensibly to meet margin calls) and similar disposals by co-founder Ronnie Poh provided further corroborating signs of the company's troubles. Finally, the second bombshell dropped in May 06 with the results of Price Waterhouse's investigations into the "overstatement of revenue" issue.

The special auditor had uncovered a whole can of worms. The 3Q04 revenue overstatement was not siginificant, but refurbishment revenue and profit had been massively overstated for the whole of FY03 and FY04. The overstatement of the revenue and profit before tax amounted to approximately S$22 million and S$19 million respectively for FY03 and approximately S$60 million and S$54 million respectively for FY04 in relation to the refurbishment business of the group. One look at the figures and one knows that this refurbishment business was dodgy: what kind of business model could for example, let one earn $54M profit on $60M revenue ie. profit margin of 90%?

The net effect of this revelation was that FY03 was just a marginal profit year while FY04 was in fact a loss-incurring year. Which means there was no meaning to the earnings multiple anymore. The company had to make massive provisions to investments and receivables, reducing net asset base to 4 cents per share --- the new base for further share price consolidation.

The entry of Philip Eng, the former CEO of Jardine Cycle and Carriage, as the new ACCS chairman later in the year helped to bring some cheer to the company. There was probably a special reason for bringing him in in addition to prestige: he had been through loss of a key distributorship before at C&C, when they lost the Mercedes-Benz account. The early optimism soon evaporated, as the company continued to make further downward revisions to FY03 and FY04 losses (eventually amounting to >S$35M losses in each year!) while issuing another set of red ink in FY05. In June 05, I had written a Hotstocksnot article against ACCS, which was justified by later events.

The company's former CFO has recently admitted to corporate fraud against Nokia and falsifying financial statements, while Victor Tan has pleaded guilty to collaborating with him in falsifying claims for the repair of Nokia handphones, for faking a "thriving" refurbishment business (using company funds), and for issuing false financial statements. Over 10 others in ACCS have been implicated in this massive fraud.

What signs were there to prevent the investor/trader from entering this stock in the first place? The PE was too high at >20, to begin with. It was the pressure to maintain the phenomenal growth rate expected by the market that might have driven the ACCS management to tamper with their accounts .... the same market pressure that drove CAO's Chen Jiulin to direct speculation in oil derivatives. If one had been in the stock when the loss of the Nokia contract was announced, a cut-loss or selling into strength on the subsequent day might have been adopted hence avoiding the follow-up carnage --- a cockroach on the kitchen floor might hint at many more in the closet. Lastly, never hope ---- just react. As the spate of unfavourable news poured in, one should have known better than hold and hope for the tide to turn. Fundamentals trends are terribly difficult to turn.

References:
(1) Straits Times articles Feb till Aug 2005, covering ACCS (obtained from the Shareinvestor website)

Black Monday 1987

2006-05-23T06:21:00.000-07:00

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In the wake of two local "Black Mondays" I thought it would be a good time to outline one of the original Black Mondays.

How much has the STI dropped in each of the last two Mondays which witnessed the largest drops compared to other subsequent days of the week? About 3% on each day. Compared to Black Monday in the US on Oct 19 1987, this was small fry: on that day, the Dow Jones Industrial Average (DJIA) fell by 23% in the course of one day. Statistically, it is not hard to conclude that many stocks probably fell by 50% or more in one day alone.

What is it about Mondays? In the other major collapse of the 20th century, 1929, it was also a 13% collapse on a Monday (October 28) that triggered a secular bear and the Great Depression; the greatest point loss in DJIA history was also on a Monday(17 September 2001, 685 points). Someone (think it's Peter Lynch) has suggested a possible reason: people have plenty of time to think over things over the weekend, and the sensation-seeking press will always make sure that they have plenty of things to worry about: trade deficits, budget deficits, rising inflation etc. So come Monday people will have made up their minds to sell off some assets and revert to cash. When enough people worry in this way, the result is a market sell-off that if uncontrolled could feed on its own momentum.

The cause of the dramatic collapse on that fateful day in 1987 are still debated by academics to this day but suffice to say that it cannot have been due to long-term fundamental factors. The best evidence was that the market recovered to its previous level within a year, and then proceeded on another decade of bull run --- the longest sustained secular bull in history.

The Black Monday market collapse in the US was probably triggered by earlier market collapses in overseas markets earlier (the US market lags Asia by ~12 hours, as seasoned investors may well know). Markets in Asia and parts of Europe had already posted heavy losses before the New York markets opened, which drew its lead from there.

Program trading has been the most-oft quoted single reason for creating and sustaining the market panic of Black Monday, so I'll discuss it although one should be aware that in post-mortems it is always easier to blame a system or institutional structure (in this case, computerised trading) than the humans involved. There are two main types of program trading being blamed here: index arbitrage and portfolio insurance. Index arbitrage takes advantage of discrepancies between markets by simultaneously buying in one and offsetting that purchase with a short position of the same size in another closely linked market. Portfolio insurance involves the sale of stock index futures to protect the value of a falling stock portfolio. These strategies are supposed to hedge against losses in fund managers' portfolios by adopting offsetting futures positions to underlying index/stock positions (compare this to the "convergence trades" practised by Long-Term Capital Management; however in a market panic what happens of course is that falling stock prices triggers fall in futures prices (as the latter are being sold to hedge) and which in turn feeds back to further falling stock prices. What might have been a self-stabilising situation under normal market conditions turned into a destabilising system. This explains the swiftness and extent of the market collapse, and also underlines the close linkages between the stock and futures markets that had developed by then.

As mentioned above, market players also had plenty to worry about. The thing about the markets is that it can be similar to marriage life: issues can be simmering below the surface while the market chugs along, but on a bad day all these can suddenly come into public consciousness and create continuous waves of psychological panic. Those who have experienced the SGX market correction these few days can testify to this: one moment everybody (including, if not especially, the analysts) were calling for a smoothly-rising economy and stock market in 2006, the next moment issues like high oil prices, rising interest rates, a weak US dollar, political instabilities (in the Middle East and South America), a slowing China, a commodities collapse suddenly float to the surface. In 1987 the issues were as follows: Iran-US spat, declining US dollar, high interest rates, high trade deficit. I suppose you can draw exact parallels between the macroeconomic concerns then and now (with the exception of the China issue). History works in mysterious ways.

At the same time, some also quoted the possible reason of US market overvaluation. The S&P was trading at 19X PE in 1987, an above-average valuation that might have formed a fundamental basis for selling down, in the minds of investors and fund managers on Black Monday. However, subsequent strong corporate earnings through the rest of the decade and beyond might have judtified this valuation.

All these factors probably contributed to creating and extending a crisis of confidence on the big day, and then accentuated (instead of nullified) by the emotionless computers through program trading. They also accentuated the problems of academicians, hitherto the preachers of the "rational investor" theory and Efficient Market Hypothesis. How could a 23% single-day drop justify their assumption that investors were rational or that the market was efficiently priced (fundamentals couldn't have declined 23% in one day)? That's why it was convenient to blame structural weaknesses (ie. program trading) for the collapse.

In the wake of the crash, markets around the world were put on restricted trading primarily because sorting out the orders that had come in was beyond the computer technology of the time. This also gave the Federal Reserve and other central banks time to pump liquidity into the system, as well as lowering short-term rates, to prevent a further downdraft. Market suspensions in the wake of drastic collapses are still practised to this day (eg. the Sensex market suspension just yesterday) to allow liquidity injections and for investors to come to their senses. Some call the Black Monday of 1987 a selling climax, where the excess value was squeezed out of the system. It reinforced the market collapses in international markets, such that by the end of October, stock markets in Australia had fallen 42%, Canada 23%, Hong Kong a whopping 46%, and the UK 26%. As mentioned earlier, the rebound from Black Monday was swift as well, and ultimately the US market recovery in 1988 onwards led the way out of the blue for world markets.

References:
(1) Wikipedia entry: Black Monday 1987
(2) Stock Market Crash Net: Black Monday- the Stock Market Crash of 1987
(3) Sniper.net: Stock market crash - Black Monday - October 1987
(4) Lope Markets: The 1987 Stock Market Crash

Personalities: Wall Street Influentials

2006-05-13T00:00:00.000-07:00

DanielXX's intro: I saw an article in Salvator Dali's blog Malaysia-Finance Blogspot that listed down the current key influential people on Wall Street (extracted from New York Magazine). While they (mainly investment bankers, private equity heads and fund managers) probably do not deserve individual mention in separate articles, they represent the movers and shakers on Wall Street currently. So I had to cut and paste the article here.

(P.S: The following were extracted from another source and is not my original work.)

Generally I do not want to do much cut and paste, but this piece from New York Magazine is worth reading. The magazine did a report on the influential people in 24 categories, naturally we are interested in the Wall Street category. Of the entire group, I think Gene Marcial and David Swensen are the standouts in my books (especially Swensen).

Henry Paulson - Chairman and CEO, Goldman Sachs. Wall Street’s last king. Paulson, who has presided over Wall Street’s most storied investment bank since 1998, just delivered Goldman’s most profitable—US$2.6 billion—quarter on record. A list of the most influential people on Wall Street could be mostly Goldman Sachs executives, and it wouldn’t be wrong. Though much smaller than the megabanks, no institution is more scrutinized, none more illustrious, and none more dominant than Goldman. And, possibly, none more arrogant: The firm has recently been accused of courting conflict; it worked both sides of the NYSE-Archipelago deal. Paulson has refashioned Goldman into a trading-profits-mad virtual hedge fund. Credit president, COO, and heir apparent Lloyd Blankfein, a former trader whose path upward was smoothed by the departure of former crown prince John Thain. Today, traders trump i-bankers in the pecking order at Goldman, and Hank Paulson’s bet on Blankfein is a bet that the trading side can keep the money rolling in.

John Thain - CEO, NYSE Group. Thain is killing the floor trader to save the exchange. Just three years after the ouster of his infamous US$187 million–earning predecessor, Dick Grasso, Thain has revolutionized the Big Board by merging it with its electronic rival Archipelago Holdings. Grasso got the publicity, but it’s Thain, who came from the banking side of Goldman Sachs, who’s changed the exchange fundamentally, transforming the 214-year-old member-owned not-for-profit into a publicly listed, modernized trading powerhouse that today plays home to 2,780 stocks worth a combined US$22.5 trillion. The Archipelago deal also signaled the death knell of the exchange’s storied trading floor, rendered virtually obsolete by electronic trading. By the way, Thain’s salary is US$6 million.

Jamie Dimon - CEO, JPMorgan Chase. The most closely watched man on Wall Street, even if he’s mostly watched for what he hasn’t yet done. After being sacked as Citigroup president by Sandy Weill in 1998, Dimon retreated to Chicago and overhauled Bank One. The prodigal son returned two years ago, when JPMorgan snapped up Bank One. Still untested as CEO (he took over from Bill Harrison in January), Dimon made his first, relatively small-time move last month, nabbing parts of Bank of New York to cement his lead in New York–area retail banking, and the purchase looks astute. The charismatic Dimon is seen as Weill’s spiritual heir, the most dynamic guy on the Street, in contrast to Weill’s actual successor at Citigroup, Chuck Prince, a lawyer and caretaker CEO put into place to solve Citi’s Spitzer problems.

Stanley O’Neal - CEO and president, Merrill Lynch. The turnaround artist. When O’Neal assumed the top post of the world’s largest brokerage firm in 2002, Merrill Lynch was a perennial also-ran in underwriting and M&A advisory work. O’Neal slimmed down Merrill, paring a third of the firm’s staff and shedding less-profitable businesses. Merrill’s stock doubled and profits tripled to US$5 billion. As rivals John Mack of Morgan Stanley and Dick Fuld of Lehman Brothers scramble to find growth opportunities, O’Neal found his in an Upper East Side diner earlier this year. Over eggs and cereal, he unloaded Merrill’s US$549 billion asset-management business to Larry Fink’s BlackRock, beating out Mack for the deal. In return, his 15,000 brokers get access to BlackRock’s US$1 trillion worth of assets.

Larry Fink - Chairman and CEO, BlackRock. The most-wanted money manager on Wall Street. Critics griped that Fink, a veteran bond trader, couldn’t sustain BlackRock’s 21.5% average annual profit growth based on its bond exposure. So Fink responded in February by snapping up Merrill Lynch’s investment-management business in exchange for 49.8% of his firm, a breathtaking deal that gives Fink’s asset-management juggernaut access to an astonishing US$1 trillion portfolio second only in size to Fidelity’s. The deal also keeps BlackRock, whose shares have risen tenfold since going public in 1999, firmly in Fink’s control. Industry watchers took note of the larger picture: One of the Street’s biggest bond buyers was taking his money and running . . . to the stock market.

Carl Icahn - Founder, Icahn Partners. Wall Street’s most notorious predator still breathes fire. More than twenty years after he perfected the dark art of corporate extortion dubbed greenmail, Icahn’s presence still inspires shudders in executive suites worldwide. These days, he conducts his hostile takeovers under the spit-polished label of “shareholder activist,” aligning his US$2 billion eponymous hedge fund with embittered shareholders. His modus operandi rarely varies. Either he battles management for changes aimed at prodding stagnant share prices—as in his bid to break up Time Warner—or he actually seizes a company and installs cost-cutting managers. Scores of aggressive hedge funds and private-equity managers, including Warren Lichtenstein of Steel Partners, and Pirate Capital’s Zachary George, take their cues from the Icahn preybook.

Steven Cohen - Chairman and CEO, SAC Capital. The hedge-fund heavyweight Cohen literally moves markets. He controls one of Wall Street’s most powerful trading firms, believed to account for as much as 3% of the NYSE’s daily volume. (That’s something like 60 million shares per day traded by SAC alone.) The phenom commands 50% fees; lesser managers get 20%. Last year, he reportedly pocketed $500 million. No wonder he has spawned countless imitators, as B-school grads shun Wall Street in favor of Greenwich, Connecticut, home to more than 100 hedge funds, including SAC. Worth an estimated US$2.5 billion, Cohen has become one of the most aggressive art collectors in the world; it was a seismic event when he started buying Impressionist works again last fall after a contemporary binge.

Stephen Schwarzman- Chairman and CEO, Blackstone Group. Private equity used to be viewed as unseemly, reserved for louche Gordon Gekko wannabes. No longer. The king of the hill is Schwarzman, who waltzes in rarefied society circles as easily as boardrooms. (Schwarzman holds the most-vaunted of society thrones, chairmanship of the Kennedy Center.) Private equity rivals the hedge fund as the hottest kind of shop on Wall Street, but Schwarzman is ahead of the curve; Blackstone is rivaled only by Washington, D.C.’s Carlyle Group as the most successfully institutionalized private-equity firm. Like any superstar, Schwarzman has spawned scores of copycats, who’ve driven up prices and made good deals scarce. Still, despite the glut, Schwarzman was able to raise a US$12.5 billion fund last year.

Stephen Feinberg - CEO and senior managing director, Cerberus Capital Management. Named after the three-headed dog that guards the entrance to Hades, Cerberus once suffered a reputation as Wall Street’s scrappy pit bull, investing in ailing companies no one else wanted. But the secretive Feinberg has refashioned Cerberus, founded with a paltry US$10 million in 1992, into a gargantuan, do-it-all firm that controls companies with total sales topping McDonald’s and Coca-Cola’s. Cerberus recently bested legendary private-equity firm KKR to buy out GMAC, General Motors’s lending arm, and snatched up iconic brands such as the Albertsons grocery chain, Burger King and Alamo Rent A Car. Cerberus embodies the rise of a new, widely imitated business model, in which the old demarcation lines of hedge fund, LBO firm, or private equity don’t apply anymore. Though his image may have softened, Feinberg is still biting.

David E. Shaw - Chairman, D.E. Shaw & Co. The Bill Gates of computer finance. Wall Street’s resident math guru runs one of the world’s largest hedge funds, with US$20 billion under management. A former computer-science professor at Columbia, Shaw is a pioneer in quantitative investing, which relies on sophisticated computerized algorithms to profit from inefficiencies in the market. Famed for its exclusive hiring process, D.E. Shaw reportedly extends an offer to only one in 500 applicants. (Amazon.com founder Jeff Bezos is an alum.) An estimated 16% of hedge-fund assets are managed by “quants” like Shaw. Among his most serious disciples (and competition): Jim Simons of Renaissance Technologies and Ken Griffin of Citadel Investment Group.

Byron Wien - Chief investment strategist, Pequot Capital Management. Though fortune-telling is de rigueur on Wall Street, Wien’s predictions are anticipated with the sweaty angst reserved for interest-rate hikes. The former strategist at Morgan Stanley, who recently made the common Wall Street semi-retirement move of joining a private-equity firm, has been publishing his annual list of “Ten Surprises” since 1986; he hosts annual summer lunches at his Wainscott home, where finance titans like George Soros and Steve Schwarzman don futurist hats themselves.

David Swensen - Chief investment officer, Yale University. The intellectual godfather of the hedge-fund era. Swensen, superstar manager of Yale’s US$15.2 billion endowment (average annual return: 16 percent), was an early advocate of hedge-fund investing, which spurred traditionally conservative pension-fund and endowment managers to follow suit; their money has been the fuel of the hedge-fund boom—and they’re expected to pour US$300 billion more into hedge funds within two years. His 2000 book, Pioneering Portfolio Management, is revered; last year’s Unconventional Success, which came out blisteringly against mutual funds, is gaining a similar reputation among individual investors. Swensen has created a generation of fund managers. When managers set up their own fund, they look for an investment from Swensen; it’s the Good Housekeeping seal of approval. Incredibly, Swensen earns just US$1 million a year at Yale, though his Connecticut compadres easily command 50 times that.

Alan Hevesi - Comptroller, New York State. Hevesi administers the second-largest pension fund in the country, with a whopping US$140 billion in assets earmarked to pay retirement benefits for 968,000 current and former civil workers. Hevesi ended the year up 8.5%, beating the S&P 500 and his own benchmarks. Sweet vindication for the countless, some say gratuitous, street fights he’s picked with everyone from Governor Pataki, over the state budget, to WorldCom, which won Hevesi a US$6 billion settlement.

David Faber - Co-host, CNBC’s Squawk Box. What’s the breakfast of champions on Wall Street? Coffee, bagel, and Squawk Box, co-hosted by Faber, dubbed “the Brain” by fans. CNBC is a trading floor’s wallpaper, and Faber’s stature allows him to debunk Internet rumors in real time; he’s a lifesaver for corporate flacks. Though market data abounds online, and real scoops have proved elusive, Faber remains the man investors can’t afford to miss.

Gene Marcial - “Inside Wall Street” columnist, BusinessWeek. Main Street’s most-followed stock picker. Though mocked and dismissed by Wall Street professionals, Marcial, who has written the weekly “Inside Wall Street” column since 1981, buoys a stock with a mere mention in his column, often for only the first day the magazine appears. But that’s long enough to send investors scrambling for advance peeks. Last month, two workers at BusinessWeek’s Hartford, Wisconsin, printing plant were charged with stealing magazines off the presses to get an early start on Marcial’s picks.

Robert Rubin - Director and chairman of the executive committee, Citigroup. A god. But in finance, Rubin, the former Goldman Sachs trader who was Bill Clinton’s Treasury secretary, is not influential at all: Citigroup, where he’s been since 1999, has been hobbled by regulators. Yet Rubin is bigger than the Street: For his role in handling the 1997–98 Asian financial crisis, he’s become the living embodiment of the Clintonian idea that capitalism—and specifically globalization—can serve a moral purpose. And he’s the living case for the argument that Democrats can manage national economic policy more prudently than the other party.

(The above was extracted from Salvator Dali's excellent blogsite on the Malaysian stock market. It originated from the New York Magazine.

Personalities: John Templeton

2006-05-04T07:06:00.000-07:00

(P.S: Sorry for any disturbances the advertisements above may have caused you)
Templeton Funds has just taken a placement stake in Asiapharm, and some might remember what happened following its takeup of a stake in Celestial Nutrifoods in December last year: the show of confidence in that stock sent it soaring and triggered a rally in the entire China stock sector. Templeton Funds today goes under the Franklin Templeton group following the acquisition of Templeton Growth Funds by Franklin Group in 1992; the hard work in building up the fund then had already been done by Sir John Templeton.

Templeton Growth Funds was started in 1954, Sir John Templeton's second startup from scratch after he had sold his original investment firm. He was at the ripe old age of fifty-six then, proof that age does not wear down the spirit of entrepreneurship. Each $100,000 invested then with distribution reinvested grew to total $55 million in 1999 --- a 15% CAGR over 45 years, an impressive long-term record by any measure (though he was less involved after 1992).

Great investors tend to have defining characteristics and ideas; for Sir John it is about searching for value in different markets. He is a value investor, no doubt about it, but the relentless search for value among different markets requires a commitment to value creation, contacts to provide relevant information, and above all a prodigious understanding of various global markets and the processing and analytical ability to sift out the key factors driving the buy decision. In this respect the man is not lacking: he was a Rhodes scholar with a degree in law from Oxford.

In his global search for value, Japan was a key country where Sir John concentrated his investment funds for much of his career, a consequence of his global search of value. PEs, for example, were one-third of that for comparables in the US and the West (the US has never been a favourite of Templeton). Given his global bargain-hunting style, it is important to single out countries that he is comfortable with, in order to scope down the search. In this respect, he looks for open economies with low socialistic tendencies and pro-investments (in this respect, he likes Singapore, incidentally). It is interesting to note how he determines value: to him , there are a hundred or so factors that can be considered in making an appraisal, but most of these are industry-specific; yet four are always present: (1)PE; (2)Operating profit margins; (3)Liquidating value (ie. NTA); (4)Growth rate (particularly its consistency). Most of us know the above four; it is probably the other hundred-odd factors that determine the degree of success....

The other key investment philosophy of Sir John is his emphasis on flexibility. In a sense this is perfectly understandable given his investing style of comparison-shopping (hence always ready to ditch one stock for a better one), and the confidence engendered by a wealth of knowledge (such as the above hundred-odd factors). This is contrast to technical analysts who follow "trading rules": it is as if they need to set OB markers to articifically manage their emotions and discipline. Flexibility is also a defining characteristic of George Soros; the whole idea is to be mentally alert and neither be complacent nor be wedded psychologically to the stocks/securities in one's portfolio. Don't trust rules and formulas, just use them as a guide.

Bargain hunters are often contrarian. Hence there are shades of Warren Buffett in Sir John's moves in the market (actually that would be unfair to Sir John, for he was operating before Buffett came onto the scene). Some examples of his moves: In 1939 he bought $100 worth of every New York Stock Exchange listed stock that was trading under $1 per share, on news of Hitler invading Poland (his motto: never sell on war news).In 1978, when Ford was near bankruptcy, he was a buyer. When everyone else piled into tech in 2000, he was a seller.

Signature moves from one of the Hall of Fame fund managers. We end with a half-joking quote from the man: "Help people. When people are desperately trying to sell, help them and buy. When people are enthusiastically trying to buy, help them and sell."

References:
(1) Money Masters of Our Time (John Train)
(2) John Templeton Foundation: Biography of Sir John Templeton
(3) 1 Apr 2004 SmartMoney interview with Sir John Templeton

The Singtel story

2006-04-16T23:57:00.000-07:00

(P.S: Sorry for any disturbances the advertisements above may have caused you)
Quick, which is the worst performing IPO that is still trading actively in the SGX in our generation (say, after the 1990s)? In absolute terms, that is. I have no numbers to prove it, but judging from Singtel's market capitalisation and its price performance since its IPO >10 years ago, it should figure among the top few.

Veteran investors would remember the year in which the company IPOed, 1993. Remember, remember the Year of the Market Trader. The then-SES was in the middle of an unprecedented bull market where the STI jumped from 1400 to 2500 within the space of one year (a similar performance for the small caps; the Sesdaq was >100 then as well!); the bull run nowadays is nothing in comparison. Stocks were being floated at about 30 times earnings during this period. It was in this environment that Singtel, in accordance with the government's privatisation drive of state-owned companies, undertook its IPO. The size of the company is reflected in the fact that although it only IPOed ~10% of its shares (the balance retained in the hands of Temasek Holdings, the state investment fund, for control), it was, and is, the largest Singapore IPO ever.

The public offer was done via three tranches of Group A, B and C shares, with the first two reserved for Singapore citizens as "part of the Singapore Government's effort to share the nation’s wealth and to enlarge the base of share-owning Singaporeans" (quote). International investors had to subscribe for the "C" tranche, priced at $3.60 or a whopping 48X forecast PE. The "A" and "B" shares were priced at about half that price ($1.90). It was a great deal for locals, and about 1.3M Singaporeans subscribed (most using their CPF), giving Singapore the highest per-capita rate of share-ownership of any country in the world.

Years later, it turned out that the "stag" strategy would have been the way to go for the IPO subscribers. The "stag" strategy, basically, is sell the IPO shares on the first (or first few) days of the IPO. The stock sold at close to $4 for the rest of 1993, then slowly drifted downwards over the next few years as the bull run fizzled out, to below $3 in 1995, below $2 in 1998 during the Asian currency crisis, and then hitting rock bottom at ~$1.20 in 2003. At this point it would be unfair if I didn't point out that since the company paid out ~3-5 cents of dividend per year, the local IPO subscribers would not have lost out as they would have collected close to 40-50 cents dividend per share a decade after the 1993 IPO. However, the Tranche "C" (unprivileged) investors would probably have suffered a total return of negative 50%.

The annual dividend payout, although seemingly generous, actually amounted only to ~1.5% dividend yield in the first few post-IPO years; therein lay the problem: the IPO pricing had been set too high. In fact, from 1993 to 2000, the company experienced steady growth, from S$2.7B revenue and S$S$1.3B pre-tax profit in FY1993 to S$4.9B revenue and S$2.5B pre-tax profit in FY2000: a profit CAGR of ~10%, very respectable if one remembers that the Asian currency crisis and its after-effects was sandwiched between those years. The price decline during these years despite the profit growth was a classic case of earnings having to catch up with share price. Years later, Singtel chairman Koh Boon Hwee was to admit that the high pricing had made subsequent corporate moves difficult in several ways: (1)for SingTel's share price to make a meaningful move upward despite strong profit growth; (2) for Temasek Holdings to reduce its large majority stake in the company; (3)to use its stock for acquisitions because "most people felt it was valued way too high".

In the later parts of the 1990s, Singtel began actively sourcing for new acquisition targets for two reasons: a limited domestic base in Singapore, and probably more importantly, the looming liberalisation of the telecom industry which ultimately took place in April 2000 (accelerated due to the dot-com boom). Attempts to acquire TimedotCom (a telecommunications group) in Malaysia and famously, Cable & Wireless HKT in Hong Kong, failed due to concerns about its links to the Singapore government. Finally in 2001 Singtel managed to acquire Optus, the No.2 telco player in Australia, its biggest acquisition so far by a long way.

Unfortunately, that pushed the earnings back into the water just when it had risen adequately to fulfil the promise suggested by the 1993 IPO price (before the merger, it was trading at a reasonable ~16X trailing PE). Because of the heavy debt incurred as a result of the high price (50X PE!) paid for Optus, Singtel's domestic earnings were dragged down by interest payments and poor performance at Optus over the next few years, such that phenomenal revenue growth was accompanied by phenomenal decline in profits. That explains the continuing decline in share price during the new millenium despite telecommunications/utilities being the classical defensive industry.

There are several lessons from this episode. Firstly, from the 1993-2000 time segment, that valuation must be watched, despite the business holding enormous promise. Don't buy into a bull market at ridiculous valuations! Secondly, from the 2001-2003 time segment, beware of major acquisitions extracted at high prices and with huge leverage being taken for that purpose. Thirdly, beware companies in heavily regulated industries; be vigilant in watching government regulatory trends. The liberalisation of the telecommunication industry in 2000 was a nail in the coffin for Singtel's domestic market growth hopes; its monopoly position would forever be gone; pre-emptory action by shareholders to sell off would have enabled them to avoid the share price stagnation/carnage that followed.

References:
(1) Article: A New Blue-Chip Is Headed For The ...
(2) Associated Press article 28 Aug 2001: SingTel IPO price too high, says chairman
(3) Singtel Investor Relations website
(4) FEER article 4 Oct 2001: Slow and steady at SingTel
(5) Fortune article 11 Jun 2001: SingTel's Trouble Down Under

Existing link:Niversphere the Savvy Investor

2006-04-07T17:54:00.000-07:00

Niversphere's blog is purely fundamentals-based, which would be quite similar to mine, except that he provides research on Singapore stocks that are worth buying. Those looking for extensive coverage of many stocks would be disappointed because he prefers to cover those in his stock portfolio only, an understandable position because it probably takes the least effort to cover these (I notice that he does not "commercialise" his site at all unlike other sites (including mine). But for those interested in the same stocks as him you would find a substantial amount of coverage and follow-through on them. I personally have benefited from a number of his stock research on several stocks, knowledge-wise, although I am not vested in the stocks. One learns to appreciate serious and well-researched views from fellow investors.

So far, Niversphere appears to have covered in detail the following:
UTAC
Hongguo (which has since run to the moon)
Ace Achieve
Tat Hong
Noble Group
Want Want

One significant point about his views is that they tend not to be valuation-driven, but business-driven. That is, his investing horizon might be longer.

You can check out the link on my sidebar on the left (Local Blogs section).

Crash Stock: New Lakeside

2006-03-30T08:29:00.000-08:00

(P.S: Sorry for any disturbances the advertisements above may have caused you)
In the context of today's euphoric China stocks theme on the SGX, it may be pertinent to have some kind of reality check once in a while by looking back at the gloom and doom surrounding this very theme just one to two years back. Another theme that is hot now and cold then is IPOs. The CAO scandal had led to a crisis of confidence in China stocks, and a string of IPOs reporting poor results immediately post-IPO had led to a similar loss of confidence in IPOs.

New Lakeside was a new China IPO in March 2004, a confluence of the above two themes, and its subsequent performance (or lack of it) was arguably a strong factor in causing the abovementioned confidence leakage in China IPOs. The company's core business was in the production and apple juice concentrate and production of animal feed using apple pomace, with clients being big US companies which used the concentrate in their various F&B products. The company IPOed at the price of $0.34, on the back of a dramatic threefold surge in FY03 revenue and profits (RMB200M and RMB30M respectively). NTUC was one of its substantial shareholders which helped shore up retail interest in the stock.

Later it emerged that the company had increased revenue so much in FY03 because it had deferred a substantial amount of sales orders fulfilment from 2002 into 2003, the reason being to "take advantage of the zero-rated anti-dumping duty for exports to the US". This was stated in the IPO prospectus and investors should learn to read such documents, which are actually legal documents (the company can be sued if it gets the facts wrong inside), and not just concentrate on the colour pages at the front offering rose-tinted views of the company.

But the worst shock New Lakeside investors received was in the interim 1H04 results several months after its IPO, which showed an unexpected loss of RMB9M (as opposed to a RMB6M profit in FY03). This included trade debtor provisions amounting to RMB8m, higher distribution costs and finance costs.

This shock set of interim results brought several issues into focus, most of them corporate governance-related, which would later form the background of fear that would overshadow the rest of the year (and brought to a crescendo by the CAO scandal). Firstly, SGX pointedly asked why the company had continued giving indications as late as end August 2004 (the 1H04 results were released in mid-September) that "there was no information that would have a material bearing on investors' decision which had yet to be announced by the Company" when such heavy provisions were eventually made; the company's reply that its auditors had only pointed out the need for such provisions very near the results announcement date, to me, was unconvincing to the neutral observer. Indeed, the market seemed to have already anticipated the poor results, dropping to <20 cents by end-July at an apparently irresistable 5X trailing PE (that was before the shocker set of 1H04 results). Secondly, the issue of companies giving timely profit warnings as early guidance and a form of transparency was also highlighted, something which New Lakeside's board had failed entirely to do, while its IPO brokers GK Goh churned out rosy reports on the company and slapping a now-ludicruous 48-cent price target on it. Thirdly, the fact that the provisions had to be made at the last minute on the advice of external auditors (Moore Stephens) showed up the laxity in Chinese accounting standards. Accounts of New Lakeside's subsidiaries were kept according to Chinese accounting standards and had to be consolidated and adjusted to meet Singapore standards; it was through the consolidation process that Moore Stephens decided that the RMB8m debt provisions had to be made due to the long-standing nature of the debts. This meant that unaudited statements from Chinese subsidiaries might not be adequate for measurement of company performance, due to significant divergence from the Singapore FRS accounting standards. Fourthly, the responsibility on IPO managers to ensure the quality of their listings was highlighted.

The onus on independent directors to force management changes when necessary was the only plus point illustrated in this whole episode, as the managing director and CFO were forced to resign in an EGM by the largely Singaporean independent directors for the poor financial management at the company's China subsidiaries (the former was later reinstated).

New Lakeside has never recovered from that debacle. It went on to make full-year losses in FY04 and FY05; for the latter it lost close to RMB100M, including another set of writeoffs amounting to ~RMB30M. Those holding the stock are effectively "stuckees", both in price and trading liquidity; the stock is at 5 cents and zero volume on most days, hence offering no means of exit for holders. An example of a company where things just get from bad to worse, it also offers the classic warning tale of putting one's money into a China stock with no post-listing track record.

References:
(1) Business Times articles Sep till Nov 2004, covering New Lakeside

New Link: Lloyd's Investment Blog

2006-03-26T00:32:00.000-08:00

I was surfing the Web and came across this very interesting US investment site, with great articles on the US stock market. The blogger doesn't update it that often, about once every 1-2 weeks, but look at the quality of his writing. That is what matters.

I've realised that there's no point just adding new links quietly to my sidebar, since most readers probably won't notice. So from now on, every link added will be simultaneously broadcast as a new post across all my blogs, starting with this one. I will probably cover the existing ones as well.

You can check out the new link on my sidebar on the left.

The CLOB Saga

2006-03-08T07:35:00.000-08:00

(P.S: Sorry for any disturbances the advertisements above may have caused you)
Having read the various postings in Shareinvestor.com for some time, it is surprising that an event which happened about eight years ago still evokes so much emotion among veteran investors in the stock market. Pan Electric and the Asian financial crisis nowadays seem like distant memories, yet the CLOB saga strikes a raw nerve among those who had their money in these stocks (including some of my relatives) when the Malaysia government froze CLOB accounts in 1998.

The move was a direct result of the Asian currency crisis, when foreign speculators shorted the currencies of highly leveraged Asian countries, with Southeast Asia being particularly hard hit. Dr Mahathir, then Malaysia's PM, came up with the idea of imposing capital controls (a move for which he was lauded later for its effectiveness) to curb speculation (if money could not be moved out, any gains foreigners made from speculating would essentially be frozen, hence the markets would stabilise).

Of course, this also meant the CLOB market facilitating buying of Malaysian shares on the Singapore market would be affected. CLOB, or Central Limit Order Book (don't ask me why it is so named... reminds me of Central Limit Theorem in statistics) was set up in Singapore to trade Malaysian companies over-the-counter in Singapore after the Malaysian and Singaporean exchanges separated in 1990. Over the years it had developed into the main avenue for veteran Singaporean investors to invest in Malaysian equities.

The amount of money in CLOB shares at the time of the suspension in trading in September 1998 gives a clue to the anguish that is still felt by many investors today. There were about 172,000 Clob investors on the books - as many as 95 percent of them Singaporeans - and the total shares had a value of approximately US$4.47 billion. That works out to about US$25,000 per CLOB investor (remember that the US$ was king then) .... an indication that these CLOB share buyers were not small fry. And yet they got killed by events beyond their control. Under the arrangements following the CLOB market suspension, all shares in CLOB accounts were to be eventually transferred to accounts in the Malaysian Central Depository for eventual trading on the Kuala Lumpur Stock Exchange (KLSE). However, the Malaysian government feared a massive share overhang in the KLSE (given the enormous amounts of money tied up) if liquidation was made possible en-bloc and hence things dragged on as the SES (the predecessor of SGX) and the KLSE worked to facilitate the share migration.

There would be no clear resolution to the issue until early 2000, and between 1998 and then there was an ugly war of words between the Malaysian and Singaporean market authorities which served only to exacerbate the unfortunate situation. Bank Negara's (Malaysia's central bank) chief claimed that during the Asian crisis, CLOB shares were being borrowed to be short-sold on the Malaysian market, hence hinting at the reason why the CLOB market was suspended. It was further suggested that the Singapore authorities had done nothing to deter such damaging actions to the Malaysian market. The war of words then shifted over to the legitimacy of the CLOB market, with KLSE noting that the CLOB market was created "unilaterally" by SES to facilitate to generate revenue for the SES, was "never endorsed by the Malaysian authorities", and was effectively an "an unauthorised market for Malaysian shares" and that there were inherent risks to those who invested in CLOB shares. SES, of course, had never made public to its investors of such a risk. On its part, the latter declared that "trading of Malaysian securities on Clob was not authorised by Malaysian authorities because it required no such authorisation", and that it was essentially a win-win game as Singaporean money provided liquidity and support to Malaysian stocks. Of course, it was win-win so long as things were going fine.... it took a major dislocation like a regional financial crisis to unleash the inner demons.

Finally in early 2000 the two exchanges worked out a scheme of arrangement for letting CLOB investors trade out of their misery, where investors were offered two options, both of which involved releasing of CLOB shares on a staggered basis over >10 months, reflecting the KLSE's abovementioned concerns of a share glut should all be released at one go. The faster scheme involved payment (something like 2% upfront) of higher administrative fees to a Malaysian company, Effective Capital, which was linked to Malaysia's then-Finance Minister Daim Zainuddin, an indication of how business operates in Malaysia. CLOB investors were strongly urged by the Malaysian side to opt for the Effective Capital scheme. Although there were calls for this to be referred to the WTO given the rather unfair scheme of arrangement and rather threatening tones adopted by the Malaysian authorities to CLOB investors to accept the proposed schemes, it appears that ultimately the CLOB investors had been worn down sufficiently by the two-year impasse to succumb and sell off at huge losses. For a US$4.5B CLOB position (believe it was measured at 2000 market prices based on KLSE), Effective Capital offered US$1.5B to "take over the risk" of holding the long position. One knows that given its government links, it would have no problem disposing of this entire line eventually in the KLSE.

Out of this whole saga arose SIAS, Small Investor's Association of Singapore, which represented the bulk of CLOB investors in liaising with the various authorities. It also gave rise to the easily understood-ed term "CLOB-bered". Most of all, it gave rise to a fear of Malaysian stocks, not just by Singaporeans but by most foreign investors, who saw the perils of putting their money in a market that could easily change tack when under pressure. There are plans by the SGX to restore trading links with Bursa Malaysia soon. Perhaps that might go some way to restore investor interest in this market.

References:
(1) Time Asia article Jan 2000: Clobbered
(2) Asiaweek article May 1999: Still CLOBered In Singapore
(3) Business Times May 1999: Clob was never illegal or unrecognised: SES
(4) Article Feb 1999: CLOB solutions: Lessons of Immorality
(5) KLSE announcement Sep 1998: KLSE ANNOUNCES TRANSFER OF CLOB ACCOUNTS
(6) KLSE announcement May 1999: CENTRAL LIMIT ORDER BOOK (INTERNATIONAL)(CLOB)
(7) KLSE announcement Sep 1998: KLSE ANNOUNCES TRANSFER OF CLOB ACCOUNTS
(8) Asia Times article Sep 2000: Investment in Malaysia
(9) Agence France press article Aug 1999: Malaysia cental banker blasts Singapore over CLOB
(10) Associated Press article Feb 2000: Renewed war of words may delay Clob resolution

Personalities: Peter Lynch

2006-02-23T07:27:00.000-08:00

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Peter Lynch is probably the next best known pure stock investor in the world after Warren Buffett. As a mutual funds manager (that's what unit trusts are known as in the US), he is undoubtedly the most famous.

What's his life story? That is probably the least interesting of any writeup on the man, but let me try. He had a rather hard life in his younger days following the death of his father, and took to caddying to support his studies; that was where he first learnt about stocks from club members' conversations. He had a formal finance education, did an internship at Fidelity that eventually turned permanent. He was to stay there for over 20 years, where, stepping in as fund manager for the little-known Magellan fund in 1977 he managed a 29% annualised return from 1977 till 1990, which would have multiplied an initial investor's capital >25 times. His efforts also attracted new funds into Magellan and ballooning it into a $10B fund, from ~$20M when he first took over. Finally, at the peak of his career in 1990, Peter Lynch quit his job and went into private investing and social work. He is still around, writing books such as One Up On Wall Street and Beating The Street.

Of the man, his ideas and investing philosophy are more interesting. He is the archetypal small-cap growth investor, and has championed the idea of "letting the profits run". Allied to this philosophy is of course the well-used, almost cliched term which he coined to describe his stocks which multiplied to several times their original value: he called them "multiple-baggers". His stock allocation strategy varies from Warren Buffett, in that he owns thousands of stocks in his portfolio. That approach, in part, is probably due to the fact that his fund had grown so huge in later years that it had to be spread thin over many stocks to avoid huge substantial interests in any particular company. A point he shares with Warren Buffett are their aversion to selling their holdings unless the fundamental story had changed.

There are two other ideas that I find are worth taking away from Peter Lynch's philosophy. One is his classification of stocks into six categories: slow growers, stalwarts, cyclicals, fast growers, turnarounds, asset plays. That is certainly a more useful categorisation than the usual two-group division of blue chips and small caps. Indeed the approaches to investing in each of the six categories are different. The second idea is that ordinary investors can make use of their local knowledge to pick good stocks: his "searching for stocks by taking a walk around the mall" advice has become a classic and inspiration for small investors. Of course, this is nothing new: doing personal research has long been advocated by Philip Fisher ("scuttlebutt") but the idea that not much effort has to go into the research, just personal observations around oneself of consumer buying patterns, certainly appeal to the individual, and has popularised the whole concept.

Why did Peter Lynch retire at his peak? This is a question that many have asked. Indeed he missed out on another ten years of bull market in the 1990s. However, he must have made more by investing for himself, all 100% undiluted share belonging to him alone. Another likely reason is that of the curse of the large investor: entry and exit strategies, and hence trading strategies, probably became more important in order to get the desired line at a good price and avoid shaking up the market too much, as Magellan became the largest mutual fund in history with assets pouring in. Being a stock-picker at heart, he probably felt it diluted his fun.

References:
(1) One Up On Wall Street
(2) Wikipedia article: Peter Lynch
(3) Article: The Peter Lynch Approach to Investing in "Understandable" Stocks

Enron

2006-02-13T07:12:00.000-08:00

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Although there were a number of corporate scandals following the rise and fall of the Internet-propelled stock market boom in 1999-2000, involving companies such as Tyco, MCI Worldcom, Global Crossing, none came close in popular impact to the collapse of Enron, one of the world’s leading energy trading companies, with claimed revenues of $100 billion in 2000. The witch-hunting that inevitably organised itself after the company's bankruptcy brought about the collapse of Arthur Andersen, hitherto one of the "Big Five" in global accounting, and led to the introduction of the Sarbanes-Oxley Act by government regulators who were finally pushed into action.

In fact, the falling stock market after the dot-com bust which dragged down all stocks played an important role in the collapse of Enron. The stock price of the company was essential in maintaining the status quo capitalisation of its now-infamous special-purpose entities (SPEs) which eventually brought about the company's bankruptcy.

SPEs are essentially affliates created by a company for certain investments, a special characteristic being that they can be kept off the balance sheet (ie. hidden from investors). The company typically transfers one of its assets to the SPE which might pay for it in future cash promises. Hence, the company gets to beef up its current account, the SPE gets an asset that is pledgeable as collateral for loans from banks (and hence lower interest rates) that can be invested in the project that the SPE was set up for.

Used in the correct spirit, the SPE concept was a useful tool to finance new capital projects without burdening the parent company unncessarily. However, Enron used it as a means of moving non-performing assets off its balance sheet, to make its return on assets, for example, look good. The cash it received from these SPEs in return (obtained from loans that were secured on the basis of these assets--- a circular flow) also helped. It was estimated that by end-1999 nearly half of their $60B were off-balance sheet ie. tied up in SPEs. Then, it had become acknowledged as the global leader in energy trading and as one of the most innovative organisations (note the irony).

Of course, so long as the creditors of the SPEs had limited recourse ie. only to the SPE vehicle, and not to the parent company, the latter would be fine. However, Enron guaranteed the loans of some of its key SPEs, using its own shares as collateral. Analogous to the negative equity situation today of many Singaporeans who had bought properties at the peak in 1996 (or to margin trading in shares), if the share price dropped there would be a call for more Enron share collateral to fill the guarantee. Yet this would pull down share price further due to share overhang, creating a vicious cycle. Worst of all, Enron's exposure to such debt guarantees was unknown to most investors, since its SPE-involvements were off-balance sheet (compare that to the off-balance sheet derivatives exposures of CAO today).

At the same time, these SPEs conducted a majority of their deals with Enron affliates. The existence of Enron and Enron-created SPEs as both buyers and sellers in many transactions raises questions about the validity of these exchanges and the prices at which they were struck. It was clear that it was a case of earnings manipulation. In proper consolidation accounting, such inter-group transactions undergo elimination. However, since SPEs were accounting-wise separated from their parent company, the transactions could easily be manipulated in favour of the mother company. Partly, that was why Enron was able to brandish outstanding results year after year. But of course, over the long-term, the SPEs must suffer financially, with the fallout trickling back to the parent.

And so this was where the 2001 falling market after the dot-com bust came in. The loaded financial dice against the SPEs must have restricted their ability to service their debts, which meant Enron's share collateral was important. But the Enron shares were persistently dragged down by insider selling at the highest management levels (those who knew it was unsustainable) such that it halved from $90 to $45 within one year from Aug 2000 to Aug 2001. And the abovementioned requirement for more share collateral to balance the price drop kicked in, causing further share price meltdown. Management knew share price had to be supported, so they, led by CEO Kenneth Lay, continued to publicly exhort investors to buy "value" while they privately sold off their stock. It was a disgraceful example of capitalism.

In October 2001 one of the key SPEs became insolvent (due to inadequate share collateral) and Enron was forced to make good its guarantee to the SPE creditors in cash. It triggered a series of cash calls in other SPEs, a cut in Enron's bonds to junk bond status, and ultimately led to the collapse of the entire Enron group within one month. In November Enron filed for Chapter 11 bankruptcy.

The tales of Arthur Andersen auditors shredding Enron trial evidence to avoid implication are now legendary, and were instrumental in making the auditing giant the second biggest victim of the Enron scandal (the biggest being Enron's investors). Many banks also suffered the fallout from Enron's collapse, their notes all turning worthless. For example, JP Morgan revealed that its full exposure to the company amounted to $2.6B. They had been aware of the linkages of the SPEs to the parent, but had taken that as a sign of security that had facilitated extending new lines of credit to these SPEs. Although the size of Enron's bankruptcy was eventually surpassed by that of Worldcom (another case of accounting fraud), it is the former that sticks in people's minds, for the sheer dishonesty of its management, and as an example of how an Old Economy blue chip can turn rotten unpredictably and in double quick time (Worldcom's collapse could at least be traced to its telco roots that suffered badly from the dot-com bust).

And so Kenneth Lay and Jeffrey Skilling, both former Enron CEOs, stand trial in 2006. It will be interesting to see their judgment, after watching Bernie Ebbers of Worldcom get 25 years of free government accommodation (jail).

References:
(1) FT.com: Enron special
(2) Article: Special Purpose Entities are Often a Clever Way to Raise Debt Levels
(3) Wikipedia article: Enron Corporation

Bull Stock: Raffles Education

2006-01-23T06:10:00.000-08:00

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Over the last five years, the top performer on the SGX has to be Raffles Education. It is a prime example of the bargains that one can pick up among the small caps which are always badly hit in a recession, and illustrates the wisdom of those timeless adages "buy-and-hold" (when done intelligently) and "let your profits run". It has opened my eyes to the massive rewards and long-term competitiveness that a strong position in a niche industry can bring.

Raffles Education, formerly known as Raffles Lasalle, enjoys that dominant niche in the China creative design education industry. It derives about 60% of its education revenue from North Asia, primarily China, where it operates eight design institutes in major cities like Shanghai and Beijing, up from four in 2002 when it listed on the Sesdaq (from which it has obviously moved out into the Mainboard since). In Singapore it now operates 5 design institutes, up from 1 in 2002. It also has grown its footprint into new Asian regions Malaysia, Thailand, India and Australia (the last via acquisition), and through its acquisition of locally-listed Hartford now derives about a quarter of its overall revenue from management courses.

If the numerical growth in the number of design institutes (ie. revenue centres) has been impressive (5 to 13 within 4 years or an annual compounded 25%), the financial performance has been even more impressive. Revenue has grown from S$15M to S$60M, an annual compounded 40% (and suggesting increasing student numbers at every institute every year), while profit has grown from S$4M to S$20M, an annual compounded 50% (suggesting increasing margins on base revenue ie. pricing power). That is simply breathtaking.

And yet there is something even more impressive than its financial performance, and that is its share price performance. Raffles Lasalle IPOed at 21 cents in Jan 2002; today it is trading at 1.80. But that is a massive understatement of price growth. Look at all the share splits/bonuses it has undergone over the years. 2:1 share split in Jan 2003, 1:2 bonus issue in Oct 2003, 2:1 share split in Oct 2004: that means outstanding shares has multiplied 6 times. An IPO investor who had held tightly to his Raffles Lasalle shares these four years would have multiplied his initial investment about 50 times, or an annual compounded 260%.

Well, this is the classic Philip Fisher growth stock. Not only did its strong business model earn it impressive year-on-year profit growth, but the market has kept on revaluing its fair trading P/E multiple. In 2002, the company was IPOed at 7 times trailing PE. Over the years the market has increased this to a current >40X P/E today. That is the reason why share price performance has outperformed profit growth by so much.

One cannot help but compare the fortunes of Raffles Education with that of a former market favourite in the same industry, Informatics. The failures of Informatics, of course, has been well-documented. Its IT education model slowed after the dot-com boom and it was followed by bad debts and aggressive accounting which ultimately dragged its hard-built brand equity through the mud. Reputation, more than anything, is what makes or breaks a service provider in service-oreinted industries such as healthcare or education. But Raffles Education is one stock I wouldn't dare to put on my hotstocksnot blogsite anytime soon, simply by virtue of its great track record as documented above. But then again, they say that the most unexpected decline starts when the last bear is gored. So let's play it by ear.

Personalities: George Soros

2006-01-10T06:51:00.000-08:00

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After Warren Buffett, George Soros is probably the most well-known market player in the world today. He has been in Singapore these past few days following a visit in Indonesia, and has given a few talks widely covered in the local papers (where he predicted a burst of the US property bubble), so it's an opportune time to cover him now.

Soros and the Quantum Fund that he used to run has been known widely in financial circles since probably the 1970s. Quantum, the hedge fund, was set up in 1969 with Jim Rogers, another legend who recently also visited Singapore (he was cited widely for his bullishness on China), and the fund engages in speculation in commodities, currencies, stocks, bonds, derivatives ie. the whole spectrum of investment instruments, with the employment of massive margin in the case of currencies and derivatives. That use of margin, partly, explains why the fund was able to achieve 33% per annum compounded returns for ~30 years ie. a 5000-bagger for an investor who stuck with the fund through thick and thin.

But the man would probably not have entered Asian consciousness in such a pervasive way if not for his alleged role in precipitating and exacerbating the 1997 Asian currency crisis by shorting several Asian currencies, as accused by Dr Mahathir. In the Western world, he probably acquired his infamy in his successful shorting of the British pound in 1992 (he believed, correctly, that Britain's currency position in the new European system was untenable) which reaped him a one-day gain of US$1B, and later in 1998 for his comments on the need for currency reform in Russia which set off a 25% collapse in the rouble within a week (Soros himself lost heavily as a result of that).

First and foremost, George Soros is a currency speculator -- that was where he made most of his big bets and big money. He is also a macro trader, which means he observes macroeconomic trends taking place in the global markets and takes positions based on his analysis and insights of their implications. This is opposed to investors like Warren Buffett who typically assess industry trends and perform detailed company analysis. Macroeconomic trends (eg. state of the economy, interest rates, fluctuations in currency markets, commodities, stocks) are often inter-related and Soros' ability to comprehend the abstruse links between them is legendary; he even has a term for it: reflexivity, which is basically a description for the feedback process that a change in one factor affects the input factors that caused the change in the first place. His bets also often take on a multi-asset approach, similar to the combined arms approach in modern warfare I guess. For example, for the 1991 British pound attack, he shorted British bonds together with the pound, and longed German marks (to protect the falling pound, the Bank of England would raise interest rates which would cause bond prices to drop; in this European crisis, German marks would be the safe haven and appreciate accordingly, ie. a convergence in value between British pound and German mark).

There are several defining qualities of George Soros' trading style, in addition to his macro-analysis approach in generating trading ideas. The first is his use of heavy margins, especially in currencies and derivatives. Such leverage can produce huge rewards when the market position moves favourably but can wipe out the trader if not: it necessitates a short-term trading approach (for if one bases his decisions on the long-term, he might not be able to see it through as short-term fluctuations clear off his margins), and also one that requires trading with the (price and market) trend. Soros constantly analyses his position real-time as the market always re-adjusts, a consequence of "reflexivity". The second quality is a consequence of the first: Soros is able to switch his position at a moment's notice as he observes the macroeconomic, corporate or price developments unfolding before him. This is not easy for we typically condition our beliefs according to our incumbent investments, when in fact it should be the opposite. As Soros himself says, ""Its not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." Typical mental framework of a successful speculator, and George Soros is the best there is.

Today the Quantum Fund is converted to an endowment fund in the wake of the Y2000 dot-com crash which slaughtered the long stock positions held by the fund; it now adopts a more conservative investment policy. Soros the billionaire is now active in philanthoropy, particularly in Eastern Europe but also in his adopted homeland of the US. Now apparently he has established one in Indonesia as well; that was the purpose of his visit to the exotic contraption that is Southeast-Asia. I wonder if Malaysia, and in particular a visit to former PM Mahathir, might be on his itinerary this time round? Maybe they'll just laugh off the Jewish conspiracy theory that was so popular during the financial equivalent of a nuclear fallout in 1997-98.

References:
(1) Money Masters of Our Time (John Train)
(2) The 1997 "Asia Crisis" (Peter Myers, July 1, 2003)

Personalities: Warren Buffett

2005-12-28T03:53:00.000-08:00

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Any outline of investment history and tales over the ages would not be complete without the personalities who have played important roles in shaping them, and hence it makes sense to also drag in this new category on investment personalities within my blogsite. I think it might even make it less boring, as it brings a human element to the hitherto rather drab tales of Pan-El and the forward contracts or how LBOs led to the 1980s junk bond boom.

And who to start with but THE man himself? Warren Buffett, the original Sage of Omaha, second richest man in the world, who built his riches around his ability to pick extraordinary stocks and having the admirable discipline to hold them to great financial effect.

I will hardly be able to cover much of the man in a few short paragraphs, given that there have been books written about him. In any case, I assume most investors will be familiar about his life history already. His was a perfectly typical American lifestyle in his formative years, except for his atypical fascination with stocks that probably grew from an early interest in horse racing (in truth, gambling and investing/trading are rather alike, in attracting people with an appetite for risk and an affinity for numbers). Probably he toyed with various techniques of playing the stock market before he, apparently, had an epiphany after reading Benjamin Graham's "The Intelligent Investor" when in university; he subsequently studied investment under Benjamin Graham at Columbia and then worked in the latter's investment firm for two years.

Buffett's basic investment philosophy were shaped from his academic and professional stints with Graham, generally acknowledged as the father of modern value investing. It was there that he learnt to view buying shares as buying a piece of a company's business, and to see intrinsic value of the business as separate from its share price. Later in his life he would integrate the ideas of Philip Fisher into his investment philosophy ie. that of growth investing, where the focus was not so much on margin of safety (typically seen as trading below NTA) but on buying great business franchises which enjoyed consumer loyalty and steady long-term growth. Some term Buffett's integrated investment approach GARP, or Growth At a Reasonable Price (But really, are value investing and growth investing so different? Ultimately, both aim to maximize the business value/share price ratio before buying, except that the focal point is different: value investing on share price, growth investing on business value).

Buffett's key triumphs have come in his purchase of so-called "consumer monopolies" (ie. excellent franchise enjoying great brand value) at bargain prices. First there was American Express in 1964 during the salad oil scandal (find out more about it yourself), Walt Disney Co. in 1965, Washington Post in 1973 during a management succession crisis, Capital Cities/ABC in 1985, and then Coca-Cola and Gillette in the mid-to-late 1980s. Each of these picks rewarded him manyfold. For example, his Gillette and Coca-Cola stock each yielded eight-to-ten baggers between 1990 to 1999.

Yet Warren Buffett's stock-picking acumen is only part of the story. There are several other facets to the man that are as admirable. Firstly, he had the moral and intellectual courage to dissolve his investment partnership in 1969 because he felt unable to find any bargains on the market. That was at the height of the bull market and he had some nerve to exit at that point. As it turned out, it was the prelude to a huge secular bear market in the 1970s: Buffett was spot-on. This courage of conviction was also exhibited during the dot-com boom when he steadfastly refused to invest in the tech stocks which he felt unable to value because he couldn't figure out the technology and how to value it. As it turned out, the market hadn't either: it had just been a massive manifestation of the greater fool game. Secondly, he exhibited superb strategic thinking in recognising that insurance companies, more than any other business, would allow him access to massive amounts of cash (the "float" otherwise known as the insurance premiums) which he could deploy to create even more wealth. Today Berkshire Hathaway, Buffett's holding company, is more than anything else a collection of insurance companies such as General Re and GEICO. Thirdly, he is marvellously articulate about his investment philosophy: just go read a collection of Buffett's essays or if you're rich enough, buy a Berkshire share worth $89,000 at last count and attend his AGM together with thousands of other Buffett fans to hear him in live action fielding questions. I haven't, but I just might before the legend passes on, as all must eventually do.

References:
(1) Money Masters of Our Time (John Train)
(2) Stingy Investor: Warren Buffett (a new link added on Jan 06

Crash stock: Informatics

2005-12-02T06:45:00.000-08:00

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Informatics surfaced in the news again earlier this week when charges were pressed against its former chairman Wong Tai and CEO Ong Boon Kheng for gross misrepresentation in their company's financial statements, specifically in 1Q-3Q 04, profit inflations which ultimately came to the fore in that fateful month April 2004 when the whole world came crashing down on their stock price with a series of writedowns and provisions in their 4Q04 results.

What a difference a quarter makes. Informatics had been growing steadily since the late 1990s and between 1997 and 2002 it tripled revenue from S$75M to S$200M while maintaining pre-tax profit margins at around 10%. By 2002 it was one of the rising stars among a sea of red (remember it was recession time then) with institutional investors such as Arisaig taking substantial interests. With >50% operations overseas mainly in the Asia-Pacific and Europe, built up through a series of acquisitions, the company was seen as an emerging education proxy play, a reputation much like what Raffles Education enjoys nowadays. The share price surged to a high of $1.60 in 2002.

It would never see that level again. In FY03 the company announced a near-halving of profit from S$21M to S$12M, on halved revenue to S$98M, leading to the share price halving to 80 cents. But the company seemingly recovered its operational execution in FY04 with revenue and profit growth by 9M04.

On hindsight, the FY03 operating performance collapse (halving of profit and revenue: what else can you call it?) should have been the first danger sign, and one should have been more skeptical about the recovery in 2004; earnings momentum is easy to ride but difficult to reverse.

It now appears that in an attempt to provide support for the share price amidst an increasingly competitive environment the top management of Informatics gave in to temptation and began to recognise revenue aggressively in 2004. It is now public knowledge that Informatics recognised revenue as soon as a student registered for a course, even though the course started much later. Some of these international students never actually took the course. Additionally, in certain cases too much revenue from franchises (overseas) was recognised upfront. Obviously such accounting measures boosted the company's topline and bottomline.

One should have noted the quarter in which the problems came to the fore-- the 4th. That's when the auditors come in to audit the full year results; 1Q to 3Q results are typically not audited. One sees the value of auditors in cases like this: they ensure the quality of the financial reports, much like quality control ensure the quality of manufactured products in factories.

Informatics declared provisions for bad and doubtful debts of S$27M in 4Q04, wiping out its gains in 9M04 and then some. Its net losses for the year were first declared to be S$21M but on a later revision (no doubt on probing by its auditors) was doubled to S$41M. It was found that Informatics had also overstated pre-tax profit by $16 million for the earlier three quarters. In May 2004 CAD commenced investigations into the affairs of the company. The stock was suspended prior to its 4Q04 results and collapsed from 80 cents to ~20 cents on lifting of the suspension.

Some hope arrived in the form of Oei Hong Leong and Berjaya Group's Vincent Tan who saw a bargain and took stakes in the company. Oei Hong Leong, savvy investor that he was, exited a year later when he saw that Informatics was still bleeding red ink in its FY05 results, to the tune of S$67M, this time due to impairment of investments overseas, slow franchising operations and general drop in business. Informatics was now in negative equity despite having raised funds through a rights issue to its key shareholders (ie. capital injection) earlier. Its revenue base was substantially lower, having sold off its loss-making and presumably less promising operations in Europe, although its China business, which produced a cumulative ~S$50M bad debt provision in FY04-05, was still under its umbrella (very likely that there were no takers).

Some consumer franchises take a tumble but recover due to implicit consumer trust in its brand equity. But Informatics' brand seemed to have been eroded seeing the way business in even its home country of Singapore had collapsed since the scandal broke; Singapore revenue dropped by two-thirds, even without any major disposals locally. Where integrity and consumer trust are strong elements of a company's business, as in service businesses like Informatics', a loss of these key elements often sound a death knell for the company's operations.

Informatics is today trading at sub-10 cents. Anyone who bought in 2002 at say, $1.50 would have suffered a reverse 15-bagger.

References:
(1) Straits Times Nov 30: Informatics founder, ex-CEO charged over profit statements

The 1980s junk bond and LBO boom

2005-11-12T16:13:00.000-08:00

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Michael Milken and Drexel Burham Lambert may be strange names to newcomers to the investing scene but in the 1980s they were at the centre of Wall Street when takeovers via leveraged buyouts (LBOs) were the rage. The former was the star junk bond dealmaker for Drexel and was hailed as the successor to Pierpont Morgan as a leader of Wall Street.

In the early 1980s, the US was emerging from a decade-long bear market characterised by surging annual inflation rates of >10%. The Federal Reserve under Paul Volcker took decisive action through raising interest rates to sky-high levels (long-term bonds had yields of >15% by 1981); by 1982 the inflation situation was under control and the Fed started lowering rates. The stock market had stagnated and having reached ridiculously cheap valuations, started to bottom out. It was in this capital market macro environment of undervalued market capitalisations (low stock prices) and declining interest rates (falling bond yields) that eagle-eyed investment professionals saw the potential for LBOs.

What are LBOs/leveraged buyouts? It is basically taking over a listed company using a combination of equity and debt, the financing structure being weighted heavily (say about 1:10 at least) towards the latter. It is similar to purchasing shares on margin: the speculator expands his investable capital through margin debt on an equity base (down here, usually equity must be >40% of total purchase at any time, I believe). LBOs are a much larger scale of such margin financing, using far higher margins, and yet having the advantage that the LBO participant is not subject to margin calls, and is not personally responsible for the LBO debt (to be explained below); ie. limited risk, high potential return. What's new: scale and big money talk on Wall Street.

It may be argued that LBO fever first set in through a demonstration of its potential in a wildly successful deal by former Treasury Secretary William Simon in 1983. He had participated in an LBO takeover of Gibson Greeting Cards which was financed by $1M in equity and $79M in debt (total purchase value $80M); 1.5 years later Gibson was refloated on the market for $300M. Simon's original investment of $330K (1/3 of the total equity stake) turned into a fortune of $66M (ie. 1/3 of the total market capitalisation), thanks to the power of 80:1 leverage.

The final piece in the jigsaw came with the arrival of junk bonds as the preferred debt financing instrument. As mentioned above, there was a need for transfer of the debt burden in LBO deals, and packaging out this debt in the form of junk bonds promising high yields to investors (usually institutional/high net-worth individuals), to be paid from future company cash flows, became a mainstream practice for LBO deals, thanks to the salesmanship of Drexel Burham Lambert and its star bond salesman Michael Milken. It would later be claimed that junk bond purchasers assumed most of the risk and "takeover entrepreneurs" took most of the reward. It certainly did not appear so at the onset (and certainly not when LBOs boomed in the mid-1980s) to the bond purchasers; what they saw were the high bond yields, not the risk of bond default.

LBO deals fluorished in the years 1984-89. Since leverage allowed limited equity capital to multiply its purchasing power manyfold, it was claimed that the playing field had been levelled, and that "the small can go after the big". Major LBO deals included the takeover of Revlon by Ron Perelman (he reportedly turned $2M equity into $3B over 10 years), multi-billion dollar takeovers by the LBO specialist partnership KKR of the conglomerates Beatrice and RJR Nabisco, and the capture of major department store chains Allied and Bloomingdale's by an eccentric Robert Campeau who used leverage on ratios ranging from 10 to 100; he even borrowed his equity portion from investment banks for the former's LBO takeover (to the banks, they didn't mind: they captured fees in the range of hundreds of millions for these LBO takeovers).

Since availability to capital no longer was a problem technically, relationships became a valuable tool. In particular, since Drexel Burham Lambert grew to command two-thirds of the junk bond market used to finance these deals, no-one could afford to antagonise them. Milken, in particular, commanded the financial and corporate worlds. And he leveraged (pardon the pun) this power well; he made astonishing cumulative earnings of $1.2B between 1985 and 1987. That is one hell of a salary, albeit commission-based.

The investment habits of the S&Ls (savings & loans funds, which take in small depositor funds and pay interest on them, something like our POSB) was a strong source of capital in purchasing the junk bonds, but their collapse in the late 1980s ultimately brought significant political attention to the pervading greed and declining deal quality in the junk bond market. In 1982 the Reagan administration deregulated the S&L industry, permitting them to source alternative funds (besides taking in deposits) and to diversify their portfolios (they had hitherto been solely providing home loans). The S&Ls' response was to expand capital exponentially by borrowing funds wholesale from Wall Street and using them to buy into risky high-return markets, in particular the emerging junk bonds market. When S&L fund managers' salaries are a function of the assets managed and the return of these assets, yet are unaffected by losses that result, this response was not surprising. By the end of the 1980s, as a result of such imprudent capital management the S&Ls had cumulatively lost about $200B, paid for by the government and ultimately therefore, the taxpayer.

Government scrutiny as a result of these market failures must have played an important part in Michael Milken and Drexel Burham Lambert being hauled up before court in 1988 for violating a series of securities laws, including racketeering, market manipulation, insider trading. There is no doubt that shady practices had been adopted in such LBO deals but as long as the market chugged along smoothly such practices might have been condoned; the laws were always on hand, however, to employ at the discretion of the government. The collapse of the S&Ls illustrated the declining quality of junk bonds in the late 1980s, with the decreasing spread between junk bond interest payments and LBO company earnings increasing the possibility of default (since interest payments were paid out of company profits). In 1989, following several junk bond defaults (including Campeau's holding company), the junk bond market went into a swoon, and Drexel Burham Lambert, with enormous junk bond holdings, became insolvent and filed for bankruptcy. Michael Milken himself was convicted, albeit for lesser offences than originally charged, in 1991. Over the early 1990s, the rate of default on junk bonds rose to around 9%, finally illustrating their highly speculative nature that had been obscured in the bond bull of the 1980s. LBO fever had subsided, and the junk bond market was effectively dead with its main evangelists removed.

When measuring the legacy of Michael Milken, one should not be overly critical. Although he ultimately inflated the market into a state of unreal speculation in junk bonds that steadily declined in quality, these junk bonds did provide useful financing for a host of other small non-LBO related firms with real need for capital, and helped them to grow. LBO deals themselves grew out of a market recognition that companies were basically undervalued on the stock market, and Milken's junk bonds arose out of a demand to finance such deals. Seen in this context, some argue that his accomplishments were positive and significant. Whatever the case, one need not worry for the financial state of the man; he is still among the wealthiest men on Earth as recently ranked by Forbes, with about $1B in assets.

References:
(1) Devil Take the Hindmost (by Edward Chancellor)
(2) Wikipedia entry: Michael Milken

The Asia Pulp & Paper debt default

2005-11-06T07:25:00.000-08:00

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The 2001 bond default of Asia Pulp and Paper, among the world's ten largest pulp processing and paper manufacturing companies, was the largest such case in corporate Asia and led to a collapse of confidence and consequently prices of assets in Southeast Asia, and Indonesia in particular, in the starting years of the new millenium. To many, it was a shock given the reputation of the management-owners (the well-connected Widjaya clan, owners of Indonesia's third largest conglomerate Sinar Mas), as well as the underwriters involved in the erstwhile bond deals (big Wall Street firms, eg JP Morgan, Goldman Sachs).

The plight that Asia Pulp and Paper landed itself in was a classic case of excessive leverage to fund expansion. In the early 1990s the Widjayas had raised capital primarily on the Jakarta exchange to fund domestic growth but in the mid-1990s decided to embark on an aggressive expansion strategy to turn their pulp and paper operations into a truly global player. To fund this expansion, they needed billions of dollars. The HQ was moved from Indonesia to Singapore in 1994 (explanation: "If one portrays oneself as Indonesian, money costs a lot more than it does for a Singaporean") and operations consolidated under Asia Pulp and Paper. The company commenced a global drive for funds and managed to issue billions of dollars worth of bonds starting 1994, with the help of the eager Wall Street investment banks, and a story that sold with investors: an emerging market blue-chip, with competitive advantage in fast-growing Indonesian hardwood, and operating in low-cost Indonesia while collecting revenue in dependable US currency. The company's ADRs (American Depository Receipts) were listed on the NYSE in 1995, another coup for the company.

When did things start to go wrong? The signs were there early, the effects only apparent when recession struck in 2001. The company did expand its manufacturing and marketing operations prodigiously in Indonesia, China and India using the raised funds, but at high financing costs. In 1995, the company's interest payments were US$448 million. By 1999 annual interest payments had climbed to >US$650 million. That year the company lost $23 million. APP's interest coverage--the ratio of cash flow to interest costs--averaged only 1.5 from 1996 to 1998, far below that of blue-chip debt issuers in the global pulp and paper industry. That meant that the company generated only one and a half times the cash it needed to meet payments. In February 1997, S&P rated APP notes a B+. By May 1998, they were downgraded to CCC+, junk bond status. Although the company had survived the Asian financial crisis relatively well, the collapse of confidence in Asian assets must also have drained liquidity to Asian markets and caused debt refinancing for APP to become more expensive. Indeed, by 2000, APP raised funds for its China unit promising a 17% bond yield; this was followed by another private placement promising a 30% yield.

The company's debt-related cash flow problems were compounded in 1999-2001 first by imprudent operations in China where APP's paper turned out to be too luxurious for the China market whose demand for for simple low-grade paper, and then the collapse in paper prices by about 50% from just a few months from 2000 to 2001.

The inevitable happened in March 2001 when the company unilaterally declared a debt moratarium and stopped servicing its debt since then. By then, APP's debt was a staggering US$13 billion. Amid accusations of fraud by sceptical investors (primarily fund managers who had bought into APP's bonds earlier) who wondered where all the money had gone (reasonable given the magnitude of the funds raised and the fact that Sinar Mas' other operations had suffered badly from the Asian financial crisis and needed funds badly), the Widjayas moved their base from Singapore back to Indonesia. Investigations made by separate auditors for the creditors and for APP later uncovered suspect or questionable transactions and balance sheet entries made by APP's Indonesian subsidiaries in preceding years, such as provisions for receivables and doubtful debts, as well as reported derivative losses, to the tune of US$5 billion. It is quite surprising that there does not seem to be any official follow-up action to trace the route back to where all this money ended up, though one might be able to deduce with a high degree of probability.

Ultimately, the debt repayment issue came to a partial close with APP and its creditors agreeing to a repayment scheme that would see APP return creditors almost US$7 billion over 10 years, covering the debt of its Indonesian subsidiaries. The debt of its non-Indonesian subsidiaries were not covered by the arrangement. The APP ADRs had long been delisted from the NYSE; it had fallen to <20 cents in 2001 when it declared the moratarium, from an IPO price of $11 in 1995.

As for the Widjaya family, ultimate owners of APP, there was no forced pledging of their personal assets, nor any injection of assets to prop up the company for debt restructuring. The family and their associates were still left as the operational managers after the whole debacle. The bondholders and ADR holders were the ones who suffered the most, the former suffering haircuts as high as 50% or more, the latter probably more looking at the abovementioned collapse in APP's ADRs on the NYSE prior to delisting.

If one is wondering why Golden Agri-Resources or Asia Food & Properties are trading so far below their NTA (50-60% of NTA) even though they have substantial revenues and have been making good reported operational profits, one has only to look at the ownership -- they are both subsidiaries of Sinar Mas. Investors do not forget easily. Fool me once, shame on you; fool me twice, shame on me.

References:
(1) BusinessWeek article Aug 2001: Asia's Worst Deal
(2) AsiaTimes article Oct 2002: Asia Pulp&Paper to cough up cash to creditors
(3) Bloomberg article Mar 2001: Asia Pulp & Paper to Default on $12 Billion in Debt

Contents up to end Oct 2005

2005-10-28T17:28:00.000-07:00

Contents up to end Oct 2005

The 1933 Glass-Steagall Act

2005-10-15T21:10:00.000-07:00

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Excessive power always creates problems: the temptation to profit personally from the power one wields, and the conflicts of interest between the various overlapping fields that one has influence in. It is the role of government to rein in such power as and when it exists in the business world.

At the turn of the 20th century it was clear to many that bankers wielded such an inordinate measure of power. Since there was no central bank in the US then, they controlled both the supply of money as well as how it was allocated. In particular, the house of Morgan (JP) was where Wall Street revolved round. The bankers controlled business financing, being both lenders of capital to business owners as well as helping to underwrite bond and equity issues. It led to a consolidation of many industries, such as steel, railroad and utilities, as bigger players with good ties with the bankers obtained favourable terms to buy over smaller peers; not a few felt that such consolidation often led to monopolistic industries and stifling of innovation. Also, bankers often sat on many company boards as a result of their upstream financing, putting them in a position to further their own interests. The Pujo governmental committee in 1912 found that the officers of three major banks (including Morgan's) held 341 directorships in 112 corporations with resources of $22B. Ultimately it led to the formation of the Federal Reserve, the de facto central bank, in 1913.

But this was only one facet of the power that bankers wielded; other important areas had not been addressed. The commercial arm of a bank had easy access to what Brandeis, one of the leading socio-economic thinkers of the times, termed "other people's money". Deposit taking was a source of easy money, that banks could channel to their investment banking arm where they could make loans to brokers, and underwrite equity or bond deals for clients who inevitably had to give them a big cut of the deal. Furthermore, banks could tie commercial loan deals with clients to other deals on the investment banking side, such as future share underwritings etc; such power was very tempting. In fact, before a central bank was established, the banks had complete control over stock market prices, since they could ratchet liquidity up and down at will through margin loan availability.

Brandeis also had also other more radical views about banks, such as banks being a "public utility", since they performed a public service and operated in the public trust; the implication was that they should be heavily regulated like ordinary utilities, such as cost-plus pricing policies. He became a Supreme Court justice in 1916, and remained an enemy of bankers with his views through the booming 1920s when times were good and nobody made efforts to change the status quo. The impetus for change was triggered by the Great Depression and the ensuing witchhunts which implicated bankers as the biggest culprits for the crash. The Pecora investigations of 1933 (a witchhunt in itself) revealed the interrelationships between the various financial institutions and the existence of "preferred lists" of clients to whom bankers extended financial privileges and sought to influence; if rich clients received favourable rates while poorer clients effectively subsidised them, it was surely contrary to the principles on which the US was built on. In 1933, President took the reins of power and the Glass-Steagal Act was passed; it was the most revolutionary banking bill ever passed (and probably to this day as well). The most significant point in the bill was that commercial banking and investment banking were to be separated; a bank could not do both. This effectively destroyed the ability of banks to both take deposits and issue securities. New firms were born: Morgan Stanley from the investment banking arm of JP Morgan (which chose commercial banking); the investment bank of First Boston from First National Bank of Boston.

Despite the initial uproar and protests from bankers that without the right to receive deposits their investment banking services would be largely compromised, and running contrary to their expectations that the Act would prove short-lived, the Glass-Steagall Act actually survived several generations and defined the path of American finance until it was repealed in 1999 by President Clinton. It had the effect of limiting bankers' influence on that most critical resource to companies: financing. Furthermore, by delinking the two, it ensured that any crisis of margin loan default by money-losing speculators on the investment banking side would not spread to the the commercial banking side and cause a run on the bank by frantic depositors; no cross-subsidising of capital across inter-linked arms would be possible now.

A mature banking industry develops with governmental regulation, and that was the primary contribution of the Glass-Steagall Act in correcting the previous no-holds-barred approach. Applying the developments described above to the Singapore context, one should be able to see the rationale for opening up the Singapore banking sector to foreign competition, and also the MAS requirement for local banks to divest of their non-banking assets by 2006. Many would have heard unpleasant anecdotes of how local banks in the past have made use of their banking and financing business to exert financial pressure on companies whose assets they have then seized to augment their non-banking divisions. Such possibilities are endless and that is why they must be nipped in the bud.

References:
(1) Wall Street A History (by Charles R. Geisst)
(2) Wikipedia entry: Glass-Steagall Act

Crash stock: Amcol

2005-10-08T08:48:00.000-07:00

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In the early 1990s Amcol was one of the semi-blue chips on the buoyant Singapore stock market. A CPF trustee stock (ie. a recommended stock for Singaporeans to put their retirement money into), positioned in the booming sector of electronics (distribution of Sony, Aiwa and Funai products), boasting revenues in excess of S$700M and profits between S$30-50M, with a long history of listing (since 1969), it was not hard to see why it was one of the investors' favourites.

It became a speculators' favourite as well between 1994-95, often a danger sign because optimism tends to rise with prices for such stocks, ultimately pricing in all the potential upsides and none of the risks. It was at the centre of a number of takeover deals by Indonesians, the prevailing trend of the mid-1990s when rich Chinese Indonesian businessmen were looking to diversify their assets to safe havens like Singapore. The share price was driven, often upwards, by such incessant newsflows and perceived prospects of future Indonesia deals, quite similar to Unifiber, another punter's favourite in our current generation. Incidentally, there is a connection between these two companies: Kang Hwi Wah, revealed as a dealmaker for Unifiber recently, was the founder and main shareholder of Amcol.

Kang was arrested for corruption in 1991 and jailed in 1994, but the stock did not crash despite his conviction. Over the years 1991 to 1994, Amcol continued to make pre-tax profits of between S$30-50M on steady revenue of S$700-800M, and acquired a new key shareholder, Hong Kong property giant New World group. The latter helped Amcol to diversify into property deals in Asia, which Kang helped to drive until his conviction in 1994.

The true speculative interest in Amcol commenced when in 1995 Kang, upon his release from jail, sold 17% of his total 24% stake in Amcol to Henry Pribadi, a close associate of President Suharto and Liem Sioe Liang, Indonesia's richest businessman. Then in early 1996, he sold another 6% stake to a company run by local businessman Lee Howe Yong and Indonesian-born executive Sukamto Sia, another Suharto associate. Although New World exited in 1995, the new Indonesian shareholders were perceived to be able to bring strong connections and business deals to the Amcol group; as we all know, relationships were what mattered in the Suharto era for doing business in resource-rich Indonesia. One must also remember that in 1995, there was tremendous market interest in the migration of Indonesian assets to Singapore, a trend driven by a sudden realisation by rich Indonesian businessmen of the need for risk management as political and social turmoil in Indonesia brewed (an example was the 1994 Medan riots), and which finally culminated in the collapse of the Suharto regime as the 1997 financial crisis proved the last straw.

The speculator interest kept the company's stock on high footing, at between $3 to $5, a total market cap of close to 1 billion, and a forward PE of above 20, comparable to the average SES (now SGX) market PE of 22. That put it on a similar pedestal with blue chips which typically trade at this PE range.

Things began to unravel in 1996. The new Pribadi-controlled management hired Merrill Lynch to review operations after the Amcol stake was bought, a strange move since it defeats the purpose of due diligence before buying. The findings were not exactly encouraging, revealing critical flaws in the company's operations and balance sheet that could not be easily repaired.

To add to the troubles, there was an inevitable boardroom struggle for management control between the various Indonesian shareholders. Presumably as a result of this politicking, some Pribadi-appointed directors approached the stock exchange about alleged irregularities, triggering the beginning of the end: Price Waterhouse were appointed to make investigations, CAD was activated, Amcol was suspended from trading.

The investigations revealed the full picture that the Merrill Lynch review may only have skimmed over: and it was not pretty; an insider commented that "Whoever was on the throne raped the company". To quote examples of "gross mismanagement, incredibly bad deals and dismal accounting" that surfaced from the investigations: (1)An electronics subsidiary sold goods at a loss to Funai, which resold them to another Amcol firm at a 12% profit; (2)The group bought into a loss-making power plant in China's Guangdong province, which has surplus electricity; (3)In Indonesia, an associate firm could not adequately document a supposed investment in satellite broadcaster Indostar, for which Amcol advanced $8.5 million. Worst of all, the company was now insolvent: it needed S$70M to meet debt payments, and all of its $800M assets might be required to cover obligations. Price Waterhouse declared that Amcol's shares were "nearly worthless", and the company was placed under judicial management.

Eventually, it took another Indonesian conglomerate to clean up the mess. In 1997, Sinar Mas, Indonesia's third largest conglomerate, acquired Amcol from its key shareholders and renamed it AFP Land, a subsidiary of Asia Food and Properties which is listed on the SGX today. The deal effectively valued Amcol at ~S$1.30 a share. The previous Indonesian shareholders had made a big loss. Pribadi, for example, had bought in his stake in Amcol for about $5 a share.

One must admire Kang Hwi Wah for his excellent sense of timing in selling off nearly his entire stake in Amcol, at the end of the day. Anyone, Unifiber?

References:
(1) Asiaweek article: The "Rape" of Amcol
(2) Asiaweek article: Singapore Spree
(3) Business Times article: Amcol & Henry Pribadi

The 1997 Asian Financial Crisis

2005-09-26T08:25:00.000-07:00

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Nowadays Asia is seen as the growth driver of the global economy, and Asian equities are booming as foreign liquidity pours in. Yet it was not too long ago when the Asian financial crisis led to many predicting the end of the Asian economic miracle.

Various people have quoted different reasons for the currency crisis that engulfed Asia, in particular Southeast Asia, in the second half of 1997, including the unforgettable accusations by Dr Mahathir of Jewish plots to impoverish Asia. But what was undeniable was that the root cause was the high gearing of many companies in the worst affected countries (Indonesia, Thailand, South Korea), even the blue chip companies; this situation was further exacerbated by the fact that much of the debt was foreign dollar-denominated (primarily US dollars).

Where did all the borrowed money go to? Mainly investments in commercial and residential property, industrial assets, and infrastructure. By the mid-1990s Asia was in the middle of a building and investment boom, fuelled by surging business optimism due to the years of exhilarating export-led economic growth. The investment boom was encouraged by governments (by facilitating loans through state-controlled banks) eager to take advantage of the wave to build national capabilities and economic power in order to catch up with the West (and additionally, a few for their own private gains). As always, over-supply usually follows excessive investment, and this was no different.

The bomb struck first in Thailand in February 1997, as the debt default and subsequent collapse of a property developer revealed similar problems in other peers and by linkage, the banks that had lent them the money to invest in what was going to turn out to be "white elephants". Currency speculators realised that there was an opportunity for shorting the Thai baht when they looked at Thailand's growing current account deficit and high dollar-denominated debt burden accummulated through the years of excess; if there was a rush to call back loans by banks due to fear of default, it meant the borrowers would have to buy dollars on the forex market (using Thai baht) in order to repay their loans. In July 1997, the Thai government abandoned the peg (1 US$ = 25 baht) and in January 1998 the baht had collapsed to 1 US$ to 55 baht, which of course ballooned the debt burden even further.

Following the devaluation of the Thai baht, wave after wave of speculation hit other Asian currencies. One after another in a period of weeks the Malaysian ringgit, Indonesian rupiah and the Singapore dollar were all marked sharply lower, as they allowed their currencies to float under pressure from speculators: the ringgit collpased from $1=2.525 ringgit to $1=4.15 ringgit by early January 1998; the Singapore dollar dropped from $1=S$1.495 to $1=S$2.68; the Indonesian rupiah suffered the worst fate, falling from $1=2,400 Rupiah to $1=10,000 Rupiah by January 1998, a loss of 75%. This was quite amazing; normally currency rates do not fluctuate greatly, and 20% swings would be considered major moves. And these devaluations took place over a period of 6 months or less!

Indonesia were hit particularly hard. The crisis brought to prominence the crony capitalism practised by President Suharto, who showered his relatives and close associates with plum contracts. Over-investment and inefficient resource allocation was inevitable given the corruption right from the top. When the IMF provided loans to the country to tide over the crisis, one of its conditions was that such crony capitalism had to be unravelled. Ultimately, the racial riots and subsequent collapse of the Suharto regime in 1998 was a direct result of financial hardship due to the crisis and Suharto's unwillingness to forsake his brand of political corruption even after the Asian crisis.

One cannot fail to mention South Korea in this crisis. It was the Northeast Asian nation hardest hit by the crisis. State direction had long governed the direction of funds and loans to the various chaebol, a form of policy lending that was practised widely in Asia but especially so for Korea. By 1996-7 there was an excess of industrial capacity in several sectors; one of the chaebol, Hanbo, filed for bankruptcy under heavy debts, and Kia, a car manufacturer nearly did. The S&P downgrade of Korea's debt, in response to these corporate troubles, made matters worse, raising the cost of debt to Korean companies, and more importantly, causing a slide in the Korean won from 1 US$= <1,000 won to 1 US$= >2,000 won by December 1997. There was speculation that as many as half of the top 30 chaebol might have to file for bankruptcy. This eventually did not materialise, as the Korean government swallowed its pride and asked the IMF for loans, agreeing to the latter's condition of opening up its market for greater foreign access.

One can argue that the property and infrastructure investment boom was a bubble waiting to be pricked, and it was going to happen sooner or later. On the local front, it brought a decisive end to the property speculation that had reached absurd heights where people were queueing overnight to buy condominiums they had no intention of staying in, only hoping to sell at higher prices and cash in on the property boom they thought would never end. It has been nearly ten years, and these people are still sitting on negative equity. On a broader scale, companies have restructured their capital base and have now become less highly geared and more equity-based, in effect adopting a more sustainable and less risky growth approach. Governments are also pulling back from close cooperation with businesses, as they learn to let the market dictate the flow of funds, the so-called invisible hand in Western economies. Some of them probably had to do so, as preconditions for getting loans from the IMF. But things have worked out for the best for everyone in the end. What is most important is that the mistakes of over-investment and excessive borrowing should never be repeated again; one must be wary especially in periods of optimism such as now.

References:
(1) The Asian Financial Crisis

Bull stock: SPC

2005-09-12T07:22:00.000-07:00

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The hot story of 2004 was China, and the hot story of 2005 is undoubtedly oil. Oil prices making new highs has been the talk of town throughout this year, but Hurricane Katrina has brought into focus the glaring global tightness of refining capacity. However, this was eminently clear as early as 2004, which had resulted in SPC, with its 50% stake in Singapore Refining Company its crown jewel, surging in share price from less than $1.50 in early 2004 to $5.50 now. Coupled with the high dividends, it would have rewarded an eagle-eyed investor with a four-bagger over less than two years!

Fast rewind to late 2001. The stock had sunk to a low of $0.60, partly a result of a downturn in sentiment following September 11 but more fundamentally its business prospects were viewed pessimistically by the investment community. It had been struggling with razor-thin margins and stagnating revenues (albeit S$2B worth) in its mid- and downstream oil business in the last few years, and indeed had made losses in two of the last three years, while technology stocks were the rage. The talk was that there had been so much global investment in oil refineries and supporting infrastructure in preceding years that now there was an over-supply and thus a long-term downward pressure on refining margins. With such negative vibes, it was no wonder that the stock became thinly traded by 2002.

Through the bearish environment of the first few years of the new millenium, SPC concentrated on building its upstream and downstream business, through acquisition of the Kakap PSC in Indonesia and pipeline deals to bring in natural gas from the same country. Its links to Keppel (and the Singapore government) probably helped facilitate such deals; effectively SPC was the national oil company and would be the de facto oil play should the commodity become hot again (as it has never failed to routinely) in the future. The key deal, however, was SPC's purchase of BP's stake in Singapore Refining Company and its retail stations in 2003, raising its stake from 33% to 50%. Revenue and profit consolidation was now possible and it had raised its refining revenue and profit base in one fell stroke, by about 50% (16% increase from 33%). With BP's islandwide retail stations, SPC had also become the third largest petrol retailer in Singapore.

The commodities craze in 2004 soon spread to oil and refining margins surged to as high as US$10 per barrel in late 2004. By then, SPC had already surged to the S$3-4 range, as investors started to wise up to its strength in refining and distribution, and the wild card in upstream production. Normally, a rise in crude oil prices is only a mild positive to refiners, as it signals strong demand (a positive) but also implies high input prices. However, in 2004 sweet light crude was scarce and hence expensive, while the Middle East were only able to increase heavy sour supplies; this meant that complex refiners with an ability to process the latter could charge premium refining rates. SPC was one of them. Net profits jumped an astonishing fourfold from S$60M in 2003 to S$250M in 2004 (also partly due to the increased ownership of SRC).

The SPC story continues into 2005 and beyond. The currently acknowledged shortage of refining capacity is ironic when one recalls that just several years back people were saying there was an oversupply. It just illustrates the law of reversion to the mean (and then some) yet again. Meanwhile, the frenzy over oil continues as the winter season sets in and demand (and refining margins) is expected to peak. Is this sustainable? Perhaps the growth for SPC in the future lies in its upstream business and its ability to secure new production contracts in South-east Asia, which increasingly looks like a hotbed of oil exploration activity in the future, as countries like Indonesia open up.

References:
(1) GK Goh's report on refining 5 Sep 05

Boom 1983-99

2005-09-07T07:03:00.000-07:00

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I just realised that I had been writing about bear markets and collapses in my last four entries in this blog, so this next one has to be a bull post to balance out. And what a bull it is too: the longest bull market in recent history, yielding an average annual total real return (with dividends reinvested, adjusted for inflation)of 15.7% from the period 1983 to 1999. (Where else do you think Warren Buffett got his well-quoted figure of 15% return from the market that an investor should expect from?)

A secular bear market invariably pushes valuations down in alignment with the most pessimistic outlooks, and this was the case with the bear in the 1970s. Although the Dow breached 1000 points in 1982, it was trading at a market multiple of 7 times, an amazingly low figure when you compare it with market multiples we are used to today of ~15-20 times for developed markets. The tide began to turn; bargain hunting had been proceeding the last few years but now a new powerful force took over: corporate takeovers. From 1984 to 1987, mergers, takeover, buybacks and leveraged buyouts slashed the supply of stock available on the market. This was the age of the junk bonds and the chief protagonist was Michael Milken of Drexel Burham Lambert (would probably cover in detail in another post). Corporate America was recognising the cheap market prices that they could acquire other companies (mergers) or even their companies (management/leveraged buyouts) for, and were scrambling to take advantage. The movie "Wall Street" probably epitomises the mood of excitement and greed enveloping the market at the peak of this period.

Black Monday in 1987 put an end to the market momentum and by 1990 the LBOs and mergers had died out. However, it turned out that the second leg of the bull market was just breaking stride. The participation of the individual retail investor in the stock market was the key factor in this phase. In the US the rise of the 401(k), similar to Singapore's CPF, meant individuals had to be responsible for managing their retirement funds which had been regularly contributed by employers while they were working. And they chose the stock market to put their money in, which would generate liquidity, that lifeblood of markets, for the next decade.

There are several reasons why stocks were the preferred choice. The old generation which had experienced the 1970s bear market had been replaced by a new generation of investors who saw the surge in the DJIA from 1000 points in the early 1980s to 3000 by 1991; clearly the desire to participate in this boom grew with the index. The collapse of the Soviet Union saw the end of the Cold War; there was a rush of new optimism now that the world could concentrate on economics instead of politics or security. Commodities prices posed few problems (ie. low inflation) for the economy as few bottlenecks (political or otherwise) proved particularly bad and supply could be easily ramped to meet rising demand.

By the mid 1990s the media had joined the circus. Financial talkshows and news bulletins became a staple on the TV diet of many Americans now hooked on the market. Presenters became celebrities, such as Louis Rukeyser whose show often generated stock ideas for the following day. Mutual funds (known as unit trusts in Singapore) became the investment vehicle of choice for many small investors, due to their incessant marketing and the superb performance of certain fund managers (such as Peter Lynch) which was trumpeted and benefited the image of the entire industry tremendously. Due to pressure on them to outperform the market, many fund managers practised momentum investing, chasing up the valuations of popular stocks because they offered the most liquidity and high probability of outperformance. And they did, because the flow of liquidity ensured that the house of cards would not collapse. The 100 most favoured institutional stocks were sold at price earnings ratios 25-50% above their historical averages; stocks like Time Warner (85 times PE), Coca-Cola (39 times), Gillette (36 times), Pfizer (31 times), Oracle (32 times); this was reminiscent of the Nifty Fifty of the early 1970s.

As long as the music played the game carried on. The surge in profile of technology stocks, in particular Internet stocks, in the mid to late-1990s brought the market optimism to a climax by the turn of the millenium. Even astute observers like Alan Greenspan, the Fed chairman, expressed optimism about a New Economy fuelling an unprecedented rise in productivity that was the underlying force for the market rise; it turned out that he had got the chicken and egg problem in reverse; it was the investments put into implementing new IT systems that had boosted earnings, not any productivity gains as a result of implementing these IT systems. This became painfully clear as the market reached a crescendo in 2000 and then finally the house of cards collapsed, conclusively bringing an end to nearly two decades of generally uninterrupted boom, a boom that had brought stock valuations from dirt-cheap to downright unbuyable.

References:
(1) Bull! A History of the Boom 1982-1999 (by Maggie Mahar)

Long Term Capital Management

2005-08-30T07:03:00.000-07:00

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Nowadays when people talk about whether high IQ rocket scientist-type geeks can succeed in the financial markets, the story of Long Term Capital Management invariably comes up in the case against. The 1998 collapse of the multi-billion dollar hedge fund was memorable for the fact that it had Nobel Prize-winning economists and legendary traders among its staff, and it was a shock to many when the fund made huge losses. However, to dismiss LTCM and its managers as complete failures would not be fair to them; their basic fund management premise was acknowledged, even after the event, as technically sound but ultimately they paid the price for assuming too much risk.

The well-known characters in LTCM were John Meriwether and the Noble Prize-winning economists Myron Scholes and Richard Merton. John Meriwether had been a star trader at Salomon Brothers before he started LTCM, drafting in the abovementioned two economiists who later shared the Nobel Prize for their work in describing the pricing of options, which would later be known as the Black-Scholes options pricing model which is a standard menu item on most finance texts. Of course, there were other lesser-known but probably no less intelligent traders in the LTCM trading office, but the main drawing power was the reputations of LTCM's management, which attracted major banks and savvy Wall Street veterans to invest with LTCM.

Arbitrage was the main operating strategy of LTCM, and the usual trading instruments were derivatives. The prices of derivatives such as options would usually be linked to their parent security instrument (a stock, bond or currency) and other "sibling" derivatives (ie. same parent security) in such a way that buying the derivative and selling its parent security /sibling derivative would yield no net financial gain to the trader ie. there was no arbitrage spread. However, occasionally there was such an arbitrage spread, and that was where LTCM would come in and take advantage by buying the under-priced derivative while simultaneously selling the over-priced one. The basic academic premise (there had to be, with two Nobel Prize winners in their midst) was the Efficient Market theory; a rational market would always price financial instruments efficiently, and close the arbitrage gap. Such "convergence plays" were very successful in the early years; a dollar invested in 1994 was worth more than two dollars two years later.

This arbitraging strategy necessitated use of high leverage since the spreads were usually very small, which was why trading in derivatives was very convenient since derivatives by their nature allowed high amounts of leverage on the parent security. But basically, this also meant that a risk-free strategy was turned into a highly risky bet on the nature of the markets by serving as a giant magnifier. If spreads failed to converge, LTCM might have difficulty finding adequate additional collateral capital (anyone playing margin on stocks would know). The initial years of success had made the partners more adventurous, such that by 1997-98 they were apparently using a leverage ratio of 30 to 1 ie. $30 of borrowings (margin) for every $1 of equity.

In 1998 the Russian bond market collapsed due to the Russian government defaulting on payments on its bonds. Although the exposure of LTCM itself to Russian bonds was small, the Russian collapse triggered a massive flight to liquidity by global bond investors to the safety of US Treasuries, temporarily causing spreads to diverge instead of converging especially in the case of short-term vs long-term US Treasuries. The inter-linkages between LTCM's positions were complex, but basically they had not hedged for this flight to liquidity in their supposedly failproof strategy, an omission further magnified by their high leverage ratios. Hence during this crisis they faced a liquidity crunch and a compelling need to unwind some of their positions to redeem cash so that other positions could be shored up.

The problem was that LTCM had grown so big that as soon as other big market players heard of its problems, they stopped buying. Nobody knew how the forced liquidation of LTCM's portfolio would affect prices, so traders pulled back. Hence market panic, another key unknown normally unaccounted for in academics' "rational market", now came in to deal LTCM another blow. There was a buying vacuum which exacerbated LTCM's precarious position, and soon caused concern to the Federal Reserve who were afraid that LTCM's collapse would pull down Wall Street together with it in a potential systemic meltdown. A consortium of banks and investment houses were pulled together to provide LTCM the capital, in exchange for 90% of their equity, so that the fragile markets would not have to absorb a forced liquidation of LTCM's assets. And thus a complete collapse was averted.

But LTCM would never be the same again. There was little mention of the fund in news articles after the rescue effort and I myself find it strange that it seems to have faded into oblivion without as much as a mention. However, footnotes revealed that the banks that supplied the funds for the rescue, such as Merrill Lynch, Credit Suisse, UBS etc had to take huge writedowns on losses for the investments (in LTCM during the rescue effort) in the later part of 1998. This was in addition to their earlier investments in LTCM when it was riding high during the mid-1990s. A case of "when genius failed", according to Roger Loewenstein in his book of the same title.

References:
(1) The Mind of Wall Street (by Leon Levy)

Crash stock: Global Tech

2005-08-25T07:56:00.000-07:00

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Since today's papers put the financial woes of this SGX-listed Hong Kong company back in focus since it was suspended from trading more than a year ago, I thought I would write about the story of this stock. It is a very interesting tale indeed, and the whole sequence of events has transpired just over these couple of years.

Global Tech was a leading distributor of Motorola, Nokia and in particular Samsung mobile phones in China, already the largest mobile phone market in the world by 2002. Its revenues had increased steadily from HK$2B in 1997 to HK$4B by 2001, with rising margins propelling bottomline from HK$500M in the same period. Valuation-wise, by 2002 it was selling at 4 times trailing PE, seemingly a great bargain given the earnings performance over the past few years.

It turned out to be the classic example of why investors should not catch a falling knife. The share price had dropped from S$0.20 (split-adjusted) in 2000 to $0.10 by mid-2002 despite the strong performance and high dividend yield of 8%. In early 2002 the company's chairman was reported to have been arrested in Guangzhou for tax evasion, which he later admitted to and had to step down from his Global Tech positions to be taken over by his brother Timothy. He was also charged with misstated sales in two of his privately- controlled companies.

By early 2003, before the release of their FY02 results, Global Tech was trading at 2 times PE and a remarkable 18% dividend yield, at a price of 5 cents. Then the bombshell dropped. In the released FY02 results, topline had grown to HK$5B but bottomline had shockingly reversed to a loss of HK$200M; there was also a restatement of FY01's profits reducing it by HK$100M. The company explained that massive provisions had to be made for doubtful debts and slow-moving inventory, amounting to an amazing >HK$200M each.

Things have deteriorated rapidly since then. Global Tech had several changes of auditors, reported another dismal set of results for FY03 with continuing losses and with revenues dropping as well. The company voluntarily suspended trading in 2004 when a number of their board members resigned and it claimed that time was needed to find replacements. Since then it has not resumed trading. The last traded price was about 1-2 cents.

The Global Tech episode clearly illustrates the importance of management integrity and transparency. Global Tech continually denied the truth of reports about its chairman being in litigation trouble, and the massive provisions in FY02 suggested that its probable overstatement of profits in previous years had finally caught up with it. The fact that auditors had to be changed several times and that non-executive directors resigned subsequently in 2003-04 also signalled deep problems within top management.

Why do I sound so familiar with the stock? That is because I was vested in it and luckily bailed out (with big losses) before it got suspended. To me it was another costly lesson not to be tempted by extraordinarily low valuations, and to have respect for how the market values stocks; it was another manifestation of the fact that generally, the Efficient Market Hypothesis does assert itself. If a stock is low-priced and continues falling, it could be pricing in some adverse news that might not yet have been made public and the investor should not plunge in just because it "looks cheap".

The 1985 Pan-Electric crisis

2005-08-18T07:45:00.000-07:00

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Small investors have been "entertained" by a deluge of corporate scandals such as CAO, Citiraya and ACCS over the past one year, leaving them wondering where the next one will come from. Veteran investors will view this in context; to them these are nothing new as the stock market is inherently about assuming risk; they will point to the Pan-Electric crisis in 1985 as an example where the SGX was caught in a greater bind, causing it to suspend trading for 3 days. This was the only time in its history since then that it did so.

The 1985 collapse of Pan-Electric was as sudden as it was catastrophic. Financing its operations with a series of forward contracts (will be explained later) that brought it into heavy debt (S$450M debt vs market cap of S$230M) which it had trouble refinancing during the 1985 economic recession in Singapore, its financial insolvency were exposed by underwriters during a proposed rights issue. The rights issue was cancelled, Pan-El trading was suspended, a rescue package planned and aborted, all stock trading on the SGX was suspended; this chronological series of events happened within the space of half a month from mid- to end-November 1985, at the end of which Pan-El went into receivership and was ultimately wound up in 1986.

Investors in the stock would have their individual hard-luck stories, all 5,500 of them who ended up with nothing, but the biggest loser in the fiasco was the man at the centre of the storm: Tan Koon Swan, a substantial shareholder of the company holding an indirect 30% stake, and the most well-known Chinese politician in Malaysia, as newly-elected President of the Malaysian Chinese Association (MCA). Exercising tremendous influence over Pan-El's directors in the entering into of forward contracts that were to bring the company to dire straits in 1985, he was later found guilty oif and jailed for attempting illegal funds transfers from various sources, including from Multi-Purpose Holdings, the commercial arm of the MCA, during the Pan-El crisis period in 1985 in his vain attempt to raise capital to rescue the company from insolvency. A witch-hunt always follows a debacle, that much is certain; and in this case it brought an end to both Tan's business and political careers.

It is also important to highlight the impact that the Pan-El collapse had on the financial system which caused the SGX to take such a drastic step as to suspend all stock trading for 3 days. The forward contracts that Pan-El entered into implicated a whole food-chain of banks and brokers. An MAS paper summarised it well: "With forward trading, a whole chain of parties is linked via promises of sale and purchase to the same lot of stock, the line only ending with a purchaser which either wants to keep the stock, or that cannot find someone else to sell it to. If this last purchaser is unable to meet its obligations to pay for the stock when they fall due, a domino effect is created and defaults could occur down the chain."

For example, if Pan-El wanted to loan $10,000 from a bank, it would pledge say, 1,000 shares worth $5,000 as collateral. The bank would enter into a forward contract with a broker A to sell the shares to this broker at a certain (higher) price at a specified future date. Broker A would then enter into another forward contract with Broker B to sell these at a yet higher price in the future, and so on up to Broker X. Pan-El would then subsequently close the loop some time later by purchasing the last forward contract from Broker X at say, $6,500; the entire value chain would have augmented their profit by $1,500 while Pan-El would have obtained cheap financing through such a system of arrangements.

A win-win situation, which unfortunately unravelled in bear markets when Pan-El had difficulty getting new loans to finance its re-purchasing of such forward contracts. This meant Broker X would not even get its capital back, and thus could not repay Broker W, who could not repay Broker V, and so on up to Broker A and the lending bank.

It was this series of inter-linkages which dragged six brokerages to their demise together with Pan-El, and caused a crisis of confidence that caused the markets to plunge when the SGX re-opened in December 1985 after 3 days of closure (a day known as "Black Thursday" in the local context). It created impetus for stricter regulation of the SGX by MAS from then on. The market changed from a self-regulated entity to a tightly-regulated one, in particular with regard to brokerage capital requirements, gearing and margin limits, as well as reserve fund requirements. This has since loosened to a disclosure-based regime, where the onus is on the individual investor to exercise caveat emptor.

References:
(1) MAS Paper on the Pan-El crisis
(1) Lessons: The debacle of Pan-Electric Industries (by Kevin Sullivan), from Asian Entrepreneur Sep 2000 issue

The 1970s Bear Market

2005-08-13T08:09:00.000-07:00

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The 1970s was characterised by rampaging inflation in the US, first due to a legacy from the surging 1960s economy boom, then aggravated by the formation of the OPEC cartel which triggered cost-push inflation. It was not until the early 1980s that the US market started to recover from the inflationary spiral and resulting stock market swoon.

The bull economy of the 1960s had started to sputter by the early 1970s, due to falling unemployment causing tight supply and hence higher prices; this was further aggravated by the rise of labour unions with better negiotating power. Faced by such pressures, the US government appeared to seek alternative methods of stimulating growth through its actions on the forex market, where Richard Nixon cut the US dollar's convertability to gold and allowed the dollar to float freely; the intention was to raise the relative competitiveness of US exports. However it set off currency instabilities on the world market, dampened sentiment towards US assets, and further aggravated the inflation in the US.

Then the classic cost-push inflation was triggered when the newly formed Organisation of Petroleum Exporting Countries (OPEC) announced a sharp rise in the price of oil in early 1973, partly for political reasons and partly to compensate for the devaluation of the US dollar which was the currency denomination their oil was traded in. Within 1.5 years the price of a barrel of oil surged from 2.50/barrel to over $11/barrel. Since then oil has been a closely watched commodity, up to this day.

The annual inflation rate which shot up to over 15% by the mid to late-1970s as a result of these factors had an immediate effect on the stock and bond markets. Stock indices dove sharply in late 1973 and 1974, with individual stocks correcting to half their 1970 price was normal; in particular the Nifty Fifty stocks, wildly popular in the early 1970s and considered the best growth stocks, the "one-decision" stocks (only need to make one decision ever: buy and hold forever), collapsed. On the bond market front, yields rose in conjunction with interest rates, causing grief to incumbent bond investors.

Such a combination of low economic growth combined with high inflation is known as stagflation, and the US government finally realised that it had to focus on fighting inflation to solve such a paradoxical combination. Paul Volcker, the new Federal Reserve chairman, began a series of aggressive interest rate hikes after taking office in 1979, in an attempt to restrict monetary growth. This initially destabilised the markets but ultimately stopped inflation in its tracks. At the same time, as the high yields became too attractive to ignore, foreign investors started coming back into the market to buy US assets (US dollars, bonds, stocks), triggering a recovery in the capital markets. The tax breaks by Ronald Reagan's new government, influenced by supply-side economics, also boosted consumer spending. 1982 saw the turning point which was to lead on to a two-decade bull market. However, the legacy of this prolonged 1970s bear market would never be forgotten. Inflation is nowadays viewed as one of the most important, if not the most crucial, economic factor to monitor and tackle by the US Federal Reserve.

References:
(1) Wall Street A History (by Charles R. Geisst)

Bull stocks: Cosco

2005-07-29T21:16:00.000-07:00

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Another stock that has benefited tremendously from the rise of China over these last few years has been Cosco Corporation (Singapore), formerly known as Cosco Investments (Singapore). Once a thinly traded stock during the dot-com boom years of 1999-2000, today it is an STI, FTSE and MSCI component stock and THE blue-chip China play following the collapse of CAO.

Although it was a subsidiary of China Ocean Shipping Company (Cosco Group), one of the world's top 10 shipping conglomerates and a China state-owned enterprise, in the late years of the last millenium and the early years of this current one Cosco was trading within a range of 20 to 30 cents with relatively thin liquidity. Shipping (in SEA and China region) formed about 60% of its revenue base, with the balance being in miscellaneous investments (hence its name Cosco Investments then).

The turning point, in terms of both fundamentals and stock price performance, came with a group restructuring that commenced in 2001 with a new management under Ji Hai Sheng. Non-core investments including its property and trading divisions were divested to allow it to concentrate on its shipping business. More importantly, it branched into ship repair with a series of acquisitions in various shipyards. In this respect its linkages with its parent Cosco Group played a big part, as most of the shipyard acquisitions were transfers of ownership from parent to subsidiary. These included stakes in Cosco Nantong Shipyard, Cosco Dalian Shipyard and sister company Cosco Shipyard Group.

The recovery in the bulk shipping sector notwithstanding, it was the ship repair division of Cosco Corp that provided the shot in the arm in terms of the group's share price performance. With the widely publicised rise of China since mid-2003, the China ship repair sector became increasingly recognised as a sunrise industry, due mainly to two reasons: on the demand side, China's burgeoning world trade implies a growing volume of vessel maintenance and repair, while on the supply side, the competitive cost structures of China's ship repair industry provide a major advantage against regional competitors such as those from Singapore. Through its various acquisitions from its parent, Cosco Corp acquired a 20% share of this market, which were positioned strategically in nine cities along the eastern coastline from north to south.

The building up of the highly promising ship repair division from a standing start of nearly 0% ignited a share price charge from mid-2003 onwards. The initial push was with the market tide that swept all stocks, but the price continued rising even as others sagged in the small-to-mid cap correction in 2004. Within two years the price rose from a stagnant 20-30 cents in mid-2003 to 2.30 today, a near eight-bagger (and that is excluding its 1-for-5 bonus issue in 2004). In terms of earnings performance, it is expected to earn >S$100M profit on >S$700M turnover in FY05. Compare this with its S$5M profit on S$200M turnover (on a low-margin shipping and investments business) in 1999. This implies over 60% CAGR (cumulative growth rate) in annual earnings over the last six years.

Of course, the FY05 figure is just a projection and in terms of share price I had expressed some doubts about overvaluation in another blog (see Hot Singapore Stocks-Not! --> Cosco). The fact remains, however, that the transformation of Cosco into a major global ship repair player these past hour years has been extraordinary, and its rise clearly illustrates two things: firstly, the advantages of having a strong parentage (tremendous help in its restructuring), and secondly, how a long-term trend (rise of China and its cost competitiveness) can lead to multi-year price gains.

References:
(1) GK Goh's analyst report 30 May 05

Robber barons of the 19th century

2005-07-22T21:25:00.000-07:00

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The mid to late 19th century is best known not for any especially significant market bull runs or collapses, but for the speculative activities, mainly revolving around the railroad stocks, and the individuals who made their money from such activities and became spectacularly rich (and feared) as a result. That they started from humble backgrounds and made it rich on their own efforts (albeit often dubious and ruthless) endeared them to the public. These were the "robber barons".

Three men stood out as the most famous operators of their day. Daniel Drew was known as the "Great Bear"; as the name suggested, he operated mostly on the short side. He was known most for his manipulation of the share price of the Erie Railroad, which he was able to exercise control to an extent that is unimaginable today. "Commodore" Vanderbilt was best known as a master of cornering, which is a tactic of squeezing shortists by accumulating the stock available on the market and forcing the shortists to cover. He prevailed over Daniel Drew in the battle of the bull and the bear over the Harlem Railroad in 1862. In his later years, he consolidated a great number of railroads which left a lasting legacy to American industry by improving the efficiency of railroad operations through economies of scale. In this aspect he contributed more to society than Daniel Drew, who essentially saw his companies as vehicles to play the stock market with loaded dice, rather than building up their business operations and boosting fundamental value. Jay Gould was a protege of Daniel Drew, who later forced his mentor out of the Erie board and became its managing director. He was best known for his attempted gold corner in 1869, which was thwarted by the US government releasing a huge amount of gold. Nevertheless, Gould managed to scramble out of the situation with huge profits with skilful covert selling and deceptive stock support by his associates, leaving a massive trail of casualties, which included individual gold speculators and brokers, on a day known later as "Black Friday".

These famous speculators marked an early period in America's stock markets, when stock market regulation was in its infancy stages. Hence the door was open for individuals who spot loopholes in the system to exploit them to the fullest. Unfair use of directorships within a company extended further than insider buying/selling, and corrupted the relationship between directors and shareholders. Daniel Drew, as a director of Erie, often thwarted attempts to corner the company's stock (when he went short on it) by issuing vast quantities of new stock, a practice known as "watering the stock" (interpret it as diluting the value). Some company directors deliberately steered their company into problems which they would publicise, accumulated the stock at low prices, then took steps to solve the problems and drive the stock price recovery.

The success of the pool operators also depended on their being able to suck in unsuspecting speculators to drive the stock up or down, which meant public communications machinery was deployed to disseminate rumours. There were often close relationships between the newspapers and pool operators, and the former were hardly independent reporters of the latter's activities.

This age of speculation was also characterised by federal entanglement in the national web of speculation. The Credit Mobilier scandal in 1872 involved a Member of Congress, Oakes Ames, receiving inflated payments to his personal company, Credit Mobilier, for construction services rendered to the Union Pacific Railroad, which was public listed. Legislative decisions regarding railroad construction and operation permits often went depending on which pool operator's political lobbyists were more effective, and also whether the legislators were themselves vested in the stock.

The next few decades would see the rise of "captains of industry" such as Andrew Carnegie and John Rockefeller who would become more well-known for their contributions to their respective industries of steel and oil, rather than their stock market operations. They represented an improvement in society values, where speculation based on stock market manipulation gave way to a more preferable method of money-making based on building new industries. However, the speculative spirit would always exist in the blood of humans, and many would think back fondly of the robber baron days with their no-holds-barred operations.

References:
(1) Devil Take the Hindmost (by Edward Chancellor)

Crash stock: CAO

2005-07-12T07:54:00.000-07:00

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There has been a series of stock scandals on the Singapore stock market over the last two years which has put one in serious doubt about the regulatory vigilance of the SGX. This is however another story for another day; I shall talk instead about the biggest scandal of them all, China Aviation Oil.

The dust over the CAO scandal has more or less settled, with blames being apportioned, independent inquests complete and creditors accepting the proposed schedule of payments. However, the figure US$550 million will forever be imprinted in the minds of unfortunate CAO shareholders.

This was the amount that CAO, in an announcement in Oct/Nov 2004, declared it had lost through derivatives trading (oil-related) over the past year. The stock had been suspended earlier in the day, and has not resumed trading since. What was the significance of this figure of US$550M? It was more than 3 times the net assets of the company, and about the total market capitalisation of the company before it was suspended (at 96.5 Singapore cents a share). With this announcement, a company which was seen as an emerging blue-chip by long-term investors was rendered insolvent (actually that is an understatement). This was a bolt out of the blue; over the next few days the CEO Chen Jiulin went missing (he returned to China, then came back), the papers had a field day, and China-linked stocks sank.

A post-mortem of this scandal must include a discussion of a few glaring issues. Firstly, why were the losses allowed to spiral upwards so uncontrollably? Apparently CAO had a vaunted risk management system but which appeared to have been circumvented by its CEO. Hedging instruments became speculative positions. Consequently, as oil prices continued their incredible spiral upwards through 2004, so did CAO's derivative losses as it made wrong bets on the price direction.

Secondly, it appeared that there were two versions of its 3Q04 results, one for internal consumption and the other for public announcement. The former, of course, captured the full losses due to the derivatives trading, while the latter took it off the balance sheet and P&L. The CFO, with his CEO's acquiescence, published the latter. If a past winner of the most transparent company award had such a practice, then the question begs: who else?!! Apparently, I heard from an auditor friend based in China that preparing several versions of financial statements for various contexts is a common practice for China companies.

Thirdly, in the frenzied trading in the stock over the month culminating to the CAO shocker, the holding company CAOHC placed out about S$100M worth of its CAO shares. Clearly this was a case of insider trading and indeed in later interviews they admitted as such. One might well have taken the insider placements as a danger sign to exit any positions and hence avoid the debacle that was to occur. The question leading from this issue is: will geographical technicalities and political sensitivities prevent action from being taken against the insider traders? Perhaps we will find out as the case for several of CAO's directors (and also concurrently CAOHC's) commences, in the near future.

Bear market in 2002-03

2005-07-06T06:53:00.000-07:00

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It is a natural human phenomenon that pride comes before a fall, and so it was after the dot-com bubble burst in 2000; the way down was long and arduous, and it would not be another 2-3 years later before the bear market was decisively ended.

The sustained bear market for the first years of the new millenium was due to several factors: over-optimism in previous years, a downturn in business worldwide, and what we may call a series of unfortunate events.

The first was clear to veteran investors who had seen and experienced several stock market cycles. Rising investor optimism leads to irrational exuberance with speculators taking over, and when this climaxes the downturn will start. Market observers had been predicting this for the last few years, and so indeed investor psychology reached an inflexion point in mid-2000.

The stock market downturn portended a sharp decline in the business cycle which started to be evident in 2001 onwards. It soon became clear that rising "productivity", credited by Alan Greenspan for the stock market rise in the late 1990s, was due to excessive investment in IT rather than brought about by IT. Thus a downturn in the technology sector struck especially hard, as orders for many EMS firms suddenly evaporated. Consumer demand declined as confidence was low and expectations of a recession became self-fulfilling. Retail businesses stagnated. Firms were reluctant to invest in new capital given the poor outlook, leading to losses by many capital equipment manufacturers. Trade flows dwindled, leading to poor business for shippers such as NOL.

Add to this climate of sudden pessimism a further series of confidence-shaking world events. The Sep 11 terrorist attacks in 2001 brought the STI down to 1200; a rally that brought it back to 1700 then fizzled out in 2002 due to the revelation of the Enron and Worldcom corporate scandals and the impending threat of war in Iraq. Then SARS struck Singapore in 2003. And so, in mid-2003, the STI was back to the post-Sep 11 index of about 1200.

To give a share price perspective of key STI stocks: by the low point in 2003, DBS was trading at about $8, Singtel at about $1.30, Capitaland at $1, Keppel at <$4, NOL at as low as 70 cents! The market was probably trading at 12-13 times overall trailing PE, compared to its historical 17-18 times. Quality small and mid-caps were trading at single-digit PEs (6-8 times!), such as Jaya, Meiban, Sincere, HTL, People's Food etc.

Viewed in this context, one need not be overly alarmed at the drastic recovery the STI has made since mid-2003. Stocks had simply risen too high in 2000 and fallen too steeply by 2003. This recent stock market cycle only again reinforces the cliche that the more things change, the more they remain the same.

Bull stock: Noble Group

2005-07-01T06:08:00.000-07:00

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In this blog site I shall also cover stocks that have had phenomenal bull runs or those that had experienced price collapse. Note that bull stocks are not necessarily good buys since they have already been recognised as such and might not be worth buying any more.

When we talk about bull stocks on the SGX over the last few years, one must surely stand out: Noble Group. According to a study in 2004, the group outperformed every other major stock on the SGX over a 3-year and 5-year period in terms of total shareholder returns. But it was not always such a favoured company.

During the great technology boom of 1999-2000, the stock stagnated at slightly above 10 cents (adjusted for all splits to compare with today's price). Indeed, it was so illiquid that on some days the stock was not traded at all. This could probably be due to its extremely low net profit margins (~2%), which caused it to suffer a loss in 1998 when revenues slumped (but of course, that was when Asian economies were suffering from the after-effects of the Asian financial crisis).

The stock price gained strength slightly over the recession years of 2001-mid 2003 as it demonstrated strong revenue growth (>50% growth every year). However, investor concerns lingered about its declining margins which caused net profit to remain stagnant despite the excellent topline growth. Some discerning ones might have spotted excellent potential in its growing business arms, as it expanded into a major supply chain manager and logistics provider in the Asia-Pacific dealing with resources that were soon to explode in demand, such as metals, minerals, ores and grains.

This was to take place in 2003, particularly in the later half when the world economy staged a strong recovery. The net profit margin improved substantially from FY2002 and this, combined with the revenue growth which continued its >50% annual growth, resulted in a doubling of net profits. Fund managers bought into the stock and with it came broker coverage and further institutional attention; it was no longer an illiquid stock.

The momentum was to continue and even accelerate. The last two years have seen the long-predicted rise of China, and with it an incessant demand for resources to build its red-hot economy. Noble was in the centre of all this, as a major player in supplying these from resource rich countries (eg. Australia and Indonesia) and to resource-hungry behemoths like China and India, netting spreads at each end. Net profit margins more than doubled to >3% in 2004, with revenues doubling from 2003. The figures are set to remain steady in 2005. Over this period, the stock has more than tripled. It is now at about $1.40; an investor holding it from the year 2000 till now would have had more than a ten-bagger, to use Peter Lynch terminology.

Today Noble is a member of the MSCI Index and the STI Index, and is acclaimed as a new blue chip. Its CEO Richard Elman is sought after for his witticisms and unconventional style at AGMs. It is seen as one of the most transparent companies. Its transformation is complete. One wonders how much longer its momentum can sustain. Given its track record, who would have the guts to bet against it?

References:
(1) Shares Investment: Facts & Figures (several issues from 2000 till 2005)

The Japanese bubble economy of the 1980s

2005-06-22T07:12:00.000-07:00

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Speculative euphoria is often associated to cultural hubris. Again and again this has proven to be so, from the Tulipmania during the glory days of the Dutch, the market boom in New York at the start of the 20th century and recently again at the start of the 21st century. So it was with Japan in the 1980s.

Japan had become an export behemoth by the early 1980s, by virtue of her expertise and efficiency in mass production, innovation and branding. One can see in China today the Japan of the 1980s. Huge trade surpluses were run annually with the Western world who consumed Japanese exports. Further liquidity was available as Japanese companies started to borrow money on the Eurobond market for further expansion.

As with export economies that start to threaten Western jobs, Japan agreed at the 1985 Plaza Accord to revalue its yen currency. Clearly this would have an impact on its export competitiveness, and to alleviate fears, the Japanese government lowered interest rates to stimulate the domestic economy.

The massive amounts of easy liquidity that was made available to both companies and individuals due to the abovementioned factors led to an asset buying craze, both domestically and abroad. Genuine buyers, and then speculators as the asset boom ensued, bid up domestic property prices higher and higher, to the point where in 1990 the total Japanese property market was valued at four times that of the entire US. Japanese investors and companies, flush with the strong yen, embarked on further overseas asset buying binges such as landmark buildings, bonds and even paintings.

The stock market was the epitome of the liquidity-induced speculation fever. By the end of the 1980s, the market was valued at an astonishing 80 times PE; individual old-economy stocks such as textiles, services, marine, transportation etc were selling for more than 100 times PE. The public rushed in, but ultimately it turned out that insiders (brokers, rich investors, politicians, yakuza) would benefit most while the public usually were on the losing end of the daily stock churning. That one stock scandal involved a Prime Minister who ultimately had to resign (Recruit Cosmos scandal) indicated how high up the speculative fever and money-making craze had spread.

In 1990, the Bank of Japan started raising rates and the monetary tightening process accelerated over the year; the air slowly leaked out from the asset speculation bubble. However, it was not going to go away quietly. There were bank and broker collapses, as bad debts incurred by speculators no longer able to pay up rose to the fore; the biggest casualty was Yamaichi Securities, one of Japan's Big Four brokers. Japanese companies which had come to rely increasingly on profits from zaitech (financial engineering instruments) that rose together with the stock markets, now saw the other side of the coin, as these instruments incurred losses. And in the midst of it all, the loss of the wealth effect arising from speculative profits (stock market, property etc) meant that consumer demand was weakened, a condition exacerbated by the numerous capital investments made during the exuberant days that had created a lot of now redundant supply. The weak asset prices culminating in a deflationary spiral have lasted to this day, more than 10 years after the Japanese asset bubble was burst.

In retrospect, the transition of the Japanese economy from an export economy to a domestic consumption economy that was sparked by the Plaza Accord currency revaluation should have been closely monitored and actively managed by the Japanese financial authorities. Such a transition should ideally entail cheaper access to foreign goods (hence low consumer goods inflation) and prudent capital investments by export industries to increase productivity and efficiency. The fact that liquidity went instead into speculating in capital assets that multiplied in price was a dangerous signal of suboptimal resource allocation. Why the Japanese government did not take action earlier was inexplicable; or perhaps not, since as mentioned many government officials were also involved in making money for themsleves during the bubble.

The Japanese experience might also explain why China today hesitates in revaluing its renminbi currency until its capital markets are more mature.

References:
(1) Devil Take the Hindmost (by Edward Chancellor)

The Dot-Com Boom

2005-06-10T00:33:00.000-07:00

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The Internet boom went at full blast in the pre-millenium years of 1998-99, sending the US stock market into a bubble that ultimately burst and then leaked slowly over the first three years of the millenium, thus bringing an end to the decade-long boom in the US stock market.

The long boom years had drawn many Americans into mutual funds (or unit trusts) as equities became seen as the best investment instrument to make money. Financial news and talkshows had been a staple of many people's TV diet, with some, such as Louis Rukeyser, becoming celebrities. Memories of the last severe bear market (early 1970s) were far away. The scene was set.

In Silicon Valley, a new industry was brewing. In fact, the Internet had been conceptualised and invented 20-30 years ago, but it was only during the late 1990s that it became commomplace and reached a critical mass of installed base, leading to new applications (e-mail, CRM, ERP, online retailing, Web TV etc, search engines) that could each be described as a potential killer application in its own right.

In retrospect, Hyman Minsky's requirements for a mania to form had fully developed: a "displacement" existed in the Internet, which people saw as heralding a New Economy, where real world applications in "bricks-and-mortar" could be mapped effortlessly to the virtual world, and thus where capturing market share was more important that profits. Even Alan Greenspan saw the technology boom as a logical consequence of "productivity growth". Secondly, liquidity was in abundance, provided by small investors and the mutual funds they influenced. Venture capitalists virtually threw money at any Internet startup with a half-decent business idea. Investment rationalities turned to speculative mania, fed by cheap equity and credit.

And so it was that the speculative mania peaked in 1999. Core technology "blue-chips" like Dell, Cisco, Microsoft, Lucent etc sported stratospheric PEs of 30-50 or more, in a hark back to the over-valued Nifty Fifty blue-chip stocks of the 1970s. Internet stocks like Yahoo!, AOL and Amazon fetched 50 times, 100 times earnings multples. Even loss-making Internet stocks (eg Global Crossing) were skyrocketing on the basis of the ".com" link, and burning cash prodigiously. In contrast, "old-economy" stocks like airlines, utilities, even Warren Buffett's Berkshire Hathaway languished. Thus a dichotomy existed.

In Singapore, tech stocks were on fire too. Creative Technology shares rose to a record $60, Pacific Century (with its "Network of the World" and Lee Kar-shing connections) rose to over $30. Chartered IPOed at $16. Contract manufacturers sold at 20-30 times PE. It was a sign of the increasing reach of globalisation and the influence of the US economy and stock market.

The party came to an end in 2000. In March the Nasdaq plunged , and by the end of the year had dropped more than 50% from its peak. Ditto for the S&P 500, qualitatively if not quantitatively. After the event, it was noted that since 1998 the market had lacked support, the advance mainly confined to the technology and Internet stocks in 1999-2000. The massive investments in the last few years had led to over-capacity in the technology and telecommunication sectors. All this while many companies had been "managing earnings", but massive insider selling over 1999-2000 indicated that they knew this was not a sustainable practice.

Once the music stopped, the speculative excesses began to unwind. Small investors suffered heavily, and as with most other manias that turned sour, witchhunts (often justifiable, but undertaken with a vengeance) were launched. A common target throughout the ages was company management, and this was no different, cases in point being executives of Enron, Worldcom and Tyco. Analysts such as Henry Blodget and Mary Meeker were a new target, not surprising given the prominent role they had played in raising investor expectations and handing out ridiculous price targets on Internet stocks even while harbouring private doubts.

References:
(1) Bull! A History of the Boom 1982-1999 (by Maggie Mahar)

October 1929 and The Great Depression

2005-06-05T20:20:00.000-07:00

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The Wall Street collapse of October 1929 marked the end of a decade of US economic growth which was accompanied by surging stock prices. It was probably the first real market collapse in the US that affected a large cross-section of the population, and it ushered in a decade of further price falls before the market finally recovered, albeit slowly.

Post-war euphoria appears to be a social phenomenon. Post-Iraq in 1991 and again in 2003; post-WW2 in the 1950s; the decade following the end of WW1 was no exception. From Jan 1920 to Sep 1929, the stock market's total return (dividends included) was an astonishing 20% per year. It was indeed testament to another natural law: the law of means reversion, that this decade-long boom was followed by a bust.

A number of well-known speculators had bailed out earlier. In 1928, Joseph Kennedy, later appointed chairman of the newly set up Securities and Exchange Commission (SEC), liquidated many of his positions, fearing that the market rise was unsustainable. By early 1929, other personalities like Bernard Baruch and John Raskob were also beginning to do so. This was a warning sign: exit of the smart money.

The unrelenting rise in the US stock market in the 1920s, coupled with ample liquidity and credit, had steadily turned the wheels of speculation. Investment trusts were a popular theme, similar to our unit trusts today, where trust managers used investors' funds to purchase common stocks of chosen companies, thus allowing the small investor to buy a piece of the action of many companies even with his limited capital. Investment pools were formed by traders and speculators who massed their capital to selectively play up (or manipulate) certain stocks and then exit on profits. The market action had reached such a frenzy by 1929 that Wall Street became New York's greatest city attraction, where many members of the public congregated to see the famous personalities; the Morgans, the Mitchells, the Lamonts. Public sentiment has always been a reliable contrarian indicator as well.

Prices actually broke on heavy volume the week before, on a Thursday. A meeting of bankers who pledged market support alleviated the pressure, but the following Monday prices broke again and there was nothing even the big-hitters could do. Major blue chips lost a third to a half of their value in one day. This was Black Monday. As the days progressed, there was to be no respite to the selling, as margin accounts were wiped out and contributed further to the collapse. The market lost half of its value in two months before rallying slightly.

But it did not end there. The early 1930s was a period of rapid economic decline, and in 1932 the country's GNP was 60% of its 1929 value, while unemployement was almost 40%. The public launched witchhunts, a common phenomenon when things turn sour. Bankers were reviled for their perceived lack of integrity in disadvantaging the small investors through their roles in investment pools; monopolies such as utilities came in for scrutiny; the government launched a campaign against short selling.

Some good did come out of all this: the Glass-Steagal Act led to the separation of investment from commercial banking to minimise conflicts of interest; the Securities Act led to the formation of the SEC which regulated stock market practices and protected small investors from being disadvantaged illegally. Over the long term, these have significantly contributed to confidence in the US financial markets.

In the midst of all this, stock prices had plunged to about 10% of their pre-crash values by 1932, as the public came to eschew stocks for bonds. Prices were so low that dividend yield was almost 10% while almost all stocks sold below book value! It led to a 1934 investment classic from Benjamin Graham, the father of modern investing, advocating value investing in stocks.

The economy and stock prices recovered slowly over the mid- and late-1930s, and it took another world war, the resulting need for war production and increased investments, and deferred consumption satisfying itself with a vengeance after the war, for the after-effects of the Great Depression to be fully erased.

References:
(1) Wall Street A History (by Charles R. Geisst)
(1) The Four Pillars of Investing (by William Bernstein)

The South Sea Bubble

2005-06-01T21:36:00.000-07:00

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1720 will be remembered for two great speculative orgies that ultimately left many individuals and companies in financial tatters. One was in France, the Mississippi bubble; the other in England, the South Sea bubble.

The England government had incurred massive debts from wars in previous years, and in order to relieve itself of this burden, it transferred its debt to the South Sea Company which was allowed to sell company shares to members of the public holding the government debt. It was in effect a share-for-debt exchange. The government paid an annuity to the South Sea Company for taking over its debt.

This in itself was an innocuous scheme, and I could compare it to the Real Estate Investment Trusts of today where investors own shares in the property trust which in turn pays them an annual yield derived from property rental income. However, the structure of the South Sea Company's deal with the government was peculiar in that it was allowed to issue a fixed number of shares that could be exchanged for government bonds held by the public. Clearly, the higher the market price of these shares, the more the bonds that could be absorbed by this fixed number of shares. Hence lay the problem: the company had strong reasons to inflate its share price and its strong link with the government meant the latter was not likely to question it.

The share price was bid higher and higher by the public, aided by ample liquidity in the European financial system in 1720 and then by the sheer upward momentum of the price. "Bubble companies" brandishing dubious business plans also sprung up during this time. One cannot help but compare them with the Internet companies during the dot-com boom. Ironically, the whole South Sea induced bubble was ended by a Bubble Act which was actively promoted by the South Sea Company through Parliament, the company clearly believing that these bubble companies were sucking away liquidity that were the lifeblood of the company's share price momentum. Instead, the Act took away liquidity for all players, including the South Sea Company.

The company's share price rose from 130 pounds at the start of the mania to 1000 pounds at its peak and then back to 150 pounds, all within the space of one year. The whole populace was enveloped, from King George on down. One of the most famous victims was Sir Issac Newton, who famously said,"I can calculate the motions of the heavenly bodies, but not the madness of people." Indeed, this episode illustrates fully the ultimate futility of the "greater fool" theory, where people trade up a commodity higher and higher but then suddenly find that when the music stops, they are the ones without a chair.

References:
(1) The Four Pillars of Investing (by William Bernstein)

Tales of the stock market

2005-06-01T09:57:00.000-07:00

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This will be an interesting site, for people can read about market history and interesting anecdotes. Tales will mainly be drawn from books which will be acknowledged, but in keeping with the spirit of my sites I will be deliberately concise in my descriptions.

Sitemap

2005-04-01T20:49:00.000-08:00

Stock Market Tales
Manias/Exuberance

The early-1990s Singapore residential property boom

The 1970s gold bull market

The 1980s junk bond and LBO boom

Boom 1983-99

The Japanese bubble economy of the 1980s

The Dot-Com Boom

The South Sea Bubble

Panics/Depressions

The 1981-2 Malaysian tin market fiasco

The 1980s US Savings and Loan Crisis

The 10 worst stock market crashes in U.S. History

The 1980 silver corner

Black Monday 1987

The CLOB Saga

Enron

The Asia Pulp & Paper debt default

The 1997 Asian financial crisis

Long Term Capital Management

The 1985 Pan-Electric crisis

The 1970s Bear Market

Bear market in 2002-03

October 1929 and The Great Depression

General Interest

The Bretton-Woods Currency System and Its Collapse

The story of Yeo Hiap Seng

A tale of investing on the Singapore market: Mossie

The Singtel story

The 1933 Glass-Steagall Act

Singapore Stocks
Bull Stocks

Crash Stocks

Financial Market Personalities

Wall Street Influentials

Robber barons of the 19th century

Feedback

2005-04-01T05:31:00.000-08:00

Hindsight is 20/20. If you have any general views on this site, please offer your comments here. It will be very much appreciated. Of course, constructive feedback in the form of suggestions on how to improve the site will be better. Of course again, one man's constructive feedback will be an insult to another, so anyway, just feedback!