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Indian IT companies are not fully cognizant of the challenges facing them. There are many forces at work here:
The terms of exchange rate contribution will be adverse. Going forward, I expect the INR to appreciate closer to 35 (INRUSD). The only variable is exactly when. At the moment, financial analysts have lulled the managements into thinking that these levels are not possible in near future. I am not so sure.
Exchange rate will trigger further competitive pressures from global IT majors.
The need for cost cutting and efficiency is driving demand for IT companies. This may not remain as strong as expected. There should be some pressure on margins in this area.
Overall I would be keen to have in-depth session with top managements of Indian IT majors.
I do not see why not. I think households should be allowed to walk away from non-recourse mortgages and no one has any business trying to create social pressure into paying more. Banks and financial institutions have played this as an economic game, no emotions. So why blame individuals when they make economic decisions.
Second, writing debt off is also used as a trick. You write off the debt but hold on the portfolio. Whatever the household pays back is then directly added to the profits. It might seem idiotic, but I have seen banks do it with ill intention.
Third, The written off portfolio is, in some cases, sold to "recovery agents". These agents follow up and try and recover as much from this as possible. In principle this is not wrong. But with inflated loans and deflated incomes this can be harsh.
These steps will impede recovery of consumption in developed countries.
He predicts another year of range-bound behaviour with higher highs and lower lows. I am not sure about the duration but I agree with higher highs and lower lows theory. Further I believe the cycles (high to low) will be much compressed this time around.
Investment Strategy
Katesenelson's investment strategy suggestions are must read for all investors. I would just add that one needs to pick winners/survivors in this crises. This is type of crisis that separates really dynamic companies from sitting ducks. So extra due-diligence is the order of the day.
Vitaliy Katsenelson's recommendation for investment strategy:
In range-bound markets, as P/Es compress they turn against investors; thus investment strategy in this very different and difficult environment needs to be adjusted for the new investment reality:
Become an active value investor. Traditional buy-and-forget-to-sell (hold) strategy is not dead but is in a coma waiting for the next secular bull market to return; and it’s still far, far away. Sell is not just another four-letter word; sell discipline needs to be kicked into higher gear.
Margin of safety needs to be increased. Typically, value investors seek for margin of safety to protect them from overestimating the “E”. In this environment it needs to be beefed up to accommodate the impact of constantly declining P/Es.
Don’t fall into the relative valuation trap. Many stocks will appear cheap based on past valuations, but past secular bull market valuations will not be in vogue for a long time, thus absolute valuation tools such as discounted cash-flow analysis should carry more weight.
Though timing the market is alluring, don’t – it is very difficult to do it consistently. Value individual stocks instead. Buy them when they are undervalued and sell them when they become fairly valued.
Increased margin of safety and stricter sell discipline will lead one to have a higher cash position at times. Don’t invest for the sake of being invested, because this will force you to own stocks of marginal quality or ones that don’t meet your heightened required margin of safety. Secular bull markets taught investors not to hold cash, as the opportunity cost of doing so was very high. However, the opportunity cost of cash is a lot lower during a range-bound market.
There is a lot of talk about return of the USD, specially after Jim Rogers declared that he is long USD. Jim Roger put out a counter trade argument. Simply put, there were too many people betting against the dollar. So no way it will go down right away. There is one more argument!
Exporter push developing country central banks to the wall!
While USD weakness is well known, the developing country central banks are under increasing pressure to manage the exchange rates at current or pre-crisis levels. Entire exporter lobby staff is on just this one task. The thing they don't understand is that US demand is not coming back to pre-Sub-Prime Crisis levels.
I expected this lobbying. But I also expected large exporters to start geographical diversification. This would suggest that exporters are buying time while preparing for new world realities. But there is still no sign of it. I believe, exporters are still in denial!
Currency tango - It still takes two for it!
Central bankers, on the other hand, do not want to be the first developing country to let their currency appreciate. So it will be a game of who blinks first. The usual strategy is such a poker game is to suggest that one will defend the peg no matter what! That is what China has done.
But I would venture they will be the first to act, and they will act decisively. But till that time we are in for holding breath under-water! It is unlikely that anything substantial will happen in 2010 on this front, may be during fall of 2010. One can only guess the impact once currency revaluation sets in. Lord have mercy!
One of my hobbies is to poke holes in stock ideas of analysts. Recently, these talking heads have put out strong buy ratings on Indian tech companies, the likes of Infosys, Wipro, TCS and even Satyam (post scandal). Here is what I need to know before I can be certain of such a trade.
Winning contracts in currency uncertain environment
Indian IT companies have been winning technology contracts from top companies, most recently Walmart. Now imagine a US company that knows USD will depreciate. So how would this impact my sourcing strategy? I, personally, would accelerate all the supplier contracts in today's dollars. Iron-clad them in legal fine-print to mitigate risks from demand collapse and currency fluctuations. The longer such a contract the better it is! Now the question for me is, sitting on other side of this agreement, how have IT companies managed this risks?
The currency risk
This is the most potent business killer, if ever one exists, in Indian IT companies. A lot of analysts have sensitivity analysis ranging from INRUSD of Rs 30/ USD to Rs 50/USD. A few smart investors have already stressed the financials till INR 20/USD and seen the impact. Even smarter investors know that the impact is non-linear in nature. Such currency volatility needs business model innovation (as above) rather than simple currency hedges. The volatility implied in such scenarios may actually test counter-parties in hedged transactions.
Survival Necessities for coming years
Given our current situations, IT companies will have to prepare differently to survive.
Multi-location operations will be an advantage: This implies having robust processes to create and manage scaling issues well. Companies like ones mentioned above are operating in various countries thus helping them react better.
Flexi-sizing will be key: If the currency valuations reach new normalcy, it will be important to relocate manpower to cheaper locations. Companies will have to be quick to rapidly expand, move or lay-off employees. While, all the companies above have what it takes to do it, we should realise it is not an easy process.
A bit more fat! The crisis is upon us and the IT companies are cash rich. The key is to keep higher than normal cash reserves and not fall into the acquisition trap at this early stage.
The best time for investment is not now!
Once the currency crisis hits, there will be more clarity on winners and losers. At that point valuations will be saner and those that survive will definitely give better results. Till such time, I would keep a safe distance between myself and IT stocks.
The way to interpret equity valuation has changed in the context of current crisis. The day CNBC talking heads realize this will mark a new beginnings in the history of mankind.
At some stages, we find same cash-flows being looked upon more kindly (higher valuations). This does not mean that analyst should rework forecasts tampering with cash-flows to retrofit the price and valuation equations. Yet, that is precisely what I am noticing currently. That is bad analysis!
It is the liquidity stupid!
There is ample liquidity in global system at the moment. This money moves across borders, based on whatever reason it deems fit, and lands into a sector or stocks. So the traditional logic of valuation is stretched a bit. Though we don't throw it out of the door. Therefore, watch the global macro in a more meaningful way.
A simple investment strategy
Given the current environment, the best way to manage investments is going back to basics.
We have to find financially robust companies that generate positive cash flows and have lesser leverage.
We then look for managements that have a vision for growth. We are looking for cash-flow accretive growth. So companies with plans to buy market share are out. Growth should be profitable growth.
Thereafter we watch these companies for opportunities to buy. Any correction is opportunity to accumulate.
Exit when the market peaks! Exit is very critical otherwise all profits are paper profits.
Notes and disclaimers
Equity investment is filled with risks so beware. The ideas above are for investors and not for speculators.
Do not construe this as advice to buy at any time. (Timing is critical). These views, though fundamentally sound, are echoed by very few people. So mostly, you will hear very different ideas.
A lot of telecom analyst base their growth forecast on tele-density figures. Tele-density refers to ratio of number of connections to population. It is usually expressed as a percentage. Tele-density determines the upper limit to subscriber growth.
MOU refers to minutes of usage or talk-time of subscribers. “Minutes of Usage” multiplied by Average Revenue per Minute (ARPM) to arrive at Average Revenue per User (ARPU). ARPM has shown a declining trend with respect to time. MOU, therefore, represents growth potential of current subscribers.
The growth potential of any telecom company is a function these two variables. Yet, the concept of teledensity and MOU have not been understood well. A few innovations in the past few years have added new life to both these variables in ways analysts have failed to grasp.
Era of bandwidth Node
The interpretation of teledensity as a cap is remnant of telephone as a voice call device era. This old era represented voice-based communication. We also discovered ways to send data over telephone lines. But this was inefficient. We were sending data over voice networks.
The era has changed and a new era is here. Today, telecom is essentially a provider of bandwidth node at a given location. The question of what to do with this bandwidth is entirely left to market forces. Market forces have deciphered one use of the node through “smart phone technology. Today our networks are essentially dual-mode networks. On the smart-phone or any 3G phone, we have access to a data network AND a voice network. We are no longer sending data over voice network.
So the correct way to look at MOU is in fact, to look at overall consumption of bandwidth. There is no doubt this is only going to go up!
Smart phones boosting data usage
The smart in smart phone is actually in usage of bandwidth tap. The smart phones have, through use of apps, created new uses of data. Further, the presence of 3G implies we are going to listen to move songs and watch more videos on the smart phone. Both these applications are bandwidth-hogging applications.
Overall data requirement of phone user has definitely gone up. And most of the time, data is served by a telecom company. Sometimes, it is your telephone cable connected to a wi-fi modem, other times it is your phones 3G network. As new apps spread, we will have increasing data requirements. So MOU, in terms of overall usage of telecom service will go up. Also, the more connected people are more are voice calls likely!
The upper limit on teledensity
Tele-density has another story. First, there is natural requirement for multiple phone connections per person. In developed countries the number is 2. So we can expect a natural phone penetration limit to twice the population. Further, simply put, there is a potential to connect all the laptops that are in use in the market currently. So the factor of 2 seems pretty understated. Thereafter, anything that is mobile and generates data is a target for embedding a phone connection.
Telecom can definitely cannibalize 50% of the GPS applications. Cars can share location data, engine performance and others. Trucks and delivery vehicles are already using telecom based location services.
Further, it does not take much imagination to foresee new applications. A door viewer that can send photo of visitors is pretty common. Telecom-equipped nanny cams are definitely well accepted. TV set-top boxes can have embedded connections transmitting viewing habits. Buses in Switzerland are already transmitting data about arrival times.
In sum, we can say that older paradigms of Tele-density need to be massively revamped.
It will happen within 5 years
The classical rebuke to these arguments is visibility. Analysts do not foresee such changes happening in near term. I think otherwise. All it needs is right pricing and little bit of imagination. The iPhone, is revolutionary in that sense. It has socialized the imagination part while retaining the basic bandwidth pipe control to itself! I am betting, we will see tremendous explosion in bandwidth consumption in next 5 years and most of this will enrich the telecom companies. That is why I have invested in Bharti Airtel (Bloomberg: Bharti IN).
There is a difference between the recovery rally and the main rally that preceded it. People have started talking about sustainable recovery in equity markets. Still, things are not as they seem. Investors should brace for a rough ride ahead. The rally seems to comprise four phases.
Four Phases of market movement
First phase of secular insanity. In this phase all stocks go up. People ignore the fundamental warning signs. Even companies with questionable managements got sky high valuations. His phase ended with the great crash of 2008. Possibly, what Rob Shiller calls "irrational exuberance" appears to be this stage.
Phase two is essentially over-excitement of the rationalists. Looking at cheap valuations and signs of strength in company performance the rationalists over-extended themselves. Midway, the irrational investors rejoin the party. The phase ends when the cynics join in. We are currently at this stage. I am watching the converstion of cynics. Even this phase ends with a crash. The dimension of the fall now will determine the long term damage to the economy.
Phase three is a placid languishing of the markets at near bottom levels. There is lack of trust and overall cynicism about any future prospects. This is the true bottom. Sweat, sacrifice and prudence regain their respect in this phase.
The hard work in phase three results in growth and proserity that is our final phase. The economy gains traction and with it, a new hope emerges.
Is the crash coming?
President Obama attempted to jump phase three into phase four. For a while it seemed possible. But I do not see the tough choices being made, or vision to take down broken structures. Sadly, we will see our third phase. The time is just about right.
Constant volume asset-backed currency is deflationary Broadly, any asset backed currency - asset availability will determine the amount of money in the system. So money supply will be limited to the extent we can find the asset - here - gold. Now,this is by no means a stable solution.
Store of value v/s transmitter of value The real problem, I believe, is due to design of money. Money was designed as carrier of value not as a store of value. It was designed as a river not as a dam reservoir. The arguments for gold-backed currency stem from "store of value" side and arguments against it originate from "transmission of value" side. Inflation helps transmission but can potentially hinder "store of value" concept. Deflation helps "store of value" but can potentially hinder" transmission" concept.
In sum... I believe these two functions are separate and must not be confused. We need a new design for money - one that can fit in both roles. Will someone open the financial innovation tool-box please? Anyone? Pandora?
Link http://www.webofdebt.com/excerpts/chapter-37.php
I have added an ideapaper detailing how telecom companies find growth. The telecom service provider does not simply grow. These companies transform from voice telephony operators to bandwidth service operators and finally into a holding company for other telecom companies. The following IdeaPaper details those five phases of transformation. I have also given some key characteristics of each phase.
Bharti-MTN deal was example of how both companies were trying to move to phase V of the transformation. As of now France Telecom, Portugal Telecom, Vodafone, Singtel are this phase. I still believe it is too early for Bharti to move to phase V, particularly since there are ample avenues for growth still open to it. Bharti's eagerness to join the club was forced by the fact that telecom is developing globally and soon there won't be many opportunities to get access to subscribers and telecom assets. Anyways the interesting part is how telecom companies find growth.
Further, there are still ways and means to exploit current opportunity for telecom companies. But that is topic for further paper.
I have put together some thoughts on How Cities develop? in the form of an idea-book. Please feel free to download it here.
Introduction
Real estate development in every city is unique. Still hidden within, are certain principles that are common. To understand it, we need to understand two central concepts. First, how town evolve and second how evolution happens within a town.
I propose a seven phase model explaining how a population surrounding a business or factory transforms into a town. Through the transformation we point to some important developments in terms of people and their work.
The idea book postulates a growth model called “Affinity Factor Model” to explain how localities develop within a town. “Affinity factors” are those that drive the citizens towards them – e.g. business district and schools are key affinity factor.
The models help us understand why airports, usually built outside city limits, attract residential populations. Or, on a lighter note, we can guess where a company will locate its office!
We also derive a method to understand relative pricing between different areas. Further, we look at fundamental ideas for knowing if house prices are higher.
I also propose a structure of a township centred around a workplace based on first principles.
Mark Cuban raises an interesting point in his TV everywhere post.
While anti-piracy proponents have a valid point of view, there is other side that needs to be fixed as well. We pay for the same content multiple times. I have bought same song (as part of same or various albums) multiple times.
Anti-piracy movement has one idea to sort out. What are customers paying for? Is it media (CD or DVD or tape or flash drive etc) or the song/serial/movie etc. Then we can ask why same movie can be priced differently on blue-ray disc, CD, or from the web or cable TV. This part is almost never part of the debate.
One of the most intriguing phenomenons during this recent slow-down has been the strengthen shown by non-dollar developed world currencies like GBP, AUD, Yen, EUR etc. I mean there has been correction, in Yen particularly. But it has not been of worrisome magnitude as anticipated.
Most of the developed world currencies are facing very similar problems like US. Consumption driven economy is fed by low-cost debt. Significant percentage of population is old. As the credit crisis struck the demand for good plummeted. The over-all economic model seems weakened just like the US. The only thing stopping a dollar collapse is USD's world currency status. But then why have these other currencies not fallen. Is the USD holding these up?
Real estate developers have been a significant part of value creation for investors. And they will continue to be. However, as times get difficult, it is important to pick the right developers to invest in. While these are logical, they are often ignored in my experience. I present an idea-Book looking into some key ideas while selecting successful real estate developers. Key points include:
I believe first thing a developer must be sensitive to is business cycle. Irrational optimism leads to a fatal failure in preparing for eventual slowdown.
Similarly, land bank quantity, quality and cost determine the future earning potential and growth of the developer.
Developers’ also need an ability to manage through-cycle earnings for the company. In search of quick profits, developers often condemn the company to future revenue de-growth and lower or negative profitability.
Cash flow management and debt structuring is other critical part of real estate business that can make or break the company.
Lastly, I mention some ways in which real estate developers prevent value realisations for the listed entity.
I hope these learning’s will be helpful. These do not comprise the complete list and must be used in conjunction with standard investment and valuation procedures and practices.
Rising asset prices over last few years triggered demand for more hotels. Calculated Risk links to article Hotels: A "Perfect Storm" in San Francisco indicating how the house of cards falls.
Actually this is a perfect storm everywhere for hotels. Too much supply - and more coming online every day. Too much debt. And too few guests.
Where is the demand?
Like most other assets, the fundamental demand for hotel turns out to be far lesser than the supply. The demand is coming from investors. There is huge appetite for investing in hotels, housing or any asset that can be converted into paper and gambled away. This is hurting the industry employee base.
Product prices do not indicate fundamental demand
Just because prices are rising does not mean there if fundamental long term demand in place. Reading the macro factors is just as important for the firm. But, what if you can quickly build out a hotel and sell it to REIT (or other RE fund) at ridiculous cap rates? Partly, this asset price increases actually triggered the boom as I discussed in Feb 08. I cannot see the last buyer still emerging. So till then its going to be painful and hotels will be a case study.
Declaration:
I own Indian Hotels since two years now due to fundamental short supply scenario in India. I am just about marginally positive on the position. I do not intend to close it for few years. Hotel investors looking at India might want to look at Indian Hotels.
Markets around the world are in a see-saw. It is not exactly clear what is driving what or who and to be fair no one really knows. The trading strategies have, therefore, moved to seeking beta.
Volatility Risks high
We are looking at huge cycles in coming months. These will be higher in magnitude and shorter in time frames making longer term commitments difficult.
Picking Survivors
Now long term is more about picking survivors than picking value. Unfortunately old world stalwarts are not always well suited for this. I am not even sure if company like GE will survive this in current form. But then GE is much better off, we are just debating the form!
Premium for alpha investing will increase
Longer term investors will seek increased premium as volatility increases and questions about company health become more aggressive. I would like markets to remain range bound at lower end of the range for at least 2 quarters. That might signal some hope of recovery. Current movements are too swift (time) and too strong ( changes are high between weeks). Possibly its just residual froth.
