Investing in Growth Themes Part 1

Technology appears to have made a strong come-back after years of investor neglect, epitomised by Apple's meteroic rise from US$80+ in early 2009 to US$350 currently, a rise of over 300%. Apple's success has been attributed to its strong product offering, beginning with the iPod, then iPhone and more recently, the iPad. Apple fans will wax lyrical over the superiority of Apple's products, and long queues which form at each new product launch is possibly a testament to the fanatical respect the company commands from technology product users.

At its current price, Apple's market capitalisation is about US$320 billion, and few companies are larger. Google Finance puts Apple's historical PE at 16.72X, not an expensive multiple of earnings, while the company's latest earnings blowout suggests that valuations are likely to fall further, should the company's explosive growth continue. Also, the macro-picture for Apple appears extremely favourable, considering the huge shift towards mobile computers like the iPad. Coupled with the relatively untapped emerging markets, the growth possibilities are enormous. Is Apple the sure-fire way to tap on an unstoppable growth theme? 
 
Before we get ahead of ourselves, history offers an alternate opinion. The automobile was a revolutionary invention which changed the way people travelled. However, few investors made money investing in this "sure" trend, and the 2008-2009 crisis even saw the collapse of the "venerable" General Motors, a member of the Dow Jones Industrial Average since 1915. Many automobile companies have collapsed, leaving investors much poorer, even though the industry has boomed (if the number of automobiles on the roads is a measure of the industry's success). Warren Buffett has been quoted to say that the best way to invest in the automobile industry would have been to short the stocks of horse-drawn carriage companies.
 
Similarly, the airline industry revolutionised long-distance travel, but investments in airline companies has been generally fared poorly in comparison to the growth in the sector. Engine and aircraft manufacturers were the beneficiaries of the sector's boom, while the airline operators saw shrinking margins as competition intenstified. Many airlines also went bust despite the astronomical growth in air travel over the years.

What does this tell us about investing in the next major growth trend? We could take an appathetic approach and ignore the growth trend (which has not generally not resulted in poor investment returns, if one considers both the airline industry as well as the automobile makers). Alternatively, we could seek investment opportunities that ride on the trend - we are looking for the horse-drawn carriage companies to short, the Boeings and Airbuses which benefit  directly rom a trend, but maintain pricing power, or the indirect beneficiaries like the Exxons and Shells, which drill and refine oil needed to power the increasing number of vehicles on the road.

Given all this, how then does one ride the growth trend of "portable new media"? We will highlight two themes that may benefit from this growth trend in our next post.    

Sino Techfibre - Fraudulent Fire?

Last Thursday, Sino Techfibre announced that a fire broke out at an office which did not affect any staff, but unfortunately destroyed books and financial records (see http://info.sgx.com/webcoranncatth.nsf/VwAttachments/Att_8CBAFFB20622E74A4825787900509C58/$file/Sino_Techfibre_Announcement_210411.pdf?openelement).

How convenient. The company's stock was halted for trading on 13 April, after auditors raised issues over the legitimacy of invoices. Now, the financial records to "verify" those invoices (likely to be "receivables" on the company's books) will most probably be lost in the fire, rendering an audit impossible.

This latest incident only serves to highlight the poor quality of S-Chips listed on the Singapore Exchange, something which has kept us from investing in the sector despite having bombed-out valuations. When balance sheets cannot be trusted, it is impossible to ascertain the true value of a company, and the track record of the sector in terms of corporate governance has been attrocious. In academic terms, the "risk premium" attributed to an investment in the S-Chip sector should be extremely high, which goes a long way in explaining the ridiculously-low valuations of most companies in the sector. We sympathise with investors who have fallen prey to these poorly managed companies and will continue to seek value opportunities outside of the S-Chip sector.
    

Further pain in the S-Chip sector; China Hongxing and Hongwei both suspended

Both Hongwei and China Hongxing are set to be suspended, following audit issues "regarding issues pertaining to the cash and bank balances confirmation" for Hongwei and "irregularities in the cash and bank balances, accounts receivables, accounts payables, and other expenses during the course of their audits of its subsidiary companies in the People’s Republic of China (“PRC”)" in the case of China Hongxing. Ernst & Young are the auditors in both cases.

We have highlighted our concerns over S-Chips in the past (see http://sgvalue.blogspot.com/2010/09/looking-at-cash-balances-of-s-chips.html and http://sgvalue.blogspot.com/2010/06/s-chipped-reprise-2010.html) and the latest audit problems in the case of Hongwei and China Hongxing serve to showcase that S-Chip companies are indeed poor quality companies which cannot be assessed based on balance sheet strength alone. We do not own any S-Chips and will continue to adopt a sceptical approach towards the sector, which is fraught with fraud (pun not intended). 

SGX to merge with ASX, to take on debt

SGX has announced a takeover offer for ASX which will see each ASX shareholder receiving a mixture of cash and shares in the new combined entity.

Under the terms of the Scheme, ASX shareholders as at a record date to be determined will be paid, in relation to each ASX Share, a combination of:
• A$22.00 (approximately S$28.04) in cash (the “Cash Consideration”); and
• 3.473 new SGX Shares (the “Share Consideration”).

The aggregate value of the Share Consideration is S$5.8 billion (approximately A$4.6 billion), based on the last traded price of SGX Shares as at the Latest Practicable Date, and S$5.8 billion (approximately A$4.6 billion), based on the volume-weighted average price (“VWAP”) of SGX Shares transacted on the Latest Practicable Date.
Accordingly, the value of the aggregate consideration payable for the Proposed Combination (the “Scheme Consideration”), based on the aggregate Cash Consideration and the aggregate value of the Share Consideration (determined by reference to the last traded price of SGX Shares as at the Latest Practicable Date), is approximately A$8.4 billion (approximately S$10.7 billion), or approximately A$48.00 approximately S$61.17) for each ASX Share.

The value of the Scheme Consideration based on the aggregate Cash Consideration and the aggregate value of the Share Consideration (determined by reference to the VWAP of SGX Shares transacted on the Latest Practicable Date), is approximately A$8.4 billion (approximately S$10.8 billion).

The move will see SGX coughing up about S$4.9 billion in cash, which will inevitably see the combined entity take on between S$3-4 billion in debt. Depending on the cost of debt, we estimate that interest could cost SGX as much as $150 million a year, which will eat into earnings (and dividends!).


We have maintained that SGX looks terribly expensive at current levels, and it is fantastic that management can utilise the expensive stock to purchase a choice asset (ASX in this case) to benefit shareholders. However, the deal would have made much more sense if an all-stock offer was utilised. By offering cash and taking on debt, it appears that the EPS-accretion (as SGX touts the deal to be, EPS of $0.3008 to $0.3612) will be difficult to achieve after factoring in interest payments.

Asset bubbles forming in Asia? Not yet, but early indications are there

We have talked about the potential for asset bubbles forming in the Chinese property market, highlighting that as a key risk to global stock markets. The potential problem appears even more dire, with Asian (and EM) assets the likely beneficiaries of waves of liquidity flowing out of developed markets.

The current situation: while developed economies (most notably the US) are required to keep interest rates low to stimulate their domestic economies, the emerging markets (and Asia in particular) are booming once again. Output is at record-high levels, while consumers on the ground hardly feel the recessionary chill of the Western world.

A quick look around us in Singapore emphasises this: Bustling car showrooms, packed shopping malls, an extremely tight labour market (a JobsDB email I receive daily highlighting jobs in the financial sector is noticeably longer, compared to a year ago). The IPO market is booming once again, with the latest IPO of GIobal Logistic Properties 12 times subscribed, and Mapletree Industrial Trust set to join in the fray. These are all indications that sentiment is turning positive again, with the STI recently climbing to new 2-year highs. 

With Asia and Emerging Markets the obvious forerunners in the post-Lehman world, investors in the US are more than happy to borrow at near-zero rates to participate in the tremendous growth opportunities in the emerging market regions. The expected appreciation of Asian currencies is an added bonus, and also the result of strong inflows of capital into the region. Singapore recently tightened monetary policy further, which will add to upward pressure on the SGD against the USD.

As with all asset bubbles, the flight of capital will be swift, and many investors will be left nursing their wounds in the aftermath. Fortunately, stock market valuations still appear fair at the moment, despite the onslaught of new capital inflows from the West into Asia. Several segments of the Asian stock market appear slightly expensive (Indonesian and Indian equities, consumer discretionary stocks in China and India, as well as hospitality/leisure plays in Singapore), but the overall market is generally fairly valued at present. We will maintain our exposure to the stock market within the portfolio, but will be keenly watching out for bubble-like symptoms which we expect to develop at some stage over the next few years.

Foreclosed Homeowners Break Into Former Home

CNBC.com Article: Foreclosed Homeowners Break Into Former Home

The investors sold the home, but before the new owner could move in, the Earls had the locks changed and moved back in themselves. "Why should we lay down?" she says her husband asked her. "We need to fight back."

Full Story:
http://www.cnbc.com/id/39726698

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Foreclosure woes have hit US bank stocks (and notably our holding in WFC) as investors worry that banks will have problems evicting homeowners due to a lack of proper paperwork.

It appears ridiculous that some homeowners believe they should be allowed to stay in their homes after failing to service their mortgages, on the basis of legal technicalities. If the courts ultimately rule that banks cannot foreclose the majority of properties due to improper paperwork, we may be looking at mass mayhem. Why should anyone pay their mortgages then?

More likely, some punitive action will be taken on improper bank practices. People who have borrowed money to buy a home MUST service their mortgage; there is no free lunch here 

Looking at cash balances of S-Chips just ain't enough

A recent examination of the US technology sector's huge cash balances highlights an interesting parallel with locally-listed S-Chips. The connection? Cash balances aren't what they appear to be. What does this mean?

A recent comment by Vitaliy N. Katsenelson suggests that Microsoft's debt issuance makes zero economic sense, as the company has approximately US$39 billion in cash and short term securities on which it is earning lower interest that what it pays for newly issued debt. The move appears to be destroying shareholder value by increasing interest costs without any apparent benefit to the company. Or is this so?

• $1 billion of 0.875 percent notes due Sept. 25, 2013

• $1.75 billion of 1.625 percent notes due Sept. 25, 2015

• $1 billion of 3.000 percent notes due Oct. 1, 2020

• $1 billion of 4.500 percent notes due Oct. 1, 2040

"Microsoft intends to use the net proceeds from the offering for general corporate purposes, which may include funding for working capital, capital expenditures, repurchases of stock and acquisitions." - Microsoft.com

Now why would a company with almost US$39 billion at its disposal need to raise US$4.75 billion to fund things like stock repurchases? The answer may lie with the location of the company's cash balances - a significant proportion of Microsoft's cash may be offshore (ie. not in the US), and repatriation of that cash back to the US could induce substantial taxes. So by raising additional capital from the bond market (which sports extremely low interest rates by the way), Microsoft is able to fund things like dividend increases and share buybacks without having to repatriate cash from overseas subsidiaries. In addition, based on balance sheet strength, the company's financial position is hardly impacted by the bond issuance, given its huge (theoretical) cash horde. 

Now, how does this relate to S-Chips? We have seen various instances of S-Chip companies which have cash holdings in excess of their debt (most are usually debt-free), and even after paying off their liabilities, the company still has a cash balance which even surpasses the company's market capitalisation. On that basis, the company can theoretically purchase all its outstanding shares with its cash holdings, leaving the management with full ownership of the company at no additional cost. Now why have we not seen this happening?

A 5 Jan 2010 announcement by one of the S-Chips (China Milk) may offer some clues:

"The Board wishes to advise that the Company is still currently awaiting clearance from the State Administration of Foreign Exchange (“SAFE”) of the People’s Republic of China (the “PRC”) for the remittance out of the PRC of approximately US$170.56 million, being for the full settlement of the Early Redemption at the Option of the Bondholders (including interest). The Company believes the delay is administrative and procedural in nature and there is no legal obstacle to the remittance of the same.

  

China Milk was in default of its convertible debt obligations to the tune of approximately US$146 million in early 2010, and with the company yet to resolve this issue, the stock still remains suspended today. The company had a rather strong balance sheet, with sufficient cash to repay its impending puttable debt obligation. The company's bonds even traded above par prior to the default, suggesting that investors believed the company would be able to redeem the bonds.

However, facing remittance issues, China Milk has yet to settle payment with bondholders, which sends a strong message to investors who are looking for S-Chips which appear cheap based on their balance sheets. The cost (and difficulties) faced with remittance of cash held offshore may mean that cash balances on balance sheets are not what they seem. Some of this cash balances may never be able to fund a share buyback programme, or a hefty dividend payout. Sometimes, a dollar in hand (or in this case, held onshore) may be worth more than two in a bush.

Jardine Strategic, the one that got away

Investment and emotions tend to get mixed, ultimately resulting in poor investment decisions. Our experience with Jardine Strategic is a case in point:

We sold the stock in June as the stock floated around new record highs, despite the generally weak market sentiment at the time. Our investment thesis was that market technicals were weak and we were more comfortable holding a larger cash position to capitalise on temporary weakness in the market.

The stock did slump temporarily thereafter, providing a short window of opportunity to re-enter (which we failed to do), and then rocketed out of reach.

What went wrong?

We unfortunately let our emotions get the better of us, and the urge to take profit on a stock in a slumping market was too tempting to resist. We failed to relook our investment thesis for the stock (which was a compelling buy despite being at a record high), and we ended up selling an extremely high-conviction stock idea. We also had no predetermined re-entry target price, which meant that we failed to load up when the stock declined.

A mistake which we will try not to repeat:

• Never sell higher conviction ideas; always start with the lowest conviction stocks

Even now, we would be hard-pressed to find a compelling alternative to one of the Jardine holding companies, which allow exposure (at a discount still) to their stable of blue-chip franchises. Would we buy the stock at this time? The stock is already one of the best-performing stocks in the STI YTD, and cliched investment mantras relating to chasing hot stocks spring to mind. Patience is a virtue when it comes to investments, and we may prefer to wait for the next crisis (which could be years later!) to time our entry into the stock.

U.S. Banks: Goldman Sachs Lowers Targets for Bank Earnings - CNBC

U.S. Banks: Goldman Sachs Lowers Targets for Bank Earnings - CNBC

Bought 150 more shares of Wells Fargo & Co. on 20th Aug at US$24.3899 per share, for a total consideration of US$3,658.48. The stock is trading near its 52-week low and also near book value on the back of recent market weakness. WFC has been exceptionally battered, with Goldman Sachs recently citing "higher-than-average" yields on its security portfolio, which are expected to normalise over the next few years (to half the current 6+% yield). While this may be alarming news, the actual numbers are less dramatic. Based on the 2Q10 financial statement, about US$16.2 billion of securities in WFC's portfolio were earning excessively high interest of 6.48%, an insignificant percentage  (just 1.5%) of WFC's total "earning assets" (US$1.069 trillion).

"S-Chipped" (Reprise) 2010

The latest Fujian Zhenyun saga is a saddening reprise of the many blow-ups which occured in the S-Chip space in early 2009. FerroChina, Fibrechem, Beauty China, Sino-Environment, Oriental Century, Celestial Nutrifoods, China Milk and China Sun are just some of the troubled companies which have run into trouble, and have since been suspended (or are pending delisting).

Earlier in 2009, S-Chips fell like flies, succumbing to a mix of fraud/accounting irregularities, an inability to meet liabilities or in several cases, the forced sale of shares which had earlier been pledged by a major shareholder of the company (and yet, not disclosed to the Exchange).

An Early Warning in September 2008

In what was to be one of the most timely warnings issued by a brokerage, JP Morgan actually released a report dated 18 September 2008 where 21 S-Shares with a market cap of over US$200 million were screened for potential warning signs - just eight passed without any warning bells (Cosco Corp, Yanlord Land, Delong Holdings, People's Food, China Fishery, Hsu Fu Chi, China Aviation Oil and Epure Intl). Interestingly, all eight are "alive" and relatively healthy today (Delong Holdings appears to be doing the worst, but it was never a great business to begin with, in our opinion).

A 30% hit rate!

The other stocks flagged by JPM were Yangzijiang, China Hongxing, Li Heng Chemical, Centraland Ltd, FerroChina, Synear Food, China Sky Chem, China XLX Fertiliser, Fibrechem Tech, China Milk, Pacific Andes Hldg, Celestial Nutrifoods, Midas Holdings. While some of these 13 stocks have not done too poorly since (YZJ, XLX, Midas), it is shocking that JPM's simple analysis of potential warning bells managed to spot 4 troubled companies (FerroChina, Fibrechem, China Milk and Celestial Nutrifoods), a "hit rate" of over 30%! FerroChina shares were actually suspended in October 2008, less than a month after the report emerged.

DBS Vickers states the obvious

As S-chips continued to implode in early 2009, owning S-chips was akin to stomping around a minefield. If you were lucky (and your company wasn't the one in trouble for any particular day), you merely had to suffer collateral damange as investors fled from the sector (and who can blame them!). A (largely redundant)12 March 2009 report by DBS Vickers ("Navigating a Chinese minefield") only served to rub salt into bleeding wounds; the damage had already been done! Former market darlings like Beauty China, Fibrechem Tech and Sino-Env had already run into trouble by then, while the Celestial's inabiltiy to meet impending liabilities from its putable convertibles was already well-documented by then.

Avoiding the S-Chip space

Our familiarity with most of the S-chip names comes from having actually being invested in a handful (yes, a handful!) of them at some point of time. Naively, we took balance sheets and accounting statements at face value. Low single-digit PEs, net cash exceeding market capitalisation, book values exceeding market value by several multiples - we interpreted this as a buying opportunity of a lifetime. It was indeed a tremendous buying opportunity, but not in S-Chips.

When one is unable to trust financial statements and the management's integrity is suspect, we see absolutely no reason to seek out opportunities in the S-Chip space. While we scrutinise balance sheets to assess financial integrity of companies we invest in, we remain cognizant of our limitations (little or no accessbility to company management). Therefore, most of our investments are in larger-cap established companies where corporate governance is not an issue. For our smaller-cap investments, we prefer to avoid the S-Chip space completely, and prefer to choose companies incorporated in Singapore.

"CONFESSIONS of a S-Chip CEO" is lengthty, but essential reading for those who still seek investments where many fear to tread. Whether the letter is real or a fake is a moot point, but it serves as a warning that in the financial world, money can be made in zero-sum games of financial innovation, and investors will do well to avoid being the patsy in the poker game.

 

Sold SGX, a quarter of the portfolio in cash

Singapore Exchange Limited (“SGX”) wishes to announce an investment of $250 million in technology, comprising $70 million for a new securities trading engine and $180 million for infrastructure outsourcing services and data centres, collectively known as the Reach initiative. The investment of $70 million was previously announced by SGX on 4 March 2010.

The investment in the Reach initiative is to create the fastest access to Asia by implementing a new high-performance trading engine, a state-of-the-art data centre, as well as introducing co-location services to its customers. The Reach initiative also includes establishing presence at key data centres in Chicago, London, New York and Tokyo. The infrastructure outsourcing services will enable SGX to benefit from improved access to technical capabilities, implementation of enhanced processes and comprehensive infrastructure management tools. (3 June 2010)

We sold SGX (finally!) at $7.28 today, bringing the portfolio's cash level to almost 25%. We actually bought SGX at around the $4+ level in mid-March 2009, in the belief that the company (and its stock price) were sure beneficiaries of a market recovery. The stock's returns have been decent since, but we see little upside from current levels, despite the hype over the new $250 million trading system which promises to boost revenues. The exchange expects additional annual recurring expenses of $12 million due to this new system, which is paltry compared to the $200+ million operating expenses SGX racks up every year, but we are sceptical that the new trading system will actually provide a substantial boost to revenue.

The problem we have with SGX is that growth for the exchange is difficult to create. The new CEO, Magnus Bocker, is pulling out all the stops to try to increase revenue, and the latest $250 million investment represents a foray into algorithmic trading, which Mr Bocker hopes will drive trading velocity in cash equities trading. In our opinion, it will be difficult to induce algorithmic traders into providing liquidity for a large number of stocks listed on the exchange - either due to a low free float or a distinct lack of buying interest. The small market capitalisation of many counters also compounds the problem. More likely, algorithmic trading will be focused on the usual suspects (the market darlings which adorn the daily top volume list) and some of the larger capitalisation companies. Traders need other buyers and sellers in order to make money, so why focus on low investor interest companies where they have to make a market to induce buyers? As has been the case in the past, higher velocity and investor interest in a select group of stocks will likely drive investors away from others, more like a zero-sum game.

Moreover, Singapore's positioning as a financial hub (and "Asia's exchange") remains in question, given that Hong Kong already enjoys tremendous levels of trading volume. Much of this stems from Hong Kong's proximity to China, whose citizens possess tremendous household wealth. Hong Kong is already facing stiff competition from the Shanghai exchange, and going forward we expect to see Shanghai obtain a more-than-fair share of new large-cap listings. What does this leave SGX? Zilch (except for numerous poor quality third-tier S-Chips).

SGX's monopoly status looks safe at present, with its infrastructure setup preventing other players from quickly stealing market share in the local market. However, with the limited growth from local retail investors, SGX is looking overseas for growth. While this could be a way to boost revenue, SGX already charges one of the highest clearing fees in the world, and there could be downward pressures on pricing, reducing margins. The ASX has recently announced lowered fees as a result of the entrant of new competitors, which could be something that SGX may face further down the road.

Sold Jardine Strategic, market technicals unfavourable

We sold our shares in Jardine Strategic today (500 shares at US$21.22), despite the much anticipated sell-off in the stock market following huge losses on Wall St last Friday. Nonfarm payrolls were poorer that expected, renewing fears that the recovery in the US isn't going to plan. Also, a curious statement from Hungary's ruling party indicating that Hungary would go the way of Greece in terms of its debt problems further fuelled investor worries.

As we have described in a previous post, European debt problems are unlikely to simply disappear, and the likely result would be a sovereign default by one or more European economies. We have yet to see a selling climax, despite the sharp YTD falls in some markets.

While we reiterate that valuations are attractive for the stock market in general, we have to acknowledge the unfavourable market technicals - the Dow Jones and S&P 500 have both fallen below their 200 day moving averages, and the moving average now appears to be a resistance for both indices. With such bearish market technicals coupled with the fact that we have yet to see the market capitulate (or a failure/near-failure of one or two European banks), we have little choice but to err on the side of caution. With our sale of Jardine Strategic Holdings, we have raised the cash level of the portfolio to about 19%. We will also be looking to dispose of SGX to increase cash to about a quarter of the portfolio.

There is a good chance that we may be wrong in our reading of the market, which is why we will remain largely invested, but our larger cash holding will help us to buffer risks to the downside, and will be a useful source of ammunition should distressed opportunities appear.

Liew Mun Leong eats his own cooking

Capitaland CEO Liew Mun Leong has purchased a unit at the Interlace for $3,737,500, while his son has also purchased a $2,467,000 unit in the same development. A discount was not announced for both transactions.

Mermaid Maritime extends contract for MTR-2

Mermaid Maritime (a beleagured performer in our portfolio) today reported an extension of its MTR-2 rig's drilling contract with Chevron in Indonesia. The rig was originally contracted until June 2010, and the rig's services have been extended for another 9 months. The company cited a potential contract value of US$24.5 million, which works out to about a US$90,700 day rate, up slightly from the US$88,814 gross day rate for 2009.

While the day rate was not up substantially, it is comforting to know that Chevron's contract has been extended. MTR-1 remains a disappointment, having not secured any work since September 2009, and the 6-month lull period anticipated by the management has been too optimistic a scenario. However, a third rig (KM-1, 75% owned by Mermaid) is slated for delivery this year (after originally scheduled for a 4Q 09 delivery), and will be contracted for 5 years drilling for Petronas.
 

WBL's 1H '10 profit up 93% to $40 million, declares 5 cent interim dividend

WBL Corp recently announced 1H '10 earnings of $44.4 million ($40.2 million recurring), up from $12 million (after an $8.8 million non-recurring loss) in 1H '09. The company's prefered measure of earnings is operating PATMI (Profit After Tax and Minority Interests), a measure of recurring income to common stockholders.

One-off gains transpired from the disposal of some buildings under Starsauto/Wisma O’Connor’s /Wearnes Electronics Shenyang (+$4.3 million), the provision and disposal of investments under Property Management Co./ Sanguine Microelectronics/Advance Science Lab (+$0.6 million) and the cessation of Starsauto/Kunming Speedling (+$0.8 million). A planned plant closure related to MFLEX's operations in the US resulted in an asset impairment of $1.5 million.

The property business division was the largest PATMI contributor in 1H '10 ($21.2 million), but 2Q '10 profit from property was just $6.5 million, was fewer units were made available for sale in Shanghai and Suzhou. The Chengdu Orchard Villa which was launched in 1Q 10 saw higher sales.

As we have previously highlighted, the Chinese property market has demonstrated speculative tendencies, especially in tier-one cities like Shanghai (where WBL has a presence), and the Chinese government has clamped down on excessive rises in prices by implementing a series of new property regulations. This has had an impact on WBL's Shanghai property sales, but this may also be due to fewer releases of units in response to the Chinese government's actions. Whatever the reason for the drop-off in property revenue, we are glad that our exposure to Chinese property is via a diversified business like WBL's, whose fortunes are not predicated by a strong property market, and can afford to hold its landbank until market conditions improve.

Euro-led slow down, tensions in Korea, can it get any worse?

The STI lost 2.7% today, falling to 2651.19, at the lowest level since early November 2009. Current investor worries (in decreasing order of importance) are:

1. A Euro-led global slowdown, leading to a double-dip global recession
2. Issues related to the Euro area: a potential debt default by one of the PIIGs, a break-up of the Euro-zone, uncertainty over European bank balance sheets, systemic meltdown of the global financial system (ie. Lehman's 2008 failure)
3. War breaking out on the Korean peninsula
4. Chinese asset bubble/tightening worries
5. A (largely benign) financial reform bill being passed in the US, and perhaps, the potential impact of Basel III on financial institutions

While stock markets have corrected severely from their April highs, most (if not all) major stock markets have recently broke through their 200-day moving averages, a rather bearish indication from a long-term technical perspective. We would rather not commit more new funds at this juncture, as the technicals are suggesting further downside but post-correction valuations look rather appealing for many stocks we are watching. 

We can hardly think of any potential positive news which may provide the investment community with a shot in the arm at this juncture (especially to alleviate problems 1 & 2), so any impending rebound will largely be the results of technicals (and the technicals hardly look favourable now!). Given that we are currently short on "powder", we want to keep some dry in anticipation of a major capitulation in the stock market. Investor sentiment is largely negative now which means that we may be approaching the point of capitulation, but we probably need to watch for some of the following to occur:

• Sell-side analysts need to turn very bearish (consensus estimates for most markets are still on the rise)
• GDP estimates need to be revised downwards (like market earnings estimates, still on the rise)
• A "haircut" taken by holders of PIIGs debt, possibly beginning with Greek debt

As austerity measures face significant protests, it is increasingly likely that the country's creditors will have to take a hit. When this happens (we think the market is not yet pricing this in, given the euphoria over the ECB/IMF bailout package), the market could suffer an even larger decline. As has been the case in various financial crises, the failure or near-failure of major financial institutions often mark the market bottom. In the current issues with Europe, the marking down of Greek, Portuguese or Irish debt by European financial institutions could mark the climax of a market capitulation, in which we would be very happy buyers of quality companies which are also sold down in the fray of madness (despite their seemingly lack of association with the troubles of the European economy). 

We continue to like and own Wells Fargo, and are well aware that any negative sentiment on the financial sector will undoubtedly hurt the stock. Nonetheless, the company's strong fundamentals, low (and stable) cost of funding, and prudent management render the company an attractive investment, separating it from its peers. 

   

Third Avenue Management LLC nominates WBL director

 SGX-listed WBL Corporation Limited (Wearnes) – an international conglomerate with key businesses in technology, automotive, property and engineering & distribution – today announced the appointment of Benjamin C. Duster, IV, Esquire, as Non-Executive and Non-Independent Director with effect from 19 April 2010.

Mr Duster is currently Executive Managing Director of Watermark Advisors, LLC, a US-based strategic advisory firm specialising in mergers and acquisitions, private capital raises, strategic valuations and financial modeling. Prior to this, he was with Masson & Company, LLC; Wachovia Securities, where he was Managing Director; and Salomon Brothers, where he worked for 16 years. Currently Chairman of the Compensation Committee of Toronto Stock Exchange-listed pulp and paper producer Catalyst Paper Corporation, Mr Duster has also chaired various board committees of companies listed in Canada, New York and Poland. Mr Duster holds a Juris Doctor-MBA from Harvard University and a Bachelor of Arts (cum laude) in Economics from Yale College. He was admitted to the Illinois Bar in 1985 and is a registered representative of the National Association of Securities Dealers.

Mr Ng Ser Miang, Chairman of Wearnes, said, "The Board welcomes Mr Duster, who brings with him a wealth of experience in the legal, corporate finance and corporate strategy & development aspects of many global businesses. His domain knowledge, international perspectives and cross-border network will be added assets to the Group." 

"Mr Duster is nominated by Third Avenue Management LLC, a substantial shareholder of the Company. The Nominating Committee of the Company reviewed his nomination and based on his qualifications and experience, recommended his appointment to the Board of Directors. "

Considering that Third Avenue Management owns 17.47% of WBL Corp, it is a positive indication that the investment firm has nominated a director on board. WBL has a huge asset base, but it may take some experienced "prodding" to realise some of this value.

Gloucester-Macarthur merger: Noble shareholders vote "No"

19 April 2010, Hong Kong


"Noble Group wishes to announce that the merger proposal between Macarthur and Gloucester was soundly defeated by shareholders in a vote held in Hong Kong at 2.30pm today."
 

The Noble-Peabody-New Hope tussle for Macarthur Coal took another strange twist today, as Noble shareholders voted down the merger of Gloucester and Macarthur, a deal which would see Noble own almost a quarter of the new entity. Considering that the proposal was "soundly defeated", this strongly suggests that Noble's management has other plans in mind (Richard Elman's trust still owns a controlling stake while CIC would not jeopardise the company's expansionary plans, not after acquiring such a substantial stake).

 

Certainly, after being so close to sealing the deal, there is no way that Noble will give up Macarthur (and its assets) so easily, and the voting down of the proposal simply indicates that a new strategy is in place, perhaps a hostile one. Noble owns 30% of Middlemount Mine, a significant asset in the Macarthur portfolio of mining assets, and has the option to raise this stake to 50% for A$100 million. Also, Noble owns 10% of the Monto project, of which Macarthur remains the majority owner. There could also be options attached to Noble's stake in Monto, which upon exercising could reduce the attractiveness of  Macarthur to Peabody (Noble highlighted its interest in both projects in a warning note directed at Peabody on 5 April, saying its quiver is "far from empty").

 

We look forward with great excitement to see what Noble has up its sleeves in this game of M&A chess.

Sharebuilder purchases for today (19 Apr 2010):
32 shares of STI ETF at $2.9989, 20 shares of Fraser and Neave at $4.84

Euphoria, but not in the stock market....yet

As we approach the 3,000 point barrier on the STI, a key question arises- is the stock market peaking? If broad-based sentiment is any indicator, we are getting close. Some troubling observable indications:

• Skyrocketing COE prices (but maybe just a manifestation of the "kiasu-ism" on the reduction in availability) 
• An increasingly excited domestic property market (just count the huge number of ads in the Saturday edition of the Straits Times)
• A huge number of IPOs (11 so far this year, and we're only in April)
• High over-subscription for IPOs (CACHE's placement tranche was 7.2X subscribed, while the public tranche was about 20X subscribed)
• A disconnect between large cap and small cap stock price movements (small cap stocks have recently found favour)

We do not profess to be excellent market timers, but these indications may be seen as "early warning signs". Nevertheless, we note that the largest gains are often had at the later stages of a market rally. Moreover, valuations of the stock market in general does not appear too stretched, which suggests that an impending sell-off (if any) may not be too substantial. We invest for the long-term, and as long as valuations of our holdings remain reasonable, we are reluctant to sell core parts of the portfolio based on any perceived notion of where the general stock market is headed. 

We will be looking to trim positions in non-core holdings should the market display signs of "irrational exuburance", but current conditions are hardly euphoric yet.

Bill Miller of Legg Mason Value and the "collateral-driven" banking crisis of 2007-2009

I had the privilege to hear from legendary fund manager Bill Miller last week at the Ritz Carlton, where Legg Mason held an investment forum. Bill Miller's Legg Mason Value fund is most famous for having beaten the S&P500 for 15 consecutive years. Unfortunately, Bill has been in the news more recently in 2008 for his then-disastrous bets on financial institutions (some may recall the comparisons made with Bill Gross of Pimco, who placed bets on the debt of Freddie Mac and Fannie Mae, while Miller held the stocks. The government's bailout immensely benefited the debt holders of these enterprises, while shareholders took massive hits).

While he "returned to form" with an outperformance of the S&P 500 in 2009, his explanation of how he incorrectly read the recent financial crisis was far more poignant for some in the audience (like myself). He talked about how the 2007-2009 banking crisis was a "collateral-based" problem, while the 1987 crash was precipitated by a "liquidity" problem. He bought financial stocks when the Fed first injected liquidity in 2007, a grave mistake as the crisis was collateral-driven, which meant that the assets backing the deposits held by banks were actually turning sour, resuling in bank capital continuing to shrink until the prices of the colletaral (sub-prime, mortgage backed securities etc.) were actually propped up to prevent further falls. This only occurred in early 2009, which was the perfect time to be buying bank stocks.