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Posted: 3 May 2012 - 0 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
Category: Research

Aswath Damodoran, finance professor at NYU’s Stern school, has some nice words here on two topics which I see as interrelated. Firstly, he looks at the dictatorial tendencies of the Google executive team, then he delves into “Governments and Value”. What interests me is that the new-age ecosystems of Google, Apple and many imitators are philosophically rather like the state systems whose cycle time at the apex seems to be ending. The wwweb is rendering the current business model of today’s state “I will take part of your money in return for part-underwriting your physical safety and some infrastructure to allow you to learn, move and trade. And you get some kind of a policy say in periodic votes” irrelevant at varying tempos across the globe.

So will the new world order – “place your product/app on my shelf and I will take X% (30?) for maintaining a tech. ecosystem in which the value of your app can be accessed and monetized on unimaginable scale” in truth be any different? Better? Worse?

Worth a passing thought, as a corporation like Google has astutely fashioned a bizarrely low tax rate for itself in the US…

Anyway, here first is Aswath’s piece on Google, (with my emphases in bold, and extracted here for the rushed):-

…Stock splits and stock dividends are empty gestures from an intrinsic value standpoint because they change none of the fundamentals of a company…

…I would find it odd that a company that just reported good growth in earnings and dividends would use a stock split as a signal. In fact, I am looking forward to seeing the full filing. Perhaps, there is “bad” news hidden behind the healthy growth that Google does not want me to pay attention to…. shares that will be created in the split will have no voting rights…

…Brin and Page think that you (as stockholders) are too immature to know what’s good for you in the long term, and they want to make these decisions for you…

…In fact, what the stock split signals (to me) is that Google is planning more controversial (and debatable) big decisions in the future and they do not want to either explain these decisions or put them up for a fair vote. …

…karmic view of corporate governance…

…Facebook being the most prominent recent member of the “spit in your stockholder’s face club”…

Google splits its stock and spits on its stockholders


I have talked about Google in prior posts on its
 voting share structure and the increasing cost it ispaying for maintaining growth. Well, the company had a big news day yesterday, starting with an impressive earnings report (earnings growth of 60% & revenue growth of 24%) and ending with an announcement that they would be splitting their stock, with a twist. I will focus on the stock split but use it to also make a couple of points about corporate control and earnings growth. 

Stock splits and stock dividends are empty gestures from an intrinsic value standpoint because they change none of the fundamentals of a company. The value of a business rests on its capacity to generate high returns (and cash flows) from existing investments, its potential for value creating growth and the risk in its operations. Splitting your stock (or its milder version, stock dividends) change the number of units in the company without affecting value. Thus, in a two for one stock split, you, as a stockholder, will end up with twice the number of shares, each trading at half the intrinsic value per share that they used to.
 
The Google split: Google’s intrinsic value does not change as a result of the stock split. If you are interested, here is
 my estimate of the intrinsic value per share of Google,, pre-split. At $630/share, the stock look a little over valued (by about 10%). After a two for one stock split, they will still be over valued (by about 10%)... 

There are two areas where stock splits or dividends can affect prices, either positively or negatively.
 
a. Price level effects:
 By altering the price level, a stock split can affect trading dynamics and costs, and alter your stockholder composition. The “splits are good” argument goes as follows: when a stock trades at a high price (say $800/share),  small investors cannot trade the stock easily and your investor base becomes increasingly institutional. By splitting the stock (say ten for one), you reduce the price per share to $80/share and allow more individuals to buy the stock, thus expanding your stockholder base and perhaps increasing trading volume & liquidity.  The “splits are bad” argument is based upon transactions costs, with the bid-ask spread incorporated in these costs. At lower stock price levels, the total transactions costs may increase as a percent of the price. The effect has been examined extensively and there is some evidence, albeit contested, that the net effect of splits on liquidity is small but positive.
The Google split: Since the split is a two for one split at a $650 stock price, there is not much ammunition for either side of the price level argument. At $325/share, Google will remain too expensive for some retail investors and the transactions costs and trading volume are unlikely to change much. As one of the largest market cap companies in the market, I don't think liquidity is the biggest problem facing Google stockholders.

b. Perceptions:
 A stock split may change investor perceptions about future growth potential in both good and bad ways. The “splits are good” school argues that only companies that feel confident about future earnings growth will split their shares, and that stock splits are therefore good news. The “splits are bad” school counters that splits are empty gestures (and costless to imitate) and that companies resort to these distractions only because they have run out of tangible ways of showing growth or value added. 
The Google split: I would find it odd that a company that just reported good growth in earnings and dividends would use a stock split as a signal. In fact, I am looking forward to seeing the full filing. Perhaps, there is “bad” news hidden behind the healthy growth that Google does not want me to pay attention to.. Or, Google is looking down the road at the oncoming competition (from Facebook and its social media allies) and does not see good things happening. Or, maybe a split is sometimes just a split (with no information about the future)... 

 

The twist in this stock split, i.e., that the shares that will be created in the split will have no voting rights, is the more intriguing part of the story. In talking about the rationale for the split, here is what Larry Page said: 
"We have protected Google from outside pressures and the temptation to sacrifice future opportunities to meet short-term demands."
 Talk about chutzpah! What outside pressure? And to do what? And what temptation is Page alluding to? Brin and Page think that you (as stockholders) are too immature to know what’s good for you in the long term, and they want to make these decisions for you.  I think it is absurd to make the argument that Google would somehow have been stymied in its long term decision making, if it did not have the shareholder structure that it has now. I will wager that there is not a single decision that Google has made over the last decade that they would not have been able to make with a more democratic share voting structure (one share, one vote). The difference is that they would have had to explain these decisions more fully, which is a healthy thing for any management in a publicly traded company to do. In fact, what the stock split signals (to me) is that Google is planning more controversial (and debatable) big decisions in the future and they do not want to either explain these decisions or put them up for a fair vote.

 

As the Google model for control becomes the rule rather than the exception, at least in the technology sector, here are the three responses you can adopt to the "Googlers":

a. Sit it out: If as a stockholder, you are becoming part owner (and partner to the current owners) of a business, I would not blame you, for refusing to buy stock in Google-like companies, because you are not being treated as a full partner. Consequently, you could decide to avoid being investors in any company that has a dual-class structure for voting. The problem, of course, is that you might end up with no investments in an entire sector (social media and young technology) that is the fastest growing segment of the market.

 

b. Price it in: The logical response to the loss of control is to price it in, effectively discounting the price you pay for low-vote or no-vote shares, relative to full-vote shares. Conceptually, it is not difficult to do and I have a paper on how you can go about estimating the discount on non-voting shares: you have to build in the expectation and likelihood that managers will misbehave in the future, and that you will not be able to stop them.  In practice, though, investors often value low-vote shares based upon recent management performance/behavior, paying too high a price when managers are behaving and performing well and pushing down the price too low, after managers disappoint them. 


c. What, me worry?
 There are investors who argue that  owning shares, with or without voting rights, gives you little say in the management or corporate governance of most companies and that the dilution of voting rights should therefore have no effect on what you should pay. My response to this karmic view of corporate governance is two fold. First, the fact that you may not be able to change managers with your shareholding (because it is small) does not necessarily imply that stockholders collectively cannot make a difference; in fact, we know that they often do. Second, if you buy into this view, you have effectively lost the right to complain about your lack of say in decision making. Thus, for those institutional stockholders in Google who were quoted in the news stories yesterday as being disappointed that your counsel was not heard, I have little sympathy for you. Google and all of its imitators in the technology sector (with Facebook being the most prominent recent member of the “spit in your stockholder’s face club) have been clear about where control lies. Buying stock in Google or Facebook and then complaining about the autocratic tendencies of Page/Brin or Zuckerberg is like getting married to one of the Kardashian sisters and then complaining about your in-laws or loss of privacy. (Let's call this the Kardashian rule and codify it....)

 

And then, just as we watch the sad attempts by SANRAL to impose a ludicrous cost structure on road tolling founder in the face of popular clear thinking, Aswath starts a three-parter on the value impact of governments with this piece on Nationalisation Risk. Quite apposite also as populism may well see the N-word re-emerge toward the next leadership cycle in Mangaung.  (And – will a Sanral default impact the cost of capital here? Will nationalization? Why doesn’t Pretoria just give back the fuel levy (which it took long ago from road funding to feed the central beast), and work harder at reducing itself so the people’s lives can accelerate?)

 

Do we have any hoodlums at the wheel here in SA?

 

Cheers

Stuart

 

(Bolded emphases extracted again for your convenience):-

…The last five years have been a wake-up call to me that governments can and often do affect value in significant ways and that these effects are not restricted to emerging markets….

…the possibility of government capriciousness into what you pay for shares in a company….

…discount rates are blunt instruments and that the risk and return models  are more attuned to capturing the risk that your earnings or cash flow estimates will be volatile than to reflecting discrete risk, i.e., risks like survival risk or nationalization risk that "truncate or end" your investment…

…Value of operating assets = Value of assets from DCF (1 - Probability of nationalization) + Value of assets if nationalized (Probability of nationalization)…

…Since my skill set does not lie in psychoanalysis, I am going to steer away from companies in these countries [Argentina Russia & Venezuela]…

…If you do not control for nationalization risk, companies in countries which are exposed to this risk will often look absurdly cheap on a PE ratio or an EV/EBITDA basis. But looking cheap does not necessarily equate to being cheap ….

…I would operate under the presumption of "fool me once, shame on you... fool me twice, shame on me" and incorporate a higher probability of bankruptcy into the valuation of every Argentine company….

…"I am a head of state, and not a hoodlum". Someone should remind her that the two are not mutual exclusive …

 

Governments and Value: Part 1 - Nationalization Risk

 

I have been writing about valuation for a long time and for much of that time period, I chose to ignore the effects, positive or negative, that governments can have on the value of businesses. Implicitly, I was assuming that governments could affect the value of a business only through the tax code and perhaps through regulatory rule changes (if you were a regulated firm), but that  a firm's value ultimately rested on its capacity to find a market for its products and generate profits from these products. The last five years have been a wake-up call to me that governments can and often do affect value in significant ways and that these effects are not restricted to emerging markets.

The news story that brought this thought back to the forefront was from Argentina, where Cristina Fernandez, the president,
 announced that the Argentine government planned to nationalize YPF. The ripple effects were felt across the ocean in Spain, where Repsol, the majority owner of YPF, now stands to lose several billion dollars as a consequence. Not surpringly, the stock price of YPF, already down about 50% this year, plunged another 21% in New York trading. If you own YPF stock, my sympathies to you, but it is too late to reverse that mistake. However, there are general lessons that we can take away from this sorry episode about how best to incorporate the possibility of government capriciousness into what you pay for shares in a company.

1. Intrinsic value and nationalization risk
There are three components to intrinsic value: cash flows (reflecting the profitability of your business), growth (incorporating both the benefits of growth and the costs of delivering that growth) and risk. If you have to value a company in a country where nationalization risk is a clear and present danger, the obvious input that you may think of changing is the risk measure. After all, as investors, you face more risk to your investments in countries with capricious heads of state or governments, than in countries with governments that respect ownership rights (and have legal systems that back it up).
There are three options that you can use to incorporate the effect of this risk on your value:


Option 1- Use a "higher required return or discount rate":
 If you are using a discounted cash flow valuation, you could try to use a higher discount rate for companies that operate in Argentina, Venezuela or Russia, for instance, to reflect the higher risk that your ownership stake may be taken away from you for less-than-fair compensation. The problem that you will face is that discount rates are blunt instruments and that the risk and return models  are more attuned to capturing the risk that your earnings or cash flow estimates will be volatile than to reflecting discrete risk, i.e., risks like survival risk or nationalization risk that "truncate or end" your investment. 


Option 2: Reduce your "expected cash flows for risk of nationalization: You can reduce the expected cash flows that you will get from a company incorporated in a "nationalization-prone" market to reflect the risk that those cash flows will be expropriated. While this may be straight forward for the near term cash flows (say the first year or two), they will be much more difficult to do for the cash flows beyond that time period.

Option 3: Deal with the nationalization risk separately from your valuation: Since it is so difficult to adjust discount rates and cash flows for nationalization risk (or any other discrete risk), here is my preferred option.
Step 1:
 Value the company using conventional discounted cash flow models, with no increment in the discount rate or haircutting of the cash flows. The value that you get from the model will be your "going concern" value.
Step 2:
 Bring in the concerns you have about nationalization into two numbers: a probability that the firm will be nationalized and the proceeds that you will get if you are nationalized.
Value of operating assets = Value of assets from DCF (1 - Probability of nationalization) + Value of assets if nationalized (Probability of nationalization)

To illustrate, consider Dominguez & Cia, a Venezuelan packaging company, which generated 117 million Venezuelan Bolivar (VEB) in operating income on revenues of 491 million VEB in 2010. A
discounted cash flow valuation of the company generates a value of 483 million VEB for the operating assets. Assuming a 20% probability of nationalization and also assuming that the owners will be paid half of fair value, if nationalization occurs, here is what we obtain as the nationalization adjusted value:
Nationalization adjusted value = 483 (.8) + (483*.5) (.2) = 435 million VEB
Subtracting out the debt (291 million) and adding cash (68 million) yields a value for the equity of 212 million VEB. At its traded equity value of 211 million VEB, the stock looks fairly priced. If you download the valuation, you can see that I have incorporated the high operating risk (separate from nationalization risk) in Venezuela with a higher equity risk premium (12%) and the higher inflation/interest rates in Venezuela with a higher risk free rate of 20%. In particular, play with the nationalization probabilities and the consequences of nationalization to see how it plays out in your value per share.

Note, though, that my 20% estimate of the probability of nationalization is a complete guess, in this case. If I were interested in investing in Venezuelan (Russian, Argentine) companies,  I would spend more of my time assessing Hugo Chavez's (Vlad Putin's, Cristina Fernandez's) proclivities and persuasions than on generating cash flow estimates for companies. Since my skill set does not lie in psychoanalysis, I am going to steer away from companies in these countries.
 

2. Relative value and nationalization risk
How would you bring in the concerns about nationalization, if you value companies based upon multiples? One is to use multiples extracted from the country in question, on the assumption that the market would have incorporated (correctly) the risk and cost of nationalization into these multiples. To an extent, this is reasonable and it is true that companies in countries with high nationalization risk trade at lower multiples.

alt

Note that while Russian and Venezuelan companies trade at a discount to their emerging market peers (and my guess is that Argentine companies will join them soon), you have no way of knowing whether the discount is a fair one.

The problem, though,  becomes more acute when you are not able to find enough companies in the sector within that country to make your valuation judgment. With Dominguez & Cia, for instance, you have the only publicly traded packaging company operating in Venezuela. If you decide to go out of the market, say look at US packaging companies in 2011, the average EV/Operating income multiple is about 10.51 in January 2012. Applying this multiple to Dominguez's operating income would generate a value of  1230 million VEB, well above the market value of 211 million VEB. However, you have not incorporated the higher operating risk in Venezuela (separate from the nationalization risk) and the risk of nationalization.

The bottom line with multiples is simple. If you do not control for nationalization risk, companies in countries which are exposed to this risk will often look absurdly cheap on a PE ratio or an EV/EBITDA basis. But looking cheap does not necessarily equate to being cheap..

Implications
While it is too late to incorporate the risk of nationalization in the value of YPF, you can adjust the estimated values of other Argentine companies. While the government of Argentina may argue that YPF was unique and that they would not extend the nationalization model to other companies, I would operate under the presumption of "fool me once, shame on you... fool me twice, shame on me" and incorporate a higher probability of bankruptcy into the valuation of every Argentine company. The net effect would be a drop in equity values across the board: that is the consequence of government action. There are other repercussions as well. A government that is cavalier about private ownership is likely to be just as cavalier about its financial obligations: no surprise then at the news that the
 default spreads for Argentina have surged after the YPF news.

In closing
While this post is about the "negative" effects of government intervention, it is possible that the potential for government intervention can push up the value of equity in other companies. In particular, the possibility that governments may "bail out" companies that are "too large or important to fail" may increase the value of equities in those companies as will the potential for government subsidies to "worthy" companies. I will come back to these questions in subsequent posts.
 

Returning again to the Argentina story, Ms. Fernandez was quoted as saying, "I am a head of state, and not a hoodlum". Someone should remind her that the two are not mutual exclusive, and the problem may be that she is both.

 


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Posted: 8 May 2012 - 0 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
Category: Research

 I always enjoy, and sometimes punt, Aswath Damodaran’s work, and I recently posted his piece on the valuation impact which Nationalisation can have  Angels & demons, which is which? .

As promised, his next piece on Subsidies is here below, with my highlights extracted again for your convenience.

Local interest comes from his case study on Tesla, the electric car company founded by  Pretoria High School old boy Elon Musk. (Sadly perhaps for Elon, Aswath finds Tesla grievously over-priced, whether the subsidy is included or not).

Cheers

Stuart

 

…subsidies in many forms:

-       providing or facilitating below-market rate financing,

-       special tax benefits,

-       revenues or price supports, and even

-       forcing competitors to provide direct benefits to a subsidized entity…

…triggered by the recent news story on First Solar, where the company announced its intent to both scale back its operations and return a $30 million subsidy it had received from the German government.

There are two ways of dealing with subsidies. One is to build them into your discounted cash flow valuation inputs and let them flow into your estimated value. The other is to ignore subsidies in a DCF valuation and to value subsidies separately and add them on.

-       Enter the subsidized cost of debt and/or the subsidized debt ratio into the cost of capital, which will yield a lower cost of capital and higher value.

-       a tax holiday or special tax rate will lower the effective tax rate and increase after-tax cash flows

-       price support increases revenue… may reduce the operating risk in the business and increase value.

…advantage of this approach is that the subsidies then get baked into the valuation… disadvantage of this approach is that it is easy to forget that subsidies don't last forever and that the firm will eventually lose them…think through how long these subsidies will last…

…break the company's value down into its operating value and its subsidy value.

…separating the effects of the subsidy from the valuation allows you to assess the costs and benefits of taking the subsidy. If the net benefit is negative, the company may be better off rejecting or returning the subsidy to the government.

Governments…are both fickle in their choice of favorites and unreliable subsidizers.

If making money on a stock requires me to count on the government's continuing indulgence, you can count me out.

 

Governments and Value II: Subsidies and Value

 

In my last post, I looked at the negative effects on equity value of the threat of government expropriation (nationalization). In this one, I want to focus on the more benign (and perhaps positive) impact that governments can have the values of some companies, through subsidies in one of many forms: providing or facilitating below-market rate financing, special tax benefits, revenues or price supports and even forcing competitors to provide direct benefits to a subsidized entity. Note that my intent in this post is not to examine the wisdom of these subsidies and whether governments should be tilting the playing field. While I do have strong views on the topic (and you can guess what they are from the subtext), I want to focus on the mechanics of how best to value businesses that benefit from these subsidies. This post was, in part, triggered by the recent news story on First Solar, where the company announced its intent to both scale back its operations and return a $30 million subsidy it had received from the German government.

Subsidy Variants
Governments, through the ages, have played favorites with businesses, either providing help to their preferred companies or, in some cases, handicapping their competition. Broadly speaking, there are at least four ways in which governments can try to benefit a subset of companies:

1. "Low or no cost" financing:  The cost of borrowing (debt) for a company should reflect its default risk. In some cases, governments can step in the fray and either provide or facilitate "cheap" or "below market rate" financing, ranging from grants (effectively free financing) to low-interest rate loans (Airbus) to acting as a loan guarantor with banks (Tesla). The net effect is the same: the company is able to borrow more money at lower interest rates than it otherwise would have been able to, which, in turns, lowers its overall cost of financing its operations. You can argue that bailouts are a variant on this subsidy, insofar as it offers a financial lifeline to distressed (usually too-big-to-fail) firms that otherwise would have faced default.
2. Tax holidays, credits and deductions:  The tax code has long been a favored device for the government to bestow benefits on chosen sectors or companies. In some cases, this can take the form of a lower tax rate on income (than the tax rate paid by other businesses) or a tax holiday, and in others it can take the form of more generous expensing and depreciation rules. Fossil fuel companies in the US, for instance,  have been allowed to expense a portion of exploration costs, granted tax credits amounting to 15% of investment costs related to enhanced oil recovery and gas pipelines can be depreciated over 15 years instead of 20 years. These benefits translate into higher after-tax cash flows (from paying less in taxes)  or timing benefits on tax savings (with expensing and depreciation breaks).
A side note:
 One oft-used proxy of which businesses get subsidized the most is the difference between the effective tax rate paid by these businesses and the marginal tax rate. I report the average effective tax rates on my website, by sector. However, I think that the dominant factor driving effective tax rates now is not tax subsidization but foreign sales. The more revenues a company (or sector) generates from overseas (where corporate tax rates are lower), the lower the effective tax rate will be.
3. Revenue or price support (Higher and more predictable revenues): In some cases, governments step in to both stabilize and increase revenues of businesses by providing price support to companies. For instance, the US government, among others, has provided price supports for some agricultural products, such as sugar. In other cases, governments benefit firms by handicapping foreign competition and imposing tariffs on imported goods. Sometimes, government can indirectly support revenues by providing the subsidies to the customers of preferred companies; an example would be credits offered to homeowners for using solar panels on their houses.
4. Indirect subsidies:
 Rather than provide benefits directly to a company, the government can also force competitors to sustain the company by either paying a cash subsidy to the company or by buying its products at an arranged price. The Zero Emissions Vehicle Program, a California state mandate requiring that auto manufacturers failing to produce a certain number of zero emission vehicles buy credits from those who did, resulted in Tesla receiving millions of dollars in payments from other auto companies.

Ways of dealing with subsidies
There are two ways of dealing with subsidies. One is to build them into your discounted cash flow valuation inputs and let them flow into your estimated value. The other is to ignore subsidies in a DCF valuation and to value subsidies separately and add them on.

1. Build into valuation 
Each of the subsidies, described above, can be incorporated into a DCF valuation input:
a. "Low cost" financing:
 Enter the subsidized cost of debt and/or the subsidized debt ratio into the cost of capital, which will yield a lower cost of capital and higher value. Thus, if a firm like Tesla that normally would not have been able to borrow money, since it is a risky, money losing company. and would have been all equity financed (say with a cost of equity of 11%) may be able to borrow a portion of its capital at a "low" interest rate (because of implicit or explicit government subsidization) and end up with a cost of capital of 10.8%.
b. Tax holidays, credits and deductions:
 Subsidies that take the form of a tax holiday or special tax rate will lower the effective tax rate and increase after-tax cash flows. To the extent that the tax subsidized operations can be kept separate from non subsidized business, the company may be able to still get the full tax benefits of borrowing. More generous expensing and depreciation rules don't increase the nominal tax benefits across time but the value of the tax benefits will increase because they occur earlier in time.
c. Revenue or price supports:
 These subsidies can show up in two places. First, the price support increases revenue to producers who can sell at the support price, which is higher than the market price. Second, to the extent that these subsidies make revenues more stable, they may reduce the operating risk in the business and increase value.
d. Indirect subsidies:
 The transfer payments from competitors will boost revenues and cash flows and increase the value of the subsidy-receiving company.

The advantage of this approach is that the subsidies then get baked into the valuation, with no need for post-valuation garnishing or augmentation. The disadvantage of this approach is that it is easy to forget that subsidies don't last forever and that the firm will eventually lose them, either because governments cannot afford them anymore or because the company loses its preferred status.
If you do decide to go this route, keep in mind at least two issues. If you build subsidies into your DCF valuation, think through how long these subsidies will last. For instance, the "low cost" financing subsidy may cease to be one, if your company becomes a larger, more profitable entity. In addition, check to see what the value of the company would be, with no subsidies. In other words, break the company's value down into its operating value and its subsidy value.

A valuation of Tesla
To illustrate the process, let me try to value Tesla Motors, the electric car company founded by Elon Musk, one of the co-founders of Paypal. Tesla Motors got a subsidy from the US government, in the form of a Department of Energy loan facility that it utilized to borrow about $250 million in 2011, at an interest rate of 3%. (You can download my excel spreadsheets, with the valuations, if you want):
Step 1: I valued Tesla Motors, with the subsidized financing. The company's borrowing gives it a debt ratio of about 10%, which with its subsidized interest rate, results in a cost of capital of about 10.8%. The valuation, where I do assume that Tesla's revenues will climb to about $ 5 billion in 10 years and that the pre-tax operating margin will converge on 12% (much higher than the average margin of 7% across automobile companies in 2011), yields a
 value per share of $10.40/share.
Step 2: I valued Tesla Motors without the subsidized financing, by assuming that the firm would have to raise the debt at a market interest rate of 9% (instead of the 3% subsidized rate). The resulting
 value per share is $9.60.
Step 3: The interest rate subsidy can be valued at $0.80/share, the difference between the valuation with the subsidy and the valuation without.
This is the narrowest measure of the subsidy. If we expand the subsidization to include tax credits for future investments (reducing reinvestment needs for the future) and perhaps less risk (if the government supports revenues or requires competitors to pay Tesla), the value per share would increase (and so would the subsidy value). In this final valuation, I expand the Tesla valuation to include broader subsidies and
 generate a value per share of $18.17/share.

2. Separate valuation
In this approach, the discounted cash flow valuation is done with inputs that the firm would have had in a non-subsidized world, and the value of the subsidy is assessed separately. Thus, in the case of Tesla, you would value the company using the 12% cost of equity (or capital) that the firm would have had in a non-subsidized world, and then value the effect of the low cost financing separately. Thus, if Tesla is able to borrow money at a lower rate, as a result of the government support or backing, the savings each year from the subsidy amount to the difference between the market and the subsidized interest rates. Taking the present value of these savings over time should generate a value for the subsidy, which can then be added on to the value obtained using the non-subsidized cost of capital.
 
While this approach requires more detailed information on the nature of the subsidy and what the firm would have looked like in its absence, it has two benefits:
a. The analyst can value the subsidy for only the period that he or she thinks it will be offered and discount it at an appropriate rate. Thus, if Tesla has $250 million in debt at a 3% subsidized rate, when it should have been paying 9%, it is saving $15 million a year because of the subsidy (9% of 250 - 3% of 250). Assuming that the subsidy is likely to continue for only 10 years and that the only risk of not getting it is if Tesla defaults, the present value of $15 million a year for 10 years, discounted back at the unsubsidized cost  of debt of 9%, yields a value today of $96.26 million.
b. If the subsidy from the government requires the company to offer something in return (build a manufacturing plant with higher cost labor), separating the effects of the subsidy from the valuation allows you to assess the costs and benefits of taking the subsidy. If the net benefit is negative, the company may be better off rejecting or returning the subsidy to the government.

Implications for investing/valuation
A company that gets significant subsidies from the government will have a higher value, in most cases, than one that does not. In some sectors, say green energy, the subsidies can account for a significant portion of the overall value of the firm (and its equity). As an investor, I have always been uncomfortable investing in these companies at prices that require the continuation of subsidies to justify the investments. Governments, especially in these times of budget constraints and sovereign defaults, are both fickle in their choice of favorites and unreliable subsidizers. Thus, if I can buy Tesla at a price that is less than its unsubsidized value, I will do so, and view the subsidies as icing on my investment cake. If, on the other hand, making money on Tesla requires me to count on the government's continuing indulgence, you can count me out. In this case, I am spared the choice, since Tesla at the prevailing stock price of $ 30 looks overvalued, even relative to the most generous subsidized value.”


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We have read and enjoyed some of Aswath’s pearls on the heavy hand that governments can exert on the amorphous markets at Angels and demons – which is which? and Fickle & unreliable - guess who?

His part III now delves into the dark heartlessness of bribery and corruption. It is clear that he can look at the planet through cold financial eyes – little wonder that capital flows so unemotionally to avoid imposts and to seek out return.

Cheers

Stuart


Highlights for me were:-


In many countries, business people know that to keep doing business, they have to grease palms and provide “gratuities” to the gatekeepers of officialdom.

…countries where these [i.e. natural] resources are most abundantly found are often also the ones with the most corrupt government officials…

India shows a nativist spin to corruption. Put in blunter terms, the ruling seemed to suggest that bribery of Indians by other Indians was par for the course, but bribery by foreign nationals was an abomination. [Aswath, of Indian background, tells it as he sees it]

…the real story that the Chinese government wants to keep a lid on is that Bo Guagua is not alone among government officials, in accumulating wealth out of proportion to his "income" as a government official…

the more licenses, permissions or other official approvals you need to operate, the greater the potential for corruption [ As Thomas Jefferson said – “if you regulate trade, the first thing to be traded will be a regulator” ]

…a lot less risky being corrupt if you have political hegemony (whether it be of the dictatorial variety or one party rule),

United States came in as the 24th least corrupt [ So 23 countries are cleaner than the USA ]

If you are valuing a company that operates in these dens of iniquity … three alternatives

-       COST So, in your operating expense breakdown, you could have a line item titled "Bribes and payments to corrupt officials" with the expense associated with it.

-       TAX the added cost of operating in China was the equivalent of facing an effective tax rate of 46%.

-       WACC – you have to generate a higher return on your capital invested to cover the cash outflows to your implicit partners.

 

...firms that understand how the system works (or who to pay and how much to pay to make it work) will generate excess returns and higher value than their more virtuous counterparts...

 

OK – here is Aswath unabridged to wrap up




"Governments and Value III: Bribery, Corruption and other "Dark" Costs

 

In this last post on the effects of government on valuations, I want to return to the value destructive effects that corruption, bribery and other "illegal" side-payments to government officials can have on value. In many countries, business people know that to keep doing business, they have to grease palms and provide “gratuities” to the gatekeepers of officialdom. A spate of news stories in the last few weeks should alert us all to the reality that the problem is not only still prevalent but that companies everywhere are exposed to its costs.

1.             In a reminder to natural resource companies that the countries where these resources are most abundantly found are often also the ones with the most corrupt government officials,Cobalt International Energy, an energy company backed by Goldman Sachs, saw $900 million of its value wiped out, after revelations that three powerful Angolan officials held concealed interests in the company.

2.             India is the second-largest telecom market in the world, with hundreds of millions of subscribers. The regulatory uncertainty that has always bedeviled companies competing in the sector was augmented to by a tainted telecom auction in 2008, which resulted in the resignation and arrests of a cabinet minister. The saga played out in the Indian Supreme Court's recent ruling taking away licenses awarded to eight companies in that auction; the fact that six of these eight companies were foreign suggested a nativist spin to corruption. Put in blunter terms, the ruling seemed to suggest that bribery of Indians by other Indians was par for the course, but bribery by foreign nationals was an abomination.

3.             Finally, from the other great growth story in Asia, China, came the story of Bo Xilai, a prominent member of the party elite, and his family: his wife, who is accused of murdering a British businessman, and a son, Bo Guagua, who goes to the Harvard's Kennedy School of Government, drives a Ferrari and has the lifestyle of a top notch capitalist. While the story is filled with the kinds of details that tabloid newspapers love, the real story that the Chinese government wants to keep a lid on is that Bo is not alone among government officials, in accumulating wealth out of proportion to his "income" as a government official.

I am not an expert on corruption but here is what I see as the ingredients that allow it to flourish. First, for official gatekeepers to have power, you need gates: the more licenses, permissions or other official approvals you need to operate, the greater the potential for corruption. Second, it is a lot less risky being corrupt if you have political hegemony (whether it be of the dictatorial variety or one party rule), an ineffective legal system (making it impossible to challenge biased official acts) and an apathetic or controlled media (that either cannot or will not view corruption as a good news story). Third, the odds of corruption increase if the system is designed on the premise that corruption is the rule rather than the exception. Thus, setting the salaries of public employees at well below what the market would pay them, given their qualifications, on the assumption that they will augment these salaries with "side payments", will ensure that you will attract the "most corrupt" people into government and a continuation of the system.

 

Rather than debate the basis of corruption and whether culture and history play a role, I want to first focus on “objective” measures of corruption . Transparency International, an organization that tracks corruption globally, releases an annual listing of corruption across the world. Just to provide a summary, the following is a list of the ten least corrupt and the ten most corrupt countries in the world, based on their ranking.

Least corrupt countries in the world

Most corrupt countries in the world

1. New Zealand

1. Somalia

2. Denmark

2. North Korea

3. Finland

3. Myanmar

4. Sweden

4. Afghanistan

5. Singapore

5. Uzbekistan

6. Norway

6. Turkmenistan

7. Netherlands

7. Sudan

8. Australia

8. Iraq

9. Switzerland

9. Haiti

10. Canada

10. Venezuela

Just for information, the United States came in as the 24th least corrupt country out of 182 countries, China was 75th and India was 95th on the list. While I am sure that there are countries where you and I may disagree with the rankings, there are clearly regions of the world where operating a business without "paying off" government officials is close to impossible.


If you are valuing a company that operates in these dens of iniquity, how do you incorporate the costs of corruption into your value? Here are a three alternatives:

1.             Treat bribes as operating expenses: From a valuation perspective, it would be easiest to deal with bribes if they were out in the open and  treated as a separate line item in the expenses. So, in your operating expense breakdown, you could have a line item titled "Bribes and payments to corrupt officials" with the expense associated with it. Perhaps, we can then assess firms on the efficiency of their bribery and treat it as a competitive advantage for companies that are exceptionally good at getting results for their money. Unfortunately, even in countries where corruption is endemic, it remains "under the surface" and unreported.

2.             Treat corruption as an implicit (and unreported) tax: In the more likely scenario, where corruption exists but is not explicitly reported, it may make sense to consider the expenses associated with it as an implicit tax levied by the government. The fact that this tax revenue goes to the government officials and not to the taxpayers is deplorable, but that makes little difference to the company paying it. While this idea may seem farfetched, PWC did exactly this in an "opacity index" that they computed for dozens of countries and converted into tax rates. In 2001, for instance, they estimated the added cost of operating in China was the equivalent of facing an effective tax rate of 46%. Unfortunately, this listing is almost a decade old and while the opacity index itself has been updated by others, the effective tax rates no longer seem to be computed by country.

3.             Increase the cost of capital to cover "government" partners: When corruption occurs at the highest levels, you can argue that as a private business owner, you have "corrupt government officials" as partners who provide no capital but get a share of the income. Consequently, you have to generate a higher return on your capital invested to cover the cash outflows to your implicit partners. You can find interesting attempts to quantify this effect here and here.

There are two complicating factors. The first is that the United States (among other countries) has laws on the books that forbid companies from paying bribes not only to US officials but to officials in other countries . As a consequence, the costs of bribery may be far greater than the actual expenditures incurred and include the penalties that these companies will be face, if the bribery is exposed. The second is that the "right connections in high places" in countries with extensive corruption is a significant competitive advantage in itself. Odious though we may find this proposition, the firms that understand how the system works (or who to pay and how much to pay to make it work) will generate excess returns and higher value than their more virtuous counterparts." 


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Posted: 10 May 2012 - 0 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
Category: Research

Our stalwart contributors from Vestact have profiled the matter of forecasts failing to satisfy the market in Cisco's case -   The disco ball falls on Cisco . (And this in a week that little shares like Spar and Barloworld felt similar pressures).

 

Now, while I am not expressing an opinion here on the invulnerability of behemoths like say Apple or Facebook, it may help people shorten their path to wisdom if they read this article on Intel - the mighty half trillion company of 2000, and how its market cap fell by $120 billion in a trice...

 

user_uploads/Intel guidance smack.pdf

 

 

The paper examines the market reaction to a press release issued by Intel on Thursday, September 21, 2000. In response to that release, Intel’s stock price dropped 30 percent, erasing over $120 billion of shareholder wealth. By analyzing the press release in conjunction with analyst reports and by using a discounted cash flow valuation model, it is argued that the information conveyed by the announcement was not sufficient to explain the stock price drop. In

an effort to explain this controversial conclusion, the paper documents the puzzling and procyclical role of analysts’ recommendations regarding Intel. Surprisingly, analysts were more strongly recommending purchase of the stock in August at $75 than they were recommending purchase in September at $40. This suggests a positive feedback between stock price movements and analyst recommendations that may increase the volatility of prices.

 

Cheers

Stuart

 

 


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Category: Research

 Just a question:-

 

If a state (tax) funded entity, like SANRAL, can get downgraded for stopping a project which would have taken a ludicrous portion of their turnover and turned it into cost, why would you allow a rating agency any credibility at all?

 

Cheers

Stuart

 

 


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Posted: 11 May 2012 - 0 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
Category: Research

Lots of questions are coming out now about whether his hoodie means fund managers can scorn Mark Zuckerberg. They feel Tottenham looters wear hoodies, not MDs of listed success stories etc etc.

 

Now I am barefoot, wearing shorts as I type, but I have another problem:-

 

If I can take your Acquaintances (kind of every business card in your rolodex, every old school buddy, etc etc), and rename them as your Friends, does it matter? Are you better off? And if I can pump up your number of (renamed) friends by linking all sort of other potential matches, are you now luckier than you were?

And then if I start charging a premium for friends of commercial intent to get a louder/brighter presence on your screen, what comes after that? Once I have 7billion shouting friends? 

 

I look forward to a validation of its business model for facebook.

 

Cheers

Stuart

 

 


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 Luxury goods company Richemont (CFR) has fixed some anxieties, and shows us that TSINFOOH - the sky is not falling on our heads.

 

Trying to put a fundamental cash based valuation on it yields the following:-

 

alt

The company reports in Euros - so to get back to rands you must times by 10.65. Hence the DCF suggests that if turnover grows at 8% ( far below the last two post doom hot years, but also well inside the 14% geometric mean growth of the last 4 years), and it can hold pretax margins at 15% (again seemingly modest) it is worth Euro6.3 or R67. So even its strong price response this morning is not there yet. And plugging in bolder drivers of say 12% growth, and 18 or 20% PBT margin - sjoe - out pops Euro9.5 or R101!

 

And its revenue growth is pretty much where one would expect - fastest by far in Asia (ex Japan, that is). See their full results at http://www.richemont.com/images/stories/3_Investor_Relations/3_5_Results/2012/ca_15052012_uwa7w2iusd8_en.pdf

 

Cheers

Stuart

 

 


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Category: Market news

Apparently President Obama has huge respect for the boss of JP Morgan, Jamie Dimon. (I doubt if that is linked to party contributions, but one never knows)

 

In a blunter than typical article on Bllomberg Businessweek (follow the link http://www.businessweek.com/articles/2012-05-16/the-hubris-of-jamie-dimon#p1 for the whole shebang), Peter Coy highlights just how well Dimon plays vocab games when it suits him:-

 

 

"...under Dimon’s management the Chief Investment Office was transformed from a risk-mitigating organization into one that became a profit center, overseeing about $360 billion. It is a basic principle of finance that a correctly executed hedge should, on average, lose money. That’s because buying protection is costly. Insurance works the same way. You pay a little bit every year to protect yourself against a devastating loss, and you’re grateful if your premiums “go to waste” because you never collect. Sure, a good hedge might make money accidentally because of a mismatch between the asset that’s hedged and the asset that’s doing the hedging. That’s known as “basis risk” in the trade. But if a transaction is outright designed to make money for the firm, it is not, by definition, a hedge. It’s speculation. The New York Times reported on May 15 that the anticipated profit from the big trade made by JPMorgan’s Chief Investment Office was called “icing” by insiders, like the icing on a cake. That’s damning.

 

“Hedging” isn’t the only word that Dimon has redefined for his own purposes. “Guidance” is another. In his May 10 conference call with analysts, Dimon said, “While we don’t give overall earnings guidance and we are not confirming current analyst estimates, if you did adjust current analyst estimates for the loss, we still earned approximately $4 billion after-tax this quarter, give or take.” So he gave guidance while insisting he wasn’t giving guidance."

 

 

 

 

The Hubris of Jamie Dimon

 

I'm not with JP Morgan

 

Cheers

Stuart


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 Vestact have profiled the results from Investec, and included this chart from the Investec presentation to illustrate their opinion.

 

alt

 

 

If one crudely re-scales the charts (all report UK pounds), the picture looks a little less attractive...

alt

SO maybe specialist banking, and Investec, are not so special...

 

Cheers

Stuart

 

alt

 


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Do you get switched on or off by hectic targets?

 

This blog from consultant Ron Ashkenas on the Harvard Business Review (HBR) blog may help your perspective...

 

Cheers

Stuart

 

 

the two keys for me:-

 

...ambitious stretch goals need to be deconstructed into lots of short-term stretch goals...
...design the short-term stretch goals [to] force innovation, collaboration, and learning...

 

Here is the blog:-

 

"Recently my fellow HBR blogger Daniel Markovitz suggested that stretch goals can be demotivating, and should be replaced by confidence-building "quick wins." Frankly, this is like saying that the taste of food is more important than its nutrient value. It's a false dichotomy. Healthy organizations need both stretch and success to stay alive and vibrant, just like a well-balanced diet includes food that is both tasty and healthy.


The key to integrating the two is to carve quick wins out of long-term goals — so that each small success is a building block towards achieving a broader challenge. It's important however that these small successes themselves be microcosms of the larger goal, and not simply serve as check-marks for harvesting low hanging fruit. Rather, these small stretches (we call them Rapid Results) need to force people out of their comfort zones to try new approaches, ideas, and ways of working in 100 days or less.

Over the past several decades, my colleagues and I have seen the power of short-term stretch goals in almost every imaginable situation. For example:


In order to achieve seemingly impossible growth targets, an adhesives materials company challenged dozens of divisional teams to each implement one "growth idea" that would generate new revenue in 100 days. One team, for instance, revised a commercial taping product for home use and partnered with Home Depot to sell it. Over the next two years, hundreds of such teams around the world helped the company increase revenues while creating further opportunities for growth. These "small stretches" also energized participants and helped them develop capabilities as growth leaders. As one manager said, "I learned more in 100 days than I had in the previous several years."

To achieve stretch sales goals, the commercial head of a health care company challenged her global team to boost revenues from older brands without losing focus on their primary products. To make this happen, a cross-functional team from each market selected ten promising brands and focused on getting initial, measurable results on one of them in 100days.Over the next year, these teams built on the initial results so that the collective gain was over half a billion dollars.

Short-term stretch goals also work with community development and not-for-profit initiatives. As part of an effort to increase education in Southern Sudan, a team of villagers with help from an NGO took on the challenge of increasing school attendance by 30% in 100 days.The villagers were so motivated to achieve this goal, that they eventually made their own bricks to construct a new building. A few years later a child from that village was the first from his region to attend a university. Currently, an effort in the U.S. to provide housing for 100,000 homeless veterans is utilizing the same approach by carving out short-term stretch goals in a number of cities around the country.
 
Regardless of context, there are two keys to the effective use of short-term stretch goals.

The first is to make sure that the immediate goals are part of a larger, more ambitious effort so that whatever is achieved and learned is a building block, not an end-in-itself. In other words, extremely ambitious stretch goals need to be deconstructed into lots of short-term stretch goals, sometimes with multiple cycles.
Second, intentionally design the short-term stretch goals in ways that force innovation, collaboration, and learning — so it's not just a matter of working harder for a short period of time. In this way, each short-term success builds capability and knowledge for the next and the next.
Let's not dismiss stretch goals as demotivating or dangerous. If you tackle them by carving out short-term challenges, and learn as you go, they can be a powerful way to accelerate progress."

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Category: Market news

1.  There is no longer a first and a third world - the merger is over.

 

alt

2. Africa's glass is more than 1/2 full...

 

alt

 alt

 

3. We have a lot to do - time to get on with it...

 

 Cheers

Stuart


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Posted: 29 May 2012 - 0 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
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Sponsorhip of major sport codes has been the province of big brands for some time, and we saw that right here in 2010 when Budweiser had the beverage marketing and exclusive pouring rights at the soccerfest. While thirst was certainly slaked, that single offering did not lift the flavour awareness of the beer drinkers who had Bud.

 

And we know all about mainstream beer driving sport-marketing, with the "belonger" psychographic profiles doing wonders with the patriotism cues of Bafana/Springbok/Protea promotions, campaigns and matches.

 

So now, how interesting that the USA is seeing CRAFT BEER EMERGING AT SPORT STADIUMS. And this seems to be happening IN RESPONSE TO MARKET WANTS - it is market driven, rather than marketing driven.

 

Here is a link and article on the topic from the eponymous Huffington Post, with a few salient points extracted to the top for the hasty... One wonders how far the South African craft beer movement is behind (or ahead) of the yanks?. Get to the solstice festival this weekend to find out.

 

Cheers

Stuart.

 

...big breweries still rule the ballpark...They have the unique ability to spend lavishly on marketing: billboards inside and outside the gates...television and radio spots during a broadcast. Smaller brewers simply can't compete.


...the groundswell of support for premium, often-kitschy, sometimes expensive and usually irreverent brands has been heard loud and clear by the baseball's establishment. There's been a shift, a cultural shift, in the beer culture in the U.S...

...No longer does a light American lager satisfy every occasion...

 


 

...brewers such as MillerCoors have noticed the shift, too, and that's in part why it offers Leinenkugel's Summer Shandy, Sunset Wheat and Berry Weiss...


...Craft beers ...represent about 5.7 percent of all sales by volume and 9.1 percent by dollar last year[2011].... [Craft] grew 13 percent by volume and 15 percent by dollars in 2011, the second straight year of double-digit increases....


..."I'd rather enjoy a couple good beers than drink the watered-down domestics that just fill you up without much flavor," said a credit analyst from Shawnee, Kan., who heads to the ballpark about half a dozen times each summer


..."I don't want a watery, light beer that lacks any meaningful flavor," another fan said. "I love the wheat beers. I like the flavor, the body...



 

http://www.huffingtonpost.com/2012/05/28/baseball-parks-craft-beer_n_1550484.html

 

 

KANSAS CITY, Mo. -- It used to be that baseball fans would head for the concourse to grab a beer between innings, a cold one as much a part of America's pastime as hotdogs and Cracker Jack.

Now they file up the aisles in search of Belgian-style pale ale.

During a period of decline in overall beer consumption, the market for craft brews is rapidly expanding, and the trend is evident at ballparks from coast to coast. Many stadiums offer upward of 60 varieties, everything from Budweiser and Coors Light to Henry Weinhard's IPA.

In the mood for a porter, with a hint of chocolate and caramel? Ask for a Great Lakes Edmund Fitzgerald at the Irish pub inside Citizens Bank Park in Philadelphia.

Taste trending toward Scottish ale? Order up Erie Brewing Company's Railbender Ale at PNC Park in Pittsburgh, one of the most beer-friendly ballparks in baseball.

Looking for something with a cloudy appearance and citrusy flavor? You can find Boulevard's Unfiltered Wheat at stands throughout Kauffman Stadium in Kansas City.

"Every market is different," said Bob Sullivan, vice president of sales and marketing for Boulevard Brewing Company. "But what you're seeing now is that stadiums are saying, `We really need to carry the local beers.' People pay a lot of money for their season tickets, and there's some obligation to give them what they want."

The big breweries still rule the ballpark – Miller Park and Busch Stadium, anyone? They have the unique ability to spend lavishly on marketing: billboards inside and outside the gates, subway cars on the way to Yankee Stadium, television and radio spots during a broadcast.

Smaller brewers simply can't compete.

Top of Form

Bottom of Form

Then there's the fact that Anheuser-Busch and Major League Baseball renewed their exclusive sponsorship deal in 2010, making Budweiser the league's official beer.

Yet the groundswell of support for premium, often-kitschy, sometimes expensive and usually irreverent brands has been heard loud and clear by the baseball's establishment.

"There's been a shift, a cultural shift, in the beer culture in the U.S. No longer does a light American lager satisfy every occasion," said Julia Herz, craft beer program director for the Brewers Association, an organization made up of more than 1,400 brewery members.

The Brewers Association documents 140 beer styles worldwide, Herz said, and the United States is the most diverse destination globally, with 13,000-plus beer labels in the marketplace.

In the past, the Royals had limited their beer category to two sponsors, and they ended up going to the highest bidders. Companies such as Boulevard couldn't compete with heavyweights such as MillerCoors and Anheuser-Busch, so even though Boulevard was able to offer its brews at the ballpark, it became a scavenger hunt for fans trying to locate the taps.

That changed this year, when the Royals decided to extend to more than two partners.

"I'd say in the last six or seven years, the overall concessions business has become much more sophisticated than in the early days, when it was a hotdog, a beer and popcorn," said Mike Bucek, the Royals' vice president in charge of marketing and business development.

Earlier this season, when the Royals announced the branding of the new "Budweiser Patio," they also announced the new Boulevard Pub and Boulevard Grill, where fans in Kansas City can grab a seat and catch the game while also enjoying their local beer.

It doesn't take long to notice Boulevard's expanded presence, either. While there's a big sign for Budweiser in right field at Kauffman Stadium, and a large sign for Coors Light in center, Boulevard's new sponsorship means it has its own sign beyond the left-field wall.

"We've seen a growth in craft beer sales, there's no question," Bucek said. "When you see the category grow, there's so much more to offer. It's pretty broad-based compared to what it was back in the day, and it's definitely evolving and continuing to grow."

Large-scaled brewers such as MillerCoors have noticed the shift, too, and that's in part why it offers Leinenkugel's Summer Shandy, Sunset Wheat and Berry Weiss at Kauffman Stadium.

Craft beers remain a small segment of the market, representing about 5.7 percent of all sales by volume and 9.1 percent by dollar last year. But that segment is rapidly growing, especially as overall beer consumption in the United States continues to slide.

Beer sales were down an estimated 1.2 percent by volume in 2010, and 1.3 percent last year, according to the Brewers Association. Meanwhile, the craft brewing industry grew 13 percent by volume and 15 percent by dollars in 2011, the second straight year of double-digit increases.

"This is an entire shift in the beer community, and culturally how we enjoy and what we enjoy for beer," Herz said. "This is a market-driven demand, not a marketing-driven demand. This was the market itself demanding, I want to go to my local baseball stadium, and enough people have asked where the beverage buyers say, `Yes, we will sell it.'"

Premium products, of course, demand premium prices.

At Safeco Field in Seattle, a beer from the mainstream brewers will set you back about $7.75, but tack on another couple bucks for one of several dozen microbrews.

"I'd rather enjoy a couple good beers than drink the watered-down domestics that just fill you up without much flavor," said Larissa Jackson, a credit analyst from Shawnee, Kan., who heads to the ballpark about half a dozen times each summer.

The San Francisco Giants have heard the drumbeat of fans. They'll hold their third annual "Brewfest" at AT&T Park on July 14, where fans will receive a commemorative tasting mug and have the chance to sample craft breweries during a 3-hour window before the Giants play the Astros.

Rick Cloues, a software engineer from Overland Park, Kan., noticed the increase in craft beer options while buying partial season-ticket packages to the Royals the past few years.

"I don't want a watery, light beer that lacks any meaningful flavor," Cloues said. "I love the wheat beers. I like the flavor, the body, and even the lemon wedge that every bar tender knows to drop in the glass. I see more micro beers popping up in the ballpark.

"Not that I could afford them at nine dollars a pop," Cloues added. "That just means my tailgating starts a little earlier than most."

 


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Posted: 31 May 2012 - 1 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
Category: Research

Beer giant SAB Miller has reported for the year to March 2012, and volumes, sales, profits, earnings per share and dividends were all higher.

 

Read their portrayal of the result here:- http://www.sabmiller.com/files/newsreleases/newsrelease_240512_f12.pdf 

 

But was that enough?

 

Here is how the JSE (rand) share price has moved, with a happy overall rise across the post GFC period, and essentially up 50% in two years.

alt

So what should one make of the mega brewer - in January the company successfully raised long term funding at better interest rates than some countries...see  SAB bond and yield curve for dummies but does the evident cash power which attracts lent moneys make it an attractive share to buy?

 

I have tried to probe its valuation, using discounted cashflow thinking, and here is my outcome:-

 

alt

 

Essentially, I can arrive at the current price (R316) only if I assume 21% profitability (profit before tax as % of sales). Yes, that is lower than this result's 25.75%, but well above the past five years' average, and combine that with ongoing topline growth of 10%. Forever. And I use a lower discount rate, of 10%, than I do with other major listed stocks. Perhaps their attractiveness in the debt market emphasises that this is not outrageous.

 

BUT will the huge company, now that it has bought major volume businesses on every continent (even scientists in Antarctica who require the strongest beers for the anti-freeze properties of alcohol are said to be targets for group marketing) be able to keep growing. There may be price possibilities if the world's mass beer markets move from pale lagers to craft beers, but the ingredient and promotional costs may offset some of the gains. And at Group level, the transport and logistics, as well as the entrenched excise engine so beloved of governments, mean it is hard to foresesee spectacular performance from the shareprice.

 

So for me, a hold, albeit a delightfully safe one.

 

Cheers

Stuart...

 


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