When Gaming Becomes Culture

You may or may not have never seen this.

It’s from the ‘08 annual report of Sohu.com. The number is simply crazy.

Remember when the dot com boom crashed, the big three Chinese Internet portal (Sina, Sohu, Netease) almost got delisted from Nasdaq?

You may also like to take a look at Netease [PDF], or Shanda [PDF].

It produced fat-cat CEOs – sometimes really wild, and world-class. Grandpa Deng once said “let somebody get rich first.” His vision has been well realized, but I guess he himself would be surprised seeing what’s happening.

Maybe we should find kids better things to do.

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Shenhua: SOBs, Corporate Governance and Market Economy

This post is on China Shenhua (01088.HK), an energy company and one of the FT/Xinhua 25 index. It’s more about things to consider in investing in Chinese state owned businesses (SOBs) than a stock recommendation.

Introduction

It operates coal mines, power plants, railroads and ports. It mines coals in central China, transports them via own railroads or national railroads to market for sales, or to power plants (most in eastern China) for power generation.

Here’s a list of assets owned.

It’s a really really profitable business. Its 2007 revenue was RMB82 bn (including coal segment RMB56 bn, power segment RMB 24 bn), 50% growth from 2006. Net profit was RMB24 bn. See income statement below.

Ownership

This is the interesting part. The listed company was part of the Shenhua Group, which is a coal energy mammoth with dozens of subsidiaries. Below is part of the org chart.

The group owns 74% of the list company.

The group itself, with RMB411 bn in asset and RMB 141 bn in revenue in 2008, is one of the most profitable state owned business.

Implications

Here’s an excerpt from the 2007 annual:

“The Company’s standard of corporate governance has been recognized in the capital market and the Company has won various awards such as the award of “2006 Best Corporate Governance in Asia” («Finance Asia»).”

To me it’s an oxymoron. For an individual investor, if it’s owned 3/4 by the parent company which is in turn owned by the Chinese government, why is corporate governance even relevant? All you can do is to trust that the parent company (hence the government) will keep it profitable. The good news is such company would rarely bankrupt.

Several implications of the story:

• Market economy

the market economy is this case would hardly work. Suppose you are one of the Shenhua managers (BTW, most of them held government positions) trying to maximize profit for shareholders, you won’t know what to do when the group tells you to pay above-market price for coal purchase, or hold longer for receivables, etc. They won’t do that being responsible, but it’s hard to know.

Or the governments says that you should sell coals to steel plants or power plants for less to help them overcome the economic downturn, since they are also owned by government. It’s socialism at its best.

• Stock market

this also illustrate why some guys advocate government supporting the stock market (though the premise is absolutely false). The Chinese stock market is government-driven, because the government has a lot in it. For stock pickers, it takes a quite different skill set.

• Environment issue

China is short of oil and natural gas but coal abundant and uses a lot of coals for power generation. The immediate issue is carbon emission and global warming, which is also a petroleum problem.

In a market economy, the government would have to adjust the incentives for the economics of the clean energy to work. For example, I seriously think the U.S. should hike the gas consumption tax, like Demark, besides the cap & trade.

The Chinese government, with its immense and somewhat skewed market power, can take a different approach. It’s a much simpler process in China to allocate land for wind and solar sites (the government, hence the people, owns the land collectively), maybe also biomass for incremental power generation. I didn’t do the math, but it would be worth it even with some heavy subsidies to begin such a national industry of tomorrow.

 

P.S. for investment decisions, look here.

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Debt, Growth and Interest Rate

Warning: this is a model.

A note on the relationship of federal debt, GDP growth and interest rate.

The Formulas

1. In the long run, the steady debt to GDP ratio is

Debt/GDP=Rdef/g

where Rdef is the rate of deficit (including interest payment) to GDP; g is the growth rate of GDP

2. In the long run, the ratio of deficit less interest to GDP is

(Def-Int)/GDP=Rdef(1-Rint/g)

where Rdef is the rate of deficit (including interest payment) to GDP; g is the growth rate of GDP; Rint is the interest rate.

What It Says

• The beginning debt to GDP ratio doesn’t matter in the long run
• If there’s GDP growth, debt to GDP ratio always stabilizes in the long run
• The net deficit (i.e., deficit less interest payment) depends on whether interest rate exceeds GDP growth
• If they equal, the net deficit is zero
• if interest rate is higher than growth, the net deficit is negative, or federal spending would have to be less than tax revenue
• The GDP growth rate here is nominal, so that inflation helps

An Example

Suppose the beginning Debt/GDP ratio is 80%, GDP growth 4%, interest rate 3%, deficit/GDP 2%:

Long-term Debt to GDP approaches 50%.

Net deficit would be 0.5% of GDP.

 

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What Mr. Market Says about Citigroup (C)

I did a ballpark (oversimplified) valuation on Citigroup, saying C should be worth more than last Friday’s closing price $1.50. Today C dropped 20% to $1.20, worse than other major banks.

I have to say I don’t understand what Mr. Market is thinking. The dialogue between the conversion scheme and the market goes like this:

The conversion: “We shall convert the preferred shares to $3.25 per common share.”

Mr. market: “It’s a bad deal for common holders. The per common share value should be worth more than the conversion price ($3.25), so that I decide to adjust the market price down to $1.20.”

Dah..

Either the conversion is expected not to go through, or something drastic will happen.

 

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FDIC: Why We Don’t Want to See Massive Bank Failures

If you’re one of the quarter-million north, FDIC should be as important to you as the new budget (for tax reasons).

Introduction

FDIC, or Federal Deposit Insurance Corporation, was created by FDR in 1933 in response to thousands of bank failures. History here.

What it does is that it establishes an insurance fund for customer deposits in the banks, so that even if your bank fails, your deposits are safe. Needless to say, its importance proved vital during today’s bank crisis – what do you do otherwise if you are worried about the safety and soundness of your bank?

When A Bank Fails

FDIC monitors and inspects banks regularly. It’s a huge workload: FDIC insures 8 thousand banks and supervised another 5 thousand.

If you care to know, this is what FDIC does when a bank is insolvent. It takes the bank into receivership, and sell the assets to pay down the debtors, depositors first. It operates based on the least cost analysis. 

An Example

Look at what happened to First National Bank of Nevada. The failed bank had assets book valued at $3.3 billion and deposits of $2.3 billion. The assets was written down by $2.3 billion in liquidation, resulting in a net worth of $-1.6 billion.

But FDIC insured and assumed the deposits, and took the loss.

Is FDIC Safe? 

Facing almost Great Depression 2.0, you have to think about things like this. Here’s some facts:

-FDIC now insures above $4 trillion of deposits, with Deposit Insurance Fund (DIF) balanced at $50 billion.

-All insured institutions has total assets $13 trillion, loans $7 trillion, deposits $7 trillion.

It very much depends on the asset combo and quality of the failed, and the availability of buyers. Suppose it resembles the aggregate balance sheet, loans valued 2 out of 7, other assets 4 out of 6, it will eat out 1 out of 7 deposits. I guess I will call it worst case.

If 5% of banks fail this way (worse happened), it will clean up the DIF.

Though history repeats itself, let’s hope it won’t happen again.

 

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