Thursday, September 22, 2005

BizzBlog Focus for September 23, 2005


Equity strategy some themes for the next five years
If you want to know my next week's favourite short you should stop reading now. This is about some themes I believe in for the next 4 to 5 years.

Equities and commodities to beat bonds. No large liquid asset class is likely to beat equities, apart perhaps from commodities. Equities are the only large, liquid asset class to benefit from economic growth. For equities I expect 3.5% dividend yield plus 1.5% real GDP growth, for a 5% real return. This compares with nominal German bond yields of just over 3%, and real rates of close to 1%, which I believe will rise. Commodities may do as well as equities or even better, as Asian (China and India) demand and lack of supply provide a favourable backdrop for another 5 to 10 years.

I prefer play European equities over U.S. equities. European equities in a global context are still catching up. Europe is still an exciting equity market that is catching up through issuance, privatisation and hopefully more entrepreneurship, the latter in part driven by favourable macro reform. In Continental Europe, market cap to GDP ratios were 4 times lower than in the U.S. in 1994, and still 2 times lower in 2004. European valuations are at a 28% discount to the U.S., versus a 20% historical average discount.

Buy European investment banks and consolidating industries like Telcos – new Tech - and Continental European banks. I think the corporate spending boom has much further to go. M&A as a percentage of market cap troughed in 2003 at 6% and is currently annualising at 10%. The peak was in 1999 at 14%. Another sign that I are early in the corporate spending boom is that bidders are outperforming the market and outperforming the targets if measured after the announcement. Corporate balance sheets are strong. Furthermore, private equity and LBO activity is rampant, as this is one of the most effective ways to benefit from low rates and low equity multiples.

The big risk is a consumer-, debt- and property-led recession around the world. This would be triggered by higher rates in the U.S., driven by the large current account deficit and the lack of household savings. The big surprise would be that Germany and Japan take over as drivers of global growth by sorting out their problems, and by their consumers spending more and saving less. My personal recommendation: Buy German and Japanese equities, avoid U.S. consumer exposure.

My model portfolio changes today I am buying Ciba Specialty Chemicals, WPP and ICAP, and selling Atlas Copco and BASF. The main theme is we are buying cyclical laggards on low/trough margins, and selling cyclical out performers on high/peak margins.

Materials remain my biggest overweight, with a heavy focus on cyclical laggards on low/trough margins, such as Paper and Specialty Chemicals. Media becomes my personal 3rd biggest overweight. Capital Goods become my biggest underweight.
- Ciba Specialty Chemicals (SFr 78.70) is expected to have an operating margin of 8.2% this year, just off last year's cycle-trough at 7.4%. Historical peak margins were 12.5% in 2001. The stock trades on an EV/sales of 1.1, at the bottom end of its historical range of 1 to 2.5. I view it as a classical cyclical laggard. Any move up in the dollar would help, as would moderation in the rise in raw materials input costs, which are currently at record highs.
- WPP Group (570p) has accelerating organic revenue growth, on my personal forecasts, together with rising margins. Global agencies are benefiting from strong Asian growth and recovering spirits within the corporate sector as the spending recession of the last few years ends. On 8.2x 2006 EV/EBITDA it is at a discount to its peers.
- ICAP (price 349p) trades at a 15% discount to other inter-dealer brokers and a 26% discount to other exchanges on estimated 2006 P/E of 16.3. Electronic trading now accounts for just 10% of revenue but is growing fast and is higher-margin business. Derivatives are a structural growth area.
- Atlas Copco (SKr 140). This stock has done very well. The analyst now expects 2006 EBIT margins of 18%, versus a previous peak of 15.1%. Average EBIT margins between 1999 and 2004 have been 12.9%. I do think the good news is in the price though. Its 2006 P/E is 13.3x, but its normalized P/E could be 20% higher if not more, we estimate. 2006 IBES P/E for MSCI Europe is 12.7 times.
- BASF (€60.10). Close to peak margins. Only 2% 2006 dividend yield versus market on 3.3%, I estimate. Has been a great stock but is now close to price target.


Koizumi Victory To Speed Reform
Prime Minister Koizumi's coalition won 327 seats in the Lower House. This exceeds the 2/3 majority needed to override rejection of bills by the Upper House. As a result, the postal reform bills will likely pass easily. Momentum for other reforms will rise, and the anti-reform forces are splintered, giving PM Koizumi a freer hand. The next areas are expected to include medical reform, civil service reform, public sector outsourcing, and government financial institution reform.

Market overview implications.
1 - Prospects for faster, more thorough reform should support the equity market.
2 - Bond markets will like the better prospects for fiscal reform, but fear the implied stronger economy.
3 - The yen will gain from more foreign money flowing into Japan, but lose from the lower risk aversion of domestic investors, who will send more funds out of Japan.

Two major risks. (1) The LDP could succumb to infighting. (2) Facing a fractured opposition, the LDP could become complacent.


Japan equity strategy vision
The Koizumi victory suggests a major shift to policies based on voter approval. The Koizumi government is establishing a new order in Japan's politics. This election moves Japan toward policy-driven politics, led by the prime minister. It also redefines elections to be tests of the popular will about policies, rather than money- and organization-driven tests.

The market implications in a short-term neutral, long-term positive. Although the ruling coalition won more than expected, I expect only modest impact in the short term because investors will quickly turn attention to the economic outlook and corporate profits. I maintain a view that the Nikkei should move toward settling in above 13,000 by year-end. In the longer term, I see a positive impact due to renewed hopes for fiscal, social security, and local government reforms.

Some risks are limited to populism. The real test of the Koizumi reforms will come after he leaves office. His successors may tilt toward mere populism.


China-Built Chrysler 300C
Chrysler Group president and CEO Tom LaSorda announced some major developments in Chinese and Taiwan markets that sure give to automaker a huge boost in both countries.
Today’s big blast is the announcement of a new joint venture to build the Chrysler 300C in China. Teaming up with long time partner Beijing Automotive Industry Corp., Chrysler we’ve created Beijing Benz-DaimlerChrysler Automotive Ltd., with the intention of building the car model. In fact, construction’s already started on a new plant where intend to build the 300C. By the moment the company reported just how popular the 300C is in China, Chrysler is gunning to expand its brands in the world’s fastest growing market.


Cautious but not pessimistic
The Taiwan stock market corrected 4.4% in August. Heavily index-weighted tech shares declined 5.7% and financial shares dropped 5.3%, whereas steel, plastic, and cement shares outperformed.

In my view, the tech sector's correction in August was caused by three factors.
a) Fear of slow demand after Dell's warning of PC inventory in the channel;
b) Worry that hiking oil prices and interest rate could dampen U.S. consumption prospects;
c) Potentially disappointing 2Q05 results.

I agree that sustained high oil prices at U.S.$70+ could create demand shortfall for tech products in 2006. In a high oil price environment, it is also understandable that technology shares are not a safe haven, as investors would be more cautious in their investment strategy. However, we still think that tech shares could lead a market rebound in the next few months due to the following reasons:
1) Tech end demand is still looking fine. Post Dell's inventory comments, ATI was the only major tech company to announce a performance warning, and it was more related to market share loss rather than slow market demand.
2) Taiwan tech companies' 2Q05 results were better than estimates.
3) I also believe seasonal momentum remains on track for the tech sector and we still expect to see 50% sequential profit growth for the sector in 3Q05 and another 23% QoQ growth in 4Q05.


Sky confirms TV to mobile plan
Richard Freudenstein, chief operating officer at BSkyB, used the occasion of his speech to the UK’s Royal Television Society conference in Cambridge to confirm earlier suggestions that the pay-TV operator was to launch a service offering access to the live content of entire channels through mobile phones. Sky is now in talks with 3G mobile phone operators to agree revenue-sharing deals, as well as suppliers of content to its existing digital platform line-up. Services offered would include Sky channels and third party channels that are carried by Sky on its subscription television service. It would include channels streamed to handsets and programmes made for viewing on mobiles. Sky has also revealed that its next generation of Sky + boxes would have a broadband capability, with consumers needing to go via Sky to use the function to download ‘on demand’ content.


India’s MTNL reveals triple-play strategy
State-owned Indian telco Mahanagar Telephone Nigam (MTNL) is launching a triple-play service, offering voice, broadband and cable TV on a single line. MTNL's the operator already procured equipment and that installation was under way, with service launch planned for November. MTNL has already secured deals with some 25 TV channels and the company is in negotiations with other channels for similar agreements. MTNL is planning to offer at least 200 channels in all.


RTVE's losses set to widen
State-owned broadcasting group RTVE - which operates La Primera and La 2 - plans to lose E801.7 million in 2006, 10 per cent more than the forecast debt for this year. In 2005, its accumulated debt will reach up to E7.56 billion. The group will see its ad revenues cut by nine per cent, from E801.7 million this year to E720 million in 2006, as a result of its planned audience decline following the entry of new TV operators in the market; Sogecable-owned Cuatro and a new analogue channel with a 70 per cent coverage. RTVE's budget in 2006 will amount to E1.54 billion, similar to that of this year with operating costs growing by 2.8 per cent up to E1.30 billion as a result of investments in digital terrestrial television.


Samsung STB for Sky Italia
Samsung Electronics announced a set top box contract with Sky Italia, the Italian satellite broadcaster owned by News Corporation. Deliveries are planned to commence in early 2006 to support the Sky Italia Digital TV service.


Online smut still homeless as .xxx is delayed again
ICANN has delayed again the approval of the .xxx top level domain (TLD) until an unspecified "future date".
The establishment of the domain was originally agreed by ICANN in June, but has been mired in political debate after conservative groups in the US raised concerns about having a TLD specifically for porn. President Bush stepping into the fray with his own worries about a virtual red-light district last month ( has only slowed the process even further. At a meeting on Thursday, ICANN's board of directors told staff that ICM Registry, the company that will operate the .xxx domain, will have to agree to further contractual provisions before the adult-entertainment TLD gets the green light. However, the hordes of feline lovers that surf the web - and what else could explain why "pussy" is such a popular search term? - need not despair. The .cat domain, intended to promote the Catalan language and culture, has been given the go ahead, and is expected to go live next year.
Source: The Register


Eurotunnel reports improved results in H1 2005
Eurotunnel has reported revenue growth of 2%, with an operating margin up 7% and net loss reduced by 18% to £87 million.
Shuttle services revenues were up 6% to £146 million, mainly due to higher truck shuttle volumes and yields. Railways revenue remained stable at £117 million, and remains protected until the end of November 2006 by payments under the provisions of the Minimum Usage Charge (MUC) in the Railway Usage Contract, which amounted to £36 million in the first half of 2005.

Operating revenue for the first half of 2005 was £268 million, a 2% improvement compared to the first half of 2004 at constant exchange rates. Operating profit improved by £12 million (19%) to £74 million for the period due to increased revenues (£5 million), reduced operating costs (£4 million) and reduced depreciation and provision charges (£6 million) despite the increase in non-trading charges (£3 million).

In 2006 the Group will no longer benefit from the Stabilisation Advances, rendering the cash flow position more vulnerable particularly at the end of July and October 2006 because of the interest payments due under the current Credit Agreements. Furthermore, Railways revenue will no longer be protected after November 2006; payments under the provisions of the Minimum Usage Charge (MUC) in the Railway Usage Contract for the first 11 months of 2006 will have an estimated effect on cash flow amounting to approximately £65 million.

From the first half of 2007 Eurotunnel will not be able to meet its contractual debt repayments.
Eurotunnel has obtained a waiver from its Lenders, valid up to 31 January 2006, which defines the conditions under which the Group can undertake debt restructuring negotiations with its creditors.

The Group is subject to two uncertainties: the ability to continue as a going concern and the carrying value at which the Group’s assets are recorded in the accounts. The Group is currently working on a refinancing plan, in which the level of indebtedness may differ from the underlying assumptions used at 31 December 2004. The Group has not revised its financial projections, which is normally carried out during the second half of the year as a part of the preparation of its medium term plan.

- Under the Railways Usage Contract dated 29 July 1987 between the Railways (SNCF and BRB) and Eurotunnel, the Railways are required to pay a contribution to the operating costs of Eurotunnel in each year. In November 2001, the Railways initiated arbitration proceedings aimed at reducing the amount of the contribution for the years 1997 to 2002. The amount claimed by the Railways for all of these years together is estimated to be a maximum of £100 million.
The Arbitration Tribunal rejected the Railways’ claims in respect of 1997, 1998 and 2000 on the basis that they were time barred. The Tribunal also rejected the Railway’s claim on allegations of breach of contract by Eurotunnel. The Tribunal ordered the Railways to pay to Eurotunnel the full amount of the provisional contribution to its 2002 operating costs.
- While the Tribunal’s decision regarding the final amount of the operating costs contribution for non-time barred years 1999, 2001 and 2002 has yet to be pronounced, Eurotunnel remains confident in the outcome of these proceedings and has therefore made no provision in the Group’s financial projections.

The termination of the contract between Eurotunnel and Transferry has resulted in a contractual dispute. Eurotunnel has accelerated improvements in its operational performance. Increased revenue in our core shuttle business has been achieved within the framework of a new marketing strategy based on our key benefits: frequency, speed, and reliability. In accordance with Eurotunnel’s timetable for the planned financial restructuring, a business plan was presented to its creditors in advance of the June 30th deadline. Negotiations with the Ad-hoc Committee and two other creditor committees remain confidential, although a progress report is expected to be released by the end of October.


Oracle to acquire G-Log
Oracle has entered into a definitive agreement to acquire G-Log, in a move that will enable Oracle to offer customers the first complete, information-driven logistics management platform for any industry with global supply chains.
Oracle and G-Log have complementary products with a shared focus that information and adaptive business processes are key to achieving corporate supply chain goals. According to Oracle’s, partners and customers will have access to proven best-in-class transportation and logistics capabilities combined with comprehensive, world-class capabilities in ERP applications and technology infrastructure – all from the same vendor. This is expected to significantly reduce total cost of ownership while increasing customers' ability to operate an integrated, information driven enterprise. By combining the talents of both organisations, we will be better able to address evolving partner and customer needs and effectively respond to industry trends that are driving the demand for complex logistics solutions. Oracle integrated solutions for logistics and transportation will address customers’ critical logistics requirements more comprehensively and will facilitate transformation of customers' logistics operations to leading-edge infrastructure that improves competitive advantage.


Intel's Manufacturing Strength Still Preeminent
Intel continues to lead the semiconductor market in manufacturing process development and in fab capacity,. Intel currently has three 90nm fabs, and will have four 65 nm fabs, including one retro fit and one 90nm conversion, ramping in 2006, the high-tech market research firm says.

But future process technologies will pose challenges as Intel and the rest of the industry struggle with rising leakage current and limitations with current process technology. As other semiconductor manufacturers turn towards partnerships for developing new process technologies and manufacturing capacity, Intel is one of the few vendors that can continue to push ahead alone and uses its technology and capacity as a competitive strength. For example, in 2004, with a strong transition to the 90nm process node and 300mm wafers, Intel realized an estimated savings of $1 billion in manufacturing costs.
A recent market analysis report found the following:
- Despite the rising cost of fabs, mask sets, and in some cases, the die size, Intel's average manufacturing cost per die will remain relatively constant at approximately $40 during 2003-2005.
- Intel's continuous goal to shrink die sizes has resulted in the ability to double on-chip cache sizes with every process generation. In the future, however, Intel will be balancing the use of this transistor budget for more memory and additional cores as a way to increase performance.
- With the transition to 65nm, Intel is planning to begin moving its entire product portfolio, including logic and memory, to a single process.