Time to ride the Asian tigers

The US-inspired love affair with technology, media and telecom stocks seems truly over. Many investors are afraid that there is still more pain to come and so they are searching for new places to put their cash. For those with an inclination towards the contrarian, a look at South East Asia markets might be fruitful.

The Tiger economies of Asia were the real emerging market stars of the 1980s and most of the 1990s. Their economies and stock markets almost without exception performed fantastically, with both corporate earnings and price/earnings multiples growing impressively. But in the second half of 1998 a financial crisis hit the region and Western investors bailed out in droves.

Most have not returned. Despite remarkable underlying economic recoveries, many Asian stock markets are down 30 to 50 per cent this year, thanks to a strong oil price, weak currencies, political uncertainty and apathy and fear from investors.

Effectively, many of these Asian markets have become irrelevant to global funds – and in many cases even specialist Asian funds. Badly burnt shareholders have despaired of crony capitalism, government bailouts, poor corporate governance and terrible liquidity. During the past two years, investors who sought risk found their fix in US internet plays and decided that Asia was too far away, too corrupt and too unstable. Silicon Valley was a wild enough ride. Institutional allocations towards many Asian markets have fallen virtually to zero.

There are many signs that markets such as Thailand, South Korea and Indonesia now offer compelling value for those who like to swim against the tide, and can cope with some risk and volatility. Both the Thai and Indonesian equity markets are down over 50 per cent in dollar terms this year. Many shares languish at the same levels they reached in the depths of the 1998 crisis – despite strong turnarounds in the meantime.

Jonathan Neill at Fabien Pictet and Partners, who has covered Asia for many years, says he has never seen such bargains. He and one or two other experts like the Asia/ Pacific team at Morgan Stanley believe that these share price declines have more than discounted economic, political and earnings worries.

A major factor creating value in these countries is technical weakness, caused by distressed selling from US mutual funds suffering redemptions. Asian/Pacific funds have seen redemptions of $1bn year-to-date, or 17 per cent of overall assets. In many cases analysts and fund managers have given up and are concentrating their emerging market resources in Latin America. Local brokers are downsizing and share volumes are pathetic. Issuance of paper has all but ceased, and initial public offerings are entirely absent. These are all excellent indicators of a market bottom.

Yet overall the nations of South East Asia are still undergoing rapid modernisation and sharp rises in population and gross domestic product. Their unloved currencies have made their exports super-competitive and many countries are running huge trade surpluses. Companies have been building up large foreign exchange reserves and improving the quality of corporate disclosure and accountability. If sentiment recovers, stock markets and currencies will appreciate.

One of the best ways to gain exposure to these bargains is via country funds. These are mostly listed, closed-end funds managed by specialists – there are a number traded in London and New York. They are easier to deal in than directly trading stocks quoted in places like Bangkok and Jakarta. They hold a portfolio of stocks and give shareholders balance through diversity. They also tend to trade at discounts to their underlying net book value. Given the unpopularity of Asian markets, the discounts have widened and are frequently 30 per cent or more.

If the Pacific Rim returns to favour among investors, not only will stock prices recover, but fund discounts will also narrow. Hence shareholders in these funds will get a double whammy on the upside. Funds worth a look include the Thai Prime Fund, Thailand International Fund, and the Thai Euro Fund. Find out more about closed-end vehicles at http://www.trustnet.com.

In many oversold Asian markets, large cash-rich companies in solid sectors like food and utilities stand on p/es of two or three. If the markets stage a comeback, such shares could treble rapidly.

Any one of several factors could trigger a revival. Domestic investors could switch their savings from the banking system to the stock market; mergers and acquisition activity could rise, fuelled by climbing corporate liquidity in many cases; companies could step up their share buyback programmes; or Western pension funds and other institutional investors could switch their asset allocations away from highly rated US stocks towards bombed-out Asian markets.

Investing in countries like Thailand, South Korea or Indonesia is not for the faint hearted. Emerging markets can be very volatile – as the extraordinary gyrations in the Turkish market this week have shown. But for those who have enjoyed the high risk/high reward of tech stocks and like betting against the crowd, now could be the time to take a punt on the Far East.

Don’t give the Panel a beating

FOR those both inside and outside the City, the Takeover Panel is a mysterious organisation – a cross between a classic Quango, the Masons, and the Spanish Inquisition.

There are some who think it is a fine body and a much superior system to the chaos and litigation prevalent during bid battles in many other countries. However, some who have dealings with the Panel find its rules arcane and its pronouncements obscure and unpredictable. It operates free from public scrutiny, able to invent and waive rules as it sees fit, helping to decide the structure of British industry. Is it the best system to police public company amalgamations?

Technically the Takeover Panel is a non-statutory body but it can punish offenders by reporting breaches of its rules to various regulators including the Department of Trade and Industry and the Financial Services Authority. In practice this means most City players take its machinations very seriously since they can be driven out of business if they ignore the Panel. There are instances of overseas companies quoted in London but registered overseas to which the Takeover Code does not apply, but these situations are rare.

The bible the Panel administers is the City Code on Takeovers and Mergers. This is a complex manual which is too obscure to have an index or numbered pages. It is full of curious terms such as “Whitewash” and “Concert Party” which tend to have opaque meanings. It seems deliberately esoteric in order that only specialist advisers understand it. These people think nothing of charging thousands of pounds for simple interpretations of a few sentences.

The Panel executive is made up of lawyers, accountants and investment bankers, most of whom are on secondment from big City firms. They help manufacture work for their colleagues in professional firms in a delicious merry-go-round of fees for the Square Mile elite. At least, this is how the Panel’s decisions can appear on a bad day.

My experience has been that the Takeover Code is applied pretty rigidly to any British public company, no matter how small it is or even if it is completely unquoted. This means the whole rigmarole of expensive and time-consuming offer timetables has to be followed whether or not it is realistic given the size and resources of the company in question.

It would be a good idea for the Takeover Code to be substantially modified for unquoted public companies and smaller public companies. The cost and time taken to comply with it and its quirks can be extortionate for small companies or those in trouble.

Even though it purports to be independent, the Bank of England effectively runs the Takeover Panel. It is full of figures from the financial establishment such as Andrew Buxton, Sir Christopher Benson and Lord Stevenson. Of the 16 members, only two are from industry – the rest are investment bankers, lawyers, accountants and institutional investors.

The panel’s members are mostly chosen by Sir Eddie George and his chums. I think they should choose more members from industry and develop a more open selection process when assembling the panel. Ideally the panel should be totally separated from the Bank of England to give it true independence.

It is interesting to compare the Panel with the regulatory regimes in other countries. In the United States the Securities and Exchange Commission controls takeover activity among public companies. Tender offers there are drawn out and highly litigious compared with bid battles here. The situation is complicated by the existence of both state and federal laws governing corporate acquisitions.

Our Takeover Panel appears a far more flexible and simple organisation than all the paraphernalia in place in the US. In places such as France and Germany there is no independent, experienced, non-governmental body which makes sure shareholders are treated fairly during takeovers. It means takeovers there are fraught with tactical litigation and political interference.

Indeed, if one compares the workings of the Takeover Panel with organisations such as the London Stock Exchange or the Office of Fair Trading, then it seems a low-cost, efficient outfit.

There has been vague talk that it should become a statutory entity, rather than a voluntary body. This would be a bad idea. It has been successfully supervising Britain’s public company takeover scene since 1968 and should be allowed to remain broadly as it is – with perhaps just a few tweaks to make it more user friendly and economic – just like a workable web site!

Don’t believe all those hot tips

Last year I appeared on a live Channel 4 lunchtime programme called Show Me The Money. I was there to promote a company of which I am chairman.

My two minute pitch to the panel of private investors came at the end of the show. But during the first 15 minutes, the shares of my company rose by 20 per cent – the market had “guessed” which stock was being featured. It was a stark example of the power the financial media now have over share prices and the whole stock market.

It is not just that the media now move markets. We are in danger of being overloaded with financial information. The internet has vastly expanded the quantity of statistics and analysis available to the man in the street. The print media have retaliated by beefing up their stock market coverage. The resources devoted to investment and corporate news by all media – old and new – have increased dramatically in recent years.

Sales of the Financial Times are at a record high; there are more financial web sites than ever before; there are satellite television channels dedicated to financial news, and much more coverage by the main broadcast TV channels than ever before – even the tabloid newspapers now have sections devoted to helping the public to get rich quick.

One of the consequences of this avalanche of space and time to fill is that journalists and commentators are ever more desperate for a story. This means they are more willing to swallow PR plugs and believe silly rumours. So although the quantity of words written and broadcast about the stock market has expanded exponentially, the quality of most material remains questionable.

Too often there are attempts to push particular stocks or manipulate prices, and the reporters either are duped or knowingly co-operate in return for other stories. In other cases the writer has done no homework and the piece ends up filled with errors.

The whole media circus whirls ever faster. The broking analysts need publicity and so feed ideas and research to the media – and the media puff stocks because they don’t know any better or they have a deadline and need the copy.

Unfortunately, the masses are not always educated or discriminating enough to know what to believe or how to interpret what they are told. Gossip and leaks masquerade as fact in market reports and tipster columns. Read the bulletin boards and you can see how gullible and reckless are some private investors. They actually believe what they read in the newspapers and have faith in the online finance services – instead of having healthy scepticism and doing their own research.

The tech boom and bull market have fed this mania for financial news. Investors watch the market on TV, read about it in magazines, tune in on the net and chatter on their mobiles. Everyone wants to be a millionaire on the stock market – and new issues seem like the easiest money of all!

In fact, flotations need a positive spin in the media more than anything else in the market. So the financial pages are full of stories of exciting upcoming floats, rather than warnings about the risks. Financial PR firms have waxed large on the juicy fees companies are willing to pay to get favourable media coverage. There is little money in being bearish or critical – and no thank you parties or friendships.

Part of the problem is that journalists do not enjoy the huge rewards given to their chums who work in the City. It can be difficult to recruit the brightest and best to work long hours as a humble reporter when even lowly analysts and broking salesmen can earn £150,000 a year.

Yet the media are more important than ever in deciding the outcome of bid battles and the success of a new issue. Competition between publications, web sites and TV means that original stories are harder than ever to find and there is little time for proper investigation.

Broadening the flow of information about financial markets to the public is, in principle, a good thing. We live in an age when people seem more prepared to take their future into their own hands – and the more they learn about what goes on in the Square Mile, the better.

But deal with the fortune tellers and gurus with caution. Sometimes they are right, but often they write and talk rubbish. And never forget that behind the scenes someone might just be pulling their strings. As usual – cut through the static and make up your own mind.

Is Scoot worth the loot?

THEY say there are four ways to get rich. You can make it, inherit it, marry it – or get lucky. And the best of all is to be lucky.

It seems to me that Robert Bonnier is lucky because he is the chief executive and almost 9 per cent shareholder in Scoot.com. His holding is worth some £75m at today’s price of 150p. Indeed, in the past year Bonnier has spent £6m in cash to buy more shares – a lot of after-tax dosh for a 30-year-old ex-stockbroker. He also has 7m options at 25p – worth nearly £9m on paper.

Now Bonnier might say: “But I’ve made it!” I take the view that he and Scoot.com are lucky because Scoot.com has lost money every year for the past five years (£72m) and brokers project that it will lose more than £80m in the next two. So in terms of actual “profits”, none has ever been made.

Scoot was once called Freepages, and before that a builders’ merchant called, eerily, Blagg. It is a company that has reinvented itself more than once, and to judge from its £900m market capitalisation, the transformations have been hugely successful in stock market terms. Originally, Scoot was a freephone equivalent of Yellow Pages – customers would be given telephone numbers of advertisers who had paid Freepages to be mentioned.

This business model didn’t really work, but by the time that had been rumbled, the internet had come along and a new model was created – based on the internet! Recently, Scoot reinvented its business model yet again by acquiring Loot, publisher of classified advertising newspapers, for £189.8m – of which effectively 95 per cent was in cash. One cannot help but suspect that the wily vendors who cashed out knew what they were doing in that transaction by taking the money and ignoring Scoot’s paper.

Loot had historic revenues of just £30m and profit before tax of £2.2m, so it was sold on a p/e of at least 120 times, and a revenue multiple of over 6 times. Scoot could only pay such a mad price for Loot because it has a fairy godmother in the form of Vivendi.

Vivendi is a bizarre French conglomerate that now owns 22.4% of Scoot.com, having subscribed for boatloads more shares in June at 230p to pay for Loot. I was a shareholder in a business bought by a French conglomerate last year, and it overpaid so massively it took one’s breath away. So anything is possible with such organisations. I believe the only reason Scoot’s shares are where they are is because of hopes of a bid from the French. Shareholders should remember than VNU, a previous fairy godmother, unloaded its 9.5 per cent stake – so a takeover cannot be guaranteed.

Scoot has an interesting share register. Ronald Zimet owns almost 53m shares. He used to be chairman, but stepped down after becoming embroiled in the Andrew Regan/Co-op bribes affair, which is due to come to court soon.

Scoot itself gets enmeshed in curious activities – it hired private detectives not long ago “to track down the source of an anonymous and highly critical report on the company, which accused it of overstating subscriber figures”. Hiring private detectives seems an extreme measure. What is Scoot so worried about? Are private detectives going to go through my rubbish bins after this article?

As it happens, and by sheer coincidence, I have separately met two ex-Scoot staff in the past couple of years. What they said about how the group functions on the ground was not encouraging. But then perhaps they are just embittered.

The problem with companies such as Scoot is that despite its substantial market value very few analysts really cover it, and those that do may not actually understand it. One analyst’s circular said it offers “an integrated infomediary model . . . [by] becoming an impartial transaction facilitator . . . a leading, multi-access, local transaction service provider”. What does that mean? I often find jargon is used when real comprehension fails.

And understanding its valuation is certainly beyond me. In its third quarter alone, to June 30, its loss rose by 44 per cent to £20m, while revenues dropped 38 per cent to just £8.2m – because it changed from a “fixed to a variable pricing model”. It says it has at least £60m in cash, but at the current burn rate that won’t last long.

The only reason I can see to buy a share like Scoot is the hope that Vivendi will bid. Excluding Loot, Scoot seems to be showing a sharp decline in sales and soaring losses. Indeed, it will surely have to raise more cash in due course if it wishes to really roll out its service across Europe.

I think lots of other organisations offer a similar and possibly better service, and I am highly sceptical of non-niche subscription services on the net, when there are so many free search services. The upside must be very limited: the downside could be massive. What do the shareholders see that I cannot?

Spot the web masters from the misses

I have seen 100 or more internet business plans in the past 12 months. Many of those projects have failed to raise any money – a few have got the capital they wanted.

How do you choose between them? What are such companies worth? Which are likely to be the really big winners? Which one might become the next Freeserve, or QXL, or even Yahoo?

These are very difficult questions and scientific replies are not straightforward. Part of the problem is that you cannot judge such early stage technology companies like conventional businesses. The game plan with such projects is normally to take the business public as soon as possible. And if you want to do this, it seems to me that some factors become more important than others – a few of which I list below:

Marketing: This is easily the biggest variable cost for many technology companies, be they business to consumer or business to business.

The web sites and internet plays that are more likely to succeed are those that have a clever way of recruiting customers, such that they do not have to risk a large proportion of their funds on very expensive media spend.

By this I mean the internet companies that can build trade via word of mouth, public relations, free cross-marketing or some other method which is effective but involves minimal cash outlay. A very large proportion of web companies that fail will do so because of poor sales, or sales which cost too much marketing spend to get.

* Partnerships: investors, executives, advisers and other stakeholders seem to love companies that recruit major technology or media or trade players as shareholders or partners or key customers.

From Scoot with Vivendi to Microsoft’s early arrangements with IBM, the route to market and credibility is all about established groups taking an interest in the particular start-up. Having the right big name on board might help with sponsors for an initial public offering or to access eyeballs.

Assessing such high risk for nascent companies is as much about belief as it is about gritty analysis. Getting endorsement from a sharp trade player gives a new company authority.
* Technology: it might be obvious, but simply having a neat idea is not enough. To really have a decent chance of doing well, your business needs superior technology. So software companies with proprietary programs and tools are much more likely to make a healthy return than a natty e-tailer going from bricks and mortar to an online model.

Unique, protected technology provides barriers to entry. This is reflected in the margins such companies make: a software business might enjoy net margins of 30 per cent – an e-tailer might achieve 5 per cent.

*Management: all companies are entirely dependent upon their people. But where you only have management and ideas and no physical assets or existing sales, and if you’re lucky a prototype or even the odd patent, then you are relying more than ever on your opinion of the founders and managers.

Consequently, you should only ever back an internet business when you are entirely impressed with the senior people in all respects. Only support the best – there are enough new companies out there that you should only work with the highest calibre individuals. And if there are major omissions in the management team, then forget it.

As you can see, I believe that using financial techniques to weigh up internet companies is much less important than looking hard at the business basics.

Everyone can prepare a series of spreadsheets of projected revenues, profits, cashflow and so forth. But these might all be a fantasy. The assumptions are the bit that really matters when looking at such rows of numbers (which curiously always go up, and always show amazing profits by the third or fourth year and painful losses in the first).

And the qualitative details of the market, the management, the selling, the technology, the actual operations and the competition are much more important than the projected numbers.

If you are tempted to take the analyst’s and accountant’s projections seriously, you can use several methods which the boffins are applying. For example, multiples of sales or discounted future cashflows, or something called analysis by components.

In truth such devices are dangerous because they might fool you into thinking that valuations in this field are rational. Momentum, fashion and sentiment are far more influential in determining prices and valuations of early stage technology firms than exact number-crunching.

As ever, the single most important factor when deciding whether or not to risk your money in such volatile investments is timing. Is this the right business for now? Will I be able to sell my shares even if their plans do not succeed? What is the next wave of technologies – is this one? Has this management a good track record in spotting and exploiting trends in technology? It is not easy catching the “next big thing” or jumping ship at the right moment.

I hope the above advice will be a little help in your adventures.

EBITDA is not everything

Corporate bonds typically make up 40 per cent of traded debt markets. The key players in this are the issuing houses – almost all the major investment banks – and the credit rating agencies. Firms such as Standard & Poor’s and Moody’s are highly influential in their assessments of the risk of default of bonds.

The ratings they grant bond issues determine what yield investors demand and therefore the cost of the debt to the borrower. This handful of agencies is consequently very powerful.

They employ a lot of boffins who crunch numbers deep into the night trying to work out whether to award an AAA or an AA rating to a particular bond issue. Occasionally the research they produce for external consumption can be first rate. Moody’s Investors Service has just published such a paper, titled Putting EBITDA In Perspective.

As many readers will know, the acronym EBITDA (Earnings before interest, tax, depreciation and amortisation) has been a fantastic catalyst for the equity bull market of the past 10 years or so. This alchemy has enabled new paradigms of valuation and sent dull old price/earnings ratios off to the knacker’s yard.

Why pay a p/e of 7 when you can show that a stock has an EBITDA multiple of only 6! Look at the cash flow, stupid. This is the age of low interest rates and high gearing – so what matters is your ability to service debt – which is tax efficient anyway.

However, Moody’s points out that too much reliance upon EBITDA can be dangerous. The usefulness of EBITDA relates intimately to the scale of the depreciation and amortisation charges.

In the past, many leveraged buyouts (LBOs) were of companies that had supposedly over-invested in plant and equipment so that capital expenditure would be unnecessary for some time to come. So the depreciation charge was too high, so that cash could be used instead to repay debt and service interest.

The growth of private equity and the culture of the buyout means a large proportion of the bargains have gone. Most conservatively managed companies which once stuffed everything into capital expenditure have either been bought or have changed their ways.

In these days of shareholder value, companies are bullied to use any cash available to either buy in shares, or pay special dividends, or make acquisitions. These companies may well be under-investing and becoming steadily less competitive, and less well placed to withstand any trading downturn or a recession.

Certain ex-buyouts which float have been starved of investment for the three years pre-float to pay for the borrowings taken on to buy the business. These new issues are likely to underperform because the company will have probably fallen behind in productivity.

The LBO will have been done on the basis of an EBITDA assumption without proper analysis of what reinvestment is required for the company to remain efficient. Inflation can mean that the investment required to maintain plant is greater in today’s money than the depreciation charge of historic capital expenditure.

One of the points about EBITDA is that it ignores working capital. Sales and profits might be recognised (and therefore boost EBITDA) but cash not actually received until later.

Frequently financial statements feature EBITDA before one-off items. The trouble is that the one-off items keep recurring, and they might still absorb cash. EBITDA does not measure the liquidity of a business – reported numbers are not the same as usuable cash in a bank account.

These days balance sheets feature lots of goodwill, most which is amortised and therefore added back to earnings to arrive at an EBITDA figure. But in some cases these amortisation charges relate to items of uncertain value: in these cases amortisation should not be added back – the questionable item should be written off. Here the costs should not be capitalised as assets but expensed through the profit and loss.

I have written before that investors should not rely on p/e ratios alone as a measure of value, but should focus on true cash flow among other things. According to Moody’s, buyouts and similar debt driven transactions should not rely too heavily on EBITDA ratios. EBITDA alone does tell one much about the quality of a company’s earnings, assets or its accounting. These days investors need a sceptical eye.