Not just old …
Europe is known as the old continent. The cradle of the culture of the Western world. In the field of communications, we believe that it would be appropriate to place the adjective old alongside that of short-sighted. Europe, the old and short-sighted continent.
Years of over-regulation in the telephone sector in Europe have caused it to lose the leadership it had 20 years ago and have relegated the continent to the world’s bottom rung in terms of infrastructure. The outlook here in 5G is very negative with loss of competitiveness, economic growth and prospects for the next generation. It’s hard to blame the national regulators, created and structured with the mandate to lower the cost of interconnection for the final consumer. Here the deficit is political and resides in the Competition Commission and, in general, in Community policy. The results are there for all to see. Over-indebted, unprofitable telephone companies with limited investment margins.
Below are a couple of charts taken from a Niche study on 5G. The first is a comparison between Europe and USA. In the U.S. operators are few, so there are significant cost savings, and phone plans are much more expensive. The result is a more efficient network and much faster 5G adoption.
Source: ETNO, NicheAM
Here is the second table representing the change in EBITDA for European and US phone companies from 2008 to 2018. For the European companies, EBITDA has almost halved in 10 years (and far more in real terms), while for the American companies it has almost doubled.
Source: Ovum
These are stark figures that invite investors, Brussels, and every national regulator to reflect. And the results are starting to show. In the UK, Holland, Belgium, and Germany something is changing. If change does not come the EU will have to invest directly in the network, a solution that would go against the last 50 years of privatization based on the experience that public infrastructure is not efficient. We expect the changes to continue. It is for this reason that we are well invested in European operators where we find margins on the bone with huge operational and financial levers. If improvements continue, the upside can be surprising.
中国人的远见
The translation of our title in Mandarin is “Chinese foresight.” And this is what Xi Jinping seems to be demonstrating in recent months.
Xi Jinping, the son of a well-known politician and acolyte of Mao Zedong, who fell into disgrace because of his critical attitude towards the government (in particular towards the Tianamen repression), took advantage of the experience of the fall in living standards that his family suffered as a result of his father’s political events. He was able to gradually grow within the party with a much more consensual approach than his father’s reformist ambitions. In hindsight, it seems that this approach was more instrumental to the attainment of apex positions than his true instincts that emerged later. In fact, he is proving to be very reformist like his father although, unlike the latter, somewhat illiberal. Calm and decisive, Xi Jinping, strengthened by his solid internal power, can sacrifice growth and consensus to ensure greater stability in the medium term. And this is the reading we give to recent events.
Over the past 24 months, a series of never-ending events have hit the Chinese market. China had already been at the centre of a stream of negative events in 2019 and 2020 starting with: 1) A trade war between China and the US that was triggered by Donald Trump; 2) Huawei, the world’s largest telecom equipment manufacturer being banned from Western markets; 3) Warlike attitudes in the China Sea aimed at reasserting control over neighbouring territories creating international friction; 4) A series of restrictive measures in Hong Kong triggering a series of protests that were harshly suppressed by the Chinese government; 5) A series of Chinese government-owned enterprises (SOEs) being delisted from the US market by Trump.
This news flow hit the Hong Kong market hard, which lost 15% in euros last year, while it did not dent the Chinese mainland market, which recorded a 24% performance in 2020, buoyed by technology stocks, and providing a remarkable signal of strength. This signal, together with the election of Biden, which boded well for Sino-American relations, made the Chinese market one of the most sought-after areas by investors at the end of 2020.
This year, the Chinese government began a regulatory overhaul in a growing range of sectors. Initially this affected large Chinese internet companies in online commerce (Alibaba lost about 50% from highs), gaming (Tencent lost about 45% from highs), transportation (Didi lost about 55% from highs) and music (Tencent Music lost about 75% from highs), which the Chinese government felt did not provide adequate competition. A review that, albeit with a different approach, we could also expect in the West, since the competitive capitalist dynamics seem to have lost the ability to manage the excess of market power (in this regard we point out a recent good article by Ruchir Sharma).
Subsequently, the government then pounced on the private education industry with companies like Tal Education losing about 90%. Not content with that, the government also touched companies in online prescriptions (Ping An Healthcare lost about 60% from its highs) and, indirectly, those in luxury (Kweichou Moutai, the exclusive liquor giant, lost about 40%). It is being studied who will be the next target.
The government’s intent is probably to curb the dominance of select player in recent years, which have led to a reduction in competition in many business areas and the emergence of a series of influential and untouchable super-rich. We also witness this development in many other areas of the world. The side effect of such manoeuvring is to slow an enthusiastic stock market. This is good: the last thing China needs is a stock market bubble. Also, structural reforms should be promoted when the economy is doing well. Like at this stage.
Today the Hang Seng trades at 9x 2022 earnings and 13x the Shanghai Shenzen CSI 300. For the Hang Seng we have value investor valuations, while the CSI allows the growth investor to stretch on high growth stocks at reasonable valuations. Below is the two-year chart of the S&P500 (green) vs CSI300 (orange) and the Hang Seng (purple).
Source:Thomson Reuters
It is hard to imagine a recovery anytime soon. Investors are scared, confused. By nature, they flee from political uncertainty and apply significant valuation discounts where it occurs. However, we put trust in Chinese common sense and believe that what is happening today lays the basis for a recovery of the Chinese stock market later on. For those who are value-oriented, and therefore accustomed to accumulating patiently during difficult phases, as already mentioned, the Hang Seng today offers a good universe from which to select securities.
We launched on the Asian Niches fund at the beginning of the year the Niche “the CUB” (China Under Biden), which wanted to benefit from the improvements in relations between China and the US by investing in state-owned enterprises (SOEs) exposed to Silk Road infrastructure (“one belt, one road” project). Companies hailed this in 2017 but now the enthusiasm has gone, condemning them to trade at 5/6x earnings and on average half tangible equity. The Niche has been defensive and is up since the beginning of the year by 22% in euros to the Hang Seng and CSI300 being down about 2% (see chart below of The CUB vs CSI 300 Niche). When we launched the Niche, we were more positive about the improving dialogue between China and the US. However, it is precisely the cooling of globalization and Sino-US relations that has given greater strength and urgency to the process of connecting to emerging countries through the “one belt, one road” project. Valuations are still very low and the status of SOEs protects these companies from hostile government attitudes. If, as we believe, the next decade will see physical infrastructure take on a driving force for global economies, this Niche could be very rewarding.
Source: NicheAM, Thomson Reuters
Logbook
Results season is almost over. Macy’s is the only company in our portfolio that reported this past week. It reports very nice data. Margins are back to a healthy level, which allows a path to debt reduction and shareholder returns to begin. A third of sales are now digital and the figure is set to grow. The company trades at 4x EV/EBITDA, 7x earnings, 1.5x tangible equity and in 12 months should have repaid most of its debt.
Western Areas is a mining company we have in our portfolio that has entered into discussions with the other Australian IGO that wants to take it over. The company has the concession for several lithium sulphate mines, the material needed for batteries for electric vehicles.
Tassal. Huon Aquaculture received a takeover offer from the Brazilians firm JBS this week at a 35% premium. Huon Aquaculture is Australia’s second-largest salmon producer after Tassal. The purchase price would equate to multiples over 50% higher than where Tassal trades, a company that trades at a steep discount to global salmon farming players and which we hold in our portfolio.
This week it’s the turn of several Indonesian companies that are reporting at a lag to the rest of the market. Among these are several that we have in our portfolio.
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