Monday, March 27, 2017

Boomerang: Travels in the New Third World

It's been hard finding bargains in this long bull market. With the extra time lately, I've been reading a bit more.

The most recent book is Boomerang by Michael Lewis. As expected, the story was entertaining, humorous and insightful. Michael Lewis is quite the story teller. In Boomerang, he takes the readers around the world to Iceland, Greece, Ireland and the US to explore the financial crisis that unraveled their economies.

There are some keen observations on the collective "madness" that drove these countries to the brink financially. At it's core, many of the failings can be attributed to a faulty wiring in humans that cannot delay gratification. That, punctuated with greed, envy, FOMO, creates both the excess and the subsequent crash that occurs all too often. It's like another variation of the gold and mining stock bubble that was described in The Big Score, similar psyche, different market.

The story continues to play out in housing in Australia and Canada which exhibits many parallels with the Irish bubble experience.

Saturday, March 25, 2017

The Big Score: Robert Friedland, Inco, and the Voisey’s Bay Hustle

Just finished this book called The Big Score. Not the Big Short, but the Big Score. The book is quite old, first published in 1998. It's a fascinating story about a Canadian mining company in the 90s. Very well written. The author weaves a great storyline, that's compelling and tense, but also easy to read and understand.

The story surrounds a group of stock promoters. Their modus operandi is to create a company (in this case, a mining company) and hype the story of huge discoveries, get the stock up and sell out at the top.

In this case, the company was Diamond Fields, a promotional story made to explore for diamond resources globally. After a string of busts, the company somehow lucked out when it got in touch with two prospectors in Newfoundland. The prospectors had discovered the massive Voisey's Bay nickel deposit in Labrador, Canada. The company at first did not even pay attention to the discovery. Only afterward did it realize and exploit the potential of the claims in Labrador.

And exploit it they did. Somehow, they managed to start a bidding war between the two largest Canadian nickel miners at the time, Inco and Falconbridge. The story ended when the once penny-stock Diamond Fields was sold to Inco for over $170 per share, split-adjusted. The transaction value at over $4 billion was the largest ever paid for a single potential mine.

The transaction also led to a boom (or even bubble) in Canadian mining start-ups/scams. Investors around the world clamored with their capital to get a piece of Canadian mining companies. Eventually this all collapsed, as it always does, with the Bre-X gold scandal and more rational behaviour. In some ways, this story has played out again in the mid 2000s in mining and O&G boom in Canada. The conditions may also be similar to the current real estate boom/bubble in Vancouver and Toronto. Inflated and rapidly rising prices, excess capital from around the world, increasingly "sketchy" players.

After reading this book, it's no wonder why it's so difficult to invest in exploration or early-stage mining companies on the TSX. Without a strong geology background and many decades of experience, it's almost impossible to not to get duped. Even with that, you are subject to a million things that can go wrong, such as financing, the integrity of the managers, stock promoters, fake claims, fake drill results, etc. etc. etc.

In Summary: It's probably best to avoid the whole commodities sector, unless you can find those rare exceptional managers with both talent and integrity.

Wednesday, March 15, 2017

Simple Rules: How to Thrive in a Complex World

Just finished this book. As the name suggests, the book champions using simplified rules to navigate complex situations. I agree. The authors' research shows that in many cases, simple rules focused on resolving bottlenecks are enough to overcome complex systems. Provided that these rules focus on the key drivers. In some ways, this is what analysts do every day. Find those key drivers of a business.

However, the whole book would probably work better as an article in HBR. There's really not that much substance. The authors tried to classify rules by type, such as, boundary rules, or timing rules and applying them to a range of situations. I think this is unnecessary. The examples felt forced, like a case of over-fitting the data to the theory. In many cases, there probably weren't any explicit "simple rules" used or factors other than "simple rules" were likely the true drivers of success.

The second issue is, the authors fail to address situations where "simple rules" have failed. You can't just attribute all successful cases to "simple rules" without examining unsuccessful cases when "simple rules" were used.

So while, simplifying has merit. And maybe, in certain circumstances, using appropriate "simple rules" can drive results. This book has not made a convincing case of the proposed methods and its own readability.

Wednesday, March 1, 2017

Who Says Elephants Can't Dance

Just finished Lou Gerstner's book (memoir?) of his time as IBM's CEO. (My 2nd book in a week!)
This book was great. I liked it more than Shoe Dog. I actually wished I had read it sooner. It's not only educational, but also had sort of a storyline. The book is packed with business ideas but intertwined with personal touches about individuals.

Gerstner was an outsider, tapped to turn around IBM through very tumultuous times. IBM, at the time, was a bureaucratic behemoth that had failed to evolve with the fast-changing technology industry.

Gerstner did a great job describing the company's culture and his attempts to right the boat. He goes into detail about his decisions and the reasoning behind them to fix IBM's strategy, business and culture. Most books explain the "what" but not the "why". He goes a step further and related to the "how" and the difficulties involved when decisions go counter to "institutional inertia". You can really learn a lot about both business and human (or institutional) behaviour from this book.

Another interesting note, even though the book was written in 2003, in the appendix, Gerstner touched on many technologies that are just flourishing today. It's clear that IBM was thinking ahead of the crowd with things like Cloud Infrastructure, Internet of Things, Machine Learning. Ironically, IBM did not become the leader in these areas. These trends such as SaaS have actually been pressuring IBM's traditional software and services business in the last few years.

The book also reminded me of the turnaround that's happening at one of the companies that I've written about, Crawford & Company. Crawford is also a complex service company that has a bloated cost structure with poor communication and disconnected business units.

The new CEO (also an outsider) seems to have done all the right things; cutting excess costs, improving cross-selling and communication between divisions, creating a culture of decisiveness, aligning all the divisions behind one company. Many of these actions sounded familiar to those mentioned in the book.

Sunday, February 26, 2017

Shoe Dog: A Memoir by the Creator of Nike

Just read my first book of the year, Shoe Dog. It's almost March, a slow start. I hope to read faster going forward. Coincidentally, Buffett also mentioned this book in his annual report. It's on sale at this year's Berkshire Hathaway Annual Meeting.

The book was a memoir by Phil Knight, the founder, of the early days of Nike. The story starts from his epic post-graduate trip around the world and ends at the IPO of Nike. The book provides his first-hand perspective of those early days at the company. It was an intriguing book, but I think, offers few business lessons.

Throughout the story, Mr. Knight sounded as if the company had little direction and was merely surviving; constantly putting out one fire after another. I haven't had a chance to read any other books on Nike, so I don't know how much of that is true and how much is embellishment.

It's surprising to me that a group of "clueless misfits" can put together such a large and powerful organization. The book had little mention of the business decisions and strategies and thought process behind those decisions.

The one point that he does emphasize, along with many other business leaders, is the company's strong and unique corporate culture. Especially compared to the bureaucratic incumbents like Adidas. In some ways, this book is similar to Howard Schultz' book on the early days and subsequent turnaround at Starbucks. Both focused on developing and maintaining the "unique" corporate culture.

Unfortunately, for an investor, the culture is also the hardest to evaluate. Without being directly involved in an organization and its competitors, it's hard to judge whether the company's culture works and is a differentiating factor. An investor could only look at financials and hope that aspects of a superior culture is reflected in them. Or maybe there is a way. This is probably an area that's worth exploring.

Monday, December 12, 2016

What's going on in China?

I'm not a macro follower, but the current situation in China is interesting.

Following years of trade surplus, China has accumulated the world's largest stockpile of foreign currency reserves. At its peak in 2014, China held almost US $4 trillion of reserves. However, over the last two years, reserves have declined to $3 trillion.

This could be caused by a combination of weaker trade flows, stronger US$, and major capital outflows. Since China is running an annual current account surplus of over $500 billion, capital outflows may have exceeded $1 trillion annually over the last two years. Should this continue, China's reserves would be depleted in only a few years. The decline in reserves has also affected the RMB which fell from a peak of 6 RMB/USD to 7 RMB/USD today.

China seems to be aware of this and has taken action to clamp down on outflows by reinforcing capital controls. New measures included banning large overseas M&A, clamping down on dual currency credit cards, stopping large cash transfers, etc.

See: What China has done to stop massive amounts of cash from fleeing the country

One has to wonder how effective these controls will ultimately be in such a large economy.

Why is this happening anyways? I think there may be two reasons, both of which are driving down returns of domestic RMB assets. As returns decline in China, it makes sense to sell RMB assets to invest overseas.

1) China is in a real estate bubble fueled by massive credit expansion
2) Over-investment in fixed assets and a slow economic transition to consumption-based economy

In China, the lack of investment options forces savers to invest in ever greater quantities of real estate, driving prices up and returns down. This has become a Catch-22. The country is wary of letting prices drop, which may lead to mass unrest. Yet, elevated prices cause poor capital allocation to proliferate.

At the same time, outflows will likely continue as long as the huge pricing discrepancy exists between domestic Chinese assets, like Tier-1 city real estate, and foreign assets. Why hold real estate in Shanghai at a large premium to prices in the US or Australia or Canada?

It's hard to say how this will end. China's response seems to be to clamp down on outflows and adjust the currency downward to sustain exports. The reserve figures and exchange rate suggests this may not be enough.

The consensus is that China is led by extremely capable leaders and has multiple levers to control the economy. This may or may not be true. If that was the case though, how did China end up in this situation in the first place?

Thursday, October 13, 2016

Canada's Policy Dilemma

You may have seen on the Toronto / Vancouver Housing page that home prices in these two cities have increased rapidly. Home prices are likely fueled by a combination of very low interest rates, loose lending standards and greed/reflexivity.

As home prices (and household debt) reach stratospheric levels, it becomes clear that any interest rate increases would strain the entire system. The authorities now face an interesting dilemma. On the one hand, a weak economy and low commodity prices need support from lower interest rates. Meanwhile, prices for certain asset classes like residential real estate have increased steadily. (Or dramatically, in Vancouver and Toronto.)

To a certain degree, higher prices (due to low rates) make sense. The carrying cost of a large mortgage at low rates is similar to that of a small mortgage at high rates. There are two fears though. One is when rates increase. The second is whether the principal repayment is at risk as mortgages get ever-larger and incomes remain stagnant.

Recently, the government stepped in with a series of targeted measures to slow price increases. The new rules were largely aimed at closing tax loopholes on foreign buyers and increasing requirements for mortgage insurance. Pushing more risk from the government-owned mortgage insurer onto private lenders should improve lending standards.

There is a certain irony to these measures though. If they work as intended and residential real estate activity decline to normal levels, the Bank of Canada may have to cut rates further to juice the economy.