Barron’s Weekend Summary: A regulatory crackdown on China’s best-known companies has been a wake-up call for investors
Cover Story:
-A regulatory crackdown on China’s best-known companies, such as Alibaba Group Holdingand DiDi Global, as well as for-profit education providers such as New Oriental Education & Technology Group, has been a wake-up call for investors, and contributed to a 13% decline this year in the MSCI China index. Beijing’s new emphasis on “common prosperity” to tackle rising inequality, and its efforts to rein in China’s debt-laden property sector and meet carbon-emission targets, have also roiled its economy and stock market, pushing giant property developer China Evergrande Group to the brink of bankruptcy and sparking the country’s worst energy crisis in at least a decade.
Tech Trader:
-‘As supply-chain issues roil the tech sector, no company underscores the issue more than Cisco Systems. The stock fell more than 6% on Thursday after the company reported financial results that were dented by a panoply of component delays. Cisco Stock Slides on Disappointing Outlook. It’s ‘Working Night and Day’ to Resolve Shortages. Cisco's CEO said it had the strongest demand in over a decade, but supply issues constrained what it could build and ship to customers, pressuring gross margins.”
The Trader:
-The valuations of electric car companies from Tesla to Rivian is worrying the traditional manufacturers like Ford and GM. Yet, “maybe there is a way for traditional auto makers to close that valuation gap: Take a page from Liberty Media’s John Malone’s playbook and issue tracking stocks. ‘The way to solve this is for GM and Ford to issue tracking stocks for their next-gen vehicle operations, such as EV, robo-taxi, etc.,’ Scion Asset Management’s Michael Burry told Barron’s in an email exchange. ‘This is an absolute no-brainer.’”
-As natural gas prices have fallen over the course of November, there are still some natural; gas stocks worth considering. One such stock is Coterra Energy, “the product of a merger between two companies focused on natural gas—Cabot Oil & Gas and Cimarex. The new company is more committed than most of its rivals to returning cash to shareholders, and is well-positioned financially to benefit from strong natural gas demand.”
Features:
How to profit from Bitcoin without owning Bitcoin is an interesting question raised by those who worry about the novel risks of cryptocurrencies. One way is to invest in the bitcoin mining operations. “The miners offer an alternative to owning the coin—betting on the network’s high-tech plumbing and potential for tangible profits. Riot Blockchain looks appealing for its growing share of the market and efficiency gains as it expands. Another stock to consider is Core Scientific, a miner that plans to go public through a merger with a special purpose acquisition company, or SPAC, called Power & Digital Infrastructure Acquisition.
Marathon Digital Holdings could also be a winner. The stock sold off this week after disclosing an investigation by the Securities and Exchange Commission related to the prior issuance of restricted shares.
-Day Trading and Options: Stocks like Teslaand Apple have become even more appealing as stock option speculators have returned to making their bets on bets. Many are retail investors holding their positions for less than a day. “This new day-trading frenzy in options is helping lift individual stocks and bolstering the revenue of online brokers like Robinhood….Earlier this month, total equity options volume reached 56.5 million contracts—the second-highest total ever, behind the 59.2 million contracts traded on Jan. 27 at the height of the meme-stock craze involving GameStop, AMC Entertainment Holdings, and others.
Europe:
-A resurgence of coronavirus cases in Europe has sent Austria into a national lockdown, with Germany also on the precipice, shaking investor sentiment and sending stocks lower. “Austrian Chancellor Alexander Schallenberg said Friday that the country would head into a new national lockdown that could last up to 20 days, starting Monday, which would include the closing of all nonessential shops. The country will also institute the first Covid-19 vaccination mandate in Europe, requiring all citizens to be vaccinated by law as of February 2022.”
-Faced with persistent market sentiment that the European Central Bank will have to raise interest rates next year to help counter inflation, ECB President Christine Lagarde insisted Friday that it would “not make sense” to react to the current inflation spike by tightening policy.
Emerging Markets:
-There’s good reason to consider the Chinese bond market these days. Although any consideration should be tempered by caution. “On balance, investors see a moment to buy, carefully. “We are building a contrarian position with a double-B focus,” says Samy Muaddi, portfolio manager for T. Rowe Price’s emerging markets bond strategy. “Tickets are working as we speak.” With potential annual returns around 15% on these instruments, “we’re being paid to take the risk,” he adds.
-Shares in Paytm dropped 27% Thursday in the group’s first day as a publicly traded company, after the fintech startup caught the attention of investors around the world in India’s largest-ever initial public offering. Paytm counts SoftBank (SFTBY), Warren Buffett’s Berkshire Hathaway and Alibaba among its backers, and has positioned itself as India’s answer to companies like China’s Ant Group. Its interests cover a range of finance and technology businesses but its primary focus is mobile payments.
Commodities:
-At the COP26 meeting, the phrase most countries wanted was a deal to “phase out” coal. What they got, after interventions by China and India, was a “phase down” of coal. Investors are less mixed about coal’s future. Shares of U.S. producer Peabody Energy fell 8% on Monday, while Arch Resources stock was off 6.6%. Still, the coal deal is a landmark, and more than 20 countries agreed to stop building or permitting coal plants. But if India and China don’t reduce coal use, it will be tough to limit global warming to 1.5 degrees Celsius. The Climate Action Tracker consortium found that COP26 pledges would produce twice the greenhouse-gas emissions by 2030 needed to meet the goal.
Streetwise:
-This week Jack Hough offers practical advice about inflation. He suggests not worrying about it too much. That is not worrying too much about making inflation-proofing your portfolio. “Don’t get caught flat-footed on inflation this Thanksgiving when family and friends gather to argue politics over dinner. Shop around beforehand for data to fit your side. budget-constrained, but it’s hardly hyper-yamflation.”
Beautigloo Raises 2.7 Million Euros
The maker of the environmentally friendly Refrigerated Beauty Box will use the funds for expansion.
Beautigloo's Refrigerated Beauty Box
COURTESY OF BEAUTIGLOO
PARIS — Beautigloo, a French company that manufactures an environmentally friendly Refrigerated Beauty Box to preserve cosmetics and boost their effectiveness, has raised 2.7 million euros in a first funding round.
Investors include business angels brought together by the Eukratos family office, Gemmes Venture private equity and venture capital fund, Bpifrance and Banque Populaire.
“We want to consolidate our industrial presence in France and increase our production capacity in order to continue to internalize our products’ manufacturing,” said Florian Ménard, cofounder and technical director of Beautigloo, in a statement. “The start-up aims to expand its product line and recruit talent to support this growth and hopes to become the world leader in refrigerated beauty. It also wishes to continue its commercial development in Europe, the United States and Russia, where it is already established.”
Beautigloo was founded in 2017 by Ménard and Clara Lizier. The company has been part of L’Oréal and LVMH Moët Hennessy Louis Vuitton accelerators at Station F, Paris’ start-up campus.
It took more than two years of research and development to create Beautigloo’s cosmetics refrigerator, which is made in France and consumes a low amount of energy. It is 90 percent recyclable, has no polluting refrigerant and retails for 299 euros.
Over the course of this year, sales have tripled at Beautigloo, which counts among its clients Biologique Recherche, Dior and L’Oréal.
“We bring value to cosmetics brands by enhancing the beauty experience,” said Lizier. “With the Refrigerated Beauty Box, the effectiveness of cosmetics is optimized and sensoriality increased tenfold.”
In January, Beautigloo opened a corner in the Galeries Lafayette department store on the Avenue des Champs-Élysées.
Prada’s Capital Markets Day Addresses Succession Plans, Potential Europe Listing, Farfetch/YNAP Merger
Prada's chief executive officer Patrizio Bertelli and his son Lorenzo fielded questions on hot topics from a possible retirement time frame and a potential double listing.
MILAN — To retire or not to retire?
That is the question swirling over the potential succession at major Italian luxury houses — recently even more insistently, with Giorgio Armani arguably top of mind despite his ongoing hands-on approach — but on Thursday, during Prada’s first Capital Markets Day since 2014, the issue of Patrizio Bertelli’s retirement was once again a topic of interest for analysts and the press meeting at Fondazione Prada’s cinema here.
Following a Bloomberg report that day that Prada’s chief executive officer was going to pass the baton to his son Lorenzo in three years, Bertelli was almost surprised by the questions about his retirement and tried to clarify his stance.
“I was asked by the journalist, but it was a bit of a trap question — we’ll see. The important thing is to plan the succession the right way. I am 75 and, statistically, there’s only a 10 to 12 percent possibility I’ll be alive in three years, but I am not anxious, I’ve spent my years well, I’ve had fun, done things. See where we all are, not in a rented hotel or a public cinema.”
Of the potential retirement, Lorenzo Bertelli said with a smile that “it’s news to me and I don’t believe it too much.” He echoed his father by saying that “it doesn’t matter whether it’s in two or three or five years, when there is a generational succession, the important thing is to plan it in time.”
Bertelli senior’s choice is not a surprise as his son has increased his responsibilities and been a driver of change since joining the company in 2017. He was named group marketing director in 2019 and, additionally, head of corporate social responsibility in 2020. In May, he joined as a director of the board. He underscored that “the Prada name is so relevant, there is the ambition to still deliver amazing results and inspire the future, like my parents have done, and Prada can inspire the most.”
His father was also asked about Miuccia Prada’s potential retirement, but he deflected the question to his wife. “You have to ask her, she will decide what she will want to do.” While the designer asked Raf Simons to join her as co-creative director in 2020, at the time she brushed off any idea of retiring.
The group has been publicly listed on the Hong Kong stock exchange since 2011 and, addressing a question about the location and a potential double listing, Patrizio Bertelli said: “We are satisfied with Hong Kong, it was the right choice.” However, he admitted “we could explore a listing in Europe. That said, we don’t feel the need to now, we are OK this way.” He acknowledged “certain investors” do not consider channeling their investments in Hong Kong, but, “after all, we [the family] have 81 percent of the capital.”
Another hot topic was the potential merger of Compagnie Financière Richemont’s Yoox Net-a-porter platform with Farfetch, building on a partnership forged a year ago. Asked if Prada would consider making an investment, responding to Richemont’s chief Johann Rupert’s call for collaboration in creating an open e-commerce platform, Lorenzo Bertelli did not rule it out, but said he did not have enough elements to commit to an answer.
“I think we can expect they will come and talk to us, we are their partners, but it’s premature, they have not even closed the conversation. We are open to any opportunity but the scenario is not clear enough yet to give an answer.”
Asked about the lack of consolidation in the Italian fashion industry, Patrizio Bertelli said: “The question should not be made to Prada, but to the Italian entrepreneurs.” In any case, the ship has sailed, he contended. “The premises are overdue, an expanded vision was needed 10 years ago, now we must defend the Italian know-how, help the small and medium-sized companies that are dealing with issues such as digital and sustainability.”
To be sure, Bertelli has been busy vertically integrating his group for years. In June, Prada and the Ermenegildo Zegna group joined forces to acquire a majority stake in Filati Biagioli Modesto SpA, which specializes in the production of cashmere and other precious yarns.
After investing 80 million euros in the 2019-21 period, further vertical integration is planned with strategic acquisitions. The group is earmarking 70 million euros for planned investments in 2022 and scouting for further opportunities.
Prada is expanding its own manufacturing capabilities. It grew its headcount in its Italian plants by 100 people in 2021 and plans to add 200 jobs in 2022. The company has 23 manufacturing sites and has been investing 100 million euros in a new 432,000-square-foot logistics plant in Levanella in Tuscany, which is almost completed and will be fully operational by the end of 2022. The hub will have a potential handling volume of up to 15 million units shipped a year and it aims to improve the e-commerce dispatching time with 80 percent of sales within 24 hours.
Prada is expanding its manufacturing capabilities, with in-house production eventually accounting for 60 percent of the total, up from the current 40 percent in the medium term. It plans to simplify the architecture of the collections across all categories to improve sell through and reduce inventories. It will reduce the number of styles launched by 43 percent compared with 2019.
In terms of product, Lorenzo Bertelli said the group is “planning a bigger launch next year for the jewelry category, always a passion” of his mother.
Patrizio Bertelli said he was not worried about the price or availability of raw materials, but rather about the rising costs of transportation and energy, which will lead to an increase in prices. He did not provide details but said “the increase will be spread throughout 2022.”
The Prada group is targeting an operating profit of around 20 percent of sales in the medium term. When one analyst suggested Prada lagged behind its peers in terms of operating profit, the executive said “the company has worked on many different aspects at the same time, investing on plants and to give identity to the products, penalizing its EBIT [earnings before interest and taxes]. Other [companies] target the short term, we work thinking of the next 20 years.”
In comparison, Kering and Hermès in 2019 had a recurring operating income margin of 30.1 percent and 34 percent, respectively.
Chairman Paolo Zannoni chimed in: “We like to under-promise and over-deliver. The brand is bigger than the business and there are opportunities to grow.”
What the Potential Richemont Deal Means for Farfetch
The fast-growing luxury marketplace’s latest results disappointed some investors, putting more pressure on the a tie-up with Richemont that could boost Farfetch’s platform ambitions.
On Thursday, Farfetch reported earnings that missed forecasts on both the total value of merchandise sold during the quarter ending Sept. 30 (they were up 23 percent instead of 30 percent year-over-year) and adjusted EBITDA, or earnings before interest taxes depreciation and amortisation (generating $5 million instead of $10 million year-over-year).
Plenty of other online retailers have reported a similar slowdown, after red-hot growth during the first year of the pandemic, when many consumers had no alternative but to shop online. Farfetch is also dealing with higher shipping costs and Apple’s new privacy rules just like every other retailer.
But for investors, the most compelling aspect of the Farfetch story was always its meteoric growth, which would someday soon lead to profits. Thursday’s results inserted a little doubt into both dreams. Farfetch’s stock plunged 10 percent Friday morning.
In an interview, founder and chief executive José Neves focused on the big picture, reiterating that Farfetch is still the market leader in online luxury, and still on track to achieve many of its original goals for the year in terms of growth and adjusted EBITDA. He attributes volatile sales to the unpredictability of the pandemic. He pointed to strategies that should bear fruit in the short- and medium-term, like increasing its fulfilment services clients to get better shipping rates, increasing the advertising it sells on its platform, launching beauty and continuing to expand in China.
Even so, analysts say Farfetch could really use a potential tie-up with Richemont and Farfetch’s largest competitor, Yoox Net-a-Porter (YNAP).
Last week, both companies confirmed the discussion of four different points: Farfetch could invest in YNAP along with other companies; YNAP could adopt Farfetch’s back-end technology; Richemont could contract Farfetch to power all of its brands’ e-commerce sites; and Richemont could start to sell its brands on Farfetch’s marketplace.
Neves said Thursday he had nothing to add to the statement that confirmed the advanced talks last week and promised no set outcome.
But clearly Farfetch stands to benefit the most from a deal that involves the addition of Richemont’s brands as clients both on Farfetch’s marketplace and, along with YNAP, on its white-label e-commerce platform.
Such a deal should boost Farfetch’s customer base and revenue and increase the supply of products it offers, driving increased profitability and growth, wrote Cowen’s Oliver Chen in a note on Thursday. Farfetch could also gain from YNAP’s curation and branding capabilities, which still sets the business apart from Farfetch.
Bernstein’s Luca Solca said “an outright majority acquisition of YNAP [by Farfetch] could raise questions, depending on the dilution it involved,” though the companies have only said a minority stake was under discussion so far.
E-commerce consultant Michel Campan said working with YNAP could at the least be a way for the marketplace to land a major new customer.
“The key in e-commerce is the acquisition of clients,” he said.
Indeed, the industry’s largest luxury brands are focused on funnelling more of their sales through their own direct-to-consumer e-commerce businesses, raising an existential threat for companies like Farfetch and YNAP that depend on their business to draw customers.
Farfetch, with its asset-light marketplace model, was already emerging as the preferred type of partner for major luxury brands moving away from wholesale, and competitors like Mytheresa and YNAP have added marketplace or e-concession options to appeal to them too.
Landing Richemont as a client would be a big get, though Campon said hard luxury will be trickier for Farfetch to sell due to the category’s different type of clientele and seasonal calendar.
But Farfetch is probably more interested in powering Richemont’s brands on their own channels, which could encourage other luxury brands to follow suit. Currently, Farfetch’s clients in “platform solutions” include Harrods and Burberry.
“I believe we are one of the few marketplace [software as service] solutions in fashion and, in my view, the only one with at-scale credentials in luxury,” said Neves on the call with analysts Thursday. “[This] represents a very large opportunity for Farfetch in the long term.”
"Something Will Rebalance": Goldman Boss Solomon Warns That Market Greed Is Outpacing Fear
Goldman Sachs boss David Solomon is the latest to speak out and admit that the market is running at a fever pitch.
In kinder terms, Solomon said this week that greed in the market is now outpacing fear, according to Bloomberg.
He was speaking at the Bloomberg New Economy Forum in Singapore, where he commented: “When I step back and think about my 40-year career, there have been periods of time when greed has far outpaced fear -- we are in one of those periods. My experience says those periods aren’t long lived. Something will rebalance it and bring a little bit more perspective.”
Goldman's comments come as indexes are up nearly multiples of themselves since the March 2020 drawdown as a result of market participants digesting the coming effects of Covid.
Solomon continued: “Chances are interest rates will move up, and if interest rates move up that in of itself will take some of the exuberance out of certain markets.”
He also commented about moving to a "green economy" and, like many who have been advocating for the coming trillions in printed dollars that will fund the "war" against climate change, argued that steps taken would need to be drastic. “We have to recognize we are trying to drive very dramatic change,” he said.
Goldman has said in the past it will be difficult to stop working with the fossil fuel industry altogether.
Solomon also commented on China, stating that the country wants to grow its capital markets and can do so by continuing to participate in other parts of the global economy.
There has been pushback on some Wall Street banks for wanting to move business into China, especially as the U.S. stands at odds with Beijing on a number of issues, including Taiwan. Goldman "has plans to double its workforce in China to 600 and ramp up in asset and wealth management," Bloomberg reported.
He said: “I think China wants to grow its capital markets, they want more listing activity in Hong Kong and onshore. [The participation of global institutions] strengthens their capital markets and so my guess is they’ll continue to support that, but the world can change."
Covid restrictions in Asia are marking a “headwind for global talent in that part of the world,” Solomon concluded.
DoorDash Investors Gobble Up European Takeout
The food-delivery company’s investors may have too high of hopes for the Wolt opportunity in Europe
Investors might have rushed their order.
DoorDash’s DASH -5.93% shares are up 12% since the company announced it was buying Helsinki-based delivery platform Wolt on Nov. 9. We still know little about the deal other than the $8.1 billion purchase price and the expectation it will close in the first half of 2022. Considering how competitive the European food-delivery battlefield is right now, DoorDash will probably keep its strategy mum.
Rumors have been circulating all year about DoorDash’s intentions to enter the European market. The Wolt deal—nearly 20 times as large as DoorDash’s second-largest acquisition, Caviar—shows just how much of a priority that market is for the company. Further stoking excitement, DoorDash later said it also will enter the German market under its own brand.
Wolt has been called the “European DoorDash” because it has grown by operating in areas overlooked by larger delivery players. DoorDash employed a similar strategy in the U.S. by dominating the somewhat overlooked suburbs. But believing its triumph can be easily replicated across different countries, all of which have their own cultures, regulations and labor policies, seems a stretch.
It is unclear how lucrative Wolt’s markets can be, though. Many, like Estonia, Serbia, Finland and Denmark have populations well under 10 million. DoorDash says Wolt had a more than $2.5 billion gross order value run-rate for this year as of the third quarter for all 23 of its countries combined. For reference, Just Eat Takeaway.com’s run rate in Germany alone this year was over $4.4 billion as of June 30.
Despite its global presence, Uber Technologies’ Uber Eats only overlaps with four of Wolt’s markets. One could choose to see that as a strategic positive for Wolt or a sign that those markets were deemed too small. DoorDash itself seems committed to the road less traveled: In Germany, it has chosen to launch its own platform in Stuttgart, a city with less than a fifth the population of capital Berlin.
There are also the relative economics of the European market to consider. While Wolt delivers more than just food, European consumers are much less willing to pay for meal delivery than Americans, according to Just Eat Takeaway.com. In the U.S., delivery companies are able to bolster profit margins by charging bloated service and delivery fees to compensate for things like restaurant commission caps and driver pay regulation. While contracted workers are allowed in the U.S. and Canada, their use is either being challenged or prohibited in Europe. In Stuttgart, Gordon Haskett’s analysis shows DoorDash is currently offering zero service fees and free delivery on first-time orders.
For Wolt, DoorDash is paying a hefty premium—nearly 2.3 times Wolt’s value following its last private round of funding in January, according to PitchBook. London-based Deliveroo has a $5.4 billion market value, despite a current run rate of nearly $9 billion in gross transaction value. Wolt’s premium, therefore, signals DoorDash’s big ambitions for a business that isn’t yet a real contender on a global scale and might never be. Some preliminary figures from the company suggested it did about $345 million in revenue in 2020 for a net loss of $45 million.
DoorDash will likely leverage Wolt’s more than 4,000 employees and their local logistical and cultural expertise in hopes of building a European powerhouse to match its U.S. success. Whether DoorDash can translate Wolt’s strategy in low population areas to cities with higher density is anyone’s guess, though. It is also unclear whether DoorDash intends to give priority to its own brand or focus on growing Wolt’s. The brands already overlap in Germany and Japan.
Investors are right to be hungry for new growth at DoorDash. They might want to wait to see what is on the menu before they dig in.
Adidas Looks for Better Post-Covid Footing. Why China Could Trip It Up.
In the past two years, the sneaker industry could be seen as a good metaphor for the global economy in the age of Covid—first hit by restrictions, then buoyed by vaccinations, and now crippled by supply disruptions.
But the leading sportswear makers haven’t been treated equally by financial markets. Compare Nike ’s stock (ticker: NKE), up 66% since January 2020 (before the pandemic began), to that of rival Adidas (ADS.Germany), down more than 2% over the same period.
Granted, the U.S. stock market, measured by the S&P 500 index, is up 45% in that time, whereas the German market, where Adidas trades, has gained only 22%, reflecting differences in the way the European and U.S. economies were hit and their different recovery paths. Still, the divergence between the sportswear makers’ stock prices seems to indicate that the industry’s common global problems—mostly in the form of supply-chain bottlenecks—aren’t the only issue.
Adidas unveiled last week the extent of its woes, due to major factory closures in Vietnam—where it sources nearly a third of its production—and a 15% decline of sales in the Chinese market.
Chief Financial Officer Harm Ohlmeyer at the time explained that the Vietnamese closures—due to renewed coronavirus restrictions—prevented the production of 100 million items in the second half of this year, leading to a one billion euro ($1.1 billion) revenue loss.
Sales in China fell due to renewed restrictions in the country’s regions and cities hit by a resurgence of the pandemic. There’s also a boycott by Chinese customers, often encouraged by authorities: Adidas is one of the companies that vowed not to source cotton from the Xinjiang province after reports of human-rights abuses against Uighur Muslims, which Beijing has steadfastly denied.
Other apparel and sports-shoe makers, such as Puma (PUM.Germany), have also warned that supply disruptions would hinder sales well into 2022.
But congested ports and shuttered factories at the end of 2021 don’t explain why Adidas sales fell by 14% in 2020 while Puma’s barely declined. That is in part what led Adidas to adopt in March a five-year turnaround plan designed to boost profitability. It included a pledge to sell Reebok, which happened in August when Authentic Brands snapped up the unit in a deal valuing it at €2.1 billion.
Looking ahead, it would be easy to distinguish between the problem that is beyond Adidas’ grasp—Vietnam—and the one it can address—China. The company is trying to tackle the first issue by relocating production to Indonesia and China, where it seems to think that, for now, it’s easier to produce its wares than to sell them.
Deutsche Bank analyst Adam Cochrane noted that the Chinese problem will be harder to address than Vietnam, which he deems largely transitory. It will require investment, he writes, because brands such as Nike and China’s own Li-Ning are progressing in consumer preferences. Adidas will have to “increase investment to regain its leading brand perception,” Cochrane adds.
But the idea that the Vietnamese factories will reopen soon should also be taken with caution, so “transitory” may last for some time. Bank of America analysts think that “expectations for a quick normalization risk being too optimistic,” because of complex rules for reopening, still-low vaccination rates in the country, and labor shortages.
Cochrane has a €345 to €350 target price on Adidas, implying a 20%-plus upside on the current price. With the short term looking challenging at best, the company will have to remain focused on the best ways to revive optimism over the medium-to-long term.
It May Be Time to Buy China’s Bonds—Carefully
Failure to communicate is standard procedure for official China. That’s making the contagion from property developer China Evergrande Group ’s travails worse than necessary.
The China-heavy KraneShares Asia Pacific High Yield Bond exchange-traded fund (ticker: KHYB) has crashed 13% since Evergrande (3333.Hong Kong), the No. 2 Chinese developer, launched debt restructuring on Sept. 13.
That’s cataclysmic for fixed income, and probably an overshoot, investors say. But the fog around Beijing’s reaction makes calling a bottom treacherous. “The market seems to see some light at the end of the tunnel,” says Paul Lukaszewski, head of corporate debt-Asia at abrdn. “But we have had no formal announcements, and what’s been reported may not be enough for many stressed developers.”
The Evergrande crisis was an optional one for President Xi Jinping’s government. The real estate sector’s junk dollar bonds total $175 billion, a drop in China’s $45 trillion financial system, notes Samy Muaddi, portfolio manager for T. Rowe Price’s emerging markets bond strategy.
Regulators have good reasons not to bail out Evergrande and a few other reckless borrowers. Their cleanup game plan has trickled out in contradictory hints and snippets, however.
Markets took a breather from their initial shock in mid-October. Then companies started reporting that banks and local authorities were freezing the cash they held for prepaid apartments.
Regulators feared that stressed builders might grab funds before delivering the units. But without clear centralized direction, they threatened the whole industry’s liquidity. “Few companies in any country or sector can survive long if their internal cash is trapped and with no access to refinancing,” Lukaszewski says.
Since then, bureaucrats have nudged back toward an industry that drives as much as a quarter of China’s economy. The central bank’s markets chief noted “misunderstandings” that might have led lenders to overtighten developers’ credit. Local governments are reportedly pressing for approval to buy private assets, lightening balance sheets.
Meanwhile, companies are pitching in with “self-help”: issuing equity or extending debt while fresh issuance is on hold. Sunac China Holdings (1918.Hong Kong), the No. 4 developer, raised $953 million through a rights offer and asset sale earlier this month.
On balance, investors see a moment to buy, carefully. “We are building a contrarian position with a double-B focus,” says Muaddi, meaning bonds rated at the stronger end of high yield. “Tickets are working as we speak.” With potential annual returns around 15% on these instruments, “we’re being paid to take the risk,” he adds.
Lukaszewski says abrdn is doing its own “deep liquidity analysis” to pick out solid credits from the distressed landscape.
History has earned China’s leaders the benefit of the doubt after 20 years of unprecedented growth, says Charlie Wilson, portfolio manager of the Thornburg Developing World fund. Recent data from McKinsey show Chinese personal wealth leaping 17-fold, to $120 trillion, from 2000 to 2020.
“I’m pretty confident they can walk the fine line between allowing some pain and a disorderly market-clearing event,” Wilson says.
Developers and banks dominated China’s stock market before 2008, he adds. Now they are a sideshow, as investors weigh growth companies from the internet to electric vehicles. Still, he admits, “transparency has never been part of the Chinese investment opportunity.”
Indeed.
Rivian Topped Ford and GM Combined. How the Old-School Car Makers Could Get a Boost From EVs.
Old-school auto makers must envy the sky-high valuations of electric-vehicle start-ups. At one point this past week, Rivian Automotive was worth as much as Ford Motor and General Motors combined.
But maybe there is a way for traditional auto makers to close that valuation gap: Take a page from Liberty Media’s John Malone’s playbook and issue tracking stocks. “The way to solve this is for GM and Ford to issue tracking stocks for their next-gen vehicle operations, such as EV, robo-taxi, etc.,” Scion Asset Management’s Michael Burry told Barron’s in an email exchange. “This is an absolute no-brainer.”
Burry is best known for a successful bet against the housing market ahead of the subprime mortgage collapse. He is a major character in Michael Lewis’s book The Big Short, and the movie based on it.
A tracking stock “tracks” the financial performance of a specific business unit. Shareholders of a tracking stock have a financial interest only in the division tracked, rather than in the entire business.
Burry’s idea builds on another, similar call from earlier in the week. On Wednesday, Data Trek Research’s Nick Colas, a former Wall Street auto analyst, wrote that Ford (F) and GM (GM) needed to spin out their EV businesses. “When it was just Tesla with a crazy valuation, they could afford to dismiss this [spinoff] idea. Now, with Rivian [RIVN], Lucid [LCID], etc., they can’t,” Colas wrote. “Automotive is a capital-intensive business, so cost of capital matters.”
Put it this way: Building a new EV plant that could produce, say, 500,000 EVs a year, along with the batteries to power them, costs several billion dollars. That‘s less than 1% of Tesla’s (TSLA) market cap, but roughly 5% to 10% of Ford’s or GM’s.
Not that Colas believes spinoffs will actually happen. Car makers are too complex, with many manufacturing plants doing several jobs for other factories in a network.
Tracking stocks, though, might be feasible. Liberty Media Formula One (FWONA), for instance, tracks the financial performance of the Formula One racing series. And General Motors did the first tracking stock ever, for Ross Perot’s Electronic Data Systems, or EDS, back in 1984.
How to value a Ford or GM tracking stock? The possibilities are tantalizing.
Ford, like Rivian, is launching an EV truck and it already sells the electric Mustang Mach E. Ford’s EV business should be about four times the size of Rivian’s by 2023, if the company hits its goals.
As for GM, it’s essentially the second-largest U.S. EV maker behind Tesla. GM’s global EV volume is at about 300,000 units when factoring in sales from GM’s Chinese joint ventures. With Lucid worth almost as much as GM and planning to sell roughly just 20,000 units in 2022, GM’s EV company could be worth multiples of Lucid.
If all electric-vehicle companies and EV tracking stocks were valued like some EV shares, auto industry valuation could easily top $4 trillion, roughly four times the value before Tesla went on its epic 2020 run.
That might be a bit aggressive.