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China Mobile and the iPhone

10/26/2013

2 Comments

 
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"I purchased a large block of shares in China Mobile before Apple's most recent Worldwide Developers Conference (WWDC) anticipating that the iPhone would finally be released on the world's largest telecommunications network.  After this did not happen, UBS downgraded the stock to a sell citing the Chinese government's redistribution of company profits to other carriers and poor management.  If you had a significant play in the stock, would you hold the stock and look for a bump, or dump it and cut your losses?"
Redistributing profits from one company’s income statement to another company’s income statement – an idea that could only be Made in China.  The weird way you have to think about China is that of one massive company which operates many subsidiaries.  All they are doing is shifting profits from one of their subsidiaries to another to create equality (or what they perceive as equality) – a core belief of socialist/communist principles.  That’s how I think of it, anyways, but I’m sure it is much more complicated.  Since you mentioned that your intent was to profit from an iPhone adoption on the network, I will focus my analysis on the short-term view of the company.

Cell Phone Carriers – US versus China

The major difference between cell phone buyers in the United States and those in the rest of the world is how the phone is purchased and/or financed.  In the United States, we buy a 16GB iPhone 5s for $199, then spend the next 2 years paying a hiked-up monthly service fee that helps to cover the remaining cost of the iPhone’s actual $649 price tag.  In the rest of the world, including China, buyers have to shell out the $649 ($549 in the case of the “cheap” iPhone 5c) at initial purchase.  That is no small investment, especially for a country with an average monthly income of less than $1,000 in its capital city (much lower for the whole country).

iPhone/3G Smartphone Adoption on China Mobile Network

I’m curious as to why you would choose to invest in China Mobile to profit from an iPhone announcement as opposed to investing in Apple.  I would think that Apple has more to benefit from selling new iPhones to China’s largest carrier than China Mobile has from more monthly subscription payments.  Nevertheless, the issue with China as a whole is that only 13% of mobile subscribers use 3G service – most likely due to the aforementioned price premium of purchasing a 3G enabled phone (smartphone).  China Mobile has been adding approximately 3 million 3G users per month over the last year, with 22% of total users utilizing 3G (169.5 million out of 755.2 million total users).  While that certainly presents a growth opportunity, the country’s standards of living and supply of low-cost smartphones will dictate how much users are willing to spend on these higher-priced services going forward.

Directly addressing the iPhone/China Mobile adoption, I personally think that the iPhone will be released on the network sometime this year or early next year.  There is a rumored November 11th release of the iPhone on China Mobile (keyword: rumored).  It is only a matter of time before the iPhone is released on China Mobile’s network, and I would be surprised if (at the very latest) it is released more than a month after rolling out its new 4G service.

Summary

One of the main reasons China Mobile reported a significant drop in profit for Q3 was higher costs associated with building the 4G network and expanding the 3G network.  If I trusted the Chinese government and China Mobile’s leadership, I would not be concerned as an investor in the company.  Despite lower profit for Q3 due to higher costs associated with network investment, the company continues to report higher subscriber growth, higher revenues, and higher percentages of customers utilizing 3G.  However, the fact that this company operates out of a communist regime seems to weigh heavily on the stock price.  If a company of similar size, growth rate, and dividend yield were offered in the United States, I estimate it would trade in the $127 to $153 range (based on industry average P/E ratios and considering the same number of shares outstanding).

Recommendation

Hold until rumored release date and reassess position on November 11th.  You have fundamentals in your favor, but technical indicators working against you.  Look for price support around the low $51 mark.  I don’t think you will recoup all of your losses in the short-term, but there is opportunity for some price appreciation.  Definitely more upside than downside at this price.

Other things to keep in mind:

China Mobile is an American Depositary Receipt (ADR) meaning a U.S. bank purchases shares in a foreign company (in the company’s domestic currency) and then gives you a fixed number of shares in the company.  There is nothing inherently wrong with this, but it adds, among other things, certain macroeconomic variables including currency risk.  Because of this currency risk, ADRs will be disproportionately negatively affected should the Federal Reserve decide to taper their QE program in the coming months.  This is because QE (since they are essentially “printing” money) causes inflation.  This means the price of China’s currency is appreciating (versus the US dollar) since the US has a higher inflation rate than that of China.  Based on current conditions, if the stock price of China Mobile were to remain the same in China’s currency, the value of China Mobile (an ADR) would increase due to the increasing value of the Chinese Yuan versus the US Dollar.  The opposite would take effect should the fed decide to taper.  Investors generally retreat from stocks at the end of the QE programs (which would cause the stock to go down), and the US inflation rate would most likely fall below the inflation rate of the Chinese Yuan, causing a disproportional drop in the China Mobile ADR versus a company that trades directly in US Dollars.

2 Comments

Best Bond Funds For Taper Talk

10/25/2013

0 Comments

 
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The Federal Reserve Bank
"Can you make some recommendations on municipal bond funds?  I like municipals due to their exemptions from federal capital gains tax.  What are things I should consider when looking for a fund?"
I want to first apologize if I am repeating things that you already know.  I try to explain things as clearly and concisely as possible, but I know that it doesn’t always happen that way.  I am going to first cover current trends in the bond market (by briefly covering fed monetary policy) then move more towards municipal bonds before recommending the best funds based on the current state of the market.  A little disclaimer before we get started – I am writing this from the perspective that you are already interested in buying a municipal bond fund, but need to decide which one exactly to buy.  I am not personally invested in any bond funds as I like to know everything I can possibly know about what my money is invested in.  Personally, I find bonds to be among the most boring things on the face of the earth and therefore cannot bring myself to do extensive research on the funds.  If I end a week losing money (as I did the first week of the government shutdown), I literally will spend hours researching what I did wrong and changing my investment strategy based on the newest events.  Okay, now I’m just rambling… now onto the bond market:

I am going to first start with explaining the possible implications for bond prices on rising rates.  This applies to the bond market as a whole, not just municipals.  There are essentially two things that change when interest rates are artificially raised or lowered by the fed (dubbed “quantitative easing” or “QE” by the media).  When the fed purchases treasuries and mortgage backed securities (as they are doing now at a rate of $85 billion per month), interest rates go down.  This is part one of the equation on a macro level – interest rates.  Lowering the interest rates on public and private debt causes the prices – part two of the equation – to rise.  This is because people begin to pay more for the “old bonds” that are paying 5% coupons as opposed to the “new bonds” that are only paying a 2% coupon.  The opposite of this is also true; and unfortunately where we are moving towards as the fed contemplates ending their QE program.  That is, the “old bonds” that have gone up drastically in value will start to lose their value as the “new bonds” start paying higher coupon rates.  Therefore, in a falling rates environment, bond funds generally perform.  And in a rising rates environment, bond funds perform poorly.  This part of macro bond funds, or what they refer to as “interest rate risk”, is pretty intuitive.  What is not intuitive is when or how the fed will start to cause these rates to rise.  Therefore, you need to choose a bond fund that has the lowest interest rate risk.

To illustrate the interest rate effect of bond prices, I will use two different examples at opposite ends of the spectrum.  The first is a 6-month bond and the second is a 10-year bond.  Because the implications for holding a 6-month bond in a rising-rate environment are much less than that of holding a 10-year bond in a rising rate environment, there are massive differences in the price changes of funds holding these different bonds.  Put simply, a fund holding a 6-month bond will probably just suck it up and hold the bond until expiration instead of selling it in favor of a bond with a higher coupon.  Conversely, a fund holding 10-year bonds will want to get rid of them as quickly as possible because they don’t want to be making 3% for the next 10 years when the rest of the market is making 5%.  The following are rough estimates for price changes of a 6-month bond and 10-year bond based on interest rate increases of 1%, 2%, and 3%.  Note that these are not exact estimates and this examples ignores the impact of convexity.  It also assumes that there is a simultaneous change in interest rates across the bond yield curve:
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Although these are rough mathematical estimates based on historical bond sensitivity to the fed funds rate, you can see the massive difference in price change of 6-month bonds versus 10-year bonds.  Because of this, I can only recommend what they refer to as “ultrashort bond funds”.  These funds’ holdings generally have maturity dates of 3-months to 1-year, resulting in a low level of interest-rate risk.  In the ‘90s, these funds were literally used as cash alternatives at some brokerage firms because of how safe managers thought they were.  Unfortunately, right before the recent financial crisis, most of their holdings were in mortgage-backed securities (worst thing to be holding during a mortgage crisis with falling homes prices).  Although these funds performed VERY poorly during the financial crisis, it is my belief that the managers learned their lesson, and they are relatively low-risk investments today. 

Now moving on to recommendations.  Because I now only use TD Ameritrade for both my options-trading and [stock] investing accounts, I can only research funds that are sold through their brokerage.  I would guess that there is a lot of overlap between TD Ameritrade and other brokerages, but I just wanted to point out that some of the funds I mention will not be available at other sites, and vice-versa.
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As you can see, these funds have very low returns compared to stocks and relatively low returns compared to other bond funds.  It is hard to swallow earning 2% per year on a bond fund when the S&P 500 is up over 19% YTD with almost everyone saying there is nowhere to go but up.  However, this run cannot last forever, and your best bet for making money in an uncertain market with dovish fed chairwoman (Janet Yellen) is in short-term municipal funds (if municipal bonds are something you are still interested in).  Let me know if ultrashort muni funds aren’t what you are looking for and perhaps I can make different recommendations.
0 Comments

Should You Buy Voxeljet After +100% Gain on IPO?

10/19/2013

1 Comment

 
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"I just read about a new 3D printing company that more than doubled on its IPO.  Is it a good investment?  What do you think of it relative to its competitors?"
First of all, it is important to note that, because Voxeljet AG is a company with less than $1.0 billion in revenues (as of December 31, 2013), the company qualifies as an “emerging growth company”.  This means that they don’t have to fully comply with the Sarbanes-Oxley Act nor do they have to present more than 2 years of audited financial statements.  To put things in perspective, the company had $11,486,000 in revenues last year, and is currently valued at $187,200,000.  The company’s revenues grew 52% from 2010 to 2011 and 20% from 2011 to 2012.  Not impressive considering 3D Systems (DDD) (the largest player in the industry) returned 44% from 2010 to 2011 and 53% from 2011 to 2012.  This shows shrinking revenue growth over the periods for Voxeljet, and growing revenue growth for 3D Systems.  Compared to most other 3D printer manufacturers, Voxeljet’s printers are extremely expensive, creating a long sales cycle due to internal assessments by customers before making a purchase.  While most other 3D printer manufacturers (3D Systems, Stratasys, Z Corporation) seem to be focusing on “how do I create a product that will be most useful to my customers”, Voxeljet seems to steer itself towards “how do I build a machine that will look most impressive on paper”.  I may be missing something, but there doesn’t seem to be much there that differentiates Voxeljet’s printers from those of the rest of the industry other than printer size and speed (two attributes that are relatively easy to replicate; especially for the firms with more resources).  This is an industry that is growing quickly, both in the share of the economy as well as the number of 3D printing companies.  Voxeljet, due to the aforementioned long sales cycle, will not experience explosive revenue growth.  If I were a purchasing manager for an automotive firm, I wouldn’t be itching to buy a capital-intensive, unproven machine from a relatively new company.  Their financial data from the first 6 months of this year (Jan 1st to June 20th, 2013) reflects this, showing a ~3.5% decline in revenue versus the same period in 2012.

On top of this, I generally don’t see IPOs as a good investment idea due to 1. The nature of an IPO and 2. The uncertainty of IPOs.  If you are a private company owner, and you believe that your company is on track to double profits every year for the next 5 years, are you going to take the company public right now?  Definitely not, because the company will be worth much more in 5 years when growth is slowing and outlook is not that great.  That is when companies have their IPO, after a great run and their owners want to cash in on the company’s growth.  900,000 of the 6,500,000 shares sold for the IPO were from previous owners cashing out their position.

I apologize if this analysis sounds overly pessimistic and biased towards the “DEFINITELY DON’T BUY” side, but I am generally skeptical of IPOs – especially ones that are so small that they are able to get past the reporting standards of larger companies (limiting what we can see), and long sales cycles (generally a catalyst for Enron-style mark-to-market accounting practices that inflate revenues in the short-term).

If you want to get into the 3D printer industry, go for one of the companies that had their IPO at least 3 years ago.  I like DDD and SSYS for these reasons.  These two companies capture 7.7% and 5.6% of the 3D printer manufacturing market share, respectively, and have more stable revenues, broader product offerings, and (perhaps most importantly), relatively realistic valuations.

I am generally interested investing if 2 criteria are met: 1. I like the stock (quantitative/valuation based – Is the company worth what they are asking for it?) and 2. I like the company (qualitative based – Would I want to own this company?).  For example, I LOVE Tesla (TSLA) as a company, but the valuation is so outlandish that I sent my professor a 4-page report (including graphics) on how ridiculous the company’s valuation is.  I am neither interested in Voxeljet’s stock nor its business.  Take a step back, watch the stock take a dive sometime over the next 2 years (like almost every single 3D IPO), then buy it cheap.

1 Comment

Is Tesla a Buy?

9/26/2013

1 Comment

 
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"What are your thoughts on Tesla Motors?  The company's newest sedan recently received a perfect crash-test rating from Consumer Reports, and their sales have skyrocketed."
1.       Chrysler vs. Tesla – Market Capitalization and Sales
The Wall Street Journal reported Monday that Chrysler is filing for an IPO.  The UAW Heath Trust currently owns 41.5% of the company, with the remaining share owned by Italian car maker Fiat S.p.A.  The issue at hand is that Fiat wants to purchase the share of Chrysler that it does not already own.  However, UAW believes their share is worth $4.27 billion while Fiat believes UAW’s share is worth $1.75 billion.  While the most viable figure is most likely somewhere in the middle, this gives Chrysler a valuation somewhere in between $4.2 billion (based on Fiat’s measurements) and $10.3 billion (based on UAW’s measurements).  In the 12 months ended in June, Chrysler sold 2.3 million vehicles, compared to about 20,000 that Tesla produces in a year.  Tesla’s biggest bulls estimate that the company can sell 400,000 vehicles per year by year 2025.  Now I understand that a lot can change in the next 13 years, but Tesla is currently valued at $22 billion (between 2.14x and 5.24x Chrysler’s current valuation).

2.       Tesla’s Emerging Competition
The Wall Street Journal reported on September 16th that General Motors (GM) is developing an electric car that can go 200 miles on a charge for around $30,000.  This would be a huge hit to Tesla as their 3 major competitive advantages are: 1. Relatively low cost of electric vehicles, 2. Sportiness of electric vehicles, and 3. Safety of electric vehicles.  GM’s new electric vehicle (ETA TBA) would easily beat Tesla in the price category (estimated $30,000 vs. $63,570 with Federal Tax Credit).  The sportiness will be Tesla’s biggest competitive advantage, but faces upcoming product releases from BMW and Mercedes-Benz – both companies that are known to produce high-performance luxury vehicles.  Lastly, the safety benefits of the Tesla Model S are a result of the car being a fully electric vehicle as opposed to technical/mechanical inventions on Tesla’s part.  As a result of not needing a gasoline engine or advanced multi-gear drivetrain, electric cars have much more space for crumple zones and other safety features.

3.       Not a Level Playing Field (but soon will be with emerging competition)
As mentioned briefly in part (2), Tesla’s sales are partly fueled by tax subsidies (a benefit that larger car manufacturers will soon be able to enjoy).  This provides a $7,500 tax credit to anyone who purchases a zero emission vehicle.  In California, where most of Tesla’s cars are sold, the government provides an even larger $12,500 tax credit.

4.       Misleading Metrics
Tesla recently reported a 33,571% increase in California car sales, causing a more than threefold increase in Tesla’s stock price in less than 3 months.  This information, in conjunction with revenue growth, was reported in Tesla’s 1Q13 earnings report and 2Q13 earnings report (released 05/08/2013 and 08/07/2013, respectively).  These last two periods reported revenue quarterly YoY growth of 5,542.615% and 4,446.853%, respectively.  These two figures are the main driving forces behind the massive stock price increase this year.  Now let me tell you why they are EXTREMELY misleading: they didn’t even sell a car that was priced below $100,000 until less than a year ago!  They went from specialty (think Ferrari or Lamborghini) to mainstream electric – of course their reported revenue quarterly YoY growth is going to skyrocket during that transition.

5.       A Short Squeeze Has Caused Massive Technical Momentum (see figure 3)

Conclusion

Great company.  Good candidate for short term traders/speculators.  Bad candidate for long-term investors.

Sources: WSJ (where indicated), yCharts (fig. 1,2,3)
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Figure 1 - Market Capitalization of Tesla, GM, and Ford
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Figure 2 - Price-to-Sales ratios of Tesla, GM, and Ford
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Figure 3 - Short Float vs Price of Tesla As you can see from this graph, a short squeeze in Tesla stock began around the beginning of March 2013. This same phenomenon occurred to car manufacturer Volkswagen in 2008 when a short squeeze temporarily drove the shares of the Volkswagen from 210.85 euros to over 1,000 euros in less than two days, briefly making it the most valuable company in the world. This short squeeze has caused massive technical momentum that has driven Tesla's stock price to an unsustainable valuation.
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