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    Naspers releases results

    Naspers is an old established company that has managed to move with the times. It reported results today for the year to end of March. The company was founded in 1915, listing on the JSE in 1994. Its traditional business has been that of print media, but has evolved to that of a technology based company with over 90% of its earnings before interest and tax coming from pay TV and the internet.

    While its print business remains an excellent cash generator, margins came under some pressure due to slower advertising revenues and operating profits were down 4%. The margins are low at 11% for the printing business and 7% for the book business.

    The core of the business remains the pay TV business. This generated revenues up 29% and earnings before interest and amortisation up 22%. It’s hugely profitable with margins at 37% for the SA operation, down slightly from 40%. Total subscribers were up 23% to 2,4 million in SA and up 33% to 916 000 for the rest of Africa.

    The brands in this division include Multichoice, MNet and Super Sport.

    The margin pressure is also due to the ongoing rollout of their compact offering at R219 a month versus the premium product at R499 per month. While they do expect an increase in competition, these brands have a definite advantage. At the operating profit level, earnings for Pay TV were up 11%

    At the operating profit level, the internet division still remains in a loss, rising from R234m to R507m. This excludes the equity accounted earnings from mainly Tencent, mail.ru and Abril which more than doubled from R654m to R1,4 billion

    The acquisition of the 35% stake in Chinese Tencent, an instant messaging, internet portal, social network business has been very lucrative for Naspers. Tencent recently achieved a $1 billion in revenue and this company dominates the Chinese instant messaging market. Its main revenue stream is from online virtual goods – it markets a wide range of online “avatars” which are online cartoon characters, customised by the millions of users - all for a fee.

    At March the business had 935m total registered instant messaging users of which 410m were active – an increase of 29% year on year.

    58million peak concurrent instant messaging accounts were recorded.

    This business’ contribution to core earnings came in at R1,2 billion from R615m. In terms of a total valuation of Naspers, Tencent forms a large part. It is listed on the Hong Kong exchange with MIH (Naspers) the largest single shareholder.

    The company has over the years an aggressive policy of making global acquisitions in high growth businesses and ultimately away from the original core printing business.

    The share price gained 3,3% to R203 and appears expensive on a price to earnings ratio of 17,5 times on core headline earnings. The way to value this business is however to place a value on each main component and aggregate this.

    This is a company with a core cash generator in the form of its pay TV business and big upside potential if it can bag another Tencent type business in global markets.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-30, 17:44:54, by ian Email , Leave a comment

    California may have to issue IOU's

    An issue that has been in the news recently is the perilous financial position of the state of California, which not only faces a budget deficit, but faces an actual cash flow shortage and unless it manages to do a last minute deal will find itself with no choice but to issue IOU’s.

    California, the largest state in the US and if ranked, would be around the world’s 8th largest economy, is more than just a microcosm of the whole US. As with all US states it runs its own budget, raises certain taxes and incurs costs. It has been building up debt and now faces a $24 billion budget deficit for its new year which starts this week on 1 July.

    The unbalanced budget and cash shortfall is apparently at a level not seen since the great depression, with a cash shortfall of $2,8 billion in July growing to $6,5 billion in September.

    The decline in revenues, brought about by the housing slump, credit crisis, hit California very hard and the unemployment levels has risen to 11,5% from 6,8%. The combination of lower property, income and sales taxes, together with steadily rising state expenditure, has put this massive state in a precarious financial position.

    Controller John Chiang is saying that the inability of the state to meet its payments, will mean short changing taxpayers, local government’s and small businesses with payments made in the form of IOU’s.

    This is the result of a portion of government that would typically meet its cash shortfalls through raising debt. The difficulty with which it is trying to close this budget deficit means that it faces a massive downgrading of its current issued debt.

    If it gets to the point that California has to part issue IOU, these will trade in the secondary market, but at a discount to their face value. The discount will give an indication of the extent to which costs will need to be cut.

    At the individual level

    While California’s economic woes may be seen as a form of the severe economic position in global governments, taken a few notches down to the private level, its virtually the same position that so many people are facing around the world today.

    i.e. high levels of accumulated debt, which need to be financed.

    On Friday I consulted to a widow who finds herself in this position. After running a few year with high levels of expenses exceeding income levels, she has allowed debt levels to accumulate beyond where they can now be properly serviced. Being an estate agent has not helped matters with both property deals and bond approvals turning down dramatically over the last 12 months.

    Individuals cannot issue IOU to meet their payments and so have no choice but to liquidate assets and pay down debt.

    This is a forced reduction in demand for new debt, which impacts many businesses.

    Today this did not affect the local financial sector, which ended up 1,73%.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-29, 19:55:59, by ian Email , Leave a comment

    Greenspan is worried about future inflation

    The current US Federal Reserve chairman, Ben Bernanke, continues to come under pressure as he was grilled in a congressional hearing this week. Meanwhile writing in the FT, his predecessor Alan Greenspan, the person many say was party to fuelling the levels of US debt that precipitated the problems, spoke about his concern for future levels of inflation.

    Greenspan was Federal Reserve chairman in the US over a protracted period where inflation was not really a problem.

    It was a time where asset price inflation, led by greater levels of debt, led to increased consumption expenditure.

    At the same time that gearing was allowing for increased spending, a lot of the world’s productive capacity was moved to China, which allowed for prices of consumer prices to remain low.

    Everything was going along well, until the global economic crisis exposed a few problem areas such as:

    • Over geared corporate balance sheets
    • Over geared private household balance sheets.
    • Over geared government, facing lower tax revenues and high fiscal deficits.

    When companies and households are under pressure, they rein in their spending – there is no choice. See the chart below which indicates US savings rates. It has declined from 12% in the early 1980 and went negative in 2005, when households did not need to save as they were extracting wealth from asset appreciation.

    Classical Keynesian theory says that governments must pick up the slack when households and corporates have to pull back. However this presumes that government has the ability to raise taxes, increase their fiscal deficits and spend. At this point in time it’s not necessarily true.

    Even locally we have the new Minister of Finance suggesting that government spending needs to be cut back as tax receipts come in lower than expected.

    Now Greenspan, the previous Federal Reserve Bank chairman is saying that government spending commitments over the next decade are “staggering”. Debt issuance is precariously close to the national borrowing ceiling and the risk is that this is going to start being factored into longer term US government bond interest rates.

    I.e. governments don’t have a lot of firing power.

    He pointed out that the US is faced with a choice of either paring back their massive budget deficits, or setting the stage for a potential upsurge in inflation. His view is that the best chance for worldwide economic growth is to continue to rely on private market forces to allocate capital and other resources.
    The worst possible scenario is low economic growth with high inflation – what has been termed as stagflation.

    Chart : US personal saving rate

    We continue to watch closely as to how this will play out.

    Have a fantastic weekend

    Kind regards

    Ian de Lange
    021 9144966

    Permalink2009-06-26, 17:27:31, by ian Email , Leave a comment

    No interest rate cut

    The expectation was for one more cut of 0,5%, but it was not to be. The Reserve Bank preferred to stay pat on its key repo rate at 7,5%. This may be the end of the current interest rate cutting cycle.

    Inflation has proved to be stubborn. The May inflation rate at annual 8% remains on the higher end, mainly due to food inflation. Housing and utilities inflation is also high due to increases in electricity.

    Nevertheless the Reserve Bank forecast for inflation is that it will continue to moderate downwards and enter the upper limit, i.e. 6% during the second quarter of 2010 and to remain there for the rest of the forecast to end of 2011.

    The Reserve Bank announcement went on to note that the very weak growth prospects for the economy remain a downside risk for the economy, i.e. weak economy will translate into lower inflation. There is a large difference between the actual production and capacity production, i.e. the output gap, which means that businesses have less pricing power.

    They note that GDP contracted in the first quarter by 6,4%, which we know, but went on to say that recent data indicates that the negative trend will continue.

    They note PPI (producer price inflation) numbers which were released. These came in at a negative 3% year on year – see chart below. This was below expectations and the first annual decline since November 2003. These very weak producer numbers will help push down consumer inflation.

    Other factors mentioned the announcement included:

    Domestic exports have been under pressure in 2009 due to the very weak global economy.

    Real final consumption by households declined on a quarter by quarter annualised rate of 4,9%, while household consumption expenditure under ongoing pressure in 2009.

    They note that this is likely to continue due to far tighter credit criteria from banks and the negative wealth effects.

    Job losses are growing with 179 000 jobs lost in the formal non agricultural sector during the first quarter of 2009

    Countering these effects on inflation, factors that will push inflation up include oil prices which have risen in 2009 with a hike in petrol prices in July now likely. Also the cost push pressures from the electricity price hike, which at an average 31,3%, is far ahead of the inflation rate.

    The announcement was a surprise. The JSE ended down. Bond holders also lost money as the yield on long bonds moved up, with the yield on the R157 up by 1,8% to 8,48%.

    Time will tell if this was the correct move. But rates have been cut fairly sharply already from December 2008.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-25, 17:29:34, by ian Email , Leave a comment

    Inflation Fails to Break 8%

    This morning saw the release, by Statistics SA, of the latest inflation data for South Africa. The inflation rate, as measured by CPI for urban areas, came in at 8.0% for the 12 months ending 31 May 2009, 0.1% higher than consensus.

    While we have seen inflation come down from a high of 13.7% that it reached in August 2008, the rate of decline has, in the last few months, been consistently slower than expected by consensus. Even though inflation has been sticky, we now have inflation at a level that hasn’t been seen since October 2007.

    As inflation sits above its targeted 6% upper band, regular economic thinking would be for the Reserve Bank to increase lending rates in an attempt to slow spending. But in an economy that shed approximately 179 000 jobs in the formal non-agricultural business sector in the first quarter of 2009 and is in recession, the MPC will most probably look to lower rates in an attempt to stimulate the economy. Higher inflation than expected could, however, limit the rate cut to 0.5%, after seeing monthly cuts of 1% since the beginning of the year. The MPC will come out with their decision tomorrow afternoon.

    We have used the below graph a few times in reports on inflation and interest rates. Here it has been updated. You can see that we are now in a situation where we have negative real interest rates, and the expected drop in interest rates tomorrow will have the effect of moving rates even further below inflation, which as mentioned before should have stimulatory consequences.

    Food and non-alcoholic beverages continue to put upward pressure on the inflation rate coming in at 12.3% for the year to May, with the ‘sin’ items (alcohol and tobacco) increasing at a rate of 10.7% over the same period. Unsurprisingly these inflation items also resulted in restaurant and hotel costs increasing by 13% over the year. Other inflation drivers included recreation and culture (13.7%) and health (11.7%).

    Items that helped bring inflation levels down over the 12 months in review were transport, at only 0.5% for the year. This is mainly on the back of an oil price that has dropped significantly since May last year resulting in private transport operation inflation being -16.2%! Clothing and footwear was up only 5% and the cost of communication up only 0.9%.

    We now await not only the result of the MPC decision tomorrow, but also the accompanying commentary to see how the Committee sees things going forward.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-06-24, 17:43:04, by Mike Email , Leave a comment

    Banks provide an update to earnings

    At the beginning of the year we mentioned that as results and announcements from companies start to come through we will gain a clearer indication of the extent to which the economic crisis has been factored into prices. Some 2 years after the start of the credit crisis in the US, it’s the global real economy that is still battling along. Banks are at the forefront of both the consumer and corporate market and a worse than this and we will see a definite slowdown in new advances.

    Today 2 banks came out with trading updates.

    Absa Bank issued a trading update for the 6 months to end of June. It mentioned that in April at the company’s AGM it had already cautioned shareholders that trading conditions had become challenging and that there would be an increase in impairments, lower interest rate margin and a reduction in the value of its investment portfolios.

    Today, now just a weak before closing off its 6 month results it is estimating that its headline EPS for Absa group will be down between 15% and 25%. The core banking component has been harder hit with the estimated headline EPS down between 25% and 35% from the prior year.

    This negative news has been largely priced into the market and the share price therefore gained 1,29% on the day.

    The current consensus is for EPS to decline by 15,5% for the year to December and so if this is tending towards a decline of 25% for the full year, there is likely to be a further downscaling of forward earnings.

    On its historical EPS the price trades at 6,9 times PE and a dividend yield of 5,8%.

    Firstrand has a June year end. It also came out with a trading statement, saying that it has also previously announced a deterioration but that in fact the scenario has played out much faster than anticipated. It mentioned declining asset growth, further increase in bad debts and the negative impact of faster than anticipated reducing interest rates on capital having a negative impact on earnings for FNB and Wesbank.

    The investment banking division, RMB, has been hard hit by a decline in asset prices, lower earnings from its private equity division, a poor second half from fixed income and currency business. The result is likely to be RMB earnings down 50% - 55%.

    Overall, Firstrand is now expecting normalised EPS for the year to June to be down between 30% and 35%.

    Again a large dose of this has been factored into the current price and it shed just 11c or 0,8% to 1329c. On an historical basis the PE is 8 and the dividend yield is 5,4%.

    Various industries have varying degrees of visibility on future earnings. Prior to this downturn, in an environment that reflects a steady increase in gearing levels, banks as lenders have done well. Now they are finding it difficult to make advances and keep bad debt levels in check in a generally over borrowed environment. Growing earnings is going to prove difficult for the larger players and those not targeting other markets.

    Global markets continue to move down. The JSE ended the day off 0,45% with financials down 0,19%.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-23, 17:50:57, by ian Email , Leave a comment

    Implied Future inflation

    The Monetary Policy committee meets again this week to decide on any change to the repo rate. The consensus remains at a 0,5% interest rate cut. Their current mandate is still inflation targeting, but this is under immense political pressure into the future. The question then is should inflation linked bonds be a part of a portfolio?

    One of the biggest risks that all investors face is inflation risk. On this risk, there seems to be a general consensus that, given the extent that governments are stimulating economies, higher inflation is looming, but that its not necessarily problematic just now.

    Investors, concerned about future inflation have the option of buying inflation linked bonds. These are bonds that, unlike conventional bonds, price in official inflation and so provide a steady real rate of return to investors. These are typically issued in countries where inflation runs fairly high and were first issued in SA in 2000.

    In the US Treasury Inflation Protected Securities (TIPS), were first introduced in 1997.

    The rationale for the issuance is mainly to show the resolve of government to keep inflation low and reduce the cost of debt. Demand for these bonds is typically high due to asset liability matching purposes and so governments find ready and willing buyers.

    One way to assess the future implied inflation priced into the bond market is to look at the difference in yields between the conventional and inflation linked bonds, known as the implied break even inflation rate.

    This differential, indicating future inflation may not be perfect because supply and demand dynamics come into the equitation. Often high demand and low issuance of inflation linked bonds is reflected in a lower yield.

    Currently the real yield on the R189 is 2,2%. The implied inflation when compared to the nominal yield on the R157 is 6,1%. The graph below reflects how these yields have moved since 2007. During December 2008 the implied inflation reduced to 4%, which reflected very expensive conventional bonds.

    At the same time the real yield on inflation linked bonds has come down from 3,5% to its current 2,2% - they appear expensive. If a bond investor believes that future inflation will be less than 6% then he should look to invest into conventional bonds. If the belief is for inflation to run higher than 6% then inflation linked bonds may still be attractive, even at these levels.

    These are some of the decisions that bonds managers face on an ongoing basis. The volatility of the differential, even over a relatively short period of time, means that active management across the spectrum of money market instruments and bonds is vital.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-22, 18:15:29, by ian Email , Leave a comment

    Short term interest rates

    We discussed the required rate of return in yesterday’s report. The base component of the required rate of return for any investment is the so called risk free rate. While in practice there is actually no risk free asset, the yield on US Treasuries is typically accepted as being as close to risk free as possible.

    The term risk free is expressed due to the very low to negligible risk of interest and capital default because the issuing government has the ability to print currency to settle its debt obligations in its own currency.

    Risk free does not therefore obviate earning a return less than inflation. In this sense low risk money market “investments” are high risk, especially where monetary authorities have a low tolerance for maintaining the purchasing power of the currency that they issue.

    In the last 12 months, monetary authorities around the world have been driving down the short term interest rates in an attempt to boost liquidity and stimulate economic growth in the aftermath of the credit crunch.

    SA was slightly behind the curve, but the Reserve Bank has reduced prime rate by 4,5% since December.

    The graph, which tracks the repo rate and 3 and 6 month Jibar gives a clear indication of how rapidly rates have fallen. Jibar is the Johannesburg Interbank Agreed Rate.

    It’s also interesting to note that the last time rates were cut so sharply was in 2003, which was the start of the major bull market in local equities, which peaked in May 2008.

    We are not suggesting that we are now at the start of the next major bull market, but the lower interest rates move, the lower the base rate used for discounting future cash flows. This is naturally attractive for asset valuations.

    These low rates are starting to make yields on short term call accounts less and less attractive.

    Have a fantastic sporting weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-19, 17:04:38, by ian Email , Leave a comment

    The required rate of return

    All investors whether they know it or not are seeking a required rate of return. The only reason to invest into a company with volatile earnings and a volatile share price rather than a bank deposit is in the expectation of a higher rate of return.

    Ultimately the success of otherwise of an investment into any asset has less to do with the outlook, earnings, economy etc, but rather the price paid relative to the intrinsic value. Overpay for an asset and no matter how fantastic the future outlook, the investment is likely to be poor. Conversely pay a cheap to realistic price for an asset and a few years of poor earnings and weak economy will do little to dampen the returns achieved.

    On this note then let’s look at valuing cash flows and the required rate of return.

    I spent the day yesterday listening to 5 local fund managers discuss their portfolios, how they have structured their asset allocation and the types of shares that they are investing in based on their investment process and outlook.

    With most managers there was an element of getting more defensive.

    One of the managers that we chatted to had however recently increased his exposure to equities following an undervalued position. Having done this on the basis that equity valuations reflected values that were historically cheap, he agreed that given some of the global structural changes, there was room to increase their required rate of return. His firm had in fact slightly upped their required hurdle rate 2 years back. The discount rate to value a listed company’s future earnings was in the ranges between 13% and 16%

    I posed the same question again to a large fund manager today, asking them given what appears to be a slight structural change in the long run returns for asset classes, are they making changes to their assumptions used. Again the answer was yes, on cash the long run expected real rate of return may well come down to 1,5% while the required equity risk premium may well have to be moved up slightly from 7,5% to 8%.

    Both fund managers had essentially updated the same assumptions to their valuations models.

    What do I mean by discount rate and equity risk premium?

    An investor with an array of options, in which to invest his capital, will want to consider the valuation of an asset using a required rate of return. The lower the perceived risk, the lower the required rate of return – the higher the perceived risk, the higher the required rate of return.

    If one considers that listed equity should provide a 8% real rate of return instead of say 7,5% real rate of return over time, then when net present valuing future cash flows, an investor will slightly increase his discount rate.

    Remember that the value of any business today is the net present value of its future cash flows. All investment managers try to make some assessment of future cash flows, discount these back to a net present value and then compare the result to the traded price.

    At the basic level the formula for the discount rate is the risk free rate plus an equity market risk premium.

    On the other hand as interest rates or the risk free rate declines, so the discount rate will decline, which is positive for valuations.

    Despite the haziness of the future outlook, and even after applying higher discount rates, there are many assets that appear attractively priced. From this reduced starting point and taking a reasonable investment horizon, investors should be adequately rewarded for the risks taken.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-18, 18:46:46, by ian Email , Leave a comment

    Technical Analysis

    While fundamental analysis is the predominant tool used by professional fund mangers, many also make use of technical analysis, especially to try and refine their entry and exit points to investments. On the other hand there are analysts that only make use of technical analysis.

    A technical analyst will monitor price action on the underlying premise that the price is a reflection of mass psychology, or crowds in action and will attempt to forecast future price movements on the assumption that crowd psychology moves between panic, fear and pessimism on the one hand and confidence, excessive optimism and greed on the other.

    A pure technical analyst will not concern himself with fundamental analysis on the premise that everything that has or could affect the share’s value, including all the fundamentals, is already reflected in the price.

    Some have identified 3 main categories to technical analysis:

    • Sentiment indicators
    • Flow of funds indicators
    • Market structure indicators.

    Sentiment indicators track different groups of investors, e.g. professional fund managers or sell side (stockbroker) analysis summarising for example ratio of up rated versus down weighted shares. Technical analysts therefore try and gauge the overriding sentiment looking for major turning points.

    Flow of funds analysis looks at things like the commitment of traders, which is a breakdown of the open interest on futures markets. It may also assess indicators such as the price of put options – these typically tend to rise in price when sellers become nervous of market values.

    Market structure indicators monitor price trends using various indicators in a way to try and gauge the health of the prevailing trend. The types of indicators used would include:

    • Moving averages
    • Trendlines
    • Peak and rough analysis
    • Momentum indicators.

    Despite common perceptions, technical analysis is far from foolproof.

    We don’t think that investing should be done on the basis of technical analysis alone, but rather that it should be used as an additional tool in the armoury of a portfolio manager.

    For Jhb investors - if you would like an opportunity to meet on the 25th or 26th June to discuss your investment planning, please contact Vincent on vincent@seedinvestments.co.za

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-17, 16:54:50, by ian Email , Leave a comment

    Liquidity risk

    Last week, in light of news about millions lost with the alleged pyramid scheme operated by Tannenbaum, we discussed some pointers that prospective shareholders should look out for when enticed with attractive investment offerings. Hard on its heals is the failure of Edwafin.

    While not necessarily on Ponzi scheme, “investment firm” Edwafin is under administration, with debts of apparently R228,5m and assets of just R16,5m. Investors were enticed to buy debentures listed by the company, but now find themselves as unsecured creditors of a company with little prospect of receiving their funds back.

    As advisors to clients, we are contacted by various promoters trying to sell their wares, including Edwafin.

    We have always placed a high premium on risk management, understanding that investing is more than trying to assess the possible returns from an array of opportunities - more often it’s analysing, understanding and pricing in the various risks.

    Risk is not necessarily volatility of a price. Some investment risks can include business risk, valuation risk, force of sale risk or liquidity risk.

    Investment liquidity risk

    Let’s look at liquidity risk. This is the risk in trying to close out an investment position. At the one end of the spectrum is money on call with a bank and at the other end is an investment into an unlisted company, or some form of structured product.

    Because not all investments are as liquid as others, this must be built into the valuation. An investment into an unlisted company is not as liquid as an investment into a listed company and therefore demands a slight risk premium. Its one factor why an investment into private equity should, but not necessarily, provide an investor with a higher return.

    Very often promoters of investments package things in such a way that has the appearance of reducing this risk. For example when we were approached by an unlisted UK property fund some 4-5 years back, I raised the possibility that because of the underlying investments in physical property, investors may find themselves in an illiquid investment, which was not being adequately highlighted by the promoters.

    While new investors were streaming in, existing investors could exit – giving the appearance of a liquid market. But, like in a ponzi scheme, as soon as new investors dried up, there was no means to pay back existing investors, who unwittingly found themselves invested in illiquid shares.

    If all the possible risks can be considered at the outset, then these can be priced in and an appropriate structure created.

    An exit strategy is just as, if not always more, important than the initial purchase.

    On that note have a good day off tomorrow. It’s getting close to mid year – perhaps time to assess your investment and retirement planning. Vincent Heys will be in Jhb on the 25th and 26th of June. Contact him for a confidential discussion about your investments and any queries that you may have. Vincent@seedinvestments.co.za


    Ian de Lange
    021 9144 966

    Permalink2009-06-15, 17:06:56, by ian Email , Leave a comment

    Some signs of an uptick in economies

    There are some signs that global the global economy is picking up from its very deep lows. However with the excesses still to be worked out, any growth is likely to be at low levels for a long time still. Two indicators that reflect firmer global demand are the oil price and the Baltic Dry Index.

    According to statistics produced by Wachovia economists, the US has been in recession for a year and a half and this will likely mark the largest contraction in the US economy in the post Word War II era. They are forecasting an uptick in GDP numbers in the second half of this year and into 2010.

    US GDP

    Oil broke above $73/bbl yesterday after the International Energy Agency raised its outlook on global demand, to 83.3Mbd, citing improving economic fundamentals.

    A report across my desk mentioned also that a number of infrastructure projects are coming back on line and there has been increased bidding for energy assets (e.g., Toronto-listed Addax Petroleum Corp soared yesterday after reports that Chinese firms will soon unveil takeover offers). It also mentioned that oil traders see “funds money” flowing into the oil market again.

    The Baltic Dry index is a shipping and trade index created by the London-based Baltic Exchange that measures changes in the cost to transport raw materials such as metals, grains and fossil fuels by sea. The Baltic Exchange directly contacts shipping brokers to assess price levels for a given route, product to transport and time to delivery (speed).

    The Baltic Dry Index is a composite of three sub-indexes that measure different sizes of dry bulk carriers (merchant ships) - Capesize, Supramax and Panamax. Multiple geographic routes are evaluated for each index to give depth to the index's composite measurement.

    After collapsing in 2008, global trade has started picking up.

    Vincent Heys will be in JHB on the 25th and 26th June and has some time to meet to discuss your investments. Please contact him on Vincent@seedinvestments.co.za

    Take care and have a fantastic weekend

    Kind regards

    Ian de Lange
    021 9144966

    Permalink2009-06-12, 17:08:54, by ian Email , Leave a comment

    Tips on avoiding investment scams

    This week South Africa was rocked with an investment scandal, that in terms of the purported sheer size of up to R15 billion, will dwarf any previous scams. While we know that despite tight regulations, there will always be scams looking for culprits, it is very important that investors assess counterparty risk before an investment is made.

    In the alleged scam of Tannenbaum billions of rands were invested into a private operating company promising investors fantastic returns. It amazes how supposed smart investors apparently put in millions without a hint of due diligence.

    I found this on the CFA (Chartered Financial Analyst) website, adapted slightly for local situation. As advisors and investment managers to high net worth investors, this is part of the due diligence process we do on an ongoing basis. There are no guarantees, but with investments it is vital that counterparty risk is reduced to as close to zero as possible.

    10 tips on avoiding investment fraud – posted after the Bernie Madoff scheme came to light.

    1. Understand clearly the investment strategy – “Some investment opportunities appear alluring simply because they are described in impressive, complicated terms. Investment strategies and financial products should be clear and understandable. The nature of the risks involved can vary widely and should be well understood. Even the venerable Peter Lynch advised people to invest only in what they understood – advice he abided by in his successful career. If you don’t understand it, stay away.

    2. Match investment strategy to reported performance – One of the red flags in the Madoff affair is that reported performance was too consistently good. Other investment scams, popular on the internet, purport to use ultra-safe “prime bank” financial instruments from the world’s largest banks. E-mails that promise double-digit returns are incongruent with the safe investment strategies they purport to offer. Also, find out if the firm has its reported performance numbers independently audited, who audits them, and if possible whether these figures comply with Global Investment Performance Standards, a set of ethical principles for calculating and reporting investment results.

    3. Watch for e-mail solicitations and Internet fraud – The internet is a low-cost way for scammers to reach millions of people. Unsolicited e-mail messages offering you investment opportunities that sound too good to be true probably are. Online bulletin boards and electronic investment newsletters are also fertile ground to disseminate false information on thinly traded stocks for a pump-and-dump scheme. Treat information from unknown sources on the internet with great suspicion.

    4. Be wary of “sure things," quick returns, and special access – Legitimate investment professionals do not promise sure bets. Legitimate get-rich-quick schemes simply do not exist. Scammers often make the implausible combination of safety and high returns seem plausible by granting you “special access” based on your relationship with a mutual acquaintance or affiliation with a specific religion or ethnic group. Also, understand clearly the terms by which you can redeem shares or exit the investment. When can it be done and what are the fees? Ponzi schemes become unsustainable when investors pull out their money.

    5. Understand what, if any, regulatory oversight exists – Fraud may be less prevalent in regulated settings, like mutual funds. Hedge funds are less regulated than mutual funds and the risks must be carefully analysed.

    6. Assess the operational risk and infrastructure – Any investment management operation should have a physical infrastructure for trading and administration. Ask to see them and inquire about the firm’s processes and controls. It is important that a firm have separate, independent operations for asset management, trading, and custody to provide checks and balances against fraud.

    7. Ask about independent audits and who performs them. An auditor should be independent, reputable, and congruent with the size and scope of the investment operation.

    8. Assess the personnel – Ultimately, the reliability of any operation is predicated on the integrity and competence of its people. So find out who makes investment decisions and who implements the investment strategy. They should be separate people with relevant experience, education, and training. Credible investment professionals speak knowledgably and comfortably about their professional standards.

    9. Perform a background check. If an advisor firm or investment manager is not listed with the FSB (www.fsb.co.za), find out why. If they are, make sure their record is clear.

    10. Limit your exposure – One of the surest ways to avoid the catastrophe associated with investment fraud is to limit the amount you invest. Diversification is one of the most fundamental and enduring investment principles. Investors often expose themselves to unnecessary risks by concentrating their funds in one or two securities. By limiting your exposure to five to 10 percent of your assets, the principle of diversification can protect you if an investment turns out to be fraudulent.

    Although these points cannot guarantee that you will avoid investment fraud, they will increase the likelihood that you will make smart choices.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-11, 20:16:20, by ian Email , Leave a comment

    US Showing Its Resolve

    The USA, and its citizens, very often gets lambasted by many people around the world. When you’re a large and prosperous country it is very tempting for citizens from other countries to try to bring you down by any means available.

    In the past the USA hasn’t generally tried to improve their image, and this has led to a further deterioration of their image abroad. Events over the last 2 years or so, many originating in the USA, which have contributed to a global recession, have pleased those who would like to see nothing more than the fall of the USA. But while their image might need a bit of a polish, a country doesn’t become a global super power without being able to deal with hardships. The USA got to where they are through hard work, and you can be sure that they will do everything in their power to remain on top.

    Much of their success over the past century can probably be attributed to the fact that they are efficient at most activities. We currently see much of the world in turmoil, and while many countries are focussing all their attention on putting out fires, the USA are already sorting through the wreckage and in some cases starting the rebuilding process again, not withstanding the fact that there are still many fires that they are attending to.

    Today we will probably see the announcement by the US Supreme Court that the purchase of most of Chrysler’s asset by Fiat SpA can go through. Chrysler filed for bankruptcy on 30 April, and less than one and a half months later the case has pretty much been finalised, and the re-organised company can look to move forward in an attempt to make profits again.

    The new entity will essentially consist of all of Chrysler’s strong assets, and the alignment with Fiat will result in the combined entity being the 6th largest car manufacturer in the world. The two companies are very complementary, with little overlap in terms of geographic reach (Chrysler in North America and Fiat doesn’t have much presence in that region) or product mix (Fiat’s fuel efficient models versus Chrysler’s gas guzzlers), which should result in large synergies between the two organisations. The US government will retain a 9.85% ownership in Chrysler.

    In other news the US Treasury has given permission to 10 banks to pay back their TARP debts in an attempt to get them to operate in a more ‘normal’ manner. Currently banks with TARP assets on their balance sheets have to operate under strict regulation from the US, and the repayment of this debt will enable the banks to operate more autonomously.

    Below is the list of banks that have permission to repay their debt, and the amount that they plan to repay:

    Here again, the US is attempting to bring their financial system back to normality as rapidly as possible. They have not just granted permission to any bank, banks have been required to pass stress tests, and then apply for permission. Bank of America, Citigroup, and Wells Fargo are among the banks that haven’t been given approval to pay back their debt yet.

    Only those banks deemed stable enough to operate without extensive government support have been given permission. The Treasury clearly doesn’t want to be in the position to bail these companies out again.

    While the merits of having a US based automaker and US banks being released from their debt so soon can be debated, what can’t be questioned is the speed with which the various mechanisms have allowed these troubled businesses to operate in a more normal manner. Time will tell whether this process was rushed, or whether the timing was spot on!

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-06-10, 17:08:17, by Mike Email , Leave a comment

    Selected shares are making new 12 month highs

    The JSE gained ground in late trading and closed back up through the 23 000 level. Gold jumped up over 2% from lower levels as bullion remained above the $950/oz level. Global markets are mixed with the US slightly down.

    Despite the local JSE being a long way off its market peak of over 12 months back now, there are selected shares that are trading at new 12 month highs.

    The list today included 6 shares that traded at a new 12 month high. 5 of these were:

    Spur, which traded below R6 last July has been moving steadily up and closed at 995c. It does not appear cheap at this level, but investors enjoy the relatively high dividend yield.

    JD Group is a share that not many would be making new highs. The furniture business has been exceptionally difficult over the last few years. JD was oversold and then had a large tax disagreement, which it eventually finalised with SARS. Having fallen to just above R20 in June 2008 it has been volatile but up and closed at R42 having touched 4319c. It’s still far off its peak of R100

    Mr Price is an investor favourite. It gained a further 10c to 2880c. Consensus forecast is for the PE to come down to 9,5 times and the DY to 5,9% and therefore it does not appear expensive. In the current environment where consumers are trading down, it is in the right market position. At its low it fell to R15 and has therefore almost doubled from a year back.

    Famous Brands is another company that traded at a new 12 month high. The shares gained 5c to R18. The company issued a cautionary announcement today

    The share graph of Nu Clicks has been essentially sideways since mid 2007. On a 1 and 2 year forward basis the price appears attractive on a 10 and then dropping to an estimated 8,8 PE ratio at the current price.

    So while there remains a lot of negative news flow, investors are finding value in various pockets and have been prepared to pay up for shares, taking values far ahead of recent lows.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-09, 17:37:46, by ian Email , Leave a comment

    Asset class returns in US dollars

    Here is a brief annual overview of returns across various asset classes from the perspective of a US dollar investor. There are numerous indices and methods used to measure returns from various asset classes and so when presented with statistics you need to ensure that they have not been distorted to present a more favourable picture than is really the case.

    An important consideration is the starting date. Start with a low base and this can present favourable compounded data for years to come.

    While some assets, such as bonds, appear to have lower risk, we consider these assets expensive with very little possibility of high real returns for investors.

    Gold in US dollars has done well, but this again is off a very low base. 2001/2002 was very cheap for bullion.

    Conversely US shares peaked in 2000 and again the starting point was relatively high, hence the low compounded return.

    Selected Asset class returns

    Source: Eleven Two Fund Management

    Notes on the stats

    1. US Bond - Measured by the Lehman Brothers Aggregate Bond Index. This is a benchmark index made up of the Lehman Brothers Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Backed Securities Index, including securities that are of investment-grade quality or better, have at least one year to maturity, and have an outstanding par value of at least $100 million.

    2. US Stocks - The Russell 3000® Index offers investors access to the broad U.S. equity universe representing approximately 98% of the U.S. market. The Russell 3000 is constructed to provide a comprehensive, unbiased, and stable barometer of the broad market and is completely reconstituted annually to ensure new and growing equities are reflected.

    3. Gold – the one ounce spot price of gold in US dollars.

    4. Foreign Stock: The MSCI EAFE Index was developed by Morgan Stanley Capital International Inc. as an equity benchmark for international stock performance. The Index includes stocks from Europe, Australasia, and the Far East.

    5. US Home Prices - The S&P/Case-Shiller® Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan region across the United States. These indices use the repeat sales pricing technique to measure housing markets. First developed by Karl Case and Robert Shiller, this methodology collects data on single-family home re-sales, capturing re-sold sale prices to form sale pairs. This index family consists of 20 regional indices and two composite indices as aggregates of the regions. In addition, the S&P/Case-Shiller® U.S. National Home Price Index is a broader composite of single-family home price indices for the nine U.S. Census divisions and is calculated quarterly.

    6. Commodities - The Dow Jones - AIG Commodity Index (DJ-AIGCI) ® is designed to be a highly liquid and diversified benchmark for commodities as an asset class. The DJ-AIGCI is composed of futures contracts on 20 physical commodities (aluminum, cocoa, coffee, copper, corn, cotton, crude oil, gold, heating oil, lean hogs, live cattle, natural gas, nickel, silver, soy beans, soybean oil, sugar, unleaded gasoline, wheat, and zinc). As much as 33% of this index is made up of energy related commodities.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-08, 17:59:02, by ian Email , Leave a comment

    Longer term investment horizons smooth out shorter term volatility

    Both time and reasonable timing are very important ingredients for successful investing. Timing is important to avoid buying into very expensive assets, with little hope of recovery over the planned investment, while a reasonable time horizon is important to smooth out shorter term volatility.

    The chart below displays annualised rolling returns. The black line is one year returns, while the red is a far longer 20 year rolling returns.

    What stands out is that the shorter term (i.e. 1 year) volatility is virtually all smoothed out when an investor adopts a longer investment horizon, which should be the case for all investors.

    In any one year period an investor is very likely to be subjected to a 12 month return of over 60% at an extreme on the positive side and a negative 30% on the downside. Most investors therefore make the incorrect assumption that this same level of 12 month volatility that they are experiencing should be extrapolated over longer periods of time.

    I.e. if returns from markets are volatile over short periods of time, they must be volatile over longer periods of time. But this is not the case. Over the past 49 years the average equity returns as indicated by the JSE All Share index has been just shy of 20%. At times the 20 year rolling average has gone just ahead of 20% and at other times just less than 20%.

    Equity rolling returns – 1 year and 20 years

    Source : Cadiz

    What is a possibility going forward 20 years from now, where companies perhaps use less and less gearing, debt becomes more expensive and returns on equity decline, is that instead of the expected 18% - 20% from the local equity market, this drops to say 15%.

    No one knows exactly what the long run average will be, but we do know that it will be far smoother than the shorter term returns.

    Have a great weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-05, 16:40:03, by ian Email , Leave a comment

    US financing concerns

    The US Treasury Secretary must be a worried man. The US requires bucket loads of new capital, which they cannot raise from taxpayers and so must go to lenders. Lenders have mostly been foreign, the biggest been China. They have less ability and indeed are also getting nervous of the financial predicament of the lender.

    The trip by US Treasury Secretary to China at the beginning of this week to meet the president and the premier was apparently unscheduled – i.e. at short notice. The main thrust was to discuss China’s concern about the US financial situation and the safety of their bond holding.

    Pimco as one of the US’s largest bond managers and one of the US government’s preferred management companies to assist with buying higher risk debt, continues to make some very concerning remarks on the US government’s predicament. This can’t be too palatable for the US Treasury secretary, but just as the US needs to placate the Chinese, they need private companies like Pimco to also be buyers of debt.

    An FT report today reporting on the failure of emerging economy Latvia to issue debt, said that global sovereign debt issuance this year is expected to be $11,69 trillion up from $10,57 trillion last year. These stats are according to the Organisation for Economic Co-operation and Development.

    According to the recent Pimco report they expect the US alone to have a gross issuance of up to $3 trillion and net at close to $2 trillion, which is almost 4 times supply in 2008.

    Bill Gross in the Pimco investment outlook goes on to question who will be buyers of this massive increase in debt issuance, saying that prior to 2009 it was enough to count on the recycling of the US trade/current account deficit to fund Treasury borrowing requirements. But with the trade deficit down substantially to around $500 billion, “…it is obvious that the Chinese and other surplus nations cannot fund the deficit even if they were fully on board – which they are not.”

    Gross goes on to say that someone else has to write out cheques for up to $1,5 trillion additional Treasury notes and bonds. The Fed can and is a buyer of last resort (i.e. print money to lend to the government). But he says that they need to tread cautiously because this is longer term inflationary. Foreigners, nervous of the US dollar, will turn into sellers.

    The obvious solution is to move quickly to a balanced budget, but in a scenario that is slowly heading to a debt trap, this is looking more and more difficult.

    Yesterday Federal Reserve chairman, Ben Bernanke was confirming the Pimco outlook, urging Congress to act to bring down long term budget deficits, also warning that if they don’t this may lead to future debt traps.

    The updated US Administration budget deficit for financial 09 is now at an expected $1,841 trillion, declining to $1,258 trillion in financial 10. At this stage the expected cumulative deficit for 2010 to 2019 in the US is $7,1 trillion.

    These are large underlying economic issues, which don’t play out in weeks or months, but over the longer term.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-04, 17:37:10, by ian Email , Leave a comment

    State of the Nation Address

    President Jacob Zuma today presented his first state of the nation address. In it he summarized government’s priorities over the next 5 years. In today’s report we take a brief look at a few of the areas of focus.

    A key aspect that the President outlined is the need to alleviate poverty through job creation. The government recognises that the slow down in global growth will have an impact on the ability of the public and private sector alike to create jobs and grow the economy, but they have made the undertaking to use the tools that they have to assist the local economy.

    Some of these tools include procuring more goods and services locally without affecting our global competitiveness by pushing the prices up too high. Government has also sought to avoid retrenchments, where possible, by offering training to those employees whose jobs are under threat. This will not only result in jobs being saved, but should also help in the longer term by improving the skill base of our population.

    The state will attempt to promote a more inclusive country by, inter alia, providing support to small and medium enterprises. One of the ways in which this will be done will be to increase procurement from these enterprises, and another is the reduction of the regulatory burden on small businesses. President Zuma implored all South Africans to hold hands and find common goals which will enable us as a country to move forward. He did warn that this will take hard work!

    The aim is to create 500 000 jobs between now and the end of 2009, and 4 million jobs by 2014.

    Education was also a high priority in the state of the nation address. The President reiterated that teaching and being taught is a two way street, “Teachers should be in school, in class, on time, teaching, with no neglect of duty and no abuse of pupils! The children should be in class, on time, learning, be respectful of their teachers and each other, and do their homework.” There is also the need to increase the number of children in schools and improve the quality of the education that they are receiving. Government has set a target of getting enrolment rates at secondary schools up to 95% by 2014, which is clearly recognition that basic education isn’t sufficient to grow the economy and reduce poverty in any meaningful way.

    South Africa remains committed to building a better Africa, which this will be done by ensuring that foreign relations contribute to an environment where growth and development can occur. A strong AU and SADC will assist in the pursuit of growth and development. The reduction in conflict in the various African regions (including Darfur and Zimbabwe) will assist in growing the continent, and by extension South Africa.

    In this address Jacob Zuma has set some tough goals to achieve. He has been accused in the past of promising everything to everyone. Now that he is in office and has put his five year agenda on the table we will be able to measure him against his targets, and see how effective he and his government are at delivering on these promises. Let’s hope that he succeeds!

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-06-03, 17:41:23, by Mike Email , Leave a comment

    UK commercial property as an investment

    Richard Bernstein, now retired chief strategist for Merrill Lynch, in distilling his 20 years at Merrill’s, penned a final report wherein he listed 10 of the most important investment guidelines learnt in his time at the firm. One of them resonated with the current investment opportunity in global property that appears attractive.

    Number 8 on his list of investment guidelines was “Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.”

    When investors are literally throwing investment funds into a specific are, it drives up prices and drives down potential future returns.

    The opposite is true, when investment capital dries up, prices come down, but future potential returns are driven up.

    An investment area that has seen such a drying up of available capital is the UK commercial property market. Many investors have over the years been attracted to investing into either an apartment or commercial property, using part equity and part borrowed money. Through the late 90’s and into the first years of this century the returns were attractive.

    The flood of money from around the world to the safe haven UK property market drove yields down and down. But investors were not concerned about low yields, because the lower yields were an indication of how their capital values were going up and up.

    Where investors had geared the investment, the returns were exceptionally pleasing.

    This was until such time as prices peaked and starting coming down. Here the positive attributes of gearing start to work in reverse. A fund that is geared 50% debt and 50% equity will experience a decline of 2 for every 1 write down of property prices. As the gearing incases, so does this ratio.

    As property prices have been marked down and down, while outstanding debt (loan) values remain the same, so loan to asset values have increased. For many funds, this weakening of capital adequacy has breached covenant agreements with the banks, who in turn have demanded that property funds lower debt (i.e. lower their loan to asset ratios).

    Property funds including large listed funds such as Liberty International have had to go through capital raising exercises; they have been sellers of property and also dramatically slowed down dividend payments to equity investors.

    New equity is being raised at deep discounts to current net asset values. This is very dilutionary for existing investors, but appears to be very attractive for new investors willing to take a 3 year plus view.

    The graph below reflects total return on physical UK property

    Having been underweight property we are starting to become excited about the values that we are seeing and looking for opportunities.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-02, 17:27:39, by ian Email , Leave a comment

    A strong start to June

    Global markets started the month off in positive territory. This follows a very strong May month and 3 month period. The JSE gained 10,3% in May and with the rand weakness was up over 17% in US dollar terms. The 3 month rally for global markets was one of the strongest since November 1998.

    Finalised over the weekend and officially announced today, GM had no option but to file for bankruptcy. The chapter 11 process in the US assists debt laden firms to apply with a federal bankruptcy court for protection under chapter 11 of the US Bankruptcy code. It allows the business to be operated under trustee principle.

    Debts can be cancelled and re-organised. The debtor company proposes a plan of action, for which all interested creditors vote.

    Part of this code allows a company in chapter 11 to sell some of substantially all of its assets. As part of its announcement, GM will look to sell the strongest parts of its business to a new entity, essentially starting afresh.

    It is hoping for a relatively quick process – 60 – 90 days from now. Some of the stronger brands will move across. GM announced staff retrenchments of 5100 salaried employees. The company has staff around the world of around 230 000.

    Ordinary shareholders who always stand last in queue in a bankrupt company will see their value written down to zero. The $27 billion bondholders will secure only a 10% stake in the new company, US and Canadian governments will initially own 72,5% and the United Auto Workers union healthcare fund 17,5%.

    The widely followed Dow Jones Industrial average of 30 large US shares replaced both GM and Citigroup. GM entered the index in 1915, but given the 90% price decline and now the bankruptcy announcement, the Wall Street Journal editors have replaced both with Cisco Systems and Travelers Companies Inc

    Because the index is weighted to prices and because GM’s had fallen below $1, the switch makes little to now impact. Indeed at the start the day, the US indices had opened up very strongly.

    Many markets are now moving up through their 200 day moving average and this is seen as a positive sign. Consensus is that this is a bear market rally. What is not yet apparent is how long or how far it will go.

    In other news Treasury Secretary Timothy Geithner arrived in China to placate the Chinese on their holdings of US government bonds. They are worried about their investment and rightly so as the US government continues to announce record fiscal deficits and ballooning cumulative debt with little hope of repayment.

    Yields on 10 year and 30 year debt have spiked up from the beginning of the year and this is hampering the residential mortgage market, which in turn is not assisting to stabilise the US property market.

    Because the government wants to stabilise the property market as the main security to the debt markets, they definitely don’t want to see yields rise. There is a possibility that the US Treasury and Federal Reserve come out and announce an increase in Fed buying of treasury issued bonds to try and reign in the yields again. If this occurs it is again likely to be a temporary measure.

    As GM’s debt levels just got too substantial relative to the income required to service it, so the US government is facing a very similar scenario, unless they can do something very drastic.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-06-01, 17:26:21, by ian Email , Leave a comment