Deep Throat: Holiday Wishes.....from a born again Investment Banker

This, of course, is the time of year when we Investors, Investment Bankers and the Titans of Finance count our numerous blessings and think about all of the good things, God's work, if you will, that we've accomplished over the last year. We rear back in our Italian leather Pininfarina Shiatsu massage desk chairs, gaze out at the skyscrapers interrupting our horizon, with a good cigar and a nice Islay Scotch. We are humbled by our good fortune and warmly give (implied) thanks to all of the "little people" who've sacrificed so beautifully to make our success possible.

The Near-ZIRP fueled markets are making new all-time highs on a nearly daily basis now. We marvel at our own year-end genius, being able to contrive yet another, dare I say brilliant, series of accounting schemes which cloak our barely viable businesses, making them appear as though, to the untrained eye, that they are actually not on life support, but perhaps, nearly profitable. Our epic bonuses, because of this creativity, have been determined, calculated and all but guaranteed. We're perusing the listings for island vacation homes and the deposits on our yacht upgrades/refits have been wired to ensure an early spring delivery. This was another huge, tremendous year. We are truly humbled and grateful.

But alas, like all truly Type-A Money Men, we are 24x7 animals. We are wound tighter than a pallet of two-dollar watches purchased at a discount on T-Mall. What keeps us up at night? What gives us those ulcers that the "little people" never seem to get? Our greatest fear, while visions of stock options dance in our heads, is that somehow, someday, when we least expect it.....

......our Collateral for this gigantic mess will somehow morph into a humongous pile of tinsel-covered doggie turds nestled under our collective Christmas trees.......

To that end, I present to you:

The Holiday Tree of "Tinsel Covered Doggie Turds!"

So what do the doggie-turd-ornaments on the above tree represent? The seven businesses above (With ample assistance from Western Investment Banks) are the poster children for debt fueled, acquisition-driven accounting schemes creating billions of dollars of "Questionable Assets" (as defined in prior posts). Of course, I've covered Alibaba, Tencent, Softbank, Yahoo! and Fosun in previous blog posts, but the numbers are getting sillier by the quarter. In the spirit of the holidays, these goofy numbers should absolutely be revisited. Make no mistake about it, this mess is a carefully choreographed, incestuous global scheme made possible by the "Theory of Financial Relativity" and the participation of US/EU/Swiss Investment Banks. The tentacles and complex interrelationships stretch much deeper than could possibly be discussed in this post, but lets take a shot at it anyway.

To start, feel free to peruse my original posts (click on the company name below), but here are the "one sentence" descriptions, gleaned from my analysis, that I'll use to describe these businesses.

Alibaba - Turning tinsel-covered-doggie-turds to gold.
Yahoo! - Expert at managing "dirty little secrets".
Softbank - The world's premier "Happiness" vendor.
Tencent - Skyrocketing revenue from "free services"...huh?
Fosun - You can't read the annual reports without laughing.....financial comedy gold
JD.com - "I can get it for you wholesale!"
Evergrande - "Why finish a project when you can just start a new one!"
Investment Banks - "Sure, we can make that happen, but the fees will be much more than the customary thirty pieces of silver..."

Now, let's take a topside view of the "Magnificent Seven" today vs. 2012.

All of the above are summarized from the relevant financial reports (links below). When we examine the above 12/31/2012 Balance Sheet Figures when compared to the most current 2016 figures a few thing absolutely jump out at us:

The Market Cap of these businesses has increased nearly five fold in roughly three and a half years from US$130 Billion to US$615 Billion.
"Questionable Assets" (Intangibles, Goodwill, Investments in "Investees", Financial Assets "held for sale", Construction Projects and Construction In Progress (Which are inherently difficult to value/reserve) have increased nearly ten fold, from US$39 billion to a whopping US$374 Billion. "Questionable Assets" of these seven businesses now represent 57% of their collective Balance Sheets.
Bonds, Notes and Bank Debt have increased seven fold from US$39 Billion to US$270 Billion.
Liabilities as a percent of "Net Assets" (Total Assets: Less: Questionable Assets) have doubled from 88% to 170% in just over three years. In other words, there are now $1.70 in bills to be paid for every $1.00 of "Net Asset" Book Value.

Here are a few hypothetical questions:

If you build 10,000 apartments and sell one for a million dollars (In a slightly less than arms length transaction) are the rest of the unsold apartments also worth a million dollars each?
If you borrow from US Investors and pay $10 million for 5% of an unprofitable, money-sucking company (purchased from a good friend), is the company now worth $200 million? When you buy another 5% for $20 million is the same company now worth $400 Million?
To paraphrase Martha Stewart, increasing assets is normally a "good thing", but ask anyone who bought a house in Florida or Las Vegas in 2007, borrowing money to buy that house set them back a pretty penny once the value of that house was reset. So what might happen when the value of the underlying assets of the Magnificent Seven is reset? What happens to the $472 Billion of liabilities ($270 Billion of which is Bank Debt and Bonds)?
As discussed in prior posts, what if the RMB is actually worth a nickel rather than 15 cents? Will the Magnificent Seven Balance Sheets, Revenues and (fake) Earnings be worth a third of what they are worth today for Western Investors? What if, like the current economic events and related hyperinflation unfolding in Venezuela, the PBOC has to re-double China's money supply ...again? Like China, Venezuela is resource rich (more oil reserves than Saudi Arabia) but their economy has been woefully mismanaged (more poverty than Brazil). Like Venezuela, China's Central Bank has been running the printing presses on overtime. The PBOC has doubled M2 in the last five years and is currently increasing broad money at 10-15% a year. What if, like in Venezuela, China's accumulated cost of mismanagement and kicking the can down the road accelerates?

Three and a half years ago the Magnificent Seven were all comparatively small, harmless little accounting schemes, floundering around in China (....and Japan with tentacles reaching to China in the case of Softbank). Is it more probable that these businesses are incredibly profitable cash machines, generating 40% YOY growth and enormous investor returns?....or, perhaps, more likely, that they just might be money-sucking Ponzi schemes (Implemented under the watch of the CCP and the PBOC) to support China's teetering dual currency system and keep tabs on their increasingly querulous population? Xi's "Social Credit System", an initiative to track Chinese Citizen's every move requires significant resource and capital. The stated goal in this Orwellian aggregation of big-data is to “Allow the trustworthy to roam everywhere under heaven while making it hard for the discredited to take a single step”. The odd twist is that a significant portion of this "social credit" system is being funded by Western Investors/Capital. As I've discussed, this wouldn't be the first time the CCP has tried to "Fake it" to control their message in an attempt to make folks believe their presentation of the facts appears to be a bit different from reality. (The old joke is that the only accurate piece of information in a Chinese Newspaper is the date….) I'll ask the obvious......Why would the Chinese government allow foreign investors to benefit handsomely from these IT "crown jewels"? Further, why would these phenomenal cash machines be aggressively seeking capital everywhere on the planet except mainland China?

As luck would have it, in their insatiable thirst for fees, Western Investment Banks saw the need/opportunity and got involved. They set up some Caribbean Shells, hired a few mail-order accountants and found some hired-gun economic “experts” supporting their thesis, in an awkward, yet successful attempt to put the details of these schemes out of the reach of US regulators while simultaneously gaining access to Western Capital. The Bankers began to slop gobs of lipstick on these little Christmas-turds and convinced greedy, naive, rudderless investors that Chinese eCommerce is/was the next big, silly thing ....and now look what we have! There is nearly US$1.1 Trillion of "Maximum Economic Impact" (MEI) concentrated in these seven bogus businesses (see above schedule). (I define MEI as the Market Cap of the stock which could/might/will go to zero.....PLUS the value of the balance sheet liabilities. i.e.) Creditors expect to be paid back......Hint: Most of them won't be.) Note that technicians would argue that the MEI should be reduced by the liquidation value of any assets plus cash on hand, but in practice, when these businesses "go dark" offshore creditors and shareholders have little/no ability to recover.

Obviously, this folly would have had a limited impact on global markets had the Investment Banks not gotten involved. Without all of this US/EU/Swiss capital deployed, the exposure/risk would have been much smaller. The now unavoidable carnage would have been substantially contained on mainland China and US Markets would have been relatively unaffected by the impending defaults. Chinese banks and regulators, as they did with the equity markets in August 2015, would step in and continue to refinance the losses, minimize the write-offs, extend credit, increase the money supply and kick the can down the road....just like they've been doing with virtually every asset class over the last few years. Unfortunately, containment is no longer possible and the contagion continues to grow.

Because, in big round numbers, roughly $3 Trillion of these securities are widely held (Again: The Magnificent Seven is just the tip of the China Syndrome iceberg) when the values reset, investors will be heading for the exits in unprecedented droves. (Remember 2009?) The trust in our financial institutions will again be destroyed. As investors, we'll lick our wounds and start all over again.....the beat goes on. TARP....to infinity and beyond.....

A Fond Holiday Farewell

This is also the time of year when regimes and administrations reevaluate their personnel. Budgets and Org. Charts get "adjusted". Organizations, despite incredible fake profits, take it upon themselves to "do more with less". We are often forced to say farewell to old friends, wishing them well in the next phase(s) of their lives. (For parachute equipped upper management it's usually "spending more time with family and friends"....for underlings, it's more often "frantically searching for employment from their parent's basement".) Of course you've heard by now that Mary Jo White, the SEC Chair, has resigned and will be vacating her post by the inauguration, forgoing the final two years of her appointment. We, of course, wish our little elf all the best as she moves on to whatever she might be moving on to.

Sadly, the passage of time will eventually show that Mary Jo was actually the second worst regulator in the history of the SEC. If you believe that the job of the SEC is to randomly send nasty-grams to CFO's criticizing their disclosures (or lack thereof) while documenting their responses, then Mary Jo's SEC has done a pretty good job. On the other hand, if you believe (as I do) that the SEC should actually review filings and IPO's and gosh-oh-golly-gee, perhaps prevent systemic fraud and questionable securities from hitting the markets in the first place, then I'm afraid the SEC under Mary Jo's watch has come up woefully short.

If our local police department operated like Mary Jo's SEC, the dialogue between officers and an (alleged) masked, armed perpetrator in a bank lobby would go something like this:

Police: "Sir, with all due respect, could you explain to us why you are wearing a ski mask and pointing a gun at the teller?"

Perp: "Absolutely....first, I'd like to thank you for stopping by and taking the time to review my business....ummmm...I mean my vacation plans. I'd also like to personally thank you for your public service. That said, I'm wearing a ski mask because I'm going on a ski trip....yeah...that's it.....a ski trip. Of course, I need to withdraw some money for my vacation. Since this is an 'open carry' state, the teller noticed my firearm and asked me if she could see it...she mentioned that she is a real gun fancier.....sort of an Annie Oakley as it were. I can see that you clearly don't understand the situation and what's actually going on here. I'm sure it looks quite confusing, but I'm also grateful that you've given me the opportunity to clear things up."

Bank Teller: (Nervous, frightened, hands in the air, nodding 'yes' in agreement.)

Police: "Well.....I guess that makes sense....you should really be more careful though. You can see how something like this might cause some raised eyebrows for someone unfamiliar with your business/vacation model....can't you?"

Perp: "Now that you mention it, I can see your point of view. I'll take your feedback under consideration on all of my future transactions. Thank you so much for your assistance. Of course, if you ever tire of police work, please feel free to look me up and I can probably find you a cushy job in my organization!"

Police: (Leaving the scene walking back to their squad car) "Wowww....can you believe that guy? What a dope...wearing a ski mask and bringing a gun into a bank? What was he thinking?.... ..LOL....LOL"

Perp: (Robs the bank.....of course.)

Police: (Upon reviewing what happened, the Police Commissioner sends a sternly worded letter to the alleged perpetrator at his Cayman's beach house, criticizing him for his lack of cooperation. The Commissioner requests additional information 'pronto' or he/she will be really, really upset.)

Of course, if the police would have simply arrested the "perp" in the bank (or at least asked him to leave before the crime took place) the problem would have been solved....and nobody would have lost any money.

I also mentioned that Mary Jo will be vilified as the "second worst" SEC Chair in history. With little doubt, based on the events about to unfold, the worst Chair in history will most certainly be the next one. My guess is that Mary Jo has resigned because she sees the handwriting on the wall (she's actually a pretty smart lady) and is hoping to distance herself as soon as possible from the impending, inevitable disaster (which she failed to see coming until now....Ooopppss!). From her point of view, the longer this mess holds together, the less likely it will be that she (rather than her successor) will be required to give those long, tedious hours of "What did you know and when did you know it...." Congressional testimony as is required by our political process once the tinsel-covered-doggie-turds hit the fan.

Based on the current political environment, Mary Jo's replacement will probably be a laissez-faire, less-government, figurehead who will spend his/her tenure making a few speeches, hobnobbing with corporate royalty and playing golf. Nice gig if you can get it. He/she will undoubtedly accept the appointment with the same oblivious, lack of understanding of his/her fate that an Iraqi goat might have while grazing aimlessly in a war zone mine-field.

Goat: (thinking) "Hey....the grass over there looks really tasty"....clip-clop-clip-clop.... BOOM!!"

So How Can We Make Money From This Mess?

I've been thinking about this for years. The obvious answer is "short the doggie-turds" and collect your pay-check. Unfortunately, as I've mentioned before, because of the "Law of Financial Relativity" it's just not that simple. This valuation anomaly can go on for quite some time. It serves no one's interest to have the whole thing collapse overnight. In fact, the problem is so consuming that Central & Investment Bankers can't afford to just let these "asset" valuations collapse without a fight. Misery loves company and tragedy makes strange bedfellows. Like most things in life, I'm sure the signals leading up to the reset will be obvious after the fact, but the real trick is to recognize them beforehand and take appropriate action. Of course, as always, I'll let you know what these signals might be as soon as I figure that out.

In Conclusion......

Finally, as you might recall, I own, in my humble, slightly biased opinion, the best insurance agency in Cleveland, OH. Since our little insurance business has been so big-ly, hugely, tremendously-tremendous this year and this is indeed a Christmas Greeting......I wanted to let all of you know that we've taken on additional part time staff to ramp up for the holidays!........for our little business, customer service is now, has been and will always be Job #1!

4 comments:

UnknownDecember 7, 2016 at 10:44 AM
I eagerly look forward to each of your offerings.
dave jangDecember 17, 2016 at 12:32 PM
Hi,

Thanks for the great blog. I'm new to it, but am a big fan. Curious about your thoughts on how Yellen's recent actions and statements with regard to raising interest rates may affect Chinese currency. A prominent hedge funder named Kyle Bass is predicting a 30% devaluation between June 2017 and approx. January 2018. Is this farfetched? Huge fan of your blog and wish you'd post more. I reread your posts quite often to see if I missed anything on previous readings. Thanks!

Monday, December 5, 2016

Holiday Wishes.....from a born again Investment Banker

4 comments: