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Anthony Grossi
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I am a full-time investor. I learned finance the old-fashioned way, out of necessity, during a career in the film and entertainment industry. I prefer to focus on long-term macro economic trends and demographics. Having identified an invest theme, I look for companies that most nearly fit my... More
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  • Hidden Catalyst for Telecoms: It's Green!
    Given the impressive adaptation rate of mobile handsets it was really just a matter of time before telecoms came under pressure from weak demographic trends and slower subscriber growth rates. Regulatory price cuts in mobile termination rates, intense competition, and a tough global economic environment have been an additional drag on the sector. These trends look set to persist as the outcome of US and European debt issues remain unsolved and regulatory pressures remain unabated, as Senate anti-trust subcommittee chairman Herb Kohl has stated that he is against the AT&T, T-Mobile merger. Furthermore, market saturation for mobile devices in urban areas has forced carriers to look to other means of driving subscription growth. All of which has been weighing down stock prices.

    The hidden potential of the telecoms is role they are sure to play in the build out of the smart grid. It would be pure speculation on my part to assign a number to the amount of money that is at stake, but for scale of reference Jeffrey Immelt (CEO of GE) has called the smart grid, "the biggest investment of the next 50 years". By 2020 the British government plans to have a smart meter in every home under a program whose cost is expected to top $11.5 billion. This will require enormous amounts of data to be wirelessly transmitted from those smart meters back to Britain's energy companies. Telecoms are racing to enable utilities to meet EU regulations regarding the smart grid, such as the requirement to bill customers on their actual energy usage instead of flat rates, and the call for "the same open access principles that apply to the Internet today". This is interesting because it moves the telecoms into building energy management software, a market that is crowded with heavyweights like Cisco.

    With the massive finds of shale gas recently found in the US and around the world, industry experts expect natural gas prices to stay below $8.00/Mcf for the foreseeable future. Gas at that price roughly equates to electricity at $0.05/kWh. That makes it hard for alternative, or "green", energy sources to compete, even with subsidies. But one area of the green movement that has a proven payoff is energy efficiency. It doesn't matter how much electricity costs, if you consume less you save money. The same goes for smart grid investments. Reducing congestion and grid inefficiencies is profitable no matter what the cost of electricity, and it is a necessary condition for introducing more renewable energy capacity in the future. That's the green potential for telecoms.

    The battle over market share and subscribers between the telco giants has now decisively moved over to the smart grid. For telecoms, the smart grid is all about using their wireless networks to sell machine-to-machine services. M2M services (not to be confused with the Vodafone subsidiary of the same name) run data over networks used by devices like electricity smart meters. A smart grid utility contract, or an M2M service, is relatively low maintenance and can diversify traffic on a cellular network. Phone companies can only add so many new subscribers in mature markets, so M2M services will be a hot area of growth and competition.

    Bringing the management of smart meter data to cloud computing style services could be a revolution for the telco industry. Cloud computing essentially offers the ability to use computing power on demand as a service. While the telecom giants are not cloud computing companies in the common use of the phrase, they are using their networks and data centers to offer cloud-like on demand services. Utilities will likely choose to work with cell phone companies because they can rent space on an existing network and therefore will not have to make the capital expenditure investment to build and maintain their own networks. Telecoms also offer utilities the benefits of the billions of dollars they spend enhancing their networks, so when the next 4G LTE upgrade cycle begins the utility company will benefit without having to pay for that investment directly.

    Conversely, some utilities are opting to build out their own smart grid networks. One reason is that owning the network allows utilities to avoid sharing bandwidth with other customers and gives the utility more control over network security. The real reason for choosing to build rather than rent is that in the US regulated utilities are allowed to earn profits on capital expenditures like building their own networks, even when it can be proven that it is cheaper to use a third party provider.

    It is inevitable that the scope of product offerings from telecoms will expand far beyond phone, internet and cable services. You can add energy management services and cloud computing to that list. In many areas telecoms and utilities already have robust relationships behind the scenes, and many cell carriers currently provide backhaul networks for grid communications. One can imagine a world where you will be offered bundled packages that offer lower rates if you wrap your cable, internet and phone in with electricity.

    Most people already think of their cable, internet and phone bills as traditional utility services and a merger of electric utilities and telecom services is starting to make more sense as a system for demand response, distribution automation, and load transferring requires that the two industries form partnerships. I don't think regulators would really allow Duke Energy and AT&T the opportunity to form a huge conglomerate but broad scale partnerships across the industry make sense as does bundling energy services with existing telecom services. This concept offers the telecoms an interesting opportunity to increase revenue and increase costumer switching costs.

    Another opportunity for telecoms to expand their empires lies in the cloud computing sector. They are already working hard to provide enterprise-ready clouds that offer the same computing, storage, and software services that every other cloud service provider is targeting. I have no doubts that telecoms will capture their fare share of that overcrowded market space. However, I just don't think it makes sense for telecoms to go head to head with the likes of Cisco, or potentially even Microsoft. Rather, I think the real prize for telecoms in the cloud space is selling access to the network. Looking at it this way, the telecoms would be in the business of providing a toll road between the enterprise and public cloud providers. The business of selling access to the internet is nothing new to the industry. What will differentiate this service is that it would be focused on delivering connectivity solely between enterprises and cloud services providers and not between enterprises or between clouds. In order to make network access cost effective telecoms would need to provide dedicated leased lines to the networks of major cloud service providers. The value added would lie in preserving the network for its intended use by the enterprise. This is an area that telecoms are uniquely positioned to compete in because they have already made extensive capital expenditures into building the infrastructure and should be able to extend their network service offerings to be the enterprise's entry point into the cloud (rather than the cloud service providers).

    Their are many new challenges and opportunities for the telecom industry to expand its range of services and continue to grow. The hidden catalyst for this future growth is the role that telecoms will likely play in the development of the smart grid. This development will allow telecoms to extend their product offerings to include energy services and access to the cloud. Not that it is most investors primary concern, but both of these developments qualify as "green tech" initiatives in that they allow energy to be consumed and distributed more efficiently. The telecom industry is at a mature stage where growth rates are declining because markets have become saturated. These new opportunities for the industry will draw fierce competition and require significant investments, but will also provide a new wave of growth for the sector. It is highly probable that telecoms will form partnerships with electric utility providers, and possibly cloud service providers, in order to enhance competitive advantages. The scope and scale of the investments telecoms are making to get in ahead of the smart grid build out suggests that there is plenty of green to go around.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Jul 22 5:57 AM | Link | Comment!
  • The Widest Moat In The World?
    The peer review process has its detractors but overall the merits outweigh the disadvantages, otherwise sites like Seeking Alpha (SA) would serve little purpose. Even investment guru Bruce Berkowitz at Fairholme Fund hires an array of outside experts to poke holes in his analysis on specific stocks and bonds. Today I am challenging SA readers to define the company with the world's largest economic moat and submit their arguments to peer review.

    For review, an economic moat is commonly defined as a competitive advantage that allows a company to earn outsized gains over time. Economic moats are usually identified under the following four subheadings (thank you MorningStar).

    1) Economies of Scale -
    2) High Consumer Switching Costs -
    3) Intangible Assets such as
        a) Patent Protection -
        b) Government Permits -
        c) Brand Equity -
    4) Network Effect -

    Is your company's moat as wide as you think? Lets take a look at two companies widely regarded as having proven wide moats.

    Phillip Morris International and Altria Group (PM and MO)

    Marlboro is one of the most iconic and profitable brands in human history and the value of this brand has allowed Altria and Phillip Morris to earn high levels of return on investment for decades, but is this moat really as sustainable as we think? First, due to taxation and smoking bans Marlboro is facing increasing competition from counterfeits and generics. The comparative quality of generic brands across all consumer product categories has skyrocketed over the past ten years and consumers are catching on to the value that some discount brands are offering. Secondly, and far more importantly, Marlboro is losing its coolness factor. Today's young adult smoker prefers mentholated cigarettes to the traditional product. Newport (LO) and Camel (RAI) are eating Big MO's lunch when it comes to the menthol category, and this means when today's Marlboro smokers die they won't have a younger generation to replace them. Lastly, there is an undeniable prevailing demographic trend among consumers toward healthier choices, the end result of which is a progressively shrinking market for Phillip Morris to peddle its wares.

    I think there's a bigger lesson to learn regarding the long term value of certain branded products. What's considered cool or popular almost never sustains the transition from one generation to the next. Even for commodities that are obviously cool like cigarettes and motorcycles, one brand rarely stays on top for long. When's the last time you had a Schlitz after work? Brand names may demand premium pricing but they don't infer continuing relevance and companies must continually invest in their brands in order to drive growth. As the quality gap between generic brands and premium brands continues to shrink, the value of a brand equity moat will continue to deteriorate. I personally find it difficult to believe that many brands like Nestle or Altria will be able to achieve the "aspirational brand" status that allows companies like Burberry (BRBY) and Coach (NYSE:COH) to sustain premium pricing.

    Johnson and Johnson (JNJ)

    Even before the seemingly never ending product recalls, consumers were already starting to figure out that the store brand cold medicine has the exact same chemical compound and list of active ingredients as the major brands, and at a lower price. Prevailing issues with the consumer products portfolio aside, the strength of JNJ has always been the patent protection of their medical devices and pharmaceuticals. Nothing can assail the competitive advantage of a patent, right? While I still believe that JNJ has a dominant moat, I think the value of patents in the health care industry are undergoing a sea change.
    Efforts by cash-strapped European and American governments to control health-care spending will result in the following...

    1) higher costs associated with proving the safety of new treatments will result in additional costs for patents pending, as the government moves to reduce its reliability for malpractice.
    2) the length of time in which new drugs are protected under patent will be put under constant pressure by government subsidized health care programs needing to reduce costs in order to stay solvent.

    Therefore the return on investment for companies in the health care sector will shrink as they cope with higher development costs and greater generic competition.
    This scenario has already been realized in the European anti-bacteria drug market (in the interest of public health, of course), and it stands to reason that it will slowly breech other market segments as well. Large cap pharmaceuticals companies will most likely see slower growth and reduced margins for their products over time. The moat around JNJ isn't going to disappear anytime soon, but the value of that moat is under pressure.

    So what are the widest moats in the world?

    While earnings will fluctuate over time due to a variety of reasons, a company's assets are more durable and easier to put a fixed value on. When a railroad lays down a peace of track there is little incentive for a competitor to lay track next to it. However, the railroad must still compete with shipping, trucking and air freight companies to deliver the goods at the most competitive price. Oil and natural gas pipelines enjoy the same advantages that railroads do from owning nontransferable physical assets, but without as much competition from alternative shipping options. In fact, when a company like Enterprise Products (EPD) agrees to build a pipeline or storage facility, they often have a long term contract in place that guarantees the company a profitable return on investment before they even start building the project. Furthermore, these companies are insulated from commodity price volatility because they are paid for volume shipped and not for the spot price of the product delivered. This makes the midstream MLP space one of the widest moat industries in the world

    However, even these strong competitive advantages are not unassailable. As the world's energy demand ramps up and individuals and governments start to take notice of the environmental cost associated with meeting that demand, there is going to be a continued emphasis on moving away from traditional energy sources like coal, oil, and natural gas toward renewable sources like wind, solar, geothermal, hydroelectric and nuclear energy. That means lower volumes for pipeline companies as the industries they service slowly but surely become technologically obsolete. Admittedly this won't happen any time soon, but even a wide moat industry like midstream infrastructure faces competitive and demographic pressures.

    So where am I casting my vote for world's widest moat company? Basic Sanitation Company of the State of Sao Paulo (SBS). 
    The company is a public water and sewage services provider to approximately 20 million people in Sao Paulo, Brasil. The company also designs and builds water treatment facilities and distribution networks. SBS is a publicly traded monopoly. The company's assets closely resemble those of Enterprise Products. They own water and sewage pipelines that deliver essential commodity services to homes and business, and the rate of return is calculated and known prior to the building of any new projects. The key advantage for sanitary water is that unlike oil and gas, potable water faces no foreseeable threat from new technologies, therefore the pipes that SBS own have a longer life span in which to earn consistent, stable and high rates of return.

    No company is perfect and SBS faces regulatory issues that may or may not force the company to make capital expenditures at unfavorable rates of return at the whim of government meddling. Furthermore, the company is heavily dependent on weather conditions as a large part of their water supply is captured rain fall. Even taking that into consideration, I  think that the company's many competitive advantages bestow a wide economic moat that will allow the company to earn outsized returns over a significantly long term investment horizon.

    An investment in any individual security assumes that the investor believes the company possesses some advantage that gives it an edge against its competition.
    Even an investment in a broad market index assumes that the investor sees a risk-reward advantage in not trying to outguess the market. By challenging ourselves to define the company with the largest economic moat we force ourselves to think critically about what characteristics comprise economic advantages and which advantages are the most valuable.

    Disclosure: I am long EPD, PM, MO.
    Apr 06 4:13 AM | Link | Comment!
  • The Biggest IPO in History of Commodities Trading
    There was a lot of buzz over the weekend about a big happening in the commodities world. Glencore is one of the world's largest suppliers of commodities and raw materials and its no longer a secret that the company is planning an initial public offering as early as May of 2011.  If you haven't heard of Glencore, you're not alone1. The company prides itself on secrecy. In fact, the company was founded by Marc Rich, who was charged with tax evasion and illegal business dealings with Iran, but was pardoned by President Bill Clinton in 20012. Glencore has been accused of illegal dealings with rogue states since the 1970's. Specifically, the CIA believes that Glencore paid more than $3 billion in illegal kickbacks to obtain oil in the UN's Oil-for-Food program for Iraq2.

    There's a well know Warren Buffet quote regarding IPO's. "It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller to a less knowledgeable buyer." The basic idea being that when private equity decides to take a property public, they are in effect calling a top in that market. When Goldman Sachs (NYSE:GS) went public in 1999, they rather effectively called the top of the market. When Blackstone Group (NYSE:BX) and Fortress Investment Group (NYSE:FIG) went public in 2007, it correlated heavily with a top in the private equity market. Therefore it stands to reason that since Glencore and Cargill are both allegedly planning public offerings this year, that we are at or very near the top of the great commodity bull run. The main effect of becoming a publicly listed corporation is to transfer financial risk from the owners to the shareholders. This would be the, "history repeats itself" side of the argument.

    Before we jump to conclusions, I think its worth taking time to detail the "this time its different" side of the story. There are a lot of advantages to Glencore going public. The first among these is that the company can use shares as an acquisition currency. Secondly, a public offering allows departing partners to sell their equity without depleting working capital. There are some limits to how fast a private equity firm can grow. For example, a public listing would give Glencore the scale to undertake very large capital projects or transformational M&A, including the potential takeover of Xstrata (OTC:XSRAF) or Anglo American (OTCPK:AAUKY). Glencore already holds 34.4% of Xstrata, and Anglo American was the object of a proposed 2009 "merger of equals" that never happened.  So basically, going public gives the company the ability to leverage up.

    There is reason to believe that this IPO could benefit shareholders as well.  According to the company factsheet, the company has total assets of $66.3 billion3 and last year London-based Liberum Capital Ltd valued Glencore at between $47 and $51 billion4. That's big enough to put Glencore in the FTSE 100, which translates into a lot of institutional buyers at index funds and pension funds that track the FTSE index. And lets not forget that shares of Goldman Sachs have walloped the S&P since its IPO.  If the prevailing demographic patterns regarding the growing rate of consumption in China and other emerging economies proves to be accurate, the next twenty years bodes well for firms exposed to the commodities sector.

    There are of course risks with this company, as there are for any other. One unique risk for Glencore is the amount of scrutiny they will receive from environmentalist and anti-corruption campaigners. The mining industry in general, and Glencore in particular, does not have the best reputation in this regard. Another risk is that the companies well guarded trade secrets will be compromised, but I think this fear is ridiculous, none of the publicly traded broker-dealers have shut down their trading desks. Probably the greatest fear for an investor is that the metals & mining sector will have a correction or that China's economy will slow down, but if the later happens it will have far reaching implications for the global equities market and pull down all sectors in tandem.

    2.  Ammann, Daniel (2009). The King of Oil: The Secret Lives of Marc Rich. New York: St. Martin's Press.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Feb 26 6:06 AM | Link | Comment!
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