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Capitalist Exploits is a team of globe-trotting professionals dedicated to seeking out and investing into unique, undiscovered, and profitable opportunities worldwide. This could be an asymmetric trading opportunity in the global currency markets, seeding a tech startup in Israel, or... More
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  • Industry Standard Be Damned!

    Some 12 years ago, on my first trip to China, I found myself pleasantly surprised by almost everything I saw. The high quality and low cost of accommodation, the fantastic roads, and overall infrastructure.

    I found a friendly people with a truly surprising level of wealth. It was a country I knew very little about; a country which, had I been listening to the brain-dead media, was "Red China", a commie outpost suffering an armageddon type battleground, overpopulated with grovelling, poverty-stricken, half dead villagers eating dogs when they couldn't find a foreigner to feast on.

    Nothing could be further from the truth, though less pleasing was the pollution in the cities, me being fussy about wanting to breathe air rather than chew it, and the surprisingly poor quality of food in general. Since that first trip the food has gotten much better while the chewable air has gotten worse.

    I bring up China since it popped into my mind recently while conducting due diligence on a deal. I was reminded about an experience I had in China which I'll tell you about in a minute...

    While looking through the term sheets and shareholder agreements, we questioned some of the elements and were told that they were "industry standard."

    "Industry standard," together with "standard procedure" are probably two of the most overused, loaded phrases in business, as they denote a certain sense of authority where the recipient is meant to find themselves as an outlier if in disagreement.

    What may be considered industry standard in one country can be completely unusual in another, and even within varying parts of the business cycle. Right now the S&P is trading at roughly 20x earnings. One could argue that is a type of 'industry standard." Does that make it right?

    A handful of examples that come to mind from recent deals we've been working on:

    • "Why is this clause in here?" - "Oh, it's Industry standard." (which never answers the question).
    • "Why is the CEO paying himself $xxx.xxx per year when the company is pre-revenue?" - "Oh, that's industry standard."
    • "Why are the founders also on a consulting agreement with the company they own?" - "Oh, that's industry standard."

    I wrote an entire post around stacked notes and how investors are getting royally screwed by companies raising money (especially in Silicon valley), and today it's considered... you guessed it - "industry standard."

    The hell with industry standard!

    To put "industry standard" in perspective let's go back to China...

    Whenever traveling to a new country there are always new norms to adjust to - driving on the correct side of the road, ensuring you use the correct means of greeting people, dressing appropriately (the UAE) and so on. We're adjusting to a new set of "industry standards" in an unfamiliar place. Nobody thinks it peculiar in their home territory. It's just the way things are done.

    One of the things that is "industry standard" in parts of China which is... ahem, different is the way they potty train toddlers.

    I was violently introduced to this while dining in a restaurant in Xian. Sitting a few meters away was a family with a toddler. The toddler, feeling the urge, proceeded to defecate all over the restaurant floor. The parents continuing to enjoy their meal, watched the process much in the same way you'd watch pigeons scoffing breadcrumbs, in other words, completely unperturbed.

    I, on the other hand, clutched for the anti-nausea medication which should have come standard as condiments on the tables. I'd seen toddlers walking around with the "slip pants," but thankfully had yet to see them being put to use. My first time was to be while eating my lunch. Lucky me...

    In Western society toddlers wear nappies/diapers and are trained to "go potty." As nasty as changing nappies tends to be, they do serve a dual purpose: as punishment to parents everywhere for bringing little brats into the world; and, more importantly it sure beats cleaning up excrement out of kids clothing, or off the floor of restaurants.

    Thank God then for disposable nappies, clearly one of mankind's best inventions, right up there with antibiotics, the Internet, quantum physics, electricity and the string bikini.

    In parts of China the use of a nappy is clearly NOT "industry standard." Having specially designed pants to enable "going potty" anywhere at any time is considered "industry standard." It's considered legitimate even if you don't agree with it.

    In business this terminology is used frequently to provide legitimacy. It can be dangerous and is certainly annoying. Just as I wouldn't let a toddler defecate on my living room floor, so too I don't want investments poorly structured, whether considered industry standard or not.

    Just remember what is industry standard today may well be looked at as completely ludicrous tomorrow. Remember the deals put together in the dot-com boom? Yeah, so much for "industry standard!"

    The difference between having human excrement on your restaurant floor or not comes down to industry standard. Next time you are reviewing business agreements and have questions, just to be told they're "industry standard," be sure to remember the crap on the restaurant floor... and make sure not to sign up for that.

    - Chris

    "The hell with the rules. If it sounds right, then it is." - Eddie Van Halen

    May 09 11:12 AM | Link | Comment!
  • This One Thing Has Killed Before And It's About To Kill Again

    While on a weekend hike with my family a few weeks ago I bumped into a very experienced alpine climber and we started chatting. This guy had climbed some of the most treacherous alpine mountains that the planet can chuck at you.

    I've never had the inclination to climb like this guy climbs. Firstly, I'm not great with heights and while I enjoy being outdoors, I like doing so without being convinced that I'm going to die. It spoils it for me.

    I was curious to know what the real risks of falling when climbing treacherous terrain were like statistically. He then told me an interesting fact: most climbing accidents involving falls happen NOT at the riskiest part of a climb, but rather in sections of terrain which you'd not expect to see the highest casualties.

    What happens is that climbers come out of very risky terrain and subsequently think they're out of the "high risk zone" dropping their concentration, and not realising they are still in a risky environment. This lack of attention kills more climbers than anything else.

    You see the same sort of thing on long stretches of straight roads. Drivers simply get lazy and stop paying attention. Next thing they know they're upside down and the airbags have been deployed (or worse, they were driving a Lada and there are no airbags).

    One of the lessons I learned when trading for a living was that when I was "cruising" I would inevitably make stupid decisions. I would be the equivalent of the climber who has just finished a really treacherous section of a climb and thinking he can "relax". I'd do something stupid, forgetting that I was still "on the mountain".

    This complacency is a killer and right now we have complacency in a number of markets, not the least of which are the debt markets, both sovereign and corporate. Our Global Debt report highlighted the truly astonishing state of our global debt markets. The data shocked even me when I first reviewed it.

    Today the situation in the corporate bond market is even worse. In a minute we'll take a look at it but before we do, what is important to know is why corporate bonds are so overvalued. To answer this question we need only look at government bond markets which have been hijacked by central bankers intent on injecting ever more liquidity into the world economy.

    Slowly but surely, government bond yields have slipped away (source: CLSA)

    The above graph is really indicative of what has driven capital into the private corporate bond market, creating in the wake of a sovereign debt bubble yet another bubble. Most notable is the junk bond market.

    Since 2008, high yield debt has gone from $300 billion to $900 billion. This is but one side effect of QE which has forced sovereign bond yields into negative real territory and sent yield hungry investors into the high yield market.

    While investors, mutual funds in particular, have been scrambling into junk bonds like fat kids after that last cupcake, the fundamentals in this market have been collapsing. The ratio of dealer inventory to fund/ETF holding has collapsed as shown above. Remember that banks act as the intermediaries between buyers and sellers providing liquidity to the market, and their holdings have gone from $286 billion to $96 billion - a mere 9% of inventory.

    Dealer inventory to US corporates has careened from 8% down to just 1%. In case readers aren't 100% clear what this means let me explain with one word: LIQUIDITY. Banks and dealers provide liquidity in any market and this one is no different. That liquidity cushion has collapsed by over 88%.

    Liquidity is so very important, especially at market extremes. Elaborating on the concept of liquidity, the ever brilliant Howard Marks of Oaktree Capital recently put it this way:

    It's often a mistake to say a particular asset is either liquid or illiquid. Usually an asset isn't "liquid" or "illiquid" by its nature. Liquidity is ephemeral: it can come and go.

    Come and go indeed!

    Bonds, unlike equities are non-linear. A bond market can, will and does go "no bid". Let's take a look at my old employer:

    What to do?

    Knowing that an event has a high probability of arriving and failing to position accordingly is like getting Scarlett Johansson into the sack and promptly falling asleep. A terrible shame! There are a number of ways to deal with this. I'll list a few that pop into my head:

    • Cherry picking the worst of the worst junk bonds and going short.
    • Shorting an ETF such as HYG (NYSEARCA:HYG) and JNK (NYSEARCA:JNK).
    • Placing bids right now for the best corporate debt out there expecting an event that drives sellers to sell high quality bonds. (I'd suggest beginning a hunt in the bonds that are populating LQD (NYSEARCA:LQD), the iShares iBoxx $ Investment Grade Corporate Bond ETF). If I'm right then the good will be dumped along with the bad for a short period of time and alert investors will be well positioned to build themselves a solid quality corporate bond portfolio which you'll likely not have to look at for another 20 years.

    Our very own Brad trades the asymmetry discussed here using optionality which is our favoured method, but who am I to tell you what to do with Scarlett in bed?

    - Chris

    "Liquidity can be transient and paradoxical. It's plentiful when you don't care about it and scarce when you need it most. Given the way it waxes and wanes, it's dangerous to assume the liquidity that's available in good times will be there when the tide goes out." - Howard Marks

    May 06 6:24 AM | Link | Comment!
  • Sam Zell May Be Onto Something Here

    Many, many years ago on a flight from New York to Vancouver I recall sitting next to a C-level executive from a pharmaceutical company which conducted business "globally," as he put it. "Global" being, as it turned out, the US and Canada. I had to humbly submit to his "international experience."

    Upon hearing of my origins being Africa, he launched full-steam ahead, educating ME about Africa. Before I completely tuned out and started searching for the air hostess to see what hard liquor was available, I learned that Africa was ONE place. Of course... how foolish of me to think of it as a continent of 53 (if we include the islands) countries!

    I also learned about the huts that we all lived in, and the wildlife (of course, the wildlife). Wildlife which littered the place like politicians litter the streets of DC. It all sounded tremendously exotic and I was eager to experience it!

    South Africa Houses

    A typical African mud hut (extensively photoshopped, of course)

    I was reminded of that conversation the other day when reviewing some of the statistics on Latin America's fastest-growing economy, and conversations I've had recently with investors while discussing Colombia.

    To the uninitiated, Colombia is seemingly an equally misunderstood place... as misunderstood as my travel companion's understanding of Africa. It is presumably wallowing in grinding poverty, social decay and despair, with gun-toting guerrillas on street corners, and mafioso shaking down every oxygen breathing organism.

    I'm very fortunate to have such a diverse and knowledgeable global network, both within our team and indeed extending out to the readership of this blog. Long-time readers may recall that Mark lived in South America for years, and has traveled Latin America extensively. We also now have a member of our team putting longer term boots-on-the-ground in Colombia in order to further develop our existing network in the country.

    What has caught our attention are some of the following cold, hard facts:

    • Colombia is growing steadily at between 4% and 5% per year, while inflation sits comfortably under 3%.
    • A recent World Bank report ranked Colombia alongside the United States for protecting individual property rights, and #1 in Latin America.
    • A World Health report recently ranked Colombia at #22 for overall health system performance and - to put this into perspective - the US ranks at #37. The high quality and low cost of healthcare has caused Medellin to become a centre for medical tourism, sporting 5 of the top rated Latin American hospitals.
    • The signs of growth are as clear as pigeon droppings on an urban windscreen. As shown below, FDI has been strong and rising for the last decade.

    (click to enlarge)

    This is balm to an investor's soul. What is even more interesting than the gorgeous Colombian señoritas is the fact that very little leverage exists in the real estate market. The domestic finance market is underdeveloped, and much of the real estate changes hands on a cash basis, or with owner financing.

    In case you're thinking that gringos have already have bought up all the real estate... less than 1% of Medellin real estate is taken up by foreign investment. We, like Sam Zell who is investing heavily in Colombia, suspect this will change.

    (click to enlarge)

    Medellin skyline (photo by: Grupo Colviva)

    What we like to look for in a real estate market is not just relative value, comparing cities around the world on a square metre basis or even build cost, for example. Instead (or at least in addition to the standard metrics), what we really like to see is a rising middle class, preferably combined with low levels of leverage, which often is a result of a pubescent finance and banking sector. Colombia sports all of those!

    Human nature rarely changes, regardless of what country you're looking at. We all want a home to call our own, have our kids spill food on our own carpets instead of a rental (crazy, I know), and this is typically the single most important purchase the middle class tends to make.

    As I mentioned last week, safety has dramatically improved in Colombia and, while not as safe as a Volvo, it's certainly not as dangerous as a tuk-tuk. Though, when looking at real estate prices the market appears to be priced as though it's as dangerous as a tuk-tuk being driven by an underage Mumbai teenager full of beer which, if I'm not mistaken, many US cities seem to be looking like! Baltimore being the last, unfortunate set of fireworks.

    The funny thing is, if I was to ask Baltimore (or Chicago, DC or Detroit) residents what they thought of moving to Medellin, Colombia the odds are high that not 1 in 10 would make the move, and most would think it more dangerous than their current environs.

    We're looking forward to getting real-time feedback from within our own team on Colombia, and we will be sharing that with you herein as time permits.

    - Chris

    "Colombia is the next star of Latin America" - Sam Zell

    Tags: GXG, Real estate
    May 02 9:55 AM | Link | Comment!
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