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lskwarek
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Wall Street emerging markets specialist since 1984. Managed proprietary and hedge fund portfolios of emerging market fixed income and equity investments. Currently managing personal investments in emerging markets, distressed equities, and plain vanilla domestic stocks. Focus on long term value... More
  • Please Keep Your Eye Out for the Fat Lady (and see if she is singing) 0 comments
    Oct 11, 2011 10:39 AM | about stocks: TEF, E
    It ain't over til the fat lady sings (sorry Angela, but the singing needs to start NOW.)

    After living, trading and surviving (with my job intact!) the first Mexican crisis (1982), the following Latin American crisis (1984-1991), the second Mexican crisis (1995), the  Asian and Russian crisis (1998 -2001), this European crisis is both scary and familiar.  Scary because honestly, Latin America at the time could have floated off to sea and no one would have cared, but familiar, because the problems and honestly the solutions are the same.  Much more difficult to implement, but the same.

    The press insists that the issue is that Greece can't repay its huge debt. And it can't -- no country could if it were all due tomorrow.  NO COUNTRY (except Russia, which actually did) repays all its external debt.  It uses the capital markets to refinance principal.  A country's solvency is based on both debt service and its ability to refinance principal. But just like all the Emerging Market crises, Greece cannot REFINANCE because the true market rates of 20, 30, and yes even on one really bad day, 100% yield make it impossible to service any new debt.

    The downside, as we know, is a big black hole, deeper than one we have ever seen before.  The pundits who banter about "Let Greece default and withdraw from the Euro", have no idea what they are talking about, unless they lived through the Indonesian food riots, the barricaded and closed Argentine banks and the empty supermarkets in Peru.  This would be 10-times worse and led truly to the destruction of the financial system.  Which sounds really cool if you are protester in Occupy Wall Street, until you call your dad for cash and the ATM doesn't work anymore.

    So what can Greece and the EC do?  You do a Mexico with a dash of Brazil. Greece cannot devalue -- but there is a lot that can be done beyond the necessary austerity measures.  No one solution will work in isolation, but just as in the Asian, Russian and Latin crisis, a combination of things to DO work.  

    1) Do a Mexico:  Create underlying demand for the debt.  Mexico did a Dutch auction where investors/debt holders put in a bid to buy new, guaranteed bonds (the Aztec bonds).  Unlike the current Greek "voluntary" scheme (Mexico was "voluntary" too) where there is a fixed price to arbitrage, Mexico's first deal was an auction and investors "bid" without knowing the acceptance rate.   What's nice now is that investors know that the first bond restructure is usually the best one, as the following ones are usually done at lower swap rates.  The market HATED this deal at first and thought it was a joke, but these bonds were trading ABOVE par after a few years.  The ECB is now trying to do this, but it is not well publicized.

    2) Buy back the new debt and throw in as much of the old debt as you can.   Mexico bought back nearly 1/3 of its bonded/restructured debt in the public market, funded/collateralized by the same debt it was buying.  Since every $1 of face value cost $ .40 cash, but had $.10 of collateral in it, some banks lent Mexico $.20 to $.30 to buy the .40 priced debt.  The debt was subsequently cancelled and Mexico saved $.60. (of the estimated $7 billion in debt repurchased, Mexico saved more than $4 billion).  The ECB can do this backwards -- Throw in the debt into the auctions now, (remember, their open market purchases of debt were likely NOT at par) making the auctions HUGE and successful into the eyes of the market), accept a new bond at a 70% face value.  The present value of the new debt will be worth more than what is sitting on their balance sheet now.

    3) Do a Brazil:  Expand the restructuring/bond guarantee program to include local banks, states and municipalities.  While this is tricky without a devaluation -- what Mexico and Brazil did is allow the private, state and municipal sector to repay in local currency to the central government who then repaid the external lenders in USD.  It sound like it is "guaranteeing the private sector", but it is not -- as the lenders continue with the credit risk of the underlying borrowers.  If the borrowers don't pay into the system, then the loans fail.  But it offered the lenders a 2% incentive fee to restructure at par (so no haircut) in exchange for a 8 year payout with 4 years interest only grace period.

    4) Create even more demand for the underlying debt -- let investors use it for debt for equity exchanges in privatizations, for investment at a discount for bank capital, for hey, even vacations for German citizens which have had to "bail out" Greece.

    As investors, understand that the market will absolutely HATE all the "financial engineering" and push prices and valuations down.  But also, understand that this brings an enormous buying opportunity to buy high yielding, secured debt or good companies. The  Asian, Russian and Latin America experienced prove that debt restructures do work, and fortunes have been made for those that study the details.  Stocks to focus on that have been hammered in merely be being in the wrong country at the wrong time are Telefonica Spain (ADR: TEF), down over 16% year-to-date, with a dividend yield of nearly 9.6%.  TEF makes most of its money, nearly 50%, in Latin America, particularily Brazil, whose internal demand for mobile phones and broadband (TEF provides both), has shown little indication of slowing from the Jan-June growth of 14% net adds in mobile and a whopping 45% additions in TV.  Others include ENI (ADR: E), the Italian oil/gas and utility company which, while up a marginal 3.5% ytd, is down 35% from its high of 71 in 2008.  ENI, like TEF, is a global company, and Europe represents only 4% of its proven net oil and gas reserves.  Libya, where some production is based, can come back to pre-2010 levels quickly as soon as the situation becomes normalized, according to their last earnings report.  The most interesting thing about ENI, other than its 6.5% dividend yield, and positive net cash flow, is that an asset breakup is possible.  ENI's asset divestures have been rumored for years, but nothing ever happened.  Perhaps the crisis will lead to that break-up as the government still owns  30% of the shares.  ENI trades at a discount of some 40% to the sum-of-its-parts.  Streamling the business by selling off some of the businesses would put much needed cash in the government coffers. 




    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Themes: European Crisis Stocks: TEF, E
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