Seeking Alpha

lskwarek's  Instablog

Send Message
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
View lskwarek's Instablogs on:
  • Please Keep Your Eye Out for the Fat Lady (and see if she is singing)
    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.
    Oct 11 10:39 AM | Link | Comment!
  • Why Emerging Markets Are Likely to Underperform This Year

    Why emerging market stocks are likely to underperform the S&P this year:


    The Bad News:


    1. Valuations: Major emerging market sectors have gotten too expensive

    2. Too crowded:  Even after the selloff: Sell-side waaay too bullish

    3. The easy part is over: Challenges abound


    The Good News:  

    1. There will be a good entry point: The party isn't over yet

    2. M&A: Focus on companies with catalysts

    3. Many alternatives: You really can play both developed and emerging markets at the same time


    1. Valuations: Duh.  It is always about the fundamentals, even if it feels like it is about funds flow chasing performance (or in this case, exiting emerging markets). 


    Just  take a look at EM banks versus developed country banks price to book ( the ratio off which I think banks really trade -- not p/e):


    Various Trailing Price to Book Ratios (P/B) for EM Banks










    Hong Kong









    Europe combined


    As of March 7, 2011



    Yes, yes, I know.  Developed market banks are a disaster and who knows what "book value" means, while emerging market banks are growing and there are a billion Chinese all waiting for a credit card.  But look at the price you are paying for that growth, while look at the value you get when you buy recovery (the "disaster").  If Europe or the US doubled, they would still be cheaper than emerging markets (with the US still trading below its long term average of 2.6x, according to JP Morgan).  


    2. The market is waaay too crowded, still.  Beware of analysts touting "buy".   The consensus predicts Brasil Foods (BRFS:US) to have an earnings growth of 91% in 2011, Walmex (Walmart of Mexico, WMMVY:US) is estimated to have a 2011 earnings growth of 21%.   From the analysts' lips to God's ears, but generally what happens is that analyst MBA's keep sticking in higher and higher estimates without wondering if it makes logical sense.  Two Brazilian Banks alone, Bradesco (BBD:US) and Itau (ITUB:US), are estimated to have a 2012 earnings growth of over 30% which is highly unlikely in an economy that will be in lock down as the central bank panics on the inflation front.   I think both are wonderful banks   -- just not THAT wonderful.


    3.  Those challenges.  The old joke that Brazil is the country of the future and always will be truly applies to all emerging markets.  Bottlenecks of infrastructure, political and judicial structure abound. all of which eat into earnings.  Emerging market majority shareholders with a tiny exception, hate to share with minority shareholders and will find lots of ways to keep the money from you.   Inflation is a bugaboo that they cannot wish away (though I doubt we ever go back to the bad-old days).  Those challenges deserve a healthy respect, and some discount to prices.


    The Good News:


    Fortunately this time, your decision on investing in emerging markets revolve really around today’s price versus value, and not about some of the issues that plagued emerging markets in the past such as debt defaults, corruption, and mismanagement (we can leave that for our home market).  As the emerging markets sell off continues, valuations will get more reasonable.  On a stock by stocks basis, some already have:  look at Tenaris (TS:US) against Oil Service Holdings (OIH:US).  TS makes pipe that the OIH stick in the ground to get oil out. (TS is an Argentine/Mexican company dressed up as an Italian company in a global business.)  It usually trades in lock step with OIH, or has for the past 5 years or so.  With the emerging markets sell off, TS now trades at an interesting 20% discount to OIH.  Ambev (ABV:US), the Brazilian/Latin arm of BUD-InBev might get to an interesting discount to its parent (it already is, depending on whose forward estimates you use).  And it just might finally buy it's 50% venture in Mexico, Grupo Modelo  (GMPCY)...someday.


    And, finally, you can hedge your bets if you still love emerging markets, but want to play the recovery in Europe and the US as companies pursue M&A in the region.   Danone sells more than 45% of its products in emerging markets (10% of all its dairy sales in Russia alone).  Both Telefonica (NYSE:TEF) and Ibedrola (IBE:SM) in Spain, gets more than 50% of its profits from emerging markets.  And even a boring US company like Heinz just bought a Brazilian company, raising its estimated sales to emerging markets to as high as 20% of total sales by 2012 fiscal year.


    So, as the old adage goes, buy low, sell high.  Emerging markets has had an amazing run, outperforming developed markets by a wide margin in 2009 and 2010.  The sell off that began last fall and continues today will generate some interesting opportunities as traders throw babies out with the bath water.  Pick your spots -- watch for a slew of earnings downgrades by analysts of all their darlings, and you will be well rewarded with good entry points.  Watch for capitulations that begin generating that valuation heartbeat again.


    (Disclosure: Of the mentioned stocks, I own OIH, Grupo Modelo, Ibedrola, and VIV (not mentioned, but TEF owns a minority stake)).  Data is sourced from Yahoo Finance, Bloomberg, and company filings.


    Disclosure: I am long OTCPK:GPMCF, OIH.

    Additional disclosure: I am also long Ibedrola in Spain
    Mar 01 1:00 PM | Link | Comment!
Full index of posts »
Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.