Tuesday, November 07, 2006

The Forest and "Cheap" Trees

I will tell you a personal secret: I become rather anxious when asset prices rise far and fast. This is partly because I hold the opinion that coordinated asset price rises are somewhat self-extinguishing in an environment of already leveraged households, already appreciated assets and rather largely indebted governments. But it is also because I hold some non-hard asset financial assets (because of what I believe to be the elevated probability of the above), and so become relatively poorer with each additional upwards vault. And as behavioural finance researchers have shown, it is indeed one's relative performance that produces anxiety.

And as I look around today, I see all asset prices doing moonshots: Global shares of virtually all sectors; Credit spreads at cyclically narrow levels; real estate of all manner in most countries at post-war peaks in terms of affordability multiples, while cap rates for commercial real estate the world over are near all-time lows. So dire is the cap rate conundrum, and perhaps so certain that the rates won't go up and that the only way to earn an incremental nickel is to lever up that Morgan Stanley recently launched the largest aggressively-leveraged real estate Fund ever seen by mankind. Art from van Gogh, Klimt to Jackson Pollock is valued in the triple-digits of millions, while even some mickingly absurdly modernist art is changing hands in the millions. Undeveloped land is raging. Media content such as recording and film libraries too are garnering impressive valuations, as is agricultural land and orchards. Infrastructure is booming (also with copious amounts of leverage). Antiques, too, are on a rampage, as anyone who's watched Antiques Roadshow can attest. Stamps, coins, curio collections of dubious pedigree, vintage cars, sports memorobilia all gallopping. Commodities of all sorts from precious & metals to softs and foodstuff are up up up.

But my realm is Japan, in general, and Japanese public equities in particular. And here, too, I will share another secret with you: despite raging asset prices the world over in every asset class, in virtually every region (except perhaps North Korea, Zimbabwe & Moldova), slightly more than 30% of listed Japanese public companies are trading south of stated "Book Value" as reported at the end of the latest fiscal year. This is approximately 1225 enterprises out of perhaps approximately 3800, not including those with negative book values. By way of comparison, the US market is, as of last night, sporting nearly 250 listed companies out of nearly 6,800 (using a $50mm market cap cut-off to avoid Chap-11 reorgs). This is a miniscule 3.7% of US listed companies trading sub-book.

Now there remains some caveats: some of these companies are really shitty, detroying shareholder value as prodigious rates. Others are merely illiquid - so illiquid that it might an entire year to acquire but a few percent of the shares outstanding. Another calss are small...in some cases really small...so small that many a hedge fund manager could buy them with their credit card! (ok this is an exaggeration). Yet others have small floats and /or concentrated ownership that they are little more than listed holding companies, and being a shareholder in a Japanese enterprise is trying enough, even before having to countenance being a minority shareholder in a Japanese Company.

To be fair, American companies all suffer from many of the same shortfalls. And perhaps, because the "best and brightest" and the "smartest guys in the room" are engaged in finance rather than engineering, the market is more picked-over, so the probability that a company that is trading sub-book is, in fact, defective is much higher than in Japan, where it is likely to be suffering from inattention, insufficient affection, and general benign neglect.

Nevertheless, 1225 (33%!!) is a large number, so this patch of forest must contain, if nothing else, a lot of assets. And since assets are such the rage these days, the question arises as to how long such potential bargains will remain, especially with money supplies the world over run amok, real rates near zero or negative on any kind of realistic inflation measure NOT calculated by the US BLS?

So perhaps next week, I will introduce a new investment fund called "Assets-'r-Us", and we will blindly buy the entire 100-acre wood, dregs and all, under the mantra: "I don't know, and I don't care, but if it's an asset, lift the offer....". Of course, these assets perhaps should be cheap, and the anomaly could very well be that all other assets are poised to collapse under the weight of their own prices and, the tighter monetary polciy that is imminent, and the contractionary effect of the inevitably deterministic rise in US energy adn income taxes.


Anonymous said...

Many of these low PBV enterprises are in stagnant or declining markets making microscopic returns on equity. Japan is just big enough (and interest rates are low enough) for them to scrape out a living. Prosper? No!
The fact that there are so many of them suggests that widescale industry consolidation is needed.
Don't hold your breath waiting for it to happen, though.

Cassandra said...

I concur, and pointed out nearly as much, yet the aggregate numbers remain staggering by comparison. The same could be said about the dregs in the US: however, they are have even worse balance sheets and are not trading as the discounts they might deserve.

Many "assets" now rallying are also very shitty: a 1965 Tim McCarver rookie card; a signed Nate Archibald basketball, an early 19th century folkart tapestry. Are the small tool&die maker, or the HVAC piping sub-contractor or ditch-digger really any different (other than its trading at a substantial discount to assets that themselves are reasonably understated for most legacy companies??

I think it will be a fascinating floor-show to watch when the raiders come wielding axes - much like the Barbarians At The Gate phenom in the USA. Except in Japan it will surely be more ritualized and entertaining...

Anonymous said...

I remain skeptical, I doubt the floor-show will ever happen - there are too many vested interests in maintaining the status quo. With "Tokyo Style" I rest my case!

Cassandra said...

Again, I concur one should not underestimate "the power of the status quo" in Japan. I personally wouldn't pick a fight with "the vested interests", at least where the intent was to wrestle the prize from them.
But bugaboo deflation WILL end (if for all intents despite offficial statistics, it hasn't already). With each day of ZIRP, and each day of >6% GDP fiscal gap, the assets in question become more undervalued. Already, we see deals being done we never we'd see: Nissan to Renault; Nissan Diesel to Scania; the sale of an autoparts maker to US carpetbagger; the MBO of Greehouse (#9689), the paying of reasonable premiums for buying in the rump of a listed sub; Stringer & Sony.

I AM a bit of a skeptic and pessimist, and find myself distinctly uncomfortably arguing for an optimistic outcome (if thats what change is) yet for every Tokyo Style or Fuji TV, I think there is an offsetting case that suggests value may yet be unlocked, even against the wishes of some vested interests.

And to be fair, Mgmt of Tokyo Style DID buy in more than 10% of stock in the depths of despair in mainly 2002- 2004. And rather than return cash, or try to build an empire with Capex or takeovers, they bought Japanese real estate which was pretty gutsy for a Japanese Co. at the time. Yeah he's not Buffet or Joe Steinberg, but he IS an inconoclast, and its not altogether apparent he's a member of the Axis of Evil.

Anonymous said...

I concede the logic of your arguments but remember, J.M. Keynes said, "We are all dead in the long run," and "Markets can stay irrational longer than investors can stay solvent." Our grandchildren might be the beneficiaries of Assets 'R' Us...
I think a more selective approach is needed. Shall we leave it at that?

Anonymous said...

Anonymous, I am not pit-bull, nor will I be overly emphatic about something tepidly interesting, but I do believe that (paraphrasing what Keynes might have also said) what's important in a beauty contest is not whether a contestant is pretty, but whether the judges believe the contestant is pretty, and the more rpecise prognostication that I will part with is: at some point in the not-too-distant future, asset-crazed investors will "discover" the viscous sub-book dregs of the Japanese stock market as certain as they doubled, tripled (and in some cases more) the apparently attractive loadsa' net-cash crop. I most certainly share your sentiments that (1) many are unworthy of the attention and (2) many will be stymied long in advance of unlocking any value. (3) a more discerning subset will do better on any risk-adjusted basis over any longer frame. My call is simply pre-empting what others will [shortsightedly?, ignorantly?] do in the near future, just a as a "Cassandra" should. Thanks for readingmy dross!