Indigestion from Acquisition

18 Mar 2011 Biting off more than one can chew? By MICHELLE TAN WITH the quarterly batch of company results due soon, the impact of various acquisition 'strategies' carried out by companies recently might come to light. Taking a walk back in time, one can probably envision the potential scenarios that could play out after companies make sizeable investments to pay for acquisitions. Some have spent funds buying out competitors or similar businesses and moved on to grow their earnings base successfully. On the other side of the coin, things can go awry when companies bite off more than they can chew by spending more than they can reasonably afford on acquisitions. Abterra Ltd could turn out to be a case in point. Just a couple of days ago, Abterra announced that its subsidiary has entered into a conditional sale-and-purchase (S&P) agreement to acquire an additional 55.22 per cent equity interest in a Chinese mining company for a ticket price of 883.52 million yuan (S$171.7 million) - more than 50 per cent of Abterra's total market capitalisation. The company said the acquisition would be funded by 'internal resources'. This might perhaps raise some sceptics' eyebrows as they ponder just where these 'internal' funds would come from, considering that the company was loss-making just last year, registering a net loss attributable to equity-holders of $8.9 million (before accounting for the proposed acquisition) and remains relatively strapped with debt. In addition, Abterra faced difficulties obtaining credit facilities from banks in the latter part of 2010, which hurt the group's earnings for the last financial year. Then there is the valuation of the asset in question. The Chinese mining company's (the acquiree's) preliminary value stands at 1.6 billion yuan, which is in line with the purchase consideration of 883.52 million yuan for a 55.22 per cent cut of the pie. However, valuing a mining company or any company at all is not an exact science. Also, the valuation was derived via the discounted cash flow method - one that could be significantly swayed by minor changes in assumptions. So in light of the abovementioned, is Abterra spending too much on its proposed acquisition? More importantly, how can investors determine whether proposed acquisitions are beneficial or potentially detrimental to the company? On paper, a company like Abterra may look like a good bet as it deals with the trading of hard commodities, such as iron ore and minerals internationally. The layman investor who hears from the grapevine that commodities are in vogue may think a quick buck could be made buying Abterra shares. The problem is that things aren't as simple as that. There is no shortage of quick avenues for businesses to grow a business. Buy out your competitors or similar businesses and integrate them. With that and a little hocus-pocus, the company now has a much bigger earnings base in quick time. But the fact is that there are potential pitfalls when a company tries to grow via acquisitions. For one, an acquisition target is unlikely to sell its business for absolute book value, unless it is loss making or straddled with debt and basically needs a quick exit strategy. To illustrate, if an acquisition target has $10 million in assets, the acquirer may be asked to pay $20 million due to the former's good reputation and strong management. The excess of $10 million paid by the acquirer will then be booked into the balance sheet as 'goodwill' - an intangible item. As the name suggests, intangible items cannot be physically valued; in other words, there are no assets to back up the extra $10 million paid. So there will be nothing to sell or use as collateral should the company run into cash flow problems. So do not be lulled into thinking that a company is safe when its balance sheet reflects enough assets to balance its debt after making hefty acquisitions. Goodwill is not a normal asset and can be written down overnight if trouble starts brewing in the business. That said, it is a general rule of thumb that companies should build market share in recessionary periods to hopefully leave the weak weaker and make the strong stronger. In contrast, companies that overspend on acquisitions in better times will almost invariably face trying times when turmoil strikes. What investors should do is to hold their horses and spend the time to do some homework before betting on a company that is making a hefty acquisition. After all, a larger earnings base derived from acquisitions might not be as beneficial in terms of shareholder value as advertised by the company itself.

Another prediction on Yen

18 Mar 2011 Analysts take the measure of the yen in wake of crisis By NEIL BEHRMANN IN LONDON JAPAN'S economy is likely to benefit in the short term as a result of the yen, which is expected to weaken substantially from its current unsustainable heights, said Brendan Brown, London- based chief economist of Mitsubishi UFJ Securities International. While Mr Brown, rated the current top forecaster on Japan by Bloomberg, does not predict an exchange rate, Goldman Sachs expects the US dollar to appreciate by some 6 per cent to 84-85 yen within three to six months and 90 yen in 12 months. The US dollar slumped to a post-WWII nadir of 76.4 yen during New York trading hours, but subsequently recovered to around 79 yen. The low occurred at a time when trading volumes were very low, according to dealers. Closures of short yen positions on derivatives markets caused the spike, they said, and the dollar subsequently rebounded on fears that the Bank of Japan would intervene. 'The upward speculation on the yen since triple disaster (earthquake, tsunami, nuclear) struck Japan makes just about zero sense,' Mr Brown told BT. He believes that repatriation of liquid foreign assets by insurance companies will not have much influence on the yen. The knee-jerk reaction of the markets is thus likely to be proved wrong, Mr Brown believes. 'The speculators on yen appreciation point to what happened after the Kobe earthquake in early 1995,' he said. 'But the yen's climb at that time had virtually nothing to do with the earthquake. Much more important was the sudden slide of the US economy into growth recession amid the Mexico debt crisis at the time and a variety of other factors that caused US dollar weakness.' Looking further back, the Tokyo earthquake and tsunami of 1923, destruction was on a scale which also transcended comprehension, Mr Brown added. The yen plunged and remained weak for years until ultimately there was a late short-lived attempt to restore the gold standard in January 1930. Facts and estimates about the present triple disaster for Japan (GDP of around US$5 trillion) are still largely guesswork. But the estimates now circulating put insured losses at around US$35 billion and reconstruction costs for government (central and local) at around US$30 billion. On top of that, there is the non-insured damage in the private sector. Then, there is the loss of economic output as a result of the disasters. Some immediately available estimates put the economic output in normal times in the stricken regions at 7-10 per cent of Japan's GDP. And there is the loss of output from Japan's nuclear power plants, which over a sustained period will have to be replaced by imported energy. Evidently, these total output losses far exceed the damage estimates. Most plausibly, the combination of post-quake forces thus imply that there will be a substantially weaker trade balance over an extended period. This cumulative deterioration of the trade account would surely outweigh any repatriation flows, which were the immediate focus of speculative flows into the yen, Mr Brown said. There is no immediate funding problem for reconstruction and aid as the Japanese government can issue treasury bills.

 

Oil trading: swimming with whales

This is another article I like, particularly the part on using whales as an analogy. Reckon it will get lost in my computer somehow so decided to keep in this blog.

Published March 7, 2011

COMMODITIES
Oil trading: swimming with whales

By TIMOTHY MORGE

EVERYONE is talking about oil now: Will oil stay above US$100 a barrel? Should I buy oil here? Should I sell it?

As a successful commodities speculator for the past four decades, I've had to perfect my tools and my approach to trading the markets. The market is a living, breathing thing, and the rhythm is created by the people with the most money and the largest positions in a given market: the 'whales'. Following a consistent method to identify the proper entry and exit points in a market is critical to successful trading. I never chase the markets; instead, I use my tools to identify where the 'whales' are feeding and then look for potential entries there.

Oil began to trend higher in February 2009 - and I began to buy oil for my portfolio at US$35 a barrel, at an area that had acted as resistance for decades - until oil prices ignited in mid-2004 (what had been resistance should act as support).

The technical analysis tools I have developed and mastered over the past 40 years allowed me to identify the probable path of oil and then plan trades in the Nymex WTI light sweet crude oil futures. By July 2009, everyone was talking about oil going to US$100 a barrel. The majority of the market participants got ahead of themselves and entered long positions with poor trade location.

'Whales' are loners - if they feel oil is going up in the long term, they don't want to have everyone along for the ride with them. They want the majority of the market participants continually 'chasing the market'. This allows them to hand off their positions to the trading public when price gets ahead of itself, as it did in May 2010. Oil sold off hard as many stop-profit and stop-loss orders were executed. But it sold off to an area where the 'whales' were willing to buy: at the confluence point of multiple prior lows.

I had been stalking this confluence point for a long entry but passed on the trade because it did not fit all of my defined trading rules. But when oil prices broke above several swing highs, I began working a 'limit buy' order. I eventually got long at US$71.35 with a tight stop below prior multiple lows; I currently have a profit target of US$114 a barrel on a portion of my position.

I would consider adding to my current long positions (at US$35 and US$71 a barrel) if price fills the open gap just below US$88 a barrel, with a stop-loss order below the prior swing low.

The trading public often feels the market is after them, trying to discourage them at every turn. Having a set trading methodology, trading rules, strict money management, a plan, and the discipline to follow all of these, is critical.

The market gets the majority of the smaller and medium-sized players excited and bullish just before it turns down. Then it turns back up right after they give up and turn bearish. The market breathes and the 'whales' take advantage of the whims of the majority of traders. My methodology is designed to identify the behaviour of the major participants (the 'whales'), so I can trade along with them.

The writer is a CME member and independent trader. He actively trades CME Group products and teaches his trading methodology at www.marketgeometry.com

Resumption of uptrend for gbpnzd - Part 2

This pair still amazes me with its huge movement daily. I cannot remember the historical big moves so
I decided to go back and screen again. On 14th Sept 1992 a single day range was 3300pips and on 8th Oct 2008 (I believe it was Lehman Brother collapse) was 2700 pips! As of now, we are past mid-march for 2011 and the move is around 2400pips from the bottom so one can imagine the kind of movement on those kind of days.

Back to the chart.. I have adjusted the channel as the uptrend continues to develop. Currently it  might see slight pullback purely based on the new channel. The fibo level will be adjusted once a new high is formed in due time. The next realistic target level will be 2.400 which is around 2600pips from current level.  See also Part 1

It's only when the tide goes out that you learn who has been swimming naked

This article is unlike the rest. At last, someone who doesn't just blabber the same old stale stuff  as what the rest of the world is doing.

Black swan Japan keeps world on its toes
By WILLIAM PESEK JR
A SUDDEN shock to the global financial system has a way of uncovering its true state.
As billionaire Warren Buffett famously said, it's only when the tide goes out that you learn who has been swimming naked. Two events since Japan's March 11 earthquake have shown the extent to which our economic reality has no proverbial clothes.
One is that the yen is rising. You would think earthquakes, tsunamis and radiation clouds would have investors actively fleeing yen assets. Not so.
On March 14, a Bloomberg News headline proclaimed 'Yen reaches four-month high against dollar on safe-haven demand'. Some haven, that Japan.
The other is how quickly Timothy Geithner, the US Treasury secretary, got in front of the biggest worry in markets: that Japan will dump its vast holdings of Treasuries to raise cash.
This latter one is worth exploring because its implications would travel farther and wider than the radiation leaking from nuclear power plants. It could just happen, roiling world markets like only a Black Swan-event can.
Theories for yen demand tread similar ground as the rationale for Japan selling its dollars holdings - just less convincingly. We always need a handy explanation for why something is happening. News reports argue that it's all about insurance companies repatriating funds to pay for quake demand.
Perhaps; yet it's only part of the story. The yen has been irrationally strong since the 2008 collapse of Lehman Brothers Holdings Inc. Even with the nuclear risks, the yen is considered a less risky currency than the US dollar and euro. It's not that the yen is attractive. It's that if the currency markets held a beauty contest, the yen would be the least ugly contestant.
The same could be said of US debt. Pacific Investment Management Company's Bill Gross, who runs the world's biggest bond fund, last month dumped government-related debt. Few investors seem willing to do the same.
The reason: What else are you going to buy? Greek debt? French debt? Gold? Try to get your hands on some of the 5 per cent of Japanese government bonds that aren't held in Japan? For better or worse, it's US debt.
That is, unless the Japanese move to draw down large chunks of its US$886 billion worth. It could trigger the nightmare chain reaction officials in Washington have dreaded since 2008. China, which holds US$1.2 trillion of US debt, might act to avoid even bigger losses. The UK (US$278 billion), oil exporters (US$216 billion), Brazil (US$198 billion), Caribbean banking centres (US$167 billion) might follow suit.
So might Asia's other dollar hoarders including Taiwan, Hong Kong, Singapore and Thailand.
If history is any guide, it might now happen. 'Based on the 1995 experience of the Great Hanshin earthquake, the risk of selling by Japanese insurance companies would appear to be limited, at least in the near-term,' says Ward McCarthy, chief financial economist at Jefferies & Co Inc in New York.
Yet the Japan of 2011 isn't the Japan of 1995. Its debt is now twice the size of the economy, leaving far less room to borrow to boost growth than there was 16 years ago.
Also, the Bank of Japan's interest-rate policies are already at zero and beyond. The next step would be massive BOJ purchases of Japanese stocks after the Nikkei 225 Stock Average fell 16 per cent the in first two trading days after the earthquake.
That would be a slippery financial slope, but desperate times do tend to lead to desperate measures. That would certainly be the case if Japan decided to start dropping big blocks of Treasuries on the market. The turmoil would catch many a government policy maker or investor swimming naked, in the Buffett sense.
Who knows? Geithner had a point when he told the Senate Banking Committee on Tuesday that Japan has 'a very high savings rate' and that 'it has the capacity to help deal with not just the humanitarian challenge but the reconstruction challenge they face ahead'.
That would be fine if we knew what to expect. Fire and aftershocks continue to strike the crippled Fukushima Dai-Ichi power plant, as officials battle to prevent a nuclear meltdown after last week's record earthquake. Clouds of white smoke or steam are rising from reactor buildings and moving in the direction of Tokyo.
Will a worsening crisis force Japan to sell hundreds of billions of dollars of Treasuries? We will see when and where the toxic dust settles.

Nikkei 1995 vs Nikkei 2011

It was only 2 days into 3rd week of March 2011 but it seems like reminiscent of a stock market which displayed the same kind of ferocity I have experienced during the financial crisis of 2008-2009. Apart from the tepid sell-down in Asian regional bourses, the real action was in Japanese market. It was literally hammered by the massive destruction brought about by the 8.9 magnitude earthquake and tsunami, which was worsened by a nuclear crisis. For those who had missed out on the plunge, I suppose there are plenty of opportunities that lie ahead as we are still in early days. Simply by comparing the chart of Nikkei in 1995 after the Kobe earthquake and the current crisis, it seems pretty obvious the downtrend will last for weeks or even months. Anyway, the dive was overdone in my opinion and we should be seeing a rebound soon which will be a second killing ground for a lot of speculators. By the way, some of my foreign colleagues were affected in this crisis and some even lost their homes or families entirely in the process. Kudos to my association, it has decided to set up a relief fund and needless to say, profits will go towards this fund.

Into the killing zone: Silver

Good call there by evilspeculator on 9th March which correctly identifies the toppish silver, and the profit taking did materialize. What surprised me was the late push in the last few hours before the weekend from a low of 34 to 36!
Since this is the first post on silver, I shall start from the megatrend of silver. From the weekly chart, one can see that historically in the last 10 years, the bull cycle each lasted about 2 years from trough to peak. The bear was fast and furious, each lasting for few weeks to months but less than a year. Currently, it is into its third year of bull run and not surprisingly, the past few months of price advancement is nothing short of euphoric. The bears are now dangerously lurking as silver enters the KILLING ZONE. Never mind the bulls have been shouting that this time is different (4 most expensive words according to John Templeton) with the emerging markets consuming more than ever commodities and with everyone's consensus that greenback is coming down in the long run (in the long run, everyone is dead !!!) and thus its certainly a no brainer betting on commodites, but I'm not about to argue with the tape. From the daily chart, it seems that the late push from 23.6 fibo to close just below 36 suggest that the bull is still raging and still has some legs to run. Looks like I'll just have to sit tight with my long positions and diligently get out entirely before the slaughters begin...