|
|
|
Arisaig Asia Diary
|
October 2008
|
Asian markets
were crushed in October on a wave of panic selling. Hedge
funds, mutual funds, private client managers, retail punters
and margin-strapped tycoons alike all tried to make a dash
for the exit at the same time. Most got stuck. Those that
squeezed through got killed in the process.
Reporting that the NAV fell 24.1% in October gives us no
pleasure whatsoever. All we would say is that share prices
have long lost touch with reality. Sure, Asia will slow. But
people will still need to eat, shop, drive their cars around
and dig holes in the road. Does the slow-down justify our
NAV per share finding itself 53.3% lower than twelve months
ago? No, of course not. Will the NAV still be this low
twelve months hence? Again, of course not.
We should, with hindsight, have done a much better job for
our investors. Our mistake was to regard the Bear Stearns
take-out as likely to signal the bear market low and on this
basis to be fully invested at end June. We were right when
we said that inflation would turn out to be a red herring
but completely wrong when we said that Asia would not be
unduly affected by what was happening in the West.
With a few exceptions (notably Korea, Indonesia and
Pakistan), Asia does not have serious structural problems.
Indebtedness is generally low at an individual, corporate
and country level. The problem has been that those playing
our markets are themselves highly leveraged.
What we had failed to take into account is that emerging
markets tend to suffer disproportionately when the US Dollar
reverses after a long period of weakness. The liquidity that
builds during times when locals and portfolio managers take
advantage of higher yields in non-Dollar assets goes into
reverse as money flies back to safe havens. The biggest
emerging market of them all, this time round, was US
sub-prime.
The extra leverage that has crept into the system as a
result of the antics of investment banks and hedge funds has
intensified the liquidity drain. What is still not clear is
the extent to which Asia consumption slows from here. It is
certainly going to be worse than we had blithely expected
barely a few months ago. For now all bets are off until the
dust settles. |
| |
The only real
casualties are those investors wishing to turn today's
irrational prices into cash. This is an especially important
issue for us given the well publicised mismatch between the
liquidity we offer our investors (28 days notice on a daily
dealing basis) and the underlying illiquidity of our
holdings.
In this respect our clients will not be surprised to hear
that the mismatch has now reached epic proportions. Many of
our stocks traded on only a handful of shares through
October. But this did not stop them gapping down as
desperate sellers hit cheeky bids posted by opportunistic
buyers.
We may over time review the question of our asset/liability
mismatch. Our lives would certainly be a lot easier if we
did not have to worry about untimely redemptions. That said,
we would still prefer to rely on a partnership approach with
like-minded investors, who know perfectly well that we are
all in the same boat, and that, by redeeming in times of
extreme distress, they simply inflict further damage upon
the NAV to everyone's ultimate disadvantage.
This high-minded approach only works, of course, to the
extent that we do actually end up with like-minded
investors. So how do things look from this perspective?
Well, we began the year with 62.6 million shares in issue at
the Asia Fund level (this was short of the cap of 65 million
shares imposed in early 2003) and have started November with
57.2 million shares in issue. In other words net
redemptions, based on shares in issue, through the first ten
months of the year have come in at 8.6%. This compares to
3.3% in 2007 and net subscriptions of 1.1% in 2006.
This slightly understates the position to the extent that we
have had modest redemptions by investors at the sub-fund
levels.
We accept that some clients, notably fund of funds and
private wealth managers, have no alternative but to take
money off the table should their end-investors redeem. This
is why we have made a special effort to restrict the number
of fund of fund investors to a small portion of our NAV
(currently about 15%) and only ones we regard as top drawer.
As to our Endowments and Foundation clients, who make up
around 65% of our investor base, they have (with one
exception) stuck firm.
We will be seeing almost all of our US clients in New York
in November when we will make the argument that they should,
in their own interests, sit tight. If any of them, for
whatever reason, feel the need to redeem at this tragic
juncture, we have every confidence that they will be willing
to agree to a "managed" withdrawal. Meanwhile, we are
itching to deploy the USD 80 million we hold in cash.
We should also mention that we are minded to reduce the
self-imposed cap on the number of shares in issue at the
Asia Fund level to 60 million. We don't wish to find
ourselves flooded with new liquidity at the bottom to the
disadvantage of long suffering investors who have waded
through blood all year. |
| |
|
The Asia Fund is trading on a
FY 08 harmonic average PER of 8.8x. In fact, we have small
cap stocks in our portfolios that are as cheap as we have
ever known - and that goes for the Asian crisis era, the
post internet bubble period and the SARS low.
Thirty six of our holdings, accounting for 25% of the Asia
Fund and with an average market cap of USD 154 million, are
trading on a FY 2008 EV/EBITDA ratio of less than 7x. In
fact in the case of nineteen of these this ratio is under
5x. In other words a buyer of these companies would be paid
back in five years or sooner out of the cash generated by
the businesses.
Our stakes in these names amount on average to 7% of the
issued capital. More tellingly, not counting the portion
controlled by founding families, we own, on average, 19% of
the free floats. Our average tenure is already 2.5 years. We
have met management on average 14 times each. We may have
the wool pulled over our eyes from time to time - despite
our very best efforts that's an occupational hazard - but
even so there are few who know these names better than we
do.
So what is the value of these holdings? How do you value our
knowledge of them? What value does one put on the fact that
we own them and others don't. In other words, turning the
question of value on its head, the replacement value of this
portfolio is, in our view, many times the current so-called
market value. |
| |
|
Our mid cap consumer holdings
are less cheap. We own twenty seven stocks in this category
accounting for 37% of the portfolio. They are trading on an
average EV/EBITDA multiple of 11x and have an average market
cap of about USD 1.1 billion.
Herein lies our dilemma. We own on average 2.5% stakes in
these larger companies or 6.6% of the free float. Their
share prices are down "only" 34% year to date and may still
be at risk as they have still not fallen to fire sale
levels; but it is impractical for us at this juncture to
sell and hope to buy back. |
| |
Then the final
portion of our portfolio is made up of what we term high
beta names. This includes the three leading real estate
brokers in Greater China (Midland, Sinyi,
Hopefluent); two stock Exchanges (Singapore's and the
Philippines') and three other financial companies in ASEAN;
a basket of six Indian banks; and six micro cap property
developers in India and ASEAN.
This group, nineteen names in total, accounts for 19% of the
portfolio. We have added to them knowing that they are the
best way of playing the bounce when it comes. Their prices
are down 62% year to date. We bought for example 12% of
Midland Realty through SARS and made five times our money.
They will make up for the historically sluggish performance
of the small cap consumer constituency in the early months
of a recovery.
Neither PERs nor historic cash flow are the appropriate way
to look at these businesses. In each case (the property
companies aside) their balance sheets are strong with net
cash or in the case of the banks low loan to deposit ratios.
A better way to measure them is versus their book value.
This group is trading on 1.1x book value. Back in March 2003
(the bottom of the SARS crisis), the equivalent number was
just under 1.0x. |
| |
We mentioned
last month how, following the death of the founder, bankers
were threatening to pull the plug on this jewellery maker.
They have now done so, alleging that some of the gold
inventory has gone missing.
This episode highlights the risks of key man dependence in
these family controlled businesses. Whilst the process of
professionalisation often brings a re-rating in its wake,
our challenge is to make sure that the people we back are
trustworthy. We have now completed a thorough post mortem
report on this case and concluded that, going forward, we
will engage forensic auditors to run background checks on
key men. |
| |
|
ARISAIG PARTNERS
7A Lorong Telok, Singapore 049019 Tel (65) 6532 3378 / Fax
(65) 6532 6618
October 2008 |
|
|
