More Evidence of a Slowing China

Today’s Sydney Morning Herald reports that mining giant BHP Billiton has put a six month hold on approvals for roughly $80 billion worth of new investments. 

According to Marius Kloppers, the company’s CEO, ”I think for the next two years, 18 months perhaps, we will just wait and see how things develop.”

Kloppers blamed rising costs and falling commodity prices for the delays. ”The economics of some of these projects has changed,” he said.

Mr Kloppers reiterated BHP’s view that the days of high growth rates in the steel and iron ore sectors were ”passed”, and in doing so, suggested BHP’s diverse portfolio was better placed to cope with a changing economy than its iron ore-dominated rivals.

Translation:  Chinese steel demand is down, and demand from other BRICs, such as India, will not be sufficient to make up for a slowing China.

How Strong is China’s Economy?

This week’s newly released Economist asks “How Strong is China’s Economy?” with the cover concluding that:

“Despite a recent slowdown, the world’s second biggest economy is more resilient than its critics think.”

But is it?

On the plus side, the chart below points to continued high GDP growth even in the absence of the export machine that fueled much of China’s growth in the 2000s.

And, while China’s reliance upon investment has been criticized as unsustainable, a comparison of capital stock vs. GDP vs Japan and South Korea seems to lessen the danger of an investment bubble collapsing.

On the other hand, one can argue that we should judge the economic data from China the way we should judge politicians in the US – ignore what they say and pay close attention to what they actually do.

According to the Economist,

“China will need to use its resources more judiciously, [which] will require it to free up its financial system, introducing more efficiency even at some cost to stability.“

But this is an easy thing to say from an office in London.  Officials in China, on the other hand, are fully aware of what “some cost to stability” really means, and are taking active steps to protect themselves from it.

As another story in the same Economist explains, Chinese use the phrase luo guan (“naked official”) to describe bureaucrats who have moved their families abroad – often taking their assets with them.

“You do not have to be corrupt to be “naked,” however.  Sending your family abroad is simply a state of maximum readiness” – though one that “does not suggest huge confidence in a stable Chinese future.” 

While immigrant investor programs in the developed West can cost up to $1 million, “the less well heeled obtain passports from other countries in the South Pacific, Africa or Latin America” for prices as low as $20,000.   Unsurprisingly, “countries that do not have an extradition treaty with China are particularly popular.”

For the moment, the Chinese government has done little to stop the emigration, and began to “formally monitor the whereabouts of officials’ families and assets only last year.”

Perhaps this is because “officials who can afford to send their families abroad are usually the most powerful, and the most aware of China’s problems.” 

“They know better than anyone that the China model is not sustainable, and that it is a risk to everyone.” 

This is not to suggest that China will implode in a wave of revolutionary violence.  But perhaps those investors counting on continued high Chinese GDP growth to bail out the world’s economy are in for disappointment, as are those who are making bets on commodity booms elsewhere (Canada, Australia, parts of Africa) that depend mostly on sales to a rapidly expanding China.

Facebook’s Mathematical Inevitability

Two recent articles in MIT’s Technology Review have analyzed Facebook’s numbers.  The first points out that Facebook’s valuation, while lofty, has not yet reached the pinnacle of the dot.com insanity.

The second, however, concludes that FB is ultimately doomed, as is every other company (with the possible exception of Google) that relies on internet advertising for the vast majority of its revenue. 

The reasoning:  a building glut of internet ads which is driving the CPM (cost per 1000 impressions) rate inevitably lower.  Some excerpts follow:

At the heart of the Internet business is one of the great business fallacies of our time: that the Web, with all its targeting abilities, can be a more efficient, and hence more profitable, advertising medium than traditional media. Facebook, with its 900 million users, valuation of around $100 billion, and the bulk of its business in traditional display advertising, is now at the heart of the heart of the fallacy.

The daily and stubborn reality for everybody building businesses on the strength of Web advertising is that the value of digital ads decreases every quarter, a consequence of their simultaneous ineffectiveness and efficiency.

This has resulted in the now famous and cruelly accurate formulation that $10 of offline advertising becomes $1 online.

I don’t know anyone in the ad-Web business who isn’t engaged in a relentless, demoralizing, no-exit operation to realign costs with falling per-user revenues, or who isn’t manically inflating traffic to compensate for ever-lower per-user value.

Facebook currently derives 82 percent of its revenue from advertising. Most of that is the desultory ticky-tacky kind that litters the right side of people’s Facebook profiles. Some is the kind of sponsorship that promises users further social relationships with companies: a kind of marketing that General Motors just announced it would no longer buy.

Facebook’s answer to its critics is: pay no attention to the carping. Sure, grunt-like advertising produces the overwhelming portion of our $4 billion in revenues; and, yes, on a per-user basis, these revenues are in pretty constant decline, but this stuff is really not what we have in mind. Just wait.

It’s quite a juxtaposition of realities. On the one hand, Facebook is mired in the same relentless downward pressure of falling per-user revenues as the rest of Web-based media.The company makes a pitiful and shrinking $5 per customer per year, which puts it somewhat ahead of the Huffington Post and somewhat behind the New York Times’ digital business.

Facebook’s business only grows on the unsustainable basis that it can add new customers at a faster rate than the value of individual customers declines. It is peddling as fast as it can. And the present scenario gets much worse as its users increasingly interact with the social service on mobile devices, because it is vastly harder, on a small screen, to sell ads and profitably monetize users.

On the other hand, Facebook is, everyone has come to agree, profoundly different from the Web. First of all, it exerts a new level of hegemonic control over users’ experiences. And it has its vast scale: 900 million, soon a billion, eventually two billion (one of the problems with the logic of constant growth at this scale and speed, of course, is that eventually it runs out of humans with computers or smart phones). And then it is social. Facebook has, in some yet-to-be-defined way, redefined something. Relationships? Media? Communications? Communities? Something big, anyway.

The subtext—an overt subtext—of the popular account of Facebook is that the network has a proprietary claim and special insight into social behavior. For enterprises and advertising agencies, it is therefore the bridge to new modes of human connection.

Expressed so baldly, this account is hardly different from what was claimed for the most aggressively boosted companies during the dot-com boom. But there is, in fact, one company that created and harnessed a transformation in behavior and business: Google. Facebook could be, or in many people’s eyes should be, something similar. Lost in such analysis is the failure to describe the application that will drive revenues.

Here’s another worrisome point: Facebook is a company of technologists, not marketers. If you wanted to bet on someone succeeding in the marketing business, you’d bet on technologists only if they could invent some new way to sell; you wouldn’t bet on them to sell the way marketers have always sold.

But that’s what Facebook is doing, selling individual ads. From a revenue perspective, it’s an ad-sales business, not a technology company. To meet expectations—the expectations that took it public at $100 billion, the ever-more-vigilant expectations needed to sustain it at that price—it has to sell at near hyperspeed.

The growth of its user base and its ever-expanding  page views means an almost infinite inventory to sell. But the expanding supply, together with an equivocal demand, means ever-lowering costs. The math is sickeningly inevitable. Absent an earth-shaking idea, Facebook will look forward to slowing or declining growth in a tapped-out market, and ever-falling ad rates, both on the Web and (especially) in mobile. Facebook isn’t Google; it’s Yahoo or AOL.

Oh, yes … In its Herculean efforts to maintain its overall growth, Facebook will continue to lower its per-user revenues, which, given its vast inventory, will force the rest of the ad-driven Web to lower its costs. The low-level panic the owners of every mass-traffic website feel about the ever-downward movement of the cost of a thousand ad impressions (or CPM) is turning to dread, as some big sites observed as much as a 25 percent decrease in the last quarter, following Facebook’s own attempt to book more revenue.

You see where this is going. As Facebook gluts an already glutted market, the fallacy of the Web as a profitable ad medium can no longer be overlooked. The crash will come. And Facebook—that putative transformer of worlds, which is, in reality, only an ad-driven site—will fall with everybody else.

Facebook – The Skinning

A few months ago, this blog (and others) sounded cautionary notes about Facebook’s upcoming IPO – noting that company data pointed to a slowing of FB’s growth rate in a typical S-curve pattern.

And, the day before Facebook stock began trading, we warned investors not to place market orders pre-IPO since those orders were likely to be filled at the most disadvantageous price for the sucker market retail investor.

But today’s news goes far beyond economic reality intruding upon an overhyped fairy tale.  Instead, CNBC reports that Morgan Stanley, FB’s lead underwriter, cut revenue estimates for the company during the middle of the “road show” – a move which allowed favored clients to profit at the expense of the broader public.  

“They definitely lowered their numbers and there was some concern about that,” he said. “My biggest hedge fund client told me they lowered their numbers right around mid-roadshow.”

That client, he said, still bought the issue but “flipped his IPO allocation and went short on the first day.”

And to whom did he flip these shares? Hint: if you bought FB the first day, don’t look in the mirror.

Once more, we have a blatant example of leading Wall Street firms fleecing the gullible public. 

Institutions and major clients generally enjoy quick access to investment bank research, while retail clients in many cases only get it later … I

The firm declined to comment when asked who was told about the research.

Since FB has such a dominant position in social media, we can expect our Congress critters to bloviate in their usual manner – but without actually enacting any real reforms that would sting their financial backers.

The real question is where the tipping point is:  at what point will the rot and corruption in the DC/Wall Street complex provoke an angry public to sweep it all away?

What Hath ZIRP Wrought?

As we all know, Bernanke’s Zero Interest Rate Policy – designed to bail out the TBTF banks in a way that will attract minimal public scrutiny – has forced pension funds to invest in lunatic schemes riskier assets in order to earn even a fraction of the amounts they have promised to their retirees.

So how is this working out? 

Not so well. 

Two recent cases in Texas are illustrative.

In the first, the Dallas Morning News (subscription required) reports that the Texas Teacher Retirement System lost $100 million, or virtually their entire investment, in the buyout of Las Vegas gaming company Station Casinos.

This was not the only ill-fated venture for the TRS.  Readers from New Jersey will be pleased to know that Texas teachers funded Xanadu, a now empty retail and entertainment complex located there.  TRS losses on Xanadu are “undisclosed” – best translated as “embarrassingly high.”

The TRS – with assets of $110 billion – is the nation’s fifth largest public pension provider, covering 1.3 million public education employees (a quarter of whom are retired).   Unfortunately, current unfunded liabilities are approximately $24 billion, and Bernanke’s ZIRP has forced the system to

shift from traditional stocks and bonds toward alternatives that offer higher returns but present higher risks.

Of the nations 10 largest public pension funds, the TRS has the highest share (31%) of its assets invested in “alternative assets.”  And, to no one’s surprise, the stench of cronyism is easily detected.  The owners of Station Casinos, for instance, were among the top donors to Governor Oops’s ill-fated presidential campaign.

Local pension funds are gambling even more of their assets away.   According to the New York Times, the Dallas Police and Fire Pension System’s alternative investments topped the national chart, with 56.3 percent of its assets committed to riskier investments.

Unfortunately for Dallas police and fire retirees, the fund pays some of the highest management fees in the industry. 

And what does the fund get in return for these fees?

In the “you can’t make this stuff up” department, Dallas police and fire retirees have invested $200 million in a development called the Museum Tower – a high rise condominium complex located next to the much-hyped Nasher Sculpture Center.  The only problem:  reflection off the building’s glass facade concentrates sunlight onto the sculpture at roughly 2.5x its already high natural intensity.

As D Magazine expressed it,

How could someone build a $200 million project in the Arts District that is in the process of destroying the very museum it uses in its marketing materials to sell million-dollar condos?

Expect more of the same from projects all over the US.  Rather than admit to retirees that their pensions will never be paid in full as long as ZIRP exists, managers will take ever more risky gambles – egged on by fee-hungry bankers and private equity moguls – until the inevitable implosions occur. 

Thanks, Ben! 

The Shearing – 15%

On Thursday, I warned retail investors not to place a pre-IPO market order for Facebook shares based on the history of favored investors using the Wall Street hype machine to flip their stock to an unsuspecting public for a quick profit.

True to form, Facebook priced at $38 – but where did the sucker retail investor get in?

At 45 (as always, click to enlarge).

FB closed yesterday at $38.23, which means that these investors – who bought into the decade’s most over-hyped stock – are already down 15%, after only one day.  

Recent months have seen a spate of articles to the effect that individuals are abandoning the stock market completely – that these investors

have finally learned that the market is rigged and no longer wish to play the sheeple that are both fleeced and slaughtered for the benefit of the big financial institutions.

Chart courtesy Zero Hedge

Gee, I wonder why? 

Time for Sheep-Shearing (Facebook edition)

A headline on Yahoo Finance today screams “Facebook Frenzy Squeezes Main Street Investors Out of IPO.”

For those who are paying attention, this is a good thing, as I and many others have warned of Facebook’s slowing growth rates and the difficulty the company will have monetizing its user base (or monetizing it enough to justify a $100 billion valuation).

See Hello Suckers (Facebook edition)

Those who still insist on joining the frenzy should heed the lessons of Groupon, the main one of which is no matter how eager you are to own Facebook stock, do not put in a market order before the IPO begins trading.

(as always, click on the chart to enlarge it)

If you qualify as an institutional investor (and to do so, your net worth should be measured with a word that begins with “B”), then by all means grab your shares at the IPO price and flip them to the eager public.

But if you’re a retail investor and you put in a market order (with no limit), the odds are high that your order will be filled at a price most disadvantageous to you. 

Caveat emptor – again.

Market Inflation – Politicians for Sale

A few months ago, we noted that for many firms, lobbying was so profitable in relation to the funds expended for that purpose – roughly $220 for each dollar – that it was a wonder that they did anything but lobby.

But what about the price of direct political influence? 

Going up rapidly. 

A recent article in Forbes noted that:

“For decades, political influence has been the most undervalued asset in America.  The market is now clearing, and Sheldon Anderson’s patronage of Newt Gingrich is just the tip of the iceberg.”

For those who have tried to blot Newt’s campaign from your memory (see “Erasing Painful Memories” in the May 2012 issue of Scientific American), Anderson created the trade show Comdex and sold it at the top of the dot.com bubble to Japan’s Softbank.  He now operates Las Vegas casinos, and his net worth, according to Forbes, is $24.6 billion.

The market shift was driven by the US Supreme Court’s decision in the 2010 Citizens United case, which eliminated the longstanding ban on corporate political spending.

Until recently, those who wanted to curry influence on an industrial scale were stuck funding a byzantine array of lobbying groups, think-tanks and “grassroots” organizations.

Now, the market is more “efficient.”  According to Forbes, the starting price for minimal influence is now $35,800.  For that, “somebody will return your call.”

Other market prices are as follows.  Forbes asked political strategist Douglas Schoen, Bill Clinton’s chief White House pollster, how a wealthy person newly empowered by Citizens United might get heard in Washington.

$35,800
“is the minimum ante to be on the radar,” says Schoen. That’s the legal maximum contribution to an election effort–$2,500 each for the primary and general phases to the campaign committee, plus $30,800 to the national party committee. “You get invited to events and somebody will return your call. It used to be that that had a bigger impact, but you’re not going to be ignored.”

$100,000 to $150,000
“makes an impact somewhere,” says Schoen. Approach a super PAC with a single issue and a contribution on that scale, and your concerns will make it to party leadership. “You can make a determinative impact on a particular issue.”

$500,000
“influences a few congressional races. You can make everyone in Washington know who you are. You’re not David Koch, but you’re not chopped liver, either,” Schoen says.

$2 million to $3 million
is enough to “have a huge impact on the party committees. You can influence a couple of races. You can be a serious player and be seen as one of the more important people in the process.”

$5 million to $10 million
makes you an influential figure in five or ten Senate races. “You will be taken seriously in Washington by every player. In traditional philanthropic giving, that’s a valuable contribution, but the president of the university doesn’t have time for you. The President of the United States does have time for you.”

$70 million
makes you “as important as anyone in America. You set the agenda. You control the action.”

 What about the average citizen who dutifully sends $100 checks in response to the “end of the world as we know it” mailers we all receive around election time?

Cue hysterical laughter – and perhaps a key chain, plus endless solicitations for more.

Is it any wonder why Congress-critters and lobbyists now rank below used car salespeople in polls of public trust?  And that honest citizens no longer believe they are being heard?

So what to do?  Given the ability of smart lawyers to circumvent any regulatory scheme, only  two answers come to mind:

1.  100% public financing of campaigns, combined with a five to ten year ban on ex-Congress critters lobbying their former colleagues; or

2.  allow unlimited personal contributions by individuals to individual candidates while banning all PACs and non-individual contributions (corporate, union, etc.), combined with full and immediate online disclosure of funding sources.

Of the two options, #2 would be least likely to run afoul of the First Amendment, and voters would know who was buying which candidates, in real time, and be able to cast their ballots accordingly.

Social Security Disability Recipients

As others have noted, Social Security disability claims have risen.  But what percentage of the US population is receiving disability payments?

The Social Security Administration provides a handy data source, which was used to create the following chart.

Today, roughly 3% of the US population receives SSDI payments – and the rate has climbed steadily since the early 1990s.

With obesity – a huge contributing cause of disability and chronic health problems – projected to increase to 42% of the US population  in the next 18 years (and the rates of extreme obesity – BMI >40 – are expected to double), what are the chances of the disabled population going down?

Given the choice between slim and none, I’ll bet on none.

Taxpayers beware:  who do you think will pay for this?

Amazon To Collect Sales Tax in Texas

Despite Amazon’s “blowout” earnings report last night, investors would do well to pay attention to the cracks in one of the foundations of the company’s impressive growth – namely its ability to avoid paying state sales taxes.

In a settlement announced today with the Texas Comptroller’s office, Amazon will begin collecting sales taxes on purchases by Texas residents beginning July 1, 2012. 

In the state’s large urban areas, the combined state and local sales tax is 8.25%.

Amazon’s top line sales growth has indeed been spectacular.  The question for investors, however, is to what extent these sales turn into profits.  And there, the outlook is more problematic.   According to observers like Karl Denninger,

Amazon’s primary “lever” is the ability to play around the edge of the sales tax system.  This gives it an instant 6% (on average) price advantage over everyone else, more than enough to offset the shipping costs (which you pay in any event; whether shipped directly to you or to a retail store, you still pay for it in the product price somehow.)

But that sales tax loophole is going to close.  Over the next few years states will find a way, as the revenue shaft is getting out of hand for them.

Now here’s the problem: Amazon has a 2.58% (ttm) profit margin and a 3.14% operating margin.  This is less than the benefit they get from evading the state sales tax system.

In short, this is a firm that only exists because of its ability to evade that tax structure.  When, not if, that ends the company is a literal zero.

I’m not sure I’d go quite that far.  I spend a fair amount of time in a smaller Texas city and often use Amazon to buy products that I cannot find locally.  But  I suspect that the main point is correct.  The Texas settlement will encourage more states to do the same, and Amazon’s already low profit margins will shrink even more.

For a stock with a P/E of 165, the price could be trimmed in a hurry. 

Disclosure:  not currently short Amazon, but thinking about it.  As always, though, the more difficult question is figuring out not what will happen, but when.