Capital Musings

Politics, Business, and Innovation

Tag: Capital Musings (page 1 of 7)

Full Interview with Bill Gross and Larry Fink at UCLA Anderson

The interview of Bill Gross and Larry Fink by Eric Schatzker has now been posted online at UCLA Anderson’s website.  We have embedded a copy below:


We have also provided a reprint of our notes below for the ease of our users.



Gross: Not a 2008 Minsky moment, but we are still de-levering. We had a lack of aggregate demand and levered up to sustain consumption. Technology & demographics are structural problems in developed countries that can’t be addressed by fiscal or monetary policy. Peaking of consumption in the next 5 to 10 years.

Fink: Agree, but much of this is already priced into the market. Owning a bond eats away on returns; just not going to achieve your expected returns with that.


On Europe

Gross: The ECB is of a different mindset vs. the U.S. Even though Trichet is French and Draghi is Italian, the ECB is dominated by a German mentality.

Fink: There are now governments working towards balanced budget amendments. Unions in Spain are talking about restructuring. Finally countries like Spain and Italy are responding to global capital markets. But stakes are very large and the outcome can be black or white. In the end, Germany doesn’t want to see the Euro disappear. It would probably mean bankruptcy for every financial institution and major company because liabilities are in Euros.


How does Europe rank in U.S. threats?

Gross: At the top. The U.S. has been flying under the radar despite a present value of $60tn in future liabilities. But with the reserve currency and growth at 2.0% to 2.5%, compared to recession prospects elsewhere, investors still buy the U.S. over Euroland.


If you were to look to America like a stock, would you buy it?

Fink: Short run yes. Long run, no.
Gross: The U.S. is not a junk bond, but is still highly levered. Ultimately it’s a question of whether there’s inflation/reflation. If you were a saver/investor, would an atmosphere of 1-2% real growth entice you to invest? He’d say no.


On policy

Gross: The failure of policy is the emphasis of benefits going to consumption instead of investment. We have also spent the past few decades making paper, not things.

Fink: We need to be a manufacturer again. We need to invest in infrastructure. Convert Fannie Freddie properties to rental [Bill Ackman made a similar suggestion at the Harmonie Club the other month; full version of that at bottom]. Agree with Bill’s conclusions, but less bearish. Think mentality of U.S. is unique: start-ups, intellectual capital of software development, still the innovator of medical research.

Gross: Yes, we have Facebook, Google, and Apple, which are significant in terms of profit creation, but they are not significant in job creation.

Fink: Many of the jobs lost were in construction. Our problem wasn’t in ’08 or ’09, but in the building during ’03 to ’07. Those were the seeds of the destruction. But would argue we are 2-3 years away from stability. 1.25mn homes are needed for replacement, immigration, and family formation. Of course we still need to work on our immigration policy and let foreign graduate students stay here to start companies and create jobs. Sees rebound by 2014; the next president will be benefiting from the stabilization of housing.

Who would they vote for?

Fink: People being unhappy with the government is not an unusual for a democracy. Actually happy with Occupy Wall Street because for the first time in 3 years you have “fringe element symmetry.” Tea Party said many good things, shaped ’10 elections, but Fink was surprised there was no Tea Party equivalent on the left at the time. Washington and the financial community really did let down a lot of people. There was huge confidence that Washington would protect people through policy. And finance effectuates governmental policy – they’re the ones that buy Fannie, Freddie.

Gross: Share sympathy with labor vs. capital. For 20-30 years, capital has been winning. Compensation has decreased from 69% to 62% of GDP while profits have increased from 8% to 13% or 14% of GDP. How could one not sympathize with their predicament? You can disagree with solution, but to not have sympathy with Main Street would be to have blinders.

Would vote for neither candidate in this election. Is a registered Republican but voted for Obama. Was there change he could believe in? There wasn’t. Washington is dominated by K Street. Jeffrey Sachs has suggested a third party. It might resemble the movement like Ross Perot’s; it might not. But Republicans and Democrats are like a two-faced one-sided Jack in a deck of cards.

If you were on the supercommittee, which sacred cows would you kill?

Fink: Entitlements are on a crash course. We have increased life expectancy but are not saving to compensate. Entitlements are going to have to be extended at a later age. Taxation will have to increase. Privately, politicians acknowledge this, but will never say it in public. Problem is the election cycle is so short that politicians are not standing up as leaders. Every state solution has been to tell retiring people that they’ll keep the benefits the same, but all the young people will bear the cost. As we continue to put more and more of the burden on young people, Fink would not be surprised by a large number of protesting by young people. To create dynamic economy, can’t place the entire burden on the young.

What do you do with your money?

Gross: Developed world has entered what Rogoff & Reinhart would call a period of financial repression. Low investment returns and negative real interest rates. We have three options: we can default, inflate, or financially repress the savers. Low interest rates or negative interest rates set the tone for the stock market as well. Without high levels of growth, the pricing of financial assets will not allow investors to achieve the returns they have had for 30 years. We are not in an 8-9% world, but in a 4-5% world.

Is now an appropriate time to be taking risk?

Fink: Bernanke is saying get out of bonds. Doesn’t necessarily think you have to be in a 4-5% world; you can find opportunities at 7%. Going to have to throw out the traditional mix of bonds and equities though. You need dividend-based equities to achieve returns. But it means minimizing allocation of bonds; if you’re bond-heavy, you’ll end up with 4 or 5% returns.

Investors have two choices: double their contribution to retirement and then a high allocation to bonds would be appropriate. If they have the fortitude to look beyond the next few years and the capability to invest for 10-year cycles, then equities will pay off. But they have to be multinational. Don’t be so U.S. dependent. Don’t be China dependent. Beauty of corporations is their ability to be global. P/E ratios are pricing in fear. Today, a larger than normal to equity and dividend securities will pay off over long cycle.

Gross: Can developed economies reflate? Can we produce an old economy of 4 to 5% nominal growth? Not a slam dunk. Look at Japan.

Fink: But Japan did not do what Bernanke did.

Gross: But that doesn’t mean policy makers will be correct in everything. Look at the policy errors in the depression. If the policy makers cannot reflate, then higher quality and safer investments are better. If they can, then equities are the better choice.

How are you investing your money?

Gross: A barbell/mix of both. On the quality side, not investing in treasuries [audience laughs], but investing munis. Then on other side, investing in global growth companies with dividends. Companies like PG, JNJ, and KO, with 3-4% dividend yields and good growth prospects.

Buffett pledge?

Fink: Yes, but don’t need to sign it.

Gross: Haven’t signed pledge but been giving for years. Would prefer the question to not have come up. Thinks there should be a place for giving without public recognition.

Fink: [aside] How Warren invests epitomizes in long cycle investing. He doesn’t care about quarterly earnings. Returns are strong because his focus is equities over the long cycle. Was talking with Warren Buffett one day when the market was down significantly and in the middle of the conversation, he got up two or three times to buy stocks. We envy and admire Warren Buffett, but most of us don’t have the inclination to invest like him.

Gross’s Question: Investment management being a non-levered business has left them in not as dire a situation. Where do you see the business 5 to 10 yrs? How will we adjust to a de-levering environment?

Fink: When he started, Wall Street was a cottage industry, with $50mn–$60mn firms. The money holders, like the big insurance companies, were the ones who controlled the business. Thinks we’re going back to future as investors have more control again. Most people are too young to remember how small Wall Street was back in the day. Believe we are going into a decade where money holders will have significant responsibility; more than we’ve had in our lifetimes.

Blackrock is also the largest investor in 2,400 companies. Think about what that means with proxies. Capital will be king. Responsive businesses will grow and the importance of their actions will increase. Voice in policy changes will be more significant.

Fink’s Question: How is it here in Newport Beach?

Gross: It’s a great life

Fink: So I’m the dumb one

Gross: [jokes] Who can argue with that?

In the past, it would have been heresy to think you could run a successful money management business from the west coast. But globalization negates the need to be in New York, London, Tokyo, or even Beijing. Get up at 4:00 a.m., home at 5:30 p.m. when there’s still some California sun.

What would do you think is best of Blackrock that PIMCO doesn’t have?

Gross: He would take the ETF franchise. Doesn’t know if he would pay for it, but would gladly take it. ETFs, which PIMCO haven’t done as well, would be an area he’d emphasize. Would also welcome the equity franchise. Blackrock is better balanced not just in terms of the domestic/global mix, but also the bond/equity mix.

What would do you think is best of PIMCO that Blackrock doesn’t have?

Fink: Has been working with PIMCO for years. Bill was Larry’s biggest client when Larry was at First Boston. PIMCO has been one of the most intellectually innovative firms. The quest for ideas and process for investing has separated PIMCO from any other firm in the business. There is a strong team and there has been a consistency in the organization. You see so many stars who are just incredible for 5 years. But Bill has been doing this since ’71.

What’s your motivation? Fame? Money? Power?

Gross: Fame [joke]. Just becoming respected in the practice of allocating capital. Not so much becoming a famous five-year flash in the pan, but becoming respected.

Fink: Fear and paranoia [joke]. Just respect. Just wants to work hard and be respected when it’s all done. Everything else is secondary to building a career or firm. That’s more important than fame, money, or power.


Featured Photo Credit: ©

New tower investments in Africa

IHS, a company that builds and rents out mobile phone towers, is raising money in order to double its business within the next year, reports the Financial Times.

  • Deal terms: $200mn in equity with Citi as lead bookrunner.
  • Use of funds: Bring portfolio of 850 towers to 2,000.
  • Addressable market: IHS estimates $50bn and 50,000 masts for the African tower market.  Voice penetration is reported at 60%, although the CEO of IHS thinks it’s more like 45%-50%.  Data services are practically nonexistent.
  • IRR for existing PE backers >20%.
  • Other deals in the space: France Telecom in Uganda, Etisalat in NigeriaOrange Telecom in Kenya, Mobiserve Holding in Egypt.

The mobile space has been one of the more high profile successes in less developed countries.  In Afghanistan, a country of 29mn people, there are 15mn wireless subscribers and, quips one visiting businessman, “My cell service is better [in Afghanistan] than in the Bay Area.”  At TED, Paul Romer showed (video at bottom) a picture in which African students had access to cell phones, but no access to electricity.

What is most notable about the telecommunications industry is its ability to attract customers in poor war-torn areas.  In 1998, cell phone users were 2mn.  By 2002, there were 30mn cell phone users.  In 2009, one report pegged new subscribers at 96mn across Africa, 89mn in China, and 128mn in India.

However, what is most exciting about the mobile phone space is the ability to piggyback new innovations.  In places where the minimum sustainable turnover did not cover capital costs for brick-and-mortar banking, mobile banking developed instead.  One consultancy, Juniper Research, estimates mobile banking will hit $22bn in Africa by 2015.  In fact, mobile banking is one industry where it seems less developed countries have leapfrogged the developed countries.  With the recent introduction of services like Google Wallet, it is only now that the United States is laying the groundwork for a banking system that was envisioned over 15 years ago.

Going back to the mobile towers specifically, to get a better idea of the terminal value of the African tower companies, one could look at more mature markets.  The United States, which has a population of around 300mn and mature levels of mobile penetration, has three main large mobile tower operators.  While their operations are not 100% in the United States and every market has its own peculiarities, we are just using this as a back-of-the-envelope calculation to get the right order of magnitude.

As of this writing, a quick look at Bloomberg pegs American Towers with an Enterprise Value of $28.0bn, Crown Castle with an Enterprise Value of $18.7bn, and SBA Communications with an Enterprise Value of $7.4bn (Enterprise Value combines market capitalization and net debt, which takes both equity holders and debt holders into account).  That would mean that for every 300mn in mobile customers, you would have at least $54.1bn worth of mobile infrastructure companies.

On a continent of 1bn people, the aggregate Enterprise Value of the tower companies would be $180bn, assuming the terminal value estimate is for roughly the same maturity level of mobile tower service in the United States today.  Give some margin of difference for varying economies of scale and competitiveness and you’re essentially looking at an undiscounted terminal value of $150bn to $200bn for the market.  Again, we are just using this as a mental exercise to get us thinking about the right order of magnitude.

Admittedly, multiples in the tower space are high with the expectation of multifold data demand increases caused by the eventual introduction of high bandwidth activities, such as laptop/tablet tethering, video streaming, and video conferencing.  Nevertheless, one could argue that the multiples of the mobile tower companies in the less developed countries should be higher because they have increasing incomes from a lower base and, correspondingly, a minuscule level of data usage compared to users in developed countries.  In other words, you’ve still got a lot more room for growth in the less developed countries.

Whatever the outcome of the mobile tower industry, it will be interesting to see how the continuing growth of telephony will affect the continent in the decades to come.

Featured Photo Credit: Released into Public Domain by Contimm

Chinese SWF shifting to infrastructure strategy

The Financial Times is out with a new report today about the China Investment Corporation (CIC) looking to invest in infrastructure projects located in the west, starting with a high speed rail line in the United Kingdom.  Historically, CIC, which is China’s sovereign wealth fund, has taken non-control stakes in order to mitigate political opposition.  Attempts by state-owned Chinese companies to initiate control stakes in western companies have, at times, been faced with political opposition.  In 2005, the state-owned China National Offshore Oil Corporation (CNOOC) bid for California-based Unocal.  However, in less than two months, CNOOC was withdrew their bid amid the political opposition.

However, times have changed.  Western governments are looking for ways to close budget deficits that have deepened in the current economic malaise.  In New Zealand, the newly re-elected Prime Minister John Key had asset sales as one of the parts of his political platform.  Whether Sinophobia will prevail remains to be seen.  In contrast to CNOOC’s strategy of full acquisition, the CIC has proposed investing as part of a fund consortium or through public-private-partnerships.

What could derail the investment process might not be Sinophobia; rather, the opposition might come on financial grounds, especially for investments with better risk-reward profiles.  While the short-term orientation of the western political process does not make us think it would be as probable a reason for opposition, a few infrastructure deals have experienced high-profile seller’s remorse.  In an attempt to close the Chicago’s deficit, the administration of Mayor Richard Daley decided to sell Chicago’s parking meters to Morgan Stanley.  The decision proved to be a political debacle.  Although the deal is de facto irreversible, Daley’s successor, Rahm Emanuel, has pledged to make sure that Chicago would not make the same mistake again.

From an investment perspective, the asset class has a stability of cash flows that, at least for some projects, can be uncorrelated with the general economy.  One type of competitive advantage for these projects can be geographic.  Take for example, the Golden Gate Bridge.  It essentially has a monopoly on transportation between Marin County and San Francisco.  No matter what the economy is doing, people who live on one side of the bridge but work on the other have no choice but to use the bridge.

If you take a look at the financial data of the Golden Gate Bridge, the greatest decline in traffic during the postwar era was -5.19% for 1973-74.  But in the following fiscal year, they were able to increase revenues from $9.5mn to $12.5mn.  During the burst of the TMT bubble, traffic flow was -3.49% in 2001-02 and -4.52% in 2002-03.  But they were able to pass a toll hike in 2002-03, raising revenues from $59.5mn to $79.4mn.

This stability also enables investors to lever their returns at a greater ratio than they would for more volatile asset classes.

Although most people think of infrastructure investing as something that happens when times are good and governments are experiencing increasing revenues, for the private investor, the investment windows in developed countries tend to be more countercyclical, when governments are trying to find easy fixes to their budget problems.  In this age of austerity, the CIC might just have the perfect timing…

Featured Photo Credit: flickr/l.bailey_beverley

Shipping industry follow-up in mining context: Vale

There is a new piece out by FT on Valemax ships.  Main points:

  • The latest figure on the proposed fleet is 35 ships.  At 400,000 tonnes, that would equate to 14mn tonnes in additional capacity, or 70 capesize ships.
  • Chinese ship makers are accusing mining companies of monopolistic practices.  But many of the ships will be built in Chinese shipyards and financed by Chinese banks.
  • Valemax ships are expected to result in cost savings of 25%.
  • The first Valemax ship was delivered on 25 November.

If you may recall, we cited the Valemax ships as fairly dramatic anecdotal evidence in our latest note on the shipping industry.  For a miner though, costs are essential.  They cannot control the value of their reserves; what is in the ground is already in the ground.

What the miners can control are their costs.  Since the bulk of Vale’s mines are located in Brazil, when selling to China, they are at a transport cost disadvantage compared to Rio Tinto and BHP Billiton, which have extremely large iron ore reserves in Australia.  These ships are meant to reduce both the level and volatility of shipping costs for Vale’s iron ore, bringing them closer to parity – at least on that segment of their cost structure.

This talk of iron ore demand in China corroborates with the data point from the Rio Tinto Investor Summit today: Rio Tinto will be increasing capital expenditures by 17% to cope with Chinese demand for iron ore as well.

Featured Photo Credit: flickr/Geoff Livingston

Rio Tinto Investment Summit, New Zealand Election

Rio Tinto Investment Summit

G’day.  Rio Tinto is currently hosting an investment summit in Sydney.  Seen as a bellwether company in the commodity space, here are some observations:

  • Contagion from Eurozone countered with positive outlook for Asian markets and inflationary pressures easing in China
  • Sign of softness in some markets.  Worried when softness is coupled with increasing costs and strength in AUD and CAD.
  • To cope with higher iron ore demand from China, capital expenditures will be $14bn next year, up 17%.  They have already bought back $5bn in stock this year.
  • LT Growth Rates
    • As Oyu Tolgoi ramps up, mined copper production CAGR for 2010-15 is now estimated at 8.2%
    • Coking coal production CAGR for 2010-15 is now estimated at 9.8%
    • 2010-15 production CAGRs for thermal coal, alumina, and iron ore are now estimated at 7.6%, 7.1%, and 6.5%, respectively.
  • Aluminium exceeds copper expenditure per capita once GDP per capita exceeds $15,000 per year.  Foresees world average income per capita approaching $18,000 to $20,000 around 2025.
New Zealand Election

In slightly related news, New Zealand Prime Minister John Key won re-election, with 48% of the vote, up from 45% three years ago.  He plans to overhaul the welfare system and pursue asset sales to help close the deficit.  As of this report, intraday rates for AUD are up 174 bps against USD while NZD is up 186 bps against USD.

Featured Photo Credit: ©

Older posts