Commentaries

A “Wynning” strategy of betting on VIPs

Top-tier casino operator Wynn has always bet on VIP gamblers. Now it is adopting the same approach with its stock market flotation. Wynn is trying to trump half a dozen recent poor Hong Kong market debuts by shunning fickle retail investors and handpicking money managers who are likely to stay the distance. It remains to be seen whether this strategy can help justify its valuation premium.

Most Hong Kong retail investors sell their shares on the first day of trading for a quick profit. By putting 90 percent of the shares in the hands of institutional buyers, Wynn is aiming to avoid the hit when its shares start trading on Friday.

That’s probably why the stock has not fallen in grey market trading, even though it was priced at HK$10.08, at the top end of the HK$8.52-$10.08 range.

Wynn has specifically obtained a waiver from the Hong Kong stock market to prevent retail investors from holding more than 30 percent of the total shares offered. But this effort turned out to be unnecessary, as private investors are simply not interested.

Retail demand for Wynn Macau is so weak that small investors are only taking 10 percent of the offering. It appears that Asian high rollers are more interested in gambling in Macau’s casinos than investing in their stocks. Many have been burned in the past by the stocks’ high volatility.

Investors are also deterred by the rich valuation. Wynn Macau has valued itself at around 16 times forecast 2010 cashflow, much higher than the 7.5 times enjoyed by Macau gambling tycoon Stanley Ho’s SJM Holdings.

That is not to say Wynn does not deserve some premium. First, it has always been an investor favourite in the U.S., with a stable institutional investor base. Money managers hold as much as 60 percent of Nasdaq-listed Wynn Resorts. SJM, in comparison, has 1.4 percent institutional ownership.

China can be smarter on reserving more resources

China might have good environmental reasons to restrict the production of rare earth metals, but export quotas and duties are not the way to do it.

Instead, it should raise environmental standards which will force consolidation in the production of these metals, which are key to green technologies. That will improve China’s environment, give it greater control over output, but reduce the risk of a trade battle.

China dominates the global production of rare earth metals — a collection of 17 chemical elements in the periodic table that are key materials for making hybrid cars, wind turbines and smart phones. This is unusual, as China depends on imports from abroad for most of its raw materials. However, the country’s control of supply has not helped it control prices.

Although demand has been rising more than 10 percent each year, prices were a third lower in 2005 than in 1990, mainly because of a surge of exports. Meanwhile, China’s reserves are being used up rapidly. They now account for only half of the world’s total, down from almost 90 percent in 1990.

In response, China has started to impose quotas and duties on rare earth exports in the hope that less supply might help improve prices. This has had some success: since 2004, exports from China have shrunk by about 10 percent each year. But it has angered China’s trading partners. Concerned that China wants to use its resources mainly for its domestic consumption, the U.S. and EU both filed complaints with the World Trade Organization earlier this year.

China’s move to restrict exports looks poorly coordinated with its recent resources acquisition frenzy. If this is how it behaves when it is the dominant supplier of a valuable resource, how can it complain that the rest of the world does not want to sell it more?

A better solution would be for China to raise environmental standards in rare earth production. This would squeeze out smaller producers and give China greater control over exports.

Bankers leave little upside for new Hong Kong IPO

A dozen or so companies have raised money in Hong Kong over the past month to cash in on rebounding equity markets, but that window is threatening to close after a string of poor debuts.

   Glorious Property was the latest, falling by 15 percent on its debut on Friday. Its poor performance came on the heels of China South City, a real-estate developer in Guangdong province, which had the worst trading debut in Hong Kong this year by falling 23 percent.     Even companies in more stable businesses, such as men’s clothing retailer Lilang and sports shoes maker Peak Sport, also fell below their offer prices last month.

   One reason for the wobble is that issuers and investment banks seem to have been greedy. IPOs are generally priced at a discount to comparable listed stocks to reflect risk and to encourage trading in the after market. But with strong investor demand, they have steadily been whittling away at the discount and relying on the froth in the market to get issues away.

   Of late, IPOs have often been more than 100 times oversubscribed with institutions as well as retail investors vying for stock. Thanks to cheap and freely available money, it has been possible for investors to borrow to fund their IPO purchases. Banks have been offering interest rates on IPO loans as low as 1.8 percent.

   But market sentiment has changed dramatically, with the Heng Sang Chinese Enterprises Index <.HSCE> down almost 10 percent in the past two weeks. This has suddenly made IPOs which had set aggressive ranges seem expensive. Glorious Property actually priced its IPO towards the bottom of the range but it still received a poor response.

   From a position of excessive enthusiasm, sentiment has now snapped the other way. Retail investors have become more cautious. Some banks have stopped offering IPO loans to retail investors, which will further temper demand for new issues.

   But the message hasn’t yet got through to some issuers. Las Vegas casino company Wynn Resorts priced its Hong Kong IPO at the top of its indicated range, which values it at a much higher multiple than Macau gambling tycoon Stanley Ho’s flagship casino firm SJM Holdings. This looks pretty daring.

For Chinese exporters, the grass is greener abroad

   The U.S.-China tyre dispute threatens to spill into other sectors and further squeeze Chinese exporters’ already razor-thin margins. It might seem mind-boggling to many that Chinese manufacturers are still hanging on to weak overseas markets even though the domestic economy looks much healthier and surely offers more potential.

    But there are structural reasons why the grass is greener outside China. The risk of not getting paid, or getting paid late, is significantly lower when dealing with foreign buyers. The cost of international shipping has dropped so much that it can be cheaper to send goods over the Pacific Ocean than across the country.

    In addition, selling to large buyers such as Wal-Mart creates enough volumes to compensate for weak margins. Moreover, Chinese exporters get all sorts of export rebates and local government incentives which help to lower their costs.

    But as the tyre spat has illustrated, Washington can slap punitive duties on Chinese imports simply by pointing to a significant increase in imports from China.  By imposing penalties in this case, President Obama has opened the door for a slew of similar complaints against Chinese goods. It will only be a matter of time before other countries, worried about where those displaced Chinese exports might end up, start to follow suit.

Identifying bubbles

One of the biggest debates about China today is whether it is at the stage of asset price inflation or has entered into a bubble. Here are some useful quotes from leading bubbleologists to help you decide:

Charles P. Kindleberger, author of Manias, Panics and Crashes: A history of financial crises, uses the term bubble to mean any deviation in the price of an asset or a security or a commodity that cannot be explained in terms of the “fundamentals”. Small price variations based on fundamentals are called “noise”.

Kindleberger and co-author Robert Aliber explain further: The bubble involves the purchase of an asset, usually real estate or a security, not because of the rate of return on the investment but in anticipation that the asset or security can be sold to someone else at an even higher price; the term “the greater fool” has been used to suggest the last buyer was always counting on finding someone else to whom the stock or condo apartment or the baseball cards could be sold.

In an effort to determine how bubbles form, Robert Shiller focuses on a psychological feedback loop among investors, who become ‘attracted to an investment irrationally because rising prices encourage them to expect, at some level of consciousness at least, more price increases. A feedback develops – as people become more and more attracted, there are more and more price increases. The bubble comes to an end when people no longer expect the price to increase, and so the demand falls and the market crashes.’

All this wisdom is helpful, but it is still very difficult to distinguish between a rise in asset prices caused by irrational exuberance and one which is driven primarily by improving fundamentals.

Take Chinese property as an example. Billions of dollars of infrastructure money has improved the value of the land so property prices deserve a revaluation. The demand for property seems to have drive up prices to the point that rental yield becomes very low, indicating that prices might have gone ahead of themselves.

That’s why I will save this for the last quote. ‘The first lesson about bubbles,’ according to Allan Meltzer, ‘is that all explosive movements are not bubbles.’

U.S.-China trade spat more about cars than tyres

Why are the U.S. and China trading blows about something as mundane as car tyres at a time when the world is trying to avoid slipping back into trade protectionism? It’s not purely about the $1 billion worth of tyres China sells to the U.S. every year. It has more to do with the $100 billion of automotive vehicles, parts and engines America buys from abroad. China is worried about the direction of U.S policy. Beijing fears that the administration may find ways to thwart China’s future plans to ship vehicles to America. China may not yet export cars to America, but it already exports a growing number of parts. Cars are in the pipeline. A recent spate of bids from Chinese companies such as Geely for failing U.S. and European auto brands have shown that it has the ambition to be the next Japan or Korea. Auto sales are the only bright spot in U.S. consumer spending due to the Treasury-financed “cash for clunkers” program. Fears about stimulus dollars leaking abroad are one of the reasons the U.S. trade unions have been aggressively pushing for anti-dumping tariffs. The worry is that the U.S. has imposed the tariffs under a law designed to protect domestic U.S. producers from being damaged by a sudden surge in imports from China. Determining whether this has occurred is a bureaucratic exercise in which experts determine whether such damage is occurring and propose remedies. But there is a political circuit breaker — the president has discretion in whether to implement remedies. At least four similar, so-called Section 421 petitions were filed during the presidency of George W. Bush, according to the international trade commentator, Scott Lincicome, but none were approved. In this case, Obama came down on the side of the union. This has raised fears in Beijing that there will be more cases in coming months. The Chinese side seems to fear that Obama is bending too much to domestic constituencies such as union and producer interests. Washington needs to be careful about this. Since it wants to export its way out of recession, it should not agitate China, which is potentially a major purchaser of U.S. exports. China does not want the Obama presidency to set a precedent by discriminating against Chinese goods at this time. Moreover, it is concerned that other countries might follow suit and start to target Chinese goods as well. Its reliance on exports is potentially the big weak link among China’s recovery. That’s why Beijing, which has limited its protest mostly to words in recent years for fear of more retaliation, quickly spun into action this time. China’s counterpunch is equally forceful. It is launching an anti-dumping investigation into imports of U.S. chicken products and vehicles. The idea is presumably to raise the political cost for Obama of taking his pen out of his pocket every time a Section 421 case, which specifically targets China, is presented for his signature. During the first half of this year, 89 percent of China’s chicken imports came from America, representing a fifth of all U.S. chicken exports. In comparison, tyres account for just 0.4 percent of the value of goods what China sells to America each year and 0.07 percent of China’s total exports. While it is no secret that America subsidises its agriculture industry, China also spares no effort in helping exporters and putting up import barriers to protect domestic manufacturers. For example, China agreed in August to stop some discriminatory charges it imposed on imported U.S. auto parts after a World Trade Organization ruling from September 1. After chicken, U.S. soybeans might be the next target. As much as 40 percent of China’s soybean imports came from America last year. And this year, China’s soybean imports increased by 28 percent. The last time China took retaliatory measures was during the “garlic trade war” against Japan and South Korea in 2000-2001. Washington and Beijing have vowed to cooperate in seeking to revive global economic growth, but the dispute over tyres has laid bare the two countries’ continued friction over trade. This could spill into the G20 summit later this month and Obama’s scheduled visit to China in November. In previous meetings between the top leaders of the two countries, mostly the U.S. lectured and China listened. Now Beijing is more outspoken about expressing its own concerns and many at home are calling for more tit-for-tat policies. It remains to be seen how the U.S. will react to a more assertive China.