Posted by: donmihaihai | May 31, 2009

Keep pumping, we need more capital!

“If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.” –Warren Buffett

For Celestial Nutrifoods, I guess I am the patsy. Despite having mapped out worse outcome, I have always assumed that they are not going to have much problem with refinancing. I guess I will be save by valuation and strong B/S. It is hard to associate having refinancing problem with strong B/S but strong B/S is not just about having load of cash but also how these cash come about. If I want to bet on someone on his whole life income, I don’t want to just know how much cash he has in his bank but how he gets those cash in 1st place which will also say about how he will earn his cash in the future. Strike Toto, 4D or having rich dad can fill bank account fast but usually it is easy come, easy go.

“I violated the Noah rule: Predicting rain doesn’t count; building arks does.” — Warren Buffett

Taking half the medicine doesn’t count too. I have seemed it coming for Beauty China, the mindless expansion and increasing trade receivables. I was worried and sold half of my current holdings and left with less than 1/4 of my original holding. But despite having receivables issues, Beauty China has lot of stuffs in their favour — years of brand buildings, scale, right market segment and strong B/S. But panic bankers and publicity kill this business. Basically when a company is being doomed in the way like Beauty China is currently going through, the only way to avoid it is no debt and lot of cash or cash lot more than debts. Big investors are doing the right job of trying to inject capital but it may be too late or if it drag too long, their brands can just die off as goods is not infront of consumer for buying due to lack of resources and unwillingness to carry more Beauty China brands.

While Celestial is in better position than Beauty China, worse case situation is the same for both as there is no stopping of Celestial for cutting off their healthy PRC subsidiaries away from BVI holding and subsidiaries. If that happened, shareholders will be cut off too.

Other Celestial and Beauty China, my other holdings are still healthy and still avoiding orgies of capital pumping at the wrong time. Even with the recent run up in equities, in most cases, equity is still very expensive, debt is much much cheaper and they are available. But lemming behavior is ruling the days whether it is run by owner or not. The current lemming behavior is to take advantage of the current depressed situation but wait everyone seem to be doing so, so who is taking advantage of whom? It will be interesting to look back 2 to 3 years later to see what kind of advantages have been taken.

Other than Sarin, TPV and maybe ARA Asset Management, the other has basically zero need to raise capital. Actually beside TPV, all other companies are being run in a way so that they don’t need the pumping of more capital. In a simple word, the need of capital can be foresee except bad luck so there is no excuse for the current wave of capital pumping.

What about Jaya? Debt to equity ratio of about 1X, not much different from Ezra and Swiber which raise massive amount and diluting existing shareholder of 10 to 20%. Of course they won’t come out and say they are rising capital because they are desperate for it, being in the crowd and say to take advantage of the situation is the safest way. But I won’t be surprise that they are being forced by their customer or potential customer to has a stronger B/S in order to take on bigger and longer duration projects. They lack the flexibility and going downstream, integrating model may not help to create competitive advantage but push the capital consumption even more.

Jaya has the flexibility. I have no doubt that Jaya has being “manipulating” their results every quarter because they have the flexibility to show what kind of results by controlling when to sell their vessels. Same thing here, if Jaya think that leverage is too high, they can de-leverage by reduction in scale and earn lesser. Reduction in scale may be unthinkable to other, this should not be something of alien to rental company. As long as the market value of the equipment, vessel in this case is not in a slump(equipment being dump somewhere with no interests), Jaya can always sell their vessels until debt level reduce to a level that they are comfortable. Earning lesser is not forever but dilution is.

Lastly, value creation or shareholder value in long term is being measured by per share basis. That says if a company is growing at 10% pa. But after share dilution, the growth becomes 5% pa. Now this is not much better than another company that grows by 5%pa with increase in number of shares. In fact, the 2nd company is actually creating more value as they are using less capital(assuming the starting capital is the same). The growth of many company like REL, Ezra, Swiber and REITs are impressive but when measure by per share basis, that growth lose some shine. In some case, ROE is unimpressive after all the growth and increased in capital.

Our long term economic goal (subject to some qualifications mentioned later) is to maximise berkshire’s average annual rate of gain in intrinsic business value on a per-share basis. We do not measure the economic significance or performance of Bershire by its size; we measure by per-share progress. We are certain that the rate of per-share progress will diminish in the future — a greatly enlarged capital base will see to that. But we will be disappointed if our rate does not exceed that of the average large American corporation. (Berkshire Hathaway owner related principles no 3)

We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As over net worth grows, it is more difficult to use retained earnings wisely.(Berkshire Hathaway owner related principles no 9)

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