How much should HDB pay for the land?

One of the most popular posts talking about HDB Singapore on this blog is titled: What's Wrong with HDB Prices?

This has a perennial debate since Marlboro Tan's time and recently our new HDB Minister Mr Khaw talked about this again. Obviously Mr Khaw is a more eloquent man and what he says make a lot of sense:

"You need to acquire a piece of land , you need to reclaim a piece of land. All those costs money to tax payers and we are just trustees of tax payers and those costs are to be accounted for. And even when you have got that land prepared, then land is only valuable when we invest in infrastructure, roads, MRT, etc etc. And all those costs billions of dollars. So to say that land cost is pittance and therefore should be excluded from total construction cost, I myself think it is not quite an appropriate argument."

The problem is always in the calibration. So how much should HDB pay? So in the 1970s HDB paid almost nothing for the land and hence it cost $10,000 to buy a 3 room then. Of course, that's too ancient to talk about and now HDB pays market rate for land parcels and sells at a loss to Singaporeans. To Mr Khaw, this seemed to be the correct approach.

However market rate is determined by supply and demand in which supply is determined by the government. Market mechanism also sometimes breaks down because moving prices create anxiety and cause people to behave irrationally. We saw that in the Singapore property market when people pay S$1700 psf for some suburban project and more than S$3000 for super luxury condos. In absolute quantum of millions and tens of millions of dollars, these are monies that can buy villas and hectares of productive land in other countries.

Perhaps the solution is for HDB to move towards targeting a long term moving average of market prices which could reduce some volatility in HDB selling prices and also for the government to better regulate the sale of land to control the market. HDB should also move towards percentage based subsidy for new buyers and receive a percentage based grant from the government to ensure that it doesn't go bankrupt.

Well actually since it's a Singapore government entity, HDB Singapore technically shouldn't go bankrupt as the Singapore government has the obligation to bail them out as the MOF had done by providing billions of grants over the years.

2013 High Dividend Stocks in Singapore - Part 1

I am close to 5 months late in publishing this. But better late than never. Here is the new and updated list of high quality dividend stocks traded in the Singapore stock market.

This is the first half of this year's list.

This round produced 28 names in total and I have splitted up the list into 2 tranches so as to gain more traffic :). Dividend related posts are the best traffic drawer for this blog in this yield hungry environment in an even yield hungrier Singapore.

Actually, to be fair to Singaporeans, this is a global phenomenon as central bankers drive down the risk-free rate and as a result pushed up asset prices and inflation. To more advanced readers, you would know this is unchartered territory in the history of global finance. What does it mean if risk-free rate goes to zero? This is something never taught in textbooks. In fact, it should never happened. Without the risk-free rate (usually taken to be the 10-year government bond yield) how do you price all other assets like corporate bonds, stocks, real estate and other instruments? Nobody has an answer, and meanwhile asset prices shoot through the roof. More on this in time.

So, knowing that will make studying this current dividend screen all the more important! Make sure you study every name here religiously!

Ok, just kidding. As I have emphasized in all my past annual dividend posts (below), this screen alone cannot help you make money. It is just a starting point for you to study the stocks here in detail. To really know a stock, I try to answer 10 key questions to understand a stock as dictated in my Stocks page.

The past dividend lists:
2012 Dividend List
2011 Dividend List
2010 Dividend List
2009 Dividend List

Swatch's distribution

Well we should get back to Swatch after a few digression. So this is a continuation on the full fledge analysis on Swatch. Today we look at the distribution prowess of the company.

Swatch has 900 point of sales from its directly operated stores but these stores generate only 20-30% of sales for its watch division. The remaining 70-80% comes from its distributors and other 3rd party sellers. This is much lower than Richemont or LVMH, its key competitors at 50% or more sales coming from their own stores.

Here is a quick breakdown of the 900 stores:

Mono-brand stores
Swatch 600
Omega 260
Blancpain 30
Breguet 22
Jaquet Droz 6
Glashutte Original 5

Multi-brand stores
Tech Airport 40
Tourbillon 21

Most of Swatch's retail operations are actually in Europe, some airports and major retail outlets while others are in major global cities such as New York, Hong Kong, Singapore etc. Control over distribution has grown in importance in the last decade and Swatch has lagged in this aspect since it had strong history as a watch manufacturer with its watch movements business, not a retailer. Also, it did not have enough key brands to muster a formidable retail strategy, unlike its peers. That was partly why it wanted to buy over Harry Winston, a high end jeweller.

However, Swatch has now emphasized the need to expand directly operated stores so as to be able to get closer to the end customers, understand their preferences better and also have a better grasp on inventory. Not to mention, posh retail outlets are one of the best ways to market luxury brands, which is why we see megabrands like Louis Vuitton and Tiffany go all out to create the grandious stores in major shopping malls all over the world. To that end, Swatch has committed USD 400-600m (CHF 300-500m) in capex for the retail expansion annually. (Note: these no.s are before the acquisition of Harry Winston)

As a result of its smaller retail operations hitherto, Swatch has relied more on distributors to sell its watches. These are the Sincere Watch and Hour Glass that we see in Singapore. But more importantly for Swatch are its distributors in China: Hengdeli and Emperor Watch. Hengdeli has close to 1,000 stores in China while Emperor has a few hundred stores.

These distributors have allowed Swatch to expand rapidly into China at the expense of Swatch giving up the distribution margin. More importantly it has also allowed Swatch to hold less inventory and hence free up its working capital for investment into its movement and other businesses. Insofar, it looks like the strategy paid off with Swatch commanding a higher market share in China while its competitors Richemont and LVMH tries to play catch-up and are still building retail operations.

The next battle for Swatch is for the firm to claw back part of its distributor margin (est to be around 15-25% judging from Hengdeli's and other distributors' gross margins). However this will require time and capex but ultimately it should pay off with the benefits listed earlier (better inventory management and better customer understanding).

Having said that, distributors will still exist side by side as Swatch and other watch makers would still need them for nurturing new brands (the up and coming Omegas and Tag Heuers) and also their presence in inner cities and regional airports etc. With 20% of the global luxury watch market, the distributors cannot afford to ignore Swatch even if the firm decides it should distribute its megabrands (Omega, Breguet) by themselves.

This dual distribution model is one of Swatch's most enduring business moats as new players find it hard to engage distributors like Sincere or Hengdeli with a value proposition that Swatch cannot offer. On the other hand, the new players are also incapable of building up huge retail operations like LVMH and Richemont. So new entrants are almost a non issue.

How does Swatch compares with other branded competitors then?

As alluded to before, Swatch is playing catch-up by building up the retail stores as it sees the value of engaging customers at the last mile. One key difference is that Richemont and LVMH are both conglomerates with businesses that stretches far beyond watches. LVMH has bags and champagne while Richemont has jewellery and pens. Swatch has always been the watch company and by focusing on its strength, it should be able to compete on an even scale in the world of watches. Although this is changing with Harry Winston coming into the picture. Also Swatch always have leverage over these players via its movements business since Swatch provides the movements to these competitors. In an earlier post, we have also talked about how Swatch wanted to prioritize in-house movement to the detriment of its competitors.

As for Rolex, Patek Philippe and a few other remaining independent watch brands, Swatch's edge is again, both scale and again movements. Swatch, with its multiple high end watch brands, sells a much larger volume than Rolex. In terms of value, Swatch is also one notch ahead. Coupled with the fact that Swatch supply some key movements even to Rolex and Patek, we can say that Swatch is not in an inferior position vs these guys.

To conclude, Swatch's dual distribution via its own retail network and outside distributors, together with its dominance, allow it to create a strong business moat that rival the best competitors and should help Swatch maintain a sustainable advantage in the watch business.

Sky Habitat's Crash Landing - Part 4

This is a continuation of a series of posts analyzing the Singapore property market. Interested readers can start from the first post.

We talked about valuation in the last post. We shall examine where the "right prices" should be for Singapore property and what if this blogger is completely wrong.

By "right prices" I mean when prices become less than intrinsic values and hence if we buy, we stand to protect our capital and hopefully earn a decent return. As with the most simple stock valuation method, we need to come up with a good earnings estimate then multiply it by a multiple. In property space, this translates to estimating a good sustainable rental income, multiplied by a multiple, or inversely - divided by a reasonable yield.

To use a specific example, we use our favourite development: Sky Habitat. Say we think that Sky Habitat can rent out at $4psf per month. ie annual rental is $48psf but after taxes and expenses we are likely to get to $40psf. And we think that a reasonable yield should be 4%. So this means that Sky Habitat's fair value should be $40 / 0.04 = $1000 psf. So at $1400psf today, it has to decline another 40% in order to become palatable to value investors.

Now how do we justify these no.s? Why $4psf? Why not $5psf? And why 4% yield and not 1% like Monaco? I have always advocated that investment is an art, not a science. These no.s are merely one set of assumptions. Well we can always explore a couple of ways to triangulate to a real and good sustainable rental and a reasonable yield.

Yield is easy, so let's start with that. Singapore's own historical range is 2-5%. 2% yield today points to super ex, and 5% in 2005 was when nobody talked about property. Globally, as shown on the previous post - 4% looks like a good average yield, with some margin of safety. You can argue using 3% too, but that is not being conservative and hence not giving yourself that important margin of safety. So I would use a 4% yield.

Let's look at rental. How do we come up with the right long term sustainable rental rate for Sky Habitat?

One easy way is to look at rental across Singapore.

River Valley $4-6psf
Orchard $5-6psf
Current Bishan $3+psf
MRT locations $4-5psf

So where should Sky Habitat be? I give it $4psf. Well some might argue for $4.5psf, or maybe $3.5psf but I shall leave it to you to work out the ranges. Remember this is an art!

Another good starting point would be our GDP per capita. Singapore's GDP per capita currently sits at SGD 80,000. This represents the average pay of a worker in Singapore. From here we need to work out what is the comfortable rental that a worker would pay. Yes most Singaporeans have a place to stay and won't rent. And most expats who would rent don't just earn SGD 80,000. But, this is the most easily accessible number so we start with this. Super eng readers (those with lots of free time) can go singstats and dig out better no.s. But do update us here!

Let's say this hypothetical average worker and his hypothetical wife also earning average pay is comfortable with using 30% of their annual combined salary ( of SGD 160,000) to pay the rental, this works out to be SGD 48,000. Assuming they are comfortable living in a 1,000 psf condo and not Mickey Mouse's toilet, this would mean that they can pay $48psf per year, or $4psf per month. So qian right? (As in such a coincidence!) $4 psf is a rental level that can be supported by an average household earning our average GDP per capita.

Well, we could always tweak the assumptions. Say Bishan should not just attract an "average" worker but an expat household earning SGD 200k. So the household income is higher, which can then support a higher rental, which leads to a higher intrinsic value. Investment is an art. So use your own liberty and artistic skills.

But no matter how you tweak, you will probably find it very hard justify $1700psf is Bishan's true intrinsic value. Not today, at our current GDP per capita, at our current rental and yield levels.

It can only happen if we push the yield very low. Remember global rental yield has a 1-9% range?

Just to make things clear again, there are 2 variables here. Rental and yield. In order to justify a high intrinsic value, you either push up rental, or push down yield or both. So to justify $1,700psf, you can argue that Bishan rental should be $5psf (ie $60psf per year or 60-70k absolute annual rental!) and yield should be 2%. So $60 / 0.02 gives you $3,000psf. So $1,700psf is now cheap! Buy Sky Habitat! Buy 2 units at one go! Wait maybe should buy the whole floor!

Ok, need to be serious.

This point on the yield actually leads me to the next important topic. What if all I have analyzed is wrong? Singapore becomes a Monaco and our yield is forever at 1-2%. This is not an impossible scenario. As we looked at the charts on previous post. Most key Asian cities have low yields. Shanghai, Taipei, Hong Kong are at 2-3%. (Though none at 1%, Monaco is still the lowest.)

In investment, you need to bet in a way such that you don't get killed if you are wrong. Nobody gets it right all the time. In fact the best investors gets it right about half the time only. So don't do silly things like selling your only home into this market or go short $300k of Capitaland. A good way would be to buy long dated puts on City Dev, or Ho Bee for that matter (this is for advanced readers here) or simply wait for property prices to collapse and then buy or upgrade to that dream condo.

But back to Monaco. Will Singapore become Monaco? And hence property rental yield is forever at 1-2% (currently it is about 2-3% which translates to 50-100% upside for here!).

This will happen if that is what our beloved Government chooses or what happens if the rich property-vested Singaporeans' opinion overwhelms that of the rest. Singapore becomes the Monaco of the East. A tax haven, a safe city for the region and a playground for the global rich to park money. We now have F1, casinos and yacht harbours, just like Monaco. Damn it, even our flag looks similar! Why not property yield?

Flag of Monaco

It can happen. I am not kidding.

But it will be a sad day for Singaporeans because our kids will never afford their own homes, and the majority (sorry actually Singaporeans will become minority since foreign talent will be more than 50% of the population when it hits 6.9 million) of Singaporeans will become slaves in their own country, working hard, earning relatively ok money but yet unable to afford anything.

Fortunately, recent Government moves sort of mitigated this. Property prices have become a political issue and the government seemed quite determined to bring down prices. And yes the white paper probably wouldn't fly given all this backlash. Let's hope that Sky Habitat lands safely.

Sky Habitat's Crash Landing - Part 3

This is a continuation of an analysis on the Singapore property market. Interested readers can start from the first post.

So we debunked the three major bull arguments in the last two posts.

1. Strong demand. While true, it is supply and demand that matters and we saw that supply should outstrip demand in the next few years.

2. There are a lot of rich people to support prices. Rich people do not simply buy when prices fall. They are also governed by greed and fear.

3. Interest rates are low. This was partly the reason why property prices skyrocketed to stratosphere and caused instability in the system. Now that the system is on the verge of collapse, interest rates do not matter that much.

But what is most important, as in all investment, is always valuation or a methodology to gauge how cheap or expensive is the investment in question.

Property valuation can be calculated based on rental yield. Rental yield is calculated simply by dividing th annual rental over the property price. A normal range of rental yield globally goes from 1-2% to 8-9%. 1-2% being very low meaning that the property is very expensive and 8% means that yield is very high and hence implying that the property is very cheap.

Singapore's residential property market has ranged from 2% to 5% looking at our own history. Most high end property today are closer to 2%. In stocks PE terms, this translates to PE of 50x - Facebook and Amazon trades at such crazy valuations. In the global property space, only a handful of cities trade at or below 2% yield, such as Taipei, Beijing, Shanghai and Monaco. The charts below give a good comparison where Singapore stands.

Asia rental yield comparison

The other way to look at the 2% yield is to think about payback in years. At 2% you need to to rent the property for 50 years just to make back the capital (and this is simplistic bcos we are talking about gross yield and not net yield - ie after we take out taxes, downtime and other peripheral expenses like renovation etc). Some might argue capital appreciation matters not rental. But this argument is so absurd it is actually laughable. Why do I say so?

Essentially what the above argument means is that from 2% yield, prices can still go up further compressing yield to 1+% (Price and yield has an inverse relationship, if price goes up it means that yield should fall). Assuming that yield in Singapore actually goes to 1%, then it takes 100 years to make back the capital, and leasehold is only 99 years in Singapore. (Recently most of the launches are leasehold as developers realized it is actually much better for profits this way.) So isn't laughable that someone would buy something at $100, get $1 every year for the next 99 years, and be happy with $99 at the end of the century?!?

There is 1 country in the world where yield is at 1% level, it is Monaco. Luckily for Monaco, nobody actually lives there as it just a getaway for rich and famous. Yes, the rich and famous do like to pay $100 and only get back $99 after they go from ashes to ashes. But that's rich and famous for you. Of course, there are also no taxes, no restriction on foreigners and property ownership is freehold.

Monaco at 1.9% rental yield

Back to Singapore, so what is the likelihood that yield goes lower to 1% matching Monaco, i.e. prices can still double from here or yield actually fall to historical norm like 4-5%, i.e prices fall a lot from here?

The answer is pretty obvious. Even if prices do not fall, it is hard to imagine a lot of upside from buying at such prices as yield should not go to 1% unless Singapore becomes like Monaco. Therefore upside can only come from absolute rental increase which can then support absolute higher prices. (In equity parlance, this means upside is coming from earnings growth and not valuation expansion.) Alas, our rental rates are already at a high level comparable to global cities such as New York, London and Tokyo. So again, this points the conclusion that prices is likely to fall.

Sky Habitat is leading that descend from heaven now as prices plunge from $1,700psf to the current $1,400psf. I would expect it to fall closer to $1,000psf over time as that is the price level that is supported by valuation.

Next post, we talk about where prices should be and what is the alternative scenario.

Sky Habitat's Crash Landing - Part 2

This is a continuation of the last post talking about Singapore property market's imminent crash. I wrote most of what is below before the additional cooling measures were announced. Now that foreigners, and even Singaporeans are slapped with additional stamp duties and smaller possible mortgage loans, Sky Habitat should crash faster.

So we can now see that supply should outstrip demand and Economics 101 tells us that prices have to fall. But wait, there are all these global rich people that will simply buy up Singapore right? The Chinese super rich love Singapoore. So do the Indian billionaires and Indonesian tai-tais. Not to mention Singapore's own rich people. How can Singapore property fall?

This has to be my favourite argument (and my favourite counter argument). Logically, it is hard to debunk. Yes Singapore has always been a safe haven and has attracted a lot of money. In fact, it might be partly due to this that we became the nation with the most no. of millionaire households per population. Of course, a lot of born and bred Singaporean have also worked hard and made a lot of money (like top civil servants and ministers, finance people, top executives and readers of this blog).

So they will simply buy if prices fall by just a bit. Now how can price fall then? Waiting for prices to fall is a futile game.

Sadly, things do not work this way in reality.

When prices fall, liquidity dries up. Rich people do not simply buy when prices fall. If so, they would have continued buying Sky Habitat after its Phase 1 successful launch which sold 80%. It's now 25% below launch price, shouldn't all the Bishan rich go cheong (dash) into the showroom and write as many checks as they can? If so, why is Sky Habitat now 70% unsold and Capitaland trying all ways and means to get people to buy?

This pic is taken using the URA app showing Sky Habitat's price decline.

Humans are driven by greed and fear. When prices are rising, greed prompts people to buy, afraid of missing the train. When prices plunge, fear takes over. People, rich or poor, simply stop buying. There was no less rich people when Tokyo prices collapse in 1990, or in US after Lehman, or in Shanghai last year (2011). Florida beachfront property plunged 50% and is now much cheaper than Sentosa. Why didn't the US billionaires buy up Florida? Why didn't the Chinese super rich buy and support Shanghai property prices last year?

Rich people are also humans and hence experience greed and fear. In the plunge, fear takes over and only astute investors dare to buy, and only when value appears (ie price is much less than intrinsic value).

Ultimately, property is an investment and we should apply the value philosophy. But more on this later. Now we look at the low interest rate argument.

It is true that interest rate should remain low for some time. Singapore's interest rate is pegged to that of our trading partners as our central bank (Monetary Authority of Singapore or MAS) had decided to use exchange rate to manage our monetary policy some time back. This has to do with interest rate parity and the impossible trinity, interested parties can find out more on Google. The conclusion is: as long as global interest rates remain low, Singapore's mortgage rate should not increase.

So, everyone can afford their mortgages, and will be enticed to buy more property right? How can prices fall?

Yes, this argument stands and on its own there is no way to debunk it. If everything is as per normal, ie prices are stable, there is no disruption, the world continues revolving. This was what happened before sub-prime and Lehman. US property prices kept rising, mortgages were safe, people had jobs and everything was fine. However as prices continue to rise and efforts were continously being made to make sure the party can go on, the market will increasingly become unstable such that any small shock will cause the whole house of cards to collapse. (Well some experts do think that the global economy with all its intricate links supported by enormous debt is analogous to a house of cards.)

Back to Sky Habitat, so now that it has fallen 25%, there could be a few owners that were not prepared for such fall. They wanted to flip before TOP (forgot what the acronym stands for but basically it means when the property is ready for stay), now they have sell, which will exacerbate the price fall. At the banks, some mortgage had valuation there was at $1,700psf. Now they have to revalue the property and ask owners to top up 25% (which could be $500k). Some bankers might choose not to, bcos they know the owners cannot pay. But even if one banker insists on a pay up, then the owner might be forced to sell. So when we are at the top, any small shock will cause things to collapse. Not to mention, the Government just came out with major bazooka cooling measures to stop the frenzy.

So the interest rate can and should remain low. But when the system is especially fragile, it does not take much to cause a collapse. The US sub-prime and Lehman crisis didn't come about with the Fed doing interest rate hike. In fact, it came out of the blue. Things just fall apart, like the balloon that is being pumped air will just reach a point that it will simply burst.

We can gauge Singapore's property market nearing that breaking point when developers have to privatize themselves to avoid paying taxes (read SC Global), 50 year mortgages and HDB Minister coming out to warn EC developers not to get ahead of themselves. We are not far and may have hit that point last night.

Next, we look at valuation.

Sky Habitat's Crash Landing - Part 1

I have had a lot of interesting discussions with a lot of people on Singapore property over the past few years. It's always an exhausting though thriling intellectual debate especially when you are the only non-consensus view in the whole room. Yep, I was the only bear and it was a really good time for bear bashing: property prices can only go up in Singapore, there are so many rich people, even if prices fall, they will buy up everything! Look! The Marq is selling for S$3,000 psf. Sky Habitat in Bishan just sold for S$1,700 psf, see how wrong the bear is...(Yep a very bruised bear...)

Everyone became a property expert (though I did always profess that my expertise is in stocks, not property, which perhaps gave them a reason to shout louder). Yet I can remember the days when nobody talked about property as it was actually not so long ago. In 2005, my block had 30% empty units. Blocks of unsold flats stood in Sengkang and Punggol. At one point there were 10,000 empty flats. Marlboro Tan, our ex HDB Minister, was slammed in Parliament for overbuilding and costing taxpayers money. Hence he resolved not to build more HDB than needed (and we now know what happened next). These were interesting bear stories that most people choose to forget. Today the bulls have 1,001 reasons why Singapore property will rise forever. Below are the most convincing bull arguments:

1. Singapore's population is increasing to 6 million, the government has to bring in more foreign talent to keep the economy chugging along. There is a lot of demand for property so it will never fall.

2. Singapore is a safe haven and global money is flowing in Singapore, the rich Chinese, Indians, Indonesians and all the global rich and famous will continue to buy property here. Plus there are so many rich Singaporeans around. They will just buy everything if prices just drop 10%. So Singapore property will never fall.

3. Interest rate is so low, everyone can afford the mortgage. Even if prices fall, people can manage the mortgage. So who is there to sell? There will be no distress selling, in fact low interest rate will encourage more buying. Some will even buy to increase debt to fight inflation. So Singapore property will never fall.

Well, it's falling now.

Sky Habitat fell from S$1,700psf to S$1,300psf. A 25% fall and still on its way to crash land back to Earth. What is happening now?

For the uninitiated, Sky Habitat is the Capitaland development in Bishan (pic below) that was touted as a gamechanger a few months ago. Its first phase was launched at S$1,700psf and was 80% sold in the first week. Nobody has ever sold S$1,700psf in Bishan. Hence it was seen as a benchmark and the new normal for Singapore property. Hiterto, S$1,700psf was a price meant for prime areas in District 9, 10, 11 meaning Orchard, River Valley. Bishan though popular, was not supposed to be S$1,700. So when it sold well, Capitaland bid up the land next to it, at an exorbitant price, hoping to renact the success. Well, good luck cashing crashing in.

Sky Habitat

Okay, let's do a real good fundamental analysis here. Actually I did a few some time back in the Property label. But this series should serve to debunk the most bullish arguments. We start first by looking at supply and demand.

There is very strong demand - both from foreign talent and Singaporeans. This argument can easily be disputed with good demand supply analysis. Let's start with demand. We know that property demand from Singaporeans is about 20,000 to 25,000 based on the no. of marriages and also previous years of property buying (esp HDB buying). While we do not know the foreigner part we can estimate that it should be similar or just slightly less because there are 2 million foreigners vs 3 million Singaporeans. And when we get to 6 million population, it will be 3 million foreigners vs 3 million Singaporeans (since I don't think emotionless Singaporeans can make 1 million babies).

So, total demand for property should be around 40,000 units growing into 50,000 units in the future. In fact it has been less in the past few years at 35,000 units or so. Now let's look at supply. The headline no. that always jumped out is the 100,000 units that Mr Khaw, our new HDB Minister, pledged to build after a huge supply squeeze that Marlboro Tan brought about after his phobia of overbuilding. On the private property side, there is also another 80,000 units in the pipeline for the next few years. So rounding the no.s we have 150,000 to 200,000 units coming out say in the next 3 years.

So no matter how you play with the no.s we can conclude that we should see a huge over-supply over the next couple of years. Only in the most blue sky scenario - we see a maximum 50,000 demand for 3 years matched with 150,000 units being built - we can avoid a supply crunch. All other scenario will leave us with at least 10,000 of unsold flats all over Singapore (Again!).

Btw these are rough no.s that I gathered over past readings. There should be more accurate info on URA and Google. So interested parties can do more independent research (but do update back here!).

Next post, we talk about the rich and famous!

Olamak!

After one of the most high profile saga, which is still ongoing - our favourite Tiger Beer / Ice Mountain love triangle and breakup, we have yet another major story hitting the Singapore stock market. Isn't 2012 exciting? Only this time, it's not a love story, and is looking more like a tragedy!

Olam International, an integrated global agricultural commodities player listed in Singapore has been slammed by short selling research house Muddy Waters. The stock crashed 10+% but only to recover most of the gains after Olam's outspoken CEO Sunny Verghese halted stock trading and hosted two conference calls to quash Muddy Waters' claims.

Now this is where it gets interesting. Muddy Waters issued a strongly worded letter to Sunny and Olam's Board of Director mocking them for not doing the right things.

Here's an excerpt:
Olam’s disproportionate reaction is extraordinary in our experience. Should Olam come to collapse (as we believe it will), its use of much-needed cash to buy back shares at this time should give rise to questions about whether fiduciary responsibilities have been breached.

This disproportionate reaction was with reference to Olam's trading halt and conference calls after Muddy Waters' criticism. Yes, Olam said they would buy back shares when they do not even generate cash and has SGD 8bn in debt, an amount more than twice its shareholders' equity, which a significant portion itself was raised from the equity markets. You see, Olam's business never actually generated much cash since it got listed. It kept asking for more money to keep going. No wonder Muddy took note and he was not the first. Some CLSA analyst raised alarm bells 2 years ago.

Here's another interesting part:
You and your investors should note that attempting to silence critics is not a plan of corrective action. In no way does it make Olam stronger... Companies that attack criticism the way Olam does fail to understand that raising money from the public is a privilege. Because Olam has received significant investment from the government of Singapore (this blogger's note - OUCH!), Olam’s mismanagement of the public trust is that much less forgivable.

This really reminds me of David Einhorn's seven year battle with Allied Capital, a complex finance company that operated a sham business but was only brought to the brink of bankruptcy by the sub-prime crisis. Einhorn shorted the stock for seven years to prove he was right amidst threat of lawsuits, getting his phone tapped and constant ridicule by Allied's management.  In an almost identical plot development, Olam is now suing Muddy Waters for defamation.

Well you can argue that suing is the appropriate course of action. After all, our Ministers sue when people mis-represent the truth about them. When truth is mis-represented, you have to set things right. The key is: when truth is mis-represented. So what's the truth? Is Olam a great commodities supply chain manager or Alamak! (Gosh!), Olam's a sham?

To understand shams, we look at past shams such as Enron, Autonomy, Olympus etc. Below are three things that keep popping up in shams:

1. It's VERY complex. To make money, the business model must be complicated.
2. The accounting is creative. Not illegal per se but controversial.
3. There are a lot of big transactions. M&As, affiliated buys and sells, asset injections, you name it.

Unfortunately, Olam hits all 3 counts. It's complicated. Olam claims that it operates in over 60 countries handling 20 commodities including cashew nuts, cocoa and coffee, just to name a few. It also claims that its business model enables it to extract value from selective integration and from its capable midstream supply chain management to bring commodities from seed to shelf.

Hmm, so it's an integration, but we have to be selective, must differentiate (dy/dx) to integrate ( ∫ ) - math lovers note the pun. And midstream supply chain know-how to bring seeds to shelf, so... how... I mean what does it mean? Integrated but midstream supply chain? But can do from seeds to shelf? Sounds like a mid-river mudfish that can jump better than carps and swim faster than sharks. I guess oxymoronic business models do perhaps add value if you incorporate them into Shakespeare's tragedies. Parting is such sweet sorrow, let me selectively love you wholeheartedly, my dear Juliet.

It's complicated. So was Enron. That was a real grand complication, like those in Patek Philippe watches. Enron was buying and selling energy via a myriad of transactions, sometimes to itself and making money out of it. People who don't understand are stupid, simply couldn't get it and do not deserve to ask questions.

Enron was also "good" with its accounting. In fact it was the best. It was booking upfront revenue for contractual agreements of energy purchase that are supposed to come over 20 years. Btw this was an accepted accounting practice back then. Its auditor, Arthur Andersen approved it! Of course, Arthur Andersen died, holding hands with Enron till the end.

Now, Olam has "biological gains" which refer to profits coming from valuation gains of its assets such as livestocks and plantations as they grow up and start to produce milk, oil, whatever, which the owner can then sell, some years down the road. So our beloved Government (not forgetting the Capital G) was forthright sincere in their plea to encourage emotionless Singaporeans to make more babies. It's for biological gains and for our own good. That explains their big investment in Olam as well.

Emotionless Singaporeans

To clarify, biologic gains is an accepted accounting practice. Olam did not break any rules. Other companies use that too, like Wilmar, another commodities play listed on SGX (Singapore Stock Exchange), where a bunch of sham Chinese co.s also got listed.

So that's the innovative accounting part.

On transactions, we must first understand that to grow big you need to do deals. Reputable companies such as IBM and P&G grow to become global leaders by buying complementary businesses, growth companies and even competitors. Scale is everything. Olam is pursuing a golden strategy. Muddy waters, pls go do some filtration!

In the past few years, Olam bought 20 companies or more with USD 1+bn, the largest two being Timbercorp, an almond producer, for USD 200+m and Gilroy Foods, a vegetable producer, for USD 250m. It is also building a huge fertilizer plant for close to a billon dollars in Africa. Bear in mind that this was a mid size company with only a few hundred million in equity at that time. Why such bold moves?

As the saying goes, no venture no gain and so the Board and CEO Sunny thinks Olam (and himself) can "show hand" and pull this off. And their investors will fully back them. I guess prudent risk-taking is not in Olam's dictionary of oxymorons.

No disrespect to Mr Sunny, but it is really hard to bet that this firm of 18,000 staff have enough talent and expertise to execute 20 M&As and multiple mega projects flawlessly. IBM, a firm with 400,000 staff makes somewhat the same no. of acquisitions and projects (somewhat over the same time frame) and is trying real hard to squeeze out synergies.

Well, we have yet to see Olam touting the synergies gained. But I must say that its small SGD 100+m of goodwill for all these buying might be evidence that Olam did not overpay all that much, though there were accusations of too many bookings of negative goodwill.

But with mega and multiple deals, eyebrows are always raised. Frauds usually have to have the deal/transaction element. The Japanese medical device and camera company Olympus comes to mind. Olympus had been cooking its books for years and kept doing shady deals to hide losses. The last deal, its USD 2bn acquisition of Gyrus, another medical device company, which was supposed to pull it all off and cover all tracks, was so big that it finally blew in the fraudsters' faces. But they just might pulled it off if not for Michael Woodford, the British CEO turned whistle-blower.

In this light, Olam's big deals do cast doubts. Does it really cost a billion to build a fertilizer plant in Africa? Why another $600m of buying up biscuit makers and sugar mills after buying 20 companies. Shouldn't we pause for digestion? Even Jabba the Hutt sleeps a day or two without eating right?

Having said all that, we must be cognizant that Muddy Waters had its misses. It got one big hit with Sino-Forest but that's about it. There was Focus Media, the elevator TV maker, that it got wrong. Focus Media was no sham and is now privatized bcos the money's too good to share with other shareholders. Not to mention New Oriental Education, the Chinese test prep course trainer. The stock plunged 60% after Muddy says short and is now almost back to where it was. There is no shorting for seven years to make a point and tell the truth like Einhorn. Maybe for Muddy, the whole point was only to market the sell recommendation as loud as possible and make some cheap money. Then that's not so honourable.

So the verdict is not out. Olam may not be Olamak. Though I have to say Olam probably won't make it to my list of recommended stocks or most value investors' lists, for that matter. Huge debt, perennial negative free cashflow, multiple equity financing and an un-understandable business model. Sorry, not my cup of tea. It may or may not be a sham, we won't know until we know, but it is definitely not a value stock.