Friday, October 30, 2009

Near Monopoly

Companies with dominant global share are usually capable of generating supernormal profits. Sadly, in Singapore, such companies are hard to come by and hence this important factor is rarely looked at and discussed.

As Economics 101 would tell us, monopoly or near monopoly creates many conditions that is ideal for the market leader. These includes

1. Huge economies of scale – hence able to produce at a lower cost than most competitors

2. Bargaining power with clients and suppliers – to the extent of pricing out other competitors or ousting them in other ways

3. Advantage in capital outlay – a market leader does not need to spend as much as a competitor when increasing capacity bcos it can always leverage a lot on its existing structure (including distribution, sales and marketing etc)

4. As a result of stifling competition, the market leader now has pricing power. Basically it can price its product or services at any rate and customers will need to accept as there is no alternative

5. Reduction in cost of operations, and hence leading to a reduction in quality. The market leader now can reduce its cost of operations – including perhaps reducing the amount of input material cost or cutting sales force. This leads to reduction in quality of product or service

I guess the whole Singapore society is an apt reflection of monopoly works. Prices are ever rising yet quality of product or service keeps dropping. As consumers, Singaporeans keep suffering. Hence it is important for us to become shareholders as well, and so more or less offset the shit thrown at us as consumers.

*Sigh*, that's life in Singapore. Tomorrow will be better. Or so we hope.

Anyways, as an example to illustrate Pt 1, 2 and 3, we have HP laser printers. HP has a dominant share in the global laser printer market. Around 60% market share. As a result of this, they have huge economies of scale. They can produce laser printers and more importantly, the ink cartridges, at a much lower cost than all other competitors. However there is no need to sell the cartridges at a lower price than competition bcos they enjoy a good brand name. But if they wanted to, they could easier crush all other competitors by selling their cartridges at a much lower price.

Since they are the No.1 leader, they can always demand the best shelf space in electronic stores, or lower distributor margins, or bargain for lower prices with their parts supplier (those who supply the various small components inside the printer).

Of course, they can build new production lines and bring in new capacity at a much lower cost than all others. So how can anyone compete at all? Despite this, the never-give-up Korean superpower Samsung is fighting hard to break HP’s monopoly. We shall see if they have the same success with LCD TVs.

Next post, we look at a Singapore company on Point 4 and 5.

Friday, October 16, 2009

Good Businesses to Own

There are businesses and there are businesses. Some companies just cannot generate good enough returns for shareholders not because management sucks or there’s too much competition. It’s the business model that’s flawed.

Usually, it’s the high capex ie very high investment needed to buy new equipment to compete. It’s so high that all the money made from good times is not enough to pay for the equipment. And these companies need new equipment to compete in the next cycle.

We all know these industries: airlines, semiconductors, shipping, heavy industries etc.

Then there are these wonderful businesses that keep churning out cash without the need to invest a lot. And the best things is people just cannot stop buying their products bcos it’s a necessity or they are tied down by other factors to buy.

One good example is actually tobacco companies. As Warren Buffett puts it: it costs a penny to make, you sell at a dollar or more, and people just keep coming back for more. And you don’t need new investments. Perhaps just 15 tobacco factories can supply enough sticks for the whole global population of smokers (my guess). Well there’s the moral issue of course…

To summarize, here are some factors that good businesses have

1. Recurring revenue stream – usually coming from

- razor and blade model (printers, games, ipod and itunes)
- necessity item (toiletries, food and drinks)
- contract/license agreement (anti-virus, telcos, utilities)
- consumables (medical supplies, office supplies)

2. Low capex needs

3. Competition is not severe - usually due to

- limited no. of competitors
- dominant market share

4. Strong barrier to entry or moat (branding, technological edge, market share)

5. Pricing Power – related to

- level of competition and market share
- position in Porter forces

6. Growth Potential

We shall talk about some of these factors and companies with superb business models in the next few posts

Wednesday, October 07, 2009

Companies that shouldn't exist

The market is efficient and smart, but only to the point of the average smartness of all its investors. Hence it allows companies that spectacularly generate low or even negative return on capital to exist for very long periods of time.

The No.1 ranking company that achieve this tremendous feat would probably be Chartered Semiconductors, our beloved high tech foundry.

Over the past decade, the company had lost over a billion dollars culmulatively, burnt two billon SGD of cash and generated a spectacular ROE of negative 6%. It has never paid a cash dividend in its entire existence and have asked for money countless times.

Considering that cost of capital is around 6% (see previous post), Chartered failed to even come close. In fact, Chartered helped investors LOSE 6% every year. Yet the market cap of Chartered had been around S$2bn for the good part of the past 10 yrs. (its peak was a whopping S$7bn during the IT bubble and trough a miserable S$300mn during the Lehman shock.) Why would such companies exist in a rational, efficient world?

Well the stock market is just one aspect of the economy I guess. Chartered provides tens of thousands of jobs considering all the peripheral companies that it supports, we cannot just let it go down right? So we did the next best thing, we sold it! And thank goodness, Chartered will be delisted.

Why has a company like Chartered lingered around for so long? Well market participants always had hope and greed and of course Chartered did serve some purpose for punters. Back in the IT bubble, it was so clear that Chartered would be a STAR. It made chips for goodness sake. And chips are what make IT possible. so that was the eternal hope. Even when the company started burning REAL cash for Hungry Ghost festival every year, investors held hope. It's biggest shareholder, Temasek, never gave up. Well until now, that is.

Here lies the new insight I have about efficient markets. Markets are efficient in the short run, ie 1-2 yrs where almost all market participants share similar thought horizon and are able to price stocks very efficiently within this time frame. And markets are efficient in the very long run, ie more than 10 yrs - companies that ultimately shouldn't exist would go, like GM, like some airlines, and perhaps Chartered. And of course, Great companies will rise through the ranks and become behemoths and rule the world, like Walmart, Toyota and Nestle etc.