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Bubbles

Vitaliy Katsenelson's picture




 

I have to confess, I am tired of writing "structured" articles, the ones where I have to limit my thoughts to 800 words.  So with this one I am taking a break.  This is an unstructured stream of thought, in no particular sequence.  

 
China bubble today vs. Japan bubble in 80s
 
I am back from San Francisco, where I had the great pleasure of attending and speaking at FAME Symposium, diligently put together by students at San Francisco University.  One of the other speakers was a famous international investor, Charles De Vaulx.  During a break Charles and I were discussing the Chinese bubble today vs. the Japanese bubble of the  late ’80s.  This conversation got me thinking.  In Japan the bubble was the most prominent in commercial real estate and to a lesser degree in residential real estate.  The house-price-to-income ratio (just take the average house price and divide by average income) in Tokyo at the height of the bubble was 9, while in China in 2010, in the big cities this number was much greater (Beijing 15, Shanghai 13), and in fact the ratio for the whole of China was over 8.  The commercial real estate bubble might have been greater in Japan; it is hard to tell.  I remember reading that at the peak of the Japanese bubble the Imperial Palace was worth more than a state of California.  But from different reports I've seen, China has plenty of empty skyscrapers.
 
But China also has a couple more bubbles, in industrial overcapacity and overinvestment in infrastructure.  Japan did not have an infrastructure bubble, for several reasons: first, it was a more developed country than China.  Second, the government played a much smaller role in the economy – Japan did not have a command-control economy, and it did not try to build for social/political stability reasons.  Japan had your garden variety real estate bubble: easy credit, inadequate banking laws, etc...
 
Also, and this point is hard to quantify, but the quality of Japanese construction is better than in China.  There are many reasons for that: less corruption, no five-year plans (i.e., output-per-capita targets), and the Japanese put a higher value on human life.  I remember reading an interview, just a few years ago (before the high-speed-train crash in China) with a Japanese high-speed-train executive.  At the time the Chinese were showcasing their high-speed-train system and rubbing in Japanese faces the fact that their trains traveled at higher speeds.  The Japanese executive said something along these lines: “Our systems are very similar, since the Chinese stole our high-speed railroad designs.  We could run our trains at faster speeds, but we just don't think it’s safe.”  Japan has a population of 130 million people, which is shrinking.  China has over a billion people and its population is growing.
 
The quality of Chinese construction is horrible; you read stories of glass and masonry falling off of buildings, and the latest story was of a girl swallowed by capsized pavement.   So they'll have to do a lot more rebuilding in the future, and thus their return on capital, which was already very low, will actually be even lower.
 
Japanese economy, despite Government debt to GDP doubling, has been stuck in a rut for over two decades.   Just saying…
 
Dot-Social and dot-cloud bubbles
 
At the FAME Symposium I was asked if we are in the midst of another bubble – the social and cloud bubble.  I said that if one really wants to make some money quick he should start a company and call it "SocialCloud".  I read a lot of articles defending Facebook paying one billion dollars for a company with less than a dozen employees, with an app that has terrific photo filters and 30 million users, but with no revenue and no network.  Once you take a picture, Instagram gives you the ability to post it to a half a dozen places, including Facebook and Twitter.  But Facebook will be paying for this acquisition with funny money – it has a $100 billion market cap on three or four billion of revenues. 
 
The Instagram acquisition by Facebook has likely injected a lot of fertilizer into the angel investing bubble. I am sure there are a lot of startups out there that will be raising money from angel investors dreaming of selling themselves to the Facebooks and Googles of the world for billions of dollars.
 
I looked at recent IPOs, and their valuations appear bubbly.   Yelp – a terrific company (more on it in a bit) – has a market capitalization of $1.3 billion, and analysts expect its revenues in 2012 to hit $180 million.  Angie's list – a website I recently used, since we were remodeling the house – has a valuation that is as silly as Yelp's, except that its website is a slight improvement over Craig's List. 
 
I know the enormous appeal Facebook has to advertisers. Never before could advertisers target their customers with such precision.  Facebook knows your address, your age, where you went to school, the music you like, whether you are married or recently engaged, where you travel, etc... All this information we volunteer when we fill out our user profile. I get it, it is incredible.  I've yet to meet a person who doesn't think Facebook will do well on its IPO.  But what if Facebook struggles to monetize its enormous user base?  There are only so many ads it can put up on a page before they start impacting the user experience.  The counterargument here is that since these ads are so finely targeted, they are more expensive and thus Facebook will not need as many. 
 
What if people will simply get tired of the social thing?  Social networking may turn out to be a fad, or at least the amount of time we spend it on it may decline a lot.  I know large employers are blocking access to Facebook left and right; it is a huge productivity drain.
 
Zynga is another stock that looks bubbly (though less bubbly then when I looked at it a few weeks ago, the stock is down 40% or so).  Social games could be another passing fad.  At the conference I described a company that we recently purchased that may benefit tremendously from social games, but for them it is an added bonus (an option), while for Zynga social games are everything.  I don't know if I am right on these stocks or not – maybe their businesses will go at a much faster rate than I expect.  But I can definitely sense that the second we mention the words social or cloud our objectivity in judging businesses dissipates.  This doesn't just apply to dot-clouds or dot-socials, it applies to boring, real companies feeling the pressure to be in the space, who are paying insane valuations for dot-social and dot-cloud businesses (Centurylink buying Savvis at 10x EBITDA comes to mind).  Since we own plenty of real companies, my concern is that they'll overpay for their dot-stuff. 
 
Yelp
 
The last time I was in San Francisco, a portable GPS was a very expensive novelty.  That was early 2006.  My best friend and I were on a road trip, driving from Denver to San Francisco and back.  We had a GPS attachment connected through a USB port to a laptop and used Microsoft mapping software.  All phones were dumb (even Blackberry, the smartest phone at the time, was dumber than a brick compared to today's iPhone). 
 
This time around armed with iPhone, I was surprised how good the Yelp app was.  Though they are trying to expand beyond it, Yelp is a social app where users review and rate restaurants.  It is crowd sourcing at its best.  All I had to do was type "sushi," select the distance from my current location that I was willing to travel, and Yelp showed me all sushi restaurants around me and their ratings.  In the absence of any other data points, you start heavily relying on Yelp's ratings, especially since many restaurants have several hundred reviews.  The feature in the app that I found astonishingly innovative was the "monocle."  You click on the "monocle" button, point your iPhone in any direction, as if you were taking a picture, and it shows you the restaurants and their ratings in that direction. 
 
Apps like Yelp’s will have a significant impact on restaurants.  They facilitate the word-of-mouth restaurant recommendations between friends and extend them to strangers. They'll also likely expedite the failure rate of restaurants.  Restaurants with high reviews will get more customers, and the ones with poor reviews will die a quicker death. 
 

 

Deadline to register for VALUEx Vail is May 1st. More info here:  http://contrarianedge.com/2012/02/24/valuex-vail-2012/ 
  
I am very excited about one of our “dessert speakers,” Jon Markman, who’ll speak about Jessie Livermore, one of the most successful (until he failed) and interesting traders ever, who lived in the first half of the last century.  No one knows more about Jessie Livermore than Jon, as he annotated one of my favorite books, Reminiscences of a Stock Operator.  Here is what I wrote about it a few years ago: “Jon’s skillful annotation takes you behind the scenes of Livermore story and provides important insights into characters and the backdrop of that very interesting time period.  Jon’s annotations are almost like a book within a book.”  
  
Omaha! 
  
It is Omaha time again!  This year Value Investor Congress, which I’ll be attending, has been moved to Omaha.  
  
May 4th – Friday 
 

12:30pm – 3pm – Cheap Talk  - Billy Blue’s Alumni Grill - We’ll have a 4th annual informal gathering where value investors get together and share ideas.  Everyone is welcome to come.   (Creighton University, Harper Center, 20th and Cass)
 
3pm – 4:30pm – Value Investing Panel IV - Creighton University (located in the same building with Billy Blue’s, see above) – it is the third time I have a privilege to participate on this panel.  For an hour and a half we answer questions from students.  This year we’ll be joined again by Bruce Greenwald, an insanely smart and articulate professor from Columbia.   This free event is followed by free refreshments – value investor’s paradise.  
 
6pm – 8 pm – Author Reception 2012 – this is a fun gathering.  You get a chance to buy paper books (they still have those), authors sign them and you get a free DQ ice cream.  University of Nebraska at Omaha Mammel Hall Atrium (67th St. and Pine)
 
8:30 – midnight – my under-taxed friend Whitney Tilson is hosting his annual cocktail party (Omaha is value investor party central!).  They are usually a lot of fun and you get to meet a lot of interesting folks.  We’ll probably go there after dinner.  To RSVP for them, please email Jennifer at jennifer@vlfund.com and include which event(s) you plan to attend as well as your name, firm (if any) and city you’re from for your nametag.


    
May 5th – Saturday 
 

Immediately following the annual meeting on Saturday, May 5th, Whitney is also hosting a casual get-together in the Blackstone A Ballroom on the 2nd floor of the Omaha Hilton, which is adjacent (and connected) to the Qwest Center.  
 
4pm – 7:30pm – Young Presidents Organization & World Presidents Organization & Entrepreneur Organization are putting together an investing panel.  I’ll be in terrific company of Tom Gayner – CIO Of Markel Corporation, Tom Russo – famed value investor, and Tim Vick author of How To Pick Stocks Like Warren Buffett.   If you are a member of above organizations you can RSVP by email ypo@cox.net . (Holland Performing Arts Center, 1200 Douglas Street)

  
  May 6th – Sunday 
 

10am – Markel annual gathering.  Markel is a very well run insurance company.   I’ve been attending its meetings for the last couple of years – they are very educational.  (Hilton Omaha Hotel, 1001 Cass Street).  RSVP: mhey@markelcorp.com

  

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

 

 

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Thu, 04/26/2012 - 01:21 | 2375705 Libertarian777
Libertarian777's picture

Actually China isn't growing population wise. The population is 1.34 bn now and projected to be 1.3bn by 2050. Birth rate is 1.54 per woman,or less than replacement rate. china's population is aging. yes they aren't at the same rate of decline as Japan, but they aren't growing their population much (0.42%)

Thu, 04/26/2012 - 01:44 | 2375724 Freddie
Freddie's picture

Omaha?  Why would anyone want to go see that corrupt CS'er Warren Buffett?  Dude you blew your credibility mentioning Buffett and isn't Whitney Tolson one of Tyler's best friends?  LOL!

The thing that is interesting is Japan's construction is better than China.  Japan has the Yakuza in everything, one of the reasons Fukishima was such a mess was the Yakuza have the maint contract.  Nothing worked during the emergency.

Anyway - I cannot imagine how all that Chinese shit construction is going to hold up say 5 years down the road.  Or the skyscrapers in the Middle East with shitty concrete that probably was mixed withs sea water.,

Wed, 04/25/2012 - 21:41 | 2375398 Dead Canary
Dead Canary's picture

I went to the store to buy some Mr. Bubble for my nightly bubble bath and it was $12! OMG! Mr. Bubble is in a bubble!

Wed, 04/25/2012 - 23:08 | 2375503 Bansters-in-my-...
Bansters-in-my- feces's picture

Remember when you were a kid and used to blow bubbles...?

I seen Bubbles the other day ,he says you still owe him one.

Thu, 04/26/2012 - 00:55 | 2375670 putaipan
putaipan's picture

sorry- it's your name. thinking frothy santorum bubbles.

Thu, 04/26/2012 - 01:54 | 2375737 putaipan
putaipan's picture

oh. hold on. you might be talkin' michael jackson''s chimp. even worse.

Wed, 04/25/2012 - 22:09 | 2375434 BeetleBailey
BeetleBailey's picture

Nightly Bubble Bath? How.....Moochelle of you.

Here's Don Ho to serenade you....

http://www.youtube.com/watch?v=mlCiDEXuxxA&feature=related

Wed, 04/25/2012 - 21:49 | 2375411 derek_vineyard
derek_vineyard's picture

hold bar of soap under faucet as you fill the tub

Wed, 04/25/2012 - 23:54 | 2375586 undertheradar
undertheradar's picture

Is it really all that simple?

Wed, 04/25/2012 - 21:32 | 2375387 chrispycrunch
chrispycrunch's picture

Facebook's enormous valuation is a function of many events coming together at the right time to assert a valuation that will be so unbelievable when it IPOs.

1. Global unemployment is at its high. What do people do then? They spend their time on facebook. Unfortunately, they have no income for which to spend on products being advertised to them.

2. Zynga's business model is proving to be a flop. 0.01% or less are paying users. The rest are free riders. Yet, Zynga is a threat to the existing business. They poached EA executives, for example. Facebook relies on Zynga as a source of revenue.

3. Facebook mobile has zero ads. Wait till ads start to get pitched on it. I was on skype and a "friend" posted an update which was just an ad. But the ad looked like a status update. That is just not right.

4. Facebook timeline is yet another modernization of the site that is pulling the site away from its roots. Again, users will probably dislike it and maybe, finally, inactivate their account.

Thu, 04/26/2012 - 00:57 | 2375674 putaipan
putaipan's picture

think netflix. think ebay.

Wed, 04/25/2012 - 21:20 | 2375370 streetcrawler
streetcrawler's picture

Chinese infrastructure at its finest: http://youtu.be/R_B1PkgA3kA

 

 

Wed, 04/25/2012 - 21:16 | 2375364 adr
adr's picture

What is amazing is that these corporations that don't actually produce anything of value, give their product away for free, and are really just marketing gimmicks are valued at multiples of billions.

I like Yelp, its cool but isn't worth more than $10 as a company. You don't need Yelp and if it goes away there are a few hundred more apps out there that do the same thing. Access to information isn't worth billions. IT'S INFORMATION THAT IS ALREADY THERE AVAILABLE FOR FREE.

There were online reviews of restaurants since the early '90s. Back then you didn't have a $100 billion valuation on a Geocities site.

We are in the mother of all bubbles right now. The social bubble makes 1999 look like the definition of sanity. All we need is more bullshit billionaires putting a fork in hard work is the path to prosperity.

Wed, 04/25/2012 - 21:58 | 2375419 Lednbrass
Lednbrass's picture

That is exactly what struck me about this article.  All the hot companies do and produce nothing substative whatsoever, just toys and distractions.  I have a hard time seeing how it can last but when they blow up, whats left?

Wed, 04/25/2012 - 21:45 | 2375404 rosiescenario
rosiescenario's picture

Let me second you....companies that produce nothing of value. In fact one could argue that Twitter and Facebook produce negative numbers as they become a time wasting sinkhole for those addicted to them.

Wed, 04/25/2012 - 21:04 | 2375352 max2205
max2205's picture

The only thing Ben can do is BLOW......bubbles

Thu, 04/26/2012 - 00:59 | 2375676 putaipan
putaipan's picture

sorry. still thinking frothy santorum.

Wed, 04/25/2012 - 20:44 | 2375319 NOPOMO
NOPOMO's picture

THE LAWS OF SUPPLY AND SCAMMED ARE THE ONLY THINGS THAT WORK IN THESE MARKETS.  BEN IS DOING A GREAT JOB DESTROYING SAVERS AND DESTROYING THE USD. 

ONE WORD TO BEN F-OFF.

Wed, 04/25/2012 - 20:43 | 2375316 Peter Pan
Peter Pan's picture

Interesting points. I remember reading that not enough fly ash has gone into making the steel for the railway system tracks and that within a decade major problems will be occuring. Not sure if this is correct but nevertheless it ties in with the incredible speed of construction and the falling pieces of building facade we read about.

China is clearly a work of chaos in progress and will therefore continue to stun us and stunt us as time goes by.

Wed, 04/25/2012 - 21:19 | 2375369 adr
adr's picture

Take a look at a home built during the US bubble. If any of them are standing in 20 years it will be a miracle.

In 20 years the great Chinese cities will be collapsing to the ground. Every skyscraper will be condemned.

Thu, 04/26/2012 - 01:49 | 2375728 Freddie
Freddie's picture

Slapped together in the US by illegals.  I cannot imagine how fast teh Chinese shit will fall apart.

Wed, 04/25/2012 - 21:46 | 2375409 Clowns on Acid
Clowns on Acid's picture

Broken window theory...

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