Behind the Finance

Dow Jones - still around 10,000

2010-01-27T13:08:00.002+11:00

As I reported in a prior blog - the Dow Jones made a spectacular run from its March lows to cross the all important 10,000 mark in October. At the time I predicted that the market was likely to hover around this area until reporting seasong began in late January. Now that it is late January, it is worth noting that the Dow Jones is currently at 10,194 - and has risen less than 2% more than three months since the previous article.

Reporting season will give direction to the markets, whether that be up or down, and will set the tone for the year. Any whisper, murmer or hinting at debt repayment issues or re-financing will send markets spiralling downwards. Whilst any indicator of growth will be quickly interpreted as good news to drive markets a little higher.

I personally feel as though the USA will have inflationary issues to deal with in the second half of 2010 that will halt any major growth. And a year end prediction of somewhere between 10,600 and 11,000 is my best estimate*.

*This is not investment advice, merely and opinion.

Australia's New Tax System

2010-01-20T16:09:00.006+11:00

It was Benjamin Franklin who first said: "In this world, nothing is certain but death and taxes."

So it is worthwhile learning a little about the tax system and exactly how it is going to change in light of the Australian Taxation Review.

Chaired by Dr Ken Henry - the secretary to the Treasury - this taxation review is the largest Australia will see in recent times. I have had the pleasure of meeting Dr Henry during a speech that he made at the University of Wollongong early in 2009 and noted that he is extremely educated, pragmatic and thoughtful leader who is well placed as the chair of the committee. He is likely to create an incredibly fair system that favours the working class population. Dr Henry's taxation review and any changes must abide by 5 key terms:

Compelling - must have a strong reason to implement
Clear - easily communicated to the public who will consume the tax
Simple - easily understood by the public
Fair - across all wealth classes
Effective - basically meaning that the tax must effectively raise revenue without bringing great inefficiencies

From the reading and research that I have conducted there are three key outcomes that are most likely to occur.

Consumption Taxes will Increase

The most obvious consumption tax in Australia is the Goods and Services Tax (GST). With a consumption tax, the user/consumer pays. It is likely that the review will involve consumption taxes on multiple levels. For example, currently road users pay consumption taxes via tolls, however, those that drive a peak times are likely to be hit with a greater toll to minimise road congestion. Or perhaps the giant mining corporations that are extracting from the earth will be taxed on the mining profits from Australia to compensate for their 'consumption'. One thing is certain is that the taxes may appear to be less to begin with, but they will definitely be broader.

GST Remains

Although Prime Minister Kevin Rudd stated during the election campaign that the GST would be an area of scrutiny for the Labor Government - I think he and Treasurer Swan have realised that the GST is an avenue for Government revenue that the Labor government cannot afford to lose in light of its recent reckless spending.

Glossy Advertising

The tax review is likely to coincide with a Public Relations campaign of glossy brochures and television advertisements highlighting the areas where the consumer (you) may save money. Whilst any areas where the tax payer is worse off will be pounced upon by the opposition at every opportunity.

Taxes are an area that effect all of us - so do your research, figure out what is best for your own circumstances and take advantage accordingly.

I will be writing a follow up to this once the review is released.

The Finance of the Football (Soccer) World Cup 2018

2009-12-15T15:18:00.002+11:00

I’m sure there are countries throughout Europe and Asia that don’t quite realise the difficulties for Australia in hosting the Football Wold Cup in 2018. However, in Australia, Football is far from the number 1 sport in the country. Depending on what state you are from. Rugby League (NRL) or Rugby Union (ARL) or Australian Football League (AFL) are easily the most common winter sports.

Given that the Football World Cup will run at the same time as these ‘more popular’ winter sports, this poses a significant issue. Federation Internationale de Football Association (FIFA) stipulates that for a country to host the world cup it requires 12 stadiums of at least 40,000 person capacity. Australia currently does not have this and requires a further $2.7 Billion to be spent on stadium upgrades. In addition to this, FIFA mandates that all stadiums are to be ‘clean’ – this does not mean ‘hygienically clean’ – but refers to ‘no sponsorship’ – FIFA control all of the sponsorship and ticketing and catering to the events and then, after the event, will pay a dividend to Soccer Australia at their discretion. The actual dividend payment is most likely not as important, in terms of viability of hosting the world cup, than the tourism dollars and job creation that the Football World Cup will bring with it.

Sponsorship and ticket revenue for venues such as the Melbourne Cricket Ground (MCG) are the biggest hurdles that the AFL and Soccer Australia need to overcome. The AFL has obviously signed contracts with its major sponsors, namely Toyota & NAB, whilst the teams which play at the MCG also have their own individual sponsors that: (a) want to see their branding and advertising around the MCG and (b) would like to have spectators in a venue the size of the MCG watching the teams which they have financially supported.

To negotiate this – there is going to be a significant contract buy-out from Soccer Australia to the AFL, NRL and ARL. This is exactly why Andew Demetriou, CEO of the AFL, is causing such an issue about it now, the more he talks about the issue prior to negotiations, the higher the contract buyout will be. He is looking out for the AFL (which he is entitled too), but neglects to mention the positive stadium upgrades which benefit the AFL as a result of the Football World Cup, a very one eyed approached to negotiations.

A report by Price Waterhouse Coopers (PWC) suggests that the Football World Cup will have a net benefit to Australia of $345million. This figure has been plucked from thin air, on a bunch of assumptions that PWC will have a lot of trouble quantifying. The same report also suggests that the government will need to pay $100million in compensation to the AFL, NRL and ARL to allow the word cup to take place. I would estimate (without intense calculations) that revenue lost in ticket sales, sponsorship and catering for the AFL, NRL and ARL during the 4 weeks that the World Cup is on will be at least 5 times this figure.

The Football World Cup would be a special event for Australia to host. The benefit to the country would be enormous. There are just a couple of contractual issues that need to be smoothed out.

Dubai - a follow up on the Debt Crisis

2009-12-01T10:26:00.007+11:00

For those of you who have kept an eye on this blog - you would have read my prior blog about Dubai.

It turns how that some of the forecasts that I made in that article have now become fact..

Dubai World - state owned conglomerate that has approximately USD$59Billion in debt that it is aiming to renegotiate with its lenders. This represents close to 75% of their loan portfolio that Dubai World is struggling with.

Currently - USD$59Billion is NOT a large amount of money when spread around various lenders across different countries. However, this is only the first company to mention any difficulties, and these difficulties have effected 75% of their loans.

My grave fear is that other privately owned companies will begin to have similar difficulties with loans as they mature in the next 12months. And with projects such as the one pictured - there is no doubt that there is plenty of debt across Dubai.

I have read several financial statements from December 2008 of property development Companies in Dubai, many have managed to get through this year whilst repaying in excess of USD$5Billion in short term loans.

With these same companies looking to report early next year - I would anticipate that there will be some nasty surprises and the amount of debt that is falling due within the next 6 to 12 months will be alarming for investors.

As I documented in my prior blog - Dubai has become heavily reliant on its wealthier neighbour emirate Abu Dhabi. However, Abu Dhabi's silence over the past 4 days is suggesting that it is not overly willing to give handouts to Dubai.

As Dubai's risk profile around the world has now increased significantly, companies that are aiming to refinance debt will be forced to pay MUCH higher interest rates - leading to further difficulties in repayments across the board.

I would expect that the current known debt that Dubai is having difficulties with is just the tip of a very large ice berg.

Collateralised Banana Obligations

2009-11-10T22:26:00.007+11:00

One of the questions that I get a lot from friends and colleague’s is this: "If the Global Financial Crisis happened predominantly in the USA, how did all these sub prime loans spread across the entire Finance industry - not just the banks?"

The easiest way to explain this is with Banana’s.

Head to your nearest super market or grocery store and approach the fresh food section.

You will often see a bunch of Bananas that has been bundled up for you with a discounted price tag. Upon a closer inspection you notice that there are some good looking Banana’s in the package; correct colour, good size etc.. You also notice that there are some small, greenish ones and a couple of Banana’s with bruising that aren't quite ideal. You make a quick decision that the 'good' Banana’s are better than the 'bad' ones overall, and you purchase the pre packaged Banana’s at a discounted price.

The grocery store feels like it has achieved a good deal by getting rid of sub prime stock, whilst the consumer feels as though they have picked up Banana’s for a bargain. Mutually beneficial transaction - everybody wins.

The SAME thing happened with ‘good’ and ‘bad’ Loans, they were called Collateralised Debt Obligations. Essentially, banks observed early that sub prime loans were going to default. To get rid of the liability from their Balance Sheets - they bundled it together with a high quality AA rated loan from a Blue Chip company and sold the pre packaged loan to a Hedge Fund, Insurance Company, Retirement Fund and Governments with a high yielding interest rate to entice the investor into purchasing.

Similar to the consumer looking for Banana’s - the Investor assumes that the 'good' loans outweigh the 'bad' loans and they will be able to return a higher yield than the risk they are taking on.

It turned out that the 'bad' loans were so incredibly bad that they outweighed the 'good' loans significantly. All of a sudden, defaulting Sub Prime Mortgages are appearing on Balance Sheets right across the USA, Europe and Asia Pacific in Banks, Insurance Companies, Retirement Funds and Hedge Funds. Which led to astronomical losses across the industry, crippling the credit system leading to the ‘credit crunch’.

The scariest part however is this: I can walk into my nearest grocery store tomorrow and see 'good' Bananas bundled with 'bad' Bananas for a discount. And I just wonder if Banks are doing the same thing with their 'bad' loans.

Be very aware when purchasing supposed Tier 1 or 2 Debt at a heavy discount from Financial Institutions - or if your Financial Advisor suggests this as a new and exciting investment opportunity. There is probably a very good reason as to why it is selling at such a discount in the first place.

Be very aware of the hype – and look at the numbers.

Australia: Financial Services Capital?

2009-10-29T10:31:00.005+11:00

The Australian Banking and Financial Services Industry is well placed to benefit immensely as a ‘Financial Services Capital’ for China and other developing countries in coming years.

Recently at the World Economic Forum – Australia was ranked number 2 out of 55 countries for ‘Financial Development’ (up from 11th last year) – which includes Institutional Environment, Business Environment, Financial Stability, Banking Financial Services and Financial Markets. Australia was only exceeded on these measures by the United Kingdom. Australia surpassed all the ‘super powers’ that were ahead of it in 2008 – including: United States, Singapore, the Netherlands, Japan, Hong Kong and Canada. Also, Australia was the only country in the top 10 to actually improve its overall score – meaning that during the worst crisis since the Great Depression, the financial stability in Australia actually improved.

Here are some very impressive statistics regarding the Australian Financial Industry taken from the Hon Chris Bowen MP speech at the Asia Securities Forum on the 12 October 2009 (http://ministers.treasury.gov.au/):

Of the 9 banks in the world that are Rated AA or above – Australia has 4 of them
Our Equity Market is the 8th largest in the world
4th largest pool of funds under management in the World – not per capita, but in dollar terms.
Now with worldwide recognition of strong Financial Development behind us, we need to promote ourselves as a Financial Services Hub for Asia, especially China and India as well as other rapidly developing nations such as Russia and Brazil.

Australia already has trade links with China via our incredibly strong commodities industry which can be used as a platform to build banking relationships. Australia also provides tertiary education to a large portion of the Chinese Market – this is also a potential avenue for strengthening financial service ties.

In terms of Baking Infrastructure present in Australia – many of the major Investment Banks of the Western World (Deutsche, Citigroup, RBS, and Sumitomo etc) are present and Australia’s 4 ‘pillar’ banks are all more than capable of business banking to support Asia.

Recently, Trade Minister Simon Crean announced the Rudd Government’s intention to spend $20 million over 4 years to help build an ‘International Brand’ for Australia to be announced in Shanghai in February 2010. If this isn’t the absolute perfect opportunity to present Australia as the perfect place for business I am really unsure what is.

In my opinion, a Government and Corporate alliance to promote Australia as a Financial Services capital would have positive effects in the following ways:

Reducing our reliance on commodities for business by diversifying our key exports.
Keep Australia’s banking and finance talent in Australia, rather than losing our best and brightest to London and New York.
Enhance Australia’s political power as a key business facilitator to Asia.
An increase in Government tax revenue from corporate profits.
Increase in the skilled workforce in business and law.
Increase in University enrolments in Commerce and Business Degrees, and an improvement in Academic teaching and research.

In this time of global economic uncertainty, Australia has a unique opportunity to be decisive and entrepreneurial and capitalise on its fortunate position.

Dow Jones at 10,000

2009-10-19T16:45:00.008+11:00

The Dow Jones Industrial Average - one of the worlds most important financial indicators has surpassed the 10,000 point mark (for now) for the first time in a year.

Since the dark lows of March 9 2009 - a 12 year low at 6,440.08 - the Dow has achieved 55% growth to get back to the all important 10,000 mark. And the economists told us that it was going to be a 'U' shaped recovery, meaning a long flat spot at the bottom, as opposed to a 'V' shaped recovery that the graph (above) is showing (http://au.finance.yahoo.com/).

With Day-Traders fascination with nice round numbers and key points of resistance/support, it is likely the Dow will hover around the 10,000 mark until about Christmas. Allowing the January and February reporting season to shape the 12 months after that.

One thing for certain is that 55% return in 7 months is extraordinary growth, largely fuelled by an unprecedented level of Government stimulus.

But what will happen when the Government 'life support' plug is pulled. Perhaps a 'W' shaped recovery will be the outcome?

Be very aware of the hype - and look at the numbers.

*Note: This is not to be used as Investment Advice - merely an opinion.

Dubai - a city of dreams? Or nightmares

2009-10-15T12:27:00.006+11:00

This phenomenal rise of ‘Dubai’ – not only as a location, but as a brand that symbolises wealth, glamour, luxury and basically meta-capitalism at its finest is a prime example of irrational investment and a complete ignorance of the finance behind the hype.

The logic behind Dubai is plausible. Essentially, ‘to build a city to attract business, tourism, fashion and high culture to alleviate the dependence of Dubai and the United Arab Emirates (UAE) on oil.’ However, the rise of that plan has expanded to levels that make no sense if the fundamentals of supply and demand are considered.

A brief look at the graph below, courtesy of www2.dfm.ae, shows the incredible rise and fall of the Dubai property and Banking/Financial Services Markets - the green and red line respectively. Both sectors have fallen to well below half of their ‘value’ from their peak in late 2007.

In fairness to Dubai, the Global Financial Crisis could not have come at a worse time. Property Developers could no longer borrow money, new developments ceased, the Bankers in Dubai were forced out of work (thus leaving the city) and the Real Estate Marketers were driven out of employment as prospective buyers in the market dried up.

The Dubai Government and Authorities have taken on significant debt to fund the expansion and now have approximately USD$50 Billion to be repaid in the next 3 years. Currently they have insufficient funds to cover this amount according to S&P Analysts (http://biz.thestar.com/). Interestingly, this figure of USD$50 Billion does not include the private debt taken on by companies from within the UAE, the United Kingdom and the USA that invested heavily in the region.

Does this feel like a mass of ‘Sub Prime Loans’ to anyone else? According to arabianbusiness.com – Dubai’s banks have 26% exposure to the Real Estate Market. A market where prices have fallen 47% from its highs in 2007, meaning that even if the banks decided to foreclose on the property to recover the outstanding debt, they would still face massive losses – at least half the value of the debt. It is almost a guarantee that ‘Western Banks’ that have scraped through the Global Financial Crisis are also carrying potentially toxic debts from loans of American and European development companies that borrowed heavily to take advantage of the Dubai property market euphoria.

The bad news for Dubai is that the market is still facing some very poor fundamentals. A report by UBS suggest that residential vacancies are headed towards 30% as ex-pats from Europe and the USA head home – this will result in rental and real estate prices declining heavily as a result of over supply.

According to www.guardian.co.uk/world - Dubai will be reliant on support from Abu Dhabi, the wealthiest Emirate that holds 95% of the UAE’s oil reserves to bail it out of debt and start afresh. Without Abu Dhabi’s help, Dubai has a very troubled future.

Be very aware of the hype – and look at the numbers.

Twitter - a baffling valuation

2009-10-02T09:52:00.000+10:00

Twitter is the latest in a string of stupendous valuations and acquisitions that have surrounded the Social Media boom. It would appear that valuations of YouTube, Facebook, MySpace and now Twitter are setting large Media and Internet Corporations for the DOT COM CRASH Rnd 2.

Twitter's most recent round of funding from Private Equity and Venture Capital Firms has valued the micro blogging service at approximately US$1Billion. To put this into perspective - here are some Australian companies that are worth a similar amount:

Pacific Brands (owner of Mossimo, Bonds, Hard Yakka, King Gee, Hush Puppies, Berlei etc etc)
Channel Seven
Sigma Pharmaceuticals

They all have a few things in common, for example..

A strong business model with experienced business leaders
Revenue Generation
A meaningful product that is useful.. and people/companies are willing to pay for..

Compare this to Twitter:

A business model that is vague at best with two co-founders that are very uncertain on the direction of the company
Almost non existent Revenue Generation
A product that has minimal 'use' outside of a peculiar cyber world where people feel the need to document their every move..

In February of this year, Twitter was valued at US$255million. Meaning that in just 6 months there has been growth in value of 584.3%. In the same space of time, the company has increased users by 1,334% (Nielson.com) - but still has not made any where near enough money to cover the costs of running the business.

A leaked internal document from Twitter stated that quarter four of 2009 (this quarter) was supposed to generate $4million in revenue, and 1 year from now, Twitter is projecting $54million for the 4th quarter. The two co-founders are yet to disclose exactly how this is going to occur. Instead they continue to flood investors and the market with Twitter hype, saying that they intend for Twitter to be the "pulse of the planet."

It would be wise to take a look at Google's acquisition of YouTube.com and E-Bay's acquisition of Skype and look at how they have progressed. Both are currently in loss making positions and are struggling to develop models for successful revenue generation.

Be very aware of the hype - and have a look at the numbers.