things burry cannot explain too well

Recently, Michael Burry made a comment which the investors seem have taken too seriously. The story is short, but has made the news big.

Burry rose to fame after he made loads of money predicting the crash of the housing bubble in 2008. He was made more famous by Michael Lewis through his book, the big short. So yeah, he is a great guy. 

But that does not mean whatever he says has to be sacrosanct. He makes mistakes too. In the story, he saying that index investing is proving to be bad. In fact, so bad that he is likening it to the subprime CDOs. 

I am not sure whether I have to feel sorry for him, or for those who believe him. There is one thing I have found short in the investors' mind: that they don't have their own conviction. That's a behavioral debt which often becomes too expensive. 

Well, Burry is saying that index investing is bad, because it does not support market price discovery. Because when too much cash chases the index, prices of all stocks - good, bad, and ugly - will shoot up. Because investors buy without any regard for the price and value of stocks. Because the index comprises of far too many small, bad businesses whose stocks do not have liquidity, and yet are priced high. And he says the crash will be ugly. 

Then he goes on to compare index investing with the synthetic asset-backed CDOs. Here I am not sure whether he is actually comparing the bubble to the bubble, or the index investing itself to the CDOs. If he did the latter, his blunder is more prominent, for the CDOs are based on disproportionate leverage, and the index stocks are not that much. So that aspect is never comparable. But let's give the benefit of doubt to Burry, and believe that he just said about the bubble, like any other bubble. 

Now coming back to his concerns regarding the bubble in the index investing, we all know that the economy and markets are like a cycle. They go up and down all the time. There are times when the prices shoot up so much that they have to eventually fall, and yet other times, the other way is true. When taken to extreme, the bubbles have to eventually lead to price fall, and the busts, price rise. And they always do. 

Also, the free market mechanism comes into play all the time. Let's suppose that the bubble crashes badly. When the prices of the index stocks go up disproportionately compared to their fundamentals, the crash is bound to happen. Remember the dot-com bust. After the crash, the good stocks represented by high quality businesses become cheap compared to their intrinsic value, and the bad stocks represented by poor quality businesses may remain somewhat expensive. The investors will shun the index and buy good quality stocks, and may even short poor quality stocks. The index will then eventually move towards becoming fairly priced, making the case for index investing. 

Let's assume that the index investors, after the crash, sell their index stocks and buy good stocks which became cheaper. After the continual demand, prices of good stocks will go higher, and value of the index will correct. Now we have the case for index investing again. Because of this free market mechanism, even those index investors, who do not sell after the index bubble and crash, will also benefit by staying put on the index investing.

In fact, that is the essence of index investing: to keep going during both good times and bad times, pushing the average price of index units lower, and getting a reasonable market return. I can even say that a good index investor can achieve a return slightly higher than the market by increasing buys during bad times. But that's another story.

The hedgers, speculators, and short-sellers are always alert in a free market, and they take advantage of all arbitrage opportunities ensuring that the price and value of stocks and, therefore, the index are never too far off, for too long.

I am surprised Burry missed this point big time. We should be asking him where else to put money if not the index. The treasuries and high quality corporate bonds yield much lower. Junk bonds are not an option for the real investors. We have two choices then: Pick the stocks, or go to the index. 

Picking stocks is not for everybody. It requires time, interest, skill, and behavior. Index investing is for everyone who cannot be a stock picker, for the investor is assured of the market returns. 

For someone who has at least a decade of investing ahead, index makes the perfect choice. Once the horizon becomes shorter, asset allocation will have to come into play. A right mix of the treasuries, high quality bonds, and the index should take care of the investor's cash requirements for the rest of life.

The fun part is that we are not even close to all-passive investing. There is huge money actively and continually chasing stocks all the time, and I believe that as much as we know of the human behavior, we have a very long way to go against it. The fear, greed, and envy will ensure that active investing will stay for a long time, and index investing will continue to give market returns for those who find it satisfactory.

It is far better to use common sense and wisdom than borrowed conviction. Life and investing then will be rewarding.

microsoft and a trillion

Microsoft Corporation share closed the day at $127.13 with a total market capitalization just shy of a trillion dollars. The entire equity of the firm was worth $245 b some time in 2008. The growth has been both phenomenal and unprecedented because of the products it was dealing with and sheer size.

Revenues in 2008 were $60 b, and comprised the following.

In 2018 as revenues nearly doubled, the segments have changed.

The intelligent cloud has been the savior for Microsoft which experimented with many things using cash flows from Office and Windows. The elusive growth has been restored at least for sometime. Operating profits and (pretax) free cash flows to firm were $35 b in 2018. The growth in pretax fcff was 8.5% and 12.4% during the last 5 and 10 years respectively. Pretty decent given Microsoft's size of operations.

There were at least 2 major acquisitions in the past decade. Skype was bought at $8.6 in October 2011, and LinkedIn for $27 b in December 2016. Taxes in 2018 were exceptional; Microsoft is capable of $25 b aftertax fcff each year. Is 40x fcff a fair price for Microsoft? I am not sure. Apple is making nearly twice free cash flows, and yet is priced similar to Microsoft. But then Apple is banking on just one product, iPhone. Microsoft has a better product mix; Office and Windows generate steady free cash flows.

Even with a 10% growth for the next 5 years, and then moving towards a steady growth state in year 10, Microsoft may not give 10% return. If you are going to be ok with that, you might as well be ok with the S&P-500 with a far lower risk.

Microsoft has done well, and it is likely to do well in terms of its business and operations. But the stock is also not coming cheap.

Let's see again the numbers coming up for the year ending June 2019.

axis and yes bank q4

Both Axis bank and Yes bank reported their financial year results, and here's the story. Axis reported Rs.50 b profits for the year, and Yes had Rs.17 b profits. 

Yes also had losses of Rs.15 b for the latest quarter weighing in heavy provisions. While people are fretting over those losses, they don't get that when an investment turns sour, it just can't be called sweet; taste it to know it. Postponing provisioning for non-performing assets doesn't make sense even when the regulator or laws allow it; that will be stupid. On that front, Yes bank has probably done the right thing. 

Yes bank's book value is Rs.116 per share, while that of Axis is Rs.263 per share. With these numbers, their stocks are trading 2x and 2.8x respectively. But that is not the way to look at it. They have more NPAs, including stressed assets, that are not yet provided for. Including them in book value will inflate equity. Adjusting for full provisions on estimated NPAs, the stocks are trading 2.68x (Yes) and 3.43x (Axis).

Both banks have decent regulatory capital ratios: Axis (12.7%) and Yes (11.3%) in Tier 1 capital. Loan book is growing for both banks. Axis has better CASA (44%) compared to Yes (33%). Axis also has lower cost of funds (5.69) and Yes (6.5%), and slightly better net interest margins (3.44%) compared to Yes (3.2%).

Yet considering the current stock price, for a return of 13-15% in the next 3 years, Axis will have to grow 20% and Yes, 15%. Of course there will be people who will shoot for Axis in terms of higher growth and better book. At its current price though, Yes bank could give a return of 8% with a 10% growth rate. This is based on the reported gross NPAs and stressed assets; any hidden NPAs should bring the book equity and returns lower.

There is also a good chance that the Yes bank stock will be hit hard in the next trading sessions, and that should give opportunities for better returns. Axis bank is also likely to do well, but its stock price as of now is a little on the higher side. 

tesla q1 2019

Tesla reported its q1 numbers, and are we in for a surprise, or we aren't? That question depends upon whether we are a Tesla bull or bear. Vehicle deliveries fell short, and apparently had to be shifted to q2. The company still stands by its guidance of 360-400 k vehicles in 2019 representing a 50% plus increase over 2018. With Gigafactory China coming up, the target is 500 k vehicle deliveries. 

There was a significant reduction in revenues compared to the previous quarter. Tesla had operating losses of $521 m, and interest charges were $157 m. Cash loss from operating activities were $639 m, and over $300 m capital expenditures meant negative free cash flows of nearly a billion dollars. Tesla also repaid over $500 m of debt. Because of these, closing cash position was $2.6 b compared to the opening position of $4.2 b. The company has a debt of $12 b, and in addition, also had operating leases which are in effect a form of debt. 

The management has a guidance of capital expenditure of $2-2.5 b in 2019. So we should expect the company to make cash flows of at least that amount just to breakeven.

To justify the market value of nearly $50 b - never mind the fall post results - Tesla should do a lot more than what it has in the past. 

coffee day

Coffee Day Enterprises operates in 6 segments: Coffee and related; Logistics; Financial services; Leasing of commercial office space; Hospitality services; and Investment operations. It operates Cafe Coffee Day chain across India. 

The total business had revenues of Rs.37 b in 2018, an increase of 21% over 2017. Revenues have been growing in double digits for the last 3 years, 2018 being the best year of growth. The financial services revenues were Rs.5.7 b and that of leasing were Rs.1.4 b. Investment operations were Rs.530 m. 

The company had book debt of Rs.50 b and operating lease debt of Rs.1.8 b in March 2018. Because it also operates in financial services business, I am not going to look at its operating profits. That will not be meaningful because for financial services, debt is like a raw material, and interest costs are part of its operations as opposed to other businesses.

Earnings for 2018 were Rs.1 b. But after adjustment for the exceptional item (sale of stake in Global Edge Software) of Rs.532 m, it is actually an increase of 13% over 2017. Earnings per share were Rs.2.51 excluding the exceptional item compared to Rs.2.28 of 2017. Return on equity is less than 5%. There aren't free cash flows generated by the business. 

But the stock is trading at Rs.291.75 implying over 100 times 2018 earnings. Who are its buyers? 

The company owned 28,056,012 shares in Mindtree representing 17.08% ownership as of December 2018.

Coffee Day Trading is a subsidiary of Coffee Day Enterprises. In March 2019, the news is that the company and its promoter have signed a definitive agreement to sell their entire stake (20.41%) to L&T for a consideration of Rs.32.69 b. The price per share works out to Rs.975; and the stock is currently trading at Rs.950. 

As per this report, the total investment in Mindtree was Rs.3.4 b: Rs.440 m in 1999 for 6.60% stake; Rs.850 m (5.57%) and Rs.400 m (2.05%) in 2011; Rs.1.71 b in 2012 (6.84%). 

If the transaction does go through, the company will have a cash flow of Rs.27 b, handy enough to reduce debt. And the promoter will reap over Rs.5 b.

Coffee Day came out with an IPO in October 2015 at Rs.328 per share, and the stock commenced listing in November 2015.

The stock is yet to recover from its IPO price. But the question is: Is the business worth Rs.62 b? 

lyft ipo

Lyft is coming up with an IPO at an expected valuation of $20 b to $25 b. Its previous private valuation was $15 b in June 2018. Now that it is coming out with a $2 b IPO, the market is going frenzy.

Here are the investors seeking a valuation as high as possible. 

And why not, when there are buyers at the price? But then pricing is a game played by the private equity and venture capitalists, and for the right reasons: They want to cash out. That's their compensation for taking risk.

What about investors who like looking at the business and numbers? I haven't got a story for Lyft, for it is beyond my imagination how far it can or cannot go. It could do very well, or it could falter. I am not sure. That's not my game. But I can lay down the numbers. 

Lyft had revenues of $343 m in 2016. They became $1 b in 2017, and $2.1 b in 2018. That's a massive increase. But the business incurred losses in operations: $693 m, $708 m, and $978 m. Markets say it is the nature of the business like any other high growth start-up. 

The business is not using much of capital. It had $3 b in cash, marketable securities, and restricted cash as of December 2018. But it will need a lot of capital going forward. Because it is losing cash every year: It has been losing over $500 m each year (2016 to 2018). For 2018, this is despite $625 m positive cash flows from changes in non-cash working capital.

We haven't got a firm hold of numbers since operating profits and earnings per share are both negative. It has had low capital spending: $71 m for 2018, and much lower during the previous two years. It acquired Bikeshare Holdings (Motivate) for $250 m, and spent $300 m on research and $352 m on advertising in 2018. That's a significant portion of revenues. There are no free cash flows yet. 

Where do we go? Easy, look at the pricing multiples. 

If we price Lyft based upon revenues: For $20 b valuation, it will be 10 times revenues. That will come down to 8x if revenues increase by 25% next year, or 6.67x if they increase by 50%, and so forth. Pricing always gets interesting.

If we choose riders: The price per rider will be $667 for the $20 b Lyft. The catch is Lyft had 18.6 m active riders. The the price per active rider will be $1,075.

How about pricing based upon bookings? 

Lyft at $20 b = 2.5 times its 2018 bookings. Cool.

There were 241.614 m shares outstanding after conversion of preferred shares as of December 2018. If we round off and consider 250 m shares, the expected IPO price will be $80 per share to get that $20 b value.

Then you can juggle, and include the options (6.828 m) and RSU (31.605 m) outstanding, and come up with 280 m shares; and the price per share will be about $70. If you include $2 b coming from IPO, the price will be $64 per share, with an additional 31 m shares being issued and totaling 311 m shares.

Lyft is a good business. But the question is at what price. That's the conundrum we face with every technology growth business, don't we?

real property, and tax

Here's the story. There was this ancestral land lingering for a long time. The house that was on the land was dilapidated. So the time was apt to do something about it. The family, finally after a long, long pause, decided to do something. 

They contacted a real estate developer, and agreed with the firm to release the land in their favor in exchange for a certain number of apartments. The developer would construct an apartment building both for residential and commercial purposes. Apart from the ones to be given away to the family all units would then belong to the developer. 

The family was keen to reduce tax, obviously. How the tax liability was to be estimated was a big question though. There was no specific reference to such transactions in the law. Neither was there any case study which was referenced in the past. At least this is what the tax consultants noted. Now what remained was how the transaction was actually interpreted: by the family, by the tax consultants, and most importantly, by the tax authorities for assessment. 

What occurred to be a simple and straightforward deal was made out to be complicated. What did actually take place? An implied sale of the land for the consideration of market value of the apartment units given in exchange. None would agree to this analysis, though, especially if the tax liability increased.

Let us elaborate. Cost of land after indexation was negligible. So the capital gain was almost equal to the consideration given. The market value of apartments given away was at Rs.3,000 per sqft. Meaning, if the apartments were sold immediately after possession, the family would get that rate. That's a deemed and implied sale. 

1) 3 apartments of 1000 sqft each: 3x1000x3000 = Rs.9 m;

2) 1 apartment of 5000 sqft: 1x5000x3000 = Rs.15 m;

3) 1 apartment of 3000 sqft: 1x3000x3000 = Rs.9 m.

That's a total market value of Rs.33 m; and a capital gain of Rs.33 m. At 20% rate, the tax liability would be Rs.6.6 m. Net cash flow to the family would be Rs.26.40 m.

Because the deal missed one step of the transaction, it appeared to be complicated. Consider this: Step 1 was sale of land; Step 2 was receipt of Rs.33 m towards sale of land; Step 3 was purchase of 5 apartments totaling 11000 sqft at the market price of Rs.3,000 per sqt; that is Rs.33 m. If these steps were carried out, the capital gains would be Rs.33 m. Just because Step 2 and Step 3 were bundled together, the fact does not change, does it? 

Of course, the family is eligible to take deductions on account of the purchase of one apartment to reduce the tax liability. Everything else should remain the same. 

No wonder there is this perverse human character that takes pleasure in making simple things difficult.