Welcome to the final Doddsville podcast. Join the team as they discuss the benefits of travel, debate the value in Alibaba and decide whether credit cards will survive.
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For the next couple of weeks we'll be transcribing the Doddsville podcast. Please let us know in the comments if this is useful so we can decide whether to continue doing so. We're publishing the transcription as is. There will be errors, but we hope it's valuable nonetheless.
Running Time: 57.00
Travel, Alibaba, Credit Cards and more. Welcome to the final Doddsville Podcast. Join the team as they discuss the benefits of travel, debate the value in Alibaba and decide whether credit cards will survive.
GS: Welcome to Doddsville I am your host Gaurav Sodhi, joining me today is Research Director, Nathan Bell, welcome Nathan.
NB: Thanks Gaurav.
GS: Nathan tells me he is 3 kilograms heavier and he looks every part that … and with us also is another bulky chap, Steve Johnson, Chief Investment Officer of II Funds, welcome Steve.
SJ: You nailed it Gaurav.
GS: I got it first time, every time I miss …
SJ: First and last.
GS: Yes, important announcement before we begin folks, this will be the final independent Doddsville Podcast ever, and to tell you why is Mr Nathan Bell.
NB: So we have recently put our feedback together from members and the survey suggested that, as you can imagine people really valued the buy ideas and the recommendations and special reports and all those sorts of things that are very practical and very important to people's portfolios. And then way down the bottom of the list was, despite Gaurav's wonderful dulcet tones we have all come to rely on each week, podcasts and videos were very much down the bottom, so what we have decided is, not to cancel out our podcast totally but to free up more time because it does take a lot of time to put these together, and not just Gaurav's time in terms of the ideas and the analyst's time, but the time that other people put into recording and publishing. We are going to spend that time looking for buy ideas and in the future what we will do is instead of having a Doddsville, a weekly podcast for Doddsville and then stock take, we are just going to have one podcast per month which will be essentially, it will be called stock take but essentially we will take the best of what we learned from the Doddsville experience and stock take to hopefully make one very good podcast per month for members.
GS: Well there will be about five very disappointed people out there.
SJ: But they are all listening to this right now, so those people who are listening I am sure you are going to be disappointed. And I know from talking to people at events and things that we have had that there are people out there that love it, and love the job that you have done with it. It's just a question of priorities, and I think everyone understands that from the results of the surveys, even the people that enjoy it. If it's a trade off between getting more good ideas out of you guys and a podcast every week, they will take the good ideas. We have made a lot of changes since Christmas and I think if you look at our results or our recommendations this year, we have already almost have had as many buy ideas this year than we had in all of last year, and I think this is just another move in that direction, obviously it helps when you are putting little portfolios together you get five for one. But at the end of the day we are all here to make good recommendations to good research and make sure people are making money. And I think we have taken on all lot of stuff over the years including podcasts, but have been less willing to let things go when we need to, it's actually quite hard for commitment buyers, I guess to stop doing things but I think this is one which should have benefits to people's portfolios.
GS: The only downside is the pressure is now on to use the time saved well so that people get a few more ideas out of the additional time. Now Nathan you spent some time in China recently, you went there as an official work trip, but unofficially there was some shenanigans going on, we will get to those a little bit later. But tell us first of all what your impression of China was, is it this communist marvel that people expect or is it something of a mirage?
NB: So I went to Russia about 15 years ago and when you are in Russia you definitely know you are in a communist state, for a whole variety of reasons, but also it was just surprising …
SJ: You mean former communist state?
NB: I do, but it was a third world country Russia which is sort of strange in a way because you see how much headlines they dominate, [0:04:40] is always in the news. But it really was, the place was falling apart, there were people in the street who had no money. And when we went to China it was nothing like that, and I was actually quite surprised I expected to see military people all over the place, and obviously you do in Tiananmen Square, but elsewhere you didn't and if you are in Shanghai and you went to the Pudong side where the CBD is, you wouldn't know if you were in New York, Sydney or elsewhere. But overall I actually thought the country was less developed than I thought it would be, I would say they are 25 per cent of the way through on what they are going to end up … or you know trying to get what I would say is a Western city like Sydney or New York, they are a long long way from that and I think there is a lot of in building and a lot of apartment buildings that will need to be knocked over and rebuilt, but that's going to take 10 to 20 years.
GS: Because we keep on hearing that the amount of building that is going on is already too much and there is sufficient housing for everyone and there is an over capacity built into the Chinese economy, you are saying that may not be the case?
NB: Look, I think its just the problem, from what it looked like to me was that we caught the train between Beijing and Shanghai which is about 5 hours and we would have seen over, maybe one or two, or maybe even three thousand accommodation towers or unit towers getting built that aren't even showing up in the numbers yet. But the problem, its not to me doesn't look like it necessarily in Shanghai or Beijing but its in these regional areas where there is just … as I said two to three thousand of these things just on our train trip and they are saying they have already got inventory in those two, three and four countries for at least a year or more. So these things that we saw, these developments aren't even in those numbers yet and the problem is the people who are in these regional areas cant actually afford to buy them. So I wouldn't be surprised if we just end up seeing a lot of those left standing there for the next 10 or 20 years.
SJ: The small percentage of the population that can afford these new houses that are being built don't need them, and the large majority of the population who need the housing cant afford to live in what is being built at the moment. I think its really important though whenever you have one of these … I mean everyone looks at the country and says its still GDP of 4.5 thousand US dollars per head, they have so much further to do. And there is potentially but that is true of India and Bangladesh and all of Africa, that you could walk around there and say look at the potential to build infrastructure here, you need the peoples income to come along to justify the infrastructure that is getting built, and that requires an economic system at the very least, but probably a political system as well that allocates resources effectively and encourages innovation and does all of those things that have got first world countries to become first world countries. So I am just not convinced that the structure is there in China yet to deliver that first world outcome and they are doing the building and the construction to deliver it without bringing all those other things along for the ride.
GS: Yeah, surely the fact that you have all these buildings that no one can afford is a sign of weakness, because supply is not following demand is it, there is no signal about what should be built and where it should be built, there is just very poor allocation of resources and that is at the heart of what when wrong in the Soviet Union and it looks like the same mistake is being repeated in China, I am actually flabbergasted that can happen on this sort of scale and without any obvious consequences so far.
NB: Steve might remember the numbers, but there is numbers out there showing the productivity of every extra dollar now that gets spent on fixed investment, and if you are going around China the railways worked beautifully, they run on time, there are heaps of trains, they go quick and if you look at the roads, the roads … like if you have driven on Parramatta road here in Sydney you wouldn't believe how good the roads are in China. They are flat, there is no pot holes, multiple lanes, the traffic doesn't move so quickly in some places, but in terms of the roads themselves they look very new. So they have spent all this money and I think a lot of that would have been extremely productive to start with, but now they have actually built all that I just wonder, you know they are trying to get this GDP at 7 per cent or 8 per cent, whatever figure they want to pick. I just can't imagine that wherever they go from here is going to be particularly productive. And we didn't get a chance to go to the regional areas, but just the anecdotal evidence is you seen airports with no planes, stadiums with no fans and all that sort of stuff. So I expect what we saw was just really the tip of the iceberg.
GS: Steve it sounds like there is a lot of unproductive capital being put to work in China, where is all this money coming from, we hear that China has the worlds largest savings rate, is there where the money is going, are people saving their money only for it to be used in these very low return areas?
SJ: There is certainly a transfer going on from individuals to exporters and businesses because of low interest rates. So in a western economy usually low interest rates mean low savings rates, because people are not getting rewarded for saving, they go out and spend their money instead. In China where your only choice is to deposit money low interest rates mean higher savings rates because you need to save more money because you are not earning interest for which you want to retire on, and yet lack of government provided healthcare and education and all those things require higher savings rates, but those people are being penalised to subsidise exporters and businesses through low interest rate loans. And it is quite clearly being wasted in terms of the GDP that is being generated from all this additional infrastructure, and the other key thing that has happened is that the debt requirements of the overall economy have gone through the roof. So I would say even still at the moment the overall levels of debt relative to a lot of western economies are still quite manageable, it's the pace of growth of that debt that is a problem and there is seemingly, well the inability of it to be repaid by some of the infrastructure projects that are being built with that money.
GS: One of the reforms that the communist party has put forward has been the freeing up of interest rates and that could be one way where this problem can be potentially corrected. Do you see it that way, is that a means for optimism?
SJ: I think there are plenty of signs of optimism out there in terms of the government taking initial steps to address what is a very obvious problem, we are not talking about something that they don't know here, the Chinese are very aware of the problem, they have spoken publically about their unbalanced nature of their growth. The issue is that, Nathan touched on this earlier, infrastructure at the moment is 50 per cent of GDP, now if you stop growing that component or even worse you contract it, it is impossible for you to get 7 per cent overall GDP growth when half of that pie is not growing at all or shrinking. Its just not going to happen, so the trade off that I would like to see them start communicating is, we are going to do all of these things, that is going to rebalance the economy, it is going to hurt short term GDP growth. And that is a message that I think everyone is very very reluctant to put out there and I think there is this whole apparent contract between the people and the communist government that as long as GDP growth goes along and jobs are being created then they are going to be left in power. And I think the concern that the communist party level is, well if we go through this period of low GDP growth what does it mean for our legitimacy.
GS: Nathan, Steven has talked about this transition that the economy is now trying to make from investment of growth to something else, what is that something else did you see any evidence of it on your trip?
NB: Look, from what I can tell, like if you go into places in China you will see all the luxury stores in the world, you will see fancy restaurants you will see celebrity chefs opening up restaurants. There is all of this, the problem is I just think it's for, you know people travelling through the country all this oober rich set. We spoke to one lady and she said, look we used to be poor but now our house is worth ten times what is used to be, so now we are rich. I don't know how broad that is, I mean we hung out in Beijing and Shanghai which are the two … you know I wouldn't put Beijing in this category, but the capital centres of China. So I don't think the northern Chinese in particular who are all in the farms are going to be enjoying all this sort of stuff. But one thing that was interesting, was even though we saw the luxury brands in terms of clothing, you know handbags and that sort of stuff. What I didn't see was just a more broader sort of advertising for Coke or just those sort of thing that I would have … you know that consumer resin that I think people are looking for. I still think people are extremely poor over there and you know we were walking around Shanghai and you can smell the people living on the streets, so I think this sort of optimism about this shift, like to me that is a 10 or 20 process, I don't think that is something that is coming tomorrow or the year after, there is still people sweeping the streets earning 5,000 dollars a year, like they are not going to be out there buying cool jeans and T-shirts just yet.
GS: And Steve as an international Fund Manager now, do you look at China and see problems, or do you look at China and see potential?
SJ: Both, the one positive over there is that stock prices, in particular across the finance sector have adjusted to what we think is going to be a very difficult future already. So you can buy banks, big, countrywide banks in China for point 7 times book value and they are currently earning 20 per cent returns on their book value, so they are earning the same sort of returns as a CBA in Australia and you are paying point 7 times book value verses 3 times book value for CBA. So there are opportunities out there and Ken Neilson has written quite a bit about this saying, this is the time to be buying some of these stocks in China, I am just not sure, and you never are sure but for me there is still too much uncertainty in my mind about how bad this is going to get and how its going to play out. Because we touched on this earlier, you have seen some initial signs, but I don't think we have seen anywhere near the sort of change you would need to see to get comfortable that this is not going to be another Japan is probably the most likely outcome in my view, that you have got all of this over investment and you have got a highly leveraged economy and you have got a whole bunch of banks that don't want to recognise bad debts, and it drags on for a very very long time. So we are not buying any stocks there, and we are buying some stocks in some crazy places at the moment like Russia, because we are finding incredible opportunity in developing markets relative to developed markets, but China is just not one of those places yet because I am still too nervous about the problems that are there and how that is going to unfold.
GS: Nathan, Steve sort of mentioned the disparity between Chinese banking valuations and Australian banking evaluations, you have previously made the case that the two are somewhat aligned. What does that mismatch in prices tell you about Australian banks?
NB: Yeah, I think they have certainly been priced for different futures, I mean I just cant see how you can have a Chinese banking system that is potentially about to suffer these huge losses, and through the connection of the resources industry that impacts Australia that we can have record or sustainable record high prices in Australia, when we have record high debt levels ourselves. I think we do lead the western world for consumer debt levels at the moment, I mean the only thing that has really been pushing house prices up and keeping the banks with their increased earnings and whatever, has been high house prices. And more so on the banks it has just really been cost cutting and you know bad debt provisions falling and bad debt charges falling. I don't think that is going to last forever, I think … I am a pretty simple person at heart and I just think if you are going to have big problems in China I don't see how that doesn't translate to big problems for us. I just think there are so many people in Australia that currently are over earning compared to their normal capacity, I have mentioned before a friend of mine who works on the oil rigs, he probably earns 120 grand a year, normally he would earn 40 grand a year as a mechanic in the country and I just think that has happened right across Australia for a lot of people. I know there is talk about you know being exposed to production volumes rather than commodity prices and all that sort of stuff, but we have got you know this huge investment process that is coming to an end and I think potentially China doesn't need as much as what they have, as Steve says, finally they are going to have to acknowledge it at some point that the game is up, and I just think that is bad news for us. So I certainly wouldn't be … you know I think the big four banks will be around for a long time to come and I think the government will get in there and do something if they really need to, but that doesn't necessarily say share holders and I think caution is warranted.
GS: Steve do you agree?
SJ: Look, I do agree, I am actually, I am interested of asking this question of you Nathan, but are you surprised how little impact what we have already seen in the regional space has had on the wider Australian economy so far?
NB: Yes, because the investment is still going on, we keep talking about these big L&G products for example that are going finish, they haven't finished yet and there has been like a lot of investment, I think like the rail systems are still being built out. I think in my view what we have seen so far is just some commodity price falls, but production has been amping up, you know seeing BHP and these guys expanding production, you know I guess the backbone behind that the infrastructure is still getting build and I still think we are potentially a year or two away before we actually … people are actually going to lose their jobs and they are going to have to go and look for another one and I think that is when we will see what impact it has.
SJ: I don't believe that … and I think there is one view to that when that stuff goes away the ozzie dollar is going fall and the rest of the economy is going to pick on the services, and the economy is going to fill the gap. I saw a chart yesterday of the amount of money that iron ore has brought into this country since 2004 and its absolutely mind boggling, I don't really know the figures, but its gone from like 4 billion to 60 billion dollars a year or more, you know maybe that income stays there because you might have more volumes at lower prices but if that falls away that is just a massive amount of money that flows out of our economy.
GS: Yeah, the volume gains from the [0:18:57] are in the order of 6 or 7 times over the last 10 years or so. So I think we were exporting about 100 or 150 million tons, we are now exporting about 700 million tons of iron ore and the world is producing more iron ore but Australian producers are actually displacing other producers. So I think that sort of capacity is probably not going anywhere, but certainly interesting to watch.
SJ: Just really quickly it's an interesting time for your portfolio and I keep saying this to the guys, we have been banging on about this for 3 years now, and we have been very right to be world clear of mining and mining services and that has done everyone's portfolio a big favour. I just think it's a time not to get complacent about it, you know share prices are coming off a bit in parts of the market and a lot of us have got cash on hand, we have got cash in our portfolios and you start thinking, well this is an opportunity that looks okay and putting some money in. I just don't want to get complacent about the risks that are here, I also don't want to get into the mindset of thinking there is only one option and it has to all fall apart down this path, because I think that can get very dangerous well and I was trying to get at this with Nathan, but I just write down and say well, what would make you change your mind about this thesis, you know what would make you say, I am wrong about that and I need to change my outlook because of it. Because it's the sort of thing that you can get very het up about and worked up about and you can find data to back yourself up, so there is two offsetting things there, but at the moment the main thing for us is just to not get too complacent, you know we had a really good US dollar exposure 2 years ago and some of that has run off as companies have got taken over and you sit there and say, if we got caught now would we be happy with where the portfolio is at.
NB: Yeah, if I could just make one final point about the banks … they are always a topic of conversation. To me its not just the macro stuff that I am worried about with the banks, its actually just the evaluations themselves, like they are high by historical standards, they are high by global standards and yes I know they keep pumping out the dividend yield, which is why people keep buying them. But it just says you know Jeremy Grantham talks about this, you can become very complacent just because something has happened for 20 or 30 years and its actually the longer something goes on the more complacent you become. And the way I feel about this China stuff, and again you have always got to keep an open mind and we have actually been recommending mining services companies recently, so I think that is a good example of holding two different ideas in your head, you are worried about the macro, but you think you might be buying stocks cheap enough to withstand that and you know if China doesn't end up imploding it, just Japan style slow sort of wrecking … you know maybe the mining services continue to do well anyway. So you have got to balance all these things up, but I just feel with the banks there is just no margin of safety in anything at the moment, they are pulling the costs out, the provisions are just so low for the bad debts. You know the thing that I would think would probably tell me that I was wrong about the banks, was if we actually saw that China didn't really have a problem, they could manage it and a bit of credit started picking up in Australia. You know I think if you saw that there is so much leverage in these banks and the big four absolutely dominate the space, more than 80 per cent of loans go through those big four banks and they have got return on equities around 20 per cent, 16 to 20 per cent and their ability to pull fees out from people … it seems the GFC has been quite remarkable so I don't want to underestimate them, but at the same time I just worry that some people have got 30 or 40 or 50 per cent of their portfolios in them and there is absolutely no protection if something goes wrong.
GS: Yeah, one of the great risks about being a value investor is you can pick a segment of the market, have expectations about it performing badly and when it does perform badly you just pat yourself on the back, wipe your hands and say well, I told you so. But I think when things falls as you expect them to then its your responsibility to go through the wreckage and look at what has happened and try and pick up cheap stocks when you can and that's partly why we have been looking at mining services, and we have been warning about it for a long time as well and its collapsed and its very hard to do but you have got to walk into the rubble and try and then pick up what you can, when you can.
SJ: It's hard for you, but it's a lot harder for the guy who is gone all the way down, so you are in the best position to think rationally about it coming in as an outsider.
GS: Yeah, fair enough. Right anything more on China gents, shall we move on?
NB: I should point out the funny thing is we wrote the first report on this, it must be two and a half years ago, recording the China crash and actually the portfolio we put in there is actually done really really well and I actually forgot about this article, but I think Jodie must have wrote about 12 months or 18 months ago, and the title was the Crash is Here. And here we are sort of 12 or 18 months on and we are still sort of waiting for it to happen. I was actually watching a video of Anton Tagliaferro of IML yesterday and he made a really important point, this is what Steve was saying, you have got to be very careful about these extreme ideas because you can actually paint yourself into a corner and start making some pretty dangerous decisions. So again this is another reason to focus on the stocks and not the macro too much.
GS: Having said that, let's go back onto the macro a little bit. Steve you have just come from overseas as well, tell us where you have been?
SJ: I have been all over the shop actually I started at the Boston Marathon and ran downhill into Boston.
GS: You ran a pretty good time I hear?
SJ: I ran an okay time, 3 hours and 6 which is my second best marathon ever, but …
GS: It sounds very fast.
SJ: I was fit enough to run faster than that, I was very fit before it and feeling very confident that I would be able to break the 3 hours, again which I have only ever done once. It was a very enjoyable day, the sun was out, the crowds were massive and that was part of the problem it was hot, it got up to about 20 degrees Celsius which is not debilitating but its too hot to be running a marathon, you want it 14 or less preferably. But it was a great day. And then I went down into New York I spent a week with two of our analyst's Kevin Rows and Gareth Brown in New York, and then we all went off to Europe, Gareth and I did a tour of Zurich Airport which we already own some shares in, I would say the best managed airport I have ever seen. The retail set up, the way they have done it is absolutely magnificent, everything is perfect from a maximising spend purpose and perspective which is already factored into their profitability, so there is probably less upside in that in some other airports. And then London, I had a whole bunch of company meetings in London I had a trace your family roots a long weekend in Glasgow, which is where my grandfather is from. And then up to Aberdeen, Oslo, Milan and Florence.
GS: That's quite interesting because as a domestic fund manager I don't recall you visiting so many companies, now that you are managing international funds you seem to be away more often. Is that because there is information gap managing overseas businesses, or is it because you have more opportunity to go, hence you go?
SJ: It's more about spending time with the guys than it is about visiting companies, and what we are doing internationally is we are trying to build up a very long list of companies we would like to own at the right price. We are finding some really interesting opportunities out there next to those interesting opportunities we are just trying to build up a list of businesses when the opportunity comes along. So we are going around and meeting with a lot of these companies that we know we are not going to buy but we just want to meet the management team, have a chat to them, build up that information that we have here in Australia in a whole heap of different markets. We spent a week together in New York City in an apartment and we found five or six really interesting ideas, of all the companies we went and visited there is not one that we want to buy apart from the ones that we already own. So I still don't … going around randomly visiting companies or broker introduced meetings is still a time consuming way to find opportunities.
NB: Just on that Steve, you know considering back on the newsletter days you probably didn't speak to management too often, I mean today we don't spend a lot of time with them. I was just wondering, have you found that … you know a lot of people swear that as a fund manager you are not doing your duty unless you are talking to the management of these businesses, do you find it valuable, it is something you do more of or is it just by the nature of some of the situations you have found yourself in with the fund over the past couple of years you have had to deal with management more directly?
SJ: Yeah, I guess we are doing more of it, but I still don't think for us it adds a lot of value. I think some people are very very good at it, at picking the right person to run their business but for us we are just more balance sheet industry analysis, crunching numbers sorts of people. And what we find these managers that are really good at communicating with people and are doing a wonderful job and do the share holder relations, well they are doing that with everyone so it's very hard I think to find something that is completely unloved that is managed by someone who is doing a great job like that. So sometimes we will find a business that we think is brilliantly managed but the guy just wont, or the girl just wont talk to anyone, wont do that part of the job which I actually quite like seeing that. But I just, we have ended up in some scenarios where the management team has done a brilliant job for us but we didn't buy it because of that, we have bought a basket of things and some things haven't worked out great, other things management team have worked out brilliantly, but it wasn't us sitting them down on day one and saying, we know this guy is going to be a genius.
GS: Yeah, I must admit I have never really found speaking to management all that useful, there are some instances where there is something very complex about a business and management can be helpful. I mean I was speaking to the investor's relations guy from Origin and he explained some of the complexities about that company that I wouldn't have understood without speaking to him but apart from that I find the CEO probably the least interesting person to speak to in the business. Some of the operations guys who head up teams inside the business they can offer insights that you wouldn't get elsewhere, but the CEO I don't think I have ever spoken or heard comments from the CEO that I have thought, yes that was worthwhile, that was really interesting I am so glad I heard that.
SJ: If you can go in well informed I think you can get a lot out of these meetings, Matt had a call with the [0:29:22] guys the other day and they had reported sales down 7 per cent in the UK, of course now that the currency is working in their favour, in Australian dollars, crunching numbers on the average exchange rate it looks to me like volumes were down 20 on the sales down 7 that you have reported, and the guy was like, you know I cant confirm, or we don't publish that number or something but he didn't refute it right. So I think if you go in there really well prepared … [0:29:53] we went and visited those guys over in Perth and I just walked round the factory and said to Matt, this place is trading at 3 times book value, its got one customer in [0:30:01] and the brewery was just a run down building that they had turned some old wheat processing place into a brewer and there were things lying all over the floor and it was just a mess, the whole place was a mess. So sometimes you come across things on the negative I think, but I haven't found too many that have worked the other way where I have just backed a person and it's worked out brilliantly for me.
NB: I think there are risks as well, I just remember when I read a fairly forceful, you might call a forceful article in the national paper and said how Gerry should shake himself, and then he actually rang me up a couple of hours later and I remember waiting for the call and for the first time I am thinking I am about to get a tirade like I have from other people over the years. And he actually came on the phone and said, oh so you want my job do you, and I said no thanks mate I don't want your job it looks like pretty tough going to me. And then I talked to him for about half an hour or forty five minutes about how he was managing the business and what they were trying to do and other bits and pieces, and he was just a very affable Australian bloke and he is a guy who has been very successful talking to me and who hasn't been anywhere near as successful as Gerry. And I just found that after talking to him I questioned whether I would ever be able to write that same article again now because I felt like I knew him personally, I am not sure I could be that sharp and I found a similar thing with [0:31:23] Healthcare and a guy that I was dealing a lot with I was trying to understand the hedging arrangement, which were a little bit complicated and I ended up talking to him, and I ended up talking to him about what I could do on holiday over there because I just happened to be going there with the family in a couple of months. And again it just softens you a bit when you have this personal relationship and I think that can be somewhat dangerous when you are trying to stand back from all this stuff and make a pretty tough call for your portfolio.
GS: They say it could be the biggest float in American history, Alibaba the … what would you call it Steve it's not really an internet stock is it, it's an e-commerce company I think, it controls about 80 per cent …
SJ: An online flea market I have seen it referred to.
GS: I like that, that's very accurate actually. But this thing is incredibly dominant within China even though it has no business outside China, it controls about 80 per cent of all Chinese commerce online and they are talking about evaluations up to 200 billion dollars for the company when it finally lists. Now …
SJ: I will just explain that really quickly, they own a few websites that are effectively like a Westfield where people set up their own shops within the Alibaba real estate and the customer takes all of the risk on delivery and on sales and on marketing and all that sort of stuff. All Alibaba is doing is providing a platform for these people to run their businesses on.
GS: And they have both a business to business site and a business to consumer portion of the site as well and both of them are extremely dominant. So it's an interesting …
SJ: 250 billion dollars of sales went through there site last year.
GS: Which is more than Amazon and EBay put together, which gives you some idea about how big this company is. Now having said all those nice things about it Steve, would you be one of the people looking to get into the float or is this something to avoid altogether?
SJ: I would just need to look at price, I am not as sceptical as a lot of people about the whole space, I think there are some businesses in the internet world that have network affects that are very very powerful, they are the same network affects that you see in telecommunications companies hundreds of years ago, you know the more people you get connected the better the network is, the more people that get connected. There are businesses that are becoming dominant monopolies or oligopolies in the space of 5 or 6 years and I think they are going to last a very very long time. So there are some very interesting businesses in the space, there is a lot of crap as well because everyone wants to own the next Alibaba, you get businesses like freelancer.com coming along that are almost, fraudulent is not the right word, but they are just not even real businesses and I have seen enough of it in Australia with car sales and we see that you get the right one at the right point you can make a lot of money out of it. So I would have a look at the price, and it's almost impossible to imagine this thing being priced reasonably but we will see.
GS: But its hard to determine what is a reasonable price for something like this because of its monopolistic characteristics it never actually looks cheap, but you can still pay a very high price and still do very well from something with this much pricing power.
SJ: And I do think its one of those scenarios where you need to forget about the current profitability of the business and focus on what is a logical, sensible market size that you are going to get through here and how much is this business going to collect of that. We have been having something of an argument I guess internally on Face book and Face book is rolling out this new advertising platform, not on Face book itself, but they are going to run advertising on other people's websites. So you go to Sydney Morning Herald potentially and instead of the Sydney Morning Herald serving your … or Google serving you an add, sorry it will be Face book that will be serving someone else's add on the Sydney Morning Herald website. Now you might sit there and say, why are they doing that, they are doing that because they have an incredible amount of data about you, the person who is looking at it, so they can serve you a much much more relevant add than certainly the Sydney Morning Herald, but also I think than Google because they have all this information about your friends and your life and what you are doing and they can serve you adds that are relevant to that and its not going to upset you as much on the Sydney Morning Herald side, as it is on Face book side. Display advertising no one has been able to make it work online and I feel like this is something that could work and could really dominate in that space, and it's a massive gigantic industry around the world. So they are very very hard to value but I think you need to recognise when the opportunity there is huge and there is only one company that is going to dominate it.
GS: Nathan you recently spoke about how we collectively had got it wrong on some of these internet stocks, RAC seeking car sales we didn't quite recognise the network value of these businesses?
NB: I am glad you said we and not me …
GS: Well no one really challenged you on it, so it's all our faults. What are your thoughts about something like Alibaba and other companies in this space, have you come around to the idea that … are these things worth potentially a lot more?
NB: Yeah, look I will just give you an example along the lines of what Steve is talking about. A friend of mine who I did the China trip with is a big owner of Zillow, now Zillow and Trulia are essentially the RA groups of the US, now I am not an expert on this but the US industry as far as I understand it is far less developed than what it is in Australia in terms of the shift of advertising, the real estate advertising moving from off line to online, which I actually find extraordinary just in itself that you have got Silicone Valley sitting there and here in Australia RA groups so far are ahead of the curve.
SJ: You know I caught a train in Boston where the guy was punching holes in the ticket with one of those hole punch things like they used to do 30 years ago. There are some things over there that are extraordinary, sorry go on.
NB: And anytime you see a list at the moment its got those sort of half a dozen to ten internet stocks and it flicks to Zillows and the rest … you know people say, here is the repeat of 1999 its internet stocks on astronomic you know valuations that they don't even make any money and whatever. But the way my friend Elton described it to me, he said well you have got, whatever the number was … lets call it 6 billion dollars of advertising that is currently getting spent on advertising for real estate in the US, and he said basically what they do is say, how much of that is going to shift online and what does the size of that market look in 10 years, and then if you have a look at what RA group has done in Australia you know that its generally one company tends to win and they have this huge market share, so you take the market share of whatever you estimate that market value size is and say well, you know these guys can make 60 per cent operating profit margins on that, what does the earnings look like in a decade. Then once you do that you know you stop looking at current earnings, you actually think well Zillow is priced at 1 billion dollars or whatever the market cap is, you know this could be a 5 or 6 billion dollar company and you could still make 6 times your money from now. The question you have got to ask yourself is you know as long as you think you have got the market size right is Zillow going to be the one that wins.
SJ: And I think that's the mistake people make, you have got to apply a probability factor to that and as things progress and change that probability factor will change, but at the moment, I don't know what number it is, maybe its one of 10 that could potentially dominate in that space.
NB: Yeah, I know Caledonia, some people might know is a fund manager in Australia, I have heard that they have got some bet on Zillow and Trulia of like 20 or 30 per cent of their … into our capital, like they are very confident that one of these two companies are going to win. But the one thing you know I have thought about having missed the sort of getting in early I guess on these stories, is that you actually get an opportunity, if you look at Amazon is a good example, if you look at the share price charts from 1997 or whenever it first started there is some huge you know sky rocket to the sky and massive dips. So its not like these things go in a straight line, even if they do work out they still go through these huge peaks and troughs, so if you really do want to own these and, yes okay you may have missed it at the moment, perhaps they are expensive it depends on what you are looking at and how you value it. But you do actually get opportunities along the way, you don't have to be the first guy there, so if you are interested in these stocks do the work and work it out and maybe when China hits a speed bump you know that's a time when those companies are trading on astronomic evaluations, just get absolutely smashed, you buy in but the story is actually unchanged.
SJ: And no different to any other business, you need to understand the motive, look at Web Jet stock prices halved in the past 6 months and you have got a similar situation with What If, where the share prices are off quite dramatically because I don't think those two businesses have the same moats that RA group or even Seek have in terms of their network affects and the ability to have a dominant business there. So it's no different to any other business in terms of the amount of work you need to do to understand, just because its online doesn't mean it's worth a fortune.
NB: I think one of the big differences for What If too was with RA group they didn't have to face any international competition coming into Australia, whereas What If has to face off against absolute giants of the, you know Expedia and all these guys can actually set up their websites here and compete locally, they are much bigger, they have got deeper pockets and it just as easy to have all the hotels on their website and charge a decent hotel, at a decent price to make money. I think that is the difference with Seek and RA they just completely dominate their local markets.
GS: That is one thing that concerns me a little bit about Alibaba that business has been successful solely because the international giants have been excluded from the Chinese market and if the day ever comes where you know a Face book or and EBay or an Amazon is allowed to operate in China how resilient would Alibaba be against that sort of competition. You would have to say that the quality of the service if its handed a monopoly like it was it cant be as good as companies that have grown up in intense competition. So I almost look at it almost as a protected company and I worry that a) it cant grow outside of China, it will be never be competitive outside of China and b) that the Chinese dominance maybe be more fragile than it seems to be. Steve do you have any thoughts on that, is that something to think about?
SJ: I don't really know it well enough to form a strong opinion on that, but I do think a lot of those Chinese businesses people like dealing with a local business rather than an international one. You look at Search and it's the one place in the world where Google doesn't really have a business and all of the chat sites that have sprung up across China and I think if they have got a very big established customer base already, that's got all the payment method set up and things it can be very very hard for someone to migrate people away from it.
NB: Yeah, when we were away on the trip, what is the Chinese equivalent of Google?
NB: Baidu, you actually had to use their website if you wanted to use Google because they actually slow the internet down for Google and it just took me for ever to get my emails off there.
GS: Onto our final segment for the final time, long or short and we will begin with … lets start with credit card payments. Steve during your road show earlier in the year Magellan was a guest speaker and one of the [0:43:04] got up and said, these master cards represent some of the greatest investment opportunities at the moment, he who has these monopoly companies with a long run way to growth, that are super profitable. He made a very compelling case, I tend to think that Visa and MasterCard are either monopolies that are earning super high rates of return or they are companies that are overcharging and are ripe for disruption. Do you see them in that sort of … and where do you fall?
SJ: They are not monopolies obviously because there are a few businesses out there doing it, but these are business that again touching on network affects there would probably only be one if the competition regulators let that happen, because the more merchants you are connected to, the more customers can use your credit card, the more customers use your credit card service, the more merchants want to connect to it and you just end up in this natural situation where there is only a few global players. And the case that Magellan put forward was that the switch from cash to plastic in terms of using a card for everything is really only in its infancy, and I actually agree with that. And I even notice myself in my own behaviour now with the pay pass that you can just tap your card anywhere, I am taking less cash out and I am using a card more. I think the other really powerful advantage they have got is that most of the end users don't actually pay for the service it's the merchant that pays. So Intelligent Investor will pay a 1 per cent fee every time someone uses a credit card to pay us every year. So there are lots of good reasons and I think that the technology is there now to disrupt what Visa and MasterCard have, they own a network and the internet is another competing network that the merchant is connected to and the user it connected to. So these guys are making extraordinary profits out of something that already has I think a replacement competitor that can do this much much much cheaper. The question is how and why that change is going to happen when the user of the credit card is not the one who pays for it.
GS: So it sounds like you are going … are we going short perhaps?
SJ: Yeah, I am short and I wrote a blog piece a couple of days after that road show where Magellan spoke and I just said, look the prices aren't stupid, you are paying 26 or 27 times earnings for businesses that have a very very clear growth path about them spit off a lot of cash. So I think there is already element of people being concerned about this in the stock prices, but I still wouldn't buy them.
NB: I think one of the big problems that competitors have had in the past is that they couldn't actually find something that was more efficient or quicker to use than the cards, so when you take a card out of your pocket and you give it to the retailer or you tap it on the machine, there is nothing that they could actually do to make it any quicker, so even if you had something on your phone you still had to pull your phone out and so it really wasn't, yes it wasn't an improvement in anyway. And I think that is actually one aspect that is changing, I think there is … I cant remember who it was now, I think it might be the guy who did Twitter, you actually walk into a shop now and just by walking in there and because your phone is on and you have got the internet connected they can tell who you are without actually having to do anything and you don't have to hand over a card anymore. So I thought that was just an interesting aspect in the way technology is changing and I essentially I guess its becoming wireless if you like. So I am actually short in the long term but I think its probably going to take a while to knock these two companies around, and again you talk about your circle of confidence, I don't know these businesses well, I don't understand the networks properly and I also don't understand the threats properly, so I am a bit naïve but short none the less, short out of ignorance.
GS: Yeah, look I think I would have to agree with both of you, although I would add when it comes to money pure rationality can be obstructed by fear as well, people are concerned about how their money is accessed and having a completely contactless internet based payment system may be cheaper but it may not inspire the confidence that a long established brand like Visa or MasterCard will. The threat from the internet has been around for a long time and hasn't really made a dent in the businesses yet. So I wonder if that will ever happen even though I acknowledge the potential is certainly there. And the other things is you don't necessarily need to use a credit card for these companies to make money because their payment system can be accessed via the web as well, so PayPal for example a method of paying via PayPal is to use your credit card, the same thing with Google Wallet which uses the credit card system by doing away with the credit card. So if they are quick they can actually jump on the piggy back off on the success of net based payments and still cut a fee from that. So I am not sure it's that cut and dry, but I have to say those margins are very high and they do look like they will be coming under some sort of competitive threat. I mean Apple … I don't know if you guys have read about this IBig in technology, but Apple are apparently pouring a lot of resources into using their phones almost like a [0:48:29] machine, not only to advertise to other stores, where you are, or what you are interested in, but allow you to walk in and without even pulling your phone out just make a payment. And they are apparently a fair way down that road, so those sorts of margins …
SJ: There will be no thieves using Iphones will they, they will get charged even when they are trying to steal something.
GS: I love that idea, that's wonderful isn't it.
NB: Look, I think its one of those things that will take longer that most people anticipate to change but then could change quite dramatically and quite quickly and faster than most people expect once it does start to take hold.
SJ: That sums up my view of China.
GS: It always comes back to China doesn't it? Well lets move onto the next one, Nathan let's begin with you this time since you have been off on holiday for so long. They tell me that in the US GDP has grown has 16 times in 50 years and yet leisure time has not grown at all, one of the promises of economic growth was supposed to be to create enough wealth to free us from the shackles of work and to let us have more fun. That doesn't seem to be the case, I wonder if people have enough fun already, is leisure overrated, do people actually not seek as much leisure as everyone assumes they would. Or is the pursuit of growth just … is that the trade off, to have a high GDP we just have to work longer hours, what do you think about that?
NB: Yeah, I have read a couple of articles on this lately and they key finding in both of them its actually not that we work harder these days than what we used to, its actually the line between work and leisure is being blurred because we tend to go home and log onto our computers. And I know this myself you sort of think … you know we have flexible hours here at Intelligent Investor and sometimes you work at home because it's far more productive. But what it actually does it turns your home into another office, so I find that I work far more hours at home than what I ever used to because I am just used to sitting there and I want to get things done and clear the decks for the next day and all that sort of stuff. So I am not surprised one bit that we have got less leisure time than what we had before and I think its one of the most challenging things, particularly for me personally as a research director to actually try and define my work life and personal life because to me they are just one in the same, you know I love investing its my hobby, its my interest and the big complaint at home is I am always on the computer. And my wife thinks I am working and it may not actually be work it may just be looking at an international stock that is not really work, but to her it makes no difference it's the same thing. So I am not surprised that there is less leisure but it seems to be this blurring of the lines between work and leisure and the ability to work at home that seems to be a big factor.
GS: Steve do we over estimate how much leisure people actively seek out?
SJ: It obviously varies a lot across the population, I think Nathan and I are probably the wrong people to be talking to because I like the blur for me between work and life because I enjoy my job so much that, I would rather go home and have dinner with my wife and do a couple of hours after than sit here until 7.30 at night and then effectively not see her, go home and eat on my own. So I am quite happy to read emails and do stuff from home and I do a lot of it. I also think that leisure for me is relative to work as well, I enjoy my leisure a lot more when I have had a good productive day at work or I have worked hard, I feel like that relativity is important in terms of leisure, then if you just had leisure then you would have all the same problems you have got with working hard all the time. I think its one of those things that you enjoy a lot because you work rather than enjoying it just for the sake for leisure.
GS: That's an interesting idea.
NB: Also for me I would just like to clarify a definition, but if every Sunday you had to look after your three kids is that leisure or work.
GS: Its definitely not leisure.
SJ: What about if you instruct your oldest child to look after the two youngest ones, is that leisure or work?
NB: That is definitely work because I have to pay for it, its [0:52:37] between my wife going to work and paying my son to look after the twins.
GS: Yeah, look I think you might have turned me round on this a little bit, but I do think we do tend to over estimate how much idleness people tend to enjoy. I don't think idleness generally is a good thing, I mean leisure isn't technically idleness but free time seems to be something that people actively don't want and they are trying to fill with something else. I mean you just see this with the use of technology, I mean technology has eaten away into almost all free time now and people don't seem to value that very highly, so I think it a dangerous assumption to think that people want time to be free or idle because it just doesn't seem to be the case from everything we have learned at the last few decades, if people did value it they would make the trade off and work less but that isn't happening.
SJ: Well there are plenty of people doing that as well, and people that I know of are working 30 hours a week and are very very happy doing that.
GS: They are the exceptions though?
SJ: Yeah, they are and we are I think we are very relative creature's humans and we wouldn't have, if you call it progression, we wouldn't have reached the stage that we have reached without being competitive and relative like that. So when you say people have the time to have a lot more leisure, when they compare themselves to their peers and what their peers have and the house that their peers have, they don't necessarily feel like they actually have that time, they feel like they need to work to earn more money to keep up with the person next to them. So whilst we are 16 times richer I don't think people necessarily feel 16 times richer.
GS: And that gents brings the final Doddsville ever to an end. Steve thanks very much for joining me today and on the many other times you have given up your time.
SJ: It has been an absolute pleasure Gaurav I have enjoyed it a lot.
GS: Now tell us how else can we follow you when we are not listening to you here?
SJ: Yeah, this is probably going to be my last Doddsville ever anyway, as of the 30th of June. The two businesses are going their separate ways so our funds management business is going to be called something different, now known but top secret. So people are going to hear all about that I am sure, but they will also always be able to find us either by searching for the Bristle Mouth Blog or getting on the website now and registering.
GS: Terrific, and Nathan we will have a, well a new version of stock take coming up next month and there will be a regular feature once a month.
NB: Yeah, that's right I don't think people should expect too much change, I think it will just involve all the good stuff that we have always done, but just once a month and hopefully more buy ideas along the way.
GS: Maybe we will convince Steve on that to pop in from time to time, maybe?
SJ: Sure we are only around the corner in the new office.
GS: Right, well there you go folks plenty to look forward to, maybe the last Doddsville but it's certainly not the last podcast.
NB: Thanks Gaurav and also well done to you over this period, I still remember when I took over Greg's job as research director and I sat myself down in a room and practised my podcast technique for about 3 days and I was just absolutely terrible, and they said why don't you just give it to Gaurav, and I said Gaurav this is all yours, and its one of the best management decisions I have ever made. So well done.
GS: Thanks Nathan it's very nice of you to say so. We should also thank our listeners who have loyally and somewhat inexplicably tuned into hear us prattle on, and for that prattling we can thank our producers Stephanie and Michelle. Gents I think that brings it to and end. Thank you for joining me this final time and for everyone else thank you for listening. Keep an eye on our new podcast which for now we are going to call stock take, it will be a monthly edition and it will begin the second Tuesday of every month starting in June.