When will the fundamentals of a company start to
show an improvement after sustained restructuring efforts by its management? When will financial markets start assigning
to a company a stock price that is closer to its intrinsic value? And more challenging still, when will a
country abandon failed policies to save itself from chaos?
Argentina is the perfect – some may say terrible –
example of a country that has followed bad economic policies for much longer
than deemed possible. Indeed, how bad
these policies have been remains unrecognized abroad: not so long ago, I recall
some reputed economists stating that the 2005 Argentine debt renegotiation was
a model for Greece, that the Argentine economy was growing at a healthy clip.
That is nonsense, but the question remains as to why
Argentina seems to defy gravity, and why it has done it for so long? Two reasons may be given.
One is that Argentina’s growth is illusory. Measured in US dollars, it is greatly
exaggerated because of an “obese” official peso/dollar rate which stands today
at 4.78. This is to be compared with the
implicit rate of around 7 when one compares the stock prices of Argentine companies
on the local and New York exchanges. In
other words, the peso is overvalued by some 45%; this led the Colombian
minister of finance to brag that, measured at true exchange rates, his
country’s GDP had overtaken Argentina’s.
The other is that the Argentine government has
picked the pockets of everyone in sight: foreign
creditors were squeezed in 2005 in a restructuring in which they lost 75% of
their money; private pension funds were nationalized and their resources used
to finance the public deficit; energy prices were frozen to subsidize consumer
spending; official inflation calculations were fudged, defrauding everybody
(and independent economists were heavily fined when their findings departed
from the official ones[1]); more
recently, insurance companies were forced to finance government-designated
projects, foreign exchange controls were implemented to try and stop capital
flight and the largest oil and gas company, YPF, was expropriated and no
compensation has been paid to date.
As Mexican president Calderon said shortly after the
YPF grab, anybody thinking of investing in Argentina should have his head
examined.
Despite grabbing other people’s money, Argentina is paying
a very steep price for its policies.
The refusal by Argentina to pay holders of
non-restructured sovereign bonds has kept it from international financial
markets since 2001. After announcing an
ambitious investment program, YPF, unable to tap these markets for billion
dollar issues can only raise $100 million at a time locally; it is also unable
to attract international partners to develop the vast Vaca Muerta shale oil
deposits[2]
because of the uneconomic pricing of hydrocarbons and pending lawsuits from
Repsol[3];
electric utilities are on the verge of bankruptcy; and the ubiquitous
intervention of the government in the economy has led to widespread corruption.
Starved for money and growth, Argentine companies
carry low valuations. That, plus the
limited remaining number of pockets to be picked has led sophisticated
investors to bet on a policy inflection point.
Eton Park, one of the most prominent US hedge funds, built a
substantial stake in YPF between September 2010 and March 2012. I estimate their average purchase price at
around $40[4]. The stock closed today at $10.46. When rumors of expropriation started to
surface last April, I was tempted to buy the stock as I thought the government
wouldn’t have the money to take the company over. I just couldn’t imagine that they would just
grab it, but they did.
Yet I think that we are getting close enough to an
inflection point to dip a toe in Argentina.
I see three reasons for that.
One is that having taken control of YPF, officially
because its former controlling owner (Repsol) didn’t invest enough, the
government now “is it”. In other words,
it must show it can succeed where others failed; it needs to attract deep-pocketed
oil and gas multinationals as partners, but for that it must (1) improve hydrocarbon
pricing, (2) settle with Repsol and (3) regain access to international debt
markets. This looks to me like a
chicken-and-egg situation as to what comes first, a major oil joint-venture or
the above three-point policy change.
Meanwhile, the clock is ticking because Argentina, once an energy
exporter, is now an importer.
Second, the 2005 restructuring saga is turning sour. Having the Navy frigate Libertad seized in a Ghanaian port is acutely embarrassing for the
Argentine government and begs the question: what next? If Ghana is not safe,
what more restrictive measures will the government have to apply to its movable
assets? Furthermore, the recent decision
by a US judge that Argentina must pay interest on all of its external debt,
including that portion which was not restructured, raises the pressure as it
carries the threat of escalation in case of non-compliance. Granted, Argentina has so far been able to
delay the execution of court decisions, but it can’t expect to do so forever. Justice may be slow but it is not dumb.
Finally and perhaps more importantly, the Argentine
people are showing growing signs of opposition to the government policies. The harsh measures taken to effectively
prevent them from buying US dollars have been received , and this is
understandable in a cvery badlyountry where there is little faith in the willingness of
the government to pay its debts, and where real inflation is on the order of 25%
p.a. High profile corruption cases,
where government members appear to have enriched themselves illegally, are
especially grating when popular unemployment is high.
A large currency depreciation may be the next step,
rather than better economic policies.
However this would only diminish people’s savings and living standard,
which would hardly be helpful in president Kirchner’s bid to amend the
Constitution in order to run for a third term.
As the above diagnosis may still be a bit optimistic - after all,
Peronism in its current incarnation still has many followers - one has to look at valuation and to what extent it mitigates the risks to be
undertaken.
In the case of YPF, the main risk is really that of
full nationalization, a close second being delisting from the NYSE (since one
buys the ADR at a 45% discount to the local share price). Looking at its ADR stock price, YPF looks
pretty cheap compared to its government-controlled peers: Ecopetrol (Colombia) and Petrobras (Brazil):
Ecopetrol
|
Petrobras
|
YPF
|
|
Market
value (bn)
|
$115.3
|
$131.1
|
$4.1
|
Proven
reserves (bn barrels)
|
1.9
|
12.9
|
1.0
|
Daily
production (‘000 of boe)
|
719
|
2,463
|
467
|
EV/boe
of proven reserves[5]
|
$61.6
|
$15.28
|
$6.36
|
EV/boe
of daily production
|
$162,880
|
$80,007
|
$13,615
|
YPF faces two specific challenges: as an oil
champion under government control, it is in the quasi permanent threat of having its management and strategies politicized; it also faces
a very onerous investment program. Another,
less politically risky way of playing the “Argentine inflection point”, is Telecom
Argentina (TEO).
The controlling
shareholder is a holding that includes Telecom Italia and the well regarded
Wertheim group from Argentina. TEO is
well managed and has strong financials.
It is the second largest telecom company in Argentina after Claro
(controlled by Carlos Slim’s America Movil).
Its investment needs are more modest than YPF’s on a relative basis.
It has a lower profile than YPF. Finally, its ADRs enjoy a similar discount to local shares. On a per mobile subscriber basis, it is worth
less than one tenth of America Movil.
As history shows, populist
governments rarely act in an economically rational way; when they control rich
countries, and when they resort to reprehensible policies, they can endure far
longer than orthodox thinkers imagine.
But even they cannot repel the laws of gravity forever. They usually don’t see the light or change
their ways; their rule generally ends when they can no longer afford handouts and
resort to heavy handed policies to stay in power.
I have started to build
small positions in YPF and Telecom Argentina.
[1] It is ironic that one of them was the former
minister of finance who had presided over the heavy-handed foreign debt
renegotiation.
[2] Which YPF estimates to hold 23 billion
barrels of oil resources.
[3] The Spanish company whose controlling
shareholding of YPF was seized by the Argentine government this year.
[4] Based on the average prices during the
periods in which Eton Park reported building its stake.
[5] EV: Enterprise value, i.e. market
capitalization – cash and equivalents + debts.
For YPF we have used the official exchange rate to convert debt amounts
to US dollars since most of these are dollar denominated to begin with.
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