Notre-Dame de Paris: ever standing and ever changing

When her roof became engulfed in flames and her spire toppled over, I couldn’t help remembering 9/11 and the Twin Towers collapsing under huge volutes of black smoke and flying debris.

Miraculously though the twin towers of Notre-Dame and much of her structure have survived this month’s fire.  The world now awaits and wonders how modern technologies will help restore this iconic monument.

We shouldn’t worry too much, for Notre-Dame has always found ways to survive disasters, adapt to successive crises and draw on human talents to stay forever young.

Consider her history.  Her construction started around 1162, under the reign of Louis VII, at a time when the king’s authority extended over a fraction of what is France today and was threatened by Henry II of England.

It took a century to complete her construction, mostly; by 1260, the first wooden central spire was erected, only to be taken down in 1790.  From the 14^th to the 18^th century, Notre-Dame was the scene of innumerable additions (new chapels, the great organ), interior redesigns, major repairs (twin towers, roof, buttresses), sloppy repainting and repurposing (the cathedral was twice used as a giant cemetery for royals and princes, and functioned as a food and wine depot during the Revolution of 1789).

After centuries of vandalism, haphazard redesigns and repairs, Victor Hugo published in 1831 his famous novel Notre-Dame de Paris and launched a nation-wide wave of support to restore the cathedral.

Then as today, captains of industry competed to fund this effort.  In 1845 architects Viollet-Leduc and Lassus submitted their project and won the right to implement it.  This would be the start of the most ambitious, comprehensive and, when Lassus died, unrestrained restoration project in Europe. 

Viollet-Leduc produced over 1,000 drawings and plans for Notre-Dame.  Deep down, he wanted to rebuild the cathedral as it should have been in the first place. 

His restoration project was extraordinarily thorough, touching all parts of the cathedral: statues, the spire, foundations, flying buttresses, the façade, the roof, the paint, the windows, etc. 

Viollet-Leduc’s imagination and ambition were boundless, as his drawing below of what Notre-Dame should look like shows.

After this massive undertaking, Notre-Dame was left more or less to herself until the 1960s when Culture minister André Malraux decided to clean her up, exposing for the first time in a century the exquisite details of her façade, sculptures and stone work.

Another period of benign neglect and meager restoration budgets ensued, until the recent fire.

Throughout her life, Notre-Dame has survived wars, revolutions, plagues, insurrections, fires and haphazard care.  She is now over 850 years old, and not a day older[1].  Time for a new make-over.  Time also to learn lessons from the past.

---

[1]  Much of the historical information was derived from a book by Jean-Louis Chardans.

Of brain waves and electric dreams

The human brain is a wonderful construct, ceaselessly recording inputs, sorting them, storing them, creating links for faster and more meaningful future use, and at times making jumps which can be baffling, one moment weighing the merits of an investment in GE and the next remembering a slightly salacious Colombian joke.

Which joke?  That of the philandering husband caught in flagrante with his mistress in a motel room by his wife.  Sobbing, screaming, in pain, his wife keeps asking:” How could you do this to me!”  The hard-pressed husband, denying any infidelity but running out of arguments, finally demands:” Are you going to believe your eyes, or are you going to believe what I am telling you?”

So where is the connection between his situation and GE’s?

When the GE stock price fell into the $7-$9 price range, the whole company became worth no more than its aviation unit[1], a natural benchmark being Safran SA from France, its joint-venture partner in the commercial jet business.  Safran SA has a market value of $56 billion with revenues which are ¾ those of GE Aviation.

GE’s Healthcare unit remains very healthy and profitable; in a 12/3/18 article, Barron’s valued it at $60 billion.

GE has retained a 50.1% stake in Baker Hughes which is worth over $12 billion at today’s stock price.

It is about to sell its Transportation unit for over $3 billion.  Its Renewable Energy unit is probably worth that much or more.

So far, these units add up to a lot more than $74 billion.  Factoring in GE’s Industrial net debts (i.e. using enterprise values rather than market capitalizations as benchmarks) lowers valuations, but not conclusively.

The big negatives though are the Power division and GE Capital.  Here, the quarterly conference call of today was helpful in shedding light.

GE’s CEO stated that while he wouldn’t absolutely guarantee that all skeletons had been removed from the GE Capital’s closets, he felt that there shouldn’t be any new material liabilities beyond those which had already been identified.

 

As for Power, while its 4Q18 revenue were down, its results in the red and the global market was still shrinking, GE’s CEO felt that it could reduce production capacity to better match expected demand and improve management to shore up results.

While GE is not out of the woods, it no longer appears in dire needs of funds, there shouldn’t be more large skeletons in the closets, its top management ranks have been upgraded and it is moving decisively to get into shape.  That is not to say there are not major liabilities, rather, that, by now, there are fairly well quantified.

The unfortunate wife of the joke was asked to believe her husband’s denials.   GE shareholders, so far, have been asked to believe short term pessimists.  Instead, they all should believe their eyes.

---

[1] $60 to $80 billion vs. $56 (Safran mkt value)/0.75 or $74 billion.

Entitlement Reform, the Sweden way

Tired of watching Alabama and Clemson fight it out for the college football Championship?  Of watching PSG sleepwalk through the French Division 1?  Nonplussed by the Gunfight at OK Corral remake starring Donald, Chuck and Nancy?  Feeling that Sudoku at the “Difficult level” has become a bore?

Why don’t you read the following paper which describes how the Swedes went about reforming their pension system?  It is very clever politically and it is sound financially.

Just imagine; if Bernie Sanders, who went to the University of Chicago in the 1960s to study political science, had instead picked economics under Milton Friedman, he could have authored such a paper and been elected US president in 2016. 

 Mitt Romney, the Republican senator of private equity fame, would have sailed through the 2012 election had he gone on a sabbatical at the Landsorganisationen i Sverige (the Swedish trade union umbrella organization) in 1994 instead of returning to Bain Capital.

 Well, there it is below, THE PAPER: www.aei.org/wp-content/uploads/2018/03/Automatic-Adjustments-Within-Entitlement-Programs.pdf.

 

Brazil, the security vote

The results of the first round are in, and they represent a major rupture with the past.  While many commentators stressed that these reflected a rejection of traditional politicians tainted by corruption, I would suggest that, more importantly, these elections are a cry, or a scream, for security.

No doubt Brazilian voters sent many political tenors home, including Dilma Rousseff, a former president, Eduardo Suplicy, a co-founder of the PT; of nine returning candidates for the senate who had been under a cloud, only three were reelected.  Voters desire to clean up Congress triggered an historical turnover, with more than 47% new faces coming in.

 

The door was also shown to moderate presidential candidates who were not viewed as corrupt and who had fared well in prior national campaigns: Geraldo Alckmin, a former governor of Sao Paulo got 4.8% vs. in 41% in 2006; Marina Silva, a former minister, 1% vs.  19% in 2010.

Voters, who had remained undecided for the longest time in years (45% vs. 20% to 30% in the past), or perhaps had not disclosed their preferences, sent a clear message: we want big change, now, and we don’t think regular politicians are up to it. 

And the biggest change that Brazilians are clamoring for is security.  In a 10/2/18 Datafolha poll, 88% of respondents declared to feel unsafe; that is a staggering number and was their No.1 concern.  This time around, incoming military-related congressmen are double the number of those in the current assembly.  Bolsonaro is a former military himself and has made security the focus of his campaign.  Today, Jaques Wagner, a PT grandee, was reported[1] to have advised Haddad to do likewise ahead of the second round.

Military and ex-policemen and women are not elected to tackle public budgets.  They are elected to reestablish law and order.  Except for G. Alckmin, presidential candidates spent very little time presenting an economic program.  When Paulo Guedes, a free-market Chicago Boy[2] tried to present a possible future tax reform, he was promptly shut down by his boss, Bolsonaro. 

Economists will lament the lack of a serious discussion of the dire state of the Brazilian economy.  But in truth, there can be no sustained and vigorous economic development without, first, public security.

Which private business, small or otherwise, will invest large financial and human resources into projects that have a three to four year payback period if its owners, managers and staff feel under constant danger for themselves or their families, and occasionally think about emigrating in search of a better life?

In the 1980s and 1990s, Colombia lived through similarly difficult times.  People in the big cities and the countryside felt under constant threat from narco-guerillas, gangs and petty thieves.  In 2002, incoming President Alvaro Uribe initiated his key Policy for Democratic Security (PSD).  It was carried out within the framework of a functioning democracy, it succeeded and the economy soared.

I believe that both Bolsonaro and Haddad understand that this is their biggest challenge and what the people want.  They must also understand that the people will give either one a wide berth on other policy issues as long as security is returned.

---

[1]  In the Folha de Sao Paulo.

[2]  A 1979 PhD in economics from the University of Chicago.

Latest back of the envelop look at GE?

Yesterday evening, after having witnessed the GE stock price tank for a week, I decided to take another look at the company and try to come up with a rational “back-of-the-envelop” valuation.  My basic premises were that (1) the company had valuable businesses, (2) the world appetite for electric energy would keep growing, and (3) for the foreseeable future, renewables couldn’t displace fossil fuels, in particular natural gas.

My conclusion was that, under this set of assumptions, GE seemed undervalued by a wide margin.  The announcement today that a new CEO with successful experience at running an industrial conglomerate had been appointed only reinforced my views.

The valuation methodology was as follows:

·        Using market value for Baker Hughes  A GE Company since its stock is publicly traded,

·        Looking at competitors for the Aviation, Healthcare and Renewable Energy divisions,

·        Taking a mixed approach for the Power division,

·        Valuing GE Capital at zero.

Baker Hughes

I applied a modest 15% control premium since GE owns 61% of the company.  This yields a $26 billion value for GE’s stake.

Aviation

The comparable here was Safran, the French company which is also a 50/50 partner with GE in the commercial jet engine business.  The benchmark used was Enterprise Value (that is market capitalization + debts – cash) to Revenues.  For each division, I had to come up with an estimate of each division’s debt.  I am sure that my allocation of GE’s debts of $34 billion, ex-GE Capital, among each division was wrong, but overall, it probably doesn’t substantially change my conclusions.  Aviation was thus valued at $74 billion.

Healthcare

This was the most critical valuation, as it assumes that GE will successfully develop its imaging, life science and IT activities.  If it does and commands the same kind of valuation as companies such as Baxter International, Medtronic or Stryker, then I put its potential value at $82 billion.

Renewable Energy

Real difficulties start here as international competitors such as Vestas, Siemens Gamesa and Nordex carry widely different valuations.  In the end, I chose Siemens Gamasa as the more comparable given its size and low profitability.  This gave me a $4 billion valuation.

Power

The most difficult division to value given its gloomy medium-term prospects and the excessive price that GE paid for the power assets of Alstom.  Still, the assets of that division were listed at $71 billion.  Today GE announced that it was writing off $23 billion of goodwill, a good deal related to the Alstom acquisition.

Possible valuations using estimated book value, multiples of revenues and p/e multiples based on future estimated normalized profits range from $49 billion to as low as $8 billion.  In the end, I thought $15 billion was a reasonable number.

This sum of the parts exercise gets us to $201 billion, or $23/share.  Again, this is not a measure of GE’s performance today, or of its best long-term potential; it is a rough estimate that incorporates a moderate turnaround at Power and a market valuation for a stand-alone Healthcare.

Indeed, if I am correct, there may never be a spinoff of Healthcare; for that reason, and unless the new management can convince investors that they will be very successful at allocating capital and running a multifaceted company, the market may impose a conglomerate discount of 10% to 15% on GE.

I also didn’t make any adjustment for yet unfunded pension liabilities, but I didn’t take into account any cash holding either.  Could this and other as yet unidentified pitfalls subtract from our estimate?  Yes.  Would a $20 billion provision cover such “unknown”, I would think so.

In summary, GE’s reasonably optimistic medium-term valuation should range between $201 billion ($23/share) and [$201 bn - $20 bn]x85%, i.e. $153 billion ($17.6/share).  The current share price of $12 seems low to me.

The Country of the Future?

In 1960 the Gross Domestic Product per capita of South Korea was US$158.  By 2016 it had grown to US$27,539.  Over the same period, the numbers for Brazil were US$210 and US$8,650[1]. 

Adjusting for purchasing power parity doesn’t change the picture much. Over the 1990-2017 period, and in constant US dollars of 2011, the results were US$11,633-US$35,938 for South Korea and US$10,345-US$14,103[2] for Brazil.

Discounting the drag caused by its much larger population and looking at overall country GDP data, Brazil still underperformed: over the 1960-2016 period, its GDP grew from US$15.2 billion to US$2.05 trillion (+13,453%) while South Korea’s grew from US$4 billion to US$ 1.53 trillion (+38,576%).

Fast forward to 2018.  Brazil is in the last stages of the biggest corruption scandal of its history, the so-called Lava Jato/Car Wash, which sent a former president and many political leaders from the left, right and center to jail; for the first time in years, active and retired military leaders are raising their voices to warn against further institutional and judicial drift; crime and personal security are foremost among the population’s concerns; and a key presidential election is less than two months away.

What next?  Is the wheel about to turn, and if so, which way?

Two polls reveal the true dimension of the next president’s challenge:

§  92 % of Brazilians believe that the judicial system treats the rich better than the poor, and
§  As recently as August 22, former president Lula, who remains in jail for corruption, led voting preferences with 39%[3].

In September, two events shook the already atypical presidential campaign: 1) former president Lula was ruled ineligible and his party, the PT, named Fernando Haddad as his replacement, and 2) Jair Bolsonaro, the rightwing candidate who was running second to Lula, was the victim of an attempt on his life and will remain hospitalized for several weeks.

Most candidates have a familiarity deficit with the population.  As of September 9, the following table shows that less than 1/3 of the population knew the main candidates “very well” and about half knew them “very well” or “a little”:
 

	Geraldo Alckmin	Jair Bolsonaro	Ciro Gomes	Fernando Haddad	Henrique Meirelles	Marina Silva
Knows very well	30%	29%	25%	17%	13%	27%
Knows a little	29%	23%	29%	21%	19%	32%
TOTAL	59%	52%	54%	38%	32%	59%

Source: Datafolha.

The PT and Fernando Haddad face a challenge: how to make the candidate from Sao Paulo nationally known without having him appear as a mere stand-in for Lula.

The other candidates face another kind of challenge: better known because they have been in politics longer and/or have already ran for the presidency, they also represent the “political establishment” which many voters distrust.

A relatively new comer on the national stage, Bolsonaro is now enjoying a rise in sympathy for having been stabbed, but over the next few weeks his ratings will likely suffer from diminished exposure and his inability to campaign in person.

The absence of a clear leader in the polls also reflects voters’ indecision:  55% of respondents declared themselves set in their choices vs. 80% in 2010 and 2006 and 70% in 2002 and 2014[4]. 

Political cleavages and history make it difficult to imagine the right or the left easily uniting behind one candidate in the second round.  Bolsonaro and his small party, the PSL, haven’t much in common with Alckmin and his traditional center coalition; the PT has historically refused to join any coalition that it didn’t lead, and Ciro Gomes so far has not been welcome. This also leaves Marina Silva, the best presidential candidate from the left in my view, out in the cold.

Can we make the outlook hazier for investors? Sure we can!

There is evidence that voters are ambivalent regarding needed economic reforms.  While Alckmin appears set to privatize many the state-owned enterprises, unions have often gone to court to block past privatizations, congress has been loath to let go of its patronage, and the public appears reluctant to see Petrobras privatized, even after the massive scandal that nearly bankrupted the company.

Apart from the PT, party discipline is weak in Brazil, making governing difficult and reforming very difficult.  This is unlikely to change this time around.  Even if Haddad wins, there will inevitably be tensions between him and Lula and their respective followers as the new leader seeks to establish himself[5].

More importantly, the diverging economic paths followed by Brazil and South Korea over the last 50 years reflect profound differences in history and culture.  These two factors are powerful and resilient, and not limited to these two countries.  For a while, leaders can overcome them, as FH Cardoso did in Brazil or Kemal Ataturk did in Turkey, but the forces to undo or blunt deep reforms are strong, ever present, and in the end often overwhelming.

The operating horizon for traders and even most investors in emerging countries is short; in Brazil, not everything is negative.

For example, the Lava Jato scandal is fresh in every memory and one can expect governments and politicians to be more careful with public assets for the foreseeable future.

Most candidates must realize that they lack broad popular support and that further dividing the population once in office would be a national disaster and politically risky.  With Lula absent from the ballots and Bolsonero in the hospital, it is close to 60% of the voters’ first choices which are gone or in jeopardy.

The presidential elections will be decided by October 28 at the latest.  While the race is wide open, it wouldn’t surprise me if Fernando Haddad, with the well-organized support of the PT and of Lula himself, were to reach the second round and face Jair Bolsonaro.  If he failed, it could be because Ciro Gomes rallied more of traditional voters from the Left.

In a second round, the outcome of a Bolsonaro/Haddad or Bolsonaro/Gomes race is a toss-up at this stage.

These are two among several scenarios, though unless the campaign dynamics change appreciably, they are the most likely for me. 

Brazilian stocks are not off-limit in the absolute, but either current prices fall further to reflect the inherent risks of this election or any buying decision should be delayed until after the second round is over, in my view.

The future always appears unclear, but the past is not and is as good a guide of things to come as any.  Days of Future Passed as the Moody Blues would say.     

---

[1]  Source: World Bank, Trading Economics.

[2]  Source: World bank

[3]  Source: Datafolha.

[4]  Source: Datafolha.

[5]  A good example of unhelpful tensions between a former president and his anointed successor was on display in Colombia between Alvaro Uribe and Juan Manuel Santos.

How much is Tesla worth?

This is a question which investors and analysts alike have been wrestling with for several years.  Some think Tesla will collapse, others that it is at the build-up stage of a brilliant future.  Its founder just twitted that $420 per share was a price he would “pay” to take it private.  So we’ll take a shot at the question.

At the current stock price of $320, Tesla is worth over $54 billion.  Its enterprise value (market cap. + debt – cash) is around $60 billion, depending on the accounting treatment of certain operating leases.  By comparison, General Motors has a market value of under $51 billion.

Is Tesla really more valuable than GM?  There is no question that Tesla, under the guidance of its CEO and founder Elon Musk, has become synonymous with advanced, stylish and expensive electric cars. Half a century ago, an environmentally driven buyer, wanting to make a small dent into our national thirst for oil, would have bought a small and thrifty Honda Civic.  Today, his wealthier counterpart will buy a Tesla S, park it next to a Mercedes S class, and feel that his car looks and performs better and is more socially responsible.

That Tesla has gained unique brand status, recognized globally, is undisputable.  What’s more, this was achieved by developing new technologies which are often years ahead of competitors like BMW and Chevrolet according to a recent report by UBS.  There is both style and substance behind Tesla’s success.

The problem is that Tesla has not been able to make such technology cheap enough to make a $35,000 car (Tesla 3) profitable; and according to the same UBS analysts, progress towards bringing unit costs further down has been very slow.  Another observer noted that the battery components were expensive, limiting further cost savings, while production volume was much too low to reduce powertrain production costs.

So, what if Tesla were to limit itself to the production of luxury electric cars like its S and X models, selling anywhere between $70,000 and $130,000 a piece?

There is one comparable car company with unique brand name, Ferrari.  Ferrari sells 10,000 cars a year at an average price (to it) of $300,000+.  Its current market value is over $24 billion (and enterprise value around $25 billion).  Today, Tesla sells around 90,000 models S and X per year.  A spectacular Roadster is in the works which will retail at a starting price of $200,000. 

I would think that the luxury car business of Tesla could be worth as much as Ferrari, $24 billion, because both share three unique characteristics: exclusivity, style and performance.

That’s great except that it leaves a $30 billion gap in valuation.  Can this gap be filled?

One logical place where to look would be businesses whose technology is complementary or close to that of the cars.  Actually, Tesla has such businesses: its energy storage and solar energy. 

The solar generation offers integrated generation and storage systems for both residential and commercial customers.  The energy of the sun is captured via low profile panels or roof tiles which look like regular ones.  Batteries are used to store the energy and release it later.  To commercial buyers, Tesla offers batteries to manage loads or turnkey solar panels and batteries to meet communities’ energy needs.

Those businesses generated revenues of $370 million in 2Q18 with a modest gross margin of 11.8%.  How much can they be worth?  The Solar City company which developed most of this technology and which was founded by Musk, was bought by Tesla for $2.6 billion in 2016.  First Solar (FSLR:NASDAQ) sells at 2.5 times revenues.  The energy businesses of Tesla are growing at close to 30% p.a.  Based on that and the Solar City and First Solar valuations, they could be worth $3.5[1]-$4.5 billion.

If Tesla focuses on luxury cars (which is not the case at present) and its energy business grows healthily, Tesla could be worth $28 billion or $164/share.

That still leaves us a gap of some $26 billion.  How can it be filled?  Will Elon Musk suddenly find a way to massively expand his energy business or discover yet another need that Tesla technology can fill?  Call it the Musk factor.  He could add another $4-$5 billion, particularly if the country gets back on the clean energy path.  That would get us in the region of $190/share.

In sum, Tesla seems to be overvalued at current levels by a significant margin.  Then again, nobody expected an individual to start a car company from nothing and build it into the epitome of great electric cars.  It will be a dizzying but fascinating ride.

---

[1]  Looking at the trailing last quarters.