How to make money without a good idea?
This an excerpt of my letter to my investors this month that i reprint here. I am not trying to sell anything to anybody here. In fact with regulation i can't market what i do. My best hope is to grow the existing clients that i have. That is what i am doing. But enough whining let's see how to make money in the market these days.
As our investors are aware equity markets are going up
almost in a straight line since March 2009 bottom. Some markets as the USA and
the German equity market are at all-time highs. Nasdaq surpassed the mythical all-time
high of 2000 this month of June. Multiples are already high. PE which is the
price to earnings multiple (how many years of earnings do I need to repay the
price I pay for this stock) are reaching 20.
One question we get time to time is how to make money
going forward. We certainly hope that since we invest in Hedge Funds to make
money in all types of markets. One area that we see more and more activity is
M&A. with this kind of multiples and with cheap money it pays to merge with
the competition (it always did of course) I will try to explain why:
In Europe we have seen several mergers in many sectors
but the Telecom sector has been one of the most active. Borrowing from the
letter of one of our HF, Marshall Wace Eureka we have seen in the past 12
months mergers of SFR/Numericable, Eplus/02 Deutschland, BT/EE, Three/02,
Telenet/Base, Orange/Jazztel and now ALTICE/Portugal Telecom in our country.
What is the rational for this. As you can see from the
nice and clean MW table below when 2 companies in the same sector merge it’s possible
to extract at the least 10% of the combined costs ( Some managements extract
much more). There are many duplications when both companies are in the same
sector.
So in the exemple below the sales of the combined
entity just add up to 200 but the costs that should be 150 fall to 135. So
EBITDA which means receipts less costs grows from 50 to 65 or 30%. Just like
that. On top of that if the combined entity has to invest the same in CAPEX
(investments to keep business going) EBIDTA less CAPEX goes up by 75%!!!! I
would argue that if two companies in the same sector combine the CAPEX could be
lower than the combined CAPEX because they don’t need to keep 2 sets of Telco
Towers etc…. Anyway as you can see a Merger of competitors can increase the
Free cash flow (EBTDA less CAPEX) by 75% just like magic.
That is one of the reasons why we are likely to see
more and more deals.
Besides the M&A I see another area of easy money. To cut
costs. If the PE of a company is 20 it means that it trades on the stock market
at 20 times the profit from one year. Profit is Revenues less costs. If a
company can shave 100 million from costs the Profits (If the costs don’t impact
the business) go up by 100 million. What happens to the value of a company? It goes
up 20 times 100 million or 2 billion!! It pays big time to give stock option to
everybody in the company and take car’s, cards , hotels, and all the fat that
you could find, namely to squeeze a bit more from the supply chain.
Control your expenses better than your competition.
This is where you can always find the competitive advantage.
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