Chinese Web

In a previous post last December, I had a quick look at the valuations of a few Chinese internet stocks that are traded in the US, solely for curiosity’s sake. At that time, I mused that Google (GOOG) may be a better bet than any of the Chinese high growth/high risk plays given its valuation. The one maybe I highlighted amongst the Chinese internet stocks was Baidu (BIDU), the so called Chinese Google. It is somewhat ironic that BIDU today fell 15% after disappointing results from higher expenses and lower revenue projections whilst GOOG, which had a great quarter due to revenue growth and squeezed expenses, is up over 20% since its Q2 results. Just shows what I know!

Given the drama in the Chinese stock market, I had another quick look over the Chinese internet stocks to see how they are performing, as per the graph below.

click to enlargeChinese Internet Stocks July 2014 to 2015

It is far too early to tell what the impact of the current turmoil will have on the Chinese consumer and on the Chinese internet sector (if any, given the government’s current policy of propping up the market). At this stage, it is interesting to see that it’s NetEase, primarily in the online game services sector, which has stood up the best so far, up 40% this year. That just confirms to me how far these stocks are outside my comfort zone.

Insurers keep on swinging

In a previous post, I compared the M&A action in the reinsurance and specialty insurance space to a rush for the bowl of keys in a swingers party. Well, the ACE/Chubb deal has brought the party to a new level where anything seems possible. The only rule now seems to be a size restriction to avoid a G-SIFI label (although MetLife and certain US stakeholders are fighting to water down those proposals for insurers).

I expanded the number of insurers in my pool for an update of the tangible book multiples (see previous post from December) as per the graphic below. As always, these figures come with a health warning in that care needs to be taken when comparing US, European and UK firms due to the differing accounting treatment (for example I have kept the present value of future profits as a tangible item). I estimated the 2015 ROE based upon Q1 results and my view of the current market for the 2011 to 2015 average.

click to enlargeReinsurers & Specialty Insurers NTA Multiples July 2015

I am not knowledgeable enough to speculate on who may be the most likely next couplings (for what its worth, regular readers will know I think Lancashire will be a target at some stage). This article outlines who Eamonn Flanagan at Shore Capital thinks is next, with Amlin being his top pick. What is clear is that the valuation of many players is primarily based upon their M&A potential rather than the underlying operating results given pricing in the market. Reinsurance pricing seems to have stabilised although I suspect policy terms & conditions remains an area of concern. On the commercial insurance side, reports from market participants like Lockton (see here) and Towers Watson (see graph below) show an ever competitive market.

click to enlargeCommercial Lines Insurance Pricing Survey Towers Watson Q1 2015

Experience has thought me that pricing is the key to future results for insurers and, although the market is much more disciplined than the late 1990s, I think many will be lucky to produce double-digit ROEs in the near term on an accident year basis (beware those dipping too much into the reserve pot!).

I am also nervous about the amount of unrealised gains which are inflating book values that may reverse when interest rates rise. For example, unrealised gains make up 8%, 13% and 18% of the Hartford, Zurich, and Swiss Re’s book value respectively as at Q1. So investing primarily to pick up an M&A premium seems like a mugs game to me in the current market.

M&A obviously brings considerable execution risk which may result in one plus one not equalling two. Accepting that the financial crisis hit the big guys like AIG and Hartford pretty hard, the graph below suggests that being too big may not be beautiful where average ROE (and by extension, market valuation) is the metric for beauty.

click to enlargeIs big beautiful in insurance

In fact, the graph above suggests that the $15-$25 billion range in terms of premiums may be the sweet spot for ROE. Staying as a specialist in the $2-7 billion premium range may have worked in the past but, I suspect, will be harder to replicate in the future.

Exabyte Zenith

There is a sense of déjà vu when you read about the competing plans of Greg Wyler’s OneWeb and Elon Musk’s SpaceX to build a network of low earth orbit satellites to provide cheap broadband across the globe over the next few years. Memories of past failures from the late 1990s telecom bubble come to mind with these network plans. Names like Iridium, GlobalStar, Teledesic, and SkyBridge. Maybe, this time, the dreamers with access to billions can get it right!

You never know, there may even be a comeback for broadband over power-lines (not likely according to this article)!

I did come across the latest figures from Cisco in their “ The Zettabyte Era – Trends and Analysis” piece, as previously referenced in this post. As a reminder, gigabyte/terabyte/petabyte/exabyte/zettabyte/yottabyte is a kilobyte to the power of 3, 4, 5, 6, 7 and 8 respectively. Cisco continues to predict a tripling of global IP traffic from 2014 to 2019. The graphics below give some colour on the detail behind the predictions.

Split by consumer and business traffic with each further split by traffic type. Unsurprisingly consumer video traffic is dominating the consumer 24% CAGR.

click to enlargeGlobal IP Traffic 2015 projections

Growth in the US, Asia and Europe is driving the impressive 29% metro CAGR whilst Asia Pacific traffic is the prime driver for long-haul growth.

click to enlargeGlobal IP Metro LongHaul Traffic 2015 projections

The split by region shows the status quo will be maintained in terms of traffic breakdown with Central/Eastern Europe and the Middle East /Africa regions projected to have growth rates of 30%+ and 40%+ respectively as opposed to approx 20% in the main markets.

click to enlargeGlobal IP Traffic Geographical Split

Exabytes are reaching their zenith and by next year global IP traffic is predicted to exceed a zettabyte.

Fidelity’s clever move on COLT

On Friday, Fidelity made a 190 pence offer, which is a 21% premium to the previous day’s close, for the approximately third of COLT that it doesn’t own. After years of underperformance and a series of restruturings, COLT has been long looking for a positive future. It bought the smaller Fidelity owned Asian carrier KVH last year (see previous posts here and here). COLT’s core European business has been slowly moving to higher growth and margin data and network business, as the graph below shows.

click to enlargeCOLT Telecom Revenue & EBITDA Margin 2006 to est2016

Fidelity’s offer values the debt-free business at £1.7 billion (or €2.4 billion or $2.7 billion at current FX rates) which I estimate to be 7 times 2015 EBITDA or 6.44 times 2016 EBITDA estimates (assuming 2015 EBITDA of €335 million and a 2016 10% EBITDA YoY growth). The independent directors have called the offer too low but haven’t made a recommendation due to the lack of options for minority shareholders.

From Fidelity’s viewpoint, this looks like a clever move to force any likely bidders out into the open or, failing any bidders emerging, to take the firm fully private at an attractive price. Robert Powell over at telecomramblings speculates that other European carriers such as Interroute or the US based Level 3 may be possible bidders. It will be fascinating to see how this one plays out.