Roach Motel Or Investing for the Long-Term: You Decide What Best Describes Temasek’s Investment Strategy.
A “Roach Motel”, originally a term used to describe a cockroach trap, has become a metaphor used by hedge fund managers to describe an investment that is too large in relation to the size of the company’s equity capital or the liquidity of the stock to allow the manager to exit without taking an unacceptable loss. For better or worse, the manager is locked into the stake and the only exit is normally either through a sale of the company, which is fine as long as a price higher than the entry price is achieved, or else through bankruptcy and the loss of the entire investment.
Roach motels sprang to mind when I read this morning that Temasek Holdings is selling a 2.5% stake, or 400 million shares in SingTel with the option to sell another 100 million shares
(http://www.businessweek.com/news/2012-09-25/temasek-decides-to-sell-singtel-shares-worth-1-dot-3-billion). Presumably it is a “bought” deal in which the lead banks, Citibank and Morgan Stanley, underwrite the sale. Since SingTel shares are now trading below the bottom end of the sale range it is unlikely that the deal size will be increased to the full 500 million. As SingTel shares were trading at nearly $3.60 at the end of July it begs the question of why they have waited till now to sell, approximately 10% lower. The explanation given for the sale was that this was normal portfolio “rebalancing.” Since Temasek will undoubtedly have to continue to hold more than 50% of SingTel it is difficult to see what difference selling a 2.5% stake would do.
This news comes on top of reports in the FT that Temasek was shopping its stake in Standard Chartered, of which it owns 18%. StanChart shares fell 20% after news broke that the New York State Banking Regulator was seeking to have it barred for helping Iranian companies breach sanctions but have since recovered most of that loss after they negotiated the penalty down to a US$340 million fine. Since StanChart trades at a premium to book value of about 1.4 in contrast to most other big banks which trade below book value it would seem on a very superficial analysis to make sense to sell it. It is not clear who would want to buy it at such a premium or what discount Temasek would have to give to offload their stake. Certainly Citibank, whose name was linked with it before the 2008 financial crisis, would be unlikely to be a buyer since its shares trade much more cheaply than StanChart’s now.
With the sale of their stake in ICICI Bank and their attempt to cut their exposure to Bank Danamon by selling their shareholding to a subsidiary (DBS) it certainly looks like Temasek is bailing out of its misplaced bet on financials which still make up over 31% of the portfolio according to the latest report. However it is difficult to see why at the same time Temasek’s managers would feel they possessed enough knowledge of the Mexican banking sector to justify investing US$160 million in the eighth-largest Mexican bank.
What is of more concern is how much of a paper loss Temasek has on its holdings in Chinese banks as well as other Asian financial institutions. For example Shanghai is the worst-performing major market this year down about 8% whereas other market indices are mostly up. In view of the slowing economy and the well-telegraphed problems in the Chinese property sector one would expect the Chinese financial sector to be performing much worse than the average. This is indeed the case. I list below the major stakes in Chinese banks and how much they have fallen by since Temasek’s last annual report on 31 March 2012. According to their 2012 report, Temasek owns a 1.5% of the total share capital of Industrial and Commercial Bank of China, a 7.2% stake in China Construction Bank and a 1.1% stake in Bank of China. They have fallen by between 10% and 15% since the last financial year-end. On my back-of-the-envelope calculations Temasek is sitting on a book loss of about $1.8 billion just on these three stakes since 31March 2012.
While Temasek probably took a much bigger hit in 2011 on their Chinese bank stakes there is likely to be much worse to come as the Chinese property bubble deflates. Indeed the slowdown in the export sector is already likely to push the Chinese growth rate below 7% in the third quarter. There are good reasons to think that even that growth rate is exaggerated. May be the worst case scenarios of “Dubai times a thousand” will not happen but there is still plenty of reason to be concerned. Indeed on 20 September Jim Chanos, who is well-known as a notorious China bear, was back on the same theme warning that China is a “classic emerging market roach motel, except it’s a really big one in that it’s very difficult to earn adequate returns for capital and get your capital back as a Western investor.” (http://www.cnbc.com/id/49099734)
The same accusation could be levelled at Temasek’s 68% stake in Bank Danamon. Suddenly it does not look like such a good bet to be so overweight in financials just when austerity policies are increasing the real value of debt. Their bet on the energy sector does not look too clever either given the slowdown in the global economy and the effect this is having on resource and mining stocks. Take for example its stake in Clean Energy Fuels of the US. This is also mentioned in the WSJ article as one of Temasek’s big bets on the energy sector. The stock fallen by some 40% since March.
Despite their increasingly energetic efforts to sell the more liquid parts of their portfolio, in what they euphemistically term rebalancing, Temasek’s managers are still stuck in far too many roach motels. In the words of the Eagles song, “You can check-out any time you like but you can never leave.” Contrast this with the Norwegian sovereign wealth fund which only exceptionally takes a position above 5% of the equity of a company.
I said in my article, “Chesapeake and Temasek: A Tale of Two CEOs and Shareholder Democracy” (http://sonofadud.com/2012/06/14/chesapeake-energy-and-temasek-a-tale-of-two-ceos-and-shareholder-democracy/), that Temasek’s international portfolio should be split from its domestic one as a first stage towards transparency and a public listing. The government has never properly explained how Temasek achieved an alleged 17% annualised return since inception. In particular how much of this return came from the injection of state companies into Temasek for zero or very nominal compensation followed by a huge revaluation when they were listed. By contrast Norway has two separate funds: one purely focused on domestic investment and the main one which has an international focus. In Singapore’s case the domestic portfolio of Temasek should be sold off. This would reduce the conflicts of interest and cronyism that have resulted in virtual monopolies and stifled innovation in key sectors of the domestic economy.
As usual Singaporeans are bearing all the risks of Temasek’s concentrated bets but reaping none of the rewards. Through a market listing, transparency and accountability to Singaporeans we can determine whether Temasek is indeed “investing for the long-term”, as our Finance Minister and PM say, or whether that is just an excuse for poor performance.