December 4, 2022

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Risking Buffett, TSMC and Taiwan

6 min read

This article is an onsite version of our Unhedged newsletter. Sign up here to get the newsletter straight to your inbox every weekday

Good morning “Walmart is becoming increasingly popular with wealthier consumers looking for savings in times of high inflation. . . three quarters of [its market share] The gains came from buyers with more than $100,000 in annual income, executives told analysts. “That sounds like a different economic story than we’ve heard for most of the past year. What about you? Email us: robert.armstrong@ft.com & ethan.wu@ft.com.

Risking Buffett, TSMC and Taiwan

Berkshire Hathaway has a patchy record as a tech investor. Basically, what I mean by that is that Warren Buffett’s conglomerate made a nightmarishly bad $10 billion investment in IBM in 2011. Buffett argued at the time that IBM’s competitive advantage was its very stable foothold in corporate IT departments. This was absolutely not the case, as subsequent events would show, and Berkshire was sold at a huge loss. Unhedged wrote about it earlier this year when Berkshire unveiled a $4.2 billion stake in HP Inc, which sells printer cartridges (the stock has since slightly underperformed the market). On the other hand, Berkshire’s huge investment in Apple, which it began buying in 2016, was a winner.

All three of these stocks have something in common with Berkshire’s most recent technology purchase, a $4 billion stake in Taiwan Semiconductor Manufacturing. All three looked cheap when bought, with price-to-earnings multiples in the low single digits or (in HP’s case) below.

But TSMC is much more like Apple than HP or IBM. Not only is it cheap, but it’s growing fast and (for a company in a capital-intensive industry) is very profitable. According to S&P Capital IQ, the company has grown revenue at a compound annual rate of 17 percent over five years and has delivered a compound return on investment of 16 percent over five years. For example, compare Intel using these two metrics: 2 percent and 12 percent at a P/E of 20.

Additionally, TSMC’s competitive moat appears to be larger than IBM’s (too annoying to fire) or HP (too annoying to buy a refilled ink cartridge). It has a virtual monopoly on making the fastest computer chips. TSMC won’t always have that crown (Intel once had it, Samsung once came close), but making chips is difficult and leadership rarely changes hands.

So why is TSMC trading at 12x forward earnings? I asked two semiconductor analysts – Stacy Rasgon of Bernstein and CJ Muse of Evercore ISI – about this yesterday. Both were clear: TSMC is only trading so low because of the risks posed by strained relations between Taiwan, China and the US.

I’m not sure if that’s true, but let’s assume it’s true. Is Buffett right to overlook this risk? One argument would be that in the extreme case of a Chinese invasion of Taiwan and US military involvement, we’re all (and every stock) in so much trouble that there’s not much point in only discounting Taiwanese stocks. Either China-Taiwan-US ties thaw and TSMC scraps its rebate, or the US goes to war with China, in which case everything gets a rebate. It’s awful to talk about, but the logic works. Perhaps some risks are too serious to price into a stock.

Praying and preparing for peace

Unhedged doesn’t often talk about the war in Ukraine. We’re a humble market column, and war is well above our pay grade.

But nine months into the war, talk of an endgame in Ukraine is increasing in the press and reportedly among some Western officials. The Russian withdrawal from the strategic city of Kherson is likely a factor, as is the first known face-to-face meeting between Russia’s and America’s top spies.

We have no idea what will happen on site; maybe nobody does. But we know that a de-escalation of the war, whenever it happens, will be important for the markets. It’s time to think ahead, so we asked around.

Most observers expect the conflict to end in some sort of deal between Russia, Ukraine, the West and possibly other actors. It is impossible to know what such an agreement would entail and it may take a long time. But markets are forward looking and unlikely to wait for official negotiations to begin.

Matt Gertken, chief geopolitical strategist at BCA Research, told us: “Once we have a stalemate militarily, I think financial markets will start sniffing out an eventual truce.” Ukraine’s victories on the battlefield, he says, create extreme risks for Ukraine the world economy: that Russia is desperate and raising the stakes. None of the possible outcomes are good for markets, including another energy shock, more sanctions, attacks on overseas infrastructure, or nuclear brinkmanship. Eliminating these downside risks would move markets:

If you can eliminate those risks. . . either by the Ukrainians running out of breath, or by the West convincing Ukraine that it needs to settle down, or possibly by a Russian withdrawal, although I don’t think that will happen. . . global sentiment can begin to recover.

The worrying opposite, however, is that a string of Ukrainian military successes could pose a major risk to markets, Marko Papic, Clocktower Group’s chief strategist, told Unhedged:

[Further Ukrainian wins] would be a problem because it would convey to the markets the reality that Ukrainians are an independent actor that cannot easily be influenced by the West. It adds uncertainty, another independent actor you need to model.

how far would they go Would they advance to Crimea? . . . And what do the Russians do when they keep telling us that they are terrible in war? . . .

Now when you talk to investors, they tell you things like, ‘Oh, the West will rein in Ukraine.’ Why do we assume this is possible? Everything the Ukrainians have shown us suggests that they are capable and confident

Which assets are most affected? Consider grains, energy and metals, all of which rose sharply as Russia invaded in February. Gemcorp’s Simon Quijano-Evans notes that good news from the Ukraine front could see open doors being opened, for example by a cut in grain prices, while global supply chains fully normalize.

The US Federal Reserve could welcome a commodity slump caused by Ukraine. It would “remove one of the key inflationary risks the Fed needs to watch out for,” says Policy Tensor Newsletter’s Anusar Farooqui. Every Fed statement since the Russian invasion has mentioned the stagflationary effects of the war.

Papic sees raw materials differently. Russian oil at cheap prices is still flowing to international markets through intermediaries like India because the West hasn’t imposed secondary sanctions, he argues. Thanks to a Turkey-brokered deal, Ukraine’s grain exports have mostly recovered, while Russia’s are rising sharply. Metals, Papic says, are trading on global recession risk and China demand prospects, not Ukraine results. He thinks the impact on the euro and European industrials is more noticeable.

Our best guess is that a de-escalation in Ukraine would push commodity prices down somewhat, but that interest rates and global recession risk are now having a far greater impact on prices. But we say that with a heap of uncertainty. let us know what you think (Ethan Wu)

Google and TCI

TCI, the activist investor, thinks Alphabet is wasting a lot of money and should stop it. From his letter published yesterday:

Alphabet’s cost base is too high. . . The company has too many employees and the cost per employee is too high. Management should announce an EBIT publicly [operating] Achieve margin target, significantly reduce losses on other bets, and increase share buybacks.

Google Services segment EBIT margin fell to 32 percent in the third quarter from 39 percent in 2021[2022]. . . In a period of high growth between 2017 and 2021, sales increased by 23 percent annually, cost discipline was not a priority. However, cost discipline is now required as revenue growth slows

Unhedged is likeable. We recently made very similar points about Meta and Amazon’s retail business. The largest tech companies must demonstrate that their investments are likely to yield an acceptable return. Activist baiting is good.

What we don’t know — and neither does TCI — is how big tech stocks will perform on this journey. What’s the right valuation for slower-growing, higher-margin Amazon, Meta, or Google? Whatever that valuation is, it could be a bumpy road to get there as the companies’ investor base shifts.

A good read

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