Saturday, June 5, 2010 8 comments ++[ CLICK TO COMMENT ]++

Bruce Greenwald interview with Forbes

I came across an interesting video interview with Bruce Greenwald, conducted by Steve Forbes. You can also access a transcript on the right side of the webpage (Thanks to Henry W. Schacht for bringing this to my attention.) Most people who read or listen to Greenwald do so for his thoughts on value investing (he is very close to a modern Benjamin Graham.) In contrast, I find him more interesting for his macro thoughts and his general views on industries.

If you are interested in some macro-oriented thoughts from Greenwald, you may also want to check out these posts from last year:

Interview with Advisor Perspectives part 1
Interview with Advisor Perspectives part 2

My comments on some topics that he covered follows..

Telecom & Cable Industries


Forbes: So, what areas do you like right now, as a value investor?


Greenwald: Well, I mean, I think cable is much despised. Telcos are much despised all over the world.

Forbes: Right.


Greenwald: And you want to do the work to see which are the telcos that are likely to, first, be in a position with this basic infrastructure, which is going to be universal. And I think there are foreign telcos that look like they're able to do that. I mean, France Telecom may eventually get there. Turkey Telecom has got a lot of fiber infrastructure and cable infrastructure, and may get there. So you want cheap telcos with a future, because the future is essentially, they're essentially trading it, like, eight to 10% dividend yields, as if they're dying, and some of them are not. And the other one is the cable companies. I think Comcast is --

Forbes: So, if you're on the highway, collect the tolls.

Greenwald: Of course. Exactly. And if you're on the highway at a really low price, because everybody else thinks the highway is going to fall apart and be really expensive, that's a lovely place to be.


Cable and telecom companies are the modern equivalent of electric utilities from 60 or 70 years ago. I don't find them attractive in general because they tend to require very high capex spending and their upside appear limited. Unless you buy them when they are distressed—this may be a possibility now given how Greenwald suggests the market is shunning them—the chances of one of these companies doubling their market cap in a reasonable amount of time looks slim.

The other potential risk, at least with cable companies, is that they may lose their television business to Internet sources. People may still access the Internet through cable companies but the profitability may be far lower than what they make off television. For example, our house spends around $30 on Internet access and probably $60 on television access (all through the cable company, Rogers.) If television ends up being replaced with Internet sources—not going to happen any time soon but likely will occur over the next decade—I can see us spending more on Internet access (for faster access, more traffic, etc) but the overall costs will probably be lower. We may spend $50 on Internet access in the future. The cable company's revenue would decline from $90 to $50.

Bearish on Amazon

Bruce is bearish on Amazon:


Greenwald: I mean, aright, I'll do the one that I've been wrong on for years. I've always thought Amazon is a bubble. They have no customer captivity. They don't have enough scale that it's hard to replicate. They occupy a really big market. They're not specialized at all.


Forbes: So how have they done so well for so long?

Greenwald: Well, first of all, they're, I think if you actually look at their reported profits, they haven't done that well.

Forbes: Okay.

Greenwald: What they're selling is this idea that they're going to continue to grow and they're going to have negative working capital. Negative working capital's an invitation to competition, right? So why they think that ultimately is not going to be competed away is beyond me. So that, I think, is a bubble.


Amazon is probably overvalued but I don't buy any of Greenwald's arguments. In fact, I completely disagree with many of them. Let me address them one by one.

When it comes to customer loyalty, it's hard to say but I have a feeling that Amazon is capturing customers one by one. It isn't a lock but I think their brand is getting stronger and stronger.

I'm not sure why Greenwald claims that Amazon has no hard-to-replicate scale. If anything, one of the reasons I like Amazon is because I believe it has big scale. It isn't so big compared to traditional, bricks & mortar, retailers or pure technology companies (Amazon has characteristics of a retailer and a technology firm.) But in the Internet space, they are huge. A lot of companies can set up online retail fronts but they can't scale up like Amazon. Having said that, the online operations of giants like Wal-mart have similar scale. However, the bricks & mortars stores may have issues with legacy costs if online was the main playing field.

As for lack of specialization and the small retail market share, it depends on how you look at it. Amazon posted revenues of around $25 billion versus $66 billion at Target; $44 billion at Sears; $74 billion at Costco. If you consider the fact that Amazon posted that revenue with a small fraction of the goods available at other retailers, it looks respectable to me. If the concern is that the bricks & mortar stores will crush Amazon through their scale, again, I think you cannot assume the physical sales translate over to the Internet. Amazon is very dominant on the Internet.

As for the negative working capital—if I'm not mistaken, this is due to Amazon's ability to collect money from the customer long before it pays its supplier—I agree with Greenwald that it will be competed away at some point. But that could be quite far off given how other Internet retailers don't seem to be much of a threat to Amazon right now.

I think one key element that Greenwald is missing is the network effect. Most of Amazon's value, in my opinion, comes from network effects (similar idea as Ebay.) If someone recommends Amazon, it is likely to spur more visits by others and more recommendations. It's possible that Amazon's benefits from network effects may weaken if competitors can push their brand online. It remains to be seen what happens.

To sum up, I am a big fan of Amazon. I think the shares are likely overvalued but the business fundamentals appear solid to me.

Looming Problems for China


Greenwald: The other one I think, and this is along the lines of growth not always being valuable, people are paying a lot of money for companies in Brazil and in China that are subject to competition.


Chinese manufacturers have to compete with other Chinese manufacturers. And the growth just gets competed away by entry, like it did for the movie business. So I think you would be well advised, especially given the political uncertainties, and everything else in the fundamental economics, not to pay a ton of money for China.

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...And they were wrong, because the Japanese were in manufacturing. And manufacturing is an area where productivity growth is much higher than demand growth, and it means, like agriculture.


Forbes: Make a quick point on that. Caterpillar, Deere and others, make the money not selling moving equipment so much as servicing it, which is local markets.

Greenwald: Exactly. Which is local markets that they can dominate. Global making markets are subject to what happened to agriculture in the 1920s and '30s, which is, everybody left it. Everybody could do it. Productivity growth was enormous, and it died.

And I think Japan has basically had this very long period of malaise because they have decided they're going to be the preeminent manufacturer in the world. It's like in 1940, the United States deciding they're going to dominate the world by being the preeminent agricultural producer. And that would've led no place. And I think China's in the same game. So, I think you're going to have real trouble in China.

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Greenwald: Secondly, I think that they [China] have done it by specializing in industries which are manufacturing industries and it's a manufacturing, export-driven economy that are going to get automated. If you go into a Japanese factory today, I mean, and this is the problem with Japan. There are more people on the loading dock than there are in the factory. And the loading dock is this service function that you talked about with Caterpillar, and so on. There is no evidence yet that they've moved into developing a vibrant, innovative service sector.

And there is equally, I think, little evidence that they've actually developed leading edge manufacturing compared to the Japanese. They've done better at the low end than anybody expected, but they're not the star manufacturing companies that the Japanese are. And a lot of good that's done the Japanese. And I think the third and most important thing is what you're talking about. That ultimately to support a standard of living that's high in this environment, you not only have to have a service infrastructure, but you have to produce intellectual capital. And the striking thing about the Japanese is they did not produce great universities. And I don't see any evidence that the Chinese are producing great universities either because the truth is, and this is related, I think, to the political system, that the very best graduates who come to the United States, and a lot of them come, all want to stay here.


Very important points made here. Foremost, contrary to what many, including anti-free-trade critics in America and Canada claim, boosting manufacturing isn't the way to go. As Greenwald points out, manufacturing has higher productivity gains than demand growth (mostly due to automation and process improvements.) This essentially means that creating jobs in manufacturing is very difficult. The fact that America, Canada, and others have been shedding manufacturing jobs is actually a good, albeit near-term painful, thing.

On top of the bubbles I keep talking about, China is going to have a very painful adjustment in the medium to long-term. They will hit a point when machines or process improvements will shed jobs.
 
 
As for the lack of great universities in Japan, that has always puzzled me. They do have some good ones but not as good as what a rich country with a lare economy should have. Part of the reason may be the tight society they run. Attempting to study in Japan, let alone immigrate there, is pretty much out of the question and I suspect this keeps talent away.
 
When it comes to Greenwald's suggestion that Japan doesn't produce much intellectual capital, I disagree. I think Japan does produce a lot of intellectual capital. But, they don't commercialize it. I mentioned this on this blog before but I find it bizarre how Japan doesn't commercialize many of its scientific advances. The culprit may be the lack of a capitalistic, or at least an entrepreneurial, environment in Japan—this is something America excels in.
 
Is India Better?
 

Forbes: So does that mean India has an advantage over China that they are more mind-oriented and not to mention the rule of law?

Greenwald: I think there are two reasons. I mean, we're, first is, that they are much more service oriented. And I think that's going to help them.

They're not committed to doing the kind of, sort of mindless manufacturing that the Chinese are doing, or blindly pursuing that alley. And secondly, I think that, yes, the politically vibrant culture that's there is going to make a big difference. On the other hand, if you look back 70 to 80 years, the dominant universities in the world today are the dominant universities then. So I think India is not going to necessarily succeed in displacing the great American and the few great European universities.


I'm not too bullish on India. It has all sorts of severe problems that are far worse than what many other developing countries face (such as rampant gender discrimination, religious strife, extremely corrupt governments, high government debt and deficits, and so on.) Greenwald says that India's high service component of the GDP will prevent problems. I agree with that but there are also shortcomings due to that. For instance, increasing productivity, which is easier in manufacturing, is likely to lead to far greater wealth creation (it's hard to increase productivity in service industries, which is also why you won't be losing jobs so easily.) So, I think a country like China will become far wealthier than one like India even if they at the same development level (in reality, India is far behind China's development.)

It's still not clear how economies will evolve in a post-manufacturing society.

Why Does Europe Lag America?
I think Bruce has a bias towards education given how he benefits from it (he is a professor) but nevertheless, it's interesting to hear some of his theories on why Europe has lagged America.


Forbes: And talking about Europe, why has Western Europe been such a laggard? I mean, they should've been at the forefront.

Greenwald: Again, I think that there are two reasons for that. And they're exactly the reasons we've talked about. I mean, that in a sense, the future is services, which are locally produced and consumed, and production of intellectual capital. And those are both state-dominated sectors. And they have not produced successful universities because they have egalitarian overlays on things that mitigate against the kind of excellence that you have at Oxford and Cambridge and in the U.S. universities.

...And the second thing is that services, and the big services are, of course, education, medical care and housing, are government dominated. Either run with very tight zoning restrictions, or they're directly run by the government, and I don't think that helps you.



I'm not really sure those are the main reasons. There are a whole hoard of other factors at play as well but I'm not going to go into this now.

America's Education System - Not What it Seems

Some of Bruce's views are non-conventional and the following one on education is definitely one of those. He suggests that, as much of a failure the American education system may appear at times, it actually works very well. I never thought of the US education system quite as he describes below but it's definitely thought-provoking.


Greenwald: ...I mean, and if I can say something about the United States, because I think it's important. There are in the world two basic ways you control human behavior and have societies function. One is material incentives. And that includes, obviously, not just money but, you know, all sorts of material sanctions. And the other is social incentives. And the U.S. is an economy that has been selected for not having social incentives because if you were an Italian, and you didn't like the social restrictions in your village, you came to the United States to do well. And what that's done is created a culture because you don't have to enforce more obedience in the schools the way they do in Europe, that is a wonderful culture.

I mean, in the United States, you can screw up till you're 35-years-old. And if you're hard-working enough and smart enough at that point, you'll do well. In France, or in Germany, or in England, or in Japan, or in China, if you screw up by 19, and in France, don't get into a grand ecole, you're finished for life. And there is no equivalent of Animal House or the huge literature on high school and college experience in the United States both in films and books in Europe. I mean, school is a grim experience in Europe. And I think that it is that attribute of U.S. society that we don't want to kill in any dimension.
Forbes: So even though a lot of our especially inner city schools mess up, if the kids are playing games, their mind develops?

Greenwald: It's not just that. I mean, there, look, there are people who develop at 15, I mean, there are people, there's a famous investor called Seth Klarman, I knew him when he was an MBA student at Harvard. He was the same then, he was as capable then, he was as brilliant then as he is today. He developed very early in life. But there are other people who develop much later in life. They develop not at 15, but at 20, at 25, at 30, at 35. And I think trying to force everybody into a European mold, where if you aren't doing well by 19, we're going to write you off, is crazy. I mean, I would let those people out of school, and let them come back to school later. It's funny, I talked to somebody here who started out, she left home at 16, to be a rock star. And she tried that for four years and then she went to NYU and obviously did well and she works for you now as a journalist.


What Greenwald describes is thought-provoking and so true! In most countries, outside America and Canada, if you didn't get into the right university afer High School; or if you didn't start your career with the right company; or if you didn't make the right contacts at a particular age; you would be screwed for life! Your potential would have been destroyed by society just because you didn't fit into the mold at a certain age. Not so in America and Canada. So many people change their careers and schools, and resident locations—before the housing bust, America had higher mobility than Europe—while still leading fairly successful lives.

I never thought about this before but it is such a huge difference between countries. The worst is probably Asia, where your adult life could be dictated more by what university you get into at 19 than what you do for the rest of your life. The first job you get could also impact your life more than what you do in that job for the subsequent 30 years.


None of this probably helps anyone's investing but it's interesting stuff...

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8 Response to Bruce Greenwald interview with Forbes

Parker Bohn
June 5, 2010 at 4:18 AM

Interesting interview.  I've never heard Greenwald speak in actual audio, and I find him quite articulate and organized (comes from being a professor, I suppose).

I'm not bullish on telcos.  Some will do great I'm sure, but as an industry, it seems to be becoming more and more commoditized and open to competition from all sorts of different players.  It is not even clear what physical infrastructure will carry data 10 or 20 years from now, much less which companies will dominate it.

I think Amazon is a great company.  I'd love to buy shares at a good price like 15 times earnings (hey, that's only a 72% drop from here, it could happen!).

On schools and social structure, I think the US is fantastic at allowing a few bright, motivated (and lucky) individuals to prosper, and to impact society with their ideas.  On the other hand, there is a huge price to pay for this chaotic wild-west 'winner-take-all' kind of system, which can be seen in the wealth disparity, and lack of basic social services (such as health care) that many Americans have little access to.

On China, I have no idea if manufacturing is going to cause them to prosper as a global economy, but at least they'll have lots of stuff!  The average Chinese lives in poverty, and it seems to me that it was manufacturing that lifted Europe, the US, etc. out of poverty generations ago, so it will have to be the same for China, regardless of the value to the rest of world, or to foreign investors.

jrm
June 5, 2010 at 10:00 AM

Greenwald is very right about the opportunities in America for risk taking, entrepreneurship and success that are not available if you "fail" at 19 in europe or asia. taleb talked about it too. we europeans in particular really need a dramatic change in our education and social model. our talents go to america to build wealth and growth there, and europe lags

June 5, 2010 at 2:55 PM

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Sivaram Velauthapillai
June 5, 2010 at 4:21 PM

Yes, although let's not blow this out of proportions. Europe does generate some benefits that aren't available in America--less volatile, smoother, lives in Europe I would say. 

Without having lived in Europe, my impression is that of a society that still clings to aristocratic traditions. Tradition is being chipped away over time but the schools in France are an example of how there is a big division between the elites and the rest. If you don't get into the right schools, you are screwed; and then society appears to discriminate against the younger workers (France often has higher unemployment for the youth (excluding <18 years) than many other places.)

Sivaram Velauthapillai
June 5, 2010 at 4:36 PM

TELECOMS
 
ParkerBohn: "I'm not bullish on telcos.  Some will do great I'm sure, but as an industry, it seems to be becoming more and more commoditized and open to competition from all sorts of different players.  It is not even clear what physical infrastructure will carry data 10 or 20 years from now, much less which companies will dominate it.  "


I am not a fan of telcos either but the thing to keep in mind is that barriers to entry are high. You really aren't going to see many new entrants. Unless there is a radically disruptive technology that emerges, it is likely that the current infrastructure will remain dominant for decades (similar to how electric utilities pretty much haven't changed for 50+ years, once they sort of built out their infrastructure.) In some countries, where competition from cable and satellite is weaker, telcoms are very dominant (I think countries Greenwald mentions like France and Turkey are like that--not 100% sure but I did research France Telecom once and they seem dominant. In America and Canada, if I'm not mistaken, the cable companies are more powerful.) So I think they will survive.

The reason I don't like them is because they have large debt loads that they used to build out infrastructure (just like utilities) and their pricing power isn't that strong (sometimes due to regulation; some of it because customers just won't pay much more.) I"m not really sure what their long-term returns will be. I can see them posting below-market returns in the long run. They will be safer and not so dependent on the economy but probably won't earn much.


AMAZON

ParkerBohn: "I think Amazon is a great company.  I'd love to buy shares at a good price like 15 times earnings (hey, that's only a 72% drop from here, it could happen!).  "


Same here :) I have been waiting for years to buy it at a low price.  Even during the crash, it didn't quite hit my target.

Sivaram Velauthapillai
June 5, 2010 at 4:51 PM

SCHOOLS

ParkerBohn: "On schools and social structure, I think the US is fantastic at allowing a few bright, motivated (and lucky) individuals to prosper, and to impact society with their ideas.  On the other hand, there is a huge price to pay for this chaotic wild-west 'winner-take-all' kind of system, which can be seen in the wealth disparity, and lack of basic social services (such as health care) that many Americans have little access to.  "


Yep... the downside to America is that discrepancy in wealth is very large (for a developed country.) It's still amazing to me how you can be driving along a road in a city, and you can literally see a thick line separating the poor areas from the richer ones. In Toronto (Canada,) you could go to the worst area and it isn't so bad. Europe also has problems but at least the poor have better welfare systems.


CHINA

ParkerBohn: "On China, I have no idea if manufacturing is going to cause them to prosper as a global economy, but at least they'll have lots of stuff!  The average Chinese lives in poverty, and it seems to me that it was manufacturing that lifted Europe, the US, etc. out of poverty generations ago, so it will have to be the same for China, regardless of the value to the rest of world, or to foreign investors."


In my opinion, what has been happening in China over the last two decades--this is one of the things that may cause the govt to fall easily--is that only a tiny portion of the wealth generated over the decades has gone to the workers. The so-called migrant workers toil away all day long yet have only seen small improvements in their lives. For instance, China's consumption as a percent of GDP has actually declined in the last decade. If citizens maintained their share of wealth that was generated, this ratio should have stayed the same or increased.

Most of the wealth has gone to the government and its corporations (SOEs.) If the government ever loses that money, either through corruption or betting it on some bubbly asset, there is going to be a political crisis.


Stars have been aligning in China's favour for a few decades now. I think it has the best shot at becoming the most dominant economic power in 100 years. But it will go through painful adjustments along the way. Their current manufacturing-based economy will see some painful adjustments soon. They are probably hitting the point where they can manufacture more than the world needs.

Rob Rosenfeld
June 5, 2010 at 7:57 PM

I agree with what Bruce says about being able to screw up longer here than in any other country and still come out ahead.

But disagree with his reasoning. It is not because you can be more playful at school in the US or develop a different approach to things or nourish an open mind. It is because the US has a very large marketplace with very powerful dynamic forces. Thus, the day someone stops screwing up that person can still try to immerse him/herself back into the market and find a place/job/occupation with some reasonable effort supported by reasonable intelligence and a hard working attitude.

Sivaram Velauthapillai
June 6, 2010 at 6:57 PM

ROB ROSENFELD: "It is because the US has a very large marketplace with very powerful dynamic forces. "



I don't know about that Rob. Some of the European nations with rigidity, like France, also have fairly large economies. Sure, it's not as big as the US but it's still fairly sizeable.

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