spex issue 18

SMU Political-Economic ExchangeAN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION HAPPENING THIS SUMMER WITH SEIC! ISSUE 18 19 JUNE 2012

First ever Community Service Project in Socio-Economics! SIGN UP NOW! - Moving Away From Theatre Opera Growth - The Eurozone Crisis Spain - A Closer Look at M&A Activity in the Mobile Commerce Industry

The Fortnight In Brief (5th May to 19th June) US: The Lumbering Giant Job creation and industrial production figures in May remain lethargic as Eurozone woes and a slowing Chinese economy continue to plague the US. While economic expansion is still underway, it is also slowing down more quickly than expected. Moreover, greater uncertainties and a weakening economy in the euro zone threaten to halt growth or even reduce earlier gains made by the US economy.

IN COLLABORATION WITH

Asia Pacific ex-Japan: Struggling with Tiresome Gloom Chinas inflation has fallen to 3% - the lowest since 2010, suggesting slightly more leeway to boost the economy through both monetary and fiscal policies. While the Chinese government has been giving much more green lights to investment projects, it failed to spur fixed asset investment as observed from its slight decline in May. Growth in retail sales suffered a slightly greater slip to 13.8%, down from 14.1% while industrial growth crept upwards by a mere 0.03 percentage points.EU: - The Eurozone's future hangs on the balance The Spanish government requested explicitly for help to bailout its ailing banks, which eventually resulted in Spain receiving a 100 billion in rescue funds to recapitalize its banks. Meanwhile, Moody downgraded the Spanish sovereign bond ratings to Baa3 from the current A3 and the country remains on review for further downgrades. However, without any concrete plans to improve and integrate the Eurozone economy, Spain's bailout has failed to move the markets and remove pressure from the Eurozone periphery sovereign bond yields. Europe's future now hinges on the election outcome in Greece, as voters prepare once again to vote, de facto, a decision on whether Greece stays in the Eurozone. PROUDLY SUPPORTED BY

Moving Away From Theatre Opera GrowthBy Vera Soh, Singapore Management University

Just when the world was hoping for a big present from the Chinese government, Xin Hua, the Chinese Communist Partys (CCP) mouthpiece announced that a stimulus package similar to the exuberant one in 2008 should not be expected. Although the exact figure is ambiguous, it is estimated that at least 70% of the 4 trillion Yuan was channeled to State Owned Enterprises (SOEs). Looking back to where the bulk of the 2008 stimulus package went to and the result of it, shrinking the size of the upcoming one appears to be a good idea. Stimulating Waste Placing too much emphasis on the number of SOEs in China tends to lead to a loss of focus of the main issue, which is how the stimulus package will be used. Having a huge stimulus going to SOEs and government spending is mal-functional only if the money is invested inefficiently regardless whether the short term intention of propping up the economy when the whole world was experiencing contraction was met. China invests half of her Gross Domestic Product1 (GDP) annually and SOEs take the lead in mal-investment2. Not only is their investment returns estimated to be 20 to 30% lower than the private sectors, many government backed construction have turned out to become halfdone, vacant dark apartments. About 50% of Chinas apartments are unoccupied. In fact, some analysts have formed conjectures that even if China halves her investments, she would still be able to grow as quickly as she had. Too Many Ministries Spoil the Route This problem of inefficient investing does not only lie with SOEs. In fact, Chinas 27 ministries are already a major source of capital waste. This large number itself brings to mind conflicting and overlapping interests and over-usage of resources such as manpower and finances in executing projects. Having too many ministries inevitably means that there will be overlapping or similar duties and functions. This creates the need for unnecessary coordination and information sharing. For example, China Railway Construction Corps (CRCC) Shanghai-Kunming project requires the Ministry of Railways, Ministry of Transport, Ministry of Housing and Urban-Rural Development and the Ministry of Land and Resources to oversee. With these various ministries dealing with overlapping issues, a single, big ministry similar to Singapores Land Transport Authority (LTA) would ease information flow and coordination; thus reducing inefficiencies. The current framework in Chinas economy is also biased against private firms, where guanxi (connections) are in favour of SOEs. Reducing the amount of stimulus would force government ministries and SOEs to increase investment efficiency. However, the current framework is not necessarily unstable. With market sentiments being unfavourable to investors and during times when animal spirits unleash themselves, state backed investment can cushion dives in the economy. However, a frenzied mal-investment-led growth has resulted in China risking the possibility of stagflation. Although 8.1% GDP growth in the first quarter of 2012 is relatively high in comparison to the rest of the world, it represents Chinas slowest growth in three years; generating more anxiety both in and out of the supposed saviour. An investment-led growth is 2 Copyright 2012 SMU Economics Intelligence Club

simply unsustainable. Moreover, only a third of Chinas GDP comes from domestic consumption. Breaking the Habit & Spending With slowing growth and consumer prices still on the rise, a substantial domestic consumption increment does not seem to be occurring in the near future. Income levels have been creeping upwards (Figure 1) but seems to have a minute impact on consumption levels. Chinas current consumption habits are moulded over the previous generations emphasizing the virtue of thrift. In addition, majority of Chinas household savings are still geared towards precautionary savings.

Figure 1: Per Capital Disposable Income (Urban)25000 20000 15000 10000 5000 0 2006 2007 2008 2009 2010 2011 Source: National Bureau of Statistics of China Per Capital Disposable Income (Urban)

Other than the usual plea for more comprehensive social safety nets, China needs to reverse the trend of an ageing population. The one-child policy has brought about a generation that will be 25% smaller than their parents. These young workers have to take on the burden of financially supporting both their own and their spouses aged parents. As much as they would like to consume more, their lack of sibling support, together with their parents lack of government support, leaves them unable to. Throw in the multi-generation long virtue of thrift; consumption habits would require a lot of time to catch up with income growth. Whether this Asian Giant and her counterparts have the patience to wait is yet another moot point. However, it is still rather comforting to note that Chinas retail sales3 data (Figure 2) shows that consumption has been recovering moderately but steadily after the 2008 financial crisis. Chinas domestic consumption seems to be heading north - it is just a matter of speed and time.

3 Copyright 2012 SMU Economics Intelligence Club

Figure 2: Retail Sales (billion Yuan)140000 120000 100000 80000 60000 40000 20000 0 2006 2007 2008 2009 2010 2011 Source: National Bureau of Statistics of China Retail Sales (billion Yuan)

Change of the Decade Whatever it is, external demand is unreliable and investment addiction is not favourable. Perhaps Peng Wensheng, chief economist of China International Capital Corp. (CICC), has made the importance of Chinas domestic consumption apparent and explicit In the last decade Made in China changed the world. In the next decade, Chinese consumption will have a profound impact on economic environments at home and abroad.

The monetary value of all the finished goods and services produced within a countrys borders in a specific time period.1 2

Investments in wrong line that leads to capital loss. aggregated measure of the sales of retail goods over a stated time period

3 An

Sources: Financial Times, CaiXin.com, World News Network, Daily New Los Angeles


The Eurozone Crisis SpainBy Tommy Tan, University College LondonJust seven months ago, Spanish Prime Minister Mariano Rajoy came to office in a landslide victory, announcing his bid to recapitalise1 Spanish banks without external help. Last week, Spain sought from Eurozone governments 100bn to rescue its banking system. In doing so, it becomes the fourth2 Eurozone member to require a rescue. We look at what brought the Spaniards to their knees, and what this all means. What Went Wrong Looking at the Greek bailout, one might conclude that the crisis stems from ill-regulated, spendthrift governments. Taking a closer look at the Spanish bailout however, we are able to illustrate the deeper problems that form the Eurozone crisis.

Source: Eurostat

Unlike some of its big-spending neighbours, the Spanish government kept a rein on its coffers. As shown in the graph above, Spains debt-to-GDP ratio is among the lowest among Eurozone countries prior to the crisis. So why does Spain need a 100bn euros loan? Whilst its government resisted the lure of cheap credit, its banks and people embraced the discount. From the early 2000s up till 2008, Spain's economy grew, powered by a booming property market. In the 4 years up till 2008, housing prices grew by 44%. The music stopped in 2008, and housing prices have since fallen 25%, causing borrowers to default on their loans and banks to suffer heavy losses. To make matters worse, rather than drawing on savings deposits to issue loans to borrowers, the Spanish lenders relied on international money markets to finance these loans a much riskier strategy. As such, Spanish banks now sit on a heap of losses, and need a rescue.


The Rescue Deal Whilst it has been estimated that 100bn is needed to rescue the Spanish financial system, the precise quantum of the deal will only be released after next week's audit of the Spanish institutions. As we wait for the economics of the deal to crystallise, the politics behind the deal stands in the limelight. In what seems like a trivial pursuit, Prime Minister Rajoy has continuously refused to acknowledge that the funds sought are a 'bailout'. Naturally, the PM's seemingly artificial almost childish - stubbornness has been criticised and even mocked. Rosa Diez, spokeswoman and founder of the Union, Progress and Democracy, a Spanish social liberal political party, urged Rajoy to pronounce the word: "Nothing will happen to you for admitting the truth, for doing it in parliament, and for calling the rescue a rescue. Say it with me -- rescue. Limited rescue, financial rescue, light rescue, marvellous rescue, but rescue," What's the significance of this point then? Politics. Previous bailout packages have come attached with stringent conditions, forcing governments to restructure economic policy and implement austerity measures. As the May 2012 Greek elections illustrate, such conditions don't sit well with electorates. With self-structured austerity measures already underway, and national unemployment soaring at 25%, the last thing Rajoy and the Spanish electorate want are foreign institutions imposing budget cuts. It is thus crucial for Rajoy to strive to avoid destabilising the political order, in order that he can address the economic problems effectively. The 'bailout' is in some sense truly distinct from previous bailouts. As German Chancellor Angela Merkel explains, whilst the loan would naturally be conditioned on Spain restructuring its financial system, it is limited only to the financial structure, as opposed to the wider conditions, such as requiring broad, economic policy reform imposed on Greece, Ireland and Portugal. As discussions on the deal mature, it is clear that political power-play as much as economics will determine the conditions of the rescue. Can The Deal Plug The Gap? The theory behind the loan is simple the funds help banks to refinance their loans and issue more credit. Borrowers then profit with the funds, thereby stimulating the economy, and debtors are able to repay their loans - voila! Whether this theory pans out however remains an imponderable in fear and uncertainty, banks might sit on their money and economic conditions might be too frail to support growth. One thing however is for sure the loan will push up Spain's debt-to-GDP ratio. Thus far indicated, although the borrowing financial institutions will be responsible for repayment, the loan will be structured as an issue onto the books of the Spanish government. With a sluggish economy and high unemployment, Spain must tread lightly to balance its books, keep market confidence of the deal up, and borrowing costs down.


To alter the capital structure (in terms of debt and equity) of an entity.

Following Greece, Ireland and Portugal

Alter the maturity date of a loan to a later date. Source: EuroStat

A Closer Look at M&A Activity in the Mobile Commerce IndustryBy Samuel Chao Zhang Jie, Singapore Management UniversityIn recent years, the phenomenon of the smart phone and the ongoing entrenchment of 3G infrastructure have led to a flurry of M&A activity in the mobile commerce sector. According to a report by Coady Diemar, the transaction value of Digital Media & Commerce M&A deals in the US rose from US$ 59.3 billion in 2010 to US$ 116.3 billion in 2011, representing a breakneck 96% growth increase despite a global environment of risk aversion arising from Europes debt woes. Within the mobile commerce sector, deals related to mobile advertising have been in the headlines. This year, our very own SingTel confirmed a 100%-cash acquisition of a US mobile advertising firm, Amobee. The transaction amounts to US$321 million (SGD 401 million), representing an estimated 10.7x revenue multiple1 and is expected to complete by June 2012. What would compel a local mobile network operator to pay top-dollar for a 100-man firm with a US$600,000 unaudited net asset value that is likely still pre-profit? (Amobee CEO Trevor Healy declined to confirm if the company is profitable, the kind of statement that is often interpreted as an indication that a firm has yet to achieve profitability). A closer look at the drivers underscoring growth in the sector might yield a clue or two. Firstly, for business models revolving around the mobile internet, subscriber growth is clearly an important metric. If more people are going online via their phones and tablets, then the products and services that utilize the mobile internet as a platform will logically enjoy a larger demand base. A study by PricewaterhouseCoopers indicates that the mobile internet subscriber base is slated to grow from 155.8 million in 2011 to 277.7 million in 2013 (shown in figure 1 below), a CAGR2 of 33.5%,. Once a certain threshold is reached, commercial models that were previously unviable can shift to profitability on a sufficiently large base of consumers.


Mobile Internet Subscribers (millions)300 250 200 150 100 50 0 2011 2012 2013 Figure 1: Growth Trends in the Mobile Internet Sector Source: PricewaterhouseCoopers, Willofsky Gruen Associates 155.8 207.2 277.7

In addition to the number of consumers joining the market, a second metric to look at would be the amount of spending that advertisers are willing to allocate to mobile internet media as opposed to wired internet media. ABI Research estimates that this amount will grow from US$16.3 billion in 2011 to US$28.9 billion in 2014 (shown in figure 2 below), a CAGR of 21%. This compares favourably to a mere 6.7% for wired internet advertising between 2009 and 2013. If global agencies are joining the game and refocusing their budgets on the mobile space, then SingTels bid to add a mobile advertising firm to its stable of subsidiaries makes strategic sense.

Global Mobile Marketing and Advertising Spend (USD billions)35 30 25 20 15 10 5 0 2011 2012 2013 2014 Figure 2: Growth Trends in Global Mobile Advertising Source: ABI Research 16.3 21.2 25.3 28.9

Amobees business admittedly possesses compelling synergies with SingTels. With a mobile customer base that numbers approximately 434 million users spanning high-growth, populous Asian countries like India and Indonesia, it is not difficult to see why an advertiser would be keen to utilize SingTels network to engage in targeted rich-media mobile advertising to ride on the mobile internet/smart phone boom that will eventually top off in these developing countries. With Amobee, SingTel improves its capabilities in this respect. However, we are still left with the question of whether they have overpaid for their 8 Copyright 2012 SMU Economics Intelligence Club

acquisition. Moreover, Amobee is far from the leading player in the market. Logically, a firm will only pay a sizable premium for an investment if it is best-in-class, unless the firm is desperate. To understand how the Amobee acquisition stands, a quick comparison can be made. Thankfully, SingTel isnt alone in that strange universe of large companies that choose to pay exorbitantly for small tech firms. In 2009, Google acquired AdMob for US$750 million, a revenue multiple of 18.8 times. In 2010, Apple acquired Quattro Wireless for US$275 million, a revenue multiple of 13.1 times. Compared to these transactions, Amobees price tag does look a fair bit less lofty. However, it is important to note that Apples Quattro acquisition did not deliver for its iAd business, which faced weak demand in 2011, causing the company to slash the minimum amount that marketers must put up to start a campaign on its network from US$1 million to US$100,000 while also increasing app developers share of revenue to 70%. If SingTels expensive foray into mobile advertising follows a similar path, an important realization will dawn on us Apple and Google are companies with roots as small entrepreneurial start-ups and with a diverse mix of shareholders, while SingTel is, for the most part, a state-owned company built on the equity of Singaporean citizens who dont have much of a say in how its run. An important justification for the existence of state-owned enterprises is closely linked to capital market failure, in which private sector investors refuse to finance projects that only yield returns in the long run while carrying high near-term risks. The state steps in to remedy this market failure by taking on promising but risky projects which the private sector does not want to channel capital towards. Within such a context, it can be argued that SingTel is performing its function. Observers will also point out that Amobees acquisition price barely amounts to 1% of SingTels market capitalization3. The debate thus lies not in whether firms like SingTel should adopt risk-taking behaviour, but in how to draw the line between strategically necessary investments and an over-eagerness to deploy idle capital. After the acquisition announcement, the market reacted with relative indifference and SingTels stock price closed only 0.6% lower, assuming the drop in price can be attributed to the event in the first place. While there might be little cause for alarm now, the firm has been demonstrating a proclivity towards technological acquisitions, with its purchase of mobile application HungryGoWhere for US$9.4 million in May. SingTel has joined the ranks of large firms who have endorsed transactions at valuations that have been stirring talk of a second tech bubble. It remains to be seen which side of the line these recent investments will fall.1

A measure of the value of a stock that compares a company's enterprise value to its revenue. The year-on-year growth rate of an investment over a specified period of time.

2

3A

variable used to measure the size of a company and is determined by the total market value of a company's outstanding shares Sources: ABI Research, Architect Partners, Business Times, Coady Diemar, PEHub, PricewaterhouseCoopers, Wilofsky Gruen Associates 9 Copyright 2012 SMU Economics Intelligence Club

The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents Shane Ai Changxun (Vice President, Publication) [email protected] Singapore Management University Singapore Herman Cheong (Vice President, Operations) [email protected] Singapore Management University Singapore Fariha Imran (Marketing Director) [email protected] Singapore Management University Singapore Randy Lai (Editor) [email protected] Singapore Management University Singapore Vera Soh [email protected] Singapore Management University Singapore Samuel Chao Zhang Jie [email protected] Singapore Management University Singapore Ben Lim (Vice President, Publication) [email protected] Singapore Management University Singapore Tan Jia Ming (Publications Director) [email protected] Singapore Management University Singapore Vera Soh (Liaison Officer) [email protected] Singapore Management University Singapore Seumas Yeo (Editor) [email protected] Singapore Management University Singapore Tommy tan [email protected] University College London The United Kingdom

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