Small Moment: Weaker CNY

This will never work (Vol 1, No 32)
Screen Shot 2018-06-20 at 3.14.48 PM
The Renminbi is falling again

Everyone is talking about the trade war and everyone is talking about the strength of the USD. What hasn’t received nearly as much play is the decline of the Reminbi.

As the DXY has strengthened from its mid-February low of 88.59 to 95.21 (up 7.5%), not only have the JPY and EUR weakened, so has the Rmb.

The Rmb was strongest on April 11, 2018 when it was trading at 6.26759 to one USD. Since then, it has weakened by 3.4% to 6.49086.

Airlines and Developers are Supposed to be Hurt by Strong USD

Conventional thinking has it that when the USD strengthens, Chinese airlines and Chinese developers get hurt. It basically comes down to a currency mismatch between their assets and liabilities (Chinese developers) and revenues and expenses (for Chinese airlines).

Let’s look at a HK$347bn market cap example

In order to put more flesh to why Chinese developers are hurt by a strong USD, let’s take a look at the 13th largest company on the Hang Seng Index. Country Garden has a market capitalisation of HK$347bn (or US$44.2bn). It is the second largest developer on the Hang Seng Index, just a shade behind SHKP’s HK$354bn market cap.

Over the past five years, as Country Garden’s revenues have grown, so has its balance sheet. Net debt has grown from Rmb20bn in 2012 to Rmb66bn. Considering its current market cap of HK$347bn, this level of net debt does not seem that large.

Rmb215bn gross debt and Rmb148bn of cash

However, if one were to split its net debt figure into the cash and gross debt component, we see that Country Garden’s gross debt has increased from Rmb36bn in 2012 to Rmb215bn in 2017. Meanwhile, as of December 31, it also carried cash balance of Rmb148bn. I guess when you have trade payables of Rmb331bn, you need a big float.

Country Garden - Cash, Gross Debt and Net Debt Position

Net USD liabilities of Rmb50.0bn

For many Chinese developers, offshore USD bonds have been a key source of financing. Since 2012, Country Garden’s USD net liabilities have increased from Rmb14.9bn to Rmb50.0bn. In the context of a company that generated contract sales of Rmb550.8bn in 2017, Rmb50.0bn of USD-denominated liabilities may not seem much but numerically speaking, the 3.4% drop in the USDCNY has now increased this liability by Rmb1.7bn.

If one were to compare Country Garden’s USD exposure to its shareholders’ funds, this has gone from an average of 44% between 2012-2015 to 50% over the past two years.

Net USD liabilities exposure (Rmb 000s)

Substance over form – Interest costs are going up

Due to an accounting quirk that allows Chinese developers to capitalise interest from borrowings, the combination of Rmb215bn of gross debt and Rmb148bn of cash results in net finance income of Rmb3,276mn (made up of Rmb146.6mn finance costs and Rmb3,422.7mn finance income).

But as they say in accounting circles, let’s focus on substance over form. You can call it capitalised interest or cost of goods sold but what matters is cash flows. If one were to look at actual interest paid, this has increased from Rmb3bn in 2012 to Rmb10.8bn in 2017.

Again, for a company that generated Rmb550.8bn in contract sales, the bulls would argue that this is just chump change.

But bear in mind that interest rates have fallen significantly over the past five years. Dividing interest paid by average gross borrowings, Country Garden’s cash interest costs had fallen from 8.2% in 2013 to 5.4% in 2016.

Interest paid and cash interest costs

But you see that little uptick to the right? In 2017, Country Garden’s cash interest costs have already started to rise, moving to 6.16%.

Unless one is prepared to pay down debt with surplus cash (and again this is a company with Rmb550.8bn of contract sales), the combination of the US Fed hiking rates as well as widening yield spread means interest burden is likely to rise.

The timing of when interest rates reset may vary but against a gross debt position of Rmb214.7bn, a 1% rise in effective interest costs works out to Rmb2.1bn.

A rising tide better lift all boats

The good news is that unlike 2012 to 2015, the company is finally able to generate positive cash flow from operations.

Cash generated from operations

For the Chinese airlines, the combination of a rise in oil prices and a strong USD, their share prices have fallen by 30% off their 52 week lows.

Screen Shot 2018-06-21 at 12.20.31 PM
Air China share price performance

But for the Chinese developers, they have been more resilient (only down 18%). Perhaps the market is anticipating that the ever rising tide of contract sales will see another wave of monetary easing.

Screen Shot 2018-06-21 at 12.18.14 PM
Country Garden share price performance

As a final contrast, let’s consider the price-to-book ratio of the two biggest property companies on the Hang Seng Index. SHKP is at 0.7x. Country Garden is at 3.0x.

This will never work

Advertisements

Mass Consumption 14 – Take Your Meds

This will never work (Vol 1, No 28)

It’s been a while since we looked into the Mass Consumption theme. This time around, we’re looking at Healthcare.

thought-catalog-612432-unsplash
Photo by Thought Catalog on Unsplash

According to the National Bureau of Statistics, although healthcare is only the sixth biggest per capita spending category, it is the fastest growing. It currently make up around 7.3% of per capita spending but grew at 15.8%.

Screen Shot 2018-06-11 at 2.39.51 PM

While’s China’s 7.3% per capita spending may appear low, it’s not. In the US, healthcare expenditure make up around 8% of annual household expenditure. The big difference is in the nominal amount of spending (US$4,612 per family Vs Rmb352 per capita).

Healthcare Index Representation – 13.9% Vs. 1.2%

Where there is a really big discrepancy between the US and China is index representation. In the US, the healthcare sector carries a 13.9% weighting but in Hong Kong, that’s only 1.2%.

chart(A)

Intuitively, the call should be straight forward, healthcare representation in the HSI should rise. But’s it’s not that easy. Remember my Investing Junkfood posts about trying to avoid investing on (i) 52 week highs and (ii) high valuation multiples?

+123% off the 52 week low and 49x PE

The three largest healthcare stocks in Hong Kong are CSPC Pharma (US$19b market cap), Sino Biopharmaceutical (US$14bn) and Sino Pharm Holdings (US$13bn). Compared to the US giants like JNJ (US$332bn), Pfizer (US$214bn) and Amgen (US$122bn), the China pharma stocks are minnows.

Chart(B)

What gives me pause is the current valuation and recent performance. CSPC and Sino Biopharm are both trading at 49x PE (JNJ and Pfizer at 20-23x) and are up 193% and 123% off their 52 week lows.

Gulp!

By comparison, Sinopharm appears a bit more palatable. It’s only up 17% off its 52 week low and its US$15bn market cap only implies 15x earnings.

But hang on, it’s not that simple.

Distributor vs. Manufacturer

While they all have the word “Pharm” in their names, Sinopharm’s business is actually very different from CSPC and Sino Biopharm. It’s a drug distributor and not a drug manufacturer.

This difference becomes very stark when you look at their gross and operating margins. In 2017, CSPC and Sino Biopharm enjoyed gross margin of 60% and 80% and operating margins of 23% and 26%. As a distributor, Sinopharm only earned gross margin of 8.3% and operating margin of 4.4%.

chart(C)

China vs. US Pharma companies – Two key differences

When I was previously looking into some of the US biotech companies, I was struck by their low PEs and high dividend yields. For the likes of Gilead, Amgen and AbbVie, uncertainty about their drug pipeline had turned them into value plays.

Across the pond, with PEs near 50x, growth expectations are very high for CSPC and Sino Biopharm. But how are they similar and where are they different?

Comparable gross margins

Looking across Gilead, Amgen, Celgene and AbbVie, their gross margins range from 75% to 96%. The average gross margin of 84% is not dissimilar to Sino Biopharm’s 80%. For CSPC, given their generic and vitamins business, it has a lower gross margin at 60%.

Much lower R&D expenses in China

One key difference is in the research and development spending. For the four US companies, R&D expenses were around 23% of their revenues (range of 14.3% for Gilead to 43% for Celgene).

chart(f).png

For Sino Biopharm, R&D was 10.8% and for CSPC R&D spending was only 5.3% of revenues.

chart (d)

This difference becomes much bigger when you consider it in nominal terms. In 2017, Sino Biopharm spent US$249mn in research and development and  CSPC spent US$127mn. In the US, Celgene spent US$5.9bn, AbbVie US$5.3bn, Amgen US$3.6bn and Gilead US$3.7bn.

M&A has not been a big driver for the Chinese

Another key difference is M&A. For the more mature US companies, one source of innovative drugs is acquisitions.

Among the four US biopharm companies, goodwill and intangibles are often the biggest assets on their balance sheets. These range from around 30% for Gilead and Amgen to 61% for AbbVie.chart(g)

But for the Chinese pharma companies, perhaps due to the relative infancy, goodwill and intangibles were only 1-4% of their total assets.

chart(h)

Hepatitis Meds – One man’s poison is another man’s medicine

As a final point of contrast, take a look at their best sellers list.

In China, meds to treat hepatitis account for 44.2% of Sino Biopharm’s revenues. In 2017, this rose by 11% YoY.

Screen Shot 2018-06-11 at 4.39.01 PM
Sino Biopharm – Revenue by therapeutic categories

In the US, HCV anti-viral meds account for 36% of Gilead’s revenues. This fell 38% YoY in 2017.

This only goes to highlight that often times, one man’s poison is another man’s medicine.

So what would you go for, value or momentum?

Choose your poison carefully.

This will never work

Value Traps 2? A broken clock

This will never work (Vol 1, No 25)
andrew-seaman-611487-unsplash
Photo by Andrew Seaman on Unsplash

We’ve been talking about potential value traps for a few days now.

Truth be told, I’m struggling with this one. When you see this post, I’ve already re-written this three times. Not sure if it is a good sign when I keep going back and forth on an idea.

Let’s get on with it. The company in question is Shun Tak. Shun Tak is a property-transportation-gaming conglomerate in Hong Kong. It runs the ferry service between Hong Kong and Macau and also owns an indirect 6% stake in SJM, one of the casino operators in Macau.

So why this one is so hard.

There’s no “Wow” factor…

For anyone that has lived in an apartment managed by Shun Tak or taken their ferries, you know that their service is only so-so. There’s no “Wow” factor. It’s okay but you won’t confuse it with a Four Seasons or Ritz Carlton. Shun Tak is more like Warren Buffett’s cigar butt idea where you hope the valuation is so cheap that there is just one or two last puffs left.

So, why do we want to look at this?

…and it’s always been cheap…

First and foremost, Shun Tak is among the cheapest company in the mid-cap space. On a price-to-book basis, even counting its recent rally, it is only trading at 0.40x PB. Further, since its 6% stake in SJM is not marked-to-market, its book value is actually understated. If one were to strip out the MV of Shun Tak’s 6% stake in SJM from both its MV and BV, the remaining property-hotel-transport stub only trades around 0.25x PB.

chart (99)

This might look very attractive BUT (there is always a but) the problem is that it has always looked cheap. Going back six years, the only time that Shun Tak’s non-gaming stub had traded in excess of 0.3x was at the end of 2012.

Taking a different look at this parent-child relationship, we can see that Shun Tak’s stake in SJM had accounted for around 26% of its own market cap since 2015. The current ratio of 34% is actually slightly elevated and reflects recent hopes that SJM’s operations is finally turning the corner.

chart (96)

But if you look at the blue bars above, we can see that the market value attributed to Shun Tak’s property-transport stake has increased in recent years.

Is this valid?

Transport and hotels are very steady…

The ferry and hotel businesses are very steady. In fact, over the past six years, these two businesses have consistently contributed around HK$3.3bn of revenues.

chart (97)

Operating profit-wise, they are both pretty low margin and the hotel side even made a loss in 2016. That said, they still churn out around HK$300-350mn a year in segmental profits. If one were to include some HK$405mn in gross rental income, Shun Tak’s recurrent income provides decent cover for its dividend (2017 at HK$365mn).

chart (98)

Considering that Shun Tak’s balance sheet is fairly lowly geared (end 2017 at only 8%), it is all the more surprising that Shun Tak has had such an inconsistent dividend stream.

chart (100)

Inconsistent dividend stream

In the last six years, Shun Tak has suspended its dividends two times (2013 and 2016). It has cut dividends three times (2013, 2015 and 2016) and also declared a special dividend once.

chart

Had Shun Tak’s dividend been more stable, one would at least be able to argue that investors are paid a 3.2% dividend to be patient. With Shun Tak’s dividend history, this is far from certain.

The elephant in the room – Property

But what we really haven’t begun to talk about is the elephant in the room – Property. By segmental assets, property is the biggest category by far at HK$33bn. The next two largest asset contributors are transport at HK$4.8bn and hospitality at HK$3.8bn.

Yes, I know that transport and hospitality are both depreciating assets whereas property is revalued annually hence it may not be an apples-for-apples comparison. Be that as it may, what is also clear is that over the past six years, property has also been the main source of new investments.

chart (1)

And this is where things get hard again.

If one were to look at Shun Tak’s main property exposure, we note several new property projects are in gateway cities like Singapore, Shanghai (Qiantan) and Beijing. Even in non-Tier One cities, the projects are in Macau and Henquin Zhuhai which plays well on the Greater Bay theme.

So geographically, there is little not to like.

But (and there is always a BUT), what makes these hard is that the projects are primarily mixed-used commercial developments. Unlike residential projects, the payback period for retail, office, serviced apartments and hotels are much longer.

And for deep value plays, monetisation is the key to shrinking their holding company discounts.

The trouble is, we have no idea when this might happen and we are also getting pretty late in the property cycle.

But then again, we can always take the comfort that even a broken clock is right twice a day and this clock has been off for quite a long time already.

sascha-israel-664450-unsplash
Photo by Sascha Israel on Unsplash

Time to put the chips down. Yes, those ones too.

This will never work.

Value Traps? What do they look like among large, mid and small caps

This will never work (Vol 1, No 22)

venus-flytrap-595235_1280

A few posts ago, I told you that intuitively I am more attracted to value than momentum. Show me a stock that has dropped 90% and I start to bring out the shovel in hopes of finding some value.

The problem is that sometimes the more you dig, the more you find that you’re just in a bigger and deeper hole. Rather than a value proposition, you are now in a value trap.

Want to know something? Nature is very smart.

As I was looking for the above picture of the Venus Flytrap, I read the following:

When an insect or spider crawling along the leaves contacts a hair, the trap prepares to close, snapping shut only if another contact occurs within approximately twenty seconds of the first strike… The requirement of redundant triggering in this mechanism serves as a safeguard against wasting energy by trapping objects with no nutritional value, and the plant will only begin digestion after five more stimuli to ensure it has caught a live bug worthy of consumption.

Source: Wikipedia

Wow, a redundant trigger to safeguard against wasting energy.

So, with that in mind, let’s survey the value landscape before we start digging.

Value among Big, Medium and Small Caps

We start by looking at the Hang Seng Composite Index.

Note, we are not talking about the more famous Hang Seng Index, which is only made up of 50 constituent stocks. Instead, we are talking about the broader Composite Index with 483 constituent companies. By market cap, the Hang Seng Composite Index is supposed to cover the top 95% of stock market cap.

 

chart (91)

The index provider has helpfully subdivided these 483 stocks into Large, Mid and Small Cap categories with 105, 192 and 186 stocks respectively.

P/B ratios for the bottom dwellers from 0.39x to 0.14x

As a valuation metric, my preferred starting point is the price-to-book ratio.

Price-to-earnings is useful but since earnings could be influenced by one-off gains/losses, this could overstate/understate the valuation proposition. Dividend yields are useful as well but similarly if a company has just declared a one-off special dividend, this could again distort the valuation appeal.

The beauty of the price-to-book ratio is that book value tends to be less volatile. Yes, you could have property revaluation gains/losses affecting book value but the impact would still be much smaller than against earnings.

 

chart (92)

So what can we note? For the bottom dwellers, we see that the price-to-book ratios becomes progressively smaller. Among the 105 large cap stocks, the lowest PB ratio was 0.39x. In the mid-cap space, the lowest PB was 0.25x. And among the 186 small cap stocks, the lowest PB was 0.14x.

Incidentally, if one were to express the PB of the three categories, we see the PB for the lowest mid cap is 36% lower than that of the cheapest big cap. And for the lowest small cap, its PB is 44% lower than the cheapest mid caps.

I guess this only goes to show that what is cheap can always become cheaper.

Dividend yield as the Redundant Trigger

Another point of interest is the difference in dividend yields. For the cheapest large cap stock, it’s 0.39x is accompanied by a 3.3% dividend yield. Not super generous but you would at least get paid something while you wait.

But interestingly, the ability to pay diminishes as overall value drops. In the mid-cap space, the cheapest stock with the 0.25x PB only pays a dividend yield of 2.8%. And in the small cap category, the 0.14x PB stock does not pay a dividend at all.

chart (93)

Although the above only covers three stocks, it does suggest that going too far down the value curve could be risky. Just like with the venus flytrap, a secondary cross-check with dividend yield could be a useful redundant trigger.

Second part of the problem – Time

There is actually two parts to the value trap. We covered the cheap can get even cheaper part already.

The second problem is time. Cheap can stay cheap for a long time. In this case, what you would wind up losing is opportunity costs.

chart (95)

Normally, if there are better companies around with reasonable valuation, one could argue you shouldn’t mess around. But sometimes, it’s hard to resist the allure of digging around in the muck.

annie-spratt-448368-unsplash

After all, isn’t that how they find truffles?

This will never work…

P2P Lenders – Unicorn or Rainbow Dashed?

This will never work (Vol 1, No 21)
4571070876_1727ab8d59_z
Source: Corsiworld via Flickr

“After a remarkable four-year journey of careful deliberation, HKEX’s new listing regime is finally open for business.  We are now at the dawn of an exciting new era for Hong Kong’s capital markets,” said HKEX Chief Executive Charles Li.

What Chief Executive of HKEX was referring to was the introduction of weighted voting rights structure, the listing of biotech companies that don’t meet the Main Board’s financial eligibility tests and new concessionary secondary listing routes for Greater China and international companies.

As Kevin Costner heard in Field of Dreams, “If you build it, they will come”.

Unicorns…

Sure enough, there’s lots of excitement that a bunch of high-tech unicorns are now stampeding to list in Hong Kong.

Among these mythical creatures is the Peer-to-Peer Lenders. On the surface, there is a certain logic to it. Make use of the internet to connect the providers and users of capital. Sounds exciting, right?

or Rainbow Dashed?

The funny thing is that the US leader in P2P lending has struggled mightily since the sixth day of its listing.

The P2P theme was really hot back in 2014. In December 2014, Lending Club raised nearly US$900mn and on the first day of listing, it surged 56%. It rose for another five days and hit an intra-day high of US$29.29 on December 18, 2014. The current share price of US$3.37 is down 89% of all time high and puts its market captialisation at US$1.41bn. Still a unicorn, I guess.

Screen Shot 2018-05-29 at 11.04.30 AM

How do P2P Lenders make money?

As and when the Chinese P2P lenders come to market, they will certainly make a case that “it’s different in China, we’ve got 1.3bn borrowers and 1.3bn lenders”.

Maybe so, but let’s have a look at the “control group” first. Later, we can see if the China variable can materially improve the economics of the P2P-lending business model.

In 2017, Lending Club’s net revenues was US$575mn, up 15% y/y. Of this, three-quarters came from transaction fees and 14% came from investor fees.

chart (87)

But what are transaction fees?

“Transaction fees are fees paid by issuing banks or education and patient service providers to [the P2P platform] for the work [they] perform through [their] lending marketplace’s role in facilitating the origination of loans by [their] issuing bank partners”.

Ok, quite a mouthful but it seems to be a fee for passing loan demand to issuing banks. Expressed as a percentage of loans originated, the transaction fee seems to be around 5%.

chart (89)

 

But hang on, one of the other key metrics that Lending Club monitors is Customer Acquisition Costs as percent of loan origination. This is basically its sales and marketing expense. If one were to net off these two, then the net transaction fee earned has been hovering around 2.4% over the past three years.

So P2P lenders earn money by generating loans and then passing them over to the banks and taking roughly a 2.4% cut.

What are Investor fee?

But there is also an investor fee too. These seem to be service fees earned from investors who provide their capital to fund some of the loans. If expressed against the US$11.9bn of loans serviced on Lending Club’s platform, the investor fee works out to around 0.73%.

Okay, my head is starting to hurt but I think I still got this.

P2P lenders earn a fee based on the amount of loans originated and also from the amount of loans that it helps to service. So it seems that as long as the amount flowing through the pipes is increasing, the business should thrive, right?

Well, yes and no.

Over the past five years, the transaction and investor fee revenues (we are ignoring fair value changes and other one-off gains/losses) has grown more than five fold.

chart (90)

The trouble is that the higher volumes have not resulted in higher operating margins. For 2016 and 2017, even ignoring one-off expenses like goodwill impairment and litigation costs, operating income margins (after general and admin expenses and engineering and product development) were still -23% and -13%.

Let’s see how “We-” can tweak this equation

Maybe I’m missing something but can someone explain why investors are holding their breaths for the listing of Chinese P2P lenders.

If we use the US P2P leader as a control subject, to make the Chinese equation work, you will need the following:

  • Loan origination in excess of US$9.0bn a year
  • Loan servicing in excess of US$11.9bn a year
  • Net transaction fee on loan origination in excess of 2.4% a year
  • Investor fee in excess of 0.73%; and/or
  • Overheads (i.e. SGA and product development) that is less than 58% of revenues.

Or failing that, just make sure you include “We-” in your name, then none of the financials matter.

Screen Shot 2018-05-24 at 3.00.26 PM
Source: sushi-abc.com

The Kinki is very fresh indeed.

Pavlov’s dog: Compensation and motivation

This will never work (Vol 1, No. 10)
matthew-henry-20172-unsplash
Photo by Matthew Henry on Unsplash

What gets measured gets done

China property is a funny business.

The industry is pretty young. It really just came into being 20 years ago.

Early 2000s – Chasing landbank size

In the early 2000s when the first waves of Chinese developers were listed, the metric that drove share prices was “Landbank size”.

So, what did these guys do? They accumulated landbank. It didn’t matter that the site was located eight hours away from the nearest town and was devoid of infrastructure. Investors wanted gross floor area (GFA), so the companies bought giant parcels of land that would take 20+ years to develop.

One day, someone woke up and said, “Hang on a minute, your landbank is not productive, we want to see sales.”

Early 2010s – Chasing contract sales

So, the Chinese developers started to target “Contract Sales”. It didn’t matter that higher sales were coming at the expense of lower margins and rising unsold inventory. If investors wanted to see ever rising monthly contract sales, then who cares if cash flows were actually negative and debt levels were ballooning.

Can this be sustained? Probably not but don’t ask anyone who has tried to short the China property sector. That strategy has been painful SO FAR.

How is management compensated?

What I don’t quite understand is why are the China property companies so fixated on these share price drivers? All companies want to see their share prices rise but how come the Hong Kong property companies are not playing the same game?

There is this risk-reward thing but my suspicion is that management compensation plays a big role.

“You pay peanuts, you get monkeys”

animal-peanuts-pet-34109

If you’re compensated well (or fairly) for your efforts, then you probably don’t need to have a side business. But when staff cannot make ends meet, that’s the time that they have to look elsewhere to boost their income.

Hong Kong Property execs used to get paid 43% more

Companies listed in Hong Kong are required to disclose the compensation for their five highest paid employees. Usually, this would include their executive directors but not all the time.

When we surveyed the Top 7 Hong Kong and China property companies, we found that back in 2012, the average pay for the a top five Hong Kong property company executive was HK$18.7mn (roughly US$2.4mn).

chart (70)

By comparison, their China peers were paid peanuts. Even including one “outlier” who got paid a boatload, the average pay for a China property executive was only HK$13.1mn.

On average, the pay for Hong Kong property executives was 43% higher than China property executives.

Pay gap has now disappeared

The good news, at least for the execs, is that everyone has gotten a raise over the past five years. The average pay for a HK property executive has risen 33% to HK$24.9mn while the China property executive has seen his pay rise 172% to HK$35.6mn.

Even excluding a huge outlier who got paid HK$343.7mn (10x the average), we can see that the average pay for a HK and China executive has now closed. In fact, the average pay for a China property executive is now 1.2% higher than their HK cousin.

chart (71)

Pay attention to the outliers

Those are the averages but what is just as interesting is the dispersion of pay levels.

  • Among the HK property company executives, the highest and lowest pay were HK$92.1mn and HK$5.3mn. Relative to the average of HK$24.9mn, this is 3.7x and 0.21x.
  • For the China property executives, the highest and lowest pay were HK$343.7mn and HK$6.5mn. Even counting this against the simple average of HK$35.6mn, the dispersion is 9.65x and 0.18x.

chart (73)

Are they properly incentivised? Salary vs. bonus

This gets even more interesting as we go deeper down the rabbit hole.

Looking at the pay structures, it is almost a mirror image between Hong Kong and China.

For the highest earner, fixed pay only made up 9% of the top Hong Kong property executive’s pay (i.e. bonus was 91%). Conversely, for the top China property executive, his fixed pay was 94% (i.e. bonus was only 6%).

At the other end of the spectrum, for the lowest paid property executive, fixed pay was 81% for the Hong Kong guy (i.e. bonus was 19%) and only 24% for the one that worked for the China property company.

chart (75)

I don’t know but this type of dichotomy suggest that one is right and the other is wrong. At the top end, if your top exec is getting paid hundreds of millions of dollar regardless of performance, this seems wrong. Conversely, at the bottom end of the curve, if your worst-paid exec is making 76% of his income via bonus, isn’t it time to adjust his base up?

Just asking.

But until this strange incentive system is fixed, I know whose interest I want to be aligned with, at least in the short term.

In the long term, this will never work.

Rage against the machine – LinkedIn

This will never work (Vol 1, No. 9)

achievement-adult-agreement-327540

It’s Monday and I’ve got a beef.

I hate getting emails from LinkedIn. They’re either about strangers checking out my profile or strangers wanting to join my network and I always feel like cattle.

I’ve got this theory. I think that the only times that people update their LinkedIn profile is when they are looking for a job.

When you’re happily engaged in your job, who has time to think about your LinkedIn profile. For more than a few times, very soon after someone’s LinkedIn profile has been updated, they have either become unemployed or changed jobs.

Don’t update your LinkedIn Profile

This got me thinking, if the main purpose of LinkedIn is to help someone change jobs, then one of the key tasks for Human Resources departments around the world must be to monitor their staff’s LinkedIn profile to see who are the flight risks.

I wanted to understand LinkedIn business model a bit more. Unfortunately, since LinkedIn was bought by Microsoft in 2016, I could only find information up to 2015.

But even then, it was interesting how different its business model was compared to other social media platforms like Facebook and Google.

Advertising was only 19% of LinkedIn Revenues in 2015

chart (69)

As we previously discussed in Quid pro quo or US$4 a month, Facebook and Google derive nearly all of their revenues from advertising (98% and 86% in 2017 to be exact). But for LinkedIn, in 2015, marketing solutions (i.e. advertising) only made up 19.4% of its overall revenues.

You are the Product – 62.8% of Revenues Comes from Recruiters

chart (67)

The biggest contributor to LinkedIn’s revenues in 2015 was Talent Solutions at 62.8%. This is defined as revenues from its Hiring and Learnings & Development Products. For “Hiring”, this is in turn consisted of “LinkedIn Recruiter, Job Slots, Career Pages, Job Postings, Job Seeker subscriptions and Recruiter Lite subscriptions.”

The description, then goes on to say “The Company provides access to its professional database of both active and passive job candidates with LinkedIn Recruiter, which allows corporate recruiting teams to identify candidates based on industry, job function, geography, experience/education , and other specifications.”

Sorry for including such a long winded description but this sounds a lot like the members are the products.

But you know this already, monthly active members are only 24%

While the public is only starting to grasp social media’s privacy issues, LinkedIn members seems to have realised this relationship a long time ago.

Back in 2015, LinkedIn reported 414mn members.

By comparison, in 4Q 2015, Facebook had 1,591mn monthly active users (“MAU”, this has now grown to 2,129mn as of 4Q 2017) and 1,038mn Daily Active Users (“DAU”, 1,401mn in 4Q 2017). For Facebook, 66% of its users are active on a daily basis.

chart (68)

LinkedIn’s user metric is a bit different. In addition to the total number of members (which numbered 414mn in 2015), it also reports the number of unique visiting members. This is defined as the total number of members who have visited at least once during a month. In other words, this is the MAU.

In 4Q 2015, LinkedIn had 98mn MAU. Expressed as a percentage of its total members, LinkedIn’s MAU was only 23.8% in 2015. Further, this ratio had fallen from 26.4% in 2013 to 25.2% in 2014 and then to 23.8% in 2015.

Good news and bad news…

The good news for LinkedIn is that while member engagement is low, recruiters and corporate HR continue to pony up. In the four trailing quarters up to March 2018, LinkedIn’s revenues under Microsoft was US$4,862mn (2015 was US$2,991mn). The bad news is that operating margins remains low at 6.9% (excluding amortisation of intangibles). If one were to include amortisation for intangibles, its operating margin would fall to -23%.

Now imagine if LinkedIn did not send you so many email about “Contacts you may know” and “Congratulate John Doe on their Work Anniversary”, what that level of user engagement will be.

Time to update the profile to “This will never work.”