First Dose Of Moral Hazard Delivered

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With an aid package finally being confirmed for Greece, the first dose of moral hazard has been confirmed and the Greek government can look forward to some breathing room now that they don’t have to rely entirely on the market to roll-over the short-term debt that’s coming due. It is still looking to continue with its roadshow in the US in an attempt to get investors for its US$ bond issue, however several Greek officials have already downplayed how much they are hoping to raise. Initial estimates indicated that the Greek government hoped to raise up to $10 billion but now that PIMCO has expressed their disinterest, many other investors are likely to follow their lead and sit out this auction. In response, the Greek officials indicated that they’ll probably only be able to raise $1-4 billion from the issue or they might even scrap the entire issue all together. If the issuers themselves have so little confidence in their own bonds, it’s hard to expect the markets to do any better.

The loan package proposed by the EU will only be given to Greece once it “asks for it”, which is really more a question of when and not if. Greek officials probably felt comfortable coming out in the open with their expectations of the US$ bond issue only because they knew they have a fall-back option in the form of the aid package. The package includes $40 billion in loans that are slated for the first year with the possibility of more loans in the years after that. The loans will be issued at slightly below market rates but will not be very highly subsidised because the EU itself needs to avoid breaking its own rule which states that none of the member countries can be “bailed out” in times of stress. Of course, Greece is indeed being bailed out but only because the definition of “bailout” is malleable enough to allow the passage of this loan package.

The intention of the “no bailout” rule was definitely in line with the notion of free markets and the risk-takers having to bear the consequences of their actions. But clearly when you’re IN the heat of the situation, no one wants to be responsible for the consequences of a failed state that results from a fiscal collapse – thoughts of moral hazard and setting a precedent for future bailouts become a secondary concern. And we saw the consequence of inviting such moral hazard almost immediately after the loan package was announced, as a Greek official said that Greece will likely need loans amounting closer to $80 billion to help it ride out the storm. No one should be surprised. The first bailout is hardly ever the last – what did we see with AIG? Or GM? Or Fannie and Freddie Mac? All of them have had repeated bailouts as the need for money grows exponentially once someone is willing to open up the tap.

With the Greek government providing lofty assurances of deficit reduction and debt controls to the EU and IMF, while its own citizens are completely against the notion of any reform that will reduce their welfare, its quite likely Greece is set for a rough and slow climb out of the hole it has dug for itself. And I have little doubt that this first package is only the beginning. Aside from Greece, you also have Portugal and Spain next in line – why should they be denied of handouts if the money is being doled out to other EU members. All they’ll need to do is duplicate – make strong, even if empty, assurances of future improvements in their fiscal situation, guarantees of debt reduction and of course claims of strong economic growth just beneath the surface.

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Google Boasts its Backbone

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I heard about this in a few podcasts recently and knew it was bound to happen sooner or later – Google finally acted in alignment with its typical image (a fearless, untamed titan) and resisted China’s attempts to continue censoring its search results.

Part of Google’s initial entry into the Chinese market was conditional on censorship of certain internet material under the Chinese government’s instructions. However, with recent considerable hacker attacks from China on various websites to stop censorship, largely on Google, the titan ultimately blamed the Chinese authorities for censorship in the first place.

The Chinese authorities obviously like to keep a tight hold of the content its citizens are exposed to. Smells a little like propaganda activity to most people. The Chinese authorities promote the internet for education and business, but keep a tight grip against obvious material such as porn, but interestingly also human rights and pro-democracy material that can expose its citizens to politically sensitive information… and maybe open them to new thoughts. More importantly, Google was on the righteous side of the battle and supported many human rights activists in China whose G-Mail accounts were part of the hackings.

Speaking of propaganda, interestingly, several Chinese newspapers actually counter-accused Google of having its own political agenda and claimed that foreign firms operating in China must abide Chinese law. It’s true – it’s never really clear what Google is up to. It dabbles around in almost every field in business, as this interesting video shows.

But, as far as this story goes, Google boasted the right part of its backbone. Censorship is as outdated as Marxism. The Chinese government will be able to contain the force of the country for only so long, and eventually (although possibly long), like every country, its boarders will open to the rest of the world. I’m not the only one that feels this way. Much support has been heard from the human rights activists whose accounts were hacked, and after Google announced its plea to fight censorship, some Chinese populace placed flowers outside their office in Beijing. Sounds like a plea for freedom to me.

It’s been said Google’s potential revenue in China is $500-600M, or about 2% – 2.5% of its 2009 revenue. In terms of monetary losses, it will be a small step if Google fully backs out of China, but it could turn out to be a big step for the mankind of China and their freedom.

Two Big Issues – RIM’s Future Hangs in the Balance

With the number of opinions being expressed on major companies like Research in Motion and Apple, it can get awfully overwhelming to try and understand from a high level what the situation is. This has especially been the case with RIM in the last few days when they released so called “mixed results” – which basically means that they disappointed the street, but not really.

It’s fairly easy to identify the things people agree on – RIM has a solid balance sheet, no debt, $2.9 billion in cash, strong growth in revenues (up 18% yoy, though still not enough for Wall Street), shrinking gross margins (now at 45.7%) and reductions in average selling prices (currently $311/unit). A brief look at any analyst report will give you that information. However, there is less certainty on other more contentious issues – as I see it, there are two big issues in the balance, and the one that comes to dominate in the next few years will determine where RIM goes from here.

Issue (Negative): Competitive pressure in retail consumer space

80% of RIM’s revenues still come from new device shipments, meaning that it still very dependent on new sales growth, as opposed to revenues from post-sale services, which make up only 16% of revenues. It’s this sales growth that many analysts feel will be compromised by the additional competitive pressures that BlackBerrys are facing in the retail marketplace from Apple’s iPhones and other Samsung and Motorola smartphones that operate on Google’s Android platform. RIM’s competitors are deemed to be better at providing a better user experience as the focus shifts away from smartphones providing just email access (where BlackBerry dominates) to a more complete experience including applications, browsing and connectivity (where BlackBerry loses out). As an analyst from Sandford Bernstein put it – RIM can expect “margin pressure as BlackBerry gets more and more into a mass-market role with vanishing product differentiation and eroding brand premium.”

So in the mass-market RIM’s products are expected to lose market share to its new rivals especially as the focus of the user experience shifts.

Issue (Positive): The enterprise market and love from carriers

It is well-established that RIM is a market leader in the enterprise space thanks to its superior security capabilities that are necessary in an environment which is less cost sensitive but also more functionally demanding. The enterprise market loves the BlackBerry for its superior email handling capabilities which are more important to that space than other “toppings” like applications and browsing. While the security features of other smartphones are likely improving, the BlackBerry still holds its own there. Its leadership in the enterprise space is the trump card that RIM holds and is using to enter new emerging markets. RIM is currently dependent on the North American market but the real growth lies elsewhere as smartphone penetration levels start to taper off in North America. With ongoing expansion efforts in China and Indonesia, you could start to see new engines of growth for RIM and this might have been reflected in the company’s higher than expected guidance for subsequent quarters.

Another area that is frequently overlooked is the relationship that RIM has with its carriers. RIM provides a lot more value to carriers than just being a handset provider. This point was well made in a feature in the Canadian Business magazine. RIM actually operates data-processing centres which look at all the information sent via BlackBerrys, in the process removing potential threats and providing a level of security that is hard to match. At the same time, the system also helps carriers manage its traffic and uses compression technologies which allow more information to be carried over the same network from the carrier – the importance of this value-add cannot be underestimated when usage is becoming increasingly data intensive and clogging most networks. One more plus point that ties carriers to RIM is the carrier’s need to differentiate its product offerings from other competitors. It’s hard for them to do that with the Apple’s iPhone which is the same across all providers since there is only one model. But with the BlackBerry, RIM actually provides each carrier with something unique through its different models and hence caters to their needs. With the carriers doing a lot of the marketing for the handsets, this relationship counts for a lot.

Watching how the cookie crumbles

Ultimately, RIM’s prospects depend on which of these issues end up being more important down the road. The big question is whether RIM’s dominance in the enterprise market, combined with its strong carrier relationships and emerging market growth is enough to outweigh or offset the market share it might lose in the North American retail space to competitive pressures from other smartphone providers.