Flatulence and the inflated market

New York City—The Dow (Dow Jones Industrial Average) continues to fall. But it is far from that critical 14,000 level where it starts to affect the Philippine bourse. Far from it.

If the Dow is any indicator of the direction that our Phisix is headed, then it appears our exchanges may be benefitting from an extended run at being overvalued where little gains are to be expected and bargain-basement prices scant and rare. While, indeed, for the financially astute there is still good money to be made, as some listed companies remain undervalued and present excellent opportunities both for marginal plays or even slight upsurges, the general inclination of Price Earnings in the market remains high.

We add this to the increasing number of gauges measuring negativity in the recent purchase of a special telecommunications bandwidth that impacts on the general public. Already, the media have been congested with negativity from the deal’s first announcement all the way to the recent announcement that the agency in charge of competitiveness has yet to approve the deal.

The skinny is that a highly diversified conglomerate, with significant holdings in almost every industry that is an economic driver and is a significant growth catalyst in the local economy, had divested itself of a special bandwidth. The divestment was to two of the largest telecommunications conglomerates, both sharing major market shares so much that both represent competing sides of a duopoly.

Size matters. The divesting entity is not simply one the largest conglomerates, but an equity investment in it represents a diversified investment across the Philippine economy.

The purchasing entities are similarly situated. One is as invested in telecommunications as it is in banking, finance and real-estate development even where the services it provides in telecommunications is perhaps the economy’s worst. The other is into broadcasting media, print, television and telecommunications utilities. It is also in mining and financial intermediation. While it is a slightly better telecommunications provider, many lump both as responsible for our national ignominy in telecommunications.

By the very nature of their DNA, any movement within their financials from the bandwidth purchase reflects on the economy, especially where these impact on stock prices. After all, each is among the most traded.
The negativity that permeates the telecommunications market on the buy-out had actually focused more on the poor quality of services the two inflict. The selling entity had previously offered a third option to the duopoly. With the buy-out, this deal robs us of that.

Unfortunately, that may not be the only downside to this deal.

The stock market today is overvalued. Where PE ratios should hover around the 15x level we suspect that stocks are trading at between 18x and 21x, thus reflecting a market with prospects of increased values slim and rare. Apply capital asset pricing models on the three entities in the bandwidth buy-out and, given the great divide between risk-free rates and the beta coefficients of those firms, expected returns on equity hover farther north of where PE multiples normally lie.

For the selling entity, the sale results in a positive cash flow and a return on successive outflows that the firm was finding harder and harder to negotiate into its final fruitful conclusion due to numerous bureaucratic roadblocks set up as barriers to entry. The duopoly tends to unfairly preserve its market shares despite the extremely lousy service both inflict.

For the purchasing duopoly, despite the limited applicability of the bandwidth on the kind of gadgetry that the greater public owns, the deal results in increasing their stranglehold on the markets.

As the stock values of all three are given an upward kick in a market already inflated by a value bubble, the buy-out will further increase market flatulence, as is the tendency of bubbles to further increase to the point of bursting.