Fannie/Freddie have tripled; Alphabet pitched on VIC; China's hard landing/crisis; Dairy farming is dying

1. The GSEs (government-sponsored entities, Fannie Mae and Freddie Mac), which were long-time holdings in my hedge fund, have TRIPLED this year on hopes that a deal might finally be struck to get them out of government control. Here's an article in today's WSJ about this: Lawmakers Promise Fresh Push to Overhaul Housing Finance. Excerpt:

Lawmakers from both parties plan to take a fresh crack at getting Fannie Mae and Freddie Mac, two companies that underpin nearly half of U.S. mortgages, out of government control.

For more than a decade, lawmakers have tried and failed to overhaul the mortgage-finance giants, which were placed in conservatorship during the 2008 financial crisis. Now, Republicans and Democrats in Congress say it is time to try again. Meanwhile, the Trump administration may soon propose steps to ease government control.

"All the policy puzzle pieces are out there, what is lacking is the political will to put them together," Rep. Patrick McHenry (R., N.C.) said in an interview, adding, "Divided government is the best time for us to legislate."

Mr. McHenry, the top GOP member on the House Financial Services Committee, this week sent a letter to the panel's chairwoman, Rep. Maxine Waters (D., Calif.), saying overhauling Fannie and Freddie could draw bipartisan support.

Ms. Waters last week said revamping the housing-finance system is one of her top priorities. "The committee... has a responsibility to look at our housing finance system and address the fates of Fannie Mae and Freddie Mac," she said in a speech on her agenda.

Repeated efforts to overhaul Fannie, Freddie and the housing-finance system have foundered since the crisis. The issue of what to do about them is politically fraught, creating divisions between and within the two parties.

Bill Ackman laid out the most sensible plan I've seen to resolve this situation in this 111-slide presentation, It's Time to Get Off Our Fannie, at the May 2014 Ira Sohn Conference.

2. Someone posted a spot-on pitch for Alphabet a few days ago on ValueInvestorsClub. It's a members-only site so I can't link to it, but here's the opening summary:

While my broader thesis is below, I want to highlight the three reasons I believe this company will appreciate sharply (+100-160% to $2,200-$2,900/share) from current prices:

1. Android is the single largest and most important "hidden asset" in the world. At present, it is only monetized indirectly through Play Store purchases. GOOG is going to, for the first time, begin charging smartphone manufacturers to pre-install Play Store, Gmail, YouTube and Maps via one license, and Search and Chrome browser through a second license, on its European phones. Ostensibly, this is to comply with European regulators and replace potentially lost ad revenue, but let's be realistic – every manufacturer is going to have to buy these licenses if they want to sell their phones. https://www.nytimes.com/2018/10/16/technology/google-android-europe-apps.html

a. Android has more than 2 billion monthly active devices and about 1.2 billion are sold annually right now. https://www.statista.com/statistics/266219/global-smartphone-sales-since-1st-quarter-2009-by-operating-system/

b. I could easily see GOOG adopting this new charge for pre-install policy globally, after all, in July, Sundar said they may begin charging for Android, writing "So far, the Android business model has meant we haven't had to charge phone makers for our technology, or depend on a tightly controlled distribution model." https://www.blog.google/around-the-globe/google-europe/android-has-created-more-choice-not-less/

c. If this policy becomes a backdoor way to charge for Android, and say GOOG were to charge $5-10 per device for these pre-installs, on 1.2 billion device sales annually that works out to $6-12 billion, which would essentially be 100% incremental pre-tax cash flow.

d. This may even be conservative, as Google management has been thinking of this as a recurring revenue stream on the full base of users. In 2010, Eric Schmidt said "If we have a billion people using Android, you think we can't make money from that?" and said all it would take is $10 per user per year. With 2 billion current users, that would be a $20 billion annual cash flow stream. https://blogs.wsj.com/digits/2010/07/28/eric-schmidt-on-google%E2%80%99s-next-tricks/

2. YouTube is probably the best (and most widely loved) business in the world, and eventually probably becomes worth more than the current enterprise value of Alphabet. Google Maps and Waymo may turn out to be second and third over time, but we're not paying for that now.

3. If Alphabet were ever to separate into 3, 4, 5 or more pieces, I believe the equity value creation would be both instantaneous and massive. The market is making a big mistake by treating break-up headlines negatively.

3. Here are two articles about China, which I sent earlier to my China-specific email list (roughly one email/week) – if you wish to join it, simply send a blank email to: china-subscribe@mailer.kasecapital.com

a) WSJ Heard on the Street: China Risks Real Hard Landing This Time. Excerpt:

Beijing's crackdown on shadow banking has gone overboard. Some backtracking looks necessary.

China's economy is at risk of its long-feared "hard landing"—a rapid slowdown in growth that would hit employment hard and could trigger big problems in global debt and currency markets.

The reason isn't, as the Trump administration would like to believe, the U.S.'s trade offensive. Instead, Beijing has overdone its own crackdown on nonbank "shadow finance"—without opening alternative channels for private-sector borrowers, who often struggle to obtain bank credit. As a result, Chinese credit growth has continued to decelerate, despite nine months of significant central bank easing. If it doesn't turn back up soon, producer-price inflation could turn negative—causing big problems in the heavily indebted industrial sector.

... China's inefficient financial system has long needed surgery. By excising the shadow banking system without a proper transplant to replace it, regulators risk killing the patient.

b) Bloomberg: Forget the Trade War. China Is Already in Crisis. Excerpt:

What goes widely unnoticed is that China is already in crisis. No, it's not the sort of hold-on-for-dear-life collapse the U.S. had in 2008 or the surprising, ferocious meltdowns the Asian Tiger economies experienced in 1997. Nonetheless, it's a crisis, complete with gutted banks, bankrupt companies, and state bailouts. Since the Chinese distinguish their model of state capitalism as "socialism with Chinese characteristics," let's call this a "financial crisis with Chinese attributes."

... Rather than a sudden explosion that destroys banks and jobs, China's version is protracted, moving so slowly that it can be hard to notice. Ultimately, though, the cost and pain will be similar to—perhaps even worse than—that of the traditional crises we've come to expect.

... As is often the case in crises, the true extent of the debt and the damage is probably higher than anyone can guess.

... What's probably required is a massive overhaul of bloated state-owned enterprises. Even worse, policymakers keep adding refuse to the pile. They remain fixated on achieving growth targets impossible to reach without infusions of more credit. China is a debt junkie, and like any addict, it needs a fix—of credit—to keep going. When that short-term relief wears off, the economy begins to slow down again. Chinese leaders get the shakes, lose their determination to tackle the debt, and inject another hit of credit.

... Even if Xi's approach gives birth to new sectors and growth, that won't necessarily undo the harm already done. The bad loans won't magically transform into gold. The only real difference between a regular financial crisis and a financial crisis with Chinese attributes is the duration. Most normal financial upheavals last months; China's may drag on for years. As the world's premier emerging economy, the People's Republic should be a source of succor to a slipping world economy. But until it finally resolves its financial crisis, China will instead remain a source of global stress.

4. A very poignant article about a lifelong Wisconsin dairy farmer who was forced out of business by industrial-scale factory farms. Dairy farming is dying. After 40 years, I'm done. Excerpt:

After 40 years of dairy farming, I sold my herd of cows this summer. The herd had been in my family since 1904; I know all 45 cows by name. I couldn't find anyone who wanted to take over our farm — who would? Dairy farming is little more than hard work and possible economic suicide.

A grass-based organic dairy farm bought my cows. I couldn't watch them go. In June, I milked them for the last time, left the barn and let the truckers load them. A cop-out on my part? Perhaps, but being able to remember them as I last saw them, in my barn, chewing their cuds and waiting for pasture, is all I have left.

My retirement was mostly voluntary. Premature, but there is some solace in having a choice. Unlike many dairy farmers, I didn't retire bankrupt. But for my wife and me, having to sell our herd was a sign — of the economic death not just of rural America but also of a way of life. It is nothing short of heartbreaking to walk through our barn and know that those stalls will remain empty. Knowing that our losses reflect the greater damage inflicted on entire regions is worse.

... But organic dairying has become a victim of its own success. It was profitable and thus fell victim to the "get big" model. Now, our business is dominated by large organic operations that are more factory than farm. It seems obvious that they simply cannot be following the U.S. Department of Agriculture's strict organic production standards (like pasturing cattle), rules that we smaller farmers see as common sense.

Although small organic farms pioneered the concept, organic certification has become something not meant for us — and a label that mega-farms co-opted and used to break us. When six dairy farms in Texas feed their thousands of cows a diet of organic grain and stored forage, with no discernible access to a blade of grass, they end up producing more milk than all 453 organic dairy farms in Wisconsin combined. Then they ship it north, undercutting our price. We can't make ends meet and are forced out of the business. We played by the rules, but we no longer have a level playing field.

This reminds me of a good book I read last fall, The Meat Racket: The Secret Takeover of America's Food Business, about how our meat supply system has been taken over by the likes of Tyson Foods, to the detriment of both the animals' and consumers' health, countless individual farmers who have been reduced to little more than sharecroppers, and entire states/regions.