In this briefing:
- Weekly Oil Views: Friday’s Price Spike Feels Like Irrational Exuberance
- 36Kr IPO (Part II): Cut in IPO Target, Expensive Valuation and Governance Concerns
- Recession Watch-III: A 2%-Growth Economy Is Set to Decelerate as the Fed Decides to Pause
- Canaan IPO Preview
Crude rallied by nearly 4% during US trading hours on Friday, in sympathy with a burst of cheer in the financial markets from unexpectedly strong US October jobs data.
Encouraging headlines about the US and China inching towards sealing a partial trade deal and the US Federal Reserve’s third quarter-point interest rate cut of the year announced on Wednesday helped shore up investor risk appetite.
We think once again, oil is unlikely to tango for long with the stock markets. Benchmark US stock indexes the Dow Jones Industrial Average and the S&P 500 are flirting with record highs, having surged 17-22% year-to-date.
Benchmark sweet crude futures, in contrast, are 10-13% below their 2019 highs, and way below their historic peaks.
Can we expect a sustainable sentiment boost in oil from a phase-one US-China trade deal? Read on for our perspective.
In our previous insight on 36Kr IPO, 36Kr IPO (Part I): Revenue Outlook and Cash-Burn Remain a Concern we discussed the company’s business model, industry and the company financials. This follow-up insight will mainly focus on the company’s valuation and the governance related concerns. The company had originally planned to raise US$100m through its US IPO, however, the company’s target IPO price range of US$14.5-17.5 per share indicates gross proceeds in the range of US$52.2-63m from the sale of 3.6m American Depositary Shares.
As we discussed in our previous insight, the company’s revenues have grown significantly over the last 2-3 years, but profitability remains a concern as the company has been generating operating losses during the current fiscal year. We believe, the company’s aggressive growth in revenue comes with increased expenses which have been eating into the company’s profits. Based on the company’s target price for its US IPO, the implied valuation multiple is at a giant premium to its peer group which we believe is not justified given our concerns regarding the sustainability of the company’s business model and deeply increasing operating losses. On the other hand, our concerns regarding the company’s governance further weighs down on the valuation. The Chinese firms have been struggling to raise capital in the US due to the ongoing trade tension between the US and China and we would not subscribe for the IPO.
Markets cheered a weak non-farm payrolls print for October 2019 (+128K, slower than the +145K average for Feb-Oct 2019, but better than the street consensus forecast of 89K). With the unemployment rate ticking up to 3.6%, and average earnings (wages) up just 3% YoY, the job market reality provides more evidence of an ageing recovery that is running out of steam. The most reliable gauge of the cyclical present and future of the US economy, the ISM manufacturing PMI and new orders, were both below 50 for the third consecutive month, suggesting persisting cyclical weakness (although the mild improvement in new orders suggests rate cuts are helping).
The FOMC cut the Fed Funds rate by 25bp for a third time, bringing the effective policy rate to 1.625%, marginally below the core PCE inflation rate of 1.7%. But the FOMC removed language saying it would “act as appropriate to sustain the expansion”, instead signalling that its next move could be either up or down (and a pause was likely at its next meeting). That real GDP growth had slowed to 1.9%QoQsa, and business (non-residential fixed) investment had declined for the second consecutive quarter (by -3%QoQsaar in 3Q 2019, the worst decline in 4 years), appears not to be of much concern to the FOMC, as long as PCE continues to hold up.
The rate-sensitive components of aggregate demand — durable goods consumption (+7.6%QoQ) and residential investment (+5.1%QoQ) — are indeed the pillars holding up the US economy currently. The absence of further rate cuts (at least for the next 3 months, perhaps longer) will weaken those two components in 4Q 2019 and 1Q 2020. Business investment only regained the pre-GFC level in 2012, edged up slightly in 2013-15, declined in 2016, then had two good years in 2017-18 due to the Trump fiscal stimulus. Stagnation and decline in capex (the normal state since 2008) have now returned, and will likely worsen in 2020. The absence of further rate cuts will ensure a further weakening in aggregate demand in 1H 2020, tipping the US economy toward recession by 4Q 2020, and ending the Trump presidency. Given the cloudy political and policy outlook (especially with a Democrat to the left of George McGovern leading in the polls, see Warren Clearly the New Front-Runner, as Trump Hurts Biden with Hunter Controversy), we expect the US equity market to decline over the next half year.
Canaan Inc. (CAN US) the second largest producer of bitcoin mining machines in the world, is getting ready to complete an IPO in the US in the next few weeks. Canaan designs chips for mainly cryptocurrencies mining machines. It is also trying to make chips for various AI applications. The company has put the IPO placeholder at $400 million.
Canaan’s IPO filings suggest that the company may be getting desperate for financial capital and at initial glance, most institutional investors will be highly skeptical of the company’s ability to complete this IPO. Canaan’s revenue declined 85% YoY to 288.8 million RMB in 1H19. Its gross profit declined by 97% to 11.2 million RMB in 1H19. In addition, the company generated a net loss of -330.9 million RMB in 1H19, from a net income of 216.8 million RMB in 1H18.
In our view, it is probably in the best interests of Canaan as well as the potential IPO investors for the company to postpone the IPO once again when the company’s financials are in a much better shape and meanwhile try to seek other private market capital. The IPO filing is on the border of being ridiculous. The potential institutional investors that put their precious capital into this IPO need to answer to their bosses and there are some serious flaws with this IPO, of which the most prominent concern is the collapse in ASPs of the bitcoin mining machines and the sharp decline in revenues.