Author Archives: zebra

Sister can I lend you a dime?

Today’s post is written by Zebra (James Glover), an occasional contributor to the Stubborn Mule, who turns his mind this time to microcredit, and the internet lending site Kiva.

Dolly lives in a mobile home and works in the fast food industry. I met her on the internet 5 weeks ago and almost immediately I lent her $500. She said she wanted the money to start her own business. Nothing too strange about that you might think. Single, lonely man meets woman online is a story as old as the internet. Nothing strange except Dolly’s mobile home is actually a tent. And when I say tent I mean a ger (or yurt), and Dolly lives in Ulan Butor in Mongolia not a trailer park in Baton Rouge. Perhaps this sounds like one of those internet scams but I didn’t meet her on MongolianWives.com either and she is a married woman with four children. In fact three of them go to university. Here is a link to Dolly’s profile so you can look and tell me if I am a sucker for an online scam.

You’ll be relieved to know that Doljinjav (her real name) has since paid back all of that loan. The website is kiva.org, dedicated to facilitating microloans to poor entrepreneurs in third world countries like Mongolia.

Microcredit works by making small loans to third world entrepreneurs like Dolly who would otherwise be unable to borrow from banks due to lack of credit history, assets and being female. It originated in Bangladesh in 1976 when Prof Muhammad Yunus set up a research project to better enable rural villagers to develop. He identified that it was lack of capital that was majorly inhibiting economic development. This is not surprising – imagine the sclerosis if financing was removed from the western economic system. In 1983 Grameen Bank (“Grameen” mean “villages” in Bangla) was set up to facilitate microloans. In 2006 Yunus and Grameen Bank were awarded the Nobel Prize for Peace. (Incidentally, Grameen Bank is the only business corporation to win a Nobel Prize).

Since then microcredit has been enormously successful. Part of the reason is that the default rate (1-2%) is negligible by standards based on historical criteria. This is attributed to the borrowers initially being collectives of women who borrow the money to set up small businesses. If one is unable to meet her obligations the others step in to support her. In practice these days, microloans are made to men as well as women, individuals as well as collectives and even in the US.

Microcredit turns around the banking paradigm that poor+woman = bad credit risk, which of course, on paper, they are. In fact it has been so successful that mainstream banks are getting in on the act themselves. Organisations like Kiva have also been set up to facilitate loans from charitable minded westerners who perhaps want an alternative to passive giving.

Kiva works by listing applications for funds by people like Dolly, which registered lenders can match in part or in whole. Typically the loans range from a few hundred to a thousand dollars. The lenders themselves have committed funds to the Kiva organisation for dispersal. Kiva don’t lend the money directly themselves but work with local partners who arrange the loans and collect the repayments. In practice the loans have already been made and the lenders are “backfilling” them. This has been a source of controversy (see below) but ultimately makes the whole process more efficient and from the borrowers point of more predictable.

It all sounds like a virtuous circle. Lenders get a more active giving experience, borrowers get access to credit they wouldn’t be able to normally access and as the loans are repaid lenders are able to relend it to others. While the lenders themselves aren’t paid interest the borrowers are charged interest. Theoretically the interest goes to pay any administration costs and any funds left over go to grow the balance sheet of the partner organisation.

But all is not well in Kiva land. Next to each applicant are posted statistics of the partner organisations and these reveal an uncomfortable truth. Typically the interest charged is 20-40% which is very high by western standards. Kiva also publishes the median interest rate of non-partner lenders in the region (ie. “money lenders”) but these are often twice as high. There has been an ongoing discussion online from dissatisfied lenders who would happily lend the money at a zero interest rate. After all they don’t get the interest themselves and besides they aren’t in it for the money. Kiva acknowledges these concerns but says the profits to the partner organsisation, after costs, are modest (typical ROA is 2-6%) and most of these are not-for-profit so goes to grow the balance sheet and increase lending. Here is a blogpost on the controversy and how Kiva responded.

The good news here is that the costs and profits are transparent and info is posted on the website. Kiva addresses its lenders concerns honestly and at the end of the day it is up to us to decide if we are happy with the process. Personally the question I ask myself is if the borrower is happier than the alternative – no credit or much higher interest. It makes you think about their situation. To consider the saying: “Walk a mile in my shoes” and then decide if you want to deny them this loan. This, in my opinion, is really the main benefit of giving, not the feel good factor. It is a privilege to be given this insight. To quote E.M. Forster, who himself lived for a long time in India, all we can hope for is “to only connect”.

I hope your interest in microcredit has been pricked. If you are already on Kiva or decide to sign up then we (the Mule and me that is) have set up a Kiva lending team called “Stable Hand” you can join. Lending teams don’t decide on how your funds are distributed but are a way to make contact with others with a similar interest. Please consider joining.

Labor’s National Broadband Network – Less than $10/month

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Our regular guest contributor James Glover (aka @zebra) returns today with a look at the numbers behind the National Broadband Network. He asks: do you think it would be value for money?

The Labor Government’s proposed National Broadband Network (NBN) has many things to recommend it, not least speeds of up to 1GB/s (currently I am on 10Mb/s for ADSL; theoretical speeds of 24MB/s on ADSL2+ and 100MB/s on VDSL are also soon to be widely available, though the reality is dependent on many variables such as distance from an exchange). It would revolutionise the way we communicate as the higher bandwidth would allow not just interactive entertainment and fast downloads, but genuinely accessible cloud applications that really felt like they sat on your computer…and of course dishwashers waking up at 3.00am to negotiate the best electricity price. I doubt whether anybody on either side of politics would disagree that, in a perfect world, this is all desirable. But like all utopias, it comes at a cost and that is where the real divergence between the Labor Party and the Coalition’s broadband policies exists. I hope to cast some light on this cost argument using the power of the Time Value of Money, in particular calculating the real cost to you on a monthly basis so you can compare it with your existing broadband cost.

Labor wants an all-connecting fibre optic network (with subsidised satellite to cover really remote areas) that will cost an estimated $46bn. The Coalition wants a more modest effort: a fibre optic “backbone” network that uses existing copper wiring in urban areas and relies on market competition to pay for further improvements. It is estimated to cost about $8bn plus later commercial costs. Both of these figures seem extraordinarily high. How to decide if it is really worth it? Well if I told you that Labor’s NBN would cost you $10 per month would that sound too high? After all that only includes the infrastructure cost, not the access cost via an ISP. But most of us don’t pay upfront for our broadband or mobile (cell) phone bills, we pay monthly. The Coalition’s figure of $8bn works out at less than $2/month each (for those so inclined, you can read the details behind these figures). But it doesn’t include any additional costs charged by commercial companies building additional infrastructure. It also only claims to provide “peak speeds” of 10Mb/s which I already get on my ADSL+.

Is $10/month a lot of money? Or $2/month for that matter? It obviously depends on what your income is and how much you are currently prepared to pay for broadband. My broadband plan costs $50 for 120GB/month. I also live in a one-person household. It doesn’t sound much to me, but all those $10/month costs add up to the thousands we pay in tax each year. There’s no point paying more for little for no benefit. Of course it’s not going to be charged directly, but through increased taxes (or decreased services). I estimate $10/month to represent an average increase in the tax rate of about 0.5%. This seems reasonable to me. After all, if in 2020 a businessperson (or BusinessBot2020) came to Australia and found our broadband to be the equivalent of dial-up today, they’d hardly be impressed enough to invest in a technology business. Of course, by 2020 with super-fast broadband we should really be able to do most business remotely, right? But we’ve been saying that since the invention of the telephone.

So I’m for the Government’s NBN plan…but what do you think?

Update: I have since writing this post changed my mind based on readers’ comments and some research. It appears that many of the benefits of the NBN are available already on ADSL2+, VDSL and 4G and the Coalition’s more modest plan to build a fibre-optic network backbone might be sufficient. There is also the question of whether a Government entity is best placed to oversee such a large scale project – it’s not like Peter Garrett is going to personally project manage the NBN but Governments in general are not (IMO) best placed to predict and respond to consumer demand. But I accept there are strong feelings on both sides. Sometimes that bright shiny thing in your vision is a light on a hill and sometimes it’s a white elephant blocking your view.

UPDATE: Let us know what you think by voting in this broadband poll.

RSPT RIP – Long Live the MRRT

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In the third in a series of guest posts on the subject of Australian mining tax, Zebra (James Glover) considers the changes to the proposed tax the new prime minister, Julia Gillard, has negotiated with miners.

The Govt has announced a replacement for the RSPT discussed in earlier posts to a Mineral Resources Rent Tax (MRRT). The principle differences are the tax rate – 30% and a change in the deduction. For established mines it is now based on market value depreciated over 25 years and the uplift rate is 12% not 5%. In addition there is a 25% deduction from earnings upfront which makes the base rate of tax 22.5% rather than 40%.

This post replaces an earlier one I put up about the MRRT in which I erroneously assumed that the opt-in about using the market value of assets applied in the way I proposed in my second post. The key statement here is:

“Miners may elect to use the book or market value as the starting base for project assets, with depreciation accelerated over 5 years when book value, excluding mining rights, is used; or effective life (up to 25 years) when market value at 1 May 2010, including mining rights, is used. All post 1 May 2010 capital expenditure will be added to the starting base.”

In the case where the mining company opts to use a market value approach I take it to mean the depreciation takes place before the MRRT is calculated. This means the formula is:

MRRT = 30% x (75% x Earnings – Price(2010)/25)

Currently the mining industry average for P/E (price to earnings ratio) is 14, though in the case of BHP-Billiton it is 19. For an average miner then Price(2010)/25 = Earnings x 14/25 = 56% Earnings so the actual MRRT is based on 19% of Earnings. However the Price is fixed at the May 1 2010 value so this will not increase over time even though earnings will. Should earnings continue to rise at the dramatic rate we have seen in the past decade then the MRRT will eventually look more like the 22.5% base rate.

It appears that the Govt and the mining industry’s compromise is to push the revenue from the tax windfall out from today to later years. In a sense the mining industry has also removed the contentious “retrospectivity” of the tax by using the current high price and choice of 25 years depreciation to ensure the current value of the MRRT is minimised but will rise at 22.5% of increased earnings going forward.

Thanks to an observant reader who pointed out my error. Mea culpa.

RSPT – A Fair Valuation Based on True Value of New and Existing Mines

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Following on from the interest generated by his last post, Mule Stable regular Zebra (James Glover) returns to the subject of the Resources Super Profits Tax in another guest post.

In a previous post I explained how the formula for the RSPT (Resource Super Profits Tax) was derived by considering the Government to be a 40% silent investor in any mining project. I showed that the correct deduction from the return on investments is indeed GBR (Government Bond Rate), as proposed, not a higher rate that includes a “price of risk”. One important thing I missed in this analysis, however, was whether the investment amount (I) was the correct basis for valuing the Government’s new 40% “investment”. I aim to show that the correct variable should actually be the Market Value of Assets (MVA) and as such the appropriate deduction from profits is several times (maybe as much as 4 times) higher for established mines.In the example given based on the mining industry “price to earnings ratio” of 14 the RSPT would only be 9% of earnings. I should emphasise this is not about having separate formulas for new and existing mines but correctly taking into account the fair, market based, price the Govt should pay for it’s 40% share of the earnings.

For new mines MVA = I (where all “=” signs should be taken to mean “approximately equal” to head off the pedants) so the proposed tax is correct in this case.

The Government says that in return for this tax take they are taking downside risk as well as upside benefit. One of the criticisms of the RSPT is that the Government is effectively nationalising 40% of ongoing mines and the GBR deduction is irrelevant as there is no serious downside risk. In the framework I propose the Government is not currently proposing to pay a fair price for this “nationalisation”. If the fair price of the Government’s stake is taken into account then the tax from existing mines is considerably lower than proposed. It may be as low as 9% of earnings. This does not require a backdown by either the miners or the Government, although the Government’s tax take might be less than forecast

If the Government is going to nationalise 40% of a mine – at a fair price – then it needs to effectively pay 40% of the Market Value of Assets (or MVA) for the mine. For new mines the Investment = Equity + Debt is pretty much set at this value. The Government RSPT tax is then:

Tax = 40% x (Earnings – GBR x MVA)

The first term is the Government’s 40% share of the earnings (here taken as Earnings before Tax). The second term is the deduction for the interest that recognizes that the funding of the Government’s share is undertaken by the mine at the Government Bond Rate or GBR. There is no good reason for the Government to pay less than the market value of this asset or MVA. For a new mine just starting up MVA = I, the investment amount, so

Tax = 40% x (Earnings – GBR x I)

If ROI = Return on Investment = Earnings/I then we can write this as:

Tax = 40% x (ROI – GBR) x I

which is the proposed RSPT formula.
For an ongoing mining operation with established operations and contracts, the market value will exceed the book value several times over. I am going to take the very simple assumption that MVA = Price ie the market value of the assets is the market value of the equity. This ignores leverage and is probably too simplistic. Price is based on share price and the number of outstanding shares. In terms of PE-ratio (the ratio of Price to Earnings as determined by the share price) we can write

Tax = 40% x Earnings x (1 – GBR x PE-ratio)

Compared to the original formula the deduction is 40% x GBR x PE-ratio x Earnings. Alternatively we can write this as 40% x GBR x I x MBR where MBR is the Market to Book ratio = MVA/I. So the original Govt funding deduction is just multiplied by MBR. The current formula assumes implicitly that MBR = 1. For existing businesses eg. banks MVA/BVA can be as high as 4 (which is BHPs current value). This gives a very simple deduction in terms of % of earnings, rather than Investment/I, of 40% x GBR x PE-ratio. Note that this is really the same formula for new and existing mines; it just makes proper allowance for the true value of established mines.

So what is the fair deduction for existing mines? It obviously varies with share price and hence market conditions. For mines which are privately held we need a proxy based on publicly traded stocks. The PE-ratio for traded mining stocks is currently about 14. So now, using GBR=5.5%, the fair deduction for the Govt’s nationalised share for existing mines is not 5.5% (as many erroneously claim) or 22% (allowing for a 25% ROI) but 31%! Note this deduction is off the 40% so the total RSPT tax on earnings would be 9%.

So under a scheme based on a fair deduction for existing mining assets the tax should be:

RSPT = 40% x Earnings x (1 – 5.5% x 14) = 9% x Earnings.

After 30% company tax this represent a total tax of 38%. Even if we don’t know what the PE-ratio would be for mines which aren’t publicly traded we can use an industry based proxy for the mines whose stocks are publicly traded. Currently this is in the range 13-14. If I was the miners I’d be pretty happy with that. Maybe they should have taken a closer look at the RSPT before opposing it. All the miners have to do is get the Govt to accept it should pay a fair value for its stake and the framework I propose makes that transparent.

Resource Super Profit Tax Everything Correctly Explained (R.S.P.T.E.C.E.)

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This guest post from Mule Stable regular Zebra (James Glover) delves into the details of the proposed Resources Super Profits Tax.

The Australian Government (hereby known as the Govt) has proposed a Resources Super Profits Tax (RSPT) for mining companies. Superficially it appears to be a 40% tax on all profits (measured by Return On Investment or ROI) in excess of the Govt Bond Rate (or GBR, the interest rate at which the Govt borrows money, over the long-term).

The key points of this article are:

1. The GBR is the correct threshold level for RSPT,

2. If the Govt increases the threshold above GBR this will represent a subsidy of miners by taxpayers,

3. The RSPT will benefit small and marginal mining projects to get finance through partial Govt backing of risks.

So for example suppose miner Mineral Wealth of Australia (MWA) invests $1bn in the Mt Koalaroo Iron-Ore mine. MWA is a wholly owned subsidiary of Silver Back Mining (SBM). In the year following they make $200m profit or a return on investment (ROI) of 20%. If the GBR = 5.5% then the 40% RSPT means a tax revenue to the Govt of Tax = 40% x (20%-5.5%) x $1000m = $58m.

This seems very straight forward. It appears that the Govt is saying that GBR represents some “fair” level of return and anything in excess of this is a “super profit” to be taxed accordingly. Not at the normal company tax rate of 30% but a “super tax” rate of 40%. This is how it has been presented by both sides in the media. Arguments against the RSPT have focused on whether the GBR as a “risk-free” rate is the appropriate benchmark for a risky profit stream. Indeed it is not but in fact this isn’t what the RSPT is about. For example normally taxes on profits have no negative impact on the Govt if the company loses money. In the case of the RSPT though the Govt has stated that 40% of any losses can either be claimed back from the Govt (as a refund) or carried over to other projects.

So what is the RSPT? A good way to consider it is if the Govt took a 40% stake in MWA as a “silent partner”, leaving SBM with a 60% stake. In this case we would expect the Govt to contribute $400m of the investment costs (raised presumably through issuing bonds at the GBR or equivalent). In return it would get 40% of the profit. The Govt return would therefore be 40% of the profit less the cost of funding its 40% investment ie Tax = ROI x 40% x I – GBR x 40% x I = 40% x (ROI – GBR) x I.

This appears to be the formula that the Govt has presented to calculate the RSPT and in this derivation it is quite straightforward. However the Govt appears to be getting something for nothing since it isn’t actually stumping up the $400m in investment capital. So what’s going on? A clever piece of financial engineering that’s what. The Govt avoids raising the capital itself (and hence have it be counted as Govt debt) by getting the project to raise it on the Govt’s behalf.

(You can easily skip the next paragraph if you aren’t interested in the details of mine financing costs)

Whilst MWA raises 100% of the $1bn in capital the Govt appears to get the upside (and potential downside) as if it has contributed $400m without doing so. Money for old rope you say. However consider MWA not to be the stand-alone mining company SBM, but the joint venture beween the Govt and SBM. Suppose MWA borrows $1bn in capital at its Project Funding Cost (or PFC). This PFC will be lower than the SBM’s Miner’s Funding Cost (or MFC) as the Govt is now backing 40% of all liabilities. In fact in an efficient market we deduce PFC = 60% x MFC + 40% x GBR. If MWA then allocated these funding costs accordingly it would charge the Govt its share, risk-weighted, not PFC, but GBR. If the GBR = 5% and MFC = 8% then we expect PFC = 6.8% not the 8% if SBM was the sole investor. Under this arrangment SBM’s cost of funding (in % terms) its effective 60% share of the joint project is the same as its stand alone cost of funds, as it should be.

An argument against raising the threshold above GBR is that this will effectively lower the miners’ cost of funds, the difference being borne by the Govt and hence us taxpayers. No wonder miners are arguing so vehemently for the threshold to be raised. In fact it can be shown that raising the threshold to 11%, as some propose, and using a GBR of 5.5% would effectively reduce the miners’ cost of funds by a whopping 3.67%! If you want a formula for the Miners’ Taxpayer Subsidy(MTS) it is: MTS = 2/3 x (Threshold – GBR) in terms of the miners’ funding cost discount (paid for by the taxpayers remember); or MTS = 40% x I x (Threshold – GBR) in $ terms. For the Koalaroo mine this would represent $22m of funding cost transferred from the mining company SBM to the taxpayer. That’s you and me. You don’t see that in their ads.

From the Govts perspective the advantage to them is that the investment does not sit on their balance sheet but the project company MWA’s and in effect SBM’s balance sheet. From a financial engineering point of view all this makes perfect sense. Having said that, it was precisely this sort of clever off-balance sheet flim-flammary that got Greece (and Lehman’s et al) in trouble. We need to make absolutely sure it is properly accounted for.

Update: Several commenters have pointed out the effect on mine financing of the RSPT. Specifically with the Govt backing 40% of any losses smaller stand-alone projects will find it easier to get project finance. As discussed above the funding cost will be lower with the Govt’s partial backing. The operating profit (so called EBITDA) of the project is unchanged so this makes them more, not less, viable. This is at odds with what the miners have been saying. Even existing projects with refinancing clauses in their loans should find it easy to convince their lenders to reduce their interest payments. For large global miners such as BHP-Billiton, who issue bonds, it will be harder to disentangle the Australian RSPT benefit to their overall cost of funds and hence spreads. But the market should over time price this in with lower spreads on their bonds. With a reduced cost of funds miners will be able to leverage their existing equity across more projects and make up for the 40% the Govt now takes out of individual profits (and losses) through the RSPT.

Update: Tom Albanese, CEO of Rio Tinto was on Inside Business on ABC on Sunday May 30. It is interesting that in arguing against the RSPT he referred to the unfairness of the Govt coming in as a 40% “silent partner”, and not about the GBR threshold. He clearly understands the true nature of the RSPT. While it was self-serving he emphasised (in my terminology) the determination of Investment or “I” for existing projects. Depreciation comes into it but some of these projects are decades old and it would an accountant’s dream/nightmare to work out the correct value of I to base the Govt’s GBR deduction on. He also questioned the “principle” (his word) of the Govt forcibly coming in as a “silent partner” on projects which are clearly profitable going forward, having survived to this point. After all they are not compensating mining companies for mining projects that failed in the past. I’m afraid I have to agree with this point, though I think it is more complex than I currently comprehend. It is good to see the RSPT being debated for once without the disinformation we have seen from less eloquent opponents. After all the Govt did say at the beginning that it was these sort of aspects of the RSPT they were prepared to negotiate on, not the 40% and not the GBR threshold.

UPDATE: Zebra looks at a fair value approach to the RSPT.