With the current debate over emerging markets going between analysts who think current outflows are justified and others who think EM stocks are too cheap, it’s strange to hear someone say that investors are actually overvaluing them. But Muddy Waters Research founder and CEO Carson Block isn’t talking about the latest trends, he thinks that investors make larger, systematic mistakes when evaluating companies in emerging markets.
“The expectations for those investments come close to discounting the risks involved – from currency and inflation issues, to fraud and the political whims of local governments, to just the difficulty of managing and executing in less-developed markets,” Block told Value Investor Insight in an interview.
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He stated further:
We also still see a lot of froth in anything related to emerging and frontier markets. While stocks in many of those markets have pulled back, investors often overly value emerging-market growth prospects in companies based in developed markets.
Public companies have poured shareholder money into emerging markets over the last several years through acquisitions and start-up projects and we generally don’t believe the expectations for those investments come close to discounting the risks involved – from currency and inflation issues, to fraud and the political whims of local governments, to just the difficulty of managing and executing in less-developed markets.
The expectation within companies and in the analyst community is often that international businesses will track their domestic experience. In many cases we don’t believe that is or will be true, and the result is that international growth potential is over-estimated and the stocks are overvalued.
Carson Block on AMT
Carson Block used cell-tower operator American Tower Corp (NYSE:AMT), which operates in many emerging markets, as a specific example of the types of problems he sees. Starting in 2008 AMT aggressively expanded into nine separate markets, building up there top line and impressing investors. But when Muddy Waters looked more carefully they found that there was actually a lot of value being destroyed. In four markets (India, Brazil, Ghana, and Germany) AMT could have done about as well just by investing in local government bonds.
There’s also the problem that AMT knowingly pays above-market prices in exchange for getting above-market rents. This gives a short-term boost to revenue, but hurts growth in the medium to long term. The company also hasn’t hedged against its exposure to foreign currency rates to protect investors, but the fact that management has hedged their own performance targets against currency fluctuations tells you that it is a real concern.
Carson Block is also bearish on American Tower Corp (NYSE:AMT) because of the potential impact that Wi-Fi and new tower technology could have, making large cell towers less important in the dense urban markets where they are currently most lucrative.
Carson Block on AMT valuation
When asked what he thinks AMT shares are actually worth (currently trading around $69), Block said that “It amuses us that the key assumptions of analysts – say on growth rates and costs of capital – are all over the place, but they still generate price targets in the same range. As shorts in the stock, we like that.” He puts AMT at no more than $45, and has seen the stock fall from a high of $85.26 since deciding the stock was overvalued.