18/06/2009 - 00:00

Selecting reverse gear in two-speed economy

18/06/2009 - 00:00


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There are plenty of opportuities for companies with a good story to sell.

Selecting reverse gear in two-speed economy

THE two-speed economy was a very popular term used to describe the haves and have-nots of the mining boom.

The concept was flexible in its application.

For instance, it could be applied at a national level. Until last year, Western Australia and Queensland were performing well while Victoria, Tasmania and New South Wales struggled. On the economic freeway, we were in the peak lane and the sluggards were stuck in heavy traffic.

Similarly there was a view that there were two speeds within the WA economy. Travelling well above the limit were the resources companies, which were furiously investing as commodity prices scaled new heights.

Many other sectors, however, were struggling to keep up with this breakneck pace as the resources companies drove up prices for important inputs such as labour. Resources companies could afford to do this because commodity prices were also rising excessively.

But those outside the mining and petroleum sectors could not lift their prices so easily and, therefore, could not increase the wages they paid.

For them, it seemed like things were actually in reverse, as talented staff left and other costs rose.

Then there was the October meltdown - when everyone, everywhere was brought to a sudden and grinding halt. More than six months later, we are starting to see the emergence of another two-speed situation, this time within the resources sector.

There has recently been a plethora of new capital raisings. Clearly the demand is there and some in the market were prepared to invest at the first opportunity.

But this is nothing like what was occurring 18 months ago; investors are cautious and doing their due diligence.

They don't know which way the market is really going to go. Is this rally a lasting recovery or, as many believe, will there be a lot more pain to come?

Either way, astute investors can use this window to position themselves to take advantage of either situation.

This creates a virtuous circle. The companies with the best prospects attract the scarce capital, which, in turn, makes them even more secure. It's a very Darwinian concept - the fittest don't just survive, they multiply and thrive at the expense of their weaker cousins.

It was described to me as a flight to quality and it's a phenomenon that is not just restricted to listed companies seeking investment, although that is where it is most obvious.

That is especially the case in WA, where more than 250 new companies were listed from 2005, mostly in the small-cap resources sector.

Many of those companies are running out of money. Many directors will be seriously questioning, in this day of shareholder litigation, whether they can sign off accounts saying that their company is a going concern.

That is a process that is going to weed out the weak very quickly over the next six months.

And so we see our two-speed sector. Those with a good story, robust business model and strong management, attract the capital. Those that aren't convincing within this matrix will be left behind, not just in the slow lane, but probably on the scrap heap.

Too big to fail?

AS the BHP Billiton-Rio Tinto deal unfolded two weeks ago I was reminded of the old saying about putting too many eggs in one basket.

The age-old rule is not just for those squirreling away their personal savings or thinking about share market investments. It is important for sovereign entities, too.

Both BHP and Rio Tinto are behemoths in their own right and have displayed duopolistic tendencies in the past. For example, they backed each other in the fight against Fortescue Metals Group over rail access.

It is difficult to see the advantages to the state in creating a Pilbara monopoly - one that will have a near monopoly (both business and cultural) over a vast area of the state, much as the old Dutch East India Company, which ran colonies like a state of its own.

The obvious issue is that cutting out costs tends to mean fewer jobs, either by shedding existing staff or reducing the need for future employment.

That equals less money trickling into WA via employment.

It also reduces the competitive tension that keeps these companies honest and innovative.

Take, for instance, the fact that the joint venture will adopt Rio Tinto's work practices. This shows that, despite all its management know-how, BHP got it wrong. They have had strong competition to help find this out.

If the Pilbara becomes one giant iron ore operation, who will they measure themselves against? When big companies make bad decisions, it costs us all.

We ought to look carefully at the US's costly experience of allowing companies to become too big to fail - those have required big bailouts when they have got it wrong - at great cost to the community, not management.


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