Odey Asset Management LLP

Transcript of Crispin Odey’s Q1-11 Conference Call

Thank you everybody for coming up to hear me today. I hope I will get through this, I am
afraid I am suffering from jet leg, not the greatest thing to have when you want to make a big
impression but anyway let’s just go ahead. I am afraid also I have inundated you with paper,
you will see that we have got about twenty-two charts, so we have got to get through it.

The whole story is really making sure that you understand where we are and we feel
ourselves to be. Speaking essentially, the half time point i.e. zero interest rates or 0.5%
interest rates cannot last forever and the only question is going to be, when will they start
moving up? Our cry at heart is they will unfortunately move up late and only after wage
inflation has taken hold in the West but up until that time what we are seeing is inflation
taking off and taking hold in emerging markets and re-pricing assets and re-pricing the West.
So that is the good news and it is why we have got a big position in equities at the moment
and we also see the real crisis coming through much later on but through the bond market.

In terms of currencies we essentially remain pretty positive on the euro and we were the first
to say that we thought European interest rates would rise. We saw that with the alliance
between both the Germans and the Spanish and the Irish for funding reasons, and essentially
our view was that the UK and the US would really not see fit to raise interest rates and we
still cannot really see why they should.

In terms of how we have done, page 2 shows you OEI was up 2.74% and OEI Mac was up
5.13% at the end of March. It has of course been quite bumpy, the fact is as we talk today the
numbers are round about 8% for Mac and round about 4.5% for OEI so it is a nice year this
year. It is quite volatile, again we have got a big book [because of what] we see, and what
makes us reasonably optimistic at this point [is that] we are not taking a great deal of risk.

In terms of what has made a contribution, it is about finding good franchises. Obviously Sky
has had a good time and that is really just due to the bid. Again the news should be that the
bid may come through at the end of this month. We have a pretty relaxed view here because
I think that for less than £9.50 we do not really want to see the company sell out to News
Corporation. If he bids too low, well we could hold onto the company, it is doing well. I am
going to talk a little bit later on about Sky Deutschland because that continues to be one of
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our major longs. Regus has done well. In Ireland, we have not had a great time there, for me
Ireland could be one of the great recoveries, it is obviously in the sick bay at the moment but
there is a lot that is going right for them.

On the short side, we made money out of Nokia, and Commerzbank was kind of free money
from the Germans basically telling us that they were going to have to have a massive rights
issue and it is not a very profitable bank and the shares were pretty well at one times book
value and we have made a bit of money out of that.

In terms of where we are today, this is a crucial thing. Let me take you to page 4 and this is
just a recap to remind you where we are coming from and where we are going to. The fact is
what we are looking at and what we have been looking at is obviously we have had a twenty
year period when essentially, when the wall came down, the emerging markets emerged with
undervalued currencies and a desire to compete. That has been of great benefit in terms of
the inflationary side; it has kept costs down, it has ensured that wages have not risen in the
West, it has brought down interest rates and it has been very good for the bond market. It has
not been quite so good for the equity market as page 6 shows you, essentially the equity
market rose happily in the 90’s when corporates were borrowing at about 10% a year, so it
was a corporate bonanza, especially after 98 when thanks to the crisis in Brazil and in Russia,
the Greenspan cut interest rates into really a boom and you can see that fed through also to
the markets. We then had the profits recession in 2003, that was the dot.com bubble and then
what we saw was Greenspan deciding that supporting property prices was a very good way of
keeping the world economy going and keeping consumer spending rising. The point is that
obviously in 2007 that story came to an end. Page 7 shows you how much housing really
took over from equities providing the growth and that was the whole period of the Great
Moderation as we know when interest rates went down because activity was low, then
basically more money went into housing, people were spending their gains and so suddenly
consumption lifted. Consumption lifts, interest rates start to rise, putting pressure on housing,
housing comes off, less money being spent, consumption comes down and that was the Great
Moderation.

We tend to live long periods of time when we see what is going to happen but it does not
always happen as quickly as we would like. The fact was that through that period 2005 to
2007, property had gone from being an asset and turned into a speculation i.e. the average
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person was paying around 200 over Libor. Libor was about 5% in most countries so they
were paying 7% for property which was yielding at best about 4%. So there was this
negative carry and the question was at some point that was going to blow up, especially
because not only was there this negative carry but actually there was monstrous amount of
lending taking place as it became more and more speculative. What we saw when the crisis
had happened was how do you turn the speculation back into an asset when you lower
interest rates to 0%, at which point property yielding 4% becomes an asset not a speculation.
So they tried to stabilise property. In the US they have not yet stabilised property, so
property and the average house in the US is now only on 2.3 times average incomes, so
property has come down a very long way in the States.

Our point here is to say once interest rates went to zero there were a lot of speculations that
have become assets. Gold basically yields at best 2% on lending, if you lent it suddenly at
zero interest rates, gold looks very interesting. In our scenario, we do not see interest rates
going from 0.5% to 3%. We see interest rates staying very low but when they do actually
start to move up through to 6%/7% and even when they get to 7%, basically finding that that
is hardly where they are going to stop, they are actually probably on their way higher still.
Our question there is obviously if interest rates go from 0% to 7% there are lots of assets
which suddenly become speculations and that means that we have to be worried for your
portfolio during that period and the whole question is, how can you insulate yourself against
that? It is easier with a hedge fund than it is with a long only book but even with a hedge
fund the truth is the duration of most interest rate plays is much shorter than the duration of
the equity market, so we have to be quite leveraged into the short end of the bond market in
order to protect ourselves and that is really where we think we will have to be so a lot of what
we do today is fire practice for the future.

Why do we think that this is all going to happen? It is really because of Northern Rock.
Northern Rock was synonymous with what was happening in the States but it comes down to
the fact that once the asset bubble was over in 2007 the authorities had a problem because
they had allowed the equity market to provide a level of confidence, they had allowed
property to basically be the engine of growth and suddenly credit was exhausted. There was
no credit going to come through and how do you get nominal GNP to grow and the answer is,
not easily.

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Page 11 just shows you [how] those happy people 2006 and 2007 [turned] into these
thoughtful people on the right hand side; and they really reflect all of us as well. The fact is it
has been very difficult not to be quite gloomy since 2007 and our cry has really been that the
only way out of this was that you had to see nominal wages rising i.e. in the West you needed
wages to rise faster and inflation to be higher than interest rates i.e. negative real interest
rates. You basically monetize a way for debt and you stabilise things and you also provide
nominal GNP growth for the economy.

Obviously though it highlights a massive difference between the way in which I think this is
going to unfold and the way in which either Goldman Sachs or Bill Gross is talking about it.
To them, they look at 2007 onwards and they feel that essentially the authorities have had to
walk a tightrope to keep the economy alive and that the markets have been far too generous to
them because quantitative easing has really provided the means to say, look we are all doing a
great job and so the view of Bill Gross is that actually the markets are going to lose
confidence in these governments and these governments are, therefore, not going to be able to
raise money at these very low levels of interest rates and so what you have would be rising
real rates and that would choke off the economy.

My point is really a very different one and that is essentially these guys will not do anything
until the West is competitive again with the emerging markets. Page 12 shows you
everything that we have been talking about. The pink line, the dotted line on the right hand
side which shows you that since 1983 essentially wages as a percent of GNP in the US have
gone from 67% down to 58% i.e. it has been the wage earner who has felt the pressure of
globalisation and emerging markets coming through and the problem is that actually what has
got to happen in the US is this labour share has got to rise and that may be quite painful for
corporate profits but it is the only way that essentially in an unequal society like America you
keep the show on the road but you must be showing that the profits of capitalism are 4% to
5% of nominal GNP and ignore whether it is real but it has got to be there. The problem that
they have and this is why they all looked a bit sad on the previous page, is that it is quite a
long way; it is one thing to understand that wages need to rise in the West but then the
problem is that the West started from a position of being quite competitive with the emerging
markets.

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So what have we been having over the last couple of years and where are we now? Well the
answer is on page 13, of course these numbers are in part exaggerated; wage growth in the
UK does appear to be picking up a little bit more than I am showing here but the essence of
everything is really what is important. What you can see is that whilst we have an
uncompetitive first world, the good news is that because the emerging markets are pegged to
the US dollar currency, they have not been able to push up interest rates to offset the wage
inflation that they have been experiencing and essentially wage inflation of 20% has been
pretty well the norm across most emerging markets and average interest rates have been
around about 5% in these countries so we are nowhere close to slowing things down.

On my holiday was my son, Felix, and he is in the middle of his economics A Level, so one
was explaining the income elasticity to demand and to price rather than price elasticity to
demand i.e. when incomes are rising then prices can also rise and it is a very crucial point this
because what we are saying here is in the emerging markets, essentially we are now building
in 20% compound inflation rates and the impact of that on the West is around about 5% or
6% inflation that we feel; and because we are uncompetitive with them our wages really
cannot move so we take that as a massive hit to our billing standards. That is why when
going around and talking to retailers, they say they have never known it as bad as it has been
for the last two months. It is exaggerated by the fact that the public sector expect job losses
to come through and so they are very nervous, so there is a bit of a savings rate rise as well
but the truth is, I am afraid, it is going to be and is quite painful in the West and if you are in
Ireland even more painful because wages are running at minus 10. But the truth is the Irish
are running towards the emerging markets because if they are going at minus 10 and wage
inflation is at plus 20, wherever you start from in emerging markets, the only question is,
when do emerging markets become uncompetitive with the West and what does that do? To
give you an idea of how fast that is going or where we are, I just take Argentina which is very
badly run but the fact is that since Kirchner died in October of last year essentially inflation
has run at 22%, that is to 22% in pretty well six months, and yet the currency is only off 4%.
So, therefore, what you are looking at is an 18% rise in the real value of the expensiveness of
Argentinean exports etc.

That is basically happening everywhere and my cry here is, obviously looking at this chart,
when you look at 2010 you see UK GNP up 6%, perfectly okay, inflation 5%, wage growth
only 1.8%, so cost of living rising by 3.2%, no good reason basically to raise interest rates.
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Looking at this year basically we are having thankfully, tighter fiscal policy, GNP at 4%,
inflation at 5%, wage growth at 1% and the cost of living rising even more sharply. Again,
no good reason to raise interest rates, especially since the currency is strong. Then the
question only is when you get to a position where the West is competitive, we are not going
to continue to see wage growth of 1.8% or 1%, because the fact is we are building up this
sense in which we are way behind the line in terms of keeping up the cost of living so we
anticipate, whether it is 2012 or whether it is 2013, that we will not see a 1% rise, we will see
a 8% rise and if we see a 8% rise, 75% of that will come through straight back into inflation.
So our forecast is that inflation, far from being 5% at the end of that, it will be at 11%.
Which means at that moment interest rates have to rise because that is the moment that the
central banks have got that mandate. If interest rates rise from 0% to 7%, you can be sure
that at round about 35% to 40% of that rise will make its way again through to inflation.

So our cry is that you move into a very different kind of cost cut inflation coming through in
which essentially the central bank remains behind the curve even if they are raising interest
rates which themselves are much higher, the rises are much steeper and faster than people
anticipate but I think that is the shock bit and that is why I hope with all of you, I spend my
life worrying about that bit, not really about where we are now but about that and making
sure that we have got the right franchises.

Where are we in terms of when is that going to come? Well the easy way to see it is
obviously with current account surpluses in these emerging markets. The other side of this is
as they become less competitive we have become more competitive, our exports rise, and
their exports fall. We see this coming through and it looks like it is not going to come
through very quickly, not yet and that gives us some time but in this environment really
again, page 15, what are you wanting to buy? When you are seeing consumption rising in
emerging markets and falling in the West, obviously you want to be in those companies that
are selling into those emerging markets; they are selling into the consumer. The answer is
that there are very few ways in which you can play that. The great joy is that Germany is
basically beautifully suited because it sells into those emerging markets in terms of capital
goods and on top of that, as page 16 shows you, it has seen this fantastic improvement in
productivity relative to major competitors and the fact that it has also been part of the euro, it
should be 20% to 30% more expensive than it is today and that 20% to 30% we think that
gives German companies about another 150 billion of profitability that they would not
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normally have at this point. It also means that in Germany the authorities are desperately
keen for interest rates to rise and we see in countries which have not got a financial crisis and
have their own currency, like the Swedes, the Swedish Krona has basically appreciated by
5% in the last six weeks and that is why we’ve gone short on the dollar, long on the Swedish
Krona for precisely that reason.

In terms of looking at the companies, where we are and what we like, there are still a lot of
the names that we have had before. Infineon we see as being quintessentially the heart of
Germany, it basically provides all the ICs for the likes of BMW, for Volkswagen, for Robert
Bosch and for Siemen’s, so they are right in the middle there. Currently they are valued
about 1.98 times sales, but with around about 0.5% sales in cash so they are really trading at
around 1.5 times sales and they are making 19% margins. We see they are beneficiaries of
the problems in Japan, of the problems the Japanese component manufacturers have had since
the earthquake and the tsunami and that we see for 25% of their business they have seen a
25% rise in flash prices and that gives them that very nice increase in profitability again
which puts them on a roundabout 7 to 8 times earnings. What one likes about these
businesses and people like Infineon is just how quickly they are increasing their value added
into the car industry. Where they were spending 100 dollars on ICs, in the car industry [in
the past] they are spending 1,000 dollars per car and Infineon are the great beneficiaries of
that.

Sky Deutschland, we have talked a lot about Sky Deutschland over time but it is well worth
understanding because it is still a very controversial opinion, partly because if you are
German you have spent a long time with its predecessors which have really given nothing
that really works. Sky have understood their world and it is like Walmart going outside of
their own country for the first time and in a way I might actually go the other way round.
Basically, page 20 shows you what we saw this quarter, we saw Nokia teaming up with
Microsoft to try and create an alternative to Apple. What Apple has shown is whereas ten
years ago when the internet was created we were sort of shown, hello this is the new world,
this is the jungle and there is a king of the jungle who is called Google and things are cheap
but it is very difficult to find them but that is the new world. What we have just seen in the
last three or four years is that Apple have created an alternative there, a very nice sort of ring
fenced community in which you can do all your shopping, you can buy anything you want
inside of that and you do not really have to go into the internet outside. As a result of that,
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Apple has been repriced, it has got a market cap of 350 billion dollars, it looks pretty
unconquerable. Nokia did not spend enough money or they certainly did not spend it wisely
enough on software and the fact is individuals are not interested about the technology but
about whether they make it work and is it good for them.

It has highlighted the value of a new franchise arising but our cry is to say there is another
franchise that has arisen over the last five years and that is in the pay TV area. Five years ago
everybody thought that people would migrate to PCs and basically where would the pay TV
business be? It has been very good for them in a way because they also have freeview which
is like the Android competitor for Apple but the crucial thing there is that when it comes to
pay TV, the screens have been improving all the time but [in the same way that] you are not
going to improve your PC screen, (why bother with that) but actually - you end up with your
television screen and you go to Blu-ray; and at the same time what we have seen is it has
really been the software, it’s the fact that now the [pay TV] terminal is a dumb terminal so
that all the software is basically introduced at the company’s convenience from HQ. It is
cheap, it is easy, it is downloaded, it also improves the quality all the time of your viewing
and really means that it always looks fresh and new.

That is really where we come onto Sky Deutschland because page 18 shows you, the old EPG
(what you looked at when you basically looked for the programming), on the left hand side
and you could hardly read it and it disappeared off the slides. The new is fantastically quick
and interactive, at any time you just press down and you get a small preview of what you
might be watching. It is very interactive; it is very ‘Appley’. Our cry about that is really that
whereas Sky in the UK spent its life worrying that people would migrate to the PC or an iPad
or whatever, so they spent a lot of money on making sure that the customer would be
followed wherever he went. In Germany what we have is we have an industry which has
essentially not moved in the last 30 years, it was created by Cable, it is very much a business
which is dominated by a lot of debt issuance against all of those Cable businesses, nothing
has been allowed to change or to move. There has been no improvement, customers have not
seen anything. Essentially what we are seeing here, on the left hand side, is that for the old
model, basically Satellite, you had to pay for on top of everything else but often the cost of
Cable was part of the rent even sometimes so you did not see it [and so seemed much cheaper
in comparison]. So essentially suddenly what we are looking at here is Sky Deutschland, they

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have not got it yet but if they can a team up with an internet provider they can provide not
only the internet for the clients but also that whole thing is much cheaper than the existing.

Our thing is to say, what are you paying for this? On page 19, we have this business with two
million subscribers, a billion of revenues which actually in August of last year was being
valued at 600 million, having put just 500 million of cash into it, so kind of 1.2 times cash
and with essentially nothing. Since then it has gone up three fold, it is now valued at about
not quite three fold, 1.7 billion. We are looking at six million subscribers three years out,
that’s essentially two billion of revenues, I mean maybe 2.4 billion there, 500 million EBIT
and currently market cap at 1.7 billion. But we are also saying, one loves to see businesses
and franchises being built out which are really giving something to the customer and are very
linked in again with sport which Sky has understood very well. Management expect, quite
optimistically, to get to twenty million households in ten years. Twenty million households
at that point we are really looking at something with 10 billion of revenues if not more than
that and we would be expecting 20% margin so that is 20 billion of market cap, currently 1.7
billion so there is a lot to go for there and that is quite typical of what we are doing.

Page 21 shows you just the correlation between stocks and the market itself and what we saw
last year, which is why it was quite painful, was really up until the end of August, it was all
about an on/off switch. It was always risk on, risk off and the answer is there is no chance of
stock picking and since the end of August through to this year, we are just starting to see
proper stock picking taking place and the benefits and that is what we can show you. Our
three month numbers and our six month numbers actually point to exactly that and our own
view is that the blue chips are very good value, they are very cheap, they are not expensive
and they are kind of in the right place in Europe because of how cheap the euro has been. To
add to that businesses which are entrepreneurial and building franchises is really what our job
is about and it is what I talked about before, we are trying to grow trees not flowers and after
periods like the last couple of years when it has been very easy to be distracted by the macro,
it has also been easy to forget what we’re currently in the business of doing.

I feel the important point to stress as I come to page 22 is the up work, we have got a lot of
companies we like, a lot of my thinking definitely focuses on what happens when we really
need that fire practice because what I see then is really no equities are going to easily be able
to withstand such a violent rise in interest rates and also a pretty big change in the way in
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which the economy is working at that point. It is interesting to see that in Argentina what is
really going gang busters is sales of washing machines and everything else but actually of
course what they saw, from the last five years until now, they saw a massive rise in their cost
of living and essentially the things that don’t get bought such as their cars or washing
machines or any of those consumer capital goods and all I want to make sure is we are kind
of really well placed at that point.

In the meantime as I say the hardest place looks to be anything that was built on the arbitrage
between cheap emerging markets and rich consumers in the West. That obviously looks like
a very, very difficult place and I do not think that is going to get any easier. Anecdotally not
only are people having a hard time there but because of what has happened to copper etc.,
these retailers are not only knowing that their current sales are terrible but that actually next
year a frock that cost £180 will cost £240 and how is that going to be squared with the
consumer? It is a difficult one but of course as we say what you have got to keep on
remembering is that actually there is a convergence going on here but there is a benefit to the
West from the fact that inflation is taking place, the fact is we do end up with much more
competitive western economies, albeit at the same time they will become flooded with
inflation.

Thank you very much indeed, bye.

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