Scalper1 News
Summary There are risks associated with businesses relying on government projects. Colt is an example of a business disrupted by losing government contract. What all investors have to be aware of for companies with a lot of government business exposure. There are an increasing number of calls for governments around the world spending a lot more money on infrastructure projects, as growth in the private sector continues to slow down. One of the tactics used to twist the arm of politicians is to point to decaying bridges and the last time they were upgraded, and similar pressures, asserted and leaked to the media to attempt to create a groundswell of public pressure to spend the money. Then there is the job creation side of it too. What lawmaker wants to be identified as one who resists the creation of more jobs; and in the case of government, those will generate above-market wages and benefits, even though in the longer term paying for all of it isn’t sustainable. With a lot of emotion on both sides of the issue, it lands on investors to sort through it and figure out if they can benefit from it. China’s ghost cities In recent history there probably isn’t anything more wasteful than the “ghost cities” created by China, which have few people living in them and no industry for jobs. They were built in order to create construction jobs, and once they were completed, the debt to develop them remained with nothing to generate revenue in the form of taxes, or to produce business momentum in the private sector. It was a classic catch-22. There were no people to inhabit the city, so there was no businesses that would want to locate in them. People were looking for jobs and businesses were looking for people to buy their products or services. Neither inhabited the cities. So the cities just sit there lying relatively bare with no reason for people to live in them. They’re simply brick and mortar built in the form of houses and buildings sitting empty. We know it won’t take long for nature to start reclaiming these cities. Political issues Since almost everything surrounding infrastructure projects are related to politics, there are all sorts of problems associated with them that the private sector usually doesn’t have to deal with; at least to the degree the public sector has to. For example, there are legal requirements for companies the work is farmed out to that they must adhere to if they want to have a chance at winning the business from the government. This plays out in a variety of ways, depending on the country. There of course is the strong potential for corruption, again, the level of which is determined by the specific region of the world infrastructure is being spent on. Also at issue over the longer term, is all of this infrastructure is very costly and debatable as to the real value it provides for citizens. That means it all has to be repaid, and that means either higher taxes or more printing of money by a central bank. That’s important because public sentiment can quickly change, which could have an impact on the future of a company doing business with the government. What’s the problem? Where the major challenge with all of this is at the level of exposure a company has in regard to government projects. That can be infrastructure or otherwise. One recent example on the government contract side was the loss of an $84 million contract by Colt three years ago, which ultimately led to its bankruptcy. Being able to provide guns to the military, once it had won the contract, meant during that time it had a monopoly on military gun sales for the duration of the contract. Once the contract was not renewed, it wasn’t able to compete in the direct to consumer market because its prices were higher than their competitors. Another reason example that’s shaking up the markets some was after the expiry of the Export-Import Bank, which Congress decided not to renew. General Electric (NYSE: GE ) has been the proxy of how it can have an effect on companies, as numerous contracts came under immediate threat because companies relied upon the Bank for financial support. Companies as large as General Electric won’t have trouble attracting financing because of its size and the type of jobs and projects it can bring to other regions of the world, but that’s not the point. The point is when dealing with governments, politics and fickle politicians can make abrupt decisions that can disrupt a business and an industry, specifically when relying on government contracts or government financing for a significant portion of a business. I’m not talking about changing laws here, I’m talking about losing government contracts or financial support that had a heavy impact on the performance of a business, and were expected to continue. Conclusion There is no doubt the global economy is slowing down, and one of the actions being called for is for governments to increase infrastructure spending. Not only does this include a lot of risk, as shown above, but many investors have ethical issues with the government taking on that type of debt and spending on dubious projects that have questionable value. That said, there are a number of companies that win contract year after year, and it’s a big part of their business success. Again, General Electric is an example of that. At issue for some investors is having to set aside personal preferences and analyze the company as it is, even if it is growing via government largesse. I’ve seen some investors look for minutia in order to find something wrong with these companies, even if they’ve locked in contracts that guarantee revenue for a number of years. For the reasons mentioned earlier, I tend not to invest in companies with a lot of reliance on government spending, because I see it as very risky. At the same time, it depends on the size of the company and the type of projects it’s engaged in as to the level of risk. It’s doubtful a company that started improving bridges would lose the contract in the middle of the work. What can’t be assumed is once a portion of the work under contract is completed, new work will be awarded to the company. That’s Colt’s story. And it’s not an unusual one when dealing with government. Infrastructure projects are highly controversial and scrutinized by a lot of special interest groups. It normally doesn’t hurt the brand of a company to be involved in them. The risk is spending money on the business with the expectations of doing further business with the government, and having another company get the business. Companies with significant exposure to government projects are okay as long as the investors understands the terms and duration of the contract. What can’t be counted on that once it’s completed the company will get more government business. That makes it hard to analyze the business because of capex needed to perform the job, and the resultant fallout if it no longer has the revenue stream to pay off its added expenses. Government infrastructure projects may sound good for the economy, but they aren’t always good for a company or investors. Invest accordingly. Scalper1 News
Scalper1 News