Before Tim Murray co-founded the edgy fraud-busting equity and macro research house, J Capital, and before he made headlines as the Labor candidate for the NSW seat of Wentworth, he could lay claim to another notable role: introducing China to the cooking of Jamie Oliver.
Murray helped set up a media company that published the leading cooking magazine in China and the bestselling cookbook series. It was illegal for a foreigner to be publishing in China, but others were doing it too, and eventually the business was acquired by Swiss group Ringier, so Murray headed its China operations.
“The way you run a publishing business in China, where you’re not allowed to own a publishing business, is you break it into parts. I’m not publishing, I’m providing licensed content to a state-owned publisher. They then rent back to me the rights to sell the advertising, and I was able to create a distribution company as the laws changed, so I could distribute,” he recalls.
“Playing cat and mouse with the propaganda bureau was hilarious.”
The least profitable title, an English-language business magazine, was “forever getting kicked by the censors”.
Murray’s team figured out if there was an article they wanted to get past their skilled 75-year old censor, the best way was to sabotage another article with deliberate grammatical errors to elicit the Chinese gentleman’s ire for imperfect English.
“He would come back and say, ‘oh, you’ve made all these mistakes here and the grammar shouldn’t be like that’. But because he put so much energy into telling us how bad we were, we could get the other one through and he didn’t notice. That’s often how you do things.”
The cooking titles were hugely successful, but hard to make money from. They were comparable to the Women’s Weekly standard of achievable and emotive recipes that elevate household cooking with stylised staging and modern flavours. A popular cover was Shanghai dumplings and anything Italian also did well.
“What we really made money from was in-flight magazines, we had the largest circulation in-flight magazine in China, and it was just throwing off cash,” Murray says. As dull as it was, it commandeered an attractive demographic.
Murray joined Ringier’s global board for new media, but saw where publishing was headed and didn’t have the same passion for online classifieds.
“So I just thought, got to get out of this. The person who I’d originally started the publishing business with, Anne Stevenson-Yang, she was already working on a finance concept company. I jumped ship and worked with her.” And that became J Capital.
“We’d been in China almost 20 years by then, both of us,” he recalls. Independent equity research is not that different to publishing, in that there is a defined audience seeking to navigate the information arbitrage between English-speaking finance markets and Chinese-speaking business activity.
“I’d never really worked in [finance] but I had run companies, I knew how companies operated and I had been screwed in business in China every single way possible.”
Identifying fraud “for us is like second nature”.
J Capital relies on primary research, not the reactionary research to economic data most sell-side brokers do. “We’ll go and speak with 10 bankers and trust companies in China in five cities to work out what actually is happening. I do commodities, so I’ll speak with steel traders, bankers, property developers.”
A macroeconomic view is essential because “policy changes everything” in China. What follows are tradeable ideas hedge funds can act on.
“You’ve got normal everyday business and complete fraud and then you’ve got gradations in between. In general if you’re not bending the rules you can’t win in China. So it’s a different ethical environment that you find yourself in. To be doing something that’s not in-line with laws, it’s pretty normal,” Murray says.
“Once you start breaking rules it’s like the thief who gets away with it once, ‘why don’t I just try again?'”
In identifying frauds he looks for margins that don’t match the industry. “Particularly if it’s a commodity-like area or an area that’s not distinguished. That couldn’t be possible.”
He also follows the auditors a company uses, and the brokers attached to the listing. Naturally, it is much harder to identify fraud in larger companies.
“Tencent and Alibaba, those two. What are they? They’re frauds for sure. Now you can talk about it because they’ve already come off [in price], but you couldn’t have talked about this two years ago, if you’d said that, people would say ‘you’re a crank’.
“But, you couldn’t have proved it. Look at their level of disclosure, there’s nothing there. Alibaba and its GMV – whatever GMV is – you can’t prove anything. Tencent was always what we call propping and tunnelling: pretending they had high profits and then tunnelling fake cash off the balance sheet through acquisitions. That’s a very common strategy. But hard to prove for an organisation of that size.”
Hedge funds would often respond, “who cares? All companies in China are a bit fraudulent. As long as it’s making money. There’s a lot of that.”
Policy moves markets
The China trade can be hot and cold, and things are looking bullish again for the shorts because of so much new equity issuance, and investors just being occupied elsewhere.
“It’s like 2012 all over again, 2012 was the best year – we did 40 short ideas, 38 of them worked out and the average return was 60 per cent,” Murray says. “The two that didn’t work out, one we were just wrong, the other one had a go-private, and who knows.”
Murray’s work has led him to conclude that China has reached the physical limit of what it can build and what appears to be demand-driven strength in commodity prices is not what it seems.
“I am going to call time on stimulus spending in China,” he says.
Steel production is reported at growing 6.5 per cent, but he disputes this.
A move to eliminate capacity overly targeted private industry capacity – most of which was not recorded in statistics. “Now that’s gone and we see statistical growth.” The supply is broadly coming from state-owned enterprises, representing a higher utilisation of state-owned capacity, which appears to be growth “but it’s not”.
Steel production is either flat or slightly negative, he says. “How do you get 6.5 per cent growth when domestic iron ore is going down, and imports of iron ore [too]? And that’s inventory adjusted. There is a way that could be the case: more scrap steel. But the adjustment of scrap steel into steel production happened 18 months ago, so you wouldn’t be seeing it in the growth this year.”
More importantly: if genuine demand is flat or down slightly, how come commodity prices are high? “Now that’s the conundrum,” Murray says.
What he finds is that a renationalisation of Chinese industry, particularly in the steel industry, has occurred, almost by accident.
“You go to the province and you say, Hebei province, the main producing province, ‘you’ve got to cut x’. Everybody’s in the party, and has been given that order and they must do it. But then you’ve got two types of steel plants in the province, private and state-owned. Will the party secretary of the province say to the party secretary of the state-owned enterprise, cut your capacity? No way.”
It seems 98 per cent of capacity elimination in Hebei province was private. And yet, in promoting state-owned enterprises by crushing private ones, the government can control prices and correct chronic oversupply, with the benefit of hitting environmental targets.
“You get the political hit of making everybody feel good because you stopped it, but what you’re doing is you’re forcing the sector to produce in a constrained way.”
A steel plant told it can only operate 60 per cent of the time will optimise its blast furnace to produce maximum output and buy high-grade iron ore and coking coal, reflecting in widening spreads.
“The price increase is created by this cartelisation of the steel sector to keep prices up. That was a policy of the central government to regain control over the industry so they can get them out of chronic debt by making the profits high, even in a low demand environment. You got to hand it to them, they can pull a rabbit out of their hat, a lot.”
But, when demand falls below supply, the incentive to use higher grades will end and the price of benchmark 62 per cent iron ore delivered to North China will fall.
“I don’t think Australia’s ready for it, because when you see commodity prices come off it will have a massive impact on revenue generation.”
Trade war issues
Since demand for construction steel used in property is down, the only alternative is infrastructure.
But that ignores the fact there has been a bifurcation of China into bad and good provinces. “Bad provinces, they’ve been exaggerating their fiscal revenues in order to spend more on infrastructure so at the end of last year the central government said ‘stop’. Places like Xinjiang, Gansu, inner Mongolia, Liaoning province, Tianjin province, all lied about their fiscal revenue.
“You can’t grow infrastructure in the bad provinces, it’s not possible. There’s not projects worth doing, they’re not fiscally capable of servicing them,” he continues. “And that is the end of commodity prices and we’ll see that next year.”
Murray thinks renminbi could trade at 10 to the US dollar, from around 7, representing a depreciation of the Chinese currency.
“That will throw fuel onto the trade war because Trump will say ‘you’re lowering your exchange rate in order to get around my tariffs,’ but they’re not.”
Having studied Chinese political economy in the 1980s, “when it wasn’t a thing”, Murray’s classical training in command economies still informs the way he analyses China today. After leaving his first job working at the Australian embassy, he joined Fosters selling beer. The brewer’s foray into China is a source of pain for investors who can remember that far back.
“It was a pretty disastrous affair and I contributed to that disaster,” Murray says. “I was doing my best but it was a tough market.” The price of a commoditised bottle of water was higher than a bottle of beer – a hangover from controlled prices.
Back when living in China, he was compelled to lend a hand to the Shanghai and Beijing international literary festivals, working with Michelle Garnaut, who runs the famous M on the Bund.
“Work dominates a lot of expatriate life, you need something outside of work,” he says, having returned to Sydney. “The other thing is expatriates are really opinionated about how Australia’s going compared to the rest of the world. Most people will talk about it but not act. So when I came back, I wanted to act.”
He joined the Labor Party and is president of his local surf club, Tamarama. “Having lived in a country that doesn’t allow civil society to blossom, you really value that, the fact you can get together and do whatever you like.”
He’s unwilling to blame government for problems, that being a shortcut for citizens to abrogate their own responsibilities. “Get it done yourself. It’s how we behave at a micro level that makes up our country. And governments will generally follow what we’re doing, they’re not setting the agenda anymore.”