Eike Batista and the "X-Factor" going wrong

A friend sent me an e-mail asking whether I was going to write something on the bad luck strike (let’s call it that) on the shares of companies controlled by the iconic tycoon Eike Batista, the infamous “group X” - my friend knows I’ve been quite skeptical about those enterprises for a long time. I replied saying I didn’t intend to because, first, I know almost nothing about the oil business - the most salient loss in the market (half of market value, during June) was from oil company OGX, in theory triggered by a cut in production estimates from an important exploration area. Second, it was still too early to declare Eike and his companies a complete fraud. This was while OGX shares were falling “just” 7% during Thursday session. By the end of the afternoon, movement accelerated to a whopping 20% plunge, shares of MMX (Batista’s iron ore mining company) lost another 17% and I got the impression that, as in the famous Rudi Dornbusch quote, things might have started to happen faster than anyone could imagine.

Eike Batista is the archetype of the “rising Brazil” illusion, a country that would get rich in just one generation with a model based in little more than commodity exploration and the belief that terms of trade will never turn worse again. The genius of Eike was perceiving that the world became convinced of those fallacies, and pre-operational companies, with all the risk associated to this stage of business cycle and the idiosyncrasies of  commodity exploration, could be sold as mature enterprises, cash cows in full swing. I think the adjustment of market prices in June (which I’m not sure is already over) reflects the end of this illusion and a repricing of the companies to better reflect the reality, instead of a future when everything turned right. A last round of repricing can happen if market convinces itself that some of the projects sold are outright frauds and the investment will be lost. I don’t know these enterprises deeply enough to affirm this will happen, yet it would not be a surprise to me. Echoing in my head are some words I heard from professor L. Randall Wray in a seminar few months ago: “nothing is more profitable than fraud”. It’s possible that the madness associated with the Brazil bullish case was taken to a point where the inflated expectation of returns could only be met with scams (and “rational” markets sometimes ask for them). Next couple of years should provide a good test for this thesis.

Another pernicious aspect of the Eike phenomena is the use of his persona as a role model of visionary capitalist genius - nothing is more illustrative of that than the ludicrous cover of a January issue of the most read weekly magazine in Brazil (Veja). Capitalism, in this case, is the exploration of the primary sector - capital intensive, with very low innovation potential and strongly regulated by the government - using huge volumes of funding at subsidised rates from a state owned development bank (BNDES). Compare with the path followed by truly visionary capitalists (may be Steve Jobs, most obvious recent case) and go find the seven errors. Even the allusion to China case is significative: brutal growth in all senses, also with the possibility of being fed beyond its potential with a myriad of frauds. Is that the model Brazil wants to replicate?

“Neither we were so bad, nor we became so good”, that’s what professor Eduardo Giannetti stated in an interview in December 2009. Thinking of markets, combining the time while the “we became so good”  illusion lasted with the second rule of Bob Farrell (“excesses in one direction lead to excesses in the opposite direction”), we can expect a long and harsh period of correction, until it looks like we’re very bad again. Maybe we’re watching the beginning of this movement. Hope for the best, prepare for the worst.