Tip for today: Being Right or Making Money

GroupMe, a service that lets users start a group chat using text messages, announced today that it has raised $10.6 million in its second round of funding — but it won’t be generating any kind of revenue any time soon.

The startup lets phone owners create a single phone number for a group chat. Whenever anyone sends a text message to that number, it’s sent out to everyone else in the group. It works for conference calls as well — anyone can dial into the number and start a group chat.

The first version of GroupMe was built over a weekend in May during a hackathon, a type of programming contest which challenges developers to swiftly create a working Web service, sponsored by TechCrunch, the technology blog now owned by AOL. Its creators famously drew offers for funding as soon as they left the stage.

GroupMe is built on top of a service provided by Twilio, a San Francisco-based startup which provides easy access to voice and text-messaging services which might otherwise be out of reach to small companies. Twilio has seen projects that use telephones to do anything from play tic-tac-toe to initiate group text messaging, has been particularly popular and even has its own seed funding program to go with it.

Right now, GroupMe doesn’t even generate any revenue — the service is completely free for users. Twilio, on the other hand, charges two cents to send or receive a text message, with potential volume discounts. Whatever GroupMe’s paying Twilio, it’s a cost that GroupMe appears to be bearing on its own for now. The development group doesn’t have any plans to try to develop a revenue-generating model in the near future. GroupMe has a few ideas like creating sponsored texting groups and brand groups. But that’s all they are for the time being — just ideas — said co-founder Jared Hecht.

“We compressed our 18-month road map into 9 months and we’re still finishing that up before we even consider thinking about revenue,” he said. “Obviously we are not focused on generating revenue right now.”

That didn’t stop Khosla Ventures or any of its other investors from throwing some cash their way. The group raised $850,000 in its first seed round of fundraising from the likes of Ron Conway’s SV Angel and Lerner Ventures. The most recent round of funding was led by Khosla Ventures, General Catalyst Partners and First Round Capital.

GroupMe brought on some pretty heavy-duty talent along with the funding as well. Jeremy Schoenherr, a former developer of Hot Potato and iPhone operating system iOS development expert, has come on board to help develop GroupMe’s mobile applications. Steve Cheney, a former writer with TechCrunch, also joined the team as a business development consultant.

Now that the “distracting” fundraising process is done and the company doesn’t have to worry about making any money for a while, it is turning its entire focus on improving the application, Hecht said.

“Now it’s product time, and it’s buckling down and spinning it out before we even consider finding a revenue,” he said.

Next Story: Access 360 Media raises $40 million-plus for outdoor digital advertising Previous Story: Gadgets galore! Consumer electronics to outpace world economy in 2011

The result is a bunch of excess inventory and poorly thought-out construction projects which have no means of recouping the initial investment needed to repay the bank loans.

This practice is similar to Spain`s situation now where they have entire uninhabited building complexes that have yet to be marked to market, and will probably ultimately be demolished. But at least in Spain, even though it was a construction boom, it was engineered by developers in Spain, and not by some manufacturing outfits like those in China.

So, multiply the bad business project factor by ten and you get an understanding of the magnitude of bad loans on the books of Chinese banks. The problem is being further exacerbated by the practice similar to Spain`s of banks making additional loans to the businesses just so that they can then turnaround and pay back the interest owed on the original loans.

The only way this would work out is if these projects magically develop revenue streams. Unfortunately, in the case of Spain, a 20% unemployment rate, coupled with a still overvalued housing market in which prices still need to come down significantly, would suggest that by the time the Spanish economy recovers enough to support the excess inventory, the abandoned projects are run down and uninhabitable.

A similar scenario could play out in China as well.

True Smart Money Wary of the Write-off Domino

Furthermore, China`s practice of overbuilding at the height of real estate valuations makes even haircuts on loan write-offs an untenable practice for banks, and by further throwing good money after bad, the ultimate mark- to-market effect could be catastrophic for Chinese Banks.

This is the main reason all the major Chinese banks have gone to the market in 2010 to raise more capital before investors wise up to the underlying deficits these banks face, as these bad loans eventually would need to be written off the books.

Victor Shih, a Northwestern University professor estimates that Chinese local governments borrowed some 11.4 trillion renminbi at the end of 2009, and that local government financing loans to be roughly one-third of China's 2009 GDP.

Shih reckons the most likely scenario over the next few years is that there would be increases of non-performing loans ratio from local governments. This would require a large scale of recapitalization of the Chinese banking system, which would eat up a large share of China's foreign exchange reserves and possibly slow down growth.

I do believe Beijing is quite capable of a few bailouts and surviving a widespread banking crisis, but this most definitely will not bode well for the financial markets. That's most likely why you see insiders removing capital from direct exposure to the inevitable re-pricing that will happen throughout Chinese markets from real estate to the stock market.

This can be seen at this early stage by the underperformance of the Chinese stock market compared to other global markets. Remember, foreigners cannot invest directly in these markets, so these capital outflows are truly the smart money.

Logistic Gridlock Crimping the Middle Class

Next let`s look at the recent news regarding a severe cutback in automobile registrations in Beijing to 240,000 in 2011 from 700,000 registered in 2010 by the municipal government. Other large cities in China are bound to follow. This is most likely related to the reported 9-day traffic jam on the Beijing-Tibet expressway in August, and other extended traffic jams throughout China in 2010.

China is trying to build infrastructure projects after the fact; whereas with proper central planning these should have been established far ahead of the massive transition from a rural, agricultural based populous to that of a modern, large city based business and manufacturing concentration.

Simply put, it is impossible for all the Chinese citizens who want and can afford automobiles to be able to own and utilize this form of transport without a total breakdown in the transportation system. We are seeing the early stages of complete and counterproductive gridlock in the transportation system of China, and it is only going to get worse over the next decade.

No Jobs for College Grads

For all the talk about how China graduates more engineers each year, and other college educated young people who have strong backgrounds in the hard sciences than most developed nations combined, this is actually another sign of problems to come over the next decade in China.

China`s wealth and emergence into the second largest business economy hasn`t been built around the need for these types of mind and skill set. So literally you have a large mismatch between the types of available jobs in China, that are supported by the heavy manufacturing and construction intensive focus of the past twenty years, to that of the recently educated pool of graduates who have grown in sizable numbers over the past five years.

The Mind Is A Terrible Thing To Waste

This results in a large human asset class that China is currently wasting, as most of the newly educated workforce is working in jobs which require little or no advanced education at the university level. So you have highly educated university graduates in areas like engineering and accounting working low level service and sales jobs that pay less than many manufacturing jobs.

In short, there are too many highly educated Chinese citizens graduating each year for the number of jobs available needing their skill set because China`s economic model isn`t built around these type of jobs. This type of misaligned employment outcomes never ends well; it usually manifests itself in increased civil and social unrest.

8% Inflation in 2011

The next major challenge for China is a skyrocketing inflation, which at its root is the fact that there are too many people chasing too few resources. This fundamental flaw in population dynamics underpins many of the problems that China faces going forward.

Recent CPI data for November illustrates the inflation problem in China with a reading of 5.1% from a year ago comparison, this is up from a 4.4% reading for the previous month. Couple this with the latest 4% hike in fuel prices in China because of rising oil prices, you could expect future CPI and PPI reports to reflect even higher rates of inflation.

For now, most of the year over year spike has revolved around higher food prices as energy has mainly been flat for 2010 thanks mostly to government subsidies. Now that energy prices have entered the picture, China will start to experience even more inflation pressures in 2011.

Furthermore, with the undervalued yuan pegged to the dollar, it is only getting worse for China in 2011 due to Fed's QE2 pressures on the dollar. The real inflation rate for Chinese citizens for 2011 will probably approach 8% next year.

An Asian Contagion by China?

This escalating inflation concern is further compounded by Beijing's lack of decisive action to combat the problem by delaying a much needed currency appreciation, and hiking interest rates in a timely fashion. There is no getting around the fact that these two things need to occur as soon as possible.

By the time the Chinese government is forced to implement these tightening tools, the damage to the economy is most likely already done. The longer China delays the inevitable serious tightening measures, the harder the economic crash that will occur in the aftermath of these policy changes. And it is unlikely to end well. The resultant impact will probably take the rest of the Asian economies down with it – an Asian Contagion scenario.

History Repeats Itself

Eventually central planners and finance ministers around the world might start to understand that policies which lead to bubbles being formed in the first place are counterproductive in the long run. But until that lesson is learned, it seems like we are doomed to repeat the same mistakes over and over again.

Right now, there are more and more signs coming out of China that all is not well with its economy, and the likelihood of a more severe downturn in the future is a distinct possibility, unless its policy makers take decisive and prudent actions to minimize the damage of a hard landing.

Dian L. Chu, Dec. 25, 2010 | Mobile Reader, Website | Google Profile
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Monday, January 10, 2011

Being Right or Making Money

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