Wednesday, February 25, 2015

HP's First Quarter 2015 Surprises Some

HP reported revenue of $26.8 billion for the first quarter of fiscal 2015, a year-over-year decline of 2% on a constant currency basis.  Diluted EPS on a GAAP reporting basis was $0.73 per share, and $0.92 on an non-GAAP basis, which was at the high end of the guidance range for the quarter.

All of the operating businesses has yr/yr improvements in their non-GAAP operating margin rates, the CEO noted.  65% of corporate revenue was recorded OUS.  Despite hitting the top end of the non-GAAP EPS guidance range, the impact of currency in the quarter was stronger than expected, and will be substantially stronger than prior expectations for the balance of FY15.

As happens in corporate reporting, especially in a behemoth like HP with distinct businesses with some many moving parts, a number might have been reached, but it was reached in a completely different way than the forecast assumed.

Currency headwinds seem more appropriately characterized as currency typhoons.  Current expectations for EPS impacts of currency were characterized as $0.60 per share gross, and $0.30 per share net, on an annual basis.

The forecast of flat revenue for FY15 yr/yr seems particularly challenging in light of the heightened currency impact, but management cited continuing progress in printing revenue, enterprise businesses, as well as a meaningful improvement in Enterprise services revenue.

All of the analysts completely missed on cash flow from operations for the quarter, as the costs of separating the company in to HP, Inc. and HP Enterprise were omitted from their models, even as guesstimates.  $80 million of expense was recorded in the quarter, $250 million is now expected in the second quarter, and $1.3 billion in corporate cost and additional taxes are expected for the full fiscal year 2015.

Printing, 20% of the consolidated revenue for the quarter, generated a non-GAAP operating profit of $1,067 billion, 39% of the segment total, with an operating margin rate of 19.2%.  The margin rate was consistent with the prior period and described as "unsustainable" and "bad for business" by the new business leader.  Supplies were down 5% and total units down 4%, as competition from Japanese vendors in corporate accounts was strong due to a weakening yen.

Personal System sales were 31% of revenue, producing non-GAAP operating margin of $313 million, a margin rate of 3.7%; PS contributed 11% of segment income, and HP reestablished itself as the leader in the notebook segment.

So, the core of what will become HP, Inc. accounted for 51%  of quarterly consolidated revenue and 50% of segment operating income.

The Enterprise Group accounted for 25% of quarterly revenue, earning $1,090 in operating profit, a margin rate of 15.6%, which was a healthy 40% of the segment operating profit total.

Enterprise Services accounted for 18% of quarterly consolidated revenue and only 5% of segment operating profit, but  the stage was being set, management said, for a better performance in the back half of FY15.  The latter two groups, plus Software, will comprise HP Enterprise.

The CEO pointed out that two Fortune 50 global companies were being created out of the separation of HP.  As complicated as the separation sounds, it is ultimately lots of nitty gritty work, expensive but very doable.  Changing the culture of one behemoth serving two distinct markets with so many different offerings would be well nigh impossible.  In this sense, the split is better for the businesses, their employees, for customers and shareholders.

Referring to our recent post the go-to-market problems facing companies like HP, the CEO noted that some "realigning of sales incentives" had occurred in the Enterprise businesses in the quarter, and it's clear to us that a different kind of sales team with different incentives will be an indispensable part of a successful tech company in the future.

A big corporate client win at Deutsche Bank was highlighted during the call, and it illustrated the nature of such wins for the future HP Enterprise.  It involved lots of different strategic business units, was led by Enterprise Services, and the Helion offering was a pivotal differentiator.

CEO Whitman noted that despite the fact that 44,000 employees have left the company since the beginning of the restructuring and more is to follow, employees with new, client-facing skill sets will have to be hired, and there are even more opportunities for HP and HP Enterprise to become internally much more efficient in their own systems and processes.

Currency aside, the softer items in the call seemed the most encouraging.

Thursday, February 19, 2015

Apple Pay on Your Apple Watch?

I forgot about the biggest head scratcher in thinking about Apple and what it really wants to be: Apple Pay.  There's nothing more profitable than a large payment network: just have a look at Visa, MasterCard, Discover and American Express.

Private label cards using the MasterCard or Visa networks are a wonderful business for their retail issuers, as research shows that they actually engender loyalty to the co-brander and, provided card users don't abuse their main card, the retail private label cards often get paid more consistently in times of financial difficulty for the card holder.

So, back to Apply Pay. Why?  Check out this link to the Apple Pay site. Look in particular at the picture that goes with this text:
"Apple Watch
 Double-click to pay and go. You can pay with Apple Watch — just double‑click the button next to  the Digital Crown and hold the face of your Apple Watch near the contactless reader. A gentle pulse  and beep confirm that your payment information was sent."

So, in order to save yourself the trouble of scanning the magnetic stripe or reading a security chip on a Bank of America card (pictured on the site), you are going to press a button on a screen which most people can barely read in order to save yourself a second or two, so your funds are debited faster? This physical action is exactly what I have to do on my old digital watches in order to change the modes: it's an awful movement, and in the case of the old watches, sometimes you have to press twice to engage the electronics properly.  The Apple consumer with a $500 watch gets her kicks out of this?

So, again, Apple wants a piece of the action from the big payment networks?  A company with a $700 billion capitalization is wasting its time doing this?

Meanwhile, MasterCard and Silicon Valley Bank have launched their own VC type effort to help entrepreneurial companies interested in setting up their own payment networks to profit from MasterCard's expertise on security and scale up strategies. The beauty of this effort is that MasterCard keeps tabs on what's out there, Silicon Valley Bank eventually gets a lending relationship with lots of warrants, and if successful, MasterCard buys new business.  Meanwhile, what will Apple Pay be doing?  Probably floundering around.

Much as I dislike the monopolistic payment networks whose interchange fees are still monstrously expensive given their economies of scale, it is good to deal with them when there are illegal or problem transactions on the card.  Because of bank and credit card industry regulations, it is easy to get problems on the record, with documentation, and eventually resolved, almost always to the consumer's satisfaction.

If Apple Pay were ever to become a significant enterprise, can you imagine contacting their customer support?  Who would they be?  Where would they be?  That organization would probably be as consumer friendly as Comcast.  What business is Apple in?  I think everyone knows.  Going forward, it may not be so clear, probably to the detriment of returns relative to the past decade.

Wednesday, February 18, 2015

Will Apple Inevitably Lose Its Way?

This parody of Rene Magritte's painting struck me as being very appropriate for this post. My former colleague Michael Moe's firm, GSV Capital, listed the Top 25 Best Performing Stocks for the period 2004-2014, and Apple was number 9, growing its EPS at a CAGR of 54% over the period and its stock price at a rate of 37% per annum.  In absolute terms, Apple's performance was stunning looking at the growth of its market capitalization: it went from $26 billion at 12/31/2004 to $647 billion at 12/31/2014.  If the Apple of Steve Jobs' reign is painted in the middle, Mr. Jobs left current CEO Tim Cook with his portrait at the left. (not exactly proportionate, but you can see the idea.)  It is almost inconceivable performance, which is why it's unlikely to be repeated.

"Trees don't grow to the sky," as students learn in their introductory microeconomics classes. Also, as GSV notes, ",,if Apple were to notch the same stock performance in the next ten years as it has in the past ten years, it would have roughly a $40 trillion market cap--nearly 2x the entire U.S. Equity Capital Markets."  GSV also notes that no company has remained in the list for two consecutive ten year periods.  

We have always taken the position that Apple is a cult stock, namely most investors buy it for philosophical reasons, e.g. they love Steve Jobs, they work in creative industries that use Macs and want to support the company that makes their great machines, they work in public education and admire Apple's commitment to that market, they believe that Apple's mission is about much more than making money, or they believe that the stock is "cheap," selling at 11x estimated earnings, net of cash. Each one of these reasons has 5 or more variations for cult members. I have considered owning it many times, but couldn't pull the trigger--my loss for the past ten years.

What are some signals flashing yellow, besides those presented above?  Apple is flush with cash.  Most companies in this position have their investors clamoring for a return of the cash through dividends or share buybacks.  The company has arguably responded on both counts by planning to return $130 billion to shareholders through the end of 2015. No yellow here.

The company announces something called Project Titan, a skunkworks to design an electric car. Hello?  This is an industry far away from Apple's core competencies, and one which is cyclical, rife with competitors, and subject to all kinds of regulation, something that Apple strenuously avoids.  This project should sound about as exciting to Apple shareholders as Google's driverless car is to its shareholders.  I don't think either of the two Steves would be excited about this project.

More recently comes the famous Apple Watch.  Initial rumors had this device being the centerpiece of the company's projected foray into consumer healthcare monitoring, patient management and anything called e-health.  However, as the Wall Street Journal reported, none of these features made it into the product to be launched this April.  Besides some features not working or being to complex, the Journal writes, "And still others could have prompted unwanted regulatory insight.."  Okay, maybe, but electric cars?

The watch being launched needs to be near an owner's iPhone in order to have wireless connectivity, and so the Journal notes that it appears to be an add-on accessory to an existing owner's iPhone. Cultish iPhone owners may go for this, but surely new customers wouldn't want to jump straight into a new Apple Watch and iPhone at one go?  That's a big ticket.  

There is a range of price points.  At the the lower end, Apple Watch competes with FitBits and other established products in a crowded segment. At the upper end, the ultra models feature 18 karat gold casing and will retail above $4,000.  Even billionaire oligarchs and young tech company CEOs who have sold their companies to Google may think twice about this.  Isn't there more cachet in a Tag Heuer or some of the newer, ultra-luxury watch brands?  

CEO Tim Cook says to the Journal, "One of the biggest surprises people are going to have when they start using it is the breadth of what it will do."  And what is that?  Even the reviewers can't come up with the wonderful things.  

Probably, the first generation product buyers will be orphaned as the company eventually figures out what the product should really be. In this respect, the company would then appear to be more like Microsoft, which first launched Surface RT before realizing that it was rubbish and launching Surface Pro 3, leaving a lot of unhappy consumers.  

When Apple launched the iPod for music, it wasn't the first player in the market.  Creative Labs made a relatively inexpensive, functional, intuitive series of players called Zen that really served music lovers well.  But, Apple miniaturized the iPod, which was very important to consumers, and it launched iTunes that turned the music business upside down.  A key innovation and a market disruption, and it led to success.  So far, the watch looks like late entry with a placeholder product.  A definite yellow signal, but shareholders have to stay tuned.

What about emerging markets?  Is Apple ceding all but the uber-middle class to Chinese and other competitors?  Will Apple become the Louis Vuitton of electronic gear?  

If Apple wants to get into other businesses like making cars, wouldn't shareholders rather diversify their holdings themselves by buying an emerging car company?  Or, wouldn't they prefer to buy an emerging healthcare informatics company?  What is Apple all about?  Could the story end for shareholders like the third panel on the Magritte parody?  Who knows. 

Tuesday, February 17, 2015

Greece Is One Problem of Many for the European Union

Here's something we wrote in 2013, writing about Greece and its possible exit from the euro:
  • The European monetary system still has fundamental design and execution flaws that make it unstable in most environments;
  • It offers peripheral members few real benefits except access to easy credit; 
  • Unless the peripheral countries undertake real economic reforms, the austerity medicine may make the patient better, if it hasn't killed him first;
  • French, European and Italian banks need to take their medicine and acknowledge the diminished economic values of sovereign debt on their balance sheets;
  • The continuing struggle for EU power between France and Germany is very analogous to the struggle between our two sides in Congress.  Despite all the nice rhetoric and the ECB posturing, their divergent interests still limit the effectiveness of the monetary union. 
What has changed, after all the posturing by the Greek governments,ECB, the Eurocrats, Chancellor Merkel, President Hollande, the IMF and all the other zombie actors on the European stage? In terms of events, lots; fundamentally nothing has changed.  

Greece has sung out of the austerity hymn book, and it has received substantial transfers, all with different names.  Although its ratio of debt to GDP has come down from its peak, it is still unsustainable and no amount of austerity can save the situation without a currency devaluation lever to help the demand side; the euro has taken this instrument away.  So, point number one is still true, as is point number two.  Greece got its bailout money, much of which comes due in 2015-2016 and which cannot be repaid, only re-restructured. 

The austerity medicine is killing the patient, as no real reforms have been undertaken.

Economic storm clouds lie over several economies, some peripheral and one core.  Dumpster diving was prevalent in nice Barcelona neighborhoods several years ago.  The latest Eurostat numbers for 2013 show youth unemployment rates of 42% for Spain, 29% for Portugal and 49% for Greece.  What's worse, the rate is 30% for Italy, a much larger economy.  

There can never, and should never, be any fiscal harmonization as the Eurocrats advocate, solely for their own perpetual employment.  Right now, the individual social compacts between Spanish voters and their government is at risk.  If their leaders really have no real economic levers to make their economies more globally competitive, and Spanish leaders look to Bonn and Brussels for a handout, then why not just take to the streets and kick them all out?  The last time I looked, the ECB does not have an army, so they would be no help. 

Chancellor Merkel has beaten on the fiscal responsibility drums for several years, and Germany voters couldn't accept mutualization of EU peripheral country debt.  Fine, but if the euro is to be something beneficial for all its members, the current system and its architecture have to be razed.  Germany has to show leadership, but it can't.

It's self-appointed co-star, France, will always be on the stage beside Germany, and its economy continues to need fundamental reforms on the domestic front. France will never let Germany take the lead in defining a new European monetary system. The Brussels bureaucracy won't let itself be unwound. 

I have listened to several webcasts from really smart economic and financial economists from Chicago Booth and various European think tanks. They are out of ideas. A Grexit would be "catastrophic," but all of the various costumes put on maintaining the status quo can lead to a Greek tragedy eventually. 

Wednesday, February 4, 2015

President Putin's Adventurism in Ukraine Won't Solve His Problems

As the Wall Street Journal notes, President Putin's objectives in Ukraine included sending a message to dissident political and ethnic groups in Russia about the consequences of looking West or for independence. As we've written about for some time, strengthening Ukraine's economy with Russian help, or at least with non-interference, would have been the best hand for him to play.

Now, the collapse in energy and materials prices have taken away the biggest levers Mr. Putin planned to use on major oil companies and on Western Europe.

In the background, the long-run demographics in Russia don't favor prolonged dominance by a native Russian majority.  Russia's Muslim population is projected to grow from some 18 million in 2010 to approximately 19 million in 2030, according to estimates reported by the Pew Foundation.

Rampant alcoholism among the native Russian population, along with public health problems and higher death rates continues to be an issue, and the WSJ suggests that the Putin government is getting desperate enough dealing with population unrest as to use vodka as a 'pacifier.'

Predictably,oligarchs and successful business owners have long been buying up London and U.S. real estate, and the capital flight continues.

This unstable situation bears watching, but our foreign-policy challenged administration seems to be focused on domestic election-oriented issues at present.