Wednesday, May 27, 2015

HP's 2Q FY 2015 Conference Call: Restructuring Fatigue

I listened to the entire conference call for HP's 2Q 2015, and it was all I could do to stay awake, and I have a huge appetite for these calls after twenty or more years doing them as the CFO/emcee or as the analyst/shareholder consumer.

Just for the context, here are the big numbers.  Revenue of $25.5 billion, down 7% year-over-year and down 2% in constant currency.  Nothing new here, the same quarterly profile and investors exhale that it wasn't as bad as the bears thought.  Diluted EPS of $0.87 were down 1%, better than expected I guess, but GAAP DEPS were down17% y/y at $0.55.

Cash flow from operations of $1.5 billion was down 51% over the anomalous prior-year.  $950 million was returned to shareholders. $950 million was returned to shareholders, of which $659 million were wasted on shareholder repurchases, but this was the same old song.

So, why I am I writing this post?  I honestly feel that everyone believes that there is a very weak case for splitting up the two companies, and you can hear it in the CEO's progress reports and in the tortured analysis of synergies and "dis-synergies," broken into one-time charges, general charges, and further amounts not suggested before.  It's too late now, everything has to go forward.

Really, what the split discloses is this: rationalizing the monster that is HP is akin to a neurosurgeon's separating Siamese twins joined at the brain.  Delicate, long, massively complicated, and the patients could die after a long effort.  No CEO or board has the stomach for this, and so split the company. It is disappointing, because there should be one customer-facing company, but there it is.

Nowhere was this feeling reflected more in the discussion of Enterprise Services: lousy results, changed management, business runoffs, executive changes, lots of new signings, but the same lousy results.

Enterprise was about 43% of quarterly revenue, and Printing about 21%. Personal Systems were 30% of revenue.  HP Enterprise will be a GARP stock according to the CEO, but Cathy Lesjak won't be the CFO, instead she will be going to the value stock, HP Printing.  It should be pretty restful for Cathy counting all that cash and perhaps consolidating some of that business over time.

It should be interesting, but the bear is in the details in this kind of split, as we said from the outset.The inter-company agreement is where things are really fought out, tooth and nail.

Monday, May 25, 2015

A Greek Exit May Be the Lesser of Two Evils

One of my favorite financial commentators, Professor John Cochrane of Chicago Booth pooh-poohs talk about a Greek exit from the euro, saying essentially that we are used to sovereign defaults and this issue is separate and distinct from a decision by Greece to exit the euro.  He writes,
"Greece no more needs to leave the euro zone than it needs to leave the meter zone and recalibrate all its rulers, or than it needs to leave the UTC+2 zone and reset all its clocks to Athens time. When large companies default, they do not need to leave the dollar zone. When cities and even US states default they do not need to leave the dollar zone. A common currency means that sovereigns default just like large financial companies."
But, unlike the U.S. dollar which gained wide acceptance after the detailed architecture of the United States of America had been put in place and operating, the euro was created as a common currency without a political union in place, so I would argue that John's comment misses an essential political difference. Finance, more often than not, turns on politics, which is logical since markets are themselves social constructs in which the rulers of the nation-state have an intense interest.

Going back to 2011, we wrote, "...a paralyzed Europe has to come to terms with the failure of the notion of their common currency union."  

In 2012, we wrote, "Meanwhile, the economic and social  costs of the adjustment to the weaker EU members will be genuinely painful."

I can't believe that it's taken four years for the financial press to wake up to the realities as opposed to covering EU press conferences. The Greek government played chicken with Germany, and Greece blinked. Cash was found, debt repayments were made, but they were made with prior loaned amounts found laying around, lent by the IMF/ECB. This was a cruel joke, and the charade continues, but at what cost?

Greece is a sovereign state, and it should have the freedom to make its own foolish economic decisions and to run itself into the ground, if there is no domestic political will.  Instead, its economy is chronically mismanaged, but more so than Italy or France?  And, though its electorate expressed revulsion at the euro scenario by bringing in a reform party, the people's will continues not to be carried out because of the eurozone's fiscal and economic reform requirements.  Sooner or later, this lack of political freedom is a genuine cost of belonging to the euro zone.  

The contagion issue is a technical red herring, in my opinion.  Policy pundits have argued about this before, to no real conclusion or benefit.  Greece needs to confront its own economic and social mismanagement and deal with monetary issues through its own elected representative government.  If Greece were to reissue the drachma, try to prohibit capital flight, and the drachma rose to 500 drachma/euro, then a rather painful adjustment process would begin and a new equilibrium found. But this process might be less destructive to the Greek polity than the slow bloodletting under the ECB/IMF/ESM, Whatever path chosen, it would be chosen by the Greek voters, without outside pressures, other than by market price signals. 

Greece would also being doing a favor for the rest of Europe by exposing the economic fraud which is the EU, that shouldn't have allowed most of the periphery to join the eurozone had it enforced its own rules.  

Friday, May 22, 2015

Is Uber Overvalued?

In a commentary on venture capital which I wrote as an Editor of the Schulze School of Entrepreneurship's EIX Exchange (University of St. Thomas), I made a reference to a yawning gap in valuations in the following paragraph:
"Uber is the example of a disruptive service that turns a large, existing market of cars-for-hire upside down.  Professor Aswath Damodoran of the Stern School of Business has estimated Uber's global TAM for taxi and car service at $100 billion.  Venture capitalist Bill Gurley of Benchmark Capital, an A Round investor in Uber, argues that over time network effects will expand the TAM to some 25 times Damodaran's estimate.  I inject this real-life example because it is the one I always have in mind when analysts talk about a "disruptive" service or product."
I studied Professor Damodoran's course material on valuation during some work at NYU and through the CFA review course books: he is unquestionably good at what he does, has applied his methods to hundreds of different kinds of companies, and has also consulted with number of big companies on the same issues.  I read his full analysis of Uber, and it is, as all his work, eminently reasonable.

Bill Gurley is a very smart investor and a very wealthy man, but he clearly has a promotional axe to grind with his valuation, since Benchmark is sitting pretty as an early investor in Uber.  "Network effects" are certainly real in particular cases, but they are widely used in this kind of patter as another form of hand waving.   Reading his article, Uber will eventually convince rational economic actors that it doesn't pay to own a car and the roads will be clogged with black Camrys providing transportation services to consumers like kids going to soccer games and grannies going to their medical appointment, even venture capitalists going up to their ski lodges.  Furthermore, it will do this in every country.  Take this fully network effected addressable market, give Uber a huge capture ratio, and you get this kind of 25x difference in valuation.   As the VCs like to say, it all scales.

But, like in every economic problem, there is at least one fixed factor, and that is time.  There are only 24 hours in a day.  Drivers can't drive 24 hours a day, and even the Uber drivers doing 8 hours a night for 5-7 days can't keep it up too long.  As Uber tweaks its model with fees and hurdles for drivers to achieve different payouts, it will run into the issue that drivers making $50,000 or so a year, probably not making their social security contributions and taking all the maintenance, debt service and insurance risk on their vehicles eventually will conclude that it's a great model for a company which is a piece of software, but not for them.  That labor force will churn, and no there's no more disruption: it's a rather typical management problem in lots of businesses.

As for taking over the world, Uber is having trouble in India, and it is using its cash hoard to take over competitors.  However, so are the local competitors doing the same things.  Software is ultimately a commodity, and Indian entrepreneurs are devising their own systems for fleet management and payments.  With all the traffic congestion in cities, owners, chauffeurs, auto rickshaws and Uber taxis are all limited in their ability to turn around rides.  No amount of cash in Uber's coffers can make this problem go away.

More up rounds have, are and will be done, but as Chuck Prince said, "As long as the music is playing, you better be dancing."

Sunday, May 17, 2015

Feds Stance on Met Life Shows Irrationality and Will Hurt Shareholders

We've written about Met Life before, first as a well managed company with a strong domestic business, and a growing international insurance business in solid markets like Japan.  It is absurd that is considered to be engaged in non-traditional, non-insurance businesses that could generate systemic risk. In fact, the company's complaint contends that Met Life has been deemed a "non-bank financial company" and therefore falling under Dodd-Frank solely because it has 15% of its assets in foreign subsidiaries.

The Financial Oversight Stability Council's lack of transparency and unwillingness to share its data and methodology for its conclusions with Met Life has pushed the company into either acquiescing to FOSC's banana republic tactics, or fighting the action as the rules allow and incurring the ongoing wrath of the Feds.

The move for summary dismissal of Met Life's protest is again arrogant and ludicrous.  Let Met Life have its day in court.  If the Feds are right, Met Life will have spent its own money, but at least it would have sought to preserve future earnings growth, multiple expansion, which are in the best interests of its shareholders.  This is good governance.

Some so-called analysts have suggested the Met Life management should have agreed to divest its foreign businesses, thereby escaping the classification as a systemically important non-bank financial corporation. That is another irrational suggestion because that would admit that the classification process had validity, and it would sell off future growth engines for revenue, earnings, while increasing the dependence on mature economies for growth.

By the kind of reasoning, Berkshire Hathaway is the ultimate, non-bank financial company, with most of its non-bank businesses being financed by the float from its insurance and reinsurance businesses.  The Feds aren't fools and wouldn't dare take on their friend in Omaha: that battle would end before shots were fired.

As the numbers attest, Met Life operates through highly regulated insurance subsidiaries, both here and abroad, which together generate 95% of corporate revenues, hold 98% of consolidated assets, 96% of consolidated liabilities; these subsidiaries are true operating subsidiaries, selling and servicing insurance policies, while managing the assets which backstop the policies.  What could be simpler? Insurance has long been effectively regulated, as far as risk and policy holder protection, by existing state and federal laws.

Met Life shareholders should be, but are probably not, flooding the mailboxes of their elected representatives to end this folly.  Stay tuned.

Tuesday, May 12, 2015

HP's Unhealthy Obsession With Mike Lynch

We've written about this several times, but HP are back at it again. Just as they approach the biggest event in their corporate history, the splitting off of HP into two companies, the issue of Autonomy's purchase has moved back center stage. This is after Britain's Serious Fraud Office ended a two-year inquiry into Autonomy's alleged misrepresentation of its financial results and deciding to take no further action on the matter.

I can't find the original court document of the current complaint, but the link above outlines the current allegations.  Former Autonomy CFO Sushovan Hussain noted that if $2 billion in fraudulent or imaginary revenue were recognized under Autonomy's IFRS standards, then among other things, an analyst would have a hard time reconciling cash using the balance sheets and income statement. He then essentially dares HP to explain how why this alleged fraud isn't evident from a very conventional analytic method.

Aggressive accounting?  It seems to have been the case, but most of the discussion seems to center on differences between US-GAAP and IFRS. By continuing to pursue this issue, HP is, by inference, casting aspersions on the Big 4 auditors, several of which were involved as auditors or consultants on the transaction.

Why not claw back money from former CEO Apotheker?  HP overruled its own CFO on the transaction.  Suits against HP show some comments by Apotheker that seem to say HP's zeal and haste to close the transaction resulted in shoddy due diligence.

By continuing this unproductive path, HP continues to make its go forward technology company look unworthy of shareholder confidence and the confidence of its customers and business partners. Let it go, HP.  Markets have already long forgotten.