U.S. stocks are up this morning, after a confusing and contradictory hash of press releases from European governments, the IMF and private research groups. Germany has been calling for private bondholders to take their haircuts, for periphery governments to implement meaningful austerity, and finally for Germany to lead a bailout financed by the sovereign Euro-North and the IMF. Instead, nothing of any consequence happened this weekend.
The Centre for Economics and Business Research Ltd. forecasts the demise of the Eurozone by 2013. The IMF communiques chiding Germany's conditions for further bailouts seem wildly out of touch; they also speak to the value of having a non-European in charge of the Fund as soon as possible. The Greek establishment realizes that it many ways, it holds the cards simply because it owes so much to so many; why would investors expect meaningful action from them in light of the IMF's finding fault with the Euro-North countries for not being more accommodating?
It's virtually impossible to forecast the trajectory of a meltdown in the Euro-zone. All in all, how could it be good for the world economy and for stocks? In a perverse way, U.S. Treasuries could benefit again as a safe haven, the least bad of a lot of worse alternatives.
Monday, June 20, 2011
Thursday, June 16, 2011
More Virtues of Dividends
Jesper Medsen, CFA is a portfolio manager at Matthews Asia Funds, and he made some interesting points about Asian companies that pay dividends. Jesper noted that 20 Chinese companies whose shares were issued on foreign bourses have been the subject of recent financial scandals and frauds; only one of these companies paid a dividend. Having to pay a quarterly dividend, he feels, generally gives an investor like himself confidence that the accounting is a bit more reliable, simply because the company has to come up with the cash. He also notes that when he asks the managements of his Asian companies about their dividend plans and target payout ratios, he finds that these managements are much more focused on capital allocation, in part because of the discipline imposed by having to pay and grow a dividend. Good points indeed.
Reinforcing our point made in an earlier post, investor Ken Feinberg of Davis Funds argues at a Morningstar Conference that the huge cash balances of Cisco and Microsoft are somewhat illusory. Given the history of their managements' proclivities to spend foolishly on projects and acquisitions, an investor should look through these balances in making an investment decision. IBM, by contrast, seems to be better at allocating capital, despite having made some horrendous strategic decisions in the past. After the shakeups of Lew Gerstner, the company refocused and exited businesses like the PC, which it invented, because it felt that it could create much better returns elsewhere. Despite having lower cash balances that Cisco or Microsoft, IBM looks to many portfolio managers to be the better company and the better investment.
Reinforcing our point made in an earlier post, investor Ken Feinberg of Davis Funds argues at a Morningstar Conference that the huge cash balances of Cisco and Microsoft are somewhat illusory. Given the history of their managements' proclivities to spend foolishly on projects and acquisitions, an investor should look through these balances in making an investment decision. IBM, by contrast, seems to be better at allocating capital, despite having made some horrendous strategic decisions in the past. After the shakeups of Lew Gerstner, the company refocused and exited businesses like the PC, which it invented, because it felt that it could create much better returns elsewhere. Despite having lower cash balances that Cisco or Microsoft, IBM looks to many portfolio managers to be the better company and the better investment.
Rethinking Share Buybacks
One of my 2010 posts, "Black and White," has been generating quite a few views recently. In it, among other things, I discuss share buybacks, which are in the media again as the market swoons and companies have excess cash.
As CFO of Possis Medical, once our downsizing, business model realignment and strategic focus had taken hold, the company was generating substantial free cash flows, in excess of business needs. We decided to embark on a share buyback program, not for financial engineering purposes, but primarily to use some of the excess cash to offset dilution from options grants to executives and key employees as the company continued to grow. Unlike most corporate programs which are announced but expire unfulfilled, we bought back about 10% of the outstanding shares. It was a good trade overall too--we didn't buy high!
Especially for the companies in the S&P 500, whose stocks are hyper-actively traded in native and derivative forms, I'm not sure that buybacks are the best thing for rewarding all shareholders. Increasing the dividend, when stocks like Intel are already yielding almost 4%, may also not be the best, as then the new level cannot be reduced without price consequences. I believe that one-time, special dividends are a good answer to using excess cash and for rewarding all shareholders, those who stay and those who collect and move on later. Hawkins, Inc., a company whose board I served on as audit committee chair, used this special divided in a response to some positive, one-time events. The permanent payout level stays the same. I think that this tool ought to be used more often.
Thinking about the one-day announcement effects of a share buyback, behavioral market analysts have posited a good explanation. Shareholders are so relieved that their managements are not immediately announcing a mega-value busting acquisition, they bid the stock up in the short term! It's not an unreasonable explanation.
As CFO of Possis Medical, once our downsizing, business model realignment and strategic focus had taken hold, the company was generating substantial free cash flows, in excess of business needs. We decided to embark on a share buyback program, not for financial engineering purposes, but primarily to use some of the excess cash to offset dilution from options grants to executives and key employees as the company continued to grow. Unlike most corporate programs which are announced but expire unfulfilled, we bought back about 10% of the outstanding shares. It was a good trade overall too--we didn't buy high!
Especially for the companies in the S&P 500, whose stocks are hyper-actively traded in native and derivative forms, I'm not sure that buybacks are the best thing for rewarding all shareholders. Increasing the dividend, when stocks like Intel are already yielding almost 4%, may also not be the best, as then the new level cannot be reduced without price consequences. I believe that one-time, special dividends are a good answer to using excess cash and for rewarding all shareholders, those who stay and those who collect and move on later. Hawkins, Inc., a company whose board I served on as audit committee chair, used this special divided in a response to some positive, one-time events. The permanent payout level stays the same. I think that this tool ought to be used more often.
Thinking about the one-day announcement effects of a share buyback, behavioral market analysts have posited a good explanation. Shareholders are so relieved that their managements are not immediately announcing a mega-value busting acquisition, they bid the stock up in the short term! It's not an unreasonable explanation.
Wednesday, June 8, 2011
What Arab Spring?
I don't know who can claim coinage of the phrase "Arab Spring," but the phrase needs to be hit with weed killer because it's superficial, inappropriate and misleading. The echo of course is to "Prague Spring." But, let's take a quick trip back and remember what happened in 1968.
Alexander Dubcek became Communist Party leader in Czechoslovakia on January 1, 1968. What became the original Prague Spring began in April 1968 with an "Action Programme" of political, cultural and social liberalization. Dubcek's plans included a federalization of the Czech Republic into Czech and Slovak entities. Long moribund cafes, salons, and theater groups came alive. This looked like a long winter had indeed given over to new life. But, remember what happened next?
By late August, Soviet tanks rolled into Czechoslovakia and a very brief, Prague Spring ended! The real playing out of the historical drama took many years. Our journalists have created a narrative more akin to "Law and Order" than to 21st century politics. In a television drama, the bad guy goes to jail in 46 minutes. It didn't happen in Czechoslovakia and it won't happen in the Arab world.
Dubcek was replaced in April 1969 by Husak, the Communist Party leader to whom Vaclav Havel addressed his famous 1975 Open Letter, by which time a reform movement had started to resurface some seven years later.
In the Arab world, Tunisia and Egypt have gotten rid of their despots, and they would seem on the surface to be the states with some political, cultural, and political infrastructure to support modernization. But, in the words of Rashid Khalidi, the Edward Said Professor of Arab Studies at Columbia, "...despots have gone, but a real transformation (in Tunisia and Egypt) has barely begun."
We have no idea where the current process of sequential, out-of-phase, cycles of unrest will resolve itself. If Tunisia and Egypt have the potential to become roses, our positions in Libya and Syria may have us grasping nettles.
Alexander Dubcek became Communist Party leader in Czechoslovakia on January 1, 1968. What became the original Prague Spring began in April 1968 with an "Action Programme" of political, cultural and social liberalization. Dubcek's plans included a federalization of the Czech Republic into Czech and Slovak entities. Long moribund cafes, salons, and theater groups came alive. This looked like a long winter had indeed given over to new life. But, remember what happened next?
By late August, Soviet tanks rolled into Czechoslovakia and a very brief, Prague Spring ended! The real playing out of the historical drama took many years. Our journalists have created a narrative more akin to "Law and Order" than to 21st century politics. In a television drama, the bad guy goes to jail in 46 minutes. It didn't happen in Czechoslovakia and it won't happen in the Arab world.
Dubcek was replaced in April 1969 by Husak, the Communist Party leader to whom Vaclav Havel addressed his famous 1975 Open Letter, by which time a reform movement had started to resurface some seven years later.
In the Arab world, Tunisia and Egypt have gotten rid of their despots, and they would seem on the surface to be the states with some political, cultural, and political infrastructure to support modernization. But, in the words of Rashid Khalidi, the Edward Said Professor of Arab Studies at Columbia, "...despots have gone, but a real transformation (in Tunisia and Egypt) has barely begun."
We have no idea where the current process of sequential, out-of-phase, cycles of unrest will resolve itself. If Tunisia and Egypt have the potential to become roses, our positions in Libya and Syria may have us grasping nettles.
Groupon IPO: I'm Forever Blowing Bubbles.
Brett Arends of MarketWatch says he has waded through the 280 page prospectus for the Groupon IPO. Normally a fairly circumspect type when he wrote for the Wall Street Journal, he describes the transaction as "one of the most ridiculous things he's seen."
One fact he cites caught my eye relative to my earlier post on Ask Jeeves. Founded in November 2008, Mr. Arends says that Groupon has run up a total of $522 million in losses. Ask Jeeves had run up $765 million in losses two years out from its IPO. Groupon looks like it should surpass this pace, based on some of the basic statistics Arends presents for subscribers, purchasers, and conversion rates.
In a direct marketing business, executives and security analysts always looked to calculate "lifetime value" of a twelve-month customer, or a repeat buyer. In these Internet businesses, the difference between a subscriber and a purchaser gets glossed over, and since there is no barrier to entry for these businesses, and little "site loyalty" it seems impossible to justify the current valuations based on any reasonable hypothesis about lifetime value of their customers.
From its inception, Amazon put a great deal of emphasis on building customer loyalty and repeat business, and that was something that Jeff Bezos focused on as part of their identity. Now, with the Internet having become an overcrowded, noisy bazaar, it is going to be much more difficult to engender loyalty and sustained, repeat business.
I love the idea of Open Table, for example. However, I know that for a new restaurant, the economics of Open Table can be very onerous. I often use Open Table to see what's available on for a restaurant I've chosen, and then call the restaurant directly to make the reservation, saving the entrepreneur a few critical bucks. How does the Open Table model continue to justify its lofty growth assumptions? There are already competing systems out there, many of which are local.
It just feels like this euphoria for these types of businesses has to end badly.
One fact he cites caught my eye relative to my earlier post on Ask Jeeves. Founded in November 2008, Mr. Arends says that Groupon has run up a total of $522 million in losses. Ask Jeeves had run up $765 million in losses two years out from its IPO. Groupon looks like it should surpass this pace, based on some of the basic statistics Arends presents for subscribers, purchasers, and conversion rates.
In a direct marketing business, executives and security analysts always looked to calculate "lifetime value" of a twelve-month customer, or a repeat buyer. In these Internet businesses, the difference between a subscriber and a purchaser gets glossed over, and since there is no barrier to entry for these businesses, and little "site loyalty" it seems impossible to justify the current valuations based on any reasonable hypothesis about lifetime value of their customers.
From its inception, Amazon put a great deal of emphasis on building customer loyalty and repeat business, and that was something that Jeff Bezos focused on as part of their identity. Now, with the Internet having become an overcrowded, noisy bazaar, it is going to be much more difficult to engender loyalty and sustained, repeat business.
I love the idea of Open Table, for example. However, I know that for a new restaurant, the economics of Open Table can be very onerous. I often use Open Table to see what's available on for a restaurant I've chosen, and then call the restaurant directly to make the reservation, saving the entrepreneur a few critical bucks. How does the Open Table model continue to justify its lofty growth assumptions? There are already competing systems out there, many of which are local.
It just feels like this euphoria for these types of businesses has to end badly.
Sunday, June 5, 2011
The Tech Bubble: This Time It's Different
The financial press shows up at investor conferences and picks up quotes from investors who are busy unloading their investments in social media companies and international search engines: "I don't think this is a bubble at all!" Boy, let's take that unbiased opinion to the bank.
The other refrain is that this group of companies have revenue and an "open business model." The first comment is irrelevant. At the multiples being paid by the IPO investors, the stocks are more than priced for perfection. I believe that an "open business model" means that the company hasn't yet decided on how it will make money. How do the IPO investors make money? Any hiccup in revenue growth or any delay in profitability and they take a shinai across the kneecaps. No, I'd have to say that all of this has an eerie familiarity.
Remember Ask Jeeves from the last Internet bubble? Here's some highlights from the web archive ( source: www.fundinguniverse.com):
The other refrain is that this group of companies have revenue and an "open business model." The first comment is irrelevant. At the multiples being paid by the IPO investors, the stocks are more than priced for perfection. I believe that an "open business model" means that the company hasn't yet decided on how it will make money. How do the IPO investors make money? Any hiccup in revenue growth or any delay in profitability and they take a shinai across the kneecaps. No, I'd have to say that all of this has an eerie familiarity.
Remember Ask Jeeves from the last Internet bubble? Here's some highlights from the web archive ( source: www.fundinguniverse.com):
- Technology pundits and VC masters-of-the-universe laud Ask Jeeves' natural language search engine, and the ability to use full sentences for queries. Wow! Can a cure for cancer be far behind!
- October 1998 searches per day at 300,000 and said to reach 2,000,000 per day by October. Probably every executive and their relatives had set their computers set to robo-query their site, but who's counting?
- All this leads to July 1999 IPO.
- Third most successful first full day trading in IPO history. Stock price soon hits $190 per share.
- Company begins a spate of acquisitions: Net Effects, Direct Hits...can any reader claim to know what these companies did?
- Revenues increase exponentially from $23,000 in 1997, to $800,000 in 1998, and $22 million in 1999.
- Profitability relative to post-IPO projections is delayed. Losses reach $765 million in 2001.
- Technology gurus and the next vintage of VC masters-of-the-universe declare that "natural language" based search is dead.
- Ask Jeeves goes on life support, and is acquired by Barry Diller company for more than $1 billion.
- Diller declares that Ask Jeeves has the potential to become "one of the great brands on the Internet and beyond."
- NOT!
Perhaps there are some winners among the Class of 2011 IPO Bubble graduates, but what is different about their stories from Ask Jeeves? This year's version of the bubble has the additional complexity of foreign issuers registering in multiple markets, deceiving their own auditors, and the opiate of growing foreign markets for growth-strapped investors.
Sunday, May 29, 2011
More Reflection on Value
I got some good feedback from a reader about my comments on Microsoft and Google as value stocks. I had referred back to the original Graham & Dodd concepts, including the margin of safety. Today, I read an interview with Matthew McLennan, the portfolio manager of First Eagle U.S. Value Fund (Class A: FEVAX), which invests $1.8 billion in assets. The firm evolved in a long path from Arnhold and Bleichroeder, the distinguished German firm that once advised Chancellor Bismarck before opening offices in London. Eventually, the firm was bought and sold by Societe Generale, before Jean-Marie Eveillard launched First Eagle. Mr. Eveillard is a classic Graham & Dodd investor, with a long term, successful track record of attracting and investing assets using a disciplined process.
Matt McLennan describes the margin of safety in First Eagle's approach as paying no more than a single digit multiple of EBIT for quality businesses. He then distinguishes between commodity businesses and other businesses, and he understands the reasons for adjusting this upward to pay a bit more for franchise value, or the ability to command prices increases. Basically, he says that to avoid making arbitrary decisions about franchise values, he prefers to stick to the single digit EBIT discipline.
Looking at their portfolio, the large cash position mirrors the position of Sequoia Fund (SEQUX), another large traditional value fund using a Graham & Dodd philosophy. They have a significant exposure to gold, and some of the names, like Comcast, reflect strong cash flows and quasi-monopoly pricing power. Interestingly, the largest sector in the fund is technology, which includes Microsoft and Intel in the top 25. Intel is really a growth cyclical, and can be bought cheaply at low points in the tech cycle. First Eagle also owns Cisco Systems.
In response to my reader, a value investor can apply the margin of safety concept to technology stocks, in this case by using the proxy of a single digit EBIT multiple as a basic screen.
Matt McLennan describes the margin of safety in First Eagle's approach as paying no more than a single digit multiple of EBIT for quality businesses. He then distinguishes between commodity businesses and other businesses, and he understands the reasons for adjusting this upward to pay a bit more for franchise value, or the ability to command prices increases. Basically, he says that to avoid making arbitrary decisions about franchise values, he prefers to stick to the single digit EBIT discipline.
Looking at their portfolio, the large cash position mirrors the position of Sequoia Fund (SEQUX), another large traditional value fund using a Graham & Dodd philosophy. They have a significant exposure to gold, and some of the names, like Comcast, reflect strong cash flows and quasi-monopoly pricing power. Interestingly, the largest sector in the fund is technology, which includes Microsoft and Intel in the top 25. Intel is really a growth cyclical, and can be bought cheaply at low points in the tech cycle. First Eagle also owns Cisco Systems.
In response to my reader, a value investor can apply the margin of safety concept to technology stocks, in this case by using the proxy of a single digit EBIT multiple as a basic screen.
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