What Are We Doing in Yemen?

After six odd years of unprecedented ineptitude and colossal arrogance informing our foreign policy, the U.S. is now "backing" a Saudi-led coalition against the Houthi in Yemen!  If a poll were taken in Congress asking "Where is Yemen," and "Who are the Houthi?" a handful at best would be able to answer.

Al-Jazeera describes the Houthi as a theologically-based peace movement. However, once their assigned role in a national government of unity was found inadequate, they have suddenly become a well-armed militia, causing the Yemeni President Hadi to seek refuge in Saudi Arabia.

Now, there is a full-fledged proxy war underway, and we are aiding air strikes that are killing civilians and fighters who seem to be dressed just the same as the civilians.  At the same time we signing "unprecedented" accords with Iran, they are running arms to Yemen in opposition to the Saudi coalition, that includes the U.S.  Got that?

No nation can rationally claim to be able to be able to stop a flow of arms by ship or tanker. Who is going to interdict vessels under different flags in territorial or international waters?  Under what authority? Now that Russia has offered high-powered weapons, President Putin would only be too eager to show his dictatorate that he will stand up to the West whose sanctions are keeping bread off their tables. China's opposition to military action has been clear, but their activities are off the radar screen.

So, Saudi Arabia has continued to export revolution to its Western customers for several decades, and now we are helping them in a battle that ultimately, among other things, will redraw the map of the Middle East in ways in which our moronic foreign policy can't fathom.

Greece Finds Some Cash

Even though we've been out of the blogosphere for a while, nothing has really changed in the drama between Greece and its creditors. Despite some last second posturing through Finance Minister Varoufakis being photographed with Russian President Putin, Greece really had no cards to play and miraculously found $450 million euro for a scheduled debt repayment to the IMF today. Answers: Greece blinked.

No good can come from extending this drama further.The longer the charade goes on, the more the politicians and their weary voters will come to feel that there is either (1) no real crisis and the drama has all been brought on by outsiders, so no need to change anything; or, (2) there is no hope for Greece except to be Europe's indebted beggar, and therefore no need to strive for growth or improvement. Neither reaction helps the nation in the long-term.

 Despite the dire consequences of a Greek exit from the euro currency, it can be handled and indeed we believe that were once contingency plans for doing just this.  27% plus unemployment rates for two years running, the uncertainty of meeting April government payrolls, the capital flight and the growing lame-duck feel to the current government all point to the benefits of Greece taking the bitter medicine and going it alone.

The euro itself will be less damaged that if the system were to countenance a "slow bailout" of Greece.

The Bank of England's recent Fiance Committee minutes show that UK banks' net exposure to Greece comprised less than 1% of the Common Equity Tier I (CET1) Capital, and bank counterparties as a whole had about a 2% exposure.  Were an exit to hit other heavily indebted countries in the eurozone, the exposure are significantly greater, but Greece itself can be ring-fenced by current capital cushions. JPMorgan Chase CEO Jamie Dimon has said that his bank has been working on a Greek exit for some time, through its risk management simulation exercises.

European stocks smugly reach new highs, while the ongoing complexion of the European experiment continues to look wan.

Who Blinks First: Greece or Germany?

Some of my most widely read posts, both by numbers and by geographical dispersion, relate to the Euro and the Grexit, dating back to 2012.  This particular one, "Revisiting the Euro and the Grexit," hit it all right on the head.

Today, even the Guardian seems to waking up out of a fog when it writes,

"A month ago, such an outcome(economic collapse or exit) to the Greek crisis looked highly improbable. It now appears far less unlikely, which is one reason why the euro has been under such pressure on the foreign exchanges. At some point, the 35% depreciation of the single currency against the dollar is going to lead to strong exports and a much-needed growth boost."

Bailing out Greece, or Germany blinking, puts another nail in the European experiment.  The EU violated its own rules when it admitted Greece (and others) into the currency union, and a bailout (or other euphemism) is the ultimate practical repudiation of both economic principles and rules.

The multi-year charade that has brought us to this point can't continue by just accepting more austerity: for the economic well being of the people and for the political self interest of its politicians, Greece needs to undertake fundamental structural reforms in taxation, labor market and public pension reforms.  Without some outside representation by the EU machinery in providing technical assistance or monitoring, it's hard to see how blank checks can be written.

If the bitter pill were accepted, how could the current Greek government, elected on a sham platform, continue to hold the confidence of the electorate?

Taking the euro down to stimulate exports helps Germany much more than it will help Greece in the short-term, without labor market and regulatory reform in, for example, Greek ports and shipping.

All eyes may turn to Mario Draghi, but his tune is already tired and won't be enough.

HP Buys Aruba: What Does It Mean?

Here we go again: HP makes another significant acquisition.  The timing, before effecting the separation of HPQ into HP Enterprise and HP, Inc. seems a bit awkward, but there were probably market reasons.

From what I can gather, Cisco having the dominant share in wireless networking (over 50% according to some industry research) couldn't have made a move on Aruba (around 13% according to industry trades) without some concerns about its prior Meraki Networks acquisition and without risks of being perceived by the Feds as anti-competitive.

Dell is probably preoccupied with its recent privatization and with internal redeployment of executives and resources to have done the deal now, but later...that could explain why HP moved now.  Many non-Cisco players have private-labeled or bundled Aruba's technology into their offerings already, including HP.  So now HP leaves Dell, Juniper Networks and Brocade out in the cold to forage over a smaller universe of targets to exploit new wireless standards with enhanced security.

According to Credit Suisse, the $2.7 billion price is 2.6x revenues, and CS projects that the acquisition will contribute about $0.07 per share to HP's FY 2015/16 earnings. According to Argus Research, HP's networking revenues in their prior fiscal year were $2.25 billion, and the annualized run rate of FY15 revenues for Aruba (based on their fiscal second quarter) is $852 million.  So, without any sales force synergies and without significant losses from Dell and other customers, Aruba's revenue contribution should be 25-35% of HP's 2015/16 networking revenues.

One thing this acquisition does point out: the acquisitions of Colubris Networks (2008) and 3Com (2010) weren't the best-timed, and the combination, along with deficient R+D spending dating back to CEO Mark Hurd's time, has failed to add value to make HP's offering credible in the future, without Aruba.

If HP Enterprise is indeed a "nimbler" company going forward and a more astute company, then the sales force, product development team and executives at Aruba will not only stay with HP Enterprise, but they will be enthused and energized by the possibilities for vastly increasing their distribution and market uptake.  If they get frustrated with a big bureaucracy of HP insiders who things the "HP Way," then this acquisition too could fall apart.

Creating an Enterprise-centric company via the split was probably a strong selling point to Aruba's management.  Let's hope that this acquisition is different.

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.

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.

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.