earnings calls: Apple (AAPL) vs. Microsoft (MSFT)

Last night after the market close, AAPL reported earnings per share that beat the consensus of Wall Street analysts–and the stock went down in the after-market.  MSFT, in contrast, reported results that fell short of analysts’ estimates–and the stock went up!

What’s going on?

AAPL gave next-quarter guidance that fell below Wall Street’s projection–but it always does this, so that’s not the reason.  MSFT’s income statement looks better after factoring out the large operating loss generated by Nokia, but I don’t think that’s the reason for the market’s positive response, either.  After all, if you wanted to (I didn’t), you could have gotten a reasonable guess at how much Nokia would subtract from the MSFT total from Nokia’s recent results as a stand-alone company.

I think the market’s response is much more a a conceptual response.

Tim Cook has made it clear that AAPL is a manufacturer of high-end mobile consumer technology.  There’s no “next big thing” on the horizon, however, with only a periodic refresh of the company’s smartphone line due any time soon.  If reports from suppliers are accurate, new offerings will include a phone with a large, Samsung Galaxy-matching screen size, and a(n even larger) tablet/phone.  For Jobs-ites, this departure from Steve’s view that phones should be small enough to operate with one hand may be earth-shaking.  But for the rest of the world, this is only catching up to what Samsung already has on the market.  So a ho-hum Wall Street response is appropriate.

For MSFT, on the other hand, the news is relatively better.  The company seems to have a focus for the first time in a long while.  The fact that Nokia is putting up operating losses at a near-$3 billion annual rate seems to me to justify the downsizing MSFT has recently announced.  The only surprise is that this wasn’t started sooner.

Leaving the X-Box content creation business is probably more symbolic than anything else, but it removes a potential distraction–especially given the continual mess the company has typically made of its game software development efforts.

One, admittedly small, figure what caught my eye was that MSFT has added another 1,000,000 individual/small business users to its Office 365 rolls during the June quarter.  I think this just shows the power of the cloud–easier administration, much lower cost-of-goods expense, and hugely better protection against counterfeiting.

For MSFT, then, the earnings were nice, but the fact that the company’s board is allowing significant changes is nicer.  True, the message may turn out only to be that the company will try harder not to shoot itself in the foot again, but even that’s an uptick.  Hence the positive market response.  Absence of missteps won’t be good enough for long, but it’s ok for now.

regulating money market funds

In the aftermath of the financial crisis, the government has been considering the risks to financial stability posed, not only be banks but also by asset management firms.  As part of this effort, the SEC is about to set new regulations for money market funds this week.

what money market funds are

One of the most important economic (and stock market) trends of the past half-century has been the emergence of focused single-purpose entities to compete with large conglomerates.  In retail, specialty firms selling jewelry, toys, household goods or electronics have offered an alternative to department stores.

In finance, money market and junk bond mutual funds, have offered alternatives–to borrowers and savers alike–to commercial banks.

Money market funds have several important characteristics:

–they provide short-term, working capital-type loans to borrowers

–as mutual funds, they promise to accept daily subscriptions from savers and allow daily withdrawals in unlimited amounts

–they have typically offered higher yields than bank savings accounts–sometimes far higher yields

–they can offer the ability to write checks against deposits

–they promise, at least implicitly, to maintain net asset value at a stable $1 per share.  In other words, they promise that, like a bank deposit, you won’t lose any of the principal or interest you have in the fund

–because a money market fund is not a bank, its deposits are not government insured.  The “no loss” promise relies solely on the good will and financial strength of the investment company offering the product.

the risks

According to the Investment Company Institute, US money market funds currently hold $2.57 trillion in assets.  That’s a lot of money.

In times of stress, the warts in money market funds begin to show.

They come in two related varieties:

–as a practical matter, many funds are so large that they might not be able to meet redemptions if large numbers of shareholders lost faith in either the industry or a particular fund and headed for the exits,

–because money market funds compete with each other primarily on yield, inevitably someone (or more than one) will hold his nose and make a sketchy loan simply because the interest payments are high.  In a crisis, such loans may not be worth what a fund paid for them; in the worst case, the borrower will default.    In past crises, including 2008-09, there have been times when dud loans are big enough to make it questionable whether the real NAV of a given fund should still be $1.00 and not $.99.  These situations have typically been resolved by the management company that offers the fund buying the securities in question from its money market fund at face value.  But there’s no guarantee this will happen in the future.  And a single fund that “breaks the buck” by writing down assets in a crisis could easily spark an industry-wide panic.

new rules

This week the SEC is expected to issue new money market rules to meet these concerns.  They’ll include:

–many money market funds that don[‘t exclusively own Treasury securities will be required to have a floating NAV, and

–funds will have the ability to suspend redemptions in times of financial stress and/or impose withdrawal fees on those wishing to get their money back.

my take

I think new rules will have their greatest impact on the investment practices of money market funds.  They’re now generally regarded as a utility-like service that requires little investment skill or management oversight to run.  That will change.  No firm will want to be the first to impose withdrawal fees or suspend redemptions.  Certainly, no one will want to destroy their reputation for financial integrity by recording an NAV different from $1.00.  As a result, management oversight will increase and investing practices will become more conservative.

For all practical purposes, NAVs will remain stable at $1.00.

For savers, the FDIC insurance offered by bank deposits will become a bit more attractive.  Since, however, 2/3 of money market shares are held by institutions, I don’t think there will be a massive shift away from money market funds when the new rules take effect.

investors continue to withdraw funds from PIMCO

A front page article in last Tuesday’s Wall Street Journal outlines the (former?) champion bond fund manager’s problems.  Over the fourteen months ending in June, a time of strong net inflows to US-based bond funds, PIMCO experienced steady net outflows totalling a whopping $64 billion.

 At the same time, the negative media attention that the article embodies is itself one of PIMCO’s bigger problems.

My, admittedly uninformed, outsider’s view:

Recent press coverage of PIMCO has focused on the succession struggle between the firm’s co-founder and Chief Investment Officer, Bill Gross, and Allianz, the German insurance company he sold his firm to in 2000.  Generally portraying Mr. Gross in an unfavorable light, it has been sparked by the surprise resignation of the successor hand-picked by Allianz, Mohamed El-Erian, in January.

Personality conflict between Mr. Gross and Mr. El-Erian may be entertaining, in a gossipy, soap opera-ish way. But I don’t think it’s the main issue.  In fact, outflows form PIMCO were smaller in the five months since Mr. El-Erian’s resignation than during the five months before.

Instead, I see two related factors involved in PIMCO’s recent struggles:

1.  The bigger problem, in my view, is that for a long time PIMCO’s marketing has been focused on the continuing ability of Mr. Gross, an industry legend, to continue to generate market-beating investment returns, as he has been able to do throughout the thirty-year+ period of falling interest rates in the US.  Because of this emphasis, Mr. Gross’s recent performance stumbles have removed the main reason for choosing PIMCO over other alternatives.  

2.  Allianz has bungled the succession issue, mostly, I would guess, because it doesn’t understand the outsized ego that comes with being an American portfolio manager.

Mr. Gross is seventy.  He’s immensely wealthy.  Clients have a concern that he will:

–suddenly decide to retire

–develop physical disabilities that will force him to do so, or, worst of all,

–remain on the job and begin to suffer age-related diminution of his investment skills.

Rightly or wrongly, this is how clients regard any successful manager after, say, age 55.  

For its part, Allianz has a similar interest in protecting the asset it owns.  So succession is a legitimate business issue.

However, rather than emphasize the large stable of successful younger portfolio managers PIMCO employs–as it has since Mr. El-Erian’s departure–and to deemphasize the role of a single key individual, Allianz decided to anoint Mr. El-Erian, a charming marketing guy with little portfolio experience as the next Bill Gross.  It then made him, however implausible, the new investment face of the franchise.

Admittedly, portfolio managers aren’t the most mature people in the world–we’re more like little kids playing video games.  Still, Mr. Gross can’t have been thrilled.  He must have felt he was being forced out at the first whiff of underperformance and that his considerable investment acumen was being trivialized by Allianz through its choice of a successor.  He may also have thought that the entrepreneurial character of “his” company was being destroyed by Allianz (forgetting that the key element in this process was his selling PIMCO to corporate “suits” at what he thought was the peak of the bond market).

I don’t have a strong feeling about how the PIMCO saga will unfold.  Will the firm continue its marketing focus on creating larger-than-life portfolio managers?  PIMCO was built on aggressive bets that interest rates would decline–is it possible it can’t adjust to a market where rates go sideways or up?  Will it remain trapped with their idea of the “new normal,” where bonds are always the asset of choice?  Will Bill Gross begin to be able to play well with others?

 

 

 

 

 

 

 

a closer look at Intel’s 2Q14

2Q14 results

After the close of Tuesday, Intel (INTC) reported a strong 2Q14.   Revenue came in slightly higher than the company’s upwardly revised guidance from last month.  Earnings per share were $.55 vs. Wall Street analysts’ expectations of $.52 (expectations which were revised upward when INTC announced in mid-June that business was looking up).

INTC also revised up its full-year revenue guidance from basically flat year-on-year to +5% growth.  It said that its server business ($3.5 billion of the company’s $13.8 billion total during the quarter) continues to boom, with both unit volumes and unit prices rising.  That’s no surprise.  In addition, however, the PC business ($8.7 billion in 2Q14 sales) appears to have bottomed and to be bouncing back a bit.

The PC development has two aspects.  Corporate customers, who make up about 40% of the PC total, are buying again.  The simplest explanation for this is that their existing laptops and desktops have just gotten too old.  Buying may also be spurred by the fact the Microsoft is ending support for Windows XP, that corporations don’t regard tablets as a viable substitute for laptops, or simply that firms are flush with cash.  In any event, corporates are buying, and will easily continue to do so in increasing amounts into next year.

Consumers, 60% of the total PC market, may also be showing signs of life–although this is more OEM and distributor body language than actual orders.

Remember, too, that INTC’s sales are not to end users.  So it stands to benefit not only from increased final sales but also by manufacturer and distributors purchases to built up bare-bones inventories.

operating leverage

INTC has substantial operating leverage, both from the capital-intensive nature of its manufacturing and its very large R&D and SG&A budgets.  As a result, small changes in revenue can make a disproportionately large impact on the bottom line (in fact, they’re almost pure profit).  At the moment, the revenue changes in INTC’s two main businesses, PCs and servers, are both positive.

tax rate

INTC is saying it  expects its tax rate to remain at 28% for the rest of the year, implying that the growth it is seeing is mostly coming from the developed world, where tax levies are relatively high.

lines of business

As is always the case in securities analysis, the line of business table is where the real work is done.  For INTC, I’ve duplicated the relevant 2Q14 lines below:

PC Client Group :    revs = $8.667 billion, op income = $3.734 billion

Data Center Group :   revenues = $3.709 billion, op income = $1.807 billion

Mobile and Communications Group : revenues = $51 million, op income = ($1.154 billion).

No, that’s not a mistake.  INTC’s tablet and smartphone chip business had revenues of $51 million for the quarter …and an operating loss of $1.2 billion.

INTC is earning operating income of $22 billion – $25 billion a year from its traditional businesses and using a chunk of that to fund the massive losses it is incurring in trying to break into the mobile computing business.

The M&C Group figures need some interpretation.  The revenue figures are net of marketing or other incentives INTC gives to buyers of its mobile chips; the operating loss includes R&D and other expenditures that arguably have an enduring value.

Nevertheless, the line of business table does convey the essence of the INTC story for shareholders wiling to pay $30+ for a share of stock.  INTC is, in effect, two companies:

–one is a mature microprocessor maker earning $2.50 or so a share and growing at maybe +10% a year

–the other is a startup currently bleeding red ink at a $4 billion annual rate.

my take

The fact that INTC is incurring large near-term losses on its M&C Group says two things to me:

–it doesn’t yet have a set of products customers are willing to actually pay for, and

–INTC believes M&C is crucial to its long-term success.

I might be persuaded to pay 15x earnings for the traditional business, if I thought it would have stable-to-rising earnings.  That would mean a target price in the high $30 range.  However, INTC’s actions imply that top management doesn’t believe the business is viable without M&C.  So maybe the right price for the traditional business would be $30.

That leaves the question of the status of M&C still up in the air, though.

On the other hand, if INTC can create a profitable mobile business, that would mean–to pluck numbers out of the air–total INTC near-term earnings could be $3 a share, with a higher growth rate.  Worth $45 a share?  …probably so.

My bottom line:  news of a cyclical upturn in the PC and server businesses probably supports INTC shares for the time being.  Eventual downside to the high $20s (?) if/as it becomes clear the mobile chip business has no hope.  Upside to $40+ on signs that INTC is narrowing its M&C operating losses.

I find it hard to assign probabilities to either outcome.  For the time being I’m content to remain a holder of the stock.

 

 

 

 

 

 

 

 

 

Intel’s good 2Q14–and Wall Street’s strong reaction to it

Last month, Intel (INTC) announced to the market that its 2Q14 was shaping up better than the guidance it had given when it announced 1Q14 earnings.  Analysts covering INTC (a pretty pedestrian lot, in my view) dutifully raised their estimates to incorporate this news.  The new consensus was centered around $.52 a share in eps for the quarter.  The stock began a 15% move higher.

A week or so ago, research firms that follow the PC industry began to suggest that the personal computer market is beginning to bottom out after a long slide.  At the same time, these firms observed that the tablet market is starting to fall off.  Some put the two observations together into a story that the tablet market was waning because customers were either finding them inherently unsatisfactory or poor value in comparison with chrome- or ultrabooks.  AAPL appeared to confirm this analysis with its announcement of a partnership with IBM to sell iPads equipped with IBM software to corporations. 

INTC reported earnings of $.55 a share after the close on Tuesday (a full analysis in tomorrow’s post).  The company also raised its revenue guidance for full-year 2014 from flat to up 5% (corporate strength, the hope that consumer demand will rebound, plus the one-time positive of wholesalers beefing up their inventories a bit).  My take:  good news–not earthshattering, but good–and pretty much in line with data that had been coming into the market over the past while.

But no.  

Yesterday INTC was up by 9%+ on quadruple normal volume, in a flat market.  MSFT, the other member of the once-dominant “Wintel alliance,” gained almost 4% on more than double normal volume.

As a holder of INTC and MSFT, I’m happy to have the gain.  But I find the market action a bit excessive.  

I have two reactions:

–it may be that part of the rise has nothing much to do with Wintel but is the market rotating toward large-cap tech laggards.  If so, it would be a sign that the upward market momentum of the past nine months or so is in its final stages.

–for INTC, the “free lunch” stage is over.  On earnings of, say, $2.10 in 2014 and $2.25 in 2015 (figures that are higher than Wall Street’s current median, though admittedly some analysts may not have published post-earnings call adjustments), INTC is no longer stunningly cheap.  To continue to hold the stock, we have to believe that the PC business is at least stable and that INTC’s foray into tablet/smartphone chips will at least get to breakeven within a couple of years.

While I may trim my position further (as I’m writing this, I haven’t yet), I like what INTC is doing and am content to remain a holder.

More tomorrow.

 

 

the Apple – IBM partnership

Jobs 1.0

Back in the early 1980s, AAPL made a better personal computer than IBM, at a time when the PC was beginning to displace the minicomputer in corporations and when individuals were starting to become a viable market for computing power.

Steve Jobs made two strategic errors, however, that ended up preventing AAPL from exploiting its advantage, which ultimately marginalized his company and put it on the verge of bankruptcy.

–AAPL priced its PC at 2x -3x the level of its MS-DOS alternatives, providing an overwhelming economic incentive to put up with the clunkiness of an IMB or a Compaq.

–Jobs marketed solely to company IT departments, which at that time had no power to make purchasing decisions.  He completely ignored the CEOs and COOs who did.  This may have enhanced his counterculture image, but it effectively closed the door to any corporate sales.

Jobs 2.0, Groundhog Day–except better so far

Arguably, Jobs 2.0 repeated the same game plan as 1.0:  make high-end, high-priced consumer devices and ignore the corporate world.  

In the post-Jobs era, and after a whole lot of waffling, AAPL management has decided to stick with Page One of the Steve playbook and is continuing to define itself as a maker of high-end consumer devices.  On the other hand, it lived (by the skin of its teeth) through Jobs 1.0 and knows how that story ended.

That’s why I think AAPL’s just-announced decision to partner with IBM to sell mobile products to corporations is potentially very significant.  It suggests AAPL is no longer willing to be straitjacketed by the Jobs mystique.  This is a good thing, because growth companies only continue to prosper if they periodically reinvent themselves.  

Also, given the continuing ineptitude of Ballmer-led Microsoft, the corporate market is much more wide open to AAPL smartphones and tablets than AAPL had any right to expect.  

I’m not rushing out to buy AAPL on the strength of a single new venture.  But it’s a start.  It suggests that Tim Cook is doing more than rearranging the deck chairs.  It argues that we should also be on the alert for further signals of favorable change in the company’s strategy.

 

 

 

 

 

who are the stock market winners?

in the US

The case for passive investing in the US, that is, buying an index fund rather than one “actively” managed is simple.  It has two parts:

–it takes a lot of time and effort to find an active manager and monitor his/her activities, and

–active managers generally do worse–sometimes, a lot worse–than the benchmark index they use to measure their performance.

elsewhere

The record outside the US is less clear, because complete data are less available.  My experience is that foreigners generally beat the Tokyo market consistently, at the expense of a woeful set of domestic investors.  I’ve always found the UK very difficult.  Beyond these two, it’s hard to know even how to group markets together, since the rest are rest are very small and sometimes have an industry–or even a single stock–that makes up 25% – 50% of the total capitalization.

So let’s stick with the US for thi dicussion.  And let’s talk about performance before managers collect their fees.

the players

hedge funds

Only the better-performing hedge funds make their records public.  Academic studies strongly suggest that some reported results are doctored to make them look better.  Despite these “enhancements,” hedge funds in the aggregate have pretty steadily underperformed the S&P for over a decade.  …and that’s before the 2/20.  The worst.

traditional institutional investors

Here the record is much longer.  The data are dependable and readily available.  They show that simply matching the S&P 500 puts a manager way up in the top half of the pack.  Managers, whether of pension money or of mutual funds, consistently underperform the S&P, though by a smaller margin than hedge funds.

the invisible players ( = the winners)

The large amount of money that the easily identifiable “professional” players lose relative to the S&P has to go somewhere.  It doesn’t just disappear.  It has to show up as gains for someone. There are three groups of possible aggregate winners:

–middlemen, meaning professional brokerage market makers and the trading rooms of institutional investors.  Again, no complete or reliable records.  My experience is that although the overall numbers are large, the cost of trading for an institutional money manager is around 0.2% of the assets under management and that a good trading room can make half of that back in trading profits.  Middlemen are not the main winners.

brokerage proprietary trading desks, meaning traders who use a broker’s own capital/information network to earn a return.  No complete or reliable records.  My sense is that these groups tend to trumpet their gains and bury their losses, so it’s difficult to get a read.  We do know that many of the best of these have formed hedge funds–which have, by and large, gone down in relative flames with the rest of the hedge fund industry.  Dodd-Frank is forcing these trading desks to close, so we’ll see for sure in the coming years.  But my guess is that they’re not big enough, either, to be the home of all the professionals’ losses.

private individuals.  Crazy as it may sound, other than company stock buybacks, you and I are the only group left.  We’ve eliminated all the other possibilities, so “whatever remains, however improbable, must be the truth,”  

I don’t mean it’s every you and me.  I think the winning you-and-mes fall into two categories:  regular people who hold a few stocks that they know well for long periods, and professional individuals or groups who manage their own money for a living and don’t seek publicity (if they’re successful, they’d have to be crazy to make their methods publicly known).

The bottom line:  achieving investment success for you and me isn’t effortless, but it’s possible.  In fact, if I’m correct, we’re the only ones who are able to do it.

 

 

 

 

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