Category Archives: Industry Analysis

Facebook: the IPO process

May 10, 2012 By in Facebook, Industry Analysis, internet, Stock ideas Tags: , , , , , Leave a comment

going public

Going public is a highly choreographed dance.  FB is in the middle of its own time on “Dancing with the Stars,” vying for a prize of close to $100 billion.

the sequence of events

When a company decides to have its stock publicly traded:

hiring Wall Street

1.  it hires a team of investment bankers

filing with the SEC

2. with the investment bankers’ help, it prepares and files a comprehensive registration statement with the SEC for that agency’s regulatory approval.  Called an S-1, it becomes the preliminary prospectus which is given to potential investors once the SEC gives its ok.  Like any other company’s, FB’s approved S-1 can be found on the SEC’s Edgar website, along with any earlier versions the SEC may have sent back for more work.

The S-1 is legally required to be accurate and complete disclosure of all material information relating to company’s business.

Note:  SEC approval means only that the document is procedurally correct.  The agency doesn’t guarantee that the S-1/prospectus is in fact accurate or complete disclosure.   Nor does it say whether it thinks the stock will be a good investment or not.

the roadshow

3.  it launches a marketing campaign, whose centerpiece is a management roadshow organized by the investment bankers.

The roadshow typically lasts a week or two.  It reaches all the major investment centers and all the important money management firms in the country.

If demand to see and hear the company is high, as it clearly is in this case, management will be broken up into two or more teams (the FB video suggests it may have as many as four).  One will normally be headed by the CEO, another by the CFO.

The schedule is brutal.  Each day begins with a breakfast meeting.  Private meetings–usually an hour long + travel time to the next one–with important money management firms follow.  Then there’s a lunch, often with large numbers of portfolio managers, analysts and the press, none influential enough (read: big enough commission payers) to justify a private meeting.  Then there are private meetings in the afternoon, followed by a dinner presentation–and then possibly a trip to the next city on the list.

Add it all up and management is telling the same story, over and over again, maybe 7x-8x a day.

Since the S-1 must contain all material information about the company, it’s important that management not say anything that’s not contained in it–especially if someone might later on construe this as important.  So the teams are highly scripted and drilled on how to answer questions commonly asked.

In a way, the teams are a bit like actors.  They’re supposed to–if they can–smile and signal to questioners their respect for his penetrating insights and the thought/wisdom behind the query.  All they while they may be thinking, “Not again!” and “Doesn’t anyone read the prospectus?  The information he wants is on the first couple of pages!”

the video

Facebook has made a very artful 30-minute video (my comments tomorrow), available on its website, which I gather it intended to play at every meeting.  Smart move.  It burns up half the meeting time.  It also provides a clear roadmap for predictable follow-up questions–responses to which can be cleared by the legal department and rehearsed in advance.  The WSJ says, however, the video wasn’t played during the big public lunch in Boston after heated complaints about it at the comparable affair in Manhattan.

pricing the offering/allocating stock

4. the investment bankers are gathering feedback from clients throughout this time.  They’re trying to gauge the level of investor interest so they can set final pricing and decide to divide up the IPO stock among investors who place orders.

At the same time, money managers will want to get a sense of how “hot” the offering is.  Usually that’s expressed in terms of how many times the books are covered–that is, by how many times the requests for stock exceed the shares available for sale.  FB is a relatively large offering, so 3x or 4x would be impressive.  My guess is that the number is already high than that.  Of course, this can be a self-reinforcing process.  When money managers believe an offering is “hot,” they may request double or triple (or more) the stock they really want, in the hope they’ll end up with a bigger allocation after everyone’s order is cut back.

More tomorrow.

 

Facebook (FB): preliminaries

May 9, 2012 By in Constructing a Portfolio, Facebook, Industry Analysis, internet, Stock ideas, Technology Tags: , , , , , Leave a comment

FB’s corporate structure

FB has two classes of common stock, A shares and B shares.  The two are identical, except for:

1.  A shares, which are the kind being sold in the public offering, have one vote each on matters of corporate policy

B shares, which are held by Mark Zuckerberg and other insiders, and which can’t be sold, have ten each.  This way insiders continue to control the company while raising money from outsiders.

2.  B shares are freely exchangeable into As, giving holders of the Bs a way to turn their holdings into cash.  But when insiders sell they don’t give “extra” votes to the buyer.

Any investor in internet companies–from Google to LinkedIn–is familiar with this structure.  It has been around a lot longer than that, though.  Hershey has a similar structure, for example, as do the New York Times and News Corp.

the offering

FB plans to sell 337, 415,352 shares in the offering.

Of that, 180 million will be new shares issued by the company.  The rest will come from employees cashing in stock grants they received as part of their compensation, and from venture capital investors cashing in stock they bought in private financing transactions.

Assuming the stock is sold at the mid-point of the announced pricing range of $28-$35 a share, the IPO will raise $10.6 billion and will imply that the entire company is worth just under $100 billion.

$5.6 billion of the proceeds will go to FB; the rest will go to selling shareholders–VCs and present/past employees.

overallotment

IPOs routinely line up commitments by sellers to provide an additional amount of stock for sale in the IPO if demand proves exceptionally strong.  In this case, FB has agreed to sell 6 million shares more, selling shareholders another 44.6 million.

why is FB going public?

In the Use of Proceeds section of the prospectus, FB says:  “…we do not currently have any specific uses of the net proceeds planned.”  The company also already has $3.9 billion of cash on the balance sheet.  So, why?  Two reasons:

–from Microsoft three decades ago, to Google, to Facebook and Linked In, tech companies have attracted highly talented workers despite relatively low salaries and the risky nature of any job with a startup.  In fact, prospective employees seek these companies out.  The financial motivation is the chance at a huge payout on stock options or restricted stock sold in a successful IPO.  The same holds true for venture capital investors.

So FB has an obligation–implied, or possibly specified in contracts with VCs–to have an IPO.

–ultimately the money will be spent on R&D, and to accelerate FB’s expansion to mobile devices and in markets outside North America.

expiring lockups

When they bought FB shares, venture capitalists may have agreed not to resell them until after the IPO.  Such agreements are called lockups. 

The selling shareholders have also made further lockup agreements with the underwriters not to sell more stock for specified periods after the IPO.

The clock starts ticking on them as soon as the IPO takes place.

–171.8 million shares become eligible for sale after 90 days

–another 137 million are freed up in the following three months

–another 235 million leave lockup in the six months after that.

The lockups mean holders can’t sell during the period the shares are restricted.  It doesn’t mean holders have to sell once the restrictions are lifted.

This is a glass-half-empty/glass-half-full sort of thing.  As long as the stock price is at least stable, history says few will feel rushed to sell once their lockup expires.

NASDAQ listing

Although Facebook picked a ticker symbol with two letters, something more closely associated with the NYSE (most NASDAQ stock symbols have four letters), it has chosen to list on NASDAQ.

One possible inducement for FB to choose NASDAQ–the exchange has just reduced the “seasoning” requirement for a new stock to enter the NASDAQ benchmark indices to a mere 90 days.  It seems to me that FB will become an index constituent as soon as possible.

This is important.  It means that every index mutual fund or ETF that tracks NASDAQ indices will be compelled to buy FB shares.  It also means that any active manager whose performance is measured using NASDAQ as a benchmark will have to think twice about “flipping” (immediately reselling) any shares garnered in the IPO.  In fact, if the manager takes a positive view on the stock, he may have to buy a lot more, in order to have a higher-than-benchmark weighting.

the IPO video

It’s part of the IPO roadshow.  Check it out.

More tomorrow.

book value in an intellectual property world: Facebook and others

May 8, 2012 By in internet, Stock ideas, Technology Tags: , , , , , Leave a comment

the Facebook IPO

I’ve had a couple of requests to write about the upcoming Facebook IPO.  So I’m slogging through the preliminary prospectus.  I’m not sure I’m going to come out with a final conclusion, but I think I will be able to highlight important points. Today, book value.

In the prospectus, Facebook (NASDAQ ticker:  FB) makes what I regard as an unusually strong effort to point out that the company has very little tangible book value.  As of March 3, 2012, the figure is $2.85 per share.  The expected inflow of cash to the company from the IPO, calculated at a purchase price of $31.50 a share (the midpoint of the expected pricing range of $28-$35) will raise that to $5.15 a share.  So FB really wants buyers to be aware they are paying a little over 6x book for the stock.

What does this mean?

book value

Every investor looks for bargain stocks.  Techniques differ, though.  One of the main tools used by early 20th century securities analysts was looking for stocks that traded at steep discounts to the net asset value shown in the company’s official accounting records.

The measure is “net” in the sense that it is arrived at by subtracting the carrying value of everything the company owes to others (its liabilities) from the carrying value of all its assets.  The resulting number is also called book value, because it’s derived from the official accounting ledgers.

an example

The idea is simple:  say a firm starts with a single asset, $1 million in cash, and has 100,000 shares of stock outstanding.  Book value is $1,000,000/100,000 shares, or $10/share.  If the company spends all the money to buy land and build a cement plant, it still has book value of $10, but now it’s all in land and plant and equipment.

Suppose shortly after this, the stock market turns down–for whatever reason–and the company’s stock falls to $5 a share, or 50% of book value.

The plant is still there, however, and would still cost $1 million, or $10 a share, to duplicate.  So you can now buy $10 worth of assets for $5!!  How can you go wrong?  (You can, but that’s a story for another day.)  At the very least, the idea that the company holds valuable assets that can–at worst–be sold should act as a cushion against further declines.

One other thing about book value:  it also includes, as plusses, profits made and retained in the business, as well as losses, as minuses.  So for a successful company, book value gradually rises; for a consistent money-loser, it gradually falls.

Warren Buffett and intangibles

Fifty years or so ago, Warren Buffett had the idea that made his investing reputation.  He noticed, far ahead of his contemporaries, that some companies–Coca Cola, for example–had substantial advantages, like famous brand names, efficient distribution networks, a reputation for high quality, that were “intangible” in the sense that they weren’t reflected directly on the company’s accounting records at all.

Nevertheless, these intangible assets have a value.  They are predictors of longevity of a business and of higher than average profit margins.  Companies that possess them fetch high prices in mergers and acquisitions.  Buffett was the first one willing to pay a little bit extra for companies that had strong intangibles. Nowadays everyone does.

most IT is all about intangibles

In the early years of the computer industry, tech companies were allowed to “capitalize,” or list as assets on the balance sheet, the salaries and expenses of their research and development efforts, instead of subtracting them from current revenue in the income statement.  But by the time I arrived on the scene in the late 1970s, the practice had led to such horrible abuses (it made profits a lot higher than they should have been) that it was banned.

Like advertising expenditures, R&D is treated as an expense, and reduces income, even though, if successful, it creates an important competitive advantage for a firm.  The more R&D, the lower profits are–which means that book value doesn’t rise very quickly.  But the intellectual property is at the heart of what makes tech companies valuable.

the Facebook case

As the prospectus indicates, pre-offering, FB has book value of $2.85.  The largest chunk of that is cash, generated both by operations and prior sales of stock.  The book value of other assets is slightly over $1 a share.

In addition, the inflow of cash from the IPO will almost double that number, creating a tremendous benefit for pre-IPO shareholders.  An IPO participant’s $31.50 becomes a claim on company assets worth $5.15.  Prior owners will have their claim on book value of $2.85 boosted a lot.

significance?

1.  Unlike the cement company, in the FB case there’s no safety net of salable assets to fall back on if the company is unable to make money. In that sense, FB carries with it a large amount of risk.

2.  For FB, it’s all about intangibles–the brand name, the goodwill imbedded in the huge number (900 million) of users of the service, whatever patents the company may have.  Traditional accounting statements aren’t built to showcase these attributes.  So analysis of the statements may not get you very far in understanding the company or its potential.

What about other tech companies.  How do they trade versus their book values?

Here’s a sample:

Priceline.com      12x book value

LinkedIn     12x book

Amazon.com     11x

Netflix          7x

Microsoft      5x

Google     3x

eBay     2.5x

Yahoo     1.5x.

It’s hard to generalize from these instances.  For fast-growing firms, trading at huge premiums to book value doesn’t appear to be a problem.  On the other hand, Yahoo traded at 8x book in 2004, when its future appeared to be more promising–and 6x book when it turned down Microsoft’s takeover bid.  So the fact of a large premium to book doesn’t guarantee anything.

 

All in all, this implies to me that evaluation of FB will be a much more subjective, and difficult, process than for a typical IPO.\

More tomorrow.

 

how big is the Macau gambling market? …potential?

May 3, 2012 By in Asian economic development, Casinos, China, Entertainment, Industry Analysis, Stock ideas Tags: , , , , , , , , , , , Leave a comment

…a lot depends on how you measure.

the Nevada comparison

Let’s compare Macau with Las Vegas.

According to the Nevada State Gaming Control Board, during the three months ending February 29th (the latest figures available as I’m writing this) the Las Vegas strip casinos had revenue of $1.67 billion.  The downtown area of Las Vegas added about a tenth to that.

During the same three months, according to the Macau Gaming Inspection and Coordination Bureau, Macau casinos took in MOP 72.9 billion, which translates into US$9.1 billion.

On this measure, then, the Macau market is 5x the size of Las Vegas.

gross revenue vs. net

That’s not the whole story, however.

The official figures don’t report the total amounts that are being bet in the market.  Instead, they record the net amount that the casinos win from customers during the period..  The amounts bet are much larger.

We have precise figures for Las Vegas.  On average, gamblers lost 9.6% of the amounts they bet in Las Vegas during December, January and February.  So they actually bet $17.4 billion during that period.

We don’t have comparable official numbers for Macau.  So we have to estimate.  Conveniently, though, virtually the only game played in the SAR at present is high-stakes baccarat, where casino win typically ranges from 2.7% to 3.0% of the money bet.  To err on the conservative side, let’s say that the win over the winter for the Macau market was impossibly high at 4%.  Using that percentage will give us a low-ball figure for total wagers.

In Macau gamblers actually bet $228 billion during the three months.  On this measure, Macau is already 12x the size of Las Vegas.

…potential?

When I began following casino stocks in the early 1980s, casino operators regarded hotels, restaurants and shopping as regrettable necessities (cost centers, in accounting jargon).  They basically gave the food away to draw patronage.  And the more spartan the room, the better.  That way gamblers spent the maximum amount of time in the casinos and not lounging around watching TV.

Since then the Las Vegas industry has been transformed–with a large assist from Steve Wynn and Sheldon Adelson–into a resort destination.  Prior to the Great Recession (and the accompanying Great Overbuilding), non-casino operations in Las Vegas made up about half the total revenue–and about an equal amount of profit.  In other words, by developing Las Vegas as a resort/convention center, the casinos doubled the size of their market.  This is the model Macau wants to copy.

My guess is that, at present non-casino revenue is only about 15% the size of casino win in Macau.  So the nascent resort business in Macau could, if it’s successful in emulating Las Vegas, be at least 3x the current size.  That would mean that–even without market growth–visitors to Macau could be spending half a trillion dollars a quarter and company profits could be close to 2x the current level.

The Financial Times just wrote a good summary of the current supply constrained situation in the SAR.

but there’s more

In its latest quarterly reporting to shareholders, LVS included in its packet of earnings presentation slides an appendix that touches on growth potential for the Macau market.

–Slide 21 illustrates the proposed high-speed rail system that will connect all the major cities, including Macau, in eastern and central China.

–The more interesting slide is #22, which breaks out recent visitors to Macau by domicile.  It shows that 72% come from nearby Guangdong province, an area with a population of 95 million.  Hunan and Chongqing provinces, which together also have a population of 95 million, but which are somewhat farther away, represent less than 7% of visitors so far.   But that number is starting to grow at a much faster than 50% annual clip.  This implies, I think, that the Macau casino market has come nowhere close to tapping its entire Chinese potential.

TSMC’s 28 nanometer problems: significance

May 2, 2012 By in Industry Analysis, semiconductor manufacturing, Stock ideas, Technology Tags: , , , , , , , , Leave a comment

Rumors have been swirling for some time in tech circles about difficulties the Taiwanese foundry, Taiwan Semiconductor Manufacturing Company (TSMC), is having in bringing its latest cutting-edge chip fabrication lines into full production.  The stories were confirmed when QCOM warned in its latest earnings conference call that over the next quarter or two it would be unable to supply customers with all the most advanced chips they wanted. (Interestingly, in its quarterly earnings call, AAPL said it would be unaffected because it isn’t using 28 nm chips.)

Why is this important?

background

1.  For many semiconductor chips, the history of their manufacture is one of constant attempts to make more complex and faster speed, but also smaller, less power-hungry and cooler output.  One of the main ways of accomplishing all but the first of these goals has been to shrink the spacing between the lines of the chip patterns written onto silicon.

2.  A nanometer is a billionth of a meter.   The 28 nanometer spacing that TSMC is having trouble with is, therefore, a distance between lines of 28 billionths of an inch.

3.  About twenty years ago, the foundry–or third-party manufacturing–business began to come into prominence, as several positive factors for that industry converged.  The increasing complexity of semiconductor “fabs” meant that it cost $3 billion to build one.  Even worse, a fab churned out $7+ billion in output, far beyond the sales of all but the largest companies.  At the same time, a generation of ambitious chip designers wanted to break away from stodgier established firms and develop chip designs on their own. Many focused on customizing templates provided by ARM Holdings (ARMH).

4.  The unquestioned leader in the foundry arena is TSMC.

a paradigm shift in the offing?

There are two big integrated semiconductor designer/fabricators left–INTC and Samsung.  Neither is having fabrication problems.  INTC is beginning to produce 22nm chips in volume, and promises 14 nm for 2013.  In addition, it is using a new production technique that it calls “3-D,” that gets an unusually large benefit from its current linewidth shrink.  Most important, in my view, is that the company seems increasingly concerned with providing customers with products they want, rather than just the latest engineering tour de force.

Samsung already provides foundry services to others–it builds many AAPL chips, for example.  And INTC’s mammoth capital spending campaign of 2011-12 has analysts asking–and the company denying–that it intends to offer similar foundry services in the future.

my thoughts

ARMH, which has–with justification–been an immense market outperformer as the one-stop-shopping way to play the mobile device chips that the design firms/foundry model has been churning out.  But the stock (at 55x historic eps) is down about 20% over the past year, a time when INTC shares (12x) is up by 25%.  Over the same period, Samsung Electronics (5930.KS) (15x) is up 50%.

Yes, the issue with ARMH may just be the high PE multiple.  And, yes, Samsung isn’t just chips.  It’s a force in smartphones and dominant in TVs.  And it trades in a market that marches to its own drummer.  But I think the market is saying that the old integrated model has more going for it than the consensus appreciates.  I also think the market is right.

TSMC’s fabrication difficulties may be the trigger that gets a wider group of investors to focus on the change.

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