Category Archives: Technology

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.

 

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.

AAPL’s 2Q12: deja vu all over again

April 25, 2012 By in China, earnings conference calls, emerging markets, Hong Kong, Industry Analysis, Stock ideas, Technology, Wireless Tags: , , , , , , Leave a comment

the results

After the close of New York trading yesterday, AAPL reported results for its second fiscal quarter (the company’s fiscal year ends in October).

It was–contrary to highly publicized negative analyst expectations–another litany of record performances.

Revenue was $39.2 billion, up 58.7% year on year.

Net income was $11.6 billion, up 93.3%.

EPS was $12.30, a 92% yoy gain.  Of 42 analyst estimates for the quarter, the lowest was $8.46, the highest $11.80, the median $9.81.  So, once again, AAPL blew away the consensus.

details

The company sold 35.1 million iPhones during the quarter, up 88%.  This compares with 46% growth in the overall smartphone market.

iPad sales were 11.8 million, a 151% yoy increase.

4 million Macs went out the door, up 7% yoy (in a PC market that was up 2%).

iPod unit volume was 7.7 million units, down by 15%.  The music player–which was once half the company–now represents only 3% of sales, however.

what caught my eye

AAPL continues to be capacity constrained with the new iPad.  The huge tablet sales gain this quarter appears to have been driven by demand–especially from schools–for iPad2, once AAPL dropped the price to $399.  I don’t see any reason to think that this new-found new source of tablet demand will go away any time soon.  And it could turn out to be very big.

Greater China was the geographical star.  Sales in the region, which made up 20% of the AAPL total for the quarter, tripled yoy.  iPhone sales were 5x the year-ago level.

Mac sales barely outpaced the market for the quarter.  But that’s comparing a newly refreshed product line a year ago with the same lineup today–now a little long in the tooth.  So I don’t think the weaker than usual comparison means anything.

Management gave its usual song and dance to “justify” its low-ball earnings estimate for the June quarter–$8.68/ share.  The company did make two reasonable points, though.  It expects to sell a lot of iPads, which carry lower margins than other AAPL products.  Also, 2+ million of the iPhones sold to telephone companies during the period went to replenish store inventories depleted during the holiday season.  This extra demand won’t be present in the current quarter.  Neither is that significant, in my opinion.  Together, they may just mean that yoy gains in 3Q12 won’t be quite as impressive as in 2Q12.

pre-announcement analyst panic

AAPL sold off by about 15% in the days before the earnings release.

I was struck by the number of analysts who rushed to publicly validate the price decline by offering negative assessments (now proven to have been wildly incorrect) of the company’s 2Q12 prospects.  One can only imagine what they were saying in private meetings with institutional clients.  I was also struck by the dearth of AAPL defenders–although it’s possible their comments were edited out.

For instance,:

–one analyst I read predicted Mac sales would be down, year on year, in the quarter–without mentioning either how difficult the comparison was or that Macs only make up a bit more than 10% of AAPL’s business.

–another said in a recent TV interview that he was lowering his forecast of iPhone sales from 33 million to 30 million–and intimated he thought that figure might still be too high.

I have four observations:

1.  I think the analysts in question extrapolated from what they knew about the US and Europe to the rest of the world.  When you think about it, that seems kind of loony.  Why would you think China, which is growing at 7%+ and where people are just starting to buy smartphones, would look like the US?

2.  More generally, the incident says something about the quality of research on Wall Street.  APPL isn’t the only case.  Analysts did the same sort of extrapolation with INTC last year.

3.  It says something admirable about AAPL that they don’t have one standard of information dissemination for ordinary people like you and me, and another one for Wall Street analysts.

4.  This shows how a rumor-driven market works.  Once a story starts, information sources rush to repeat and amplify the rumors, mostly because they’re worried that otherwise they’ll be thought to be out of touch.

AAPL’s stock?  It still looks cheap to me.

 

INTC’s 1Q12: encouraging signs

April 24, 2012 By in earnings conference calls, Industry Analysis, Stock ideas, Technology, Wireless Tags: , , , , , , , Leave a comment

the results

After the close of trading on April 17th, INTC reported 1Q11 results that were a bit better than the company had guided to three months earlier.  Revenues came in at $12.9 billion, net income at $2.7 billion and eps at $.56 ($.53 on a non-GAAP basis).  This compares with the Wall Street analysts’ consensus of $.50 and $.58 that the company posted in the year-ago quarter.

Quarter on quarter, results were down, as the company felt the full force of the supply disruptions caused by flooding of hard disk drive factories in Thailand.  Basically, INTC customers couldn’t get hard drives to make all the PCs they wanted.  They also didn’t know when production would return to normal.  So they cancelled orders for new microprocessors from INTC and ran down to the bone the microprocessor inventories they had on hand.

Year on year comparisons aren’t straightforward, either.  1Q11 contained 14 weeks, versus a “normal” quarter of 13, like 1Q12 was.  So the yoy revenue comparison, $12.9 billion in 1Q12 vs. $12.8 billion in 1Q11 is considerably better than it looks.  The biggest yoy difference in expense comes in R&D, where this year’s $2.4 billion is much higher than the $1.9 billion INTC laid out in 1Q11.  Had R&D spending been flat yoy, INTC’s net would also have been flat, and eps up slightly (on a lower share count) yoy.  Not bad for a component-constrained quarter that was one week shorter than 1Q11.

details

I reread my post on INTC’s 4Q11 before starting to write this.  I think you should read it, too.  I haven’t changed my thinking.  And otherwise, I’d just be repeating here what I said there.

Three factors are new, though:

–it looks like the hard disk drive shortage is over already, a couple of months earlier than INTC had initially thought.  The company expects 2Q12 sales to be in line with final demand, with inventory restocking by customers only happening in the second half.  My guess is the net result will be a slight uptick (maybe $.05) in full-year eps from my prior guess of $2.75 for 1012, rather than just a reshuffling of the quarters. (Remember, this includes $.15 a share that Thai flooding shifted out of 2011 and into this year.)

–INTC has dropped its tax rate guidance from 29% to 28%, which I take to mean the company is lowering its expectations for the US and raising them for emerging markets.

–INTC is starting to churn out 22nm chips in volume.  At the same time, TSMC is reported to be having trouble with its 28nm manufacturing process.  This should help extend INTC’s performance lead–or close its performance gap–versus competitors who use foundries (meaning just about everyone).

where to from here?

As I wrote three (and six) months ago, at $20 a share I think INTC was a buy simply on the notion that the company wouldn’t fade away within the next two or three years.

At close to $30, the decision is different.  I think you have to believe a lot more–at the very least, that ultrabooks will be a big success.  It would be better, of course, if INTC could make some inroads into ARMH’s franchise in tablets and smartphones, as well.  In both areas, signs are encouraging.

–There are already almost two dozen ultrabook models on the market, with another hundred or so on the way before yearend.  Some will be configured to use the touch features of Windows 8; some will be hybrid devices that can function as tablets as well as traditional PCs. Better still, to my mind, is the fact that ultrabooks are coming from Samsung, Asus and Acer–meaning they’ll be stylish and more reliable than, say, Dell.

Ultrabooks have also gotten a very favorable mention in computer guru (and Mac aficionado) Walter Mossberg’s Spring laptop buyers’ guide in the Wall Street Journal. 

–Rather than waiting for customers to come knocking at its door, INTC created a “reference design”–a detailed blueprint–for the ultrabook and presented it to computer manufacturers.  It’s taking a similar tack with cellphones.  It’s offering its reference smartphone design to carriers to use as their “house brand.”  It’s already signing up customers.

Who knows where this will lead?  But the fact that most carriers are selling iPhones to customers at $400 below their cost should be a powerful motivator to look for cheaper alternatives.

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