Category Archives: Stock ideas

Microsoft (MSFT) buying the Nook e-reader?

May 10, 2013 By in Current Market Thoughts, e-readers, Industry Analysis, Publishing, Stock ideas Tags: , , , , , , , , Leave a comment

the news

Yesterday, the stock of Barnes and Noble (BKS) soared 22% on more than 10x normal volume.

The reason?

…a TechCrunch post saying MSFT is preparing a $1 billion offer for the company’s Nook-related digital assets.  The assets are held in BKS’s Nook Media subsidiary, which also contains the company’s college bookstore operations.  Leonard Riggio, who controls 31% of BKS, owned the college bookstore business privately but sold it it BKS in 2009 for $514 million.

The TechCrunch report is based on its examination of internal MSFTdocuments which the New York Times says are genuine, though perhaps dated.

is the headline figure, $1 billion, all that it seems?

Maybe not.  The most favorable interpretation of the TC scoop is that MSFT is willing to pay $1 billion for the portion of the BKS digital assets it doesn’t already own.  The least favorable is that the offer values the entire Nook Media at $1 billion.

The difference?  Three factors:

1.  MSFT already owns 17.6% of Nook Media.  Pearson owns another 5%.  Under the more favorable interpretation, the $1 billion would be split between Pearson and BKS, with the latter getting $940 million.  Under the less favorable, which I think is probably the correct interpretation, BKS would collect $774 million.

2.  Does the $1 billion value include the college bookstores, which–as I read the BKS financials–are the company’s most profitable operations?  If so, cut the MSFT offer in half.

3.  In its original deal with BKS, MSFT promised to fund up to $180 million in Nook R&D.  I think this was a loan, not a gift.  If so, part of the $1 billion may be forgiveness of the loan, not a new cash inflow.

In the least favorable case for BKS, subtract $500 million from the $1 billion headline number if the college book stores aren’t included.  Another $176 million represents the stock MSFT already owns.  Let’s say a further $100 million represents repayment of the R&D advance.  Then, the “$1 billion” offer would mean a cash outflow of  about $250 million, of which BKS would get about $235 million.

the Nook is bleeding red ink…

…for three reasons.

In the Darwinian world of consumer electronics, stand-alone e-readers like the Nook are an evolutionary dead end.  They’re being replaced by small, light tablets.

The Nook is an also-ran among e-readers.

As I read the BKS  financials, the company has a razor/razor blade strategy for the Nook.  It prices the device roughly at cost in the hopes of generating a lot of high-profit e-book sales from users.  In fiscal 2013 (ended in April), however, BKS appears to have lost $350 million trying to persuade consumers to take Nooks off their hands.  It’s hard for me to see how BKS can sustain deficits of this size.

why buy the Nook? 

1.  MSFT takes in $1 billion in cash every two weeks.

2.  To compete in the tablet and smartphone businesses, MSFT needs an e-reader feature.  Because of the company’s tiny market share in both businesses, developers aren’t beating down the doors in Redmond to make reading apps for it.  MSFT’s plan would apparently be to stop making e-readers and refocus the Nook division on creating/enhancing e-reader apps, especially for Windows devices.

3.  According to TechCrunch, the MSFT documents project Nook “ revenues to gradually recover, up to $1.976 billion by fiscal year 2017, for EBITDA profit of $362 million.”

Given that sales of e-readers make up the huge bulk of Nook Media’s sales, the most polite thing I can say is that this forecast is extremely optimistic.  Revenue growth appears to assume a rocketship ride for sales of digital content.  The $750 million positive swing in EBITDA looks too good to be true.  But it does make Nook Media look cheap.  My hunch is that this is its main purpose–to justify the purchase.

(One caveat:  it’s impossible for me to judge how revenues and costs for the Nook devices and for digital content are figured and split between the retail and Nook divisions of BKS.  The only way I can see for Nook Media revenues to rise without hardware sales is if the whole basis of revenue calculation is somehow changed.  EBITDA of $362 million is only plausible to me if somehow post-acquisition Nook Media’s SG&A expense of around $400 million a year completely disappears, or if somehow a whole bunch of digital content profits are now being attributed to the retail division but revert to Nook Media post-acquisition.)

For what it’s worth, TC says the MSFT documents value BKS as presently constituted at $1.66 billion.

4.  MSFT is anything but a shrewd acquirer, in my view.  Just look at its $40+ billion bid for YHOO in 2007 (it has taken a 70% rise in YHOO’s stock price over the past year for that company to recover to a market cap of $30 billion-).

5.  Nook Media may be MSFT’s best alternative–and it may feel it can’t allow the business to die.

I don’t have an investment opinion about BKS.  I don’t own the stock and I have no inclination to be a buyer.  Any holder must ask himself where he sees upside from the current level, and how much that might be.

PS:  I wonder who leaked the documents   …and why.

bird flu: investment implications from the SARS experience

May 9, 2013 By in Current Market Thoughts, Portfolio management, Stock ideas Tags: , , , , , , , , , Leave a comment

coronaviruses

Three times in the past decade we’ve had global flu pandemic scares from coronaviruses:

–SARS in 2002-03

–H5N1 in 2008, and

–H7N9 currently.

I don’t know enough to say any more than that in each case the disease is carried by birds or animals and transmitted to humans through contact,  Contact can come either from physical proximity to live animals or from eating undercooked meat.

The truly dangerous development would be a virus mutation that allowed the disease to be transmitted from an infected human to other humans.  In the case of H7N9, this possibility hasn’t been ruled out, but the evidence for or against appears to be unclear.

SARS

The S&P 500 dropped by about 10% once the threat of SARS became apparent;  the Hang Send fell by closer to 20%.  The emergence of the following two viruses have been greeted mostly with yawns.  Still, I think it’s worth looking back at the SARS episode to remember what happened then–just in case H7N9 takes a negative turn.

Beijing

One key difference between SARS and the others is that the government in China, where all these flu strains have originated, initially tried to cover up the SARS outbreak.  That allowed the disease to spread for months before any systematic action was taken to combat it.  And even then China didn’t want to release details to the international medical community about how bad SARS had become.  And it rebuffed foreign offers of medical cooperation and assistance.

As a result, before the spread of the disease was controlled through quarantine, 8,273 cases of SARS were reported, the vast majority in China and Hong Kong.  About 10% of those infected died.

Beijing’s attitude is now completely different.  China has already supplied virus samples to world medical agencies so they can begin work on possible vaccines.

what a repeat would mean for stocks

Economically, what would a repeat of the SARS experience look like?  Here’s what I think:

1.  World GDP growth would slow down.  Factories in the affected areas would cease production, with employees possibly quarantined.  As in the case of the recent floods in Thailand, we would doubtless find that shuttered manufacturers made some low value-added, but nevertheless key, industrial components that would force work to be curtailed all through the supply chain.

2.  International trade would decrease markedly.  Export destinations would be reluctant to accept shipments of goods for fear of contamination.  transport hubs wouldn’t want to handle cargoes.

3.  Global travel would come to a screeching halt.  Travelers would fear being infected while on aircraft.  For the same reason, no one would want to receive business visitors, especially from affected areas.  Less obvious, though most important, travelers would fear being quarantined–possibly for months–at a foreign destination and not allowed to return home.  That could reduce their work effectiveness, as well as potentially forcing them to remain in an area where medical care might be sub-par.

stock market effects

In the SARS case, stocks stayed depressed for around three months.  They began to rebound once signs emerged that quarantine was effective and the virus was coming under control.

Back then, stocks in Hong Kong were hurt across the board (in today’s world, the biggest losers would likely be the casinos in Macau). Industries badly hit around the world included, as you might expect, hotels, ports, airlines and all businesses in international tourist/business destinations.

Pharmaceutical companies, especially those with related expertise, did well.

Were H5N9 to mutate into a form that’s more dangerous than it is now, I’d expect the same general pattern to recur.

Let’s hope it doesn’t.

Dr. Copper is speaking–but what is he saying?

May 7, 2013 By in Mining, Portfolio management, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , , , Leave a comment

Albert Edwards

Albert Edwards of Société Générale is one of the longest-tenured strategists of global securities markets around.  He’s very smart.  He foresaw the problems that would result in the peripheral EU countries from the very beginning.  He predicted long ago the current condition of globally low interest rates and slow growth, which he dubbed the “ice age.”  It took a more uplifting spin by marketing juggernaut Pimco, which called the situation the “new normal,” before the idea gained wide acceptance.

In some sense, Mr. Edwards’ predictions are  …well, predictable.  He’s almost always bearish.

Dr. Copper

He’s currently listening to “Dr. Copper,”  whose price has been falling since the beginning of the year.  Mr. Edwards likens today’s situation to that in 2007, when a swoon in the red metal (it ultimately lost 2/3 of its value) presaged recession.

Why is copper so important?  Its use is highly economically sensitive.  It’s tubing and wiring in building construction; it’s the guts of an electric power generator; and a new car can contain up to a hundred pounds of it.

Recession in the back half of 2013 wouldn’t be pleasant.  Monetary spigots around the world are already wide open.  Fiscal loosening takes a long time to have an effect–and, ex the EU, dysfunctional legislatures are unlikely to agree on anything positive in any event.  So for the first time since WW II, we’d just have to take our lumps.

is this right?

I’m not sure that Mr. Edwards is correct, though, about what’s causing the copper price to fall this time.  A tripling in the price of copper since 2006 has caused new mine projects to start up  and existing mine production to rise steadily.  I haven’t been able to find good statistics for recycled copper, another important source of supply, but I’m confident that it’s up as well.  As a result, a market that was chronically short of supply has recently turned into one where supply is now slightly ahead of demand.  Hence the price fall.  Unlike 2007, my view is that Dr. Copper is swhispering that supplies will be plentiful from now on, not that demand is drying up.

Europe is cheap

By the way, Albert Edwards has another big insight.  This one is bullish.  So, coming from a bear, it’s well worth listening to.

He thinks European stocks are startlingly cheap.  Copper is telling him that world economies are going to hell in a handbasket over the next eighteen months, so the timing isn’t quite right today.  But if–like me–you think he’s getting the wrong message from Cu, they’re worth taking a look at now.

a strong 1Q13 from Las Vegas Sands (LVS)

May 2, 2013 By in Casinos, earnings conference calls, Entertainment, Industry Analysis, Stock ideas Tags: , , , , , , 1 Comment

the report

After yesterday’s close, LVS reported 1Q13 earnings results.  Revenues came in at a record $3.3 billion, up 19.5% year-on-year.  Earnings per share were $.71, up a penny from the 1Q12 EPS, but $.04 higher than the Wall Street analysts’ consensus.

The results are actually much stronger than the raw numbers would suggest.  As regular readers will already know, casinos count as revenue only the amount that patrons lose when they gamble, not the amount they bet.  Over long periods of time, gamblers losses adhere to highly predictable patterns.  Over short periods, however, they can fluctuate a lot from the “house advantage,” based mostly on random “luck” factors.  To get a clear picture of how a casino company is doing, we have to adjust for this.

In LVS’s case, luck made 1Q12 revenue (and operating profit) look $177 million better than it should have; luck made 1Q13 revenue look $25 million worse.  Adjusted for these differences, income for LVS was up by about 30%.

why so good?

Macau

–Chinese gamblers elected to keep low profiles during the recently completed leadership change in Beijing.  Now they’re returning to the baccarat tables in Macau.

–better transportation and streamlined border controls mean more visitors can easily reach Macau

–unlike, say, WYNN, LVS has ample spare capacity to accommodate new customers, so it’s benefiting disproportionately from the market upturn.

Singapore

–mainland Chinese gamblers, whose patronage of the Marina Bay Sands has been more highly economically sensitive than their visits to Macau, are coming back

–so too, gamblers from Indonesia

US

–Las Vegas was flattish, with strength in non-casino operations

–Bethlehem, PA continues to perk along

Asian retail mall operations

In response to an analyst question about why LVS had not yet sold any of its Macau or Singapore retail operations as previously planned, management said the businesses were still growing much more quickly than anticipated.  The company thinks the Asian malls may ultimately be worth $8 billion – $10 billion, or around 20% of the company’s market cap.

For the first time, LVS is providing segment detail about these operations.   1Q13 operating profits were $68 million, up 23.4% yoy.

a special dividend?

Management also said it’s considering borrowing in the US, à la AAPL, to fund either a special dividend or a share buyback.

my take

LVS isn’t wart-free. It’s involved in a number of lawsuits.  And its long-time auditor has just parted ways.  Still, by my calculations, the Asian operations explain more than the entire market cap of LVS.  I don’t think either Hong Kong or Wall Street has appreciated the potential of the Asian retail malls.  LVS is the only way to get exposure to Marina Bay Sands and the easiest way to participate in Sands China.  I’m not in a great rush to buy more today but I’m very happy to hold.

new financing for J C Penney (JCP)?

April 29, 2013 By in Retail, Stock ideas, Uncategorized Tags: , , , , , , 1 Comment

the news

During New York trading last Friday, CNBC reported that Goldman had lined up $1.75 billion in new debt financing for JCP.  The stock, which had already been rising strongly on news that the Soros-run Quantum Fund had acquired a 7.9% stake in the ailing retailer, jumped sharply.  JCP ended the day at $17 a share, up 11.6% on the day.

According to the Wall Street Journal, which isn’t 100% clear, the new loan to have the following characteristics:

–$1.75 billion in size

–a five-year term, after which repayment in full would be due

–a 6.5% interest rate, implying $113.75 million in annual interest expense

–secured by many/most/all the company’s assets not already acting as collateral for other loans.

Neither JCP nor Goldman have confirmed the press reports.  As of Sunday night, when I’m writing this, there’s no SEC filing about this on the Edgar site, either.

my thoughts

1.  From the WSJ account, this new financing appears to be a bond offering rather than a bank loan.   Two differences:   on the one hand, the loan must be made all at once, starting the clock on interest payments, even though the money might not be needed right away; on the other, the lender has, generally speaking, no right to ask for early repayment.

The cost of the financing–before Goldman’s fees– would be close to $570 million over the next five years.

Unlike a bank loan, which can have an indeterminate term, JCP would have to have $1.75 billion available to repay the loan five years from now.  It’s possible that JCP could negotiate an extension, or borrow from someone else to get the money.  Without one or the other, the loan would seem to put a time limit on how quickly the operational turnaround must occur.

2.  To the extent that any assets of JCP serve as collateral for the loan, they would presumably not be able to be sold without the lender’s permission.  This could prove another, possibly severe, limitation to JCP’s options.

In a related story, the WSJ cites a brokerage report by ISI.  The report, which I haven’t seen, asserts that if the top 300 of the properties JCP controls were rented to third-parties instead of being used by JCP, they would fetch yearly rental income of $1.2 billion.  That’s more money than JCP has made in any of the past five years!

I don’t know whether this figure is correct.  If it is, it suggests that even pre-Ron Johnson the value of Penney’s real estate was being frittered away supporting a retail operation that only turned a profit because of a massive rent subsidy.

I’m sure JCP situation is much more complicated than just shutting down retail and allowing the value of the company’s real estate to be recognized–especially now that JCP stores have absorbed so much damage in the recent past.  Still, the point is that accepting the new loan might close out completely the possibility of forming a separate entity with these properties and rerenting them.

It will be interesting to see what JCP chooses to do.

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