Tag Archives: investing

Warren Buffett has been selling INTC–should we? //the INTC dividend

May 16, 2012 By in Dividends, Stock ideas Tags: , , , , , , , , Leave a comment

Buffett’s INTC buy

Institutional money managers are required to disclose their equity portfolio holdings to the SEC each quarter in a filing called a 13F. (The 13F is not to be confused with the 13D, a filing the SEC requires ten days after anyone not an institutional investor acquires a 5% of any class of securities (equity or debt) of a public company).

In its 13F filing for the December 1011 quarter, Berkshire Hathaway indicated that it had bought 11.5 million shares of INTC, worth over a quarter billion dollars, during the period.

In its just-released March 2012 13F, the company says it held only 7.7 million INTC shares at the end of the quarter–meaning it sold a third of its holding in the interim.  As thestreet.com points out, Buffett added roughly the same dollar amount to his holding in IBM.

What’s going on?  Should we follow the Buffett lead?

my thoughts on the recent selling

1.  Mr. Buffett makes no secret of the fact he feels he doesn’t have a deep understanding of technology nor is he comfortable with large tech holdings.  He likes financials like GEICO, instead.  IBM, a steady grower that sells a branded set of services on a recurring subscription basis through a large sales force, is much more his style.

2.  My guess is that, at least implicitly, Buffett has put a dollar size limit on the INTC position because it’s in an industry he’s not an expert in.  He’s trimming to keep the position from getting too big.

3.  Coming at INTC from a slightly different angle, the company is a turnaround story.  To me, at $20 a share, the stock was so cheap that it didn’t matter too much whether the company’s efforts to reinvent the PC ( or at least clone the Macbook Air) and crack the mobile market will be successful.  At $30 a share, in contrast, it seems to me that a buyer/holder is betting that ultrabooks are a hit and that designing bespoke cellphones for carriers will work, as well.

I feel no strong urge to buy at today’s level, but I’m content to wait and see what happens.  Mr. Buffett seems to me to be acting in line with my general analysis.  He wants to continue to make the positive bet–or else he would have sold everything–just not a big one.

4.  Stock picking is like baseball, in that it’s the season’s average that counts, not a given at bat.  Even the most successful professional equity managers are wrong at least 40% of the time (the industry cliché is that 55% right/45% wrong = genius, the reverse proportions = unemployed).  So riding on anyone’s coattails on a single decision is a risky position. Think:  Albert Pujols.

the INTC dividend increase

On May 7th, INTC announced its board of directors had upped the quarterly dividend to $.225 from $.21.

I’m pleasantly surprised.  This is the fourth boost to the payout in less than three years.  My picture has been that 2012 would be a flattish year, before a reacceleration earnings during  2013.  I thought the company might wait until November or December to decide on a dividend increase.  That’s because dividend decisions are never made in anticipation of future profits.  They’re always backward-looking.  They’re made based on what earnings already booked will support.

I take the board action as an indication INTC’s current business is going better than I’d anticipated.

 

Facebook: my take

May 11, 2012 By in Facebook, Industry Analysis, internet Tags: , , , , , , 2 Comments

how is FB describing itself to the financial community?

I think the roadshow video is very instructive.

First of all, it is very expertly and painstakingly scripted and filmed.  A great deal of time, energy and thought went into it, in my view.  Therefore, it should be taken seriously as saying how FB wants to position itself in the minds of investors.

What are the main messages?  I think there are three:

1. FB is as much a social cause as a company.  And, by implication, we all now have a chance to be a part of the movement by becoming owners.

Mark Zuckerberg says both in the video and in a letter in the prospectus that he didn’t initially intend for FB to be a company.  He created it (I think I see a slight change in his delivery as he says this on the video) because it needed to be done.

“Facebook was not originally created to be a company.  It was built to accomplish a social mission–to make the world more open and connected…There’s a huge need and a huge opportunity to get everyone in the world connected, to give everyone a voice and to help transform society for the future…We hope to strengthen how people relate to each other,” he writes.

2.  FB is in a unique position among internet companies. 

Everyone else has succeeded only in creating the “raw tools” that FB is cementing together into a comprehensive communications network.  Because of this unique position, future applications developers will doubtless build their products on the FB infrastructure, giving the company huge profit expansion potential.

3.  FB is only at the start of its “rewiring” of the way people communicate with one another.

There’s very little discussion of current operations in the video–despite the fact it’s a half-hour long.  You’ll see why below.  To me, the implication is that the concept of a possible future is much more important than the present.  It’s a sort of “If you build it, they will come” message.

what about current operations?

Here are the numbers I find most interesting:

users

As of March 31, 2012, FB had 901 million registered users worldwide who have interacted with Facebook in some fashion at least once over the prior month.

As of the same date, it was averaging 526 million registered users who have some interaction with Facebook on a given day.

Of monthly active users, 83 million use mobile devices exclusively to interact with Facebook; 405 million others use both computers and mobile devices.  This is a big change.  Mobile usage grew by 69% over the past year.  It contributed most of the gains shown in North America.

Overall user growth was 33%.

geography

FB breaks out active users into four geographical areas:  US and Canada, Europe, Asia, and Rest of World.

US/Canada

20.7% of all users

average quarterly revenue/user = $2.86, up 14% year on year

user growth was +91% two years ago, +46% last year, +15% this year

biggest boost to growth appears to have been through mobile devices

Europe

27.9% of all users

average quarterly revenue/user = $1.40, up 18% yoy

user growth +94% two years ago, +46% last year, +20% this year

Asia

25.5% of all users

average quarterly revenue/user =$.53, up 23% yoy

user growth +268% two years ago, +93% last year, +47% this year

RoW

26.9% of all users

average quarterly revenue/user = $.37, up 19% yoy

user growth +137% two years ago, +58% last year, +33% this year

what these figures mean

To me, they suggest that the North American market is maturing rapidly and that Europe may be only a year or so behind.  Not surprising, given that Facebook users in North America already outnumber non-users.

The two regions make up three-quarters of FB’s revenue.   So, if it isn’t already, emphasis in North America has got to shift away pretty soon from grabbing as many new users as possible (to prevent rivals like Google+ from snatching them us) to raising revenue per user.  How that will go is unclear (to me, anyway).

income statement

FB has two sources of revenue:  advertising and payments, the latter mostly generated by microtransactions in games. During calendar 2011, FB collected $3.154 billion in ad revenue and $557 million as its share of payments (the lion’s share of that from Zynga).  That was an 88% yoy gain.  Net income was up by 66%.

For the latest quarter, however, net was down yoy, despite a 45% yoy rise in revenue to $1.058 billion.  How so?

Expenses rose by 97% yoy during the period.  R&D was up by 168% to $153 million, marketing by 134% to $159 million, spending on infrastructure by 65% to $277 million.

I interpret this as FB’s recognition that to continue to grow it has to do so in a new way.  It either has to sign up a whole big bunch of low-revenue users outside the US and Europe, or find new ways to raise average revenue per user in its more affluent, but more mature markets in North America and Europe.

It’s conceivable that during this transition time, eps growth will be nothing to write home about.  It’s also not 100% clear FB will be successful, although it is in a very powerful position in the social networking arena.

conclusions

FB’s IPO materials tell two different stories.

–one, portrayed in the video, is of a unique company with boundless potential in an increasingly interconnected world.

–the other, from the numbers in management’s discussion of operations in the prospectus, is of a company that has already picked most of the low-hanging fruit and which is ramping up spending to fend off slowing revenue growth.  The price of this ramp may be lackluster profit growth for at least a while.

Which story to believe?

Here I have no strong opinion.

On the plus side,…

…good growth companies tend to reinvent themselves every few years.  For example:

–Microsoft was originally the PC operating system company.  Then it was the Windows graphical interface company.  Then it was the corporate Office productivity suite company.  Then, a dozen years ago, it stopped growing.

–Apple was the iPod company.  Then it was the “halo effect”/Apple Store company.  Then it was the iPhone company.  Now it’s the iPhone/iPad/iCloud company.

–Amazon, which I think FB resembles the most closely, was originally an Internet “concept” company that sold books in cyberspace and didn’t make much money.  Then it “pivoted”, expanded the range of products it sold itself and began to act as an online sales conduit for third parties.  Profits exploded.

What could go right in this fashion for FB?

Let’s say that corporate advertising on Facebook could double–I’m not sure whether this is an aggressive assumption or an underestimation–over the next two or three years, while FB maintains something like its current cost base.  If so, earnings would rise by about 150%.  Companies would arguably shift ad dollars to FB because it’s cheaper and because customer targeting is better.

Or something really good that’s unexpected by the investment community could develop, as happened in all the cases I’ve cited above.

On the minus side,...

…the valuation, based on current profit levels, is high at 96x earnings per share.  That’s not necessarily a deal-breaker.  LinkedIn, which I don’t think is as promising a company, trades at 686x.  Amazon trades at 186x, with a similar story of heavy investment in new product development.

Priceline.com, clearly a more mature company, trades at 30x.

An “old” warhorse like Apple, where the price earnings multiple has been contracting for the past several years, trades at 14x.

Microsoft, which hasn’t shown any innovative spark so far this century, trades at 11x.

what will professional investors do?

Value investors will hold onto their MSFT and not touch FB with a ten-foot pole.

Growth investors will probably take all the FB they can get in the IPO.  Knowing that the stock will very soon be part of the NASDAQ index, I think they’ll try to build their positions to the point they have only slight underweights and then await further developments.

For me, the stock would be a roll of the dice–something I try to avoid.  It’s not simply a question of valuation. If I thought FB’s earnings in three years would be close to triple the current level, as a doubling of revenue/user would achieve, I’d be very happy to buy it.  I don’t know the company well enough to have that conviction.  But I believe this is the key question potential investors should have an answer to.

Note:  Since I  wrote this post, two new pieces of information have come out:

–FB amended its prospectus to reflect what was apparently a management answer to a question posed during the roadshow.  FB said that some users were switching to accessing Facebook through mobile devices rather than through computers.  This has a negative effect on revenues, since FB runs fewer ads through mobile devices and advertisers pay less for them.

–apparently demand is strong enough for the issue that FB is talking about raising the IPO price to $34-$38.

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.

 

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.

 

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