Monthly Archives: November 2010

Disney’s 4Q10: a strong quarter Wall Street initially panned

November 12, 2010 By in earnings conference calls, Entertainment, Industry Analysis, Lodging, Stock ideas Tags: , , , , , , , 2 Comments

DIS reported fourth quarter fiscal 2010 (ended October 2nd) results yesterday.  The earnings release was supposed to be available only after the close.  DIS worried that the information was somehow leaking out into the market, however, and published the figures at 3:45pm, fifteen minutes early.  The stock dropped about 4% on the news, but recovered a bit before the close–and some more after.

the results

DIS earned $.45 per share, adjusted for writeoffs, on revenue of $9.74 billion for 4Q10.  This compares with eps of $.46 on revenue of $9.7 billion in the comparable period of fiscal 2009.  DIS doesn’t give detailed earnings guidance.  The reported results fell a penny shy of the Wall Street consensus, however, which covered an unusually large amount of territory for the quarter, ranging from $.39 to $.53.

the adjustments

Hang onto your hat.

1.  DIS’s financial reporting is based on weeks.  This has not-so-obvious accounting consequences.

Q:  How many weeks in a year?  A: 52.    But 52 x 7 = 364.    This means 52 weeks falls one day short of a full year, except in leap year, when it falls two days short.  Therefore, to keep its accounting year more or less anchored to the actual calendar, every six or seven years, DIS has to make a leap-year-like adjustment by having a 53 week year.

That happened in fiscal 2009.

Because of this, the fourth quarter of fiscal 2010 contains 13 weeks, but the fourth quarter of fiscal 2009 contained 14–meaning it had 7.7% more days in it.

There’s no easy way to make an accurate adjustment that will make the year on year comparison an apples-to-apples one.  The the thing any portfolio manager worth his/her salt will do is to make an easy adjustment that may not be accurate but will give a flavor of what the right number should be.  In this case, let’s assume the extra week has no operating leverage effects.  In other words, let’s just multiply the 4Q2010 eps by 1.077.  That yields eps of $.485, a $.035 gain.

2.  DIS’s cable deals are like oil and gas deals, insanely complex and no two alike.  One common feature, though, is minimum performance guarantees (of one sort or another).  In general, these contract clauses call for higher payments to DIS throughout the year if the product it sells exceeds the contractual guarantees (whatever they may be in a given contract).

How does DIS account for these contracts?  It starts out with the assumption that it will not meet the guarantee minimums (even though it may think it can do so in its sleep) and reports the only the amount it would earn if it didn’t.  Once it achieves the minimum, however, DIS does two things.   It begins to report the higher amount from that point onward; and, in the quarter it hits the minimum, it reports–in one big lump–all the extra money it has earned year-to-date at the higher meeting-the-minimum rate.

Normally, this is a bonanza for the fourth quarter.  Fiscal 2010 was so good, however, that the big payday came in the third.  Here are the figures:

deferred revenue recognized:

3Q2010     $344 million     vs.     3Q2009     -$37 million

3Q2010     $170 million     vs.     4Q2009     $524 million.

Net extra payments in the second half of 2010 were $27 million higher than in the second half of fiscal 2009.  But hitting the minimum performance levels earlier this year than last shifted $.09 in eps that would normally be shown in the fourth quarter into the third.

3.  Oh, yes.  DIS is exiting its image capture business, IMD, and wrote off $100 million ($.07 a share) that reduced operating income from the Media Networks segment.

Let’s add all this up.  $.45 reported + $.035 to correct for the extra week last year + $.09 for the cable contract timing shift  +  $.07 for IMD   =  $.595.  In other words, 4Q2010 was a really good quarter.

things I noticed in the report

From an investment point of view, the key positive is that the advertising market is growing very strongly, both for ESPN and for ABC.  But there are other positives that caught my eye as well, namely:

Writeoffs of older, unsuccessful movies appear to have stopped.  For the full fiscal year, DIS reported impairment charges of $132 million, the largest part of which was for writeoffs of abandoned/unsuccessful movie projects.  The fourth quarter number was only $3 million.  If I’m correct, this is a real positive.

The theme parks are perking up.  Adjusting for the extra week last year, park attendance was up 1% and spending per person up 6% for the quarter.  Hotel occupancy was flat, with spending up about 5%.

Hotel reservations are up 5% year on year so far in 1Q11, with room rates also up by about 5%.  Unlike the case during the past couple of years, both metrics are moving in a positive direction.

what about the stock?

I like it.  It probably won’t be a rocket ship ride, but up 15% in eps is easily achievable in the current fiscal year, I think.  The company has also been buying back its own stock at around the $35.50 level recently–always a good sign.  I probably should mention, though, that I trimmed my DIS position a bit a couple of weeks ago, because I thought it had gotten too big.

 

 

 

Manpower, Inc. survey: Chinese managers now being attracted to local firms, not multinationals

November 11, 2010 By in Asian economic development, China, economics, emerging markets Tags: , , Leave a comment

Happy Veterans Day (I’m one)!!!

Happy Birthday, to me!

I was remarking to a friend just the other day that Western investors tend to underestimate the manufacturing skill and management sophistication of mainland Chinese firms.  An early example was an electricity-generating utility that Lehman IPOed in the early 1990s.

The Lehman story was that this company distinguished itself from its peers by using virtually exclusively US- or European-made generating equipment.  Investors, with a little help from Lehman, were quick to conclude that this distinguishing characteristic was the product of sound management judgment.  As buyers of the stock ultimately worked out (or at least, should have worked out), the reality was far different.

Chinese electricity demand was growing exceptionally quickly at that time–to the degree, in fact, that demand for new generating equipment outstripped the ability of the domestic industry to supply it.  Similar-quality equipment was available from foreign vendors, but cost about 25% more.  So there was a big political fight among electric utilities to avoid having to buy equipment from GE or ABB, and thereby raise the price they would have to charge for electricity to make a profit.  The government ultimately decided that one utility would be selected to “take one for the team,” as it were, and buy the majority of the foreign-made equipment China required.  That utility, the one Lehman IPOed, would be the highest-cost (read: worst) company in the industry.

In this case, China knew that Westerners were prone to mistakenly equate low per capita GDP with lack of intelligence and used that prejudice against them.  And as a general principle of commerce, if people are willing to pay a high price for inferior goods, there’s no reason to offer them the crown jewels.

As I turns out, soon after this conversation I ran across a press release from Manpower, Inc., the employee recruitment and training company.  Manpower China did a recent survey in which it contacted 1041 job hunters and HR representatives from 1143 organizations to ask them about what they were looking for in an employer and in a job.

The results:

1.  61% of management-level respondents would prefer to work for a local company that for one of the “golden brands” of foreign multinationals.  Their reasons:

–pay and benefits at Chinese companies have risen close the level of multinationals

–they perceive that multinationals have  “glass ceilings,” above which local managers are very unlikely to penetrate

–they have begun to believe that local companies have better expansion opportunities in China than multinationals.  (I think there are two aspects to this belief:  that local brands are beginning to gain greater awareness in China, and that Beijing will restrict the domestic expansion of foreign-owned brands.)

2.  60% of the HR departments of foreign companies are already seeing this more intense competition for management talent from local competitions.  So far, almost no one is doing anything about it, however.

3.  Cultural issues continue to make it difficult for local companies to hire and retain foreign high-level managers (No surprise here.  This has been an issue throughout the twenty-five years I’ve been watching China).

It’s no secret that every country in the world creates a “home field advantage” for  domestically owned firms.  The Diageo bid for Shui Jing Fang will probably give us more insight into what the rules of the game in China are.  But the Manpower survey suggests (and I think it’s true, too) that the outside world is continuing to commit the fallacy of equating accumulated wealth with brains, by underestimating the value of Chinese brands and the skill of the managers who are building them.

Basel III and trade finance

November 10, 2010 By in Asian economic development, Banks, China, economics, emerging markets, Hong Kong, Industry Analysis, trade finance Tags: , , , , , , , Leave a comment

A heated lobbying effort is underway to change the way that the new comprehensive banking regulations, known as Basel II, propose to deal with trade finance.  It’s being led by Asia-centric banks like Standard Chartered and HSBC, for whom this sort of relatively low-risk lending has been a staple for a long time.

Under present rules, banks have to provide reserves against trade credit advanced to customers that are equal to 20% of the outstanding amount.  Basel III proposes to up that to 100%.

This is an important issue.  Globalization and the resulting growth in trade have been main pillars of the increase in worldwide prosperity of the past several decades.  Standard Chartered says the new rules, if implemented in their present form, would depress world trade by 2%, and clip a half-percent from global GDP.  Presumably things would be considerably worse for HSBC and Standard Chartered.

how trade credit works

Let’s say Very Big Department Store of San Francisco orders 50,000 pairs of blue jeans at $5 each from Great Wall Blue Jeans of Shanghai.

When the contract is signed, Great Wall asks Very Big to have VB’s bank send a letter of credit to GW’s bank, the Hong Kong branch of the Bank of China.  VB goes to its bank, Bank of America, to have BA issue the letter.

The letter is normally irrevocable.  In it, BA tells the Bank of China to pay GW $250,000 when GW presents proof specified in the letter–usually a bill of lading from the shipping company handling transport of the order–that the order is complete and the goods are under way.  BA also promises to reimburse GW immediately.

Based on the signed contract or on the letter of credit, Bank of China will most likely be willing to make a working capital loan to Great Wall, if needed, to finance the manufacture of the jeans.

So, BA and BC both collect fees associated with the letter of credit.  Both may also make working capital loans to their customers, to finance, respectively, the purchasing and the making of the jeans.  The banks’ risk exposure is of short duration.  Assuming that both Great Wall and Very Big are well-known customers, the chance of anything going wrong with the transaction is remote.  This is plain vanilla, everyday low-risk business (other than at times of historically high stress, like the recent financial crisis, when this business completely dried up).  But it’s also very profitable.

my thoughts

It seems to me that the Basel III rules have to change.  But it’s something to keep an eye on.  The obvious losers were the proposed rules to stay as they are now are the trade finance-oriented banks.  But I don’t think this is the main issue.  If China or Brazil go from 8% growth to 7.5%, no one will really notice.  But neither the US nor (especially) the EU are likely to have enough extra economic energy that they can shrug off the loss of .5% in expansion.

The World Bank’s “new gold standard”–what’s that about?

November 9, 2010 By in China, economics, Gold, Recent Market Action, reserve currency Tags: , , , , , , , , Leave a comment

Robert Zoellick, an American who’s head of the World Bank, has recently called, in an op-ed piece in the Financial Times, for the nations of the world to agree to a new framework of international economic cooperation that would be tied together using gold as a “reference point” for value.  “…markets are using gold as an alternative monetary assets today,” he writes.  Gold shot up on this news.  There’s also been an outpouring of nasty comments by professional economists deriding the idea as nonsense.  What is this about?

gold (my view, anyway)

I’ve come to realize that–contrary to my conscious belief that I don’t care that much one way or the other about gold–that I actually do have deep-seated convictions about gold.  Unlike some of my other beliefs, they’re not simply plucked out of the blue, but derive from my having spent close to ten years analyzing natural resources industries, especially metal miners.  This was at a time when, having virtually bankrupted themselves developing massive deposits of base metals, miners were concentrating on gold. (That’s because gold deposits offer high value in small deposits, making them faster and cheaper to develop.)  At the same time, I was also studying the developing countries that are the main sources of demand for the yellow metal (you can find more under the “gold” tab on my blog).  I have three basic conclusions.

1.  Gold is not some sort of proto-money, Ur-money or the “essence” of money.  It’s a metal that used to act as money, but doesn’t in most places any more.  Its virtues are that a small weight/volume contains a lot of value.  You can wear it.  You can break off little pieces to buy stuff.  And, if you want, you can bury it in the back yard so no one–especially the government–knows you have it.  It’s also great if you don’t trust the banks to give back the money you have on deposit.

If you don’t need these attributes, gold is a waste of effort.  You have to safeguard it.  You have to assay it all the time in significant transactions.  And you have to deal with a potentially large bid-asked spread.

2.  Gold doesn’t give inflation protection.  Yes, it has gone up a lot during the past decade.  But that’s not the same as protecting against inflation.  Since 2000, the price level in the US has risen by about 25%.  Gold is up by 450% during the same period.  Not a great match.

From 1980 to 2000, the domestic price level rose by about 80%.  The gold price fell by over 50% during those two decades.

3.  The more you look, the less historical evidence there is for any of the gold bugs claims.  Maybe this is #2 all over again.  But, for example, during the early days of the nineteenth century, metal coins were used as a common medium of exchange in the US.  But they were silver, not gold.  And Spanish coins were preferred to ones from the US, because of their higher purity.

a “true” gold standard

In its purest and simplest form, this means that the money that circulates is either itself gold or is exchangeable into a specified amount of gold on demand.

I don’t think any serious student of economics or history advocates a gold standard in this sense, despite its two positive points:

1.  Governments can’t just print money, willy nilly, to pay for stuff.  No extra gold means no extra money.

2.  Countries have to watch their foreign exchange positions carefully.  A trade deficit is extremely dangerous.  If a creditor nation were to exchange its holdings of a deficit country’s currency for gold, instead of putting the money into the latter country’s government bonds, it would shrink the money supply of the deficit country–causing a recession.

The negatives of such a system outweigh the positives, however.   First of all, the two positives are themselves two-edged swords.  The first would likely prevent a government from taking counter-cyclical economic measures, subjecting it to periodic very violent economic downturns.  The second potentially turns commerce into a political/military battleground, where it is possible to inflict terrible economic damage on a country by redeeming its currency.

Then, of course, there are issues related to the world’s physical supply of gold.

–It is often pointed out that a static, or very slowly growing supply of gold would mean similar limits on world economic growth.

–One might also look back to the effects of the mid-nineteenth century California gold rush, which made millionaires of many Westerners, including the maker of Levi’s jeans, but unleashed a horrible wave of inflation at the same time that destroyed the real value of the savings of just about everyone else.

–Then, of course, there’s my favorite worry.  It’s that a real-life Goldfinger might steal the gold reserves of a given country (likely a small one), thereby rendering its money worthless and stopping its economy in its tracks.

so, what is Mr. Zoellick after?

He knows all this.   In fact, in any proposal over the years that advocates a return to gold, if you read carefully (or read at all), what’s being said has virtually nothing to do with gold per se.  the “gold” part only provides political cover for countries to agree to a course of action which may imply that they’ve been negligent or imprudent in the past, but doesn’t require that they admit it.  And it allows politicians to deflect blame from themselves if an agreement requires painful measures in the future.  After all, it’s not as if they would be choosing to inflict pain.  Gold is forcing them to.

In this case, the issues are obvious.  Politicians in Washington, and in many capitals in Europe, have been stunningly incompetent in managing economic affairs for a long time.  The Great Recession is only one manifestation of this.  China has reached the point where export-oriented emerging economies have always faced their most difficult challenge–persuading the powerful beneficiaries of the status quo that the country must turn away from exports and toward developing the domestic economy.  All sides realize it is likely political suicide to be seen to be “giving in” to the other.

In this case, popular myths about gold can be made to serve a useful purpose.  Maybe I’ve got to warm up to gold, in this sense at least, after all.

 

 

Activision’s 3Q10: plusses and minuses

November 8, 2010 By in Current Market Thoughts, earnings conference calls, Industry Analysis, Stock ideas, Technology, Uncategorized, Video games Tags: , , , , , , , , , Leave a comment

the results

After the New York close last Thursday, ATVI reported its September 2010 quarterly earnings results.  On an adjusted basis, earnings per share were $.12 vs. the analysts’ consensus estimate of $.09 and the company’s guidance of $.08.

At the same time, despite the CEO, Bobby Kotick, citing “the continued strength in our business and our confidence in our continued execution,” ATVI revised down its expectations for the December quarter by about 4%, saying it was equal parts unfavorable foreign exchange movements (presumably meaning costs denominated in non-dollar currencies) and increasing competition in its Activision console game business.  On this news, ATVI stock dropped about 3% in Friday trading.

the details

August was a busy month for Blizzard:

–It launched its long-awaited StarCraft II, which sold 1.5 million copies in its first two days and 3 million in its first thirty days.  The fact that ATVI provided no information for the full quarter suggests sales slowed dramatically after that, however.

–It finally got government permission to launch the second expansion of World of Warcraft, named Wrath of the Lich King,in mainland China.  This was enough to push global WoW subscriber numbers decisively above 11 million+, where it had been stuck for some time, to 12 million.

For the yearend holiday season:

–WoW:  Cataclysm, the third WoW expansion, will be released on December 7th.

–Call of Duty:  Black Ops launches on November 9th.  Pre-sales for Black Ops have apparently been stronger than for Modern Warfare 2, which was ATVI’s blockbuster success of 2009.

–ATVI will also have its usual assortment of new Tony Hawk, music (DJ Hero 2) and James Bond games.

ATVI now has close to $3 billion in cash on its balance sheet.  The company generated about $1.2 billion in cash over the past twelve months, half of which it has used since February to buy $600 million worth of stock (or 55 million shares, 4% of the amount outstanding) at an average cost of $10.90 or so.

stepping back

ATVI has been a disappointing stock this year and a severe laggard since the market bottom in March 2009.  What can we expect from now on?

Here are the company’s year-to-date revenues and earnings by operating segment:

Activision Publishing:   revenues $983 million, operating loss $88 million

Blizzard:  revenues $1086 million, operating income $559 million.

This compares with an operating loss from the Activision segment of $49 million in the first nine months of 2009 and an operating profit of $393 million from Blizzard over the same period.

You might (correctly) say that this is not an entirely fair snapshot of ATVI’s results.  The Activision segment is highly seasonally skewed toward the December quarter.  Activision games also have their biggest sales in the US and European markets, both of which have been hardest hit by the financial crisis.  However, the figures also points to two realities:  the sudden maturation/contraction of the traditional video game console market, and (I think) that the cost structures of the game software companies are still geared for expansion.  In other words, there is still considerable cost-cutting to do.

When Activision and Blizzard merged a few years ago, I imagined the resulting company as the marriage of two equals:  Vivendi, the former owner of Blizzard, got better management for its games unit + a share in a viable shrink-wrapped software business; pre-merger Activision got access to a very talented group of developers + a share of a growing online subscription business in Massively Multiplayer Online Role Playing Games.

Today, the picture looks much different.  Yes, Activision management doubtless helped Blizzard expand–and finally publish Star Craft II. But the key difference is due to the collapse of the traditional video game business.  That’s what the numbers above show.

where to from here?

It seems to me that ATVI is trying to reposition itself, both in reality and in the minds of investors, as an incubator/administrative hub for MMORPGs.  It already has the immensely successful World of Warcraft. It has just launched Star Craft II, which it hopes will be a second.  And it is positioning the Call of Duty, franchise, and Black Ops in particular, to be much more like a MMORPG than a traditional console game.

In addition, ATVI says Blizzard is cooking up an as yet unidentified new MMORPG.  And the company has hired the team that created Halo for MSFT to produce a fifth.

The growth investor “dream,” then, is that Star Craft emulates Warcraft in becoming a source of $300-$400 million in annual income over the next few years.  And that it is followed by at least one other success–time frame unknown.  It would also be helpful if some combination of reduced costs/higher revenue have the traditional Activision games turning a profit again.

On the other hand, eps will be around $.75 for 2010.  What about 2011?  The launch of Star Craft II looks like it generated operating income of about $160 million in the September quarter.  Let’s assume ATVI produces an expansion pack next year that, to pluck a figure out of the air, generates half of the operating profit the game itself did, or about $80 million.  Let’s also say that Blizzard overall, ex the Star Craft expansion pack, grows by $50 million next year.  And let’s assume that the shrink-wrapped software business chips in an extra $30 million in 2011.  Maybe cost-cutting helps, maybe a better economy–and ATVI has always had a knack for identifying new trends.  That all ads up to flat earnings.

In any event, matching 2010’s earnings in 2011 is possible, if a tad on the optimistic side.

On the one hand, I find it hard to be confident that eps will be any higher than that.  On the other, the company has no debt and is immensely cash generative.  The prospective multiple is 12x-13x, ex the cash, which I think is reasonable.  And ATVI is waiting in the wings to buy more stock just a few percent below today’s price.

My bottom line:  For now, I think the stock goes sideways.  I’m not in a hurry to sell and I’d be tempted to trade it if it spikes up.  I’d also use it as a source of cash if another, really good, idea comes along.