Monthly Archives: December 2011

Thai floods mean lower earnings per share for Intel

December 13, 2011 By in earnings conference calls, Industry Analysis, Recent Market Action, Stock ideas, Technology Tags: , , , , , , , , , , , Leave a comment

the INTC announcement

Yesterday, INTC issued a press release and conducted a brief conference call to say that earnings per share for 4Q11 were going to be lower than anticipated. The stock fell about 4%, in a weak market, on the news.

The reason?

Recent flooding in Thailand (see my post) has put most of that country’s hard disk drive manufacturing capacity–about 40% of the world’s HDDs are made there–out of commission.  Production won’t be back to normal until May or June.  INTC’s original supposition that inventories of HDDs in the supply chain would be enough to tide makers of PCs and servers over has proved to be too optimistic.

About two weeks ago, HDD makers began to tell device makers how many HDDs and of what type they would be able to deliver in 1Q12.  The numbers are low.  Device makers immediately cancelled orders for large numbers of chips they’d planned to buy from INTC, since there’s no sense in buying components that will be gathering dust in a warehouse waiting for HDDs so a PC can be assembled and shipped.   Hence the public announcement of lower 4Q11 results.

1Q12 eps will doubtless also be less than Wall Street had been expecting, although INTC had not given formal guidance.

eps for 4Q11…

The press release was very brief.  Previously, INTC had expected revenue of around $14.7 billion for 4Q11.  Due to order cancellations, the company now thinks revenue will be closer to $13.7 billion.  Margins will be relatively unaffected.  Yes, volumes will be lower, but device manufacturers are putting the HDDs they are allocated into their highest-profit products (duh!)–which typically also contain INTC’s highest-margin chips.

Analysts had been figuring that INTC would earn $.69 per share for 4Q11.  I think the actual outcome will be around $.63.

 

Looking at the figures another way, INTC was selling chips at a rate of $1.13 billion a week before the industry became aware how low 1Q12 production of HDDs would be.  Subsequent cancellations amount to a bit less than one week of INTC’s December production, or about a quarter of its monthly output.

…and 1Q12

This is anyone’s guess.  Everything depends on how quickly HDD output in Thailand can be restored and on whether it comes back in a linear fashion or in big lumps.  It’s possible, for example, that INTC will be selling at 75% of a normal rate for most of the quarter and then have a huge number of chips fly out the door during the last two weeks.

My stab in the dark is that earnings per share for the quarter could be as low as $.50 but will probably be higher.

more important, earnings will be deferred–not lost

INTC said repeatedly during its conference call (analysts kept asking the question, over and over) that the revenue decline it is experiencing is due solely to lack of HDDs from Thailand.  Its monitoring of sell-through of PCs and servers indicates that end-user demand remains strong and is growing in line with INTCs expectations.  True, Europe may be a little weaker than INTC thought, but Asia is better.

Servers are unaffected.  Device makers are simply not producing the lowest-priced PCs.

Once HDDs are again available, INTC expects the market to return to normal.  Device makers will doubtless boost purchases from INTC to restore the inventory levels they are now running down.

impact on INTC’s production

INTC isn’t going to slow production down, even though my guess is that about 25% of what it is making will, in one form or another, remain in inventory for a while.  Several reasons:

–it can take months to make semiconductors, so INTC can’t just turn production on and off

–INTC is just beginning to ramp up production of its next generation 22 nanometer chips, so it doesn’t want to slow down on them

–the company believes (correctly, in my opinion) that there will be a pickup during late 1Q12 or early 2Q12 that’s just as rapid as the current slowdown.  It would be crazy to miss that sales opportunity just to save a penny or two in eps now.

what about solid state drives?

…the ones made from flash memory.  So far, INTC sees no move by PC makers to substitute more expensive SSDs for HDDs.  INTC, however, believes the future of laptops is in Ultrabooks, sleek Macbook Air-like devices.  So it’s going to see what it can do to use the shortage of HDDs to push device makers to transition more quickly to SSDs.

the stock

INTC shares lost 4% yesterday, in a market that was down 1.5%.  I interpret this as meaning Wall Street is going to ignore the current eps weakness and focus instead on INTC’s low valuation, high dividend and reasonable prospects for growth.  I think that’s the right thing to do.  (A purist might argue that a deferral of, say, $.20 in eps for six months is really a loss of at most a penny, so that the $1 a share fall in the INTC stock price is excessive.  But you’ve also got to factor in something for the uncertainty of the situation and the fact that the market as a whole was down.)

I still think the stock is cheap.  There may be a better buying opportunity when the market gets around to thinking about 1Q12 earnings, or if the current period of market weakness continues into next year–which it could.  On the other hand, there may not be.  I own a lot of INTC, so I’m not tempted to buy.  If I owned none I might be.

another week, another crisis: life in the EU

December 12, 2011 By in Current Market Thoughts, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , , , Leave a comment

background

The Maastricht Treaty (or Treaty on European Union), signed in 1992, laid down the minimum economic requirements for entering, and remaining in, the EU.  It specified, among other things, that any member country’s budget deficit should be no more than 3% of GDP and its outstanding government borrowings should be below 60% of GDP.

Members would be entitled to use the common currency, the euro–thus becoming part of the Eurozone.

One quirk of the arrangement was that the economic rules could be enforced only at the point of initially applying for membership–by denying entry to the EU to countries that didn’t qualify.  After that, there was nothing.  Why not?  No country wanted to give up sovereignty.

Italy, for reasons of bella figura, underwent an heroic restructuring of its economy so it could be among the charter members–and began backsliding almost immediately.  Greece probably never qualified for membership, but the EU overlooked its well-cooked books to advance its pan-European reach.

One other thing:  most EU members adopted the euro.  A few, notably the UK and Sweden, did not.  The latter are in the EU but not in the Eurozone.

the crisis

Trouble had been brewing for years. Even less creditworthy countries could borrow large amounts of money at favorable rates by issuing sovereign debt in euros, on the idea it would be guaranteed by the full Eurozone.  The situation reached a boiling point in 2010 when Greece announced it had been falsifying its national accounts for years.  Belatedly, lenders began to worry that the Eurozone would not stand behind all euro-denominated debt.  Worries soon expanded to include Berlusconi-led Italy.

the problem

Moral hazard.  Germany balked at stepping in to bail out Greece–and potentially Italy–without a way of enforcing the Maastricht economic criteria.  Otherwise, it risked throwing good money after bad.

where we are now

At the latest in a series of “summits,” the Eurozone countries agreed last week to amend the Treaty on European Union to give EU institutions the power to enforce the Maastricht economic criteria.  That was the final condition Germany wanted before it would be willing to stand behind Italian debt.

But…

…the UK vetoed the idea of using EU government institutions to police Eurozone member countries.  Why?  It wants concessions that will preserve its position as the premiere financial market in the EU.   (This, even though the UK’s “regulation light” philosophy nearly brought the country to its knees, gave protection to the perpetrators of the US sub-prime mortgage debacle, and resulted in sketchy ex-Soviet bloc mining companies becoming major forces on the stock exchange).

So the Eurozone countries say they’ll develop an alternative enforcement mechanism by Christmas.  But until they do, the securities markets will continue about the survival of the Eurozone.

my thoughts

It seems to me that a necessary condition for politicians to back any measure that will bring pain to their constituents is that the alternative appear worse, so that they can cast themselves as heroes for having “rescued” voters from a worse fate–even if they themselves have created the worse alternative by their inaction.  That’s just life.

The Eurozone countries are making progress, though.

Either the Eurozone will cobble together a new enforcement mechanism or–more likely, I think–it will grant some concessions to the UK in return for permission to have Brussels enforce the new Eurozone economic rules.  After all, I don’t think the UK wants to be left completely on the outside of Europe, looking in.

In any event, ratification of the new rules won’t be completed until next March.  Until then, I don’t expect to see significant Eurozone action to support the bonds issued by Italy.

My guess is that support will come, but not until Spring.

For equity investors like us, I think two factors are important:

–Europe will be in recession in 2012.  The question is only how deep it will be.  This is a time to think through how well our holdings of global companies are insulated from European demand weakness, with an eye to emphasizing those with the least EU exposure.

–it’s still too early, in my opinion, to be bottom-fishing in the EU.  There’ll be time enough for that in, say, February.

raising capital… (II): venture capital

December 8, 2011 By in Industry Analysis, Investment firms, Private equity Tags: , , , , , Leave a comment

Although I’ve observed the venture capital industry at work for most of my career and have invested in lots of companies making their first move away from private equity financing, I’ve never actually worked in the venture capital industry.  So this post will be brief.

venture capital

Venture capital is a form of private equity financing.  VCs support early-stage companies that they think have substantial growth potential, but which are too small, and too risky, to get conventional bank financing.  Their small size and immature businesses also rule out the possibility of a conventional IPO.  Again, the risk it too high.  In addition, if the company wants to raise, say, $10 million, fee income would at most be $1 million–too little to interest most reputable investment banks.  (The only time I can recall seeing brokerage houses reaching down into venture capital territory in a big way was in the latter days of the internet bubble in 1998-99–and we all know how that turned out.)

In the US, venture capital is typically associated with Silicon Valley in California.  In their search for start-ups with explosive growth potential, they have acquired deep knowledge of technology-related industries (where that potential resides) and of skilled entrepreneurs who can turn that potential into a fast-growing firm.  So they feel comfortable there.

VC activity isn’t always in the tech world.  But you won’t see venture capitalists backing firms in, say, furniture retailing, where it’s difficult to see earning several times your initial investment in a reasonable period of time.

funding rounds

Venture capital financing isn’t a one-shot deal.  It typically occurs in a number of stages, or “rounds,”  where a company gets more money, so it can move to a higher level of development.

Stages might correspond to company needs for:

–seed money, where the VC firm supplements funds committed by the entrepreneurs themselves, or their friends and family.

–product development

–manufacturing and marketing

–working capital

–expansion.

If everything is going smoothly, each round of funding will be at a higher stock price.  The funding may be done through convertible securities rather than straight equity.  This gives the venture capitalist some income while he waits for the company to mature.  Convertibles can also give the VC a stronger claim on company assets than ordinary equity holders in the case that things go badly.

exit strategy

The venture capitalist has traditionally expected to cash out of the company he has invested in thorough a conventional IPO–at which time he will have the option of selling some or all of his shares.  In today’s world, however, it’s equally possible that a private sale to a much larger firm in the same industry will happen instead.

pluses

Venture capitalists are willing to invest in companies at a much earlier stage of development than others.

VCs also typically provide organizational help, management and technical expertise that may be sorely needed by a fledgling company but which may not be available any other way.

minuses

If you don’t have stellar growth potential, VCs probably aren’t interested.  Simply getting their money back, with interest, isn’t enough.

At some point, usually very early on, part of the price for additional financing will be that the entrepreneurs cede control of the business to the VCs.  In most cases, this is probably a good thing, since risk-taking visionaries don’t often make great managers (look at the early Steve Jobs).

That’s it for today.  More tomorrow.

raising capital–traditional IPO, venture capital, crowdfunding (I): a traditional IPO

December 7, 2011 By in Industry Analysis, Investment firms, preliminary and final prospectuses, securities markets, stock market Tags: , , , , , , , 2 Comments

I want to write about what I think are the implications of the new legislation circulating in Congress to permit greater use of crowdfunding by start-up companies raising money.  But to do this I think I should outline the way corporate equity capital is typically raised today.

going public through a traditional IPO

This is still the best way to raise LARGE amounts of money for expansion.  That’s not the only reason for going public, however.

One of the many clichés on Wall Street is that small companies should raise equity capital when they can (in other words, when investors would kill to acquire shares in a hot new concept), not when they absolutely need to.  Better to have cash you don’t have a present use for than to find the equity market closed to IPOs in a recession.

A public listing will probably be seen by potential business partners as a sign of company maturity and stability.

A public listing allows a company to pay employees in stock and stock options rather than cash.  For techy start-ups, it’s the possibility of making a fortune on stock options by being in on the ground floor of the next Google or LinkedIn that lets the fledgling firms attract top-notch talent.

the IPO process

Anyway, let’s say a firm decides to go public through a traditional IPO.  What happens next? The firm contacts an investment bank.  It may be that the company’s CFO already has connections on Wall Street.  It may be that brokerage house securities analysts (who in many ways are marketing agents for the bank) have already been calling on the firm for a while and the company selects the firm the most influential of them works for.  Investment bankers may have made marketing pitches as well.

The investment bank performs several functions:

1.  it helps the firm gather the materials it needs to file a registration statement with the SEC

2.  it performs its own investigation that allows it to vouch for the company with its clients

3.  it forms an underwriting group and a selling syndicate to market the issue.  The salespeople will already have the necessary national and state licenses to sell equities; the firms will already have established that the securities are suitable investments for the clients they sell them to.

4.  it prepares a preliminary prospectus (called a red herring in the US because the fact it isn’t final is highlighted in red print) to circulate within its client network and obtains informal indications of interest

5.  it arranges a sales campaign that may include meetings between management and potential buyers

6.  it recommends the final issue size and price.

Until the past few years–when the big brokerage houses laid off most of their experienced analysts–the investment bank would also commit itself to have continuing analyst coverage of the firm.

there are lots more ins and outs, but that’s the basic process.

plusses

The traditional IPO route gives a firm access to the investment bank’s distribution network.

It also gets the company a lot of publicity.

In normal equity offerings, the underwriters buy all the stock from the issuer and take the (usually negligible) risk of selling the issue to investors.  At the very least, the issuing company gets a specified price on a given date.

minuses

The traditional IPO is expensive.  The investment bank may charge as much as 10% of the issue for its services.

In pricing the issue, the investment bank’s loyalty is divided.   The issuer wants a high offering price, so it gets the most money.  The bank’s biggest customers, on the other hand, want a low offering price so the stock will go up a lot on opening day.

Many small companies are below the minimum size that will interest an investment bank.

 

That’s it for today.  More tomorrow.