a weak 3Q12 for Tiffany (TIF)

the results

Before the New York open on November 29th, TIF announced 3Q12 earnings results (the company’s fiscal quarter ended October 31st).  Sales were up 4% year on year.   Profits for the three months, however,  were down 30% yoy at $63 million, or $.49 per share–lower than the company had guided to during its 2Q12 conference call.  TIF also revised down its expectations for the full fiscal year to eps of $3.20-$3.40 vs. its prior guidance of $3.55 – $3.70.

What’s behind the earnings miss?

Business was better than expected in Europe and Japan. It was so-so in Asia-Pacific—comparable store sales down 4% yoy—but in line with management’s view. In the US, however, which still comprises about half the company, sales weren’t as good as TIF had expected.

Not only that, but product mix was a problem. Purchases of items costing over $500 each held up well. Sales of less expensive silver jewelry, however, flagged. And they carry higher margins at the moment.

 How can sales be up and profits still fall by almost a third?

As I interpret TIF’s actions in preparing for 2012, the company expected a sales advance for the year of around 10%. So it increased sales space and added staff with that kind of increase in mind. Those extra costs are now acting against the company (negative operating leverage) because sales aren’t yet high enough to absorb them fully.  That cost the company about $6 million in operating profit in 3Q12, I think.  More important,

TIF also build its inventories aggressively. The fundamental choice a firm makes is between:  do I keep inventories small and risk losing sales?  …or do I keep the shelves full, at the risk of having too much?  Based on its sales forecast, TIF picked the second.

In addition, in carrying out its strategy TIF appears to have acquired or made goods containing gold when the yellow metal’s price was relatively high. That decision has two consequences that have also turned into temporary negatives. Because their costs are high, those pieces carry lower gross profit margins than TIF has shown in recent quarters. This wouldn’t be a big deal if sales were growing as rapidly as TIF thought. Better to lose a couple of points of margin on a necklace or ring rather than have a customer walk out empty-handed because there’s no merchandise in the store. But when sales are slow, as they are now, lower-margin merchandise can end up being a big chunk of sales for an entire quarter or two.  As I reckon it, this cost the company about $30 million in operating profit in 3Q12.

At some point, however, maybe in 4Q12 or 1Q13, TIF will have sold all these items and gross margins should rebound.

Finally, to carry out all its plans and still continue to buy back its stock, TIF’s debt has gone up by about $250 million yoy.  Interest expense is $4 million higher in 3Q12 than in 3Q11, as a result.

Do TIF’s quarterly earnings matter at this point?

Yes and no. The stock dropped by about 10% in the pre-market Thursday before rebounding to close down 6% or so. To my mind, that’s not much of a negative reaction, considering how big the earnings shortfall was vs. expectations and how strongly the stock has performed in recent months.

To my mind, investors have clearly been betting that we’re at or near a business cycle low point for high-end jewelry sales. They’re buying TIF in anticipation of a significant upturn in profits. For these investors, the overall story is still intact. Their timing may have been a bit off, but they’re not worried.  And, in my view, TIF’s management didn’t do anything crazy.  It carried out an intelligent plan for 2012 that’s been undermined by a weaker than expected world economy.

On the other hand, I suspect it will be difficult for the stock to advance from the present level without the company demonstrating that the low point is behind it.

One other note: it seems to me that the area of concern for Wall Street based on 3Q12 results can’t be China, even though sales there were down yoy. Why do I say that? Chow Tai Fook Jewellery, which caters solely to the China market, was up 4% overnight in Hong Kong.

why did Amazon (AMZN) just issue $3 billion in bonds?

I’ve known about AMZN since its inception.  I’ve never owned the stock, however–which has, since 2006, been an embarrassing oversight on my part.  But as one of my former bosses used to say, in her characteristically non-PC way, “You can’t kiss all the pretty girls.”

AMZN is clearly a pivotal company in the transformation of US–and ultimately global–retailing.  But at its typical 100 times earnings or so, I’ve always found the valuation a bit too steep.  I am an Amazon customer, though, and an Amazon Prime subscriber.  I also use a Kindle (and an iPad) to read.

Anyway, several things about this week’s issue of $3 billion in AMZN bonds caught my eye:
–the interest rate, which is at only about a 60 basis point premium to Treasuries

–the stated purpose of the issue, namely the boilerplate “general corporate purposes”

–the lack of relevant commentary, although I really shouldn’t be surprised.  I’ve read some suggestion that part of the net proceeds will go to pay for the company’s new $1.16 billion HQ in Seattle.  AMZN does mention in a supplement to the original prospectus that it has agreed to buy the complex.  But it would be weird for the company to disclose that and not mention the buildings as a use of proceeds if that were so.  My assumption is that the new HQ will be financed separately with non-recourse debt.

looking at AMZN financials

–capital spending is up very sharply recently, from around $200 million a year in 2007 to $1.8 billion in 2011 and the current $23 billion annual rate (I’m taking all figures in this post from the Value Line Investment Survey, the industry bible for such data). That’s slightly more than the cash generated by operations, not counting working capital changes (see the second item below this one).

–operating margins are down.  They were more than 6% of sales a half-decade ago.  They’re under 4% currently.  I interpret this is the effect of selling e-books and kindles for little or no profit, or at a loss.

I don’t think this is necessarily bad.  I point it out only as further evidence of the dedication to expanding its digital footprint–even at the expense of profits–that has marked the company for the past few years.

–$5.2 billion in cash?…yes, and no.  The September balance sheet for AMZN shows that figure.  But look at Payables (the amount AMZN owes suppliers) and Receivables (the amount customers owe AMZN).  They’re $8.4 billion and $2.4 billion, respectively.  The difference is $6.0 billion.  In other words, all the cash on the balance sheet (plus another $800 million) is explained by the fact that customers pay AMZN very quickly and suppliers don’t get their cash very fast.

There’s nothing wrong with running a negative working capital business.  In fact, it’s great.  But the cash it generates is only there as long as sales are stable or rising.  If they start to shrink, so too does the cash level.  So spending this money on capital projects, where AMZN can’t get to it quickly, has some risk attached to it.

why the offering?

I think it signals AMZN’s belief that the current environment of intense competition for digital dollars, of low margins and of capital spending larger than cash flow isn’t going to change any time soon.

I wonder whether Wall Street realizes this.  I also wonder how many remember the long struggle toward profitability AMZN had up until 2002.  The average analyst earnings estimate for AMZN in 2013 is $1.80 per share, with one analyst projecting close to $4.  I haven’t done any numbers, but, to me, the just-completely bond sale implies even the $1.80 is probably much too aggressive.

large one-time dividends in 2012: why they drive stock prices up

big payouts

A significant number of publicly traded companies in the US are declaring large special (i.e., one-time) dividends to be paid before yearend.  In every instance I’ve seen–the latest being LVS and COST–the stock has gone up significantly on the announcement the company is taking this action.

two tax reasons

There are two reasons for this, the first of which relates to the current income tax preference for dividend income (a maximum 15% federal tax rate) versus “ordinary” or “earned” income (a maximum of around 40%).  They are:

1.  The reasonable supposition that the income tax on dividends will go up in January, either as part of a political deal to avoid the “fiscal cliff” or in a subsequent, more general reform of the tax code whose provisions are made retroactive to January 1st.

A dollar in dividend income today nets the taxable recipient $.85.  In January, it may only have an after-tax value of $.40.

Let’s say, to make the numbers easy, a stock is trading at $100 a share.  It has $8 a share in excess cash.  It has no sure-fire investment projects that have the potential to make large future gains, so that $8 will remain $8 in present-value terms.  For a taxable investor, that $8 a share inside the company is worth $4.80 if it will be paid out after December 31st.

If, however, the entire $8 is paid out in 2012, it is worth $6.80 after-tax–a $2 difference.  So the taxable investor is $2 better off because of the dividend payment.

That’s not the whole story, either.

2.  When this stock goes ex-dividend, its price will presumably drop by about $8, simply because the ex-dividend buyer isn’t entitled to the $8 dividend.   In a very simple world, the $100 price falls to $92.

For the taxable investor who buys the stock for $100 right after the dividend announcement, the fact of going ex-dividend “manufactures” a short-term tax loss of $8.  This loss can be used to shield  otherwise taxable income at the holder’s highest marginal tax bracket.

If that rate is 40%, then the tax loss is worth $3.20.  (For what it’s worth, the part of T. Boone Pickens’ reputation that doesn’t come from relentless self-promotion is based on creating dividend situations like this on a massive scale.  There was also a one time a type of investment vehicle, called a dividend capture fund, whose main purpose was to capture the tax benefits of dividend-paying stocks going ex. )

#1 and #2 together make $5.20.  So the declaration of the $8 dividend has made the stock 5%+ more valuable to taxable investors than before.  In theory, the stock should rise on the dividend announcement until that “extra” value disappears.  That’s also what’s actually happening.

Of course, to use the short-term loss the holder has to sell the stock, creating downward pressure on the price once it goes ex-dividend. But at the same time, non-taxable investors, for whom there are no tax benefits, may be attracted to the issue and lend support because of the substantially lower price.

worth looking for?

For highly specialized professionals, yes.  For the rest of us, no.  One of the first lessons I learned as a portfolio manager is that you should focus all your time trying to find the 30% gains, and the 50%s and the 100%s.  If you see a 5% on the ground in front of you, pick it up.  Otherwise, the gain is too small to spend time on.

So, while it’s nice to understand why a stock is going up, these aren’t worth chasing.  Nor, in my view, is searching for stocks where a large potential special dividend payment is the major attraction worth the time and effort.

the fading of Bloomberg Radio

first ESPN…

Over the Thanksgiving holiday my older son pointed out to me that family friend, John Koblin, had written a critical article for Deadspin on how ESPN has gradually lost its journalistic way as it chases television ratings.

The example John focusses on is the network’s apparent obsession with New York Jets football player, Tim Tebow–a legendary college football figure who appears to be the latest in the parade of Heisman Trophy quarterbacks not quite good enough to make it in the NFL.

How is Tebow a continuing story?  ESPN2’s unsuccessful morning show First Take switched format in late 2011.  The new look:  …a staged debate between two cartoonish figures who duel in vintage WWF fashion over some item of sports news.  Their favorite topic:  Tebow.

ESPN discovered that the new First Take was surprisingly popular, even taking audience share away from its mainline morning show, Sportscenter.  It reacted in two ways:

–more phony debates all over the network, complete with loud voices, exaggerated gestures and bombast, and

–Tim Tebow all the time, no matter what the ostensible topic of a given show.

I’m of two minds about this ESPN development.  As a holder of DIS shares I guess I should approve.  As a sports fan, I’ve got to find other sources of sports information and analysis.

…now Bloomberg

Yesterday I was on my way in the car to Delaware and turned on the Bloomberg Radio morning broadcast for the first time in a while.  Five years ago I used to listen every day, either live or through podcasts of important segments.  No longer.  As Bloomberg dialed down the information content and dialed up the reporter self-congratulation I began to look elsewhere.

Anyway, I caught the last part of The First Word, with Ken Prewitt, who strikes me as the only savvy professional journalist left on Bloomberg.  Then came Bloomberg Surveillance, which appears to have had a format tweaking since the last time I listened.  Mr. Prewitt is gone (…or maybe he was just taking a day off from the insanity).  What remains is a veritable First Take of loud voices and self-congratulatory glorification of trivia.

To my mind, this can’t be an accident.  The radio personalities must have been trained, à la ESPN, to speak louder, create fake “debate” and constantly tell the audience how important the topics–and the radio hosts themselves–are.

And, as with First Take, the quest for higher ratings is the most likely explanation, with Fox News and CNBC as the models.  It’s probably also cheaper to simply act as if you’re conveying relevant information rather than to do the research and analysis needed to create it.

The written Bloomberg news appears not to have been infected by this broadcast tendency.  I figure the investment professionals who pay $30,000 a year or more for Bloomberg terminals wouldn’t put up with the stuff that’s now on Bloomberg Radio.

Where is the real financial news today?  It’s in newspapers like the Financial Times  and the Wall Street Journal.  And, like sports, it’s in the blogosphere.

We may mourn the loss of Bloomberg Radio as an information source, and the fact that the search for relevant stock market information is somewhat more difficult without it.  But this also means that insights we may develop are that much more valuable–because they are less likely to have been fully disseminated into the market at the time we figure them out.

thoughts on Hewlett-Packard (HPQ) and Autonomy


In mid-August 2011 HPQ announced an all-cash, $11 billion+ bid for the British software company, Autonomy.  The offer came at more than a 60% premium to the latter stock’s close the prior day.  The deal, masterminded by HPQ’s then CEO Leo Apotheker, closed in early October last year.

By mid-May 2012 both HPQ executives who championed the deal, Mr. Apotheker and HPQ’s head of strategy, Shane Robison, had been shown the door, as had Autonomy founder Michael Lynch, as well.

Last week, when reporting its 4Q results for fiscal 2012, HPQ announced a whopping $8.8 billion writeoff “relating to the Autonomy business”!  In an 8-K filing with the SEC, HPW explained:

“The majority of this impairment charge relates to accounting improprieties and disclosure failures at Autonomy Corporation plc (“Autonomy”) that occurred prior to HP’s acquisition of Autonomy, misrepresentations made to HP in connection with its acquisition of Autonomy, and the impact of those improprieties, failures and misrepresentations on the expected future financial performance of the Autonomy business over the long-term.  The balance of the impairment charge relates to the recent trading value of HP stock (emphasis mine).”

What’s going on?

two aspects to the mammoth charge

first, according to the statement above, HPQ now realizes it paid twice as much as it should have ($5 billion+ extra) for Autonomy.  It feels this happened because it received false, misleading or incomplete information about Autonomy’s business while considering the acquisition.

HPQ has asked both the FBI and the UK’s Serious Fraud Office to determine whether any laws were broken.

second, HPQ says something like $3.5 billion of the charge comes from “the recent trading value” of HPQ stock.   Huh!?!

let’s start with the second item

Oddly, the company gave no further explanation on its conference call, even though, assuming it’s $3.5 billion–we’re talking about a writeoff equal to 15% of HPQ’s market cap.  No analyst asked about what the charge was about, either.  Nor have I seen any financial media comment explaining what the charge is.

What really gets my attention is that in thirty years of looking at stocks, I’ve never before seen a statement/explanation like this one.   What can it mean?

–To begin with, the charge is big enough that it had to be disclosed.

–HPQ isn’t making an off the cuff remark.  The 8-K statement above was repeated, word for word, at least twice during the earnings conference call.  So the wording has been carefully crafted and presumably approved by batteries of lawyers.  It also can’t be an accident, in my view, that there’s no further elaboration (isn’t this a “disclosure failure”?).

We have a few other clues.  The $3.5 billion or so is a non-cash charge (meaning no actual money is being paid out by HPQ).  It relates to the Autonomy acquisition.  It appears to have been triggered by the recent declines in HPQ stock.

On the other hand, the charge appears to have nothing to do with the wildly optimistic estimate of the present state and future profit potential of Autonomy that HPQ made in 2011.

My guess:  to me, it looks as if the recent decline in HPQ stock below some level, say, $20 a share, has triggered a contingent liability of HPQ’s–one by which it either forfeits a payment of $3.5 billion or which requires it to issue new stock with that market value.

If so, this could be “related” to the Autonomy acquisition in the sense that HPQ interprets the fall in its stock to be a direct result of Autonomy’s shortcomings (how you can make that argument is beyond me, though).

Or it could be “related” in the sense that the bank agreement HPQ struck to finance the Autonomy purchase called for stock issuance in the event the riskiness of the loan increased–as measured by a fall in the HPQ stock price.  I’ve looked at the Autonomy acquisition-related documents, including the bank financing arrangement pretty carefully (okay, sort of carefully)–and have found nothing.  A good bit of the loan agreement has been redacted, however, so it’s still possible that the banks have demanded collateral.

All in all, this part of the writeoff seems to me to have more to do with HPQ decisions on how to shape its capital structure than about Autonomy per se.  The worst part is the lack of explanation.

HPQ’s information shortfall about Autonomy

As I understand it, there are several questions of accounting technique that HPQ is now calling improper:

–when Autonomy delivered software to OEMs or other distributors, it booked the revenue immediately, rather than waiting for the distributor to resell it to an end user.  This isn’t the most conservative approach, but it’s what sellers of video game software customarily do.

–when Autonomy sold multi-year software licenses, it recognized all the profit immediately, rather than over the term of the license.  Again, not the most conservative  …but the way Apple accounts for its iPhone sales.

–when Autonomy sold directly to end users, it recognized revenue when the sale was agreed to, unless there was an acceptance period, in which case it would wait until the user signed off as satisfied on the installation.

None of these practices are in themselves deceptive, in my view.  Autonomy maintains they’re fully disclosed in the annual report (which, in general terms, they are).

HPQ has made more than fifty IT-related acquisitions over the past decade.  So it should know that the way a company chooses to recognize revenues and costs is perhaps the question in understanding an acquisition target’s financials–and that the devil is in the details, not in the annual report generalities.  Nevertheless, it sounds like neither the top management at HPQ nor the directors of the company asked for any elaboration.  The firms HPQ hired to do due diligence also found nothing wrong.

I’ve seen intimations in the press that during the time Autonomy was shopping itself to other software firms it may have “stuffed” its indirect distribution channel with more software than distributors could reasonably be expected to sell, or persuaded direct customers to start the software purchase process early–measures calculated to make recent growth rates look better than they actually were.   Anyone with a skeptical bone in his body would check for this.  And either tactic should be relatively easy to detect–for anyone who had some knowledge of accounting, the experience to be aware of typical “tricks” used in the industry, and a willingness to do due diligence.    Apparently in this case no one did until mid-2012.

In short, it’s hard to understand how a group of seasoned technology veterans in an M&A-intensive firm could have allowed itself to be as thoroughly deceived as HPQ is now claiming.

And then there’s Oracle, which asserts Autonomy pitched itself to it on April Fool’s Day 2011.  Oracle says it knew simply on the basis of a short presentation that Autonomy was substantially overvalued, even at the then market price of $6 billion (Oracle has posted the slides presented by investment banker Frank Quattrone.  The fine print Disclaimer at the end of the first set says it’s sent “in connection with an actual or potential mandate,” meaning an M&A transaction.  Ugly slides;  not much pertinent info.)

call for criminal/civil investigations 

I suppose it takes a certain amount of courage for a highly compensated group of supposed battle-scarred businesspeople to admit to having been bamboozled out of $8.8 billion of shareholder cash.  On the other hand, coming clean is probably the best option the HPQ management and board had.  Certainly, trying to disguise the facts would be worse–and would weigh on reported results for years.

The call for criminal and civil probes of the Autonomy transaction may well boomerang on some present or former HPQ executives.  But alerting the regulatory authorities eliminates a lot of possible skepticism that HPQ might be downplaying the affair.  Of course, so far as I’m aware, none of the HPQ directors who rubber-stamped the Autonomy acquisition feel bad enough to have offered to resign.

a stock market buy?

Deep value investors might be tempted.  Why?  …precisely because the company has a recent history of inept management and because the stock has lost 3/4 of its market value since ex-CEO Mark Hurd departed in a personal conduct scandal.  The S&P is up by about 1/3 over the same span.    The argument would have two aspects:

–the same assets in more competent hands could be worth a lot more than the current $12.44 a share.  Mr. Hurd demonstrated during his tenure how that can happen.

–you can’t fall off the floor.  i.e., the worst is already in the HPQ share price.

The big imponderables are:  whether all the company’s dirty laundry is in display, and how different from current management the new hands might be.

As a growth investor I don’t have the background/skills or inclination to reach a conclusion and place a bet.