online gambling in the US

from sayonara to Cy Young

It isn’t that long ago that the US authorities were hunting down and arresting the owners of internet gambling websites, accusing them of Ponzi scheming and assorted other bad stuff.

Yet, late week the state of Nevada legalized internet gambling. New Jersey may not be far behind. In fact, the Borgata hotel/casino in Atlantic City has begun to offer in-room gambling through the TV set.  It plans to expand soon to gambling through mobile devices like phones and tablets that are hook into the wi-fi network on its grounds.

What’s changed?

The gambling market in the US is saturated, that’s what.

There’s already too much casino capacity in the domestic market (arguably, ex Las Vegas). And there’s more on the way, as new casinos open up in Massachusetts, New York, Florida and who knows where else. Yes, these new venues do attract a few people who’ve never gambled before. But to a large degree they take business away from casinos in neighboring states. Just look at Atlantic City.

I’m going to write about this topic in two posts. Today, I’ll cover some general principles. Tomorrow, I’ll write about the stock market implications for the casino industry in the US.

1.  saturation

Early in my career as an analyst I heard a pithy statement of basic marketing from a hotel executive who was explaining why his company—and the whole industry in the US, for that matter—was diversifying from mid-market hotels into new areas, like luxury and no-frills offerings. He said: “ You don’t start selling chocolate ice cream while the market for vanilla is expanding. You only do it after the vanilla ice cream market matures.”

What’s stuck with me through the years is that if you see a company deviate from what it’s always done successfully, it’s a very good bet the traditional business is nearing the end of the line.

That’s what’s happening here.

Nevada is by a mile the biggest gambling state in the union; NJ is #3, having just been surpassed by its neighbor, Pennsylvania.  I can’t imagine that the legislature in either state would be legalizing internet gambling without the encouragement of the major casino operators.

2.  self-cannibalization isn’t good, but it’s the best alternative

Yes, the advent of online gambling means that some people—we don’t know how many, or how much revenue they represent—will gamble online rather than go to a casino. My guess, which isn’t worth much, is that poker will be the first game to feel the effects of online competition, and the one most deeply hurt.

Online revenue is money that will be lost to the casinos. The corporations that own the casinos have two basic choices:

–they can either pretend online gambling isn’t going to happen, or do everything they can to oppose legalization. In either case, they suffer the full revenue loss. Or,

–they can get out in front of the trend, establish their own online operations and recapture at least a portion of the money they stand to lose. Maybe they’re lucky and end up net winners. But even if they aren’t, unless they completely botch their online operations they’re better off than by ignoring the issue.

3.  real estate doesn’t go away quickly

Hotels, including casino resorts, typically last many decades.  Once they’re built in an already saturated market, overcapacity is the order of the day until/unless the market expands to absorb it.

Casinos are particularly tenacious, because operators can increase table game gambling capacity simply by changing the little table betting limit signs.  Though a more expensive proposition than a $5 sign, slot machines can be swapped in or out quickly.

Structures do age, especially if management doesn’t continually spend on refurbishment.  A hotel, for example, may start out as  Marriott.  If the owners decide at some point to run it to maximize cash, they stop refurbishing.  The hotel may may then become a Great Western, then a Knights Inn…  Ultimately, it will be converted into, say, a nursing home and disappear as a hotel.  But that process can take twenty years or more.

More tomorrow.

more on Bloomberg radio

I’ve had a surprisingly large amount of interest in my previous post “The fading of Bloomberg Radio.”  Some comes from fans of Ken Prewitt, wondering where he might be and if he’s well.  Some is from others who have detected the same decline in substance at Bloomberg Radio that I have.

So I decided to write about a BR program I was listening to in my car last week.  It was the middle of the day, and the topic was immigration.

The guest–over the phone–came from the Cato Institute.  As one might expect from an organization founded by the Koch family, he had a strong libertarian, conservative bent.

He started off with a number of anodyne statements about illegal immigration, like that:

–the overwhelming majority of farm workers are illegal immigrants,

–a tightening of border controls has resulted in a shortage of farm laborers that, in some cases, is causing farmers not to plant as much as they might like.  They know they won’t be able to find workers to harvest the crops

–most jobs illegal immigrants take–farm work in particular–are ones American citizens don’t want.  They’re seasonal, and they’re hard physical labor.

At this point, the host groaned her disbelief and asked about the effect of the minimum wage on American interest in farm jobs.

The guest replied that the minimum wage is not an issue here, that, for example, some apple pickers in Oregon earn $28 an hour.  (The average for farm workers, according to the Wall Street Journal, is around $10.50/hour.  The guest didn’t say this; the host apparently had done no preparation for her work that day.)

The guest then said that the government was the main factor in Americans’ aversion to farm work.  To someone collecting unemployment insurance, he continued, relocating to take a farm job made no economic sense.  A little polemical, maybe, but a subject for discussion if one thought the opposite.

Not for our host, however.  She became audibly angry   …and then HUNG UP on the guest!


I have to admit that this isn’t the first time I’ve heard behavior like this.  Sometimes, on a long drive I’ll choose WFAN over Bloomberg.  I listen typically when Mike Francesa (formerly part of the “Mike and the Mad Dog” duo–but the MD went to satellite radio) is on the air.  It’s a staple of this broadcast form for the host to disconnect a rambling or ill-informed caller.  In fact, some of these shows are simulcast on TV, so you can actually see the host turning to switchboard and pressing the “off” button.  He continues to talk, however, as if the caller is still on the line–but awed into silence by the host’s discourse.

The twist, in my Bloomberg case, is that the guest was the coherent, polite and well-informed one–yet all that got him was a dial tone when the host showed herself to be the unarmed opponent in a duel of wits.

A new low, in my Bloomberg Radio experience.

the Italian election–investment significance

I’ve always found the Italian stock market–yes, there is one–to be a waste of time for foreigners.  There aren’t very many interesting companies (I’ve only held Tod’s and Bulgari in my portfolios, other than when I’ve taken on turnarounds).  Also, to my mind the market there is run for the benefit of political and industrial insiders, not for the average Italian, and certainly not for investors from other parts of the world.  Even if I could have tapped into the underground flow of inside information, it’s not clear it would be usable without violating US securities laws.

Anyway, the current election issue isn’t about the viability of Italian stocks.  It’s about the viability of the euro.

setting the stage

Italy is the third-largest economy in Euroland, after Germany and France.

Italy has a very inflexible, high-cost, slow-growing economy.  Many of its industries are under competitive attack, not only from elsewhere in Europe but from emerging Asian giants like China, as well (think:  clothing, leather goods and furniture).  Rather than allow/force adjustment to the new reality, the Italian government has borrowed lavishly and spent with abandon to help keep an uncompetitive economy above water.  For a long time, although bond investors saw the government debt piling up–it’s now around 140% of GDP, they assumed that Euroland as a whole was guaranteeing repayment.

Then the Greek crisis erupted.   …and bondholders began to work out that:

(1) maybe Euroland wasn’t really guaranteeing Rome’s borrowings, and

(2) the debt was so big that maybe Euroland couldn’t make good even if it wanted to.

Seeing the credit markets closing their doors to Italy, the country ousted the prime minister, Silvio Berlusconi, who had overseen the creation of much of the mess, and replaced him with a “technocrat,” Mario Monti.  (“Technocrat” means combination hatchet man and fall guy–someone who would make necessary, but politically suicidal, reforms and then fade into the woodwork.)

Monti did heroic work.  He wasn’t able to address sky-high labor costs, but he did restore government spending to what’s called a primary surplus, meaning that government income is covering all expenses, ex interest on debt.  The country’s government bond mountain is no longer growing; it’s starting, very slowly, to shrink.  To put this in context, this is more than Washington has had the courage to do.

the election

Monti got nudged out and an election was called to form a replacement government.  It was held last Sunday/Monday.

Four main parties:

–the Democrats; labor-backed, reform-friendly;  led by Pier Luigi Bersani

–People of Freedom; roll back reforms, start spending again; Berlusconi (a figure sort of like a cross between Nixon and Rupert Murdoch, without the redeeming qualities)

–Civic Choice; pro-reform; Mario Monti (who decided not to fade into the woodwork)

–Five Star; get rid of the political establishment, default on government debt, leave the euro; Beppe Grillo (like Jon Stewart, only taken seriously).

pre-election polls 

Polls from fifteen days ago, the latest allowed by law, predicted the Democrats would get the most votes (45%?)  and would form a coalition with Civic Choice (15%?).  Grillo might get 15%.  With 25%, Berlusconi would be left out in the cold.

“instant” exit polls

In Italy these are done by phone.  They’re not reliable.  But they showed the expected outcome.

as it stands now

Later polls, and preliminary voting results, show a different picture.

The Democrats will win the lower house outright.

In the Senate, however, it looks like this, according to USA Today:

Bersani          32%

Berlusconi          30%

Brillo          24%

Monti          14%.

In other words, the two pro-reform parties, led by Bersani and Monti, would fall short of a majority in the the upper house, so the coalition they had been planning on forming would be useless.  Why?    …both Brillo and Berlusconi did a lot better than expected.

where to from here?

No one knows for sure.

None of the others want to link up with Berlusconi.  That leaves a possible Bersani-Brillo combination.  But it’s not clear they have enough in common to form a coalition.

It may be that another election is on the cards.

investment significance

From the perspective of a global investor with no intention of buying Italian equities–Prada IPOed in Hong Kong, after all–it isn’t, strictly speaking, necessary for me to see Italy solve its structural problems.  All I need is for the country to limp along in its current state of denial, on the road to insignificance.  I might even be able to stomach a rollback of some of the Monti reforms.   That’s providing Italy doesn’t repudiate its debt, leave the euro, turn its primary surplus into a deficit or otherwise punch a big hole in the bottom of the euro boat.

At this moment, I consider the stuff on my “bad” list as highly unlikely to occur.  Nevertheless, absent a miracle solution to the Italian Senate partisan logjam, we’re going to go through a period of Euroland jitters until Italy has a new government.  My guess is that the shaking will mostly take the form of euro weakness.  Also, dedicated European equity investors will likely make their portfolios a bit more defensive, and will probably get the funds for doing so by aggressively trimming recent outperformers.

With little European exposure myself, I’m content to remain on the sidelines for now, with an eye out to possibly add shares of Europe-based multinationals that may come under selling pressure.

Note:  One minor conceptual worry–not one for today or tomorrow, though.  I’ve been channeling my inner Trotsky for a while now.  I’ve already consigned Japan and Europe to the dustbin of history–with a potential double dose of bin for Greece and Italy.  If I  keep on going like this, at some point there’s more dustbin than anything else.    That would be bad.

Einhorn stops Apple (APPL) shareholder vote on preferred stock


Hedge fund manager David Einhorn has been urging AAPL for some time to adopt his pet idea of issuing preferred stock that would basically be backed by the company’s gigantic accumulated cash position.

APPL isn’t interested.

In the Steve Jobs days, I think the AAPL CEO would have told Mr. Einhorn, either directly or through the press, that his answer was “No!!,” and that Einhorn should stop trying to interfere with the running of AAPL’s business.  This probably would have been the end of the matter.

The current AAPL management didn’t do that.  Instead, it put on the agenda at the company’s annual meeting this week a shareholder vote to change the company’s charter in a way that would forbid the kind of perpetual preferred Einhorn is championing (see my analysis of the preferred idea).

Not only that, but AAPL wrapped this proposal in a package of others and asked for a single vote on the whole bundle.

last week

Mr. Einhorn sued, saying in effect that the bundling violates both common sense and SEC rules.  On Friday, a federal judge agreed–and barred a vote on “Proposal #2” at this annual meeting.

According to the Financial Timesby the time of the court ruling AAPL had received ballots representing 40% of the outstanding shares.  Of them, 97.5% had voted for the company and, by implication, against Mr. Einhorn.

the voting results are no surprise

In my experience, individual shareholders vote with management no matter whether it’s in their economic interest or not.  Hard for me to understand, but easy to predict.

For almost two decades, the SEC has been pushing the compliance departments of professional money managers on proxy voting.  The regulator wants them to take seriously their fiduciary obligation to vote the shares under their stewardship in the best interests of their customers–or else.  This pressure has resulted in the rise of third-party firms like ISS and Glass Lewis, which have set themselves up as independent experts in proxy analysis and making shareholder-friendly voting recommendations.  The path of least resistance for institutional investors seems to me to be to subscribe to  one of these firms’ services and vote accordingly.

Both ISS and GL recommended voting for AAPL in this matter.

In other words, all the individuals and all the traditional institutions were going to vote against Einhorn.

why a vote at all?   …and why this vote?

Mr. Einhorn points out on the Greenlight Capital website that because no one has tried his preferred suggestion, that doesn’t mean it’s a bad idea.  Of course, it doesn’t mean it’s a good one either  …or a good one for AAPL.

What’s clear, however, is that AAPL doesn’t want to discuss the idea publicly–even to say that it’s a thought, but one that won’t work for AAPL.  I think this is a mistake.

I think I understand why AAPL set up the vote as a bundle, though, rather than a straight yes-or-no on the preferred issue alone.  From my common sense viewpoint, as well as from an SEC perspective, grouping a bunch of disparate proposals together just doesn’t seem fair.  (In addition, for what it’s worth, I don’t see how narrowing the scope of possible future preferred issues serves shareholders interests.  It just makes Mr. Einhorn go away.)

Why bundle?  AAPL must know that institutions pretty much vote whatever way ISS tells them.  I think AAPL presented the preferred proposal to the advisory service in a package that it simply couldn’t recommend voting against.  It thereby also avoided the risk that if the preferred ban were offered separately ISS would recommend a “no” vote, which a ton of institutional holders would then cast.

AAPL management hasn’t done itself any favors, 

…in my view.

The company’s unwillingness to lay out reasons–like that the preferreds might constrain needed US-sourced cash flow–for opposing the Einhorn proposal make management look weak.

The bundling makes the company look like it has something to hide.

AAPL’s odd behavior suggests there’s considerably more to this story than meets the eye.

Wal-Mart’s “total disaster” emails? …a tempest in a teapot

Wal-Mart (WMT)’s 4Q13 earnings announcement

A week ago Bloomberg reported on internal emails sent by Wal-Mart executive Jerry Murray.   In them, he characterized the firms’ early February sales as a “total disaster,” worse than anything WMT went through during the Great Recession.   Naturally, the stock declined on the news. 

Early yesterday morning, WMT reported its 4Q13 (ended in January) results.  Comparable store sales were up, WMT gained market share, the company is having success at cutting costs and free cash flow increased strongly year on year.

As to 1Q14 sales, WMT has begun to see income tax refund checks show up in its stores.  Sales have “normalized” back to the level the company had been anticipating.  The company lowered its 1Q14 guidance a bit to account for the weak start to the quarter, but otherwise WMT apparently sees no disaster, just business as usual.

WMT also announced yesterday that it’s raising its dividend by 18%, to $.47/share.  That’s the same percentage fiscal 2013 free cash flow went up by.  This is important.  Were there any question about the sustainability of the current level of profit and cash flow, the board of directors would never have authorized a dividend increase.  That’s because the effects on a company’s stock are so devastating if adverse circumstances ever force a cut in the payout level.

So the “total disaster” is really a tempest in a teapot.

two queestions

How does WMT know about the refund checks?

It’s because many WMT customers number among the 15%-20% of Americans who don’t use traditional banking services.  That’s either because they don’t qualify or because they find banks too expensive.  They use WMT’s in-store check cashing services, among other non-traditional options, instead.

It’s also because WMT has incredible software for gathering and analyzing customer information.

How did Bloomberg get the Murray emails?  

I don’t know.  I can’t imagine that Mr. Murray was the source.  I think it was either an instance of hard-ball office politics, where a rival executive hoped to embarrass Mr. Murray publicly by showing he’s too quick to jump to conclusions; or it was a subordinate, hoping to get Mr. Murray to lay off the caffeine.

deferred taxes (II): how they’re important

Yesterday I wrote about what deferred taxes are.  Today,

why it matters

1.  The two most important sources of money coming in the door (i.e., cash flow) for companies are net income and depreciation.  Deferred taxes–that is, tax expense that’s shown on the income statement but not actually paid to the tax authorities, are number three.

Most companies succeed in pushing back the tax bill for an extremely long time.  So although deferred taxes aren’t as rock-solid as net or depreciation as a source of cash flow, they can be pretty dependable.  This means that companies in a heavy investment mode (building new buildings, installing new machinery/computers…) have more money in their hands than the income statement shows.   Look at the cash flow statement–the statement of sources and uses of funds–to see what the effect of deferred taxes on cash flow may be.

Mature companies are gradually forced to pay the tax-break piper.  After all, we’re talking about taxes deferred, not forgiven.  So they have less money coming in than the income statement suggests.  Again, check the cash flow statement.

2.  Deferred taxes have a second, even less intuitively obvious, accounting use.  It’s crucial to understand, though, when dealing with “deep value” (read: really junky) companies.

Suppose the company has a pre-tax loss of $1,000,000 on its tax books.  It can typically “carry back” at least part of the loss, meaning it can retroactively apply it to prior years’ income and get a tax refund.  If it can’t, the after-tax loss is $1,000,000.  And the firm can “carry forward” the loss to use as an offset against taxable income in the future.  These loss carryforwards expire if they’re not used within a certain number of years, however. (Relevant information will be found in the tax footnote to the financials.)

Financial reporting treatment is different.  Normally the firm’s accountants will assume that the tax loss carryforwards will be used to offset future taxable income before they expire.  If so, and the firm has a pre-tax $1,000,000 loss on its shareholder books, the accountants will apply in the current statements deferred tax credit of, say, $350,000.  So the financial reporting loss will not be $1,000,000 but $650,000.

In this case, the financial reporting books understate the loss.

the crucial issue

That’s not the crucial issue, though.  The accounting firm that prepares the company’s books will only allow the deferred tax deduction as long as it believes the firm will be a “going concern”  (read: will avoid bankruptcy) and will generate enough future taxable income to use the loss carryforwards.  If it decides otherwise, it must require that the company reverse some or all of the previously recorded deferred taxes.

The worst about this is, of course, not the change in accounting treatment, but it signals the words dead and duck have begun to dance across the auditors’ minds.

Check out my post on Mike Mayo and Citigroup for a real-life example.

deferred taxes (I): what they are

Last week I wrote about how publicly traded companies typically maintain three sets of books:  tax books, management control books and financial reporting books.

The two sets we’ll be concerned about today are the financial reporting books and the tax books, the ones that outsiders get to see.

Hang onto your hat and let’s get started!

why deferred taxes?

It’s reasonable to ask whether these two accounting pictures of a company’s financial health exist in parallel universes–one to poor mouth the company in order to minimize taxes, the other to flatter results so that shareholders will be happier than maybe they should be     …or is there something that ties the two sets together?

they connect tax and shareholder records

There are, in fact, two ways in which these sets of books are connected.

First, the IRS doesn’t let a company pick radically different accounting methods for tax books from the ones it uses for shareholder reports.  Inventories–meaning all that FIFO or LIFO stuff–are an example.

In addition, there are deferred taxes.

what they are

The income tax line is the one place that financial accounting standards compel a company to reveal something about the books it keeps for tax authorities.

When the financial accountants work down the income statement, they start with the sales line.  They subtract various costs, like materials, marketing, interest payments…   from revenues as they work their way to net profit.  When they’ve figured out  pre-tax income, they apply the appropriate income tax rate and subtract to get to net income.  They do this country by country, local and national.  

Then they reconcile with the tax books

They do this by dividing the tax figure they’ve arrived at into two components:

–the tax actually paid to the IRS or its equivalent, called cash taxes; and

–the rest, called deferred taxes.  

The deferred tax figure can be positive, meaning the company is sending smaller check(s) to the tax authorities than the total amount of tax shown on the financial reporting books; or it can be negative, meaning the company is paying out more than the total tax charge shown on the shareholder records.

Sounds weird, doesn’t it?  That’s because it is.

But try to get used to the idea.  It can be important.

how deferred taxes come to be

Lots of ways.  But it’s all about timing differences.

for example

The simplest is this:  a company builds a factory that costs $1,000,000, has a useful life of 40 years and has no value after that.  On the shareholder books, the company allocates the factory expense evenly over the 40 years, at the rate of $25,000 a year.  Accountants call this the straight line depreciation method.

On the other hand, the national government may want to encourage companies to build factories of this type.  So it gives them tax breaks by, say, allowing firms to front-load the tax writeoffs.  Maybe it allows a firm to write off $250,000 of the total cost in the first year (lowering otherwise taxable income by that much), $100,000 in the second, and the rest in progressively smaller amounts over the following seven years.  This is an accelerated depreciation method.

Let’s assume this is the only difference between the company’s tax books and its shareholder books.  If so, in year one the tax books will show $225,000 less in pre-tax income than the shareholder books ($250,000 – $25,000), due to the faster timing of the factory writeoff on the former.  Depending on the rate of corporate income tax, the company will pay something like $80,000 less in cash taxes than the financial books show as due.  This amount will be recorded as deferred tax.

where you can see this stuff

Usually not on the income statement.

Two places:  in the tax footnote to the income statement, and in the cash flow statement   …not usually, however, on the income statement itself.

Tomorrow:  why this geeky stuff can be important