the SEC investigates store chains’ internet sales claims

the SEC questions internet sales hype

According to the Wall Street Journalthe SEC recently sent inquiry letters to a bunch of retailers asking them to quantify claims managements were making in quarterly earnings conference calls about internet sales and internet sales growth.  Fifth & Pacific (Kate Spade, Juicy Couture…), for example, told investors it had a “ravenously growing” web business.  Others tossed around numbers like up 30%.

On the other hand, while online sales in the US may be growing faster than revenues from bricks-and-mortar operations, they’re still only in posting increases in (low) double digits, and make up less than 6% of total retail.  So the SEC was concerned that the company talk might be more hype than reality.  Why no disclosure of internet sales as a percentage of total sales?

The SEC got two types of reply:

equivocation.  Some retailers said they don’t disclose the size of online sales because they’re “omnichannel” firms.  An individual customer may sometimes visit a store, sometimes order from a desktop at work, sometimes buy from a smartphone on the train going home in the evening.  It’s the total customer relationship that counts, they said, not the way someone may buy any particular item.  Translation:  online sales are almost non-existent, but we know shareholders will react badly if we say so.

confession, sort of.  Others said that online sales were “immaterial,” meaning no more than a couple of percentage points of total sales.

there’s information here

Why not just say so?

…because it sounds bad.

Why bring up internet sales in the first place?

…because we have no other good things to say.

look at the income statement

I could have told you that, just from taking a quick look at company income statements.

Here’s my reasoning:

–if a company’s internet sales are growing at, say, 20% and comprise 10% of total sales, then they’ll contribute 2% to overall sales growth.  Because online sales are free of many of the costs of bricks-and-mortar stores, like salespeoples’ salaries and rent, they should carry (much) higher margins than sales in physical stores.  Therefore, if internet sales are big, we should see accelerating sales growth and rising margins.

Take Target (TGT) as an example.  Aggregate sales are growing at about a 3% annual rate with no signs of acceleration.  Operating margins are flat to down.  If online sales contributed 2/3 of total growth, TGT would have to disclose that  …and margins would be heading up noticeably. Therefore, internet sales can’t be anything close to 10%–or even 5%–of TGT’s business.

By the way,  TGT’s response to the SEC was that its internet sales are immaterial.

why the SEC investigation?

Every company is going to try to spin the facts of its performance in a favorable way.  Just take a look at the 10-K, where management can go to jail if disclosure is incomplete or counterfactual.  It’s chock full of dire warnings of what might go wrong.  It’s also in dense print with no pictures.  Compare that with the annual report, where every page is glossy, every face is smiling and the skies are always blue.

Also, retailers are marketers, after all, so we should expect an unusually rosy portrayal of results and prospects from them.

Still, there are limits.  Even if the border line is a bit fuzzy, there comes a point where  positive spin becomes deception, where touting the fantastic prospects of a currently minuscule business becomes fraud–especially if it’s in an area like online where Wall Street is intensely interested.

I interpret the SEC letters a warnings to the companies involved that they have been treading dangerously close to that line, and may even have stepped over it.  Expect a much more 10-K-ish assessment from now on.


what makes emerging markets different (II): market dynamics

Yesterday I wrote about emerging countries.  Today, it’s their stock markets.

There are two important factors to consider, in my opinion, before taking the plunge in any given emerging market.

1.  The engines of an emerging country’s economic growth may not be available on its stock market   …and if they are, foreigners may not be able to buy them.  There are a number of reasons for this:

–generally speaking, every country, emerging or developed, has limits on foreign ownership of key industries, usually media, telecommunications and transport

–also, in general, there’s no reason to think, as many do, that there’s a close correspondence between the structure of a country’s economy and the structure of its stock market.  There usually isn’t.

But, for emerging economies in particular:

–a country, understandably, won’t want to allow foreigners to gain control of its economic crown jewels for what would be seen a decade down the road as a pittance.  So foreigners may be relegated to non-voting shares or limited in the percentage of any company that they, as a group, may own.  Depending on the rules, “foreign” shares may have far different performance from “local” ones.  That can be either very good or very bad, again depending on the rules.

–local investors, many times an ultra-wealthy elite, may regard stocks as a particularly risky kind of bond.  If so, they may be only willing to buy shares in mature companies with limited growth prospects but large free cash flow generation–and therefore rising dividends.  This difference in risk preferences may slant the local market away from the kinds of stocks foreigners find most rewarding.

I’m not saying don’t buy emerging markets stocks.  My view is quite the opposite.  But you have to look before you leap.

2.  Many emerging markets have very little local trading support.  Brokers are dependent for their commissions on the kindness of foreigners.

In a country where average annual income may be, say, $5,000 a year, the ordinary citizen is lucky to have a bank account.  He has no interest in the stock market.  His employer probably doesn’t offer a pension plan or retiree health care, either.  So, in addition to the absence of retail support for the market, there are probably no large pools of local institutional money interested in stocks, either.

Therefore, under most circumstances, there’s no local guy eager to take the other side of the trade when foreigners want to transact.  So when foreign money wants to enter, stock prices skyrocket.  When it wants to leave, the bottom falls out of the market.  (By the way, a stock market like Germany’s was like this in the 1980s.)

Again, I’m not saying don’t invest.  Quite the contrary.  But expect a lot of volatility.  On the brighter side, there’s significant money to be made by timing the swings in foreign sentiment correctly.


what makes emerging markets different (I): politics/economics

A widespread selloff in emerging markets is currently in progress.  This is partly the result of portfolio realignment by veteran fund managers who believe that economic growth there is slowing, while growth in developed markets–weak as it is–is beginning to accelerate.  They’re reacting to what they perceive, rightly or wrongly, to be a change in momentum.

It’s also partly the result of novice investors, many of them retail, working out the risks in what they bought when they rolled the dice on an emerging markets fund a couple of years ago.

why emerging markets?

Conceptually, foreigners invest in emerging markets for two reasons:

–the possibility of very rapid economic growth in these countries, and

–the chance  that foreigners’ knowledge of how growth has occurred elsewhere to make superior stock selections.

The first point probably gets you to try an emerging markets index fund.  The second sends you looking for a seasoned emerging markets portfolio manager who can beat the index.  I’ve done both.

they’re different, though

But emerging markets aren’t just like, say, the US, only the people speak a different language.  There can be major differences in countries’ economic health, as well as in the types of stocks available for purchase.

Tomorrow, I’ll write about stock markets.  Today, I’m going to write about countries.  (NOTE that in all of this I’ve taken off my hat as a human being and put on my hat as a portfolio manager.  I’m not writing about what’s right or wrong;  I’m writing about what a foreigner has to think about to protect his investments.)

Three topics for today:

1. political stability

This is not something investors typically think about in developed markets.  We take it for granted that shareholders’ rights will be preserved, and that the legal conditions for companies doing business won’t change arbitrarily.

These are reasonable assumptions in large, mature economies.  But not necessarily elsewhere.

–Egypt, for example, has had two changes in government over the past year or so.  Protests forced a dictator to step down.  His successor was removed by the army.

–Thailand’s system of administration change through bloodless military coups blessed by the king has recently broken down into violent confrontation between the army and advocates for a different system.

–During the Asian Crisis of the late 1990s, as one of a number of measures to protect politically connected insiders, Malaysia arbitrarily refused for about a year to allow foreigners to repatriate funds from stock sales.

On a deeper level, in some countries the political debate is still open as to whether, and to what extent, capitalism should be allowed. In others, the question is whether the same proections afforded to local investors should be extended to foreigners.  In most cases, the answer to the latter question is “No!!,” at least until a crisis requiring foreign capital happens.

Political issues aren’t necessarily deal-breakers, but they are risk factors.

2.  macroeconomic stability

–India is a current case in point.

The economy is heavily dependent on monsoon rains.

The government is running a large current account deficit.  It’s being made worse by the fact that many people there either can’t afford or don’t trust banks, so they save by buying gold–which must be imported.  In addition, Delhi heavily subsidizes the price of petroleum products–again an import–meaning people use a lot more than they would if they had to pay world market prices.  The difference between what India buys from the rest of the world and what it can pay for through its own exports has become large enough to reach a tipping point where investors fear the country won’t have enough foreign currency to meet its obligations.

India is also a place where the capitalism/socialism debate is still not settled.  As a result of that and of the presence of very powerful industrial groups, the central government is dysfunctional.

–What about the rolling currency crisis in smaller Asian countries during the late 1990s.


Debt crises aren’t only a factor in the developing world.  Look at the US financial crisis or the EU.  But the latter two have the financial wherewithal to fix their problems.  That’s not always true in emerging markets.  And, unless you’re paying close attention, the difficulties there can fly under the radar for a long time.

3.  accounting methods

Personally, I’m not an advocate of having a single world accounting standard for financial reporting.  My point isn’t that the books in emerging markets are constructed using different systems than US GAAP or the IFRS of the EU.

I’m also not talking about occasional frauds, like Enron in the US or Polly Peck in the UK.

The issue is that in some emerging markets, there is either not enough information disclosed, or that the disclosure has little to do with reality.

This doesn’t mean you can’t get solid information about a company.  It just takes a lot more legwork + time and experience observing how a given company operates.  Think of all those bogus Chinese companies that have listed in the US over the past few years.  There’s a reason they didn’t list in Shanghai or Hong Kong, which are their natural markets.  Why not list in Asia?  It’s because investors there knew who the companies and the reputations of their backers were and would have refused to buy the shares.

Tomorrow, emerging stock markets.

Pershing Square has sold its entire stake in J C Penney (JCP) overnight

Pershing no longer owns any JCP

Bill Ackman has followed up his departure from the board of JCP by describing his investment in that company as a “failure” and striking a deal with Citigroup (C) to sell his entire 38.08 million share holding (about 18% of the outstanding stock).

Ackman’s investment group will receive $12.90 a share, less fees.  My guess is that they’ll net about $12.25.  We’ll know for sure when the final prospectus comes out.

Contrary to earlier press reports, which said C was going to take this massive position onto its own trading books and gradually dribble the stock out to the market (which would have entailed a huge risk) this is a straightforward underwriting.  The only twist is that there’s no big underwriting/sales group.  C is the sole underwriter.

The underwriting process goes like this:

–Pershing Square asks C to lead an offering to sell its JCP stock

–C assembles the underwriting/sales group, in this case itself

–C calls clients to get indications of interest and to try out possible prices.

–C sets a price (in this case $12.90 a share), distributes a preliminary prospectus, gets firm commitments from clients and buys the stock from Pershing Square.  This last apparently occurred yesterday.

Technically speaking, client commitments aren’t legally binding.  Unless you’re very big and powerful, however, there’s a fat chance you’ll ever get to see a good IPO allocation again if you go back on your word

–C sells the stock to clients.  This is presumably happening  this morning.

As part of the deal, C gives buyers a final prospectus, which– legally speaking, is the only official offering document.  The client has a brief time to review it and return the stock if he doesn’t like what he reads.  In my experience, however, clients seldom read the final prospectus.  I don’t know anyone who’s ever returned stock.

what bothers me

I’m usually a solidly free markets guy.  Laissez faire and all that.  But Pershing-JCP is a case of corporate bungling on an epic scale.

Ackman enters in cape and tights to “save” a company that’s not a world beater but nevertheless is muddling along.  He installs similarly-clad Ron Johnson as CEO.  Johnson promptly alienates customers, loses a third of company sales and burns up a ton of corporate cash.  All the while he’s defended by Ackman.  Both exit the now-smoking wreckage with a few tepid words of apology.

Yes, both lost money and their reputations are tarnished a bit   …but that doesn’t seem to me to be enough.  On the other hand, I’m not sure what other penalties there should be.  Disbarment?

Maybe it’s just the speed at which disaster struck that disturbs me. As I think about it, I can come up with many examples of the same incompetence  in slower-moving corporate train wrecks.  Think:  C. Michael Armstrong at ATT, and then Citigroup (as a board member).  How about Carly Fiorina…or just about any CEO…at Hewlett-Packard?

one other note:  It’s interesting that C was able to find buyers for 18% of the stock at $12.90.  A floor on the stock price?

measuring Steve Ballmer

On the day before Steve Ballmer took over as head of MSFT, that company’s market capitalization was a tad below $600 billion.  If MSFT shares had matched the performance of the S&P 500 since then (about +15%), the company’s stock market value would now be just  under $700 billion.  Instead, just before the stock spiked on news of Ballmer’s surprise resignation, MSFT was worth barely a third of that figure.  Under his stewardship, then, MSFT owners lost a staggering $450 billion in relative stock market performance.

Sometimes the simplest measuring sticks are the best.

(Yes, MSFT management has bought back about 20% of the outstanding shares since 2006, but it’s hard to know what the net effect of the stock purchases would be.  Certainly, earnings per share would be lower.  Arguably, the stock price would be, as well.)

In late 1999, I sold the MSFT shares I had held for a decade.  The price earnings multiple was crazy high and it was clear that MSFT has no internet strategy.  But for a while I kept going to the annual analyst meetings in Seattle.

At one of them, Mssrs. Ballmer and Gates were jointly hosting a Q&A session.  One analyst raised his hand and observed that the annual earnings growth rate of Microsoft had dropped from 20%+ to mid-single digits.  He asked when management thought the company would resume its former rate of growth.

Awkward   …especially in a public forum.

I don’t think the questioner had any ill will, though.  He just wasn’t a particularly vivid-color crayon.

The response was illuminating.

Gates and Ballmer were both very harsh.  They all but called the guy an idiot, and asserted that it was a triumph of management to achieve any earnings growth in a firm of MSFT’s large size.  Wow!

What did I take from this?  Three things:

–neither Gates nor Ballmer was a very nice person,

–working for them it would be their way or the highway, and

–MSFT wasn’t going to have huge earnings growth because neither of the top people thought it was possible.   (The fact they subsequently brought in the head of a forest products company, a mature, cyclical commodity industry, to cut costs as CFO says it all.)

For the record, I thought Steve Ballmer was a bad CEO.   Not Carly Fiorina bad, but pretty terrible.

On the other hand, Bill Gates selected Ballmer and kept him as CEO for more than a decade.  So until very recently, he clearly approved of what Ballmer was doing.

If we want to lay blame at anyone’s door for MSFT’s weak performance during Ballmer’s tenure, the lion’s share would be delivered to the front of the Gates compound.

demographics, aging populations, and China

I first learned about the importance of demographics from the stock market from an economist at Donaldson Lufkin & Jenrette (which was ultimately acquired by Credit Suisse) in the mid-1980s.

He used to say that you can’t just manufacture a whole bunch of 30-year olds out of thin air–in other words, that a country’s population profile can have a profound influence on consumption patterns for a very long time.  Yet, in the rough and tumble of everyday trading on Wall Street, demographics is often forgotten.

At that time, his main point was the enduring influence on consumption of the post-WWII Baby Boom.  The sheer size of the cohort was important.  But not only that, but so too was its aging–and the resulting age-related shift in their buying habits.  Today, I imagine he would be stressing the age-related fading of the Baby Boom’s influence on consumption, as well as the issues surrounding the cohort’s longevity in retirement.

There are already two examples of aging advanced economies where the work force is significantly older than in the US.  They’re Japan, whose workforce is the oldest in the world and which has already been shrinking for many years due to age; and the EU, whose workforce age is about midway between the US and Japan.

I’ve written often about the social/cultural basis for Japan’s protracted economic decline.  I think this is the main reason, both for that country’s quarter-century of stagnation and why Abenomics won’t work.  But sometimes I wonder how much of Japan’s troubles are simply demographic–and therefore a harbinger of what may be in store for the US at some point.  It doesn’t help my mood that the next-oldest area in the world, the EU, is exhibiting many of the same symptoms that Japan did in the 1990s.

Although I’m not sure how well-known it is, China is, despite all its current economic dynamism, the other important aging country–thanks in large part of the policies of Chairman Mao.  Stratfor (a service I don’t subscribe to but which has competent analyses of world affairs) has just published a good summary of the situation.  The prose is a little too breathless, in my view, but the facts are basically correct.  China is facing workforce retirement issues comparable to those in the US.  Its industrial base is relatively unstable,  It’s in the early stages of transformation from labor-intensive, export-oriented manufacturing, to higher value-added production.

It seems to me that the new Chinese administration is well aware of its demographic problem and is taking sensible steps to redirect its economy to cope.  In fact, Beijing appears to be acting as if its aging workers are its principal long-term issue   …which I think it is.  That would also explain why China is so willing to sacrifice short-term economic growth in order to establish a more advanced, and more stable industrial base.  It would suggest, as well, that investing in basic industry in China–no matter how cheap the companies look–would be (to my mind, anyway) a big mistake.

Bain’s “A World Awash in Money” (II)

Let’s assume that Bain is correct that the world will be awash in capital over the next decade or so, and that this money will be coming both from investors in the developed world and–increasingly–from the emerging world as well.

I draw two conclusions from this (keeping in mind that Bain may, or may not, be correct):

1.  Interest rates won’t rise as much as the Wall Street consensus expects.  The Fed is saying that the normal rate for overnight loans in the US is 4%+.  This implies that 10-year Treasuries should yield at least 5%, probably more.  If Bain is correct, these figures are much too high  …and, therefore, the rise in bond yields following Fed hints that monetary tightening is on the horizon may have already achieved as much as half the total rise that tightening will bring.

2.  Consider the factors of production:



–land/materials/resources and

–knowledge (technology, entrepreneurship, craft skill).

Which of these will be in short supply relative to the others?   I.e., which will be the most valuable?

If Bain is correct, it won’t be capital.

The natural resources boom of the past decade has resulted in mining companies making massive investment in new capacity.  Shale oil and gas are beginning to provide new low-cost sources of energy.  So the shortage factor is probably not land etc.

There’s still massive amounts of unskilled labor in emerging economies.  There’s also significant unutilized labor in the US and EU.  So labor isn’t the key factor.

That leaves knowledge, either as technology, craft skill or entrepreneurship as the factor of production in short supply.


For investors, the main takeaways are that:

–the current monetary tightening cycle may not be as negative for bonds or stocks as the consensus fears

–like the Internet, ready availability of capital undermines the defensive position of large companies with significant manufacturing capabilities and established brand names.  Think:  Hewlett-Packard, Dell, Barnes and Noble, J C Penney.

There’s a second point to this list, as well.  In all of these cases, finding leaders with the right knowledge base to put the firms’ substantial assets to work has proved to be very difficult.  It may be that in an environment where capital is easy to come by, talented entrepreneurs have much better alternatives than masterminding turnarounds for financial buyers.  If so, the value investor tactic of buying shares in asset-rich companies and waiting for something good to happen may not retain its traditional allure.  So-called value traps will outnumber successful turnarounds by a lot.