Yearly Archives: 2013

the heavy half

October 22, 2013 By in heavy half Tags: , , , , Leave a comment

the heavy half

I Googled this marketing term before starting to write, just to see how current it still was.  I got a lot of nonsense about the rear ends of different kinds of trucks.  Nevertheless, I’m pressing on.   …a bit outdated, maybe; but still useful.

The heavy half isn’t about weight, and, strictly speaking, it isn’t about halves.  It’s an extension of the idea that consumption of a firm’s goods and services isn’t uniform across all customers.  Some use more, some use less.  But it may turn out–and very often does–that a relatively small number of customers represent a disproportionately large percentage of company profits.  Those customers are the heavy half.

examples

For instance, in its heyday Nokia sold cellphones encrusted in jewels and/or encased in precious metals, mostly through the Vertu brand.  As I understand it, these high-priced phones accounted for about 5% of unit volume for NOK, but over 20% of profits.

Until very recently, and although the full positive impact was disguised through transfer pricing (most analysts had no clue), a luxury goods customer in Japan might have been worth 2x-4x what an affluent American or European one was.  So sales to Japanese customers might have represented 10% of total revenues, but could have been 30% of profits.

Customers in the midwest drink twice as much Coke as those in California.  Supposedly, 20% of the beer drinkers in America consume 80% of the brew.  In these cases, the heavy half is probably also literally true.

The top 20% of US consumers by income buy about half the discretionary items sold here.  The bottom 20% buys almost nothing.

why it’s important

Any well-managed company knows who its heavy half is.  Most don’t want anyone else to know.  They don’t want to alert the competition, for one thing.  But the heavy half can also be a mixed blessing.  If 20% of your customers buy 60% of your products–and there are thousands of them, that’s great.  If one customer buys 90%, that’s potential trouble if it dawns on him how important he is.

For an investor, discovering a company’s customer/profit profile can be key, especially if you do so ahead of everyone else.  It gives you an inside track to forecasting earnings surprise.

why today

Why am I writing about this today?  I read a Wall Street Journal article about the gambling industry recently that asserted that it has a dramatically skewed profit profile.  According to the newspaper, almost all the income comes from about 10% of the customers.

I think that’s wrong. More tomorrow.

(not so) “Happy Meal” convertible bond offerings

October 20, 2013 By in Convertibles, Current Market Thoughts, hedge funds, Investment firms, the Happy Meal Tags: , , , , , , 2 Comments

Pinky, the more astute of the two eponymous stars of the long-running documentary on genetically engineered mice, once opined that “if they called them Sad Meals, no one would buy them.”  So true.

Wall Street “Happy Meals”

Recently, the Wall Street Journal has been writing about a convertible bond offering technique, known as the Happy Meal, which has come under SEC scrutiny.   It shows what a colorful, inventive but cold-blooded place Wall Street is.

The Happy Meal is/was an offering of convertible bonds, in which the issuer arranged at the same time to lend large amounts of company stock to buyers so that they could sell the stock short.

Got that?  …probably not.

So let’s pull the pieces apart.

1.  A company issues convertible bonds.

Convertibles are bonds with a provision that allows them be exchanged for a specified number of shares of the issuer’s common stock under certain circumstances.  Until they are converted, the buyer collects interest income.

Generally speaking, a company would rather issue common stock or straight bonds, or borrow from a bank.  The fact that the firm is issuing a convertible almost always means these other, more attractive, avenues aren’t open to it.

2.  In the case of the Happy Meal companies, the convertible form wasn’t inducement enough.

Conventional long-only buyers turned thumbs down.  Who would these buyers usually be?  …specialized convertible securities funds, or bond funds looking to boost their returns by holding equities.  They avoid violating the letter of their investment mandates by buying stocks wrapped up in a bond package.

3.  That left hedge funds willing to do convertible arbitrage.

That is  to say, the hedge funds would simultaneously buy the convertibles and sell the stock short.  Exactly what a given hedge fund would do varies.  One technique would be to sell short enough stock to eliminate entirely any effect of stock movements (up or down) on the position–leaving the hedge fund to collect a stream of interest payments.  But a fund could also shade its holding to the positive or negative side.

4.  There’s more.

To sell stock short, you typically borrow the stock from a third party who owns it, using a brokerage firm as a middleman.  In the Happy Meal case, that wasn’t possible–either because there weren’t enough holders of the stock or because holders were reluctant to lend.  So the issuing company itself lent the stock that hedge funds dumped out into the market right after the offering.

What a mess!  A company would have to be really starved for cash, in my view, to contemplate serving up a Happy Meal.

not so appetizing any more

Companies have begun to turn sour on Happy Meals.  Two reasons:

–enough Happy Meal issuers have suffered significant stock price declines after their offerings that simply announcing a Happy Meal issue is now enough to make the common stock swoon, and

–according to the WSJ, a retired investment banker has turned whistleblower and reported the Happy Meal to the SEC.

His claim? …that issuers and their brokers are negligent by failing to disclose in the offering documents  how aggressive post-issue short selling is likely to be.

A concerned citizen, yes.  But one who also stands to collect a bounty under the Dodd Frank Act if the SEC investigation leads to significant fines.  In other words, a vintage Wall Streeter.

Las Vegas Sands (LVS) and Sands China (HK: 1928): 3Q13 earnings

October 18, 2013 By in Casinos, China, earnings conference calls, Entertainment, Hong Kong, Industry Analysis, Macau, Stock ideas Tags: , , , , , , Leave a comment

the results

After the New York close yesterday, LVS announced 3Q13 results for itself and for its subsidiaries, Macau-based 1928 and wholly owned Marina Sands of Singapore.

Revenues for LVS came in at $3.57 billion, up 31.7% year on year.  EBITDA (earnings before interest, taxes, depreciation and amortization)  advanced by 45.5% yoy to $1.28 billion.  EPS was $.82, a 78.3% yoy increase.  That figure exceeded the Wall Street consensus by $.05.

During the quarter, LVS repurchased 4.6 million shares of its stock, at an average price of $65.18.  It says it will buy back a minimum of $75 million in stock a month from now on.

LVS also raised its quarterly dividend from $.35/share to $.50, giving a forward yield of 2.8%.

 

1928 rose by almost 10% in overnight trading in Hong Kong (in a market where other Macau casino stocks were up by 4%-5% or so).  LVS has barely budged in this morning’s pre-market trading.

 

the highlights

Macau

LVS is a convention hotel operator.  Its strength is catering to customers who have, say, $10,000 to gamble during a stay rather than VIPs with $1 million or more.  Its huge investment in hotel/casino capacity in the Cotai section of Macau on the conviction that if Sands built it, customers would come, is beginning to pay off royally now.

EBITDA for 1928 came in at $785.3 million for the quarter, up 61.7% yoy.

Singapore

Marina Bay’s EBITDA was $373.6 million, up 43.3% yoy.  However, the amount bet by VIP gamblers was only up by 16.9%.  The largest portion of the EBITDA increase comes from the casino “win” (the amount gamblers lose, which is what casinos count as revenue) bouncing back from an abnormally low 1.79% of the amount bet during 3Q12 to a more normal 2.85%.

US

Down a bit, yoy.  EBITDA in Las Vegas was $87.1 million (vs. $98.2 million during 3Q12).  Bethlehem, Pa brought in $29.6 million (vs. $32.1 million).

my take

At this point, over 90% of LVS’s EBITDA comes from Asia.  That percentage will continue to climb.

Marina Bay is an enigma to me.  …a good enigma, but a puzzle nonetheless.  It isn’t that long ago that Marina Bay and Macau were neck-and-neck in generation of cash for LVS.  But while Singapore has been relatively stagnant, LVS’s Macau EBITDA have doubled.  Has Marina Bay already topped out at $1.5 billion in annual EBITDA?  I find it hard to think this is the case, but I can’t see any evidence to the contrary from the financials.

Macau is booming   …and the market is rapidly developing a large resort/convention segment, which is LVS’s management specialty.

valuation

At today’s Hong Kong closing quote, LVS’s interest in Sands China is worth $49 billion.

If we make the (conservative, in my view) assumption that Marina Bay will generate about $1.5 billion in annual cash flow and that we’re willing to pay 10x for that, then the Singapore subsidiary is worth $15 billion.

The same calculation for the US operations (let’s put a cash flow multiple of 8 on it) would value it at about $4 billion.

Total value = $68 billion.  That compares with a total market cap for LVS at yesterday’s close of $58.5 billion.

If these back of the envelope figures are close to correct, LVS is trading at about a 15% discount to the sum of its parts.  Further upside could come from continuing flowering of the Macau operations, which I think is highly likely, and/or a return to growth for Marina Bay.  (I own the stock and am happy to remain a holder.  At some point, I’ll have to trim the position simply because of size, but see no present reason to do any other selling.)

 

 

Washington crisis over …what now?

October 17, 2013 By in Current Market Thoughts, Portfolio management, Strategy Tags: , , , , , , Leave a comment

Federal government workers in the eastern US are on their way beck to work as I’m writing this.  The debt ceiling crisis has been postponed for several months.

What happens next on Wall Street?

On the one hand (the bigger one), I think investors will also go back to their “normal” work.  That is, they’ll:

–continue to absorb information from the 3Q13 earnings season and company guidance about 4Q13 prospects, and

–continue to form expectations for the global economy in 2014.

They’ll reshape their portfolios in response to news.

Here’s what I expect–

Prior to the shutdown, the US economy appeared to be gradually picking up steam.  My guess is that steady progress will resume, after a short air pocket caused by the layoff without pay of government workers.

As for 2014, it will probably be a stronger year for the global economy than this one:

–the EU continues to give signs that its economies have bottomed and are trundling, albeit slowly, down the road to recovery

–China is trending up again, possibly more quickly than the consensus expects

–ex more destructive emanations from Washington, the US will likely continue to have the strongest growth in the developed world.

This analysis suggests that the same equity portfolio structure that produced market-beating results in 2013 should be good for 2014, as well.

On the other hand,

there’s the question of possible stock market fallout from Washington’s continuing dysfunction.  This could come in one of two ways:  investors might demand a higher risk premium for investing in the US than they have previously; or Washington might, by accident or design, do something that further damages the country’s economic prospects.

Who knows?  I certainly don’t   …nor, in my opinion, does anyone else.  Nevertheless, this is an issue.

In situations like this, what professionals do is to try to construct a portfolio where the answer to an imponderable question is unimportant.  This is not a hedge.  It’s an attempt to find stocks where the answer to a thorny question makes little difference.

For example, an investor can:

–rotate European holdings away from multinationals with US exposure toward domestic-oriented firms (something one would probably do anyway)

–shift away from domestic names in the US toward companies with EU or Pacific ex Japan exposure

–get China exposure through Hong Kong stocks instead of US ones

–opt for secular growth companies rather than business cycle-sensitive ones.

I think professionals will do all these things.

In addition, foreign pms will probably opt to hold less in the US.  Domestic US managers may do so as well–although this would be an active portfolio response to the question of the future tone of Washington policy, rather than simply a way to make it as irrelevant as possible.

The net result will be to take some of the shine off US equities.  They’ll still go up, in my view, but not as much as if the government shutdown had never happened.

 

 

3Q13 earnings for Intel (INTC): the wait continues

October 16, 2013 By in earnings conference calls, Industry Analysis, semiconductor manufacturing, Stock ideas, Technology Tags: , , , , , Leave a comment

I’m on the road today, so this will be brief.

Yesterday after the market close, INTC reported earnings for 3Q13.  EPS were $.58/share, considerably above the Wall Street consensus of $.53.  Initially, the stock was up by around 2% in the aftermarket on this news.  Then it reversed course and lost about 2%.  Symmetrical, but not wonderful.

As I see it, the news can be divided into two halves–current market conditions and INTC’s future viability as a chip firm.

The near-term bucket is looking good.

–The high speed and cloud server businesses continue to boom, and now make up at least half of INTC’s total server revenues.

–Regular old corporate servers are even starting to pick up.

–The middlemen and OEMs that INTC sells its PC chips to are slowly starting to build their inventories in response to a bottoming of the PC market in the US and the EU.  Stocks, however, still remain smaller than normal, so there’s more improvement to come.

–More tablets will be appearing over the coming weeks with INTC chips inside.

4Q13 eps, traditionally a big quarter for INTC on holiday sales, will be flattish with 3Q13, on revenues up only slightly, quarter-on-quarter.

The future. on the other hand, has once again been pushed out–this time for another year, until 2015.

INTC’s industry-leading 14 nanometer chips have been delayed by a manufacturing glitch for three months until January.  So their higher speed and lower power use won’t be available during this holiday season.  To my mind, this is not a big deal.  On the other hand, during the conference call that accompanied the earnings announcement, CEO Brian Krzanich said he doesn’t think INTC can make its manufacturing operations as flexible as they need to be to respond to customer needs for another year to eighteen months.

This contrasts with the comments of former CEO Paul Otellini, for whom full competitiveness with rival chipmaker ARM Holdings was always just a quarter or two around the corner.

In hindsight, Otellini had a habit of being too optimistic.  In contrast, Krzanich, as a new CEO, has no incentive to make promises he can’t keep.  His best course of action is to underpromise and overdeliver.

The bottom line, however, is that the turnaround holders like me are hoping for has once again been pushed out.  That’s why the stock is down in the pre-market this morning, though not by as much as it was last night.

I’m content to hold and collect the dividend.