Avago (AVGO) and Broadcom (BRCM) …and Intel/Altera

Two days ago the rumor hit Wall Street that chipmaker and serial acquirer AVGO had found its newest target, BRCM.  Yesterday the offer was announced:  cash and AVGO stock, in approximately 45/55 proportions, totaling $37 billion.

my thoughts

When customers in a given industry group become bigger and more powerful, the natural response among suppliers is to do the same.  This is part of what is going on here.  More than that, AVGO appears to seek out companies whose technological virtuosity far outstrips their management skills.  So it gains not only the marketing benefit of size but also the rewards of improving the profitability of firms whose main virtue has been their intellectual property.

What’s striking about this deal is that in revenue terms AVGO is more than doubling its size.  Although I have no intention of selling the AVGO shares I own, experience says that acquirers often bite off more than they can chew when they make the jump from small acquisitions to super-size ones like this.

One of AVGO’s rumored other targets had been Xilinx (XLNX), the junior partner with Altera (ALTR) in the field programmable gate array duopoly.  I had thought that ALTR would feel more favorably disposed to overtures being made by Intel (INTC), given the possibility that AVGO would buy XLNX and turn the firm into a much more aggressive competitor.  That threat is now gone.  INTC must now rely on pressure on ALTR management from its major shareholders (shareholders are, after all, legally the owners of ALTR and the employers of management) to return to the negotiating table.

As a practical matter, managements have a lot of autonomy, despite the fact that we the shareholders are, technically speaking, the bosses.  Wall Street seems to believe that ALTR is holding out for a higher price from INTC.  While that may be the rhetoric being used, I think the real issue is more basic.  Who would want to go from being the master of all he surveys as the top dog (and treated as a demigod) at a major publicly traded company to being a near-invisible division head in a conglomerate?

return potential for US stocks–suppose Goldman is right?

Yesterday I wrote about the view of Goldman equity strategist David Kostin that, on a capital changes basis (i.e. , not counting dividends), the US stock market will be flat over the coming 12 months and will edge higher at only about a 2% annual rate for at least several years after.  Collecting dividends will be a major source of total returns.  In fact, if the reason for this sub-par showing (by historical standards) is that earnings will grow but price earnings multiples will contract as interest rates rise (I’ve only read a bare-bones summary of Mr. Kostin’s view), then dividends may be the major source of returns.

Let’s suppose Mr. Kostin is right.  What does this mean for investors?

my thoughts

1.  Losing stocks will be devastating.  Large losses always hurt more than large gains.  But a strongly rising market tends to act somewhat like a safety net to cushion the fall, as well as offering a chance to catch the next shooting star to make up for the mistake.  A flat market is less forgiving, and will presumably offer fewer chances to recoup from losses.

2.  One or two winners will probably be enough to make a portfolio manager’s year.  Careful securities analysis will be rewarded with outperformance, provided a manager can avoid having big losers.  Again, this is nothing new–although the idea that having a ton of stocks you spend only a little about is not as good a strategy as having a few you know inside out has eluded academics until recently.

3.  Trading stocks, aka market timing–a tactic reviled in investment folklore–probably becomes more important as a source of performance (maybe this is why GS is content to let Mr. Kostin publish).  This will be doubly so for non-taxable accounts.

If we truly believe the major trend is sideways, buying and selling portions of positions based on valuation–especially in the case of stable, mature companies–becomes a more attractive strategy.  This is sort of like bunting for a base hit–you need a lot of successes to score a run.  But it may be the only way to get on the board if the market is throwing blanks.

4.  For institutions, trading through derivatives–maybe in the same fashion big bond funds operate–would provide liquidity and speed that gigantic portfolios can’t get otherwise.  Custom-tailored OTC derivatives may be the most preferred.  Not for you and me, but probably for the largest money management houses.  Great for brokers’ profits, too.

 

return potential for US stocks

Yesterday’s Wall Street Journal contains a summary of projections by Goldman equity strategist, David Kostin, for US stock market returns this year and beyond.

His view is that stocks will be flat over the coming 12 months–investors will collect dividends but no capital gains.  After that, stocks will average +5% yearly total returns for the rest of the decade, miniscule a meaning they’ll continue to collect dividends plus, on average, miniscule capital gains.

Of course, like any brokerage house, Goldman has a plethora of strategists, not just Mr. Kostin.  The ones waiting in the wings cover the waterfront from bullish to bearish with their views, so at least one is bound to be right–and can come off the bench to replace Kostin if need be.

Still, Mr. Kostin has the title, and he’s the one who makes the rounds of brokerage clients to present Goldman’s views.  So his is most likely the firm’s official position–and agrees at least  in spirit with the beliefs of Goldman’s top management.

Kostin’s is a peculiar stance for a broker, nonetheless.

In the real world, no brokerage research report is intended to be “pure” scholarship.  Yes, every document is intended to show off the firm’s deep factual knowledge and analytical skills.  But it’s also supposed to produce revenue by flattering the firm’s investment banking clients and persuading its money management customers to transact.

A bearish strategy may do the first but it certainly won’t do the second.  It won’t produce the kind of revenue a document like this is aimed at achieving.

So why publish something like this?

I can think of several reasons:

–it’s possible that Goldman figures that institutional money management clients aren’t going to generate much trading revenue from now on (the substitution of index funds for active managers?), so it no longer matters that much what the firm tells them,

–maybe Goldman senses that a pollyannaish story from, say, Senior Strategist Abby Joseph Cohen, would go down worse,

–perhaps the Kostin view is actually bullish, or at least as bullish as Goldman is willing to be.  Maybe Goldman anticipates a big stock market selloff as interest rates begin to rise and intends the idea that, given time, investors will steadily regain what they’ve lost (plus some) to stand as a beacon of hope.

–it could be that Goldman wants to sell non-traditional products to investment managers as a way of dealing with potential hard times.

More tomorrow.

Hope over experience?—S&P Indexology

I subscribe to the S&P Indexology blog.  It’s written by S&P staff involved in manufacturing the company’s well-known financial markets indices.  Usually it’s interesting, although the writers’ true-believer conviction that no active manager is capable of matching–to say nothing of outperforming–his benchmark index often shines through.

Yesterday’s post, titled “Hope over Experience, ” is a case in point.  It takes on a recent, pretty silly Wall Street Journal article that muses about an “Old-School Comeback”  of active stock mutual fund management, based on recent outperformance of the average active manager over the S&P 500.  “Recent” in this case means the first four months of 2015; “outperformance” means a gain of .33% versus the S&P.

The obvious observations are that the time period cited is extremely short and that the gain versus the index is probably statistically insignificant.  S&P Indexology goes on to say that the comparison itself is bogus. The S&P 500 is neither the appropriate or the actual official benchmark for many stock mutual funds, which have, say, growth, value, small-cap or other mandates and other benchmarks than the S&P 500.

So far, so good.

Then come two comments straight out of the university professor’s playbook:

–The first is the argument that because an active manager’s portfolio structure may be dissected, after the fact, into allocations that could have been replicated by indices, actually creating and implementing that structure in advance has no value.  That I don’t get at all.

–Indexology concludes by suggesting that because investing in the aggregate is a zero-sum game–the total winner’s pluses and losers’ minuses exactly offset one another, before costs–there can’t be any individual investors who consistently outperform.

I believe that life in general, and investing in particular, is a lot like baseball.  (I’ve been thinking about baseball recently because it’s in season).  The second Indexology comment is much like saying that the Giants’ winning three World Series in five years is a random occurrence.   …or that the change in ownership of the Cubs and the hiring of Theo Epstein have nothing to do with the club’s success this year.  Yes, bad teams get a preference in the draft each year, but the end to a century of futility?

…and what about the Braves and Cardinals, who consistently field above-average teams even though their draft positioning does them no favors.

To be clear, I’m an advocate of index funds.  My reasoning for this is not that outperformance is impossible (the ivory tower orthodoxy) but that it takes more time and effort than most people like you and me are willing to put in to locate and monitor active managers.  I’d be much more comfortable with Indexology saying this.

Etsy (ETSY)

ETSY debuted on Wall Street on April 16th at an offering price of $16 a share.

The initial trade was at $31.  The stock fluctuated between $28.22 and $35.74 before closing at $30.

Since then, the stock has been steadily drifting back toward the IPO price.

The stock dropped by 18%, to $17.20 on Wednesday, after the company reported a disappointing March 2015 quarter.  The consensus estimate of (three) Wall Street analysts was that the company would report non-GAAP earnings of $.03 a share.  The actual was a loss of $.12.

Revenue for the quarter rose by 44.4%, year on year.  Adjusted EBITDA (earnings before interest, taxes and depreciation/amortization), which is arguably the most flattering possible way of presenting profits, rose by 9.3%.  Also, in ETSY’s case, the adjusting removed both a $20.9 million foreign exchange loss and a $10.5 million yoy increase in income taxes.  On a GAAP basis, ETSY had a loss of $0.5 million in 1Q14 and $36.6 million in 1Q15.

Media comment about the sharp drop in the stock price after the earnings report puts the blame for the decline on the narrow slate of IPO underwriters and on ETSY’s “authentic” counterculture philosophy/image.

I don’t think that’s the case, at least not directly.

To my mind, the central fact is that ETSY’s March quarter ended more than two weeks before the IPO priced.

The stock’s price action since then says to me that on the first day of trading investors weren’t aware of how weak 1Q15 results would be.  The steady decline in following sessions suggests that the bad news was gradually making its way into the market.  The 18% drop on announcement implies the actuals were worse than the rumor mill had been whispering.

Where was ETSY management while all this was happening?

I can only see two possibilities:  either the company has terrible financial controls and was unaware during and after the quarter how weak the quarterly results would be; or it did know and decided–presumably at the urging of the underwriters–not to disclose this plainly to potential investors during the road show.  Neither one makes me want to run out and buy the stock.

Note:  I haven’t studied ETSY carefully and I didn’t see the roadshow.  My picture of what’s happened is based on reading the earnings report and observing the stock’s trading history.

 

 

 

ZipCap

ZipCap, short for Zip Code Capital, is a San Diego-based startup alternative lender featured in the Business section of today’s New York Times.  It provides low-cost loans to local businesses that aren’t able to get credit from traditional banks–presumably either because they’re not (or not very) profitable or because they don’t have a good enough financial handle on their enterprise to know whether they make money or not.

ZipCap helps a client business form an “Inner Circle” of customers who pledge to buy a minimum amount of stuff from the client over a specified period.  ZipCap lends against that commitment.  In the case of the restaurant/coffee house featured in the NYT article, 130 entities pledged to spend $475 each ($61,750 in total) over the following year.  That got Beezy’s Cafe a $10,000 loan at 3.99%.

If all of this were new spending, my back-of-the-envelope guess is that it would bring in $40,000 or so in fresh operating income, far in excess of what would be needed to repay the debt.  For Beezy’s to be better off simply from forming the Inner Circle, a quarter of the pledges would have to be new spending, or about $2.50 a week per Inner Circle member.  That figure would need to be adjusted up if not everyone keeps his word.

 

It seems to me, from the limited data in the NYT and on the ZipCap website, that ZipCap isn’t really about lending.

It’s not a social service, either.  Chances are that Beezy’s would be better off getting, say, business students from a local college to create financial tracking to help figure out what makes money for the cafe and what doesn’t.

What ZipCap does do, I think, is provide a socially acceptable, non-toxic way for a struggling business to proclaim that, though it might appear to be thriving, it isn’t   …and, at least implicitly, that it won’t be around for long unless it gets more community support.

Of course, there may be unintended consequences of the Inner Circle creation.   Assuming the extra spending doesn’t come out of thin air, IC creation at Cafe A may force Cafe B to close its doors.  Or it may make it extra hard for a new Cafe C to get started.

It will also be interesting to see how ZipCap deals with rising interest rates, as and when they occur.