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.

 

the Supreme Court and 401k plans

On Monday, the Supreme Court made a narrow ruling on a technical point that may have far-reaching implications.

Participants in the 401k plan offered by Edison International, a California utility, sued the company claiming that it stocked the plan with “retail” versions of investment products that charge higher management fees than the lower-cost  “institutional” versions that it could have chosen instead.

The company defended itself by successfully arguing in a lower court that the statute of limitations for bringing such a lawsuit had expired.  The Supreme Court said the lower courts were mistaken.  An employer has a continuing duty to supervise its 401k offerings.  So even though years had passed since the 401k offerings were placed in the plan, the statute of limitations had not expired.

So the case goes back to the lower court, where presumably the question of whether Edison was right to offer a higher cost product than it might otherwise have.

Was this a mistake?

Why wouldn’t any company have the lowest cost share possible in the 401k plan?

The short answer is that the company receives a portion of the management fee in return for allowing the higher charges.

Typically the company argues that the fee-splitting helps cover the costs of administering the 401k plan.  In practical terms,thought, the move doesn’t eliminate the costs.  It shifts them from the company to the plan participants.

If the Wall Street Journal is correct, this is the case with Edison, which is reported as pointing out that the fee-splitting is disclosed in plan documents.

I have two thoughts:

–the sales pitch from the investment company providing the 401k services probably sounded good at the time.  The 401k would be inexpensive (free?) to Edison.  High fees would shift the cost onto employees instead–which makes sense, the seller might argue, since employees are the beneficiaries of the plan.

On the other hand, to anyone without a tin ear, this sounds bad.  The amounts of money are likely relatively small.  Edison is probably spending more on legal bills than it “saved” by choosing the plan structure it did.  And if it turns out that Edison is profiting from the arrangement rather than just covering costs, the reputational damage could be very great.

–fee-splitting arrangements on Wall Street are far more common than I think most people realize.  This case could have wide ramifications for the investment management industry if the courts ultimately decide that Edison acted improperly.

 

 

an Intel (INTC) – Altera (ALTR) deal re-emerging?

Market gossip is that ALTR recently refused a friendly offer from INTC at $53 a share.

Speculation resurfaced yesterday with rumors that talks have started up again.

The catalyst seems to be the fact that serial acquirer Avago (AVGO–I own shares) appears to be considering a bid for ALTR’s rival Xilinx (XLNX).

AVGO seems to have a knack for finding firms that have excellent technology but which, for one reason or another, find it difficult to achieve consistent profit growth.  AVGo buys them, reorganizes them and puts the profit machine into high gear.

In this case, the sub-industry involved is the sleepy world of field programmable gate arrays (FPGAs), dominated by the cozy duopoly of ALTR and little brother XLNX.  AS the name suggests, FPGAs are chips whose program structure is not hard-wired (those are application-specific integrated circuits–ASICs).  So they can be reprogrammed, upgraded, debugged…even after they’ve been put into machines that are now in use.  This allows manufacturers to get, say, cutting-edge telecom equipment into customers’ hands very quickly.  The drawback is cost.

The AVGO move suggests the FPGA arena is about to become considerably more competitive.   AVGO/XLNX would be four times the size of ALTR, implying easier access to capital and the ability to offer a much wider variety of products to customers than ALTR.  This suggests ALTR realizes the status won’t be quo for much longer and it needs to be part of a bigger entity in order to compete.

To my mind, the big winner in all this would be INTC.

inheritance tax changes as a lever for structural change in Japan

value investing and corporate change…

One of the basic tenets of value investing in the US is that when a company is performing badly, one of two favorable events will occur:  either the board of directors will make changes to improve results; or if the board is unwilling or incapable of doing so, a third party will seize control and force improvements to be made.

…hasn’t worked in Japan

Not so in Japan, as many Westerners have learned to their sorrow over the thirty years I have been watching the Japanese economy/market.

Two reasons for this:

culturally it’s abhorrent for any person of low status (e.g., a younger person, a woman or a foreigner) to interfere in any way with–or even to comment less than 100% favorably on–a person of high status.  So change from within isn’t a real possibility.

–in the early 1990s, as the sun was setting on Japanese industry, the Diet passed laws that make it impossible for a foreign firm to buy a large Japanese company without the latter’s consent–which is rarely, if ever, given.

The resulting enshrinement of the status quo circa 1980 has resulted in a quarter century of economic stagnation.

Abenomics to the rescue?

Abenomics, which intends to raise Japan from its torpor, consists of three “arrows”–massive currency devaluation, substantial deficit government spending and radical reform of business practices.

Now more than two years in, the devaluation and spending arrows have been fired, at great cost to Japan’s national wealth–and great benefit to old-style Japanese export companies.  But there’s been no progress on reform.  The laws preventing change of control remain in place.  And there’s zero sign that corporations–many of whose pockets have been filled to the brim by arrows 1 and 2, are voluntarily modernizing their businesses.  Mr. Abe’s failure to make any more than the most cosmetic changes in corporate governance in Japan is behind my belief that Abenomics will end in tears.

One ray of sunshine, though.

Japan raised its inheritance tax laws at the end of last year, as the Financial Times reported yesterday.  The change affects three million small and medium-sized companies.

The top rate for inheritance tax is 55%, with payment due by the heir ten months after the death of the former holder.   This development is prompting small business owners to consider how to improve their operations to make their firms salable in the event the owner dies.  More important, it’s making them open to overtures from Western private equity firms for the first time.  Increasing competition from small firms may well force their larger brethren to reform as well.

For Japan’s sake, let’s hope this is the thin edge of the wedge.