the Blue Apron (APRN) offering

Meal delivery service APRN (originally named Petridish Media) went public yesterday at an offering price of $10 per share through an underwriting syndicate led by Goldman Sachs.

The original pricing range was reportedly $15 – $17, but was reduced to $10 – $11 after Amazon and Whole Foods announced their intention to merge.

The stock traded as high as $11 yesterday, before fading back to the offering price later in the day.  I didn’t watch the stock and there’s surprisingly little price information from yesterday’s trading available this morning, but it seems as if the underwriters made few (if any) “stabilizing” purchases at $10 to keep the stock from closing below the offering quote.

Today APRN opened at $9.98, slipped to $9.50, and is trading at around $9.70 or so as I’m writing this.

Although I have zero interest in owning APRN at this point, I think it’s an interesting issue from a number of perspectives:

–the concept is, I think, for APRN to be the “first mover” in home meal kit delivery.  Doing so would give it brand recognition and scale that rivals starting up later would find difficult to match.  Whether APRN can achieve this position remains to be seen

–as I read the prospectus (meaning: I find it hard to believe what I’ve read), 100% of the proceeds from the offering are going to the company.  None of the VC backers or otheer insiders are cashing out any portion of their positions.  If so, this is either very good (they think APRN is a gold mine) or not so much (they don’t want to scare away buyers)

–APRN is an “emerging growth company,” listing under the provisions of the Jumpstart Our Business Startups Act (JOBS).  JOBS allows early-stage companies to go public without meeting all the SEC-mandated disclosure requirements for public companies.  This makes the financials hard to interpret.  Still, it seems to me that there may be a serious deterioration in APRN’s working capital during 1Q17

–the main metrics/issues for APRN are the cost of acquiring a customer and its ability to retain one once acquired.  Again, it’s hard to get a good read, but Wall Street’s apparent worry–apart from AMZN/WFM–is that the answers to these questions are “high” and “low.”

All in all, the risks of APRN are too high for me, but this will be an informative one to watch.





Sprint and the cable companies

The Wall Street Journal reports this morning that Sprint, Comcast and Charter Communications are discussing an agreement for mutual support in providing a discount mobile telephone service.

Sprint is controlled by the Japanese conglomerate Softbank, whose chairman, Masayoshi Son, made his first mark in that country by launching a successful deep-discount mobile phone service that resulted in much lower prices for consumers there.  Mr. Son has already tried once to repeat this move in the US.  To gain the requisite size to offer a similar disruptive service in the US, he agreed to combine with T-Mobile.  This would have formed a third big mobile telecom group, after Verizon and ATT.  But the federal government ruled against his plan, on the grounds that joining Sprint and T-Mobile would reduce the number of big telecom companies in the US from four to three (violating an anti-trust rule of thumb that frowns on market shares above 25%).  The fact that Mr. Son wanted to provide more competition, not less, made no apparent difference to the regulators.

Hence, I think, Mr. Son’s very visible support for Mr. Trump, as a businessman who might see through regulatory clutter.

I’m not sure what will develop from talks among the three parties.  I don’t think this is simply a way for Son to extract himself from an investment gone wrong in Sprint, however.  My guess (as someone with too-high cellphone bills, my hope?) is that a viable mobile service with adequate national coverage will emerge from the talks.

If so, while this may/may not be good news for the companies involved, it is definitely bad news for both Verizon and ATT.

Whole Foods Market (WFM)–final round

As I pointed out last week, WFM has gross margins that are much higher than the average supermarket’s.  WFM also turns its inventory in a little less than two weeks, which is two or three times the rate of a typical grocery store.  Over the past several years, it has been generating over a billion dollars in annual cash flow.

On the other hand, sales are falling.  The largest use WFM has been making of the money it generates is to buy back stock ($2 billion worth over the past three years).  Its working capital management seems to produce much less cash for it than rivals–although this may be the result of an unusual product mix and/or worry that the current poor sales trend will continue.

In addition, it appears WFM is attempting to extend its brand downmarket with the opening of 365 stores–a tacit acknowledgement that its core high-end market is saturated.  In my experience, though, this strategy rarely works.  Its main effect is typically to degrade the upscale image of the main brand.  Tiffany is the only exception I can think of.

what interests Amazon (AMZN)

–WFM has a well-known brand name, that stands for healthy, high-quality, and ethical behavior.  But it also stands for “whole paycheck,” an attribute that AMZN can most likely eliminate without damaging the rest of the image

–an ironic plus, WFM doesn’t appear to have kept up with the times in pricing, computerization or inventory control.  So there’s arguably low-hanging fruit to be picked

–WFM has a physical distribution network that culminates in 430+ physical stores covering most major markets in the US

–the NPD Group, a leader in consumer marketing research, points out that:

—-WSM stores are located in areas that are younger and more affluent than average

—-52% of online grocery buyers are members of Amazon Prime, and therefore arguably disposed to by groceries through AMZN if the company had an adequate delivery mechanism

—-60% of Millennials bought at least one item from AMZN last year vs. 24% who bought something from WSM.  So AMZN has, at least on paper, the potential to deliver a large new audience to WFM

–according to a Morgan Stanley survey, which I read about in the Wall Street Journal, 62% of WSM’s current customers are already members of Amazon Prime.  Arguably, there’s a big opportunity for AMZN to increase the frequency/amount of WSM purchases through the Prime network.

my take

From its high in early 2015, the WFM had almost been cut in half–in a market that was rising by 15%–before Wall Street began to anticipate a couple of months ago that the company would be either restructured or sold.  Although I’m by no means an expert on WFM, that negative price action is hard to ignore.  So, too, the declining sales trend.

The picture that emerges to me is of an high-end retailer that has saturated its niche and whose chief product–healthy, but expensive, food–is being commoditized by rivals.  To date, management has marshaled no adequate response to this competitive threat.

AMZN provides a face-saving way for WSM to retain its counterculture self-image while turning over its market problem to more competent hands.





high margins vs. low

Many traditional growth investors characterize the ideal investment as being a company with substantial intellectual property–pharmaceutical research or computer chip designs or proprietary software–protected by patents.  This allows them to charge very high prices, relative to the cost of manufacturing, for their products.

Some go as far as to say that the high margins that this model generates are not just the proof of the pudding but also the ultimate test of any company’s value.

As I mentioned yesterday, the two issues with this approach are that: the high margins attract competition and that the price of maintaining this favorable position is continual innovation.  Often, successful companies begin to live the legend instead, hiding behind “moats” that increasingly come to resemble the Maginot Line.

In addition, high margins themselves are not an infallible sign of success.  Roadside furniture retailers, for example, invariably have high gross margins, even though their windows seem to be perpetually decorated with going-out-of-business signs.  That’s because furniture is not an everyday purchase.  Inventories turn maybe once or twice a year.  Margins have to be high to cover store costs–and, in normal times, to finance their inventories.

Although I am a growth investor, I’ve always had a fondness for distribution companies–middlemen like auto parts stores, or pharma wholesalers, or electrical component suppliers, or Amazon, or, yes, supermarkets (although supermarkets have been an investment sinkhole that I’ve avoided for most of my career).  My experience is that the good ones are badly misunderstood by Wall Street, mostly, I think, because of a fixation on margins.   In the case of the best distribution companies, margins are invariably low.  So that’s the wrong place to look.

Where to look, then?

the three keys to a distribution company:

–growing sales, which will leverage the fixed costs of the distribution infrastructure,

–rapid inventory turns, measured by annual sales/average inventory.  What a “good” number is will vary by industry.  Generally speaking, 10x is impressive, 30x is extraordinary,

–negative working capital, meaning that (receivables – payables) should be a negative number   …and getting more negative as time passes.  Payables are the money a company owes to suppliers, receivables the money customers owe to the company.  For a healthy firm, its products are in high enough demand that customers are willing to pay cash and suppliers are eager enough to do business that they offer the company generous payment terms.

A simple example:  all a company’s customers pay for everything (cash, debit or credit) on the day they buy.  Suppliers get paid 90 days after delivery of merchandise.  So receivables are zero; payables will end up averaging about 90 days of sales.  This means the company will have a large amount of cash, which will expand as long as sales increase, available to it for three months for free.

not just cash generation

The best distribution companies will also have a strategically-placed physical distribution network of stores and warehouses.

They’ll have sophisticated inventory management software that ensures they have enough on hand to meet customers’ needs + a small safety margin, but no more.  It will also weed out product clunkers.

They’ll have stores curated/configured to maximize purchases.


…the curious case of Whole Foods.




A regular reader asked me the other day to explain why I said I thought the margins of Whole Foods (WFM) are too high.  Here goes:

what they are

Margins are ratios, usually some measure of profits (gross profit, operating profit, pre-tax profit…) divided by sales. (Yes, in cost accounting contribution margin is a plain old dollar amount, not a ratio.  But it’s an exception.  I have no idea why the misleading name.)

when high margins are bad

At first thought, it would seem that the higher the margins, the better off the seller is.  Buy the item for $1, sell it for $2.  That’s good.  Raise your prices and sell it for $5, that’s better.

The financial press encourages this notion with articles that talk up high margins as a good thing.

At some point, however, other people will work out how much you’re making and start doing the same thing.  They’ll typically go for market share by undercutting your prices.  So now you’ve got a competitor who wasn’t there before and you’re facing a price war that will at the very least undercut your brand image.

Creating what analysts call a price umbrella below which competitors can price their products and be protected from you as a rival is one of the worst mistakes a firm can make.

In my experience, it’s infinitely better to build a market more slowly by yourself than to have to try to dislodge a new rival who has spent time–and probably a lot of money–to enter.

One potential exception:  patented intellectual property (think:  Intel or drug companies). Even in this case, however, there’s the danger that once-successful firms become lazy and fail to continue to innovate after initial success.  The sad stories of IBM, or of Digital Equipment, or INTC for that matter, are cautionary tales.

More tomorrow.

tweaking stock market indices

When I started my career as a professional investor, the providers of stock market indices were a sleepy group inhabiting a financial industry backwater.

The rise of interest in markets outside the US and the increasing prominence of index funds over the past decade have changed all that, however.  Now index providers are movers and shakers in the financial world.

The two issues of the day:

–whether and in what amount to include mainland China-traded A shares in emerging markets indices.

The argument against has been that the Chinese government controls very strictly not only which foreigners can have access to local stock markets, but also in what amounts and whether/how they can repatriate profits.

The argument for is that the recently instituted Stock Connect mechanism has alleviated part of the problem.  Also, at some point one begins to question the legitimacy of an emerging markets or foreign index that has no representation of the largest emerging market of them all.  Further, the first index to include mainland China names is sure to score points with Beijing.

There’s nothing new about this debate, other than the large size of the A-share market means the decision may have significant consequences.  My guess is that the indices will begin by merely dipping a toe in the water and seeing how things go.

–whether to exclude companies that use multiple classes of shares in a way that allows a small group of insiders to control the corporation despite owning a small fraction of the outstanding equity.  Think:  Alphabet (formerly known as Google), Facebook or Snap.

I find it interesting that index providers are even contemplating excluding multiple-class companies from their indices.  I’m sure they regard this as a service, a natural extension of the legal responsibility of index funds to take part in corporate governance on behalf of the investors who own fund shares.

Maybe that’s right.  But I have three reactions:

—-this type of decision comes awfully close to active management

—-who wants a US index, to say nothing of a US tech index, without Google and Facebook?

—-excluding important names makes an index easier to beat for an active manager, who can gain outperformance by holding non-index names.  I imagine that my former colleagues who are still working are praying that the index providers start down the exclusion path.