a rainy Friday in August in New York

August is the month when many senior portfolio managers are away from the office on vacation.  So big decisions on portfolio structure tend not to be made.

Friday is the day of the week when short-term traders’ thoughts turn to flattening their books so they won’t carry risk over the weekend.

It’s raining, which sparks thoughts in traders of sleeping in or leaving work early.

Add all that up, and the heavy betting should be that US stocks will likely move sideways in the morning and fade off toward the close.

That means this is a good day to stand on the sidelines and size up the tone of the market.


In pre-market trading, tech is up and bricks-and-mortar retailing (on the earnings miss by Foot Locker) is down.  …nothing new about this.  At some point there will doubtless be a fierce counter-trend rally.  But the negative earnings surprises are still provoking severe selloffs.  So I don’t think today is the day.

Pundits are speculating about the damaging effects on his political agenda of Mr. Trump’s apparent defense of neo-Nazis in Charlottesville.  …but the Trump trade has been MIA since January, with the US a laggard among world stock markets during Mr. Trump’s time in office so far.  Yes, there may be residual hope for corporate tax reform from the administration, which this latest demonstration of the president’s ineptness as a executive could arguably undermine.  My guess is, however, that he is already well understood.

Two questions for today:

–will the market perform more strongly than the season and the weather are suggesting? This would be evidence that there’s still an untapped reservoir of bullishness waiting for somewhat better prices to express itself.

–should we be buying in the afternoon if it’s weaker than I expect?  My answer is No.  I think there is a lot of untapped bullishness, but we’re in a slowly rising channel whose present ceiling is less than 2500 on the S&P 500.   That’s not enough upside for me.  I’m also content to wait for any incipient bearishness to play itself out further.

It will be interesting to see how today plays out.


sometimes cash isn’t really cash

This is a post about reading the balance sheet, not a more theory-laden discussion of whether having cash is a good thing for a company or not.

three examples

–The most obvious case where cash is not an unadulterated plus is when it’s offset by short- or long-term debt.  Having $5 a share in cash and no debt is certainly a different situation than having the cash but owing $15 a share to your bankers.  There are all sorts of subtleties here–bonds vs. bank debt, factoring receivables, coupon payments vs. accretion of discount, payables/receivables–but these are stories for another day.

The other two concern working capital, ex debt (as it turns out, the prospectus for Blue Apron (APRN) made me think of both of these).

deferred revenue.  If you subscribe to a magazine or newspaper or a home-delivery food service, you typically pay for the service in advance.  The way this is accounted for on the balance sheet of the company you’ve contracted with is:  the total amount you pay is listed on the asset side as cash; on day zero no services have been delivered so the cash is counterbalanced by an equal deferred revenue entry on the liabilities side.  As services are provided, the deferred revenue is gradually reduced by the amount being recognized on the income statement as sales.

(Note:  I can’t recall ever having seen a long-term deferred revenue balance sheet entry.  MSFT, maybe?  My guess is that if long-term deferred revenues exist, they’re folded into “other” among long-term liabilities.)

Pre-IPO APRN had $61.2 million in cash and $21.8 million in deferred revenue

receivables vs. payables.  Receivables are trade credit a firm extends to customers; payables are trade credit that suppliers are offering to the firm.  Having few payables and a lot of receivables is usually a sign of corporate strength.  Suppliers are eager enough to do business that they offer their wares on credit; customers eager enough to consume that they pay upfront.

Nevertheless, payables are basically the same as short-term loans.  They just come from a supplier rather than a financial lender.  In computing working capital (short-term assets minus short-term liabilities), payables are a subtraction.

In the APRN case, the pre-IPO company had $0.5 million in receivables and $77.7 million in payables.  Receivables – payables  =  -$77.2 million.


more on the APRN situation

In APRN’s case, $61.2 million (cash) – $21.8 million (deferred revenue) – $77.7 million (net receivables) =  – $38.3 million.

If we compare APRN at 12/31/16 with 3/31/17, we can see the transition from a positive of about $7 million for the calculation in the paragraph above to the -$38.3 million.  This is financed, as I read the balance sheet, by a $55 million increase in long-term debt during the quarter.  So APRN is not generating cash; it’s burning through it rather quickly.

My quick perusal of the prospectus didn’t turn up enough other data to draw a strong conclusion (e.g., is this seasonal?), but the 1Q17 cash deterioration certainly looks odd.


thinking about retail: Dicks Sporting Goods (DKS)

DKS reported disappointing earnings Monday night.  Its stock dropped by 23% in Tuesday trading.  So far this year it has lost 49% of its value, in a market that’s up by 10%.  …this in spite of the bankruptcies of rivals Sports Authority and Gander Mountain, which should arguably have cleared the way for better results.

The obvious culprit here is Amazon (AMZN).

I’m sure that AMZN is a factor.  On the other hand, although AMZN is growing at 4x the +5% rate of annual expansion of sporting goods sales in the US, the online giant represents only about 4% of the total sporting goods market.  DKS alone is 50% bigger–and its bricks-and-mortar competition has shrunk considerably.  So online can’t be the whole story.

I think two other general factors are involved:

–Millennials vs. Boomers, with DKS, to my mind, clearly oriented toward Baby Boomers’ tastes.  This issue here is that although Boomers have more money than Millennials, their star is waning as Millennials’ is rising.

–a “normal” business cycle.  During most time periods and in most parts of the world, in my experience, consumers are constrained in their buying by the limits of their income.  As new households form and families rent/buy a residence, rent/mortgage and, sooner or later, things like furniture become significant purchase categories.  This means less money for other purchases–like new golf clubs.

From the late 1990s through 2007, however, that wasn’t the case. Universal availability of home equity loans enabled consumers to avoid budgeting and prioritizing purchases.  So the typical pattern of contraction in some retail categories while housing-related, expands was absent for an extended period.

Now it’s back.  My sense is Wall Street has yet to catch on.

As an investor, I’m not particularly interested in the sporting goods category.  But I think the pattern I see here isn’t an isolated phenomenon.  If I’m correct, we should be doubly careful of any traditional retailer.



Blue Apron (APRN) at $5+

APRN went public less than two months ago at an offering price of $10 a share.  That was down from pre-offer brokerage chatter (which is  always very optimistic) of $15 – $17.   Given that the average cost for pre-IPO shareholders is just above $1.60, though, any double-digit price must have looked good.

Certainly, the possibility of Amazon/Whole Foods as a competitor was–and still is–a worry.  There are, however, others:

–lack of barriers to entry

–churn:  stories that very large numbers of customers who signed up for trials at promotional discounts balked at continuing at the full price of about $10 a meal

–continuing working capital deterioration.  According to the prospectus, at yearend 2015, APRN had $127 million in unrestricted cash.  By 3/31/17, that figure had shrunk to $61 million, despite APRN taking in $121 million through long-term borrowing and advance subscription payments by customers (listed on the balance sheet as deferred revenue).  Looked at this way, APRN’s operations gobbled up over $180 million in fifteen months.  By 6/30/17, the situation was $30 million worse.

As it turns out, one of my sons had a Blue Apron subscription in the months before the IPO.  I helped prepare some of the meals.  I thought the recipes were excellent but that the ingredients supplied suffered from trying to keep costs down.  So I’m not a fan.  In fact, I’m a bit surprised the IPO went as smoothly as it did.

where to from here?

My initial take is that IPOs like APRN or Snap indicate there’s too much cash sloshing around in the system.  That always seems to end up chasing speculative deals.  My hunch is that APRN won’t be a big success without a significant revamp of strategy.

On the other hand, there’s arguably a price for everything.  In addition, the activist investor that pushed for changes at Whole Foods, Jana Partners, has just disclosed a 2% stake in APRN.

…maybe a turn for the better.  But, as things stand now, I’ll be watching from the sidelines.



paying for brokerage research

As part of an EU overhaul of the financial industry, the UK has recently concluded an inquiry into pricing practices for mutual fund and other products offered to individual investors.  Press commentary is that the good luck for an industry with a bewildering array of prices (much higher than in the US) and little link between cost and value is not having been referred to the law enforcement authorities for criminal prosecution.

One big issue has been “soft dollars,” that is, paying brokers higher than usual commissions in return for their research, or for trading machines, or even newspapers–items that customers generally believe (and rightly suppose, in my view) they are paying for through management fees.   …but no!

Asset managers have been proclaiming that this is a weighty and complex issue, that the don’t know how to proceed.  They’ve generally been gnashing their teeth.

To me, this is all somewhat comical.  For decades, firms that do business in the US have been following an SEC mandate to keep meticulous records of the amount of their soft dollar expenses and what is being paid for.   The general rule was that if you stayed in line with industry practice, meaning doing whatever Fidelity did, you’d be ok legally.  They know exactly what they’ve been doing.  Also, the EU inquiry (see the link above) has been going on for three years.

There are two real issues:

–there’s a lot of money at stake, and

–handling the potential outcry from customers when they realize they’ve been paying twice (management fee + soft dollars) for research expenses.

An example:

A mutual fund has $50 billion in assets.  It turns those assets over at the industry average of 50% per year.  That means $50 billion in buys and $50 billion in sells.

Let’s say: the average stock trades for $40; the soft-dollar markup is $.02 per share; and the markup is taken on 20% of all shares traded (maybe slightly high, but the math is easier).

So, the fund “service” includes giving up $10 million a year of customer money on brokerage commissions in order to get the management company free goods and services.  That’s even though they’re collecting something like $250 million in management fees from the same customers.

disclosure vs. restructuring

Internally, I think disclosure is the lesser of the two issues.  The more difficult one is that industry revenues are stagnant or falling and by far the largest expense of any investment manager is salaries.  So, whose pocket does the lost soft dollar revenue come out of?

Vanguard, this decade’s Fidelity

Just prior to the 2007 financial crisis, Fidelity decided to turn up the competitive heat on fund management rivals by declaring it was unilaterally going to stop using soft dollars.  This time around, it’s silent so far.

Last week, Vanguard made a similar announcement.


Disney (DIS) as a conglomerate

DIS can be seen as a collection of only loosely connected businesses:  ESPN; the ABC television network; Disney theme parks; and Marvel, Pixar, Lucasfilm and Disney movies.

The sharpest line of separation can be drawn between ESPN (or ESPN + ABC), on the one hand, and the DIS animation, film and theme park businesses, on the other.

When I began to examine DIS stock about a decade ago, my first thought was that the company should change its name to ESPN, to reflect the fact that ESPN represented about three-quarters of the company’s earnings and virtually all of its growth.

That situation has changed dramatically during Bob Iger’s tenure as chairman, on two fronts.

–Iger fixed the formerly ailing Disney movie studio.  He acquired Marvel and Lucasfilms, which provided DIS with rich sources of underdeveloped content, as well as a collection of male characters to balance its previously almost completely female lineup.  In addition, the new characters allowed the theme parks to increase their attractions and merchandising to become a more important part of the profit picture.

–ESPN’s profits stopped growing.  This changed its investment attraction from earnings expansion to cash flow generation.  The shift arguably makes the case for splitting DIS up into ESPN and the residual DIS a stronger one, since the company now seems to consist of an income component and a capital gains one.

Arguably, investors interested in capital gains would pay a higher price for residual DIS earnings if they didn’t have to worry about ESPN.  Income-oriented investors would pay a higher price for ESPN cash flow if it were being dividended to them and if they didn’t have the unwanted risk of the business cycle sensitivity of the residual DIS businesses.


why I think a voluntary breakup won’t happen

Two reasons:

–ESPN cash flow may be in slow secular decline.  But it is still a large and convenient source of funding for the rest of DIS, and

–the current market cap of DIS is $160 billion, too large to be a takeover target.  Post-breakup DIS would have a market cap of, to pluck a figure out of the air, $85 billion.  Yes, that’s a large number, but it would change the takeover calculation from impossible to hard-but-doable.

So management likely has zero interest in breaking the company up.



…are collections of businesses, often with little operational connection with one another, linked together by common ownership.  Outside the US, the controlling entity typically exercises its influence by taking large minority interests in the subsidiary firms;  in the US it’s more common that the controlling entity owns its subsidiaries entirely.

The former structure allows greater reach; the latter makes it easier to dividend cash from one arm to another without incurring tax.

the conglomerate era

Looking back, it’s often strange to see investment suppositions that, to us, are patently crazy but which investors of another era held as gospel.

In particular, there was a conglomerate “era” in the US during the 1960s.  This was a time when Wall Street thought that there is such a thing as “pure” management, which could be applied by expert practitioners to all kinds of businesses, no matter what they were.   So, a management expert could run, say, a movie studio without knowing anything about entertainment, or head a department store chain without knowing anything about fashion or real estate or retailing, or a lead computer chip company without knowing anything about coding or chip fabrication or materials science.

What were these “pure” management skills?  Allocation capital was one.  Your guess is as least as good as mine about any others.

During that period–a decade before I entered the stock market, so I’ve only read about it–conglomerates traded at a premium to the sum of their parts.

Maybe 1950s-style conglomerates made some sense.  I don’t know.  But their executives soon worked out that they could use debt to make acquisitions that would give a (temporary) boost to ep that would get their firm a higher earnings multiple.  So companies like Gulf and Western, ITT, National Student Marketing and Textron turned themselves into M&A machines.  As long as investors believed in the supposed alchemy of management, the worst low-PE dross a conglomerate held its nose and acquired, the greater the gain from multiple expansion when those earnings came under the conglomerate umbrella.

This all ended in tears in the late 1960s, through a combination of higher interest rates, the dead weight of senseless acquisitions,and the inability of conglomerate managers to improve businesses they owned but didn’t know the first thing about, that caused the conglomerates to crater.

today’s view

Today’s view is that conglomerates should trade at a discount to the sum of their parts.  It has its roots–not in the companies per se–but in the idea that investors want to fashion portfolios for themselves, not buy pre-assembled packages.  Off-the-rack conglomerates should be worth less than bespoke portfolios.

One of my favorite examples of this belief (which I think is basically correct) comes from one of the old opium trading companies in Hong Kong, Swire Pacific.  At one time, Swires was a property development company + an airline.  The first component is income-oriented and buttressed by a steady stream of rental payments.  The other is a highly economically-sensitive industrial.

Income-oriented investors, the argument goes, must be compensated through a lower overall PE for having to hold the airline component of Swires they don’t really want.  Similarly, more adventurous investors have to be compensated for being stuck with an income vehicle they don’t want.

Therefore, the parts separated should be worth more than the two together.

In fact, when Swires announced it would seek a separate listing for Cathay Pacific, the stock rose by 40%.


Tomorrow, Disney as a conglomerate.