background, as I see it

The concept behind the Reagan/Thatcher political revolution is the simple idea that just about everything works worse in government hands than in private. Therefore, the chief goal of a national leader who wants to maximize GDP growth is to deregulate as much as possible.

One way of forcing the transition from public to private ownership is to cut taxes, especially income taxes, thereby reducing the money available to entrenched bureaucrats to fund government-run activities. Academics like Arthur Laffer argued that it was most important in this effort that the taxes of the wealthiest be cut. Two reasons: the rich would then shift their efforts away from creating tax shelters for themselves to opening new businesses that would provide high-paying jobs for ordinary workers (trickle-down economics), and the government might even end up collecting more money than before once tax shelters were no longer a thing.

This hasn’t worked out. Three unintended consequences of the strategy:

–income tax cuts made the cash flows of mature businesses much more valuable than before, and therefore more attractive vs. taking the risk of starting a new enterprise

–their increased wealth made the owners of industries of the past more politically powerful, again tipping the scales away from progress toward preserving the status quo.

–ignoring the occasional toll highway, public goods like roads or schools haven’t transitioned smoothly to the private sector, as neo-liberal theory suggested, but have deteriorated instead. A weak education system, meaning a less-skilled workforce, and increasingly third-world infrastructure have translated into the near disappearance in the US of productivity gains as a source of GDP growth

The UK has gone down virtually the same path as the US. It’s schools may be better than ours, but the country has managed to dim its economic prospects more considerably than we have by voluntarily severing its privileged access to its largest export market, while potentially reopening the conflict between northern and southern Ireland.

what just happened in the UK

The recently installed UK government of Liz Truss decided a couple of weeks ago to give the domestic economy a shot in the arm, using the signature move in the neo-liberal playbook–a large, unfunded cut in income taxes.

No applause from financial markets, though. Instead, a spike in interest rates and a record low for sterling against the dollar.

Collateral damage as well: older, corporate defined benefit pension plans in the UK had been playing out the string by holding mostly all bonds and, apparently with government encouragement, using derivatives to hedge heavily against falling interest rates. The Truss tax cut proposal triggered large enough margin calls on these positions that the Bank of England had to step in to absorb the resulting selling.

The optimist in me thinks that maybe the world is starting to reconsider an academic theory that may have been great for the 1980s but that has had serious negative unforeseen consequences and is well past its use-by date.

Last week, the major crude oil producing nations, ex the US, agreed to cut a total of two million barrels from their aggregate daily production. This reduces total world production by about 2%. That’s twice as much as the consensus had expected.

This is actually a more significant decrease than it might seem. Oil demand is relatively inflexible–meaning that what are minor changes in supply can cause large changes in prices.

What strikes me as most odd about the current situation is also something that I don’t see being discussed in the financial press–the fact that crude oil prices aren’t following their usual seasonal pattern.

Prices are typically their weakest from the end of January through, say, April, when the deliveries for the (northern hemisphere) winter are over and the summer driving season hasn’t yet begun. The summer is the strongest part of the year, driven by auto usage in the US. After Labor Day, demand slips for a short time, before recovering in October, as providers of heating fuel begin to build inventories.

This year, though, the crude oil price has been falling steadily since June, admittedly from a Russian invasion-induced peak. No sign of an early October pickup, however. And the oil price recently cracked $6 or so below the $85 a barrel level that Saudi Arabia needs to balance its budget.

Where is the demand shortfall coming from? My guess is China, where oil imports appear to be down yoy by a million daily barrels. How much is due to the 2008-US style property collapse now underway there or the covid-motivated industrial shutdowns, I have no idea.

My reading of the recent OPEC meeting is that it was much less an expression of solidarity with Russia than of the belief that Chinese economic weakness is not going to go away any time soon. Arguably, if OPEC’s goal were to strengthen the pro-OPEC, pro-Russia Trump wing of the Republican party, the price increase would have been immediate.

From a longer-term perspective, it seems to me, OPEC derives its political power in large part from US policy. We represent 4% of the world’s population but consume 20% of the world’s petroleum. Bringing ourselves into line with usage in other industrial nations would cut our consumption in half and leave OPEC in tatters. What is stopping us? …a highly-protected, inept domestic auto industry and a powerful fossil fuels lobby.

A friend mentioned the other day that Amazon has canceled its Glow communication service less than a year after making it available. Glow’s gimmick, if that’s the right word, was to involve kids in family video calls.

This prompted me to take a look at ZM for the first time in a long while.

my “before” thoughts

My view on ZM and Roku (ROKU), for that matter, has been that these are quintessential stay-at-home stocks, with an iffy future in a post-pandemic world …but being priced as if that uncertainty were not an issue.

I do think Zoom + the pandemic have made a fundamental, lasting change in the way people communicate with one another. 

My worry has been that although the service is the best around, I’m not convinced the company will be able to get many new entities to pay $15 a month or so for it.  Governments are already committed to Cisco’s Webex, and Google and Microsoft have corralled most big companies.  The latter two also have free services for individuals. Those may not be very good, but they act as a cap, I think, on what ZM can charge before customers will defect to an inferior, but free, alternative. And any religious or civic organization likely to use Zoom has probably signed up a year or more ago. 

what I found

the obvious: ZM is down by about 85% from its 11/20 high, and is now trading at about 25x trailing earnings.

the financials:

–They’re hard to read, which is the case with any youngish tech company that compensates many employees largely through restricted stock unit grants.

–ZM has about a quarter of its market cap, or about $5.5 billion, in net cash

–The value of RSUs is listed as an expense on the income statement, usually on the research and development and sales and marketing lines, even though there’s no cash outlay. In the case of ZM, the value of such issuance has doubled yoy, presumably because grants made a year or two ago may well expire worthless.

–Tp me, this makes the revenue line (up about 8% yoy) in the income statement more important for analyzing companies like ZM than it would usually be.

–And it makes the cash flow statement much more essential reading, since it explicitly identifies this kind of non-cash charge. ZM’s shows the company to be operating at roughly breakeven on a cash in – cash out basis, after spending $425 million so far this fiscal year repurchasing its own stock. Put another way, the company seems to me to be using all the net cash flow it generates for stock repurchases.

competitive advantages?

I had the misfortune to be on a Webex call recently, where I had to phone the other party to get audio. It might be that CSCO, MSFT and GOOG are not as good as ZM because their services are built on top of inflexible 30-year (or so) old code. I have no idea. But, if so, maybe these competitors can’t get any better at a cost they could justify. That would be a plus for ZM.

my bottom line

The company is doing better than I would have guessed. 25x earnings is also a better bargain than 160-ish x earnings at the 11/20 high of $478. There’s also the makings of a bullish story–the hope that revenue gains accelerate next year and/or expense growth abates, with the result that eps rises sharply, driving the stock higher.

I have no idea whether this is just hope or the glimmer of a more promising story, so I choose not to bet. The surprising thing for me is that, unlike two years ago, when the price was prohibitive, one can sort-of, kind-of, maybe make a case for owning the stock. That’s considerably better than I’d expected. At the same time, this suggests to me that maybe the entire market’s fundamentals are better than the consensus expects or that current prices reflect.

I’ve just updated my Keeping Score page for September, 3Q and 2022 year to date.

Two really bad things happened to the UK in 2020: covid and Brexit, the self-inflicted economic wound of withdrawal from the EU.

It’s hard not to see similarities with politics in the US: a group of politicians capitalize on the sense of grievance of left-behind rural citizens by vowing to restore the country to its former glory. In this case, it’s by cutting economic ties with continental Europe, thereby shutting off the inflow of foreign workers at the same time. MUKGA, in other words.

Although the pandemic muddies the waters, this has worked out so far at least as badly as one might have expected–especially so for those who favored Brexit. So the recently minted prime minister, Liz Truss, turned this week to the neoconservative playbook for a way to stimulate growth. What she found there: tax cuts for the rich, on the idea that making them wealthier will eventually “trickle down” to gains for ordinary citizens.

Three issues:

–with no offsetting reduction in government spending, the cuts–$50 billion over the next five years–will presumably be funded by increased government borrowing

–as the world is trying to dampen high inflation, the last thing it needs is more stimulus

–the underlying economic malady is Brexit, not too-high taxation.

One market reaction was a sharp drop in sterling, part of which has since been reversed.

A second was a rise in interest rates, on the idea that the UK government would be forced to borrow a lot more to fund the tax cuts. An unintended result (I can’t see why Truss would have intended this outcome) has been a mad scramble by UK traditional pension funds to cover hedging losses that the sudden and unexpected rate rise generated.

Possibly the most damaging has been the highly-indebted, high-inflation emerging country look that Truss’s announcement conjured up for her country.