on phoning a company to talk about operations

Although this was a staple of my working life, I haven’t done this much over the past few years, until recently. Three reasons:

–disclosure through company websites and SEC filings is usually more than enough for me to make an investment decision,

–SEC Regulation FD (Fair Disclosure) from 2000 prohibits selective disclosure of material non-public information about company operations. To avoid violating this rule, company spokespeople have developed artful ways of presenting publicly available information to shareholders that make it seem as if they are revealing deep, dark secrets. This presupposes, of course, that listeners haven’t read company disclosures carefully, but in my experience this tactic is surprisingly successful, and

–I’ve been more focused for a very long time on company-specific information rather than thematic information about industry or sector trends, until the current calmer, sideways market has got me looking more at the Consumer Discretionary sector and how that is changing, post-pandemic

If you’re on the fence about whether or not to buy/sell, contacting a company can provide valuable information, despite Regulation FD. In my experience, however, you get a clear signal only if you’re treated badly, though. As a general rule, the attitudes and behavior of top management very quickly permeate a company. So if the investor relations department has no time for an actual or potential owner, chances are that’s because the CEO is signaling that creating value for shareholders a relatively low priority.

I can think of three important instances of this in my career:

Intel. This was about eleven years ago. The stock was trading at a discount to book value and had a very high dividend yield (which kept the stock from going even lower). The big issue with the company was, and still is, that its chips were too big and threw off too much heat to be used in mobile devices. And the company appeared to be falling farther behind its ARM-based competitors in the race to make new offerings cooler and smaller. On the other hand, the stock was very cheap. So a bought a little and called the investor relations department. I introduced my self as a professional investor and a shareholder. The IR person refused to speak with me, other than to say I could get any information I needed by paying a broker for a research report.

Put a different way, INTC was happy to provide, for free, copious amounts of company data to brokerage firms that didn’t own the stock and might even be aggressively shorting it. Even though I was a part-owner of the firm, the IR department was saying I could only get relevant information about my company by buying it from a broker the company had gifted it to.

This is crazy. But it’s a common point of view among mature companies whose arteries have hardened and whose managements have become bureaucrats, more concerned with preening at investor conferences than making money for shareholders.

From that call I learned something very valuable–that INTC had its priorities all messed up. So I knew that this was not going to be a long-term holding. The stock came close to doubling over the next few months, because it had been super-cheap when I bought it. I just checked the current stock price. The stock is lower today than when I exited.

–Sony. In hindsight, this was a stupid stock to buy. That was brought home to me when I went to a tech conference in California. As I took a seat in the room where Sony was about to present, a Sony IR person came up to me and asked me to leave. I told him I was a shareholder. He replied that the briefing on the latest developments with the company was only for brokerage house analysts, not for owners. I said I wasn’t leaving and he left me alone. When I got home, I sold. The stock has doubled since then, but the S&P has tripled. And Sony, unfortunately for shareholders, has transformed itself from the plucky maverick that started operations in a quonset hut after WWII into a clone of the brain-dead traditional zaibatsu conglomerates.

–Disney. This was right after the acquisition of Marvel was announced, about a year after Michael Eisner’s shareholder-unfriendly reign as CEO of DIS had ended. It was right at yearend and I had a question about whether the deal would settle in 2009 or 2010. I identified myself as a professional investor and a shareholder of Marvel (hence effectively also of DIS) and said I had a time-sensitive question. I was told I would have to wait until after all brokerage houses had been briefed on the deal before anyone could speak with me. I read the answer to my question in the newspaper the next day, about 12 hours before DIS called back.

I knew there were huge synergies from the Marvel deal, with more theme park attractions, getting powerhouse DIS distribution for Marvel merchandise and getting competent movie makers to tell the stories of Marvel characters. I attributed the insensitivity of the DIS IR department more to the disastrous Eisner management regime of the early 2000s (think: Eurodisney) rather than Iger, so I didn’t sell.

There are few flat-out rules in equity investing. The most sure-fire is that when someone starts talking about the Dow Jones indices, you know that person is clueless. Evidence that a company management is more interested in impressing brokers, who are at best frenemies, than in communicating with shareholders is up there as a strong second, usually a clear signal to head for the door.

DeSantis and Disney (DIS)

On the politics side of things, which is not my area of expertise, it strikes me as very odd that Ron DeSantis would launch his campaign for president by setting out to wreck the profit prospects of one of his state’s biggest taxpayers, employers and tourist attractions–Disneyworld.

I find it just as strange that despite DIS’s half century as a key corporate citizen in Florida, there wasn’t any legislative pushback against implementing DeSantis’s vindictive agenda. Despite its central role in Florida’s economic growth for a half-century, DIS seems to have no friends in high places there (As a side note, I also find it curious that so many prominent KKK-ish politicians are spawned by Harvard and Yale law schools.)

Contrary to his intentions, however, the DeSantis move may turn out ultimately to have been a considerable gift to DIS. …in the form of a wake-up call.

How so?

DIS is a relatively mature company. (Note: I became a DIS shareholder when it bought the Marvel shares I held. Despite some misgivings (tomorrow’s post) I saw the potential for change in what had been an arrogant, elitist, totally inept prior management, so I bought a bunch more. I sold at about $90, just before the huge leap the stock took on streaming potential.)

At one time, the growth engine was ESPN. But by the time DIS acquired Marvel (2009), cable had begun its slow contraction. Very strong resistance from the incumbent sports news broadcaster, Rupert Murdoch, in the UK made it clear that international expansion of ESPN sports network was not going to happen. So ESPN became a cash cow.

Marvel, and the subsequent purchase of Lucasfilm (2012), did two things for DIS. Along with Pixar (bought in 2006), they revitalized the DIS movie business. They also provided a stable of male characters to complement DIS’s predominantly female heroes and villains–with the idea of boosting merchandise sales and welcoming boys to what had been female-themed amusement parks (yes, DIS had Jack Sparrow, but that says it all). This created a huge one-time growth spurt to the media and parks businesses (ESPN had made 3/4 of overall DIS profits fifteen years ago). But that was well over a decade ago.

The third arm of DIS is the theme parks–Florida (by far the biggest moneymaker), California (the original), Disney Paris (the former ill-starred Eurodisney) and assorted ventures in China and Japan. Theme parks aren’t a particularly growthy business. They’re hard to manage, and they’re highly cyclical. As a result, the market tends to assign a low PE to their earnings.

For a while, streaming seemed to be the next big area for growth. The stock’s ride back down from close to $200 illustrates the stock market’s rapid discovery that, for now anyway, there are too many entrants and too few barriers to launching a streaming service.

This is also the reason, I think, that DIS decided that the best use of its cash flow would be to plow it back into the low multiple, highly cyclical, world of theme parks. …and into Disney World in particular. Probably it’s no surprise that the decision came from the chairman, Bob Chapek, whose previous job had been as head of the parks division of the company.

Enter Ron DeSantis, whose toxic politics poses two threats to DIS: the removal of tax benefits routinely given to businesses in Florida; and, more important, the damage to the worldwide DIS brand from adopting his race- and gender-hatred stance.

What has happened since?

–Bob Chapek is gone. If press reports are correct, it’s due in part to input from the CFO, one of whose jobs is to look at return on capital

–expansion plans in Florida have already been cut back

–most important, I think, is that DIS is cutting costs throughout the company. This is an important task for any mature company, but often overlooked because it’s hard to do, and it requires managers to admit to the slow-growth character of their enterprise.

DeSantis has forced DIS to take a hard look at itself that it probably wouldn’t have done otherwise. At the same time, he’ll be the focus of any blame for the cost-cutting campaign DIS is starting.

issues with commercial real estate, including one I didn’t know about

In my experience, there’s always been a boom-and-bust pattern to the market for urban office space, despite its record of longer-term strong profit growth.

The traditional sequence goes something like this:

–the economy expands; companies need more office space as they hire more workers; the central business district gets filled up and rents there rise, sometimes sharply, so companies turn to office space in the suburbs

–at the same time, developers start large new CBD projects, which will only open after several years

–new CBD office space comes on the market–often as the economy is peaking, or even contracting; the combination of lower initial rents needed to fill these new buildings + economic softness = companies leave the suburbs and consolidate workers in the center city again.

Over longer periods, the newest, highest-quality CBD buildings perform the best; older and suburban buildings feel the boom/bust the most.

Confidence in a strong secular growth trend underlying cyclical fluctuations has made urban office buildings the premiere sector for real estate investment in the US and elsewhere.

What’s new:

–remote work is an important feature of post-pandemic life, implying lower overall need for office space. Here again, it seems to me, older, less centrally located space is faring the worst, though–but in a market where contraction is likely more than cyclical

–sponsors of traditional pension plans now routinely own not only stocks and bonds but also have large chunks of their assets in private equity or private real estate investment funds. The latter have, on paper at least, held up better than the public markets. So plan sponsors have begun to rebalance their portfolios–taking money away from the private portfolios to reinvest in public markets. This is a risk control measure, not necessarily expressing a view on the relative prospects from this point on

–private real estate funds have responded by invoking contractual limits on the size of withdrawals and by culling their portfolios of their weakest properties. In some cases, this has meant the funds defaulting on loans secured by buildings they now think will be incapable of servicing their debts, leaving the bank lenders in possession of the properties

–(new to me), but also apparently happening. In the bad old days of bank lending to emerging economies, an international bank consortium would finance, say, a 10-year project likely to generate its first cash in year five, with a four-year loan. That meant that the borrower would not only have to pay large origination fees at the beginning of the loan but would also have to negotiate new terms in mid-loan, since it wouldn’t have cash flow to make interest payments (generating even more bank fees). According to a recent Businessweek article I’ve just read, the same kind of thing is now a feature of the office building market.

This might have been just a bump in the road if we envisioned ever-increasing demand for office space, at higher rents, that would eventually cover the increased costs. But it seems to me that scenario is far less likely today that when the construction loans were taken out.

So commercial real estate–and commercial real estate lending–may be in worse trouble than I’d been thinking.

AI and the stock market

In a broad sense, AI has been around the stock market for a long time. Initially, it took the form of arbitraging tiny differences between the bid-ask spreads set by different market makers in the same stocks. Competition in this area gradually became so hot that the physical distance between the arbitrageur’s computer and the market maker’s became a crucial element for success. Then there were autoregressions that attempted to predict near-future price movements. And there are now bots that analyze and react to company earning reports, conference calls and other announcements.

Financial news organizations are now reportedly part of an overall traditional media consortium negotiating with tech company creators of chatbots about payment in return for access to media written, audio and visual output to train the bots.

I think that this development has potentially important implications for you and me. Older efforts at computer driven trading were driven by efforts to act faster than humans on the freshest data. This has been lucrative for the firms doing this, I’m sure. But I personally don’t find it that interesting. And it’s a game most of us aren’t going to be able to compete in. It’s just another reason to take a longer time horizon than most–which is where the inefficiencies you and I can can exploit are most likely to be found.

Not so this latest development. As for AI use of media images, I don’t think there’s much stock market relevance, other than for companies like Adobe. Financial reporting, though, is another matter.

With the exceptions of the Nikkei News and its Financial Times subsidiary, I don’t think financial print reporting is very good at analyzing what companies are doing. Radio and TV personalities are, as far as I can see, mostly actors playing the role of financial experts, rather than the skilled financial minds they pretend to be. So I think there’s the potential for AI to come to–and act on–erroneous conclusions about stocks based on mistaken beliefs about the financial press. Resulting share price ups and downs may present the chance to buy or sell into AI-driven transactions.

It will be interesting to see how this all develops.

Warren Buffett and the sogo shosha

Buffett adds to his position

Berkshire Hathaway recently announced that it has increased its holdings in the five major Japanese trading companies (sogo shosha) to around 8% of the outstanding shares. Its biggest position is in Mitsubishi Corp, which I regard as by far the best of the group.

what the sogo shosha are

It’s a little complicated…

Feudal Japan was ruled by an emperor, with his military leader, the shogun, as his number two. In the early seventeenth century, shogun Tokugawa Ieyasu seized control and established Edo (Tokyo) as the new capital. He kept the feudal barons in check by demanding that they provide family hostages and samurai troops to reside under his control in Tokyo. The samurai had nothing much to do, so they started businesses that evolved in to the powerful industrial conglomerates (zaibatsu) of the pre-WWII era.

Post WWII, the zaibatsu were officially disbanded by the US occupying forces for their role in carrying out the war. In practical terms, though, only the name disappeared. The industrial groups, and their commercial and social relationships, remained intact, but now known as keiretsu. At the heart of each is a bank and a trading company (sogo shosha) that are interfaces between the group and the world outside Japan. The trading company acquires raw materials for its keiretsu and helps distribute its products, in the same way the bank provides financing. Trading companies also act to some degree as national champions, taking on the obligation of acquiring natural gas, for example, for the country as a whole.

the samurai angle

I began investing in Japan in 1986. One of the first brokers I met was a former academic whose field of studies had been Japanese culture. In his (strong) opinion, the key to understanding the keiretsu was through samurai training manuals. One of his favorite illustrations was the slogan “Stamp your feet loudly and walk through a wall of iron.” The idea was that given a focused mind and strength of will, the laws of physics and economics mean nothing…and will wilt before samurai determination.

I thought he’d spent a little too much time in the library. But as I learned more I began to realize he was absolutely correct.

In the case of the trading companies, this means they are not economic profit maximizers, as they might be if they were in the US. They are the service arms of the keiretsu they are members of. Their main job is to maximize the profits of the group manufacturing companies.

what I think Buffett is doing

In old school Japan, companies cemented a business or banking relationship they were establishing by buying shares in each other’s firm. Such relationship shares symbolized the relationship and were not intended to be traded. I think this is, at least in part, what Berkshire is doing–greasing the wheels for Berkshire-controlled companies to do business with the keiretsu, and with the trading companies in particular.

About 15 years ago I asked the then chairman of Mitsubishi Corp, whom I considered to be a savvy executive, if he would ever consider consolidating his 400+ main subsidiaries (given that the span of control was impossibly wide). His body-language reaction was that only a crazy foreigner could entertain such a lunatic thought.

That was back then. Buffett may think the shareholdings give him a better chance of acquiring stray trading company subsidiaries that will complement companies he now controls. I think this makes sense. The much bigger prize, in my opinion, would be the value created by the trading companies breaking up into more focused units. In my day, this was unthinkable. But maybe things have changed.