Broadcom (AVGO) and Qualcomm (QCOM)

(Note:  the company formerly known as Avago agreed to buy Broadcom for $37 billion in mid-2015.  Avago retained its ticker symbol:  AVGO, but took on the Broadcom name.  Hence, the mismatch between name and ticker.  That deal is on the verge of closing now. Presumably AVGO’s recent decision to move its corporate headquarters from Singapore to the US is a condition for approval by Washington.)

AVGO and QCOM

AVGO is a company that has very successfully grown by acquisition (my family and I have owned shares for some time).  Its specialty, as I see it, is to find firms with excellent technology that are somehow unable to make money from either their intellectual property or their processing knowhow.  AVGO straightens them out.

QCOM, a firm I’ve known since the mid-1990s, seems to fit the bill.  The company makes mobile processors for cellphones.  It also collects license fees for allowing others to use its fundamental and important cellphone intellectual property.  QCOM has been in public disputes over the past couple of years with the Chinese government, which has forced lower royalty payments, and with key customer Apple, which is threatening to design out QCOM chips from its future phones.  As I see it, these disputes are the reason the QCOM stock price has stagnated over the recent past.

the offer

AVGO is offering $70 a share in cash and stock for QCOM, a substantial premium to where QCOM shares were trading before rumors of the offer began to circulate.  The current price for QCOM (I’m writing this at around 10:30) of $63.90 suggests that the market has doubts about the chances for AVGO’s success.

Standard tactics would be for QCOM to seek another buyer, one that would keep current management in place.  Since an overly pugnacious management has arguably been QCOM’s main problem, my guess is that a second bidder is unlikely to emerge.

If I were to try to participate in this contest (I don’t think I will), it would be to buy more AVGO.  I believe AVGO’s assertion that the acquisition would be accretive in year one.  So it’s likely to go up if the bid is successful.  If not, downward pressure from arbitrageurs would abate.  On the other hand, I don’t see 10% upside as enough to take the risk QCOM will find a way to derail the bid.  After all, it has already found a way to anger Beijing and 1 Infinite Loop.

Jeep as a Chinese brand

A mainland Chinese company, Great Wall Motor of China, has recently expressed interest in acquiring either the Jeep brand + manufacturing operations or all of Fiat/Chrysler.

The press has since been filled with commentary whose thrust is that Washington will oppose either sale proposition.

Several things strike me as odd about this:

–brands like Volvo and Jaguar have looked a lot more interesting recently since coming into Asian hands, so that shouldn’t be an issue (although this is likely the crux of the matter)

Jeep is now part of an Italian company   …which bought it from a German firm that was slowly sinking under the weight of a senescent Chrysler   …which had been foundering despite a government bailout in the 1970s and a huge injection of badly needed engineering talent under Daimler.  So a firmer economic footing for the whole Chrysler enterprise is unlikely to come without outside-the-box thinking.  Also, it’s hard to make a logical argument that foreign ownership for any part of Chrysler is a problem

–if the Great Wall Motor interest is real, it suggests the company has access to foreign exchange at a time when Beijing is cracking down on reckless foreign m&a by domestic corporations.  That likely means that Great Wall has enough influence in China to be able to expand the Jeep brand’s reach quickly

–I haven’t heard a lot of posturing from Washington.  Either I’m really out of touch on this one, or the anti-Great Wall sentiment is mostly in the minds of reporters.

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.

 

 

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.

Verizon (VZ) and Disney (DIS)

A short while ago, rumors began circulating on Wall Street that VZ is interested in acquiring DIS.

Yesterday, the CEO of VZ said the company has no interest.

some sense…

The rumors made a little sense, in my view, for two reasons:

–the cellphone market in the US is maturing.  The main competitors to VZ all appear to be acquiring content producers to make that the next battleground for attracting and keeping customers, and

–the Japanese firm Softbank, which controls Sprint, seems intent on disrupting the current service price structure in the same way is did years ago in its home country.

…but really?

On the other hand, it seems to me that DIS is too big a mouthful for VZ to swallow.

How so?

–DIS and VZ are both about the same size, each with total equity value of around $175 billion.  If we figure that VZ would have to offer (at least) a 20% premium to the current DIS stock price, the total bill would be north of $200 billion.

How would VZ finance a large deal like this?  VZ’s first instinct would be to use debt.  But it already has $115 billion in borrowings on the balance sheet, so an additional $200 billion might be hard to manage, even though DIS is relatively debt-free.

Equity?  …a combination of debt and equity?

An open question is whether shareholders in an entertainment company like DIS would be content to hold shares in a quasi-utility.  If not, VZ shares might come under enough pressure for both parties to want to tear up a potential agreement.

dismember DIS?

VZ might also think of selling off the pieces of DIS–like the theme parks–that it doesn’t want.  The issue here is that all the parts of DIS, except maybe ESPN, are increasingly closely interwoven through cross-promotion, theme park attractions and merchandise marketing.  So it’s not clear the company can be neatly sectioned off.

Also, as the history of DIS’s film efforts illustrates, the company is not only a repository of intellectual property.  It’s the product of the work of a cadre of highly creative entertainers.  Retaining key people after a takeover–particularly if it were an unfriendly one–would be a significant worry.

From what might be considered an office politics point of view, VZ’s top management must have to consider the possibility that after a short amount of time, they would be ushered out the door and the DIS management would take their place running the combined firm.  Would key DIS decision makers want to work for a communications utility?

my bottom line

All in all, an interesting rumor in the sense that it highlights the weakness of VZ’s competitive position, but otherwise hard to believe.

 

 

 

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), again

another bidder?

WFM and Amazon (AMZN) announced late last week that the two firms had agreed to a friendly deal under which AMZN would acquire all the shares of WFM for $42 each in cash.

Since the announcement, WFM share have traded on very large volume and almost continuously at prices above the deal.

What does this mean?

deal mechanics

If I’m a holder of WFM and the current deal stands, I’ll receive $42 a share from AMZN in, say, three months.  The value of that future $42 today is slightly less.  It’s $42 minus the interest I could earn on the money in the intervening three months.  Let’s say that amount is $0.25.

If I believe the deal is a sure thing, then, I should pay no more than $41.75 for an AMZN share today.  However, there’s always some risk that the deal will be called off.  The possibilities may be far-fetched–a government agency might forbid the acquisition, there might be something funky in the WFM financial statements…  This means the $41.75 is a ceiling, not a floor, on the stock price.  Typically, trading starts below the present value of the future payment and gradually approaches it as the deal gets closer, and as possible obstacles are cleared.  The amount below varies from deal to deal, depending on perceived risks.

Ithink WFM should probably be trading, at best, in the $41.25 – $41.50 range now, rather than at around $43.

the difference

The $1.50 difference represents a bet by the market that another, better, offer will emerge.  As a practical matter, most often these bets turn out to be correct.  Maybe it’s because the bettors have deep industry knowledge or maybe because they’re acting on information from/about another potential acquirer you and I are not privy to.

For me, this will be an interesting case to watch, since I can’t figure out who the other buyer might be.