Category Archives: Entertainment

rent vs. buy: examples

April 3, 2014 By in cloud services, Entertainment, software, Technology, Video games Tags: , , , , Leave a comment

Olympus Optical of Japan (yes, the huge-derivative-speculation-losses, put-out-a-hit-on-the-new-chairman Olympus) was the first company to open my eyes to the value of the rental model vs. selling an item.  The company makes endoscopes, the computer plus coated fiber optic cable devices used in colonoscopies and endoscopies.  Olympus initially used a razor/razor blade model to sell these devices around the world.  It sold the computer devices at slightly above cost.  The fiber optic cables were supposed to be the razor blades, being replaced at regular intervals with new ones, generating high profits.

Olympus didn’t make much money from endoscopes, however.  Physicians generally refused to buy replacement fiber optic cables, even when Olympus salesmen told them they risked having the cables break apart in patients’ bodies.

So Olympus tried an experiment in the US.  It switched to a rental model.

Let’s say an endoscope kit sold for $60,000 (a number I made up).  If so, the new idea was to rent the units, throwing replacement cables to avoid safety problems, for $1,000 a month.  Because $1,000 a month was easier for a doctor to stomach than $60,000 upfront, more doctors signed up for the machines.  In addition, because Olympus was collecting rent for each machine over something like a ten-year useful life, reported profits skyrocketed.  Yes, this is partly a question of accounting technique (more about this tomorrow), but the amount of money Olympus ultimately collected for each machine was double what it had before.

Anixter, the wire and cable company.  This was one of the first companies I covered in my career as an analyst.  Back then, Anixter’s main business was industrial wires and cables.  It ran a national system of warehouses.

The Anixter salesman would call on a customer, ask how much wire and cable inventory a company had–usually a lot more than anyone realized– and offer to buy it all on the spot.  Anixter would guarantee to meet all the company’s wire and cable needs from Anixter warehouses.  Outsourcing to Anixter would mean the customer could repurpose its warehouse space, lay off or reassign the three guys who dealt with the inventory, and free up, say, $10 million the firm had lying around in wire and cable stock.

The manager who shifted the company from owning its own inventory to working with Anixter would be a hero in the eyes of top management.  People couldn’t sign on the dotted line fast enough.

At the same time, although apparently not many clients realized this initially, there’s no going back from a decision like this.  If you’ve taken a victory lap for creating $10 million in cash out of thin air, as well as saving $300,000 in annual expense, you can’t subsequently return to the board to say you need money to build a new warehouse, hire new employees–and, by the way, you need another $10 million (or more) to fund inventory.

As well, in the case of Adobe, there’s no place to go back to.  As the company put it, ADBE has burned the boats.  It no longer sells its media products.  It only rents them.

Electronic Arts  In the early days of MMOGs, I was at an analyst meeting for ERTS.  Someone asked how many users the company had for its MMOG.  The then-CFO, long since retired, said he didn’t know.  All he knew was that the company collected $10 a month from 180,000 credit cards.

I took this to mean that the company had a significant number of people who were renting the game but never using it.  This isn’t necessarily a good situation.  You’d prefer that people love your service so much that they’re heavily engaged every day.  On the other hand, the no-show users are pure profit.

Tomorrow:  the Achilles heal of rental, the upfront capital needed to get going.

Comcast (CMCSA) and Time Warner Cable (TWC)

March 21, 2014 By in Cable, Entertainment, Industry Analysis, internet, Stock ideas Tags: , , , , , Leave a comment

I laughed out loud when I heard the press report that the Roberts family, which controls Comcast, is concerned that customers are not giving them credit for their attempts to improve service.  On virtually any metric you’d care to choose, and for as long as I’ve been watching the company–both as an investor and as a customer–CMCSA has consistently ranked at or very near the worst in customer satisfaction.  It’s the only reason TWC isn’t in last place.

Hence the legislative and regulatory concern about consolidating the bottom of the pile into one low-service mega-company.   …and, I presume, the claim that customer service is now a priority for CMCSA.

I have only limited experience with TWC.  My impression is that no one is in charge.  This contrasts with CMCSA, where I don’t think incompetence is the issue.  Instead, I believe the profit-maximizing strategy of the firm is to:

–find the line where customer dissatisfaction turns into revolt and make the minimum investment necessary to stay just above it.  I’ve never discussed this with CMCSA management–in fact, I can’t recall ever having spoken with them.  But companies all have personalities.  And that’s the way CMCSA acts.

CMCSA wouldn’t be the first to do this.  Marriott (MAR) had  similar thinking at one time.  It built its hotel rooms with the ceilings an inch or two lower than other companies and the rooms, say, 10% smaller in total area.  The hot water was never really hot.  MAR managment argued to that these deviations from the norm all saved money and were too small for anyone to notice.  People would, at worst, only be vaguely uncomfortable.  And then they wondered why they were never able to attract (lucrative) business customers.

Eventually, the lightbulb came on for the Marriotts. The family ousted the management that thought up this approach.  (Those guys decamped to Disney, where then created the Eurodisney fiasco, and, after being pushed out the door again, went on to severely clip the wings of Northwest Air.)  MAR began to build more comfortable hotels and built a thriving corporate business (by the way, I own MAR shares).

The difference between MAR and CMCSA is that the latter is a semi-monopoly.  Customers have very few other choices.  That’s why a customer-unfriendly strategy continues to work.  It’s also why the question of whether regulators should encourage this behavior is coming up.

I’m not a CMCSA customer any more.  I use FIOS now.  Superstorm Sandy did me in.

The week after the storm, Verizon (VZ, another stock I own) trucks were all over our neighborhood, repairing their mobile and wired internet infrastructure.  CMCSA trucks didn’t arrive for a month!!  Nevertheless, CMCSA continued to charge for the service it was not delivering.  The customer service representatives I spoke with on more than one occasion explained that I could get a refund for the time the service was unavailable.  To do so, however, I would have to submit proof that my electric power had been restored.  And I would not get a refund for any time (a week, in my case) that the electric power was out.  Yes, CMCSA cable and internet weren’t available for a month after the storm.  But for CMCSA that was irrelevant.  Their argument was that without electricity I couldn’t receive the service CMCSA couldn’t provide.  So I had to pay for the non-service anyway.   Talk about through the looking glass.

Anyway, like most everyone else on our street, we switched to FIOS.

It will be interesting to see how the regulators treat the possible merger of CMCSA and TWC.

Netflix and Comcast

February 26, 2014 By in Cable, Entertainment, Industry Analysis, internet, Technology Tags: , , , , , , Leave a comment

Netflix just agreed to pay Comcast an undisclosed amount to ensure that the video rental company’s customers can access subscription content rapidly through the Comcast network.  In doing so, Netflix belatedly joins high internet traffic-generating firms like Google, Yahoo and Amazon in paying ISPs to get enough bandwidth that their offerings function correctly on subscribers’ computers or tablets.

Terms have not been disclosed.

why now?

Three factors are likely at work:

–a Federal appeals court recently ruled that the rules for net neutrality laid down by the FCC in 2010 exceed that agency’s authority, meaning it’s not clear what obligation, if any, Comcast has to make sure Netflix works right.

–inability of Netflix subscribers (like me) to access “House of Cards” when it first came out led to numerous customer complaints.

–Comcast has bid for Time Warner Cable.  If the deal survives Federal anti-trust scrutiny, Comcast will have considerably more market clout than it has today.  If so, terms would probably be better today than after the merger closes.  Also, in the meantime, Comcast presumably doesn’t want Netflix arguing against the combination.

what changes?

My guess is that in terms of profits the deal makes little difference to either Netflix or Comcast.  Before, Netflix didn’t pay Comcast and Comcast didn’t allocate capital to improving its ability to transmit Netflix.  Now, Comcast gets money, but will have to spend on equipment to support Netflix.  Presumably some people who had avoided Netflix previously will become customers.

I’m not sure whether I’d bet the farm that this is so, but given that as outsiders we have very little information, I think the safest assumption is that the deal doesn’t move the profit needle much for either party.

What I find interesting, though, is the way that Comcast wants its relationship with Netflix to evolve.  Until now, Netflix has been using third parties to route traffic.  They also attempt to smooth traffic’s flow as they connect Netflix to “last mile” ISPs like Comcast.  According to press reports, both Netflix and Comcast want to stop using such intermediaries.   Although the precise form of, and rationale for, the new working arrangement isn’t clear (to me, at least), the gist is that money formerly paid to middlemen will now go into Comcast’s pockets.

Maybe the structure of the new deal will unfuzzy itself after the government rules on the proposed Time Warner Cable merger.  Maybe not.  But the main investment conclusion I see is that Comcast is true “owner” of its internet customers and will continue to use that power to shift money away from middlemen and toward itself.

a short reprise of the Zynga (ZNGA) IPO

February 24, 2014 By in Current Market Thoughts, Entertainment, Industry Analysis, internet, Technology, Video games, Wireless Tags: , , , , , , , , , Leave a comment

King Digital Entertainment, PLC  is the maker of the fabulously successful mobile-centered game Candy Crush Saga.  The firm has filed a form F-1 in preparation for an IPO.  King (proposed ticker: KING) intends to raise around $500 million.

Not surprisingly, the KING offering has reawakened bad memories of the 2011 IPO of ZNGA, which was led by Morgan Stanley and Goldman (no shock, either, that neither of those firms has a role in the KING IPO).

I haven’t yet read the KING offering document.  It’s possible that I won’t.  But I still thought it might be useful to look back at the characteristics of ZNGA that, in my view, made that stock an unattractive investment from the start.

1.  Virtually all the traffic coming to ZGA’s games was generated by Facebook.  This made it difficult to tell whether ZNGA’s games were successful because they were great games, or because they were being featured on FB.  If the latter–which subsequently proved to be the case–FB held the economic power in their partnership.  Any lessening of FB’s marketing efforts would quickly translate into a reduction in ZNGA’s profits.  A big weakness of ZNGA, not a plus.

2.  A reasonable way of assessing social games is to measure:

–the time needed to reach the peak number of players,

–the number of peak users, and

–the rate at which the number of users fades from the peak.

Even prior to the IPO, ZNGA offerings launched after its signature game, Farmville, were peaking faster than Farmville, and at lower numbers of users than Farmville.  In addition, they were as fading from the peak more quickly.  In other words, none of them had anything near the oomph of Farmville. This was all bad news.

3.  The actions of  the lead underwriters, both before and after the ZNGA IPO were quite odd, in my view.

For one thing, according to the New York Times, Morgan Stanley mutual funds bought  $75 million worth of pre-IPO shares of ZNGA in February 2011 at $14 a share.  Some have suggested that this was done to help persuade ZNGA to choose Morgan Stanley as a lead underwriter.

For another, the underwriters released the top management of ZNGA, as well as some venture capital investors, from IPO share “lockup” agreements that prevented their sale of stock prior to May 29, 2012.   Instead, a sale of 49,4 million shares at $12 each raised close to $600 million in early April for these high-profile holders.  By the original lockup expiration, the stock was trading at little more than half that level.

My overall impression is that the underwriters (incorrectly) thought that the heyday of tech investing was over.  This would imply that they and the companies they were moving to initial public offerings had only a short time to cash in before the rest of the world figured this out.  As a corollary, the traditional rules of trust and fair play between underwriter and professional portfolio manager/wealth management client no longer held–because there would be no follow-on business that once-burned clients would shy away from.

relevance for KING?

Again, I should mention that I haven’t yet analyzed KING.  Candy Crush Saga may well prove a fleeting fad and KING a one-trick pony.  On the other hand, the underwriters are different this time.   And I don’t sense the same IPO-before-it’s-too-late urgency that was in the air in 2011.

the evolution of Macau gambling

February 5, 2014 By in Casinos, China, Entertainment, Hong Kong, Industry Analysis, Macau Tags: , , , , , Leave a comment

an old fashioned winter here

We woke up to see  two foot snow boulders blocking our driveway this morning, a product of the second of three snowstorms hitting the northeast US this week.

Macau gambling stocks sold off sharply in Hong Kong overnight on reports that the year-on-year revenue gains are starting to shrink in percentage terms.  I find this a little weird.  Of course the comparisons are narrowing.  We’re cycling past the period of weakness surrounding the change in Communist Party leadership in later 2011 – early 2012.  Who didn’t know this?  In particular, who didn’t know this when the stocks were shooting through the roof less than a month ago?

Anyway, on to today’s topic, the evolution of Macau gambling.

— When Macau was a Portuguese colony, it had a single monopoly casino operator, Stanley Ho.  Although I’ve visited a lot of Asian casinos, I never made it to Macau.  Friends told me operations were dull, potentially dangerous and with a strong influence from the Chinese underworld.  …sort of  like Las Vegas in the very early days.

–When Macau reverted to Chinese rule, the new government decided to remake its gambling industry into a Pacific clone of present-day Las Vegas.  To do so, it invited in WYNN–and later LVS–among others, to set up shop.

–The early focus was on the high-roller gambling niche.  This required the least infrastructure.  It tapped an already existing clientele that was able to sidestep the considerable administrative hassle involved at that time in leaving the mainland.  The government intention was always to create a large mass-market gambling result in the SAR, however.

–The high roller business isn’t as easy as it might seem.  Clients are typically highly skilled gamblers, who lose, at high stakes baccarat  (the dominant game in Macau), around 3% of the money they bet.  However, they require perks while they’re gambling.  The intermediaries who steer them to a given casino (sometimes the high rollers themselves) also collect commissions for doing so.  The commissions can amount to half the pre-amenities take by the casino.

At one point, a potentially ruinous bidding war broke out in Macau, as less successful entrants sought to “buy” high roller business by conceding virtually all their profits to junket operators who brought the VIPs.  The government stepped in, though, and set limits on commission payments, saying its goal was to ensure that all the casinos remained profitable.

–During the past year or so, Macau reached the tipping point where there were enough hotel rooms, restaurants and entertainment to foster a mass market tourist business.  There were also much better transportation links (even better ones to come) and a much more relaxed attitude by Beijing toward travel to Macau.

The important thing to note is that mass market gambling operates by different rules.  It’s much more a “normal” resort hotel business.  Negotiation with the client is at a minimum.  Very little personal attention is required.  Gamblers bet less–but they’re generally not very skilled, so they can lose 20% – 30% of the money they wager.  Therefore, allocating casino space to them can still be very lucrative–especially so for operators who don’t have a knack for running high roller operations.

Put in different terms, you no longer need to be Steve Wynn to succeed in Macau.  The market is expanding to include Sheldon Adelson’s wheelhouse, as well.

Two investment consequences:

–most casinos are increasing their allocation of floor space to mass market gamblers because, for them at least, it’s much more profitable to do so.  So they’re making more money.

–the reduction in the number of casinos using price as their main tool to attract VIPs means that downward pressure on the profits for Wynn Macau-like operations is abating, as well.

Everyone becomes more profitable!

PS:  When I wrote this post I hadn’t yet looked at the website of the Macau casino authority.  The DICJ reports that monthly revenue from the SAR’s casinos was up only 7% year-on-year in January.  I think the true run rate is well more than double that figure.  The main reason for the weak reported outcome, I think, is the timing of the Lunar New Year.  As the New York market works this out, both WYNN and LVS, which were each down by over five percent in early trading, have rallied close to breakeven.