Category Archives: internet

thinking about Apple (AAPL)

May 31, 2013 By in Current Market Thoughts, Industry Analysis, internet, Technology, Wireless Tags: , , , , , , , , Leave a comment

setting the stage

(I should say at the outset that, although at one time I owned AAPL for years, I don’t hold it now and haven’t for a long while (except for a couple of days in January).

Q:  What does AAPL do for a living?

A:  It makes smartphones and other mobile computing/consumer electronics devices targeted at affluent consumers willing to pay a premium price for the perceived superior aesthetics and more user-friendly software.

A mouthful.

in other words, a niche player…

If my definition is correct, AAPL has decided to carve out a niche for itself in the high end of the mobile device market.  It’s a very desirable and lucrative niche, one it dominates.  But AAPL is a niche player, nonetheless.  It’s a little like TIF or WYNN.

Like any market strategy, this one has its pluses and minuses.  Anyone listening to the AAPL earnings calls over the past few years can’t help having heard the persistent questioning from Bernstein about what the company would do once everyone who can afford a $600 smartphone already has one.

Move downmarket?  Unlikely.  TIF is the only company I’m aware of who has taken this path and not completely destroyed its brand image–thereby losing its original customers.  Better to lose low-margin sales in the mass market than to kill the goose.

Absent new blockbuster products, however, the price of maintaining the upmarket strategy for AAPL is that sales slow as volume-oriented manufacturers ride down the cost curve and churn out smartphones that retail for $100-$300.

That’s where we are now.

Tons of publicly-available-for-free data has been available for years showing where the smartphone marke, and AAPL, have been heading.  So this outcome can’t have been a surprise.

…with an “ecosystem”

Another characteristic of AAPL devices is the “ecosystem,”  which has tended to make customers more sticky.  All AAPL devices work well together.  All reside in a “walled garden” created by AAPL software–reminiscent of the way AOL worked back in the infancy of the internet.

on this description…

…the current PE of 10.8x–8.0x, after adjusting for cash on the balance sheet–seems crazy low.  It’s less than INTC’s, for instance.

is there more to the story?

There’s an obvious risk in securities analysis of taking the current stock price as the truth and trying to come up with reasons why  it is what it is, rather than taking out a clean sheet of paper and trying to imagine what the future will be like.  The Efficient Markets hypothesis taught in business schools despite overwhelming evidence that emotional storms of greed and fear that routinely roil financial markets, encourages this thinking.

Admittedly possibly being influenced by the recent swoon in the AAPL share price, I’ve been asking myself recently whether the conventional wisdom about AAPL, which is my description above, is correct.

I have two questions.  No answers, but questions anyway.

my questions

1.  Is the high-end niche defensible?

In most luxury retail it is.  In consumer electronics, it clearly isn’t.  Think: Sony.  Based on the (small) number of entrants in the mobile appliance market and the (small) number of products sold, AAPL may be closer to Sony than to Hermès.

2.  Is the “walled garden” a mixed blessing?

It certainly worked for AOL for a long while. But then the Wild West of the early internet was gradually tamed and customers discovered there was a much more interesting world outside the garden.

I don’t think AAPL aficionados have any intention of tunneling out–at least not yet.  But the inaccessibility of AAPL customers to GOOG has prompted the latter to introduce the “hero phone” later in the year through its Motorola Mobility subsidiary.  The idea seems to be to create an attractive, user-friendly, high-end smartphone, load it with GOOG software and sell it at cost.

The “Made in USA” label and the management description of the “hero” seem to me to indicate it’s targeted directly at the large concentration of AAPL customers here in the US.  It’s an open question whether GOOG/Motorola can create a smartphone that’s attractive to iPhone users, or whether they’ll consider switching.  But a technologically inferior PC sure did undermine the Mac with consumers in the 1980s almost solely because it was a lot cheaper (btw, the Mac lost out to IBM with corporate customers because it had no clue how to sell to them).  And the wireless carriers will certainly welcome the “hero,” assuming it works well.

AAPL’s 2Q13–some answers, still some questions

April 24, 2013 By in earnings conference calls, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , , Leave a comment

the report

After the New York close yesterday AAPL reported its 2Q13 earnings results (AAPL’s fiscal year ends in September).  Revenues were $43.6 billion, up 9% year-on-year.  EPS, however, were down 18% yoy, at $10.09.   The latter figure was slightly ahead of the Wall Street analyst consensus of $9.97, a number that been ratcheting down in recent weeks.

The company guided to flattish sales in 3Q13, with mild margin contraction.

It announced a 15% increase in the quarterly dividend to $3.05 a share, meaning a current dividend yield of just over 3%.

APPL also intends to buy back $60 billion in stock before the end of calendar 2015.  That would be 15% of the company at current prices.  AAPL now has $147 billion in cash, of which $104 billion is held outside the US.  It won’t touch the foreign holdings for the buyback.  Instead, it will issue bonds in the US to get the money it needs.

This piece of financial engineering will have two impacts.  It will boost the growth rate of EPS by at least an additional 5 percentage points per year.    And the financial leverage will increase AAPL’s return on equity from its already heady 25%+.

The stock was initially up about 5% on this news.  Then, during the conference call, AAPL management said it won’t have its next new product launch until fall.  The gains evaporated and were replaced by a slight loss.

what’s going on

Two factors:

margin erosion

1. smartphones

As I see it (remember, AAPL is pretty opaque), the emergence of Samsung as a competitor in the high end of the smartphone market,where AAPL makes its biggest profits, has caused that segment to mature faster than AAPL had expected.  Unit volume growth is now coming mainly from emerging markets, where the price of AAPL’s cutting-edge phones is too high.  The company is selling older models (iPhone4s) there, at discount prices–and therefore reduced margins.

2. tablets

A year ago, it looked to me like 2/3 of AAPL’s tablet volume was from its newest model iPads.  Today, unit volumes are much higher, but less than a quarter are the newest 10″ iPads.  The rest is a combination of iPad minis (a runaway success) and bulk sales of iPad2s to institutions.   Both of the latter are at lower margins.

My guess is that we’re at or near a gross margin low point now.

continuing PE multiple contraction

The maturing of the smartphone market has been actively discussed in the financial community for a couple of years.  In my view, worry about this possibility is the main reason that, despite booming sales and earnings, the price earnings multiple on AAPL’s stock had contracted from the high teens to around 12 by the second half of last year.  Relative to the market, the multiple went from a premium of 25% to a discount of 25% over the same time period.

Unpleasant for holders, maybe, but understandable.

Over the past 6-8 months, however, the multiple has contracted further, both in absolute terms (to under 10) and relative (to a discount of more than 40%).  In fact, yesterday’s Wall Street Journal had an article comparing AAPL with HWP and DELL.  That’s kind of like comparing night and day–the single thing I can see that ties AAPL to these two truly terrible companies is the similarity of their price earnings multiples.

Yes, when fast growers begin to slow down, the PE contracts, often violently.  And because a good portion of the contraction is an emotional thing, the multiple shrinkage is usually greater than one would expect.  But even seeing this process over and over, I didn’t imagine that a fundamentally sound company like AAPL could be trading at 9x in a market trading at 15x.

where to from here?

Note, first, that I’ve been wrong about the stock for a while.

I think the stock buyback makes economic sense, and it will probably at least stabilize the AAPL stock price.  I don’t think the addition of debt to the capital structure will have any effect.

It may be a big stretch, but to me the 15% dividend increase says that’s what AAPL’s board expects its earnings growth rate over the next few years to be, financial engineering aside.  I think that’s a reasonable assumption, and could be conservative.

AAPL management would do the most for its stock by being more forthright with investors about current business challenges and how it plans to deal with them.  That’s not likely, however, if the 2Q13 earnings call is any indication.

That leaves holders waiting for new product announcements–and subsequent earnings acceleration–at summer’s end.

 

Aereo’s courtroom win–what it means

April 4, 2013 By in Aereo, Current Market Thoughts, Industry Analysis, internet, Stock ideas Tags: , , , , , , , Leave a comment

Aereo?

It’s a company in the Barry Diller stable.   Aereo has assembled a ton of tiny little over-the-air television antennas deep in the bowels of Brooklyn, each tagged with the name of the individual customer Aereo rents it to.  The antennas capture the signals of the traditional broadcasters that use public airwaves.  Aereo repackages these signals, adds pause, rewind and record features–and then streams them to each renter’s computer, tablet, smartphone, Apple TV or Roku box.

(For what it’s worth, in addition to all the over-the-air channels, Aereo tosses in Bloomberg TV.)

The service is currently available in New York City, Long Island, plus seven NY counties in/around the Hudson Valley. Thirteen counties in New Jersey qualify as well, as do Fairfield County in Connecticut and Pike County in Pennsylvania.

how much does it cost?

You can “try” Aereo for an hour a day, with (so far) no limitations, for free.  No DVR, though.

You can buy a Day Pass for $1.  That gets you 24 continuous hours of viewing and three hours of recording (lasts ten days).

You can subscribe for $8 a month and get unlimited viewing + 20 hours of DVR space.  $12 a month gets you 40 hours of DVRing.  You can also plunk down $80 for a year’s worth of watching–plus three free months.

the lawsuit

All the big TV networks have sued Aereo, maintaining that the firm is making an unauthorized public transmission of their content (translation: Aereo isn’t paying retransmission fees the way cable/satellite companies do).  Aereo says its service is no different from a guy putting an old-fashioned TV antenna on his roof–except that in this case it’s super-tiny and lives in the lower intestinal tract of Kings County.

On Monday, an appeals court reaffirmed a lower court ruling that Aereo is right and that the networks are unlikely to win in a trial.  So the court isn’t going to shut the service down, like the networks wanted.

The networks say they’re going to bring the case to trial anyway.  Even if they do, and eventually prevail, that will be years–and lots of potential damage–down the road.

my take

1.  After its court wins, Aereo is going to expand its service to 22 new cities (the list is on the Aereo blog).  To me, this means that Aereo is soon going to be more than a minor annoyance.  (Note, however, that there are no plans to set foot in California–perhaps because a court there has already shut down an Aereo-like service, according to the New York Times.)

Aereo has already spawned imitators, so the phenomenon could spread much faster than anyone now suspects.

There’s also nothing to prevent unaffiliated content providers from selling their offerings to Aereo, either (but don’t hold your breath for network-controlled programmers like ESPN).  So Aereo-like services could turn out to be bigger than anyone now thinks.

2.  All the cord-cutters in my family have line-of-sight access to digital broadcast sources–something that’s not common in New York.  So $8 a month is a lot more expensive for us than buying the $35 digital antennas we hook up to our TVs.  But we’re unusually lucky.

Of course, an hour a day of live TV may be enough for many folks, supplemented by the occasional $1 to view, say, important sports events.

And Aereo is an awful lot cheaper than getting the lowest-level cable service.

So Aereo may have a surprisingly large impact on the cord-cutting decision.

3.  If I were a cable company paying retransmission fees to the networks, I’d certainly want to negotiate them down.  After all, I could always try to cut a deal with Aereo if I didn’t get a favorable response.

4.  Original content, à la Netflix, on Aereo?  …shouldn’t be too hard for Diller, who ran Paramount and built Fox Broadcasting.

investment significance

If I didn’t have my trusty digital antenna, I’d be an Aereo customer today.

If I could invest in Aereo today on reasonable terms, I’m pretty sure I’d do it.

Buy into an Aereo IPO?  –harder to say, since if the service gets rolling, the offering price might be crazy-high–even Zynga- or Groupon-high (convulsive trembling!).

At the very least, Aereo may well be the stone that starts the avalanche–and which forces the network broadcasters and cable/satellite companies to scramble to avoid/minimize damage, if they can.

I think it’s an important phenomenon to monitor.

a blast from the past: eToys and the IPO market

March 11, 2013 By in internet, internet bubble, Investment firms Tags: , , , , , , , , Leave a comment

In yesterday’s New York Times, business reporter Joe Nocera wrote an opinion column about investment bankers’ behavior in bringing companies public.  It’s based on documents from an ongoing lawsuit between 1999 IPO star, eToys (which went into Chapter 11 in 2001), and its lead underwriter, Goldman Sachs.  Mr. Nocera got the data from the New York County Clerk’s office, where they were supposed to have been under court seal, but weren’t.

eToys

No, it’s not the one with the sock puppet.  That was Pets.com.  eToys was an online toy retailer.  Both made it into CNET’s Top Ten internet bubble flops, though.

The pricing range for eToys shares in the initial prospectus was $10-$12.  The final offering price was $20.  The stock closed on its opening day at $77.  It peaked a few months later at $84.  It was trading at $.09 when it went belly up.

The lawsuit:  eToys contends that Goldman failed in its fiduciary duty to get the best price for eToys shares.  Although it was losing money at the time of the IPO, eToys thinks that if it had raised, say, $400 million (an offering price just north of $50) instead of the $155 million it got, it would have been able to stay alive long enough to become profitable.  This was basically the AMZN strategy.  In eToys’ case, who knows what might have happened.

Goldman’s defense is apparently that it had no such duty.

the documents

Grammar and spelling errors aside, the Nocera documents shed some light on less well-known aspects of the IPO process.  No one comes out looking especially good.  For example:

–Goldman allocated 20% of the offering to “flippers,”  that is, to brokerage clients who had no interest in owning the IPO companies.  They just wanted to sell, or “flip,” the stock during first-day trading.

–one investment manager said he did large amounts of trades with Goldman simply to get IPO allocations.  He also appears to me to have paid commissions at almost twice the then going rate.  A cynic would say he got no services for this extra payout;  he just wanted to make the payments fatter–and thereby get a bigger IPO stock allocation.

–an internal presentation argues that Goldman should look at first-day trading gains in an IPO stock as being an asset of the firm, one that Goldman should seek to maximize the return on.

–Goldman regarded first-day gains as a quid pro quo for two things–the size of a client’s commission business and his willingness to participate in “cold” IPOs.  (“Cold” IPOs are ones with little or no upside; participation allows the underwriting syndicate to earn IPO fees at lower risk.)

–Goldman kept track of the first-day gains achieved by each client and informed at least some that it expected to receive 20%-30% of that figure back in increased trading commissions.

the underwriting fee/trading commission tradeoff

In the eToys IPO, the underwriters (I’m including the selling syndicate in here, too) received fees of $11.2 million, or 6.75% of the offering price of $20 a share.  If we assume they received from all brokerage clients what amounts to a kickback of 25% of the first-day gains of $53 on 8.2 million shares, that would have amounted to $108.7 million.

If, on the other hand, the IPO had been priced at $50, the underwriting fees would have been $28 million.  The commission “kickback” would be $47 million.

The total investment banking take at an IPO price of $20 a share would be $119.9 million; at $50 it would be $75 million.

This is Mr. Nocera’s point, and eToys lawsuit contention–that Goldman had every incentive to underprice the offering.

on the other hand…

…let’s suppose that the underwriters could only collect from flippers, who made up 20% of the eToys offering.  SEC-regulated money managers, after all, have a fiduciary obligation to get the lowest possible commissions.  If so, the “kickbacks” would have amounted to $21.7 million and $9.4 million.  The total investment banking take $20 a share would be $32.9 million; at $50 a share it would be $37.9 million.  Not a huge difference.

And I suspect this is closer to the true state of affairs.  Still, the tone of the documents Nocera unearthed suggests to me that Goldman felt it was missing a golden opportunity by not exploiting its underpricing better–not that there was something wrong with the underpricing strategy.  It may also be they knew that firms with more Internet cred, like Merrill (whose famous analyst, Henry Blodget was subsequently barred from the securities industry for fabricating his research reports) or Morgan Stanley (Mary Meeker apparently convinced the SEC she really believed the crazy stuff she wrote) were better able to cash in.

 

 

 

Intel’s 4Q12–waiting for the upturn

January 18, 2013 By in earnings conference calls, Industry Analysis, internet, Recent Market Action, semiconductor manufacturing, Stock ideas, Technology, Wireless Tags: , , , , , , , , , Leave a comment

the report

Yesterday afternoon, INTC reported earnings results for 4Q and full year 2012.  For the quarter, INTC made $.51 per share on revenue of $13.5 billion.  Revenues were down 3% year-on-year, and flat sequentially during a normally seasonally strong quarter.   EPS were off 24% vs. 4Q11.  The profit figures were considerably better, however, than the Wall Street analysts’ consensus of $.45.

For the full year 2012, INTC’s revenues were down by 1% yoy, at $53.3 billion.  EPS were down by 10%, at $2.24.

INTC also gave initial guidance for 2013 yesterday–basically for a not much more than flattish year, with considerably better performance during the second half than in the first.

The stock rose initially as traders saw the better than expected quarterly EPS, only to fall by 5% then they read down the page to the 2013 guidance.  As I’m writing this on Friday morning, INTC shares are down more than 6%.

the details

INTC’s overall business began to decelerate in the second half.  Weakness continued through 4Q.

As worldwide economic growth slowed, corporations responded by cutting spending on servers and PCs.  PC demand from individuals in emerging markets, who had been pillars of strength through the first half, began to sag as well.  Cloud computing everywhere and servers in China were exceptions to this trend.  Weakness was especially acute at the bottom of the PC market.

INTC’s customers spent 4Q working down the inventories of PCs, especially Windows 7 machines, that they already had on hand, rather than buying lots more chips from INTC and making new ones.  Knowing this was likely to happen, INTC shuttered some older production lines earlier than expected and using many of the machines to accelerate development of state-of-the-art 14 nm chips.  These moves (which I think were the right things to do) created one-time changes that whacked 5.5 percentage points from INTC’s gross margin during the quarter (plant writeoffs + startup expenses), clipping about $.10 a share from EPS.

where to from here?

INTC expects an improving world economy to give a boost to its general corporate server business and to its burgeoning PC business in emerging economies as 2013 progresses.

The company also thinks that the personal computing market among affluent individual customers will bifurcate into a large smartphone/7″ tablet market and a second one, consisting of 10″ and larger devices.  It thinks the latter market–ultrabooks, convertibles, tablets–will demand the full speed and computing power of traditional PCs, but in increasingly lighter, thinner, less power-hungry forms   …and that INTC chips will be the only ones able to satisfy these needs.  The first proof of this thesis will likely come late this year.

Significant cellphone market penetration will be a 2014 story, at the earliest.

paid to wait?

That’s the Wall Street cliché about poor-performing high-dividend stocks–that you’re being “paid to wait” for good things to happen.  In the INTC case, I’m content for now to do so.

I must admit, though, that I had expected the good news to be, if not knocking at the door, at least to be walking up the street toward my house, by now.  I don’t think INTC management did much to disabuse me of that view, either.  I don’t mean to say that they misled me;  rather, I suspect this is turning out to be a much longer haul than they expected, too.

Having said that, INTC shares are for me becoming the kind of uncomfortable question that every professional portfolio manager has to deal with sooner or later.  On the one hand, every time you trade you think you know more than the people on the other side of the bargain.  This is somewhat delusional because, on the other hand, experience shows that even Hall of Fame players are wrong at least four times out of ten.

One thing I’ve learned over the years is that if my brain is telling me one thing and the charts are telling me another, the worst decision I can make is to add to a full position (which is what INTC is for me).  The next worst would be to have INTC be one of my two or three largest positions (it isn’t).  So I’m going to sit on my hands for now.