Category Archives: internet

why did Amazon (AMZN) just issue $3 billion in bonds?

November 29, 2012 By in Amazon, Industry Analysis, internet, Recent Market Action, Stock ideas Tags: , , , , , , , , Leave a comment

I’ve known about AMZN since its inception.  I’ve never owned the stock, however–which has, since 2006, been an embarrassing oversight on my part.  But as one of my former bosses used to say, in her characteristically non-PC way, “You can’t kiss all the pretty girls.”

AMZN is clearly a pivotal company in the transformation of US–and ultimately global–retailing.  But at its typical 100 times earnings or so, I’ve always found the valuation a bit too steep.  I am an Amazon customer, though, and an Amazon Prime subscriber.  I also use a Kindle (and an iPad) to read.

Anyway, several things about this week’s issue of $3 billion in AMZN bonds caught my eye:
–the interest rate, which is at only about a 60 basis point premium to Treasuries

–the stated purpose of the issue, namely the boilerplate “general corporate purposes”

–the lack of relevant commentary, although I really shouldn’t be surprised.  I’ve read some suggestion that part of the net proceeds will go to pay for the company’s new $1.16 billion HQ in Seattle.  AMZN does mention in a supplement to the original prospectus that it has agreed to buy the complex.  But it would be weird for the company to disclose that and not mention the buildings as a use of proceeds if that were so.  My assumption is that the new HQ will be financed separately with non-recourse debt.

looking at AMZN financials

–capital spending is up very sharply recently, from around $200 million a year in 2007 to $1.8 billion in 2011 and the current $23 billion annual rate (I’m taking all figures in this post from the Value Line Investment Survey, the industry bible for such data). That’s slightly more than the cash generated by operations, not counting working capital changes (see the second item below this one).

–operating margins are down.  They were more than 6% of sales a half-decade ago.  They’re under 4% currently.  I interpret this is the effect of selling e-books and kindles for little or no profit, or at a loss.

I don’t think this is necessarily bad.  I point it out only as further evidence of the dedication to expanding its digital footprint–even at the expense of profits–that has marked the company for the past few years.

–$5.2 billion in cash?…yes, and no.  The September balance sheet for AMZN shows that figure.  But look at Payables (the amount AMZN owes suppliers) and Receivables (the amount customers owe AMZN).  They’re $8.4 billion and $2.4 billion, respectively.  The difference is $6.0 billion.  In other words, all the cash on the balance sheet (plus another $800 million) is explained by the fact that customers pay AMZN very quickly and suppliers don’t get their cash very fast.

There’s nothing wrong with running a negative working capital business.  In fact, it’s great.  But the cash it generates is only there as long as sales are stable or rising.  If they start to shrink, so too does the cash level.  So spending this money on capital projects, where AMZN can’t get to it quickly, has some risk attached to it.

why the offering?

I think it signals AMZN’s belief that the current environment of intense competition for digital dollars, of low margins and of capital spending larger than cash flow isn’t going to change any time soon.

I wonder whether Wall Street realizes this.  I also wonder how many remember the long struggle toward profitability AMZN had up until 2002.  The average analyst earnings estimate for AMZN in 2013 is $1.80 per share, with one analyst projecting close to $4.  I haven’t done any numbers, but, to me, the just-completely bond sale implies even the $1.80 is probably much too aggressive.

11th Annual Bain Luxury Goods Worldwide Study, October 2012 (ii): long-term trends

November 20, 2012 By in Bain luxury goods study, Industry Analysis, internet, Luxury goods, Retail, Stock ideas, Strategy Tags: , , , , , , , Leave a comment

post # 2

This is Day two (of three) blogging about the 2012 Bain global study of personal luxury goods.  Yesterday I wrote about Bain’s analysis of the industry’s growth prospects.  The consulting company’s general picture seems to be that after a post-Great Recession surge in luxury goods spending the industry is settling back toward trend growth.

In the Worldwide Study, Bain has pencilled in 4% – 6% annual revenue expansion as being “trend.”.  My sense, however, is these numbers are there more as prudent (read: low-ball) placeholders than the product of hard core analysis.

Trends

That was yesterday.  Today I’m going to write about the major trends Bain sees in the luxury goods market.  They are:

–tourism  

According to Bain, 40% of the total money spent by buyers outside their home country!  I knew that this phenomenon was big, but I didn’t realize it was so large.

Why not spend at home?

—price   Prices are cheaper in the EU than anyplace else.  This is partly because luxury goods makers set prices higher in Asia and partly because of government duties imposed on foreign luxury goods imports.   Outlet shopping may also not be available in the home country (more below).

—selection  Two-thirds of worldwide luxury goods distribution is through third parties like department stores, which may focus on only a small number of items.  In some cases (think: China) there may not be stores nearby

—anonymity  Buyers may prefer to make purchases that don’t advertise their affluence to their friends and neighbors

–authenticity  Buying from a luxury firm’s retail store gives greater assurance that the merchandise isn’t counterfeit

—vacation atmosphere  buyers may be less careful about spending when abroad.

How does Bain know this?  Traditionally, the information comes from credit cards, although in today’s world more progressive companies will be using “big data.”  If so, they’re probably not telling anyone, though.

the geographical spending mismatch

Chinese citizens do 25% of global luxury goods spending; China accounts for 7% of worldwide sales

Europeans do 24% of global spending; Europe accounts for 35% of worldwide sales

Americans do 20% of global spending; the US accounts for 31% of worldwide sales

Japanese do 14% of global spending; Japan accounts for 9% of worldwide sales

Everyone else does 17% of global spending, everywhere else accounts for 18% of worldwide sales.

In the aggregate this is an East/West phenomenon.  Yes, Americans do a little bit of luxury shopping in Europe and Europeans in the US.  But Japanese and Chinese citizens do the majority of their personal luxury goods buying abroad.

–China accounts for 25% of the global luxury goods market.  That’s more than any other country.  And it’s up from basically nothing 12 years ago.

–accessories, not apparel   Accessories, typified by leather goods and shoes, are now the largest segment of the luxury goods market, comprising 27% of total sales vs. 26% for the #2 category, apparel.  They’re also growing faster than apparel.  Reasons:  lower prices, greater recognizability, faster innovation

–men, not women…  Fifteen years ago, men made up a third of the luxury goods market.  Today, that’s up to 41%.  The impetus for this change is the emergence of younger male consumers in China.  Now luxury brands are beginning to cultivate males in the US and Europe as well, where men hav e traditionally been second-class citizen, on the view that men “normally” buy less than women–and are much more highly business cycle sensitive customers.

–…except maybe for China, where Bain notes, for the first time I’m aware, that women business owners, “power women,” are becoming a significant force in luxury goods consumption

–off-price  Outlet shopping, long a staple in the US (59% of global off-price sales this year) , has arrived in Europe–and is being rapidly developed from a very low base in Asia.  Bain reports growth in luxury outlet sales from Chinese customers in Europe of up to 100%+.

The category as a whole will likely grow at a 30% clip in 2012, although it will only account for about €13 billion in total sales.

–online  This market, which is still tiny at an estimated €7 billion in sales this year, is growing at about a 25% annual rate.  It’s 2/3 full price, 1/3 off-price, with off-price growing faster.  Private sales, flash sales and sites for men are the hottest sub-categories.

That’s it for today.  Tomorrow, structural features of the personal luxury goods market.

ESPN’s role in DIS

November 14, 2012 By in earnings conference calls, Entertainment, Industry Analysis, internet, Stock ideas Tags: , , , , , , , Leave a comment

Still no internet/TV.  Still no sign of Comcast trucks.  Nor is Comcast willing to say how much longer the outage will last–today is Day 17.  The whole neighborhood is switching to FIOS.  

This is, of course, a trivial issue when compared with the devastation in low-lying areas of Long Island or with the low-income housing in NYC that still has no power (but whose residents are still being charged full rent–rebates to come in January???).  

This post is prompted by a reader’s question about ESPN.  It also addresses some assumptions I’m making about ESPN in saying I think DIS will be a good relative performer over the coming year.

limits to what I know

I’m very comfortable as an investor that I know more than I really need to about how the Disney part of DIS works.  I think I know enough about ESPN, too.

This is an important distinction, however.  In my mind–if nowhere else–there’s an unresolved question about the long-term growth prospects for ESPN.  I don’t think this is a near-term issue.  I don’t think it’s primarily about competition, either.  In its simplest form, it’s how long can ESPN continue to grow revenues at twice the rate of nominal GDP, as it is currently.  When does growth slow down?

ESPN’s importance to DIS

Today, ESPN accounts for 2/3 of DIS’s profits.  What happens if ESPN stops growing at 15% a year and slows down to 10%?  What does the rest of the business have to do to take up the slack? The answer: rev up growth to +25%/year.  Is that possible??  Possible, yes; probable, no–in my opinion.  Therefore, if ESPN slows down, Wall Street revises down its estimates of DIS’s long-term growth rate–and the stock adjusts downward.

ESPN doesn’t have to speed up for DIS to be a good stock.  But it can’t slow down either, in my view.

sports programming

What’s unique about sports programming–and what makes ESPN so attractive–is that it’s the only type of mass media where consumers are regularly willing to pay higher prices for pictures of events in cutting-edge resolution, and for tons of expert (or even not so expert) commentary.

This is not only true in the US, where there’s a mad rush to buy the latest model TV set just before the Super Bowl (the Big Game, to those unwilling to pay to use the SB moniker).  It’s the same in every country whose stock market I’ve ever been involved in.

programming rights

Not everyone can broadcast a sporting event.  Most sports teams/leagues periodically auction off to the highest bidder exclusive rights to broadcast their games.  For many profession teams (and icons like Notre Dame), these broadcasting rights can be their single most important asset, running into the hundreds of millions of dollars in value.

Many organizations break the rights down into a number of pieces to make them more affordable, and therefore encourage more spirited bidding.  The NFL, for example, has separate packages for Sunday Night Football, Monday Night Football, Thursday Night Football, NFC Football and AFC Football–broadcast by NBC, ESPN, the NFL Network, Fox and CBS, respectively.

where ESPN fits in

ESPN is by a mile the dominant sports broadcasting distribution network in the US.  It broadcasts all the major sports.  It also fills a bunch of channels, in both English and Spanish, with 24/7 commentary and analysis.  Over the years it has been consistently innovative, so it possesses an unparalleled internet presence as well–only commentary but fantasy league and broadcasting, too.

network effects

ESPN’s is a business where the rich get richer and the poor get poorer.  As a distribution network gets larger and if a distributor can raise prices (which so far ESPN has been able to), the distributor generates more money to spend on content, including broadcasting rights.  This gives it a huge, and growing advantage over smaller rivals.    At some point, the amount of capital needed to enter the market, or even to maintain a presence, becomes prohibitively high and the weak links drop out.

For market leaders like ESPN, this is a great business.

a sign of maturity?

About two years ago, ESPN decided to make a major move into soccer.  Two reasons:  this would be the leading edge of ESPN’s expansion into Europe; and ESPN could become the leading distributor to a small but growing fan base in the US.

The heavy investment ESPN began to make implied to me that management saw this as the company’s most attractive long-term expansion opportunity.  (Otherwise, it would have focused on something else.)

ESPN, however, lost out in the bidding for Premier League soccer rights in Europe to incumbents who recognized the threat ESPN posed.  It was worth losing money to them just to keep ESPN out.  Not a great solution to the threat of ESPN, but probably the best alternative available.

So, for now anyway, the geographical expansion is off the table.

spending up on the Disney side

Since then, DIS has agreed to buy Lucasfilms for $4 billion.  It has added Cars Land to Disneyland and is overhauling Fantasyland at Disneyworld.  It’s also installing new reservations/guest interface software at the parks.

…a coincidence that Disney capital spending is rising just after ESPN’s need for capital has decreased?  Maybe.  Another interpretation, though, is that DIS’s capital is going into the highest return projects–and that none are in ESPN.

my take

It’s not necessarily a bad thing if ESPN sees no new big untapped markets to enter.  In fact, DIS’s generally conservative accounting philosophy implies ESPN’s near-term profits will likely be higher because the expenses of European soccer rights and of expanding its soccer coverage won’t be there.

But DIS’s shifting capital allocation priorities do bring up the issue that ESPN won’t continue to grow at the current rate indefinitely.

The only practical conclusion I’m drawing is that if what I’ve just said is right, I’ve got to be careful to set a price target ($55?) and remember to sell.

Intel’s 3Q12: softness continues

October 17, 2012 By in earnings conference calls, Industry Analysis, internet, semiconductor manufacturing, Stock ideas, Technology, Wireless Tags: , , , , , , , , , Leave a comment

results

After the close of equity trading in New York yesterday, INTC reported its 3Q12 earnings results.

Revenues were flat, quarter on quarter, at $13.5 billion, during the typically seasonally stronger 3Q.  The same with operating expenses.

EPS came in at $.60 vs. $.57 for 2Q12, based largely on a lower than expected tax rate (implying to me that business was stronger than expected in emerging markets, weaker in the US and EU).

The numbers were considerably better than the downward revision to guidance that INTC announced in early September.  At that time INTC expected revenue of $13.2 billion and EPS (my estimate) of $.52-$.54 (see my post on the pre-announcement).

Year on year, results were down.  3Q11 revenues were $14.2 billion, EPS $.65.

The stock fell about 3% in the aftermarket Tuesday.  In the Wednesday premarket, it’s about the same, while S&P futures are flat.

details/guidance

details

Demand for PCs in the US, EU and China continues to be lackluster.  As a result, INTC’s customers, the machine manufacturers, continue to pare chip inventories.  This is typical behavior:  the buyer gets the sniffles, the component manufacturer gets pneumonia.   But INTC customers appear to be shrinking inventories to even lower levels than the company anticipated a month ago, implying their ability to read end-user buying intentions is especially low.

Business did pick up a bit in September in anticipation of Windows 8.

Demand for servers from corporations has also begun to slow down, as company cash flows flatten out due to the current deceleration in global economic growth.  This is a new element in the INTC story, although not a huge surprise.  No matter what anyone says–including the companies–corporations usually don’t borrow to fund capital expenditures.  Spending is a function of the cash flows that operations generate.

Cloud computing remains very strong.

guidance

Visibility is very low.

INTC appears to expect that 4Q12 will more or less mirror 3Q12.  The company normally keeps inventories of just over a month’s sales.  It now has 5%-10% too much.  It will slow down manufacturing a bit during 4Q12, as a result.  This won’t affect revenues.  But the company will shut some production lines and shift the machinery to new leading-edge uses.  This will mean lower capex during the quarter, as well as an unspecified amount of equipment writedowns.

During 1Q13, INTC will begin another of its bi-annual production upgrades–which will mean lower gross margins by a few percentage points for a quarter or two as the company gets the new lines up to speed.

earnings guesses

I’m pencilling in $.60 (excluding writedowns) for 4Q12, which would mean full-year EPS of $2.33.  I’m thinking that 2013 will bring a minimum of $2 a share, with $2.50+ likely if the global economy begins to reaccelerate.

the stock

Since the bottom for the S&P in June, the index is up about 14%.  Over the same time span, INTC is down by 14%.  Most of the damage has happened since mid-August, when the global slowdown became more apparent.

At $22 a share, INTC is trading at 9x trailing earnings and at, I think, at most 10x what it can earn in 2013. INTC shares now yield 4%, a full percentage point above the 30-year Treasury.

I’m surprised that the stock has performed as poorly as it has.  I’d thought INTC might give up some of its run to $29+, but I’d expected it to settle in around $25 or so.

That’s clearly been wrong.  And it’s always a danger signal when a stock doesn’t do what you expect.

As far as I can see, the current earnings weakness has revived all the old fears that INTC products have no place in a post-PC world dominated by tablets and smartphones.  And this, rather than business-cycle softness, is what’s causing the sharp underperformance of INTC shares.

It’s possible that the negative scenario will turn out to be true.  I continue to think, however, that INTC shares are now being priced as if that outcome were a certainty–that ultrabooks and INTC’s forays into tablets and smartphones won’t be successful.  So I’m continuing to take the contrary bet–noting, though, that there are risks in saying that everyone’s out of step but me.

thinking about the iPhone 5 launch

September 28, 2012 By in Current Market Thoughts, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , , , , Leave a comment

Thinking about the iPhone 5 is, for me, a good way of focusing on the question of where APPL goes from here.  My conclusions in this post are preliminary enough that I haven’t documented what I’m writing in the way I would usually.

Here goes:

importance of the iPhone

The iPhone is by far APPL’s largest and most profitable product, accounting for over half the company’s gross  income.  It generates huge upfront cash from device sales (Industry estimates are that the iPhone 5 costs about $200 to make.  It sells for $650.).  In addition, APPL gets a percentage of the recurring fees the wireless networks charge their iPhone customers.  It also gets a big chunk of the money iPhone users spend on apps, books and periodicals.

On top of all that, the iPhone has replaced the iPod and the Mac as the iconic APPL device–the one that powers the brand name and motivates customers to buy the newest/best in the whole range of AAPL products.

the iPhone 5

–in many ways, it’s a “me, too” product.  Its most important new features, like larger screen size and LTE network access, have already been available on Android phones for a while.  Yes, Siri is apparently better (could she be worse?) and you can take panoramic photos, but still…

I don’t think this is necessarily a bad sign.  It probably signals, instead, that AAPL thinks that significant future hardware changes will be harder to come by, and easier to copy, than ever before.  Therefore, competition between iOS and Android (Google/Samsung) will play out on other fronts.

–AAPL is offering proprietary mapping services, provided by a wholly-owned, newly acquired, subsidiary.   GOOG maps are gone.

All the initial publicity is about how the new AAPL maps are, at present, not up to snuff.  I think they soon will be.  One might say that Safari and iWork aren’t great confidence builders, but they’re parts of what is now a small legacy business for AAPL.  I think there will be a lot more emphasis 1 Infinite Loop on getting maps right.

More important, AAPL may see proprietary apps as the next big phone differentiator.  This could be the way AAPL would like to steer the smartphone business, or it could simply be the way it diagnoses the competitive environment will evolve, whether the company wants it that way or not.

If so, rapid improvements with Siri and maps, as well as new proprietary apps will be keys to watch for.

–the iPhone 5 appears to have fewer Samsung parts in it.  If so, this is probably another facet of the intercompany competition highlighted by recent copyright litigation between the two.  To me, this would imply making a foundry-like deal with INTC as the logical next step.  For INTC, this might mean a better chance to have its proprietary processors (not just foundry output) appear in AAPL phones.

–the iPhone 5 appears to work on more networks than the one a customer contracts with.  According to one report I’ve read, changing the tiny sim card inside the phone will enable it to work on either T or VZ networks.  It may be capable of working on other networks as well.

If so, why have this feature?

There may be some manufacturing efficiencies, but I don’t imagine that’s the reason.

As the smartphone business matures, and assuming APPL wants to retain its upscale image, the company faces the issue of motivating customers in the developed world to buy a new $650 phone every two years.  At the same time, the price of the iPhone is far too high for all but the wealthiest users in the developing world to afford.  So the biggest growth area for smartphones would seem to be closed out to it.

Suppose, however, you could “recycle” used iPhones by buying them from T or VZ for, say, $100, replacing the sim card and furnishing them to a telecom carrier in the developing world?  Then you could expand your user base–and the associated income stream from carrier charges and apps etc.–without being forced to manufacture a cut-rate phone for the developing world that would threaten to dent your upmarket image.  You’d also be giving the developed world user a $$$ reason to upgrade.

Something to watch.

my bottom line

The best growth companies re-invent themselves every few years.  AAPL has already gone through several evolutions, from Mac company to iPod company to iPhone/iPad company.  The next turn of the wheel may be to become predominantly a software developer and usage royalty generator.  If that process is already under way–and if it’s successful–there may still be a lot more growth in AAPL than the consensus expects.

I don’t think there’s anything built into today’s AAPL price for the possibility.  I don’t think may people are thinking about it, either.  There’s a temptation to conclude that owning AAPL gives you a free call on the potential upside. In assessing downside risk if something like this doesn’t happen, however, the relevant question is whether AAPL becomes a MSFT (and just drifts) or a RIMM (and plummets).