Category Archives: internet

Verizon (VZ), Vodafone (VOD) and flowback

September 10, 2013 By in flowback, hedge funds, index funds, internet, Stock ideas, Technology, Wireless Tags: , , , , , , , , , , , Leave a comment

VZ is buying the 45% of Verizon Wireless that VOD owns.

VZ, which owns 55$ of Verizon Wireless, recently agreed  to buy the other 45% from VOD for around $130 billion.

From what I can tell so far, the deal will be good for VZ.  And, at the very least, VOD gets a boatload of cash and stock.  In hindsight, VZ would have been a lot better off striking the same deal in March, before the Fed began hinting that it was thinking of ending the current post-recession period of extra-super-accommodative money policy in the US.  The interest rate VZ would have paid on newly issued bonds would have been lower.

More on this topic in future posts.

There may not be a great need to load up on VZ ( which I own) immediately, however–even if you think the deal is a spectacular coup for VZ (too enthusiastic for me).  The reason is flowback.

what flowback is

VZ is going to issue over a billion shares of new stock to VOD as part of the purchase price.  VOD has already announced it will distribute to its shareholders all of the VZ stock it receives.  That’s something like one VZ share for every 40 VOD shares held (the exact ratio isn’t important).

What is important is that VOD is a UK corporation whose stock is traded in London.  The bulk of its shares are held either by UK or Continental European institutions.  US institutions hold only about 15%.

Put another way, early next year almost everyone who owns VOD will receive shares in a foreign stock, VZ.

What will they do with it?

For index funds, the answer is clear.  If it’s not in the index, it has to be sold.

For institutional managers in the EU, the answer depends, in the first instance, on what their contracts with customers say.  They’ve presumably been hired for their expertise in EU equities.  Management agreements probably stipulate that they’re not allowed to hold non-European securities.

Even if they are permitted to hold VZ, why do it?  Why take the risk of holding a stock that’s outside your area of competence–and which will require considerable research effort to get a firm grasp on.  Selling is a much safer option.

For individuals, if form runs true, the first they’ll hear of the deal will be when their broker calls to tell them that shares of VZ have plopped into their accounts–and to urge them to get rid of this weird thing.

That’s flowback.

It happens in all cross-border deals that involve stock.  When shares of the issuing company leave the home country, some portion will be sold immediately by investors who are unable or unwilling to hold what is for them a foreign stock.

Where do these sales take place?   …ultimately in the home market of the issuer.

the VZ case

For VZ, average daily trading volume is around 10 million – 12 million shares.   Occasionally, volume can get as high as 30 million- 40 million shares without moving the stock too much.

Let’s make up a number and say that flowback will be 300 million shares.  That’s easily an entire month’s trading volume.  So this could be a serious issue for VZ’s price.

mitigating factors

There are three that I see:

–Verizon Wireless is the largest and most important asset for both VZ and for VOD.  Non-index investors in the EU must have wanted exposure to Verizon Wireless to be holding VOD shares.  Arguably, they will want to continue to have that exposure and will therefore be less inclined than normal to want to sell.  So maybe some will be able to wangle exceptions from their clients.

–trading volume in VZ over the past seven trading days (not including today) has averaged about 25 million, or–let’s say–12 million shares above normal.  If this is all merger-related short-selling, which it probably is, then this trading has already created demand for 80+ million shares of VZ when the shorts are covered.

–the stock has a current dividend yield of 4.6%.  At some point, this and other VZ fundamentals should provide price support.

my take

Worries about flowback are one reason large cross-world acquisitions involving stock aren’t that common.  This one was clearly too big for VZ to do any other way.

My guess is that anticipatory selling in advance of the acquisition will make it hard for VZ to go up for a while.  I also think, however, that downward pressure from potential flowback will abate long before the deal actually occurs.

At some point, an excellent buying opportunity for VZ will emerge from acquisition-related stock activity.  The trick is deciding exactly when.  The most prudent strategy, I think, is to establish a small position and await further developments.

 

 

Microsoft (MSFT) and Nokia (NOK)

September 6, 2013 By in Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , , , Leave a comment

A few days ago, MSFT announced a $7.2 billion deal to buy Nokia’s cellphone business.  That breaks out into $5 billion for the cellphone division + $2.2 billion to license Nokia’s relevant telecom patents.

Rather joining in the chorus of MSFT-bashing that’s accompanied the deal’s announcement, I want to make a single point.  This deal has been a long time in the making–at least two years–even if MSFT may not have realized this.

In late 2010, Stephen Elop, a consultant/general manager with a tech background who had worked for almost three years at MSFT, became CEO of NOK.  He promptly issued his “Burning Platform” memo, in which he likened working in NOK’s cellphone business to being stuck on an offshore oil platform that was being consumed by fire.  Two choices:  jump into the ocean or burn to death.

He followed that up in early 2011 by declaring that NOK was opting for the briny deep by abandoning its proprietary Symbian cellphone operating system in favor of Windows.  Why not Android, which would have been the safer choice?  Differentiation, Elop’s familiarity with MSFT, the potential for support from MSFT in the form of access to its smartphone intellectual property and possibly to its enormous pile of unused cash.

Sounds a little like Ron Johnson at J C Penney, doesn’t it?   … drama, and a bet-the-farm moment.

The announcement that Symbian’s goose was cooked had the predictable result.  People around the world stopped buying Symbian phones.  Cash flow from cellphones turned from strongly positive to significantly negative.  The situation didn’t improve when the first Windows-based Lumia phones debuted later that year.

By early 2012, it seems to me, the NOK board had to begin contingency planning.  What if the Lumia phones were slow in taking off?  How much of NOK’s cash flow from its other businesses would it be willing to plow into smartphones?  How much financial support would MSFT kick in?  When would continuing to prop up a failing Lumia line threaten to pull the parent company itself under?

We now know the answers.

NOK began to negotiate the sale of its smartphone business to MSFT in February, telling us that by that point NOK had determined it couldn’t continue its aggressive Windows phone bet without putting the entire company at risk.

Why did MSFT agree to buy the NOK cellphone business?

Without a Windows smartphone, MSFT’s grand vision of creating a Windows ecosystem like Android or Apple is DOA.  Also, MSFT probably regards itself as playing with $.65 dollars.  It gets to use a (small) portion of its foreign cash without repatriating it to the US and paying corporate income tax.

Anyway, NOK’s bungling the transition from flipphone to smartphone set a chain of events into motion that resulted in its willingness to sell.  MSFT’s bungling of its decade-long mobile phone initiative made it an eager buyer.  Whether the cobmination of the two will have a happier outcome is a completely different question.

 

 

CBS vs. Time Warner Cable: what’s at stake

September 4, 2013 By in Aereo, Cable, Entertainment, Industry Analysis, internet, Stock ideas Tags: , , , , , , , , , Leave a comment

CBS and TWC have settled their differences, but only after a month-long blackout of CBS (and Showtime) on TWC.

The dispute got ugly as time passed.  Toward the end, CBS personalities were appearing in ads offering to help TWC customers switch to other providers.  TWC was helping introduce customers to Aereo, the antenna company, as an alternate source of CBS content.  (The latter seems to me to have a strong shoot-yourself-in-the-foot aspect to it, although the networks hate/fear Aereo, so maybe it did something.)

According to SNL Kagan, the media guru that’s the source of most of the hard data in this post, in New York City, Verizon FIOS boosted its customer base by 16%+ during the struggle, presumably all coming from TWC.

The ferocity of the dispute and the length of time it took to resolve indicate the core issue–retransmission consent–is a key subject.  I think negotiations also underline the precarious position of the traditional cable content sales model.

background

Cable companies pay the traditional free over-the-air broadcasters for permission to retransmit network content to cable subscribers.  NFL football is probably the most important item, since lots of people watch.  They watch it live, too–commercials included.  For a long time, the networks regarded the fees they got as “found” money.  All they really cared about was ad revenue.

Not any more.  Over the past few years, as ad revenues have begun to wane, networks have become increasingly aggressive in pushing retransmission payments up.  In the aggregate, the ota networks will collect about $3 billion in retransmission fees in 2013.  That could balloon to $12 billion five years from now.

CBS vs. TWC

According to SNL Kagan:

–CBS had been charging  TWC $.65 – $.75 per subscriber per month for retransmission consent.  It was aiming to raise that to $2/sub/month by 2018

–the reason the previously doggy local affiliate stations are being scooped up in large numbers by predators is their share of the retransmission loot.  SNL estimates that local stations’ share of retransmission revenues has risen by 50% since 2011 and now accounts for a third of EBITDA for many of them.  The way things are going, retransmission will be the dominant source of income for them before the decade is out

—TWC was ok with $2 a subscriber/month.  Digital rights were the main sticking point.  “Digital rights” is a broad concept.  It covers on-demand rights and online rights–everything from on-demand over the internet, to ads in on-demand, to fast-forward disabling of broadcast content.  During the years when it wasn’t paying much attention, CBS had apparently granted TWC wide latitude in this area for free.  Now it wants those rights back–presumably so it can charge extra for them in later contracts with cable operators.

no one’s leaking settlement details

That suggests that one party made the lion’s share of the concessions.  My money would be on CBS having come away from the table as the big winner, if I had to make a bet.

a tipping point for cable?

As monthly cable/broadcast satellite/telco video bills approach $100 a month, subscribership is beginning to decline, albeit slowly.  Although an extra $1.50 a month doesn’t sound like much–$6 a month when multiplied to account for all the major ota networks–passing along these new costs may trigger a disproportionately large loss of subscribers.

Cable’s response?

The nuclear option, to put little ota antennas in cable boxes, is probably too expensive.  Partnership with Aereo would be iffy, given the unclear legal status of the service (a Federal court in New York has ruled in favor, one in California has ruled against).

Maybe the retransmission issue forces a rethink of cable’s whole current pricing philosophy.

 

 

 

 

 

 

the SEC investigates store chains’ internet sales claims

August 30, 2013 By in Amazon, Industry Analysis, internet, Retail Tags: , , , , , Leave a comment

the SEC questions internet sales hype

According to the Wall Street Journal, the SEC recently sent inquiry letters to a bunch of retailers asking them to quantify claims managements were making in quarterly earnings conference calls about internet sales and internet sales growth.  Fifth & Pacific (Kate Spade, Juicy Couture…), for example, told investors it had a “ravenously growing” web business.  Others tossed around numbers like up 30%.

On the other hand, while online sales in the US may be growing faster than revenues from bricks-and-mortar operations, they’re still only in posting increases in (low) double digits, and make up less than 6% of total retail.  So the SEC was concerned that the company talk might be more hype than reality.  Why no disclosure of internet sales as a percentage of total sales?

The SEC got two types of reply:

—equivocation.  Some retailers said they don’t disclose the size of online sales because they’re “omnichannel” firms.  An individual customer may sometimes visit a store, sometimes order from a desktop at work, sometimes buy from a smartphone on the train going home in the evening.  It’s the total customer relationship that counts, they said, not the way someone may buy any particular item.  Translation:  online sales are almost non-existent, but we know shareholders will react badly if we say so.

—confession, sort of.  Others said that online sales were “immaterial,” meaning no more than a couple of percentage points of total sales.

there’s information here

Why not just say so?

…because it sounds bad.

Why bring up internet sales in the first place?

…because we have no other good things to say.

look at the income statement

I could have told you that, just from taking a quick look at company income statements.

Here’s my reasoning:

–if a company’s internet sales are growing at, say, 20% and comprise 10% of total sales, then they’ll contribute 2% to overall sales growth.  Because online sales are free of many of the costs of bricks-and-mortar stores, like salespeoples’ salaries and rent, they should carry (much) higher margins than sales in physical stores.  Therefore, if internet sales are big, we should see accelerating sales growth and rising margins.

Take Target (TGT) as an example.  Aggregate sales are growing at about a 3% annual rate with no signs of acceleration.  Operating margins are flat to down.  If online sales contributed 2/3 of total growth, TGT would have to disclose that  …and margins would be heading up noticeably. Therefore, internet sales can’t be anything close to 10%–or even 5%–of TGT’s business.

By the way,  TGT’s response to the SEC was that its internet sales are immaterial.

why the SEC investigation?

Every company is going to try to spin the facts of its performance in a favorable way.  Just take a look at the 10-K, where management can go to jail if disclosure is incomplete or counterfactual.  It’s chock full of dire warnings of what might go wrong.  It’s also in dense print with no pictures.  Compare that with the annual report, where every page is glossy, every face is smiling and the skies are always blue.

Also, retailers are marketers, after all, so we should expect an unusually rosy portrayal of results and prospects from them.

Still, there are limits.  Even if the border line is a bit fuzzy, there comes a point where  positive spin becomes deception, where touting the fantastic prospects of a currently minuscule business becomes fraud–especially if it’s in an area like online where Wall Street is intensely interested.

I interpret the SEC letters a warnings to the companies involved that they have been treading dangerously close to that line, and may even have stepped over it.  Expect a much more 10-K-ish assessment from now on.

 

measuring Steve Ballmer

August 26, 2013 By in internet, Stock ideas, Technology Tags: , , , , , 3 Comments

On the day before Steve Ballmer took over as head of MSFT, that company’s market capitalization was a tad below $600 billion.  If MSFT shares had matched the performance of the S&P 500 since then (about +15%), the company’s stock market value would now be just  under $700 billion.  Instead, just before the stock spiked on news of Ballmer’s surprise resignation, MSFT was worth barely a third of that figure.  Under his stewardship, then, MSFT owners lost a staggering $450 billion in relative stock market performance.

Sometimes the simplest measuring sticks are the best.

(Yes, MSFT management has bought back about 20% of the outstanding shares since 2006, but it’s hard to know what the net effect of the stock purchases would be.  Certainly, earnings per share would be lower.  Arguably, the stock price would be, as well.)

In late 1999, I sold the MSFT shares I had held for a decade.  The price earnings multiple was crazy high and it was clear that MSFT has no internet strategy.  But for a while I kept going to the annual analyst meetings in Seattle.

At one of them, Mssrs. Ballmer and Gates were jointly hosting a Q&A session.  One analyst raised his hand and observed that the annual earnings growth rate of Microsoft had dropped from 20%+ to mid-single digits.  He asked when management thought the company would resume its former rate of growth.

Awkward   …especially in a public forum.

I don’t think the questioner had any ill will, though.  He just wasn’t a particularly vivid-color crayon.

The response was illuminating.

Gates and Ballmer were both very harsh.  They all but called the guy an idiot, and asserted that it was a triumph of management to achieve any earnings growth in a firm of MSFT’s large size.  Wow!

What did I take from this?  Three things:

–neither Gates nor Ballmer was a very nice person,

–working for them it would be their way or the highway, and

–MSFT wasn’t going to have huge earnings growth because neither of the top people thought it was possible.   (The fact they subsequently brought in the head of a forest products company, a mature, cyclical commodity industry, to cut costs as CFO says it all.)

For the record, I thought Steve Ballmer was a bad CEO.   Not Carly Fiorina bad, but pretty terrible.

On the other hand, Bill Gates selected Ballmer and kept him as CEO for more than a decade.  So until very recently, he clearly approved of what Ballmer was doing.

If we want to lay blame at anyone’s door for MSFT’s weak performance during Ballmer’s tenure, the lion’s share would be delivered to the front of the Gates compound.