Category Archives: Industry Analysis

Broadcom (AVGO) and Qualcomm (QCOM)

November 6, 2017 By in mergers and acquisitions, Technology, Uncategorized, white knight Tags: , , , , 1 Comment

(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.

how online ordering is shaking up the food business

October 16, 2017 By in food, Industry Analysis, Uncategorized Tags: , , , , 1 Comment

I’m less and less a fan of the Wall Street Journal as time goes on.  Writers seem to be more interested in filling up the page than providing astute analysis.  But there is an interesting section on “The Future of Food” in today’s edition.

What strikes me:

–the threat to supermarkets isn’t simply the shift of dollars to online vendors.  A disprortionately large portion of supermarket profits come from two sources:  house-brand goods; and impulse purchases from endcaps and, more importantly, the shelves along the checkout line.  Even if the online order goes to the supermarket, the chance of selling for $2 during checkout the soda that’s $.40 as part of a six-pack in the beverage aisle is lost.  Also, at least in these early days, online purchasers choose many more national brand items than house brands

–consumers in general, and online orderers in particular, are increasingly gravitating toward healthier foods.  This means less sugar.  The difficulty for food manufacturers is not only switching sugar for some non-sugar thing that tastes the same.  There’s also the volume that must be replaced and the physical properties of sugar that are lost–like that it makes ice cream soft and bread less prone to mold.  Sugary foods are on the way out, but its not clear that the traditional brands will be able to hang on to all their customers during the transition

–ex Amazon, the food ordering app business is complicated by the fact that customer expectations/behavior can be far different from what, say, a fast food conglomerate or coffee chain expects.  Again, the risk of losing customers during a transition period is there

investment implications

Of course, everything has a price.  So at some point traditional food manufacturers and supermarket chains will be cheap enough that all the potential bad news will be more than baked into the stock price.  But I suspect we’re not at that point yet. The issue is operating leverage.  The arithmetic of distribution company profits is such that a 2% drop in sales can mean a 5% fall in pre-tax income.  If the sales lost carry double the average margin, however, the negative effect on profits will be multiplied by at least twice (most likely more).

the stock market crash of 1987

October 9, 2017 By in correction vs. bear market, investment advice, Investment firms, Portfolio management, Strategy, Uncategorized, Wall Street Journal Tags: , , , , 1 Comment

The Wall Street Journal has an interesting article today on the birth of the ETF–and the index fund, for that matter.

Two factors stand out to me as being missing from the account, however:

–when the S&P 500 peaked in August 1987, it was trading at 20x earnings.  This compared very unfavorably with the then 10% yield on the long Treasury bond.  A 10% Treasury yield would imply a PE multiple on the S&P of 10x–meaning either that bonds were dirt cheap or that the stock market was wildly overvalued vs. the bond market.

–a new product, called at the time portfolio insurance, a form of dynamic hedging, had very recently been created and sold to institutional investors by entrepreneurs steeped in academic efficient markets theory.  Roughly speaking, the “insurance” consisted in the intention to stabilize equity portfolio values by overlaying a program of buying and selling futures against the physical stock.  Buy futures as/if the market rises; sell futures as/if the market falls.

One of the key assumptions of the insurers was that willing/eager counterparties for their futures transactions could be found at all times and at theoretically predictable prices.  On the Friday before Black Monday–itself a down day–the insurers’ model required them to sell a large number of futures contracts.  Few buyers were available, though.  Those who were willing to transact were bidding far below the theoretical contract value.  Whoops.

On Monday morning, the insurers, who appear to have had negligible actual market experience, capitulated and began selling futures contracts at whatever price they could get.  This put downward pressure both on futures and on the physical market.  At the same time, pension funds, noting the large gap between the price of futures and the (much higher) price of the underlying stocks, began to buy futures.  But to counterbalance the added risk to their portfolios, they sold correspondingly large amounts of stocks.  A mess.

Arguably, we would shrug off at least part of this today as just being crazy hedge funds or algorithmic traders.  Back in 1987, however, equity portfolio managers had never before seen derivatives exerting such a powerful influence on the physical market.  It was VERY scary.

conclusions for today

Stocks and bonds are nowhere near as out of whack with one another as they were back in 1987.  The nearest we have today to a comparable issue is what happens as worldwide excess liquidity is drained by central banks from money markets.

The trigger for the Black Monday collapse came from an area that was little understood, even by those involved in it–activity that had severe negative unexpected consequences.  The investors who did the best after the crash, I think, were those who understood the most quickly what had happened.

Collateral damage:  one of the most important results of Black Monday, I think, was the loss of confidence in traditional investment advisers working for the big brokerage houses that it created.  This was, I think, partly because of individuals’ market losses, but partly, too, to the generally horrible executions received when they sold stocks in the aftermath.  This was the start of a significant acceleration of the shift to discount brokers and to mutual fund products.

Silicon Valley backlash?

September 25, 2017 By in agency problem, internet, Technology, Uncategorized Tags: , , , 2 Comments

I think we may be at a watershed moment in terms of the acceptability of the corporate behavior of tech/internet-related companies.

Up until now, it has been enough for investors that Silicon Valley produce increasing profits.  Institutionalized poor behavior on the part of the firms’ managements–whether that be violation of some employees’ civil rights or less-than-ethical treatment of customers or shareholders–has made little difference to their stocks’ performance.

Uber is perhaps the poster child for this phenomenon, which has also been, aptly, I think, characterized as “fratboy” behavior.  But now Uber appears to be losing its license to operate in London, which holds 5% of the worldwide active users of the taxi service, because of its not being a “fit and proper” operator.

The case of Facebook (FB) is just as interesting.  Founder Mark Zuckerberg announced plans last year to give a large amount of his stock in FB to a charitable trust that he and his wife would run.  In order to preserve his majority control of FB despite divesting a large chunk of his shares, he proposed that each A share, the ones with super voting power that insiders like him hold, be “split” into one A + two C shares, the ones with no voting rights.  Zuckerberg could then give away the C shares, representing about 2/3 of his wealth, without any decrease in his 53% voting control of FB.

The board of FB appointed one of its members, Marc Andreessen, a developer of the Mosaic and Netscape browsers, to represent third-party shareholders in this matter–to ensure that this restructuring would be fair to them.

Institutional investors sued.  During discovery, they found among other things, emails between Andreessen and Zuckerberg in which, far from defending third-party holders,  Andreessen appears to be coaching Zuckerberg on how to present his proposal to the board in the most favorable light for him.

Today, FB announced it’s dropping the restructuring plan.

 

If I’m correct about a fundamental change in investor sentiment, what does this mean for us as investors?

At the very least, I think it means that the business-is-what-you-can-get-away-with attitude (borrowing from Andy Warhol) of many tech companies will be penalized with a discount valuation.  It may also prevent some early stage firms from being able to list–preventing employees from cashing in on what they’ve built.  On tech/internet’s notorious anti-woman bias, I’m not sure.  After all, the investment business isn’t that far ahead of tech in eliminating this form of prejudice.

 

 

more on Whole Foods (WFM) and Amazon (AMZN)

August 31, 2017 By in Retail, Strategy, Uncategorized, Whole Foods Tags: , , , , , , 3 Comments

I was reading an article from Fortune magazine about the AMZN takeover of WFM.  Although it echoed much of what the rest of the press is saying, I was struck by it–mostly because my expectations for Fortune are higher than for financial reporting in general.

Three ideas in the article stuck out in particular:

–that AMZN’s goal with WFM is to compete head-to-head in groceries with Wal-Mart (WMT)

—the implication that because the margins of grocery chains are low they have a poor business model

–that the price cuts made by AMZN on Monday are small, therefore they make no difference.

my take

–ten campers, including yourself, are being chased by a bear.  If the goal is purely personal survival, you don’t need to outrun the bear.  You only need to outrun one of the other nine.

Put a different way, the goal of, say, Zara or Suit Supply is not to compete head-to-head on price with WMT.  that would be suicide.  Instead, those firms intend to provide differentiated clothing to a more focused audience.  Yes, it’s still clothing, but it’s different clothing.  Initially, at least, that’s AMZN’s goal with WFM.  It wants to expand WFM’s appeal to a smaller, younger, more affluent audience, not steal traffic from WMT.

–the key to profitability in a distribution business is to turn inventory over rapidly, taking a small markup on each transaction.  This is surprisingly badly understood by most professional investors, as well as virtually all the financial press–and by WFM, as well.  This is one reason that as an investor I love distribution companies.

Low markups defend against competition and create customer loyalty; continual effort to keep the growth in inventory under the growth in sales creates positive operating leverage.

WFM appears to me to have chosen do pretty much the opposite–to take large markups on each transaction, a “strategy” that has stunted sales growth.  Inventory turns are higher for WFM than for other grocers, although I suspect that this is a function of differences in product mix.  In any event, something else (or, more likely, a bunch of other something elses) in WFM’s organizational structure is all messed up.  The income statement shows that its very fat gross margins are frittered away almost completely by high overhead expenses.

If I were AMZN, I’d figure I’d attack what I think is the abundant low-hanging fruit in operating inefficiency and lower food selling prices as I made gains there

–it’s very easy to lower prices.  It’s extremely hard to raise them again–a key reason that couponing is a favorite supermarket strategy.  So it would be crazy for a merchant to lower prices across the board on day one.  $.49 a pound bananas, displayed prominently by the store entrance, is aimed at setting customer expectations about pricing throughout the store.  It’s a symbol, a promise   …at this point, nothing more.