Category Archives: Technology

reason six why analysts mis-estimate company earnings

July 25, 2011 By in Casinos, earnings surprise, Entertainment, Industry Analysis, internet, reasons analysts mis-estimate company earnings, Technology, using research, Wireless Tags: , , , , , , , , , , Leave a comment

reason #6

In my post from yesterday, I titled this reason “making dumb mistakes.”  I’m not sure what else to call it.  Let me illustrate with two examples of recent huge misses by analysts who should have known better.  They’re the June quarter results from two high-profile companies with plenty of Wall Street coverage, WYNN and AAPL.

Let’s take WYNN first.

WYNN’s 1Q2011

In 1Q2011, WYNN earned $173.8 million, or $1.39 per fully-diluted share.  Look one line higher on the income statement, and you see that the $173.8 million figure is after deducting $52.5 million in “income attributable to non-controlling interests.”  That’s minority interest.  It’s income that belongs to the 27.7% of Wynn Macau that WYNN doesn’t own.  (Wynn prepares its financials as if it owned 100% of Wynn Macau, and then subtracts out the minority interest at the end.)

From the minority interest figure and the magic of long division, you can calculate ($52.5 /.277) that Wynn Macau’s total net income was $190 million. WYNN’s share was $137 million.  Therefore, WYNN, ex its interest in Wynn Macau, earned $36.8 million for the quarter.

One unusual feature of 1Q11:  gamblers at the WYNN tables in Las Vegas had bad luck by historic standards during the quarter.  They lost a bit over 30% of what they wagered vs. historical loss experience of 21%-24%.

Any analyst who follows the company could have found all this out in five minutes of studying the 1Q11 income statement.  Given that the analysts’ consensus for 1Q11 was wildly low at $.73, you’d assume they’d do so to try to figure out where they went so wrong.

turning to 2Q11

In 1Q11, 80% of WYNN’s income came from fast-growing Macau, 20% from slowly-recovering Las Vegas.

From figures the Macau government posts monthly on its Gambling Coordination and Inspection Bureau website, we knew on July 1st that gambling revenue for the market as a whole was 12% higher in 2Q11 than in 1Q11.  If we assume that Wynn Macau grew in line with the market, and that a 12% increase in revenues produced an 18% jump in income (basically, adjusting for normal operating leverage and the fact that Wynn Macau “adds” gambling capacity by raising table stakes), then Wynn Macau would have earned about $225 million in 2Q11.  Of that, WYNN’s share would be about $165 million.  That translates into around $1.35 a share for WYNN in eps during the quarter.

What about Las Vegas?  It chipped in $.25 a share to first quarter earnings.  “Luck” at table games returning to historical norms would probably push that figure back to zero.  On the other hand, room rates at both Wynn and the Encore are gradually rising, so zero might be too low.  But let’s stick with zero from Las Vegas is the most reasonable guess.

In other words, a sensible back-of-the-envelope guess for WYNN’s eps in 2Q11 would be $1.35 + $.00  =  $1.35.  This isn’t necessarily the most conservative forecast, but it is one based on factual data about the Macau gambling market and the assumption that nothing much goes wrong (or right) in Las Vegas.

What did the professional analysts say?

The median estimate was $1.01.  The highest was $1.25; one analyst had the dubious distinction of saying eps would be $.69.  For this last estimate to have come true, WYNN would have had to break even in Las Vegas (it earned about $.25/share) and to have revenues in Macau drop by 25% quarter on quarter, while the market was growing at 12%.

Given that WYNN’s results are so strongly influenced by Macau, even the median was predicting a relative disaster for the company there.  What were they thinking?

(True, they might have been assuming a disaster in Las Vegas, not Macau.  And, I’ll admit, I thought WYNN has done surprisingly well in Las Vegas so far this year.  But Las Vegas isn’t big enough to move the eps needle down to $1.  And the situation is a little more complicated than I sketched out above:  Wynn Macau pays a large management and royalty fee to the parent, almost $40 million in 2Q, so the better Macau does, the better ex Macau looks.)

APPLE

AAPL’s 2Q11 (ended in March)

During 2Q11, AAPL earned a profit of $6.40 a share.  Its business broke out as follows:

Macs     3.76 million units     $4.98 billion in revenue

iPod      9.02 million units     $3.23 billion (includes iTunes)

iPhone     18.6 million units     $12.3 billion

iPad     4.7 million units     $2.84 billion

Other                                         $1.3 billion

Total                   $24.7 billion

turning to 3Q11

Let’s try a back-of-the-envelope forecast for AAPL’s 3Q11.  To make things ultra-simple, we’ll ignore operating leverage, which will bias our estimate to the low side.

Macs  growing, but slowly in a developing world where overall PC sales are flattish.  Let’s say $5 billion in sales.

iPod  flat, $3.2 billion in sales

iPhone     industrywide smartphone unit sales are growing at 80% year on year.  All the growth is coming from half the market, Android and iPhone, with Android growing faster; Nokia and RIM are taking on water and sinking fast.  Let’s pencil in 19 million units at $660 each = $12.5 billion.

iPad  this is the tricky one.  We know that AAPL is capacity constrained, is adding manufacturing capacity as fast as it can, and sold 4.7 million units in 2Q11.  Let’s put in 6 million units at $600 each, the average price from 2Q11.   That’s $3.6 billion.

Other Leave it flat at $1.3 billion.

Add all these numbers up, and we get $25.6 billion.  If we assume constant margins–i.e., no operating leverage (which a really terrible example to set–working with margins instead of unit costs, but I’ll do it anyway), then earnings will come in at $6.60-$6.75 a share for the quarter.

As events turned out, my guess is way too low.    …oh well!   AAPL reported eps of $7.79.  The big difference?  The iPad sold 9.2 million units and brought in $6 billion in revenue.  That alone adds more than $.60 a share in earnings.  The rest is bits and pieces.

So I missed badly.  That’s not really the point.  The real question is how my ten-minute approach stacks up against the work of the 45 professional analysts who follow the company for a living–and for whom AAPL is probably their most important stock.  Check them out and I’m starting to look pretty good.

the analysts

The median estimate of the 45 was $5.82 a share.  The low was $5.10, the high $6.58.

How could they consensus be projecting an almost 10% quarter on quarter drop in earnings?

APPL’s main business, smartphones, which accounts for 50% of total company revenue, and a higher proportion of profit, is exploding. The category is growing by 80%.  Rivals NOK and RIMM are not only going nowhere, they’re getting worse by the day.   In fact, NOK’s smartphone sales in the June quarter fell year on year–probably by a third. So AAPL’s continually taking market share from them.  Quarter on quarter sales were likely up.

We don’t know what 2Q11 iPad revenues could have been, only that they flew off the shelves as fast as AAPL put them on.  So product sales had to be up, maybe substantially, in 3Q11.

If both iPhone and iPad were flat, quarter on quarter, the only way to get company results to be down 10% would be if Mac sales, which represent about a fifth of the company’s business, were cut in half.  Hard to fathom, given that the PC industry is growing, if only slightly, and Macs have been gaining significant market share from Windows-based PCs.

what did I do differently?

I think everybody ignored AAPL’s “guidance” of $5.03.  WYNN doesn’t give guidance.

I did five things:

I gathered industry information from the internet.

I read the prior-quarter results carefully.

I used a line of business table to make (very primitive) quarter on quarter projections.

I ignored macroeconomic forecasts of slow growth for the US, since both firms target the affluent here–AAPL more so than WYNN, I think.

I didn’t worry about missing on the high side.  I didn’t want an estimate that was deliberately too conservative.

What didn’t the analysts do?

I only have guesses.

It’s possible that they were influenced by downbeat general economic news.  Even so, I don’t see how you could have gotten to the consensus figures for either APPL or WYNN if you did a line of business table.  But that’s one of the first lessons in Security Analysis 101.  Maybe the analysts in question were out that day.

Intel’s strong 2Q11

July 23, 2011 By in Current Market Thoughts, earnings conference calls, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , Leave a comment

the results

INTC reported 2Q11 results after the close of trading in New York yesterday.  The company posted earnings per share of $.59, up 16% year on year, on revenue of $13.1 billion, a 22% gain vs. 2Q10.  The revenue number was an all-time high for INTC, thought it was helped along by the recent acquisitions of McAfee and of some chip businesses from Infineon.  Earnings handily beat the analyst consensus of $.51.

guidance

INTC typically doesn’t talk about future eps.  The company expects that 2H11 will show its normal seasonal strength vs. 1H, and that revenues over the period will likely be up by around 25% vs. 2H10.  This seems to me to suggest full-year 2011 eps of $2.50 or so.  INTC expects 2012 will be considerably better than 2011.

The mix of revenues will be different from what INTC thought three months ago, however.  More about this below.

details

Demand from emerging markets, which makes up the majority of INTC’s business, is booming.

Corporations around the world continue to spend heavily on new servers.  The development of cloud computing is adding to that.

The global consumer appetite for notebooks and desktops, with demand skewed toward the emerging world, is growing at double digits.

INTC saw some weakening of its business in Japan.

The corporate tax rate for the quarter was lower than anticipated, signalling that a greater proportion of its revenues than the company expected are coming from outside the US and EU.

The only fly in the ointment for INTC is netbooks.  Sales of the Atom chips which power them have swung from being up 4% year on year in 1Q11 to being down 15% year on year in 2Q11.

a lower PC unit growth forecast for 2011

Predictably, this is the one thing from the INTC earnings release and conference call that the press has seized on.

Third-party consultants have been saying for some time that they expect growth in global PC unit sales this year to by only about 5%.  INTC, in contrast, has been saying that it expects “low double digit” growth (10%-12%?).

The difference?  INTC says, in effect, that the consultants only have good information about the developed world.  They’re incorrectly extrapolating weakness there to the emerging markets, where conditions are far better.

None of that has changed.  What has taken INTC by surprise is a recent falloff in sales of Atom chips that go into netbooks.  It sounds to me that there’s worse in store for Atom than the 2Q11 sales drop cited above.  That’s  because Atom is the reason INTC is lowering its global PC unit growth forecast by about 2%, to up 8%-10%.

On the other hand, people still buying PCs are selecting higher priced ( and higher profit) chips than INTC thought.  The two factors are cancelling each other out on the revenue line.

my thoughts

They haven’t changed since my last post on INTC.  I was a little surprised, when I looked at a year to date chart a couple of minutes ago and saw that INTC has outperformed the S&P during 2011 (based on price action in July).  On a one year view, INTC is a substantial laggard, though.

The bearish case, as I understand it, is that INTC is a child of the PC generation.  That time is past; INTC has been displaced by ARMH in the new tablet/cellphone era.  Therefore, no matter how good earnings are today, they will inevitably decline.  And, as these situations typically develop, the falloff will be sooner than you think and very rapid.

An implicit assumption is that INTC will be unable to adjust.

The bullish case is a little more complicated.  It’s that:

–servers for general corporate needs and for cloud computing will remain booming businesses

–corporate users and consumers in the developing world will ensure that the traditional PC business will be at least stable, and won’t decline precipitously

–at 9x 2011 eps ( and 8x? 2012), and with a dividend yield higher than a ten-year Treasury, all but the most bearish outcome is already baked into the INTC stock price

–it’s possible that some combination of INTC’s chip innovation and the success of MSFT products in the cellphone and tablet markets will enable INTC to transition its consumer business in the developed world to the post-PC era.

I own INTC; I’m in the bullish camp; but I’m somewhat concerned that I’m simply tuning out the (negative) message that the stock price has been sending out for a long time.  I still think, however, that if the developed markets consumer business disappeared tonight and tomorrow INTC appeared as a fast-growing cloud computing and emerging markets play the stock would be a lot higher than it is now.  So for now I’m content to wait.

—

AAPL’s eye-popping 3Q11

July 20, 2011 By in Current Market Thoughts, earnings conference calls, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , 2 Comments

the results

AAPL reported earnings for its fiscal 3Q11 (the company’s fiscal year ends in September) after the close of trading in New York yesterday.  Sales came in at an all-time high for the company at $28.6 billion.  That’s up 82% over 3Q10.  Net income of $7.3 billion ($7.79 a share) was another company record and represents 125% more than in the comparable period of last year.  Analysts had been expecting eps of $5.85.

the details

All the company’s product categories showed interesting deviations from what one might have expected:

iPad  …the biggest positive surprise.  iPad was over 20% of AAPL’s revenue in the quarter, in which the company sold 9,246,000 of them.  Sales were up 97% quarter on quarter in units and 113% in revenue.  Year on year, units were up 183% and revenue 179%.  The iPad continues to be capacity constrained, meaning AAPL is selling them as fast as it can make them and still can’t satisfy demand.  With manufacturing capacity added in early July, the company appears to be close to supply-demand balance, however.  My hunch is that there’ll be a strong seasonal uptick in the December quarter as consumers buy holiday gifts.  If so, we may see shortages again in a few months.

iPhone  …another big number.  The company sold 20,338,000 in the June period.  That’s up 9% in units and 8% in revenues qoq, and +183% in units, 179% in revenue, yoy.  A continuing surge in smartphone sales, combined with the fall from grace of both NOK and RIMM, are the main reasons.

Mac   Overall sales were up 5% in units qoq and 14% yoy.  Portables, however, were up only 1% qoq and 13% yoy.  One reason is the strength in the prior-year quarter, which saw a new MacBook Pro introduced.  Another, however, is that some customers are buying iPads instead of Macs.

iPod  …sales dropped sharply.  This shows how far APPL has evolved in the past half decade.  The product that sparked AAPL’s revival and effectively doubled the size of the company now represents less than 5% of current total revenue.  Management said the 7,535,000 units AAPL sold in the quarter exceed its expectations.  But qoq units were down 16% and revenue down 17%;  year on year, units were down 20% and revenue minus 14%.

what caught my eye/ear

1.  The company conference call seemed to me to be almost devoid of content.  Maybe it’s always been this way and the fact just hasn’t struck me so forcefully.

2.  Analysts did ask two interesting questions, both of which the company evaded.

–The first concerned the relative strength of Android-based phones, which appear to be growing faster than iPhones.

–The second was about whether the iPad is cannibalizing Mac sales to a greater degree than it’s cannibalizing Windows-based machine sales.

The non-answers suggest two things to me.  First, the ability of Android phones to cover a wide spectrum of price points, vs. AAPL only at the high end, is a bigger competitive issue for AAPL than the consensus thinks.  Second, while it’s always better to cannibalize your own sales than to allow a competitor to do so, it sounds like more potential Mac buyers than AAPL expected (maybe MacBook Air buyers) are “trading down” to an iPad instead.

3.  Look at the difference between analysts’ estimates and AAPL’s actual reported eps for fiscal 2011 to date.

1Q:   $5.40 estimate, $6.43 actual

2Q:  $5.37 estimate, $6.40 actual

3Q:  $5.85 estimate, $7.79 actual

Actuals were 19%, 19% and 33% above what analysts had projected.

Two points:  analysts have been pretty awful–and unusually so–at projecting AAPL’s earnings this year.  Also, despite the big positive earnings surprises, huge earnings growth, and a price earnings multiple in the mid-teens, AAPL has been no better than a market performer in 2011, until a couple of weeks ago (more about this phenomenon in a day or two).

the stock

The numbers continue to be stellar and the PE is low, so I think AAPL will continue to be at least a mild market outperformer.  For the first time in many years, however, I don’t feel that I can pencil in an aggressive earnings growth number for the upcoming fiscal year and be confident the actuals will be at least what I’ve estimated…and probably substantially more.  In fact, if you told me you thought AAPL’s eps would only be up by 15% in fiscal 2012, I’d have to do a bunch of spreadsheet work before I could express an opinion.  (Note, too, that AAPL is making a minor accounting change that will depress near-term results slightly.)

That shouldn’t be so surprising, since the stock (I haven’t owned it for some time) is up 30x since I first bought it, and is now one of the largest-cap stocks on Wall Street.  Could this maturing of AAPL’s business be what Wall Street has been discounting for a while now?  In conceptual terms, probably.  Myself, I think the inflection point for growth is a new thing–but it’s possible I’ve just been behind the curve.

there are hard-core digital gamers, lots of them

June 28, 2011 By in Industry Analysis, Stock ideas, Technology, Video games Tags: , , , , , , , 2 Comments

shrink-wrapped software–yesterday’s story

In the heyday of shrink-wrapped video game software, the dominant companies, like Nintendo, Electronic Arts and Activision, had three key advantages other than engaging original content. None were well understood by Wall Street.  They were:

–these firms owned/controlled the strongest distribution networks

–like other entertainment forms, fans restocked their inventories with titles in the newest format.  So they enjoyed a big surge in sales growth every four or five years as a new generation of game devices was introduced, and

–perhaps the key competitive advantage, the industry spawned a group of intense users of their products, maybe 300,000 strong in the US and an equal number abroad.  These hard-core gamers could be counted on to buy almost any well-crafted game.

hard-core users

How important was this group?  If you figure that the wholesale price of a shrink-wrapped game would be $40, and that it would be a hit only in the US or only abroad, then you could be very confident of generating revenue from a good game of about $12 million from the hard-core group.  Until the past few years, when game development costs spiraled up over $20 million, that meant that a well-made game would be highly profitable even if no casual gamers bought it.

social gaming

Enter simple games, cheap to develop and delivered either through social networking sites or through cellphones.  My assumption, and that of Wall Street, I think, has been that these gamer players are by and large casual fans who dabble but don’t get very involved in game play.  Maybe it’s just that the games are relatively simple and don’t require the lightning reflexes most hard-core shrink-wrapped gamers display that fosters this belief.

It turns out, however, that that’s not so, at least according to a recent survey by market researcher NPD.  In fact, there is a large group of hard-core mobile and social networking gamers.  These gamers bear more than a passing resemblance to their hard-core console gaming counterparts.  For example:

–avid console gamers spend 18 hours a week (yes, that’s right) playing; their digital counterparts spend 16 hours

–hard-core console players buy 5.4 games a quarter; digital gamers buy 5.9.

One big difference between the two groups is size.   There are presently about twice as many obsessed console gamers as there are mobile/digital ones.

A second is dollar purchasing volume, although the disparity may not be quite as high as it seems at first.  At $50 each, hard-core console gamers spend just under $1100 a year on games.  Their mobile/digital counterparts lay out only a tenth of that.  But console gamers’ net outlay can be far lower than the gross, depending on how many of their games they resell, either privately or through video game stores.

investment implications

The real question on the table, if you think there’s a chance (as I do) that social gaming will develop along the very lucrative lines of console gaming, is how to make money from the idea that digital/mobile gamers aren’t as “casual” as they may seem.  Using the shrink-wrapped game industry as a model, I think one should look for companies that:

–control distribution

–can charge by the device for use, and

–are able to attract large numbers of hard-core gamers who provide a steady stream of recurring revenue–whether by buying game downloads, microtransactions or advertising.

Ideally, this would seem to mean finding social network companies that have their own game subsidiaries.  As far as I’m aware, the only publicly traded ones exist in Japan.  The worry about companies like DeNA and Gree (I own both) is whether they will be able to exporting their very successful domestic market model to the rest of the world.  All the Japanese firms are trying, and aiming either at China or the US.  But it’s too early to tell.

 

I’m suddenly a tablet advocate: here’s why

June 15, 2011 By in e-readers, Industry Analysis, Publishing, Technology Tags: , , , , , , , Leave a comment

my take on tablets

I like gadgets.

I’ve had my eye on a tablet since I first saw one in a university bookstore (a MSFT product) almost a decade ago.  But that one was very clunky and didn’t let you do much more than highlight Word documents.  I looked at a Lenovo combination laptop/tablet a few years later, but it was very underpowered.  And there was still no infrastructure of applications to justify the tablet part.

Now there’s the iPad.  It’s the usual well-designed AAPL consumer device.  But to me it has seemed little more than another device to lug around that’s not much more than an expensive e-reader and an extremely costly way to play Angry Birds.

my newspaper problems

Then the Financial Times newspaper stopped coming to the house.

Yes, I still read the physical newspaper.

I read:

–the FT (comprehensive global business news; a UK perspective on US/world economic and political developments),

–the NY Times (reasonable, US-oriented business news, good–though weakening–sports coverage) and

–the Wall Street Journal (good sports, lots of gossip in the NY section, almost no useful business coverage–meaning I won’t renew).

why the physical paper

I’m not a fan of wood products per se.  But I’ve thought the physical paper has several advantages over the web version:

–the amount of news in the physical paper is greater than on the front page of the newspaper website.  So the editors’ selection of what’s most important is a greater influence on what you see online than in the physical paper.  As a result, the chances of finding information whose significance is not adequately understood is greater in the physical paper.

–I think the web presentation is organized to highlight stories that will maximize visits.  In contrast, the physical paper is organized to deliver information.

–I thought (not any longer) that it’s easier to reconstruct with the physical paper a timeline of information flow by reading back editions you might not have gotten on the day of publication than it is to go back a day or two in time on the website.

my call to the FT

When I called the FT last Saturday to get replacement copies of the papers that didn’t come, the representative I talked to mentioned the e-paper that’s available through ftnewspaper.com.

The site is run with software from Olive Software, a private company in Aurora, Colorado.  ftnewspaper.com has daily back editions.  You can turn the pages of each edition, just like an online catalog.  You can pop out to larger size and different formats the articles you want to read in depth.  I also discovered that, through FT email alerts, I had already read most of “today’s” paper online yesterday!

ftnewspaper.com has been around for a couple of years.  I just didn’t know about it.

my calculation

Anyway, I can cancel my physical paper subscription and save a couple of hundred dollars a year.  No more worries about cancelling delivery when we may be travelling.  No more toting around piles of unread orange newsprint.  Less recycling to do.

All of that just means that I can rationalize paying for a tablet with the money I’ll save by stopping a newsprint subscription.  But I’ve also found a sophisticated and valuable application, other than email, that’s completely suited to what a tablet can do and that I use every day.  This means that I have a positive reason to buy one.

I’d like to see the new Google tablets, as well as iPad 3, before I take the plunge.  I have only one concern.

one concern

In my career on Wall Street, I’ve observed the long struggle for control of brokerage houses between researchers and traders that has been decisively won by the latter.  I’ve thought of this as somewhat like the age-old high school contest between jocks/cool people and the nerds.

It seems to me that the same battle is going on in newspaper firms between traditional reporters and online search engine optimizers–the latter being more interested in eyeballs than in information.  As I study successful financial websites with an eye to improving this blog, I can see the same dynamic in play in this arena–well-crafted and very popular websites with lots of advertising, but almost no useful investment information.

By shifting my financial support from the reportorial nerds to the online jocks, I’m most likely speeding the day when even the FT will suffer from a content deficiency.    But that’s a problem for another day.