Category Archives: Technology

merger mania in the computer chip business: why?

October 16, 2015 By in Current Market Thoughts, internet, semiconductor manufacturing, Technology Tags: , , , , , , , Leave a comment

This year has been market by a spate (like that word?) of mergers/acquisitions in the computer chip industry, the latest being the potential combination of stodgy Analog Devices with Maxim Integrated Products.   Why is this happening now?

Three reasons:

–cheap financing, even though not necessary in all cases, is still plentiful.  This may not continue to be the case as interest rates in the US rise

–the cost of creating and fabricating new generations of products is becoming very expensive, to the point that some firms can no longer afford to stay independent and remain in the game

—most important, though, is the emergence of mega-customers like Apple and Samsung, or Acer and maybe even Asus, which has changed the competitive structure of the industry.  The situation now is that these few large buyers of components can play one supplier off against another to get better prices.  The only way suppliers can get any market clout is to combine.

 

One might think that this is evidence of the overall tech industry maturing, meaning that we’re entering a period of slower industry growth.  While that may be true, maturity isn’t the sole, or even the main, reason for consolidation.  When the EU was created, for example, cross-border mergers became feasible for the first time.  Small national supermarket chains combined to become EU-wide powerhouses.  For a while, food suppliers remained as small as before.  But the mammoth size of EU-wide purchase orders from the big supermarket chains became so enticing that food suppliers offered unusually high discounts to get the business.  These firms soon realized that they needed scale, both just to get the big supermarket orders and fulfill them and to streamline operations and lessen profit-destroying discounting.  The large scale of the customers forced the suppliers to scale up as well.

The economics works in the other direction, too.  Large scale on the suppliers’ part forces customers to scale up.

In the case of chip companies, I don’t see an easy way to make money right away from ongoing consolidation.  Many of the actors remain unattractive on a stand-alone basis, in my view.  Also, the general rule is that half of the combinations won’t work out, either because the principals can’t get along post-merger or an acquirer pays too much for a target.  Better to let the dust clear and try to assess the combined firms, say, next Spring.  Having said that, I do own Intel and Avago, two consolidators.

capital raising by Tesla (TSLA)

August 17, 2015 By in Autos, battery power, bond market, securities markets, Stock ideas, stock market, Technology Tags: , , , , , , Leave a comment

the offering

Last Friday, TSLA filed a final prospectus with the SEC, indicating that it is selling up to 3.099 million new shares of common stock (including underwriters’ over-allotment) at $242 a share.   This will net the company close to three-quarters of a billion dollars, which it needs to fund ambitious expansion plans–the Gigafactory to make batteries the chief among them.

I presume the precipitous decline of TSLA shares over the past ten days or so was triggered by underwriters soliciting indications of interest in this offering from hedge funds and other institutional investors.  Two bullish signs:  the offering was initially pitched as being 2.1 million shares, but raised to 2.7 million on Friday (not counting the underwriters’ allotment, which will have been bumped up as well).  As I’m writing this prior to Monday’s open, TSLA shares are trading at around $255 each.

my thoughts, (somewhat) randomly presented

  1.  TSLA made what I consider a firm-transforming offering of $3 billion in convertible bonds (at a conversion price of $350 (!!!) a share) last year.  This says something about how professional fixed income investors feel about the attractiveness of straight bonds.  More important for TSLA, the successful offering took talk of building the Gigafactory out of the realm of fantasy and placed it solidly into reality.
  2. The automobile world has changed significantly over the past year, with the plunge in oil prices and the rise of ride-sharing services like Uber.  The former may mess up the economics of electic vehicles; the latter calls into question the highly operationally leveraged corporate structure of traditional car companies (translation into English:  if they need to run at, say, 80% of plant capacity to break even, will that be possible if Millennials en masse use Uber instead of buying a car themselves.  Will the car industry be a replay of the current commodities debacle).
  3. My guess is that these shifts: (i) increase TSLA’s attractiveness to stock market investors vs. conventional car companies, and (ii) make Teslas relatively more attractive abroad, where petroleum products are more expensive than in the US.
  4. It seemed clear to me from the outset that the 2014 bond offering didn’t totally solve TSLA’s need for capital.  Another offering had to happen in 2015.  I’d expected more bonds.  Why stock instead?  Market etiquette says that a new offering should be at a higher price–here meaning a higher conversion price–than previous ones (otherwise last year’s buyers look like idiots).  Also, potential lenders periodically want companies to prove that they still have enthusiastic equity backers.  This is a combination of lenders not wanting financial leverage to be too high, their not wanting to be the only ones holding the bag if things go sour, and their knowledge that bonds are going to be under pressure as interest rates begin to rise.
  5. Last year’s offering signaled a near-term top for TSLA shares.   My instinct is to think that this offering establishes a near-term bottom.  I own a small position in the stock, however, so I may have an interest in thinking this is the case.

 

big day for Amazon (AMZN)–why?

July 24, 2015 By in Amazon, cloud services, Current Market Thoughts, Industry Analysis, internet, operating leverage, Recent Market Action, software, Stock ideas, Technology Tags: , , , , , , Leave a comment

AMZN reported 2Q15 results after the close last night.  They were very good.

Sales were up 20% year-on-year; expenses rose by 17%, three percentage points less.  As a result, the company reported an operating profit of $464 million vs. a loss in the second period of 2014.

More than that, AMZN’s cloud services division, AWS, had revenue growth of 81% yoy and a quintupling of segment profits (basically operating profits less stock option expense) to $391 million.  AWS, broken out as a separate segment for the first time after 1Q15, remained a bit more than a third of the AMZN total.

 

AMZN posted an overall profit of $.19 a share for the quarter, vs. analysts’ expectations of a loss of $.13 a share and a deficit of $.27 per share in the year-ago quarter.

On the announcement, the stock immediately rose by 15% in aftermarket trading.

AMZN opened up by 20% this morning, before drifting down steadily during the day to close +9.8% in a market that was down just more than 1%.

 

Why the strong advance?

I have no good explanation, although I do have some ideas.

1. The obvious factor that changed overnight was the earnings announcement.

It contained a significant positive earnings surprise, one that makes it more likely that the company will earn, say, $1- a share in the current year. It makes the analyst consensus of $2.78 a share for 2016 more believable.   On the other hand, the stock was trading at $482 before the earnings report, or 173x the 2016 consensus.  Looking at the stock price another way, let’s say that at maturity for its businesses (whenever that may be), AMZN shares will be trading at 20x earnings.  To sustain the pre-earnings report price, that would imply a burst of rapid growth that shoots earnings up to around $24 a share.  That would be something like a doubling of earnings each year for the next five or six.

That’s already baked in the cake.  A buyer of the stock at this level must believe that $24 a share in eventual earnings is way too low.

I find it hard to believe that a $.32  per share earnings surprise during one quarter–when expectations were already sky-high=-would be enough to add 20%, or even 10%, to AMZN’s perceived market value.

2.  A second hypothesis…

What if investors are beginning to separate AMZN into two parts, AWS and everything else, and are doing a sum-of-the-parts evaluation.  To me, this sounds a little more plausible.  What would the numbers look like?

Let’s say that in 2016 AWS will comprise half of AMZN’s earnings and AMZN Retail the remainder.  To make the figures easier, let’s say each half earns $1.50 a share next year.

Let’s assume AMZN retail can grow in earnings at 20% a year for a long time, and that we’d be willing to pay 50x current results–a big number for a retail stock–for that future profit stream.  If so, AMZN Retail is worth $75.  To reach a sum-of-the-parts value of $482, AWS must therefore be worth about $400, or close to 270x its 2016 eps.  Ok, while I personally wouldn’t be willing to pay that much for AWS, I can see how someone else might.  However, I still don’t understand why confirmation that a holder at 270x earnings isn’t insane would cause the multiple to expand.  (Also, before I’d be comfortable valuing AWS as a separate company, I’d want to know more about how AMZN apportions revenues and costs among segments to ensure the published numbers don’t flatter AWS.  I’d also think long and hard about the possible effect of stock options.)

3.  The explanation for AMZN’s rocket ship ride that I’m leaning toward, however, is more technical.  Two factors may be involved.  At what Google Finance reports as 21+ million shares, today’s trading volume in AMZN was 7x normal.  The sharp opening spike suggests to me that algorithmic trading computers were at work reacting to the earnings report, not humans.  Humans, I think (?!?), would have a better sense of valuation.  I also suspect that the report and immediate upward move triggered a lot of short covering.

I’m partial to #3 because I think the whole reaction is a little  crazy.

Why is any of this important?  AMZN is a high-profile, large-cap stock with almost two decades of operating history.  There’s got to be a way to make money from the possibility that something like AMZN’s big move will occur with other similar names.

 

 

2Q15 earnings for Intel (INTC): back to waiting mode

July 16, 2015 By in cloud services, Current Market Thoughts, earnings conference calls, Industry Analysis, semiconductor manufacturing, Stock ideas, Technology Tags: , , , , , , , , 1 Comment

the results

After the close last night, INTC reported 2Q15 results.  Revenue came in at $13.2 billion, down 5% year-on-year.  Operating profits were down by 25%.  Net was $2.7 billion, however–off by only 3%.  EPS came in at $.55, flat yoy (due to continuing share repurchases shrinking the total shares outstanding).  That figure beat the analyst consensus of $.51.

The main points, as I see them:

–cloud business was stronger than expected

–PC business was weaker, due presumably to overall GDP softness in emerging markets, especially China, and in the EU

–the overall business is shifting to higher-end, more cutting-edge products.  This is resulting in lower than expected volumes.  Higher prices and margins are offsetting this

–even though INTC is expecting a bounceback during the back half of the year from an unusually weak first six months, it is edging down its full-year forecasts slightly to account for continuing weakness is the PC market

–the 2Q tx rate was a miniscule 9.3%, compared with 28.8% in 1Q.  That’s because INTC has decided that some cash balances earned abroad and held overseas are permanently invested there and is asking the IRS for a refund of taxes previously paid on this money.  Eps would have been around $.47 at the 1Q15 tax rate.

waiting for…

–the Altera (ALTR) acquisition to close and new field programmable gate array-based microprocessor products to emerge

–world GDP to accelerate

–the product balance to shift to non-PC products (the cloud, the internet of things…) to a degree that they, not PCs, define the company

–tablets to become profitable

in the meantime

I’ve been surprised by the weakness in INTC shares over the past six weeks or so, as the extent of softness in the 2Q15 PC market has become apparent.

My picture has been that the stock goes sideways, supported by a discount PE multiple and a 3%+ dividend yield, while the company (successfully) transitions into a post-PC world.  I continue to think that this is not so bad for shareholders during a time like the present when the market in general is likely to go sideways.

The key question, for which I have no strong answer (because I’ve been thinking I still have time to formulate one), is what to do as/when economic activity begins to accelerate.  Clearly, in my mind at least, if overall corporate profits begin to rise quickly, being paid 3% to wait for future developments won’t appear to be such a good deal.  I don’t think the current weakness in INTC shares is the first inkling of this sort of shift.  But it’s something I have to consider.

 

Avago (AVGO) and Broadcom (BRCM) …and Intel/Altera

May 29, 2015 By in activist investing, mergers and acquisitions, semiconductor manufacturing, software, stock market, Technology Tags: , , , , , , , , , , , , Leave a comment

Two days ago the rumor hit Wall Street that chipmaker and serial acquirer AVGO had found its newest target, BRCM.  Yesterday the offer was announced:  cash and AVGO stock, in approximately 45/55 proportions, totaling $37 billion.

my thoughts

When customers in a given industry group become bigger and more powerful, the natural response among suppliers is to do the same.  This is part of what is going on here.  More than that, AVGO appears to seek out companies whose technological virtuosity far outstrips their management skills.  So it gains not only the marketing benefit of size but also the rewards of improving the profitability of firms whose main virtue has been their intellectual property.

What’s striking about this deal is that in revenue terms AVGO is more than doubling its size.  Although I have no intention of selling the AVGO shares I own, experience says that acquirers often bite off more than they can chew when they make the jump from small acquisitions to super-size ones like this.

One of AVGO’s rumored other targets had been Xilinx (XLNX), the junior partner with Altera (ALTR) in the field programmable gate array duopoly.  I had thought that ALTR would feel more favorably disposed to overtures being made by Intel (INTC), given the possibility that AVGO would buy XLNX and turn the firm into a much more aggressive competitor.  That threat is now gone.  INTC must now rely on pressure on ALTR management from its major shareholders (shareholders are, after all, legally the owners of ALTR and the employers of management) to return to the negotiating table.

As a practical matter, managements have a lot of autonomy, despite the fact that we the shareholders are, technically speaking, the bosses.  Wall Street seems to believe that ALTR is holding out for a higher price from INTC.  While that may be the rhetoric being used, I think the real issue is more basic.  Who would want to go from being the master of all he surveys as the top dog (and treated as a demigod) at a major publicly traded company to being a near-invisible division head in a conglomerate?