Masayoshi Son and Donald Trump

Masayoshi Son is the visionary entrepreneur who controls Softbank, an innovative Japanese communications and internet giant.  Several years ago, Softbank gained control of the US wireless company Sprint.  Mr. Son’s intention was to buy T-Mobile and merge the two, creating a third large national wireless company able to compete with ATT and Verizon.

The Obama administration vetoed the combination on antitrust grounds.  On the surface, this made sense, since the number of competitors in the US market would be reduced from four to three.  On the other hand, the relative market shares of #3 and #4 ares small enough that they have not made much difference in how the two giants operate.  Also, Mr. Son entered the Japanese wireless market in the same fashion, piecing together a national network out of smaller firms. Then he disrupted the existing oligopoly through very aggressive, consumer-friendly, price competition.  He created competition–and much lower wireless bills–where there had been none before.

His intention is to do the same in the US market.  From where I sit, government disapproval of the proposed merger of Sprint and T-Mobile stifled competition rather than promoting it.

My guess is that Mr. Son will have better success explaining his motives to the Trump administration.  A Sprint/T-Mobile combination would likely be good for us as consumers of wireless services, but bad for the incumbents, ATT and Verizon.

Softbank and ARM Holdings

a brief history of Softbank

Softbank is a Japanese company incorporated in 1981.  It has a non-establishment CEO, Masayoshi Son, notoriously opaque financials and a reputation as a maverick in its home country.  The company’s earliest successes came as an investor partnering with international internet companies entering Japan, like Yahoo and eTrade.  It was also an early supporter of now-huge Chinese internet businesses.

In 2006, it became an active business owner, entering the Japanese cellphone market by acquiring Vodafone’s network.  It revolutionized that business in Japan by rebranding as Softbank Mobile and launching a very successful discount cellphone service.

In 2012 it decided to employ the same strategy in the US, buying a controlling interest in Sprint.  Softbank appears to me tohave made the bold $21+ billion commitment thinking it could build a viable nationwide network by merging Sprint with T-Mobile.  Anti-trust regulators prevented that from happening, however, leaving Sprint in its current weak position and Softbank with a mess.

About a year ago, perhaps chastened by his Sprint error, Mr. Son announced he was stepping down as CEO and hired his apparent successor, Google executive Nikesh Arora.

Late last month Mr. Arora, who had been working to reduce Softbank’s financial leverage through asset sales, announced he was leaving the company, and Mr. Son that he was now planning to remain as CEO for perehaps ten more years.

This weekend we learned why–Softbank announced that Arm Holdings, the UK-based chip design firm, had accepted its all-cash bid of £24 billion ($32 billion), a 40%+ premium to its Friday close in London.

which Son is making this purchase?

Is it the prescient buyer of Alibaba and Vodafone Japan?    …or is it the sorely disappointed purchaser of Sprint?  Mr. Son is apparently arguing that development of the Internet of Things will generate a surprisingly large explosion of licensing fees and royalties for Arm.

More tomorrow.

on the Apple Watch

Yesterday, AAPL formally introduced its new Watch, which “was designed with a deep reverence for fine watchmaking,” and which has “a beauty that is both timeless and thoroughly modern.”

It comes in aluminum, stainless steel and 18-karat gold versions so far.  The first costs $350;  speculation is that the last will go for $10,000+, maybe $10,000++.

Analyst and media comment has focused on three points:

–smartphones have replaced watches to some degree, particularly with younger people, so it isn’t clear how big the market is

–the Watch is fully functional only when tethered to an iPhone, so Android users need not apply, and

–AAPL now gets,say, 60% of its revenue and 75% of its operating profit from cellphones.  Whatever its success, the Watch will just be a drop in the bucket.

I think the Watch is more important than that.

I think it’s an experiment, imitating something Nokia did almost two decades ago.

In its heyday, Nokia sold a small number of luxury cellphones, initially under its own name, later under the Vertu brand (long since spun off).  Although Nokia didn’t call much attention to Vertu, it represented maybe 5% of Nokia’s unit volume but (my estimate) around 25% of its profits.

Two implications, if the high-end Watches sell well, which I expect they will:

–AAPL’s Watch profits will be much higher than is generally expected, although they will probably remain in the drop-in-the-bucket category. More important, though,

–if very upscale Watches work, meaning they amount to 5% of unit volume, why wouldn’t $10,000+ iPhones work, too?

ARK Investment Management and its ETFs

ARK

I was listening to Bloomberg Radio (again!?!) earlier this month and heard an interview of Cathie Wood, the CEO/CIO of recently formed ARK Investment Management.  I don’t know Ms. Wood, although we both worked at Jennison Associates, a growth-oriented equity manager with a very strong record, during different time periods.  Just before ARK, she had been CIO of Global Thematic Strategies for twelve years at value investor AllianceBernstein.  (As a portfolio manager I was a big fan of Bernstein’s equity research but I’m not familiar with her Bernstein output.)  She’s been  endorsed by Arthur Laffer of Laffer Curve fame, who sits on her board.

ARK is all about finding and benefiting from “disruptive innovation that will change the world.”

Ms. Wood was promoting two actively managed ETFs that ARK launched at the beginning of the month, one focused on industrial innovation (ARKQ) and another the internet (ARKW).  Two more are in the works, one for genomics (ARKG) and the last (ARKK) an umbrella innovation portfolio which will apparently hold what it considers the best of the other three portfolios.

What really caught my ear in the interview was Ms. Wood’s discussion of the domestic automobile market (summary research available on the ARK website).  Most cars lie around doing nothing during the day.  What happens if either ride-sharing services like Uber or the Google self-driven car, which make more constant use of autos, catch on as substitutes?  According to Ms. Wood, until these innovations reach 2.5% of total miles driven (based on the idea that on a per mile basis ride-sharing costs half what owning a car does), there’s little effect.  But at 5% penetration, the bottom falls out of the new car market.  New car sales get cut in half!

Who knows whether this is correct or whether it will happen or not   …but I find this a very interesting idea.

about the ETFs

The top holdings of ARKW are:  athenahealth, Apple, Facebook, Salesforce.com and Twitter.  These comprise just under 25% of the portfolio.

For ARKQ, the top five are:  Google, Autodesk, Tesla, Monsanto and Fanuc.  They make up just over 24% of the portfolio.

Both will likely be high β portfolios.  Both have performed roughly in line with the NASDAQ Composite since their debut.

The perennial question about thematic investors (I consider myself one) is whether the high-level concepts are backed up by meticulous company by company financial research.  This is essential.  In addition, it’s important, to me anyway, that the holdings be arranged so that they’re not all dependent on a single theme–the continuing success of the Apple ecosystem, for instance.

I’m not familiar with Ms. Wood’s work, so I can’t say one way or another (Fanuc and ABB strike me as kind of weird holding for ARKQ, though).  But I think her research is worth reading and her ETFs worth at least monitoring.  For us as investors, the ultimate question will be whether Ms. Wood can outperform an appropriate index.  The NASDAQ Composite would be my initial choice.

 

 

 

 

 

earnings calls: Apple (AAPL) vs. Microsoft (MSFT)

Last night after the market close, AAPL reported earnings per share that beat the consensus of Wall Street analysts–and the stock went down in the after-market.  MSFT, in contrast, reported results that fell short of analysts’ estimates–and the stock went up!

What’s going on?

AAPL gave next-quarter guidance that fell below Wall Street’s projection–but it always does this, so that’s not the reason.  MSFT’s income statement looks better after factoring out the large operating loss generated by Nokia, but I don’t think that’s the reason for the market’s positive response, either.  After all, if you wanted to (I didn’t), you could have gotten a reasonable guess at how much Nokia would subtract from the MSFT total from Nokia’s recent results as a stand-alone company.

I think the market’s response is much more a a conceptual response.

Tim Cook has made it clear that AAPL is a manufacturer of high-end mobile consumer technology.  There’s no “next big thing” on the horizon, however, with only a periodic refresh of the company’s smartphone line due any time soon.  If reports from suppliers are accurate, new offerings will include a phone with a large, Samsung Galaxy-matching screen size, and a(n even larger) tablet/phone.  For Jobs-ites, this departure from Steve’s view that phones should be small enough to operate with one hand may be earth-shaking.  But for the rest of the world, this is only catching up to what Samsung already has on the market.  So a ho-hum Wall Street response is appropriate.

For MSFT, on the other hand, the news is relatively better.  The company seems to have a focus for the first time in a long while.  The fact that Nokia is putting up operating losses at a near-$3 billion annual rate seems to me to justify the downsizing MSFT has recently announced.  The only surprise is that this wasn’t started sooner.

Leaving the X-Box content creation business is probably more symbolic than anything else, but it removes a potential distraction–especially given the continual mess the company has typically made of its game software development efforts.

One, admittedly small, figure what caught my eye was that MSFT has added another 1,000,000 individual/small business users to its Office 365 rolls during the June quarter.  I think this just shows the power of the cloud–easier administration, much lower cost-of-goods expense, and hugely better protection against counterfeiting.

For MSFT, then, the earnings were nice, but the fact that the company’s board is allowing significant changes is nicer.  True, the message may turn out only to be that the company will try harder not to shoot itself in the foot again, but even that’s an uptick.  Hence the positive market response.  Absence of missteps won’t be good enough for long, but it’s ok for now.

a short reprise of the Zynga (ZNGA) IPO

King Digital Entertainment, PLC  is the maker of the fabulously successful mobile-centered game Candy Crush Saga.  The firm has filed a form F-1 in preparation for an IPO.  King (proposed ticker: KING) intends to raise around $500 million.

Not surprisingly, the KING offering has reawakened bad memories of the 2011 IPO of ZNGA, which was led by Morgan Stanley and Goldman (no shock, either, that neither of those firms has a role in the KING IPO).

I haven’t yet read the KING offering document.  It’s possible that I won’t.  But I still thought it might be useful to look back at the characteristics of ZNGA that, in my view, made that stock an unattractive investment from the start.

1.  Virtually all the traffic coming to ZGA’s games was generated by Facebook.  This made it difficult to tell whether ZNGA’s games were successful because they were great games, or because they were being featured on FB.  If the latter–which subsequently proved to be the case–FB held the economic power in their partnership.  Any lessening of FB’s marketing efforts would quickly translate into a reduction in ZNGA’s profits.  A big weakness of ZNGA, not a plus.

2.  A reasonable way of assessing social games is to measure:

–the time needed to reach the peak number of players,

–the number of peak users, and

–the rate at which the number of users fades from the peak.

Even prior to the IPO, ZNGA offerings launched after its signature game, Farmville, were peaking faster than Farmville, and at lower numbers of users than Farmville.  In addition, they were as fading from the peak more quickly.  In other words, none of them had anything near the oomph of Farmville. This was all bad news.

3.  The actions of  the lead underwriters, both before and after the ZNGA IPO were quite odd, in my view.

For one thing, according to the New York TimesMorgan Stanley mutual funds bought  $75 million worth of pre-IPO shares of ZNGA in February 2011 at $14 a share.  Some have suggested that this was done to help persuade ZNGA to choose Morgan Stanley as a lead underwriter.

For another, the underwriters released the top management of ZNGA, as well as some venture capital investors, from IPO share “lockup” agreements that prevented their sale of stock prior to May 29, 2012.   Instead, a sale of 49,4 million shares at $12 each raised close to $600 million in early April for these high-profile holders.  By the original lockup expiration, the stock was trading at little more than half that level.

My overall impression is that the underwriters (incorrectly) thought that the heyday of tech investing was over.  This would imply that they and the companies they were moving to initial public offerings had only a short time to cash in before the rest of the world figured this out.  As a corollary, the traditional rules of trust and fair play between underwriter and professional portfolio manager/wealth management client no longer held–because there would be no follow-on business that once-burned clients would shy away from.

relevance for KING?

Again, I should mention that I haven’t yet analyzed KING.  Candy Crush Saga may well prove a fleeting fad and KING a one-trick pony.  On the other hand, the underwriters are different this time.   And I don’t sense the same IPO-before-it’s-too-late urgency that was in the air in 2011.

Apple (AAPL) today

the stock vs. the company

the company

As a company, Apple has in most respects followed the typical pattern for businesses of high-flying growth stocks.

The company stabilized itself as a computer maker, after a brief flirtation with bankruptcy, with the return of Steve Jobs as CEO.  It took a chance on making the iPod, which a geeky DJ apparently brought to it.  That produced a series of big profit increases that lasted several years and doubled this size of the company.  Just as the iPod wave was cresting, Apple reinvented itself again, as the iPhone company.  Another huge profit surge followed, which crested as the global market for expensive smartphones matured.

Yes, Apple has reinvented itself again as the iPad company, but each blockbuster must be progressively larger to move the profit needle for a firm whose income has grown exponentially over the past decade.  The iPad doesn’t have enough oomph to do so.  Heartless as it may seem, Apple has gone ex-growth.

Look at IBM, or Oracle, or Cisco, or Wal-Mart  …or, on a smaller scale, the Cheesecake Factory or Chicos or PF Chang.  Same pattern.

the stock

What has been strange about Apple has been the behavior of its stock.  Typically, as a company’s earnings begin to accelerate, the price-earnings multiple begins to expand as well.  So the positive effect of the earnings growth is magnified.  When (or just before) earnings growth beings to disappoint, as it sooner or later will the PE begins to contract.–and the stock plunges.  Timing this shift is the key issue for growth investors.

Not so much with AAPL.  Its PE peaked in 2008, four years prior to the peak in earnings (which were, by the way, almost 8x the 2008 level).  The multiple contraction has been pretty continuous, moving from 30x ( and 1.8x the market multiple) in 2008 to 12.3x (and a .7x relative multiple) for 2013.

an investment thesis

Growth investors, who are searching for the next AAPL, have abandoned ship andgone elsewhere, leaving the field to their value counterparts.

For value investors, I think the key question revolves around the PE.  When growth stocks fall from grace, the multiple typically contracts severely–and over a long period of time.  The decline ends in an overreaction on the downside.

Looking at AAPL,nine months of stock price pain (late 2012 – mid-2013) would be unusually short period of time.  But, then, the AAPL multiple has already been contracting for five years.

Although I’m not a value investor (read: although I’m no good at making these judgments), my sense is that the AAPL PE is too low.  I don’t feel an overpowering urge to buy the stock.  But 10% earnings growth + one point of multiple expansion this year doesn’t sound so bad, either.