Square, venture capital and the late-1990s Internet bubble

a bubble deflating

Internet payments company Square came to market yesterday.  It has a two-letter symbol, SQ, and trades on the NYSE, not NASDAQ.  But the most salient fact about the offering is that the IPO price was a lot below the private market value that venture capital investors had placed on SQas little as a year ago.

At the same time, the small number of mutual funds which have been aggressive venture capital buyers in Silicon Valley have been, more or less quietly, writing down the carrying value of their non-public company holdings.

What we’re seeing is, I think, a smaller and much more benign–both for the economy and for us as stock market investors–analogue of the deflation of the Internet mania of the late 1990s that started in early 2000.

the late 1990s and the internet

I remember noticing in 1998, that earlier- and earlier-stage companies were coming to market successfully.  Some were little more than concepts.  Take Amazon (AMZN), for example, which IPOed in mid-1997.  The pre-offering roadshow that I saw emphasized that investors had made gigantic fortunes on buying unknown companies like Microsoft during the personal computer era and that AMZN was a lottery ticket to a similar outcome in the Internet Age.  Of course, even a success like AMZN didn’t turn profit for its first eight years as a public company, surviving on the proceed from the IPO and follow-on debt offerings.

I thought at the time, and unfortunately committed my theory to writing, that we were seeing a fundamental change in the role of the stock market in capital formation.  Portfolio managers were gradually taking on the role previously played by venture capital.  So, I mused, managers of mutual funds like me might have to think about reserving a small place–no more than, say, 5%–of their portfolios for developing companies that they normally wouldn’t have touched with a ten-foot pole.

Not my finest intellectual hour.

today’s bubble deflation

The slow escape of air from the venture capital bubble that is now going on will not have much effect on publicly traded companies, I think, for several reasons:

–the amount of money involved in this speculation is much smaller

–investors of all stripes still wear the scars of 2000-2001, so they haven’t been anywhere near as crazy this time around

–the people who are losing money now are, or represent, wealthy, seasoned speculators, not retail investors

–maybe most important, much of the original internet froth surrounded highly capital-intensive efforts to build a global physical internet transport infrastructure.  Names like Global Crossing and Worldcom come to mind.

Yes, too much physical capacity did get built back then, and some builders were highly financially leveraged.  But also dense wave division multiplexing, a technological breakthrough in technique (basically, putting glorified prisms on each end of a cable), made it possible for each fiber optic strand to carry 2x, 4x, 8x, 16x ( in 2015 the number is 240x)…  more traffic than initially anticipated.  Thanks to DWDM, suddenly, despite the rapid growth of internet traffic, an acute shortage of signal transport capacity turned to mind-boggling glut.  The transport industry was facing collapse as customers played a ton of potential suppliers against each other for lower prices.  Naturally, new construction–and related orders for all sorts of high-and low-tech components, dried up completely.   So did investment, employment in civil engineering   …and the stocks.

In today’s software world, there’s no equivalent, other than perhaps the market for software engineers.  And there are no signs I can see of recession in this arena.  Quite the opposite.


failing toll roads in the US-why?

I’m convinced that studying the behavior of Millennials –and in particular how it differs from previous generations’–will ultimately produce a treasure trove of equity investment ideas.

So my ears perked up when I began noticing recent reports of continuing failure of toll road investment projects that had been in vogue ten years or so.  Many were packaged by Australian investment bank Macquarie and/or Spain’s Ferrovial.

Chapter 11 filings have been attributed in the media to a sharp slowdown in total miles driven by Americans since 2007 (“…largest decline since World War II,” said one article).  Millennials’ aversion to autos and the suburbs are the supposed causes.

A quick check shows that’s not exactly right.

The Federal Highway Administration’s monthly Traffic Volumes Trends indicates that total miles driven by Americans has fallen from the peak of 3.03 trillion miles in 2007.  But the present level is still 2.98 trillion, a seven-year decline that totals only 1.65%.  Yes, this is a change from the pretty steady rise of just over 1% annually during the prior couple of decades.  But it’s hard to image that worst-case planning didn’t allow for a flattening out of traffic volume.

Two other characteristics of these deals stand out to my, admittedly cursory, glance, as being much more important:

–they’re very highly financially leveraged, and

–they contained a ton of derivative protection against rising interest rates–which backfired horribly, adding significantly to the already-high debt burden.

The deals also appear to have suffered from wildly overoptimistic projections of future road usage, although these were likely less linked to project survival and more to the possibility of above-average gains.

In any event, my main point is that this is not a story of differing Millennial behavior.  It’s all about bad project design and mistaken derivatives overlays.




the Tesla (TSLA) convertible issue

The new TSLA convertible issue came to market yesterday.  Demand was so strong that the company raised an extra $400 million in seven-year notes (yield = 1.25%), bringing the total amount raised, before underwriting fees, to $2.0 billion.  That breaks out into $1.2 billion in seven-year notes + $800 million in five-year (yield = 0.25%).

The conversion premium is a whopping 42.5%!

If the underwriters exercise their overallotment, the total will rise to $2.3 billion.  (The underwriters actually sell more securities to their customers in an offering than the headline amount.  They use this extra to absorb any selling by buyers who intend to “flip,” or sell quickly.  The idea is to stabilize the issue price during the period immediately following the offering.  Sounds weird.  Yes, it’s price manipulation.  Yes, it’s legal.  In this case, the overallotment is $300 million.)

Clearly, no one is in this issue for the interest payments.   It’s all about possible capital gains if the TSLA price can rise by more than 42.5% before the bonds mature.

Tells you something about what bond managers think the prospects for straight bonds are.

At the same time, the issue proceeds take TSLA’s gigafactory–which will ultimately enable the company to sell 500,000 cars, it says–out of the realm of pie in the sky.  Say the company can make $2,000 in profit per car (a number I plucked out of the air).  That would mean that TSLA could be earning $1 billion a year by, say, 2020 – 2021.  At a price of $250, TSLA is currently trading at 30x that figure.  To me, this means two things:  buyers must have a rosier future than this in mind for TSLA, and academics who insisted that at $80 a share TSLA was priced for perfection (>10x earnings at maturity) had no idea what they were talking about.

As a practical matter, anyone who thinks the company will make $5000 per car would at least be content to hold.  Is that possible?  I don’t know.  As I mentioned yesterday, if I hadn’t sold too soon, I’d be selling now.

good news from Harley Davidson

the results

Harley Davidson (HOG) reported 2Q11 earnings before the New York market opened on July 19th.  EPS came in at $.81, a gain of 37% year on year, on revenues that were up by 18%, at $1339.7 million.  The Wall Street analyst consensus for HOG was $.71.

In contrast to most of the companies I’ve been watching, whose stocks have either shown little positive reaction–or gone down–after big positive earnings surprises (look at WYNN or AAPL), HOG shot up about 9% on this news, capping a run that has seen the stock rise 50% since mid-June.

the turnaround

HOG is an intriguing turnaround story, with three elements to new management’s plans:

–recovery from very serious damage done by the recession

–broadening the customer base beyond American males who watched Easy Rider as a first-run film, secretly love the Grateful Dead and need the extra stretch HOG puts in its tee shirts to accommodate seriously expanded waistlines, and

–overhauling inefficient manufacturing and distribution.

I’m not sure that at today’s price you’ll make a lot of near-term money in the stock.  I don’t own HOG now, though I owned it for years in a small-cap portfolio I once ran (despite the fact that I consider a US company having a ticker symbol that spells a word to be a serious red flag).  I did think about buying the stock after good 1Q11 results, but decided I had enough risk in my personal portfolio without it.

Anyway, what interests me most about HOG’s 2Q earnings report is what it says about the current state of the US economy.

a little history

Like a motor boat, or a two-seater sports car, a motorcycle–especially an expensive one like a Harley–is not a very practical purchase.  The riding season is short in many parts of the country and rainy weather turns a ride into an unpleasant experience for most people.  Sales of any of these vehicles are highly sensitive to the state of the economy.

During the boom years in the middle of the last decade, lots of people were feeling wealthy enough to buy Harleys.  Many got financing from HOG.  As the recession developed, a large number of these new owners couldn’t afford their payments any more and turned the keys back over to Harley.  This had two bad consequences for HOG:  demand for new bikes dried up; and dealers’ lots were flooded with tons of repossessed next-to-new used motorcycles that needed heavy discounting to be resold.  That depressed prices across the board.

Pretty ugly.

the sound of a corner turning

What caught my eye about HOG’s 2Q11 earnings report is that, for the first time since late 2006, retail sales of new motorcycles are up year on year in the US–by 7.5%.  Dealer inventories are below normal.  The credit experience in HOG’s financing arm has been improving for four quarters–although this is probably mostly a function of better underwriting.  And the company has raised its projected shipment numbers for the second half.

This is certainly welcome news for HOG.  More important to me, the increase in demand for new motorcycles seems to show that consumers are more confident, and that therefore the US economy is on a sounder footing, than the consensus realizes.



the Fedex 4Q11 earnings report: blue skies ahead

the results

FDX reported quarterly results for its 4Q11 (the FDX fiscal year ends in May) before the start of trading in New York yesterday.  The company posted earnings per share of $1.75, up 31.5% year on year, on revenues of $10.6 billion, a 12% gain vs. sales in the fourth quarter a year ago.  The numbers, which Wall Street typically forecasts with a very high degree of accuracy, exceeded analysts’ eps estimates by $.04.

eye-popping earnings guidance for fiscal 2012

In the same earnings release, FDX gave its initial earnings guidance for 1Q12, as well as for fiscal 2012 as a whole.  For the full fiscal year, the company expects to earn $6.35-$6.85 per share;  for 1Q12 it thinks it will have income of $1.40-$1.60. Taking the midpoint of both ranges, that would imply profit growth for the full year of about 35%, and for the first quarter of about 25%.

These are eye-popping numbers.  They reflect:

–the strength of FDX management,

–the company’s high gearing to world trade, which responds in a high-beta way to world economic growth, and

–FDX’s significant exposure to international markets, which the company thinks will approach half of total revenue, and represent the majority of the firm’s profits, this year, for the first time in its history.

the stock

Let’s say the earnings guidance signals that FDX really thinks $7 a share is within reach for the fiscal 2012.  That would imply that the stock is now trading at around 13x forward earnings, or a slight premium to the market.

I’ve owned FDX on occasion over the years.  My overall take is that the management is excellent, but that the stock is so widely followed and respected that it seldom trades at a bargain price.  My first instinct is that the shares do look cheap today.  But glancing at the issue’s multiple relative to the market during the past decade, this is about where FDX normally trades.  So I’m sitting on my hands for the moment.

the FDX economic outlook

Transport and logistics companies are interesting in themselves.  But there’s also a second reason they’re so widely watched.  Because they have such intimate knowledge of the production plans of their customers, they have an unusually good understanding about how the economy is faring in the areas where they operate.  With its long experience, and its position as the premier global air transport firm, FDX has a particularly advantaged view.

Here’s what it’s expecting over the coming twelve months:

–“moderate” economic growth, with the rest of the world doing better than the US,

–acceleration of growth as the year progresses.  Why?

ο  FDX thinks that 40% of the current “soft patch” is due to the the negative effects of the earthquake/tsunamis in Fukushima during March.  The company can already see activity picking up, however.

ο  Higher oil prices caused another 40% of the slowdown, in FDX’s view.  The oil price has been falling for two months, however, in large part because consumers have reacted by using less.  FDX expects oil to stay at today’s level or lower–exhibiting the same behavior it has in similar circumstances in the past.

ο  The remaining 20% is negative sentiment, based on the previous two factors.  FDX expects sentiment will gradually recover as consumers see supply-chain recovery in Japan and lower petroleum prices.

my comments

Two things strike me about the FDX report.  First, the company’s economic forecast sounds very much like the one Fed Chairman Bernanke outlined yesterday.  Second, even a so-so economic environment is enough to allow well-managed companies to make very large profit gains–implying good stockpicking will be well-rewarded in the current environment.




the Fedex 2Q11 (ended November 30th) results

the results

Yesterday I listened to the FDX 2Q11 earnings conference call, which was held before the market opened in New York last Thursday.

FDX reported earnings of $1.16 a share on revenues of $9.63 billion.  The revenues were up by 12% year on year, the eps less than half that.  Earnings per share also just barely hit the bottom of the range of $1.15 – $1.35 that FDX guided analysts to when it reported 1Q11 results on September 16th.

Despite the close call, FDX raised its guidance for the full fiscal year from a range of $4.80 – $5.25 a share to a new range of $5.00 – $5.30.

The company did caution that its third fiscal quarter is always vulnerable to bad weather, of which the midsection of the US has already had plenty so far this month.  So it’s not yet clear what the quarterly breakout of the earnings will be.


The International Priority (IP) business, notably deliveries from Asia to the US, continued to grow rapidly, with revenues expanding by 14% over a year ago.  Notably, the domestic parts of the FDX distribution chain grew at about the same rate, and benefitted from improved operating efficiencies.

So what went wrong?

1.  After what was reported as only three hours of deliberation, a jury in Indianapolis awarded now-defunct airline ATA $65.9 million in its suit against FDX that it wrongfully terminated a long-term contract with ATA to transport US troops.  A reserve for this judgment–FDX said nothing on the call about a possible appeal–clipped about $.15 from eps.  That’s also the main reason the IP business had flat year-on-year operating income.

2.  FDX overestimated the strength of the IP business during the second quarter.  It extrapolated the frantic rate of shipment growth of the spring and summer into the fall.  But that didn’t happen.  Revenues in the IP segment grew by 23% y-o-y in 1Q2011 after an almost 30% gain in 4Q10–but decelerated to 14% growth in 2Q11.  (True, comparisons are affected by the fact that FDX’s business really began to pick up from recession lows in the second quarter of last fiscal year.  But FDX guidance still anticipated better than what it got.)

3.  FDX is now projecting a better full year than it was three months ago.  I’ll get to this in a minute.  Because of this, it is also projecting bigger bonus payments to employees than it was.  Therefore, it made a higher provision for bonuses in 2Q, and presumably also had to make a catch-up accrual for 1Q.  FDX mentioned this as a factor but gave no further details.

why the slowdown in the international business?

In ordering from suppliers, a merchant faces two complementary inventory risks:

–he can order what he is confident he can sell plus some more, and risk the expense of holding excess inventory for longer than he wants or selling it at clearance prices, or

–he can order only what he knows for sure will sell–or maybe less, and risk losing business as customers come into the store and find the shelves bare.

FDX wasn’t 100% clear on the point, but it seems to believe that retailers got cold feet as they planned for the holiday selling season.  They collectively made the cautious decision that the risk of being out of stock was much more acceptable than the risk of having excess inventories.  So they slowed down the pace of their new orders from Asia.

They are now finding out, too late to do anything about it, that customers are in a much better spending mood than anticipated.  As a result, store inventories will be severely depleted by the end of December.  This means, in FDX’s view (I think they’re right) that there’ll be a mad rush to restock early in the new year.  That will be very good for FDX.

In addition, FDX clearly believes that world economic growth is beginning to gain momentum and will continue to do so for at least this year and next.

my thoughts

I haven’t done enough work on FDX to have an opinion about it as a stock.  Clearly, earnings are going to improve, both as the global economy expands and as the costs of resuming normal operations–restoring pay and benefit cuts for employees and reactivating planes mothballed in the desert during the recession–now being charges against income–fade from the financials over the next couple of quarters.  To me, the real question is how much of that good news is already reflected in today’s stock price.

Be that as it may, FDX is a large, sophisticated company.  Because of the business it’s in, it has unusually good insight into the workings of the world economy.  It sees, directly or indirectly, manufacturers’ production plans and retailers sales experience.  And it must already have a good feel for the tone of business for the next several months.  I happen to think the company’s view of world economic growth is correct.  But, unlike my guesses, theirs is based on a wealth of commercial data that few other entities have.  So I think FDX is evidence that it’s still right to be bullish.



FedEx’s first fiscal 2011 quarter (ended August 31st): stronger global growth

the FDX report

Last Thursday FDX reported strong first quarter fiscal 2011 results.  Earnings per share were $1.02 for the three months, up 108% from the $.58 tallied in the comparable three months of fiscal 2010.

FedEx also announced plans to address the loss-making freight segment by merging FedEx Freight with FedEx National LTL (less than truckload) commercial shipping operations into one unit next January.  Despite terminal closings and layoffs, FDX expects to gain market share–and profits–with the move.

FDX upped full-year earnings per share guidance from the previous range of $4.60 – $5.20 to $4.65 – $5.25, ex merger related expenses of $150-$200 million.

By line of business, operating earnings for the quarter were as follows:

FedEx Express     $357 million vs. $104 million in the year-ago quarter

FedEx Ground     $287 million vs. $209 million

FedEx Freight     -$16 million vs. $2 million.

FedEx as bellwether

Transport has a high-beta relationship with overall economic growth.  FDX’s strong earnings performance is a good indicator that economies, around the world but especially in Asia, are continuing to expand.

Express, primarily an international business, saw international package volume rise by 19% and weight by 41%, producing revenue growth of 20%, year over year.  Small, high value packages from Asia (like cellphones or iPads) are a particular strength.  So much so that FedEx has added two scheduled daily flights from Asia over the past few months, bringing the FDX total to 12.  The company will soon boost capacity again as it replaces older airplanes with new purchases.  FDX’s planes are booked through the year-end holiday season.  Load factors are the highest they’ve been in ten years.  Customers are upgrading to premium service.

Revenues for Ground, a US-centric business, were up 13% on a 7% increase in package volume.   The volume boost comes almost completely from market share gains.  In FDX’s view, the US economy is showing “slow but sustained” growth.  The shape of the recovery is “normal.”

The US LTL industry suffers from chronic overcapacity.  Too many trucks chasing too few goods–plus contracts signed when things looked bleakest last year–are the two reasons for FDX’s poor showing in its domestic Freight business.  The company thinks it sees a remedy by using advanced software to more or less replicate the structure of its international air business on the ground at home.   Hence the merger of Freight and National LTL.

The ongoing recovery of world economies is being led by the industrial sector, and by China, India, Mexico and Brazil.  From the remarks FDX management made in its conference call, it seems to me that FDX thinks the securities analysts who follow it–and by extension, American investors generally–just don’t “get” how big these countries are.  Presumably, the international business will be a major topic of the firm’s annual analyst day in Memphis in a couple of weeks.  The main idea will likely be that the developing world is growing like a weed.  In 1980, the developed world made up two-thirds of the global economy and was twice the size of the developing nations.  Within two or three years, however, the developing world will make up over 50% of global output, more than the developed countries’ GDP.

FDX as a stock

I know what the issues are but I don’t know FDX well enough to have an opinion.

1.  At present, manufacturers are controlling the distribution of products by keeping inventories centralized and shipping them at the last minute by air.  The other alternative would be to put the output on boats and truck them to their final destination from the destination port.  The former means higher transport costs but creates extra flexibility for firms to avoid sending products to places where inventories are already high and sales are unexpectedly slow.

The current situation plays to FDX’s strengths and is a financial bonanza for it.  The company strongly believes customers are not reacting to worries about an uncertain world, but are rather taking advantage of supply chain management software advances that save them money through more precise inventory control.

Sounds reasonable to be, but I don’t know.  Not good for FDX if manufacturers go back to using boats.

2.  The domestic freight business has low barriers to entry.  FDX is trying to create one by introducing advanced software to control its commercial truck freight shipments in the same way it does internationally with air.  Its marketing research says customers want the pricing flexibility the new system will provide–and that therefore FDX will be able to make more (or at least some) money with less invested capital.

I’m big on “work smarter, not harder,” so again this sounds good.  But we still have to see.

3.  Fiscal 2011 is a transition year, filled with all sorts of one-time costs.  There are:

–maintenance for previously mothballed planes now being put back in service

–capital expenditure for new planes to service booming international package demand

–higher personnel costs from health care plus restoration of salary and benefits cut during the recession

–writeoff of merger costs, estimated at $150-$200 million.

This kind of stuff happens every once in a while.  It seems to be bothering analysts, but I don’t think it’s such a big deal–especially if #1 and #2 end up doing what FDX thinks.

If both #1 and #2 pan out, FDX looks to me like a very cheap stock.