Category Archives: earnings conference calls

more thoughts on Intel (INTC)

January 22, 2013 By in earnings conference calls, Recent Market Action, Stock ideas Tags: , , , , , Leave a comment

reaction to INTC’s 4Q12

I’ve been reading financial commentary on the INTC 4Q12 results.  Analysts seem to fall into two camps:  one thinks that the stock declined by 6%+ because the 4Q report confirms the secular demise of the PC industry; the other thinks the earnings were, for one reason or other, disappointing.  I don’t think either is right.

As to the earnings, fourth quarters are always tricky to figure.  Companies apportion costs quarter by quarter during their financial year on a pro rata basis given their projections of full-year results.  4Q is a kind of residual quarter when all sorts of final adjustments are made to the accounts, so that the quarterly numbers total to the full-year actuals.   It’s impossible for outsiders to figure out in advance what these adjustments may be.  In addition to these “usual” difficulties, in the INTC case we also knew there would be plant and equipment writeoffs + startup costs to be factored in.

In other words, the idea that the consensus Wall Street estimate for 4Q would be accurate had to be taken with a heavy grain of salt.  INTC beat it handily, anyway.

The decline of the PC story has been with us for some time.  It may also be true, especially in the developed world.  But I think the situation is more complex than is typically portrayed.  Cyclical economic weakness is certainly playing some role in lackluster sales, especially in emerging markets, where a PC is a major consumer expenditure.  In addition, the major sellers of PCs in the US, Dell and HP, make machines that are ugly, clunky and unreliable.  Both are gradually being displaced by Asian manufacturers like Asus and Acer, I think, but that won’t happen overnight.  In other words, evaluating the global PC market from the state of the US, which most analysts do, is probably a mistake.

Personally I’m keeping an open mind about the “demise” story.  But since I think the assumption that it’s correct is already heavily discounted in INTC’s current price, I don’t think “demise” is a reason to sell the stock.

what worries me

1.  As I understood the INTC story, 2012 was supposed to be a transition year for earnings, marked by peak R&D+ plant and equipment spending.  2013 was supposed to be the year when INTC began to cash in on this heavy investment.  Spending would recede, and INTC would be buoyed by its first significant participation in the cellphone and tablet markets.

Instead, we learned from the INTC earnings announcement that 2013 will see higher investment on R&D and P&E than 2013.   I’ve read from tech blogs that INTC chips tuned for Windows tablets may not be available until September.  Cellphones, according to the company, are a 2014 story, at best.

In other words, the reemergence of INTC as a cutting-edge chip supplier to the post-PC world has been pushed back a year.

2.  During its conference call, the company said it had plenty of money to “defend” the dividend, which I take to be an assurance that the current payout won’t be cut.  Also, even though the company’s stock spent a good part of November and December either right around, or below, the $20 a share level, this weakness didn’t cause INTC to accelerate its share repurchase program.  It ended up buying its typical $1 billion worth of stock, at an average price of $21.20.

Neither of these items may mean anything.  Still, to me they suggest that INTC is thinking its coffers aren’t as bottomless as they might previously have thought and that it has to husband its cash.

3. In its earnings report, INTC presented its current situation, in my view, as something everyone should be fully aware of.  I wasn’t, though.  And the sharp decline in the share price since the call suggests to me that I wasn’t alone.

Although this may be a minor point, I suspect that INTC has a very old-fashioned view of investor relations–thinking that talking to a small group of sell-side analysts means it is reaching the investment community at large.  That model certainly worked when I entered the business thirty years ago.  It’s next to useless today, however.  Odd for a tech company, too, to deliberately dress itself up in old-fashioned clothes.

The result is continuing surprises to investors–and probably a PE multiple a point lower than it would be if INTC embraced the 21st century–or even the late 20th.

my bottom line

I think of INTC as a bit like DIS–a firm where a dynamic new management team has been shaking up a mature business that had become complacent and was gradually losing its relevance.

INTC’s turnaround is taking longer, and is proving more expensive, than I had thought.  The 2H12 industrial slump hasn’t helped matters.

My expectation is that we’ll see an upturn in the PC business in the developing world during the next quarter or two.  The server business should follow suit.  By that time we’ll have more evidence about whether INTC can make any inroads into the tablet market.

For now, I’m content to hold the stock I own.

 

Intel’s 4Q12–waiting for the upturn

January 18, 2013 By in earnings conference calls, Industry Analysis, internet, Recent Market Action, semiconductor manufacturing, Stock ideas, Technology, Wireless Tags: , , , , , , , , , Leave a comment

the report

Yesterday afternoon, INTC reported earnings results for 4Q and full year 2012.  For the quarter, INTC made $.51 per share on revenue of $13.5 billion.  Revenues were down 3% year-on-year, and flat sequentially during a normally seasonally strong quarter.   EPS were off 24% vs. 4Q11.  The profit figures were considerably better, however, than the Wall Street analysts’ consensus of $.45.

For the full year 2012, INTC’s revenues were down by 1% yoy, at $53.3 billion.  EPS were down by 10%, at $2.24.

INTC also gave initial guidance for 2013 yesterday–basically for a not much more than flattish year, with considerably better performance during the second half than in the first.

The stock rose initially as traders saw the better than expected quarterly EPS, only to fall by 5% then they read down the page to the 2013 guidance.  As I’m writing this on Friday morning, INTC shares are down more than 6%.

the details

INTC’s overall business began to decelerate in the second half.  Weakness continued through 4Q.

As worldwide economic growth slowed, corporations responded by cutting spending on servers and PCs.  PC demand from individuals in emerging markets, who had been pillars of strength through the first half, began to sag as well.  Cloud computing everywhere and servers in China were exceptions to this trend.  Weakness was especially acute at the bottom of the PC market.

INTC’s customers spent 4Q working down the inventories of PCs, especially Windows 7 machines, that they already had on hand, rather than buying lots more chips from INTC and making new ones.  Knowing this was likely to happen, INTC shuttered some older production lines earlier than expected and using many of the machines to accelerate development of state-of-the-art 14 nm chips.  These moves (which I think were the right things to do) created one-time changes that whacked 5.5 percentage points from INTC’s gross margin during the quarter (plant writeoffs + startup expenses), clipping about $.10 a share from EPS.

where to from here?

INTC expects an improving world economy to give a boost to its general corporate server business and to its burgeoning PC business in emerging economies as 2013 progresses.

The company also thinks that the personal computing market among affluent individual customers will bifurcate into a large smartphone/7″ tablet market and a second one, consisting of 10″ and larger devices.  It thinks the latter market–ultrabooks, convertibles, tablets–will demand the full speed and computing power of traditional PCs, but in increasingly lighter, thinner, less power-hungry forms   …and that INTC chips will be the only ones able to satisfy these needs.  The first proof of this thesis will likely come late this year.

Significant cellphone market penetration will be a 2014 story, at the earliest.

paid to wait?

That’s the Wall Street cliché about poor-performing high-dividend stocks–that you’re being “paid to wait” for good things to happen.  In the INTC case, I’m content for now to do so.

I must admit, though, that I had expected the good news to be, if not knocking at the door, at least to be walking up the street toward my house, by now.  I don’t think INTC management did much to disabuse me of that view, either.  I don’t mean to say that they misled me;  rather, I suspect this is turning out to be a much longer haul than they expected, too.

Having said that, INTC shares are for me becoming the kind of uncomfortable question that every professional portfolio manager has to deal with sooner or later.  On the one hand, every time you trade you think you know more than the people on the other side of the bargain.  This is somewhat delusional because, on the other hand, experience shows that even Hall of Fame players are wrong at least four times out of ten.

One thing I’ve learned over the years is that if my brain is telling me one thing and the charts are telling me another, the worst decision I can make is to add to a full position (which is what INTC is for me).  The next worst would be to have INTC be one of my two or three largest positions (it isn’t).  So I’m going to sit on my hands for now.

 

 

a weak 3Q12 for Tiffany (TIF)

November 30, 2012 By in Asian economic development, China, earnings conference calls, Gold, Hong Kong, Industry Analysis, Japanese development, Luxury goods, Retail, Stock ideas Tags: , , , , , 1 Comment

the results

Before the New York open on November 29th, TIF announced 3Q12 earnings results (the company’s fiscal quarter ended October 31st).  Sales were up 4% year on year.   Profits for the three months, however,  were down 30% yoy at $63 million, or $.49 per share–lower than the company had guided to during its 2Q12 conference call.  TIF also revised down its expectations for the full fiscal year to eps of $3.20-$3.40 vs. its prior guidance of $3.55 – $3.70.

What’s behind the earnings miss?

Business was better than expected in Europe and Japan. It was so-so in Asia-Pacific—comparable store sales down 4% yoy—but in line with management’s view. In the US, however, which still comprises about half the company, sales weren’t as good as TIF had expected.

Not only that, but product mix was a problem. Purchases of items costing over $500 each held up well. Sales of less expensive silver jewelry, however, flagged. And they carry higher margins at the moment.

 How can sales be up and profits still fall by almost a third?

As I interpret TIF’s actions in preparing for 2012, the company expected a sales advance for the year of around 10%. So it increased sales space and added staff with that kind of increase in mind. Those extra costs are now acting against the company (negative operating leverage) because sales aren’t yet high enough to absorb them fully.  That cost the company about $6 million in operating profit in 3Q12, I think.  More important,

TIF also build its inventories aggressively. The fundamental choice a firm makes is between:  do I keep inventories small and risk losing sales?  …or do I keep the shelves full, at the risk of having too much?  Based on its sales forecast, TIF picked the second.

In addition, in carrying out its strategy TIF appears to have acquired or made goods containing gold when the yellow metal’s price was relatively high. That decision has two consequences that have also turned into temporary negatives. Because their costs are high, those pieces carry lower gross profit margins than TIF has shown in recent quarters. This wouldn’t be a big deal if sales were growing as rapidly as TIF thought. Better to lose a couple of points of margin on a necklace or ring rather than have a customer walk out empty-handed because there’s no merchandise in the store. But when sales are slow, as they are now, lower-margin merchandise can end up being a big chunk of sales for an entire quarter or two.  As I reckon it, this cost the company about $30 million in operating profit in 3Q12.

At some point, however, maybe in 4Q12 or 1Q13, TIF will have sold all these items and gross margins should rebound.

Finally, to carry out all its plans and still continue to buy back its stock, TIF’s debt has gone up by about $250 million yoy.  Interest expense is $4 million higher in 3Q12 than in 3Q11, as a result.

Do TIF’s quarterly earnings matter at this point?

Yes and no. The stock dropped by about 10% in the pre-market Thursday before rebounding to close down 6% or so. To my mind, that’s not much of a negative reaction, considering how big the earnings shortfall was vs. expectations and how strongly the stock has performed in recent months.

To my mind, investors have clearly been betting that we’re at or near a business cycle low point for high-end jewelry sales. They’re buying TIF in anticipation of a significant upturn in profits. For these investors, the overall story is still intact. Their timing may have been a bit off, but they’re not worried.  And, in my view, TIF’s management didn’t do anything crazy.  It carried out an intelligent plan for 2012 that’s been undermined by a weaker than expected world economy.

On the other hand, I suspect it will be difficult for the stock to advance from the present level without the company demonstrating that the low point is behind it.

One other note: it seems to me that the area of concern for Wall Street based on 3Q12 results can’t be China, even though sales there were down yoy. Why do I say that? Chow Tai Fook Jewellery, which caters solely to the China market, was up 4% overnight in Hong Kong.

thoughts on Hewlett-Packard (HPQ) and Autonomy

November 26, 2012 By in earnings conference calls, Stock ideas, Technology Tags: , , , , , , Leave a comment

background

In mid-August 2011 HPQ announced an all-cash, $11 billion+ bid for the British software company, Autonomy.  The offer came at more than a 60% premium to the latter stock’s close the prior day.  The deal, masterminded by HPQ’s then CEO Leo Apotheker, closed in early October last year.

By mid-May 2012 both HPQ executives who championed the deal, Mr. Apotheker and HPQ’s head of strategy, Shane Robison, had been shown the door, as had Autonomy founder Michael Lynch, as well.

Last week, when reporting its 4Q results for fiscal 2012, HPQ announced a whopping $8.8 billion writeoff “relating to the Autonomy business”!  In an 8-K filing with the SEC, HPW explained:

“The majority of this impairment charge relates to accounting improprieties and disclosure failures at Autonomy Corporation plc (“Autonomy”) that occurred prior to HP’s acquisition of Autonomy, misrepresentations made to HP in connection with its acquisition of Autonomy, and the impact of those improprieties, failures and misrepresentations on the expected future financial performance of the Autonomy business over the long-term.  The balance of the impairment charge relates to the recent trading value of HP stock (emphasis mine).”

What’s going on?

two aspects to the mammoth charge

—first, according to the statement above, HPQ now realizes it paid twice as much as it should have ($5 billion+ extra) for Autonomy.  It feels this happened because it received false, misleading or incomplete information about Autonomy’s business while considering the acquisition.

HPQ has asked both the FBI and the UK’s Serious Fraud Office to determine whether any laws were broken.

—second, HPQ says something like $3.5 billion of the charge comes from “the recent trading value” of HPQ stock.   Huh!?!

let’s start with the second item

Oddly, the company gave no further explanation on its conference call, even though, assuming it’s $3.5 billion–we’re talking about a writeoff equal to 15% of HPQ’s market cap.  No analyst asked about what the charge was about, either.  Nor have I seen any financial media comment explaining what the charge is.

What really gets my attention is that in thirty years of looking at stocks, I’ve never before seen a statement/explanation like this one.   What can it mean?

–To begin with, the charge is big enough that it had to be disclosed.

–HPQ isn’t making an off the cuff remark.  The 8-K statement above was repeated, word for word, at least twice during the earnings conference call.  So the wording has been carefully crafted and presumably approved by batteries of lawyers.  It also can’t be an accident, in my view, that there’s no further elaboration (isn’t this a “disclosure failure”?).

We have a few other clues.  The $3.5 billion or so is a non-cash charge (meaning no actual money is being paid out by HPQ).  It relates to the Autonomy acquisition.  It appears to have been triggered by the recent declines in HPQ stock.

On the other hand, the charge appears to have nothing to do with the wildly optimistic estimate of the present state and future profit potential of Autonomy that HPQ made in 2011.

My guess:  to me, it looks as if the recent decline in HPQ stock below some level, say, $20 a share, has triggered a contingent liability of HPQ’s–one by which it either forfeits a payment of $3.5 billion or which requires it to issue new stock with that market value.

If so, this could be “related” to the Autonomy acquisition in the sense that HPQ interprets the fall in its stock to be a direct result of Autonomy’s shortcomings (how you can make that argument is beyond me, though).

Or it could be “related” in the sense that the bank agreement HPQ struck to finance the Autonomy purchase called for stock issuance in the event the riskiness of the loan increased–as measured by a fall in the HPQ stock price.  I’ve looked at the Autonomy acquisition-related documents, including the bank financing arrangement pretty carefully (okay, sort of carefully)–and have found nothing.  A good bit of the loan agreement has been redacted, however, so it’s still possible that the banks have demanded collateral.

All in all, this part of the writeoff seems to me to have more to do with HPQ decisions on how to shape its capital structure than about Autonomy per se.  The worst part is the lack of explanation.

HPQ’s information shortfall about Autonomy

As I understand it, there are several questions of accounting technique that HPQ is now calling improper:

–when Autonomy delivered software to OEMs or other distributors, it booked the revenue immediately, rather than waiting for the distributor to resell it to an end user.  This isn’t the most conservative approach, but it’s what sellers of video game software customarily do.

–when Autonomy sold multi-year software licenses, it recognized all the profit immediately, rather than over the term of the license.  Again, not the most conservative  …but the way Apple accounts for its iPhone sales.

–when Autonomy sold directly to end users, it recognized revenue when the sale was agreed to, unless there was an acceptance period, in which case it would wait until the user signed off as satisfied on the installation.

None of these practices are in themselves deceptive, in my view.  Autonomy maintains they’re fully disclosed in the annual report (which, in general terms, they are).

HPQ has made more than fifty IT-related acquisitions over the past decade.  So it should know that the way a company chooses to recognize revenues and costs is perhaps the question in understanding an acquisition target’s financials–and that the devil is in the details, not in the annual report generalities.  Nevertheless, it sounds like neither the top management at HPQ nor the directors of the company asked for any elaboration.  The firms HPQ hired to do due diligence also found nothing wrong.

I’ve seen intimations in the press that during the time Autonomy was shopping itself to other software firms it may have “stuffed” its indirect distribution channel with more software than distributors could reasonably be expected to sell, or persuaded direct customers to start the software purchase process early–measures calculated to make recent growth rates look better than they actually were.   Anyone with a skeptical bone in his body would check for this.  And either tactic should be relatively easy to detect–for anyone who had some knowledge of accounting, the experience to be aware of typical “tricks” used in the industry, and a willingness to do due diligence.    Apparently in this case no one did until mid-2012.

In short, it’s hard to understand how a group of seasoned technology veterans in an M&A-intensive firm could have allowed itself to be as thoroughly deceived as HPQ is now claiming.

And then there’s Oracle, which asserts Autonomy pitched itself to it on April Fool’s Day 2011.  Oracle says it knew simply on the basis of a short presentation that Autonomy was substantially overvalued, even at the then market price of $6 billion (Oracle has posted the slides presented by investment banker Frank Quattrone.  The fine print Disclaimer at the end of the first set says it’s sent “in connection with an actual or potential mandate,” meaning an M&A transaction.  Ugly slides;  not much pertinent info.)

call for criminal/civil investigations 

I suppose it takes a certain amount of courage for a highly compensated group of supposed battle-scarred businesspeople to admit to having been bamboozled out of $8.8 billion of shareholder cash.  On the other hand, coming clean is probably the best option the HPQ management and board had.  Certainly, trying to disguise the facts would be worse–and would weigh on reported results for years.

The call for criminal and civil probes of the Autonomy transaction may well boomerang on some present or former HPQ executives.  But alerting the regulatory authorities eliminates a lot of possible skepticism that HPQ might be downplaying the affair.  Of course, so far as I’m aware, none of the HPQ directors who rubber-stamped the Autonomy acquisition feel bad enough to have offered to resign.

a stock market buy?

Deep value investors might be tempted.  Why?  …precisely because the company has a recent history of inept management and because the stock has lost 3/4 of its market value since ex-CEO Mark Hurd departed in a personal conduct scandal.  The S&P is up by about 1/3 over the same span.    The argument would have two aspects:

–the same assets in more competent hands could be worth a lot more than the current $12.44 a share.  Mr. Hurd demonstrated during his tenure how that can happen.

–you can’t fall off the floor.  i.e., the worst is already in the HPQ share price.

The big imponderables are:  whether all the company’s dirty laundry is in display, and how different from current management the new hands might be.

As a growth investor I don’t have the background/skills or inclination to reach a conclusion and place a bet.

ESPN’s role in DIS

November 14, 2012 By in earnings conference calls, Entertainment, Industry Analysis, internet, Stock ideas Tags: , , , , , , , Leave a comment

Still no internet/TV.  Still no sign of Comcast trucks.  Nor is Comcast willing to say how much longer the outage will last–today is Day 17.  The whole neighborhood is switching to FIOS.  

This is, of course, a trivial issue when compared with the devastation in low-lying areas of Long Island or with the low-income housing in NYC that still has no power (but whose residents are still being charged full rent–rebates to come in January???).  

This post is prompted by a reader’s question about ESPN.  It also addresses some assumptions I’m making about ESPN in saying I think DIS will be a good relative performer over the coming year.

limits to what I know

I’m very comfortable as an investor that I know more than I really need to about how the Disney part of DIS works.  I think I know enough about ESPN, too.

This is an important distinction, however.  In my mind–if nowhere else–there’s an unresolved question about the long-term growth prospects for ESPN.  I don’t think this is a near-term issue.  I don’t think it’s primarily about competition, either.  In its simplest form, it’s how long can ESPN continue to grow revenues at twice the rate of nominal GDP, as it is currently.  When does growth slow down?

ESPN’s importance to DIS

Today, ESPN accounts for 2/3 of DIS’s profits.  What happens if ESPN stops growing at 15% a year and slows down to 10%?  What does the rest of the business have to do to take up the slack? The answer: rev up growth to +25%/year.  Is that possible??  Possible, yes; probable, no–in my opinion.  Therefore, if ESPN slows down, Wall Street revises down its estimates of DIS’s long-term growth rate–and the stock adjusts downward.

ESPN doesn’t have to speed up for DIS to be a good stock.  But it can’t slow down either, in my view.

sports programming

What’s unique about sports programming–and what makes ESPN so attractive–is that it’s the only type of mass media where consumers are regularly willing to pay higher prices for pictures of events in cutting-edge resolution, and for tons of expert (or even not so expert) commentary.

This is not only true in the US, where there’s a mad rush to buy the latest model TV set just before the Super Bowl (the Big Game, to those unwilling to pay to use the SB moniker).  It’s the same in every country whose stock market I’ve ever been involved in.

programming rights

Not everyone can broadcast a sporting event.  Most sports teams/leagues periodically auction off to the highest bidder exclusive rights to broadcast their games.  For many profession teams (and icons like Notre Dame), these broadcasting rights can be their single most important asset, running into the hundreds of millions of dollars in value.

Many organizations break the rights down into a number of pieces to make them more affordable, and therefore encourage more spirited bidding.  The NFL, for example, has separate packages for Sunday Night Football, Monday Night Football, Thursday Night Football, NFC Football and AFC Football–broadcast by NBC, ESPN, the NFL Network, Fox and CBS, respectively.

where ESPN fits in

ESPN is by a mile the dominant sports broadcasting distribution network in the US.  It broadcasts all the major sports.  It also fills a bunch of channels, in both English and Spanish, with 24/7 commentary and analysis.  Over the years it has been consistently innovative, so it possesses an unparalleled internet presence as well–only commentary but fantasy league and broadcasting, too.

network effects

ESPN’s is a business where the rich get richer and the poor get poorer.  As a distribution network gets larger and if a distributor can raise prices (which so far ESPN has been able to), the distributor generates more money to spend on content, including broadcasting rights.  This gives it a huge, and growing advantage over smaller rivals.    At some point, the amount of capital needed to enter the market, or even to maintain a presence, becomes prohibitively high and the weak links drop out.

For market leaders like ESPN, this is a great business.

a sign of maturity?

About two years ago, ESPN decided to make a major move into soccer.  Two reasons:  this would be the leading edge of ESPN’s expansion into Europe; and ESPN could become the leading distributor to a small but growing fan base in the US.

The heavy investment ESPN began to make implied to me that management saw this as the company’s most attractive long-term expansion opportunity.  (Otherwise, it would have focused on something else.)

ESPN, however, lost out in the bidding for Premier League soccer rights in Europe to incumbents who recognized the threat ESPN posed.  It was worth losing money to them just to keep ESPN out.  Not a great solution to the threat of ESPN, but probably the best alternative available.

So, for now anyway, the geographical expansion is off the table.

spending up on the Disney side

Since then, DIS has agreed to buy Lucasfilms for $4 billion.  It has added Cars Land to Disneyland and is overhauling Fantasyland at Disneyworld.  It’s also installing new reservations/guest interface software at the parks.

…a coincidence that Disney capital spending is rising just after ESPN’s need for capital has decreased?  Maybe.  Another interpretation, though, is that DIS’s capital is going into the highest return projects–and that none are in ESPN.

my take

It’s not necessarily a bad thing if ESPN sees no new big untapped markets to enter.  In fact, DIS’s generally conservative accounting philosophy implies ESPN’s near-term profits will likely be higher because the expenses of European soccer rights and of expanding its soccer coverage won’t be there.

But DIS’s shifting capital allocation priorities do bring up the issue that ESPN won’t continue to grow at the current rate indefinitely.

The only practical conclusion I’m drawing is that if what I’ve just said is right, I’ve got to be careful to set a price target ($55?) and remember to sell.