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UCLA Wins Another Title…But for Different Reasons This Time

As a man with a broken heart, given the departure from the tournament of the Maryland Terrapins last weekend, a non busted bracket, with all four final 4 teams still alive, a 17 year old looking at colleges, and a penchant for financial analysis I find myself in a unique positon to perhaps offer a different take on this year’s field of 64.  Though the winner in my tournament will have the least points, not the most, based on a RMM (Real March Madness) score that represents the sum of the school’s annual tuition costs and student acceptance rate.  The idea is to develop a reliable measure of overall value, both educational and financial, in a college environment plagued by spiraling tuition costs.

The seeds of this analysis were actually sown in last year’s tournament, with the heartwarming first round exit of the Duke Blue Devils at the hands of the Mercer  Bears.  I will confess to never having heard of Mercer until that moment.  Further investigation yielded a 180 plus year old institution in Macon GA with over 8,000 students, though two other metrics, Mercer’s acceptance rate (around 70%)  and tuition (around $35K for an RMM score of 105) , really caught my eye.  And those two metrics form the basis of an index I have used to analyze the March Madness field from a different perspective.

Fast forward to this year, with 114 year old Sweet Briar College in Virginia announcing its intention to shut down and some well publicized, and on target in my view, comments from Mark Cuban suggesting the closure as indicative of a much larger bubble in higher education and student loan debt.  While inclined to agree at a high level, especially as a father experiencing the sticker shock of initial collegiate exploration, I wanted to put some quantitative analysis behind what to date has been a gut feeling that institutions that accept more than half of their applicants should not be charging $40K in tuition.

The simple analysis I have conducted is aimed at finding out why that might be, with a feeling that the fact that some do (for now) was more a result of widely available student loan funding than anything else.  As we saw when the Federal government became a major actor in housing finance, it tends to distort the rational economic function of a market.   Thus my analysis attempts to find the “real” national champion from the field of 64 in terms of bang for the buck in education by adding two factors into an overall RMM (Real March Madness) score.

  • Acceptance Rate- a proxy for a school’s overall level of desirability, encompassing issues of academic quality, job placement, alumni networks and so on.
  • Tuition Amount- Dollar amount for tuition only, with an average taken for in and out of state tuitions in the case of state schools.

The lower the score the better in this analysis, with scores ranging from a low of 45 (UCLA, 20% acceptance rate plus $25K average tuition- 20+25=45) to a high of 115 (Valparaiso) with an average of 84 (Arkansas) , which yields some interesting results when applied to this year’s bracket seedings.  It is notable in this context that Sweet Briar’s score comes in at 119, and there are some nuances in the analysis of private vs state school that are discussed below.

We have listed our Sweet 16 by region below for a broader sense of schools that score well on the analysis, and note that our Final Four is composed of Hampton, North Carolina, Virginia and UCLA, with UCLA taking the National Title, defeating North Carolina in the finals.  Number 3 overall San Diego State has some hard luck in meeting UCLA in the Elite 8 after barely squeezing by Duke in the Second Round.  In many cases the analysis imitates real life, with the Tar Heels nosing out Harvard in the First Round,  and Georgia State reprising their First Round victory over Baylor only to lose in the Second Round (to Ole Miss in this case)  Iowa State did narrowly survive its first round matchup with UAB is this tournament, though was also in UCLA’s path in the second round..

However, the RMM Tourney Bracket is primarily about upsets.  Top seeds Kentucky and Villanova went out in the First Round, losing to  to Hampton and Lafayette, respectively.  Second round seeds also dropped like flies, with Arizona losing to Texas Southern, Gonzaga losing to North Dakota State and Kansas losing to New Mexico State, all in the First Round. Interestingly, we end up with a Sweet 16 almost perfectly balanced between perennial powers and Cinderallas.

Midwest                              West                                                     East                                        South

Hampton                             Wisconsin                                            NC State                 San Diego State

Maryland                             North Carolina                                   UC Irvine                           Georgetown

Texas                                   Ole Miss                                                   Albany                                 UCLA

Indiana                                Texas Southern                                 Virginia                               Davidson

As a graduate of two wonderful state institutions, Maryland and UCLA, I would be remiss not to point out a few mitigating factors in the analysis.  First, by taking an average of in and out of state tuitions state schools are penalized to some degree given what is in some cases a very wide gap. Things look somewhat, though not terribly, different from a purely in state perspective.  Second, given what I view as the appropriate mission of state institutions to cast a wide net in terms of in state admission, admission rates in some cases are understandably high.  Having said that, it’s arguable that some of the more competitive state schools may be underserving their in state missions.  The risks appear to accrue more to private institutions with RMM Scores in the 90’s or triple digits, of which there are a dozen in the analysis, to demonstrate value to both students and their families.

 

Tim Savageaux, BS University of Maryland 1987 MBA UCLA 1992

 

RealMarchMadnessBracket

Well this week’s Barron’s cover certainly helps explain the nature of recent Barron’s cover stories (Bull on Pogo stick Dow 16,000, Millennials as Generational Saviors) that we have referenced in recent blog posts and reports. Always interesting to wake up on a Saturday morning five blocks from Haight Street and see a marijuana leaf on the cover of one of the nation’s most venerable financial publications. Ironically of the three the current cover is arguably the most controversial at face value and least controversial in terms of fundamental arguments.

This newfound trend toward sensibility could also be found in this week’s magazine in an article questioning the exclusion of stock based compensation from earnings estimates and noting the valuation implications of doing so. Generally speaking Terrapin is fairly well positioned with regard to this topic, with short positions on some of the most egregious offenders (CRM, AMZN) for whom stock based comp represents 100% or more of non GAAP earnings, and meaningful longs on some of those deemed to be solid citizens (MSFT). We do however have our share of long ideas on the scofflaw list (BRCM, GOOG) though in general tend not to get overly worked up on this topic, seeing it as one of many potential yellow flags on earnings quality. The impact of option issuance is felt in fully diluted share count, though the article does make a fair point about the role of share buybacks in diminishing that impact.

Though the residue of the activity in the cover feature department appears to have crept into the technology department this week, leading to a euphorically bullish story on the potential of INTC’s share price to double in five years (perhaps sooner!). The thesis is focused on four factors and largely reflective of the consensus sell side bullish thesis (1) increasing smartphone and tablet penetration (2) continued increases in data center/server revenue (3) a macro driven recovery in the PC business and (4) potential for growth on the foundry side. We continue to see far more attractive fundamental exposure to the first three elements in the thesis at Microsoft, which has been consistently outgrowing Intel in its data center focused businesses, will share in any PC related recovery, and in our view has better prospects for meaningful and material penetration of mobile device markets all while trading at a modest PE discount to INTC. And while Intel has made some reported inroads in the ARM-based Android ecosystem of late with a rumored win in a Samsung Galaxy tab. It remains unclear whether Intel might have more to lose in the PC arena to ARM than it has to gain in mobile. MSFT stands largely outside of this debate with Win8 variants running on both processing platforms. As we noted recently in context of the Xbox launch, we also find the company’s consumer/entertainment focused prospects to be far superior to Intel’s. There was no mention in the article of Intel’s OTT/set top initiatives, and the company has not been a major player on the gaming console/graphics side with the likes of AMD and NVDA picking up most of that business. On the semi side in particular, we continue to find NVDA relatively more attractive as well with far more developed and material exposure on the mobile front, similar exposure to any PC related upturn and still very attractive value given the cash balance.

Sticking with Microsoft for the moment, the company’s marketing department has been busy of late turning out effective advertising, as we noted recently with the “wedding brawl” ad for the Lumia 920 and more recently with the “less talking, more doing” ad pointing out in a clever and amusing fashion once again reminiscent of Samsung’s iconic Galaxy S2 ads some important differences in capabilities and price among Win8 tablets and the IPad. Given the company’s push into the smartphone and tablet markets consumer branding is more important than ever, and we expect these efforts to be aided by the Xbox One launch later in the year. There is a great deal of innovation and creativity on display at Microsoft these days in terms of both developing and marketing new products.

So much so, in fact, that at least on the mobile side the look and feel of the WinPhone user interface appears to be inspiring some copy cats. A recent ad for the BlinkFeed feature on the HTC One looks like a combination of WP8 Live Tiles and Flipboard and the “app digging” theme referenced in the ads speaks to a big part of the value proposition of the WinPhone UI. It is unclear that tiles that update continuously is close enough for trouble from an IP perspective, and as the clumsy closing line of the ad indicates “It’s everything your phone isn’t” the guys at HTC appear to be having trouble finding the line between a gentle ribbing employed in the Samsung and Nokia commercials and something offputting (eg think anything AT&T has ever done up until the 4G kids roundtable ads). I know I am focusing on advertising a lot here, but as Apple can attest it’s important, gives a good insight into senior level decision making and potential consumer appeal. HTC by the way stands as Nokia’s main competitor in the WinPhone market in the US with the 8X, and we note that despite some recent weakness in NOK shares we are unable to find a black Lumia 928 available anywhere, including Best Buy and Amazon. We remain big buyers under $4.

Another weekend, another ironic, superlative laden Barron’s feature to spur some thoughts about the direction of both a number of big cap technology stocks that reported last week, as well as the direction of overall market indices.  And while the Barron’s cover story this weekend predicting a rise in the DJIA to 16,000 within a year amid record bullish sentiment might not be as absurd as predicting a sustained turnaround in ST Micro (Terrapin Sector News Post 4/8/13- note STM is down 10% in the interim while ALU is flat), it could well be close.  Clearly a key factor underlying such a prediction is the global levering of central bank/sovereign balance sheets, and we also saw another indication of the great benefits of massive leverage this week as Intelsat priced its IPO.  As we have noted recently another irony we continue to find is the premium valuations accorded the most highly levered names across various aspects of the TMT space, from FSL (the subject of a similar blog post upon its IPO – Freescale Limps Out of the Gate 5/25/11) to the proposed DISH/S combination to CHTR to another recent IPO WSTC.  As with a lot of what we are seeing these days across both the TMT sector and broader markets, the positive correlation between increased leverage and increased valuation metrics doesn’t make much sense to us.

We move back to the blog given some of the high level musings in this analysis, but also include some comments on relevant large cap tech reports late last week later on in our discussion.  We have been sidling up to MSFT in recent months and move to long 2 post the company’s report late last week, coincident with increasing our INTC short position to maximum levels.  We also note another strong report for GOOG (long 2) as well as strong results from TSMC which feeds most of the world’s fabless players including BRCM (long 3) which has been under pressure of late along with AAPL.

The main irony in the Barron’s DJIA story is that it appears after the worst week for the index in several months, one that could and likely should have been a lot worse given the earnings driven weakness in IBM (the second most favored name in the Barron’s survey) , GE and MCD on Friday which together speak to a non trivial portion of the US and global economies.  Which brings us to another irony, resulting from an analysis that we actually started to put together prior to seeing the Barron’s piece but is even more interesting in context.  And while the Dow gets a lot of heat for being outmoded and not terribly representative, we do note that there is $4.3 trillion in market cap accounted for below.  The index remains a key focus from a retail perspective, is straightforward to analyze from a component perspective and in truth usually in pretty well in sync with the S&P outside of days like Friday when warnings from several of the world’s biggest companies was apparently not news for the S&P 500.

The analysis below follows the general format of some of our recent earnings analyses for companies in the tech space (Let’s Look at Some Charts 6/11/12, Let’s Look at Some More Charts 2/4/13) with a focus on comparing movements in forward looking estimates with movements in share prices.  What we find is the typical of the contradictions we have seen throughout the market in recent months.  Over the last twelve months, the average revision in earnings estimates has been down 6%, with the average change in share price up 12%. 80% of Dow components have seen negative earnings revisions over the period, while 76% have seen increasing share prices.  Only three names have seen meaningful upward revisions (eg greater than 5%), while 13 have seen meaningful downward revisions.  The most effective strategy appears to be to manage a slight (1-4%) decline in earnings estimates and let the liquidity tsunami do its trick, with the 11 companies in that category posting an average 18% annual gain in share price.  At a high level, for an index coming off all time high’s one would think the earnings picture would be a bit better.

Table 1: Prices Up, Estimates Down in the DJIA

2013 EPS

Price

4/13

4/12

chg

4/13

4/12

chg

P/E

Div

Yld

Mkt Cap

AA

$0.57

$0.94

-39.4%

$8.08

$9.73

-17.0%

14.2

$0.12

1.5%

9

CAT

$7.68

$11.45

-32.9%

$80.52

$102.77

-21.7%

10.5

$2.08

2.6%

53

INTC

$1.88

$2.68

-29.9%

$22.40

$28.40

-21.1%

11.9

$0.90

4.0%

111

HPQ

$3.51

$4.42

-20.6%

$19.56

$24.76

-21.0%

5.6

$0.53

2.7%

38

DD

$3.89

$4.79

-18.8%

$49.19

$53.46

-8.0%

12.6

$1.72

3.5%

46

XOM

$7.99

$8.88

-10.0%

$87.45

$86.36

1.3%

10.9

$2.28

2.6%

391

UTX

$6.10

$6.73

-9.4%

$93.22

$81.64

14.2%

15.3

$2.14

2.3%

85

CVX

$12.33

$13.55

-9.0%

$115.90

$106.56

8.8%

9.4

$3.60

3.1%

225

MCD

$5.78

$6.29

-8.1%

$99.95

$97.19

2.8%

17.3

$3.08

3.1%

100

BAC

$0.98

$1.05

-6.7%

$11.66

$8.11

43.8%

11.9

$0.04

0.3%

126

MSFT

$2.84

$3.04

-6.6%

$29.90

$32.05

-6.7%

10.5

$0.92

3.1%

249

GE

$1.65

$1.76

-6.3%

$21.75

$19.58

11.1%

13.2

$0.76

3.5%

226

KO

$2.14

$2.25

-4.9%

$42.66

$38.16

11.8%

19.9

$1.12

2.6%

190

PG

$4.05

$4.20

-3.6%

$81.43

$63.64

28.0%

20.1

$2.41

3.0%

222

PFE

$2.28

$2.35

-3.0%

$31.06

$22.90

35.6%

13.6

$0.96

3.1%

223

MMM

$6.82

$7.02

-2.8%

$105.71

$89.36

18.3%

15.5

$2.54

2.4%

73

JPM

$5.48

$5.60

-2.1%

$47.23

$42.98

9.9%

8.6

$1.52

3.2%

178

MRK

$3.63

$3.70

-1.9%

$47.29

$39.24

20.5%

13.0

$1.72

3.6%

143

T

$2.52

$2.56

-1.6%

$38.28

$32.41

18.1%

15.2

$1.80

4.7%

210

UNH

$5.51

$5.56

-0.9%

$60.04

$56.15

6.9%

10.9

$0.85

1.4%

61

AXP

$4.75

$4.79

-0.8%

$67.24

$60.21

11.7%

14.2

$0.80

1.2%

74

VZ

$2.76

$2.78

-0.7%

$52.25

$40.38

29.4%

18.9

$2.06

3.9%

149

JNJ

$5.41

$5.44

-0.6%

$84.49

$65.10

29.8%

15.6

$2.44

2.9%

236

IBM

$16.61

$16.70

-0.5%

$190.00

$207.08

-8.2%

11.4

$3.40

1.8%

212

CSCO

$1.99

$1.98

0.5%

$20.46

$20.16

1.5%

10.3

$0.68

3.3%

109

WMT

$5.34

$5.28

1.1%

$78.28

$58.91

32.9%

14.7

$1.88

2.4%

258

DIS

$3.45

$3.40

1.5%

$61.56

$43.11

42.8%

17.8

$0.75

1.2%

111

HD

$3.51

$3.26

7.7%

$74.00

$51.79

42.9%

21.1

$1.10

1.5%

156

BA

$6.38

$5.70

11.9%

$85.00

$76.50

11.1%

13.3

$1.94

2.3%

67

TRV

$7.17

$6.32

13.4%

$84.81

$64.32

31.9%

11.8

$1.84

2.2%

32

Median

-2.9%

11.4%

13.3

2.7%

Mean

-6.1%

12.0%

13.6

2.6%

Perhaps the point of the Barron’s piece further significant downward revisions are expected in earnings estimates for the Dow and hence further boffo share price performance. Though in reality rising corporate earnings is cited as the key factor in driving future gains in indices, though given recent performance it’s hard to see that as a lock.  Even for downwardly revised 2013 EPS estimates there is a bit of a hockey stick in place for the second half of the year, with those Dow components with December fiscal year ends booking about 22% of their annual profit expectations in Q1.  IBM, for example, is still expected to show revenue growth in fiscal 2013 despite a 5% top line decline in Q1.

The generally weak earnings data we have seen so far this quarter correlates well with weak overall macroeconomic reports of late.  However, as is also made plain in the Barron’s piece, the TINA narrative (there is no alternative [to equities]) remains firmly in place, driven by low interest rates, relatively attractive dividend yields and continued liquidity from massive central bank money printing and fiscal stimulus.  We do however see one major risk to this narrative, namely that stocks can never go down.  Which is to say, a 2.6% dividend yield doesn’t do a whole lot of good if stocks are in a double digit correction. All of this monetary and fiscal intervention needs to lead to actual growth in corporate revenues and earnings for these index moves to be sustainable, and based on this analysis there is not much evidence of that happening.  In fact, there appears to be more evidence supporting deterioration than improvement in fundamentals at this point.

Moving further in our discussion of the apparent myriad benefits of huge amounts of leverage from the macro to the company specific level, last week’s IPO of Intelsat may set a new high (low?) in terms of public market investors apparent willingness to bail out highly levered private equity backed companies.  As outlined in the table below, Intelsat, in addition to going for the single letter ticker, comes to market with a huge debt load to compliment a satellite communications network under increasing competitive pressure from terrestrial fiber and exhibiting little to no growth.  The  IPO priced well below the original $21-25 range, pricing at $18 only to open below $17 and subsequently rally over $20.  With the world’s largest and far better positioned communications service provides trading at around 6X EBITDA, it’s hard to argue for a 25% premium for I on any basis other than it needs one to have a positive market cap.   An absolutely amazing quote from the FT after the deal priced cites an unnamed private equity source which pretty much says it all:  “The reason we decided not to pull [the IPO] was that at the end of the day, the natural home for the business was on the public markets,” one person familiar with the process said.

This deal follow a similarly noxious PE backed IPO from call center and E911 service and technology provider West Corp.  As the description would indicate, there is not a lot of organic growth here either in what has mostly been a roll up story, and like I the WSTC IPO was not well received.  Even so however the company still has a positive market cap despite leverage that is typically unheard of in technology circles (outside of FSL of course, which continues to set records along those lines at least temporarily) and trades at a premium to other far less levered and faster growing names in the space

Table 2: What Could Possibly Go Wrong?

I

WSTC

FSL

CHTR

DISH/S

Price

$20.25

$20.46

$12.73

$103.04

$39.00

Mkt Cap

2066

1698

3195

10407

25857

Net Debt

15385

3457

5689

12880

40600

EV

17451

5155

8884

23287

66457

EBITDA

2100

750

750

2787

8500

EV/EBITDA

8.3

6.9

11.8

8.4

7.8

ND/EBITDA

7.3

4.6

7.6

4.6

4.8

 

While public market investors may have forgotten that the downside scenario with so much leverage can mean a complete eradication of equity value, this is certainly not the case in the private market as LBOs both large and small, Conexant and TXU, have filed for Chapter 11 bankruptcy over the last week or two.  And thus while the prescribed course for a CTL (long 2) or PCS (long 3) would appear to be to add twice as much debt to current 2.5-3.0 to 1 debt ratios and hence dramatically increase lagging EBITDA multiples, we will hold to our apparently controversial views that Debt to EBTIDA ratios in the 5-7 range,  for service providers in an increasingly competitive (eg non monopoly, cable operators used to carry there ratios when they had zero competition) market and certainly for actual technology companies should result in discounted not premium multiples.

The catalyst for the Dow analysis was a focus on the big cap tech elements of the index and our work on INTC and MSFT in particular, as we continue to focus on TMT fundamentals from a bottoms up standpoint despite being buffeted by a lot of the tops down aspects previously discussed.  In our comments on the Intel report we had indicated plans to look at the WinTel alliance more broadly post the MSFT report.  As the analysis below indicates, Microsoft exhibited solid growth in its report on Thursday, outgrowing its Wintel partner in both the data center and more PC centric markets with far higher margins while continuing to trade at a solid valuation discount.  Thus should the solid 2H recovery in PC and enterprise markets that INTC is forecasting occur, we feel confident the MSFT will benefit as well if not to a greater extent, and we believe MSFT is better positioned in the mobile OS market relative to INTC’s positioning in the mobile semiconductor market.  We remain constructive on the prospects for WinPhone8 as evidenced by both our recent re-addition of NOK to the long list as well as our current addition of MSFT.

Table 3:  The Win in the Wintel Alliance

MSFT

INTC

Revenue

PC

$5.7

$8.0

Data Center

$5.0

$2.6

Enterprise

$6.3

Other

$3.4

$1.0

Total

$20.4

$12.6

Growth

PC

0.0%

-6.0%

Data Center

11.0%

7.5%

Enterprise

8.0%

Other

28.8%

-9.0%

Total

7.6%

-2.3%

OM pct

35.6%

19.8%

EPS

$0.72

$0.40

growth

8.0%

-27.3%

Price

$29.70

$22.44

Shares

8.429

4.95

Mkt Cap

$250.3

$111.1

Debt

$14.2

$13.2

Cash

$74.4

$14.7

EV

$190.1

$109.6

2013E EPS

$3.01

$1.90

P/E

9.9

11.8

GOOG (long 2) continued to validate our view that they are unlikely to do much wrong in their Q1 report on Thursday, with continued strong revenue and earnings growth in the high teens and very strong execution across desktop, mobile and video markets.  Having recently moved back to long 2 in our Q1 Review and Outlook, we continue to be unabashed fans of both the company’s near term execution and long term innovation and see a company far more worthy of the benefit of the doubt trading just over a market multiple than the market itself or many of its highly valued peers (AMZN short 3) or highly levered denizens.

StrangePhones, Here We Come

November 13, 2012

Things have gotten weird enough across the smartphone ecosystem over the last 24 hours for us to (a) move back to the blog given what will be some speculative comments regarding a number of rumors and/or inadequately explained actual events and (2) reference one of the greatest albums ever made as our guide to the madness.

  • “I Started Something I Couldn’t Finish”-  Reports were confirmed last evening that the executive leading Microsoft’s Windows group, and a potentially successor to CEO Ballmer, had left the company.  This is clearly almost impossibly bad timing given the ongoing launch of Windows8, though interestingly mirrors recent senior management departures at Apple.  Combined with yesterday’s possibly misconstrued comments from Ballmer around “modest” initial sales of the Surface tablet, these events paint a picture of disappointment with the initial Win8 launch despite the massive (and effective, in my view) advertising blitz that has accompanied it.  Then again, what better time for an apparently polarizing, hard charging executive to make his move for the CEO position that in the midst of a “bet the company” launch with the potential PR disaster of his departure a huge leverage point.   Whether his bluff was called, or this was part of the plan, both represent  negatives at least from an external perception standpoint.  This is somewhat ironic given a massive, record breaking Halo4 launch confirming the company’s strong Xbox franchise and what looks to be a truly innovative ecosystem developing around Win8, WinPhone and the Surface (both of which I found very impressive in initial test runs), we have been seeing a lot of reasons to own MSFT lately and are intrigued with the sell off.
  •  

  • “A Rush and a Push and the Land is Ours”-  Upset in Win8 land has clear potential negative implications for lead smartphone partner Nokia, which is interesting in light of a number of positive indications from around the globe, most recently in China, around the launch of the company’s flagship Lumia 920 device.  The launch is clearly receiving “plus” support from carriers, retailers and Microsoft, with featured displays both on line (the Lumia 920 featuring the Will Arnett ad is now the main landing page) and in stores and national advertising launched over the weekend.  While the market will focus on US progress we note that NOK has been out of the US market broadly for quite some time, though we expect steady progress and hold to our view expressed at the launch that the device is fully competitive and arguably superior to the market leaders from Apple and Samsung
  •  

  • “I Won’t Share You”- The ongoing intellectual property battle among Apple and Andriod, in this case handset makers HTC and Samsung, has also been very much in evidence in the recent news cycle.  Following the official announcement of a patent settlement between HTC and Apple, somewhat of a non event given HTC’s struggles over the last year, come two far more interesting rumors out of Asia that may both speak to the Apple’s ongoing melee with Samsung.  First comes a fairly stunning story indicating early production of the IPhone5S targeting a Spring 2013 launch with the IPhone5 launch not yet two months old.  We would expect rapid denials unless (a) the company is intending to freeze the current I5 launch in its tracks or (b) the rumor is true.  The second story speaks to the latter point, with reports of Samsung pushing through a 20% price increase to Apple for the tens of millions of applications processors it produces for Apple, which certainly marries up well with the company’s recent weak gross margin guidance and could well represent a new front opened by Samsung in the ongoing IP battle.
  •  

  • “Death of a Disco Dancer” Finally we have news of Research In Motion’s planned launch of it’s much delayed BB 10 operating system in January.  While it’s possible to see some value remaining in the current Blackberry subscriber base (though with a $2.5B enterprise value RIMM remains valued more than $2.5B higher than NOK’s smartphone unit), to the extent the market is having a tough time believing that WinPhone can emerge as a viable third O/S ecosystem it remains game over for RIMM

     

    We see one major theme arising from most of what we see above, along with one minor theme albeit with contradictory datapoints.  The major theme is management and execution, which we variously see as shockingly sloppy in the case of AAPL (supply chain, production delays, and as we initially noted really a me-too device), unsurprisingly sloppy in the case of Microsoft (at least from an optical perspective with the management departure, we remain impressed with both the style and substance of the Win 8 launch) and RIMM, and unsurprisingly crisp and brutal on the part of Samsung, which we continue to view as a leviathan (see our CES 2012 Wrap- It’s Samsung’s World and We All Just Live in It- 1/16/12 and also "note" the recent and amazing LeBron James ad for the Galaxy Note II).

    The minor theme focuses around end to end control of strategic technologies and/or the ecosystem. And here both the strategies and the outcomes are all over the map, though we note to date that the big winners here at present look to be those with favoring an at least somewhat open model with regard to hardware and operating systems namely Google and Samsung.  And one could make a fair argument that Apple’s closed end to end approach is finally catching up with them, as it has devastatingly caught up to RIMM, resulting in slower innovation on both the hardware and software fronts.

    Despite Microsoft’s foray into tablets and continued success in gaming consoles pushing them closer to straddling the open/closed line, we see the model as fundamentally software driven and benefiting from an array of hardware partners including Nokia.  And though we would love to see it, we don’t think MSFT buying NOK makes any more sense than AMZN buying TI’s processor unit.  This is again somewhat ironic given the apparent advantage that Samsung’s deep chip capabilities have conferred on them relative to Apple, though we view this more as a potential Apple supply chain management failure than an indicator of sustainable advantage by hardware integration from the device to the chip level.  Though consider that Apple is attempting to do all three, hardware, software and semiconductors, and that is a tall order.

    “Stop Me if You’ve Heard This One Before” - Harkening back to our post AMZN AAPL earnings rant  we see one aspect of our ire relieved, with AAPL down not $30 but $60 since it’s 10/25 report.  While AMZN continues to levitate up here mostly due to a lack of any meaningful metrics, we will leave that for another day noting only that we continue to find the GOOG AMZN pair compelling.   We also continue to look to sidestep the Apple/Samsung battle on the device side through a long position in BRCM. We finally continue to see a compelling proxy short in TROW (short 2) given its outsize exposure to AAPL (with GOOG and AMZN rounding out the top three holdings) as well as overall market weakness and a share price that has barely budged  in the recent sell off.


Well as my father used to say about basketball games, if you are going to get down 20 points, make sure it’s in the first quarter.  With regard to the month of June at least, the market finds itself in a similar position.  Oddly enough however, while we continue to see plenty of risk to the market at a high level, from a bottoms up perspective in tech Friday’s sell off seemed less punishing.  This is not to say there hasn’t been damage.  Through the end of May Terrapin has given up about a point of the up 7% recommendation performance in the first quarter.  A marked turnaround in semi performance as names like FSL and STM have come down precipitously has been more than offset by poor performance in systems as ALU has come back toward lows.  Consumer/Internet performance has remained unchanged as a drubbing in the GOOG/AMZN pair where we remain steadfast was offset by successful social networking shorts most notably ZNGA.  Optical performance improved solidly on the heavy FN short, while comm services deteriorated a bit as the continued implosion of Telefonica offset an improving DTV short.

It’s been almost exactly a year since I first began commenting on the excesses and associated management and banker hubris of this most recent batch of Internet/Social Networking IPOs (P as is Pride;   6/6/11- catalyzed by the upstart’s choice of a single letter ticker and also ironically noting MS as the lead).   That reassuringly successful experience in the Internet space (see table 1 below) has reaffirmed to us the notion that arrogant, delusional managers make bad decisions in good times and worse decisions under pressure and their stocks tend to go down especially given valuations that leave zero room for error.  Though it is also nice to impute something karmic into these outcomes as well.  We contrast this with the paranoid humility we have seen from the likes of LNKD, and wonder if the same exists out there in financial land opposite the uber pompous Mr. Gorman.

The intersection here is the delusional leading the delusional, in that MS led nearly every one of these deals that have, with the exception of LNKD , been a disaster. Four out of five have declined substantially, an average of 40%, yielding a .200 batting average for Morgan Stanley for deals in which they exercise complete control.  Those are boiler room numbers, and in essence we have been short MS by proxy all along in shorting these deals with the exception of LNKD which, based on the data, one would have to conclude that Morgan Stanley got lucky and that Morgan Fairchild would have done almost as good a job.

What we saw out of Mr. Gorman on CNBC last Thursday was nothing short of astonishing and in my view actionable and potentially terminal.  To state the obvious, I view the FB IPO as the Titanic of all equity offerings, easily the biggest screw up in the history of the underwriting business.  Safe to say that if this had occurred at Robertson back in the day the trading floor would have resembled a post battle scene from Braveheart and/or the revenge speech from Animal House (Head of Capital Markets, DEAD,Marmalarde. DEAD  Niedermeyer; DEAD).  Instead we get a man who is plainly arrogant, delusional or both blaming absolutely everything and everyone but himself and his firm for  FB’s poor performance and referring to his clients as naïve for expecting the most high profile IPO in history not to implode immediately upon pricing.  Gorman kept referring to the hype around the deal and while I don’t expect much from Maria B how one couldn’t ask the obvious question is beyond me “Hey Jimbo, do ya think that dramatically raising the price and the range may have had anything to do with this hype you are referring to?.  What is also beyond me is how any MS institutional or retail clients could witness these back to back displays of professional incompetence and dismissive arrogance and not sever or reduce relationships in meaningful numbers.  Given that access to the IPO calendar is a negative vs a positive, it’s hard to see what the point is given several other big bank peers capable of providing the same or better in terms of research, corporate access and balance sheets.

Table 1: Social Networking Comps- GRPN ZNGA P Investors Apparently Also “Naïve”

FB

LNKD

Z

P

GRPN

ZNGA

YELP

IPO Price

$38.00

$45.00

$20.00

$16.00

$20.00

$10.00

$15.00

TR Rec Price

na

$63.00

$30.00

$16.00

$20.64

$14.00

na

Last Update Pr 5/2

$40.00

$106.00

$37.00

$8.73

$10.58

$8.98

$23.00

Current Price

$27.80

$91.15

$36.36

$9.96

$9.69

$6.01

$15.60

pct chg IPO

-26.8%

102.6%

81.8%

-37.8%

-51.6%

-39.9%

4.0%

pct chg TR

na

44.7%

21.2%

-37.8%

-53.1%

-57.1%

na

 

Shares

2833.0

102.6

32.0

-0.4

668.4

880.0

69.0

Mkt Cap

$78,757

$9,352

$1,164

-$4

$6,477

$5,289

$1,076

Net Cash

$10,364

$400

$98

$95

$900

$1,800

$120

Ent Value

$68,393

$8,952

$1,066

-$99

$5,577

$3,489

$956

 

CY12 Revs

5500

900

111

416

2338

1450

124

-growth

48.2%

72.4%

68.2%

51.8%

44.3%

29.9%

112.0%

CY12  EBITDA

3025

175

20

-20

368

400

0

margin

55.0%

19.4%

18.0%

-4.8%

15.7%

27.6%

0.0%

CY12 EPS

$0.65

$0.90

$0.20

-$0.17

$0.20

$0.27

-$0.30

EV/Revs

12.4

9.9

9.6

-0.2

2.4

2.4

7.7

EV/EBITDA

22.6

51.2

53.3

NA

15.2

8.7

NA

P/E

42.8

101.3

181.8

NA

48.5

22.3

NA

CY13 EPS

$0.95

$1.10

$0.50

$0.03

$0.75

$0.37

$0.00

P/E

29.3

82.9

72.7

NM

12.9

16.2

NA

 

Lead Mgr

MS

MS

Citi

MS

MS

MS

GS

 

 

Now I recognize that the financials have come down a lot, are trading well below book value, etc.  However as discussed below if the SHTF again, the world doesn’t need Morgan Stanley the same way it needs JP Morgan.  And after this FB episode and interview, there might even be a cheer or two if MS went down for good.  Mr Gorman has stated plainly that the interests of the firm’s employees and investment banking clients come well ahead of its institutional and retail investor “clients”.  It is worth wondering indeed why the world needs another entity to speculate on derivatives (and the counterparty risk here is likely the only reason the firm might be kept alive), burn their clients and blame them when they do.  We have discussed the MS short in recent weeks in the FB aftermath and have added it to TROW here in our speculative “other” category and look to pair it with a small JPM long to hedge sector rebound risk.

There is a corollary to the “get down early” thesis; there are no 10 point plays, you come back two at a time.  Thankfully, this is where the similarity with the stock market ends.  There are 10 point plays (with a deep bow to Taleb, this seems like a time to note the normal distribution of basketball scores compared to the power distribution of market returns).  Just ask holders of HUTC on Friday.  As I have been noting here and there of late, it seems like one can’t swing a dead cat with hitting a potential 3-5 bagger in tech these days as this sell off progresses.  As usual the issues are timing and catalysts, but the risk reward equation in all cases is compelling in some part because the “risk” aspect is a binary survival call at these levels.

Table 2: The Dirty Almost Half Dozen

Company

Ticker

Price

52 wk high

Upside Potental

Alcatel Lucent

ALU

$1.49

$6.05

At $6 trading at 0.6 EV/Revs

Clearwire

CLWR

$1.16

$4.35

Spectrum worth more than ever

Nokia

NOK

$2.65

$7.38

Burning platform memo 2/8/11 @ $11

Oclaro

OCLR

$2.37

$8.94

Merger could produce $1.00 in EPS

Opnext

OPXT

$0.99

$2.52

Over $4 in last optical rally; 1x revs =$5

.

There are others in micro cap land that offer a similar profile including EMKR IKAN and SQNS.  It’s fair to wonder whether these more marginal names could survive the sort of major global economic downturn that the market seems to be pricing in.  I think the answer is yes to probably in almost all cases.   Everyone on the list has asset value, even impaired asset value, well in excess of liabilities as demonstrated below with NOK and ad nauseum with ALU and CLWR.  Opnext is in a solid cash position as a standalone and the combined entity is in good shape, and OCLR does have non telecom assets that it could monetize in the extreme.  On the other hand, despite its precipitous decline, it’s hard  to see how an FSL survives a serious downturn given its capital structure.  Same with HPQ, with CIEN at risk as well.  It’s also hard to see how names can trade at triple digit PE (eg the AMZN and CRMs of the world) or double digit revenue multiples (eg EZCH Z) with an assumption of total immunity from the global economic concerns at hand .

Nokia is near the top of this list with substantial upside potential in the successful development of the WinPhone platform relative to a handset unit now valued at zero.  We saw a data point on Friday that speaks to the downside risk factor for NOK in Verizon’s $600M plus acquisition of automotive locations based services and telematics  firm Hughes Telematics.  The deal came at nearly a 200% premium (advised amusingly by none other than UBS)  and at 6x a rapidly growing but still money losing revenue run rate with deals with Mercedes and Volkswagen likely the key assets.  As we have noted, NOK has a sizeable, profitable and growing concern in Navteq which is also a player in the GPS and location based services space.  In fact, representatives from Navteq and Hughes Telematics appeared on the same panel at a summit on connected and networked automobiles in 2009.  Nokia paid $8B for Navteq in 2007, which grew revenue nearly 20% in Q1 to $350M with operating margins of 12.9% and might not be worth $8B now but likely is worth at least $2-3 compared to the $4B cap of the entire company.

Finally I also wanted to check in on Randall Stephenson’s comments at the Bernstein conference last week to see whether anything had changed or been amplified.  As it turns out there was a NY Times story on the potential rural broadband initiative we discussed in our report Tuesday.  Outside of that more commentary around spectrum and HTML5, only with more emphasis on near term developments regarding the latter.  On the subject of AT&T it was notable to me as I belatedly work my way through the biography of the far more odious than the hype Steve Jobs to read the following on page 136 “IBM was essentially Microsoft at its worst; they were not a force for innovation, they were a force for evil.  They were like AT&T or Microsoft or Google is”.  Now I could write five blogs on the hypocrisy and foolishness of this statement, but let’s just say that self-awareness with regard to either individual or corporate behavior was clearly not this man’s strong point.

My main interest here for now is the AT&T part.  I have been working on this thesis for over a year, namely they telco’s being perceived as evil as they seek to fund their huge infrastructure investments by taking a few points of the app and software providers 40 points of operating margin versus the perception of AAPL as a koala bear as they tear the throats out of competitors with IP suits, developers with fat tolls, and ruthlessly squeeze suppliers and partners.  It is clearly even more ironic given the role AT&T played in bringing in the IPhone to market. Given that role I wonder if Stephenson takes being called evil in 2011 personally after helping to put $200B in Jobs’ pocket.     Next time I get a chance I will ask Stephenson that question, if anyone beats me to it please let me know what he says and it what type of forum it was asked.  In any case, it certainly underscores the desire to create alternative smartphone ecosystems in addition to GOOG (who I think really wear the white hats here to the extent that matters) and perhaps punish APPL with NOK as a prime beneficiary.

Is TROW Our Next UBS? or Mr. Finn, meet Mr. Eiswert.

March 25, 2012

Readers may recall our “where there is smoke…” commentary around UBS last Spring and early Summer that developed into useful short hedge to both our inherent Euro-zone exposure with ALU and the broader macro issues emanating from Europe and affecting the US market. At that time, catalysts for that view were multiple missteps at the [...]

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Going Social, Valuation Crazy II

December 4, 2011

In an update last week we referenced the potential for a shortable upside move in our long time poster child for inflated late stage/social networking/clean tech (which incidentally saw yet another climate change summit marred by Climategate 2.0 email releases last week) GSV Capital. The driver at the time was $100B valuation chatter for Facebook, [...]

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Zzzzzzzzzzzzz

August 24, 2011

While Zillow might be forgiven for its single letter ticker selection given a likely lack of competition, certainly relative to P or N, it still rang the hubris meter in a similar fashion and remains one of the few remaining poster children for wildly overvalued IPOs.  As I have mentioned in the past, 15x revenue [...]

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$23B of Silicon Valley Cash Heading East…

August 19, 2011

So we now have a pair of $10B plus technology acquisitions this week after an upside Cisco number last week.  Is it 1999? Not so much, especially after today’s action.  And with apologies to the Purple One if anything it’s better, in 99 no one would dream of using cash with so much inflated currency [...]

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Captain Ahab in the Amazon

July 26, 2011

Well huzzah to AMZN for convincing the investment community that profitability doesn’t matter as long as the “moat” in under construction and developing a remarkably compliant sell side following.  Though we see a lot of parallels with the NFLX story here, conference calls aren’t one of them as they conducted an interactive though CEO free [...]

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