• My Thoughts on Competitive Advantage
    Posted by on July 10th, 2014 at 1:29 pm

    I’ve always been a bit unimpressed by studies of business management. I can’t get through the writings of Peter Drucker without feeling like I’m reading a list of Benjamin Franklin-like truisms, just loaded up with modern business jargon. “An apple a day keeps the doctor away” becomes “companies utilizing preventative management systems have proven to be a net reducer of future operating costs,” and so on.

    I’m reminded of fluffy TED talks that are long on anecdotes and iffy on data. Is a horizontal structure better than a vertical one? Beats me. I suppose it depends. Whatever works, works, and I don’t see the need to spin some grand theory out of it.

    With the ideas of Harvard professor Michael Porter, the leading guru on strategy and competitiveness, I take a more nuanced view. I’m inclined to think there are solid ideas in Porter’s work, but they’re buried under an overly mechanistic ideology (the five forces of this, the four corners of that).

    To me, Porter’s key insight is that the economist’s view of business is all wrong. Supply and demand and EMH are all fine and good for the textbooks, but a business is first and foremost concerned with differentiating itself and keeping competitors out. Perfect competition is for the birds.

    Ideally, you want to have a business with high barriers to entry and low barriers to exit, and you want to differentiate yourself with whatever it is you do. You can do that by exclusivity or by price. That’s your competitive advantage. Once you get that, then you get better managers, better advertising and a stronger brand name. But it starts with a competitive advantage.

    I think people often have difficulty with the concept of competitive advantage because they want to see sinister forces at work. And make no mistake: I do believe the tempering forces of free enterprise can sometimes break down and give a particular firm a lasting advantage that has nothing to do with its own inherent merit. It could be that they were in the right place at the right time.

    For example, many years ago, the Japanese government gave AFLAC a monopoly on selling cancer insurance, and this translates into a huge market share today. Naturally, this is unsettling to those of us raised on the idea that the world wants a better mousetrap. But the truth is, it doesn’t. It wants the one it’s heard of. Just like in politics, the incumbent holds a lot of power.

    Now I feel I must address the concept of First-Mover Advantage. This was a huge idea in the 1990s, and I think it served as unrecognized fuel for the Tech Bubble. The idea also goes by the name Winner-Take-All. (That was the name of a book in the 1990s, and the phrase turned up in Bill Clinton’s campaign speeches.)

    The idea is that an early entrant could establish an industry standard which remains in place simply because it’s already there. It’s not better—it’s just there. I can’t tell you how many times I was told that some Internet stock was just like the QWERTY keyboard. In the 1990s, Microsoft was an obvious example of a first mover that became enormously successful, but investors wanted to see were the next standard would be. There was even a magazine called the Industry Standard. Wikipedia tells us that “in 2000, it sold more ad pages than any magazine in America.” Unfortunately, the magazine achieved room temperature in August 2001.

    While being a first mover can certainly give one a competitive advantage, it doesn’t mean it will last. It’s also a bit more complicated than being first. For example, it’s nice to have lots of upgrade cycles.

    One of my friends who works with the U.S. Navy explained to me that there are only a handful of shipyards left that are capable of building modern, large-scale ships for the Navy. These shipyards have become, in effect, government sponsored quasi-monopolies. I doubt anyone wanted that to happen, but things turned out that way.

    This is an important point that Warren Buffett has often discussed. Nowadays, Buffett is the “aw shucks” face of nice-guy American capitalism, but it wasn’t always this way. In the 1970s, he and Munger bought the Buffalo Evening News. The Buffalo Courier-Express, a rival newspaper, did everything it could to make them seem like evil out-of-town capitalists. Buffett was beat up hard in the press, and I think that episode has stayed with him ever since.

    In the court case that followed, the opposing lawyer used Buffett’s words against him:

    Warren Buffett once said that owning a monopoly newspaper was like owning an unregulated toll bridge. His words were, “…in an inflationary world, a toll bridge would be a great thing to own if it was unregulated.” When he was asked for his rationale, he said, “Because you have laid out the capital cost. You build the bridge in old dollars and you don’t have to keep replacing it.” He was then questioned whether he used the term “unregulated” to mean the ability to raise prices. Buffett said, “That is true.”

    It sounds rough, but that’s about the best description of a competitive advantage I can think of. Investors should be on the lookout for these kinds of opportunities, but beware—a competitive advantage can be fleeting.

  • CYNK Technology +24,000%
    Posted by on July 10th, 2014 at 11:04 am

    Since June 17, CYNK Technology ($CYNK) is up nearly 25,000% — and it’s not clear if they exist.

    The company’s stock, which the folks at ZeroHedge first alerted us to, has gone from $0.10 on June 17 to $14.71 as of Wednesday’s close. At its current stock price, the company’s market cap is $4.29 billion.

    This is a gain of more than 24,000%. For some perspective, Apple, one of the most successful companies and stocks of the last generation, is up about 18,000% since it went public in 1980.

    But there is, as you could imagine, a slight problem with CYNK: It’s not clear if there’s any value to it.

    The website associated with the company is introbiz.com. On introbiz.com, under the “About IntroBiz” section, it states that, “Thru our marketplace you may both buy and sell the ability to socially connect to individuals such as celebrities, business owners, and talented IT professionals.”

    This premise, as we understand it, is basically a Facebook-like social network where you would pay IntroBiz (or CYNK, or whoever), to connect you with someone else.

    CYNK has been as high as $16.69 per share today.

  • Is a Consolidating Industry a Good Buy?
    Posted by on July 10th, 2014 at 10:57 am

    Here’s a thinking-out-loud post. And I have to warn you beforehand, I have no conclusions to draw. This is a lot of just me babbling. But bear with me.

    The issue I’ve been pondering lately is: Is an industry undergoing consolidation likely to be a good or bad investment?

    I lean towards thinking it’s a bad one, but I’m not fully convinced. The crux with a thought exercise such as this is that it deals with generalities, and it makes us focus on why a particular industry might be undergoing consolidation.

    On the plus side, an investor can do quite well if they own the target of a buyout. He can make a handsome premium overnight. But obviously, there are risks as well. Even announced deals can fall though. The acquisition target usually has to be a smaller player that offers something the big boys don’t have. The economics of the industry have to reach a point where it’s easier to buy market share rather than go out and work for it. On top of that, if financing is important, then the bond market has to cooperate as well. Sometimes, that means the junk-bond market.

    I often look at previous buyouts and quite frankly am baffled as to why a large organization which must have had a lot of smart folks working for it made such an obviously poor decision. Hindsight bias? Possibly. Yet all too often, Company A’s motives for buying Company B remain mysterious. It’s surprising how often the answer is nothing more complicated than they felt that they had to do it before Company C moved in. These moves are made by people who thought that they had no other option, or were choosing the least-worst option. Hence it’s good to be generous when judging the past.

    So what causes a merger wave in an industry? There are times when the driving force is a change in regulations. In 1999, Congress repealed parts of the Glass-Steagall Act, which spurred a wave of banking consolidation. In fact, Citicorp bought Travelers (to form Citigroup) before Congress acted. They forced the issue and assumed, correctly, that Congress would change the law. With a regulatory-related change, I would be hesitant to say that the industry in question is either good or bad for investors because so many variables are in flux. For example, I’m inclined to believe the big-tobacco settlement was very bullish for tobacco stocks, yet I’m not sure of the specifics.

    In my mind, the strongest bear argument against a consolidating sector is that it isn’t consolidating because it’s growing too fast. At some level, future growth is broadly seen as being in doubt. And that’s probably right.

    In a commodity-related business, a fall in the price of the commodity can spark a wave of consolidation. In the late 1990s, the price of oil dropped sharply, and in 1999, Exxon merged with Mobil to form ExxonMobil (I’m still surprised they haven’t dropped the Mobil part). The year before, British Petroleum and Amoco got hitched.

    It’s a matter of simple economies of scale: the variable costs are falling relative to fixed costs. You can bring two companies together and cut redundancy like accounting, legal and HR. Of course, these types of mergers are most likely preceded by lower share prices. If things turn around, then sure, it can be quite bullish.

    Yet for as much attention as mega-mergers get, their track record isn’t so impressive. AOL Time Warner comes to mind. Many mergers look great on paper, but it’s not so easy merging two different cultures. If the fixed costs are high enough, that can be a high barrier to entry—which I could see being worth paying a premium for.

    A merger wave can also be caused by surplus. There are simply more companies than are necessary. As an investor, I would be very wary of that situation.

    I also worry about mergers ruining good balance sheets. The companies are saddled up with large amounts of debt, and that can hurt margins which are already under pressure. Perhaps a consolidating industry is neither bearish nor bullish; it’s something that just happens.

    Overall, I’m leery of an industry that’s consolidating. The forces driving the mergers probably outweigh any perceived bargains.

  • Morning News: July 10, 2014
    Posted by on July 10th, 2014 at 6:47 am

    Euro Strength Defies Draghi’s Loosening Plans

    Rate Rise Chatter Grows As Bond Yields Climb

    China Agrees to Reduce FX Intervention ‘As Conditions Permit’

    China June Trade Data Misses Forecasts, Doubts Over Economy Linger

    Modi Budget Relies on India Revenue Boost as Subsidies Untouched

    DLF Leads Surge in Property Shares as Jaitley Plans REIT Rules

    Aussie Teens Show Financial Smarts

    Fed Saw Investors as Too Complacent on Risk as Exit Plan Evolves

    Hedge Fund to Give American Apparel a Lifeline

    Alcoa’s Q2 Earnings Top, Turn to Profit – Analyst Blog

    Boeing Sees 4.2% Gain in Airliner Market to $5.2 Trillion

    IndiGo Said in Talks With Airbus on $20.6 Billion Order

    Is Sun Valley All About the Guest List?

    Edward Harrison: The Fed is Already Creating the Next Bubble

    Cullen Roche: Brazil’s Soccer Collapse and Economic Waste….

    Be sure to follow me on Twitter.

  • QE to End in Q3
    Posted by on July 9th, 2014 at 2:24 pm

    The Federal Reserve just released the minutes from its June 17-18 meeting. One surprise is that the central bank plans to end QE with a big $15 billion taper in October.

    Here’s Binyamin Appelbaum in the New York Times:

    The Federal Reserve intends to end its bond-buying program in October provided the economy continues to grow, according to an account published Wednesday of the central bank’s most recent policy-making meeting.

    The minutes of the June meeting reflected the confidence of Fed officials that the economy had rebounded from a rough winter and their expectation that growth would continue over the next few years. But it also reflected the growing consensus that damage from the recession would continue to limit the pace of growth.

    The Fed plans to add $35 billion to its holdings of Treasury and mortgage-backed securities in July, $25 billion in August and September, and a final $15 billion in October, according to the account. The Fed had previously left unclear whether it might extend the purchases by adding $5 billion in November and December.

    The minutes said that ending the purchases in October rather than December was not intended to signal any change in the timing of the next step in the Fed’s retreat – the first increase in its benchmark interest rate since December 2008. Investors generally expect the Fed to start raising interest rates next summer.

    This is, you know, kinda big news. On Twitter, I wondered: “Why the heck wasn’t this in the last FOMC policy statement?”

    Appelbaum responded, “Really good question.”

  • Wells’ Profit Streak Likely to End
    Posted by on July 9th, 2014 at 12:36 pm

    Wells Fargo ($WFC) reports earnings on Friday. The bank has increased profits for the last 17 quarters in a row. That streak has probably come to an end. Wells has also beaten expectations for the last 10 quarters in a row.

    The bank turned to other businesses as 30-year home-lending rates rose more than 1 percentage point, curtailing mortgage refinancings. Lenders probably made $109 billion of such loans in the second quarter, down from $453 billion in the final period of 2012, according to the Mortgage Bankers Association. Total quarterly originations will stay below $300 billion through 2015, the Washington-based group forecasts.

    Wells Fargo, which accounted for about 28 percent of U.S. mortgages in the first quarter of 2012, watched that share decline to 16 percent two years later. Mortgage-banking revenue slumped to $1.51 billion from $2.87 billion in the same period.

    Stumpf, 60, mostly left investment banking and trading to Wall Street before the 2008 purchase of Wachovia Corp. Wells Fargo’s push into those businesses drew a nod in February from JPMorgan CEO Jamie Dimon, whose firm was the largest global investment bank by revenue in 2013, according to data compiled by Bloomberg Industries.

  • Stocks and Buyback Correlation = 0.61
    Posted by on July 9th, 2014 at 12:03 pm

    You should read the whole thing, but I wanted to share three sentence from Mark Hulbert’s latest.

    New stock buybacks fell to $23.2 billion in June, the lowest level in a year and a half, according to fund tracker TrimTabs Investment Research. In May, the total was just $24.8 billion, and the monthly average in 2013 was $56 billion.

    (…)

    According to Santschi, the correlation coefficient between monthly buyback volume and the stock market’s level, for the period from 2006 until this spring, was 0.61.

    (…)

    Over the past five years, for example, per-share sales growth for S&P 500 companies has been an annualized 2.4%, lagging far behind the 20% annualized earnings per share growth rate.

  • Life Imitates Parody
    Posted by on July 9th, 2014 at 11:55 am

    Yesterday, Bloomberg ran this headline:

    Concern Over ‘Severe’ Pullback Sends U.S. Stocks Lower

    As a joke, I tweeted this three months ago:

    Stocks Are Down on Fears of Lower Share Prices

  • The One- and Two-Year Treasuries
    Posted by on July 9th, 2014 at 11:45 am

    I thought this was a simple but fascinating graph. It shows the yields for the one- and two-year Treasuries.

    The difference between the red and blue line reflects the expectations that the red line will increase. The wider the spread, the more the red line is expected to rise over the next year. In 2009, those expectations were massively wrong. Gradually, the spread got narrower and narrower until 2011 and 2012 when there was very little difference.

    In the last year, there’s finally been some daylight between the two lines. While the one-year yield hasn’t moved much, the two-year is beginning to creep higher. It recently cracked 0.5%. By looking at the two lines we can infer where the market expects the one-year yield to be one year hence.

    The takeaway is that the market expects the Federal Reserve to do nothing to interest rates in the short term, but it expects an increase about one year from today.

  • NYT on James H. Simons
    Posted by on July 9th, 2014 at 11:31 am

    The New York Times profiles James H. Simons, the only person who’s ever made money off math:

    Dr. Simons received his doctorate at 23; advanced code breaking for the National Security Agency at 26; led a university math department at 30; won geometry’s top prize at 37; founded Renaissance Technologies, one of the world’s most successful hedge funds, at 44; and began setting up charitable foundations at 56.

    This year, he was elected to the National Academy of Sciences, an elite body that Congress founded during Lincoln’s presidency to advise the federal government.

    With a fortune estimated at $12.5 billion, Dr. Simons now runs a tidy universe of science endeavors, financing not only math teachers but hundreds of the world’s best investigators, even as Washington has reduced its support for scientific research. His favorite topics include gene puzzles, the origins of life, the roots of autism, math and computer frontiers, basic physics and the structure of the early cosmos.

    Wow.