Friday, January 07, 2011

Regarding Amazon & Growth

This morning's Wall Street Journal's Heard On The Street column is a cautionary note regarding Amazon. Martin Peers warns that Amazon's slipping DVD sales will undermine its stock price performance. The article is filled with all sorts of micro-analysis of media consumption and data on Apple's video downloads.

Like other analysts observing Apple, about which I wrote as an investment in this recent post, I believe Peers is underestimating Amazon.

Back when the online retailer was a profitless favorite of investors, my equity selection process avoided it. As the first price chart for Amazon, Apple and the S&P500 Index, going back to 1998 illustrates, I didn't miss much. Amazon pancaked in the tech bubble crash, then began a much more measured, sustained growth, along with Apple.

However, at present, every equity portfolio selected by my process which is active contains Amazon. It's actually more prevalent than Apple, and outperforming the S&P in every active portfolio in my strategy.

The second chart focuses on the last five years of performance for the three entities. Amazon and Apple share a very close performance path, both handsomely outpacing the index.

While Peers cites DVD sales growth as the reason to doubt Amazon's continued outperformance, I prefer to see the company's equity in the context of the broader market. While, as I mentioned, my process did not find Amazon acceptable in prior years, lately, it has become one of the most consistent performers in the S&P.

Peers writes,

"But Amazon looks to have lost the music battle......Given Amazon's success elsewhere, losing in video may only reduce its red-hot growth rate by a few percentage points. But given its sky-high valuation, that isn't something investors could ignore."

I guess that's one way to view Amazon.

Here's another. In recent years, the firm's growth rate is the 14th best in the S&P 500, while it's P/E ratio is 19th best. Taken together, the firm's valuation for its growth rate is quite reasonable. Much as Dell's was in 1998, when I owned it, contrary to the advice of most Dell-watchers. As I mentioned in the prior linked post, Dell went on to be one of the S&P's top ten total return performers that year.

As I also noted in the linked post, analysts who get totally focused on the internal mechanics of the companies they follow tend to lose, if they ever had it, perspective on the companies' performances among the broader market.

In this case, Amazon's general management of its businesses has sustained its performance for years. I would suspect that it's going to take a lot more than being an also-ran in just one particular product segment for Amazon's outperformance to end imminently.

Thursday, January 06, 2011

Is The Online Social Network Sector Another Investment Bubble?

You know a trend is becoming important when both the Wall Street Journal and the Economist mention it within the same month.

In this case, the trend is a resurgence of bubble-like valuations in online social networking companies.

Back in September of 2007, the Journal's Dennis Berman wrote an excellent piece concerning the online communities business, about which I posted here. Berman's piece covered a lot of territory, but my concluding observations and quotes from his piece (in blue) were,

"At some point, the questions about Facebook the business will eclipse the praise of Facebook the social phenomenon. And once that point hits, Mr. Zuckerberg will be less able to dictate the terms of how fresh capital is put to use."

Mr. Berman pulls no punches. From his initial description of the now-essentially-defunct GeoCities, to the likely fate of Facebook, his superb writing uncovers a wonderful, timeless story of business innovation, absorption, mismanagement, the rise of new competitors, and the continuing weakness of the underlying business model.

Aside from the marvelous business strategy expose, Mr. Berman makes it hard for the reader to avoid asking the question,

"If no other, larger firm, had bought, or bought stakes in, GeoCities, or was trying to buy or invest in Facebook, would Bohnett and Zuckerberger realize millions in wealth simply from the profitability of their businesses and business model? Or would they become, like Amazon, long on initial market value gains, but short on realized profits?"

That last passage came to mind immediately as I read the Economist's piece on the current frothiness of social networking site valuations. It referenced Groupon rebuffing a $6B offer from Google, Twitter being valued at $3.7B, and Facebook's private offerings valuations rising 77% in just three months. Of course, the big recent news is Goldman's funding a private offering for Facebook, with the shares to be allocated among its most-favored clientele.

Holman Jenkins, Jr., of the Journal, made the Facebook private offering the subject of his column last week, supporting Zuckerberg's choice to remain private and take time to mature before going public.

Perhaps Berman's observations of three years ago are outdated and no longer germane. Then, again, the collapse of the late 1990s technology valuation bubble came after many pundits disregarded the need for profits. Facebook is reputed to have annual revenue in the low billions thanks to ad revenue and a share of sales from games through its site. Still, I wonder if they really have solved the challenges about which Berman wrote so eloquently.

An older veteran CEO with whom I spoke recently was dismissive of Facebook and other online businesses as genuinely value-creating. I'm not quite so sweeping in my scepticism. For example, it's clear what value Amazon and Google have managed to create. I can sort of comprehend Groupon's appeal, although I continue to wonder how profitable it is, and/or what its growth prospects are, or what the long-run financial costs are to the businesses granting the discounts. Twitter doesn't seem to be a viable business.

Facebook continues to confound. Is global social networking truly a value-added proposition and business model on a par with Google's search and related ad businesses? Is online gaming via social networking really so novel and profitable?

Or is Zuckerberg merely enjoying the latest, most profitable round of social networking hype?

One thing may be a positive, however. That is, Facebook, Twitter and Groupon, at present, are not public. So any frothiness that subsequently deflates, with concomitant value destruction, will be absorbed by wealthy, so-called 'sophisticated' investors, rather than the general public.

Wednesday, January 05, 2011

Ken Lewis' BofA Tab for Countrywide Up 50% Over 2008's Price

Three years ago next week, I wrote this post discussing Ken Lewis' purchase of the part of Countrywide which BofA, of which he was CEO, didn't already own, for some $4B.

Yesterday's Wall Street Journals Money & Investing section headline read 'BofA Pays for Soured Loans,' with the subheading 'Lender Gives Nearly $3 Billion to Fannie, Freddie Over Countrywide Mortgages.'

So that makes the running tab for Countrywide $9B, when you include the $18/share purchase of Countrywide equity in August of 2007 for a total of about $2B. By the way, when Lewis made the January purchase, Countrywide's stock was less than half its August price, or $8/share.

According to the Journal article, a Sanford Bernstein analyst assesses the additional put back risk to BofA at as much as $4B.

I'd love to see Ken Lewis questioned now by someone with good data on the August, 2007 and January, 2008 final Countrywide equity purchases. With the $6B paid for Countrywide by three years ago, $1B of which had already vanished as loss between mid-2007 and early-2008, this week's $3B, and up to $4B more in givebacks over the next two years to private investors, Lewis' Countrywide deal might ultimately cost BofA over double it's 'final' price three years ago.

It's difficult to believe that would still make the Countrywide acquisition by BofA the profitable masterstroke Lewis contended it was.

Oddly, the Journal article didn't seem to mention any of this. But a glance at the nearby price chart for BofA and the S&P500 Index shows how far the former's stock price has collapsed since Lewis closed the Countrywide deal.

While the S&P has lost a few percentage points of value, BofA has dropped by more than 60%!

What do you suppose was BofA's manner of assessing risks of the Countrywide portfolio and its upstreamed mortgages? Could they really have assumed no or minimal losses, when Countrywide was collapsing due to a general residential real estate value meltdown?

Perhaps the Countrywide deal will serve commercial bankers as a cautionary tale of buying badly-damaged financial institutions with far-flung liabilities in the form of loan sales.

Tuesday, January 04, 2011

Mort Zuckerman On Commercial & Residential Real Estate In 2011

On the afternoon of yesterday's post regarding housing prices, Mortimer Zuckerman, the Chairman of Boston Properties, as well as US News & World Report, weighed in with similar views to Peter Schiff's in an interview on CNBC.

It was interesting to observe Zuckerman carefully avoiding agreeing with CNBC co-anchors that commercial real estate would henceforth escape a serious crisis. What he did say was that his Boston Properties firm, which just purchased the Hancock Center in Boston, concentrates on high-end commercial properties, which do better in downturns. He implied that he expected a further softening of the market, but didn't explicitly say that.

However, he did reinforce Schiff's contentions, in the latter's recent Wall Street Journal piece. He went on to observe that with continued high unemployment and probable declines in residential real estate prices, there could well be an economic softening later this year. Further, he railed against continued excessive government spending, even in the guise of the recent tax rate extension bill.

Zuckerman isn't infallible, but he's a very shrewd guy. It seems that evidence continues to mount for worrisome, real estate-led economic developments later this year.

Monday, January 03, 2011

Housing Price Trends

Despite dire warnings for the just-finished year 2010, the S&P500, according to today's Wall Street Journal, posted a 15.06% return for the year.

Yet home prices continue to be a sobering economic backdrop for the US economy in 2011. Thursday's Journal featured an editorial by Peter Schiff entitled Home Prices Are Still Too High.

Schiff details the meteoric rise of the Case-Shiller 10-City Index gains of an average of 19.2% per year from January, 1998 to June, 2006. Schiff contrasts this with the index's co-creator, Robert Shiller's calculation that the average US home price increase for 1900-2000 was only 3.35% per year. Using this datapoint, Schiff's Big Point is that the current Case-Shiller Index "remains well above the long-term trend."

Doing the math, Schiff contends that "this would suggest that the index would need to decline an additional 20.3% from current levels just to get back to the trend line."


Schiff adds these observations,

"From my perspective, homes are still overvalued not just because of these long-term price trends, but from a sober analysis of the current economy. The country is overly indebted, savings-depleted and underemployed. Without government guarantees no private lenders would be active in the mortgage market, and without ridiculously low interest rates from the Federal Reserve any available credit would cost home buyers much more. These are not conditions that inspire confidence for a recovery in prices.

In trying to maintain artificial prices, government policies are keeping new buyers from entering the market, exposing taxpayers to untold trillions in liabilities and delaying a real recovery. We should recognize this reality and not pin our hopes on a return to price normalcy that never was that normal to begin with."

Listening to quite a few economists, one is reminded that, while sectors like technology have continued to grow, housing in the US remains mired in recession, or at least a doldrums. Schiff makes reasonable points concerning the government's continued actions to unrealistically prop up housing values and (unfairly)discriminate in favor of current homeowners, rather than prospective ones, at lower prices.

That 20.3% further decline, even if only in the once-hottest real estate growth markets, would seem to portend some economic pain for 2011. And just a few weeks ago, pundits, including S&P's David Blitzer, have warned of the second part of the notorious 'double-dip' recession.

Sometimes equity markets feast on short-term trends, amidst larger, longer and more painful economic trends. There was at least one equity bull market during the Great Depression of the 1930s.

With an allegedly more fiscally conservative Republican House majority and the US at record levels of foreign-held debt, it's unclear how much longer the federal government can mask the true weakness of the housing markets. We know that the nation's large commercial banks continue to sit on many properties which should be foreclosed and resold on public markets, which will almost certainly drive prices down again across many areas in the US, thus causing more damage to household net worths and, probably, spending.

Whether this purported housing sector weakness, as Schiff suggests, will spill over into the general economy in 2011, is something to seriously consider.