Friday, April 08, 2011

Odds & Ends

I found it amusing to hear Roger Altman, erstwhile Clinton advisor, sing the praises of Warren Buffett on CNBC yesterday morning, despite the recent Lubrizol/Sokol front running/insider trading flap.

The network, I guess to curry more favor with selected guests, and coincide with a golf tournament, has been plastering the title "Market Master" on all manner of financial oldsters for the past week, regardless of whether they ever managed a live portfolio.

Altman was interviewed yesterday, and, when asked, fairly leaped to the defense of Buffett that characterized him as angelic. The superlatives tripping out of the investment banker's mouth made it crystal clear that, by doing business in circles which intersect with Buffett, Altman was not going to say a single negative thing about him. In a business where contacts are everything, you could see Altman had become a shill.

So charming.

In an unconnected story, Netflix, which entered the S&P500 last December, replacing the New York Times, has finally entered my equity portfolio.

For the past few months, I've been hearing CNBC's Herb Greenberg criticize Netflix's accounting practices and equity price. While not recalling all of the specifics, Greenberg's attacks largely centered on content acquisition costs and cash flows. Here's what he wrote a couple of days ago,

"So far this year, Netflix has committed to spend between $300 million and $400 million on new content, including "Mad Men".

If you just look at their balance sheet and cash flow statements you might say: “Not so bad.”

They have about $350 million in cash and about $230 million in debt.

Even cash flow positive, with reported free cash flow of $82 million.

Here’s the problem: In their 10-K, they disclose $1.3 billion in content obligations spread over a number of years, and that’s before these recent deals.

That gets us to their payables, which have been rising to levels not ever seen: $222.8 million last quarter, up from $92.5 million a year earlier. Another way of looking at it: Payables to revenue are 9.35 percent — the high end of its range; it was 5.2 percent in the fourth quarter of 2009.

Adjust the cash flow to reflect the payables and suddenly cash flow isn’t quite what it appears. Len Brecken of Brecken Capital, who has been short Netflix, says that if 2010 operating cash flow of $276.4 million were adjusted for the ballooning accounts payables it would fall below 2005 levels of $157.5 million.

(And this is before getting into his argument that net income is inflated by artificially low amortization of cash content costs.)

My take: Netflix has done an exceedingly excellent job capturing mind share and market share and building a seemingly unbeatable brand."

With the equity now among my selections, I'm no longer a disinterested observer. But Greenberg's arguments are not time-dimensioned. You don't get a sense of when he believes the stock's price will go into free fall.

Meanwhile, Netflix seems to continue to enjoy wide consumer appeal, thanks to its instant viewing capabilities. Yes, I know Facebook and Amazon are competing with Netflix. But there's still the ability with the latter to obtain physical DVDs for viewing material that isn't on demand anywhere. For a fixed price.

If Netflix had more of an opaque profile in terms of what it sold, and to whom, I would take Greenberg's concerns more seriously. As it is, he and other, like-minded critics have been vocally objecting to Netflix's valuation and accounting for several months. That ought to be sufficient time for investors to have factored these stories into their buy or sell decisions. And the firm's equity price has continued to strengthen.

In the past, my equity selections have included Tyco and a few home builders. In each case, my selection process had exited the equity in question long before its price cratered.

I'm not a long term holder of equities. There's a potential for a portfolio to turn over quite significantly after six months. That doesn't mean an equity won't continue to be selected monthly for some time. But each month's decision to include an equity is different than the prior month's. Just last year, Intuitive Surgical and McAfee proved to be disappointments. But  that didn't prevent the strategy from nearly doubling the S&P's gross returns.

So while Netflix is now in a portfolio, its weight isn't out sized. And, honestly, I don't care, presently, where its price is in two years. Or even a year, for that matter. It takes a lot of investors with varied valuation models to make a market. Sometimes, despite a firm's flawed long term strategy, you can make money in the meantime.

Thursday, April 07, 2011

About Last Week's Employment Numbers

Last week's BLS employment number for March was 216,000 net non-farm payroll additions.

I was discussing this with a friend over the weekend. She's not a business person or economist, so it was an opportunity for me to explain the overall job loss and recent growth dynamics since 2008.

At this point, I can't find a single reliable number for how many jobs have been lost since the recession began in 2007, but it's certainly at least 6 million. In this post from February, discussing Brad Schiller's outlook for unemployment and job growth. He had written, as I quoted in that post,

"The latest employment reports have not been encouraging. At the rate of 36,000 new jobs a month—the number gained in January—we will never get back to full employment. Even if we keep adding jobs at the December rate of 121,000 new jobs, we wouldn't achieve full employment in this millennium.

At the trend growth rate of 1.2% annually, we get another 1.8 million labor force participants a year, and with them, the need for another 1.8 million new jobs.

To get back to full employment tomorrow, we could get by with another seven million new jobs. To reach full employment by the end of this year, we would need at least nine million new jobs (some 750,000 a month). There's simply no way we will experience that kind of job creation.

Each year brings another two million-plus workers to the labor force (new workers plus the re-entry of discouraged workers). Thus we would need monthly job gains of 460,000 to achieve full employment in time for the 2012 presidential elections.

We created that many jobs one time in the last four years (May 2010)."

So let's use the 9 million number. I looked back at last year's posts on monthly employment numbers, and saw that April's was much like last month's.

So despite all the positive comments last year over a few months of 100,000+ job growth, here it is, a year later, and we're only at 216,000.

If job growth doubled to around 400,000/month, we'd still need 22 months to absorb 9 million new jobs. Obviously, at half that rate, you're talking about 4 years. Writing in the wake of January's anemic number, Schiller's math showed it taking forever, because job growth was being outstripped by new entrants into the labor market. We need at least 150,000 net new jobs/month to soak up the incoming flow to the base of job-seekers each year. Right now, we're at 65,000 more than that, in an economy that has rising inflation, increasing regulation and serious government fiscal and monetary challenges.

Explaining this to my friend, I found myself reacquainted with the truth about the current unemployment situation. That is, while the administration and various pundits are cheering the erratic but mostly rising series of monthly BLS employment numbers, the rate of increase and current levels are just too low to support a serious economic recovery anytime soon.

Schiller's focus on the basic math of the challenge is sobering. And March's employment numbers do not, in the larger picture, really constitute sufficiently good news to celebrate much of anything yet.

Wednesday, April 06, 2011

The Economics of Electric Vehicles

Margo Thorning's editorial in an edition of last month's Wall Street Journal, entitled Pull the Plug on Electric Car Subsidies, assembled a useful set of data concerning the economics of electric vehicles.

Going back to 1832, Ms. Thorning noted the invention of the first electric car in Scotland by Robert Anderson. She mentions the first American electric vehicle making its appearance in 1907, then writes,

"Since that time Americans have seen tremendous innovations in everything from air travel to microwaves, yet there has been little progress converting consumers to vehicles powered by rechargeable batteries."

She begins by quoting Consumer Reports reviews which trashed Chevy's Volt as inefficient as both an electric and gasoline car. In terms of cost, she reveals that the Nisan Leaf's battery costs $20,000, yet still only provides an 80-mile range under optimal, which is to say, temperate weather conditions. Drive it in hot or cold weather, and that range shrinks dramatically. The charging unit for such a vehicle varies between $1-2,000. Of course, using an electric vehicle merely transfers energy usage from gasoline to our mostly coal-fired power grid.

Surprisingly, Thorning contends that you'd need $300/bbl oil, along with an electric car battery costing 25% of the current $20,000, to make an electric vehicle cost-competitive.

Thorning then ticks off the various government subsidies to try to sway consumers to buy electrics. There's the $7,500 tax credit, as well as credits for "installing charging stations in homes and businesses and for building battery factories and upgrading the electric grid."

Citing the current administration's goal of one million electric vehicles driven by 2015, she estimates this will result in a $7.5B federal subsidy.

Having read this piece last month, then reading Paul Ryan's editorial in yesterday's Wall Street Journal in support of the House GOP's 2012 budget, I have to wonder whether these subsidies will survive the next two years of federal spending fights.

And, in that environment, with such reliance by Ford, GM, Nissan on federal largess to market these cars, whether those auto makers are due for a nasty surprise, having sunk so much capital into designing and producing electric vehicles.

I saw Alan Mulally show a new Ford Explorer on CNBC's morning program yesterday. The amount of digital technology in a new car, including various remote cameras and warning systems, certainly distinguishes such a car from one that is just five years old. But those systems are hardly so novel as to be a barrier to competition.

That means all the major car makers will be designing and selling better cars with more useful safety/electronics systems without prices for them rising out of control.

So where will the payoff ultimately come for Ford, GM and the other competitors for electric vehicle design and production that ultimately makes no economic sense? Wages aren't rising, and unemployment is still high. Federal spending is now under more scrutiny than at any time that I can recall in my life.

With Thorning's informative editorial as evidence, does anyone really think the money being poured into electric vehicles is actually going to make an adequate return for these firms any time soon?

Tuesday, April 05, 2011

Government Employment vs. Private Sectors

Stephen Moore wrote an interesting piece in Friday's Wall Street Journal regarding the balance between government/public sector and private sector employment.

Here are some of his statistics,

"Today in America there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million)....More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined.....Nearly half of the $2.2 trillion cost of state and local governments is the $1 trillion-a-year tab for pay and benefits of state and local employees.....Surveys of college graduates are finding that more and more of our top minds want to work for the government."

Moore goes on to note that employment in teaching has doubled, per student, from 1970-2005, while test scores remained flat. Similarly, mass transit spending is up, while usage is a smaller share of transportation than in the past.

Now, I find some fault with Moore's simplistic presentation of data. For example, manufacturing value in America has remained high and stable for decades, but, thanks to productivity, employment has declined. Low-complexity, low-wage manufacturing goes overseas, now to Southeast Asia and China, while more difficult manufacturing remains onshore and pays well, albeit to fewer workers. More automation and mechanization ensures higher quality and more consistency of output.

So griping about a reversal of government and manufacturing employment from 1960 to the present isn't completely fair or representative of what's going on.

That said, it's stunning to simply read that there are 22.5 million government workers in America. How do we measure the value they create for our society? We can't and we don't. That is troubling.

Here's the way I prefer to consider Moore's numbers.

Jobs should entail adding value. When numbers of jobs, and total wages, increase, that should mean that the sector involved is creating more value. Thus, while private sector jobs typically follow that route, government does not. Or, more importantly, we can't tell.

The teaching and transportation statistics are troubling, because, as Moore puts it, they are backward. When we don't like results in those sectors, we do not, as in business, cut resources. Instead, we spend more. It becomes a case of buying service levels at any price.

That's why the average voter should ask why government ever does anything through its own employees, short of military and policing, rather than contract it out every 3-5 years? We don't want to employ people in government, because that's tax money. We want productivity, which is best bought via competitive contracting over the relevant time period to get the most out of facilities and the productivity gains of a contractor's operations.

I wish Moore had noted the total private sector US employment versus government employment, and those numbers over time. And, then, total wages and benefits for both over time.

Now that would be revealing.

Monday, April 04, 2011

Research On Oil Shocks & The US Economy

Don Luskin wrote an interesting editorial in last Tuesday's Wall Street Journal which contained some valuable empirical information on the effects of oil prices on US economic activity.

One of the pieces of research cited by Luskin "suggests that oil prices imperil the economy when they reach a new three-year high."

Another "says the overall economy is threatened when the 12-month average oil price exceeds the year-ago 12-month average price by more than half. Below those levels consumer and investor expectations aren't sufficiently disrupted to make a difference."

Luskin then observed that "both conditions are very far from being triggered at today's prices."

I don't follow the oil markets specifically, so I'll have to take Luskin's word for that conclusion. After all, there are various grades of oil priced at various places, and Cushing, Oklahoma, the standard US pricing nexus, has, I am aware, some capacity issues which can distort prices there.

However, it's pretty clear that today's trailing 12-month average price of oil isn't very high above the prior year-ago 12-month average, although, just typing that reminds me of how much specific price information is required for that determination. Information I don't typically have at my fingertips.

But I do find coherence between the oil effect researchers' approaches to comparing recent prices with year-ago averages or prior peak prices. I've observed similar equity-market-related effects using not entirely dissimilar lagged point-in-time average comparisons. The notion of modeling human behavior regarding surprise or accommodation is not new, and it makes a lot of sense. If changes aren't too drastic over a year's time, people can often adjust to them and, thus, attenuate their impact.

Luskin goes on to cite some more interesting statistics which build upon the US economy's improved energy efficiencies since the first Arab oil embargo of 1973-74. He writes,

"It may come as a surprise to many, but today in the U.S. we're consuming the same amount of crude oil that we did 12 years ago and real output is more than 25% higher. For all the talk of our being the planet's most villainous energy hog, we've become remarkably oil efficient."

Wow. Imagine that! No subsidies for cutting oil usage, and it's become more efficient all on its own. Why, that sounds like a market that responds to price signals, economizing on that which is becoming more expensive, doesn't it?

Maybe oil's price trend and the uncertainty of its level has affected US oil efficiency on its own, without the dubiously-effective subsidies to wind, solar and other ostensible replacement sources.

It is a constant source of comforting amazement to me that US energy efficiency improves over time, on its own, while critics point to simpler, less-useful numbers such as total oil usage. After all, if you have a large economy that creates much economic value, it will tend to use lots of inputs to do so. That doesn't make it bad nor inefficient solely on the basis of scale.

Luskin's piece is valuable, therefore, for two reasons. He highlights some important empirical research suggesting what sorts of oil price increases will be necessary to really cripple the US economy due to consumer behavioral changes, and reminds us that, meanwhile, the country's natural economic behavior has increased the efficiency with which we use this expensive energy input.