Big Boy Finance- It's Major League Time on Wall Street

It has been a very interesting two weeks in the financial markets as investors have seen groundbreaking deals which could potentially alter the competitive landscape in the media and telecommunications industries.  We have seen massive bets placed by large participants in the quest for market share and future growth.  Let's take a look at what has transpired and what the implications may for quite a few different segments.

A few days ago, Facebook's Mark Zuckerberg placed a $19 billion dollar wager by buying WhatsApp, a mobile messaging service which is growing like a weed and has accumulated nearly 500 million users.  WhatsApp has an interesting business model in that users don't pay fees for the first year of usage, and after the initial annum pay a whopping $1 a year for unlimited SMS and other services.  Facebook is betting on the continued growth of its acquisition, especially in large markets like India and Brazil.  In some Southeastern Asian countries like South Korea and Thailand, companies have created large user bases with free SMS services and then tried to make money by adding additional pay layers to the free service, with some traction.  Facebook is trying to duplicate their success of buying Instagram, especially on the strategic front.  Many view the purchase of WhatsApp as a defensive measure because it tries to address the growing naysayers that Facebook's s popularity with young users is slowly eroding.  Zuckerberg financed most of the deal by issuing Facebook stock, and used cash as an incentive to retain the WhatsApp employees.

 

Deals in Silicon Valley are done primarily with stock as a way to retain the upside potential, but with interest rates where they are, the deal strikes me as one which probably could have been done a bit differently and would wind up far more tax efficient.  Still, the main issue in the future is going to be how well Facebook can take WhatsApp and create a large and ever growing cash stream from the user base.  The purchase price is a big hurdle and some of us old fogies remember services like AOL's Instant Messenger which were going to lead to large revenue streams in the future.  Until they weren't.   Still, it is a bold bet and certainly probably made the boys and girls from Google, Yahoo, and Apple sit up nice and straight in their chairs, or penthouse suites, and take notice.

 

If that were not enough, last week saw Comcast agree to buy Time Warner Cable for nearly $160 a share, or a market value of nearly $50 billion   I certainly have been very vocal about thinking John Malone and Charter Communications would ultimately wind up with Time Warner Cable (full disclosure- at every level- company, personal, and family, all members of the Liberty Media "family" are holdings).  Many investors and the media have portrayed John Malone as 'losing' to Brian Roberts and Comcast because Charter was not able to merge with Time Warner Cable.  As is so often the case, there is far more involved with this situation than to declare a winner or a loser.  Let me offer up my thoughts as to how to potentially view what transpired, keeping in mind I am looking at it from the Liberty shareholder point of view.

 

First, the person who really recognized the value at Time Warner Cable is John Malone.  The management at Time Warner Cable, including current CEO Rob Marcus, has not invested in their own infrastructure for a number of years, and it's customer service is notorious for being, shall we be kind, substandard (atrocious could also be used as a description).  As such, Time Warner Cable has proceeded to lose cable subscribers for the last two years.



John Malone's has a fourty year track record of literally turning feces and urine to gold.  If you have been an investor in almost any of Malone's public companies you should be congratulated because chances are, he has made you money, and probably quite a lot of it.  John Malone bought nearly 30 percent of Charter from a group of private equity companies, and when he did he knew Charter has something like $7 billion dollars of tax loss carry forwards as tax assets.  In addition, Liberty Media has a 52% ownership stake in Sirius Satellite and voting control of its path forward.  Sirius also possesses something like $5 billion dollars of tax loss carry forwards, has over 25 million paying subscribers, and generates over a billion dollars a year of cash, which should also grow nicely in the future.  Liberty is trying to consolidate its ownership of Sirius by buying the rest of what is does not already own.  John Malone's attempt to merge Time Warner Cable with Charter would have taken Charter's paying subscriber base from 4 million to over 15 million in one transaction.  A new entity could then shield it's substantial income from taxes with over 10 billion dollars of tax loss assets.  Just as important, Charter does not compete with Verizon or AT&T's broadband tv services in nearly any area of the country.  Charter has a clear path to growth for a long time, especially after spending this year upgrading their systems to a digital platform.  Even now, Charter is an appealing company for any cable company which is cash generative and looking for additional scale to better negotiate with content owners like ESPN, Discovery, Fox, and others.  Charter has a relatively small subscriber base of 4 million, so if it merges or acquires customers of 3-4 million, the growth in subscribers is potentially very dramatic.  Adding 11 million paying customers would have been transformational, and potentially a big home run for Charter and Liberty Media, call it a asymmetric payoff.  So what happened and why did Malone "fail"?

 

Malone had two large problems in trying to make this one happen.  First, he came to a gun fight with a knife.  What I mean is while Charter is just starting to generate larger amounts of cash and has significant tax assets, it was trying to acquire a company three times its size.  Comcast is nearly ten times the size of Charter in terms of revenue and  five times it's size based on cash flow.  In reality, the only reason Charter could even entertain thoughts of buying Time Warner Cable is because John Malone led the charge and saw the potential in a possible deal.  Once he did he made a very bold bet and tried to make it happen.  In fact, he did so for nearly a year and was turned down three times by the Time Warner Cable management, an entrenched group if ever there was one.  Malone is not someone who is easily dissuaded and eventually Charter nominated their own board to potentially replace the existing one.  My own personal opinion is he was probably gaining traction with many of the institutions who owned large blocks of Time Warner Cable stock, and Comcast was very aware of the situation.  It is reported Charter and Comcast were negotiating about how to potentially split up the subscriber base and eventually disagreed about what Comcast should get.  Also, and this is crucial, Comcast disagreed with Charter about how to structure the deal and wanted it to be all equity, which is how it wound up.  John Malone is not going to do a deal which is not tax efficient, and this probably was a big source of the disagreement as well.  Another key point is also the price as TWC's stock is up over 65% during the last year, and probably a great deal of it was based on speculation a deal would get done with Charter.  In the end, Malone did not have the firepower to compete with Comcast, and very few companies would.  Still, once Comcast recognized Charter could realistically wind up with TWC, they essentially paid full price.  So now we turn to the implications of the deal and what might take place in the future.

All across the media landscape, including content providers, cable companies, telecommunications carriers, and social media enterprises, the purchase of Time Warner Cable by Comcast is very important.  If the deal gets approved by all government agencies, Comcast would provide over 30% of all U.S. homes their internet access, a massive market position.  New court rulings have thrown out net neutrality provisions, but the FCC has now indicated they are looking at new ones which better reflect market reality.  Comcast has indicated it will abide by the existing net neutrality rulings and maintain them once the transaction is approved.  Comcast is saying they won't raise prices on content providers for quite some time.  If you are one, like Netflix, Google or Facebook, you have to be very wary of this deal because already Comcast is starting to charge more for preferred access to their networks- the "dumb pipes" if you will.  You can see the content owners are going to lobby very hard to get, at the very least, their pound of flesh in terms of concessions by Comcast, and if possible, a way to deny the deal.  I suspect the transaction will be approved, but not after plenty of political grandstanding, especially by those with a very liberal slant.  You already see this from the comments of Senator Al Franken, and one can only imagine what Elizabeth Warren or Ed Markey is going to come up with.  Still, Comcast has plenty of lobbying experience and is very tight with the current administration, so odds are it will probably get done.

 

As for Liberty and Mr. Malone, the great thing about them is you never know what they are going to do, but you know they are trying to find ways to "create value" in every possible manner.   In fact, what made me a bit uncomfortable about this situation is it was not really a Malone kind of deal.  Usually, you just wake up and something is announced, it is done.  With the Time Warner Cable situation, it took way too long and there were too many rumors.  You know the old saying- loose lips sink ships.  I would bet Malone will continue to try to expand Charter and to try and to use those tax losses.  He will also try and buy the rest of Sirius and get that done.  You know, 10 billion dollars of tax shields is quite a lot.  Come to think of it, maybe the owners of Cox Communications might think they are attractive.  Malone has been partners with Cox and the Newhouse family for a long time in the ownership of Discovery.  Many investors find investing in Liberty Media too troublesome and too confusing.  Still, I'll take my chances with Malone, Maffei, Charter, and Liberty's path forward versus what Comcast has to offer any day of the week.  Five years from now, it will be interesting to see which group created greater shareholder returns.

Thanks for reading the blog post and have a great weekend.  

Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.

Yellen, Obama's Phone and Pen, and Shark Tank-

 
Janet Yellen is now the head of the Federal Reserve, and  on Tuesday she gave an update to House Financial Services Committee on the state of the U.S economy.  The Fed "Head" indicated the current policy of slowing down the purchase of fixed income securities remains in place ("Tapering" for those who don't pay attention to Fed speak).  According to her testimony, it is apparent the priority is reducing unemployment closer to "full" employment, which simply means they want far more people out looking for, and actually obtaining, jobs.  As part of the Fed's dual mandate, the other main objective is to control inflation.  With the big "I" submerged at an annual rate below 2%, the Fed clearly believes they have inflationary forces under control.  Many skeptics believe deflation is the major problem the country faces, with still stubborn low labor force participation and factory capacity utilization rates.   The most recent jobs report indicated progress on both fronts, as the two categories were at their highest levels in quite some time.  Obviously, the equity markets liked what Mrs. Yellen had to say, as low interest rates for as far as the eye can see remain a soothing balm for long skittish investors. 
 
President Obama's recent quotes about having "a pen and a phone" are certainly suggestive of the realization by our nation's "leader" he is legislatively frozen, and probably acknowledgement of the potential loss of the Senate during the November elections.  As such, the comment speaks to what he can accomplish on his own through Presidential directives.  Looking at it differently, an objective observer might ponder the serious question of unilateral decision making in a country which was founded on the idea of a government based on a series of checks and balances.  Consequently, when you see how the Affordable Care Act has now been modified in quite a few ways since it has been implemented, one gets back to the principle of checks and balances and whether of not our "leader", along with his partisan pal Senate Majority Leader Harry Reid, have any recognition their policies might not be working.  Opponents of Mr. Obama might say that instead of having a pen and a phone, a brain would be more useful.

 

The Olympics started last week in Russia, and Mr. Putin's face was never more evident as he proudly unveiled the Winter Games in the new facilities that many companies in Russia ponied up hundreds of millions of dollars for in the hope of being reimbursed.  Nyet, and in reality, the country will probably face a situation where many of these monuments won't get near the kind of usage they thought when originally conceived.  Enjoy the games, Vlad, you will be paying for them for quite some time.

 

Over the last few months, the market has corrected some and the sector which has seen the largest beating would be in the social networking space, where Twitter and LinkedIn had some of the froth taken out of their stock prices. Certainly, there are other companies which still enjoy stratospheric valuations, like Tesla and Amazon.  Another interesting tidbit is Google overtook Exxon in market capitalization last week.  I took a look at both companies and on nearly every financial metric, Exxon has larger numbers, but in the crucial statistic of free cash flow, Google is relatively close.  What this speaks to is the difference in the kinds of business each company has in terms of capital efficiency.  If you add in the fact Google is growing much quicker, it is not out of the realm to see why Google overtook Exxon.  It does not mean I agree with it, or it is a permanent situation either. 

 

The television show Shark Tank is now prominently featured on Tuesday night on CNBC.  If you have not seen it, four prominent investors, including Dallas Mavericks owner Mark Cuban, listen and evaluate pitches by entrepreneurs in search of funding to potentially grow their start up companies.  One striking thing about the show, or at least my impression of it, was many of the presentations were from business owners who really do not show up fully prepared.   The other aspect which really bothered me was how disrespectful, mean, and arrogant the venture capitalists are towards their potential partners.  Yes, they are asking for an investment, which requires serious analysis.  However, nobody deserves to be made fun of and it seems the venture capitalists find it their job to be as insulting as they can.   The show can be viewed to see what other interesting ideas people have and how they might be applied to your business, but the negativity of the "Sharks" makes it very painful to watch. 

 

In traveling around the world on vacation, it was nice to see the various attitudes which come across when in different locations.  For example, in London, the airport was bustling and manners were prim and proper.  The Brits do everything they can to be pleasant, or at least those who I encountered did, and it was much appreciated.  In Africa, the laid back attitude of the locales was very prominent, and you certainly could make the case a more professional approach might be considered.  Interestingly enough, the first Burger King in the country opened while we were there, and the lines were two hours long.  If you ponder the idea people actually lined up for the Whopper, well, not much more needs to be said. 



Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.

The Wolf of Wall Street, Oil Issues, Security, and Earnings!

This past week I was in the locker room at my gym when I ran across a friend who told me he went to see the movie "The Wolf of Wall Street."   My reaction was one of disgust as I went to see the it a few weeks ago and found it to be lacking of any redeeming quality.  It is even more amazing, at least to me anyway, the film has been nominated for five academy awards.  What does this say about Hollywood?  Charlie Munger has a very appropriate saying which is applicable (and in many other cases as well), "Eat my bread, sing my song."
 

Martin Scorsese uses the life of a criminal, drug addict, and misogynist to glamourize everything wrong with the investment world.  In fact, probably 90-99% of those responsible for investing other people's money are trying to do a good job for people.  In a sad, but memorable scene with Matthew Mcconaugey, there is only derision given to the idea of a mutually beneficial relationship between the client and those who invest their capital.  Leonardo Dicaprio is a good actor who has done fine work in many other films.  However, he is as complicit as Scorsese in making a production which is garbage, at best. The bottom line is the film is typical of what Hollywood has now become, a place where studios churn out anything in search of a buck, irrespective of the validity or ramifications of what it produces.  I find it interesting there are so many good stories around in history and in all areas of life and yet the major studios in Hollywood make gutless choices like this as a way to attract audiences to their films.  I certainly won't be seeing any more Dicaprio or Scorsese productions, and I hope you won't either. 

Moving from fantasy to reality (although many valuations of companies these days could very well be thought of as make believe, too), this past week opened the earnings season for corporate America.  A few of the major money center banks performed nicely, while Citi had a subpar report.  In the consumer space, two enterprises which had poor reports were Sodastream and Best Buy.  The stocks were obliterated, one down nearly 20% and the other 40% over the course of two days.  These two situations are just further proof volatility remains at least one constant in the equity market.   Fluctuations can either be feared, or embraced, depending on the approach of the participant.

In the energy market, the big news came from Shell, who guided down their results for the final quarter of 2013.  Shell has been hurt by the tough refining environment in Europe and Asia, as well as poor choices related to shale projects in North America.  Still, with a new CEO on board, Shell as indicated their priority will be return on invested capital as opposed to finding sources of new production growth.  All across the energy sector, the rationalization of investment versus returns on capital will be a theme which have a permanent seat at the table.  In addition, choosing projects with stable operating environments certainly is going to have to factor into these decisions.  When it costs billions to invest in a project, the prospect of facing terrorists while trying to find a very valuable resource just does not make much sense.

 

Elsewhere in the energy world, the most recent railcar crashes in North Dakota yet again highlight the danger of working with resources like oil.  As more and more "black gold" gets moved by railroads, accidents like these have a higher probability of occurring .  Historically, the safest method of moving oil has been pipelines.  North America actually remains underserved by the pipeline network, which is why the Keystone proposal has plenty of merit to it.  However, the decision has been delayed for going on four years now.  In fact, the Canadian government has indicated it's frustration with the slow pace by the notoriously ineffective Obama Administration.  Essentially, it's (bleep) or get off the pot.  I am afraid the Canadians are probably going to be disappointed by the ultimate outcome. 

All over the globe, a more apparent problem are the security issues related to the use, storage, and  processing of data facing businesses, government, and consumers.  You see this with the lapses at Target, the NSA, and most recently, Starbucks (if you consider it a breach).   As technology evolves, these issues are going to take on even more importance as the public is not going to accept situations where their data could be compromised.  Especially in business, where every lawyer under the sun is looking for any reason to sue a company with financial resources, it is becoming more obvious that paying more for proper data security is going to be a fact of life going forward.

In the emerging markets, the major story which has broad implications is the effort of the Chinese government to move their economy from one heavily dependent on infrastructure spending to one which is more based on domestic demand.  For countries whose economies are very much based on exporting raw materials, worries about sharp reductions in GDP growth has resulted in some currency weakness and capital flight.  As a result, the investment world is starting to become far more interested in different growth possibilities in countries like Mexico, Indonesia, Vietnam, and Malaysia.  The world is a big place with plenty of possibilities, and the quest for investment returns never stops.

Thank you for reading the blog, I hope you have a healthy, happy, and productive week!!!


Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.

Winners Are Bold-Liberty, Apple, Marissa, and T-Mobile-

In the competitive environments of business, politics, and sports, the most applicable saying is- "To the Victor Goes the Spoils."  If you are a participant in the business or investment world, in many industries there are typically one or two large companies which control the vast majority of market share, and the remaining entrants are left to scrap for the crumbs.  As a result, the largest valuations and premiums in the market are given to the biggest winners.  Taking this reality even a step further, companies are in a competition to acquire as many customers as possible and fight as hard as they can to maintain, keep, and grow their bases.  The natural conclusion is every public company has to strive to create the perception in the public eye that they have the best offering in market.



As an investor, I think you have to try and identify situations where leaders realize they have to be bold and make big bets which are rational and have good risk reward potential.  In addition, it is not enough to take swings, companies have to execute on the leaderships vision.  For example, JC Penney thought they had a trans formative leader in Ron Johnson and tried to change the company.  It failed because of an inability to implement his plans in an organized, coherent, and predictable manner.  So, it is not enough to have grand plans, the ability to "Bring it to life," is the name of the game. 



When it comes to grand leadership, John Malone and Greg Maffei at Liberty Media stand out in a universe of, shall we say, mediocrity.  Malone's latest plan is to buy the rest of Sirius XM Satellite and exchange it for a new class of non voting Liberty Media shares.  Naturally, the Sirius-XM shareholders don't like the price being offered.  The noted consumer advocate and long time want to be serious presidential candidate Ralph Nader even weighed in on the supposedly ridiculous offer, even commenting that Carl Icahn should get involved.  Law firms from all over the country have announced they are looking at the proposal for fear the Sirius shareholders are being taken advantage of.  As a shareholder of Liberty's for well over 15 years now, the plan is classic Malone, and if Sirius shareholder don't think they are getting a fair price, they can vote no on the offer.  However, I would just note that this is not Malone's first rodeo and I suspect eventually Liberty will buy in the rest of Sirius and move on to the main event, which, for those of you following the saga, is Time Warner Cable.  If you are a Sirius shareholder, just a thought, you might want to stick with the Malone guy.


Turning to the next large wager, Apple has decided to place their retail stores in the hands of ex-Burberry CEO Angela Ahrendts (here is a nice article exploring her background even further-http://www.macrumors.com/2014/01/06/how-angela-ahrendts-burberry-experience-could-drive-the-future-of-apple-retail/).  She is very familiar to me as a Burberry shareholder and did a great job of positioning the company perfectly for the future.  I was sorry to see her leave and go to Apple.  She will have a large task ahead as the Apple retail opportunity is currently about $20 billion in size, compared to $6 billion or so at Burberry.  In time, I suspect she will make a big impact on Apple and it is a great example of how human capital and strong leadership skills could potentially have a major impact on an already important industry leader.


Another lady who is not afraid to make massive wagers is Marissa Meyer, the CEO of Yahoo.  She spoke this week at the CES show in Las Vegas while announcing an acquisition.  Yahoo investors essentially get a call option on her big bets as their existing position is almost based entirely on the their ownership stake of the Chinese giant Alibaba, which will have an IPO later this year.  If managements investments in human capital, a change in the corporate culture, and a overhaul of their mobile platform begin to work, shareholders potentially could have a reason to "Yahoo."


On the audacious leadership front, T-Mobile CEO John Legere certainly does not lack for chutzpah.  He decided to crash an AT&T presentation at CES and the publicity he received from the stunt has been through the roof, which won't hurt the business.  In fact, Legere has been very innovative in going after Verizon and AT&T customers and during the recent quarter, a record 1.6 million consumers became subscribers.  Just last week, T Mobile began an offer to pay hundreds of dollars as an incentive to get AT&T customers to jump to T Mobile.  Do you think that had anything to do with why Legere was thrown out of the AT&T presentation?

Finally, it appears the markets is starting to reprice assets which probably needed to be adjusted.  Last week, a very good friend of mine commented on Twitter's valuation and how it was probably a very easy short.  I dismissively thought otherwise, for any number of reasons, but the bottom line is the stock is now down 17% since that time.  No, we don't own shares and I think Twitter has a bright future, however, in many cases, market prices in no way reflect business reality, and this may have been one of those situations. 

Thank you for reading the blog and if you have any comments, opinions, or questions about the blog, please feel free to email them to me at information@y-hc.com!

Y H &C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.