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So much for “decoupling.”

Posted on July 3, 2008
Filed Under Companies, Markets & Finance | Leave a Comment

Somehow those economist and strategist types talking about decoupling a few months ago failed to notice one little thing, every country uses energy and food.  So even as regional economies develop their own production and consumption ecosystems we will still be tied very closely together thanks to the things we share. 

This is another reason we work hard to make sure we provide some researched short ideas for our clients.  Our mobile Internet picks are all down of late (Google, Apple, Research in Motion) but our shorts (Iron Mountain, Symantec, Constant Contact, Juniper, Seagate) cushion the blow.

We will never be able to predict stock performance by the month or quarter but going out a year or two has worked well in this market.  Our longs are gaining share and have great business models thanks to the industry trends we are seeing.  The market remains uninspiring on the long side of things but we’d encourage long-term investors to own the mobile Internet group without hesitation.  (We published a short 2-page note($) on this along with price targets and an ecosystem of names on June 5th.)

Tags: Apple, RIM, Google, Mobile Internet

The lunacy of financial analysts versus industry analysts.

Posted on June 18, 2008
Filed Under Research | Leave a Comment

This has been brewing for a while but has reached truly absurd proportions. For those that don’t know technology companies divide their analyst "relationships" along the lines of industry (Gartner, Forrester) and financial (Goldman Sachs, Morgan Stanley.)  This means that analysts talk to different people, attend separate meetings and receive distinct types of information and contact points in the company.

Besides having no real foundation in the first place, today this practice has taken on a mantle of irresponsible idiocy that remains somewhat characteristic of large companies.  Here are the key reasons:

1. Why would any industry analyst disregard the financial and business aspects of a technology vendor?  Why would a financial analyst attempt to do their job without a deep understanding of the technology, product strategy and other "technical" details of the business opportunity?  Can one do a restaurant review using just the prices on the menu and not tasting the food? Can you write up the food and ignore the prices of the items?  Silly.

2. Industry analysts are no longer distinct from financial analysts in terms of talking to public market investors.  Gartner has a huge business built around serving up their analysts to discuss companies with investors.  Firms like Gerson Lehrman blur this distinction even further.  Everyone is part industry analyst, part business/financial analyst.  Every single "industry analyst" firm we know has a substantive business where analysts service institutional investors.

3. Companies holding industry analyst meetings no longer provide any extra information that is financial in nature. They cite the "black out period" the same way they use it in financial analyst meetings.    Another distinction without a difference.

Obviously companies have lots of stake when talking to analysts which is why they work so hard to craft their message and information to market the image they want analysts walk away with.  Of course the primary job of the analyst is to find the reality and relate it to the needs of their own clients, not to grasp and simply repurpose the information.

Analyst meetings are certainly valuable and should continue.  But they should be open to both types and a detailed agenda allows analysts to decide how well the program fits with their needs.  Pure financial types may elect to skip product briefings and industry analysts may pass on the CFO presentation if there is one. 

We realize that the "blackout period" is a dumb invention to comply with "FD" regulations but since there is no objective definition of it nobody knows how to use it intelligently.  CXO executives refuse to talk to financial analysts for long periods while customers and prospects continue to get detailed information and participate in regular briefings with the company.  All it does is prompt analysts to develop relationships with the clients, channel partners, competitors and prospects for a company which end up being more useful anyway.  However company managements lose out because they miss the advice they can get back from analysts who spend time with clients, prospects and investors.  The dialog is greatly reduced.  Some companies actually pay over $100K for "advice" on how to script their quarterly calls but do poorly at understanding expectations. 

We could certainly go on but today most of the problems don’t impact us anymore now that we are outside the oppressive and unproductive broker/dealer research sector but the industry/financial analyst distinction gets more silly every day.

– Kris Tuttle

Tags: Research, Company Managements, Analyst Meetings

Amazon: Where there’s smoke there’s fire?

Posted on June 11, 2008
Filed Under Companies, Markets & Finance | Leave a Comment

We love Amazon as a company.  However last year the abrupt move from $40 to $80 caught us off guard.

We’ve watched it closely and continue to like it but… lately there have been some major outages.  Not just the ones that got headlines but quite a few more.

Speculation is out there about what might be going on but facts are few.  If Amazon is having infrastructure problems we have no doubt that they will figure them out and come back as strong as ever.  However until we know more we think it’s best to avoid the shares.  In fact we just took out a small short position.

Amazon is all about their infrastructure and while web services have not been impacted as far as we know they are certainly losing business from the public and the non-public outages. 

In addition we might be in a bit of a lull as we enter the summer season. Kindle is very interesting but it’s early for it to move the needle much.  Also other firms, like Google, are entering the fray with potent alternatives to Amazon EC2 and S3. 

Valuation is an issue here as well with the stock trading at levels that leave it vulnerable to selling in a rough market looking for excuses.  Any more outages or other issues could send the shared down sharply. 

We remain long term buyers on Amazon as a company but are keeping a neutral/negative postion for now.

– Kris Tuttle

Tags: Amazon, Shorts, Longs

Is JNPR losing steam?

Posted on June 11, 2008
Filed Under Companies, Markets & Finance | Leave a Comment

Juniper is a company that has amazed us with their ability to execute in a hyper-competitive market.

However lately there are bits of data coming in that suggest they are facing some fresh headwinds.  While they appear okay on the enterprise front the carrier business could be more punk.  Cisco continues to execute very well in the carrier area and 2nd tier vendors like Nortel (NT) are even winning some business in place of JNPR.

The other major concern we have on JNPR is high valuation.  At 5x sales and 30x earnings we find the stock at least 20% overvalued as we go into a period of what we expect to be somewhat soft conditions.

We prefer other names like Corning (GLW) on the networking side and Research in Motion (RIMM) on Mobile Internet.

[R2Capital is short shares of JNPR and long shares of GLW and RIMM.]

Tags: JNPR, Carrier, Shorts

Symantec makes to “Most Dangerous Stocks” list.

Posted on June 5, 2008
Filed Under Companies, Markets & Finance, Research, Software, Technology & The Web | Leave a Comment

A few days ago our friends over at New Constructs released their Most Dangerous Stocks for June list and we couldn’t help but note that SYMC was added to the large cap list.

The stock has had a great short term rally since we published our research note on April 30th, highlighting the challenges the company is facing in their core market according to their customers.  We recommended it as a short but on a fundamental versus a trading basis.

With the stock up from $17 and change to about $21 we feel the short is looking more attractive.  Our price target remains $14.

The company will be hosting their analyst meeting on June 12th and we expect more general enthusiasm around the meeting since management is very good at telling analysts and investors what they want to hear.

Insiders have been selling heavily with no buying.  The CEO, John Thompson, has taken $3.5M out in May alone.

Sentiment on the name has improved but there continues to be room for more upside if management gets more analysts over to their way of thinking around the meeting.  Despite the recent stock move analyst community is mostly at a Hold (20) with 12 at Strong Buy/Buy and 1 lone Sell rating.

We’re currently short the name but secretly hoping for some further share appreciation and further confirmation of our concerns on the fundamentals.

Anyone long or short SYMC should read the research note above as it contains quite a bit of customer data that loudly suggests management is out of the loop on the fundamentals.

– Kris Tuttle

Tags: SYMC, Short Ideas, Analyst Meeting

We need a research architecture and better tools

Posted on June 3, 2008
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We’ve been documenting a broad range of sources and services we have adopted to perform our regular research tasks.  In the process we have hit upon what we think is an important question for us and anyone else who is actively investing capital in the public markets.

Years ago the hedge funds helped cement the concept of the "mosaic" for a particular stock idea or market condition.  When looking at buying or selling a name these portfolio managers consulted a few sources that created a picture for them from a set of well defined aspects.  The classic case was a set of inputs that suggested near-term business was tracking better than consensus expectations, insiders are buying, new analysts have been visiting the company implying that new coverage is coming, and the valuation is attractive.  A set of consistent positive inputs means an informational mosaic that says "buy." As we have said many times before a successful analysis includes fundamentals (business trends), expectations (consensus thinking) and valuation.

There’s been a huge proliferation of information sources, sources that vary by type, scope and quality.  There’s also been a continuing trend of increased specialization.  Now institutions regularly consult firms like Gerson Lehrman for internal morale or insight on a potential investment, use another to do channel checks, get models and consensus thinking from brokers, bring in raw data from services like NPD, or Majestic, commission a custom survey, use a too like Bloomberg, or Reuters for insider transactions, lock-up expirations and so on.   Some are using consumer services like Google and Yahoo more to get a retail view of stocks and the market.  Add to that the growing number of interesting alternative sources of information like Monitor110, Covestor, Stockpickr and other ways to glean changes in sentiment or market adoption.  The full range of sources often also shifts based on whether an institution is in "idea generation" or "due diligence" mode. 

As we begin to document and semi-automate aspects of our own investment process we are forced to consider some architecture to pull these diverse and changing elements into our universe of knowledge and analysis so we can further optimize our portfolio and the quality of our decisions.

Every week we find and try to incorporate more good information sources, additional industry experts and smart people, different methods of getting and sharing information (first email then Skype now Twitter?)

We’re trying to incorporate a few overlapping layers and a fairly comprehensive view but even doing the basics begs for a simpler way to match fundamentals with consensus and valuation.  Why aren’t the online tools better?  Who has a simple and flexible architecture to put all these research elements in a context for decision making?

Better tools are needed.  Right now it looks like we need to develop most of what we want ourselves.  If nothing better appears we’ll produce them for the rest of the world when we are done.  Meanwhile, we welcome any good ideas.

– Kris Tuttle

Tags: research, investing, technology

Investment research industry update: The 10 year transition.

Posted on June 2, 2008
Filed Under Research | Leave a Comment

When we left the broker-dealer/investment bank universe of equity research we could certainly see the industry would have to work through a large and painful transition to a set of new products and business models.  Given the huge size of the "industry" our guess was that it would take 10 years to work itself out.

When we saw news of unbundling and new funding for research startups several years ago we thought that changes might start to come quickly.  These initial positive signs seemed to just die out.  Recently we mused that we may have been off by a factor.  The industry seems like it may need 20 years to things out.  After going back to the drawing board we have decided to stick with the 10 year forecast but admit that it’s going to be as back end loaded as an enterprise software quarter.

Thanks to a number of industry changes in the broker-dealer/investment banking world we are now getting the "Street" research we asked for.  That is, no research at all.  The lack of value has only helped to accelerate the devaluation of the work product and create a pervasive unwillingness to pay for research in general.

Today the only high returns available from quality investment research come from investment management fees.  This is why so much of the growth in research staffing has been on the so-called buy-side over the last five years.

It’s true that there have been some new and successful models.  The most well-known and now broadly imitated is Gerson-Lehrman.  Although their use of an expert network available to investors is fairly obvious and has been tried before, their structure of nearly all variable cost business model have been the key factors that have made them successful.  There are also hundreds of small independent research shops focused on verticals or other data segments that have been able to build reasonable though less famous businesses from the institutional investment community. 

 That said we are still sitting in a transition stage where the basic value proposition for sell-side investment research is seriously in question.  There is no better testament to this than the recent restructuring moves at Morgan Stanley.   In the face of serious progress in their research ranking (moving from #8 to #6) in the widely respected Greeenwich Associates study, they have terminated a large number of their senior research staff. 

In several large coverage areas: oil and gas E&P, health-care services, and automobiles and components, the analyst teams had vaulted from rankings in the pack to #1 or #2 before being fired.

Imagine their surprise… you work for years at Morgan Stanley, crank away and in the year you break through to be the #1 coverage in your industry… they fire you along with several others who obtained the same success.   If that doesn’t send a message of "research isn’t worth anything" I don’t know what does.

It also says that we are very much in the same place that we were for broker-dealer research back in 2003-2004.  During that time a huge investment in research on the part of what was then Adams, Harkness and Hill was undertaken.  Despite a new focus on improved research and a big ramp in the number and quality of the analysts, it didn’t move the needle.   It makes no sense to invest heavily in an aspect of the business that clients are either unwilling or unable to pay for.

Where does that leave us in 2008?  We have some uncertainly as to picking the starting year for this 10 year transition.  It was probably 2000 at the earliest and 2004 at the latest.  We do see some clear and undeniable evidence that industry conditions might be improving.  (Not for research at brokers or bankers but for independents.)  That would put our 10 year transition into 2010 or 2014.  Based on some of the things we are seeing we are expecting it to be closer to 2010.

Some investors are getting smarter.  They are beginning to understand that they need to look beyond the consumption of analyst reports and meetings with company management if they hope to outperform.  Under-performance has become more of a problem thanks to increased transparency and the rise of easy alternatives like ETFs.  At the same time many firms are introducing new and useful research products based on data and facts that can be tied directly into business trends and future shifts in company fortunes.   We’ve also seen a dramatic increase in the straight up payment for research versus so-called soft-dollar on trading commissions.

We’re working with some of these emerging data and fact-based research organizations to incorporate their information into products that are unique and of great value to institutions.  By combining proprietary and meaningful data, industry expertise and insight, and financial/stock analysis we generate the type of product upon which performance-enhancing investment decisions can be made.  It takes all three.

In conclusion the move by Morgan Stanley may mark the turning point for research.  It signals that the current system is so broken that what is touted as a great success leads to the elimination of the effort.  Reportedly Morgan Stanley is even taking a pass on subscribing to more detailed information about how their research group is performing.  Adding a form of "we don’t care" to "it doesn’t matter."

To anyone not familiar with the modern sell-side research effort in a broker dealer, getting to be the number one team involves covering the largest and most well-covered stocks in a group and then setting out to market yourself to every large institution to that votes in the annual survey.  It’s a ton of work.  One has to be up on every blip and nuance surrounding an industry or a stock.  It requires encyclopedic knowledge and hundreds of calls a week to voting institutions.  Of course this leaves little, if any, time for actual research, finding new ideas, helping people really make money in stocks.  But then again that’s the sell-side research we deserve.  At least Morgan Stanley has made some moves that might bring the charade to an end.

– Kris Tuttle

Tags: Research, Wall Street, Sell Side, Morgan Stanely

At least make an effort on Dell.

Posted on May 30, 2008
Filed Under Companies, Markets & Finance | Leave a Comment

We were thrilled to see some short-term upside on Dell last night post the strong results.  It is still a multi-quarter story but positive reinforcement is a good thing.

What puzzles us is how inept some of the large firms still are at helping people make money in stocks.  Dell is a very large, well covered firm.  It was impossible not to see tremendous value in the shares at $19 given their franchise and huge cash flow.  With an influx of new management and some clear evidence that fundamentals were steady and getting better there were plenty of reasons to believe the company would get back on track.  Add to that a huge share buyback and the inevitability of eventual easy compares and you have a perfect set up to make money on a one year view in a very large liquid stock.

At one level we’re happy to see the lack of thoughtful analysis because it means it’s easier for our fund to make profits on stocks that are supposed to be well-covered.  But still as a recovering DoR I can’t help but scratch my head when I see the upgrade today from Merrill.

To miss the chance a lower prices before the turn isn’t that big of a sin.  We’d all like to have perfect timing but know that’s impossible.  The real crime isn’t upgrading the stock today when it is likely to open at $23-24 but it’s putting a $27 price target on it.  Who is reviewing the research product?  It’s easy to do a long-term valuation and come up with a very conservative current fair value of $30-34 on Dell.  If you don’t use a discount you can stay quite reasonably that the stock could be trading at $40 in 12-18 months.  That’s what you do when you are upgrading after a $19 to $24 move and want to get back in the game.

If you don’t believe it then you keep your hold, provide your arguments and have some clarity of message and intellectual integrity.  Maybe ML still uses one of those bogus systems where the price used as the "upgrade price" would be yesterday’s close.  It’s obviously fraudulent since the real price where will be where the stock opens this morning but in the past this technique has been used to publish great performance figures on research analysts that nobody can remember ever making them any money.

– Kris Tuttle

[R2 Capital remains long shares of Dell.]

Tags: Dell, Wall Street, Research, Merrill Lynch

Dell Report

Posted on May 29, 2008
Filed Under Companies, Markets & Finance | Leave a Comment

Dell has been an important position for us for the last several months. Unfortunately it has also been a large losing position albeit our only one YTD.

The fundamentals on Dell have been improving all though most analysts are impatient for immediate results.  Most of the positive data points on Dell server shipments are probably priced into the stock going into the report.  The shares have been trading up and we’ve seen industry data from IDC and brokerage reports citing Dell strength in the market.

In the last few months there have also been signs of better expense control which could help make the quarterly report a more positive event than the last one.

Our expectation is that the recover of Dell will still require another several quarters to play out.  There are some major opportunities for upside but we ran our long-term valuation analysis today to arrive at a near-term fair value estimate of $30-34 on the stock.  It’s a bit above most of the price targets we have seen which hover around the high $20’s.

From a PM standpoint we had a little extra exposure on when the stock was down at $19.  We have taken that off but maintain a full position into the report though we have no idea what the numbers and the call may hold.  The Street has been fairly unfriendly to Dell of late so our expectations are fairly low.

Our confidence in stock is based on improving fundamentals, a reengaged management team and most of all outstanding returns on invested capital.

– Kris Tuttle

[R2 Capital currently has a long position in DELL.]

Tags: Dell, Earnings, Valuation

Tidbits from the recent GaveKal NYC briefing

Posted on May 26, 2008
Filed Under Companies, Markets & Finance | Leave a Comment

During a recent client briefing by our friends at GaveKal there were a few comments and observations that struck us as interesting:

1. The US is the Saudi Arabia of food. Higher average prices are good for the country while hurting many others.

2. Emerging economies are feeling quite a bit of pain already.  Small ones like Vietnam have been visibly hurt and larger ones like India are beginning to show the strain.

3. The earthquake in China is a game-changing event.  There may be as many as five to ten million homeless.  The onset of the rainy season and snow melt will bring added flooding in the valleys.  The containment of inflation will no longer be a priority for a government that needs to rebuild ten millions homes.  Closed mines and factories that were below even Chinese standards for safety and emissions are being put back into service.

4. The increase in Asian consumption is still a 10 year trade. 

5. Two major investment opportunities that should benefit from a return to mean valuation levels are Japan and technology stocks.  Japan may be on the verge of a trend of upward revisions.  It’s also very interest to consider the massive R&D investment (22%) Japan has made relative to their (10%) market capitalization.   The US also compares well on this metric.

6. Spending on technology, information and communication is benefiting from nearly all levels of spending increases, from emerging economies to more personal digital content to increased business investments in technology platforms. 

7. There appears to be a large carry trade in operation that is shorting the USD to buy Crude.  Obviously on a momentum basis it’s been working well.  However the unwinding could be volatile depending on how crowded the trade becomes.

8. It turns out the financial crisis is the factor behind recent spikes in commodity prices, especially food.  The natural sellers, farmers, have been taken out of the market because banks that routinely financed their futures transactions no longer will do so.  This leaves the markets to function purely on speculation and in the absence of most real sellers.

9. The long-CDS trade has worked out to some extent but lessons learned from the recent collapse of Bear Stearns call the merits of the trade into question.  If the CDS is a sort of insurance policy that is cheap to buy but then does pay off even when the suspected event happens, does it makes sense to own them as investments?  Bear may only be one case but would the ECB take similar steps to bail out a faltering Italy or Greece? 

[Please note these are just scattered comments.  Any merit should be attributed to GaveKal and any errors or omissions are our own.]

– Kris Tuttle

Tags: China, Macro, Oil, Japan, Tech, Investing