Monday, August 20, 2012
Good due diligence is defined by the deals you walk away from
As regular readers of this blog know - I don't much like buying stocks where I am competing with potential private equity (PE) buyers.
PE buyers have two advantages over me. Firstly they are able to borrow large amounts of money often at mid single digit rates. I don't think a mid single digit rate of return is worth getting out of bed for - certainly I will not invest my client money on those returns because the mistakes I make (and there are plenty) would wipe out any profits.
The second advantage is more important. That is private equity firms get to do a proper-due-diligence before they close any transaction. They can talk to staff throughout the organization. They can open the books up on any part of the business. They can talk with suppliers and customers. They can sit in on business meetings. They can even talk to critics and investigate the claims of those critics. In fact competence requires that they understand (and hence can investigate and dismiss) the claims of critics.
That is a pretty big competitive advantage. If I sought that advantage it would be called insider-trading and I would be sent to prison for it.
For a PE firm - its called good business practice.
Due diligence (or legal insider trading) is the main thing that makes it attractive to be a PE investor.
However if a PE firm always closes the deal then - almost by definition it is forgoing the main advantage of being a PE firm. A PE firm that eschews that advantage is - in my view - not a worthy investment.
This is especially true in China. Private equity investors have been involved in some egregious frauds in China.
Probably the most prominent example is how Richard Heckmann, a normally a very competent deal maker, was utterly defrauded when he invested in a Chinese water company. He now tells the world he was swindled. But other examples abound - such as Carlyle investing in China Forestry - a company which can now verify less than 1 percent of its previously reported sales.
I have a test for the competence of a private equity firm. A private equity firm is to be judged by the deals they walk away from.
What you really don't want as a PE investor is for them to announce a deal subject to due diligence and then close a bad deal because they get "deal fever".
Competence is the ability to walk away. It is what defines a really good PE firm.
I collect examples.
One recent example of a PE firm dropping a deal (though we will never know why) was Texas Pacific which bid for CNInsure (CISG:NASDAQ). They dropped out. Whilst we never know why they dropped it shows a willingness to drop out - and hence demonstrates a culture of competence.
Texas Pacific have also walked away from other deals.
Closing a deal on a fraud in China where the closure was subject to due diligence is the very definition of incompetence. I have a few examples at least as nasty as the Heckmann case. However there is no need for name calling here.
Just saying to potential PE firm investors: if a PE firm is known for always closing a deal you probably should not invest in them.
John
Thursday, August 16, 2012
Pricewaterhouse Coopers - the see-no-evil audit firm
A short post written in frustration.
I wrote to PWC (via their email-contact service) asking for an email address to send a large dossier alleging fraud at a company Pricewaterhouse Coopers audits.
I received no reply. It may be because PWC does not want the dossier and is happy to audit the firm regardless.
I presume PWC will remedy this (and I will report back when they have).
If they do not remedy it then I will dub PWC the audit firm that chooses to "see no evil".
John
It took about 24 hours - but I have now been contacted by PWC. Thanks for roughly 10 people who sent this to contacts at the firm.
I wrote to PWC (via their email-contact service) asking for an email address to send a large dossier alleging fraud at a company Pricewaterhouse Coopers audits.
I received no reply. It may be because PWC does not want the dossier and is happy to audit the firm regardless.
I presume PWC will remedy this (and I will report back when they have).
If they do not remedy it then I will dub PWC the audit firm that chooses to "see no evil".
John
It took about 24 hours - but I have now been contacted by PWC. Thanks for roughly 10 people who sent this to contacts at the firm.
Monday, August 13, 2012
T-Mobile to go private with the Sole True Hero!
Fierce Wireless is reporting that there is a private equity bid in the works to buy T-Mobile led by none other than my least favourite telecom executive, Mr Sol Trujillo.
As an Australian I have had some experience with Sol Trujillo - he was CEO of our local incumbent teleco - Telstra.
At first Sol looked to be a great salesman - but he systematically undermined any political and eventually customer goodwill with Telstra. He then took a me-against-the-world view as the business crumbled around him. That was a head-in-the-sand display that matches Microsoft's original dismissal of iPhones as laughable.
Sol Trujillo eventually asserted that his problems were caused by Australian racism - but they were not. They were caused by his personal intransigence and his tone deafness. The wags took to calling him the Sole True Hero simply because he could not build any coalition of support around his positions.
When he left the Prime Minister welcomed the news with a single word: adios. That was asserted as proof of Australian racism - and maybe it is indicative of such. However telecoms are ultimately a regulated business and an executive who makes a populace and a Prime Minister so angry that that is reasonable response has not succeeded as a teleco exec.
This is a warning to the capital markets. Anyone seriously contemplating backing that bid should look at Sol Trujillo's record at Telstra in Australia.
That record is subject of a previous blog post.
John
As an Australian I have had some experience with Sol Trujillo - he was CEO of our local incumbent teleco - Telstra.
At first Sol looked to be a great salesman - but he systematically undermined any political and eventually customer goodwill with Telstra. He then took a me-against-the-world view as the business crumbled around him. That was a head-in-the-sand display that matches Microsoft's original dismissal of iPhones as laughable.
Sol Trujillo eventually asserted that his problems were caused by Australian racism - but they were not. They were caused by his personal intransigence and his tone deafness. The wags took to calling him the Sole True Hero simply because he could not build any coalition of support around his positions.
When he left the Prime Minister welcomed the news with a single word: adios. That was asserted as proof of Australian racism - and maybe it is indicative of such. However telecoms are ultimately a regulated business and an executive who makes a populace and a Prime Minister so angry that that is reasonable response has not succeeded as a teleco exec.
This is a warning to the capital markets. Anyone seriously contemplating backing that bid should look at Sol Trujillo's record at Telstra in Australia.
That record is subject of a previous blog post.
John
Friday, August 10, 2012
Advice from the gardening column: XP Power edition
I have a friend - a journalist - who refers to the stock-tipping parts of his newspaper as "the gardening column": full of plants he says.
But the Financial Times is not any ordinary newspaper - and its stock tipping columns should be a little better than that. So I read David Schwartz column on how to manage your investments on holiday with great interest. Fantastic stocks - ones you can put in the bottom drawer and know they will deliver - they are the stuff I need to take the stress out of my life.
Here is what he recommends:
Power converters - the things you plug into your laptop or into the life-sign monitoring equipment in a hospital to feed them nice stable DC current - don't seem to me to be a massively prospective business. There are lots of suppliers. I am not particularly fussed about which one I use. If I want power reliability then I get an "uninterruptable power supply" and even those are a competitive market. I would expect a story of thin margins made good only by lots of product development and fairly large sales.
XP Power confounded my expectations. Completely confounded them. The accounts were nothing like what I expected to see. Here is the P&L from the last annual report:
Revenue was £103.6 million. Gross profit was £50.9 million. The gross margin was 49.1 percent.
Operating profit was £25.3 million. Operating profit margin was 24.4 percent.
Research and development expenditure of a mere £4.2 million pounds. Not a big number - but a moderately healthy 4.1 percent of revenue.
These ratios looked strangely familiar. But I could not quite put my finger on why. And then a light went off in my brain. A light from Cuppertino. Apple! Yes that company.
Here - and on an entirely different scale - is Apple's P&L for the last three years:
The sales last year were $108.2 billion. Gross margin was 43.8 billion. Gross margin was 40.5 percent - a little lower than our humble XP Power. But Apple's operating margin (31.1 percent) is higher than XP Power.
But hey - David Schwarz - writing for the esteemed Financial Times - tells us that XP Power is going to increase its margins. Apple like numbers here we come!
XP Power history
By now I am seriously impressed with XP Power. It makes a seeming commodity electronic product but has a higher gross margin than Apple. Surprisingly despite the fact that it does not advertise much or run all those fancy stores it manages - after SG&A to wind up marginally - and only marginally less profitable than Apple.
Pretty darn impressive.
If it just turned up this way - a new entrant into the realm of super-profitable electronic hardware companies - then I would be surprised - but not stunned. But XP Power has been pushing out astounding numbers for a decade. Larry Tracey - Executive Chairman - is quoted in the last annual report as follows:
Wow. Now I am really wondering why it took a share-tipping column to alert me to this wonder stock.
XP Power products
By this stage I had found a nearly unknown electronics company with margins nearly the match of Apple and with a hugely impressive growth rate. And it did what looked to me like a commodity business.
I had to go looking for their products.
Alas they were harder to Google than you would think - if only because XP Power got mixed up in articles about the Microsoft XP operating system and computer power requirements. Here however is a typical example:
It is a simple 15 watt DC converter (about a quarter of the capacity of the converter for my laptop). It is priced at 28 quid - cheaper in quantity. Still this is more expensive than the cheapest laptop computer DC converters suggesting that higher than normal margins are possible.
The balance sheet puzzle
An electronics company with a proud history (rapid, continuous growth) and margins within a whisker of Apple would normally - I expect - have a balance sheet similar to Apple. Maybe not in size - but I would expect to see a lot of cash - cash being the tangible representation of past profits.
But XP Power does not look like that at all. Here is the balance sheet:
The balance sheet has on it lots of assets representing past profits. Notably it has 31 million pounds of goodwill (they have purchased very well as acquisitions have not diluted profits). They also have 22 million pounds in inventory.
But they have that very un-Apple like thing. Net debt. Strange given their profitability - but with this record - well - you just have to trust them.
But I will not be buying the stock
David Schwartz "holiday buying case" for XP Power is that it will have increasing profitability. That is for a company that is already trading with Apple-like margins.
I am an old fashioned kind of investor. I like to think what a company will look like in five years before I pull the trigger.
To buy this stock I would need to be able to finish the following statement: I believe XP Power will in five years time have margins similar to Apple because...
I can't answer that. Indeed I can't imagine that you can stay this profitable in a seeming commodity business - so I shorted the stock. Maybe I need to find another gardening column.
John
To clear up confusion with my North American readers who forget there is a stock market in Old Blighty - this stock trades in London measured in pounds. [The Americans who forget there is a world outside the lower 48 know who they are!]
But the Financial Times is not any ordinary newspaper - and its stock tipping columns should be a little better than that. So I read David Schwartz column on how to manage your investments on holiday with great interest. Fantastic stocks - ones you can put in the bottom drawer and know they will deliver - they are the stuff I need to take the stress out of my life.
Here is what he recommends:
Turning to my own portfolio, I have just bought shares in XP Power (XPP), a designer and manufacturer of power converters. These are devices that allow electronic equipment to operate efficiently.
XP Power shares were in the 1,600-2,000p range during the first half of 2011. But investors ran for cover after the level of new orders began to slip in mid-year. The slowdown eventually caused lower profits in the first half of 2012.
But the company’s order rate is now spiking higher. I expect second-half results to be much higher than last year’s figures.
Even better, XP Power is quite optimistic about its future. It recently launched 10 product lines. It brags about its strong design win record in the current year. The share of revenues derived from products manufactured internally is rising. These are more profitable than those manufactured externally. Its new factory in Vietnam has just come on stream, which will also help to increase margins.
The dividend has just increased and now approaches 5 per cent.
Power converters - the things you plug into your laptop or into the life-sign monitoring equipment in a hospital to feed them nice stable DC current - don't seem to me to be a massively prospective business. There are lots of suppliers. I am not particularly fussed about which one I use. If I want power reliability then I get an "uninterruptable power supply" and even those are a competitive market. I would expect a story of thin margins made good only by lots of product development and fairly large sales.
XP Power confounded my expectations. Completely confounded them. The accounts were nothing like what I expected to see. Here is the P&L from the last annual report:
Revenue was £103.6 million. Gross profit was £50.9 million. The gross margin was 49.1 percent.
Operating profit was £25.3 million. Operating profit margin was 24.4 percent.
Research and development expenditure of a mere £4.2 million pounds. Not a big number - but a moderately healthy 4.1 percent of revenue.
These ratios looked strangely familiar. But I could not quite put my finger on why. And then a light went off in my brain. A light from Cuppertino. Apple! Yes that company.
Here - and on an entirely different scale - is Apple's P&L for the last three years:
The sales last year were $108.2 billion. Gross margin was 43.8 billion. Gross margin was 40.5 percent - a little lower than our humble XP Power. But Apple's operating margin (31.1 percent) is higher than XP Power.
But hey - David Schwarz - writing for the esteemed Financial Times - tells us that XP Power is going to increase its margins. Apple like numbers here we come!
XP Power history
By now I am seriously impressed with XP Power. It makes a seeming commodity electronic product but has a higher gross margin than Apple. Surprisingly despite the fact that it does not advertise much or run all those fancy stores it manages - after SG&A to wind up marginally - and only marginally less profitable than Apple.
Pretty darn impressive.
If it just turned up this way - a new entrant into the realm of super-profitable electronic hardware companies - then I would be surprised - but not stunned. But XP Power has been pushing out astounding numbers for a decade. Larry Tracey - Executive Chairman - is quoted in the last annual report as follows:
Our strategy and its execution resulted in earnings per share of 106.4p for 2011, an increase of 27% over 2010. The compound average growth rate of earnings per share has been 27% over the last 5 years and 18% over the last 10 years.It is not Apple - but this is way more impressive than most companies. 18 percent for 10 years is more than 500 percent growth. Previous years are also at very high margins.
Wow. Now I am really wondering why it took a share-tipping column to alert me to this wonder stock.
XP Power products
By this stage I had found a nearly unknown electronics company with margins nearly the match of Apple and with a hugely impressive growth rate. And it did what looked to me like a commodity business.
I had to go looking for their products.
Alas they were harder to Google than you would think - if only because XP Power got mixed up in articles about the Microsoft XP operating system and computer power requirements. Here however is a typical example:
It is a simple 15 watt DC converter (about a quarter of the capacity of the converter for my laptop). It is priced at 28 quid - cheaper in quantity. Still this is more expensive than the cheapest laptop computer DC converters suggesting that higher than normal margins are possible.
The balance sheet puzzle
An electronics company with a proud history (rapid, continuous growth) and margins within a whisker of Apple would normally - I expect - have a balance sheet similar to Apple. Maybe not in size - but I would expect to see a lot of cash - cash being the tangible representation of past profits.
But XP Power does not look like that at all. Here is the balance sheet:
The balance sheet has on it lots of assets representing past profits. Notably it has 31 million pounds of goodwill (they have purchased very well as acquisitions have not diluted profits). They also have 22 million pounds in inventory.
But they have that very un-Apple like thing. Net debt. Strange given their profitability - but with this record - well - you just have to trust them.
But I will not be buying the stock
David Schwartz "holiday buying case" for XP Power is that it will have increasing profitability. That is for a company that is already trading with Apple-like margins.
I am an old fashioned kind of investor. I like to think what a company will look like in five years before I pull the trigger.
To buy this stock I would need to be able to finish the following statement: I believe XP Power will in five years time have margins similar to Apple because...
I can't answer that. Indeed I can't imagine that you can stay this profitable in a seeming commodity business - so I shorted the stock. Maybe I need to find another gardening column.
John
To clear up confusion with my North American readers who forget there is a stock market in Old Blighty - this stock trades in London measured in pounds. [The Americans who forget there is a world outside the lower 48 know who they are!]
Monday, August 6, 2012
Something is happening here and you don't know what it is - do you Mr Hempton: Richemont edition
I am wrong often enough to hurt - but rarely this fast. Richemont just pre-announced a big sales increase. I expected at best low single-digit sales increases and the company to guide down. I blogged about it only on Friday. Richemont was a modest sized short position and I was trading it for what I thought would be an earnings miss.
This company sells very fine jewellery and high end watches. By high-end I mean up to half a million dollars.
Richemont is - as I said in the original post - an amazing company that has managed to make super-luxury goods ubiquitous whilst they remain exclusive.
The sales rise during the first four months is 24 percent (16 percent in constant currencies).
We have a broken thesis rule at Bronte. We search for things that falsify our thesis - and when we find them we close our position. This big sales increase tells me that something is happening in this business that is outside my thesis and not obviously consistent with the thesis.
So we just covered. Loss to clients was about 40bps of our funds under management. It was not the first time and it will not be the last time we make a mistake...
Speculations
As of about five minutes ago we no longer have any interest in Richemont, long or short. But that won't stop me trying to work out what we did wrong. The sales increase is enormous given current economic trends. Lets think this through by jurisdiction...
I would expect a (big) sales increase in Japan because the previous corresponding period includes the earthquake and tsunami.
I would be startled by anything other than a sales decline in Europe. There is an economic crisis there and as one of my correspondents put it - the one percent are becoming the half a percent.
North America is doing OK - so I would expect a sales increase - but low single digit.
South America will - like Australia - be beginning to feel some commodity price anxiety - so sales increases will be small.
The anecdotal stuff out of China and Hong Kong is all bad. Correspondents sent me many anecdotes - all supportive of my thesis - and the plural of anecdote has always been data.
None of this allows for a twenty percent sales increase.
I have heard only one alternative thesis - and that is that sales within Mainland China are increasing - not because they want the watches and jewellery but because they are portable wealth that you can move over a border with or store like gold. It might be true - but watches and jewellery strike me as poor stores of value. The anecdotes in my email suggest that the gray market is weak - but those anecdotes are so thin that I doubt them.
Any other thoughts - because I am at a loss.
John
This company sells very fine jewellery and high end watches. By high-end I mean up to half a million dollars.
Richemont is - as I said in the original post - an amazing company that has managed to make super-luxury goods ubiquitous whilst they remain exclusive.
The sales rise during the first four months is 24 percent (16 percent in constant currencies).
We have a broken thesis rule at Bronte. We search for things that falsify our thesis - and when we find them we close our position. This big sales increase tells me that something is happening in this business that is outside my thesis and not obviously consistent with the thesis.
So we just covered. Loss to clients was about 40bps of our funds under management. It was not the first time and it will not be the last time we make a mistake...
Speculations
As of about five minutes ago we no longer have any interest in Richemont, long or short. But that won't stop me trying to work out what we did wrong. The sales increase is enormous given current economic trends. Lets think this through by jurisdiction...
I would expect a (big) sales increase in Japan because the previous corresponding period includes the earthquake and tsunami.
I would be startled by anything other than a sales decline in Europe. There is an economic crisis there and as one of my correspondents put it - the one percent are becoming the half a percent.
North America is doing OK - so I would expect a sales increase - but low single digit.
South America will - like Australia - be beginning to feel some commodity price anxiety - so sales increases will be small.
The anecdotal stuff out of China and Hong Kong is all bad. Correspondents sent me many anecdotes - all supportive of my thesis - and the plural of anecdote has always been data.
None of this allows for a twenty percent sales increase.
I have heard only one alternative thesis - and that is that sales within Mainland China are increasing - not because they want the watches and jewellery but because they are portable wealth that you can move over a border with or store like gold. It might be true - but watches and jewellery strike me as poor stores of value. The anecdotes in my email suggest that the gray market is weak - but those anecdotes are so thin that I doubt them.
Any other thoughts - because I am at a loss.
John
Friday, August 3, 2012
Richemont: waiting for the bullet
At my hedge fund we usually short frauds. Stuff with dodgy accounts and dodgy prospects promoted by people who would be car salesmen if stock promotion were less lucrative. But sometimes, just sometimes we find ourselves aching to short a real company with fine management where business prospects are going south very fast.
Richemont - the mega-luxury good maker with a focus on watches and jewellery is the latest example. We are waiting for a highly valued high quality company producing spectacular goods to have a similarly spectacular earnings miss.
The company describes its brands as "Maisons" (French for houses) harking back to some long established tradition in a Swiss-French mountain chalet surrounded by snow where they produce fine (if somewhat pretentious) luxury goods. Still these brands have taken over the world - and now if you walk through Venice or Hong Kong or Shanghai or around the areas frequented by Asian tourists in Hawaii or Sydney you find the global standard set of luxury goods. The fact that they could make their product both ubiquitous and exclusive somewhat amazes me - but they have achieved that. These are amazing companies.
With amazing profits too. The Jewellery Maisons [Cartier, Van Cleef & Arpels] in the (March ended) 2012 financial year produced €4.59 billion in sales with €1.51 in operating profit. The growth rate has been almost Apple-like. In 2007 sales were €2.68 billion, profits €742 million. In 2004 the Jewellery Maisons had only €367 million in profit. This stuff did unbelievably well out of the rising of a new plutocracy - but particularly out of a new kleptocratic Asian plutocracy.
Watches did similarly well. I find watches strangely redundant (a smart phone is both more accurate and more useful and you probably carry one anyway). However they have become the only really acceptable piece of male jewellery by which the elite can show their status. In these days of business casual (and the studied casual of Ralph Lauren) an Italian tailored suit does not do it.
An iPhone or a Galaxy IIIs shows status amongst the middle and upper middle income. A ten thousand dollar or five hundred thousand dollar watch will do a (far) worse job of telling the time - but screams in only the way stupid-money can. I am not (at all) interested in watches so I had to look up the Maisons. These are houses like Vacheron Constantin of Geneve and A. Lange and Söhne from Glashütte (Saxony, Germany). Sort of glad I don't fancy their products because looking around Vacheron Constantin sell relatively plain gold watches at fifty thousand a pop:
A. Lange and Söhne sells similarly plain watches at prices marginally lower - but also sell less plain watches at prices closer to half a million dollars:
Remember both these products are inferior for purpose to the smart phone already in your pocket. But they do say "look at me" the latter in a particularly Rococo fashion.
It is the Rococo stuff that is winning. The Federation of the Swiss Watch Industry publish export data from Switzerland (not sales to end consumers). June data shows a 4.1 percent reduction in volume, a 21.7 increase in value. The average price of a watch is going up sharply. This has been the case for years. The Federation published this graph which shows that (relatively accurate) electronic watches have been flat in value for years - but that mechanical movements (inaccurate but reassuringly expensive) have gone skyward:
Moreover a disproportionate amount of the volume - and an even more disproportionate amount of the value has gone to Hong Kong. Hong Kong is the destination for a quarter of Swiss watches by value and an even higher proportion of the most expensive stuff.
Why Hong Kong? Because the sales tax rate is lower than China. If you are buying a thousand dollar watch you can buy it in Shanghai. But if you want a half-million dollar watch (no, not kidding) then the sales tax differential makes it worthwhile to fly to Hong Kong, get a nice hotel room and go shopping. That is why the value is in Hong Kong. The Hong Kong market is it - it is the biggest pile of value and the biggest place for the super-pretentious stuff - the stuff with fat margins. This stuff is really Rococo - and Rococo is a style beloved only by rappers and kleptocrats.
The Chinese kleptocracy has been very good to Richemont. Indeed they famously love their watches. And it is not only watches. Van Cleef & Arpels is Rococo too. Try this ring:
Or this hair clip:
As I said - this is the stuff of rappers and kleptocrats. And there are far more kleptocrats in China than rich rappers anywhere.
Data sources
There are several data sources I watch to keep tabs on spending by Chinese elite. The Swiss Watch data is obvious.
Exports to Hong Kong in June were up 21.2 percent. It was about the same in May (but the monthly data has disappeared from the web). It was about the same every other month this year. They keep upping the exports to Hong Kong.
But Hong Kong also has sales tax data which comes from the sales tax receipts. There is in the data a series for "Jewellery, watches, clocks and valuable gifts" by both value and volume. The value series - relatively flattering, has monthly sales (versus previous corresponding period) for the last six months as:
The slowdown in Hong Kong (super) luxury goods is a faster decline than other Chinese data. Why so fast?
I have a theory given to me by a China watcher. The theory - it turned bad sharply with the ouster of Bo Xilai and now the murder charge on his wife Gu Kailai. Gu Kailai is going to have a hard time avoiding a mobile execution unit. This changes the stakes and it is structural. A half million dollar watch no longer says "look at me". It says "look at me, I am a kleptocrat". Thoughts of that beautiful Van Cleef and Arpels hair clip become the last thing that runs through your brain before the bullet.
The optimists - and there are many - think the super luxury good market in China will return when the political situation stabilizes. To quote Bernard Fornas in that WSJ article:
But who said the new kleptocracy will love Rococo just as much as the old kleptocracy? Maybe party self-preservation will require less ostentatious displays of wealth. After all ostentatiously showing off wealth to an oppressed billion people does not seem like a way to preserve your power.
We know what a completely collapsed luxury good market looks like. Brazilians like a bit of bling. But in the late 1980s and into the 1990s the kidnapping rate in Brazil went skyward. (There is an horrific documentary about that called Manda Bala which translates "send a bullet".) After kidnapping became a major industry (particularly in São Paulo) carrying a $3000 handbag no longer said "look at me", it said "kidnap me".
A collapsed luxury good market in China may - if the Gu Kailai case is a guide - look different. Bling will mark you as an enemy of the people. This is a company about imagery - it sells a dream. Here is the nightmare:
Just saying - when it turns it can get uglier than you ever imagine.
John
Richemont - the mega-luxury good maker with a focus on watches and jewellery is the latest example. We are waiting for a highly valued high quality company producing spectacular goods to have a similarly spectacular earnings miss.
The company describes its brands as "Maisons" (French for houses) harking back to some long established tradition in a Swiss-French mountain chalet surrounded by snow where they produce fine (if somewhat pretentious) luxury goods. Still these brands have taken over the world - and now if you walk through Venice or Hong Kong or Shanghai or around the areas frequented by Asian tourists in Hawaii or Sydney you find the global standard set of luxury goods. The fact that they could make their product both ubiquitous and exclusive somewhat amazes me - but they have achieved that. These are amazing companies.
With amazing profits too. The Jewellery Maisons [Cartier, Van Cleef & Arpels] in the (March ended) 2012 financial year produced €4.59 billion in sales with €1.51 in operating profit. The growth rate has been almost Apple-like. In 2007 sales were €2.68 billion, profits €742 million. In 2004 the Jewellery Maisons had only €367 million in profit. This stuff did unbelievably well out of the rising of a new plutocracy - but particularly out of a new kleptocratic Asian plutocracy.
Watches did similarly well. I find watches strangely redundant (a smart phone is both more accurate and more useful and you probably carry one anyway). However they have become the only really acceptable piece of male jewellery by which the elite can show their status. In these days of business casual (and the studied casual of Ralph Lauren) an Italian tailored suit does not do it.
An iPhone or a Galaxy IIIs shows status amongst the middle and upper middle income. A ten thousand dollar or five hundred thousand dollar watch will do a (far) worse job of telling the time - but screams in only the way stupid-money can. I am not (at all) interested in watches so I had to look up the Maisons. These are houses like Vacheron Constantin of Geneve and A. Lange and Söhne from Glashütte (Saxony, Germany). Sort of glad I don't fancy their products because looking around Vacheron Constantin sell relatively plain gold watches at fifty thousand a pop:
A. Lange and Söhne sells similarly plain watches at prices marginally lower - but also sell less plain watches at prices closer to half a million dollars:
Remember both these products are inferior for purpose to the smart phone already in your pocket. But they do say "look at me" the latter in a particularly Rococo fashion.
It is the Rococo stuff that is winning. The Federation of the Swiss Watch Industry publish export data from Switzerland (not sales to end consumers). June data shows a 4.1 percent reduction in volume, a 21.7 increase in value. The average price of a watch is going up sharply. This has been the case for years. The Federation published this graph which shows that (relatively accurate) electronic watches have been flat in value for years - but that mechanical movements (inaccurate but reassuringly expensive) have gone skyward:
Moreover a disproportionate amount of the volume - and an even more disproportionate amount of the value has gone to Hong Kong. Hong Kong is the destination for a quarter of Swiss watches by value and an even higher proportion of the most expensive stuff.
Why Hong Kong? Because the sales tax rate is lower than China. If you are buying a thousand dollar watch you can buy it in Shanghai. But if you want a half-million dollar watch (no, not kidding) then the sales tax differential makes it worthwhile to fly to Hong Kong, get a nice hotel room and go shopping. That is why the value is in Hong Kong. The Hong Kong market is it - it is the biggest pile of value and the biggest place for the super-pretentious stuff - the stuff with fat margins. This stuff is really Rococo - and Rococo is a style beloved only by rappers and kleptocrats.
The Chinese kleptocracy has been very good to Richemont. Indeed they famously love their watches. And it is not only watches. Van Cleef & Arpels is Rococo too. Try this ring:
Or this hair clip:
As I said - this is the stuff of rappers and kleptocrats. And there are far more kleptocrats in China than rich rappers anywhere.
Data sources
There are several data sources I watch to keep tabs on spending by Chinese elite. The Swiss Watch data is obvious.
Exports to Hong Kong in June were up 21.2 percent. It was about the same in May (but the monthly data has disappeared from the web). It was about the same every other month this year. They keep upping the exports to Hong Kong.
But Hong Kong also has sales tax data which comes from the sales tax receipts. There is in the data a series for "Jewellery, watches, clocks and valuable gifts" by both value and volume. The value series - relatively flattering, has monthly sales (versus previous corresponding period) for the last six months as:
- +18.3%
- +14.1%
- +18.4%
- +15.1%
- +2.9%
- +3.1%
Sales growth stopped. However exports to Hong Kong kept up (note that 21.2 percent figure above).
The volume growth actually went negative - being negative 3.4 and 3.1 percent for the last two months.
What do you do with an inventory glut of hundred thousand dollar watches. You can't really discount them - so they just sit there, looking a little stale and slowly devaluing your brand.
And that is why I am short the stock. It is a trading short really - this company is likely to miss earnings and it will miss it in an unfortunate way - they are going to be swamped with inventory.
It is not just watches either. Anecdotally a Van Cleef and Arpels show that was huge last year was distinctly quieter this year.
The company has given a hint of this. Bernard Fornas - the chief executive of Cartier - gave an interview to the Wall Street Journal. To quote:
"After a phenomenal year last year, there's been a bit of a slowdown in mainland China," he explained.
"Mainland China is still holding for us. One month is worse, one month is better. The curve is not yet clearly defined.”
Fornas added that while Cartier’s watch sales are still increasing, it is not at the same rate as 2011. He declined to reveal figures or percentages, however.
But that quote is misleading. He says it is one month worse, one month better. But it is one month worse and the next month bad too.
My guess: this company is not being entirely straight with market about how much tougher things are getting. The company will guide down and the stock will be singled out for "special treatment". I am short - just waiting for the bullet.
So why did the slowdown happen so sharply?
I have a theory given to me by a China watcher. The theory - it turned bad sharply with the ouster of Bo Xilai and now the murder charge on his wife Gu Kailai. Gu Kailai is going to have a hard time avoiding a mobile execution unit. This changes the stakes and it is structural. A half million dollar watch no longer says "look at me". It says "look at me, I am a kleptocrat". Thoughts of that beautiful Van Cleef and Arpels hair clip become the last thing that runs through your brain before the bullet.
The optimists - and there are many - think the super luxury good market in China will return when the political situation stabilizes. To quote Bernard Fornas in that WSJ article:
"When you talk to the people over there, they are all waiting for a new president to come in. That will fuel the economy with fresh money and lower interest rates."
But who said the new kleptocracy will love Rococo just as much as the old kleptocracy? Maybe party self-preservation will require less ostentatious displays of wealth. After all ostentatiously showing off wealth to an oppressed billion people does not seem like a way to preserve your power.
We know what a completely collapsed luxury good market looks like. Brazilians like a bit of bling. But in the late 1980s and into the 1990s the kidnapping rate in Brazil went skyward. (There is an horrific documentary about that called Manda Bala which translates "send a bullet".) After kidnapping became a major industry (particularly in São Paulo) carrying a $3000 handbag no longer said "look at me", it said "kidnap me".
A collapsed luxury good market in China may - if the Gu Kailai case is a guide - look different. Bling will mark you as an enemy of the people. This is a company about imagery - it sells a dream. Here is the nightmare:
Just saying - when it turns it can get uglier than you ever imagine.
John
Monday, July 30, 2012
Weekend edition: Car Dealers
I am a hedge fund manager who trades in marketable securities only. I look at a quote in a market - take it or leave it.
I have developed no negotiating skill - if I don't like the quote I just walk away. If the quote is way too high I short sell it. If it is low I buy.
But mostly I just walk away. It is not rude to walk away. The person on the other side of the trade does not even know who you are. It is not personal. Simply: if the quote is not right I do not want to deal.
If I have to negotiate I will generally leave it to my wife who has more patience whilst people muck around on price. People who want to waste half an hour negotiating to an end point that could be got to in 2 minutes are a waste of time and space.
Further - mostly I short-sell frauds. I find people who are lying (and I am very good at determining when someone is lying). Whey they lie I short-sell their securities. The slogan (mostly true) is once a scumbag always a scumbag. Shortselling scumbags in moderation (always in moderation) is generally a profitable strategy.
And so I come with a general hatred of buying a car.
These days buying a car is a fairly transparent business. They give you a quote off something that looks like a supplier provided list price. You ask them if they can do a better deal and depending on how ambitious they are and how much room to move they have they offer you a "deal".
Then you go home, look up the internet chat boards, see what people have negotiated elsewhere and come back with a price.
We did that - and the price we came back with was about 5 percent below where I figured they were prepared to deal. I told them I had looked at the chat boards and told them that price was lower than I expected and that they should just come back with something realistic.
The told me that they would be losing $4000 at the price I suggested.
I knew that was a lie. They knew I knew it was a lie. I said so and said that I will not deal if they will not be straight with me. They bristled.
I walked out. I don't have the patience to deal with scumbags and liars.
If this were senior management/promoters of a listed security I know what I would do. I would turn around and short-sell them. Liars then are nice because they are profitable for me.
But dealing with scumbag car-dealers makes me feel strangely powerless and angry.
And it leaves me despising car dealers and the companies they represent. I am not even going to mention the brand because I suspect it could be any car brand.
[Still for the rest of my life XXX Brand will be associated with scumbag people and no amount of advertising will fix the image-association.]
Why are people like this?
Here is a question that has puzzled me for a while. I short sell stocks promoted by slime-bag individuals. People who may be rich but you would be horrified if they married your daughter.
There are a surprisingly large number of such people around.
My question was were those people born that way or did 10 years of exposure to other scum-bags on Wall Street turn them into the gebbeths they have become? Understanding the development and career path of scumbag stock promoters will make my job easier. Finding these little piles of pus and short-selling their wares is one of my main career tasks.
But it is hard to track stock promoters. They are a shadowy lot and saying out loud that they are slime doesn't get me very far.
But it is easy to track car dealers - and their sliminess is readily apparent to all. It is not even controversial.
So how did car dealers get this way? Do car dealers actively go out of their way to recruit more scumbags? Or does being a car dealer turn you into a scumbag?
If it is the former how do they find these scumbags so effectively? (As someone who short-sells I want to copy that method!)
If it is the latter how long does it take as a car dealer before the basics of human decency have been stripped from you? How hard is it to corrupt people - to take away their soul?
Just asking.
John
I have developed no negotiating skill - if I don't like the quote I just walk away. If the quote is way too high I short sell it. If it is low I buy.
But mostly I just walk away. It is not rude to walk away. The person on the other side of the trade does not even know who you are. It is not personal. Simply: if the quote is not right I do not want to deal.
If I have to negotiate I will generally leave it to my wife who has more patience whilst people muck around on price. People who want to waste half an hour negotiating to an end point that could be got to in 2 minutes are a waste of time and space.
Further - mostly I short-sell frauds. I find people who are lying (and I am very good at determining when someone is lying). Whey they lie I short-sell their securities. The slogan (mostly true) is once a scumbag always a scumbag. Shortselling scumbags in moderation (always in moderation) is generally a profitable strategy.
And so I come with a general hatred of buying a car.
These days buying a car is a fairly transparent business. They give you a quote off something that looks like a supplier provided list price. You ask them if they can do a better deal and depending on how ambitious they are and how much room to move they have they offer you a "deal".
Then you go home, look up the internet chat boards, see what people have negotiated elsewhere and come back with a price.
We did that - and the price we came back with was about 5 percent below where I figured they were prepared to deal. I told them I had looked at the chat boards and told them that price was lower than I expected and that they should just come back with something realistic.
The told me that they would be losing $4000 at the price I suggested.
I knew that was a lie. They knew I knew it was a lie. I said so and said that I will not deal if they will not be straight with me. They bristled.
I walked out. I don't have the patience to deal with scumbags and liars.
If this were senior management/promoters of a listed security I know what I would do. I would turn around and short-sell them. Liars then are nice because they are profitable for me.
But dealing with scumbag car-dealers makes me feel strangely powerless and angry.
And it leaves me despising car dealers and the companies they represent. I am not even going to mention the brand because I suspect it could be any car brand.
[Still for the rest of my life XXX Brand will be associated with scumbag people and no amount of advertising will fix the image-association.]
Why are people like this?
Here is a question that has puzzled me for a while. I short sell stocks promoted by slime-bag individuals. People who may be rich but you would be horrified if they married your daughter.
There are a surprisingly large number of such people around.
My question was were those people born that way or did 10 years of exposure to other scum-bags on Wall Street turn them into the gebbeths they have become? Understanding the development and career path of scumbag stock promoters will make my job easier. Finding these little piles of pus and short-selling their wares is one of my main career tasks.
But it is hard to track stock promoters. They are a shadowy lot and saying out loud that they are slime doesn't get me very far.
But it is easy to track car dealers - and their sliminess is readily apparent to all. It is not even controversial.
So how did car dealers get this way? Do car dealers actively go out of their way to recruit more scumbags? Or does being a car dealer turn you into a scumbag?
If it is the former how do they find these scumbags so effectively? (As someone who short-sells I want to copy that method!)
If it is the latter how long does it take as a car dealer before the basics of human decency have been stripped from you? How hard is it to corrupt people - to take away their soul?
Just asking.
John
Thursday, July 26, 2012
Changing my mind on Microsoft
Seldom have I looked at something that is a major long in the portfolio, changed my mind, sold the entire position and continued selling to go short (albeit in a small way).
I just did that on Microsoft. The immediate trigger was Windows 8 - but the thinking has been longer and harder than that.
This post is to run through my thinking - and maybe generate some comment. (Smart readers - and you are smart readers - are a great testing-board for my theories...)
Quick background to the Microsoft story
The background to Microsoft is well known. In the late 1990s Windows developed huge market power. Whilst not strictly a monopoly the company had plenty of monopoly characteristics. Sure you could buy a Macintosh - but that market was so small that people did not develop software for Macs and hence Macs were for people who did not need a wide range of software. You could also load a computer with Linux (although despite being a sometime-geek I could not imagine doing except for a server). In those days Microsoft even dominated the server market.
This was - for all effective purposes - a growing global monopoly with very low marginal costs producing for what was fast becoming one of the most important industries in the world (personal computers).
Moreover it had huge pricing power. I purchased a computer from Gateway (remember them) and spent about $1200. The $50 operating system was embedded - a small cost embedded in a large cost. I assure you Microsoft made more from the transaction than Gateway. Gateway even ran a store to sell me that beige box - the store ultimately being run for the benefit of Microsoft.
The company had a virtuous circle. People developed software to run on Microsoft using Microsoft developer tools. They did not bother developing for other platforms because those platforms were economically irrelevant and the Microsoft developer tools worked. Because all the software you might want to use ran on Windows you were effectively compelled to run a Windows machine thus perpetuating the cycle.
Microsoft used its power for better and for worse. My personal gripe was how poorly Microsoft thought about and handled security issues. My Linux computer is as far as I know virus free. Apple only had to remove their virus-immune claims recently. Windows security issues are everywhere and it did not need to be so. The first computer virus I ever saw was in 1989 and it was on a Mac - these problems - if not entirely soluble - were controllable. Microsoft did not control them. Whether this was arrogance or incompetence or monopolistic-disinterest I do not know though I have heard arguments for all three propositions.
Still Microsoft gave us acceptable if not brilliant product and I never quite bought the "evil-empire" line. In my view they were a large, increasingly fat, slightly disinterested monopolist that had stopped thinking clearly about users.
Developers: the key to the Microsoft virtuous circle
The key to Microsoft's market power was the virtuous circle whereby people used Microsoft computers because software was developed for Microsoft and people developed software for Microsoft because people used Microsoft computers.
Making all this work required that Microsoft make available easy to use "developer tools". A large developer tools business would include tools for software development and training tools to train future developers. If the developer tool business ran at (say) a billion dollars in loss that was perfectly acceptable so long as more and more software was developed to be Microsoft platform specific.* Indeed the developer tools business never played much of a role in the sector-breakup of Microsoft - but that did not diminish its importance.
If you are not convinced that developers are the key to Microsoft's lock-in look at this classic video of Steve Balmer:
Balmer is sufficiently worked up that the wags captioned this video with the text deodorant, deodorant, deodorant. However the extent to which he is worked up tells the Microsoft crowd what they should be focussed on.
The rise of platform-agnostic developer tools
The Microsoft virtuous circle is now dead. Two related things killed it: the rise of platform agnostic developer tools and the rise of alternative operating systems (Linux for servers, iOS and the "Big Cat" series for Apple, Android).
To my way of thinking the platform-agnostic developer tools came first - though this is a chicken-and-egg problem. The first really important platform-agnostic tool was Java. Programs written in Java run on Linux computers precisely the same way as they run on Apple computers or Microsoft computers. If you developed something on Java you could run it anywhere and you thus undermined the Microsoft virtuous circle.
Developing things for Java became widespread when people downloaded programs (applets really) from the internet. The person writing the applet had no idea what the customer computer set-up was and so had to write in a platform-agnostic fashion. Interactive Brokers for instance writes its software to run on Java - and they do this because it is a complex piece of software that has to run on many different flavours of client computer.
Over time Python developed as an even more important platform agnostic developer tool.
Nowadays nobody under thirty writes anything on Microsoft developer tools unless they are demented or brain-dead. Firstly the kids out of the colleges know the platform agnostic stuff well. Secondly when half the computers leaving factories either run iOS or Android (that is are smart-phones) nobody sensible will write in a way that does not allow easy porting to these platforms.
Microsoft's developer tools business and the customer lock it created has had a bullet through the brain. The body is lying on the floor - and most the users who have never developed anything and did not know that there even was a developers tool business have not noticed the blood-soaked victim.
The lock that Steve Balmer worked himself into a frenzied sweat over is dead.
The lock is dead: long live the lock
An asset management firm I know well has 100 thousand or so customers. The customer relations system for the firm is proprietary. They developed it themselves and it integrates with their business practice.
And it runs on Microsoft. It was developed by people who are now over 35 - and hence used Microsoft developer tools.
This firm is very progressive with their computing structure. All internal computer now run as virtual machines (not desktops) running on two mondo-powerful Linux servers. The virtualization platform is Citrix. Nobody has a functional box under their desk any more.
However on top of this enterprise cloud is 65 virtual Microsoft machines all running Windows. The company has got rid of the desktop computers entirely (sorry Dell and HP), it has a hugely powerful internal network system (currently provided by Cisco but in the future provided probably provided by Nicira). Disaster recovery is a mirror of the two mondo-powerful servers 100km away.
In other words this is the enterprise computing platform of the future.
But they still use Microsoft as if they had the computing platform of 1999.
Why?
Because they used the developer tools of 1999 to build mission-critical enterprise software.
Nobody is locking new stuff up in Microsoft but there is huge amounts of intellectual capital built up in Microsoft's old platform and that intellectual capital continues to force people to use Microsoft. Some of this property is trivial (I know to shut down the computer I go to the "start" button). But things like the front end for a customer relations system for a largish financial firm - that is non-trivial and it is very sticky.
Why I owned Microsoft
When I purchased Microsoft I was well aware of the death of the lock (developer tools). I knew the future for Microsoft would not (unless they were very lucky and well managed) be anything like as glorious as the past - but there were two really decent trends in favour of Microsoft.
Firstly as enterprises moved their computing platforms to enterprise clouds the Microsoft computers - rented as virtual computers - would be pervasive. Microsoft was going to be able to charge rents for a long time. People would upgrade their computer (meaning the physical hardware running linux and Citrix or VMWare on top of that) but they would still pay rent to Microsoft.
Moreover these Microsoft dead-enders - locked in by the enterprise software that they wrote a long time ago - are very sticky. It is expensive to redevelop proprietary systems - and so they were likely to use Microsoft for decades. The pricing would be to lease seats to virtual computers and those lease fees could be high and increasing.
Second, there was one beautiful tailwind for Microsoft which has alas disappeared. In 1999 if you purchased a computer it was probably a beige box. (Laptops were prohibitively expensive and underpowered.) If you purchased a computer in India it was a beige box it came loaded with a hot (ie pirated) version of Microsoft.
By 2007 if you purchased a computer it was likely a laptop. Boxes have become objects for gaming enthusiasts, developers and dinosaurs (I say this as the proud owner of a couple of boxes). The computing power you need can (mostly) be put in a smaller package at a reasonable cost. It is almost impossible to buy a laptop which is not pre-loaded with an authentic version of Microsoft. That was true in India too. I do not even use Microsoft but if I buy a Lenovo computer in Australia on their website I am forced to include a copy of Windows. The tailwind de-jour was the rise of computing in developing countries and most importantly the shift to laptops reducing piracy to almost zero. This was profoundly nice to Microsoft - but as a trend it is dead. The new generation of computers is going to be pads - they may have plug in keyboards - but they are pads. Even laptop sales are problematic.
Moreover laptop prices are falling and falling. Five hundred dollars now buys quite a nice laptop. The laptop I use day-to-day is not worth much more than that (except for add-ons like a large solid state hard drive). Microsoft once buried $50-80 of software in a $2000 computer and that made their (fat and profitable) take disappear. It is much harder to bury $50 of software in a $300 computer - but that is where we are going.
But in essence we had two trends: pricing power on dinosaur enterprise computing driven by the old customer lock (previously developed enterprise software). That pricing power would remain and turn into rental contracts as computers disappeared into enterprise clouds. And we had developed world laptops (a trend that is now turned quite sour).
A Vision of Windows 8
I had a vision of Windows 8 which addressed all of this - and I doubt that it was a vision that was very far from Microsoft's own vision.
Windows 8 was to serve a dual purpose. It was to be above all a pad operating system - one that doubled as a desktop operating system. You were going to be presented with bunch of tiles - the functional equivalent of Apple's app icons. If you used it as a pad it would have the limited functionality of a pad.
However you could take the pad, put it on a docking stand and use it with a keyboard and mouse as a desktop computer. This solves a lot of problems.
(a) it offers a distinct improvement over existing pads which are not very good for content creation. I cannot see myself editing a video on a pad or writing a blog post this long. But hey - I could with a plug-in-keyboard and mouse,
(b) it offers enterprises a chance to take their existing enterprise software and make it mobile. For example if a customer relationship system runs on Windows you could - without much further development - make it run on a Windows pad. This means there would be no incentive to redevelop it using (say) Python to run on iOS.
(c) it gets a large number of people used to the Windows system. There is a lot of human capital developed in using computer systems - trying to change - even Windows to Mac or vice-versa costs a lot of time as you work out how to say copy a file to an external hard drive or from a camera.
(d) it leads you to a world where the pad has some computing power - but if you need more grunt you connect it to a docking station in turn connected to a fast internet connection and you put the power in a cloud and rent the power out by usage. A world of semi-smart terminals - a pad if not docked, a super-computer if docked.
But the combined desktop interface has a big problem. Because desktops and pads and phones do different things they have different interfaces. A windows, icons, mouse and pull down menu interface has a venerable history because it works.
The Ubuntu Unity failure
Microsoft is not the only party that sees a convergence of pads and computers. Ubuntu - by far the leading attempt to make a workable Linux desktop for a very large market - did a complete revamp of their desktop changing from a Windows type interface (Gnome 2) to a Mac/pad type interface (Unity). They had large, immovable buttons - just right to use with fingers. Pull down menus were dramatically reduced in frequency and importance.
This transition was a mess. Utterly horrible. You are not convinced: google the phrase unity sucks.
However - and this is fair - Linux desktop users (we are a small tribe) are probably the most motivated to learn new systems of any group on the planet. Moreover Unity did get better through time.
Apple also knows that combining the interface is very difficult. That is why they have never taken their Mac interface and put it on a pad or vice versa.
You could have worked out the difficulty just by trying to use Unity (but I doubt too many people in the Microsoft development team tried that trick - because it is Linux and not developed there).
I told the whole sorry Unity story to a senior former Microsoft employee and he thought they would not be so stupid to try the combined desktop. He thought that the interface would change dramatically when the computer was docked - looking more like Windows 7 (a good system) when docked and more like a Windows phone (also an adequate system) when mobile.
What Microsoft has done
Microsoft have tried what I originally thought impossible or at least stupid. They did not change the interface of Windows 8 much to deal with the different ways you communicate with that interface. (Fingers versus keyboard and mouse for instance.)
Here is the video which had me selling my Microsoft stake. Its a computer reviewer filming his dad trying to use Windows 8.
I watched this and the pain of problem recognition came over me. This was exactly how I felt when I first used Ubuntu Unity.
This was a predictable problem. It is a problem that every user of Ubuntu suffered through. This is a management stuff up of the first order.
What Microsoft has done to its business
Firstly Microsoft has not understood its real franchise. Its real franchise is computers on which people do work. They don't play. They write stuff. They enter data. They manipulate graphs. They might even edit a video.
These computers are tools and the operating system is just the air they breathe. On a day to day basis they don't think about the operating system - they only think about it when it changes.
What they should have done is kept something close to a Windows 7 interface when the computer is docked and something close to a pad interface when the computer is mobile. Instead they forced people to relate to a pad interface via a keyboard. They assumed their users were as motivated as (say) Ubuntu users - whereas most their users don't give a fig about learning a new system. Changes to a proven interface either have to be incremental (so you bring your audience along with you) or so self explanatory that the audience learns in 20 minutes (thank you Apple). Windows 8 is neither.
Prediction: this will wind up with a lower corporate take up rate than Vista (ie next to none).
Prediction 2: this will accelerate, rather than slow down, the rate at which enterprises take their enterprise specific software into platform independent programs
Prediction 3: by stuffing this up Microsoft has just about lost its bet on moving the retail computer market into docking cloud computers. Apple will do this. And they will do it by stealth.
Apple, the forthcoming death of the Mac Pro and cloud computing
Bob Cringely laid out Apple's plans a while ago - commenting on all things the lack of an upgrade of the motherboard of a Mac Pro during the latest round of Apple upgrades. The Mac Pro is the most powerful Mac and the only Mac on which users can add their own components through expansion slots.
Being the most powerful Mac it is beloved by power users. The definitive power users are people like video editors. These people want to download huge amounts of data to their (expandable) machine and hence like the fastest download protocols. The fastest current USB protocol - used for say getting material from high definition camcorders - is USB3. You would think that USB3 would be standard in a Mac Pro.
But the motherboard does not have it despite USB3 being a few years old.
And when they did not upgrade the Mac Pro to USB3 Cringely rightly asked what Apple would do about their power users. Here was his conclusion:
Windows 8 - a product that gets people used to and software developed for a pad that docks - was Microsoft's way of getting used to the idea of portable computers with rented super-computer cloud space.
And it will be a failure because Microsoft, not for the first time, have lost their view of real users.
I held Microsoft for 18 months (and it was not a bad investment). But last night I gave up.
For comment.
John
*There are other lock-ins at Microsoft - for instance my business partner irregularly writes Visual Basic algorithms for spreadsheets. Visual Basic is Microsoft proprietary and these spreadsheets lock us into having at least one Microsoft machine in the office. I complain regularly about this - but Simon is over 40 and teaching old-dogs new tricks is hard. He has a lot of human capital invested in his ability to crank out something in Visual Basic.
I just did that on Microsoft. The immediate trigger was Windows 8 - but the thinking has been longer and harder than that.
This post is to run through my thinking - and maybe generate some comment. (Smart readers - and you are smart readers - are a great testing-board for my theories...)
Quick background to the Microsoft story
The background to Microsoft is well known. In the late 1990s Windows developed huge market power. Whilst not strictly a monopoly the company had plenty of monopoly characteristics. Sure you could buy a Macintosh - but that market was so small that people did not develop software for Macs and hence Macs were for people who did not need a wide range of software. You could also load a computer with Linux (although despite being a sometime-geek I could not imagine doing except for a server). In those days Microsoft even dominated the server market.
This was - for all effective purposes - a growing global monopoly with very low marginal costs producing for what was fast becoming one of the most important industries in the world (personal computers).
Moreover it had huge pricing power. I purchased a computer from Gateway (remember them) and spent about $1200. The $50 operating system was embedded - a small cost embedded in a large cost. I assure you Microsoft made more from the transaction than Gateway. Gateway even ran a store to sell me that beige box - the store ultimately being run for the benefit of Microsoft.
The company had a virtuous circle. People developed software to run on Microsoft using Microsoft developer tools. They did not bother developing for other platforms because those platforms were economically irrelevant and the Microsoft developer tools worked. Because all the software you might want to use ran on Windows you were effectively compelled to run a Windows machine thus perpetuating the cycle.
Microsoft used its power for better and for worse. My personal gripe was how poorly Microsoft thought about and handled security issues. My Linux computer is as far as I know virus free. Apple only had to remove their virus-immune claims recently. Windows security issues are everywhere and it did not need to be so. The first computer virus I ever saw was in 1989 and it was on a Mac - these problems - if not entirely soluble - were controllable. Microsoft did not control them. Whether this was arrogance or incompetence or monopolistic-disinterest I do not know though I have heard arguments for all three propositions.
Still Microsoft gave us acceptable if not brilliant product and I never quite bought the "evil-empire" line. In my view they were a large, increasingly fat, slightly disinterested monopolist that had stopped thinking clearly about users.
Developers: the key to the Microsoft virtuous circle
The key to Microsoft's market power was the virtuous circle whereby people used Microsoft computers because software was developed for Microsoft and people developed software for Microsoft because people used Microsoft computers.
Making all this work required that Microsoft make available easy to use "developer tools". A large developer tools business would include tools for software development and training tools to train future developers. If the developer tool business ran at (say) a billion dollars in loss that was perfectly acceptable so long as more and more software was developed to be Microsoft platform specific.* Indeed the developer tools business never played much of a role in the sector-breakup of Microsoft - but that did not diminish its importance.
If you are not convinced that developers are the key to Microsoft's lock-in look at this classic video of Steve Balmer:
Balmer is sufficiently worked up that the wags captioned this video with the text deodorant, deodorant, deodorant. However the extent to which he is worked up tells the Microsoft crowd what they should be focussed on.
The rise of platform-agnostic developer tools
The Microsoft virtuous circle is now dead. Two related things killed it: the rise of platform agnostic developer tools and the rise of alternative operating systems (Linux for servers, iOS and the "Big Cat" series for Apple, Android).
To my way of thinking the platform-agnostic developer tools came first - though this is a chicken-and-egg problem. The first really important platform-agnostic tool was Java. Programs written in Java run on Linux computers precisely the same way as they run on Apple computers or Microsoft computers. If you developed something on Java you could run it anywhere and you thus undermined the Microsoft virtuous circle.
Developing things for Java became widespread when people downloaded programs (applets really) from the internet. The person writing the applet had no idea what the customer computer set-up was and so had to write in a platform-agnostic fashion. Interactive Brokers for instance writes its software to run on Java - and they do this because it is a complex piece of software that has to run on many different flavours of client computer.
Over time Python developed as an even more important platform agnostic developer tool.
Nowadays nobody under thirty writes anything on Microsoft developer tools unless they are demented or brain-dead. Firstly the kids out of the colleges know the platform agnostic stuff well. Secondly when half the computers leaving factories either run iOS or Android (that is are smart-phones) nobody sensible will write in a way that does not allow easy porting to these platforms.
Microsoft's developer tools business and the customer lock it created has had a bullet through the brain. The body is lying on the floor - and most the users who have never developed anything and did not know that there even was a developers tool business have not noticed the blood-soaked victim.
The lock that Steve Balmer worked himself into a frenzied sweat over is dead.
The lock is dead: long live the lock
An asset management firm I know well has 100 thousand or so customers. The customer relations system for the firm is proprietary. They developed it themselves and it integrates with their business practice.
And it runs on Microsoft. It was developed by people who are now over 35 - and hence used Microsoft developer tools.
This firm is very progressive with their computing structure. All internal computer now run as virtual machines (not desktops) running on two mondo-powerful Linux servers. The virtualization platform is Citrix. Nobody has a functional box under their desk any more.
However on top of this enterprise cloud is 65 virtual Microsoft machines all running Windows. The company has got rid of the desktop computers entirely (sorry Dell and HP), it has a hugely powerful internal network system (currently provided by Cisco but in the future provided probably provided by Nicira). Disaster recovery is a mirror of the two mondo-powerful servers 100km away.
In other words this is the enterprise computing platform of the future.
But they still use Microsoft as if they had the computing platform of 1999.
Why?
Because they used the developer tools of 1999 to build mission-critical enterprise software.
Nobody is locking new stuff up in Microsoft but there is huge amounts of intellectual capital built up in Microsoft's old platform and that intellectual capital continues to force people to use Microsoft. Some of this property is trivial (I know to shut down the computer I go to the "start" button). But things like the front end for a customer relations system for a largish financial firm - that is non-trivial and it is very sticky.
Why I owned Microsoft
When I purchased Microsoft I was well aware of the death of the lock (developer tools). I knew the future for Microsoft would not (unless they were very lucky and well managed) be anything like as glorious as the past - but there were two really decent trends in favour of Microsoft.
Firstly as enterprises moved their computing platforms to enterprise clouds the Microsoft computers - rented as virtual computers - would be pervasive. Microsoft was going to be able to charge rents for a long time. People would upgrade their computer (meaning the physical hardware running linux and Citrix or VMWare on top of that) but they would still pay rent to Microsoft.
Moreover these Microsoft dead-enders - locked in by the enterprise software that they wrote a long time ago - are very sticky. It is expensive to redevelop proprietary systems - and so they were likely to use Microsoft for decades. The pricing would be to lease seats to virtual computers and those lease fees could be high and increasing.
Second, there was one beautiful tailwind for Microsoft which has alas disappeared. In 1999 if you purchased a computer it was probably a beige box. (Laptops were prohibitively expensive and underpowered.) If you purchased a computer in India it was a beige box it came loaded with a hot (ie pirated) version of Microsoft.
By 2007 if you purchased a computer it was likely a laptop. Boxes have become objects for gaming enthusiasts, developers and dinosaurs (I say this as the proud owner of a couple of boxes). The computing power you need can (mostly) be put in a smaller package at a reasonable cost. It is almost impossible to buy a laptop which is not pre-loaded with an authentic version of Microsoft. That was true in India too. I do not even use Microsoft but if I buy a Lenovo computer in Australia on their website I am forced to include a copy of Windows. The tailwind de-jour was the rise of computing in developing countries and most importantly the shift to laptops reducing piracy to almost zero. This was profoundly nice to Microsoft - but as a trend it is dead. The new generation of computers is going to be pads - they may have plug in keyboards - but they are pads. Even laptop sales are problematic.
Moreover laptop prices are falling and falling. Five hundred dollars now buys quite a nice laptop. The laptop I use day-to-day is not worth much more than that (except for add-ons like a large solid state hard drive). Microsoft once buried $50-80 of software in a $2000 computer and that made their (fat and profitable) take disappear. It is much harder to bury $50 of software in a $300 computer - but that is where we are going.
But in essence we had two trends: pricing power on dinosaur enterprise computing driven by the old customer lock (previously developed enterprise software). That pricing power would remain and turn into rental contracts as computers disappeared into enterprise clouds. And we had developed world laptops (a trend that is now turned quite sour).
A Vision of Windows 8
I had a vision of Windows 8 which addressed all of this - and I doubt that it was a vision that was very far from Microsoft's own vision.
Windows 8 was to serve a dual purpose. It was to be above all a pad operating system - one that doubled as a desktop operating system. You were going to be presented with bunch of tiles - the functional equivalent of Apple's app icons. If you used it as a pad it would have the limited functionality of a pad.
However you could take the pad, put it on a docking stand and use it with a keyboard and mouse as a desktop computer. This solves a lot of problems.
(a) it offers a distinct improvement over existing pads which are not very good for content creation. I cannot see myself editing a video on a pad or writing a blog post this long. But hey - I could with a plug-in-keyboard and mouse,
(b) it offers enterprises a chance to take their existing enterprise software and make it mobile. For example if a customer relationship system runs on Windows you could - without much further development - make it run on a Windows pad. This means there would be no incentive to redevelop it using (say) Python to run on iOS.
(c) it gets a large number of people used to the Windows system. There is a lot of human capital developed in using computer systems - trying to change - even Windows to Mac or vice-versa costs a lot of time as you work out how to say copy a file to an external hard drive or from a camera.
(d) it leads you to a world where the pad has some computing power - but if you need more grunt you connect it to a docking station in turn connected to a fast internet connection and you put the power in a cloud and rent the power out by usage. A world of semi-smart terminals - a pad if not docked, a super-computer if docked.
But the combined desktop interface has a big problem. Because desktops and pads and phones do different things they have different interfaces. A windows, icons, mouse and pull down menu interface has a venerable history because it works.
The Ubuntu Unity failure
Microsoft is not the only party that sees a convergence of pads and computers. Ubuntu - by far the leading attempt to make a workable Linux desktop for a very large market - did a complete revamp of their desktop changing from a Windows type interface (Gnome 2) to a Mac/pad type interface (Unity). They had large, immovable buttons - just right to use with fingers. Pull down menus were dramatically reduced in frequency and importance.
This transition was a mess. Utterly horrible. You are not convinced: google the phrase unity sucks.
However - and this is fair - Linux desktop users (we are a small tribe) are probably the most motivated to learn new systems of any group on the planet. Moreover Unity did get better through time.
Apple also knows that combining the interface is very difficult. That is why they have never taken their Mac interface and put it on a pad or vice versa.
You could have worked out the difficulty just by trying to use Unity (but I doubt too many people in the Microsoft development team tried that trick - because it is Linux and not developed there).
I told the whole sorry Unity story to a senior former Microsoft employee and he thought they would not be so stupid to try the combined desktop. He thought that the interface would change dramatically when the computer was docked - looking more like Windows 7 (a good system) when docked and more like a Windows phone (also an adequate system) when mobile.
What Microsoft has done
Microsoft have tried what I originally thought impossible or at least stupid. They did not change the interface of Windows 8 much to deal with the different ways you communicate with that interface. (Fingers versus keyboard and mouse for instance.)
Here is the video which had me selling my Microsoft stake. Its a computer reviewer filming his dad trying to use Windows 8.
I watched this and the pain of problem recognition came over me. This was exactly how I felt when I first used Ubuntu Unity.
This was a predictable problem. It is a problem that every user of Ubuntu suffered through. This is a management stuff up of the first order.
What Microsoft has done to its business
Firstly Microsoft has not understood its real franchise. Its real franchise is computers on which people do work. They don't play. They write stuff. They enter data. They manipulate graphs. They might even edit a video.
These computers are tools and the operating system is just the air they breathe. On a day to day basis they don't think about the operating system - they only think about it when it changes.
What they should have done is kept something close to a Windows 7 interface when the computer is docked and something close to a pad interface when the computer is mobile. Instead they forced people to relate to a pad interface via a keyboard. They assumed their users were as motivated as (say) Ubuntu users - whereas most their users don't give a fig about learning a new system. Changes to a proven interface either have to be incremental (so you bring your audience along with you) or so self explanatory that the audience learns in 20 minutes (thank you Apple). Windows 8 is neither.
Prediction: this will wind up with a lower corporate take up rate than Vista (ie next to none).
Prediction 2: this will accelerate, rather than slow down, the rate at which enterprises take their enterprise specific software into platform independent programs
Prediction 3: by stuffing this up Microsoft has just about lost its bet on moving the retail computer market into docking cloud computers. Apple will do this. And they will do it by stealth.
Apple, the forthcoming death of the Mac Pro and cloud computing
Bob Cringely laid out Apple's plans a while ago - commenting on all things the lack of an upgrade of the motherboard of a Mac Pro during the latest round of Apple upgrades. The Mac Pro is the most powerful Mac and the only Mac on which users can add their own components through expansion slots.
Being the most powerful Mac it is beloved by power users. The definitive power users are people like video editors. These people want to download huge amounts of data to their (expandable) machine and hence like the fastest download protocols. The fastest current USB protocol - used for say getting material from high definition camcorders - is USB3. You would think that USB3 would be standard in a Mac Pro.
But the motherboard does not have it despite USB3 being a few years old.
And when they did not upgrade the Mac Pro to USB3 Cringely rightly asked what Apple would do about their power users. Here was his conclusion:
Apple will eventually have to explain to those folks [power users] how less is more and how this new world [no expandable computers] is even better for them. I think I know how Apple will do it.
When the Mac Pro dies for good Apple will replace it in the market with a combination of Thunderbolt-linked Mac Mini computing bricks backed up by rented cloud processing, all driven from an iMac or MacBook workstation.
I just wonder when they’ll get around to telling us?Apple's balance sheet is consistent with this vision. Apple has been developing huge cloud computing facilities evidenced by the vast expansion of property, plant and equipment in their balance sheet (which has been piling this stuff on in the billions).
Windows 8 - a product that gets people used to and software developed for a pad that docks - was Microsoft's way of getting used to the idea of portable computers with rented super-computer cloud space.
And it will be a failure because Microsoft, not for the first time, have lost their view of real users.
I held Microsoft for 18 months (and it was not a bad investment). But last night I gave up.
For comment.
John
*There are other lock-ins at Microsoft - for instance my business partner irregularly writes Visual Basic algorithms for spreadsheets. Visual Basic is Microsoft proprietary and these spreadsheets lock us into having at least one Microsoft machine in the office. I complain regularly about this - but Simon is over 40 and teaching old-dogs new tricks is hard. He has a lot of human capital invested in his ability to crank out something in Visual Basic.
Wednesday, July 25, 2012
Italy, Portugal, Greece, Spain, Australia: Some comments on Vodafone's rusults
Here is an extraordinary slide of revenue by jurisdiction from the last Vodafone conference call...
Revenue is great in growing emerging markets (Turkey has become a land of smartphones). Revenue is bad in Italy, Portugal, Greece and Spain. The biggest driver there is mobile termination rates - these are markets where you pay to make a call to a mobile phone and these calls are discretionary.
The shocker though is Australia - and it has been a shocker for a while. Revenue performance in Australia is worse than any Southern European country.
This was entirely predictable.
In Australia Three ("3") merged with Vodafone and network performance was abysmal. This video went up on YouTube a little over a year ago parodying the (combined) company.
That video has roughly 200 thousand views - or 1 percent of the Australian population. These companies spent a lot of money on advertising and sports sponsorship: all wasted because of high credibility parodies and word of mouth. The results speak for themselves as this press article demonstrates:
My guess, in terms of lost customers and future profits the stuff up will wind up being worth something like a billion dollars.
And it takes a special customer-service incompetence to get this bad. One disgruntled customer who wanted to be let out of their contract because the service did not work wound up setting up a website (vodafail.com) to let customers grieve. Eventually Vodafail did let the victim out of their contract - but when it takes a successful social media campaign to get the company to do the right thing there is something deeply wrong with management. [Vodafail did not meet its part of the obligation - it did not deliver a phone service...]
The #vodafail tag is still active in Twitter as the following shows:
Yes - the company still converts iPhones to iPods and can take half an hour to update twitter. This problem is not yet solved.
But to be fair it is nowhere near as bad as during 2011 - and the frequency of tweets with the #vodafail tag is declining. Moreover the Vodafail website has gone (relatively) quiet noting that:
This was an execution stuff-up of the first order. And it took until March 2012 for them to parachute in a new CEO (Bill Morrow) who has (rightly) declared that his task is network, network, network and network...
But he also has to get back trust - especially in a business that asks people to sign 24 month contracts and then won't let them out when they can't meet their end of the contract (their end being to make your phone work). He has made a start - allowing a 30 day let-out clause: Here are the terms:
I don't envy Bill Morrow his job. And I wonder why it took 12 months after Vodafail was the but of musical parody to actually change the CEO. Surely there are enough network-technical-junkies in Vodafone who would like a 6 months emergency working gig in Australia to get the network fixed up.
The whole thing petrifies me because I own Vodafone stock (despite this problem) and they are doing a much bigger integration in the UK where they are merging with Cable and Wireless. Stuffing that one up would matter much more than my little local market.
Oh for the old days of stock picking
All of this makes me pine for the old days of stock picking. Vodafone (as a stock) is currently driven by two things:
(a) the terms on which it can extract value from its 45 percent stake in Verizon Wireless, and
(b) the value/profit proposition of their (strained) European mobile networks business.
The first is a corporate governance concern, the second a macroeconomics concern.
Australia - a pea-sized market at the edge of the world - is entirely driven by competitive positioning (once good, now less good) and execution (which has been abysmal).
In the old days stock picking was a matter of understanding competitive dynamics and business execution. If you bought a stock at a mid-teens multiple where the competitive dynamic did not deteriorate and the management executed you did fine. If you paid 12 times you did well. If you paid 9 times you made-out-like-a-bandit.
These days I spend much of my time considering whether macroeconomics can make a company blow up (macro concerns) or whether the management is going to steal from me (governance concerns).
Vodafone Australia and its problems remind me of the pitfalls of yesteryear's stock picking. Whether that world is more fun or less fun I will leave to readers imagination - but the outcomes were generally more palatable for the wider public.
John
Revenue is great in growing emerging markets (Turkey has become a land of smartphones). Revenue is bad in Italy, Portugal, Greece and Spain. The biggest driver there is mobile termination rates - these are markets where you pay to make a call to a mobile phone and these calls are discretionary.
The shocker though is Australia - and it has been a shocker for a while. Revenue performance in Australia is worse than any Southern European country.
This was entirely predictable.
In Australia Three ("3") merged with Vodafone and network performance was abysmal. This video went up on YouTube a little over a year ago parodying the (combined) company.
That video has roughly 200 thousand views - or 1 percent of the Australian population. These companies spent a lot of money on advertising and sports sponsorship: all wasted because of high credibility parodies and word of mouth. The results speak for themselves as this press article demonstrates:
Hutchison Telecoms Australia, 50 per cent stakeholder in Vodafone Hutchison Australia (VHA), announced yesterday afternoon that VHA lost 178,000 customers and reported a loss of AU$260.2 million for the first six month of 2012.
In what has been a disastrous 18 months for the company, following its infamous network outages in 2011, Vodafone's customer base slid below 7 million to 6.8 million, from a high of 7.5 million in 2010.Note the scale of this stuff-up. The population of Australia is 22.6 million and there are roughly the same number of mobile phones. They lost 700 thousand customers or three percent of the population. [This is in a business where a one percent movement is a big change in share...]
My guess, in terms of lost customers and future profits the stuff up will wind up being worth something like a billion dollars.
And it takes a special customer-service incompetence to get this bad. One disgruntled customer who wanted to be let out of their contract because the service did not work wound up setting up a website (vodafail.com) to let customers grieve. Eventually Vodafail did let the victim out of their contract - but when it takes a successful social media campaign to get the company to do the right thing there is something deeply wrong with management. [Vodafail did not meet its part of the obligation - it did not deliver a phone service...]
The #vodafail tag is still active in Twitter as the following shows:
Yes - the company still converts iPhones to iPods and can take half an hour to update twitter. This problem is not yet solved.
But to be fair it is nowhere near as bad as during 2011 - and the frequency of tweets with the #vodafail tag is declining. Moreover the Vodafail website has gone (relatively) quiet noting that:
More recently, traffic to Vodafail.com has declined significantly. Having achieved the goal of raising awareness and promoting concrete action in early 2011, we have now reached the point of closing Vodafail to new complaints. The site will remain online for as long as possible as a reminder and an example of what is possible when we share our experiences.
This was an execution stuff-up of the first order. And it took until March 2012 for them to parachute in a new CEO (Bill Morrow) who has (rightly) declared that his task is network, network, network and network...
But he also has to get back trust - especially in a business that asks people to sign 24 month contracts and then won't let them out when they can't meet their end of the contract (their end being to make your phone work). He has made a start - allowing a 30 day let-out clause: Here are the terms:
The new Vodafone network - rolling out now
We're confident you'll be happy with our new network, so now we guarantee it.
Upgrade on a new Postpaid Mobile or Mobile Broadband Modem service and if you're not happy with your network experience you can cancel your contract within the first 30 days. No cancellation fees, just pay for what you've used, until cancellation is finalised1.
We're investing $1 billion on rolling out a new Vodafone network to give you:
- Stronger signals
- Faster downloads
- Better indoor coverage
Than ever before from Vodafone. Find out more Vodafone.com.au/network
Trust is a special thing in business. Once it is gone I don't know how much cricket you need to sponsor to get it back.I don't envy Bill Morrow his job. And I wonder why it took 12 months after Vodafail was the but of musical parody to actually change the CEO. Surely there are enough network-technical-junkies in Vodafone who would like a 6 months emergency working gig in Australia to get the network fixed up.
The whole thing petrifies me because I own Vodafone stock (despite this problem) and they are doing a much bigger integration in the UK where they are merging with Cable and Wireless. Stuffing that one up would matter much more than my little local market.
Oh for the old days of stock picking
All of this makes me pine for the old days of stock picking. Vodafone (as a stock) is currently driven by two things:
(a) the terms on which it can extract value from its 45 percent stake in Verizon Wireless, and
(b) the value/profit proposition of their (strained) European mobile networks business.
The first is a corporate governance concern, the second a macroeconomics concern.
Australia - a pea-sized market at the edge of the world - is entirely driven by competitive positioning (once good, now less good) and execution (which has been abysmal).
In the old days stock picking was a matter of understanding competitive dynamics and business execution. If you bought a stock at a mid-teens multiple where the competitive dynamic did not deteriorate and the management executed you did fine. If you paid 12 times you did well. If you paid 9 times you made-out-like-a-bandit.
These days I spend much of my time considering whether macroeconomics can make a company blow up (macro concerns) or whether the management is going to steal from me (governance concerns).
Vodafone Australia and its problems remind me of the pitfalls of yesteryear's stock picking. Whether that world is more fun or less fun I will leave to readers imagination - but the outcomes were generally more palatable for the wider public.
John
Friday, July 13, 2012
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