Posted on April 17, 2007
Filed Under Companies, Markets & Finance, Research | Leave a Comment
The launch of the Apple iPhone precipitated an avalanche of commentary, almost all glowing but for the fact that Apple had chosen Cingular as an exclusive service provider partner. We were thinking along the same lines at the time. But then a little voice started reminding us that maybe we can make more money by thinking the other way.
Visualizing a revitalized AT&T piqued our interest. At the time AT&T was trading at less than 5x operating cash flow. Although we are not expert investors in communication service providers, in the past buying similar companies at such a multiple (like Telecom Italia back in the ’90 s) has paid off well. Since then T has done well and was the top performer in the Dow for Q1. Developing fundamentals hint that there may be a larger story here.
First of all the iPhone may indeed be a catalyst for the company in terms of visibility and investor sentiment. It’s becoming clear that the pull of having the coveted iPhone is more powerful than the objections to AT&T as a service provider. While the business may not move the needle in terms of the overall revenue it should be a strong win for AT&T in terms of acquiring new customers.
What about the rest of AT&T? In combination with BellSouth and Cingular it’s over a $100B business that will need way more than the iPhone to drive. AT&T has been doing pretty badly the last couple of years making for easier comparisons and perceived improvements. At least a few things have been going right for AT&T including their IPTV offering, which is accelerating rapidly after a false start in 2006. The enterprise sector is at least healthy enough for them to execute an orderly consolidation plan. Lastly the company has plenty of opportunity to improve cash flow and dividends as efficiencies are driven by the combined organization. When one imagines the cost structures of AT&T/SBC/Cingular it conjures up pictures of some low-hanging fruit to start picking.
I short we see the company improving operational results across the bulk of their businesses and growing the desirable segments of wireless, broadband and data much faster than the rest of the company. As a major Dow component AT&T won’t wildly outperform the market but at these levels it still looks too cheap on both an absolute and relative basis. Compared to GE, Cisco and Verizon the shares should be 20% higher and if the stock gets afforded a better multiple (say a 15x PE on 2008), the shares could certainly trade in the $45-47 range. — Kris Tuttle
Posted on April 15, 2007
Filed Under Energy, Research | Leave a Comment
Today there may be more value in viewing energy as a technology rather than a natural resource industry. There is a strong theory proven by historical events that energy (and other raw materials) decline inexorably in cost over time. Despite our intuition, natural resources (energy included) are not in any way finite or scarce. Our notions about declining supply and scarcity are deeply rooted in our individual experience of shrinking production from an oil well and sparser lodes of ore from existing mines. However these individual notions are the opposite or our collective experience throughout history. The implications are not only lower energy costs going forward, but also great advances in innovative solutions and new technology.
Julian Simon, noted professor at Maryland University and senior fellow at the Cato Institute, spent several decades researching and documenting these findings, which include the impacts of human population growth on raw materials cost, pollution and bio-diversity. His work, while controversial, has never been disproved. Despite the truth these theories do not garner as much attention from analysts, economists and investors as near-term price fluctuations and old-fashioned notions that black pools of oil left by the dinosaurs will run out and leave us with secular increases in energy costs.
These ideas strike people as objectionable or unsatisfactory because we don’t want to be complacent about our planet. Particularly in areas that inspire emotions like global warming and shrinking bio-diversity, people wrongly take these theories to mean that we should do nothing and the problems will simply go away. Simon’s Law says quite the opposite and acknowledges the collective power of society to focus on and solve problems by applying our best efforts to what is most important. There’s no reason to believe the outcome this time will be any different than it has been during the last few thousand years.
We will spare our readers a pile of statistics on inflation and energy prices but two things should be noted. The first is that the Department of Energy statistics on global supply and demand show that oil is a very orderly market; supply equals demand with very little difference, year after year. The second is that the recent increase in crude prices reflects more of a reversion to the mean from very low prices a few years ago. In 2003 crude was selling about the same price it did in 1983 ($26/bbl) despite the fact that inflation figures would allow crude to trade at more than double that figure and still be well within the envelope of a long-term decline in real energy prices. After four years of major increases (+22%, +41%, +19% and +25%) the 2006 average price of $58/bbl is still not abnormal. However we can’t resist pointing out that since 1949 we have never had four straight years of double-digit price increases and past declines warrant preparation for $30/bbl prices in the next few years.
Today we can already see the forces that Simon outlines beginning to drive the changes that will lead to a larger, more efficient energy industry. First and foremost is the huge wave of financial and intellectual effort now mobilizing into energy. Of course traditional energy companies themselves are stepping up their investments in exploration and production. Increases in extraction rates are coming from the application of newer 3D imaging techniques, steam injection, smarter drills, better pipes and a myriad of other tricks that are worth the effort at current oil prices.
Venture capital investments into innovations around energy more than doubled in 2006 to $1.8B invested in 183 companies. The increase was even greater in the alternative energy sub-segment, which jumped 272% to $727M in 39 companies. It’s easy to foresee another big increase in 2007 based on current levels of activity and enthusiasm for the sector. Thankfully for venture capitalists the virtuous cycle has just received a major boost from the $2B acquisition of Horizon Wind Energy by a Portuguese utility company. Large companies like GE, ADM, the automobile manufacturers and the semiconductor material and equipment providers are also shifting more of their spending on alternative energy sources.
The ultimate success of new innovation in energy depends on the development of a large and viable marketplace. Public attitudes and the political environment for creating incentives and subsidies for new forms of energy supply and conservation has probably never been better. This is necessary now because if one simply runs the numbers on making use of solar panels on a residential property they don’t suggest a very attractive return. Tom Evslin at Fractals of Change has done a complete analysis for his own situation taking account of installation costs as well as the ability to take advantage of higher time-of-day rates which gives solar an edge of wind. After all is said and done the current ROI appears to be about 2% in his circumstances. Of course over time we can expect the initial investment per watt of solar faceplate to decline.
More help is on the way from none other but our favorite financial innovators, the investment banks. In particular Goldman Sachs has created a structure whereby a large commercial customer can switch to solar without having to make any capital investment or worry about ongoing maintenance of the system (handled by a third party). They do have to sign a long-term supply agreement but at rates already lower than what they are paying now. Structures like this are so attractive that they can drive the commercial industry forward into solar with some force.
Local providers are starting to figure out that they can build franchises around this business in the residential sector. There are already emerging providers like Ready Solar springing up that provide a simple kit that can be easily installed by general contractors. Some utilities may enter this market as well as they have done in the past with energy efficient appliances. Small financial services companies are creating a package that includes analysis and financing for homeowners that takes into account the numerous incentives and tax breaks available in many states along with low-cost home equity financing. (What a great way to create jobs for all the unemployed sub-prime mortgage agents!)
There is also an attenuation of demand that comes from a huge number of small improvements from use of LED and fluorescent illumination to replace incandescent lighting, more energy efficient vehicles and hybrids, greater use of geothermal to cut heating and cooling costs and so forth.
Having been convinced that the future opportunities in energy innovation are here to stay and that they have everything to do with technology and investments we hereby plant our flag in the space. As we did with the software space we will be introducing a “Power 20” group of companies that best represent the investment vehicle for this space and will include sector and company reports beginning with solar energy where we have already done a considerable amount of work and then moving most likely to advanced materials and energy related technologies. We’re excited about adding this space.
Tags: Finance, Energy, Oil, Economics, Alternative Energy
Posted on April 5, 2007
Filed Under Companies, Markets & Finance, Software, Technology & The Web | 1 Comment
Can you speed up the teleprompter please? Software AG held a call today to discuss their acquisition of WebMethods. None of the presenters could muster much genuine enthusiasm for this deal. However as transactions go it’s certainly well-grounded in terms of the numbers.
Prior to the call we had been noting Software AG with some interest thanks to fairly strong execution and an attractive valuation. The company has a strong mainframe and maintenance legacy but has been working on a growth strategy with their CrossVision product line.
The call was consistent with a fairly low profile and offered the usual rhetoric around "strengthens Software AG in the US and strengthens WebMethods in Europe" along with "this merger of two leading companies creates a powerful player."
Financially the deal was done at a low valuation at $546M for a company with about $200M in cash and $200M in TTM sales. Guidance is that the deal will be neutral to 2007 numbers and accretive to 2008. [No explicit numbers were given but there was some mumbling at the very end of the call about adding 10% to earnings in 2008. It was unclear whether this is just a general view or related to the acquisition.]
From a market positioning standpoint the companies are looking to combine SOA and BPM to provide SOA Governance, Monitoring, Composition and so on down the line. The combined company will have just over 60% of revenues in maintenance and professional services and 30% license revenue.
As it stands the transaction is expected to close in June but there seems to be quite a bit of focus on other potential offers and whether or not this was a competitive process. At 1.5x net TTM sales (net of cash) the deal is at the low end of software transactions.
U.S. analysts and investors will be happy to have WEBM off their coverage lists and out of their portfolios. Few, if any, are likely to take up SAG in the near term but Software AG execution in 2H2007 could make a difference. Will there really be an upsurge in operational vitality in the U.S. vis a vis Software AG products? Will we see some differentiation from better product integration between Software AG and WebMethods? Are there any new products or technologies in the works that are likely to help the combined company gain market share versus other market players that seem to have stronger solutions?
Tags: software, Software AG, WebMethods, WEBM, M&A
Posted on April 3, 2007
Filed Under Software, Technology & The Web, Starting Up | 1 Comment
We’ve experimented with quite a few technologies to be used for personal organization and productivity. Most recently we have been using Google Apps, MindManager (planning), Backpack (projects) and Qumana (blog).
Google Apps: So far we’re a little disappointed. We are going to stick with Google Apps for our Research 2.0 business because it works well enough for email but the other applications are just plain flaky. We have had to abandon many a spreadsheet due to sporadic performance or freezes. We just don’t have any patience for that so will be using Microsoft Excel for our work unless and until something changes there. Documents are a little easier to work with but again we find ourselves still doing most things in Word instead.
MindManager: We’ve tried earlier versions but the new one rocks. We are using V6 for Mac and it seems to answer many of our demands for planning flexible networks of tasks, projects, flows and so on. The latest version makes it easy to incorporate notes, files and links which was the key ingredient missing from the earlier versions we tried. Although it is expensive for us it’s worth the price. (There is a free trial download.) We had been using Yojimbo which is fairly solid but the network model in MindMap is far more reflective of how we plan and model.
Backpack: We like the products from 37Signals and use the little brother (Ta-Da Lists) for some family projects and the big brother (Basecamp) for clients. Backpack seems just right for us as a personal project tool. We use it mostly for organizing material since it has the key feature of allowing email access to projects. This makes it very practical to add bits of content, thoughts, links or whatever to projects with a simple email and get project data sent to you on request as an email.
Qumana: Updating blogs is not fun online. Even one is a pain and having several makes it essential to find a better way of doing it. Of the tools we tried Qumana is the best since it has plenty of features but is very easy to use, extremely stable (hasn’t crashed in several days with three sites open) and cheap. The ability to build posts and do everything offline is essential. If one is doing a personal blog about what your cat did today you don’t need it but if you are publishing a professional blog or doing multiple blogs you will love this software.
Hope those of you picking through tools to do these types of things will find this information helpful.
Tags: Organization, GTD, Blogging, Planning, PIM, Qumana, Backpack, MindManager, Yojimbo
Posted on April 1, 2007
Filed Under Research | 1 Comment
On March 22nd the Merrill Director of Equity Research, Candace Browning, penned a memo regarding the state of equity research and some strong actions Merrill is taking to protect the value of their research product for clients. Having been there and done that at one time it certainly made us chuckle. Beyond humor value I wonder if their actions to try and restrict access will work at all and if it signals any sort of coming shift in the economics of the business. The memo itself shows a remarkable lack of awareness of the business today as well as misstatements about how healthy it is.
It starts out in a surprised tone regarding the fact that Merrill research is broadly available to the public just after it comes out. How can you be shocked by this? It’s been a fact in the business for at least five years and has spawned many unsuccessful efforts to stem it. In fact most of the client value delivered by sell-side brokerage analysts comes via their verbal dialog, voicemails, conferences and management access rather than published research and ratings changes.
Still Merrill states their are going to terminate research access by non-clients, increase access restrictions and delays for media access, eliminate licensing agreements unless they can be done at higher, non-eroding prices (whatever those may be.) It’s odd seeing this from Merrill since the one obvious value their research has over others is it’s broad reach (no matter the content) and the fact that many institutional and retail brokers rely on it. Taking that away leaves little, if anything, of value. This as opposed to some of the other banks which have indeed improved and created some true value-add in their research content.
The other part of the memo is just misinformed over the perceived value of street research. The claim that recommendations produced a global return of 19.5% versus 16.2% for the MSCI is empty given way changes are effectively backdated and not measured by actual stock transactions. Citing 42% total commission allocation to high-quality sell-side ideas (Greenwich Associates) doesn’t translate into anything meaningful for Merrill since they are a liquidty provider rather than an idea shop like Piper Jaffray, American Technology Research, or Majestic Research.
Lastly nothing that hedge funds allocate a great percentage (55%) of their commissions to research has more to do with them spending on special providers (Gerson-Lehrman), consultants and industry research groups rather than the street. New providers of investment research services like Monitor110 will garner more of these research dollars in the future.
Having been there and done that I understand the need to try and trumpet the value of sell-side research and make people think they need to pay up for it. Of course it rings absurdly hollow this many years into the decline and coming from Merrill lacks any credibility. Merrill has been working to reduce their research costs for years and views it as a pure cost center. Merrill analysts are measured on market capitalization under coverage rather than ideas and spend the bulk of their time fielding calls from sales, marketing themselves to clients to get votes and dealing wtih the kafka-esqe legal and compliance systems part of broker-dealer operations today.
Does the memo signal anything new for the broker-dealer research industry? If so I’d love to hear about it!
Tags: Research, Wall Street, Merrill Lynch, Brokers