Felix Salmon

How companies should take advantage of markets

Felix Salmon
Dec 20, 2013 14:08 UTC

I like Matt Levine’s dry take on Facebook’s secondary offering: “Whatever else you think of Facebook,” he writes, “it is unusual among public companies in its desire and ability to sell stock at local maximums.” And really, he’s right: it makes perfect sense for a company (and its controlling shareholder) to sell stock when demand is greatest and the price is at its highest. After all, share sales are a simple transaction: you give me a one-off slug of cash today, and in return I’ll give you ownership rights in perpetuity. Anybody engaging in such a deal should at least want to maximize the amount of cash they’re getting, which is another way of saying that you should only sell stock if you think it’s overvalued.

On the other hand, I don’t buy Cyrus Sanati’s criticism of the deal, which is that Facebook shouldn’t be diluting its shareholders like this when it already has more than enough cash on hand — and is profitable, to boot. But let’s put this “dilution” into perspective, here. For one thing, the 27 million shares that Facebook is selling to the broad public constitute less than half of the 60 million new shares that Facebook is issuing to Mark Zuckerberg personally, as part of its most recent options grant. If you want to complain about dilution, then complain about the options, not the secondary. And in any case, before this deal (and before the options grant), Facebook had 2,458,051,029 shares of stock outstanding. Which means that the new stock being issued by Facebook is dilutive to the tune of just under 1.1%. In a world where Facebook stock has doubled in the past five months, that’s really nothing.

The real news here is that Zuckerberg has finally started cashing out in a very big way. While he did sell some stock in the IPO he only really sold enough to cover his personal tax bill; in this deal, however, he’s selling 41,350,000 shares — which is significantly more than the amount he would need to sell to cover the taxes on his latest options grant. And by “significantly” I mean one billion dollars net after taxes. That billion dollars in cash is over and above the other billion dollars he’s giving to charity in the form of Facebook stock, which will have the pleasant side effect of reducing his annual taxable income by exactly the same amount.

Interestingly, for all that Zuckerberg is selling $3.3 billion of stock as part of this offering, his control of the company is greater now than it was before the IPO: back then he controlled 56.9% of the total voting power in Facebook, while after this deal he’s going to control 62.8%.

It seems to me, then, that the real way to look at this deal is to remember that Facebook is Zuckerberg’s company, and that drawing distinctions between the two is not very helpful. Zuckerberg wants to diversify his wealth out of Facebook, and he’s doing that now. He also knows — almost better than anybody else on the planet — just how quickly large technology companies can get disrupted. After all, he did that himself. So he wants Facebook to have a very large warchest of cash, which he can then use to acquire the kind of fast-growing, mobile-native products which threaten to make him obsolete. And right now is a great time to amass such a warchest: Facebook is being added to the S&P 500, which means that lots of index funds want to buy his stock. That kind of permanent step-change in demand for Facebook stock can easily justify a small step-change in the number of Facebook shares outstanding.

Or, to put it another way: three years ago, Facebook could entice talented engineers away from Google by promising them lots of Facebook stock, on the grounds that one day, Facebook would be a $100 billion company and they would be rich. Now, however, Facebook is a $100 billion company. (To be precise, it’s a $135 billion company.) As a result, its stock is much less attractive to someone looking for massive appreciation in the next few years: you’re much more likely to go from $30 billion to $120 billion than you are to go from $125 billion to $500 billion. Which in turn means that Mark Zuckerberg has moved on, and is now offering cash, rather than stock, to the companies and individuals he really covets. (The $3 billion he offered for Snapchat is an enormous amount of money, but it’s a lot less than the $10 billion of cash that Facebook currently has on its books, gathering dust.)

Zuckerberg has made a determination that he wants a lot of cash, both for himself and for Facebook, and that it’s worth selling a few shares in the company in order to get it. That doesn’t, pace Sanati, mean that Zuckerberg thinks Facebook is overvalued. It just means that there’s a cycle to these things. Facebook already has a large market capitalization; having a large market capitalization and billions of dollars in cash gives you more power and more optionality.

Who’s at the other end of the cycle? Which firm is currently most similar to Facebook circa 2010, looking to attract talent by giving out equity? The answer is Square, where Jack Dorsey has given back 10% of his shares, just so that the company can attract the very best talent going forwards. That’s smart. Dorsey doesn’t need the money: what he’s looking for is growth. If Dorsey needs cash, he can always sell some of his Twitter shares, which are currently valued at well over a billion dollars. But if he wants to attract Silicon Valley engineers who dream of becoming dynastically wealthy on the day of an IPO, then right now he needs to be able to hand out significant chunks of stock.

What Zuckerberg and Dorsey have in common is that they’re taking full advantage of the astonishing valuations which can be bestowed on companies — and their shareholding employees — by public markets. Zuckerberg is tapping those markets for cash; Dorsey is pointing to their potential. This is a really good thing: this is what markets are for. Markets provide incentives, and the owners of companies take advantage of those incentives. Shareholders shouldn’t want to have it any other way. Even if certain index-fund managers feel a bit as though they’re being dragooned into shipping billions of dollars over to Mark Zuckerberg, right at the point at which the stock hits an all-time high.


Does Zuckerberg use 10b5 plan to sell his stock? If so, how does he time his sales based on stick price? If not, how is it not insider trading?

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Why companies are raising their dividends

Felix Salmon
Dec 18, 2013 03:36 UTC

Matt Yglesias presents the case against dividends today — and it’s a case I’m sympathetic to. But before you can determine whether stocks should be paying dividends, it’s important to understand why stocks are paying these dividends. And the answer is in the chart above.

The blue line, in this chart, US after-tax corporate profits as a share of GDP — and it shows that they’re at an all-time high of around 11%, when they’re normally closer to 6%. This is the chart which should worry anybody invested in the stock market: while the market’s price-to-earnings ratio still seems pretty sane, that’s only because corporate earnings are much higher than they’ve ever been in the past. If this number starts reverting back towards its historical mean, then stock prices are certain to fall, possibly quite sharply.

What investors are looking for, then, is reassurance that the impressive profits they’re seeing today are here to stay, rather than being some kind of historical anomaly. And so that’s also the message that CEOs are seeking to send to their shareholders.

It’s here that dividends start being a lot more attractive than stock buybacks. It’s exactly the same reason that you’d much rather get a thousand-dollar raise than a thousand-dollar bonus. Dividends aren’t bond coupons: they can go down, if they have to — and, in hard times, you can be sure that they will go down. But in general, no company will set a dividend this year which it doesn’t think it can meet next year, and the year after that, and the year after that. A dividend is a company telling the market that the cash it’s throwing off today isn’t some kind of exceptional good fortune, but is rather something that shareholders should get used to, year in and year out for as far as the eye can see.

And that is a message which is much more supportive of a stock price than any stock buyback. (Especially since buybacks are easy to announce, and very few people bother to check whether the companies which announced them actually followed through on their promise.)

If you’re going to return a certain amount of cash to shareholders, then there are lots of reasons why it makes sense to do that with a buyback rather than through a dividend payment. But once a buyback is over, it’s over. A dividend is much more predictable than a buyback program; what’s more, it’s often something which grows predictably, as well. (AT&T has been raising its dividends every year for 30 years.) In a low interest rate environment, a permanently-increasing income stream, even if it only increases in line with inflation, is worth a small fortune.

When a company earns profits, there are lots of things it can do with the money. It can hold on to the profits as a cash balance; it can spend that cash buying back its own stock; it can pay that cash out as a dividend; it can give its employees raises, or bonuses; it can reinvest the money in R&D or other capital expenditure; it can acquire other companies; and so on and so forth. But if you invest your money in employees or capex instead of using it for dividends or buybacks, then that reduces your profits — which in general is bad for your share price.

There are exceptions to the rule, or course — Amazon is a great example of a company with a stratospheric share price, and p/e ratio, despite (or because of) its lack of visible profits. But then again, it was none other than Matt Yglesias who described Amazon as “a charitable organization being run by elements of the investment community for the benefit of consumers”. He can’t really have it both ways. And in any event, if you want to keep your profits high, and send a message to the market that they’re going to stay that way, then it makes a certain amount of sense to boost your dividend.


What helps the most, honestly, is not to focus on the shareholders, but to focus on the people who drive economic activity; their employees. Rather than engaging in buybacks and increasing dividends, they SHOULD be raising wages and letting money flow into the economy rather than hoarding it.

Yes, it’s important to ‘reward’ investors by giving them a return on their loan. But it should never EVER be the primary focus of any company. The primary focus of every company should be to provide goods and or services at a reasonable cost.

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The definitive Twitter value play

Felix Salmon
Nov 7, 2013 07:29 UTC

Twitter is about to raise more than $2 billion, on a valuation of more than $18 billion, in its IPO. At some point on Thursday morning, an opening price for the stock will be set — a price which will almost certainly be north of the official IPO price of $26 per share — and after that, it’s off to the races. Will Twitter stock go up? Will it go down? Is it a buy? Is it a sell? Is the company worth what the market says it’s worth? It’s a pretty silly game to play, at heart, since no one has a clue what the answers are, not even Twitter’s underwriters, who had to raise the valuation of the company twice.

Still, silly games are often the most fun, so, go knock yourself out with the official Breakingviews Twitter valuation calculator! Or, you can use Lex’s version, which is a relatively pure discounted cash flow model, not dissimilar to the back-of-the-envelope calculations by which the Economist managed to come to a “reasonable” valuation of $18 per share. Anything north of that level, intones the venerable weekly, constitutes “a poor long-term investment”.

But the fact is that when it comes to valuing a technology stock, it’s stupidly easy to get any number you want. Here’s one extreme: the valuation of any company should be equal to the net present value of its future dividends. Twitter is going to pay no dividends for the foreseeable future, therefore, its value is zero. Or, here’s another extreme: Twitter should easily be able to generate $5 billion a year in revenue pretty soon, and grow to that level very quickly, which would justify a multiple of, I dunno, 12X revenues. Which would mean a capitalization of $60 billion, or about $110 per share.

The point is that any valuation for Twitter is a result of guess upon guess upon guess. Take Henry Blodget’s attempt, for instance. We know with reasonable certainty that Twitter is going to generate about $625 million in revenue this year, so why not treble that number, and declare that its revenues are going to grow to $2 billion in 2015. Then, multiply that number by 10, since that’s more or less where Facebook and LinkedIn are trading — and you get a valuation of $20 billion, or about $35 per share.

If you wanted to get a bit more sophisticated, you could try using probability distributions instead of hard numbers — but we have no more insight into the probability distribution for Twitter’s 2015 revenues than we do into a single forecast for those revenues. And there are certain valuation metrics, like “the amount of money Twitter might get bought for”, which are even more tenuous — yet clearly important.

So if anybody has any real conviction, one way or another, with regard to whether Twitter’s stock is overvalued or undervalued, you can be pretty sure that they don’t really know what they’re talking about. It’s going to be a trading vehicle for the first few days, with investors jockeying to get in or out at the best possible price. All of which is going to make the price-discovery process even more drawn-out and unreliable than it normally is. We are living, after all, in a world where a single bitcoin is worth more than $250, even though it has no cashflows at all.

So how is the individual investor supposed to navigate these treacherous waters? It’s actually incredibly easy. And it works like this. Twitter’s profits, if and when they ever appear, are going to be some fraction of its revenues. Its revenues, in turn, are going to be some fraction of the value it provides to its users. I have personally already extracted many thousands of dollars in value out of Twitter, over the past five years, and it hasn’t cost me a penny. On an ROI basis, I’m doing unbelievably well — and my returns are only going to keep on growing into the future.

Here’s my advice, then: take the amount of money you were thinking of investing in Twitter, and divide it by the rate at which you value your own time. So, if you were going to invest $5,000 and you value your time at $50 per hour, then you’d end up with a figure of 100 hours. Then, instead of spending the $5,000 on Twitter stock, spend 100 hours on Twitter: the cost is the same. The value you get from being on Twitter — from interacting with people you admire, from learning new things, from being able to express yourself so easily and concisely — will be much greater than the value you’d ever get from buying $5,000 of Twitter stock. And you’ll still have $5,000 left over to do whatever you want with, whether it’s putting it into some other investment or spending it on something awesome — a holiday, perhaps, or a gift to a friend, or even some fine wine.

Twitter is an amazing platform, where nearly all of the value ultimately accrues to the people who use it. If you don’t use it, you’re missing out. And maybe you think that it’s a silly distraction, and that you don’t have the time for such things. If you do think that way, then go ahead and buy yourself that time, with the money you were thinking of investing in Twitter stock. Leave the noise trading to others: you’ll be on to a much more certain thing.


From my experience every moment of interaction with Twitter is a net loss, so this investment heuristic doesn’t work very well for me.

I am going to buy (correction: just bought in the middle of composing this) some Twitter stock to hold for the long term. It seems like it’s more likely to go the way of Google/Amazon than disappear or be supplanted.

If the people to whom it’s best targeted–like our esteemed host–are extracting thousands of dollars of value, I expect that it will find a way to capture some of that.

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There’s no global wine shortage

Felix Salmon
Nov 1, 2013 07:04 UTC

Have you heard about the global wine shortage? Of course you have: it’s been covered in pretty much every media outlet imaginable, but Roberto Ferdman’s piece for Quartz (“A global wine shortage could soon be upon us”) was one of the first, and also one of the most detailed. Still, it was the classic single-source article: it basically took one Morgan Stanley report, reproduced a bunch of the key charts, and added a clickbaity headline.

The charts, on their face, tell a pretty clear story, especially this one:

But if you look closely at the Morgan Stanley report, it starts to look less like a dispassionate analysis of supply and demand dynamics in the wine world, and more like an aggressively-argued attempt to put forward one particular investment thesis as strongly as possible. What’s more, the investment thesis is not, particularly, based on the existence of any present or future wine shortage; it’s simply trying to present the idea that demand for Australian wine exports is likely to rise, and to justify the fact that  a company called Treasury Wine Estates is the bank’s “top Australian consumer pick”. (The report was written by Morgan Stanley Australia.)

For instance, the scary chart above is actually this rather less scary chart, tweaked a little:

To create the first chart, Morgan Stanley just took the second chart, added 300 million cases to the red line, and then — this is pretty cunning — simply deleted 2013 altogether, so that the uptick at the end disappears. (The 300 million number is Morgan Stanley’s estimate of the annual demand for “non-wine uses” of wine.)

Although the first chart is scarier than the second chart, even the second chart does a little bait-and-switch, which you can only find by looking at the sourcing note at the bottom of the page. The numbers for the charts come from OIV, the Organisation Internationale de la Vigne et du Vin, including the estimate for 2012 production and consumption. But the 2013 estimate, showing a modest increase in production, is not the OIV estimate; it’s the Morgan Stanley estimate. And what Morgan Stanley doesn’t tell you is that the OIV estimate for 2013 is much higher. Here are the OIV charts:

These charts are less polished, but are actually much more useful. (They also have different units from the Morgan Stanley charts: they’re measured in million hectoliters, which is 100 million liters, while Morgan Stanley uses million unit cases, which is 9 million liters. So when Morgan Stanley says that 300 million unit cases are used for non-wine consumption, that works out at about 33 million hectoliters.)

For one thing, the OIV charts draw sensible straight lines between points, instead of turning them into elegant curves which make the trend seem continuous. The trend is not continuous: these are annual figures per vintage, and each vintage is a unique, separate event. What’s more, while the amount of wine that will be drunk and produced in 2013 is not yet entirely clear. So OIV gives a range of possibilities, while being reasonably certain that wine production is going to increase substantially this year, by somewhere between 7.1% and 10.5%. Morgan Stanley, by contrast, gives no rationale at all for the fact that it has a forecast which is much lower than OIV’s; indeed, nowhere in the Morgan Stanley report is its 2013 forecast ever even quantified.

Add it all up, and the OIV actually concludes, quite explicitly, that the production-consumption difference for wine will “be higher than the estimated industrial needs” in 2013, for the first time since 2007. In other words, far from entering a period of global wine shortage, it looks like the 2008-2012 period of shortage is actually ending.

This global wine shortage, then, just simply isn’t real. Don’t take my word for it: ask the wine trade. Stacy Finz of the San Francisco Chronicle asked a bunch of industry types about the Morgan Stanley report, and none of them took it seriously; Victoria Moore of the Telegraph conducted a similar operation in Europe, and came to much the same conclusion.

My wine-making contacts raised more than an eyebrow at the ready, steady, panic news.

“Tell them to come to the Languedoc if they are worried,” said one. “I think I can help them out.”

Another noted that it is still possible to buy hectares of good vineyard in parts of France and Spain for less than the cost of planting one. In other words, the price of some wine is still lower than its true cost of production, an indication that the balance of supply and demand is still favouring the demanders, not the suppliers.

The Morgan Stanley report paints a picture of a long-term secular downward trend in area under vine, which is running straight into a long-term secular upward trend in global demand for wine. But reality is more complicated than that: thanks to a combination of technology and global warming, an acre of vines can reliably produce more wine, and better wine, than it ever did in the 1970s. And of course if demand for wine really does start consistently exceeding supply, then there’s no reason why area under vine can’t stop going down and start going up.

But never mind all that: the Morgan Stanley report has numbers and charts, and journalists are very bad at being skeptical when faced with such things. Even Finz’s Chronicle article, which sensibly poured cold water on the report, ends with a “Wine by the numbers” box which simply reproduces all of Morgan Stanley’s flawed figures. And besides, the debunkings are never going to go viral in the way that the original “wine shortage!” articles did.

As analysts have known since long before Henry Blodget was covering Amazon, the way to make a splash is to come out with a bold, headline-worthy thesis. Morgan Stanley did exactly that with this report, and I’m sure succeeded beyond their wildest dreams. I’m sure they’ve been celebrating their PR coup all week — probably with sparkling wine of some description.


A splendid insight-Interestingly the link to Morgan- Stanley does not go through – Felix can you provide the reference ?- I am unable to get to the report and look at it. The fact that Frederico Castellucci affirmed your post must make you feel good!

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Apple should be like Bloomberg

Felix Salmon
Oct 29, 2013 20:20 UTC

I’m very glad that the WSJ has published today’s debate between Farhad Manjoo and Dennis Berman on the subject of Apple. Manjoo has been writing some very insightful columns about the company, including the one yesterday which explained that Apple has many better options, when it comes to spending its cash, than taking Carl Icahn’s advice and essentially mortgaging the entire pile to conduct a stock buyback.

The Manjoo vs Berman debate displays two important phenomena surrounding nearly all public companies. Firstly, there’s the confusion between a company and a stock; and secondly, there’s the bigger problem with going public in the first place.

Upon going public, every company is doomed to be judged by its share price — and, all too often, it’s doomed for the share price to become more salient, in the public’s mind, than the company itself. Icahn, as a speculative shareholder, has only one interest in this game: he wants the share price to rise, so that he can then sell his shares at a profit. And Berman is, conceptually, on Icahn’s side. He talks about what investors want, and says that if Apple makes a lot of money, “there will be no choice but to give back significant sums to shareholders.” He also likes the idea of Apple racking up vastly more debt than it already has:

Right now, Apple has 30 cents of debt for every dollar it brings in yearly EBITDA. The median figure for the Standard & Poor’s 5000-stock index is $1.90 – or basically six times Apple’s current ratio, according to figures compiled using CapitalIQ. Were Apple to have a median amount, its current debt would move from $17 billion to $108 billion. Is that crazy? No.

In short, Apple’s business model exhibits the rarest traits seen in nature: relatively low capital demands and immense profit generation.

This would be funny, if it weren’t so depressing. Berman concedes that Apple is an extremely rare outlier in the corporate world: it makes a lot of money without having to invest a huge amount up front. Most companies which aren’t Apple, by contrast, have to borrow and invest a huge amount of money before they can start generating earnings. Berman’s bright idea, here, is that if Apple is fortunate enough not to have to go into massive debt to finance its investments, then, er, it should go into massive debt anyway, just because everybody else is doing it.

What good would that huge new debt pile actually serve? Well, it might help increase the share price — or it might not, who knows. (Icahn, for his part, is convinced that the share price will rise either way: he says in his letter to Apple that “the opportunity will not last forever”.) Obviously, it would also burden Apple with billions of dollars of fresh liabilities, in the form of new interest and principal payments. But Berman is unfazed: in his world, liabilities are assets, and assets are liabilities. Seriously: he says, on the liability front, that “the key to keeping Apple sharp will be actually to push more money than comfortable back to shareholders”. And on asset side of the balance sheet, he describes Apple’s cash hoard as “something of a liability”, on the grounds that it is “stranded and unproductive”. (Never mind that even under the Icahn plan, the cash hoard will remain untouched, and be just as stranded and unproductive in future as it is right now.)

This is the mindset of the financial engineer, and while it can make lots of money for corporate raiders, that doesn’t make it a good idea. Berman is a fan of Icahn: “the man doesn’t have stadiums named after himself for no reason,” he writes. Well, yes: the reason is that he spent lots of money to have his name put on those stadiums. He’s a wealthy individual. But Berman seems to think that anything which makes Carl Icahn rich must therefore be the right thing to do.

But here’s the thing: Tim Cook is a caretaker of a company which is designed to be around in perpetuity. Icahn, on the other hand, for all that he claims that “there is nothing short term” about his intentions, still has an exit strategy: he wants to buy low, drive the share price up through shareholder activism, and sell high. Apple should go along with Icahn’s plans only if they increase the long-term value of the company — and it’s pretty obvious that they don’t: Icahn is, at heart, advising Apple to have both large borrowings and a large cash pile at the same time. Which is bonkers.

Manjoo, on the other hand, definitely sees Apple as a company — a company navigating a highly fluid environment, and one where most of its profits come from a single product, the iPhone. Apple needs to stay one step ahead of what consumers want, says Manjoo, and it’s much easier to do that if you’re not saddled with interest payments. Even Manjoo, however, has internalized Silicon Valley’s fetish for endless growth, even when the company in question is already a giant. “What I’m arguing,” writes Manjoo, “is that Apple begin using its cash to act like a different kind of company — that it act like the big-thinking, future-proofing, market-share-buying behemoth it could be… the boldest thing Apple could do with its cash is transform itself into a different kind of company.”

Manjoo’s “different kind of company” is a lower-margin company: one where Apple decides to “give away a lot more free stuff”, and buys market share, or even buys a cellular carrier. This is much less stupid than Berman’s idea. The single most exciting thing about my new iPhone 5s has nothing to do with Apple: instead, it’s T-Mobile’s free international data.

But even Manjoo is working on the assumption that all companies must always want to grow at all times — even if that means becoming “a different kind of company” altogether. Hidden just beneath Manjoo’s writing is a pretty Berman-esque assumption: that the share price should go up rather than down, and that Apple should do everything it can to ensure that outcome. When Manjoo exhorts Apple to “act before trouble hits”, the trouble he has in mind is basically anything which causes the stock price to fall significantly lower than it is already.

So let me put forward an even more radical idea: Apple should just keep on doing exactly what it’s doing. For substantially all of its history, Apple has been a luxury retailer, making beautiful, functional, high-end goods. Its retail stores are in the most expensive neighborhoods, and it never discounts — much like Louis Vuitton. Its products are status symbols. And they can cost eyebrow-raising sums of money: the new Mac Pro, for instance, starts at $3,000 — and that doesn’t even include a screen.

In general, companies are good at doing what they do well, and they’re not good at doing what they don’t do well. That’s one big reason why mergers, and pivots, generally fail. Apple is fantastic at product design, and at maintaining extraordinarily high quality standards on everything it produces. At some points in time, its products touch the public nerve more than they do at other points. No one expects the iPhone’s dominance to last forever: that’s why Apple is trading at about 13 times earnings, while Google’s multiple is more than twice as high. (Don’t even get me started on Amazon.)

Debt makes sense when you need money to invest today, and can repay that money with a substantial future income stream. Apple is in the exact opposite situation: it needs no money to invest today, while its long-term future income stream is quite uncertain. So it makes sense to save up in flush years, like it has been doing. It will continue to create amazing new products; what’s less clear is whether any of those new products will have the ability to become a world-conquering profit monster like the iPhone. The job of the markets is simply to price the shares accordingly; it’s not the job of management to change the deep structure of the company just to make the markets happy.

Steve Jobs always regretted going public. He raised very little money by doing so, and in return he ended up with people like Carl Icahn constantly second-guessing his decisions. Jobs was good at ignoring such gadflies; his successor, Tim Cook, is a little more shareholder-friendly. But shareholders really do nothing for Apple, which hasn’t had a public stock offering in living memory, and which has so much money now that it can pay its employees large amounts of cash to retain talent, instead of having to force them to gamble with restricted stock units.

In other words, Apple should be run a bit like Bloomberg: as a profitable company which pays well, which concentrates first and foremost on making its product as great as possible, and which doesn’t try to be something it’s not, or allow itself to be distracted with financial engineering. Sometimes its stock will go up, and sometimes its stock will go down. But the company, and its core values, will endure.


In a slight defense of the new Mac Pro, while its price does represent some level of Apple premium, nobody is selling Xeon-class workstations with dual GPUs for real cheap, either.

But as a long-time Apple customer (going back to an Apple II+ in 1979), I’ve been pretty disappointed in the iOSsification of the Mac that’s been happening over the past few years, and having been moving a lot of my work to Linux.

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Data crashes: inevitable and mostly harmless

Felix Salmon
Aug 22, 2013 21:34 UTC

When you look up the price of a stock on the Nasdaq stock exchange, you’re not really looking up the price at which it’s trading on that exchange. All of the Nasdaq stocks trade on dozens of exchanges, all of which have the right to trade in those stocks. That right is known in the market as unlisted trading privileges, or UTP. The job of the Nasdaq is to serve as the securities information processor, or SIP, for all those different exchanges: the exchanges report to the Nasdaq all of the information they have on bids and offers and trades, and then the Nasdaq aggregates all that information and presents it in one place. Most importantly, it shows the most recent price at which any given stock traded, on any exchange. That’s the price you’re looking at.

Now the Nasdaq is an exchange itself, but it doesn’t really have to be: it could halt all trading on its own exchange tomorrow, and no real harm would be done. So long as Nasdaq stocks could trade on all the other exchanges, and the Nasdaq could continue to keep tabs on all the trading going on across the different exchanges, no one would really notice. The real importance of the Nasdaq, then, is not its status as an exchange, but rather its status as a SIP.

The stock market is a bit like chess, or backgammon: it’s a game of (to coin a phrase) total information awareness. Everybody in the market receives the same information in real time. Of course it’s up to any individual trader how — and how quickly — they act on that information. When you enter the stock market, you basically sign a waiver giving up all privacy rights; the Nasdaq, doing its best NSA impression, watches your trades, collates the data on each one, and then republishes it. It’s a prime example of a situation where all the value lies in the metadata: if an exchange stops trading, the effect is much less drastic than if the SIP stops collating and disseminating its index of what’s going on.

Today, of course, that’s exactly what happened. In the parlance of the Nadsaq, there was “an issue at the UTP SIP”, and as a result, all trading, on all exchanges, came to a sudden stop at 12:14pm. The system stayed down for most of the afternoon, until 3:25pm.

The financial system can cope with a three-hour outage, of course. The entire stock market was closed for two days after Hurricane Sandy, and for four days after 9/11. Yes, unexpected intraday outages are bad things — they leave traders with open positions which can’t be closed. But in this case, the Nasdaq managed to reopen before the end of the day, and not much happened over the course of the three dark hours.

But the Nasdaq’s systems aren’t designed to go down and up like this. It’s really just good fortune that the Nasdaq managed to get things working again before the close. Our system of stock exchanges is so incredibly complex, with so much information flowing around at mind-boggling velocity, that it is certain to fail from time to time — and to fail in unexpected ways. We probably won’t know for days what caused today’s mysterious “issue” — and even if the Nasdaq manages to put patches in place to ensure that it doesn’t happen again, something else — something equally unexpected — will happen instead. As Alexis Madrigal says, the surprising thing isn’t that the Nasdaq broke, it’s that we don’t see this kind of thing far more often.

In fact, if I had the opportunity to interview Edward Snowden, that’s one of the questions I’d love to ask: How well do the NSA’s systems work? How often do they just crash, or otherwise stop working for an unexpected and unpredictable reason? The NSA is dealing with orders of magnitude more data than the Nasdaq, and has to do so in conditions of great secrecy. My guess is that things go wrong on a pretty regular basis. But the real-world consequences of today’s market outage, just like the real-world consequences of the flash crash, were pretty slim. And so too is it hard to determine what if any harm might be done by a temporary failure of America’s national security apparatus. When we look at an ultra-high-tech world of server farms and state-of-the-art code, we tend to assume that it’s all incredibly valuable and important. But it turns out, when we lose it, that most of us don’t even notice.


….”with so much information flowing around at mind-boggling velocity”….

Thank you for admitting that a lot of the high velocity “trading” is CIRCULAR.

Posted by kiers | Report as abusive

The incredible shrinking company

Felix Salmon
Aug 22, 2013 17:26 UTC

Christopher Mims has a good piece on Meg Whitman’s Hewlett-Packard today, pointing out that the company’s success (at least as measured by its stock price) over the past year or so is in large part due to her cost-cutting abilities.

Mims doesn’t mention that this strategy is hardly new for HP: it was executed with just as much success under Mark Hurd. The really big errors at HP have taken place at the board level, both in terms of hiring and firing CEOs and in terms of approving ridiculous over-ambitious acquisitions. When it puts its mind to it, HP turns out to be pretty good at shrinking. It’s growth which turns out to be where the pitfalls lie.

Which is why I’d take issue with Mims here:

A more efficient, better-managed HP doesn’t mean much in the long run if the company cannot move beyond the stagnating businesses that make half of its current revenue—PCs and printers…

Without any innovative consumer products to speak of, HP is essentially at the mercy of big businesses’ appetite for technology. And they seem to be wanting less and less of whatever HP is selling…

While she’s managing HP’s consolidation and retreat admirably, is she the CEO who can get the company to once again break the mold? Given her background as head of eBay, a company that changed little under her decade-long rule, we have to be dubious.

I can understand where Mims is coming from. HP is a technology company, and under the unspoken rules of the US stock market, all public companies, and especially all technology companies, should constantly be growing as fast as possible. It’s the inexorable mathematics of discounting: if a company can deliver consistent growth which is faster than the prevailing discount rate used to calculate net present value, then its stock price should, by rights, be infinite. Consequently, given that infinite upside, it’s worth risking quite a lot to achieve growth.

But the facts are pretty plain: (a) HP is very good at producing excellent products in the shrinking markets which make up most of its business right now; (b) HP has in recent years shown no particular ability to produce excellent products in other markets; (c) Meg Whitman is not by nature a visionary innovator. Given those facts, it makes perfect sense for HP to run its existing businesses as efficiently and as profitably as it can, and to extract as much value out of them as possible, in the knowledge that all companies are mortal. In fact, it makes more sense to do that than it does to follow the Tim Armstrong playbook, where AOL’s CEO decided to take his enviable dial-up revenue stream and invest it in doomed content plays like Patch.

John Kay had an excellent column on this subject yesterday, under the headline “sometimes the best that a company can hope for is death”. He finds the genesis for the Mims view in the work of marketing guru Theodore Levitt, who said 50 years ago that companies can and should reinvent themselves in imaginative ways. Levitt was wrong, says Kay: what really matters is not imaginative executives, but rather competitive advantage. HP has a competitive advantage making PCs and printers and servers; that doesn’t mean that it can readily apply that competitive advantage elsewhere.

Kay’s example of JC Penney is a good one. Bill Ackman looked at Penney and saw it as a company in the “retail” bucket, just as Mims looks at HP and sees a company in the “technology” bucket. Ackman then looked for the biggest retail success story he could find — Apple — and tried to inject Apple-style success into JC Penney by hiring Apple’s Ron Johnson as Penney’s CEO. That didn’t work:

The outlets of both JC Penney and Apple are shops but the age group and disposable incomes of their customers – and their reasons for visiting the stores – were entirely different: JC Penney and Apple were not really in the same business.

Penney was not going to succeed by looking at successes elsewhere in the retail space and trying to copy them with little regard for its own existing strengths. And similarly, if HP decides to “break the mold” again, the inevitable consequence will be yet further billions in avoidable write-downs. Once upon a time, HP had a legendary R&D operation — but that operation fell victim to Hurd’s cost-cutting, and in any case no R&D shop can maintain excellence forever. The HP board knows that, which is why they were open to ambitious acquisitions; they simply failed to notice that the acquisitions in question were fundamentally really bad deals.

In general, the stock market’s bias towards growth makes it very difficult for a public-company CEO to execute a strategy of shrinking profitably. Maybe at some point, as a result, Whitman will decide to take HP private, or will accept a takeover offer from a private-equity shop. But for the time being, an ambitious growth strategy is the last thing that HP needs.

It’s not easy to excel in a shrinking business: as Kay says, it goes against human nature to accept that there might be a natural life cycle for a company. But if you work with the cycle, rather than against it, it’s still possible to get extremely impressive results. Just look, for example, at Lehman Brothers International Europe — the bankrupt entity which has been spending the past five years quietly trying to repay its creditors as much money as it can. The latest news? Those creditors are going to be repaid 100 cents on the dollar — including statutory interest at 8%. As a result, some Lehman claims are trading at as much as 120 cents on the dollar.

The best thing for Whitman to do, then, is to accept that HP’s core business is in decline, but to still execute that core business as efficiently as possible. That takes a very different style of management than Silicon Valley is used to, but it can be done. And it’s much more likely to work than some Hail Mary acquisition attempt.


What percentage of total Lehman Bros. was LB International Europe? It looked like their liabilities were $8B which would be in the single-digit percentage of the full Lehman Brothers company.

Posted by winstongator | Report as abusive

Why MoneyGram is going private

Felix Salmon
Jun 21, 2013 20:51 UTC

File this under “highly misleading Bloomberg headlines”: “MoneyGram Seen Cashing In at Decade-High Price”.

The story is about a company which has put itself up for sale; today’s price is about $21.50 per share, which means the merger arbs don’t buy the Bloomberg tale that the final price could be as high as $27. But even if MoneyGram does end up selling for $27 per share, that would be a long, long way from constituting a “decade-high price”. MoneyGram’s IPO took place in 2004, at $16.93 per share; on a split-adjusted basis, that’s equivalent to $133 per share today. By the beginning of May 2006, MoneyGram was trading at more than $280 per share — more than ten times the best possible sale price in 2013. Here’s the stock chart, to put today’s share price in perspective:


So what is Bloomberg talking about? Here’s the way they justify their headline:

MoneyGram may be able to fetch as much as $27 a share, said Macquarie Group Ltd. and Compass Point Research & Trading LLC. At 37 percent more than the stock’s 20-day average, it would be the highest takeover premium in the commercial financial services industry since 2003, according to data compiled by Bloomberg.

This has nothing to do with stock price, or even corporate valuation. Rather, it’s just a measure of the takeover premium that MoneyGram might be able to fetch: the amount that the company is worth to a strategic buyer, or to some PE shop, compared to the amount that public shareholders have been willing to pay of late. Another way of looking at that number is that it’s the discount inflicted on the company for being public.

Why would being public mean that a company like MoneyGram trades at a discount? Simple: it’s one of those companies which is very profitable today, but whose long-term future is dim indeed. Money transfer is in the process of being disrupted: never mind bitcoin, all you really need is ubiquitous smartphones, and it’s not long before any number of companies have developed apps making money transfer incredibly cheap and easy. Money transfer used to have enormous barriers to entry; technology is eroding them, and the long-term future for MoneyGram and Western Union is cloudy at best.

That’s why MoneyGram is trading at a pretty depressed level for a cash cow which is going to have more than $100 million in earnings next year and whose income is hitting new highs. The current market capitalization is about $1.2 billion, for a forward p/e of 12. The forward earnings yield is a very healthy 8.3% — much higher than the cost of funds for just about any financial buyer.

MoneyGram, then, is up for sale for two different reasons. The first is simply that its current owners can sell it at a substantial profit to the bargain-basement price at which they recapitalized it at the height of the financial crisis. The second is that it’s a perfect PE play: it is a company throwing off large amounts of cash, and PE shops are great at maximizing the value of such companies, even if they ultimately go to zero.

Being publicly-listed is good for companies which are growing. It’s not good for companies which are shrinking. As a result, when a company is about to embark upon a long period of profitable decline, that’s normally the best time to take it private. The MoneyGram sale might come at a premium to the public share price. But that doesn’t mean MoneyGram itself has a rosy long-term future. Quite the opposite.


“Being publicly-listed is good for companies which are growing. It’s not good for companies which are shrinking.”

You assert this as true? Is there some particular reason I am to believe it is true? I can imagines reasons it might be true, and reasons the reverse might be true.

Posted by QCIC | Report as abusive

Markets revert to common sense

Felix Salmon
Jun 20, 2013 22:33 UTC

John Abell has a good question for me: how could everything be selling off today? Aren’t the various different asset classes (stocks, bonds, gold) meant to be hedges against each other?

The simple answer is that although it would be great if that were the case, it isn’t — it never was. You do get a certain amount of diversification benefit by investing in a series of asset classes, but, as we all learned during the financial crisis, correlations have a tendency to go to 1 exactly when you don’t want them to. If you want to hedge your long stock exposure, you’re going to have to do that with some kind of short stock position: a long bond position, or long gold position, won’t help you when you most need help.

The interesting thing about today’s market action is not that the risk-off trade materialized in markets around the world, from the Australian dollar to local-currency emerging-market debt. Rather, it’s the lack of any flight to quality: Treasury bonds got whacked for a second successive day, with the yield on the 10-year rising more than 10bp to reach 2.42%. And gold fell almost 7% as well: the world’s oldest safe-haven trade wasn’t working today.

There’s something counterintuitive here: if money leaves one asset class, you’d think that it should turn up in another. You can’t have everything fall at once. But the fact is that you can. Volume was heavy today — but remember that, as always, the number of shares bought was exactly the same as the number of shares sold. What we really saw today was not a move out of stocks, or bonds, or gold, but rather a repricing within each asset class. Think of it this way: if the price of Damien Hirst paintings falls, that doesn’t mean lots of people are selling them. Quite the opposite. It just means that potential buyers aren’t willing to pay as much for such things as they used to.

Buy-and-hold investors can safely ignore everything that’s going on here, or possibly step up their buying pace if prices start looking increasingly attractive. Because the big picture here is that what we’re seeing is markets returning to normal — or, to be more precise, markets anticipating that, finally, almost five years after the crisis hit, a return to normal might be coming at some point in the foreseeable future.

“Normal”, here, just means a world where the Fed isn’t dropping money from helicopters; a world where global interest rates aren’t all stuck at zero; a world where real interest rates can’t happily sit in negative territory for years on end; a world where metals don’t have especial value just because they’re particularly shiny; a world, most broadly, where assets are valued based on fundamentals, rather than being based on capital flows.

At his press conference yesterday, Ben Bernanke reiterated his view that the way QE works is through simple supply and demand: since the Fed is buying up fixed-income assets, that means fewer such assets to go round for everybody else, and therefore higher prices on those assets and lower yields generally. In reality, however, the flow always mattered more than the stock: when the Fed is in the market every day, buying up assets, that supports prices more than the fact that they’re sitting on a large balance sheet. And even more important is the bigger message sent by those purchases: that we’re in a world of highly heterodox monetary policy, where the world’s central banks can help send asset prices, especially in the fixed-income world, to levels they would never be able to reach unaided.

Traders always try to skate to where the puck is going: if they see that the Fed is embarking on a round of QE, they’re going to start buying up assets so long as they’re cheaper than they will be at the end of that round. And similarly, once the Fed signals that it’s on its last round of QE and that from here on in monetary policy is only going to get tighter, they’re going to sell assets so long as they’re more expensive than they will be once money is no longer falling from helicopters.

As a result, the common thread which explains all of the different market moves over the past couple of days is that they’re all part of what you might call the “reversion to sensible” trade. If real rates are bizarrely low, they will rise. If the Australian currency is bizarrely strong, it will fall. If emerging-market debt has rallied to the point at which it no longer prices in all the idiosyncratic risks associated with buying assets governed by Ruritanian law and denominated in the Ruritanian currency, then it too will fall — a lot.

In the long term, this is a good thing: it means that markets are doing their primary job, which is price discovery. In the short term, of course, there will be disruption and volatility: it’s not going to be easy getting there from here. But if you’re an investor, rather than a trader, there’s nothing to worry about here. In fact, there’s a lot to welcome.


QE has had no impact on money growth; all of it is sitting at the Fed in the form of sterile excess reserves. Money growth, especially the broader aggregates, has been abysmal since 2008. This is due to credit contraction following the Minsky Moment. Money growth should pick up later this year if household credit starts to grow. QE is irrelevant to money growth and to economic growth.

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