Friday, August 03, 2007

Nortel Wants To Buy Something

Nortel (NYSE:NT) has disappointed investors again. Long term telcom equipment and Nortel investors must be getting used to the pain. So what does management do? Lets buy our way out of this mess. Nortel Networks is in takeover mode, CEO Mike Zafirovski has announced. Wall Street has been speculating for a while about the maker of telecommunications equipment.

Nortel who when riding high had acquired many a company using its own stock as currency. This option is not as attractive at the present time. The takeovers will need to be financed in cash. This will compete with internal organic opportunities. If too many internal projects get bumped then in house R&D will conclude "Whats the point" and Nortel will have to make acquisitions.

The sector is still staggering about not having recovered from its last boom. Many companies future's are openly questionable. If you had a neat little start up that was worthy of a lucrative buy out where would you make the deal.

I still think Motorola (NYSE:MOT) should buy out Nortel and hopefully kill two problem birds with one controversial deal.

Thursday, August 02, 2007

Disney Gets Penguin

Disney (NYSE:DIS)has purchased Penguin for $350 million. The creators of Penguin have scored big time. There is promise of additional payment depending on performance. After the Sony (NYSE:SNE) deal fell apart its probably a relief.

But Disney how closely did you look at the numbers or is this a strategic acquisition where math and those guys from finance are not allowed into the meetings. Penguin currently has approximately 700,000 paying subscribers and yes it is growing quickly. But it only generates gross revenues of $5.00 per subscriber which is only $3.5 million. That's only a 1% yield assuming there are no expenses.

Disney that is ridiculous. Even if the subscriber base triples how will this create accretive earnings?

The Penguin offering apparently appeals to children from 6 to 14. For those of us who have raised children your 14 year old has a different perspective on life than a 6 year old. The target metric is suspicious. Disney of all people should know that. Also as a business model children's entertainment is not an annuity. You are dealing with short time frames. Ask any elementary school teacher how quickly a child's perspective can change in very short time frames.

Disney panicked in the social networking space. For $350 million they could have developed their own properties. Penguin came out of no where in two years. That's about the same time it takes to make a feature movie from script development to release. Disney does not have confidence in its own brand's ability to be a leader.

Correction Posted Aug 3: Mea culpa I got it wrong on the monthly pricing and I take responsibility for that. I assumed monthly pricing was annual. I still feel that given the very young youth metric there will be a lot of churn as kids grow up and move onto other things and the subscriber revenue will need to be replaced. Also for $350 million (perhaps $700 million) Disney clearly could have developed something on their own. They are acting as a financial investor and not as a content developer. That is why I doubt their own in house ability.

Penguin currently operates on a shoestring. As they develop more scale and attempt to become a platform for other Disney products the overheads will grow. Will they be able to maintain a positive margin with such a low price? Disney will want to protect their overall brand by not disappointing the user. Rapid growth in the petrie dish is very difficult to perpetuate in the real world large scale that Disney will need. I do not see this acquisition as a win.

Wednesday, August 01, 2007

Murdoch Takes It. Now What?

Rupert Murdoch and News Corp (NYSE:NWS) have successfully captured Dow Jones (NYSE:DJ). Now that it is all done, other than the legalisms, what did you expect? Fifth generation members of the lucky sperm club had been riding their nest egg rather hard. If they did not do the deal, chances are they had bad chances coming up. But on to the future.

Rupert Murdoch is launching his challenger to CNBC this Oct. The official takeover of Dow Jones will probably close sometime this fall also. The time frames are short and ultimately Dow Jones will contribute mightily to the new venture. But in the meantime how much of a factor can it be? Can one move into a new house before the lawyers have closed the deal? Rupert Murdoch will want fast traction for his $5 billion.

In the meantime CNBC and its ultimate owners GE (NYSE:GE) have been closely watching and preparing. GE opted not to pay an exorbitant amount of money. GE probably has been making other arrangements to replace Dow Jones. I suspect there has been a behind the scenes race of epic proportions to replace the necessary infrastructure.

If I was GE/CNBC I would cut out Dow Jones immediately if not sooner. The faster CNBC stops highlighting Dow Jones coverage the sooner the Dow brand just starts to hang out there. Contractual arrangements you say. Perhaps. Enforceability issues will abound. What if CNBC insists on holding Dow Jones to their deals, pays them whatever the tariff was going to be and then stops using them as much as possible. Brand hijacking? GE would love to ice the competitor for as long as possible.

Eventually the elbowing and tripping will come to an end along with the lawsuits that it will engender. Then the real work of competition will commence.
GE used to say they want to be number one or two in the subject market place. Will a one or two strategy apply in a two product race. GE has exited business before. The exits have been strategic in nature and usually well considered. I cannot recall GE running home with its tail between its legs.

For News Corp the scrutiny of Dow Jones will be intense. Every piece will be publicly vetted and examined for secret agenda’s. The so called editorial independence provisions that the Bancrofts are insisting on should be made public as soon as possible. The investment world is an information seeking culture. The investment world is Darwinian in nature. If you feed the market something that is integrity challenged you will ruin your own brand and franchise, be held to public and private ridicule not to mention the lawsuits.

The Battle Royale is only just commencing. One major problem for both entities exists. Financial news services and other investor tools typically correlate to the market. If markets are bullish and optimism prevails investors watch and pay for services. When markets trend downwards (Bearish?) investor participation dries up. I believe CNBC viewership has reflected this in the past.

So instead of fighting over a dollar the two may be fighting over seventy-five cents. This calls for deep pockets and patient capital. Who fits the profile better GE or News Corp. In any event both entities will probably have less than adequate financial returns in this category.

Tuesday, July 31, 2007

Avon Cosmetic Dilemna

Avon (NYSE:AVP) beat the drum and reported Q2 revenue to be up 12%. Then they slip in that Q2 net income in the second quarter 2007 was $113 million, or $.26 per share, compared with $151 million, or $.33 per share in the year-ago quarter. So in terms of real money they are falling behind.

Avon is desperately attempting to restructure by exiting unattractive product lines. Traditionally a direct sales company "Avon Calling" they are rolling the strategic dice with a huge advertising spend. They are also attempting to execute on product simplification.

Andrea Jung CEO claims to be pleased with the results. Q2 advertising increased a whopping 74% to $93 million. But global revenues are up only 12%. North American revenues are flat so the ad campaign is rather ineffective. Ms. Jung continued with "Given the success we are seeing in our business, we decided to increase our full-year advertising investment to $375 million, 50% above 2006's level, versus our earlier plan of a 35% increase."

Essentially Avon and Ms Jung are doubling down on a less than adequate pair. When you increase advertising at these percentages you should see return on your investment. The ad spend is so high investors are actually losing money and earnings are down.

Look at the balance sheet fundamentals. Cash is down by $1 Billion. Inventories are up by $100 million. Debt maturing within one year equals cash on hand. Stock repurchases in Q2 totalled $280 million. The strategy is not having the necessary results. When will investors decide the dividend is in danger?

The pig is using the wrong lipstick.

Monday, July 30, 2007

Are Pharma Companies Investable?

Can investors continue considering pharmaceuticals suitable for investment? Consider the pharma ETF (AMEX:PPH) A one year hold takes you from $75 to $78 approximately. Thanks a lot! Longer term holds are more lamentable.

Most pharmaceutical companies continue to lay eggs one way or the other. Perhaps with the exception of Bristol Myers (NYSE:BMY) and Schering Plough (NYSE:SGP) most companies cannot keep producing new drugs into the market and then come up with adequate defences against patent expirations, lawsuits, intellectual infringements, FDA dis-approvals and the ever popular re-structuring where the company offers to consume vital body parts in desperate bids to shore up short term valuations.

The investor is more than skeptical. The question has become why bother holding this asset class? Today’s good news turns around and bites you tomorrow. Investors cannot wait for industry fundamentals to swing around such as with home builders or other cyclicals. Pharmaceutical fundamentals are death and disease, perhaps two of the most constant and compelling problems known to mankind. These drivers should adequately produce positive financial results but have proven fickle.

Larger pharmaceutical companies are amalgams of success and failure seasoned with product life cycle problems. The failures overwhelm the successes. Is it time to reconsider how we hold wealth in this volatile business?

I am looking for a corporate structure where one drug or therapy is placed into one say partnership structure with tradeable units. Each partnership will have an identifiable business. Investors may reach their own conclusions buying selling or holding. Third party companies may be involved in the overall corporate management structures. Similar to REITS.

I doubt if the current tax advantage for partnership units will hold politically. So anyone’s analysis should include a full tax load. But with all the necessary R&D some of the marginal rates may prove attractive.

By spinning off the units you allow value to be unlocked. The value would be naked and identifiable. The business unit becomes more accountable to the marketplace and investors are able to make case by case decisions. This replaces the current method of buying a blind pig in the poke which is what most pharmaceuticals companies are becoming.