Sunday, August 28, 2011 2 comments ++[ CLICK TO COMMENT ]++

Mobile phone market dynamics

A couple of weeks ago, asymco produced a comprehensive chart plotting the volume by price metrics for various smartphone manufacturers. I thought it was an insightful chart that illustrated the competitive positioning of all the major competitors (for which Asymco has data or can make an estimate). I thought I would add some notes highlighting my interpretation of the various segments of the smartphone market, and raise a couple of key issues for smartphone investors.

In the chart below, I have marked up the chart with the traditional, high-volume/low-price to low-volume/high-price, segmentation. As common in business, nothing ever fits perfectly so the classifications are just ideas. Asymco's charts are in line with my classification except for Sony Ericsson, which should be moved further to the left since it is a low-volume/high-price manufacturer.

Sorry about the small font on the axis labels. Click for a larger chart but the font is still too small. Hopefully it doesn't detract from the main observations.

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Sunday Spectacle CXXXVII

American Job Losses From Pre-recession Peak

(source: "Percent Job Losses in Recessions July Aug 5, 2011," CalculatedRisk, downloaded Aug 28 2011)

This is one of my favourite charts because it shows the true severity of the recession. The recovery is unlike anything USA has seen in the post-war years. Since the 2001 recovery is also very slow, I wonder if the slow, flat, recovery is indicative of the collapse of manufacturing. If so, and I believe it is, then how the US economy restructures will dictate its future for the next 50 or so years (similar to how the collapse of farming during the Great Depression set the stage for the future). It may not feel like it but if the US economy doesn't find new areas to replace those lost manufacturing jobs, it will probably deteriorate (economically) relative to the world.

Even if you are bearish on the economy, it's really hard to see how it can enter another recession since the employment picture is so bad.

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Saturday, August 27, 2011 0 comments ++[ CLICK TO COMMENT ]++

Innovating your way from inventions

(Illustration by Paul Rogers for The New Yorker. "Creation Myth," The New Yorker, May 16, 2011)

In 2008, Malcolm Gladwell wrote "In the Air," an essay suggesting that innovation and scientific discoveries aren't as rare as they are widely believed, and he continued his thesis in an article for The New Yorker earlier this year. That latter article, "Creation Myth," is now available for free on The New Yorker's website. If you haven't check it out, I highly recommend it.

In "Creation Myth," Gladwell looks at the differences between inventions and innovations, and how inventions feed into innovations. As a case study, he look at two examples.

The first example Gladwell focuses on—the more interesting and insightful of the examples in my view—is how Apple took the idea of the computer mouse from Xerox and turned it into a commercially viable product (with Microsoft subsequently turning it into a mass-market success).

(source: "Creation Myth" by Malcolm Gladwell, The New Yorker. May 16, 2011)

In late 1979, a twenty-four-year-old entrepreneur paid a visit to a research center in Silicon Valley called Xerox PARC. He was the co-founder of a small computer startup down the road, in Cupertino. His name was Steve Jobs.


Apple was already one of the hottest tech firms in the country. Everyone in the Valley wanted a piece of it. So Jobs proposed a deal: he would allow Xerox to buy a hundred thousand shares of his company for a million dollars—its highly anticipated I.P.O. was just a year away—if PARC would “open its kimono.” A lot of haggling ensued. Jobs was the fox, after all, and PARC was the henhouse. What would he be allowed to see? What wouldn’t he be allowed to see? Some at PARC thought that the whole idea was lunacy, but, in the end, Xerox went ahead with it. One PARC scientist recalls Jobs as “rambunctious”—a fresh-cheeked, caffeinated version of today’s austere digital emperor. He was given a couple of tours, and he ended up standing in front of a Xerox Alto, PARC’s prized personal computer.

An engineer named Larry Tesler conducted the demonstration. He moved the cursor across the screen with the aid of a “mouse.” Directing a conventional computer, in those days, meant typing in a command on the keyboard. Tesler just clicked on one of the icons on the screen. He opened and closed “windows,” deftly moving from one task to another. He wrote on an elegant word-processing program, and exchanged e-mails with other people at PARC, on the world’s first Ethernet network. Jobs had come with one of his software engineers, Bill Atkinson, and Atkinson moved in as close as he could, his nose almost touching the screen. “Jobs was pacing around the room, acting up the whole time,” Tesler recalled. “He was very excited. Then, when he began seeing the things I could do onscreen, he watched for about a minute and started jumping around the room, shouting, ‘Why aren’t you doing anything with this? This is the greatest thing. This is revolutionary!’ ”


After Jobs returned from PARC, he met with a man named Dean Hovey, who was one of the founders of the industrial-design firm that would become known as IDEO. “Jobs went to Xerox PARC on a Wednesday or a Thursday, and I saw him on the Friday afternoon,” Hovey recalled. “I had a series of ideas that I wanted to bounce off him, and I barely got two words out of my mouth when he said, ‘No, no, no, you’ve got to do a mouse.’ I was, like, ‘What’s a mouse?’ I didn’t have a clue. So he explains it, and he says, ‘You know, [the Xerox mouse] is a mouse that cost three hundred dollars to build and it breaks within two weeks. Here’s your design spec: Our mouse needs to be manufacturable for less than fifteen bucks. It needs to not fail for a couple of years, and I want to be able to use it on Formica and my bluejeans.’ From that meeting, I went to Walgreens, which is still there, at the corner of Grant and El Camino in Mountain View, and I wandered around and bought all the underarm deodorants that I could find, because they had that ball in them. I bought a butter dish. That was the beginnings of the mouse.”

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Wednesday, August 24, 2011 1 comments ++[ CLICK TO COMMENT ]++

Steve Jobs resigns as CEO of Apple

Most of you probably already saw the news but Steve Jobs handed in his resignation letter to Apple. The content of the letter is quoted below. This ends one of the biggest corporate turnarounds of all time and likely ends the executive duties of one of the top CEOs in American history.

If health wasn't a problem, I'm sure Steve Jobs would still be running Apple. But alas, the health issues has finally got to him. Steve will still likely carry out some board director responsbilities but I suspect it will be quite limited. It remains to be seen how Apple performs with the new leadership. Steve Jobs wasn't an easy guy to work for but he was exceptionally talented when it came to sales and design. He cannot be replaced.

Steve Jobs' Resignation Letter

To the Apple Board of Directors and the Apple Community:

I have always said if there ever came a day when I could no longer meet my duties and expectations as Apple’s CEO, I would be the first to let you know. Unfortunately, that day has come.

I hereby resign as CEO of Apple. I would like to serve, if the Board sees fit, as Chairman of the Board, director and Apple employee.

As far as my successor goes, I strongly recommend that we execute our succession plan and name Tim Cook as CEO of Apple.

I believe Apple’s brightest and most innovative days are ahead of it. And I look forward to watching and contributing to its success in a new role.

I have made some of the best friends of my life at Apple, and I thank you all for the many years of being able to work alongside you.


Sunday, August 21, 2011 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CXXXVI

Apple iPhone Cost Breakdown

(source: "Slicing an Apple," The Economist. Aug 10 2011)

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Sunday, August 14, 2011 1 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CXXXV

Rolling 20-year Returns vs Starting P/E Ratio
(click to enlarge)

(source: "Generation Returns," Crestmont Research. Last updated 2010.)

Bull markets don't start from high P/E values; that's one reason the market has been in a bear market for the last 10 years or so. Right now, the P/E ratio appears to have dropped to the level that it was in back in 1989.

Having said that, P/E ratio is influenced by inflation. Typically the P/E ratio tends to be low—that is, market attaches low valuation to business worth—if inflation is high or negative (i.e. deflation). The inverse relationship between P/E ratio and inflation is very clear in the graphic below from Crestmont Research.

Inflation vs P/E Ratio
(click to enlarge)
(source: "P/E Ratios & Inflation," Crestmont Research. Last updated 2010.)

Whether stocks are cheap or not (note that I am talking about the market as a whole and not necessarily specific stocks) depend on what the actual inflation ends up being. If inflation is high or negative, P/E will contract further and possibly result in capital losses. If inflation stays low, then the current P/E, which is similar to what it was in 1989, is fairly reasonable.

Over the last 50 or so years, a positive inflation expectation has always been the right call. Though, right now, my feeling is that the inflation call is very difficult. Deflation is a real threat for the first time in 50 years (just last week, Federal Reserve took the unprecedented(?) step of committing to keep rates really low for around 2 years, which some of you may recall was what Paul Krugman has suggested in the past to battle deflation i.e. market participants need to be "ensured" positive inflation expectation). US nominal GDP actually contracted by -2% in 2009, which happens to be the first time in over 60 years (prior to this, it was in 1949 when GDP nominal growth was -1%). So what we are seeing is certainly something that has been uncommon over the last 50 years.

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Sunday, August 7, 2011 1 comments ++[ CLICK TO COMMENT ]++

Historic downgrade: S&P lowers USA's credit rating from AAA to AA+

Most of you would have heard it by now but I thought I would blog about it because it may turn out to be an historical event in world history. For those that missed it, S&P downgraded USA's sovereign credit rating to AA+ from AAA. This was the first time in history that USA was downgraded from AAA.

I am bullish on USA in the long run but if the view of some skeptics who think USA has peaked turns out to be true, this rating downgrade may be as close to any bell being rung at the top.


Sunday Spectacle CXXXIV

Ever Wonder What the Most Expensive Keywords on Google Are?

(click to view enlarged full image)

(Graphic by and WordStream. Source: "Infographic: The Most Expensive Keywords in Google AdWords," The Atlantic. July 28, 2011)

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Saturday, August 6, 2011 2 comments ++[ CLICK TO COMMENT ]++

Is Netflix's streaming model uneconomic? I don't think so

Netflix (NFLX) is an online and mail-order movie rental business that has been one of the high growth stocks of the last few years. Its valuation looks sky-high and there are quite a number of investors who are bearish on the stock. I don't have an opinion on the stock or its valuation but how about its business fundamentals? Is the online movie streaming model being pursued by Netflix sustainable?

A blogger on SeekingAlpha, Slim Shady, is apparently short the stock and provides a write-up, "Why the Economics of Netflix's Streaming Business Is Likely to Fail," purporting to show that Netflix's model doesn't earn enough money to justify any reasonable valuation for the company. I think there is a flaw in the author's argument. Here is his/her bearish thesis (bold by me):

Over the average lifetime of a subscriber of 1 year, at $7.99 per month, the company will receive about $96 of revenue. Their marketing cost to acquire a domestic subscriber in the 6/30/11 quarter was $15.06. As of 6/30/11, total Current Content on balance sheet due within the next 12 months was $499 million plus Content Obligations within 1 year off balance sheet were $625 million or a total of $1.124 billion, which is $46.62 per ending paying sub (which assumes that all current subscribers become streaming subscribers).

The annual cost to stream content is estimated at about $4 per sub. General & Administrative expenses and Technology costs have totaled about $1.28 per month per average paying subscriber, which is $15.36 per year. Adding it all up, you get the following economics of a streaming customer over its entire average life, rounded up to one year:

Revenues $ 96
Less: Marketing Costs to Acquire (SAC) $ 15
Less: Content Costs $ 47
Less: Content Delivery Costs $ 4
Less: General Admin & Tech $ 15
Total Pre-Tax Profit $ 15
Tax Rate 40%
After-Tax Profit over the average life of a streaming subscriber $ 9

The total after-tax profit over the lifetime of a streaming subscriber is only $9 - not thousand, just $9. At the current market value of $14.3 billion, it would take almost 1.6 billion new streaming subscribers (without discounting to the present value) to justify the current market cap.

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Monday, August 1, 2011 22 comments ++[ CLICK TO COMMENT ]++

Is this the beginning of a credit correction in emerging markets?

I ran across an interesting article from Bloomberg describing the weakening of credit conditions in some key emerging markets. Although too early to say if this portends to any serious calamity, it does feel, at least to me, like the HSBC sub-prime earnings warning from 2007 (of course, when HSBC warned in early 2007, it was widely ignored by many, including me :( ).

I hate to quote so much but this could be an important story. Bloomberg reports,

Brazil’s financial shares have lost more this year than counterparts in crisis-stricken Europe as consumer defaults hit a 12-month high in June and borrowing costs climbed to 46 percent. Bank stocks in China are trading at lower valuations than global emerging-market indexes for the first time since 2006. The country faces a financial crisis with bad debt that may jump to 30 percent of total loans, Fitch Ratings said.

In India, the cost of insuring banks against default has climbed to the highest level in a year. Loan-loss provisions at State Bank of India (SBIN), the nation’s largest lender, rose 77 percent in the first three months of 2011, while net income fell 99 percent.

“People are beginning to smell the credit cycle turning,” Michael Shaoul, chairman of Marketfield Asset Management and chief executive officer of New York-based brokerage Oscar Gruss & Son, said in an interview. “Credit cycles have tremendous momentum, and whenever they turn you want to pay attention,” said Shaoul, who recommends selling high-yield bonds in emerging markets and betting on further losses in bank shares.
One of the problems in emerging markets is that their credit growth has been massive. People complain about the debt growth in USA but the emerging markets are in a different league. It isn't uncommon to see debt expand 30% per year in those countries. Those countries do tend to have high GDP growth but even then, the debt growth is far larger. For example, China, like other emerging markets, has seen debt expand around 30% per year yet its nominal GDP growth is probably no better than 16% (say, liberal estimates of 10% real GDP + 6% inflation).

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Some banks start demolishing unsaleable homes

I remember hearing someone say a while back that the American real estate crisis will be near the end when we start seeing homes being demolished. Although very small and in the early stages, it seems that it is starting to happen (h/t The Atlantic):

Bank of America Corp. (BAC), faced with a glut of foreclosed and abandoned houses it can’t sell, has a new tool to get rid of the most decrepit ones: a bulldozer.

The biggest U.S. mortgage servicer will donate 100 foreclosed houses in the Cleveland area and in some cases contribute to their demolition in partnership with a local agency that manages blighted property. The bank has similar plans in Detroit and Chicago, with more cities to come, and Wells Fargo & Co. (WFC), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM) and Fannie Mae are conducting or considering their own programs.

The number of homes in question for demolishion is negligible but, nevertheless, it does indicate that inventory is being taken off the market.

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