In 2006, I blogged extensively about the newspaper business decline. By then, newspaper stocks had dropped precipitously from 2004. I read and discussed it extensively. Comments ranged from a former newspaper editor - "what would people read in the toilet?" to my children - "you mean people actually pay for old news?" The best comment came from Warren Buffett who, like myself, grew up delivering newspapers. He said, "if there were no newspapers, would they need to be invented?" With his epiphany, I closed out my newspaper research process and saved myself much agony.
I was surprised that he continued to purchase newspapers as their prices dropped even further. Unable to resist a bargain, a fan of newspapers and aided with a flush balance sheet, I imagine that Chairman Buffett was unable to contain himself - despite the profound insight he shared. Further, once in a business, rarely does he give up. But he did on Tuesday.
Lee Enterprises (LEE) announced that it had purchased 40 newspapers from Berkshire Hathaway (BRK) for $140 million - all of it financed by BRK. In addition, BRK was financing another $400 million for LEE (all of LEE's debt) at 9% for 25 years with no fees or performance contracts. This structure is extraordinary - akin to selling something "to someone for part of whatever he can make on it." It does express that 1) in Buffett's opinion, there is little value to the local newspaper model and 2) Buffett stands behind his commitment to do all he can to help local news by selecting high grade people to find a new sustainable model.
Perhaps LEE can innovate to create an app or a Google or Facebook based revenue stream. It's unclear and the markets did not really respond. LEE traded at $40 per share in 2004, $31 in 2006 and is now at $2. The P/E is exceptionally low and the support is there, despite high leverage. Clearly there is a model for digitally important local news, but who will find it?
Friday, January 31, 2020
Saturday, January 18, 2020
Private-Equity Companies - Own The GP?
Alternative investments are an expanding universe and include categories such as hedge funds and private-equity (PE) funds with PE funds expanding seven-fold since 2002. Over the last five years ending June 2019, hedge funds have done much worse than the S&P 500 (5.5% vs. 10.7%) while private-equity funds have done much better (14.4% vs 10.7%). In some ways, this is sensible as hedge funds are theoretically structured for downside protection while private-equity funds are structured for upside gains and the past five years have been expansive.
As a result of these gains, pensions are flocking into PE funds. Currently, PE funds have over $1.5 trillion in cash to invest along with the likely contribution of an additional $500 billion this year. Institutions are lining up. Much of the dramatic reduction in publicly traded stocks (down 50% over the last 20 years) can be attributed to PE activity, as well as M&A and share repurchasing. As Jim Grant, of the eponymous Grant's Interest Rate Observer says, "On Wall Street, success begets failure. Take a good idea, emulate it and embellish it, drive it into the ground like a tomato stake. Voilà: It's a bad idea." The Achilles heel of PE funds is their leverage. PE funds increase equity returns by levering up. In a slowing economy, PE results would be challenged, as would their bonds. (The location of ownership of these bonds is important.)
But PE funds may continue their winning ways. If that is true, why not invest in the general partners who are collecting these handsome 2% plus 20% fees? For example, Blackstone, Apollo Global and Carlyle all seem to be on the more generous side of these investments. Why wouldn't the institutions simply buy the publicly-traded general partnership interests? Is the avoidance of market to market that extreme by institutional investors?
As a result of these gains, pensions are flocking into PE funds. Currently, PE funds have over $1.5 trillion in cash to invest along with the likely contribution of an additional $500 billion this year. Institutions are lining up. Much of the dramatic reduction in publicly traded stocks (down 50% over the last 20 years) can be attributed to PE activity, as well as M&A and share repurchasing. As Jim Grant, of the eponymous Grant's Interest Rate Observer says, "On Wall Street, success begets failure. Take a good idea, emulate it and embellish it, drive it into the ground like a tomato stake. Voilà: It's a bad idea." The Achilles heel of PE funds is their leverage. PE funds increase equity returns by levering up. In a slowing economy, PE results would be challenged, as would their bonds. (The location of ownership of these bonds is important.)
But PE funds may continue their winning ways. If that is true, why not invest in the general partners who are collecting these handsome 2% plus 20% fees? For example, Blackstone, Apollo Global and Carlyle all seem to be on the more generous side of these investments. Why wouldn't the institutions simply buy the publicly-traded general partnership interests? Is the avoidance of market to market that extreme by institutional investors?
Sunday, January 5, 2020
"Disaggregated Business Model": Cisco (CSCO)
For years, Cisco (CSCO) dominated the internet routing business, earning the moniker "the plumber of the internet." At the height of the "tech bubble," CSCO's stock hit a price of $77 - a price it has not come close to since - and was one of the most valuable businesses in the world. Since then, CSCO has continued to thrive, but its market cap has never recovered. Why?
For years, CSCO has sold its networking solutions as an integrated system. Such systems set themselves up for what Clayton Christiansen defined as the "innovator's dilemma." What does that mean? That means that some businesses set up their business profitability based on a margin driven by the "value-added" of integrating components. The nature of capitalism is to disaggregate these components and commoditize them. Often this occurs by a lower-cost modular innovation, such as connected microcomputers replacing mainframes.
Based on Christiansen's framework, CSCO was a prime candidate for commoditization. By 2014, the largest companies in networking, such as telecommunications and Big Tech companies, had moved forward into software-defined networking (SDN). SDN allowed companies to use lower cost hardware and then design software to meet their specific requirements. The result was a lower cost, higher quality outcome. CSCO protested that their security was better. But the large purchasers increasingly pursued SDN.
Last week's WSJ reported the inevitable modularization as it announced that CSCO would now allow customers to purchase the chips alone. Given that this was going to occur, it may be that CSCO has finally accepted the inevitable because either 1) it is better to stop losing market share and accept lower margins or 2) it is now in a prepared position with vastly superior chips that allow for a reorganization of value into one of the components - the chip. It will be fascinating to see which way this develops.
For years, CSCO has sold its networking solutions as an integrated system. Such systems set themselves up for what Clayton Christiansen defined as the "innovator's dilemma." What does that mean? That means that some businesses set up their business profitability based on a margin driven by the "value-added" of integrating components. The nature of capitalism is to disaggregate these components and commoditize them. Often this occurs by a lower-cost modular innovation, such as connected microcomputers replacing mainframes.
Based on Christiansen's framework, CSCO was a prime candidate for commoditization. By 2014, the largest companies in networking, such as telecommunications and Big Tech companies, had moved forward into software-defined networking (SDN). SDN allowed companies to use lower cost hardware and then design software to meet their specific requirements. The result was a lower cost, higher quality outcome. CSCO protested that their security was better. But the large purchasers increasingly pursued SDN.
Last week's WSJ reported the inevitable modularization as it announced that CSCO would now allow customers to purchase the chips alone. Given that this was going to occur, it may be that CSCO has finally accepted the inevitable because either 1) it is better to stop losing market share and accept lower margins or 2) it is now in a prepared position with vastly superior chips that allow for a reorganization of value into one of the components - the chip. It will be fascinating to see which way this develops.
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