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These are the adjectives Bank of Greece (BoG) governor George Provopoulos used yesterday to describe what has quite evidently become unavoidable. As we noted here last week, the 'debt restructuring' (euphemism for default) of Greece's sovereign debt has lately moved from being 'discussed behind closed doors' to being openly discussed, even if some in the eurocracy continue to cling to the notion that it must be avoided at all costs.
The fact that the BoG governor speaks out against a default is probably a function of the fact that the national central banks are all part of the 'euro-system' these days, and hence represent the long arms of the ECB. The ECB in turn remains dead set against anything that could expose the banking system and/or its own balance sheet to potentially grievous losses. More grievous, that is, than they already are. On Monday Greece's two year note yield vaulted above 20% for the first time, to 20.34% in a huge 1.832% single day move.
Monday's move in Greek 2 year note yields. (Click charts to expand)
In January, the same note yielded slightly over 11%, and as recently as October 2010 its yield made a low at about 7.4%. Clearly, 20.34% is a sign that the markets no longer believe there is any possibility of avoiding a debt restructuring. As we have noted before, even though the ESM bailout provides Greece with financing at a much lower rate, this does not alter the size of the existing mountain of debt or the freight train of unfunded liabilities bearing inexorably down on the Greek government (while the same is true of all other Western welfare states, in Greece's case the figures are especially worrisome). Moreover, with EU/IMF loans enjoying seniority, existing debt has become that much more risky.
The cumulative debt-to-GDP ratio of Greece is estimated to reach about 160% within two years (if unfunded liabilities are included, we get to nearly 800%), and while the austerity measures are likely to shrink the annual deficit, GDP is at the same time still contracting. Since the likelihood of debt repayment or the ability to tap debt markets for rollovers is gauged by this ratio (which tells us both how much debt reduction there is and how big the effect of inflation on the economy is, given that GDP growth figures are likely to reflect the effect of monetary inflation on prices and little else) , Greece finds itself in an impossible position.
As the WSJ reports:
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The disaster for investors is already manifest given the plunge in Greek bonds, but given that some estimates speak of '50% to 70% haircuts' for bondholders they could certainly grow. That said, for about half of the past 180 years Greece has been in some form of government debt default, so it wouldn't be the first time. We would also note, a debt restructuring will not obviate the need for further belt-tightening and reform. Alas, it would obviously be far better to start afresh with a reasonably clean slate.
The fact that Greece will have to somehow restructure its debt fairly soon has in the meantime been admitted by Mrs. Merkel's parliamentary budget director Otto Fricke, which seems to have hastened today's move in Greek bond yields to fresh highs. Mr. Fricke was reduced to "hoping that Greece would somehow get through the summer."
Greece's main union meanwhile has called for a general strike against the government's austerity measures on May 11 as discontent over the policy continues to simmer.
Concurrently, the 'True Finns' party has made vast electoral gains in Finland's elections over the weekend (it got 19% of the vote) and it appears a euro-skeptic (or rather, 'bailout skeptic') coalition will form the new government. As CNN reports, this could mean trouble for the most recent ESM/IMF bailout, namely that of Portugal:
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Whether the new government of Finland will actually vote down further bailouts remains to be seen, but evidently this election outcome has made the markets rather nervous. As we noted last week when we asked whether the reprieve was over, this new tendency for governments that have supported bailouts to lose the support of voters is becoming quite widespread – the social mood is clearly deteriorating in Europe. It seems now that CDS spreads and bond yields that have recently declined have indeed bottomed out, and correlations across the euro area in these markets are once again rising. Not surprisingly, both Portuguese and Greek CDS spreads have hit new all time highs.
Most notable and important for the near to medium term future however is the fact that Spain's fortunes are turning with those of the others – and Spain likely remains the big 'make or break' lynchpin of the entire ESM / bailout project. We don't want to leave Italy unmentioned, which may come under a cloud eventually as well. Italy has the great advantage that most of its debt is held by domestic investors, but it is no less in fiscal and economic trouble for that. Italy has managed to 'muddle through' for a long time with its vast debt burden, but in the past it had a currency it could, and frequently did, devalue, a luxury no longer available to it.
Rather incongruously, the ECB has begun to make more hawkish noises on Monday as well. To this it should be noted that monetary conditions in the euro area have lately been tightening rather noticeably. Consider e.g. that the year-on-year growth of euro area TMS has recently plummeted to a mere 3.4%, with the most recent quarterly annualized growth rate at 3.1% and the monthly annualized growth rate clocking in at minus 10.1%.
The year-on-year growth of euro area M 3 and euro area TMS (true money supply, via Michael Pollaro) – the current y.-o-y. growth rates are 1.8% for M 3 and 3.4% for TMS – click for higher resolution.
And yet, remarks made by ECB officials on Monday seem to indicate that the ECB has after all embarked on a more extended rate hike spree than hitherto assumed.
As Bloomberg reports:
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The only economy in the euro area that really deserves to be called 'strong' at the moment is Germany's – for which current interest rates are clearly too low and have set a boom into motion. Alas, if the ECB hikes rates further it will undoubtedly put more pressure on the peripheral economies – this is unfortunately especially true of Spain, where mortgages are as a rule variable rate loans that are tied to the central bank's administrative rates. We happen to think that an acceleration of the liquidation of malinvested capital in the nations that have been home to massive real estate bubbles can only be salutary for their long term economic health, but it seems likely that the problems besetting both banks and sovereign debtors in the peripheral nations of the euro area will initially intensify if the ECB's goes through with the planned rate hikes. In fact, we expect the ECB to do an about-face once the problems flare up again – which they currently seem set to do.
Given strong growth in euro area TMS in 2009 and parts of 2010, the lagged effect of this previous phase of monetary inflation on prices will likely continue to percolate through the euro area for a while still (this is just a guess, as such lags are variable). This upward pressure on prices is what motivates the ECB to hike its rates now, but as shown above, money growth is already slowing sharply of its own accord. Hence economic activity is likely to slow down as well in coming months.
As a somewhat humorous aside, Standard and Poors chose this Monday to remind the world of the glaringly obvious – namely that the fiscal debt of the US is also becoming slightly worrisome in terms of both its magnitude and growth rate. Apparently S&P failed to consult the chartalists, as it rudely decided to put the US government's debt on 'negative watch'.
As the Washington Times reports:
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We would note that the upcoming liquidation of bubble activities once the Fed's 'QE2' money printing exercise stops will likely weaken what appears to be an already slowing economy further. Consequently there is little chance of the government's fiscal gap closing in the near future, quite irrespective of political differences between the parties. There is has been a noticeable drop-off in corporate tax receipts in Q. 1, which have plunged by 31%. This is usually a sign of slowing economic activity and may be a bad omen for the ongoing earnings season as well.
The Charts:
1. CDS (in basis points, color coded)
5 year CDS spreads on Portugal, Italy, Greece and Spain – a rocket ride into new high territory for Greece and Portugal, while Spain and Italy rebound to their highest levels in more than a month (note that we have to keep shifting the y-axis for Greece)
5 year CDS spreads on Ireland, the senior debt of Bank of Ireland, France and Japan. Only Japan's CDS are still coming in – the European spreads have taken back a good deal of their recent decline.
5 year CDS spreads on Austria, Belgium, Hungary and Romania, all bouncing in sympathy.
The Markit SovX index of CDS on 19 Western European sovereigns – also back at a one month high.
2. Euro Basis Swaps (in basis points) and Other Charts
One year euro basis swap – these swap rates remain well behaved for now.
5 year euro basis swap – also hanging on to most of its recent recovery.
5 year CDS spreads on Saudi Arabia, Bahrain, Qatar and Morocco – the recent increase in unrest in Syria may be driving these up again at the moment.
The SPX, T.R.'s VIX based proprietary volatility indicator and the gold-silver and gold-commodities ratios. Gold-silver still plunging, but gold-commodities continues to streak higher lately, reaching a three month high. This is a fly in the ointment for the stock market – we have remarked on the signal given by this ratio a few times before and it appears now that it might indeed be meaningful.
The SPX and the AUD-JPY cross rate (as a barometer of risk appetite) – the divergences here may turn out to be meaningful as well – click for higher resolution.
From a report by Société Générale, the debt-to-GDP ratios of several European countries plus the US, including unfunded liabilities (2010 estimate). Severe austerity over an extended period of time would be required in all cases to lower these debt mountains. It seems more likely that it will be attempted to inflate them away, as dangerous as such a course is.
Via Markit, the CDS spread on US debt – it used to oscillate between 5 and 15 basis points once, nowadays it fluctuates between 40 and 60 basis points. This is by no means an alarming level, but it does show that market concerns about the debt have increased somewhat.
Charts by: Bloomberg, Société Générale, MarkIt, Michael Pollaro
With the the likely appointment of Janet Yellen to Vice Chairwoman of the Fed, don’t expect the easy money policy to grind to a halt. In fact, Janet “easy money” Yellen is more dovish than Kohn and another cog in the easy money wheel. She supports extremely low rates to keep this economy artificially inflating.
In February, she commented on the economy saying that while the economic tide appears to have turned and recovery is well under way, “the economy faces a long period of subpar growth, high unemployment and downward inflation pressure, and so it will continue to need “extraordinarily low interest rates.” Let the good times roll.
The news has certainly helped pressure the dollar in the last couple days, but the dollar remains bullish for now and just consolidating recent gains.
Pershing LLC Chairman and CEO Richard Brueckner, COO Brian Shea, and managing director Frank La Salla sat with Investment Advisor for an exclusive interview at the firm's annual conference in Hollywood, Florida, on Friday, June 11. The conversation focused on the company's direction in the face of new regulation, the euro debt crisis, and the advisor industry's move to independence.
"At this conference two years ago, the advisor and RIA attendees wanted to know about international investing, but it was more simple and straightforward: 'How do I invest in BMW?'" La Salla began. "Today, it's still about overseas investing, but it is much more sophisticated."
"In the interim, it was about a massive flight to quality," Brueckner added.
Specifically, La Salla said attendees want information of two- and three-year foreign paper, such as Australia or even Germany. They are also interested in individual foreign stocks and foreign currency, but also low risk vehicles. Sovereign debt from quality countries is also popular, and Brueckner noted advisors and investors don't have to go far to get it, naming Canada as one such country.
"With budget deficits the way they are here in the U.S., they now see risk here and look to mitigate it by going abroad," Shea said. "People are increasingly interested in foreign exchange as an asset class."
When asked who now owns the debt that led to the global crisis in 2008, and more recently the crisis in Greece and Portugal, Brueckner said it isn't known.
"Regulators might know, but they don't talk to one another," he said. "Disclosure rules in Europe aren't like they are in the U.S."
New Initiatives
The executives also spoke about Pershing's new initiatives for both its broker/dealer clearing clients and RIAs. Specifically, Shea mentioned Pershing's RIA Complete effort, which gives independent broker/dealers two different options for accommodating reps who are doing, or want to do, advisory work. Some 20 B/Ds are already participating in RIA Complete, said Shea.
Brueckner spoke glowingly about the soon-to-be-closed acquisition of PNC's Global Investment Servicing (GIS) business, which is a transfer agency but also houses Albridge Solutions, the data aggregation company.
"We'll be able to offer the Albridge Solutions product to our 100,000 customers" who are on Pershing's one-year-old NetX360 technology platform, Brueckner said.
A final piece of the PNC acquisition is Coates Analytics, which provides mutual fund companies and distributors with marketing and distribution intelligence.
The Volcker Rule
The conversation then turned back to the proposed Volcker Rule, meant to limit proprietary trading by firms and install other safeguards to limit systemic risk in the financial system. Brueckner calls it problematic.
"It's a rule specific to the domestic market, which makes it difficult to work in an increasingly interconnected global market," he said. "The Europeans are big on the universal banking model, and this rule limits the universal banking model. We don't engage in a lot of proprietary trading, but sometimes our clients need it, and they will ultimately be negatively impacted by limiting it or by banning it outright."
Also, said Brueckner, the Volcker Rule is confusing and contradictory. For instance, Congress says it wants every firm engaged in the mortgage-backed securities market to hold least 5% of the assets in MBS in order to have "a stake in the game." Yet the Volcker Rule would ban firms from seeding their new fund products with their own money, a common practice to attract investors.
"Clients like to see our money in there because it gives us that 'stake in the game,' which the Volcker Rule says we can no longer do," Shea said. "We can't continue to regulate in a silo. It just won't work."
"Legislation is a powerful, but blunt, tool," Brueckner added. "It's best left to regulators to use surgical tools instead."
The stock of�Bank of America (NYSE:�BAC) crossed briefly the $7 mark in early morning trade, gaining close to 40 percent since the middle of December when it dipped below $5. BofA joins the early January rally in financials, which have lost 17.14 percent of their value last year�measured by the performance of the Financial sector SPDR Fund (NYSE:XLF). Does this run-up make the stock a buy?
As we did write in a previous piece, BofA is for aggressive investors who may want to take their chances trading the stock. Conservative investors may want to stay away until the bank leadership addresses the bank�s structural problems�correcting the two strategic mistakes of the past that end up costing the bank dearly: the purchase of Countrywide Financial and that of Merrill Lynch.
The purchase of fast-growing mortgage company Countrywide Financial supposed to be the quick ticket into the mortgage market, a natural area to expand for a bank with plenty of funds to lend. As it turned out, the purchase of Countrywide Financial was the poison bait for bank of America, as the finance company was at the poster child of the excess in the mortgage market during the preceding years�not to mention that the price paid was too high for a company with such huge liabilities.
The purchase of legendary Merrill Lynch was supposed to be the quick ticket of expanding in another market investment banking � again, another natural area for a bank to expand in the era of financial deregulation. As it turned out, this movement wasn�t terribly good either; Merrill Lynch had its own liabilities, and its own aggressive culture that it didn�t blend well with Bank of America�s conservative one.
Now, four years later, these strategic mistakes come to haunt the bank. It is still in business thanks to generous support from American taxpayers, its management fights the one lawsuit after another, and its stockholders are bleeding left and right.
The bottom line: What makes a broken stock a long-term buy isn�t just its price, but a clear strategy that addresses the root causes that drove the stock to that price, which I don� see at this point.
Disclosure: I am long BAC. I am an active trader and may switch positions at any time.
Seeking Alpha editors Eli Hoffmann and Jason Aycock contributed to this post.
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America�s favorite pastime used to be baseball. But during the last couple of years, that has changed. The new American pastime has become to get long Apple (NASDAQ:AAPL) any way that you can and wait for the profits to accumulate.
Over the last two years, AAPL has skyrocketed from around $190 to $500 � simply staggering! Since June 20, AAPL has run from $315 to its current level of $502 � that�s a meteoric rise of 60% in just eight months!
Let me say that one more time: a 60% rise in eight months! You don�t often see that kind of movement, in that short of a time frame, in a stock that�s trading in the triple-digits.
So why shouldn�t it continue? Actually, this is dangerous territory for Apple � and for AAPL perma-bulls. Here�s why.
Strange Volatility for a Soaring Stock
Over the last two weeks, AAPL has shown a changed personality that you should be aware of. This personality is much different than the fun-loving, �get on my back, and I�ll take you up, up, up to always-higher stock prices.�
From a psychological perspective, this personality change started about two weeks ago around Feb. 3. AAPL was trading at $460, and the March at-the-money implied volatility was around 19.
What does that mean in English, Spanish and Portuguese? It means everything was OK, and no real fear of the downside was cropping up.
But was it?
Meanwhile, the speed to the upside was really picking up. From Nov. 25 to Feb. 3, AAPL went from $363 to $459, 26% in a little over two months. Everybody wanted in!
On Feb. 10, AAPL hit $493 and the March at-the-money implied volatility in the calls spiked to 27.
What�s the big deal? Well, option volatility usually decreases on the upside as prices go up and fear of the downside tends to dissipate. And remember, this is AAPL — this is America!
But then last week, the personality disorder got much worse.
As AAPL climbed a bit higher to $500, the March at-the-money option volatility climbed higher to 32 in the calls. That is an increase in two weeks from a 19 implied volatility to 32, an increase of 68% with the stock rising.
What does this mean to you? Well first, let�s look a little more closely at why there�s so much volatility in AAPL options right now � and what you can do to protect yourself and even turn a profit!
Why are the option volatilities in AAPL going up? The simple answer here is SPEED!
Look at a pivotal day, Wednesday Feb. 15, when AAPL traded intraday to $526 and closed at $497. That�s a decrease of 5% from the daily high to the close. The stock�s rate of speed up and down intraday really picked up in both directions, which said that sellers were coming in a bit!
The last time I really saw this kind of speed to the upside was the Internet debacle many years ago, when stocks were screaming to the upside. Do you remember what happened after they went up so fast? (The phrase �tech wreck� probably comes to mind!)
What does increasing option volatility mean to the retail trader? It means the green light on the stock may possibly be turning to yellow, and you should exercise a bit of caution.
Does this volatility news mean I can�t stay bullish on my beloved AAPL?� No, it just means HOW you get long may need to change.
This leads me to the options trading strategy for today if I want to be long AAPL but be cautious!
How to Profit from AAPL�s Personality Change
With this disturbingly changed personality in AAPL the last two weeks, I would approach any bullish trade very cautiously and make sure the risk/reward looks acceptable to me.
In other words, if AAPL nosedives, I�m very comfortable with my total downside risk. I would initiate the below strategy after one to two down days.
With the stock trading at $502.50, you can buy 1 AAPL March 500 Call and sell 1 AAPL March 505 Call for a net debit of around $2.40 ($240 per contract). This strategy, called a vertical debit spread, allows you to play a high-priced stock for a very reasonable cost.
It doesn�t matter what you pay or collect for the individual legs of the spread, as long as your final price is around $2.40 to enter the trade.
In this call option trade, we are actually selling an option (the March 505 Call) with more time premium than we are paying for with our long (the March 500 Call). This is good considering that option volatilities (i.e., implied volatility) have skyrocketed the last few weeks.
The risk-to-reward ratio is about 1-to-1 — meaning, we can make $250 profit potential with a maximum risk of $250.
If the stock is trading at $505 or higher at expiration (2 � dollars higher than the current $502 level), you can make 100%. This again is a cheap way with limited downside risk ($250) to play a very expensive and volatile stock.
Be careful and have a great week!
DirecTV (DTV) after the close Tuesday said it reached an agreement with investor John Malone to restructure his family’s holdings in the satellite TV company.
Under terms of the deal, the Malones will exchange their 21,809,863 Class B shares – all of the shares in the class – for 26,547,627 Class A shares. By giving up the Class B shares, which have 15 votes each, the Malones cut their voting interest to 3% from 24.3%. As part of the deal, Malone will resign from the DirecTV board. Also leaving the DTV board:Liberty Media CEO Greg Maffei and Liberty Global director Paul Gould.
DirecTV says the transaction is intended to satisfy a condition imposed by the FCC when Liberty Media acquired the News Corp. stake in DTV in February 2008.
DTV in late trading fell 83 cents, or 2.4%, to $33.91.
When you’re not in a bull market for stocks, it’s obviously much more difficult to generate capital gains. That’s why dividends become so important. For me, I like an equity portfolio to have a mix of holdings; some risk-capital trades and some large-caps that pay dividends. I think a stock market portfolio should not just diversify among different industries, but also with different time horizons for investment. I’ll dedicate a certain percentage of a stock market portfolio to short-term trading, medium-term holdings, and several positions that are very long-term in nature that pay dividends. No matter what kind of stock market it is, my preferred strategy is not just to diversify among assets, but to diversify among time frames.
The stock market offers up good opportunities no matter whether you’re in a bull market or a bear market, but different kinds of businesses behave differently on the stock market, depending on whether it’s a bull or a bear. The degree to which a stock performs is directly related to the degree institutional investors are willing to be interested in the story. A company growing its earnings by eight percent per year and paying dividends is going to be much less attractive than one growing 20% per year in a bull market. But, in a bear market, investors’ needs change and consistency becomes king.
I want to highlight for you two businesses that I really admire. I admire them because of the wealth they have created for shareholders and the consistency with which they’ve performed on the stock market. Both of them pay a modest amount of dividends and these businesses are what you might call boring and unexciting. In a bullish stock market, I’d bet most investors would ignore these companies. It would be a mistake, however, considering the consistency with which they make money over time. (See The Dow, S&P 500 & the NASDAQ: Why It’s Time to Ignore Them.)
If you have a chance, pull up a long-term chart (20 years) on Ecolab Inc. (NYSE/ECL). This company, based in St. Paul, MN, started out selling carpet cleaning products to hotels. Now the business sells cleaning supplies, and pest control and maintenance services to the foodservice, hospitality and healthcare industries. It isn’t fancy, but it makes money and the stock has been an outstanding, consistent wealth creator for years. It’s up about 20-fold over the last 20 years (not including dividends) and it’s weathered every shock to the system with demonstrable strength. The stock just hit another new record high and I’m surprised that Warren Buffett hasn’t bought it out yet.
The other consistent wealth creator that I admire is W.W. Grainger, Inc.(NYSE/GWW). This company pays a similar amount of dividends to Ecolab (current yield about 1.3%) and has been an outstanding, consistent wealth producer for many years. Based in Lake Forest, IL, W.W. Grainger is a wholesale distributor of industrial equipment such as electric motors and fasteners. It’s not the kind of business that you get excited about, but that doesn’t mean it hasn’t made a ton of money for shareholders. On the stock market, it just hit a new all-time record high, doubling since the beginning of 2010 and quadrupling since 2004 (not including dividends).
Ecolab and W.W. Grainger are but two examples of outstanding businesses that pay dividends and have created an enormous amount of wealth on the stock market. And they’ve performed consistently and with very little downside historically.
An equity portfolio, in my view, needs to have some boring, but consistent wealth creators in order to smooth out the effects of the business cycle on your holdings. You can trade thestock market for capital gains sure, but, at the same time, it can also pay big-time to hold great businesses that pay dividends. In my mind, a consistent business is just as useful as the next high-tech breakthrough.
*By Mitchell Clark, B.Comm. for Profit Confidential
The Organization for Economic Co-operation and Development, the OECD, which includes the US, the European Union, and several other developed countries, has reached an agreement on how airlines will be able to finance purchases of new passenger jets. The deal is not especially good news for Boeing Co. (NYSE: BA) or Airbus maker EADS (OTC: EADSY), but should be helpful to makers of the smaller regional jets, like Canada
‘s Bombardier Inc. and Brazil’s Embraer S.A. (NYSE: ERJ).
The old rules did not permit an airline based in the home country of a manufacturer to qualify for export credits when buying a plane from a manufacturer from outside the country. The effect falls hardest on smaller carriers, like Ryanair Holdings plc (NASDAQ: RYAAY), which have used the export credits to reduce the financing costs of buying new aircraft.
Large carriers like Delta Air Lines Inc. (NYSE: DAL) and United Continental Holdings (NYSE: UAL) did not qualify for the credits, and have wanted the rule change for some time.
Under the new rules, export credit providers, like the US Export-Import Bank, will charge fees to those airlines that qualify for the credits that will bring the financing charges more in line with commercial rates. The fees will not rise more than 10% from quarter to quarter. Existing export financing rules will be allowed through the end of 2012.
Ryanair and other members of a group that benefited from the old rules wanted extended financing through the end of 2013. The new rules could effectively double the financing charges for these airlines.
Boeing and Airbus favored the old rules, fearing that the higher financing costs will reduce demand for their passenger planes, which would lead to production cuts. Some critics of the old rules pointed out that the export credits artificially boosted demand for new aircraft during the recent recession, when commercial credit was hard to get.
It remains to be seen what the impact on Boeing and Airbus orders will be, but a good guess would be “not much.” The large airlines should benefit from a more market-driven cost of financing. They were concerned that smaller airlines able to receive the export credits were poaching their routes. Makers of smaller jets should feel no impact, except for the certainty that comes from having an agreement. The major impact will be on carriers like Ryanair, where higher financing costs could stifle growth.
Paul Ausick
Johnson & Johnson (NYSE:JNJ) announced third-quarter earnings Oct. 18 that were a mixed bag. Sales grew 6.8%, to $16 billion, while earnings per share declined 6.5%, to $1.15 a share. On an adjusted basis, they were essentially flat. They weren�t horrible but they weren�t anything to write home about either. Investors can do better elsewhere. My advice is to sell J&J and replace it with GlaxoSmithKline (NYSE:GSK). Here�s why.
Johnson & Johnson and GSK announced Q3 earnings within eight days of each other. Let�s have a closer look to see how they compare. Including the currency exchange, J&J�s revenues grew 2.6% year-over-year compared to 3% for GSK.
However, GSK faced some difficult year-over-year comparisons. In Q3 2010, it got a boost from one-time, pandemic-related revenue. In Q3 2011, its diabetes drug Avandia saw a sharp decline in sales due to potential heart risks associated with its use, and Valtrex, its drug to treat herpes, came off patent cover. Excluding those items, GSK�s revenues increased 6%, with all three segments (pharmaceuticals, vaccines and consumer health care) producing positive gains.
On the earnings front, J&J delivered $3.4 billion in net income, which is a net margin of 21.5%, 130 basis points lower than in the third quarter last year. GSK had net earnings of $1.5 billion for a net margin of 21.1%, 140 basis points higher than the third quarter last year. Head-to-head, GSK�s third quarter was marginally better.
Both companies have mature businesses in North America and Europe, so let�s start our examination with their performance in the rest of the world. J&J�s revenues in the rest of the world grew 18.7% in the third quarter and represent 31.3% of its overall sales. GSK�s grew 17% in the quarter, while its rest-of-the-world revenue accounts for 38% of sales. While J&J�s revenues grew slightly faster, GSK has a more balanced geographic mix, so I�ll call it a draw.
Comparing profits for the rest of the world is a lot more difficult because Johnson & Johnson�s press release doesn�t break down geographic operating profit, only revenues. However, GSK�s information gives a few hints. Its operating profit for the rest of the world in the third quarter for its pharmaceuticals and vaccines segment was $1.04 billion on revenue of $2.47 billion, for an operating margin of 42.1%. The consumer health-care segment�s revenue in the rest of the world was $780.46 million.
The operating margin for the entire world, including the U.S. and Europe, was 24.7%, so even though the margin�s likely higher in the rest of the world, I�ll use the same number, which comes to $192.77 million. Overall, its rest-of-the-world operating profit totals $1.23 billion on revenue of $3.25 billion, for a margin of 37.8%.
JNJ�s rest-of-the-world revenue in the third quarter was $5.01 billion. It didn�t provide operating profits by segment in the Q3 release, so I�ll use the second-quarter margins, plus a couple of percentage points for good grace. We�ll have a better idea when it releases its 10-Q in a couple of weeks.
Its overall operating profit based on its three segments� operating margins (consumer, pharmaceuticals and medical devices) was $4.1 billion, which is very close to the actual results with an operating margin of 25.6%. That�s 510 basis points lower than GSK.
If you apply the same discount to its rest-of-the-world operating margin (37.8% less 5.1%), Johnson & Johnson�s operating profit in the quarter was $1.64 billion, leaving $2.46 billion for the U.S. and Europe on $11.0 billion in revenue. GSK is clearly outperforming J&J on a margin basis, so why the lower valuation?
The Gallup global employment data are out, and there’s a huge amount of meat within (worldwide, 40% are employedfull-time; U.S. unemploymentwas at 9.3% in mid-December), but I'm particularly taken by this unemployment map:
[Click all to enlarge]
U.S. unemployment, on this measure, is in the double-digit range — significantly above the global average of 7%. Meanwhile, Germany, with a much stronger social safety net, has unemployment of less than 5%. (Remember, these aren’t official national statistics, they’re Gallup’s attempt to apply the same yardstick to all countries.)
Zoom in on Europe, and you can see where all the current tensions are coming from, especially in the stark contrast between Germany and Spain, and in general the difference between a relatively prosperous north and a struggling south -- which is also much closer to the hardships of north Africa.
David Leonhardt has a smart take on this data: Essentially, that the U.S. is doing well by its corporates and its full-time employees (Caroline Baum notes that fourth-quarter withheld income tax receipts rose 17 percent from a year earlier), and is letting the unemployed fall through the cracks; Europe and Canada, by contrast, have attempted to spread the pain more widely.
I fear, however, that even if the U.S. adopts the kind of job-boosting policies Leonhardt is extolling, ultimately Tyler Cowen and Jayme Lemke are right, and it’s going to take years of hard-won economic growth before we make a significant dent in the U.S. unemployment rate. In the interim, it’s important for society to look after the unhappy minority which has found itself, to all intents and purposes, unemployable. When the median period of unemployment exceeds the maximum duration of unemployment checks, that’s a sign of a country which has simply given up on its neediest.
The Blizzard division of Activision Blizzard (ATVI) generated $1.2 billion in annual revenue last year without releasing a single new game in 2009. Blizzard still gets some of its revenue from legacy games like the original Starcraft that was released more than a decade ago in 1998. In fact Starcraft managed to crack the list of top 10 PC games as recently as May 2009 according to the top game industry research firm NPD Group. Starcraft has been spotted in the top 20 multiple times since the announcement of Starcraft 2 in 2007.
The beta version of Starcraft 2 featured in the video below was released last month and the game is expected to ship sometime in the first half of 2010.
A majority of Blizzard’s revenue however comes from its hugely popular MMORPG World of Warcraft (WoW) that had 11.5 million subscribers as of last month and has helped Blizzard generate above average operating margins when compared to Activision as a whole. Operating margins for the Blizzard division in 2009 were over 46%.
Given how important World of Warcraft numbers are to Activision, I decided to dig into the subscriber numbers and specifically look at the growth opportunity from China as I have received a couple of questions about this from SINLetter subscribers.
As you can see from the chart below, World of Warcraft experienced exponential growth from its launch in November 2004 through 2008. Only Second Life by San Francisco based Linden Labs, which unlike WoW is free to play, managed to surpass WoW’s subscription numbers. Keen followers of the Massively Multiplayer Online Gaming space noted that the 11.5 million subscribers that Activision Blizzard reported at the end of 2009 were the exact same number of subscribers reported at the end of 2008.
click to enlarge image
With WoW restored in China as of September 19, 2009 following regulatory hurdles, are subscription numbers going to start growing again or has WoW peaked until the next expansion pack Cataclysm comes along? The bigger question to ask is how many of the 11.5 million subscribers are from China and how much revenue do they generate for Activision Blizzard.
If all 11.5 million subscribers were paying $15/month or $180 annually to play WoW, Blizzard’s revenue from just this one online source would be,
$15 X 12 months X 11.5 million subscribers = $2.07 billion.
Even after averaging the monthly fee down to roughly $14 after taking into account that some subscribers pick the cheaper $13.99 plan by paying for three months at a time or the $12.99 plan by paying for 6 months upfront, the expected revenue drops to,
$14 X 12 months X 11.5 million subscribers = $1.93 billion.
This is significantly higher than the $1.2 billion in revenue the entire Blizzard division reported for 2009. So it stands to reason that a large number of these 11.5 million subscribers are Chinese subscribers that don’t shell out roughly $14/month like their North American and European counterparts do.
ased on what I have read from various sources, it is possible that between 4 to 6 millions subscribers are from China and they pay 6 cents per hour to play the game. Assuming 5.5 million subscribers and adopting a conservative estimate of 10 hours played per month, annual Chinese revenue works out to,
10 hours X $0.06 X 12 months X 5.5 million subscribers = 39.6 million
Chinese revenue is probably even smaller after Activision splits the proceeds with its Chinese partner Netease.com (NTES). The rest of the non-Chinese 6 million subscribers generate approximately $1 billion in revenue, putting the total WoW subscription revenue at $1.04 billion. Taking the sales of legacy titles like Diablo, Starcraft, etc., into account, we get very close to the $1.2 billion in annual revenue Blizzard reported for 2009.
There is a good chance that given the addictive nature of the game, Chinese players spend more than 10 hours/month playing the game and that the release of expansion packs (some of the old ones have not yet been approved in China) might drive additional revenue. But even if you were to double both the hours and the number of subscribers, revenue would top out at $158.4 million before Netease takes its cut.
The conclusion I came to after digging into the China factor was that the Activision Blizzard investment thesis cannot rest on expectations of growth from China. The strong pipeline of games from Blizzard for 2010 and the potential of another MMORPG are better reasons to get excited about Activision.
Disclosure: Author holds a position in ATVI in his model portfolio.
Blockbuster’s (BBI) auditors gave the company a “going concern” letter which is often a kiss of death. The document is a way for the accounting firm to say the�operation is unlikely to make it another year. In Blockbuster’s case, the news probably is not all that bad. The firm’s creditors have already agreed to restructure debt and give Blockbuster more time to re-create its business and build back the revenue that it
is losing from renting movies out of stores. Alternatively, there is some expectations that Blockbuster can slash expenses so brutally that its operating income will recover.
The note, contained in the company’s 10-K,� also says that Blockbuster has reached agreement with its lenders on both term loans and revolving credit facilities. Now, the pressure is on the management to deliver operating margins this year.
Looking at the company’s position, the road to profit is almost certainly closing a significant number of the firm’s nearly 3,900 company-owned stores. If leases on the retail outlets can be reduced or terminated, Blockbuster gets to not only reduce the costs of those obligations but can fire the employees at every store that it closes.
It is a hell of a way to run a railroad, but Blockbuster does not have any other options.
Douglas A. McIntyre
Celestica (NYSE: CLS ) reported earnings on Jan. 26. Here are the numbers you need to know.
The 10-second takeaway
For the quarter ended Dec. 31 (Q4), Celestica met expectations on revenues and beat expectations on earnings per share.
Compared to the prior-year quarter, revenue shrank, and GAAP earnings per share increased significantly.
Margins grew across the board.
Revenue details
Celestica reported revenue of $1.75 billion. The 13 analysts polled by S&P Capital IQ predicted sales of $1.78 billion. Sales were 6.5% lower than the prior-year quarter's $1.88 billion.
Source: S&P Capital IQ. Quarterly periods. Dollar amounts in millions.
EPS details
Non-GAAP EPS came in at $0.33. The 10 earnings estimates compiled by S&P Capital IQ forecast $0.26 per share on the same basis. GAAP EPS of $0.23 for Q4 were 189% higher than the prior-year quarter's $0.11 per share.
Source: S&P Capital IQ. Quarterly periods. Figures may be non-GAAP to maintain comparability with estimates.
Margin details
For the quarter, gross margin was 7%, 50 basis points better than the prior-year quarter. Operating margin was 3.2%, 50 basis points better than the prior-year quarter. Net margin was 3.9%, 250 basis points better than the prior-year quarter.
Looking ahead
Next quarter's average estimate for revenue is $1.66 billion. On the bottom line, the average EPS estimate is $0.21.
Next year's average estimate for revenue is $7.33 billion. The average EPS estimate is $1.11.
Investor sentiment
The stock has a three-star rating (out of five) at Motley Fool CAPS, with 161 members out of 181 rating the stock outperform, and 20 members rating it underperform. Among 51 CAPS All-Star picks (recommendations by the highest-ranked CAPS members), 45 give Celestica a green thumbs-up, and six give it a red thumbs-down.
Of Wall Street recommendations tracked by S&P Capital IQ, the average opinion on Celestica is hold, with an average price target of $9.88.
