Wednesday, November 30, 2005

Da Radiologists

Preparing to leave Chicago—home of “Da Bears”—after two days of stalking the floor of the McCormick Place Convention Center along with 60,000 doctors, salesmen and investors at the annual radiology show, one scene that sticks in my mind illustrates better than any what makes Chicago, well, Chicago.

It did not occur during the Bulls game that I attended at the United Center (Bulls beat the Magic by 9)—although the legacy of Michael Jordan that still grips this city hangs from every rafter in the joint.

It did not occur at the McCormick Center itself, being, as it was, inundated with about as diverse a population from around the world as you could find under one roof, all talking animatedly and in great detail about those areas of the human body that most people do not talk about—radiologists deal with breasts and colons the way auto mechanics deal with brake pads.

And it certainly wasn’t at Fogo de Chao, the restaurant I went to with a group of radiologists where “The Gaucho Way of Preparing Meat” was demonstrated by a swarm of waiters slicing pieces of lamb, steak, pork and chicken from long metal stakes right onto your place without giving you time to inhale—thereby providing future customers for the radiologists at our table.

It was at a Starbucks.

Early in the morning most Starbucks look the same. Two weeks ago near Carlsbad California, the early morning Starbucks line-up consisted largely of forty-somethingish women weighing all of ninety pounds with their blond hair pulled back beneath a pink baseball cap, just finished with their morning run.

Yesterday in Chicago it was a sixty-somethingish guy who looked like he could have come from watching a football game at Solder Field—leather jacket, cap and a matter-of-fact manner. He got his coffee and joined a couple of friends already sitting down at a corner table, talking about Da Bulls.

Great town.

In a future post we will examine some investment ideas coming out of this conference. In brief, though, think digital.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Saturday, November 26, 2005

Why She Feels Better

One of the more obvious mistakes the mainstream media usually makes at this time of year is to refer to the American Shopper via the male-gendered third person pronoun He.

I guarantee that during some news report about holiday sales this weekend, some Talking Head will use this form when describing the shopping results from Black Friday, as in:

The American consumer is still spending; in fact Wal-Mart stores says he spent 4.3 per-cent more in November than last year…

The fact is that any retailer except maybe AutoZone and online engagement-ring seller Blue Nile will tell you that women drive their business.

Blue Nile, indeed, has made a business out of the fact that men hate to go to malls. More specifically, they hate to look for parking spaces, they hate to walk long distances past kiosks with stupid names, they hate to ask for help from some guy who knows nothing but how much commission he will earn selling this particular ring, they hate that awful fake smile and handshake when they've finally chosen a ring to buy, they hate to wait while the ring is boxed and wrapped, they hate to talk to the lady who takes their credit card and they hate to be smiled at and thanked and wished have a nice day! by the vaguely androgynous guy hanging around the exit…because men know deep down in their guts that they are being ripped off at every step of the way.

Blue Nile’s simple online ring selection converts what had been a shoot-me-please-before-I-have-to-listen-to-another-sweaty-salesman-tell-me-about-the-four-C’s-or-whatever-the-hell-it-is torture session into a sort of paint-by-numbers process that is so simple even a guy can now buy an engagement ring, in his pajamas.

No parking, no salesman, no problem.

Fortunately for most retailers, however, Blue Nile is still a small company with a very limited product line. Walk any mall in America and you will see women, mostly, leading the charge. Even tough guys—including, and I am not making this up, major league baseball managers—let their wives do most of the shopping.

How do I know this?

Well, I once spotted Mike Hargrove, now managing the Seattle Mariners but back then Manager of the red-hot Cleveland Indians, at a shopping mall in downtown Baltimore. It was 1997 and the Indians were in town to play the Orioles—believe or not, the Orioles had a good team back then—in the American League playoffs.

Hargrove was not, as a baseball fan might have expected, leading a bunch of rowdy Indian coaches and players on the late-morning tag-end of an all-night pub-crawl (his great team included a young right-fielder named Manny Ramirez).

No, the manager of the mighty Cleveland Indians was following his wife from store to store around the mall, and he was carrying the shopping bags for her.

I saw immediately that Mike was exhibiting all the signs of Husband Shopping Coma Syndrome (HSCS), in which the male’s arms become strained from carrying various cutesy shopping bags from various cutesy stores such that the blood has drained down into the hands, depriving the brain of vital red blood cells necessary to stay awake, which results in, first, sloth, then lethargy, and finally despondency.

I put Mike in the post-lethargy stage, dangerously close to despondency, though still functional, walking as he was in the staggering steps of a man ready to give up.

Furthermore, it was clear that noxious vapors—probably from the leather purses in the Coach store—had shut off the oxygen flow to his brain, causing his eyes to begin rolling back into his head.

His debilitated condition allowed me to catch up with him as he put the bags down and leaned against a railing overlooking the huge atrium at the center of the mall—looking, I thought, like a man weighing the merits of ending it all right then and there.

It was the first autograph I ever got in which the famous person giving the autograph seemed genuinely relieved to see me. (I will tell the Story of the Sting Autograph some other day.) We even had a nice, brief chat about the playoff game that was happening that very night.

And then his wife came out of the store, with another shopping bag, and I left.

Which is why I say that even major league baseball managers let their wives do most of the shopping, and why the key to this holiday season’s sales is in her, not his, hands.

And since gasoline prices have collapsed in the last month—from over $3.00 a gallon at their post-hurricane peak all the way down to $2.17 a gallon currently, according to AAA, which is up a mere 12% from the same time last year, as compared to up 50% at the end of September—I think she is feeling a little better lately.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Friday, November 25, 2005

Raising Charlie from “Out-Perform” to “Strong Buy”

Every business morning my instant message light starts flashing around 7:30 with the first of as many as a dozen morning research summaries from around Wall Street.

These usually take a highly abbreviated form, with stock tickers used for company names and recommendations such as “Strong Buy” or “Outperform” abbreviated to “SB” and “OP”—the goal being to pass along as much information as possible in as few words as possible.

For example, last week this came in one morning:

SNDK overreaction, Samsung and Toshiba not meeting demand, MU better for sale yesterday, prlly same today…

In a nutshell, the broker’s research analyst was saying that Sandisk’s ten-point price drop (following Intel and Micron announcement of a joint venture to manufacture flash memory for Apple) was an overreaction, because currently the largest flash producers—Samsung and Toshiba—could not meet demand anyway. Also, their trading desk saw Micron stock probably being for sale prior to the open, as it had been the day before.

Understand that these things come one after the other, usually about stuff in which I only have peripheral interest (WEBX downgrade to EW from OW—WebEx Communications being a stock I have on my radar screen as an eventual Microsoft casualty) to that which I have no interest in at all (Cont’d seller of SPY & sold 2mm XLE...—having, as I do, as little ability to play index futures as I would a roulette wheel).

What I am looking for is good stuff—anything new, interesting and fundamentally based.

So this morning when the first message popped on my screen from Charlie O’Connor, my ace contact at Leerink Swann, a healthcare research boutique, I clicked on it expecting Charlie’s usual brief, helpful, information-packed, fundamentally based briefing from his analysts.

What I got was the following (keep in mind, “OP” stands for “Outperform”):

TURK-OP-basted with garlic and herbs, was moist and tender...dont want to overload as can cause s-t coma like symptoms.

STUFF-OP-made with brown rice, cracked rye bread, marsala soaked the buy rating.

MASH-OP-White and sweet potato blend, sourcream, butter salt and pepper, needs nothing else.

CORN-OP-spoonbread, half cake, half pudding, loaded with corn,onions and tradition over here

GRAVY-OP-pour over entire plate, garnish with cranberry sauce.

PIE-OP-must have been 5 or 6 to choose, lost count tried em all...

This morning, I am raising my rating on Charlie O’Connor from “OP” to “SB.”

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Wednesday, November 23, 2005

Wal-Mart Gets Serious

Look, if you had one shot, one opportunity to seize everything you’ve ever wanted… “Lose Yourself”—Eminem

Like the Eminem alter-ego in “Lose Yourself,” Wal-Mart—one of the world’s truly great companies—has, thanks to union protests, California Luddites and a consumer base dealing with hurricanes and gasoline prices, been “chewed up and spit out and booed off stage” for the better part of the last two years.

There is an irony, I know, in using Eminem lyrics to describe the world’s biggest retailer, given that Wal-Mart stores do not themselves carry Eminem’s cds—what with the f-words and all.

But that song sprang to mind reading this morning’s articles about Wal-Mart’s plans to, as the song says, “seize everything” this coming Friday on the busiest shopping day of the year.

Despite all the recent bad press, including that very lame CNBC probing of Wal-Mart’s so-called dark side—the low point of which had to be a David Faber interview with the bitter ex-manager of Pillowtex, the former high-flying textile consolidator that crashed and burned, who predictably blamed most of his terrible operating record on his largest customer—Wal-Mart more or less has kept rhyming, adding $20 billion in sales the first nine months of 2005 alone. That amount is, annualized, the equivalent of half the entire Target chain’s full year sales.

And today we see that Wal-Mart is set to tear the roof off.

“According to early copies of Black Friday circulars,” the New York Times reports, Wal-Mart will offer “doorbuster” deals to get customers in the stores—it will match competitors’ circular prices while offering some whopping discounts of its own, such as a 42-inch plasma TV for $997, compared to $1,499 at Best Buy.

Toys “R” Us, which I’ve long thought of as Toys “Aren’t” Selling, dismisses the Wal-Mart onslaught by saying “You can’t match what you don’t have,” claiming that 80% of the discounts Toys “Aren’t” Selling will offer on Black Friday can’t be found at Wal-Mart.

Before it went private, Toys “Aren’t” Selling was a highly seasonal retailer with flat sales growth and awful stores in desirable locations. Despite a 33% gross profit it brought less than 2% to pre-tax profits—implying a cost structure amounting to 31% of sales.

And that was before the company went private.

Wal-Mart—which is still growing 10% a year with a quarter trillion in sales—generates more than 5% in pre-tax profits on a 23% gross profit margin, implying a cost structure of about 18% of sales.

Hmmm....18% cost structure versus 31% cost structure...

I think we know who is going to capture the moment on Black Friday. Like the song says, you can do anything you set your mind to, man.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Monday, November 21, 2005

When One plus One Equals Not-Quite-Two

It’s not like they aren’t trying.

The Sears Essentials store, a by-product of Eddie Lampert’s ambitious attempt to shmoosh two aging retailers together and come up with a store people actually want to shop, is not, as I have discussed before, all that bad.

Recall that “Essentials” (an appealing but bizarre name, when you think about it: this is not a convenience store we’re talking about, but a big old apparel-to-corn flakes general merchandise store) are refurbished ex-Kmart locations rebranded with the Sears logo and Sears-branded merchandise added to the mix.

Having visited one store in the upper reaches of rural Connecticut (see “Eddie to the Rescue,” September 9, 2005), I wanted to check out its brethren in the freeway-clogged suburbs of Los Angeles.

I found one on the outskirts of Corona off Interstate 15, in a very typical this-used-to-be-a-decent-area old Kmart location. It was a relatively easy store to spot because of the large Sears Essentials sign on the building…and because of the rather desperate looking young Sears employee standing on the sidewalk waving a “Sears Sale!” sign at passing motorists.

Now that I have seen them on both coasts, I think I can safely generalize about them.

For starters, the Sears Essentials stores are clean, well-lighted places with bi-lingual signage and plenty of merchandise—nicer by far than the old Kmart you knew and did everything in your power to avoid entering.

The Sears house brands—Craftsman tools and Kenmore appliances—give the stores a flavor entirely different from the previous failed occupant, while the electronics department is now bigger and more coherent than the old Kmart version, with row after row of flashy TV screens along the wall. And there is plenty of Martha Stewart merchandise everywhere, from towels to $250 artificial Christmas trees.

The theory behind Essentials is that by expanding distribution of widely recognized (and still trusted) Sears house brands into Kmart locations that previously failed to generate enough business to justify the lease payments, Sears Holdings would generate higher sales and transform a liability—a long-term lease in a mediocre location—into an asset. The basic idea being that one plus one would equal three, maybe four.

Indeed, like its counterpart in northeastern Connecticut, this L.A. Essentials store had shoppers—not nearly so many as the clean, well-lighted, terrifically merchandized Target store a few miles away, but it had some shoppers.

Yet as I walked around the store and saw the merchandise placed with its usual Sears cluelessness, I found myself understanding why the whole thing seems so inconsequential: by opening Sears Essentials stores in old Kmart locations, all that has happened is…Sears has opened a bunch of new, mediocre stores.

That’s all.

Meanwhile Target, Wal-Mart, Costco and the rest continue to open well-merchandised stores with great prices where people actually want to shop, without requiring employees to stand on the sidewalk waving “Sale!” signs.

The math behind Sears Essentials? One plus one equals not-quite-two.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Friday, November 18, 2005

Divide By Ten

Google at $400:Is It on Merit Or Just a Mania?

Thus asks the Wall Street Journal this morning, in a rather silly article devoted to a rather silly topic: the meaning, if there is one, of the fact that Google shares hit $400 yesterday.

Don’t get me wrong: I like Google as a business model and a company. And I’m not indifferent to the share price (although I make no recommendations here regarding stocks and never will).

But uncommented on in this morning’s “Merit or Mania?” article is the fact that shares of Yahoo had a much bigger move yesterday than Google—and also reached the same milestone.

Yet nobody seemed to notice.

All you have to do is divide Google’s stock price by ten. Do that, and shares of Google merely rose 53 cents yesterday to close at $40.35.

Yahoo shares, meanwhile, rose over $2.00 and closed at $42.23.

You can also multiply Yahoo by ten to make it comparable to Google: looked at this way, Yahoo shares rose more than $20 yesterday and closed at $422.

Which makes Google's $5.35 pop to $403 a bit less eye-catching, and
in and of itself no big megillah, at least compared to a peer company.

But the fact that Google’s market valuation is larger than Coke, as the article pointed out, is worth looking into.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Thursday, November 17, 2005

Tomorrow’s Headline Today?

Sales of New Homes Plummet

The 40% decline for 3-month period is sharpest in 15 years.

Thus reads the headline over a front page story in yesterday’s Business Section of the Sacramento Bee, the daily chronicler of the economic and social activities in what had, up until several weeks ago, been one of the hottest real estate markets in the country.

As reported by Andrew LePage, a Bee Staff Writer:

Sales of new homes in the Sacramento region dropped 40 percent over the past three months compared with the same period last year, according to the local Building Industry Association.

It's the sharpest decline the group has seen for the August-October period since 1989-1990, when sales plunged nearly twice as much - 79 percent.

The most amusing aspect of the article, if there is one, is that, as explained in banner ads surrounding the story on the Bee website, “The Business Section is brought to you courtesy of Beazer Homes.”

Beazer Homes is one of those aggressively expanding publicly traded homebuilders benefiting from the trees-grow-to-the-skies nature of the housing market.

Beazer’s just-completed fourth quarter earnings reveal a $2.9 billion land and housing inventory, up from $2.3 billion in 2004 and a mere $630 million five years ago.

That 36% compound growth in Beazer’s inventory might be one reason Sacramento in particular suddenly appears to be awash in housing, according to the Bee article:

The 1,388 new homes sold during the past three months marks the lowest total for the August-through-October stretch since 2001, reported the North State Building Industry Association. The group tracks roughly 55 percent of the new home subdivisions in the capital region and reports net sales - the number of escrows opened each month, minus any canceled deals.

Cancellations of pending home sales have spiked in recent months because more buyers, including investors, either got cold feet, couldn't qualify for a loan or couldn't sell another property fast enough, industry sources reported. Also, some builders insist they're strictly enforcing the anti-speculator clause in their sales contracts and will cancel deals if they learn a buyer is an investor, not a primary resident.

But Sacramento's slower resale market may be the biggest reason that sales of new homes are down so much.

"One of the drivers (of cancellations) is people not being able to sell the home they have for the price they expected to get for it," said John Orr, president of the local BIA. "On the resale side ... the sellers aren't in the bargaining position they once were."

But you wouldn’t have gleaned a bit of this from Beazer’s recent (November 2) earnings call. Asked about developments in the Sacramento region, Beazer CEO Ian McCarthy told Wall Street’s Finest not to worry:

We are still seeing pricing power there. We are very focused in that market on being affordable. In fact, our whole strategy in California is making sure that we're affordable. We have not played in the very highest prices there in either Northern California and we are only in Sacramento.... I would say we're not seeing flattening, we're still seeing some price appreciation.

Mr. McCarthy ought to pick up a copy of yesterday’s Bee, or access its web site (complete with Beazer’s own banner ads) and check out the story, which goes on at some length:

Still, there's no disputing the pronounced cool-down in the new home market…. Greg Paquin, head of The Gregory Group, agreed that "it seems pricing may have gotten ahead of itself."…In addition, lenders are beginning to scrutinize loan applications more closely, meaning some marginally qualified borrowers now find it more difficult to use the most aggressive, riskiest forms of financing.

Builders have been using these increasingly lucrative incentives, such as $50,000 toward upgrades on higher-end homes, in lieu of lowering prices.

This last may explain the apparently gaping chasm between Beazer’s optimism regarding Sacramento home prices, which are not “flattening,” and the recent collapse in Sacramento home sales according to Sacramento’s own Building Industry Association: the homebuilders have yet to cut prices.

As anybody on Wall Street knows, price follows volume. And volume in Sacramento is down.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Tuesday, November 15, 2005

The House of Paaaaaaain

Housing Market ShowsFurther Signs of Cooling

The pace of U.S. home sales is showing further signs of slowing, amid a widening gap between sellers' asking prices and the amount skittish buyers are prepared to offer, according to an industry survey, real-estate brokerage firms and housing economists.

Rising mortgage rates, higher energy costs, widespread talk about the risk of a "bubble" in housing and a surge in the number of homes on the market are among the factors behind the apparent slowdown. They have combined to make home shoppers more cautious, economists and real-estate brokers say.

Buyers are taking their time to look for bargains, while many sellers have put unrealistically high price tags on their homes. That leads to a standoff, causing the number of sales to drop -- a classic ending to a period of unusually rapid house-price increases.

In a survey conducted last week, real-estate consulting firm Real Trends found that the number of home-purchase contracts signed last month dropped 8% from a year earlier at 48 of the nation's large real-estate brokerage firms. Those brokers responded to an email poll sent to 80 brokerage firms.

That’s the lead story in today’s WSJ, and, as usual, it arrives six months too late to help anybody stuck with a just-closed-on McMansion in Upper Bergen County.

My apologies to Jim Cramer for stealing his wonderful Mad Money “House of Pain” routine for the title of this piece, but that was all I could think of as I read through the article, with quotes like “the frenzy is over” and “newfound sense of urgency among sellers to get out.”

Today’s environment reminds me of the early 1990s, when the housing market in New England (and all across the country) flamed out after years of overbuilding marked by a condo frenzy that ended only after sucking in every last possible buyer, (including my parents).

I got so bearish I put our house on the market. We fixed things up, put in a bright new kitchen window and invited realtors in for a look. At the end of the day we had over 100 real estate agent business cards on our dining room table.

And we got precisely one bid for the house.

I grabbed the bid and never let go, even when they asked for a new roof on the garage and my attorney told me to break the deal.

Whether or not this cycle ends as badly as that last cycle remains to be seen. One could argue that very little has changed from last summer’s Time Magazine this-has-to-be-the-peak front cover everybody-in-the-pool story on housing (see this blog’s The Last, Best Hope For Prosperity about it, June 12)—if anything, the economy is stronger than anybody had reason to expect back then.

But short-term interest rates are up a bunch, and even the long end has moved up lately, yielding mortgage rates at a two-year high. And don’t think every potential buyer still out there doesn’t read the newspaper headlines that say “the frenzy is over” without re-thinking their bid on that McMansion.

If there’s any doubt about the fact that this particular housing cycle is over, even the chief economist of the National Association of Realtors told the Journal, “The air is coming out of the balloons”—and when was the last time you heard the chief economist of any association say something like that?

It is indeed looking like a house of pain.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Sunday, November 13, 2005

The “Core Inflation Rate” at My Church: 10%

“Our budget will increase by 10% because of rises in fuel, electricity and insurance costs. Just to stay where we are, we need to increase our pledge income by 10%…”

Thus reads the pledge request included in my church bulletin today. Seems that, along with the rise in utility expenses, our insurance costs are going up 50% next year and our heating oil costs are rising—and altogether our cost increases average out to 10%.

Now, this is just one individual church in one small corner of New England. A quick Google search reveals a total of 386,000 churches in America and over 3,700 synagogues. Clearly, a 10% inflation rate at one small church does not represent the trend at several hundred thousand other houses of worship.

But, unlike government statistics—which are based on samples that are massaged, averaged and seasonally adjusted—it is a real number.

It is not presented “ex-food and energy,” the way most economists have been trained to consider inflation. And it does not whimsically delete certain costs, in the same way that the government inflation statistics delete, say, 20% increases in hotel room rates.

That’s right: in this weekend’s edition of the Wall Street Journal, we read the following:

According to the Labor Department, hotel prices were down 2.5% in September from a year earlier, but industry executives say prices are actually rising robustly.

Patrick Jackman, a Labor Department statistician, says the government's index of hotel prices doesn't include the price of hotels for business travel. That tends to strip out higher-price business rates.[Emphasis added.]

In that same article, titled “Inflation Toehold? Firms Gain Power to Boost Prices,” the paper notes that the price of a standard room at the Waldorf-Astoria hotel in New York is up 20% over last year.

Yet that 20% increase has vanished from the official government statistics because, apparently, “consumers” do not pay it.

Getting back to my church’s 10% inflation problem, I should note that not a dime of this 10% budget increase is producing better mission programs or higher administrative salaries.

Not one individual except, perhaps, the Russian men who stole state oil fields following the collapse of Communism, and their forebears in the Middle East and Southeast Asia, as well as the investors clipping coupons from Exxon-Mobil and Chevron, benefits from this 10% cost increase.

Nevertheless, it is a true, unadjusted, out-of-pocket cost increase which must be paid in order to turn on the lights and heat the building that supports the fifty twelve-step programs that use our building each week, not to mention the nursery school program and Bible studies. And, of course, Sunday services.

So enjoy the 2% adjusted, massaged, refined, imputed, restructured, and redefined CPI while you can…because my church needs to spend 10% more money "just to stay where we are."

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Friday, November 11, 2005

The $14.9 Million Small Pheasant Vase

I don’t know too much about Sotheby’s, the old-line auction house—save that its sales peaked during the 1999 bubble year and dropped four straight years; its CEO went to jail for conspiring with Christie’s to fix the market, and after a few years out of the headlines the company has rebounded along with the art market, which appears to be on fire.

So I found the recent earnings call interesting, both from a Sotheby’s-specific point of view, as well as the company's own world view from the vantage point of its auction business.

Most interesting was the company’s commentary on the exploding international art markets, particularly in Russia.

Now, I am not suggesting Sotheby’s is a good “Russia Play,” or “China Play,” or any other kind of play.

But I find it intriguing that Ariel Capital, a firm whose long-term point of view and concentrated investment style I admire, now owns 15% of Sotheby’s common. I find it intriguing that there were precisely four analysts on the recent earnings call—and none of them from large investment houses. And I find it intriguing that the company stands to benefit from the rise of China, the flow of oil money coming out of the ground in Russia, and emerging-market trends elsewhere around the globe.

And I thought management’s commentary regarding the state the business and its view of the world to be sound—and worth sharing.

Bill Ruprecht, Sotheby's - President, CEO

A couple of comments, just on the fourth quarter and the business -- we've had exceptional sales so far in the fourth quarter. As I already indicated, our Impressionist and Modern Art sale last week in New York achieved results above our expectations....

The evening sale topped its high estimate and that's the first time that's happened with us since 1990. The higher items of sale was a Pablo Picasso preliminary drawing for the Women of Avignon, which sold for $13.7 million, which was triple its presale estimate of 3 to $6 million.

We had Hong Kong sales last month which were really superb. Sales totaled almost $110 million, which was the highest total in our 31-year history in Hong Kong, demonstrating remarkable strength and depth of interest in that marketplace.

We achieved, in that period, the highest price ever paid at auction in Asia for a work of art; it was the sale of a small pheasant vase, which sold for $14.9 million.

A couple of unique single-owner sales which recently took place, one in Germany, where we sold works belonging to the Royal House of Hanover, took place over nine days at the Marienburg Castle in Germany. We sold over $50 million, more than triple its pre-sale estimate of $16 million. Last week at the same time as our Impressionist series, we had the sale of more than 600 items from the collection of Lily and Edmond J. Safra. That sale achieved $49 million, above its pre-sale estimate of $26 million, for really wonderful French/Continental/English furniture, clocks, porcelain paintings, carpets, Faberge, Russian works of art; it was a terrific sale.

George Sutton, Craig-Hallum Capital - Analyst

Okay, last question, more specific to the strong Chinese and Russian markets -- can you give us any sense of expansion plans you might have there, either geographically or just through additional people?

Bill Ruprecht, Sotheby's - President, CEO

I think that the two marketplaces, frankly, could not be more different. As you probably know, there's an extraordinary concentration of wealth in Russia among a relatively small group of people. We've got very effective representation in Russia as well as in London and in New York, working closely with a large group of clients in that marketplace.

I would say that it feels to us as if we are serving that market well, having sold somewhere in the neighborhood of $300 million worth of Russian works of art in the last several years versus our traditional competitors having sold less than 100. So, we've got a bead and an intimacy on that marketplace that we like without a lot of fixed localized costs in Moscow, which I do not believe is the best way to serve that market.

In China, it's a fascinating marketplace, of course. There's a domestic PRC marketplace and then there's a Hong Kong marketplace, both sort of pan-Asian sales. Our trading environment historically has of course been in Hong Kong, welcoming buyers both from the mainland China marketplace as well as from the rest of the world. I think it's fair to say that the ceramics marketplace out there, which is a significant portion of the marketplace, is a very international market with many collectors inside the PRC but many collectors outside, spread throughout the world, in the States as well as in Europe.

This is a long-winded answer to say that, on the other hand, there's a very, very robust market inside the PRC for paintings and in particular modern paintings....

I think we're looking at it very carefully. I think we believe there's a role for us in the PRC marketplace, but we don't have any appetite to lunge into anything and create a bunch of enemies in the process.

Informed opinions and observations are welcome.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Wednesday, November 09, 2005

Bill's Hideaway, Part II

“It’s clear that if we fail to do so [adapt to changes in online business models], our business as we know it is at risk.”

Thus writes Ray Ozzie, the genius who developed Lotus Notes and is now Microsoft’s Chief Technology Officer, in an email “sent to top Microsoft executives and engineers.”

I made a modest suggestion earlier this year that Microsoft founder Bill Gates spend less time holed up in a cabin for weeks on end thinking great thoughts about technology (I am not making that up, he really does do that) and more time hanging around college campuses to see what kids do with computers (see Bill's Hideaway at

I take it my suggestion has not been heeded.

I base this conclusion mainly on the continued self-delusion by the folks in Redmond as discerned in Mr. Ozzie’s memo—which is dramatically recounted in today’s WSJ, as if writing an email actually changes the focus of a large corporation whose entire existence is based on sales of computer software.

The biggest delusional whopper in today's article has to be this:

Microsoft, he [Mr. Ozzie] wrote, has long “understood mobile messaging,” but “only now are we surpassing the Blackberry.”

Surpassing the Blackberry!

Where, on earth, is Microsoft surpassing the Blackberry? Possibly, in a building on Microsoft’s Redmond campus, there is somebody who prefers Microsoft’s solutions to the Blackberry. But I doubt it.

More likely the “surpassing” of which Mr. Ozzie speaks involves some sort of great technical prowess measured by lines of code and terabytes of gigaflops by which Microsoft has crammed sixteen thousand superfluous functions into its mobile messaging software, none of which are easy to use—as compared to the handful of things Blackberry does spectacularly well.

The simplicity and focus of the Blackberry is, not coincidentally, what saved Intuit, and Adobe from the onslaught of Microsoft. And it is what might save Google.

In his memo, in fact, Mr. Ozzie hits on that very attribute which has, thus far, made Google the perceived threat to Microsoft’s model:

“Through Google’s focus they’ve gained a tremendously strong position.”

But it is not Ray Ozzie that needs to be convinced of Google's strength. It is Bill Gates, who, according to the always-breathless WSJ article, "to be sure, retains that role as Microsoft's chief software architect, and isn't expected to give up the title anytime soon."

What I suggest Mr. Gates give up is those twice-a-year trips to the woods.

Instead, I suggest he get on a bike, ride to the local Peet's, and watch what people are doing with the internet, and the iPod, and the Blackberry.

And then Microsoft might surpass somebody.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Tuesday, November 08, 2005

“It Appears We May Be Entering a Period of More Moderate…”

"Yes, it's been trending up, which is really astounding. Every day I get the New York Times and The Wall Street Journal, and I don't think they've missed a bad article in our regard in the last two to three weeks. And it's amazing to me that we're doing the business that we're doing, which is tremendous, in the face of this bad press.

I mean, if there's anybody left in the U.S. that hasn't read an article that this is the absolute peak, I'd like to meet them. So who are all these people that are buying at the absolute peak, according to the newspaper?

They're people who want the move up home, whether it be attached, multifamily, or single, and aren't willing to play the market according to the press. It's really astounding to me that we've been doing the business that we've been doing." —Toll Brothers CEO Robert Toll, August 8, 2005

Well the news this morning is about homebuilders—specifically Toll Brothers, and more specifically CEO Robert Toll's cautionary commentary in this morning’s earnings release, which is quite a change from the “trees-grow-to-the-sky” view which management has consistently (and correctly) given during every short-term wiggle in the housing market for the last several years (see August 8th quote above).

The contents of today’s press release from Toll Brothers need no elaboration from me:

``In addition to delays in community openings, about twenty-five percent of our communities still have backlogs extending twelve months or more, and, therefore, are not open for sale on a regular basis. Even though we produced record contracts against FY 2004's challenging fourth quarter comparison (FY 2004's fourth quarter contracts were up 51% above FY 2003's fourth quarter), we believe a shortage of selling communities, coupled with some softening of demand in a number of markets, negatively impacted our contract results.

``Since Hurricane Katrina in early September, we have observed buyers taking longer to make their purchasing decision. We attribute this change to the significant decline in consumer confidence in the last two months that was precipitated by the hurricanes and their aftermath, and to record gas prices.

``It appears we may be entering a period of more moderate home price increases, more typical of the past decade than the past two years. Comparing the current market to the past five years, excluding 2004, which was extraordinary, FY 2005's fourth quarter 'per-community' non-binding reservation deposits exceeded the five-year average from FY 1999 to FY 2003 in seven of the last nine weeks (encompassing September and October) of FY 2005.

``We remain optimistic. The demographics for our industry remain outstanding due to continuing, regulation-induced, constraints on lot supplies and a growing number of affluent households. With approximately 81,000 lots under our control, compared to 60,189 at FYE 2004, and a projection of approximately 265 selling communities by FYE 2006, we believe we will enjoy continued growth as we expand geographically, diversify our product lines and continue to gain market share.''

Expect plenty of fireworks on the conference call at 2pm, Eastern Standard Time.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Wednesday, November 02, 2005

Jawboning the Street


Such are the number of times Procter & Gamble management—first the CFO, then the Treasurer, and then again the CFO—used the word “strong” during their discussion of first quarter earnings yesterday.

That’s a total of 23 times the word “strong” was used even before the question and answer session started.

During the Q&A that followed, in fact, management used the word another 17 times.

Total usage of the adjective “strong” during the P&G conference call: 40 times. That’s got to be some kind of record.

In and of itself, the use of an adjective such as “strong” is meaningless. Who cares if management chooses to say “strong growth” and “strong business momentum” and “very strong top and bottom line results,” as the P&G Treasurer did in three successive paragraphs? When a company has “strong” results and chooses to call them “strong,” that’s their right.

But as I have learned watching other companies over the years, “meaningless adjectives” can be employed in all kinds of ways to defuse, defer and decoy the numbers—and therefore deny reality—until it is too late to deal with the underlying problems.

If any company had the right to use the word “strong” in a recent conference call, it was Google. Google’s growth, both sequential and year-over-year, stayed astonishingly high, and margins didn’t budge—leading to a net earnings number that beat Wall Street’s expectations by a full 20c a share.

Yet Google management used word “strong” exactly twice in the management discussion.

Procter & Gamble, it should be noted, “beat the number” by precisely one penny, and used the word 23 times in the management discussion.

(For the record, P&G did not actually beat the number by a full penny. According to a sharp-eyed reader of this blog, "The reported number was $0.7657, which if it had been 0.0008 less would be be rounded down to $0.76, rather than up to $0.77...about $2 million on a quarterly expense structure of $12 billion.")

But P&G management went further than deliberately infuse the adjective “strong” into their “upbeat” presentation. CFO Clayt Daley devoted the final part of his introductory discussion to a Lyndon Johnson-style in-your-face jawboning effort for a higher P/E ratio:

Now I want to conclude by providing some perspective on our price-earnings ratio. We have received a number of questions recently on this topic. We believe there are some important factors that investors should keep in mind when evaluating P&G's P/E multiple both versus history and versus peers.

After noting P&G’s broad product portfolio, expensing of stock options, near-term dilution from the Gillette acquisition and one-time charges, Daley concluded the P/E lobbying effort as follows:

We believe that a simple P/E comparison does not fully capture the fact that P&G is a very different company today than it was five or 10 years ago. P&G has a much different organization structure that allows the global business units to focus on their consumers and competitors while capturing the scale benefits not available to competition.

Additionally P&G has a much stronger portfolio of businesses, a more diverse geographic mix and a significant opportunity to build shareholder value with Gillette, and we are confident that we will be able to deliver our new top and bottom line targets through the end of the decade.

(Notice he got in another “strong” there!)

Forgive my cynicism here, but most of the times I’ve heard a company baldly lobby for a higher P/E ratio, it’s a management team consisting of two guys in an office suite off Route 101 in Burlingame trying desperately to get whatever half-baked small-cap start-up they’ve put their life savings into lumped together with whatever hot new technology is firing investors’ imaginations at the moment—not the highly regarded heads of one of the oldest and most durable consumer products companies in the world.

Happily, I can report, Wall Street’s Finest did not entirely roll over to have its collective belly scratched by the firm, guiding hand of Mr. Daley.

Deutsche Bank Analyst Bill Schmitz, for one, asked the obvious question:

You sort of gave us a little lecture on valuation and why the P/E is too low. Why wouldn’t you just accelerate your share repurchase then if you thought that the multiple was too low now? You still have considerable flexibility in terms of repurchase…

To which CFO Clayt Daley said:

“I’m buying as much stock as I’m allowed to buy.”

For the record, P&G's shares outstanding dropped by not quite 40 million in the quarter, on a 2.7 billion fully-diluted share base.

So why the jawboning? Why the use of the adjective “strong” forty times during an hour long conference call? Why not just take the company private if it's so darn cheap?

The answer to that lies, I believe, in the guts of yesterday’s conference call, in which management outlined not only the “strong” results, but also numerous headwinds facing a consumer products company that just completed its largest consumer products acquisition ever, at a time when the Federal Reserve seems intent on slowing down the buying habits of those very same consumers to which Procter & Gamble sells diapers, coffee, liquid Tide and now Gillette razors.

Chris, I would just say two quick things. One and the most important one is, when we go into periods like this where there are big increases in energy pricing, especially gasoline, there are consumer households whose budget is stretched. Okay? And one of the typical reactions that you see from retailers is to begin to push their private-label brands. We've seen this happen in the '70s during the oil shock. It has happened in every mild or severe recession since.

So I think we're seeing a normal pattern. Frankly, I'm not -- there the manufacturers of private-label diapers are seeing all the same energy and raw material and packing material price pressures that we are that are operating on much thinner margins than the branded competitors. And in the past, some of them have driven themselves into bankruptcy because the margins got squeezed so severely.

No wonder the management jawboned. LBJ would have been proud.

Jeff Matthews
I Am Not Making This Up

Updated 11/5/05

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

Tuesday, November 01, 2005

Kilroy Was Here

One of the most interesting conference calls I’ve listened to in the past few weeks’ worth of earnings calls was a REIT called Kilroy Realty.

I don’t know the company well, but I thought the call would be worth a listen.

It was.

For the record, “Kilroy Realty Corporation, a real estate investment trust (REIT), engages in the ownership, operation, development, and acquisition of Class A suburban office and industrial real estate in suburban submarkets, primarily in Southern California.”

The following are excerpts from the conference call transcript, with no elaboration.

California's economy produced steady, diversified growth during the third quarter. Employment hit another record high in September, according to the monthly survey of households while total nonfarm payroll jobs grew by 226,000 year-over-year.

The unemployment rate as of September stood at 5.1%, down from a full percentage point from a year ago. Continued job growth has boosted other economic indicators including personal income which rose an estimated -- or rather an annualized 2.9% in the second quarter versus 2.2% a year ago. For the period California accounted for 13% of total national personal income.

KRC remained very productive during the quarter. Within our stabilized properties we have now signed new or renewing lease agreements on 1.4 million square feet of space year to date. And we continue to lead the pack in terms of deal capture and rental growth. Overall occupancy in our stabilized portfolio fell a couple of percentage points in the quarter to just under 93%. This occurred primarily because our recently renovated 909 Sepulveda property was moved to the stabilized portfolio and a tenant vacated a 130,000 square foot building in San Diego.

Now let me give you a big picture summary of what we are seeing in Southern California. As we have been saying for several quarters, the Southern California real estate markets have been strengthening. Throughout many of our markets we are seeing and the brokers are reporting a shift from a tenant's market to a landlord's market. This is more pronounced in some submarkets than others but there is more and more sentiment that tenants need to act now, particularly those with larger requirements. C.B. Richard Ellis is reporting tightening vacancies and rising lease rates in Los Angeles with minimal new construction.

C.B. is predicting significant rent increases in Los Angeles as large blocks of space get absorbed and vacancy rates continue to decline. Our experience also supports an improving market in Los Angeles where our west side assets are effectively fully leased and we have begun to make significant progress in El Segundo.

While it took a entire year following completion to get to 25% committed we have essentially doubled that in our 909 building in the last quarter, moving the committed percentage to 49% today. As for the Orange County office market, Cushman and Wakefield has also reported a move from an equilibrium market to a landlord's market as population growth and a growing economy are driving demand. Office vacancy rates are down to 10% from 14% a year ago and rents are up 6% year-over-year.

Finally in San Diego, we continue to see a significant increase in demand for new state-of-the-art facilities in the market in which we operate.

One of the Southern California markets where new office construction does make sense is in the better San Diego submarkets where the combination of rental growth and robust demand provide attractive returns. In contrast, development does not make sense in most Los Angeles submarkets and won't until rents significantly increase.

Also in Orange County, given the current strength in residential economics we have the opportunity to rezone at least a couple of our industrial properties for residential and sell the sites to home builders at a significant profit. We expect to have more to come on this on future calls.

The real estate markets are improving across the board in Southern California with a shifting taking place from a tenant's market to a landlord's market. The brokerage communities and others are increasingly indicating that there is a growing sense of urgency among tenants to find space.

The strength in the markets is moving up the coast. While San Diego continues to be the strongest market in Southern California, Orange County has improved significantly over the last year. Most Los Angeles submarkets are also tightening and even El Segundo is now showing meaningful reductions in vacancy.

Construction costs have increased significantly over the past four years with most of that occurring in the last 12 to 18 months.

And if we look at our AMN building which is probably the highest quality building in San Diego which we came on stream in late 2002, the cost of that building core and shell is up about 40%. And that's plus or minus pretty much the same for other buildings. So the other thing that's increased is, depending -- it doesn't always effect Kilroy although it does when we buy new property is that land costs have increased in many markets, including San Diego..

Cap rates, we've seen them continually go lower.

What we're seeing is a number of second and third chair properties trading at 6% plus or minus cap rates, and I also mention maybe higher quality assets but not in very good markets in that same range and we're seeing high quality assets particularly particularly down in San Diego in a sub 6 range.

We're not seeing any letup in the appetite for people to acquire. I've never seen more people wanting to acquire assets than today.

If the Fed is seeing what Kilroy is seeing, I wouldn’t expect the Fed to let up any time soon.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.