Tuesday, August 31, 2010

DG FastChannel®, No Longer “Executing” on its “Strategies”


“The company continues to execute on its strategic business plan.”

—DG FastChannel® CEO Scott Ginsburg, August 4, 2010



We admit we know next-to-nothing about DG FastChannel® except that it has an “R” with a circle in its name in the headlines to its press releases.

Oh, sure, DG FastChannel® calls itself “a leading provider of digital media services to the advertising, entertainment and broadcast industries.” But what that actually means we here at NotMakingThisUp have no clue.

And, following yesterday’s drama—a nearly 40% collapse in DG FastChannel® stock on the heels of a press release from the company announcing a $30 million stock repurchase program—we strongly suspect that more than a few of Wall Street’s Finest have no clue either.

Now, you might think news of a $30 million stock repurchase would be good news.

And it would be good news, unless, of course, the placement of the happy headline at the top of the press release was meant to dilute some less happy news contained further down on the same page…which is something we have seen more than a few companies do in our day.

Sure enough, while the press release started with three paragraphs devoted to the $30 million share repurchase (described by the aforementioned Scott Ginsburg as “a good use of our cash, reflecting our strong belief in the value and opportunity…”), it then delivered the less welcome news that the company was guiding Q3 earnings expectations (actually EBITDA expectations, for DG FastChannel® is one of those companies that waves non-GAAP numbers in front of Wall Street’s Finest) somewhat lower than Wall Street’s Finest had been expecting.

Like, 15% lower, according to one such Finest.

Now, one might wonder what Wall Street’s Finest were thinking, running around with earnings expectations so far from reality that shares of DG FastChannel® would give up 40% in a few hours of trading.

The answer, of course, is that DG FastChannel® boasted of good things to come in a conference call with Wall Street’s Finest not so long ago.

And by “not so long ago” we mean just about three weeks ago.

That’s right: as quoted above, it was August 4, 2010 when DG FastChannel® reported “Record Second Quarter 2010 Results” and bragged right there in the press release that which forever makes our skin crawl:


“The company continues to execute on its strategic business plan.”

In fact, so successfully was DG FastChannel® “executing” on its “strategy” that Chairman and CEO Scott Sinsburg used his prepared remarks in the ensuing earnings call to offer the following ebullient outlook:

"As you continue to follow our results for the year 2010, you might consider the following -- 2010 has been a better year for advertising than 2009 and will continue to be according to all the people who look at this, the sooth sayers who look at where we are in 2010, and as we look at the balance of the year we would look at continuing positive results from the markets, the video markets.

"Second, we know that TV spot advertising demand has rebounded from 2009 levels. We look at up front acquisitions in the TV network market. We look at cable, we look at broadcast TV, we look at both national and scatter markets, and they look very healthy at this time. Next, as you know this is a mid-term election and both for issue advertising and political advertising DG FastChannel represents the gold standard and we expect to get more than our fair share of that particular vertical.

"Finally, the adoption curve for HD advertising continues to increase. We expect our revenues and deliveries to improve throughout the year as well as our standard definition business as well. We have a robust business and expect it to continue for the balance of this year and in future periods. With that, operator, I would like to open up the dialogue and take some questions at this time."

—Scott Ginsburg, CEO

That was August 4th: by August 30th, however, the outlook had gotten murkier.

Precisely how it got so much murkier so suddenly is hard to say. Yesterday’s release cited “normal seasonality” in one aspect of its business—apparently the company had not bothered to check the calendar last time around—and a “shift in our customer mix” that has “put short term pressure on revenues.”

Naturally, despite the SNAFU, the company declares “We remain confident” in double-digit growth in revenue and EBITDA for the full year.

Don’t they always?

As we here at NotMakingThisUp wrote not long ago—August 16, to be precise, in “My Dog Charles, Executing His Yadda-Yadda”—we have never seen a strategy that was not executed on.

And “strategies” are “executed on” until they are not.

As shareholders of DG FastChannel® just found out.


P.S. For the record, my dog Charles® continues “executing” his “strategies” quite successfully—sometimes two at a time. Just yesterday he a) jumped into a car, b) curled up on the back seat and went to sleep.

Despite that strong track record of “successful execution,” however, I would not buy stock in Charles®. He recently “executed” a different “strategy”—the one involving eating grass until he throws up.


And then, he, well, let’s just say, as dogs will, Charles® decided to execute a very different strategy...


Jeff Matthews
I Am Not Making This Up


© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.



Monday, August 23, 2010

Hurd by Numbers


Now that the Mark Hurd Affair has devolved into a tit-for-tat post-mortem between the HP Board and unnamed proxies for Hurd—reaching its Clintonesque nadir last week when the Wall Street Journal actually reported that Hurd himself had let it be known through his ‘camp’ that “This woman and I never had sex”—we thought it worthwhile to return to more concrete means by which to evaluate the worth of the man Larry Ellison ranked right up there with Steve Jobs as far as “reviving HP to its former greatness” goes.

And those means would be strictly this: the numbers.

By the numerical yardstick of Wall Street’s Finest—the analysts we regularly poke fun at in these virtual pages (having been one years ago, we know the game well enough)—the answer to the question of whether Mark Hurd really revived HP “to its former greatness” is an unequivocal “Yes.”

Of course, Wall Street’s numerical yardstick does not necessarily include certain intangible factors that make a company great in the long run—things like corporate culture, employee turnover, new product development, or anything else beyond the realm of what happens outside the stock prices flickering across their Bloomberg terminals.

For it is no secret that the primary number Wall Street cares about is a company’s stock price.

(If you think that’s being too cynical, go back in time and leaf through the so-called “research” reports on Enron, say, or Lucent, or WorldCom, or any of the spectacular mortgage frauds of the housing boom: you will find consistently that, at the end of the day, continued strength in a stock price trumps short-selling reports, skeptical articles in Fortune, and even, in the case of David Einhorn’s 100% accurate prediction that Lehman was doomed to fail without some form of massive restructuring, public speeches defining the exact nature and dollar amounts of a company’s misdeeds.)

And on the basis of stock price, Hurd did indeed very nearly revive HP to its “former greatness.”

HP’s shares nearly tripled during his tenure, not only adding $50 billion in market value to HP shareholders in five short years, but also restoring HP’s stock price to within 20% of its Dot-Com Bubble-era all-time high of $68.

(By way of comparison, Cisco has never gotten back to within 50% of its all-time high.)

Of course, stocks don’t generally increase over a long period of time if revenues and earnings don’t also increase, and, under Hurd, increase those revenues and earnings did: from 2005 to 2009 (using HP’s fiscal year, which ends in October), annual revenues jumped roughly $30 billion—from $87 billion to $115 billion—while operating income grew $6 billion, from $5 billion to $11 billion.

And while we here at NotMakingThisUp pay very little attention to reported earnings per share (it is a number which can be, and frequently is, manipulated via special charges and artificially depressed depreciation charges and low book tax rates), the more relevant net “free cash flow” per share of HP stock, according to our Bloomberg, neatly doubled during Hurd’s tenure, from $2 a share in 2005 to $4 a share in 2009.

Thus, it is no wonder the stock performed as well as it did under Hurd. It is also no wonder that many of Wall Street’s Finest would agree with Larry Ellison that Mark Hurd did “revive HP to its former greatness” (even if they disliked his Michael Ovitz-style severance package).

But did he really?

First let’s look at where that $30 billion increase in annual revenue from 2005 to 2009 came from. We find it came essentially within two business segments: $20 billion from services and $10 billion from notebook computers.

Specifically, HP’s “Services” business grew from $15 billion to $35 billion between 2005 and 2009. At first glance, that would appear to be a good thing, considering that HP sought mightily over the years to emulate the IBM business model of providing lower-margin consulting and outsourcing services to its business customers in order to help spread its own higher-margin hardware and software throughout the business world.

In HP’s case, however, that entire $20 billion revenue increase could be accounted for by EDS, which was doing $22 billion of revenues when HP bought it in 2008.

As for the $10 billion increase in notebook computer sales, from $10 billion to $20 billion between 2005 to 2009—well, notebooks are not the high-margin, proprietary kind of business Hurd sought to emphasize with the likes of his $4.5 billion Mercury Interactive acquisition in 2006.

Thus, we find that two-thirds of the revenue growth at HP under Hurd came from an acquisition, rather than organic growth, while the remaining one-third came from a decidedly unglamorous, commodity business not much reminiscent of HP’s printing franchise in its prime.

And revenue aside, the HP of 2009 was, in some respects, not much better off than the HP of 2005.

For starters, sales per employee dropped big-time, from $580,000 to $380,000, thanks to the labor-intensive nature of the services business acquired under Hurd.

And gross margins—the best measure of the inherent profitability of a business, and the hardest number to gin up—didn’t budge more than a few basis points during his tenure: from 23.4% to 23.6%, according to our Bloomberg.

Now, it is true that operating margins—which Wall Street’s Finest would no doubt argue reflect the real genius of Mark Hurd, ‘the execution machine’—jumped from a little under 6% to a little under 10% under his tenure.

Nevertheless, one might want to consider some of what it took to achieve that heroic step-function in profitability while sales per employee was collapsing and gross margins were staying put: what it took was layoffs, R&D cuts, and the kind of recurring “one-time” restructure charges that most investors assumed were going to disappear after the Enron, WorldCom and Lucent accounting scandals cast a pall on the use of “Non-GAAP Earnings” and “one-time” charges.

Under Hurd, annual Research & Development spending declined from $3.5 billion to $2.8 billion from 2005 to 2009. Given the rise in sales over that same time period, this resulted in a 40% drop in HP’s R&D ratio—a figure commonly used across Silicon Valley as a shorthand way to measure a firm’s commitment to new product development—from 4% of sales to 2.4% of sales.

As for “one-time” or “non-operating” charges, HP under Hurd took a whole lot of ‘em: by our math, $7.5 billion worth in the 2005-2009 period (not to mention another $2.1 billion taken in the first half of the 2010 fiscal year), including $3 billion of the kind of “restructuring” charges companies incur when doing real things, like lay-offs.

All excluded under "Non-GAAP" accounting.

Consequently, of the roughly $40 billion of operating income HP reported to Wall Street’s Finest during the 2005-2009 period, nearly $8 billion—or 20%—seems to have appeared thanks to the exclusion of costs by means of employing accounting principles which are not generally accepted by accountants.


Now, Hurd supporters, including his fans among Wall Street’s Finest, may well point to the fact that 2009 was not exactly a banner year for business, coming as it did on the heels of the worst financial crisis since the Great Depression.

And they may also point out that, whatever the details as to how it got there, HP’s return on equity rose from 6.4% to nearly 20% under Hurd, while earnings per share (using the HP, Non-GAAP method) jumped from $1.65 to $3.85.

To this, we point out that, also under Hurd, both those measures were inflated by a drop in HP’s effective tax rate, from 32% to 19%.

Also, thanks to share buybacks at high prices and large, intangible-asset-boosting acquisitions, HP’s tangible book value per share declined from a modest $6.04 per share when Hurd arrived to an even more modest $0.15 per share. (Yes, that’s right: HP’s tangible book value, as calculated by our Bloomberg, was almost zero the day Hurd left.)


So “How should we think about this?” to steal a line from Wall Street’s Finest.

How can we frame HP’s results under Hurd, which, on a superficial level go a long way to explain the $50 billion increase in market value from 2005 to 2009, but which, on deeper inspection, point to a host of issues that might well bolster the Board’s decision to say “See ya”?

Let’s look briefly at IBM, the closest “comp” to HP and a company revered by Wall Street’s Finest for its consistent earnings, free cash flow and share buybacks.

For starters, IBM’s recent stock price (at $128 or so) is within shouting distance of 1999’s $139 all-time high. That’s a better recovery from the Dot-Com Bubble than HP or any other large technology company we can think of, aside from Amazon.com. Score one for IBM.

IBM’s revenues, meanwhile, grew more modestly than the $30 billion increase at HP under Hurd—by a mere $5 billion on a $91billion base. And while IBM made no EDS-type $22 billion revenue-enhancing acquisitions during the period, it did, as did HP, consummate many small deals (the biggest being Cognos in 2008, which added almost $1 billion in sales) to boost revenue. Score one for HP.

As for gross margin, however, IBM started well above HP’s at 40% in 2005 and rose even higher, to 45.7% in 2009, thanks to IBM's focus on adding software while HP was adding services and notebook computer revenue. Score two for IBM.

Bringing things down to operating income, we find that IBM plays similar games as HP, removing charges and “one-time” items from “reported operating income”…but nowhere near of the same magnitude. Thus, despite an already-quite profitable mix of business, IBM managed to increase its reported operating margin from 10% in 2005 to 18% in 2009. Score three for IBM.

IBM’s return on equity, like HP’s, jumped—from a healthy 24% in 2005 to an absurd 74% in 2009, thanks to share buybacks and the ensuing decline in equity. And while IBM likewise reduced its book tax rate (from 35% to 26%), the boost to reported earnings and return on equity was less than HP’s. Score four for IBM.


So, again, did Mark Hurd “revive HP to its former greatness,” as Larry Ellison claims?

Far be it for anyone to argue with a man who has created more value for more people—investors and businesses alike—than maybe anybody except Steve Jobs.

And it is true that today’s HP is nothing like the HP that Mark Hurd took over. In 2005, HP’s great printer franchise generated two-thirds of operating income, while the rest came from a mix of computers, storage and services; by 2009, that ratio was turned on its head: printers were a bit over one-third of operating income, and the remaining two-thirds came from services (nearly half of operating income) and a mix of PCs, storage, and servers.

Yet while HP’s new line of printers (which can print from a file emailed from anything without printing capability, like, oh, an iPad) developed under Hurd will no doubt fortify that longstanding razor/razor-blade franchise, the rest of HP, as reconstituted by him, consists of a large, low-margin service business; a large, low-margin notebook computer business; and a handful of more proprietary product lines that don’t move the needle too much.

At the end of the day, then, the HP Board may well have been looking at more than a faulty expense account report and the potential distraction of a drawn-out tabloid-feeding legal drama.

They may have been looking at the numbers, too.



Jeff Matthews
I Am Not Making This Up


© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

Monday, August 16, 2010

My Dog Charles, “Executing His Yadda-Yadda”


One thing I found surprising this week was learning that to many H.P. observers Ms. Fiorina no longer seemed quite so bad. It was actually her strategic vision that Mr. Hurd had executed, I heard again and again [emphasis added]. Her problem was that while she talked a good game, she lacked the skill to get that big, hulking, aircraft carrier of a company moving in the direction she pointed. Mr. Hurd was a brilliant operational executive, but had the strategic sense of a gnat, and knew only how to cut costs.

—“Real Reason for Ousting H.P.’s Chief” by Joe Nocera, New York Times, August 13, 2010.



So wrote Joe Nocera, ace New York Times business columnist, in Saturday’s paper. And the funny thing is, we’ve been hearing the exact same thing about Mark Hurd and Carly Fiorina from longtime HP-ers for the last three years, as follows:

“Hurd (and this is always said in a huffy, exasperated tone) was simply executing on Carly’s strategic vision”…


...as if spending $19 billion in precious shares of HP stock to buy an aging commodity supplier of PCs—that would be Compaq—was some kind of “vision.”

Anybody using a Compaq these days?

Carly defenders also gloss over the fact that she tried to buy the computer services business of PricewaterhouseCoopers (yes, that’s the actual name) for a cool $18 billion at close to the all-time peak of the technology business cycle in September of 2000.

One of Wall Street’s Finest said of the PWC deal at the time, “Strategically, HP is focused on being a growth company. That is the critical issue here.”

Now, Gartner Group estimated that PWC’s 30,000 service employees were generating $5.6 billion a year in revenue in those heady days, which means that Carly’s “strategy” was to become a “growth company” by paying 3-times revenue at the peak of the market for, essentially, a body shop.

Fortunately for HP, cooler heads prevailed and the $18 billion deal fell apart before it could be consummated. (Not only that, but one year later, HP and PWC announced an “alliance” to do what the $18 billion was intended to do—only the “alliance” cost HP zero.)

How, one may well wonder, is it possible for spin-doctors to insist that Mark Hurd merely “executed the strategy” formulated by his predecessor? Perhaps Hurd’s $13 billion acquisition of EDS eight years after the PWC near-miss was seen as an attempt to provide what the $18 billion PWC deal promised: an army of consultants grafting HP hardware and software onto Fortune 500 companies.

And while that may be the case, there is one difference, and it is huge: Hurd paid a mere ½ of revenue and a slight 6-times cash flow for EDS, compared to the offered 3-times revenue and who-knows-what-times cash flow for PWC.

But there is a broader aspect to this issue of “executing the strategy” that was on our minds even before Nocera’s excellent piece hit our screen Saturday afternoon, and it has been on our minds ever since the latest round of earnings calls began early last month:

Just what is “executing the strategy,” anyhow? And is there a company in America that does not “execute the strategy”?

We hereby present a list—incomplete, at that—of companies that proudly announced they have been “executing the strategy” on recent investor calls in the last 30 days.


Let’s start with the company about which this virtual column began:

8/6 Cathie Lesjak, Interim CEO, Hewlett Packard

“Finally, I can assure you that as acting CEO, my sole focus will be to keep this great company focused on executing our strategy.”

Note she does not say “Carly’s strategy” or “Mark’s strategy,” but we can be assured there is a “strategy.” Let’s move on to the other companies on our list.

8/6 Thomas Mangas, CFO, Armstrong World Industries

“Certainly…we are…thinking through what is the role of the balance sheet in executing our strategy.”

8/5 Marita Zuraitis, President, Hanover Insurance

“This morning I’ll review our operating results and…the progress we’ve made in executing our strategy.”

8/5 Koppers Holdings, Walt Turner, President

“We remain firmly committed to enhancing shareholder value by executing our strategy…”

8/5 Viacom, Thomas Dooley, COO

“…we remained focused on executing our strategy.”

8/5 MF Global Holdings, Jon Corzine, CEO

“…we’re not taking enormous market risk in executing our strategy.”


Yes, that last “strategy” was “executed” by the same man who, as Governor of the State of New Jersey forgot to wear a seatbelt while his official car was being driven at high speeds over the roads his State had not been repairing thanks to the horrible state of governance by people like him. (Apparently Mr. Corzine forgot to “execute” the “seatbelt strategy” that most Americans manage to “execute” every day.)

Moving on, we find that so many “strategies” were being “executed” last quarter, we can’t quote them all. Here we go:

8/4 Terremark, ADC Telecommunications
8/3 Mastercard
7/30 Genworth, First Potomac Realty Trust
7/29 Federal Mogul, Avon Products, Dresser-Rand, Integra Bank
7/28 Nalco Holding, Jones Apparel

And there are even more, including Harley-Davidson, Weyerhaeuser, Green Mountain Coffee and Gartner Group, not to mention perennial earnings-disappointer Take-Two Interactive, which is one company that is not exactly “top of mind” when it comes to “executing strategies,” if you get our drift.

The conclusion to which we have arrived is that a) strategies are a dime a dozen; and b) all companies execute them.


Ergo, even my dog Charles could “execute the strategy” if the “strategy” was to 1) eat, or 2) sleep, or 3) jump in whatever nearby car has an open door, or 4) eat miscellaneous weeds until he throws up.

Why, just this morning Charles successfully “executed” many “aspects” of his “strategy” several times—but he did not bother holding conference calls to brag about it.


Therefore, in light of the fact that “executing the strategy” is fast becoming the most overworked cliché on Wall Street, we here at NotMakingThisUp suggest that any CEO or CFO who for whatever reason feels compelled to use the dreaded phrase to describe whatever random actions the company has been taking recently, they should simply say “we are executing our yadda-yadda,” and get on with it.

And now that we here at NotMakingThisUp have “executed our yadda-yadda,” we can get on with it.

My dog Charles would no doubt approve: he is at this moment outside our window “executing” his “strategy” to eat miscellaneous weeds until he throws up.


And he is executing that strategy very, very successfully, we might add.


Jeff Matthews
I Am Not Making This Up


© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

Tuesday, August 10, 2010

What if Dell Made Cars?


Our checks in the Taiwan PC food chain indicate order rates from the PC end market deteriorated sharply during the last part of July…

So begins a morning research update from one of Wall Street’s Finest, who in this case happens to be one of the few members of WSF who actually performs work above and beyond 1) saying “Great quarter, guys” on earnings calls, and 2) writing retrospective pieces on why they are either a) reiterating their opinion on a falling stock, with the words “Our thesis remains intact”; or b) giving up in disgust on a fallen stock whose thesis has become irreparably broken, with the phrase “We are throwing in the towel,” long after the towel should have been thrown.

But we digress.

We digress because it is fun to be able to write a full sentence once again.

The reason we can write full sentences once again is not, however, because severe carpel tunnel syndrome has caused a diminution in our ability to manipulate a keyboard, for example.

It is because our ability to manipulate a keyboard had until recently been diminished by what we call Severe Dell Keyboard Syndrome, in which the ability of certain keys on our keyboard to respond to things like finger pressure suddenly disappears, for no apparent reason, for days on end.

Yes, we generally write these virtual columns on a Dell notebook—of the type, apparently, whose order rates “deteriorated sharply during the last part of July,” at least according to the missive quoted above.

And while we have no idea if Dell is, in fact, reducing order rates (we’re told Dell’s order rates are actually “stable,” for what that’s worth), we think Severe Dell Keyboard Syndrome, along with a host of other mysterious glitches that never get talked about in glossy research reports, but which, in fact, are rather swiftly draining the so-called “Wintel” swamp of whatever water is left to drain, explains at least a part of the recent slowdown in notebook computer sales in general.

What exactly is Severe Dell Keyboard Syndrome (SDKS)? Well, for the last two days, this particular Dell notebook (two years old, tops) has refused to type an “S.”

Not to mention a “W” and a “2.”

Now, looking at the QWERTY keyboard, you can see that those three letters appear in a column, one on top of the other. Obviously, something went wrong with whatever goes on underneath the delicate keypad that is meant to trigger a response when one taps a key, expecting to see a letter appear on the screen. (And it's not dirt, or dust.)

This condition made it difficult to do things like, oh, type emails and respond to instant messages, not to mention sign onto Bloomberg and certain other critical but password-protected services that did not accept attempts to copy the missing letters from an existing Word document and drop them into the “User Name” or “Password” lines.

Yes, we actually were forced to do that, until, after shutting down and restarting a few times, the “S” key suddenly and mysteriously functioned correctly.

But this isn’t the first time SDKS has occurred: in fact, we began experiencing Mysterious Key Outages as far back as April, when of a sudden the “H,” “J,” “T” and “U” keys went out for two days.

Imagine if Dell made cars—better yet, don’t. The mind reels! Dashboard lights would go dark. Left blinkers would get stuck on, forever. Brakes would stop working, then steering wheels...t
he consequences would be staggering.

Dell-made cars would cause recalls that make the Toyota break problem look like a piker, except that the Dell problem would be real, not the imaginary hypersensitivity of a few jumpy consumers egged on by the trial lawyer lobby, as with Toyota.


Unfortunately for Dell and the other denizens of the Wintel swamp, however, internet users including yours truly now have a simple, reliable, easy-to-use non-Dell backup that we did not have in April: the iPad.

Of course, the iPad is not yet a full substitute for even this lousy Dell with the floating key-outage. Bloomberg, for example, hasn’t yet figured out how to accomplish on an iPad what Bloomberg can accomplish on even a lousy Dell.

But eventually it will get there, and these Dells and HPs and Acers will finally be relics of a time when a company with a monopoly—that would be Microsoft—could create such a rotten experience for users that even a monopoly would not stop users from fleeing when a simple, reliable, easy-to-use alternative appeared.

And “ evere Dell Keyboard yndrome” ill be a thing of the p st.



Jeff Matthe
I Am Not Making Thi Up


© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

Saturday, August 07, 2010

The Hurd Instinct: One Fiction Leads to Another


“HP had momentum…”

—Talking Head, CNBC, August 5, 2010

So it was that one of the many talking heads competing for air time with the hosts of CNBC last night summed up his thoughts—so-called—as to why the removal of Hewlett Packard CEO and Wall Street Fave Mark Hurd came as such a shock to so many people both on Wall Street and off it.

Momentum,” of course, is one of the most overused expressions on Wall Street, along with “Our thesis is still intact,” generally employed by Wall Street’s Finest when a company begins losing “momentum,” and “We’re throwing in the towel,” which is generally employed when a company has so completely lost momentum that it can no longer be defended with a straight face, even by one of Wall Street’s Finest.

“Momentum” is, after all, at once descriptive (a company that manages to “beat and raise” its earnings every quarter is said to have it), and meaningless: after all, companies always seem to have momentum...until they somehow don’t.

So to describe HP as a company with “momentum” struck us as the most singularly vacuous comment in a string of vacuous comments from the HP-defending cognoscenti called together to discuss the “shock” at Hurd’s ouster, which seemed to be everywhere.

We here at NotMakingThisUp, however, admit to no such shock.

Longtime readers know that we never subscribed to the Myth of Mark Hurd, and said as much in these virtual pages nearly one full year ago, in “Including the Good Stuff while Excluding the Bad Stuff: Come to Think of It, We Will Get Fooled Again!” from August 25, 2009.

The gist of our argument, (see http://jeffmatthewsisnotmakingthisup.blogspot.com/2009/08/including-good-stuff-while-excluding.html), was simple: by reporting so-called "non-GAAP" earnings, HP was able to include good stuff from the EDS deal (EDS-related earnings), and exclude the bad stuff (EDS-related costs).


That kind of "non-GAAP" earnings management was a practice we thought had ended with the fall of Enron, WorldCom, and the many other Dot-com-era practioners of earnings fakery whose eventual falls from grace yielded losses for investors, howls of indignation from the halls of Congress, and calls for the elimination of "non-GAAP" earnings from the vocabulary of Wall Street's Finest.

Yet HP was able to revive the practice, and make something of an art of it, with the complicity of Wall Street, its analyst community, and even the press: our Bloomberg, for example, reports only the non-GAAP earnings in its HP earnings page, without so much as an asterisk.

What prompted us last August to look at how HP had become a “beat the number” machine under Hurd?

It was a quarterly earnings report in which the company had managed to earn exactly one penny per share more than Wall Street’s Finest were expecting, despite an aging business profile and an exceedingly complex operating entity:

HP is, after all, a $100 billion-a-year company with more than 300,000 employees manning far-flung operations across the globe. Two-thirds of its revenues are derived in foreign currencies that fluctuate every day.


Not only that, but four of the company’s five major businesses experienced sales declines of 20% or more in the quarter. Of the five businesses, one looks doomed to eventual irrelevance (personal computers), a second looks doomed to brutal competition as far as the eye can see (servers and storage) and a third is exposed to the kind of technology shift that brought about the collapse of the aforementioned Eastman Kodak (printers.)

Oh, and the one business that showed growth in the quarter did so entirely thanks to the fact that the company spent $13 billion buying EDS, in a deal that closed one year ago tomorrow.

With all that going on, one might reasonably wonder how in the world it is possible for anybody, even the heroically numbers-obsessed Mr. Hurd, to beat “The Number” by the requisite penny? The answer—aside from brutal cost-cutting—is that HP waves “Non-GAAP” earnings of 91 cents a share, up nicely from last year’s 86c a share, in front of Wall Street’s Finest, thus distracting the thundering herd from actual GAAP earnings, which are more of a downer.


Like, 25% more of a downer.

That’s right: HP’s July quarter GAAP earnings were only 67 cents a share—25% below the 91 cent so-called “Number” used by HP management and Wall Street’s Finest—and down, not up, from last year’s 80 cents a share GAAP earnings.

—JeffMatthewsIsNotMakingThisUp, August 25, 2009

Yes, you are reading that correctly: merely by the use of “non-GAAP” earnings, Hurd’s HP turned a 16% GAAP earnings decrease into to a 6% non-GAAP earnings increase.

And Wall Street’s Finest ate it up.

Call it the Hurd Instinct for playing to the madness of crowds: Mark Hurd did possess a genius for it. And that genius pervades HP today, for the same Hurdesque numbers manipulation continued right up to yesterday’s press release announcing Hurd’s resignation, in which the company announced that HP managed to, somehow, “beat and raise” once again:

HP announces preliminary third quarter results; raises full-year outlook for revenue and non-GAAP EPS

HP is announcing preliminary results for the third fiscal quarter 2010, with revenue of approximately $30.7 billion up 11% compared with the prior-year period.

In the third quarter, preliminary GAAP diluted earnings per share (EPS) were approximately $0.75 and non-GAAP diluted EPS were approximately $1.08. GAAP and non-GAAP EPS were negatively impacted by $0.02 pertaining to one-time charges relating to the previously announced U.S. Department of Justice settlement. Non-GAAP diluted EPS estimates exclude after-tax costs of approximately $0.33 per share, related primarily to restructuring, amortization of purchased intangible assets and acquisition-related charges.


—Hewlett Packard Press Release, August 5, 2010


Like my dog Charles, who gets easily distracted by shiny metal objects, fleeing squirrels, lumbering raccoons or anything else that happens to cross his line of vision, Wall Street’s Finest remain easily distracted by the inflated earnings figures at HP that became a fixture under Mark Hurd.

In fact, just to make certain Wall Street’s Finest continue to be easily distracted by earnings that are not prepared according to Generally Accepted Accounting Principles, HP’s Interim CEO, Cathie Lesjack, again waved the magic non-GAAP number across the Finest’s line of vision during last night’s hastily assembled conference call to explain the Hurd outster.

Said Ms. Lesjack, when asked whether the $1.08 per share so-called non-GAAP earnings was net of the 2 cent per share charge related to the Department of Justice settlement:

“That is correct. So, apples to apples, when you look at the consensus that was set, we delivered $1.10.”

Thus the fiction of HP’s reported earnings continues, even beyond Mark Hurd.

All that said, one might very well ask—as did several of the talking heads thrashing the issue to death last night—why the mighty Mark Hurd, who built HP into a “make the numbers” machine much to the satisfaction of the lazy spreadsheet-builders on Wall Street (and the even more immense satisfaction of HP shareholders thanks to the roughly $50 billion added to the market value of HP during his tenure), was expelled from a company for some measly expense-account misstatements?

We here at NotMakingThisUp don’t know the full story, although we do know a few things about Mark Hurd that have never made it into the so-called research reports of Wall Street’s Finest (never trust a CEO who colors his hair, for starters).

But as we see it, a guy who can fool all of Wall Street’s Finest all of the time—by among other things, turning 75 cents worth of earnings into $1.08 worth of earnings through the magic of numbers prepared using accounting principles not generally accepted by accountants—could certainly convince himself that a great deal else can be accomplished through the magic of other principles not generally accepted elsewhere in life.


In other words, one fiction may reasonably lead to others.

Whatever the true story behind the story, however, one thing we know remains true: the more things change on Wall Street, the more they stay the same.


Jeff Matthews
I Am Not Making This Up


© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


Tuesday, August 03, 2010

“Buffett’s Possible Successor”? It Ain’t Over Til It’s Over


Seems like just last week the Wall Street Journal was trumpeting a successor to Warren Buffett in his role as chief investment officer (“capital allocator,” is how Buffett puts it) at Berkshire Hathaway.

And indeed it was just last week—Friday, in fact—that the Journal wrote the following about a previously little-known (outside Berkshire circles) Chinese investor name Li Lu, in “From Tienanman Square to Possible Buffett Successor”:

Twenty-one years ago, Li Lu was a student leader of the Tiananmen Square protests. Now a hedge-fund manager, he is in line to become a successor to Warren Buffett at Berkshire Hathaway Inc.

Mr. Li, 44 years old, has emerged as a leading candidate to run a chunk of Berkshire's $100 billion portfolio, stemming from a close friendship with Charlie Munger, Berkshire's 86-year-old vice chairman. In an interview, Mr. Munger revealed that Mr. Li was likely to become one of the top Berkshire investment officials. "In my mind, it's a foregone conclusion," Mr. Munger said.


—The Wall Street Journal, July 30, 2010


Now, Charlie Munger’s imprimatur is no small matter.

Munger is Buffett’s intellectual equal and has been his business partner and investment consigliere for decades—the skeptical “Abominable ‘No’-Man,” Buffett calls him.

And while Buffett buys entire companies these days without Munger’s specific input, he would no more anoint a successor without Munger’s approval than he would provide quotes for a glowing Wall Street Journal story on Li Lu as his “possible successor” if there wasn’t something to the story.

Mr. Li’s primary attribute for the role of Chief Investment Officer at Berkshire Hathaway, should that title ever be conferred on anyone but Warren Buffett, is not merely the returns Mr. Li has reportedly generated in his hedge fund—the Journal puts them at 26.4% annually since 1998, whether net or gross is not clear—but also, undoubtedly, the personal attributes that endeared Mr. Li to both Buffett and Munger, for neither man suffers fools gladly.

In fact, Munger suffers them not at all.

In addition, Mr. Li has already made Berkshire and its shareholders more than a billion dollars, thusly:

The Chinese-American investor already has made money for Berkshire: He introduced Mr. Munger to BYD Co., a Chinese battery and auto maker, and Berkshire invested. Since 2008, Berkshire's BYD stake has surged more than six-fold, generating profit of about $1.2 billion, Mr. Buffett says.

—The Wall Street Journal, July 30, 2010


BYD has also been mighty profitable for Mr. Li. In fact, BYD has accounted for what looks to be something like $360 million of the $460 million in gains recorded by Mr. Li’s hedge fund—if Friday’s article was accurate (we make no representations here).

And yet, BYD is not exactly hitting the cover off the ball these days, according to…the Wall Street Journal.

That’s right: today’s Heard on the Street contains a different side to the BYD story:

BYD's dreams are crashing into a humdrum reality.

The Chinese auto maker, famous both for its plans to market electric cars and for an investment from Warren Buffett, has hit a sticky patch. Sales are stalling, up just 3% on-year in June, according to data from J.D. Power & Associates.

In particular, sales of the F3 model, BYD's most popular car last year, slumped 30%. The compact car segment it is in has become the most competitive part of China's auto market. Accordingly, halfway through the year, BYD's made only 36% of its vehicle-sales target of 800,000 in 2010.

—The Wall Street Journal, August 3, 2010

Seems BYD had plans to build a plant in western China but “local officials are querying the legality of its land purchase there, putting the project’s future in doubt,” according to the article.

Furthermore, China’s auto market is flattening out in the wake of government efforts to deflate the Chinese property bubble.

Of course, the “sizzle” in the BYD story is not about selling conventional cars to middle-class Chinese: it is about developing lithium batteries capable of powering mass-market electric cars and storing energy from solar and wind:

Says Mr. Munger: "The big lithium battery is a game-changer."

—“From Tienanman Square to Possible Buffett Successor,” The Wall Street Journal, July 30, 2010

Now, we have no insight on whether BYD will win that race, or even finish near the head of the pack.

But Buffett watchers have learned over the years that the man who nurtured Berkshire Hathaway from failing textile maker into one of the most successful long-term investments in NYSE history can change his mind.

Indeed, longtime Berkshire followers will recall that Rich Santulli, the genius who started what became NetJets before selling it to Buffett and staying on to run the business, was once one of the faired-haired men deemed in line to take Buffett’s place as Chief Executive Officer of Berkshire Hathaway.

But late last year, Santulli was “disappeared,” in the lingo of Latin American dictatorships, and banished from the Berkshire family like a prodigal son after spending NetJets into a near death-spiral of ballooning debt and losses, about which Buffett himself abjectly apologized in his Chairman’s Letter this spring.

Whether BYD’s near-term problems herald the potential for longer-term concerns with Mr. Li, we have no clue. He clearly has the most interesting background for Buffett’s investment job, having confronted Chinese tanks at Tiananmin Square in 1989.

Also, and most importantly, he comes from where the world is moving. After all, the “Next Warren Buffett” will not likely be a young stock broker from Nebraska sitting in his upstairs room reading Moody’s manuals and S&P sheets.

Still, it ain’t over til it’s over


Jeff Matthews
I Am Not Making This Up


© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: 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. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.