MorningWord 10/2/12: Mister Softee, We Hardly Knew Ya

by Dan October 2, 2012 9:22 am • Commentary

MorningWord 10/2/12:  The financial media gets really geeked up about headlines like this one yesterday from Bloomberg: *GOOGLE’S MARKET CAP SURPASSES MICROSOFT IN EARLY TRADING.  The truth is, aside from the 24 hour financial news cycle, whose job it is to create headlines, the only people who generally care about such milestones are C-level execs at the companies of the surging stock, if for nothing other than bragging rights.  What is more interesting though, is the divergence in the 2 aforementioned stocks, as GOOG traded at a new all time high, closing up nearly 1%, on a flat day in the Nasdaq, while MSFT closed down nearly 1%, to the lowest levels since early Aug.

GOOG’s recent strength can likely be attributed to a rotation out of AAPL in the last couple weeks, as the stock made new all time highs and a completed a much anticipated iPhone5 launch, while MSFT’s recent woes are more tied to good ol’ fashioned fundamentals.

Back in March, MSFT was dramatically out-performing the Nasdaq, up nearly 25% on the year, now the stock sits about 11% lower from those levels up only ~14% ytd, and now under-performing the Nasdaq which is up nearly 20%.   There are a couple obvious factors contributing to MSFT’s recent malaise, tablet cannibalization is real and will only magnify pc-centric company’s woes in the months/years to come, Windows8 will not spur any real PC upgrade cycle, and that MSFT’s latest stabs at mobile (both tablet and smartphone) are practically DOA.  

Here is the thing though, MSFT is a really horrible short.  Other than the above, there are very few boxes to check to help build conviction to press the recent weakness.  The company generates a ton of cash, has $51 billion in net cash on their balance sheet (~20% of their market cap), has a 3.12% dividend yield, expected to grow earnings at about 10% a year for the next 3 years, and only trades at about 9x those expected earnings.

So many readers may ask, why are you long OCT Put Spreads (read here), the answer was easier when I put the short on in Mid August in the face of horrible PC data from DELL and HPQ, but with both of the stocks apparently making new multi year lows every day, the trade may now be a tad obvious.

If I go back and look at the one year chart of MSFT, the technicals may help  inform my decision as we head into MSFT’s fiscal Q1 report Oct 18th and their expected Nov launch of Windows8.

On a one year basis, the chart below shows the clear wedge that the stock is forming.  Additionally, the stock is approaching the mid-point of the 12 week range, which could serve as a massive inflection point, one way or the other.

[caption id="attachment_17336" align="aligncenter" width="490" caption="MSFT 1 yr chart from Bloomberg"][/caption]


My near term price target on the stock is obviously about $28, as I chose the Oct 30/28 Put Spread, but I would be inclined to take profits on the spread south of $29, prior to earnings, and would look for any strength post their results to re-establish put spreads for what I think will be horrible reviews of Windows8 and many products made by others to run it.

So to be clear, I am not a fan of MSFT, the stock, their products, their strategy etc etc, but the stock is a tough short here for a whole host of reasons.  That said, I want to define my risk with tactical long premium shorts when the stock is up on spikes.  Vol is reasonable enough to express directional bearish views, despite the cheapness of the stock.



MorningWord 10/1/12:  When previewing NKE’s Q3 earnings report last week we mentioned that we thought it was curious that the company, the week before their report, announced a share repurchase program of $8 billion, double the previous one.  I am by no means an expert in corporate governance, but from a purely anecdotal standpoint, I would have to guess that a disproportionate amount of these sorts of announcements do not come out while the company is in its “quiet period”, essentially closing the books for the quarter.  Conspiracy theories aside, the Stock opened up nearly 3% on the announcement on Sept19th, only now to sit 5.5% lower from those highs.  While the company intends to buy a lot of shares, investors used the enthusiasm to sell.

NKE 10 Day Chart from Bloomberg

Over the weekend there was an article in the WSJ suggesting, Beware All Those Buybacks.  Nothing particularly earth-shattering, but a good reminder that while the mechanics of buybacks are usually in shareholders’ best interests, many corporations use their corporate coffers to manage earnings, which compared to dividends is likely to be a far less attractive approach to returning cash to shareholders.

Here are a few quick highlights:

-During the second quarter of 2012, companies in the Standard & Poor’s 500-stock index repurchased nearly $112 billion of their own shares, up 32.6% from the previous quarter

-investors have to make sure that is actually happening. Many companies buy back shares purely to offset the issuance of new ones as part of compensation packages, says Andrew Lapthorne, head of quantitative analysis at Société Générale.

-On July 18, for example EBAY reported it had bought back $355 million of stock during the second quarter and would repurchase $2 billion additional shares. The primary objective, the company said, was to offset the additional shares being issued as compensation.

-On average, buybacks haven’t been a great way to boost shareholder value, says David Zion, an accounting analyst at Credit Suisse.  From 2004, when companies first were required to disclose monthly share repurchases, through the end of 2011, 31% of S&P 500 companies have seen the value of those shares fall, Mr. Zion says. And just 36% have returned more than 7%.

In Enis’s Q3 preview of AZO on Sept 18th, he highlighted the company’s history of buying back their stock, using most if not all of their operating free cash flow to do so, while also raising debt to buyback their stock since 2007.  The stock has been a monster since the lows in 2008, up almost 300% in that time period, and with a tiny float, short interest at about 4%, a whos who of long only investors, plus some famed activist hedge funds, this stock seemed like it was built for these sort of corporate shenanigans.

Make no mistake about it, you’d rather own stocks, where the company sees the same value at current levels that you do, but as was the case with EBAY mentioned above, and FB’s announcement to do the same to offset additional shares to be offered for future employee compensation is just a simple corporate shell guy, stealing from Peter to Pay Paul so to speak.