A look at developments in the financial markets over the last week or so.


Amazon Bought This Man’s Company. Now He’s Coming for Them
Jet is an attempt at reinventing the wholesale shopping club – online. The wholesale shopping club model has been well-proven by the likes of Costco and Sam’s Club, but it remains to be seen if this success can be replicated online.
After a 90-day free trial period, Jet customers will be asked to pay $49.99 a year for access to what Lore claims will be prices that are 10 percent to 15 percent lower than anywhere else online. Like Costco (COST), Jet plans to make money on membership fees.

Why the Google downgrade is a year too late
A bullish look at Google using information from a recent downgrade by an equity research group. The downgrade was based on the idea of multiple contraction – Google’s growth is slowing/less certain and so investors want to pay less for it on a multiples basis (for example on a price-earnings basis). The author flips this logic around and compares Google to the likes of Kraft, showing that on a multiples basis Google actually appears to be trading at a discount to a number of stable, slow-growing companies.
The post focuses on Google’s market value rather than its fundamentals, so it’s worth noting the following two points on its business model:
Bullish: Google’s rumoured expansion into financial services, including auto insurance. New businesses aside, Google is still growing. It has strong return on equity and capital, so a continued price drop could offer some value.
Bearish: “The mobile revolution is putting more pressure on Google to build up “vertical” search engines for specific categories, since smartphone users are being trained, for instance, to go direct to Amazon’s app to buy products, or Expedia’s app to book a flight or a hotel room. If Google doesn’t provide more efficient services that cater to particular types of searches, it risks being cut out itself.

Bed Bath and Beyond Third Quarter and Nine Months of Fiscal 2014 Results
The company announced its third quarter numbers last Thursday. Sales and profit figures were flat year-on-year, and the stock dropped ~7% the following day. Bed Bath and Beyond (BBBY) is a mature business in a saturated market with strong competition from online retailers. However, it is also very cash-generative, has industry-leading margins and continues to return cash to shareholders through a massive share buyback program. Some thoughts on BBBY as an investment:

  • The company is still growing and is quite profitable, although margins continue to shrink and growth is relatively flat. It’s also been shown to be able to compete with Amazon on price.
  • BBBY is highly cash generative, which gives it a number of options to increase shareholder returns. There are three primary ways in which it can do so:
    • Acquisitions – the company is in a position to make relatively large acquisitions without raising debt, as it did in 2012 when it purchased Cost Plus World Market ($560 million) and Linen Holdings ($108 million) for cash. Related to this is the possibility of international expansion, as it currently only operates in the US, Canada and Mexico (It does ship internationally).
    • Investment in its online offering and technology – the company continues to invest strongly in this area, including improving its websites and distribution facilities; and leveraging technology to improve its logistics and omnichannel customer experience. Until recently BBBY had a very weak online offering compared to its competitors. As such, success in this space could have a relatively larger effect on its valuation, as many of its competitors already have their online success priced into their shares.
    • Share buybacks – this is the primary consideration for any investor looking at the stock. Over the past few years, management has returned ~100% of the company’s free cashflow to shareholders by repurchasing ~10% of its shares each year. The company recently issued debt at a low coupon to perform an accelerated share repurchase at a depressed price (~$61/share). At this rate, the company will repurchase itself within a decade.

There are a number of negative issues facing the company: slow growth, shrinking margins and management not having reacted fast enough to online retail trends. The question is: is the company in a position to address these negative issues over the next decade and continue its ~10% share repurchases each year?

Upcoming IPOs
There are a number of interesting IPOs coming to market. Here are two that are interesting, although no pricing or timelines have been provided yet.

TheTrainline.com – this is the leading online rail ticketing platform in the UK. It’s offering is strong, and there are opportunities for expansion into other products (it provides hotel and car rental booking now too) and markets (it plans to expand into Europe).

Virgin Active – the company operates gyms in a number of countries, and will most likely list in South Africa on the JSE – an indication of the importance it places on that market. The gym (subscription) business model offers steady cashflows, which could translate into a solid dividend.


Negative yielding eurozone debt swells to €1.2tn
A look at a new “asset class” created by the European Central Bank (ECB) over the last few months – negative yielding deposits – charging depositors for keeping their money safe. A number of reasons are given for central banks doing this, the question is whether it will work.
One of the possible effect is higher equity prices as investors continue to chase yield. Declining government bond yields affect corporate bond yields. There are a number of companies now able to issue bonds with ~1% coupons. Unattractive bond yields lead investors to look for yield elsewhere – property and dividend stocks for example.
Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero.

Thinking About International Bond Yields
How can it be that interest rates on U.S. government bonds are so much higher than on European bonds — not just German bunds, but even Spanish and Italian bonds are now paying less than their U.S. counterparts… Is the U.S. government really a riskier bet than that of Spain?

Long Reads

The Red Queen Effect
An evolutionary hypothesis proposing that organisms must constantly adapt and evolve, not only to gain advantage but also to merely survive as they compete against other ever-evolving organisms in an environment that is constantly changing. Essentially, running faster just to stay in the same place. The hypothesis was initially used to explain the evolution of organisms, but can equally be applied to in a business context.
Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide. Viewed individually, each company’s capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralised each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes). After each round of investment, all the players had more money in the game and returns remained anaemic.” – Warren Buffett

The Simple Concept of Intrinsic Value
This post provides a simple framework for evaluating companies before buying stocks. Simply: “What can the business earn? And…How much is that worth to me?


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