GigaOM » Kevin Kelleher Archives

Debunking the Myths About Facebook’s Stock Split

Kevin Kelleher — Sat, 02 Oct 2010 19:05:33 +0000

What is it about a stock split that sets off speculation? It is one of the most mundane and technical developments in the stock market, with little or no impact on a company’s fundamental performance, and yet news of a split can set a stock’s valuation soaring.

It’s a common enough phenomenon in the public markets and, as Facebook shows, it can happen to privately held companies too. On Friday, Facebook said each of its shares would split into five shares, worth one-fifth of its former value. It was a mere formality intended to help bring Facebook’s share price back down into the range of its peers, a move helpful in granting stock units to newer employees.

Hint: More shares don’t make a higher value

This is pretty boring stuff. And yet much of the coverage of the split made it sound like it was magically pumping up Facebook’s valuation. Some sites, which only a week ago estimated the company to be worth $25 billion, now said it was worth $32 billion. That would mark a 28 percent surge in one week, with little news besides the stock split (and David Fincher’s unflattering movie, which certainly couldn’t have helped).

Adding to the speculation about Facebook’s value was Peter Thiel, a board member who said the company was worth $30 billion. Even the Financial Times pegged the startup’s value at $34 billion, based on the prices paid on Sharespost, an online secondary-market for stocks of privately held companies.

I defer to Thiel’s knowledge of Facebook’s financial details. But I also respect common sense, which tells me that a company making $1 billion in revenue this year can in no rational way be valued at $30 billion right now. And besides, valuing a private company is more art than science, a process of building consensus among insiders, outside investors and supposedly independent appraisers. Consider that Google’s underwriters initially valued its 2004 IPO as high as $37 billion. Google debuted a few months later worth $23 billion.

Trading volume is too low to make an accurate valuation

While I also think sites like Sharespost offer a potentially valuable service by facilitating trading of privately held stock, there is a big risk in using their data to value a company. Most of the recent trades of Facebook shares that have been completed have been between $70 and $76 a share, a range that implies a value for the company between $31 billion and $34 billion a share.

But look closely, and you’ll see there have only been ten trades in Facebook’s stock so far this year. Companies can be hard to value in illiquid markets, and one trade a month is more than illiquid — it’s a drought. In such a market, two Facebook shareholders could sell 500 shares back and forth to each other and invent whatever valuation they desired. And nobody would be the wiser.

A legal loophole could create pent-up demand for an IPO

In fact, Facebook shares have been so scarce on the secondary market that there must be a substantial premium to pay simply for the right to own them. This is by design. Back in 2004, Google was pressured to go public against its wishes, in part because of a securities law that required companies with more than 500 shareholders to disclose financial data. Today, Facebook has 1,700 employees. Most of them must hold some equity in the company. But Facebook doesn’t plan to go public for another two years.

Why? Facebook created a loophole in the securities law. It handed out restricted stock units to employees that could never be sold to another person until Facebook was acquired or until six months after an IPO. Then it won the SEC’s permission to delay an IPO as long as those stock restrictions remained in place. Presumably, the few shares you could buy on a secondary market like Sharespost were issued before the restrictions went into place.

This was a cunning move, allowing Facebook to keep private and disclose only the information it wishes to. But one day it could come back to haunt the company. Eventually, employees will demand an IPO so they can cash in on their long-held shares. Then six months after the IPO, when insiders can freely sell shares on the public market, the pent-up demand will be unleashed, driving down the stock price with the sudden supply.

And if that happens, Facebook’s market value could be worth considerably less than $30 billion.

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The Return of the Tech Dividend

Kevin Kelleher — Sun, 19 Sep 2010 23:00:53 +0000

It says something about the state of the tech industry that one of the biggest stories in the sector this week is that Cisco is paying dividends to investors. They won’t start until next summer, and payments will be equal to one or two percent of the stock’s price. At today’s prices, that’s an annual dividend of 22 or 44 cents a share. Dividends aren’t unheard of in tech. Texas Instruments started paying them way back in 1962, back when the Beatles released their first record. Intel has paid dividends since 1992, and Microsoft has been paying them since 2003.

However, Cisco’s news had that tipping-point feeling to it: Would Silicon Valley — where the rule of thumb had always been high-tech equals low-dividend — start to pay more dividends? Cisco’s news came on the same day that Microsoft said it would increase its dividend from the current 52 cents a year, even if it meant taking on new debt. In other words, Microsoft was willing to pay interest so that it could pay dividends.

That reignited a debate over dividends. Some asked whether it was bad news for investors. Others thought it was a good thing. But it echoed the debate over dividends that has continued for decades. On one hand, shareholders are a company’s owners, so they’re entitled to a portion of the profits. On the other hand, profits are better plowed into creating more profits, which can enrich investors by increasing the stock’s value.

The anti-dividend sentiment prevailed in Silicon Valley simply because, since the late 1970s, tech companies have largely been growth stocks. During the dot-com boom, the notion grew even more deeply entrenched, but as IT spending remains stagnant, the idea of tech dividends suddenly doesn’t seem so absurd. There are a lot of reason why, but two stand out: Tech giants are hoarding cash, and tech giants have very cheap P/E ratios.

Cisco provides an excellent example of both trends. Cisco’s revenue grew 11 percent last year and is expected to maintain that rate this year. Its operating margins are steady around 20 percent. So, while it’s a maturing company, it’s maturing with impressive growth. Yet the price-earnings ratio has been hovering around 16, below the 20.6 ratio for the S&P 500. Other tech giants have been trading cheaply for some time as well, such as Intel, Hewlett-Packard (11) and Microsoft (12).

Meanwhile, these companies have amassed vast piles of cash. Cisco has $40 billion in cash on hand. A 2-percent dividend would cost it about $2.5 billion, or 6 percent of the total. Microsoft has $37 billion. Much of this money is overseas, and subject to currency losses if the dollar gains. The chart from Ycharts shows the different trajectories taken by Cisco’s P/E ratio and its cash on hand.

In the past, tech companies have used cash to expand operations through organic growth or acquisitions, but few want to expand organically when the forecast for IT spending is looking uncertain at best. Some are concerned that cash-fueled M&A activity has been artificially inflating the value of acquired companies; the huge premium paid for 3Par by HP offering is a good example. That creates a nice payout for startup founders, but it doesn’t make investors very happy.

Until tech stock prices start rising again, pressure is likely to continue from investors and analysts on tech companies to offer dividends, and once they start offering dividends, to raise them. Rather than winning praise as a large-cap tech stock offering dividends, Microsoft had been pressured to fatten dividend payments in the months before this week’s announcement.

There will be holdouts, too, such as Apple and Google, with cash hoards of $25 billion and $30 billion, respectively. Google offering a dividend to investors is as likely a scenario (albeit one more pleasant to imagine) as Eric Schmidt performing a strip tease at a shareholder meeting. Google has always made it clear it will shovel profits into more innovation.

However, if enough companies start offering dividends, it will increase pressure on others. One of the benefits of dividends is that it rewards long-term shareholders like company employees who’ve obtained stock through options packages. If they see their peers at a rival company getting a de-facto raise through dividends, they may start to speak up themselves.

Intel Sees Netbooks Sales Doubling in 2009

Kevin Kelleher — Tue, 14 Apr 2009 23:15:15 +0000

Intel’s smallest chip, the Atom, sits inside many netbooks. So when the chip giant reported first-quarter earnings Tuesday afternoon, it also offered some insight into the health of the netbook market. Intel executives said on a call with analysts that demand for netbooks was strong in the first three months of this year — but only strong enough to help reduce an inventory overhang that had built up in late 2008. Still, the company expects sales of netbooks to double in 2009, with Intel CEO Paul Otellini saying, “This is still one of the hot categories out there and one of the great technology stories.” As for ultra-thin, ultra-light notebooks higher up in the market, he said prices could decline this year to the point that they’re not longer just “executive jewelry.”

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Bill Gates Trash Talks Bill Gates

Kevin Kelleher — Fri, 01 Aug 2008 16:45:58 +0000

Bill Gates has so much money that pieces of his empire of investments are in conflict — over trash hauling. So like any emperor, he’s mediating a hostile takeover battle in the form of an unwanted attempt to snag Republic Services by Waste Management, the king of trash hauling, and of which Gates’ personal retirement fund owns 2.3 percent. Funny thing is, Gates’ Cascade Investment also owns a 15 percent stake in Republic. What does Bill want? It seems to be a bigger payout from WMI for Republic. Read the whole story on Earth2Tech.com.

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PG&E fiddling as the grid burns?

Kevin Kelleher — Fri, 27 Jul 2007 03:49:48 +0000

Om’s post about the power grid as the Web’s weakest link got me thinking about where utilities like PG&E are spending their money if it’s not going into capital expenditures to fix the cables that are decaying beneath our feet. I singled out PG&E because it oversaw the crippling outage yesterday and because, with a billion dollars in profits, it should have had enough money to invest in capex. Continue Reading.

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Amazon, the stock, just keeps rising

Kevin Kelleher — Mon, 28 May 2007 20:15:45 +0000

You’ve got to hand it to Amazon.com. For bulls and bears alike, the stock keeps making as many sudden and unpredictable turns as a Harry Potter novel. And it inspires as much debate as a passionate screed from Al Gore or Christopher Hitchens.

Of course, the plot turns have been much more enjoyable for the bulls in recent weeks. After reporting its earnings for the first-quarter, traditionally a sleepy one for retail, the stock rallied 40% in two days. Amazon did in the quarter what few were expecting – it showed it was serious about pushing down margins that had been eroding for quarters.

Many observers, including myself, believed that surge was just a short squeeze that wouldn’t last long. We were wrong: The stock has pushed further to $73.31 last week, another 17% gain, largely on the back of its decision to sell DRM-free music tracks.

Few stocks can make moves like that without raising eyebrows. But we all know that’s just Amazon being Amazon – the stock operates according to its indigenous logic. As it turns another page to open up a new chapter, now is a good time to ask: Is Amazon finally too expensive? To answer that, it helps to review its short history:

In 1994, Jeff Bezos stared into a browser and saw a way to radically simplify the way we all shop. The idea let him take company public; but as the stock soared and Amazon expanded, the debt piled up. Bears predicted losses piling up until they drowned the company, but Amazon turned profitable in 2002, single-handedly kindling a tech recovery in the ashes of the dot-com bust.

But the bears wouldn’t admit defeat: Amazon wasn’t a technology company but just another retailer, they said – worse, a retailer with grimly low profit margins. But Amazon forged into new technologies, many successful (S3, Web services) and some not (Unbox). The 80% gain in Amazon’s stock in the last three months should shut down the Amazon’s-just-a-retailer argument, but also amplify the debate over its stock’s value.

You can see the whole epic in a glance in its one-decade stock chart. It almost looks like Amazon’s headed back up to the territory it charted during the last bubble.

Valuation-wise, Amazon is about as pricey as it’s been ever since it turned a profit. It’s trading at 55.7 times its forward earnings, even after analysts have repeatedly upped their profit forecasts. In early October 2003, right before the stock began a slow but rocky slide from $60 to $25, its P/E ratio was only slightly higher, at 58.9.

I like Amazon as a (technology) company, and think its underlying operations are strong and poised for more growth. For that reason, I am glad to see it’s not being beaten down by the bears anymore. But also for that reason, I hope it doesn’t surge much farther away from a sober valuation.

If it does, it would give the bears and the shorts another excuse to pummel the stock. But I suppose it would also open the door to yet another sequel in Amazon and Bezos’ excellent adventure.

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Google, Sergey and 23andMe: Why it all makes sense

Kevin Kelleher — Fri, 25 May 2007 01:00:58 +0000

There is a good deal of buzz in the tech-news world about a $3.9 million investment that Google has made in a company called 23andMe, a startup in hiring mode with dreams of “helping consumers understand and browse their genome”.

$3.9 million? What’s the big deal about a company that Google is investing less than 1/750th the cash is put out to buy DoubleClick? As Eric Schmidt has pointed out, Google buys companies with “1-2-3 people and you never, never hear about them.”

The big deal is this: Anne Wojcicki, who is a co-founder of 23andMe and who is also a shareholder and member of the board of directors, is married to Sergey Brin, Google’s President, Technology and one of its founders. Sergey also holds approximately 35% of Google’s Class B common stock.”

Oh, and some of that $3.9 million is going to pay back a $2.6 million loan that Brin made to 23andMe. Also, another participant in the round of investment is Genentech, whose CEO Arthur Levinson also sits on Google’s board.

All of which has prompted some bloggers to proclaim this “an obvious conflict of interest“. After all, this is all coming to light mere days after Brin broke so many hearts by marrying Wojcicki.

Okay, but hold on. A case could be made that there is a good reason for Google to make this deal. And although I realize I may end up regretting it, I am going to make that case.

The conflict-of-interest theory holds that Google was not only willing to breach business ethics, but defiantly disclosed it in an SEC filing. And that Brin was so intent on getting this deal done that he managed to get Levinson and his company, not to mention two top VC firms (Mohr Davidow and New Enterprise Associates) to join him in his lapse of integrity.

That’s a lot of intelligence to vanish all at the same time, on the same deal. There is a lot of crazy thinking in Silicon Valley these days, but not that crazy.

Marital bliss aside, does the deal make sense? The first thing I thought of when I read about is was another deal: Microsoft’s purchase of health-care search engine Medstory in February. It was the latest of small, quiet buys Microsoft has made to get a footing in the market for consumer-oriented health-care information. Microsoft sees a big market there one day, and an investment in 23andMe lets Google chart yet another collision course with Microsoft’s ambitions.

It’s also interesting to see Google and Genentech collaborating on a deal. Both have been innovative leaders in their respective industries, and this investment could signal that they see a rekindling in bioinformatics years after the initial buzz surrounding genomics fizzled away.

Finally, I’ve been poking around only a little bit, but I haven’t yet found a company that gives Google a better entry into a genomics-for-consumers startup. There is Family Tree DNA but it’s focused more on genealogy than health. And 454 Life Sciences which is geared more toward companies than consumers, and SNPedia more of a resource than a service.

That’s far from an exhaustive list, and if anyone can find a more deserving vehicle in this niche for Google’s money, please leave your comments below.

Whatever conflicts there may appear in this deal, it’s a far cry from a $2 million birthday party for Mrs. Kozlowski. If Google wants to really organize the world information, it needs to consider DNA, the most personal of data. And what 23andMe is purporting to sell is the ultimate in navel gazing.

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Did Microsoft go lose its head over aQuantive?

Kevin Kelleher — Sun, 20 May 2007 21:30:08 +0000

I’ve been trying to find a way to illustrate just how screwy Microsoft’s $6 billion bid for aQuantive is, and here it is: For $6 billion in cash, Microsoft could have hired, in a single day, 60,000 engineers and salespeople (plus managers to make sure they earn their pay) – paying each one of them a $100,000 salary.

Of course, if Microsoft did that in one day everyone would think its executives had gone mad. After all, it already employs a modest 71,000 people around the world. Instead, it’s paying out $2.85 million for each of the 2,106 employees who work for aQuantive. Which, no matter how hard as people labor to rationalize this deal, is at the very least slightly more mad than that, if not good old-fashioned American bat-shit insanity.

Just as Microsoft was obsessed 10 years ago with an iron grip on the computer desktop – a vision that proved almost fatally shortsighted – it’s now obsessed with having a Bigfoot-sized imprint in the online-advertising industry.

Sure, being shut out by Google and to a lesser extent Yahoo has to be painful today, but the fact is Microsoft is seeding several markets that may well be just as important if not more important in a few years on: video games, online business transactions, health-care software and consumer-oriented robotics.

Still, Microsoft blunders on into online ads like a middle-aged ex-quarterback bent on reliving those glory days of high school. In the world of M&A, as in a post-midnight dive bar, desperation is a cheap cologne. If anyone smells it on you, they hold it against you. After Friday’s news, Microsoft is fairly doused in eau de désespoir.

Yet as always happens whenever something occurs that makes no sense whatsoever, there is no shortage of explanations: Microsoft lost Yahoo, so this is its last best option in online advertising. No wait, this allows Microsoft to get back into the courting dance with Yahoo. Or just maybe, Microsoft knows a bargain when it sees it.

The thing is, aQuantive is a respectable enough, if already overpriced, company. But its value has been erratic. Before the whole media-merger mania caught fire, aQuantive went from $11 two years ago to $29 in early 2005, down to $19 that same summer, and back up to $29 a few months on.

So aQuantive as an investment is kind of like John Travolta’s career: It really all depends on when you catch him. Are you getting the epoch-defining Saturday Night Fever or its unpalatable sequel Staying Alive? Pulp Fiction or Michael?

Just Microsoft’s luck, Travolta is about to headline the new Hairspray in drag. Microsoft wants a bride who resembles Doubleclick, snatched away by Google earlier this spring, but aQuantive has been dabbling all along in, shall we say, alternative revenue streams: “behavioral targeting businesses” and “creative development and branding,” and whatever those euphemisms, taken from aQuantive’s last 10-K, might suggest.

Microsoft has often been compared with Google unfavorably in recent years. One thing both companies shared in common was their restraint in spending hard-won capital. But with Google’s $3 billion buy of Doubleclick and now Microsoft’s buy of aQuantive that’s twice as large, I fear we are in uncharted territory of M&A-Land.

Well, territory that hasn’t been charted since the hyper-aQuisitive days of the dot-com years. But who would rationally choose to return to those silly times?

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(Apple) Stock Hacking & the power of DisInformaton

Kevin Kelleher — Thu, 17 May 2007 00:56:58 +0000

If you’re tired of the old cliché that information is power, here’s a new one: Disinformation is every bit as powerful.

That much we know from the mischievous email that was apparently sent out to Apple employees and that – naturally – quickly found its way into the tech-news cycle via the respected and highly trafficked tech site Engadget. The terse email said simply that the iPhone would be delayed to October from June and that the OS X Leopard operating software would not be released until January.

(Apple declined to offer any comment beyond reiterating that the email “wasn’t authentic” and that both the iPhone and Leopard are on track as previously announced.)

That was enough to cause Apple’s stock to tumble 5% from its morning high.

It took only seven minutes for Apple to fall to its intraday low of $103.42 from $108.83. Apple was trading below $105 for only two minutes, but in those two minutes more than 2.2 million shares were traded.

In the volatile 23 minutes of turmoil between the minute the disinformation hit the stock market at 8:55 PST and Apple’s announcement that the initial email “is fake and did not come from Apple,” nearly 15 million shares changed hands. That’s 60% of Apple’s normal volume in well under a half hour. That’s also an awful lot money lost for some investors – and gained for others – all of it because of a lie.

There are two things about this that are interesting: The practice itself, seeding the stock market with deceptive news that moves prices, is usually reserved for over-the-counter stocks, where a frantic post on a hyperactive message board can cause illiquid stocks to rise or fall five or 10 percent in less than a day.

But Apple, with an average trading volume of 25 million shares a day, is no penny stock. And yet, given all the hype that has surrounded the iPhone since January you’d have to think long and hard to come up with a piece of fake-news that would cause, in a matter of seconds, more investors (and Apple fanboys) to lose control of their anal sphincter muscles than this rumor did.**

The other notable twist is in how the fake news was spread. It seems someone figured out how to send an email to Apple employees around the world, putting the familiar “Bullet News” in the from line (for Apple’s sake, one hopes this is not as simple as sending an email to “everyone@apple.com”).

A week ago, I noted how H-P pre-announced key earnings data after a non-employee had been emailed access to the market-moving numbers. This incident is the dark side of the same phenomenon: An email leads to investors being broadsided with surprising news, only this time the message is false.

And the fallout? Apple reacted as swiftly and judiciously as H-P did. The SEC would do right to take this as seriously as they do backdated stock options, and look into who may have profited from shorting the stock ahead of the news.

And there is also already debate about how Engadget handled the news. Some say it just ran with what an Apple employee sent in; others say it could have benefited from double-checking with Apple. But let’s not forget that only 11 days ago, the New York Post, the country’s 13th oldest newspaper, ran the rapidly discredited news of a Microsoft-Yahoo merger. That fake news drove Yahoo’s stock up 19%, and most of those gains have since eroded away. The SEC has its work cut out for it.

But what really stands out for me in this bizarre but fascinating episode is that Apple investors were taken by a technological goof that could have happened a decade ago but that in 2007 is like being sold the Eiffel Tower. If the irrational hopes surrounding the iPhone had not gotten so overheated, this would never have happened.

Hat tip to Paul Kedroksy for coming up with the phrase, Stock Hackers

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Orbitz, the worst IPO of 2007?

Kevin Kelleher — Fri, 11 May 2007 10:00:53 +0000

We’re not even halfway through 2007 and I’m ready to make a nomination for worst IPO candidate of the year: Orbitz.

You may recall that Orbitz – the online travel site founded by five major airlines in 2000 – went public at $26 a share in 2003. It filed documents Thursday to go public again. But the Orbitz of 2007 is very different from the Orbitz of old.

A lot has happened since that first IPO. Nine months later, Cendant bought Orbitz for $27.50 a share. Cendant rolled Oribitz into its online-travel segment, named Travelport, and sold it to private equity giant Blackstone Group last summer. Now Blackstone and Travelport want to spin off Orbitz to the public market.

Orbitz isn’t a bad company, and there’s nothing wrong its spinoff. The problem is how it’s being spun off. It’s happening way too early, and with little consideration of Orbitz itself or its future shareholders.

Look through the financials in the prospectus. As Paul Kedrosky pointed out on his blog, “these are absurdly complex financials with difficult historical comparables.” After so many deals and restructurings, only its name hasn’t changed.

But there’s one simple thread running through Orbitz’ financials: Any way you slice it, the company had a net loss and an operating loss in 2004, 2005 and 2006. It used to be companies in the red couldn’t get through the IPO gates. Now most are, but they’re not doing so hot afterwards.

That’s okay, because as a fund manager buying a big stake in Orbitz, you’ll have some say in how it’s run, right? Wrong: As the prospectus says, “Travelport’s controlling holders will continue to control us and may have strategic interests that differ from ours or yours.”

So let’s see – no voting rights, a history of losses, a financial statement complex enough that a doctoral student could base a dissertation on it, and more plastic surgery in the past three years than the Gabor sisters combined – what’s not to like?

But wait. IPOs can raise capital to help companies expand with new staff, marketing and R&D. So surely Orbitz will benefit from that?

Wrong again. Take a look at this document, marked “confidential” but posted for all to see on Travelport’s investor-relations site. It’s from a presentation Travelport CFO Mike Rescoe made at a UBS investment conference Wednesday. On page 11, it notes that the IPO will happen by October, then says this:

“All net proceeds will be used to pay down Travelport OpCo debt. In addition, Orbitz will raise debt at its OpCo level, a portion of which is also expected to be used to pay down Travelport OpCo debt … We expect the Orbitz related transactions to result in a $1.3 billion paydown of Travelport OpCo debt.”

This latest Orbitz IPO is a lamb being rushed to the sacrificial altar simply to pay off Travelport’s debt. Why is Travelport in such a hurry? The answer may lie on page 12 of the UBS investors presentation:

“Additional potential paths to drive additional debt repayment include (i) follow-on sale of Orbitz shares and (ii) IPO of a combined Travelport/Worldspan and GTA business, among others.”

In other words, after wringing Orbitz dry through initial and secondary offerings and new debt, Travelport will take itself public. Travelport’s biggest and most profitable business is Galileo, which started out as Europe’s answer to Orbitz, but now includes data from nearly every airline in the world.

Given how cavalier the markets have grown about IPOs, I don’t blame Blackstone for this gambit. I actually admire its boldness. As for anyone bold enough to buy into this IPO, the payoff isn’t anywhere as sure.

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Anatomy of HP’s Earnings Surprise

Kevin Kelleher — Wed, 09 May 2007 02:00:25 +0000

Hewlett-Packard caught Wall Street off guard by essentially giving a sneak preview into its second-quarter earnings 75 minutes before the markets opened. The announcement, the result of an errant email, caught a lot of attention. But just as interesting, I thought, was the way it all unfolded.

H-P was supposed to deliver its earnings a week from tomorrow, but an unnamed employee emailed financial information from the quarter to clients to an unnamed recipient. It must have been to someone who could easily have shared the info – a reporter, an analyst or a well-connected investor – because H-P hustled to release “guidance” before the markets formally opened.

H-P did the right thing, of course, and it’s hard to think of how a company could have reacted better. But the incident reveals two interesting aspects about how companies have come to handle financial information and how the markets are able to react immediately.

Let’s take the market’s reaction first. H-P’s announcement rolled across Business Wire’s feed at 8:45 a.m., EST (when even Om was still asleep.)

H-P said its latest quarter’s revenue would be between $25.50 billion and $25.55 billion and EPS of 69 or 70 cents a share. That’s basically revenue 3.9% above the mean forecasts of analysts, and EPS that is four or five cents higher than the 65 cent estimate – a fairly substantial surprise. It also said EPS in the current quarter would be two to four cents higher than the 61-cent estimate the Street had guessed.

The chart below, using Google Finance’s nifty pre-market charts, shows what happened next. Within a minute, there were 128,600 shares traded in pre-market trading. That is, investors who saw the release had one minute to re-value the stock based on the unexpected numbers.

By 8:46, the stock had shot up 2.7% to $44.92 a share. That’s not a huge percentage gain per se, but for a stock as large as H-P’s, it meant $3.2 billion injected into its market cap in one minute.

After the stock opened, sell orders more than made up for buying demand at first, but throughout the day, as investors had a chance to digest the new numbers, the stock recovered to $45.01, or only nine cents higher than the initial valuation accorded to H-P’s stock only moments after its announcement was revealed.

That’s a pretty nice example of quick thinking on someone’s part.

The other aspect that H-P’s action illuminates is just how ridiculous the ritual has grown surrounding the quarterly earnings report. This is hardly unique to H-P, but part of the culture of Wall Street. H-P insisted on using the term “guidance” but they have essentially announced most of the key numbers everyone was waiting for.

Couldn’t H-P have just delivered its actual announcement a week early? Maybe not, if all of the details haven’t been confirmed. Even so, it’s going to look very silly next Wednesday when H-P goes through the old sclerotic ritual – the tedious conference call and its perfunctory chants (“We are encouraged by these financials,” “Great quarter, guys,” etc.) – where executives, analysts and reporters act their parts even though they know now the play’s happy ending.

It feels a little archaic that, in an era of realtime information and ever-improving financial-management software, companies still adhere to the decades-old practice of announcing financials once a quarter. In 2007, the market can adapt to a big surprise in one minute, yet companies are disclosing financials as if it were still 1957.

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Wall Street stumped, surprised by Internet Cos

Kevin Kelleher — Sun, 29 Apr 2007 07:00:10 +0000

ANALYSIS (Q1 2007 Earnings Season): Internet companies are playing a game of stump the analysts. And they’re winning.

For the second straight quarter, the research desks on Wall Street have significantly and pretty consistently fallen short in their earnings estimates.

This is no small matter for analysts. Their job is to query the company, talk to its customers and crunch its numbers to distill it all into a single number: an EPS forecast that, if short by a penny or two is no big deal. But a forecast off by 23 cents, as happened with Apple this quarter – well, that can cost clients money. And clients hate to lose money.

Take a look at the graph below. With the exception of Yahoo – whose earnings were among the few tech giants to disappoint Wall Street this quarter – all of their net profits came in at least 9% ahead of the consensus of analyst estimates.

The biggest surprise of all – in every sense of the word – belonged to Amazon, whose 26 cents a share profit was 11 cents, or 69%, above the 15 cents the Street had been forecasting. Most analysts had given up hope that Amazon’s profit margins would ever rebound, with some arguing the company was no different from an old-fashioned bookseller.

Boy were they wrong. Amazon’s net profit more than doubled while its ever-scrutinized operating margin expanded thanks to some spending discipline. Piper Jaffray downgraded Amazon’s stock a day before its blowout earnings. Amazon’s stock rallied 40% in the next two days.

Even Microsoft, which many had assumed was aging into a steady machine of predictable profits, took the Street by surprise Thursday. All of the 34 analyst forecasts were calling for EPS in a narrow range from 45 cents to 47 cents. Microsoft’s number came in three cents ahead the highest of all those forecasts.

Nor is this parade of surprises a one-quarter aberration. In January, when the same companies were reporting earnings for the fourth-quarter of 2006, it was Yahoo who had the biggest surprise. Apple followed closely behind. All of the others had surprises that were at least 9% above the consensus.

What’s going on? Most of these companies were easier to predict a year ago, when the surprises were much more modest. Did they suddenly become harder to read?

Part of the disconnect is due to analysts, who were probably inclined to paint the tech sector with a broad brush, one that foresaw a market slowdown. A slumping housing market was expected to spill over into the economy at large. Overall profit growth this year was expected to be half the 14% rate of 2006.

Within that mindset, most analyst expected some tech giants to come up short: One or two might surprise to the upside, but surely not all of them. But companies like Amazon, Microsoft and eBay, under pressure for years to rein in spending while ensuring past spending would translate into present growth, were starting to deliver.

All of this is good for contrarians and for spectators like us in the press. Aside from Yahoo, these companies have in aggregate several tens of billions of new dollars in their stocks that weren’t there a couple of weeks ago.

But it makes life tough for analysts. Having resuscitated their reputations after the excessive antics of Blodget, Grubman et al, they are now facing a new crisis: Relevancy. If they don’t get a better handle on earnings of the biggest tech names, it won’t be hard to forecast the impact on their own income.

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Steve Jobs, saved by the rising stock

Kevin Kelleher — Thu, 26 Apr 2007 10:00:40 +0000

Thursday will mark a red-letter day for Apple: For the first time its stock will rise above $100 a share, a tenfold increase in a little more than three years. Think about that: If Google had risen that much since its IPO, it would be trading at $850.

Apple’s stock was trading at $102 in aftermarket trading Wednesday, a 7% surge above its formal closing price of $95.35. Unless something big happens overnight, Apple’s stock is likely to see a similar jump Thursday.

And why not? The company posted a net profit of 87 cents a share. That’s 85% above the 47 cents a share in the year-ago quarter and 36% above the consensus forecasts among analysts. This is a textbook case in a blowout earnings report and reason to wonder why analysts bother with Apple estimates.

Unfortunately, the success will also probably keep CEO Steve Jobs from facing deeper scrutiny for the company’s backdating scandal, an omission of clarity that could cause harm far beyond Cupertino.

The future looks just as bright. Sales for Mac products were up 36% year over year, substantially faster growth than in iPods and iTunes, which were up 25%. Apple is successfully broadening away from dependence on music products, a trend likely to strengthen later this quarter with the introduction of the iPhone.

The report caps a week that will probably be remembered as a milestone in the apotheosis of Steve Jobs. Looking past Apple’s earnings and its
stock price, it’s getting harder and harder to pretend that Jobs didn’t violate securities law in the options-backdating scandal facing the company.

The SEC filed civil charges this week against Apple’s former CFO Fred Anderson, who has settled with regulators, and its former general counsel Nancy Heinen. Then Anderson, who might just as soon put the episode behind him, took the extraordinary step of issuing
a public statement saying Jobs misled him on board decisions on options and that Jobs knew about the risk of a backdating charge.

Mark McQueen, CEO of Wellington Financial, a firm that manages $400 million, summed it up well on his blog

“When was the last time in recent memory that a corporate scandal led to very serious charges being brought against the CFO
and General Counsel, but not against the CEO? … It’s curious that a former Apple CFO pointing fingers isn’t sufficient for the
Securities Exchange Commission to proceed against Steve Jobs.”

Anderson’s version of events actually makes sense, given Jobs’ reputation as a control freak and his instrumental role in using options to lure in talent after he returned to Apple. But Jobs is unlikely to face any action from the SEC, even though Anderson’s statement is begging for a deeper probe.

Why? Ask any attorney who has left the SEC’s enforcement division in the past few years. They’ll tell you the department is well-intentioned and talented, but criminally understaffed and toothless. They took on Anderson and Heinen to set a high-profile example in the options scandal, which involves more than 100 companies.

But they didn’t take on Jobs. And the Justice Department, which may be looking into the Apple as well, is unlikely to either. He has become, more than any American businessman, an icon of success. It’s like throwing the golden goose under the train. There would be a massive revolt among Apple shareholders.

It was a similar case with Mark Hurd, who accomplished the near impossible by turning around H-P. When it became clear he was involved in the pretexting scandal, ethicists suggested he should step down. Shareholders said he shouldn’t, and they won.

I like Steve Jobs. As a consumer, I’m grateful for his achievements at both Pixar and Apple. But I’m troubled by the very real possibility he participated in options fraud and is being treated as above the law. Otherwise, regulators are sending a disturbing message to tech
executives: As long as your stock is soaring higher, you can dabble in whatever scandals. If we ever get back in a bubble – when all stocks are surging, not just the deserving ones like Apple – that thinking will cause a lot of accounting messes.

An open, clean investigation would prevent this: If Jobs is innocent, the debate is over. If not, he makes amends while shareholder support
will keep him as CEO. Either way, this image of Steve Jobs as above the law, a toxic one for the stock market, would go away.

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Don’t Blame Panama: The Real Threat Facing Yahoo

Kevin Kelleher — Wed, 18 Apr 2007 10:59:07 +0000

Taking a look at Yahoo’s first quarter number, one word comes to mind: heedless.

Not “heedless”, as in Yahoo executives who led the Street on until it believed that, thanks to its vaunted Panama search technology, revenue and profits would surge in the first quarter of 2007. Or even “heedless”, as in investors who had gotten a little ahead of themselves by betting that Panama would deliver sooner than promised.

No, Yahoo CEO Terry Semel was clear on that point a quarter ago: “The first time we see any benefit will be at the end of the second quarter,” he told the New York Times. “Every quarter thereafter we will start to get better.”

Despite that cold dose of reality, Yahoo bulls bid up the stock 19% since that cautionary interview. It could charitably be written off to long-term optimism. But today, people are slamming Yahoo for getting it wrong.

“Yahoo recently overhauled its online advertising system, giving some investors hope for a positive earnings surprise. So far, that hope hasn’t materialized,” the Wall Street Journal wrote Tuesday. Who knew?

Any selling Wednesday on Yahoo’s first quarter results may miss the point. Yahoo could be facing tough times in 2007, but not because Panama didn’t lift profits in the first quarter, but rather because of something that happened last week: Google is finally getting serious about banner ads.

The real threat for Yahoo is that it could well remain on the wrong side of the profit pendulum. Here’s what I mean by that.

Yahoo was a big player in search before Google came along. But it didn’t capitalize enough on that position. Instead, it focused on branded ads (a nice way of saying banner ads – something that regular Web users have learned to either ignore or block, but not enough for Yahoo or, now Google, to care.).

Want to know the dirty little secret of Yahoo’s stock? It’s this: In the two years before Google went public, its stock rallied 376% to $28.61 from $6.01. As of Tuesday, before Yahoo’s first quarter 2007 report, it had risen another 12% to $32.09.

That’s partly because, before Google IPO, investors had nowhere else to put their money than Yahoo. Then came Google, who knew better than Yahoo how to make ad money off search results: that is, no banner, only text ads that maybe, just maybe may be relevant to you.

In other words, the pendulum swung. Search/text ads grew like crazy even if banner ads grew at a more-than respectable pace. Yahoo realized it had to match Google in its intuitive search algorithms, so it began to hatch Panama. It wasn’t an easy proposition. There were critical delays.

Still, Yahoo remained clear about Panama’s timing, warning investors if it would release later than expected – which is more than Google did for the un-beta release of Google News or that Microsoft did for … well, pretty much anything Microsoft ever did. No one ever called Panama vaporware.

And they shouldn’t today. Because the real risk for Yahoo is that Panama is finally catching up to Google right as Google is catching up to Yahoo in its core market of branded – er, banner – advertising.

This could go either way: If you’re a true believer in Google’s instincts, banner ads (along with video ads) will catch up with its text and search ads. But if Yahoo has been right all along, Google is essentially leveling the playing field to Yahoo’s advantage.

The antitrust concerns about the DoubleClick buyout are off mark, but I do wonder if they may help tip the balance from Google toward Yahoo.

Take Semel Tuesday on Yahoo as a alternative to Google: “We have heard concerns from various advertisers, ad agencies and others,” he told Reuters. “My guess is there’ll be some who are fine and there’ll be many who, perhaps, aren’t fine. That’s up to them.”

So it is. Everyone else, place your bets now.

Who will be the real heedless: Investors in Yahoo, which loses ads to Google because of its superior ad-personalization algorithms? Or investors in Google, because Yahoo’s Panama eats into its search pie, while the DoubleClick deal prompts advertisers to defect to the prime alternative, Yahoo?

Thank you, Internet gods. Just maybe, it is once again a two-horse race.

Kevin Kelleher is a writer living in Berkeley, Calif. He has a regular stock column at TheStreet.com and is a contributor to Wired, Business 2.0 and Popular Science. He has previously worked at Bloomberg News, Wired News and The Industry Standard magazine.

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What’s Weighing Down Google’s Stock?

Kevin Kelleher — Fri, 13 Apr 2007 12:00:23 +0000

A funny thing is happening to Google on the way to near-certain immortality. Its stock, it seems, is as fallible as any other.

Consider the year-by-year appreciation of Google’s stock price:

2004: Up 126.8%, from the offering price of $85 to $192.79.

2005: Up 115.2% to $414.86.

2006: Up 11.0% to $460.48.

2007: Up 1.5%, as of April 12.

Google, which joined the S&P 500 a little more than a year ago, has since failed to outperform that index: The S&P 500 returned 16.5% in 2006 and is up 2.1% this year. So after two years of glorious gains, Google has since lived a life less ordinary.

What’s going on here? It’s well known that Google’s revenue growth rate is slowing, as it does with any company that is getting larger. But it’s not as simple as that. Google’s profit margins are rising. And investors can be awfully forgiving about slowing revenue growth if margins are getting fatter.

Whether or not you factor in traffic acquisition costs, Google’s revenue percentage growth has slowed from three digits to two in recent years. But its operating margin has risen to 33% in 2006 from 20% in 2004 (the year of its IPO), while its net profit margin has risen to 29% from 13%.

But as any investor knows, there are other factors besides profit growth at play in stock performance: things like financial transparency, speculative trading and liquidity. All of these have buffeted Google’s stock at one time or another since it went public, but liquidity – that is, the balance or imbalance of supply and demand for its shares – is right now the determining factor.

One event that is having an underappreciated impact on Google’s stock is the secondary stock offering in September 2005, which added 14.2 million shares to the 19.6 million already in the market. That offering began a gradual tilting of the balance-o-meter of Google stock in favor of supply over demand.

Demand for Google remained high in 2005 as the company blew away earnings in the third quarter ($1.51 a share vs. the Street’s estimate of $1.36) and Net stocks in general rallied toward the end of the year. But think about this: Google ended the first week of 2006 at $465.66. If you bought it 15 months ago, you haven’t made money.

The supply caught up with demand. If anyone was hot on Google, thinking it might fulfill the orgiastic fantasies of analysts who had a $2,000 price target on the stock, there was always someone more than happy to sell shares to them.

Google added to the supply of shares when it bought YouTube for $1.65 billion in a stock acquisition. Google’s 10-K says it issued another 3.2 million shares for that. Since those stocks were issued on Nov. 13, the stock has traded flat to down.

Then there are all those stock options that are starting to trickle into the total number of Google outstanding shares as they are vested and exercised. In a thoughtful article Wednesday, the San Jose Mercury News asked whether employees who are receiving the last of their four-year allotments of Google’s pre-IPO options will bolt.

The story pointed to the obvious cultural and HR questions that such events raise: will Google’s valued veterans move on to create startups that could steal Google’s thunder? Will a class-system emerge where wealthier employees are resented by the newly hired? Google, as you’d expect, is making intelligent moves to stave off these problems.

But from a liquidity standpoint, there remain problems. On the one hand, exercised options add to the number of stocks outstanding, further dampening demand. On the other, a stagnant stock price – like Google has seen for five quarters – could deter new hires who are motivated by the lure of options gains.

Google could solve this problem the way most tech companies do: by buying back its stock in the open markets. At nearly $500 a share, that’s a pricey proposition. And it would betray the company’s oft-declared intention to invest only in future growth, not its stock.

In the now legendary “Owners Manual” that Larry and Sergey penned for shareholders, Google swore that it wouldn’t care about capital gains as much as “doing no evil” and “making the world a better place.”

Now, like so many tech giants before it, Google is faced with the unsavory reality of taking cash that could be spent on its future and instead spending it on the unglamorous reality of stock buybacks. Whether it makes this move or not will have, in time, an increasingly bigger weight on investors and employees, past and future.

Kevin Kelleher is a writer living in the San Francisco Bay Area. He has a regular stock column at TheStreet.com and is a contributor to Wired, Business 2.0 and Popular Science. He has previously worked at Bloomberg News, Wired News and The Industry Standard magazine.

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