@Royal_Arse Asks

Nature, Sports, & Money: Cycles of Life.

Equity Style Variance As Tool for Tactical Asset Allocation

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There is plenty to observe in this chart. The primary thesis is summarized in the top right hand side: does buying by value investors (relative to all stock investors) indicate a high likelihood of stocks outperforming bonds? Over the past three years there is some evidence that eager buyers of value stocks signal bottoming in broader stock market, thus sell bonds, buy stocks.

UPDATE: Bottom Fishing Comstock Resources $CRK as Classic Value Play?

On Feb 7th I published a post analyzing the merits of buying $CRK.  It can be found here.

After a 2-day dip buyers promptly rushed in at higher prices moving $CRK modestly higher over the next few weeks.  Then, on Friday March 15th $CRK announced the sale of a significant asset. 

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The details of the sale: Comstock Resources sells all of its 40,200 net acres in oil-rich Delaware Basin to Rosetta Resources Inc.

The oil-rich assets are in West Texas and the total proceeds of the sale are ~$768 million. Note that Comstock has ~$2.6 Billion in total assets (vs. $1.3 in total debt), so this cash infusion represents a significant influx for the company at a time when investors were penalizing the stock for being over-leveraged. 

Proceeds from the sale will be used to reduce its outstanding debt and to fund an increase to its 2013 drilling program in the Eagle Ford shale. Capex was down for 2012 since they were in a tight cash flow position, so we can expect production to ramp up as Comstock is no longer as restrained in their CAPEX.

Production impacts:

Total oil production in 2012 was 6300 Boe/d.  The asset sold was roughly 25% of their oil production and 1% of total natgas.  However the cash will be used to enhance production elsewhere and over time their substantial reserves will be tapped to fill the output gap created.

Market Loves the Sale:

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Bottom Fishing: Comstock Resources a value pick? $CRK

*Originally published on 7 Feb 2013, for an update on 16 Mar 2013 please click here.

The idea behind this trade is buying an out-of-favour security with a reasonable probability of turning their string of quarterly EPS losses into gains in 2013.

Comstock Resources is an oil and gas company in the energy-production friendly US jurisdiction with all of their assets on-shore.  The stock traded around $30 for most of past 6-7 years despite a brief rip to ~$90 during 2008 oil rally.  Technically it is setting up a nice pattern for a long entry with well-defined buy/stop loss levels.

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The fundamental case has both pro’s and con’s.  Asset quality is average-to-above average, but cash flow has been negative and they are indebted heavily.  If they can get their operations in order the consensus sees profits in 2013 which could be a major upside catalyst.  
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Disclaimer: No position in $CRK.  This is not investment advice.  Do your own research and consult with a qualified investment professional before purchasing any security.  The purpose of this post is to encourage discussion about the merits of bottom fishing and/or value investing and is for educational purposes only.  

MUTUAL FUNDS vs ETFs: INNOVATION IN THE FUND INDUSTRY

FROM MOVING SCRAP TO PUSHING PAPER: What is the best fund option for my investments? 

SUMMARY:

 The trend within the financial planning industry is towards greater adoption and usage of exchange-traded funds (ETF).  Many advisors and investors have warmed up to their low costs, simple diversification, and potential tax advantages.  While an ETF does not always serve as a direct substitute for an individual stock, bond, or actively managed mutual fund, it has rightfully earned a place in the portfolio of many savvy investors.

 

Our dynamic economy changes by the minute with each industry moving at different speeds.  The smartest firms compete the hardest often end up with a game-changing innovation that forces a paradigm shift unto the world.  The laggards bemoan their struggles caused by a reluctance to venture into new and previously undiscovered territory while the leaders stride ahead to confidently face the next challenge.

The financial sector has taken due pressure from regulators, shareholders and others following the financial crisis for creating and selling the ‘Financial Weapons of Mass Destruction’- derivatives!  Insiders know these securities themselves are not inherently evil, but that didn’t stop the media from running with a good story.  It’s a shame that as the ETF industry was reaching critical mass in the United States their housing bubble was bursting.  It overshadowed the remarkable success of ETFs and the dynamism between investors and their wealth.  When they put cash back to work following the Great Financial Crisis, investors chose ETFs as the vehicle with stunning abundance. 

In the US, ETF inflows from 2000-2007 totaled over $500 Billion USD, raising assets under management (AUM) from $80 Billion USD to nearly $600 Billion USD.  In that period the total number of ETFs listed in the US went from 81 to over 600.  After a slight lull in 2008 & 2009, growth of total AUM and number of ETF offerings shot up over 50%, now boasting 1000+ different vehicles stewarding well over $1 Trillion USD in capital. Image

Globally the story is the same for over 200 ETF providers on 54 exchanges worldwide: in the first half of 2012 ETF assets have increased by 11% from US$1.35 Trillion USD to $1.5 Trillion. In early 2013 ETP’s surpassed $2 Trillion in AUM.  This capital flow is indicative of numerous trends in the markets, many of which will be discussed here.

First a comparison of two very familiar businesses: Canadian investment funds and internal-combustion engine automobiles.  Astonishingly neither has changed much from their original incarnation.  Nips and tucks around the edges perhaps, but the obvious limitations of mutual funds & automobiles put them at risk.

POWER AND INGENUITY 

Over a century has passed since a near-deaf Thomas Edison shouted in a young Henry Fords’ ear, “Yes, that hydrocarbon, an excellent fuel!” and our cars perilously burn the same noxious petroleum.  The automobile industries’ absence of innovation has left them some vulnerable to slumping sales, government bailouts and public acrimony.  Readers of this passage familiar with the financial industry will immediately see the paralleled plight.

Both the Canadian fund management and automobile industries manage titanic amounts of financial and intellectual capital.  Heavy investment in existing operations can prohibit these goliaths from pivoting swiftly in response to changing market dynamics as plants, parts and people too familiar with time-tested procedures operate comfortably numb to new ideas and competitive threats. 

However, as the likes of Tesla, T. Boone Pickens and others embrace the emerging trends in alternative fuels, so goes various ETF providers in relentless pursuit of alternative investments.  Spirited innovation and progress has brought investors a suite of ETF options that offer diversification and value-for-money in a time of dire need.

OH NO CANADA: Funds and Fees

Fees are a 100% ‘tax’ on your capital.  While it is accepted and understood that prudent investment management is worth paying for, clients should be mindful of how fees impact their returns.  Canada is a notorious jurisdiction for mutual funds fees.  Over the past decade competition has decreased average MERs, but it remains stubbornly north of 2% overall and lags behind all of developed economies. 

Savvy investors’ aversion to these prohibitive fees created a gap that ETFs are bespoke-tailored to fill. With meaningfully lower MER’s (ranging from less than 25bps to +80bps) ETFs can provide similar market exposure at markedly reduced costs.  A hypothetical investor with $100,000 stands to pocket $1500 tax-free in unpaid fees per annum (MF fee 200bps = $2000 per year vs ETF fee 50bps = $500 per year) by switching from mutual funds to ETFs. 

Intuitively we know unpaid fees are a benefit the growth of our savings.  This money remains invested and accrues interest & dividends adding significantly to long-term capital appreciation. However, the magnitude of this positive impact is far greater during periods of ultra-low interest rates as some bond instruments may yield less than the MER of the fund!  Starting off ‘in the hole’ leaves average investors little chance of positive absolute returns in difficult markets.

There is plenty of room to run for ETFs in Canada. The distribution of investable assets heavily favours mutual funds.  BMO estimated recently that only 5-7% of fund allocations are in ETFs.  The massive expansion possibilities for this market have banks and stand-alone ETF providers (now 7 in total, offering 200+ ETFs on TSX) jostling for market share in a burgeoning arena. The industry has exploding in popularity with AUM growth rates of 20% year-on-year over the past 5 years; few question that this trend will continue.

LOW COSTS: BUNDLING 

Another cost advantage arises when considering brokerage commissions on purchase and sale of ETFs vs. stocks.  If an investor seeks exposure to the Technology sector they may purchase dozens of different individual securities prior to achieving sufficient diversification.  An ETF tracking a similar basket, or index, of tech companies can be acquired with a single transaction and achieve instant diversification.  The simplicity and savings are driving factors in ETF adoption.

USING ETFs FOR ANALYTICS

ImagePerhaps an unintended benefit of ETF adoption is their value as a tool for gauging market sentiment.  For example, comparing sector-specific ETFs against one another over time becomes a valuable tool.  By measuring the relative strength of these securities and reporting their activity to other investors many small boutique research firms have flourished.

 

FLASH CRASH & PAPER CLAIMS

Some are critical of ETFs going as far as to blame them for the flash crash.  Others, often precious metal fans, portray ETF providers as straw men who may or may not hold the underlying security in question.  Their effort to undermine ETF’s is largely misguided.  Like the mutual fund industry ETFs are heavily scrutinized by regulators and savvy investors.  As they approach $2 trillion in assets worldwide people are displaying their trust in this asset class — by buying ETF shares.

Investment management firms and financial institutions are churning out new ETFs with increasing breadth and specificity.  The combinations are endless allowing unimaginable diversification with great ease.  Advisors have constructed index ETF portfolios with 6 or fewer holdings that give the investor access to 1500+ underlying securities for as low as 10-20bps.  Active ETF’s are have also emerged where for a slightly higher MER, say 60-80bps, you gain the added professional management and asset allocation from a firm (or individual) acting as sub-advisor to the issuer.  Competition further driving down fees (as we’re witnessing in the US) suggests a structural change in the investment fund industry is upon us. 

ETF’s at Work: TAX ADVANTAGES BY CREATING ASSETS WITH TACTICAL PLANNING

Sound tax planning is a cornerstone of good investing. Paper-based returns are flashy, but the bottom line — after-tax returns – pay the bills.  Generate alpha for show, tax plan for dough.  Many are familiar with tax-friendly options for mutual fund investors with non-registered assets.  Corporate class funds for example helpfully eliminate deemed dispositions during tactical re-balancing of a portfolio.  How can ETF’s be utilized in a tax friendly manner? 

Tax Loss Harvesting:  this strategy is a swap of like-for-like asset to record a capital loss.  It is a risk- and asset allocation-neutral rebalancing with low costs and high potential rewards, in this case using corporate bonds (a segment of the market which is heretofore uninhabited by most retail investors and many advisors). 

Through greater liquidity, access to institutional bond pricing, and reduced risks via broad issuer diversification overall returns can be enhanced.  In practice corporate bonds can be difficult to access and complicated to manage.  Using a bond ETFs as an alternative to holding individual corporate fixed income securities provides transparency and aids accurate forecasting of expected yield-to-maturity.  Many pay a monthly floating distribution are offered with maturities ranging from 2013 through to 2021 providing a full range of options for short- and long-term goals. 

 Assume you own the Target 2017 Corporate Bond Index ETF and in November you are stuck with a 10% loss.  Sell Target 2017 to crystallize the capital loss and immediately repurchase Target 2018 Corporate Bond Index ETF with the proceeds. 

 

This allows an investor to:

  1. remain in the market,
  2. create a tax asset (capital loss to offset future/previous capital gains)
  3. avoiding being penalized by the superficial loss rule
  4. rebalance by shifting one-year down the duration curve. 

 

Because you utilizing the proceeds for the purchase of a very similar, but not identical, security your overall risk level and asset allocation change only marginally. 

 [Note: The interpretation of likeness between ETFs is critical. If deemed identical this strategy would not have merit.  This strategy is thus limited to those instances where longer-dated versions are sufficiently different according to local tax code.  You could employ this tactic successfully by sliding further away from 2018 into 2019, or 2020, etc versions.]

Financial Planning & Wealth Management Strategies: Earnings Referrals

Client referrals are a great way to build a strong investment business. Unfortunately, a roster full of satisfied clients does not directly prompt them to boast about your services to family and friends.  A simple solution is to be more proactive by readily asking for referrals following every successful client meeting.  It’s critical to be open about your desire for referrals and always ask for business, but there is a more nuanced approach to growing your business through client-generated leads.

 “Women who are loyal to their financial advisors refer twice as much as men.

Advisors would be wise to shape their conduct with couples and female clients around this remarkable yet unsurprising fact.  Women are generally more social and likely to share information that men may view as personal or private; financial matters inclusive.  Acknowledging this social dynamics’ impact on who is apt to refer, and why, may remedy the problem of a lack of referrals.

Characterizing an advisor as fit-to-recommend doesn’t fully explain why some are more successful than others at earning referrals.  In addition to being proactive, advisors who frequently generate referrals connect with their female client base more effectively by utilizing a remarkably obvious, yet forward-thinking approach to managing money: establish rapport equally with every client.  They build financial literacy, comfort and trust across the board, but with women especially, through a combination of sound advice, basic and complex tools, and great interpersonal skills.

 Comfort & Trust = Rapport

Are satisfied clients more apt to describe their advisors as trustworthy and caring, or bright and diligent?  While all are desirable traits, clients are more likely to speak of their experience with advisors from an emotional base.  Thus for advisors connecting emotionally – a strength of women relative to men — can be more important than delivering a whip-smart presentation on a great investment opportunity. The decision-making process is determined more by rapport than recommendation, same goes for earning a referral.

Given that 90% of women report feeling insecure when it came to personal finance, and 48% of women agree with the statement, “Investing is scary for me”, there are enormous opportunities.  To fill this gap advisors need to integrate sound financial advice into a dedicated process, communicated with the aid of high- and low-tech tools.  The process must be sensitive to who clients are and the purpose of their meeting, nevertheless it’s beneficial to adhere to routine in conjunction with the following three core principals described by Kathleen Burns Kingsbury (expert on giving financial advice to woman full article here).

  •  Analyze 

“Your job is to find out where your client’s deficits lie and to develop a plan for building these areas.”

  •  Build     

“Financial intelligence is the sum of your financial literacy, money skills, and the ability to understand what you think and feel about money and wealth.”

  • Coach

“Be as creative and collaborative as possible during the building phase, often clients have wonderful ideas on addressing their problems”

Benefits:

Using these core objectives to guide the advice experience will boost clients’ financial esteem through more vigorous participation.  Use props (many banks have Life Cards) to provide a helpful visual anchor for clients when more complex planning concepts are explored.  They expand the dialogue as engagement levels rise for couples, men and women alike.  Remember, the means of extracting information from clients — your process, language, and rapport – is enormously impactful on their satisfaction level and the likelihood of being referred.  Rather than drawing dry questions form a rout list to understand your clients be creative and collaborative.

Follow-Up

Being proactive and smart about your process from start to finish will boost productivity and yield strong long term results.  When following up, divide your time equally between both spouses; but insist on speaking with Mrs. Smith to remind her you’d be honoured to assist their friends and family with their investments.

Questions to Consider:

  1. Does this imply that female advisors are more successful at obtaining referrals?
  2. How should this impact the composition an advisory team if true?
  3. Would the dynamics matter to a newer business looking to grow more so than to a mature business?
  4. What does that say about potential Planning/Advisor partnerships in general?
    1.  Is there a meaningful difference between teams partnerships?
      1.  male-male vs. male-female vs. female-female

Twitter Quarrels with StockTwits over Cash Tags $$

“From ancient grudge break to new mutiny,
Where civil blood makes civil hands unclean.
From forth the fatal loins of these two foes
A pair of star-cross’d lovers take their life”

The announcement that Twitter reclaimed the cashtag [$tag or ‘$’] from StockTwits brought about a unique cocktail of personal feelings.  Upon learning this long-standing agreement was terminated — as an avid user and bull on the company who was fortunate to lunch with CEO Howard Lindzon — it struck me as monumental.

First take for most is something like “Twitter kneecapped StockTwits”.  Others claim that StockTwits is just a copy-cat anyway and they don’t desire cash-tag exclusivity.  Whatever  StockTwits is/was has just been disrupted by Twitter.

The decision to reclaim the cash tag $ is a move sure to incite a saga akin to tortured, passionate lovers abruptly parting ways: intermittent fireworks amid the grinding emotional decay.  With a single conspicuous tweet on Monday night the break-up was broadcasted:

Stocktwits built a community through curation of tweets containing tags like $GOOG, $SPY and $AAPL and combining it with other relevant financial information.  Their tools are top-notch for investment professionals seeking info on stocks, ETFs etc.  An impressive network of professionals generating content fosters a smart culture and pleasurable user experience.

I met CEO Howard Lindzon in Spring 2011, a period encapsulating my search for new professional challenges while coping with my own heartbreak suffered days prior.  It is singularly most intense period of my life.  I hadn’t eaten much in days, sleeping poorly and struggled to reconcile my desire to evolve with yearning for familiarity. Nothing like a meeting with an influential entrepreneur to jostle things into place.

Battling my position in the matrix of modern society I strolled through the rain in Toronto.  With plans to meet for coffee, I sat down nervous, malnourished and wet in a Sushi restaurant across from the CEO of a multi-million dollar tech company. Blankly gazing at the menu trying not to choke on my tongue I demanded a black coffee.

Black coffee, on an empty stomach, in a sushi restaurant.  Howard orders 6 items and looks across the table, “We’ll share.”

Fuck it, let’s do lunch.

The raw fish and general distress caused my focus to be off somewhat, but we engaged on social media, technology, venture capital and investing, the media, and most specifically StockTwits.  What is it, and how can I get involved?

His goals were not modest.  Stocktwits was about the community, its growth potential limitless thanks to effective presentation and curation of cash-tag generated news feed.  Stocktwits attracts a strong demographic increasing the likelihood it could sustain itself with ads, should they avoid being acquired.  He was dialed in on their initiative to become a world-class Investors Relations platform.  Exit strategies? Imagine being worth a fraction of the $20Bil valuation they put on Twitter? Maybe Yahoo Finance places a bid, or a struggling print publication looking for ready-made digital jumps in?  What about Twitter bidding themselves?

What About Twitter?

My gut burned with the niggling idea that Twitter was driving the bus in the whole operation.  Although Howard guarded plans to expand and future partnerships, we acknowledged the plain fact StockTwits — in some form — depended on a 3rd-party source:  Twitter.

With the recent announcement any visions of the utopian scenario in which Twitter is the White Knight Acquirer, have been blurred.  Twitter has chosen to be adversarial, much the way they confronted Tweetdeck when they built upon Twitter infrastructure to improve the user experience.

What about a patent?
If Twitter eliminated the accommodation provided to StockTwits via $ curation, what happens to their business model?  Distressed and beleaguered I do not recall a firm declaration either way on the legal recourse StockTwits may possess should Twitter withdraw their access.    It only percolated to the surface how precocious their venture may be before it was whisked away like the sashimi tumbling into the vacuous gorge that was my stomach.

Now its right in front of their faces.  Twitter dropped a bombshell and broke it off with Stocktwits.  Howard has publicly responded in a blog post here. While this debacle has gifted StockTwits.com a short-term boost in traffic, the end game is unknown.  Can they reconcile, or has their relationship suffered irreparable damages?

Does StockTwits have the stones to look upon the hand that feeds and place a civil action into its grasp? I have no inside knowledge into the outcome, but my suspicion is that legal action is unlikely at this point.  Primarily because of the potential costs of litigation, but alternatively since the response from Mr. Lindzon lacked any indication that a contract, or agreements in principle, had been violated.  It suggests that the original relationship between StockTwits and Twitter was established verbally and not formalized, whatever that means in court…

Lastly, I believe legal action is unlikely because StockTwits is a great product with a strong team that will continue to innovate and deliver.  The site remains up and running with most of its functionality intact.  There is always hope that loves springs eternal, a spark might rekindle their fire, but Howard, Phil and the crew are surely confident they can stand alone and thrive.  Business as usual.

Commodities and Loonies: CAD strong because of ZIRP

Listening to @randycass on BNN and he makes the case that CAD is overvalued since it’s fundamentally a commodity-driven currency. As GDP in Asia and Europe languish the CAD should weaken alongside a basket of hard and soft raw goods.

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The fundamental case is sound, CAD correlates positively with various commodities.   This argument alone ignores broader characteristics of the currency; its stale, incomplete and unsatisfying like the online dating profile of an overweight cougar. (Thanks to @David_Stendahl  for this excellent collection of CAD correlation charts).

Investing in sovereign credits are, especially in Canadian government bonds at 10yr hits All-Time-Low Yields, all about the manipulation of interest rates by central banks and the distortion of prices of all debt instruments.

Since the pool of capital (money supply) is increasing globally and being distributed from CBs to Global Mega Banks, it needs to be ‘stored’. As such cash seeks the comfort of Canadian government bonds: AAA, liquid, relatively high-yielding and secure credit instruments that can be reliably bought and sold in large quantities.

This has keep the CAD strong during the on-going, cyclical weakness in Asian commodity-demand. I expect this effect to be transient as China is widely believed to be planning another large stimulus packages. (Lets put this $3 Trillion to work, eh?) If this is announced before the presidential election I believe the market will rally strongly until the outcome of BARRY vs. MITT is known.

Smash & Scoop: Market Call for H2 2012.

With H12012 in the rear view mirror it’s a good time to reflect and consider the investment environment for H22012. General optimism for certain markets in the near-to-intermediate term dominate my thesis, they are documented specifically below.

[To review H1 2012 Market Call click here.  Turned out to be very accurate with major themes, pardon me while I slap my back with vigour.  Proud that I was sufficiently vague to justify being bullish on the US economy!]

Back-End of 2012: Where To?

The next 3-6 months should bring prosperity for investors in Emerging Market corporate bonds, US technology and Apparel companies, food/fertilizer & agriculture-related themes, plus Canadian-government bonds. These markets seem poised for varying degrees of strength, in contrast to global resource & energy plays which could struggle if Europe and China continue their recession and tepid growth respectively.

Expect to witness to further strength in US housing for H22012. As this market turns from complete disaster to resurgent asset class the tangential economic activity will goose GDP higher. Alongside a favourable wealth effect consumers will feel lubricated and spending on luxury goods and services should remain firm, especially since oil is below $100. As the worlds biggest oil importer, Americans pinching pennies may find more disposable income via de facto tax cut from lower oil prices and this should be helpful for $AAPL Apple & $LULU Lululemon. Also, Nike $NKE has also moved closer to $100 after a recent plunge where greedy buyers supported $90 well. True Religion $TRLG fell markedly on recent results from Levis (earnings miss due to higher cotton prices), but remains great value in a luxury goods & apparel.

Monsanto $MON is one to watch, one peek at the chart any novice investor would know its a prime break-out set-up. Agrium $AGU looks strong on the assumption that droughts in North America will produce poor crop yields and that food stuffs will be in scarce supply (US may in fact start importing surplus grain from South America in a huge shift for the #1 corn producer/exporter in the world). Farmers are slashing their fields to collect insurance payouts since the yields are so poor. Wet, cool weather is needed and fast to avoid one of the worst harvests in nearly 30 years. The rain doesn’t appear forthcoming, meaning profits for fertilizer suppliers and GMO seed patent-holder $MON.

Canada is linked very close to China and its GDP, which is probably 5-7% this year, not in the 9-10%+ range in which it’s vacillated for three decades. This will drag on Canadian stocks/mutual funds since TSX is heavily skewed towards energy and commodities, with the banks composing another large share. Given the Canadian housing market faces considerable headwinds there is a high likelihood of 5-10% YoY decline in residential home prices looking out 12 months, this will drag meaningfully on the returns for investors in $XIU.ca or $EWC and related S&P-TSX60 index funds. Current consumer Debt:GDP is now 95%, the same level at which the US peaked prior to housing bubble collapse and the government is actively manipulating the mortgage market in Canada to engineer a soft landing.

On the debt side, slightly more favourable conditions in Emerging market corporate bonds persist relative to North American issues. If I wanted fixed income to own now and hold for a while I’d find an emerging markets corporate fund (BlueBay asset management) or ETF with exposure to these low-leverage, high growth securities (who historically have similar write-off and recovery rates to similar Developed market issues).

Bonds in developed markets (namely, North America) will probably hold up just fine, but don’t expect out-sized returns at any point along the risk curve. Rather more slow and steady as the chase for yield narrative persists alongside ZIRP. However, stocks are cheap relative to these bonds and there should be some good returns into Xmas.

US corporate bonds have outperformed stocks for the past 3 years. High yield and junk bonds have attracted monstrous inflows and media attention since yields are so low in sovereigns. The likelihood of continued outperformance here is small given equity valuations, earnings and dividend yields. Income-oriented plays will remain in demand but likely lag stocks somewhat in H22012 as the flow of funds reverses into stocks-based funds from Fixed-income related.

Technology turns my crank big time here. All the best growth companies in the world are in this space, so $QQQ should do well under a bullish S&P 500 scenario, I’d expect small caps to perform well too making returns on major indices QQQ > IWM > SPY. Apple $AAPL remains the king and should be owned by all bulls.

As it appears EU still in recession and choking on austerity they are not a place I would expect outperformance from in the next 3-6 months. However, once Greece leaves, or there is a definitive Eurobond deal, Europe could offer some value, just don’t see this as a short term idea, more of a long term home run-type scenario after the drama plays out.

Where overall asset allocation is concerned, international exposure should come in the form of Emerging markets and not Developed, prefer the debt to the equity. In contrast, in North America, I prefer the equity to debt markets and while I have faith in Canada long-term (especially CAD government bonds), for the short term H20212 period, prefer US equities to Canadian. A risk-oriented strategy should resemble 60-70% equities, 30-40% FI, with an overweight position in US tech and emerging market bonds likely presenting the best opportunities on risk:reward basis.

DISCLOSURE: no positions in any ETFs/Securities mentions. Currently about 50% cash, own EM bonds via $ZEF.ca + basket of US tech via $ZQQ.ca

Sports Stadia: Seattle Going Down the Rat Hole

Even during wholly prosperous times publicly subsidized sports stadia are a bad idea.  The literature is clear on this as I have shown previously.  Despite the body of work demonstrating that building sports stadia does little-to-nil for the local economy, every few months another politician in North America trots out drivel in favour of robbing their constituencies purse to erect a monument in honour of their ignorance.

When you integrate financial realities of these projects with the current macroeconomic environment of high debt levels (individuals & public/municipalities) and poor household disposable income growth, its obvious that private businesses should finance these infrastructure projects, not taxpayers.

Seattle: Politicians Seeking Fame & Notoriety. 

Private investor Chris Hansen and his yet-to-be-revealed partners have proposed building and operating a pro basketball and hockey arena in Seattle’s SoDo area.

Minor flaw in their plan: they don’t have the money to fund these ambitions.  Rather they are attempting to coerce the public into subsidizing their arena-building endeavour “in the form of municipal bonds totaling hundreds of millions in public debt backed by local governments.”

Analysts from UBS visited the discussion with a lengthy piece on the merits of investing in the bonds that are created to finance sports stadia construction.  Generally, they conclude in an almost conciliatory statement what readers of this blog have long known:

“Unfortunately, independent academic research studies consistently conclude that new stadiums and arenas have no measurable effect on the level of real income or employment in the metropolitan areas in which they are located”

“There is no broad economic benefit from most sports stadia, rather public financing props up the ever-inflating value of privately-owned sports teams”

They go on to discuss the ‘Cycle of Construction’ of sports stadia and describe how politicians are increasingly captured by the sexy appeal of being a ribbon cutter.  Despite most sports stadia being privately owned prior to WWII:

“Many of the stadiums built after the Second World War were abandoned in favor of more modern facilities. By the end of 2012, 125 of the 140 teams in the five largest professional leagues (NFL,MLB, NBA, NHL, and MLS) will play in stadiums constructed or significantly refurbished since 1990.”

The majority of these projects are financed with public funds.  To ensure the public play along in this income-redistribution scheme, the cities pump out feasibility studies propagating mythical economic realities.  The flaw in these studies is explained perfectly:

Feasibility studies for professional sports facilities often fail to account for the substitution effect. Individuals generally maintain a consistent level of entertainment spending so money spent on sporting events typically comes at the expense of cash spent in restaurants, on travel, and at movie theaters.

The substitution effect is particularly meaningful during a deleveraging period in which average consumers have limited disposable income.  The piece-of-the-pie allocated to traditional entertainment is very low for most families in 2012.

That means that after taxes, debt repayment, food and other mandatory costs-of-living these 40-50x yearly events (41 reg seasons game for NBA/NHL teams) far too often run under capacity.  This is why leagues are embroiled in revenue sharing agreements that suck profits out of the successful teams to subsidize the fiscal laggards.

As the majority of revenue for the NHL/NBA is gate-driven its paramount to understand how butts in the seats equal profits.  In other words, household disposable income growth + winning = financial prosperity.

[Aside: In contrast to the NFL who can support its bottom quartile teams with their share of the enormous TV-related revenue.  As some have speculated, you could host NFL games (8-10x annual events) in a 3000-seat TV studio-turned-arena and they would still be the most profitable sports league in North America.]

Cost Centres Breed Taxation
The debts created to build these stadia are repaid primarily by created new taxes.  For example, hotel & rental car surtaxes are implemented on all visitors, and boosted general sales taxes increasingly cast an accretive net over the money spent by non-sports-fan consumers in town for business or leisure.  This additive disincentive is hardly a means to improve commerce in a given municipality over the long run, a fact which is either misunderstood or ignored by the folks who approve these stadia deals.

When the public demands more due diligence, like they have in Markham, the council slams the door on transparency in the name of expedition.  Rather than allow all the members of council to become involved in the process, they have voted for a smaller, more nimble special committee to go ahead and call the shots:

Deputy Mayor Jack Heath expressed anxiety about the “urgent” nature of the project and the tight timeframe required to have the facility finished by fall 2014.
“We need to get going on this,” Mr. Heath said.

The lack of incentives for civic leaders to spend wisely has never been more apparent.  Sports fans and citizens alike should not allow these actors to allocate their tax dollar on toys, when the funds are spent much more productively on roads, bridges and public transit.

I guess everyone is comfortable paying higher property taxes so long as owners and athletes come to town and pocket the difference?  Probably not, but prudence and logic will not stop these impregnable project from being undertaken at the peril of the community.

Recruiting Profits: Profile of LinkedIN and comparison to Monster Worldwide

LinkedIN is a fascinating business.  The Facebook for professionals interested in networking with those who can enhanced and grow businesses at all stages.  LinkedIN is a social network that serves as a digital resume, crystallizing your accomplishments in a single public webpage.  Its bait for head hunters, a stealthy self-promotional platform that provides fertile ground for B2B promiscuity.

LNKD Chart

LNKD data by YCharts

There are many ways LNKD can make money, their May 3rd Q1 results break them out as follows:

  • Hiring Solutions: Revenue from Hiring Solutions products totaled $102.6 million, an increase of 121% compared to the first quarter of 2011. Hiring Solutions revenue represented 54% of total revenue in the first quarter of 2012, compared to 49% in the first quarter of 2011.
  • Marketing Solutions: Revenue from Marketing Solutions products totalled $48.0 million, an increase of 73% compared to the first quarter of 2011. Marketing Solutions revenue represented 26% of total revenue in the first quarter of 2012, compared to 30% in the first quarter of 2011.
  • Premium Subscriptions: Revenue from Premium Subscriptions products totaled $37.9 million, an increase of 91% compared to the first quarter of 2011. Premium Subscriptions represented 20% of total revenue in the first quarter of 2012, compared to 21% of revenue in the first quarter of 2011. 

Which can be translated into:

  • social network model: “We sell ads”
  • job search website: Simplified recruiting services “We sell access to critical information to head hunters”
  • Freemium: a subscription business model. “We offer an enhanced version of our free product for a subscription fee.”

Social networking elements to LinkedIN are obvious to anyone who has visited their own homepage.  The interface is similar in design and concept to that of your Facebook homepage.  They will sell targeted ads in the same fashion as FB, with a notable exception.

Where Facebook dominates in total users, there is little doubt LinkedIN will trounce their value per user due to distinct demographic configurations.  LinkedIN is loaded with professionals, people who make money and household-buying decisions.  Whence the advertisers get word of this they’ll be throwing money at LinkedIN to target their captive audience.

The hidden value of LinkedIN is embedded in the demographics of their user base: average consumers with busy lifestyle and lots of free cash flow.  While Facebook has every high school student in the free world using their service, they aren’t particularly apt to click-thru from display ads and buy stuff.  They probably don’t have a credit card.

Well the LNKD users have black cards.  Their appetite for social media is expanding faster than any other demographics: GenX’s and Boomers are slowly becoming tech savvy (aka iPads make everything online easy) and more  will look FIRST to LinkedIN over Facebook.

Geographically, LinkedIN business as of Q1 breaks down:

  • Revenue from the U.S. totalled $120.8 million, and represented 64% of total revenue in the first quarter of 2012. Revenue from international markets totaled $67.6 million, and represented 36% of total revenue in the first quarter of 2012.

Suggesting that plenty of expansion is possible given the low barrier to entry for their service (free) and scalability (online; low COGS).  Tons of room to expand abroad and at home, as shown by nearly 300% Adjusted EBITDA YoY growth ($38.1 million Q12012, 20% total revenue; v. $13.3 million Q12011, or 14% of revenue).

Some food for thought on their recent success might be a comparison, say with Monster World Wide:

Image

MWW Free Cash Flow Chart

MWW Free Cash Flow data by YCharts

The Struggles of one due to the success of LinkedIN? Maybe, but its a noteworthy comparison to show the diversity of LinkedIN Cash flows and potential to grow those over time.

On particular concern with LinkedIN is the following company projection: 2012 revenue forecast of $210-$215Mil, adj. EBITDA to $40-$42 million, stock-based comp: $18-$19Mil.  I’m questioning whether this ratio is high?  I am now investigating further the tech-industry standard for the rate at which employees take equity out of the company. With the management at $LNKD is 10:1 (revenue:stock comp) excessive or merited?  TBD.

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