Consumer Debt Paydown Crimps GDP Growth

It’s election season so both candidates would love for you to think that the POTUS has a lot of control over economic growth, but this week we got a report that sheds light on one of the major reasons the U. S. economy is growing at around 2%, down from its long-term average of around 3% per year. The New York Federal Reserve reported that credit card debt balances last quarter dropped a $672 billion, a level not seen since 2002. It also marks a 22.4% decline from the peak we saw in the fourth quarter of 2008.

So how exactly has this de-leveraging trend negatively impacted GDP growth? Well, consumer spending represents about 70% of GDP, so a drop in credit card balances of $200 billion over the last few years represents a lot of money that was sent off to pay bills, not spent on goods and services. Toss in another $100 billion of spending that would normally be incremental over that time period due to overall growth in the underlying economy, and you can see that about $300 billion of consumer spending has been absent from the system, compared to what would have been normal.

With annual U.S. GDP at around $15 trillion, this consumer credit card de-leveraging represents about 2% of GDP growth lost. Over 3-4 years, that comes out to about 0.5% GDP impact per year. In a world where GDP growth has dropped a full percentage point from its long-term normalized level, consumer debt repayments account for a major portion of that slowdown. You aren’t likely to hear much about that on the campaign trail, but politicians rarely deal with facts and truths when it comes to hot-button issues like the economy.

Apple Sets Market Value Record As iPhone 5 Debut Nears

Earlier this week I wrote a piece on Seeking Alpha that outlined why I believe investors are likely to value Apple (AAPL) shares similarly to other blue chip consumer brands, which would mean a valuation of 10-12 times trailing cash flow (defined as EV/EBITDA). Bulls on the stock have a multitude of reasons why Apple should trade at a premium, but in recent quarters the market has disagreed. In fact, even as Apple stock has broken out to new highs, setting a new market value record in the process, AAPL shares fetch about 9 times trailing cash flow (at the current quote of $665), a discount to other superb consumer brands.

If fair value is somewhere in the 10-12 times cash flow range, that would equate to $725-$850 per share. That would mean fair value is somewhere between 10% and 25% above current levels. That is why I continue to hold the stock, despite its enormous run-up lately.

In terms of future potential, I continue to be intrigued by the possible launch of an Apple TV set. When I think of the large market opportunities for Apple, those that can really move the needle for a company worth more than $600 billion, the television market is the only one they have yet to target that has real appeal. Outside of desktop, laptop, and tablet computers, phones, music players, and televisions, I am not sure where else Apple could find significant future expansion potential (although I am sure they would disagree and are looking for some already). After launching a TV, I think Apple’s strong growth days might fade. Assuming the stock traded in line with other blue chips at that point, I would likely look for an exit point.

I have not sold yet, mainly because a TV is still not here (some are even arguing they aren’t going to make one, just a set-top box) and the stock’s valuation on current products, at 9 times cash flow, is still below that of other large cap blue chips. So while I am not as bullish as some, I still see room to run for the stock.

Full Disclosure: Long Apple at the time of writing, but positions may change at any time

Bubble Bursting 2.0 (Part 2): Isn’t Groupon Worth Something?

Last November, in a post entitled “Numbers Behind Groupon’s Business Warrant Caution After First Day Pop”, I cautioned investors that the IPO of daily deal leader Groupon (GRPN) looked sky-high at the initial offer price of $20 per share, which valued the company at an astounding $13 billion:

“It is not hard to understand why skeptics do not believe Groupon is worth nearly $13 billion today. To warrant a $425 per customer valuation, Groupon would have to sell far more Groupons to its customers than it does now, or make so much profit on each one that it negates the lower sales rate. The former scenario is unlikely to materialize as merchant growth slows. The latter could improve when the company stops spending so much money on marketing (currently more than half of net revenue is allocated there), but who knows when that will happen or how the daily deal industry landscape will evolve in the meantime over the next couple of years.

Buyer beware seems to definitely be warranted here.”

A few things have happened since then. First, Groupon has cut back on marketing spending and is now making a profit (free cash flow of $50 million in the second quarter). Second, the post-IPO insider lockup period has expired, removing a negative catalyst that the market knew was coming. Third, and most importantly, Groupon’s stock has plummeted from a high of $31 on the first day of trading ($20 billion valuation) to a new low today of $4.50 ($3 billion valuation).

Here is my question, as simply as I can put it; “Isn’t Groupon worth something?” The stock market seems to be wondering if many of these Internet IPOs will exist in a few years. Today’s 8% price drop for Groupon was prompted by an analyst downgrade to a “sell” and a $3 price target. Here is a company with $1.2 billion in cash, no debt, and a free cash flow positive business that will generate over $2 billion of revenue this year. That has to be worth something. How much is another story.

I would argue that it is too early to write off companies like Groupon as being “finished.” It is far from assured that they will be around in 3-5 years, but many of them have huge cash hoards ($2 per share in Groupon’s case), no debt, and a business that is making money today. My most recent blog post made the point that many of these Internet companies are going to survive, and in those cases bargain hunters are likely to make a lot of money. Will Groupon be one of them? I don’t know, but if an investor wanted to make that bet, at $4.50 per share, they are paying about $1.8 billion ($3 billion market value less $1.2 billion of cash in the bank) for an operating business that is on track for more than $2 billion in sales and $200 million in free cash flow in 2012. And who knows, with this kind of negative momentum, the shares could certainly reach the analyst’s $3 price target in a few more days.

Bottom line: these things are starting to get pretty darn cheap. If they make it, of course.

Full Disclosure: No position in Groupon at the time of writing, but positions may change at any time.