If you needed more proof that there is another bubble forming in Silicon Valley 15 years after the last one ended badly, how about this headline:
“Facebook to acquire WhatsApp for $19 billion”
This announcement makes the Facebook ($FB) deal to buy Instagram for $1 billion in 2012 look like the biggest bargain in U.S. corporate merger and acquisition history. Maybe the Snapchat guys were smart to turn down the $3 billion Mark Zuckerberg offered them. Their asking price is probably $10 billion now and they just may get it now. All of the sudden the debate over whether Twitter ($TWTR) is worth $40 billion with only $1 billion in annual revenue takes a back seat. Now WhatsApp, a company many people have never heard of, is in some eyes worth half that price without a penny of revenue(Correction at 5:05pm PT: The WhatsApp app is free for the first year, then users pay $0.99 per year, so they technically do have revenue, although 8 cents per month is not material in my mind).
Rather than debate whether startups without fully formed business models are worth tens of billions of dollars, the more interesting thing to me is that Facebook’s current market value is now $185 billion after you add in the $15 billion of new stock they are giving WhatsApp (along with $4 billion in cash). Amazon ($AMZN), after its recent post-earnings report decline, has an market value of just $160 billion.
I might be completely wrong about this, but if I had to pick one of those stocks at those prices for the next 5 years, I’d take Amazon over Facebook in a heartbeat, even ignoring the fact that I would be getting it at a discount. I just don’t think Facebook usage five years from now will be as high as it is today. They seem to share this view, based on their recent buying spree, which has resulted in them targeting competing apps that they intend to operate completely separately from the Facebook platform.
Essentially, it’s an “app grab” and they have plenty of money and equity-raising ability to pay huge amounts in order to place bets on which apps will dominate in the future. Given how fast consumers’ technology preferences change (if you looked at the top 10 most visited web sites from 10 years ago you would giggle), I think it will be really hard to know which apps will be long-term winners. And paying $19 billion for one seems truly remarkable to me.
Along those lines, for investors looking for a way to play their opinions on how these kinds of things play out longer term, I think you can make some interesting bets using paired trades to reduce your market risk. For instance, getting Amazon for a 15% discount to Facebook looks intriguing to me, and I am putting a little money on that paired trade; short Facebook, long Amazon. It’s a market-neutral bet that simply is a play on Amazon narrowing that valuation gap, and quite possibly overtaking Facebook, in the next, say, 3 to 5 years.
Now, I could be completely wrong here (and in technology it’s easier to be wrong than in other industries), but right now I just think the sentiment has shifted so much lately (to Facebook and away from Amazon, though not for the same reasons), that I’m willing to put a little money on the line. It wasn’t that long ago that Faecbook was written off shortly after its disasterous IPO and after a mediocre holiday quarter (in the eyes of some anyway), Amazon shares have dropped 60 points in short order.
Full Disclosure: Long Amazon and short Facebook at the time of writing, but positions may change at any time
The stack of unread books in my office has been getting higher and higher in recent months so I took the long holiday weekend to trim it down a bit. “Confidence Game” by Christine Richard takes readers through hedge fund manager Bill Ackman’s multi-year attempt to blow the whistle on one of the largest bond insurance companies in the world, MBIA, which for years went to great lengths to hype its business model and support its ever-rising stock price. In doing so the company continually mislead investors and played a large role in the credit crisis.
While I thoroughly enjoyed the book, it does go into extreme detail about MBIA’s business model (insuring debt securities so that they could be given AAA ratings and sold easily to investors) and therefore might not appeal to a wide array of readers. However, if you follow Bill Ackman and his hedge fund (Pershing Square Capital Management) and are at all curious about what makes the guy tick and how much work he does on his investments, I think you will find the story very interesting.
You may know that Ackman current crusade is against Herbalife, the large mult-level marketer of diet supplements. Many other hedge fund managers have mocked Ackman’s assertion that HLF is a pyramid scheme, and so far have fared well taking the other side of his short bet against the company. After reading this book, it made me wonder if maybe Ackman has done more work on HLF than many believe. The guy spent as much time digging into MBIA as is humanly possible and was proven right. I’m not saying that means anything about Herbalife (I don’t know the company well at all), but I just found Ackman’s rigor impressive.
If you would enjoy learning more about one of today’s most talked about hedge fund managers, or want to read about a company that has been written about in far less detail than many when it comes to the recent financial crisis (by now I think the Countrywide and AIG stories have been covered enough), I can confidently recommend “Confidence Game.”
Since the political party in power will always try to spin economic data postively, while the opposing party tries to convince you the country is still in the doldrums, sometimes it’s nice to put metrics like the U.S. unemployment rate in perspective by showing historical data without political interference. Accordingly, below is a chart of the unemployment rate over the last 40 years. As you can see we are back down to “average” today (the 40-year mean is the red line), so things are neither great nor terrible. That’s surely not what you’ll hear as the mid-term elections get into full swing this year, but that’s yet another reason why politics and investment strategies shouldn’t be mixed. Investing is far more dependent on reality than politics.
Sears doesn’t have a sales problem, it has a profit problem. Whether you agree or not (my personal view is that a sales problem both contributes to, and serves to exacerbate, an underlying profit problem), that’s the conclusion drawn by CEO Eddie Lampert. As a result, he is closing dozens of stores and trying to figure out ways to make others smaller (and therefore perhaps more profitable).
In fact, Sears has a relatively new subsidiary called Seritage Realty Trust that has been given the task of managing (read: restructure and/or redevelop) about 10% of Sears’ locations. Seritage has its own web site, with many of its projects listed. Included on that list are locations tagged for a “box split,” which means they would like to subdivide the current store and rent out space to another retailer. The thesis is that Sears will make more in rental income from the subleased square footage than it did using it to sell Sears’ inventory. In addition, they could see sales per square foot increase in the Sears store that remains open by rationalizing their product selection. Overall, it’s an interesting strategy with potential, but since it is early in the process it is also largely unproven.
There are only 9 “box split” store candidates listed on the Seritage web site and it just so happens that one of them (the Alderwood Mall store in Lynnwood, WA) is only about 30 minutes north of my home in Seattle. This past weekend my wife and I drove up there to check out a new mall (we’ve only lived here for about 6 months) and see what, if anything, of note was happening at the Sears store. Perhaps not surprisingly (given that we are talking about Sears after all), there were some good things, some bad things, and some strange things going on.
First, some good things if you are rooting for Sears to find its footing:
1)The Alderwood Mall is a high-end mall (owned by GGP) located in a suburb of a relatively wealthy city.Sears owns the store outright (it’s not leased). The two floors are 82,000 square feet each, excluding a 13,000 square foot Sears Auto Center attached. You might not think the fact that the mall is high-end jives with the core Sears customer (and I would not disagree), but the real value here is in the fact that the real estate is owned and high end mall space is worth top dollar.
2)This store (not surprisingly given it was selected for Seritage’s portfolio) appears to be an excellent candidate for a “box split.” At ~165,000 square feet it has more floor space than Sears really needs (you should see how many clothes this place is stocking), and it has two exterior entrances but just one mall entrance. This means Sears could split the box in such a way that another retailer could occupy half of the first floor (40,000 square feet) and have a dedicated entrance from the parking lot, while Sears could retain one exterior entrance as well as a mall entrance. Here’s a map of the mall:
3)Despite Sears being known for skimping on capital expenditures since Eddie Lampert took over as Chairman, this store was not falling apart like many others. In fact, it appeared to be in very good condition despite being built in 1979. It’s good to see that capex reductions are not happening at the “best of the best” locations in the Sears property portfolio.
So that’s the good news. But it’s not all good, especially considering that this idea is still very much a development concept. There were no signs of any construction or preparation work being done in the store that would lead one to believe any tenant is close to signing a lease at this location and has asked Sears to get the ball rolling.
You can probably guess what kinds of things stood out as being “same ol’ Sears.” My biggest gripe with the chain has always been that Sears stores are almost always terribly disorganized, making for a miserable shopping experience. It boggles my mind when I go inside one because all I can think to myself is, “has a senior manager ever walked this store, and if they have, how could they not realize that if you simply cleaned up the clutter and organized the inventory in a better way, you would likely see better sales production?” It really doesn’t take much money (or any) to focus on organizing stores better, it’s just time and effort.
How bad was it? Well, how about some pictures:
As for Jackson Hewitt, that’s not the only place they are advertising; they are also targeting shoppers before they even get to Sears:
We also checked out the Lands End section. This is a case where not only does the merchandise they pair with the men’s clothing section make absolutely no sense, but I question why Sears even carries the products at all (stuffed bears in the kid’s section at least would make sense).
My wife was actually looking for Lands End socks, but couldn’t find any on the floor, so we asked one of the dedicated Lands End employees for assistance. Despite the fact that she only works in a small section of the store (Lands End shops in Sears stores average 7,400 square feet, which is less than 10% of the first floor of this particular store), she didn’t even know if they had any socks in stock. “It’s really hard to keep track of where things are,” she said. “They move everything around so much.”
So not only is the store disorganized for shoppers, but the Lands End employees can’t even keep tabs on their own inventory. Again, management here is a serious problem. Sears gets called out for skimping on store upkeep, but this is simply an organizational and inventory management issue having nothing to do with money. We finally found maybe 10 pairs of women’s socks on display after wandering the department for a few minutes. None of them were black (a common sock color!?), the color my wife was looking for, so we left the Lands End department empty-handed.
This brings up another issue, because a big part of Eddie Lampert’s “integrated retail” strategy involves carrying less inventory in the actual stores, but installing kiosks that allow you to order online while in the store, in case you need a size they don’t have, or one of the various colors that they don’t stock in physical stores at all. In one of the rare interviews he agreed to do, Lampert explained his thinking to the Chicago Tribune:
“The integrated retail part of our strategy is really about how you work between online, mobile and store, not just from a customer standpoint, but from a supply-chain standpoint,” Lampert said. “If we have a shirt in the store in four colors, we might have that shirt in 10 additional colors online. To have 14 colors in the store may be too risky because what you don’t sell, you end up losing money on, (compared with) having a group of it online that serves all the stores so that if people want more variety, they can get more variety.”
This may sound like a good idea at first blush, but most people who prefer to shop online aren’t coming to your store to then order at a kiosk or their smartphone. More likely, they are in your store because they want to try on or see the actual item prior to buying. If you don’t have black socks in stock, and there 100 other stores in the mall, I think that customer is more likely going to go buy from a competitor. Contrary to what Lampert seems to think, ordering online from an actual store is not always convenient for the shopper. If they wanted to order from your web site, they never would have driven to the mall. And if they wanted to buy a physical product from a store, they are likely going to find better selection elsewhere in that very same mall.
In addition, I am baffled as to why Lampert believes those extra 10 colors sitting in a warehouse awaiting an online order are any more profitable than those same colors sitting in the store awaiting an in-person buyer. Sure you could argue that warehouse space is cheaper than store space, but aren’t the odds higher that someone will see the product and make an unplanned purchase if the item is in a store and not sitting in a warehouse somewhere? Not to mention the fact that Sears shoppers tend to be older, so they are less likely to be avid technology users and more likely to prefer seeing and touching the product before buying it. I think Lampert’s integrated retail strategy might work better for some businesses than others, and I don’t think Sears is a good fit relatively speaking. Perhaps that is a contributing factor as to why sales trends are so poor right now.
Before heading out of Sears, I also checked out the hard lines department, the biggest segment for Sears. I was impressed with the hardware and tools section (one of the largest Craftsman selections I’ve seen) and then I ventured upstairs to check out appliances and electronics.
This just felt strange. Not a very inviting shopping experience. There was one employee manning the jail, and I doubt it would deter you from browsing if you were looking to make an immediate purchase, but it just seemed so unneccesary, and the first of its kind I have seen. I’d be curious to see if shoppers are less likely to browse an enclosed area like this, assuming they weren’t looking for something specific, just because it would feel like the employees were more concerned with making sure you didn’t steal something, as opposed to enticing you to buy something. My wife and I had a good laugh (and we didn’t go inside, though we did have to raise our voice to ask the saleswoman through the glass where the nearest restroom was located).
All in all, it was an interesting trip. Nothing really has changed about my view of Sears though. They still don’t seem to know what they are doing when it comes to creating a positive shopping experience, relative to their competition, and although they aren’t skimping on upkeep at this valuable piece of real estate, they don’t seem to really be focused on maximizing the profits from the store either. The potential redevelopment opportunity from a real estate perspective is definitely there, but progress is slow. At a mall of this caliber (it’s a combined indoor-outdoor complex that very much represents the typical high-end GGP mall), you would think Sears could really turn their 165,000 square feet into something unique and profitable. Time will tell.
Full Disclosure: In order to attend the 2014 Sears Holdings annual shareholder meeting (Mr. Lampert rarely speaks publicly outside of this event and this year I decided to go) I am long a small “odd lot” (i.e. less than 100 shares) of SHLD stock. However, this is merely to permit me to attend the meeting and not for investment purposes. In addition, I am long Sears bonds as an investment. Positions may change at any time.