Month: November 2005

“It’s clear that if we fail to do so [adapt to changes in online business models], our business as we know it is at risk.”

Thus writes Ray Ozzie, the genius who developed Lotus Notes and is now Microsoft’s Chief Technology Officer, in an email “sent to top Microsoft executives and engineers.”

I made a modest suggestion earlier this year that Microsoft founder Bill Gates spend less time holed up in a cabin for weeks on end thinking great thoughts about technology (I am not making that up, he really does do that) and more time hanging around college campuses to see what kids do with computers (see Bill’s Hideaway at http://jeffmatthewsisnotmakingthisup.blogspot.com/2005/03/bills-hideaway.html).

I take it my suggestion has not been heeded.

I base this conclusion mainly on the continued self-delusion by the folks in Redmond as discerned in Mr. Ozzie’s memo—which is dramatically recounted in today’s WSJ, as if writing an email actually changes the focus of a large corporation whose entire existence is based on sales of computer software.

The biggest delusional whopper in today’s article has to be this:

Microsoft, he [Mr. Ozzie] wrote, has long “understood mobile messaging,” but “only now are we surpassing the Blackberry.”

Surpassing the Blackberry!

Where, on earth, is Microsoft surpassing the Blackberry? Possibly, in a building on Microsoft’s Redmond campus, there is somebody who prefers Microsoft’s solutions to the Blackberry. But I doubt it.

More likely the “surpassing” of which Mr. Ozzie speaks involves some sort of great technical prowess measured by lines of code and terabytes of gigaflops by which Microsoft has crammed sixteen thousand superfluous functions into its mobile messaging software, none of which are easy to use—as compared to the handful of things Blackberry does spectacularly well.

The simplicity and focus of the Blackberry is, not coincidentally, what saved Intuit, and Adobe from the onslaught of Microsoft. And it is what might save Google.

In his memo, in fact, Mr. Ozzie hits on that very attribute which has, thus far, made Google the perceived threat to Microsoft’s model:

“Through Google’s focus they’ve gained a tremendously strong position.”

But it is not Ray Ozzie that needs to be convinced of Google’s strength. It is Bill Gates, who, according to the always-breathless WSJ article, “to be sure, retains that role as Microsoft’s chief software architect, and isn’t expected to give up the title anytime soon.”

What I suggest Mr. Gates give up is those twice-a-year trips to the woods.

Instead, I suggest he get on a bike, ride to the local Peet’s, and watch what people are doing with the internet, and the iPod, and the Blackberry.

And then Microsoft might surpass somebody.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

“Yes, it’s been trending up, which is really astounding. Every day I get the New York Times and The Wall Street Journal, and I don’t think they’ve missed a bad article in our regard in the last two to three weeks. And it’s amazing to me that we’re doing the business that we’re doing, which is tremendous, in the face of this bad press.

I mean, if there’s anybody left in the U.S. that hasn’t read an article that this is the absolute peak, I’d like to meet them. So who are all these people that are buying at the absolute peak, according to the newspaper?

They’re people who want the move up home, whether it be attached, multifamily, or single, and aren’t willing to play the market according to the press. It’s really astounding to me that we’ve been doing the business that we’ve been doing.” —Toll Brothers CEO Robert Toll, August 8, 2005


Well the news this morning is about homebuilders—specifically Toll Brothers, and more specifically CEO Robert Toll’s cautionary commentary in this morning’s earnings release, which is quite a change from the “trees-grow-to-the-sky” view which management has consistently (and correctly) given during every short-term wiggle in the housing market for the last several years (see August 8th quote above).

The contents of today’s press release from Toll Brothers need no elaboration from me:

“In addition to delays in community openings, about twenty-five percent of our communities still have backlogs extending twelve months or more, and, therefore, are not open for sale on a regular basis. Even though we produced record contracts against FY 2004’s challenging fourth quarter comparison (FY 2004’s fourth quarter contracts were up 51% above FY 2003’s fourth quarter), we believe a shortage of selling communities, coupled with some softening of demand in a number of markets, negatively impacted our contract results.

“Since Hurricane Katrina in early September, we have observed buyers taking longer to make their purchasing decision. We attribute this change to the significant decline in consumer confidence in the last two months that was precipitated by the hurricanes and their aftermath, and to record gas prices.

“It appears we may be entering a period of more moderate home price increases, more typical of the past decade than the past two years. Comparing the current market to the past five years, excluding 2004, which was extraordinary, FY 2005’s fourth quarter ‘per-community’ non-binding reservation deposits exceeded the five-year average from FY 1999 to FY 2003 in seven of the last nine weeks (encompassing September and October) of FY 2005.

“We remain optimistic. The demographics for our industry remain outstanding due to continuing, regulation-induced, constraints on lot supplies and a growing number of affluent households. With approximately 81,000 lots under our control, compared to 60,189 at FYE 2004, and a projection of approximately 265 selling communities by FYE 2006, we believe we will enjoy continued growth as we expand geographically, diversify our product lines and continue to gain market share.”

Expect plenty of fireworks on the conference call at 2pm, Eastern Standard Time.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

6…12…5

Such are the number of times Procter & Gamble management—first the CFO, then the Treasurer, and then again the CFO—used the word “strong” during their discussion of first quarter earnings yesterday.

That’s a total of 23 times the word “strong” was used even before the question and answer session started.

During the Q&A that followed, in fact, management used the word another 17 times.

Total usage of the adjective “strong” during the P&G conference call: 40 times. That’s got to be some kind of record.

In and of itself, the use of an adjective such as “strong” is meaningless. Who cares if management chooses to say “strong growth” and “strong business momentum” and “very strong top and bottom line results,” as the P&G Treasurer did in three successive paragraphs? When a company has “strong” results and chooses to call them “strong,” that’s their right.

But as I have learned watching other companies over the years, “meaningless adjectives” can be employed in all kinds of ways to defuse, defer and decoy the numbers—and therefore deny reality—until it is too late to deal with the underlying problems.

If any company had the right to use the word “strong” in a recent conference call, it was Google. Google’s growth, both sequential and year-over-year, stayed astonishingly high, and margins didn’t budge—leading to a net earnings number that beat Wall Street’s expectations by a full 20c a share.

Yet Google management used word “strong” exactly twice in the management discussion.

Procter & Gamble, it should be noted, “beat the number” by precisely one penny, and used the word 23 times in the management discussion.

(For the record, P&G did not actually beat the number by a full penny. According to a sharp-eyed reader of this blog, “The reported number was $0.7657, which if it had been 0.0008 less would be be rounded down to $0.76, rather than up to $0.77…about $2 million on a quarterly expense structure of $12 billion.”)

But P&G management went further than deliberately infuse the adjective “strong” into their “upbeat” presentation. CFO Clayt Daley devoted the final part of his introductory discussion to a Lyndon Johnson-style in-your-face jawboning effort for a higher P/E ratio:

Now I want to conclude by providing some perspective on our price-earnings ratio. We have received a number of questions recently on this topic. We believe there are some important factors that investors should keep in mind when evaluating P&G’s P/E multiple both versus history and versus peers.

After noting P&G’s broad product portfolio, expensing of stock options, near-term dilution from the Gillette acquisition and one-time charges, Daley concluded the P/E lobbying effort as follows:

We believe that a simple P/E comparison does not fully capture the fact that P&G is a very different company today than it was five or 10 years ago. P&G has a much different organization structure that allows the global business units to focus on their consumers and competitors while capturing the scale benefits not available to competition.

Additionally P&G has a much stronger portfolio of businesses, a more diverse geographic mix and a significant opportunity to build shareholder value with Gillette, and we are confident that we will be able to deliver our new top and bottom line targets through the end of the decade.

(Notice he got in another “strong” there!)

Forgive my cynicism here, but most of the times I’ve heard a company baldly lobby for a higher P/E ratio, it’s a management team consisting of two guys in an office suite off Route 101 in Burlingame trying desperately to get whatever half-baked small-cap start-up they’ve put their life savings into lumped together with whatever hot new technology is firing investors’ imaginations at the moment—not the highly regarded heads of one of the oldest and most durable consumer products companies in the world.

Happily, I can report, Wall Street’s Finest did not entirely roll over to have its collective belly scratched by the firm, guiding hand of Mr. Daley.

Deutsche Bank Analyst Bill Schmitz, for one, asked the obvious question:

You sort of gave us a little lecture on valuation and why the P/E is too low. Why wouldn’t you just accelerate your share repurchase then if you thought that the multiple was too low now? You still have considerable flexibility in terms of repurchase…

To which CFO Clayt Daley said:

“I’m buying as much stock as I’m allowed to buy.”

For the record, P&G’s shares outstanding dropped by not quite 40 million in the quarter, on a 2.7 billion fully-diluted share base.

So why the jawboning? Why the use of the adjective “strong” forty times during an hour long conference call? Why not just take the company private if it’s so darn cheap?

The answer to that lies, I believe, in the guts of yesterday’s conference call, in which management outlined not only the “strong” results, but also numerous headwinds facing a consumer products company that just completed its largest consumer products acquisition ever, at a time when the Federal Reserve seems intent on slowing down the buying habits of those very same consumers to which Procter & Gamble sells diapers, coffee, liquid Tide and now Gillette razors.

Chris, I would just say two quick things. One and the most important one is, when we go into periods like this where there are big increases in energy pricing, especially gasoline, there are consumer households whose budget is stretched. Okay? And one of the typical reactions that you see from retailers is to begin to push their private-label brands. We’ve seen this happen in the ’70s during the oil shock. It has happened in every mild or severe recession since.

So I think we’re seeing a normal pattern. Frankly, I’m not — there the manufacturers of private-label diapers are seeing all the same energy and raw material and packing material price pressures that we are that are operating on much thinner margins than the branded competitors. And in the past, some of them have driven themselves into bankruptcy because the margins got squeezed so severely.

No wonder the management jawboned. LBJ would have been proud.

Jeff Matthews
I Am Not Making This Up

Updated 11/5/05

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

One of the most interesting conference calls I’ve listened to in the past few weeks’ worth of earnings calls was a REIT called Kilroy Realty.

I don’t know the company well, but I thought the call would be worth a listen.

It was.

For the record, “Kilroy Realty Corporation, a real estate investment trust (REIT), engages in the ownership, operation, development, and acquisition of Class A suburban office and industrial real estate in suburban submarkets, primarily in Southern California.”

The following are excerpts from the conference call transcript, with no elaboration.


California’s economy produced steady, diversified growth during the third quarter. Employment hit another record high in September, according to the monthly survey of households while total nonfarm payroll jobs grew by 226,000 year-over-year.

The unemployment rate as of September stood at 5.1%, down from a full percentage point from a year ago. Continued job growth has boosted other economic indicators including personal income which rose an estimated — or rather an annualized 2.9% in the second quarter versus 2.2% a year ago. For the period California accounted for 13% of total national personal income.

KRC remained very productive during the quarter. Within our stabilized properties we have now signed new or renewing lease agreements on 1.4 million square feet of space year to date. And we continue to lead the pack in terms of deal capture and rental growth. Overall occupancy in our stabilized portfolio fell a couple of percentage points in the quarter to just under 93%. This occurred primarily because our recently renovated 909 Sepulveda property was moved to the stabilized portfolio and a tenant vacated a 130,000 square foot building in San Diego.

Now let me give you a big picture summary of what we are seeing in Southern California. As we have been saying for several quarters, the Southern California real estate markets have been strengthening. Throughout many of our markets we are seeing and the brokers are reporting a shift from a tenant’s market to a landlord’s market. This is more pronounced in some submarkets than others but there is more and more sentiment that tenants need to act now, particularly those with larger requirements. C.B. Richard Ellis is reporting tightening vacancies and rising lease rates in Los Angeles with minimal new construction.

C.B. is predicting significant rent increases in Los Angeles as large blocks of space get absorbed and vacancy rates continue to decline. Our experience also supports an improving market in Los Angeles where our west side assets are effectively fully leased and we have begun to make significant progress in El Segundo.

While it took a entire year following completion to get to 25% committed we have essentially doubled that in our 909 building in the last quarter, moving the committed percentage to 49% today. As for the Orange County office market, Cushman and Wakefield has also reported a move from an equilibrium market to a landlord’s market as population growth and a growing economy are driving demand. Office vacancy rates are down to 10% from 14% a year ago and rents are up 6% year-over-year.

Finally in San Diego, we continue to see a significant increase in demand for new state-of-the-art facilities in the market in which we operate.

One of the Southern California markets where new office construction does make sense is in the better San Diego submarkets where the combination of rental growth and robust demand provide attractive returns. In contrast, development does not make sense in most Los Angeles submarkets and won’t until rents significantly increase.

Also in Orange County, given the current strength in residential economics we have the opportunity to rezone at least a couple of our industrial properties for residential and sell the sites to home builders at a significant profit. We expect to have more to come on this on future calls.

The real estate markets are improving across the board in Southern California with a shifting taking place from a tenant’s market to a landlord’s market. The brokerage communities and others are increasingly indicating that there is a growing sense of urgency among tenants to find space.

The strength in the markets is moving up the coast. While San Diego continues to be the strongest market in Southern California, Orange County has improved significantly over the last year. Most Los Angeles submarkets are also tightening and even El Segundo is now showing meaningful reductions in vacancy.

Construction costs have increased significantly over the past four years with most of that occurring in the last 12 to 18 months.

And if we look at our AMN building which is probably the highest quality building in San Diego which we came on stream in late 2002, the cost of that building core and shell is up about 40%. And that’s plus or minus pretty much the same for other buildings. So the other thing that’s increased is, depending — it doesn’t always effect Kilroy although it does when we buy new property is that land costs have increased in many markets, including San Diego..

Cap rates, we’ve seen them continually go lower.

What we’re seeing is a number of second and third chair properties trading at 6% plus or minus cap rates, and I also mention maybe higher quality assets but not in very good markets in that same range and we’re seeing high quality assets particularly particularly down in San Diego in a sub 6 range.

We’re not seeing any letup in the appetite for people to acquire. I’ve never seen more people wanting to acquire assets than today.


If the Fed is seeing what Kilroy is seeing, I wouldn’t expect the Fed to let up any time soon.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.