Category: Uncategorized

Far and away the most interesting—and meaningful—conference call I’ve listened to the last couple of weeks was the Blue Nile on Tuesday night.

Blue Nile is what investors like to call “a nice little company”—with good sales growth, healthy margins, actual earnings, and real free cash flow.

Blue Nile also happens to be an internet retailer (of jewelry), and it learned about real free cash flow the hard way, having started up during the internet bubble and survived the internet crash thanks to the extreme diligence and sharp focus of its founder, Mark Vadon.

Unlike, say, Overstock.com, whose CEO went out and bought $7 million worth of diamonds and cobbled together a clunky “Design Your Own Jewelry” site to attempt to sell the stuff, Blue Nile operates as a virtual jewelry store with a terrific, user-friendly site and a well-developed supply chain.

Gross margins are half the brick-and-mortar model—but because Blue Nile carries almost no finished inventory and gets paid via credit card before whatever it sells (usually an engagement ring) is assembled and shipped, it generates good margins and real free cash flow that piles up on the balance sheet and goes into share buybacks when the stock gets beat up, as it occasionally does when the company misses quarters, which it occasionally does.

As it did this week.

Being an Internet pioneer that survived the bust, Blue Nile has also witnessed the rise of the Google/Overture keyword advertising model, whereby advertisers buy “keywords” and then pay Google or Overture (now Yahoo!) every time a user “clicks-through” the ad that pops up during a search of those keywords.

And ever since Google came public, Blue Nile has been answering questions about click fraud, cost-per-click and Microsoft’s intentions in the space, always reaffirming the value of keyword advertising to Blue Nile’s business model.

Just last November, Vadon told analysts the following:

And what we really have to do is not go out and run television commercials like an Overstock.com, but what we need to do is stay focused on delivering a great experience and let the market mature and let people grow comfortable with the Internet. If we do that, I think you’ll see us continue to grow at the rates we’re growing now for at least five more years.

But that was then, and this is now. Blue Nile missed its fourth quarter revenues and earnings by a wide mark, in large part owing to higher search-related marketing expenses. Specifically, Vadon said the following:

During December, we saw extremely aggressive increases in the cost of online advertising. Our cost per click on Google, for example, rose by over 50% from a year earlier. While the cost of online marketing grew significantly in Q4, we remain disciplined in our spending, in order to maintain profitability on new customers rather than to chase unprofitable growth, as some of our competitors have done.

If this sounds familiar, it should be. In “The Most Interesting Press Release You Didn’t Read” I highlighted comments from FTD Group in late December, which said essentially the same thing.

When asked for specifics, Vadon discussed “irrational behavior” in Google search pricing:

To give you perspective, in our top five keywords, our cost per click was up over 80% compared to a year ago. To us, it looks like, frankly, some irrational behavior in the marketplace. I think, if you follow our business, you know that we monetize Internet traffic for jewelry better than anybody in the world, and if we are getting nervous about the pricing of search, it means there’s some people out there who are deficit spending and perhaps are back to the mentality of 1999….

As far as who is out there bidding, it’s slightly different in Q4 as opposed to Q1. I think in Q4 — you asked about Amazon. We haven’t seen them at all in the online search market. We saw a couple larger players; I think Zales was pretty aggressive, Macy’s was pretty aggressive. And then we see just a tremendous number of small players, and these are very small companies. And they don’t play for very long. They will come into search for a week or a couple weeks. And I think there’s just a lot of — and then I think they burn through their budget fairly quickly and fall off the screen. But we just saw a lot of those types of players coming out.

The problem is not limited to the cost of keywords themselves: it extends to the diluted quality of the internet users clicking through to the Blue Nile web site, following Google’s move last summer to place more paid ads per search:

So an important matter is how well you can convert. Over time from search, we see slight declines, and it’s not tremendous but slight declines in the conversion rate. I think, to some extent, that has to do with the search engines placing more ads. So, when you went to a search term a year ago versus going to it today, you are going to see more paid search placements today than you did a year ago.

Furthermore, as more companies advertise on search engines, the value of the incremental customer is dropping:And as there’s more people there competing for the same traffic, if one consumer is shopping — so if you’re shopping for a plasma TV, you are probably going to go to many merchants, or at least a handful of merchants, before you make your purchase. And so you will be clicking on multiple ones of those, but only buying one plasma screen. And the more paid placements there are, probably the more click-throughs you’re going to have.So what that results in for merchants is downward pressure on the value of those customers

Having always thought highly of the Blue Nile CEO and his company’s business model, I’d say something has changed, quickly and significantly—in ways not discussed on Google’s own quarterly earnings call last week.

This is most apparent in the fact that Blue Nile, which has almost exclusively marketed online, is, like FTD Group, considering a shift away from online search:

Given these results, we will be looking to broaden our marketing efforts beyond search in the future. As we seek alternative marketing vehicles to complement our efforts in paid search, I would expect growth to be relatively conservative as we ramp our efforts toward broadening our marketing outreach. This is the right long-term solution for our business. As I’ve stated before, throughout all of our marketing efforts, our focus is on the maximization of gross profit contribution, in keeping with our overarching objective of free cash flow generation….

So what that results in for merchants is downward pressure on the value of those customers. So just as bidding is going up, you’re seeing downward pressure in conversion. Again, this points to our desire in the channel to be less aggressive with our bidding. And if that means giving up some volume to other people who perhaps are not measuring that and doing that ROI calculation, as well, we will do that until it rationalizes somewhat.

I’ll be the first to say I didn’t expect to hear comments like these for another year or two. Just two weeks ago (“Google: ‘Our Thesis is Still Intact’“) I reported that various sources within the corporate Google-using community, with one exception, saw no FTD Group-style slow-down in their marketing spend on paid search.

But with Blue Nile easing off the Google search pedal, it looks like the internet search market is indeed rationalizing—not because of Microsoft and not because of click fraud, but because of good old-fashioned free markets.

And it’s happening now, in Internet 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.

No doubt the PowerPoint slides are being reviewed, critiqued, and reworked at the Pfizer corporate office in preparation for Friday’s Big Analyst Meeting.

Pfizer, hailed Company of the Year by Forbes Magazine in its January 11, 1999 issue, has lately fallen on very hard times—both business-wise and stock price-wise, and analysts, widows, orphans and brokers are eagerly looking for guidance at tomorrow’s first post-collapse presentation to Wall Street’s Finest.

Is it any coincidence that Pfizer’s stock peaked at $50.04 on April 16, 1999—just three months after the Forbes Cover Story?

Everybody on Wall Street has either experienced first-hand or knows examples of the “Cover Story Curse”—the tendency of major publications to recognize a major trend, fad, or corporate success precisely as that trend, fad, or corporate success has bred the seeds of its own destruction—and Pfizer is Exhibit A of the Cover Story Curse.

[As readers might recall (see “The Last, Best Hope for Prosperity” on June 12), Time Magazine provided the most recent “Cover Story Curse” last summer, when its “Home Sweet Home” cover story (“Why we’re going gaga over real estate”) preceded the top in the house-buying mania by maybe three months.]

And so it was that Pfizer-the Great slowly lost its way, until earlier this year anxious callers to “Mad Money” asked Cramer for advice on their holdings in what had once been regarded as the bluest of blue-chip stocks.

“I am giving you permission to sell Pfizer!” Cramer would scream, slamming the “Sell-Sell-Sell” button and no doubt contributing to the wash-out bottom in the stock, shortly before welcome litigation news and a huge dividend boost sent the stock up, and altered the mood among Pfizer investors from feeling we’re-all-doomed to the more hopeful it’s-not-dead-yet.

And now the Wall Street Journal reports that Pfizer may be preparing to sell the old Warner-Lambert consumer franchise, comprised of Listerine, Visine and other stalwarts that have lately been knocking the cover off the ball in comparison to the drug business.

Numbers being tossed around are as high as $11 billion, and interest is said to be high.

But why stop there? Why stop at selling off $4 billion or so worth of Pfizer’s $50 billion in sales? Why not sell the whole thing? And I don’t mean a merger with, say, P&G or some Big European Drug company.

I mean a good old fashioned leveraged buyout.

The idea is probably as farfetched as it sounds, and the probability is next to nil. I would never buy the stock on the assumption that some private equity group could round up the quarter-trillion or so that it would cost to leverage-up the company.

Also, Pfizer guys are corporate guys—they like the company, they like the lifestyle to which it has accustomed them, and they have probably become too accustomed to being the buyer to ever think about being the seller, despite the fact that they have granted themselves something like a half a billion shares worth of stock options.

And they are probably not the most entrepreneurial management in America.

I say that because I once sat on the train to New York next to a Pfizer executive. He spent the entire train ride—more than an hour—working on his laptop computer moving boxes around on an organizational chart.

I am not making that up.

But a leveraged buyout of the ex-Company of the Year is worth thinking about, if for nothing else than trying to understand the valuation currently accorded to Pfizer on the market.

The math is really pretty simple:

1. Pfizer had EBYYY—“Earnings Before Yadda-Yadda-Yadda”—of around $22 billion last year. (In serious terms, EBYYY is what Wall Street calls “EBITDA”—earnings before non-cash charges, such as depreciation, and capital-related charges, such as interest and taxes.)

2. Pfizer has no debt, net of cash. In fact, Pfizer has a lot of cash, thanks to the repatriation of $30+ billion from overseas entities as part of the so-called “Jobs Act.”

So let’s pretend a leveraged buyout group paid $32 a share for PFE—just pretend. Call it 7.4 billion shares outstanding, and that would cost the buyers $237 billion.

Now, pretend the buyers put up $37 billion of their own equity and borrow the remaining $200 billion, upon which they might theoretically pay, what, 9% interest—about $18 billion annual interest expense?

(Hey, Russian Federation bonds yield roughly 6%—and which credit would you rather own, a country run by an ex-KGB agent or a company whose business is keeping aging Baby-Boomers alive?)

So, under these assumptions, Pfizer’s EBYYY of roughly $22 billion would cover the $18 billion annual interest tab, with $3 billion available for capital expenditures (which amounted to something under $2.5 billion last year) or dividends to the new owners.

Furthermore, the new owners—being rapacious high-leverage types—could immediately set about selling off assets (the Listerine franchise, for example) to the highest bidders, in order to reduce debt or, more likely, pay themselves fat dividends and the kind of “advisory” fees that LBO groups grant themselves once they control the piggy bank.

Far-fetched? Yes.

But here’s the most compelling part: figure that the average LBO generates legal, banking and advisory fees of up to 5% of the value of the deal.

5% of $237 billion is $11.9 billion—$11.9 billion of fees for Wall Street’s lawyers and bankers and analysts!

Dream away! But don’t expect an announcement tomorrow.

Jeff Matthews
I Am, In This Case, Making It 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.

“We have to defend our fatherland.”

Who said that recently—Hitler? Stalin? Hunter S. Thompson?

Of course not—they’re all dead. So here’s a hint: the man who said that also said this:

“We still need a higher number of rifles. The 100,000 Russian rifles are not enough, Veneuzuela needs to have one million well-equipped and well-armed men and women.”

That’s right: it was Hugo Chavez, President of Venezuela, the largest oil exporter in the Western Hemisphere.

I’m not making this up. The leader of a country in the Western Hemisphere actually said he needs a million well-armed men and women, to prepare for an invasion by the United States.

But that leader, who just as well might be Hunter S. Thompson, what with all the guns and paranoia flying around, does not lead just any country—he runs Venezuela.

And Venezuela, as I have discussed before (“Instability Adds Up”) supplies 11% of the crude oil imports to which we are “addicted,” as our President, who has heretofore done exactly zero to reduce that addiction, noted in his State of the Union speech recently.

Not only does Venezuela supply crude oil, but years ago that country bought Citgo, the United States-based refining and marketing company which happens to operate four refineries with about a million barrels-a-day capacity.

In other words, Venezuela produced about a gallon of the gasoline currently sloshing around in the average American’s gas tank.

And Chavez has threatened to close down those refineries:

“I could easily order the closing of the refineries that we have in the United States…I could easily sell the oil that we sell to the United States to other countries in the world…”

Meanwhile, on the other side of the world, the leader of another major oil producing country—slightly less daffy and therefore more scary—is moving ahead with plans to develop nuclear weapons. Oh, and he has said, publicly, that Israel should be “wiped out.”

Finally, and being perhaps the Reggie Jackson of this dangerous mix—the “straw that stirs the drink,” as the Yankees ex-slugger once described himself—Muslims are burning embassies over cartoons.

Yet, in the midst of what looks to me like the most combustible mixture of political, social and religious issues since the Shah of Iran fled his palace in 1979, private equity firms are rushing to buy up U.S. companies—not at bargain-basement prices in the midst of depressed operating conditions—but at all-time record prices in the midst of all-time record operating margins.

Jon Huntsman, the cancer-surviving, charity-supporting family man from Utah whose chemical company survived a harrowing brush with bankruptcy during the last down-cycle in that notoriously cyclical business put it well in yesterday’s Wall Street Journal:

“It appears to me that many of the private-equity shops are going to reach into some very marginal businesses with all the available capital,” he said. “Any time you have to reach too far to put your money to work, you’re going to take a higher risk.”

And with the Latin American Hunter S. Thompson running Venezuela and his soon-to-be nuclear-equipped counterpart running Iran, the risks may be higher than anyone thinks.

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.

Okay, let’s get it over with right up front: I couldn’t care less about the Super Bowl. World Series, yes; Super Bowl, no.

Which is why I didn’t quite believe it when one of my daughter’s friends called from the college dorm where they were watching the Super Bowl to tell me Overstock.com had run an ad during the Big Game.

“Overstock?” I asked him.

“Yep,” he said. “The guys in your blog.”

“What kind of ad? The lady in white?

“Sexy lady. She was in bed.”

Sounded like Overstock, but I still didn’t quite believe that a web retailer with negative operating margins had bothered spending money on a Super Bowl ad.

That is so, as they say, 1990’s.

But sure enough, in my USA Today today is a “Super Bowl Ad Meter” ranking every single ad shown last night—and there it is, described thusly: “Overstock.com: O as part of life.” (Overstock’s web site calls it “Red Objects.”)

Unfortunately for Overstock, however, this description appears under the heading “5 least popular.” In fact, the USA Today Ad Meter ranks Overstock’s sexy bed-lady 56 out of all 58 ads.

(According to the paper, the “Ad Meter” comprised “207 adult volunteers in Phoenix and McLean, Va” whose reactions were “electronically charted” during the game.)

Their favorite ad came from Bud Light, and scored an 8.39. The top ten ads—six from Budweiser alone—averaged in the high 7’s. The least favorite, from Gillette, scored a 4.05. The second least favorite, from Slim-Fast, scored a 4.28.

Next was Overstock’s “O as part of life,” at 4.91.

All of this is eerily reminiscent of last year’s so-called “binomial marketing experiment,” which is how the Overstock CEO described a mysterious, not-quite-defined $2.6 million expenditure that added to the 2005 first quarter’s woes.

Long-time readers will recall that following the earnings report some of Wall Street’s Finest dutifully wrote “$2.6 million binomial marketing experiment” in their research reports, despite the fact that not one of them appeared to understand what that actually meant. But it sure sounded cool.

While I took plenty of math in school, my own memory of binomial coefficients and how they bear on marketing expenditures is a little shaky—unless, perhaps, “binomial” comes from the Greek roots “bi” meaning “buy” and “nome” meaning “very little.”

I am, of course, making that definition up. But I am not making up the cost of a Super Bowl ad, according to USA Today today:

“The evening didn’t come cheaply for the winners—or losers. Each 30-second time slot cost a record $2.5 million—or $83,333 per second.”

I don’t know what Overstock actually spent on last night’s ad. Nor can the opinions of 207 individuals be said to accurately reflect the 50 billion or however many people watched the Super Bowl. And I assume that more than a handful of individuals will, as a result of the sexy bed-lady, check out the site and pump up the numbers.

It will be interesting to hear the spin on tomorrow’s conference call…but beware “binomial marketing experiment” and other euphemisms.

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.

I got a bang-up response to a recent post about the sorry state of Dell’s customer service (“Dell Screws Up a Good Thing”).

Out of 28 comments directly related to Dell and the state of its customer service, readers posted 23 scathing-to-nasty first-hand opinions on Dell and five lukewarm-to-positive responses.

So, it might not just be me.

I wrote the blog because, having used only Dell desktops for the last twelve years and had nothing but good experiences the few times I needed to call Dell for service issues, I was astonished last month when a simple walk-me-through-this-wireless-configuration-please phone call turned into a nightmare of New York City Motor Vehicle Bureau type I-don’t-handle-that responsibility-avoidance and please-hold-while-I-get-finish-this-solitaire-game customer-support.

Even the Muzak was terrible, being a bunch of 1980’s syntho-hair-band British pop, including, and I am not making this up, “Hungry Like The Wolf.”

The fact that Dell seems to think Duran-Duran might help an angry customer calm down indicates better than anything how far the once-mighty have fallen.

So when I received the following email, you can imagine what went through my mind.

Your Dell service contracts expire in 60 days

Dear Jeffrey Matthews,

Some of your Dell service contracts expire within the next 60 days. It’s time to make sure all of your vital systems are well protected, and Dell is here to help.

Dell makes it easy to stay on top of everything You’ve got hundreds — maybe thousands — of systems to manage on a daily basis. Each one of those systems is business-critical to somebody. Your Dell service contracts can help you keep all of your Dell equipment up and running with as little hassle as possible. Unless you let those contracts expire.

Call 1-877-825-5385 to renew today!

Get the most out of your systems — and your staff

Your IT systems represent a huge investment. With Dell service, you can get maximum value from your equipment and reduce downtime. Plus, because Dell handles any problems that arise, you can save on costly repair bills and free up your resources to focus on higher value tasks.

Listed below is a status of some of your service contracts that require immediate attention:

Call 1-877-825-5385 to renew today!

If your service contract has expired and exceeded the 30 day grace period, you will be subject to a reinstatement fee up to $200 per machine.

Call us to renew!

A Dell Service Sales Representative will help you select the best options. Call today!

1-877-825-5385
Renewing your service contracts is a smart choice, especially when you consider the potential impact on your bottom line. But you’ve only got 60 days until your contract expires, so call us today!

Sincerely,
Dell Service Sales

P.S. It’s a good time to consider upgrading your services for any crucial or high-risk systems. Dell offers additional services tailored to unique needs. A Dell Service Sales Representative will help you select the best options. Call today!


Call “a Dell Service Sales Representative”?

As Jack Nicholson once said, “I’d rather stick needles in my eyes.”

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.

Shell said total oil and gas production fell 9% to 3.5 million barrels of oil equivalent a day from 3.84 million a day a year earlier.—Wall Street Journal

How the mighty have fallen.

During the last oil crisis—1980—when I was putting together the data to be used in the “Monthly Petroleum Review” for my boss in the equity research department of a large and fondly-remembered brokerage firm whose name rhymes with “Feral Winch,” Royal Dutch Shell was probably the best-managed of the seven international oil companies.

Exxon in those days was dealing with, among other things, a failed diversification program into, believe it or not, integrated circuits (I am not making that up: Exxon had purchased Zilog for some bizarre reason), while British Petroleum was still partly owned by the UK Government, which was not exactly a value-added board-member, and also managed to top-tick the entire 1970’s inflation cycle by buying Kennecott Copper in 1981.

Royal Dutch, meanwhile, was focused on gaining control of its U.S.-based affiliate, Shell Oil, which was the best-run of the domestic majors, and building a mind-boggling worldwide portfolio of oil and gas assets—all based on its original 1890 franchise: exploiting Sumatra oil fields in the Dutch colony of the Netherlands Indies.

But that was then, and this is now, as reported in today’s Journal:

The company [Royal Dutch] said it expects its closely watched reserve-replacement ratio – the rate at which a company finds new reserves of oil and gas to replace the energy it pumps out of the ground each year – would be between 60% and 70% in 2005. Companies typically try to achieve 100% reserve replacement…

Yes, no kidding oil companies “try to achieve 100% reserve replacement”: anything less and they are a depleting asset.

Meanwhile, the best our current administration can come up with is something called “cellulosic ethanol.”

I don’t know about you, but even my dog Lucy knows that “cellulosic ethanol” is not the answer to anything in a world demanding 84 million barrels of oil each day.

Back when I was crunching those numbers for the “Monthly Petroleum Review,” China was a net exporter of oil while Indonesia—which two years ago followed China’s example and started importing oil products—was a major oil exporter and key OPEC member…and the entire world consumed a modest 55 million barrels a day.

A 60-70% reserve replacement ratio is not, for any extraction-dependent company, a good thing. For an oil company as large and important as Royal Dutch, it is a bad thing.

And for the world at large, it is a terrible thing.

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.

“Beef is ugly.”

So stated Richard Bond, CEO of Tyson Foods on yesterday’s earnings conference call.

Or, rather, lack-of-earnings call, because Tyson both missed the estimates for the quarter and guided down the full year by half, which you don’t see very often, except at companies like Tyson that not only don’t control their input costs—beef and chicken—but don’t control their selling prices either.

Like its CEO Mr. Bond’s namesake when he gets caught in one of those shrinking elevators devised by whatever evil nemesis is seeking his doom, Tyson is being squeezed on all sides: a Midwestern U.S. drought cut the beef supply, raised beef costs and, well, sliced beef margins. Meanwhile, Asian-Flu scares hurt international poultry sales, causing the chicken side of the business to, er, lose altitude.

More interesting than the miscues of a nuts-and-bolts food processing company will be the earnings calls from both ends of the Internet spectrum: Overstock.com next Tuesday, and Google tonight.

Expectations for high-growth, high-margin, high-everything Google run very high, with all eyes focused on sequential net revenue growth.

Depending on the analyst talking, Wall Street expects a minimum of 22% sequential growth (more than most growth companies experience year-over-year) and as much as 30% sequential growth (way more than most growth companies experience year-over-year). “Pro-forma” earnings should be at least $1.75 a share—and probably closer to $2.00 to satisfy the hoards.

I have no idea what the numbers will look like when Google reports after the close, but we have some clues that add up to strong numbers—particularly the fast growth in eBay marketing costs (eBay is Google’s largest user) and the continued ramp-up in online marketing spend described on many conference calls in the last two weeks.

Indeed, if the Alexa.com numbers are to be believed, Google usage has continued to grow substantially—significantly outpacing Yahoo!

You can see this yourself: go to Alexa.com’s “Traffic Rankings” page, type in “google.com” and then type “yahoo.com” into the “Compare Sites” function. You will see the Google blue line crossing the Yahoo red line—at least for internet users utilizing the Alexa.com toolbar.

Whatever the outcome tonight, I doubt there is much of a short-term “play” in Google stock, because short-term option volatility has soared to absurd levels and will almost certainly collapse the minute the press release hits the tape.

I’d be willing only to bet that Google put buyers and Google call owners see little profit, unless Google management misses huge or beats very large.

Expectations are not so high, however, for Overstock.com, following its pre-announcement of weaker-than-expected sales in the 60% range, along with negative cash flow and earnings—a sorry state of affairs for a company whose CEO once said, “You tell me when you want me to stop growing at 80 to 100% per year, and I’ll tell you when we can get profitable.”

Judging by the urgent emails I get each day (“Month-End Closeouts – Hurry, Time is Running Out!” reads today’s version) from Overstock, as well as the reach and page view graphs on Alexa.com, I wonder how sales currently look at “Earth’s Biggest Discounter™” or whatever the company is calling itself these days.

Although it’s unwise to read too much into one data point, I have found the Alexa.com data to be a decent directional indicator. And as of now, they indicate flattish-to-downish year-over-year reach and page views on Overstock.com—in contrast to, for example, what looks like a nearly 100% year-over-year increase at Buy.com. Spikes in Overstock.com usage appear to correlate (and I stress “appear to”) with changes in shipping fees.

Tyson will, no doubt, recover in time, thanks to the magic of market forces. I give Mr. Bond credit for one of the most direct statements about the state of his business on any conference call this season.

Would that other CEOs might adopt such a direct, no-frills approach.

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.


Note: Last night Overstock issued the following statement:

Overstock.com, Inc. (Nasdaq:OSTK – News) today announced that it is scheduled to release fourth quarter and full-year 2005 financial results before the market opens on Tuesday, February 7. An accompanying webcast and slide presentation are scheduled for 11:00 a.m. Eastern Time on Tuesday, February 7.

Shareholder.com reported that the Overstock.com webcast was scheduled for January 31: that information was incorrect and should not have been published.

Having examined a Guidant deal three years ago and passed, the company [Boston Scientific] became intrigued at possibly taking advantage of a lower J&J bid.

“J&J opened the door to us, and we’re gutsy enough to walk in,” said one Boston Scientific executive.—Wall Street Journal

Thus the Journal reported how it was that Boston Scientific sprung its surprise $25 billion bid for Guidant just a few weeks after Johnson & Johnson had negotiated a price cut with the regulatory-entangled Guidant.

Wall Street loves a good bidding war, of course—what with the duplicate advisory fees, duplicate legal fees, duplicate financing fees, and, in the end, the higher share price upon which so many other sharks in the tank can feed.

But will Boston Scientific shareholders benefit from the company’s self-proclaimed “gutsy” move?

Consider that J&J had agreed to buy Guidant in December 2004. Think about the number of J&J lawyers, finance people, doctors and consultants combing through Guidant, evaluating the business units product-by-product, working out the details of the merger and how the post-merged company would function.

Consider the fact that the deal had to be approved by our Federal Trade Commission as well as the European Union, and think about how many individuals from both companies had to work together to convince hundreds of regulators around the world to approve the deal.

Ask yourself how much J&J was spending on the deal—a million bucks a day? Two million a day?

And consider the detailed due diligence J&J had thereby acquired on every aspect of Guidant during that entire process

Now, recall that six months after the deal was announced, Guidant reported a flaw in one of its defibrillators, and soon pulled five of the devices from the very market for which J&J wanted Guidant in the first place.

And recall that J&J felt compelled to issue a press release describing these product issues as “serious matters,” but said it was working with Guidant to resolve the issue.

Then think about why it was that J&J eventually lowered its deal price for Guidant—the very act which “opened the door” for Boston Scientific to swoop in with its dramatic, 11th Hour offer and ultimately prevail with the kind of high drama and stretched bid that Wall Street loves and for which it has been cheering on the BSX crew.

And ask yourself who really knows more about Guidant and what it will take to restore its franchise and take advantage of the medical and demographic trends upon which the premise of the deal itself rests?

Is it the folks at J&J who, metaphorically speaking, spent over a year roaming the House of Guidant, peering in the attic, ripping up floorboards, checking the plumbing and inspecting the roof?

Or is it the outsiders at Boston Scientific, who drove by a house they had thought of buying three years ago, before the price tripled, but had passed on it—and now, admiring anew what they saw, found a friendly set of bankers and started bidding?

“Gutsy” may be the right adjective for the bid-‘em-up folks at Boston Scientific—they’ve proved themselves full of that quality in years past.

Time will prove whether “stupid,” “desperate,” “naive” or, perhaps, “brilliant” are better.

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.

“As you know, we’re in the middle of a transition in search advertising business, moving from Yahoo’s platform to our own proprietary ad platform called MSN adCenter, which we began testing in the US during the quarter.”

When you hear somebody start a discussion with the qualifier “As you know,” you brace yourself for news that is not-so-great, and that’s how Microsoft began its discussion of search results at Microsoft Network on last night’s call.

The bad, though not-necessarily-unexpected, news came in the next sentence:

“The ramp-up of a new ad platform requires significant investment from Microsoft, both in development costs as well as in reduced revenues related to fewer numbers of overall advertisers and the resulting lower keyword pricing.”

In other words, Microsoft’s online search business, in the midst of the biggest boom in the history of the world, was down year-over-year and flat sequentially. Readers should keep in mind that Google is expected to show 100% year-over-year and 20-25% sequential growth when it reports earnings next week.

After a company like Microsoft, with so many hopeful investors eager for a hint of past glory, drops that kind of news, you should expect some positive spin in order to leave the masses feeling more upbeat—after all, Yahoo! got smashed last week after reporting “only” 13% sequential search growth.

Microsoft obliged as follows:

“The good news is that in response to our platform has been great, and we are ramping up deployment by rapidly on-boarding advertisers and moving more search traffic to the platform.”

Microsoft may be ramping up advertisers, but that doesn’t mean it is ramping up the customers that actually use Microsoft Network. I know one individual who has shifted his entire email business away from Microsoft Network to Google’s Mail product; and based on the increasing numbers of emails I receive from “gmail.com” addresses, it appears I am not alone.

For that reason, and because of the fact that Microsoft’s entire reason for existing is not to create the greatest search product but to drive people to buy Microsoft operating system software, I doubt Microsoft will win the search war, no matter how much money it throws at the business.

Now, Google may or may not be a good investment, stock-wise. I have been a fan of the company for some time, but reasonable people can disagree on the company’s prospects and the stock’s valuation. In any case, much ink, both real and digital, will be spilled in the next few days trying to game the company’s fourth quarter earnings report, due out next Tuesday after the close.

A few weeks ago I highlighted a press release (“The Most Interesting Press Release You Didn’t See”) from FTD Group, the flower-delivery organization that utilizes internet search advertising to generating a significant portion of its business.

In the release, FTD said that online search costs had “increased significantly,” causing the company to curtail its use of the medium and ponder “a more diversified marketing portfolio.”
It looked like search—for FTD, at least—had reached the limits of its marginal utility.

In response, I received a number of comments, some agreeing with the FTD experience and others disagreeing entirely. Feedback from friends whose businesses utilize search for a significant portion of their customer acquisition were likewise mixed, although more indicated that the bills they paid to Google were still increasing than not.

Just yesterday, however, another data point emerged in the search-cost conundrum, squarely on the side of Google.

1-800 Flowers.com (yes, that’s the actual name of the company) reported 21% revenue growth, as well as continued dependence on, and effectiveness of, search-based advertising:

“During the quarter we attracted more than 1.3 million new customers with 57% of them coming to us online, up from approximately 1.2 million and 54% in the second quarter of last year….

“Certainly search is an expensive yet effective marketing vehicle for us, one of our overall marketing channels. We did not see any spike in costs this holiday season. Actually, this past holiday season, search costs were comparable to last year’s holiday season.”

I hesitate to extrapolate from this any firm conclusion about next Tuesday’s earnings report from Google.

However, I suspect—to use one of Wall Street’s Finests’ favorite, most clichéd, and least informative old sayings, “Our thesis is still intact.”

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.

I make fun of those I call “Wall Street’s Finest”—the brokerage firm employees who call themselves “analysts”—so frequently that it might appear I have no use for any analyst working for any brokerage firm anywhere.

This, of course, is not true.

I started on Wall Street as just such an analyst, but very low on the totem pole, being one of those junior assistants whose job it is to construct the vast Excel spreadsheet models which form the backbone of every research report, good or bad, coming out of every broker on the Street.

Except in those days we didn’t have Excel spreadsheets: we had a centralized computer center where strange FORTRAN-literate employees created earnings models on mainframe computers, using our hand-scratched numbers.

We’d get a ream of computer paper back from the FORTRAN guys, look at pages and pages of numbers, make adjustmentss and send it back. And repeat the process any number of times, until we had a nice-looking computer-generated forecast that was basically meaningless by the time it was done.

Eventually we acquired something totally new: personal computers, which came with a cool spreadsheet program called “Lotus 1-2-3.”

What this revolutionary, time-saving device did was allow me to spend all my waking hours experimenting with complex formulas, typing in numbers, hitting the “recalc” button and playing with secretary-style formatting techniques in order to create a computer-generated forecast that was, likewise, basically meaningless by the time it was done.

Garbage in, garbage out, as they say.

Which is why I find most Wall Street “models” to be pretty much nonsense, at least so far as the precision that is implied in an earnings forecast of, say, $3.28 per share in 2008. (Why not just round to the nearest nickel, or dime, or quarter?)

A good example of the garbage-in, garbage-out school of earnings models relates to Nextel, which we looked at a few years ago when that company was coming out of its near-death experience and appeared to be on the verge of showing positive cash flow—something not many of Wall Street’s Finest were expecting, having finally abandoned the former darling of the Telecom Bubble on the Worldcom scrap-heap.

Nextel stock looked cheap, and I requested an Excel spreadsheet from one of the larger Wall Street houses. The “model” had everything—income statement, cash flow statement, balance sheet—and more, including a very impressive bottoms-up construction of the revenue forecast, with subscriber additions, subscriber churn and “ARPU” as the Street calls it (Average Revenue Per User)… In short, everything you needed to forecast the future for Nextel.

Except for one couldn’t-be-bigger problem: the cash flow statement was entirely wrong.

During its build-out years, Nextel had accumulated huge operating losses which would shelter any forward earnings from Federal taxes up to some amount in the billions. The analyst—detailed though his spreadsheet was—had neglected to take this “NOL” into account.

What happened was this: even though the model showed Nextel generating future earnings, and even though the model’s income statement included, correctly, a provision for Federal income taxes that would not be paid thanks to the large NOL, the model neglected to add back the NOL-sheltered taxes into the cash flow statement.

Consequently, one of Wall Street’s Finest was understating Nextel’s future cash generation by more than a billion dollars. Hardly a rounding error.

(I figured I was missing something, so I called the firm’s salesman who talked to the analyst…who agreed that the model was incorrect.)

Now, there are some truly good-to-great analysts out there who balance the poor-to-middlings.

Kurt Wulff, for example, revolutionized the way Wall Street looks at energy stocks back in the early 1980’s, demonstrating their value was reserves in the ground rather than in earnings-per-share. (Kurt is still at it and posts his research on his own web site).

More recently, and on a less grand scale, I have another nominee for one of Wall Street’s Finest, based entirely on a single piece of research written a few weeks ago by an analyst I have never actually met.

The analyst is David Manthey at Robert W. Baird, and the piece he wrote was about Hughes Supply.

Hughes Supply is a good company I have followed for many years—a fairly mundane distributor of plumbing, electrical and building products that got its start supplying the contractors who built Walt Disney World in the late 1960’s. And for those paying attention to the headlines, Hughes recently agreed to sell out to Home Depot.

Speculation surrounding a Home Depot-for-Hughes deal surfaced in the fall, and the stock had been bouncing around in the high-$30’s in the months following an October 31 press release stating that the board had authorized management to look at “strategic alternatives” to “maximize shareholder value.”

But most analysts, who prefer not to get too close to the line when it comes to takeover speculation, either stayed radio silent on the issue or proffered vague price targets based on theoretical deal-multiples.

Which is why Mathney’s update on January 6—brief though it was—came as such a pleasant surprise:

“We believe it is very possible that Hughes’ senior management, seeing the stock in the mid-to-upper $20s, and hearing rumors about Home Depot, decided to line up financing to take the company private.

“Doing nothing, HUG [the Hughes ticker symbol] could potentially be acquired at a much lower price, with the acquirer deriving the benefits…. By partnering with a financial buyer, management could increase equity stakes, make changes as a private enterprise, and accrue the benefits of margin enhancement. Eventual exit strategies could include a sale, break-up, or IPO.

“By announcing the process, Hughes’ board likely clears fiduciary responsibility to shareholders by seeking the highest bid from the public markets, potential acquirers, or management’s own bid.

“We believe shareholders should hold the stock, because if HUG is acquired by any entity, it would likely occur at a premium to the current price [then $37.62]…. We believe the ceiling would likely be in the $45 range or 10x 2006 [estimated] EBITDA, which would represent a similar multiple as Home Depot’s National Waterworks acquisition.”

Four days later, Hughes Supply announced it would be acquired by Home Depot for $46.50. The stock is trading for $45.72. Wall Street’s Finest, indeed.

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.