All The Hoopla
Friday, August 27th, 2010
By Dian L. Chu, Economic Forecasts & Opinions
The most active market sector in terms of consolidation is definitely Technology and there is a reason for this wave of M&As. At the forefront of any analysis it is always important to follow the money. This is the real driver of this trend that has been going on for the past year, and will only intensify over the next four months.
Who has all the money in the world to spend on major technology purchases? The answer would be large corporations and big governments with both the money and need to cut costs to be more efficient and productive through more advanced technology infrastructure.
Law of Diminishing Returns & Survival
Tech sector is not immune to the Law of Diminishing Returns, which means margins will inevitably continually come down as technological products and services become commoditized. The high margins are always in the new growth areas of technology that have yet to become commoditized. Thus enter all the hoopla over cloud computing. This is an area that will produce the high margin growth opportunities in technology for at least the next five years.
All the big players want to make sure they get in a better position to fully capitalize and compete in this new area of high margins. It is the death of a technology company to be left in the realm of commoditized product offerings. The battle over 3PAR between HP (HPQ) and Dell is really about the future survival in the technology arena.
Dell – Too Late in the Diversification Game
Dell should have been thinking along these terms five years ago the way HP has diversified itself along the higher margin spectrum to offset the commoditized portion of their business portfolio. Instead, Dell has failed at becoming competitive pursuing its strategy of the past three years of trying to come up with “cool” products to drive higher margins—-a la Apple (AAPL).
Now, Dell is trying to play catch-up in an attempt to duplicate HP’s successful transition from strictly a commodity provider to that of a value added business enterprise based revenue model. Well, Dell is probably too far behind and don`t have enough resources at this point to go this route, in my opinion.
And this little 3PAR dogfight is just a microcosm of what is taking place in strategy sessions all over Silicon Valley, and boardrooms across the world as technology companies constantly have to fight to stay relevant.
Not Enough Margins to Go Around
The problem is that there are not enough resources to go around in the high growth areas. There are too many big players fighting for the same territory, whereas it was much easier in the past to divide up the space and say Dell and HP do hardware, Cisco does routers and Networking, IBM does large mainframe and consulting, etc. All that has changed as the sector has become intensely competitive, with every player increasingly encroaching onto each other’s turf, particular in the higher margin categories.
But here is the rub–there can only be high margins with few competitors. As more competitors fight for the same space in the category, inevitably margins for the category start shrinking. As such, there will continue to be these smaller deals in tech as companies try to position themselves to better compete in these high margin growth areas. However, this is really just missing the forest for the trees.
The bigger picture is that the tech sector is still relatively fragmented with too many big players competing for the same high margin growth categories, and not all of them are going to survive. Some of the big players will need to consolidate with some of the other big players in the sector in order to preserve any kind of pricing power. Otherwise, ultimately they will all be reduced to low-margin commodity providers, even in the currently attractive high margin category.
A Short List Fitting the M&A Prerequisites
The list of big technology players includes Microsoft, IBM, Oracle, Cisco, Apple, HP, Intel and Google. Some firm on this list most likely will need to be subsumed under the umbrella of one of the other in the group.
One prerequisite of acquiring another big player is a healthy stock price and market cap. Since these deals will be so big to be all cash, a firm`s market cap and stock price will become crucial in stock swap conversion ratio, which will be a major component of any deal. For example, HP`s current market cap–just under $89 Billion—is the smallest on the list, and thus precludes them from being a major player.
The second element will be a perceived strategic fit between both firms. A third requirement will be a bold leader who is ahead of the curve, and fighting the battle of next five years, instead of just this year. Another component may include a lack of attractive organic growth prospects in the acquiring firm. But in general, the stronger company will acquire the weaker company.
Remember, in these deals it is not where the two firms are today, they may seem like alliances with no true synergies, but it is where both companies are heading three years down the line as future competitors.
On a side note, a smaller firm can actually acquire a much larger firm and be quite successful. Several come to mind, but it is more risky, and given the current economic environment, will be a concern for boards in considering this type of bold move.
Potential Deal Scenarios
Microsoft, IBM, and Apple are the strongest companies on this list. I would have included HP on this list a couple of months ago, but as noted earlier, their current low stock price precludes them from being active as a major acquirer.
Apple is sitting on tons of cash, but acquisition actually goes against their fundamental strategy of seeking growth organically. Furthermore, Apple is so distinct in developing products that fit in with the Apple Culture that the only firm on this list that I could envision Apple acquiring would be Cisco, as the other possibility—Intel–would probably have anti-trust issues that would be insurmountable.
IBM could acquire HP much easier from an anti-trust perspective than, say, Oracle, but both acquisitions would make for strategic sense along different lines. Meanwhile, the most likely deals for Microsoft would be them buying Cisco or HP, as these are the only two with a strategic fit and without as much anti-Trust concerns.
An Oracle – HP alliance would be intriguing, but again I think Oracle is too small to acquire HP, but from a business enterprise software and hardware standpoint maybe three years down the line there would be some excellent sales synergies to be gained from this combination.
A Cisco –HP alliance would make considerable strategic sense, but neither of them is in a position to acquire the other–Cisco is not quite large enough to acquire HP, and HP stock is still in crisis mode to be the acquirer either.
Intel and Google are sort of stuck in the middle as both want to branch out into other areas and diversify their revenue streams, as both have not succeeded so well with their organic growth initiatives outside of their core competency over the last five years.
However, both Intel and Google either lack enough synergies for the others to acquire, or are problematic from an anti-trust perspective. Furthermore, I don`t foresee either firms realizing they need to make a bold acquisition to genuinely diversify their revenue streams until it is too late, and they have both become commoditized players in technology.
Anti-trust Not As Problematic
Let me mention here that anti-trust issues are not as problematic for these types of Mega Mergers as people might think. The tech sector has become very crowded with at least six to eight major players in a given category instead of two or three major competitors in the old days. This fact reduces anti-trust concerns to a deal being done in many potential scenarios.
Fight for the Greener Grass
So yes, in technology, the grass is greener on the other side. And everybody has their hands in everybody else`s kitchen so to speak. Apple wants to start making video game players, Microsoft wants to create a great smart phone, Amazon wants to make all encompassing Tablets, HP wants into storage, Dell wants to be like HP, they tried being like Apple, etc. But in the end all these companies are going to merge into the same high growth areas, and fight it out with distinct winners and losers.
And the advance of cloud computing is only highlighting the fact that there are too many big players, and not enough available high margin growth areas for all to flourish. Eventually, some will have to team up with others, some will be relegated to low margin commodity players, and only a handful of the strong-and-fit-to-survive will emerge at the finish line as Mega Tech Giants that dominate the high-end of the technology landscape in the future.
Disclosure: No Positions
Dian L. Chu, Aug. 27
Tags: 3par, Aapl, Active Market, All The Hoopla, Business Portfolio, Cool Products, Economic Forecasts, Growth Areas, Hp Hpq, Inevitable Solution, Large Corporations, Law Of Diminishing Returns, Major Technology, Market Sector, Product Offerings, Sector Watch, Technological Products, Technology Arena, Technology Infrastructure, Technology Purchases
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Saturday, April 10th, 2010
The Economy and Bond Market Diary (4/10/2010)
Treasury bond yields were modestly higher this week on generally stronger than expected economic data.
With little in the way of high impact domestic economic data this week we turn our sights to the international markets. The headlines were dominated by negative news on the Greek debt situation and how it appears very likely the IMF will need to step in and provide a loan to Greece to calm the markets. With all the hoopla surrounding the Greek situation, many investors may have missed some very impressive positive data points out of China. Chinese passenger car sales rose 63 percent year-over-year and hit 1.26 million units, the second highest monthly total ever. For the first quarter, passenger car sales total 3.52 million units, 76 percent higher than a year ago and an annualized pace of 14 million vehicles which would likely place China as the largest car market in the world for the second year in a row. The Chinese government is providing subsidies to encourage purchases and it is obviously providing a big economic lift.
- In addition to the very strong car sales in China, Russian car sales jumped 38 percent month-over-month with the introduction of a “cash for clunkers” program. These strong car sales globally are very positive for the global economic recovery.
- Retailers appeared to have another good month as March same store sales data beat expectations in a wide margin and gains were across a wide variety of store types.
- The ISM Non-Manufacturing Index rose to the highest level since May 2006 in a sign the service sectors are seeing a pick up in activity.
- Concerns surrounding the Greek debt situation create significant uncertainty for the whole euro zone area and likely dampen investor and business sentiment.
- Mortgage rates hit the highest level in eight months and are a headwind for the housing markets.
- Australia raised interest rates for the fifth time in the past seven months citing a strengthening economy driven by strong Asian demand. The Reserve Bank of Australia also indicated that more rate hikes were likely in the near future.
- If financial markets are a good mechanism for discounting the future, the future appears relatively robust. The markets have been able to shake off bad news relatively easily recently, probably a good sign for the economic recovery.
- When governments around the world begin to wind-down the monetary and fiscal stimulus programs put in place during the economic crisis, it will likely present a headwind for the economy.
Tags: All The Hoopla, Bond Market, Business Sentiment, Car Market, China Chinese, Debt Situation, Domestic Economic Data, Euro Zone, Fifth Time, Headwind, Market Diary, Million Vehicles, Mortgage Rates, Negative News, Passenger Car Sales, Russia, Russian Car, Service Sectors, Treasury Bond Yields, Wide Margin, Zone Area
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Friday, September 25th, 2009
Canada is on the cusp of something big. A boom in commodities means Canada will outperform the US over the next decade. Our recovery and upward trajectory is tied to global demand coming from China and India, and the rest of the developing world. And with attractive risk/reward fundamentals, sound fiscal position, and strong banking sector, Canada is destined to become a darling of global investors. At this time, Canada resides in a sweet spot of long term investing opportunity, but not for the one reason – inflation – that gets cited most often. Not yet anyway.
Mark Carney says Canada’s economic recovery is merely a ‘consequence’ of unconventional measures. And, his report cites that prices are still falling in Canada.
This flies in the face of all the hoopla surrounding the inflation-motivated theme of investing in commodities and/or commodities producers. Investing in commodities producers is by no means a bad idea; its the rationale for doing so, by way of inflation, that may be flawed. Investing in commodities falls under the aegis of inflation protection, because if indeed we find ourselves in inflationary times again, we will be happy to own real things, such as commodities and real estate.
In the U.S. however, is it really a big surprise that the G20 meeting is yielding a “strong dollar” consensus? China, and other dollar reservists, Brazil, Russia and India, have been squawking about the faltering greenback, threatening to take measures to reduce its appetite/dependency on the US dollar since before the crisis began. If you listen to the Michael Pettis interview regarding China, you’ll get the idea very clearly that China is in no position to undo its marriage to the US. At least not anytime soon. Un-pegging from the greenback would have destabilizing consequences for China, not too mention the global economy, if not because of its effect on China, then due to its effect on the US economy. The US/China relationship is a symbiotic one. In the meantime, we will watch the U.S./China economic ballet continue.
Therefore, as the G20 has reached a strong dollar consensus, the Canadian, Aussie and NZ dollars have all pulled back. It preserves balance for the dollar, yen and euro economies, and more importantly it keeps everyone happy politically. As for the Canadian dollar rising in value, it’s not a good development for the Canadian economy, but rather a by-product of the demand for what we produce. Its terrible for our non-commodity exports. So, balance works for us too, in the long run.
Kathy Lien: The Canadian Dollar tumbled against the greenback as investors took profits ahead of G20 meeting. Oil prices also fell more than 4 percent while gold prices closed below $1000, providing no support for the commodity currencies. The Canadian government returned to easier monetary policy after Canadian Finance Minister Jim Flaherty proposed an expansion of mortgage buy-backs to C$125 Billion or $116.4 Billion. The proposal comes on the midst of yesterday’s comments by Governor Mark Carney who claims the recovery is not “self-sustainable” and is a mere consequence of unconventional measures. If they proceed further with this, we could see a turnaround in the Canadian dollar.
In What is Gold to China?, we discussed the idea that gold is a safer long term bet as a result of the “Beijing put,” the notion that whenever gold falls to lower levels, the Chinese come in as strong buyers, bidding gold back up, as they are continually out to diversify their reserves into other currencies. Its all part of a symphony of intervention that is choreographed between the US, Europe, the IMF, Japan, and China to keep the dollar in a fundamentally stable range. Having said that, this too, benefits Canada as one of the world’s biggest gold producers, despite the fact the price of gold is subject to the manipulation of central bankers.
In that vein, Canada, as important as it is in today’s world, is along for the ride. Our recovery will depend upon a stable global recovery determined by steady interest rate policy and coordinated currency balancing.
Herein lies the opportunity; we just need to recognize it, and get our (long-term) peas lined up.
The long-term rationale for investing in Canada
Canada has what the world needs (resources), a sound fiscal position, and a strong banking system – So why haven’t the dollar reservists chosen to invest in Canada bonds, as an ultra-safe alternative to US Treasuries? Simple.
Canada has so much of what the reservists (BRICs and other emerging economies) need and want in order to build out their own economies, that investing in our debt would raise the price of the very things they want to buy from us, such as wheat, oil and gas, metals, and minerals. They are not just interested in importing commodities from us; more important, they have their eyes on buying the companies that produce the commodities, as well. Despite this, Canada’s bond market may perform well in the near term, as a by-product of today’s continued price weaknesses. And, the time will come, though not in the near future, when foreign investors will alternatively opt to buy Canada bonds.
Among the great inefficiencies that have plagued Canada is our conservatism (or rather the reluctance among Canadians to invest risk capital in the most strategic areas of our economy), and our complacency. Canadian companies have historically faced shortages of domestic investor capital, and that issue has forced them to look first to the US, and now globally for substantial sources of capital. This has meant that Canadians have foregone the ownership of our homegrown companies to foreign interests. Its this inefficiency that makes the opportunity to invest in our own commodities producers, and other companies so attractive.
By the way, every time something creative comes along to make it easy to raise money in Canada, for example, income trusts, someone in government comes along and shuts it down. There’s no doubt that there was some abuse and stretching of the rules which led to the legislation shutting them down, but then again, it was also one of the most successful equity financing periods in Canada’s capital markets history. At times it feels as though the Canadian government would rather help foreign investors take over our industries, rather than police the tax incentives that make raising capital easier, more fairly. Then again, this too, is part of our conservatism as a society, isn’t it?
Foreign investors are more interested in our companies than we are. As a country and as investors we need to realize that our assets are worth far more to foreigners right now than they are to us. We take our greatest assets, our natural resources, water, oil and gas for granted, because we have always lived in a state of surplus and exported most of what we produce, mainly to the US.
Now that the balance of demand is coming increasingly from the large emerging economies who face massive future shortfalls of materials, water, food, and energy we need to prepare for the geometric growth of demand coming in the next several decades. We sincerely owe it to ourselves to exercise our right to own and nurture these precious assets, before they pass into the hands of foreign corporate interests.
David Rosenberg states in his latest report, out today, that Canada is in the sweetest of spots because we are in the midst of a secular commodities boom. He cites Chindia as the key driver of demand over the next decade, but initially 2009 and 2010, where it is shown that China and India will lead the world in GDP growth, and currently command 21.4% share of Global GDP. This is no big surprise to anyone following commodities, but rather, more confirmation.
We believe that commodities are in a secular bull market, and this is where Canadian outperformance relative to the United States comes into play – nearly 45% of the TSX composite index is in resources; almost triple the share in the U.S. Almost 60% of Canada’s exports are linked to the commodity sector, roughly double the U.S. exposure. This explains how it is that the Canadian equity market has managed to outperform the S&P 500 this year by a cool 2,000 basis points (in this sense, Canada is basically a low-beta way to play the emerging markets via commodity exposure).
This by no means indicates that the US and the Western consumer will cease to be the world’s top consumer, but rather that we will have to line up with the new consumers from the developing world, to buy the same stuff. That is ultimately inflationary, but not for some time.
Rosenberg points out very nicely that commodities prices bottomed last year at the highest recession levels ever.
And, that prices bottomed at levels above historical peak prices.
This last chart is remarkable, because it illustrates how strong demand has gotten during the last ten years with the rise of China and India. Even after last year’s blow-off, prices are fundamentally higher because of the surge coming from the developing world’ growing appetite for food, shelter and commerce.
Forget about inflation, at least for now, as a reason to buy commodities. There are two overriding themes, that should be front and centre:
1) demand for commodities – Foreign interests wish to lock up supply which means the commodities themselves will be bid up.
2) demand for producing companies - Foreign interests, particularly China and its rapidly developing and mutually rich peers have their eyes squarely focused on our businesses and our natural resources. Mergers acquisitions and hostile takeovers will bid up the prices of Canada’s most desirable commodities producers, and it won’t be only China which comes knocking, though they will likely turn out to be the most aggressive. The onslaught of foreign-sourced capital markets activity is likely to come well in advance of peak prices for the commodities themselves.
What do policymakers think of, in the now wealthier, fastest growing countries of the world, whose nations are facing shortages of materials, oil, water, and food that would be devastating to their economic progress? “What will we need, and what do we have to do to get it?”
Let’s come back to the notion of complacency. Canadian complacency. We have taken our most valuable assets for granted, because they are abundantly available in our backyard. Also, the last year’s turmoil has also made it more difficult for investors to commit long term capital out of fear.
In the period ahead, it is not so much inflation, but rather pure and simple demand for the future supply of commodities that will take centre stage. Inflation, when it re-appears will be the icing. Canadian investors should view any market corrections as opportunities to accumulate meaningful overweight positions in their portfolios in the commodities complex in some combination of commodities and commodities producers.
This period represents Canada’s big chance to get out in front of foreign interests in our own backyard. We have the right to participate in the growth that will come Canada’s way as a result of the massive global economic transformation that is underway or we can choose to be bystanders.
We will continue to write and drill deeper into this subject in the coming weeks and months.
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