Columnist Lee Schafer provides short takes on economic incentives and choices, business strategy and performance, market moves, what business leaders are saying and doing and other topics that pique his interest.

Keeping St. Jude's Slide From Getting Lost in Translation

Posted by: Lee Schafer Updated: February 6, 2015 - 4:39 PM

A colleague pointed out one of great examples of corporate-speak in recent memory, lifted from a slide presented Friday morning by CEO Dan Starks of St. Jude Medical at the company’s investor day .

As a former financial officer for a NASDAQ company, I accepted the personal challenge of properly translating it.

The context here is that Starks was covering a few of the good things that happened in the recent past including a consolidation into a more efficient operation. And here’s the bottom bullet point from that slide:

“This will help us continue to leverage adjusted EPS on a constant currency basis in a growth oriented environment in 2015 and beyond.”

Read it again slowly. “This will help us continue to leverage adjusted EPS on a constant currency basis in a growth oriented environment in 2015 and beyond.”

Okay, let’s start with leverage. That’s easy.

By focusing on efficiency, St. Jude’s profits will can go up faster than sales do.  It’s called operating leverage, with sales going up a little faster than the total of the product costs and operating expenses it takes to generate the new sales. If managed well, it should be pretty easy to grow profits quite a bit with just a little growth in sales. 

Now, as for “adjusted EPS.” The second part, EPS, just means earnings-per-share. The value of St. Jude shares in the market is largely determined by multiplying the earnings-per-share by an accepted market multiplier, either the EPS number just reported or future expectations of earnings-per-share. So EPS is the one indication of profitability that really matters.

As for “adjusted,” St. Jude is not the only company that talks about numbers that have been tweaked just a bit from what appears on the financial statements required under Generally Accepted Accounting Principles. In doing so it's trying to be easier to understand, not throw dust in the air. The company reports its profits, in things like the earnings release, as adjusted EPS, and the analysts all track and forecast adjusted EPS.

What’s being adjusted out of the calculation for St. Jude are the after-tax impact of restructuring activities, litigation charges and the like. It’s a perfectly fine practice, but it's also important to read the footnotes to find out exactly what companies are doing.

Next is that part about “constant currency.”

This is a global company, like all big medical device companies, and a lot of its business gets done using local currency rather than dollars. The financial results are all reported in dollars, however. The thing to do, then, is report the financial results after correcting for swings in exchange rates since the same quarter last year, which is the quarter everybody uses to compare progress.  

If the company like St. Jude didn’t do that, and depending on what happened with the value of the dollar, it would be possible to report a growth quarter when the actual sales, meaning products actually shipped to customers, went down compared to the prior year’s quarter. Using constant currency is a better practice.

Now we come to “growth oriented environment,” the last part of this great sentence on St. Jude’s slides.

After giving this considerable thought ….I have no idea what that’s supposed to mean.

The Only News From Davos Worth Reading

Posted by: Lee Schafer Updated: January 27, 2015 - 2:44 PM

For those who managed to skip reading the news last week out of the World Economic Forum in Switzerland, the only thing really worth noting was an exquisite self-parody of the whole billionaires-jetting-off-to-Davos set provided by a Florida investor named Jeff Greene. 

“America’s lifestyle expectations are far too high and need to be adjusted so we have less things and a smaller, better existence,” Greene told Bloomberg in an interview in Davos. “We need to reinvent our whole system of life.”

He went on to it express his concern for the economy as the continuing transition to knowledge-based work destroyed the jobs and wages of more and more people who work in manufacturing and other middle-income occupations.

This isn’t necessarily controversial to say things like that, at Davos or anywhere else.  What’s controversial is that he’s the one who said it.

Greene is best known as an investor for making a lot of money in the Great Recession by betting against sub-prime debt securities. But he’s just as well known for his grand lifestyle, and Bloomberg noted that he flew to Davos for the week on a private jet with his wife, kids and two nannies.

In fact, Greene’s lifestyle is so grand that he rivals Jay Gatsby in his utter lack of interest in any system of life that means having less things and a smaller, better existence.

Although it’s not clear he ever really lived in it, one of his homes is called the Palazzo di Amore, or Palace of Love, on 25 acres in Beverly Hills, Calif. This place includes a vineyard that produces hundreds of cases of private label wine a year, along with a bowling alley, cinema and rotating dance floor. Its 53,000 square feet of living space has 23 bathrooms and 12 bedrooms, including a 5,000-square-foot master bedroom. 

That house, where he was married in 2007, burst into the news last year when, according to Yahoo Homes, it was the country’s most expensive personal residence. He listed it for sale for $195 million. 

He owns two other places in Southern California, his principal residence in Florida and, as befitting a titan of finance, a place on Long Island east of New York City. The Long Island property is a 55-acre estate called Tyndal Point with 3,000 feet of beachfront. And it only cost $36 million.

The 60-year-old Greene made his money in real estate and investments, but he has run for Congress as a Republican and more recently for the U.S. Senate in Florida as a Democrat. It was during the latter failed campaign that news broke about some party mischief that reportedly took place aboard his 145-foot yacht called the Summerwind.

Really, it’s hard to make stuff like this up.

Bloggers and the New York tabloids lit up in the past few days as there was no way to play his comments on the economy as anything other than the self-crowned King lecturing the serfs from the palace balcony.

But the reality, as always, is more complex. Greene has committed himself to the Giving Pledge, for example, which calls for the wealthiest people to give away most of their assets.

And he pointed out, also in the Bloomberg interview, that his office in Florida is right next to the big hotel where he once worked as a busboy and waiter. And what he wants, he said, is for there to continue to be opportunities like he had for this generation of busboys.

To be more effective as a spokesman for economic good sense, however, he might try selling another of his houses. 

It may be time to take deflation seriously

Posted by: Lee Schafer Updated: December 19, 2014 - 3:42 PM

At least Narayana Kocherlakota didn’t waffle about what he thinks.

The statement Friday by the Federal Reserve Bank of Minneapolis president more or less pounds his colleagues at the Fed for not being worried nearly enough about the specter of deflation. It’s not just what the Fed is doing that’s wrong, through the policy levers it can throw, but it’s what the Fed is saying about the economy and its policy.

Talking now about raising interest rates eventually, he wrote, is a really bad idea. If it were up to him, he would keep alive the idea that the Fed would continue its extraordinary purchases of bonds, called quantitative easing, so long as the inflation rate stays below the Fed’s target.

It’s clear that for at least this Fed president, the threat of deflation looks very real.

It’s still a bit jarring for those of us who are baby boomers to hear talk of deflation, as most of us came of age when the big problem in the economy was too much inflation, or an overall increase in the general level of prices.

But inflation hasn’t been much of a problem for a while, and at least since the end of the Great Recession there’s been talk about the risk of deflation. And if you think inflation is bad, wait till you live through deflation.

Falling prices for many of the things we buy is not inherently a bad thing. Productivity gains and technological change can drive down the cost of products or services, the notable example being computing power. The iPhone on my desk is far cheaper and far more powerful than the computer I bought a decade ago.

The problem is when the price of everything seems to fall, and worse is if consumers and business people assume prices are going to keep falling. When Kocherlakota talks about expectations, that’s what he’s referring to.

Falling prices can mean lower sales and profitability for businesses, leading to cutbacks and wage reductions for workers, who in turn cut their spending. And then with falling prices they put off buying the things they do need, assuming they are soon going to be available at cheaper prices.

The normal functioning of the debt markets also more or less stops, too. People with bonds get paid back in dollars that are worth more than the dollars they lent, enhancing returns even though the interest rate may be near zero. The reverse is true, of course, for borrowers. Each scheduled payment becomes progressively more expensive as the purchasing power of the dollar increases.

Very few Americans still alive can remember what it was like to live in a deflationary period, during the Great Depression of the 1930s, but there have been far more recent examples of a big market economy that experienced a long period of deflation, such as in Japan.

But deflation can occur even without being precipitated by a deep recession. And deflation has played a significant role in US history, including a period called “the Great Deflation” that lasted basically from just after the end of the Civil War in 1865 until the end of the century.  

There was more than one reason for it, from the return to a strict gold standard after the sloppy financial practices of the Civil War era to improvements in productivity as the nation industrialized. For whatever the reason, prices just kept dropping, and that was before the Panic of 1893, a sharp and brutal depression.

Some of the major political battles of the late 19th century, such as the debates over so-called “free silver,” were all about mitigating some of the effects of deflation.

Farmers of that era had an expression for when they faced economic challenges, saying “times were hard.” And you must admit, a decade or two of hard times doesn’t sound like very much fun.

The California Bear on Best Buy is Still Bearish

Posted by: Lee Schafer Updated: November 21, 2014 - 4:14 PM

One good quarter of comparable-store sales growth didn’t shake the conviction of Michael Pachter, a senior analyst with Wedbush Securities of Los Angeles and a holdout among securities analysts who post a recommendation on Best Buy Co.’s stock.

According to Thomson Reuters, of the 27 investment recommendations published about Best Buy’s stock on Friday, 17 were a buy or strong buy rating. There was precisely one sell recommendation.

That’s got to be from Pachter, who actually has an “underperform” rating with a 12-month target price of $18 per share. If he’s right, that would be quite a painful ride down for shareholders, given the current share price of more than $38.

Pachter, in an update report published Thursday after Richfield-based Best Buy released its quarterly results, once again makes a very good case for skepticism. If his were the only research report a shareholder ever read, that investor just might sell.

It is important to note that he is not critical of the people running the company. To the contrary, he’s somewhere between fair and generous in his comments.

In his latest update he apologizes even, for not only having been wrong in his comments in a TV appearance about the iPhone 6’s impact on revenue growth, but also saying Best Buy was disingenuous. 

After seeing this CNBC segment, I would maybe suggest he think also about following up with a handwritten apology note. And maybe flowers. 

The point he makes in his far more measured research report is that the challenges are beyond the talents of anybody trying to run Best Buy.

It’s hard to summarize his lengthy analysis, but perhaps the simplest way to sum up his views is that Best Buy is doing a good job of improving the experience of customers who come into a store, but it just can’t seem to get any new customers.

Further, having to match prices will mean more very painful margin contraction. Finally, the company’s online efforts are just too late.

He wrote that one of the biggest mistakes of his career was thinking that Blockbuster was going to be able to build a competitive online business to go head-to-head with Netflix. After $1 billion of cost and Blockbuster’s bankruptcy, he concluded that any traditional retailer trying to catch up with an online competitor faces very long odds.

Pachter may one day be proven spectacularly wrong about Best Buy, yet his position is actually an easy one to respect.

If one quarter of stronger-than-expected revenue growth was enough to collapse his convictions that Best Buy remains vulnerable, then he wouldn’t be an analyst worth following.

Why Cash is Piling Up on Balance Sheets

Posted by: Lee Schafer Updated: October 24, 2014 - 2:35 PM

In looking for data this week on how American businesses use their cash, to confirm the observations of a longtime Minneapolis portfolio manager interviewed for an upcoming column, I reviewed the most recent look at cash flow produced by The Georgia Tech – Scheller College of Business.

The authors have a broad enough view to produce a regular report on cash flow that’s far more interesting than might be suggested by the title “Cash Flow Trends and Their Fundamental Drivers.”

The authors are looking at the cash flow data of 3,000 or so companies that have a market capitalization in excess of $50 million. The focus of their study is “free cash flow,” which is the cash profits left over after all obligations have been paid.

It’s truly “free,” meaning the company can use it to make acquisitions, invest in capital items like new stores or increase the dividends to shareholders.

The most recent report has data back to 2000. While the numbers from quarter to quarter bump around a little, and it’s easy to see impact of the Great Recession in several charts, there are long-term trends that are very striking.

One is that cash and short-term investments, usually shorthanded as simply “cash” when investors and columnists write about corporate finance, just continues to steadily mount. The median amount is about $88 million, up from just over $30 million 14 years ago.

What explains that?

Well, one other long-term trend is the shortening of the cash cycle, measured in days. This basically is keeping track of the money tied up in inventory and receivables, after subtracting the bills the company has paid yet. And it’s down from over 60 days in 2000 to less than 50 days in 2014.

Another is the decline of capital expenditures, the investments companies make in capital items like buildings or new computer technology. It was around 5 percent of revenue early the last decade, and most recently declined to less than 3.5 percent of revenue.

Capital spending, of course, rolled off the table in the Great Recession and did not recover all the way to prerecession levels, but it had been declining before the start of the last big downturn.

The way to summarize this is that American companies have increasingly figured out how to own fewer assets other than just cash. They might now outsource manufacturing, and thus don’t need a big assembly plant. They may drive more sales through e-commerce channels rather than open more physical stores. And they are a lot savvier about limiting inventories.

One way to look at this is that it’s great that American companies became more efficient with capital, and they should be able to return more capital to shareholders in the form of share buybacks and dividends.

Then there is a contrary view, that American business managers remain excessively cautious and focused on short-term profitability. They would much rather let cash balances build than invest in new technologies or new physical assets. And this can’t be a healthy thing for the economy over the longer term.

Support MNsure? How about MNgrocer?

Posted by: Lee Schafer Updated: September 19, 2014 - 1:44 PM

In talking about MNsure in the last week, one of my go-to guys in the health insurance market tried to once again explain the continuing hostility toward MNsure on the part of a large slice of the public as well as many health benefits brokers and others in the market.

It’s fundamentally opposition to its very existence and really not criticism of its effectiveness or doubts about the intentions of the people now in charge.

MNsure was created as an online marketplace in Minnesota for those seeking to purchase health insurance who might be eligible for subsidies under the Affordable Care Act. States had the option to proceed with such an exchange or have everyone go to a federal exchange.

For MNsure critics, the issue is that MNsure is an artificial market, created by the state, and people who are eligible for subsidies for their health insurance costs have no choice but to use it.

They say there had to have been a better way, leaning on the private sector, to achieve the policy goal of enabling a subsidy to reduce the number of uninsured people.

As my expert pointed out, folks eligible for the Supplemental Nutrition Assistance Program, or SNAP, usually get an electronic benefit card. They can take that into Target, Cub or Coborn's to shop for groceries.

Imagine, he said, if the MNsure model came to food, and the state made everybody eligible for SNAP go to MNgrocer.

There would be an uproar, and not just because it’s a grocery store located in an industrial area of St. Paul that’s not easy to reach from public transit, or it may not have fresh milk that day.

The irritating part would be that participants on their way to MNgrocer would pass a Target or Cub that is perfectly able to meet their needs – with fresh milk that’s competitively priced.


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