Sodastream - Fizzing Up, Or Bubbling Over?

Establishing that the concept has been around for quite some time does not help answer the question that many investors have in mind about Sodastream: ‘Is this a fad, or could this be a disruptor of long established bottlers such as Coca Cola & Pepsi?’ A few retail investors-oriented research firms touting Sodastream stock seem inclined to believe that there is little in the way of an almost inevitable multi-year expansion.

Israeli-headquartered Sodastream International is a leading enterprise developing,

manufacturing and selling home beverage carbonation systems worldwide. Its business model appeals very much to investors in that it resembles the razor/razor blades, which made the fortune of companies such as Gillette, whereby high-margin consumables are sold to repeat customers.

In Sodastream’s case, the carbonation system is sold in the USA at prices ranging from 69$-200$ depending on design and features, while refill CO2 canisters after first purchase can be swapped when emptied for new ones at around $15. The company’s turnover is further fuelled by the distribution of a great variety of syrups, many of them licensed by well-know brands, sold in bottles or mono-dose caps to dissolve in carbonated water.

The concept of a home made carbonated drink is know from a long time, as it originated with G. H. Gilbey, a gin distiller who came up with the first system in 1903. Although the first commercial systems were already marketed in the 1920s, the first home systems were sold only in the 1950s and became very popular in the 1970s and 1980s.

The bull case is predicated on seemingly simple premises: geographic expansion through a broader distribution network (especially in the USA), product innovation and increasing market penetration thanks to multiple partnerships with well-known consumer brands offering an ample choice of drink flavourings.

As a corollary to that, either Sodastream’s market valuation is too cheap, if compared to the low-single digit growth expected from the majors, or it will become a take-over target for anyone keen to expand in this promising market. The answer is not a straightforward one, as we all know that its previous success has not withstood the test of time.

Sodastream’s model is appealing to many consumers for the convenience it provides for making your own fizzy water and flavoured sodas at home, without the trouble of carrying often much weight. Moreover, higher awareness nowadays for environmental issues allows Sodastream to build on a greener company image than its competitors, thanks to its lower carbon footprint due to less recycling required.

Sodastream CO2 canisters carry a proprietary valve, which allows control of their distribution network and price. The logistics of taking back empties and selling (technically leasing) back to customers the filled ones do represent a barrier to new competitors. On the other hand it is an issue for customers who have routinely to rely on the closer distributors for the swap, but also for small retail outlets, which do not enjoy the economies of scale of larger distributors to deal with this process.

Canisters can refill between 60-130 litres, according to the company, depending on how much fizz is used. If we add the cost of flavourings it is probably fair to say that the cost a Sodastream drink is about the same (or slightly higher) as a major brand large bottle, without taking into consideration the quality of tap water.

Sodastream generic branding for soda syrups, with the exception of a few licensed deals, does not provide yet as much brand recognition as the global brands. More marketing investment on this front should probably be required to strengthen its brand awareness, but that would also inevitably pose a cash flow problem.

Competition from the likes of Pepsi and Coca Cola could become much more fierce in the future. Global brands have deep pockets and it would be wrong to assume that they will not make any move against Sodastream should they keep on grabbing more market share.

In fact, Coca Cola is rapidly introducing Freestyle Soda machines across many establishments in the USA, competing directly with Sodastream. Other initiatives such as the recent original launch of a Coke bottle made of ice represent a clear sign of environment awareness and innovative thinking from the major brands.

Even relatively unexpected competitors, like Green Mountain Coffee Roasters in the USA, have recently identified the ‘make your own soda market’ as a target and are launching their own carbonated system. In Europe, it is no coincidence that an intense Sodastream marketing campaign in Italy is coinciding with rising competition from companies undercutting their lucrative refill canisters at much lower price points.

One further threat could also come from DIY carbonator systems. Such homemade devices could bypass a pricier refill with Sodastream for a fraction of what the company is charging. A simple Internet search can provide ample choice to choose from amongst different DYI systems, which allow using even bigger and cheaper CO2 canisters.

Sodastream is unlikely to be a fad, in fact, it’s been about too long to be truly called a fad, but any growing business with high margins and relatively low barriers to entry, sooner or later attracts new competition. Not only they have to compete for space in the kitchen with other appliances, but they also have to fend off possible competition from other domestic appliances manufacturers or global brands likely to enter the market.

A takeover is still possible, as speculated in early June when the stock rose above $80 on rumours that Pepsi could make a move for Sodastream. Such a move appears unlikely though, given the strains it would bring for the relationship with bottlers. In all likelihood the share price drop following the recent market rumours down to below $60 reflects the elevated uncertainty of an imminent takeover.

Logic would dictate that such move would be more likely to come from a large appliance manufacturer or a food brand willing to expand in a different segment, rather than a global beverage brand, which could cannibalise its own sales.

Regardless of any business scope an acquirer should also be prepared to swallow a meaningful geopolitical risk, given its significant manufacturing base in the Occupied Territories beyond the Green Line, which marks Israel border.

Sodastream stock is probably fairly priced at current levels around $60, as the European business is somewhat under some pressure and less likely to grow as fast as in the past, while a rapidly expanding distribution at supermarket and store chains should provide ample opportunity to expand its footprint in North America.

During its first meeting with investors in May 2013 Sodastream set a bold $1 billion turnover target in 2016, exciting many investors eager to ride a growth stock which is bolstering its top-line revenues, having recently signed partnership deals with Honeywell and Samsung.

Regardless, margin guidance in the past has provided high stock price volatility like in 2011 and encouraged the sceptics to heavily short Sodastream (as demonstrated by a very high short interest, to the tune of 37% of free float).

Recent quarterly results have provided Sodastream’s bullish investors reason to feel better about its top and bottom line growth. Nonetheless, while enthusiasm is high on forward guidance expansion, many investors remain somewhat wary and continue monitoring margin trends and free cash flow generation, rather than earnings and profits alone.

As such, Sodastream valuation multiple remain relatively compressed if compared to low-growing  global brands such as Coke and Pepsi. Their free cash flow yield is at about 5-5,5%, while Sodastream has still to show a positive yearly cash flow return to shareholders, let alone paying any dividends.

A stark reminder that sales and profit growth alone does not always equate to a higher market capitalization; the market can usually read through fizzy and bubbly numbers.

Tesla Motors - Roaring Apple-Style Hype, or a Ground-Breaking Car Maker?

For Tesla Motors’s CEO & founder Elon Musk, 2013 will be a year to remember. This is the first year since the company was founded in 2003 that Tesla Motors has reported a quarterly profit. Mainly for this reason, Tesla shares have taken off this year, breaking through the barrier of $10bn market cap as a listed company in the Nasdaq. 

Tesla Motors has tripled its share price since last March and reached an all-time high of $114 in May. What is behind this remarkable stock market success and what does the Tesla Motors business model represent for the automobile industry?

Tesla Motors was named after Nikola Tesla, a renowned Serbian-American inventor and pioneer in the electricity field, with several remarkable contributions, such as the design of modern AC induction engine, which the company has basically adopted for its vehicles.

Tesla’s, young, charismatic and South African-born founder Elon Musk is an eclectic inventor and business pioneer himself. A self-taught software developer when he was merely a teenager, after completing his studies at university in business and physics, he co-founded Paypal, which he later sold to Internet giant Ebay.

During his studies Musk drew inspiration from Nikola Tesla’s works, nurturing his dream of bringing back the electric car to the masses. After founding Tesla in 2003, he also became involved in the space exploration business with SpaceX and in the solar business with a company called SolarCity.

Unlike most innovators of his generation, Musk had not forgotten that after many decades of dominance from combustion engines, electricity vehicles were among the earliest passengers vehicles. In the 1900s, before powerful internal combustion engines became the mainstay, electric automobiles held several records for speed and distance on land. At the turn of the century, there were more electric than gasoline-powered vehicles and at one point they even out-sold gasoline-powered vehicles, having about 28% of the automobile market share.

A decade ago, Musk decided to enter the electric car industry, because he was convinced that no major car manufacturer would have any serious intentions to build one. He recognised a growth opportunity in a new market and went for it, well aware that the consensus considered it a rather crazy proposition.

In fact, many companies had already failed for decades to accomplish the goal of bringing back EVs to their former splendour. As a stark reminder of such a difficult challenge, Fisker Automotive and Miles Electric Vehicles, two US manufacturers of hybrid and all-electric cars, have recently filed for Chapter 11.

Elon Musk’s intuition was to try a rather different approach. Building a car purely for the purpose of transportation, efficient but with no-frills, would never make the cut. You really had to make it a desirable object, something that would capture customers’ imagination. Such features were notably missing for example, with the GM Impact, to name one of the most promising attempts by a major automobile maker to create an all-EV in the mid-1990s.

Tesla therefore ‘aimed at markets in which rich people could afford to buy a Tesla as a status symbol… third or fourth car’, as former Internet analyst and now popular financial commentator Henry Blodget recently declared.

Elon Musk's strategy therefore started with targeting a niche market, with a high price/high performance Roadster model, produced in low volumes. Once the brand became established, he then ramped up production volumes and targeted a broader high-end market with unit prices from about $70k, the successful sedan Tesla S. This is remarkably lower than the $109k price set for the Roadster. The next step will be in a few years time, to further lower the price point towards an average of $30k-$40k, while significantly ramping up Tesla’s production volumes.

Meanwhile, Musk positioned the company in such a way as to cooperate with Daimler and Toyota Motors (respectively partners with 4,7% and 10%) helping to jointly develop all-EV models or to supply powertrain components.

This partnership strategy left the company in decent financial shape, after a very troubled 2008 when Musk dug deep in his own pockets to manage a serious liquidity problem. Moreover, it elevates Tesla's technology in this industry, while leaving the door open to a takeover down the line, if the company starts to fire on all cylinders.

Another interesting feature of Tesla Motor’s strategy is its challenge to US car dealers by adopting a direct sales model, similar to the Apple stores. For this purpose, three years ago Tesla hired George Blankenship, a former Apple Executive, to help develop Tesla's retail strategy worldwide.

In fact, Elon Musk has no qualms about taking on powerful lobbies, such as car dealers, which benefit from special protection under the law in many US states by not allowing cars to be sold directly by manufacturers.

Similar to Apple in the early stage of development, Tesla’s marketing is unique, in the sense that it relies heavily on word-of-mouth, rather than heavy advertising budgets.

Musk's genius was in his capacity to harness social media, communicating as often as possible and creating a constant buzz around his enterprise. Social media plays a major role behind the success of the Tesla brand, so much so that Musk's omnipresence and easy accessibility to the media have drawn 225k Twitter followers. Quite a lot, given how relatively few cars Tesla is currently selling (roughly 21,000 this year, compared to about 16 million vehicles overall in the USA).

Could Tesla’s business model work in Europe, where incidentally, the EU has just announced its 2020 CO² target of 95 gram/Km for vehicle gas emission?

Firstly, let's keep the Tesla hype in perspective. The all-EV market, similar to the USA, still represents, a very tiny fraction of the entire European automobile market, accounting for roughly 0,23% of all cars currently being sold.

A bounce in all EV sales during the first two months of 2013 got some industry commentators a bit excited, considering also the launch of new models such as Nissan Leaf or Renault Zoe, which should mark a bigger presence of all-EVs in terms of car sales going forward.

Industry leaders such as Carlos Ghosn, CEO of Nissan, have great hopes for all EVs, claiming that by 2020, demand for these types of vehicles will represent about 10% of total demand. In the UK, the Committee on Climate Change, an independent advisor to the government, hopes to see 1,7 million EVs on the road by the same deadline, if the UK is to comply with its greenhouse gas targets.

In theory, all this should augur very well for an electric car manufacturer, but here’s the rub: Tesla Motor is not competing with EVs such as Smart, Nissan Leaf or Renault Zoe for the simple reason that it’s still a luxury carmaker.

Elon Musk himself could not refrain from laughing when asked during an interview with Bloomberg last October, whether he was worried about competition from the likes of BYD (a Chinese automaker, with an array of products including hybrids and all-EVs, which counts Warren Buffett as a major investor). Such is the gap between the Tesla market segment and other EV carmakers.

It is widely noted that this EU agreement (still to be approved by each state member) on stricter emission targets by 2020, is a carefully orchestrated compromise deal by Germany. It is aimed at ensuring that its high-end automobile makers, such as BMW and Daimler, can continue to produce more polluting cars.

The EU deal will not allow the carry-over of supercredits earned before the 2020 deadline, but will maintain retention of the multiplier (a factor which increases the number of supercredits a manufacturer earns for each low emission vehicle it builds).

Essentially, Germany gets to preserve its high-end combustion engine automobile market for longer, while also benefiting from introducing more low emission vehicles.

Given that at this stage Tesla Motors, with its high price point is addressing precisely the segment dominated by German carmakers, it is unlikely that this EU stricter regulation will do much good for them.

More importantly anyway, Tesla's financial resources only allow to prioritize the US market, given its commitment to develop new models and install their 480 superchargers stations network on the US territory.

Tesla Motors indeed opened a handful of stores in Europe, establishing its stores in London, Munich, Milan, Zurich and Paris, together with a few sales reps in other major European cities. In spite of that, it is my opinion that Tesla’s presence in Europe for several years to come will be more symbolic than strategic.

Tesla Motors is making car enthusiasts reel with its eye-catching design and outstanding driving performance. However, well-known issues persist within this car segment, such as affordability, longevity of batteries and anxiety over the distance the car can actually go, these will be hard to dispel.

It is still too early to tell whether all-EVs can really take off and if Tesla can reach its stated goals. But for those thrill seekers who cannot afford to ride the actual Tesla cars, there is a cheaper option: buy Tesla Motors shares at $109 each…

A rollercoaster ride is guaranteed, given its current lofty valuation and high level of speculative short interest in the stock. Whether you are driving a Tesla or owning shares in the company... take my advice: fasten your seat belt!

Eurozone Credit Crunch: a disease still waiting for stronger remedies

The debate on how to tackle the SME credit crunch should not deflect EU focus from resolving structural imbalances and weaknesses within the Eurozone banking system. The calm EU debate over how to improve the economies in the Eurozone does not reflect a sense of urgency, an urgency which dire economic conditions throughout Europe would otherwise suggest.

The relative tranquility in European markets seems to have provided solace to European leaders, to the point of hiding the scent of burning with a strong whiff of complacency.   A recent statement from French President François Hollande regarding the end of the Euro crisis is emblematic in that respect.

Regardless of the Euro-leaders’ lack of meaningful resolve to tackle the dismal Eurozone economy (six consecutive quarters of economic contraction), a generally shared view is that Small & Medium-sized Enterprises (SMEs) seem to be suffering the most from the current conditions.

Growth is still elusive, not only because of widespread austerity measures put in place by European governments, but also because of insufficient credit available to SMEs.

A dearth of bank lending, noticeable even in countries outside the EU such as the UK, seems in strident contrast with the loose monetary policies adopted by central banks, precisely to facilitate the transmission of credit into the economic system.

ECB Chairman Mario Draghi, over the course of the last year, has issued statements in support of lending, with an emphasis on SMEs.  In his view, special attention to SMEs is required, due to the fact that they account for about 75% of employment and some 60% of economic output. Not only that, access to wholesale markets (for example via bond issuance) is hardly an easy option for them.

Recent research from J.P. Morgan, nonetheless, argues that evidence about SME problems and their underlying causes are not self-evident. Their conclusion seems to suggest that SMEs probably don’t deserve preferential treatment vis-à-vis large corporations or households.

According to the Markit PMI data, a number of economic indicators on the biggest economies, indicates that SMEs in Spain and Italy are not obviously under-performing larger firms. In fact, employment and output indices do not show much difference between those two groups. Rather surprisingly, in these two countries small firms are not faring relatively worse than their peers in Germany or France.

On the financing side, the most recent ECB lending survey does not show stricter tightening of lending standards towards SMEs rather than households or large corporations. In terms of funding costs, MFI interest rate statistics highlight that banks in the Eurozone periphery countries charge higher rates than core countries on all loans. However, the spread between small loans and large loans is very high, only in Spain. Access to finance varies across different countries, with strong evidence that in Spain, SMEs are more penalized than large corporations, if compared to the rest of the Eurozone, while in Italy this applies as well, but to a lesser extent.

This study does raise an interesting point with regards to why the ECB should focus on SMEs rather than other categories.  On the other hand, I think drawing the conclusion that SMEs might not deserve more attention than other economic sectors, purely on the basis of a relatively limited statistical data may miss the scope of Draghi’s point of view.

SMEs are inherently riskier borrowers and credit access is structurally more difficult for them to obtain than for larger corporations, who may have access to alternative funding, other than traditional banks loans.

Furthermore, SMEs tend to have a very strong connection with the local territory, probably more so than large corporations. In the last 20 years, the consolidation of the banking industry may have reduced the role of local banks when it comes to the financing of SMEs.

Given current economic conditions, large national banks have to look after their P&L and (especially in the Eurozone periphery) carefully manage their balance sheets, while new EU banking regulations are curbing leverage.

Therefore, given the deleveraging at large banks, without a more coordinated set of policies in favour of SMEs, it could be difficult to mitigate the double wham of weak demand and difficult access to credit.

Draghi’s approach also makes sense when we consider that SMEs are usually more labour intensive than large corporations. Given the size of small ones, supporting them will go a long way towards helping households too, improving overall employment and private consumption.

Nonetheless, having identified a target such as SMEs to focus on does not necessarily provide a straightforward solution to the problem of growth and employment in the Eurozone.

The recent gathering held in Rome last Friday with high ranked Labour and Finance ministers discussing such issues, seems at least to have identified a shared view on several measures to adopt.

While no concrete measures have yet been finalized, discussions revolved around how to improve long-term credit to SMEs, together with the European Investment Bank (EIB) and national state development agencies, such as Italy's Cassa Depositi e Prestiti, France's Caisse des Depots and Germany's KfW.

The 10 billion euros capital increase which took place at the EIB last year could be leveraged to as much as 60 billion euros using its balance sheet as a lending facility. With that in the background, European governments are evaluating several proposals, including issuing special "mini bonds" and securitized loans backed by state members or the EIB.

Other measures are already available to help SMEs, such as loan guarantee programs, but their efficacy could be further enhanced if AECMs (European Association of Mutual Guarantee Societies) were more localised and were provided with additional financial firepower, going forward.

Eurozone state members face a daunting task of promoting alternative access to funding, increasing liquidity and reducing SMEs dependence on traditional bank loans, while at the same time sticking to Germany-led austerity (albeit more relaxed than in previous years).

State members should focus their activity in several directions, in cooperation with all economic entities.

For a start, there should be a coordinated effort between banks and mutual guarantee societies to provide long-term credit facilities to SMEs. Easing funding charges for banks, who provide increased lending to SMEs at cheaper rates would go a long way towards re-connecting the banking system with its customers.

The private sector could benefit from new regulations, which enable the issuance of new capital and incentivise inter-company borrowing. Wholesalers and large traders could leverage their funding by lending to their own customers. The new rules could also include promotion of Venture Capital and the issuance of corporate debentures.

Public administrations in Europe should also tackle the delay of payments to the private sector (Italy’s abysmal record of about 63 bn euros stock of trade credits and advances payable, springs to mind), improving liquidity for many SMEs in a meaningful way.

Clearly, these are only a few examples of specific measures for SMEs, but by no means, the only ones. While they are obviously important, they cannot replace the fundamental role of banks to kick-start economic growth.

I cannot stress enough the importance of the EU delivering sooner rather than later on broader issues regarding the banking industry.

Reforms aimed at restoring trust in the banking system, improving risk evaluation, recapitalizing banks in difficulty and introducing a regulatory framework for supervision of large institutions at the ECB are still lagging.

The timeline for these reforms is still somewhat hazy, due to the difficulty of overcoming political resistance, mainly from Germany, to undertake more courageous measures.

Recent statements from Germany and France seem to hint at delaying direct bank aid from the ESM (European Stability Mechanism). The Finnish Finance minister Urpilainen has also been on record saying that the second phase in banking union will not be easy, highlighting also that the joint EU deposit guarantee is a not a timely issue.

Such inaction speaks volumes on how difficult it is to further advance political integration inside the EU.

 ‘Virtuous’ countries seem to be pushing harder on each state member to adopt pro-growth initiatives and reforms, shunning any increase in the financial burden for the ECB (or its supranational agencies for that matter) necessary to support such policies.

Without a more substantial coordinated effort at the EU level to resolve some of the critical issues which plague the credit system, it is unlikely that small doses of several different medicines will be sufficient to cure the Eurozone credit crunch.

Apple - Don't Show Me The Money... But The Products!

Apple Inc. is not only one of the largest and most iconic corporations in the world. To my eyes, it is also a stockholders’ darling trying to regain its shining reputation. Seems only yesterday that the Apple share price was ripping through new highs for several years in a row, reaching an all-time high of $702 in September 2012 with an astonishing market capitalization in excess of about $658bn. It is hard not to be mesmerized by a 50-fold increase in market capitalization over 12 years.

What happened in the last year or so is all too familiar for those who dabble in tech stocks investing: a sudden recognition that expectations reflected in the stock price were loftier than warranted by the rapidly changing competitive landscape.

As Pimco’s guru Mohamed El-Erian wisely put it, Apple’s brand name got disconnected from reality and valuation, while competitors, particularly in the smartphones and tablets arena, were beginning to catch up.

Following this stark return to reality, investors hammered Apple all the way down to a recent bottom of $385 at the end April. Since then, the share price seems to have stabilized, hovering in a range between $400/$460.

The abundance of news and market commentary on Apple is mind-boggling, which makes it a fascinating story to follow. To a certain extent, all this noise makes it also hard to invest, because with such a wealth of information and commentaries, it is very hard not to assume that everything has already been discounted in the share price.

Nonetheless, when I look back to the most relevant news spanning over the last 12 months about Apple, I cannot help but notice that this company has been on the front pages, mostly for the wrong reasons.

Mega-trials on patent disputes, formal apologies to China for allegedly poor customer service, a botched update of its operating system iOS6, ballooning costs for building a spectacular new headquarters, lawsuits from disgruntled hedge fund shareholders (i.e. David Einhorn) unhappy for the way that Apple's humongous cash pile of $145bn is being managed. If all this was not enough, now the US Congress is investigating its questionable, albeit probably entirely legal tax practices, which allow Apple to lower substantially its tax base through foreign subsidiaries.

The list above could actually go on, but each item covered and dissected ad nauseam by the media, actually brings me to the point I am going to make. Which is precisely that Apple has become more and more a ‘show me the products’ kind of story, differently from most other stocks that tend to be (to paraphrase Jerry Maguire) ‘show me the money’ stories.

It is obvious to all investors that Apple is still generating a spectacular level of profitability, despite a contraction of its gross margins from 48% to about 37% in the most recent quarter. That makes it in financial jargon either a ‘value trap’ or a ‘screaming bargain’.

Investors bullish on Apple are pointing out that its cash pile provides a more than adequate buffer to navigate through a transition period, during which new products (new wearable devices or perhaps an iTV) and revamped smartphones and tablets models will bring new life to flagging sales and falling profits (albeit still high). Apple valuation multiples, based on broad consensus estimates, would not be justified, unless the market was not leaning towards the notion that Apple is almost a broken story.

I tend to believe that although the market is not always right, in the case of large capitalisation stocks, it is wise to listen to what the share price is telling us.

The recent rebound in Apple shares has probably more to do with short covering (investors who bet hard on a falling share prices during the 1Q13) based on the view that the 2Q13 and 3Q13 would be weak and new product introduction would be slow or disappointing.

The share price rebound also indicates that the market has favourably received the company’s capital allocation plans, which entail significant debt issuance at low interest rates, expanded share buybacks and increased dividend returns to shareholders.

Now it is time for Apple to deliver again on the ground that really matters for the long term: product innovation.

Apple seems to be losing (at least on the surface) the innovation race against Google, which is far more open to demonstrate its R&D prowess and even more importantly to investors, its flexibility to adapt to the changing tech ecosystem.

Google Glass represents an example of the above reasoning, where it seems that Apple is falling behind in the wearable computing device race. Apple’s CEO Tim Cook is entitled to play down Google Glass as a potential mass-market item, but as a reluctant and always late adopter of any tech gadget, probably even I for one would jump on that product at the right price point.

Samsung’s surging market share in smartphones and tablets, together with the likes of Microsoft, Amazon or resurgent smartphone makers like Nokia, RIM and other Asian OEMs, is pointing to intensifying competition.

Apple’s market share in tablets has already fallen in the 1Q13, from 58% to 39% if compared to a year ago. I would find surprising that the same trend we have seen in smartphones over the last 12 months would not develop in tablets as well.

The new Apple iPhone and a cheaper version to be launched later on this fall will no doubt mitigate market share erosion, but I wonder if these steps are not belated. Most of all, will they answer the main question: can Apple still deliver innovation with must-have products?

It would be simplistic just to point out that nothing has come out of Cupertino in the last 7 months. Apple’s CEO Tim Cook, while delivering somewhat vague promises for new products, appears more at ease steering the ship on financial engineering and tax manoeuver than inspiring the younger generation with cool products.

However, product differentiation is becoming more problematic with the smartphone and tablet mass market. Price seems to drive consumers rather than brand alone, as witnessed by Samsung, with its unparalleled ability to penetrate new markets and product categories. Hence, the urgency for Apple to introduce more rapidly new eye-catching and lower price models in order to be able to compete in emerging markets, if not to gain market share, at least to avoid being marginalized.

My view is that given the progressive decline of PCs, the new frontiers of growth in tech will likely be wearable devices and the transformation of the TV in a multifunction media hub for all portable devices.

It would be wrong to say that Apple will not be able to match Google’s head start in wearable devices, but it could mean they will have to play catch-up, becoming a price taker instead of a price setter. Given that about three- quarters of smart phone features can be performed on wearable devices like Google Glass, it is not hard to imagine that this could be a product enabling us to change the way we communicate in the future, displacing a good portion of smartphones.

On the TV front, it appears to be difficult for Apple to launch an iTV soon enough to avoid that competitors such as Microsoft’s XBox One and Roku will not have a strong presence with their entertainments units and streaming players. By the time that Apple can deliver anything more innovative than its current offering, it could be difficult to make inroads in that market.

History tells us that making money out of television sets is a very difficult proposition. In the last two decades scores of large TV sets makers have not managed to maintain their leadership and/or profitability. It is questionable that Apple can achieve that without launching an earth-breaking new device. Assuming Apple can do that, what will be a meaningful sales volume/market share for their P&L, assuming they will likely address the high-end segment?

In general, it is fair to say that few technology stocks have demonstrated the ability to fend off competition and protect above normal profitability over an extended period of time. When it comes to consumer electronics, the likelihood of that happening is even lower.

Apple under the leadership of Tim Cook seems a very different animal than under enormously revered Steve Jobs. I sense that investors would rather have more clarity on the product front rather than on cash management and taxes before jumping on board again big time. Hedge funds flows seem to indicate a lingering scepticism at best on Apple’s future, judging from the relatively muted money flow in the stock.

If the smart money is still on the fence, I would opine that the average retail investor should take heed from this and wait for the ‘iClouds’ to dissipate, before buying more Apple shares.

Buffett’s Berkshire Hathaway, Victim Of Its Own Success?

Berkshire Hathaway is the well-known holding company run by its famed CEO Warren Buffett, regarded by many as the most successful investor of all time. Buffett is also famous for holding court with his many aphorisms about money and investing, such as ‘investing is easy but not simple’ or ‘Wall Street is the only place where people ride to in a Rolls Royce to get advice from those who take the subway’.

A philanthropist and a pragmatist, despite his enormous wealth accumulated over the past 50 years, Buffett is also humble enough to admit that he’s been lucky to be born at the right place and the right time in history.

Testament to his lucky star, here stands Berkshire Hathaway, a humongous financial behemoth, whose market capitalization is north of $270 billion, surpassed only by three public companies in the USA such as Exxon-Mobil, Apple and Microsoft.

Buffett and his somewhat under-appreciated partner Charlie Munger have managed to turn a small flailing textile business acquired in 1965 into a large diversified financial conglomerate. Berkshire operates in a wide array of businesses (confectionery, food, retail, railroad, banks, electric and gas utilities, home furnishings, manufacturing, jewellery, publishing…) around his core insurance operations.

Buffett built his empire using the ‘float’ provided by his insurance business (that is paid premiums which are not held in reserves for reported claims and that may be invested) to finance his investments, a practice that he referred to as ‘having one’s cake and eating it too’.

In the early stage of his career Buffett mainly focused on long term investments in listed public companies. Recently, given the size of his company, he has shifted his focus to buying whole companies.

Since 1965, Berkshire Hathaway has never paid out a dividend to shareholders, but has reportedly grown its book value by about 19,7% compounded annually, versus 9,4% for the S&P500 index (calculated accounting for reinvested dividends).

This outstanding performance looks a little less impressive, if we look at the most recent years.  In fact, Buffett himself in the last annual letter to shareholders admitted that unfortunately his holding company has underperformed the S&P 500 Index in 3 of the last 4 years, with a negative absolute return in 2008 and 2011.

Moreover, this could actually mark the first year during which Berkshire has underperformed the broad market over a 5-year stretch, raising doubts from Buffett’s critics on his legendary magic touch at making money.

I would note that Berkshire’s difficulty to beat the market consistently has actually already been noticeable for quite some time. If we calculate a simple moving average of the 10-year relative performance versus the S&P 500 index, it is easy to plot a chart, which clearly shows a declining trend, from about 18% in the 1985 down to about only 2% last year.

This would suggest that Doug Kass’s criticism at investing nowadays in Buffett’s Berkshire could bear some validity.

Doug Kass, head of hedge fund Seabreeze Partners, has been a long time Buffett admirer and always revered his common sense investing approach.

However, about 5 years ago Kass started calling into question a number of issues related to Buffett and his company. Eventually he put his money where his mouth was… by short-selling Berkshire Hathaway stock (that is betting Berkshire’s stock price would fall or would return below market average)!

Since then, Buffett has been questioned on several other issues, starting from the intensity of his work at Berkshire and the role of his succession at the helm of Berkshire Hathaway.

Buffett’s son’s role as non-executive Chairman, to preserve the values that distinguish Berkshire, left many investors at odds with his decision. Likewise, the fact that the role of executive CEO has been selected by Buffett in total agreement with Berkshire’s board but has not yet been revealed to the public.

In the meantime, fund managers Todd Coombs and Ted Weschler are gradually assuming a bigger role in terms of actively managing his portfolio of stock holdings, while Buffett and Munger still maintain their role of key decision makers when it comes to new acquisitions or large capital investments at its subsidiaries.

Some detractors of the Sage of Omaha point out that his unfortunate response to the Sokol’s affair in 2009 was far from optimal. In that instance, reports highlighted that David Sokol, than Berkshire’s CFO and apparent heir to the throne, had front-run a major Berkshire’s investment in Lubrizol, raking up millions on his personal account. Buffett initially said he saw nothing wrong with Sokol’s dealings, only to change his mind later on acknowledging the impropriety of those trades when pressed by criticism from the investment community.

That certainly took some shine off his clean image that Buffett has cultivated over decades, trying to stay away from Wall Street shenanigans.

On the other hand, I believe it would be wrong to criticize Buffett on the grounds of his opportunistic investment in Goldman Sachs during the financial crisis in 2008 or because of its stake in Moody’s (both institutions had questionable roles in the collapse of the financial markets as contributors to the housing bubble were involved in unethical practices).

Warren Buffett pragmatist as he is, always stuck to his golden rule that all investors should keep in mind: do your homework when it comes to money.

Buffett has also always avoided common practices in Wall Street, such as short-selling (another popular criticism often remarked upon during bear markets), or at times following the crowd (still memorable the tech bubble he missed by not investing in technology in the mid 1990s).

As far as short-selling is concerned, I believe that his optimistic view of America and life in general would not be suitable to such an investment strategy and I would promptly dismiss this criticism altogether. Buffett is at his best when he identifies an investment and pursues it aggressively, with the view to hold it over the long term, not speculating in order to make a quick buck.

As per not following the crowd during the tech bubble, he followed his tenet of not investing in any business you do not understand (he partly backtracked by investing in IBM only a few years later). Frankly, I don’t see anything wrong with that either, looking at the outcome he produced.

Despite his (or his successors’) talent at spotting sound investment opportunities, the law of big numbers is probably working against Berkshire, though. Declining returns in the future (especially when compared to Geico, his insurance crown jewel) are a distinct possibility. The recently announced 1st quarter results at Berkshire seem to prove this point.

In spite of a 50% jump in profits, well ahead of market expectations due to a very favourable performance of its insurance operations, Berkshire book value increase still lagged the broad market performance in the same period.

Given all the above arguments, what’s the investment case in Berkshire Hathaway?

I would contend that at this stage it is unlikely that Berkshire will generate significant above average market returns.

Berkshire insurance operations require a lot of capital, as rating agency S&P highlighted with Berkshire’s recent downgrade by one notch. The agency noted that Berkshire’s holdings make the company risky and its practice of maintaining less capital to hedge against losses than its competitors could be an issue, should the economy fare worse or take a hit in the reinsurance business.

Some financial analysts believe that Berkshire Hathaway’s intrinsic value is still higher than its current market capitalization. Regardless, in light of Berkshire’s recent price appreciation and the many issues the company will have to face going forward, I would be more inclined to participate in the market with low cost efficient ETFs rather than owning Berkshire’s high priced stock (one share of class A stock is worth almost 170k dollars).

The Sage of Omaha may well be with us for many more years to come, but the odds he will be able to outsmart the market going forward are probably less than his adoring fans would have us believe. On the other hand, there is great scope in following Berkshire’s management choices in terms of portfolio selection, with new additions or sales. This is an insightful exercise, very helpful to identify interesting investment themes and to provide valuable clues on the US economy from some of the most brilliant investment minds in the world.

Bend It Like... Corning?

The idea of making a type of flexible glass that does not break easily is centuries old and already in the Ancient Roman age the idea of creating such glass was mentioned in several accounts. According to historian Petronius, a glassmaker was granted an audience with Emperor Tiberius to showcase his invention. Unfortunately, the emperor had him beheaded for fear that such an amazing material could undermine the value of gold and silver.

We have no evidence that such material ever existed, of course, but the dream of creating a flexible glass is soon to become part of our life thanks to Corning Inc.

Last June, Corning presented his most recent creation called Willow, a type of glass that is as thin and as flexible as a sheet of paper. It can be drawn to form sheet with high quality surface area and bent enough to be spooled.

The capability to make very thin glass is not unique to Corning or new to the glass industry. What is new is that glass can be made to very thin levels, while preserving all the excellent chemical physical attributes required of the modern substrate.

Willow is made with Corning’s core manufacturing technology called fusion forming. This process involves heating glass in a trough at very high temperatures, in such a way that molten glass evenly pours over the sides and solidifies at the bottom. The difficulty for Corning was finding the rate at which to draw the glass after it fused, in order to achieve high-grade surface quality and getting it onto rollers.

What really sets Corning apart from competitors is that they figured how to make glass sheets in large quantities, so that customers will be enabled to use their own production lines (i.e. TV manufacturers).

This process shows the extent to which technological innovation in the glass industry will rely more and more on a close link between R&D and manufacturing at the OEM level.

Such close cooperation was already evident in the case of Apple, when in 2006 Steve Jobs asked Corning to develop a new type of high performance glass (later named Gorilla glass) that could meet the requirements (durability, thinness, clarity and resistance to scratches) needed for a new generation of mobile devices like the iPhone.

Flexible thin glass roll-to-roll processing meets the growing need toward managing the mass production of high performance displays, such as those used in electronic mobile devices.

High performance displays are employed where there has been a significant change to the backplane technology. The backplane is the part of the device that actually drives the pixels, turning them on and off.

With high-resolution displays consumer electronics manufacturers are trying to create more vivid colours, smaller pixels to achieve superior image resolution by packing more of them and at the same time to have a faster device for more compelling video performance.

To enable high performance displays it is required that a substrate glass has intrinsic thermostabilty to benefit of smaller and faster transistors.

Plastic is not the right answer for the challenges posed by the manufacturing process of such devices as it cannot provide the same clarity or withstand high temperatures.

Mobile devices require the layering of several panels performing functions such as TFT substrate, colour filters cover, 

touch-sensor feature and mobile cover. All these functions could in the future be performed by Willow, bringing the overall thickness of a display down by about a third, with great advantages in terms of weight, flexibility and production cost.

It is widely believed that the adoption of Willow, tentatively scheduled in the next three years, as recently announced by Corning, should accelerate the pace of product innovation in many industries.

In consumer electronics the trend towards thinner, lighter and larger screens is gathering pace as people become accustomed to rapidly evolving personal devices as thin and light as possible. Now customers expect the same in devices such as notebooks and tablets, with the consequence that glass becomes even more important than ever before, while moving up the value chain.

Television could experience a renaissance after the introduction of OLED and 3D viewing, pushing the envelope on features like image clarity and size, while integrating touch-screen functionality.

With this process in place, it is possible to imagine a whole new range of applications, including all those who benefit from touch-screen features (not only in consumer electronics mobile devices, but also digital wallpaper or windows) as designers get accustomed to think about glass not in terms of one limiting factor, but as a vital component of the entire product design.

Flexible glass will go a long way to help creating products such as wearable electronic devices, such as the often talked Apple iWatch, smart eye-glasses, bendable mobile phones and tablets for the mass market or even new interactive game consoles.

Other fields like architecture or the photovoltaic industry, where photosensitive materials needing protection from oxygen and moisture to avoid calcium degradation, will benefit greatly from such type of glass. OLED lighting (organic light emitting diodes) could be printed on flexible glass and used in a curved shape (think about lamp shades that generates lights instead of a bulb). How quickly the transition to roll-to-roll processing will happen could also significantly make a difference in terms of an investment in Corning shares.

Corning is in my opinion not only a remarkable company from the point of view of constant innovation and forward thinking; it is also an interesting investment proposition for investors who wish to diversify their portfolio into equities with a long term perspective.

Few companies in the USA have managed to stand the test of time by staying in business for more than 150 years like Corning Inc. Founded in 1851 by Amory Houghton, Corning established almost from the onset its glass making operations in the small town that carries its name.

Over the course of its last 100 years, Corning has diversified its operations achieving great success in numerous areas, such as consumer products (Pyrex), telecommunications (fibre optics), clinical lab services and diagnostics (Quest and 

Covance were spun off in the 1990s), specialty materials, solar panels and environmental technologies.

Corning survived a disruptive crisis in the aftermath of the tech bubble, when its core high tech fibre optic business collapsed and the share price fell from a peak of $60 down to a little over $1. The company managed to stay in business thanks to a solid balance sheet and to its long-standing commitment to innovation and R&D. In fact, even nowadays the company keeps its expenditure in R&D close to about 10% of total revenues, in good or bad times.

Investors have been shunning Corning for quite some time during the recent market rally, underperforming this year the main indexes at some point by almost 15%.

Nonetheless, a week ago when the company announced its quarterly results above expectations, the market promptly started to re-evaluate Corning’s  prospects. Corning announced not only better profits, but gave clear indications that several business lines are having good traction with customers, with sales of Gorilla glass on a strong growth trajectory.

Management is convinced that the share price has been so undervalued that the board has committed to a $2bn share buyback (roughly 9% of its total market capitalisation).

Corning currently still trades below its book value, sporting a 2,8% quarterly dividend yield which the company just upped to 10c/share. It is my opinion that on the current valuation metrics, Corning is a very compelling investment proposition for those seeking exposure to the next up-cycle in glass, specialty materials and environmental technologies.

Bank of Japan, New Policy Implications - The Reverb

The decision of the Bank of Japan last week to up the ante on asset purchases and to extend the maturity of purchases was a truly remarkable surprise to the financial markets. From many perspectives it could be considered an unprecedented monetary policy decision with deep repercussions to being felt around the world.

Market expectations before last week's announcement were set somewhere at about 2-4 trillion Yen additional asset purchases, as opposed to 7 trillion Yen as indicated by the BoJ Governor Haruhiko Kuroda, not to mention the surprisingly wider array of asset classes and maturities eligible under his new plan.

The goal of this plan, to defeat deflationary pressure in the Japanese economy, is unequivocally positive from a risk-taking investment point of view, at least in the near term. I am inclined to think that this plan is almost certainly a game-changer as far as a decline in the Yen, relative to other currencies, is concerned.

In fact, the scale of monetary easing involved is estimated to reach around 30% of Japan's GDP by the end of 2014 (incidentally, the FED balance sheet expansion is about 15% over a period of 5 years) and the pace of Yen depreciation should pick up steam fairly quickly towards the 100 Yen/$ mark.

Kuroda's program is aimed at turning around Japan's deflationary environment and raising expected inflation to 2%. Nonetheless, past experience tells us that a story of countless and arguably unsuccessful Quantitative Easing policies from the BoJ have done little to eradicate deflation. Hence I would argue that to successfully fight deflation, the Government needs to put forward, as per its intentions, a comprehensive set of supply side reforms aimed at improving its competitiveness, together with stronger long term fiscal control over its public finances.

On these two counts of course, it will be Prime Minister's Shinzo Abe's job to deliver, particularly on highly contentious matters, such as an increase in the sales tax, a greater resolve on to cut unproductive government expenditures and last but not least to push for more competition in an overregulated economy.

In the aftermath of this announcement from the Bank of Japan will this three-pronged approach bring to a Yen avalanche, as has been suggested by prominent investors such Bill Gross and George Soros? The implication would be that in their opinion what the BoJ started might actually slip out of control, considering that the BoJ seems the most aggressive central bank pushing the envelope on the adoption of experimental monetary measures using somewhat imperfect tools.

Although this is a legitimate concern, in my opinion the likelihood of that to happen is probably not very high for at least two main reasons:

1. The BoJ has not given any indication that there will be any purchase of foreign currencies against sale of Yen.
2. The fact that differently from the recent FED Quantitative Easing 3, this plan has no open-ended expiration date.

One might also argue that the most industrialized countries could try to put the brakes on Yen depreciation before the 2% inflation goal has been achieved. Regardless, from an investment perspective history tells us the Y/$ exchange rate has been hovering in a broad range around the 110-115 level for the most part of the decade before 2009.

Therefore I do not see a strong reason to believe that such an exchange level could be reached without much resistance, gradually offsetting what the US monetary policies of the last five years have achieved in terms of dollar appreciation versus the Yen. 

As a corollary to a continuing of a weak yen environment, I would also be inclined to maintain or start an overweight allocation to Japanese equities with particular emphasis on exporting companies.