<THE BORING PORTFOLIO>
Mr. Market Is Not That Dumb
Suggested Reading
by Dale Wettlaufer ([email protected])
ALEXANDRIA, VA (Jan. 25, 1999) -- What is going on with Andrew Corp. (Nasdaq: ANDW)? That's the question that we're asking today in light of listening to the first quarter conference call last week. Year-over-year, sales declined 5% for Andrew and net income was down 18%. This was mitigated by the company's repurchase of shares, bringing in an EPS decline of 12% year-over-year. I'll get the specifics of last week's conference call posted this week, but for right now, I'm worried that our decision to hang onto the shares despite the outlook may be incorrect.
Here's why. You can model something to death and not capture the essence of what is going on. In our valuation of the company, the numbers in the model are very small. They would be seemingly easy to achieve. As I learn more about Andrew, however, the thing that I miss is the company's positions in the PCS buildout across the globe. The part about Andrew I fear is the changing outlook for infrastructure investment per population unit in Andrew's markets. Namely, sale-leaseback transactions of towers conducted by Andrew's customers could mean a permanently lower potential growth path in certain market segments for Andrew.
With these sale-leaseback transactions, a wireless communications provider no longer has control over its own towers. It just leases the space on the tower from whatever company buys the properties and that buyer then leases the tower out to other wireless companies. In one set of transactions, the wireless company that formerly owned the infrastructure now gets to redeploy capital and the company that buys the infrastructure gets to increase capacity utilization of those assets. My fear is that Andrew loses all the way around -- as far as towers, cable, microwave relays, and other products go.
Mr. Market Is Not That Dumb
We are going to add this as a Boring Tenet. In a sense, we fear that Andrew's total potential growth path has shifted downward. Mr. Market is not that dumb. On occasion, he suffers from bi-polar episodes. He'll offer you a price that is way higher than the intrinsic value of the business at times. At other times, he'll offer to sell you his part of the business for far below what a rational buyer would pay for the company. On the whole, however, Mr. Market is a rational individual. His assessment of a company's value is usually pretty good because he knows a lot about the company and is usually pretty good at estimating how a company will do in the future.
With Andrew, we are afraid that Mr. Market has guessed that its potential growth path has indeed shifted down and that Andrew's position, as far as PCS infrastructure growth goes, won't be the same as for cellular infrastructure growth. Indeed, only about 10% of the first quarter's orders were for PCS products, as PCS orders fell 33%, or $10 million, in the latest quarter. But that was about 23% of the approximately $44 million year-over-year decline in orders at Andrew. When your marginal growth driver falls as badly as this and when anecdotal evidence of PCS orders in the U.S. show very robust growth, you start to worry. Andrew said that some of the lead-times on products are very short. But if the market is efficient, and we believe it is most of the time, the market would have correctly discounted this by now. It tried earlier this year, but the conference call left investors cold on guidance.
As we've said in the past, we love what Andrew is doing with the buybacks and we wouldn't mind being owners of this company in a private situation. But there are a number of better opportunities in the public equity markets today, even at higher valuations, than this one. We know Andrew's management is doing a good job, but we can't see where this company is going in the future. We'd rather own the companies that are adding the most value to telecom, such as Cisco Systems (Nasdaq: CSCO), than a company whose best days may be behind it. Don't be surprised to see us part company with Andrew this week.
I just learned about this website today, but it contains some articles that I have read before. I cannot recommend it highly enough. It's the website to "deliver material from the Securities Analysis and Investment Courses at The Graduate School of Business, Columbia University, New York City." The essays and thinking here are the products of some of the most innovative securities analysis thinkers around. Michael Mauboussin of CS First Boston and Paul Johnson of BancBoston Robertson Stephenson are two of the sharpest analysts on Wall Street these days. Johnson is a co-author of The Gorilla Game and Mauboussin is the guy shaping the intellectual process of the analysts at CS First Boston.
Alex particularly likes the behavioral finance articles, I know, as he has written about them in the past in the Evening News. I highly recommend what I consider to be two cornerstones in the way Mauboussin and Johnson think about things and that have shaped the way Alex and I think about the investing world.
The following articles are in Adobe Acrobat format. AOL users will have to set the helper application. The URL for the website is http://www.capatcolumbia.com.
1. Thoughts on Valuation. I didn't remember this until I wrote this sentence, but in this article Mauboussin addresses exactly what I wrote above: That Mr. Market is not so stupid. Such is the influence his thinking has had on my own thinking over the last year.
2. Does Valuation Matter. Another cornerstone. This talks about, among other things, why equating P/E with growth rate of EPS can totally miss the boat.
And a third that is probably very interesting:
3. Open Letter to Warren Buffett. I've never read this one. Guess what I'll be doing tonight?
I suggest reading anything from these guys you can get your hands on and I also suggest for anyone who would like to learn more about return on invested capital to read this piece.
In addition to reading the above, I'll also be working on a presentation of Costco Companies (Nasdaq: COST), one of the most dynamic retailers in the U.S. This is a very strong contender to replace Andrew Corp. in the Boring portfolio.
Have a great Monday night. We hope to see you on the message boards. A special thanks to the thoughtful posters on our Web boards that have made hosting the board very enjoyable. I like our group there.
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