<THE BORING PORTFOLIO>
Announcing a Buy
Welcome to APC
By Dale Wettlaufer (TMF Ralegh)
ALEXANDRIA, VA (April 14, 1999) -- American Power Conversion (Nasdaq: APCC) fell into the Boring Port's buy range today. Thus, we are announcing our intent to acquire $7,000 worth of the stock within the next five business days. We've discussed the company at length on the Boring Port board. In regard to why the stock has been falling recently and in regard to the company's business model, I call your attention to the following email exchange between myself and a friend of the Boring Port, which was published on our board.
I've revised downward our range of the company's intrinsic value, mostly because I've become more conservative with our near-term revenue growth assumptions and the longer-term competitive position of the company. That's just to say that we want to be neither too optimistic nor too pessimistic about the company's prospective growth in the future.
Here's our APC model (formatted for Excel 95 and 7.0; 116k) showing our growth assumptions and valuation assumptions. I've discounted all the models at 15% because that's what we see as our cost of capital. After today's close, the company's share price is pretty squarely within the range of intrinsic value that we've estimated. We know the concerns that some have about the PC industry and we don't share those concerns as strongly as some do.
Yes, we're always concerned that the secular growth rate we've witnessed over the last 15 years in PCs will fall off. If it does that tomorrow and doesn't come back, sure, we'd be hurt. We just don't think that will happen, which we've discussed numerous times in past portfolio reports. Given our growth rate assumptions and other financial assumptions (e.g., falling gross margins per the company's guidance), we think the market is pricing in the risks and the rewards fairly here and that our return will reflect the growth of the PC and communications markets as well as the company's ability to execute on those.
You might have noticed a 3.6% discount between Berkshire Hathaway's "A" class and "B" class shares, as of today's close. Economically, the only logical way to explain this is due to proportionally smaller voting rights due holders of the "B" shares. Other than that, I think it's just a market price setting issue. There's no way to arbitrage away the difference when the "B" shares are selling below the "A" shares, since "A" shares are only convertible into "Bs" and not the other way around.
This is an article from the L.A. Times on the lawfirm of Milberg Weiss et. al. You've probably seen the name if you own any stock that has suffered a little volatility in its share price or somehow showed results that didn't match what the company's executives thought they would be. Milberg is probably the most active lawfirm in the country involved in class action lawsuits against companies. Apparently, they've recently had a taste of their own medicine. I've had fantasies of joining a class action lawsuit, getting the law firm to make projections of what they might be able to recover for shareholders, and then launching a class action lawsuit against the firm when it falls short of projections.
Cashing in on the Internet
About 10 days ago on the Boring board, "mwf" asked about NetB@ank. The shares subsequently rose about 150%. My immediate reaction was that the large companies are not at all unprepared for this. NetB@nk's numbers are tiny in comparison to established companies such as Wells Fargo's (NYSE: WFC) already-operating Internet distribution. Other companies we pay attention to, such as U.S. Bancorp (NYSE: USB) or private companies we know, have much better numbers and product offerings. I mean, 8,000 new accounts last quarter doesn't really do much for me. And of course NetB@nk can generate lots of account growth if it wants to pay up for the deposits.
NetB@ank says it has an advantage over the bricks and mortar world because it doesn't have to operate branches, and thus can pay higher interest rates on deposits, including checking deposits. Here's where I have to look at my thinking in a critical light. Can this company do what Amazon.com (Nasdaq: AMZN) did to the bookselling industry? That is, can it destroy the advantage the bricks and mortar banks have in their ability to attract non-interest-bearing, fee-generating transaction deposits from customers that are local to their areas? Just as Amazon.com brought more value to many book buyers (and buyers of CDs, prescription drugs, etc.) with its business model, will the same happen with the Internet banks?
After all, if NetB@nk is going to pay more for deposits, then it decreases the relative attractiveness of doing business with a local bricks-and-mortar bank. And as I've said lately, I think people are fed up with paying huge service fees to the big national banks and are sick of feeling like they're being done a favor by being served by the big banks. NetB@nk pays more for deposits than the big banks, charges less fees, and is more convenient in many ways for many customers.
So what about the valuation? Sure, it's huge. A smarter person than I made the point to me yesterday that the market is assigning the company a proxy valuation. That is, the opportunity available in banking over the Internet is so large and the available investment vehicles to get direct exposure to that are so small, that the market is acting as a signaling mechanism here. Which is not some new age thing I'm making up, either. Free markets have always been an information feedback loop. The market is expressing in NetB@nk's valuation that more capital should be devoted to the segment.
Finally, on that note, NetB@nk could very easily monetize some of its market value and see a huge cash infusion with a stock offering. It could increase its shareholders equity by over 400% with less about a 15% addition to its diluted sharecount. The company would all of a sudden be trading not at nearly 30 times book value and 295% of assets but around 6-7 times book value and 242% of assets. Which are all, of course, shorthand for valuing the company. Putting a value on the company would necessitate a much deeper look into how it operates and a much more thoroughgoing process of discounting cash flows. But you get the point. If the company were a very good operator and had a management team whose heads are screwed on correctly on building shareholder value, we wouldn't have the toughest time in the world paying the latter multiples for the company. In short, we are never bound by our first reaction to things and we are constantly re-testing our assumptions.
Cisco falls after acquisition announcement
Cisco Systems (Nasdaq: CSCO) fell on announcing yesterday its acquisition of call center software company GeoTel Communications (Nasdaq: GEOC). I believe the acquisition is excellent -- Cisco is going to need call routing and control applications if it wants to be the leader in voice-over-IP switching and VoIP software and hardware. This is obviously a pricey acquisition, but the way to look at the company's acquisitions is to look at how they fit into Cisco's overall business goals.
If you look at a portfolio of acquisitions that Cisco has done, some are going to show horrible return on investment (ROI) results and some are going to show unbelievably high ROI results. Taken in the aggregate, the company's average return on investment results are excellent. We don't have any complaints about the company's willingness to use its equity to do acquisitions. Their track record is certainly good and I think it's a competitive advantage that they don't show the hesitation that other companies in this space do when it comes to their M&A activity. If someone at another company argues that 50 times revenues is insane, that's a competitive disadvantage for them. I believe Cisco knows what it's doing here.
Speaking of that, our portfolio's return will largely mirror Berkshire's and Cisco's progress over the long term. In the short term, it will mirror their market price movements. Since I have a good idea about what I think of the long-term prospects of these two companies, then I have a good idea of the long-term prospects for the Boring port. As for the short term, I don't have much idea at all. Thus, I can't let our decision making be ruled by the short term.
Have a good Wednesday night and we hope to see you on the Boring board.
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Stock Change Bid BRKb -4 2345.00 CSL - 1/16 42.69 CSCO -3 3/8 110.75 GTW - 5/8 66.81
Day Month Year History BORING -1.28% -1.14% -0.87% 33.11% S&P: -1.58% 3.28% 8.39% 121.06% NASDAQ: -2.94% 1.86% 14.36% 140.88% Rec'd # Security In At Now Change 6/26/96 225 Cisco Syst 23.96 110.75 362.32% 8/13/96 200 Carlisle C 26.32 42.69 62.16% 12/31/98 8 Berkshire 2244.00 2345.00 4.50% 2/9/99 100 Gateway 20 72.38 66.81 -7.69% Rec'd # Security In At Value Change 6/26/96 225 Cisco Syst 5389.99 24918.75 $19528.76 8/13/96 200 Carlisle C 5264.99 8537.50 $3272.51 12/31/98 8 Berkshire 17952.00 18760.00 $808.00 2/9/99 100 Gateway 20 7237.50 6681.25 -$556.25 CASH $7658.52 TOTAL $66556.02
</THE BORING PORTFOLIO>