Friday, August 28, 2009

Apple Sells iPhone in China

China Unicom agreed to buy 5m phones for $1.5B, or $300 each. (UPDATE: or not?) We haven't heard what Apple's revenue-sharing agreement is with China Unicom, though. If the reported (low) up-front cost is accurate, Apple is presumably angling for participation down the road; China Unicom may have agreed to obtain a competitive position against its rivals. After all, iPhone users are a premium slice of the subscriber market. (Assuming the numbers are correct as initially reported, and there is no service revenue sharing, and Apple's incremental cost to make the phone is $175, Apple presumably adds at least $625M -- the margin on the minimum order -- to its bottom line over the life of the deal.)

Given the confusion in the media about the terms of the deal, it's premature to speculate what it means for Apple. Supposing that Apple is selling the phones cheaply in China, consider some of the other sources of revenue Apple might tap. The App Store is a ten-figure-a-year business before considering Chinese software demand, for example.

Imagine application demand with Chinese and Indian developers fighting for a share of that pie, competing against each other on cost to make the iPhone more and more useful for less and less money. Imagine the effect on iPhone's value as a platform. (Of course, American programmers will answer: in China and India they can't code anything you will like using; and if this is true, Americans will be selling to China and India rather than the other way around -- but at American per-unit prices, it's doubtful that the unit volume would be very high. Talk to Microsoft about that.) The point is that the App Store as a property is much more interesting when it services a platform that is so much more widespread. This turns Microsoft's old platform argument against it: with Apple's platform so vastly more numerous (and in the hands of such predominantly premium users, who will actually buy apps and services), why would any programmer choose to target a different platform first, or with superior effort?

Interesting, eh? Apple as a dominant platform vendor. How the worm turns.

The fact that the iPhone's development environment is Cocoa, and requires a Mac to code, suggests interesting things about the future of that platform as iPhone dominates the mobile universe. (Note: John Gruber predicts that iPhone will eclipse MacOS X development next year, though he notes that iPhone developers seem interested in becoming Mac developers.)

NOTE: Those wishing to follow this story might check out this site, where Apple's phones in Asia get lots of time and attention.

Sunday, August 23, 2009

Discount Background Checks Not All She Hoped

51 Minds' reality TV show Megan Wants a Millionaire (the iTunes and web content of which has been pulled by VH1) succeeded in setting up former model Jasmine Fiore with show contestant Ryan Jenkins. However, its background-checking contractor didn't succeed in informing 51 Minds beforehand that Jenkins' record included a 2007 assault conviction. Had 51 Minds' background-checking contractor learned about Jenkins' violent criminal history, Fiore might have had some persopective from which to avoid some of her own: Jenkins was charged in June with battering Fiore with his fist, and now stands accused of her murder.

The two were married in March after Jenkins failed to win Megan Hauserman's hand in the show. Fiore's corpse was found in a dumpster with its teeth and fingers removed, and had to be identified by the serial numbers on its breast implants.

Saturday, August 22, 2009

Apple Takes Credit for Google App Non-Approval

Apple's response to the FCC inquiry can be found on Apple's web site. Apple isn't the only responder, and discussion over various companies' statements (and silence) in connection with the flying inquiries is worth reading.

In short, Apple says it never rejected Google's app ... it just didn't approve it yet because it was still mulling issues related to the application's unknown internal behavior, iPhone UI disruption (e.g., evading visual voicemail and Apple's SMS app and channeling calls from Apple's phone app), and so forth.

The interesting thing is that Apple takes all the credit/blame for the non-approval.

Thursday, August 20, 2009

Google Tags Jaded Consumer as Spam Blog

Google's review of the Jaded Consumer has come in, and the results aren't good.

This blog has been locked due to possible Blogger Terms of Service violations. You may not publish new posts until your blog is reviewed and unlocked.

This blog will be deleted within 20 days unless you request a review.

The details reveal the site is suspected of being a "spam blog." I've requested a review. I suspect that the multiple links to ACAS' 10-Q (in many different places where it is the source for data) sent up a red flag, though I'm not sure. Maybe Google doesn't like Apple now that Schmidt isn't on the Board :-)

Feel free to leave comments about the mindless, robotic nature of the vacuous content at the Jaded Consumer!

Apple in Canada: Vision of the Future?

Apple has hit double-digit market share in Canada. This, however, is not the big news. Apple's share growth is based on the strength of its MacBook sales, and Apple is actually the number-two notebook vendor in Canada. Number one? Acer, with a lineup of netbooks. Outside Acer's 57.5% catch of low-end el-cheapo netbooks, the only significant seller of notebooks in Canada is Apple. Apple's smaller slice of the notebook market, however, includes the market segment where most of the profit is.

Sound familiar?

Being the number three vendor in Canada by volume (behind HPQ and DELL) is interesting, but being the number one vendor by profit is much more interesting. How one frames one's measurements impacts how one interprets the measurements, no?

Wednesday, August 19, 2009

ACAS: Studying Apparent Duds

A little while back, Jaded Consumer described a couple of profitable exits that demonstrated actual sale prices above FAS-157-compliant "market value" reported to the SEC. There is a serious bias to suffer in observing only exited investments, and an even more serious bias in looking only at investments that are described in company press releases. Of course those will look good! (The idea behind those posts was that ACAS could raise cash, and it could get a good return in the process.)

The Jaded Consumer then strolled briefly through ACAS' 10Q for some interesting-looking holdings for times of recession, the idea being to find out what kinds of preparation ACAS might be able to rely on for income after those high-profile exits.

But folks worried about the company have a totally different focus: what's with the companies that have "fair value" below ACAS' basis? What about the dogs? Should we be worried? Without cataloguing the whole portfolio (for which you can look here), it seemed possible to look at some holdings that looked bad on paper, and ask just how bad they in fact likely were. This process is complicated by the fact that each of the portfolio companies is free to disclose or to conceal what it likes, and ACAS has routinely expressed disinterest in entertaining holding-specific questioning about a portfolio containing hundreds of companies. We're kind of on our own, though we have some help: we know how badly hated some classes of assets are now, and that nonpaying illiquid debt of privately-held companies isn't considered much of an asset, so we can draw some plausible conclusions about the quality of an asset's performance based on the value that survives FAS-157.

Advertisements By Mail
According to, Money Mailer LLC at the end of 2007 had annual sales of $25.1m and is controlled by Roark Capital Group (ever heard of Cinnabon? Schlotzky's? Carvel? All are Roark portfolio companies I recognized). Money Mailer is the nation's second largest shared-mail advertising company; it bundles local businesses' ads into one mailer and targets shoppers, those who've recently moved, and other targets in exchange for advertising revenues from local vendors seeking customers. It operates through a series of franchises, which tithe uphill to Money Mailer LLC – whose tens-of-millions in revenues isn't anything to sneeze at. It'd be nice to know the overhead at the level of the franchisor (what does that franchisee support cost to provide?), but we're left guessing.

ACAS' 3.5% interest in Money Mailer was surely entered on the expectation of receiving a share of distributable LLC receipts (and not resale; a 3.5% owner lacks the control required to effect a buyout). After all, unlike ACAS investments in which it took equity stakes with zero basis while spending money recapitalizing portfolio companies in connection with buyouts, ACAS actually spent $900k on its interest in Money Mailer. Interestingly, Money Mailer as an LLC presumably ticks the "tax me as a partnership" box when filing with the IRS. ACAS being a BDC, ACAS pays no tax despite holding the bag for its share of Money Mailer's taxes (instead, you do as a shareholder). From ACAS' perspective, there's no tax loss anyplace in the chain unless ACAS retains capital gains and pays tax on shareholders' behalf in connection with the "deemed dividend" associated therewith. However, in a tax-deferred account, ACAS income from an enterprise like Money Mailer would reinvest without losses from annual taxes -- something one doesn't get from most other investments (American Express, Berkshire Hathaway). The fly in the ointment? Money Mailer has been non-income-producing for at least a couple of quarters.

Anyone know what the present, or future, of advertisement mailings holds?

Anyone with information on how MoneyMailer LLC is doing, or what kinds of benefits LLC members might be getting from their interest, is invited to post. Unless ACAS expected a distributable income share, I'd be hard-pressed to imagine why it'd have bought a minority equity stake. The fact that it isn't making districutions at present could be a result of any number of things other than imminent business failure (like strategic reinvestment, which might make sense in a downturn). Assuming business just sucks for Money Mailer and that there's no profit to distribute, the fact that the company is structured to depend on independent franchisees means that it has partners working to make the organization succeed, which may be valuable if its survival is at stake. If ACAS entered Money Mailer with the expectation of being paid when Roark Capital Group structures an exit for itself and its equity partners, Money Mailer could be a long, tiresome road for ACAS' shareholders.

Running Big Rigs
ACAS holds both senior (12.8% on $23.9m face; $23.9m basis and $21.1m fair value) and subordinate (16.3% on $17.8m face; $16.9m basis and $11.4m fair value) debt of Phillips & Temro Industries, Inc., an auto components supplier whose products seem to include noise reduction, cold-start technology, and green idle-free cab support for rigs. The company also offers power generation equipment, a business likely buttressed by its cold-start tech and noise reduction products. Somebody else holds the equity, meaning that ACAS is toward the front of the line if things really head into the toilet. Assuming they don't tank and stay there, ACAS' long-term return looks good. The company supplies OEMs with technology to help keep rigs from idling when they need to run A/C and heat while not driving, and technology to help get them started from a cold start in frigid conditions. The company seems owes ACAS nearly a million and a half per quarter in interest, though the subordinate debt recently went on non-accrual (leaving $764.8K a quarter in not-non-accrual senior debt payments). The lower-returning senior debt retires in the next couple of years, and the subordinate comes due in 2013. Based on comparisons (basis and face face value) to prior periods, it looks like the company is paying some of its debt in additional notes, rather than all on time in cash.

Temro is an investment that is collateral on an ACAS secured-debt facility.

Golf, Anyone?
When Audax bought Nivel Holdings, LLC in 2007, ACAS kept 10.6% senior debt (face value $61.8m). Nivel makes aftermarket parts for golf cars, and ACAS hasn't any apparent interest in its profitability -- just its ability to make good on its senior debt. ACAS' basis of $61.3m leaves it with an investment valued at $55.0m, which presumably means that Nivel is still paying its bills. It just means that Nivel, as a private company with modest overall value, is hated by people who are putting price tags on debt that's not being traded. Presumably ACAS' $61.8m principal earns it over a million and a half per quarter in interest, and will do so most of the way through 2013. (If the company weren't making its interest payments, would the debt of this unheard-of little private company be valued so high?)

The Nicel Holdings debt is used by ACAS as collateral in a secured credit facility.

Retailing Stuff Without A Storefront
Orchard Brands Corp. (a Golden Gate Capital company) issued two classes of senior (7.3% on $170m face, 10.2% on $150.6m face) and one class of subordinate (9.8% on $63.3 face, which I assume means there's a conversion feature that results in ACAS enjoying upside if things go well; else, why would the subordinate coupon be lower than the second class of senior?) debt still held by ACAS. Orchard Brands runs several catalog businesses with niches ranging from one-of-a-kind interesting gifts to one of various classes of shoes. The growth of Internet sales seems to underscore the basic advantage of outlets without brick-and-mortar overhead: people can shop your wares without having to drive or park, and order them delivered to their doors, and maybe even avoid sales tax into the bargain.

Maybe Orchard doesn't know how to exploit its target niches. Maybe it's on the rocks after a crummy holiday season. It's hard to tell on available information whether this is a company that will come back. Hard to tell exactly what's going on in this one (e.g., why subordinate debt would have lower coupon than a senior class of debt? some conversion feature or the like at work?) though it's understandable it's suffering if it depends on seasonal sales and last holiday season was a worldwide bust. The senior debt is valued at more than half its face value, which suggests it's got some plausible security or is paying to some extent (at the end of 2008, the debt was current). Although the first-listed senior debt is not yet on non-accrual, the subordinate debt and the second class of senior debt are on non-accrual. Without knowing who else Orchard's creditors are and how they are secured, it'd be hard to figure out what ACAS' position is if Orchard fails. Since Orchard is still making payments under one of its senior debt classes, it's evident Orchard still has some business to recover. But 7.3% isn't exactly the return ACAS was angling to get when it went into business, and ACAS' cost of debt has increased since this investment was made.

Orchard is one of the investments whose debt is collateral under one of ACAS' secured debt agreements.

Future Foods Inc. apparently manufactures and sells organic sea vegetables in various forms for use in flavoring and as salt replacements. Leveraging a worldwide supply network, the company offers "soy derived nutriceuticals" and freeze-dried organic herbs. The company seems to have expertise in food areas in which there's cutting-edge demand in the health-food marketplace – omega oil ingredients, new antioxidants, herbal remedies, and so on. The new-age granola crowd isn't dead, as a trip to Whole Foods will demonstrate. Health food producers needing ingredient support seem to offer a promising market for the future. Since the senior debt is valued at par (ACAS' basis in the 5.3% notes is $17m, though the principal and the market value are both $17.2m), it seems the company is paying this debt with some room to spare – or that the paying senior debt is well-secured. The below-par status of the company's subordinated debt ($7.6m basis in $8.m face having $0.5m market value; coupon is 12%) isn't hard to figure: subordinate debt of small, illiquid companies isn't in high demand now, and the subordinate debt has been on non-accrual for at least a few quarters. The equity and warrants are valued at nil, which may be FAS-157-compliant (there's not much market for small illiquid companies that have unpaid debt) but is inaccurate if the company isn't a goner. If the company is a goner, how is the senior debt worth par, and more than basis? It's a puzzle. I suspect that an experienced player in a growth industry like high-end inputs for the health food industry has a solid future even if the illiquid debt of a private company with no banking references (because it gets its financing privately) is considered a poor risk when valued by third parties.

Energy Infrastructure
ACAS owns debt (8% senior, with $44.2m face, $43.8 basis, and $44.2 market value) and equity (apparently 4.6%; ACAS and its affiliate bought 6.8%, and 30% of that investment was through one of ACAS' managed funds, so the 70% remaining is presumably ACAS' and should amount to 4.6%) in EXPL Pipeline Holdings LLC, which is presumably the holding company for Explorer Pipeline Company, which owns and operates the second largest refined petroleum products pipeline in the U.S. It's apparently a significant item of energy infrastructure along the Gulf Coast. Being familiar with growth along the Gulf Coast, I am pretty sure that whatever ills may befall the region in the short term, there is (a) a demand for petroleum products, (b) a certainty that owning energy infractructure in the area will be valuable, and (c) no reason to believe that transmission (this isn't an oil well company, it's a pipeline company) is suddenly going to suffer lack of demand (particularly in light of the long-term contracts that typically support infrastructure of this type). The fact that ACAS' equity in this enterprise is not valued at zero like most of the other equity suggests the company must be doing fantastically well by the standards of illiquid privately-held companies. (Else it's evidence that membership in the LLC is more liquid than ACAS' other investments. Anyone know?). On an equity basis of $44.6m, ACAS is required to value the equity at $12.0m. I'm suspicious that ACAS will keep getting its 8% debt paid by the pipeline company until 2017. Tthe debt is not on non-accrual, though the equity is currently listed as non-income-producing. I have no data that the equity being non-income producing is a special problem at present. (The LLC likely holds the underlying company as a close corporation, electing tax-pass-through status, and allowing ACAS to receive distributions prior to income tax withholding. Presumably ACAS ordinarily does expect income from the equity as well as from the debt.) ACAS' minority holding doesn't appear calculated to place ACAS in a position to flip the company or control a re-organization intended to improve its operational efficiency -- it appears calculated to provide steady income and exposure to a business with long-term contracts in a field that will be necessary longer than you or I live.

Note: EXPL Pipeline Holdings LLC is listed among control investments, which works against my minority equity owner thesis. It's possible that ACAS' senior debt has conversion features, or that its class of membership has unusual control features, or that something else interesting is going on there. Theories welcome :-) Inc.? [updated]
ACAS holds investments in something called Inc. If one visits the web site, one sees an offer for "simple, convenient, and reliable" conference calls for "businesses, organizations, and individuals." Just register. Clicking around, it seems that some features involve per-minute access charges. Since ACAS' debt holdings are trading at face value ($13.2m at 6.8% and $10.2m at 15%), and the preferred stock is valued above zero ($9.2m on a basis of $13.9m), it stands to reason that the interest payments are current and the company's outlook for solvency is good. But ... if the main offering is free, what kind of revenue can really be expected? ACAS' additional holdings of common stock and warrants suggest that it expects to benefit in an eventual exit, though if it's getting (on average) double-digit interest in the meantime, it might not be particularly worried about the timing of that exit.

Presumably, the move toward globalization, telecommuting, and mobile workers is thought to be a driver of this kind of service. The idea must be to make money on volume; 10¢/min for 1-800 access seems a very tight place to try to make margins.

ACAS is an opaque company: its investments aren't easy to evaluate (but then, what is GEICO worth if sold by Berkshire Hathaway? Tons, yes ... but what number is fair?), and the outlook for particular companies is hard to ascertain. Even knowing a company has one or more debt classes on non-accrual, what can one tell about its ability to survive if its lender -- ACAS -- is willing to work with it? Management has made clear that the last downturn offered both a resurgence and good buying opportunities; of course, the last downturn was not so harsh.

ACAS has tremendous diversity, though: its primary risk seems to be leverage, not concentration. As ACAS pays off maturing debt (I assume some of the cash raised in recent sales is destined to pay off bonds maturing this year), its overhead will look better -- but to thrive, ACAS needs more than just to survive, it needs its portfolio companies to enjoy success. With such a diverse portfolio, the best promise of broad success is economic recovery.

Anybody got a can of that lying around?

UPDATE: Some suggestion has been made that ACAS is doomed because it overpaid at high multiples. This has the attractiveness of being half-true. ACAS overpaid for some investments (remember the Internet company that went to zero when Google killed its referral income? Ouch.), and ACAS did buy some investments at higher multiples than at present. However, conference call listeners will recall that ACAS routinely enters investments with the assumption that it will have to exit at worse multiples, and prices purchases accordingly. ACAS works very hard to do effective due diligence, and once it enters a position its performance teams assist portfolio companies to control overhead while growing EBITDA (which drives up value despite multiples contraction). ACAS' price plummet over the last 18 months has been a disaster for shareholders (and management), but it's not obvious that ACAS' management has suddenly been hit with the wand of a wicked faerie. AGNC's value has grown in the same time period while its dividend has increased, under ACAS' management. The primary difference seems to be that AGNC's portfolio is liquid and easily used as collateral. Assuming the economy does turn around, what should we exepct of other ACAS-managed portfolios? What will become of non-accruing debt's value when PIK notes that previously reinvested at double-digit rates begin paying cash? What will become of the fair value of equity now valued at zero?

ACAS has serious chalenges, not the least of which is the possibility that even more portfolio companies default on debt -- or existing defauted debtors default on more classes of debt -- as the economy continues to threaten business. Income is critical to ACAS' survival, whatever the theoretical prospects of portfolio companies. ACAS doesn't have forever.

The question is, does ACAS have long enough? If it's able to make cash with profitable exits to handle debt maturities and can limp along on ordinary income until things turn up, ACAS is cheap at a small fration of its NAV. If ACAS can't keep its bills paid, its goose is cooked. The fact that ACAS has investments with some classes of debt in default is unfortunate, and the fact that this default reaches a fifth of the face value of ACAS-held debt is genuinely alarming. The question is whether ACAS' diversity, and the fact that many of these companies are still current on other classes of debt, give ground for security that things are not as dire as to justify a share price south of half NAV.

Tuesday, August 18, 2009

Clouds in North Carolina

Apple's 500,000 square-foot datacenter facility has been deemed clear evidence of intent to enter cloud computing. The center is located where overhead is cheap, not where connectivity is currently maximized.

I'm missing some information, but it's possible I might disagree. By the time the facility is online, I think the location in North Carolina may be as connected as anyplace else -- and closer than current datacenters to Research Triangle Park's nation-leading density of Ph.D. talent (RTP was a Forbes top-five wired city, incidentally; the infrastructure for wired access might not be hard to come by in North Carolina), which may help Apple attract and keep some of the talent needed to make the center as effective as possible.

One thing is sure: it's not merely one of multiple redundant hubs for disseminating music or other static content. The new center will be capable of doing things Apple hasn't done before.

Apple Sells 25% of US Music

The news represents continued growth in iTunes market share. While carrying 69% of digital sales, the growth in digital sales suggests Apple's slice may get bigger as its pie gets bigger: digital is expected to equal physical album sales by the end of next year.

Apple isn't just defending the iPod with the store, it's really placing Apple in a position to fund marketing for Apple properties like iTunes, the App Store, iPods, iPhones, and anything Apple makes that interfaces with the above. Good experience with the store should result in warm fuzzy feelings about Apple's products generally.

The halo is apparently no joke. Despite being only the third-largest smartphone vendor with under 14% of sales, Apple claims a full third of smartphone profits. Pushing Apple products with the strength of associated products -- which themselves offer potential profits -- can't hurt Apple's position.

Friday, August 14, 2009

Desktop Linux Casts Growing Shadow

Steady demand for Linux hardware drivers and for pre-installed desktop Linux herald bad things for Redmond: the low-end desktop won't be Microsoft's milking cow forever.

And: where Linux goes, would MS-Office be bought?

Tick ... tick ... tick ....

Sunday, August 9, 2009

The Case Against the Case Against Apple

Here we find an unhappy post on why Apple is done. Aren't articles about why Apple is done ... you know ... done? (Well, "the end of Apple Computer" is accurate insofar as the name changed to drop the word "computer" but otherwise ....)

The most recent diatribe against Apple is written by a late-thirties guy connected to a tech conference, so it's tempting to dismiss anti-Apple vitriol as simple marketing: people love to read stuff about Apple, whether because they want to see Apple fail or because they think Apple's being picked on. So it's a win-win: you get traffic from people who hate your post, and from those who want to believe it. Yea, right?

But the Jaded Consumer is about criticism of the tripe we're offered as steak. Let's take it point by point.

Six Years Ago The Author Started Buying Apple's Products.
He says he dropped $20K on Apple wares. I don't know how many there are like him, but as a shareholder may I be the first to say: God Bless You, Mr. Calacanis.

He says everything on Apple's platforms costs twice as much, but he was willing to pay for quality because his money wasn't precious and the quality was. The relative value of Apple's products is an endlessly fruit-bearing tree, and we can't exhaust it here. Suffice it to say that Apple has had some recent high-profile attacks on the price of its machines, and the chief impact has been to drive chintzy, low-margin customers to Dell a little faster. Apple's own sales have improved at a better pace than those of the U.S. market as a whole, which means Apple has actually gained share against Microsoft's OEMs (who comprise the non-Mac market).

The author has this to say about his experience with Apple: "I over-pay for Apple products because I perceive them to be better." The Jaded Consumer asks: why is it over-paying to pay more for something perceived to be better?

The Author Is Mad At Steve Jobs
"Steve Jobs is on the cusp of devolving from the visionary radical we all love to a sad, old hypocrite and control freak--a sellout of epic proportions."

The author's hypothesis seems to derive from the apparent view that Apple now stands in the abusive monopolist's shoes Microsoft wore fifteen years ago. The author offers no support for the view Apple could possibly wield the kind of market power Microsoft ever wielded, or that it holds such power in any particular market.

As we've seen in the music market, Apple did capitulate to the demands of indispensable third parties (companies with the rights to distribute music) and offer DRM-laden music, but was happy as a clam to blast DRM as a flawed strategy even as it obeyed industry demands, and eventually – when it became able to negotiate contracts to support the move – to offer music products with no DRM at all. The fact that Apple can't offer tethering, and is restricted in offering applications that compete with carriers whose business model depends on selling airtime minutes rather than allowing IP calls on the back of customers' pre-existing all-you-can-eat Internet access, seems quite obviously to result from the same kind of restriction imposed by a necessary third party. In the case of IP telephony and using the iPhone as an unlimited-usage 3G modem for notebook computers, the indispensible third party in question is plainly the cellular carriers – in the U.S., an exclusive carrier, AT&T.

Why would Apple reduce the value of iPhones by refusing to allow "tethering" and Internet telephony? Apple has no incentive at all to make its products less attractive at the same price. These features would steal customers from competitors all day long, and Apple knows it. (I know people paying Verizon $50 to $100 a month for unlimited wireless Internet for notebook computers, and Apple's ability to offer the same thing from iPhones would be a clear win for Apple's move on the technophile world.)

Apple is clearly not the bad guy on things like DRM (the only plausible basis for arguing Apple's store ties music buyers to Apple music players) or tethering or IP telephony. The author is simply not thinking.

The Myth of Non-Openness
The author blames Apple for third parties' hardware not synching with Apple's products. Anyone is free to offer music players for Apple products (Cassady and Greene offered SoundJam before Apple bought SoundJam and renamed it iTunes, for example), and Apple does nothing to keep people from allowing their hardware to communicate with the software they deliver their hardware customers for use on Macs. Apple's excellent and well-documented loadable kernel extension system for supporting unknown hardware added on-the-fly by customers with tools Apple has never heard if is a great way to let developers of third-party applications support whatever hardware they want -- whether from Apple or from any other vendor. Bashing Apple for "neglect" of hardware in such slight demand that the author admits mobody knows what it is called is frankly silly. Apple can't be expected to read the minds (or spec sheets) of every 0.02% market share player and ensure support.

Music players aren't like cameras, in which Nikon, Canon, and a few other manufacurers need Apple's support to allow users to access their self-made content. Music players come from what the author admits are a dizzying array of manufacturers, with a hellish range of features and hardware variations, and nothing like a big base of users around which Apple might build a sensible basis for third-party device support. Just supporting cameras was so rough that Apple called it "the chain of pain" -- and cameras offer computers much less range of supported features than some of the MP3/movie/TV/radio gadgets that the author seems to think are so badly missed by Apple customers (but which I for one have never hoped to own).

The author's confusion – that Apple's lack if iTunes supprt for others' hardware is like a Microsoft effort to stop third-party hardware from being accessed by users of Microsoft's operating systems – is absurd. iTunes is not an operating system. Microsoft doesn't write and bundle hardware drivers for all the MP3 players in the known universe, which is what the author claims Apple ought to do. And Apple doesn't prevent manufacturers from offering support for their own hardware by MacOS X users, which is what the author falsely suggests in its attack on iTunes.

The author's argument is a transparent straw-man. He should be ashamed.

The Author Wants Third-Party iPhone Browsers
Apple has a well-documented scheme for well-behaved iPhone applications: how apps store and use data (Apple offers a data storage API based on CoreData that allows persistent databases full of usable data of all kinds, but doesn't want applications littering the iPhone with self-organized garbage in the filesystem), how they should behave when users open different applications (they should close, to allow other apps a fair shot at limited system resources), and how they should maintain the security environment supported by the signed-application system that keeps Trojans and viruses from running rampant on the iPhone platform.

Applications that dynamically hunt the Net for plugins (read: foreign executables of uncertain origin) to load in order to process stuff hunted down off the Net blow this totally out of the water: they download files for storage on the phone where users can't find them, they load applications nobody has vetted for their behavior and whose authors aren't known in case they turn out to be malicious, and they handle content in a way that can't be shut down if it's found out there's a security problem. The author's call for third party iPhone browsers sounds exactly like a plea for this very kind of application that has been positively identified as a menace to the iPhone.

Anyone wanting to offer browser power in an iPhone app can access WebKit, just like Safari does. If someone has information about a browser that doesn't try to deploy unsigned plugins, that Apple has nixed, then I'd like to hear about it. However, an application that offers WebKit and nothing more ... well, it does the same thing as Safari but will fewer frills, right? Who benefits from this kind of project? Is there a non-plugin browser that depends on a different rendering engine, that might have some value for iPhone users? Does anyone care about this besides refusniks like the author? Is this a real problem, or just one cooked up by bashers of the App Store (which has done the public some good by shutting down really ugly apps that do nothing but steal users' money)?

Author Claims Apple Hates Competition
The author says Apple warned off would-be competitors with this ultimatim: "Don't create services which duplicate the functionality of Apple's own software. In other words: 'Don't compete with us or we will not let you in the game.'"

The facts say otherwise. Although Apple clearly would benefit if everyone satisfied all their music needs using Apple's music store, the App Store has lots of music apps – not just to make music but to find it on the Internet to hear in direct competition with Apple offerings. Google quickly supplies a top-twenty list.

Apple's warning about duplicating the functionality of Apple software might be ambiguous, but it's not stupid. Imagine an application that tries to synch your iPhone with your Apple-supplied applications. Imagine this app might screw up your data, or get out of synch with current versions of Apple applications, and botch synch. Why would you want a third party app doing what Apple is already doing automatically? Why would you want the confusion of having to update this app, and wonder if current versions are adequate to current tasks, or if the sortware is even being maintained?

Summary: Another Vacuous Apple Bash
The author's positions are generally baseless. Apple may have some problems with consistent treatment of applications submitted to the Apple Store -- these are pretty well documented in the blogosphere already -- but the offensive denials that prevent tethering, IP telephony, and so forth are pretty certainly results of carrier contracts just as offensive DRM was a result of music labels.

The fact that the author fancies the Opera browser is entertaining -- it's not the smallest or the fastest browser, and the vast majority of the Web-using world is clearly opposed to paying money for a browser -- but hardly constitutes evidence that Opera ever contemplated a browser that meets Apple's general guidelines for designing applications on the iPhone, much less evidence Apple ever rejected such a submission by Opera.

The author says "Man, do I miss being a journalist. I wish I could split 50% of my time being a journalist and 50% of my time being a CEO." I say: thank goodness this tripe isn't being passed off as journalism. I can't imagine wanting a CEO with such weak analytical powers, but at least the victim pool in that case is limited to company stakeholders, and not the news-reading public at large.

UPDATE: This isn't the only place that silly opinion-piece is being ripped.

Microsoft's Razorfish Sale: Refining Direction, Or Just Confused?

Microsoft's Sale of Razorfish in an auction to the Publicis Groupe suggests Redmond is may be trying to focus resources on fields in which it has native competence rather than parlay its wealth into domination of every market it can imagine. Aquired by Microsoft in its 2007 purchase of Razorfish's then-parent aQuantive for $6B. The $530M cash-and-stock purchase price reported in the Razorfish sale is less than 10% of Razorfish's all-time-high market-cap of about $6B, before the dot-com bubble burst.

After seeking to build a content business in order to draw traffic to feed its advertising business, and to build money-losing game console hardware to lock in business for its games programmers (whom Microsoft expanded by buying successful independent game designers, at least some of whom it later spun back off), and a series of music store partnerships and even a sole-operated music store to feed its DRM licensing ambitions, has Microsoft finally decided to retract operations toward those in which Microsoft has some proven success?

Time will tell whether the sale reflects a new corporate attitude toward disciplined expansion and toward growth in areas Microsoft knows how to compete. With Microsoft freeing Bungee (though retaining a game development contract governing Halo licensing, which presumably rewards Microsoft well), killing MSN Music (and presumably its customers' ability to continue listening to music bought there on any subsequently-bought hardware, see EFF letter on the subject; compare Yahoo and Google refunding their customers on store closure and death of support for content with orphaned DRM), shedding Razorfish, and otherwise divesting itself of businesses that once seemed integral parts of Microsoft's push toward global domination of every facet of the public's electronic lives, one wonders whether Microsoft is refining its push, capitulating, or simply has no idea at all what it is doing.

Whatever it is doing, it evidently can't follow Bill Gates' instructions.

Wednesday, August 5, 2009

On ACAS' Results: 2Q2009

ACAS' earnings were a disappointment: NOI shrank to $0.09 per share and SEC-reportable NAV dropped to a dividend-adjusted $7.42 per share. Between realized losses and FAS-157 write-downs, ACAS reported losing $2.52 per share in the quarter.

The $0.09 isn't really the quarter's NOI, though. The $0.09 is what's left of NOI after an accounting exercise in which prior-quarter payment-in-kind ("PIK", or non-cash "payment" of debt) is reversed. Presumably, some PIK notes (interest paid in more IOUs rather than in cash) have become so impaired in value that the "income" that consisted in PIK has been reversed.

ACAS might be required to accept PIK under some of the debts it holds, or ACAS could have the right to accept PIK on more onerous terms than it could stick to delinquent debtors if cash were required. Whether PIK turns out to have value depends on whether the debtor issuing the PIK turns out to be solvent eventually, or not. At present, lots of little debtors look terrible. ACAS' management keeps saying that its experience in the last downturn was that lots of companies recovered, so it'll be interesting to see how much zero-valued debt turns out later to be largely payable. This isn't helpful in the short run -- nonpaying debt doesn't generate cash flow, and insolvent portfolio companies hardly seem candidates for a rich sale -- but is a possible consideration for the longer term.

One poster commented about ACAS' debt-to-equity ratio and the face value of its bad debt. Clearly one wants to see ACAS with a debt-to-equity ratio of less than 1:1, and small single-digit bad debt. In my post comparing ACAS to banks, the fact that banks commonly had a 10:1 ratio was a reason to love ACAS -- as was its ability to earn more than bank interest when its bets went right. Although ACAS has a debt-to-equity ratio that's worse than 2:1, this doesn't mean that ACAS lacks enterprise value any more than banks ordinarily have zero enterprise value despite being much more leveraged.

ACAS' willingness to finance long-term obligations with short-term debt is definitely a point over which one might become concerned. On the other hand, ACAS' short-term financing of long-term obligations at its managed company AGNC has worked wonders even as ACAS' own shares have been slashed 90% in price. ACAS is making a mint at AGNC by financing long-term assets with short-term debt. The principal difference is that AGNC's assets are easily-valued and liquid agency-backed securities that retained their value after FAS-157 when the non-government-backed debt took a henous haircut, and ACAS' assets are illiquid assets that are difficult to value. ACAS' problems, frankly, result from their illiquidity and the consequent lack of clarity in their value.

But the difficulty of valuing illiquid portfolio companies is why ACAS is supposed to be able to make great deals in that kind of asset, right?

Tuesday, August 4, 2009

ACAS' Share-and-Cash Dividend

On August 7, 2009, stockholders of record as of the close of business June 22, 2009 will receive a dividend with a nominal value of $1.07. Depending on the shareholders' individual elections, they will receive either a distribution of cash and stock ($0.185 and 0.275 shares per share) or a distribution of stock (in which case, 0.332 shares distributed per share held). Investors holding the shares in a taxable account will be taxed in either case as if receiving $1.07.

What's the impact of this on shareholders? For the sake of simplicity, the Jaded Consumer will first look at the case of a stockholder whose shares are held in an IRA or other tax-deferred account. The $0.185 will be worth exactly 18.5¢ on August 7 when paid. The trick is to estimate the value of a shares received on August 7 is more, or less, than the $3.2199 price against which the division was calculated.

In one sense, the value difference is purely speculative: ACAS has hardly closed the same price two days in a row in months, and on day in which the shares were traded at all, they were certainly traded at more than one price. Who knows what the price will be August 7?

In another sense, ACAS' share price on August 7 is immaterial if ACAS' net asset value -- the value on which ACAS is earning shareholders their future returns -- is several times the share price. While the NAV will certainly decrease in the issuance of new shares just as it would decrease in the case of a stock split (a 0.332 share dividend looks an awful lot like a 1.332-for-1 stock split, save for its tax characteristics), the fact is that this is not a stock split: some shareholders are getting cash, at cash value, and not shares with an arguable value related to NAV. This means that stockholders who elected to receive only shares (that's about 40% of the outstanding shares) will end up holding shares that represent a greater fraction of ACAS' net assets than the stockholders who elected to get a partial payment in cash. Those folks effectively sold their stock split at $3.2199 per share.

Based on recent sales that suggest ACAS can realize more value than it is allowed to claim under FAS 157, I suspect that the long tern value of the shares is not only more closely related to asset values than to trading price, but that the value of the assets is also rather greater than reflected in ACAS' recent SEC filings.

I think the August 7 payment will be a good thing for those who elected not to be paid in cash.

(Those who hold shares in taxable accounts will have to figure out what their after-tax net is on receipt of the shares to estimate what their returns are, but if NAV is several times trading price, receiving shares remains the clearly superior choice for post-payment value.)

New Math at Harvard Business School Blog

Harvard's vaunted business school has some bloggers who don't seem to be very sharp on margins. They hypothesize that by building iPods in the U.S. at U.S. labor prices, thereby increasing labor cost per unit from $4 to $62, the cost of an iPod would increase $58, or a "mere" 23%. Of course, this estimate is qualified:
perhaps they overstate the price differential, because ... they assume Apple passes on increased labour costs entirely to consumers.
Umair Haque via Harvard Business Publishing
Part of what makes Apple so attractive is its margins. Doubling the cost to produce an iPod Shuffle with a $30 labor increase doesn't increase its price $30, it approximately doubles the price unless margins are sacrificed. This business student Haque -- I certainly hope it's a student and not a paid analyst or, worse, an instructor -- seems to suggest that moving manufacturing to the U.S. in order to increase labor costs and possibly decrease net profit will somehow benefit the United States, or Apple, or its consumers. What makes Apple valuable is (a) its profit, and (b) the amount of cost Apple must incur to produce the profit. However, Haque suggests Apple murder its margins with a completely uncompensated $58 cost hike, and consider killing its net profit for an encore (maybe to prop up lost sales numbers) by eating some of this price hike itself.

Mind you, Apple's margins on iPods are high. To maintain margins after a $58 cost hike, Apple would be adding about twice that to the retail cost of Pods. Else, Apple's margins deteriorate and its valuation suffers.

The reason Chinese labor is so cheap is that China is gaming its currency's value to prop up exports. This means that Chinese are made to work at a discount for th benefit of foreigners. Chinese loan the U.S. money with which Americans can buy houses, build houses, and furnish their lives with a standard of living that would have left an earlier century's kings gasping in disbelief. Haque seems to suggest we ought to ignore the undervalued foreign service and supply offerings and somehow create an isolationist community in the United States based on the pride of paying more for local service.

The next step, surely, is to stop importing steel. And automobiles. After all, there are steel workers and auto makers we could be paying more ....

Haque hasn't got an innovative idea to improve value or trade balance; he simply calls for irrational economic behavior so he can cheer the employment of those who can't afford grad school at Harvard. Let's spell it out: he wants manufacturers to pay more for construction, not on the basis of reasoned quality improvements but to consumers can pay over 20% more (this is if the manufacturer charges nothing for its extra capital input, but passes it along "for free"; the number is otherwise on the order of 50% more) for consumer products in which there is active worldwide competition. Should the manufacturer lose a sale, it would be to a foreign manufacturer whose ownership is less concentrated in U.S. retirement plans and whose employees are not earning salaries taxed in the U.S.

To hell with logic! Companies should play chicken with their employees' livelihoods and retirement like G.M. and see what happens! Whee!

Seeing this drivel from Harvard really makes me wonder what they put in the water in Massachussets. I had previously held the place in such high regard ....

Note: Harvard Business Publishing, while owned and controlled by Harvard, is despite its name and the use of Harvard's logo, not apparently a part of any particular Harvard graduate program but is a nonprofit dedicated "to improv[ing] the practice of management and its impact in a changing world." Apparently making less money so you can be driven off the cliff of insolvency like G.M. is the way to improve the world, because the union becomes the company's main shareholder and the workers therefore own the means of production and the great class struggle is ended in voctory. At least, if you didn't consider that the foreigners buying up the remains aren't worker-owned, and that profit derived from US-based manufacuring will be exported to economic competitors and taxed there rather than here, and that once people have lost their jobs they aren't technically "workers" any more and therefore can't claim part of the victory in owning the means of production they are no longer allowed to use.

Monday, August 3, 2009

On Schmidt Leaving Apple

Eric Schmidt resigned from Apple's Board of Directors. Some yahoo claims this is explained by serious and growing competition between the companies in browsers and operating systems and application sales.

When Apple took on Schmidt in 2006, the companies promised to offer significant synergy -- particularly in open standards for online communication and providing alternatives to the once-unavoidable products from the monolithic and anticompetitive Microsoft.

Browsers No Bother
At the time Schmidt joined Apple, Safari had been out for over three years. More critically, Safari's rendering engine had been open-sourced for over three years. The KHTML team, OmniWeb's developers at OmniGroup, Nokia , and other groups have been making products from the same code base for years, both before and after Schmidt joined Apple's BoD. The fact that WebKit gained the support of Google's browser developers, who included it in the Chrome browser, did nothing to undermine either the standards Apple hoped to foster or Apple's ability to deliver products based on solid, fast code. The fact that Nokia incorporated the rendering engine to make products directly competitive with Apple's own handhelds suggests that corporate competition need have little to do with the technology behind rendering engines.

Claiming that Apple and Google have some kind of irreconcilable conflict because each distributes a browser is frankly silly. "Entrench[ment] in the web browser game" is hardly reason to find the firms -- one, a premium hardware vendor with products distinguished by software; the other, an online services company hoping to reduce hardware costs to increase the addressable market for its services -- in some kind of conflict. Apple knew the world could use WebKit to build browsers. Had Apple not wanted the world to do so, Apple could have made its code improvements available in a less user-friendly format than an oven-ready Cocoa framework. Apple wanted WebKit to become popular so that the online experience would increasingly depend on verifiable standards -- that is, would cater to non-Microsoft browsers -- in order to make the world a better place for Apple customers. The fact that other non-Microsoft browser users would benefit from standards and consistency was in no way an injury to Apple's objective of avoiding being frozen out of the online world by MSFT-controlled secret protocols and other ancient evils common from the land of Redmond.

OS No Obstacle
Google's entry into general-purpose operating systems offers little problem for Apple. Schmidt recently approved Google's foray into general-purpose operating systems, but this isn't a threat. Why? Look at the market segments approached by each. Google seeks to make devices cheaper by creating a license-free OS -- so it can increase its addressable market. Google's threat is to Microsoft's business model, which is to increase devices' cost through operating system licensing fees. At the low end of the hardware market, the OS is a material charge that moves the needle on profitability. Consider commodity PC maker Dell, which suffers so badly from OS costs that it must earn advertising revenue by filling new machines' desktops with ad-ware. The low-end box is where Google's OS products will make a difference, not the high end where users have costly software investments that depend on Microsoft's desktop APIs.

Google's OS will free users from desktop APIs by leveraging the Google Gears technology it developed for delivering full-featured applications on desktops. Google will continue to be able to deliver these on desktops through browsers, meaning that Apple's' products will continue to be part of the addressable market for Google's products and services. Apple and Google aren't an an either/or proposition. Google simply makes ultra-low-end products possible -- and thereby access to third-world markets that don't yet exist, because devices are just not cheap enough there to be affordable.

At the high end, Apple already commands an enviable position. There's little suspicion that Google will soon compete in such a space.

Flap Over Google Apps
The author of the piece I lauch at seems to think Google's telephone application is a concern for Apple, and is behind inter-company friction. BS. What interest could Apple possibly have against Google making Apple's internet-connected devices more valuable through the offering of a voice application? The only party unhappy with this prospect would be a carrier company, who presumably wants to sell minutes instead of allowing users attached to a LAN to make calls through fast wireless networks. (If the application supports sufficient call quality to enable 3G wireless calls, carriers would really brim with irritation: they would support calls with unlimited data plans and lose minutes charges. Imagine.)

The friction here isn't about Apple and Google, it's about carriers fighting to keep competition from devices. As with DRM (which Apple seemed to champion, but only at labels' demand and only until they could negotiate their way out of it after the model had proven a failure), Apple's support of the minutes-billing-system and other carrier-caused crippleware (instant messages with a per-message fee? Why is SMS different in kind than AIM or other IM?) will eventually prove not to come from the heart at all.

Mobile Phones (and their applications)
To suggest that the phone rivalry is heating up is to ignore that there isn't a single Android device that competes head to head with any Apple product on features. Android is a tool to enable lowered OS licensing fees -- as on desktops, to enable increasing the size of the addressable market for Google's service offerings. I have yet to see evidence that Android is an iPhone OS competitor.

Indeed, Android's support for so many hardware variations will certainly make application development much less accessible to users (applications depending on features not present on specific phones, or that assume different key layouts or the like, will not offer much in the way of a user experience). Without the application base, Android will compete in niches in which a certain phone and its attendant applications make a compelling value argument. (The hardware variety issue, which Apple doesn't fear because it controls the hardware, is a real problem for Android: Google expects 18 models by year-end.) Apple's marketing approach is quite different. Apple doesn't care whether its competitors use Nokia or Google operating systems that offer users a WebKit-based Internet; Apple just cares that the Internet works great for mobile users with WebKit applications so that its customers like what they see. If MSFT's mobile offerings are obliterated in the process, so much the better.

Apple and Google share a strong interest in ensuring that Microsoft doesn't establish a position in mobile devices that precludes competition on the basis of product quality. Creating product classes that ensure the possibilty of pursuing corporate objectives by offering customers meaningful product choice works in favor of both companies. The fact that their offerings have no overlap is of no consequence, provided the choice is real: Google is offering software-only licensing to third party hardware vendors, and Apple is offering a soup-to-nuts integrated solution delivered through Apple-controlled retail channels. Google will take share from the market segment most impacted by licensing fees, and Apple will take share from the market segment most responsive to its (traditionally) high-cost premium products. Each will develop revenue entirely differently from the products (except that Google's mechanism will allow it to derive revenue even from Apple's products, though less revenue than Apple would derive). Provided competition can exist -- a condition both companies require, and a condition made more likely by widely-adopted standards-- both Apple and Google both benefit in Mobile space to a much greater degree than if the space were ceded to Microsoft or to vendors conspiring with carriers to lock users into a limited range of premium-fee applications and services.

Apple and Google aren't really competitors in the mobile space, or in mobile applications.

The article claiming that Apple and Google are now eating each other's lunches and that the departure of Schmidt was based on animosity and competition is simply bunk. The fact that Schmidt's company's products now appear in so many niches in which Apple products compete makes the threat of antitrust oversight more of a nuisance than either company wants to suffer, regardless that there's no merit in the worry (yet), and with Schmidt bowing out of strategic talks on operating systems, mobile platforms, online stores, developer relations, content contracts ... well, what's left Apple would want Schmidt to share his insight about?

The departure isn't made inevitable by growing competition, it's made reality by effort to ensure no anticompetitive concerns are colorably raised -- and formalizing it in Schmidt's withdrawal form Apple's board changes little. The places where Apple and Google best cooperate -- making good code that tends to free users from dependence on Microsoft products -- are alive and well (in the form of the companies' numerous open-source development programs and for-a-fee products and services), and in some places involve active cooperation, such as on WebKit, which powers both firms' broswers. Where active cooperation isn't present, the mere fact that Microsoft isn't ceded territory and must fight tooth and nail (and lose share on the way) protects the marketplace for users and their suppliers of hardware and software.

Google and Apple will continue to share a desire for standards and interoperability and cross-platform access -- and toward that end their valuable cooperation will continue at the operational level even if at the strategic level the need to have Schmidt on the Board is diminished. It's not like Schmidt and Jobs haven't got each other's number if something comes up.

ACAS: Portfolio Includes Recession-Weathering Brands

American Capital Ltd. (ACAS) has been slammed over the last year or so, with share price losses in the range of 90%. Those of us with options exposure needed cardiac treatment to return to the dinner table. Net Operating Income (NOI) has decreased as the economy has battered ACAS' portfolio companies' ability to service debt owed to ACAS, much less to make the growth targets ACAS bargained for when it invested.

As news outlets chatter about whether the economy has hit bottom, it is worth looking at what ACAS has done to protect itself.

Repair, Not Replace
ACAS owns the nation's largest transmission repair network. AAMCO Transmissions, which under ACAS' leadership acquired Cottman in 2006 (I've seen and know both transmission companies' outlets), has 1,100 retail outlets and grossed something like $600m/y back when people were still buying new cars. Now that drivers are tightening their belts, fixing the old car is a bit more attractive than risking good money on a new auto whose value will plummet measurably as one puts the first mile on the odometer.

A 2007 One-Stop-Buyout also gave ACAS control of vehicle fleet supplier Imperial Supplies LLC. ACAS' subordinated debt holdings have a fair value equal to their face value, $22.3m (on a basis of $22.1m), its redeemable preferred stock holdings have a fair value of $22.1m (on a basis of $15.2m), and its common and convertible preferred have zero and little value, respectively, totaling $1.2m on a combined basis of $31.5m. Equity in illuquid companies is apparently considered valueless, whereas the same companies' current debt is worth the number printed in the corner. ACAS earns 16% on the subordinated debt, and for the debt to be valued at face it would appear that the debt is both current and supported by adequate underlying business metrics for the forseeable future -- giving apparent lie to the zero value assigned to the company's common shares.

Sweet, Sweet Profit
In a 2007 One-Stop-Buyout, ACAS bought the New England Confectionary Company, purveyor of those candy hearts everyone buys around Valentines' Day. NECCO also owns other brands, like the Squirrel Nut Zipper (apparently resurrected after the emergence of the Big Band of the same name) and Clark bars. Buffett noticed the money to be made owning and nurturing the business of Sees Candies and snapped it up for Berkshire Hathaway. Wilkus' team has done the same with NECCO. Candy is both a cheap thrill and a high-margin business, dependable when times are tough.

ACAS' existing investment in NECCO Holdings Inc. includes debt and equity, and has a basis of $4.3 million. Its fair value at the last quarterly filing was $8.1m. ACAS also has an investment in NECCO Realty Investments, which is likely related (despite both subject-matter differentiation and a lack of description of the realty business on ACAS' site) because of the involvement of ACAS' realty business in its Special Situations Group's identification of NECCO as a buy. In deciding NECCO was a buy, ACAS specifically mentioned NECCO was a value-oriented purchase. Despite the apparent collapse in real estate markets, ACAS' investment in NECCO Realty Investments LLC has a last-quarter fair value of $48m, up from ACAS' basis of $42.4m. Both NECCO units pay ACAS double-digit interest on senior debt ACAS continues to hold, and ACAS' investment in both is overwhelmingly comprised of senior debt bearing 12% (NECCO Holdings) and 14% (NECCO Realty) interest rates.

Taking Care of Business
Since a One-Stop-Buyout in 2007, ACAS has owned SMG Holdings, Inc., operator of 98% of the publicly-owned exhibition space operated by private companies in North America. This includes the million-sqare-foot Reliant Park, which since opening has been home to the Houston Livestock Show and Rodeo -- which as the astute reader surely knows is the world's largest rodeo. Now that the Summit has closed, it's one of the best places locally to see ZZ Top (in that the Reliant is an indoor venue). It's also the longtime locus of the biggest chili cookoff I know. (An account here.)

But enough about the Rodeo. Millions of square feet and countless visitors attending seminars, graduations, parties, competitions, concerts, training programs, trade shows (like the Offshore Technology Conference), and every type of gathering you can imagine all support SMG's business and that of its restaurants and accommodations businesses. Major arenas are also a great place for SMG to ply it consulting business, which includes naming rights and sponsorship support. Since its founding in 1977, SMG has grown to operate hundreds of venues and has tens of thousands of employees worldwide.

ACAS' existing positions in SMG's senior (8%) and subordinated (12.5%) debt retains a fair value equal to its face value, $126.6m; ACAS equity positions are carried at $101.2m (from a basis of $147.3m). (ACAS presumably successfully syndicated other debt to banks or other buyers impressed with ACAS' willingness to hold subordinated debt and even equity for the indeterminate future, or invested non-ACAS funds managed on behalf of third parties.) ACAS' investment is likely intended to last through the maturity of the debt, in 2014 and 2015 (management has explained it intends holding most debt through maturity), allowing ACAS to benefit from the broad growth of demand for large public spaces for entertainment, education, and business purposes in the nation's population centers.

Good For Your Health
ACAS owns a health practice manager, Affordable Care Inc., which it has funded to acquire multiple dental practice managers. As health care continues as a major American enterprise and obtains a higher profile as a subject of increased funding initiatives, ACAS demonstrates foresight to be in a position to profit from these trends.

ACAS holds investments in Affordable Care Holding Corp. (15% subordinated debt with face value of $65.1m, valued at $65.1m on basis of $64.3m, convertible preferred fairly valued at ACAS' basis of $85.6m, and common stock valued at $13m from a basis of $17.7m), "Health Care Providers and Services" portfolio company MW Acquisition Corp. ($35.1m on basis of $38.4m, an investment that includes $25.2m in face value of 16.2% subordinated debt and a presumably controlling interest comprising common and convertible preferred shares).

Future Shock
ACAS doubtless holds numerous other companies that are less well positioned for rough weather -- companies having trouble paying their debts, and sporting "fair values" well south of basis. However, ACAS' effort to prepare for economic doldrums may have provided it with some seriously stalwort revenue sources for rough times even if ACAS' effort didn't result in de-leveraging before the combined effect of Fas-157 and a credit panic collapsed share values. As the economy turns around, portfolio companies less prone to blossom in harsh weather may begin turning in their bargained-for results: entertainment companies, sporting goods, luxury items, and so forth. In the meantime, ACAS looks forward to steady payment from high-profile holdings like AGNC, but also from little-known holdings carefully positioned to maintain steady performance as the world tightens its belt but continues to need to drive, buy sweets for its sweethearts, fill the occasional dental cavity, and attend business meetings and the occasional graduation or major conference.

ACAS' power to grow is potentially amplified by the fact that much of the common stock on its books is carried with a "fair value" that is zero. Other than a bankrupt, would a company really trade at zero in an open market? Yet, even where ACAS' preferred stock (the means by which it presumably exerts control in these situations) has a value, its common stock holdings (whose basis is also sometimes zero) is often nil. How good is a valuation like that for estimating ACAS' eventual exit values, or the current value of an investment's future income streams? As ACAS' portfolio responds to the eventual springtime of the economy, I expect fair-value surprises -- perhaps first seen at exit -- to become a regular fixture in ACAS' economics.

In the meantime, let's keep an eye on NOI and the developing debt issues.