iPhone 4: Don't Expect A Recall

Unless you've been living at the bottom of a well sided in RF-resistant stone, you have seen several volleys of iPhone4 signal-reception complaints, criticisms, defenses, reviews, "analyses", explanations, translations, refutations official-sounding corroborations, and commentary. The highlight may be Consumer Reports' swift reversal from giving the iPhone the highest rating it gives any phone (if you don't have a subscription, trust me: max rating is 76 the day this was written, and that's the iPhone4's CR rating), defending the phone's reception issue as "not unique" and possibly unimportant, then suddenly refusing to endorse the iPhone4 on the basis of in-house RF testing.

The latest in this running gunfight is the latest entry on the blog of electromatic engineer Bob Egan that derisively explains that Consumer Reports' methodology was poorly designed and its conclusions were incapable of being supported by the claimed evidence. For only a couple more iPhone4s, Bob offers to produce real RF testing using a shielded room and a proper experimental design intended to identify the real source of the observed phenomenon.

The Jaded Consumer hasn't gotten an iPhone4, but it's not because of conscientious objection: there's too much time left on last year's AT&T contract to get another subsidized phone. For the record, I tried using an iPhone without a protective case and decided it was too risky because my hands were often dry and the thing could slip out of my hand while pocketing/withdrawing it, which involves turning it about behind my back while aiming into a pocket or past the pocket's hem. The very people with the greatest risk of accidentally bridging the iPhone4's metal-edge antenna are the damp-handed folks for whom adequate friction has never been a problem, and who are least in need of a protective case because they hardly ever have anything slip out of their grippy fingers. For the most of us, who don't want to drop the phones or prefer they were protected in case of a fall, the Consumer Reports suggestion users band-aid the problem with ugly duct tape is superfluous: we've been using cases that would avoid the bridging problem and would never have noticed it except for Consumer Reports trying to boost traffic with an apparently half-baked iPhone4 criticism.

So, with crisis communications experts calling a recall inevitable, what's Apple to do? The Jaded Consumer's view is pretty straightforward: as long as the thing keeps flying off the shelves, and holds Consumer Reports' top phone rating, Apple is clearly selling what the people want and what the critics like. (Well, Mossberg isn't recommending it unless you think AT&T is adequate, which given the rest of his commentary isn't so much a dig against Apple's product as against AT&T's service.) And Apple usually end up selling a phone case, too.

The Jaded Consumer says: Keep up the good work! And don't hold your breath for a recall unless you have medical assistance standing by.

The Jaded Consumer expects the folks who sell adhesive shields for phone screens to be out soon with a product for people who don't want a case, that covers the metal edges so that sweaty-palmed users have a grippy but non-conductive but largely invisible layer protecting the iPhone 4's three external antennae sections from being bridged. Just like some folks pay a few bucks to have the usually unscratchable screen protected from keys in a purse or pocket, and do so without a public outcry for recalls despite the importance of a screen to a modern smartphone, some folks will be willing to pay for similar treatment of the phone's edges. I expect that the fraction of folks using the phones au naturale will have been low enough that there's no serious rebellion among users (there are, after all, no widespread reports of returns despite that Apple waived the restocking fee), but that the large number of iPhone4 users combined with the press on this issue will make protective devices a competitive market.

The more competitive, the better pricing for later buyers like the Jaded Consumer. Bring it on!

On Recent ACAS Exits

ACAS' recent completion of its debt exchange has freed it to direct its attention on its primary business: making deals in the middle market.

ACAS' subsidiary ECAS has converted some assets from equity and debt holdings in GO Voyages to cold hard cash in the amount of €74m, realizing en passant a double-digit rate of return (16% mezzanine rate and 19% equity rate) including the realization of €10m in equity gains. ECAS exits have been few, as the press release states that the only other ECAS exit in 2010 has been the Spotless Group exit.

ACAS' exits from its non-ECAS portfolio have, by contrast, included a number of smaller, not announced transactions that will be harder for investors to follow. For example, the unreported exit of ACAS from Resort Funding Holdings Inc. in the second quarter was described by an anonymous poster as likely resulting in a $25m loss; in the last-filed 10-Q, ACAS had disclosed its Resort Funding Holdings investment as having a value of $7.4m, consisting of $7.4m in 8.2% senior notes valued at face value, and common stock valued at zero (with a basis of $20.5m). According the poster, the exit occurred in 2Q and the earnings release made later in Q3 will reflect the disappearance of the investment. ACAS has been able to IPO holdings such as RRTS, but withdrew another IPO when pricing did not meet management's standards. Being a patient investor, ACAS can wait for the market to better appreciate interesting alternative-energy technology and compliance plays like Mirion; however, investors have a hard time keeping up with the deals that result from ACAS' investment operations. Unlike Cramer, however, who hates ACAS in part for what he refers to as "opacity", the Jaded Consumer likes that ACAS can do deals under the radar: ACAS can enter deals no-one else has seen, and find buyers who value the secrecy of deals that give it a competitive edge without drawing attention. Selling Naurus to Boeing shows ACAS' capability to find strategic buyers, rather than depending on private investors or IPOs for its exit strategy. Although the details of the Naurus exit aren't yet known, the strategic value of portfolio companies to publicly-traded would-be parents may offer rich valuations: HP previously bought Extream Software from ACAS for $5m over the prior-quarter "fair value". Cybersecurity is valuable, and an aerospace giant like Boeing with international corporate espionage concerns may be willing to pay top dollar for outstanding talent and technology.

ACAS should keep doing deals. Investments in which management has lost confidence should be exited to allow capital to be deployed more productively (and to realize losses that will help ACAS keep down required dividend payments; dividends of BDCs are based by law on taxable income and not SEC-reported "income" that includes unrealized changes in portfolio values). Investments that have succeeded well enough that buyers offer a strong price for a holding should be considered for sale in light of the alternate available investments, the benefit of holding for ongoing income from the portfolio company, and the premium offered by buyers to management's assessment of the investment's true value.

Growing ACAS will allow ACAS easier access to cash when it has payments to make, and returning to business as usual may aid ACAS in returning to the days of NAV premiums as usual. In the meantime, ACAS' operations can't turn on what people will or won't think about ACAS' share valuations. ACAS must look to the long-term returns of its portfolio, one deal at a time, and try to buy excellent companies cheaply and, having grown them with the aid of its in-house operations experts, sell them as dearly as possible.

Warren Buffet's comment is appropriate: In the short term, the market may be a voting machine; but in the long run, it is a weighing machine. Like ACAS' management, we may do best being patient investors. Here at the Jaded Consumer, news of ACAS' results in this arena are

iPad > electronic competitors

Nielson's survey suggests that paper books are easier to read than iPad books: readers of iPad books read 6.2% slower. However, Kindle readers were 10.2% slower than paper readers. Oddly, both the Kindle and the iPad users rated the experience more enjoyably than paper (the iPad>Kindle>paper scores were 5.8, 5.7, and 5.6; it was a close match, and one wonders about novelty effects – the scores were, after all, in order of device novelty, and relatedly but differently, in order of gizmo sexiness).

iPad also gets top marks for making the computer experience a lot simpler than it used to be. This review pretty much sums up why Apple is able to reach people who never were interested in computers: you don't need to be interested in computers, only in your music or your email or your photos the internet or the like. This is virtually the hallmark of a well-designed tool: you don't notice it really when you use it, just the power it lends you.

ACAS Exits CreditCards.com

ACAS' recent sale of CreditCards.com to BankRate frees the company from a property that, as I understood it, didn't live up to its billing and had ended up being primarily a vehicle for obtaining referral fees. The purchase at $145 million is not all going to ACAS (though the preferred redemption feature may make ACAS effectively a bigger owner than just the size of ACAS' control block), but this value is above ACAS' last-published fair value for the company (<$120m), which makes it interesting to wait for the news. (Of course, exiting 13.9% and 19.0% bonds makes it interesting to ask what ACAS would do with the money that's better. Still, realizing an equity loss will help ACAS avoid paying a larger dividend next year, which is important to maintaining its capital. As much as I enjoy having zero tax expense at ACAS, I enjoy reinvestment more. Realizing losses when recovery looks dim is absolutely sensible.)

ACAS' management has always said that it didn't just sell winners, and getting back capital to invest in more promising deals had great value; this exit seems right in line with that thinking. ACAS will get out of a deal that didn't do what management hoped, and help prevent an outsized dividend next year by realizing losses in the current period on its equity investment in Creditcards.com Inc. Since ACAS (as a BDC) is required to pay 90% of its taxable income in dividends, and ACAS can't be sure it will be in a position to raise capital above NAV to pursue interesting deals, avoiding payment of outsized dividends by early realization of losses makes good sense when the price is right.

With the debt restructuring distraction behind ACAS, I hope to see many distressed situation entries – and shedding unexciting investments seems a great way to fund a more exciting future.

The next question is interesting: why is ACAS under $5? Did people expect a non-bankruptcy pop and then exit when they were bored? Personally, I think we need to see next quarter's earnings results to allow the benefit of the debt restructuring to have any likelihood of showing up in the share price.