Sunday, February 6, 2011

Hollywood Mined for Chinese Propaganda

CNN posted a story about China getting caught faking video in a news broadcast about Chinese fighter pilots. The news compares the fake to the Iranian video fakes previously discussed here. The comparison is fair – the Jaded Consumer was thinking about it even before CNN drew the comparison.

There's something about despotic regimes' cheerleaders that seems to draw them to faked images and other distortions when illustrating their claims. Working hypothesis: they have no respect for the truth. Indeed, they may even have no respect for their own claims.

Dell vs. WalMart: What "No Moat" Means

The Jaded Consumer published an article (republished a few days later on Seeking Alpha) a few years ago before the 2008 crash hit in September, and recently noticed that it had accumulated a series of comments. Seeking Alpha doesn't notify authors of comments, so the comments took some revisiting to notice. With the perspective of a few years, it's interesting to return and see how the post held up against the criticisms in the comments.

The most disagreeing commenter was Value Geek, who asserted on September 3, 2008, that Dell shared the kind of competitive moat that was enjoyed by WalMart:
Dell DOES have a moat, and its the same moat that Walmart has. Dell doesn't need to diversify into software or services, it just needs to maintain and increase its market share in PCs and laptops. Walmart was derided by analysts for years while it pursued the strategy of using razor-thin margins to build market share. Have you taken a look at Walmart's stock price recently?
Hence, the title of this article – and the time frame for the comparison graphs. A description of what constitutes WalMart's "moat" and how Dell differs follows. (A note: the Jaded Consumer never endorsed WalMart and never owned any; the comparison was Value Geek's idea. According to the Associated Press, WalMart has had its own share of difficulty keeping customers and competing. The Jaded Consumer simply doesn't agree that (a) Dell had a substantial moat or that (b) any moat it did have was the same moat that made WalMart a success.)

First: check out the tale of the tape. Compare the performance of Dell and WalMart from early September 2008 through the present. Comparisons on Yahoo and Google are based on client-side tools that don't lend themselves to links. A static graph of September 2008 through January 2011 appears below:

Neither exactly boomed. Compare Apple, which has been described here as having a genuine and sustainable moat. Apple competes with Dell, and like it – but unlike WalMart – doesn't sell milk or eggs or anything people can't go years without buying:

But the difference between WalMart and Dell is significant. Dell is a commodity box maker in cutthroat competition with foreigners who can buy the same parts at the same prices and spend less money assembling them, assuming there's anyone interested in buying them. WalMart sells something that people need every month (soap, food, etc.) and has such buying power that it can get products for its shelves at prices few can touch; moreover, it has fequently negotiated payment terms that allow it to put off paying for the products until a month after WalMart has already sold the products. WalMart thus is in a position to make significant money on razor-thin margins by investing the float of retail prices prior to inventory payment. On WalMart's economics, it's actually possible to make a profit while selling below cost, because of float-period investment opportunity. Dell may have been a supply-chain pioneer, but it can't claim to sell a box before paying for the parts.

Of course, WalMart doesn't sell below cost. WalMart sells at what the market will bear, and is happy to use its buying power to put competitors out of business. For an example of this kind of large-volume purchasing at work as an economic weapon, look at Bruno's in Gulf Breeze, Florida. There used to be a grocery store there. That is, an open one. Publix moved in a mile away, and Bruno's promptly failed. When this kind of competition succeeds, the bigger player becomes the major supplier in an area and develops local moat by being the supplier against which would-be incoming competitors are reluctant to risk capital. WalMart thus has both a financial moat (preferential pricing based on scale) and a moat based on being the sole source (in many cases) for staples one can't get on the Internet: milk, meat, toothpaste when you are in a hurry, toothbrushes the day of a big date, deodorant Sunday before the start of the work week, notebook paper the day before class starts, sugar/vanilla/flour/etc. when you are having a baking emergency, a candy bar when you are jonesing for a sugar fix while shopping ... you get the idea.

Dell is none of that. If you need it today, you go to a local vendor – which Dell is not, unless perhaps you are in Austin, Texas. Dell sells a product people can go years without buying again. Dell is no more accessible than any other Internet or catalog vendor. Value Geek's last paragraph seems a confession of the expectation that Dell will continue to explore the commodity vendor niche:
In the past, Dell has imitated the Walmart strategy too aggressively, and has cut even essential expenditures like customer service and R&D, which resulted in a loss of market share. Michael Dell is in the midst of correcting these mistakes. I bet that 5 years from now, Dell will still be providing value computers to millions of customers around the globe at razor-thin margins, and will be making a decent profit doing so.
The problem with hypothesizing "a decent profit" selling in volume "at razor-thin margins" is that investors aren't generally hoping to find a commodity vendor that can make "a decent profit" doing what a slew of competitors do, some of them much better and – due to advantages like lower labor costs or in-house software development – some of them do at a much higher profit. Why is Dell a compelling investment?

A compelling investment has some distinguishing characteristic that cannot readily be appropriated by competitors: it has a moat. WalMart may have a moat in its outrageous buying power or global product procurement program, which sets is apart from stores trying to make $0.20 on a $2 bag of sugar. Well, that's a bad example: sugar is often sold below cost to get people in the door for the rest of their groceries, meaning that vendors risk losing a few dimes on the sugar to get your business for wine, wrapping paper, bread, butter, fresh chicken (or, God forbid, frozen dinners), and all the spices that make your cooking palatable. WalMart puts all this stuff on its shelves cheaper so that when it sells at cutthroat prices it makes a bigger profit, allowing it to choke down on prices until competitors turn blue and expire, at which point prices can be re-inflated to a level that's tolerable to the market but frightens off would-be competitors (who can make more money risking their capital elsewhere).

And Dell? Dell is in head-to-head competition with HP which can buy all the exact same components at the exact same prices, and uses the exact same shipping companies to give customers their purchases. Dell is also in competition with the likes of Acer, which doesn't even have to pay US-based management US-level management salaries, much less pay local workers US rates for anything. And Dell can't charge more for most of its machines if it expects to sell any. It's stuck in a commodity trap. Even if Michael Dell manages to keep Dell in the black, the prospects for outsize profits seem pretty dismal. Check out Dell and WalMart against Hewlett-Packard over the period we're reviewing:

HPQ may not be an Apple, but it's got some competitive advantages (high-margin enterprise software and consulting businesses) Dell hasn't got any start on emulating. Over the period, it has at least not lost money. Maybe Michael Dell's rescue will be successful and Dell's future will be more reliably competitive in its commodity niche.

But why bother risking money for a result like that? The rest of the market hasn't.

Wednesday, February 2, 2011

ACAS Exits triVIN Above "Fair Value"

ACAS just announced the details of its sale for cash of its portfolio company triVIN Holdings, Inc. to DealerTrak Holdings. The exit netted ACAS $11m in realized gains and returned $72m of ACAS' capital for investment use. (Not just for ACAS: the results here are ACAS' fraction of an investment in which funds under management also participated. The aggregate proceeds received in Q1 from the transaction were $108m, including $19m of gain.)

Maybe "returned" is the wrong word here; ACAS never put $72m into the company. In fact, according to the immediately-prior 10-Q, the last FAS-157-compliant "Fair Value" ACAS was able to claim on the company was $56.8M. ACAS realized 41% more than that "fair value" – $15m more than the SEC's yardstick allowed ACAS to claim the thing was worth. In other words, FAS 157 had the investment pegged as a loser when it was, in fact, a winner.

Imagine that.

This isn't the first time ACAS has announced a result that suggests that FAS 157 understates its ability to generate results from investments. ACAS might do better to improve the transparency of exited investments' returns, as previously mentioned here. After all, if ACAS' list isn't updated regularly, people will suspect that it's because it's ashamed of those results.