"Racehorse" Haynes Was Right About The Old-Woman's Car

Over ten years ago I climbed out from behind a 1982 Mercedes 240-D – a two-ton Diesel sedan with four cylinders, no turbocharger, and acceleration like a snail heading up a wall. But it was reliable.* There, steps from the old Diesel, I met Richard "Racehorse" Haynes. We talked cars for a few minutes while approaching the auditorium that was our destination.

"I used to have a Mercedes," he said. An 8-cylinder S-Class coupe, as it turned out.

But ... used to? Why'd he get rid of it?

The answer was quick and clear: Mercedes makes "an old woman's car."

Fond of my own (admittedly sluggish) Mercedes, and having no firsthand experience with the Porsche with which he currently drove, I didn't have any particular argument to raise. We changed subjects: law. And given I was speaking to "Racehorse" Haynes, that conversation was amusing in its own right – but that's a different story. This tale is about the old woman's car.

The Old Woman's Car
Being a huge fan of my old Diesel, I was excited when Mercedes in 2004 returned to selling a Diesel sedan in the North American market. I bought a 2005 E320CDI the very summer it launched. I won't go into detail how my neighbors thought I had joined a car-of-the-month club (due to the machine being at the dealer's so frequently for unexpected service), or how little plastic parts in the shoulder belt assembly buzzed near my ear when I drove while trying to listen to the huge-priced sound system, or even how the car left me stranded repeatedly due to unexpected complete failure. And I won't go into the oft-imitated abomination that is the headrest, which forces one's head more than an inch forward of one's shoulders so one can't relax in the passenger seat (the E-class luxury seat had such awful ergonomics that L, who has significant anatomical and ergonomic training, preferred to ride in C-class Mercedes seats). I will just talk about the lag and sag of Mercedes' old-woman's car.

First: the lag. The 2005 E320 CDI did not offer 4-Matic. Two-wheel drive was the only option. So, when road conditions require harsh acceleration (e.g., a right angle on a road that winds so you can't see approaching traffic from either direction), great care was needed to obtain the best acceleration one could without pushing the rear wheels to the point of spinning out, then being called into check by the anti-skid system. But this was impossible due to old-woman's car lag.

Performance
Mercedes' vehicles are very carefully engineered – I asked high-end Mercedes-only mechanics' shops about solutions and learned that the problem exists all the way up to 12-cylinder sport coupe models, some of whose drivers had actually sold their hot rides in disgust over the issue – to wait a half-second before responding to the accelerator. Now, how long is a half-second? When you are carefully applying the accelerator searching for the most juice you can safely give the car in order to traverse a curved road with mere yards of visibility, and do so without losing control of the car to a rear-wheel spinout, you push until you feel the car is doing everything you need and then you let off so you can stop accelerating on the other side of the road. Unfortunately, the half-second lag means that you get nothing as you push, so you push a bit more, and a bit more, and by the time the car starts responding you have no idea what depth of accelerator push is having what effect on the car but by the time the car starts turning the rear wheels it's not moving at all, because they've leapt past the limits of their traction in a way no car ever behaved, even when driving a 440-cubic-inch engine in a car at least as heavy, and you've lost control of the Mercedes to a computer that is flashing a triangular warning with an exclamation point in it -- warning that the car's traction control system has overtaken the wheels.

And this isn't the scary part. Embarrassing yourself while burning rubber off your tires in public probably is bad enough, but its not the depth of this bad. No. The worst is that you are still at a stop sign, perpendicular to a curved road with mere yards of visibility along a road with a 35mph speed limit, but instead of being safely behind the stop sign waiting until it looks clear both ways you are now well into the southbound lane, moving about 2mph, with a flashing exclamation point to tell you that you're not yet in control of the Mercedes' acceleration.

In the ancient Mercury Grand Marquis, this never happened because the accelerator pedal mecahnically pulled a carburator valve, causing immediate power transfer to the rear wheels; you knew precisely what amount of push caused what acceleration because you felt it just as it happened, enabling instantaneous and intuitive adjustment to ensure you got just enough, not too much, and had complete control. But don't blame the computers. Mercedes' brake system makes hundreds of adjustments each second to prevent wheel lock-up during braking (as did the 1991 Lincoln Towncar, with its fuel-injected V-8, even more powerful than the Grand Marquis!), and could in the hands of a competent engineer solve all the same problems with acceleration.

But Mercedes doesn't want you to have controlled acceleration. Mercedes is an old woman's car. Mercedes only cares about stopping. Even when you buy a 4-wheel-drive Mercedes, you don't get 4-wheel acceleration every time you punch it -- you get two wheels until Mercedes thinks traction is failing, then you get a reactive switch into 4-wheel mode, which lasts only so long as Mercedes thinks you need it. I haven't bothered to test whether Mercedes' 4-Matic products are any better about getting across this intersection, but I've found the answer and it's such an elegant, fun answer there's little point to making excuses for Mercedes' broken products.

And a half-second delay in acceleration is broken. It robs drivers of control. It strands them at 2mph half into a lane of traffic that cannot be vetted for safety because the foliage and curving road make a pipe dream out of visibility in any conditions but night, when headlights might warn of traffic by illuminating the opposite side of the road from oncoming traffic. And rush hour is nowhere near nighttime. The half-second isn't required by any computer system, but is a direct result of a computer system that is buggy, sickeningly buggy, and probably drove my stroke risk several-fold before the vehicle finally convinced me it needed replacement.

Reliability
Mind you, the Mercedes didn't suck from bumper to bumper. The engine was a thing of beauty, pumping out ample power from six cylinders of twin-turbocharged Diesel engine. The power would have been much more appreciated, especially at the low end where Diesels have so much torque, if the accelerator lag didn't make it basically uncontrollable unless you drove like you were on your way to Church on Sunday along roads marked only with high-visibility stoplights as traffic signals, so you could trust that at every intersection it didn't matter when you moved or how quickly because you relied implicitly on the safety created by your legal right-of-way. God forbid that some municipality install a stop-sign that required you to wait until judgment and observation were required to assess safety, or that the stop was anything but an all-way stop.

The power of the engine could be felt not only in the acceleration, control of which was usurped by computers whenever lag made it impossible for a human to assess, but even driving. For example, one day I felt a vibration akin to a rumble-strip while slowing to a stop on a freeway access road. I checked, and I was nowhere near the road edge. But as I slowed, so did the frequency of the rumble, until at idle it was a slow procession of little bumps. The light changed and I touched the accelerator -- and felt the pace of the rumble strips speed.

I've seen cars that had plastic bits hanging into their wheel wells, and I've seen cars dragging parts, and I've seen all kinds of things. And this particular car had been in the shop so often with weird and intractable suspension issues that caused all kinds of clicks, bumps, and other strange noises and feelings that I frankly could imagine just about anything. Within a half mile, I had to stop: the vibration became so heinous, and the noise so awful, that I could not be reassured by the voice on the tele-aid system that there was no problem. There was a serious problem, and it was getting worse. I will save you the troubleshooting nightmare and cut to the chase: two of the engine's three (sophisticated, vibration-isolating, liquid-filled) engine mounts had failed. Basically, the engine was being held up from falling into the street by forces being exerted on the transmission. Without warranty, the repair would have been thousands of dollars. This was at about 50K mi, when factory warranty would have just expired. They say extended warranties are not a good buy, but let me tell you: don't own a recent Mercedes without one.

Undrivability didn't require 50k miles to materialize, though. Before 1K, the thing died within a block of home with no explanation, and I found myself pushing it backward out of the intersection in which it had halted. Mercedez-Benz of Greenway Plaza carefully inspected the car and pronounced it cured, but when I went to pick it up, it died the exact same way on the valet. Apparently, dealer-added security technology didn't play well with at least some of the car's numerous built-in computers, which went on strike at odd and unpredictable intervals. Eventually Greenway Mercedes removed the gear and replaced it with LoJack Early Warning, which I do not recommend unless for the insurance discount; it's a long story, but LoJack won't tell you where the car is, and Houston Police Department (to which LoJack will refer you if you call looking for your car when a tow driver drops it in an unknown location in Houston) will transfer you numerous times before you finally realize nobody at HPD has any way to obtain the location from LoJack, either. See, LoJack won't find it for you, only for the police; and the police expect LoJack to help you because finding your car isn't their problem and they've no idea who to call to get a car located with LoJack. But the insurance discount is real; price it, compare it to the LoJack product, and make a business decision. They will never find your car (the owner of the lot where the car is dumped will help you on the next business day), but the insurance discount will come like clockwork.

The clicking and bumping that occasioned slow turns on smooth pavement was an interesting lesson in maintenance. Either Greenway Mercedes lied about replacing all those suspension parts, or Mercedes' suspension parts are horribly short-lived. But there is a third option: Greenway Mercedes is incompetent, and misdiagnosed the problem repeatedly, replaced a part unrelated to the issue you demonstrated over and over after they said they'd fixed it, and kept charging Mercedes for warranty work. Actually fixing the problem would be to kill the goose that was laying the golden service eggs, no? Much better to run you and Mercedes in circles. But I conjecture. Other Mercedes-certified mechanics were shocked to hear the lengthy story of my suspension woes with the 2005 E320 CDI, completely disbelieved that Mercedes would build a product so frequently failing, and suggested in no uncertain terms that the folks at Greenway Mercedes might not be the biggest crooks in the country, but were probably the biggest crooks west of the Mississippi.

So I started having its many warranty problems handled by the evidently more competent technicians at Alex Rodriguez Mercedes. These gentlemen will bring you your loaner, swap you your car, and bring you yours back fixed – all on a schedule you agree in advance. You never have to sit in a waiting room, fight traffic, suffer scheduling problems and so forth just because you had the bad judgment to believe that because Mercedes could build an outstandingly reliable car in 1982, it would surely be able to build a reliable car in this century. Let me save you some trouble: they've completely forgotten how. But if you live anywhere near the Johnson Space Center – the place Man first tried to reach when it spoke those first words back from the surface of the moon and uttered the word "Houston", but which is too unimportant to be allowed to display any of the Space Shuttles it successfully guided into space and back – I urge you to rely on Alex Rodriguez Mercedes-Benz. They can't make the car more reliable, but they'll make you much happier while it's being maintained.

One fine day I made an appointment for A-Rod Mercedes (as they call themselves) to look into why my stereo had quit working. This was a pain for me; I like music, which is why I paid a fortune for a plussed-up sound system. I wasn't exactly surprised that it had failed; I'd had the "Command" system (which includes the plussed-up sound system controls) crash repeatedly, including while I was depending on it for maps in a strange town while under a deadline, and remain broken and unbooting for days at a time, but this time I was determined to show a competent** technician the problem so that it might finally be diagnosed and fixed. After years of this kind of mistreatment, I was determined to have it solved before the extended warranty ran out. So I explained that I had a non-emergency problem, I wanted a loaner, and I was scores of miles away. A-Rod Mercedes' friendly service advisers set me up with an appointment to have a loaner delivered the very next Monday – less than a week away – so they could sort it out with minimal inconvenience.

A few other things associated with the Command system died over the next couple of days. I assumed it was an expansion of the audio problem; the radio, the auxiliary input I used for an iPod, the mapping system (which has a voice component), all became unresponsive. Still, the Mercedes' broad array of potential text messages available to warn the driver about everything from upcoming maintenance to impending engine calamities lay silent, suggesting that nothing particularly critical was amiss, just another audio-related bug. So on Friday – three days before the Monday loaner dropoff appointment – I don't expect serious trouble when I get the car loaded with people for a little outing. Everybody is in the car, everybody is buckled, the garage door is open, and I move to turn the key.

Nada.

A red backlight emphasizes the message that there is a malfunction. But since it's not even trying to turn over, I know damned well there's a malfuction. And I call A-Rod, who promptly sends a flatbed to haul off the dead husk of the "powerful" Mercedes. Diagnosis? For over a week the car had been slowly shutting down "non-essential" systems out of concern over a "dying" battery. One would think that if the car were at the point of deliberately killing non-essential systems in anticipation of failure, it might send me a little note that failure was at least foreseeable. But no, I got stuck for the Nth time by the "new" Diesel, which disgusted me mostly because I had come to Mercedes' defense so many times when explaining how the "old" Diesel had withstood so much for so long. (And still does: everything but the crummy A/C system runs like a champ, and the A/C system is just hopeless because it was designed by people who live in a country where A/C is an option and not a necessity in a roadcar. New Mercedes A/C systems were designed by a team Mercedes sent to Arizona not to come back without an A/C that could be sold in the South with a straight face. So the new A/C is very powerful but assumes that it's being used in a dry desert, and so promptly fills with condensation in the swamps of coastal Texas and thereafter, following an incubation period, gives off a persistent and nasty mold smell that dealers pretend is not a systematic problem even as they cycle through a long list of imaginative fixes that plainly reflect substantial post-development engineering resources, but none of which work. Short term, your dealer can kill it with harsh treatments that leave the car smelling like a chemical plant, but long term it all just grows back.)

So I asked about this "battery failure". The Diesel has, after all, two big-assed batteries. Oh, I'm told, they both failed. Ahem. Both? At once? I'm thinking its the recharging system; one of the batteries had just been replaced less than a year before. Haha, that battery will be replaced under warranty, but the other one will be about $400. I search online, certain I can find a better price, but I can't: the online price for a comparable battery is actually worse than I am quoted by A-Rod Mercedes. The thing is huge, uses cutting-edge technology to produce enormous cold cranking amps, and just can't be had for cheap. The alternative is that I can't start my car; so I shell out, dubious about the charging system and about the battery life and about the reliability of a car that knows it's failing but chooses to keep the fact a secret even while shutting down ill-designed electronic subsystems I assumed were falling to crasher bugs I'd previously seen.

So I start looking for a different ride.

Trading Three-Point Stars for Four Rings
And let me tell you what fun that new ride is. With approximately the same engine displacement, the 6-cylinder 2008 Audi A6 Quattro*** has comparable interior room, a trunk that's vastly bigger even than the 2.5-corpse trunk of the Mercedes, and full-time four wheel drive. This is a huge win. You want to cross an intersection, the car doesn't lose traction then claw to get it back: it uses all four wheels to get you across with no perceptible loss of traction.

You are at full speed on the freeway and some nutjob thinks it's a good idea to swerve directly into you? The Mercedes was controllable at speed, to be sure. You turn the biiig leather wheel and, dampened beneath a fortune in ground-insulating suspension, the front wheels turn and lean on Mercedes' peculiar front-end control system and the car – driven against the front tires by the rear tires' answer to the call of the relentless Diesel – is pushed sideways out of harm's way while you rely on anti-skid technology to protect you from the risk of strange traction issues on the freeway. Once in your new lane, the Mercedes settles down from the swaying induced by the little duel between the turned front tires and the pushing, ever-pushing rear wheels. And then you're back in the bank vault, insulated from the world, safe.

The same incident passes quite differently in the Audi Quattro. You pull the wheel with the same force – part fear of the near-wreck, part anger at the risk caused by the idiot coming your way – and there is no swaying left-to-right, no conflict front-to-back, no post-lane-change settling-down period. You turn the wheel and the Audi doesn't grudgingly agree to change lanes only while grumbling about what an imposition it is to be asked.

Instead, the Audi leaps with excitement, thrilled to do your bidding, ecstatic that you've asked it to do something more interesting than keep straight-on between an endless series of dashed lines. The Audi's all-time four-wheel drive pulls you where you want to go, ignoring road oil, rain, debris of other cars' shredded tires and shattered fiberglass, and eagerly awaits your next command – its next fondest wish. Sure, the Diesel in the Mercedes has more torque and feels like it's got more raw power, even though the Audi's gasoline engine has much more listed horsepower, but most of us aren't in a roadrace and are unconcerned with track times. What we want is to know what it feels like.

And in the Audi, I feel in control. Not worried about unexpected equipment failures. Not worried about lag in reacting to emergency commands. Not worried that the maps will quit while I'm in a rush in a strange place. Not worried even that the buzzing of Mercedes' plastic parts signifies other overlooked details with safety and reliability implications that will bite me, hard, in the back when I am most vulnerable. In the Audi, I am not worried at all about the car failing for any reason to perform exactly as I demand. And that security, and that control, represent the kind power I care most about.

* Except the A/C. Well, that was reliable too I suppose – it reliably sucked.
** Competent technician in this circumstance means a technician qualified by the absence of any relationship to Mercedes-Benz of Greenway Plaza.
*** After the value fiasco I had with the new Mercedes, I was gun-shy about buying new. In 2004, the '05 was the only recent-generation Diesel to buy from Mercedes, and my personal history with cars was to keep them longer than a decade so I didn't really have a lot of concern about resale value. Never having owned an Audi, but liking the reliability and performance implications in a firm able to take 1st, 2nd, and 3rd in a grueling long-distance torture event like LeMans (in 2010; in 2011 they took 1st after losing their other cars to crashes while overtaking slower Ferrarris, for the tenth victory in twenve 24-hour races), I thought buying used would give me an opportunity to try one out for a few years to see it if treated me like I expect a car ought.

ACAS: NAV Up Again In 2Q2011

American Capital announced its 2Q2011 quarterly result, and the result is more of the same: secured debt decreased ($100m repaid; ACAS has a debt:equity ratio of 0.4:1), and net operating income increased (to $71m, 145% above the year-ago quarter). But this is not the metric that most interests me as ACAS recovers from the liquidity crisis that crushed the valuation of its portfolio assets and share price. The single metric that most impacts my assessment of ACAS' recovery is the increase management is able to achieve in net asset value.

This quarter, management increased NAV to $13.16, up 10% from $11.97 in 1Q2011 and up 44% from $9.15 in 2Q2010. This valuation increase still shows some undervaluation in assets, though: ACAS claims the value of its investment in ECAS is $933m, though the value of ECAS' assets (over which ACAS has complete dominion, just as it has dominion over ECAS itself) is $1.035B. (Note that the gap between asset value and ACAS' claimed "fair value" is decreasing; it's just not yet at parity.)

One might try to draw some conclusion from ACAS' realized losses and compare them to ACAS' unrealized gains. A familiar meme among critics and a repeated question in conference calls is whether ACAS is selling its winners to look good and getting stuck with a portfolio of losers. The fact that ACAS is able to achieve $179m in realizations is nice, but the fact that this resulted in a realized loss of $177m strongly suggests that ACAS is reclaiming unproductive capital from investments whose thesis didn't survive the crash and isn't sticking investors with dogs in the name of making a quarterly number. The realized loss is a decrease from the year-ago quarter, but ACAS realized a gain last quarter. Which brings us to ...

... what games ACAS might be playing with its books. As suggested by management previously, ACAS has just announced that it had, or by the deadline would have, failed a RIC test. Intentionally failing a RIC test was one of management's schemes to roll forward operating losses whose value would otherwise be lost to ACAS and its shareholders. Losses are a tax asset: they offset taxable income. Losing the loss would really suck, and the failed RIC test preserves the perishable asset for next year. Management said at the same time that it expected to meet the RIC test in the future: this is a tax planning stratagem, not some kind of business failure. What does that mean? ACAS may be accelerating losses into this year when they are available so that it will make the most out of its carry-forward opportunity. We usually get an opportunity to see how the quarter's business has affected the portfolio mix, but there's strong reason to doubt that with investments as illiquid as ACAS', there's a lot of power to move the timing of deals in a transaction pipeline. I don't think we'll see that the quarter's business has really changed the overall numbers for the whole ACAS portfolio, even if ACAS management were trying to rush losses and working to bargain up gains in a way that would slow their transactions into a later reporting period.

The quarterly announcement discusses things like unrealized appreciation (can't complain about $587m in unrealized appreciation, can you?) and net earnings ($410m), but these things don't affect its eventual obligation to pay a dividend on resumption of BDC status (that is driven by taxable income, not SEC-reported "earnings"). For the time being, the metrics that have my attention are NAV (what the company is worth) and NOI (what the company earns without swapping assets around). The NOI increase has definitely shown the increases I expected following the debt restructuring, and I look forward to viewing it as a barometer of the success of the company's portfolio companies.

With respect to the NAV and NOI, ACAS has one strategy that has bourne some interesting fruit. Over the last year, ACAS has grown assets under management not only by holding them while value recovered, but by having controlled companies issue equity to new investors. American Capital Agency's issuance has been accretive to shareholders of AGNC (i.e., has raised AGNC's NAV at each issuance), and has boosted ACAS' assets under management – and thus ACAS' management fees, a source of NOI. Whether the public has an appetite for shares of American Capital Mortgage Investment Corp will determine whether ACAS can use MTGE to effect more of the same.

The breadth of the portfolio companies' business across industries and geographies makes it sensitive to broad macro-economic conditions, which is why management's prediction of success bears the qualification "if the economy continues to recover." I think long-term bets are in favor of recovery, and especially as ACAS has 0.4:1 debt:equity and is no longer in debt covenant default, there's very little reason not to regard ACAS as a long-term investment. Indeed, I bought some during the quarter for my niece. This is the niece whose mother sold the AAPL I recommended ten years ago, because her broker told her it had already moved up. This ACAS purchase is an account I won't be handing over to my sister's broker.

See you next quarter :-)

Apple Profit Share Revisited: Phone Revenue Rocks

As previously discussed (regarding both notebooks and smartphones), Apple's profit share exceeds its market share. This is a result of choosing to compete in market segments where it can command a premium, and ceding undesirable share to commodity vendors.

Recently, asymco's Horace Dediu reported on vendors' profit share in the mobile phone market. According to the article, Apple holds 2/3 of the profit among carriers with substantial market share. The asymco graphs drive this home nicely, with Apple's widening wedge of profit share squeezing everyone else into a shrinking slice of the available profit. The good news for these vendors is that in a growing market, they can still theoretically make a profit.

Of course, Motorola – whose leadership said that making cell phones was hard, and that Apple was not going to succeed as it imagined – has been pushed pretty much off the bottom of the graph since then. And the history of other handset manufacturers who tried to use Microsoft's platform in phones hasn't been much better. Apple's success hasn't been what Apple said it was hoping to achieve – 1% of the cell phone market – it's been much greater. There are complaints to be brought against Apple's products, to be sure – and these will increase in volume as Apple's success grows – but so long as Apple's products are so attractive to users we should expect to see

And You Thought Using MSFT Products Was Bad Enough Already

You might have thought that Microsoft's customers had enough to worry about with bloatware, viruses, undocumented file formats, vendor-lock-in, unexpected network activity of word processors (for example, MS-Word opens network connections to phone about the LAN to see what license numbers other copies of MS-Word are using), and other irritations from the products themselves. New Aptiquant research suggests (as discussed on CNN) that there may be a problem with Microsoft's customers themselves: its Internet Explorer customers are reportedly also less intelligent than average.

Apparently Microsoft has had trouble getting customers to upgrade off broken and obsolete browsers it no longer supports, suggesting that there may be something to the thickness of Explorer users. Of course, with Microsoft seemingly unable to keep its own systems patched, maybe the issue is something one catches from the products ....

iPad : Tablet :: iPod : MP3 Player

Another tablet launches, and hit-hungry web "journalists" ask breathlessly whether the iPad is finally done for. According to AllThingsD, the newest HP tablet uses an LG display akin to that of the first-generation iPad and lacks a GPS, allowing it to trim cost to $306.65 for the version it retails for $499. Electronista reckons that this puts HP's current product's parts costs (not including marketing, assembly, licensing, etc.) at $17 less than that of the iPad2. The device is a bit thicker, lacks the breadth of available applications, doesn't support HD video capture, hasn't got a rear camera, and the top user review at cnet reports the device "freezes often [but] otherwise [has a] nice interface". But the most damning indictment of the new tablet isn't something one can cure with a product refresh: it isn't an iPad. John Paczkowski of AllThingsD went beyond JadedConsumer's previous comparisons between Apple's iPad strategy and its prior success with the iPod in declaring that Apple has already succeeded in redefining the tablet product category to the point that consumers want iPads (instead of "tablets") in the same way they began shopping for iPods (instead of "MP3 players").

If Apple's steady state in the iPad market – ahem, sorry, the tablet market – comes to rest north of 70% as it did with the iPod mark– so sorry, I meant the music player market ... then Apple will be sitting pretty on a high-margin and huge-growing consumer segment with international appeal. And Apple's tech is uniquely suited to meeting international demand by supporting international needs of developers. The things that made Apple's iPhone easy to sell internationally make its WiFi and 3G-capable tablet-market-redefining iPads a cinch for international sales. DisplaySearch's forecast suggests Apple's touch screen supply control will leave it in control of the tablet market through 2011. Control of the tablet market didn't mean much a few years ago, but since the launch of the iPad the segment is looking to eclipse notebook computers in worldwide unit volume, according to UK researcher Canalys – with every two tablets costing notebook makers a unit of lost sales. So strong is this trend that Gartner has lowered PC growth forecasts based on tablet cannibalization. Counting tablets as PCs as Canalys does, Apple has grown the market and has become the fourth-largest PC vendor by worldwide unit volume.

I've got a friend who's never synched either of her family's iPads, and a few months ago I sat agape wondering what century she lived in. Yet, with the iCloud announcement, Apple has signaled the view that she isn't expected to, need not be inconvenienced to do so, and should never have to bother to do so except wirelessly from the device itself. Between Apple's online application store, cloud services, and computer-free device synching, Apple stands to improve the stickiness of its products and the value they offer customers in the form of convenience.

Apple is owning this market.

Apple: Still Ripening

After passing Microsoft in market capitalization, then in revenue, Apple has finally passed it in quarterly profit. This comes not in some quirk of seasonal doldrums or in the wake of some unusual charge-down, but in the very quarter Microsoft announced solid quarterly profit buoyed by record expansion of its server and tools business segment. Apple's profit – and MSFT's struggles in Windows OEM licensing (MSFT's profit surge was attributed to the Office franchise, not the the company's Windows division) – appear directly related to Apple's success against Microsoft's offerings in the netbook space. In a related move, Microsoft launched ads seeking to compare Apple's MacBook Air to underpowered Windows netbooks that are being crushed by iPads.

Netbooks aren't Apple's only success. The iPhone business has been cleaning up. In the United States, Apple's share of the smartphone platform market (as measured not by new sales, but by subscribers) was up about half a percent from 25% to 25.5% over the period Dec'10 to Mar'11, but its share of hardware share of all mobile subscribers gained 1.1% of the entire market, from 6.8% to 7.9% (a 16% gain from its position at the end of 2010). Other vendors sell some non-smartphone products, but Apple does not: as the market heads toward smartphones, it grows Apple's addressable market. Over the period, Apple gained on RIM, which lost smartphone share (from 31.6% to 27.1%) but due to shifts toward smartphones, lost only a tenth of a percent in the broader mobile hardware market.

One can look out into the future and wonder what effect some of the major competitive trends will be – whether "free" operating systems will really place hardware competitors in a position to compete with Apple on margins, or whether control of the OS will allow Apple to capture post-sales revenues that otherwise would be lost to the hardware vendors – but the near-term has a pretty clear outlook: Apple is trouncing the competition. Not by lowering prices in a bid for short-term share, but by raising quality to capture the most premium segment of a growing market. Very nice.

ACAS 1Q2011 Earnings Announcement: What It Suggests

ACAS has done it again: rather than succumbing to a dissolution in bankruptcy, it's announced another profitable quarter (presentation materials here).

First: the NAV. ACAS closed the quarter with a NAV of $11.97, up $1.26 (12%) from the prior quarter and $2.99 (33%) from 1Q2010. Honestly, this is better than a dividend: you get to defer the income until disposal.

Second: NOI. NOI isn't where ACAS gets most of its money, but it tells a story about the interest income ACAS earns and the success of operations that, due to the consolidated accounting that occurs at ACAS by virtue of its >80% ownership of its control investments, flow straight to ACAS' bottom line. NOI of 23¢ per share is up $0.04 from Q42010, and "includes ... $0.04 ... of non-recurring income related to the removal of investments from non-accrual status." (presentation, p.3) So, NOI is stable except that its non-accruing investment picture has improved over the quarter. Assuming that non-accruing investments going off non-accrual status means future investment performance, this is not really non-recurring in the sense investors care about: it's a prospect for better future performance.

The third thing is realized income. This number is quite different from SEC-reported income, because that number includes things like unrealized appreciation and other factors that readers don't think about as income. It's a useful metric at a Business Development Company because it drives the obligation to pay dividends. The prospect (obligation) for a dividend is looking clear out in the future: with $0.22 in net realized earnings over the quarter, ACAS is building a record that (when its tax loss carryforward has been exhausted) will lead to a dividend-paying requirement. And not a bad one, either.

During the quarter, ACAS paid down $517m in debt, including $300m in secured debt not due to be paid until 2013. The debt-to-equity ratio of 0.4:1 gives ACAS more freedom to do creative things going forward, as it hasn't got the noose of lender veto hanging over its fundraising and financial transaction structuring options.

The $269m in cash realizations show that ACAS is still liquid. Also, it's not involved in a series of equity fire sales: $206m came from principal payments. The exits, as usual, had little impact on overall portfolio characteristics; management offers a table to this effect on page 11 of the presentation materials.

What's ACAS doing for new investments? Slide 10 is educational: ACAS invested in three portfolio companies and provided another $97m for European Capital. ACAS is investing where it understands the business. The distressed opportunities ACAS is pursuing aren't easy to see from the high-level investor presentation (acquisition by a portfolio company?), but I like to see distressed opportunity investments. I'd like that more than the debt pay-down, frankly, though the debt pay-down may be a prelude to late-in-the-year transactions designed to obtain value from soon-to-become-worthless operating losses. I can imagine a structure in which shareholders exchange shares of old-ACAS for shares of new-ACAS that contain the exact same investments but some extra cash, while old-acas merges with a company that can use operating losses and deducts them. There's quite a bit of transaction cost for something like this, but if there are enough millions for someone to make, the transaction cost will be easily worth the price of admission for the buyer. The rumor that GE Capital is interested in ACAS is less interesting than the details of management's current hypotheses regarding mechanisms by which to glean value from the loss carryforwards.

A look at ACAS' loans on non-accrual (p.6 of the presentation) shows that past-due loans at cost have plummeted. ACAS' loans are either on non-accrual, or they're paying on time. The now-nearly-binary nature of ACAS' loan performance (Performing? Y/N) helps us assess ACAS' loan portfolio performance a bit. ACAS has $3.4B in loans at cost, of which 0.7B are on non-accrual. The non-accrual loans represent a bit less than were reported last quarter at cost. This may be a number to watch; non-accrual loans that begin performing again are a potential source of future value. This quarter, loans coming off non-accrual were worth 4¢ per share, for example. I'd like to hear what management says about the extent of this possibility.

Years ago, ACAS' management used to harp on conference calls about how the market should be valuing the company as an asset manager rather than as a heap of assets. ACAS has been working to grow assets under fee-based management – first in private funds, then in ECAS and AGNC – and although ACAS took ECAS private, it's had AGNC issue quite a few shares (in accretive, above-book-value issuances) and appears set to launch a new public fund under the symbol MTGE. Currently, ACAS' $6B in assets are being dwarfed by $37B and growing assets under management (presentation, p.24). Between AGNC and MTGE, the managed-assets column will be almost all mortgage investments. What that tells the Jaded Consumer is that ACAS is getting a lot of mileage out of its mortgage investment team. Raising the deal size is a way to better leverage the same research and market-modeling costs. Management fee doesn't scale with head count, but is linear with net assets. Every above-book issuance at AGNC is a pay raise at ACAS.

Upshot? Until the dividend resumes, I think the NAV tells the story. And that story is good. I really don't want the buyout-at-$15 rumor to be true, I want a few more quarters of this kind of NAV increase. More than a few.