1-2 Knockout

Wall Street Analyst Immortalized with New Opera

Confessions of a Wall Street Analyst author Dan Reingold (the Luke Skywalker to Jack Grubman's Darth Vader) has been given arguably the biggest honor that any 'Streeter could ever hope to achieve:  his life's work made into an opera, Das Reingold to be preformed by the famed New York Metropolitan Opera.

In a story "traversing the realms of nymphs (uh...), dwarves (Grubman), gods (Weill), and giants (Ebbers), the Opera highlights all of the seemingly-unbelievable details of the life of the former star telecom Analyst.

Das Reingold shows in March and April, 2009.  Tickets go on sale this August at www.metopera.com

I'm Moving to Guatemala

Not that this is news to anyone who, uh, actually reads the news, but the two men running for President of the U.S. are, how to put this gingerly, economically retarded.

Karl Rove did a piece in the WSJ yesterday, calling out these two pandering politicos on their blatant b.s., the most painful example of which may be the idea of taxing "windfall" profits (of course, avoiding any discussion of what, exactly, constitutes said "windfall".  Not to go off on a rant here, but wtf is up with the wind references, "windfall", "headwinds", etc?) 

Rove accurately points out that margins for the current corporate pariah du jour, oil/energy companies such as Exxon Mobil, are amongst the slimmest in any industry.  So, if these populism-promoting politicians aren't defining windfall profits by margins, they must mean by sheer size, right? 

Wrong. 

It's not the profit margin, but the total number of dollars earned that is the problem, Mr. Obama might say. But if that were the case, why isn't he targeting other industries? Oil and gas companies made $86.5 billion in profits last year. At the same time, the financial services industry took in $498.5 billion in profits, the retail industry walked away with $137.5 billion, and information technology companies made off with $103.4 billion. What kind of special outrage does Mr. Obama have for these companies?

It's one thing when the most liberal senator on Capitol Hill blabbers incoherently about things which he clearly does not understand (as a matter of fact, its pretty much par for the course, no?), but when a so-called "Regan Republican" like John MCcain allows himself to sound similar ignorant, its a sign that we're all in serious trouble.

This past Thursday, Mr. McCain came close to advocating a form of industrial policy, saying, "I'm very angry, frankly, at the oil companies not only because of the obscene profits they've made, but their failure to invest in alternate energy."

So yea, about the title of this post.  I'm not kidding.  When the next leaders of the free world (ha!) not only say stupid things, but I fear, will actually follow their rhetoric with action, bad things will happen.  Very bad things.

Gas Prices Are WAY Worse Than We Thought

Receiving little, if any coverage in the media are the horrific effects high gas prices are having on the country club set.  In hindsight, this shouldn't come as a surprise, considering that the average vehicle in any country club parking lot probably gets somewhere around 10 miles per gallon. 

Anyway, things are so bad that Callaway, maker of such legendary products as the Big Bertha driver,  has resorted to offering customers free gas cards when they purchase a new sledgehammer driver. 

I'm sorry folks, its one thing when drab automaker du jour, Chrysler, offers gas cards when people buy their cars (or whatever they sell these days), but golf clubs?  Callaway?  I mean, does Congress know HOW BAD IT REALLY IS, or, do THEY HAVE NO IDEA??????

Taken at Sports Authority, 6/19/2008

Random Musings

Looking at Iowa this week I have to ask: why on earth should we expect Mother Nature to provide any more energy security than “imported oil/energy”?

Last time I checked you could at least bribe, invade, or otherwise coerce “despotic”, “unfriendly” regimes; the weather, not so much.  If we are to actually believe that Global Warming is the end of the agricultural system as we know it then it’s probably not the brightest idea to rely on farms for providing our food and energy.   With 30% of this year's harvest going towards not making it onto plates or cars this ethanol "plan" is probably not our finest policy decision...to say the least.

The Apple Ad That, uh, Never Quite Made it

(Mis)Adventures in Myopia

We're all supposed to 'know' that investors are myopic, that they tend to focus on the present and very-near future while ignoring the long-term.  While this may be a convenient assumption in modern finance, it behooves the prudent investor to look beyond the 'now', so-to-speak, beyond the hype, to find attractive long-term investment success.  Unfortunately, this approach seems to be about as popular as Nick Hogan at a MADD conference.  The sheer amount of evidence is staggering, but I'll keep it light and let Bloomberg do the work:

Retail sales in the U.S. rose twice as much as forecast in May as Americans snapped up electronics, clothes and furniture, evidence that they aren't hoarding their tax-rebate checks or using them just to pay for gasoline.

``It's just amazing -- the American consumer's resilience in the face of everything negative,'' Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh, said in an interview with Bloomberg Television.

Yes!  Long live consumer whoredom!  Maybe we can spend our way out of this 'recession' after all, no?  Hell, the S&P Retail Index is off its year lows (although well-below its highs), and, as Bloomberg points out, retail sales were up TWICE as much as expected!!!  The rest of the article above takes this tone, that the worst of our problems are already behind us.  But, lest we prematurely jump to any conclusions, the very last paragraph reminds us of that which so many seem to be overlooking:

The bulk of the tax rebates will probably be spent from July through September, giving third-quarter growth a lift, before the economy decelerates again in the last three months of the year, the Bloomberg poll also showed.

Oh.  So they're saying that, Aeropostale isn't going to keep increasing same-store sales 20% every quarter? That people are going to have to decide between filling the tank in their Escalade or buying a new XBox?  HOGWASH!  I bet next you're going to try to tell me that defaults on auto and other consumer loans are on the rise, ha!  Rubbish!

And so, sarcasm aside, despite what by all measures is an inevitable storm of difficulties for the economy - especially the consumer discretionary sector - the S&P is already up almost 10% from the lows reached only 3 short months ago.  It seems daily, the so-called pundits, experts, and talking heads in the media are trying to convince us that the worst is already behind us, that the economy is strong.  It is certainly possible that we may be further along towards absorbing the negative affects of the subprime mortgage fiasco, but we've only begun to scratch the surface of the secondary and tertiary effects of a slowing, or receeding economy.  Trading in November, 2008 CBOE Volatility Index (VIX) options strongly support this thesis, as there is massive open interest all the way up to $37.50, implying that some market participants are seriously hedging their bets (or betting outright) should things tank over the next 2 quarters.

It seems, especially in the retail and discretionary sectors, that results have been heavily influenced by the receipt of tax refunds and "stimulus" checks.  While most of the relevent data has yet to come out, early indications suggest that consumers were spending more of their "free" money at the malls, instead of paying off their ever-increasing debt load.

Higher commodity and energy prices, ever-increasing consumer (and government) indebtedness, and a generally downward turning business cycle do not bode well for the state of the U.S. (nay, Global) economy in the itermediate-term.  Unfortunately, it seems that our human nature (or the nature of crowds), the predisposition towards unbridled optimism - even in the face of mounting evidence to the contrary - has been, and will continue to overpower logic and reason. 

Only time will tell, but as I write this and overlook the menacing clouds hovering over the East River, I can't help but think of the storm cloud of consequences from our irresponsible and short-sighted decision-making, threatening the economic well-being of the entire Country as a whole.  Hopefully I'm just letting my predisposition towards cynicism get the best of me, but until I see substantial evidence that my worst fears are only that, I'll be cautiously taking the other side of your long America trades. 

Disclosure: Anal_yst is short Aeropostale, but really long America (at least in heart, but less in portfolio, or something).  Anal_yst is not a creative writer (clearly).

NBC Does Something Right

Just in case you were about to go put a bullet between your eyes because you'll be at work during today's continuation of this year's amazing US Open, 1-2 Knockout is here for you.  Without further adu, the live simulcast from NBCSports.com.  You can enjoy it all day here at 1-2.

Update:  Apparently I spoke too soon in saying NBC "did something right".  Their stream is extremely slow and the AV sync is way off.  Go to www.usopen.com for some cleaner video.

Taking Satire to a Whole New Level

We at 1-2 Knockout dabble in sarcasm, occassionally toying with satire and other witticisms, but its usually limited to words.  These folks have taken it to a completely new level, and if for nothing else, deserve a pat on the back.  Presented without further commentary:

The Official Website of the Predatory Lending Association

Said Nextel, "Let Them Eat Cake"

Over at tech uber-blog Engadget, there is an interesting story that Sprint/Nextel waived early-termination fees (the other ETF) for Government employees/agencies.  This is especially interesting, since Kevin Martin, chairman of the FCC is trying to push the mobile carriers to come to some sort of agreement to chill out with the ridiculous ETFs.

Thats all well-and-good, and I'm sure theres some yet-to-be-explored angle there, but I'm more interested in the discussion that followed in the comments section on Engadget.  As could be expected, many decried the CRAZY early termination fees as usurious extortion by the carriers.  Some tried (and failed) to kind-of explain, but even the most 1/2 hearted attempts fell on deaf ears.  I also tried (and failed) to lend some reason to the debate, but the kind folks at Engadget refuse to recognize my logon/password, even though I copied it directly off the automated confirm sent to my email when I first signed up.  Alas, I shall not be ignored!

I put together a quick & dirty (spreadsheet ) to illustrate a simple example of the cell phone retail business model, but to summarize, it goes something like this: 

• Step 1. Subsidize cost of phone (i.e. sell as loss-leader)
• Step 2. Amortize the loss/make $$ by locking customers into long-term contracts.
  • Step 2.5. Charge mucho dinero to customers for walking away from said contracts.

Now, some people have a hard time with these fees, which can be as much as $250 (if not more).  My first reaction is generally somewhere along the lines of, "READ THE CONTRACT BEFORE YOU SIGN (idiot)."  Of course, we all know the average person's ability to read (nay, comprehend) contracts is not so good ("hey, who wants a no-doc, stated-income jumbo option arm mortgage?"), so this response is pretty much a waste of breath. 

In reality, people need to understand that they simply cannot have their cake (i.e. affordable handsets) and eat it too (no/low early termination fees). Thats just how the world works.  Deal with it.

In this example, I assumed a 2-year contract period, on which the carrier takes a loss (subsidy) of $200 on the handset at purchase, a contract costing $50 monthly, and an annual interest rate of 9% (semi-arbitrary).  The NPV to the carrier over the life of the contract is about $900.  However, if there we assume a hypothetical situation where there is no early-termination fee and the customer were to cancel after only 12 months, the NPV drops down to about $375, almost a 60% drop in profit.  To the layman, this may seem silly, as the company is still 'making a profit', but that only captures a small part of the picture, running a mobile communications company is an awfully expensive proposition.  Thus, the "profit" generated by long-term mobile contracts enables the company to conduct business, that is, it doesn't simply trickle down to the bottom line uninterrupted.

We'd be delusional, of course, to expect every Joe and Jane Doe understand the complex business model of a wireless carrier, and we'd be similarly delusional to expect the fervor surrounding early-termination fees to die down any time soon. 

Lets assume that the FCC and the carriers come to some sort of agreement limiting the ETFs, avoiding the possibility that Cox & Crew will bow to the anti-capitalist cries from the masses and mandate they be eliminated entirely.  How, then, will the carriers account for the increased uncertainty of future cash flows from service contracts?  One thing is certain:  The carriers are absolutely not going to roll over and play dead.  I'd imagine they'll play ball, so-to-speak, and give up some restrictions on early-termination, but where they're losing money (and the attendant certainty of that money) they'll make up for it elsewhere.  I'd expect they'll keep up with the practice of heavily subsidizing handsets as their main sales driver, and reducing ETFs should definitely increase sales, as people can upgrade their phones more often. 

Its important to keep in mind that not only are the carriers losing out on previously-certain future cash flows, but they'll also suffer a hit to their gross margins as higher handset sales directly increase their CoGS.  To offset this, I'd expect the carriers will increase the cost of service contracts to even-out the PV calculation, and changing the structure (i.e. tenor) of the service contracts they offer.  I think the most obvious solution is that there will be a shift towards 1-year contracts, reducing the likelihood that a customer will switch carriers or upgrade their phone before the contract expires. 

Of course, the trade off is that the shorter-duration contracts will most likely cost more per month than the traditional 2-year variety, but as I said, you can't have your cake, and eat it too.

Welcome to Economics 101, n00b

Every now and then I read something so obscenely dumb, I can't help but respond.  This was one of those times:

DJ Mark to Market: How Much Would You Pay For an iPhone?

By Jim Murphy
A DOW JONES NEWSWIRES COLUMN

...For those readers who don't remember it, the iPhone initially cost $599, but
Mr. Jobs is not concerned about a backlash from existing iPhone customers,
disappointed that they paid significantly more for their cell phones than
future users, the WSJ reported. "This is the way the technology markets work,"
he said.

This is not a revolutionary thought: People should be charged what something
is worth, not whatever the highest possible amount of money the provider of
that something can squeeze out of them.

Oh, duh!  Lets just sell a product for what its worth, my god its so obvious now!  Ok, enough sarcasm, but lets get serious folks, the above statement, and its normative language is in-itself ridiculous, but to make such a claim based upon some arbitrary, unexplicable ideal is at-best painfully ignorant.  I'd have less of a problem (but still one regardless) if the author had presaged the statement with some sort of disclaimer admitting his point doesn't exactly make much sense, or if he'd elaborated as to how one is to determine this mystical idea of "worth."  To be fair though, that statement is far from the most eggregious failure of financial understanding I've seen to-date, it just happened to catch my eye when it could stand to take no more; it was the proverbial straw that broke the camel's back. 

(1-2 chime in)

That being said, the pricing scheme Apple has embarked on makes perfect sense.  It is simply a well executed version of third-degree price discrimination.  By setting the price high for the early adopters (who he arguably didn't charge enough judging by the opportunity cost forgone those who lined up for hours on end to wait for the phones release proved...well maybe their opportunity cost just wasn't that high).  It is the same principal as using coupons to segregate segment customers by price elasticity.   Those who are willing to hunt for coupons are obviously more price sensitive than those who don't care to search through newspapers daily, thus they are charged less.  These are the same people who are now being charged less for second generation iPhones (the price sensitive group), while the inelastic purchasers (early adopters) were charged a price that was able to extract more of the consumers' surplus.

However, it remains to be seen what kind of demand destruction this quickly shifting price structure has.  This is obviously more a branding question with economic impacts than a straight economics question, but if people don't trust that their new iGadget will retain its value for longer than six month they may just not buy first generation products.   It is a careful balance to strike, but perhaps Jobs has it just right.

 

Either way, this was not a benevolent break by Steve Jobs. 

This is a perfect application of price discrimination...the good kind.