Open Letter to Board of Hewlett-Packard

Fire Leo Apotheker right now.  He clearly thinks of only in the short-term to appease Wall Street analysts.  On August 18^th, HP announced that they are looking into strategic alternatives for their industry leading PC unit.  Huh?  That is corporate speak for management either totally screwed up and needs to dump an asset OR that the management does not have a clue what it takes to run the business and would rather have the cash.

Why would you get out of an industry where you have a leading market share especially when the companies name is synonymous with PC’s?  HP has over a 29% of the US PC market.    I agree the overall PC market is shrinking as tablets eat into PC and laptop sales.  But tablets are not serious business machines.  Today they are mainly play things.  I am sure they will improve with time but over the next couple of years they will only marginally impact the PC market.   It will be years and many generations of technology before the tablet replaces the laptop.  Years HP has to get tablets right.

HP clearly recognized the threat that tablets pose to the PC market.  HP purchased Palm for $1.2B to get an edge on the mobile PC market in April 2010.  They used the purchase of Palm to help create a new operating system (OS) for tablets called WebOS.   In addition they hired some of Apple’s key employees hoping to jumpstart the new unit.

In July 2011 HP debuted its new tablet to try and capture some of the market from Apple and the Android market.  Within a month, HP is now announcing that they are going to be getting out of the tablet market and started selling of the new tablets at fire sale prices.  What could have possibly changed in one month?  This is typical short-term thinking that is so prevalent in US businesses today.  They spent literally billions of dollars to purchase Palm, design new OS and new tablets.  They then spent millions on rolling out a new product and decided to pull out of the market within one month.  This shows nothing but piss poor management.  Management and the board had to sign off on their purchase of Palm.  They also had to agree that HP should form a division to concentrate on tablet computers.  And management had to know about the large ad campaign to roll out the product.  If management was doing their job they should never spent the money on Palm, creating a tablet and software and then releasing it if they were going to kill it within a month.  Somebody screwed up big time and should be fired.  Start with Leo and then look at the chairman of the board.  Both are clearly incompetent. 

What to do to fix HP?

Fixing HP is relatively straight forward.  HP obviously has too many managers that they have become a bureaucratic nightmare.   HP is slow on releasing new ideas to the market.  They are more concerned with the bottom line than their products.  To see what I mean go to HP’s own website and read the customer reviews of their new printers.

I was looking to replace my existing HP wireless printer that was top of the line about 5 years ago.  At the time the price was running about $500 for the model I own.  The printer works fine but it does not work with my iPad because it is too old for HP to want to add it to their printer app.  It also has a fax feeder issue that is slightly annoying but not so much as to force a change.  I happened to see a new wireless HP printer at the local Staples that was marked down from $379 to $229.  The new printer also had cheaper printer cartridges that supposedly printed more pages per refill than my current printer.  Mathematically the new printer would save me approximately $180 per year on print cartridges which made the purchase of the printer a nobrainer.  It would almost pay for itself within a year.

Before I purchased the printer I had enough sense to read some reviews on the model.  I went to www.HP.com to read some reviews.  On a scale from 1 to 5 (5 being the highest), it scored a 3.5 with a large amounts of people wanting to rate the printer lower than a 1 if the website let them.  The amount of problems on the machine was almost comical.   

•  The machine would go into power save sleep mode and never revive without a complete shutdown

• The print cartridges would prematurely dry out forcing someone to buy more print cartridges instead of less

• The fax feeder would send clumps of paper through the feeder jamming the machine

• The machine would go into an endless reboot and shut down cycle

• See for yourself   http://www.shopping.hp.com/product/printer/Officejet+Pro/1/storefronts/CM756A%2523B1H?tab=reviews&#defaultAnchor

The machine is being called “the worst printer ever” by multiple reviews on their own website!  Apparently HP does not review their own website for a clue what is needed to be improved on.

How about spending some time and money fixing your products and reputation instead of short-term moves designed to prop up your lackluster stock?  If HP concentrated on making tech products that worked with few issues they would be very successful.  That is one of the main drivers of people willing to pay more for an Apple.   They could charge higher prices because demand would be there.  The only way HP has found to sell their cheaply made products is by lowering prices.  With a bloated management structure you can only do that so long before you are bankrupt.

Stock Projection

I cannot make any projection about the stock because it took such a beating with the announcement of looking to get rid of the PC division and cancelling the tablet.  I also expect current management to be fired within the next 6 months which will probably boost the share price.  I would not own the stock at any price right now because the management has to be the worst there is in the technology base companies right now.  Bad management tends to ruin things and I don’t expect anything different this time with HP.  If you own it sell it and look at better run companies that have a clue what they are doing and where they want to be in the coming years.  HP clearly has no clue.

Full disclosure

I have been an HP product fan for almost a decade.  Almost all my PC’s and printers in my business and home are HP.  It pains me to bad mouth them but they are steadily getting worse.  The management is clearly just thinking about quarterly earnings and not about their products and reputation.

As of August 30^th I do not own any positions to do with HP stock or bonds.

What is wrong with having a Recession?

A lot of the mess that we are in as a nation is due to the policies directly tied to the US Federal Reserve and US politicians (Read BOTH parties).  The policies I am specifically suggesting are policies tied to always trying to make the United States never experience the downside of the business cycle- a dreaded RECESSION.  OOOO! Such a nasty sounding word.  It sounds negative.  It must be bad right?

Well not really.  Recessions are needed.  They play an important role in the business cycle.  They clear out bad investments, bad managers of assets (abusers of capital), and the overleveraged.  They are the yin to the yang.  You cannot have one without the other.  

During boom periods people, companies, and governments tend to take bigger risks since they are generally in a positive mood because the economy is expanding and they are making more money, have more jobs, and more opportunities.  As time goes on during a period of expansion, most profitable (i.e. lowest priced) assets get purchased and the easier returns have been made.    The low hanging fruit have been picked.  To make similar returns, as the lower priced assets, the purchaser of new assets needs to take on more risk either by increasing leverage or taking on larger or riskier projects. 

Not all investments workout.  Some assets/projects fail.    Naturally at this point in the business cycle humans being lazy humans decide if they cannot easily win they will pick up their toys and play another day.  Without growth from investments the economy normally slows and those that took on too much risk get hammered.  This generally leads to increased unemployment and general unhappiness in the economy.  We as people like to take this unhappiness out on other people and this is where the politicians come in.  During down periods in the economy people want to see change because they do not like the social mood of the economy.  Change for politicians usually means they lose the job to somebody willing to make a change or show a new approach.  Nobody likes to lose their job especially if it is a cushy job with lots of perks.

Recessions are good because the high priced assets tend to be marked down to prices a lot lower than when they were last purchased.  These lower prices lead to larger returns for the new owners who purchased these assets at severely discounted prices.  This is how the business cycle is supposed to run.  The weak businesses and investors go bankrupt or lose their assets and the strong investors purchase them to run them properly and make a profit. This starts the cycle all over again.  

Prediction about where we are now

Since the end of WWII recessions in the US have lasted on average less than a year with only slightly more than a 3% decline in GDP.  3% is nothing compared to the period before the Great Depression where we regularly had recession that had declines greater than 25%.  

Recession year Started	How Long it Lasted	Lasted (yrs)	Between Recession (yrs)
1945	Feb to Oct 1945	0.67	6.67
1949	Nov 1948 to Oct 1949	0.92	3.08
1953	July 1953 to May 1954	0.83	3.75
1958	Aug 1957 to April 1958	0.67	3.25
1960	April 1960 to Feb 1961	0.83	2.00
1969	Dec 1969 to Nov 1970	0.92	8.83
1973	Nov 1973 to March 1975	1.33	3.00
1980	Jan 1980 to July 1980	0.50	4.83
1981	July 1981 to Nov 1982	1.33	1.00
1990	July 1990 to March 1991	0.67	7.67
2000	March 2001 to Nov 2001	0.67	10.00
2007	Dec 2007 to June 2009	1.50	6.08
	Average Since WWII	0.90	5.01

Our last recession ended in June 2009.  Typically we have approximately 5 years between recessions.  Our shortest since WWII was 1 year and our longest 10 years.  We are now slightly more than 2 years since our last recession.  If we follow the average we would expect a recession sometime around 2014.  I do not think that will happen.  I think our next recession will come much sooner.  In fact I put the odds of a recession starting this year at 25% and 75% next year.  My reasoning is quite simple. 

The stimulus that the Fed has been doing since the 1980’s and changes in the law sponsored by both the Congress and the Presidents have built up like plaque in the arteries of our economy.  We have gotten fat by just having sweets of financial engineering instead of healthy long-term beneficial investments.  Our sickly money center banks are allowed to stay on life support instead of being allowed to fail.  The banks realize that anytime they get into trouble they are bailed out.  By not having any negative repercussions from making bad investments, banks are willing to take on ginormous debts and risks to make larger profits. 

This time it will be different because the US government has built up such a large pile of debt that they too are getting sickly.  A lot of the debt occurred during the last recession when the US government had to bail out large banks like Bank of America and Citigroup plus a number quasi government agencies (Freddie Mac and Fannie Mae).  This left a really bad taste in the mouth of the US tax payer that has to ultimately pay for these bail outs.  The next time that banks need to be bailed out by the US government it will more than likely not be able to backstop (financially and politically) the large money center US banks from collapsing.   

In the obese patient it is usually not the last bite of junk food that kills you; it’s the daily doses of junk food they have eaten regularly over the last 20 years.  The buildup of plaque causes the heart attack.  The buildup of debt and risk over the last 20 years will cause the financial heart attack that leads to the next US recession.  

Maybe I should eat a salad tonight.

Full Disclosure

As of August 28^th, 2011 I do not have any positions in any of the companies or US government agencies mentioned.

Apple the perfect long-term short

To start with I like Apple.  I generally like their products even though they are more playthings than serious business tools.  They are clearly the current technology leader in devices and computers.  Steve Jobs did an incredible job remaking the company from a has been to the market leader.  After so many years a company gets too large and bureaucratic.   Think IBM and Microsoft.  

The stock has skyrocketed to more than $400 per share in August 2011 from below $5 a share in 1997 (allowing for splits).  A number of business books have been written about Apple’s success.  Steve Jobs has been showcased in 100’s of magazines and TV programs.  The stock has obtained an almost mythical quality.  Investors view the stock as a sure thing and one of the markets key holdings.  The company is clearly at its pinnacle.  

It has nowhere to go but down.  We can argue that the balance sheet and products are all rock solid.  We can even show that there are still millions more that want and need iPhones, iPods, and iPads    The revenue and profit numbers for Apple have been steadily increasing over the last few years thus making it very predictable stock for mutual funds and retail investors to purchase.  This has caused a strong psychological uptrend in the stock, steadily separating the value of the stock from the fundamentals of the company.  

What can break a long term psychological uptrend?  A down quarter?   A new competitor products product?  Or a management change?  The latter is the one that I am most concerned about for the Apple stock.  Since Steve Jobs has obtained this surreal persona there is a big risk that public perception could now change once people think the Apple story was based on mostly on Steve Jobs and not the company in general or the new CEO specifically.  This has happened to many stocks like Microsoft and GE.  Once their storied CEO’s left the company the heirs of the throne had a difficult time measuring up to the predecessor.  All it takes is time and one slight kink in the armor like a missed quarterly number or failed new product offering to start the ball rolling downhill.

• When Jeff Immelt took over from Jack Welch at GE in September 2001 GE was trading at $40.90  and as of August 25^th it is trading at $15.45 a 62% decline

• When Steve Balmer took over from Bill Gates to become CEO of Microsoft in January 2000.  In January Microsoft was trading at $97.87 and as of August 25^th it is trading at $24.57 an almost 75% decline

This is where I think Apple is now.  I am speculating that Apple will shortly be starting a long downward stock price trend as psychological quality of the stock retreats back to a more normal level.

Prediction

On the close August 25, 2011 Apple stock (APPL) closed at $373.72.  I would predict the stock would take a drop of 50% to 60% from their peak.  This usually takes between 24 and 36 months to trade down that level.  It would mean that in my opinion Apple stock should trade down to approximately $150 per share by August 2014.   I am basing this prediction based solely on what I perceive to be a stock trading more based on psychology than on fundamental values.

Full Disclosure

As of August 26^th, 2011 I do not own any Apple shares, Options, or debt.  I also do not have any shorts or puts tied to Apple stock.  I do own 150 shares of an ETF that shorts the S&P 500 which Apple is a member. 

US is really almost bankrupt and should be rated junk bond status

The premise of this posting is that the US Government treasuries should be rated junk status by the large bond rating firms.  To date only one firm, Weiss Ratings, seems to be close to where the US Government should be rated.   They have them rated C- which is approximately one rank above junk.    Egan-Jones and S&P also rate US Government below the vaulted AAA ranking.

My concern stems from how the rating agencies rate the debt in the first place.  One of their key measures of risk is the amount of debt a sovereign nation has compared to the GDP of that country.  GDP is a measure of the entire income of a country in one year not what the government takes in with regards to taxes or other revenue generating activities.  To me this is plain wrong. 

These same rating companies use a different measure when comparing corporations and municipalities.  When they compare the debt of say a bank to revenue they only use the revenue of the bank they are evaluating and not the entire banking industry.  This massively distorts the debt to income ratio of the sovereign nations and hence artificially inflates rating of sovereign nations.

I have a couple of reasons why I think this is done.

1.       The rating agencies feel that most sovereign nations can raise taxes to help pay their debt thus they can easily raise their revenue making it easier to pay their bills.  To me this is a false assumption on the part of the rating agencies.  How far can a country raise taxes as a percentage of GDP before the GDP plunges?  The US has historically been taxed by the US Government between 15% to 20% of GDP.  Imagine if the US raised taxes to say 40% of GDP.  What would happen?  My guess is the all the 777 and A380 planes flying out of the country would be full of business owners moving to other countries OR tax evasion would become a favorite pastime of the rich like in most third world countries and southern Europe.

2.       Another reason might be that the rating agencies probably cannot get accurate revenue figures on a timely basis or they simply do not trust the numbers they get so they feel the GDP figures are more reliable.  This might be the case but there are enough countries that report these numbers on a regular basis and are quite accurate.  If you cannot trust the government revenue numbers you probably cannot trust their GDP figures either.  This is most likely not a valid reason.

3.       They might do it because it is simply easier to get (i.e. the agencies are being lazy).    This is probably not the reason but you never know.

4.       Finally they might have been misled by governments a while back using reason 1 and nobody has challenged them to make a change now that information is easier to get.  This to me might be the likely reason.

I do not know what the reason is officially but I believe it is plain wrong.  To show this point further I will compare an AAA corporation, a junk rated corporation, and the US government simply just using debt to income ratio.  You be the judge.

Company/Country	ExxonMobil	Charter Communications	US Government
Rated by most agencies	AAA	BB-	AAA, AA1
Last complete year Income	$383,221,000,000	$7,059,000,000	$2,161,700,000,000
Last Year's Profit	$30,460,000,000	-$237,000,000	-$1,294,100,000,000
			including Social Security
Total Long & Short-term Debt	$15,014,000,000	$12,306,000,000	$9,017,800,000,000
			Held by public only
Debt to Revenue Ratio	4%	174%	417%
Debt to profit Ratio	49%	-5192%	-697%
Source	Yahoo Finance	Yahoo Finance	CBO
Fiscal Year	12/31/2010	12/31/2010	9/30/2010

Now tell me who is junk now!  The US Government is clearly way over indebted.  I only used publicly held debt and not the debt held by the “Social Security Trust Fund”.  I also used the deficit numbers after Social Security and US Post Office receipts.

If you look at the $9T in debt versus a GDP of $14T the debt to “Income” ratio is a mild 64%.  Not AAA standard but probably not junk.  This clearly shows that a simple distortion can make a large deal when rating a sovereign nation.

As everyone can clearly see the downgrade from S&P was clearly way overdue.  In my opinion they are being generous.  I would have rated them probably junk around B+ at best.  I think the fact that the US Government is going after S&P in a retaliatory strike is a joke.  They are trying to shoot the messenger.  I fully expect to see the US Government rated AA3 within the next 5 to 10 years once the other rating agencies grow some balls.

Full Disclosure

I do not own any treasuries but I do own approximately $250 in face value of savings bonds my kids received from grandparents and friends that I have never got around to cash yet.  Given these figures I might want to soonJ!