Consumer Debt Paydown Crimps GDP Growth

It's election season so both candidates would love for you to think that the POTUS has a lot of control over economic growth, but this week we got a report that sheds light on one of the major reasons the U. S. economy is growing at around 2%, down from its long-term average of around 3% per year. The New York Federal Reserve reported that credit card debt balances last quarter dropped a $672 billion, a level not seen since 2002. It also marks a 22.4% decline from the peak we saw in the fourth quarter of 2008.

So how exactly has this de-leveraging trend negatively impacted GDP growth? Well, consumer spending represents about 70% of GDP, so a drop in credit card balances of $200 billion over the last few years represents a lot of money that was sent off to pay bills, not spent on goods and services. Toss in another $100 billion of spending that would normally be incremental over that time period due to overall growth in the underlying economy, and you can see that about $300 billion of consumer spending has been absent from the system, compared to what would have been normal.

With annual U.S. GDP at around $15 trillion, this consumer credit card de-leveraging represents about 2% of GDP growth lost. Over 3-4 years, that comes out to about 0.5% GDP impact per year. In a world where GDP growth has dropped a full percentage point from its long-term normalized level, consumer debt repayments account for a major portion of that slowdown. You aren't likely to hear much about that on the campaign trail, but politicians rarely deal with facts and truths when it comes to hot-button issues like the economy.

Apple Sets Market Value Record As iPhone 5 Debut Nears

Earlier this week I wrote a piece on Seeking Alpha that outlined why I believe investors are likely to value Apple (AAPL) shares similarly to other blue chip consumer brands, which would mean a valuation of 10-12 times trailing cash flow (defined as EV/EBITDA). Bulls on the stock have a multitude of reasons why Apple should trade at a premium, but in recent quarters the market has disagreed. In fact, even as Apple stock has broken out to new highs, setting a new market value record in the process, AAPL shares fetch about 9 times trailing cash flow (at the current quote of $665), a discount to other superb consumer brands.

If fair value is somewhere in the 10-12 times cash flow range, that would equate to $725-$850 per share. That would mean fair value is somewhere between 10% and 25% above current levels. That is why I continue to hold the stock, despite its enormous run-up lately.

In terms of future potential, I continue to be intrigued by the possible launch of an Apple TV set. When I think of the large market opportunities for Apple, those that can really move the needle for a company worth more than $600 billion, the television market is the only one they have yet to target that has real appeal. Outside of desktop, laptop, and tablet computers, phones, music players, and televisions, I am not sure where else Apple could find significant future expansion potential (although I am sure they would disagree and are looking for some already). After launching a TV, I think Apple's strong growth days might fade. Assuming the stock traded in line with other blue chips at that point, I would likely look for an exit point.

I have not sold yet, mainly because a TV is still not here (some are even arguing they aren't going to make one, just a set-top box) and the stock's valuation on current products, at 9 times cash flow, is still below that of other large cap blue chips. So while I am not as bullish as some, I still see room to run for the stock.

Full Disclosure: Long Apple at the time of writing, but positions may change at any time

Bubble Bursting 2.0 (Part 2): Isn't Groupon Worth Something?

Last November, in a post entitled "Numbers Behind Groupon's Business Warrant Caution After First Day Pop", I cautioned investors that the IPO of daily deal leader Groupon (GRPN) looked sky-high at the initial offer price of $20 per share, which valued the company at an astounding $13 billion:

"It is not hard to understand why skeptics do not believe Groupon is worth nearly $13 billion today. To warrant a $425 per customer valuation, Groupon would have to sell far more Groupons to its customers than it does now, or make so much profit on each one that it negates the lower sales rate. The former scenario is unlikely to materialize as merchant growth slows. The latter could improve when the company stops spending so much money on marketing (currently more than half of net revenue is allocated there), but who knows when that will happen or how the daily deal industry landscape will evolve in the meantime over the next couple of years.

Buyer beware seems to definitely be warranted here."

A few things have happened since then. First, Groupon has cut back on marketing spending and is now making a profit (free cash flow of $50 million in the second quarter). Second, the post-IPO insider lockup period has expired, removing a negative catalyst that the market knew was coming. Third, and most importantly, Groupon's stock has plummeted from a high of $31 on the first day of trading ($20 billion valuation) to a new low today of $4.50 ($3 billion valuation).

Here is my question, as simply as I can put it; "Isn't Groupon worth something?" The stock market seems to be wondering if many of these Internet IPOs will exist in a few years. Today's 8% price drop for Groupon was prompted by an analyst downgrade to a "sell" and a $3 price target. Here is a company with $1.2 billion in cash, no debt, and a free cash flow positive business that will generate over $2 billion of revenue this year. That has to be worth something. How much is another story.

I would argue that it is too early to write off companies like Groupon as being "finished." It is far from assured that they will be around in 3-5 years, but many of them have huge cash hoards ($2 per share in Groupon's case), no debt, and a business that is making money today. My most recent blog post made the point that many of these Internet companies are going to survive, and in those cases bargain hunters are likely to make a lot of money. Will Groupon be one of them? I don't know, but if an investor wanted to make that bet, at $4.50 per share, they are paying about $1.8 billion ($3 billion market value less $1.2 billion of cash in the bank) for an operating business that is on track for more than $2 billion in sales and $200 million in free cash flow in 2012. And who knows, with this kind of negative momentum, the shares could certainly reach the analyst's $3 price target in a few more days.

Bottom line: these things are starting to get pretty darn cheap. If they make it, of course.

Full Disclosure: No position in Groupon at the time of writing, but positions may change at any time.

Bubble Bursting 2.0: Coming To A Dot-Com Stock Near You

By now you probably know the poster children for the bursting of the 2012 Internet bubble:

Facebook (FB) IPO price: $38.00, Current quote $21.75 (down 43%)

Zynga (ZNGA) IPO price: $10.00, Current quote: $2.95 (down 70%)

Groupon (GRPN) IPO price: $20.00, Current quote: $6.66 (down 67%)

And as was the case in 2000, we are seeing violent selling in most any Internet company that reports a less-than-impressive quarter as a public company. We are also likely to get a repeat scenario in terms of bargain basement prices, for a time anyway, even on those companies who are able to survive and grow with a profitable business model. I think it is time to start monitoring these dot-com IPOs in search of those that might be written off prematurely. After all, unlike the late 1990's, many of these companies do make a profit. The issue today is more that they don't always make enough to justify multi-billion dollar stock market valuations.

Today's disaster du jour is CafePress (PRSS), a profitable e-commerce site that has been around since, you guessed it, 1999. CafePress, which projects 2012 revenue of more than $200 million, went public in late March at $19 per share, giving it a market value at the time of about $325 million. In today's trading the stock is falling by nearly $6, or 42%, to a new low of under $8 per share. Loss since the IPO: 58%.

So why bring up CafePress? I think it is the kind of company (a viable, profitable, and growing Internet operation) that might fall into that "written off way too early" category as the air continues to flee from the 2012 Internet company bubble. Granted, I have only spent an hour or so looking at CafePress specifically, so this is by no means a huge ringing endorsement yet, but it is the kind of stock I think warrants a closer look.

Even with reduced financial guidance for 2012 (the reason for today's steep stock price decline), CafePress is predicting more than $20 million in EBITDA on more than $200 million in sales this year. With sales growing by about 20%, coupled with an 11% cash flow margin, PRSS is certainly a viable company. And yet, at under $8 per share, the stock price is indicating otherwise. The market value is now down to $135 million. PRSS has $60 million in cash on the balance sheet, so at current prices Wall Street is saying that the CafePress operating business is worth just $75 million, or 3 times EBITDA. That is the kind of valuation that Wall Street normally reserves for companies in a steep decline. As a value investor, numbers like these can't help but get my attention.

Comments on the Internet stocks in general, or CafePress specifically, are always welcomed.

Full Disclosure: No positions in the stocks mentioned at the time of writing, but positions may change at any time

Chipotle: A Lesson in High P/E Investing

Shares of Chipotle Mexican Grill (CMG) are falling more than 90 dollars today after reporting second quarter earnings last night. Revenue rose 21%, with earnings soaring 61%, beating estimates of $2.30 per share by an impressive 26 cents. However, light sales figures (same store sales of 8% versus expectations of double digits) are causing a huge sell-off today. This is a perfect example of what can go wrong when investors rush into stocks that are very expensive relative to their overall profitability. Any hiccup results in a violent decline. And this really isn't a hiccup except relative to lofty expectations. If you simply read the press release and ignored the analyst estimates, you would conclude the company is absolutely printing money at its restaurants. Unit-level margins approaching 30% are pretty much unheard of in the industry.

The problem is that prior to today's drop, CMG stock traded for a stunning 59 times trailing earnings. Even using this year's projections gets you to a P/E of 45x, more than 3x the S&P 500 multiple. Even a meaningful earnings beat can't help investors with the bar set so high. Today could very well be a buying opportunity if one believes in the long term growth story at CMG, however, with the P/E still sitting around 34 on 2012 earnings, it is definitely not cheap enough for value investors to get interested.

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Full Disclosure: No position in CMG at the time of writing, but positions may change at any time

Values Abound in Enterprise Computing

With the European recession beginning to impact earnings guidance for U.S. companies in recent weeks, one of the sectors to really get hammered is enterprise-focused technology. While second quarter profit reports and forward guidance will likely be unimpressive this month, some of the current valuations on Wall Street make little sense even in that scenario. As a result, I would expect strategic mergers and private equity buyers to begin looking at some of these companies.

There are far too many ideas to list here, or buy for clients, so I will just point to one that looks intriguing; enterprise collaboration hardware maker Polycom (PLCM). Polycom earned $1.18 per share last year, but weakening demand has pushed forecasts for 2012 down to just $0.89 which has crushed the stock from $32 a year ago to a recent quote of just $9 per share. What really bulks up the bullish case for the stock is that Polycom has no debt and a whopping $600 million of cash in the bank, which equates to about $3.50 per share in net cash. Investors are getting the business for only $6 per share, or 5 times trailing earnings.

With such a pristine balance sheet, the odds of Polycom being acquired rises materially relative to the average hardware company. It would be a logical target for a Cisco, HP, or Dell, all of which are companies that either compete with PLCM or are looking to expand their product offerings to enterprise customers. Even without a deal, the stock should likely command at least a market multiple, which would put fair value in the high teens inclusive of cash. This is just one of many enterprise computing companies that have been decimated in recent months, which make them very attractive in my view.

Full Disclosure: Clients of Peridot Capital own shares of Polycom at the time of writing, but positions may change at any time.

J.C. Penney Stock: Back to Earth

It has been less than four months since my bearish post on J.C. Penney (JCP). Since then the $42 stock has fallen nearly 40 percent to $26 per share. It turns out Ron Johnson does not have magical pixie dust to sprinkle on his 1,100 stores. As the retailer slashes prices on old merchandise, initiates an everyday low pricing strategy, and begins shifting towards its "stores-within-a-store" concept, sales and profits are plummeting. Same store sales fell 19% last quarter, a figure almost unheard-of in the retail sector. The stock is below its level on the day Ron Johnson was hired.

So what now? Well, the stock is no longer clearly overvalued, as it was four months ago. In the mid-twenties, it now has material upside if Johnson's plan bears fruit. It will still take a long time, so investors need not rush in if they still believe in the new management team. That said, it is probably time to start formulating a game plan if you want to get in. The first quarter results were really the first in what may be a series of bombs as the company right-sizes its inventory and pushes forward with its revamp. The year-over-year comparisons early next year will be very favorable for the company. And who knows, maybe Johnson can drum up some excitement over the holiday season. He does have another six months or so to make a strong push there.

For investors who want to get in on the Ron Johnson JCP experiment, it seems reasonable to scale in slowly with an understanding that Q4 2012 and Q1 2013 may be when we start to see the sales and profit figures turn around. Between now and then we really don't know how bad it will get. The stock could certainly drop to the low 20's or even high teens depending on how 2012 progresses and if the red ink continues short term.

Still, as Bill Ackman of Pershing Square Capital Management pointed out shortly after JCP's recent earnings miss, there is still a lot of potential here and we are really only in the first inning of the company's plan. Specifically, he pointed to sales of $600 per square foot in JCP's in-store Sephora boutiques. If Johnson can get exclusive merchandise in JCP and mimic the Sephora "store-within-a-store" concept, there is certainly upside here. Given that the stock was worth about this much before he was even hired, he would really have to screw up the entire brand and alienate his customers in order to destroy the stock permanently. As a result, JCP's turnaround remains a very interesting story to watch.

Full Disclosure: No position in JCP at the time of writing, but positions may change at any time

The Most Surprising Thing About Facebook's IPO? Trading Has Been Completely Rational!

Today's Facebook (FB) IPO is the first time I can remember being completely shocked at the lack of trading excitement and volatility for a much-hyped IPO. Ironically, the reason for such unexciting, rational behavior is because of how hyped the Facebook IPO was to begin with. The share allocation to retail investors at the $38 offer price was huge. I put in orders for my larger clients at E*Trade, one of the brokerage firms that got a sizable piece of the IPO, but did not really think they would allocate us any shares (there were reports that Fidelity would not even consider giving out shares to any clients who had less than $500,000 with them). What happened? We got every share we asked for.

With that much hype, especially from the retail side, and with that many investors actually getting 100 or 200 shares, it would be completely rational that, since the supply was very large and the price was fair, a large first day surge would be unwarranted. But we are not used to seeing first day rationality for hot Internet IPOs. In hindsight, it makes sense that Facebook opened at $42.05, only up $4. With so few incremental buyers (given the huge retail allocation at the IPO price), it also makes sense that the stock would see selling at the open, which did occur, sending the stock down to $38 exactly within the first 30 minutes of trading.

So while I am pretty shocked that this IPO has been so calm, I think it bodes well for how the financial market worked. For what could very well be the most hyped IPO ever, investors are acting completely rational and the investment bankers have done a really solid job of not only correctly pricing the deal, but also letting the "Average Joe" participate. The retail brokerage customer won't be getting rich off of this IPO on day one, but that is not the way it should work anyway. With so many people getting stock, the immediate paper gains should be modest. That is how the marketplace should work. It is all about supply and demand after all.

Full Disclosure: I received Facebook shares at the IPO price, as did a few of my clients. I was planning to look for a chance to flip them today, after a nice pop, but with this interesting trading action to start the day, we have yet to sell a single share as of the time of this post. As always, positions may change at any time.

UPDATE (5/18): I sold my client's Facebook shares after this post was originally published, in afternoon trading at $40.09 each.

JPMorgan Sell-Off Excellent Example of Contrarian Opportunity

News of a $2 billion trading loss at JPMorgan Chase (JPM) last week prompted a 15% sell-off in the stock, which now sits more than 20% below its 52-week high, at a trailing P/E ratio of 8, at only a slight premium to tangible book value, and with a dividend yield above 3%. One of the best ways to be a successful investor is to buy quality companies at times when their share prices are temporarily depressed due to short term news headlines that likely will not impact the long term profit generation of the company. Warren Buffett has perfected this investment strategy over many decades. While JPM was not really on my radar before last week, the recent events at the company have changed that. At around $36 per share I think JPM makes for a very attractive long term investment. As a result, I have initiated a position in the company.

Full Disclosure: Long shares of JPM at the time of writing, but positions may change at any time