mjs111

I have seen this before! Adobe did it after their big Marketo acquisition. When one company acquires another company that has a lot of deferred revenue (usually subscription revenue), you’ll often see an accounting phenomenon where a portion of the acquired company’s revenue magically “disappears” post acquisition, coupled with a revenue writedown of the acquired company’s deferred revenue balance sheet asset. A somewhat recent example of this is Adobe’s recent acquisitions of Marketo and Magento, which will result in $75 million worth of deferred revenue write-downs in 2019, a 0.67% hit to Adobe’s $11.15 billion 2019 revenue estimate. The reason why these deferred revenues are typically written down is that in a merger all of the acquired company’s assets get revalued “at fair value,” with each asset’s definition of fair value based on specific GAAP accounting rules. With respect to deferred revenue, GAAP accounting rules specify that it get revalued based on the estimated actual cost of the performance obligation plus an appropriate profit margin. With software, most of the cost to develop the software and then support the customer has been done either before the sale or very early on in the service contract life, and the remaining life of the service contract is usually pure gravy, with little associated cost. When this remaining deferred revenue is revalued based on actual cost plus a margin, it almost invariably results in a non-cash deferred revenue write-down, recognized in the year that the revenue would have recognized. Since many service contracts are a year in length, a typical thing you’ll see is the combined company’s revenue go down compared to the sum total of the two companies’ separate, pre-merger revenue streams the first year, and then pop back the next year when new year-long service contracts are written post merger. However, if the acquired company’s service contracts were longer than a year, this non-cash reduction in revenue could extend out further than a year. Looking at the appendix of the slide deck, it looks like the non-GAAP revenue is related to acquisition-based deferred revenue adjustments. As long as the acquiring company doesn't lose a large chunk of the subscribers it acquired, I think looking at the non-GAAP revenue figures is useful. Mike

If you look at a theoretical environment with no inflation, where 100% of capex and acquisitions can be depreciated and/or amortized, then once a company hits terminal growth annual capex and d&a charges should level out. In reality, I've found this rarely to be the case, even for 100+ year old firms like Coke and Johnson and Johnson. All it takes is a little inflation or the occasional acquisition with a little bit of unamortizable goodwill or land value to boost capex and acquisitions higher than d&a indefinitely. In my valuations I'll typically have capex plus acquisitions get closer in line with d&a long term (this should happen as growth comes down), but I can't recall ever bringing capex down to completely match d&a. There's too much friction from inflation and unamortizable stuff for that to typically happen. What helps bring this into focus is to look at 3, 5, and 10 year averages of d&a vs. capex plus acquisitions. Year to year capex is too lumpy but when you look at a string of years, what I've generally found is that capex always averages a bit higher than d&a. Mike

He has one with Howards Marks as well. #53. Mike

Chris Bloomstran has a good one hour interview on the April 30th "Invest Like The Best" podcast. https://podcasts.apple.com/us/podcast/invest-like-the-best/id1154105909 Mike

The Airbnb problem these people are having seems like a miniature version of one of the key flaws of WeWork. The Airbnb'ers took on long term debt to fund an asset that had short term cash flows. Mike

I recently finished reading “GDP: A Brief But Affectionate History,” by Diane Coyle. The book’s key theme is that GDP is a synthetic measure of a nation’s productivity, an abstract idea, with many judgment calls in its construction. Measuring GDP is not like measuring the depth of an ocean or the speed of a train. In the case of GDP, the “object” being measured is just an idea, based on a foundation of judgment calls and assumptions. GDP is not something with an independent existence waiting to be discovered and measured. Changing the assumptions and judgment calls changes the resulting GDP, and changes have been made many times in the past. Here are some notes from the book: Prior to the nineteenth century there generally wasn’t the same interest in measuring and tracking national income like there is today since changes for most countries year to year were minuscule. Back then the idea of long term economic growth wasn’t really a thing. If you wanted to expand your piece of the pie you took from someone else’s piece of pie (i.e. sacking and pillaging), and then later someone else came and took back some of your pie when you weren’t looking. The pie itself didn’t expand much year after year on average like it does today. The Industrial Revolution changed that. The idea that the world economy just keeps expanding at low single digit rates is now largely taken as a given since it’s happened for so many decades now, but it’s still a relatively new phenomenon compared to all of human history. It’s called “Gross” Domestic Product because it takes into account investment spending but not depreciation, so it doesn’t net out spending to counteract wear and tear and obsolescence. If it did factor in depreciation it would be Net Domestic Product. “Domestic” means everything that occurs within a nation’s borders, as compared to Gross National Product, which is the economic activity worldwide owned by a particular nation. You can measure GDP in three ways, all of them theoretically equivalent to the other. You can add up all the output of the economy, all the expenditures of the economy, or all of the incomes. The expenditure-based model is the most commonly used in the media and in textbooks, though many countries will calculate GDP with multiple approaches, and some will publish the statistical discrepancy (the U.S. and U.K. do). The expenditure-based model of GDP is defined as: Consumption + Government Spending + Investment + Net Exports Measuring GDP in the United States became formalized during the Great Depression and World War II years, when President Franklin Roosevelt wanted a more accurate measure on how the economy was doing. When creating the GDP metric, Roosevelt wanted government spending included. During the Great Depression personal consumption was down but government spending was way up. Previous calculations of national income didn’t include government spending. Prior to the early-mid twentieth century, governments were quite limited in scope and size relative to a nation’s overall economy so factoring it in was less important. Additionally, the thought at the time was that government spending could only exist through taxation, so government spending was not a net gain in a country’s output, but a transfer. Disregarding government spending during the Great Depression and ensuing World War II, however, would not count the vastly increased government spending while only counting the vastly reduced personal consumption, making it look like GDP was decreasing, and no president wants contracting economic figures on his watch. There was argument back and forth on whether or not to include government spending, but in the end Roosevelt won. It’s interesting to look at how things would be if you didn’t include government expenditures in GDP. If you ignored government spending you would now no longer count any of the revenue Lockheed Martin, Boeing, General Dynamics, Raytheon, and any other defense contractor makes selling to the government. Money contractors make building and repairing roads and freeways wouldn’t be counted, nor would any of the salaries for anyone employed by the government. Before GDP was formalized in the Roosevelt era, government defense expenditures were actually subtracted from the national income estimate, with the remainder the estimate of production left for non-war purposes, with the thinking that war was a necessary but non-productive expense. This is a good example of one of the many judgement calls behind GDP. There’s no real right answer here, but starting in 1942 when GDP data was first published in the U.S., all government expenditures were included as a contributor to GDP, marking a change from the last two centuries worth of thinking that the economy was just the private sector. The pattern of growth from before World War II, through the war, and after would have looked very different if, as before, government non-defense expenditures were not included in GDP and defense expenditures were subtracted. Soon afterward, other countries adopted the U.S. model of GDP which included government spending. Not adopting this model while everyone else did would make your numbers look quite weak in comparison! The U.K. was the first to follow the U.S., and in 1947 the U.N. published the first set of standards for calculating GDP, based on the U.S. system. These days the U.N.’s System of National Accounts (SNA) defines the standard on how to measure GDP, which all countries are supposed to follow. While the SNA defines the standard, adhering to it is strictly voluntary, the agency has no enforcement ability, and every country has its own means of implementing the standards, which are influenced by the nation’s interest and ability to keep detailed records, a country’s opinions about certain SNA standards, and of course, by cheating. When measuring consumption, only final goods and services are counted to avoid double counting. For example, nails sold to a furniture manufacturer are not counted, but the furniture sold to the consumer is. That’s a clear-cut example, but things can often get fuzzier. The entire value of the iPhone is considered an import from China since only final goods are considered and not all the intermediate steps, even though only the relatively low-value final assembly occurs in China. Another judgment call example is business software. Software bought for business purposes was originally not counted at all, considered an intermediate purchase and not a final good or service. Later the rules were changed and software is now considered a capital investment, and so now when a business purchases Microsoft Office it is included in GDP. Of course all these rules are easier said than actually implemented. This is easier said than implemented. It’s easy for a statistical agency to count software purchases bought directly from the vendor by Fortune 500 companies. It’s much harder to count the thousands of small, single proprietor shops that may buy the software from Staples or Amazon. Double counting is not corrected for when measuring government spending, so things like office supplies and trash hauling that a government pays for do get counted, and then double counted when the office supply store and trash hauling service book their revenue. This is because the allocation between intermediate and final public services for government is considered too difficult to clearly discern. A judgment call was made not to include an estimate of value for unpaid work. if the value of all this unpaid work such as house cleaning, child rearing, and volunteering were added, it’s been estimated it would create a 10-20% boost to U.S. GDP, depending on how conservative or liberal you wanted to be on what you wanted to include and what value you wanted to put on it. Not counting unpaid work also creates weird situations such as if a person marries his/her housekeeper but the housekeeper keeps doing the housework afterward, this will be recorded as a drop in GDP. Not including the value of all this unpaid work is as big a judgment call as including government spending. These calls could have gone either way. GDP only considers output, and doesn’t factor in the explosion of choice that’s occurred in many areas: compare the number of TV channels, breakfast cereals, soft drinks, types of shoes, etc. you can choose from today vs. in 1940. Also, since GDP only considers output, it doesn’t factor in the sustainability of that output: GDP may be rising nicely but the planet may be getting destroyed in the process. Social Security, Medicare, and Medicaid payments are not included in the government spending figure since these are deemed transfers from one citizen to another. While all government spending could (and used to be) considered a transfer and therefore not a part of national income, strictly disregarding Social Security, Medicare, and Medicaid is the way things currently stand. The U.S. could instantly boost GDP by relabeling all payments currently deemed “government transfers” to “government expenditures.” Services aren’t well represented (or at least directly represented) in GDP growth. For example, you can’t point anywhere in GDP growth and say this component is due to Google’s free search engine. Google’s search engine is represented in GDP by the electricity Google uses to run its servers, the electricity we use to go online, Google’s ad revenues, and the salaries Google pays, but there is no search engine “product” being sold and counted. The same goes for Wikipedia, Facebook, Twitter, YouTube, and even down to the countless free blogs out there. In 1987 Italy increased its GDP by 20% overnight by including an estimate for illegal and grey market activities. In 2014 the other members of the European Union started including their own estimates of illegal activities into GDP. The average is about 15% of GDP. The U.K. is on the low end with 4%. Greece provides a very generous estimate of 25%, and one of the things Greece did when it tricked the EU into giving it more loans that were based on the size of Greece’s GDP was to boost the impossible-to-prove-or deny illegal activities estimate. While the SNA now recommends including illegal activities in its GDP standards, the U.S. doesn’t. If illegal activities were included it’s estimated that it would expand U.S. GDP by about 7%. Illegal drug sales alone are estimated at $111 billion annually in the U.S., theft from businesses another $109 billion, prostitution $10 billion, and illegal gambling $4 billion. I learned about Benford’s Law for the first time in this book. Really interesting stuff. In counts of things, lower numbers appear much more frequently than higher numbers since you must always count through the lower numbers to get to the higher numbers. Greece was eventually caught cooking their GDP numbers, and the made-up GDP figures violated Benford’s Law, something forensic accountants later found. After reading about Benford’s Law it’s strange this wasn’t caught much sooner, but I imagine this was largely due to everyone in the EU wanting the numbers to be true. A Greek official who pressed for more true-to-life GDP statistics was charged with crimes against the state. For a primer on Benford’s Law and how to build an easy check for it in Excel (seriously, EU, you can build a check for it in Excel), look here: https://www.journalofaccountancy.com/issues/2017/apr/excel-and-benfords-law-to-detect-fraud.html Mike

I can only speak anecdotally. I have a subscription to Adobe Photoshop at $10 a month. I've never thought of canceling it. Similar to Netflix, it's below the price where canceling it would have any sort of affect on my finances. Same with Microsoft Office 365 (though that's billed once annually, not monthly). So for me, no. They're just too cheap relative to the large amount of value I get from them. Speaking at the company level for graphics companies I've worked at (users of all Autodesk products on the Media and Entertainment side, Adobe Photoshop, Microsoft Office Suite), no, there's no talk of renegotiating payment at the moment. The software is all mission critical with no good substitute. Even if there were a substitute no one I know is eager to rebuild pipelines now. That expense would defeat the purpose of saving money on the software. This doesn't pertain to the current time, but I remember our purchasing agent calling Adobe looking for a price concession about a year ago, and Adobe said no. When we pushed back they suggested we use something else other than Photoshop. We shut up and paid the bill. Mike

Ha! No problem. Ping me if you have any follow up questions. Mike

I can weigh in a bit on the Media and Entertainment side, since people have already talked a bit about the Architectural and Engineering side. I've worked in feature film visual effects and more recently at a AAA game company. These are companies like Disney, ILM, Weta, Sony Imageworks, Blizzard Entertainment, etc. All of these studios use Autodesk Maya for modeling, rigging, and animation. They typically have hundreds of licenses per company and have a lot of custom tools built for Maya. Maya is the industry standard modeling, rigging, and animation package, which means when you hire outside talent that they likely know, and are expected to know, Maya. Conversely, if you have some proprietary animation package, you now would have to train them up on your software, and your software better be like Maya from a UI standpoint if you want that process to go smoothly. It would be difficult and expensive to switch out your core modeling/rigging/animation package, and there's no great alternative out there with a much better feature set to switch to anyway. If you don't use Maya for animation, you likely may be using its "competitor," 3DS Max. Autodesk owns that too. Autodesk also owns Mudbox, one of the two industry standard tools for sculpting (the other package is Zbrush). Artists seem to love one or the other here. Less of a moat on this tool since there are two tools from two different companies of roughly equal feature set out there and it's not a core tool like your modeling, animation, or rendering package. For rendering, Autodesk owns Arnold, one of the industry-standard renderers. A lot of feature films you've seen have been rendered with Arnold. Competitors here include Pixar's Renderman, Redshift, and V-Ray, among others. Big studios will buy hundreds, if not thousands of render node licenses. The biggest studios, like Weta and Disney/ILM, will write their own renderers, which helps when you scale your render farm out to tens of thousands of processors (Weta's render farm is around 80,000 procs, last I heard). Disney/Pixar/ILM, all of which are owned by Disney, have no explicit license costs when it comes to Renderman licenses, since it's written in-house. Visual effects and game production is a complex project to schedule and keep track of, consisting of many different technical and creative departments, hundreds or even thousands of digital assets and shots, all moving through the pipeline very quickly. You need something to track all of this. One of the industry standard tools for this is Shotgun. Autodesk owns this too. Once your studio is set up tracking, bidding and scheduling shows with a particular piece of software, you're not going to switch unless something new comes along that's many times better. There's just too much infrastructure built up around it to be switching out all the time. Mike

full 2 hour interview is here: https://www.cnbc.com/video/2020/02/24/watch-cnbcs-full-interview-with-berkshire-hathaway-ceo-warren-buffett.html

Great decision buying AMD. It continues to surprise me how some (only a few) companies can re-invent themselves. My son (who is in grade 12) alerted me about 2 years ago to what was going on at AMD; he and his buddies are into technology and he explained to me that AMD was a company on the rise. Alas, i was too busy thumb sucking to do anything about it. I use it as an example with him to how small investors can do well if they do what Peter Lynch advises: take advantage of what you see in your circle of competence. I was quite torn about selling it since my cost basis was so low. I like the management team and what they’re doing. I think they have been executing very well. Solid products, good growth in multiple segments and a really solid pipeline. But the valuation has gone bananas. 200+x earnings is too rich for me. But I’m definitely looking for another entry point. It’s hard to say whether this will trade at a fair value anytime soon. Thanks So, if you are concerned about taxes, why didn’t you wait a couple more days until next year and then sell? This would push out paying taxes another year. Is this correct? I think you may still need to pay estimated tax otherwise if your tax bill after withholdings at year end is too big, you may have to pay a penalty? From the IRS: In general, taxpayers don’t have to pay a penalty if they meet any of these conditions: *They owe less than $1,000 in tax with their tax return. *Throughout the year, they paid the smaller of these two amounts: **at least 90 percent of the tax for the current year **100 percent of the tax shown on their return for the prior year – this can increase to 110 percent based on adjusted gross income https://www.irs.gov/newsroom/the-basics-of-estimated-taxes-for-individuals So like the name says, you kind of have to estimate. If you estimate you need to pay tax on a realized sale in Q1, you'd have to pay it by 4/15/2020. Mike

The online version of the financial data is no longer useful for me but if I download the data as an Excel file it's better. I miss the old format where I could control the number of significant figures in the financial data, rounding up and down. The current format shows too little and I can't get more granular data unless I download the Excel file. Mike

Anyone know a place where I could look up the pre-merger historical stock prices of Anheuser Busch (BUD) before it merged with InBev in 2008? Thanks! Mike

Yeah. For a typical slow/moderate growth REIT the dividend is much of return you get as an investor, plus some capital appreciation over time. Since the REIT is paying out most of its income as dividends, if it needs to raise money it does it by taking on new debt, issuing more shares, and/or selling appreciated properties. If the REIT is smart it's raising money with the right tool at the right time, ex. issuing shares when shares are expensive and not cheap, etc. Mike

Amazon and Microsoft have their own data centers but also lease space from places like Equinix and Digital Realty. In fact, that's an additional selling point these REIT's offer. You have the option to directly connect in with AWS's and/or Microsoft's Azure servers of you co-locate in one of their data centers: https://aws.amazon.com/directconnect/partners/ https://www.equinix.com/partners/microsoft-azure/ As far as cap rate goes, I'd say it depends. It's a ratio of net operating income to purchase price, so you can increase cap rate by raising rents or buying at cheaper prices, or some combination. A REIT may buy a property at a cap rate of 5%, but the property's leases are below market rents, it's not fully leased up, and the leases that are in place are ending soon. That REIT is in a great position to increase that property's cap rate. Sometimes you'll see this when a large company buys, say, a strip mall that was independently owned. The original owner didn't have the funds to keep the property maintained well enough to charge market rents. On the other hand, a REIT that buys a fully-leased up property that's charging market rents at a cap rate of 6% probably doesn't have much room to raise its net operating income further. Mike