Circuit City, you are not alone- said Best Buy

It was Forbes magazine's "Company of the Year 2004" and then it made in to the Fortune's List of Most Admired Companies in 2006. It survived the financial catastrophe after 2007 unlike its rival Circuit City, but seemingly it does not want to leave its pal- Circuit City alone.

Consumer spending has been above the levels businesses saw in 2008-2009. As per reliable sources, Black Friday and Cyber Monday sales of the year 2011 were up by 26% as compared to the year 2010. These all favor the prosperity of the retailers like Best Buy. But that is not the fact. Financial statements and stock performance of Best Buy deliver the different and dubious story.

Source: Yahoo! Finance

Best Buy is losing their support in the equity markets."Going out of the business" is a probability after 2-3 years and no one is able to put that out of the question. But why only Best Buy? My only explicable answer is:  "the fierce competition" from diversified retailers who have many other things to offer unlike Best Buy. Free shipping, heavy discounts and extended season of the deals cause only one thing and that is shrinking Best Buy's margins. I have no specific thing in my mind which Best Buy can do to come out of this misery, but if they are not able to do anything revolutionary, those shrinking margins will eventually burn all cash.

Few days ago, I read an article on Amazon, which was considered to be "Online store of Best Buy". I could not deny with that, could you? Because that sums up everything here...

Cash is "The King"

What is the difference between the great recession started in 2007-2008 and the global crisis we are currently facing? It is a 4 letter simple word. CASH- no matter what currency it is.

If I focus on the US, the biggest economy in the world, all big banks and corporations are sitting on the huge piles of cash. This was not the case 4 years ago. Most of them were cash stricken. After Apple Inc, the most valued company on this planet, released its 2011 Q2 results, it showed over $70 billions of cash & cash equivalents which is more than the GDP of many countries. Lessons learned perfectly- that's what we can say! Now the question is if these mammoth companies have enormous amount of cash, then why are we on the verge of another worldwide crisis? It is because everyone is too skeptical about economy, political unrest and discomfort in European economies. No one wants to spend their cash based on weak outlooks. If there is no cash circulating in the markets, then how can one make money and drive economy along?

In the course of company's life cycle, if management thinks there is no more growth ahead, then they distribute  excess cash as dividends to reward investors or buy back their own shares. Recently, share buy back has been a spree which is a good sign since companies buy back their "cheap" shares in anticipation of increase in share value. But many companies are issuing cheaper bonds to raise cash and use that cash to buy back their shares. Isn't it unusual? Why would they not use abundant cash they have and end up paying interest payments to bond holders? We have connected the dots here. No one wants to use "cash" they have. Everyone has figured out that cash is the only way to get their company out of the potential financial mess. And once again, it has been proved that cash is the only king you want to save till the end.

Netflix confuses subscribers with a canny idea...

Price hikes. They are riding on the ECON 101 rule of growth and competitiveness in an industry. From my perspective, I was ok with paying half dozen bucks more a month after I heard the news couple of months ago. I think the money I pay for the service and access to the huge library I get is worth. But I am not on the same page with many of the 23 million domestic subscribers. We all do not need to be...

Reed Hastings, CEO of Netflix, sent an apology email to all domestic subscribers for the current pricing disappointment the company has given to their subscribers. The email also contains a brief on the company's plan to separate their streaming (Netflix) and DVD rental unit (will be named as Qwikster). Why? Why would they do such thing when everyone is still coping with the mess company has recently created? And I can imagine a canny idea behind this.

Internet access is ubiquitous. YouTube, Amazon Instant Streaming, Dish Network's acquisition of Blockbuster library and many more to come to share a pie of video streaming business. Growth is going to be good for next few years. Decline phase is not in sight. While the reverse is the destiny for DVD business which has sluggish growth forecasts and is going to be nearly unseen in next 10-15 years. In simple language, if weak outlook for DVD business persists, then Netflix (streaming only) is a better place to get handsome ROI than Netflix (Current: streaming + DVD).

"Wall Street to Netflix: Try Again". I read that on Twitter. After Hastings's public apology, share price tumbled further. So, a tweet justifies a stock market reaction to this event. But now I do not think alike. This seems like a smart move to me rather than pleasing the investors on day-to-day basis. Growth is not immortal. The more you extend your maturity phase, the longer you survive. And Netflix may have learned that already.

What Is Risk-Free Rate?

Let's begin with RISK-FREE RATE 101 class. (Prerequisites: Default-free, Treasury, Safe, Secured)

2 years in the business school and reading all those books of CFA program curriculum. The most repeated term has been- Risk-Free Rate (Rf). It is considered as yield of US Treasury securities. US Government is (was?) considered as default-free thought it fought hard to prevent default recently. Whenever global economy melts or shakes, investors look for Treasury securities. They have been known as the safest investment since there is no volatility or risk included. We employ many risk-return tools (for example, Sharpe Ratio) to calculate excess return achieved by investing in particular assets. This excess return is calculated by considering risk-free rate as benchmark. Many countries with political instability and higher inflation rates do not have their risk-free rates. They add their inflation rate to US risk-free rate to get the benchmark rate for their country. And thus long-term bond yields and so on. This is what the biggest economy stands for.

But in the recent turmoil, I am not able to believe completely that we should still use Treasury yields as risk-free rate or not? I do not want to discuss why S&P has recently downgraded US credit ratings to AA+ from AAA. It may be reversed or may be not. S&P might be wrong in deriving this verdict or they might be late in doing this. I do not know the facts. But few things I surely know that there are few problems in Washington DC. There are serious fiscal challenges we have been facing. Looking at the current scenarios, US may not deserve AAA. But when country has to put efforts to prevent default which US did last week, their risk-free rate should not be considered as default-free rate or benchmark rate. Why can't we change that? Why can't we use risk-free rates from countries like UK, Germany and Canada who still have AAA?

I am not sure about literature we used in the business school, but CFA institute updates its books every year based on recent market conditions. I will not be surprised if I see Canadian rates as risk-free rate in those books next year...

Chipotle: Expectations vs Fundamentals...

I never thought that "burritos" would bring me out from hibernation (it has been nearly more than 3 weeks since I wrote the last blog). I love their food. Many of us do. It is Chipotle Mexican Grill, Inc (ticker: CMG). Short, simple and affordable- 3 words help it rule its peers. An inspirational success and growth story. Following chart  says it all:

Phenomenal growth. Handsome return to investors. Stock was worth $38 on November 20, 2008. Stock is worth $330 today. Do I need to show return figures? Company's business model is fundamentally strong. They target fast food consumers who want to spend $5-$10 on their meals. It has nicely managed the global food inflation. Its store operate in all metropolitan area of the US and try to provide affordable options in such areas. Conclusion: Sweet & Sound!

Yesterday, they announced their second quarter earnings. Earnings were pretty good despite of rough outlook of the global economy. All numbers were decent and higher than last quarter. But I heard the voice.... "Clear Disappointment". I am still trying to figure out why I was supposed to hear that. Reason was--- they missed analysts' estimates. What bothers me is they missed it by dozen cents. Negative earnings surprise. I understand that analysts on the street perform all fundamental analysis and provide their estimates. But I still consider a phrase "Failing to meet expectations" which may make another phrase "Clear Disappointment". If we compare all the numbers with its peers and industry overall, they are still the leader. There is nothing wrong happening with its revenue generating model. It is partially because of too much expectations, isn't it?

Based on Chipotle's news, I wonder what happens in the market if mammoth Apple Inc misses its estimates. Worse. Worst. Why? They never respect analysts' estimates and always believe it positive earnings surprise!! Yesterday, they announced those bottom line numbers 25% greater than estimates. And that sends the story to investors for their EXPECTATIONS from Apple in the next quarter...

How long can you put on your 3D glasses?

When I graduated from high school, I and one of my friends went for IMAX 3D "show". I did not write "movie" because it was a 30 minutes educational/ informative documentary which we always find here in museums. It was expensive. And rare! Times have changed. Now every Friday, we get at least one movie in 3D to spend our wealth on.

Before 3-4 years, when releasing movies in 3D was not as normal as it is now, it started to change the definition of movie watching on the big screens. Stumbling Regal Entertainment Group & AMC Theatres during the painful recession got some room to breathe. Rapid rise of 3D movies boost the earnings for Regal Group, RealD and the hopes for an IPO for AMC. Entertainment sector was almost back on the track with the 3D hits like Toy Story 3, Avatar, Transformers and Harry Potter. Then AMC postponed their IPO plans. Why?

• 3D Burnout- Excess leads to an destruction. Well said! Burnout is the term often used during mortgage refinancing phase for prepayments. When rates are low, you refinance the loan by prepayments. After few years, when rates become lower again, you have nothing much left to refinance. Same applies here. 3D movies and its craze cannot be placed in the category of sustainable items.
• Online movie providers- Ah! Internet is killing everyone. Surge in the paid subscription based online movie providers like Netflix, Amazon, YouTube have clearly staged their competition with these entertainment giants.
• 3D TVs- Dance until music stops. And that is the reason why we can see the brand new isle of 3D TVs at Best Buy or Wal-Mart stores. 

RealD does many innovative things. It recently launches "Wimbledon 3D" for 2011 Grand Slam. Beautiful. Wimbledon 2011 is still in progress, but still RealD stock is suffering today. Why? It is because of less than expected, not poor, box-office performance of Cars 2 which also released in 3D during last weekend. It is a lovely example of positive correlation, isn't it?

Let's see how long we are able to witness the entertainment industry's fight against sustainability and volatility.

A documentary explains "The Capture Hypothesis"

We have avoided disaster and we are recovering... But the men and institutions that caused the crisis are still in power... and that needs to change. They (mammoth banks) will tell us that we need them, and that what they do is too complicated for us to understand. They will tell us it wont happen again... It wont be easy, but some things are worth fighting for.

Finally, I got some time to watch last year's academy award winning documentary, "Inside Job". And what a masterpiece it was! Perhaps, it is the finest documentary I have seen in my life. Neat and straight. It is based on the catastrophic financial crisis from which we are still trying to recover. Last year, I read a book by Suzanne McGee, "Chasing Goldman Sachs: How the masters of the universe melted Wall Street down... and why they will take us to the brink again." The reasons why I like this book and this documentary are the timing, my education and my area of interest. I was about to graduate from business school in  the midst of this crisis. And I was exposed directly or indirectly to majority of the events listed in the book and shown in the documentary.

"Inside Job" emphasizes on the critical issues like political influence, lobbying power of Wall St, corruption- collectively "Wall Street Government" and other market changing events like introduction of derivatives in early 90's, housing bubble, ponzi schemes, subprime lending and the rise of structured products like MBS, CDO and credit derivatives like CDS. But the most important thing I have understood through this documentary is an industry regulation theory, "Capture Hypothesis". According to this theory, regulators of different industries are elected/selected from the pool of experienced and influencing candidates from their respective industries only. For example, regulator for environmental issues cannot be selected from the finance & banking industry. And that is the reason why regulators are more biased towards industry rather than consumers. If they do not support the industry, their spot will become endangered. That is what happened with the failure of 3 big Iceland banks. That is what happened with the regulators' decisions(influenced by Henry Paulson and other top executives from number of big banks) of permitting banks' leverage ratio to rise as much as 20:1 and loosening the regulations on derivatives. Eventually, this led to the collapse of Lehman Brothers, AIG, Bear Sterns, Merrill Lynch, Washington Mutual, Wachovia and many others.

When I was in grad school, I had to watch Wall Street, Boiler Room and Rogue Trader. I am sure that B-school finance majors will have to watch documentaries like "Inside Job" down the roads since ethics and finance and banking and investment are all coherent with one another.