How Google gets rich off of Android system by pretending that it is “Open SOurce”



Since Android was first released, many of us have wondered how open it really is. Last week, we learned more about Google’s (GOOG) tight control over Android through documents released as part of an European antitrust investigation.

The story was first reported by the Wall Street Journal, based on an analysis by Harvard professor Ben Edelman. (The WSJ said that Google declined to comment). The meat of the revelation were copies of the 2011-2012 “Mobile Application Distribution Agreement” (MADA) that was signed by Android licensees Samsung (OTC:SSNLF) and HTC(OTC:HTCCY). The agreements were exhibits in the Google-Oracle (ORCL) (née Sun Microsystems) Java copyright lawsuit in the Federal District of Northern California.

Ties That Bind

Rolfe Winkler of the WSJ summarized the (MADA) agreements as follows:


The Samsung and HTC agreements specify a dozen Google applications that must be “preinstalled” on the devices, that Google Search be set as the default search provider, and that Search and the Play Store appear “immediately adjacent” to the home screen, while other Google apps appear no more than one screen swipe away.

The terms put rival mobile apps, like AOL Inc.’s MapQuest and Microsoft Corp.’s Bing search, at a disadvantage on most Android devices. Mr. Edelman, who is a paid consultant for Microsoft, said the terms “help Google expand into areas where competition could otherwise occur.”

Google has successfully promoted its own apps on Android. Four of the top 10 most-used apps on Android smartphones in the U.S. during December were Google’s, according to comScore. On Apple’s iPhone, only one Google app—YouTube—was among the top 10.


Calling Edelman a Microsoft consultant seems like a red herring. More relevant is that he embarrassed Google by noting that it tracked user browsing even when users disabled it. Edelman seems an equal opportunity Internet activist, having spent his entire adult life at Harvard (earning an AB, AM, JD, and PhD in econ before becoming an assistant and associate professor at Harvard Business School).

In his own analysis, Edelman shows how Google’s activities constitute tying:


If a phone manufacturer wants to offer desired Google functions without close substitutes, the MADA provides that the manufacturer must install all other Google apps that Google specifies, including the defaults and placements that Google specifies. These requirements are properly understood as a tie: A manufacturer may want YouTube only, but Google makes the manufacturer accept Google Search, Google Maps, Google Network Location Provider, and more. Then a vendor with offerings only in some sectors—perhaps only a maps tool, but no video service—cannot replace Google’s full suite of services.

I have repeatedly flagged Google using its various popular and dominant services to compel use of other services. For example, in 2009-2010, to obtain image advertisements in AdWords campaigns, an advertiser had to join Google Affiliate Network. Since the rollout of Google+, a publisher seeking top algorithmic search traffic de facto must participate in Google’s social network. In this light, numerous Google practices entail important elements of tying:



If a wants Then it must accept
If a consumer wants to use Google Search Google Finance, Images, Maps, News, Products, Shopping, YouTube, and more
If a mobile carrier wants to preinstallYouTube for Android Google Search, Google Maps (even if a competitor is willing to pay to be default)
If an advertiser wants to advertise on anyAdWords Search Network Partner All AdWords Search Network sites (in whatever proportion Google specifies)
If an advertiser wants to advertise onGoogle Search as viewed on computers Tablet placements and, with limited restrictions, smartphone placements
If an advertiser wants image ads Google Affiliate Network(historic)
If an advertiser wants a logo in search ads Google Checkout(historic)
If a video producer wants preferred video indexing YouTube hosting
If a web site publisher wants preferred search indexing Google Plus participation


Not all tying is illegal. But tying by a dominant firm is legally suspect — even more so in Europe, where the competition policies are more aggressive (especially for US firms like Google).

Technically Open, Commercially Not

From a practical standpoint, phone makers have no choice but to comply with Google’s terms (with the exception of China’s domestic market, where Google’s services are blocked). As OSS IP maven Florian Muellerwrote:


Technically you can take the free and open parts of Android (in terms of the amount of code, that’s probably the vast majority, though the share of closed, tightly-controlled components appears to be on the rise) and build a device without signing any individual license agreement with Google, and some have indeed done so. If that is so, why did Samsung and HTC sign those agreements that have now come to light? For commercial reasons.

If you want your Android device to sell, you normally want to be able to call it an Android device. To do that, you need a trademark license from Google. Open source licenses cover software copyright, they may come with patent provisions, but licenses like the GPL or ASL (Apache) don’t involve trademarks.

The trademark — the little green robot, for example — is commercially key. In order to get it, you must meet thecompatibility criteria Google defines and enforces, which are mostly about protecting Google’s business interests: the apps linked to its services must be included. And those apps are subject to closed-source, commercial licensing terms. That’s what the MADA, the document Samsung and HTC and many others signed, is about.

Even if you decided that the trademark isn’t important to you, you would want at least some of the apps subject to the MADA. What’s a mobile operating system nowadays without an app store? Or without a maps/navigation component? Google gives OEMs an all-or-nothing choice: you accept their terms all the way, or you don’t get any of those commercially important components. And if you take them, then you must ensure that the users of your devices will find Google services as default choices for everything: search, mail, maps/navigation, etc.



This “free” software comes at a price. Even if Google doesn’t charge royalties to use its applications, the London Guardian estimated last month that it costs $40k-$75k to test a new handset for compliance with Google’s standards and thus be allowed to ship Google’s applications.

Google Isn’t Open About Not Being Open

Most troubling for me has been — since the beginning of Android — thegap between Google’s rhetoric of openness and the reality; for example, see “Open source without open governance” (June 2008), “Perhaps someday Android will be open” (July 2008), “Sharing in faux openness” (October 2009), “Google’s half-full glass of openness (January 2010), “Andy wants you to buy his openness (June 2010) “Semi-open Android getting more closed” (October 2013).

While these agreements have been in place for at least three years, Edelman notes that Motorola redacted the most important provisions of the MADA when it disclosed excerpts in a 2011 SEC filing. Google’s lack of transparency about its non-openness helps it be more successfully non-open:


MADA secrecy advances Google’s strategic objectives. By keeping MADA restrictions confidential and little-known, Google can suppress the competitive response. If users, app developers, and the concerned public knew about MADA restrictions, they would criticize the tension between the restrictions and Google’s promise that Android is “open” and “open source.” Moreover, if MADA restrictions were widely known, regulators would be more likely to reject Google’s arguments that Android’s “openness” should reduce or eliminate regulatory scrutiny of Google’s mobile practices. In contrast, by keeping the restrictions secret, Google avoids such scrutiny and is better able to continue to advance its strategic interests through tying, compulsory installation, and defaults.

Relatedly, MADA secrecy helps prevent standard market forces from disciplining Google’s restriction. Suppose consumers understood that Google uses tying and full-line-forcing to prevent manufacturers from offering phones with alternative apps, which could drive down phone prices. Then consumers would be angry and would likely make their complaints known both to regulators and to phone manufacturers. Instead, Google makes the ubiquitous presence of Google apps and the virtual absence of competitors look like a market outcome, falsely suggesting that no one actually wants to have or distribute competing apps.



With some irony, the WSJ article quoted Google’s former CEO:


“One of the greatest benefits of Android is that it fosters competition at every level of the mobile market—including among application developers,” Google Executive Chairman Eric Schmidt wrote to then-U.S. Senator Herb Kohl in 2011.


Peeling Back the Layers of Openwashing

While the most specific and conclusive, this latest revelation is not the only evidence that Android is more openwashing than open source.

For example, in October Ron Amadeo of Ars Technica listed all the cases where “open source” Android once came with a key application available in open source, but then Google orphaned the open source app when it brought out a fully-featured closed-source replacement. This includes the Search, Music, Calendar, Keyboard, Camera and Messaging apps.

At the same time, Google (with great success) sought to convince app developers to use the Google Play APIs rather than the official Android APIs — thus making these apps incompatible with devices that use only the open source part of Android (e.g. Amazon’s Kindle). If you want to use apps from the Google app store, you have to use the Google APIs.

Finally, there’s the matter of the Open Handset Alliance, the organization nominally leading Android development. Amadeo makes clear that OHA is more like the Microsoft Developer Network than the Eclipse Foundation (emphasis in original):


While it might not be an official requirement, being granted a Google apps license will go a whole lot easier if you join the Open Handset Alliance. The OHA is a group of companies committed to Android—Google’s Android—and members are contractually prohibited from building non-Google approved devices. That’s right, joining the OHA requires a company to sign its life away and promise to not build a device that runs a competing Android fork.


Google: Partly Open and Opening Parts

In the early 2000s, open source was a paradox. When I began researching my second open source article (which I used as a job talk in December 2001 and was published in 2003), it was not clear how firms could make money from something nominally open. Based on a study of Apple, IBM and Sun, I concluded that firms made money off of openness with strategies that were open in one of two ways: they opened parts (leaving other parts close) or they were partly open (granting some rights, but not enough to enable competitors).

Google is clearly doing both. Amadeo emphasizes that with Android, Google is only opening parts — leaving key components under tight control. Meanwhile, the latest news points to Google being only partly open: rights to use the “open source” (actually, a mixed-source) system depend on complying with a series of Google restrictions.

In 2011, mobile analyst Liz Laffan studied the openness of eight mobile-related open source communities. Building on a 2008 study I did with Siobhan O’Mahony, she developed a 13-factor openness score for firm controlled open source communities. In her report (summarized in a 2012 journal article) Laffan assigned scores from 0-100% open. Android was lowest at 23%, and in fact the only project less than 50%. At the other extreme, Linux was 71% and Eclipse (designed to be open from the start) was 84%.

Conclusion: Real World Android is a Proprietary Platform

In the 1980s and 1990s, Microsoft won commercial success by widely licensing its PC operating system to all comers. However, after the initial licenses (with its launch customer IBM), Microsoft largely dictated the terms of these licenses.

When people buy an Android phone, they are not buying the Android Open Source Project but (as Amadeo makes clear) the Google Play Platform. This platform — call it Real World Android — has the following characteristics

  • Like Apple’s (AAPL) OS X (or IBM’s WebKit), it combines open source and proprietary elements.
  • Like Windows, it is licensed to a wide range of hardware manufacturers.
  • Like both OS X and Windows, much of the value comes from bundling a wide range of proprietary, closed-source applications

In short, Real World Android is a proprietary platform: proprietary in that it is a mixture of open source and proprietary elements, but the complete platform (including application functionality and access to the Android app ecosystem) requires licensing proprietary technologies under a restrictive proprietary contract. (For a true open source system, the open source license would be enough).

A few market experiments (notably Kindle and the Chinese market) have been made using the Android open source project (which Amadeo dubs AOSP). For the remainder, as Florian notes, commercial success requires agreeing to Google’s terms to use its proprietary platform. If it was ever accurate to refer to Android as an open source platform, it’s clearly no longer true today.

Yes, by using an ad-supported (two-sided market) approach Google doesn’t have to charge royalties, but that doesn’t make it free (as in speech or as in beer). With 42% of the US mobile ad market — and Android accounting for the majority of US smartphones — Google makesbillions off of Android users. Google’s preloaded apps command choice real estate, and if Google didn’t control this real estate, handset makers could sell this real estate to the highest bidder.

So despite all the rhetoric, Google is just another tech company that wants to rule the world and make zillions for its founders and executives. It controls its technology to gain maximum advantage, and (like many firms nowadays) uses openwashing to render spotless its proprietary motivations. This shouldn’t be surprising. It won’t be a surprise for anyone who reviews the how Android evolved (and the strategy emerged) over the first five years.


Professor, tech, energy

Some Smart Hedge Funds like AAPL


BY: Hedgemony.   A social research tool to discover where hedge funds and other investment managers are finding investment opportunities today. Join now to find out where to put your money to work like the experts do!

We all know Apple (AAPL) has had a tremendous decade of growth, but just to explicitly remind you how astronomical it has been, below is the table of Apple’s yearly performance. The stock has been up nearly every year by sensational amounts, and even though 2013 was a rocky year, it still managed to put forward a positive post.

Date Price Change % Change
12/31/2013 561.02 28.847 5.42
12/31/2012 532.173 127.173 31.4
12/30/2011 405 82.44 25.56
12/31/2010 322.56 111.828 53.07
12/31/2009 210.732 125.382 146.9
12/31/2008 85.35 -112.73 -56.91
12/31/2007 198.08 113.24 133.47
12/29/2006 84.84 12.95 18.01
12/30/2005 71.89 39.69 123.26
12/31/2004 32.2 21.515 201.36
12/31/2003 10.685 3.52 49.13

What is more interesting about the quality of Apple’s return, however, is that the correlation to the broader market is at an all-time low. I graphed the 120-day daily rolling correlation to the SPX index, and it is at a decade low of 12% (having peaked as high as 80% from 2008-2011).

(click to enlarge)This signals that Apple is becoming a source of diversification to the broader market, believe it or not, and may even be a source of true alpha generation going into 2014 after a lackluster 2013 with what many agree has resulted in cheap valuations at 12x PE (when the SPX index itself is at 17.5x today). Out of curiosity, I looked into who the smart money institutional owners of Apple are, and I was surprised to find an eclectic collection of well-respected hedge fund managers that are each known for their unique and proven investment strategies.

Top 5 Hedge Fund Holders Explained

If you look through the Top Holders of Apple on Hedgemony (, you can observe that there is an array of institutions – from banks to sovereign wealth funds. I sorted the list by “percent of Portfolio” which is what I think remains the best proven metric of the investment thesis conviction. While percent of shares outstanding is important to gauge size in market, a portfolio manager’s conviction is only reflected by sizing within his fund assets. Of the 100 fund holders that have sized Apple to be 4.5% or greater, I share with you the top five hedge funds that remain relevant players today. I will provide you a brief biography so that you understand their pedigree and investing philosophy, which may perhaps even motivate you to peak into what other stocks they own so that you can gather new intelligence if their investing philosophy is in line with yours.

Shares % of Portfolio
Greenlight 2,397,706 20.29%
Andor 350,000 12.40%
Valiant Capital 258,431 10.57%
Empire Capital Management 180,000 9.89%
Nokota 425,000 8.84%

1) Greenlight – Long term value + activism

David Einhorn really needs no introduction to anyone who follows the hedge fund industry. A Cornell graduate, Mr Einhorn has demonstrated success not only in long positions but also in shorts through some various highly publicized inquiries (there was Green Mountain (GMCR), Chipotle (CMG), and even Herbalife (HLF) at one point before the infamous you-know-who got involved). He has returned ~20% annually for almost two decades, with a beta less than half and now currently runs close to $5 billion. His investing philosophy tends to be very long-term oriented so his portfolio does not turn every quickly. In fact, comparing quarter to quarter on his 30 stocks according to the 13Fs, only three are new initiations in Q3 2013, and of the remaining 27, 16 of them didn’t even change in sizing. That’s value investing. And guess how much Apple Greenlight owns? A whopping 20.3%. In fact, it’s his largest position in the portfolio and if there’s any career investor you can trust who did his homework, it’s Mr. Einhorn. Regarding his activism, he has advocated for an efficient reorganization of the capital structure; a similar theme was more recently repeated by Carl Icahn himself. While suing Apple initially was probably not the friendliest of actions, he remains level-headed in the pursuit of several share buyback arrangements that have been received positively by Tim Cook. 2014 may be the year that everyone waited for the release of Apple’s cash to determined investors. Fun fact: he is also related to Sheryl Sandberg as cousins, for what it is worth.

2) Andor – Technology guru + concentrated risk

Andor Capital is run by a guy named Dan Benton, ex Pequot. It is a technology specific hedge fund with reported assets north of $1bn of which a significant chunk were from investment gains itself. The firm suffered horrible losses in 2008 during the financial crisis and was temporarily shut down, so risk management is not the strongest suit. The firm employs a traditional long short strategy, but is known for taking very concentrated positions (15-25 names), with the top 5 names to account for over half the risk during various cycles – potentially the reason why the firm faced such difficulty in 2008. His most notable longs in 2013 were Google (GOOG), Cirrus Logic (CRUS), Mellanox (MLNX), eBay (EBAY), among others. Today, his top position remains Facebook (FB), but Apple is a close 2nd.

3) Valiant Capital – International markets focus + Tiger grandcub

Valiant Capital is a $2.5bn long short fund managed by Chris Hansen, a member of the Tiger family. It was founded in 2008, and Chris was formerly an MD at Blue Ridge Capital for over five years. His performance unfortunately in 2013 was lousy – most likely due to shorts, and his past performances has been mediocre as well. Also important to note is that he invests internationally (60%+ of his longs are non-US) – and emerging markets generally has had a tough environment, especially India and Brazil. Regardless, Mr Hansen is a stubborn investor who sticks to what he knows and likes best – and he likes value and shorts frothy fraud-like names of utmost exuberance. This didn’t work in 2013 with the social media frenzy and general appetite for multiple expansion, but his pedigree and value-oriented picks should give comfort to why Apple remains a strong buy from a macro angle beyond the US stock market.

4) Empire Capital – Longevity

Empire Capital is arguably the least known fund on this list – and that’s perhaps because the fund is a lot older than others (which is a good sign and the reason for my inclusion of conviction). It is run by Scott Fine and Peter Richards, and is one of the oldest technology hedge funds in existence, having launched in 1996. Apple remains their 2nd largest position. The conviction I get from Empire Capital being on the list is that they are one of the few tech funds to have experienced the tech bubble and then survive to rise. My guess is that they are careful in their longs being fundamentally sound and not momentum driven, as a survival period of ten-plus years in the tech investing space is a testament to its own success. There are not even many technology firms themselves that last that long.

5) Nokota – Event Driven + Tactical

Nokota, saved for last, is nonetheless a compelling addition to the roster. Nokota, founded in 2011, is run by two guys named Matt Knauer and Mina Faltas. What is truly outstanding about this firm is that both PMs come from two of the most successful hedge funds ever – Appaloosa Management and Viking Global Investors. In fact, David Tepper helped seed Nokota, which is a strong signal of conviction for his fellow analyst. Nokota tends to traffic in event-driven names and situations, where a tactical component is maintained to dynamically mange the risk from a top-down level in addition to being fundamentally driven. It combines the best practices of both worlds thanks to the PM’s complementing experiences. They own Apple through options, which is an interesting implementation that signals that there may potentially be the necessary event in the short-term to capture outsized volatility in the right direction. Nokota also tends to own relatively unknown names, so seeing a brand name like Apple on the list makes me believe that it is compelling beyond general expectations.


What I have tried to highlight is that of the five hedge fund holders on the list that are each known for different expertise, Apple remains an outsized top position for all in unison. Be it fundamentally value driven with an activist component, or a tactical overlay to an event-driven strategy, by sector generalists or technology gurus, from 1996 launches to 2011 newly minted managers, it really is the most solidly diverse source of conviction that anyone can ask for. It is when such consensus among varied investors is reached that an average investor can gain conviction in joining the camp. Sometimes, it is just as simple as that – you win by following the smart money ahead of you.

Micro: Leasing Software




At the end of each year a special stock buying situation occurs, and I like to pick up some beaten down bargains before the window closes. Typically between November 15 and December 31, stock owners reduce income taxes by selling some losing positions. This is especially important in 2013, as even mediocre investors likely have substantial trading profits that need to be protected from Uncle Sam.

Since 1950, 80% of the periods comprising the last 7 trading days of each year and the first 3 days of the following year have been positive for stocks. The average gain during those periods has been 1.5%. Tax selling in the weeks immediately before Christmas may be one dynamic that has funded these “Santa Clause Rallies.” Additionally, tax selling is generally credited as a cause of another market phenomenon known as the “January Effect,” the tendency of small cap stocks to outperform in January.

I am very respectful of the market philosophy of not trying to “catch a falling knife.” There are reasons why a stock has underperformed and is being sold for tax benefits. Therefore, I have a few filters I prefer to use before investing in a value proposition that is on sale during tax-sale season:

  1. The negative influence on the stock was limited to a one-time or short-term event.
  2. Positive influences are probable in the following year.
  3. I prefer small caps that were possibly oversold by retail investors (January Effect candidates).
  4. The stock should have reasonable fundamentals and growth prospects.
  5. The stock should be showing signs of reversing the fall.

One candidate that meets these requirements is NetSol Technologies (NTWK), a software developer for the leasing market, with finance and leasing arms of most of the world’s leading auto makers as clients. The company announced blow-out annual earnings in September, but was subsequently hard hit by sellers fearing big costs associated with an aggressive expansion plan outlined in the annual conference call. A few weeks later, there appeared a vicious short attack in a SA article citing “potential” accounting irregularities, and traders and short sellers hammered the stock. The company issued a professional but mild rebuttal that got little exposure and minimal market reaction. Finally, a disappointing first quarter earnings report dropped the stock into the bargain basement. However, 2014 should be kinder to NTWK as present growing pains subside, and new products could put NTWK back on path to achieve its stated initiative of double digit revenue growth and expanding margins for the next five years.

(click to enlarge)

I think part of the problem for this company is some misunderstanding of the company culture. NTWK is not a fly-by-night newcomer. It went public in 1997, was a darling and survived when most others crashed by cutting costs, working closely with solid clients and eventually emerging as an enterprise with a double-digit growth profile. On April 23, 2013, the company’s first and only CEO, Najeeb Ghauri, stated in an interview with a NADAQ reporter that the company “has never lost a single client.” One reason the relationship is so important to both NetSol and its clients is that NTWK’s product is customized to work with the various accounting and enterprise programs utilized by each client. Daimler Benz (OTCPK:DDAIY) is different from Nissan (OTCPK:NSANY), Toyota (TM), BMW, Volkswagen (OTCQX:VLKAY) and other NetSol clients, so the custom application creates a long-term marriage.

About half of the revenue comes from service fees working for new and existing customers. The other half of revenue is split between software license sales/renewals and maintenance fees for existing licensees. These activities represent some reliable, recurring revenue. The NetSol bread and butter is getting its foot in the door, and then working with the clients to continually upgrade and improve their systems, which manage the full spectrum of the leasing cycle, from applicant processing to disposal of assets, and all the administrative and accounting functions in between. NTWK has focused on financing and leasing operations in Asia, India and Middle East markets primarily, but also has clients in Europe, the US and Latin America. A company initiative is to double US and Latin American operations in the next three years. This is part of the reason for the recent introduction of its next generation leasing software platform, NFS (NetSol Financial Suite) ASCENT.

Are NetSol’s negative influences near-term or systemic?

In September, NTWK reported annual earnings indicating a 27% revenue increase, and earnings per share more than doubled.

Net Revenues: 2013 2012
License fees 17,756,444 13,369,701
Maintenance fees 9,550,471 7,866,930
Services 23,490,243 18,538,893
Total net revenues 50,797,161 39,775,524
EPS .95 .39

So why is NTWK selling with a PE of 5 times trailing earnings? As the stock shot above $12, the company clarified in the conference call that it was embarking on an aggressive plan to hire about 300 engineers and build a facility in Pakistan for their workplace. The company explained that their customers were indicating the need to upgrade and expand their NTWK services, and growth with new markets and customers required them to add staff to meet it. The company stated that it would require about 6 months of training before the new engineers would be productive, so they could not provide guidance for the following quarter or year. Traders immediately realized that the added expansion costs would negatively impact the stock for at least two quarters, and they bailed out.

Seeing the stock’s weakness after a blow-out year, the short seller, a first-time SA contributor, published an article attacking the company, implying “potential” accounting problems. Specifically, he stated that the company was “hyper-aggressive” in capitalizing R&D instead of expensing those outlays. Also he cited “red flags,” trying to imply insider deception at NTWK due to long-term relationships with it’s auditor and investor relations company, which both had past clients in their history which had duped investors. Given the company culture of developing and maintaining relationships, it is understandable that NTWK would stay with the firms that helped them survive the dot-com bubble implosion. This inclusion of unrelated stock failures was irrelevant, but, combined with the accounting concern, the short attack was effective in dropping the stock several points.

Regarding the accounting concern, the FASF rule is that the engineering costs should be capitalized if the company expected to realize revenue generation from the effort. Of course the R&D was primarily to meet needs of existing clients and respond to their suggestions to improve the existing software; therefore, NTWK was well within the guidelines for its selected accounting method. Actually, the company could gain a tax advantage by expensing those costs, but that would seem to be more subject to scrutiny, given the company’s business model. The short seller further cited unrelated technology companies that expensed those costs, without regard for business differences and tax preferences…another irrelevant point.

In general the points in the short seller’s article were mostly based upon innuendo and its own manipulation of accounting, but it should not be discarded completely. The company business model generates engineering work before revenue collection, and collections have been slow. NTWK has added a new CFO recently and there has been inconsistency in that position. The company has noted, and reports bear out, that the Accounts Receivable collection has improved, but remains more than 100 days of sales, which is high. This is actually not very unusual for companies operating in Asia, where payments are notoriously slow. Also, the credit quality of the major auto manufacturers should be reliable, but the high AR is the largest problem that I see in the accounting area.

In the latest quarter, ending in September, the company introduced the ASCENT software, but the only impact on the earnings for that quarter were the costs associated with the launch of that product, as new deals had not had time to be finalized. Since then the company has announced that Nissan Thailand has adopted the new software. The company also reported reduced revenue in the September quarter, explaining that clients were holding off license purchasing and upgrades, aware that NTWK was developing a better product. This also meant that service fees were reduced, as those are partly triggered by license sales. The company results indicated a net loss, and the stock dropped below $5 from the $12 it sold for after blow-out annual earnings.

Expectations for 2014

At its current price, NTWK appears to be a reasonable value, selling well below book value and with a market cap below annual revenue. If the company meets its goal of 55 – 60% gross margins for 2014 and double digit revenue growth, it will need a fast acceptance of the ASCENT platform and booming sales in the rest of 2014. However, analysts are assuming that the losses will continue for the current quarter, with profit in the last half of the fiscal year (ends in June) just balancing out the losses in the first two quarters. They also expect NTWK to produce more than $1 per share earnings in 2015. Although accounting issues can cloud the book value and EPS calculations, YAHOO statistics indicate that operating cash flow exceeds $1 per share, even including the weak recent quarter. However, I should mention that any investor considering an investment in NTWK should expect cash flow to be plowed into the growth and expansion initiatives this year.

The intelligent stand might be to wait until a couple quarters have been reported to be sure that ASCENT will take off as expected, and risk missing the chance to get in at a bargain price. After all, we should know by mid-year if the 300 new engineers will be producing profitable services, making the drag of the current training costs look like a smart investment. On the other hand, short sellers may be waiting for the year’s end to buy back shares, and the January Effect could be a particularly powerful tailwind on the NTWK stock. Waiting until everything is clear and verified is a luxury that stock traders do not have. Technically, the stock is showing signs of life, so the bottom may be in.

Ii is difficult to determine the seasonality of license sales and renewals for NTWK, but many such software vendors experience slow end of year sales, with the best quarters being the first two calendar quarters in the year (NTWK’s last two fiscal quarters). This has to do with capex budgets and spending, and I think that is why the timing of the new release was made late in the year, to take advantage of a ramp up to a busy marketing effort in early 2014.


NetSol Technologies has been in the business of developing programs to facilitate the processing, administration and accounting for leasing companies, particularly those in the auto industry since 1997. We have had this stock on our radar for some time, because the auto leasing business in emerging countries has only begun and there is much room for growth. NTWK has chosen a niche that is not free from competition from generic software, but the special custom features of its products and customer service are the differentiating factors in its market. The proof is the long-standing relationships with the leasing divisions of many of the world’s leading auto makers, which provide a valuable recurring revenue stream. The company has established management and has weathered tough times before. There is a lot to like about NTWK.

Concerns about operating in potentially unstable locations, complicated accounting that arguably is not as conservative as some companies, high levels of accounts receivable and unknown acceptance of the next generation product are clouds that have hung over the company lately. Those have kept the stock price at a level that has frustrated investors this year. That frustration is exhibited in tax selling, which appears to have created an oversold situation.

Of those concerns, the one that is most important to me is the question about the acceptance of the ASCENT platform. It is good to remember that NTWK is in constant contact with its clients, performing improvements to the existing systems and listening to their needs. I have to think that before embarking on an aggressive expansion of staff and facilities, that the NTWK management had good visibility about the market for the new technology. In fact, if the industry widely expected a newer version to be available that meets new needs, the potential buyers certainly would wait for that product. This explains the lack of activity in the past quarter, which could indicate that pent-up demand will materialize as new IT budgets are established by clients and potential clients in early 2014. Management has also indicated that they feel that the ASCENT product has enough competitive advantage that they will not be offering deep discounts to make sales. The company is focusing on larger contracts and expanding margins. Those deals can take longer to finalize and the company has indicated the pipeline is healthy.

Software companies typically carry a PE of more than 20, and at the end of 2014, we expect that NTWK will be earning at an annual $1 EPS clip and growing revenues at a 10-20% rate. By the end of 2014, a PE of 20 would create a target price of $20 per share, opposed to the current $4.80 share price. Although we are more conservative, that is not out of the question, as it would represent a price of 4 times sales and less than 3 times book value. The company may have been able to continue for some years with an EPS near the 2013 level of $.95 without the drama and risk of the aggressive growth plan. However, we would not be so interested in a small company that was satisfied with only treading water.

I do think it is reasonable to expect that NTWK will have some lumpy revenues, as big clients move the needle, and growing pains with the new platform. However, I agree with the strategy of making a controversial move to dramatically increase market share and grow the company. There is some leverage in the revenue and earnings growth potential, because sales of the new ASCENT system also create additional service fees. It is a speculative bet for sure, but the current tax-selling season is probably the best time to place that bet. We think the NTWK management has worked hard and been through much to get this company healthy, and they would not jeopardize that on an ill-planned expansion. We have lower expectations than they do, but we do expect NTWK to double in 2014 to $9.60.


SUPERCOM Interesting stock. Elements of a turnaround in the framework of a startup.  It is back where it was six years ago, after a huge fall and more than five years of going nowhere.

Nasdaq: SPBC. PE 10.31

Note the interviewer is Lazarus InvestmentsPartners, an  Investor in Supercom

Introduction(LAZARUS) . Every once in a while we walk out of a first meeting with a management team and are interested in immediately buying stock in the company they run. That was the feeling we had the first time we met with the team from SuperCom (SPCB). We were so intrigued by our initial visit that we followed up the next day by returning to their office for a second meeting. Weeks later we became one of the company’s largest shareholders. What we saw, and still see, in SuperCom is the rare combination of:

  • a highly incentivized management team with a track record of building shareholder value
  • a corporate turnaround to which the market was giving no credit
  • an acquisition (now complete) of the company’s largest competitor that nearly triples the revenue base and grows EBITDA 2.5x
  • a recurring revenue model with long term visibility
  • a loyal customer base that’s extremely sticky
  • growth opportunities that offer the prospect of multiplying the top line
  • a very low valuation

We’ll give a quick overview of the business but spend most of the article expanding on the above points, followed by an interview with SuperCom executives. (If you want more background on the company, try this article by Tom Shaughnessy, this article by Irit Jakoby, and the company’s recent road show presentation.)

What they do. SuperCom has two business segments which both use proprietary technology to service long term contracts with sticky customers.

The electronic ID [EID] division offers a full solution for managing countries’ digital identity programs, such as drivers’ licenses, passports, and national ID’s. These programs are essential to countries’ operations and also serve as revenue sources for governments. The number of countries with national EID’s is expected to grow by 70% over the 5 years ending 2015.

The RFID (radio frequency ID) division offers complete solutions for monitoring and tracking people and assets. SuperCom focuses on 3 verticals: public safety (offender tracking), home & healthcare (patient and medical equipment tracking), and animal intelligence (herd and pet tracking). SuperCom’s RFID technology has several important advantages over competing products, including battery life that is up to 10 times longer and price points a fraction of competitors’. The slowest annual growth rate among these verticals is 70%, driven in large part by cost savings. One example: the cost for maintaining an inmate for 1 year is $30,000 to $60,000 whereas the annual cost of electronic monitoring is $1,000 to $5,000.

The company sells software, hardware, and services which altogether offer attractive profitability, on an adjusted basis: over 80% gross margins and operating margins over 25%.

Transformative acquisition. Just a few days ago, on December 26th, SuperCom announced that it closed on the acquisition of On Track Innovation’s (OTIV) [“OTI”] Smart ID division. This division is very familiar to SuperCom, since it used to be part of SuperCom before it was sold to On Track. The purchase price to SuperCom was an exceedingly low 3.5x EBITDA.

Before we tell you about the significance of this acquisition let us address a question that is probably on your mind – if the Smart ID division is so attractive, why did OTI sell it, and why did they sell it so cheaply? We met with OTI management earlier this month and they explained that they were going through a restructuring and had to choose which businesses to focus on and which to move out. There was much debate inside OTI, and they considered making the Smart ID business their main focus. In the end though, they decided to sell this segment to their competitor SuperCom and focus on their NFC (near field communication) technology business. SuperCom was the natural buyer because of their prior ownership of this division and because they were its chief competitor. Most other buyers would have had to add significant infrastructure to bring on OTI’s division. The acquisition multiple was so cheap on a pro-forma basis because it’s based on the contribution to SuperCom’s EBITDA; SuperCom already had the experience and the assets so they can just plug and play this division. The multiple would have been higher for another buyer acquiring the division on a standalone basis.

OTI’s Smart ID division was SuperCom’s single largest competitor in the EID business. The two companies were of comparable size and often both made it to the short list on competitive RFP’s. The acquisition positions SuperCom to win more contracts and also reduces the pricing pressure when they bid. It diversifies SuperCom’s revenue base and adds new countries to the client list. This last point is very important since once SuperCom is awarded one contract in a country (eg, voter registration) that gives them a huge advantage when the country wants to add other services (eg, passports and border control) since new services involve only an additional module to SuperCom’s platform, rather than having to install and manage a whole new system.

The financial impact of this acquisition is dramatic. We’ll cover ahead the RFP pipeline that SuperCom is acquiring. On a trailing basis, looking at 2012 pro-forma numbers, the addition of the OTI segment takes SuperCom’s revenues from $8.9 million to $26.3, an increase of 296%, and grows EBITDA to $7.9 million, up from $3.1 million, an increase of 255%. SuperCom’s market cap today is just north of $50 million.

A business Buffett would love. SuperCom’s EID segment has many of the hallmarks of a classic, defensible business – the type Warren Buffett and other savvy investors are drawn to. Globally, there are only about a dozen full service solutions providers for national identity systems. No surprise, governments are very, very picky about whom they entrust to run these sensitive programs. SuperCom has a track record of successfully implementing programs for over 20 governments. If you are a competitor looking to get into this space but haven’t already done it for years someplace else, you don’t have a chance.

The contracts are long term in nature, with stable recurring revenues, often paid monthly. Five to seven years is typical for a contract minimum, as are multi-year renewals. Some of SuperCom’s contracts have been in place for 15 to 20 years. The reason for this is very simple: once you run a massive national program on a system, you can’t switch that easily. Millions of people have ID’s on that system and agencies rely on the system to run their operations, so there are both cost and logistical barriers to switching.

Once you have your technology infrastructure in place with a country, you are a shoe-in for the addition of any new systems the country needs. Competitors will offer entirely new systems and won’t be able to match the price, timing, or convenience that comes with adding an incremental program to a system already familiar and in operation.

Besides impacting national security, SuperCom often services programs that are revenue centers for governments, so contracts tend to grow in size over the years.

To be fair about it, the flip side to having very sticky customers means that the decision-making process for a contract award can take 2 to 3 years. This makes it hard to add new contracts over a short period of time – unless you happened to have acquired a full pipeline of RFP bids, the way SuperCom just did.

The pipeline. In the interview you’ll read SuperCom management get into the details surrounding their pipeline of opportunities. In brief, they are feeling great about things since they not only took out their largest competitor but also got to add that competitor’s pipeline to their own. The combined pipeline included over 50 bids in more than 20 countries. The bids SuperCom has out are at various stages, with a number of contracts expected to be announced in 2014. The contracts vary in size, from $5 million to $150 million. There are larger contracts out there, but SuperCom wisely chooses not to compete against industry giants such as 3M (MMM) and Gemalto (OTCPK:GTOMY).

Based on the interview it sounds like SuperCom only needs to win 10% to 15% of the contracts they are bidding on to keep busy for the next 7 years. Arie, SuperCom’s CEO, commented, “I do believe that, if we can make the most of having both companies combined together, that a win rate of over 10% is very, very achievable.”

What’s possible.

Listen further to what Arie is saying about the magnitude of what’s possible with the EID pipeline of opportunities:

“In the EID market we talk about contracts that, in many cases, can be 3-times larger in size than the combined revenue of SuperCom and OTI. So investors may be surprised to see that — maybe — we’ll announce a contract that will double our revenue in the next three years, just from one contract.”

– Arie Trabelsi, SuperCom’s CEO

After growing revenues from $9 million to $26 million with the OTI acquisition, SuperCom is suggesting that it has multiple opportunities that can again triple revenues to the $78 million range.

Management is targeting growing revenues as much as ten-fold over the next 5 years, to the $200 million to $250 million range-and that’s before accounting for possible acquisitions. Every time we publish an article suggesting that the future of a company might be different from its past we get vitriolic “how dare you!?” comments, and we’re confident this article will be no exception. We do wish to point out that SuperCom was highlighted by Forbes for its 30-fold increase in value this year, so when Arie suggests a mere 10-fold increase in revenues over the next 5 years, it just might be possible.

We’ve chosen to focus on the EID segment more than the RFID segment for this article, but note that management is guiding for RFID contract awards in 2014. This segment is growing even faster than EID and the company feels that their technology is the best on the market, in many instances.

Management also happened to mention a number of sizeable acquisitions that occurred in the RFID space (Safran bought L-1 for over a $1 billion, and 3M bought Attenti for over $200 million, for example), some at high multiples. We certainly see a takeout as a possibility for SuperCom, if not in whole than at least segments of their business.

Management. SuperCom’s management has a long history of turning around companies, growing businesses, and completing accretive acquisitions. As we noted above, this year alone the stock has been a huge winner, yet there’s an ambitious 5-year plan to continue to grow the company to multiples of what it is today. An investment in SuperCom is a chance to ride management’s coattails with their latest venture.

To give you a feeling for how driven Arie Trabelsi is, we’ll point out that to accommodate our schedule, he held the below interview at 1:30 am local time. He hadn’t slept much in recent weeks as he was rushing to get the OTI acquisition financed and closed, but he still made time for the interview. If you are wondering why Arie is so motivated to grow SuperCom, look no further than the Trabelsi family’s 44% stake in the company.

The Trabelsis got involved with SuperCom in late 2010, when the business was plagued with a bloated cost structure and lack of focus under prior management. Note the trend in the company’s operating income, from losses in 2010 to a small profit in 2011 to a handsome one in 2012. Almost as soon as Arie and the new management had the company turned around, they completed the OTI acquisition that tripled revenues. The team has the drive and the record of building shareholder value.

2010 2011 2012
-$1.048 million $0.054 million $2.006 million

Valuation. Despite the recent acquisition, SuperCom remains under the radar of many investors. And despite the increase in SuperCom’s share price this year, shares remain exceedingly cheap. Simply put, if it’s off the radar today, it was out of the solar system earlier this year. The presentation from just a few months ago showed shares trading at 2.5x earnings. Below is a snippet so you’ll know we don’t make this stuff up.

Shares have increased in price since then, but post the acquisition of OTI, on a pro-forma basis for 2012, we calculate SuperCom’s P/E ratio at the still incredibly low multiple of 6.5x. This number includes some financial income and the adjusted number will look a bit higher depending how you calculate it, but it’s still extremely cheap. It’s worth noting that the company has close to $50 million in net operating losses, so tax favorable treatment of profits is on the horizon.

For the first 6 months of 2013 (SuperCom is an international company that reports differently from US companies), on a combined pro-forma basis SuperCom recorded $0.45 a share in EPS leaving the company at 9.8x earnings from half a year. If second half earnings match the first half, the P/E ratio for 2013 will be 4.9x. Investors buying shares of SuperCom today have a lot of the risks behind them since the turnaround has already proven itself out and the OTI acquisition just closed.

Recurring revenue businesses with highly visible revenues and sticky customers typically trade at high multiples – especially when they have clean balance sheets and minimal warrants and options outstanding, like SuperCom.

SuperCom competes in more than one business and the company’s competitors (see the F-1 for names) are often divisions of larger companies. One competitor, Zetes Industries (BRUSSELS: ZTS) trades at 25x earnings. If we take a discount to that and use 20x, applied to pro-forma combined 2012 earnings, you end up with a market cap of around $170 million, which is more than 3x the current share price.

Recall that this calculation does not include any of the strategic benefits that SuperCom will experience from having acquired its largest competitor. Recall further that there’s a pipeline of over 50 bids outstanding, a number of which they expect to hear back on next year, and at least several of which management took the time to point out could triple company revenues yet again.

If management executes on its 5 year plan and revenues grow to the $250 million range, at a multiple of 2x sales, the stock will be worth over nine times its current price. We believe that 2x sales is the very bottom end of a sales multiple, as some acquisitions have taken place at 6x, so substantially higher prices are possible – but again, it’s contingent on the company growing into something that it is not currently today.

Risks. As stable and as visible as SuperCom’s revenues appear, they are not without risk. This is a technology company, and any failure in the operations or security of SuperCom’s technology could ruffle clients. The company just closed on a major acquisition so the next few quarters will be crucial for management to demonstrate a smooth integration. Contract awards in the industry take years and despite high hopes, there’s no guarantee that SuperCom will win any. SuperCom is based in Israel, so an investment in the company is subject to the risks of investing in that country. The CEO’s family owns a significant stake in the company which may leave some investors feeling they are along for the ride, but we like being aligned with that kind of economic incentive and talent.

Management interview. We offer a very sincere thank you to Arie, SuperCom’s CEO, and Ordan, the company’s Vice President of US Operations. During an exceedingly full month that included financing and closing the OTI acquisition, they made some time to talk to us and summarize the company’s progress and opportunities. We are pleased to share a transcript of the conversation.

Let me kick off by wishing you congratulations on closing the OTI acquisition. Would you tell us a little about the business you just acquired and what attracted you to it?

Arie: Thank you for the congratulations. This acquisition is absolutely transformative for our company. We are all very excited about it. OTI’s Smart ID division was our main competitor in our applicable electronic identity [EID] market because of their size, flexibility, and technological capabilities. This is a very highly synergistic and accretive acquisition for us, both from a strategic and financial point of view. This acquisition means that our largest competitor has joined us to form a very strong solutions provider.

Ordan: Strategically, the acquisition boosts not only our revenues but also our sources of revenues, to different places around the world. We’re expanding to Africa, Asia, South America; areas with great potential going forward and, with the local subsidiaries that provide us with outstanding pre and post sale operations, we can capitalize on that potential to get more and more contracts in those regions of the world.

It also brings in some great employees, very experienced technical and marketing experts in the EID space. People like this are very hard to find because of the high barriers to entry in the EID space – there aren’t many people out there who have this kind of experience.

Arie: Moreover, we are inheriting a huge pipeline of bids around the world and, as some of you might know, the bidding process in the EID space is very long term. It can take two to three years to win a contract. But, once you win these contracts, you have a very long term base of revenues. So we’re inheriting a pipeline with bids in over 20 countries around the world and many of them are close to maturity and we expect to see a number of these awards be given out in 2014, which has potential to increase our revenues significantly going forward.

Lastly, perhaps overlooked by some, a major source of our competitive advantage in the EID space is our technology. The technology we are receiving from OTI is not only complementary to ours, but also consists of a field proven, very robust, and well known platform – Magna. This will help us capitalize on our current strengths to adapt to any customer’s needs around the world, giving us the substantial edge we need to target rapid growth while sustaining a leading position in the EID space.

What are highlights of the financial impact of the acquisition?

Ordan: In terms of revenues, we’re looking at around a near three-fold increase in SuperCom’s revenues on a 2012 pro-forma basis, from around $9 million to $26.3 million.

In terms of margins, in any industry, when you consolidate with a competitor, especially one as significant as this, you can expect a natural margin increase. But here, it’s even more apparent because, besides the overhead costs that are not being transferred over to SuperCom, $5.6M on a 2012 pro-forma basis, there are real operational synergies. Their division is very similar to ours in terms of size, operation, and the nature of the contracts it serves. We have capacity to take their operations and government contracts and place them onto our current division and management structure without having to allocate more overhead costs.

But more than that, as we continue to integrate OTI, we plan to see the same kind of improvements that we saw in SuperCom’s margins over the past three years. As you recall, we’ve done a turnaround on the company that included improving the gross margins and the operating margins. We’ll apply that same process to OTI’s division.

What price did you pay for the OTI acquisition?

Ordan: The price we paid for this division is relatively low for us because its contribution to our 2012 pro-forma EBITDA comes to around 3.5x the price we’re paying. That comes from just the basic overhead cost savings that are not being transferred over to SuperCom. Just removing those overhead costs gives contribution of around $5.6 million.

Arie: I also want to mention R&D. Building the backend technology to serve EID contracts takes a lot of R&D dollars. OTI is coming with terrific technology so we’re going to save more than $5 million worth of net R&D in the next three years just by acquiring this division, and of course also have a more rich and robust software platform, which allows us to bid on many more contracts around the world and hence shorten the time to market and speed up revenue growth.

Taking a step back, would your share some background on the EID industry? What should investors know about this business?

Ordan: The solutions provided in this industry are systems for managing all aspects related to the issuance and usage of a country’s national ID cards, passports, drivers’ licenses, and so forth. They are large, complex systems that are mission critical for the safety and operations of any country, while providing a constant stream of high margin income for the governments.

It’s a very lucrative industry, around $12 billion a year and growing. Most interesting to us is that there are super high barriers to entry. You need to have around up to ten years’ experience deploying these types of systems in other governments before you even bid on an international contract. You can imagine that for systems so important, the governments are very careful who they award them to.

It takes a long time to win a contract in a government, but, once you do that, you enter their infrastructure. You usually deploy a full production line within a government: the printers, the materials, the software, the databases, and the readers. And since it is core to the operations of a government and it takes a while to install it and it also takes a very long and expensive process to remove it, once you are installed in a government, you have very long term recurring revenues. We’ve seen one of our contracts supply us with nearly two decades of growing revenues; it keeps on being renewed.

There are less than a dozen end-to-end turnkey EID solution providers around the world. That makes it sort of a closed group of players with a growing market size so everyone has potential to see some growth, especially the players who are strong in the emerging markets such as SuperCom and OTI’s Smart ID Division which we just acquired.

How would you characterize SuperCom’s track record in the industry?

Arie: We at SuperCom have an impeccable record that every one of our systems that has been installed and delivered has run through for the full length of the contract, something which can’t necessarily be said by all the players in the industry. And with that capability, you know that your revenues are going to be sticky for a very long period of time.

Also important to mention is that these operations, the electronic ID’s, are actually a source of income for the governments. So, not only are they producing something that’s vital to the operations of the government, but they are revenue generating, making the deterioration of contract revenues even less likely.

Two of our major competitive advantages are our track record and our technology, and both have been emphasized thanks to our acquisition of OTI’s Smart ID Division. Both SuperCom and the Smart ID division have ongoing contracts with happy and satisfied customers, some of them for over 15 years. This gives us strong references to provide to new potential customers. Our proprietary technology offers not only very strong security, but also drives our ability to offer lower prices, shorter deployment times, and very high customization, elements which are of very high importance in the international tenders of our addressable markets.

Between all your contracts, including the newly-acquired ones from OTI, can you mention the names of any countries or agencies that you serve?

Arie: I think that OTI provided to the public some examples — Tanzania in Africa, and Ecuador and Panama in South and Central America. We have contracts in Europe and in Asia.

Separate from the EID business, SuperCom has another business segment that uses RFID technology. Can you tell me about that?

Arie: RFID, we believe is going to be a powerful growth engine for the company for years to come. That’s because we have proprietary products which were developed in the company for many years that have specific advantages over other products in the market, both from a technology point of view and from a cost perspective. Better solutions with easier configuration and with a lower price.

We have a very wide range of products that are proven with thousands of customers in the United States. The next step for us is to focus on the right vertical markets we’ve identified, those that are growing fast and that are large enough to attract attention.

And which markets are those?

Arie: One large one is public safety — think for example of wrist or ankle bracelets that track an individual’s location. 3M has put over $500 million in this market by acquiring companies so they can gain a presence. In this market, our solution is probably the most advanced available. Like in our EID business, in the public safety market once you’ve secure a contract with a government it is likely going to be with you for many, many years with a nice stream of cash or revenue every month. Market research presents that this vertical is growing 200% a year and will be a $6 billion market in 2018.

Healthcare and home care is another vertical. We are providing the IT managers and hospital managers with the ability to track their assets, to track and monitor their patients, to prevent disease, and to make sure that they will be able to comply with regulations, like sanitizing their equipment before it is used by other people. The growth of these markets for electronic monitoring and tracking is about 70%.

The third one is probably the fastest growing one – it’s what we call animal intelligence. We provide solutions that monitor, track, and analyze data from cows and livestock for example, pets as well. A tag on the animal tracks its movement, location, life cycle and, probably most uniquely, you can analyze its health condition to prevent diseases early on. There is a huge return on investment. A farmer can buy our system and get the full recovery of their investment in less than a month.

We are leveraging some key abilities from our EID business – our expertise in database, data analysis and other IT technologies, our proven track record in effective deployment of large decentralized systems, and our experience working with governments and structured bidding processes. This together with our proprietary products’ IP in RFID – the board design, the RF and antenna design, the optimized firmware and the algorithms – gives us a very strong value proposition and competitive offering to secure a leading position in these three verticals.

I’ve seen a bunch of acquisitions in the asset tracking space.

Ordan: Definitely. Some of the companies that we’ve seen, for example, Attenti was acquired for over $230 million in 2010 by 3M. 3M-Attenti is a solutions provider to the public safety market, and is a direct competitor to our public safety solution.

In the healthcare space, a company called AeroScout was acquired in 2012 by Black & Decker for over $240 million. It was acquired at 6x trailing revenues, again representing the rapid growth of this vertical. AeroScout is a solutions provider for the real time hospital market, and is a direct competitor to our healthcare solutions.

For both divisions, meaning both the EID and the RFID segment, it sounds like much of future growth is dependent upon winning new contracts. Would you comment on the pipeline for the next 12 months? If not, specifics, than any commentary that you can share.

Arie: I think the important thing here is that on one side we have contracts which continue to generate revenue on a recurring basis. On the other hand, we have a pipeline of bids in different stages. Some of them are very close to the point of award. Some are in the early stages. Others are in the middle. We believe that, right now, we’re in an excellent position in terms of our pipeline.

In EID, what we have, both from OTI and SuperCom, enables us to potentially see a nice stream of contract awards implemented over the next seven years. We are talking about a wide range of proposals, opportunities or bids that can range from $5 million up to $150 million. When you take them and you put each one on a timeline, you see that you can fill out seven years of revenue just from the award of some of them. If we estimate a win rate of 10% to 15% of those opportunities, I believe we’re going to be in excellent position in comparison to the combined OTI and SuperCom revenue for the year 2012. And I do believe that, if we can make the most of having both companies combined together, that a win rate of over 10% is very, very achievable.

Are you able to provide more specific commentary in terms of how many contracts you have an open bid on? And of those, how many might you hear from back in 2014?

Arie: I don’t know if I can disclose numbers. I could just say that it’s well-known that in the market there are at least, I think, 30 opportunities every year. Now, we don’t bid on all of them because we concentrate on the ones where we have a competitive advantage, for instance with our technology. We have over 50 of open proposals and bids in more than 20 countries and our goal is to secure at least three contracts every year.

Given our uniquely modularized technology solution, securing a contract in a new country is a major goal, because one contract with a country provides us with the ability to get more and more contracts in the same country. Once we get a contract, for example, for passport, we have huge advantage to be awarded other EID contracts. Our technology is deployed in a manner such that we can use the same infrastructure that we built for the passport for all other solutions. This gives us a huge advantage in pricing and time to market. In this situation, governments are not likely to go to a competitor because it’s going to cost them much more money and take so much longer.

Besides hearing back on a number of contracts, what are the other important things that investors should look for out of SuperCom in 2014?

Arie: First of all, I think investors probably will look to see if we are able to integrate this acquisition with OTI. Something very important for us to show to the market is that we’re able to do it and that we have the capability of acquiring companies and delivering synergies.

Aside from integration, which we don’t think will take more than a quarter or two, the big thing is delivering contracts wins. You asked me to talk about things outside of contracts, but there are things about the contracts that I need to explain. Can I promise anything here? Not with certainty. But what is possible is that every few months we could be announcing a new contract award, some of which are very, very large.

In the EID market we talk about contracts that, in many cases, can be 3-times larger in size than the combined revenue of SuperCom and OTI. So investors may be surprised to see that — maybe — we’ll announce a contract that will double our revenue in the next three years, just from one contract.

The other thing our investors should expect to see from us are more and more implementations of our RFID solutions. We are going to bid and secure more and more contracts and deliver more solutions there.

Arie, you have a history of turning around companies, of building and selling companies. What’s the goal with SuperCom? Where do you think it can go over five years? Are you looking to build it up to an exit?

Arie: Our goal is build a strong company with streams of recurring revenue. We would like that our investors will see every year that the number of contracts with recurring revenue is increasing. We are talking long term contracts — five years, seven years — so each new add is cumulative to what we’ve added over the prior few years.

Our goal is to increase our market share to a point that our company will be in the range of $200 million to $250 million of revenue in the next five years. No, that’s not guidance, but I’m telling you what my goal is. And I’m talking about growing organically. I’m not talking about acquisitions on that scale, although we may do some very selectively.

We are not looking to sell the company, although we believe from what we see, more and more, both in the EID market and the RFID markets, that large organizations find those markets very attractive. Given the high barriers to entry, these organizations have made large acquisitions in order to become players in these markets. SuperCom probably can be and will be considered by large organizations as a natural target for acquisition. In terms of increasing shareholder value, though, we think the opportunity over the next few years is much greater when we focus on the growth we can deliver organically rather than seeking or approving an acquisition proposal.

For closing remarks, would you summarize the key reasons why investors should take a look at SuperCom right now?

Ordan: What we’ve done since current management took over is complete a significant turnaround rather quickly. The same type of fast results we achieved at SuperCom, we hope to see with the OTI business we acquired. This capability helps us to grow very quickly in a market where it takes a long time to win contracts. But if you can acquire the contracts as we just did and deploy them on a very lean cost structure, then you’re creating massive shareholder value.

Looking at our peers, our share price may be viewed by some as undervalued. Look at Zetes Industries, ZTS on the Brussels Euronet Exchange; it trades at a P/E of 25. Or consider the L -1 Identity Solutions acquisition at an EV to EBITDA multiple of 20. Some may view our share price as even more undervalued when they add in the Smart ID acquisition at 3.5x EBITDA, and investors may get comfortable with a nice margin of safety when taking into account the recurring revenue businesses model and pipeline of opportunities that could start delivering in the next few months.

Arie: SuperCom is a company that on one hand has very nice recurring revenue — stable, not so sensitive to economic slowdown. And on the other hand, has rapid growth engines that can move the company’s revenue to a very high level. I’m referring to the near-term pipeline in EID and the opportunities we have right now in RFID.

The market likes visible revenues. When investors will look at our company once we’ve seasoned the OTI acquisition, they’ll see our revenue baseline for the next five years, based on announced contract wins. All growth and new contracts will be gravy. Subscription businesses can achieve very high multiples, once people understand them and the steady free cash flows they can generate. A year from now once we will have integrated OTI and hopefully have announced several new contract wins; we could be in a very, very different place.

I mentioned before that my goal is to hit $200 million to $250 million in revenues over the next 5 years, just from organic growth. If we find other acquisitions like OTI where we can add assets that fit into our business very well and where we can pay attractive prices, we’ll consider those opportunities. On 2012 pro-forma we just tripled our revenues, yet I feel that we are only getting started with where SuperCom can go.

Thank you very much, both of you.

Krug on Money


This is a tale of three money pits. It’s also a tale of monetary regress — of the strange determination of many people to turn the clock back on centuries of progress.


The first money pit is an actual pit — the Porgera open-pit gold mine in Papua New Guinea, one of the world’s top producers. The mine has a terrible reputation for both human rights abuses (rapes, beatings and killings by security personnel) and environmental damage (vast quantities of potentially toxic tailings dumped into a nearby river). But gold prices, while down from their recent peak, are still three times what they were a decade ago, so dig they must.

The second money pit is a lot stranger: the Bitcoin mine in Reykjanesbaer, Iceland. Bitcoin is a digital currency that has value because … well, it’s hard to say exactly why, but for the time being at least people are willing to buy it because they believe other people will be willing to buy it. It is, by design, a kind of virtual gold. And like gold, it can be mined: you can create new bitcoins, but only by solving very complex mathematical problems that require both a lot of computing power and a lot of electricity to run the computers.

Hence the location in Iceland, which has cheap electricity from hydropower and an abundance of cold air to cool those furiously churning machines. Even so, a lot of real resources are being used to create virtual objects with no clear use.

The third money pit is hypothetical. Back in 1936 the economist John Maynard Keynes argued that increased government spending was needed to restore full employment. But then, as now, there was strong political resistance to any such proposal. So Keynes whimsically suggested an alternative: have the government bury bottles full of cash in disused coal mines, and let the private sector spend its own money to dig the cash back up. It would be better, he agreed, to have the government build roads, ports and other useful things — but even perfectly useless spending would give the economy a much-needed boost.

Clever stuff — but Keynes wasn’t finished. He went on to point out that the real-life activity of gold mining was a lot like his thought experiment. Gold miners were, after all, going to great lengths to dig cash out of the ground, even though unlimited amounts of cash could be created at essentially no cost with the printing press. And no sooner was gold dug up than much of it was buried again, in places like the gold vault of the Federal Reserve Bank of New York, where hundreds of thousands of gold bars sit, doing nothing in particular.

Keynes would, I think, have been sardonically amused to learn how little has changed in the past three generations. Public spending to fight unemployment is still anathema; miners are still spoiling the landscape to add to idle hoards of gold. (Keynes dubbed the gold standard a “barbarous relic.”) Bitcoin just adds to the joke. Gold, after all, has at least some real uses, e.g., to fill cavities; but now we’re burning up resources to create “virtual gold” that consists of nothing but strings of digits.

I suspect, however, that Adam Smith would have been dismayed.

Smith is often treated as a conservative patron saint, and he did indeed make the original case for free markets. It’s less often mentioned, however, that he also argued strongly for bank regulation — and that he offered a classic paean to the virtues of paper currency. Money, he understood, was a way to facilitate commerce, not a source of national prosperity — and paper money, he argued, allowed commerce to proceed without tying up much of a nation’s wealth in a “dead stock” of silver and gold.

So why are we tearing up the highlands of Papua New Guinea to add to our dead stock of gold and, even more bizarrely, running powerful computers 24/7 to add to a dead stock of digits?

Talk to gold bugs and they’ll tell you that paper money comes from governments, which can’t be trusted not to debase their currencies. The odd thing, however, is that for all the talk of currency debasement, such debasement is getting very hard to find. It’s not just that after years of dire warnings about runaway inflation, inflation in advanced countries is clearly too low, not too high. Even if you take a global perspective, episodes of really high inflation have become rare. Still, hyperinflation hype springs eternal.

Bitcoin seems to derive its appeal from more or less the same sources, plus the added sense that it’s high-tech and algorithmic, so it must be the wave of the future.

But don’t let the fancy trappings fool you: What’s really happening is a determined march to the days when money meant stuff you could jingle in your purse. In tropics and tundra alike, we are for some reason digging our way back to the 17th century.

ABX-December 2013



Barrick Gold – A Contrarian Play Based On Improved Capital Allocation

Dec 11 2013, 04:20                         by: Tim Travis  |              about: ABX,

Disclosure: I am long ABX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

After gold’s stellar performance from 2000-2010, television commercials seemed saturated with a great deal of snake oil salesmen, pitching gold coins with outrageous commission structures to market participants concerned about the strength of conventional global currencies. Despite the metals ascension, gold mining stocks have been abysmal performers, as cost inflation and poorly conceived capital projects have produced terrible returns on invested capital. Barrick Gold (ABX) is an example of a company that in the past hasn’t focused on maximizing per share value, but instead has been more interested in building the world’s largest gold mining company via acquisitions and massive capital expenditure investments. It is my belief that the recent decline in oil prices and in the stock of Barrick Gold, has finally brought about changes, which should make for a more attractive future for the company’s shareholders. Management is now concentrating on right-sizing the balance sheet and focusing on the highest returning projects, which should unveil the fact that the sum of the parts is greater than the market price being given to the whole company right now. Value investing is about buying businesses such as Barrick when they are priced with extreme pessimism and selling them when the outlook is more optimistic.

Barrick has built a powerful and diverse collection of mining assets that have considerable upside potential, but that also require heavy investment, which only makes sense in an extremely accommodative pricing environment. In broad terms, North America represents that more conservative region of Barrick’s mines, with strong returns and drastically less political uncertainty. This region was bolstered by the addition of Pueblo Viejo in 2012. South America is the company’s highest risk and most capital intensive development region, but that could also offer the highest long-term returns. The major $10 billion project in South America, which has been the source of extreme angst for shareholders, is the Pascua-Lama mine on the border between Chile and Argentina. Pascua-Lama was expected to average 825,000 ounces in the first five years and because of ample silver credits, the cash costs were anticipated to be quite low, but this project has now been curtailed due to the volatile declines in gold prices over the last year, which has put further pressure on the CAPEX budget. The controversial decision to temporarily shutter the mine could lead to political backlash, but hopefully for Barrick shareholders, when prices recover, the mine could still potentially yield solid long-term profitability.

The Australia/Pacific and African regions are home to most of Barrick’s non-core assets in my opinion, due to their higher costs and risks, so if further divestitures are needed in the next couple of years, I would expect them to come from those assets. Barrick intelligently offered 26% of Africa Barrick Gold to the public in 2010, but the company paid way too much to acquire Equinox and its disappointing mines in Zambia and Saudi Arabia. It is telling that this $7.66 billion acquisition of non-core assets, now represents nearly 40% of the current market capitalization of the company, despite contributing a great deal less than that in the value and earnings of the company. This type of poor capital allocation decision at nearly peak commodity prices destroyed incredible shareholder value both by paying too rich of a price, and through necessitating an equity issuance at an extremely unfavorable time, which diluted shareholders.

On September 30th, Barrick had cash and equivalents of $2.3 billion and $4.0 billion available under its credit facility. The company generated operating cash flow of $3.22 billion in the first nine months of 2014. ABX had approximately $1.3 billion of cumulative debt maturing by the end of 2015. On November 14th, Barrick announced that it had completed its previously announced equity offering of 163.5MM common shares at a price of $18.35 for net proceeds of approximately $2.9 billion, meaning that the company now has approximately 1.16 billion shares outstanding. The company is using $2.6 billion of the net proceeds to redeem or repurchase outstanding debt, primarily short and medium-term debt. Specifically, Barrick is using $1.1 billion to redeem the outstanding $700MM aggregate principal amount of 1.75% notes due 2014, together with the $350MM aggregate principal amount of 4.875% notes due 2014. Barrick is also using approximately $1.5 billion of the net proceeds to purchase other notes pursuant to its tender offer, which was announced 10/31/2013. This reduces net debt by 21% and eliminated $2.5 billion of debt repayments over the next 5 years.

On October 31st, Barrick Gold reported 3rd quarter financial results. The company had gold production of 1.85 million ounces at all-in sustaining costs (AISC) of $916 per ounce. Copper production was 139 million pounds at C3 fully allocated costs of $2.15 per pound. Adjusted net earnings were $.58 billion ($.58 per share), down from $.88 billion ($.88 per share) and adjusted operating cash flow was $1.3 billion, down from $1.4 billion YoY. Net earnings were $.17 billion ($.17 per share), which were down from $.65 billion ($.65 per share) in the year ago period. Realized gold and copper prices for the quarter were $1,323 per ounce and $3.40 per pound, respectively, compared to the spot averages of $1,326 per ounce and $3.21 per pound.

Management made the decision to suspend construction at the Pascua-Lama project, which will further reduce 2014 capital costs by up to $1.0 billion. In addition, the company is flattening its operating model to save an additional $500MM per year. This will include a reduction in headcount, reduced procurement costs and other initiatives. Also, African Barrick Gold (GM:ABGLF) has targeted annual savings of $185MM. ABX made the decision to sell Barrick Energy for total consideration of $435MM, including cash of $387MM and a future royalty valued at $48MM. The company also sold Yilgarn South assets to Gold Fields Limited for $266MM, consisting of $135MM in cash and $131MM in Gold Fields Limited Shares.

(click to enlarge)

Source: ABX 3rd Quarter 2013 Report

Barrick expects that for the full year and adjusted for the sale of the Yilgarn South mines, full year gold production is now expected to be at the low end of the original 7.0-7.4 million ounce guidance range. All-in sustaining costs are expected to be within the range of $900-$975 per ounce and the company has lowered the top end of its adjusted cost guidance to $575-$600 per ounce. Barrick increased its full year company-wide copper production guidance to 520-550 million pounds. Full year C1 cash cost and C3 fully allocated cost guidance has been reduced to $1.90-$2.00 per pound and $2.40-$2.60 per pound, respectively.

(click to enlarge)

Source: ABX 3rd Quarter 2013 Report

For the first nine months of 2013, Barrick has reported a loss of $7.5 billion compared to net earnings of $2.5 billion in the first nine months of 2012. The decline reflects the impact of $8.7 billion in impairment charges (net of tax and non-controlling interest effects), lower realized gold and copper prices, higher interest expense and higher income tax expense for Pueblo Viejo, primarily due to the recognition of an increase in the deferred tax liability, which will be drawn down over the life of the mine, as well as an acceleration of current taxes payable for 2012 and 2013 related to the substantive enactment of the revised SLA, partially offset by higher gold and copper sales volumes. Adjusted net earnings for the nine month period of 2013 were $2.2 billion compared to adjusted net earnings of $2.8 billion recorded in the nine month period of 2012. EPS and adjusted EPS for the first nine months of 2013 were ($7.53) and $2.16, respectively. Operating cash flow was $3.223 billion, down from $4.138 billion during the first nine months of 2012.

While Barrick has been battered over the last year due to some poor decisions, there is still tremendous value in the company’s portfolio of assets. For example, 55%+ of 2013 production came from 5 large mines at all-in sustainable costs of around $700/oz. These 5 mines had 58.2 million ounces in reserve as of December 31, 2012. Pueblo Viejo is one of the growth mines, which should reach full capacity in the first half of 2014 with AISC of $700-$750/oz. Costs will come down materially, allowing the company to significantly close the cash flow gap that has concerned investors. With the stock price so cheap, I’d expect to see further dispositions, which should highlight the higher value of the sum of the parts, despite a weak pricing environment.

At a recent price of $16.86, ABX trades at around 8 times forward earnings and 3.5 times forward cash flow. The cash flow multiple is more than 50% cheaper than historical averages and while earnings might be revised lower, Barrick is still far cheaper than it has been in years. The company has tremendous low-cost assets, which should generate reasonable cash flows. Costs and capital expenditures will go down dramatically, reducing the need for the company to access the capital markets moving forward. It is extremely difficult to predict gold prices or value this business with anything close to an approximate number, but when you look at the assets, it is tough to imagine losing money over the long-term. To make the investment even safer, one might look to sell long-term put options. The $15 January 2016 put options are going for around $280 per contract right now, which would mean that assuming the stock closes above $15 at expiration, the investor would earn 23%, or 11% annualized on the maximum risk of $1,220 per contract. The breakeven price is $12.20 per share, so the stock would have to drop 36% by expiration for you to be in a losing situation upon being exercised. If the stock appreciates significantly prior to expiration, it is very likely that the puts could be bought back at much higher than targeted annualized rates of return.

Source: Barrick Gold – A Contrarian Play Based On Improved Capital Allocation

Software is Eating the World

In the good old days you bought a computer and it had hardware. You bought IBM, or Honeywell or DEC and that became your world: hard or soft it was all from one company. Now software is flexing its muscles and Google’s Android software packages are a key element. They have become what UNIX hoped to become.

Apple is swimming strongly against the tide. They feel that if you like their software you will have to buy their hardware. And to a very large extent that is true. Let’s call this model A.

Elsewhere, cheap chips mean cheaper tools. Wholesale prices of bottom of the line Android phones are under $50. Google sells the operating level of the software and thousands of hackers and small firms and rapidly growing firms make the software gadgets that some of these users want. If the potential market for your $8.95 software gadget is a billion plus [as of September 3, 2013, 1 billion Android devices have been activated] then you need a tiny percentage of that to be profitable.

The Android software is based on Unix principles and Open Source philosophy. Android was unveiled in 2007 along with the founding of the Open Handset Alliance: a consortium of hardware, software, and telecommunication companies. So although it’s not a huge cash generator for Google, it shows them building a different customer-ecology than Apple and demonstrates their software expertise.

At the moment then, Google is sitting on a mound of cash from its main source of revenue: on line ads and clicks. Here’s a summary from Rizzi Capital.

Nov 20 2013, 08:59                              by: Rizzi Capital  |              about: GOOG

Google (GOOG), the third largest company by market cap in the world has been on a tear lately. It’s shares are trading just shy of an all time high, and investors are rejoicing. And soon, shareholders will have another reason to cheer – Google may be just a few months away from announcing its first dividend. The blogosphere and analysts have been buzzing with speculation on this subject for the last year, and now the writing may be on the wall.

Google fights every day to win over consumers, and the Google investor relations team works diligently from morning to night working to please investors. With major tech competitors such as Apple (AAPL), Microsoft (MSFT) and Cisco (CSCO) all returning huge shareholder value via buybacks and dividends, Google will have little choice but to join the tech stock dividend bonanza. Considering Google’s massive cash hoard and abundant free cash flow, it seems like a very small price to pay.

Cash Is Flowing

Google has always been a cash flow generating machine. Its basic core business model of selling advertising space on the back of its search engine results required low capital expenditures and provided fat profit margins. As Google expanded its offerings and made some expensive acquisitions, such as YouTube, DoubleClick and Motorola, as part of its growth strategy, its cash flow generation slowed marginally. However, now, under the leadership of CEO Larry Page, it has integrated most of its businesses and is focusing on strategic, organic growth opportunities. Cash flow is once again powering higher at an accelerating rate and capital expenditures are remaining rather tame.

The chart below shows Google’s net operating cash flow as well as its capital expenditures.

(click to enlarge)google cash flow

It’s always a beautiful thing to see. As net operating cash flow has increased dramatically since 2009, capital expenditures seem to have reached a plateau. In 2013, a year which is not shown in the chart, the numbers only get better.

A cash flow of this size is something which few companies can brag about, and it’s an enviable problem to have. Google has been storing away a large portion of the cash on its balance sheet, and has accumulated more than $50 billion so far. This is more than enough cash for the company to have on hand for any foreseeable capital expenditures. Furthermore, given their debt level, stock price, and the current rock-bottom financing costs, Google would have ample resources available if it wanted to make a major acquisition in the future. There is just no good reason for the company to continue stockpiling cash.


The company fundamentally has two main options. Google can either use their cash to buy back shares on a massive scale, or they can institute a quarterly cash dividend. Either one of these options would be applauded by shareholders, but one option is more likely than the other.

In terms of a share buyback, we should note that Google shares are currently trading near an all time high at over $1000 per share. I know Google. I love Google. But can the company really justify a massive share buyback? Even though Google operates in a virtual monopoly and it is growing rapidly, investors would be hard pressed to say that the shares are cheap based upon any commonly accepted valuation methods. Apple recently announced a massive share buyback worth $60 billion. But Apple has a P/E ratio of 13.12. By comparison, Google’s P/E ratio is 29.5. That’s not exactly discount territory.

In addition, it should be noted that Google “only” has a cash hoard of about $50 billion, of which only 20% is held onshore. Considering that Google’s present market cap is over $300 billion, a small share buyback valued at under $10 billion, would not be particularly meaningful.

For this reason, the most likely course of action will be for Google to institute a dividend program similar to that of its rival, Apple. The program will likely start small, with quarterly payments, and then rise as cash flow continues to increase. For comparison, when Apple initiated its dividend program, the initial payout ratio was about 12% in the first year but was boosted to almost 30% in the second year. Google would likely follow a similar path. At a 12% payout ration, Google would have an initial dividend of about $5 per year, based on analysts 2014 earnings per share estimates of $43.50. Although a dividend of this amount would not compute to a very high yield, it would send a clear message to investors that Google is committed to return value to investors, and not only through price appreciation of its shares.

At the same time Google would be retaining a large enough portion of its cashflow to fund any foreseeable acquisition or to implement a share buyback if market conditions would warrant it. Analysts are predicting that by 2016 Google will have free cash flow of over $20 billion per year. Google would clearly be able to adjust the dividend higher as the cash flows increase.

Counter Arguments

Some analysts have been vocal that Google will not implement a dividend policy for at least 2 more years. These analysts state that Google will want to hold on to as much cash as possible in order to finance a possibly huge acquisition. They claim that until Google reaches the goal of having $100 billion in the bank, it will not return value to shareholders via a dividend. To be honest, I dismiss these claims.

Google is now the largest company in the world not paying a dividend. It has made large acquisitions in the past, such as Motorola and Youtube, but when we really compare these purchases to the massive size of Google’s cash balance, they are minor. Google is a tech company headed by a CEO who is focused on changing the world. Larry Page pumps Billions of dollars into R&D and projects like Google Glass and Google X. From time to time there may be a complementary acquisition which might help further his endeavors, but ultimately Google does not have the culture or history of making massive acquisitions which would radically affect the company. Larry Page has his eyes set on using Google’s cash reserve on research and development to create revolutionary products from scratch. These so call “moonshot” projects require large development costs, but given Google’s size, they do not make a significant impact on cash flow.

“While they’re-in absolute dollars-probably significant amounts, they’re not significant for Google, and I think you should actually be asking me to make more significant investments. I wish I knew how to do that,” – CEO Larry Page, when asked about Google R&D expenditures.

Furthermore, stating that the company would choose to only start paying a dividend once it had $100 billion in cash on the balance sheet is arbitrary. Google is already facing scrutiny from the government because of it’s low tax rate and high offshore cash reserve. Would it really want to make global headlines by declaring it had achieved the dubious honor of joining the $100 billion club?

Bottom Line

Google is a company which is growing rapidly and generating more cash than it knows what to do with. It has a war chest worth over $50 billion, and will likely not want to keep adding to that number for very much longer. As all other large technology companies have started paying dividends, shareholder pressure for a return of value is intense and will only increase. In a situation like this, shareholders will inevitably be rewarded. All the elements are in place for Google to implement a dividend policy next year. While it will likely start with a low payout ratio as compared to competitors, as cash generation accelerates, shareholders will be rewarded with a rapid dividend increase. Look for an initial quarterly dividend of $1.25, or $5.00 annually, and expect it soon.

What Apple Should Buy

A good summary.  55 Billion shopping spree.

After spending the better part of yesterday digging deeply into Samsung’s (OTC:SSNLF) analyst day materials, it has become clear to me that Apple (AAPL), over the long haul, stands very little chance against the Samsung behemoth. While Apple’s products truly are wonderful, and while its engineering prowess is certainly very impressive, it’s clear that Samsung will brute-force its way into taking more and more marketshare from Apple at the high end while at the same time will enjoy key structural advantages in the low end that Apple would – at least in its present form – not be able to match.

Apple needs to start getting much more aggressive if it is to survive and thrive against the Samsung assault and it needs to move quickly.

Samsing Owns Nearly The Entire Smartphone/Tablet Bill Of Materials

Samsung builds the following:

  • DRAM
  • NAND
  • Displays
  • Apps processors (it even builds them for Apple)
  • Cameras

On the other hand, Apple relies on third parties for just about every one of these. In fact, while Apple has been attempting to move away from dependence on Samsung for many of these components, it has been one of the key enablers of Samsung’s semiconductor manufacturing strength. When you’re building the apps porcessors (as well as potentially modems) for every iPhone and iPad, then that’s going to help drive reinvestment.

Samsung, of course, leverages this great cost structure to not only flood the very high growth low end market with smartphones, but it also pushes the envelope at the high end at prices that match (or even undercut) what Apple provides. Let me show you an example.

Galaxy Note III versus iPhone 5S – An Example

The most obvious comparison is the Galaxy Note III versus the iPhone 5S. For $299 with a contract, Samsung sells users the following:

  • 5.7″ 1920×1080 display
  • 3GB of RAM
  • Either Snapdragon 800 or Exynos 5 Octa SoC
  • 32GB of storage

Apple, on the other hand, gives you the following for $299 on contract:

  • 4″ 1136×640 display
  • 1GB of RAM
  • Apple A7 SoC
  • 32GB of storage

Now, thanks to the superiority (to many customers, anyway) of iOS and the power of the Apple brand, Apple can get away with offering “less” hardware for the same price, but just how much longer can this last?

It’s clear that in order to preserve its margin structure, Apple could not, say, offer 2GB of RAM to go with its new flagship (and moving to 64-bit – which leads to a 20-30% increased memory footprint – without increasing the RAM size seems to be indicative of this). But Samsung has no problems sticking in 3GB of RAM and calling it a day since it produces its own DRAM.

The same thing on the display side of things. Since Samsung builds its own displays, it can not only invest in next generation display technology to gain an edge on competitors, but it can also afford to put such displays in the devices that it sells at very attractive cost structures. Apple, on the other hand, needs to pay somebody else’s margins for its displays, which is why it’s not as aggressive on the display front on smartphones as its competitors are.

Finally, Apple has to pay for the fabrication of its applications processor. In fact, it pays this margin to Samsung. Samsung, on the other hand, builds many of the applications processors that it uses in smartphones (although not all as Samsung uses plenty of Qualcomm (QCOM) silicon built at TSMC (TSM) – for now. This will likely change as Samsung does more silicon in-house)

What Can Apple Do?

Apple needs to stop wasting money on buybacks when there is still plenty of growth ahead. It should use this money, in no particular order, to do the following:

  • Buy Micron (MU) so that it will have DRAM and NAND sourced in-house, thereby significantly improving its cost structure. This not only benefits the phones, but the Macs, too. Apple can also make a mint actually selling DRAM to the other players. Apple also gets NAND flash with such a deal, which will only continue to become more important going forward
  • Buy a semiconductor logic foundry. It’s clear that Apple has the volumes to sustain a leading-edge semiconductor foundry, and if it wants to really improve its cost structure here, owning a semiconductor foundry and funding the development of world-class semiconductor manufacturing technology is probably the way to go. I am sure Mubadala is just itching to get Global Foundries off of its hands, so perhaps either a full ownership of that company – or a big fat equity stake – would be the way to go there.
  • Bring display manufacturing in-house. Apple should either outright buy a company that can build its device displays for it (again, Apple has very nice scale with iPhone, iPad, and Mac), or it should make a very big equity investment in such a firm. Sharp Corporation would only cost Apple ~$5b (assuming a 40% premium to current market price)

So, how much would it cost for Apple to do all of this? Well, buying Sharp would probably cost the company about $5B, Micron would probably cost $30B (slightly over 50% premium to current price), and buying Global Foundries may cost at most $20B. All in all, we’re looking at a shopping spree of about $55B. While this is certainly not a trivial amount of money, it’d all be a much more effective way to create shareholder value than an the absolutely insane (I mean this as negatively as possible) $150B buyback that Icahn is trying to push management into pursuing. I get that Icahn wants quick returns today, but Apple needs to focus on delivering long-term value. Buying back stock when there’s another leg of growth to be had is simply foolish.

In fact, Apple should probably issue stock to do most of these deals. Yeah, it dilutes the shareholders, but so what? If Apple can successfully integrate these acquisitions, then they should eventually drive meaningful top and bottom line growth and the share price could be at well over $1000 as it would be in a position to take back significant share from Samsung and own the majority of the smartphone space.

Bottom Line

Will Apple do this? Probably not, but the point is that Apple needs to drive the next leg of its growth, and it needs to do so by becoming much more like Samsung (and beating it at its own game thanks to its own advantages). Samsung, at its analyst day, says that it sees a path to $400B in revenues by 2020. Apple needs to be able to see the same or this stock will be dead money at best and set to decline substantially at worst.

Source: Samsung Is Apple’s Worst Nightmare

GOLD vs the US Dollar

There is often a directional linkage between Gold and the Dollar. Here’s one analysis. By Richard Cox.


GLD Falling As Expected

Many of this site’s readers know that I am generally bearish on gold. I am speaking now from a personal perspective as the metal’s practical applications are negligible — and, aesthetically, gold is tacky. I have never worn anything made of gold and I have no interest in seeing any of it in my home. Bulls like to cite the long-standing history of gold usage as a store of value and a hedge against inflation. But the sad reality is that this is no longer the world we are living in, and the time for excitement has long passed. Of course, there are plenty of people that disagree, as interest in emerging Asia shows evidence of increasing. For these reasons, it should be understood that not all of my articles on gold are bearish.

But I feel the need to give complete disclosure: Instances of bullish viewpoints will usually be based on mean reversion, the need for markets to correct themselves, or one-off fundamental events that are finite in nature. This is made even more true by the fact that there are some clearly troublesome issues involved when holding non-physical assets like the SPDR Gold Trust ETF (GLD). So, if I am bullish on GLD, expect the recommendation to come from a trader’s perspective that is short-term in nature. But you can expect the bearish recommendations to be longer-term — and more of “the real thing.”

Momentum is Telling

Late last month, I suggested it made sense to sell gold as it posted a weak rally. This recommendation has been largely supported by price activity, which has fallen in line with the longer-term momentum in the markets:

(click to enlarge)

Valuations in GLD have fallen-off significantly from the time I made the recommendation, and upside bounces have been limited. There are two important arguments for why these declines will continue: We have yet to see the price gap filled after the move above 124, and Fibonacci support in the low 125s has yet to be tested.

Watch the Dollar

The majority argument in my October recommendation was based on the fact that GDP fundamentals in the US to not match the weakness in the country’s currency itself. Weakness in the US Dollar has been propelled by the fact that the market feels the need to reposition itself for continued stimulus after the recent government shutdown. But these fears have yet to be matched by the overall growth performance, especially when we start looking at the macroeconomic situation in Japan, the Eurozone, and the UK. As the Dollar goes, so goes gold (in its inverse correlation):

(click to enlarge)

ETFs like the PowerShares DB US Dollar Index Bullish ETF (UUP), which track the US Dollar have seen impressive gains. After bouncing from 21.30 we quickly saw a break of resistance at 21.75 with almost nothing to be seen in the way of corrective retracements. The suggestions here in the impulse move are clear, and the Dollar set for substantial moves higher. Recent weakness is a buying opportunity.

AAPL. Graphics: sizzle

The new 64 bit CPU makes a difference–with other upgrades. Techy, but interesting. And if you like camera details=—check out this.




My good friend and I were addicted to building computers and seeing how vibrant games like “Battlefield 2 Special Ops”, “Battlefield 3” and the “Command and Conquer” series popped off of the screen. At the time we had the Intel (INTL) core 2 duo 2.66 GHZ processor, two gigs of ram and a 512 mb graphics card by Nividia (NVDA). When the news broke regarding Apple’s (AAPL) drive to double the speed of the iPhone 5 with the iPhone 5S and to include a 64-bit processor, I was blown away. The first thing that went through my mind was the ability to now play powerfully real games that would be groundbreaking on a mobile device – and let me tell you, I was surely amazed.

Tech Specs:

It is no surprise that the 5S has a lead over the 5 under the hood, sporting the new 64-bit A7 chip compared to the older 32-bit A6 chip.

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Everyone is aware of the differences in specifications, although how does this compare over to the actual experience of the user? Below are two benchmark tests that demonstrate the graphics differences between the iPhone 5, the iPhone 5S and some industry peer devices such as the Samsung (OTC:SSNLF) Galaxy S4.

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As we can see from the two above benchmark tests, the iPhone 5S crushes the iPhone 5 and earlier models with regard to graphics. The first test is an extremely intensive GPU test to see how the device’s graphics card holds up, a competition the 5S won easily. The second test shown is a heavy game simulation test, where the iPhone 5S crushes, is able to deliver smooth game-play at 35fps (frames per second) – being the first device to crest the 30fps barrier.

Enough of the Specs, Get To The Games:

I don’t blame you, looking at charts gets annoying – unless you are using the new Numbers, Keynote or Pages applications that ship with each new iPhone. These apps are so powerful that functions can be used in Numbers, full presentations can be created in Keynote and Pages is reminiscent of Microsoft (MSFT) word. You can even track changes with these apps, share your work through mail or messages or use templates. I was skeptical at first, thinking that the screen would be too small to create projects, although these applications are user friendly with features such as the disappearing text bar, zoom and other creative features.

Now For The Real Game: Right on Apple’s website, it boasts the new A7 chip alongside a picture of a game called “Infinity Blade 3“. At first I was shocked at the graphics power conveyed by the image, although I wanted to take a look deeper into the game and see the real graphics processing power. Even though there are screen-shots available on the company’s website, I have been in contact with the company and have been allowed to post my own screen-shots from the game.

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Going from the bright outdoor environment, to the darker ones – the graphics in “Infinity Blade 3” are simply amazing on a mobile device.

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The fighting scenes in the game are truly compelling, but even better is the fact that the game is easy to play on a mobile device and you do not miss having a controller.

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The amazing part of all of this is the mixture of the iPhone 5S’s extreme computing power coupled with the insane craftsmanship in the available applications.
What Else Does The iPhone Pack?

The iPhone is a very advanced device. Honestly, I was angered by some people’s viewpoints that the device was not an advancement or that users did not enjoy the device. Below are some other facts that I would like to compound – that I have come across while using the device:

  • The fingerprint scanner is not only fast, it is very accurate. You can even purchase apps on the app store through the device.
  • The new camera is amazing. The two flashes feature a possible of 1000 combinations of the flash for the best picture possible. The sensor on the 5S has been increased to 1.5 microns along with a f/2.2 aperture to allow more light in. Engadget has an amazing comparison as well on this topic.
  • The 5S also has a 120 fps slo-motion video mode.
  • The new line of real leather colored cases compounds the premium feel of owning an iPhone. Personally, I would have thought the new Burberry Executive addition to Apple would have been the one to present this idea.

What Does This Mean

As a dear friend led me to the concept, the new capabilities in the iPhone 5S are tangible. The user can hold Apple’s innovation and experience the next generation of mobile power that is only available on an iPhone 5S – another foothold gained by Apple’s brand power. Articles can come about attacking Apple’s future and the advancements of its competitors, although one thing is now A7 clear – Apple is the one setting the bar on mobile devices. Personally, I had an iPhone 5 and an iPhone 5S in addition to a string of Android devices and even BlackBerry phones a while ago, and I have to say I am again amazed at the iPhone 5S. Although this article focuses mostly on the graphics power of the new iPhone 5S, there are many advancements that can not be seen through a game – such as the increased LTE bands for connectivity that can all be found on Apple’s website.

Source: The iPhone 5S’s Graphics Are Insane

Additional disclosure: This article is meant be informational, do not execute any trades before talking to a financial professional to make sure an investment/trade is right for you.