Tuesday, April 24, 2012


What bothers me about investing these days is the disconnect between a company's inherent worth--its capacity to address market needs and customer desires, translating those solutions into real profits for the company while delivering benefits for its customers--and the value of its shares.

NFLX, source E*Trade Financial

Let's take Netflix for example. Netflix was founded in 1997, as an online version of a traditional DVD rental and sales outlet.* In 1999 they lighted upon a brilliant scheme: offer DVDs through the mail by subscription for a flat monthly fee. By early 2000, they dropped the per item model entirely. Brilliant!

In 2002, the company went public. Already in 2000, CEO and founder Reed Hastings saw the future of Netflix as "owning a transition stage as rental converts to video-on-demand." Clearly, ahead of his time, the streaming model was in mind. To put that in perspective, YouTube was not founded until 2005.

Towards the end of the first decade of the 21st Century, Netflix was on a tear to increase its share of streaming as a percentage of its business. By 2011, the decision was made to make the shift. Sure, there were some missteps in designing and executing the shift, and in anticipating and responding to customer confusion and resistance to the shift.

But here's my take: the model is sound. The DVD through mail model was innovative in terms of distribution and convenience. The streaming model is liminal (in part because the infrastructure to handle the huge amounts of bandwidth required is still fragile as ISPs seek a profitable path forward) but clearly the future. A future that Netflix foresaw.

But the share price of Netflix stock is volatile beyond reason. In the middle of 2011, around the time of upheavals regarding separation of DVDs from streaming, the share peaked at around $300, dropping below $70 before the end of the year. Then back up, and now, today, shares fell off a cliff, off by 10-15% from yesterday!

NFLX falls off a cliff 4/24/2012, source E*Trade Financial
Sure, even at today's pricing, Netflix trades at a PE ratio north of 30. And the news that came out yesterday is that Netflix exceeded analysts estimates. While revenues grew by 21 percent, it lost 8 cents per share as opposed to the 27 cents per share analysts expected. The point I make is that stock prices, and the wild swings of over-selling and over-buying, are out of line with a company's core, which is delivering market solutions, and making a profit on sales that exceed costs.

A business leader should remain focused on this: how do I develop and deliver products and services to the market that benefit my customers and make a profit for my company, employees, and owners? But the stock market distorts these values. It certainly gives this entrepreneur pause in considering whether going public is an exit strategy to aspire towards.

Full disclosure: I currently own no shares in Netflix (NFLX). At the end of 2011 I made two purchases of shares at $67.25 & $67.89 respectively. All these shares were sold in February 2012 at $129.75. I am a customer of Netflix, formerly subscribing to the DVD mailing subscription, then DVD and streaming, currently streaming only.

* Much of the history of Netflix is gleaned from http://www.fundinguniverse.com/company-histories/Netflix-Inc-company-History.html & http://en.wikipedia.org/wiki/Netflix.

Monday, April 23, 2012

Shares Per Earning?

In the heyday of gargantuan Urban Assault Vehicles, before petroleum topped $100 per barrel, the joke was that fuel efficiency could be measured in gallons per mile not miles per gallon. I have written on this blog critically about established companies that refuse or decline to pay a dividend to their shareholders. Recently, Apple (AAPL) decided to reinstate dividends after a 17 year absence, in an effort to draw down some of its reported $100 billion stockpile of cash, and incidentally to reward shareholders. Their announced quarterly dividend of $2.65 translates to an annual dividend yield of about 1.85% at today's stock price.

I've mentioned how the Price-Earnings ratio (PE) is often used as a rough measure of valuation, with a 15/1 PE ratio being a traditional conservative target. Apple currently trades at a fairly reasonable PE of 16. I've also noted the recent increase in dividends by financial institutions, to yields around 2.5%.

E*Trade's website is currently touting high-yielding stocks, with the highest yield (by AT&T) at 5.7%. Wow I thought. What's their PE ratio? As it turns out, their annual dividend of $1.76 is significantly higher than their earnings per share of $0.61 (trailing 12 mo. earnings for those curious). And their PE ratio is a not so appealing 47.

That means, AT&T is currently paying out dramatically more to shareholders in dividends than the company is earning. The shares trade for about what they did a year ago, having come up from a trough in the fall. What is their strategy here? Their quarterly dividends have been above $0.40/share since 2008, and have slowly increased from the $0.20s to the $0.30s, and into the $0.40s over the past decade.

Clearly they have a treasure chest of cash ($23 billion to be accurate), else they couldn't sustain such a dividend through thick and thin. The yield at least in part explains the share price. But how sustainable is this approach? With 5.9 billion shares outstanding, they're spending more than $10 billion per year in dividends, or about $6.75 billion per year more than they are earning. Three to four years then it would seem, unless they increase their market share.

*Full disclosure: I personally own neither Apple nor AT&T stocks, and have no immediate plans to purchase either.

Saturday, April 21, 2012

Innovator as Sculptor

I don't mean the plastic arts per se. Erwin Schrödinger said:
The task is ... not so much to see what no one has yet seen; but to think what nobody has yet thought, about that which everybody sees.
There is talk that innovators create disruptive technologies. Iron oxide may sizzle and flare, but it quickly burns out. A flash in the pan may momentarily disturb, but not likely disrupt. Disruption follows transformative innovation, not simply novelty or difference.

Not all that glitters today will be the light bulb, telephone, or computer of tomorrow. What most we can learn from nineteenth and twentieth century inventors is their commitment--the unrelenting drive to define new problems and solve them often before the world had even awakened to the possibility of their existence.

It is common to see a setback as a sign of defeat, to read an obstacle or hurdle as an impasse. The process of deconstruction may be easy if the focus is simply on identifying the flaws in what has come before. We can all complain with little effort or engagement about the failings of one technology, process, or another, like clicking thumbs-up or down on a website.

But this is not innovation. Destruction is simple. Innovation requires the emergence of something new out of what was before, or even what didn't appear to be; it is sculpture in its most essential form: to envision and realize potential out of raw substance.

There is a long, deep view required for true innovation. It is a willingness and ability to see beyond the amorphousness of yesterday to the form of tomorrow. It is not simply seeing in a child's eyes the glimmer of accomplishments to come; it is imagining that child in the raw soup of chemistry and cells from which they may someday emerge.

In practical terms, it is creating a vision of tomorrow, based in sound ideas, backed by knowledge and evidence, but challenged on every side and at every turn. The difficulty is not the envisioning, but holding fast to that vision, through the fog of quotidian existence. It is the patience of the planter, who sets an apple tree for their grandchildren to climb, along with the forethought and perseverance to align the tree and property today with what will be in fifty years.

Friday, April 20, 2012

Publish or Patent?

The mantra of the Academy has long been "publish or perish". The April 14th edition of The Economist presents an op-ed entitled Academic Publishing: Open Sesame in which they argue:
Government bodies that fund academic research should require that the results be made available free to the public. So should charities that fund research.
This is a significant issue for those of us who receive government funding to support for-profit R&D (such as the U.S. Small Business Innovation Research awards). A major dilemma for unaffiliated researchers is whether to publish or patent, or in some cases simply stay mum (trade secret, anyone?).

Academic-minded government agencies, like the NIH, NSF, and Department of Education may likely view the lack of peer-reviewed publications by the principal investigator on the subject of their proposed research as a sign that their ideas have low value in that domain, and may thus not fund the research. But publications may foreclose the possibility of patenting an invention or innovation, a death warrant for self-supporting R&D-driven companies. It's a Catch-22 of sorts. But if the end game is to commercialize the innovation, jockeying for the first influx of early-stage funding needs take second seat.

For researchers supported by an academic institution, especially those with tenure, the choice to give freely of their knowledge is an easy decision to make. Their jobs and careers are secure. Yet university technology transfer offices must keep the balance between enlightening publications and enabling ones, to preserve the potential for patents. But the ranks of unaffiliated, world-class researchers is growing as opportunities in the Academy diminish or become less appealing. We simply don't have the luxury of a fully-staffed and accommodating tech transfer team.

While I've asked the question before whether defensive publishing may not at times be worthwhile, it seems the best long-term tack for small businesses and independent researchers is simply to keep quiet, even at the risk of being marginalized by the broader field.

Thursday, April 5, 2012

A Solution in Search of a Problem?

I have found that all too often entrepreneurship is stereotyped from an almost exclusively business-minded stance. We frequently hear statements like:
It's not about the technology; it's about the sales.
So, how do you monetize that?
Ah, so you're a solution in search of a problem.
Well, no, not really. The problem with this sort of dismissal is that it presumes only one aspect of a venture is relevant, that only one sort of expertise is valid, and belittles the great diversity of other knowledge and skill sets as meaningless. It reminds me of the attitudes of many insecure academics, who seek to denigrate their colleagues in adjacent disciplines, because their respective specialties don't fully overlap.

It seems to me, we need each other to accomplish great things. It is true that one can make a lot of money without doing anything earth-shattering, and that without revenues even the greatest innovation may fail. It's akin to politics in that way: the best leadership is empty if your candidate isn't elected.

But entrepreneurship isn't simply about counting the money (that's for the Bernie Madoffs of the world). Entrepreneurship is about taking calculated risks to accomplish something greater as a result of your efforts than you started with.

No, I am not a solution in search of a problem; I am a technology in search of a business model. I am a game-changer is search of sustainability.

Would anyone today question the value of Pixar's innovations that Disney acquired for $7.4 billion in 2006? Was the company worth the $5 million that Steve Jobs paid Lucasfilms in 1986, or the subsequent $50 million he reportedly poured into it over a decade to keep it afloat before Toy Story was released?

Did Ed Catmull, who led the enterprise from it's origins at Alexander Shure's New York Institute of Technology beginning in 1974 start with an eye toward monetization and a solid business model? No, I think it's safe to say that for 22 years his principal aim was to solve the technical challenges that would enable a feature-length animated film to be rendered.

Thankfully, he expended his greatest effort in line with his talents, and left it to others, more skilled in the realm of sales and marketing, to work their magic there. Somehow, I can't imagine the marvels of CGI to ever have reached such lofty heights had it been otherwise.