TheChek News Flow

Elon Musk Unveils Apocalyptic Vision For The World

Elon Musk is no stranger to futurecasting a foreboding dystopia ahead for mankind, as we noted recently. But during a speech he gave today at the National Governors Association Summer Meeting in Rhode Island, Musk turned up the future-fearmongery amplifier to '11'.

As a reminder, in the past, when he was asked about whether humans are living inside a computer simulation, Musk made headlines last year by saying he thinks the chances are one in billions that we aren’t.

“The strongest argument for us probably being in a simulation I think is the following: 40 years ago we had Pong – two rectangles and a dot,” Musk stated.

“That’s where we were. Now 40 years later we have photorealistic, 3D simulations with millions of people playing simultaneously and it’s getting better every year. And soon we’ll have virtual reality, we’ll have augmented reality. If you assume any rate of improvement at all, then the games will become indistinguishable from reality, just indistinguishable.”

Here Musk is referring to the exponential growth of technology, the lynchpin of the Singularity theory. If in 40 years we’ve gone from the two-dimensional pong to the cusp of augmented and virtual reality, imagine where we’ll be in another forty, or a hundred, or 400. And that is where he began today...

But today, Musk discussed a broad range of topics from energy sources in the future...

"It's inevitable," Musk said, speaking of shift to sustainable energy. "But it matters if it happens sooner or later."

As for those pushing some other type of fusion, Musk notes that the sun is a giant fusion reactor in the sky. "It's really reliable," he said. "It comes up every day. if it doesn't we've got (other) problems)."

It’s a compelling argument, but only partly true. As a revealing new academic study shows, big pharmaceutical companies have spent more on share buybacks and dividends in a recent 10-year period than they did on research and development. The working paper, published on Thursday by the Institute for New Economic Thinking, is entitled “U.S. Pharma’s Financialized Business Model.”

The paper’s five authors concluded that from 2006 through 2015, the 18 drug companies in the Standard & Poor’s 500 index spent a combined $516 billion on buybacks and dividends. This exceeded by 11 percent the companies’ research and development spending of $465 billion during these years.

The authors contend that many big pharmaceutical companies are living off patents that are decades-old and have little to show in the way of new blockbuster drugs. But their share buybacks and dividend payments inoculate them against shareholders who might be concerned about lackluster research and development.

A few companies have spent more money repurchasing shares than they allocated to research over the period, the study found. They included Gilead Sciences, which spent $27 billion on buybacks versus $17 billion on research, and Biogen Idec, which repurchased $14.6 billion in stock and spent $13.8 billion on research and development.

“The key cause of high drug prices, restricted access to medicines and stifled innovation, we submit, is a social disease called ‘maximizing shareholder value,’” the study’s authors concluded.

This concept, the authors said, is actually “an ideology of value extraction.” And chief among the beneficiaries of the extraction are drug company executives, whose pay packages, based in part on stock prices, are among the lushest in corporate America.

“There’s no shortage of spending on R&D in the U.S. economy, and no shortage of spending on life sciences, even though it has declined somewhat in real terms,” one of the authors, William Lazonick, a professor of economics at the University of Massachusetts, Lowell, said in an interview. “But there really is very little drug development going on in companies showing the highest profits and capturing much of the gains.”

(The other authors are: Matt Hopkins, Ken Jacobson, Mustafa Erdem Sakinç and Öner Tulum, all researchers at the Academic-Industry Research Network, a nonprofit organization.)

While stock buybacks appear to be particularly troublesome among drugmakers, big companies in other industries — in sectors like banking, retail, technology and consumer goods, among others — are also buying back boatloads of their shares. Through May, some $390 billion in buybacks have been announced this year, $13 billion more than at this time in 2016, according to figures compiled by Jeffrey Yale Rubin at Birinyi Associates, a stock market research firm.

June 28 was the biggest single buyback announcement day in history. That was when 26 banks disclosed buybacks worth $92.8 billion, largely a response to having just passed the stress tests administered by the Federal Reserve Board. That figure blew past the previous record of $56.4 billion announced on July 20, 2006.

Many companies contend that stock buybacks are a great way to return value to their shareholders. Investors often agree. By reducing the equity outstanding at a company, the repurchases increase its per-share earnings, often giving a boost to its stock.

Buybacks made at low cost can be a fine use of a company’s capital. But when share repurchases replace a company’s research-and-development spending, that indicates its management is unable or unwilling to spend on innovation that could generate future earnings to shareholders.

As the buyback binge continues, another new academic study shows, a heavy reliance on them actually hurts corporate performance over the long haul. These researchers found that the more capital a business invests in stock repurchases based on its current market capitalization, “the less likely that company is to experience long-term growth in overall market value.”

“Secular Stagnation” is by Robert U. Ayres, emeritus professor of economics, political science and technology management at the global business school Insead, and Michael Olenick, a research fellow there. It compares the performance of companies that lean heavily on buybacks with those that do not.

Spending money on buybacks and dividends has increased among United States companies from negligible levels in the 1980s, the researchers said, to 38 percent of earnings in 2000. By 2011, buybacks had grown to 79 percent of earnings, rocketing to 110 percent in 2015.

The research looked at 1,839 large company buybacks from January 1990 through last month, examining 6,516 inflation-adjusted transactions. The academics then examined the amounts these companies had spent on repurchases compared with their current market capitalizations.

Mr. Ayres and Mr. Olenick found that 199 companies repurchased shares equal to at least half their current value. Some 64 companies spent over 100 percent of their current market capitalization on buybacks.

When the academics combined these companies’ current market values with the amounts they had spent on buybacks, the sum showed what the companies should have been worth if they had invested the money in a money-market account instead.

Fifty companies have spent more inflation-adjusted capital buying back stock than their businesses are currently worth in market value, the study found. Companies on this list include HP Inc., J. C. Penney and Sears Holdings.

By contrast, the research identified 269 strong performers that have repurchased stock worth just 2 percent or less of their current market values. They include Facebook, Xcel Energy, Berkshire Hathaway and Amazon.

Company executives who buy back large numbers of shares instead of investing in their businesses are committing corporate suicide, Mr. Olenick said. “When managers can’t create value in the business other than buying their own stock,” he said in an interview, “it seems like it’s time for a management change.”

His co-author, Mr. Ayres, said he suspected the buyback craze was rooted in executives’ laser focus on short-term results. “They have short-term expectations,” he said in an interview. “They’re in their jobs for a few years at most; they’re not really interested in the long-term future of the company.”

Share buybacks provide immediate gratification, the stock market equivalent of a sugar high. That makes them alluring in the short term. Until the crash that usually follows.

Rep. David Cicilline, the leading Democrat on the House’s antitrust committee, is asking for a hearing.

Another member of Congress is urging fellow lawmakers to take a closer look at Amazon and its $14 billion bid to buy Whole Foods.

As the Trump administration prepares to review the merger, the top Democrat on the House’s leading competition committee is pushing for a hearing, arguing that Amazon’s newest gambit in the grocery business — and its continued attempts to supercharge its same-day delivery services — could present new threats to its competitors.

In a letter to the panel’s Republican chiefs — who set the committee’s hearing schedule — Rep. David Cicilline said the deal “raises important questions concerning competition policy, such as how the transaction will affect the future of retail grocery stores, whether platform dominance impedes innovation, and if the antitrust laws are working effectively to ensure economic opportunity, choice, and low prices for American families.”

For one thing, Cicilline pointed to the stock market, where grocers took a thrashing immediately after Amazon announced its merger plans. The congressman also highlighted the merger’s effects on Blue Apron, which slashed the value of its own public offering following the news.

More generally, the Democratic lawmaker expressed fears the deal might “increase Amazon’s online dominance, enabling it to prioritize its products and services over competitors.” And Cicilline said that might come in the form of the data Amazon collects from customers, which he said “may increase the risk of self-dealing or enable Amazon to leverage its platform over other businesses.”

Cicilline took care to stress he wasn’t “taking a position on the legality” of Amazon’s attempt to purchase Whole Foods, and even cited some favorable analysis by top antitrust professors that showed it might prove beneficial for consumers.

But his letter continues a slow, steady push for Congress to take a closer look at the $14 billion deal. Earlier this month, another prominent Democrat — the tech-backed Rep. Ro Khanna, who represents a broad swath of Silicon Valley — expressed fears that Amazon’s plans would “put pressure” on local businesses.

"The main problem is it is going to hurt local grocery stores," he told CNBC.

A spokesman for Amazon declined comment.

Meanwhile, a spokeswoman for the House Judiciary Committee, which oversees competition issues, said it had no hearing scheduled at this time. A spokesman for the GOP leader on the Senate’s version of the panel declined comment.

Nevertheless, other Democrats have defended the merger, including New Jersey Sen. Cory Booker, who was asked about it on Twitter earlier this week.

AT&T planning reorganization ahead of DOJ demands

The Justice Department has yet to ask AT&T for concessions on its proposed $85 billion takeover of Time Warner, but it looks like the phone company already knows what it plans to serve up.

Bloomberg reported a detailed reorganization of the company’s business lines. suggesting that AT&T would separate its content and distribution assets in two.

It’s unclear, however, how such a separation would ease concerns that AT&T could jack up rates for rivals who buy Time Warner content, or quash competition in rural areas.

One source told The Post it was still unclear where DirecTV would sit in the new organization. John Stankey, AT&T’s entertainment boss, is set to become chief of the unit that will house Time Warner.

But it’s still being discussed whether DirecTV will be folded into AT&T’s traditional operations or remain with Stankey.

“No decisions on org structure or leadership have been finalized,” an AT&T spokesman said. “Randall [Stephenson] and Jeff are working through that.”

Time Warner Chief Executive Jeff Bewkes is expected to remain through a transition period.

Meanwhile, AT&T has said it will find $1 billion in synergies from the deal, but it’s not clear where the Dallas-based telecom will make cuts.

“Once they started digging in, they were shocked by the salaries in the movie business,” one source said. “They don’t get that — the cost structure and the salaries. They initially thought there were cost savings.”

AT&T is also anticipating that Makan Delrahim will be appointed as the Justice Department’s chief antitrust cop.

As reported by The Post in March, Delrahim’s nomination as the nation’s antitrust regulator has made people close to AT&T and Time Warner nervous about the merger’s prospects for approval.

On Wednesday, US Sen. Richard Blumenthal (D-Conn.), who sits on the Senate Judiciary Committee, said he wants to know what communications Delrahim has had with the White House on the AT&T/Time Warner merger plan.

* Cover story: Eight energy stocks look tempting after a bad performance by the sector this year; these companies are restraining capital spending and focusing on earnings and free cash flow (Positive on CVX, XOM, CNQ, SU, APA, EOG, COG, RRC). 

Adidas Shares Could Double as Profit Margins Expand

The white-shoe craze helped the German sportswear company generate tons of black ink. Management has a good game plan to keep it flowing.

Adidas shares have run up by nearly 40% in the past 12 months, to 180 euros ($205.21), stretching the sportswear giant’s jump since late 2014 to a threefold rise. The latest gain was propelled in part by sales of the company’s Superstar tennis shoe, a white, shell-toed classic that ranked as the best-selling sneaker last year in the U.S. market, knocking Nike out of the spot it had held for more than a decade.

But the retro Adidas white-shoe craze has peaked, at least according to retailer Foot Locker (ticker: FL), in widely reported comments a few weeks ago. Given Adidas’ (ADS.Germany) advance, it must be time for investors to throw in the three-stripe towel, right?

Not so fast, say portfolio managers for European equities at Hermes Investment Management, who have owned Adidas since 2009 and count it as their largest “active weight” relative to their benchmark. Adidas shares still have significant upside, they argue, particularly if the company can make good on its goal of achieving the lofty profit margins of rival Nike (NKE). “If they were to do that with their existing structure, there’s no reason why the shares couldn’t more than double,” says Chi Chan, the London-based lead portfolio manager for Hermes’ euro-zone strategy.

Matching Nike’s U.S. profit margins, and scoring a twofold advance in the share price, could happen within two years, according to Chan. Adidas had a net profit margin of 5.5% in the past 12 months, compared with Nike’s 12.1%, according to FactSet. Chan says he prefers to look at operating profit margin, with Adidas at 7.7% in the past fiscal year, behind Nike’s 13.8%. That owes, in large part, to the German company’s far smaller U.S. market share; it is 11%, against nearly 50% for Nike.

While doubling the stock price won’t be easy, few analysts and investors foresaw Adidas’ huge surge in recent years, Chan notes. If the stock were to double and maintain the current price/earnings ratio, the company would have to earn €12.40 per share in 2019, some 40% above the consensus forecast, he says. “This would seem a pretty tough ask, but boosting the U.S. profit margin would go some way toward achieving that,” Chan says.

One key to lifting profit margins is an ongoing effort to trim the fat. Chan praises CEO Kasper Rorsted’s focus on cost cuts and other efficiencies. Rorsted, who previously led German adhesives maker Henkel, has a reputation as a turnaround specialist.

A native of Denmark, Rorsted was named Adidas’ new chief in January 2016, and took charge in October. Shareholders cheered him from the get-go, with fund managers at Germany’s Union Investment saying they hoped it meant “an end to the long dry spell” in Adidas’ profitability.

“His background is in adhesives—a pretty different world—but he knows how organizations run,” Chan says. “They very much want to drive out inefficiencies in the whole value chain.”

The attempt at streamlining included a May announcement that Adidas is selling off TaylorMade and other golf-equipment brands for $425 million as it focuses on shoes and clothing, and its two main brands—its namesake and Reebok.

ADIDAS SHARES AREN’T exactly a steal at 26.2 times forward-four-quarter estimated earnings, versus Nike’s 23.8 P/E. But they’re below Puma (PUM.Germany), at 35.7 times earnings, and investors are getting growth. Earnings per share were up 9%, compounded annually, over the past five years, and revenue compounded at 8% a year. Analysts see earnings per share rising 24% this year, as revenue climbs 13%. Footwear generated 58% of Adidas’ net sales in this year’s first quarter, and apparel delivered 34%.

The “athleisure” trend has been another driver of Adidas’ stock, which also trades in the U.S. via American depositary receipts (ADDYY). Chan bats back suggestions that it is already priced in, and looks for a growing percentage of people to don athletic-type clothing as everyday wear.

While the Superstar sneaker has enhanced Adidas’ “cool” factor, it is hardly the company’s only hit. Adidas’ Stan Smith, a similarly iconic white shoe named for a U.S. tennis star of the 1970s and ’80s, has also been a hot seller. Chan notes that the company’s ZX sneaker line likewise is doing well, as is the Yeezy line, created for Adidas by Kanye West. “They’ve got all these other things bubbling in the background,” he says. “There is kind of an overall halo effect that is pulling the brand up.”

Efforts to speed up manufacturing ought to pay off as well, he says. Adidas plans to open a “Speedfactory” in Atlanta later this year after opening its first in Germany, as the company aims to launch products faster, make greater use of 3-D printing, and allow for more customization. Nearly 20% of production for Adidas and Nike shoes will move to more automated factories by 2023, due to a “buy now/wear now” shopping environment driven by the shift to e-commerce, Morgan Stanley has forecast.

White shoes produced a lot of black ink for Adidas in recent years. It looks like management has a good game plan to keep it flowing.

The Coming Revolution in Investment Research

Clients will pay for research, rather than be part of commissions and fees. One result: fewer analysts.

Stock analysts around the world are counting down to Jan. 3, when new European regulations will change investment research everywhere. On that date, the European Union rules known as the Markets in Financial Instruments Directive will require asset managers to pay for research reports they’ve been getting for free from brokers in exchange for trading commissions. By putting a price on research, the regime known as MiFID II could reduce overall spending on the analysis of stocks and bonds, narrow coverage of small stocks, and force all but the biggest brokers to sack some analysts. Since so many of Wall Street’s money managers and brokers do business in Europe, U.S.-based firms are preparing to toe the MiFID II line.

The shadow of MiFID II already casts a chill. Back in March, Evercore ISI banking analyst Glenn Schorr looked ahead in a note titled, “Writing My Obituary Again?” Researchers at specialized boutiques and investment-banking giants all claim they’ll thrive as the research economy goes from all-you-can-eat to à la carte, but Schorr acknowledges they can’t all be right. “A smaller fee pie is never a good thing,” he says. “There will be market-share shifts, which by definition mean some firms will lose share in a business where it was already very tough to run a reasonable P&L.”

Proposals to unbundle research payments from trading commissions have floated around since at least 2003, when Britain’s Financial Services Authority aired the idea as a way for asset managers’ customers to ensure their managers were obtaining value for money spent on both trade execution and information. Fourteen years later, the MiFID II directive will oblige asset managers either to pay for research out of their own pockets, or to charge their customers explicit research fees, in addition to charges for management and trading. Money-management firms will need to draw up periodic budgets for research and set aside research-payment accounts funded pro rata by the endowments and pension funds they serve. The details of MiFID II regulation are left to each EU member country, so Britain’s rules will be somewhat different from France’s.

While retail traders and wholly domestic U.S. firms might ignore MiFID (at least until pension consultants deem the EU rules a “best practice”), preparations are under way at global asset managers and investment banks, as well as at U.S. firms with European customers. The Securities and Exchange Commission historically has shown little interest in the issue of research payments, or in accommodating MiFID’s impact here, but brokers are expected to seek the agency’s assurance that they can receive cash for research without being deemed investment advisors.

Nor will MiFID’s rules provoke huge changes to business practices at those money managers in the habit of transparently assessing the value of research they’ve received. At some mutual fund shops such as Fidelity Investments and T. Rowe Price Group (ticker: TROW), and at hedge funds such as Millennium Management and Citadel, portfolio managers vote on how to allocate pools of “soft dollar” commissions among outside research providers. But not every manager seems prepared. “We get paid by something like 1,500 clients,” says Schorr at broker Evercore. “And we get a detailed, transparent vote from maybe 100 of the 1,500.”

Because MiFID II requires an advance budget for research, there’s an industrywide exercise in price discovery going on in negotiations between asset managers and their asset-owning clients, and then between the managers and their stockbrokers. The talk might get testy, in an era of active-manager underperformance that has already pressured management fees and brokerage commissions.

THIS IS THE FIRST TIME many asset managers have had to implement a formal system for procuring research. Before, says Michael Mayhew, the founder of the Darien, Conn.–based consultancy Integrity Research Associates, obtaining research has been like walking into Best Buy, taking a 55-inch flat-screen TV and telling the salesman, “I’ll let you know in six months what it’s worth.”

Scrambling to help Wall Street deal with MiFID are a dozen vendors of software and services, according to an April 2017 study by Integrity Research. They include agency brokers like Investment Technology Group (ITG) and the Instinet subsidiary of Nomura Holdings (NMR), plus software and data vendors such as the United Kingdom’s Commcise and IHS Markit (INFO).

MiFID II will become another cost and compliance burden driving consolidation among asset managers and brokers, says IHS Markit’s head of brokerage and research services, Tom Conigliaro. Big money management conglomerates like Janus Henderson Group (JHG) and the soon-to-be London-listed Standard Life Aberdeen will be better able to fund internal and external research.

Everyone seems to agree that research spending will shrink in the unbundled world of MiFID. The brokerage-research population could end up distributed like a barbell, says Conigliaro, with most dollars going to a few big brokerage firms that offer “waterfront” coverage of many stocks, but some money also going to specialized firms and independent boutiques. “Me-too research at midtier firms will be gone,” predicts Conigliaro. “Many asset managers complain they don’t need 40 people telling them that GE just reported third-quarter earnings.”

But me-too analysts won’t be the only ones to lose their jobs under MiFID. The market’s efficiency may suffer from a reduction in coverage of public companies that haven’t caught the eye of analysts at big banks. That unanticipated consequence of MiFID would hurt investors large and small.

One boutique researcher who hopes to adapt to MiFID’s world is Mark Roberts, who has discussed the short ideas of his Off Wall Street Consulting Group in these pages for 25 years. The Cambridge, Mass.–based analyst has been hiring researchers to add long ideas to Off Wall Street’s output. “In a shrinking market,” Roberts says, “managers are going to spend their money more carefully. Highly differentiated research should gain share.”