Category Archives: Cloud Computing

Why Etsy’s Stock Jumped 24% Amid Some Complaints From Sellers and Buyers

Artisan craft marketplace Etsy has had its ups and downs since going public almost three years ago, but new CEO Josh Silverman appears to have convinced investors that sales are on track for solid growth in 2018.

Etsy’s stock price jumped as much as 24% in midday trading on Wednesday, and has now more than doubled from a year ago, thanks to Silverman’s turnaround strategy that got the company out of Amazon’s long shadow. Silverman, a veteran of eBay’s (ebay) Shopping.com site, has emphasized simple improvements like adding “best seller” badges and site-wide sales for Labor Day and Cyber Monday last year, as well as deeper changes that improved customer searches using artificial intelligence and machine learning with a program Etsy calls “Context Specific Search ranking.”

The results pleased Wall Street. Etsy reported solid fourth quarter results on Tuesday evening, including sales on the site increasing 15% to $1 billion—the company’s first billion dollar quarter ever—while Etsy’s own revenue, which includes its cut of the sales plus other services it sells, increased 21% to $136 million. Earnings per share of 36 cents reversed a loss of 19 cents per share last year and beat Wall Street’s expectations of just 13 cents (though the latest quarter included a one-time benefit from the new tax law).

Analysts also cheered Etsy’s forecast for 2018, including overall sales on the site increasing 14% to 16% to as much as $3.8 billion and its own revenue growing 21% to 23% to as much as $543 million. Analysts had forecast Etsy’s 2018 revenue would hit only $519 million.

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Silverman explained the improvements that led to last year’s growing sales, while also offering more ideas that will boost growth this year. “There’s still much work to do to improve the shipping experience on Etsy and this will be an area of strong focus in 2018,” he told analysts on a call on Tuesday.

Still, there were complaints from some sellers and buyers last year that Etsy was losing its identity as a craft marketplace focused on individual artisans amid all the changes. Silverman said the latest results were proof that, on the whole, his strategy was working for most.

“You know as a platform our job is to make the experience better for all of our buyers and sellers,” he said. “On any given day, there will be individual winners and losers because that’s the nature of the marketplace–you know, is the product that a particular seller is selling, is it in fashion or not, how is it resonating with the marketplace, that’s up to each of our sellers.”

Under prior CEO Chad Dickerson, Etsy stumbled in the face of growing pressure from Amazon (amzn), which introduced its own handmade craft-oriented platform just a few months after Etsy went public. Dickerson was pushed out last May after a disastrous first quarter that led to layoffs

Further improvements at Etsy this year will come from giving sellers better data analytics tools, making it easier for buyers to have items shipped quickly, and further optimizing search results, among other initiatives, Silverman said. The company will also look at hosting more site-wide events with discounting, though Etsy (etsy) doesn’t want to become known as a discount site, he said.

In many cases, “these are things that are perhaps best practices already used in other parts of the web that we haven’t yet adopted,” Silverman said. “We also want to make sure that we’re stretching ourselves and we’re thinking about bolder bigger events.”

Google not obligated to vet websites, German court rules

FRANKFURT (Reuters) – Google (GOOGL.O) is not obligated to ensure websites are free from defamatory content before displaying links to them in search results, Germany’s highest court ruled on Tuesday.

The case, which comes in the context of debate about the so-called “right to be forgotten”, had been brought by two individuals seeking Google to prevent its search engine from displaying links to websites on which they were verbally attacked by other internet users.

They wanted Google, a unit of Alphabet Inc, to set up search filters to keep those websites from appearing in future search results, information about the users who had posted the offending comments and payment of damages, saying Google was partly responsible for the violation of their rights.

The German Federal Court of Justice said, however, that a search engine operator need only take action if it is notified of a clearly recognizable violation of individuals’ rights, rather than checking ahead of time whether the content complies with the rules.

“Instituting a general duty to inspect the content would seriously call into question the business model of search engines, which is approved by lawmakers and wanted by society,” the court said in a statement.

“Without the help of such search engines it would be impossible for individuals to get meaningful use out of the internet due to the unmanageable flood of data it contains,” it added.

In May 2014, the Court of Justice of the European Union (ECJ) ruled that people could ask search engines, such as Google and Microsoft’s Bing (MSFT.O), to remove inadequate or irrelevant information from web results appearing under searches for people’s names – dubbed the “right to be forgotten”.

Google has since received requests for the removal of more than 2.4 million website links and accepted about 43 percent of them, according to its transparency report.

Reporting by Maria Sheahan; Editing by Mark Potter

Britain's big banks play catch up with fintech with new apps

LONDON (Reuters) – British retail banks are poised to introduce money management apps to compete with those already launched by financial technology start-ups, betting their trusted brands, broad client base and deep pockets will help them make up lost ground.

HSBC (HSBA.L), Lloyds Banking Group (LLOY.L) and the Royal Bank of Scotland (RBS.L) are at various stages of producing cutting-edge apps that will allow customers to pull data from different accounts, even those at rival lenders, on their mobile devices and home computers.

They are playing a serious game of catch-up. Numerous fintech firms and digital banks like Monzo and Money Dashboard already offer the kinds of apps the banks are building, winning fans among the young and tech-savvy.

The user base for Monzo’s app, which analyses and categorizes spending habits, sends budgeting nudges and allows users to freeze and unfreeze cards at the click of a button, soared by 300 percent to 450,000 in nine months last year.

After years spent rebuilding balance sheets and managing regulatory change after the 2008 financial crisis, technology is now at the top of the banks’ agenda, said Edward Firth, managing director for UK banks at brokerage Keefe, Bruyette & Woods.

“This is all they’re talking about,” he said.

The drive has been turbo-charged by new “open banking” regulations requiring Britain’s nine biggest banks to share data so that customers can access their financial information across providers in an aggregated format and make it easier to compare services as well as change banks.

The rules were supposed to be implemented on Jan. 13 but six of the banks, including Barclays (BARC.L) and HSBC, have asked for more time to ensure the data is secure.

The changes will now start for the majority of customers in March, although some banks have been allowed to delay until next year for certain segments of their customer bases.

Jeremy Light, managing director of Accenture Payment Services for Europe, Africa and Latin America, said the changes will spark a competitive technology race in which aggregator apps will be the “bare minimum”.

“You will have to have them, because if you don’t you’re out of the game,” Light said. “It’s really all of the other services that you then start offering.”

Monzo, Starling Bank and Revolut have already opened a “marketplace” within their apps where users can shop around for and sign up to other products and services from fintech firms, banks or even energy and insurance companies.

HSBC is the only major lender to show an interest in this kind of service so far, teaming up with fintech firm Bud to trial a money management and marketplace app with users on its First Direct brand.

MONEY, BRAND AND LOYAL CLIENTS

FILE PHOTO: The HSBC headquarters is seen in the Canary Wharf financial district in east London, Britain February 15, 2016. REUTERS/Hannah McKay /File Photo

Big banks have the advantages of scale, name recognition and funding power, Accenture’s Light said.

Lloyds, which had 13.5 million users of its online and mobile offerings in 2017, plans to unveil a new app with “full open banking capability”, Chief Executive Antonio Horta-Osorio said at the bank’s annual results announcement on Feb. 21.

He did not give a date for the launch, but a source familiar with the matter had previously told Reuters it was expected sometime this year.

Horta-Osorio also unveiled a 3 billion pound investment program focused mainly on digitization and staff over three years.

HSBC’s app, dubbed HSBC Beta in the pilot stage, aggregates data from users’ current accounts, loans and savings, calculating their disposable income each month and sending nudges like Monzo’s app.

The app will launch to existing clients “imminently”, said Raman Bhatia, head of digital at the lender for the UK and Europe, and will eventually be available to other banks’ customers too.

HSBC has earmarked $2 billion for investments in and 3,000 people working on digital technology globally, with Britain taking a large share of the funding and around a third of the workforce, he said.

Tom Moore, a 30-year-old graphic designer, is taking part in a trial of the HSBC app and told Reuters via Facebook that although there are some features he would like to change, he would trust such products from HSBC above others.

“The benefit of this being done by HSBC, rather than some mysterious company nobody has ever heard of, is definitely in their (the bank‘s) favor,” he said.

RBS will launch its account aggregator app some time in 2018 but tests with customers have already started, Jane Howard, managing director of personal banking at RBS, told Reuters.

Barclays said it was too soon to talk about its plans.

Light said smaller firms tended to be able to deliver slick technology faster and more effectively than big rivals who have to contend with vast user bases and complex legacy technology.

Nikolay Storonsky, founder & CEO at Revolut, which claims more than one million customers across Europe, says he isn’t worried, “no matter how much funding the big banks have”.

“They may copy some of our savings products 12 months after we’ve launched them, but by that time we have three or four other features in this area and we’re moving onto the next big thing,” he said in an email.

“To keep younger customers excited and loyal, they will need to focus on reducing red tape, attracting top developers and begin innovating, not copying.”

(GRAPHIC – Digital banks rise: tmsnrt.rs/2BdERcZ)

Editing by Sonya Hepinstall

Huawei in early 5G trials with 30 telcos; CEO rejects U.S. security fears

BARCELONA (Reuters) – The chief executive of Huawei [HWT.UL] said on Monday the pace of commercialization for next-generation 5G wireless network is picking up pace as the Chinese telecom equipment giant has begun pre-commercial development with more than 30 telecom operators.

Speaking to reporters at the annual Mobile World Congress in Barcelona, CEO Ken Hu also said he welcomed “factual debate” about any security concerns governments or network operators may have about security threats from its products.

Hu dismissed U.S. government concerns that its products pose security threats as “groundless suspicions”.

Reporting by Eric Auchard; editing by Jason Neely

Vote Against The Rite Aid/Albertsons Merger

Grocer Albertsons signed an agreement to buy all Rite Aid (RAD) stores not bought by Walgreens (WBA). The deal is unusual, to say the least. Rite-Aid shareholders will effectively get $2.50 a share, which is a far below amount Walgreens paid for the 1,932 stores it bought. Shareholders should demand more than the low-ball offer.

RAD

Walgreens bought 1,932 stores for $4.4 billion, which values the stores at $2.28 million a store. Conversely, Albertsons will get the approximately 2,670 Rite Aid stores for $1.83 of cash plus a share of Albertson’s, for every 10 shares of Albertson’s. The exact terms of the deals are as follows:

Under the terms of the agreement, in exchange for every 10 shares of Rite Aid common stock, Rite Aid shareholders will have the right to elect to receive either (I) one share of Albertsons Companies common stock plus approximately $1.83 in cash or (ii) 1.079 shares of Albertsons Companies stock. Depending upon the results of cash elections, upon closing of the merger, shareholders of Rite Aid will own a 28.0 percent to 29.6 percent stake in the combined company, and current Albertsons Companies shareholders will own a 70.4 percent to 72.0 percent stake in the combined company on a fully diluted basis.

Source: Rite Aid

The approximately $2.50 per RAD stock values the buyout at $2.6 billion, or just $970,000 for each store. Paying less than half what Walgreens paid is wholly inadequate for shareholders. If an activist investor like Elliot steps in, as contributor Seven Corners Capital Management suggests, it would have a strong case in forcing Cerberus to raise its offer.

RAD Stock:

Chart
RAD data by YCharts

Take Cash and New Share or No Cash and More Shares

If no activist investor gets involved to get more for each RAD stock, then shareholders may either take the $1.83 in cash plus 1/10 Albertsons shares or take a bit more Albertsons shares only. As you will notice, the deal is structured to give very little money to shareholders. Investors need to consider how weak the combined company will be when it merges. Finding $375 million in synergies is hardly assured. As author Vince Martin calculated, assigning a 5x multiple to EBITDA and the combined Rite Aid/Albertsons would have a market cap of $7 billion. That would imply a share value of just $2 a share.

Speculating on Rite Aid

Author Daniel Jones believes the merger is good for shareholders. The bullishness is based on the combined firm achieving the cost synergies, $400 million in free cash flow from Rite Aid, and a P/FCF of just 4.2 times. The problem with this view is that Albertson’s stores are all dated and are in need of a major refresh. Prior to the merger, Rite Aid had walked through a more innovative business model that would embrace technology in its business. It would have focused more on delivering a better customer experience. This merger sets Rite Aid’s turnaround back.

Reader Sean Livingstone figures Amazon.com (AMZN) could swoop in to buy some of Rite Aid’s stores. The online retailer is working with Berkshire Hathaway and JPMorgan Chase to partner on health care. Yet the new company will focus only on the technology solutions. It will need a physical storefront to deliver easily accessible drugs.

Merger Sets Too Low a Value for Rite Aid Stock

Chart
CVS data by YCharts

The merger values RAD stock at just 0.2x EV/Fwd Revenue. CVS Caremark (CVS) is worth 0.5x while Walgreens (WBA) is valued at 0.6 times.

Source: finbox.io

Rite Aid is worth north of $3.50 a share at a 0.3x EV/Fwd. Revenue and that excludes assuming management succeeds in fixing the business and generating higher revenue in the future:

Source: finbox.io

Final Word

Rite Aid shareholders should vote against the merger and, should the deal go through, sell the stock before the Albertsons shares are issued. Cerberus failed to take Albertsons public through an IPO for over three years. This backdoor entry into the stock market is a troubling deal that hurts the RAD shareholder. Rite Aid had a fundamentally better chance of turning around its business as a pure-play pharmacy chain. The merged firm has two bifurcating goals of growing in the supermarket business and in pharmacy. The synergies between the two businesses are limited. Post-merger, the firm will suffer from low p rofitability and extra costs needed to put the two operations together.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Apple moves to store iCloud keys in China, raising human rights fears

SAN FRANCISCO/BEIJING (Reuters) – When Apple Inc begins hosting Chinese users’ iCloud accounts in a new Chinese data center at the end of this month to comply with new laws there, Chinese authorities will have far easier access to text messages, email and other data stored in the cloud.

That’s because of a change to how the company handles the cryptographic keys needed to unlock an iCloud account. Until now, such keys have always been stored in the United States, meaning that any government or law enforcement authority seeking access to a Chinese iCloud account needed to go through the U.S. legal system.

Now, according to Apple, for the first time the company will store the keys for Chinese iCloud accounts in China itself. That means Chinese authorities will no longer have to use the U.S. courts to seek information on iCloud users and can instead use their own legal system to ask Apple to hand over iCloud data for Chinese users, legal experts said.

Human rights activists say they fear the authorities could use that power to track down dissidents, citing cases from more than a decade ago in which Yahoo Inc handed over user data that led to arrests and prison sentences for two democracy advocates.  Jing Zhao, a human rights activist and Apple shareholder, said he could envisage worse human rights issues arising from Apple handing over iCloud data than occurred in the Yahoo case.

In a statement, Apple said it had to comply with recently introduced Chinese laws that require cloud services offered to Chinese citizens be operated by Chinese companies and that the data be stored in China. It said that while the company’s values don’t change in different parts of the world, it is subject to each country’s laws.

“While we advocated against iCloud being subject to these laws, we were ultimately unsuccessful,” it said. Apple said it decided it was better to offer iCloud under the new system because discontinuing it would lead to a bad user experience and actually lead to less data privacy and security for its Chinese customers.

As a result, Apple has established a data center for Chinese users in a joint venture with state-owned firm Guizhou – Cloud Big Data Industry Co Ltd. The firm was set up and funded by the provincial government in the relatively poor southwestern Chinese province of Guizhou in 2014. The Guizhou company has close ties to the Chinese government and the Chinese Communist Party.

The Apple decision highlights a difficult reality for many U.S. technology companies operating in China. If they don’t accept demands to partner with Chinese companies and store data in China then they risk losing access to the lucrative Chinese market, despite fears about trade secret theft and the rights of Chinese customers.

     BROAD POWERS

Apple says the joint venture does not mean that China has any kind of “backdoor” into user data and that Apple alone – not its Chinese partner – will control the encryption keys.  But Chinese customers will notice some differences from the start: their iCloud accounts will now be co-branded with the name of the local partner, a first for Apple.

And even though Chinese iPhones will retain the security features that can make it all but impossible for anyone, even Apple, to get access to the phone itself, that will not apply to the iCloud accounts. Any information in the iCloud account could be accessible to Chinese authorities who can present Apple with a legal order.

Apple said it will only respond to valid legal requests in China, but China’s domestic legal process is very different than that in the U.S., lacking anything quite like an American “warrant” reviewed by an independent court, Chinese legal experts said. Court approval isn’t required under Chinese law and police can issue and execute warrants.

“Even very early in a criminal investigation, police have broad powers to collect evidence,” said Jeremy Daum, an attorney and research fellow at Yale Law School’s Paul Tsai China Center in Beijing.  “(They are) authorized by internal police procedures rather than independent court review, and the public has an obligation to cooperate.”

    Guizhou – Cloud Big Data and China’s cyber and industry regulators did not immediately respond to requests for comment. The Guizhou provincial government said it had no specific comment.

There are few penalties for breaking what rules do exist around obtaining warrants in China. And while China does have data privacy laws, there are broad exceptions when authorities investigate criminal acts, which can include undermining communist values, “picking quarrels” online, or even using a virtual private network to browse the Internet privately.

Apple says the cryptographic keys stored in China will be specific to the data of Chinese customers, meaning Chinese authorities can’t ask Apple to use them to decrypt data in other countries like the United States.

Privacy lawyers say the changes represent a big downgrade in protections for Chinese customers.

    “The U.S. standard, when it’s a warrant and when it’s properly executed, is the most privacy-protecting standard,” said Camille Fischer of the Electronic Frontier Foundation.

WARNED CUSTOMERS

Apple has given its Chinese users notifications about the Feb. 28 switchover data to the Chinese data center in the form of emailed warnings and so-called push alerts, reminding users that they can chose to opt out of iCloud and store information solely on their device. The change only affects users who set China as their country on Apple devices and doesn’t affect users who select Hong Kong, Macau or Taiwan.

The default settings on the iPhone will automatically create an iCloud back-up when a phone is activated. Apple declined to comment on whether it would change its default settings to make iCloud an opt-in service, rather than opt-out, for Chinese users.

Apple said it will not switch customers’ accounts to the Chinese data center until they agree to new terms of service and that more than 99.9 percent of current users have already done so.

Until now, Apple appears to have handed over very little data about Chinese users. From mid-2013 to mid-2017, Apple said it did not give customer account content to Chinese authorities, despite having received 176 requests, according to transparency reports published by the company. By contrast, Apple has given the United States customer account content in response to 2,366 out of 8,475 government requests.

Those figures are from before the Chinese cyber security laws took effect and also don’t include special national security requests in which U.S. officials might have requested data about Chinese nationals. Apple, along with other companies, is prevented by law from disclosing the targets of those requests.

Apple said requests for data from the new Chinese datacentre will be reflected in its transparency reports and that it won’t respond to “bulk” data requests.

Human rights activists say they are also concerned about such a close relationship with a state-controlled entity like Guizhou-Cloud Big Data.

Sharon Hom, executive director of Human Rights in China, said the Chinese Communist Party could also pressure Apple through a committee of members it will have within the company. These committees have been pushing for more influence over decision making within foreign-invested companies in the past couple of years.

   

Reporting by Stephen NellisEditing by Jonathan Weber and Martin Howell

With 1 Tweet, Kylie Jenner Cut $1.3 Billion From Snapchat. Here's the Explanation Everyone's Missing

With a single tweet yesterday, Kylie Jenner sucked $1.3 billion out of the market capitalization of Snap, Inc.  

Her whole message ran just 18 words, and that includes “sooo” and “ugh.” It all ads up to more than $72 million lost, for each word she wrote.

So, was it simply a tweet? Is Jenner just throwing in with the 1.2 million people who signed a petition objecting to Snapchat’s recent redesign?

Or is there something else going on?

I don’t have any inside information, but the timing of the tweet–the exact timing–makes me raise an eyebrow.

Here’s the background. Jenner is a social media influencer of the first order, making between $250,000 and $500,000 per post, according to one estimate.

That’s more money for a single post that almost everyone who reads this article makes in a year. Big-time influencer money. 

Pretty impressive performance for a woman who won’t even be able to drink legally in the United States until August 10 of this year. But Jenner is a Kardashian (half-sister of Kourtney, Kim and Khloé Kardashian).

Whatever else anyone may say, the Kardashians are brilliant marketers. I’m not exactly their demo, but I have to respect something about what they’ve managed to build.

And, whatever else they do, they don’t do things like this without thinking it through.

So, three things.

First, the change in Snap’s design potentially impacts the degree to which Jenner–heck, any of the Kardashians–can make money on the platform. Those 1.2 million Snapchat users who signed the petition? They’re her audience.

If there’s a change, of course she’d make noise. Double irony points for doing so on Twitter.

Second, the timing of the tweet: 4:50 p.m. Eastern time–less than an hour after the U.S. markets closed.

Recently, I wrote about how Mark Zuckerberg’s post in January about changing how Facebook’s news feed works sent his company’s stock into a tumble, and devaluing his own stake by $3 billion. Next time he posted, he did it outside trading hours.

So, by posting just outside trading hours, it’s almost as if Jenner knew she could impact Snap’s share price–but didn’t want to overwhelm it.

I don’t have any inside information. It’s just a hunch, but it feels like a a warning shot: Hey Snap, pay attention to what I can do if I want to!

But, it also feels like it’s not intended as a fatal blow. In fact, KJ did tweet again, reminding Snap that it was her “first love.” 

Awwww.

Sure enough, the stock price rebounded later Thursday, too. All’s well that ends well, right? 

At least until the next tweet.

Elon Musk Is Leaving the Board of an AI Safety Group He Co-Founded

Tesla CEO Elon Musk has been described as an artificial intelligence alarmist even as the tech billionaire invested in AI research. Now, Musk is leaving the board of a non-profit AI research company he co-founded in 2015 due to potential conflicts with his ongoing work at Tesla.

The research group, OpenAI, said in a blog post this week that Musk will leave its board in order to avoid any conflicts with his work at Tesla and its AI-supported autonomous driving technology. “As Tesla continues to become more focused on AI, this will eliminate a potential future conflict for Elon,” OpenAI said in the blog post. Musk will remain an advisor to the group and he will continue to donate to OpenAI’s research efforts.

Over the past couple of years, OpenAI has worked to develop applications of AI in fields such as robotics and gaming, among others. Its goal is to independently research artificial intelligence “in the way that is most likely to benefit humanity as a whole, unconstrained by a need to generate financial return,” the group said in 2015.

At the same time, Musk’s Tesla continues to push deeper into the world of AI research itself as it develops machine learning technology for autonomous vehicles. He has also been vocal about the potential dangers of artificial intelligence—even describing AI as “the greatest risk we face as a civilization” while engaging in a war of words with Facebook CEO Mark Zuckerberg over their disagreement on the subject. Among Musk’s concerns regarding AI are the idea that artificial intelligence could become dangerous if it evolves past the point of human intelligence, and that unregulated AI could potentially be used to start global conflicts by “manipulating information.”

Musk created OpenAI with technology executives and investors including LinkedIn co-founder Reid Hoffman, Y Combinator’s Sam Altman and Jessica Livingston, and PayPal co-founder Peter Thiel. With additional support from corporate backers such as Amazon and Infosys, the group formed with over $1 billion in donations.

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OpenAI also announced a group of new donors this week, including former Olympic athletes Ashton Eaton and Brianne Theisen-Eaton as well as Skype founder Jaan Tallinn.

CBL's 17% Dividend Yield And What Investors Should Make Of It

By Jonathan Weber for Sure Dividend

CBL & Associates Properties (CBL) currently offers a very high 17% dividend yield to investors, but the future of the REIT is highly doubtful. There are not many securities with yields near that of CBL’s. You can see the full list of all 402 securities with 5%+ yields here.

In this article I will lay out why I believe that CBL may not be a good choice for conservative income focused investors. For adventurous investors CBL offers some chances though, as the valuation the REIT is trading at is extremely low.

Company Overview

CBL, which was founded more than 50 years ago, owns a large portfolio of grade B malls and other real estate assets that it operates throughout the US.

Source: (CBL’s 10-K filing)

Despite the struggles in the mall industry CBL’s performance through 2016 has not been bad at all:

Source: (CBL’s 10-K filing)

CBL had managed to grow its sales per square foot whilst at the same time reducing its debt levels significantly.

Retail trends such as shoppers moving from malls to online shopping avenues has hurt brick and mortar retailers in the recent future, and has had an impact on retail REITs as well:

Source: ^DJUSRL data by YCharts

Over the last three years the Dow Jones Retail REIT index is down 25%, but CBL’s performance has been significantly worse over the same time frame; Shares dropped by more than 75%.

CBL Looks Like It Is Priced For Bankruptcy

This deep decline in CBL’s share price has brought down the REIT’s valuation, and it currently looks like the market is pricing CBL as if it would go bankrupt in a couple of years.

Source: CBL Price to Book Value data by YCharts

CBL trades at 0.7 times book value right now. This indicates a steep undervaluation by the market, assuming that CBL’s stated book value is what it would receive if it sold its assets.

Source: (CBL 8-K)

More than 90% of the company’s assets are made up of real estate, and those values already include $2.5 billion of accumulated depreciation. Depreciation rules do not necessarily reflect the exact real world worth of a building, though. It is possible that the buildings CBL owns, which were originally valued at $6.7 billion, have a current worth of more than the $4.2 billion they are valued at in the balance sheet.

These so called hidden reserves are something we see regularly among assets such as real estate and other long-lived assets. Balance sheet values for short-lived items such as inventories usually have to be adjusted downwards to get their real values.

In CBL’s case, since the majority of its assets consist of buildings and land, the true value of its assets is likely higher than what is stated on the REIT’s balance sheet. A scenario analysis gets us to this picture:

Depreciation overstated by

Adjusted book value of Real Estate

Adjusted book value of equity

Price to book ratio

$5.16 billion

$1.24 billion

0.72

5%

$5.29 billion

$1.37 billion

0.65

10%

$5.42 billion

$1.49 billion

0.60

15%

$5.54 billion

$1.62 billion

0.55

20%

$5.67 billion

$1.74 billion

0.51

It is obvious that past depreciation being too high has a large impact on CBL’s price to book valuation. This is due to the fact that CBL is very highly leveraged (its debt to equity ratio is about four) — small changes in book value therefore have a big impact on the price to book multiple.

The high depreciation expenses CBL accounts for have another big impact. CBL’s net earnings are negligible, but since depreciation expenses are a non-cash item we can add those back to get to the REIT’s funds from operations.

Source: (CBL 8-K)

CBL trades at 2.2 times last year’s FFO, and at 2.3 times last year’s adjusted FFO (using a market capitalization of$816 million). CBL’s funds from operations have declined by about fifteen percent over the last year, and the market currently prices CBL as if this trend would not only continue, but accelerate:

Year

Adjusted FFO

Present value of FFO

Accumulated present value of FFO

2017

$355 million

$355 million

not included

2018

$308 million

$280 million

$280 million

2019

$268 million

$221 million

$501 million

2020

$233 million

$175 million

$676 million

2021

$202 million

$138 million

$814 million

2022

$176 million

$109 million

$923 million

I discounted all future FFOs by 10% annually to get to the present value number in the above table. We see that the present value of the funds from operations over the next five years is higher than the current market cap even if FFO continues to decline by a whopping 15% annually.

The current price of CBL’s shares thus only makes sense when we assume that the market believes that either FFOs will drop at an even faster pace going forward, or that the REIT will go bankrupt in the not too distant future.

Dividend Investment And What Management Should Do With The REIT’s FFO

Like all REITs CBL uses parts of its FFO to pay dividends to its shareholders. After a dividend cut in 2017 CBL currently pays out $0.20 per share per quarter, which means a dividend yield of 16.7% with shares trading $4.80.

CBL’s payout ratio (relative to its FFO number) is rather low at 45%, which means that CBL has a lot of excess funds that it can utilize elsewhere. When we look at CBL’s cash flows this becomes even more apparent:

Source: (CBL 8-K, page 19)

CBL has produced $423 million in cash flows during the last year, this means that cash flows after dividends total $264 million annually (all else equal). CBL has been using the majority of these cash flows to pay down debt and to upgrade its malls over the last quarters. Both of these actions imply that CBL plans to remain in business for a long time — otherwise upgrading malls would not make any sense.

Since the market seems to have the opinion that CBL will not remain a going concern forever, another approach could be more beneficial for shareholders. If CBL chose to return all of its cash flows to its owners via dividends and / or buybacks investors would very likely get much more than $4.80 over the coming years.

At the same time CBL could try to drive its cash flows further by selling off properties wherever possible. This approach would, in the long run, result in the shutting down of the REIT, but investors would at least receive a substantial amount of cash during the process.

The current approach (investing a lot of cash back into the business) is not showing a lot of success yet. Rent per square foot and other operating metrics continue to decline, and the market is not putting a lot of value on CBL’s shares.

What does this mean for income investors? Currently they receive a very high dividend yield (17%), and CBL can very likely continue to pay this dividend for the next couple of years even if its FFOs decline further. It is doubtful whether management is planning to do that though, currently it looks like the focus is being put on investing for the future to keep the REIT going.

This approach, which leads to a lot of cash being deployed into property improvements, could make management cut the dividend again in the future. CBL thus will very likely not be forced to cut the dividend in the next couple of years (due to the payout ratio being so low), but the REIT might still announce another cut. That is, if management comes to the conclusion that it is in the REIT’s best interest to invest for the future rather than to return more cash to its owners.

Management has an incentive to prioritize the long term survival of the REIT (their income depends on it) over total shareholder returns, more dividend cuts could therefore be coming in the near future.

Due to these reasons I believe that CBL might not be a very good income investment at the current level, even though its dividend yield is very high. The very low valuation and the price to book discount (which does not yet include any hidden reserves) make CBL a value play that could be interesting for adventurous investors though.

Final thoughts

CBL has operational problems and it is unlikely that this will completely reverse. Due to a very low valuation shareholders could see positive total returns even if things do not improve going forward, though — right now CBL is priced as if the REIT would go bankrupt in a couple of years.

Investors can get a very high income yield if they buy here, and the payout ratio looks quite low. Operational problems and management’s strategy of trying to turn the ship around via investments into its properties could lead to more dividend cuts.

CBL is not necessarily a bad investment, but it is more likely suitable for adventurous investors that want to speculate that CBL’s equity is undervalued. For conservative income investment there could be significantly better REIT choices, but with lower yields than CBL’s.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Broke Out Of This Jailhouse REIT

It’s one thing when jails are successful in housing and rehabilitating prisoners, but when those jails themselves become dysfunctional, something has to give. We were originally very positive on the concept of private prison ownership, knowing that the government couldn’t handle or didn’t want to handle the workload. But with its own set of issues and challenges, we are throwing in the towel on this Jailhouse REIT.

CoreCivic Inc. (CXW) (formerly Corrections Corporation of America) is a real estate investment trust company specializing in correctional, detention, and residential reentry facilities and prison operations. It also makes certain healthcare, food, work and recreational programs available to offenders as well as providing a variety of rehabilitation and educational programs like basic education, faith-based services, life skills and employment training, and substance abuse treatment – programs that intend to help reduce recidivism and prepare offenders for their successful reentry into the society upon their release.

It earns revenue on an inmate per-day based on actual or minimum guaranteed occupancy levels. In 2016, the company recorded $1.9 billion revenue. It has 13,755 employees and is the largest player in the correctional facilities industry with 34% market share. It owns 57% of all privately owned correctional and detention capacity.

Source: CoreCivic Investor Presentation

If Planning To Visit

As of September 30, 2017, CoreCivic owned 79 real estate assets and manages 7 additional facilities owned by its government partners. It owns 44 correctional facilities with 64,064 bed capacity and manages 7 facilities with total bed capacity of 8,769 beds. It leases 2 correctional facilities with 4,960 beds capacity and leases 7 residential centers with a total of 1,047 beds capacity to other operators and leases another 3 properties with total area of 30,000 sq. ft. to the federal government. It also operates 23 residential reenter centers with total capacity of 4,792 beds.

Aside from its principal executive offices in Nashville, TN, it also owns two corporate office buildings.

Source: CoreCivic Investor Presentation

Customers/Key Buyers

CoreCivic’s customers consist of federal and state correctional and detention authorities. Its key federal customers include the Federal Bureau of Prisons (BOP), the United States Marshals Service (USMS), and U.S. Immigration and Customs Enforcement (ICE).

Contracts from federal correctional and detention authorities account for about 51% of the company’s revenue whereas contracts from state customers account for about 42% of its revenue. Most of these contracts contain clauses allowing the government agency to end the contract at any time without cause. Moreover, these contracts are also subject to annual or biannual legislative appropriation of funds.

Aside from diversifying within federal, state, and local agencies, the risks of ending a contract prematurely is that CoreCivic has staggered contract expirations with most of its customers having multiple contracts. In the past, BOP has tended to let contracts end rather than end them prematurely as it is dependent on private prisons to house low-security inmates – typically undocumented male immigrants.

We knew about the concentration of government dependence when we invested in the stock but have become increasingly concerned with both the lack of inmate growth (see below) and the potential for government decisions that could adversely affect revenues – particularly in a highly polarized political environment that frankly, we find unpredictable.

Source: CoreCivic Investor Presentation

Recent Trends

Because the majority of the company’s revenue come from the federal government, its contracts are susceptible to annual or biannual appropriations, and having short terms of just three to five years, CoreCivic could be largely affected by an impending government shutdown. At present, immigration policy is one of the major issues wherein the Republicans and Democrats have opposing stances. For example, from January 19th to the 22nd, the U.S. entered a government shutdown after the two parties failed to come to an agreement about the funds allocated to immigration issues like the Deferred Action for Childhood Arrivals (DACA).

With the U.S. Immigration and Customs Enforcement being one of the major customers of CoreCivic, the company is directly affected by these shutdowns.

During a shutdown, the government will not be able to pass any short-term spending bills that allow budget allocations to be released to various agencies. Companies like CXW receive fixed monthly payments so the BOP may not be able to release funds or pay CoreCivic for a short period of time, depending on when and how long the shutdown occurs – resulting in cash flow and working capital challenges. Luckily, the government shutdown did not last very long, but the potential for a similar risk in the future is still relevant.

Another trend that is likely to affect CoreCivic’s business is the continuous decline in the number of prisoners. The number of prisoners under state and federal jurisdiction has declined by 7% from 2009 when the U.S. prison population peaked (See the table below). Federal prison makes up 13% of the total U.S. prison population and contributed 34% of the decline in the total prison population in 2016.

Source: U.S. Department of Justice

Accordingly, prisoners being held in private prisons have declined. According to Pew Research, after a period of steady growth, the number of inmates being held in private prisons has declined since 2012 and continues to represent a small share of the nation’s total prison population. We’re not confident this trend will reverse.

Another reason for the declining population in private prisons is the growing government commitment to progressive criminal justice, particularly to nonviolent offenders – low-security prisoners who are catered by private prisons. For example, the recommended mandatory minimum sentencing for nonviolent drug traffickers has been reduced. These progressive trends are likely to lead to further decreases in inmate populations.

Source: Pew Research

In August 18, 2016, the DOJ also issued a memorandum to the BOP directing that as each contract with privately operated prisons expires, BOP should either decline to renew contacts or substantially reduce scope in line with the BOP’s inmate population.

However, despite the said memorandum, BOP did exercise a two-year renewal option for CoreCivic’s McRae Correctional Facility. Moreover, in February 2017, the Department of Justice also reversed the memorandum to phase out private prison. It argues that this policy will impair the government’s ability to meet the future demands of the federal prison system. This decision saves the private prison industry from the risk of being phased out in the near future but may only push that decision out a few years. The uncertainty worries us.

To make matters worse, a class action lawsuit (Grae v. Corrections Corporation of America et al.) was filed against CoreCivic’s current and former offices in the United District Court for the Middle District of Tennessee. The lawsuit alleges that from February 27, 2012 to August 17, 2017, the company made misleading or false information and public statement regarding its operations, programs, and cost-efficiency factors to inflate its stock price. CoreCivic insists that these accusations are without merit but it still puts CXW and private prisons in a negative light.

Lastly, CoreCivic has also been receiving criticisms about its services. Complaints were received from Trousdale Turner Correctional Center in Hartsville after allegedly failing to address the concerns of prisoners and their families, including the healthcare needs to diabetic inmates. The scabies outbreak in its Metro-Davidson County Detention Facility is also cited as an example of its negligence to protect the wellbeing of prisoners. These lawsuits do not help CoreCivic’s image especially after it has laid off 500 employees after losing three jail contracts in Rusk, Jack, and Willacy counties.

Outlook

According to IBISWorld, the correctional facilities industry revenue is expected to grow minimally at an annual rate of 0.1% to reach $5.3 billion from 2017 to 2022, but industry profit is not expected to rise significantly. The trend in the number of prisoners will slow down the growth of the industry despite the overcrowding problem in the state prisons, which may or may not compensate for decreased demand for its services at the federal level.

Overall, we do not view the company’s prospects favorably in light of industry trends, governmental risks, and reputational image that can affect fundamentals and create unwanted headline risk. For this reason, we are selling CXW out of the REIT Portfolio.

America is the land of the second chance – and when the gates of the prison open, the path ahead should lead to a better life. – George Bush

Disclaimer: Please note, this article is meant to identify an idea for further research and analysis and should not be taken as a recommendation to invest. It is intended only to provide information to interested parties. Readers should carefully consider their own investment objectives, risk tolerance, time horizon, tax situation, liquidity needs, and concentration levels, or contact their advisor to determine if any ideas presented here are appropriate for their unique circumstances.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.