Should Microsoft Acquire This Handset Maker?

This post is syndicated at The Motley Fool http://beta.fool.com/malayappan/2013/08/16/should-microsoft-acquire-this-handset-maker/43543/

Microsoft (NASDAQ: MSFT), recently introduced Windows 8, an operating system that powers desktops, phones, and tablets alike. While this software giant simultaneously introduced its own Windows 8-powered tablet, the Microsoft Surface, it chose not to unveil a similarly Microsoft-branded smartphone.  Instead, it relied on its traditional model of partnering with hardware manufacturers to introduce the new Windows Phone to the market.  Was this an oversight -- or a deliberate strategy with a future acquisition in mind?

Strong Symbiotic Connection

From a single glance at Microsoft's Windows Phone website, its strong relationship with the lone manufacturer that ships the majority of Windows phones is glaringly apparent.  According toForbes, handset maker Nokia (NYSE: NOK) shipped 80% of all phones powered by the Windows OS during the first quarter of 2013.  

Given the strong synergies that currently exist between these two companies in the Windows phone business, many investors wonder where this relationship's going. It seems to make sense for Microsoft to acquire Nokia, creating a strong smartphone business in one fell swoop.  After all, hasn't their broad strategic partnership been getting stronger over the years?

First, consider who runs Nokia: former Microsoft executive Stephen Elop.  Elop is one of Microsoft's largest shareholders, and instrumental in directing Nokia's seismic shift from their native Symbian OS to the Windows Phone platform.  Additionally, according to Forbes, Elop already tried to woo Microsoft into buying Nokia, but failed to convince them. Given that Nokia has gone "all-in" by jumping on to the Windows Phone bandwagon, an acquisition by Microsoft might turn out into  a make or break for Nokia!

The Microsoft Disadvantage

Close to a year after the launch of the heavily advertised Windows 8 OS, which Microsoft touted as "revolutionary", the market share of Google's Android and Apple's iOS is still largely intact.

Microsoft came late to the smartphone party and failed to impress, despite spending nearly $2 billion on the latest marketing effort.  While Apple offers an integrated hardware and software solution with a closely-tied-in iTunes apps ecosystem, Google has gone the open-source route, offering Android as a freely downloadable OS.  Microsoft licenses its OS also, but vendors have to fork over a licensing fee for every device. Google has its own Google Play apps store, which is further augmented by an Amazon.com app store that offers only Android apps for now. Microsoft doesn't have a similarly broad-based app ecosystem like its competitors.

Microsoft is a behemoth that is slow to change course and catch up with the latest technology trend.  We have seen the company initially fall behind the curve in more than one instance. The most glaring examples are office productivity software such as Wordperfect (for word processing) and Lotus (spreadsheets), Internet browsers such as Netscape, and search engines such as Google.  

However, Microsoft has also shown that on occasion, it can and does catch up and overtake first movers -- including Lotus, WordPerfect, and Netscape -- through aggressive marketing and worldwide distribution.  Microsoft has the potential to pose a challenge to the dominant players in the smartphone and tablet space. Its best bet would  be to follow the integrated software and hardware route, while still licensing its OS to hardware vendors.  In fact, Google is also following this strategy by acquiring Motorola Mobility while leaving the Android OS freely available.

The Microsoft  Advantage

Microsoft today is the dominant operating system software maker, with its Windows OS running on about 90% of the roughly 1.1 billion computers in the world (as of the end of 2012). That kind of reach offers a ready consumer market for new smartphones with people who are already comfortable with the Windows interface.

Nokia, on the other hand, has a huge presence in emerging markets across Asia and Africa, and sells well in Europe and Latin America as well. Both Microsoft and Nokia have widespread name recognition and trust. Together as one company, they would be a formidable combination.

Microsoft is still the preferred choice for office productivity software. Microsoft Office Mobile is well-integrated into the Windows Phone and offers a natural segue from the desktop to a handheld device. Given its penchant for aggressive marketing strategies, one would expect Microsoft to put incredible might into promoting an integrated smartphone business. 

The Final Take

If Microsoft acquires Nokia, it would most likely pay a premium over Nokia's prevailing stock price.  Investors in Nokia today could very well be rewarded down the road for their patience.

Starbucks Looks Like a Million Bucks!

This post is syndicated at The Motley Fool Network: http://beta.fool.com/malayappan/2013/01/31/starbucks-looks-million-bucks/23249/

Starbucks (NASDAQ: SBUX), reported first-quarter fiscal 2013 earnings that blew past revenue expectations on Wall Street.  The company also reaffirmed fiscal 2013 targets.  Will investing in Starbucks give your portfolio a caffeine jolt?

Strong growth

Starbucks' revenue rose 11% in its most recent quarter, continuing a string of impressive growth throughout 2012.  The company reaffirmed predictions for similar expansion in fiscal 2013.

The company has opened over 1,000 new stores globally in fiscal 2012, and it expects to open another 1,300 in fiscal 2013.  Operating revenue for fiscal 2012 was higher than fiscal 2011, and the company expects to improve it by a full percentage point in fiscal 2013.  In short, the growth trajectory for Starbucks looks rosy.

Operating margin for Starbucks was 16.6% for the first quarter of 2013, up from 15.4% in the previous quarter.  After dipping briefly a year ago, these margins have been steadily increasing in recent quarters, reflecting a mature, yet growing company with a worldwide presence. 

How Starbucks Got There

It seemed that at the depth of he economic downturn in 2008, Starbucks was doomed; many observers predicted its demise. Founder Howard Schulz had just returned to the helm in an effort to save the company. The immediate items on his agenda were to close unprofitable locations, restructure the company, and open more stores globally.  As his plans got under way, the company struggled through difficult times.  The stock reached single digits in late 2008 before getting past the teens in late 2009. It was a rough climb back up.

This 2010 New York Times article describes how Mr. Schulz helped turn around the company and recaptured the imagination of both its customers and its employees. Key to his success was the idea that employees needed to revitalize their sense of belonging to the company through the revival of a "startup" culture.  He also changed the coffee ordering process, encouraging purchases from smaller suppliers as well.  In fact, Mr. Schulz has taken on an active role in job creation through support and encouragement of small businesses.

Through a renewed focus on its customers, its suppliers and the communities that it is present in, Starbucks appears to have a holistic turnaround that is reflected in the rebound in the stock.

Competitive Landscape

Dunkin’ Brands Group (NASDAQ: DNKN), owner of the Dunkin Doughnuts store chain, and McDonald’s (NYSE: MCD) have gone after Starbucks’ core business by offering gourmet coffee drinks of their own.  However, while they have shown impressive results, it is unclear if they have taken away market share from Starbucks.

Dunkin reported fourth-quarter 2012 and full-year 2012 results on Jan. 31.  Its adjusted operating income was up by about 16% from the previous quarter, and its adjusted operating income margin was about 47%. Dunkin's third-quarter 2012 results, released in October 2012, showed a 12.5% adjusted operating income increase over the previous quarter, and an adjusted operating income margin of 49.7%. Dunkin’s results have been pretty much consistent for the previous few quarters.

McDonald’s reported fourth-quarter 2012 and full-year 2012 results on Jan. 23 that were similarly impressive.  Operating income increased by 4% and revenues increased by 2% from the previous quarter.  Their earnings per share increased by $0.05 from the previous quarter.  Their full-year results for 2012 reflected a 3% revenue increase over 2011.

How They Compete

McDonald’s and Dunkin’ Brands represent two opposite ends of the spectrum when it comes to the strategy of competing with Starbucks. McDonald’s offers the McCafe line of gourmet coffees, which appear to compete with Starbucks' coffees. Dunkin’s Brands offers a premium line of espressos, cappuccinos, and lattes.  However, are they direct competition to Starbucks, which sells higher-priced coffees? 

McDonald’s found it necessary to explain the higher price point for its gourmet coffees in its FAQs.  In its last 10K report, McDonald’s lists “specialty coffee shops” as a competitor.  It also says that its restaurants and franchises “continue to expand their coffee business,” and discloses over 1,500 McCafe locations.  For a while, during the depth of the economic downturn, it appeared that McDonald’s was indeed offering an alternative. Recent earnings results for Starbucks, however, tell a different story.

Dunkin’ Brands, on the other hand, is trying to compete with Starbucks on other fronts as well.  They are aggressively promoting the K-CUP, much like Starbucks is promoting their brand. Dunkin’s coffee is found at retail outlets such as supermarkets, much in the same way asStarbucks.  Apart from the supermarket coffee aisle, both have burgeoning in-store full service locations.  McDonald’s does not compete with Starbucks in the same way as Dunkin.

Prospects for Starbucks

The future of Starbucks looks bright.  It appears to have reclaimed its mojo, and seems set to continue its expansion both in the US and abroad.  While Dunkin’ Brands appears to pose the most direct threat to Starbucks, it doesn’t quite have the same, nearly ubiquitous presence across the globe.  For quite the foreseeable future, therefore, Dunkin’ poses no immediate threat. 

McDonald’s and other fast as well as fast casual restaurants might appear to offer an additional alternative as well.  However, they are just that – an alternative. It, too, poses no immediate or long-term threat to Starbucks' domination. 

I rate Starbucks a buy.

Will Apple Fend Off Competitors Nibbling at its Feet?

This post is syndicated at The Motley Fool Network: http://beta.fool.com/malayappan/2013/01/23/will-apple-fend-competitors-nibbling-its-feet/22420/

Apple (NASDAQ: AAPL) reports its first-quarter results on Jan 23.  Earnings for last year's first quarter showed record quarterly revenue and profit, driving Apple's stock 6% higher on almost twice the volume of the previous day. Will this year's earnings report do the same?

Changed Dynamics

In the previous year’s earnings release, Tim Cook, Apple’s CEO was extremely upbeat about the company’s prospects.  He promised new products in the pipeline and waxed excitedly about the record-breaking sales in the previous quarter.  Apple stock rose to an all-time high of over $700 late in the year.

The pent-up excitement over Apple’s rosy future appears to have suddenly gone awry, with the stock tanking more that 30%.  In Sep 2012, I wrote about profiting from the possible downward trajectory of the stock, and I was spot on with my prediction. But I didn’t expect things to go south so quickly.  Is Apple's slump coming to an end now?  Let’s find out!

Robust competition.

First, the competitive landscape has changed dramatically over the past few months. It is one thing for a company like Samsung to put out great new products.  It is another thing to witness customers rapidly adopting those products, as evidenced by better company earnings reports.  Consumers are turning to the Samsung Galaxy and other smartphones from Nokia (NYSE:NOK), HTC, LG and others. Greater adoption rates of competitor offerings changes the dynamics of overwhelming advantages that Apple has recently enjoyed.

2013 brings robust competition to the smartphone marketplace and somewhat muted competition in the tablet marketplace. There is a plethora of choices as far as mobile phones and smartphones go.  As recently as one year ago, the competitive landscape was not as abundant with choices.

The tablet scenario is different.  The Surface tablet from Microsoft, the Galaxy Note 10.1 from Samsung and the Nexus from Google are all competitors to the iPAD, but do not offer a compelling threat as of now. 

Research in Motion (NASDAQ: RIMM) is introducing the Blackberry 10 on Jan. 30, a debut the market is anticipating with bated breath.  The Blackberry Playbook, which sold just about 250,000 units in the most recent quarter, needs to do substantially better to be taken seriously. There is already considerable hype about the Blackberry 10 smartphones, and it is natural that the expectations extend to their tablet product.

Nokia recently provided a rosy outlook for its fourth-quarter 2012 earnings, to be released on Jan 24, and an optimistic outlook for the first quarter of 2013. Apparently, its decision to embrace the Windows phone platform and ditch its proprietary Symbian OS is paying off handsomely.  Nokia does not offer a tablet as of now.  However, a new tablet is rumored to emerge in 2013.  That tablet is expected to be based on Microsoft’s Windows RT, which resembles Windows 8.

Prospects for Apple

It is clear that the competitive landscape in both the smartphone world and the tablet world is rapidly changing, making it unlikely that Apple will continue to enjoy an unchallenged advantage.  As we can see, earnings results of both Samsung and Nokia allude to the erosion of first mover advantage for Apple.  This is likely to pose problems for the stock.

The market expects that apple will continue to capture the imagination of its fans with new and innovative products.  The Apple TV is rumored to be in the works and there is speculation of aphablet being designed as well.  While retail investors are latching on to such news, Wall Street might be more skeptical.

Tomorrow’s earnings results might offer an opportunity for investors to determine for themselves what the future holds for this tech giant.

Will a New Loyalty Program Help This Drugstore?

This post is syndicated at The Motley Fool Network: http://beta.fool.com/malayappan/2013/01/22/will-new-loyalty-program-help-drugstore/22297/

At recent shareholder events, Walgreen (NYSE: WAG) talked up its newly introduced Balance Rewards program.  Designed to encourage loyalty towards Walgreen, this program resembles those already provided by its competitors -- but this one's late in coming.  Can Walgreen's program entice customers to shop more frequently, and thus juice the company's bottom line?

Stemming the Exodus

Walgreen has been putting in extra effort to stem the customer exodus that followed it 2011 contractual dispute with Express Scripts (NASDAQ: ESRX).  That spat has cost the country’s largest drugstore chain dearly.  The two companies apparently patched up their differences in 2012, and Walgreen was admitted back into some of Express Scripts' networks.  However, that deal appears to have been struck on terms that Express Scripts dictated. 

Rite Aid (NYSE: RAD) and CVS Caremark (NYSE: CVS) have been picking up Walgreen customers who had been forced to fill their prescriptions elsewhere.   From a glance at the earnings releases of these Walgreen competitors, it is apparent that these customers have been slow to return.  Customers cannibalized from Walgreen continue to result in increased revenue over recent quarters for Rite Aid and CVS.

Loyalty Programs

Walgreen did not have a loyalty program, unlike Rite Aid and CVS, which both had robust programs of their own.  Rite Aid has the Wellness+ program, and CVS has the Extracare program.  Both have incentive segments that allow members to earn reward dollars that can be used towards future purchases.  These programs are extremely important to both companies' bottom lines, as seen from this letter from Rite Aid to its investors.  

Walgreen has sought to transform the shopping experience at its stores by introducing its own new loyalty program.  In its most recent quarterly earnings release and conference call, Walgreen boasted that 45 million new members have signed on to the program.  That’s impressive!  Compare that to the roughly 69 million members at CVS, where a program has existed for over a decade.  However, will Walgreen's growing program translate into additional business?  Earnings results from the next quarter will tell the story.

Drugstore chains have always attempted to capitalize on foot traffic into the store generated by customers who came in to fill prescriptions.  Apparently, the sales generated by merchandise, grocery items, and beauty and healthcare products were previously too insignificant for Walgreen to consider a loyalty program.  But after the fallout with Express Scripts, Walgreen has gone out of its way to generate foot traffic with store items other than prescriptions.  The new loyalty program is its most recent initiative.

Benefits to Walgreen

It is well known that generally, drugstores are more expensive places to shop for daily necessities, but somewhat more convenient for immediate needs due to more choices.  Drugstore chains target certain products for promotions every week as a way to earn rewards points, and thus encourage shoppers to visit the store when they otherwise wouldn’t.  Many items are loss leaders that stores use to entice customers in with the hope of generating more regular-priced sales.

Drugstore loyalty programs might work; in fact, they resemble the mileage accrual loyalty programs used by airlines, in that they allow customers to accrue points outside of its stores.  One such example is the Walk With Walgreen program, which awards points for walking. 

Loyalty programs also allow these chains to monitor customer behavior and tailor their marketing to drive more repeat business.   There is a certain loss of privacy when customers sign up for loyalty programs, but it's usually not a deterrent.  CVS for example, actively seeks to capitalize on this by offering a more “personalized experience.”

Future Prospects

The new loyalty program at Walgreen is definitely a step in the right direction.  However, it is not entirely clear at this point that this will make up for the loss of customers to Rite Aid and CVS.  Wall Street obviously feels optimistic.  According to Walgreen Investor Relations, 19 analysts have a consensus rating of Outperform.  Although it might be tempting to write off the stock due to the setback it received from the Express Scripts fiasco, this new program could offer investors hope for its future.

Will a Crucial New Product Make This Tech Stock Worth Buying?

This post is syndicated at The Motley Fool Network: http://beta.fool.com/malayappan/2013/01/18/research-perpetual-motion/22051/

The battle among mobile phone manufacturers is heating up. Research In Motion (NASDAQ:RIMM) is planning a global launch of its much-anticipated BlackBerry 10 on Jan. 30. Given the great expectations for the launch event and the hype surrounding it, is it realistic to expect a major turnaround from RIM?

RIM’s Outlook for the Future

RIM’s third-quarter fiscal 2013 results showed $950 million in cash flow, as well as an increase in cash reserves to $2.9 billion. Adjusted net loss was $114 million. After reviewing the past few earnings releases, it is clear that this company is past its prime. The stock has been relatively flat year over year, but rebounded back to about $15 from a low of about $7 in Aug 2012. 

RIM provides a near-future outlook that is not expected to be any rosier than the third quarter. It expects to make a loss for the fourth quarter due to increased marketing expenditures for the launch of BlackBerry 10.  Additionally, the company expects that customers will hold off on purchases of older BlackBerries in anticipation of the launch.  Planned initiatives such as more attractive pricing on existing products is expected to offset some of these effects. 

However, the question is whether BlackBerry 10 will have a significant enough impact to regain some market share and re-energize the existing customer base.  In preparation for its launch, RIM says that over 150 carriers across the world have been performing acceptance testing. Additionally, over 120 enterprises are testing the BlackBerry Enterprise Service 10.

What are the obstacles to a successful BlackBerry 10 debut?

Competitor Landscape

The smartphone landscape has dramatically repositioned new players, giving consumers new choices.  First, Nokia (NYSE: NOK) is making major inroads with its Lumia 800 & 900lineup, which utilizes Windows technology from Microsoft (NASDAQ: MSFT). Samsung is selling its Galaxy series of phones faster than analysts have expected. The Korean tech giant has in fact provided fourth-quarter guidance that builds on successful previous quarters.

The Android operating system provided for free by Google (NASDAQ: GOOG) has had an outsized effect.  While Samsung, HTC, LG, and others offer Android-based lineups, they all offer Windows-based phones as well.  There is flexibility in the business models of such companies that allows them to reposition their products based on the hottest-selling trends in the marketplace.

RIM is placing its bets on a proprietary operating system, much like the major player in the mobile phone market: Apple (NASDAQ: AAPL). Apple uses iOS, which so far has been well-received in the marketplace. 

Major shifts in consumer preferences will require similar efforts by these manufacturers, a necessity that can be avoided by their competitors.  Therefore, mobile phone makers who do not rely on a single operating system lineup have a distinct advantage.  Nokia discovered that, and the Finnish phone maker is doing better because it embraced that paradigm shift.  Nokia used to base all its products on its own proprietary operating system, called Symbian.  Not anymore.

Prospects for RIM

The BlackBerry 10 appears positioned to be well-received.  It will appeal to customers who are looking for the next hot gadget, and to existing customers who have been long waiting for the next WOW product from RIM.  If the BlackBerry 10 lives up to expectations, it will only solidify RIM's existing customer base and perhaps incrementally increase it. 

On the other hand, if the product disappoints, then expect another hit to RIM’s reputation.  I consider that unlikely.  Either way, the stock is not likely to go up much higher from here.  I expect it to tread water for quite some time while RIM puts up a strong fight from here on out.

What's up With Lithium in the Air?

This post is syndicated at The Motley Fool Network at: http://beta.fool.com/malayappan/2013/01/17/whats-lithium-air/21944/

Boeing (NYSE: BA) has been losing ground lately over news that there might be flaws in the design of its latest Model 787-8 aircraft. 

The Federal Aviation Administration (FAA) issued an Emergency Airworthiness Directive (AD) on Jan. 16, requiring modification of the battery system on any 787s currently under manufacture, plus a few already in service at United Airlines (NYSE: UAL) and All Nippon Airways among others. As a result, 787 aircraft all over the world are being grounded. 

The AD was issued as a result of recent incidents involving the lithium-ion batteries used to power most of the plane's onboard systems.  The stock has been weighed down by these recent reports, along with the recent FAA action, and has lost about 5% of its value since the beginning of this year.  Should investors be worried?

The Lithium-ion Battery Conundrum

Lithium-ion batteries have caused previous problems on jet airplanes. In 2010, the FAA issued a Safety Alert For Operators (SAFO) that addressed “Risks in transporting Lithium Batteries in Cargo by Aircraft.”  The FAA indicated that tests showed that these batteries had certain characteristics that caused them to overheat, thus posing the dangers of fire and smoke. 

In fact, the FAA notes that these batteries are suspected to have contributed to United Parcel Service (NYSE: UPS) Flight 006's crash in the United Arab Emirates on Sept. 3, 2010.  That flight carried large quantities of Lithium-ion batteries as cargo.  The FAA has not placed definitive blame on these batteries; however, the TSA follows FAA limits on the size of lithium batteries that passengers can carry on board. 

Given the previous anecdotal experiences with transporting lithium-ion batteries by aircraft, one would have expected Boeing to conduct extra testing and due diligence on any new aircraft that used these batteries extensively. Lithium-ion batteries are preferred mainly because of their light weight, along with other advantages such as no memory effect, which would progressively reduce battery life. 

Boeing has stated in a press release that it stands behind the safety of the 787.  However, there is still the question as to what it will take to identify the problem and fix it.  That could involve redesign of the battery systems on already built aircraft, resulting in delays in aircraft delivery schedules. 

The 787's Importance For Boeing

In its third-quarter 2012 earnings release, Boeing raised year end guidance for revenue, earnings and operating cash flow and talks about growing momentum of 787 deliveries. What happens when that “momentum” gets reduced due to these battery problems, which could potentially delay deliveries? 

Boeing would likely have a cash flow problem, at least temporarily.  Given the company's $378 billion backlog, and its status as a duopoly along with Airbus (owned by European-tradedEADS), these problems are unlikely to be devastating to the stock. 

Commercial airplanes form the bulk of Boeing’s revenue, according to its latest earnings release.  The 787 model has over 800 orders, as shown on the company's orders report. 49 have been delivered so far, based on their 2012 & 2011 reports. 

The popularity of this airplane owes to the expected fuel savings resulting from the use of lighter materials. Airlines are looking forward to these deliveries, and delays might affect their plans, but don’t expect a rash of cancellations.  A radical redesign requirement might be the only reason for increased worry, but that possibility is remote.  However, any redesign, even if minor, requires FAA recertification, which will cause delays.

Prospects for Boeing
The stock is generally a stable one that also pays a dividend.  The company has a strong balance sheet that should allow it to weather any hit to future earnings.  In fact, Boeing's Q4 2012 results are scheduled to be released on Jan. 30.  It would be wise to wait until them to initiate a position, if one is so inclined.

The Fox Guards the Henhouse!

This post is syndicated at The Motley Fool Network: http://beta.fool.com/malayappan/2013/01/09/fox-guards-henhouse/20986/?ticker=AMZN&source=eogyholnk0000001

"The fox guards the henhouse." This proverb appears in many forms, but basically means that you should not trust something that you value to someone who might be tempted to exploit it for his or her own ends.  For example, you wouldn’t want a hungry man to watch over your lunch, would you?  Amazon.com (NASDAQ: AMZN) has proved this old adage over and over again in situations where they have been trusted to run another company’s online business. In those situations, Amazon has ended up directly competing with its customers, sometimes destroying their business in the process. 

One spectacular example is that of the now-defunct Borders book stores. Borders declared bankruptcy in 2011 and cited "online competitors" as one reason that led to its bankruptcy filing.  Borders committed the fatal mistake of trusting Amazon to host their website and take responsibility for everything including order fulfillment! Amazon was already billing itself as the world’s largest bookseller; by controlling Borders’ website; they were effectively the proverbialFox in the Henhouse! 

Considerable irony lies in the fact that Jeff Bezos, founder of Amazon, sent over a case of champagne to Borders to celebrate the outsourcing deal!  Amazon had no stake in the survival and success of Borders, and while business steadily declined at Borders, Amazon’s business steadily prospered.  

Despite this highly visible example, it seems that other companies today such as Netflix (NASDAQ: NFLX) are repeating the mistake that Borders made.  They are not likely to fare any better.

The Public Cloud Model

The nascent dot-com boom of the late '90s and early 2000s involved a rapid evolution of Internet technology.  As technology infrastructure matured, architecture improved as well, offering companies greater choices in deploying their online presence.  In the early days, it was easy and preferable to outsource all aspects of an online business to a website operator such as Amazon.  This meant that hosting companies like Amazon were privy to the very internals of outsourced business operations of companies they were competing with!

The latest twist to the website operator model of the past is the Public Cloud model. Public Clouds come in various forms, but the concept in essence is very simple.  A Cloud Operator, such as Amazon will offer customizable and configurable hardware and software, along with services to manage it. Companies and even individuals can then host their applications on this infrastructure. 

The difference with this model over the older website operations model is that Amazon is now NOT privy to the internals of their customer’s business operations.  Amazon is responsible only for the maintenance, performance and general health of the infrastructure.  But, what happens when Amazon provides infrastructure to a company that it is directly competing with? Thanks to recent events, we know.

The Netflix Story

On Dec. 24, 2012, Christmas Eve, Netflix (NASDAQ: NFLX) suffered a major disruption to its online video streaming service. Its streaming videos were hosted by Amazon Web Services, the public cloud division of Amazon.com (NASDAQ: AMZN). At that time, Netflix blamed the outage on malfunctions in Amazon’s cloud computing division; Amazon apologized for the disruption and explained in somewhat technical terms that this affected only some customers who relied on an aspect of their cloud architecture called Elastic Load Balancing Services. Its own Amazon Prime Video streaming service that is hosted on the same infrastructure platform was however not affected.

In addition, in a detailed explanation on their website, Amazon described their error which could be traced back to the lack of enforcement of best practices in the IT (Information Technology) world.  For instance, it is not a good practice to allow developers to access production and development environments from the same device or bypass CM (Change Management) processes.  

On Dec. 31, 2012, exactly a week later on New Year’s Eve, Netflix experienced another disruption, this time in its DVD fulfillment section. Netflix did not blame Amazon this time -- at least not publicly. The disturbing fact is that these two events were not the first time that this has happened to Netflix.  There was a similar prior outage in August 2011, after which Netflix claimed to have learned some “lessons” from that incident.  One wonders.

Other Examples

Another great example of overly trusting Amazon is Toys “R” Us, the well-known and privately held toy retailer.  Toys “R” Us struck a deal with Amazon in 2000 to take over their online operations.  The deal went sour as detailed in this article by the Wall Street Journal and unlike Borders, Toys “R” Us was smart enough to notice the rapid cannibalization of its core business by Amazon and wanted out. However, Amazon resisted. Apparently, the Fox was NOT going to let go of its chicken! 

Toys “R” Us successfully sued Amazon to terminate the agreement.  The list of disenchanted customers goes on.  The nascent dot com boom of the late 90's roped in a lot of retailers, including Target (NYSE: TGT), who trusted their online operations to Amazon, only to discover later that they were being ripped off.  In 2011, Target finally launched its own website after separating from Amazon, again after a lawsuit. However, the damage has already been done and it is a long lasting one, despite attempts at retaliation such as the decision by Target not to sell Kindle devices any more.

Netflix and Amazon

The Netflix story is not likely to have a happy ending, either.  As one variation of the oft repeated quote (attributed to George Santayana) goes, “Those who ignore history are condemned to repeat it.”  Netflix has repeatedly ignored the warning signs and if nothing else, is making a major mistake in trusting its core business to a rapidly growing competitor.  For $79 per year, Amazon offers a service called the “Prime Instant Video” that includes unlimited on demand video streaming in addition to free two day shipping on thousands of items it sells.  For those not interested in a subscription, Amazon also offers the “Amazon Instant Video” that allows A la carte downloads. 

Technology architects at Netflix justify using AWS because they want to “use public clouds, not build them.” This reflects shortsighted thinking.  Amazon not only built Netflix’s infrastructure, but also profits from it by purveying its own video service on the same platform!  If only Netflix had been savvy enough to build out its own infrastructure, their future would have been brighter.  At the very least, one would have expected them to have turned to other cloud providers such as Oracle, HP or DELL.  Why trust a cloud provider who is also a major competitor? 

I rate Netflix a Sell. 

Is The Party Over For Gun Stocks?

This post is syndicated at The Motley Fool Network: http://beta.fool.com/malayappan/2013/01/02/party-over-gun-stocks/20141/

On December 14, a Friday, a young gunman by the name of Adam Lanza took a Bushmaster rifle and in cold blood massacred 20 innocent and helpless small children along with 6 equally helpless adults at Sandy Hook Elementary School in Newtown, Connecticut. Adam murdered his mother before heading to the school and committed suicide before law enforcers could close in.

On December 24, while millions of Americans were preparing to celebrate Christmas, a much older convicted criminal by the name of William Spengler lured Firefighters to a blaze that he had started and then shot and killed two of our Heroes and wounded two more before killing himself.  The gun that this man employed was the same Bushmaster rifle that Adam Lanza deployed. William Spengler left a note stating that he wanted to “kill as many people as possible” -- a task the rifle was apparently well capable of performing.

For lack of a better way to vent their frustrations, many Americans have sought to punish the stocks of publicly traded gunmakers over the recent gun violence.  However, is it realistic to expect that the nearly four year run up for stocks of gun manufacturer's is really over?  It doesn't appear to be so.

Cost of Freedom

Bushmaster Firearms is owned by the Freedom Group, a gun company that owns other recognizable brands such as Remington and Dakota Arms among others.  Freedom Group is a privately held company that is controlled by Cerberus Capital Management, a hedge fund. Following the outrage over the Newtown massacre, CALSTERS (California State Teachers Retirement System) exerted pressure on Cerberus to divest itself of its investment in Freedom Group.  Cerberus obliged, promising to hold an auction sometime next year to find a buyer to take over its investment in Freedom Group.

The decision by Cerberus shows how investments in gun manufacturing companies might become quickly unattractive, at least in perception.  Cerberus Capital Management is run by Stephen Feinberg and has the likes of former Vice President – Dan Quayle and former US Treasury Secretary – John Snow among their senior leadership team. 

Cerberus manages money invested by several other pension funds including another California public employees’ pension fund called CALPERS and New York State Common Retirement Fund.  While investing in gun manufacturers either through mutual funds or directly may or may not be a moral question, it is helpful to be aware of these otherwise hitherto extremely lucrative investments. In anticipation of strict gun control laws in  the horizon, sales of high capacity magazines and rifles have gone through the roof.  Expect to see gun makers rake in the dough at least in the short term.

Publicly Traded Companies

While the Freedom Group is privately held and reportedly a bonanza for the Cerberus Group, there are a couple of publicly traded manufacturers that have profited handsomely over the past few years thanks to a boom in gun ownership. This spike has been largely due to the much-anticipated, but little-materialized tough gun control laws that the Obama administration was expected to champion.

Two names stand out and they are Smith & Wesson (NASDAQ: SWHC) and Sturm, Ruger and Company (NYSE: RGR).  Although the media reported that these two companies saw their stock prices drop sharply after the Newtown shootings, in fact they have stayed remarkably flat over the days after Dec. 14. 

Sturm, Ruger and Co.

In contrast to its stock price performance over the days after the Newtown shootings, RGR has appreciated nearly 9 fold since December 2008. That’s a whopping 900% return for someone savvy enough to have invested right after President Obama won the 2008 election.

One might have expected gun stocks to have tanked due to the widespread indignation over the recent gun violence, it is an unrealistic expectation. Why?  Because there is a huge market in the United States for firearms and the right to gun ownership is protected by the Second Amendment .  Robust gun sales are backed with an even greater manufacturing backlog for a handful of manufacturers.  The market for potential gun buyers is not restricted to new buyers alone.  Existing buyers go out and buy more varieties and spend additional money on ammunition.  News of future gun control laws only serve to accelerate more purchases, creating more tailwinds for gun stocks.  In their Third Quarter 2012 results, Sturm, Ruger and Co., reported earnings of $0.88 per share, compared to $0.56 cents per share over the same quarter in 2011. In addition to spectacular stock price movement, this company has also declared steadily rising, healthy dividends with $0.38 cents per share in their most recent quarter.  That’s amazing, when compared to a measly $0.08 cents per share in 2008!  Suffice it to say that an Investor in this company in 2008 would have made out nicely. 

What are the prospects for this company going forward?  Don’t expect the stock to go on a downward spiral anytime soon, despite any new gun control legislation.  However, the company cautions that the dividends it hands out is not a fixed amount per share, but rather a percentage of earnings.  In other words, don’t consider this stock as a valuable dividend play.  However, the presence of a dividend for this stock does give it an edge over its publicly traded competitor - Smith & Wesson.

Smith & Wesson

The other beneficiary of Obama’s first Presidential term is Smith & Wesson with a stock appreciation of about 5 fold over the same time period as Sturm and Ruger.  However, Smith & Wesson doesn't offer a dividend so the returns don't look as robust as their competitor.  In terms of performance since the Newtown shootings, one might consider the nearly 10% drop in the stock price, but in terms of long term impact over the next several months, it is likely to be minimal for the same reasons cited above. Over the next four years of President Obama’s second term, despite anticipated tougher gun laws, this gun maker is certainly not going back to the $2 levels last seen in 2008!

In their most recent Second Quarter Fiscal Year 2013 report, the company announced a $332.7 million firearms backlog, nearly double from the same quarter last year. The company also announced a $20 million stock repurchase program until June 2013.  Furthermore, the company's board authorized an additional $15 million share buyback on Dec. 27.  According to Yahoo Finance, the company has 61.48 million shares in float.  With a $35 million buyback program, and the stock at a current price of about $8.18, the float should reduce by about 4 million shares.  Even if the shares don't substantially appreciate, expect the share buyback program to provide downward resistance to the stock price.