Getting Ready To Strangle Apple

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July 24, 2007 | Stocks | Author Asif

If the 2000-2003 bear market was one of the longest bear markets in history, this resilient bull market, which has now lasted over 52 months also happens to be one of the longest bull markets without a meaningful correction. It is getting harder and harder to find good opportunities whether you look at different asset classes (stocks, bonds, real estate, commodities, etc.) or in geographically diverse locations. Without insinuating that we are in the midst of a global bubble (the euphoria that usually defines bubbles is largely missing), I can say from experience that it is becoming harder and harder to come up with one or two new ideas for the newsletters each month. I am still trying to figure out if I really admire or am perplexed by some stock pickers who come up with ideas almost on a daily or weekly basis.

If you are familiar with options, straddles and strangles, please feel free to skip through the next two paragraphs.

In this environment I have been considering using a certain options strategy that is best suited when you have a neutral market outlook. We have used options in the past to hedge our long portfolio. In contrast, this strategy is a calculated neutral bet on volatility with a slight directional bias. In case I almost lost you with that sentence, let me elaborate further. There are two options strategies called straddles and strangles that allow you to benefit from sharp upward or downward movement of stocks. You do not have to believe that the underlying stock is likely to do well in the future (a bullish/long opinion) or that it will eventually suffer a terrible fate (a bearish/short opinion). All you have to believe is that the stock is volatile and likely to jump in either direction. Hence the best use of this strategy is during a period of general market volatility or when a specific event such as an earnings announcement is likely to make a stock react sharply.

A couple of years ago someone asked me if it was possible to benefit from both going long and short a stock at the same time. While I could understand why this question was asked, the answer was that it was not possible to benefit from such a neutral strategy, unless you used a different instrument such as options on the underlying stocks. In a straddle, you buy both a put option and a call option at the same strike price. For example, on July 18th or 19th when Google (GOOG) was trading at around $550, you could have bought a August 2007 put on Google at a strike price of $550 and a August 2007 call at the same strike price. The idea would have been that you were either expecting Google to report results that fell short of expectations or very good results the following evening and hence a sharp movement in the stock. As it turns out, Wall Street was disappointed with Google’s results and the stock dropped more than $28 on July 20th. At this point, your call option would have been worth close to nothing but your put option would have soared in value as it gave you the right to sell Google at $550 even though the stock was trading at $520. As long as you paid less than $30 for both the call and the put option, you would have made money (assuming the options moved to the same extent as the stock, which is often not the case). If this is not complicated enough, straddles come in two flavors called long straddles and short straddles. You can get all the details about these flavors in this Wikipedia article.

Since near the money options on Google tend to be expensive, to reduce your cost basis and hence your capital at risk, you could have also bought slightly out of the money options such as $560 calls and $540 puts. This strategy is called a strangle. It is this strategy that I plan to use with Apple (AAPL) today but with a slight long bias as I expect Apple to do well in the coming months. Apple reports quarterly results after the close tomorrow July 25th. As I write this blog post, the stock is trading almost $7 or 5% lower today thanks to a comment made by AT&T during their conference call about the number of iPhone activations.

On the flip side I also plan to strangle the maker of the popular Blackberry devices Research In Motion (RIMM) with a slight short bias as I expect Apple’s iPhone to eat into RIMM’s market share and profit margins. After conquering businesses, RIMM decided to expand beyond their core business customer base and target regular consumers with their Blackberry Pearl. I currently use a Blackberry 8700 and can personally vouch for how good the device is for email, checking stock quotes as well as making calls. I also had a chance to play with both the Pearl as well the Blackberry 8800. However when I got my hands on an iPhone a couple of weeks ago, I was totally blown away. The interface is so simple and easy to use that even folks who are not gadget freaks would love this device. Stock quotes with charts, Google maps with traffic overlaid, a video iPod, a Safari web browser that is very usable, a decent camera and Wi-Fi internet access beyond AT&T’s EDGE network - it is hard not to fall in love with this device. I liked it so much that I picked one up for a gift last week.

As for business users, the iPhone offers the ability to get email either through a POP3 connection or directly from an enterprise exchange server similar to Windows Mobile devices like the ill-fated Motorola Q. While RIMM derives more than 75% of its revenue from hardware sales, it does enjoy very good margins from software sales. Blackberry Enterprise Server for Microsoft Exchange with a 20 user limit can set back enterprises as much as $4,000. Once you include this cost, the iPhone almost begins to look cheap for businesses. In fact I noticed the price of the Pearl and 8800 drop significantly a couple of months before the release of the iPhone.

So based on this slightly bullish sentiment on Apple and the slightly bearish sentiment on Research in Motion, here are the options I am going to buy for the SINLetter model portfolio to create the strangles. I am going to purchase the options for Apple right now in order to cover the earnings announcements on July 25, 2007 and will purchase the RIMM options sometime in September to cover the earnings call on September 27, 2007. I will use the market closing price today as the price for these options.

  • 4 Contracts of Aug 2007 $140 Calls on Apple
  • 3 Contracts of Aug 2007 $130 Puts on Apple

Voluntary Disclosure: I do not own any positions in any of the companies mentioned but will buy these options for my personal portfolio after this blog entry is published.

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Festival of Stocks #41

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June 17, 2007 | Stocks | Author Asif

SINLetter is honored to host the Festival of Stocks #41, a weekly blog carnival featuring recent posts by contributing investment blog authors.

If this is your first time on SINLetter, please feel free to explore this blog, read the investment newsletters in the archives section or check out the model portfolio, which automatically updates itself during market hours.

Here is the list of submissions for this festival.

  1. Bryan Moore of discusses a very interesting investment strategy that utilizes mutual funds to generate “hedge fund”-like returns. The performance has been consistent over the past 4 and a half years with little downdraw and less volatility than the S&P 500 index.
  2. Eddie Bravo of the rather uniquely titled blog Value tudo investing has a lengthy and very interesting post about exploring the universe of stocks that are selling at a discount to their net current asset value. The comments at the end of this post add more color to the topic and made it my favorite amongst all the submissions this week.
  3. Tyler McKinna of Dividend Money submits Where Did The Cash Flow Go?, a discussion on how the debt-to-equity ratio would be a more viable method of evaluating companies that have recently merged.
  4. Bill Trent of Stock Market Beat is back with a post that has a mind-bender title of What to Expect When You’re Expecting? The Unexpected. In case you are wondering, this post has nothing to do with babies and everything to do with Adobe’s (ADBE) quarterly results.
  5. I scored an interview with the head of TCS America and in the same week was interviewed by a Dow Jones reporter about WisdomTree.
  6. Average Joe of Investment Jungle (not to be confused with the other more urban Average Joe) analyzes UnitedHealth Group (UNH). This post was of particular interest to me as I had the misfortune of picking UnitedHealth Group for the SINLetter model portfolio right before the mother of all option scandals broke out.
  7. Unless I am mistaken, the Investment Jungle Average Joe also happens to operate another website called Dividends Matter and is impressed by the dividend history and current dividend yield of the King of Beers, Anheuser-Busch Companies (BUD).
  8. To wrap up this festival check out this post titled London to overtake New York and rival Silicon Valley. While this post is not directly related to stocks, it makes for an interesting read.

Hosting for the next festival of stocks is still open and if you would like to volunteer to host it on your blog, please drop George of an email.

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An Interview With Tata Consultancy Services

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June 11, 2007 | Stocks | Author Asif

When I wrote about the possibility of India’s largest IT company, Tata Consultancy Services (TCS) listing on the NYSE, little did I realize that I would be contacted by TCS regarding a correction to my article. While providing me information about the number of acquisitions done by TCS in 2006, the company also offered me an opportunity to interview their senior executives. Having featured competitors Wipro (WIT) and Infosys (INFY) on SINLetter in the past, I used this opportunity to ask Surya Kant, Vice President and Head, TCS America, a number of questions that are probably on the minds of most investors in the Indian IT sector.

  1. TCS is the leading Indian consulting company with $4.3 billion in annual revenue and almost a billion dollars in net income. Despite this leadership position, TCS does not have the same visibility in North America that Infosys and Wipro enjoy. Beyond raising capital for acquisitions, would TCS consider an NYSE IPO as a means to improve the visibility of TCS amongst US businesses?A US listing is not a part of our immediate primary agenda for TCS.

    Nonetheless, North America continues to remain an important market for us. The US accounts for more than 50% of the TCS’ $4.3 billion annual revenues from our last fiscal year, ended March 31, 2007, making TCS the 11th largest player globally. In terms of market capitalization, TCS is ranked 4th globally, behind IBM, HP and Accenture.

  2. Over the last 5 years, the US dollar has lost more than 30% of its value against the Euro. Since the rupee was pegged to the US dollar much like the Chinese yuan, Indian outsourcing firms benefited from this positive currency exchange trend. The Indian rupee has recently gained strength against the US dollar rising from an exchange rate of  44.61 rupees per dollar to 40.59 rupees per dollar over the last six months. Do you think the rupee is likely to continue gaining strength against the dollar?

    The rupee’s appreciation vis-à-vis the dollar is definitely of concern to the industry and TCS. To what extent the government will succeed in the short term in addressing inflation will determine how the rupee’s rise will play out.

    In the past two months, we had a 7% increase in the value of the rupee against the dollar. But even with that challenge, TCS has been able to maintain strong margins because of the value that we provide. About 40% of our business comes from fixed-priced bids, so as we continually improve our business processes and leverage our own intellectual property as part of the solution, our margins can get better.

  3. If yes (to question 2), how will this impact earnings? Have you hedged your currency risk through futures or other financial instruments?

    We’ve hedged fairly well in the last quarter. But because of the mechanism and costs involved, we can only go to a certain point. So anything below 43 rupees vs. the dollar will continue to worry us.

    TCS has taken currency hedges worth about $1 billion, up 30% from an earlier level of $750 million from a year ago. Also, our revenues are already partly hedged as our costs are also in dollars in many contracts — so it’s not that this appreciation hits your full turnover.

  4. Indian IT salaries have been rising at  a rapid pace of 15% per year. If this were to continue, the competitive cost advantage that companies like TCS and Infosys offer will slowly diminish. With GDP growth in India reaching 9.2% in 2006-2007, inflation at 5.66% and a shortage of skilled labor, it would be hard to step away from salary increases? How are you handling this risk?

    The competition for talent is certainly intensifying, not only as TCS grows, but as other multinational companies open large R&D and service facilities in India. However, we believe this high wage inflation won’t last for too long before it levels out; it should settle down in two or three years.

    We expect the impact of wage increase to be very similar to the impact that it had last year because we expect the Indian salary to go up by 12-15%, and as far as overseas is concerned it, is going to be between 3% and 5%. This is the same as it was last year. So the impact is going to be more or less the same and we have worked out this kind of a detailed plan to meet that impact.

  5. Employee attrition is another major problem faced by most Indian IT companies. What steps is TCS taking to reduce attrition and improve employee retention?

    TCS has the lowest attrition rate out of all IT services companies headquartered in India (11.3%, well below the industry average). It is important to continually invest in the long term growth of our people, with frequent training to upgrade their skills, by rotating assignments, and providing opportunities for travel and foreign assignments. Well planned job rotations give our employees the opportunity to work on varied technologies, varied customer and industry domains and geographic locations.

    In terms of recruiting we have a highly evolved recruitment process across the globe. For instance, the number of colleges we go to in India alone each year just crossed 300. We’ve been successful in ensuring we get invited to campuses early in the game (achieved 93% day 1 slots). We also engage students through summer projects, training and have strong ties with the faculty.

  6. While the Dow Jones Industrial Average is at record levels, the US economy is beginning to slow down. GDP for the first quarter came in at a lower than expected 1.3% (before it was revised lower) when compared to 2.5% in the fourth quarter of 2006. Since TCS derives more than 50% of its revenue from the US, how much impact is a slow US economy going to have on TCS?

    We see no slowdown in U.S. spending on technology services. Our U.S. revenue recently exceeded $2 billion, slightly more than 50 percent of the total.

    We see IT spend increasing in transformation programs; the type of customer engagements are increasingly transformation programs. Both enterprise solutions and business intelligence solutions are experiencing high growth, along with the traditional IT services.

    The North American market is strong for us and all our existing clients are buying new services from us. We are also participating in larger deals, with greater frequency – In the last quarter TCS closed 3 deals of around $100 million each.

  7. As you look towards the future, what will be the key drivers of growth at TCS?

    Service lines like global consulting, BPO, Infrastructure management, and assurance services fetched 18% of revenues in FY ’07 up from 10 per cent in the previous financial year. For instance, TCS’ Global Consulting Practice achieved a robust 50% year-on-year growth in Q3 2007. All of these growth engines will continue to gain momentum in the coming quarters.  At the same time the IT services including package implementation are also expected to grow well.

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2007 Dogs of the Dow: All Bark, No Bite

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May 17, 2007 | Stocks | Author Asif

The Dogs of the Dow had a spectacular 2006, posting a gain of 24.8% excluding dividends. This compared with gains of just 14.25% and 11.82% for the Dow Jones Industrial Average and S&P 500 respectively. While I was enthusiastic about the Dogs in early 2006 and used the theory to pick Pfizer (PFE) in January 2006, I decided to stay away from the Dogs in 2007 as mentioned in the January 2007 edition of SINLetter.

A couple of people wrote to me this week to let me know that the real time returns calculated in the Current Dogs of the Dow page should be higher once you take into account the recent spin-off of Kraft Foods (KFT) from Altria (MO). On March 30, 2007, Altria spun off its remaining stake in Kraft and the price of its stock fell $19.59 on April 2, 2007. Since we cannot add Kraft shares to the Dogs of the Dow list, we have to make an adjustment to the price of Altria.

Based on the tax basis information (pdf) document provided by Altria on its website, I multiplied the December 31, 2006 price of $85.82 by 0.7512 to arrive at an adjusted price of $64.47 for Altria. Before making this adjustment, the Dogs of the Dow had gained 5.05% since the start of the year and after the adjustment, the year-to-date gains jumped to 7.74%. However this is still below the 8.13% returned by the entire Dow Jones Industrial Average this year.

We still have more than half the year to go before we find out if the 2007 Dogs are going to repeat their 2006 performance and outperform the indices but my bet lies with the Dow this year.

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Update on TCS Acquisitions

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May 3, 2007 | Stocks | Author Asif

For my previous blog post titled Tata Consultancy Services Listing on the NYSE? I scoured through all the press releases issued by Wipro (WIT), Infosys (INFY) and Tata Consultancy Services (TCS) in 2006 and also looked through the transcripts of the annual conference calls but it looks like I missed a few acquisitions that were done by TCS in 2006.

The folks at TCS got in touch with me last week and provided me with a list of acquisitions that were done by TCS in 2006. Apart from the acquisition of Australia based TCS Management that I mentioned in my last post, given below is a list of other acquisitions that were done by TCS in 2006.

  • Jan 2006: TCS subscribed to 51% of the share capital of C Edge Technologies Ltd, a company formed to provide IT enabled services and solutions.
  • Feb 2006: TCS acquired TIL Limited and merged TIL into TCS Limited. In connection with this acquisition TCS recognized goodwill of Rs. 1,783.1 million, intangible assets of Rs. 95.9 million.
  • March 2006: TCS through its subsidiary, Diligenta, acquired on a going concern basis certain businesses of Pearl Group for a cash consideration of Rs. 4,261.9 million. TCS has acquired 76% of the voting share capital of Diligenta Ltd with the balance being held by the Pearl Group. TCS has the right as well as obligation to acquire the remaining shareholding of Pearl Group in Diligenta over the next five years.
  • Oct. 31, 2006: TCS announced that it had expanded its portfolio of banking products and consolidated its European operations after completing the acquisition of 75% equity stake in its Switzerland-based partner, TKS-Teknosoft (TKS), from the promoter for CHF 100.5 million.

I guess instead of going through all the press releases, it would have been easier for me to contact investor relations to get the complete list. I regret the omissions and appreciate the data provided by TCS.

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