This week the technology world is jolted by the news of Intel acquisition of security software maker McAfee. It has been a while since Intel made a headline grabbing news, especially in M&A. Therefore, being the technology analyst me, I decided to share my thoughts on this latest acquisition by Intel.
First, let's begin by spitting out the merits of the deal. Intel has been itching to grab market share in the mobile chip market, the latest with the launch of Atom processor 2 years ago. However, the battle has been an uphill climb with ferocious competition especially with competitors adopting the ARM technology. Therefore, Intel decided to spend $884 million last year to buy Wind River Systems because it makes software that goes into lots of products. Intel keeps Wind River separate while looking for opportunities to leverage its silicon chips to customers.
And this week, Intel decided to splurge $7.68 billion on McAfee, a 60% premium on the share price right before the news. Intel touted that it needs to venture into "security", which is a growing business because of the threat of mobile devices being maliciously attacked by hackers. Intel believes that integrating security features into its chips will make them more appealing and differentiates the company from the others. Thus, this will be their strategy to win more market share, especially in the mobile market. Again, Intel maintained that McAfee would not be consolidated into its operations but separately run by its present CEO under Intel.
Unfortunately, the merits of the deal end here. Instead, there are lots of unanswered questions of how this deal could actually help Intel in the long run. Below I list out the reasons why the deal is wrought of ambiguities and uncertainties:
Valuation
A 60% premium on McAfee share price is unjustifiable because Intel paid 3.29 times McAfee’s revenue, compared with a five year median of 2.07 times revenue. According to Bloomberg analytics, there have been 171 acquisitions in the Internet security business with an average premium of 22.3% in the last 5 years. This isn't the 90s, therefore its cash hoard should be prudently managed. The company has spent billions in 2000 to acquire businesses that largely haven't panned out as promised, resulted in a sale of its business to Marvell for $600 million. It should return its cash hoard to shareholders if attractive investments could not be found. Instead, spending $7.7 billion on another technology outfit with the purpose of finding revenue and margin growth smacks of risks. McAfee shareholders are the obvious benefactors from this deal.
Where is the synergy?
In any M&A deal, management and analysts look for revenue and cost synergies. In this case, Intel management does not intend to bundle McAfee's software with its chips. I don't see where the revenue synergy is. Moreover, McAfee's operations are separately maintained by Intel with no plans for layoffs. Therefore, there is no cost synergy. With no synergies, investors would not be able to see the benefits of the deal in the first few years. After the announcement, Intel's market cap lost $3.6 billion, almost half of the acquisition value. This is a testament of Intel investors' worry about the benefits of this deal.
Low power is the holy grail, not security
Intel seems to have forgotten the key to grab more market share in mobile market is to produce chips that consume less power than others. ARM technology is clearly winning in this niche market. Therefore, Intel touting the benefits of security inside silicon is tantamount to a big gamble because it has not identified what sorts of hacker attacks might affect mobile devices. The embed of security into chips does not resolve chip power consumption issue as well. In other words, there is no guarantee of success in the market with the introduction of more security features in mobile.
Friday, August 20, 2010
Thursday, August 19, 2010
10-year Treasury yield hit 2.58% record low. Is it a flight to quality or a Treasury Bubble?
That's right! 10-year Treasury yield has hit a new low of 2.58% today. This low level is virtually unheard of since early 2009.
So, is it a flight to quality, or a bubble in Treasury bonds? Or a consequence of the FOMC signaling QE2 program to keep monetary easing in place, with close to zero rates for an extended period of time.
To me, this Treasury rally sooner or later will run its course. Investors who fear deflation risks are parking their money in Treasuries in the present uncertain economic outlook. They may get burned if the recovery is sustainable and yields eventually rise. However, investors are preferring to suffer from small losses on Treasury holdings rather than sustaining huge losses in stocks and risky assets if economic outlook deteriorates or the Fed is unable to steer the economy. This risk aversion is known as Prospect Theory, which underlies much of behavioral finance.
So, is it a flight to quality, or a bubble in Treasury bonds? Or a consequence of the FOMC signaling QE2 program to keep monetary easing in place, with close to zero rates for an extended period of time.
To me, this Treasury rally sooner or later will run its course. Investors who fear deflation risks are parking their money in Treasuries in the present uncertain economic outlook. They may get burned if the recovery is sustainable and yields eventually rise. However, investors are preferring to suffer from small losses on Treasury holdings rather than sustaining huge losses in stocks and risky assets if economic outlook deteriorates or the Fed is unable to steer the economy. This risk aversion is known as Prospect Theory, which underlies much of behavioral finance.
Wednesday, August 18, 2010
The fate of the zombies? Who else but Fannie Mae & Freddie Mac. What will be the future of housing finance?
The fate of Fannie and Freddie has been put on the back burner while Congress is busy with the passage of the financial overhaul bill since last year. However, the Obama administration has convened a housing summit this week to discuss precisely the fate of both behemoths. Both agencies have cost taxpayers $148 billion in bailouts so far, with no end in sight. They are also backstopped (unlimited) by the government until 2012.
What is certain about these agencies is that there are no easy solutions to deal with them, which certainly will cause heated debates between the government, bankers, Congress, and last but not least U.S. taxpayers. The first salvo was fired by Geithner, who said "we will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support." Furthermore, he said "we will not support a return to the system where private gains are subsidized by taxpayer losses." To me, that is the crux of the whole mess concerning these 2 agencies.
Available solutions range from full nationalization at one extreme to privatization with no government support at the other, with alternatives in between. Government guarantees may need to be provided to cover the risk of losses and structured to minimize taxpayer losses. The government would have to decide how to structure such guarantees, determine which loans would qualify for insurance, what the underwriting standards should be and how private mortgage insurance might be used. Full privatization at this point is not feasible because the agencies and FHA guarantee more than 90 percent of all mortgage loans in the country. Without their guarantee, mortgage rates will increase and cause housing demand to sap which in turn depresses home values further.
Bill Gross from Pimco argued for "full nationalization" of the mortgage finance system. He suggested that private financing is unrealistic and impractical. This is at odds with government officials who have urged for a smaller footprint in the housing market. Furthermore, Geithner reiterated the need to begin the process of weaning the markets away from government programs and make room for the private sector to get back into the business of providing mortgages. The need to keep mortgage rates reasonably priced is also important for mortgage borrowers.
The government has targeted to overhaul housing finance by January 2011. However, the voices that called for full government support will only hamper the progress to wean both Fannie and Freddie from further taxpayer bailouts. Solutions will be forthcoming from both sides, but I think a solution with structured government guarantee and private capital will probably be the way to go. A healthy market with competition would be the best way to encourage more private capital to provide mortgage solutions. At stake is the more than $10 trillion US housing market.
What is certain about these agencies is that there are no easy solutions to deal with them, which certainly will cause heated debates between the government, bankers, Congress, and last but not least U.S. taxpayers. The first salvo was fired by Geithner, who said "we will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support." Furthermore, he said "we will not support a return to the system where private gains are subsidized by taxpayer losses." To me, that is the crux of the whole mess concerning these 2 agencies.
Available solutions range from full nationalization at one extreme to privatization with no government support at the other, with alternatives in between. Government guarantees may need to be provided to cover the risk of losses and structured to minimize taxpayer losses. The government would have to decide how to structure such guarantees, determine which loans would qualify for insurance, what the underwriting standards should be and how private mortgage insurance might be used. Full privatization at this point is not feasible because the agencies and FHA guarantee more than 90 percent of all mortgage loans in the country. Without their guarantee, mortgage rates will increase and cause housing demand to sap which in turn depresses home values further.
Bill Gross from Pimco argued for "full nationalization" of the mortgage finance system. He suggested that private financing is unrealistic and impractical. This is at odds with government officials who have urged for a smaller footprint in the housing market. Furthermore, Geithner reiterated the need to begin the process of weaning the markets away from government programs and make room for the private sector to get back into the business of providing mortgages. The need to keep mortgage rates reasonably priced is also important for mortgage borrowers.
The government has targeted to overhaul housing finance by January 2011. However, the voices that called for full government support will only hamper the progress to wean both Fannie and Freddie from further taxpayer bailouts. Solutions will be forthcoming from both sides, but I think a solution with structured government guarantee and private capital will probably be the way to go. A healthy market with competition would be the best way to encourage more private capital to provide mortgage solutions. At stake is the more than $10 trillion US housing market.
Has Bernanke embarked on a new QE2 program? What will be the impact to the economy?
Last week, Bernanke and the FOMC have predictably maintained its pledge to keep the federal funds target low for an extended period which has been the same from beginning of 2010 until now. However, there is a twist this time around. The Fed also announced that the principal payments on its mortgage-backed securities(MBS) and agency debt would be reinvested in Treasuries, with $2 trillion floor adopted for the securities portfolio. These purchases will help keep Treasury yields and mortgage costs low and prevent the level of monetary stimulus from shrinking further.
What prompted the Fed to do more quantitative easing rather than signaling an exit strategy in 2nd half of 2010? The answer: The Fed was cognizant of the fact the economy is losing momentum with latest unemployment figure hovering north of 9%. Therefore, the Fed signaled its willingness to intervene, if necessary.
On the surface, it seemed the policy action announced did not have major implications to the economy. However, the Fed is quietly laying the groundwork for further monetary stimulus and a gradual policy shift. To Bernanke, deflation risks must always be nipped in the bud before they could rear their ugly heads. Hence, his nickname "Helicopter Ben".
If the economy deteriorates further, the Fed would have no choice but to swell the balance sheet level further. The problem is the Fed purchase of Treasuries is unlikely to stimulate the economy and reduces unemployment. One critic is Anthony Crescenzi from Pimco. He argued that creation of jobs and emphasis on investments, not consumption should be the government priorities and policies. Furthermore, he harped that the government should build programs to increase the level of exports.
It would be interesting to note actions the Fed would take in the coming FOMC meetings. The million dollar question is where the economy is heading and whether further stimuli are needed to bolster the economy.
What prompted the Fed to do more quantitative easing rather than signaling an exit strategy in 2nd half of 2010? The answer: The Fed was cognizant of the fact the economy is losing momentum with latest unemployment figure hovering north of 9%. Therefore, the Fed signaled its willingness to intervene, if necessary.
On the surface, it seemed the policy action announced did not have major implications to the economy. However, the Fed is quietly laying the groundwork for further monetary stimulus and a gradual policy shift. To Bernanke, deflation risks must always be nipped in the bud before they could rear their ugly heads. Hence, his nickname "Helicopter Ben".
If the economy deteriorates further, the Fed would have no choice but to swell the balance sheet level further. The problem is the Fed purchase of Treasuries is unlikely to stimulate the economy and reduces unemployment. One critic is Anthony Crescenzi from Pimco. He argued that creation of jobs and emphasis on investments, not consumption should be the government priorities and policies. Furthermore, he harped that the government should build programs to increase the level of exports.
It would be interesting to note actions the Fed would take in the coming FOMC meetings. The million dollar question is where the economy is heading and whether further stimuli are needed to bolster the economy.
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