Dutch Trader's  Instablog

As mentioned in my short idea and article of July 2 Anheuser Busch Inbev A Great Company For The Long Run the brewer (BUD) came with disappointing numbers.

Second quarter EPS grew 22% year-over-year to $1.22, clearly above consensus estimates of $1.09, on a lower-than-anticipated tax rate (12.6% vs. expected 20.6%). The beat at the EPS level is the brightest spot. Other figures came in almost entirely below expectations:

Sales -0.8% to $9.87 billion (est. $9.94 billion), normalized EBITDA -4.1% to $3.59 billion (est. $3.74 billion) and margin -80 basis points to 36.4% (est. 37.6%).

On an organic basis, sales +4.7% (est. +5.5%) with volume -0.1% (est. +1.3%) and EBITDA +2.5% (est. +6.2%).

Asia Pacific (organic sales +19.3% and EBITDA margin +120 basis points to 15.2%) was the only region beating estimates. North America posted organic sales growth of 2.3% (est. +2.3%), but EBITDA declined 1.2% (est. +3.5%) and margin was down 140 basis points to 41.9% (est. 43.9%). Organic volume dropped 1.8% (est. -1.0%) with sales-to-wholesalers (STWs) -2.1% and sales-to-retailers -0.2%. The hot weather in the US seems not to have boosted sales. In Brazil, organic volume growth was 2.3%, lagging sector development of 3.1%, which led to a share decline of 20 basis points to 68.8% in Q2.

Outlook

The company reiterated FY12 guidance, including price increase ahead of inflation, mid single-digit input costs inflation, good momentum in its US beer business, positive volume growth in Brazilian beer operations, a slightly lower tax rate, and net debt/EBITDA below 2x before M&A activity (e.g. Modelo) this year and below 2x including M&A by 2014.

Final Note

Anheuser Busch Inbev's Q2 results disappointed. Especially the margin development was a negative surprise. Volume trends in its biggest markets, the US and Brazil, were rather sluggish. Although outlook was confirmed, the relatively weak Q2 figures should put the stock under profit-taking pressure, after its very strong run in the recent two months. A buy under $70, but for now a shorting candidate.

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

Could electronic sweatshops hurt Apple's business? That's the big question.

Illegal and exploitative working conditions in some Apple factories is nothing new. The question remains if Apple (AAPL) is doing enough to prevent illegal and exploitative working conditions for adults.

On Current Countdown Sam Seder talks to Apple customer Mark Shields to learn about Shields' petition protesting poor working conditions in manufacturing plants that are part of Apple's supply chain. Shields used Change.org to draw attention to the cause, gathering more than 200.000 signatures so far. Mr. Shields calls on Apple to address the issue, saying:

I love these products and what this company has done for the world - I want them to do it better. They've said, "We're the ones that think different," and I want them to think differently about this."

Another initiative comes from SumOfUs.org they urge to make the iPhone 5 ethically. SumOfUs refers in their petition to the company's use of overseas manufacturing from companies such as Foxconn, which have recently come under fire for their working conditions and practices. According to a Jan 25. New York Times report, the Foxconn Technology factory, where Apple manufactures many of their products, has repeatedly been criticized for ethics violations and socially irresponsible working conditions.

Violations included in the report included:

• Crowded dormitories where many workers were forced to live.Workers forced to stand until their legs were swollen and they were unable to walk.
• Underage workers.
• Improper waste removal.
• Wages of less than $17 to $22 a day.
• Multiple suicide attempts by workers, including a recent instance where 150 workers threatened to jump off a roof due to a work and pay dispute.

Apple itself acknowledges the violations. It conducted 229 audits of supplier factories in 2011 and found 93 violations of exceeding the 60-hour workweek limit and a similar number of workers working six or more days a week.

The petition of SumOfUs asks Apple to overhaul the way its suppliers treat their workers.

What can we do?

Boycotting Apple doesn't help the hundreds of thousands of impoverished Chinese who depend on our buying. Their unemployment will have little effect on the improvement of working conditions.

Where companies are highly sensitive about their public image, as Apple sometimes is, we might hope that bad publicity will force them to switch production to factories where workers are treated better. Why not make the iPhone in the U.S. or in Southern Europe. You help to lower unemployment and drive economic growth in your own backgarden.

For many people around the world, even those who support socially responsible manufacturing and business practices, their iPhones and iPads have become must-have devices for both work and personal use. Now they're being forced to ask themselves whether they are willing to ignore strong evidence that their beloved devices are being made by mistreated and underpaid employees.

Apple has to react

A company with such profit margins and cash on their balance sheet has to give a good example. In this case an ethical example.

Improving working conditions costs money. So if Foxconn did improve the conditions inside its factories this would translate into higher costs passed onto Apple and in turn us, the consumer. The iPhone is already too expensive for many consumers around the world. Would you pay an extra $100 on top of the normal retail price?

Apple should just absorb the extra cost and lose a few percentages on its profit margin sheets, it can certainly afford it with over $70 billion operating cash in the bank. As the biggest company in the world and the biggest brand in the world it needs to lead by example. Apple has the power and the resources to demand better working conditions for the people who make its products.

Apple's growth has it's price, but the price is too high. If they don't do something about it could hurt their business and growth.

With enough media attention the issues mentioned in this article could have serious impact on quarterly numbers. Especially if Apple doesn't force Foxconn to take immediately action. Graphics like the one below could continue if Apple introduces an Ethical iPhone 5 and other ethical Apple products.

If Apple can market Social Responsibility and really cares about it, the future looks even brighter than it is right now.

Apple's announcement that it has asked the Fair Labor Association to conduct "special voluntary audits" of working conditions at the plants of Chinese suppliers is the first step in the right direction.

Apple said the first inspections, by a team of labor rights experts led by FLA president Auret van Heerden, began last Monday morning at Foxconn's Shenzhen facility.

"We believe that workers everywhere have the right to a safe and fair work environment, which is why we've asked the FLA to independently assess the performance of our largest suppliers," said Tim Cook, Apple's CEO. "The inspections now underway are unprecedented in the electronics industry, both in scale and scope, and we appreciate the FLA agreeing to take the unusual step of identifying the factories in their reports."

The announcement added:

"As part of its independent assessment, the FLA will interview thousands of employees about working and living conditions including health and safety, compensation, working hours and communication with management. The FLA's team will inspect manufacturing areas, dormitories and other facilities, and will conduct an extensive review of documents related to procedures at all stages of employment."

Final Note

Despite the outrage of millions of Apple users around the world the stocks performs well and holds firm above $500. The latest Apple actions give an indication that they are starting to understand the danger they are in. Maybe they have begun to understand that their choices may have caused irreparable harm to their brand. If they could force the radical changes needed at Foxconn and other suppliers consumers and investors would cheer the stock price to even $800 at the end of this year, otherwise I think Apple could be doomed and ended up losing market share to their biggest rivals.

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

With the much waited IPO approaching, many brokers, banks and financial advisors have been questioned by investors about the prospects of investing in Facebook. With a S-1 already available some information can be publicly be shared.

Revenues 2011

Facebook revenues in 2011 were USD 3.7 bln a +88% growth rate as compared to 2010 with the number of monthly active users growing 40% to 850 million as of December 2011 from December 2010. Operating income came at USD 1.76 bln, +70% over 2010.

Revenue streams

Facebook posted two main revenues streams on its prospects, the most important being advertising through their site but increasing faster and already representing 17% of total revenues, the "payments" division. Payments would be Facebook's subscribers that can effectively have virtual Facebook accounts in order to purchase virtual or digital products through Internet (games, virtual gifts, etc). To take the prospect example, in a social game such as FarmVille, a subscriber could buy machinery for his virtual farm through a Facebook account previously feed by the subscriber. Facebook would take some fee on this sale when passing through the results to the game developer.

Capitalization

There will be 2 classes of shares with different voting rights, class B having 10 voting rights per share while class A with 1 vote per share. According to some estimates, the IPO will generate some USD 5 bln of resources, at USD 40 per share; the first estimates value Facebook at near USD 100 bln in the market value. CEO and founder Mr Zuckerberg will have 57% share control.

Balance Sheet

At the end of 2011, Facebook registered a USD 4.9 bln book value and cash balance plus investments were USD 3.9 bln with no debt.

Some first thoughts…

Valuation

If the IPO is priced at USD 40 per share, the company will start with a market value nearing USD 100 bln, which represents roughly 27x trailing 12 months sales ratio or around 100x trailing 12 months earnings ratio. Needless to say that these ratios are much higher than currently public companies in the Internet sector such as eBay (trailing PE of 19x and price-to-sales at 3.8x) or Google (trailing PE of 20x, price-to-sales at 6.7x). The first question that comes to mind for an investor willing to put money into Facebook would be:

How long can Facebook continue to run at these growth rates in order to justify the hefty premium observed in this IPO according to these data? To answer this question we have already some numbers: monthly active users (MAU) reached 845 million worldwide at the end of December 2011; which is already more than 10% of earth's population. We do not know yet if subscriber's growth rate has a significant impact or correlation with revenues growth rate, but running at +40% currently, MAU would reach total earth's population in less than 10 years. So the real question investor should ask would be: "Can Facebook sales continue to grow even if MAU growth stalls?" The payments division could be a new growth driver non-related to advertisement to support growth in the future. Is there any other business that could arise in the future to monetize such a 845 million rich subscriber base?

Future prospects

Is Facebook's business model sustainable for the long term? Facebook evolves in a very rapid changing world. Looking back at some internet successes of the past we have seen that landscape in tech generally can change rapidly. Facebook is being the first good example of that by making MySpace irrelevant in only few years in the social network space. The same happened to Yahoo! in the search field a few years ago. So will Facebook be the social media of the future and how can they monetize that to justify such high multiples?

Company's shareholders.

Facebook is coming to the market at a much more mature stage than it closest peers from internet in the past. The company do not really need money as mentioned above, and they are selling only 5% to 10% of the company to the public. That said, we will be in a situation where we will have a minority amount of individuals (Mr Zuckerberg and other private equity owners) controlling a significant major stake of the company and following this IPO, we will have a incredible amount on individuals chasing only 5% or so of the shares available. This situation might cause some scarcity effect following the IPO and make them even more expensive then it already appears, when looking at the aforementioned valuation ratios.

Institutional investors

With only 5% floating, the question remains if Facebook will be interesting for big institutional fund managers at these prices? And what will private equity owners, having already a big profit following the IPO do with their shares, or part of it, after the end of the lock up period? What will Mr Zuckerberg do himself with its 57% stake or part of it? How will hedge funds react to such a hyped IPO?

Final Conclusion

There are still many questions that are open and can't be answered right now. Those questions can have a significant impact on the share price following the IPO.

Because the offering price and the exact number of shares offered are unknown, it's impossible to have an opinion. But looking at the hype and the high levels of valuation, savvy investors should take a cautious approach when investing money in Facebook following the IPO.

This IPO could be marginally favorable to other internet names linked to advertising and internet, because the valuation gap between them and Facebook (according to recent published numbers) will make them look like a bargain.

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