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Posted 11/7/2005
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Software shenanigans and Dell's dilemma
Companies are still playing games they learned in the mania that led to huge losses. Meanwhile, the problems of Dell and Intel just get worse.
By Bill Fleckenstein
There were fireworks on my screen last Wednesday, as a software company I was short, Mercury Interactive, was down about $10, or more than 30%. Though not a household name, its recent history illuminates several points.
By way of background, I had been short the stock (and a handful of others) since September, as I had a hunch that some software companies might have problems. In addition, Mercury Interactive (MERQE, news, msgs) has seen lots of personnel leave. So, it sounded to me like the company was headed for a world of hurt.
On Oct. 4, it cut its third-quarter revenue guidance, and the stock dropped from about $37 to about $33. Then it drifted down to about $30. However, in the last three days of October, lo and behold, Mercury rallied 8%, from about $32.50 to $35, i.e., higher than where it was when it gapped down on the preannouncement.
Voila! Rising Mercury
I thought that was odd, and upon checking, I saw that as of the last reporting date, two firms owned a little more than 20% of the company. T. Rowe Price (TROW, news, msgs) was the largest holder, with an 11% stake. I asked myself: Why did the share price spurt? Why did it spurt at month-end? Did it spurt because of the buyer's newfound faith in the fundamentals of Mercury? Or because of the buyer's need to have the share price go up? I commend these questions to someone with the power to subpoena trading records.
In any case, while Mercury was rallying, I thought it would be important to see how the stock traded after the month-end -- because if it started to fizzle (indicating it was a ramp job), I planned to sell more. I didn't get that chance, due to Wednesday's gap.
Related news and commentary on MSN Money
That day, a probe was announced into stock-option allocations, and a handful of executives were asked to leave. The company said that the fourth quarter looks to be challenging and that it (still) couldn't file its financials -- and oh, by the way, its financials haven't been filed since last June. (As for the 35 members of the dead-fish community, roughly half rated Mercury a "buy/outperform," the other half rated it "neutral/market perform" and only one said "sell it.")
A tsunami in Armani
The point of this little discussion is twofold:
- Sometimes market action can be deceiving -- as in the pop at the end of October.
- There is a common thread among the hundreds and hundreds of month/quarter/year-end ramps that I have seen in the last 10 years -- some firm (or, usually, a couple of firms) has a huge position.
Now maybe it's just coincidence that this happens, but I kind of doubt it. For the life of me, I do not understand why the SEC doesn't look into this activity. In the interest of fairness, I guess it could be said that the SEC has investigated the subject and found no evidence of wrongdoing. But I've never heard of such an SEC probe.
In fact, back in 1995, when I unearthed evidence that strongly suggested aggressive tape-painting by Jeff Vinik, who was then running the Fidelity Magellan fund (FMAGX), nothing ever came of it.
I'm not going to take the time to rehash all the data that I found, but this evidence was reported in many major publications after Grant's Interest Rate Observer broke the story.
The dog ate my watchdog
If the SEC wants to put a stop to the full-blown lies that have run rampant, it should begin by looking into these "minor" bits of dishonesty like tape-painting and the practice of companies' "making their numbers" on the nose, or by a penny, which is not the way the real world operates. It is just a variation of cooking the books.
You'd think this would have been stopped after the last stock bubble, but here we are, five-plus years since the bubble bust, and it's still occurring. My guess is, after we finally go through "the next time down," all of these practices will be cleaned up. For now, though, the perpetrators seem to have the attitude: Prove it.
Innovation: Ultimately uneventful
Now for another of last week's losers: Dell (DELL, news, msgs).
During the mania, I made the point that the PC business (Dell, Gateway (GTW, news, msgs), etc.) was just a commodity business and no different from selling TVs. As a result, I was laughed at and sent hate mail. But in fact, over the last two years, both Dell and Gateway have begun selling TVs to boost revenues. That's why, for those following the fading fortunes of the PC business, last week's preannouncement by Dell should not have been earthshaking. (For more on Dell, please see my Aug. 22 column: "Dell can't boot up demand.")
However, it seems to be lost on today's bulls that the tech business generically, not just PCs, is a commodity business. Commoditization of tech products is ultimately what brings their prices down (although it's certainly not the case when those products are first created). "Profitless prosperity" then becomes the order of the day.
We didn't see profitless prosperity in the late 1990s because of the explosion precipitated by Microsoft's Windows 95 operating system and the technological advances it spawned. That may be why so many investors appear not to understand the concept. (Editor's Note: Microsoft is the publisher of MSN Money.)
Twilight of the tech gods
So, PC commoditization is the first of Dell's problems. Like all companies in the PC business, Dell is also fighting a saturation problem, as well as the law of large numbers. In addition, Dell has led people to think it can grow faster than it can. Last but not least, Dell has hitched its star to a technological also-ran named Intel (INTC, news, msgs). That is why Dell's recent growth was slower than Hewlett-Packard's (HPQ, news, msgs) -- and not faster than the overall market's -- for the first time in many, many years. (Intel, too, is slowly but surely losing market share on a regular basis to Advanced Micro Devices (AMD, news, msgs).)
As I noted in my daily column a few days before Dell's preannouncement: "Gateway announced in its conference call that in going 'direct,' the only money to be made is in the small-business arena -- which is to say, the higher end. What that means is: Going directly to the consumer is no longer viable, with shipping costs, etc., the way they are now. This is why Dell is changing its strategy, in terms of sending lower-end boxes to post offices, etc. I think the PC-buying world has changed, and Dell (Intel, too) is in an enormous amount of trouble."
In my opinion, the decline of about 25% in Dell's stock price that began in August is the start of that recognition. I would expect that, on its conference call on Nov. 10, Dell will also take numbers down for next quarter (though it has not done so thus far). Thus, I think that Dell's woes are a multiquarter problem, at a minimum, and Intel's will last longer than that.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money. At the time of publication, Fleckenstein was short Dell and Intel, he was long Advanced Micro Devices and long Dell and Intel puts.
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