A little financial analysis lesson

Hello everyone!

In this post I wanted to highlight for each of you one of the moments that always catches my attention as an investor. Namely, when a successful business decides to branch out into an entirely new field. Because this sort of thing is so common, it is important that we have some skills in evaluating these kinds of decisions. So here goes…

As a case study we are going to use Cox Communications which is one of the nation’s largest cable television providers. Cox is currently building a cellular communications network and wants to launch cellular service later this year.

Investors should always be alarmed by these kinds of announcements. Cox is a cable TV company, not a cell phone company. Yes, they manage a television network and they have subscribers to that network, but that is a very different sort of business than the cellular communications business.

• Our first question is always: why? Why is Cox, a cable company, wanting to enter the cell phone business? The reasons given are: by offering cell service Cox can bundle together TV, broadband and cell service; also the company wants to increase the number of cell phone users that currently watch streaming video on their cell phones. No, I am not kidding.

My own personal belief is that these sorts of corporate boondoggles are brought about by a company amassing a lot of cash due to an already successful business and yet they have no place to invest that cash. Thus, cash rich businesses, such as the monopoly of cable, begin to look for new investments. My question to these businesses is always the same: rather than pursue a white elephant, why not just pay out your excess cash to shareholders in the form of a dividend?

The classic example of this was Microsoft who for years chased a lot of white elephants, with the Xbox being the only exception to their string of failures. Eventually, after much shareholder argument the behemoth finally paid out a massive, one-time dividend. Amen!

• So the second question in these situations is: Do they have expertise in the business that they are wanting to enter? In Cox’s case the answer would have to be: sort of. Can you imagine hiring a job candidate who is sort of qualified? Didn’t think so.
• The next question in these sorts of situations is: how much competition is there in the new field? Well gosh, how many major and minor cellular communications providers are there in the U.S.? Over a dozen. So Cox has limited expertise in a business that they are entering and there is lots of competition in that business, too. Bad combo.
• And the next question is: how much money do they intend to spend on the new venture? The answer in Cox’s case is ~$300 million.

After you have weighed the answers to these questions we then need to make a decision: buy or sell? In Cox’s case I would have to say “sell.” Because I don’t own shares in Cox, the “sell” is simply interpreted as “not buy.” Not only that, but I have it on my mental bulletin board to pay attention to Cox. Why? Not because I want to see if they fail. No, because by watching to see if my assumptions about Cox’s new venture are correct I can evaluate my own performance as an investor. You see your performance is not just measured by what you buy, but also by what you do not buy. That means that every company in the U.S. is an opportunity for you to test your investment mettle. And this is a very inexpensive way of becoming a better investor. Does this make sense?

I hope that this was useful.

Jason