Back to the video itself, embedded inside: thought-provoking presentation on (buzzword alert!) “information shadows”, “the sensor web”, cloud computing, data collection, processing and presentation/ visualization, local marketing + micropayments, P2P credit-card payments, social network risk evaluation… and how all this is coming together to create new products and services that feed on the cloud and/or organize it. It’s still impossible to tell just how practical this is and who will make money from this, but it’s nice food for thought.

This is from the June 30th report of Spinoff & Reorg Profiles.

INCENTIVE STOCK OPTION EXERCISES AND INSIDER BUYING

Sharps Compliance (SMED) is a medical waste disposal company. The most recent quarter’s loss notwithstanding, its trailing return on employed capital is over 200%, and shares trade below 7 times earnings. The company has no debt, and cash reserves of about 10 times last quarter’s loss. Unfortunately, its operating history is too short to satisfy many conservative investors; still, we find it interesting, both on its merits and as a foil to illustrate how and when incentive stock option exercises may act as an insider signal.

SMED shares are down over 60% since November, and over 40% since its first-quarter loss was revealed in May. Yet insiders are suddenly buying, after years of consistent net selling. On June 14, a director purchased half a million dollars’ worth of SMED at market. More interestingly, the CEO exercised options on a quarter million shares in May, but has sold none.

To illustrate the strength of the latter signal, we must first relate a doleful tale of of investment calamity from several bubbles ago. In 1999, one of the author’s former business school classmates was sitting on millions in paper gains from incentive stock options at a frothy dotcom. To minimize taxes, the guileless MBA committed all his cash to exercise all his options, intending to hold shares for a year and qualify for capital gains treatment. At the exercise date, the spread between the strike and market prices was large enough to trigger the alternative minimum tax the following April; but by then, his company had collapsed, leaving him with no income, no cash, worthless stock, and a vast AMT liability. He was wiped out. (We betray no confidences in telling this story, as he confessed it all in a page-one piece in the Wall Street Journal in June of 2000. Perhaps understandably, he later changed his name, but that is for another story.)

The situation faced by the CEO of SMED is not dissimilar, in that his stock options were struck at just 80 cents; the resulting spread could in theory incur a tax liability of as much as three quarters of his recently reported annual compensation. The exercised shares are about a sixth of his total holding in SMED. In short, the numbers are big enough to matter to him. Unlike the author’s classmate of yore,
this CEO is 71 and presumably experienced, so to make such a big decision, he must be highly confident that SMED is now cheap.

To summarize, the exercise of incentive stock options may indeed be a buy signal if (i) the spread is large, yet the exerciser does not sell, thus taking on personal exposure where he had none before; (ii) the amounts are large relative to his estimated net worth and income; (iii) the activity is historically unusual, per company filings; (iv) the activity accompanies unusual cash purchases by other insiders; and, most importantly, (v) the behavioral signal is backed up by fundamental value, such as the low P/E and very high return on capital here.

The same NYT edition also had this article that makes shallower claims but it’s in the same vein as the one above, and there’s already a reply by Steven Pinker with interesting remarks. Steven points to yet another article, and this was something we thought about posting a stand-alone story about: “We have met the enemy and it is Powerpoint“. Taken together, this is an interesting “linguistic/ communications” debate that we pay attention to because the efficiency of communication is a very important aspect of our business – how we communicate internally, with our clients, our current and potential investors and with our service providers. Spreading the right information at the right time to the people who can make use of it while allowing for some measure of serendipity is something we’ve been working on since our foundation.

The impacts of such moves are never immediate and almost always underrated at first, and there’s always the risk of data deluge. That said, they’re trying to speed things up via Google and an app development contest, which could lead to interesting uses for all this information.

Data wants to be free, some would say – but still others remember that this was public data to begin with. No doubt some companies will come up with organized, value-added products – in print or online (mobile or not) – that build from this data something greater.

Here’s the video where Bob Zoellick explains the initiative:

Quick highlights from the executive summary:

- E-commerce grew 30% to R$ 10.6 Bi and average ticket of R$ 335 (up just 2.1%);

- 17.6mm people purchased something online in 2009, up 33%;

- Within that group, 77% did at least one purchase in the last 3 months of the survey;

- Quality logistics is the key for keeping delivery dates, which is a determining factor in customer satisfaction. (Easier said than done!)

We’ll never get tired of saying this: dump the checklist approach to CG. Actually, dump the checklist approach to anything.

Corporate Governance and alignment of interests is about so much more than the proportion of “independent” directors or separate CEO and Chairman roles and so on… It’s like saying that Berkshire’s governance lacks substance because “Buffett is both Chairman and CEO and keeps family and friends in the Board” without digging deeper – and by the way, many people do say this. The fact that Buffett only takes home US$ 100,000 in annual salary with no stock options and has about 99.7% of his net worth tied to Berkshire stock (all of which he purchased directly in the market) goes unnoticed. The percentage of stock owned by WB, Charlie Munger and Buffett relatives amounts to so much of the company that it’s like having a saber-tooth tiger as a watchdog for minority shareholders.

The truth is that it’s way too early to assess the full effects, but analysts are already throwing around conclusions. When one thinks about it, most of the reform’s effects will happen after 2014, longer than most people’s investment horizons, which means most investors are either ignoring reform or using it as a means to speculate. Fixed income markets may be looking at greater future fiscal deficit, but haven’t acted on it yet.

IP’s position has always been to recognize our own ignorance and try not to depend on particular outcomes – without neglecting selective Healthcare exposure. We’ve chosen diversified companies over time, whose business is much more associated with a “picks and shovels” theme (such as Thermo-Fisher) or those in which there’s a strong consumer brand poised to benefit (such as Johnson & Johnson).

About the bill in general, politics can be a very volatile field – it’s a governance conundrum one could be happy to stay away from. The long debate on health reform ended with what seems to be a hard outlook for some health plan operators, but a broad tailwind for the general industry: plan coverage, by various means, should increase substantially going forward (estimated 32mm new enrollees over 10 years).

Large pharma companies are, at first, picking up the bill for the entire drug value chain (US$90 Bi fees over 10 years), which makes research equipment providers (upstream from pharma) as well as drug distributors (downstream) prone to benefit from increased coverage without a significant burden. Over time these fees should flow along the chain and, ultimately, to consumers.