Street Capitalist: Event Driven Value Investments

Today, Abnormal Returns asks us what role it should have in the future of the investment blogosphere. This question brings to mind some of my own thoughts on investment blogging and some ideas I’ve had in my head for a while. Before addressing what Abnormal Returns should be, I’d like to go over some of the ideas in that post.

Quality Control by Blog Type

Quality control is the most important problem facing investment blogs today. The metrics for assessing quality are dependent upon the type of blog. In the investment blogosphere, blogs generally come down to two sides:

1. Commentator types, like Paul Kedrosky who mainly focus as a central source for news he thinks is important and an outlet for his comments on current events. Going to Kedrosky’s site will keep one informed, but is probably not the best place for learning investing.

Quality control with these blogs is hard to peg. There might not even be a need for quality control. These sites are more like opinion pieces in the newspaper and in that case, they don’t have to be correct. They only need to serve as a place to get a specific type of perspective.

2. Trader/investor sites. These sometimes overlap with the previous topic. They’re written from a trader or investor’s point of view, and often you will see posts that actively go over new investment strategies or even ideas.

It’s my belief that quality control here is vastly more important, there are actual investment ideas being generated here. The best thing that these sites can offer to their readers is a level of transparency in their posts. For my blog, I list the positions I hold and make posts that note my entry date in these positions, and update a few times a year with how they’re doing. If I propose an investment idea i’ll also address whether or not I actually hold a position in the company myself. Both of these are important aspects that I believe should be adhered to.

A while back, I took part in an academic study on the investment blogosphere by a prominent university where I was asked questions on how I know what blogs to read and how I rate them. I specifically mentioned that I look at the track record of these bloggers in order to see whether or not they’re worth reading. A track record does not have to solely be your actual performance, it can also be the way you research, the way you summarize and explain your methodologies for how you invest/trade. All of these are sources that actually teach us and probably teach us more than a simple performance number — this is the key to monitoring the quality of trader/investor blogs.

Gatekeepers, Traffic, and Quality Control

I look at Abnormal Returns as the Drudge Report for investors. Often, I’ve discovered new sites by just visiting AR and they get added to my RSS Feed list. AR seems to take an active approach to showing a variety perspectives on one of its daily themes which makes it worth reading. A key difference between Matt Drudge and AR is that they at least appear to have different motives. Drudge pushes a certain ideology, while AR pushes themes of the day.

One thing I want to point out is that “gatekeepers” like AR can actually help in quality control. Linkfests like Abnormal Return push traffic to us which can help start discussions and create discourse.

If you compare us (financial bloggers) to our older second-cousins (political bloggers) there are some big differences. The political blogosphere is vastly greater than our own. Looking at some of the latest traffic numbers, you’ll see that sites like the Drudge Report (which does not actually report but showcase) and the Daily Kos or Huffington Post actually receive more hits than many newspapers.

Nielsen Online Names Top 30 News Sites

With such huge numbers in traffic, these groups are able to bring together larger debates than we can, which can uncover shoddy analysis and perform fact checking.

Look at the traffic numbers of major financial media outlets: the Wall Street Journal, the Financial Times, the Economist (or FMSM- the financial mainstream media). They generally perform better than the closest “independent” blogger driven competitor available - Seeking Alpha. Part of this is because we’re thinking strategically when we conceive our blogs. Most bloggers realize that there is little chance of them competing with the financial press establishment in general reporting.

The other part is because the FMSM typically have strong brand names and are associated with quality. In financial journalism, quality is an important factor, and I think this is primarily why the financial press is an oligopoly of sort. The barriers to entry - earning the recognition that you’re a worthwhile voice to listen to is difficult.

Some of us fight the war of the flea. We (initially) write about niche areas in finance that are not served by the FMSM.

To give you a few examples, look at Equity Private, Tanta (Calculated Risk), or Macro Man. Each brings a perspective that simply could not come from your run of the mill financial journalist. Unfortunately, what ends up happening is that these blogs become valued by industry professionals but typically lack a broader appeal.

Calculated Risk is probably an exception tot his, but part of that is probably because of the constant news about sub-prime mortgages in the news. I’ve been wondering if the broader audience will keep reading sites like Calculated Risk, after the credit mess blows over.

The future for Abnormal Returns and the investment blogosphere?

I can’t help but wonder about the future of the investment blogosphere and the FMSM. Will a blogger driven site ever match the traffic of the WSJ? To do so would be tough. First, content would have to be aggregated. This alone puts up a host of issues. Many bloggers have their own advertising and feel that aggregators take their content for free, without contributing traffic to add meaningful revenue to their blogs.

Then, somehow content would have to be screened. Seeking Alpha is just a mass glutton for content, they end up carrying some trashy contributors. The Huffington Post and Breitbart both supply the news, but also offer contrasting perspectives. The Breitbart blog network is mostly comprised of conservatives while Huffington Post offers a liberal perspectives. Maybe new investment aggregators could come onto the scene that provide different perspectives on the market. Some contrarian, some more mainstream. The fact that these aggregators would have content written by investors and traders, or commentators with professional backgrounds would help differentiate themselves from the typical financial journalists.

Finally, there would be the issue of the financial press broadening its scope. The FT and WSJ feature extensive coverage on current events, foreign and domestic. An aggregator would have to feature that content as well to match and be a true competitor.

With respect to Abnormal Returns though, they should stick with what they’re doing - making a good daily linkfest. I’m actually pretty glad that they have not taken a Digg or Reddit approach. Some sites are trying to become the Digg for financial news, but the problem with this model is that it thrives on mob mentality. Contrarian perspectives can get ignored by these sites and makes the editorial nature of AR’s linkfest advantageous. As for pursuing profit, as long as it is tasteful, I don’t see how a few ads here and there could hurt.

Is Starbucks the next AOL? Maybe.

Trading at levels last seen in 2003, Starbucks looks like they are in trouble. There is glorious talk about a turnaround for the brand, and a recent investment by Nelson Peltz seems to indicate that there is promise. However, so far, everything I have heard from the company does not seem to indicate what I would be looking for in a possible turnaround.

Starbucks is a little like AOL. AOL came onto the scene in the early 90’s and figured out how to turn the internet into a commodity for consumers. AOL brought the internet to the masses. But AOL did not change as fast as consumers preferences and when faced with new competitors.

In somewhat of the same way, Starbucks did a lot of the same things. They cannibalized the existing café market by opening up on block after block, driving small indie cafes out of business. As a result, more consumers became exposed to coffee. Cafes went from being havens for college students and older left-leaning adults, to symbols of suburbia where teens congregated to appear older and housewives went for their daily boost of caffeine before picking up the kids from soccer practice.

This ubiquity, allowed for people of all walks of life who were not normally associated with gourmet coffee consumption to actually try it and like it. For a while, this worked really well. But exposing the masses to a product that can be commoditized like coffee has its drawbacks, and that’s what I think we’re seeing at the moment.

Schultz mentions that companies are gunning for their consumer, and he’s right. By exposing consumers to coffee, Starbucks did the heavy lifting. They got consumers, to try a pricey product that may have been outside of their comfort zone. All this did though was create a new group of consumers for companies to go after, and they have. McDonalds is unrolling their iced coffee line and Dunkin Donuts has diversified into offering competitive iced drinks that deviate from normal coffee and appeal to the general population. We also know that Starbucks does not serve the best quality coffee, or provide the best experience (lack of real cups and plates). Each of these cases show how easily consumers of Starbucks can be poached to coffee outlets that better serve their needs.

This is precisely why my outlook for Starbucks, at least in its current form, is dim. Schultz is looking at things like bringing better tasting coffees, making the interior more friendly (smelling better, architecturally more welcoming), and bringing healthier options. I don’t buy that these things are enough. None of them are really a game changer and they don’t address some of the wide-scale problems that are affecting Starbucks.

McDonalds and Dunkin Donuts are about to extract an advantage by chipping away at the more working-class consumers who will be more cost sensitive. Cost sensitivity will remain highly important as consumers continue to come to grips with costlier gas and food and it will be tough for Starbucks to compete on this end. For consumers that are health conscious, Starbucks becomes an even more perplexing choice.

Starbucks does not benefit from geographic isolation, they are found on city blocks and corners that are usually filled with other offerings - from traditional fast food/casual dining outlets to places like Jamba Juice which will always appear to be more healthy because of the inherent emphasis on fruit. Then there will also be traditional food outlets that will remain more competitive as well. I know that the only reason I buy a muffin from Starbucks is because I want a sweet baked good, I’m sure many people share the same sentiment (which would also be why the breakfast sandwiches were removed in the first place).

This leaves going after tastier drinks (perhaps inspired from Italy) but again, this doesn’t help too much. Starbucks already offers a wide variety of easy to customize drinks, diluting any kind of effect that a new one may have.

So Starbucks might have to live with new entrants coming onto their turf, taking their customers. Especially competitors who may be able to specialize and cater towards the needs of certain niche groups in the market. This leaves only a few solutions, with no one solution looking like the best course of action.

First, Starbucks could pursue a plan where stores are better differentiated to fit the types of locations they’re in. A Starbucks near a college could offer cheaper drinks/promotions conducive to ordering multiple drinks, making it worthwhile to utilize Starbucks as a study spot. Starbucks in nicer neighborhoods could also reflect that, and could have things like real china to make the atmosphere more hospitable. Perhaps even some higher end coffees.

Regional tastes could be taken account also. For example, McDonalds is adept at catering towards not only national but also regional palettes. Sweet tea is big in the south, but Starbucks really has not offered any unique sweet tea to cater to, they instead offer their existing teas in an iced and sweetened form. Their stubbornness to cave to regional tastes seems reflected by their poor showings in international stores, and would be yet another strike against their one size fits all strategy.

Store differentiation works to an extent. To go further though, I think that an emphasis on franchising is needed. With Cap Ex rising 68% in two years, it must be understood that the current strategy is incorrect. A franchise driven model would help alleviate some of the burdens of running Starbucks and transfer much of the risk into the hands of budding entrepreneurs, after all, store openings are one of the company’s major costs. Shifting that aspect of the business out would allow the company to focus on products more which would also be helpful. The strong competitors that are appearing are all companies that are franchise driven, so it’s possible that they carry an advantage that Starbucks does not in this sense.

Nelson Peltz is a numbers savvy guy who likes good brands - see his purchases of Snapple, Tiffany Co., and Wendy’s. These brands had strong followings but poorly allocated capital, which he sought to change. My belief is that he might agree that franchising could be the way to go for Starbucks.

Finally, there needs to be a de-centralization of the company. If you read articles about Starbucks, you hear everything about the return of Howard Schultz. There’s even comparisons between Schultz and Steve Jobs, perhaps because both pay such close attention to the smallest of details regarding their products and services. Starbucks and Apple are two very different companies. Apple has become successful due to the iPod. It made consumers come over and try a product from a company that they had long forgotten. The iPod served then as a bridge to other Apple products, like their laptop line and iMacs.

Starbucks tries to do this, but in a bad way. You come in for a coffee drink and you are faced with products that bridge into the whole Starbucks “lifestyle”. What is this? CDs (a dying breed), teddy bears (???), and coffee to make at home (who wants to make coffee at home? isn’t this why you go to Starbucks in the first place?).

None of these products had much of a competitive advantage, making the Starbucks strategy very un-Apple. Furthermore, Apple’s products are simpler to group (mp3 players, phones, laptops, PCs, iTunes, operating system). The introduction of a new product line, like the iPhone for instance, has a tremendous effect on the company. I fail to see how the introduction of a fruity drink at Starbucks will have the same level of effect on Starbucks. Consumer preferences here are quite different, Apple caters to status and utility, Starbucks caters to individual palettes - which are extremely fickle.

So Howard Schultz is no Steve Jobs, and maybe the company should start reflecting that more. People think that the founders of companies can solve all of their problems, but just look at Jerry Yang at Yahoo if you want an example of a founder coming back and having trouble. So maybe it is time for stores to have more autonomy, so that decision making will come down from the top to the front-lines and create an environment for more innovation.

Still, even these ideas might not be enough and that’s the trouble with Starbucks. I used to think that Starbucks is a great business that I would love to own at a good price. Now, I’m not entirely sure about that. Howard Schultz is facing competitors who have been serving customers much longer than Starbucks has even existed - while also having to battle new insurgents entering the market. Good luck Mr. Schultz and shareholders at Starbucks, you’re going to need it.