Does Europe have what it takes to create the next Google?

LONDON (Reuters) – Europe is making major strides to eliminate barriers that have held back the region from developing tech firms that can compete on the scale of global giants Alphabet Inc’s Google, Amazon.com Inc or Tencent Holdings Inc, a report published on Thursday shows.

An attendee interacts with an illuminated panel at Google stand during the Mobile World Congress in Barcelona, Spain, March 1, 2017. REUTERS/Paul Hanna

The region has thriving tech hubs in major cities, with record new funding, experienced entrepreneurs, a growing base of technical talent and an improving regulatory climate, according to a study by European venture firm Atomico.

While even the largest European tech ventures remain a fraction of the size of the biggest U.S. and Asian rivals, global music streaming leader Spotify of Sweden marks the rising ambition of European entrepreneurs. Spotify is gearing up for a stock market flotation next year that could value it at upward of $20 billion. (reut.rs/2wYORnI)

“The probability that the next industry-defining company could come from Europe – and become one of the world’s most valuable companies – has never been higher,” said Tom Wehmeier, Atomico’s head of research, who authored the report.

Top venture capitalists and entrepreneurs in the region told Reuters they are increasingly confident that the next world-class companies could emerge from Europe in fields including artificial intelligence, video gaming, music and messaging.

“What we still need to develop is entrepreneurs who have the drive to take it all the way – I think we are starting to see that now,” said Bernard Liautaud, managing partner at venture fund Balderton Capital, who sold his software company Business Objects to SAP for $6.8 billion a decade ago.

The Atomico report is being published in conjunction with the annual Nordic technology start-up festival taking place in Helsinki this week and set to draw some 20,000 participants.

STRONGER FUNDAMENTALS

Capital invested in European tech companies is on track to reach a record this year, with $19.1 billion in funding projected through the end of 2017 – up 33 percent over 2016, according to investment tracking firm Dealroom.co.

The median size of European venture funds nearly tripled to around 58 million euros ($68.7 million) in 2017 compared with five years ago, according to Invest Europe’s European Data Cooperative on fundraising investment activity.

Beyond the availability of funding, Europe has a range of technical talent available to work more cheaply than in Silicon Valley, enabling start-ups to get going with far less funding.

With a pool of professional developers now numbering 5.5 million, European tech employment outpaces the comparable 4.4 million employed in the United States, according to data from Stack Overflow, a site popular with programmers.

London remains the top European city in terms of numbers of professional developers, but Germany, as a country, overtook Britain in the past year with 837,398 developers compared with 813,500, the report states, using Stack Overflow statistics.

While median salaries for software engineers are rising in top European cities Berlin, London, Paris and Barcelona, they are one-third to one-half the average cost of salaries in the San Francisco Bay Area, which is more than $129,000, based on Glassdoor recruiting data.

PUSHING UP AGAINST LIMITS

Big hurdles remain. A survey of 1,000 founders by authors of the report found European entrepreneurs were worried by Brexit, with concerns, especially in Britain, over hiring, investment and heightened uncertainty in the business climate.

Although Europe has deep engineering talent, many big startups focus on business model innovation in areas such as media, retail and gaming rather than on breakthrough technology developments that can usher in new industries, critics say.

Regulatory frameworks in Europe put the brakes on development on promising technologies such as cryptocurrencies, “flying taxis” and gene editing, while autonomous vehicles and drones face fewer obstacles, the report says.

A separate study by Index Ventures, also to be published on Thursday, found that employees at fast-growing tech start-ups in Europe tend to receive only half the stock option stakes that are a primary route to riches for their U.S. rivals. Yet their options are taxed twice as much.

The Index report said employees in successful, later-stage European tech start-ups receive around 10 percent of capital, compared with 20 percent ownership in Silicon Valley firms.

“There is quite a gap today between stock option practices in Europe and those in Silicon Valley,” Index Ventures partner Martin Mignot said in an interview. “There are other issues where Europe is behind, but we think stock options should be at the top of the agenda.”

Another factor holding back Europe is that regional stock markets encourage firms to go public prematurely, Liataud said.

“Europe has markets for average companies. In the U.S., going public is hard. You have to be really, really good. You have to be $100 million, minimum, in revenue,” the French entrepreneur-turned-investor said. “Nasdaq and the New York Stock Exchange have not lowered their standards.”

($1 = 0.8442 euros)

Reporting by Eric Auchard in London; Additional reporting by Jussi Rosendahl and Tuomas Forsell in Helsink; Editing by Leslie Adler

Our Standards:The Thomson Reuters Trust Principles.

The 5 Most Likely IPOs of 2018

With the economy still strong and the stock market still flying high, some observers are predicting that 2018 will be a good year for IPOs–better than the past few years have been. That’s probably good news for the current crop of technology unicorns that have gotten deep into the alphabet of funding rounds and must at some point repay their investors. (A “unicorn” is a pre-IPO or M&A startup with a valuation of $1 billion or more.)

With the likely IPO boom in mind, the personal finance site GOBankingRates has come up with a list of likely IPOs for 2018, rating their likelihood of going public next year from high to low. These are the unicorns GOBankingRates thinks are most likely to go public in 2018. You can find the full list here

1. Airbnb

Valuation: $31 billion

Airbnb has raised $4 billion from investors, including series F funding. It now has 3 million listings and operates in nearly all nations on Earth. It also became profitable in 2016 and is expected to show a profit this year as well. It certainly sounds like a company that’s quite ready to have an IPO.

In an interview with Fortune in October, CEO Brian Chesky said the company “would be ready as absolutely soon as we can.” On the other hand, he said, people who expect the short-term rental company to go public in 2018 might be disappointed. “The vast majority of people are saying that you should take your time and do whatever you need to do on your timeline,” he explained, adding that some companies have had a tough time once they got out in the markets. “It’s a defining thing,” he said.

2. Dropbox

Valuation: $10 billion

Many observers have been expecting Dropbox to go public this year. It’s certainly given many signals that an IPO was in the works, raising a $600 million line of credit from several large investment banks (getting cash without giving up equity is a good sign). Dropbox CEO Drew Houston told Bloomberg earlier this year that the company had positive EBITDA (earnings before interest, taxes, depreciation and amortization–a measure of day-to-day profitability for heavily indebted companies). 

Dropbox has 500 million registered users worldwide, and 200,000 business customers (that is, people who actually pay for the service). It recently launched a $19.99 per month “Professional” level of service which some interpreted as a measure to beef up revenues in preparation for an IPO. This one could happen any day now.

3. Spotify

Valuation: $16 billion

Spotify is in the unique position of wanting to sell shares to the public but being blocked so far because the company does not want to go the traditional IPO route. Instead, it hopes to simply list its shares on the New York Stock Exchange without bothering with (or paying for) the rigmarole of having an investment bank set up an IPO. That carries some risks for Spotify, since its share price would immediately be set by the market, whereas an investment bank would work with investors to set the initial price and would likely have buyers lined up in advance. 

Still, with 60 million paying subscribers, Spotify is in a pretty good position to do what it wants. Its continued success in the crowded field of streaming music where competitors include Amazon, Apple, and Google, remains impressive. Spotify execs met with Security and Exchange officials to discuss its unusual plan and lobby for their approval. The company will also need a rules change from the NYSE before it can go forward. There’s a pretty good chance that both will be forthcoming next year. If that doesn’t happen, Spotify may change its mind and go the usual route. Stay tuned.

4. WeWork

Valuation: $20 billion

“One thing we’re not afraid of is going public,” WeWork CEO told Fortune back in July. Back then, there was a flurry of speculation that the coworking company would soon have an IPO but so far that hasn’t materialized. Instead, the company raised yet another round of funding, bringing its valuation to $20 billion. It used that money to expand into Asia and Latin America

WeWork has 120,000 members and revenues of about $1 billion a year, so it’s in a good position for an IPO. As GOBankingRates puts it: “WeWork is going public–we just don’t know when.”

5. Buzzfeed

Valuation: $1.7 billion

Buzzfeed seemed all set to go public in 2018–but now it looks like it will miss its revenue target for 2017 by 15 to 20 percent. That may mean that the media company’s hopes for an IPO next year may have to wait. 

Buzzfeed says it is growing both revenue and visitors to its site,which should be good news for investors. But the growth led to higher costs, and in the digital media industry, ad prices are notoriously low, leaving thin profit margins. So increased costs–and especially missing revenue targets–could be an ominous sign. Still, Buzzfeed has a total audience of $650 million and the site has been profitable. So you never know, it might still happen.

Indian telecom regulator recommends rules in support of net neutrality

MUMBAI (Reuters) – India’s telecom regulator on Tuesday recommended explicit restrictions on any discrimination in internet access as part of its much-awaited recommendations on net neutrality.

The Telecom Regulatory Authority of India (TRAI) said it was not in favor of any “discriminatory treatment” with data, including blocking, slowing or offering preferential speeds or treatment to any content.

In February 2016, TRAI ruled in favor of net neutrality by prohibiting discriminatory tariffs for data after an extended campaign by internet activists, who argued that Facebook’s Free Basics platform and other offerings by Indian telecom companies violated net neutrality principles.

Reporting by Rahul Bhatia

Our Standards:The Thomson Reuters Trust Principles.

This 11% Yielding, Fast-Growing Stock Is Killing It, But There's A Catch

Residential mREITs are one of the hardest high-yield industries to do well in over the long-term, which is why I generally avoid owning them.

However, I’ve made an exception with New Residential Investment Corp. (NRZ), because of its highly profitable niche, which means that it’s thriving in a challenging market environment that is grinding down its peers.

Let’s take a look at how NRZ is capable of delivering blow-out growth quarter after quarter, as well as impressive book value and dividend growth.

More importantly however find out why NRZ remains a high-risk stock, and one that I’ll be trimming substantially before the next recession when a combination of factors could put the dividend at risk of a severe cut.

Fortunately, there are several key trends you can watch to help minimize the chances of being caught unawares when the next economic downturn strikes.

Another Blowout Quarter From A World-Class Management Team

New Residential Investment Corp. was spun out of Fortress Investment Group back in 2013, and since then has been one of the fastest growing residential mREITs in the country especially compared to more traditional peers such as Annaly Capital (NLY) and AGNC Investment Corp. (AGNC).

Chart

NRZ Revenue (TTM) data by YCharts

The key to this torrid growth has been the niche nature of its business model, which is essentially a hedge fund that specializes in mortgage servicing rights (MSRs), excess MSRs, mortgage advances, and unsecured consumer debt.

As I’ll explain later, the nature of these loans is riskier than most traditional residential mREITs, but results in extremely high returns on investment.

Source: New Residential Investment presentation

Mortgage servicing is basically where a third party (non originator) owns the rights to service a mortgage, meaning collect payments from homeowners, as well as handles any delinquencies and foreclosure proceedings.

New Residential actually outsources this to several counterparties, including Ocwen Financial (OCN), which it recently bailed out in a $440 million deal that will greatly reduce its subservicing costs, and resulted in last quarter’s blow-out 100% earnings growth (due to a one-time accounting change).

However, this quarter, New Residential proved that its continued fast pace of new loan acquisitions can indeed continue an impressive growth rate, at least for now.

Metric Q3 YOY Change YTD YoY Change
Net Investment Income 46.6% 74.7%
Core Earnings 60.8% 88.8%
Shares Outstanding 28.2% 29.1%
Core EPS 25.4% 46.2%
Dividend 8.7% 7.2%
Core EPS Payout Ratio 77.6% 66.6%
Book Value Per Share 19.0% 14.4%

Source: Earnings release, YCharts

That’s because the overall markets in which New Residential operates are staggeringly large ($27.5 trillion), and thus pose a rich hunting ground for the top-notch management team to continue to find new and highly profitable investment opportunities.

This is precisely what New Residential has been doing with very steady large purchases of new servicing rights over the past few quarters.

In addition, New Residential has also been growing its call rights business, as well as its portfolio of unsecured consumer loans at a breakneck pace.

However, what truly stands out about New Residential’s business model is that unlike most residential mREITs, which are being hammered by a compressing yield curve (more on this later), and declining book value, NRZ’s loan portfolio is among the best suited to survive and prosper in a rising rate environment.

In fact, NRZ has seen its book value per share steadily rise over time, while rivals such as Annaly and AGNC have struggled with decreasing BVPS because higher rates decrease the value of their assets and a compressed yield curve makes it harder to replace maturing loans with equally profitable ones.

Chart

NRZ Book Value (Per Share) data by YCharts

The bottom line is that NRZ is experiencing a sweet spot in growth right now, where a combination of improving fundamentals are putting the growth winds at its back including:

  • Declining delinquency rates on its loans.
  • Rising value of its MSR assets (due to rising rates lowering debt prepayments).
  • Plentiful opportunities to grow its high-yield loan portfolio.
  • Steady and accelerating economic growth (helps keep delinquencies and defaults low).

This is why New Residential has been able to generate the industry’s best dividend growth record since its IPO.

And with earnings growth continuing to rise quickly, it’s likely that for as long as NRZ continues to bask in these positive fundamentals, investors may be looking forward to even more dividend growth in the years ahead.

However, while all these beneficial trends make NRZ one of the largest holdings in my high-yield retirement portfolio, there are nonetheless numerous pitfalls that still make this a high-risk stock, one that I plan to eventually trim substantially ahead of the next recession.

BUT Lots Of Risks To Keep In Mind

There are three major risks to keep in mind with New Residential that in my opinion make it a high risk stock, and why I plan to eventually lower my position (over time) to 2.5% of my portfolio.

The first is that this is essentially a hedge fund, where management pays itself first and foremost.

  • Base fee is 1.5% of gross equity, which it defines as the equity of the original spinoff, plus net proceeds of stock offerings (selling new shares).
  • Incentive fee of 25% of adjusted funds from operations (basically net interest income adjusted for asset sales), above a 10% growth hurdle rate.

Now I’m not necessarily opposed to management getting well paid for the kind of success we’ve seen so far. After all NRZ’s generous yield, and industry leading dividend growth have resulted in returns since its IPO that not only just crushed its larger peers but also handedly beat the market as well.

Chart

NRZ Total Return Price data by YCharts

However, the rate of management incentive pay has been growing even faster than either NII, Core EPS, or dividends.

  • Q3 2017 up 175% YOY
  • YTD 2017 up 446% YOY

Now it’s actually normal for management pay to increase this quickly, given the growth rate and rapid rise in shareholder equity (which boosts the base management fee).

In other words, because of how NRZ is structured (as a hedge fund paying itself 1.5% and 25%), management pay is likely to rise much faster than investor gains.

However, while this is less of an issue today, when growth is proceeding at a torrid pace, high management pay could well become a major growth headwind in the future.

Which brings me to the second biggest risk for the stock, replacing its maturing loan portfolios.

Remember that New Residential is basically a collection of loans, and those mature and roll off over time. That means that going forward NRZ’s growth will almost certainly slow as its asset base grows larger (harder to grow quickly once you get to a certain size), and proportion of maturing loans rises over time.

For example, take the mREIT’s most successful investment, the SpringCastle portfolio of unsecured consumer debt.

NRZ has been able to generate astonishing 89% returns on this portfolio because since it purchased the risky loans (at great prices), the strong economy has caused the charge-off rate to fall 50%.

However, newer consumer loans, while still highly lucrative, have been far less impressive.

NRZ Prosper Portfolio

For example, NRZ’s Prosper portfolio of peer-to-peer loans has only generated 20% returns so far.

Combined with the fact that management has said it’s passing on a growing number of MSR deals, and it may very well be that the same improving economic conditions that are benefitting NRZ’s book value right now, is making it harder for management to find sufficiently profitable deals to keep the growth rate at today’s high levels.

That’s especially true given that NRZ has always been focused on riskier loans, with a focus on smaller sizes, lower FICO scores, and older loans (that will mature faster).

In addition we can’t forget that NRZ’s access to growth capital has been greatly aided by the fact that its shares have historically traded at a premium to book value.

Chart

NRZ Price to Book Value data by YCharts

A premium to book value basically means the market is valuing the company for more than the value of its loan portfolio, which is a strong endorsement of management’s skill.

For example, with shares currently trading at 20% above book value, it means that shareholders are saying that each $1 in NRZ assets they buy will be worth at least $1.20 later, because of confidence that management will continue executing well on its long-term growth strategy.

Or to put another way, at the current share price, NRZ is able to effectively print free money ($0.17 per $1 in shares sold) with which to invest in its highly profitable loans.

However, as you can see, at times fickle investor sentiment means that NRZ’s shares sometimes trade below book value, meaning that any shares sold at those times (to raise equity growth capital) will be destructive to shareholder value.

The bottom line is that NRZ is a highly complex, “black box” of a financial company, which has so far enjoyed stupendous growth courtesy of excellent investments by management, but also a steady, long, and accelerating economic recovery.

And as its loans mature, there is a large risk that management will find it much harder to invest as profitably as in the past without taking on a larger amount of credit risk that could blow up in its face come the next recession (more on this in a moment).

Payout Profile Is POTENTIALLY Great, But Highly Uncertain

Stock Yield YTD Payout Ratio 10 Year Projected Dividend Growth 10 Year Potential Total Return
New Residential Investment Corp 11.2% 66.6% -5% to 5% 6.2% to 16.2%
S&P 500 1.9% 44.5% 6.1% 8.0%

Sources: GuruFocus, Fast Graphs, CSImarketing, Multpl.com

The only reason for owning any high-yield stock is ultimately the payout profile, meaning a combination of: yield, dividend security, and long-term growth prospects.

My goal as an investor is to avoid dividend cuts whenever possible, including during recessions. This makes mREITs a highly challenging industry because even the best mREITs, both residential and commercial, have a poor history of maintaining steady dividends during economic downturns.

Chart

NLY Dividend data by YCharts

This is why I’m planning on eventually reducing my holding of NRZ to 2.5% of my portfolio, which is my targeted position size for high-risk stocks, meaning those whose dividends I’m uncertain can survive the next recession.

The high risk is also a function of the unpredictability of NRZ’s underlying business model, one in which it’s impossible to predict how profitable the company’s future loans will be.

That means that the variability in the long-term dividend growth rate is very wide. In fact, I estimate that over the next decade, NRZ’s CAGR payout could vary anywhere from -5% (bad recession) to 5% (no recession). Analyst consensus is basically for the midrange of that estimate, at 1%.

Or to put another way, NRZ’s highly uncertain dividend growth rate means that its total returns could be anywhere from 6.2% (market loser) to 16.2% (double the market’s likely return from current valuations).

Valuation Is Reasonable… Maybe

Chart

NRZ Total Return Price data by YCharts

Over the past year, NRZ has crushed the market, which isn’t surprising given Wall Street’s love of fast growth. However, that means that NRZ is far from a deal today.

Price/Book Value Historical P/BV Yield Historical Yield Percentage Of Time Since IPO Yield Has Been Higher
1.20 1.18 11.2% 11.2% 62.6%

Sources: GuruFocus, Yieldchart

I like to value mREITs on two main metrics, the price to book value and yield, both on an absolute basis and relative to historical norms.

Today NRZ is trading right smack in the middle of its historical price to book value and yield ranges, meaning that shares are likely fairly valued.

However, note that the yield has been higher than today’s 62.6% of the time since its IPO, indicating that if you’re patient, you can likely get a better price and higher yield.

Of course, that’s assuming you are comfortable with owning a high-risk mREIT at all, because it’s extremely challenging to model the intrinsic value of this company.

Forward Dividend 10 Year Projected Dividend Growth Projected Dividend Growth Years 11-20 Fair Value Estimate Dividend Growth Baked Into Current Price Discount To Fair Value
$2.00 -5% (bearish case) 0% $13.39 -0.4% -33%
0% (likely case) 0% $18.26 -0.4% 2%
5% (best case) 5% $27.64 -1.6% 35%

Sources: GuruFocus, Fast Graphs

For example, with high-yield stocks like this, I generally like to determine intrinsic value based on a discounted dividend growth model.

That means using a 9.0% discount rate (historically the post expense CAGR return on an S&P 500 index ETF since 1871, and thus the opportunity cost of money) to determine the net present value of a stock’s future (20-year) dividend flow.

Of course because NRZ’s business model is highly unpredictable that means we get a huge variance in estimated fair values, ranging from $13.39 in a bearish scenario (33% overvalued) to $27.64 (35% undervalued) assuming that management can maintain strong dividend growth over time.

The likely case, at least according to analysts, is for NRZ to basically maintain a flat payout over time, which means its shares are fairly priced today.

However, remember that any valuation model is a best guess at future earnings and payouts. That means that any fair value estimate is always a moving target, one that’s adjusted as actual results come in.

Which brings me to the biggest risk for NRZ, a recession, and how I plan to not just reduce my position before that happens, but how I plan to recognize when the next downturn is likely on its way.

Winter Is Coming So Be Prepared

I view residential mREITs, including New Residential Investment Corp., as mostly “fair weather economic friends” meaning that a recession is likely to wreak havoc on earnings due to rising loan delinquencies and outright defaults.

That means that investors need to manage their risk when it comes to how large a percentage of your portfolio any stock is, based on its dividend risk profile.

  • Low risk (dividend likely safe and growing for at least 5+ years): 10% max size (core holdings)
  • Medium risk (dividend likely safe for two to three years): 5% max size
  • High-risk (dividend likely safe for one year): 2.5% max size

That’s how I think of dividend risk, and the long-term plan I have for right sizing my position sizes to adjust for long-term risk to the dividend.

Now I’m gradually updating my portfolio (as one must do in a rapidly evolving world), which means that today NRZ is about 10% of my holdings and about 4X overweight.

However, given the strong fundamentals so far, and the fact that the growth winds remain at NRZ’s back for now, and as long as the economy keeps growing, there is no need to run out and immediately sell 75% of my position.

Rather my plan for trimming NRZ down to an appropriate size is based on my best guesstimate of when the economy will peak.

Of course this is very hard to do in real life, which is why the common joke is that economists have predicted nine of the last five recessions.

Which means that rather than simply “ringing a bell at the top,” I’m focused not so much on any individual economic metrics, but longer-term trends of several key metrics.

The first is the yield curve, specifically the 2- and 10-Year US Treasury spread.

An inverted 2-10 curve, meaning that 2-year US bonds yield more than 10-year bonds, has “predicted” five of the last recessions (going back to 1976), with an average lead time of 12 to 24 months.

Of course in reality things aren’t that simple or clear cut. Basically the idea behind a yield curve inversion is twofold.

First, because bonds markets are largely a long-term vote by investors on future economic growth and inflation, if a short-term bond yields equal or more than a long-term bond, it basically means that bond investors are expecting little or no economic growth or inflation in the future.

In other words, there is no risk premium for owning longer duration bonds (tying up your money for longer) because bond investors are bearish on growth and potentially expecting inflation to remain flat or even potentially negative.

Fundamentally there is also a plausible reason that an inverted yield curve can potentially signal a recession.

That’s because financial companies, such as banks or mREITs effectively borrow at short-term rates, to invest in longer-duration assets. The spread between these is where profits are generated.

Which means that if the yield curve is steep, banks and other financial institutions have large incentives to do brisk business, such as loan to consumers and businesses (or buy mortgage backed securities and thus help fund the housing market).

However, if the curve inverts, then financial companies can’t make a profit, then loans dry up, credit slows or shrinks, and consumer and business spending ends up declining; potentially triggering a recession.

So those are the basic theories behind the yield curve and why it’s worth watching. However, keep in mind that while the correlation between inverted yield curves and recessions is strong, that doesn’t necessarily mean that the causation is real.

For example, the US has had 47 recessions or depressions since its founding, or an average of one every 5.1 years. Thanks to greater involvement by the Federal Reserve, this has now increased to about a recession every 8 to 10 years.

However, with a one- to two-year lead time, it’s possible that the yield curve’s predictive power is potentially overstated (since it covers a relatively large amount of time).

Source: St. Louis Federal Reserve

That being said, I do consider the yield curve to be worth watching, and since the start of the year (when optimism about reflation and faster economic growth was at its peak), it has been steadily declining.

Going forward, the Fed’s accelerating roll-off of its balance sheet should help to push up long-term rates (due to less Fed buying of long-term mortgage and US Treasury bonds), however, that could be offset by up to six rate hikes the Fed is currently planning through the end of 2019.

While short-term rates aren’t directly controlled by the Fed (it only raises and lowers the Fed Funds rate which is the overnight interbank lending rate), the Fed’s rate hikes do have an indirect effect on borrowing rates because they are one of the benchmarks used by financial institutions for determining what rates they lend at.

In other words, the current yield curve trend, while troubling, is far from spelling economic doom anytime soon.

Of course trying to predict something as complicated as economic growth and recessions requires more than just a single metric. Which is why I’m also looking at a meta analysis of leading economic indicators, which is tracked brilliantly by Jeff Miller in his weekly market/economic updates.

Currently the economic outlook is largely positive, with economic data, according to the New York and Atlanta Feds, signaling accelerating economic growth. Meanwhile the three- and nine-month recession risk of about 4.4% and 15%, respectively.

While no economic model, including the Atlanta and New York Feds’ is perfect, should US economic growth indeed come in at 3.4% to 3.7% in Q4 that would mark the first time since 2004 that the US has seen three consecutive quarters of economic growth.

What’s more, the growth rate in all three quarters would be accelerating indicating a potentially very positive trend.

That’s especially true given that the labor market remains strong, and eventually, wage growth should start to rise faster than the 2.5% YOY pace we’ve seen most of this year.

Higher wages with muted inflation would mean stronger real purchasing power and could further boost consumer spending and economic growth, as might tax reform (about 0.3% by most analyst estimates).

Add to this numerous other positive trends and you have the potential for economic growth to continue for quite some time:

  • The continued strength in consumer and business confidence (highest since 2000).
  • The fact that 75% of major world economies are now growing simultaneously.
  • S&P 500 earnings forecast to grow 9.5% this year, and 11.1% next year (without tax reform that would add about 8% to that figure) which could keep the bull market (and wealth affect) running for a few more years

The bottom line for recession risk is that chances of a near time economic downturn are far lower than most would think, given the length of this economic recovery.

That being said, any given data point is just a snapshot in time so it’s important to keep in mind the longer-term trends of these metrics.

So how exactly do I plan to use a holistic approach to watching economic trends to time my trimming of my NRZ position in the future?

  • If yield curve inverts, sell 25% of my position
  • When nine-month recession risk hits 33%, sell 25%
  • When nine-month recession risk hits 50%, sell final 25%

Now these are somewhat arbitrary exit points, and everyone needs to manage their portfolio risk in whatever way they are most comfortable.

However, I believe that the above plan will maximize the chances of reducing my position in NRZ to an appropriate risk-adjusted size for my goals, and do so long before the next recession strikes (whenever that may be).

Bottom Line: New Residential Is Literally The Best At What It Does, But This Stock Is A High Risk Black Box That Will Likely Work Until It Doesn’t

Don’t get me wrong, when it comes to residential mREITs, literally no one does it better than New Residential Investment Corp. The highly profitable niche that management has proven itself an expert in makes it by far the most appealing choice in this high-risk industry.

But that doesn’t change the fact that NRZ is still a high-risk dividend stock, one that should only make up a small to modest position in a very well diversified high-yield portfolio.

Because, while the current risk of a near-term recession is low, at some point one will invariably strike, and at that time, the last thing you want to do is be overly exposed to a highly risky dividend that may end up getting slashed.

Disclosure: I am/we are long NRZ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Why I Just Sold Half Of My Bitcoin

I am a believer in the long-term value of blockchain technology. I also think that cryptocurrency is here to stay, though the value of it will continue to fluctuate. I do not think Bitcoin (OTCQX:GBTC) is comparable with tulip mania. I strongly suspect that the current banking system will be circumvented at an increasing rate in the future, thanks to cryptocurrency and the innovations being created thanks to it. But I just sold half of my investment in Bitcoin. In this article I will explain why.

Some background about myself

I have been an owner of a very small amount of Bitcoin since 2013. I bought them on a whim, after a sudden drop in price. In one of my previous articles about Bitcoin, I have stated that I was never comfortable with the volatility of cryptocurrencies. In my investing experience, I tend to focus on stable, dividend-growing companies. Bitcoin was truly an investment which was outside of my regular investing spectrum.

Still, I was committed for the long term. I wanted to hold Bitcoin because I thought (and still think) there is much future value in cryptocurrency. So let me explain why I recently changed my mind.

Reason #1: The forks are like stock splits of the 90s all over again

Crypto forks are a lot like stock splits. Instead of one share splitting in 2 or more of exactly the same shares, a cryptocurrency splits in 2 separate types of entities. Logically, the value of the pre-fork currency should be the same as the value of the two post-fork currencies. But recently, forks are said to be boosting the price of Bitcoin; some people even call the forks a type of dividend. This is ridiculous.

During the fully-fledged stock market bubble in the 90s, companies were often not hesitant in using stock splits. During this bubble, many people were stock picking, and companies viewed stock splits as a way to keep shares affordable for small investors. Though they did not change underlying value, these stock splits often generated excitement and a short-term price surge for the companies involved.

Cryptocurrency forks have a drawback which stock splits do not have: they complicate everything. One year ago, a Bitcoin investor would just own their Bitcoin. If he continued to hold this Bitcoin, he currently would also have Bitcoin Cash and Bitcoin Gold, not to mention all the potential forks which could happen in the future. Not all of these forked-off cryptocurrency is supported by the same wallets, and though they all have a quoted value on exchanges, it is sometimes not easy to trade them.

Reason #2: Bitcoin is technologically inferior compared to other cryptos

I always argued that Bitcoin is so popular compared to other cryptos because it is still profiting from its first mover advantage on the cryptocurrency market. This could be valid at the moment, and it might also still be the case in a few years. Maybe even in a few decades if Bitcoin can consolidate its position as the gold standard of crypto. I am far from sure about this, though. Many other cryptocurrencies are much better in a technological sense, and it would need many Bitcoin forks or innovations to make up for that difference. One of the most glaring problems of Bitcoin is that its mining process unnecessarily consumes an extreme amount of electricity.

A brief overview of some cryptocurrencies which are better than Bitcoin in their niches:

– Litecoin is basically a more efficient version of Bitcoin with regard to financial transactions
– Ethereum is suitable for smart contract or distributed applications
– Zcash is more secure than Bitcoin
– Ripple is a quick and efficient way of payment, which does not need mining and consumes little computing power
– Monero is a secure, private and untraceable way of transferring money

Bitcoin only has their first mover advantage to compete with these and many other cryptocurrencies. Though Bitcoin becoming the gold standard of cryptocurrency looks like an attractive future for it, I am getting more and more doubtful that this will be enough to thrive in the future. I simply feel I have too much trouble picking winners in the cryptocurrency world.

Reason #3: The late majority starts becoming enthusiastic

This is not a very straightforward argument, albeit my most important one and the reason which finally tipped the balance and made me sell half of my Bitcoin. It also seems counterintuitive: if a part of the population becomes enthusiastic, this would rather be reason for optimism, right?

Let me first explain what I mean with late majority. The adoption of almost every technology happens in phases, which are characterized by specific types of people which start using a technology. After the birth of a specific technology, people who start using it quickly are called innovators. They have a higher risk tolerance than other parts of the population and are not afraid to try new things. After the innovators, the early adopters start using a technology. Early adopters generally have a high degree of opinion leadership, which means that their opinion is held in high esteem by other parts of the population. Though they are more discrete with their adoption choices than innovators, they generally have a larger influence on the general population. The early majority and late majority are by far the biggest part of the population. These people generally start adopting a new technology if it has proven their worth to people before them, and are less likely to try new things straight away. A difference between the early and the late majority is that the latter is usually more skeptic about an innovation. Last to adopt are the laggards, which are usually characterized by a big aversion to change and focus on traditions. They are least likely to adopt a new innovation quickly.

In the graph below, you can see a depiction of the market share and the proportions of the population with regard to technological adoption.

laggards

Source: Rogers: Diffusion of innovations

When applying this theory to Bitcoin, we should adopt it a bit: I do not think that Bitcoin ever will achieve a 100% adoption rate among the population; but instead, a 100% adoption rate means everyone who is willing to adopt it did it. I would use a notion of awareness here: only a part of the population will start using Bitcoin or cryptocurrency, so I will consider ‘adoption’ to be an active decision to use it or not.

Innovators in the Bitcoin adoption process are for instance the early miners and developers which have invested in it from the beginning. Early adopters are people who started investing in it shortly after the innovators. I believe the early majority started to get interested in Bitcoin during the last year. Public knowledge and media coverage of Bitcoin reached a much higher gear since then: the late majority might be joining in right now.

But this is good news, right? Well, history often proves otherwise. Many a stock market crash was preceded by relatively inexperienced investors joining in. Though tulip mania is in many ways not comparable at all with Bitcoin, here the market crash also happened after regular folks started getting involved in the tulip trade. Therefore, I usually get nervous when I see all sheep are moving in the same direction.

There are definitely signs that we are reaching the late majority at this moment:
– I don’t know about you, but in my surroundings more and more people are starting to talk about Bitcoin or cryptocurrency. These include people who admit themselves that they know very little about it. I always get suspicious when these things happen: these are not the early adopters, this might be the late majority joining in.
– Big media start focusing ever more attention on Bitcoin: The Big Bang Theory will air an episode named ‘The Bitcoin Entanglement’ in which Bitcoin will play a major role. It will air on the 30th of November. Also, a family from my home country The Netherlands which sold all their possessions and invested all their money in Bitcoin has been getting quite some attention in the media lately.
– The hype cycle of innovation also shows that we are likely at or around the peak of inflated expectations with regard to cryptocurrency.

Reason #4: I am happy with my returns

Wait, let me rephrase this: I am extremely happy with my returns. This has been an extraordinary journey, one which has resulted in a profit of more than 1200% over the course of 4 years, or 90% annually. I’m fully aware that I will likely never achieve such returns again. I started out with Bitcoin being a very insignificant part of my investments, which eventually grew to a part which was too large to be insignificant. Let me just say that as a buy and hold investor, if your crypto holdings grow to be larger than your largest stock position, it is probably wise to re-balance. I am happy with my returns and sold half of it.

I am not renouncing ever adding to my Bitcoin position or any other cryptocurrency altogether. If there is going to be a big correction, I will be ready to step in again. I am fully aware that this big correction could never happen and I might slap myself in my face in a couple of years for selling now. So be it. I will still profit from the other half which I have left.

I’m not calling the top of the Bitcoin price. I am neither saying it is certainly a bubble, though it might very well be. Still I sold half, and I am considering to sell the rest of my Bitcoin holdings as well if I get more signs that the late majority of the people have joined the party. But it would be a goodbye, not a farewell.

Thank you for reading, please tell me what you think about my reasons for selling Bitcoin below! If you have any opinion about the other half of my holdings, please let me know as well. If you liked this article please click the “Follow” button next to my name.

Disclosure: I am/we are long BITCOIN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Black Friday, Thanksgiving online sales climb to record high

CHICAGO (Reuters) – Black Friday and Thanksgiving online sales in the United States surged to record highs as shoppers bagged deep discounts and bought more on their mobile devices, heralding a promising start to the key holiday season, according to retail analytics firms.

Customers push their shopping carts after making a purchase at Target in Chicago, Illinois. REUTERS/Kamil Krzaczynski

U.S. retailers raked in a record $7.9 billion in online sales on Black Friday and Thanksgiving, up 17.9 percent from a year ago, according to Adobe Analytics, which measures transactions at the largest 100 U.S. web retailers, on Saturday.

Adobe said Cyber Monday is expected to drive $6.6 billion in internet sales, which would make it the largest U.S. online shopping day in history.

In the run-up to the holiday weekend, traditional retailers invested heavily in improving their websites and bulking up delivery options, preempting a decline in visits to brick-and-mortar stores. Several chains tightened store inventories as well, to ward off any post-holiday liquidation that would weigh on profits.

TVs, laptops, toys and gaming consoles – particularly the PlayStation 4 – were among the most heavily discounted and the biggest sellers, according to retail analysts and consultants.

Commerce marketing firm Criteo said 40 percent of Black Friday online purchases were made on mobile phones, up from 29 percent last year.

No brick-and-mortar sales data for Thanksgiving or Black Friday was immediately available, but Reuters reporters and industry analysts noted anecdotal signs of muted activity – fewer cars in mall parking lots, shoppers leaving stores without purchases in hand.

People shop for items in Macy’s Herald Square in Manhattan, New York. REUTERS/Andrew Kelly

Stores offered heavy discounts, creative gimmicks and free gifts to draw bargain hunters out of their homes, but some shoppers said they were just browsing the merchandise, reserving their cash for internet purchases. There was little evidence of the delirious shopper frenzy customary of Black Fridays from past years.

However, retail research firm ShopperTrak said store traffic fell less than 1 percent on Black Friday, bucking industry predictions of a sharper decline.

A cashier handles money in Macy’s Herald Square in Manhattan, New York. REUTERS/Andrew Kelly

“There has been a significant amount of debate surrounding the shifting importance of brick-and-mortar retail,” Brian Field, ShopperTrak’s senior director of advisory services, said.

“The fact that shopper visits remained intact on Black Friday illustrates that physical retail is still highly relevant and when done right, it is profitable.”

The National Retail Federation (NRF), which had predicted strong holiday sales helped by rising consumer confidence, said on Friday that fair weather across much of the nation had also helped draw shoppers into stores.

The NRF, whose overall industry sales data is closely watched each year, is scheduled to release Thanksgiving, Black Friday and Cyber Monday sales numbers on Tuesday.

U.S. consumer confidence has been strengthening over this past year, due to a labor market that is churning out jobs, rising home prices and stock markets that are hovering at record highs.

Reporting by Richa NaiduEditing by Marguerita Choy

Our Standards:The Thomson Reuters Trust Principles.

U.S. prosecutors' letter spurred orders in self-driving car lawsuit

SAN FRANCISCO (Reuters) – The judge overseeing a lawsuit between Uber Technologies Inc [UBER.UL] and Alphabet Inc’s (GOOGL.O) Waymo self-driving car unit issued a series of orders this week, prompted by information shared with him by the U.S. Department of Justice.

FILE PHOTO: The Uber logo is seen on a screen in Singapore August 4, 2017. REUTERS/Thomas White/File Picture

U.S. District Judge William Alsup in San Francisco disclosed on Wednesday that he had received a letter from Justice Department attorneys about the case, which is set for trial in December. The judge did not reveal the letter’s contents.

However, Alsup issued two subsequent orders, including one on Saturday, that discussed some details. He ordered Uber to make three witnesses, including a former Uber security analyst and a company attorney, available to testify on Tuesday at a final pretrial hearing. Trial is scheduled to begin on Dec. 4.

It is unusual for the Justice Department to share information with a judge days before a civil case is set to begin.

Earlier this year Alsup, who is hearing the civil action brought by Waymo, asked federal prosecutors to investigate whether criminal theft of trade secrets had occurred. That probe is being handled by the intellectual property unit of the Northern California U.S. Attorney’s office, sources familiar with the situation said. No charges have been filed.

Representatives for Waymo, Uber and the Justice Department declined to comment. The former Uber security analyst could not be reached for comment.

FILE PHOTO: The Waymo logo is displayed during the North American International Auto Show in Detroit, Michigan, U.S., January 8, 2017. REUTERS/Brendan McDermid/File Picture

Waymo sued Uber in February, claiming that former Waymo executive Anthony Levandowski downloaded more than 14,000 confidential files before leaving to set up a self-driving truck company, called Otto, which Uber acquired soon after.

Uber denied using any of Waymo’s trade secrets. Levandowski has declined to answer questions about the allegations, citing constitutional protections against self-incrimination.

Since the case began, Uber said its personnel have spent thousands of hours scouring its servers and other communications devices but have not found Waymo trade secrets.

In an order on Friday, Alsup referred to a former Uber security analyst in connection with the letter from the U.S. Attorney’s office and to certain “devices” the former employee said were maintained by Uber.

Alsup asked Uber to disclose whether it had searched those devices for relevant evidence in the case.

Reuters is part of a media coalition seeking to maintain public access to the trial.

Reporting by Dan Levine; Editing by Sue Horton and Marguerita Choy

Our Standards:The Thomson Reuters Trust Principles.

O Tidings Of Comfort And Joy For Realty Income Investors

Last week I noticed a Realty Income (NYSE:O) press release announcing that they were redeeming $550 million of 6.75% notes that were not due until August 15, 2019 and that they were going to pay a substantial amount of unearned interest to the note holders:

Realty Income To Redeem All Outstanding 6.75% Notes Due 2019

Nov 15, 2017

SAN DIEGO, Nov. 15, 2017 /PRNewswire/ — Realty Income Corporation (Realty Income, NYSE: O), The Monthly Dividend Company®, today announced that it intends to redeem all $550 million in principal amount of its outstanding 6.75% notes due August 15, 2019 (CUSIP No. 756109AK0) (the “Notes”). The redemption date for the Notes will be December 15, 2017 (the “Redemption Date”).

The estimated redemption price for the Notes will be $1,101.62 per $1,000 principal amount of the Notes, representing 100% of the principal amount of the Notes being redeemed, accrued and unpaid interest thereon to the Redemption Date and a “make-whole” amount calculated in accordance with the indenture governing the Notes. [More…]

I wondered why Realty Income would redeem these notes at this time and pay a significant amount of interest not due until 2019? One thought I had was that it would make sense if they were doing it as part of a strategy to earn a credit rating upgrade.

Well on November 21, 2017, Moody’s upgraded Realty Income:

Moodys

Rating Action: Moody’s upgrades Realty Income to A3; stable outlook

Global Credit Research – 21 Nov 2017

New York, November 21, 2017 — Moody’s Investors Service (“Moody’s”) upgraded the senior unsecured rating of Realty Income Corporation [NYSE: O] to A3 from Baa1. The outlook is stable.

The upgrade to A3 reflects the REIT’s long track record in maintaining conservative balance sheet metrics, exceptionally strong ability to obtain long-term financing at low costs, and a geographically diverse net-lease retail portfolio with steady operating performance throughout real estate cycles. The A3 rating also recognizes the depth and experience of Realty Income’s management team. [more…]

This is very good holiday news for investors in Realty Income. The new higher investment grade rating will enable the company to lower its cost of capital, which will increase profit margins and support increased distributions to shareholders going forward.

About The Company

Realty Income was “Founded in 1969 to provide investors with monthly dividends that increase over time.”

The company acquires commercial real estate leased to selected high quality tenants on long-term lease agreements, typically 10–20 years, with built in rent escalation terms. The leases are structured so that the tenant is responsible for the operating expense for the property (taxes, insurance, and maintenance), an arrangement called Triple-net. The lease payments received each month are used to support predictable monthly dividend payments to our investors.

The stock was listed on the New York Stock Exchange for public trading in 1994 with the trading symbol “O.” The company is a member of the S&P 500 index and the S&P High Yield Dividend Aristocrats index. As of November 22, 2017, the company’s stock closed at $58.56 and the yield is 4.5% paid monthly. The company headquarters is located in San Diego, California.

Portfolio

Realty Income seeks tenants with proven success operating businesses that provide non-discretionary goods and services at low price points. The company now owns over 5000 free standing commercial properties in prime locations with good visibility, evenly distributed among 49 states roughly in proportion to population, and leased to tenants engaged in Retail 79.9%, Industrial 12.8%, Office 5.1%, and Agriculture 2.2%.

The average remaining lease term is about ten years with staggered lease expirations. Current occupancy is 98.3%; the lowest occupancy the company experienced was 96.6% during 2010.

Most tenants operate commercial retail businesses that provide non-discretionary goods and services at low price points. 46% of revenue comes from tenants with investment grade credit ratings.

Top 20 Tenants

Company management is well aware of the risks posed to the retailer by expanding e-commerce development and has responded by seeking tenants with limited risk. 20% of total portfolio rent revenue now comes from tenants with no exposure to e-commerce risk. 77% of rent comes from retail tenants with at least one of four risk-controlling characteristics: service industry, non-discretionary product, low price point, or an investment grade rating.

eCommerce Defense Strategies
Performance

The company has been an extremely reliable investment since going public in 1994, outperforming almost every alternative public investment opportunity.

Realty Income Historical Performance versus IndicesThe portfolio of high-quality tenants with long-term leases with built-in rent escalators allowed the company to raise its dividend every year right through the great recession. What a great place to have your retirement savings during times of economic uncertainty and stress.

Uninterrupted Annual Dividend ncreases 1994 - 2017Quality Of Management

When I review the list of the top 20 tenants above, I see a few businesses that give me a little concern. I think Walgreens (NASDAQ:WBA) may be challenged as more prescriptions are filled remotely and delivered to the customer through the mail, which may reduce traffic in the stores. I am not 100% confident about the viability of the cinema business as it now exists. But if I see these risk factors, I have 100% confidence that Realty Income management have already considered them and have a plan to monitor and manage these risks just as effectively as they have managed tenant risks over the past 48 years.

Valuation

I am not a trader or a market timer. I only recommend investors consider this company as a long-term investment.

Realty Income stock closed at $56.35 on November 22, 2017. Based on the most recent monthly dividend of $0.212, the annualized yield is 4.52%. The price earnings ratio is 48.20 and the price/FFO ratio is 18.3 based on the third quarter FFO per share annualized. Realty Income is not cheap at this price but it is selling below its highest historical valuation.

I expect that as news of the credit upgrade is considered by the investment community, it will have a significantly positive impact on the value of Realty Income stock.

Happy Holidays!

Disclosure: I am/we are long O.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

GE Investor Update Review

This is a follow-up to my October 24 article about General Electric (GE). My basic decision stated in that article was that I like the initial comments and actions by new CEO John Flannery, and I’m not inclined to close the GE position. However, I would view GE as CAFD (cash available for deployment) if an unusual opportunity came along and I didn’t want to use existing cash for the purchase.

I decided to take no action until the November 13 GE Investor Update. I’ll provide more details about my portfolio action at the end of the article.

Key takeaways

GE’s November 13 Investor Update packed an abundance of information in the 2-hour, 50-minute presentation (including the question-and-answer segment). Here are my key takeaways, with elaboration to follow later in the article:

  • Flannery is in charge. He has charted a new direction for the company, has built his own leadership team, and is re-shaping the Board.
  • Miller is making a significant contribution. New chief financial officer, Jamie Miller, will be a key part of GE’s turnaround story.
  • Joyce leads “GE at its best.” Vice Chairman David Joyce since 2008 has been the CEO of GE Aviation, the company’s most profitable division.
  • Stokes is the one to watch. Russell Stokes, the CEO of GE Power, has the tough job of turning around GE’s largest and most challenged division.
  • “Complexity hurts us.” Flannery is designing a simpler and more focused GE, putting priority on units with cash flows that grow the bottom line.
  • Collaborative, competitive rigor. Flannery expects pushback and thrives in fluid situations where options are open-ended and vigorously debated.
  • Growing cash flow, operating earnings, and dividends. 2018 will be the base from which growth will be measured. Flannery expects growth.

John Flannery’s stock purchases

CEO John L. Flannery maintains that GE is a good holding for someone with at least a 3-5 year time horizon. Translation: “This won’t be a quick turnaround.”

On November 15, Flannery purchased 60,000 GE shares at $18.27, or $1.096 million.

In August, shortly after becoming CEO, Flannery bought 104,000 shares at $25.56 per share, or $2.7 million worth of GE shares, bringing his total at that time to 615,000 shares, worth (at that time) $15.6 million. He also owns 101,000 restricted stock units and options to purchase 2.6 million shares at a $11.95-38.75 price range (SA Aug. 10).

So, since becoming CEO, Flannery has purchased 164,000 GE shares at an average cost of $23.15 for an investment of $3,796,000. GE shares closed at $18.21 on November 17, so the 164,000 shares recently purchased are now worth $2,986,440. Flannery has a paper loss of $809,560, or 21.3% on those two purchases.

This brings his total stake (not counting restricted stock units and options) to 675,000 shares, worth $12,291,750 as of November 17.

Quotations below are from the November 13 Investor Update held in Atlanta, Georgia. You can access a replay of the webcast at the GE website, and you can also access an edited version of the transcript from the GE website.

Basic direction

I like the basic direction charted by Flannery. At the beginning of the Investor Update, Flannery affirmed GE’s long history of innovation in “light, flight and health,” which are “the absolute underpinnings of the modern world.” Flannery is a 30-year veteran of GE and he affirms the company’s long history and the culture that he believes made GE a great “iconic” company:

“…the 125-year history of the company… . is just an incessant stream of technology breakthroughs going back to the first light bulb, the first X-ray, the first jet engine, the first CT, the LEAP, the H turbine.”

“…I’ve been in the company for 30 years … I love the company and I’ve always loved the culture. … It’s always been a culture of meritocracy… compliance and integrity.”

(Logo graphic from underconsideration.com)

While affirming GE’s heritage, Flannery is forthright about GE’s problems and the need for new direction:

“So it’s a heavy lift. But I think for our teams, what we’re motivated by, this is the opportunity, really, of a lifetime to reinvent an iconic company.”

Flannery concluded his prepared remarks at the Investor Update with this statement to his GE colleagues:

“…to the GE team, my colleagues at GE team. This is our time. This is our time to reinvent the company. This is our time to show our passion and our fury, and our resolve and our grit. This is an incredible opportunity for all of us. It’s game on. And I just want to say I couldn’t be more secure or more confident in fighting this fight with all of you.”

The following excerpt provides an excellent summary of the pivot that Flannery is leading. It expresses the cultural shift he is driving:

“There are things, though, that I think we can sharpen in the culture, with things that are going to change the performance of the businesses, the performance of the team, and that’s really what I’m focused on when I’m talking culture. … Accountability, outcomes matter. Effort’s good, outcomes matter. Transparency, more candor, more debate, more pushback. Rigor, intense analytics, use data, probe, verify, revisit. And then lastly, consistency, making sure that we have compensation schemes, goals and metrics that drive us to perform on a consistent basis over an extended period of time for investors. So I have spent a ton of time on the culture with our officers, with the rest of the company. And I don’t think there’s any confusion inside the company about what I expect here in terms of behaviors and motivations.”

“So that’s it… strong franchises; 2018, a reset year; capital allocation, critical; portfolio simplification, critical. We know what we need to do, and it’s show-me time. We have to perform and execute, and that’s what we owe all of you.”

An insider’s outsider

Former CEO was widely disparaged, and some GE shareholders hoped for a clear break with the Immelt years. As CEO of GE Healthcare, John Flannery was viewed by some as an “accomplice” who bears some responsibility for GE’s recent past.

Although Flannery has been at GE for three decades, he is not a “me, too” person. He thinks for himself and he has moved thoughtfully yet quickly to implement strategic change. I consider him an “insider’s outsider.” He has demonstrated the ability to view familiar territory objectively and analytically. He knows how to “orbit the giant hairball” without becoming entangled in it. He is an insider who is leading from the outside.

GE announced Flannery’s appointment as CEO on June 12, 2017, effective August 1. The four presenters at the November 13 Investor Update represent the heart of Flannery’s new team. Like Flannery, the team combines years of experience at GE with fresh perspectives:

“I’m just a believer that there’s a lot of power and benefit in melding fresh eyes with people that have institutional memory. And this is something that worked extremely well for me in Healthcare, and we’re going to do the same thing again here with the company.”

Flannery, GE’s new CEO, previously was CEO of GE Healthcare. Jamie Miller, the new CFO, previously was CEO of GE Transportation. Russell Stokes, the new CEO of GE’s most challenged division, GE Power, was previously CEO of GE Energy and he is tasked with merging GE Energy with GE Power. The announcement of Stokes’ appointment came two days after the announcement that Flannery would be the new GE CEO. David Joyce, the CEO of GE’s most successful division, GE Aviation, has been in that role since 2008 and he serves as GE’s Vice Chairman. The common thread is that each of these key leaders has had experience running a GE division.

Other key team members

Senior Vice President and Chief Financial Officer Jamie S. Miller was prominent in the Investor Update presentations. She fielded questions along with CEO Flannery. She is new to the CFO position, moving a few weeks ago from her role as President and CEO of GE Transportation.

Miller joined GE in 2008 as VP, Controller and Chief Accounting Officer. She served in that role for two and a half years before leading GE Transportation. She announced two changes in the way GE will report:

“…on earnings per share, we’ll be moving … to an adjusted earnings per share measure. … it starts with continuing operations EPS. … back out gains and restructuring, and … back out non-operating pension expense.”

“…On cash reporting, we’re moving from CFOA (cash from operating activities) to industrial free cash flow … just like our peers… CFOA, less deal taxes, less gross P&E additions and capitalized software.”

Miller said management has identified some $3 billion in cost reductions over the next two years. Corporate headcount will be down 25% as the company moves into 2018. She reiterated management’s view that 2018 will be “a reset and stabilization year for the company. And we see adjusted EPS of $1 to $1.07, with industrial free cash flow at $6 billion to $7 billion.”

Miller said:

“I think the one thing that I’m most excited about benefiting free cash flow is the fact that our incentive comp programs are going to be mostly aligned with free cash flow as a primary metric.”

GE Aviation’s revenue was $6.816 billion, or 22.7% of the $30.046 billion Industrial Segment revenue in 2017 Q3. GE Aviation’s profit for Q3 was $1.680 billion, or 46.3% of GE Industrial Segment’s profit of $3.630 billion for Q3. Flannery said this division is “GE at its best.” David L. Joyce, Vice Chairman of GE and President and CEO of GE Aviation, made this statement:

“Our projections for op profit growth this year, about 5% to 6% on revenue of 2% to 4%, with a free cash flow conversion which will be a little north of 90%. In 2018, you should expect us to be at about 7% to 10% growth on op profit on the same growth in organic revenue. As John said, our goal is to hold op profit rate as we move forward with this big LEAP ramp as well as the Passport ramp, which is new engine in the business and general aviation space. We have to continue to focus on structural reduction in cost to do that. Our SG&A will be below 6% of sales in 2018.”

GE Power’s revenue was $8.679 billion, or 28.9% of the Industrial Segment revenue in 2017 Q3. GE Power’s profit for Q3 was $0.611 billion, or 16.8% of GE Industrial Segment’s profit for Q3. Russell T. Stokes, Senior VP and since June 2017 President and CEO of GE Power, described some of the challenges facing GE Power:

“… We are going to right-size the business for the realities of the market… Structural cost… could be better. …investments … focused on the right things. … a more holistic view of our service franchise. … Better performance on outages for our customers, better cost execution out in the field. We can broadly execute better. Improving on working capital, higher say/do ratio, … delivering on an objective and very transparent environment… Cash as important as returns, system transparency, so everybody sees what goes on.”

Transparency, tone and temperament

I like the new management’s transparency. There’s been a consistency of content and style in Flannery’s public interviews, the 2017 Q3 earnings call and the Investor Update. I’m convinced his message is the same to the public and to individuals inside and outside the company.

It’s not uncommon for a CEO to be guarded in his or her public assessment of a company’s situation. However, Flannery has demonstrated a refreshing openness about GE’s weaknesses as well as strengths. He is comfortable being the leader of a public company, and he is clearly willing to be evaluated by the marketplace and by his colleagues:

“I expect rigorous debate. I expect rigorous tracking of how things are going. I expect a lot of pushback.”

Flannery was asked in the Q&A session:

“…as CEO, what would you like to see your biggest impact and the biggest change be…?”

He responded:

“I want the team to move forward. I want the team to have confidence. I want the team to be focused… execute with rigor, maximize the value of everything else. And those things will take care of themselves and write their own legacy. I really do not need to be motivated by that.”

I like the new management’s tone. Some CEOs might be tempted to gloss over problems or (on the other extreme) throw the previous CEO under the bus. Flannery has struck a different tone. He has expressed respect for his former boss/CEO, Jeff Immelt. The only mention of Immelt in the Investor Update expresses both an appreciation for Immelt’s focus on digital and Flannery’s new direction:

“Digital continues to be very key to the company. Jeff was very early in his seeing this trend, and I’d say we’ve only had growing validation of what we’re seeing and able to achieve with customers. … We’re still deeply committed to it, but we want a much more focused strategy.”

This respectful tone is extended to Flannery’s colleagues on his leadership team. As one who ran GE’s Healthcare division, he understands the importance of the CEOs and teams of the various segments:

“… businesses run their operations. My job, our job at the center of the company, really is to allocate the financial resources, the financial capital of the company and the human resources, the human capital of the company to the highest and best use.”

Flannery seems to be establishing a tone of collegiality and teamwork while blending GE veterans with fresh blood and setting high expectations:

“…About 40% of the team is new since June. I love the team. … I especially love the team dynamic. This is a team that’s comfortable with debate back and forth. It’s a team that’s competitive as hell, a team that’s fun. And I feel very confident working with this team…”

The tone set by Flannery has the sound of a cash register. He has established a clear focus on cash growth as the measure of success. The management team appears to be united around the effort to grow GE’s cash flow:

“To me, purpose of the business at the end of the day is to generate cash for investment and return to investors.”

“…we’re going to focus on improving the cash flow of the company. … the … free cash flow in 2018 (will be) double what it is in 2017.”

“So growth in cash to me (is) the ultimate litmus test. … the cash is what people consume. The cash is what lets you invest. The cash is what lets you do all the capital allocation things you want to do. … if we’re growing and generating a lot of cash, people are going to like what they see.”

Flannery’s shift in the metrics he and the team will pursue is another illustration of “turning the page” from the Immelt era, and it’s a cultural shift:

“…there was a premium in that universe on top line growth, on operating profit. Nothing wrong, obviously, with either one of those metrics, but we really needed to close the loop more with a focus on cash, cash flow, free cash flow. So … you can see just a growing delta between what our operating earnings were, our operating profit earnings were and our cash earnings. So as we go forward, we’re going to focus on much simpler metrics … a handful, things like revenue and operating profit, free cash flow. Free cash flow is a much more penetrating metric. It incorporates, obviously, capital spending, software spending, et cetera. So cash is going to be a huge focus, and simplification of metrics is going to be a huge focus as we go forward.”

Flannery’s comments about GE’s dividend made it clear that dividend growth is a function of growing cash flow:

“…we are intensely focused…on the cash generation of the company, discipline in the company, taking cost out of the company, restoring the oxygen of cash and earnings to the company. And that’s openly what we’ll be able to use to grow and expand the dividend…”

“…we’re comfortable with the dividend relative to the cash flow of the company… The cash flow of the company will grow … in 2018. Businesses that we focus on will continue to grow cash flow…”

Flannery is taking a new approach to compensation for 190 company officers, focused less on cash and more on equity compensation:

“Much more equity is the biggest point. Today, for its senior executives… equity would be probably about 20% of their compensation. It’s going to be 50%… My compensation, 100% equity compensation, PSUs, equity granted over 3-year time period, simple set of metrics. …an environment … much more aligned and rewarding of our team for and with shareholders.”

The Investor Update slide presentation included an explanation of the new compensation structure for management:

I like the new management team’s temperament. It starts with CEO Flannery. A strong leader is unflappable and does not become defensive when criticized. Here’s a question posed to Flannery during the Investor Update:

“…What … duration … should (we) give you? And what metrics we should be looking at to decide whether this current construct is a success versus something … like a larger breakup?”

Flannery’s response made it clear that he isn’t playing to an audience. He is focused on the performance of the business and on strategic outcomes:

“Listen, that’s for the market to decide. I think we’ve laid out very clearly where we’re going… where we compete, where we have competitive advantage, where we generate cash. I recognize fully it’s show-me time. … And until we produce the results, not going to matter. … we’re focused on what we can control, where we’re allocating the capital, how we’re running the company, how we’re driving the teams. You guys will decide what you like and don’t like.”

Flannery’s style seems to follow Good to Great author Jim Collins’ description of “Level 5” leadership:

“The essential ingredient for taking a company to greatness is having a ‘Level 5’ leader, an executive in whom extreme personal humility blends paradoxically with intense professional will.”

One of the slides from the November 13 Investor Update slide presentation summarizes Flannery’s approach to driving GE’s cultural change:

Holding GE

I plan to continue to hold shares of GE. I’m more impressed with CEO John Flannery after the Investor Update. He has articulated a clear set of values and priorities. He seems to thrive on fluidity and the challenge of a changing landscape.

He announced a plan to raise $20 billion in divestitures. Some people might have expected that he would produce a list of assets to be sold, with an approximate price tag on each. But Flannery is approaching this $20 billion target in a pragmatic and (I believe) appropriate way. The company is continuing to manage and grow each of the segments to maximize profitability as it explores options for how to maximize shareholder value.

As for Baker Hughes (NYSE:BHGE), Flannery said:

“We own 62.5% of this company. We want to maximize the value of that for the shareholders of our company… how we deliver synergies… how we share technology. And part of that might be, is there a different form or structure for the ownership of that asset.”

As for the troubled GE Power unit:

“…our Power business is a challenged business right now. We’ve got a lot of work to do. … It’s a heavy lift to turn around, but it’s a fundamental asset, strong franchise in an essential infrastructure business. We can improve that a lot in the next 1 to 2 years.”

When asked directly why he’s putting GE Transportation on the block:

“… you’ve been in the business 100 years … You make big machines, lots of sensors, lots of digital content, customer service agreements. So it just seems like it fits. So why put it on the block?”

Flannery replied:

“…we’ve talked about is focus and … we’ve talked … which businesses are exposed to cycles. … we foresee a protracted slowdown in the North American market … around coal shipments and other things. So it is an excellent asset. We have a very strong franchise. We have incredible customer relations. But we think it’s going to be an extended slow period in North America, and the international business can pick up some of that, point one. Point two is … we’re exploring the options that we have with these assets. So that may be a sale, it may be a spin … And then the last thing I would say is focus means focus. … Transportation is a great asset (but it’s only) 3%, 4%, 5% of the company. And so we’re concentrating deliberately on the areas where we think we can make the most impact for the owners, and then we’ll maximize the value of the other assets.”

This is a good example of how Flannery charts a course (i.e., “we intend to sell GE Transportation”), but the “when” and “how” of that decision will depend on how well the division executes and how macro market forces unfold.

Conclusion

I have a brokerage account and an IRA. I’ve had some holdings in both accounts. For simplicity, I’m eliminating duplications. I was holding 80% of my GE shares in the IRA and 20% in the brokerage account. I decided to sell the GE shares in the brokerage account (where I’ll realize a tax loss by selling at $18.27). I applied the proceeds toward the purchase of some shares of Magellan Midstream Partners (MMP) at $65.00. It makes more sense to hold MMP in the brokerage account.

The sale of 20% of my GE shares reduced the allocation from 1.96% of the portfolio to 1.61%. I feel better with this somewhat lower allocation for GE. I agree with John Flannery that this is “show me” time. If I continue to view GE’s new management favorably and if the turnaround materializes, I would be willing to add more GE shares. One factor I’m watching is whether Standard & Poor’s maintains its AA- credit rating on GE. S&P has placed GE on negative watch for a possible downgrade.

I expect GE shares to trade in a range of roughly $15.00 to $20.00 over the next 12-14 months. The stock’s price dropped to $5.87 on March 4, 2009, in the depth of the Great Recession’s bear market. The 2010 price range was $13.75 to $19.69. I could see the price of GE stock approximating the 2010 range in 2018. During 2010, GE paid $.46 per share in dividends, which approximates the current $.48. I think GE will hold at the $15 level, although a severe market downturn could knock GE shares down to the 2010 lows.

We’ll have a clearer picture after the 2018 results are reported about 14 months from now.

My target price to consider adding more GE shares is $16.67, which would equal a dividend yield of 2.88%. I might lower the target if S&P lowers GE’s credit rating.

My goal is to write at least one article a week, usually about a company in my retirement portfolio. I’ve been writing recently about REITs in the portfolio. That will continue for the next few weeks, but I wanted to provide this update about GE. I always learn from our Seeking Alpha conversations. I welcome your opinion because your responses enrich our discussion. What’s your take on GE’s new management and the company’s prospects?

You can access a list of previous articles here.

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It’s not my intent to advocate the purchase or sale of any security. I offer articles to provide ideas for stocks to study and to share a journal of my effort to design and build a retirement portfolio that puts a priority on relative safety, a history of dividend growth and solid future prospects. Your goals and risk tolerance may differ, so please do your own due diligence.

Disclosure: I am/we are long GE, JNJ, PG, MMM, WMT, MSFT, MRK, PFE, XOM, AAPL, CSCO, TD, SPG, ADP, RY, BCE, O, VTR, DUK, KMB, PPL, SKT, PEP, NNN, WPC, GPC, EPD, MMP, BEP, BIP, TGT, SO, IBM, TXN, VFC, QCOM, KO, HRL, UL, PEGI, MRCC, HASI, APLE, BIF, VTI, VEA, VWO, VYM, VOE, VNQ, VPU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Uber’s Cover-Up of Its Massive Data Breach May Lead to E.U. Investigations

(BRUSSELS) – European Union privacy regulators will discuss ride-hailing app Uber‘s massive data breach cover-up next week and could create a task-force to coordinate investigations.

Uber faces regulatory scrutiny after CEO Dara Khosrowshahi said the company covered up a data breach last year that exposed personal data from around 57 million accounts.

The chair of the group of European data protection authorities – known as the Article 29 Working Party – said on Thursday the data breach would be discussed at its meeting on Nov. 28 and 29.

While EU data protection authorities cannot impose joint sanctions, they can set up task-forces to coordinate national investigations.

When a new EU data protection law comes into force next May, regulators will have the power to impose much higher fines – up to 4 percent of global turnover – and coordinate more closely.

Uber paid hackers $100,000 to keep secret the massive breach.

The stolen information included names, email addresses and mobile phone numbers of Uber users around the world, and the names and license numbers of 600,000 U.S. drivers, Khosrowshahi said. Uber declined to say what other countries may be affected.

For more on the Uber data breach, see Fortune’s video:

“We cannot but voice our strong concern for the breach suffered by Uber, which was reported belatedly by the U.S. company. We initiated our inquiries and are gathering all the information that can help us assess the scope of the data breach and take the appropriate steps to protect any Italian citizens involved,” said Antonello Soro, President of the Italian Data Protection Authority on Wednesday.

The British data protection authority also said the concealment of the breach raised “huge concerns” about Uber‘s data policies and ethics.

Long known for its combative stance with local taxi regulators, Uber has faced a stream of top-level executive departures over issues from sexual harassment to data privacy to driver working conditions, which led its board to remove Travis Kalanick as CEO in June.