Archives for March 2018

Micron: How The War Is Won

We’re another quarter deeper into the cash flow generation era of Micron (MU) and the memory train is full steam ahead. The just reported quarter saw records in revenue, gross profit, earnings and cash flow. So what’s not to like?

Not much to be honest.

With a trailing 12-month cash flow of $6.7B and annualized future cash flows of over $8B, it appears Micron is in a position to be the strongest it ever has at the end of this fiscal year. The question is will the memory market cooperate and usher Micron into balance sheet glory? Thankfully, Micron is somewhat lengthy on its narrative of the industry environment as well as its own memory expectations.

(Source: durangoherald.com)

Coal In The Micron Locomotive

The industry-wide narrative includes a more firm 20% DRAM bit output for the calendar year. CEO Sanjay Mehrotra says demand remains strong due to “secular technology” drivers. NAND output is seen closer to 45% rather than 50% – as of last quarter – and this may calm fears of a drastic oversupply of NAND in 2018. Micron expects this bit output to bring the NAND market into balance – contrary to some analysts predicting an oversupply scenario.

Company-specific narrative revolves around capital expenditures, as it begins to pay dividends in terms of market share gains and technology node transitions. The company updated its bit output guidance for DRAM to go from below industry bit output to inline with industry bit output for the year – more on this shortly. Additionally, the company’s SSD (solid state drive) segment was up 80% overall year-over-year with “sales of cloud and enterprise drives more than tripling for that same period.” Mehrotra appears to be correct in his previous assertions of NAND being highly elastic – as pricing softens, demands increases and drives the feedback loop onward.

Lost The Battle, But Winning The War

I couldn’t think of a good way to keep the train analogy chugging along for this section because there’s not a better way to describe the situation Micron has presented for this quarter and for the rest of the year.

I’m of course referring to the news Micron had a nitrogen supply disruption last week at one of its fabs in Taiwan. Management expects a return to full production by this week. The company expects an impact to DRAM output of 2-3% for the quarter due to this.

My subscribers knew I had an expectation for $3.00 in EPS for Q3’s guidance so when I saw $2.83 +/- $0.07 I knew something was amiss. I decided to do some math on this nitrogen supply impact to gather what guidance would have been had the fab been running at full capacity.

Using the insight from Mehrotra for a 2-3% DRAM output disruption and CFO David Zinsner’s expectation of a 2% overall revenue impact, I have a starting point to work back from. At a guidance midpoint of $7.4B we can calculate the DRAM revenue using a conservative 70% – as this past quarter it accounted for 71% of revenues. This gives us a breakdown of $5.18B in revenue. If we reverse engineer the math, DRAM should have been $5.29B-$5.34B without this nitrogen disruption. At 66% gross margins and 84% operating margins the math works out where operating income is negatively affected by $61-$89M. Drilling down with a non-GAAP net margin we get a net income of $58.7M-$85.4M or $0.06-$0.07 in EPS. This would bring guidance to a midpoint of ~$2.89-2.90 – meaning a high end guidance of $2.97.

This is a closer expectation to my original estimate and while still just a little soft from my aggressive expectations, was still leaps and bounds above analysts’ expectations for sequential negative growth.

Now while a small battle lost for the quarter, the war is being won on the R&D and technology ramp front. Here I’m referring to the positive news of the company exceeding its own expectations for its 1X nm DRAM node ramp. Due to this transition to 1X faster than prior nodes, Micron has gone from expecting to be under the industry bit output to in-line with the industry, with the payoff coming toward the end of the year.

(Q1 Conference Call Slide)

(Q2 Conference Call Slide)

This means Micron may be looking at additional DRAM revenue for the calendar year it was not expecting just a quarter ago, as it now sees 1X nm bit crossover as it exits calendar year 2018.

What’s the impact to revenues you ask? I decided to make an assumption and give the numbers a shot. If Micron was expecting 18% bit growth (my assumption) and now expects 20% bit growth, my model says an additional $500M is possible for the fiscal year. If I use the same formulas above this equals out to an additional $0.22 in EPS for the year.

So while Micron may have had a slip up in the current quarter, it appears the execution it does have control over is bringing it in-line with the industry while overcoming the hiccup. Every quarter that goes by, Micron chips away at the lead of Samsung in terms of technology transitions. This is a Micron ready to win the war through sheer execution and technology excellence.

How About The Stock?

How about the stock, huh? If you’ve been around the Micron block once or twice with us you know the current share price action is nothing out of the ordinary. Those serious about the long-term don’t expect Micron to go up after earnings – you should always take the other side of that bullish bet if a friend offers.

But that doesn’t mean we haven’t come a long way in this battle. Remember, Micron shares were $38 just six and a half weeks ago. Today, while we are well off the fresh highs of $63 and change, we’re still in the $50’s – 34% higher than those disgusting (and very profitable) lows.

That being said, let me break out the chart for you and show you what I am seeing and what I expect. First lesson – the trend is your friend.

The red line is roughly the trend since the cycle moved out of the trough and started heading higher in mid-2016. As you can see the stock has gotten ahead of itself a little in the last run-up to $63. But, Micron is good about reverting to the trend, whether it overshoots or undershoots. Patience is key here as well as setting yourself up for a profitable strategy through medium-term options.

Next, Micron tends to want to test its previous highs, and it has yet to do so. The last high where it stalled out but then broke through just recently was $50.

Since the stock has broken through the previous high, it has yet to test it and confirm support. It’s possible Micron in an intra-day move also tests the 50-DMA while it’s at it. Another tidbit is the stock likes to be in the bounds of the Bollinger Bands and any move outside the top band usually gets smacked back in.

In other words, be patient with the stock as it finds its way back to the trend line as well as finishes testing the prior resistance. From there I expect Micron to churn for a bit before heading back higher and through the recent 52-week highs. Hint, hint: pick up near-the-money calls as it finishes its bottoming out period.

Fundamentally, the company is solid and hasn’t diverted course since my last statement on the fundamentals. In fact, the accelerated node transition positions it even better than prior estimates. The chart is doing its typical thing and we must be patient until it settles out and it, too, does the thing it has been doing for the past nearly two years.

Please tip your waitress as you relax on the Micron train.

If you’d like to be made aware of my opinion and analysis in the future on Micron and other tech companies, then I encourage you to follow me by clicking the “Follow” link at the top of this page next to my name.

Disclosure: I am/we are long MU.

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.

No, Buffett Is Not Buying GE

Yesterday, rumors began swirling that General Electric (GE) might be of interest as a significant investment, or even as a takeover candidate, from none other than Warren Buffett’s Berkshire Hathaway (BRK.A) (BRK.B). So enthusiastic were investors that GE might finally catch a break that shares went up as much as 6.5% – no small sum that represents over half a billion in market capitalization.

Unfortunately, dreamers that bought GE are likely to be disappointed. Here’s why.

Buffett’s past with GE

Ten years ago, the Oracle of Omaha famously invested $3 billion in GE preferred stock at the height (or perhaps in the depths?) of the Great Recession. The preferred shares, superior in dividend preference to common stock but inferior to debt, came at a high price for ‘The General’: 10% interest per year in perpetuity. If GE wanted out, it could repurchase Buffett’s preferred stock at a 10% premium (which it did for a total of $4.1 billion, including dividends, in late 2011). As icing on the cake, Buffett’s Berkshire received warrants to purchase nearly 135,000 shares of GE’s stock at $22.25 per share.

If this sounds like a sweet deal for Buffett, you’re right – it borders on usurious. It’s good to be The Oracle, after all.

A struggling giant

Now, a decade later, GE is faced with a different problem. Macroeconomic storms have given away to microeconomic travails:

General Electric Selected Financial Results

FY 2015

FY 2016

FY 2017

Total Revenue

$117.4 billion

$123.7 billion

$122.09 billion

Gross Profit

$32.09 billion

$33.4 billion

$17.99 billion

SGA Expenses

$21.9 billion

$19.36 billion

$20.44 billion

Operating Income ( Loss)

$11.65 billion

$14.05 billion

($3.9 billion)

Net Income

($6.12 billion)

$8.83 billion

(5.8 billion)

Free Cash Flow

$12.58 billion

(7.44 billion)

$3 billion

Data Sources: General Electric, Scout Finance.

The winding down of GE Capital, as well as other “one-time items” has distorted GE’s net income. But, as Buffett’s teacher Benjamin Graham pointed out in The Intelligent Investor, why ignore such costs in valuing a business? Graham knew that a company of any reasonable size (and especially enterprises of GE’s scale) will ALWAYS have expenses like this crop up.

The more reliable figure for a quick-and-dirty analysis, free cash flow, is flashing an alarm bell (Fun fact: GE’s free cash flow, according to our friends at Scout Finance, came in at a whopping $15.12 billion in 2013 and a staggering $20.6 billion in FY 2014.) What a difference a few years makes.

Buffett knows this, and he will inevitably look to each division’s results for signs that the ship can be righted. Unfortunately, the prognosis here is not good:

GE Segment Revenues

Source: General Electric FY 2017 10-K.

General Electric Segment Profit

Source: General Electric FY 2017 10-K.

By shedding GE Capital, ‘The General’ was getting back to its industrial roots. Unfortunately, its industrial roots aren’t exactly growth businesses these days (save for Renewable Energy, but even that represents a small portion of the whole). Any buyout of GE means you get the whole thing – and the whole is not thriving.

John Flannery now leads the company, acknowledged to be a smart company man and touted as the man who turned around GE Healthcare. Alas, Healthcare’s performance over the past three years, the approximate period Flannery was at the helm, was not anything to write home about (see above).

Flannery seems to have the situation in hand (which unfortunately forced him to cut GE’s dividend and plan large cost cuts). The problem is that the situation is an extremely tough one and almost certainly not something Buffett would want to dive into. That is unless GE is willing to part with one of its top performing divisions, of course.

Buffett’s Cash Won’t Fix GE

Arguably, Buffett made his first millions as a distressed investor and turnaround artist. Anyone who has read just one of the numerous biographies of the man has no doubt heard the tale of Dempster Mill Manufacturing, GEICO, and even a New England textile manufacturer named Berkshire Hathaway.

But those days are over. Buffett wants to buy great businesses at fair prices – low stress is the name of the game.

Not only that but Buffett’s other well-known “opportune” investments in national brands (made at a time of distress) all had one of two characteristics: (1) The source of trouble is immediately solved with capital. The simple need for cash was the case with Buffett’s 1970s investment in GEICO when the company needed cash to survive, but the fundamental business of providing low-cost insurance to government employees remained intact. Once the capital infusion occurred, the insurance regulators backed off. Or (2), the business itself is excellent, but the company has a dark cloud over it. This was the case with Buffett’s investment in American Express (AXP) in the 1960s.

General Electric is different.

A pile of money won’t solve its woes (although that wouldn’t hurt given the company’s debt load) and most of its businesses are barely growing – if that. So, no, Buffett won’t be buying a massive stake in GE nor will be gobbling up the whole thing.

What you need to know

Buffett will not be riding in to rescue GE on a white horse.

Could I be wrong? Absolutely. Buffett has unmatched insights and access to information (how often do you suppose he and Flannery have talked in the past few months?). Combining any one of GE’s businesses with Berkshire’s could lead to significant cost savings – a potential source of upside that few possess. Or perhaps he could call up his friends over at 3G Capital for some good old fashioned zero-based budgeting magic.

But I doubt it.

It SOUNDS like the cap to a fantastic investing career. But it wouldn’t be Buffett. If anything, he’s talking to Flannery at the time of this writing about acquiring one of GE’s better performing industrial businesses. I can only hope Mr. Flannery takes a pass. The worst thing one can do in a crisis is make a deal on onerous terms, a lesson I can only hope GE learned in its previous dealings with Mr. Buffett.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Now Is The Time To Buy The 2 Best Dividend-Paying Pharma Stocks

(Source: imgflip)

My dividend growth retirement portfolio has an ambitious goal of generating 12% total returns over time. The cornerstone of my strategy is a highly diversified portfolio of quality dividend companies bought at fair price or better.

That means I use a lot of watchlists and patiently wait to buy the right company at the right price. Well, the market correction, plus a disappointing drug trial result, mean that two of my favorite blue-chip drug makers, Johnson & Johnson (NYSE:JNJ) and AbbVie (NYSE:ABBV), have finally fallen to levels at which I can recommend them.

Let’s take a look at why these two industry leaders likely have what it takes to continue generating years, if not decades, of generous, safe, and steadily rising income. Traits that history indicates will lead to market-beating total returns, especially from their currently attractive valuations.

Johnson & Johnson: The Most Trusted Name In Pharma Continues Firing On All Cylinders

The pharmaceutical industry is both wide-moat and defensive (recession-resistant). That can make it a potentially attractive industry for low-risk income investors. And when it comes to big drug makers, none are lower-risk than Johnson & Johnson, which was founded in 1885 and is the world’s largest medical conglomerate. The company has over 250 subsidiaries operating in over 60 countries, making it the most diversified drug stock you can own.

(Source: JNJ Earnings Presentation)

All three of its business segments posted strong growth in 2017, resulting in company-wide operational revenue growth of 6.3%.

Metric

2017 Results

Revenue Growth

6.3%

Free Cash Flow Growth

14.4%

Shares Outstanding

-1.6%

Adjusted EPS Growth

8.5%

FCF/Share Growth

16.2%

Dividend Growth

5.4%

Dividend FCF Payout Ratio

51.3%

FCF Margin

23.3%

(Source: JNJ Earnings Release, Morningstar)

Excluding major acquisitions, such as the $4.3 billion purchase of Abbott Medical Optics and the $30 billion purchase of Actelion, operating revenue was up 2.4%. However, what ultimately matters to dividend growth investors is the company’s free cash flow, or FCF. That’s what’s left over after running the business and investing in future growth, and it grew by an impressive 16.2% last year. And despite the lower-margin medical products and consumer goods segment, JNJ still managed to convert 23.2% of its revenue into free cash flow in 2017.

FCF is what funds the dividend, and with an FCF payout ratio of 51.3% JNJ’s track record of 54 straight years of rising dividends is all but assured. In fact, the company will raise it again next quarter, with the analyst consensus being for about an 8% hike for 2018. That’s thanks to highly positive management guidance, including:

Metric

Mid-Range 2018 Growth

Operational sales

4%

Operational sales ex acquisition

3%

Total sales

6%

Operational EPS

8.20%

Adjusted EPS

11%

(Source: JNJ Earnings Presentation)

This is largely thanks to the strength of its pharmaceutical segment, particularly the oncology division, which saw worldwide sales growth of 25% and generated $7.3 billion in sales for the company. The strength of JNJ’s cancer drug business was largely fueled by such drugs as:

  • Darzalex (multiple myeloma): Worldwide sales up 117%
  • Imbruvica (lymphoma, Leukemia): Worldwide sales up 51%

These offset the small (9.3%) decline in global Remicade sales, which is the company’s blockbuster immunosuppressant that treats rheumatoid arthritis, psoriatic arthritis, ankylosing spondylitis, Crohn’s disease, plaque psoriasis, and ulcerative colitis. This decline was caused by the loss of patent exclusivity.

The good news is that while Remicade is in decline, other immunology drugs like Stelara (psoriasis and arthritis) are quickly stepping up to fill the gap. For example, in 2017, Stelara’s worldwide sales grew 24% to $4 billion, nearly matching Remicade’s $6.3 billion revenue.

In addition, JNJ is partnering with Theravance Biopharma (NASDAQ:TBPH) in a $100 million deal to develop its potentially far superior immunology drug to replace falling Remicade sales. That drug, TD-1473, is highly effective in very small doses. Early trials indicate it shows no significant broadscale immunosuppression, which has been the main side effect of all previous drugs in this category.

If future trials go well, then JNJ will likely pick up the tab for the drug’s registration costs, and its giant sales force will be responsible for marketing the drug. That’s in return for 2/3rd of US profits, as well as all global profits minus a double-digit royalty to Theravance.

This is great example of smart capital allocation, which reduces development risk immensely. JNJ has done this kind of co-development/co-marketing deal before. In 2011, it paid Pharmacyclics (now owned by AbbVie) $150 million to help it develop Imbruvica. Today, that cancer drug is one of Johnson & Johnson’s top sellers with nearly $2 billion in sales.

Pharmaceutical market analysis firm EvaluatePharma expects that figure to hit $7.5 billion by 2022, which is projected to make it the 4th-best selling cancer drug in the world. JNJ and AbbVie each have about 50% rights to Imbruvica, though AbbVie also enjoys royalty rights that it acquired when it bought Pharmacyclics.

Edurant, an HIV drug, also saw strong sales growth of 24.6%. This shows the major strength of JNJ. Which is that while most of its profits come from volatile, patented pharmaceuticals, it remains highly diversified, with even its largest medication representing only 8.2% of companywide revenue in 2017.

Best of all, JNJ’s drug development pipeline is deep, with 19 drugs in late-stage clinical trials for 85 indications in the US and the EU. And those are just late-stage phase three trials. In total, the company’s pipeline has 34 drugs, including 10 potential blockbusters that it expects to receive approval for by 2021. These are drugs the company thinks could generate over $1 billion in sales each.

This includes prostate cancer drug Erleada, which EvaluatePharma thinks could generate $1.6 billion in annual sales by 2022. Meanwhile, JNJ has Imbruvica in trials for seven more indications, four of which are expected to boost annual sales by at least $500 million each. All told, EvaluatePharma expects JNJ’s new drug/indication expansions over the next five years to drive $14.9 billion in additional sales, or nearly $3 billion per year.

And while it’s the least sexy part of the company, I like the consumer goods segment for its strong record of innovation.

(Source: JNJ Investor Presentation)

Consumer products has numerous highly trusted brands that have given the company a strong, non-patent reliant source of global revenue, including 55% from outside the US. In 2017, this segment’s sales grew 2.2%.

(Source: JNJ Investor Presentation)

In the last three years, JNJ has managed to use its enormous economies of scale to cut $1.7 billion in annual operating costs, resulting in operating margins rising by 4.5%. Going forward, the company expects to be able to achieve 1-2% above industry average growth, while achieving 20.3% operating margins.

Meanwhile, medical devices give the company much-needed diversification. It also provides a long growth runway given that in the future, global demand for surgical, orthopedic, cardiovascular, vascular, and vision devices is set to grow strongly.

Medical devices is a wide-moat industry, with JNJ controlling dominant positions in both orthopedics and endo-surgical devices (minimally invasive surgical tools). Surgeons are generally loath to switch suppliers, since they train and gain expertise using particular medical devices. This creates a stickier ecosystem and stronger pricing power.

The segment generated 5.9% growth in 2017. This was led by 46% growth in vision care (Abbott Medical Optics acquisition) and cardiovascular’s 13.4% growth in global sales.

The bottom line is that JNJ is a world-class drug maker, but also so much more. It has a strong track record of innovation and medical product invention in drugs, consumer products, and medical devices. Combined, these create a relatively steady river of free cash flow that has resulted in the industry’s best dividend growth track record – one that is likely to continue for many years and even decades to come.

AbbVie: Despite Recent Trial Failure, The Best Name In Biotech Still Has Plenty Of Growth In The Tank

Chart

ABBV Price data by YCharts

It’s been a rough few days for AbbVie, with shares plunging on news of disappointing phase two results for its Rova-T lung cancer therapy. Lung cancer, due to the large number of smokers in the world, is the most profitable sub-segment of the already very lucrative oncology market.

AbbVie paid $9.8 billion for Stemcentrx in 2016, including $5.8 billion up-front ($2 billion cash and $3 billion stock). The deal also included potentially $4 billion in cash earnout payments if the drugs developed from Rova-T hit certain milestones.

The reason that investors are reacting so negatively is that the results showed only 16% of cancer patients responded to the treatment, instead of the expected 40% response rate. So, AbbVie is abandoning plans to file for an early approval with the FDA.

This poor trial means higher risks of failure for the drug’s other trials, including much more important first- and second-line treatment indications. It also calls into question the Rova-T/Opdivo combination trial that AbbVie is partnering with Bristol-Myers Squibb (NYSE:BMY) on, and for which results should be in by 2019.

The biggest reason this freaked out investors so much is because AbbVie was spun off from Abbott Labs (NYSE:ABT) in 2013 with all of that company’s pharmaceutical assets. By far the most valuable has been the immunology drug Humira, which is used to treat arthritis, psoriasis, ankylosing spondylitis, Crohn’s disease, and ulcerative colitis. For several years now, Humira has been the best-selling drug in the world.

(Source: Statista)

This is why AbbVie has continued to put up incredible growth. In fact, in 2017, it had the best sales growth in the industry and came in number two in terms of adjusted EPS growth.

Metric

2017 Results

Revenue Growth

10.1%

Free Cash Flow Growth

43.7%

Shares Outstanding

-1.7%

Adjusted EPS Growth

16.2%

FCF/Share Growth

46.2%

Dividend Growth

5.4%

Dividend FCF Payout Ratio

44.1%

FCF Margin

33.4%

(Source: ABBV Earnings Release, Morningstar)

More importantly for income investors, AbbVie’s free cash flow exploded, thanks to the incredible margins it’s earning on its patented drugs.

Better yet? Thanks to tax reform, the company raised its 2018 Adjusted EPS guidance from about 17% to 32%, which is why management decided to hike the dividend for this year by 35%. However, the FCF payout ratio should still remain about 50%, due to the company’s strong growth in sales and free cash flow.

But if AbbVie is booming, then why is the market freaking out so much over Rova-T? Because AbbVie’s success with Humira is a double-edged sword. The drug was responsible for 65% of the company’s sales in 2017. This means that its prodigious profits and cash flow have a lot of concentration risk.

Investors are worried that AbbVie might end up going the way of Gilead Sciences (NASDAQ:GILD), where a single (in GILD’s case, two) blockbuster drug ends up seeing sharp sales declines that drag on earnings growth for years. That’s because in 2017, Humira lost EU patent protection. In addition, every major drug maker has a biosimilar rival in development.

The biggest risk was Amgen’s (NASDAQ:AMGN) Amjevita, which won approval in 2016. AbbVie has been battling in the courts to keep that rival off the market. In 2017, AbbVie and Amgen agreed that Amjevita would remain off the US market until 2023. That’s because while the FDA approved the rival drug, it didn’t take into account the 61 patents that AbbVie still has in effect.

Rather than proceed with a costly trial scheduled to begin in 2019, Amgen has backed down. This is why AbbVie CFO Bill Chase says that management has “come to the conclusion that this product [Humira] is durable.” And that investors are “not going to see anything catastrophic,” such as Humira sales falling off a cliff anytime soon.

In fact, AbbVie expects that with no biosimilar competition until 2023, it has a clear runway to keep steadily growing the drug’s sales.

(Source: AbbVie Investor Presentation)

But the point is that even if AbbVie’s rosy forecasts of Humira sales do come true, the company still needs to diversify if it’s going to avoid a major future decline in profits and cash flow.

After all, by 2023, the drug is going to face an onslaught of biosimilar rivals that will likely steal a lot of market share, or at the very least force AbbVie to reduce its prices significantly. In fact, by 2025, three years into competition with biosimilars, AbbVie expects Humira sales to fall to just $12 billion a year.

Which is why Rova-T was so important. Management believed that if approved for all indications, it could be a $5 billion blockbuster by 2025.

(Source: AbbVie Investor Presentation)

That was about 14% of the $35 billion in risk-adjusted (expected sales adjusted for probability of drug approval), non-Humira sales the company was forecasting for 2025.

In other words, Rova-T was such a big deal that the company spent a lot of money in order to try to reduce its Humira revenue concentration from 65% in 2017 to just 26% in 2025. However, the fact is that even if you assume a total failure on Rova-T, AbbVie’s sales should still come in at $42 billion by 2025, with Humira representing about 29% of revenue.

AbbVie: Lots Of Potential Growth Catalysts Ahead

Right now, AbbVie is all about Humira, the world’s most popular immunology drug and top-selling pharmaceutical period. But while immunology is indeed a booming industry, it’s far from the only growth avenue for this company.

(Source: AbbVie Investor Presentation)

In total, AbbVie thinks there is about a $200 billion market for the four key segments it’s targeting.

And the company has one of the deepest and most potentially profitable drug pipelines in the industry. In fact, in 2017, EvaluatePharma estimated that AbbVie’s new drugs in development could generate $20.4 billion between 2018 and 2022. That meant it had the third-strongest development pipeline in the world. Even if you assume a total failure of Rova-T, the new drug sales projection drops to $15.4 billion, which means that AbbVie’s pipeline drops to number four, just above Johnson & Johnson’s $14.9 billion. That’s because it still includes drugs like:

  • Risankizumab (psoriasis, ulcerative colitis, Crohn’s disease): $5 billion in projected 2025 sales off at least four indications
  • Upadacitinib (rheumatoid arthritis, dermatitis, Crohn’s disease): $6.5 billion in projected 2025 sales off at least six indications

And that’s just immunology. We can’t forget that oncology is going to become a major growth market in a fast-aging world where cancer becomes more common.

The leukemia drug Venclexta won approval in 2016, and is expected to generate peak sales of up to $2 billion. And of course, there’s Imbruvica, co-marketed with JNJ, which continues to put up massive growth as its number of approved indications increases. That drug’s peak $7.5 billion in annual sales potential would mean about $4 billion per year for AbbVie’s top line. Meanwhile, the drug maker has 23 drugs in development for solid tumors, with over 10 more expected to enter trials within a year.

Other opportunities to profit from demographics include Elagolix, an endometriosis drug. This is expected to generate up to $1.2 billion in annual sales by 2022.

And keep in mind that Rova-T’s results, while disappointing, were not necessarily a disaster. That’s because the results showed that Rova-T increased one-year survival probability from 12% with current treatments to 17.5%. That is why Morningstar’s pharmaceutical analyst Damien Conover thinks it might still obtain approval for most of its first and second line indications. That could mean total peak sales come in at $1 billion, down from Morningstar’s $3 billion projection before the trial results came in.

The point is that even if you assume the worst-case scenario – i.e., zero revenue from Rova-T – AbbVie is still looking at potential sales growth of 5.2% CAGR through 2025. And if Rova-T manages to get approved, then that figure could rise to 5.3%. And with strong operating leverage from economies of scale (cost savings driving EPS growth faster than revenue growth), that means that AbbVie’s long-term EPS and FCF/share should still come in between 10% and 15%.

Which, in turn, means that AbbVie investors can likely expect some of the best dividend growth from any drug maker in the coming years. Combined with its mouthwatering yield, that makes it a very attractive income investment right now.

Dividend Profiles: Safe And Growing Dividends Likely To Result In Market-Beating Total Returns

Stock

Yield

2017 FCF Payout Ratio

Projected 10-Year Dividend Growth

Potential 10-Year Annual Total Return

Johnson & Johnson

2.60%

51.30%

7% to 8%

9.6% to 10.6%

AbbVie

4.00%

44.10%

10% to 14.2%

14% to 18.2%

S&P 500

1.80%

32%

6.20%

8.00%

(Sources: Company Earnings Releases, Morningstar, F.A.S.T. Graphs, Multpl.com, CSImarketing)

The most important part of any dividend investment is the payout profile, which consists of three parts: yield, dividend safety, and long-term growth potential. This determines how likely it is to generate strong total returns and whether or not I can recommend it or buy it for my own portfolio.

Both Johnson & Johnson and AbbVie offer far superior yields to the market’s paltry payout. More importantly, both dividends are very well-covered by free cash flow.

However, dividend safety isn’t just about a reasonable payout ratio. It also means checking to see whether a company’s balance sheet is strong enough to support continued investment in future growth as well as a rising dividend.

Company

Debt/EBITDA

Interest Coverage

Debt/Capital

S&P Credit Rating

Average Interest Cost

Johnson & Johnson

1.4

26.0

32%

AAA

2.7%

AbbVie

3.6

9.0

72%

A-

3.1%

Industry Average

1.8

12.5

41%

NA

NA

(Sources: Morningstar, GuruFocus, F.A.S.T. Graphs, CSImarketing)

Here is where JNJ takes a clear lead over AbbVie. Johnson & Johnson’s leverage ratio is below the industry average, and its sky-high interest coverage ratio indicates that the company has no trouble servicing its super cheap debt.

In fact, JNJ is just one of two companies (the other being Microsoft (NASDAQ:MSFT)) with a AAA credit rating, which is one notch higher than the US Treasury’s. That’s why it is able to borrow at such attractive rates.

AbbVie, thanks to a slew of acquisitions in recent years, has a much-higher-than-average leverage ratio. In addition, its interest coverage is below that of most of its peers. However, while this high debt load is something I plan to watch carefully going forward, it isn’t yet a danger to the dividend. After all, AbbVie still has an A- credit rating and is able to borrow at very cheap rates as well. But in a rising interest rate environment, that might change. So it’s good that management plans to hold off on more acquisitions for now, while it uses the company’s enormous and fast-growing river of FCF to pay down debt.

As for dividend growth potential, this is of key importance, because studies indicate that a good rule of thumb for future total returns is yield + dividend growth. This is because, assuming a stable payout ratio, the dividend growth rate must track earnings and cash flow growth. And since yields tend to be mean-reverting over time, this combines both income and capital gains into one formula.

JNJ’s dividend growth rate potential is smaller than AbbVie’s, due mainly to its larger size. This makes it harder to grow quickly. However, analysts still expect about 7-8% earnings growth from this Dividend King. That should allow for similar payout growth and result in market-beating total returns.

AbbVie’s dividend growth outlook is more uncertain, though larger, thanks to its strong development pipeline. Unlike JNJ, AbbVie has no diversification into non-drug businesses, and so, its growth is more unpredictable and volatile.

However, I conservatively estimate that AbbVie should be able to achieve 10% dividend growth, while analysts expect about 14%. When combined with today’s attractive yield, that should be good for about 14% total returns. That’s far above what the S&P 500 is likely to provide off its historically overvalued levels.

Valuation: JNJ Is Finally Fair Value, While AbbVie Is On Sale

Chart

JNJ Total Return Price data by YCharts

Up until a few months ago, both JNJ and AbbVie investors were enjoying a very solid year. JNJ was tracking the market during a freakishly low-volatility 20% run in 2017. AbbVie was booming thanks to strong growth in Humira and the news that its cash cow wouldn’t get any competition until 2023. However, in recent weeks, JNJ and ABBV have suffered major losses that make them both potentially attractive investments.

Company

Forward P/E

Historical P/E

Yield

Historical Yield

Percentage Of Time Yield Has Been Higher

Johnson & Johnson

15.5

22.4

2.60%

2.90%

40%/30%

AbbVie

13.0

21.5

4.00%

3.00%

11%

(Sources: GuruFocus, F.A.S.T. Graphs, YieldChart)

JNJ and AbbVie are now trading at lower forward P/E ratios than their historical norms. More importantly, AbbVie’s yield is much higher than it’s been since the company’s 2013 spin-off. JNJ’s yield is not, but keep in mind that the company’s about to announce its 55th straight annual dividend bump. This should raise the forward yield to about 2.8%.

And even at a 2.6% dividend yield, JNJ’s payout has only been higher 40% of the time. And going off the likely 2.8% forward yield in a few months, 30%. Meanwhile, AbbVie’s yield has only been higher 11% of the time, indicating that it’s likely highly undervalued.

(Source: Simply Safe Dividends)

A rule of thumb I like to use for determining fair value is that I want to buy a stock when the yield is at least at the 5-year average. Taking into account the upcoming JNJ dividend hike, I now estimate that it is fairly valued. And under the Buffett principle that “It’s better to buy a wonderful company at a fair price than a fair company at a wonderful price”, I have no issue recommending JNJ today. After all, it’s the ultimate pharma blue chip, with the best dividend growth record in the industry.

Meanwhile, AbbVie is about 17% undervalued, which is why I consider it a more attractive investment today. That’s why I added it to my own portfolio during the recent correction and during the Rova-T freakout.

Note that if I had the cash, I’d have bought JNJ as well, and I highly recommend owning both blue chips in your diversified income portfolio. That’s assuming, of course, that you are comfortable with the complex risk profile of any pharma/biotech company.

Risks To Consider

When it comes to complexity and uncertainty, few industries are as challenging as pharma/biotech. That’s because of numerous risk factors that make it very challenging for companies to consistently grow safe dividends.

For one thing, the same regulatory hurdles that provide a wide moat and windfall profits for a time also make new drug development incredibly tricky and time-consuming.

(Source: Douglas Goodman)

For example, fat profit margins are created by patent protection, which usually lasts for 20 years. However, drug makers need to file for a patent at the start of the development process, which usually takes 10-15 years to complete. That means drug companies only enjoy patent-protected margins for a relatively short time before patent cliffs kick in and generic competition can steal market share.

And we can’t forget that the process itself is highly unpredictable, monstrously expensive, and only getting more so over time.

(Source: Tufts Center For The Study Of Drug Development, Scientific American)

When factoring in all the preclinical, clinical, and follow-up studies, it can cost as much as $2.6 billion to develop a new drug. And as we just saw with Rova-T, a promising drug can fail at any time. That can potentially result in a total write-off and gut-wrenching short-term price volatility.

Worse yet, because only about 1 in 10,000 compounds/treatments ends up making it through the FDA regulatory gauntlet, drug makers often have to acquire rivals to obtain promising pipeline candidates in late-stage development. All major M&A activity is inherently packed with risk.

For example, if a company overpays, then even a successful blockbuster drug can end up not contributing much to EPS or FCF growth. Meanwhile, synergistic cost savings, which are often counted on to make deals profitable, might not be fully realized. And what if a key drug that was a major reason for a large acquisition fails in trials? Then large write-offs can result, as may happen with Stemcentrx and Rova-T. And don’t forget that a failed acquisition can lead to a costly break-up fee. For example, in 2014, AbbVie abandoned the $55 billion attempt to buy Shire (NASDAQ:SHPG), resulting in a $1.6 billion break-up cost to shareholders.

The good news is that according to AbbVie’s CFO, when it comes to additional short-term acquisitions, investors shouldn’t “expect anything major.” That’s because, he said, “Running out and buying something of size doesn’t make sense.” Holding off on more acquisitions for a few years means that the company will have time to deleverage its balance sheet while it brings its strong development pipeline to market.

In addition, AbbVie does have a pretty good track record on acquisitions, since the $21 billion purchase of Pharmacyclics in 2015 was reasonably priced. It gave the company the blockbuster Imbruvica, which is its second-largest but fastest-growing seller.

But even if everything goes right, a company makes a smart acquisition at the right price, and the potential blockbusters in the pipeline are approved, there’s the issue of massive competition to contend with. For instance, patents on drugs are highly specific. Competitors are free to create alternate versions, including of highly profitable biological drugs. That’s why every pharma/biotech and their mother is constantly racing to develop biosimilars to the hottest blockbusters on the market.

In this case, Remicade faces competition from over 20 potential rivals, including Pfizer’s (NYSE:PFE) Inflectra, which is selling at a 10% discount to Remicade. And without patent protection, analysts expect Remicade sales to continue to deteriorate at an accelerating pace. Meanwhile, JNJ prostate drug Zytiga is also expected to see generic competition this year, due to patent expirations.

In order to keep their pricing power, pharma companies are also fighting constant legal battles. That’s to protect patents and also to try to block generic and biosimilar competition for as long as possible. All legal challenges are themselves highly uncertain, and a negative outcome can have a large impact on both the share price and future cash flow growth.

And we can’t forget about the other kind of legal uncertainty: class action lawsuits in case an approved drug ends up being harmful to consumers. For example, Merck (NYSE:MRK) had to pull popular pain drug Vioxx from the market in 2004 when post-clinical studies showed it significantly increased the risk of heart attack and stroke. The company has spent over 12 years in and out of courts, as a plethora of class action suits have continually pushed up the final settlement costs. In 2007, Merck settled most of the cases for $4.9 billion. But individual holdouts have continued suing the company, and the total cost is now at $6 billion, with several cases left to be settled.

And that is just one extreme case of what can go wrong. Often, legal liability is a death from a thousand cuts. For example, AbbVie recently lost a case in Chicago where a man successfully sued over AndroGel, a testosterone replacement cream. The plaintiff claims that AbbVie’s cream caused him to have a heart attack. While the jury did not find the company strictly liable, it still awarded him $3 million. The company faces about 4,000 more such cases over AndroGel. Each case is likely to have a different outcome, and some of them might be thrown out or be reduced on appeal. But the point is that even non-blockbuster products can end up as a major financial liability.

Meanwhile, in the past, JNJ has faced its own legal hassles, including numerous consumer product recalls, defective knee, hip implants, surgical mess, and a $2.2 billion settlement over antipsychotic drug Risperdal.

Finally, we can’t forget the other major legal risk: government regulations and healthcare policy, both in the US and abroad.

(Source: HCP)

In the US alone, the rapidly aging population means that healthcare spending is expected to increase by about $2 trillion per year by 2025 and consume 20% of GDP. This means that the US government as well as private payers will be desperate to bend the cost curve lower. Blockbuster drugs and their high profit margins are an easy target for populist politicians to go after in this country and around the world.

For example, President Trump announced that:

“One of my greatest priorities is to reduce the price of prescription drugs. In many other countries, these drugs cost far less than what we pay in the United States. That is why I have directed my Administration to make fixing the injustice of high drug prices one of our top priorities. Prices will come down.”

The president has also said in the past that drug makers were “getting away with murder”, a sentiment many Americans share. And it is true that foreign countries do enjoy lower drug prices, largely because government involvement in healthcare is far more common. Of course, that is why most R&D recoupment is generated in the US.

But that’s not guaranteed to continue. Because even if Congress doesn’t enact outright price controls on drugs, it can easily lift the current ban on Medicare/Medicaid negotiating bulk drug purchases at a discount. That’s a far less controversial proposal that represents low-hanging, cost-saving fruit – one that could potentially hit margins across the entire industry.

In the meantime, Joaquin Duato, JNJ’s executive vice president and worldwide chairman of its pharmaceuticals segment, has said that insurers and pharmacy benefit managers are putting on extra pressure to lower drug prices. This is why the company’s pharma growth plans are focused on volume and not price. It wants to grow profits by expanding indications and launch new medications to treat more conditions, specifically in immunology and oncology.

The bottom line is that pharma is a wide-moat industry with huge potential for future growth. However, it’s also fraught with peril and risk. Drug makers face a never-ending hamster wheel of uncertain, time-consuming, and costly drug development. This means steady growth in sales, earnings, and cash flow is very challenging.

Only enormous economies of scale, highly skilled capital allocation by management, and safe and growing dividends make it worth considering the industry at all. Which is why I avoid all but the most proven blue chips in the industry, and recommend most investors do the same.

Bottom Line: These 2 Industry-Leading Blue Chips Are Likely To Make For Strong Long-Term Income Investments At Current Prices

The drug industry has a lot of favorable characteristics. It’s recession-resistant, wide-moat, and is potentially poised to enjoy a major secular global demographic growth catalyst in the coming years and decades.

That being said, it’s also one of the most complex, cyclical, and competitive industries in which you can participate. That means the best course of action for most investors is to stick with industry-leading, blue-chip dividend stocks – those with shareholder-friendly corporate cultures and proven management teams.

Johnson & Johnson and AbbVie represent the top names in pharma and biotech, respectively. And at current valuations, I am able to recommend both for anyone looking for low-risk exposure to this defensive industry. That being said, AbbVie has better total return potential, and its recent disappointing drug trial results mean that the company is far more undervalued. That’s why I bought it over JNJ for my own portfolio during the correction.

Disclosure: I am/we are long ABBV.

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.

ICE Reportedly Uses Facebook Data to Track Suspected Illegal Immigrants

Cambridge Analytica isn’t the only entity using Facebook data for its own ends.

The U.S. Immigration and Customs Enforcement (ICE) has relied on Facebook data to find and track immigrants suspected of being in the U.S. illegally, according to a new report by The Intercept.

The report tells of one instance in which ICE used backend Facebook data to determine when the account of the person in question was accessed, as well as the IP addresses corresponding to each login. The agents reportedly combined this data with other routinely used records, such as phone records, to pinpoint his location.

Alongside Facebook’s Cambridge Analytica scandal, the Intercept story underscores questions about Facebook’s data privacy, but the use of Facebook data in ICE’s investigations is not illegal. The Intercept reports that the Stored Communications Act lets law enforcement request information from third-party record holders, including Facebook.

Facebook corroborated this point, telling The Intercept that “ICE sent valid legal process to us in an investigation said to involve an active child predator,” explaining that it responded to this request “with data consistent with our publicly available data disclosure standards.” However, Facebook denies that the data was used to identify an immigration law violation, saying it “does not provide ICE or any other law enforcement agency with any special data access to assist with the enforcement of immigration law.”

Beyond the legal issue, the report further demonstrates the increasingly aggressive tools ICE is using in its mission to crackdown on immigration and comply with the Trump administration’s deportation drives. Last September, ICE worked with Motel 6 to obtain guest information and in January immigration agents targeted dozens of 7-Eleven stores, arresting 21 people suspected of being in the U.S. illegally.

Trade Tariff Tensions: Correction Could Morph Into A Major Meltdown For Stocks

Source: USAToday.com

What a week for stocks, the worst in over two years to be exact. More than a 5% drop for the S&P 500/SPDR S&P 500 Trust ETF (SPY), the world’s most closely watched stock index. The S&P 500 now sits at the 200 – day moving average, a level essentially on par with the closing low reached during the height of the recent correction. It’s becoming apparent that markets are taking the threat of a potential trade war with China very seriously.

Source: StockCharts.com

So, what is likely to happen next? Are the fears overblown? Will stocks recover, or will the correction deepen? And could this be the beginning stages of a bear market instead?

About SPY

SPY is the first major and most popular ETF in the world. It’s designed to mimic the exact movement of the S&P 500. The SPY Index fund has roughly $275 billion in net assets, and each share in the fund represents a fraction of the holdings. SPY provides investors with exposure to the S&P 500 index, which is widely regarded as the most significant stock market average for U.S. equities. Since SPY tracks the exact movements of the S&P 500, I will use SPY and the S&P 500 interchangeably throughout the article.

Trade: U.S. Vs China

If you think the heightened trade talk rhetoric is only effecting U.S. stocks you’re mistaken. Chinese and other Asian stocks are getting pummeled as well. On Friday alone Hong Kong’s HSI Index lost 2.5%, Shanghai’s Index gave up 3.4%, China’s Shenzhen Index cratered by 4.1%, and Japan’s Nikkei lost over 4.5%. I think it’s clear, as much as a potential trade war could hurt certain U.S. companies and industries it would hurt China much more.

The U.S.’s trade deficit with China was over $375 billion last year. In other words, China swamps the U.S with everything from machinery, to textiles, to plastics, to furniture, to computers and electronics, and so on.

Source: MarketWatch.com

Free trade does not necessarily mean fair trade. In fact, when it comes to trade with China it’s anything but fair. One of the reasons the U.S. has such a massive trade imbalance with China is because in addition to China being able to manufacture goods much cheaper, the Chinese have a far easier time bringing their products to the U.S. market.

For example, it costs the U.S. 25% to bring a car into China, while it costs the Chinese just 2% to bring a car into the U.S. And this doesn’t affect only cars, this is a widespread phenomenon. To avoid the huge tariffs, U.S. companies must “partner up” with Chinese firms who then proceed to strip their American counterparts from their valuable intellectual properties. This allows Chinese companies to catch up much faster and then effectively compete in global markets. This is only a small taste of how the U.S./China trade relationship is skewed much more towards China’s favor.

Source: TradingEconomics.com – As you can see the U.S.’s trade picture is not looking good, and since the majority of the imbalance comes from China, it is the logical place to start.

So, why should the U.S. remain at a perpetual disadvantage to China when it comes to trade? Right, it shouldn’t. Therefore, when President Trump talks about reciprocal, or mirror trade between the two countries it makes perfect sense. Maybe not to the Chinese, because who would want to give up such massive unfair advantages? But the bottom line is if the Chinese don’t like a more balanced trade relationship that is just too bad.

It’s like pulling off a band aid. Yes, it may be painful at first, but in the end, it simply must be done. Of course, the Chinese are going to make a fuss in the media. The strong man communist regime can’t simply stand by and do nothing while a U.S. president takes the punch bowl away. So, expect more economic saber rattling, and possibly some more volatility in the short term. But with a $375 billion trade imbalance, and the rules hugely geared towards China’s favor, it is ultimately China that has the most to lose here, not the U.S.

Possible Scenarios

There are several possible scenarios that could play out from here in relation to stocks.

Scenario 1: This is the correction retest. This could be a delayed retest of the correction bottom. In which case, we can expect an intraday move to around the 2,525 level in the S&P 500. Following the retest, we can expect a sharp rebound and a gradual move back towards the highs. The retest would probably occur within the next few trading days.

Scenario 2: The correction will deepen. We could be in for a more serious decline. Rather than the current 12% correction we could easily see something like a 15-18% decline. A correction of 18% from the highs would bring the S&P down to around the 2,350 level. Such a decline would essentially wipe out all the gains from the prior year.

Scenario 3: The correction will morph into something worse. It is possible that a bear market in stocks has begun. There is no denying it that stock valuations became lofty in recent months, and the current economic and political instability may be triggering a bear market in stocks to ensue. If this downturn transitions into a bear market, depending on its severity we can expect a decline of about 20-50% from the highs. This would take the S&P down to the 2,300 – 2,150, 20% – 25% in case of a mild bear market. And all the way down to the 1,437 level in case of a severe 50% bear market pummel.

Technical View

We can see that SPY has declined by roughly 7% since the recent high 2 weeks ago. The selling has increased in recent days and SPY now appears quite oversold in the short term. The RSI is at the extremely oversold 30 level, on par with the correction low. The CCI at -239 is also suggesting a very oversold environment. The technical image indicates that any further selling is likely to be met with a reflex of buying. We appear to be close to what will likely at least amount to a tradeable short term bottom. But if this correction is destined to turn into something worse the selling will resume once a short-term bounce concludes.

The Bottom Line

Markets are noticeably on edge, and the recent trade tariff tensions are clearly amplifying anxieties. Volatility ticked up notably last week, and many high alpha stocks have released some air. Moreover, this trend may continue until the current downturn gets resolved. Therefore, focusing on some rotation towards basic materials, energy, precious metals, defense, consumer staples, and other sectors that could outperform in the underlying environment may make sense here.

Ultimately, weather this is the correction concluding, continuing to play out, or the start of a bear market, remains to be seen. But despite the steep selling, I remain skeptical that we are in the opening stages of a bear market. Simply too many elements are pointing to this being an unlikely scenario.

Many of the economic numbers coming in look great and are not indicative of an imminent downturn in the economy. Moreover, there are various government stimuli such as tax cuts, government spending, deregulation, and other initiatives that have been introduced recently and are likely to produce additional growth going forward. Therefore, in my view this is still “just a correction” but it may be wise to implement a slight shift in investment strategy to protect prior gains.

Note: SA has introduced a new feature. Hit the “Like” button if you enjoyed reading my article! Also, feel free to hit the “follow” link to receive updates about my future ideas. Thanks for reading, hope you enjoyed my article, happy trading everyone!

Disclaimer: This article expresses solely my opinions, is produced for informational purposes only, and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please always conduct your own research and consider your investment decisions very carefully.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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 Some Schools Pay More Than Others When Buying From Apple

When administrators in Ohio’s Mentor Public Schools were buying MacBooks during the 2015-16 school year, the local Best Buy was offering a lower price than Apple, even after the company’s standard discount for school districts. Superintendent Matt Miller pushed for a better deal, but Apple said it would not budge from its price list. The company prohibits most third parties from selling new devices to school districts, so Miller couldn’t place a bulk order with Best Buy as a district official.

Frustrated at the thought of spending money he could use elsewhere in his budget, Miller devised an extreme workaround. He told Apple he would buy gift cards for each of his 2,700 high school students, bus them to Best Buy and let them purchase their own MacBooks. He threatened to invite local news outlets and create a media circus.

Apple backed down. While the company listed those MacBooks at $829 per device, it charged Mentor Public Schools $759 each, according to school officials. The 8 percent discount saved the district nearly $200,000.

Miller, now superintendent of the Lakota Local School District in Ohio, can be a bulldog at the negotiating table, but thinks he shouldn’t have to be. “I’m just tired of fighting that fight,” he said.

Miller is one of many vocal critics of the wide disparities in education technology pricing, which he and others contend is becoming an increasingly pressing problem as more devices and software enter U.S. classrooms. Almost 14 million devices were shipped to schools last year, up from 3 million in 2010, according to the market research firm Futuresource Consulting. Technology has become a vital component of teaching and learning, and it is considered a classroom requirement to adequately prepare students for life after graduation. The market research firm IDC estimates that $4.9 billion was spent on devices by K-12 schools in 2015, and the Software and Information Industry Association estimates that nearly $8.4 billion was spent on software.

Yet the same device or program can cost more from one state to another and even from district to district. Responsibility to negotiate with vendors falls on school districts that often do not have the time or resources to drive a hard bargain. Many also don’t have information about discounts that other school districts have received, and, when purchasing from a company like Apple, which has a reputation for being rigid with pricing, some district officials don’t even know they can ask for larger discounts.

The Benefits of Transparency

Although purchasing information is technically public, it is not widely disseminated and is rarely available online. School officials’ knowledge is often limited to the information they can get by calling colleagues in other districts — if they even have the time to do that. Some educators and advocates have begun to argue that more shared information and pricing transparency would help schools save money. The Technology for Education Consortium, a nonprofit formed to facilitate exactly that, estimates that school districts could collectively save at least $3 billion if they all got the best deals on hardware and software purchases. That’s nearly 23 percent of the total amount spent.

And there’s evidence that increased transparency works.

Efforts by the national nonprofit EducationSuperHighway to publicize how much districts pay for broadband have allowed many school systems to negotiate bandwidth deals to get greater capacity for a fraction of the cost. With school budgets stretched thin, even small deals on ed tech can make an impact.

“Every dollar saved for this necessary utility can and should be repurposed for the teaching practices that can improve education,” said Daniel Owens, a partner at The Learning Accelerator, a nonprofit focused on expanding blended learning in U.S. schools. “This is public money that should be used in the best possible way.”

Administrators at some schools buy their own tech; elsewhere, district officials handle the task. The negotiating process depends on the products that schools want. When buying specific software, administrators may have to purchase directly from one company. But they might be able to advocate for deals if they have a large order. Or, if they know a company has given discounts in the past, school officials can request a repeat bargain.

For some hardware, districts can comparison shop. To buy Chromebooks, the most-purchased device on the ed tech market, school districts can check prices from Google, Acer, Samsung, HP and others.

The Chromebook market is considered a buyer’s market; if school district purchasers don’t like a price from one vendor, they can try another. That’s all part of Google’s strategy to get into as many classrooms as possible. The company has held down the overall cost of Chromebooks, too, and schools have jumped at the opportunity to buy the devices at low prices.

Everything Apple produces, on the other hand, is proprietary. Many district officials say they are willing to pay more for what they call higher-quality devices that have greater functionality, last longer and have resale value even years later. But, with very limited exceptions, school districts must purchase Apple products directly from the company — the issue Ohio’s Miller ran up against. That policy, the rationale for which Apple officials would not discuss, ensures that Apple will not have to compete with others to make bulk sales to schools.

While purchasing scenarios differ from product to product, and exact comparisons can be difficult to make because of variations in things such as warranties and device memories, price disparities in product costs remain a constant.

Discounts Vary Widely

A Hechinger Report analysis of Apple purchasing documents from 75 school districts around the country found big disparities in prices on devices, warranties and professional development support. Five districts received double-digit percentage discounts, while dozens of others got no money off at all, even when making large purchases.

Many of the discounts uncovered by the Hechinger analysis came on iPad Airs in the year before Apple discontinued them. Some discounts came on accessories, AppleCare and teacher training. But even among those discounts, there was wide variation.

Apple officials declined to comment on discount practices and instead directed the Hechinger Report to the company’s published price lists.

In June 2017, Henry County School District in Georgia got $21,196 knocked off an Apple purchase of more than $3.2 million, a savings of just 0.66 percent. By comparison, in February 2016, Lawrence School District in Kansas got a discount of nearly 24 percent that dropped a $4.1 million bill to $3.15 million. Lawrence officials said that the person in charge of that purchase had left the district, and they were unable to explain the discount; many other districts said they had received discounts without knowing precisely why.

Northern Illinois’ Glencoe School District 35 got a 4 percent discount last winter when it spent almost $425,000 on hundreds of Apple products, including iPad Air 2s, MacBook Airs and iMacs. The district saved about $17,700 on its order, including $181 off each 10-pack of iPad Airs, which normally cost $4,530.

Superintendent Catherine Wang said that the 1,200-student K-8 district always asks Apple sales reps whether there is an education discount or a bulk discount available. But Apple’s sole-source policy limits the district’s bargaining power.

“We have zero flexibility with saying, ‘Oh gosh, we can get this from another vendor for $100 less, what can you do for me?’ ” Wang said. “There’s much less wiggle room with Apple.”

Others school districts don’t even ask.

Jeff Mao, who led the Maine Learning Technology Initiative for a decade, finds people working in schools tend to have a “defeatist attitude” when negotiating with vendors, often failing to ask for discounts in the first place. But, Mao said, schools can make particularly compelling cases for discounts. They are spending public dollars, for children, and they’re at the mercy of extremely tight budgets, after all. Even when he worked in a small district in Maine with just 3,000 students, Mao negotiated prices with Apple, securing a discount on his orders.

“No matter how big or small you are,” Mao said, “you have to push the idea that you are an educational buyer. You deserve a break, to some degree.”

Mao found that negotiating on the extras that came with the devices gave him the most room at the bargaining table as he brokered three successive statewide contracts.

To win the 2013 contract from the Maine Learning Technology Initiative, Apple had to meet a long list of needs relating to software as well as hardware. Mao said the company’s original bid didn’t include an app that would help students learn computational thinking, something he had asked for from the start. Mao argued that an additional app was necessary to meet the requirements of his request and pushed Apple to include it without increasing its per-device price. The company eventually agreed.

In another example from that same year, Mao and others from his team were on the phone with Apple representatives. Mao muted the phone so he could discuss an offer but then couldn’t unmute. He said his team’s silence prompted the Apple reps, who didn’t know about the phone problem, to lower their offer. Because of the fluke technological glitch, the final costs were even lower than Mao said he would have accepted.

Keith Madsen, director of technology at East Allen County Schools in Indiana, said he bargains on everything. Apple knocked 14 percent off a big order he placed in 2016, saving the district $425,000.

When it comes to software licenses, Madsen said he has seen prices drop 20 percent over the course of a couple weeks of negotiating.

“We’re always working on trying to get that license down as much as we can because obviously education has a very limited budget,” Madsen said.

Sharing Data

Many districts seem to miss out on the best deals for ed tech because they simply don’t know how little they could be paying. The Technology for Education Consortium (TEC) is attempting to change that.

According to the nonprofit, about 150 school districts have joined the group and are sharing their ed tech purchasing data.

The consortium’s review of iPad Air purchases in 2015 found that some districts paid as much as $115 more per device than other districts for the same model and warranty package. On Chromebook purchases, some districts paid up to $90 more for the same product and services.

And while hardware can be the starting point for educational technology, the bulk of district spending is on software. TEC found that, collectively, 95 of its member school districts bought 360 different apps, and prices on the most-purchased apps varied by 20 percent. In one extreme example, prices ranged from $4.97 to $7.54 per student for licenses for Accelerated Reader, a product of Renaissance Learning. A Renaissance executive said pricing decisions are complex, and influenced by factors such as timing and volume, but that the company supports the TEC’s efforts to increase transparency.

Brent Maas, director of marketing and outreach for the Institute for Public Procurement, a nonprofit association for procurement officials, is among those who consider more transparency to be the solution. With enough transparency, districts can establish benchmarks for prices and identify seasonal trends that impact costs. But this doesn’t always mean they’ll refuse to buy products for anything more than rock-bottom prices, he said, just as consumers might decide they’re comfortable paying $100 more for a TV in January than they would have paid on Black Friday.

“It’s about an agency identifying what’s their tolerance,” he said. “It’s hard to do that now because it’s difficult to achieve broad data.

“On the whole, I would say most folks are running somewhat blind. They’re doing the best based on what they know.”

Without a centralized place to look up how much peer or neighboring districts pay for ed tech, school district purchasers are necessarily limited.

TrueCar and Kelley BlueBook enable potential buyers to see very clearly how much a car is worth with a simple online search. Healthcare Bluebook does the same thing for medical procedures. And EducationSuperHighway brought pricing transparency to school district broadband purchasing.

“Creating that transparency was really the starting point for us,” said Evan Marwell, CEO and founder of the nonprofit. Being able to show that some districts were paying the same monthly price as neighboring districts but getting just a fraction of the bandwidth uncovered a hidden problem.

Now, with the organization’s free Compare & Connect K-12 tool, school districts can see exactly how much other school districts pay for broadband and compare it with their own contracts.

In addition to the Technology for Education Consortium’s work, districts in some regions are banding together to share their own purchasing information and capitalize on deals that their peers have successfully negotiated.

But districts need to be careful when looking at others’ purchasing information, said Karen Cator, president and CEO of Digital Promise, a nonprofit that supports education innovation through technology. The same product might come with different amounts of technical support or professional development help, for instance.

“You can oversimplify the situation by just simply looking at the price of the product from one place to the next because there’s so much else involved,” said Cator, who worked at Apple for 12 years. “Many times companies have a good reason for variations in pricing and sometimes they don’t.”

Because of that, though, Cator thinks the answer is to seek detailed and complete transparency about what exactly other districts bought and how much they paid. “You can see very quickly if you’re comparing apples and oranges,” she said.

Mao questions whether transparency will actually lower costs for school districts. He said there’s a chance that more companies will refuse to negotiate with schools, leaving them to pay higher prices overall. But Marwell, from EducationSuperHighway, said he heard the same concerns when he started advocating for price transparency in bandwidth purchases, and the worst-case scenarios haven’t materialized. Vendors have not colluded to charge more, he said.

For Miller, the Ohio superintendent, price disparities in ed tech purchasing are an equity issue. He hopes lawmakers will consider passing regulations that require companies to offer districts good deals. The federal E-rate program already does this for telecommunications companies that provide goods and services to schools, and the Federal Communications Commission has issued fines and sued companies found to be overcharging districts.

The bottom line, for Miller, is that something has to change.

“Technology is a great equalizer for kids across the country,” Miller said, “and, I think, to maximize that, school districts need to be on an even playing field.”

This story was produced by The Hechinger Report, a nonprofit, independent news organization focused on inequality and innovation in education.

Learning Curve

Southwest Airlines Thinks United and American Are Really Bad at Math (Here's How It Wants Them To Get Better)

Absurdly Driven looks at the world of business with a skeptical eye and a firmly rooted tongue in cheek. 

Four big airline groups  have the America’s skies largely to themselves.

They own more than 80 percent of all the available seats. 

And if you call what they do competition, then it’s not quite the NBA’s Western Conference.

So when any of the Big Four start kvetching at some of the others, it’s cause for fascination.

Last week, I wrote about how Southwest Airlines’ chief revenue officer Andrew Watterson described his rivals’ Basic Economy offering — featured, for example, by Delta, United and American — as “substandard products.”

This week, I hear of another, well, difference of opinion between Southwest on one side and United and American on the other.

As Skift reports, the Department of Transportation produces figures every year for which airline loses the most bags.

It has always been calculated by dividing the number of passengers that flew on the airline by the number of bags reported by passengers to have gone AWOL.

This is about to change, as it doesn’t really paint an accurate picture.

That’s because it doesn’t count all the bags that get checked at the gate, those that came from a different airline and those that get checked when you’re already on the plane.

So now the new math will involve dividing the total number of bags carried by an airline with the number of bags lost.

To a lay mathematical eye, it seems logical.

Southwest has a particular issue here.

Because it doesn’t charge for the first two bags, it often ends up with the most bags lost.

After all, when you can check bags for free, you’re more likely to,

Ergo, Southwest carries more bags than its rivals. On official tallies, that is.

And further ergo, there are more likely to be more customer reports of lost bags.

On United and American, which charge for checked bags, passengers are more likely to chance getting the bags on as hand luggage. 

If they don’t get away with it, those bags are checked, but not necessarily added to the official baggage tally.

So the DOT is asking airlines to install better equipment to make sure the baggage number is accurate.

You may enjoy this delicious quote from United and American offered to Skift: “No party has convincingly demonstrated that the government has a legitimate role in a deregulated industry of requiring airlines to report this service metric.”

Some might choose to translate this as: “It’s nobody’s business how often we lose passengers’ bags.”

And here’s Southwest’s view, offered to Skift by its senior attorney Leslie Abbott: “Right now, the metric is out of date and highly misleading. It compares two numbers that are unrelated to each other.”

Yes, the airlines are fighting over data, because they know that the data matters to some customers. 

Indeed, this all comes at a time when Airlines for America, a lobbying group that represents, among others, Southwest, United and American, is fighting to make it harder for customers to see data such as on-time percentage and cancellation rates of various flights.

Oddly enough, Southwest isn’t so magnanimous about all its data being given to consumers by every means.

It doesn’t share its fare data with third-party sites such as Kayak and Expedia.

You can only book on Southwest’s own site.

Still, it insists it’s better at math. So that’s something.

4 Habits of Ultra-Likable Leaders That Are Hard to Find

I often tell people that leadership is a journey. When you think you’ve arrived at the top of the mountain, look up. You’ll always find another peak to climb.

The truth about leadership is actually coming to terms with never arriving at an absolute truth about how to lead yourself and others — it’s an ever evolving process of learning and growing. And the best of leaders never stop evolving; their journey never ends.

As you journey down your own leadership path, consider some of the best lessons every good leader has learned to steer them to make good decisions and influence others. Here are four of them.

1. Every good leader turns away from arrogance.

Because society place so much value on external accomplishments, appearance, and self-aggrandizement, the virtue of humility is mistakenly viewed as soft or weak — it’s the skinny kid that gets sand kicked on him by the neighborhood bully. 

The Washington Post reports that, according to a 2016 College of Charleston survey, 56 percent of 5th and 6th graders believe that “the humble are embarrassed, sad, lonely or shy.” And when adults are asked to recount an experience of humility, “they often tell a story about a time when they were publicly humiliated.”

That’s the perception of humility. And nothing could be further from the truth.

Groundbreaking research by Bradley Owens and David Hekman, as reported by The Post,  concluded that a humble leader doesn’t believe success is inevitable. “He constantly tests his progress. He revises and updates plans, in light of new situations and information. Acknowledging he doesn’t have all the answers, he solicits feedback. He encourages subordinates to take initiative. He prefers to celebrate others’ accomplishments over his own,” states The Post.

That’s certainly a more accurate depiction which emphasizes the strength of humility, and as the researchers assert, it doesn’t weaken leaders’ authority. Rather, “it gives them more flexibility in how they use their power.” 

But here’s the thing: Calling oneself “humble,” however, is something a good leader cannot do; the very admission of it exposes them as potentially cocky. But I will say this — leaders with a humble disposition avoid the temptation of reacting from their bruised egos by wielding their positional power and weight for personal gain or to crush others. Instead, they draw from their inner strength, trusting in their integrity, self-control, and emotional intelligence to a different and better outcome.

2. Every good leader soaks up the wisdom of others.

Smart leaders stretch their knowledge beyond intellectual pursuits. They continually evolve by soaking up the wisdom of others, acknowledging that they don’t know it all. Remember this quote?

If you’re the smartest person in the room, you’re in the wrong room.

You must view yourself as a small fish in the great big pond of life — seeking out connections and appointments from those further down the path than you in order to master new things.

3. Every good leader practices patience.

A leader who practices patience and is slow to anger receives far less attention and acclaim than a charismatic leader with a commanding presence but a short fuse. Yet the former has the clear edge.

In one 2012 study, researchers found that patient people made more progress toward their goals and were more satisfied when they achieved them (particularly if those goals were difficult) compared with less patient people. 

Other research also found that patient people tend to experience less depression and negative emotions and can cope better with stressful situations. Additionally, they feel more gratitude, more connection to others, and experience a greater sense of abundance.

You can usually see through someone without patience because they tend to lack perspective and can’t stop their impulse from jumping into the worst conclusions. 

On the flip side, people who exercise patience have self-control — their conduct is steady, rational, and manageable. In conflict, they seek to understand first before being understood; they speak little — giving them a clear edge in communicating and diffusing someone else’s anger.

4. Every good leader is self-aware. 

In a study reported by Harvard Business Review, teams with less self-aware members substantially suffered; they made “worse decisions, engaged in less coordination, and showed less conflict management” as opposed to more self-aware individuals.

Self-awareness is crucial in leadership roles. They look at the whole picture and both sides of an issue. They tap into their feelings and the feelings of others to choose a different outcome to solving organizational or personal challenges.

Daniel Goleman, the foremost emotional intelligence expert, once said:

If your emotional abilities aren’t in hand, if you don’t have self-awareness, if you are not able to manage your distressing emotions, if you can’t have empathy and have effective relationships, then no matter how smart you are, you are not going to get very far.

China gives Baidu go-ahead for self-driving tests after U.S. crash

SHANGHAI/BEIJING (Reuters) – China’s capital city has given the green light to tech giant Baidu Inc to test self-driving cars on city streets, indicating strong support for the budding sector even as the industry reels from a fatal accident in the United States.

A Baidu’s Apollo autonomous car is seen during a public road test for self-driving vehicles in Beijing, China March 22, 2018. REUTERS/Stringer

Beijing’s move is an important step as China looks to bolster its position in the global race for autonomous vehicles, where regulatory concerns have come into the spotlight since the crash earlier this month.

The accident in Tempe, Arizona, involving an Uber self-driving car, was the first death attributed to a self-driving car operating in autonomous mode, and has ramped up pressure on the industry to prove its software and sensors are safe.

Beijing has given Baidu, best known as China’s version of search engine Google, a permit to test its autonomous vehicles on 33 roads spanning around 105 kilometers (65 miles) in the city’s less-populated suburbs, the firm said in a statement.

Baidu is leading China’s push in driverless technology, with Beijing keen to keep up with global rivals such as Waymo, the self-driving arm of Google parent Alphabet and Tesla. It has a major self-driving project called Apollo.

“With supportive policies, we believe that Beijing will become a rising hub for the autonomous driving industry,” Baidu Vice-President Zhao Cheng said in the statement.

Baidu’s Apollo autonomous cars are seen during a public road test for self-driving vehicles in Beijing, China March 22, 2018. REUTERS/Stringer

Two people close to DiDi Chuxing, China’s dominant ride-hailing company which is also working on self-driving, said earlier this week firms developing autonomous vehicles were not likely to slow down plans for testing and developing

“I am quite positive on the potential of the technology because autonomous technology makes vehicles far less prone to accidents than human drivers,” one of the people said.

Didi declined to comment.

Earlier this month China issued licenses to auto makers allowing self-driving vehicles to be road tested in Shanghai, which included Shanghai-based SAIC Motor Corp Ltd and electric vehicle start-up NIO.

Regulations in the sector are, however, still catching up with fast growth and increasing numbers of firms wanting to carry out tests on public roads.

Baidu Chief Executive Robin Li tested his firm’s driverless car on Beijing’s roads last July, stirring controversy as there were no rules for such a test at the time. The firm hopes to get self-driving cars onto the roads in China by 2019.

Baidu said that before conducting tests on public roads, autonomous vehicles using its Apollo system would go through simulation tests as well as trials on closed courses.

Reporting by Adam Jourdan and Norihiko Shirouzu; Editing by Stephen Coates

BlackBerry to provide software for Jaguar Land Rover EVs

(Reuters) – BlackBerry Ltd and Tata Motors Ltd’s Jaguar Land Rover (JLR) said on Thursday they reached a licensing agreement to use the Canadian company’s software in the luxury car brand’s next-generation electric vehicles.

FILE PHOTO: A Blackberry sign is seen in front of their offices on the day of their annual general meeting for shareholders in Waterloo, Canada in this June 23, 2015. REUTERS/Mark Blinch/File photo

BlackBerry will provide its infotainment and security software to JLR, in the Canadian firm’s latest licensing deal for its autonomous-driving technology after similar agreements with Qualcomm Inc, Baidu Inc and Aptiv Plc.

BlackBerry’s QNX unit, which makes software for computer systems on cars and has long been used to run car infotainment consoles, is expected to start generating revenue in 2019.

Its Certicom unit focuses on security technology and serves customers such as IBM Corp, General Electric Co, and Continental Airlines.

JLR, which was bought by the Tata group in 2008, said last year that all its new cars would be available in an electric or hybrid version from 2020.

Britain’s biggest carmaker said in January it would open a software engineering center in Ireland to work on advanced automated driving and electrification technologies.

Reporting by Ismail Shakil in Bengaluru; Editing by Amrutha Gayathri