Air travel – an overview

Includes US stocks AVAV, BA, CAR, DIS, GE, HTZ, IRDM, JBLU, LMT, MAR, RTN.
Disclosure: I’m long General Electric Company (GE), AeroVironment, Inc. (AVAV).

I’ve listed the headings on a separate page – Headings in “Air travel – an overview”. It might be useful for navigating.


• Annual growth of 4.1% in the global number of air passengers carried is predicted from 2014 to 2034.

• A variety of trends and factors supports the growth, from more Chinese tourists to the “free routing” of airplanes, but a number of risks could affect it.

• Growth in air travel increases revenue in many industries, but due to competition there are few where the money sticks.

• Out of many companies I looked at, I believe only Disney combines pricing power with reasonable safety.

• I have not researched the stocks in depth, and I hope to learn that more of them are safe and have pricing power.

Businesses that should benefit from increased air travel

JetBlue Airways Corp (JBLU) offer air travel with low cost but with good service and amenities. At least they did, according to “A New Era Has Begun for JetBlue, and Travelers Will Hate It” by Brad Tuttle, Nov. 19, 2014 ( According to a more recent article aimed at investors, the service and amenities are as good as ever, see “SWOT Analysis: JetBlue Airways Corporation” by Iason Dalavagas, June 29, 2015 ( But – “JetBlue starts charging for all checked bags” by Carl Surran, SA News Editor, Jun 30 2015 (

The policy of never cancelling flights backfired in 2007 when a snowstorm resulted in passengers waiting in a plane for 11 hours, only to have the flight cancelled. JetBlue are not likely to repeat the mistake, instead I see the incident as a general warning that marketing-friendly policies might be stuck to rigidly until experience teaches otherwise. There’s more company history on Wikipedia.

The Export-Import Bank has closed, meaning overseas airlines won’t get new planes subsidized by the U.S. government (find “Boeing’s Bank” below).

JetBlue look cheap on Morningstar with a forward P/E under 11 and Price/Cash flow under 7. Morningstar also show a high quality of fund ownership, giving five funds 5,5,5,4 and 0 stars out of a maximum of 5. Morningstar’s financial history shows that a double digit return on equity and on Invested Capital was only achieved in 2014 and “ttm”. The high leverage is the likely reason why double digit ROE is possible, given the single digit return on assets, which was below 2% from 2005 to 2012. The Operating Cash Flow has been much higher than operating income, but very high capex has resulted in erratic free cash flow, with big negative figures for 2005 to 2008. Although results have ticked up recently, I have not found a convincing reason why the future should follow the recent uptick rather than earlier financial history. If increased demand allowed JBLU to charge for all checked bags without the number of customers falling, sooner or later supply is likely to catch up with demand. My conclusion based on Morningstar’s figures and little research could be wrong, and the high quality fund owners could be right.

I have never researched airlines much because I believe they are likely to compete away any benefit to the industry. Warren Buffett has described himself as an “airoholic”, and said

    “Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.” (Berkshire Hathaway shareholders’ letter 2007)

Airports are more like unavoidable toll-gates. I found two companies domiciled in Spain with some airport ownership, I don’t like them much but I’ve written about them in “Aena SA – Spanish airport operator” and “Ferrovial SA – Spanish infrastructure company with an Airports division“. There are six other stocks in “Airport stocks list – none in the U.S.” (

Airbnb should benefit if air travel increases, but they are not likely to IPO on an attractive valuation, see “Airbnb raising $1 billion in new funding” by Sara Ashley O’Brien, June 18, 2015 ( Uber might benefit (and might have an IPO) but they face restrictions, e.g. “Uber Drivers Are Getting Into Trouble at DC Airports” by Eric Hal Schwartz, 02/25/15 ( This – “Ride-hailing firm Uber faces big challenges in China” is about the raids, protests and competition in China, which has not deterred Uber from making China their top priority, pushing growth by paying drivers more than the customer pays. See also “Uber Lands Big Chinese Backer“.

The stock of hotel and lodging company Marriott International Inc (MAR) has been volatile, with a sharp drop from $75.31 in May 2006 to a low of $12.63 in March 2009, then rising to $74.80 on July 3, 2015 with a P/E of nearly 28. The low in 2009 was reached without much competition from Airbnb which was founded in 2008. To be interested I’d need to learn a good reason why there will be no repetition of the previous 83% drop (or even half that), or of the negative net income and free cash flow from 2005 to 2008, as they don’t seem to offer the growth that would compensate for the risk.

For Walt Disney Co (NYSE: DIS) (Morningstar, Seeking Alpha) to be relevant here, there would need to be more tourists attracted to theme parks by cheaper flights or quicker journeys than are encouraged to fly abroad as an alternative to visiting a theme park closer to home. I expect that to be true, especially if tourism from Asia expands. A long term share price chart shows a low of $15.83 in March 2009, another low of $30.16 in September 2011, and fast share price appreciation up to $114.97 as at July 3, 2015. The fast rise may suggest waiting for a dip.

Warren Buffett said good things about Disney’s moat in this PDF – “Buffett Lecture at the University of Florida School of Business October 15, 1998” (, mostly about how Disney’s movies are a reliable choice for parents.

The company is excellent at merchandising, and the more characters and franchises they make money off, the more they can show in the parks (I needed this – “What’s the difference between Disneyland, Walt Disney World and the Magic Kingdom?“). The more movies are seen, the more tourists are attracted to the theme parks, and the more they make on rides. A good experience at Disneyland is likely to reinforce brand loyalty.

Apparently, not everyone that gets Disney wants Disney (BTW there was annoying junk on the page) – “Disney Targeted By Cable Bundle Critics In Campaign Urging More Consumer Choice On TV” by Christopher Zara, May 27 2015 ( They want Disney in China – “World’s largest Disney Store is forced to close just 1 HOUR after grand opening as eager shoppers queue more than a mile to get inside” by Emily Chan and Edward Chow, May 21, 2015 (

I see aspects of the product as including emotion, experience, utility (keeping kids out of parents’ hair) and digitized information. The mix, the reputation and the cross-selling might be good enough for a moat for a long time, but I don’t see it as guaranteed. Way back when music came on vinyl, copyright must have seemed like good protection – if the product was consumed, profit would be made. It doesn’t work like that now. Disney have not gone the way of record labels, but I can’t be 100% certain that the model won’t be undermined, although that might just be because I don’t know enough or understand enough.

CAR and HTZ are mentioned next, and AVAV, BA, GE, LMT and IRDM are mentioned where they are relevant, further down.

Car rental

Car rental revenue is likely to increase if the number of enplaned passengers increases. Avis Budget Group, Inc. (CAR), Hertz Global Holdings Inc. (HTZ), and Enterprise Rent-A-Car dominate the car rental market and the airport segment in the US. However, when a rental company has an on-airport concession, it has to charge fees with names like Customer Facility Charge or Airport Access Fee and give them to the airport. There are also off-airport concessions, with some disadvantage through inconvenience or dependence on the airport. San Francisco International Airport lists “off-airport rental car shuttle” under “Ground Transportation” here, and they will charge the “ground transportation providers” that provide the service.

Industry consolidation has led to this – “Rental-Car Chains Bask in the Power of Higher Prices” by Justin Bachman, August 06, 2014 ( Car rental companies compete to some extent with Uber, but some people might reject car ownership in favor of a mix of car-sharing, rental, Uber and conventional taxis.

Car-sharing is like rental but for only a few hours, in urban areas. Avis, Hertz and Enterprise all offer car-sharing, and synergies include demand at different times for rental and sharing. See “Avis to Buy Car-Sharing Service Zipcar” by John Kell, Jan 2, 2013 (, and there’s a useful insight into how big rental companies profit on disposals, in “Explaining The Avis Takeover Of Zipcar” by Tim Worstall, 1/02/2013 ( Generations used to streaming entertainment instead of buying and owning records or movies may be more open to the idea of car-sharing and other alternatives to ownership.

Hertz are at $17.25 (July 5, 2015) compared to a peak of $31.61, possibly due to this – “Hertz Global discloses another $30M in accounting errors” May 18 2015 (, and may be expensive with the forward PE around 20, although Morningstar gives a Price/cash flow ratio not much over two (as at July 3, 2015).

Avis may be a better investment, see “Avis Budget Group Set To Dominate U.S. Rental Cars” by Insider Monkey, May 28, 2015 ( Their US airport locations are listed here.

This – “Global Car Rental Market Poised to Hit US$ 106 Bn by 2020” (March 03, 2015) has a reasonable amount of info but they’re hoping you’ll want the full report. It’s positive about car rental at airports but it assumes the global economy will be good.

Given the fees airports collect from car rental, it’s possible that airports may be in a position to grab most of any benefit to car rental from increased enplanement, but that’s not a certainty. In fact it’s an interesting game theory problem – three rivals who compete but who also have the potential to benefit from cooperation are bidding to rent from not just one local monopolist, but a series of them. The ‘series’ makes the problem similar to a repeated game, and cooperation is higher in repeated games because there is more opportunity to punish cheaters. If an airport is squeezed too hard by the rental companies, it might be able to force rental customers to take a taxi or other transport to an off-airport car rental site, and make their money from the transport provider. In future, driverless taxis from Google could increase the competition to the advantage of airports, but domination by Google or further consolidation could follow. I have to stress I’m not accusing anyone of anything illegal, although collusion against airports would not excite much condemnation when the airports are using their monopoly position to add to the rental bill.

Imagine using an app to hail a driverless car. There are regulatory hurdles, but the possibility shows how the players need to be watchful and not let change pass them by. In contrast, there isn’t much car makers and dealerships can do about car sharing and driverless taxis eating into car ownership, and they’re on the wrong side of the discounts which big fleet buyers get, which may explain “Ford Jumps Into the Car-Sharing Pool With Pilot Program” Jun 24, 2015 (

I mentioned how consumers used to streaming instead of buying might see less need for ownership generally. The change in attitude is likely to spread from the US, but it’s hard to say how long it would take for the desirability of car ownership to fade in China. Maybe more people need to be able to afford cars before ownership becomes a less important aspiration.

The hospitality market

See this 36 page PDF from Ernst & Young – Global hospitality insights – Top thoughts for 2015. “Outbound investment from Asia” starts on page 10, the outbound hotel investment from Asia reached nearly 42% of the global total and it may continue to rise.

Asian tourists are not getting the service they want from western hotels, and that’s especially true for Chinese tourists – “The Services Chinese Tourists Want, But Aren’t Getting, From Western Hotels” by Eliza Ronalds-Hannon, Skift ( See also “The new chinese traveler is on the move and combines business and pleasure“, which mentions that Chinese tourists abroad have little interest in gambling.

Airport hotels could be next investor targets” by Jan Freitag, June 27 2014 ( – The chart of ADR (Average Daily Rate, the rental of occupied rooms) shows a rise, but it had not recovered to the peak reached in 2008.

PWC’s near-term forecast for annual growth in revenue per available room (RevPAR) in the U.S. is 7.0% for 2015 and 6.1% in 2016.

This piece about San Francisco, “2015 hospitality forecast: Hotel room shortfall puts damper on tourism boom” by Annie Sciacca, Jan 2, 2015 (, shows that a shortage can develop which is good for hoteliers but bad for tourism. Investors are put off by low occupancy following the DotCom crash and the financial crisis. Normally I’d say that investors would get over it and invest, or over-invest, but awareness of Airbnb will be very high in San Francisco.

From this piece “PKF Hospitality Research Issues Consistent U.S. Lodging Forecast” June 4, 2015 ( it’s possible to infer a long-run average growth in US RevPAR of 3.4% to 3.6%, with twice that predicted for 2016 and 2015.

PWC’s “Room for growth: European cities hotel forecast for 2015 and 2016” does not give overall figures for 2015 and 2016, but Dublin is expected to lead with a near 9% increase in RevPAR for 2015. The tone is generally positive, but with a warning that competition is hotting up, and Airbnb is mentioned. One factor is the use of robots and other advanced technology, partly to reduce costs (see “Starwood Introduces Robotic Butlers At Aloft Hotel In Cupertino” by Jordan Crook, Aug 13, 2014 (

Consultants can get it wrong, at least in India – “Bankers reluctant to fund hoteliers as projections go awry” by Anita Bhoir & Varuni Khosla, Dec 10, 2014 (

I found no long term projections for the hospitality industry.

Tourist arrivals

UNWTO, the United Nations World Tourism Organisation, has published it’s free booklet “Tourism highlights, 2015 Edition” (PDF). UNWTO use a broad definition of tourists, saying 53% of international tourist arrivals were for leisure, compared to 14% for business (27% were in a broad category including visiting family, pilgramages etc.). They expect global tourist arrivals to grow 3.3% a year between 2010 and 2030, reaching 1.8 billion. I don’t know why a 2015 edition needs to start a projection from five years ago. For emerging markets, the projected growth is 4.4%, double the 2.2% projected for advanced economies. The global figure is lower than IATA’s projection for air passengers carried, although the periods are different as well as the item projected (IATA forecast 4.1% average annual growth from 2014 to 2034).

The 2.2% for arrivals in advanced economies is lower than I’d expect from the pieces I’ve linked to about tourism from China. UNWTO describe China as already being “the world’s top tourism source market”, and their spending abroad increased by 27% in 2014.

International tourist arrivals grew from 25 million in 1950 to 1,133 million in 2014, averaging 6.14% pa, but with major dips. In the same period, the receipts which destinations earned grew from $2 billion to $1,245 billion, averaging 10.58% pa. Assuming that’s not adjusted for inflation, I multiplied the 1950 figure for receipts by 9.80420 to get 19.6084, and the growth in real terms is 6.70% pa. (I used moneychimp and’s Inflation Calculator.)

The trend is for more overnight visitors to travel by air, with 54% by air for 2014, and 39% by road.

The interplay of hospitality, airlines and airports

Increased competition in hospitality is bad for margins in hospitality but good for airlines and airports.

Increased competition in airlines is bad for margins in airlines but good for hospitality and airports.

Other factors such as cheaper fuel costs or less fear of terrorism feed through to benefit all three industries.

It’s harder for airports to compete with each other, possibly because major cities already have airports and it’s not easy to get agreement or permission for another one.

Airport proximity

I found some airports close to each other on “What are the two closest airports to each other in the world?“. There are two airports only 1.7 miles apart in the Orkney Islands, Scotland – Westray Airport and Papa Westray Airport (the links are to Wikipedia). The scheduled flight time between them is two minutes, including taxiing. The two closest airports in the US might be Chignik Fisheries Airport and Chignik Lagoon Airport in Alaska. Those four airports are tiny. Zorg en Hoop Airport (small) and Johan Adolf Pengel International Airport (bigger) in Suriname, the smallest sovereign state in South America, are only 4.6 km apart.

While airports can be close, they don’t proliferate to the point where oversupply makes earnings crash, whereas in many capital-intensive industries, capacity increases until there’s a glut. Bankruptcy is still possible – Ciudad Real Central Airport in Madrid went bust after three years. It’s been alleged that the investors benefitted from construction contracts and never expected the airport to be viable. “14 of the world’s most amazing abandoned airports” has seven U.S. cases, not all civilian or international airports. One airport was attacked by a submarine.

An airport can be a natural monopoly, rather like “one town, one local newspaper” was for towns of the right size before the internet, but that isn’t a requirement for pricing power. London in the UK is served by three airports –

London airport ~ passengers in 2014 ~ distance from London center

Heathrow ~ 73.4 million ~ 14 miles
Gatwick ~ 38.1 million ~ 29.5 miles
London City ~ 3.6 million ~ 6.9 miles (smaller planes only)

Even with three airports, London is still so short of capacity that the mayor backed a proposal to put an airport on an estuary island, which would have cost £70 bn to £100 bn ($111 bn to $159 bn). The project, known as ‘Boris Island‘, has been rejected.

Other airport considerations

Privately owned airports are likely to be restricted by regulation which means they can’t increase landing fees to maximize their local monopolies (e.g. at Heathrow Airport near London). Disputes over landing fees in the U.S. seem to have been partly settled in 2008 – “Federal policy will let airports charge landing fees” 1/15/2008 (, with airports allowed to base fees on time and traffic volume. The piece expressed the hope that eastern airports close enough to be alternatives to each other would compete on landing charges.

When I looked for material about competition between US airports, all I found was this – “The Decline and Fall of the U.S. Airport” by Patrick Smith, January 24, 2015 ( It’s mostly about long waits caused by the entry procedures for travelers arriving from overseas, even if they’re in transit to a third country. The same author wrote “Cockpit Confidential: Why International Business Travelers Avoid U.S. Airports” in May 28, 2013, opening with a survey by CNN that showed a substantial minority of business travellers to the US would not visit again or recommend visiting, due to the procedures. Monopolies have their limits, and for routes of equal distance travelers prefer to go the other direction around the globe to avoid a stop-off in the US. The list of taxes and fees collected by the government (e.g. “Federal Segment Fee”) indicates that airports don’t keep the monopoly benefits all to themselves, although US airports tend not to be privately owned so all the fees go to one level of government or another.

I’ve only checked reviews for two airports, and picked on Orlando. Orlando Airport scored five out of ten in customer reviews on, with many complaints about immigration control. The smaller Orlando Sanford Airport scored seven out of ten.

It’s not hard to find material about competition between airports in Europe, but I didn’t find anything very good. This book promo – “Airport Competition: The European Experience” indicates that it’s a complex and subtle issue, and there must be substantial natural monopoly benefits to airports or there would be no need to review the debate in a book, or for a reviewer to asset that competition “can and does exist”.

Non aeronautical sources of revenue have been increasing, and increased traffic results in more revenue from parking, transport (ground based), rental cars, retail and duty-free, see “How Do Airports Generate Money? New Study Shows Nearly Half Comes From Non-Aeronautical Sources” by Christopher Harress, November 18, 2013 (

Air freight, FedEx and UPS

The same costs that affect passenger transport generally affect freight, with implications for FedEx Corporation (FDX) and United Parcel Service, Inc. (UPS). Two recent articles are – “FedEx: Down But Not Out” by Daniel Jones, Jun. 22, 2015 ( and “United Parcel Service – Will Deliver Returns As The Economy Expands” by Khen Elazar, Jun. 9, 2015 ( Investors need to decide if size gives the companies a moat, and if crowdsourced delivery is a threat, see “Amazon eyes crowdsourced delivery service” Jun 16 2015 ( and “I Just Tried Uber’s New Delivery Service ‘Rush’ And It Got Me My Package In 20 Minutes” by Alyson Shontell, Oct. 23, 2014 ( (There’s also UberEATS.) Obviously it’s harder to crowdsource delivery over longer distances, across borders or over seas. The companies ought to benefit from the trend for shopping online.

I have not studied Fedex or UPS in any depth, but they have defined benefit pension schemes and I expect they have employed many staff over the years without very high productivity. Both companies now use “mark-to-market” for the accounting, and maybe I ought to be reassured by this piece – “Five years of mark-to-market pension expense reporting” by Bob Collie, June 10, 2015 (, which explains that the method is transparent, at the cost of volatility.

Risks to the air travel industry

Air travel is vulnerable to economic downturns, war, terrorism, satellite failure, accidents, strikes, weather and volcanic ash clouds (see “Air travel disruption after the 2010 Eyjafjallajökull eruption“). See also “Cyber-Attack Warning: Could Hackers Bring Down a Plane?” ( This may have been Nato jamming during a military excercise, but they weren’t commenting – “Dozens of aircrafts briefly vanished from Europe radar” Fri, 13 Jun 2014 (, attributed to “Guardian”). Satellite failure is covered in links under “Satellite communications” below.

I have not said much about recent tragedies because I don’t think they have seriously affected the air travel industry generally. Malaysia Airlines were technically bankrupt and are relaunching, which is mentioned in “Malaysia Airlines plane makes Melbourne emergency landing” June 12, 2015 (

The world economy faces a few problems. In emerging markets, there’s around $9 trillion of dollar-denominated debt which could trigger a ‘flight to safety’ of capital to the US, pushing up the US dollar and making the debt harder to repay. The risk was a theme of mine until I judged the media had caught up enough and the dollar had risen enough to highlight currency risks, although I learned I was way behind the economists Worth Wray and John Mauldin. See “Feeling green – Debt-ridden emerging markets are heading for a nasty dollar hangover” Mar 21st 2015 (

IMO Greece is too small to have much effect on the European or world economy, but it may provide the spark for a big drop in stock or bond prices, given the generally high valuations, or it may spark a ‘flight to safety’. For example Greece owes Turkey over $30 billion (from “A Week of Unseen Things”, below). The Greek drama could make markets notice and start a flight of capital from Turkey and then maybe other emerging markets. I’m not saying that’s likely, I’m using it as an example of possibilities that are hard to predict. Some people believe that reduced liquidity in the bond markets increases the risk of a collapse. IMO liquidity is likely to dry up in any crash, as no-one wants to buy the ‘falling knife’. The Fed would probably react with Quantitative Easing, or if interest rates had been raised, lowering them again. With the EU now doing QE, they are likely to do more in extreme circumstances.

Also IMO, if Greece or any other country leaves the Euro (the European common currency), twenty years is long enough for recovery from the shock, and the common currency may do more harm to inefficient members than it benefits the exports of efficient members like Germany. Air travel does not seem to be very sensitive to the world economy, find “only a short-lived slowdown in the growth of passengers carried from 2007 to 2009” below.

Readers have probably heard enough about Russia, but maybe not so much about territorial disputes in Asia. This piece – “Territorial Disputes in Asia Show Sovereignty Still Matters” by Francesco Mancini, July 8, 2013 (, starts with a fisherman who was killed by Philippine coastguards, leading to outrage in Taiwan, sanctions, and cyber attacks in both directions. The scale is far below Russia’s invasion of parts of Georgia and Ukraine, but it may show a tendency for national pride to cause outrage and a refusal to back down or apologise. I’d guess that escalation is possible but unlikely.

This – “Dormant and Unresolved Border, Land, and Maritime Disputes in Southeast Asia: a New Threat For ASEAN?” is a fairly dull list of academic research abstracts, with only one conflict with casualties (Thailand vs Cambodia), but it claims a “multitude” of dormant and unresolved disputes that could threaten stability. That isn’t reflected at all in Wikipedia’s List of territorial disputes.

China has extensive claims in the South China Sea based on maps with dashed lines, the earliest of which was published in 1947 according to Wikipedia. There are recent articles relevant to the claims on nine-dashed-line (, and see “Images show Chinese airstrip on man-made Spratly island nearly finished” by Dean Yates, Thu Jul 2, 2015 (

The Japanese occupation of Korea is still a live issue, e.g. “Korean sexual slavery victim to hold protest rally in front of Japan’s embassy in Washington” 2015-06-27, even though South Korea and Japan are both threatened by North Korea. About sites from Japan’s industrial revoluation – “Korea objects to heritage status for Japan’s World War II ‘slave labour’ sites – by Donald Kirk” The Independent, May 26, 2015 ( Japan and Korea won’t fight a war over their differences, but old issues between East Asian countries could make an effective alliance against Chinese ambitions harder to achieve, or harder to achieve soon enough, which could encourage China to pursue claims more aggressively.

In “Chinese Nationalism: The CCP’s ‘Double-Edged Sword’” by Jessica Chen Weiss, November 25, 2014 (, the author/interviewee argues that Chinese demonstrations of nationalist anger are genuine and not the result of party manipulation. Japan is a popular target. When Vietnamese protests over an oil rig led to the killing of Chinese workers, China did what it could to keep its population calm, because their strategic objective had been achieved and there was no point in inflaming the losers.

Probably no-one wants a war, given the economic consequences and the danger of escalation to nuclear levels, and I don’t mean to imply that a major war in the region is likely.

Europe isn’t free of internal tension, for example “Serbia asks Russia to veto UN resolution that calls Srebrenica massacre ‘genocide’” July 4, 2015 ( There’s tension over Greek debt, with occasional reminders about the forgiveness of Germany’s debt, see “Greece and Spain helped postwar Germany recover. Spot the difference” by Nick Dearden). Even so, for most of the countries a border incident or military conflict between them is about as unthinkable as for the US and Canada.

The United States vastly outspends other countries on defense. From Wikipedia, for 2013, in billions –

US $640.2
China $188.4
Russia $87.8

Even so, with threats, trouble or tension around Russia, the Middle East, and East Asia, the US could become overstretched.

air passengers carried after 9-11 terrorism

Air passengers 1990 to 2013

The chart is based on figures taken from or derived from a table provided by the World Bank. I calculated “North America” by adding the figures for the USA, Mexico and Canada, and according to Wikipedia I missed out a lot of countries (see “Spreadsheets” below).

air passengers carried - short
Air passengers 2014 to 2034

The data used for the next chart was taken from the press release “New IATA Passenger Forecast Reveals Fast-Growing Markets of the Future“. IATA forecasts 4.1% average annual growth in air passengers carried globally from 2014 to 2034.

There are problems with the data. It’s imprecise, for example the figure of 2.9 billion passengers for Asia-Pacific in 2034 only gives one decimal place, and corresponds to a range between 2,850 million and 2,950 million (minus one). The full report is likely to be more precise, but it costs $2,500. The problem is compounded because in most cases I had to subtract the projected increase to get the 2014 figure, and for Europe I had to work from only the increase and the annual growth rate. Using imprecise figures in calculations leads to even less precision. The categories don’t look the same as for the historic data in the previous chart, with “Asia-Pacific” instead of “East Asia & Pacific”, “Middle East” instead of “Middle East and North Africa”, and “UAE plus Africa” instead of “Sub-Saharan Africa”. It’s not surprising that the chart is not continuous with the chart up to 2013, but the implied drop in the total from 3,973 million to 3,167 million is 20.3% and may be due to a major difference in methodology.

The figures in the forecast are for flights “to, from and within”, although that’s only stated for Asia-Pacific. It means a flight from one region to another will be counted in both regions (and presumably a return journey will be counted again). Passengers flying from the US to China can be US travellers to China or Chinese tourists returning home. It doesn’t make much difference to plane makers, airports etc but it makes a big difference to businesses in hospitality, attractions, car rental etc., if they are not equally represented in both countries. Increasing Chinese air travel is at least consistent with the “surge in tourists and other visitors to the US” (from China) which I mention later.

IATA is the trade association for the world’s airlines. While readers should consider that IATA may not be impartial, the forecast was made with a subsidiary of Oxford Economics, who claim “Oxford Economics continues to outperform other global forecasters, August 2013“. The reliability of almost any twenty-year forecast is doubtful. The inputs from demographics are probably more reliable than the assumptions about economic growth, which may have been optimistic to get the forecasted 4.1% global growth in air passengers carried. However, my charts show only a short-lived slowdown in the growth of passengers carried from 2007 to 2009, while the financial crisis was severe, and recovery from the recession that followed was slow. There has been no shortage of bad news from Europe since then, also concern about China’s debt and slowing growth, and demand for commodities cooled, affecting many emerging economies, yet the passengers kept flying in increasing numbers since 2009.

I applied a smooth growth rate to get from the 2014 figures I calculated to the 2034 figures.

There is more information in the press release. Under “Explanation of demand drivers” there are paragraphs for “Living standards”, “Population and demographics” (population decline in Japan, Russia, and Ukraine, rapid growth in Africa), and “Price and availability”. There’s no mention of terrorism, war, or the kind of sub-war conflict that could affect flights. Although a reduction in the real cost of air travel is forecast at around 1% to 1.5% pa, it’s my impression that they have probably not fully factored in the potential of “free routing” aircraft across the skies (see below), but find “Price and availability” in the release and see what you think. It’s unlikely they’ve factored in any benefit from holographic radar (see below). There’s also this PDF from the FAA – “FAA Aerospace Forecast Fiscal Years 2014 – 2034“.

air passengers carried 2014 to 2034
Air passengers 1970 to 2034, log chart

A slowdown from 4% growth to 3% growth might not be clear in a normal chart, but when the logarithm is charted it would show up more clearly as the gradient becoming less steep. The top half of the chart shows the discontinuity between the World Bank’s figures which end at 2013, and IATA’s projections which start at 2014. In the bottom half I shifted IATA’s lines up so they joined with the World Bank’s lines. Because I used base 10 (for the logs), an increase of 1.0 represents growth by a factor of ten, e.g. from 7.0 to 8.0 (7.0 means 10,000,000 – with 7 zeros, and 8.0 means 100,000,000 – with 8 zeros). The scale is marked in steps of 0.2, and each increase of 0.2 in the log represents an increase of 58.5% in air passengers carried.

air passengers carried 1970 to 2034 - log
Air passengers, stacked chart

Because the regional figures are for flights “to, from and within” the regions, there will be double counting in the totals represented by the heights of the stacks. The implied totals are good for the percentages in the charts. In other words, without the double counting in the total, I would expect the percentages for each region to add to more than 100%. At least, that’s the theory. My “stacked” total for 2034 is 7.0 billion, but IATA project a total of 7.3 billion for 2034. The difference could be due to the problems with the data I mentioned above, in particular the rounding error of figures to only one decimal place, compounded by further calculation. I have not included every warning about the data in every chart.

air passengers carried 1970 to 2034 - stacked
Air passengers, China, US, India, UK and Brazil

I forgot to say the scale is in millions.

top countries air passengers 1970 to 2034
IATA’s growth figures and the 2034 top 9

Extracted from their press release, average annual growth in passenger flights 2014 to 2034 (to, from and within regions and countries) –

    Total 4.1%
    China 5.5%
    Asia Pacific 4.9%
    Middle East 4.9%
    Africa 4.7%
    Latin America 4.7%
    North America 3.3%
    US 3.2%
    Europe 2.7%
    Japan 1.3%

Predicted top 9 countries for flights in 2034 (by traffic to, from and within) and movement from 2014

    1 China – up from 2
    2 United States – down from 1
    3 India – up from 9
    4 United Kingdom – down from 3
    5 Brazil – up from 10
    6 Indonesia – new in the list
    7 Spain – down from 6
    8 Germany – down from 5
    9 Japan – down from 4

Trends and factors affecting air travel and transport

• Tourism and travel from Asia
• The low oil price and other cost reductions
• Free routing

In more detail –

Tourism and travel from Asia

Increased tourism and travel from Asia and especially China is likely if economic growth continues and discretionary income increases as a result. China’s rebalancing from an investment-led economy towards consumption and the private sector should favor growth, spending and travel in the long term, but the huge amount of debt in China could cuase problems.

The Top Chinese Travel Trends to Watch for in 2015” by Rafat Ali, Skift, Dec 24, 2014, ( One prediction is a surge in tourists and other visitors to the US.

I found no evidence of a large number of Chinese tourists heading to Las Vegas. My searches turned up “$4 billion Chinese-themed resort coming to Vegas” and Vegas casino operators with casinos in Macau. Macau (Google map) is a region near Hong Kong with an area of 11.6 sq miles and high population density, which could limit the scope for casinos to expand. For comparison Las Vegas is 135.82 sq miles and the metropolitan area is 83 sq miles.

This piece makes five optimistic predictions – “What will 2015 Bring for Chinese Tourism in the United States?” by Avery Booker, 06 January 2015 (, about the US vs Europe, investment, mobile devices, a mobile ‘chat’ app, and individual tourists.

Value Retail are a private company but they have an interesting business model, selling discounted luxury goods through nine shopping villages in Europe and one in China. They sell to shoppers who want discounted luxury brands and who demand a luxury environment that does not feel like a dumping ground for surplus stock. Shoppers who have travelled thousands of miles particularly value the experience as much as the discount (even if they fund the trip by selling purchases back in China). Brands occupy space in the villages and pay a percentage of sales to Value Retail. The model minimizes the damage that discounting can do to brand image. They followed the principles and predictions of retail guru Marvin Traub, which are in this PDF from 2008.

It looks like Value Retail know how to exploit China’s retail tourism – “Value Retail promotes shopping tourism with Chinese airline partnership” by Staff reports, June 5, 2015 ( – it’s a kind of mutual promotion, or cross-selling between different companies. See also “CEO Talk | Scott Malkin, Chairman, Value Retail” June 5, 2013 (, which says quite a lot about Chinese shoppers.

China’s retail tourism could be hit by this – “China cuts import taxes to boost consumer demand” 25 May 2015 ( Unilateral tariff cuts might seem un-Chinese, but outbound retail tourism costs their economy more than importing the goods, and it’s possible that more tax will be collected in total, even with lower tariffs. The effect will be good for luxury goods makers, and bad for air travel.

Not too worried – “Another Glimpse Into China’s Debt, And Where It’s Heading” by Kenneth Rapoza, 5/29/2015 (

More worried, but about financial zombification rather than a crisis – “The great hole of China” Oct 18, 2014 (

There’s an ebook with the snappy title “A Great Leap Forward? Making Sense of China’s Cooling Credit Boom, Technological Transformation, High Stakes Rebalancing, Geopolitical Rise, & Reserve Currency Dream”, where the contributors are mostly pessimistic but not all of them (on Amazon). Here’s a long synopsis by co-editor John Mauldin.

The bank HSBC are considering moving their domicile from the UK to Asia, possibly to Hong Kong. If they aren’t bluffing to influence UK policy, they are likely to have a positive outlook regarding Asia, and with their large business in the region they should be well placed to judge the prospects. The Guardian’s article about it only considers the politics and regulation in the UK.

Because stock prices could conceivably have a wealth-effect on spending, I’ve linked to “A Week of Unseen Things” by John Mauldin, July 4, 2015 (, find “Shanghai Falls to Earth” in it. More Chinese are piling into stocks but as momentum traders rather than value investors, and the likely result over time is stocks going higher but with volatility and sharp pullbacks. Previously I heard about Chinese investors spending less so they could buy into the bubble, which is the opposite of the usual supposed wealth effect, although I can’t substantiate the story. You can get a chart of the Shanghai Composite Index from 1996 on the link by choosing “all data”. It shows that the peak in 2007 has not been surpassed (as at June 30, 2015).

Chinese stock valuations are highly uneven, there’s room for quality stocks to go up while the crazy valuations fall, and as investors take advantage of liberalisation, Hong Kong stocks could rise as Shanghai stocks fall.
See “Opinion: China’s Stock Connect: More boom and bust?” by Craig Stephen, Apr 12, 2015 (

A high dollar is not good for incoming tourism. One point to consider is that dollar strength tends to go with low commodity prices, including oil.

One of China’s aims is to make the Remnimbi a reserve currency, challenging the US dollar, but the aim might not be compatible with the growth they want. Reserve currency status seems likely to make the remnimbi higher than otherwise, by increasing demand for the currency. A high remnimbi makes tourism from China more affordable.

It’s been projected that half of the world’s cruise passengers will be from China by 2020, see “CSSC joins race to build China’s first cruise ship” ( In the US, 49% of cruise passengers were aged 50 or older (in 2011), but Chinese cruises are expected to attract younger passengers and families.

Using rough historic approximations, assuming 300 ocean-going cruise ships averaging 2,000 passengers each, guessing 10 days per cruise (so about 37 cruises per ship per year), I get 300 * 2,000 * 37 = 22,200,000 passengers per year, compared to 3,972,988,179 for air travel in 2013 (from summing the World Bank’s table). That’s about 22 million cruise passengers and 3,973 million air passengers, or 181 air passengers for every cruise passenger. I don’t expect cruise holidays to have much effect on air travel.

The low oil price and other cost reductions

The benefit of the lower oil price is passed on to passengers through competition by airlines, and the low oil price could lead to increased discretionary income and more travel (although some employment is favored by a high oil price). Technology such as lighter, stronger materials and more efficient engines (helped by 3D printing) increases the fuel efficiency of aircraft (although the planes and engines aren’t cheap).

In the U.S., the cost of extracting unconventional hydrocarbons is still coming down. Efficiency has been increasing with experience, which is one of the features of extraction from shale that makes it more like manufacturing than conventional extraction. The next link explains it better than I’ve ever seen before – “The Shale Boom Shifts Into Higher Gear” by Donald L. Luskin and Michael Warren, May 31, 2015 ( The fact that shale oil is front-loaded (i.e. a well peaks early) has been seized on by writers who call shale production a “Ponzi scheme”, which seems like a loaded term to apply to unconventional production, although the financing may be another matter.

There is still controversy over how much can be extracted, but there’s also the possibility of applying the techniques in other parts of the world. In “Govt Report Says Shale Oil Will Run Out Soon, Start Drilling Offshore” Mar 26, 2015 (, the government’s pessimistic view is disputed. Also, “Shale oil and shale gas resources are globally abundant” January 2, 2014 (

The cost or benefit to a company of short term movements in the oil price depends on how much of the impact is hedged.

There’s been much talk of growing algae to make aviation fuel, but Solena Fuels and Velocys plc (VLS.L) (I’m long VLS.L) are pioneering a “biomass-to-liquids” process, see “GreenSky London site selection” about the production of aviation bio-fuel scheduled for 2017. Solena claims to sell fuel at spot prices with no subsidies. The customer British Airways has committed to buy at long term market competitive rates, which may be lower than the suppliers initially expected. It’s possible that the technology could become cheaper once it is established. The partnership lags behind China’s Sinopec and Hainan Airlines – “China commercial flight uses Sinopec bio-jet fuel” 25 Mar 2015 (

Sorry, Everyone, Making Fuel Out of Seawater Isn’t Gonna Save Humanity” by Martin Robbins, April 19, 2014 ( is about the mis-reporting of the Navy’s demonstration of a “fuel from water” process. The author is right that the media is hopeless at reporting such stories accurately, and right in pointing out that the methane by-product is a potent greenhouse gas. There’s actually nothing surprising about being able to turn one form of energy into another (except for ambient temperature heat, see “Maxwell’s Demon” for the physics), and in this case electrical energy was turned into chemical energy – the energy unlocked when fuel is burned. The conversion efficiency matters (and the by-products), but the volume of water required is probably not very important because no-one cares much about the water produced when fuel is burned. If a suitable region has surplus electric power for some periods, it may be economic to use it to make fuel, depending on various factors.

The cost of solar photovoltaic energy is falling, roughly in line with Swanson’s Law, a kind of solar power version of Moore’s law. The installation costs are likely to be stickier. To compete more broadly with oil, intermittent renewables need more affordable energy storage, which might still be some way off, and batteries with higher energy density would help the take-up of electric vehicles.

If you google “solid state lithium ion batteries” (without the quotes), you’ll find big names like Google and Toyota in the research race. I’ve also read that Apple are in the race and General Motors have had some kind of involvement. The U.S. startup Sakti3 seemed to emerge from nowhere, and U.K. appliance-maker Dyson have invested $15 million in them. (I’m long Ilika plc (IKA.L), who are in the race.) Tesla, the high-end electric car-maker, is building a ‘Gigafactory’ to make conventional li-ion batteries for use in vehicles and the Powerwall home battery unit, and Elon Musk (of Tesla) obviously does not believe that new technology was worth waiting for.

The cost of stored renewable energy will put a ceiling on the price of fossil fuels, and the cost will come down, in the same way that the cost of shale oil puts a ceiling on the oil price, and the cost of extracting shale oil is coming down.

The low price of oil means aviation fuel is cheap, but the relation could conceivably change in extreme circumstances. In theory, if demand for the other fractions of crude oil falls, aviation fuel would get more expensive. In the simple case of two products A and B with production of them in a fixed ratio, increasing demand for A will mean more of B is produced and B will usually be cheaper as a result. Similarly, less demand for A makes B more expensive, and more demand for B makes A less expensive. The economics is more complicated for fractions of oil, partly because the fractions produced can be varied by using heavier or lighter oil, and by cracking or coking. This image for the fractions of crude oil is from “Getting gas from Crude” by Heading Out, March 13, 2006 (, and is available under a Creative Commons license.


This … “General Electric Bids its Fuel Efficient Future on 3D Printing” by Theo Valich, July 15, 2014 ( is about ‘printing’ fuel efficient nozzles. 3D printed parts can also be lighter, because the best design might be lighter and too complicated to make by conventional methods. (Whole jet engines have been 3D printed, but only two copies of an old engine that were put on display.)

While cheaper oil is good for air travel which is good for sales of planes and their engines, the lower oil price reduces the benefit of fuel efficiency, making it harder to sell expensive fuel-efficient aircraft, according to “Lower Jet Fuel Prices Shake Up Aircraft Market” by Robert Wall, Jan. 19, 2015 ( General Electric invested in oil & gas at the top of the market, and the WSJ’s “Shake Up” piece implies a risk that the low oil price will hit sales of GE’s efficient engines. However, recent sales news has been good – “GE Aviation tallies $19 billion in engine deals at air show” by Chelsey Levingston ( There’s a piece I like about GE’s tech opportunities – “Big Data, The Industrial Internet, And How GE Stands To Profit” by Adam Stockmeister, Jun. 23, 2015 (

Against GE, there’s a history of underperformance with the share price of $26.78 (on July 3, 2015) well below the price of $41.40 on Sept 28, 2007. There’s also a lot of debt, which will be reduced due to the divestment of financial operations, but they’re having problems closing a big acquisition (Alstom, it’s French), while the disposal of Electrolux has hit regulatory opposition. GE’s unions won significant improvements in wages, healthcare and pensions, see “GE Announces Details of Proposed Labor Contracts” June 24, 2015 ( They might expect another good deal in four years time. GE were a top-ten beneficiary of export subsidies that have ended, find “Boeing’s Bank” below.

Boeing Co (BA) contradict the WSJ’s “Shake Up” piece – “Cheaper oil to boost aircraft sales, Boeing official says” March 2, 2015 (, emphasizing the effect of cheaper fuel on increasing air travel.

Boeing’s 787 Dreamliner has attracted some sensational headlines, such as “Boeing 787 software problem could lead planes to fall out of the sky”. Further investigation shows the problem was quickly solved with a software update. I like the headline “Turn your Boeing 787 off and on again, or it will crash”, but for an unsensational overview I suggest “ANALYSIS: After three years in service, how is 787 performing?” by Stephen Trimble, Nov 14, 2014 ( Apparently, airlines have tolerated various glitches because they like the fuel efficiency. Al Jazeera have been highly critical of the 787, see “Review: Al Jazeera’s 787 Report Misses the Mark” by Vinay Bhaskara, 9/10/2014 ( I’m not reassured by the author’s claim that it’s hard to find any major industrial plant without drug use. Boeing claim to have standard drug-testing procedures. I checked the titles of articles on Seeking Alpha back to Sept 11, 2014, they are mostly positive, and the few negative titles I saw were not concerned with safety.

Competitor Airbus Group SE (EPA: AIR) has also had incidents. On Wikipedia, the four incidents involving the A320 family in 2015 can be summarized as: murderous co-pilot (fatal), wind shear (injuries), loss of height (unexplained) (injuries), and landing accident (no-one hurt). About a military Airbus driven by compter-controlled propellors – “Fatal A400M crash linked to data-wipe mistake” by Leo Kelion, 10 June 2015 (

Boeing subcontracted sub-assemblies for the 787 to various suppliers, it was supposed to reduce costs but the cost reductions have been slow. The 787 is expected to break even this year. The company has good cash flow, but the accounting is complicated – “Boeing 787 unit loss declines, but deferred costs rise” by Stephen Trimble, Apr 22, 2015 ( Those deferred costs were for production and the amortization of tooling, and they rose to over $30 billion. A deferred cost is an expense that will be recognised later, which is accounted for as a notional asset. The notional asset gets wiped when the cost is paid (or recognized as paid, on the books). The $30 billion of deferred costs will hit income as they are recognised. Boeing’s half-a-trillion dollar backlog should keep the cash coming in, but the deferred costs could build up with it. I suggest doing your own research in the area before investing a lot in BA.

“Boeing’s Bank” has shut – “Export-Import Bank Closes: Kill Subsidies To Cut Federal Liabilities, Promote Economic Fairness” by Doug Bandow, 6/30/2015 ( The ‘bank’ provided finance at below market rates (for $67 billion of Boeing’s sales over seven years), and took on the risk of non-payment. From the article (page 2) it looks like the financing was not a major factor in closing sales, so if there was any rush to buy Boeing before the bank closed, it was probably not a stampede and not likely to have a massive effect on future sales. Other agencies to promote exports remain.

Boeing and Airbus have been fighting each other over subsidies for years, see “Boeing warns Airbus over reports of state aid” by Russell Hotten, 17 June 2015 (

This is about how China is struggling to make commercial airliners, and the author’s reasons are rooted in the technical complexity of a modern airliner and the organizational complexity of making them – “Can the Chinese Create a Competitive Commercial Aviation Industry?” by Thomas Duesterberg, Jan/Feb 2015 ( The Dreamliner seems to have been a struggle for Boeing, which I put down mostly to the size of the challenge rather than any fault of the company.

Airbus in China” ( is best read after the previous link. A cynic might say it’s about how Airbus are giving China their technology and know-how, undermining the future of European and US aircraft manufacturing.

Free routing (next) could mean fewer planes are required for the same number of passengers carried.

Free routing

Flight along legacy air corridors means inefficient zigzagging, and there are moves to bring routing into the twenty-first century.

Free flight” Sep 6th 2014 ( is about the prospect of new technology allowing pilots to “free route” and choose direct routes when possible, with the potential of quicker journeys and lower costs. Direct routes increase the ‘useful miles flown’ per day with no increase in the cost of fuel, aircrew pay, maintenance, or other overheads except for the cost of the new technology. Trajectory-based routes include altitude, and instead of ascent, level, ascent, level, descent, level, descent (etc.), a smoother route in the “height” dimension adds to the effieciency.

One company The Economist mentions is Indra Sistemas SA (IDR:Soc.Bol SIBE), a diverse Spanish consulting and technology multinational which includes developing air traffic management systems (on their “Air traffic” page).

There’s also a promo which summarizes “Free Routing” on “New Space to Fly” Dec 3, 2014 (click “More”), but to download the radio program you probably have to be in the UK (and you’ll need to download the BBC iPlayer).

The US has its “Next Generation Air Transportation System” (Wikipedia) aka “NextGen”, which will also allow the selection of direct flight paths. Implementation started in 2012 and should be complete by 2025.

Security is not mentioned in the Economist piece about free routing. The Wikipedia piece about NextGen in the US only mentions that crucial signals are “unencrypted and unauthenticated”. The signals are ADS-B (Automatic Dependent Surveillance Broadcast). The paths involved are from transponders in airplanes to other airplanes and to air traffic control. The transponders receive a time signal from GPS satellites from which they calculate their position, which is then transmitted.

I’d say that the more automated a system is, generally the more damage can be done by hacking it. A system which manages too much is more likely to have unforeseen glitches, and hopefully the authorities know what change and what pace of change is safe. If a dynamic automated system operates safely in the air, it could strengthen the case for allowing driverless cars and coordination of their operation on the ground.

One problem with global roll-out is that many Air Navigation Service Providers run systems that are behind the capabilities of modern aircraft, and the focus in air traffic management is on encouraging upgrades to allow harmonization and interoperability. That might need to be complete in a region before starting a program of radical change (the world’s nine regions are mapped here).

I’m guessing that another inefficiency exists which technology could fix – when a flight is cancelled, there will be newly available slots for take-off and landing. These are likely to be wasted quite often unless the cancellation is a long time in advance, either because the information system can’t cope, or because people prefer to play safe and stick to the filed flight plan, or stick to the plan to avoid the stress and effort of making a new plan within a tight deadline.

Free routing increases the capacity of airplanes to carry passengers between airports (i.e. more flights per airplane per week), and closer spacing between aircraft increases the capacity of the airspace. If those capacities increase, the effect on an airport depends on various factors (these are fairly abstract and complicated) –

• In principle, an airport with excess capacity which is limited by the capacity of the airspace would benefit the most, but in practice there’s no reason to have provided the excess capacity in the first place.

• An airport at around full capacity which can increase its capacity (e.g. by adding a runway) would have the opportunity to increase passenger volume.

• ‘Second choice’ airports (further from a city or other destination) get the leftovers, and volume depends on the capacity and pricing of their more convenient competitors in relation to total demand for flight to the destination.

• If an airport and its airspace both have excess capacity, there’s no benefit from increasing the capacity of either.

• If the infrastructure is not a constraint, a city can handle a lot of visitors and departures, but a resort will have limited capacity and too much expansion could ruin the experience.

Although fairly complicated, that’s still a simplified version because it ignores time (the difference between peak and off-peak times at airports) and geography (airspace could be congested to the north but not to the south). There are also sub-cases such as where spare capacity becomes a shortfall, and the statements are rough rather than rigorous.

All of those considerations could have some effect on hotels, attractions, conference centers etc. Negative effects only seem likely on a local level, if an airport becomes stranded because a nearby airport can handle more traffic.

The more efficient use of planes will mean lower sales of planes, engines and other parts, unless air travel increases by enough to compensate. Lower costs and increased capacity from free routing and associated upgrades will help to increase air travel, and airlines, airports, car rentals and hospitality will generally see higher volumes than otherwise. Airports may be best placed to capture the cost benefit, but it depends on regulators allowing it.

Rail can sometimes compete with air travel and transport, and while trains obviously can’t “free route”, there is scope for information technology to allow the spacing between trains to be reduced, increasing capacity without needing to lay new track. They’re talking about it in the UK, and working on it in Australia, see “Advanced Train Management System” ( Lockheed Martin Corporation (LMT) are best known for expensive jet fighters, see “Pentagon’s ‘Too Big to Fail’ F-35 Gets Another $10.6 Billion“, but their “What we do” list is diverse enough to include biometrics and robotics.

Existing flight management

Software has already made flight planning easier, see “SkyDemon Flight-Planning Features“. The system is visual, and a route can be made by setting waypoints, and then edited for example by dragging, which will be needed if a warning is generated that the flight goes through restricted space. The feature suggests that at least a degree of free-routing has already been implemented, although NextGen is not due for completion until 2025. Journey time and fuel use are displayed.

Flight plans can still be submitted on forms filled in manually, and you can download a flight plan form (PDF) here.

According to Wikipedia’s “Flight plan” page, for domestic flights a flight plan should be submitted at least one hour before departure, and for international flights, the minimum is up to three hours before departure. Those are recommendations, and it’s possible for a flight plan to be submitted after take off.

The existing systems are already sophisticated, but so far as I can tell, if a change in the weather means that a different route would be more fuel efficient or avoid delay, the pilot is likely to stick with the flight plan that’s been filed, rather than go to the trouble of having a more efficient flight plan calculated and submitted. BTW if severe weather threatens safety, an airplane will usually turn back or be routed around it. In “AirAsia QZ8501: Plane crash blamed on weather“, it’s reported the pilot requested permission to climb to avoid bad weather. Big modern planes have weather radar that usually allows problems to be seen in time, but sometimes (rarely) pilots can under-estimate the risk or make mistakes when conditions get worse quickly.

TRACON stands for “Terminal Radar Approach Control” and a TRACON handles the descent and approach to an airport, usually for more than one airport. A TRACON jurisdiction is divided into sectors with a controller for each sector. The controllers in the TRACON have radar view of all the sectors and can easily communicate with the other controllers, which allows a smooth transition from one sector to another. According to, there is not the same communication between TRACONs, and as a result some routes are longer to preserve safety. Presumably that restriction will be phased out under “NextGen”.

For more background see Wikipedia’s “Air traffic control“.

Holographic radar

The Economist’s piece about Free Flying describes the limitations of existing radar. While radar might never be as accurate as positioning by satellite, using satellite signals depends on systems in the plane as well as the satellite. If there’s an incident or failure on the plane, or if anything such as a solar storm affects the satellites or the ability to pick up the signal, good ground radar is needed. The good news here is that ground radar has just got better.

When Russian jets fly dangerously close to airliners in the Baltic, the Russians don’t respond to radio or give the normal transponder signals that would give position data. The usefulness of ground radar in tracking uncooperative jets depends on how stealthy the jets are. However, it’s been suggested that the military pass on some of their radar surveillance data to civilian air traffic control, which implies that the jets are detectable by radar (see “Free route aspirations face rogue jet threat” below).

Holographic radar has been pioneered by Aveillant, a privately owned spin-off from Cambridge Consultants in the UK. According to the sales blurb – “What makes Holographic Radar different?“, Aveillant’s “static staring” system is on target 100% of the time, compared to under 1% “dwell time” for scanning radars. For decades, engineers have focused on squeezing more info out of that 1%. Previously, radars collected too much information to process effectively, and they operated by electronically filtering out the least useful info. Aveillant’s founders say they realized that advances in digital technology meant the filtering could be avoided.

This – “Aveillant pioneers win industry accolade” by Aimee Turner, November 28 ( explains the technology fairly simply, and I’ll quote – “it observes the complete airspace”. It confirms that Aveillant have overcome a key problem – telling a wind turbine from a plane.

There’s more about the technology from suppliers Boston Limited – “NVIDIA GPUs and Supermicro UK servers fuel Aveillant’s Holographic Radar™” January 13, 2014 (

This is the most comprehensive piece about the tech – “All-seeing EYE” May 6, 2015 (

The radar is good for knowing the position and velocity of drones, which could favor their civilian use.

Aveillant’s CTO is making a 45 minute presentation at the Military Radar Summit 2015 (agenda), on “Holographic RadarTM – Target Centric Surveillance”.

Satellite communications

About satellites and safety – “SB Safety installation marks flight deck comms revolution” 14 August 2014 (

About satellites and broadband – “Honeywell partners on advanced in-flight connectivity system” Apr 14 2015 (

Satellite providers angling for new business in air-traffic changes” – More frequent reporting of airplane position will allow them to fly closer, i.e. not so far ahead or behind each other. The increased traffic allowed will be good for airport business, though for a single airport it depends on how often capacity is reached, what limits capacity, would an extra runway be feasible, etc. Demand from aviation for satellite services looks likely to grow in the long term, although it will drop whenever flights or miles flown drop.

The first two links refer to Inmarsat, a UK company which I’ve put on the “Airport stocks list”. A US stock could benefit from the same demand –

Iridium Communications Inc (IRDM).

The forward P/E is under 10 (as at July 3, 2015). Morningstar’s financial history page shows –

Operating cash flow about twice earnings (very roughly).
Capex about twice OCF.
The returns metrics are poor single digit figures.
Income has grown quickly but the rise in the number of shares means that EPS does not show a clear growth trend.

Iridium depends on successful launches for cash flow to cover interest on debt. I have to give credit to slboomer and 2tired2talk for their comments about launches, cash flow and debt under “Betting Against Beta With Iridium” by Celan Bryant, May 4, 2015 ( An obvious point is to be sure IRDM have good insurance before investing in them ahead of critical launches. I don’t know if it’s possible to insure every aspect of deployment. Iridium’s big investment could make life tough for competitors. I’ve checked that two European projects won’t compete – the European Data Relay System will relay satellite data to ground stations by laser, and the EU Sentinel satellites will monitor the earth and the data will be freely available.

See “Iridium NEXT — Iridium’s second-generation global satellite constellation“. It’s probably just coincidence that Iridium use “NEXT” and “second-generation” while “NextGen” (above) is the big Air Transportation System upgrade. Iridium talk about “truly global mobile communications on land, at sea and in the skies”.

Getting back to satellites in general –

GPS and the European equivalent GALILEO are provided by governments, but it’s a key part of products and services from Iridium and many other companies.

Why satellites fail?” by Marryl Azriel, March 7, 2013 (

What would happen if all satellites stopped working?” by Richard Hollingham, 10 June 2013 ( Air travel is one of the casualties. The author does not seem certain about the far-reaching consequences, and maybe few people if any know for sure.

Satellite insurance” (Wikipedia)

This is of historical interest, it’s a long slow-burner but the tension gets high – “Elon Musk’s Space Dream Almost Killed Tesla” by Ashlee Vance, May 14, 2015 (

3D radar

This is just to give some idea of what radar can already do (i.e. non-holographic radar). 3D radar has applications in weather monitoring, air defense, surveillance and the imaging of underground structures. Some links –

3-D Radar of Mystery Object That Hit Louisiana” by Staff, 10/16/2012 (
Acquisition of 3d-Radar – Chemring Group PLC” about mapping underground structures
British fleet’s new radar system can detect a supersonic tennis ball 25 km away” by David Szondy, March 19, 2013 (

Other staring radar

My amateur guess was that Aveillant’s holographic radar could not do the tennis ball trick (in the previous link), because the best way to pick up a reflection from a small distant fast-moving object is to focus a lot of energy on it, even if it’s only for a short time as the object intercepts a swept focused beam. However, the private South African company Reutech has demonstrated a staring radar array which they claim is good for detecting and tracking small fast-moving projectiles. It’s good at discriminating between projectiles and complex clutter, which seems similar to Aveillant’s radar being able to tell wind turbines from planes. Although developed for military applications, Reutech claim possible applications in automotive, mining and security.

Possible radar losers

It’s possible that staring radar threatens part of some companies’ defense revenue, such as Raytheon Company (RTN). I stress ‘part of’, e.g. Raytheon look well positioned with their expendable drones (which cost about $400,000 each, but as they’re launched from aircraft to jam enemy radar, they wouldn’t be as cheap as surveillance drones).

Thales SA (HO:Euronext Paris) supply air traffic management systems ( They combine radar and non-radar for surveillance, which may provide some protection from Aveillant’s radar, and they should benefit from the need to upgrade the CNS infrastructure (communication, navigation and surveillance) to support free routing and associated improvements. See also “Thales launches STAR NG, revolutionary new ATC radar with specific dual civil/military applications“. The name “STAR NG” rather suggests “staring”, as in Aveillant and Reutech’s staring radar. The picture looks like it’s of a directional radar, but there’s no caption to say exactly what is pictured. The radar is an “S-Band Primary Surveillance Radar (PSR)”, a kind Aveillant claim their holographic radar is superior to.

This is better than Thales’ sales spiel at explaining the need for integrated civil/military surveillance – “Thales’ STAR NG heralds primary renaissance by Aimee Turner, June 15, 2015 ( The immediate problem is (probably) Russian jets flying close to passenger aircraft over the Baltic Sea, as described in “Free route aspirations face rogue jet threat” by Aimee Turner, June 24, 2015 ( I’m not sure how free routing aspirations are threatened, as uncooperative aircraft can fly just as close to planes in an air corridor as they can to free-routing planes. The article says the jets were close to the EU region’s borders, but the European Commission says –

    “Apart from two areas under Russian sovereignty at the far end of the Gulf of Finland and off Kaliningrad, the Baltic Sea is now under the jurisdiction of European Union Member States.”

Keying “russian jets in ” into Google’s searchbox gets a list of prompts with continuations such as English Channel, American airspace, Irish airspace, Alaska, etc. That only shows what people have been searching for, but I checked for the English Channel (between England and France), and found “UK scrambles jets as Russian planes and ships spotted“. IMO using relatively cheap drones to fly dangerously close to Russian jets might be effective (when they are not close to airliners), as it’s clear who would have the most to lose in a collision, but I can’t be sure about feasability and the likely responses from Russia need to be considered. In any case, wherever there are uncooperative jets it will be easier for Thales to sell their integrated civil/military surveillance, but I’m not tempted to buy the stock due to the possible impact of Aveillant’s radar.

AeroVironment, drone maker

AeroVironment, Inc. (AVAV) makes drones and charging stations for electric vehicles. Most of AVAV’s drone business is military, but IMO the opportunity is (or was) in civilian drones.

Data from the EU Sentinel satellites (linked to above) will be free, requiring only registration. For applications where Sentinel’s spatial resolution of 10 m in the visible spectrum is good enough, observation drones might not get the business, although they have the advantage of being able to fly under clouds and as frequently as needed. The satellite’s resolution will not be good enough for the inspection of infrastructure like roads and pipelines.

AVAV have been concentrating on the upmarket “Enterprise” segment of the civilian drone business, but there’s a strong hint in this – “AeroVironment (AVAV) Timothy Conver on Q4 2015 Results – Earnings Call Transcript” Jun. 30, 2015 ( that they will enter the consumer drone business (find “consumer appetite” in the transcript), bringing some kind of technological advance to the market.

The consumer market seems like an easy one for anyone to enter and likely to become highly competitive and low margin. AVAV should probably have entered the market earlier rather than later. If they have an advantage that transfers to the consumer market, I can’t see it. “The 7 Best Agricultural Drones on the Market Today” by Andrew Amato, 1, 2014 ( has the “Lancaster” drone from PrecisionHawk at number 3, with LIDAR among other features, and there’s no mention of AVAV. There’ll be more drones on the farm as restrictions ease – “Why 2015 is the year agriculture drones take off” by Clay Dillow, May 18, 2015 (

In “Drones Revolution Means Big Data Cloud Services” by Colin Snow, February 18, 2014 (, the president of PrecisionHawk imagines analytics app-stores. That has me thinking, should AVAV be developing an analytics app-store, will they put out their own apps, and will they be late again.

Military drones, Shaving costs” Feb 17th 2014 ( In short: AeroVironment’s Raven – $76 thousand, University of Virginia’s Razor – $2 thousand. The two drones won’t be exactly comparable, and control through a smart phone with apps does not sound secure.

Management are keeping the cash generated by the business to fund growth, and the cash needed to fund growth depends on how opportunities develop. It’s good that management realise growth is a marathon, not a sprint (my cliche, not management’s).

The financial history on Morningstar is poor. The return metrics have declined since 2006 to pathetic levels, with return on assets, equity and investment all below 1% for fiscal 2015. However, the metrics are based on income, and the operating cash flow and free cash flow have been much higher than operating income for the past three years.

Overflight Fees

One reason for a plane to sometimes avoid a direct route is the overflight fees charged by government agencies (overflight means ‘flies over a country without taking off or landing in it’). The FAA‘s fees look like they go up every October, and they’ve gone up from $43.82 in 2012 to $56.86 in 2014 (per 100 nautical miles). At least it’s simple, unlike the algebra on Eurocontrol.

Every country has the right to deny overflight but there are agreements between countries to allow it, usually under the “Freedoms of the air” (Wikipedia) framework. “Freedom” should not be confused with “no fee”, as the deals to allow overflight also allow a fee to be charged. The fees have to be “reasonable”, which can mean the same fees as for domestic airlines, but the reasonableness of fees can still be disputed.

Russia did not sign up to the “Freedoms of the air”, but they still allow overflights (usually), and earn about €300 million a year from European airlines. They’ve threatened to stop foreign overflights, but it would hurt them more than the airlines according to “Russia’s Still Not Quite Getting These Trade Sanctions Things; Now It’s Overflight Rights” by Tim Worstall, 9/09/2014 ( I’m not so sure. Russia doesn’t seem likely to ban overflights by Chinese airlines, or any airline based in a country which has not hit them with sanctions. I’m not sure that European countries could do much if their airlines complained about competitors having the advantage of overflying Russia.

Greece is probably well positioned (literally) to collect overflight fees.

Exotic air passenger transport

IATA’s forecast to 2034 has something missing – “London to Sydney in just two hours? By 2030 travellers will jet the world on a 13,750 mph spaceship” October 2, 2011 ( Unfortunately, in November 2014 Virgin’s spaceplane broke apart after prematurely deploying “feathers” that were meant to slow the descent on reentry, and prevent burning up in the atmosphere. I’d guess if anyone has the will and resources to persist through such an ambitious project, it would be the Chinese government, and success would enable them to leap ahead without the expense of working up to a dreamliner. Their “humans in space” capabilities are covered in Wikipedia’s page about the Tiangong-1 space station.

Passenger airplanes that look like stealth bombers would have lower drag and better fuel efficiency, if they can solve problems like yaw (horizontal rotation) and where to put the windows – “Northrop Grumman’s Futuristic Flying Wing Cribs From its Past” by Jason Paur Gear, 01.25.12 (

Electric planes are a long way from being commerical. This plane can fly for up to an hour, and I imagine serious range anxiety.

Solar Impulse have already broken the record for non-stop solo flight with their 118 hour flight from Nagoya in Japan to Hawaii. The solar plane is a sophisticated piece of engineering, but there are practical problems in applying the principles to commercial aircraft. The plane had the wingspan of an Airbus but only carried the pilot, so a purely solar airliner is not feasible. Putting solar cells on airliner wings means less fuel is burned to generate electricity, but the cells and the bonding to the wings would need to be very strong because damage would produce drag and airlines like to keep maintenance needs as low as possible. There’s the question, would and should the minimum safe fuel requirement be reduced to take account of the solar energy generated.

Facebook have test-flown a prototype solar powered drone with an airliner’s wingspan and a car’s weight.

The Autonomous Human Drone Taxi” ( The hanging seat is probably too scary for most passengers. Although it’s only ‘proof of concept’, adding a cabin would increase the weight. It might suit applications like supplementing emergency response in remote areas, rather than city use, if the necessary range is achieved.

Links to gurufocus

Altman Z Score (bankruptcy risk)

AVAV safe, BA grey, CAR distress, DIS safe, GE distress, HTZ distress, IRDM distress, JBLU grey, LMT safe, MAR safe, RTN safe

The score indicates the risk of bankruptcy within two years, with a “grey” zone between the distress zone and the safe zone. It ignores cash quantities because they were not usually disclosed when the test was invented, but it has had good statistical support many years after its invention. Professor Altman’s later test is available, for a fee. Like all financial tests that I know of, the Altman Z only considers figures in the main accounts, i.e. nothing off the balance sheet. If your favorite stock is in the distress zone, check the table of history which gurufocus put at the bottom. If it’s been in distress every year since 2005 without bankruptcy or other failure, the indication has been false for at least 8 years.

Beneish M-Score for earnings manipulation


Lockheed Martin (LMT) are reported as being an earnings manipulator, but gurufocus did not complete the calculation so the result should be ignored. The M-Score is unreliable (I don’t mean the calculation by gurufocus) and if a company fails it, further investigation could show there’s no real problem.


These are on Spreadsheets used for “Air travel – an overview”. I have not reproduced the data from the World Bank’s tables. It’s probably easiest and safest to check my work by reproducing it from the sources, find “was taken from the press release” and “taken from or derived from” above.

To get the historic data in similar categories to the forecast data, I had to calculate the air passengers carried for North America. I did that by adding the figures for USA, Canada and Mexico. That missed out a number of countries, mostly Carribean or Central American, at least according to Wikipedia’s list (find “Countries, territories, and dependencies”). As a result, the historic totals are under-reported in my spreadsheet and charts. That’s in the wrong direction to explain the discontinuity between the historic data and the projected data, which shows as a drop from 2013 to 2014.

And finally …

You’ve probably heard of ‘Lawn chair Larry’ (Darwin awards). This YouTube video takes 39 secs before getting to Larry. There’s also “On a high: Adventurer becomes first person to cross Channel in chair attached to helium-filled balloons” by Vanessa Allen for the Daily Mail, 29 May 2010.

Thank you for reading this.

DISCLAIMER: Your investment is your responsibility. It is your responsibility to check all material facts before making an investment decision. All investments involve different degrees of risk. You should be aware of your risk tolerance level and financial situations at all times. Furthermore, you should read all transaction confirmations, monthly, and year-end statements. Read any and all prospectuses carefully before making any investment decisions. You are free at all times to accept or reject all investment recommendations made by the author of this blog. All Advice on this blog is subject to market risk and may result in the entire loss of the reader’s investment. Please understand that any losses are attributed to market forces beyond the control or prediction of the author. As you know, a recommendation, which you are free to accept or reject, is not a guarantee for the successful performance of an investment.

Ubiquiti Networks – charts up to Q3 2015

Disclosure – I’m long Ubiquiti Networks, Inc. (UBNT).

Closing price May 22, 2015: $30.46

The company and the business model

From the company’s 10-K – “Ubiquiti Networks develops high performance networking technology for service providers and enterprises.” The service providers are typically Wireless Internet Service Providers (WISPs). “Our technology platforms deliver highly-advanced and easily deployable solutions that appeal to a global customer base, particularly in under-networked markets.” Manufacturing is outsourced, resulting in low capex. Sales costs are low as the company relies on an internet forum/community to evangelise the products, which allows disruptive pricing, while the pricing encourages the evangelism. Headcount is low and Ubiquiti are able to concentrate on R&D.

About this piece

This is an update to my previous piece, “Ubiquiti Networks – charting volatile revenue” February 18, 2015 ( I’ve written less in this update, making it easier to refer to the charts while accessing other material. I recommend reading this – “Ubiquiti Networks’ (UBNT) CEO Robert Pera on Q3 2015 Results – Earnings Call Transcript” May. 7, 2015 ( The CFO had left and only the VP of Investor Relations accompanied the CEO.


I’ve used 10-Qs and 10-Ks from the company’s SEC filings page.

Revenue and earnings

Ubiquiti revenue and earnings to Q3 2015 and Q4 guidance

In the next chart I’ve fitted trend lines, and the chart includes an explanation of why I don’t trust them for making projections. That tends to be my general attitude regarding trend lines fitted to financial results. If you want to get results such as “Standard Error of Slope” online, you can use the Linear Regression Analysis page on The Chinese University of Hong Kong. You’ll need to navigate via “Data modelling” and “Linear Regression”. Although the chart’s scale is in millions, the formulas are based on thousands, and that’s true for all the trend lines in this piece. There’s more about statistics in the blog post I linked to at the top.

Ubiquiti revenue and earnings to 2015 E

Ubiquiti margins to Q3 2015

Ubiquiti margins to 2015 E

Cash flow

“Cash from operations” includes changes in working capital which can sometimes be volatile. The investing cash flow accurately represents capex, consisting of only “Purchase of property and equipment and other long-term assets”.

Ubiquiti quarterly cash flows to Q3 2015

Ubiquiti quarterly cash flows per share to Q3 2015

Revenue by regions

Ubiquiti quarterly revenue total and by geography

The R-squared value of 0.753 means the trend line explains 75.3% of the variation in total revenue. The next chart uses the same data, but drops the total and puts trend lines on the regions.

Ubiquiti quarterly rev by geog with trends

Product types

Ubiquiti quarterly revenue by product type stacked

My data for the current two product types starts from Q1 2014, and growth since then has been slower. Adding the coefficients in the trend line formulas (below) gets 3056.000-39.607 = 3016.393, which implies about $3 million growth in sales per quarter, which is about 2.0% based on Q3 2015 sales of $147,456 thousand, or 8.4% annually (although projecting an annual growth rate would contradict the assumption of linear growth implied by the trend line). The growth between Q1 2014 sales and Q3 2015 sales works out to $2,962 thousand per quarter, which is very close to the growth implied by the trend line formula.

Ubiquiti quarterly revenue by type with trends

Correlations between regions and between product types

The charts in this section help to answer the questions, how closely do sales in the regions move together, and how closely do the product types move together.

The data for regions runs from Q1 2012 to Q3 2015, and the general direction in the charts is from the bottom left to the top right. The slope of each trend line is given by the number in front of “x” in the trend line formulas, for example “0.524x” in the next chart means that for every dollar sales increase by in EMEA (Europe, Middle East and Africa), sales in North America increase by $0.524, on average, according to the line fitted.

The slope does not depend on the units (whether the data is in thousands or millions of dollars). The constant 6927.608 in the next chart implies that sales in North America would be $6,927.608 thousand (i.e. about $6.9 million) if sales in EMEA were zero. I do not regard that figure as accurate or meaningful, however I decided against forcing the lines to pass through the origin, which is sometimes done when there’s a good reason to believe that variables have an underlying relationship which is strictly proportional.

Ubiquiti quarterly revenue scatter chart EMEA

The red R-squared value of 0.206 in the chart above means only 20.6% of the variation in revenue from South America is explained by variation in revenue from EMEA in conjunction with the line fitted (the red one). Sales from South America are mostly independent of sales from EMEA, or in simple terms, even though both regions have trend lines that slope up, sales from South America can easily go down while EMEA goes up (which has happened in five of the last fourteen quarters).

The two regions where sales are the most in step with each other are EMEA and Asia Pacific, where 69.3% of the variation in one is explained by the movement of the other in conjunction with the line fitted.

If you want the correlation, taking the square root of R-squared gets R, the correlation coefficient. R-squared is probably more intuitive, as it measures the proportion of variation explained by a fitted line.

Ubiquiti quarterly revenue scatter chart N America

In the next chart I’ve zoomed in on the area that matters, but I also show a view which includes the origin. The line fitted has a negative slope, which implies that more sales in “Enterprise” mean less sales in “Service provider”, and vice versa. The R-squared value is only 0.360, and in my opinion the relation implied by the negative slope is likely to be spurious.

Ubiquiti Enterprise tech on Service provider tech - scatter

The spreadsheets

Ubiquiti revenue and earnings to Q3 2015 spread

Ubiquiti revenue and earnings to Q3 2015 formulas

Ubiquiti cash flow to Q3 2015 spread

The formula view below shows that in the spreadsheet above, most columns are a mixture of data and formulas, and in some columns the formulas vary. The reason is that cash flows for a single quarter are only in the SEC filings for Q1. The result is the kind of complication that makes spreadsheet errors more likely, even though each formula is only simple arithmetic.

Ubiquiti cash flow to Q3 2015 formulas

Ubiquiti segments spread part 1

Ubiquiti segments spread part 2

Ubiquiti segments spread part 1 formulas

Ubiquiti segments spread part 2 formulas

Thank you for reading this.

DISCLAIMER: Your investment is your responsibility. It is your responsibility to check all material facts before making an investment decision. All investments involve different degrees of risk. You should be aware of your risk tolerance level and financial situations at all times. Furthermore, you should read all transaction confirmations, monthly, and year-end statements. Read any and all prospectuses carefully before making any investment decisions. You are free at all times to accept or reject all investment recommendations made by the author of this blog. All Advice on this blog is subject to market risk and may result in the entire loss of the reader’s investment. Please understand that any losses are attributed to market forces beyond the control or prediction of the author. As you know, a recommendation, which you are free to accept or reject, is not a guarantee for the successful performance of an investment.

IPG Photonics – charts up to Q1 2015

Disclosure – I’m long IPG Photonics Corporation (IPGP).

There are a few remarks about particular issues, but I mostly let the charts speak for themselves. My sources are the SEC filings and the press release “IPG Photonics Reports First Quarter 2015 Revenue Growth of 17%” on IPG’s site.

Charts of quarterly data

In the first chart, for Q2 2015 “Net sales”, I used the figures for “revenue” in the guidance ($215 million to $225 million). “Revenue” is likely to mean the same as “net sales” because the earnings release gives similar figures for Q1 2014 “Revenue” and “Net sales” ($170.6 million and $170,575 thousand).

IPG results to Q1 2015 bars and line

In the short period charted, I’d say Q2 and Q3 look strong, but the 10-K for 2014 has –

    “Historically, our net sales have been higher in the second half of the year than in the first half of the year.”

IPG results to Q1 2015 stacked

IPG EPS to Q1 2015

IPG EPS growth to Q1 2015

I have not charted quarterly Other Comprehensive Income, but annual charts further down show a big OCI loss for 2014 due to “translation adjustments”, i.e. the effect of changing exchange rates on the U.S. dollar value of assets and liabilities. For Q1 2015, the OCI loss was $38,276 thousand, leaving comprehensive income of only $19,070 thousand.

Cash flow charts

In the cash flow charts below, cash from operations includes variation in current assets and liabilities, particularly inventories, accounts receivable and accounts payable. If I’d also shown cash from operations without those movements (still with depreciation, stock-based compensation, etc. added back to net income), the resulting chart might look smoother, but it’s a lot of work.

For some companies, it would be essential to use capex rather than cash invested, because cash put into short term investments is more like parking cash for a while than an investment in the company’s operations. Some long term investments can also have little to do with investing in operations.

In IPG’s case, there were “Purchases of short-term investments” of $25,451 thousand in 2011, and exactly the same amount was “Proceeds from short-term investments” in 2012, due to the investments maturing. (Financial activity in 2012 included a stock offering, a special dividend, and buying out a minority interest.) As a result of the short-term investment, the investment flow I’ve used overstates the cash invested in IPG’s operations in 2011, and understates by the same amount in 2012. I only use the charts to get a general impression and I’m not concerned by shifting a portion of old investment by a year.

The short-term investment accounted for 32.2% of the investment flow in 2011, and 46.1% in 2012. There were no purchases or proceeds from short-term investments in other years from 2009 to 2014. In 2013 there were “Proceeds from sale of investment”, but only worth $495 thousand.

For comparison, Net cash used in investing activities rose from $10,639 thousand in 2009 to $90,080 thousand in 2014.

The cash invested is dominated by investment in the company’s operations. “Purchases of property, plant and equipment” accounts for most of the investment flow ($88,601 thousand, or 98.4% in 2014). There’s also “Acquisition of businesses, net of cash acquired”, which hit $11.6 million in 2012, the highest amount in the past six years, and the “Purchase of intangible assets” of $2 million in 2014 also counts as an investment in the company’s operations.

IPG cash from ops against cash into investment

IPG cash from ops against cash invested per share

A more conventional chart of cash flow per share –

IPG cash from ops and cash invested per share

This chart is logarithmic, so the slope of a line corresponds to the compound growth rate –

IPG logarithmic cash flow - to 2014

The charts for growth in OCF between any two years are probably understood best if I show the spreadsheet first. Although there’s no “2014”, the table is up to date, for example the bottom row is for 2013, the only entry is “49.6%” in the column for 1 year ahead, and the increase from 2013 to 2014 was 49.6%. The figure in the top right shows growth of 30.2% (CAGR) between 2004 and 2014.

IPG CAGR CFO per share - spread

IPG CAGR CFO per share by year

Sometimes growth over five years is used as a metric. In the chart below, find the columns grouped above “5”, and you can see that growth measured over the previous five years has been over 20% for each of the past five years, i.e. for 2004 to 2009, 2005 to 2010 … up to 2009 to 2014.

IPG CAGR CFO per share by number of years

Sales, costs and profit charts

In some cases I’ve used a stacked and a non-stacked chart of the same data. If any subjective bias results from the way a chart represents data, a different type of chart might not produce the same bias.

In order to get the stacked charts, I needed to change the sign of expenses, which are negative in the 10-Ks (as indicated by brackets). For some years in some stacked charts there will be minor distortion due to the inclusion of a negative quantity, for example “Interest expense (income)” has mostly negative figures, but the absolute amounts have declined from about 5% of net sales in the early years, to 0.01% in 2014.

I changed some item-names, e.g. “OTHER INCOME (EXPENSE), Net:” in the 2014 10-K is “Other expense (income), net” in my charts, to make the name consistent with the sign change which was needed to get a stacked chart.

Interest expense is the only expense I found to be capitalized as investment, instead of charging it as an expense on the income statement. From the 10-K –

    “Expenditures for maintenance and repairs are charged to operations. Interest expense associated with significant capital projects is capitalized as a cost of the project. The Company capitalized $383 , $524 and $142 of interest expense in 2014 , 2013 and 2012 , respectively.” (thousands)

That compares to an expense of $77 and $1 for 2014 and 2013 on the income statements (i.e. not capitalized), and interest income of $319 in 2012 (all in thousands). The capitalization is small and probably conservative. The capitalization of expenses is too complicated a subject to explain in detail here, I’ll just mention that a few companies have taken it to fraudulent levels.

The items reported changed between 2006 and 2014, which presented problems. A few expenses were only significant or relevant in 2005 or in early years, for example the Series B warrants have not been relevant since 2007. 2006 is the earliest 10-K I used.

IPG sales breakdown by cost and income

IPG sales breakdown by cost and income as percent

In the next chart I’ve zoomed in and the detail is clearer, but some percentages for 2002 and 2003 are off the scale. The percentages are represented in the chart above, and they’re in the spreadsheet titled “Data as percentage of sales” near the end.

IPG income and cost as percent of sales

IPG sales costs and income

IPG operating expenses

IPG sales and profit

The following chart is unorthodox. It’s often supposed that a drop in margins warns of problems. When a company has pricing power, falling margins can warn of the erosion of pricing power through increased competition. Analysts are aware of other causes, such as variation in product mix, but it still occasionally happens that an officer at a company with high margins will remind analysts of just how high the margins are, when the analysts are probing a drop of 1% or 2%. The chart is intended to let you judge if margins predict results, as in sales, operating income, net income or cash from operations. By showing the quantities as a percentage of 2014 net sales, I got everything to fit the percentage scale on the left.

IPG margins and main results

I do not see evidence that a fall in margins predicts disappointing results, but this is a subjective exercise and you may interpret the chart differently. 2013 was a relatively poor year for margins, cash from operations, net income and operating income, but 2014 was a good year all round.

IPG earnings per share

IPG annual EPS growth

IPG Logarithmic chart of sales and profit

Comprehensive income charts

Other comprehensive income (OCI) in 2014 consisted mostly of an unusually large loss on Translation adjustments, of -$110,734 (thousand). The loss on translation adjustments was more than twice as big as the rise in net income in 2014, with a sharp fall in comprehensive income as a result.

“Translation” refers to the currency exchange rates at which assets valued in foreign currency are converted to U.S. dollar values. For the Russian operations, a low Ruble keeps costs low, and is good for net income, but a fall in the Ruble’s value against the dollar reduces the dollar value of Russian assets, which affects OCI. If the Ruble stays at a constant low level, there would be no further effect on asset values and OCI, while costs in Russia could continue to stay low, depending on inflation. I have not seen the impact of the Ruble broken out.

The impact of a low Yuan would be different. China is not a production center and does not have large long-lived assets (find “long-lived assets” below). It follows that local costs are likely to be small relative to sales in China, so there would be little benefit to costs from a lower Yuan, while the exchange rate would be bad for sales, although the size of the hit would depend on various factors including the price elasticity of demand and competitors’ costs. I don’t mean to imply that the Yuan is still falling – the Yuan’s big fall ended in January 2014.

Recently, the high U.S. dollar and low Ruble have dominated the currency effects, although the Ruble has partly recovered this year and the U.S. dollar index (DXY) has weakened since March.

25.45% of the $110,734 (thousand) translation loss is explained by the currency hit on Cash and Cash Equivalents. From the 10-K for 2014, in thousands –


The 10-Q for Q1 2015 has a “Total other comprehensive loss” of $38,276, due to Translation adjustments of -$38,319.

This is from the 10-K, about valuing foreign assets, and where they put the cash –

    “Foreign Currency — The financial information for entities outside the United States is measured using local currencies as the functional currency. Assets and liabilities are translated into U.S. dollars at the exchange rate in effect on the respective balance sheet dates. Income and expenses are translated into U.S. dollars based on the average rate of exchange for the corresponding period. Exchange rate differences resulting from translation adjustments are accounted for directly as a component of accumulated other comprehensive loss.

    Cash and Cash Equivalents — Cash and cash equivalents consist primarily of highly liquid investments, such as bank deposits, marketable securities with original maturities of three months or less with insignificant interest rate risk and marketable securities with remaining maturities of three months or less at the date of acquisition.”

Don’t worry about bars you can’t see in the next chart. Charting an insignificant quantity is my way of demonstrating the insignificance visually.

IPG comprehensive income

IPG comprehensive income per share

Geography and sales breakdown charts

Russia is included in CIS, which is in IPG’s region “Other including Eastern Europe/CIS”. CIS is the Commonwealth of Independent States, which includes Azerbaijan, Armenia, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Uzbekistan and Ukraine.

IPG geography stacked

IPG geography stacked percent

IPG physical assets by location

    “Our major manufacturing facilities are located in the United States, Germany and Russia.” (10-K for 2014)

The three countries account for nearly all the long-lived assets. China accounted for 32% of net sales in 2014, but only 2.30% of the long-lived assets. (IPG have two application centers in China, in Shenzhen and Beijing.)

The evidence suggests that long-lived assets are dominated by manufacturing, and the relative size of long-lived assets by physical location is likely to be a reasonable proxy for relative production, although it is affected by foreign exchange rates and changes in them. There could also be differences in asset turnover, for example diode production is centered in the U.S., and the turnover is not necessarily the same as for other production.

IPG physical assets by location percent

IPG’s materials processing sales have grown, but other applications have not. Three small categories were consolidated into “Other applications” in 2012.

IPG materials processing and other

IPG materials processing and other - percent

Days Sales Outstanding and days of inventory charts

I fitted trend lines to DSO and days of inventory in the next chart. The DSO trend line formula shows that every year on average, DSO increases by 0.3771 of a day. However, the R-squared of 0.0707 shows the line only explains 7.07% of the variation. Taking the square root gives R, the correlation coefficient, of about 0.2659 which is low, with a 45.78% chance that there was no underlying linear trend, with random variation probably the most likely alternative. It’s conventional to reject a hypothesis with 5% or more chance of being false, as here.

The trend line formula for days of inventory shows that every year on average, days of inventory falls by 2.8046 days. The R-squared of 0.5212 shows the line explains 52.12% of the variation. Taking the square root gives R, the correlation coefficient, of 0.7219418, with only a 1.84% chance that there was no underlying linear trend. I’m wary of projecting the trend, for example a step change between the first five years and the last five years would also fit the data.

If you want to check the figures, there’s a calculator on The Chinese University of Hong Kong‘s site. Navigate – Stats toolbox Home / Correlation / Stat Sig of r. For the days of inventory, enter 10 for the sample size, and 0.7219418 for R. The results include “p=0.0184”, which translates to a 1.84% chance of the hypothesis being false.

IPG DSO and days inventory

Analysts and markets generally don’t like rising DSO or rising days of inventory. Some less sophisticated investors might even look at accounts receivable and inventory without adjusting for sales. There is some statistical evidence for the predictive power of the metrics, for example in Beneish’s work on his M-Score for earnings manipulation. If rises in DSO or days of inventory are a strong indication of trouble for IPG, the effect ought to be discernible in the next chart. I suggest looking at the chart and seeing if DSO or days of inventory predict anything for sales, income or cash from operations.

IPG DSO days inventory - sales income and CFO

So far as I can tell, rises in DSO or days of inventory have not foreshadowed problems, and neither have above average DSO or days of inventory. The only serious blip was in 2009, when IPG were affected by the recession which followed the financial crisis. I would not blame the results on the lengthening of IPG’s cash conversion cycle, especially as cash from operations was hardly affected. I would also not try to predict the next recession by looking for a rise in IPG’s DSO or days of inventory. The chart shows that the metrics fell along with sales and income in 2009.

Analysts will continue to probe any increase in DSO or days of inventory, some authors will take a gloomy view of any such rises, and so might the markets, but so long as the metrics don’t rise by or to unprecedented levels, I don’t see evidence that they predict trouble for IPG. I have not completed a full investigation, and in particular I have not looked at quarterly figures.

IPG hold high levels of inventory, keeping stocks of parts that can be assembled quickly when orders are received. This helps sales by giving customers low lead times, but the low lead times reduce the visibility of future sales. Given the high net cash and the good free cash flow, IPG might as well operate with high levels of working capital so long as it benefits sales. Growth adds to the need for inventory, and occasional preparation for higher growth and the launch of new models adds more. From the 10-Q for Q1 2015 –

    “Given our vertical integration, rigorous and time-consuming testing procedures for both internally manufactured and externally purchased components and the lead time required to manufacture components used in our finished products, the rate at which we turn inventory has historically been comparatively low when compared to our cost of sales. Also, our historic growth rates required investment in inventories to support future sales and enable us to quote short delivery times to our customers, providing what we believe is a competitive advantage. Furthermore, if there was a disruption to the manufacturing capacity of any of our key technologies, our inventories of components should enable us to continue to build finished products for a reasonable period of time. We believe that we will continue to maintain a relatively high level of inventory compared to our cost of sales. As a result, we expect to have a significant amount of working capital invested in inventory. A reduction in our level of net sales or the rate of growth of our net sales from their current levels would mean that the rate at which we are able to convert our inventory into cash would decrease.”

Balance sheet charts

The value of overseas assets and liabilities is affected by exchange rate movements, and for 2014 both will be lower than otherwise due to the higher dollar. The lower Ruble will have had an effect on asset values, particularly on Property, plant, and equipment, net. From an accounting perspective, the translation adjustments which dominated the negative Other Comprehensive Income in 2014 would have the effect of pushing asset values down (but that was more than offset by income pulling the value up). The translation adjustments imply that overseas assets are bigger than overseas liabilities. That’s to be expected as the overall assets are bigger than liabilities, and it’s common for an international company with head office costs in the U.S. to have its liabilities concentrated there.

The unrealized gain on derivatives in 2014 was only $172 thousand, and I found no indication of a realized gain on currency hedges in 2014. IPG report Cash Flow Hedges but they were for fixing interest rates, not hedging currencies. From the 10-K for 2014 –

    “We have no foreign currency derivative instrument hedges as of December 31, 2014 . We will continue to analyze our exposure to currency exchange rate fluctuations and may engage in financial hedging techniques in the future to attempt to minimize the effect of these potential fluctuations.”

The 10-Q for Q1 2015 has a similar statement with “We have no foreign currency derivative instrument hedges as of March 31, 2015 .”

IPG assets

IPG assets per share

IPG assets per cent of total

IPG liabilities and equity

Regarding the note in the graphic above, in the balance sheet spreadsheet at the end, the equity is called “Total IPG Photonics Corporation stockholders’ equity”. The name is used in 10-Ks for 2009 to 2014. My calculation agrees with Total liabilities for 2012 to 2014, but is greater than stated total liabilities for 2011 as my calculation includes minority interests. In 2010 the term “Total liabilities” was used but not on the balance sheet, and in 2006 the term was only used in connection with a covenant ratio.

There were many claims on assets in 2005, including series A, B and D, warrants, Notes receivable from stockholders, and Deferred compensation. Most of those items were gone by 2006, but I still preferred to use my simplification so I could take the charts back to 2005. The term “non-stockholder claims on assets” would have been more accurate, as my “calculated liabilities” includes liabilities, minority interests, and the variety of claims on the 2005 balance sheet.

IPG liabilities and equity per share

IPG liabilities cash and current assets

IPG liabilities as percent of cash


I don’t repeat the spreadsheet for cash flow growth which I’ve shown above. The only omission I know about is for the “Logarithmic chart, base 2, of sales and profit” (before the title “Comprehensive income charts”, above), where I don’t show the results or formulas of the logarithmic functions. The logarithmic formulas all have this format, with only the cell address varying –


IPG results to Q1 2015 spread

IPG cash from ops and into investment - spread2

IPG Photonics sales costs and profit - spread

IPG Photonics sales costs and profit - sign adj - spread

IPG Photonics sales costs and profit - sign adj - formulas

IPG Photonics sales costs and profit sign adj percent - spread

IPG Photonics sales costs and profit sign adj percent - formulas

IPG comprehensive income - spread

IPG comprehensive income - formulas

IPG sales breakdowns spread

IPG DSO days inventory - sales income and CFO - spread

IPG balance sheet spread

That’s all.

DISCLAIMER: Your investment is your responsibility. It is your responsibility to check all material facts before making an investment decision. All investments involve different degrees of risk. You should be aware of your risk tolerance level and financial situations at all times. Furthermore, you should read all transaction confirmations, monthly, and year-end statements. Read any and all prospectuses carefully before making any investment decisions. You are free at all times to accept or reject all investment recommendations made by the author of this blog. All Advice on this blog is subject to market risk and may result in the entire loss of the reader’s investment. Please understand that any losses are attributed to market forces beyond the control or prediction of the author. As you know, a recommendation, which you are free to accept or reject, is not a guarantee for the successful performance of an investment.

IPG Photonics’ cutting edge

Disclosure – I’m long IPG Photonics Corporation (IPGP)

The Q1 earnings call has encouraging information about technological advance. I’ve described the highlights and made some comments, but I recommend reading the original – “IPG Photonics (IPGP) Valentin P. Gapontsev on Q1 2015 Results – Earnings Call Transcript” Apr. 28, 2015 ( I’ve mostly quoted from the prepared remarks which can be downloaded from IPG’s site.

Technology highlights

Cutting thick metals (2D)

    – steel, aluminum, titanium, tungsten, and others
    – thickness 3 to 10 centimeter
    – the package includes high grade cutting tables 3 to 12 meters long
    – new generation of IPG 10 kW to 15 kW lasers
    – unique cutting heads for up to 20 kW optical power

Cutting highly reflective metals (2D)

    – copper, gold etc.
    – new kW class single mode green fiber lasers

Welding thick metals (developed by the Russian subsidiary)

    – steel (up to 10 cm)
    – titanium (up to 5 cm)
    – other metals (not specified)

Cutting pipes

    – first high quality pipe cutting machine
    – installed in customer sites

“5D” acquisition

    – “5D” probably means the laser can be pointed in any direction from any position, within limits (as you could for a hand-held laser pointer)
    – a 76% interest acquired in a small 25 years old Belarusian technology company serving the Russian market
    – develops tools and controls for large-scale high-power 5D laser systems
    – focus on cutting, welding, cladding and prototyping
    – will use IPG laser sources for applications with little laser penetration currently
    – integrates laser sources, CNC, software, and electrical controls and drive systems, and uses specialized optical heads

Technically, 5D might mean five “degrees of freedom” – the normal three dimensions for position, plus two degrees of rotation, as in a tank where the turret rotates and the barrel on the turret can tilt, allowing the barrel to have any orientation (within about a hemisphere). It’s possible for “5D” to mean control of five parameters which are not all for position and orientation, find “Superman memory crystal” below.

Further to “Welding thick metals” –

    “… On the basis of these results, we have started some very large scale projects in the oil industry, large bridge sections and other similar products manufacturers. For example, in Q1 we achieved good progress in the development of mobile machine for oil pipe casing welding. The direct tests of our equipment in the field, on the well drilling stations, should start next month.” (the prepared remarks)

3D printing

Sales of fiber lasers for additive manufacturing, which includes 3D printing, were over 60% above the year-ago quarter.

From the prepared remarks –

    “Notwithstanding slow growth of the economy in the Eurozone, European sales grew 15% year-over-year to $65.1 million, driven by even stronger growth in Germany from sales to the automobile and 3-D printing industries, partially offset by weakness in Russia related to the economic environment.”

    “We expect demand for 3D printing applications to continue to grow.”

Niche and customized systems

A car-maker will usually want to make cars rather than put resources into developing systems built around lasers and the associated optics. The same applies to many industrial customers. A systems integrator could develop systems for them, but integrators can be too slow or too conservative regarding new applications. Rather than let such opportunities pass by, that’s the kind of case where IPG consider developing a complete solution including hardware and software.The CEO made it clear that they will not compete with the customer (meaning systems integrators or OEMs, as they clearly aren’t going to make cars, planes etc.).

Cutting thick metal with higher power (10 Kw) lasers is such a case. Higher power naturally leads to faster cutting, and the problem to be solved when developing a high power cutting system is in maintaining quality (as well as safety and reliability). The CEO believes 100 of the cutting machines could be sold in 2015. IPG are willing to sell all the parts a system integrator would need, including the lasers and the optical heads.

The way I see it, if the makers of cutting systems don’t make high power systems, they will lose potential sales to IPG. There’s no guarantee that integrators will put IPG lasers in their systems – they might buy IPG for the specification or because the lasers are proved for the application, but they might be wary if they see IPG as a competitor. IMO it’s likely that either system integrators will follow IPG’s lead using IPG’s lasers, or IPG will realize the opportunity to sell their own systems. If IPG keep having to show the way, they will be more of a threat to OEMs, but they will want to underplay the threat.

Paint removal is a different example. There was a clear need for paint removal by laser, for aircraft. The technical challenge must have been considerable, because the solution involved IPG working with many partners for about a decade. The resulting system is mobile, and as well as a laser includes a robot and “very complicated scanning system software” (from the Seeking Alpha transcript).

    “Now, the long-term project is turning from qualification to the mass deployment phase, and IPG fiber lasers are playing the role of an excellent engine there. Recently we received a request from a leading customer to become a key supplier of complete systems.” (the prepared remarks)

From the Q&A in the earnings call transcript on Seeking Alpha –

    “we found that total market for paint removal, it’s more – only in the U.S. only in Air Force more than $800 million per year, but total worldwide more than $3.5 billion per year. Up to now, this is how this removal making by chemical and other, … Laser technology allow to simplify dramatically with this solution make much more perfect,”

I don’t know how much of that could be revenue for IPG. For context, 2014 net sales were $769.8 million.

    “now a situation than it was really going from developed, made, and qualified for many application and going native for mass production. Our customer – leading customer who can – who will be able to produce and supply highest quality of such volume, such equipment …”

    “But we develop as much a better pulsed laser – multi-kilowatt pulsed laser, not CW, they open now still a new opportunity for this. So it’s really now the time, new phase when really the demand will grow very fast. It’s only still – they don’t have customer, don’t have real good quality manufacturer. We’re ready to take such position.”

Paint removal is likely to be a commercial success for the customer as well as IPG, demonstrating the potential reward of involvement in bringing IPG’s laser technology to new applications.


Lidar means ‘LIght Detection And Ranging’, a kind of laser-based version of radar. A laser is scanned ahead, and various kinds of backscattering can then be detected. Depending on the application and the design, the backscattering can be processed to infer the position and velocity of a vehicle, the movement of air, and many other quantities involving position and movement.

Following the quote about paint stripping in the prepared remarks –

    “Other large volume potential projects include fiber laser lidar sensors for driver-free vehicles and many other applications.”

Driverless trucks from Komatsu have been used in remote mines since 2008, apparently using radar rather than lidar.

This piece about the difficulty of writing the software confirms that lidar is a key technology for driverless vehicles on the road.

Wikipedia lists a variety of applications for lidar, including agriculture, space flight, mapping the biodiversity of redwood forests, detecting air turbulence, and the “speed guns” used by the police.

Zinc brazing

Car makers have changed from coating steel chemically to using hot melted zinc. That may have been for environmental or safety reasons, because the hot zinc process has variable quality resulting in too many defective cars. IPG now have a brazing system which solves the problem. Brazing is like welding except that two different metals are joined. Like welding, and unlike soldering, both metals need to melt to get a strong mechanical join. The application here is coating which is obviously different to the usual joining of metal pieces. The brazing system has passed tests, and the CEO reports high interest and expects quick market penetration. I find that plausible because the problem is new rather than something the industry has learned to live with. From the prepared remarks –

    “The elegant, patent-pending IPG solution resolves very significant technical limitations of other processes. Currently we are finishing successful production tests with one of the largest car manufacturers and we expect to start mass deployment in the second half of the year.”


The fast likely take-up of IPG’s zinc brazing technology is in contrast to the seam-stepper welding technology. The zinc brazing was started later and looks likely to achieve substantial sales earlier. The seam-stepper has the advantage of providing laser welding without requiring an expensive laser-safety cell, a kind of light-tight hut with a laser and usually a robot in it. It’s on the 5th generation now, without substantial sales. The difference is that car-makers were under pressure to find a better coating technology, and there’s no such pressure to drive seam-stepper sales. The CEO is still very hopeful, and so am I, but it shows how commercialization can take time.

BTW, the laser-safety cell plus robot plus laser is the kind of area where IPG are unlikely to compete, as it is well served and competition from IPG would probably alienate OEM customers.

Developement, commercialization and time

Car-makers are conservative. In 2013, the CEO of Ford admitted that the pace of innovation in the industry had been too slow, before promising to put that right at Ford, mostly in the area of digital technology. SatNav was not developed by the auto-makers and even today many drivers prefer to use a smartphone to built-in StaNav when it’s available. The top R&D spender in any industry in 2014 was Volkswagen, with Toyota 7th, but Tesla was the only auto-maker in the top ten innovators (by recognition, as it’s hard to quantify innovation) (see here).

    “Many of our target markets, such as the automotive, machine tool and other manufacturing, communications and medical industries, have historically adopted new technologies slowly. These markets often require long test and qualification periods or lengthy government approval processes before adopting new technologies.” (10-K for 2014)

The long period of development of the paint removal technology (for aircraft) was simply because it took that long to develop. Sales for 3D printing took a long time to grow to a level worth commenting on in an earnings call. The examples indicate that conservatism about new technology, development time, and time for the market and sales to ramp up, can all mean a long time before commercial success.

Previous tech concerns

I have had various concerns about technology which could impact IPG. These tended to be low probability threats from emerging technology, at the research stage or being commercialized by small companies, rather than incremental advances from established competitors. Revisting the possible threats shows that either they did not develop, or IPG have been able to counter them. IMO the ability to avoid being leapfrogged by technology is crucial whenever a company is in a technology race.

    Direct diode technology

Direct diode seemed like a possible threat to IPG due to the advantages claimed, of high brightness and high electrical efficiency. Two small companies made direct diode lasers, and now IPG, Coherent and others make them. The minnows are TeraDiode and DirectPhotonics. TeraDiode received contracts and Small Business Innovation Research Awards from the Department of Defense in 2011. The threat in materials processing dropped when IPG announced a range of lasers with over 45% electrical efficiency, clarified to wall plug efficiency above 45% in the Q1 2014 earnings call. In the same call it was stated that production costs of the range were more than 50% lower than for the IPG lasers they replaced.

For direct diode lasers –

    TeraDiode claim 40% wall plug efficiency,
    Coherent claim Greater than 45% electrical to optical efficiency. Electrical to optical efficiency ought to be the same as wall plug efficiency, but I have to wonder why they don’t use the same term as other laser-makers.
    The only clue I found for the efficiency of Trumpf’s TruDiode range of direct diode lasers is this general statement in a press release from October 2014 – “The special advantage of the diode direct laser is its relatively high efficiency level – as much as 40 percent.”
    IPG claim 50% wall plug efficiency.

    TeraDiode’s highest power is 4 kW (with a prototype up to 8 kW),
    Coherent’s highest power direct diode lasers are 10 kW,
    Trumpf’s TruDiode range goes up to 6 kW laser power,
    and IPG’s direct diode lasers only go up to 2 kW.

IPG lead in efficiency but trail in power. I don’t see direct diode laser technology as a serious threat to IPG.

The power is enough for many applications, but for some comparison, IPG have sold 100 kW fiber lasers since 2013 (finding IPG’s most powerful laser is not easy – the site lacks a button labelled “I just want to zap something”).

Direct Photonics received their first order in 2013 for 2 kW lasers and generally seem non-threatening.

As for all of IPG’s lasers, the company’s direct diode lasers use single emitters –

    “Another key element of our technology platform is that we use multiple multi-mode, or broad area, single-emitter diodes rather than diode bars or stacks as a pump source. We believe that multi-mode single-emitter diodes are the most efficient and reliable pumping source presently available, surpassing diode bars and stacks in efficiency, brightness and reliability. Single-emitter diodes have substantially reduced cooling requirements and typically have estimated lifetimes of more than 100,000 hours at high operating currents, compared to typical lifetimes of up to 10,000 to 20,000 hours for diode bars.” (10-K for 2014)

TeraDiode and most laser-makers most of the time seem to use the diode bars.

This is informative about direct diode lasers, and has some discussion of the relative merits of using single-emitters versus diode bars in them – “PHOTONIC FRONTIERS: DIRECT LASER DIODES: Making direct laser diodes shine more brightly” by Jeff Hecht, 03/01/2013 ( When “fiber” is mentioned it’s not the active fiber in fiber lasers.

To show that IPG are not the only users of single-emitter diodes, number 9 in this list is a direct diode laser from Raycus which uses single-emitters – “Top 9 laser products of 2014” Dec 17, 2014 ( Trumpf are in the list with a short pulse (800 femtosecond) laser, and IPG are not in the list.

Slightly off-topic, I said “IPG announced a range of lasers with over 45% electrical efficiency, clarified to wall plug efficiency above 45% in the Q1 2014 earnings call.”. Trumpf don’t give the efficiency of their limited TruFiber fiber laser range, and they say this about their disk lasers – “The latest generation of diode-pumped lasers have an efficiency of over 30%”.

    Resistance spot welding of aluminum

In the Q2 2012 earnings call the CFO said that aluminum and harder steel used in the auto industry was difficult for resistance spot welding, and fiber lasers were well suited for welding those metals.

By September 2012 General Motors had developed a new resistance spot welding process that worked for aluminum, posing a threat to the use of fiber lasers for welding in the auto industry.

In the Q1 2014 earnings call the CEO stated that the seam stepper could weld aluminum.

A variant of IPG’s zinc brazing system has some potential for welding aluminum. The system was described as the “new one-of-a-kind 3-beam fiber laser system for brazing of zinc coated steel parts in the automobile industry”, and IPG said this about it –

    “The other version of the same system looks very hopeful for an essential increase in aluminum welding quality. The growing use of aluminum in autos and other industries saves weight and increases fuel economy. So, aluminum welding continues to be a strong opportunity for us.” (the prepared remarks)

That’s in addition to the welding technology developed by the Russian subsidiary (listed near the top, with steel, titanium and “other metals”).

Hopefully IPG will be able to incorporate the advances in a new version of the seam-stepper. It’s possible that new welding techniques have delayed the uptake of laser welding in the auto industry, and it may be a factor in the slow uptake of the seam stepper, but with IPG’s advances in welding metals, time is on the side of IPG.


Research into HOFGLAS (Hollow core Optically pumped Fiber Gas LASers) a few years ago showed some promise of overcoming the scattering and thermal lensing which increases in an active fiber as more power is put into it. Googling found nothing relevant in the past year except for an academic paper – “CW hollow-core optically pumped I2 fiber gas laser”, which you can buy here if you’re really keen.

Hollow fiber is an obvious application for telecoms, because light travels fastest through a vacuum, a little slower through air, and 30–40% slower through glass than through air. That might not affect which laser is best for shining into the fiber.


Vertical Cavity Surface-Emitting Lasers (VCSELs) are two-dimensional arrays of laser diodes on the same chip. If these become good enough, it would be hard for IPG to adopt the technology, because they differentiate themselves by using only their own discrete ‘single-emitter’ laser diodes.

The problem with a VCSEL is that it’s flat and the radiation is perpendicular to the surface, so the area that can be cooled is about the same as the cross-section of the beam. Increasing the power is not a problem if you increase the emitting area by the same proportion, but the area of the beam cross section will also increase by the same proportion. For a diode where light comes out of the side, the area that can be cooled is bigger than the cross-section of the beam. The highest continuous wave (CW) output power reported on Wikipedia was only 200 W, in 2007. A previous record was achieved using a diamond heat sink. Heat disappation seems to be an engineering problem where breakthroughs don’t happen.

VCSELs produce a large-cross-section single-mode optical beam, which diverges less than the beam from standard ‘edge-emitting’ laser diodes. That’s an advantage when you want to get light into an optical fiber, and VCSELs are used in the optics-based Gigabit Ethernet. They might have the same advantage for pumping a fiber laser, but I could not find good evidence.

Wikipedia lists applications including pumping of solid-state lasers and fiber lasers, wrinkle removal, and atomic clocks. They include various materials processing applications (excluding welding), but I doubt that VCSELs will account for much market share, short of an unexpected breakthrough. See also “VCSELS for Manufacturing: High-power VCSEL arrays make ideal industrial heating systems“12/10/2014 (

There’s a paper from 2013 called “High Peak Power VCSELs in Short Range LIDAR Applications” which you should be able to get by googling the title. It was about a military application, detecting flying shrapnel, and it might not be as suitable for lidar in driverless cars, where IPG’s CEO claimed potential for fiber lasers.

There’s an optically-pumped variant called “VECSEL” (Vertical External-cavity Surface-emitting Lasers) which have high beam quality, and they might be able to produce more power than VCSELs, though cooling is still a problem. Wikipedia give industrial machining as an application, and mention “high power and efficiency”. VECSELs can be pumped by diode bars with low beam quality and still produce a high quality beam, but other optically pumped lasers turn the output of cheap laser diodes into a high quality output beam, including fiber according to the University of Southampton (find “cheap”).

    Digital lasers

‘Digital lasers’ represent a low-probability high-impact threat. In an old-style laser with light bouncing between two reflective surfaces, one of which is an opaque mirror, instead of the normal mirror there’s an LCD image. Changing the image changes the characteristics of the laser. Being able to change the image will not increase the power or efficiency, and if it isn’t feasible to apply the same idea to fiber lasers (where reflection is between Bragg gratings in the fiber), I don’t see much threat. If that proves possible, increased versatility reduces the number of models needed for a given set of applications. While the impact of fewer models could be huge, I can’t predict the implications for IPG’s income. I wrote about digital lasers in “IPG Photonics – growth, cash, markets and technology” September 27, 2013 (find “Digital lasers”), along with other exotic technology under “Advances and applications”.

It might be possible to apply the technique to disk lasers, which Trumpf still make, but the impact of that involves three fairly imponderable factors – the potential of digital lasers, the ease of applying the technology to disk lasers, and the merits and drawbacks of disk lasers compared to fiber. To see the advantages Trumpf claim for disk, search for the PDF “IMTS High power solid state lasers and their applications” and find “Why did Trumpf choose the disk laser architecture”. One claimed advantage is modularity. A key advantage of fiber is the ease of cooling, see Wikipedia for more. VECSELs incorporate an external mirror, and applying the digital laser technology to them might be easier.

A search found nothing new about digital lasers, just a July 2014 rehash of the old story, which I think is a bit sad. I don’t believe the possible threat from digital lasers is likely.

My conclusion from the review is that a technological advance with the potential to erode IPG’s sales is not likely to be a good reason for much pessimism, although I’d still rather know about the advances.

2015 Prism Awards

Winners named for 2015 Prism Awards for Photonics Innovation” 12 February 2015 ( – IPG won in the “Industrial Lasers” category, for their GLPN-500-R, which was liked for being a fiber laser with output in the visible spectrum (green). It’s a single-mode laser, meaning a pure single frequency and highly coherent
(with a long coherence length). Applications include welding and cutting highly-reflective metals (one of the highlights at the start), and solar cell manufacturing.

I counted nine categories (with just one winner in each). Other winners’ applications included the 3D printing of optical components, the measurement of bacteria in fluids at low concentration, and a rugged spectrometer the size of a fingertip. In 2013, TeraDiode beat IPG in the Industrial Lasers category, and as I’ve explained, IPG are now ahead in wall plug efficiency but behind in power for direct diode lasers. The 2014 “Industrial Lasers” winner was V-Gen for a versatile fiber laser which exceeded others on peak power, pulse energy and narrowness of pulsewidth, and was suitable for materials processing (although welding was not listed), for a very wide variety of materials.

The awards are a reminder that IPG are not the only innovator in materials processing or in other fields of laser technology.

There’s a section about “New laser technology and applications” which I put near the end because IMO the possible threats aren’t all that serious.

Competitors will have the scale for vertical integration

The closer competitors get to achieving IPG’s level of vertical integration, the more IPG rely on innovation to stay ahead or at least stay differentiated (if competitors innovate successfully in other areas). Size is a factor in the ability to achieve vertical integration. The following charts are only meant to give a rough idea of IPG’s relative size. The first chart is only for the companies in the Industrial Laser Index on Industrial Laser Solutions’ site.

IPG relative size

If you want to research the companies you can use these links to Seeking Alpha – COHR, ESIO, GSIG, IIVI, IPGP, JDSU, NEWP, ORBK, RSTI, UTEK.

Trumpf (a private German company) is not included in the index, and I’ve included them in the next chart. Trumpf also have a large machine tools business, and I have not seen figures for only the laser segment. (They also started a bank recently.)

IPG relative size inc Trumpf

Most of IPG’s industrial laser competitors will be less concentrated in materials processing, industrial lasers and fiber lasers. Because the charts only give a rough guide, I also give other opinions about which companies count.

This piece – “Laser Processing Market Expected to Reach USD 17.26 Billion in 2020 Globally” Sep 24, 2014 (, lists companies in “laser processing”, with Trumpf first and IPG the last of nine named companies before “and others”.

This looks more relevant, and the order looks purely alphabetical – “Research and Markets: Global Industrial Laser Market 2015-2019 with Coherent, IPG Photonics, Rofin-Sinar Technologies & Trumpf Group Dominating” Jan 27, 2015 (

This page is also on, it has a basic description of the high power laser market, and lists IPG Photonics first out of twenty.

I see no chance of IPG achieving a market share so big that competitors won’t have the scale necessary for vertical integration. The markets are expanding and diverse, and while strong in materials processing, IPG can’t quickly squeeze peers out of medical and other areas (see below, about defense). A good year for IPG does not even mean that Trumpf have to have a bad year.

Vertical integration and innovation

    Vertical integration by Trumpf

About two years ago I looked into Trumpf’s claim of being vertically integrated (here, find “two lists of in-house production”). I found they were probably not as vertically integrated as IPG in fiber laser production, although the evidence was not strong and was open to interpretation. IPG were likely to have a lead in vertical integration for fiber because for a long time there was scepticism about fiber lasers (which IPG pioneered), and competitors were late to wake up to their potential. Trumpf own SPI Lasers, and SPI acquired JK Lasers on April 15, 2015. SPI say about JK

    “one of the world’s leading manufacturers of high-power Fiber Lasers for industrial use”

    “bringing improvements in both experience and expertise to SPI Lasers, creating a more versatile organisation, with enhanced vertical integration.”


    “their acquisition helps SPI Lasers to strengthen their position as a leader in the Fiber Laser market.”

Trumpf can only claim to be “a leader” in fiber, because IPG are “the leader”.

I’m not particularly impressed by JK Lasers’ range. The “High Power Fiber Lasers” are for 1 kW to 4 kW (Average Output Power), and while “Energy efficient” is claimed, I could not see a figure on this page or on the datasheet you can download. They might be good on other parameters.

SPI’s maximum power for fiber lasers (pre-acquisition) seems to be 1 kW, and to see the specifications you need to register or log in. Trumpf also have various lasers on their site.

    Vertical integration in China

China is catching up in lasers. The PDF “Chinese Laser Technology, Industry and Market” by Xiao Zhu and Jiayu Wang, 12 Dec 2014 ( describes the advance of the Chinese laser industry from small beginnings. The authors claim that the first 10 kW fiber laser made in China ‘last year’ (2013) was also the second in the world (presumably, the second company in the world to achieve that). The laser diodes and active fiber were still not made in China, but much was being invested by the state and big companies in a strategic effort, “aiming to achieve vertical integration as IPG.”.

The PDF about China describes how the state is backing ‘blue sky’ research while the companies are pushing up the power and making other incremental developments. That’s quite normal, and there has always been some risk that a big ‘blue sky’ development somewhere in the world might not be accessable to IPG. I believe the risk is greater in China. Firms will be favored with the fruits of research depending on how Chinese they are or how well they are politically connected. There’s a risk that laser companies could be given cheap loans for investment and survival, as happened with solar photovoltaic modules. Chinese solar production crashed world prices and caused a variety of tariffs and protectionist measures around the world, but the barriers to commoditization seem higher for lasers, due to the high and increasing diversity of applications and the lasers required for them. Customized laser systems obviously require working with the customer rather than rolling vast amounts off a production line and selling below cost. IPG’s innovation and diversification out of mainstream industrial materials processing is probably the best defense.

Trumpf’s Annual Report 2013/14 has some comment about China. The country entered the mechanical engineering sector in 2008 with “ultra-low-end products” and are now the third largest machine exporting country in the world. Trumpf expect China’s laser industry to follow a similar path. A paragraph is headed “Cooperating instead of competing”, about how they acquired CNC Machine Company Ltd. (JFY), and needed to reconcile the mature sophisticated German approach and China’s “keep it simple” attitude. Trumpf say Chinese customers are highly loyal, and lasers sold by JFY are probably the result of Trumpf using JFY as a channel to exploit the customer loyalty.

    Cheaper laser diodes reduce IPG’s cost advantage

The cost of laser diodes has fallen dramatically, and the cheaper diodes become relative to other costs, the less IPG’s diode cost advantage matters. The PDF “Master of metal” on Coherent, Inc’s site mentions “price” in connection with laser diodes a few times. A vice chairman of Trumpf is quoted as saying he doesn’t think the price will come down as fast now that the cost of diodes is not such a significant part of the cost of a laser. I’d say that even if the general price trends down, the highest power diodes could stay expensive if IPG maintain a lead, although I don’t have facts to support that. Find “Czech Republic” below for a project with a vast amount of laser diode power.

Having their own diode production will still contribute to IPG’s ability to design better lasers, but a big chunk of the advantage from vertical integration will have disappeared, at least for diode powers where competitors have scale. That’s my opinion, and they ought to know more at IPG. Here’s what they say, from “IPG Photonics’ (IPGP) CEO Valentin Gapontsev on Q3 2014 Results – Earnings Call Transcript” Oct. 28, 2014 (

The CFO –

    “… I think that the cost basis of diode manufacturers in the market is still substantially higher than IPG. IPG benefits … from technological advantages around yields, automation, simplicity of package design … I don’t know exactly where the manufacturing cost of the competitors is, but it is probably at least — their manufacturing cost may be 300% higher than ours and the price that we see in the market — or hear about in the market is still five times higher than our diode manufacturing costs. …”

The CEO –

    “We don’t see serious diode competition. It is only the (indiscernible) who produce diode chips and package outside. But it also increases the cost of final product … we increase each year the volume by 40% the last two years, per year. So it is — nobody warrants with such volumes and so on to reach such volumes should be enormous contributor to time and investment.”

Innovation and Russia

IPG are keen to emphasize the advantages of vertical integration. IMO they say less about the advantage of low cost production in Russia, which is bigger when the Ruble is low. Successful innovation reduces the dependence on low cost production in Russia, but much of the innovation originates in Russia.

IPG benefit from photonics expertise in Russia and Belarus, and have been able to acquire Russian companies and the controlling interest in the “5D” Belarusian company. To some extent that may offset the Chinese government’s willingness to support their laser industry. Europe gives a 20% subsidy to approved research, see “Horizon 2020 to splash €700 m on photonics research and development” by Matthew Peach, 12 Dec 2013 ( IPG might not get the full benefit of Russian research due to the U.S. domicile of the holding company, and that might apply particularly to high power lasers with potential in directed-energy weapons as well as industrial uses.

New laser technology and applications

I have to admit that a few of these are not directly commercially relevant, but they show some of the diversity in laser technology and applications.

New laser could upgrade the images in tomorrow’s technology” by Jim Shelton, January 19, 2015 ( The tech is called “chaotic cavity laser” and it could apply to imaging from microscopes to holographs. It solves the problem of being as bright as a laser but without the speckle. Light from LEDs don’t have the speckle but aren’t bright enough. The chaotic cavities are electrically pumped semiconductors, as are LED’s, VCSELs and laser diodes. IPG are not big in the imaging area, although they have lasers for projection in 3D cinemas.

Metals Now Water-Repellent With New Laser Technology” by Jenna Iacurci, Jan 21, 2015 ( A fine pattern is engraved in the metal’s surface, and the result is more water-repellent than teflon but the process is slow. I can’t help wondering if the surface would make torpedos go faster.

Laser technology offers new option to treat epilepsy” by Leslie Hill, Mar. 12, 2015 ( “Ablate your brain” might not sound appealing, but it seems to be less invasive than the current surgical option.

Northwestern Scientists Develop First Liquid Nanolaser” by Megan Fellman, April 24, 2015 ( Instead of bouncing light between two mirrors, light bounces between tiny reflective particles of gold. Like the ‘lab on a chip’, it has microfluidic channels, and flowing a different liquid into the channels changes the characteristics of the laser. The gold nanoparticles are in a fixed array, presumably fixed to the surface of the channels so they don’t move with the fluid (a diagram would have been nice). One possible application is in medical diagnostics. (In a fiber laser, reflection occurs between Bragg gratings in the fiber, near the ends.)

This one isn’t cutting edge, but when lasers replace chemicals it’s environmentally friendly – “New York Peace Monument At Point Park Restored With Laser Technology” Monday, April 20, 2015 (

This is about the French version of America’s National Ignition Facility – “EXCEPTIONAL TECHNOLOGY FOR THE LASER MEGAJOULE FACILITY” by thierry lucas – Publié le 09 avril 2015. The text is in English but some readers might need to know that “Fermer” means “Close”. I’m sure “Les cookies” needs no explanation.

European x-ray free electron laser” (

This one is being constructed in the Czech Republic. I don’t know what it is with Europeans and high energy beams lately. “Team deploys world’s highest peak-power laser diode arrays” Mar 12, 2015 (

The man who wants to control the weather with lasers” by Jacopo Prisco, for CNN, April 24, 2015 ( Conventional cloud seeding puts chemicals into the environment. Lasers provide a chemical-free alternative, but require short bursts of extremely high energy. I have not found an explanation of how lasers create droplets in clouds.

This one includes cloud brightening – “Scientists Propose Using Lasers to Fight Global Warming From Space” by Brian Merchant, Senior Editor, August 22, 2014 (

Trumpf’s Annual Report for 2013/14 (15 Mb PDF) includes a section on invisibility (PDF page 60). This is based on a photonic metamaterial which bends light around an object and the light emerges on its original path, as if nothing had been in the way. There’s an interview with the physicist Tolga Ergin, and no technology from Trumpf is mentioned.

This isn’t new but I can’t leave out Superman memory crystal – 5D optical memory in glass could record the last evidence of civilization Jul 09, 2013 ( In this case, the five “dimensions” are 3 for position, 1 for orientation, and 1 for size, presumably for some feature written into the glass.

For no good reason, and it’s far from being battle-ready – “Laser weapon blasts through truck” March 07, 2015 (

International Year of Light

2015 is the United Nations’ International Year of Light and Light-based Technologies. The effort is intended to raise awareness, and much of the focus is on the history of optics. The “Economic Impact” page looks low-priority, recycling old projections with some future left, which you can download. There’s a claim that growth in the world’s optics industries was twice as fast as world GDP growth from 2005 to 2010. The “Year of Light” might encourage careers in photonics.

About the main sources

Where I’ve drawn on the prepared remarks and the Q&A in the Seeking Alpha transcript, I’ve only given highlights. It’s worth reading those sources, which have more detail including applications I have not mentioned up to now – silicon polycrystal films annealing, and the manufacture of train cars and steel.

With thanks to Seeking Alpha for their policy regarding quoting from transcripts, which you can find at the end of the transcript. I’ve quoted 173 words from the Q1 2015 transcript and 149 words from Q3 2014, for a total of 332 words.

Thank you for reading this.

[ I added data for Trumpf’s direct diode lasers on May 10, 2015 ]

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Gilead Sciences – a dose of information

Disclosure: I’m long Gilead Sciences, Inc. (GILD).

Share price as at April 1, 2015: $97.72.

Contentious profile

Gilead say they are a “… research-based biopharmaceutical company that discovers, develops and commercializes innovative medicines in areas of unmet medical need.” (from the 10-K). Pure “bio” companies can make things like stem cells or complex proteins that are hard for anyone else to make (see Biosimilar on Wikipedia). Producers in India, China and Bangladesh are capable of making Gilead’s big sellers or the intermediates they can be made from. Gilead have the same reliance on patents as any other pharma innovator, and similar risk, except for the unusual attack from AbbVie’s controversial combination-finding model.

About this piece

Investors who are new to Gilead might like to read from “Litigation regarding Sofosbuvir” (below) first, to see if they are comfortable with the risk and with their ability to assess it.

My simple explanations may bring more pain than joy to well informed readers, who might prefer “Gilead Sciences – the charts” (, where I’ve cut nearly all the text.

I cover many aspects of the business, with a lot about hepatitis C but not much about HIV.

I start with a table and chart for customer concentration, then break down revenue by geography, type and product, which leads into product descriptions, the pipeline, and more.

Customer concentration

Gilead customers over 10pc rev - spread

Gilead customers over 10pc rev

Revenue by geography

Gilead revenue by geography - spread

Gilead revenue by geography

Gilead revenue by geography percent

Revenue by type

This is overwhelmingly product sales. The other category is Royalty, contract and other revenues.

Gilead rev by type - spread

Gilead rev by type

Revenue by product

Gilead product breakdown spread

(The spreadsheet formulas are shown here.)

Gilead product pie detail

Gilead product pie type

Harvoni was only on sale for a short time in 2014, with approval from the FDA in October 2014 and from the European Commission in November 2014. Quoting from “Gilead Sciences’ (GILD) CEO John Martin on Q4 2014 Results – Earnings Call Transcript” Feb. 3, 2015 ( –

    “prescription data at year-end indicate that for each Sovaldi patient, three patients started therapy with Harvoni.”

It’s hard to estimate 2015 sales of Harvoni by extrapolating from the short period of sales in 2014, partly because –

    “Although after the launch of Harvoni we saw payor restrictions increasingly in place across all patient types and especially for those with lower fibrosis scores.” (the Seeking Alpha transcript, linked to above)

and there has been news in 2015 which affects price and volume. Payor restrictions have been eased, but in return for lower pricing. If you want to estimate 2015 sales of Harvoni, you may be better off looking at the weekly prescriptions and multiplying by the average price, if you can estimate it, but the prescription data I found is U.S. only and might not catch every prescription.

In the two pie charts that follow, I set Harvoni sales equal to Sovaldi sales in 2014, to give a view of the product concentration which does not grossly under-represent Harvoni. The simple kludge is not intended as a projection, or as an adjustment to 2014 results. Some Harvoni sales will replace Sovaldi sales, and the charts take no account of that.

Gilead product pie detail extra Harvoni

Gilead product pie type extra Harvoni

Gilead’s products

I’ve quoted selectively from a list on page 6 of the 10-K PDF. Lots of crucial info is omitted to keep the length down. I put in the percent of Total product sales I calculated, when the sales of the product were disclosed.


• 4.89% ~ Stribild is an oral formulation dosed once a day for the treatment of HIV-1 infection in treatment-naive adults. Stribild is our third complete single tablet regimen for the treatment of HIV and is a fixed-dose combination of our antiretroviral medications, Vitekta, Tybost, Viread® and Emtriva® (emtricitabine).
• 5.02% ~ Complera/Eviplera is an oral formulation dosed once a day for the treatment of HIV-1 infection in adults.
• 14.18% ~ Atripla is an oral formulation dosed once a day for the treatment of HIV infection in adults. Atripla is our first single tablet regimen for HIV intended as a stand-alone therapy or in combination with other antiretrovirals.
• 13.65% ~ Truvada® (emtricitabine and tenofovir disoproxil fumarate) is an oral formulation dosed once a day as part of combination therapy to treat HIV infection in adults.
• 4.32% ~ Viread is an oral formulation of a nucleotide analog reverse transcriptase inhibitor, dosed once a day as part of combination therapy to treat HIV infection in patients two years of age and older.
• Emtriva is an oral formulation of a nucleoside analog reverse transcriptase inhibitor, dosed once a day as part of combination therapy to treat HIV infection in adults.
• Tybost is a pharmacokinetic enhancer dosed once a day that boosts blood levels of certain HIV medicines.
• Vitekta is an oral formulation of an integrase inhibitor, dosed once a day as part of combination therapy to treat HIV infection in adults without known mutations associated with resistance to elvitegravir, the active ingredient of Vitekta.

Liver Diseases

I’ll start with some info about the seven major genotypes of HCV viruses, after describing “genotype”.

Every person has a gene for eye color. There’s an allele for brown eyes, an allele for green eyes, and an allele for blue eyes. Another example of an allele is the allele for lactose intolerance. A person’s genotype is their complete set of alleles. (I’m ignoring details like the existence of dominant and recessive alleles.)

Although virus reproduction is very different, they still have genes, alleles, and genotypes. Genotypes are grouped into classes, and HCV is currently divided into seven major genotypes, numbered 1 to 7 (according to Wikipedia, but most sources I’ve seen only mention 1 to 6). Genotype 4 is broken down into 4a, 4b etc. up to 4j, while genotype 5 has no sub-types (I’m not sure that’s up to date).

Approximate relative prevalence of genotypes in the U.S. –

Genotype 1 ~ 70%
Genotype 2 ~ 20%
Other genotypes ~ Wikipedia claims about 1% for each other major genotype, presumably leaving about 5% for all the minor genotypes.

Genotype 1 is also the most common genotype in South America and Europe.

Genotype 1 is subdivided into genotype 1a and genotype 1b, while genotype 2 is subdivided into genotypes 2a, 2b, 2c and 2d. I assume that when it’s stated that a product can be used for treating genotype 1, that includes the sub-variants. The 10-K for 2014 has “genotype 1” several times in connection with HCV, and no instance of “genotype 1a” or “genotype 1b”.

Sources: “Hepatitis C” (, Genotype (, “Hepatitis C” ( – I’m not sure who they are), What are Genotypes? – Definition, Examples & Quiz (

For more simplified science, find “Sofosbuvir-aka-Sovaldi bio-chemistry”, below. I also write about “Compensated and decompensated cirrhosis of the liver”, below.

• 8.69% ~ Harvoni is an oral formulation of the NS5A inhibitor with a nucleotide analog polymerase inhibitor dosed once a day for the treatment of HCV genotype 1 infection in adults. … Harvoni is also indicated for certain patients … those with HCV/HIV-1 co-infection.
• 42.2% ~ Sovaldi is an oral formulation of a nucleotide analog polymerase inhibitor dosed once a day for the treatment of HCV as a component of a combination antiviral treatment regimen. … Sovaldi’s efficacy has been established in patients with HCV genotypes 1, 2, 3 or 4 infection (in United States and Europe) and genotypes 5 and 6 infection (in Europe), including … those with HCV/HIV-1 co-infection.
• (4.32%, listed under HIV) Viread is an oral formulation of a nucleotide analog reverse transcriptase inhibitor, dosed once a day for the treatment of chronic HBV in adults with compensated and decompensated liver disease. … Viread is also approved for the treatment of HIV infection.
• Hepsera® (adefovir dipivoxil) is an oral formulation of a nucleotide analog polymerase inhibitor, dosed once a day to treat chronic HBV in patients 12 years of age and older.


• Zydelig is a first-in-class PI3K delta inhibitor, in combination with rituximab, for the treatment of certain blood cancers.


• 2.43% ~ Letairis (ambrisentan) is an oral formulation of an endothelin receptor antagonist (ERA) indicated for the treatment of pulmonary arterial hypertension (PAH) (World Health Organization (WHO) Group 1) in patients with WHO Class II or III symptoms to improve exercise capacity and delay clinical worsening.
• 2.08% ~ Ranexa® (ranolazine) is an extended-release tablet for the treatment of chronic angina.
• Lexiscan®/Rapiscan® (regadenoson) injection is indicated for use as a pharmacologic stress agent in radionuclide myocardial perfusion imaging (MPI), a test that detects and characterizes coronary artery disease, in patients unable to undergo adequate exercise stress.


• Cayston® (aztreonam for inhalation solution) is an inhaled antibiotic for the treatment of respiratory systems in cystic fibrosis (CF) patients seven years of age and older with Pseudomonas aeruginosa (P. aeruginosa).
• Tamiflu® (oseltamivir phosphate) is an oral antiviral available in capsule form for the treatment and prevention of influenza A and B. Tamiflu is approved for the treatment of influenza in children and adults in more than 60 countries, including the United States, Japan and the European Union.


• 1.59% ~ AmBisome® (amphotericin B liposome for injection) is a proprietary liposomal formulation of amphotericin B, an antifungal agent to treat serious invasive fungal infections caused by various fungal species in adults.
• Macugen® (pegaptanib sodium injection) is an intravitreal injection of an anti-angiogenic oligonucleotide for the treatment of neovascular agerelated macular degeneration.


Gilead pipeline

The data is from counting blue bars on Gilead’s pipeline page. I’m not sure what a blue bar means, e.g. a blue bar completely across Phase 2 suggests the phase is complete, but all the blue bars go all the way across. I’ve emailed Investor Relations and not seen a reply. (I failed to draw a definite conclusion by looking into GS-4774, which has blue bars up to Phase 2, and is the subject of “Safety and Efficacy of GS-4774 in Combination With Tenofovir Disoproxil Fumarate (TDF) for the Treatment of Subjects With Chronic Hepatitis B and Who Are Currently Not on Treatment” (

There’s a statement at the top of the ‘pipeline’ page –

    “Safety and efficacy of the following compounds have not been established.”

In some cases, Gilead won’t get 100% of any profit, for example –

    “Complera/Eviplera is a fixed-dose combination of our antiretroviral medications, Viread and Emtriva, and Janssen’s non-nucleoside reverse transcriptase inhibitor, Edurant (rilpivirine).”

Some of the revenue from that would go to Janssen Pharmaceuticals (and when other companies use a Gilead product in a combination, it’s good news, rather than competition).

The pipeline page omits anything pre-clinical.

On Gilead’s site, the Earnings page has the PDF “Fourth Quarter 2014 Earnings slides” which includes diagrams for the pipeline which I prefer to the diagrams on the pipeline page, because it’s clear which phase a candidate is in. The pipeline page should be more up to date, though. The Earnings page also has the Q4 results and guidance for 2015, and audio for the earnings call.

Approvals timeline

I’ve reduced Gilead’s page showing year, picture and name, to number of approvals in this chart –

Gilead approvals numbers

The numbers add up to 22. The trendline I added should not be taken too seriously, but the four approvals in 2014 are probably above any reasonable trend, and a fall looks fairly likely. The R-squared of 0.416 means the trend line only explains 41.6% of the variation. The number of approvals in a year says nothing about the commercial potential of each of them.

Recent Phase 3 results for TAF (for HIV)

See “Gilead Announces Phase 3 Results for Investigational Once-Daily Single Tablet HIV Regimen Containing Tenofovir Alafenamide (TAF)” (

The TAF regimen being tested was found to be “Non-Inferior” for treating HIV, with less side-effect damage to the liver and bones. The reason why TAF is needed is that HIV patients are living longer than previously, increasing the need for treatments which cause less damage. The trial subjects were adults with HIV-1 infection who had not previously received treatment.

Patent expiration timeline

Shareholders will know that Gilead have a good patent expiration timeline, with the big sellers Sovaldi and Harvoni not due to expire until 2029 and 2030. The expiry of Atripla and Truvada in 2021 is not so far off but is not imminent either. There’s a full list on page 17 of the 10-K for 2014 PDF. My table below shows the 2014 sales. It misses out the products in the two ‘other’ categories (in the product sales breakdown), but they only accounted for 1.04% of product sales. I compiled the table by combining the disclosures for sales per product, with the patent expiry table. I’ve shown a simplified (or kludged) version, because it only gives the date of U.S. expiry, along with global sales.

    “For our product that are single tablet regimens (e.g., Truvada, Atripla, Complera/Eviplera and Stribild), the estimated patent expiration dates provided correspond to the latest expiring compound patent for one of the active ingredients in the single tablet regimen.” (10-K for 2014)

The Harvoni combination gets it’s expiry dates based on the latest expiries of its two components. The combination only has patent applications and pending patents (there’s more on that later).

Gilead US patent expiry 2015 spread 3

The next chart tries to show the benefit of the U.S. expiry years, compared to the assumption of an equal amount of U.S. sales expiring every year (expiring with the patents), from 2015 to 2030.

The charts are only meant to give a very rough view, because various assumptions and fudges were needed due to the lack of detailed data. I assumed 2014 sales would repeat until patent expiry, followed by zero sales. I split the ‘rest of the world’ between U.S. and E.U. I did not adjust for Harvoni’s launch date, and because of that the timeline should be better than in the chart.

Gilead US patent expiry 2015

What counts in the chart is that the brown line is above the straight blue line, which means that annual sales are greater than they would be if the effect of expiry was spread evenly throughout the period.

The benefit is not so big for the E.U., but E.U. product sales were less than a third of the U.S. sales in 2014.

Gilead EU patent expiry 2015

One thing that seemed certain enough was the strength of the IP, because an expiration date tends to imply that a patent protects a product until expiry.

Litigation regarding Sofosbuvir

While the risk from the patent disputes may be hard for some people to judge (including myself), it should not be forgotten that nearly half of Gilead’s revenue in 2014 was not from hepatitis C (the disputed area), Gilead have a strong pipeline, and the valuation is relatively low.

Details of Gilead’s litigation start on page 18 of the 10-K PDF.

Sometimes, the U.S. Patent and Trademark Office (USPTO) notices that the claims of a pending patent clash or “interfere” with a patent that’s already been granted. They told Gilead about interference from pending patents for a class of compounds which includes metabolites of sofosbuvir, the drug in Gilead’s Sovaldi and one of two ingredients in Harvoni. (Metabolites are the result of the body’s metabolism turning one compound into other compounds. Technically, sofosbuvir (Wikipedia) is a “protide prodrug”, which is metabolized to an active antiviral.) The pending patents for the class of compounds belong to Idenix Pharmaceuticals, Inc.

In cases of interference, it was necessary to establish who was first to invent (under the law at that time). In March 2013, the USPTO Patent Trial and Appeal Board decided in favor of Gilead. The reason was that Idenix had not given instructions on how to make the disputed compounds. After that, the USPTO board decided Pharmasset (which Gilead acquired) were the first to invent sofosbuvir, because Idenix couldn’t prove they thought of it first, or identified the structure of the compounds or any use for them, or tested them, in the relevant time period. Idenix has appealed to the U.S. District Court for the District of Delaware. That’s only the “First Idenix Interference”. In the “Second Idenix Interference”, Gilead have won the first phase.

(The law has changed, as most of the Leahy-Smith America Invents Act (Wikipedia) became effective on September 16, 2012 and March 16, 2013. America’s principle of “first to invent” was out of step with the rest of the world, which operates on “first to file”. It’s easy to see which filing date was earlier, but the content still needs to be examined, for example to see if it described how to make a compound. The law does not affect previous patents, and it’s the pre-Leahy-Smith law that applies to Gilead’s patent disputes over sofosbuvir.)

The dispute has spread to other Idenix patents, such as ‘191 and ‘572, although patent numbers could be different because they are filed overseas. The dispute has gone on a world tour, with Idenix losing in Norway and the U.K., and withdrawing in China. A trial in Canada started in January 2015. A decision from a court in Düsseldorf, Germany, was expected in mid-March 2015. A trial will start in Sydney, Australia, in September 2015.

From the 10-K,

    “Idenix was acquired by Merck in August 2014. While the acquisition does not change our view of the lack of merit in the claims made by Idenix, Merck has greater resources than Idenix and may therefore choose to fund the litigation at higher levels than Idenix.”

Litigation with Merck

From the 10-K for 2014 –

    “In August 2013, Merck contacted us requesting that we pay royalties on the sales of sofosbuvir and obtain a license to U.S. Patent Nos. 7,105,499 and 8,481,712, which it co-owns with Isis Pharmaceuticals, Inc. We believe that Merck’s patents are invalid and are not infringed by” etc.

For more about Merck, find “Merck’s HCV pipeline” and the link “Merck’s hep C drug no longer a ‘breakthrough’”, below.

See also “Gilead Sciences: Clear The Dockets And Settle With Merck Already” by Small Pharma Analyst, Oct. 21, 2014 ( There are some good points in the comments about why Merck’s case is probably weak. It’s still true that judges don’t always decide correctly or as expected. Chemist357 pointed out that Merck’s provisional patents expired worthless. For a provisional patent to stake an invention date, the patent application had to be filed within 12 to 13 months.

Litigation with AbbVie, Inc.

USPTO (the U.S. Patent and Trademark Office) is likely to refuse a patent for a combination of two drugs which attack different vulnerabilities of the same pathogen, on the grounds that it’s an obvious thing to try. It’s not too surprising that Gilead has no patent for the combination of sofosbuvir and ledipasvir in Harvoni. More surprising is the granting of five patents for the combined use of the same two drugs to Abbvie. Instead of claiming their scientists had discovered the combination, Abbvie claimed it was the result of a virtual model. That seems to have been enough to convince USPTO that AbbVie’s combinations did not fail the test of obviousness.

You can find statements by Gilead starting at the bottom of page 20 of the 10-K PDF.

      “We own published and pending patent applications directed to the use of combinations for the treatment of HCV, and, specifically, to the combination of ledipasvir and sofosbuvir. Certain of our applications were filed before the AbbVie Patents. For this reason and others, we believe the AbbVie Patents are invalid.

Accordingly, in December 2013, we filed a lawsuit in the U.S. District Court for the District of Delaware seeking declaratory judgment that the AbbVie Patents are invalid and unenforceable, as well as other relief. We believe that Abbott Laboratories, Inc. and AbbVie conspired to eliminate competition in the HCV market by falsely representing to the USPTO that they, and not Gilead, invented methods of treating HCV using a combination of ledipasvir/sofosbuvir. In February and March 2014, AbbVie responded to our lawsuit by filing two lawsuits” etc.

Obviously, “If a court determines that the AbbVie Patents are valid and that we have infringed those claims, we may be required to obtain a license from and pay royalties to AbbVie to commercialize sofosbuvir combination products.”.

I’ve included a few links –

AbbVie (ABBV) Uses Patents To Ambush Gilead Sciences, Inc. (GILD)” by Mark Terry, Breaking News Staff, 11/13/2014 (

Gilead Sciences Gets Ambushed By The Patent Troll, AbbVie” by Small Pharma Analyst, Nov. 12, 2014 ( With 325 comments, most of the arguments are likely to have been made already.

The Seeking Alpha piece prompted – ‘“Seeking Alpha” labels Abbvie a patent troll.‘ by Lawrence B. Ebert, November 12, 2014 (, although it was the author Small Pharma Analyst and not Seeking Alpha who used the ‘troll’ label.

The Seeking Alpha article is long and highly informative. The biospace and Seeking Alpha articles both use the word “ambush”. Both authors expect the case to drag out over years. Small Pharma Analyst supports the “troll” label by explaining the obstacles to Abbvie commercializing a copy of Harvoni, which only leaves the extraction of cash from Gilead as the way to exploit the relevant patent claims. Although firms that specialize in “patent trolling” have faced some headwinds in recent years, the ‘trolling’ is not illegal. (For the basics of patent claims, see “How do I read a patent? – the Claims” ( and find the “motor vehicle” example.)

Gilead’s accusation of conspiring to eliminate competition is more colorful than you normally see in a 10-K. I can understand them being outraged, but fear of massive loss would also be consistent with the tone of the statement. Gregg H. Alton, an Executive VP, is a member of “the U.S. Government’s Industry Trade Advisory Committee on Intellectual Property Rights” (under Senior leadership), and the company has been through enough litigation that inexperience is not a likely factor. See Small Pharma’s article for more fairly extreme accusations in Gilead’s lawsuits.

About a lawsuit against AbbVie – “Gilead in 2013: AbbVie sought to eliminate competition and dominate market for HCV drugs” by James Love, July 16, 2014 (

You might not expect gas pedals to have much to do with drug combinations, but see “Is Chunky Monkey an Obvious Combination?” by Peter Pitts, 5.23.07 (

About obvious combinations and prior art, in order of increasing unreadability – the U.K. (, the European Patent Office (, and USPTO (

Litigation with generic manufacturers

This mostly concerns Teva Pharmaceuticals, over Tenofovir Disoproxil Fumarate, Emtricitabine and Fixed-dose Combination of Emtricitabine, Tenofovir Disoproxil Fumarate and Efavirenz, and you can find the details on page 21 of the 10-K PDF.

It’s an obvious tactic for a generics manufacturer to try to break patents. It’s less expensive than developing new drugs, but when patents are successfuly broken, the generics manufacturer has no monopoly on the benefit.

Doctors of the World

Charity challenges Gilead’s European patent on hepatitis C therapy Sovaldi” (Ref: Bloomberg, The Guardian, CNBC, Doctors of the World – Médecins du Monde) by Joe Barber, February 10th, 2015 ( Médecins du Monde claim that Sovaldi depends too much on a breakthrough at Cardiff University, and have filed a patent challenge with the European Patent Office. Médecins du Monde (Wikipedia) are a non-profit that provide medical care and campaign for equal access to healthcare.

Also in the piece, in January, India refused a patent for Sovaldi, implying that the inventive step was too small. I suspect their conclusion, because even if Gilead only tweaked a molecule as alleged, the effect of tweaking a molecule is not necessarily obvious. The tweak might not be easy to make, even if the chemical diagram does not change much. Both those points seem likely to be magnified when it’s only the metabolites that are active. Roche were an early leader in HCV, but their products were never good enough, which supports the view that success was not easy. The same applies to Bristol-Myers Squibb, who acquired key IP (see “Hepatitis C drug set to give Cardiff University financial boost” 12 January 2012 ( If there was an obvious and easy way to build on the university research, it begs the question, why did the researchers at the university or at Bristol-Myers Squibb not make that last inventive step.

Awards for patent infringement

Awards in patent disputes are meant to compensate for lost profits and the extra costs incurred. That naturally includes backdated royalties. I’ve read that big awards for patent infringement are scaled back on appeal more often than not, but I can’t find a link which confirms that.

I googled “record patent awards” and the biggest I could see was “Jury Awards $1.67B to Drugmaker in Record-Breaking Patent Verdict” by Martha Neil, Jun 29, 2009 (

Following that up – “Abbott Wins Reversal of J&J’s $1.67 Billion Patent Victory” by Susan Decker, February 23, 2011 (

The 2011 piece gives Abbott’s worldwide sales of Humira (the relevant product) at around $6.6 billion. If I assume the sales were the same in 2009, the ratio of award / sales = 0.2530303 or 25%. Although that’s for a record-breaking award (for patent infringement), the size of the annual sales would be a large factor. The ratio of award / sales is probably not record-breaking, but IMO it’s likely to be above average. 25% of sales is big when sales are big, but not likely to be a company-killer. Because pharma costs are mostly up-front, with high gross margins, an award like that does not look as bad as failing phase 3, not getting approval, or having very low sales due to a superior competing product, all normal risks for a pharma company.

I did not find another case where damages and the infringer’s sales were both reported, and the studies I found showed the academics had no interest in the relation between the two quantities. A single case is not much to go on but better than nothing.

The amount in a settlement depends on how the case develops, perceptions of the strength of a case and the likely size of an award, attitude, etc.

Pfizer Reaches $2.15 Billion Protonix Accord With Teva” by Sophia Pearson, Susan Decker and David Voreacos, June 12, 2013 (

Assuming Teva and Sun’s sales equaled Pfizer’s lost Protonix sales, their annual sales were –





      = 1094

Settlement / Annual sales
= 2150 / 1094
= 1.9653
= 197%

That’s much higher than the award / sales of 25% for the Abbott vs J&J case.

Assuming the infringing sales only occured in 2008, 2009 and 2010 (the patent expired in January 2011) –



      x 3 years


      = 3,282

Settlement / Total sales (over the three years)
= 2150 / 3,282
= 0.6550 or 65.5%

It was a clear case of jumping in before expiry, and Pfizer’s lost sales really were evident in a lower sales figure. Generics manufacturer’s have smaller gross margins, and the settlement would have hurt. Abbott vs J&J seems more relevant, but it’s just one case.

This lists various IP deals, awards and settlements – “Patent/copyright infringement lawsuits/licensing awards“.

These academics claim to have figured it out – “Explaining the “unpredictable”: An empirical analysis of U.S. patent infringement awards” (PDF) by Michael J. Mazzeo, Jonathan Hillel, Samantha Zyontz, Accepted 2 March 2013 ( I’m not convinced that forward citations are a good proxy for the economic value of patents. I’d guess that applying the methods to cases could produce an endless stream of ‘cookie-cutter’ articles.

Sofosbuvir aka Sovaldi bio-chemistry

Some knowledge of the bio-chemistry should help when assessing competitors’ pipelines, because there are no sales figures to go on. This is meant for people who don’t know much of the science, and while I’ve made it simple, it won’t be as reliable as if I’d regurgitated the technicalities.

The hepatitis C virus (HCV) hijacks a host cell’s machinery to make copies of itself. The virus has a strand of RNA that codes for making proteins, and those strands of RNA need to be reproduced. Each strand of RNA is actually a chain of nucleotides, and a new strand of virus RNA is made by adding one nucleotide at a time to the end of a growing chain.

One way to stop or reduce the virus’s reproduction is to give it some fake nucleotides. That’s a tricky proposition, because the fakes have to be close enough to the real thing to be added to the chain, but they can’t be exactly the same because the whole point is that a chain which includes a fake does not work like a normal strand of virus RNA. The fakes also have to be very effective against virus reproduction compared to the harm they do to the patient.

In the body, Sofosbuvir is turned into metabolites which are “nucleotide analogs”, which means fake nucleotides.

RNA can be understood as a kind of template for building proteins, with the template being read one nucleotide at a time. The nucleotide analogs (the fake building blocks) are designed so that when one of them is read, it’s interpreted as a kind of end-marker, with the effect of saying “stop what you’re doing, we’re finished”. Getting technical, the end marker is called a “stop codon”, and when it causes the chain-building to stop, it’s called “RNA chain termination”.

The chain-building involves a thing called a polymerase. A polymerase is an enzyme that builds a polymer, “polymer” is the word for any kind of molecular chain, and DNA and RNA are both polymers.

NS5B is the Hepatitis C virus’s RNA polymerase, which it uses to replicate its RNA.

If you see Sofosbuvir described as a “nucleotide analogue inhibitor of HCV NS5 B polymerase”, you should now have some idea of what that actually means –

nucleotide analogue – fake building block with a sneaky “stop” sign.
inhibitor of … polymerase – stops the polymerase from finishing a long molecule (by putting an early “Stop!” sign in the template).
HCV – the hepatitis C virus
NS5B – the virus’s RNA polymerase, which it uses to replicate its RNA.

When I read “nuc”, I assume it’s short for “nucleotide analogue” and that it probably inhibits something vital for virus reproduction. “nuc”s are generally good for most genotypes, because all versions of a virus have to make use of the same four or five kinds of “building-block” nucleotides. They are good to have in drug combinations for HCV because they work across many genotypes and act differenctly to other kinds of antiviral. The more efficient a “nuc” is, the less need there is for combining it with drugs that cause severe side-effects. It wasn’t easy to get a good “nuc”, and getting a “nuc” as good as sofosbuvir or better, which is also different enough to be patented, will not be easy.

It’s harder for a virus to evolve resistance to a combination of effective anti-viral agents, because a mutation that gives resistance to one of them should not allow the virus to reproduce and spread the resistance, due to the effect of the other antivirals.

One more term. You might see “Uridine” in a description of Sofosbuvir, as in

“Uridine nucleotide analogue inhibitor of HCV NS5 B polymerase”

There are five kinds of nucleotides. Three of them occur in both DNA and RNA, but the nucleotides built around thymine are only in DNA, and the nucleotides built around uracil are only in RNA. Uridine is a kind of nucleotide analog built around uracil (well, not quite, because it’s a nucleoside, but I can’t explain everything). You don’t need to make every building block a fake, you just need to have at least one fake in a sequence often enough (and not at the end), and faking the uracil nucleotides is good enough.

I’ve missed a lot out, (ribosomes, positive sense RNA, messenger RNA, etc.) which you can tell if you look up the links.

Wikipedia: Nucleoside analogue, Nucleotide, RNA polymerase, Hepatitis C virus, Translation (biology).

Other sources: Nucleoside and Nucleotide NS5B Polymerase Inhibitors (, Nucleoside/Nucleotide Analogues (, about hepatitis B).

Protease inhibitors

HIV and hepatitis C viruses make a number of different proteins by making them all in one long molecule, and then slicing the molecule into the parts they need. The slicing up is done by their protease enzymes. A protease inhibitor is an antiviral molecule which attaches itself to the protease enzyme and stops it from working. See “Protease inhibitors” (

Gilead have two HIV products which work in combination with protease inhibitors, and have a combination for HCV in Phase 2 which includes a protease inhibitor. (From the 10-K, slightly ediited – Fixed-dose combination of GS-9857, sofosbuvir and GS-5816 – GS-9857 is a pan-genotypic NS3 protease inhibitor being evaluated in combination with sofosbuvir and GS-5816 for the treatment of HCV.)


    “If successfully developed and approved by regulatory authorities, this treatment would represent the first protease inhibitor-based STR and thereby continue Janssen’s commitment to providing its HIV products in more simplified dosing presentations.” (10-K for 2014)

(STR is probably “single tablet regimen”.)

Merck’s HCV pipeline

Of the three Hepatitis C candidates listed on Merck’s pipeline page, one is a combination in phase 3, and the other two are combinations in phase 2.

The phase 3 combo is of grazoprevir and elbasvir, each of which is oral and once-daily, and for treating chronic hepatitis C. The combo is an Investigational New Drug (IND), which only means the company has permission from the FDA to ship the drug across state lines before a marketing application has been approved. The 10-K has –

    “MK-5172A, a once daily, fixed-dose, combination, chronic HCV treatment regimen consisting of MK-5172, grazoprevir, an investigational HCV NS3/4A protease inhibitor, and MK-8742, elbasvir, an investigational HCV NS5A replication complex inhibitor, began Phase 3 clinical trials in June 2014. MK-5172A is being investigated in a broad clinical program that includes studies in patients with multiple HCV genotypes who are treatment-naïve, treatment failures, or who fit into other important HCV subpopulations such as patients with cirrhosis and those co-infected with HIV.”

Elbasvir is described as a “HCV NS5A replication complex inhibitor”, which has some similarity to Gilead’s NS5A inhibitor ledipasvir, one of the drugs in Harvoni (the other is sofosbuvir, a NS5B polymerase inhibitor). Harvoni is on sale, but Gilead also have GS-5816, a pangenotypic NS5A inhibitor, and a combination with sofosbuvir is currently in Phase 3 clinical trials. AbbVie and Achillion each have a NS5A inhibitor In Phase 2 (AbbVie’s is ABT-530, and Achillion’s is ACH-3102).

The phase 2 entries on the pipeline page don’t have much detail. One has both grazoprevir and elbasvir, as for the phase 3 combo, and the other has grazoprevir without elbasvir. They both have MK-3682, which I describe later in this section.

From the news item “Interim Data from Proof-of-Concept Study of Merck’s Investigational Hepatitis C Treatment Grazoprevir/Elbasvir in Combination with a Nucleotide Inhibitor (C-SWIFT study) Presented at The Liver Meeting®” Sunday, November 9, 2014 (,

    “To date, no discontinuations due to an adverse event and no drug-related serious adverse events have been reported. Most adverse events were mild or moderate in intensity, with no apparent dose effect.”

I don’t know just how serious the adverse events were. It remains to be seen just how bad they’ll be in phase 3, and the effect on demand, pricing and sales if the combo gets through the remaining stages.

(This section is about Merck’s HCV pipeline, but I’ll mention that the pipeline page has a HIV candidate in phase 3 – “MK-1439 is an investigational orally available HIV non-nucleoside reverse transcriptase inhibitor (NNRTI) being evaluated for the treatment of HIV infection.”, with a link for the clinical trials. The HIV candidate is “investigational”.)

There are two relevant tables in “Is Merck Ready To Soar Or Flop? The Challenging Question Of Predicting Pipeline Potential” by Pharma Doc, Mar. 17, 2015 ( The tables compare Gilead’s Harvoni, Abbvie’s Viekira Pak (both on sale), and Merck’s MK-5172A aka Grazprevir/Elbasvir (in Phase 3). The data used is from phase 2 and phase 3 clinical trials. Taking into account Abbvie’s higher pill count and the side effects, Merck’s candidate seems to be slightly inferior to Harvoni, but better than Abbvie’s Viekira Pak. “GT1” means “genotype 1”, and the author seems to regard MK-5172A as being only good for that genotype, probably for a good reason, although the quote above from Merck’s 10-K included “patients with multiple HCV genotypes”.

The author is also hopeful about an HCV combination made possible by Merck’s acquisition of Idenix. It looks like the combo is MK-3682/MK-8742 (elbasvir)/MK-5172 (grazoprevir), the phase 2 candidate with the mild or moderate adverse events. It seems to be aimed across genotypes, and would compete with Gilead’s Sovaldi. The 10-K says very little except “The Company expects to begin Phase 3 studies in 2015.”, and does not give the combo a name. The component MK-3682 was acquired from Idenix, and it gets –

    “MK-3682 is a nucleotide prodrug in Phase 2 clinical development being evaluated for potential inclusion in the development of all oral, pangenotypic fixed-dose combination regimens.” (Merck’s 10-K)

“prodrug” means it’s the metabolites which are active against viruses (as for Gilead’s sofosbuvir, aka Sovaldi).

“nucleotide” is also in common with Gilead’s sofosbuvir, which is described as a “nucleotide analog polymerase inhibitor” in the 10-K (nucleotides are described in “Sofosbuvir aka Sovaldi bio-chemistry”, above).

In other words, Merck’s MK-3682 looks like a “nuc”, and because of the adverse events it’s probably not as good as Gilead’s “nuc” (Sofosbuvir), even though the “adverse events were mild or moderate in intensity”.

Achillion’s HCV pipeline

The pipeline shows four compounds, two in phase 2, one in phase 1, and a compound between discovery and preclinical. Clicking the names gets more detailed information.

The first compound, in phase 2, is called ACH-3102. It’s an HCV NS5A Inhibitor, which Achillion claim is “second generation”. They also say it’s been “fast tracked” by the FDA, but I wouldn’t be surprised if technically it’s been given a Breakthrough Therapy Designation. There’s a pilot Phase 2 for the use of ACH-3102 in combination with Gilead’s sofosbuvir, and that might be all the compound’s phase 2 activity. Gilead, Merck and AbbVie have NS5A inhibitors in trials, find “Elbasvir is described as a” above. Gilead’s Harvoni includes a NS5A inhibitor and is selling well.

Achillion’s phase 2 candidate pairs their HCV NS5A Inhibitor with Gilead’s HCV NS5B Inhibitor (sofosbuvir). I’m sure they would rather use their own NS5B polymerase inhibitor if they could. That’s the second compound on the pipeline page, in phase 1, a pro-drug uridine nucleotide analog NS5B polymerase inhibitor (after rearranging the words), the same description as Gilead’s Sovaldi/Sofosbuvir (so it’s a “nuc”). It does not seem to be as good as sofosbuvir, as it needs to be taken with ribavirin or pegylated interferon or both, which have side effects. There are some other criticisms in Achillion: The Dark Side by Kanak Kanti De, Feb. 26, 2015 (

Nasdaq give Achillion a market cap around $1.24 billion. Revenue so far has been zero. Liquid assets from cash to receivables are nearly $160 million.

UPDATE: Achillion Pharmaceuticals (ACHN) Will Be Left Behind, Barclays Starts at Underweight” March 3, 2015 ( – the short piece looks a few years ahead, and puts Gilead and Merck ahead of Abbvie, but the opinions are not explained.

For more research into Achillion, you could start with Seeking Alpha. One recent news item is the resignation of the Chief Regulatory Officer.

My own research into Achillion has not gone much farther than what you see here.

Selling a combination which is mostly sofosbuvir is great news for Gilead, but it might not be such good news for Achillion. I haven’t seen anything from them that looks like it would beat or equal sofosbuvir in a combination, which seems to make them less of a threat to Gilead than almost any company with positive cash flow, ambition in the area, and some relevance to the market. Cash-burners can also find it harder to raise cash when the market they hope to address is declining, although in this case the peak has not yet been reached, and Achillion have been able to raise capital. (Find “prevalence peaked in the 1990s”, below.) Sometimes genius is surpassed by even greater genius, and that’s probably what Achillion would need to be a threat to Gilead. I’m not saying Achillion are doomed, just that they are not likely to be a serious threat, based on the little information I’ve gathered.

Achillion’s NS5A inhibitor in phase 2 would be more valuable to Gilead than to anyone else, because owning it would mean owning the whole combination. If the combination of the inhibitor and sofosbuvir has not been spat out by AbbVie’s magic model, owning the combination would reduce Gilead’s vulnerability if they lose the patent dispute. But, the combination might not be as good as the candidates in Gilead’s liver disease pipeline, and Gilead might not want to show interest in an acquisition while Achillion’s stock is high on acquisition hopes.

If Merck acquires Achillion, it would be with the intention of using Achillion’s HCV NS5A Inhibitor with their own HCV NS5B Inhibitor (because they don’t need another NS5B “nuc” which is not as good as Gilead’s). Trials for the combination would have to start from scratch. While the combination is likely to be inferior to the NS5A Inhibitor/Sofosbuvir combination which Achillion are putting through trials, it might still improve Merck’s position in HCV relative to Gilead, but the necessary clinical trials would take years, and the market is due to peak. Merck could face complications if they apply for a “breakthrough” designation with the FDA, because the combination would probably be inferior to Achillion’s combination (with Gilead’s Sofosbuvir), and killing that combination to make their own rank higher would probably not impress the FDA. Against that last point, Achillion were hoping to replace Sofosbuvir with their own version as much as they could, and the problem seems to be with the quality of their version, not the attitude of the FDA.

When the FDA rescinded its Breakthrough Therapy designation for Merck’s HCV combination of grazoprevir and elbasvir, Achillion’s stock fell, apparently because Achillion’s breakthrough designation might be at risk, and future breakthrough designations are less likely, as the FDA’s action shows they believe the number and standard of HCV treatments warrants raising the bar. See “Why Achillion Pharmaceuticals, Inc. Stock Is Crashing Today” by George Budwell, February 4, 2015 (

Abbvie’s HCV pipeline

Abbvie’s HCV pipeline has a combination for HCV genotype 1 which does not need Interferon, in “PHASE III/SUBMITTED”, and a combo in phase 2. There’s no information about phase 1.

From “AbbVie’s (ABBV) CEO Richard Gonzalez on Q4 2014 Results – Earnings Call Transcript” Jan. 30, 2015 ( –

    “Clearly another important driver of performance in 2015 will be our interferon-free HCV therapy Viteron [ph] which is now been approved in the US, EU and a number of other countries around the world. We are pleased with Viekira product label and updated AASLD treatment guidelines and we believe both reflect the strength of the product’s clinical profile across genotype-1 patient population.”

I can’t find anything else about “Viteron”, and I’m wondering if it’s a transcription error. I can’t see it on “2014 FDA Approved Treatments For Hepatitis C” or “New Hepatitis C Drugs Coming in 2015” by Nicole Cutler L.Ac., January 12, 201 (

All I could find in AbbVie’s 10-K about their HCV pipeline was –

    “AbbVie is also currently conducting Phase 2 studies of its next-generation HCV program which includes ABT-493, a potent protease inhibitor, and ABT-530, AbbVie’s new NS5A inhibitor.”

Gilead, Merck and AbbVie have NS5A inhibitors in trials, find “Elbasvir is described as a” above. Gilead’s Harvoni includes a NS5A inhibitor and is selling well.

I have not found much detail about Abbvie’s HCV pipeline. In addition to their normal development pipeline, Abbvie’s virtual model and legal action can be seen as an another way to get income from intellectual property in addition to acquisitions or developing the pipeline.

Further research into competition in the pipeline

One line of research is to go to and search for HCV. Not every result will be relevant. The site was not designed for investors and I haven’t seen any info linking trials to companies.

Recent financial results

In the table below, I’ve noticed that I have not been consistent about making expenses negative and red. I needed most of them to be positive, for the appearance of the chart (the 3D chart after the table).

Gilead 3 years earnings to 2014 spread

Gilead 3 years earnings 3D

Gilead margins

Gilead cash flow 2012 - 2014 spread

Gilead cash flow 2012 - 2014

Gilead balance sheet spread

Gilead balance sheet

About the “Long-term marketable securities”, I believe they are relatively realizable. On page 93 of the 10-K PDF for 2014, they are classed as “available-for-sale securities”, of which only $18 million have a contractual maturity over 5 years (compared to $1,598 million of Long-term marketable securities). None of the assets recorded at fair value are “Level 3”, the hardest of the three levels to assess (for 2013 or 2014).

To see figures for the fantastic growth from 2005, and excellent returns metrics, see Morningstar’s Ratio tab (


Sometimes companies are too enthusiastic about capitalizing costs to make them look like investment instead of expenses. Nothing in the investment cash flow suggested that. I found “We had unamortized capitalized software costs on our Consolidated Balance Sheets of $80 million as of December 31, 2014 and $84 million as of December 31, 2013.”, and “We capitalized $20 million related to the milestone incurred in connection with the FDA approval of Stribild and $12 million related to the milestone we incurred in connection with the European Commission approval. Both milestones are being amortized over the useful patent life of elvitegravir, which is approximately 10 years, expiring in 2023.”. The “accumulated depreciation and amortization” of $620 million includes “$2 for 2014 and 2013 relating to capitalized leased equipment”, i.e. $2 million, and while the value of capitalized leased equipment will be a lot bigger than that I’d guess it’s still small. Because life is short and the items are small compared to the $2,854 million R&D expense, I did not worry about whether or not the capitalizations were proper.

Full Year 2015 Guidance

The guidance is in the earnings call, the earnings release and the “2015 Guidance” PDF on Gilead’s Earnings page. In the following table, the first three columns show the 2015 guidance, and they are likely to be the most reliable columns.

Guidance only gave Product sales, and not Royalty, contract and other revenues. Instead of adjusting guidance to include royalties etc., I adjusted the 2014 figures where necessary to exclude the royalties etc., to give a reasonably fair comparison with the guidance, although I’m not asking anyone to trust the comparison a lot. A full explanation would have taken too much time and space. If you need to know what I did, you can find the formulas by finding “The spreadsheet formulas” above, for a link. I calculated the 2014 non-GAAP gross margin backwards from the non-GAAP EPS, and if you find a better source, that might not be necessary.

It was reasonable to put the highest R&D expenses under the ‘Worst case’ columns, but I don’t mean to imply that high R&D expense is bad. Similarly, SG&A expense is necessary to build the business, and a higher expense is only likely to be bad if it’s the result of inflation or inefficiency.

Gilead guidance for 2015 spread

Gilead beat Q4 analyst estimates after Q3 fell short (according to Zacks on Yahoo). Apparently the outlook disappointed. Estimates were “crushed” back in Q1 according to Gilead Beats by a Billion” by: Ian Wyatt, 05/09/2014 (, which shows that analysts can be wrong about Gilead.

2014 net product sales beat revised guidance. Non-GAAP R&D expenses were bigger than guided, due to two one-offs – buying a voucher for FDA priority review, and a collaboration with Ono Pharmaceutical, possibly buying the rights to Ono’s Once daily BTK inhibitor outside of Japan, China and ASEAN countries (for the treatment of B-cell malignancies and other diseases).

I thought Gilead’s 2015 guidance was probably conservative, and I’m not alone – find “Michael Yee and RBC Capital” below.

Compensated and decompensated cirrhosis of the liver

Anyone with a liver problem should refer to reputable sources and not rely on my writing (investors can do the same, if they have the time).

According to Wikipedia, 30% of cases of cirrhosis are caused by hepatitis B, and 27% by hepatitis C. Those are global figures and they could be lower for the U.S. and other developed countries. The second most common cause is alcohol consumption. Wikipedia gives bullet points to 16 causes.

Cirrhosis of the liver is permanent scarring, which results when the liver tries to repair damage. The damage means it doesn’t work as well.

Compensated cirrhosis is the first stage, with relatively light damage, and patients might not be aware of anything wrong at first. Symptoms include feeling tired, nausea, abdominal pain, loss of appetite, weight loss, and small red spots on the skin called spider angiomas.

Decompensated cirrhosis is the second stage, with serious liver damage. Symptoms include fluid buildup in the legs, feet and abdomen, itching, bruising and bleeding, and the skin yellowing (jaundice). For the non-squeamish, there’s a picture on Wikipedia.

For more symptoms and detail, see Wikipedia or “Cirrhosis” (

Pharmasset acquisition

The Pharmasset acquisition (for hepatitis C drugs) was criticized at the time due to the price and the lack of meaningful revenue. For one example of the criticism, find “Paying Too Much” in “Gilead to Buy Pharmasset for $11 Billion to Win in Hepatitis” by Margaret Tirrell and Ryan Flinn, November 21, 2011 ( Gilead were already the leaders in HIV, and now lead in hepatitis C. One risk is that another big deal might not go as well, although the company is now bigger and could survive a setback better.

With Pharmasset, Gilead acquired Sofosbuvir which is now sold as Sovaldi. Harvoni contains Ledipasvir (which Gilead already had) and Sofosbuvir.

The hepatitis C cures

Sovaldi is generally useful against HCV across genotypes as part of a combination, while Harvoni targets genotype 1, the common genotype which infects 70% of HCV patients in the U.S..

Sovaldi is the commercial name for the drug sofosbuvir. It was approved in the U.S. in December 2013, and by the European Commission in January 2014 for genotypes 1 to 6. Gilead claimed high rates of cure and a shortened course of therapy (12 weeks), patients who can’t take Interferon had their first option for a completely oral treatment, and previously there was no effective regimen to stop HCV from recurring after a liver transplant, that could be taken while waiting for a transplant. See this News release about the E.C. approval. The claim that Sovaldi was good for genotypes 1 to 6 was qualified by –

    “The clinical data supporting the use of Sovaldi in patients with genotypes 5 and 6 is limited.”

but the 10-K for 2014 has –

    “Sovaldi’s efficacy has been established in patients with HCV genotypes 1, 2, 3 or 4 infection (in United States and Europe) and genotypes 5 and 6 infection (in Europe),”

The problem may be that genotypes 4, 5 and 6 are uncommon in Europe.

Harvoni combines ledipasvir with sofosbuvir (aka Sovaldi). It was approved in the U.S. in October 2014, and in the E.U. in November 2014. Harvoni is a single pill once a day, benefiting the “type 1” patients who needed to take interferon and ribavirin with Sovaldi, or use Viekira Pak from competitor AbbVie with a higher pill count. The pill count affects how regularly patients take the pills, and the regimen is obviously less effective if the pills are missed or taken at the wrong time.

From “Gilead Sciences’ (GILD) Management Presents at Cowen & Company 35th Annual Health Care Conference (Transcript)” Mar. 3, 2015 (,

    “Harvoni is recommended for genotype 1 patients and requires a dramatically lower pill count compared to Viekira Pak.”.

Sovaldi sold $10 billion worldwide in 2014, with 32,000 patients treated. 31,000 patients started treatment with Harvoni between launch and the end of 2014.

Market share in HIV and Hepatitis C

Biotech Head-to-Head: Gilead vs. Celgene” by Todd Campbell and Michael Douglass, February 26, 2015 ( An industry analyst (and enthusiastic shareholder) implies that around 80% of new HIV patients have a treatment which involves a drug from Gilead.

This site has too much page junk, IMO – “Gilead Sciences, Inc. Continues To Lead The Hepatitis C Market; Its HCV Drugs See 4.5% Growth” by Hannah Ishmael, Feb 28, 2015 ( The prices in the article look higher than the prices likely to apply in practice, find the link with “US pharmacy deals could cut costs”, below.

Why Gilead Sciences Doesn’t Seem Too Worried About AbbVie’s Hep-C Treatment” by Ben Levisohn, February 17, 2015 (

This is probably the most relevant link – “The Hepatitis C Scorecard: Gilead is Trouncing AbbVie, but at a Price” by Ed Silverman, Feb 12, 2015 ( The ‘price’ is the discounts Gilead had to make, find “46% overall discount”, below. Also find “Info about prescriptions” below, about getting weekly figures for US prescriptions.

Hepatitis C (HCV) numbers

2% to 3% of the world’s population are estimated to be infected by hepatitis C, with a lower rate of infection in developed countries, see “Hepatitis C” by Deborah Holtzman (Centers for Disease Control and Prevention). Applying 2% to 3% to a world population of 7.2 billion gives 144 million to 216 million.

Many cases are undiagnosed, and when diagnosed, many cases are not treated unless or until there are serious effects, such as cirrhosis of the liver. About the delay in treating diagnosed cases –

    “in many countries patients are unlikely to use prescription drugs that are not reimbursed by their governments. In addition, negotiating prices with certain governmental authorities can delay commercialization by 12 months or more.” (10-K for 2014)

Infection is through sharing or reusing hypodermic needles, or unscreened blood transfusions or unscreened organ transplants. In developed countries, screening is much more effective than in the past. It’s harder to reduce infection by intravenous drug users who share needles.

The WHO has reported the prevalence of transfusion-transmissible infections (TTI) in high, middle and low income countries. For HCV prevalence in blood donations, the figures are –

      0.02% for high-income countries


      0.37% for middle-income countries


    1.07% for low-income countries

but with quite wide ranges in each case.

The figures are from “Blood safety and availability” Fact sheet N°279, Updated June 2014 (

Myanmar is an exception I did not expect, see “Myanmar National Blood Center: Receiving a Prestigious International Award” June 1, 2014 (

The piece in the next link claims that prevalence peaked in the United States in the 1990s and will be down to a third of the peak level by 2030. Serious liver disease peaks later than prevalence, and the delay should mean that the incidence of disease can be predicted more easily. “Revolutionizing Treatment Outcomes in Hepatitis C: Managed Care Implications and Considerations—The New and Evolving Standards of Care” by Gary M. Owens, MD, March 24, 2015 (

This is a bit old, but it looks quite far ahead – “U.S. Hepatitis C-Related Health Care Costs to Peak at $9.1B in 2024” January 24, 2013 (

The paper – “Chronic Hepatitis C Virus (HCV) Disease Burden and Cost in the United States” by Razavi H, Elkhoury AC, Elbasha E, et al., Hepatology June 2013, online May 6, 2013 ( – looks like the source of at least some articles with projections. The abstract, conclusion, and much of the rest are readable by non-academics, although there’s a high density of facts and figures. It’s easy enough to get the general idea from four charts showing various peaks. Bearing in mind the title (so the costs should be HCV-related, and U.S. only), paraphrased from the paper –

      Prevalence of compensated cirrhosis was expected to peak at 626,500 in 2015.


      Prevalence of decompensated cirrhosis was expected to peak at 107,400 in 2019.


      The annual cost of compensated cirrhosis of the liver was expected to peak at $1.9 billion in 2022.


      The annual cost of decompensated cirrhosis of the liver was expected to peak at $4.2 billion in 2025.


    The annual cost of chronic hepatitis C (CHC) was expected to peak at $1.4 billion in 2025.

(Technically, prevalence should be a proportion, but I’m not trying to write a Phd thesis.)

I probably shouldn’t add peaks for different years, but I have, and it comes to $7.5 billion. Those projections may be out of date already, but it’s hard to be sure because I have not found figures which are higher, more recent, and confined to the same categories. For comparison, a chart near the top of this piece shows Sovaldi sold $10,283 million, and Harvoni sold $2,127 million, in 2014. The sales will be heavily U.S. weighted, and Harvoni was not on sale for long. While prices have come down, access has been improved.

The article “New hepatitis C drugs predicted to place a dramatic financial strain on health care system” University of Texas M. D. Anderson Cancer Center, March 16, 2015 (, gives a projection which amounts to an average cost of $27.2 billion per year over the next five years, for hepatitis C drugs. Another source projected spending on hepatitis C drugs in the U.S. to reach over $20 billion in 2018, getting there with growth over 6% p.a., find the link “At $84,000 Gilead Hepatitis C Drug Sets Off Payer Revolt”, below (the info is under the heading “Increasing Costs”).

The figures in the bullet points below are from “Gilead Sciences (GILD) CFO Robin Washington Presents at RBC Healthcare Conference (Transcript)” Feb. 27, 2015 (on I’m not sure what all the figures mean, for example the prevalence in Italy is probably all cases of HCV infection, but it was not specified.

• Patients treated in 2014 in the United States with either Sovaldi or Harvoni, 140,000.

• Expected to be treated in the U.S. in 2015, under 250,000 (240,000 and 250,000 were also mentioned).

• Diagnosed patients in the U.S., 1.6 million (that would last 6.4 years if 250,000 were treated per year, without counting new cases).

• Undiagnosed cases in the U.S, 2 million, but prevalence is estimated at over four million (which is more than the sum of diagnosed and undiagnosed cases, 1.6 + 2 million = 3.6 million).

(It’s also been claimed that 3.2 million Americans are infected with HCV, and more than three quarters of them develop chronic infection, which can be without symptoms until damage to the liver causes them. Find the link “FDA Approves Olysio (simeprevir) in Combination with Sofosbuvir for Genotype 1 Chronic Hepatitis C Infection”, below.)

Advertising and education could help to get more cases diagnosed. The current attitude in the medical profession is that early-stage liver disease does not need treatment urgently, so there will be a delay between diagnosis and treatment, and not every case is likely to be treated.

The limited number of doctors and the patients they can see is also a ceiling on the rate at which diagnosed patients can be treated.

The size of the market puts a ceiling on the opportunity, and competitors will take at least some market share.

While not stated, the numbers above seem to be U.S. only.

• Expected to be treated in 2015 in Europe, 100,000.

• Prevalence in Italy, 1.5 million (unusually high, and prevalence could be above average in other southern European countries).

• Run rate in Europe, $2 billion per year. The run rate probably assumes that sales are level with the most relevant recent period, and is not a projection. It’s based on sales in only two countries, France and Germany, Sovaldi only (no Harvoni sales), with restrictions that are likely to become looser because prices have been agreed.
Agreements in Europe vary between countries, and some are confidential. In Europe, lower prices result from higher volume, rather than better access. Until the data is in, it’s not easy for Gilead to give an average European price, probably for any product with potentially high volume, and it’s harder for anyone else, due to the confidential agreements.

The suggestion that prices in Europe would be 65% to 70% of the U.S. price was not “totally out of the ballpark” according to the CFO.

• Number of HCV patients in Japan, a million. (The article “A No-Nonsense Projection Of Gilead In 2015” by Anthony Clarke, Mar. 18, 2015 (, has a lot about Japan. See also “Japan’s Ministry of Health, Labour and Welfare Approves Gilead’s Sovaldi® (sofosbuvir) for the Treatment of Genotype 2 Chronic Hepatitis C” Mar. 26, 2015 (

• Proportion of genotype 2 and 3 patients in Japan, 30%. Harvoni won’t be prescribed for genotype-2, but Sovaldi could be.

    “Marketing applications for sofosbuvir and the fixed-dose combination of ledipasvir and sofosbuvir are pending in Japan.” (10-K for 2014)

(I’ll remind that sofosbuvir is known commercially as Sovaldi, it’s one of the two ingredients in Harvoni, and Harvoni targets HCV genotype 1.)

According to the analyst Michael Yee, genotype 1 represents the other 70% of the HCV market in Japan. Bristol-Myers Squibb got there first with a product that’s only good for genotype 1, with about a quarter of a billion sales (USD) in a quarter.

Revenue from Japan (for HCV) is likely to start near the end of 2015.

BTW I don’t usually have much praise for analysts, but Michael Yee asked some pertinent questions about how hepatitis C sales will trend over several years.

A ‘promising’ HCV vaccine

A “Promising new HCV vaccine” by Audrey Lin, 11 November 2014 (, seems some way off.

The genetic diversity of HCV is a problem mentioned in the paper. Some people with HCV spontaneously clear the virus, and the vaccine is based on the T-cell response seen when that occurs. 15 healthy volunteers showed the right kind of T-cell response, and the vaccine appeared safe. The author says the vaccine “shows promise”.

Hepatitis B (HBV)

Worldwide, about 240 million people have chronic HBV, see Hepatitis B by Francisco Averhoff (Centers for Disease Control and Prevention).

Viread is used to treat HIV, but it’s also listed under “Liver diseases” and is …

    “dosed once a day for the treatment of chronic HBV in adults with compensated and decompensated liver disease.” (10-K for 2014)

It’s licensed to GlaxoSmithKline Inc. (GSK) for chronic HBV in China, Japan and Saudi Arabia.

Hepsera is listed under “Liver diseases” and is dosed once a day to treat chronic HBV, in patients 12 years old or older. It’s licensed to GSK for the treatment of chronic HBV in Asia Pacific, Latin America and some other places.

The pipeline includes –

      TAF (nucleotide reverse transcriptase inhibitor) (in phase 3)


      (Phase 3 has been completed for TAF for HIV.)


      GS-4774 (Tarmogen T cell immunity stimulator) (in phase 2)


    GS-9620 (TLR-7 agonist) (in phase 2)

Apart from the phase 3 results for TAF for HIV, the info is from Gilead’s Q4 2014 earnings slides PDF.

I don’t know what proportion of HBV patients could be treated with Gilead’s approved or candidate products.

HIV numbers

See “The HIV/AIDS Epidemic in the United States” Apr 07, 2014 ( Over 1.1 million people are infected in the U.S. New infections peaked in the 1980s, but have remained stable at around 50,000 for over a decade.

The WHO puts the number of people with HIV/AIDS worldwide at 35 million, in 2013 – “HIV/AIDS” (

From “UNAIDS reports that reaching Fast-Track Targets will avert nearly 28 million new HIV infections and end the AIDS epidemic as a global health threat by 2030” 18 November 2014 ( –

    “We have bent the trajectory of the epidemic,” said Michel Sidibé, Executive Director of UNAIDS. “Now we have five years to break it for good or risk the epidemic rebounding out of control.”

Fast-tracked competitors

The FDA can give a drug in development either “Fast Track” status, or a “Breakthrough Therapy Designation“. In each case, the FDA will expedite the approvals process, although it depends on the company not delaying its communications with the FDA. The links give clear explanations. Investors tend to say that a treatment has been “fast-tracked” if it’s actually been given the breakthrough designation.

The criteria in the links for both designations do not include increasing competition. I can’t say “The FDA will never fast-track a product in order to increase competition.”, but I know of no evidence beyond the fact that most approvals probably hurt a competitor.

Two competing hepatitis C products have been fast-tracked, and then taken off the fast track, due to the existence of four licensed products. See “Merck’s hep C drug no longer a ‘breakthrough’” by Thomas Meek, 5th February 2015, (, where the list of four new treatments starts with two from Gilead, and see “BMS follows Merck as glut of HCV drugs leads to loss of fast-track status” By Dan Stanton+, 11-Feb-2015 ( The ‘glut’ is the same four products as in the previous link.

Pricing in the U.S. and other developed countries

The piece “US pharmacy deals could cut costs of AbbVie and Gilead’s HCV treatments” By Dan Stanton+, 06-Jan-2015 (, allows the quote –

    “Gilead and AbbVie’s exclusive deals with payers CVS and Express Scripts could help cut the cost of the new class of treatments for America’s three million Hepatitis C sufferers.”

Governments don’t like high prices for drugs. The tax in France (later) was an open measure to claw back cash one way or another. It’s normal for drugs to start at a higher average price and sell mostly to private buyers, and for the price to come down as more sales are made to public agencies, and as agreements are made with the large buyers. Management have stated in earnings calls that the process has been accelerated (a physicist would say no, it’s been faster). The average price is also affected as sales build in other countries.

Typically, in return for rebates (from Gilead), restrictions can be eased, such as how badly diseased a liver has to be before an insurer pays for the relevant medication. (Find “The insurance companies that Gilead” for a comment by rational2168 under the Q4 2014 earnings call transcript, and there are other well-informed comments there).

This gives a flavor of the opposition to Gilead’s early pricing – “Activists Hold Die-In to Protest High Price of Gilead’s Hepatitis C Drug” by Michel Sidibé, UNAIDS, July 24, 2014 ( The article grives a price range of US$84,000 to $168,000 for the Sovaldi regimen in the United States. Less committed sources stick with $84,000 – “At $84,000 Gilead Hepatitis C Drug Sets Off Payer Revolt” by Drew Armstrong, January 27, 2014 ( For comparison – “U.S. FDA approves AbbVie hepatitis C drug, costs $83,319 for 12 weeks” by Caroline Humer, Mon Dec 22, 2014 ( See also “Payers hit back at Gilead for $94,500 price tag on brand-new hep C combo pill” by Carly Helfand, October 13, 2014 (

About interest from the U.S. Senate –

    “In July 2014, we received a letter from the U.S. Senate Committee on Finance requesting information and supporting documentation from us related to Sovaldi and the pricing of Sovaldi in the United States. The letter raised concerns about our approach to pricing Sovaldi, its affordability and its impact on federal government spending and public health. We are cooperating with the inquiries. It is both costly and time consuming for us to comply with these inquiries. We cannot predict the outcome.” (10-K)

See “US lawmakers question price of Gilead’s hepatitis C drug Sovaldi” by: Joe Barber, July 11th, 2014 (

That might not be much of an issue now, as I could not find “letter”, “Senate” or “Committee” in the earnings call transcript, or the RBC or Cowen & Co conference transcripts, although there might not have been much point in asking about it before any further news.

The media frequently highlighted the “$1,000 a day” or “$1,000 per pill” price tags (google – Gilead $1,000 a pill). A cure is better than a lifetime palliative, and requires fewer pills. A short course of treatment is better and requires fewer pills. A single pill is better than mutliple pills, and requires fewer pills. Once per day is better than more than once per day, and requires fewer pills. Pills are better than most other methods of treatment (exceptions, such as acidic pills given to elderly patients, don’t seem to be relevant here). The total cost of a course of treatment matters, as well as all the benefits including the benefits of convenient administration. “$1,000 per pill” does not reflect those considerations.

While initial prices may have been too high, it’s normal for the price to come down. There’s a third factor for Harvoni – volumes were surprisingly high, or shockingly high for the the PBMs (Pharmacy Benefit Managers) who had to pay, so they were keen to get rebates, and in return, Gilead got improved access (meaning Harvoni was available to a wider set of patients). I don’t go into the ability of PBMs to pass on the cost, because the issue here is not who bears the ultimate cost, and PBMs don’t say “never mind, we’ll just pass the cost on”, they resist high prices.

Price variation in the U.S.A.

There is not usually a single price for a drug. Pharmacy Benefit Managers (PBMs) like Express Scripts (ESRX) buy in bulk and negotiate discounts. They can get a bigger discount in return for an exclusive agreement, to buy only one company’s product for a particular condition. Some patients with the condition could have a variation which means they can’t be prescribed the product with the exclusive agreement, and the buyers have to buy from a pharma company which won’t be happy about being excluded. The excluded company will not want to give any discount on such sales (and would like to charge as much as possible). The resulting price will be higher than the price charged where the company has agreed a lower price in return for volume. These links have information about exclusive deals, but not about the revenge of excluded companies – “Sorry, Gilead. AbbVie cuts exclusive hep C deal with Express Scripts” by Tracy Staton, December 22, 2014 ( That’s fairly anti-Gilead, and for balance there’s “How Drug Company Gilead Outpaces Its Competitors—And Common Diseases” by J.J. McCorvey ( which also mentions Express Scripts. Gilead’s CFO Robin Washington said –

    “If you take a look at the large PBMs, nine out of 10 have ultimately chosen Harvoni. And of those nine, eight have chosen exclusive.” (

For the source and a link, find “RBC Healthcare Conference (Transcript)” above.

It’s possible that sometimes when exclusive deals are referred to, that might be short for “preferred or exclusive formulary status”, a phrase used in the link “The Hepatitis C Scorecard: Gilead is Trouncing AbbVie, but at a Price” (above). I can’t prove that any use of “exclusive” ought to have been “preferred or exclusive”.

So I can write more about price variation, I’ll assume here that Gilead’s IP is rock-solid – If a competitor sells a combination which includes a Gilead product, the combination could cannibalize the product’s sales. Gilead’s management would have to be crazy to agree a discount big enough to make the total revenue smaller, the more of the competitor’s combination is sold. Gilead could agree a discount if the combination gained access to patients, if the cannibalization of Gilead’s sales was low enough or non-existent. That’s another kind of case where pricing can be at the high end. When two companies use each other’s products in combinations, the terms are more likely to be reasonable, to the extent that the relationship is equal. In such cases the pricing is likely to be closer to the pricing that a single company would choose based on normal commercial factors.

For an example of a competitor using a Gilead product in a combination, see “FDA Approves Olysio (simeprevir) in Combination with Sofosbuvir for Genotype 1 Chronic Hepatitis C Infection” Nov. 5, 2014 ( Olysio / simeprevir belongs to Janssen Therapeutics. Gilead’s 10-K mentions the drug at the end of …

    “Our HCV products, Sovaldi and Harvoni, compete with a product marketed by AbbVie Inc. (Abbvie) and Janssen R&D Ireland’s Olysio (simeprevir) in the United States.”

… under “We face significant competition.”.

The relationship is reversed for Gilead’s HIV combo Complera/Eviplera, which includes a Janssen product.

    “Complera/Eviplera is an oral formulation dosed once a day for the treatment of HIV-1 infection in adults. The product, marketed in the United States as Complera and in Europe as Eviplera, is our second complete single tablet regimen for the treatment of HIV and is a fixed-dose combination of our antiretroviral medications, Viread and Emtriva, and Janssen’s non-nucleoside reverse transcriptase inhibitor, Edurant (rilpivirine).”

The 10-K lists Janssen under “Commercial Collaborations”, as well as naming them as a competitor. Janssen are owned by Johnson & Johnson.

I’ll repeat here that government agencies pay less.

About guidance, the CEO said –

    “What we have in there is the range of different prices depending on the mix of private to public and there are a range of different discounts offered across all those areas.” from the Seeking Alpha transcript “Gilead Sciences’ (GILD) CEO John Martin on Q4 2014 Results – Earnings Call Transcript”, linked to above.

From the same transcript, about “gross to net” –

    “We expect our 2015 growth to net adjustments for our HCV products in the United States to be approximately 46% or a little more than double of that where we ended 2014 which was around 22%.”

The 46% overall discount is sometimes called “Gross to net”, where “gross” is at the list price and “net” is net of rebates or discounts. “growth to net” in the quote looks like a transcription error.

The effect of exclusive deals

The exclusive deals that Gilead and Abbvie have signed with the major PBMs don’t seem to leave much room in the U.S. market for treatments in other companies’ pipelines (find “Merck’s HCV pipeline” and “Achillion’s HCV pipeline”, above). I don’t know how long the agreements last, but I”d guess that anything much more than a year or two would be anti-competitive, because it would deny patients the benefit of innovation from other companies. Gilead have stated that they prefer letting doctors choose, but they can’t be expected to refuse exclusive agreements when that’s what the PBMs want, and when the giant Express Scripts signed an exclusive agreement with a competitor.

One reason for the PBMs’ enthusiasm for exclusive deals in this area may be that the drugs work, and they are safe, leaving limited room for improvement, even though Gilead’s liver disease pipeline is aimed at doing just that.

Obviously a U.S. deal does not affect sales in the rest of the world. If the U.S. market is sewn-up for a while, it does not necessarily mean that excluded companies have poor prospects in HCV, although the U.S. is a major market and it’s expected to peak.

The TRIPS agreement

The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), is generally what you’d expect from the name. The HIV/AIDS epidemic in Africa prompted some loosening of IP protection to allow access to essential medicines. A modification in 2003 allowed exports from one developing country to another, with restrictions such as packaging which is clearly different from the packaging used in developed countries. Those simple facts can cause complications for pharma companies and give rise to financial journalism of the kind light on nuance.

Production for low-price sales

Gilead can’t stop unauthorized production in Bangladesh and Egypt, because the World Trade Organization allows the non-enforcement of patents in some poor countries. Authorized production in India is sold at much lower prices than in the U.S., and is authorized for sale into agreed countries (poor ones). My guess is that unauthorized production in Bangladesh would leak into India if the price in India was much higher. In any case, India refused to grant a patent for Sovaldi (Gilead will appeal). India also has a big problem with counterfeit drugs.

See “$10 version of Sovaldi available in Bangladesh” by Douglas W. House, SA News Editor, Mar 9 2015 (, and Indian drug firm cleared to sell generic sofosbuvir” by Douglas W. House, SA News Editor, Mar 12 2015, (

I don’t mean to imply anything about the Indian companies Gilead have agreements with, but it’s worth knowing about the problems in India. See India becomes a hub for fake medicines on safemedicinesindia (not dated), and if you can bear the page-junk, “Is your medicine a fake? Government report warns counterfeit drugs are flooding India” by Neetu Chandra, March 5, 2014 (, which includes the claim that India has over 10,000 drugs manufacturers.

This looks exaggerated – “How India’s Patent Office Destroyed Gilead’s Global Game Plan” by Bruce Einhorn, January 15, 2015 ( The most credible claim in the article is probably that India’s ruling will help challenges to Gilead’s Sofosbuvir patent in other countries. IMO courts and agencies in developed countries will not take a lead from India. No block-buster drug is likely to be sold at developed country prices in developing countries, by any company, and yet it seems to be big news when Gilead don’t achieve that. Bloomberg say Bruce Einhorn is an “Asia regional editor” and was an “Asia technology correspondent” (you can check the frequency and variety of his article titles here.)

I suggest finding the comment by Ptatty which mentions “TRIPS” under “Gilead Sciences Inc. Faces An Uncertain Future After Patent Loss In India” by Rami Alsamaraee, Mar. 30, 2015 (

Overseas online pharmacies

The sellers that don’t abide by the law in the country they operate from are likely to supply sub-standard or dangerous pills. I suggest reading Wikipedia’s page or finding your own source for more detail.

Wikipedia describes verification programs. This is one of them – Verified Internet Pharmacy Practice Sites (VIPPS) program. When I put “h t t p : / / w w w.drugs******.com” into the box and clicked “Verify” I got “This pharmacy is not in the VIPPS database. Please report this occurrence to NABP by using our feedback form.”. (The spaces are so the URL won’t work as a link, and the asterisks are because I don’t want to publicize the drug seller.)

This story suggests there were allegations in China that Alibaba’s employees allowed fake drugs to be sold. “Chinese square off against Alibaba in palace intrigue as online drug sales loom” by EJ Lane, February 2, 2015 ( The story is vague, because it avoids saying directly that the fakes included drugs, or even that sales of fake drugs were alleged, yet “drug” occurs 21 times and the story is on It isn’t hard to google-up things like “High Quality Sofosbuvir API/ Purity 99% Sofosbuvir ( sovaldi )” on For ledipasvir, one result on Alibaba quoted “US $ 10,000 – 50,000 / Gram”, while a “Verified Supplier” quoted “US $ 1 – 100 / Kilogram” for what seems to be 99% pure ledipasvir in powder form, from any port in China. I don’t know how fussy the supplier is about who they sell to (I could guess). Some of Gilead’s HIV drugs seem to be on sale, or at least intermediates for them. I’d appreciate comments here because I’m not sure how to interpret the offers on Alibaba, but on the face of it, the active ingredients are made and sold at low cost in China.

Opinion on the low-cost trade

Everything from the problems patenting sofosbuvir in India to unauthorized cross-border trade is not special to Gilead. Instead I see an unresolvable tension between the need for pharma companies to have an incentive to develop drugs, and patients who desparately need a cure and can’t afford it, as well as other patients and other parties who want to keep costs down. The tension creates a suitable environment for generics companies, lawyers, online pharmacies of varying legitimacy, etc. A crucial factor is that the costs are both up-front and intellectual in nature, so there’s little up-front cost for copyists.

Gilead in France

See “France uses tax to put pressure on hepatitis C drug prices – (Daily Mail via NewsPoints Desk)” September 30th, 2014 (

It’s a concern because there doesn’t seem to be any downside for France, which other countries are likely to notice, and unlike the rebates in the U.S., there’s no volume or increased access for Gilead in return for the tax.

Tax in the U.S.A. and overseas

See “Gilead Avoids Billions in U.S. Taxes on Its $1,000-a-Pill Drug – (Bloomberg via NewsPoints Desk)” February 26th, 2015 (

Info about prescriptions

On the blog site “Gild – Gilead Science Shareholders” (, find “GILD Harvoni’s scripts were”, and you’ll see a list of weekly figures for US prescriptions. As at March 13, 2015, the figures show a steady rise for the year so far. “nrx” means new prescriptions, and I’d guess “trx” means total prescriptions (new plus repeat prescriptions).

The sources are “Symphony/BBG”, or Symphony Health Solutions and Bloomberg. I don’t know who their sources are, and I would not assume that every body gives them the data they would like to have. I expect that every prescription counted was real, but I would not assume that all prescriptions were counted. The conservative approach is to not assume that Gilead’s U.S. prescriptions are much more than reported (at least, not without a good reason), while not assuming that low numbers for a competitor are accurate. So long as the exclusions stay the same, a rise in the weekly figures is very like to reflect a real rise in the U.S. total. I hope that someone who knows more about it can simplify my qualifying statements.

See also the “BMD Asset Management and Research” instablog (on


The employee reviews on Glassdoor can give a valuable insight into a company, although employees are no more unbiased than other stakeholders, and the “disgruntled employee” is common enough for the adjective to have become fairly standard. Unfortunately, I can only get the UK version, and I suggest checking the US version if you can. The score I see is very nearly three whole stars out of a possible five.

Generally, the drug devlopment side is praised. There’s much complaint about the work/life balance (which is not unusual, but it seems to be worse than average). There’s one low opinion of each of these – the commercial side, the IT, and the bureaucracy. It’s worth finding the review which contains “Little company syndrome”. The most severe criticism includes “turf fights”. The lean model is blamed for demanding too much from staff. It’s reported that staff changed tasks fairly frequently, but it was not said to be excessive or reduce productivity.

Employee reviews on give an average of four stars (out of five), and were mostly very positive. Reviews on Indeed seemed more effusive and less critical of management, but I haven’t compared reviews from the two sites in any systematic way.

A bear’s view, and insider deals

This is bearish – “Forget Gilead Sciences (GILD), Buy These Biotech Stocks Instead” by Zacks Research Staff, March 06, 2015 ( The EVP and a director have recently sold over $700,000 worth of shares, and earnings estimates have gone down.

A director bought nearly $1 million worth of shares on February 20, 2015, see “Gilead insider buys 10000 Shares“. As Peter Lynch said in “One up on Wall Street”, there are many reasons why an insider might sell shares in the company, but there’s only one reason to buy.

Michael Yee and RBC Capital

I noticed Michael Yee’s questions were pertinent and unusually relevant to the long term in the RBC Healthcare Conference. Michael Yee of RBC Capital is in tipranks‘ top 5% of analysts. He has rated Gilead more times than he’s rated any other company. I’ll just say the number is in double figures but under 20, and his performance is likely to have been assessed over a few years at least. The performance of each rating is based on returns over the following year.

Before 2014 results were out, RBC were reiterating “outperform”. Soon after the results – “Gilead (GILD) Price Target Lowered to $118 at RBC Capital” February 4, 2015 (, although “outperform” was maintained. Michael Yee believes Gilead’s guidance is conservative, see “Bigger drug discounts put question mark over Gilead’s stellar run” by Reuters, Fortune Editors, February 4, 2015 (

On Tipranks I noticed a buy recommendation by Michael Yee for Uni-Pixel (UNXL) from two years ago. They are a tiny company that were developing touchscreens. There was much bitter argument about the company on Seeking Alpha, with serious accusations levelled at management (I think the management has been mostly replaced, but I stopped following the company). Two years ago, a short term profit could have been made, but UNXL were not a safe company to hold for one or two years. I also saw a ‘hold’ for Dendreon Corp. (DNDN) two years ago, and they went bankrupt. He may be weak at assessing some major risks, or maybe his outperformance was only possible because he learned from experience. Michael Yee’s performance is good relative to other analysts, but I saw no info about performance relative to sector or market indexes.

Less factual …

My piece – Gilead Sciences – highlights, opinions and unconfirmed points (

Last point about Gilead

Management have delivered.

Seeking Alpha transcripts quoted from

“Gilead Sciences’ (GILD) Management Presents at Cowen & Company 35th Annual Health Care Conference” Mar. 3, 2015 (
Words: 19

“Gilead Sciences (GILD) CFO Robin Washington Presents at RBC Healthcare Conference (Transcript)” Feb. 27, 2015 (
Words: 26

“Gilead Sciences’ (GILD) CEO John Martin on Q4 2014 Results – Earnings Call Transcript” Feb. 3, 2015 (
Words: 120

“AbbVie’s (ABBV) CEO Richard Gonzalez on Q4 2014 Results – Earnings Call Transcript” Jan. 30, 2015 (
Words: 63

Total words: 228

Thanks SA

With thanks to Seeking Alpha for their policy about quoting from transcripts, which can be found at the end of the transcript. I hope they don’t mind me quoting from four of them.

That’s all

Thank you for reading this.

DISCLAIMER: Your investment is your responsibility. It is your responsibility to check all material facts before making an investment decision. All investments involve different degrees of risk. You should be aware of your risk tolerance level and financial situations at all times. Furthermore, you should read all transaction confirmations, monthly, and year-end statements. Read any and all prospectuses carefully before making any investment decisions. You are free at all times to accept or reject all investment recommendations made by the author of this blog. All Advice on this blog is subject to market risk and may result in the entire loss of the reader’s investment. Please understand that any losses are attributed to market forces beyond the control or prediction of the author. As you know, a recommendation, which you are free to accept or reject, is not a guarantee for the successful performance of an investment.

IPG Photonics – the hard-to-gauge reliance on their Russian operations

Disclosure – I’m long IPG Photonics Corporation (IPGP).

About this piece

This is about possible disruption to IPG’s vertically integrated supply chain, if political action restricts supply from the Russian operations to the rest of the company. If you are sure that sanctions against Russia won’t get worse, or that escalated sanctions would not hit IPG’s Russian operations, there isn’t much point in reading any more.

Company profile

    “As a pioneer and technology leader in fiber lasers, we have built leading positions in our various end markets with a large and diverse customer base.” (10-K for 2014)

IPG claim “significant competitive advantages” (2013 Annual Report) from having vertically integrated operations, which are likely to be a big part of why the company has industry-leading margins.

Main sources

I’ll be quoting from the 10-K for 2014, which you can find on IPG’s SEC page, where there’s also a link for the Annual Reports. For SEC filings in .htm format you could try these EDGAR Search Results (if that doesn’t work, try the EDGAR Company Search and put IPGP in the ‘Fast Search’ box).

Find “Conference Call” and “Q3 2014 Results” (below) for the transcripts on Seeking Alpha I’ve quoted from.

The risk

The bold highlighting is mine. From the 10-K for 2014 –

    “Recent events in Ukraine have resulted in the United States and the European Union imposing and escalating sanctions on Russia and certain businesses, sectors and individuals in Russia. The United States and the European Union also suspended the granting of certain types of export licenses to Russia. Russia has imposed its own sanctions on certain individuals in the U.S. and may be considering other sanctions on the U.S. and the European Union or certain businesses or individuals from them. We have a large manufacturing facility and research and development operations in Russia which supplies components to our U.S. and German manufacturing facilities and finished lasers to our subsidiary in China. In addition, we supply components from our U.S. and German manufacturing facilities to our Russian facility. To date, we have not experienced any material disruptions or impact from current sanctions. Should there be disruption of our supplies from or to our Russian operations, or should the United States, the European Union or Russia implement different sanctions, our production and/or deliveries as well as results of operations would be affected.”


An important question is, if the Russian operations were severely restricted and the company faced a shortage of components as a result, just how badly would IPG have to be affected before the statement above becomes too mild to protect management from regulatory consequences? The phrase “would be affected” does not imply an upper limit to the damage, so I expect that management are well covered by the statement, though I have no expertise in the area and I’d appreciate a comment if you know better.

IPG’s production sites

It would be nice to have some idea of how dependent the non-Russian manufacturing facilities are on components from Russia. I found nothing that settles the matter, but there’s some information in the 10-K for 2014. If you find –

    “Our main facilities at December 31, 2014 include the following:”

there’s a list of 13 locations. Five locations include “Components” under “Primary Activity”, and the other eight do not. I’ve extracted info for the five locations with component production, and included the two locations with other manufacturing. The locations I’ve omitted only have administration and service listed.

    Owned or Leased (with expiration date if leased)
    Approximate Size (sq. ft.)
    Primary Activity

    Oxford, Massachusetts
    Diodes, components, complete device manufacturing, administration

    Marlborough, Massachusetts
    Manufacturing, administration

    Mountain View, California
    Leased February 2015
    Components, complete device manufacturing, administration

    Burbach, Germany
    Optical fiber, components, final assembly, complete device manufacturing, administration

    Fryazino, Russia
    Leased July 2016
    Components, complete device
    Manufacturing, administration
    (I explain further down why I believe the activities are not split as shown between the Leased and Owned floorspace.)

    Manchester, New Hampshire
    Leased December 2016
    Components, complete device manufacturing, administration

    Cerro Maggiore, Italy
    Complete device manufacturing, administration

    Total (Owned plus leased)

    Total Russia (Owned plus leased)

    Total Russia / Total (Owned plus leased)

    (Total sq.ft. occupied, including locations with no manufacturing: 1,647,900.)

There’s no reason to suppose that the proportion of the total floorspace in locations with manufacturing is a good guide to the dependence of the company on component production from a country. It’s a massive leap from the result for “Total Russia / Total” to say that about 40% of IPG’s component-production is in Russia, but I can’t see any better way to estimate it. The problem is not just that 39.33% is a lot, but that the true figure could be much more (although it could also be much less).

There may be some ambiguity about the “Primary Activity” in Russia. Either the activities are split between the leased and the owned floorspace as I’ve indicated, or all the activities listed for Russia are spread over both kinds of floorspace.

    Leased – “Components, complete device”
    Owned – “Manufacturing, administration”

The five other instances of “complete device” are all part of “complete device manufacturing” with a lower-case “m” in “manufacturing”. My guess is that “Components, complete device manufacturing, administration” applies to both classes of floorspace (for Russia), with no allocation of an activity to only one class of floorspace. I believe that’s supported by the long quote near the top, which includes “We have a large manufacturing facility and research and development operations in Russia which supplies components to our U.S. and German manufacturing facilities and finished lasers to our subsidiary in China.”. It does not necessarily matter if I’m wrong about that, as I explain in the next paragraph.

Most of the floorspace in Russia is owned, and here I’ll assume the activity is “Manufacturing, administration” (the activities on the same line as “owned”). If Manufacturing does not include components, then only 79,000 sq ft or 13.35% of the floorspace in Russia is for “Components, complete device”. That only works out to 5.25% of the “Total” (for all locations with some kind of manufacturing). However, I regard that 5.25% as even more tenuous than the 39.33% figure (as a guide to IPG’s dependence on Russian-made components), because there is no information for the overall percentage of floorspace used for making components (relative to the manufacturing floorspace, or in fact any class of floorspace).

I did not find much hard information about IPG’s reliance on components made in Russia. Without more information, points about the reliance are likely to be speculative and arguable. Unfortunately, that’s likely to be true for claims that the reliance is low, as well as for claims that the reliance is high, although I don’t want to pre-judge arguments which I have not seen or thought of.

Diodes all made in Oxford, Massachusetts

These are laser diodes, which are more like Light Emitting Diodes (LEDs) than the kind which only function as a ‘one-way-street for current’.

If supplies from Russia are disrupted, it’s good that diodes were not in Russia’s “Primary Activity” list. (There’s some risk in only making diodes in Oxford, Massachusetts, which suggests that economies of scale apply at IPG’s diode capacity, and they are big enough to outweigh the risk of concentrating production, or managements’ perception of the risk.)

More square feet

    “We plan to continue our expansion of our operations in Russia, Germany and the United States to meet the demand for our products and our sales and support needs. We believe that we will be able to obtain additional land or commercial space as needed. The additional expansion for Russia, Germany and the United States will provide an approximately additional 212,200 square feet, 114,500 square feet, and 191,200 square feet (excluding building and land purchases in 2014 for our California and Alabama locations), respectively once these additions are completed and occupied. With the amount occupied as of December 31, 2014, once all expansions are completed in 2015, we will have approximately 2.1 million square feet of occupied space to continue to execute on our planned strategies.” (10-K for 2014)

The “additional expansion”s listed sum to 517,900 sq ft, and Russia’s 212,200 additional expansion is 40.97% of the sum. Adding Russia’s additional expansion of 212,200 to my “Total Russia” figure of 591,700 (based on data “at December 31, 2014”), gives 803,900 sq ft, or 39.75% of the total floorspace in locations with some kind of manufacturing, after the additions referred to in the quote. That’s only slightly above the 39.33% I calculated using data “at December 31, 2014”. However, my calculations based on the “additional expansion”s are fairly rough, because locations are not broken out of countries, and the U.S. includes Novi, Michigan where IPG only list “Administration, service”.

Subsidiaries and the scope of sanctions

When sanctions against Iran were extended to cover overseas subsidiaries of U.S. corporations, a wind-down period was granted (see “U.S. Tightens Sanctions on Iran: Foreign Subsidiaries Wind-Down Period Ends March 8” ( See also “Clarity for foreign subsidiaries of U.S. companies winding down Iran ops” (

It looks like U.S. companies with Iranian subsidiaries would have been forced to divest, but I have not found an explicit statement of that. It would be a big blow if IPG is forced to sell its Russian subsidiary. It would also make many of my ‘if’s and ‘but’s irrelevant.

Finished lasers from Russia

    “We are subject to risks of doing business in Russia through our subsidiary, NTO IRE-Polus, which provides components and test equipment to us and sells finished fiber devices to customers in Russia and neighboring countries as well as finished pulsed lasers to China. Further, over 30% of our sales are to customers in China. The results of our operations, business prospects and facilities in these two countries are subject to the economic and political environment in Russia and China.” (10-K for 2014)

If IPG’s supplies of finished lasers from Russia dried up, I expect that to some extent the subsidiary in China could be supplied from other locations (although any shortage caused by not being able to export components from Russia to the U.S. and the E.U. would affect IPG’s global production of finished lasers). IPG are likely to have spare capacity after substantial investment (find “near finishing a round of investment” under “Nothing about Russian components in the Conference Call”, below).

The supply of finished lasers from Russia would be affected if IPG were unable to export their diodes from Massachusetts to Russia. So long as suitable diodes and other parts are available in Russia, components produced there could (possibly) be used in finished lasers for sale in China, the Russian home market, and many other countries even if the U.S. and the European Union tighten sanctions to include lasers (unless IPG would be punished for exporting from Russia, to China, for example). If sanctions caused a shortage of Russian-made components in the U.S. and the E.U., that could be offset by increasing Russian exports of finished lasers to countries where the trade is allowed (given the conditions: suitable diodes and other parts remain available in Russia, and IPG would not be punished in the U.S. for exports such as Russia to China).

The CEO has claimed that an auto product (presumably a laser or laser-system) has been made in Russia with Russian parts except for some metal parts which could be made in Russia if needed. From “IPG Photonics’ (IPGP) CEO Valentin Gapontsev on Q3 2014 Results – Earnings Call Transcript” Oct. 28, 2014 ( –

    “… our Russian company, really sales efficient Russian entity, which produced of auto product without any impact of the devices from outside of Russia. It’s all made in Russia from Russian components. Is only a few metal parts (indiscernible) we still import outside, but it is not — this is a part we can replace if need …”

The transcript also has management stating that Russian revenue was less than a twentieth of the total revenue (“Russian revenue” must be only for the Russian home market), although seasonal factors and expectations of strong growth in Russia are mentioned (find “It is less than 5%” in the transcript).

The ‘worst-case’ and the business model

I’ll assume here that sanctions stop the export of components from Russia, and the possible offset I just described is not enough to stop a shortage of IPG-made components. The only countries that I know have imposed sanctions against Russia are in North America and Europe, which is where IPG have their manufacturing. (In addition to the U.S. and the E.U., there’s Canada, where the sanctions seem to be mostly against named individuals and some entities, and Norway.)

If IPG don’t have enough components coming out of Russia, and that continues until stocks run out, they face a difficult choice – 1) Sell fewer lasers, or 2) Use the same sources as their competitors. The consequences of selling fewer lasers are likely to include lower revenue, customers not regarding the supply as assured, and lost customers who might be reluctant to return. About the downside of using the same sources as their competitors, from the 10-K for 2014 –

    “Our vertically integrated operations allow us to reduce manufacturing costs, control quality, rapidly develop and integrate advanced products and protect our proprietary technology.”

About the second item, “control quality”, would IPG say “Some of our lasers are not as good as they were.”? If they say “All our lasers are as good as ever.” it will be hard to claim a quality advantage from vertical integration when it’s restored. If they say nothing, there could be speculation about IPG’s sourcing of components which could force a statement, and customers who believed that IPG’s vertical integration resulted in higher quality would feel cheated. Obviously I can’t accuse IPG of a crime that’s in the future, I’m just showing how none of the choices available would be attractive. A reduction in quality would be bad, and if there’s no reduction in quality, the statement about vertical integration would look rather tenuous. A claim that standards were being maintained by thorough quality control could be met by competitors claiming that’s just what they’ve always done. On top of the hard choice, some quick redesigns may be needed if components from other suppliers can’t always be simply ‘slotted in’ to replace IPG components.

IPG say –

    “we design and manufacture most of our key components used in our finished products, from semiconductor diodes to optical fiber preforms, finished fiber lasers and amplifiers.” (10-K for 2014, the bold italic highlighting is mine)

That may leave some leeway for substitution if components can’t be shipped from Russia.

Competitors are unlikely to follow Grantland Rice‘s advice –

Instead, they’re likely to take maximum advantage of any weakness at IPG that results from sanctions. Any market areas where IPG have become weak, could be examined by competitors to see if they could dominate or address the areas profitably. IPG shareholders would be hoping that competitors settle for higher margins, rather than think strategically (see “What is strategy?” June 4, 2013 (

IPG reported Cash and cash equivalents of $522 million, compared to only $164 million of Total liabilities. It’s good to have a cash cushion if a crisis hits.

Is the ‘worst-case’ too crazy to happen?

You could argue that sanctions by either side which would affect IPG, would hurt both sides, without any measurable gain. However, in conflict a simple cost-benefit analysis is not necessarily relevant, any more than it applies to a game of ‘chicken’. The relevant branch of math is game theory, not the more direct methods of optimization.

For comment on geopolitics, you could try ‘Stratfor‘ (Strategic Forecasting, Inc.) who give free weekly Intelligence Reports. Their point of view tends to be based on the long term effect of geography, such as the lack of natural barriers which made Russia hard to defend.

Before World War I, many people thought that war in Europe was unlikely due to the interdependence of the European economies (possibly due in part to not understanding a book called “The Great Illusion“). It’s not the only war which demonstrated that mutually-advantageous trade links could be broken.

In less violent conflict, trade can be disrupted when it favors one side more than the other, and also when it’s believed that something needs to be done, and the alternatives are less attractive.


Maybe IPG could quickly replace lost Russian component production by stepping up production in the U.S. or Germany, but there isn’t much information to base that on. IPG’s soon-to-be-completed round of investment suggests that there should be spare capacity, but not necessarily of the right kind to replace Russian component production.

Inventories for the latest quarter fell year-on-year (from $172,700 to $171,009, in thousands), so there’s no evidence there of increased production of components in Russia for stockpiling outside the country. While the effect on reported inventories might not be great if vital components are produced at low cost, the simplest explanation is that IPG were not stockpiling components made in Russia.

About resilience more generally, IPG were hit by the financial crisis/recession in 2009, and bounced back very quickly (see the Morningstar link at the top, and find the nine-year history on the ‘Ratio’ tab). The problem then was probably the recession causing low demand across the industry, which is different to a single company having a problem with supply.

Costs in Russia

Employment costs are probably lower in Russia. You could try finding “What is the Russian Middle Class?” on Doctors earn less in Russia than in other European countries, see “Russian Doctors Protest as Reforms Threaten Jobs” Agence France-Presse, November 18, 2014 ( That isn’t directly relevant, but google keeps thinking I want to know about sanctions when I’m trying to research staff costs. If employment costs are much lower in Russia, that could explain some of IPG’s superior margins. In any case, so long as a low Ruble translates to lower costs in Russia, news which is bad for the Ruble is good for IPG’s costs. Potentially, increased tension could increase IPG’s margins via a lower Ruble, at the same time as increasing the risk in various areas (to the Russian operations, the company’s revenue, the share price etc.).

Nothing about Russian components in the Conference Call

See “IPG Photonics’ (IPGP) CEO Dr. Valentin Gapontsev on Q4 2014 Results – Earnings Call Transcript” Feb. 20, 2015 (

These are the Russia-related topics covered –

In Q4 2014, revenue from the “other products” category “decreased 47% year-over-year to $9.6 million”, the result of “a decline in system sales in Russia due to economic conditions and foreign currency devaluation there as well as having had a comparatively large system order” (in Russia) “in Q4 of last year”. The “other” category is volatile, and small compared to the quarter’s total revenue of $207 million.

Sales in Europe grew to $69 million, “partially offset by weakness in Russia related to the economic environment there” (and the year-ago system order mentioned previously).

There’s a paragraph about the effect of the strong dollar and weak Ruble on the value of inventory, which was about $9 million lower as a result.

The quarter’s revenue from Russia is described as “good” given the headwinds.

The company is near finishing a round of investment in Russia, the U.S., and Germany, which should provide enough capacity to double revenue (find “finishing the round” in the CC).

I saw no questions from analysts about the effect on the rest of the company if components can’t be shipped from Russia. Maybe they are wrong to ignore the risk, or maybe they have better information and regard the risk statement about Russia as legal boilerplate.

Corruption in Russia

Yukos ( Oil giant Yukos was seized by the Russian government, over 2003 to 2007, under Putin’s leadership.

U.S. Investor’s Lawyer Dies in Moscow Jail by Gregory L. White, updated Nov 18, 2009 ( Hermitage Capital were accused of not paying taxes. Hermitage claim they paid, but the taxes were pocketed by fraudsters. The company’s lawyer was jailed and denied medical treatment.

See Russia, Corruption Timeline ( and Corruption in Russia ( I’ve read that IPG were developing their own distribution network in Russia, due to the corruption there, but I can’t find any evidence. Many of IPG’s management team were educated in Russia and some of them may be able to advise on how to avoid trouble.

All IPG say about corruption in the 10-K is that anti-corruption laws are complex and often difficult to interpret and apply, with penalties if they get it wrong. They comment on the risk associated with Russia and China –

    “The results of our operations, business prospects and facilities in these two countries are subject to the economic and political environment in Russia and China. In recent years, both countries have undergone substantial political, economic and social change. As is typical of an emerging economy, neither China nor Russia possesses a well-developed business, financial, legal and regulatory infrastructure that would generally exist in a more mature free market economy. In addition, tax, currency and customs legislation is subject to varying interpretations and changes, which can occur frequently.”

Miscellaneous links

IPG’s Management and Board of Directors (

This article briefly mentions the proportion of IPG’s employees based in Russia – “IPG Photonics – Growth And Technological Leadership Offer Appeal” by The Value Investor, Feb. 23, 2015 ( (Some comments by myself repeat points I’ve made in this piece.)

I wrote positively (mostly) about IPG in my blog post “Three cash3 companies“, January 17, 2014 (on


I’ve focused on the adverse possibilities, and it’s worth bearing in mind that maybe sanctions will not be escalated, or an escalation will not have much effect on the Russian operations, or the effect will mostly be limited to Russia, or a shortage will be dealt with by quickly by ramping up production of components outside of Russia. If the risk is material, management ought to have considered it, and plans could already be in place.

Thanks, SA

With thanks to Seeking Alpha for their policy about quoting from transcripts, which can be found at the end of the transcript.

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Hewlett-Packard – long term charts

Disclosure – I have no financial interest in Hewlett-Packard Company (HPQ). I’m long UBNT.

Additional disclosure – I won’t make any transaction relating to HPQ within 72 hours of publication.

My piece “Hewlett-Packard – three spreadsheet tables, and the quality of cash flow” shows the data the charts are based on. The formulas are in my ‘build the spreadsheet’ pieces, “Build the big HP spreadsheet and “Build the HP Operating Cash Flow growth spreadsheet“.

Revenue and earnings, in millions:
HP revenue and earnings

HP margins

Assets, liabilities and equity, in millions:
HP assets liabilities and equity

HP liquid assets

‘Per share’ charts

My reason for using ‘Shares calculated from EPS’ is that HP disclosed EPS adjusted for stock splits, but not an adjusted number of shares. I use ‘Shares calculated from EPS’ later to get figures for Operating cash flow per share (adjusted for stock splits). The number of shares is adjusted for the stock splits in 1995 and 1996, but not for 2000. I then used an adjustment factor for the 2000 split only, when I calculated split-adjusted values for dividend, cash flow per share, etc. (Find “build” for a link with the formulas.) It’s complicated but the smoothly rising adjusted dividend means I probably got it right.

HP number of shares

HP EPS and dividend

HP EPS divi and OCF per share

IMO the most pronounced feature of the period is the steep fall in OCF from 1998 to 2001. EPS lagged, falling from 2000 to a negative value in 2002. The 2012 drop in EPS is dramatic, reflecting an $8.8 billion writedown for the Autonomy acquisition, but OCF looks like it was not affected, with a dip that does not look bigger than average. The 2012 dip in OCF was during a rise, but it’s hard to pick a start for the rise, and the rate depends on the start.

HP trends for EPS and OCF

There are reasons to not trust the trendlines in the chart above –

1) The R-squared values are fairly low. They measure the amount of variation explained by the trendline, so an R-squared of 0.60 means the trendline explains 60% of the variation, and an R-squared of 0.53 means the trendline explains 53% of the variation.

2) If both trends continued, EPS would overtake OCF per share (OCFPS), and the ratio OCFPS / EPS would approach zero. That’s because the trendline for EPS has an exponential formula, which implies a fixed annual percentage growth (on average), whereas the OCFPS trendline has a linear formula, which implies the annual percentage growth rate will fall to zero. It’s extremely unlikely that OCFPS / EPS will approach zero, so at least one of the trendline formulas must be wrong. Visually, it looks like the gap between the trendlines narrows from 2010, increasingly rapidly, while the actual quantities have diverged.

3) It’s possible to select a shorter period which gives different trendlines and higher values of R-squared, such as 2001 to 2014:

HP trends for EPS and OCF 2001-2014

In each case I’ve used the trendline with the highest R-squared (out of Linear, Log, Exponential, and Power). Whether or not it’s mathematically correct, the power curve fitted to EPS since 2001 looks suspiciously like a straight line. It also looks too steep, and too high for the latest three years.

I would say for 1991 to 2014, the trend has been up, with such big and long deviations from any simple trend you could fit, that you can’t reasonably seperate the data into trend and noise. If you can’t pick out a trend in EPS or OCFPS in 24 years of data, there is no meaningful trend other than more up than down. The reversal that started in 1998 shows the danger of trying to ride a shorter term trend. I would be wary of any investment case that relies on trends in EPS or OCFPS.

One constant feature is that OCFPS has stayed higher than EPS. While in some cases earnings can smooth out variations in cash flow, in the long term it’s the cash flow that matters (given reasonable assumptions, such as OCF not including a disguised financing flow). It’s cash that can fund investment or be returned to shareholders, not earnings.

The following chart is based on my definition:

    Free cash flow = Operating cash flow – net PPE – net cash paid for acquisitions (all ‘per share’)

Rearranging that gives:

    Operating cash flow = net PPE + net cash paid for acquisitions + Free cash flow

In the chart, I’ve stacked the three quantities on the right, and for most years the top of the blue ‘Free cash flow’ bar corresponds to Operating cash flow. For some years the quantities don’t stack well in the chart. For most of those years, the height of the stack above zero is a good approximation of OCF. Two exceptions are 2002 and 2011 –

2002 – Operating cash flow was $2.17 per share, and Free cash flow was $1.63 per share.
2011 – Operating cash flow was $5.93 per share, and Free cash flow was negative (at -$0.61 per share).

HP components of OCF per share

Before showing the ‘walk charts’ for HP’s capex and cash-from-ops, I’ll show what an excellent chart looks like with this old chart for Ubiquiti Networks (I’m long UBNT).

Ubiquiti cash walks per share to 2013

Ubiquiti’s latest chart is in my previous blog post, and it shows a dip in 2014. Still, their cash-from-ops has grown fast without much need for cash to be invested (the investment flow includes capex). Not many companies can do that (and skepticism about it could explain the shorting). HP’s chart (below) shows loops. There isn’t much point in working out if they went round an old loop clockwise or anti-clockwise, what matters is the lack of clear progress during the loop. HP stayed mostly on the positive-free-cash-flow side of the chart, and finished in a better area than where they started.

HP walk chart OCF and capex

HP walk chart OCF and PPE per share

HP walk chart cumulative OCF and capex

HP’s Trade receivable sales

Increasing sales of receivables can imply a deteriorating quality of cash flow, because the sales cannot be increased indefinitely, so they potentially represent an unsustainable source of cash flow growth. I don’t think that’s likely to be a serious problem. There were claims relating to the 2012 results that sales of receivables were propping up the cash flow, with a strong rebuttal from HP. I write more about it in “Hewlett-Packard – three spreadsheet tables, and the quality of cash flow” (already linked to), where I give reasons why the increasing sales of receivables might not be a problem.

HP Trade receivable sales and more

HP’s growth of Operating Cash Flow per share

HP OCF growth CAGR - spread



I’ll repeat that for EPS and OCFPS, there’s no clear trend in the 24 year period, other than more up than down. Overall growth in OCF per share has been an unexciting 6.42% (1991 to 2014, adjusted for stock splits), but the rate depends very much on the period you look at. OCF per share has been more stable than EPS, maybe because downturns or acquisitions require writedowns which affect net income but not OCF, although variation in the optimism applied to accounting judgments is also a possibility. It’s natural for a long-lived company to have a succession of CEOs and variable earnings, and shareholders need to consider the possibility that a new CEO might at some point have ‘kitchen-sinked‘ to some extent (for example, see “Some Analysts Question Numbers in H.P.’s Write-Down” by Peter Eavis, November 21, 2012 ( Free cash flow has also been less stable than OCF, which is often the case due to capex being more lumpy than other expenditure.

At the risk of stating the obvious, HP’s changing fortunes will be due to some combination of industry cycles, the changing market for its products and services, and the varying quality of its leadership. The dotcom boom and bust may have had some effect on HP’s business around 2000, through the misallocation of capital in tech companies.

The walk charts are consistent with the fairly common view that HP are good at generating cash flow, but have allocated capital badly, through poor or overpriced acquisitions. Poor performance has also been blamed on uncertainty or a lack of clarity about HP’s purpose and what it is or should be trying to achieve. That problem seems to be over, with the advanced technology HP are developing, and the planned split into a printing and personal systems company (printers and PCs), and the ‘Enterprise’ company.

HP’s long term performance is not fantastic or abysmal, but is quite patchy. Looking at the cash flows on a per share basis, results have improved under the current CEO, but I’m not 100% certain that the rapid rise in the sales of receivables has not been a factor in that. I like the technology HP are developing, although I’m currently not sure how far I should trust management. (I write about trusting management in general, here).


I’m less sure of my facts in this part.

I can’t pin down just how well HP are recovering and catching up in the areas they operate in. I give three relevant links under “Cash rush” in my “three spreadsheets” piece. It looks like heavy cuts on the service side from the EDS acquisition have caused low morale and an exodus of expertise. Such restructuring yields cash flow, for a while, which contributes to the flow needed to develop the Moonshot servers, hybrid cloud and R&D generally. I can’t say if HP is deliberately neglecting services to fund other areas, and that would never be admitted because of the effect on customers. It may be the result of the succession of CEOs with different visions of which markets HP should be in. One risk for HP is that the CEO will leave (to sort out IBM?), and IMO whatever you think of her, HP does not need another CEO changing the direction yet again.

IBM have been criticized for cutting costs in their services side and providing no more than is agreed to in the contract, making them undifferentiated from companies in emerging markets while being no cheaper. India-based Infosys has an excellent record of return on assets and equity, and have accumulated cash. The article “Innovation And Acquisitions Will Drive Growth For Infosys” by Economics Fanatic, Jan. 9, 2015 ( suggests to me that Infosys are looking to differentiate their service, while services from IBM and HP are becoming commodity-like through cost cutting. It’s not about Infosys having access to cheap labor – IBM employ staff in India, and have been criticized for low pay which results in the best staff leaving when they have enough experience. Maybe it’s too hard for IBM and HP to compete with the Indian companies, and it makes sense for them to move out of the way. There are other competitors –

    Enterprise Services. ES competes in the IT services, consulting and integration, infrastructure technology outsourcing, business process outsourcing and application service markets. Our primary competitors include IBM Global Services, Computer Sciences Corporation, systems integration firms such as Accenture plc. and offshore companies such as Fujitsu and India-based competitors Wipro Limited, Infosys Limited and Tata Consultancy Services Ltd. We also compete with other traditional hardware providers, such as Dell, which are increasingly offering services to support their products, new players in emerging areas like cloud such as Amazon, and smaller local players.” (10-K for the year to October 31, 2014)

“HP Enterprise Services” is the name given to EDS some time after the acquisition in 2008. EDS have been described as an “IT outsourcing giant”.

I’ve listed most of those named competitors by their stock ticker, with a link to the morningstar Ratios page where you can see the financial history including some return metrics. HPQ (poor ROA), IBM (reasonable ROA), CSC (poor ROA), ACN (good ROA), WIT (good ROA), INFY (good ROA). Obviously there’s more to the financial history than ROA, and more to a company than its financial history. IMO Accenture stands out, then India-based Infosys and Wipro look good. HPQ trails. Check the leverage, which indicates roughly how ROA is levered to increase the return on equity (ROE) which in turn tends to determine growth and the return of cash.

The Autonomy dispute

After acquiring Autonomy, HP accused the former management of fraud. See my short piece – “The Autonomy dispute after the UK’s fraud-buster gives up” February 01, 2014 (On this site). The U.S. authorities are still investigating. I look into the record of the UK’s Serious Fraud Office, then describe the point of view of Autonomy’s former management, with a little comment.


I mention the technology which HP will be investing heavily in, in one of my comments (as “fnoobler”) under an article titled “Server acceleration Altera FPGAs vs nVidia GPUs” on Seeking Alpha. The article is relevant to the future of servers. There are some technically informed comments under it, and I like to think that my less-informed speculations encouraged them. Also see Hewlett-Packard’s (HPQ) Management Presents at Citi 2014 Global Technology Conference (Transcript) Sep. 2, 2014 (

Issues with implications for cash flow

From “Hewlett-Packard’s (HPQ) Presents at Barclays Global Technology Conference Transcript” Dec. 10, 2014 (

    “restructuring and the focus on cost, has also then allowed us to plow money back into R&D.”

I assume that “restructuring” mostly means job cuts. HP expect 55,000 jobs to have gone by the end of 2015, making 5,000 to go after about 50,000 in recent years (in Meg Whitman’s tenure, I think).

Much of the transcript is about the planned split. The printer and PC side generates cash, and with the Enterprise side not having access to that cash flow after the split, there was a need to get Enterprise to generate more cash, which may have motivated the restructuring. ‘Enterprise’ gets the one-off benefit of shifting debt to the printer and PC side (apart from the debt in the financing operations), while keeping most of the cash.

Reawakening The Sleeping Giant At Hewlett-Packard” by Gary Hirst, Dec. 3, 2014 ( Much of the article seems to be based on the Barclays and Citi conferences. One other area covered is the contrast between HP’s program for developing paradigm-shifting server technology, and IBM’s program which is big but based on pushing existing tecnnology further.

History and awards etc.

Wikipedia list the company’s history. A chart showing the stock price since 2000 above the tenure of four CEOs, currently stops at 2013 and misses the rise under Meg Whitman, to $40.08 on Jan 26, 2015. HP have won many environmental and business awards, including “Most Respected Company in China” nine times in a row (there are various categories, quite a few winners, and IBM say they won it in 11 consecutive years). Making a Forbes list in 2010 where criteria included “use of corporate assets” may seem odd or a case of ‘award curse’, given the acquisition record, and some abrupt changes of plan when CEOs Hurd and Apotheker were ditched (in 2010 and 2011).

Errors and fudges

My extraction of long time series from 10-Ks was not straightforward and may not be reliable. The issues are described under an “Errors and fudges” section in the ‘three spreadsheet tables’ piece I linked to above.

Short term charts

See “Hewlett-Packard – Trying to find a pattern in the changes in working capital“. Skip the scatter charts if you like – the results were negative (as in theories not proved).

Thank you SA

With thanks to Seeking Alpha for their policy regarding quotes from transcripts, which can be found at the end of the transcript.

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