Baby, Don’t Leave
State governments collect billions of dollars in taxes every year, and they work just as hard to protect their revenue base as their friends at the IRS. Sometimes that means putting lots of eggs in one basket — then watching that basket very, very carefully. But one state acknowledges taking that particular strategy to a new level. In a move that falls somewhere between “I can’t believe they haven’t done this already,” and “Wow, that sure sounds like stalking,” the Connecticut Department of Revenue Services has revealed they’re “keeping an eye” on their top 100 individual taxpayers to make sure they don’t leave the state — and take their taxable income with them.
Connecticut residents boast the fourth-highest median household income of any state in the country. It takes $678,000 per year to join the much-discussed “top 1%” club, compared to $389,000 for the United States as a whole. But we’re not talking about dime-a-dozen Wall Streeters here. We’re not talking “the millionaire next door.” No, we’re talking true fat cats. James Bond-villain money. Guys who are literally buried in so much cash it would take an entire village full of torch-wielding peasants to storm them out of their castles.
Let’s take a closer look at one of the state’s new pals. Steve Cohen is a hedge fund manager who lives in Greenwich in a 35,000 square foot home with an ice-skating rink the size of the one at Rockefeller Center and a two-hole golf course. He charges his clients four percent of the assets he manages, plus up to 50% of their gains. Forbes magazine reports that he hauled in $2.3 billion in 2014. (That’s right, “billion” with a “b.”) The Nutmeg State’s top tax rate is 6.7%. A little fourth-grade math tells you the state siphoned $154.1 million out of Cohen’s bulging pockets.
Now let’s put that tax bill in a broader perspective. Connecticut’s budget for Fiscal 2013 was $28.1 billion. That means Cohen picked up more than half a percent of the state government’s entire tab for the year, all by himself. (Ironically, last year Cohen closed his fund to outside investors in the wake of an insider-trading scandal, which will virtually eliminate his earned income. We doubt that federal prosecutors were thinking about his state tax bill when they filed charges against his fund!)
Cohen’s income may have vaulted him to the top of the heap. But he’s hardly the only super-earner to make it rain in Connecticut. One accounting firm with offices in Greenwich reports preparing tax returns for three unidentified Nutmeggers with billion-dollar incomes. Ray Dalio, head of Bridgewater Associates, raked in $900 million in 2013. (Sure, that sounds like a lot, but it’s actually down from $3 billion in 2011). Paul Tudor Jones, who lives in a Monticello-inspired mansion with a 25-car garage, scored $700 million.
“There are probably a handful of people, five to seven people, who if they just picked up and went, you would see that in the revenue stream,” says Kevin Sullivan, the Department’s commissioner. Two years ago, Sullivan adds, his office heard that one particular hedge funder might be leaving, and set up a meeting to urge him to stay. The manager moved (d’oh!), but agreed to keep his company back in “the little state that could.”
Would you be flattered if you knew the government was watching your tax payments like a jealous lover? Or would you be creeped out? Either way, you’d probably want to pay less so you could disappear from that particular radar. That’s where we come in. We give you a plan to keep as we show you ways to reduce your taxes.
In The Headlines
Ace Hardware – the $4.7 Billion Corner Store Co-op
When Jeremy Melnick’s grandfather opened his first Ace Hardware store along Chicago’s ritzy Gold Coast in 1950, there was not a whole lot of competition. Wal-Mart was an Arkansas five-and-dime. Lowe’s was two stores in North Carolina. Home Depot was still 29 years away from opening its first location. Amazon CEO Jeff Bezos was 14 years shy of being born.
The Melnicks—Jeremy, 43, and dad Les, 67—own six of the 4,794 Ace Hardware stores that make up the country’s largest retail cooperative outside of the grocery sector. As they have expanded their family business-within-a-business into a local chain, some 20 Home Depots have cropped up along greater Chicago’s highways and strip malls in the past two decades, each 100,000 square feet (versus the Melnicks’ 8,000-square-foot corner stores). “They surround us,” Jeremy says.
Despite the competition, his business is good—surprisingly good. And so is Ace Hardware’s bottom line. The Oak Brook, IL co-op expects a year-on-year revenue increase of 13% to about $4.7 billion, and a profit boost of 35% when it releases its 2014 annual report in April, following eight consecutive quarters of record sales. The reason for success, explains Ace CEO John Venhuizen, a charismatic 44-year-old who speaks with the fervor of a preacher, is store owners like the Melnicks. Entrepreneurs with a deep knowledge of their local market, inventory fine-tuned to a neighborhood’s demographic, and the sort of exacting customer service a typical big-box store with low pay and high employee turnover just cannot match.
Jeremy knows the make and model of bathroom faucets installed in every condo complex and apartment building within a short drive of all his Chicago stores, a boon in attracting fellow small business owners, like local plumbers, to Ace. “It’s a big deal,” says Venhuizen, a 22-year company veteran. “It’s a differentiator. And I’ll tell you, it’s exceedingly hard.” Jeremy knows his stores’ strengths. He does not sell lumber. For that you can go to Home Depot or Lowe’s. He does sell what seems like every kind of lightbulb in production. When a bulb blows he knows you would rather grab a new one from your local Ace than navigate the labyrinthine aisles of a big box or wait in the dark for an Amazon delivery. “If you want to remodel your house, you’ll go to them,” he says. “We’re making our money $20, $25 at a time.”
The company’s co-op business model means its store owners are its only shareholders. It is the opposite of a franchise system. Thousands of entrepreneurs like the Melnicks band together to boost their collective buying power and reduce costs. The corporate structure, with Venhuizen at the helm since 2013, exists only to do their bidding, overseeing 14 regional distribution centers that supply each store with the right mix of $800 Weber grills and $15 hammers.
When an Ace store opens (or an existing hardware outlet converts to Ace), the owner buys $5,000 in shares. He or she can purchase any of the 80,000-odd products from the co-op’s warehouses, make use of the well-known red-and-white logo and branding (“The helpful place,” its motto promises) and receive dividends based on purchases rather than equity. Each store kicks in for activities that benefit the whole co-op, like advertising and marketing (Ace’s annual ad budget is $100 million). In the past 18 months Ace has seen some 144 stores jump ship from competitors, including a handful from its two fellow hardware co-ops, True Value and Do It Best. During that same time,just 49 Ace stores have left the fold. In order to increase your market share, you have to go out and steal stores from someone else,” says Jim Robisch, senior partner in retail at the Farnsworth Group, a home improvement industry consultancy.
Next up, Ace is tackling same-day delivery, one of the hottest trends in retail. Tests in 33 stores across six states started on Jan. 26. It’s a pretty obvious move, says Venhuizen, since 70% of U.S. households are within a 15-minute drive of an Ace store. “I don’t know if you can deliver a grill with a drone, but our trucks will get it there,” he says with a grin. Besides, 60% of Ace’s stores already provide delivery to customers, albeit in a haphazard way–more like a favor to a friend who does not have a car than part of a business model. Jeremy Melnick has delivered plungers. He’s screwed in lightbulbs. “They do this already,” says Venhuizen. “Doesn’t everybody?”
Next Up for Apple – the iCar?
Apple, Inc. is working on an electric vehicle, according to people familiar with the matter, showing the consumer-electronics giant is open to stepping outside its lucrative focus on mobile devices. Apple has put a few hundred employees to work on the secretive project and Steve Zadesky, vice president of iPhone product design, is leading the effort. The project is code-named Titan and the vehicle design resembles a minivan, the Wall Street Journal reported recently. Some Apple executives have flown to Austria to meet with contract manufacturers of high-end cars, the report said, citing people familiar with the matter. Apple ultimately could decide not to proceed with a car. In addition, many technologies used in an electric car, such as advanced batteries and in-car electronics could be useful to other Apple products.
Apple often investigates technologies and potential products, going as far as building multiple prototypes for some things that it won’t ever sell. Any car would take several years to complete and obtain safety certifications. Building cars is capital intensive, costing hundreds of millions of dollars for design, tools and production, and certifications. Auto makers also must help ramp up a supply network for the thousands of components that go into a vehicle. But the size of the project team and the senior people involved indicate that the company is serious.
Apple already has technology that may lend itself to an electric car and expertise managing a vast supply chain. The company has long researched battery technology for use in its iPhones, iPads, and Macs. The mapping system it debuted in 2012 can be used for navigation. And last year, Apple also introduced CarPlay, a software system that integrates iTunes, mapping, messaging, and other applications for use by automakers.
Apple has batted around the idea of developing a car for years. Phil Schiller, Apple’s senior vice president of marketing, said in 2012 court testimony that executives discussed building a car even before it released the iPhone in 2007. Mickey Drexler, an Apple board member and head of J Crew Group Inc., also said in 2012 that Apple co-founder Steve Jobs had wanted to build a car. The Financial Times reported that Apple is hiring auto experts to work at a new research lab.
Other Silicon Valley companies are also creating cars. Google, Inc. is working on a self-driving vehicle. Tesla Motors, Inc., makes electric cars and has hired at least 150 former Apple employees, more than from any other company, even carmakers. “From a design philosophy, Apple is relatively closely aligned,” Elon Musk, Tesla’s co-founder and chief executive officer, said recently in an interview. Musk also said Apple has been trying to poach employees from his Palo Alto, California-based company, offering $250,000 signing bonuses and 60 percent salary increases. “Apple tries very hard to recruit from Tesla,” he said. “But so far they’ve actually recruited very few people.”
Apple has hired from the auto industry over the years. Zadesky joined Apple 16 years ago from Ford Motor Co., where he was an engineer for three years. Apple’s chief financial officer, Luca Maestri, has worked at General Motors Co. Over the past two years, Apple hired Haran Arasaratnam from Ford to work as a battery engineer, and Apple also brought on Robert Gough in January to work on special projects. He had spent the past four years at auto supplier Autoliv working in the company’s radar division and developing active safety sensor technology.
The expense of getting into the auto business is a barrier to entry to many potential competitors, but would be less of a hurdle for Apple, which reported holding $178 billion in cash as of the end of 2014. Also, while auto makers tend to operate their own factories, Apple has relied on contract manufacturers to build its products. That has helped Apple keep a lean supply chain and reduce inventory exposure.
Citations
1. http://onforb.es/1A8OgwT – Forbes
2. http://bloom.bg/1BdlFJG – BusinessWeek
3. http://on.wsj.com/1zBD9sL – Wall Street Journal
The Good News Is . . .
• Real gross domestic product (GDP) increased 2.6% in the fourth quarter of 2014, according to the advance estimate released by the Bureau of Economic Analysis. For the full year 2014, real GDP rose 2.4% after rising 2.2% in 2013. The increase in GDP in the fourth quarter reflected an increase in consumer spending of 4.3%, as well as increased investment in inventories by wholesalers and manufacturers, and rising exports of goods and services.
• Cisco, Inc., the leading manufacturer of networking equipment and software, reported earnings of $0.53 per share, an increase of 12.8% over year-ago earnings of $0.47. The firm’s earnings topped the consensus estimate of analysts by $0.02. The company reported revenues of $11.9 billion, an increase of 7.0%. Management attributed the company’s results to solid performances across all of its product lines, and the successful transition to providing cloud-based and mobile services to customers.
• The online travel booking company Expedia announced its second acquisition in two months, agreeing to buy Orbitz Worldwide for $1.3 billion in cash to add yet another well-known brand to its ranks. Under the terms of the deal, Expedia will pay $12 a share in cash for each Orbitz share. Over all, Expedia said that it expected the acquisition to contribute about $75 million in cost savings. The transaction further solidifies the American market for online travel booking to two companies, Expedia and the much bigger Priceline Group.
Citations
1. http://1.usa.gov/1zfk4xp – Bureau of Economic Analysis
2. http://www.cnbc.com/id/18080780/ – CNBC
3. http://bit.ly/1uWYZLJ – Cisco Inc.
4. http://nyti.ms/1Afy3Jo – NY Times Dealbook
Planning Tips
Guidelines for Investing in Emerging Markets
If you have been following the business news over the past 10 years, chances are you have heard someone say the “emerging markets” are a good investment bet. And that is largely true, with some caveats. Like any asset class, you should not overdo it. It is important to consider the risks and consult with your financial advisor before making any investment decisions.
What is an emerging market? – An “emerging” market is generally understood to be a high-growth developing country. What these countries have in common is high growth rates, often driven by export economies and consumption. Many have young populations, so the shift to urban consumer lifestyles results in greatly increased imports and, in time, greater domestic manufacturing.
How do you invest in emerging markets? – Because many U.S. investors lack familiarity with emerging-markets companies, choosing quality mutual funds and ETFs led by capable managers is as essential here as in any area of the market. A good fund will have an experienced and knowledgeable research team with a deep understanding of the companies and markets in which they operate. Emerging-markets index funds are also available and provide emerging-markets exposure for investors who prefer passive management. Investors may also choose to obtain emerging-markets exposure via a broadly diversified foreign-stock fund.
Whichever approach you prefer, the point is to go with investment vehicles run by professionals who know how to navigate this very tricky segment of the market.
What are some of the risks? – Below are some of the additional risks you are likely to encounter when investing in emerging markets:
• Growth can be uneven – Emerging markets have more volatility. It is nearly impossible to predict which years will provide excess returns and those when investors flee for safer shores. Once you decide how much exposure to volatility you can handle, keep within those limits.
• Risks are difficult to measure – Emerging market companies report results, but the interplay of regulation, market forces and competition are much harder to grasp from thousands of miles away.
• Currency comes into play – Currency shifts will affect your return, and predicting those outcomes is very difficult.
• Political risk is greater – A single election can change the fortunes of companies in emerging markets overnight. Incoming governments can hike taxes and change policies dramatically. Domestic monetary policy is a factor as well and broadly unknowable until it is too late to act.
Focus on the companies rather than the countries – Research has shown that, even in emerging markets, company earnings growth, PE multiples and valuations are more important than general economic data as predictors of longterm investment performance.
Alternatives to emerging market stocks – Emerging markets offer a variety of sovereign, municipal, corporate and structured debt just as developed markets do. Offerings are divided into domestic and external, with the former being local currency issues and the latter denominated in U.S. dollars or another developed currency. Emerging markets debt is a readily accessible asset class through mutual funds. Well-known fund managers offer funds that access a variety of countries and product types.
Citations
1. http://bit.ly/1DaJLWi – Morningstar
2. http://bit.ly/1ATqAQc – Institutional Investor
3. http://onforb.es/1cUKic8 – Forbes
4. http://bit.ly/1A8ONPl – Investopedia
5. http://on.wsj.com/1A8OPXx – Wall Street Journal
