The 4th annual Excellence in Investing: San Francisco conference took place this week and MarketFolly was there to cover the event. Excellence SF partners with the Sohn Conference Foundation and is dedicated to the support of education and other children's causes.
It's not too late to make donations and here's a link to do so, The success of the event has grown over time and this year marked record attendance. Since inception, more than $1 million has now been raised in support of these causes.
Notes From Excellence in Investing: San Francisco 2013
John Burbank III - Passport Capital
Idea: Long Digital Garage (TYO:4819)
Thesis: Things seem frothy now. Like plays linked to innovation. The QE fueled rally is likely coming to an end. Stay away from growth coming from and derived from QE. Tech is less sensitive to GDP. Innovation is not EM activity, it is DM activity. In Japan Abe says follow Abenomics. Likes Digital Garage. It has around a 20% stake in Kakaku (TYO:2371). Owns small stake in Twitter (possibly $100M). CEO owns 14% of the company. Stock just split. Thinks it has a 22% upside to current value PLUS optionality on the future. Can hedge out Kakaku if you want given that company's high valuation. Burbank also recently had a macro discussion with Kyle Bass that we've posted as well.
Kurt Billick - Bocage Capital
Idea: Long Domestic Oil Refineries (specifically Tesoro (TSO) & Marathon Petroleum (MPC))
Thesis: Likes Malcolm's presentation on CF (below) as his idea has a similar theme, but with refineries. North American oil business was thought of as mature and in structural decline. Gulf coast's ability to refine oil will be overwhelmed with supply. Discount in price of oil for US refineries is less than that of all of the margin for many refineries in rest of globe. Other advantages are processing costs lower due to cheaper natural gas and financial arbitrage. Likes all refineries (ALJ, DK, HFC, MPC, PBF, TSO, VLO and WNR). His favorites are Tesoro (TSO) and Marathon Petroleum (MPC). TSO is still in early stages of getting discounted crude. Dan Loeb's Third Point has also written their thesis on TSO in a past letter. MPC is a recent spinoff with management just now getting in tune with running as a standalone refiner. Billick also recently appeared on a best ideas panel at another conference that you can read about at that link.
Mick McGuire - Marcato Capital Management
Idea: Long Sotheby's (BID)
Thesis: Owns 7% of the stock. These are their first public comments regarding the investment. Capital has not been allocated well. Core business is good. Lots of opportunity to unlock value of real estate. There are under-utilized assets. Thinks stock is worth $68 which is more than 30% above current price. One of two major auction houses with Christie's. Has been falling behind Christie's in some areas. Opportunity for improvement there with the income statement. Regarding the balance sheet, opportunity to unlock value with the real estate holdings. They've been growing the lending business with after tax profits from the auction business. Instead they should be funding this with other facilities like securitization or receivables. Dealer segment not big, but performance there is symbolic of poor capital allocation. $1.3B in trapped equity with poor opportunities for reinvestment. This money should be returned to shareholders through buybacks, etc. You can view McGuire's slideshow presentation on Sotheby's here.
Mason Morfit - ValueAct Capital
Idea: Incentive Based Investing
Thesis: Many companies have perverse incentives in place right now. He prefers to reward to performers, not caretakers. One of the problems with financial metric based performance is that management sets targets. They have implemented changes at Valeant Pharmaceuticals (VRX) and Adobe with significant increases in price after the changes. Note that ValueAct recently trimmed their ADBE stake.
Christopher James - Partner Fund Management
Idea: Long Adobe (ADBE)
Thesis: Mobility is impacting marketing and advertising. Spending is migrating to mobile, social and online marketing. Emergence of "Marketing Cloud". Closed Loop Marketing... key players are becoming SalesForce (CRM) and Adobe. Both are focusing on this trend and building platforms and making acquisitions to establish dominant platforms. Adobe has been moving from traditional software model to SAAS. Better economics with this newer model as acquisition costs are low and renewals are high. Thinks they can do $3 in FCF in 2015 and $4 in FCF in 2016.
David Herro - Harris Associates
Idea: Long Select European Equities (Credit Suisse, BMW Group, Diageo)
Thesis: Looks for opportunities from Mr. Market where price is significantly below intrinsic value. Use a discounted cash flow model to calculate intrinsic value. Likes European equities. Fixed exchange rates caused distortions. Very different micro-economic policies by country in EU create bottlenecks to adjustment. Unit labor costs in Europe declining. Debt yields are dropping. Competitiveness is increasing. Europe trades at a discount. Consider European companies based there, but with global or US reach. Europe is good at luxury. Likes Credit Suisse as it is trading at less than 10 times normalized earnings. BMW Group has over 20% of profit from China. EV to EBITDA is less than 6. Weathered the recession very well. Diageo (DEO) is the world's largest premium spirits and beverage company. Yield is over 3%. Great business for the long, long term.
Malcolm Fairbairn - Ascend Capital
Idea: Long CF Industries (CF)
Thesis: Based largely on dynamics relating to natural gas and nitrogen. China is the largest producer and user of NatGas. Nitrogen demand growing 2% a year. Futures suggest price doesn't break $5 until 2020. CF benefits from low prices. CF has leading margins but trades at discount to peers. Recently increased dividend. Thinks price could be $250 based on the peer group's 3.8% yield with a 50% earnings payout. We've also posted Third Point's thesis on CF from their past letter.
Christopher Lord - Criterion Capital Management
Idea: Long Tower Companies (American Tower (AMT), Crown Castle (CCI) and SBA Communications (SBAC))
Thesis: Last years pick was Google. Things look frothy now. Likes "Towers". Seen a 35x increase in mobile traffic the last six years. Estimates the increase will have been 430x for ten year period ending 2017. Towers are winners. The US is going from 2 top cell carriers to 3 or 4. Tower companies build towers and cell carriers pay most of the other costs. These businesses can't be replaced. Best real estate is already taken. There are also restrictions on new towers. Contracts also have automatic price escalators. Given that models have high operating leverage, much of the price increases go straight to bottom line of the towers. Picks are AMT with a target of $110, CCI with a target of $100, and SBAC with a target of $110. Right now these companies are trading at lower multiples to other types of REITs, but they have higher growth rates. Bonus thoughts: likes shorting 3D printers, Cree (CREE), SAAS Cloud Companies trading at greater than 20x Revenues, Cisco (CSCO), EMC (EMC), VM Ware (VMW).
Brian Zied - Charter Bridge Capital Management
Idea: Long Brunswick (BC)
Thesis: Charter Bridge runs a long/short fund. Prior to founding the firm, Zied was at Maverick Capital. He focuses on consumer driven small and mid-size businesses. Brunswick focused on Marine, Fitness, Bowling and Billiards. Strong in engine business. Attractive investment with many ways to win (depressed boat cycle, marine innovation, restructuring opportunity). There is a 40 year history of boat sales. For a long time new boat sales were between 300K and 500K boats a year. Boat cycle was at 120K at the bottom of recession, now at 150K boats a year. Participation in boating is at an all-time high. Boats have a 25 to 30 year life. There are 200K boats being scrapped per year. Obviously, these trends are going to run in to each other with new boat sales rising. Revenues still haven't come back from pre-crisis levels. Innovation in GPS sky hook anchoring and joystick controls. Precrisis boat revs were greater than $2B, now only at $1B...the recovery is inevitable. Typically new boat sales are 25% of annual boat sales, right now they are only 16%. Largest position in their portfolio. Brunswick is currently at 7.4x EBITDA and 14.9x PE whereas most peers average 10.5x EBITDA and 17.4X PE. Sees a free call option with 50% to 80% upside.
Carl Kawaja - Capital Research Company
Idea: Long EADS (EAD)
Thesis: Flight is still a modern miracle that many don't appreciate. Likes companies that solve problems. Planes are BIG. This business has a moat that won't get disrupted by three kids in a dorm room (like social media). Majority of world flies less than once a year. Air travel won't revert to mean, it will just continue to grow. The business of airlines is getting better. Fuel efficiency is driving sales of new planes and will increase profits for manufacturers. Thoughts on valuation: 1) Earnings will grow... a lot. Many of the upfront costs already incurred for R&D. 2) They will get more orders...addressable market is more than $1T with a $800B backlog. Market cap is $51B... PV of future ops alone is worth more than $64B. Sees stock doubling over time.
Michael Moe - GSV Capital
Idea: Long Twitter (TWTR)
Thesis: From 1991 to 2000, there were 550 IPOs per year. Following decade has seen an average of 113 IPOs per year. Before market caps were around $100M at time of IPO, now they are on average over $1B. This means VC firms must invest longer before firms go public. In 2013, IPOs are performing very strong. GSV is a public vehicle for VC stage companies. Twitter is his idea. They currently have a position in it. It is 15% of the fund. Ad growth of 124%. There are 620 million shares outstanding. At $25 a share the market cap is about $15.5B. Positive cash flow the first half of 2013. Participating in multiple trends including: Social, Personal Branding, Mobile, Second Screen Watching TV, Next Gen Devices. Mobile usage has now surpassed desktop usage. Vine (Twitter owned) is #1 App. Thinks it could go as high as $160 a share.
Christopher Balding - HSBC Business School
Idea: Macro Call of Short China
Thesis: He's an Associate Professor of Finance and Economics at the HSBC Business School of Peking University Graduate School. A lot of data from China is manipulated. China is a huge bubble. Example of bad reporting is growth numbers. Growth reported from provinces aggregates to 10.8% growth whereas official GDP from China is 7.8%. Another example: official CPI housing price inflation up 14% while real estate prices up 111%. Price in income ratio for real estate in San Francisco is 9.4. This seems high, but it is 32 in Shenzhen. The official numbers say that steel companies in China have $500B in debt and only $300M in profits. Would be very careful before simply taking financial and economic data at face value. Banks in China are starved for capital right now. There is risk dispersion. 2/3rds of the stocks in China have been really hurt while 1/3rd are trading at a premium. Example is BYD trading at a P/E of 1,100. If you don't want to short China directly, another option is shorting China derivative plays like companies in Australia heavily tied to China. We've also posted up Jim Chanos' short China thesis as well for those interested.
That wraps up notes from Excellence in Investing: San Francisco 2013. For more coverage on top hedge funds, scroll through the hedge fund letters we've posted up recently.
Friday, October 25, 2013
The 4th annual Excellence in Investing: San Francisco conference took place this week and MarketFolly was there to cover the event. Excellence SF partners with the Sohn Conference Foundation and is dedicated to the support of education and other children's causes.
Excerpts from Lone Pine's Q3 letter [II Alpha]
Some excerpts from Conatus Capital's Q3 letter [CNBC]
Children's Investment Fund is the largest Royal Mail shareholder [FINalternatives]
Hedge funds with high 'human alpha' outperform their peers [ValueWalk]
A profile on ValueAct's Jeff Ubben [Fortune]
Buffett's Berkshire cuts Tesco stake by 300m [Telegraph]
Perry Capital to sell stake in LEG [HedgeWorld]
Regulation changes the way hedge funds grow [FT]
Pension Funds love Wall Street [Bloomberg]
Shanghai aims to be hedge-fund central [WSJ]
College endowments show little investment skill [Forbes]
Carl Icahn's new activist website [Shareholders' Square Table]
While Bill Ackman has been in the media a lot for his J.C. Penney and Herbalife plays, the Pershing Square founder also has quite a successful investment on his hands: Canadian Pacific (CP). And now we get news that he's set to trim his stake by $800 million or so.
Post-sale, the hedge fund will retain around a 9.8% ownership stake in the railroad. CP has been a big winner for Ackman, tripling his investment.
Various investment banks are leading the sale of CP shares and this is the second time this year that Ackman has trimmed his CP stake, as he did so this summer already.
For more from this hedge fund manager, head to Bill Ackman's Q3 letter.
Howard Marks' hedge fund firm Oaktree Capital has filed a 13G with the SEC and disclosed a 15.8% ownership stake in NewPage Holdings with 1,117,192 shares.
The filing was required due to activity on October 22nd.
Per Google Finance, NewPage Group is: "After struggling through several financially challenging years for the coated paper making industry, NewPage would like to do just that, turn over a new page. Through subsidiary NewPage Corp., the company is one of the largest makers of coated and specialty paper in North America. From mills in the Eastern and Midwestern US, NewPage churns out about 3.5 million tons of paper annually. Its papers are often used to produce annual reports, magazines, and catalogs. Customers include xpedx, Advance Magazine Publishers (dba Condé Nast), McGraw-Hill, Time Inc., and Avery Dennison. NewPage Corp. filed for Chapter 11 bankruptcy in late 2011."
Thursday, October 24, 2013
Mick McGuire of activist hedge fund Marcato Capital Management pitched Sotheby's (BID) at the Excellence in Investing San Francisco conference yesterday. We'll be posting up notes from the event soon, but in the mean time here's Marcato's take on BID.
Marcato's Presentation on Sotheby's (BID)
McGuire feels there's an opportunity for BID to return capital to shareholders and suggests that a $1.3 billion accelerated repurchase (around 38% of market cap) could boost shares to $68, up 56% from July 30th close. He's also looking for various operational improvements that can contribute to the upside.
Marcato isn't alone on their bullish and activist stance on BID as Dan Loeb's Third Point sent a letter to the BID board recently.
Embedded below is McGuire's presentation from the Excellence in Investing San Francisco conference:
Check back soon as we'll be posting up notes from Excellence in Investing SF shortly!
John Lykouretzos' hedge fund Hoplite Capital is out with its Q3 letter. In it, we see that they added to positions in Sea World Entertainment (SEAS), Monster Beverage (MNST), and H&R Block (HRB) during Q3 as shares sold off but their theses remain unchanged.
HRB is their largest position and Lykouretzos writes,
"While HRB has recently announced that it will no longer be selling its bank to Republic Bancorp, we are confident they will either sell the bank or shut it down and pursue a more shareholder-friendly capital structure."
The hedge fund also exited their stake in Intuitive Surgical (ISRG) during the quarter as their thesis was incorrect.
This year, ISRG shares tumbled from $500 down to $420 after the second quarter and then continued to cascade to current levels of $369. Numerous other prominent hedge funds like Viking Global were long shares of ISRG at the end of the Q2 so we'll have to wait and see if others sold in Q3 when the next batch of 13F filings come out.
Some of Hoplite's shorts include a semiconductor manufacturer and a wireless telecom operator in an emerging market. They've recently added to shorts in companies that supply equipment to mining companies or that have exposure to mining in general and these are some of their top shorts.
Their Q3 letter also mentions that they were short a "handset manufacturer" that spiked when part of the company was acquired, and we assume that this position was Nokia (NOK). As we detailed this week, Dan Loeb's Third Point bought NOK recently.
At the end of Q3, Hoplite had gross exposure of 150.7% and was 54.9% net long.
For more of the latest hedge fund letters, head to:
- Greenlight Capital's Q3 letter
- Third Point's Q3 letter
- Cobalt Capital's Q3 letter
- Corsair Capital's Q3 letter
Activist Carl Icahn today launched a new website, Shareholders Square Table and included a release of the letter he sent to Apple (AAPL) CEO Tim Cook. Icahn has been quite busy as yesterday we highlighted he sold half of his Netflix stake and he's also now disclosed that he's increased his Apple stake from 3.8 million shares up to 4.7 million shares.
Icahn says he thinks Apple should buy back $150 billion of stock. He loves what Cook is doing operationally and his only 'beef' with the company is regarding the size of their buyback as he argues a more sizable buyback will boost EPS and share prices.
Icahn's Letter to Apple's Tim Cook
It was a pleasure meeting you for dinner at the end of September. When we met, my affiliates and I owned 3,875,063 shares of Apple. As of this morning, we owned 4,730,739 shares of Apple, an increase of 22% in position size, reflecting our belief the market continues to dramatically undervalue the company, even when taking into account the recent market appreciation, which in turn makes our proposal unchanged with respect to a $150 Billion buyback. We were pleased to hear at our dinner that you appreciated our input and that you would speak to us again in three weeks to continue the dialogue. In anticipation of doing so soon, we aim to reiterate in this letter the point of view already expressed to you directly with the hope of effectively summarizing it for the company’s board of directors and our fellow shareholders.
From our perspective, Apple is the world’s greatest consumer product innovator and has one of the strongest and most respected brand names in history. We consider Apple to be our most compelling investment. I first informed my followers on Twitter on August 13, 2013 of my “large position.” I also expressed to you my opinion that “a larger buyback should be done now.” At that time, we owned 3,448,663 shares and the stock price was $467. Since then we have purchased an incremental 1,282,076 shares (bringing the total value of my position to $2.5 Billion) and we currently intend to buy more.
We want to be very clear that we could not be more supportive of you, the existing management team, the culture at Apple and the innovative spirit it engenders. The criticism we have as shareholders has nothing to do with your management leadership or operational strategy. Our criticism relates to one thing only: the size and timeframe of Apple’s buyback program. It is obvious to us that it should be much bigger and immediate.
When we met, you agreed with us that the shares are undervalued. In our view, irrational undervaluation as dramatic as this is often a short term anomaly. The timing for a larger buyback is still ripe, but the opportunity will not last forever. While the board’s actions to date ($60 billion share repurchase over three years) may seem like a large buyback, it is simply not large enough given that Apple currently holds $147 billion of cash on its balance sheet, and that it will generate $51 billion of EBIT next year (Wall Street consensus forecast).
The S&P 500 trades at roughly 14x forward earnings. After backing off net cash, Apple trades at just 9x (not factoring into account that the company has a significantly lower cash tax rate than the rate Wall Street analysts use). This discount (cash adjusted) becomes even more compelling given our confidence that Apple will grow earnings per share at a rate well in excess of the S&P 500 for the foreseeable future. With such an enormous valuation gap and such a massive amount of cash on the balance sheet, we find it difficult to imagine why the board would not move more aggressively to buy back stock by immediately announcing a $150 Billion tender offer (financed with debt or a mix of debt and cash on the balance sheet).
While this would certainly be unprecedented because of its size, it is actually appropriate and manageable relative to the size and financial strength of your company. Apple generates more than enough cash flow to service this amount of debt and has $147 billion of cash in the bank. As we proposed at our dinner, if the company decided to borrow the full $150 billion at a 3% interest rate to commence a tender at $525 per share, the result would be an immediate 33% boost to earnings per share, translating into a 33% increase in the value of the shares, which significantly assumes no multiple expansion. Longer term (in three years) if you execute this buyback as proposed, we expect the share price to appreciate to $1,250, assuming the market rewards EBIT growth of 7.5% per year with a more normal market multiple of 11x EBIT.
It is our belief that a company’s board has a responsibility to recognize opportunities to increase shareholder value, which includes allocating capital to execute large and well-timed buybacks. Apple’s Board of Directors does not currently include an individual with a track record as an investment professional. In my opinion, any further delay in executing the buyback we hereby propose will reflect this lack of expertise on the board. My firm’s success and my expertise as an investor would be difficult for anyone to argue. Per my investment thesis, commencing this buyback immediately would ultimately result in further stock appreciation of 140% for the shareholders who choose not to sell into the proposed tender offer. Furthermore, to invalidate any possible criticism that I would not stand by this thesis in terms of its long term benefit to shareholders, I hereby agree to withhold my shares from the proposed $150 Billion tender offer. There is nothing short term about my intentions here.
Chairman, Icahn Enterprises (IEP)"
Jeff Ubben's activist hedge fund ValueAct Capital filed a Form 4 with the SEC regarding its position in Adobe Systems (ADBE). Per the filing, ValueAct sold 3,466,894 shares at prices of $52.52, $53.01, and $53.22 on October 18th, 21st, and 22nd respectively.
After these transactions, ValueAct is still left holding a sizable stake of 25.3 million ADBE shares. For more activity from this hedge fund, we posted when they boosted their Rockwell Collins stake. You can also view Jeff Ubben's presentation from the Value Investing Congress.
Per Google Finance, Adobe Systems is "a diversified software company. The Company offers a line of software and services used by professionals, marketers, knowledge workers, application developers, enterprises and consumers for creating, managing, delivering, measuring and engaging with content and experiences across multiple operating systems, devices and media. The Company markets and licenses its software directly to enterprise customers through its sales force and to end users through application stores and its Website at www.adobe.com. Adobe also distributes its products through a network of distributors, value-added resellers (VARs), systems integrators, independent software vendors (ISVs), retailers and original equipment manufacturers (OEMs). In May 2013, Adobe Systems Inc acquired Ideacodes LLC. In July 2013, Adobe Systems Inc announced the completion of acquisition of privately held Neolane."
Wednesday, October 23, 2013
Margin debt hits new high [WSJ]
A dozen things learned from Bill Ruane about investing [25iq]
Look to helicopter Ben for clues to Yellen's Fed [FT]
The biggest emerging market in the world: the US [FT]
Do investment consultants pick future winners? [CBS News]
Sales are colossal, shares are soaring. All Amazon is missing is a profit [NYTimes]
Painful prescription: looking at Express Scripts [CNN Money]
In 5 years, Microsoft will be the most valuable company [BusinessInsider]
Not already invested in Twitter? Might want to stay on the sidelines [AnObjectiveView]
Why Warren Buffett passed on the Washington Post [Fortune]
Interview with now-Nobel laureate Robert Shiller [WashingtonPost]
Emerging market investors sour on Mexico stocks [WSJ]
On hot chocolate demand and cocoa prices rising [FT]
Death of the American mall and rebirth of public space [The International]
Investing as a hobby [AbnormalReturns]
Buying shares in star athletes [NYTimes]
Christopher Begg is out with East Coast Asset Management's Q3 letter to investors entitled "Architecture of Reason." In it, they outline some of their thoughts on the current market, as well as dive into aspects of their investment checklists.
"As many of the businesses we own now trade at higher valuations, we now find ourselves in a middling period of fair value. We are not finding as many new businesses to purchase at a discount yet we remain content with the harmony of our portfolio in absolute terms and in proportion and perspective to other investment considerations, including the octave of cash and the extremely dissonant harmony of bonds."
In the letter, Begg also outlines their economics and competitive advantage checklists:
Economics - Owner Mindset
1. Owner Earnings - cash flow is the lifeblood of the business
2. Wealth creation engine - what is the number? the operating metric
3. Number vector - what is the vector of the number?
4. Economic 'goodwill' - the only goodwill that counts
5. Real vs. nominal profitability - the inflation test
6. Metrics - custom economic score card
7. Intangibles and the vanishing point - demystify all intangible assets
8. Non-economic accounting maneuvers - testing for disease
9. Debt - proportion: is debt proportional to operating income?
10. Statement of cashflows: management's "statement" - initial capital allocation test
11. Equitiy - proportionality: E=MC2 - is equity used in proportionality with its value?
12. Total other obligations: ideal city - harmony - company specific / community
1. Novice test - explain what the business does to a novice
2. TAM - total addressable market by business unit
3. H4 industry - longitude/critical data points of the industry
4. ABC's - diagrams - an actual unit sold, the business model and competitive landscape
5. Degree of Timelessness - is it eternal?
6. Variant viewpoints - CEO parachute test - company and competitor
7. Advantaged moat - the give external senses
8. Nuthatch concept - test 1 - locality: are they a local champion?
9. Test 2 - inversion: can they do something their competitors cannot do?
10. Aggregation of owner earnings - ten years out: confidence of whole vs the parts
11. Gating factors: for industry and company success
12. Elasticity of demand and supply - pricing power - it (is) not but only a tiny knowledge of the eye
Embedded below is East Coast's Q3 letter:
For more investor letters from this quarter, head to:
- Dan Loeb's Q3 letter
- David Einhorn's Q3 letter
- Corsair Capital's Q3 letter
- Cobalt Capital's Q3 letter
Carl Icahn's firm Icahn Enterprises has sold half of its stake in high-flying Netflix (NFLX). Per an amended 13D filing, Icahn now owns 4.5% of NFLX with 2,665,557 shares, marking a 62% reduction in his position size since the second quarter.
Icahn was selling NFLX shares in mid-October and as recently as October 22nd. Most of his sales were around $341, while some sales were in the low $300's. Icahn originally invested at $58.
While Carl's son Brett won in a previous decision to hold onto NFLX shares a while ago, Carl overruled him this time around, basically saying you have to harvest some gains when you're up over 400% in a year.
Keep in mind also, that now that Icahn has sold down below the 5% threshold, he doesn't have to report his activity in the name, allowing him to continue to sell-down his stake without disclosing it if he so chooses.
Icahn's Thesis on Netflix
Included in the filing, Brett Icahn and David Schechter outline their thought process regarding their position and NFLX thesis, so it's worth reading:
"Our cost basis in Netflix is $58 per share. Despite its notable appreciation in just over one year to $323 per share, for the reasons set forth below, we believe the company remains significantly undervalued. As a subscription service priced at only $7.99 per month, we believe Netflix is one of the great consumer bargains of our time. We find it difficult to understand why a household would not subscribe to the service, considering the low monthly price, the robust content aggregation (which includes an increasing mix of premium and award-winning original series) and the dramatically superior user experience from both an interface and overall technology perspective. Netflix’s predominately fixed content cost (variable primarily to the extent management chooses to further improve the service) gives the business model massive operational leverage. Our recognition of this operational leverage, combined with our expectations for both domestic and international subscriber growth with modest price increases over time, has been and continues to be the core of our investment thesis.
With respect to Netflix’s opportunity in the United States, Reed Hastings’ estimated range for a total domestic market size of 60 million to 90 million domestic subscribers implies that Netflix will add 30 million new domestic subscribers, using the low end of that range. While the timeframe is debatable, we share Reed’s confidence in the overall size of this market, and we note that Netflix is currently adding six million net subscriber additions per year. Furthermore, at just $7.99 per month, we think Netflix has pricing power – and while we do not expect price increases for the next two years we think it is reasonable to anticipate that the company could ultimately raise prices to $9.99 per month over the course of the next five years (this equates to a very modest annualized increase of roughly 4.6%). Together, we expect these new subscriber additions and price increases would raise domestic streaming revenues by $4.3 billion annually. Even if the company decides to increase spending on cost of revenues (largely content) by $1 billion annually (a 55% increase) in order to seek to achieve this growth by further improving the user experience, the operating leverage would still be impressive, adding $3.3 billion to domestic contribution profit.
While the domestic growth story alone is compelling, we believe the international opportunity is even larger in the long term. We strongly support the company’s strategy to reinvest its domestic profits into international growth and recognize that its rapidly improving domestic operating profit implies an accelerated pace for future international expansion, with large new markets launched in 2014 and beyond. There are large portions of the world in which Netflix has yet to launch, and the company is still in the early innings of the international game, including the markets already launched. Because Netflix launches its product in each territory with a robust service, it must spend on the completion of this product, and the marketing of it, in advance of signing up new subscribers, which is why we expect the international segment to continue losing money in the near term. However, as these international markets mature, we expect that the aggregate international operating profits will actually exceed the domestic.
Given this opportunity set and the company’s management team, which we view as exceedingly competent, we believe Netflix’s valuation is still relatively low. In our experience, there are few companies at any given time in history that represent the pure life blood of a colossal secular growth category, and even fewer where the CEO of that company instills deserved confidence among the company’s investors by repeatedly exhibiting both vision and the ability to execute on that vision. We are proud to have identified Netflix as such a company and believe that it is well positioned for greatness.
Carl Icahn stated:
While I basically agree with David and Brett’s assessment above and have often held positions for many years, as a hardened veteran of seven bear markets I have learned that when you are lucky and/or smart enough to have made a total return of 457% in only 14 months it is time to take some of the chips off the table. I want to thank Reed Hastings, Ted Sarandos and the rest of the Netflix team for a job well done. And last but not least, I wish to thank Kevin Spacey. I also want to thank David and Brett. The Sargon Portfolio which David and Brett co-manage and I supervise, has generated 37% annualized returns since its inception on April 1, 2010 through September 30, 2013 and currently manages in excess of $4.8 billion for Icahn Enterprises and my own capital. Icahn Enterprises has assets of approximately $29 billion."
For more on this investor, we've highlighted some of Carl Icahn's recent portfolio activity here.
Tuesday, October 22, 2013
Strategist Jeff Saut recently released a slideshow from Raymond James entitled 'Gleanings' where he touches on how to invest in a slow-growth environment. He recently held a conference call with Tom O'Halloran who runs Lord Abbett's Growth Leaders Fund and they both agree on many of the same themes.
6 Investing Themes in a Slow Growth Economy
O'Halloran outlines his 6 rivers of growth as follows:
1. Ongoing Digitization of Society - "Driving that revolution are such growth engines as e-commerce (sales over the Internet), hosted software (the delivery of software from a site where it is hosted on the Internet), social networks (platforms that connect individuals and businesses), mobility, and cloud computing (a vast network of remote servers that have added unprecedented functionality to the technology ecosystem). Meanwhile, the Internet has enabled a mobility boom by linking itself to telecommunications networks. This has led to a proliferation in advanced wireless devices and has changed the way consumers and businesses communicate."
2. U.S. Mass Consumerism - "Consumer companies are helping consumers look good and feel good. These companies also are making people’s lives much more convenient through a growing market in at-home products and services. Rapidly growing social networking sites are empowering individuals to take full advantage of this market. These trends open up big new markets for "winner take most" companies. Affected markets and products include apparel and retailing as well as a wide variety of beauty products, ranging from cosmetic lasers to invisible braces. Compelling approaches to basic human needs or desires, such as sleep, beauty, and health, are also generating significant growth. "
3. Emerging Nations - "The superior growth rates of emerging nations are giving rise to a growing middle class in these nations. The implications for increased spending are staggering. The Organization for Economic Co-operation and Development (OECD) believes the middle class in the Asia-Pacific region alone could spend an incremental $25 trillion by 2030. The growth in emerging nations will shift this decade toward the consumer sector of those nations and away from the sectors tied to Chinese industrialization. Increasing disposable incomes in these emerging nations have particularly benefited the consumer, healthcare, and technology areas."
4. Modern Medicine - "Three areas of innovation that have fueled growth in health care include genomics, biotechnology, and minimally invasive devices and procedures. In genomics, significant progress in identifying genetic defects has led to breakthrough diagnostics, targeted drug therapies, and preventive medicine. The biotechnology industry is a major beneficiary of the greater understanding of human genetics and physiology. Scientists at biotechnology companies have used this knowledge to fundamentally change the drug-discovery process and develop new drugs they believe will be more effective and/or safer than earlier treatments."
5. Manufacturing Renaissance - "U.S. exports to China alone have accelerated a whopping 583% between 2000 and 2012. Against that backdrop, there are opportunities in leading providers of advanced technology and training that will increase industrial productivity, flexibility, and efficiency while lowering costs and making manufacturing competitive globally. These include: fiber lasers used in cutting and welding applications, a producer of vision systems and surface inspection systems, and a provider of 3-D measurement and imaging systems that speed up the design and development process of highly engineered products. The dramatic improvements in 3-D software and printing technology should also help fuel the growth of U.S. manufacturing, particularly in the medical, motor vehicle, and aerospace sectors, where faster prototyping and time to market can become a significant competitive advantage."
6. North American Energy Revival - "Thanks to horizontal drilling and hydrofracking technology that breaks open shale rock by pumping high-pressure fluids into the ground, shale gas is now abundantly accessible. According to some experts, the United States alone has a 200-year supply of this unconventional energy source. With natural gas in abundance, the economics of high-performance, fuel-efficient internal combustion engines that run on natural gas have become increasingly attractive to consumers. Shale producers have been so prodigious that they have created a supply/demand imbalance. For now, users of the cheap natural gas are the biggest beneficiaries. These include chemical companies and companies that make equipment used to compress and liquefy natural gas."
For more from Saut, we posted his latest market commentary here.
Dan Loeb is out with Third Point's Q3 letter and in it the hedge fund firm reveals they started a new stake in Nokia (NOK) in the third quarter after the company sold some of its businesses to Microsoft. The other main takeaway is that due to strong performance, Third Point will return 10% of capital at year-end.
Third Point's Thesis on Nokia
Third Point writes,
"At our purchase price, we seized an opportunity to create new Nokia at a substantial discount to target value. The company will have approximately €8 billion of net cash when the transaction closes, and we expect a meaningful portion of the excess will be distributed to shareholders in coming quarters. Either a buyback or a special dividend is possible, which should draw additional investors to new Nokia when the cash return scenario develops following the deal closing."
This is the kind of event-driven play they like and their letter below details the breakdown of the separate businesses left at the 'new' Nokia.
Third Point's Q3 Letter
For more Q3 hedge fund letters, head to:
- David Einhorn's Q3 letter
- Excerpts from Cobalt Capital's letter
- Corsair Capital's thesis on News Corp
Monday, October 21, 2013
Barry Rosenstein's hedge fund JANA Partners has been quite active submitting SEC filings as of late. The activist investor has revealed their latest target: QEP Resources (QEP). Per a 13D filed with the SEC, JANA has revealed a 7.5% ownership stake with 13,500,000 shares.
This marks a 55% increase in the number of shares they own since the end of the second quarter. The filing was made due to activity on October 11th.
JANA was out buying in late August, sporadically throughout September, and then all throughout October at prices ranging from $27.68 to $31.46 and are now the largest institutional shareholder. However, they've owned QEP shares for over a year.
JANA's Letter to QEP's Board
Rosenstein penned a letter to QEP's board, noting that the company needs to unlock the value of its midstream business. JANA also wants to see bolt-on M&A and organic project development for growth. Additionally, the hedge fund calls for more board members and management with proven Midstream experience and to align management incentives. Lastly, JANA is looking for the company to return capital to shareholders.
Embedded below is JANA Partners' letter to QEP Resources:
For more on this hedge fund, head to a recent interview with JANA's Barry Rosenstein.
Market strategist Jeff Saut is out with his weekly investment strategy commentary. In it, he highlights various positive economic datapoints and he thinks GDP growth will accelerate in 2014 to 3%.
Saut also points out that the Fed is on the market's side with Janet Yellen set to takeover and "that implies no tapering and plenty of liquidity."
He also touches on how housing market bulls have cooled a bit due to rising interest rates. He notes that over the past few weeks, rates have retraced a bit.
Weyerhaeuser (WY) as a Play on Housing
Saut highlights a "second derivative way" to get access to the housing theme via Weyerhaeuser (WY). This is one of their analysts' current favorites and here's their take:
"We believe: 1) the embedded value of Weyerhaeuser’s homebuilding platform is underappreciated relative to other public builder valuations (most notably, the 17,700 lots it controls in California); 2) the recent underperformance of WY shares has created a buying opportunity; and 3) in the context of our REIT coverage, there are relatively few opportunities to find similar long-term earnings/cash flow growth stories. In our view, Weyerhaeuser’s homebuilding platform (one of the 20 largest in the country), significant wood products business, and immense timberland portfolio position it as a compelling alternative to pure-play homebuilders in this housing recovery. Weyerhaeuser is targeting a payout of 75% of FAD over the cycle and is well positioned to raise its dividend as the housing recovery gains momentum. The company has already boosted its dividend by 33% since October (WY shares currently yield ~3%)."
Embedded below is Jeff Saut's latest market commentary:
You can download a .pdf here.
And you can catch up on some of Saut's previous commentary here.
Activist investor Carl Icahn will do some selling instead of buying this time around. In an amended 13D filed with the SEC today, Icahn has said that his investment vehicles will sell 5,527,433 shares of WebMD (WBMD) back to the company for $32.08 per share.
Previously, Icahn owned 12% of WebMD (WBMD). The transaction will close today (Monday October 21st).
For more activity from this activist, we recently highlighted Icahn's new Talisman Energy stake.
Wayne Cooperman's hedge fund Cobalt Capital is out with its Q3 letter. In it, they briefly detail their thesis on EOG Resources (EOG), a stock they were buying in the third quarter.
If you're unfamiliar with Cobalt, the name Cooperman should ring a bell as Wayne is Lee Cooperman's son. Lee, of course, runs a hedge fund himself: Omega Advisors. Cobalt has compounded 15.3% net annually since inception.
During Q3, Cobalt averaged 60% long and 28% short for net exposure of 32%.
Their view on markets is that interest rates heading higher and less earnings growth will be problematic for markets. That said, Cooperman, like his father, feels equities are the best asset class. And with the Fed on the market's side for the time being, the market should have a tailwind. They're cautious but still on the lookout for opportunities both long & short.
Cobalt's Thesis on EOG Resources
In his Q3 letter, Cooperman writes,
"Our largest purchase in the third quarter was EOG resources. EOG has some of the best oil resource assets in North America, particularly its large core position in the Eagle Ford Shale. We tracked EOG’s well results in the state-reported data and believed that production was trending above expectations. With the stock trading at just 5-6x forward EBITDA, a one-to-two- turn discount to peers despite better assets and growth, we took advantage and purchased shares at a meaningful discount to intrinsic value. Generally speaking, we have found that oil-focused E&P stocks have been a much better value than gassy E&P’s and other energy plays lately, especially given their scarcity value as oil prices have risen and global tensions remain acute. In general, oil stocks do not price in oil remaining at or near current levels for long so we have been able to purchase high quality oil assets at good prices and we have hedged out some of our oil exposure by shorting oil futures."
At the end of the third quarter, EOG was Cobalt's fifth largest position.
For more hedge fund letters, we recently posted up David Einhorn's Q3 letter, as well as Corsair Capital's thesis on News Corp.