The fear
The selling
(Indirect source)
Is a facebook-like moment coming? Sell the rumor, buy the event.
As a result, shouldn't we buy the fiscal cliff, even if it occurs?
Friday, December 28, 2012
The bull market to continue 1/1/2013?
With the persistent back and forth in the fiscal cliff:
The fear
The selling
(Indirect source)
Is a facebook-like moment coming? Sell the rumor, buy the event.
As a result, shouldn't we buy the fiscal cliff, even if it occurs?
The fear
The selling
(Indirect source)
Is a facebook-like moment coming? Sell the rumor, buy the event.
As a result, shouldn't we buy the fiscal cliff, even if it occurs?
Sunday, December 23, 2012
RIMM & Two Things About Recurring Revenue
RIMM did not have a good week, or rather a bad Friday (12/21):
Why? Of course, there's the 45%+ yoy revenue drop this quarter and consequently 90% drop in net income (incidently, mostly from tax recoveries):
But beyond that, it looks like the one recurring/stable part of RIMM's revenue is question. That is, while hardware sales (i.e. phones) are faltering, the services division of RIMM (36% of revenues) have held firm, even grown slightly. This is because mobile carriers actually continually pay RIMM for the use of BlackBerry servers, as shown the most recent 6-k (quarterly report):
Services actually grew yoy to 974 from 965 million year over year! Not so bad right?
But as this article notes, the new BlackBerry 10 OS presents the BlackBerry service portion as "optional." This is huge, because it is effectively a further price concession on top of the already discounted RIMM hardware/phones. RIMM has now ceded pricing power on all its new products before even launching! It is admitting that it can only compete on price now, which (for RIMM investors) is upsetting to say the least. After all, didn't Buffett say "The single most important decision in evaluating a business is pricing power"
Disclosure: no position in RIMM
But beyond that, it looks like the one recurring/stable part of RIMM's revenue is question. That is, while hardware sales (i.e. phones) are faltering, the services division of RIMM (36% of revenues) have held firm, even grown slightly. This is because mobile carriers actually continually pay RIMM for the use of BlackBerry servers, as shown the most recent 6-k (quarterly report):
Services actually grew yoy to 974 from 965 million year over year! Not so bad right?
But as this article notes, the new BlackBerry 10 OS presents the BlackBerry service portion as "optional." This is huge, because it is effectively a further price concession on top of the already discounted RIMM hardware/phones. RIMM has now ceded pricing power on all its new products before even launching! It is admitting that it can only compete on price now, which (for RIMM investors) is upsetting to say the least. After all, didn't Buffett say "The single most important decision in evaluating a business is pricing power"
Disclosure: no position in RIMM
Monday, December 17, 2012
Three things about Mortgage Servicing Rights (MSRs)
Last month, JPMorgan bought MetLife's mortgage servicing portfolio - in response, Nationstar Mortgage, an independent servicer, (NSM) fell by nearly a 1/3 that month (36 to 25). Why did investors sell?
It seems like the market has been focusing on:
1) Government regulation that penalizes mortgage servicing rights as part of tier 1 capital,
2) Decreasing prepayments/foreclosures rates and as a result,
3) The rise of non-bank servicers.
Mortgage servicing rights are exactly what they sound, the right and obligation to collect payments from borrowers and send them to the ultimate investor/lender. Given the often rapid changes in the end investor, the servicer provides a key service, a middle-man keep payments going where they need to maintain documentation and provider certain advances/escrow servicers when in default.
This is not a glamor business. This area has existed for many, many years as many banks kept the rights themselves when originating mortgages (e.g. JPMorgan's 1.1 trillion unpaid principal balances (UPBs) portfolio of rights). LPS & OCN are similar stocks which, even during the housing bubble, were range-bound at best. What has changed?
1) Basel III regulations do not give full weight of MSRs to count for Tier 1 capital. (
http://www.jdsupra.com/legalnews/proposed-basel-iii-capital-rules-for-mor-14054/). Previously, banks could could 100% of the value of MSRs as Tier 1 capital. Now, then can only count 10%. As capital is precious and funding requirement increase now that MSRs don't fully count, there is now an artificially higher cost for banks to be involved in servicing mortgages. As a result, banks such as Bank of America have been exiting the business (http://online.wsj.com/article/SB10001424052702303918204577448560134617328.html). This is forced selling, pushing down price of such rights.
2) MSRs are similarly, but not exactly affected the same way as mortgages proper. MSRs are paid 25-50 bps of the unpaid principal balance - regardless of prevailing interest rates. Now, there are other nuances to be had here, as prepayments from refinancing or foreclosures do affect it, as the fees are based off of principal. Both are moving down due to low rates and accommodation from fed/us govt (many sources for this). As a result, I believe it is reasonable to think such rights are at least as valuable as before.
3) Other non-bank participants have seen this coming, with the formation of NSM and growth of OCN (http://finance.yahoo.com/news/ocwen-wins-bid-buy-rescap-190917643.html) as non-bank servicers bid for such rights.
But how far has this trend gone? The JPMorgan acquisition at top is actually in the opposite direction. Have rights become valuable enough that banks are willing to take the capital hit? Does that mean the explosive growth of companies is over? (even after only say a 6 month run?)
It seems like the market has been focusing on:
1) Government regulation that penalizes mortgage servicing rights as part of tier 1 capital,
2) Decreasing prepayments/foreclosures rates and as a result,
3) The rise of non-bank servicers.
This is not a glamor business. This area has existed for many, many years as many banks kept the rights themselves when originating mortgages (e.g. JPMorgan's 1.1 trillion unpaid principal balances (UPBs) portfolio of rights). LPS & OCN are similar stocks which, even during the housing bubble, were range-bound at best. What has changed?
1) Basel III regulations do not give full weight of MSRs to count for Tier 1 capital. (
http://www.jdsupra.com/legalnews/proposed-basel-iii-capital-rules-for-mor-14054/). Previously, banks could could 100% of the value of MSRs as Tier 1 capital. Now, then can only count 10%. As capital is precious and funding requirement increase now that MSRs don't fully count, there is now an artificially higher cost for banks to be involved in servicing mortgages. As a result, banks such as Bank of America have been exiting the business (http://online.wsj.com/article/SB10001424052702303918204577448560134617328.html). This is forced selling, pushing down price of such rights.
2) MSRs are similarly, but not exactly affected the same way as mortgages proper. MSRs are paid 25-50 bps of the unpaid principal balance - regardless of prevailing interest rates. Now, there are other nuances to be had here, as prepayments from refinancing or foreclosures do affect it, as the fees are based off of principal. Both are moving down due to low rates and accommodation from fed/us govt (many sources for this). As a result, I believe it is reasonable to think such rights are at least as valuable as before.
3) Other non-bank participants have seen this coming, with the formation of NSM and growth of OCN (http://finance.yahoo.com/news/ocwen-wins-bid-buy-rescap-190917643.html) as non-bank servicers bid for such rights.
But how far has this trend gone? The JPMorgan acquisition at top is actually in the opposite direction. Have rights become valuable enough that banks are willing to take the capital hit? Does that mean the explosive growth of companies is over? (even after only say a 6 month run?)
Monday, December 10, 2012
PANW update: how much would you pay for growth?
PANW just reported earnings 12/6 after close and after a flat (but volatile) Friday ended down significantly today at post IPO lows ($48.82).
On face and the top line, results were decent - 50% yoy revenue growth to new all times highs in ttm revenue, but what about the bottom line? This is below the ~100% revenue growth from before, but nothing to sneer at either. But what about the bottom line?
"GAAP net loss for the fiscal first quarter was $3.5 million, or $0.05 per basic and diluted share, compared with net income of $4.1 million, or $0.00 per basic and diluted share, in the fiscal first quarter of 2012"
Despite such great top-line growth, eps went negative versus 12-months ago, what gives?
General R&D, Sales and Marketing and General & Administrative costs all grew at 80% yoy, outstripping revenue growth. Sure, a growth company often incurs growing pains/costs, but revenue growth has be decreasing (50% yoy vs 100% from 2011 to 2012), while costs are still rising at a faster rate?
In particular, the Sales & Marketing expense nearly doubled - if PANW's products are so game-changing, why does it need to spend almost 2/3rds of the new revenue on new sales alone (85-57 revs vs 42-22 sales & marketing change)?
Disclosure: I am short PANW
On face and the top line, results were decent - 50% yoy revenue growth to new all times highs in ttm revenue, but what about the bottom line? This is below the ~100% revenue growth from before, but nothing to sneer at either. But what about the bottom line?
"GAAP net loss for the fiscal first quarter was $3.5 million, or $0.05 per basic and diluted share, compared with net income of $4.1 million, or $0.00 per basic and diluted share, in the fiscal first quarter of 2012"
Despite such great top-line growth, eps went negative versus 12-months ago, what gives?
General R&D, Sales and Marketing and General & Administrative costs all grew at 80% yoy, outstripping revenue growth. Sure, a growth company often incurs growing pains/costs, but revenue growth has be decreasing (50% yoy vs 100% from 2011 to 2012), while costs are still rising at a faster rate?
In particular, the Sales & Marketing expense nearly doubled - if PANW's products are so game-changing, why does it need to spend almost 2/3rds of the new revenue on new sales alone (85-57 revs vs 42-22 sales & marketing change)?
Disclosure: I am short PANW
Thursday, December 6, 2012
Three Ways to "Risk"
"Risk" is a versatile, albeit somewhat ambiguous term in financial markets. Journalists like to say, "traders are paid to take risks," traders use risk often to mean a position in the markets, i.e. "I like this risk, so am leaving it on."
But really, what is risk?
1) Volatility - the mainstream academic and practitioner's method. Volatility can be standard deviation of returns in an absolute basis or relative to a benchmark. Have an equity portfolio that often swings 2x as much as the market on a daily basis? You are twice as risky as the market. Bond traders measure a bond position's "risk" by sensitivity to interest rates (e.g. treasury yields of matching tenor). If the bond position you have moves 10% if rates (treasury yields) move by 1% your duration is 10 and when converted into dollar terms (dv01, dollar value of a basis point), that's your risk.
Then for credit products/corporate products - what happens if the credit spread of your AA bond widens by one basis point? If your duration is 5, you lose 5bps of face/mkt value (depending on your specific definition of "duration" etc.). That's risk too.
The list continues, but idea is this - only a daily basis, how much could the market value of your investment change in value, either on absolute or relative to a benchmark? Or in other words, how much does the market herd affect your investment tomorrow?
2) Being "right", or permanent loss of capital. The value investor/distressed investor, used by many Michael Burry of Scion Capital, Howard Marks of Oaktree, and of course Warren Buffett of Berkshire Hathaway.
Who cares about the noisy of the crowd? What matters is when the investment matures (or over a long period), does the underlying investment make the money? I.e. for corporate bonds, will the issuer pay me back interest & principal?
Naturally, this is easier for fixed income than for equities (or is it?), since there is a built in catalyst (maturity). Nonetheless, if you buy FB on the belief that it will earn $10B a year in profits 3 years from now and are correct, the market price at that time will probably be higher. In other words, forget about tomorrow - how about many years from now?
3) Drawdowns - until your exit, how much can the market move against you? Disclosure: my personal favorite, though admittedly much harder to measure/reduce. Used by some fund managers such as Monroe Trout from New Market Wizards (portfolio wide stops of down x%, when he'd liquidate all).
If you want to buy FB in anticipation of that $10B net income (that your presumably researched etc), how much could the stock go down from now until then? Do you expect that eps growth will be linear, exponential, noisy? What if next quarter's eps misses? Based on the last miss, a 10%+ drop would be possible. But is that a reasonable comparison?
^Those questions are far harder to answer, but may be more fruitful? After planning your actions (if any) and adjusting the position size/composition, it might remove some of the emotions of a casino-like quality of investing.
Indeed, the final approach is, how much pain will there be until proven right or wrong?
What other thoughts on risk do you see?
But really, what is risk?
1) Volatility - the mainstream academic and practitioner's method. Volatility can be standard deviation of returns in an absolute basis or relative to a benchmark. Have an equity portfolio that often swings 2x as much as the market on a daily basis? You are twice as risky as the market. Bond traders measure a bond position's "risk" by sensitivity to interest rates (e.g. treasury yields of matching tenor). If the bond position you have moves 10% if rates (treasury yields) move by 1% your duration is 10 and when converted into dollar terms (dv01, dollar value of a basis point), that's your risk.
Then for credit products/corporate products - what happens if the credit spread of your AA bond widens by one basis point? If your duration is 5, you lose 5bps of face/mkt value (depending on your specific definition of "duration" etc.). That's risk too.
The list continues, but idea is this - only a daily basis, how much could the market value of your investment change in value, either on absolute or relative to a benchmark? Or in other words, how much does the market herd affect your investment tomorrow?
2) Being "right", or permanent loss of capital. The value investor/distressed investor, used by many Michael Burry of Scion Capital, Howard Marks of Oaktree, and of course Warren Buffett of Berkshire Hathaway.
Who cares about the noisy of the crowd? What matters is when the investment matures (or over a long period), does the underlying investment make the money? I.e. for corporate bonds, will the issuer pay me back interest & principal?
Naturally, this is easier for fixed income than for equities (or is it?), since there is a built in catalyst (maturity). Nonetheless, if you buy FB on the belief that it will earn $10B a year in profits 3 years from now and are correct, the market price at that time will probably be higher. In other words, forget about tomorrow - how about many years from now?
3) Drawdowns - until your exit, how much can the market move against you? Disclosure: my personal favorite, though admittedly much harder to measure/reduce. Used by some fund managers such as Monroe Trout from New Market Wizards (portfolio wide stops of down x%, when he'd liquidate all).
If you want to buy FB in anticipation of that $10B net income (that your presumably researched etc), how much could the stock go down from now until then? Do you expect that eps growth will be linear, exponential, noisy? What if next quarter's eps misses? Based on the last miss, a 10%+ drop would be possible. But is that a reasonable comparison?
^Those questions are far harder to answer, but may be more fruitful? After planning your actions (if any) and adjusting the position size/composition, it might remove some of the emotions of a casino-like quality of investing.
Indeed, the final approach is, how much pain will there be until proven right or wrong?
What other thoughts on risk do you see?
Saturday, December 1, 2012
Harvard's Merger Arbitrage, Endowment Investing
Apparently Harvard (or more specifically, its endowment) engages in merger arbitrage. Taking a 5.77%
percent stake in Teavana Holdings, Inc. (NYSE:TEA) after it agreed to be
acquired by Starbucks (NYSE: SBUX), Harvard now owns 2,240,000 shares valued at
roughly $33mm as of TEA's closing price on Friday. With a portfolio valued at
over $30 billion, this represents ~0.1% of the
total endowment and therefore ~0.6-0.7% of the ~15% "absolute return"
portion of the endowment. It is far from large for Harvard, yet makes it one of
the largest holders of TEA.
It can do this because Harvard operates an active, "hybrid" investment model. Unlike most endowments such as Yale, Duke, MIT, etc., Harvard Management Company (HMC) has external as well as internal managers to handle its investments. This has has indeed turned parts of HMC into a hedge fund, spinoffs and all. In particular, Convexity Capital Management (founded in 2006 by the Jack Meyer, former head of the endowment) shows some of the more complicated options/swaps-based strategies that were employed, discussed here.
But what about other methods of investing for endowments? This article from Greycourt & Co. looks to the (equity) index approach take by Norway's sovereign wealth fund, which does the "anti-Yale" approach in investing mostly in passive, liquid indices and has still done with. One possible explanation given is that 1) Yale's focus on alternatives (mirrored by Harvard now) was done when illiquid assets were cheap/undiscovered, hence their legendary returns under David Swenson. As a result, recent lackluster returns by large endowments focused on alternatives (real estate, hedge funds, private equities) may be a function of over-interest.
What can we gain from this? Maybe, it's that like anything else in investing, no asset class always does better and outperformance is ultimately driven by value.
Disclosure: I am short TEA.
-Stanley
It can do this because Harvard operates an active, "hybrid" investment model. Unlike most endowments such as Yale, Duke, MIT, etc., Harvard Management Company (HMC) has external as well as internal managers to handle its investments. This has has indeed turned parts of HMC into a hedge fund, spinoffs and all. In particular, Convexity Capital Management (founded in 2006 by the Jack Meyer, former head of the endowment) shows some of the more complicated options/swaps-based strategies that were employed, discussed here.
But what about other methods of investing for endowments? This article from Greycourt & Co. looks to the (equity) index approach take by Norway's sovereign wealth fund, which does the "anti-Yale" approach in investing mostly in passive, liquid indices and has still done with. One possible explanation given is that 1) Yale's focus on alternatives (mirrored by Harvard now) was done when illiquid assets were cheap/undiscovered, hence their legendary returns under David Swenson. As a result, recent lackluster returns by large endowments focused on alternatives (real estate, hedge funds, private equities) may be a function of over-interest.
What can we gain from this? Maybe, it's that like anything else in investing, no asset class always does better and outperformance is ultimately driven by value.
Disclosure: I am short TEA.
-Stanley
Wednesday, November 28, 2012
Got TEA? Pesticide-Filled Goodness
Glaucus Research, a research-driven short selling firm similar to Muddy Waters/Citron Research, released a report and follow up on this month about the recent deal by Starbucks (NYSE: SBUX) to acquire Teavana Holdings, Inc. (NYSE:TEA). The latter is a retail-based seller of organic/premium tea and is a growing segment for SBUX.
In short, Glaucus alleges that TEA's tea, far from organic and premium, is pesticide-ridden and in violation of EU pesticide standards and by extension US FDA regulations. As a result, SBUX's acquisition (and TEA's entire business) is in danger of falling apart.
What is truly interesting about this particular situation are the odds involved. SBUX's acquisition price of ~$650mm equates to roughly 16$ per share. At current prices of $14.50, conservatively speaking, short sellers are risking $1.5 per share.
How about the upside? Prior to the sale, TEA was already at 52-week lows at 10.50$ , that's $4 a share downside even if just acquisition fails. However, the reason for such a failure would be a drastic negative on the stock, especially given the due diligence that SBUX would have uncovered to scuttle the deal. In reality, the lower bound of the stock may be $5 or even lower, given legal/business model risk.
So, before further analysis, short sellers are getting better than 2 to 1 odds with a predefined catalyst (acquisition due-diligence)
*Disclosure: I am short TEA
-Stanley
In short, Glaucus alleges that TEA's tea, far from organic and premium, is pesticide-ridden and in violation of EU pesticide standards and by extension US FDA regulations. As a result, SBUX's acquisition (and TEA's entire business) is in danger of falling apart.
What is truly interesting about this particular situation are the odds involved. SBUX's acquisition price of ~$650mm equates to roughly 16$ per share. At current prices of $14.50, conservatively speaking, short sellers are risking $1.5 per share.
How about the upside? Prior to the sale, TEA was already at 52-week lows at 10.50$ , that's $4 a share downside even if just acquisition fails. However, the reason for such a failure would be a drastic negative on the stock, especially given the due diligence that SBUX would have uncovered to scuttle the deal. In reality, the lower bound of the stock may be $5 or even lower, given legal/business model risk.
So, before further analysis, short sellers are getting better than 2 to 1 odds with a predefined catalyst (acquisition due-diligence)
*Disclosure: I am short TEA
-Stanley
Sunday, November 25, 2012
Shorting PANW ($52) - Part 3, final
- Finally, insiders have sold the equivalent of 1x ttm revenues in last year only four months after ipo. A secondary offering this past month (with no money flowing to the company itself) so close to ipo implies, “why the desperation?” PANW has allowed insiders to circumvent the original lockup restrictions in place only 4 months before.
Date
|
Insider
|
Shares
|
Transaction
|
Value*
|
TBA, filed 10/17/2012
|
Many sellers
|
4,800,000
|
Current price is 52
|
$
249,600,000
|
10/22/2012
|
BONVANIE RENE- Officer
|
37,500
|
Sale at $60.48 per
share.
|
$
2,268,000
|
10/22/2012
|
BATRA RAJIV- Officer
|
185,500
|
Sale at $60.48 per
share.
|
$
11,219,040
|
10/22/2012
|
LANFRI WILLIAM A-
Director
|
30,000
|
Sale at $60.48 per
share.
|
$
1,814,400
|
10/22/2012
|
MCLAUGHLIN MARK D-
Officer
|
46,000
|
Option Exercise at
$10.77.
|
$
495,420
|
10/22/2012
|
MCLAUGHLIN MARK D-
Officer
|
46,000
|
Sale at $60.48 per
share.
|
$
2,782,080
|
10/22/2012
|
ZUK NIR- Officer
|
200,000
|
Sale at $60.48 per
share.
|
$
12,096,000
|
7/24/2012
|
BATRA RAJIV- Officer
|
202,000
|
Sale at $39.06 per
share.
|
$
7,890,120
|
7/24/2012
|
ZUK NIR- Officer
|
350,000
|
Sale at $39.06 per
share.
|
$
13,671,000
|
Total
|
$
301,836,060
|
More generally, secondary offerings close to ipo have been a reliable
predictor [i] of future price
declines. Examples with 30%+ declines from sale price include Bazaarvoice
Inc (BV), Zynga, Inc. (ZNGA). The rationale is that unlike planned insider
selling, insider selling that breaks lockup restrictions is a purposeful act – companies
have to ask underwriters to sell renegotiate the earlier restrictions.
Final valuation
Trading at over 4,000 times ttm earnings, comparing earnings
is not very meaningful because of the high stock compensation/expense. That by
itself is very telling, echoing the stock expense issues of the dot-com era. Valuations
make more sense on a revenue basis, on which PANW is still the most
richly-valued at over 14x ttm price to revenues.
Comparable Companies Analysis
("Comps")
|
|||||||
*Averages are unweighted
|
|||||||
*As of 11/23/2012
|
Market Cap ($bil)
|
($bil)
|
($bil)
|
($bil)
|
($bil)
|
||
Equity
|
Enterprise
|
Revenue
|
Revenue
|
Revenue
|
|||
Companies
|
Price ($)
|
MCAP
|
Value1
|
2011 (A)
|
2012 (E)
|
2013 (E)
|
|
CHKP
|
46.01
|
9.38
|
7.93
|
1.25
|
1.35
|
1.45
|
|
FTNT
|
19.06
|
3.05
|
2.67
|
0.44
|
0.53
|
0.62
|
|
FIRE
|
47.15
|
1.42
|
1.25
|
0.17
|
0.22
|
0.26
|
|
Average
|
4.62
|
3.95
|
0.62
|
0.70
|
0.78
|
||
PANW
|
55.41
|
3.79
|
3.47
|
0.12
|
0.23
|
0.39
|
|
Enterprise
Value /
|
Consensus
|
||||||
Revenue
Multiples (x)
|
Estimated EPS ($)
|
||||||
Companies
|
|
2012 (E)
|
2013 (E)
|
2012 (E)
|
2013 (E)
|
||
CHKP
|
6.36
|
5.87
|
5.47
|
3.17
|
3.48
|
||
FTNT
|
6.02
|
5.07
|
4.31
|
0.51
|
0.61
|
||
FIRE
|
7.55
|
5.71
|
4.74
|
0.81
|
1.00
|
||
Average
|
6.64
|
5.55
|
4.84
|
1.50
|
1.70
|
||
PANW
|
29.26
|
15.41
|
9.01
|
#N/A
|
#N/A
|
||
(above data), PANW is July vs Dec of other years[ii]
PANW is priced at 9x 2013 ttm revenues, a 100% premium to
all its competitors (9.01/4.84). The difference is even more absurd when
looking at earnings (which is not even meaningful). I believe this premium is unjustified
given the questions about PANW’s ability to replace CHKP products and renew revenue.
Risks
-Acquisition by CHKP or other competitor (~20-30% from
current levels)
-Acceleration of growth and monetization as PANW takes
market share from CHKP.
Implementation
-This is a highly
volatile stock, and can easily move 20-30% to the upside before the thesis
holds, and given the correction in the broader stock market, now is a time when
PANW is highly vulnerable to upward bursts (e.g. PANW two Fridays again).
Conclusion
While the picture remains incomplete, I believe there is a
compelling case to be short to the 20-25$ range. This is conservative, and only
assumes the market revalues the EV/Revenue premium vs. its competitors.
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