Search This Blog

Thursday, October 24, 2013

Notes from 2013 Excellence in Investing Conference

BTIG was good enough to summarize the presentations from: Michael Moe, Malcolm Fairbairn, Christopher Lord, Christopher Balding, Kurt Billick, Christopher James, Mick McGuire, David Herro, Brian Zied, John Burbank III, Carl Kawaja, and G. Mason Morfit.


Michael Moe, Chief Investment Officer of GSV Capital
Trade Idea: Buy Twitter (TWTR)
Price Target: Given a $15.5B assumed IPO valuation and a 620mm share count, TWTR is worth $41.16 now, $53.23 in 12 months and $163.68 in 36 months
Valuation: Comparable valuation to Facebook (FB) and LinkedIn (LNKD) with a smaller user base currently but with a revenue growth pace of 105% vs. FB at 53% and LNKD at 59%.
Themes: IPOs have changed since the 1990s. There are fewer of them, the companies going public have been incubating longer and therefore accruing more value for private investors than public, since private investors are capturing more of the initial growth. TWTR is arguably more like an older IPO, with more growth ahead for public investors than has been the trend.
TWTR is at the forefront of numerous value-creating changes. As computing shifts to mobile usage (there are 6.5B total mobile phones  vs. 1.5B smartphones), TWTR has usage that is already 77% mobile. As video increases as a percentage of data, TWTR has a popular app in Vine. As the second screen becomes a core feature of media usage, 67% of the 18-34 demographic tweets while watching television. As wearable devices develop, TWTR’s mobility and brevity will capture share.
How will this be monetized?  In various ways – one powerful example: a 1% shift in current ad spending from TV to mobile implies $2B in new value for social media.  The acquisition of MoPub gives TWTR an early edge.
Catalysts: Steady growth at the current trajectory in users, views and tweets will translate into free cash flow – TWTR only needs to achieve half of FB’s users and match its ARPU to achieve valuation targets.

Malcolm Fairbairn, Chief Investment Officer of Ascend Capital
Trade Idea: Buy CF Industries Holdings Inc. (CF), avoid potash companies in general
Price Target: Current asset replacement cost is $280/share and will be $353/share by 2016  millions?  Billions?
Valuation: CF is the low-cost producer in the global marketplace and deserves to be valued, at minimum, at replacement cost. It is currently valued at 5x adjusted EBITDA and deserves the 6.5x EBITDA valuation that Lyondell and other cost-advantaged commodity producers receive.
Themes: Despite the shale gas revolution making the US the lowest-cost region for nitrogen fertilizer (feedstock is 70% of costs), the US is still a net importer. 10 world class plants would need to be built to make the US a net exporter. CF has the best cost structure, is the largest US player, second global player and has excellent locations in the mid-continent.
At current trough levels of pricing ($300/ton) CF can earn more than $16/share. At a reasonable recovery in pricing (say $400/ton vs. $4 in natural gas prices as input) CF can earn between $28 and $35/share.  It will be able to increase capacity by 25% by 2016.
Catalysts: Holders are getting paid a dividend to wait while the world fertilizer market sorts itself out. In the meantime, CF has $1.9B of share repurchase capacity, can borrow at 4% and buy back shares at 15%, could avail itself of an MLP structure to unlock value (as RNF and UAN) and could also increase its dividend which is now less than 20% of EPS.

Christopher Lord, Managing Partner of Criterion Capital Management
Trade Idea: Buy tower companies – Crown Castle International (CCI), American Tower (AMT), SBA Communications (SBAC).
Sell 3D printers (XONE, DDD, VJET), CREE, “communications box companies” (CSCO, EMC, VMW) and certain “second and third tier” CRM cloud firms trading at 20x to 30x revenue multiples.
Price Target: $100 (CCI), $110 (AMT), $110 (SBAC)
Valuation: Towers currently receive a REIT discount because of rate concerns. But even factoring this out, towers get a 16x multiple vs. 20x for the better REITs and this despite 15% free cash flow growth vs. 8% for REITs.
Themes: Mobile data has increased 35x in 6 years and will increase 430x over the next ten years to 11.2 exabytes per month. Who wins in data growth? Towers do. It is a real estate business that is neutral to winners and losers among service providers, enjoys 5-10 year leases with price escalators, has nearly insuperable barriers to entry, and has ~100% incremental EBITDA margins and 60% incremental free cash flow margins.
US nationwide service providers are moving from a duopoly of players with fast data capability to 3 or 4 players. Softbank is committed to building a superior data network at Sprint. This is how Softbank won share in Japan: they believe in the strategy.  This means more customers per tower and also densification: more cell splitting and redundancy in networks to enhance them. This means a lot more capital expenditures being directed to towers.
Catalysts: Earnings and cash flow will grow as the market ramps up to 3 and possibly four national rich data players, and the management teams of the tower companies are committed to returning capital to shareholders and will take steps to do so.
Short Idea Theses: 3D printing companies are in an easily commoditized business and trade at 10x revs, DDD is the easiest short. Major data players like GOOG, FB and AMZN have moved beyond box solutions like CSCO for their needs and will not give these companies 70% margins ever again. CREE’s business can be replicated more cheaply in China and this is happening already. Also-ran cloud CRM firms are overvalued and have no competitive advantage.
Christopher Balding, Finance Professor at HSBC Business School of Peking University
Trade Idea: Buy and flip certain kinds of Hong Kong secondary offerings
Sell the higher quality Chinese companies, sell commodities linked to China, sell shares of commodity related companies in linked markets like Australia, sell AUD
Price Target: no specifics
Valuation: Valuations in the marketplace right now are skewed, while 65% of Chinese shares are below HK share historical averages (P/Es are 12x, P/Es of state owned enterprises are closer to 4-6x) these shares are not cheap. There has been a “flight to quality” with the market shifting to more verifiably profitable companies, but these now trade at sky-high multiples (Byd Co – 1211 HK)  now has an 1100x P/E.
Themes: All financial data from China is false and manipulated. The provinces report 10.8% GDP growth, China reports 7.8% GDP growth. These are all official numbers, but there is no official explanation for the missing 3% in GDP growth. There has been a 111% appreciation in real estate pricing in recent years while the state reports 14% inflation in housing CPI. The manipulation is willful – on June 4th the Shanghai index was down 3% or 64.89 points. This was a manufactured “omen” – a numerical representation of the date of the Tiananmen Square revolt (“the June 4th Incident”).
China is the largest bubble in human history. The steel industry has $500B in debt and $300mm in earnings – these are official numbers. Chinese solar capacity is 1.6x global demand – the entire industry can only operate at a loss. Housing prices to household income in San Francisco are 9.4x.  In Shenzhen the ratio is 32x. Real estate costs in China are 25% higher than San Francisco in a country with incomes lower than rural Alabama.
Right now banks are pricing secondaries at a discount of as much as 18% to HK prices – this desperation for capital creates an arbitrage in buying and flipping the shares. However, the fine print must be read closely – there are lockups and windows.  This goes in tandem with shorting radically overvalued “real business” stocks.
Catalysts: No one can predict when exactly a bubble will burst. What is true is that when the bubble bursts, there will be capital controls and a lack of liquidity.  This is why the linked trade recommendations were given. China is the marginal buyer of iron ore, copper, coking coal and other commodities, creating a short opportunity in those liquid and internationally traded commodities that is harder for Chinese regulators to stymie. The same goes for the AUD and Australian mining companies.

Kurt Billick, Chief Investment Officer of Bocage Capital
Trade Idea: Buy US refiners in general, and specifically TSO and MPC
Price Target: no specific targets
Valuation: Valuations have been kept artificially low, in the neighborhood of 4x EBITDA, because of legacy assumptions. These are businesses that should trade at 8x EBITDA.
Themes: Until recently, the US was considered a mature oil province in structural decline. The shale revolution has obviously changed that dynamic going forward, but refinery logistics are still configured on the old model and are just getting adjusted to the new reality.
The old model was that the US had to import crudes, and given the producing geographies, the imported crudes were heavier and more sour. This has lead to refining capacity biased toward heavy crudes and less optimized for light, sweet crudes.  This has also lead to a pricing deck that made more expensive Brent a driver of input costs, compressing refiner margins.  Long-term supply contracts keep volumes of imported crudes running through US refineries.
This is changing. With contracts rolling off, refineries can switch to LLS and get a positive $5 or better differential in costs.  The current margin for Singapore refineries is $3.90. US refineries’ differential benefit is already larger than foreign refineries’ margins.  In 2014 capacity utilization in the US Gulf Coast will soar.
Besides the differential arbitrage and the transport cost savings (mid-Continent vs. overseas), there are also process heat savings: cheap and abundant natural gas eliminates the need to burn more expensive feedstock oil as fuel.  There is also financial arbitrage, with the potential to use MLP structures.
TSO has excellent refining assets.  It will realize a $16 differential in moving from Alaskan North Slope oil to Bakken.  Its Carson acquisition – and its use of its MLP to drop the asset down – created $500mm of synergies, passed the asset cost through to the MLP and freed up cash flow which can be used to delever or repurchase shares.
MPC had been the biggest user of international crudes and will get the most leverage out of the sourcing shift. It was also a disregarded appendage of an IOC before and now has the benefit of new management focus as a standalone. It has $4B of assets it can drop into MPLX and can use the cash for buybacks or other accretive measures.
Catalysts: All of the thematic developments are already in process. Drop downs and margin improvements will drive improving market valuations.

Christopher James, Managing Partner of Partner Fund Management
Trade Idea: Buy Adobe (ADBE)
Price Target: no specific target
Valuation: 2012 free cash flow was $2.45. 2016 FCF could be $4.00 – and the multiple should expand from the 2012 multiple because of business model improvements.
Themes: 80% of people who access the internet now do so using mobile devices vs. desktops. Social media is changing how business is done. The old model was aggressively selling to hard-to-reach multitudes using large advertising campaigns with controlled messages. The new model is connecting personally using small gestures and transparent messaging.
The ground is shifting quickly. Social media has a 26% CAGR and mobile applications have a 38% CAGR. ADBE, by transitioning to a service model, is taking short term pain but adopting a value proposition that helps it compete in the long term. Software in the marketing cloud was an $11B business in 2012 and will be a $17B by 2015. Two companies now reach across most of the range of the highly fragmented cloud marketing sector: ADBE and CRM.
This enables them to engage in closed-loop marketing.  They will know the customer, learn what the customer’s interests and desires are from social media, and provide tailored, location-based offerings in real time. Chief marketing officers at Fortune 500 firms will spend more money on technology than CIOs do by 2017.  ADBE is ahead of this trend.
Catalysts: ADBE has already implemented its shift in business model and the metrics are proving this out. While FCF numbers have experienced near term declines, that situation will reverse in line with the metrics and grow 60%+ by 2016.

Mick McGuire, Managing Member of Marcato Capital Management
Trade Idea: Buy Sotheby’s (BID)
Price Target: from $58.52 (sum of the parts) to $68.02 (success in activist agenda)
Valuation: Current market valuation reflects $1.3B of trapped equity value.
Themes: Sotheby’s core auction business is a brokerage business.  BID has poorly allocated capital into low-return, extraneous businesses and investments and should reallocate it. No company should invest in projects below its cost of capital.
BID enjoys a 250 year old duopoly with Christie’s in auctions. There are ways to improve the performance of the core business, but there are three other businesses which should be exited.  The first is $875mm of real estate holdings – the US and London headquarters plus other London properties. The valuation is reasonable, based on market data. The second is the $441mm “banking” business, in which BID gives customers advances on auction proceeds and even lends them term loans to finance their collections using BID’s balance sheet.  This is an attractive, low-risk (0.3% losses over 20 years) portfolio for banks – its 5% return is a bad investment for BID, but would be a good securitization.  Much smaller is the $61mm loss- making art dealership – but it is a symbol of poor capital discipline and needs to go.
Catalysts: Marcato will go into greater detail in their 13D filing, but the catalysts are BID following the advice of shareholder activists and divesting these businesses.

David Herro, Chief Investment Officer-International Equities at Harris Associates LP
Trade Idea: Buy Credit Suisse (CS), Diageo (DEO), BMW (BMW GY)
Price Target: no specifics
Valuation: These firms are trading at discounted multiples due to geography -  as Europe recovers, these firms will grow and return to previous P/E multiples from before the European crisis even as they grow cash flow
Themes: While the European debt crisis dominated the headlines for 18 months or more, high value firms with good balance sheets and durable businesses weathered the storm without damage.
The European crisis was a political crisis that did not impair fundamentals.  Effectively the Euro is a device that fixes the prices of exchange rates even as the different nations in the currency union pursued radically different microeconomic policies.  The monetary inflexibility coupled with regional inconsistency extended the dislocation and created value bottlenecks.
MSCI US and MSCI Europe are still divergent, European prices to book, cash earnings multiples and dividend yields are all lagging the US even though these firms have comparable ROE.  This divergence is unjustified and will close, even as Greek and Irish yields have narrowed.
CS now has minimal sovereign exposure, a profitable private bank with 7% growth, is trading less than 10x earnings and has adequate capital. Management has been reducing risks while increasing book equity and is in a position pursue growth or return capital.
BMW is a symbol of Europe’s strength in luxury brands. Although 20% of revenues come from China, BMW has a better than 15% return on capital, trades less than 6x EBITDA and is well positioned for growth in the US and Europe.
DEO is the world’s leading spirits company, trades at only 13x cash flow despite growing 7-8% per year, has durable businesses that resisted the downward cycle and has a management team that focuses on the balance sheet.
Catalysts: Investors are getting paid to wait as European asset pricing catches up to US valuations.

Brian Zied, Portfolio Manager of Charter Bridge Capital Management  LP
Trade Idea: Buy Brunswick Corporation (BC)
Price Target: 50% to 80% improvement from current $44 share price ($66-$80)
Valuation: Currently valued at 7.4x EBITDA and 15x P/E – these metrics do not need to shift as long as they follow the cash flow improvements that BC can achieve.
Themes: BC’s business is 50% marine by revenue and 70% by EBIT. It has a solid defensible business in marine engines – BC and Yamaha have 70% of the global market and BC is first in the US and second globally. BC’s engines are superior – lighter, more efficient, fewer moving parts. This is a good and improving business.
The real key to unlocking value for BC is the other piece of the marine business: the vessels themselves. Boats are 25% of revenues, but just 2.6% of profits. The boat market has been depressed to a greater extent than has historically been the case – before the recession, annual demand had been 300,000 units. It is now only 150,000 – up from a trough of 120,000. In the meantime, other indicators of boating enthusiasm have remained intact (new licenses, etc.). The recession created a broad market for used, over-mortgaged boats that stifled the newbuild market.
Since the business is breakeven so close to the nadir, if the market rebounds to $2.6B in size from $1B then the segment could see excellent cash flow.  The indicators are already evident in firming used boat prices.
Catalysts: Increasing strength in used boat prices will be followed by improved earnings and the stock will rerate.

John Burbank III, Chief Investment Officer of Passport Capital
Trade Idea: Buy Digital Garage (4819 JP), with potential hedging out of Kakaku (2371 JP) exposure
Price Target: Y3527
Valuation: Target assumes a straightforward sum of the parts valuation – but this is a starting point for a more difficult to quantify innovation premium that should eventually be recognized. Its Kakaku holding alone accounts for 70% of its value.
Themes: The past decade of the global economy has been dominated by monetary and fiscal policy adjustments.  Cheap credit initiatives were followed by China’s entry into the WTO and then by quantitative easing. In the 1990s the economy was driven by innovation.  It is a bad idea to invest solely based on themes that are derivative of policy.
The TOPIX tells a different story than the European and US charts.  While Abenomics will likely have a strong impact on Japanese equities, which are underinvested and which may get renewed liquidity from new initiatives at GPIF and elsewhere, the right Japanese equities to identify are innovation stocks that create actual value.
The US leads in innovation and its share prices reflect that. China has a “Great Firewall” of isolationism that prevents access to innovative value in that market. Japan has been culturally closed – but Digital Garage is a company that shares the incubator mentality of the old Softbank: it not only owns 20.6% of Kakaku and a sliver of TWTR, it offers exposure to a broad range of ecommerce businesses in Japan (“ecommerce is GDP independent”).
Catalysts: Market recognition of Digital Garage’s innate asset value.

Carl Kawaja, Senior Vice President of Capital Research Company
Trade Idea: Buy EADS
Price Target: $116 long term
Valuation: Currently valued at a discount of two turns of EBITDA to BA, based on trailing margins of 6.7% vs. 11% for BA – should be valued on the margin of its future backlog. The $51B of market capitalization represents 10% margins on $800B in backlog at a 35% discount.  Assuming a fair share for EADS of future backlog growing at 3% a year discounted by 8% yields the long term target.
Themes: “Airplanes are amazing.” More specifically, there is a reason why there are only two major global commercial aircraft companies – this is extremely complicated technology that adds tremendous value and which is very difficult to replicate. So there are barriers to entry.
There is also an enormous addressable market – China and India are just beginning as markets for air travel. Mobile phones were once thought prohibitive in these geographies and now they are becoming ubiquitous and indispensable.  That is a path for air travel – it is a technology that solves problems efficiently.
EADS has 8 years of backlog right now. The industry as a whole has 29,000 in real backlog through 2020. Two things make long term growth in aircraft deliveries feasible.  The first is fuel efficiency. If EADS can provide the low end of fuel savings its promises (25%) it will boost its customers’ operating profit by a factor of three, creating more capital to spend on more planes.
In the meantime, aircraft deliveries may be at an all-time high – but so is scrapping, due to underinvestment during the recession and the fuel inefficiencies in the current crude environment. This supports increased volumes.
Catalysts: No specific near term catalysts – this is a matter of valuations catching up to end market conditions.

G. Mason Morfit, President of ValueAct Capital
Trade Idea: A strongly implied buy recommendation on COL, MCRS, MSCI and CF
Price Target: none given, reference was made to past successes at VRX, BCR and ADBE
Valuation: no specifics
Themes: ValueAct is an activist fund that focuses on executive compensation plans that create long term value in the form of total shareholder return, rather than simply management of metrics. There are three main barriers to successful executive compensation incentives.  The first is the media, which focuses on dollar figures with little attention to value creation or destruction, “say on pay” votes which are not conducive to long term incentives and proxy advisory firms which are more focused on corporate governance rather than creating value for owners.
Managing for EPS and other goal posts can destroy value by emphasizing “box checking” over the wise use of capital for reinvesting in the business, acquiring quality assets that may not be immediately accretive, etc. Companies that link pay to EPS wind up compensating managers handsomely “just for showing up” while the market – smarter than the media or proxy advisors – justly rewards this lack of initiative with lower P/E ratios.
Firms that adopt total shareholder return as a goal that aligns management with owners will outperform.
Catalysts: Presumably incipient activism along the ValueAct model.

No comments: