Bill Gross June Investment Outlook: How to Make Money

https://investoralmanac.com/2017/06/13/bill-gross-investment-outlook-when-the-music-stops-can-you-make-money-with-money/" rel="nofollow" target="_blank" >https://investoralmanac.com/2017/06/13/bill-gross-investment-outlook-when-the-music-stops-can-you-make-money-with-money/[tag]Bill Gross:
Making Money with Money[/tag]

Because of the secular headwinds, currently labeled as the “New Normal” or “Secular Stagnation”, investors have resorted to making money with money as opposed to old-fashioned capitalism when money was made with capital investment in the real economy
Making money with money: think of it simply as an extension of maturity and risk
All beginning with bills in your purse or stashed in the cookie jar
Since cash yields nothing (in fact, depreciates in value given even low 1-2% inflation), savers/investors exchange cash for alternative choices involving less liquid, longer maturity, and in some cases more risky assets
Start with bank deposit that earns no interest but offers ATM accessibility, then a 6-month CD or a 90-day Treasury bill where yields approach 1%, then further out the risk/liquidity/maturity spectrum – corporate bonds, stocks, private equity
Savers/investors make money with their money as long as economies grow and inflation stays reasonably conservative. Nothing new here but it helps outline why today’s economy is so different from that of decades ago and why it induces risks that were not present before
“New Normal” high debt, aging demographics, and deglobalization along with technological displacement of labor are the primary culprits
Excessive debt/aging populations/trade-restrictive government policies and increasing use of machines create a counterforce to creative capitalism, which worked well until the beginning of 21st century
Investors sense future headwinds that will thwart historic consumer demand and therefore slow down investment; productivity then slows down (productivity in the US and almost everywhere in the developed world has flat-lined for nearly 5 years now and has increased by only 1% annually since 2000 and the aftermath of dot-com recession)
So instead of making money by investing in economy, savers/investors increasingly steered toward making money in the financial economy – thanks to nearly $8 trillion of QE assets purchases from major central banks and holding of short-term borrowing rates near 0 or even negative, this shift was extremely profitable
Zombie corporations are being kept alive as opposed to destroyed as with the Darwinian “survival of the fittest” capitalism of the 20th century
Standard business models forming capitalism’s foundation such as insurance companies, pension funds, and banking are threatened by the low yields that have in turn, produced high asset prices
These sectors have long-term maturities and durations of their liabilities and their assets have not risen enough to cover prior guarantees – so we see Puerto Rico, Detroit, and perhaps Illinois in future years defaulting in one way or the other on their promises
Faulty finance-based capitalism supported by destructive monetary policy begins to erode, not support the real economy
Making money with money is an inherently acceptable ingredient in historical capitalistic models but ultimately must then be channeled into the real economy to keep the cycle going
You have the potential for low asset returns in which the now successful strategy of “making money with money” is seriously threatened – how soon this takes place is of course the investor’s dilemma and the policymakers’ conundrum
But don’t be mesmerized by the blue skies created by central bank QE and near perpetually low interest rates. All markets are increasingly at risk
It’s the real economy that counts and global real economic growth is and should continue to be below par

Kerrisdale Capital's Long Thesis for Yelp

Full Summary of Long Thesis on YELP

Yelp

Recently retained a long position in Yelp
With over 127 million reviews and nearly 200 million unique monthly visitors, Yelp is a leading and unique local search and review site
Due to higher than expected customer churn, management reset expectations for 2017 on its latest earnings call – sent shares down 28% after-hours to below $25/share (34% decline in enterprise value)
Considered the price action a gross overreaction to the lowered guidance
Revised forecast gave us the opportunity to buy shares at 2x LTM revenue, 13x LTM EBITDA and 16x LTM FCF
Very unique asset and believe its brand, breadth of content and popularity would be extremely difficult to replicate
While there’s a perception of Yelp as being a restaurant/bars only review site, that category represents only 18% of reviews and even less so in terms of revenue
For other businesses, such as a local dental office or a fitness center, understanding the value proposition of advertising on Yelp is easier for a variety of reasons
Nearby competitors are fewer, each customer review is more valuable for the client since less reviews are provided for non-restaurant businesses, etc
Being at the top of Yelp searches is similar to the need to be on the first page of Google results
In recent years, Yelp has introduced other features on the site such as Eat24 (competes with Grubhub) and Yelp Reservations, an alternative to OpenTable that allows customers to make reservations directly on the Yelp site and app
Popularity is undoubtedly growing as transaction related revenues grew 28% in the last 12 months
Further engaging user base, increasing the value of the platform to both the local businesses and users
Has the potential to grow well beyond its current base of 143,000 customers
Will grow top-line by 20% in 2017 and sell-side calls for ~$1.2B of revenue by 2019, representing a CAGR of 18%
Applying a 3x revenue or 20x FCF multiple on 2019 revenue/FCF yields nearly $45/share, implying more than 60% upside
Also believe that Yelp has significant strategic value and in that scenario, shares would be worth meaningfully more

Overhyped Lousy Company Destined for Bankruptcy

Vilas Capital's Short Thesis on Tesla

Summary

Tesla is an over-hyped, lousy company, from a financial perspective that is destined to go bankrupt
Contrary to the likely barbs and pitchforks we will receive, I do wish that global warming was not occurring and that polar bears and penguins could live undisturbed in their former environments
Tesla Background

Current revenue is roughly 99% automobile related and due to Model 3 introduction and projected sales, this ratio will likely remain similar for quite some time
Thus, Tesla is an auto manufacturer, plain and simple
Panasonic supplies TSLA with batteries and other companies provide TSLA with electric motors, tires, wheels, etc
Thus, with a few extraneous business lines, TSLA designs and assembles cars
Honda makes jet airplanes, ATV’s and boat motors – still, Honda is considered an auto company as the majority of its revenue is derived in that business
Until TSLA’s battery storage and solar equipment business become majority contributors, it will remain viewed as an auto company
Unfortunately for Tesla, none of these businesses are currently profitable nor do we see any possibility of them becoming materially profitable over any visible time horizon
TSLA has had a ton going for it: extremely cheap equity and debt capital, government loans, huge government subsidies, a manufacturing plant that was purchased for nearly nothing, a marketing oriented CEO who has an eye for beautiful cars, and a great idea to put a really big battery in high end electric cars so that it can go over 200 miles before needing to be recharged
However, with all of these positives, company has not made an annual profit despite catching the auto giants asleep at the wheel
Now, to help raise capital, they’ve shown large demand for electric cars (373,000 Model 3 reservations at last disclosure) and have placed a large bullseye on their back
Executives inside top 10 auto manufacturers now all need electric car strategy and what was once a niche market that Tesla could dominate will become far more competitive with time – there is no doubt or argument about this
Microeconomics 101

Due to their desire to be vertically integrated, Tesla stated that it must construct a large factory to manufacture enough batteries to supply their cars
Elon Musk stated that this factory would double the amount of production of lithium ion batteries worldwide and that for each 500k cars manufactured, another battery factory must be built
If it requires the tripling of lithium ion battery production to simply make 1 million electric cars per year, out of a ~90 million worldwide car market, will that not affect the price of the raw materials that go into battery production?
Since raw materials make up roughly 85% of batteries’ COGS, would that not overwhelm the potential for economies of scale of building a really big battery plant?
When US mandated ethanol and used roughly 30% of corn production to make it, price of corn rose roughly 3 or 4x for a significant period of time
We are talking about increasing production of lithium ion batteries by 200% to get to 1 million cars per year (roughly 1% of worldwide market share) – will this not cause the cost of batteries to rise? Will this cost inflation not hurt the economics for electric vehicles? Of course it will.
Valuation and Returns

TSLA has a significantly larger enterprise value than Ford – we will use Ford as an example as it is the only domestic auto company to avoid bankruptcy and is therefore selling at a premium to the rest of industry
TSLA has 176 million shares fully diluted; nearly $7B of debt; thus at $302/share, TSLA has an enterprise value of roughly $60B (Ford enterprise value is roughly $29B)
On an enterprise value to revenue basis, Ford trades at 0.2x
As a growth company with large capex and working capital needs, odds of TSLA paying material dividend or share repurchase in the next ten years are, for all practical purposes, zero
Stock must rise to provide the market-like returns, say 10% annually for the next 10 years
Could use higher expected returns on TSLA as I am sure few shareholders believe their future returns will be this low
At 10% per year for 10 years, TSLA’s share price will be $785/share; assuming 180 million shares outstanding vs. current 176 million shares to account for future stock option grants, this implies an equity market valuation of $140B in 2026
Ford, on the other hand, may not grow at all but could use its profits to continue paying the 5% dividend that is paying today while also buying back roughly $2B of its shares per year, creating a 10% return for shareholders
Thus, in 10 years, Ford would continue to have same revenues and same $45B market cap but would have far fewer shares outstanding, leading to a higher stock price
Capital Efficiency

Ford is far more efficient with its capital investments than Tesla – Ford generated $152B in revenue in 2016 while employing $60B in gross PPE
For Ford, this PPE vastly understates replacement cost scenario as many of these plants were acquired many decades ago
Tesla produced $7B in revenue in 2016 with $7B in gross PPE
We agree that asset efficiency will improve in time and will rise from $1 of revenue to $1 of PPE to a Ford-like $2.5 of revenue to $1 of PPE
However, TSLA’s current asset turnover is being helped immensely from the bargain purchase of the NUMMI plant in California
Also, TSLA is vertically integrating by owning their battery production facility, their dealers, and their refueling stations – which cost a tremendous amount of money
Assuming Tesla will be a relatively mature company in 2026 with similar profit margins to those Ford enjoys today, it stands to reason that TSLA will have a similar valuation to a mature auto company
Assuming EV/revenue of 0.2x, this implies that TSLA will need to have revenue of $735B in 2026, assuming they roll over their $7B in debt and do not take on additional debt
Quandary

The issue is, how is TSLA going to pay for the capex to manufacture $735B/yr of stuff? Cars, solar gear, and batteries are not software
Again, Ford has roughly $60B of PPE
If Tesla had similar fixed asset turnover in the future as Ford (despite the vertical integration), it would mean $294B of gross PPE
Given that TSLA is losing money and will likely do so for the foreseeable future, where is the additional $287B of capital to invest in PPE going to come from?
Further, this ignores the very real need for working capital to fund raw material purchases and salaries for workers prior to the sale of cars
It is clear that Tesla cannot sell $287B of equity over the next 10 years; TSLA will not earn $287B and they will not be able to borrow $287B
TSLA will not be able to grow to $735B in revenue in 2026 as they will not have the PPE to do so
Therefore, TSLA cannot return 10% per year or anywhere close to that number
Even keeping the stock flat would be a herculean effort: TSLA would have to increase revenue by 40x to simply grow into their current EV in 10 years (ignoring effects of additional dilution from equity sales or taking debt into account)
Even this would require roughly $110B of additional PPE
Where is this $110B coming from? Not Mars.
Either Tesla has to miss estimated growth rates badly or they have to raise an insurmountable amount of money
History Lesson

There are those that will say that we are crazy for this “low” estimate of EV to revenue multiple
If we look at past crop of very exciting, high growth, glamour companies such as Cisco, Sun Microsystems, EMC, Yahoo, AOL, Microsoft, etc, as they matured, they all fell to very low mundane multiples a decade after their rapid growth phase
In fact, these companies who once collectively traded at roughly 5-10x the multiples of stodgy IBM and HP, dramatically underperformed IBM and HP from 2000-2002
Each glamour company witnessed extreme multiple contraction, if they had earnings and/or remained independent, and eventually sold at roughly 10-12x earnings a decade later, similar to IBM and HP
Glamour companies lost their entire valuation premium over the decade from 1999-2009
Outlook

Due to the fact that TSLA has not made money on its high end, highly optioned and highly priced cars, odds of them making money on the Model 3 are slim
Profit margins on high end cars are far higher than mass market cars
Due to Model 3 needing a similarly large battery to their higher end cars, it is unlikely that the costs of this car will be proportionately lower to its sale price; in fact, could make a strong argument that costs of producing Model 3 will fall far less than the sale price when compared to the Model S
Additional competition is coming and coming fast
Contrary to common wisdom, electric car is vastly easier to design and build than a standard internal combustion car
Majors just didn’t think that people would buy an all-electric car that took a long time to recharge and focused on hybrids – this was a short-term marketing error, not a capability differential
For those that believe TSLA has a huge technology lead, remember that Elon Musk gave away all their patents to the world for free (indicated to us that these were not valuable patents)
For those who will focus on remaining 1% of the business, battery storage business is a low margin business and the solar equipment business is very, very difficult
Tesla has over $6B in debt that will be coming due over the next 5 years
Tesla is a poorly capitalized company, compared to the competition, operating in a low margin and highly capital intensive, cyclical business
What if a recession were to occur and Wall Street capital is no longer available? By the way, it is not an “if” question but a “when”
When market figures out Tesla is extremely capital intensive, low margin, cyclical, and unable to grow into its valuation, the stock will fall dramatically
This will make it nearly impossible to raise equity capital; with a credit rating of B- and a depressed stock, believe that debt markets will close for Tesla
Given capex needs, working capital needs, debts to be repaid, purchase commitments and residual value guarantees, which total nearly $17B, it is highly likely that Tesla will, at some future point, struggle to remain current on all of their obligations
We believe that over the next 5 years, odds of a standalone TSLA becoming insolvent and requiring the filing of a bankruptcy petition are over 90%
Only salvation would be to find a “Time Warner”
Conclusion

Tesla is merely one of a huge crop of companies who sell “the future” to the markets, both private and public, and rely on the “there is a pot of gold at the end of the rainbow” storyline
There is a reason for GAAP; there is a reason for valuation and cash flow analysis; there is a reason for competitive strategy analysis; there is a reason for consistent profits; there is a reason for conservatively managing a company’s balance sheet
Even though Tesla buys batteries from Panasonic and most other components from other suppliers, thus not creating a technology but using widely available parts in a somewhat novel way, how did true innovators, Wilbur and Orville Wright, and their company do? Let’s just say that there was a little airplane company in Seattle (now Chicago) that did somewhat better
Tesla is mainly owned by growth investors with little experience or understanding of the capital intensity, or cyclicality, of the auto business. People defer purchases of cars in recessions, especially expensive cars
A hard lesson will be learned by the “trees can grow to the sky” crowd

Why David Einhorn Publicly Went Activist on GM

Summary of David Einhorn's 1Q17 Letter on GM

Prefer to avoid public activism and the last time we did this was with Apple in 2013 after owning the stock for 3 years
Similar situation; had owned GM for years before advancing our idea to management
When we offer companies private advice and they reject the idea, we understand the reasoning and prefer not to press the issue; sometimes, we agree to disagree, and then decide whether to hold or exit the position
In the case of GM, felt the need to press the issue as we believe there is a lot of value to unlock and the company did not fairly evaluate our idea
Management made a decision and spent a great deal of effort to justify that decision
To poison our idea, went so far as to misrepresent the proposal to the credit agencies
Ironically, our idea was designed to be credit positive and the least invasive way to unlock billions of dollars of shareholder value
This sort of behavior leaves us no room to agree to disagree
We know this is a tough fight but the math is on our side and the ultimate decision will be made by fellow shareholders
Believe others recognize that stock is deeply undervalued and when shareholders grasp the math and the extent of GM’s behavior, they will vote with their wallets and for needed change at the Board level

Tesla: Over-Hyped, Lousy Company Destined for Bankruptcy (Vilas Capital)

Summary of Vilas Capital's short thesis

Summary

Tesla is an over-hyped, lousy company, from a financial perspective that is destined to go bankrupt
Contrary to the likely barbs and pitchforks we will receive, I do wish that global warming was not occurring and that polar bears and penguins could live undisturbed in their former environments
Tesla Background

Current revenue is roughly 99% automobile related and due to Model 3 introduction and projected sales, this ratio will likely remain similar for quite some time
Thus, Tesla is an auto manufacturer, plain and simple
Panasonic supplies TSLA with batteries and other companies provide TSLA with electric motors, tires, wheels, etc
Thus, with a few extraneous business lines, TSLA designs and assembles cars
Honda makes jet airplanes, ATV’s and boat motors – still, Honda is considered an auto company as the majority of its revenue is derived in that business
Until TSLA’s battery storage and solar equipment business become majority contributors, it will remain viewed as an auto company
Unfortunately for Tesla, none of these businesses are currently profitable nor do we see any possibility of them becoming materially profitable over any visible time horizon
TSLA has had a ton going for it: extremely cheap equity and debt capital, government loans, huge government subsidies, a manufacturing plant that was purchased for nearly nothing, a marketing oriented CEO who has an eye for beautiful cars, and a great idea to put a really big battery in high end electric cars so that it can go over 200 miles before needing to be recharged
However, with all of these positives, company has not made an annual profit despite catching the auto giants asleep at the wheel
Now, to help raise capital, they’ve shown large demand for electric cars (373,000 Model 3 reservations at last disclosure) and have placed a large bullseye on their back
Executives inside top 10 auto manufacturers now all need electric car strategy and what was once a niche market that Tesla could dominate will become far more competitive with time – there is no doubt or argument about this
Microeconomics 101

Due to their desire to be vertically integrated, Tesla stated that it must construct a large factory to manufacture enough batteries to supply their cars
Elon Musk stated that this factory would double the amount of production of lithium ion batteries worldwide and that for each 500k cars manufactured, another battery factory must be built
If it requires the tripling of lithium ion battery production to simply make 1 million electric cars per year, out of a ~90 million worldwide car market, will that not affect the price of the raw materials that go into battery production?
Since raw materials make up roughly 85% of batteries’ COGS, would that not overwhelm the potential for economies of scale of building a really big battery plant?
When US mandated ethanol and used roughly 30% of corn production to make it, price of corn rose roughly 3 or 4x for a significant period of time
We are talking about increasing production of lithium ion batteries by 200% to get to 1 million cars per year (roughly 1% of worldwide market share) – will this not cause the cost of batteries to rise? Will this cost inflation not hurt the economics for electric vehicles? Of course it will.
Valuation and Returns

TSLA has a significantly larger enterprise value than Ford – we will use Ford as an example as it is the only domestic auto company to avoid bankruptcy and is therefore selling at a premium to the rest of industry
TSLA has 176 million shares fully diluted; nearly $7B of debt; thus at $302/share, TSLA has an enterprise value of roughly $60B (Ford enterprise value is roughly $29B)
On an enterprise value to revenue basis, Ford trades at 0.2x
As a growth company with large capex and working capital needs, odds of TSLA paying material dividend or share repurchase in the next ten years are, for all practical purposes, zero
Stock must rise to provide the market-like returns, say 10% annually for the next 10 years
Could use higher expected returns on TSLA as I am sure few shareholders believe their future returns will be this low
At 10% per year for 10 years, TSLA’s share price will be $785/share; assuming 180 million shares outstanding vs. current 176 million shares to account for future stock option grants, this implies an equity market valuation of $140B in 2026
Ford, on the other hand, may not grow at all but could use its profits to continue paying the 5% dividend that is paying today while also buying back roughly $2B of its shares per year, creating a 10% return for shareholders
Thus, in 10 years, Ford would continue to have same revenues and same $45B market cap but would have far fewer shares outstanding, leading to a higher stock price
Capital Efficiency

Ford is far more efficient with its capital investments than Tesla – Ford generated $152B in revenue in 2016 while employing $60B in gross PPE
For Ford, this PPE vastly understates replacement cost scenario as many of these plants were acquired many decades ago
Tesla produced $7B in revenue in 2016 with $7B in gross PPE
We agree that asset efficiency will improve in time and will rise from $1 of revenue to $1 of PPE to a Ford-like $2.5 of revenue to $1 of PPE
However, TSLA’s current asset turnover is being helped immensely from the bargain purchase of the NUMMI plant in California
Also, TSLA is vertically integrating by owning their battery production facility, their dealers, and their refueling stations – which cost a tremendous amount of money
Assuming Tesla will be a relatively mature company in 2026 with similar profit margins to those Ford enjoys today, it stands to reason that TSLA will have a similar valuation to a mature auto company
Assuming EV/revenue of 0.2x, this implies that TSLA will need to have revenue of $735B in 2026, assuming they roll over their $7B in debt and do not take on additional debt
Quandary

The issue is, how is TSLA going to pay for the capex to manufacture $735B/yr of stuff? Cars, solar gear, and batteries are not software
Again, Ford has roughly $60B of PPE
If Tesla had similar fixed asset turnover in the future as Ford (despite the vertical integration), it would mean $294B of gross PPE
Given that TSLA is losing money and will likely do so for the foreseeable future, where is the additional $287B of capital to invest in PPE going to come from?
Further, this ignores the very real need for working capital to fund raw material purchases and salaries for workers prior to the sale of cars
It is clear that Tesla cannot sell $287B of equity over the next 10 years; TSLA will not earn $287B and they will not be able to borrow $287B
TSLA will not be able to grow to $735B in revenue in 2026 as they will not have the PPE to do so
Therefore, TSLA cannot return 10% per year or anywhere close to that number
Even keeping the stock flat would be a herculean effort: TSLA would have to increase revenue by 40x to simply grow into their current EV in 10 years (ignoring effects of additional dilution from equity sales or taking debt into account)
Even this would require roughly $110B of additional PPE
Where is this $110B coming from? Not Mars.
Either Tesla has to miss estimated growth rates badly or they have to raise an insurmountable amount of money
History Lesson

There are those that will say that we are crazy for this “low” estimate of EV to revenue multiple
If we look at past crop of very exciting, high growth, glamour companies such as Cisco, Sun Microsystems, EMC, Yahoo, AOL, Microsoft, etc, as they matured, they all fell to very low mundane multiples a decade after their rapid growth phase
In fact, these companies who once collectively traded at roughly 5-10x the multiples of stodgy IBM and HP, dramatically underperformed IBM and HP from 2000-2002
Each glamour company witnessed extreme multiple contraction, if they had earnings and/or remained independent, and eventually sold at roughly 10-12x earnings a decade later, similar to IBM and HP
Glamour companies lost their entire valuation premium over the decade from 1999-2009
Outlook

Due to the fact that TSLA has not made money on its high end, highly optioned and highly priced cars, odds of them making money on the Model 3 are slim
Profit margins on high end cars are far higher than mass market cars
Due to Model 3 needing a similarly large battery to their higher end cars, it is unlikely that the costs of this car will be proportionately lower to its sale price; in fact, could make a strong argument that costs of producing Model 3 will fall far less than the sale price when compared to the Model S
Additional competition is coming and coming fast
Contrary to common wisdom, electric car is vastly easier to design and build than a standard internal combustion car
Majors just didn’t think that people would buy an all-electric car that took a long time to recharge and focused on hybrids – this was a short-term marketing error, not a capability differential
For those that believe TSLA has a huge technology lead, remember that Elon Musk gave away all their patents to the world for free (indicated to us that these were not valuable patents)
For those who will focus on remaining 1% of the business, battery storage business is a low margin business and the solar equipment business is very, very difficult
Tesla has over $6B in debt that will be coming due over the next 5 years
Tesla is a poorly capitalized company, compared to the competition, operating in a low margin and highly capital intensive, cyclical business
What if a recession were to occur and Wall Street capital is no longer available? By the way, it is not an “if” question but a “when”
When market figures out Tesla is extremely capital intensive, low margin, cyclical, and unable to grow into its valuation, the stock will fall dramatically
This will make it nearly impossible to raise equity capital; with a credit rating of B- and a depressed stock, believe that debt markets will close for Tesla
Given capex needs, working capital needs, debts to be repaid, purchase commitments and residual value guarantees, which total nearly $17B, it is highly likely that Tesla will, at some future point, struggle to remain current on all of their obligations
We believe that over the next 5 years, odds of a standalone TSLA becoming insolvent and requiring the filing of a bankruptcy petition are over 90%
Only salvation would be to find a “Time Warner”
Conclusion

Tesla is merely one of a huge crop of companies who sell “the future” to the markets, both private and public, and rely on the “there is a pot of gold at the end of the rainbow” storyline
There is a reason for GAAP; there is a reason for valuation and cash flow analysis; there is a reason for competitive strategy analysis; there is a reason for consistent profits; there is a reason for conservatively managing a company’s balance sheet
Even though Tesla buys batteries from Panasonic and most other components from other suppliers, thus not creating a technology but using widely available parts in a somewhat novel way, how did true innovators, Wilbur and Orville Wright, and their company do? Let’s just say that there was a little airplane company in Seattle (now Chicago) that did somewhat better
Tesla is mainly owned by growth investors with little experience or understanding of the capital intensity, or cyclicality, of the auto business. People defer purchases of cars in recessions, especially expensive cars
A hard lesson will be learned by the “trees can grow to the sky” crowd

Alibaba Investment Thesis & Value Investing In Tech Space

Summary of Coho Capital Letter - Value Investing in Tech

Alibaba:

Dominates world’s largest e-commerce market with 49% share compared to Amazon’s 20% share of the US online retail market; approximately 73% of all online retain transactions in China utilize Alibaba’s online payment platform; profit margins of 44% compared to 0.5% for Amazon
Has a lot of things we desire in a business: network effects, switching costs, scalability, latent pricing power
Grew sales 54% y-o-y in the most recent quarter and counts 493 million monthly active users across its three platforms
Supplanting of brick and mortar by e-commerce is happening more quickly in China than US due to less robust physical retail infrastructure; Chinese e-commerce sales grew 36% last year to ~$900B and now roughly 18% of aggregate retail sales (compared to 12% in the US)
With 80% share of Chinese e-commerce, fair to think of Alibaba as a toll on online Chinese consumption
BCG predicting 20% CAGR in online spending over the next four years
Multiple business units reinforce each other, creating a business ecosystem that grows more valuable with each additional user and transcation
Provides a platform for onboarding new services such as online payment, mobile operating system, map service supplier, online grocer, group shopping, cloud computing, video hosting and streaming and others
Massive platform of users opens multiple pathways to monetize user data; opportunities to cross-sell additional products and services to its large and growing base of customers
Despite its dominant position and compelling growth opportunities, does not have a demanding valuation
Core business should trade at least 25x forward earnings given its inherent operating leverage and projected sales growth of over 28% over the next few years – this results in stock price of $114
Add $15/share for investments and stake in Ant Financial – gets you to $129 (27% higher than today’s quotation)
Expect emergent businesses such as Alicloud and digital entertainment to be material contributors to future economic returns providing downside support
After Amazon, Alibaba is our second largest position

https://investoralmanac.com/2017/03/08/coho-capital-letter-value-investing-in-tech-alibaba-facebook-google-visa-sp/

Natural Gas Is Mispriced

Summary of RBN Energy 2017 Prognostications

Natural gas, particularly wet natural gas, will be a more attractive market than crude oil

No big recovery in crude, gas forward curve too low, and NGL prices increasing more than both oil and gas

Ethane production will be ramping up as rejection flips to recovery
Between late 2017 and end of 2018, almost all ethane rejection in PADD 3 and 4 will be recovered; only ethane rejection will be due to pipeline constraints out of Marcellus/Utica and Bakken

The frac spread is coming back along with margins for gas processing
Heading back to $5-6/MMBtu level after languishing at $2.30 from Jan. 2015 through end of 2016; good news for processors and producers

Big natural gas price differentials are coming to West and South Texas
Won’t be long before Waha could experience takeaway constraints and situation similar at Agua Dulce

The new administration may Trump down oil and gas prices
US succeeded in overproducing under carbon-unfriendly Obama administration – what might they do if the shackles come off?

The natural gas forward curve is mispriced
As of last day of 2016, 2017 strip was $3.62, 2018 was $0.48 lower and 2019 was $0.27 lower at $2.87; strip in 2022 is only $2.93 – it just can’t be

Capital will drive economics
Historically, plays with best economics attracted capital; now, producers with access to capital are building out significant contiguous acreage positions in their core areas

Rig productivity will continue to improve
From 2011 to 2016, rig productivity was up 260% in Bakken, 465% in Permian, and 840% in Niobrara; this trend is going to be with us for the foreseeable future

US crude production in 2017 will increase, but not at the 1 MMb/d a year growth rate seen from 2012-2014
Decline curves are flatter in the marginal basins and production declines from older wells are slowing; it makes it easier for new wells in the Permian to contribute to production growth

We’ll see no crude price breakout in 2017, one way or the other
OPEC and NOPEC will muddle along and US E&P’s will contribute to the muddle by increasing crude production over time to offset a portion of any real OPEC/NOPEC cuts

Summary of RBN Prognostications: https://investoralmanac.com/2017/01/05/energy-prognostications-for-2017/

Case Study of WDFC Valuations

Beware of "Bubble" in Safe Stocks

WD-40: A Case Study of the Bubble in “Safe” Stocks

One of the biggest risks in the market today comes from investors overpaying for conservative, income-generating companies
Mirror image of 1999 Dot-Com bubble, when investors overpaid for high risk, non-yielding stocks; today is characterized by eye-popping valuations for “safe” assets from bonds to the most conservative sectors of the stock market
WD-40 (NASDAQ: WDFC) is a case study of a seeming “safe” company whose valuation has been bid up so high by investors that it now represents a very risky bet on a perpetual continuation of today’s abnormal valuations
WD-40:
Maker of ubiquitous household product people use to make things stop squeaking; very solid company and found in over 80% of US households; higher penetration than Coca-Cola and Gillette razors; no meaningful competition and healthy returns on capital
Limited growth opportunity and limited reinvestment opportunity, so high payout ratio
Slow growth opportunities can make for great investments when they command strong returns on invested capital to return capital to shareholders in addition to producing modest growth
For instance, from 2001 to 2007, stock price appreciated 6.6%/yr while generating 3.2% returns from dividends (9.8%/yr total return; compared to 5.3% S&P returns)
This is exactly what made dividend yield-focused investing attractive
2001-2007 period began and ended with 10-yr treasury yields of about 5%; using this as proxy for risk-free rate, generally stable attitudes towards low-risk assets
WDFC traded for 15-20x during the period
From 2001 to 2016, dividend generating power is essentially unchanged, demand or competitive landscape has unchanged, growth expectations are no different – but today, investors are paying 34x, or twice as much for each dollar of earnings
Seeing similar willingness with 10-year treasury yield with yield falling from 5% in 07, 3% in 13, and 1.5% today – this is equivalent to PE ratio on the treasury going from 20x in 07, 33x in 13, and 67x today
For context, at the peak of 1999 Dot-Com bubble, S&P was trading at PE ratio of 30x
High appreciation of WDFC has brought dividend yield to just 1.4%
Over the next decade, if you assume dividend growth of 5% per year, dividend contribution to total return will be just 1.7%; and if PE ratio stays constant, total annual return will be just 6.7%
What if PE ratio returns to the 17.5x pre-crisis average? Then assuming the same 5% earnings growth rate, the stock will end the next 10-years at a price of $93, down over 20% from today’s price of $117 – total return will be a terrible -0.6% per year
When investors overpay for these characteristics, they turn a safe company into a risky stock
Idea that WDFC’s PE ratio to be cut in half may sound outrageous; but given how low the dividend yield has gotten today, if the stock price is cut in half today, dividend yield is still only 2.8% (this happens to be the average dividend yield that prevailed in 01-07 time period)
WDFC is not an outlier; quality, dividend paying companies of all sorts are trading at abnormally high valuations

Great summary of Case Study and perils of current market valuation: https://investoralmanac.com/2017/01/04/beware-of-bubble-in-safe-stocks/

Thesis for Verisign

Summary of Saber Capital Letter

Verisign
Operates the domain name registry for the .com and .net “top-level domains”
“Toll road” of the internet; exclusive registry for .com and .net (monopoly)
Collects annual fee (around $8) for each of the 142 million .com and .net registered domains
Margin on this recurring revenue is extraordinarily high and minimal need for cash in the business
Bought back stocks aggressively in the last ten years (diluted shares shrunk from around 250 million to 125 million)

Full Summary of Saber Capital Letter: https://investoralmanac.com/2017/02/14/saber-capital-letter-2016-review-apple-verisign/

AAPL Thesis as a Consumer Brand

Summary of Saber Capital Letter

Apple
Began looking in the fall of 2015 when stock dropped from around $130 to $90 in a matter of few months (massive $200 billion swing in market value)
Eventually came to a conclusion that Apple shouldn’t be analyzed as a computer hardware manufacturer, it should be thought of as a consumer brand
Consumer brands like Nike, Coca-Cola, or Starbucks all buy commodities (raw materials) and sell brands
Nike’s shoes might be nice but the material isn’t all that different than Russell’s or Champion’s
Commodity material is similar but Nike gets its 50% gross margins thanks to the brand it has built over time
Great business inside of Apple is their services business (App Store, payments, music, etc)
App Store did $28 billion in revenue last year of which Apple gets a 30% cut which is nearly pure profit (service business alone will reach somewhere around $30 billion this year)
Now over 1 billion Apple devices and this “installed base” continues to grow (over 100 million new active devices added last year alone); each device acts like miniature retail stores for Apple, collecting very high margin revenue on a recurring basis from apps, games, music, storage, and payments
Believe Apple’s brand will lead to very predictable sales and willing to bet that this will be the case 5 years from now as well (2 short years ago, was not in the watch business – they are now the second largest watch company in the world)
For less than $95, you were getting a very high quality business that was producing $9 or $10 of FCF/share and $30 per share of net cash; at a P/FCF of 7x, seemed like a no-brainer

Full summary of Saber Capital Letter: https://investoralmanac.com/2017/02/14/saber-capital-letter-2016-review-apple-verisign/

EQT Activist Pushes Merger with RRC or AR

Summary of Activist Letter

Potential E&P-related synergies:
Enhanced present value and well IRRs through contiguous acreage and longer laterals
Improved capital allocation from drilling best locations of the merged footprint
Enhanced Marcellus/Utica and wet/dry production optionality
Realized prices/netbacks optimization
Financial flexibility would enable higher production growth
Offer a bigger/better platform for strategic delineation
Increased reservoir understanding and improved well development

Potential Midstream and Marketing-related synergies:
Coordinated field gathering and compression development enabling reduced capital spending
Increased pipeline fee income from OVC and MVC pipelines
Equitrans could be expanded with additional captive volumes
EQGP unit price appreciation resulting from improved EQM distribution growth
Combined company to have more leverage with pipeline companies and end-market customers

Other potential synergies:
Strengthened management team
EQT’s minimally levered balance sheet and investment credit rating to be capitalized
G&A and opex savings
Potential value accretion from follow-on acquisitions and roll-ups
Potential value creation from a down-the-road full separation of upstream/midstream

Full summary: https://investoralmanac.com/2017/01/05/activist-pushes-eqt-on-a-merger-with-antero-or-range/

Elon Musk's Email to Employees

Elon Musk's Email to SpaceX Employees

Date: June 7, 2013, 12:43:06 AM PDT

To: All All@spacex.com

Subject: Going Public

Per my recent comments, I am increasingly concerned about SpaceX going public before the Mars transport system is in place. Creating the technology needed to establish life on Mars is and always has been the fundamental goal of SpaceX. If being a public company diminishes that likelihood, then we should not do so until Mars is secure. This is something that I am open to reconsidering, but, given my experiences with Tesla and SolarCity, I am hesitant to foist being public on SpaceX, especially given the long term nature of our mission.

Some at SpaceX who have not been through a public company experience may think that being public is desirable. This is not so.Public company stocks, particularly if big step changes in technology are involved, go through extreme volatility, both for reasons of internal execution and for reasons that have nothing to do with anything except the economy. This causes people to be distracted by the manic-depressive nature of the stock instead of creating great products.

It is important to emphasize that Tesla and SolarCity are public because they didn’t have any choice. Their private capital structure was becoming unwieldy and they needed to raise a lot of equity capital. SolarCity also needed to raise a huge amount of debt at the lowest possible interest rate to fund solar leases. The banks who provide that debt wanted SolarCity to have the additional painful scrutiny that comes with being public. Those rules, referred to as Sarbanes-Oxley, essentially result in a tax being levied on company execution by requiring detailed reporting right down to how your meal is expensed during travel and you can be penalized even for minor mistakes.

YES, BUT I COULD MAKE MORE MONEY IF WE WERE PUBLIC

For those who are under the impression that they are so clever that they can outsmart public market investors and would sell SpaceX stock at the “right time,” let me relieve you of any such notion. If you really are better than most hedge fund managers, then there is no need to worry about the value of your SpaceX stock, as you can just invest in other public stocks and make billions of dollars in the market.

If you think: “Ah, but I know what’s really going on at SpaceX and that will give me an edge,” you are also wrong. Selling public company stock with insider knowledge is illegal. As a result, selling public stock is restricted to narrow time windows a few times per year. Even then, you can be prosecuted for insider trading. At Tesla, we had both an employee and an investor go through a grand jury investigation for selling stock over a year ago, despite them doing everything right in both the letter and the spirit of the law. Not fun.

Another thing that happens to public companies is that you become a target of the trial lawyers who create a class action lawsuit by getting someone to buy a few hundred shares and then pretending to sue the company on behalf of all investors for any drop in the stock price. Tesla is going through that right now even though the stock price is relatively high, because the drop in question occurred last year.

It is also not correct to think that because Tesla and SolarCity share prices are on the lofty side right now, that SpaceX would be too. Public companies are judged on quarterly performance. Just because some companies are doing well, doesn’t mean that all would. Both of those companies (Tesla in particular) had great first quarter results. SpaceX did not. In fact, financially speaking, we had an awful first quarter. If we were public, the short sellers would be hitting us over the head with a large stick.

We would also get beaten up every time there was an anomaly on the rocket or spacecraft, as occurred on flight 4 with the engine failure and flight 5 with the Dragon prevalves. Delaying launch of V1.1, which is now over a year behind schedule, would result in particularly severe punishment, as that is our primary revenue driver. Even something as minor as pushing a launch back a few weeks from one quarter to the next gets you a spanking. Tesla vehicle production in Q4 last year was literally only three weeks behind and yet the market response was brutal.

BEST OF BOTH WORLDS

My goal at SpaceX is to give you the best aspects of a public and private company. When we do a financing round, the stock price is keyed off of approximately what we would be worth if publicly traded, excluding irrational exuberance or depression, but without the pressure and distraction of being under a hot public spotlight. Rather than have the stock up during one liquidity window and down during another, the goal is a steady upward trend and never to let the share price go below the last round. The end result for you (or an investor in SpaceX) financially will be the same as if we were public and you sold a steady amount of stock every year.

In case you are wondering about a specific number, I can say that I’m confident that our long term stock price will be over $100 if we execute well on Falcon 9 and Dragon. For this to be the case, we must have a steady and rapid cadence of launch that is far better than what we have achieved in the past. We have more work ahead of us than you probably realize. Let me give you a sense of where things stand financially: SpaceX expenses this year will be roughly $800 to $900 million (which blows my mind btw). Since we get revenue of $60M for every F9 flight or double that for a FH or F9-Dragon flight, we must have about twelve flights per year where four of those flights are either Dragon or Heavy merely in order to achieve 10% profitability!

For the next few years, we have NASA commercial crew funding that helps supplement those numbers, but, after that, we are on our own. That is not much time to finish F9, FH, Dragon V2 and achieve an average launch rate of at least one per month. And bear in mind that is an average, so if we take an extra three weeks to launch a rocket for any reason (could even be due to the satellite), we have only one week to do the follow-on-flight.

MY RECOMMENDATION

Below is my advice about regarding selling SpaceX stock or options. No complicated analysis is required, as the rules of thumb are pretty simple. If you believe that SpaceX will execute better than the average public company, then our stock price will continue to appreciate at a rate greater than that of the stock market, which would be the next highest return place to invest money over the long term. Therefore, you should sell only the amount that you need to improve your standard of living in the short to medium term. I do actually recommend selling some amount of stock, even if you are certain it will appreciate, as life is short and a bit more cash can increase fun and reduce stress at home (so long as you don’t ratchet up your ongoing personal expenditures proportionately).

To maximize your post tax return, you are probably best off exercising your options to convert them to stock (if you can afford to do this) and then holding the stock for a year before selling it at our roughly biannual liquidity events. This allows you to pay the capital gains tax rate, instead of the income tax rate.

On a final note, we are planning to do a liquidity event as soon as Falcon 9 qualification is complete in one to two months. I don’t know exactly what the share price will be yet, but, based on initial conversations with investors, I would estimate probably between $30 and $35. This places the value of SpaceX at $4 to $5 billion, which is about what it would be if we were public right now and, frankly, an excellent number considering that the new F9, FH and Dragon V2 have yet to launch.

Elon

https://investoralmanac.com/2017/02/16/elon-musks-email-to-spacex-employees-taking-the-company-public/

David Einhorn's Case for Gold

David Einhorn's Case for Gold Under Trump Presidency

In light of Trump presidency, thoughts on current positioning:
Long a variety of low-multiple, tax-paying, US value stocks: most benefit to companies that have profits on which to pay taxes (AMERCO, CC, Dillard’s, and DSW)
Long AAPL: to benefit from repatriation of foreign cash and tax reform
Long GM: more jobs, higher income, and higher wages to drive demand for consumer durables; also falls under low-multiple, tax-paying US value stock category
Short “bubble baskets”: mostly don’t have profits (no tax benefits) and accelerating economy should allow investors to find growth without needing to pay nosebleed prices for a narrow group of profitless top-line growth stocks (Netflix)
Short oil frackers: economies still don’t work when all investment and corporate costs are taken into account; “drill-baby-drill” attitude is likely to lead to additional mal-investment which will lead to lower prices and deeper losses; generally not cash tax payers
Short CAT (and a few other similar industrial cyclicals that have moved much higher post-election): CAT sells machines that are used in infrastructure but this is only a small part; CAT’s biggest segments are mining and energy; just completed once-in-a-generation boom in iron ore mine development and horizontal drilling which means we can produce more oil with fewer rigs; even in infrastructure boom, CAT closed the year at 33x forward earnings
Continue to own gold; there has been a knee-jerk decline in gold since the election, as investors presume that higher short-term rates are good for the dollar and bad for gold; great economic, geopolitical, and policy uncertainties, wider budget deficits, and possibility of inflation problem all support gold

https://investoralmanac.com/2017/01/17/greenlight-capital-4q16-letter-positioning-for-trump-presidency/

Rare Seth Klarman Letter on Market

Seth Klarman Warns of Trump Market Euphoria

Seth Klarman, who usually maintains an extremely low profile, published an investor letter in late January which is garnering media interest, starting with The New York Times (letter obtained by Andrew Ross Sorkin)
“Despite my preference to stay out of the media… I’ve taken the view that each of us can be bystanders, or we can be upstanders. I choose upstander”
Trump cheerleaders on Wall Street are ignoring the real problems holding down wages while offering all the wrong solutions
Trump’s stimulus efforts could prove quite inflationary, which would likely shock investors
“Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers”
“Trump may be able to temporarily hold off the sweep of automation and globalization by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces. While they might be popular, the reason the US long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off”
Concerned about swelling national debt that could undermine the economy’s growth over the long term
“The Trump tax cuts could drive government deficits considerably higher”
“The large 2001 Bush tax cuts, for example, fueled income inequality while triggering huge federal budget deficits. Rising interest rates alone would balloon the federal deficit, because interest payments on the massive outstanding government debt would skyrocket from today’s artificially low levels”
“The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making”
“The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty … Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan”
“If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst”

https://investoralmanac.com/2017/02/09/seth-klarman-warns-of-trump-market-euphoria/

Summary of Buffett's Annual Letter

Best summary of Buffett's 2016 Annual Letter

Performance

In 2016, Berkshire’s gain in net worth was $27.5B which increased per-share book value by 10.7% (per-share market value of Berkshire increased 23.4% versus S&P with dividends of 12% in 2016)
Over the last 52 years, per-share book value has grown from $19 to $172,108, a rate of 19% compounded annually
What We Hope to Accomplish

Buffett and Charlie Munger expect Berkshire’s normalized earning power per share to increase every year; actual earnings will sometimes decline because of periodic weakness in US economy; insurance-specific events may occasionally reduce earnings
Berkshire gradually shifted from a company obtaining most of its gains from investment activities to one that grows in value by owning businesses; took baby steps initially by making small acquisitions
Despite the cautious approach, made one particularly egregious error, acquiring Dexter Shoe for $434MM in 1993
Dexter’s value went to zero; story gets worse: used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at yearend 2016 were worth more than $6B
This wreck was followed by three happenings: two positive and one negative:
Acquired half of GEICO that wasn’t already owned in 1996, a cash transaction that changed the holding from a portfolio investment into a wholly-owned operating business: quickly became the world’s premier property/casualty business
Unfortunately, followed the GEICO purchase by foolishly using Berkshire stock to buy General Reinsurance in 1998: General Re was a good investment but Berkshire issued 272,000 shares which increased outstanding shares by 21.8%; error caused shareholders to give more than they received
In 2000, bought 76% of MidAmerican Energy in cash: firmly launched Berkshire on its present course of 1) continuing to build insurance operation; 2) energetically acquiring large and non-insurance businesses; and 3) largely making deals from internally-generated cash
Portfolio of bonds and stocks, deemphasized though it is, has continued in the post-1998 period to grow and to deliver hefty capital gains, interest, and dividends; portfolio earnings have provided major help in financing the purchase of businesses
Expectation is that investment gains will continue to be substantial and that these will supply significant funds for business purchases; by avoiding issuance of Berkshire stock, any improvement in earnings will translate into equivalent per-share gains
“Early Americans, we should emphasize, were neither smarter nor more hard working than those people who toiled century after century before them. But those venturesome pioneers crafted a system that unleashed human potential, and their successors built upon it. This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the build-up of wealth will be interrupted for short periods from time to time. It will not, however, be stopped. I’ll repeat what I’ve both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history”
Share Repurchases

Assessing the desirability of repurchases isn’t that complicated
From the standpoint of existing shareholders, repurchases are always a plus; though the day-to-day impact of these purchases is usually minuscule, it’s always better for a seller to have an additional buyer in the market
For continuing shareholders, however, repurchases only make sense if the shares are bought at a price below intrinsic value; when that rule is followed, remaining shares experience an immediate gain in intrinsic value
Puzzling that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed; when CEO’s or boards are buying a small part of their own company, they all too often seem oblivious to price – would they behave similarly if they were managing a private company with just a few owners and were evaluating the wisdom of buying out one of them?
There are two occasions in which repurchases should not take place:
When a business both needs all its available money to protect or expand its own operations and is also uncomfortable adding further debt
When a business acquisition offers far greater value than do the undervalued shares of the potential repurchase
Berkshire’s own repurchase policy: authorized to buy large amounts of shares at 120% or less of book value
As the subject of repurchases has come to boil, some people have come close to calling them un-American – characterizing them as corporate misdeeds that divert funds needed for productive endeavors
Simply isn’t the case: both American corporations and private investors are today awash in funds looking to be sensibly deployed; not aware of any enticing project that in recent years has died for lack of capital

Full summary of the article: https://investoralmanac.com/2017/02/25/warren-buffetts-2016-letter-to-shareholders-performance-share-repurchase-activepassive-investing/

$SEAS Thesis Wrong and Exits at a Loss

Broyhill Asset Mgmt - Was Wrong and Exited at a Loss

Theme parks are mediocre businesses; they earn low returns on capital and pile on debt to juice equity returns for investors; that being said, they have attractive characteristics such that buying at the right price can be very profitable
Thought we bought SeaWorld at the right price
Initiated a position in August 2014 at what we believed was the point of maximum pessimism (backlash from Blackfish)
Investment thesis correctly identified company’s animal rights challenges as a temporary problem likely to be solved via the passage of time
Recognized that heightened competitive environment represented bigger risk
Incorrectly assumed that the unique experience that SeaWorld has successfully offered for decades would be enough to differentiate the parks from Disney and Universal
Every investment cycle sows the seeds for its own conclusion; excess spending reaches a level which is unsustainable, and industry participants eventually figure out that if they cut back on ridiculous levels of spending, profits quickly improve
Assumed this cycle would be no different
Disney and Universal were spending like drunken sailors and new attractions at SeaWorld failed to drive the rebound in attendance we expected
Two years seemed like a sufficient time horizon for SEAS to get its house in order
Even though we bought SEAS at a bargain price, heightened competitive environment gradually eroded margin of safety
Lost money on SEAS but believe our judgment was sound; identified the primary risk before getting involved and bought with a sufficient margin of safety which limited downside risk
Over time, odds like this should shake out in our favor; a collection of investments with similar payoff profiles should result in quite satisfactory long-term gains

Great summary of Broyhill Asset Management's Letter: https://investoralmanac.com/2017/02/28/broyhill-annual-letter-trump-activepassive-investing-seaworld/

Case Study of Costco Valuations and Right Entry Point

Summary of case study and good read on common valuation pitfalls

Costco (COST) Case Study:
Over the past two decades, COST generated a cumulative return of 1790% vs 337% in the S&P – probably safe to say that COST was not overvalued over this period
Costco membership costs about $45/yr and in exchange, people shop at Costco because goods are priced at a fixed 14% markup over cost
Costco’s operating costs are extremely low and this makes it difficult for even WalMart to compete as they can’t make money pricing goods as low as Costco
In order to make money selling at 14% above cost, revenues need to be very high
Competitive advantage is derived from what management does with this revenue advantage – passes efficiency gains back to consumer to drive more growth
Consumers benefit from firm’s expansion which drives supplier prices down
Over the past two decades, traded on average at 24x forward earnings estimates (stock looked always expensive)
We estimate steady state value for COST around $74/share which is nearly half of COST’s recent stock price – but this is conservative due to a number of factors temporarily depressing current profitability
COST stores are immature – newer stores only generating $80-100MM in sales vs $160MM on average and $180MM for stores open for 10+ years
Assuming new stores eventually ramp up to average, newer stores are under-earning by $8.7B
If you consider likelihood for a near-term hike in membership fees and maturation of existing store base, normalized steady state value increases to $80/share (60% of today’s value)
Costco is profitable enough to self-fund growth and has done so throughout history; so growth has been more measured in pace and more sustainable as COST is not dependent on capital markets
5-year average ROIC stood around 13% vs. long-term average of 12%; despite the recent increase, believe normalized returns are greater than indicated by reported financials – assuming maturation of existing stores, estimated normalized ROIC of 16%
Assuming 16% returns, company’s earnings multiple should fall somewhere in the range of 15.7x to 25.5x depending on one’s expectation for earnings growth (4% to 10%)
Management appears comfortable with current pace of square footage growth – assuming 4-5% annual growth, equates to 1050 to 1150 stores in ten years
For perspective, HD and LOW have 4,000 combined stores in the US alone
In summary, future value for COST might be in the area of $40-80 per share – adding steady-state value of $80-90/share, puts fair value in the range of $120 to $170
Bottom line, would be happy to own COST at a 25% discount to our estimate of intrinsic value or roughly $100/share
At an entry point of $100/share, assuming mid-single digit comps and store growth, would expect to generate ~20% annual returns

Full case study and read on common pitfalls of valuation: https://investoralmanac.com/2017/03/02/multiples-vs-valuation-growth-vs-returns-cheap-vs-value-drivers-of-value-creation-costco-case-study/

Dan Loeb's Thesis for Banks and Financials Equities

Summary of Dan Loeb's Letter

On November 8th, financials portfolio was 4.4% of the fund; one day later, it was 6%; one week later, 10.5%; one month later, 11.8%; reallocated half of initial holdings from high-multiple, FCF businesses in payments, ratings, and P&C (which traditionally outperform during periods of deflation), to more traditional reflationary exposures in banks, brokers, and geographically, in Japan
Some believe rally in financials has been driven by expectations of tax cuts, or potential repeal of Volcker Rule, or reduced compliance costs, or more relaxed capital regulations
These would bring material additional upside to bank stocks but our focus is different: pendulum in monetary policy has begun to shift away from austerity and its limiting factors; bullish for rate-sensitive financials
Rising rates have the obvious benefit of boosting net interest margins but this is particularly true today because banks are sitting on more excess cash and liquidity than ever; rising rates also unlock activity across fixed income trading
As relative policies between countries diverge, currency trading and hedging accelerates
Most will underestimate the significant operating leverage inherent in financials: expanding interest income or more velocity in trading does not require additional technology or more personnel

https://investoralmanac.com/2017/03/01/third-point-4q16-letter-reviewoutlook-financials-equities-credit-cycle/

Tesla Is A Zero
Mark Spiegel's Presentation: Tesla Is A Zero

“It’s pretty amazing that we live in an age when a CEO of two public companies can give a talk about colonizing Mars and shareholders don’t see that as a warning signal” – Dave Pell (Editor of NextDraft)

Presentation is called “Tesla is a zero” but actually think because of debt, equity is worth less than zero
3 broad reasons: 1) current financials are horrible even with no direct long-range EV competition yet massive competition ahead; 2) no meaningful proprietary technology and its hard assets are worth less than its $6 billion of debt (including SolarCity); 3) “bet on Elon” is a bet on someone who can’t be trusted and has a long track record of making misleading statements
Longs are “all about the future” so quick look at the current financials: Q3 GAAP loss excluding one-time ZEV credit sales of $117M; GAAP loss per car sold or leased ex-ZEV sales was $4,710; estimate that Q4 FCF will be around minus $1.5B; these numbers are before SolarCity which itself has nearly $2B/yr of negative FCF
Over the next few years, massive number of long-range electric cars will be on the market often at prices subsidized by profits from conventional vehicles (option Tesla doesn’t have), so pricing pressure will be intense
Chevy Bolt (available now): $30,000 cheaper than the least expensive Tesla
Production and investments confirmed by: Audi Q6, Audi A9, Mercedes, Porsche Mission E, Porsche Cayenne Coupe, VW, Jaguar SUV, Land Rover, BMW, Nissan, Ford (13 EV’s), Volvo, Hyundai, Honda, Mazda, Mitsubishi, Toyota, Aston Martin, Bentley Mulsanne, Maserati Alfieri, Renault, Peugeot, Subaru, Skoda, Borgward, and many other start-ups
What about batteries? What about “Gigafactory”?
TSLA’s battery cells are made by Panasonic (Panasonic will sell its cells to anyone); cell-making is fully automated and beyond a certain point, limited economies of scale; Panasonic’s investment in Gigafactory is really a capital lease of its equipment to TSLA
Competition: LG Chem, Panasonic, Samsung, BYD, SK Innovation, ACCUMOTIVE, VW, BMW, Ford, Toyota, Bosch, Sony, Dyson, Rimac, Kreisel
What about battery storage?
Battery storage is at least as competitive as electric cars
Competition: Panasonic, Samsung, LG Chem, GE, BYD, AES, Mitsubishi, NEC, Hitachi, ABB, Saft, Enersys, Blue Energy, E.ON, ESS, SOLARWATT, Mercedes, Schneider Electric, sonnen, Kokam, Sharp, Eaton, TESVOLT, Aquion Energy, Kreisel, Leclanche, Lockheed Martin, GreenCharge, Imergy, Exergonix, Stem, Alevo, Eos, UET, Belectric, Sunverge, Fluidic Energy, Primus Power, SimpliPhi, redT, ZCell
What about autonomous driving?
2017 Audi A8 to feature autonomous tech; Mercedes developing; Volvo planning (jointly with Uber); BMW developing with Intel; GM developing (with Lyft); Ford developing; Nissan debuted; Toyota developing; Jaguar to start UK tests; Hyundai debuted fully autonomous cars; Acura developing; Google; Delphi-Mobileye developing self-drive; Bosch developing; Apple developing
What about 120kw SuperChargers?
BMW, Daimler, Ford, and VW with Audi & Porsche plan joint venture for ultra-fast, high-power charging along major highways in Europe; White House announces new EV corridors; BMW and VW new US fast-charging network; VW pays $2B to fund clean cars infrastructure; Switzerland getting 150kW chargers at 100 sites; Fastned readies for 150kW and 300kW charging
What about the “$35,000 mass-market” Model 3?
Q3 TSLA gross profit (excluding ZEV sales) for non-leased cars averaged $25,200/car at an ASP of $105,900 – it costs TSLA almost $81,000 to build each car it sold
No higher volume per-car savings in engineering or R&D costs because they are expensed (not part of COGS)
Estimate that base Model 3 will cost TSLA at least in the high $40,000s to build – either sell them at loss starting $35,000 or price them into a much smaller market segment (neither choice validates the hype)
After Tweeting Model 3 reservation numbers leading into May’s stock offering and featuring it in the prospectus, Musk now refuses to update it; when asked on Q3 conference call, he said it was “not a figure of merit”
Track record of misses and questionable morality:
In 2011, said Model S starting at $49,900 will arrive next summer (2012)…
February 2012: Musk said “TSLA does not need to ever raise another funding round” (5 financings since then)
In November 2014, Musk said that TSLA essentially sold every car they had and there is nothing to sell. According to Consumer Reports in November 2014, source inside TSLA told them there is 2,300 Model S remaining that the company is selling at a discount
In February 2016, Musk said “we do not discount our cars for anyone, including me” but since July 2015, TSLA has run a $1,000 per car discount referral program open to anyone
Talked merger with SolarCity CEO before sale of stock?; exaggerated safety claims; unloading stocks contrary to his public messaging; conflicts of interest – SpaceX, SolarCity?

https://investoralmanac.com/2017/01/02/tesla-is-a-zero-mark-spiegel/

EQT Activist pushes for consolidation in Appalachia

Summary of the letter
Potential E&P-related synergies:
- Enhanced present value and well IRRs through contiguous acreage and longer laterals
- Improved capital allocation from drilling best locations of the merged footprint
- Enhanced Marcellus/Utica and wet/dry production optionality
- Realized prices/netbacks optimization
- Financial flexibility would enable higher production growth
- Offer a bigger/better platform for strategic delineation
- Increased reservoir understanding and improved well development

Potential Midstream and Marketing-related synergies:
- Coordinated field gathering and compression development enabling reduced capital spending
- Increased pipeline fee income from OVC and MVC pipelines
- Equitrans could be expanded with additional captive volumes
- EQGP unit price appreciation resulting from improved EQM distribution growth
- Combined company to have more leverage with pipeline companies and end-market customers

https://investoralmanac.com/2017/01/05/activist-pushes-eqt-on-a-merger-with-antero-or-range/

EQT Activist pushes for consolidation in Appalachia

Summary of the letter
Potential E&P-related synergies:
- Enhanced present value and well IRRs through contiguous acreage and longer laterals
- Improved capital allocation from drilling best locations of the merged footprint
- Enhanced Marcellus/Utica and wet/dry production optionality
- Realized prices/netbacks optimization
- Financial flexibility would enable higher production growth
- Offer a bigger/better platform for strategic delineation
- Increased reservoir understanding and improved well development

Potential Midstream and Marketing-related synergies:
- Coordinated field gathering and compression development enabling reduced capital spending
- Increased pipeline fee income from OVC and MVC pipelines
- Equitrans could be expanded with additional captive volumes
- EQGP unit price appreciation resulting from improved EQM distribution growth
- Combined company to have more leverage with pipeline companies and end-market customers

https://investoralmanac.com/2017/01/05/activist-pushes-eqt-on-a-merger-with-antero-or-range/

EQT Activist pushes for consolidation in Appalachia

Summary of the letter
Potential E&P-related synergies:
- Enhanced present value and well IRRs through contiguous acreage and longer laterals
- Improved capital allocation from drilling best locations of the merged footprint
- Enhanced Marcellus/Utica and wet/dry production optionality
- Realized prices/netbacks optimization
- Financial flexibility would enable higher production growth
- Offer a bigger/better platform for strategic delineation
- Increased reservoir understanding and improved well development

Potential Midstream and Marketing-related synergies:
- Coordinated field gathering and compression development enabling reduced capital spending
- Increased pipeline fee income from OVC and MVC pipelines
- Equitrans could be expanded with additional captive volumes
- EQGP unit price appreciation resulting from improved EQM distribution growth
- Combined company to have more leverage with pipeline companies and end-market customers

https://investoralmanac.com/2017/01/05/activist-pushes-eqt-on-a-merger-with-antero-or-range/