The growth of alternative energy demand is one of the hottest trends within the market today. Investors have poured dollars into countless sub-sectors of solar, wind, biodiesel, geothermal, etc. The hope that a few of these trends will soon compete with our traditional sources of energy (fossil fuels) offers considerable rewards for long-term investors willing to bear the risk. AllStar sees the considerable promise in solar through photovoltaic cells (PV) and has reaped considerable returns from the trend through Suntech Power (STP), a Chinese company that is one of the major players within the industry.
The company designs, develops, manufactures, and markets various photovoltaic cells and modules to provide electric power for residential, commercial, industrial, and public utility applications worldwide. Though most of the solar industry operates on shaky fundamentals and continues to trade with the wild mood swings of the market, Suntech is company that generates substantial revenues, earnings and cash flows. The company has several major end markets in Europe, with the majority of revenue coming from Germany and Spain. China, despite its massive energy demand and worsening environmental conditions, is not yet one of the major end markets for the company, though CEO Zhengrong Shi optimistically visions that Suntech may supply 2% of China’s energy needs by 2020. While government subsidies and feed-in tariffs continue to support the entire industry, the initiative to make solar competitive with traditional grid electricity is real for the major players like Suntech. Suntech’s strategy is to “be the global market leader for the development and manufacture of PV products and spearhead the movement to deliver solar-based electricity at a cost equal to the cost or retail electricity.”
Suntech shares were unfairly hammered since the last earnings report where the company broke its streak of consistently exceeding production targets and forecasts due to skyrocketing solar module demand. Suntech’s 2008 target production of only 530MW despite 1GW of capacity shows how higher silicon costs have stalled the growth of the industry. Though the company has had a strong record of signing long-term silicon supply contracts at better fixed prices, even at this low target of production, Suntech will rely on the spot market to supply 40% of its silicon needs. With spot silicon prices continuing to soar upwards of $400/kg (up 30% vs. a year ago), Suntech’s decision to scale back its production to preserve margins was wise. Though the expected glut of silicon due to increasing capacity may be years away, even a slight ease expected in the latter half of 2008 or 2009 would be massively accretive to Suntech’s operating performance. In a recent note, an analyst at Raymond James & Co noted that with an ease of spot silicon prices from $400/kg to $300/kg, the gross margin on each produced solar module would jump from roughly 4% to 23%.
Though the near-term impact of high silicon prices is a point of concern for the expansion of the industry, for long-term investors, Suntech’s commitment to research and development is the strongest point of differentiation in the race to grid parity. Even as revenues surpassed $1.3 billion in FY07, the company continued to dedicate at least 1% of revenues to R&D. Improving conversion efficiency of solar modules is the most essential goal. The conversion efficiency is the percentage of sunlight that is converted to energy. Over the past five years, the conversion efficiency of Suntech’s multicrystalline cells has improved from 14.0% to 14.9%. In the more efficient monocrystalline cells, the conversion has improved from 14.5% to 16.4%. The promising innovation on the horizon is Suntech’s Pluto technology which, in pilot production, has reached industry-leading conversion efficiency of 18% to 19%. A commercial production line using Pluto technology is being rolled out this year.
The R&D spend has also shown promise in combating rising silicon costs. One of the other benefits of the Pluto technology is that it can be applied not only to monocrystalline wafers, but also polycrystalline wafers and lower grades of silicon. The further development of this technology will give the company the flexibility to use a wider range of silicon sources. Suntech has also been able to reduce silicon wafer thickness from 220 microns to 180 microns, allowing the company to use less silicon per wafer.
Thin-film cell development is the company’s other major R&D investment due to the growing demand for thin-film products. Though thin-film cell technology currently holds about half the conversion efficiency of typical cells, the technology near equally cost effective as thin-film cells are more flexible and can cover more area since they are not limited to the large panels. This includes BIPV (building-integrated photovoltaic) products, which are incorporated within the design of a building or rooftop. The company broke into the BIPV space by purchasing MSK, a competitor within the industry and is currently constructing a major thin-film R&D and manufacturing plant in Shanghai, with the plant is expected to reach 50MW of thin-film capacity by the end of 2008.
At $45 per share, Suntech shares seemingly command a hefty valuation at 44x 2007 EPS. However, the multiple is very reasonable given the growth figures. Capacity of 1GW in 2008 is expected to double to 2GW by 2010. Revenues are also expected to grow in the range of 40%-50% over the next two years, which with flat margins would place the PEG at around 1. Though at present the valuation is reasonable, the most tempting reason to buy shares is the massive upside potential if the race for grid parity is indeed successful. For example, shares of First Solar (FSLR) soared from $25 to over $250 in 2007 because the company’s PV technology is presently the closest in the race. As Suntech narrows the gap, long-term investors willing to ride the volatile shares will be rewarded.
Neal Sangani
Disclosures: I own shares of STP. My comments are for educational purposes only.
Monday, April 14, 2008
Friday, November 30, 2007
Video Game Pair Trade: Buy Activision, Short Electronic Arts
The AllStar Portfolio bought Activision (ATVI) this week just before the company raised its FY (Mar) 2008 revenue outlook on strong sales of Guitar Hero III and Call of Duty 4. The stock had sold down to $19 per share since its earnings release Nov. 5th as both the company and video game retailer Gamestop (GME) on Nov 20th set an overly cautious tone for the holiday season, despite both companies handily beating estimates for the past quarter. Though we made a quick 16% this week on the trade following confirmation of strength during the Black Friday weekend, we are holding ATVI for the long-term as the immense sell-through of its key titles will continue to outpace conservative estimates. Moreover, unlike larger, more diversified video game publishers like Electronic Arts (ERTS), the success of hit titles will further boost the company’s margins to lead profits well past still cautious estimates.
We agree with the growing number of analysts that have projected ATVI to surpass its FY outlook of $0.85 EPS (adjusted) and $2.30 billion in revenue. Call of Duty 4: Modern Warfare is also likely to remain one of the top titles this season on the positive reviews by gaming critics. Spiderman 3 has also seen success, one of the company’s licensed titles. Most importantly, there are no longer concerns that ERTS’s Rockband will sour sales of Guitar Hero III: Legends of Rock. Rockband sells at almost twice the price and was released a month later than Guitar Hero III. Additionally, Electronic Arts president John Riccitiello commented, “We won’t be able to put up enough inventory [of Rockband] to meet the demand of this fiscal or calendar year.” Guitar Hero will not even have to compete with Rockband in Europe, as it will not be released until 2008. Rockband is also limited to the PS3 and Xbox 360, missing out on the still robust sales of the Wii console.
In general, video games are insensitive to weaknesses in consumer spending. With those concerns now out of the way, the only concerns left are that the company has peaked with its key games out this year, and will slow next year on tougher comparisons. Two analysts have downgraded the stock: Janco Partners to market perform from accumulate, and Piper Jaffray to neutral from buy. While there no doubt that game publishers need to constantly innovate, we believe the company still has opportunities in FY 2009 on its licensed franchises, including Tony Hawk and James Bond which is more successful in Europe. ATVI also acquired Bizzare Studios a U.K.-based developer that will allow new expansion into the genre of racing games.
Despite our confidence in the video game software cycle, with a slight premium on its expected forward earnings multiple, we are shorting a smaller position in ERTS as an industry hedge on concerns that its own key titles may not live up to expectations. The company recently cut prices on games including NCAA Football, Madden, NBA Live, Nascar, Medal of Honor, Tiger Woods and FIFA ‘08. Also, despite enthusiasm following the companies recent quarter, Deutsche Bank put a sell rating on the stock noting the premium on shares. We share these concerns for a larger developer like ERTS as the company is not as capable of driving top-line acceleration, especially with most of its hit titles not benefitting from the success of the Wii. Though console cycles are longer today, if we see the usual past trend of gaming stocks collapse in the year following a console release, we expect ERTS to be one of the hardest hit.
Neal Sangani
Disclosures: My comments are for educational purposes only.
We agree with the growing number of analysts that have projected ATVI to surpass its FY outlook of $0.85 EPS (adjusted) and $2.30 billion in revenue. Call of Duty 4: Modern Warfare is also likely to remain one of the top titles this season on the positive reviews by gaming critics. Spiderman 3 has also seen success, one of the company’s licensed titles. Most importantly, there are no longer concerns that ERTS’s Rockband will sour sales of Guitar Hero III: Legends of Rock. Rockband sells at almost twice the price and was released a month later than Guitar Hero III. Additionally, Electronic Arts president John Riccitiello commented, “We won’t be able to put up enough inventory [of Rockband] to meet the demand of this fiscal or calendar year.” Guitar Hero will not even have to compete with Rockband in Europe, as it will not be released until 2008. Rockband is also limited to the PS3 and Xbox 360, missing out on the still robust sales of the Wii console.
In general, video games are insensitive to weaknesses in consumer spending. With those concerns now out of the way, the only concerns left are that the company has peaked with its key games out this year, and will slow next year on tougher comparisons. Two analysts have downgraded the stock: Janco Partners to market perform from accumulate, and Piper Jaffray to neutral from buy. While there no doubt that game publishers need to constantly innovate, we believe the company still has opportunities in FY 2009 on its licensed franchises, including Tony Hawk and James Bond which is more successful in Europe. ATVI also acquired Bizzare Studios a U.K.-based developer that will allow new expansion into the genre of racing games.
Despite our confidence in the video game software cycle, with a slight premium on its expected forward earnings multiple, we are shorting a smaller position in ERTS as an industry hedge on concerns that its own key titles may not live up to expectations. The company recently cut prices on games including NCAA Football, Madden, NBA Live, Nascar, Medal of Honor, Tiger Woods and FIFA ‘08. Also, despite enthusiasm following the companies recent quarter, Deutsche Bank put a sell rating on the stock noting the premium on shares. We share these concerns for a larger developer like ERTS as the company is not as capable of driving top-line acceleration, especially with most of its hit titles not benefitting from the success of the Wii. Though console cycles are longer today, if we see the usual past trend of gaming stocks collapse in the year following a console release, we expect ERTS to be one of the hardest hit.
Neal Sangani
Disclosures: My comments are for educational purposes only.
Friday, November 2, 2007
Crocs: Buy Panic
Shares of Crocs (CROX) tumbled 36% today after the company's forecast failed to impress jittery Wall Street investors. This was certainly not a move I was expecting having pitched the stock for the AllStar Portfolio just three weeks ago. Yet, at the same time, the magnitude of the move is by no means surprising. Crocs has always been, and will be for the next few years, a momentum stock. A slight disappointment to the market can easily lead to the reaction we saw today.
First, it is worth mentioning that the stock is now trading at lows not seen since... August. The rally in shares ahead of the results makes the sell-off appear more severe than it would be for the long-run investor. The stock has also still more than doubled this year. However, whether the sell-off is severe or not is irrevelant.
I would encourage long-term growth investors to not waste time worrying about near-term momentum-related market reactions and overreactions. Instead, as always, focus on the fundamental drivers relevant to your thesis. Sell-offs like this may offer the best entry points into excellent growth names or opportunities to double-down. As I mentioned in my newsletter rebuttal following my pitch of Blue Nile (up 110% since): a sharp momentum-related sell-off may be the best thing that could happen to your stock.
So the quesition on to ask on Crocs is whether the sell-off was related to deteriorating fundamentals or momentum. In spite of cautious tone set by the retailers for the holiday season, Crocs is still expecting 35%-40% revenue growth for 2008 ($1.11 billion to $1.16 billion) in-line with my prior expectations. Remember, we are still in November 2007 and most management teams selling to the consumer would be prudent to stay conservative for now. Even under the current guidance, the company is now trading at roughly 18x-19x forward earnings. Yes, there are concerning trends given the rise in inventories and the conservative tone for the rest of 2007; but overall, things don't seem to be bad at all, certainly not enough to erode $2 billion in market capitalization. Demand, the most important metric, still remains strong, though seasonality and infrastructure build has somewhat clouded forward visibility. But what do I know; let's see what the experts on the fundamentals have to say.
While market participants were selling all day today, the analysts did not seem fazed by the numbers. Robert W. Baird analyst Mitch Kummetz reitereated his "outperform" rating on the stock and raised his price target from $80 to $87. Analysts at J.P. Morgan, Thomas Weisel, Piper Jaffray, and Wedbush Morgan, each found that the sell-off provides an attractive entry point for the shares.
And, as I am writing, the Crocs Board just authorized the repurchase of $1 million shares. So now we know what they think of the sell-off as well. Regardless, I believe that those that had the stomach to buy into the panic today made the right move. That is not to say that Crocs has bottomed, but focusing on the fundmentals is almost always a win with volatile momentum stocks. Check a 2-year chart of Hansen Natural (up 60% since my newsletter pitch). This stock got crushed nearly 50% when the momentum guys exited the stock a year ago. It has more than recovered those losses since, even as skeptics decried energy drinks are a fad ready to implode. 18 months from now, I believe Crocs's chart will be almost identical.
Skeptics may have won today's round, but time will tell who wins the game. Stay tuned.
Neal Sangani
Disclosure: I own calls on Crocs. My comments are for educational purposes only and are solely my opinions.
First, it is worth mentioning that the stock is now trading at lows not seen since... August. The rally in shares ahead of the results makes the sell-off appear more severe than it would be for the long-run investor. The stock has also still more than doubled this year. However, whether the sell-off is severe or not is irrevelant.
I would encourage long-term growth investors to not waste time worrying about near-term momentum-related market reactions and overreactions. Instead, as always, focus on the fundamental drivers relevant to your thesis. Sell-offs like this may offer the best entry points into excellent growth names or opportunities to double-down. As I mentioned in my newsletter rebuttal following my pitch of Blue Nile (up 110% since): a sharp momentum-related sell-off may be the best thing that could happen to your stock.
So the quesition on to ask on Crocs is whether the sell-off was related to deteriorating fundamentals or momentum. In spite of cautious tone set by the retailers for the holiday season, Crocs is still expecting 35%-40% revenue growth for 2008 ($1.11 billion to $1.16 billion) in-line with my prior expectations. Remember, we are still in November 2007 and most management teams selling to the consumer would be prudent to stay conservative for now. Even under the current guidance, the company is now trading at roughly 18x-19x forward earnings. Yes, there are concerning trends given the rise in inventories and the conservative tone for the rest of 2007; but overall, things don't seem to be bad at all, certainly not enough to erode $2 billion in market capitalization. Demand, the most important metric, still remains strong, though seasonality and infrastructure build has somewhat clouded forward visibility. But what do I know; let's see what the experts on the fundamentals have to say.
While market participants were selling all day today, the analysts did not seem fazed by the numbers. Robert W. Baird analyst Mitch Kummetz reitereated his "outperform" rating on the stock and raised his price target from $80 to $87. Analysts at J.P. Morgan, Thomas Weisel, Piper Jaffray, and Wedbush Morgan, each found that the sell-off provides an attractive entry point for the shares.
And, as I am writing, the Crocs Board just authorized the repurchase of $1 million shares. So now we know what they think of the sell-off as well. Regardless, I believe that those that had the stomach to buy into the panic today made the right move. That is not to say that Crocs has bottomed, but focusing on the fundmentals is almost always a win with volatile momentum stocks. Check a 2-year chart of Hansen Natural (up 60% since my newsletter pitch). This stock got crushed nearly 50% when the momentum guys exited the stock a year ago. It has more than recovered those losses since, even as skeptics decried energy drinks are a fad ready to implode. 18 months from now, I believe Crocs's chart will be almost identical.
Skeptics may have won today's round, but time will tell who wins the game. Stay tuned.
Neal Sangani
Disclosure: I own calls on Crocs. My comments are for educational purposes only and are solely my opinions.
Saturday, October 13, 2007
Skeptics Will Not Stop Crocs
Pop quiz. In its most recent quarter, a company grows revenue 162% and earnings 205%. Domestic revenues are up 99%, and international revenues are up about 400%. It trades at a 4x forward revenue multiple, and a 27x forward earnings multiple. Its EBIT margin is in excess of 30%. Guess how IAG votes?
Normally, you would have to do some thinking to answer the question. Sit down, actually determine what type of growth rates and margins this company will earn. Determine how fast the size of its market and overall market share will grow. Not an easy task when the growth rates are so high, so you would have to look at relevent metrics of performance, in the case of a retailer: door growth, revenue growth, gross margin expansion, operating margin expansion, market penetration. You would have to put the metrics in perspective given the size of the company, the size of the market, its business strategy, and its competition. How does this company sustain a competitive advantage? Now you have to look at its revenue breakdown: what percentage is coming from what products, what markets, etc. Compare all of this against comparable companies. Hint: Comparable companies doesn't necessarily mean companies that sell the same product.
Before you start crunching numbers, or doing months of industry research as I have, remember that we are in IAG. All of this is unnecessary when you have a growth company. What exactly is a growth company you ask? This is a company where there is a certain level of uncertainty in the future. This is a company with an impressive, but short operating history, which creates senstivity to near-term earnings or projections. And of course, given the strength of its business, this is usually a company at the fearful, dreadful, absolutely and utterly terrifying level known to most as the "52-week high."
Now guess how IAG votes. Pass by an overwhelming majority that shocked even me. 6 vote play. And nearly 100 students on the other side. Though it is tempting for me after losing the battle on Crocs (CROX) to berate the decision of the members, IAG is mostly a young club still learning the ins and outs of the market. I have always been impressed by how quickly the members have been able to analyze the typical "value plays" in the market. It usually doesn't take members long to see the rationale in investing in a company with a strong and long operating history, healthy margins, and low multiples (especially when the multiples are relevant to cash flow). IAG does very well in this arena and I believe it is because of former great PMs teaching the philosophy of value investing.
However, when it comes to growth, IAG usually screws up big. Whether they were ultimately voted pass or play, great companies like Google (GOOG), Wynn Resorts (WYNN), Chipotle Mexican Grill (CMG), Blue Nile (NILE), and now Crocs have had a very difficult time making it into the IAG portfolio, even while one is supposed to resemble a "growth" portfolio.
Why? I asked several IAG alum the same question and we agreed the problem is that IAG members are not conditioned to analyzing these types of companies. They see a stock go up 500% or trading at 50x earnings and they simply wonder, how can this company keep possibly going up. Even if they take the next step and look at the fundamentals of the company, they see triple-digit growth rates, and cannot see how that business can keep growthing at a fast clip.
Then, in come the DCF enthusiasts, whom I have been criticizing for almost a year now for the arrogance and lack of reasoning employed in their projections. The Crocs "DCF" dropped revenue growth from 135% for 2007 to 25% for 2008. Given the numbers stated above, anyone would agree that this is absurd. How do we compensate for the lack of intuition in the model? Let's just plot 25% revenue growth for the next five years so we don't have to analyze the company's expansion strategy. Let's keep EBIT margins constant so we don't have to do any research on how they may improve or decline. Let's pay absolutely no attention to near-term analyst projections.
The DCFs are pretty terrible when it comes to companies like Crocs, but sometimes the relatives don't get any better. Last year, a presentation on Palm (PALM) showed a bar graph with forward earnings multiples on Palm and its competitors. "Research in Motion (RIMM) has a 67x multiple while Palm's is only 14x! Buy buy buy Palm! Sell sell sell RIMM!" The reasoning behind my oppenent's CROX relative wasn't much better. It compared Crocs to companies like NIKE (NKE), Sketchers (SKX), Heely's (HLYS) and the average of the footwear industry. Guess who's multiples are going to be the highest? Sketchers is the only one I would call a comparable, but even that is a stretch given its slow growth expecations. But who cares? If they make shoes then we're close in enough.
After spending so much time on errant DCFs, the quality of understanding of the company and industry usually suffers. This was very evident to me last night having experience looking at consumer stocks. Insider selling? Book value? Competition in a market that has only penetrated 2%. The entire reasoning was very flawed. Yes, Sketchers and Nike can make a Crocs-like shoe. But at this stage, that would only expand the growth of the market of those types of shoes rather than slow Crocs's growth. Think of Crocs as Red Bull energy drink. Coke (KO) and Pepsi (PEP) were very eager to enter the energy drink market that Red Bull dominated. But that only made the energy drink market that much bigger. Red Bull lost sizeable market share, but the market grew by such an astonishing rate that it isn't even material anymore.
To be fair for my part of the presentation, in a solid relative, you should have more than one other company to base your judgments. I only included one: Under Armour (UA) because its is without a doubt the most and only comparable to Crocs. There are similar market capitalization, growth estimates, revenue. Moreover, both companies have a similar business strategy in the retail market: trying to expand their business through a hit product. The only difference is that Crocs has much better margins and a much lower earnings multiple. I tried to reconcile those differences, but eventually proposed the market was underestimating Crocs's potential while full appreciating Under Armour. Either way, Crocs is certainly not trading at an unreasonable level. The PEG multiple on CROX is 1.2 trailing (60x/50%), with a forward PEG about .77 (27x/35%).
I believe Crocs is at a very attractive risk/reward level and will continue to perform in measures that a beyond the scope of reasoning currently in IAG. Our presentation on Blue Nile was met with harsh criticism and the stock went up 170% on the fruition of our thesis. Crocs is 5x the size of Blue Nile, but there is still plenty of upside left. It is now my top pick, and I believe I will once again have pitched the best performing stock of the school year. At the same time, I will try to continue to teach members how to invest in growth stocks:
1. Determine on the fundamental growth drivers of the company at hand.
2. Make judgements based on the information (metrics) you have available.
3. Put the market valuation (multiples) in the context of what you learn in 1 & 2.
4. Make a thesis.
5. Reevaluate your thesis as more information becomes available.
Watch Crocs and stay tuned.
Neal Sangani
Disclosures: I own calls on CROX. My comments are for educational purposes only and are solely my opinions.
Normally, you would have to do some thinking to answer the question. Sit down, actually determine what type of growth rates and margins this company will earn. Determine how fast the size of its market and overall market share will grow. Not an easy task when the growth rates are so high, so you would have to look at relevent metrics of performance, in the case of a retailer: door growth, revenue growth, gross margin expansion, operating margin expansion, market penetration. You would have to put the metrics in perspective given the size of the company, the size of the market, its business strategy, and its competition. How does this company sustain a competitive advantage? Now you have to look at its revenue breakdown: what percentage is coming from what products, what markets, etc. Compare all of this against comparable companies. Hint: Comparable companies doesn't necessarily mean companies that sell the same product.
Before you start crunching numbers, or doing months of industry research as I have, remember that we are in IAG. All of this is unnecessary when you have a growth company. What exactly is a growth company you ask? This is a company where there is a certain level of uncertainty in the future. This is a company with an impressive, but short operating history, which creates senstivity to near-term earnings or projections. And of course, given the strength of its business, this is usually a company at the fearful, dreadful, absolutely and utterly terrifying level known to most as the "52-week high."
Now guess how IAG votes. Pass by an overwhelming majority that shocked even me. 6 vote play. And nearly 100 students on the other side. Though it is tempting for me after losing the battle on Crocs (CROX) to berate the decision of the members, IAG is mostly a young club still learning the ins and outs of the market. I have always been impressed by how quickly the members have been able to analyze the typical "value plays" in the market. It usually doesn't take members long to see the rationale in investing in a company with a strong and long operating history, healthy margins, and low multiples (especially when the multiples are relevant to cash flow). IAG does very well in this arena and I believe it is because of former great PMs teaching the philosophy of value investing.
However, when it comes to growth, IAG usually screws up big. Whether they were ultimately voted pass or play, great companies like Google (GOOG), Wynn Resorts (WYNN), Chipotle Mexican Grill (CMG), Blue Nile (NILE), and now Crocs have had a very difficult time making it into the IAG portfolio, even while one is supposed to resemble a "growth" portfolio.
Why? I asked several IAG alum the same question and we agreed the problem is that IAG members are not conditioned to analyzing these types of companies. They see a stock go up 500% or trading at 50x earnings and they simply wonder, how can this company keep possibly going up. Even if they take the next step and look at the fundamentals of the company, they see triple-digit growth rates, and cannot see how that business can keep growthing at a fast clip.
Then, in come the DCF enthusiasts, whom I have been criticizing for almost a year now for the arrogance and lack of reasoning employed in their projections. The Crocs "DCF" dropped revenue growth from 135% for 2007 to 25% for 2008. Given the numbers stated above, anyone would agree that this is absurd. How do we compensate for the lack of intuition in the model? Let's just plot 25% revenue growth for the next five years so we don't have to analyze the company's expansion strategy. Let's keep EBIT margins constant so we don't have to do any research on how they may improve or decline. Let's pay absolutely no attention to near-term analyst projections.
The DCFs are pretty terrible when it comes to companies like Crocs, but sometimes the relatives don't get any better. Last year, a presentation on Palm (PALM) showed a bar graph with forward earnings multiples on Palm and its competitors. "Research in Motion (RIMM) has a 67x multiple while Palm's is only 14x! Buy buy buy Palm! Sell sell sell RIMM!" The reasoning behind my oppenent's CROX relative wasn't much better. It compared Crocs to companies like NIKE (NKE), Sketchers (SKX), Heely's (HLYS) and the average of the footwear industry. Guess who's multiples are going to be the highest? Sketchers is the only one I would call a comparable, but even that is a stretch given its slow growth expecations. But who cares? If they make shoes then we're close in enough.
After spending so much time on errant DCFs, the quality of understanding of the company and industry usually suffers. This was very evident to me last night having experience looking at consumer stocks. Insider selling? Book value? Competition in a market that has only penetrated 2%. The entire reasoning was very flawed. Yes, Sketchers and Nike can make a Crocs-like shoe. But at this stage, that would only expand the growth of the market of those types of shoes rather than slow Crocs's growth. Think of Crocs as Red Bull energy drink. Coke (KO) and Pepsi (PEP) were very eager to enter the energy drink market that Red Bull dominated. But that only made the energy drink market that much bigger. Red Bull lost sizeable market share, but the market grew by such an astonishing rate that it isn't even material anymore.
To be fair for my part of the presentation, in a solid relative, you should have more than one other company to base your judgments. I only included one: Under Armour (UA) because its is without a doubt the most and only comparable to Crocs. There are similar market capitalization, growth estimates, revenue. Moreover, both companies have a similar business strategy in the retail market: trying to expand their business through a hit product. The only difference is that Crocs has much better margins and a much lower earnings multiple. I tried to reconcile those differences, but eventually proposed the market was underestimating Crocs's potential while full appreciating Under Armour. Either way, Crocs is certainly not trading at an unreasonable level. The PEG multiple on CROX is 1.2 trailing (60x/50%), with a forward PEG about .77 (27x/35%).
I believe Crocs is at a very attractive risk/reward level and will continue to perform in measures that a beyond the scope of reasoning currently in IAG. Our presentation on Blue Nile was met with harsh criticism and the stock went up 170% on the fruition of our thesis. Crocs is 5x the size of Blue Nile, but there is still plenty of upside left. It is now my top pick, and I believe I will once again have pitched the best performing stock of the school year. At the same time, I will try to continue to teach members how to invest in growth stocks:
1. Determine on the fundamental growth drivers of the company at hand.
2. Make judgements based on the information (metrics) you have available.
3. Put the market valuation (multiples) in the context of what you learn in 1 & 2.
4. Make a thesis.
5. Reevaluate your thesis as more information becomes available.
Watch Crocs and stay tuned.
Neal Sangani
Disclosures: I own calls on CROX. My comments are for educational purposes only and are solely my opinions.
Wednesday, October 10, 2007
VMW's Valuation Disconnect With EMC
"The market can stay irrational longer than you can stay solvent."
True, but you would think that market's would start becoming a little smarter after the major collapses of the dot-com bubble. I of course was still in high school; but no business education is complete without learning about some great collapses. 3Com (COMS) spun off Palm (PALM) with an IPO that generated a significant amount of hype. While 3Com held a major stake in the company, Palm shares were driven so high that they accounted for more than 3Com's entire market value. In other words, the market valuation of Palm implied 3Com's core business (ex-Palm) was worth less than zero. Obviously, we know exactly where Palm went when the bubble popped.
The typical corporate finance interview question for this case is usually: "Does this violate the expectations of market efficiency?" One might be tempted to answer yes, but the answer is no. Right after an IPO it is nearly impossible to short shares. Intelligent market participants could not profit from the absurdity of the situation.
Fast forward about 7 years to VMWare (VMW) and EMC (EMC). Again we have a much hyped spinoff that has risen from an IPO price of $29 to $107 in about one month. At current prices, if VMW represents approximately 75% of EMC's market capitalization. If VMW were to outperform EMC by another 30%, EMC's core business would have an implied value of zero. Again, it is very difficult to short shares given the small float of VMW shares (EMC holds 86%). However, options are traded and intelligent investors can buy puts or short calls.
A number of sources including Seekingalpha and Barron's have pointed out the disconnect and I am looking for opportunities to make some fast money. There are only two possible explanations here: EMC is grossly undervalued, or VMW is grossly overvalued. If we were to take on a simple hedge, we would short .75 shares of VMW for every 1 share of EMC we bought, and then short a competitor of EMC for the remaining .25.
The AllStar Portfolio has taken a large bet that VMW is about to take a significant fall as the market assumes a state of rationality. The fact that the company is at a market cap of $42 billion at 116x forward earnings is not even core to our thesis. Obviously, we have thus far, and expect to continue to take heavy losses as VMW shares are on a tear. However, the valuation disconnect is too enticing to ignore. As a mock portfolio, we do not face the risk of margin calls that would occur in the real world with a trade like this. Yet, we also have a much shorter time horizon for this trade to pay off. VMW reports earnings on Oct. 24. More importantly, the lockup period will expire 180 days after the IPO. Stay tuned.
Neal Sangani
Disclosures: I purchased puts on VMW today. My comments are for educational purposes only.
True, but you would think that market's would start becoming a little smarter after the major collapses of the dot-com bubble. I of course was still in high school; but no business education is complete without learning about some great collapses. 3Com (COMS) spun off Palm (PALM) with an IPO that generated a significant amount of hype. While 3Com held a major stake in the company, Palm shares were driven so high that they accounted for more than 3Com's entire market value. In other words, the market valuation of Palm implied 3Com's core business (ex-Palm) was worth less than zero. Obviously, we know exactly where Palm went when the bubble popped.
The typical corporate finance interview question for this case is usually: "Does this violate the expectations of market efficiency?" One might be tempted to answer yes, but the answer is no. Right after an IPO it is nearly impossible to short shares. Intelligent market participants could not profit from the absurdity of the situation.
Fast forward about 7 years to VMWare (VMW) and EMC (EMC). Again we have a much hyped spinoff that has risen from an IPO price of $29 to $107 in about one month. At current prices, if VMW represents approximately 75% of EMC's market capitalization. If VMW were to outperform EMC by another 30%, EMC's core business would have an implied value of zero. Again, it is very difficult to short shares given the small float of VMW shares (EMC holds 86%). However, options are traded and intelligent investors can buy puts or short calls.
A number of sources including Seekingalpha and Barron's have pointed out the disconnect and I am looking for opportunities to make some fast money. There are only two possible explanations here: EMC is grossly undervalued, or VMW is grossly overvalued. If we were to take on a simple hedge, we would short .75 shares of VMW for every 1 share of EMC we bought, and then short a competitor of EMC for the remaining .25.
The AllStar Portfolio has taken a large bet that VMW is about to take a significant fall as the market assumes a state of rationality. The fact that the company is at a market cap of $42 billion at 116x forward earnings is not even core to our thesis. Obviously, we have thus far, and expect to continue to take heavy losses as VMW shares are on a tear. However, the valuation disconnect is too enticing to ignore. As a mock portfolio, we do not face the risk of margin calls that would occur in the real world with a trade like this. Yet, we also have a much shorter time horizon for this trade to pay off. VMW reports earnings on Oct. 24. More importantly, the lockup period will expire 180 days after the IPO. Stay tuned.
Neal Sangani
Disclosures: I purchased puts on VMW today. My comments are for educational purposes only.
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