Seth Klarman is a value investor and also a Portfolio Manager of The Baupost Group, an investment partnership. The Baupost Group, which was founded in 1982, currently manages $7 billion and has been averaging returns of about 20% annually since its creation. Before the establishment of Baupost, he has worked for Michael Price and Max Heine of the Mutual Shares Fund, which is now a part of Franklin Templeton Investments.
Klarman usually has a large array of investments which range from the rather conventional value stocks to some more uncommon investments such as liquidations, distressed debt and foreign bonds or equities. Furthermore, Klarman is not perturbed at all by the notion of standing on the sidelines and holding cash if investment opportunities do not abound. Despite such non-traditional tactics, Klarman consistently achieves high returns. Klarman is quite a conservative investor, often holding important amounts of cash within investment portfolios, even in excess of 50% of the total amount. Very often, investors seem to focus on the one easy number "return" while ignoring the risks that have been incurred to generate such number.
When investing, I consider myself a business analyst and not a macroeconomic analyst, which means that I usually invest with a businessperson's perspective. I consider the business in holistic terms and thus examine all qualitative and quantitative aspects of its financial position, management and purchasing price. I believe that Klarman also follows this view. Therefore, I find it interesting to research Klarman's holdings to understand which of his choices could be researched further.
Bp PlcOil & Gas Producers (BP)
BP plc, based in London, England, is among the world's largest energy companies. It offers energy for heat and light, fuel for transportation, retail services as well as petrochemical products. The company operates within three segments: Refining and Marketing, Exploration and Production as well as Other Businesses and Corporate.
I am positive that Klarman researched the fact that the firm is on track as regards its program of $30 billion asset divestitures, which is bound to help it master its liquidity concerns. I think BP will most likely have enough funds to cover all spill-related liabilities. The firm is expecting to finish its asset sales during the first quarter of the year 2012 and is planning for an additional $15 billion for divestments before the year 2014. Those include mainly pipeline, non-core upstream assets and gas plants.
A further element contemplated by Klarman's analysis is that the company is still focused on some upstream activities. It is my belief that its new strategy of active portfolio management, including more exploration activity with more precautionary actions and repositioning of refining and marketing shall generate value for stockholders. As from this year and until 2014, the firm has stated that it expects to bring 17 more material upstream projects online. Cash margins per barrel on such projects are currently projected to double the average of the firm's portfolio, which will in turn enhance cash flow. BP has also stated that half of this cash flow improvement will be expended on growth capex, whereas the balance is bound to be allocated to stockholder returns (share buybacks and/or dividends) as well as cutting down debt to a lower half of its target range of 10-20%.
The current net profit margin of BP is 6.65, which is higher than its 2010 margin of -1.23. I prefer companies that have increased profit margins as compared other years. It is essential to know the reason why that happened. Its current return on equity is 24.90. It is higher than the 20% standard I look for in companies I invest in. It is also higher than its 2010 average return on equity of -3.78.
In terms of income and revenue growth, BP has a 3-year average revenue growth of 1.73 and a 3-year net income average growth of 6.70. Its current revenue year over year growth is 25.10, lower than its 2010 revenue growth of 26.63. I do not like it when current revenue growth is lower than the one of the past year. It shows that business is decelerating for a certain reason.
In terms of valuation ratios, BP is trading at a Price/Book of 1.3x, a Price/Sales of 0.4x and a Price/Cash Flow of 6.7x in comparison to its industry averages of 1.8x Book, 0.7x Sales and 6.1x Cash Flow. It is vital to analyze the company's current valuation and check how it is trading in relation to its peer group.
With regard to valuation, I deem that the smooth economic recovery after the Gulf of Mexico issue and the firm's focus on its upstream activity are downright favorable factors. BP's managers remain positive on its growth profile and are looking forward to its recovery, not to mention its consolidation with a view to reducing operational risk or other oil spill related tasks. I believe that the firm's new tactics of higher exploration activity, active portfolio management as well as refining and marketing repositioning are bound to generate value for stockholders. However, BP is facing important risks from a fall in natural gas processing margins, including decline in domestic gas and oil drilling as well as end market demand, which may wind up lowering the firm's growth rate.
Excepting an important and prolonged fall in gas and oil prices, the firm is likely to create enough operating cash flows to pay up capital investment and dividends. Free cash flow as well as the firm's asset divestments should enable BP to honor its Macondo obligations and either pay up or seek a refinancing of near-term debt maturities.
ViaSat Inc. Technology Hardware & Equipment (VSAT)
ViaSat Inc. is engaged in designing, producing and marketing advanced digital satellite telecommunications as well as other signal processing and networking equipment. The firm develops and markets its technology by means of strategic alliances for the emerging markets, including mobile applications, private corporate networks, alternative carrier access as well as broadband Internet/Intranet access through satellite in connection with multiple servers.
As regards quarterly results, some of ViaSat's third quarter highlights include:
- Following quarter end, the firm announced the novel ExedeSM of ViaSat residential services at the International Consumer Electronics Show, which will offer satellite broadband services with the possibility of downloading data at speeds of up to 12 Mbps, whose prices will be starting at $50 per month;
- Following quarter end, it launched its commercial service, started increasing its broadband service subscribers and turned on its service by means of 75% of its gateways and service beams, thus keeping all actions on schedule to finish the full commissioning of its broadband network.
- The company has received over $44 million as regards follow-on orders in order to furnish equipment as well as broadband services to the U.S. military with a view to supporting several airborne operations.
"Our third quarter financial results were generally in line with our expectations," Mark Dankberg, the firm's CEO and chairman, has stated. "New orders, revenue and backlog are growing compared to last fiscal year, but costs associated with the ViaSat-1 launch delay weigh on earnings. Now, with the successful launch of the groundbreaking ViaSat-1 satellite in October and the subsequent introduction of our new high-speed ExedeSM broadband service early in 2012, we can really grow our broadband subscriber base for the first time since the WildBlue acquisition two years ago."
The current net profit margin of VSAT is 4.50, which is lower than its 2010 margin of 4.53. I do not like it when companies see lower profit margins than past ones, yet it could be a reason to examine why that occurred. Its current return on equity is 4.53. It is lower than the 20% standard I look for in companies I invest in. It is also lower than its 2010 average return on equity of 5.14.
In terms of income and revenue growth, VSAT has a 3-year average revenue growth of 11.76 and a 3-year net income average growth of 2.52. Its current revenue year over year growth is 16.59, higher than its 2010 revenue growth of 9.54. That revenue rose from last year demonstrates that the business is now performing well. The current net income year over year growth is 15.99, higher than its 2010 average of -18.77. I consider it favorable it when net income growth is higher than the past.
In terms of valuation ratios, VSAT is trading at a Price/Book of 2.2x, a Price/Sales of 2.4x and a Price/Cash Flow of 18.3x in comparison to its industry averages of 2.2x Book, 1.6x Sales and 11.8x Cash Flow.
Hewlett Packard Technology Hardware & Equipment (HPQ)
Hewlett-Packard , which was established in 1939 and is based in Palo Alto, California, is one of the leading global providers of technologies, products, solutions, software and services to consumers, small-sized and medium-sized businesses as well as large enterprises, which includes those that are active in the educational and public sector. The firm offers personal computing as well as various other access devices, printing-related and imaging-related services and products, enterprise IT infrastructure (like server technology and enterprise storage), not to mention software optimizing business IT investments as well as multivendor customer services, including technology maintenance and support, integration and consulting as well as outsourcing services. The firm serves over one billion customers in over 170 countries throughout six continents. In addition, since it launched the HP consumer support forum in November of the year 2008, HP has enjoyed more than 17 million page views, with about 28,000 registered users, nearly 42,000 posts and over 1.25 million searches.
Why did Klarman purchase this stock? Having a portfolio spanning personal computers (PCS), printers, software, services and IT infrastructure, HP is one of the world's largest IT firms, with revenues that amount to $127.2 billion in the fiscal year of 2011. The firm now leads the market in the computing field, since it has a 25.3% market share, which places HP ahead of Acer and Dell. Additionally, the company maintains its leadership position in the servers segment, considering that it enjoys a 29.7% market share. Furthermore, HP is the largest printer seller and has allocated more sales resources to find incremental opportunities in enterprises and several other markets. All of this has resulted in quite a diverse and worldwide customer base. The firm's wide product portfolio is thus aligned with market growth areas, meaning that HP's sales efforts have consistently proved to be considerably effective. Due to its strong product portfolio, its leading market position as well as its lean cost structure, I believe that HP will keep growing both its top line and bottom line.
Furthermore, I am convinced that Klarman considered investing in HPQ because, with a view to broadening both its geographic presence as well as its lower manufacturing costs, the firm has decided to open an advanced manufacturing facility within Chongqing to improve its capacity to satisfy the quick-growing Chinese market and to profit from West China's economic development. The firm seems quite well positioned to profit from the growing small-sized and medium-sized businesses. Additionally, HP has also been rationalizing its core portfolio through the strengthening of its main businesses and the relocation of certain production towards low-cost regions, including the sending of its mono-laser business to the city of Shanghai.
The current net profit margin of HPQ is 5.56, which is lower than its 2010 margin of 6.96. I do not like it when companies achieve lower profit margins than the past. Among others, it could prove to be a reason to analyze why that took place. Its current return on equity is 17.89. It is lower than the 20% standard I look for in companies I invest in. It is also lower than its 2010 average return on equity of 21.64.
In terms of income and revenue growth, HPQ has a 3-year average revenue growth of 2.44 and a 3-year net income average growth of -5.30. Its current revenue year over year growth is 0.96, lower than its 2010 revenue growth of 10.02. I am not in favor of having current revenue growth be lower than the one in the past year. Usually, it goes to show that its business seems to be slowing down for some reason. The current net income year over year growth is -19.26, lower than its 2010 average of 14.37. I do not prefer companies with a current net income growth lower than the one in their past year. I generally target companies that manage to increase both profits and revenues.
In terms of valuation ratios, HPQ is trading at a Price/Book of 1.2x, a Price/Sales of 0.4x and a Price/Cash Flow of 4.7x in comparison to its industry averages of 5.3x Book, 2.0x Sales and 10.6x Cash Flow. It is vital to analyze the company's current valuation and check how it is trading in relation to its peer group.
As for valuation, the firm's shares are now trading at 6.5x P/E 2012 EPS of $4.02, which is below the peer group and the S&P 500. The firm's current trailing 12-month earnings multiple for now is 4.5x, in comparison to 13.0x for the S&P 500. During the last five years, HP's shares have been traded within 4.5x to 18.2x trailing 12-month earnings. Its stock is also being traded at a discount to the industry's average, as based on forward earnings estimates. Its current P/E is now at a 61.8% discount in comparison to the industry's average for 2012.
The firm's financial health has been deteriorating within recent years. HP's $31 billion debt load for now is manageable, however, mostly on account of the yearly free cash-flow generation of over $8 billion and nearly $8 billion in cash as well as cash equivalents on hand.
Theravance IncPharmaceuticals & Biotechnology (THRX)
Based in South San Francisco, California, the firm Theravance is a biopharmaceutical company that discovers, develops and markets small-molecule medicines. Theravance thus produces medicine for bacterial infections, respiratory diseases and central nervous system related pain.
The firm's only commercialized drug, namely Vibativ (telavancin), is an injectable antibiotic now commercialized by its partner Astellas Pharma within the US. The drug has been developed for treating complicated skin and skin structure infections that are usually caused by gram-positive bacteria, which include resistant pathogens like the methicillinresistant staphylococcus aureus. The company is receiving royalties from Astellas that range from the upper teens to the upper twenties in accordance with the drug's sales volume. Vibativ is also being commercialized in Canada for complicated skin and skin structure infections and is currently being reviewed within the EU for such a disease.
Besides from complicated skin and skin structure infections, the drug has also been studied as regards nosocomial pneumonia (NP) or hospital-acquired pneumonia (HAP). As such, the drug has been approved within the EU for NP during September of 2011, which marks the very first approval for the treatment of NP, linked to high mortality rates. Furthermore, the drug is approved for sale in Switzerland and Norway for NP. Launching plans are currently under review. In America, nonetheless, the firm has received a complete response letter regarding NP indications.
I believe that Klarman invested in THRX because the firm is actively collaborating with Glaxo as regards the Relovair, MABA and LAMA/LABA ('719/VI) programmes. The Relovair program has the largest potential in the firm's pipeline, which is aiming to substitute Advair, one of Glaxo's blockbuster drugs. Relovair is a corticosteroid (inhaled once a day) and a LABA combination medicine currently being developed for treating COPD and asthma. Relovair's phase III program has now enrolled all 11,000 targeted patients.
A second reason supporting Klarman's pick is that the royalties on Vibativ's sales could provide the firm with some of its much-needed funds. This drug has been approved for treating adult patients with complicated skin and skin structure infections that are caused by gram-positive bacteria. The drug, developed together with Astellas Pharma, is commercialized in Canada and the US. It is being commercialized and sold by the Astellas firm, while in the meantime Theravance is receiving royalties that range from upper teens to upper twenties in accordance with the sales volume. Besides complicated skin and skin structure infections, Vibativ is also under study for NP. Although this antibiotic has not yet been approved for treating NP in Canada or the US, such drug was approved for the same purpose within EU in September of 2011. As such, this is none other than the very first approval for treating NP, which is a condition linked to high mortality rates. Vibativ's approval for NP within EU is now expected to stabilize even further the firm's cash flow.
The current net profit margin of THRX is -470.56, which is lower than its 2010 margin of -346.21. I am not positive about companies with lower profit margins than previous ones. Of course, it could also be a reason to seek to understand why that came to happen. There is no information on the firm's return on equity.
In terms of income and revenue growth, THRX has a 3-year average revenue growth of 2.00. There is no information on its 3-year net income average growth. Its current revenue year over year growth is 1.19, higher than its 2010 revenue growth of -0.62. Revenue rose from last year, so the business is most likely performing well.
In terms of valuation ratios, THRX is trading at a Price/Book of -18.6x, a Price/Sales of 62.9x and a Price/Cash Flow of -17.4x in comparison to its industry averages of 4.9x Book, 5.4x Sales and 27.0x Cash Flow. It is very important to analyze the company's current valuation and check how it is trading in relation to its peer group.
In connection with the firm's valuation, it is my belief that earnings reports are now a non-event for the firm, since the investor's focus will be placed on the pipeline programs in collaboration with GlaxoSmithKline. Even though the firm's pipeline is indeed impressive, I reckon that its potential lies within the collaboration regarding Relovair. The drug, upon approval, will be well positioned to substitute Glaxo's blockbuster medicine Advair. In consideration of mixed results arising from the studies, I remain prudent about Relovair's possibility to win a first-round approval. It is possible that the FDA may ask both companies for more information regarding the asthma indication. I deem that the year 2012 will be important for the firm on account of considerable clinical catalysts. Therefore, I prefer to stand on the sidelines and thus wait to watch how the year unfolds for this firm. Theravance's enterprise value by the end of the fourth quarter of the year 2011 stood at $17.82 per share, meaning that the stock is now trading at a premium of 1.57% to such EV.
Microsoft Corp Software & Computer Services (MSFT)
Microsoft Corporation, headquartered in Redmond, Washington, is among the today's largest broad-based technology providers worldwide. Even though software is its most significant revenue source, the firm's offerings also encompass hardware as well as online services. Furthermore, the company provides support services as consultation, certification and training of system developers and integrators. Microsoft posts revenue in five segments, all of which target specific user groups.
Why did Klarman decide to invest in MSFT? He found that Microsoft enjoys a position of dominance within the PC market, since its operating systems are being employed by the majority of PCs around the world. The firm decided to launch its operating system called Windows 7 during 2009, as it saw a quick adoption of both desktop and mobile platforms. Initially, attach rates managed to accelerate and are likely to keep going forward in a steady manner. The adoption of Windows 7 within emerging markets is also expected to be even stronger, as growth in these developed markets is bound to be rather tempered by the current impulse to transfer computing operations to the so-called "cloud". In addition, both the iPad as well as other tablets are now starting to take up a share of the consumers' PC spending. However, Gartner, a provider of PC growth expectations during 2011, believes that PC shipments (not including mobile) will be growing by 3.8% during 2011, which is down from the previous 9.3% growth projection. The growth expectations of 10.9% during 2012 have also been lowered from the 13.6% that was forecasted earlier. Such important fall from previous projections is due to a negative trending in the U.S. and Western Europe by reason of excess inventories, cannibalization by tablets and economic turmoil.
In addition, I deem that Klarman was attracted by the fact that introducing the operating system Windows Phone 7 has proved a turning point in the firm's mobile tactics. This operating system is now an absolute breakaway from the company's earlier OS. Unlike previous versions, the firm has even designed the hardware running the operating system, thus eradicating multiple issues linked to user experience and performance. Other versions of the WinMo had been offered as a license, which had caused some compatibility issues detrimental to user experience. Due to the considerably short life cycles of cell phones as well as their inherently consumer nature, it has proved quite easy for consumers to change to other alternatives, which has thus eroded Microsoft's market share. Simultaneously, Research in Motion's Blackberry as well as Apple's iPhone, which both employ proprietary hardware, have kept growing strongly and oftentimes at the firm's expense. The entering into an agreement with Nokia, an agreement whereby Nokia phones are to be based on the Windows Phone 7 operating system, has brought about an enormous opportunity for Microsoft. Nokia has been dominating the emerging markets, mostly in Asia, but the firm has been losing ground as regards shares in the very recent past. Microsoft's superior operating system might thus allow Nokia to re-conquer its market share. Furthermore, Mango, its latest iteration, may also assist Nokia (as well as Microsoft) in recovering part of its share in the developed markets, where Research In Motion, Apple as well as Android-based phones have started to gain important traction. The firm currently stands to gain inasmuch as the firm Nokia is to incur all hardware costs, which will leave Microsoft to enjoy higher margins that are typical of software businesses. Simultaneously, licensing will be the result of a very close relationship (instead of other licensing of the operating system to all and miscellaneous agent), so that compatibility problems may be minimized. In recent times, Microsoft has also introduced the Windows Phone 7.5 (called "Mango"), which will build on such platform.
The current net profit margin of MSFT is 33.10, which is higher than its 2010 margin of 30.02. I choose companies that have better profit margins as compared to previous years and believe that it is necessary to ascertain why that occurred. Its current return on equity is 44.84. It is higher than the 20% standard I look for in companies I invest in. It is also higher than its 2010 average return on equity of 43.76.
In terms of income and revenue growth, MSFT has a 3-year average revenue growth of 5.00 and a 3-year net income average growth of 9.40. Its current revenue year over year growth is 11.94, higher than its 2010 revenue growth of 6.93. The fact that revenue could be increased in comparison to last year is a perfect example of a situation where business is performing well. The current net income year over year growth is 23.40, lower than its 2010 average of 28.77. I am not pleased when current net income growth is lower than in the past year. Most of the time, I look for companies that have managed to increase both their profits and revenues.
In terms of valuation ratios, MSFT is trading at a Price/Book of 4.3x, a Price/Sales of 3.9x and a Price/Cash Flow of 9.6x in comparison to its industry averages of 4.1x Book, 4.1x Sales and 11.0x Cash Flow. It is essential to analyze the company's current valuation and check how it is trading in relation to its peer group.
With regard to valuation, the firm's shares are now trading at 10.8X its trailing twelve months earnings in comparison to 43.6X of the peer group as well as 13.9X for the S&P 500. Such important discount as regards the peer group is due to the investors' concerns on Microsoft's share losses for mobile computing platforms. Nonetheless, although this is a near-term negative, I believe that Windows 8 is due to gain quite some traction next year. During the past five years, shares have been trading between 8.6X and 23.2X trailing twelve-month earnings. As such, it is now trading around the low end of its historical range. Microsoft is also trading at a considerable discount on account of forward estimates for the fiscal years of 2012 and 2013. Therefore, Microsoft's shares are quite likely to begin trading up, although the expected earnings growth during the next five years of 9.6% will be trailing the 19.5% growth that is expected of the peer group.
The firm enjoys a solid balance sheet, with about $52 billion in cash as well as its equivalents, and nearly $12 billion in debt. It is my belief that the company will generate over $20 billion in free cash flow a year, which will enable it to service comfortably its debt obligations while still investing in the expansion of its business.
Disclosure: I am long MSFT.