Road Less Invested

Long/short equity, deep value, value, special situations
Road Less Invested
Long/short equity, deep value, value, special situations
Contributor since: 2012
Company: NA
Mark, I agree with your end assessment that there is significant upside here (and have similar outlook for 2016), but I don't think the math behind your target price is correct.
If I am following you correctly, $95 million x 6 = $570 million enterprise value. Less $401 million of net debt is about $170 million equity value. With 22 million shares outstanding you get to ~$7.65 price target.
However, it would appear that you need to take into account the convertible preferred equity ($45 million), as well as there are an additional 3.4 million shares of "rollover" shares that are convertible to common stock on a 1 to 1 basis (shown on financials as non-controlling interest but search "rollover" in Q). In addition, there are numerous restricted and performance based shares that have been issued to management (~2.7mm shares currently issued) that ultimately have some claim on company.
I think when you account for these items you get to a price that is much closer to, if not below, the current stock price (at least based upon 6x 2016 EBITDA).
1) I would not confuse growth %'s with actual amounts. Imports can't grow 15% per year. It is not sustainable (simply put they overtake the economy). Growth at mid single digits does not seem unreasonable (if not slower than the past)
2) You are making the argument that "there is no demand for anything" and decoupling is essentially a myth. This might be true, but you actually do not show any data to support the domestic side of the equation you refer to. Presenting the case domestically would strengthen your case. Data you present does speak to why China's growth is not recovering to past years but does not speak to state of the US economy. Maybe china is no longer competitive? Maybe U.S. economy is worse than reported. Who knows.
"Buy... with both hands"
How do I do this? Do I need two computers and two mouses that allow me to simultaneously purchase with each of my hands?
This is one of my favorite comments of all time.
LJ - I am not advocating long or short as this is the first time I have seen anything on this company.
But you cannot judge a stock by its price alone. A $2 stock might be the same value as a $4 stock... It all depends on how many shares are outstanding. ARTX stock price is $3.71 and its mkt cap is ~$72mm according to Yahoo. Alcatel-Lucent has a stock price of $3.92... its market cap is ~$11 billion. Huge difference.
Happy investing and good luck.
Stephen, thanks for the article. You are right... There is a huge untapped market. But the reason that it is frustratingly slow entry abroad is because of barriers to entry. These are the same barriers that make Wabtec's presence in U.S. so dominating... Huge installed base of customers (for record, 50% market share is only on braking products though they have a lead position in many others too).
Much of the international share they have gotten has come from acquisitions of companies in the markets with installed customer base.
One thing to look out for here is what is organic vs. acquisition growth. If you look at their 10k's going back to 2006 and look at their Acquisition Footnotes, you can see that organic growth under current management has been between 4-5% on a CAGR basis (since 2005) and just 1% since 2008. They have cut R&D costs as a % of sales by nearly 2 pts. With their most recent acquisition announced, they have have announced 23 acquisitions since beginning of 2006 with run rate revenues equal to 40% of their 2014 revenue guidance. The average multiple they paid on revenues was just 1.2x. They are trading over 3.0x 2013 revenues and 2.7x 2014 revenues... For a collection of businesses relatively recently acquired for 1.2x.
I would be very wary of a manufacturing business trading at 3x LTM revenues and 25+x earnings that only grows 4-5% per year absent M&A.
Good business though. Good luck.
Thank you Alex for the article. Even assuming your earnings profile is correct, your midpoint valuation still reflects nearly 29x LTM EPS in 2019 - and that's on basic share count so maybe 30+ times diluted. That's a big number 5 years out and would reflect some pretty heady growth going forward from that point.
Good luck on your investment and happy investing!
I fail to see the investment significance of this article.
The issue is that with declining population there is less active workers to support government programs and debt. Today, majority of Japan's debt is priced at essentially 0%, but it still makes a very high % of government outlays. If the market balks and rates go up, interest costs will overwhelm the budget. This will force a devaluing of the Yen to meet debt obligations. There is basically no conceivable way for Japan to get its debt balance back in line, so if the market ever stops believing the deflation story it will happen quickly. Boom. Don't thank me, thank Kyle Bass for his passionate dedication to this cause.
I do not know the % that Groove represents, but the company does consider it their signature pant.
Management has said the affected product represents 17% of all bottoms available, but I believe its a much higher % of both pant and total revenues.
Michael, thanks for the comments. FYI, we are not short at this point. Given recent price action, someone must think that LULU will make positive announcements regarding product shortages soon, maybe with Q1 results. This could result in a price spike / short squeeze. As a result, were on the sidelines.
However, over the long-term I believe the story deteriorates.
One issue just glancing at the balance sheet is that the company does not record deferred taxes on its unrealized gains as part of net assets (they do have a small amount of deferred taxes related to pension expense). With over $469mm of unrealized gains, an investor would have a tax liability of over $70 million or ~ $18 per share if the company was liquidated (also assuming he only pays long-term capital gains tax of 15%). Combined with the private companies / lack of liquidity of investments, this could at least partially explain the discount (not that the taxes need to be paid today).
Anyways, interesting article and definitely worth exploring further. I think the next analysis needs to be looking at the company's history of where values were marked on unlisted investments vs. where they were sold. A solid track record would definitely help the case.
It is funny how every time an author writes an article that questions LULU's valuation out comes the the take it on faith crowd chanting "two words: international expansion," as if that solves everything.
We admire LULU's meticulous business model / practices... enough to know they have been the key to success. So just because they are beginning to more aggressively expand into these mysterious international markets does not mean suddenly they no longer will have to go through the painstakingly slow process they have always gone through: open up show rooms (btw, they have had a show room in Hong Kong for two!!! years now and are just now opening a store), build relationships with local fitness instructors, build brand awareness, train employees, pick the ideal real estate locations...
In other words, international expansion does not increase the pace, it just potentially sustains it for longer... with increased costs of working in far flung places. But as the base gets bigger the growth comes down because it does not scale that easy. It really is that simple. In fact, what should really worry people is the fact that comps for the 4th quarter, even if higher than guidance, will likely be lower than mid-teens. There is only so much in sales you can push through a 2,800 sf store.
Another key issue not being discussed: a year ago they were saying they would not focus on international markets because they had so much opportunity in the US. Literally 9 months later the story changed. Why?
Regardless, we are neither long or short. We recommend conservative, long-term investors avoid. We will be watching Q4 for:
1) Guidance on SS sales for 2013 - Single digit guidance is really bearish at current prices
2) How many stores are they actually going to open and where - if it stays less than 40 range then growth is not scaling
3) Margin guidance - our guess is op margin leverage is gone as a result of increased costs with expansion. If that is indeed the case that is another bearish sign.
Putting the cash issue and everthing else aside, the dcf terminal value is fundamentally flawed. The tv = roughly 3x his terminal earnings. A simple no growth assumption and 8% discount rate would result in 12x multiple and much different result.
Let's all move on. It's busted analysis.
Right or wrong, I have no opinion or position, the logic of this article is faulty. The entire crux of the argument is based isolating the bold text but ignoring the text that comes immediately after it:
Herbalife's future share repurchases, if any, may take place from time to time [at management's discretion] based on market conditions, and shares may be purchased in open-market, privately negotiated or other transactions. (Emphasis added)
Author makes argument that repurchases are "at management's discretion", but then ignores that they may be through "privately negotiated or other transactions." Privately negotiated or other transactions could refer to a lot of things but certainly includes ASRs which can often be structured to result in repurchases through what normally would be a blackout period. Of course, the plan would have to have been put in place ahead of time and be binding as noted.
Again, the authors accusations may or may not be correct, but this particular argument does not seem to benefit the case.
Matt's explanation is right on. Jameskuwe, note that BRK has gone up ~12% since this article was originally published. It is now trading closer to 1.3x as opposed to what was slightly below 1.2x book.
Dolby does not make vast majority of products using their technology, they just license its use to other. In other words, most competitors understand the technology and many of their customers have their own competing technologies. So as soon as the patents expire, it is challenging for Dolby to charge for it. Customers definitely recognize the Dolby name and Dolby has tried the "Intel Inside" approach to marketing to the customer (despite they do not sell to the end customer). Dolby even tests products to verify that they meet their standards. That said, I believe companies could just label their products Dolby compatible and would not have to pay Dolby for it.
Again, these are just my understanding. I am not a technology expert.
David, thanks for the article. I agree with Max 100%. When looking at Dolby, I must admit I don't know what their future revenue profile looks like. That is why I am on the sidelines. If someone had more insight on this issue, then they could potentially make a lot of money here.
David, a few suggestions on your analysis:
1) the major one is that you do not address the patent cliff and how revenues will evolve with a transition away from optical disk and PC to mobile and TV. TV seems to be coming along but mobile is unclear. Will margins remain at similar rates with new revenue streams etc.
2) Regards to your return on capital calculations, their ROIC is actually much higher than what you are calculating. Let me explain. The company has significant excess cash on its balance sheet that is not earning a meaningful return. If they paid that cash out as a dividend or repurchased shares, you would see their equity capital go down, but earnings of company would not change much. I think if you back out impacts of cash, you will see ROIC closer to 80%. This is not surprising given most of revenues and profits come from licensing technology which would have been 100% expensed as R&D in the past.
3) Small point. GAAP earnings do not determine what taxes you pay, your IRS tax returns do. There can be significant timing and permanent differences between GAAP and IRS income.
Thanks again for the article and analysis. Good luck!
Curious, how did you come upon this article now?
There basic plan is two fold: (1) to try to roll Dolby Digital users to Dolby Digital Plus which has a later expiration date and (2) push their latest technologies into mobile and other new arenas.
They have had some success moving licenses from Dolby Digital to Dolby Digital Plus, most notably Blue Ray is DD+ and latest agreement with MSFT is DD+ as well. However, optical disk including Blue Ray is in decline, and it appears that PCs maybe facing same issue (that, and contract with MSFT actually produces less revenues than it did previously under old Windows 7 contract). So it has been two steps forward, one step backwards in some sense on this front, but there has been progress albeit slow.
On mobile front they have also made some progress, but it is not what they would like. I think the issue they are facing on mobile side is that the rates or what they earn are a lot lower so they are not making up for the decline elsewhere. The trick is can you get someone to pay for something they get for free (i.e. streaming video content). I believe they may get there, but it is far from certain what the end result will be.
Also, note my instablog which I believe shows that the company has at least made some progress on DD+ front, or cynically speaking pays attention to SA. This was a follow up to this article:
Great article. I totally agree with your conclusions regarding predictions. It is impossible to make any concrete conclusions over what is likely to happen in the next 12 months. Investors should stick to places where they can have a high degree of confidence. Coca Cola being the prime example. Predicting the earnings of KO 10 years from now is impossible, however, we can say with a fairly high degree of confidence that earnings will likely be higher than they are today. That is a really powerful statement that many people fail to fully appreciate, because it really limits your downside risk.
Aqua - I agree, which is my point about interest rates which I believe is driving much of the discount in insurance stocks. I believe that will normalize over a longer period of time, say five years.
Thank you. We appreciate the kind words.
Thanks Kvanhoften - we appreciate the comments. We too are interested to see how the ivivva line develops. There is a lot going on here!
Thanks Rohitchulani. I agree with Garrat re shorting. There is not enough capital or time in the world to short this stock. A good quarter could send it flying.
Thanks for all your comments. Very good points. Much appreciate the thoughtful responses.
Very much agreed. What I wanted to show is that you did not have to detect the fraud to know there was a problem. Thanks for the post!
That is the bull argument, and clearly the strategy of the company. But mobile is much more competitive space with no clear winner. The real point is they are not disclosing how much revenue is coming from various technologies so it is tough to know what the cliff even looks like. Maybe there is no revenue cliff in 2017, but how do we know?
Also, if they were being successful upgrading people to their newer technologies, why does their revenues still "principally" come from the original technology from 20+ years ago. We like Dolby, but out of principle we do not invest in companies we do not understand.