In this article I will provide an update on the "Poised to Triple Portfolio", including our take on which ones are still poised to be acquired or triple.
For over 8 years, Pipeline Data has helped fund managers to outperform the market with our quarterly reads on leading technology companies. Since 2009, we've been providing selected investment ideas to SeekingAlpha in order to showcase Pipeline Data's capabilities.
Let's start by reviewing our past picks (hat tip to our intern Matt). all data as of April 1. Detailed commentary and updates will follow. You can also find links to all of our initiation pieces at the end of this article.
Poised to Triple Performance
|Ticker||Initial Price||Peak Price||Peak Return||Current Price||Current / Final ROI||Current Classification|
|RNWK||16.23||19.83||22%||7.71||-20%||20% Stop *|
|ZHNE||2.01||3.24||61%||0.92||-20%||20% Stop *|
|CERP||4.92||5.30||8%||0.02||-20%||20% Stop *|
|OTCPK:ATRN||3.26||6.15||89%||0.00||-20%||20% Stop *|
|ALVR||1.16||1.34||16%||0.36||-20%||20% Stop *|
|RMKR||1.04||1.37||32%||0.45||-20%||20% Stop *|
* Our picks have the potential for great gains, but also great losses. Selling losers early is one of the keys to maximizing profits. Thus, we employ a 20% loss-limit (from our initiation price) in our portfolio.
A few things stand out:
- The Bad News: 20% of our picks drop more than 20%
Some will even go bankrupt. That may sound like a lot of losses, but the other 78% of our picks have gone up an average of 77%. You can avoid big losses by employing a 20% loss limit, which we use in our performance tracking and highly recommend (see the Stocks To Triple Instruction Manual for details).
- At their peaks, our picks average a 100% gain
Of course, nobody can attain peak returns consistently. However, this statistic indicates that our picks provide ample room for trading errors. Using our investment "instruction manual", you would attain an average profit of 52%. Without it, the average gain drops to 27%. The takeaway is simple -- read the instruction manual!
- Over 33% of our picks have tripled or been acquired
We're most proud of the latter. Our long-time readers know that our picks are "real companies". This stat gives new readers the same level of confidence. The "secret" is our research method. We employ industry experts (often at a considerable cost) to confirm the attractiveness of our investment candidates before we recommend them to readers. Not surprisingly, large corporations often use these experts for advice on strategic planning and M&A.
- Take note of our "Current Classification" column
It provides our current rating and links to key articles regarding when to take profits. My profile provides all the information you need to track our ratings on an ongoing basis. It's a must-read if you want to maximize gains and avoid heavy losses (which is always the risk when seeking triples).
- Our Latest Picks Have Risen Nearly 50%
The chart below depicts our latest picks. As you can see, RMKR was a major disappointment and triggered our 20% loss limit. The rest have picked up the slack, leading to an average gain of 49%. Our highlight to date has been HIMX, which rose nearly 60% last month after we released an analysis showing irrefutable evidence that the company will likely power Google Glass.
Poised to Triple Portfolio
|Ticker||Initial Price||Peak Price||Peak Return||Current Price||Current ROI||Current Classification|
Excluding RMKR, which reached our loss limit, this is our current official portfolio. We believe that each of these picks remain poised to triple (or be acquired). Most fall within our Three-Stage classification system. Stocks with a "Wait Time" classification should be approached cautiously until upgraded back up to "Gold Mine" status. HIMX, our sole "Great Find" is still riding its first major wave of investor interest. We will be monitoring its progress closely.
As of April 1, we are most bullish on FB and QADA. At present, we feel that their current share prices represent exceptional value.
In Part II of this article, we'll discuss these stocks in greater depth.
In Part I of this article we reviewed the stocks in our "Poised to Triple Portfolio". We will now discuss the latest thinking on a couple of our top picks.
At present, two of our favorite picks are Facebook and QAD Software . We believe their current share prices represent exceptional value and the timing seems right. Both companies have been underperforming the market of late. Also, both are trading well off of their respective 52-week highs. In other words, investor sentiment is low or indifferent -- and sentiment is well-known to be a contrary indicator.
Facebook: Monetization Will Send The Shares To $50
Back in October, amid similarly negative investor sentiment, we stated that Facebook would find a way to successfully monetize its mobile traffic. A few months later, the company reported better than expected Q4 results, including exceptional mobile revenue growth. The news sent the stock to a new 6-month high (and nearly double its September lows).
The shares remain well above those lows (and our initiation price of $18.03), but have recently retreated from 32 to the mid-20s. We view this as an opportune entry point. Bears will argue that traffic and new user growth have flattened out. Both are true. However, as valuation arguments, these points are overshadowed by the fact that FB has barely begun monetizing its massive user base.
Over time, FB will unveil a plethora of new capabilities, even as cashes in on its more established features. As a result, its revenue per user will continue its steady ascent (see chart below). Indeed, we expect that growth in revenue per user will far outpace any degradation in user growth and/or traffic.
Consider this -- just $1 of profitability per user per month would represent a current P/E of 5. At that level of profitability, a P/E of 25 would necessitate a quintupling from current levels. Bears should consider the risk/reward involved with attempting to gain 50% on a short that could just as easily rise 400%, especially when their case is misguidedly based on user and user-growth statistics.
Again, our math assumes just one dollar of profit per user. As you can see in the table below, revenue per monthly active user (MAU) has steadily risen and stood at $1.56 as of December 31, 2012. Operating margins in the quarter approached 50% (about 42-cents per MAU). With FB's enviable operating leverage, the path to $1 in net income per MAU is not difficult to envision. Of equal importance, few would argue that FB's user count or traffic will decline by over 90% in the coming years. However, that's what it would take to keep earnings in check under this scenario.
|Quarter||MAU (000)||Revs ($000)||Revs/MAU||MAU Growth||Rev Growth|
|Source: Facebook and Pipeline Data, LLC estimates|
It's more likely that Facebook will continue to advance its lock-in and monetization strategy. For example, over the past few months, the company has positioned itself to become more of a direct competitor to Google's (NASDAQ:GOOG) search business. Each company has its strengths and weaknesses, but the match-up has the feel of a legitimate fight. We would give the clear nod to GOOG, but not without ceding some valuable market share in the process.
From a valuation perspective, GOOG has an enterprise value (NYSE:EV) of $220B. FB's EV is less than a quarter of that ($50B). At 50% of GOOG's EV, FB will be valued at over $50 per share, nearly a triple from our initiation price of $18.03. It won't happen overnight, but a couple of years from now we expect Wall Street analysts to be projecting earnings of close to $2.00 per share. Give that a P/E of 25 (it's currently trading at 33x next year's estimate) and the stock will be $50.
QAD: Value Stock Has The Potential To Triple
We initiated coverage on QADA last month. In that piece, we stated that its shares are poised to rise 50%. In reality, the shares could triple for reasons we'll outline below. Before we do, we would note that recent news flow has been positive for QADA's prospects. The latest data regarding auto sales and California real estate have both been bullish. This, in turn, is bullish for QADA's business (which is largely tied to the automotive sector) and the value of QADA's company-owned land and buildings (which sit on an oceanside cliff in Santa Barbara).
In addition to recent trends in U.S. manufacturing and real estate, we performed an analysis of QADA's recurring revenue stream and operating structure. Starting with its recurring revenue stream, a few things stand out:
1. Deferred revenue rebounded sharply in fiscal 2013. As you can see in the chart below, deferred revenue growth is a leading indicator of recurring revenue growth. Thus, investors can bank on stronger recurring revenue growth in the coming year.
|FY Ended Jan||2009||2010||2011||2012||2013|
|Maintenance and other||132,354||129,658||130,104||137,659||138,563|
|Total Recurring Revenue||135,861||133,667||135,877||147,446||153,401|
2. The quality of QADA's deferred revenue has also improved. In fiscal 2012, over 5% represented services and R&D, which are low-margin sources of deferred revenue. In fiscal 2013, that number dipped below 3%, while deferred revenue from maintenance (+3%), subscriptions (+49%), and licenses (+283) all grew at a favorable pace.
3. QADA's total recurring revenue balance now stands at $153 million. In other words, the company's enterprise value is about equal to one year's worth of recurring revenue. Its entire market cap is just 1.6 times maintenance. This is a remarkably low ratio, historically reserved for unprofitable, small, and/or volatile software companies like Astea . QADA is none of these things. In fact, even companies that are going through hard times, like Progress Software (NASDAQ:PRGS), command multiples in excess of 3 as long as they are somewhat stable and profitable.
|Symbol||Name||Market Cap||Maintenance Multiple|
In M&A situations, the typical maintenance multiple has been between 4 and 6 (and often higher), as you can see below.
|Symbol||Name||Buyout Price||Maintenance Multiple|
The reason for this is simple. Older enterprise software companies generally have large installed bases of customers, 90%+ of which typically renew their maintenance contracts year after year. That maintenance revenue usually carries gross margins in excess of 75% and require little in the way of operating expenditure. However, rather than let that profitability drop to the bottom line, most public software companies tend to use it to fund R&D projects. Many (if not most) have a growth-company mentality, but should be acting more like cash cows.
Oracle (NASDAQ:ORCL) astutely caught on to this about 10 years ago and started acquiring such companies, beginning with PeopleSoft in 2004. By cutting R&D and SG&A, we estimate that ORCL (and other such acquirers) have been able to increase the operating margins of its targets by 20-40 percentage points. At the low-end of that range, QADA's operating profits would increase five-fold.
Thus, we can envision how shares of QADA could triple utilizing two different methodologies.
1. If QADA were to be acquired at the midpoint of the typical M&A maintenance multiple, the shares would triple. The typical multiple (as stated above) has been 4-6. The midpoint of that range is 5. QADA is currently trading with a multiple of 1.6. A multiple of 5 would represent more than three times its current valuation.
2. Assessing the impact of ORCL's past acquisitions on its operating margins, we estimate that ORCL typically cuts its acquisitions' operating expenses by upwards of 50%. If QADA cut its operating expenses by just 20%, its operating profits would triple. Assuming that its valuation multiple remained stable, the stock would also triple by default.
Keep in mind, 20% is a fraction of the cuts that often get enacted by acquirers. However, in this case, it would be enough to make shares of QADA triple. Of course, the company would have to actually cut expenses or be acquired to unlock this potential. We believe that one of these scenarios will eventually play out.
In the meantime, the company has been buying back shares while offering a solid 2.4% dividend. Both provide a nice floor under the shares, giving QADA one of the most attractive risk/reward ratios we have encountered. Accordingly, QADA remains one of our top picks.
Appendix: Initiation Pieces