Over the past week, we published a pair of meaty short ideas that got the market's attention. We also published a few interesting long ideas, including ones that may be popping up on value investor screens far and wide. For this week's Editor's Notes, I review the highlights on both sides of the aisle and share some notes on where investors might go next in their research.
We published 19 short ideas over the past week. As ever, Tesla (TSLA) was prominent with 4. We skip those and find a lot of meaty short ideas. Here are five.
This is among the meatiest short ideas we've published in a while. Rota Fortunae - whose hits have included Hudson (HDSN) and Link Motion (LKM) (nee NQ Mobile), counterbalanced by a miss on K12 (LRN) to date - started with the headline that Farmland Partners (FPI) has failed to cover its dividend over time and has negative cash flow. Real estate investment trusts (REITs) have tax benefits and different fundamentals that make net income less useful, which leads companies to report funds from operations (essentially a cash flow pre-dividend number) and adjusted FFO. Rota Fortunae points out that capex is not included in RF's measurement of historic negative cash flow, which is just a reminder that it pays to look closely at the actual numbers for REITs, rather than just what management reports.
More critically are the well-supported questions raised about the legitimacy of revenues based on loans to related parties. RF's argument is that these revenues don't jive with industry conditions and that the company has a fair deal of related-parties loans that could, in fact, be what's driving revenue growth, which would be a problem for the actual fundamentals of the company.
The company has disputed the claims made in the article, though not yet in great detail. The stock has recovered a little but is about 30% off as of this writing from where it was before the piece came out.
Sentiment Check: Most contentious short ideas that allege management malfeasance, especially on a dividend name, draw a lot of flak from readers. So it may be a testament to the work done here that the comments were mostly approving of the article. Part of it may be that articles on Seeking Alpha have been fairly mixed about the company for some time.
Where to look next: Several authors have analyzed the preferred (FPI.PB) as a potential fall-back play. It may be worth assessing what a legitimate value and path is for the company if everything on the books is accurate, and then assigning some probability to the fact that they might not be, to see what the risk/reward is either long or short. There should be some key events to assess whether the company can recover from this or whether the analysis is accurate about the threat of insolvency.
Reality About To Set In For Simulations Plus Investors; Up To 70% Decline Possible by Monocle Accounting Research
It was a big week for a couple stocks that had short coverage on Seeking Alpha, as Simulations Plus (SLP) also sold off handily the day after an article came out. In that case, it seemed to be more of a reaction to the earnings report released after the article came out, though I couldn't find anything special on the call except the questions were not live on the call, and that it confirmed the fundamental argument Monocle had about shifting business model.
Monocle's article had three main points. The first was the fundamental one - SLP is doing more and more consulting, which is not recurring revenue. Their main business is a high gross margin, recurring revenue software one, the sort of business that earns very high multiples. Consulting is lower margin and project-based; so, in theory, less stable and less worthy of a premium. In addition, Monocle argues that growth in the core software business is slowing.
The second was that the company has been paying for research from Taglich Brothers. And the third was that there were discrepancies in new CEO Shawn O'Connor's bio in various places.
I find the first point fairly compelling. What is the right way to value a growth company and how do you factor in the lower margins and the slowing growth? Is SLP's model shifting meaningfully? If so, what does that mean?
The paid coverage is also concerning. I understand that some firms may want investors to be aware of them so as to increase liquidity in the name, but it's still the sort of direction that is not great. The O'Connor stuff doesn't strike me as particularly relevant except as a supplement to this concern.
So despite the wider wrapping, this mostly feels like a valuation short, and a worthwhile discussion for all that.
Sentiment Check - Comments were also fairly positive here towards the author. A few people disagreed, including long-time bull Brendan Rose (whose work I am a big fan of), but not a lot of knee-jerk reactions.
The comment stream pointed out a poor response on the earnings call to a question about PKPlus, which was a component of Monocle's argument.
Where to go next - Rose's work is a good place to start on the deeper business outlook of SLP and the bullish perspective. Buddy Lyons's piece from two years ago is also helpful in this regard. What is the real upside here and what is priced in?
Winter Is Coming For DaVita by Ethan Watkins
Watkins is newer to the website, and his two articles so far have been about DaVita (DVA) as a short. DaVita is well known as a Berkshire Hathaway (BRK.B), but also as a company that has raised questions, be that from John Oliver or from SIRF Report. Watkins' addition to the story is to focus on referendums that might force DVA to institute higher staffing levels and a price cap. There are also issues with American Kidney Fund's (AKF) patient grant program and Davita.
DVA has had a lot thrown at it. The work that has been done on it, including these additions, is impressive. It's possible there's a parallel to something like Valeant (VRX), where lots of questions were raised and then something pushed it to a breaking point and the short thesis played out. But I would be skeptical about relying too much on regulatory changes in the current environment, and it's hard for me to anticipate when that tide might turn if it hasn't already.
Editor's Note July 16th 2018 - an earlier version of this article said the AKF funds DVA, when it in fact funds kidney dialysis patients directly. The comment at the end of the first paragraph of this section has been revised.
Sentiment Check - DaVita comments are colored by two things - the value of dialysis to the patients and the need for them to continue treatment, and the Berkshire position. We haven't had as much coverage as I anticipated on the stock, though there has been a good mix of bearish and bullish over the past year.
Where to go next - The company trades at 12x 2017 free cash flow. How safe is that cash flow if reimbursements change? How likely are those reimbursements to change? Angry Uptick's long idea from a year ago is the most complete recent bullish piece on the stock.
This is a very basic piece about Americold Realty Trust (COLD), a great-tickered name. The author starts with the pending lock-up expiration, which may be meaningful in the short term but is unlikely to be a long-term issue.
But the author claims to have significant experience in the space, and the analysis speaks of someone who knows where to look. There's not a full case here, but the guts are that the company's market position is not as strong as it seems and it is unlikely to sustain the revenue growth it has touted (6.5% according to Bobfoxing's first article). The company is trading at 43.5x EV/AFFO or Core FFO, from what I can tell, so it's a company that needs a lot of growth. If the author is close to right that growth will be tough (and we see 5% revenue growth year over year in Q1 and 3.6% revenue growth in 2017), then the valuation becomes hard to justify.
Sentiment Check - Not a lot out there yet. Few comments and we have one bullish piece and a couple neutral ones besides Bobfoxing's work.
Where to go next - I would want to understand the FFO calculations and the model and see if there is any weirdness in the numbers and any potential for outsized growth. That would be the inversion of this thesis, and if it doesn't hold up, I would be concerned.
Two other short ideas I found interesting but don't have a chance to fully cover:
- DexCom And The Missing Connection Between Stock Price And Fundamental Business by Daniel Schönberger
- tronc Margins And Stock Price Likely Headed Lower by Overdue Diligence (new author)
We published 277 long ideas in the past week (busy week!). I didn't find anything that caught my eye among the most read articles, so I'm going into a few more obscure cases.
Argan (AGX) shows up on a lot of value screens these days. It has fantastic revenue growth over the past five years (42% CAGR) and a 13x TTM PE. Not bad, right? Of course, this is where you should realize that something is going wrong.
The issue, I think, is the company is a construction company whose business is reliant on new contract wins. This is the opposite of a recurring revenue software business. Margins are unclear and the backlog is not certain until delivered upon.
Eliot Murray argues that the backlog is bigger than the market is pricing in, based on a recent deal announcement. Assume historic margins and add cash on the balance sheet (over half the current market cap!) and AGX is almost a can't lose play.
Sentiment check - Henrik Alex, one of the most reliable devil's advocates on Seeking Alpha, popped up to point out that the margins are not a sure thing and that the stock is still in a trader's range rather than an investment. Most of the other comments are positive on the company and the article, but that's a worthy counter perspective.
Where to go next - Murray's example on the modeling is helpful and valuable. I would say working on your own modeling and understanding what margins might be, then modeling around the range of margins would be the best bet.
Select Energy: Q2 Shaping Up To Be A Blowout by Mr. Bert
Mr. Bert has been following Select Energy (WTTR) closely on Seeking Alpha. The company, per Bert, has a unique model as a publicly traded water manager for fracking companies. It has only been on the market for 15 months, and this is the first upcycle that it is experiencing in the oil sector. With few analysts covering the stock, this is room for the enterprising investor to get out in front of the market, and Bert argues that Q2 is going to be a winner precisely because the market hasn't put the pieces together yet.
Sentiment check - A lot of bullishness around this - I reviewed each of Mr. Bert's articles' comment streams and while there are over a thousand comments, so I can't speak definitively, it looks like there are very few negative comments.
Where to look next - I get worried about crowds. The analysis is convincing and I'd like to study it for myself closer, but is there something the crowd is missing or is this a legit case where people are getting ahead of a transition?
Entravision (EVC) is a name I know well, as I owned shares in the company from 2014 until earlier this year. It's a name that is getting increasing coverage (5 articles this year after nothing in 2017), and I think it's because it screens well right now. Foley's piece does a good job acknowledging the limitations of the screening approach. He started with a screen but addressed the company's recent issues. It has a 4% yield, which may be attractive in the current climate.
I remark on it because I finally closed my long position this year. The spectrum thesis - the company sold a bunch of spectrum it wasn't otherwise using - played out with not much permanency, as the core business is really struggling. Its content provider for the TV networks, Univision, does not seem to be in a good place. And the company is increasingly moving into digital advertising, which is one of my least favorite businesses on the market.
Sentiment check - While articles lean bullish, there are a good number of commenters who have background on the company and are skeptical.
Where to go next - Lord Baltimore has been the axe on the stock and was one of the earliest to the spectrum story (full disclosure - my position predated the spectrum story and was mostly a demographic idea). His work and his recent comment show that there could be something still here.
American Superconductor: Where To Now? by Elle Investments
Similar to EVC and its spectrum story, American Superconductor (AMSC) has hit a bit of a snag after an anticipated settlement with a Chinese ex-client came in for less than expected (the recent Cristiano Ronaldo signing for Juventus (OTCPK:JVTSF) is also a case of buy the rumor sell the news so far). The $58M settlement announcement has led to the stock dropping off about 30%.
Elle Investments reminds that the investment thesis is also about the company's actual wind and grid business. The company is about to have cash almost equal to its market cap but also burned essentially a quarter of its market cap worth last year. So it does stand to reason that while the settlement might have bought more time for AMSC if it came in higher, the investment thesis has to be about whether it can ever get to profitability.
Sentiment Check - This is the first article on the stock in a year. It has not performed well historically - an understatement - and commenters appear to have lost some patience with the company.
Where to go next - How long until profitability vs. how much cash does AMSC have? If that equation is reasonable, there may be something more to look at with the company.
That's it for this week's edition. Anything catch your eye? Let me know below, I'd love to see what you're finding in this hot market (in all senses!).
Disclosure: I am/we are long BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.