Adding Verizon (NYSE:VZ)

Six months ago, I threatened to switch to AT&T if  Verizon did not offer me lower rates. The customer service representative politely told me to kick rocks. When the customer service representative would not budge, I pulled the manager card. When the manager didn’t budge I resigned myself to expensive cell phone bills and hung up. I should have invested immediately. That is serious pricing power.

I am adding a position in Verizon Wireless (NYSE:VZ). There has been a lot of publicity about Berkshire Hathaway’s recent stake. I am honestly a bit ashamed to drag along after Buffett and Paulson. I was confident that I could find a better investment in the space, and Bezeq came pretty close. Ultimately, my telecom investment was about safety. VZ’s numbers are fantastic and reassuringly consistent. Cell phones today are as necessary to the average Joe as water or electricity. This is essentially a utility stock, which pays a dividend of 4.26% currently, and which consistently generates a high free cash flow yield of over 7%. VZ’s gross margin hovers around 50%, with an operating margin that stays in the high teens. The current Price/Free Cash Flow multiple is 8.02, well below it’s main rival AT&T, which is trading at a P/FCF of 14.55.

By altering its capital structure, Verizon takes on more debt at historically low rates, and sheds itself of a significant drain to dividends. Assuming that Verizon can continue to generate strong Operating Cash Flow, this act should increase Free Cash Flow Return on Invested Capital from a historical range of 8-11% to over 15%! If Verizon stays true to its history shareholders will see dividend hikes in the future. This is a classic value investor play.

I also looked hard at Vodafone (NASDAQ:VOD), but opted for the proven track record at Verizon. I think VOD has fantastic potential in the emerging markets, but I am worried about regulation in Europe. VOD also has a spottier track record of returning cash to shareholders. Lately, management has been quite generous with dividends, but I wonder if they can keep it up. I may invest in VOD in the future, but prefer to keep my options open for now. Price/Free Cash Flow appears low at 5.26, but whether management will invest or distribute cash wisely is another question altogether. Historically management hasn’t used free cash flow effectively.

My other prospect was Bezeq, the Israeli Telecommunications Company (TLV:BEZQ). The firm has declining sales volume in a fleshed out market. On the positive side, they pay a very attractive 7.9 % dividend after foreign residence tax, with a payout ratio of 100%. Bezeq appears to have a headlock on the local communications market (cable, internet, and cell phones) despite government-mandated market reforms. P/FCF here is also attractive at 6.55. What scares me away from Bezeq is the possibility of currency fluctuations. The whole point of a Telecom investment to me was to find a safe place to park some cash. VOD could work because of its international diversification. Verizon works because I live in the U.S.

It also helps that Verizon and AT&T represent a duopoly. Some investors have been skittish to invest because of the debt load. I would ask them to try going a day without their cell phone. Better yet, try to negotiate a discount.

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Portfolio Update: ANGI Short Back On, Closing out Long HSBC Position

I have decided to close out my long HSBC position after the firm posted terrible earnings this morning. It is becoming clear that the firm’s new compensation structure is not effective. Additionally, I feel that my positions in Banco Santander and J.P. Morgan represent better long-term holdings. I am not unhappy with a relatively flat return over the holding period (3% since an initial position in 2011), but there are certainly lessons to be learned.

Initial Thesis

The initial mid-2011 HSBC thesis revolved around the bank possessing stronger margins and higher ROE than Banco Santander, while at the same time being undervalued to peers. Price/Tangible Book Value was particularly attractive at 1.04. The dividend also paid over 4% at the time. London had a strong reputation as a center for international finance, and HSBC was well-respected within the space. I liked several European banks at the time, and thought investing in both HSBC and Banco Santander would spread the risk of increased regulation between countries. I also liked HSBC for its Asia focus in particular.

What Went Wrong

Regulations imposed on British banks have altered the landscape a bit. To workaround the current compensation rules, HSBC has misaligned employee compensation using stock options. Asian earnings have not grown enough to offset other geographic trends. No catalyst exists on the horizon the drive the stock higher.

The Takeaway 

I failed to evenly split my investment between Banco Santander and HSBC. Had I done so, the gain from SAN would have outweighed the lag from HSBC. As it stands, I put about 2X the investment into HSBC, because I felt that it was a less volatile play. I was right that it was less volatile, but it also under-performed the sector, and the compensation changes have hurt rather than helped. Thankfully, Banco Santander looks to be performing well. As punishment for a bad trading idea, I will be placing the money from the HSBC sale into a passive ETF for the long-term.

ANGI Short Back On as of April 30th

Short interest in ANGI has decreased, while ANGI’s results have been as terrible as always. The song remains the same:

  • Bad Business Model
  • Accruals-driven Earnings/CFO
  • Insiders Selling Out
  • “Independent” Board Members Leasing Buildings to ANGI
  • Massive Deferred Revenue
  • Growing Accounts Receivables w/Inadequate ADA
  • Large Amount of Prepaid Expenses
  • Significant Short Interest
  • Several customer-related lawsuits
  • Marketing Spend per Customer Acquisition > Lifetime Revenue Per Customer
  • Negative Book Value

I am confident this business will fail, it is only a matter of time and will be shorting for as long as I can do so without having to borrow at high rates.

Synta Pharmaceuticals (NASDAQ:SNTA) – A Heavily Discounted Biotech Investment

Synta Pharmaceuticals (NASDAQ:SNTA) is a yet-to-succeed firm in the Biotech space with a Phase 3 candidate drug designed to treat cancer. Synta’s lead anti-cancer drug candidate, Ganetespib, has been studied in over 800 patients in more than 25 clinical trials. In preclinical models, Ganetespib inhibits a molecular chaperone called Hsp90, essential to the function of many of the most fundamental drivers of cancer cell growth and proliferation. Ganetespib is currently in Phase IIb/III FDA trials.Ganetespib utilizes a proprietary HDC delivery platform to deliver drugs to cancer cells. The company bills it as “Targeting the molecular chaperon in cancer”.

 

Image

Synta represents a unique opportunity because of its history. It’s initial HSP90 candidate failed in Phase III trials, burning shareholders and forcing the company to reformulate. Shareholders have seriously discounted the company’s potential in relation to other Biotech firms. The recent departure of a lackluster CEO prompted a recent sell-off as well.

Timeline of Drug Phases
Timeline of Company-Sponsored Drug Phases

 

 

Competing Hsp90 Candidates

Pharmaceutical Company Anti-Cancer Therapy Last Known Therapy Status
Astex Pharmaceuticals (ASTX) AT13387 Phase 2
Biogen (BIIB) BIIB021, BIIB028 Suspended
Debiopharm/Curis (CRIS) Debio 0932 Phase 1/2
Esanex SNX-5422 Restarted
Exelixis (EXEL) XL888 Suspended
Infinity Pharmaceuticals (INFI) Retaspimycin HCI Terminated after failed trial studying NSCLC
Kyowa Hakko Kirin (OTC:KYKOF) KW2478 Phase 1/2
Myrexis (OTCPK:MYRX) MPC-3100, MPC-0767 Suspended
Novartis/Vernalis (NVS) AUY922 Phase 2
Samus Therapeutics PU-H71 Phase 1
Synta Pharmaceuticals Ganetespib Phase 2b/3

Major Fully-Funded StudiesIndustry professionals are feeling confident about Synta’s drug as well. Multiple health-care organizations are funding their own studies of Ganetespib Most recently the EU, has decided to fund a $100M trial. In total, Ganetespib has the largest clinical study group ever assembled in the space (over 700 patients). Clearly the firm does not want to take chances with another Phase III failure. The amount of partnered organizations signals a clear interest from academia.

Partnered Institutions
Partnered Institutions

Interestingly, the heaps of data being provided are scaring investors away, leading them to the wrong conclusions about the drug and it’s efficacy. Seeking a blockbuster wonder-drug, investors are hesitant to invest in a firm which has accepted the reality that Ganetespib will do best when paired with other drugs. This is only an incrementally better cancer treatment than what is currently on the market, because of this the market is substantially discounting the sales potential. The stock has approximately a 40% short interest, with no clear thesis I have been able to discern other than momentum.

Short Interest
Short Interest

On the flip-side, insiders have been major purchasers, accumulating over $40M worth of shares in the past 6 months.

Note the miniscule sales to purchases
Note the miniscule sales (invisible here due to tiny size) to purchases

Here are some conservative sales estimates. We assume that Ganetespib only succeeds with androcarcinoma patients, a tiny subsect of the total addressable cancer market.

2013 2014 2015 2016 2017 2018
Ganetsib Sales 0.00 0.00 55.00 75.00 495.00 650.25
    Growth % 0.00 0.00 5,500.00 36.36 560.00 31.36
International Royalties 0.00 0.00 0.00 5.00 10.00 15.00
Collaboration Revenues 0.00 0.00 5.00 10.00 15.00 10.00
Grant Revenues 0.00 0.00 0.50 0.50 0.50 0.00
Total 0.00 0.00 60.50 90.50 520.50 675.25
New Cases Cancer per Year % NSCL % Androcarcinomas Market Share Est Customers Price Per Customer Revenue Per Year Est
500000 0.85 0.3 0.15 19125  $     34,000  $                            650

Now we turn to one of the more interesting sides of Biotech valuation. Because these companies are generally unprofitable, we derive the likely probability of drug approval and multiply that probability by the total potential cash flow to yield what is considered to be a fair value for the company.

Here are the generally prescribed probabilities of FDA drug approval at various phases.

Pre-Clinical Phase I

 Phase II

 Phase III

 Final

 1%15%35%60%90%

I have assigned much lower probabilities than the generally used examples. I feel Synta merits a more conservative estimate because of its past failures. Additionally, cancer treatments generally have a tougher time getting FDA approved. Even with the lower probabilities, sub-GDP terminal growth rates, and a WACC of 14%, SNTA appears to be significantly undervalued.

Discount Rates
Terminal Growth Rate 15.00% 16.00% 17.00%
2.50% 12.50% 13.50% 14.50%
2.00% 13.00% 14.00% 15.00%
1.50% 13.50% 14.50% 15.50%
Fair Value          
  Approval Probability Terminal  Enterprise Fair Value Per Share Gain
Bear Case 0.25 3,172.21 1,613.75 1,649.28  $ 4 -1%
Base Case 0.4 3,301.68 1,749.82 1,785.35  $ 7 71%
Bull Case 0.5 3,440.75 1,900.09 1,935.62  $ 10 132%

Most analyst estimates are around $14/share. The investor willing to take on the substantial risks of this stock could triple their money. The risks are substantial and should not be downplayed.

  • Lack of partnerships signal may signal that drug companies are not thrilled by drug prospects
  • Previous formulations of HSP90 treatment failed in Phase III trials – Management is mitigating this risk with large-scale randomized trials designed to better target sub-segments of patients which yield greatest efficacy. Previous trials have already provided scads of patient data points.
  • Company may need to issue more shares to continue to fund operations, resulting in shareholder dilution (modeled into DCF)
  • As a drug class, HSP90 inhibitors have yet to achieve regulatory approval. Furthermore, the development history of competitor HSP90 inhibitors includes the emergence of hepatic, cardiac, and ocular toxicities as a result of formulation issues, but also presumably, in part, as a consequence of the on-target mechanism of action. If Ganetespib is unable to maintain an acceptable safety profile and/or demonstrate meaningful enough efficacy in clinical trials, the drug may not receive the regulatory approval necessary to become marketable.
  • Change of focus from mono-therapy to combination treatments are a bad sign for orphan status, but risk is priced in already
  • There are several companies with clinical stage Hsp90 inhibitors, many of which have lead development programs in advanced lung cancer. Additionally, multiple companies are developing drugs in NSCLC that may compete with HSP90, or alter the standard of care before Ganetespib reaches the market. Some of the companies competing with Synta have substantially greater resources and development capabilities.

The best way to hedge this risk is to diversify it away. I remain long in SNTA, PETX, EPZM, and BIND. At least one of these companies will likely fail. One or two others will probably do OK. One of them may go to the moon. I feel that SNTA may in fact be one of the safer plays, because the market has severely discounted past failures. I regard the CEO leaving as a potentially good thing. He displayed a tendency to zealously exaggerate drug potentials, and Glassdoor.com reviews were largely negative towards him in particular. Positive clinical results by the end of 2014 could propel this stock upwards over the next couple years.

Trimming Corning (NYSE:GLW) adding to Smith & Wesson (NASDAQ:SWHC)

The past year has been good to Corning shareholders, with the stock appreciating over 45%. While I believe the company has great long-term potential, with a well-known and enduring brand name over 100 years old, I have decided to trim my position by 2/3rd in order to increase my cash holdings. The initial undervaluation thesis appears to have largely played out, and I do not see any big catalysts on the horizon. I am keeping about 3.5% of my total portfolio invested in the stock for the long-term. I believe the trend towards a touch-screen world still has a lot of room to run, but after a 65% gain in my initial investment in the firm at $10.70/share in mid-2012, I believe it may be time to take some gains and reallocate capital.

I have also increased my position in Smith & Wesson (NASDAQ:SWHC). SWHC currently represents 6% of total holdings. The story of an under-appreciated management team continues to play out. Recently, a poor earnings release by competitor Ruger made shareholders nervous enough to sell this great company before its own earnings report a few weeks later. The stock rocketed up over 10% when SWHC’s most recent report came out. I believe SWHC possesses a superior management team, is materially undervalued, and will continue to yield superior cash flow over the next few years.

Anytime the market starts hitting new highs, I tend to get a bit nervous and increase what I perceive to be undervalued stocks such as SWHC and BP. I have been watching a few Biotech companies with some interest, and believe that as the shine comes off the sector, a few good investment opportunities are presenting themselves.

Buying to Close ANGI short

I have decided to end my ANGI short for the following reasons:

  1. This is my first short
  2. Stocks tend to go up
  3. I have made over 10% within less than 2 months

I learned quite a bit via the exercise, and am still extremely confident that Angie’s List will fail in the long term. Unfortunately, I cannot predict the short-term and believe the stock may have hit a floor. I will post again when I believe the stock is primed for another sell-off.

Angie’s List – Pump and Dump Probability Rises

Do you use Angie’s List? Do you know anyone who has? I certainly do not. When an internal stock pitch competition called for a short pitch on a technology stock and I stumbled across ANGI, I knew I had something.

Recently, I wrote a post about Angie’s List (NASDAQ:ANGI) promising to dig more. Well I dug, and this company is far worse than I suspected.

Some serious questions are starting to pop up around Bill Oesterle. Google was not kind. Probably the most damning allegations stem from his purchase of $2M worth of property with another Angie’s List board member. Who did they lease the property to? Angie’s List, for over $6M. One wonders where the additional $4M dollars went, since Glassdoor.com reviews complain about the poor quality of the buildings in which employees work. Most of the positive reviews on Glassdoor are by the commissions-based sales force which emphasize that you can make a lot of money at ANGI. It is nice to know the sales force is being well-taken care of by a company which has never turned a profit in 18 years.

Additional shady details on the building deal can be found here. Now there could be perfectly legitimate reasons to do this sort of thing, but combined with the massive insider stock selling, we should be very skeptical. ANGI has also been rated as having aggressive accounting practices by GMI. Specifically, prepaid expenses got ticked as dangerously large, this would increase Operating Cash Flows, which management has been emphasizing as the best performance metric by which to gauge the company.

Additionally, despite having a much smaller user base, ANGI actually has more negative reviews than all of Yelp. Reviews of Angie’s List, written by both service providers and members, can be found here, here, here, here, and here.

The CFO and CTO have both been changed out this year. I’m not sure how much more I really need to dig into this. All the factors we’ve mentioned in our first post and this one, by themselves would be concerns. Combined, these are klaxons blaring “Abandon Ship”.

Consensus estimates paint a rosy picture. I will not. I finally had some time this weekend to work out a DCF. The primary assumptions are listed below:

  1. ANGI stays in business and is able to pay off coming loans in the next two years
  2. Membership revenues decline and ANGI focuses on service provider (contractor) revenues
  3. Margins remain at their historically awful levels, improving only slightly
  4. Revenue growth continues to be high

Bear and Bull Cases

Base Case

Being a little generous on the WACC (10% and Terminal Rates)
Being a little generous on the WACC (10% and Terminal Rates)

DCF Results Fair Value

It is possible that Yelp or another firm could purchase ANGI, but I have to wonder why. Management has been trying to sell the company for years, and has not been able to find a willing buyer. The firm is neither large nor profitable, so the competitive threat is minimal to a firm like Yelp or Ebay. To be safe, I would estimate ANGI is worth $5-6 as a takeover target.

The more I dig the more disgusted I have become with the practices behind this business. Good products sell themselves. Yelp does not need a call center, staffed with hundreds of sales specialists to obtain site visits. The reality is that management could pull a lot of levers to keep the company going for at least another year. I really feel bad for the shareholders who have invested in this firm. This story will probably not end well for them.

More links are listed below:

http://www.forbes.com/sites/greatspeculations/2013/09/10/aint-it-time-to-say-goodbye-to-angies-list/

http://www.investopedia.com/stock-analysis/100713/why-angies-list-doesnt-rate-well-shareholders-angi-hd-iaci-goog-yelp.aspx

http://seekingalpha.com/article/1776412-angies-list-worth-9-based-on-expected-lifetime-member-value-in-2015

Again I would like to thank my fellow student for conducting much of the research, especially the per-member analysis. He can be reached on Twitter as @adammcash

I intend to short the stock until December, in case a major institution decides to cut losses. This is my first short, and I do not want to be greedy. I have already made ~17% since initiating a position in late October.

Angie’s List – Say Goodbye to 90s Internet (NASDAQ:ANGI)

Angie

I need to thank my fellow b-school student for doing a LOT of the digging which went into this:https://twitter.com/adammcash

I have never shorted a stock before. Even when I have had a compelling case, timing has been a huge problem for me. I am now shorting Angie’s List. I feel so confident in an impending collapse at this point that I have put a small portion of my portfolio into the short.

For those of you who have not seen the terrible commercials, Angie’s List is a premium-membership review site.

NASDAQ:ANGI targets households worth $100,000 or more and provides premium services. The company plan is to grow memberships as big and fast as possible, and sell advertising to service providers. Angie’s is attempting to develop a Facebook-like ecosystem. Angie’s List promises its members better quality reviews of local contractors. Angie’s then turns around and promises its contractors/service providers access to higher net-worth customers. Angie’s also offers search ranking boosts and other positioning perks to its contractors as well for a fee. Membership fees cover SG&A while advertising is supposed to benefit profits.

Anyone under 30 can see that the business model is flawed. You can’t claim to offer unbiased reviews of contractors to members, charge them money, and then turn around and promise those same contractors better search placement and reviews, also for money. It’s one or the other. Competitors recognize this, and there are many.

Competitor Logos

There have been rumblings out of management that they might tweak the model. Doing so at this point would put a significant drain on their cash reserves, and, as you will see, those reserves are already extremely weak.

Angie’s List 2013
Market Cap $784,000,000
Total Assets $109,735,000
Total Liabilities $132,766,000  < Yikes!
Total Members 2,378,867
Average member value $280
Total Shares 58,420,000

Negative book value is never a good sign. For a tech company we might shrug it off and say, “well maybe it will grow”. So let’s look at the growth.

Service Provider Revenue 69% (increasing)
Membership Revenue 31% (decreasing)
New Members Added y/y 933,556 (flattening trend)
Average Lifetime Membership 4.5 years (decreasing)
Avg Yearly Membership Fee $30 (decreasing)
Avg Yearly Service Revenue/user $40 (decreasing)
Avg Cost of Acquisition $80 (steady)
Avg Maintenance Cost/user $55 (steady)

Average costs need to decline in order for the business model to succeed. Membership growth is slower than anticipated. Membership fees have been slashed as of October 2nd. Angie’s List is alienating it’s customer base, experiencing membership churn of 5-7% per quarter. There are only so many +$100,000 households out there. As the company grows advertising, the ads get less targeted and less valuable.

Adam crunched some NPV membership numbers for Angie’s List:

Membership Lifetime
5 yrs 4 yrs 3 yrs 2 yrs
Membership Fee $40 $67.91 $49.83 $28.13 $2.08
$30 $38.00 $23.94 $7.06 ($13.19)
$20 $8.10 ($1.95) ($14.00) ($28.47)
$10 ($21.81) ($27.84) ($35.07) ($43.75)
Current Value  
Value per User $5.00 – $6.00
Market Cap $784,000,000
Share Price $13.32

Adam assumed an advertisement revenue per member of $50 and a 20% discount rate. Those are heady numbers for a company which may abruptly change its model to something more like Yelp! What happens to all the members who paid for a 5-year membership if Angie’s List were to change to a free member model? One giant refund.

I estimate it to be around $40M, which would represent all of the cash that Angie’s List has on hand! $42M!

Well OK what about a loan? That gets pretty dicey for a company such as Angie’s List which has negative book value already (more liabilities than assets).

Management is in dire straits and they know it, but really they’ve known it all along. Having cashed out over 10M shares (20% of the shares outstanding), and made no substantial purchases since the IPO in 2011, they must clearly understand that they are riding a sinking ship. There has not even been any rhyme or reason to insider stock sales, which would probably help them claim innocence during the inevitable lawsuits and bankruptcy proceedings to come.

I conducted a regression analysis, to try to determine whether management was timing sales, or simply dumping as many shares as possible every month. It is rare for management to sell so much stock periodically, when ANGI is not making a single dime of profit. How many start-up entrepreneurs cash out of their firm when it is not making money??

No Pattern to Insider Sales

R2 No Pattern

Note the incredibly low R-Square. These guys aren’t cashing out at a certain price point, or attempting to sell at some internal price goal. They just want out. The CEO has already sold over $16M since the IPO. An astounding total of $133M (1/7th of the float) has been sold by insiders since the IPO! What does that say about management’s honest outlook?

Management has two options:

1. Rework the business model, take a massive hit to current assets, hopefully get more loans from the underwriting banks, and continue to fight for revenues in a crowded space against established competitors. Meanwhile, app-based competitors run the risk of outflanking Web 2.0 models entirely.

2. Sell the business.

Option 2 is really the only viable option, and the company has been for sale for years now. Bankruptcy looms within 2-3 years max. I put it at 1-2 years personally. I don’t think the banks are going to be willing to throw much more sunk cost in. The only banks recommending the stock as a buy are the ones still holding the paper, in loans,bonds, and equity. More numbers to come as I dig deeper at one of the worst public companies I have seen.

On a good day, if the wind is right, this stock is only worth $9-10 dollars as a buyout candidate. In reality, this company is worth maybe $3-5. I intend to short until it hits $10/share.