Wednesday, July 6, 2016

Brexit Sell-off Ideas

News 4 July 2016
  • Potential for reversal on Brexit decision politically - however the current asset price volatility is not over. We have only reached the prices leading up the the exit vote - we may see a sell-off from here of a higher magnitutde than past sell-offs. The market is still digesting the news.
  • UK recession signal UK recession signal
  • Last week the volatility was contained within Europe; emerging markets prices held up well; so far.
  • Lots of liquidity expected by central banks - the more decisive and coordinated, the more likely the markets will continue higher - at the continued slow pace.
    • ECB, BOE all hinting at looser QE, and easing
  • Australia’s best fund manager going to cash allocation
  • Good article on Turnbull’s history

Whilst Australia’s politics remain uncertain, a higher allocation to US equities remains the better play.

Twitter (TWTR)

$16.10
Report earnings: 27/7/2016
Twitter still remains a value proposition in the current market climate. Due to the sell-off since the huge run up; with last two quarterly reports showing flat User growth and decelerating revenue growth. The company still has a high cost for operations, and thus reporting negative earnings.
The climate for large tech companies have changed - with M&A’s becoming possibilities. Linkedin got bought out at 50% premium by MSFT, and there was reports of a bidding war with Salesforce.com (CRM).

CBRE (CBG)

$23.50
Report earnings: 27/7/2016
Has a large portion of its revenue from EU and UK, it’s one of the few well branded companies that have been hit heavily; however it’s earnings power is unlikely changed - there will be more opportunities for value accrestive acquisitions

Cameco (CCJ)

$10.10
Uranium prices can get lower in the short term, but after the company cut supplies and energy demands are not falling.

Potash (POT)

$16.20
Report earnings: 28/7/2016
Dividend yield of 6.2% may be unsustainable, but the bottom of potash prices have been called by management in the last earnings call.

Fiat Chrysler (FCAU)

$5.10
This is a position based on the valuation and macroeconomic scenario where auto vehicle sales continues it’s recent trend in line with economic growth and low oil prices driving consumer spending.

Diana Shipping (DSX) , SALT, NVGS, NM

I’m summarising some points from one of the best learning blog

Baltic Index

“Dry bulk is a screaming buy; one of the best entry points in the cycle in the last thirty years. But be prepared to sustain a prolonged period of poor freight market conditions and have plenty of cash reserves and low leverage. In other words, you have to have a longer-term perspective than most investors–three to five years at least.

Since 2009 The Index has been falling to lows
Since 2009 The Index has been falling to lows

Last few months the recovery could be beginning
Last few months the recovery could be beginning

Shipping Cycles (Short Video)

DSX reports: 29/7/2016
$2.44

SALT reports: 29/7/2016
$2.77

NVGS reports: 29/7/2016
$10.88

NM reports: 18/8/2016
0.77

Anti Fragility

Monday, June 27, 2016

Brexit Links

untitled

The market showed that it can get expectations wrong. Market was expecting U.K to vote in favour of staying - the market ripped higher the night before the vote - and to see a complete reversal, with FTSE getting slayed and SP500 also falling 3.5%. Whilst the single day market reaction was the worst in a long time, the key thing to watch is for whether the sentiment will continue in risk assets - a continued sell-off; and the obvious central bank response. Given central banks are already at negative rates in the euro; we might see a return of LTRO and potentially helicopter money. These actions are most likely to put a floor in the marekts again. If central banks step in heavily to stop systematic panic selling then it would be good to start setting up positions within the next few weeks.

Just What the Doctor Ordered

Immigration fears and the disintegration of EU following brexit

Forbes article about the sell-off after brexit being not out of the ordinary

Bank sell-off and CDS surges

Majorities in major EU countries want referendums

Why BP and Royal Dutch closed higher after brexit

Stocks are a Great Buying Opportunity

Brexit proves experts know nothing

Brexit will take two years

Brexit Charts

Expect more uncertainty

Monday, June 6, 2016

Winning by Losing

Evernote: Observations from the Star

Observations from the Star

“You don’t learn to hold your own in the world by standing on guard, but by attacking and getting well hammered yourself. - George Bernard Shaw”

Pat asked the question, ‘are you going to play?’ and Peter responding with ‘I’m too smart for that’. In a vacuum; his answer is totally correct. Life is a game of avoiding mistakes. However, there are some games where there is a price to sit at the table; a price to learn the game; a price it takes to be good at the game.

Would an intern refuse a zero salary intern position at a prestigious firm because it is measured financially as a net negative outcome?
What about the unreturned losses of the psychology of reciprocation?

Gambling, if you choose to participate is about loss-minimisation - you are learning the first skill of value investing. There are some bets you are going to make that go wrong - how will you deal with it? Deciding to cut your loss versus when to press your bet. You have to learn to both cut and press to survive in this game of elites. The second lesson is the gambler’s fallacy which is based on Martingale is doubling your bets when you expect a streak to end. Learning this fallacy while attempting it and losing big in gambling amounts but minuscule in investment amounts can actually equip investors for the market psychology that will creep in when you see a stock going straight to zero. Answering whether the value stock is worth holding and going down with the ship; or whether it is actually a prudent move to be adding to the losing position is probably one of the most critically debated risk management topics amongst traders vs investors. Traders pledge to cut losses early, value investors pledge to bet big and keep adding when losses are occurring (assuming your analysis is correct). The biggest moment in my investing education was when I realised, that investing is the superior style; and has the billionaires to prove it.

The biggest paradox of value investing is that as a price gets cheaper one of two things are happening:
1. You are losing money and becoming more wrong (and the market is being more correct) - this is the efficient market hypothesis.
2. You are getting better odds of payoff (the market is over or under reacting) and the divergent view that you hold will be profitable.

In the case of 1/ you must sell your holdings and minimise your losses. In the case of 2/ you must add to your losing position and capitalise on the fact that you will eventually be correct. People think dealing with these scenarios is as simple as having a pre-calculated spreadsheet with a DCF or EPV value. Most of the value in investing is lost; simply because fund managers are unable to utilise zigging when others are zagging. There are times when momentum works, and there are times when value works. Is it possible to jump investment styles during trend changes? Research indicates it is unlikely; sticking to a value style will mean you under perform at times, and those are the times when you should be increasing allocation to this style.

Learning that in gambling you will never have the edge is correct. Losing consistently and seeing your own psychology to losses and how you deal with them is the purpose of a learning based approach to gambling; risk management in institutional terms. Can you walk away after committing your initial outlay? Can you bet the full, committed amount for the night? Are you able to press the winning streak, despite the irrationality; why even gamble if you aren’t gambling to win big?

The tale of Amazon almost two decades without a profit - yet it became one of the greatest value creators to investors in the last decade. A stock that many value investors have shunned as ‘overpriced’. The reasoning lies squarely with those who refuse to take negative EV propositons without seeing the long run implications and value of long run market dominance that began with loss making short run transactions.

“One gains by losing and loses by gaining”
Dao of Capital

Tuesday, April 12, 2016

Xero Valuation - How do you value a company without earnings? $XRO

Anyone who believes that exponential growth can go on forever in a finite world is either a madman or an economist - K Boulding



If users are growing like that, then why is share price doing this:




What is a SaaS company growing users at an exponential rate worth?


Over $1bn with 593,000 users  - find the moat talks about the value in more depth.   The current Enterprise Value for Xero is $1.6bn ($14.10 share price).

Estimates of when the company will turn a profit

First let's start with the analysts estimates of when the company will turn a profit

Analysts are expecting break-even to occur between 2019 and 2020.  The model I have created has break even at the same period, 2019; after it earns over $A 400m in revenue with over 1m users.


Why and how does a SaaS invest for future profits?


A positive development is that the last quarterly cashflow saw that the cash burn is slowing; which would alleviate concerns of another round of dilution in equity.


What is the Market Size

Whilst the total market for cloud services may total around 29m, the target for total users for XERO would be just over 2 million.

The development of cross platform cloud solutions are critical to the growth of XERO.  Most small businesses are still delaying the move to cloud based accounting - with a lot of users still using desktop software.  My own personal experience was MYOB forcing me into their cloud software and the process of bookkeeping actually took much longer than the desktop software; 30 seconds lags between saving entries was the biggest issue.  Xero dramatically reduces the time it takes to do the BAS reports compared to MYOB and the ability to add users to the software with cross platform capability is the feature that MYOB sorely needed.  XERO beats MYOB in all attributes of accounting software for small businesses except for the lack of keyboard shortcuts for frequent data entry tasks.


What are investor's expectations from last year?

There are various reasons why the ASX market participants will find it hard to value XERO higher than the current $1-2bn range; one is the anchored number of lifetime value of $1bn, makes it hard for investors to want to pay for growth.  The latest funding for the company was done from people who have previously invested into SaaS companies and more importantly have a different risk profile to the retail investors.
Retail investors want to see normal looking statements, with growing profit numbers.  When the net losses are increasing at an accelerating rate as your revenue grows, then it's easy to take the usual reasoning that if it costs too much to grow your business, it's not worth growing. Thus it could be a rational business decision to profit from local markets (AU and NZ) that have matured and slow down on the marketing spend for global markets.  However, the cloud space tends to be stable at only one or two dominant players; and clearly XERO is investing heavily for that position.  If this is the scenario that does reveal itself in the next 3 years (expect users to be over 1 million by 2018); then the valuation for XERO would be 5 to 10 times what it is now.  This is how you would reverse engineer the projections that the VC firms may be making when they make late round investments into the company at $20.00/share.  I'd say the target value for the VC rounds would be between 25%+ for 5 years+, looking for a minimum exit value of $6bn.  This is about $44.00 per share.


DCF Valuation

It is difficult to value a business with any degree of certainty, when it operates within a rapidly changing industry.  

Assumptions for growth in users:


2017201820192020202120222023
users900,0001,055,0001,146,8001,258,6181,370,4541,482,3091,556,532
y/y %33%17%9%10%9%8%5%
2024202520262027202820292030
users1,635,3541,719,0901,808,0761,902,6732,003,2692,110,2772,224,145
y/y %5%5%5%5%5%5%5%

The absolute total users at 2030 at glance seems high; however if we look at the table for regional breakdown by 2030, we can see that we are already factoring in slowing growth in AU/NZ markets and the remaining growth will come from the U.S and U.K markets at a moderate pace; as we assume intense competitive pricing pressures from Intuit and Sage.  Given Xero's head start in cloud, and it's captured service partners in the platform for services space, it's very likely XERO will get it's share in the U.S and U.K markets.  As a comparison Sage (U.K) have over 6m, MYOB (AU) have over 1m, Intuit(US) 7m customers.


Year2030
NZ203
AU564
UK717
US740
Total (000's)2224

The argument that the accounting business is a sticky business, with high switching costs is true. The time and energy it takes to learn a new accounting system and move the accounts are usually not worth the struggle, given the usage of the system is during a few weeks where the accounts are being prepared.  The opportunity for XERO occurs when the incumbents such as MYOB, Intuit and Sage customers force their own inferior cloud software to their clients that want to keep their desktop software.  The need to compete with XERO has rushed to market a vastly inferior product which can only compete by lowering price. In the case of MYOB, the cloud offering is a hybrid slower, clunkier and less flexible across multiple users and cross platform (pc/mac). The increasingly tech savvy business operators will make the move to try out other software.

My expectation of the upcoming earnings report is 640-720k users for 2H16, if I had to pick one number it would be 675,000.  Weighting the probability of different users reported, the valuation would be $20.45; 31% discount to today's closing price $14.00.


usersvalueprob %e(v)
60016.973%0.51
64018.3810%1.84
68019.7945%8.91
72021.1924%5.09
76022.615%3.39
80024.013%0.72
100%$20.45


Peter Lynch claimed to look around you when looking for investment potential; something that can grow at high rates for a long period of time, can compound into multiple baggers.  Phil Fisher and his scuttlebutt method of research was one reason why I realised this was a much superior product than others on the market that has a team dedicated to long term value creation.  If you can look beyond the short term losses, this first half year might be the last time the stock may be bought under $20.