Risk Management is, sadly, more about the appearance of Risk Management.
The Archegos episode – where a hedge fund run by Tiger Cub Bill Hwang blew up because of margin calls from their prime brokers – is yet another reminder that Risk Management “manages” the wrong type of risk at hedge funds and banks. In Banks, Risk is a bit simpler to quantify since transactions are short-term. So, Volatility (Standard Deviation) and its Gaussian variants (like VaR, CvaR etc.) do the job most of the time. And yet, Credit Suisse failed massively. But Goldman Sachs escaped relatively unscathed.
We’ve always found it weird that many hedge funds don’t hedge the right risk. Many Risk Management processes were derived from Banks (trading desks at investment banks). They were too short-term oriented. And sometimes they don’t apply to longer-term strategies. The main risk at many investment firms (and less so at trading-oriented ones) is Thesis Risk. If your investment thesis is wrong, no amount of “market neutrality” or “VaR Budget” will save you.
A lot of fancy Risk Management tools miss the most important risks. They’re just there for appearances.
UBS thinks Apple's iCar may be worth $14 a share. Very precise. Too precise.
We laud UBS's precise attribution of value to one particular project. We don't usually do this sort of attribution. But for Berkshire Hathaway, we did a similar sum-of-the-parts analysis. We want to make 2 points about this:
- Price Targets: We have price targets for all our investments, but we don’t treat them as anything sacred. We estimate it as a rough marker, so we that can be reasonably confident about buying something at a discount. We use 30% as our Margin of Safety. We bring this up because we thought UBS’s precise valuation of Apple’s future business can mislead people. It represents a 10-12% upside from Apple’s current price. In our view, this is not enough margin of safety to buy Apple because of its potential Autonomous business.
- Why do we hold Apple? Because it’s a Global Dominator – in cellphones, PCs, Operating Systems and Music. Until that changes, we will
J Powell thinks Bitcoin is "digital gold" at best, not digital currency. He's right.
Our main gripe with cryptocurrencies is the “currency” label. It’s as much of a currency as Gold is. Maybe some people use Gold to pay for things (seems rather medieval). But somehow, most people prefer the dollar or the euro or the pound or whatever. Why? Price stability. People are reasonably confident that their currency will buy roughly the same basket of goods in the foreseeable future (say, a year from now). So, maybe “cryptos” can be currencies. But are they better than the one you’re using? Try and keep politics out of it.
Unless cryptocurrencies are tethered to the real economy – real production, credit, investment, wages and consumption – they’re just video-game money. Or something to speculate on – like Gold.
We're surprised the BionTech stock hasn't rallied more. And what is mRNA?
This company is among a few that’s literally saving the world. And yet their stock hasn’t rallied like some other stocks. Check this out:
What is the holdup? It could be valuation, but you’d think that in this world of meme-trading valuation doesn’t matter. We’re also surprised because from what we’ve read, mRNA vaccines are a big deal. So, the potential upside in BionTech goes beyond Covid-19. Check out this description of mRNA.
Some interesting factoids:
- It stands for messenger RiboNucleic Acid.
- Unlike traditional vaccines, mRNA vaccines trick a body into producing some of the viral proteins itself. Traditional vaccines are made up of small doses of the whole disease-causing virus.
- To do that means producing synthetic versions of the mRNA that the virus uses to build its infectious proteins.
- Both points 2 and 3 imply that producing mRNA vaccines should be easier, more cost-effective and more potent.
In any case, our bet in Healthcare is very top down – the ETF called XLV is our only bet. We will refrain from investing in specific companies unless:
- We understand the product, so we can easily break down revenue into price X volume, OR…
- We recruit someone who does.
Qualcomm thinks its Industrial IoT business will grow by 10% a year.
As we’ve mentioned in our Qualcomm thesis, IoT is a natural extension of its core mobile chipset business.
Spotify plays catchup for the first time
ClubHouse has made a big entrance with live podcasts. Spotify was caught snoozing. But the company promptly rectified its tardiness by acquiring an app called Locker Room to compete with Clubhouse. We don’t have any stats on who’s winning. Clubhouse seems to be attracting more attention (this is anecdotal). But Spotify has a massive advantage in good old-fashioned recorded podcasts.
Spotify stock does look overpriced. But for now, we’ll continue holding on to Spotify at a roughly 3% weight, just because it’s a Global Dominator.
The new Biden Plan helps Vestas. Next stop for us: QuantumScape
The newly unveiled $2 trillion Biden Infrastructure Plan included a $174 billion allocation to promote electric vehicles. Another $100 billion will be allocated to modernize the grid – surely some of that flows into incentivizing Wind Turbines. Advantage Vestas.
On the EV front, we keep missing out on these stupendous Tesla rallies. But we’re interested in company called QuantumScape, which is trying to make solid-state batteries at scale. This would be a massive game-changer in the EV space. Solid State Batteries, if perfected, can essentially eliminate the make deterrent to mass EV adoption: Range Anxiety.
Our valuation suggests Doordash stock has substantial margin of safety.
We had factored in some aggressive growth assumptions for DoorDash. As of writing this, the stock is nearly trading nearly 50% below our valuation estimate. The most aggressive assumption we had made was a 500% growth in order volume.
We’ll do a deep dive on them soon and revisit this 500% growth assumption. In a 3-year timeframe, it seems quite believable.
WeWork is now valued at approximately $9 billion. Down from 40-something.
Will WeWork have a future after things open up and work-from-home (at least a few days a week) becomes normal? It seems to us that they’ll need to change a few things:
- Expand out of the city-center. There’s a market for WFH people who still want a sense of community but not the commute.
- To do #1, maybe look at dying shopping malls.
- Make it easy to network within the WeWork network. This would be a big incentive to pay $500 a month for a desk.
We’re sure they’re working on a post-Covid rejuvenation plan.
5G is the new cold war.
In doing our research for Qualcomm, we were surprised (again) at the extent of the Huawei ban. It seems like HiSilicon is basically out of business unless the US reverses the embargo on them. It’s also surprising that China hasn’t done anything in retaliation. Yet. But what can they do? Will Chinese OEMs stop using Qualcomm chips? They could. But if the US retaliates back with restrictions on semiconductor equipment – which are mostly American – it’s a big problem for China.
If both countries think 3-4 steps ahead, the whole cold war doesn’t make sense. But Xi Xinping also needs to be a strongman to maintain his power. We’re not sure how this will play out. That’s why we reduced our stake in TSMC from 5% to 3%, just as we took a 3% position in Qualcomm.
17 reasons to be optimistic - the first few mirror our AI & Big Data worldview.
We like to invest in inevitabilities. And the most uncontroversial call on inevitabilities is the compounding of data. This (fairly reasonable) list of 17 reasons to be be optimistic of the next decade has that inevitability laced all over it.
Investing Giant Howard Marks thinks returns will be hard to come by.
Howard Marks is one of our heroes - we even have a mental model based on him. We look forward to his periodic memos on investing. In his latest memo, he reviews 2020. While his conclusion was somewhat underwhelming - be cautiously optimistic - this is the most lucid description & prognosis of equity and bond markets we've read so far.
Volkswagen is taking the fight to Tesla.
Volkswagen has officially declared that it's going-all-in into the EV revolution. Mr. Market loved it! Check out VW's stock price (US ADR):
Shopify vs. Stripe: Who wins the race?
This is a wild race. Stripe was recently valued at nearly $100 billion, by virtue of a new funding round. But it made us think - will Stripe use the new funds to build out an e-commerce backend system a la Shopify or will Shopify build out it's own payment backend system? Both these companies have dominated the small-online-business segment. Their valuations reflect that domination. Shopify is publicly traded while Stripe is not. Based on our latest AI & Big Data Watch List.
The world is getting older. We're invested in it.
This is the core of our Healthcare Thesis. This is from the latest UN Economic and Social Affairs Newsletter:
By 2050, one in six people in the world will be over age 65 (16%), up from one in 11 in 2019 (9%). Regions where the share of the population aged 65 years or over is projected to double between 2019 and 2050 include Northern Africa and Western Asia, Central and Southern Asia, Eastern and South-Eastern Asia, and Latin America and the Caribbean. By 2050, one in four persons living in Europe and Northern America could be aged 65 or over. In 2018, for the first time in history, persons aged 65 or above outnumbered children under five years of age globally. The number of persons aged 80 years or over is projected to triple, from 143 million in 2019 to 426 million in 2050.
What do we have to believe to invest in the Indian IT Sector?
This is tied to our AI & Big Data Watch List update. The Indian IT sector is on our radar. It scored well in our "Priority Test" - which means they're worth digging into (after 4 other companies). For more details, click here.
We've updated our Industry 4.0 Watch List.
Honestly, the average revenue upside we need to believe for this sector seems high. We'd like to dig into Analog Semiconductors and Texas Instruments. But we'd need to believe that their revenue would grow by 70-80%. It's possible. However, it's stocks we've owned before that look more reasonably priced - such as Sensata, ABB and FLIR Systems.
Facebook's underpriced growth vectors: VR and Whatsapp
We've talked about the Whatsapp growth vector before, although it's hard to value it within the context of Facebook's stock price. The AR/VR growth vector may be even harder to value. However, that won't stop us from trying. Facebook recently announced some new AR developments that look a heck of a lot more practical than VR headsets. Check out these new wrist bands. This uses something called "neural input tech", which is, frankly, mind-boggling. Facebook's AR/VR product head Andrew Bosworth thinks Neural Input tech will spread faster than most people imagine.
It's always Day 1 at Amazon. But that comes with expected failures.
Shira Ovide of the New York Times (previously at Bloomberg) is one of our favorite tech journalists. Recently, she made a controversial point: Maybe Amazon doesn't have a Master Plan. But if you think about it, it's not so controversial. AWS (their Cloud Service) as the main driver of free cash flow wasn't part of the master plan back in, say, 2005. Kindle wasn't part of the plan when Bezos Amazon launched in the mid-90s. Those were successful. But some other projects weren't - like the Fire Phone. Similarly, it looks like they haven't found much luck in physical grocery stores. Incidentally, Wal-Mart has screened as quite "reasonably priced" in our latest Retail Watch List.
We're always tempted to pick up more Lumentum stock.
Lumentum is in a bidding war for another photonics company called Coherent. In recent weeks, this has hurt the stock price. But nothing in the company has changed. We're still confident of all it's growth vectors - 5G, AVs, Photonics, AR/VR. In fact, we'll be picking up some more stock, but maintaining our weighting at around 3%.
Over the next few weeks, we're refocusing on our largest theme.
Inflation or not, rising interest rates or not, we think we're still in the early innings of what is our biggest bet in our portfolio: the compounding of data. This bet has worked out very well for us and we plan to stay as heavily invested in it as we always have. Over the next few weeks, we'll re-focus our energy on this investment them. Our research pipeline over the next few weeks includes (in no particular order) :
- Snowflake - this firm is literally about Big Data.
- AMD: They could finally be the "Intel-killer" if the Xilinx deal goes through.
- Salesforce: After acquiring Slack and Tableau, the Moat looks wide.
- Google: Sum-of-the-parts analysis - how much growth in the non-advertising business.
- What the **** is Kubernetes and how does it affect our portfolio?
- Analog Semiconductors - this veers into Industry 4.0 territory.
The Fed Flywheel...
Everyone has a "flywheel" nowadays (thanks Jeff Bezos). So, I figured that will all the confusion (and misinformation) about the bond markets, equity markets inflation and the Federal Reserve, I should do a a "Fed Flywheel".
This is a crude but approximately right depiction of what the Fed is striving for. Their dual mandate is Price Stability and Maximum Employment, but that just a fancy way of saying "smoothen out wild swings in economic activity". To do that, they need to make sure that economic conditions are good enough to maintaining a rough balance in supply and demand in 3 key areas: Goods & Services, Labor, and Capital. Ultimately, what the Fed wants is this: anybody employable should find a job, which depends on the condition that any firm that wants to produce goods having the requisite level of labor and capital to produce it.
This is a hard orchestrating act - smoothening out wild mismatches in supply and demand. It's not a science. The Fed tries to conduct this symphony primarily through the private-sector banking system. The Fed may get it wrong in these unprecedented times, and inflation may get out of hand (as bond markets seem to bet). But as we've argued before, the Fed (and most major central banks of the world) have got a lot of institutional memory on tap to tame not only Inflation but also stave off Deflation. If we had to bet (we don't, thankfully), we'd side with "Inflation under control".
Smooth, calm balance - that's what they're striving for. Some people may argue that's too much government intervention - that's a separate philosophical discussion.
Is this the one?? A new battery technology holds promise.
We've been tracking battery science since we first started. But this new technology seems to have the backing of the creme de la creme of Renewable Energy investors. It's hard to say if QuantumScape is the one. But we're excited that it's a publicly traded company, which means we can dig in and possibly invest.
Bitcoin is a speculative punt. Nothing wrong with that but be honest about it.
Jim O'Neill coined the term BRICs while he was heading up Goldman Sachs's asset management unit. Now, in our eyes, that doesn't make him an authority on economics or investing (sorry, we don't know his investing track record) but he makes a cogent argument.
"Moreover, underlying these three functions is the rather important role of monetary policy. Currency management is a key macroeconomic policymaking tool. Why should we surrender this function to some anonymous or amorphous force such as a decentralized ledger, especially one that caps the overall supply of currency, thus guaranteeing perpetual volatility?"
Counterpoint: Check out this Tim Ferriss podcast with Ethereum Creator Vitalik Buterin and crypto enthusiast/investor Naval Ravikant. They make some cogent arguments too.
The EU's vaccine rollout has been a major fail.
It's hard to say whether coordination failed because of politics or just good old "Eurocracy". Ironically, in the continent of more centralized healthcare systems, coordination between each of those centralized systems has been an epic fail. And bear in mind that the continent relies heavily on summer tourism too boost its economy. One would think they'd do everything they can to get out of the pandemic before June 1. It looks unlikely.
India might have just become a viable manufacturing alternative to China.
Apple is now going to have its new and shiny (and incredibly complex) IPhone 12 in India. This is a major step to "de-China" its supply chain. Other companies may follow suit. This is an important data point for us because the main India thesis-buster (even in our India holdings - HDFC Bank and ICICI Bank) is the lack of jobs in a country that's churning out working-age young people with great speed. This could be a harbinger of good things to come. We'll keep an eye for more such stories.
We need ideas...
Snowflake is now in our research pipeline. But we're still unsure about their competitive advantage. We were, however, curious to see that they also have some data management and analysis tools for Digitizing Factories. Since we don't have an Industry 4.0 name in the portfolio now (we sold our FLIR Systems position), finding an investment in this theme is a top priority for us. Analog semiconductors, also part of our AI & Big Data theme, is a logical place to start.
We have a new Retail Watch List.
This most interesting one here is Walmart. These numbers suggest the we don't need to assume any revenue growth to buy into the story. The question is whether Walmart's fixed costs will remain stready as they try to digitize their operations. Check out the Portfolio Page for all Watch Lists.
We missed the Caterpillar rally. What happened?
Caterpillar was one of our holdings for a long time (this was our main Urbanization bet; now it's mostly just Xylem) before closed out our position (for no significant gain or loss) during the aftermath of the Covid headlines in March. We had readjusted our portfolio to position for growth in asset-light and debt-light companies for the most part. That bet paid off. But we also missed out on some massive rallies. We can't really explain the CAT rally in 2020. It makes us wish we had held on. From their last earnings report it seems like 2020 revenues were down 22%, and operating margins fell from 15% to 10% in a year. We're guessing these were better-than-expected results. But does it explain a >100% rally over the last 12 months?
Verizon looks appetizing.
Berkshire recently bought Verizon stock. So, we were wondering how much growth they'd need to factor in. According to our estimates, not much growth needs to be factored into Verizon stock - about 13% cumulative revenue growth by our estimates. Classic "value" buy by Berkshire.
Apparently Inflation will kill the inevitable compounding of data...
The latest sell-off in the markets was particularly pronounced in the tech sector. AI & Big Data is our biggest theme in terms of portfolio exposure. And we're exposed mostly via semiconductors like TSMC, ASML and Nvidia. Those stocks have taken a beating over the last few days. We're not perturbed by it. Our long-term view of these businesses is that their global domination is unlikely to be threatened. We got into these stocks at a low price and we'll hang on to them as long as we believe that data will compound at a faster rate than most investors imagine. We will, of course, constantly be on the lookout for relatively cheaper ideas as replacements. But they're hard to find.
What do we do about this Growth to Value "rotation"?
Nothing. We don't focus on academic "factors" such as "value" and "growth". People interested in such labels will probably say that The Buylyst has a bias towards Growth. But that's not deliberate; it's a consequence of being invested in our chosen themes - AI & Big Data, AVs and EVs etc. And we did that because we're long-term investors. We'd rather be playing the right sport - be invested in multi-decade growth vectors - rather than play with fire in structurally declining industries.
But Some "hyper-growth" investors could accuse us of being too sheepish. They could say, "why aren't you invested in Tesla or Roku or even Bitcoin???" I guess that's where our Value bias comes into play. We don't just buy stories. We buy stories if they're cheap relative to their utterly believable growth potential. Yeah, you guessed it - they're hard to find. That's why we'll always run a concentrated portfolio.
"Big Opportunities come infrequently. When it rains gold, reach for a bucket, not a thimble." - WB
Wag the Dog.
The latest sell-off in the market was instigated by the bond market - by long-dated bond rates rising (slightly) thereby signaling a possible hike in short-term interest rates. Tail wagging the dog? But the dog will likely remain steadfast in keeping the banking system as accommodative as possible to promote full employment. Here are some takes from the horse's (umm, dog's) mouth...
"...But a surge in demand and any inflationary bottlenecks would likely be transitory, as fiscal tailwinds to growth early this year are likely to transition to headwinds sometime thereafter..."
"...These changes mean that we will not tighten monetary policy solely in response to a strong labor market. The long-standing presumption that accommodation should be reduced preemptively when the unemployment rate nears estimates of the neutral rate in anticipation of high inflation that is unlikely to materialize risks an unwarranted loss of opportunity for many of the most economically vulnerable Americans."
The Tech Stack
As Thomas Friedman put it, "the world is flat". India's Tech Stack is a prime example of this. In some way, the "third world" is leapfrogging the "first world". Check out our India Newsletter on Substack.
Berkshire's results helped by "old world" companies. But...
Berkshire Hathaway reported results this weekend. I'm not going to go through a laundry list of numbers. But I'd like to point out something that caught my attention. Berkshire's 2020 results were pumped up by both tech holdings and "old world", asset-heavy holding in railroad and oil. But it sounds like Buffett wants more tech investments. He says:
"Our leadership in fixed-asset ownership, I should add, does not, in itself, signal an investment triumph. The best results occur at companies that require minimal assets to conduct high-margin businesses – and offer goods or services that will expand their sales volume with only minor needs for additional capital. We, in fact, own a few of these exceptional businesses, but they are relatively small and, at best, grow slowly."
"Companies that require minimal capital to conduct high-margin businesses..." sounds like software. Recall that Berkshire recently invested in Snowflake - a cloud-based database management software company. The story seems to be that Buffett's words above seem to signal a transition in the way Berkshire manages money. What worked for the last 40 years under Buffett may not work for the next 40. And that Snowflake investment may be the harbinger.
Stellar results! Yawn.
Two of our holdings - Palo Alto Networks and Nvidia - reported very good earnings. But Mr. Market wanted more. Or not - maybe these reports just coincided with the bond-induced rout that took place. Both these company had a great 2020. Palo Alto's revenue grew 25%. Nvidia's full year revenue grew 53%!
To be fair to Mr. Market, both these stocks are trading at high prices. At The Buylyst, we generally like to stick to our "global dominators" regardless of their price - IF we bought these stocks are cheap prices in the first place. Of the two holdings here, we're more inclined to stick with Nvidia as long it dominates the world of GPUs (Graphics Processing Chips). AMD is Nvidia's only credible GPU competition, but that's more in the gaming market. In AI and Data Centers, Nvidia is the undisputed heavyweight champion.
Car companies are in a bind. They're so heavily dependent of semiconductors that any supply disruption causes massive headaches. The interesting part of the story is that the power dynamics have changed. When cars were almost entirely mechanical, there was a whole supply-chain ecosystem developed around them. Now, it seems, the balance of power has shifted to suppliers - chip companies that produce highly sophisticated products. In many cases, these chip companies have very little or no competition. If they're constrained, car companies are constrained. As vehicles get more electrified and autonomous, this is will be a power dynamic to watch. Either way, chips are needed. And our largest holding - TSMC - gains from this. They manufacture chips for chip designers like NXP Semiconductors at scale. TSMC has noticed this trend of demand outstripping supply, which is why they're spending big money on beefing up their Automobile Chip manufacturing facilities.
Car companies are in a bind. They're so heavily dependent of semiconductors that any supply disruption causes massive headaches. The interesting part of the story is that the power dynamics have changed. When cars were almost entirely mechanical, there was a whole supply-chain ecosystem developed around them. Now, it seems, the balance of power has shifted to suppliers - chip companies that produce highly sophisticated products. In many cases, these chip companies have very little or no competition. If they're constrained, car companies are constrained. As vehicles get more electrified and autonomous, this is will be a power dynamic to watch. Either way, chips are needed. And our largest holding - TSMC - gains from this. They manufacture chips for chip designers like NXP Semiconductors at scale. TSMC has noticed this trend of demand outstripping supply, which is why they're spending big money on beefing up their Automobile Chip manufacturing facilities.
Bitcoin or Sh*itcoin?
Janet Yellen: Bitcoin is "extremely inefficient way to conducting transactions..."
Charlie Munger: “Since I never buy gold, I never buy any Bitcoin”.
Bill Gates: "My general thought would be that if you have less money than Elon, you should probably watch out".
Cathie Wood: "Market Cap could reach trillions of dollars..."
Elon Musk: "Prices seem a bit high..."
My question to both Cathie Wood and Elon: "How do you know what price it should trade at??"
Our Berkshire thesis is - fittingly - valuation-driven.
Do valuations matter? As you've guessed by now - to us, they do. Our Berkshire Hathaway investment thesis is almost entirely valuation-based. We asked ourselves, what do we need to believe about 3 main parts of their business:
- The Insurance & Private Investments part
- The famous Public Investments Portfolio
- The mountain of >$100 billon in cash on the balance sheet that they had.
When we estimated Berkshire's value (this was soon after the great Covid-19 crash), we had concluded that the stock was reasonably cheap. We bought some, and the bet paid off. The crux of the thesis was what we phrased as "the option-value of the cash on the Balance Sheet". While they've deployed some of that cash, there's still a long way to go.
The stock has reached our target valuation. If the stock moves up another 10% or so, we'll look for replacements. Until then, we'll let Warren, Charlie, Ted and Todd do their thing.
Bill Gates has a plan.
Bill Gates is on a roll. First, he was all over the news with the pandemic. And while he was doing that, he was quietly working on a book on the impending doom of Climate Change. There are a lot of conspiracy theories flying about - that Gates is secretly making money out of vaccines etc. - but I don't buy them. I think he's genuinely trying to do the right thing. He doesn't need or want more money. What he wants - in my opinion - is to be lionized like Steve Jobs. I mean, I'm sure he's genuinely concerned about global problems like malaria, drinking water, pandemics, climate change etc., but I've been trying to think of what it is that drives him day-to-day. There's got to be an extra something.
I think that he thinks that...he doesn't get his fair share of credit for changing the world as Jobs does. He's treated like a Salieri when he's just as much of a Mozart. I think that irks him; it would irk me but maybe Gates is a more I mean, a new version of Excel is just not as cool as the new iPhone, but Excel may is ubiquitous! Windows is much more popular than Macintosh! I wonder whether it's unfair that Bill doesn't get the same hero-like status. Also, I think Bill genuinely loves investing, especially in fascinating new science-y things that will potentially change the world. I think he enjoys the art of investing almost as much as his good friend Warren does. I, for one, am glad that Bill Gates is spending all his time, energy and money in making our world a better place. If it's legacy that's driving him, I don't mind at all.
In the meantime, we're always on the lookout for a new Renewable Energy investment idea - that's public and liquid. Our Vestas bet has worked out well. But we may need to replace it soon. We've held the stock for almost 3 years.
There is a related issue that's been gaining momentum - the blame laid on Wind Turbines for the power outage in Texas. What happened in Texas is a tragedy. Texas, you might be surprised to know, leads the US in terms of Wind Turbine installations. But the turbines were not to be blamed for the power outages. Natural Gas and Coal power plants shut down too. The problem was that Texas's power market is not conveniently connected to the rest of the country. Maybe this tragedy will make ERCOT, Texas's power market regime, rethink it's almost extreme independence. ERCOT, in my view, should have deeper connections with neighboring power market regimes.
Blunder down Under
It's a bizarre story from down-under - the Australian government mandating Facebook and Google to pay for news links that users share. The Australian government contends that most people get their news from these platforms, which, therefore, gain from this increased engagement. Meanwhile, traditional news organizations miss out on all the advertising dollars. I don't fully agree with this.
I'm no fan of Facebook and their revenue-maximizing conduct under the garb of "free speech". But it seems to me that the Australian government has gone too far. The contention that Facebook and Google are in some way "stealing" content and depriving traditional news companies of revenue is a bit of a stretch. It's how the people want their news. That's not good, or bad, but it is what it is. Facebook's content - it's feed - is based on ads (mostly) and posts by friends and family (if you can find them amongst the barrage of ads). If I share a Washington Post article with you, why should Facebook pay for my actions? One reason could be that they're constantly collecting my behavior data from which they gain advertising dollars; news organizations want a piece of this. I dunno....
With Google, I'm a little less conflicted. Google has a News tab that is filled with content from News Organizations. They gain from this - because users like me prefer this one-stop-shop for biggest headlines fo the day. Google presumably gains because they're constantly collection my behavior data, and they get a repeat customer (my psychographic data) because I've personalized my page with news content that some journalists have worked hard at. These journalists should get paid somehow. But what is a fair payment?
My take at the moment is this: News Organizations should think of Google and Facebook as free or paid advertising for - this is important - their subscription-based news model. New York Times, for example, has famously switched to a predominantly subscription-based model from a failing advertising-based model. They've done it quietly over the last 8-10 years. Others, like the Washington Post, have followed.
Maybe I'm biased and wrong, but to me a "my content is so good - please pay me for my hard work if you like it" is a much more sustainable model than "my content is so good - please watch or read my stuff so that big, giant corporations can post ads which will ruin your experience while you read my brilliant content...".
Our long-term semiconductor bet is paying off.
- There's a big chip shortage for all things computerized - which is in basically everything. PlayStations, TVs, Cars, and even Washing Machines are cautious about supply-chain roadblocks because of chips. Chip companies can't keep up with demand. That's not a bad thing for us.
- Our biggest thematic bet in our portfolio is AI & Big Data, and our biggest conduit for the last 2.5 years has been semiconductor companies. Our largest holding is still TSMC - the world's largest semiconductor manufacturer. With pent up demand, which we anticipated a while ago, we're in no hurry to reduce our semiconductor exposure. This is decade-long bet, at least.
- In other AI & Big Data news, Microsoft keeps raking in the $$$. Nadella's strategy of "cloudifying" Windows and Office, and making Azure a formidable competitor to Amazon AWS is paying off handsomely. We're still holding on to them despite their high price because they're still a Global Dominator in what they do.
- Maybe the biggest story in the Art of Investing is Elon Musk's apparent endorsement of Bitcoin, which has propelled Bitcoin to new heights. We're still skeptical about cryptocurrencies as viable currencies. We think that, at best, they're commodities (like Gold or Silver) - without any intrinsic use.
- If that wasn't crazy enough, there's a new trend on Wall Street called SPACs - Special Purpose Acquisition Companies. These are companies that behave like publicly-traded Venture Capital firms. So, you and I may buy shares of a SPAC because, you know, maybe the guy who runs it is a genius and we know that he'll make great acquisitions and take 'em public so we can all make good money. The New York Times has a piece on SPACs that explains why this new trend is a sign of bubbly times.
Full Speed ahead.
- The global chip shortage is affecting car production. Modern cars are basically small data-centers that roam around on streets. They're more computerized than mechanical these days. But TSMC - the largest semiconductor manufacture in the world and our largest holding is dedicating billions to Chips for Autonomous Vehicles.
Let there be light.
- One of our recent holdings (and a stock we've held in the past) - Lumentum - is trying to buy a company called Coherent, which is a Photonics Technology company. What is Photonics? It's about doing stuff - like transmitting and reading information - using light instead of electrical 1s and 0s. The funny thing is that Lumentum's bid for Coherent attracted other bids (at least 2 others). Now it's a bidding war. We don't know what Lumentum's management will do about the war, but we sure hope that they don't overpay (winner's curse). Lumentum's stock has taken a beating in recent days because of this proposed acquisition. But we're still happy holders of this cutting-edge photonics company. By the way, here's a cool video about photonics and fiber optics that we had used in our Lumentum thesis.
- This is our most "top-down" bet in the portfolio. Usually, for all the other investment themes mentioned here, we zoom in from 30,000 feet to find one or two companies that are spearheading one of these big, broad, civilization-scale changes. In Healthcare, we deferred to a more "passive" approach. But then extraordinary situations...extraordinary measures. Last week, we referred to the Annual Letter from Bill and Melinda Gates - they called for massive spending in Healthcare, globally. It may be already happening. Spending in Asia for basic healthcare equipment - masks, gowns etc. - is already projected to grow at nearly 10% a year over the next decade. India, for example, more than doubled it's healthcare budget just a few days ago! Speakin' of India...
- Check out our India Newsletter on Substack. This week, our India Expert - Manab Sen - talks about the Farmer Protests, Banking (our main conduit to India's growth potential) and Digital Banking.
Need to look harder.
- We don't have any "pure" Industry 4.0 holdings at the moment. We used to hold FLIR Systems until recently, which we had classified as Industry 4.0. But we sold our position because it reached its Target Valuation. However we're in no real hurry because the thing is that many of our holdings actually are already exposed to the digitization of factories. Digitization involves semiconductors. And our portfolio is quite semiconductor-heavy. However, we're always on the lookout for a good Industry 4.0 company. We're looking at you Analog Chipmakers!
One app to rule them all...
We invested in Paypal as soon as we found an opportunity during the March 2020 crash. And it's paid off handsomely. We were always confident that a cashless, contactless, card-less society is inevitable (it may take decades). But, honestly, the run-up in the PYPL has surprised us. Of course, their Q4 2020 results are fantastic - 22% growth in revenue, 33% growth in payment volume. Our thesis was that it aims to be the "platform of platforms" - the one app you'd need to pay anyone - P2P, B2B, B2C...Digital payments are here to stay.
People are bored, and that's paying off for us.
- If we take a look at all the latest earnings calls in our Media & Entertainment theme, they've all been great in a tough year. But it's not all that surprising, given that we are one big, bored world. Streaming and Social Media stocks have appreciated significantly in a Covid-19 world. Disney is the latest of our holdings to reach our valuation estimate, on the back of Disney+ which was the crux of our thesis. But we're in no hurry to sell. There are things that the pandemic has changed forever. Streaming and E-Commerce are just too convenient - pandemic or not. Our positions in Disney+ and Pinterest reflect that long-term, irreversible phenomenon. We're waiting to pounce on Netflix if there's a market crash. Our valuation of NFLX is just a shade above $600.
The pandemic's silver lining...
Something good came out of this horrible pandemic. We humans created less nasty fumes because we weren't allowed to move freely. Sucks for us, but animals say thanks!
People are spreading out...
Check out this data from Zumper. In the US, rents fell dramatically - by 20% - in the top 8 cities in 2020 but actually rose a bit in Tier-2 cities. People seem to be migrating. This could be another long-lasting Covid-19 legacy.
Lumentum reports solid FY 2021 Q2 (CY 2020 Q4) earnings.
Lumentum reported sold revenue and earnings growth and an optimistic outlook but the stock dropped almost 8% after numbers came out. Why? Their outlook wasn’t as rosy as some on the street expected. This doesn’t faze us. The drivers of our BUY thesis are still in play. Here are some snippets from the call:
- Revenue grew 4.6%. Operating Income grew 54%.
- They achieved their highest gross margin: 48% (GAAP), 53% (Non-GAAP).
- Management is very bullish on all the megatrends.
- Digital Transformation – moving data to the Cloud.
- High speed network – 5G, photonic solutions, advanced ROADMs.
- LiDAR for Autonomous Vehicles.
- Lumentum recently acquired Coherent to beef up its photonics portfolio. Photonics – the use of light rather electricity in transmitting data – is a new thing. The use-cases are plenty:
- 5G data transmission
- Semiconductor manufacturing, especially photonic chips
- Energy storage (I don’t know how but that’s something management mentioned)
- Lumentum’s leading face recognition technology (used in iPhones) is slowly but surely making its way through the Android universe.
- “World-facing” computational photography is the next big thing.
- About the Huawei situation:
- We remember clearly when Lumentum stock sank nearly 40% because of the Trump trade war and embargo on Huawei. This was back in 2019. Huawei was a big client.
- Huawei is no longer a client. And management tells us that the demand for high-end chips used in 5G backhaul equipment has now been replaced by a “western competitor”. Our best guess is Ericsson.
- Finally, Management is bullish about the future. They expect to meet or exceed the financial targets they set for 2021. Somehow this wasn’t good enough for the Street.
IBM keeps disappointing.
IBM’s Q4 2020 results disappointed, as usual. The company has a new CEO (as of April 2020) but it’s still searching for an identity. Revenue was down 8% year-over-year in Q4. But for the full year 2020, revenue was down 4%. IBM’s free cash flow – at around $10 billion – has remained steadfast over the last couple of years. CEO Arvind Krishna and CFO Jim Kavanaugh mentioned in the earnings call that they expect Free Cash Flow to climb to $12-13 billion by 2022. Using our customary valuation multiple of 20X Free Cash Flow for companies with durable competitive advantages, it would put IBM’s valuation at more than $200 billion. IBM currently trades at a market cap of around $106 billion. The upside is massive…IF
…IF there is a durable competitive advantage. Clearly the market doesn’t think so. Our IBM thesis was dependent on the company’s ability to become THE DATA INFERENCE FIRM. The combination of it’s Cloud offering and it’s AI applications could be a potent value-add to clients as they move most of their workloads to public or private Clouds. IBM’s Cloud business is the silver lining – in 2020, for example, Cloud Revenue grew 20%.
IBM’s other businesses are the laggards – AI Software, Servers, Consulting, and IT Services. CEO Krishna is determined to spin off IT Services and parts of the Consulting business to a separate company, still called “NewCo”. He wants to keep IBM purely focused on Hybrid Cloud and AI.
We’ve been patient investors for more than 2 years now, with no returns to speak of from this investment. While Free Cash Flow has been stable, more or less, we’re having a hard time visualizing IBM’s durable competitive advantage. The RedHat acquisition was expensive but it may pay off. RedHat makes container software that allows companies and their developers to migrate entire applications to the Cloud in an easy, secure way. But what’s unclear is how IBM adds value via software after that happens. Its AI offering is hard to visualize.
When we had written our original thesis back in 2018, we had expected IBM to put the Watson debacle behind it and offer tailor-made differentiated AI solutions to its clients in industries like Banking or Pharmaceuticals on an IBM Cloud Platform-as-a-Service (PaaS). We don’t see any evidence of that or any talk of it. But there is a reason the company generates $10 billion in Free Cash Flow. Going forward, will it translate to a durable competitive advantage?
Electronic Arts posts solid Q3 FY 2021 (Q4 CY 2020) results. But stock falls.
These were some of the highlights from the earnings call:
- Delivered record net bookings driven by live services outperformance
- Raised the full year net bookings outlook and forecasted growth for next fiscal year
- Delivered a record TTM operating cash flow
But Wall Street was disappointed because Management’s FY 2021 revenue forecast was lower than expected. Management guided us to a $5.6 billion revenue number for the 12 months ending June 30th, 2021. This compares to $5.8 billion in revenue for the 12 months ending December 31st, 2020. We can see why some investors may be disappointed.
However, we’re holding on to EA unless we see a better investment opportunity among its videogame rivals Activision, Take-Two and Nintendo. EA is one of the dominators in this space with a safe niche that it’s carved out for itself. Our thesis remains intact even though EA stock has exceeded our valuation of it.
Spotify reports significant revenue and user growth. But stock falls.
Here are a few highlights:
- Monthly Active users grew 27% year over year (yoy) to 345 million.
- Premium subscribers grew 24% yoy to 155 million.
- Revenue in Q4 2020 grew 17% yoy to 2.2 billion Euros.
All this is good, but Wall Street was disappointed with lower earnings. Now, at The Buylyst, we don’t care about earnings or Net Income – as defined by the US Generally Accepted Accounting Principles. We focus on Free Cash Flow because it’s a clean number. Either way, one quarter doesn’t make a big difference to us if the fundamentals of the company remain unchanged. In Spotify’s case, the fundamentals are intact.
It’s still a Global Dominator in what it does, rivalled only by Apple Music. In our Spotify Thesis, one of the central pillars was the prospect of Spotify dominating the entire Android phone market. Our assumptions were aggressive, but they’re still believable.
- No of smartphones in the world: Roughly 3.5 billion.
- Assume “Music Streaming Penetration” of 80%.
- Spotify Market Share: 30% (with Apple, Amazon and Tencent dominating the rest)
- Number of Monthly Active Users: 924 million (3.5 billion x 80% x 33%)
- Paid Subscribers: 370 million (assumed 40% in line with current ratio)
- Ad-Supported: 554 million (assumed 60%)
- Average Monthly Revenue per month from Paid Subs: $4.5
- Expect this will decrease to maintain high market share.
- Paid Subs Revenue = 370 million * $4.5 * 12 = Roughly $20 billion.
- Advertising Revenue: Not counting.
- Total Revenue: $20 billion.
At current run-rate + some marginal growth, Spotify is on its way to $10 billion in revenue – about halfway to our scenario. We expect more growth in international markets.
But the truth is that Spotify is trading at giddy prices – at around $318 as I write this. That’s much above our valuation of $179. Normally, we’d be tempted to take our profits and find other opportunities. But Spotify is a rare global dominator with very little competition, offering a product that brings joy to hundreds of millions of people. Unless we find a blindingly good investment opportunity to replace it, we’re hanging on to SPOT.
Bill Gates copies our Healthcare Worldview. Kidding! Sort of.
Bill and Melinda Gates recently wrote an open letter about the pandemic and how it has changed the world permanently. They were confident that the world will see another pandemic sooner than most people expect and offered up some suggestions on how we can be prepared to fight it. Here’s an excerpt I liked:
“Stopping the next pandemic will require spending tens of billions of dollars per year—a big investment, but remember that the COVID-19 pandemic is estimated to cost the world $28 trillion. The world needs to spend billions to save trillions (and prevent millions of deaths). I think of this as the best and most cost-efficient insurance policy the world could buy.”
This echoes our investment thesis on Investing in Healthcare. We’re convinced that a large-scale doubling or tripling of healthcare spending is necessary and, more importantly, that it will be acted upon, at least partially. We see our investment in Global Healthcare as an Option – a Call Option on governments doing what’s necessary to be ready to handle another pandemic. If they do, the upside is meaty; if they don’t, our loss is limited.
Investing in India, demystified.
In this week’s Investing in India newsletter:
- India controls the pandemic.
- IMF now cautiously bullish on India.
- Big Spender – Modi Government.
- World accelerates investments in India.
Something good came out of this pandemic.
It seems that the world got a little cleaner, a little greener:
Micron suddenly finds wings.
For most of our existence, Micron has been a portfolio laggard. We had bought into the stock in the summer of 2018, and until recently it had almost always traded below our purchase price (around $60 per share). It was frustrating to watch this stock go nowhere for 2.5 years. Why did this happen? Micron’s stock seems to move in tandem with DRAM memory prices. Now, DRAM has become a commodity, which is why most DRAM companies have gone out of business over the last decade. Three companies remain standing – Samsung, SK Hynix and Micron – and now it’s a triopoly. This was a big part of our thesis – that supply-demand imbalances would be less severe with only 3 large players.
Our Micron Thesis was also based on:
- Volume: the exponentially greater need for memory with the advent of AI and the data explosion.
- Product Differentiation: the bet that the lines between Memory and Logic in semiconductor chips will start blurring, thereby making Memory technology less commoditized.
The first part played out as per script. The second part is still unclear. We believe that as more AI-heavy technologies take center-stage in our lives, Memory will become a more specialized technology. But nobody knows when that will happen.
Having said all this, Micron’s stock has found enthusiastic buyers in the last couple of months. What has changed? It’s the same old cyclical datapoint: DRAM pricing. Forecasts are rosy today. They won’t be next month or next quarter. We’ve seen these cycles for the last 2.5 years.
Despite Mr. Market’s constant swings from enthusiasm to despair about Micron’s prospects, we’ve been steadfast in our valuation estimate of Micron at $100 per share. We will probably sell if the stock gets close to that level unless the Product Differentiation part of our thesis materializes in a big way. If that happens, we’ll revaluate Micron. If not, we’ll probably exit at around $100.
TSMC continues dominating.
TSMC has crossed our (recently raised) valuation estimate by a significant margin now. The company released its Q4 2020 earnings last week and the numbers were brilliant. Full year 2020 revenue was up 25% compared to 2019. Imagine that – in a year marred by the pandemic and by economic shutdowns all over the world, this company has had its best year ever!
The explanation is simple: TSMC is THE global dominator of semiconductor manufacturing. Any major company not named Samsung or Intel has probably recruited TSMC to manufacture their chips at some point. TSMC’s current client list includes the who’s who of the semiconductor industry – AMD, Nvidia, Xilinx, Qualcomm and Apple among others.
In this latest quarter, TSMC’s massive profit was driven by industry-leading 5 nanometer chips in Smartphones. Their HPC or High-Performance Computing segment (chips for AI and Cloud Datacenters) also contributed significantly. It’s heartening to see that TSMC’s investment in getting a lead on the incredibly difficult 5nm node is paying off. The company has bet decisively on increasing its manufacturing capability over rivals like Intel, Samsung and Global Foundries.
TSMC’s management is resolute on spending whatever it takes to increase its manufacturing lead. Their Capital Expenditure Budget dwarfs its rivals. It looks like they’re going for the jugular – they want to dominate semiconductor manufacturing. This is one of those cases where we’re confident that the massive amount reinvested in the business will widen the Moat. So, we don’t mind the high Capex.
The biggest risk in this story is China. What will be China’s policy towards Taiwan? It’s no secret that China’s highly coordinated public policy includes some sort of a “tech dominance” goal. If China can’t beat TSMC, will they orchestrate a hostile takeover?
In the coming weeks, we will evaluate the China risk. In the meantime, we continue to hold TSMC at a 5% target weight.
Intel gets a new CEO.
While our largest holding, TSMC, is dominating, Intel is scrambling. The company recently announced a CEO change – from Intel veteran Bob Swan to an outside hire – Pat Gelsinger (from VMWare). We’re not sure if this will solve Intel’s problems. But there’s always hope with a new CEO.
Intel’s main problem is this: The possibility that its ubiquitous X86 CPU architecture will either become obsolete in the next 5-10 years, and while that happens, Intel may not be able to transform into an “XPU” company (from a CPU company) in good time. Then there’s the constant threat that rival AMD will keep chipping at Intel’s market share.
We held Intel shares for a while, but we got rid of our exposure the moment Apple announced that it will transition the Mac line from Intel chips to Apple’s custom in-house, ARM-based chips. The lost revenue for Intel wasn’t the main concern; it was the long-term implication of Apple’s move. Here’s our rationale.
Bitcoin has gone crazy. No FOMO here.
We have nothing against cryptocurrencies. But we don’t see how they can be viable currencies. We think Bitcoin is a commodity (albeit without any intrinsic use) built for speculation. The main characteristics of a currency are:
- Store of value
- Medium of exchange
- Unit of account
There is a 4th characteristic of money that binds all of the above – Stability. A currency is no good if one can’t be reasonably confident that its purchasing power will not remain the same in 6 months or a year or even 3 years. Bitcoin doesn’t pass this test because of a very simple reason – it is disconnected from the real economy (just like Gold).
We’ve gone into detail about how the fiat currency system (the one we use now) generally works even if it’s not perfect – the gist is that central banks in most major economies have figured out from past mistakes how to maintain price stability. It’s a mandate which many central banks around the world take seriously. Inflation is literally their primary barometer.
Price Stability is important. Without that a currency is a commodity whose prices are driven by supply-demand imbalances. Speculation on supply-demand imbalances affects consumption, savings and investment in real economy – where people buy and sell products & services. Then it no longer remains a “store” of value, but rather a (theoretical) “grower” of value. That’s not a currency.
Buy cryptocurrencies if you must. But go in with your eyes open. They will never be a “currency” unless their supply and demand are connected to real economy variables such as:
- Profit Markup
- ….and so on.
The Gold Standard – a commodity-based currency system which Bitcoin’s creator Satoshi Nakamoto seems to support – failed for a reason. It was disconnected from the real economy.
If you’re into Cryptos, here’s an interesting trading strategy – the answer is in the stars! Just kidding.
Index Funds distorting the market?
Bloomberg is now reporting on Index Funds potentially distorting the equity markets. It made us want to say, “…you know, ‘I told you so’ somehow just doesn’t quite capture it…”.
Some time ago we did research on this topic. We had noticed a marked change in price behavior of US stocks since the Great Financial Crisis of 2009. We did some number crunching – our hypothesis that this was due to the rise in “Passive Indexing” became a viable theory.
The one factor that we found hard to isolate (maybe some expert quants can guide us) was the change in Monetary Policy. There’s a fashionable theory going around nowadays that it’s this highly accommodative monetary policy that’s driving equity markets to bubbly valuations. It’s hard for us to quantify this effect.
Thematic Funds - a scam?
This one caught our attention because we pride ourselves on thematic research. This article makes the fundamental (and correct) point that it’s risky to bet heavily on a thematic fund focused on one theme. At The Buylyst, we invest in 10-12 themes, which we collectively like to call PROGRESS. It’s also worth stressing that the point of our thematic research is not to ride the wave but to minimize our risks – we treat the potential upside as positive optionality and, at a minimum, we just don’t want to play the wrong sport.
Most importantly, between our 10-12 themes of Progress, The Buylyst Portfolio (or 20-30 stocks and ETFs) is well-diversified – enough to hold most of our money. We don’t find the need to diversify across hundreds of stocks and a myriad of asset classes. Our goal is double-digit annualized returns over the long-term and we can do that with 20-30 stocks, while sleeping well at night.
Our first and (maybe last) ETF holding.
We did something naughty – we took the short-cut and bought an ETF – a Healthcare ETF called XLV. Mostly, it’s because we want to stay invested in Healthcare but, sadly, we don’t have the expertise to have a nuanced view on pharma, biotech, and healthcare tech companies. However, we were able to estimate the “revenue growth rate we would need to believe” for each of XLV’s constituents. The weighted-average estimate of 42% - cumulative revenue growth we’d need to believe – was, well, believable. We’ll probably hold XLV for a few years unless we see the Healthcare industry go through a terrible recession.
India’s demographic trends - dividend or liability?
Our in-house India expert, Manab Sen, puts some tangible numbers around the cliché – “India’s demographic dividend”. It’s a young country, hungry to restore its lost pride and catch up with the developed world. But that requires as set of bold economic policies, the likes of which the country hasn’t seen since Dr. Manmohan Singh’s Liberalization Plan of 1991.
Check out Manab Sen’s Weekly post on The Buylyst India Newletter on Subsctack.
Teledyne’s buying FLIR. We’re selling.
We had bought FLIR in the middle of the pandemic. We had been watching the company and its stock for a while – ever since we explored Virtual Reality. During the early months of the pandemic, when everything was trading at a significant discount, FLIR caught our attention because they had been among the largest suppliers of temperature scanning technology used in many airports and offices. We had surmised that demand for this type of technology won’t subside too much even if this particular pandemic is successfully quelled. And heat-sensing technology has many other applications, not least of which is in our Industry 4.0 theme (digitization of factories).
It turns out that Teledyne, another industrial technology company, probably had the same thesis. News of the (pending) purchase of FLIR helped its stock reach new heights, and it’s past our valuation estimate. While we still like the FLIR story, especially because our thesis hasn’t completely played out yet, we will be selling our stake over the next few weeks because:
- FLIR is not exactly a “global dominator” and…
- We are actively looking to limit our portfolio to under 25 holdings.
What’s up with WhatsApp?
Everyone’s scared of Facebook snooping around their WhatsApp messages. There was a week of (ironically) misinformation spreading on WhatsApp about WhatsApp. It showed the level of distrust people already have with Facebook. The default assumption is that Mark Zuckerberg will steal whatever data he needs to make Facebook more profitable. Whatsapp, which Facebook acquired for $19 billion back in 2014, is yet to become a significant cash generator. It’s about time, isn’t it?
The rumor is that Zuck will use private content in messages to improve ad-targeting on Facebook and Instagram. This would be the easiest path for Facebook. But it’s a bad PR move. Recall also that, not too long ago, the creators of WhatsApp had a fallout with Zuck over the privacy issue. Facebook went on a charm offensive to quell fears about WhatsApp’s famous end-to-end encryption being eroded.
WhatsApp is a massive force with more than 2 billion users. Facebook hasn’t quite figured out how to monetize this behemoth. They’ve given some hints – about installing a payments mechanism on WhatsApp, for example. But specific monetization plans are still missing.
In our opinion, WhatsApp (and its possible integration with Facebook and Instagram for commerce) is the big upside in the Facebook story. It is under-covered and undervalued in the US because most Americans never really warmed up to WhatsApp. And it takes imagination (even on Zuck’s part) to assign a value to it. We are not deterred by any requirements of precise valuations. We will rely on our tried, tested and logical method of Expectations Investing – we’ll back-solve into what growth assumptions are required to justify buying the stock and then make a subjective assessment of whether that’s feasible.
Facebook is on our to-do list.
Salesforce buys Slack for 27 billion. What should we do?
We have Salesforce on our Watch Lists. Before this deal was struck, here’s what our Watch Lists suggested: We’d have to believe a revenue growth rate of 128% to buy into Salesforce. Is that believable after the Slack acquisition?
It depends on execution. Salesforce had also bought data visualization company Tableau a couple of years ago. Now they’re buying a messaging application. You could argue that if Salesforce seamlessly combines its core product with the capabilities of Tableau and Slack, they can be the best CRM company in the world by a mile.
The big threat now is Microsoft – with Teams and Dynamics 365. Microsoft’s big advantage is Microsoft Office – which is meant to latch on to any other Microsoft product to make office work seamless. But Microsoft has never really excelled (pardon the pun) at integrating its various strengths to create a cohesive experience. Salesforce has the opportunity to do that with the Slack acquisition.
We will be digging into find out if the Slack acquisition – when (theoretically) combined with the core product and Tableau – make Salesforce an attractive buy.
Why PS5 will win the console battle.
Tae Kim at Bloomberg makes a good case for the PS5. In his view, the PS5 will massively outperform the latest Xbox release because of Sony’s investment in gaming software. It makes sense because Sony’s main bread-and-butter is Gaming. For Microsoft, Gaming is a side project. What surprised us about this article was the fact that "Microsoft had no new games ready for its first console launch in seven years…"
We’re holders of stocks in both companies but for different reasons. Sony’s thesis hinges on it’s newfound ability to stabilize cash flow volatility and become less cyclical. Microsoft is a Cloud Tech play - it’s dominance in “productivity software” and it’s entrenched position in the Enterprise market (offices etc.) are unmatched.
Spotify’s bull run has been fantastic. Is it time to sell?
The short answer is No.
Spotify’s stock price has far exceeded our Mach 2020 valuation of around $180. The stock now trades at close to $322 per share as of writing this. Yes, we’ve let it run wildly. But we’ve held on to it because it is a Global Dominator. Our thesis was hinged on the assumption that Spotify would corner the entire Android market. We had made some aggressive assumptions about its market share within a massive total addressable market. So, it’s tempting to conclude that the stock is ridiculously overvalued. We ran it through our Expectations Investing test of “what do we need to believe in order to buy this stock?”. It turns out we need to believe that revenue will grow by 225% over the last-12-months level. Is that believable? Well, let’s see.
Number of Monthly Active Users - Spotify: 320 million
Number of Paid Subscribers - Spotify: 144 million
Number of Android Users (global) - Android: 2,000 million.
There is room on the upside. Can Spotify end up with, say, 300 million subscribers? That would mean a 15% market penetration rate in the Android community. Believable? Yes. Probable? Maybe. But the real reason we’ve held on to the stock is because it is a Global Dominator - a scalable, software product that has limited competition (Apple and Amazon). We weren’t in a hurry to replace it and we still aren’t. It does, however, require a revaluation.
Think of Stocks as Options. What?
Many years ago, I got one of the most salient lessons on investing in a small “fireside chat” at Carnegie Mellon. The main guest was David Tepper. When asked about his investment philosophy, he said (and I’m paraphrasing), “I look for free options...”.
It didn’t click at the time, probably because I had just spent the previous week wrestling with the idea of Risk-Neutral Option Pricing Theory.
But over time, I got it. Even in good ole plain-vanilla long-only equity investing, we need to look for “free options". OK, it’s almost impossible to find “free options” - this implies NO risk, which is extremely rare. "Cheap Options", however, implies manageable risk - these are easier to find. Look for Cheap Options.
Think of stocks as out-of-the-money call options with no expiry date. However, unlike actual Call Options, you’re not paying for the right to buy the underlying stock at a certain pre-determined price. Think of a stock as paying a premium to buy the upside from the underlying story – the future economic prospects of the underlying company.
Sure, you’re paying more up-front, and there is less of a leverage effect. But you also have no expiration date on this positive optionality, which is a massive plus point.
This option on the story – manifesting as potential free cash flow – will be cheap if you buy the story at a cheap price. That’s possible when you find a long-term growth story that’s underpriced in the stock. Back-solving into implied expectations in a stock price is more art than science. It’s a guesstimate. This is Expectations Investing.
Buy Low Expectations. Buy at a considerable Margin of Safety. Reduce your probability of the downside. And hope for the best on the upside.
Value Investing - usually associated with Warren Buffett - has had a rough go over the last few years.
Now The Economist is dissing Value Investing as well. But the problem isn't so much a failure to calibrated ROI on Intangible Assets as they have described. The main problems with Value Investing are as follows...
1. ...The complete disregard for a well-formed Thematic Worldview in investing. Where is the world heading? How is civilization progressing? "Purely Bottom-Up" became a selling point for asset managers, as if that's a great sign of discipline. No point buying buying the cheapest company in a structurally declining industry. Good Luck fighting that headwind.
2. ...The general acceptance of Accounting numbers like Book Value or Net Income as reliable indicators. We all love short-cuts but ratios like Price/Book, Price/Earnings etc. are perilous.
3. ...The general acceptance of "Value" as an investment style - this came about after the lords of academic finance made up a statistical factor called Value. This was physics-envy, nothing more.
4. ...The notion that "there is no right or wrong investment; there is a right or wrong price...". This is dangerous. It may work for some asset classes (like High Yield Bonds where there is a theoretical lower bound) but it doesn't apply to equities.
Lumentum Q3 Earnings and outlook look good.
Lumentum is our most recent position. We were holders of this stock in 2019 and had exited our position before the great Covid crash of March 2020. That was part luck, part vigilance. Lumetum had far exceeded our target price of $90 by February 2020. However, since then, the company had beaten our expectations in terms of both size and stability of cash flow. That trend continues.
Our most recent thesis was focused on Lumentum’s prized 3D Sensing business. More specifically, baked into our estimate of sustainable revenue was our view that 3D Sensing (Face Recognition) revenue would double in the next few years. In Q3, 3D Sensing revenue grew strongly thanks to a strong mobile phone upgrade cycle (iPhone) and growth in the Android market. The latter holds the key to a big upside. About 85% of the world’s phones are Android-based, and 3D-Sensing has only reached the top-end phones.
Overall, Lumentum expects a strong Q4, followed by a strong 2021 - based primarily on proliferation of 5G infrastructure (fiber), datacenter interconnect growth (photonics), 3D-sensing gains in the Android market and the “moonshot” possibility of 3D-Sensing gains in the nascent Autonomous Vehicles market. It’s hard to put a number on each of these growth vectors. But we don’t need to; it turns out that we didn’t have to assume a lot of revenue growth to buy into the growth story.
Our valuation of Lumentum stand at around $111 per share. The latest Q3 earnings report reaffirms our conviction.
Nvidia earnings report smashes records - AI Inference has massive upside left.
Nvidia is our best performing holding to date. We had taken a position back in December 2018, and since then we haven’t looked back. A word of caution: our valuation of Nvidia is stale. We had valued it back in 2018, but since then it has surpassed our expectations. When Nvidia had reached our target valuation, we had trimmed our position from 5% to 3% of the portfolio. Every quarter or so, we rebalance our position back to 3% if the stock price appreciates significantly. Why are we still holding on despite its high valuation? Because it is a Global Dominator in what it does - making semiconductors (GPUs) for AI Training and Inference, and for video games.
Nvidia’s quarterly results are in the table below, so we won’t waste time repeating facts. But here are some salient points based on their recent earnings report:
The new Ampere architecture (a new generation design GPU for AI) is seeing strong demand.
The new A100 chip is gaining popularity in Machine Learning applications.
This is big: Nvidia estimates that its installed base of GPUs for AI Inference applications across the 7 major Cloud Hyperscalers exceeds the aggregate CPU installments.
Numbers support this guesstimate: Datacenter revenues were up 162% year-over-year.
However, the vast majority of AI Inference is still being down using CPUs, which is highly inefficient. This also suggests massive headroom in the addressable market.
Nvidia’s Omniverse product looked very interesting. It’s 3D modeling capability is a natural fit for one of our other Investment Themes - Industry 4.0.
Nvidia’s Economic Moat remains CUDA - its software stack used by Hardware engineers to optimize GPUs for specific tasks.
Palo Alto Networks earnings impresses the market.
Palo Alto is our main cybersecurity play. They are a giant in the field, and according to our channel checks they offer some of the most comprehensive cybersecurity tools. In this pandemic year, work-from-home has been a real tailwind for Palo Alto and its cybersecurity competitors. This reflected in the Q3 results as shown in the table below.
A few points need to be highlighted:
The business is now being reorganized into 2 units for more clarity and transparency:
Cloud & AI
This reorganization may seem minor but it highlights a salient transformation in the business: from hardware to software.
The “softwarization of hardware” in firewalls is a big source of potential upside in the business - while Network Security will still have a hardware sales, the Cloud & AI segment will be entirely software. CEO Arora reaffirmed that software contracts are signed based on data consumption rather than on a fixed-fee basis.
We were also told that Palo Alto now serves 70% fo the Fortune 100 companies. In cybserscurity, scale beats scale, so it is good to see this level of proliferation.
There are a couple of risks to our Palo Alto position:
The stock has exceeded our valuation. We are therefore, trimming the position down to 3%. We will exit if we find a better cybersecurity story.
Apple’s M1 chip is a paradigm shift.
Apple released new MacBooks furnished with the homegrown M1 chip, based on an ARM architecture. For a long time, Apple has been using Intel chips. Reviewers claim that the new MacBooks are faster, less noisy and longer-lasting. But is it a paradigm shift?
We discussed why it is a paradigm shift here in more detail here. The shift possibly kick-starts a mass exodus from the original grand daddy of CPUs - the Intel X86 architecture. In fact, when Apple announced a few months ago that it would move to it’s own ARM architecture-based chips, we immediately sold our position in Intel - not because of the impact to Intel’s cash flows but because of the impact on computing in general.
Bitcoin reaches record highs. But we still think of it as a speculative commodity, not as a viable currency.
Bitcoin prices are back to their 2017 highs. The reason is unclear but our best guess is that it’s a combination of:
The pre-built algorithm that halves the no. of new coins allowed to be mined. This raises the perceived value of existing coins.
Fear that the US dollar (and every major currency in the world) is at risk of devaluation due to the “do what it takes” approach to government spending in 2020.
Our approach on Bitcoin deserves another deep-dive. But we suspect that our opinion won’t change: At best, Bitcoin is a commodity, like Gold; it is not a viable currency. Here is our train of thought on Bitcoin:
Industry 4.0 is a multidimensional theme.
Our main Industry 4.0 holding is FLIR Systems. The theme is about investing in the inevitable fusion of sensory and digital realms. Light, sound, pressure etc. will be converted into digital data more and more over the next decade. The main avenues of investments are sensors, semiconductors and robots. The theme, therefore, straddles many of the our other investable themes. FLIR produces sensors cased inside devices that detect heat and light signals. They’ve generally been suppliers to militaries around the world, but they are now diversifying towards applications like Autonomous Cars.
But there are other holdings in our portfolio that have a sizable exposure to this theme. Sony, for example, is spending a bulk of its Capex in building out its CMOS sensor business, usually used in cameras. But they’re predicting demand in other vectors like Autonomous Cars and Robotics. Micron, for example, sees massive upside in digitized factories. TSMC - one of our largest holdings - also sees growth in IoT over the next few years.
One of the names on the Watch List that looks attractive is Qorvo. They make chips for IoT and Telecom Equipment devices. Qorvo also shows up on our 5G Watch List. We don’t know how to categorize it yet. Maybe we should create a catch-all theme called “Softwarization”.
Disney Earnings are all about Disney DTC (Disney+, ESPN+, Hulu, Star, Hotstar).
This was the first earnings report after CEO Bob Chapek publicly declared that Disney DTC will be the firm’s main product. Every other business line will be an ancillary product that exit to support DTC sales. Disney is walking the talk. Disney+ subscriber count reached 73 million, whereas the overall DTC lineup now has over 110 million subscribers. This compares to 195 million Netflix subscribers. But bear in mind that Disney+ has existed for only a year. The subscriber growth is a testament to their unmatched library of content.
Our Disney thesis is hinged on this “DTC first” model. We’ve made aggressive assumptions on subscriber growth but bear in mind that this is a play on the inevitable shift from linear braodcast TV to streaming. Just the growth potential in Asia alone accounts for ample positive optionality in this story. Also bear in mind that this is long-term play. Our assumption that Disney can generate about $15 billion in free cash flow if it successfully transitions to a DTC-first business will take a few year to materialize. How soon the market believes this type of FCF growth is anybody’s guess. We’re prepared to wait.
Vestas Wind Systems stays atop the Wind Turbine industry - revenue and free cash flow both growing.
Vestas was one of our first investments. We’ve held this company in our portfolio for 2.5 years, and boy has it paid off. The stock has far surpassed our initial valuation of $35 per share. But we held on to it because (as we suspected back in 2018), the company is dominating the Wind Turbine industry with little competition. One of its main competitors - GE - is drowning in its own mess. Siemens Gamesa and Goldwind are formidable competitors, but that’s the landscape - 3 or 4 dominators in a fast-growing business. Economies of scale makes a big difference in reducing costs.
We need to revisit our Vestas thesis and update our valuation. In doing so, we’ll try to break down estimates of revenue growth with some Price X Volume numbers. The Volume part of the equation - growth in Wind Generation - was never much in doubt. But pricing was always a danger. But the good news is that it seems to have stabilized. Here’s an important chart from their latest earnings presentation:
There were two other salient points that came out the most recent earnings call.
Massive growth in Asia-Pacific.
Massive increase in Service Revenue.
The last point is important. Growth in Service Revenue is a result of the size of Vestas’s installed base of Wind Turbines. This is a manifestation of a Moat - cash flows that are protected from competition.
Overall, we’ll be revisiting our thesis and valuation on Vestas. But we’ll probably hold on to it for a while.
New Healthcare Tech Theme initiated.
We are now initiating a 11th investment theme: Healthcare Equipment. This is, as you suspect, a reaction to the pandemic. But we’re looking forward 10, 20, 30 years, and the Covid-19 pandemic just gave this 21st century growth vector a booster shot. Combine that with the inevitabilities of an aging population in developed countries and rising incomes in developing countries, tailwind is hard to dispute. We can’t ignore it. However, we’ll stick to our knitting.
We are not going to publish opinions on, or invest in, trendy pharmaceutical or biotech companies. They’re far outside our circle of competency, and we prefer companies whose revenue we can break down into Price X Volume. So, we’ll focus on Healthcare Equipment instead. As always, we’ll prefer companies that make unique products with little or no competition.
Next week, we’ll publish a worldview article on this new them. But it will take a few weeks for us to zoom into find a worthy investment. In the meantime, we’ll start with a work-in-progress Watch List. You’ll find this in the Portfolio Page.
Notes on Capital Expenditure Split:
- 50% is assumed to Maintenance Capex.
- 50% is assumed to be Growth Capex.
- Growth Capex is not deducted to arrive at Free Cash Flow. The underlying is assumption is that the payoff on Growth Capex is virtually certain. This is consistent with our subjective view of the company.
- For the lates update on our subjective view, please read TSMC: Thesis Update 2020.
Please see rationale in The Sony-ssanece.
On revenue, we’ll go with Management’s FY 2020 projections as a substitute for our “Sustainable Level” numbers.
The rest of the assumptions are customary:
- Assume same EBITDA margins as last-12-monhts (LTM).
- Assume similar Capex levels.
- Assume similar tax rate.
Now, there is one big difference between LTM numbers and our sustainable numbers. We’ve assumed that Changes in Working Capital amount to $0, instead of the nearly $1.6 billion cash release Sony realized over the last 12 months. This puts a bit of a dampener on our Sustainable Free Cash Flow estimate. But it doesn’t change the conclusion.
The net result is that our estimate of Sony’s Sustainable Free Cash Flow reduces down to about $6.7 billion. That translates to a valuation of about $135 billion, or $106 per share. That’s still a 30%-ish upside from Sony’s current share price.
In short, we’ve assumed no growth in Sony’s overall business. All we’re really assuming is stability in its current cash flow profile – abetted by the continued role of subscriptions in its revenue stream. This assumption of cash flow stability is the big difference compared to our last deep-dive on the company. It’s good to be in the content business these days. And again, we believe the CMOS Sensors business can be a huge cash generator in a couple of years.
We see a lot of positive optionality in this Global Dominator. What’s great is that we don’t really need to pay up for partaking in the potential upside.
Some key assumptions:
- Growth Capital Expenditure not deducted in Free Cash Flow calculation. Assumption is that the investment will pay for itself - with no meaningful return on capital beyond and IRR of 0%.
- Assumed cash paid for acquisitions will be paid by debt or equity issuance. Assume that transaction will be leverage-neutral - the extra debt added to fund acquisition divided by the extra EBITDA will not be incremental.
Sustainable Free Cash Flow? About $16 billion. Translates to about $179 per share.
The main thrust of the assumptions below is this: The Parks, Media Networks and Studio Entertainment businesses will decline, while Disney DTC will grow to more than offset those declines.
About the declines, here are the main assumptions:
- Media Networks revenue will decline by 50%.
- Parks revenue will decline by 30%.
- Studio Entertainment revenue will decline by 50%.
- This is IMPORTANT: All costs will remain unchanged. No declines in costs – Production Costs, Costs of Labor, Market Costs – are assumed.
The rationale behind revenue decline in Media and Studio is simple: Much of the production will be given free to Disney DTC. And there will also be a decline in advertising revenue as Disney pares its Linear TV assets. Remember, the strategy is “digital-first”, with Disney+, ESPN+ and Hulu as the main storefronts. Everything else is either a content-feeder or a marketing tool.
The Parks business is still an attractive product. It will probably remain a rite of passage for many kids around the world. But we’ve assumed that the 2020 numbers – with basically a quarter written off – will be the “new normal”. Post-Covid19, people may travel less and spend less on discretionary items like Disneyworld. A 30% decline seems reasonable.
Assumption #4 is big because it is conservative. With a 30% decline in Parks revenue, for example, some variable costs will decrease. But we’re not assuming that. The same goes for Media Networks and Studios. However, one can look at it another way: A decrease in operating costs of Parks, Media and Studio will be offset by increased operating costs at Disney DTC. Net-net, we don’t want to assume any “cost-synergies”.
Here’s an important point: With the assumption made above – revenue declines combined with no declines in operating costs – those 3 “legacy” businesses end up just about breaking-even from a cash flow perspective. So, all the Free Cash Flow comes from Disney DTC.
About the DTC assumptions, here’s the rationale.
The underlying notion behind these assumptions is that Disney’s core product – it’s library of past, present and future content – is compelling and differentiated. Few would argue with that. But the real leap of faith is in Management’s ability to execute on Disney DTC and sell it to the world. If early numbers are any indication of future results, the leap of faith is less of a leap and more of a reasonable assumption.
- Capital Expenditures remain at similar levels.
- Working Capital needs revert back to 2018 levels.
- Debt levels – and cash interest charges – remain similar.
On #2, working capital increased significantly in 2019. There was a massive tax charge associated with the disposal of certain Twentieth Century Fox assets – like Fox News and some regional sports channels. The tax charge amounted to about $6.5 billion. This was expected, but it was a one-time charge. Going forward, it won’t be a factor.
Please see the Valuation Page for more details.
All things considered, here’s the bottom-line: If we assume that things will remain as they are now (after a return to some semblance of normalcy), the stock is just about fairly priced. However, if we assume that the DTC strategy will reach its full potential as the main storefront of Disney, there is lot of upside left in the stock.
The downside is manageable. The upside is big. That’s the kind of payoff profile we like. We rate Disney a BUY
It seems that Netflix is just about fairly priced as I write this. The question I wanted to answer was: What do I need to believe to buy this stock now? A lot, it appears. But it turns out that the key variable is not Revenue; it’s Cost of Goods Sold. The real question I’m left with is: How much do they need to keep spending to attract (and retain) subscribers?
Let’s take revenue first. Since, our view is that Netflix’s growth is hinged on International audiences, we broke out our assumptions by region. Here they are:
Our assumptions seem aggressive, but we’ve broken it out below. Yes, the scenario is debatable, but we think this is utterly achievable. This view is hinged on 3 assumptions:
- The transition from Linear-TV to Streaming will accelerate over the next 2 years.
- The competitive landscape won’t change much – Streaming will still be dominated by the “Big 3”: Netflix, Amazon and Disney.
- Netflix’s big spend on Original International Content will pay off in the next 2-3 years.
Here are the assumptions:
This type of revenue growth is believable if they keep spending on content. But we don’t know how much is enough. Here’s a believable scenario, however:
How about 1 new big-budget movie or show released per week per region? So, that’s 5 movies per week, at a budget of say, $100 million, per week. $500 million per week, equates to about $25 billion per year on content spend. This compares to about $17 billion they spend currently.
Then there are other cash costs. We’ve assumed that some of the fixed costs – like marketing – will increase. But these increases won’t be as drastic as COGS.
- Increase Maintenance Capex to $400 million from $291 million.
- Decrease Cash Paid of Interest to $100 million from $600 million. If Netflix gets close to a $40 billion revenue level, it won’t need debt to fund production.
- Assume Effective Tax Rate of 20%.
All these assumptions trickle down to a Free Cash Flow of $9.6 billion. And if slap on our standard 20X multiple on FCF, it translates to about $440 per share. Based on these assumptions, there is no Margin of Safety in NFLX stock.
All assumptions are debatable, but the most debatable one is COGS or the cost of production. We think it’s reasonable to assume that given Netflix strategy of Original Content on a global level AND with increased competition from Disney, Netflix will need to keep feeding the beast. However, we’re not assuming any “capital efficiency”, meaning that it’s possible that Netflix does less of “spray and pray” and figures out a more targeted way to invest in content. If that happens, then NFLX stock could sneak into “buy” territory. But for now, we’ll wait for one of two (preferably both) events:
- We do a deep-dive on Disney. Maybe, we change our $25 billion COGS assumption after a look at Disney’s strategy.
- There’s a panic-crash in the markets, and NFLX drops by 20% or more.
In the meantime, let’s find a new show!
Many Happy Returns.
- The Valuation table pertains to only the Insurance + Private Investments segment of Berkshire. This includes Railroad, Utilities and Energy assets but not the Public Equities portfolio.
- Valuation? $247 per share based on little to no growth expectations.
Compared to our usual method of valuation – of estimating Sustainable Free Cash Flow – and then slapping on a 20X multiple (a result of the assumption a 5% discount rate on Free Cash Flow to Shareholders) – Berkshire needs a different approach. Much of its value lies in assets that have a future payoff.
For reasons discussed here, it helps to look at Berkshire in 3 parts in our attempt to estimate a fair value.
- Private Investments + Insurance
- Investments in Public Companies
- Cash available to invest
We can use our normal 20X Sustainable FCF method on the Private Investments + Insurance part of the business. We assume Sustainable Free Cash Flow as a simple average of the last 3 years. That amounts to roughly $13.7 billion. We’ll assume just a 5% annualized return from this point on. Why? We’re being conservative. But we also have reservations about Berkshire’s Energy portfolio. We’ll assume that those investments will lose value, thereby offsetting most gains from Berkshire’s other private investments. If we slap on a 20X multiple to our Sustainable FCF estimate, we get roughly $275 billion. This is our estimate of how much the Private Investments + Insurance part of the business is worth.
As for Investments in Public Companies, we can attach a reasonable rate of return to the current portfolio of roughly $248 billion. We’ll take 5% here as well. The Airlines investments bother us, and we’ll assume that they’ll negate a lot of the meaningful returns from the other Public Investments.
Put together, the two groups of investments above are assumed to just about cover their cost of capital – which we assume to be the long-term interest rate of 5%. This makes our math easy. The present value of these two portfolios put together will be:
$275 billion + $248 billion = $523 billion.
And finally, we have the massive pile of cash that Berkshire has yet to invest. Right now, there’s about $120 billion on the balance sheet. We’ll keep the math simple here as well. We’ll assume a 5% return into perpetuity, at the cost of capital of 5%, thereby estimating the present value of this portfolio to be about $120 billion.
So, our final conservative estimate of Berkshire Hathaway’s net worth is:
$275 billion + $248 billion + $120 billion = $643 billion.
Their current book value is roughly $424 billion (as of the end of 2019). And their current market capitalization is about $457 billion. It’s trading at about 1X Book Value. Historically, this is around the lower end of things. Here’s the patter over the last 10 years:
At 1.3X Book Value – the long-term average over this time period – the implied market value of Berkshire should be roughly $551 billion, which is still higher than the current market value. In our (sort of) bottom up analysis, we think Berkshire should be worth roughly $640 billion. Maybe the truth lies somewhere in the middle. Let’s call it $600 billion. That would imply a share price of roughly $247 compared to the current price of about $184.
That’s a 30%-plus margin of safety between price and valuation. That’s big enough for us to take a bet on it.
Do valuations matter??
It seems like nothing matters anymore in the markets. Thanks to free online trading - a recent phenomenon - "meme stocks" are a thing now. There are a lot more "buy the story, brah!" or "f*** the system" or "it's the next Amazon, brah!" type of analyses flying around. Popular financial blogger Ben Carson makes the case the valuations won't matter for a long time! The GameStop episode was the poster-child for this phenomenon.
Whatever the current fashion is, I find that it's best to stick to some semblance of rationality rather than ride the FOMO bandwagon. This goes for any meme stock or cryptocurrency. If I can't estimate what it's worth based on how much money the asset makes with reasonable confidence, I can't buy it. Here's something I had recently posted on LinkedIn.
The case for Fundamental Analysis is Risk Management. It’s as simple as that. And Risk doesn’t mean Volatility. It means the prospect of losing money by not knowing what you’re doing. Yes, we know that “Intrinsic Value” is a mirage. Yes, Discounted Cash Flow Models are “garbage in, garbage out”. Yes, we know that there is no “fundamental truth” in valuation. There are no immutable laws in investing.
But it is easier to fathom that, over the long-term, companies with durable competitive advantages will lead to durable (and increasing) profits, which will further lead to higher stock prices or market valuations. This is not guaranteed BUT it’s far more believable than someone claiming to have the “skills” to “feel” what the market thinks about a certain stock, especially of a company that's a lone star in a structurally declining industry.
FOMO/YOLO may be a repeatable "strategy" for some. For the rest of us, we'll stick with our rough idea of rationality, thank you very much.
Berkshire invests in Verizon.
Some people still like the art of Valuation - the art of figuring out what something should be worth before paying for it. That's the kind of old-fashioned thing that Buffett and Berkshire stand for. So do we. Verizon is their latest purchase and it kind of makes sense why they'd do it.
VZ generates about $15 billion in Free Cash Flow. If we use our standard Buylyst 20X multiple, we would peg VZ's valuation at about $300 billion. Currently, it trades at around $236 billion. So, there's some (theoretical) upside.
But usually when we apply our 20X multiple, we assume some cash flow growth. Buffett must think that the transition to 5G in the US will be a net-positive for Verizon. Another angle to this his thesis could be: AT&T - Verizon's main rival - seems to be prioritizing its entertainment business, now that it owns TimeWarner and HBO. I don't blame AT&T - Streaming content is so much cooler than installing 5G infrastructure across the vast land mass of the US. And the old, basic equation of Revenue = Price X Volume is so much easier to model in Streaming.
Shopify & Chill.
Shopify's revenue grew 86% in 2020. $120 billion of goods were bought through their system in 2020. That's insane. Pandemic or not, I don't see this trend reversing or slowing down. Once you taste the genius of ordering stuff you don't need from your couch (while binging Netflix), you're not going to suddenly go back to expending needless energy visiting stores. But I highly recommend buying shoes in person, in a real store. And please wear socks while you do that. Better yet, try shoes in a store and then order online, just in case the store doesn't fumigate shoes after others have tried them on. Gross.
Basically, I’m assuming that Management can achieve its target of $85 billion in revenue. As discussed earlier. Here’s a reminder of the possible roadmap:
Essentially, these are the assumptions:
- Revenue grows to $85 billion by 2023.
- EBITDA margin stays the same at 46%.
- Maintenance Capex stays at 2019 levels, but Growth Capex increases to $8 billion from $7.5 billion.
- No benefits from working capital swings.
- Debt does not increase. Intel generates more than enough cash to fund R&D and Capex.
- Tax rate remains the same.
The end result is that Intel plateaus at about $18 billion in Free Cash Flow, compared to just over $14 billion today. This suggests a roughly 24% upside as I write this. That’s border-line “buy”.
The basic assumption in these numbers is that Intel’s Data Center business will grow at a 10% clip while the PC business will decline at a 2% clip. Given our views on AI and Big Data, this seems reasonable. However, the margin of safety is low, so we will start with a small position of about 2% of the portfolio and build it up slowly over the next few months to 4-5%.
Ford 2019 Earnings Report
- Buylyst Thesis unchanged.
- Ford’s overall 2019 results were disappointing but not unexpected. Snapshot of numbers below.
- The company is in transition – from being a gas-guzzler to being electric and autonomous. CEO Hackett and team are decisive about that.
- The path to a “Ford-E”, if you will, is not going to be easy. It needs to offload its loss-making units. It needs to divert capital towards its leading, profit-making products.
- At the beginning, the central part of our Ford thesis was twofold:
- Ford is diverting most of its capital spending towards a hybrid/electric lineup.
- Ford has many market-leading products in the gas-guzzling world, which it can port over to the electric world.
- That thesis remains unchanged. The number of market-leading products Ford has (slide below) is enviable. GM doesn’t come close in market-leading products.
- The transition period is full of new product launches, which create a J-curve in cash flows. Initially, cash inflow from these products takes time to catch up to the cash outflow (R&D and Capital Expenditure) dedicated to that product.
- 2020 will be a significant product launch year – a J-curve year. Chief among all of Ford’s launches will be:
- The new all-electric Mach-E – a Mustang-based SUV.
- The cult-favorite Bronco SUV will be re-introduced into the Ford stable.
- Ford is on the right path. Q4 was a downer. But nothing in investing (or running a company) ever moves in a straight line. The uncertainty lies in execution, not in the strategy. Q4 was not a good execution quarter. But management realizes this – in fact they opened their earnings call with this admission.
- In 2019, Ford generated about $2.8 billon in Adjusted Free Cash Flow. That compares to our assumption of Sustainable Free Cash Flow of about $3 billion in our valuation. IN 2020, Management expects between $2.6 and $3.4 billion.
- Our assessment of the business is proving to be reasonably correct. The difference between us and the market is that we believe this $3 billion-ish number is sustainable. The market seems to value the company and its stock as if this number will decrease significantly in the future.
Xylem 2019 Earnings Report
- Buylyst Thesis unchanged.
- Xylem’s disappointing cycle of performance continues. This is the hard part of investing Buffett-style. You need to wait for the tipping point.
- Xylem’s revenue growth was essentially flat in 2019. But there were some encouraging signs.
- 2 parts of the business are growing fast:
- India and China
- Measurement and Analytics
- The Buylyst thesis was hinged on growth in these two “vectors”, and it’s panning out just as anticipated.
- But then slowdown in other parts of business – especially North America and Europe – has its ebbs and flows.
- The China and India vectors have staying power. Over the last few year, Xylem’s India business has doubled. And management seems to be even more optimistic about India now.
- In China, the Coronavirus outbreak may impact business. But in the long-term the rivers still need to be cleaned and the cities’ infrastructure still needs to be modernized.
- Overall, Xylem’s business seems to have stagnated at a $5.2 billion revenue level. But we’re looking for a breakout. And that will happen in China and India. It’s a matter of waiting, which is not easy.
- Xylem’s stock took a hit on the day earnings were announced. But it has recovered since then.
- We’ll be holding on to this stock for the long-haul.
As per The Buylyst estimates, Paypal generated just a little over $3 billion in Free Cash Flow in 2019. So, the jump from $3 billion to $7 billion seems aggressive. It is. But it’s not unreasonable.
Here’s the big assumption: In the next 2 to 3 years Paypal revenue will jump from $17.7 billion to $29 billion. This seems like a big leap. But it’s based on the following assumptions:
Assumption: Number of Active Accounts grows by 20% each year to about 40% over current levels:
Assumption: Number of payments Transactions per Active User grows to 12 per quarter:
Calculation: The result of the prior 2 assumptions is that the Total Number of Transactions grows to 5,124 million.
Assumption: Amount per transaction modestly increases to $58.
Calculation: Total Payments Volume increases to $297,192 million per quarter.
Assumption: Revenue/TPV – our proxy for pricing – remains stable at $2.5
Calculation: Total Revenue increases $7,430 million per quarter
The end result is that Total Revenue – annualized – is roughly $29 billion.
We think that is achievable, and even probable (probability >50%) given the assumptions above. The wild one, if you will, is the 40% growth assumption in Active Users. But consider this: Active Users grew by about 20% in 2019. Another 2 years of this – while Paypal’s technology stack gets better and more complete – gets us to 40%. That’s the argument then: will Active Users grow by 20% for the next 2-3 years? We would bet YES. But that’s our subjective assessment based on our view of the payments landscape in which Paypal is already a dominant force.
The rest of the assumptions are standard and match up with historical trends, except one: EBITDA margin improves to 32% from 30%. We assume that some operating leverage will kick in as revenue increases by about 50-60%.
Now, as mentioned before, if this scenario plays out, it will take 2-3 years. And usually, we’re willing to hold a stock for that long. But not unless we expect at least a 30% return. In this case, it appears PYPL is already fairly valued. So, we’ll wait for a market correction to buy in.
Electronic Arts: Solid numbers in Q3 FY 2020.
- Buylyst Thesis unchanged.
- EA reported good numbers last night – both on revenue and free cash flow – and yet the stock took a beating (along with the rest of the market).
- One sell-side analyst called it a B+ quarter, when investors were expecting an “A”.
- Regardless of expectations, the fundamentals of the business remain solid. Not only that, the story is playing out almost as scripted in our thesis (written in May 2019).
- Revenue was up 23% this quarter over the same period last year. But on a trailing 12-month basis, revenue was up just 1.5%. However,…
- Free Cash flow was up 21% on a trailing 12-month basis.
- Free Cash Flow (as per the company’s calculations) was $1,763 million over the 12 months ending December 31st, 2019. But, at The Buylyst, we also deduct cash paid for interest and taxes to arrive at our FCF number. That would put it at about $1,663 million.
- I was happy to see that number, because it matches up closely to our estimate of “Sustainable Free Cash Flow” of $1,777 million. Snapshot below.
- I was prepared to wait about 2 years for EA to reach that number. But it’s happening sooner than expected.
- The reasons are clear, and match up well with our thesis:
- New game releases – like Star Wars Jedi: Fallen Order – have worked well. EA has released 8 new games in 2019.
- Sports games like Madden & FIFA continue to be massive cash cows. This was a big part of our thesis. These IPs form an enviable Economic Moat.
- Movement from “packaged” games to digital/live delivery of content is improving margins.
- Apex Legends is proving to be a formidable competitor to the mobile game champion Fortnite. EA plans to keep spending cash on Apex over the next couple of years. This is one of the points we made in our most recent worldview – Investing in Global Dominators 2020: Incumbents have a massive advantage if they leverage delivery-via-cloud to keep updating (without intrusion) their products. Other examples are Adobe and Intuit. Which upstart can compete with them now?
- Console transitions by Sony and Microsoft will prove to be a significant tailwind for EA, as per Management’s comments in the call.
- Recall that we had started digging into EA as a way to “Invest in Virtual Reality”. We had also dug into Sony and had given it a pass at that time, so we could divert our attention to EA. We liked that it was a content-creator, which can be agnostic about the technology that gamers use. Gaming, in our view, would be one of the first commercialized applications of VR. Well, VR still seems to be a while away, but I continue to hold the view that it will be another significant tailwind for top content creators like EA.
- Overall, we got in at a good time and have made some money on EA. But the stock has yet to reach our target price and may even go well beyond it. We will hold on to it with great pleasure until that happens.
- EA makes up about 5% of our Portfolio.
IBM gets a new CEO.
This is good for IBM. Rometty had energy and enthusiasm, but it wasn't enough. Arvind Krishna is a bona fide tech guy, and from the hours of IBM calls and presentations I've seen, he knows what he's talking about. For starters, he doesn't just talk in generalities. This is decisive move towards making IBM a leading Cloud+AI company, instead of a “jack of all trades”. Time will tell if Krishna can captain the transition.
UK doesn’t ban Huawei.
They don’t need to. This is a point I had made in Investing in 5G – 2019 Update: the oddity of the 5G architecture is that it’s decentralized and software-driven. No one system-provider needs to dominate the whole network. Checks and redundancies can be put in place. The UK’s telecom regulatory body had written a very fine blog on the Huawei issue a while ago. It’s good reading!
Tesla stock keeps flying!
Tesla report good numbers on Jan 28th, 2020. The stock had already been shooting up for the last few months. But this earnings report gave it another shot in the arm. I looked through the numbers and it seems what stood out was that they generated $1 billion in Free Cash Flow in Q4. That’s astounding – almost unbelievable. So, I’ve decided to dig in again, as I have done before.
Ericsson stock suffers after earnings.
Ericsson’s numbers in Q4 were softer than expected. It was pretty simple – their North America business didn’t get much traction because of the stalled merger between Sprint and T-Mobile. And some of their costs increased due to the initial J-curve of getting new contracts. None of this was a surprise. And the market keeps hating the stock. That’s fine. We’ll pick up some more when we can. Full report next week.
Ericsson earnings miss.
The market is pummeling Ericsson stock today because its North American business slowed down in Q4 2019 and its costs went up. But this is temporary stuff. The reaction seems to be overdone, but we’re quite happy to add to our position. Ericsson is just over 3% of our portfolio. We’re quite happy to build it up to 5% over the next couple of months. More on this earnings report in the next few days.
IBM earnings beat!
At last, IBM does something right. Well, right in the eyes of the market. IBM revenue and free cash flow seems to be stabilizing if not growing. It has shown some signs of life – and competitiveness – in the hunger games of Cloud providers. Microsoft and Amazon still dominate. But it looks like there may be some room for Google and IBM. More on this earnings report in the next few days.
Netflix earnings miss.
We don’t own or cover Netflix, but now I’m a bit curious. The market pummeled the stock on earnings day, only to pull it back up the next day. They still bleed cash, so it’s unlikely we’ll buy at this point. But one area where they do have a competitive advantage is in International Shows. They have some high production value shows in a lot of populous countries. And this shows in their numbers. North America subscriptions seems to be plateauing but International is growing. I’m curious to play around with the numbers.
American Express earnings beat!
They just reported a few hours ago, so this is new. Amex is one of our recent additions to the portfolio so it’s too early to declare “our thesis is working!”. However, we like the earnings beat and will continue to build our position in it. Amex is about 3% of portfolio at the moment. We will look to build it up to 5%. Our thesis is hinged on them being a differentiated player in the card networks arena. We expect them to grow due to the overall growth in cashless-ness and all the room they have in the International arena where Visa and Mastercard dominate.
Check out Rivian!
This is the main competition to Tesla’s ugly pickup truck. I look the look of this. I bring it up because Ford, one of our frustrating holdings, has taken a sizeable stake in this all-electric pickup truck company. This could be their best investment. At the very least, it’s jives perfectly with Ford’s decisive strategy of going electric.
Amazon makes a big push in India.
Jeff Bezos is in India making bold promises. He wants more of the action in India. And why not? We obviously agree with him that it’s a good place to invest. Initially, I started reading more about Jeff’s India trip because it straddles 2 our themes: India and Retail. But as I kept reading, I couldn’t help feeling that Amazon is losing its sheen of invincibility. It’s still a fantastic company, but it’s facing tougher competition in everything it does: from Walmart and Reliance in India Retail, from Microsoft in Cloud Computing, and from new streaming entrants for its Prime Video product (which is, I believe, an incredibly expensive customer acquisition cost for their Prime Shipping business).
Visa buys Plaid for >$5 billion.
Plaid is a tech firm that makes back-end software allowing banks and neobanks to make cashless/cardless payments easy. Visa is spending big on Plaid (I don’t know how much money Plaid makes). But this is a decisive bet towards a cashless/cardless world. We just did a deep-dive on “the cashless world” a few weeks ago. And we even made an investment in it – not Visa.
Wind + Solar Energy to grow by 61 Gigawatts in the next 2 years.
This is the Energy Information Administration’s forecast. This is big. EIA expects Wind and Solar to significantly outpace every other source of power. Check this out: over the next 2 years, they expect Coal-fired capacity to decrease by 18.5 GW and Natural Gas-fired capacity to increase by just 11.4 GW.
The US still opposes Huawei.
Some senators want to throw money at Huawei’s competitors. We won’t mind that because we’re invested in Ericsson, which is sure to be on top of that list of 5G equipment manufacturers. And in related news, the US seems to be putting a lot of pressure on the UK to reject Huawei in building their 5G infrastructure. The UK is not buying the US argument. I went over in some detail about why the UK’s stand is what it is in a 5G update a few months ago.
Nvidia launches new Autonomous Driving chips at CES.
Our Nvidia investment worked out well for us in 2019. Our entry into it was a bit weird. We had initially given in a pass in 2018, when it was too expensive. We had gone with Xilinx, instead, which worked out well for us. But then we looked at in again in 2019, when we started digging into cryptocurrencies. Why? Because cryptocurrency mining required these high-powered chips (GPU) that Nvidia makes. As we dug into it, it turned out that Nvidia had a lot more going for it than just GPUs. One of the themes in which Nvidia was investing heavily was Autonomous Vehicles. They were using their dominance in GPUs and AI to carve out market dominance in chips used for self-driving cars. That vector is an exciting, and it's exciting to see that Nvidia is continuing to invest in it. The Buylyst still holds some Nvidia stock - we think it's a Global Dominator with very little competition.
CES 2020 was a hit - seems like everything will be connected.
I didn't have time to look at all the gizmos that tech and consumer electronics companies showed off at this year's CES. But I read this NY Times summary, which basically concluded that the overarching theme was IoT. I was happy to read it because that's one of our main investment themes. IoT and 5G are inseparable. We're heavily invested in it. We've gained from it. And there's more in this lucrative theme.
The Economist thinks investing in Memory is smart.
Well, The Buylyst was on to this a long time ago. Long-term, memory is a good bet. We're heavily invested in Micron. So, we generally agree with The Economist's take on Memory, with one slight departure. Going forward, we think Memory will be less of a commodity and more specialized. That's a big part of our Micron thesis.
India wants to invest more in Infrastructure.
It's about time. Not too long ago, we had concluded that this sort of Keynesian spending was on the cards. The Modi government is doing everything it can to boost the economy. The Buylyst's India bet is heavily skewed towards infrastructure, with Caterpillar, Eaton and Xylem - all of whom should gain with if the Modi government follows through on its plans.
Wind and Solar dominant in the USA.
Take a look at this data - Wind and Solar were the 2nd and 3rd most used sources of electricity in the US in 2019, behind Natural Gas. This is phenomenal. Renewable Energy was one of the earliest bets we took. Vestas is one of our bigger holdings.
The numerical assumptions leading to the $6.5 billion cash flow number are:
- Revenue: Assumed an increase of 10%. This is consistent with Management’s expectation of 8-10% growth in 2020. They have a good track record of meeting or exceeding their guidance. I should point out that my assumption is meant to arrive at a Sustainable revenue number, not just a 2020 number. I expect revenue growth to continue beyond 2020. Essentially, I’m assuming their business doesn’t grow much beyond 2020. This is conservative.
- EBITDA: Assumed a similar margin as the last 12 months. I expect Amex’s margins to improve because of increased digitization (it’s cheaper to launch and maintain new products and services) but I have not factored in any improvements.
- Working Capital Swings: This is a big variable, which makes sense because of the nature of Amex’s business. There are big movements in Accounts Payables and Accounts Receivables as you can imagine. Assuming a “sustainable’ level for this is hard. But a run-rate of about $4 billion seems reasonable, consistent with the past couple of years. A lot of this also happens as adjustments are made to “Provision for Loan Losses”. That’s the nature of the banking business. To its credit (pun intended), Amex has kept its bad loan ratio around the 2.5% range for many years now. The client segment they go after – high income, good credit score – almost ensures that their bad loan ratio will never be out of control.
- Taxes: Assumed same rate as last 12 months.
- Capital Expenditure: All Capital Expenditure is assumed to be “Maintenance” rather than Growth.
- Dividends and Share Buybacks: As is customary, usually I don’t deduct cash spent on dividends and buybacks to arrive at Free Cash Flow. I assume those are cash back to the shareholder, which can be reinvested back in the shares anyway.
Assumptions for Sustainable Free Cash Flow of $2,948 million:
- Assumed some Rupee depreciation. FX Rate of 75 INR per USD. Current Rate: 70.
- All past and current financial numbers restated at FX rate assumption of 75 INR/USD.
- Time-periods shown as follows:
- Every calendar year show roughly mirrors the company's Fiscal Year, which end every March 31st. So, 2017 show in the Valuation Table is actually FY 2018 numbers, which is as of March 31st, 2018.
- Revenue: Assumed no increase over the last 12 months.
- We expect expansion in the ICICI’s balance sheet – loans and deposits – in tune with their experience over the last 12 months. Their loan book has been growing at a clip of 20%. But there may be some economic headwinds in India over the next 12 months, which could slow loan growth. We’re being conservative.
- COGS and Operating Costs: COGS include Interest Expense attributable BOTH to deposits and to long-term debt.
- All Operating Costs booked under “R&D and Cost of Labor”.
- EBITDA: Assumed same margin as last 12 months.
- Capital Expenditure: Assumed all Capex is Maintenance. Assumed same as last 12 months.
- Working Capital: No positive swing assumed. Assumed Changes in Working Capital will normalize to $0 over the next few years. This is an important assumption!
- Remember: Loan Loss Provisions in the Income Statement is a non-cash charge.
- The last few months have seen a lot of Working Capital positive swings because of extra allocation to Loan Loss Provisions. This show up as an increase in Operating Liabilities in the Cash Flow Statement, when adjusting Accounting Profit towards Cash Flow from Operations. I expect this trend to reverse.
- The NPA (nonperforming asset) % has decreased over the last few quarters. This will – sooner or later – result in lower loan loss provisions. This will reverse the working capital swing.
- Cash Interest: Already included in COGS.
- Cash Taxes: From Cash Flow Statement.
The big takeaway is this: Assuming NO GROWTH in revenue, and assuming that Management hangs on to its newfound control on Credit Risk, there seems to be considerable upside to the ICICI story. The MAIN RISK is that about 30% of its loan book is in Home Loans. It’s a Macro risk that’s hard to quantify. It depends on the employment situation in the country and, consequently, on overall stability of wages. We’ve put out our views on it here. But if ICICI’s current credit quality profile – as per internal ratings - is to be believed, then the impact of “bad loans” in this sector should be muted. About 94% of its loan book is rated A- or higher. This is a significant improvement over the last 2 years.
All things considered, this seems to be a decent long-term bet on the Indian Consumer and on the resurgence of the Indian Banking Industry, after a massive, much-needed clean-up effort by the country’s Central Bank and – by extension – the ICICI management. The bet is that most of the skeletons in the closet have been cleaned out.
Changed Ciena rating from "Watch" to "Buy" on November 5, 2019.
Ciena is at the heart of the 5G movement. It was rated "Watch" on June 19th, 2019. But upon further analysis of the 5G landscape, and after Ciena's price declined, I decided to take a small position in it. This was the original thesis and it still stands:
Key player in 5G network deployments, with expertise in hardware and software required to incorporate fiber optics into existing cellular infrastructure. A worthy "Huawei Hedge
Added Twitter as a "Buy" on November 15th, 2019.
This was purely reactionary and not dependent on a series of Worldview articles. Here's one Worldview article on it. And here's why I decided to dig into Twitter:
This is a bit odd for me because I’ve consciously stayed away from Social Media companies. And the reason I’ve been reticent about digging into them is because they’re Advertising businesses based on private information of users. Lately, they’ve been under political scrutiny. It’s a bit of a minefield if you ask me. But over the past few months, two things have happened to me:
- I’ve started using Twitter regularly. After a few months, I can see its potential.
- They’re making some decisive moves towards separating themselves from the ethically questionable Facebook.
So, I took a quick look at Twitter’s numbers and decided that the company is worth a real dig-in. It seems to me that there is significant upside potential. But the hard part, as always, is attaching a probability to that potential.
Ford had a good weekend.
Big weekend for Ford during the weekend of 11/16-11/17, 2019. First, the movie Ford vs. Ferrari seems to be a hit. And second, Ford unveiled its first fully electric vehicle - the Mustang Mach E. It's a Mustang-inspired SUV. I like it. It combines two key products at which Ford has a competitive advantage - the Mustang and SUVs. But the launch got mixed reviews. Some Mustang petrol-heads are not happy. But the direction Ford has taken is unmistakable now. And I'm happy with the direction - it was central to The Buylyst thesis on Ford, which is taking a long time to play out. This launch was a much-awaited data point.
Changed Ericsson Rating from "Watch" to "Buy".
Changed Ericsson price target from $8.8 to $10.5, suggesting a 15% upside. Rationale delineated here: Remember Ericsson? Valuation model updated.
Please see the full explanation in Lyft Valuation here.
IBM Q3 2019 Earnings: Stable numbers, which Mr. Market didn’t like.
- Thesis unchanged.
- Revenue declined by 0.6% from this time last year.
- Free cash flow also declined slightly. On a trailing 12-month basis, Free Cash Flow is stable about$12.8 billion. That’s a positive for me as the business transitions to becoming a Cloud + AI firm.
- Indeed, among the 4 business segments, the Cloud & Cognitive Software segment grew the most. Here are the segment revenue growth numbers:
- None of this is surprising. I expect Revenue will decrease but Free Cash should grow if the thesis is right.
- And the thesis, in short, is this: IBM will be able to offer a complete, cohesive solution to enterprises that want to migrate their workload to the Cloud and infuse it with AI capabilities. In doing so, IBM will rely on its Global Business Services (it’s consulting arm) to not only do some hand-holding but also offer expertise in data analysis in specific industry vertices.
- The thesis hasn’t played out, as the stock price suggests. The Cloud business is growing and it seems that Management is focused on that more than it is on AI. At least, that’s the feeling I got from this earnings call and the last one.
- The big story is the recent Red Hat acquisition. The general feeling “on the street” is that it was a good addition to IBM’s portfolio, but they overpaid for it. That’s debatable. If this quarter was any indication, business momentum is good. The play is simple: As IBM’s clients move their data and processes to the Cloud, IBM should offer the easiest, most painless way of doing so. Red Hat is about that.
- There was almost no talk of AI, Watson, or industry verticals.
- My argument in my last look at Cloud Computing was that there are 3 layers of value-add:
- Infrastructure-as-a-Service (Iaas)
- Platform-as-a-Service (PaaS)
- Software-as-a-Service (SaaS)
- IBM seems to have conceded that that IaaS battle has been won by Amazon and Microsoft.
- But maybe with PaaS and SaaS, it still has a chance. But for that, clients will need to able to parlay IBM’s PaaS and SaaS offerings onto their data on AWS or Azure. Red Hat facilitates that.
- Maybe the discussion will shift to PaaS and SaaS (read as AI offerings) over the next 12 months. I will wait and watch.
Ford Q3 2019: Good quarter but disappointing outlook.
- Thesis unchanged.
- Revenue was down 2% but Free Cash Flow was up 80% compared to last year. Obviously, that was because last year Q3 Free Cash Flow was negligible. This Q3, it was $200 million
- But Mr. Market reacted badly because Management adjusted it’s Q4 EBIT forecast downward and, consequently, it’s 2019 EBIT forecast downward. Revision from $8bn to $7.5-8bn.
- Why? Because there are some legacy warranty costs related to models built in 2018. This was unexpected.
- The transition continues. And Ford’s lineup will go through a significant change starting next month. It’s committed to Electric and also Hybrid.
- One of the analysts asked an interesting question: Is Ford committed to Full Eclectic, Hybrid or both? Management seemed to say both, which I thought was a bit non-committal. But that may be the practical way to go about this – range anxiety for electric vehicles won’t decrease until people see charging stations everywhere. That may take a couple of years.
- But the challenge with being committed to BOTH Electric and Hybrid is cost. It’s more expensive to run both lines of production. And Hybrid vehicles are more complicated to make compared to pure electric.
- The overall story seems to be same as the last few quarters – North America business is strong. Europe and Asia businesses are weak.
- Ford’s proposed solution is:
- Streamline product lineup – focus on strengths like SUVs and Trucks.
- Move towards an electric powertrain.
- Both parts of the solution are “progressing” but we haven’t seen any tangible results yet.
- Having said that, they’re still on the right path. It’s just taking a whole of patience to see results.
Updated HDFC Bank Valuation Details after a review of their latest performance amidst mayhem in the Indian banking industry.
- To avoid confusion, the numbers in the table have now been reinstated according to the time-period used by the company. Their Fiscal Year ends on March 31st of each year. So, Fiscal Year 2019 ended on March 31st, 2019.
- Source of financial numbers is HDFC Bank's 20-F Filing with the SEC.
- Exchange Rate used to convert the financial statement numbers remains at 75 INR/USD. The current rate as of writing this is around 71 INR/USD.
Valuation Updated on 11/19/2019.
Micron Earnings Fiscal Year 2019: Disappointing Numbers, Positive Outlook.
- Thesis unchanged.
- But Micron has been a massive test of patience. Was I wrong about the stock? No, but…
- I was wrong about how soon we’ll see an impact of AI, IoT and Autonomous Vehicles:
- Showing up in the revenue numbers and…
- Showing up in the stock price.
- The basic premise of The Buylyst thesis on Micron was this:
- Much more Memory will be needed in a new AI-infused world.
- Volume will more than offset price declines.
- New growth vectors – IoT and AVs – are not priced in.
- Micron will move into less commoditized and more specialized products like 3D X-Point.
- Pricing power will improve because the industry (especially DRAM) has consolidated. There are only 3 major players left in DRAM in the world – Micron, SK Hynix and
- None of the above happened so far in 2019.
- DRAM and NAND memory have both seen massive price declines due to inventory build-up amongst customers.
- The only positive thing that’s happened is: Volume has grown at a healthy rate despite market challenges such as the trade war.
- The overall financials for Fiscal Year 2019 are shown below. But the price vs. volume dynamics for DRAM were:
- Revenue down 28% Y/Y
- Bit shipments up low-single-digit percent range Y/Y
- ASPs down approximately 30% Y/Y
- Price vs. volume dynamics for NAND were:
- Revenue down 12% Y/Y
- ASPs down mid-40 percent range Y/Y
- Strong bit shipment growth
- You can see in both cases that price declines more than offset volume growth. In my thesis, I expected the opposite.
- Of course, it’s hard to time exactly when new growth vectors and new products will materially impact cash flows (and hence the stock). It’s been a frustrating 15 months with the Micron stock, to put it mildly.
- But the new growth vectors are yet to kick in. If I believe that IoT and AVs will be a part of our society, then cash flows should improve from this point on.
- The one positive thing to come out of the earnings call was CEO Mehrotra’s assessment that the pricing environment will improve in 2020 because the supply-demand dynamic will improve.
- Overall, it’s tempting to change the Micron thesis. But the main growth vectors in the original thesis have yet to play out. I believe they will happen. It’s just hard to time the impact on the stock.
Quantum Supremacy scares the **** out of me.
This was a wild week for Quantum Computing. What is that? It's a whole new way of processing information. Dumb explanation below, but first: This week, IBM said that they have the most powerful commercial-grade Quantum Computer for use on their Cloud. Then Google came out and said that they've achieved "Quantum Supremacy"! It sounds amazing (and scary) but it's not so bad. Yet. Quantum Supremacy means out-calculating and out-processing the world's most powerful "classical" supercomputer. So far, Google's claim about "supremacy" is very narrow, for a very specific task. It will take a while to propagate through "the grid" before it touches our lives.
Quantum Computing is about qubits...totally different. Think of qubits are 3-dimensional signal processing, compared to quaint 2-dimensional binary system...you know, 1s and 0s. I need to do a full-fledged worldview article on this topic. But I suspect I'll need to do months of research to write anything credible. The research process has begun.
My big fear with this Quantum stuff is this: The Matrix or Terminator - take your pick. Why? Advances in AI - mixed with Quantum computing - is something I can't even fathom.
Ford debt gets downgraded by Moody's.
Moody’s downgraded Ford’s debt to “junk”status. It sounds more ominous than it is. I mean, it’s not a positive development but 1) it has happened before and 2) it is transient. #2 is important. Most investors, traders and analysts have the habit of reacting to every bit of news and adjusted their valuation models to adjust for the news. At The Buylyst, we don’t do that. Even in our valuation models we estimate “Sustainable” numbers of revenue, costs and free cash flow. Sales, pricing, costs, stock prices move up and down. It’s futile to react to every news item. But it is important to gauge whether any news item affects our estimate of “Sustainable” free cash flow. In this case, Ford’s downgrade doesn’t affect our thesis. They have ample cash flow and cash on the balance sheet to take care of their debt charges. If that ability decreases of increased by a few percentage points, it doesn’t affect our view of the company.
Active vs. Passive Investing: Greatest Hits.
Here is a recap about the great debate on investing that was started by Michael Burry (of The Big Short fame). He claimed that there is a Passive Investing “bubble”. I’ve listed that article and the passionate responses to Burry’s views. If you remember, a few days ago I made a related point about the Active Passive debate. I’ll summarize my take in the section below. But first, the greatest hits in the Active vs. Passive Investing debate.
Roku - we missed this amazing story. But...
One of my regrets this year is missing out on Roku. You can google its price chart - it's fantastic. And it makes me angry for missing out on this. But consider this: It generates less than $50 million in Free Cash Flow. It's valued at almost $20 billion by the market. That's 400 times and optimistic estimate of 2019 Free Cash Flow. That tells me that there is stupendous growth of Free Cash Flow built into the price. There is no way I can justify it. Let's look at it another way. If Roku doubles it's cash flow every year for the next 4 years - let's assume - a "sustainable" cash flow number would end up being $800 million. Then I could justify paying today's price. But I need to believe that. To me, this starts drifting into "speculation" territory. The most believable "bull-case" is probably the prospect of a buy-out by Apple or Amazon. Again, speculation.
Waymo wants to share data.
This is a good move. One of the biggest constraints in making safe Autonomous Vehicles is lack of data. AVs haven't been around long enough. But if all AV companies - Waymo, Tesla, Ford, GM, VW etc. - pool their data, society in general will gain. Then competition comes down to "quality of code", "user-experience" and all that good stuff. That's probably Waymo's angle - they may have an advantage on those things. But - at the end of the day - we all want the safest AVs possible. Whatever get us there is most welcome.
India's Central Bank bows down to Govt. pressure.
This news comes at a time when the very function of Central Banking is under immense political scrutiny. In many countries, including India, a heady mix of populism, nationalism and anti-intellectualism have won resounding mandates. It's fashionable to dismiss Economists, who make up most of the important staff at any Central Bank. I'm not a big fan of Economists in general, but Central Bankers are different. I respect them because they have "skin in the game". Their theories are tested by empirical data, after which they stick their neck out and adjust the supply on money in an economy. If they're wrong, it's very public, which is enough incentive to be right. This is much more admirable than publishing papers based on dubious regressions. My view is that they should maintain their independence from Government. If politics muddies the waters, central bankers' jobs will get more complicated. That's what's happening in India, after two Governors left the Reserve Bank of India (RBI) due to policy disagreements with the Modi governments. Finally the government got what it wanted. RBI reserves are now being used to aid the Modi Government's fiscal policy mandate. Even through the amount is not huge, this is not a good precedent. If the RBI loses credibility, over time the Indian Rupee will lose credibility. That cannot be good for a massive, growing economy. Sound Monetary Policy by a credible central bank is the cornerstone of Price Stability. Just ask Argentina!
Buffett's valuation method is shockingly unpopular.
One of the great mysteries of my investing career has been this: A shockingly small percentage of investment professionals have actually Buffett's letters, lectures, interviews or speeches. Most, I found, have second-hand knowledge of his investment process - through the Wall Street Journal, FT and the like. Within Buffett's process, the things that's baffled me the most is how the investment community just ignores his valuation methods. I concede that it's hard to find his technique all in one place. That's why I took the time to write this. But here's a source I used while I was writing my piece. If you're feeling especially nerdy, this is a treasure trove.
GlobalFoundaries sues TSMC, but it looks like a nothing-sandwich.
GlobalFoundaries, an American semiconductor fabrication company, sued TSMC (a Buylyst holding) for stealing trade secrets. Inititally, I got worried. And then it occurred to me that this could be petulant outburst of a smaller company that's being beaten by big guns like TSMC and Samsung. Then this article came along and sort of makes the same point. And it seems like Mr. Market didn't really care either if the stock price is to be believed. Also, remember that TSMC snatched away a lot of business from GlobalFoundaries in the last year - most notably AMD. By the way, check out TSMC's market share (in this business, scale matters): 49% - #1 by far.
Disney+, the biggest threat to Apple TV+ and Netflix.
Disney recently released some details of their Disney+ streaming service...to be released this November for - get this - just $7. They're going up against formidable entrenched players like Netflix and Amazon. But, in my view, Disney is a big threat for these reasons:
- Disney already has a massive library of blockbuster content.
- Disney now has the Marvel Universe and Star Wars as a cherry on top of that amazing library.
- It's easy to point out what Disney content stands for - family entertainment.
- They also have ESPN and Hulu, which they can/will bundle for an affordable price. Even $15 sounds reasonable.
Netflix faces the biggest challenge. It's bleeding cash trying to create content and maintain market share. Amazon Prime may be OK because customers get 2-day shipping with their subscription. Apple TV+ may also have a hard time competing - what does it stand for?
Why the P/E Ratio is bogus.
The other day, I had an argument with someone about the efficacy of EBITDA. Yes, I’m a nerd. My position was that EBITDA is useful because it’s a cash flow measure, BUT – as Buffett says – we must account for Maintenance Capital Expenditure. Anyway, one thing led to another, and I came upon this paper written by Michael Mauboussin on the P/E Ratio. It captures, eloquently, my gripes with this ubiquitous metric. If you’re feeling especially nerdy, go for it!
Tesla’s Solar week: Topsy-Turvy.
Tesla made some changes to its SolarCity business model this week by announcing a Rental Plan. Then a couple of days later, Walmart sued them because some of their roof panels started catching fire. So, all-in-all, a not-so-good week on the Energy business at Tesla. This was a concern I had raised in the latest update on the Tesla thesis a few weeks ago – a constant underinvestment in the Solar Panels and Energy Storage business. Together, these 2 make a formidable combination. Maybe the rental plan is the way to go – that way users can try it out for a year without committing thousands upfront. Tesla has a competitive advantage in this niche – they’re not utilizing it.
Xylem Q2 2019 Earnings: Good Numbers, Good Outlook.
- Thesis unchanged.
- Revenue grew 5% organically.
- Margins expanded.
- Adjusted EPS grew 10%.
- Best of all: the growth was fueled by double-digit growth in China and India.
- Those were exactly the growth vectors that The Buylyst thesis was based upon.
- Xylem is a doing well by doing good. Water is becoming a serious issue in many parts of the world. In India, for example, there is a crisis now.
- Xylem’s management said that they’ve been getting a lot of business from municipal organizations in China and India. That trend to continue, if not accelerate.
Lumentum Fiscal Q4 (Calendar Q2) 2019 Earnings: Good Numbers, Good Outlook.
- Thesis unchanged.
- Revenue was up 25% for the full fiscal year 2019. But, to be clear, this includes Oclaro (a recent acquisition) numbers.
- On the other hand, the numbers also include loss of business from Huawei – one of Lumentum’s major customers – because of the embargo in May this year.
- Management mentioned that going forward they expect their Huawei business to stay roughly flat.
- They also mentioned that there are 3 customers now that each account for more than 10% of revenues. Apple is the big one.
- Lumentum makes 3D-sensors that facilitate the iPhone Facial Recognition technology.
- A big part of The Buylyst thesis was the potential for this product to penetrate the Andriod market – a much bigger pie.
- Revenue from this product segment grew more than 10% this past quarter.
- Management mentioned that they’ve won some Android orders.
- But, to me this progress seems a little slow – I would have expected a flood of Android order to have come through by now.
- Management says they expect Android orders to pick up over the next 6 months.
- In other segments, Lumentum’s deliberate shift into Telecom (5G components to support Fiber Optics) is paying off. Revenue from this segment continues to be strong.
- Just to recall, Fiber Optics is another growth vector that drove The Buylyst thesis.
- Overall, the main drivers of The Buylyst thesis remain in play. The numbers indicate progress. The big risk remains the Trade War and Lumentum’s exposure to Huawei.
Caterpillar Q2 2019 Earnings: Good numbers, but China question remains.
- Thesis unchanged.
- Revenue was up 3% and EPS (a flawed measure) was basically flat compare to Q2 last year.
- Among the segments:
- Construction Industries was up 5%.
- Resource Industries was up 11%.
- Energy & Transportation was down 4%.
- Management reaffirmed its guidance of record revenues and profits for the year 2019.
- But the market wasn’t too happy to Caterpillar’s earnings.
- Concerns about China are topical.
- Energy was a drag this quarter because of a slowdown in US Shale.
- The Buylyst thesis was hinged on the inevitable growth in Urbanization in the Emerging Market. That thesis is in play but hasn’t materialized into a serious revenue boost yet.
- The other growth vector is the need for infrastructure repairs in the developed world – especially in the US. That has yet to pick up.
- The point is that in a tough year, CAT has still performed well.
- Going forward, the concern is a global recession, which may slow down spending everywhere. If that happens, then there will be very few safe havens.
- But in the event of a slowdown, I still expect Urbanization spending in China and India to remain at healthy levels.
- CAT has unfortunately become a poster-stock for “Trade War Causalities”. Any hint of a drop in revenue from China seems to be freaking out Mr. Market.
Vestas Q2 2019 Earnings: Disappointing Numbers, Positive Outlook.
- Thesis unchanged.
- Revenue was down 6% in Q2 compared to Q2 last year.
- EBIT margin was at 6% - much below Management’s own expectations of about 8%.
- Management cited the trade war increase in raw material costs. The decrease in revenue is transient, especially in light of the order backlog.
- Vestas saw a record order intake of 5.7 Gigawatts this quarter. That’s 50% more than the order intake in Q2 last year.
- Volume doesn’t seem to be the issue, even if growth is lumpy quarter-over-quarter. Price declines have been the problem. But this problem seems to have stabilized. Chart below.
- Last week, The Buylyst put out a thesis on Siemens-Gamesa, Vestas’s main competitor. Vestas highlights some of the same issues:
- Demand in China and India have been weak so far.
- US continues to be the biggest market.
- The point about the US is a double-edged sword. Some of the Renewable Energy tax credits expire in 2021. Worst-case, there could be a big demand slowdown in the US. But in the meantime, the growth here is fantastic.
- Management’s counter to this concern is that by that time growth in Asia will pick up the slack. It’s a believable story. But the key variable is this: LCOE or Levelized Cost of Energy.
- If LCOE of a Wind Farm is still competitive compared to that of a Natural-Gas-Powered Plant, nothing changes.
- The Buylyst view is that LCOE will remain competitive, subsidies or not.
- The positive part of the call was the outlook. Management reaffirmed its 2019 outlook, while narrowing the range because of better visibility.
- As mentioned above, the backlog figures are encouraging.
- And the Offshore JV with MHI is finally seeing some demand. But as we saw last week – Siemens-Gamesa has a head-start in Offshore.
Here is the pricing chart: Signs of stabilization.
ABB Q2 2019 Earnings: OK Numbers but declining margins.
- Thesis under review.
- Revenue was up 2% in Q2 since this time last year.
- Orders grew by 1%.
- But EBIT margins declined by 150 bps.
- The problem, as the numbers above suggest, is not volume. I thought it was pricing. But Management assures us that it’s “business mix”. That basically means they’ve sold lower margin products compared to last year.
- The Buylyst’s ABB thesis is under review because ABB is getting rid of its Power Grids business. Their potential role in the Smart Grid rollout was part of the original thesis. But that won’t be a diver for ABB’s revenues as much as I thought. But…
- Electrification is still a big and growing segment – that includes ABB’s EV charging and Datacenter businesses. This segment did well in Q2
- Revenue was up 4% year-over-year.
- Order Backlog was up an impressive 10%.
- EBIT margin was down. But Management expects this to improve in Q3 and Q4.
- The Industrial Automation segment did OK.
- Revenue grew 3%.
- But orders were down 4%.
- EBIT margin was down.
- The Motion segment (trains etc.) did well.
- Revenue grew 5%.
- Orders grew 4%.
- EBIT Margin improved.
- Robotics didn’t do well this quarter, surprisingly:
- Revenue was down 3%.
- Orders were down 9%.
- This was mostly due to anemic demand in Autos, China and India.
- ABB is among a slew of companies that’s seeing a slowdown in China. This is a worrying and salient point to take away from this earnings call. Robotics – in which ABB is a #1 or #2 player – was the odd one out this quarter. It’s a direct effect of the Trump trade war.
- ABB’s end-markets are still very attractive. As the world gets more electrified and automated, ABB’s business should keep growing. But a review of The Buylyst thesis is due, nonetheless.
Volvo AG Q2 2019 Earnings: Great Numbers, Lower outlook on Trucks.
- Thesis unchanged.
- Revenue was up 16% year on year.
- Operating Earnings were up 12.5%.
- Operating Cash Flow increase to 13.9 billion SEK from 8.3 billion SEK.
- This was a record quarter for Volvo AG.
- Orders were down, especially for trucks in North America.
- Order were down also for trucks in Asia – especially China and India.
- That may be the only reason this stock hasn’t appreciated. They had a blowout quarter, but these numbers won’t be as good going forward if the year-over-year decrease in backlog is the leading indicator.
- However, there are some promising, tangible growth avenues for the company:
- It’s Autonomous truck – Vera – is now in operation with a logistics company.
- The Renault fully-electric garbage trucks are in operation in Lyon, France. And they will be commercialized in late 2019.
- It has signed an agreement with Nvidia for Autonomous Driving technology.
- It signed a deal with Samsung for battery packs.
- The Construction Equipment segment continues to grow – both in revenue and order backlog.
- Basically, Volvo is committed to Autonomous and Electromobility. And that’s an important theme at The Buylyst – Volvo is a good conduit to play that theme. It generates a ton of cash, which it can re-invest in these new technologies.
- Apart from the decline in orders of trucks in North America, the recurring theme was the slowdown in demand from China and India. This is a common talking point in all earning calls.
- Overall, the original Volvo thesis was essentially that it’s a good conduit to play the intersection of Retail, Urbanization and the AV/EV themes. That’s a powerful trifecta of themes that’s bound to grow in the next few years.
Canadian Solar Q2 2019 Earnings: Good Numbers, good outlook, stable pricing.
- Thesis unchanged.
- Net revenue was $1,036.3 million, compared to $484.7 million in the first quarter of 2019 and second quarter 2019 guidance of $970 million to $1.01 billion. Net Revenue decreased from a great Q2 last year but that was expected.
- Gross margin was 17.6%, compared to 22.2% in the first quarter of 2019 and second quarter 2019 guidance of 13% to 15%.
- This was a good quarter, but Management’s outlook was particularly optimistic. Their words: “For the third quarter of 2019, the Company expects total solar module shipments to be in the range of 2.2 GW to 2.3 GW, including approximately 160 MW of shipments to the Company's utility-scale solar power projects that may not be recognized as revenue in the third quarter of 2019. Total revenue for the third quarter is expected to be in the range of $780 million to $810 million. Gross margin for the third quarter is expected to be between 24% and 26%, reflecting the positive impact of planned higher gross margin project sales primarily in Japan and the U.S. The aforementioned revenue forecast does not include the potential sales of a project that may be completed in the third quarter. If the transaction is closed in time, total revenue for the third quarter is expected to be in the range of $970 million to $1 billion and gross margin between 27% and 29%.”
- For the full year 2019, the Company now raises its guidance for total module shipments to the range of approximately 8.4 GW to 8.5 GW from the previous guidance of 7.4 GW to 7.8 GW. Total revenue for the year is expected to be in the range of $3.5 billion to $3.8 billion
- But there were 2 points that I found particularly encouraging:
- Growth in the Energy business: Management says – “As of July 31, 2019, the Company's portfolio of utility-scale solar power plants in operation was 795.8 MWp with an estimated total resale value of approximately $1.0 billion.
- Stabilization in Average Selling Prices of Solar Modules. In fact, Management expects a slight price appreciation in the next couple of quarters.
- Both those points were big parts of The Buylyst Thesis. The second point about price stabilization is encouraging but it must be taken with caution. Solar Modules are fairly commoditized. If China floods the market, ASPs may come back down. But that’s why the Energy business is so attractive – its revenue model is based on long-term power purchase agreements, which are relatively immune from movements in Module prices.
Canadian Solar: Changed Rating from "Watch to "Buy"
Please see Canadian Solar Q2 2019 earnings notes. Rating change based on:
- Price stabilization
- Positive revenue backlog and outlook by Management.
Uber loses $5 billion.
Uber came out with results last week, and they pointed to all the reasons why The Buylyst didn't pull the trigger on Uber. Here's a summary. It's burning through cash to hang on to its market share. Our thesis was that Uber would need to increase its ridership by at least 4X to justify this type of valuation. Competition is heating up. What is Uber's Moat? At the moment, it seems to be brand-name and familiarity. Those are fickle. On the other hand, the technology is indisputable. But then I wonder, what is that part of the firm worth to a potential buyer?
GM and VW make a decisive bet on EV.
The Buylyst thesis on Ford was hinged on decisiveness on Electrification by CEO Jim Hackett and team. While Ford has no doubt that the future is about Electric Vehicles that are Autonomous, they've clung on to the "transition technology" of Hybrids. VW and GM see no point in investing in Hybrids. I think this is wise. By the time investments in Hybrids will be expected to pay back some returns, EVs may well become mainstream. I'm with GM and VW on this one. But Ford does seem to have a leg up in Autonomous Vehicles. That's why VW has a tie-up with them.
Apple Card shows us the future.
Apple Card got a review in the Wall Street Journal, which (I've sensed) is usually quite critical of Apple. But this time the review was generally positive. It's seamless integration with with Apple Pay and it's state-of-the-art budgeting tool in the app. Apple would, of course, try to use this as a way to keep (and attract) user in its ecosystem of the iPhone, Mac, iPad, TVOS, etc. It seems to me that whatever Apple does now is to ensure that once you're using some Apple product, you're better off using other Apple services. As for Apple Card, the only missing feature, as per this review, is Airline Miles and other points that we get with our plastic cards. That is a temporary drawback, in my view. The points will come. The future is undoubtedly cardless. Apple showed us how. Others will follow.
A counterpoint on Bitcoin.
I stumbled upon this somewhat rational defense of Bitcoin. The Buylyst's view on Bitcoin, so far, is that it doesn't solve the problem of deflation. This article seems to say that it does. But there is no explanation given. See passage below. However, it does a good job explaining the basics of Bitcoin. I'm still not buying into it.
"The cryptographic protocol prevents anyone from falsifying an account, and, in particular, from flooding the market with newly issued currency, leading to a collapse in its value. Holders of bitcoins are also protected against inflation. New bitcoins are issued at a predetermined rate and the supply cannot exceed the quantity specified in the protocol. A deflation of the currency is thus impossible.
Cisco Earnings Fiscal Q4 (calendar Q2) 2019: Good numbers, muted Q1 outlook.
- Thesis unchanged.
- Revenue in Q4 was up 6%. Net Income (a flawed measure) was up 9%.
- The fiscal year 2019 also finished strong, with revenue up 7%. Net Income was up 9%.
- So why did the stock take a beating?
- They provided “soft” guidance for fiscal Q1 (ending Sep 30th). They expect revenue to grow between 0 to 2% in the quarter.
- Cisco’s management cited some slowdown in “Service Provider” revenue in Asia, particularly China and India. This is based on preliminary data in July, after last quarter ended.
- China happens to be a small part of Cisco’s business – CEO Chuck Robbins says it makes up just 3%.
- The Buylyst started looking in to Cisco earlier this summer precisely because it’s a worthy trade war hedge.
- Cisco’s China business is small.
- It will be the preferred vendor for routing/switching equipment as customers build out their 5G networks in the US and Europe.
- Indeed, CEO Robbins mentioned that business in the Americas and IN Europe is strong.
- Perhaps the statement that shocked some in the market (leading to the stock falling by 8% on Aug 15th):
- “We're just being -- we're being uninvited to bid. We're not being allowed to even participate anymore. So those are the enterprises. That's where the the large impact was this past quarter. So it was, it was just a much faster decline of what we candidly expected.”
- This is a direct impact of the trade war. The Trump administration should take notice.
- But The Buylyst thesis isn’t hinged on Cisco’s small China business.
- It’s hinged to 3 vectors:
- On 5G, the results are flowing in, but they have slowed down a bit because of the trade war. Suddenly service providers in the US and in Europe had to redraw plans as they weren’t allowed to use Huawei equipment any more.
- This is a temporary issue.
- On IoT, revenue has yet to flow in. The IoT vector will gain traction once 5G gains traction.
- On Subscriptions, this is the most heartening part of the call since it’s a major part of The Buylyst thesis. Here’s the graphic from the presentation:
- Fiscal year ends September 2019.
- FX Rate assumed: EUR/USD = 1. Being conservative.
India reignites the Kashmir tinderbox.
As an investor in India, the Kashmir issue (revocation of Article 370) is a tinderbox. I'm all for the proper integration of Kashmir into India. But if a group of people have had some autonomous rights for 70 years (mistakenly or not, it is what it is), when you forcibly revoke those powers, decency and common sense calls for at least these 2 arguments:
What is the upside for the people of Kashmir? Give specifics. Some vague idea of the promise of India based on some right-wing ideology doesn't count .
While we all wait for that "upside", how will you mitigate the downside? How will you maintain peace in one of the most volatile regions in the world? By military force? Back to square one. The upside is vague but the downside is imminent and tangible - the vicious cycle of accusations of forced occupation on one side and terrorism on the other. Now, with more fuel to the fire.
The fire can spread quickly across the subcontinent. As an investor, calibrating the probability and the magnitude of this risk is impossible.
Huawei launches a new Operating System.
Huawei has been busy. They've launched their own operating system for smartphones, which is a reaction to the Trump Trade War. If Trump somehow manages to stall Google's Android OS (currently the operating system that runs on Huawei phones, then it's a big problem. So, Huawei developed their own operating system - HarmonyOS. My initial take is that it's extremely hard to build an OS from scratch, especially now. 2 reason:
1. Only 2 companies have been successful at this, because it's hard. That's Apple and Microsoft.
2. iOS and Android are prime examples of impregnable Moats - they have such a massive app-store ecosystem and user-base now that it's hard for anyone to break through.
Interdigital Q2 2019 earnings: Improving numbers, bad market reaction.
- Thesis unchanged.
- Revenue increased over last quarter by 10%, but Free Cash Flow decreased.
- Free Cash Flow, this year, is negative. A lot of that is because of cash flow timing. This time last year, there was an Accounting Standards change to ASC 606, which prescribes that companies which have licensing businesses spread out their revenue recognition over a longer period of time.
- The accounting issue mentioned above changed Interdigital revenue profile – it started allocating much more to “recurring” revenue rather than non-recurring revenue.
- In short, the change was good (in my view) but not according to the market. It made the number look lower. But there is now much less volatility in it. It’s predictable license fee.
- But the market isn't buying it.
- The Buylyst thesis on Interdigital hinged on the growth in 5G and IoT. Neither has happened yet.
- Interdigital makes money by collecting fees on cellphone sales. That’s because it develops technology that it licenses to cell-phone manufacturers. It has invested a lot in 5G technology. That investment is yet to pay off.
- The China trade war is another problem. Interdigital revenue depends on cell-phone manufacturers paying their dues. Chinese cellphone manufacturers are notorious for not paying fees on intellectual property rights. This is one of the key issues (if not THE KEY issue) in the trade war.
- The downside is that Interdigital loses access to the largest cell-phone market in the world. The upside – if the trade war gets resolved – is that is the IP rights issue is sorted (even partially), it opens up a huge market for the company.
- Combine the above with the near-inevitability of 5G and IoT, and the upside is huge.
- But it feels like Waiting for Godot.
Investor money flocks to safe-haven assets.
You may have heard chatter about the Yield Curve Inversion on TV or read about it in the papers. People tend to talk about it as if it's a harbinger of a recession. There is no causal effect. At best, a yield curve inversion is a symptom of investor sentiment - that buying long-term treasury bonds is safer than holding risky stocks. The surge in demand for long-term treasuries causes prices to rise and, therefore, yields to fall. This chart looks scary, if history repeats itself. But my point is that everything must be put in context. This time it's about bad policy (trade war) and not ridiculously leveraged assets (like 2008):
Barney's New York files for bankruptcy.
Nothing is safe in retail any more. I read a joke somewhere the other day, which read something like: "If Amazon is in your line of business, get out. If it's not, get out - your business is crap." In my take on the Retail sector, I had argued that luxury retailers were relatively safe from the Amazon onslaught. I still think they are. But the problem, in my opinion, is this: Luxury retailers like Barneys used to serve the role of fashion curators (sometimes even consultants). It was an offshoot of the old distribution model - they give shelf space to luxury brands based on their assessment of what will sell and, in essence, curate for their shoppers. But in today's hyperconnected, hyper-influenced and hyper-blogged world, do the super-rich - especially the new generations who are starting to make enough money now - need a brick-and-mortar fashion curator? Isn't it really easy for any of the leading luxury brands, and even some new entrants to speak directly to their audience. They don't need a middleman as much as they used to. In luxury watches, for example, why do I need a shopkeeper on Madison Avenue to tell me about the latest Jaeger-LeCoultre model? JLC has all the info on it on their website, on social media, on connoisseur blogs etc. I may then go to a shop to try it out. But then I may or may not buy it at the store. I may just order it online - straight from the manufacturer. This is the problem: Does the world really need Barneys, other than some quaint idea of a personal shopper?
Hydrogen could be back in fashion.
For a couple of decades now, there’s been buzz about Hydrogen being the wonder-fuel to save our planet. But it never really gained traction beyond a few buses in Germany. Now it’s being looked at as a source to store electricity generated from Wind and Solar farms. I guess the buses never took off en masse because the way to generate hydrogen is by electrolysis of water. And a traveling electrolysis setup is probably not that efficient. But this new use-case, of electricity storage deserves a lot of research. If it works, Wind and Solar Energy could a new boost.
Climate Change – Global Warming – Air Conditioning. Vicious Cycle.
Climate Change causes temperatures to rise. We’re experiencing that this summer. Temperatures reached 40 degrees Celsius in Paris. Paris! We expect that type of temperature in a place like New Delhi. But in New Delhi, where it’s been a part of life, the go-to solution is air-conditioning. This works in the short-term, but it makes matters worse in the long-term. Air-conditioners consume a lot of power. In peak times, air-conditioners consume 40-60% of power in the city. And if power generators are fossil-fuel-based, as they are in India, it exacerbates the Climate Change problem. And on and on the cycle goes. The scary part is that this effect is non-linear. And we don’t know the extent of non-linearity. For now, we just turn a blind eye, walk into our houses, and turn on the AC. This won’t end well unless we change our power generation systems to Renewables. Remember, a county like India is still relatively poor. How many millions of ACs will enter the picture when millions move into the middle class?
Apple Q3 2019 Earnings: Non iPhone business shines.
- Thesis unchanged.
- Revenue growth was flat. Decline in iPhone sales were fully offset by gains in non-iPhone sales.
- iPhone revenue decreased 17% year-over-year. But this is a transition year.
- Revenue excluding iPhone was up 17% year-over-year.
- Products, ex-iPhone, grew 20%.
- Services revenue, ex-iPhone, grew 13%.
- Growth in Mainland China is back. But maybe the latest trade-war salvo on August 2 by Trump derails this.
- Grew strong double digits in India and Brazil.
- Wearables and Services growth was impressive. Together, they now approach the size of a Fortune 50 company.
- Wearables business is now bigger than 50% of the companies in the Fortune 500.
- Services saw double digit growth in all regions of the world.
- Monthly viewers on Apple TV are up 40% year-over-year. The number is surprising because the new TVOS and Apple TV+ haven’t been launched yet.
- Mac and iPad numbers are resilient, which is consistent with one of Apple’s immutable strengths – “the cult of Mac”.
- Apple Pay doubled in volume since last year. It is now operational in 17 countries. Tim Cook wants to focus on “transit integration” as they just did with the New York Transit System.
- Long-term, the most significant point Tim Cook made was essentially this: Apple is alone in offering a software-hardware ecosystem that is known for ease-of-use and seamlessness across devices. Soon, he implies, all of Apple’s Operating Systems – iOS, MacOS, TVOS, iPADOS (soon to be launched) will talk to each other to make it easy for both users AND developers. Users should be able to access any work or content on any device. And developers should be able to write code just once, to beam down their creation for use on any OS on any device.
- This will be Apple’s biggest Moat in the future. Only Google can compete, if at all.
- Overall, I’m more confident that Apple is not iPhoning it in anymore.
TSMC Q2 2019 Earnings: Good Numbers, Good Outlook.
- Thesis Unchanged.
- Revenue increased by 9.2% from last quarter, down 1.2% from Q2 last year. In NT$ terms, revenue was up 10.2% and 3.3% respectively.
- Revenue came in at $7.75 billion, higher than Management’s guidance for the quarter. This was driven by higher demand in Higher Performance Computing and IoT markets.
- Cash Flow was lower because of increased Capital Expenditure associated with 7nm and 5nm R&D.
- CFO Laura Ho says that TSMC has now passed through the bottom of their business cycle, with clear signs of increasing demand in the next few quarters.
- Management expects smartphone demand to pick up, thanks to
- 7 nanometer chips now make up 21% of production volume, all set to become the dominant revenue source by year-end.
- 5nm is set for production in the first half of 2020. CEO C.C. Wei says that 5nm chips will show:
- 80% density advantage over 7nm.
- 15% speed advantage over 7nm.
- CEO Wei also confirmed that the 7nm node is a larger revenue stream for TSMC compared to the 28nm node – previously its largest revenue generator. The 28nm node coincided with the advent of the smartphone revolution starting in 2010.
- Management mentioned that they expect the 5nm node to be a significant revenue generator as well.
- Overall, TSMC is at the junction of several high-growth vectors – AI, 5G, IoT, Autonomous Vehicles etc. – as the only major independent semiconductor fabricators in the world. Their main competitors – Intel and Samsung – mostly fab their own chips. “Fabless” companies that design chips – like AMD, Nvidia, Apple – tend to rely on TSMC. This is an enviable position to be in, and this fantastic competitive dynamic is at the heart of The Buylyst thesis.
Ford Q2 2019 Earnings: Decent numbers, below expectations.
- Thesis unchanged.
- The stock was down more than 7% due to the same old concerns: Global slowdown, EV prospects, China losses. Nothing new there. But since Q1 was a positive surprise, analysts expected Q2 to be great as well. It wasn’t bad.
- Revenue was flat compared to this time last year. Free Cash Flow was up.
- Volume in North America was down but it was offset by an increase in Ford’s product price mix. This reflect Ford’s conscious decision to focus on products it’s good at: SUVs, Mustang, Vans etc.
- The big positive surprise was China. The China business still bleeds money, but losses shrank by a couple of hundred million dollars. 2019 and 2020 are big product launch years for Ford in China. Ford hopes that it can turn a profit based on its new product lineup.
- Ford is drastically restructuring its Europe business. Even there, it wants to focus on its strengths – namely Commercial Vans and Pickups. The end-goal is to dominate these 2 utilitarian products in an Autonomous-Electric world. The seeds must be sown now. This brings me to the next point.
- The alliance with Volkswagen resulted in a $2.7 billion investment in Argo AI – Ford’s AV unit. It’s still a research outfit but this investment implies a valuation of $7 billion. Compare that to the fact that Ford Motor’s overall Market Capitalization is $38 billion. The $7 billion valuation of Argo has not been priced into Ford’s stock yet. If things pan out the way VW and Ford think it will, that right there is a source of substantial upside. Of course, that’s assuming that Ford’s profit margins improve as it changes its product mix to suit its strengths.
- The basic of the Ford-VW alliance is this: Ford will use VW’s EV technology and VW will use Ford’s AV technology. I have high hopes for this alliance, especially regarding commercial vehicles. It’s hard to put a valuation on this.
- Ford expects Free Cash Flow to improve in 2019. In my original thesis, I had assumed that Ford would achieve a sustainable FCF of about $3 billion. I think Ford is on track to get there.
- A lot hangs on execution as Ford transition to an AV/EV world. But they’ve been decisive and they’re sticking to a strategy that I think is the right one.
Apple buy's Intel's 5G Modem unit.
This news signals a source of upside in Apple that hasn't really been priced into its stock. Yes, iPhone demand has stagnated. Yes, Apple's shifting heavily to Services. But 5G is a big tailwind, not just for Apple but all phone makers. Apple would like to use this paradigm shift as a way to differentiate the iPhone even more, much in the same way that it differentiates the Mac from its Windows-run competitors. It's been successful in selling the message that end-to-end software and hardware means better quality. In phones, we've seen Apple design its own AI Bionic chips. Now it wants to have a lot control over its 5G modems. Apple doesn't want to depend on Qualcomm like it did in the past. That would mean no real differentiation from its Android-based competition.
Wind Energy outpaces Coal for the first time in Texas.
This isn't a surprise to me but it'll probably surprise most people. In a traditionally fossil-fuel-friendly state, with an administration in D.C. that's hostile to renewable energy, Wind Energy has now become a bigger source of energy than Coal. Call the Texans what you will, but they are practical when it comes to Energy. It's in their DNA.
India is trying to kick its Coal habit.
This article is another re-iteration of the obvious thing to do in India. It seems the effects of pollution are felt everywhere - in the air, in water, in droughts that cut into most of the country's livelihood - agriculture. The is article points out the Modi Government is serious about Renewable Energy. Here are a couple of excepts of the article that highlight the point:
"India is investing heavily in renewable energy. It has increased its solar energy capacity from less than four gigawatts in 2015 to nearly 30 gigawatts — about 8% of its total energy capability."
"We are accelerating the pace of renewables in a very, very big way," says Amitabh Kant, CEO of National Institution for Transforming India, a government think tank.
"India's biggest strength is not in coal but in the sun," he adds. "I think in the next three to four years you will realize that the acceleration towards renewables will be phenomenal."
Terraform spends $720 million to buy 300 MW of Solar assets.
Since Terraform is a holding at The Buylyst, my first question was: is this money well-spent? It seems that management expects a 9% to 11% return on its investments. At first glance, I was a bit disappointed. But the other side of any ROI calculation is Risk. In this case, Terraform saw two risk-mitigating reason to purchase these assets:
Diversify its portfolio, both in terms of regional exposure and in terms of technology - wind vs. solar.
Sign potentially long-term Power Purchase Agreements that guarantee a minimal level of cash flow for years.
On point #2, it's about good execution. It's up to Brookfield Asset Management - Terraform's equity sponsor - to make sure they can secure such a contact.
An Electric F-150 tows a million pounds.
"Built Ford Tough" ports over nicely into the new Ford - the Electric Ford. Ford has bene decisive about its transition to Electric Vehicles (it's restructuring its firm by spending $11 billion). One of concerns was whether Ford's dominance in the pickup truck arena will be affected by the company's electrification. It seems not. This electric F-150 pulled a train weighing a million pounds! Electric Vehicles have some vroom and some power!
Morocco builds a Solar Farm as large as Manhattan.
This story highlights a number of points that explain the surge in Renewable Energy:
- Most countries rely on imports (often from questionable regimes) for their energy needs.
- Most countries would like to be completely dependent on Renewable Energy – if technology and economics allow it.
- The biggest technological constraint in the Renewable Energy boom is mass-scale Energy Storage.
This Morocco project checks all the boxes. It’s a 500-megawatt facility, which is as big as most Natural-Gas power plants in the US. Morocco imports more than 90% of its fossil fuels, so this type of a project is big priority for them. By 2020 (next year!), they want almost half their power needs to be facilitated by Renewable Energy. To do that, they’ve come up with a novel Energy Storage Solution: Salt.
Instead of connecting hundreds of thousands of solar panels directly to the grid, these panels are used to heat up pipes that carry heat to a central tower that contains molten salt. Apparently, that’s a good heat-storing agent. Basically, energy is stored as heat but dispatched as electricity. Pretty cool. Or should I say, “Pretty Hot!”?
India has ambitious Renewable Energy plans.
India, it seems to me, embodies all the reasons why countries should move away from fossil fuels as fast as they can: Energy Security, Pollution, Heat, Droughts…the list goes on. Today, most of India’s power needs are met by Coal. But the government wants the country to kick this addiction. Here’s a line from this article that captures India’s intent:
“The government is aiming for 175 gigawatts of renewable energy by 2022, with 100 GW to come from solar power, 60 GW from wind, 10 GW from biofuels and 5 GW from hydropower.”
New York gets in on the Wind Energy boom.
New York State recently passed a massive Renewable Energy law. The state wants to source 70% of electricity needs from renewable sources. And this auction for Offshore Wind Turbines is the first step in executing that plan. The facility is supposed to have a capacity of 1,700 megawatts. That’s roughly 3 full-size power plants. At The Buylyst, we hope that Vestas – one of our first holdings – gets a significant chunk of this business.
Wall Street Journal tests out 5G in the US.
This article lists 7 findings as some journalists from “the journal” went across to the country to experience 5G firsthand. These were the findings:
- Finding 1: Soooo fast.
- Finding 2: Got a 5G signal? Don’t move.
- Finding 3: Got a 5G signal? Don’t go inside.
- Finding 4: AT&T’s 5GE isn’t 5G.
- Finding 5: Ice packs not included.
- Finding 6: Sprint finally has an edge.
- Finding 7: 5G doesn’t do much right now.
Most of the negatives are related to coverage and penetration. It’s a problem, sure. But I think the problems are fixable with more MIMO antennas and Fixed Wireless technologies. As those technologies stand today – they may be too cumbersome to spread around. But to assume that technology won’t improve is usually erroneous.
IBM Q2 2019 Earnings: Decent numbers but Is it an Inflection Point?
- It feels a bit like “Waiting for Godot” with the company’s transition away from its legacy business over to the new world of Cloud Computing, AI and Big Data.
- The dynamics are simple: Can IBM’s “new revenue stream” more than offset its “legacy revenue stream”? At the moment, it seems like the growth in the latter pretty much cancels out the decline in the former. That’s not such a bad thing, especially after years of revenue decline. Since last year, it appears that the decline has been arrested.
- The crux of The Buylyst thesis was that IBM may have finally found new relevance in this brave new world with its competitive advantage in AI, delivered via Cloud. And the underlying assumption in that bet is that while Amazon, Google and Microsoft will likely lead in both Cloud infrastructure and in AI tools, they won’t make up 80-90% of the market; there will be room for others – IF they carve out a niche for themselves. About this – carving out that niche – the jury on IBM is still out.
- In terms of the numbers, this quarter was mostly good.
- Revenue was down less than 1%, but earnings and Free Cash Flow were both up.
- Gross Margin improved significantly – by 100 basis points. I recall that that this time last year, Mr. Market dinged IBM stock because Gross Margin had declined slightly. This quarter, Mr. Market was happy.
- In terms of Revenue, 2 segments saw some growth and 2 didn’t:
- Cloud & Cognitive Software grew by 5%.
- Global Business Services grew by 3%.
- Global Technology Services declined by 4%.
- Systems declined by 18%.
- The first business segment – Cloud & Cognitive Software – is the crux of the “new IBM”. 5% growth doesn’t look impressive but it’s not bad in a world where Amazon, Google and Microsoft get all the attention.
- The second business segment – Global Business Services – is being reorganized to complement Cloud & Cognitive Software.
- The third and fourth segments are more in the “old IBM” bucket. The Systems segment sells servers for Datacenters, so it could be considered a “new IBM” type of business. But this business is cyclical. And it’s super-competitive.
- Numerically, the most heartening news was the improvement in Free Cash Flow by about 900 million in the first half of this year compared to last year. It turns out that the improvement was due to a reduction in NET capital expenditure. This was due to cash inflow associated with some divestitures – a sign that IBM is acting decisively to clean up house.
- The other elephant in the room was the Red Hat acquisition. CFO Kavanaugh said that IBM will update investors on August 2nd. I’ll tune in for that.
Micron issues $1.75 billion in bonds.
The proceeds from this transaction will be used to finance Micron’s buyout of Intel’s stake in the joint-venture both companies had previously formed. The point of the JV was to develop new memory technologies – chief of which was to be some kickass combination of DRAM and NAND memory. As I’ve discussed before – each of these types of memory has some advantages and disadvantages. As AI and IoT start proliferating our civilization, combining them would be a massive achievement (read as $$$!) for Micron or any of their 2 big competitors. Intel, it seems, has decided to go their own way in developing this sort of “hybrid” memory technology. For now, I think Micron – being a dedicated Memory company – has the advantage.
Cisco acquires an Optical Communications company.
This news got me excited, not so much about Cisco but about Lumentum. The big bet with Lumentum was that Optical Communication will dominate in the new AI-infused-5G-IoT world. It seems Cisco is also investing heavily in that. With Cisco, the main investment rationale was that they dominate parts of the 5G architecture that Huawei doesn’t compete in; and hence they’d be relatively immune to this trade-war mess. But the reality is that Cisco’s main products fit into a larger network. And if that network is mostly comprised of Fiber Optics – meaning that data is transferred using light rather than electricity – Cisco’s products will need to be compatible with the (literally) lightning-fast network.
Apple doubles down on India.
The Buylyst investment thesis on Apple is more than a year old. A big part of that thesis was the India angle. I must admit that the India story hasn’t played out. Apple has failed to create that aura in India – the aura of a premium product that others copy – that it enjoys in most other parts of the world. In India, most people are quite happy with an Android phone that costs a few hundred dollars less.
It seems that Apple hasn’t given up on India. It is now planning to open Apple Stores in the country. They’ve also started manufacturing iPhones in India, which presumably lowers their price in India. The upside is big. Maybe the India part of The Buylyst thesis will play out in time.
Volkswagen invests in Ford’s Autonomous Car unit.
This is a big deal. I’ve made several comments about an impending deal between these two companies before. Both these companies have already joined forces to build and market Commercial Vans and Pickup Trucks. Joining hands on Autonomy is the next logical step. It’s not hard to see that this is where the world is going: Less ownership of passenger cars, more vans for last mile-deliveries and urban transport, and a stable demand for utilitarian vehicles (things will still need to be built and fixed even if millennials and Gen Z folks don’t own many cars). In this world, the VW-Ford partnership could turn out to be the big fish. That’s the strategy anyway. It makes sense.
India’s 2019 Federal Budget, in charts.
Here’s a nice pictorial article about India’s 2019 Budget – the process of detailing the Central Government’s allocation of resources in front of the Parliament. We were watching for some eye-popping details but there was nothing revolutionary in this budget – the first from the newly re-elected Modi government. However, the article does mention 3 sectors that seemed to have gained new prominence: Agriculture, Renewable Energy, and Labor. All 3 happen to be the main pillars of our India strategy. In our case, we’ve bet on Water, Urbanization and Consumer Spending. Of course, we expect Solar and Wind energy to be a big focus in India going forward and we hope that our bet on Vestas harnesses some that tailwind.
Johny Ive - Apple's design genius - to leave company.
This is a big blow to Apple - the company that took Design in consumer products to a whole new level. That was mostly because of one man - Johny Ive - who shot to fame with those iMacs in the late 90s. That was the product that revived Apple, and provided a lot of cash to reinvest in a game-changing product called the iPhone, the design for which was also spearheaded by Ive. But it seems that Ive will launch his own firm and continue to work with Apple. So, that's good.
This Indian airport relies solely on Solar Power.
This is an amazing story, and an inspiration to the rest of the country. Cochin's airport is now totally self-reliant using solar panels.
India has long had massive power shortages throughout its heartland. It's only recently that most villages have access to power. But power cuts and blackouts still happen. On top of that, India still relies on dirty coal for most of it power needs. For a country that viscerally feels the effects of pollution and climate change, it's an untenable situation. India has got ample sunshine. Solar power is an obvious solution. Cochin shows them how.
How about Floating Solar Power?
Japan's come up with neat new solution (no surprises there) - they put miles of solar panels on lakes and ponds. In a country that's a little short on land mass, this seems like an obvious solution. This line makes the point succinctly...
"The biggest Japanese floating solar plant sits behind the Yamakura Dam at Ichihara in Chiba Prefecture. It covers 18 hectares, can power nearly 5,000 homes and is saving more than 8,000 tonnes of CO2 a year."
And that facility fits on a lake. I agree it's not the prettiest thing to look at but I would think this technique can be used at sea as well. We already have Offshore Wind Farms. Why not Offshore Solar Farms?
India exceeds 10 terrawatt-hours from Solar Power.
It's an artificial milestone, sure, but it's an indication of where the country's heading. This amount of Solar Power still accounts for only 3.4% of India's total power output. But consider the fact that the growth in solar-power this year is about 57%. And if you open up the article, you'll see the projections for Solar Power's proportion of the future supply stack of India. Even to reach half way there, it's a long way.
Why does India have a water problem?
The India Today magazine has a great article on India's water problem and its causes. The main cause: Overusing groundwater. That problem exacerbated this summer as monsoons were delayed. 50% of India's urban water supply and 85% of its rural water supply depend on groundwater. But reservoirs are running out faster than they're getting refilled. The situation is untenable. Here's another shocking stat: 21 cities will reach Day 0 by next year - this is according Niti Aayog, the Central Government's think tank.
Micron Fiscal Q3 earnings: Bad numbers, positive outlook.
- Thesis unchanged.
- Revenue was down 18% from last quarter and 39% from last year.
- Revenue was down mostly due to pricing. Volume was roughly flat.
- I expected the price declines, but I had thought volume would increase since last – it was central to the thesis. This hasn’t happened because there was a lot of inventory build-up over the last few quarters.
- Both DRAM and NAND faced pricing declines. And volume wasn’t up for both product categories.
- Then there is the Huawei issue: Huawei makes up about 10-13% of Micron’s revenue. But it turns out that there are a few products that Micron can ship to Huawei despite the ban. We weren’t given a precise number. The upside, I guess, is that the 5G transformation is inevitable – if not Huawei, then someone else will need Memory. The downside is a net loss of, say, 6-7% in 2020 revenue – attributable to the Huawei ban. We’ll see what happens at the G-20 meeting.
- The positive outlook was about inventory management. CEO Mehrotra said that Capex and production cuts that were put in place earlier this year by the “big 3” (Micron, Samsung, SK Hynix) will kick in during the second half of 2019. That would arrest the price decline, while long-term estimates of volume growth continue to be positive. In short, revenue should start growing again in a quarter or two.
- In fact, the guidance given for the next quarter’s revenue is about the same as this quarter. That suggest a trough, assuming that expectations of demand growth for memory remain intact.
- Revenue associated with Autonomous Vehicles and ADAS hasn’t improved. This surprised me. However, Mehrotra did mention that Micron won a top OEM order for Autonomous Vehicles this quarter.
- The move to “high value products” also seems slow to me. It’s been about a year since I wrote the Micron thesis, so I expected to see some cool, new memory products by now – products that new Chinese DRAM companies simply cannot catch up with.
- Overall, numbers for this quarter look ominous. But the guidance for next quarter suggests that this is the bottom of the trough. I am surprised that volume growth has been so lethargic. Granted, it’s just one quarter. And surprisingly, the market was fine with it. The stock shot up more than 10%.
Apple buys Drive.ai to boost its AV efforts.
Apple trying its hand at Autonomous Vehicles (AV) is not new. Project Titan has been this mysterious concept since last year. In fact, when I wrote the Apple thesis about a year ago, I thought AV was going to be one of their new growth vectors. Now it's been a year, and they go out and buy this (allegedly) financial challenged company. The Value Investor in me is smiling. But I wonder if this purchase is a dollar short and day late. These lines from the article didn't instill a lot of confidence in me:
"Apple is vying against rivals such as Alphabet Inc’s Waymo to develop self-driving vehicles. In the past year, Apple has revamped its efforts, bringing former Tesla Inc engineering chief Doug Field to oversee the operation, which includes more than 5,000 workers."
Waymo has "way mo.." data already (get it :)). But when it comes to software, I would never count Apple out.
Ford to lay off 12,000 in Europe.
Mr. Market took this news positively. I agree. I've long maintained that Ford would be a much more profitable company if it would get rid of its Europe and Asia business. Of course, I didn't recommend that. My point was that Ford should compete where it can win - in Europe that would be in Commercial Vans. Concentrating on that specialized segment would, of course, result is mass layoffs.
The assumptions behind this number are simple:
- Revenue increases by about 20% before stabilizing. This is based on my expectation that Cisco will be able to monetize the growth in data traffic and IoT in a way that more than offsets the inevitable decline in traditional hardware revenue.
- EBITDA margins remain unchanged compared to the last 12 months – this is a conservative assumption given my expectation that the transition to a subscription-based revenue stream will increase margins.
- The rest of the numbers – Capital Expenditure, Debt, Tax Rates etc. – remain at roughly the same level as the last 12 months.
- Assumed that cash paid for acquisitions will be recovered over the long-term. In other worlds, a 0% IRR, which is conservative.
- I’m using the customary multiple of 20X Free Cash Flow for valuation – The Buylyst standard for “comfortable” companies.
2018 Working Capital number was fantastic because of a one-time tax benefit due to the new corporate tax law.
Nvidia and The Volvo Group join hands for Driverless Trucks.
2 of The Buylyst's holdings are joining forces to position themselves as a force to reckon with in what I consider a "inevitability": Driverless Trucks. Their competitors - as things stand today - are Tesla, Scania (VW), Ford (for smaller trucks) and The Daimler-Benz Group. Volvo, by the way, already has smaller driverless construction equipment and trucks operating in some mines in Norway.
Wind and Solar Energy will make up about 50% of our power supply by 2050.
Today that number is at roughly 7%. So, the 50% prediction by Bloomberg New Energy Finance looks very aggressive. It's hard to predict these things. But even if BNEF is wrong by half and, say, Wind+Solar make up about 25-30% of our power supply, it's enough tailwind to aggressively find ways to stay invested in Renewable Energy. The Buylyst is committed to this theme - most directly via Vestas and Terraform.
New York State commits (by law) to 100% Renewable Energy by 2040.
Renewable Energy still has many skeptics and scoffers, at least in the US. The Trump Administration is amongst those who are in denial. Renewable Energy looks like an unstoppable movement now. Several states are committing to 100% Renewable Energy in the next couple of decades. New York is the latest. This article says that New York joins some other populous states in taking a stand against Climate Change:
"...New York would join a list of states and other jurisdictions to institute a 100% clean energy requirement, including: California, Nevada, Hawaii, Washington, New Mexico, Washington, D.C., and Puerto Rico."
As much as skeptics will try to pain this as a "hippie" thing, the fact is that now it's Economics driving these decisions as much as "hippiness".
India's water problem is untenable.
Climate Change, mismanagement, political battles...the reasons are many. But a solution must be found. This should be the newly re-elected Modi government's top priority. Chennai, one of the largest cities in India ran out of water. That is astounding! But to many Indians it's not entirely surprising. This article points out a sad reality in India:
"Water is scarce in most Indian cities at the best of times and residents don't expect their taps to run round the clock, so they store it."
In developed countries, we take water for granted. But millions of people around the world are forced to spend a big chunk of the most productive hours of their day just to fetch water. The economic cost must be staggering.
Slack debuts on the NYSE without help from Investment Banks.
Spotify did it last year. Now it's Slack. The phenomenon is called Direct Listing. It's catching on, and I think it's a good thing. I don't have anything against Investment Banks but the whole Initial Public Offering system never passed the smell test for me. I mean, it's no secret that IPOs are underpriced, so as to almost guarantee a healthy profit to the well-connected, "sophisticated" investors who get a special allocation of the new listing. Tech companies - generally idealistic - have found this workaround. More to come, I would wager.
Here's how Unicorn IPOs have done this year.
Recode has a nice chart on the most celebrated IPOs of the year. I'm surprised by the interest in Pinterest. I haven't dug into their financials, but it seems like something society doesn't need at all. Maybe I'm missing something. The online-meeting company Zoom tops the chart. Uber and Lyft haven't been impressive, which is sort of heartening to see. It makes me feel there is some sanity in the markets.
Facebook launches its own cryptocurrency: Libra.
This was expected. Verge has a good timeline of headlines that led up this announcement. I haven't dug into it's nuances but right off the bat it's easy to see 2 big differences compared to Bitcoin:
- The "mining" process is supposed be more environment-friendly because it won't involve solving hard math puzzles. Libra will be based on some of sort of algorithm designed by Facebook.
- Libra will be tethered to established currencies of the day - USD, EUR, GBP etc.
Point #2 is interesting because the whole point of the cryptocurrency movement was independence from "evil" Central Banks. I've argued that Bitcoin is much more of a political statement than an economic one.
The Fed vs. Trump.
The Federal Reserve provided a lot of relief this week, as we can see from the amazing rally. Chairman Powell was very dovish in his assessment of what the Fed needs to do in the near future - the probability of rate cuts has now increased significantly. The Wall Street Journal has a nice summary of the 5 takeaways from Chairman Powell's press conference. Here they are:
- Mr. Powell sounds ready to cut rates.
- A rate reduction could happen soon.
- Monetary policy may not be the best tool to cushion against a trade slowdown, but that won’t stop the Fed from using it.
- Low inflation is a pressing concern.
- Who’s afraid of full employment?
The subtext of the presser was essentially this: The Trade Wars will probably hurt the economy. If that happens, the Fed will step in with whatever tools it has to make sure that deflation is staved off. For the markets, it's Fed vs. Trump now. Everything else is secondary.
GE should have bet on Wind Energy.
You know, just occasionally, I go back and read my investment theses and pat myself on the back. Usually, I'm happy being "just about right". But sometimes the problems with a company are so obvious, it doesn't take a genius to call them out. In my original thesis about GE, I had explicitly said that GE needs to make a decision - Natural Gas Plants or Wind Energy - and stick with it. At the time, I had hoped that GE went with Wind Energy. But it turned out that they underestimated the pace at which the economics of Wind Energy would make it super-compelling. Suddenly the growth in Natural Gas Plants in the US lost its sizzle. This is a reminder that it's not enough to depend on historical numbers to make a decision. You've got to have a worldview to figure out the right sport to play. That goes for investors like us. And for big companies like GE.
Norway's sovereign wealth fund - one of the largest in the world - moves away from fossil fuels.
I like this story because of the fact that Norway built up it's enormous public fund on the back of Oil. But, culturally, Norway has (paradoxically) been a fan of Renewable Energy. Apparently, outside the US, one of Telsa's largest markets is Norway. But, more importantly (and selfishly :)), it highlights a definitive stand The Buylyst took more than a year ago, with The Buylyst wager in Energy.
Elon Musk makes a nice presentation on Tesla's Investor Day.
Tesla recently had its investor day. And the presentation was compelling. I maintain that this is a great company with great products. This presentation highlights that. However, as I've shown in my most recent worldview on Tesla, a 25% reduction in demand would put the company in trouble. Obviously, as that unfolds, the stock would get pummeled.
Hedge Fund investor Dan Loeb has a plan for Sony.
Famed hedge fund investor Dan Loeb of Third Point is one of Sony's largest shareholders. He gave a presentation to Sony's shareholders about unlocking Sony's true value, which he feels is deeply underpriced in its stock price. He gave many possible reasons for this but his key point was that it's a conglomerate and investors just find the portfolio of assets too complex to evaluate in combination. He suggested that the Semiconductor business should be spun off. He thinks this business would be worth a lot more on its own. That way shareholders in the remaining conglomerate would get rewarded for it.
If you've read The Buylyst thesis on Sony, I had a slightly different perspective. I had argued that Sony should get rid of any segment that doesn't fit into Entertainment, which are their Financials, Smartphones, and Electronics units. I guess one could argue that Electronics - TVs and Sound Systems - are Entertainment products. True, but Sony doesn't have a competitive advantage in them - Samsung and LG probably dominate the TV market. With the Semiconductors business, Loeb brings up a point I had made in my thesis, which was that the segment is predominantly about CMOS image sensors. They go into smartphones nowadays - think of them as a semiconductor chip that can see. But I had argued that the future of Gaming (Sony's biggest business) is intricately tied to Virtual Reality. And in those VR hardware units, this expertise may be useful. Loeb makes a good point that the unit doesn't get enough credit. In my view, it's Financials, Electronics and Smartphones that drag down the company. On this we agree - Sony should become an Entertainment behemoth.
Mary Meeker - top Venture Capitalist - thinks about the world so we don't have to.
Mary Meeker raised more than a billion dollars for her new fund, "Bond". I can see why - she really thinks things through. TechCrunch got a hold of her second "Internet Trends Report". Meeker goes through - with data - every part of the internet, which basically touches every industry. The presentation is more than 300 pages long! It's a treasure trove. Now, this is what I call a Worldview! For example, 3 data points stood out to me (amongst many others):
- For the first time, this year people consumed more entertainment on their mobile phone than any other device.
- Only 22% of workloads have made it to the Cloud.
- Internet penetration, globally, is only at about 50%. What!?
Apple’s Developer Conference raised some eyebrows.
A few days ago, Apple had its annual WWDC or Worldwide Developer Conference. This event is meant for developers, as the name suggests, so it tends to be a little more “forward looking” than the consumer-oriented product-launch type of events. This is the nuts-and-bolts conference. Investors look for clues on Apple’s future products. Here’s a list of the main announcements:
- Killing iTunes on MacOS. This was expected.
- The Apple Watch gets its own App Store.
- At the same time, iOS Apps will work on MacOS.
- And the iPad gets its own operating system called iPadOS (not a very creative name).
- Updates on tvOS. Apple Music will run on tvOS.
- Launch of the $5,999 Mac Pro. With a stand that costs $999! Yup.
There’s been lots of media coverage about the $999 stand, maybe rightly so. It’s ridiculous. But that computer is meant for creative professionals who make high-quality videos, music or graphics. Maybe $999 ain’t so much on a corporate expense account. But enough about that. I’m more interested in the other stuff: #1-#6. That’s because they’re central to The Buylyst thesis on Apple.
The Buylyst thesis was about Apple becoming an Entertainment juggernaut again, years after it revolutionized the music industry with iTunes (which it’s killing). Apple’s advantage, I had argued, would be its proficiency with BOTH devices and operating systems. Its competitors have one or the other, or none. In a post-iPhone world, Apple would sell “services” that make its slick devices even more attractive. That was the rationale. This WWDC suggests Apple is going down that route.
I’m going to stick my neck out and say this – Apple is trying to:
- While Operating Systems may differ from device to device, Apple will make it possible to use any app on any device at any time.
- Apple will try to make tvOS the “netflix of the netflixs”, which would include movies, shows, music and video-games.
- Apple Watch gets its own operating system because Apple will try to make it much more than it is now – a biofeedback device, a “wellness” device…and so on.
The competitive advantage of Apple remains the end-to-end architecture they enjoy. Google tries it with some devices. And in reality, the iPhone era is over – the Moat has narrowed. Apple wants to move the fight back to entertainment, software and the overlap between the two.
Here's a scathing assessment of Uber as an investment.
I agree with a lot of the points they've made: unless Uber can control costs and hold them steady while revenue grows, there is no hope of cash flow. I disagree with this article on one major point: that most of Uber's costs are variable. In my assessment, I broke down the numbers and finally assumed about 50% of its costs to be fixed. That may have been a generous assumption, because the worldview was an intellectual exercise rather than an investment thesis. But the point is that there are many "fixable" costs.
May was brutal, but get over it.
Another insightful piece by Ben Carlson of A Wealth of Common Sense. A 5% correction from double-digit returns through April (just 4 months) is quite mild by historical standards. In fact, Ben points out that double-digit corrections are normal. He says about peak-to-trough corrections:
"...almost 40% of the time stocks didn’t fall double digits and stayed in the 5-10% range. Another 38% of the time stocks fell 10-20% from the highs and 16% of the time losses were in excess of 20%."
So, this correction may have more room to go.
Hedge Fund investors in Lyft don't expect Lyft to be profitable.
This article highlights the biggest driving force in "unicorn investing" - the idea that "...I'm going to buy this stock because others would buy into the hype, even though I know that profitability is many years away, if at all...". It's what I call "trader-bro" investing. It ignores one of the foundational principles of Intelligent Investing:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” - Benjamin Graham.
The trouble is, there is no clock that tells you exactly when "the short run" ends and when "the long run" begins. You just don’t know when the market will start “weighing”. You could get caught in a quicksand before you know it. Better to always “weigh” rather than “vote”.
“I have always found it easier to evaluate the weights dictated by fundamentals than votes dictated by psychology.” – Warren Buffett
Palo Alto Fiscal Q3 2019 (Calendar Q1) Earnings: Good, but below market expectations.
- Palo Alto is currently rated as a “Watch”.
- Thesis unchanged.
- Numbers were good. Revenue was up 30% from this time last year, as was Free Cash Flow. Pretty impressive.
- But Mr. Market punished the stock mostly for Management’s outlook.
- Outlook wasn’t bad. Mr. Market has 2 complaints about outlook:
- Timing of cash flows
- About cash flows: Palo Alto is moving towards a SaaS model, focused on securing Cloud infrastructures. Subscription models are generally annual plans. This is different from the usual 3-year contracts they’ve had with their clients. That slows the inflow of cash – they come in lots instead of a lump-sum.
- About acquisitions: CEO Nikesh Arora has a penchant for making acquisitions. The fear is that they come at a high price – either with a high purchase price or shareholder dilution. Or they could just not turn out to be “value-accretive”.
- Palo Alto intends to acquire 2 companies – Twistlock and Puresec, just announced a few days ago. They’re both meant to beef up the company’s Cloud Security offering.
- On the first point about Cash flow, I think this is a positive. Subscriptions make cash flows sticky – just as much as 3 year-long contracts. The advantage of an annual contract is that win-rates will probably be higher – more prospective clients will be willing to try out a SaaS product for a year, especially if it involves no hardware installations. In fact, this was part of the Buylyst thesis as a positive. Even if there are cash flow timing issues, I expect the total amount to increase over time. The amount matters more than timing.
- On the second issue of acquisitions – this was listed as a negative in the Management section of The Buylyst thesis. This is an ongoing issue. The flip-side of the argument is that clients want a one-stop shop in cybersecurity. The challenge now is to provide them with a neat, cohesive dashboard that puts all the components of security on a single screen. Funnily enough, Palo Alto acquired Demisto not too long ago to serve this purpose.
- Palo Alto launched PRISMA – a Cloud Security focused dashboard and analytics software tool.
- The fundamentals of the company haven’t changed. This negative reaction to timing of cash flows, in my view, is an algebra problem for many analysts. They have discounted cash flow models that spit out a target price. If cash flows have to be moved around, it penalizes the stock price for realizing cash flows later than they normally would. I don’t think this is a big problem. It’s very short-term oriented. This is why The Buylyst focuses on “sustainable” level of cash flows.
TSMC not affected by Huawei.
The trade war (along with the Huawei issue is calling all the shots. Tech stocks are getting pummeled. TSMC is no exception. Recently, the company's management insisted that the Huawei ban doesn't really affect them. But the market doesn't care. It's all about Beta now, without any regard for fundamental changes in a company's prospects.
A ban is not the way to deal with Huawei.
No one is calling out the real problem: Let's say Huawei has these mysterious "backdoors" that can steal "secrets" through its 5G equipment. Is there no way to check a physical equipment for software of hardware idiosyncrasies? This whole issue reminds me of another spook story from October 2018, which had a big hand in instigating another market free-fall - when Bloomberg claimed that Chinese server components had "spy chips". Nobody found anything. What happened? Are they so small that no microscope or scanning equipment can detect them? Somehow, Bloomberg News can?
I don't normally agree with a lot of WSJ op-eds but I agree with this writer that instituting security check rules rather than creating supply-chain havoc is the way to deal with Huawei.
Investing in Modi’s India.
You either love him or hate him. Prime Minister Modi (“NaMo”) is either overly glorified or overly vilified. He has a Hindu-Nationalist streak in him, given his history with right-wing ideologues like the RSS. At the same time, he seems to be genuinely interested in economic development and technology. He seems genuinely motivated to lift hundreds of millions of Indians out of poverty while racing towards a $5 trillion economy. I hope that in his second term - his "legacy term" - he focuses on his economic ideas rather than communal ones. I've read reports that his plans would amount to about $1.4 trillion in government expenditure. That seems unattainable. Modi may have to pick his battles.
One area which seems to be at the lucrative intersection of Modi's proclivities and India's needs: Renewable Energy. In fact, many analysts believe that one of the main reasons Modi and the BJP won so convincingly is because of their success in electrifying India – down to the most remote villages. While Coal Power still dominates in India, Modi has been interested in Solar and Wind Power. That may accelerate. Bloomberg New Energy Finance has high hopes about this. And they've based their hopes on evidence. For example, they report:
"Under five years of Modi government’s tenure, the grid-connected renewable energy capacity increased by roughly 2.5 times to 79GW from 32GW in May 2014."
The Buylyst is already invested in Renewable Energy and in India. It's time to find opportunities, if there are any, within the intersection of these two bastions of growth.
NXP buys Marvell Tech's wifi and bluetooth assets.
NXP is a going full steam ahead with its Autonomous Vehicles focus. It's hard for me to judge the quality of this acquisition, or its price, but it's heartening to see that they're focused on, and determined to invest in, their competitive advantage in what is a "near-inevitability".
Interdigital may be turning a corner.
Interdigital has been one of the most frustrating stories for me. It's been chugging along, waiting for the market to recognize the potential bump in revenue that would come from proliferation of 5G and 5G handsets. That hasn't happened. Throw on top of that the Huawei ban, and it weighs on the anticipation of 5G, IoT and the works. My original thesis was based on: 1) proliferation of 5G, which brings 2) proliferation of IoT, along with 3) a more stable, subscription-based revenue stream. Only #3 has come to fruition. This latest news of an upward guidance in revenue, in connection with a private offering of convertible bonds, is a welcome change. It may be a sign that this more stable revenue stream may finally see some tailwind as the world moves on to 5G, with or without Huawei. The stock was up more than 5% yesterday.
Replaced Tesla thesis with Tesla Inc. thesis.
This was done for 2 reasons:
- Over the last 12-13 months, the original Tesla thesis dropped down to our original $250 price target and beyond. We view this as a validation of The Buylyst way to evaluating companies - primarily refraining from paying for hype.
- We adjusted down our new price target to approximately $200, in light our recent deep-dive of Tesla.
ASML price target adjusted to approximately $200 from $167.
ASML's EUV technology seems to be growing into its own. Big customers like Samsung and TSMC are accepting it, incorporating it, and now see it as a necessary technology to ensure their companies' competitiveness for the next few years as Moore's Law reaches its limits.
Please see "Is Tesla investable now" for assumptions.
Also assumed a higher share count of 183 million shares, based on the expectations that Tesla will issue more shares in the near future.
Does ASML’s valuation change?
The main reason for the change is increased confidence in the numbers. Specifically, it’s increased confidence about the number of EUV machines that will be shipped in 2019 and 2020. In 2019, Management seems quite confident that they’ll ship about 32 units. In 2020, they expect to ship about 40 units – the annual run-rate at which ASML expects to plateau. Management gave us some pricing information: about $100 million per “B” unit and $130 million per “C” unit. The latter is newer and more efficient.
If you do some quick math, 40 units at $130 million a pop is about $5 billion in revenue. Coincidentally, or not, the low end of Management’s 2025 revenue guidance range is about $15 billion - $5 billion more than the current run-rate (their range is $15bn to $25bn). Not coincidentally, that’s about what I had originally assumed as “sustainable” revenue. The main assumptions behind that were 1) increased EUV sales and 2) declining revenue from older products offset by Services revenue attached to new products (like EUV machines). These assumptions remain intact. So, what changes?
Based on my renewed confidence that EUV is a legit product – as suggested by Management’s confidence about shipment volume and by comments made by clients of ASML – I adjusted two rather draconian assumptions I had made 6 months ago:
- EBITDA margin: I had assumed a rather harsh 37% based on the expectation that EUV will dilute gross margins. That will happen. But at a rate of 40-unit shipments in 2020, Management expects to earn more than 40% in gross margins. While still dilutive, I would peg the new EBITDA margin at around 40% for the overall company.
- I had factored in a rather draconian assumption on Capital Expenditure earlier. I assumed that ASML would require heavier investments in EUV than Management had led us to believe. But Management has now reassured us that the current run-rate Capital Expenditure of over $500 million is a good run-rate assumption. My assumption was almost $700 million, which seems harsh going forward. It seems to me that Management has a much better handle now on what’s required to make EUV capable of churning out chips at mass-scale.
So, there it is. With these changes in mind, ASML should be trading at around $201 per share. That’s a big step up from the $167 price target I had before. But now, I have more confidence in the revenue assumptions, and it seems that my cost assumptions were too harsh. If there is a tech war, it’s products will be more in demand – that’s more upside. If there is no trade war, demand should mirror the assumptions made here – 40 units of EUV machines a year. Either way, ASML seems to be trading at around fair value. I’d be more comfortable to step in if the discount was steeper. As I write this, ASML is just about 5% away from fair price. Another dip or two, and ASML could get a “buy” rating.
Nvidia Q1 Fiscal Year 2020 Earnings: Bad numbers as expected, positive outlook.
- Thesis unchanged.
- Nvidia’s numbers compared to this time last year look horrendous. But this was expected.
- The biggest reason for the drop in numbers was cryptocurrency mining, which was super-hot in the beginning of 2018 but has retreated big-time since then.
- Cryptocurrency mining is a power-and-processor-heavy computing exercise that needs GPUs (Nvidia’s bread-and-butter product) to run.
- Revenue was down 31% compared to Q1 last year.
- Apart from cryptocurrency miners, Gaming was down as well.
- In addition, there’s been a slowdown amongst Cloud Hyperscalers, which is another key customer segment for Nvidia.
- All-in-all, it was a “perfect storm” quarter for Nvidia.
- I should remind you that the original thesis on Nvidia was partially based on the cryptocurrency boom. But at the time, Nvidia was initiated with a “Watch” rating – even with NO upside from cryptocurrencies factored in. In fact, a substantial downside was factored in. That was in no small part due to my unfavorable view of cryptocurrencies in the first place – published in October 2018. I viewed Nvidia as a possible “call option” on cryptocurrencies, in case my view of the hot sector was wrong. Turns out, it wasn’t.
- When the crash of Q4 2018 happened, Nvidia was given a Buy rating in early December, based primarily on its dominance in Cloud, Gaming and its revenue potential in Autonomous Vehicles. The second – and maybe more salient – reason was CUDA, Nvidia’s software stack. CUDA makes Nvidia’s chips easily programmable, which is a Moat that no other competitor (like AMD or Xilinx) can cross, at least not yet.
- All 3 bullet points above remain intact.
Can Tesla go bankrupt?
Tesla's stock price has crashed in the past couple of months. And it's one of The Buylyst "Watch" ratings that has proven out to be true - numerically at least, as measured by the stock price. I posted a deep-dive update into Tesla last Tuesday with the intention of:
- Checking how the thesis held up - qualitatively.
- Evaluating what the chances are of Tesla going bankrupt.
Ford wants robots and self-driving cars to deliver packages.
This is pretty ambitious from Ford, a company that's known for gas-guzzlers like the F-150, Explorer, and the Mustang. Those products still fund most of Ford's operations. But Ford is on a new path now - electrification and autonomy - not as much to innovate but to survive. All auto companies are scrambling to survive in a brave new world kick-started by Tesla, which, ironically, is scrambling to survive as I write this.
India is investing more in Solar than Coal for the first time.
This was always in the cards. India is the land of sunshine. And it's a resource it must tap to power its widely anticipated economic boom over the next couple of decades. Coal was (and still is) cheap. But it pollutes, and India already has a pollution problem. If India does manage to grow at 6-7% a year, its people will consume much more electricity per capita. At that point, pollution in some of its cities may become untenable. Prime Minister Modi just won a re-election, and he's known to be a proponent of Solar Power. Is there a way to invest in this "near-inevitability"? I must mention that "investing in solar power" is conspicuously missing from The Buylyst. This shall be corrected soon.
Sony and Microsoft join hands to dominate Gaming.
This partnership is big. In both the Sony and Electronic Arts theses, I pointed out that both companies need to be ready for one near-inevitability above all - the "Netflix-ization of Gaming". Well, it seems like this agreement is the biggest step forward towards that. Keep in mind, Sony (Playstation) and Microsoft (XBox) already dominate the console market. They're also prolific producers of games - the software. This alliance is a game-changed, quite literally.
The investor community factors in Climate Change - reluctantly.
The UN recently released a report titled "Changing Course: A comprehensive investor guide to scenario-based methods for climate risk assessment, in response to the TCFD." That's a mouthful. I skimmed through it and found it to be quite "fluffy". I mean there were some nice "frameworks" but I didn't find anything concrete in the report. The usual Risk Management buzzwords were thrown around: VaR, CVaR, Stress-Testing, Scenario Analysis, so on and so forth. The problem with Risk Management has always been: Garbage In, Garbage Out. That's also a problem with these "ESG" type quantification attempts. My take is simple: find investment opportunities in renewable energy and in technology that can counter potential effects of Climate Change (like water treatment). Treat them like "optionality plays" - consider investing if they're valued attractively "with the way things are today", they'll probably have a massive (albeit unquantifiable) upside if the effects of Climate Change are more palpable than they are today. The last sentence there highlights the main problem with the lethargic attitude towards Climate Change: the effects are not palpable enough to drive a systemic change in mindset, even in the investor commnunity. As Thomas Friedman pointed out in his book Hot, Flat and Crowded, today's decision-making generation has an "IBGYBG" problem: "I'll be gone, you'll be gone."
India has a massive water problem.
It's election time in India. And I've been keeping an eye on it. If you think American and British elections have become tacky reality shows, you should check out the farce in India. It's all about political rhetoric and cheap name-calling. No major political party talks about real issues. And one of the most important issues is Water. This report says that 70% of India's water is contaminated. 70%! To me, this is a much fixable issue than Healthcare or Education, which may take a decade to fix, even with the right political motivation. Water is fundamental. It's tangible. There's nothing intellectual and ephemeral about it. This should be an easy electoral win for any political party. The Buylyst's thesis on Xylem rests partly on the need to fix this fundamental problem in India.
Britain goes a week without Coal Power. Cheers.
For the first time since 1882, Britain didn't turn on any coal-powered plants. This is massive. And it's a massive step towards their government's goal of being coal-free by 2025. Good for them. And good for the world.
Why Buffett succeeds.
A long time ago, I had written an article about this. This one by Ben Carlson of the blog A Wealth of Common Sense is a nice confirmation of it. The gist is: he stays the course and doesn't give a **** about what "the market" thinks. You might say, "well, that's easy for him to do - he's the great Warren Buffett!". But then you'd have read the argument backwards. He became who is precisely because (among other things) he has the emotional resilience to stay calm in the face of pandemonium.
Lumentum Q3 2019 (Calendar Q1) Earnings: Beats expectations.
- Thesis unchanged.
- Revenue grew by 45% year-over year, but part of that is due to the Oclaro acquisition which inflates the number.
- However, the core business of ROADMs that are used in Fiber Optic networks has grown significantly.
- The 3D sensing business declined because of the slowdown in smartphone sales (especially Apple) compared to last year. Sales to Android phone companies – for Face Recognition technology – while gaining steam, still don’t make up a major part of their revenue.
- Management expects Android sales to pick up significantly in the second half of 2019.
- Management reiterated its focus on key growth areas:
- Fiber Optic Networks for 5G.
- 3D-Sensing for phones and other devices.
- Missing from the discussion was any talk of LiDAR for Autonomous Vehicles.
- In short, the Buylyst thesis on Lumentum remains intact – that it has competitive products for the key growth areas mentioned above.
Interdigital Q1 2019 Earnings: Growing Recurring Revenue
- Mixed quarter. Thesis unchanged.
- Recurring Revenue grew by 16%. But overall revenue decreased by 21% because of a massive decrease in non-recurring patent royalties.
- The market reacted positively because it’s no secret that Management has been gearing the business towards 100% Recurring Revenue, which involves putting a stop to some non-recurring patent licensing contracts. This shift will have a “J-Curve” – total revenue is expected to fall before it increases. It’s hard to time when that upswing will occur. My bet is 2020.
- The main advantage of having a full Recurring Revenue model is stability. Revenue and Profit variability will decrease significantly once this transition takes place.
- Management stressed that its priority now is:
- Sign IP licensing contracts with ALL Chinese smartphone makers. Most of them don’t have contracts with Interdigital yet. This priority is right in the epicenter of the trade war issue which is spooking the markets as I write this.
- Find new contacts for the recently acquired Technicolor Video Technology business.
- The 2 markets that will probably fuel huge revenue growth for Interdigital haven’t taken off. They are:
- 5G smartphones.
- IoT in consumer, industrial and transportation sectors.
- Overall, it’s frustrating to see the revenue declines in the legacy non-recurring IP business. But the growth in Recurring Revenue is encouraging. And that’s sticky revenue.
Xylem Q1 2019 Earnings: Good Numbers but Margin issues
- Thesis unchanged. In fact, thesis bolstered.
- Revenue grew by 6% in constant currency terms – all of it organic.
- But operating margins decreased. Management admits that much of it was due to bad inventory planning. They say the problem has been fixed.
- And so, the stock took a bit of a beating yesterday. But it seems to have mostly recovered from that downturn today.
- Analysts were worried about the margin surprise, and most of the questions in the earnings call were focused on that. The main question was: How confident is Management that margins will recover?
- Management seemed pretty confident. They reiterated their outlook for the year and repeated many times that they identified the problem and have fixed it.
- Management expects EBITDA margins to hover around the 20% range in 2019 and beyond.
- Away from margins, the most striking thing for me was the fact that Xylem’s India business grew by 58%! Much of this was due to a new “smart metering” project in a major urban area. This is particularly satisfying to hear because Xylem is a lateral play on Indian Urbanization at The Buylyst.
- On the India point, it seems that the Ganges is still dirty. If the government (current or new) really gets behind this, it could be a windfall for Xylem.
- Overall, Management expects the business to continue growing at a clip of mid-single digits over the next couple of years. The Buylyst view is that Water as an investment theme is yet to take off. Xylem stands right in the middle of that almost-inevitable windfall (or should I say waterfall?).
Eaton Q1 2019 Earnings: Good Numbers, Lowered Outlook.
- Thesis unchanged.
- Revenue was up 4% organically, offset by FX headwinds of 3%. Net revenue growth was thus 1%.
- That was fine, even expected, but where Mr. Market got slightly spooked was in Management’s outlook.
- Some were down, some were up. What’s new?
- Revenue growth and Operating Margins outlooks concerning 2 of the 6 segments were lowered – Hydraulics and Vehicles segments.
- But outlooks on 2 other segments were raised – for Electrical Products and Aerospace.
- Outlooks for the remaining 2 segments – Electric Services and E-Mobility – were unchanged from guidance given last quarter.
- The decline in revenue and margin expectations in the Hydraulics and Vehicles segments comes from expected trends in Light Trucks and Commercial Vehicles sales.
- To me, these are cyclical issues. It doesn’t affect the overall health of the company.
- Particularly satisfying was the fact that the Urbanization-related sectors did well, and outlooks on those sectors were raised.
- Urbanization was the primary reason why The Buylyst looked at Eaton in the first place.
- Overall, cyclicality remains in some parts of Eaton’s business. But that was expected.
Tesla raises more capital. I told you so.
Sometimes we get to claim prescience. And it is so satisfying. No, but seriously, I can't actually claim supernatural powers. This was not surprising to most people who've followed Tesla. But indulge me - this is straight out The Buylyst Thesis on Tesla (try to find the words "incessant capital raising". :)
Renewables overtake Coal in US Power Generation.
It was inevitable. This has been the Buylyst wager for a long time - fossil fuels are a losing sport in the long run. The biggest constraint in Renewables really, well, fossilizing fossil fuels is Battery Technology. If that roadblock is removed, fossil fuels are toast. Until then, Renewables will inch into Coal and Oil territory. Buylyst holdings like Vestas stand to gain from this momentum. And they have.
Ford Q1 2019 Earnings Report: Beats Expectations
- Mr. Market loved the results. Buylyst Thesis unchanged.
- Revenue was down 4% from this time last year.
- And yet, the stock shot up more than 10% on the day Ford reported. Why?
- Simple reason: The “refocusing” strategy is showing some tangible results.
- Ford calls it Financial Fitness. But their strategy is basically this: Focus on Ford’s strengths (SUV, Trucks, Vans) and divest its weaknesses (Sedans).
- They started doing this in 2018 – this was a big part of The Buylyst Buy Thesis.
- Mr. Market (and I) was impressed by Ford’s margin expansion – this was the “tangible” result of the refocusing strategy.
- As a result, even though volume was down for the entire industry, Ford made it up in Pricing – it’s best products like Trucks, Vans and SUVs are high margin products
- Another tangible result of the strategy was this: CEO Hackett showed a slide of a Michigan Plant that’s been re-fitted to manufacture the Ford Ranger truck and the upcoming Bronco SUV; the plant used to make small sedans like the Focus (ironically). It won’t anymore.
- As laid out in “Ford: Right Turn Ahead”, Ford’s problem is its competitiveness outside North America. All other regions are loss-making.
- China is still a puzzle for Ford. It’s bleeding money. But Management tells us that much of that is because of a stale product lineup. More than 20 new Ford products are up for release in China in the next 2 years, starting in 2019. Most of them will be SUVs, Trucks and Vans.
- In Europe, Ford is now concentrating on Commercial Vans. It is the #1 Commercial Van maker in the continent. It has also tied up with Volkswagen to jointly build mid-size pickup trucks.
- Overall, this was the quarter that said to us: “maybe Ford can turn things around”.
TSMC Q1 2019 Earnings: Weak Quarter, Positive Outlook.
- Buylyst Thesis Unchanged.
- TSMC had a tough first quarter. Revenue was down by 16% compared to the first quarter last year. Free Cash Flow was down by a similar percentage.
- The weak first quarter was expected as smartphone sales (especially iPhones) and Cryptocurrency mining revenue made the year-over-year comparisons tough.
- TSMC still generated about 77 billion Taiwanese Dollars of Free Cash Flow in Q1. That’s about USD 2.5 billion. Most companies in the world would love to have this Free Cash Flow profile.
- TSMC’s stock took the weak quarter in its stride (and actually shot up about 7% in the last few days) because CEO C.C. Wei’s outlook was positive. He’s not the typical CEO who always projects a rosy outlook. He has a lot of credibility with the Analyst community.
- Smartphone sales should pick back up. New technologies like 5G are now gaining traction (Remember TSMC fabs chips for Qualcomm and Xilinx) and AV technology is developing at a rapid pace. TSMC, being one of only 3 large scale semiconductor fabs in the world, is right at the center of this data revolution.
- Among other significant news, TSMC announced its 6-nanometer process. Moore’s Law is coming to an end. But the progress towards 5nm and less is on-going. As nanometers shrink, only the best can fabricate a semiconductor.
- In related news, Samsung wants to expand its Chip Fabrication facilities.
Elon promises Robotaxis by 2020.
Elon does it again - making promises that are hard to keep. To be fair to him, Tesla does have the ingredients to do this. But in a year? Vehicles are bound to become more autonomous. Whether they become fully Autonomous or not is still an open question. The Buylyst view is that any kind of mass-scale Autonomy would need a 5G network - just to handle the volume of data going back and forth between an AV and the Cloud (where at least some of the data processing will be done). Given the amount of data and code involved, AVs will essentially be mobile datacenters. Elon also says that Tesla has developed its own Chip for AVs to process that data. He says it's better than Nvidia's - the current leader in AV system-on-chips. The jury is still out. At the moment, investors simply want to see Tesla do the simple, bread-and-butter stuff right - keep building great Electric Cars and corner that market before the Germans start pumping them out en masse in 2020. Robotaxis can wait.
Ford pumps in $500 million in an Electric Pickup truck company.
Ford is putting money behind the strategy it laid out last year. It's good in SUVs, Pickup trucks and Commercial Vans. It's not so good in passenger cars. It's refocusing its business towards what is does best. That's good. The results show that this strategy is paying off. But electrification is also part of that refocusing strategy. And to that end they invested $500 in Rivian, a company focused on building electric pickup trucks. The partnership looks like a great match on paper. And in this space - commercial electric vehicles - it could become a Tesla-beater.
Microsoft Earnings Q3 (Calendar Q1) 2019: Strong Results, Record Cloud Revenue.
- Thesis Confirmed. And Unchanged.
- Revenue was $30.6 billion and increased 14%
- Operating income was $10.3 billion and increased 25%
- Net income was $8.8 billion and increased 19%
- The biggest growth driver was Azure – Microsoft’s Cloud Infrastructure – which was the central part of The Buylyst Thesis. Azure Revenue grew 75% in constant currency terms.
- CEO Nadella tries to portray Azure as a differentiated Cloud Platform, which offers productivity software, and Edge-Computing apps built by Microsoft. He’s right. Azure’s advantage over Amazon AWS is the fact the Microsoft is a bona-fide software developer.
- It seems clear that Microsoft will market the Surface as the “preferred Azure Edge device” for enterprises. Surface revenue grew by 25%.
- Azure customer retention is strong, which makes sense. Once customers are in a Cloud environment with their data and processes, there is little incentive to move all that to a competitor unless there is a massive problem with the Cloud environment.
- New Azure client wins include Volkswagen, Renault Nissan and Refinitiv – A Blackrock-ThomsonReuters JV.
Caterpillar Q1 2019 Earnings: Strong Results, Record Profits.
- Thesis Unchanged.
- Revenue increased by 5% due to both volume and pricing increases.
- Profit per share (not a favorite measure at The Buylyst) reached $3.25/share in Q1, which is a record. It’s good news nonetheless.
- Construction and Mining sectors contributed most to the strong results. The Energy and Transportation sector was flat.
- Asia-Pac infrastructure spending remains strong – this is a data point I watch out for because it’s a big part of the thesis.
- Surprisingly, Construction in North America was a strong contributor as well. Apparently, Road construction has picked up. In the Northeast, at least, we’re yet to see any of this infrastructure spending.
- In related news, China’s Xi Jinping reaffirmed commitments towards infrastructure spending.
- There wasn’t much discussion about the US-Chine Trade War. But one analyst brought it up. The takeaway was that customers and CAT Management were “cautiously optimistic”. Also, there could be some pent-up projects that customers may have held back on so far; those projects may come to fruition in 2019.
- Management raised the full-year 2019 profit outlook, mostly due to a tax benefit received in Q1.
- But they expect the price realization, margins, and volume trends to stay at the strong levels of Q1.
IBM Q1 2019 Earnings: As Expected.
- Buylyst thesis unchanged.
- IBM reported revenues that were lower than Wall Street expectations. But it beat expectations on Earnings.
- Revenues were down about 2% year-on-year.
- Earnings were down about 8%.
- But most importantly, Management reaffirmed its Free Cash Flow Guidance for 2019. It expects the company to generate about $12 billion.
- Management defines Free Cash Flow as Operating Cash Flow minus Capital Expenditure.
- The revenue decrease was caused mostly by 2 transient factors:
- FX headwinds
- Normal Cyclicality in Hardware (Servers/Mainframes) sales.
- But Mr. Market was worried again that IBM won’t be able to compete with Google, Amazon and Microsoft in Cloud and AI.
- That’s a legit concern. But IBM’s Cloud business has grown over the last 12 months, while this competition has been around.
- Watson has been getting a lot of negative press. But it is true that it’s still the major industry-specific AI module on the Cloud.
- IBM’s approach is a little different from those 3 formidable giants. 2 main differences:
- An industry-specific delivery model for AI-over-Cloud, in conjunction with a Consulting arm.
- With the Red Hat acquisition, a focus being the go-to company that helps enterprises manage a multi-cloud IT infrastructure.
- In conclusion, IBM needs to carve out its own space among formidable competitors. In 2018 and Q1 2019 are any indication, IBM is a finding its footing, albeit slowly.
- The risk in the story is still that between Amazon AWS, Google Cloud and Microsoft Azure, Enterprises find everything they need for their Cloud infrastructure. That would mean slim pickings for IBM.
TSMC Q1 2019 Earnings: Weak Quarter, Positive Outlook.
- Buylyst Thesis Unchanged.
- TSMC had a tough first quarter. Revenue was down by 16% compared to the first quarter last year. Free Cash Flow was down by a similar percentage.
- The weak first quarter was expected as smartphone sales (especially iPhones) and Cryptocurrency mining revenue made the year-over-year comparisons tough.
- TSMC still generated about 77 billion Taiwanese Dollars of Free Cash Flow in Q1. That’s about USD 2.5 billion. Most companies in the world would love to have this Free Cash Flow profile.
- TSMC’s stock took the weak quarter in its stride (and actually shot up about 7% in the last few days) because CEO C.C. Wei’s outlook was positive. He’s not the typical CEO who always projects a rosy outlook. He has a lot of credibility with the Analyst community.
- Smartphone sales should pick back up. New technologies like 5G are now gaining traction (Remember TSMC fabs chips for Qualcomm and Xilinx) and AV technology is developing at a rapid pace. TSMC, being one of only 3 large scale semiconductor fabs in the world, is right at the center of this data revolution.
- Among other significant news, TSMC announced its 6-nanometer process. Moore’s Law is coming to an end. But the progress towards 5nm and less is on-going. As nanometers shrink, only the best can fabricate a semiconductor. TSMC already leads its main competitor Intel on this issue.
Jeff Bezos writes another great shareholder letter.
He's definitely reaching Warren Buffett quality with these letters. In this latest letter, the message he harped on was this: Failure is very useful. It's uplifting. He discussed how the Fire failure allowed them to build the Echo. And how AWS is helping them do great things with AI. This is a good place to mention this: A lot of people ask me why I don't like Amazon. That's not true. I like the company. But it's too overvalued. The market behaves as though it will rule the world. That's what's baked into the valuation. And unlike Mr. Market, I'm not going to factor in a 100% probability that we're going to living in the United States of Amazon in the near future.
Disney finally releases Disney+.
This was a long in the making. Disney undercut Netflix on price. They'll charge $7. Disney's big strength is content. And they've got such an amazing library that they won't need to spend the obscene amounts of $6-8 billion on content like Netflix. No wonder the shares are up today. I wish I had bought Disney back in January. But at the time I thought it was fairly valued. I was waiting for a market crash to get in and swoop me some Disney. But it never happened.
The Buylyst Portfolio is hedged over the next 3 months.
A lot of time and energy has been spent over the last 10 days to make sure that The Buylyst portfolio is protected from any 2018 Fourth Quarter style market crashes. The idea is to keep this sort of a hedge on at all times - cost permitting. By sacrificing about 1% of the portfolio's return, we can sleep well at night. And if the market crashes, we'll sleep just as well. Put Options have been added to The Buy List. If you're interested in hedging your portfolio, I suggest you read what we did in this sequence:
Borophene might be the new wonder material.
A few years ago, Grpahene was the big thing. Now it's Borophene. This one looks more convincing. This story caught my eye because it can significantly improve Battery Technology. I still maintain what I mentioned in The Buylyst Wager on Energy - the day a new, industrial-scale battery tehchnology (away from Lithium Ion) is invented, the Oil & Gas industry is toast; well, the investments in Oil & Gas anyway.
Electric two-wheelers for India. Please.
It makes sense. If you've been to India, you know that it's Urbanization at its ugliest. Traffic, Housing, Pollution - it's a bit of a mess. I should say that things are improving in urban planning. But pollution is easier to contain - it requires less governmental coordination. One obvious idea is electrification fo vehicles. But EVs are expensive, which will be a problem until India becomes a rich country. But electric two-wheelers could be affordable. This story digs into the startup world in India that's trying to develop these. However, I can't help thinking that even if they do introduce an affordable electric two-wheeler, the problem is charging stations. Unless they're ubiquitous, EVs will never become mainstream.
Intel buys a chip that can transfer data 1,000 times faster.
This article was interesting to me because it talks about the need to reduce proximity between Memory and Processing in AI chips. It highlights a point I've bene making about Micron - that memory is going to less commoditized going forward.
Sony PS4 game bags a best game award.
God of War wins Best Game. As mentioned in the Sony thesis, it's got a fantastic library of games that Google and Apple (the new entrants) will find hard to match. Console games are unparalleled in quality and experience. Mobile games don't come close. Now if Sony can offer a compelling VR experience with more God of War type of games, their Moat is secure. Same goes for Xbox.
Ford, GM and Toyota to set safety standards for Autonomous Vehicles.
Ford, General Motors and Toyota will partner with SAE International to develop a safety and testing framework for autonomous vehicles (AVs). This is good for Ford. It signal seriousness about AVs. And it puts them on the forefront of AV development along with their rivals GM and Toyota.
Apple Music overtakes Spotify in the US.
The last line in this article captures the essence of Apple's "Services" strategy: “From Apple’s perspective, they’re not looking at this business for overall dollars,” said Ben Bajarin, an analyst with the technology firm Creative Strategies. “It’s about making the value of their hardware go up.”
IMF says monopolistic power in the world is increasing.
This is an issue I touched upon in Investing in Global Dominators. In some cases, technology is exacerbating the differences between dominators and scrappy competitors. Cloud technology is a good example. And then success begets success. If a scrappy upstart challenges a Global Dominator, they just buy them out.
Giants of Investing want to fix American Capitalism.
Ray Dalio (founder of Bridgewater, the largest hedge fund in the world), Howard Marks (founder, CEO of Oatktree Capital, a preeminent Bond fund) and Jamie Dimon (CEO of JPMorgan Chase) all got philosophical this week. Dalio wrote his piece on LinkedIn. Marks opined in his regular newsletter on the Oaktree website. Dimon wrote in JPM’s Annual Shareholder Letter. They each (independently, I assume) wrote about the current state of Capitalism in America – this week. Is there a Political Economy convention I don’t know about? They all made some good points, which I will list below. If I may, I’ll follow it up with my own visceral, real-life understanding of the flaws of American Capitalism (Before the question pops up in your mind - No, I’m not a Socialist or a Commie).
- All 3 giants agreed the Capitalism is much better than Socialism. I have no arguments there. The evidence is clear – we’ve had decades of “controlled experiments”, if you will. You can compare economic growth numbers and other non-economic indicators of capitalist vs. socialist countries. It’s obvious what works and what doesn’t.
- But all 3 giants also agreed that Capitalism in the US is not functioning as well as it should – it leaves too many people out of the party. So, even if it is the “best worst system”, it can always be improved. And it must be improved before resentment takes an ugly turn. Hopefully, it’s not too late.
- Dalio captures the Capitalism-Socialism debate beautifully in this sentence: “I think that most capitalists don’t know how to divide the economic pie well and most socialists don’t know how to grow it well…”
- Dalio makes a good point that the income inequality gap in the US is now at levels not seen since the 1920s, the era that preceded the Great Depression – which, by the way, had repercussions across the pond that can be linked directly to the rise of right-wing populism in Germany. The rest, as they say, is history.
- Marks talks more about Left-Wing populism. To be fair, he talked about Right Wing populism in his previous letter. His point is that the left-wing populist attitude that all corporations are evil is dangerous. I agree.
- To make his point, Marks relied on Churchill’s eloquence:“The inherent vice of capitalism is the unequal sharing of blessings . . .”. And “. . . The inherent virtue of Socialism is the equal sharing of miseries.”The Indian in me finds it painful to quote or to praise Churchill, but he did know how to weave words together to make a point.
- Marks also agrees that capitalism has gone array, but he doesn’t offer any solutions. All he’s saying is that doing things like turning away Amazon from New York City is not the solution.
- Jamie Dimon’s letter actually had some ideas about solving this problem. He mentioned some general categories like taxation, education, healthcare, infrastructure. But all his solutions require a level of government effort and coordination that the US hasn’t seen since the 60s. That’s a problem.
- Dimon wasn’t afraid to mention the so-called “Social Democracies”, implying that the US could learn a few things from those European countries. He stopped short of naming those countries and praising them. He said: “Many countries are called social democracies, and they successfully combine market economies with strong social safety nets. This is completely different from traditional socialism. In a traditional socialist system, the government controls the means of production and decides what to produce and in what quantities, and, often, how and where the citizens work rather than leaving those decisions in the hands of the private sector.”
I don’t have their intellectual bandwidth, but this is a topic that affects all of us. We’re all entitled to an opinion. Here are my 2 cents:
American Capitalism works, but it can work much better. People save, they invest, it funds innovation, innovation thrives, production is scaled, it creates jobs, and profits are reinvested into more innovation, and the pie grows. The cycle yields some fantastic results. You don’t have to read boring Economics papers to see that it works. You’re holding a computer in your hand (your smartphone) that’s many times more powerful that what NASA had when they landed a man on the moon.
But something seems amiss. Dalio quotes a lot of income inequality figures in his article. He’s right – a large section of the population hasn’t seen real wage growth for a long time. But I don’t think income or GDP per capita captures well-being accurately. In the US, most people have seen a marked improvement in lifestyle over the last 3-4 decades that can’t be measured by GDP per capita. I mean, Netflix costs $12 a month! How awesome is that? And you can get most things shipped to your home in 2 days for $12/month as well!
OK – the examples may be frivolous. My point is that when it comes to the sheer choice of consumer products, Americans are much better off than they were 40 years ago, or even 10 years ago. An alien coming back to earth after 10 years would be impressed by our lifestyle. But we don’t think in those terms. We’re humans. We’re not rational. We don’t feel better about life by reminiscing about a black-and-white TV while binge-watching Game of Thrones on our 55-inch LED TV. These are just distractions. They don’t improve the feeling of well-being, not in the long-term anyway. Affording bigger TVs or cooler phones is not the problem. The problem with American Capitalism today is Anxiety about more important things. And Anxiety can quickly snowball into mass-scale social unrest. 3 basic things seem to be increasingly out of reach for many Americans:
- Affordable Housing
- Quality Education
- Quality Healthcare
All 3 used to be much more accessible during the “socialist” era of the US, post-WWII. Back then, infrastructure spending wasn’t frowned upon, the top marginal tax rate was 90%, and public education in the US was among the best in the world. For about 3 decades, this relatively socialist period worked pretty well for most people.
As Dalio points out, inequality of income has gone wild and unchecked, especially since 1980. And it seems to me that housing affordability has become an amplified representation of that. Housing is cheap in places where there aren’t many jobs. Where there are jobs, there doesn’t seem to be enough housing. Housing was too affordable, unsustainably so, in the 2000s. And then that bubble burst. Since then, the Fed has tried to prop it back up. But something seems amiss. The “free market” isn’t working like it should – where supply and demand intersect to create a “market clearing” price and quantity. Ah, only if Econ 101 always worked in the real world.
Education is another casualty of income inequality. Dalio talks a lot about this. K-12 education in America is highly dependent on the tax revenue of a local municipal area. Tax revenue is linked to income of local residents. As inequality of income increases across the country, so does the inequality in the standard of primary education. Then it becomes a self-reinforcing phenomenon. Kids in poor neighborhoods receive poor K-12 education, which makes it harder for them to get into good colleges, which makes it harder for them to get good jobs. And the cycle continues. Even if they get into college, their parents need to go deep into debt to fund that education. (Why American colleges are so ******* expensive is infuriating; that’s a whole other can of worms). It seems to me that many (if not most) kids these days borrow money to go to a college where they’re taught skills for jobs that don’t exist anymore by people (many of whom) have never worked in industry. And then they get a low-paying job which barely covers the monthly payments of their massive student debt. Anxiety seeps in.
Then there’s Healthcare. At any given point in time many Americans are very uncertain about their healthcare bill over the next 12 or 24 months. As the US population ages, this will become a bigger problem. For one, it’s hard to predict when you’ll get sick. Second, it’s hard to predict how serious your ailment will be. And third, what your final cash bill will be once the Insurance company has done its “due diligence” is a complete mystery. Dalio pointed out that most Americans in the bottom 60% of the income ladder will struggle to come up with $400 for an emergency. Uncertainty = Anxiety.
If all 3 basic needs are intricately tied to some job that may or may not exist 2 years from now because it’s the era of Global Dominators (the other side-effect of unchecked capitalism) you’d be anxious too. Anxiety about these 3 things creates a nagging feeling that the system is broken, that something’s not right. “It shouldn’t be this hard to get these 3 basic things…” – that’s the movie that keeps playing in peoples’ minds. In the “social democracies” that Dimon alluded to, at least Education and Healthcare are not sources of anxiety. Yes, their tax rates are high, which is the downside. But they’re generally fine with it because it reduces anxiety about 2 major pre-requisites of success in the modern, globalized economy – good health and good education.
My suggestion is this: Let’s make it a priority to ease at least one of these anxieties in the US. Less anxious people will be more productive, less destructive. I think fixing the Education anxiety is a good start.
In our new tech-heavy, globalized economy, education is a life-long pursuit. Many of us will need to reinvent ourselves more than once. Gone are the days of a secure job in a secure corporation after a 4-year degree from any 4-year college. If we're not skilled craftsmen (carpentry, network engineer...etc.) we need to make it easy for people to get educated, and re-educated. And funding that education and re-education should not be linked to a soul-crushing job or the level of a parent’s income or the level of family wealth. Start with K-12 - I think there should be a standard per-student budget for K-12, regardless of where a public school may be. It should not be predominantly linked to local tax revenue. But this requires government action, so I’m not holding my breath. As for college, maybe Jamie Dimon and JP Morgan Chase can take the lead by offering some new, innovative very-low-interest student loan that eases national anxiety. I’m sure he’ll find a way to make money doing it – or he should treat it as a Marketing Expense. He’s already trying to do something in Healthcare along with Warren Buffett and Jeff Bezos. In the meantime, Ray Dalio is all set to publish part 2 of his article – solutions to the problems he identified. If bona fide Capitalists can fix Capitalism, I’m all for it. At least they recognize that there is a problem.
Apple's trying to be a Services company. Definitely. Maybe.
Apple had a big, splashy event this week launching a few new Services products: 1) Apple News 2) Apple Card 2) AppleTV App and AppleTV+ 3) Apple Arcade. Like the Google Stadia event last week, the launch wasn't really a launch. It was more of an announcement. They were specific about the new Apple News, which is a subscription based service - like a Netflix of magazines and newspapers for 9.99/month. All the other services announced didn't have any pricing details. Apple TV+ was the splashiest part of the event, with celebrities like Spielberg and Oprah giving us a teaser about what they're producing for Apple. Apple Card, I thought, was pretty cool. It'll hook up to my Apple Pay. It has no fees, no penalties, nothing. It doesn't require me to carry around a plastic card. But if I want to, I can. I think I will because it looks so cool, in true Apple style. Apple Arcade was also surprising - in how amazing the graphics were for games that are supposed to be mobile-native. Apple is taking Google, Sony and Microsoft head-on in the gaming arena. From what they showed, it looks like they'll be very competitive.
Most of the media reports are sort of "meh" about the whole event. My take is a little different - I've maintained that Apple's core competency has hardware devices at its core. All these "services", in my view, are meant to differentiate its hardware. Sure, all the things announced were sort of me-too services. They're not original. But the idea is that you can get this Apple-designed experience on an Apple-designed device. That's its competitive advantage. Google can compete. But it doesn't have the Apple sheen or "taste", Steve Jobs would put it.
Apple Arcade vs. Google Stadia. Let the games begin.
The Guardian has a nice comparison of the two rival services announced in the last week. Both Apple and Google, apart from always trying to out-do each other, are taking on the gaming giants Sony and Microsoft. It's a long, uphill battle - Sony and Microsoft are sure to enhance their (already existing) game streaming services. And they've got decades of games in their library. Apple and Google have to build games from scratch. Also, as I mentioned in the Sony Thesis, bandwidth is still an issue. It's good enough for streaming movies. Streaming games is a different, well, ballgame.
Majority of Coal Plants uneconomical because of Renewables.
This study highlights the basic point made in The Buylyst Wager in Energy - trying to find "value" investments in a losing game: fossil fuels. Sure, Renewables cannot possibly account for the world's energy needs yet. But we're heading towards that scenario. The things is: Wind and Sunshine are free. Now that leaves 2 other Power Generation costs: Building cost and Operating Cost. Building cost of Wind Turbines and Solar Farms used to be a deterrent. Not anymore. In Operational Costs, electricity storage is a big cost. But that's getting cheaper as well. The trend is clear. Coal may have its moments in the coming years, but it's a losing sport.
Cars will be watching you.
This story is creepy but I guess it can save some lives. Cars will soon have ways to monitor their driver - if his eyes are the road, if he's drowsy, distracted etc. Not sure I want my car to watch me loudly obliterate all my favorite songs. I bring this story up because it's one of the growth areas of a for a company like Lumentum. In fact, Lumentum's management mentioned this specific use-case in their presentations. Sure, cars can have a camera, but I suspect people won't like that. They may not mind a face recognition technology. We'll see.
America's infrastructure is a roadblock for Autonomous Vehicles, literally.
The richest country in the world has mediocre infrastructure - actually very bad, if we go by this rating. This may be a case of "the barber recommending a haircut". But I think this isn't much of an exaggeration. Public funding has been systematically diverted away since the 1980s. This fear and loathing of public spending has resulted in old bridges, roads, trains, subways...you name it. If you're on the east coast, you can feel the lack of funding every day. D+ may be harsh, but not by much.
Book Value is a load of BS.
This Economist article highlights the issue The Buylyst has with using standard accounting numbers and ratios for valuation - they don't reflect the economic reality of the company. They should but they don't, which is why we spend countless hours digging into financial statements, rearranging and recalculating them to reflect the economic reality of the business in which we're looking to invest. That's why we like cash flow - cash is cash is cash. Book Value and Earrings (which feed into Book Value) are nebulous numbers that don't reflect the true earnings of a company. Book Value also has all sorts of "estimates" of asset and liability values included in it. It can be inflated or deflated easily, depending on what the company's management wants to do.
FX Rate Assumed: 120 Yen per USD for all years.
Sony's Fiscal Year ends every March 31st, like many Japanese companies. The numbers in the valuation table reflect the fiscal year. For example 2018 reflects numbers ending March 31st, 2018.
Here are the main assumptions in arriving at a Sustainable Free Cash Flow number:
- Revenue – excluding Financial Services – decreases by 10%.
- EBITDA margins remain stable at the level achieved over the 12 months ending December 2018.
- All other numbers remain consistent with levels seen over the 12 months ending December 2018, except for Working Capital.
- Sony typically requires a lot of working capital, to fund movie production among other things. And the level of working capital increase in 2018 was uncharacteristically low. The Sustainable Level assumption is that working capital returns back to its historically high level. This number is the cause of a lot of cash flow variability.
- Assumed a conservative exchange rate of 120 Yen per USD. The current exchange rate is about 110 Yen per USD.
Google releases a Netflix for videogames. Sort of.
This story comes at an opportune time, as I'm researching another gaming company within the context of Virtual Reality. It seems obvious to me that this is the future - a menu of top-notch games that are available either on subscription or a la carte. The main constraint today is bandwidth. Streaming games is a lot more complicated than streaming movies, because it's interactive. The flow of data is a two-way street. And it requires more on-the-fly computing. Video lags on games are a thousand times more frustrating than video lags on movies. Not sure how Google will handle that. Google's release raised more questions than it answered. But this is the future. It'll be convenient and economical. Add in VR to the mix and you can forget about kids playing soccer or basketball outside. It's good to be a game content creator nowadays. It's also good to be invested in Semiconductors, Cloud Computing, 5G and Memory.
Ready. Player. One.
New York tests an Autonomous Bus. It's ugly.
I was excited to read this story. And then I saw the picture. Awful. And the fact that it's in the Navy Yards is a bummer. But big things - big, inevitable things - have small beginnings.
Ford ramps up investments in Electric Vehicles.
This is welcome news because Ford's decisiveness about Electric Vehicles and Autonomous Vehicles is central to The Buylyst thesis. But the question - "is Ford a dollar short and a day late in the EV/AV race?" - still remain. It has been taking some actions to shut down operations that are loss-making. That's good. Ford also hired a CFO from Snap (and Amazon), and that made some headlines about Ford "going tech". I mean, he's a CFO; I'm sure he's "talented" but he didn't exactly come form the tech side of tech. But Ford's CEO himself is a tech enthusiast - Jim Hackett used to head up Ford's AV unit before he became CEO. So, maybe this is a sign.
Nvidia releases a smashing product - to train Autonomous Vehicles virtually.
This product has it all. I mean, all of Nvidia's strengths converge on to this one - Graphics Processing, Ray Tracing technology, AI, ubiquity in the Cloud. It seems inconceivable that any other company could have pulled this off. Nvidia releases this Drive Constellation during it's GTU festival. If this product can significantly reduce the number of miles a live AV needs be on real roads, it'll be a huge success.
Added Lumentum to The Buy List on March 19, 2019.
I had an eye on Lumentum since the stock crashed in late 2018 after rumors that iPhone sales were down. Lumentum makes the key components of the Face Recognition technology in the new iPhones. 3D Sensing is one of Lumentum’s main businesses. When the news of the stock crash hit the wires, it caught my eye because I was already looking into the company. That’s because their 3D Sensing technology is also used in LiDars for Autonomous Vehicles. That’s the worldview I was writing at the time – Investing in Autonomous Vehicles. But back then, I had decided to spend my time on NXP. Lumentum went into the background. Now it’s back, after some meditation and deliberation on Virtual Reality. And again, it’s 3D Sensing business is the main attraction. Of course, there’s more to the business, which opened up a new-ish world to me: Optical Transport and Transmission. It’s all coming together with Lumentum, which sits at the crossroads of many of the worldview threads of The Buylyst:
- Virtual Reality
- Autonomous Vehicles
- 5G and IoT
- Cloud Computing
With 4 vectors of potential growth behind its back, this company is worth a deep-dive.
Changed Microsoft Rating to "Hold".
Microsoft seems to be decidedly in the sub-10% Upside territory. Along with Apple and Amazon, it keeps fighting for the coveted title of "Most Valuable Company". It doesn't look like it's going to stop competing with those other two giants any time soon.
Nvidia wins big Amazon contract.
Well, I assume it's big. I don't know the exact numbers but it kickstarted a rally in Nvidia's stock. The line from the news release is an Nvidia special: "NVIDIA Turing architecture fuses real-time ray tracing, AI, simulation, and rasterization to fundamentally change computer graphics." I don't think any other company or chip can do that.
Micron reported Fiscal 2nd Quarter results. Beat Street expectations.
- Thesis unchanged. There is still no conceivable reason why this stock should trade at 3X earnings, despite what happened to the company in 2016. It’s a different world now, a different industry, a different company, a different management.
- Micron’s second quarter results beat street expectations but came in lower compared to last year. This year-over-year decline was expected.
- Revenue was down 20.6% this last quarter compared to the same time last year. The split amongst its 2 main categories of products was: DRAM down 28%, NAND down 2%.
- Just to remind you (and myself), last quarter when Micron reported record results, Mr. Market penalized the stock because of Management’s outlook. Well, a lot of those points have materialized. That’s why it’s this quarterly decline is not a surprise.
- DRAM prices were expected decline. They did.
- CPU supply issues still linger (thanks Intel) – this impacts memory demand, because hyperscale Cloud companies won’t buy Memory if they can’t get their hands on all the CPUs they need. Micron’s Management expects these CPUs to last another couple of quarters.
- Swings in memory supply and demand will keep happening. And that will determine swings in price. DRAM is still fairly commoditized.
- However, in this “bad quarter”, Micron still generated about $1 billion in Free Cash Flow – in one quarter. That’s a decline from last quarter, sure, but it’s an enviable number by any standards. Very few companies achieve this level of profitability.
- Management reiterated that it expects the second half of Calendar Year 2019 to be much better in terms of both demand and supply, which should significantly increase profitability.
- The most surprising data point from the earnings call: Management lowered its Capital Expenditure budget for the year because it doesn’t want to oversupply the market with DRAM and NAND, thereby causing steep price declines.
- The market seems to have rejoiced this move – because it should lead to better supply/demand dynamics.
- Having said that, the market keeps dismissing 2 facts:
- It’s a different industry now, with just 3 major players in the DRAM world. There were many others in 2016, during the last downturn.
- Demand for memory is not decreasing. It’s increasing.
Here are the assumptions made to arrive at a Sustainable Free Cash Flow number.
- Incorporated Oclaro numbers as per Management’s guidance (the low-end) for the next quarter, which will be the first quarter of the combined Lumentum-Oclaro business. And then I annualized that quarterly number.
- Here’s the big assumption: Added a 10% premium to that combined annualized revenue. I expect Management to achieve some of the revenue synergies over the next couple of years. Revenue should increase because of that and 3 other reasons:
- The Q3 numbers come at a precarious time for Lumentum, when iPhone sales are anemic.
- China demand for ROADMs is going to keep growing.
- The Android business should accelerate.
- EBTIDA margins reduced to 20%.
- Capital Expenditures expected to remain the same. Management expects to unlock some synergies there.
- No Working Capital Benefits assumed. This is a big one because working capital has been cashflow-positive over the last couple of years. Last year it released about $85 million in cash.
- Interest charges assumed at $25 million – the interest rate on the loan that the company took on to fund the Oclaro acquisition.
- Tax Rate assumed to be the same.
- Assumed that acquisitions will be funded via cash on the balance sheet and/or debt and/or equity.
The Cloud is actually in the ocean.
Another great report by The New York Times - this time about Cloud Computing. I loved the map they showed - we don't think about it too much when we send a high quality video to a friend in another country, but there is actual, physical infrastructure that does a lot of the work. Most of that infrastructure is in the form of glass cables under our great oceans. Fascinating.
Back to the Future: How we stopped Climate Change.
Great imagination by NPR - it's a hopeful picture of the future because it's realistic. This sentence sums it all up: "This is the foundation of a zero-carbon world: Electricity that comes from clean sources, mainly the sun and the wind, cheap and increasingly abundant." The reality is that we're not there yet. And the main constraint is Battery Technology - the ability to hold electricity generated by wind and the sun, at industrial scale. It's been a year since The Buylyst had a worldview on Battery Technology. Time to revisit.
Probably the greatest list on the oddity of investing I've read.
The Irrelevant Investor is a blog you should follow, if you're not doing so already. Batnick comes up some great ways to slice and dice market data. This list might be his greatest yet. Here's my favorite set of 3 (for those of you obsessed with gold), in a list of 20 such gems:
- Gold and the Dow were both 800 in 1980. Today Gold is $1,300/ounce, the Dow is near 26k.
- Cash flows > commodities.
- Over the last twenty years, Gold is up 340%. Stocks are up 208%, with dividends.
- You can support any argument by changing the start and end dates.
- Since 1980, Gold is up 153%. Inflation is up 230%.
- See above.
A powerful weapon to fight Climate Change: The Light Bulb.
The New York Times had an amazing story about the humble light bulb. It turns out that those things play a major role in reducing our energy consumption. Since the Great Recession, energy usage per household has fallen in the US, after decades of an upward trajectory. Here's why: LED bulbs went mainstream. Today, they make about 14% of bulbs in use in the US. The impact, however, is big. That's because they last longer, expend a lot less wasted energy, and use one-sixth the power.
Norway to reduce its Oil & Gas investments.
I found this story interesting because Norway is one of the world's largest Oil producers, which has resulted in them having one of the world's largest sovereign wealth funds. So, yes, diversification makes sense but that's now new. That rationale would have been true since the inception of their fund. I think this line from their Ministry of Finance is more indicative of the real reason: "A permanent reduction in the oil price will have long-term implications for public finances". The Buylyst view on Oil is similar.
Nvidia buys Mellanox to expand in the Cloud.
Wow, do I wish I had owned Mellanox. A while ago, Xilinx was supposed to buy them out (check out the Xilinx feed here). But Nvidia outbid them and Intel. Winner's curse? Maybe. But I don't mind it as a shareholder - they should focus on datacenters, as opposed to other "growth" markets like cryptocurrencies. Mr. Market liked it too. Nvidia shares have done since the announcement.
Volvo FY 2018 Earnings: Great Results
- Volvo reported solid results for the year 2018. Thesis unchanged.
- Revenue was up 10% (excluding currency effects, 16% with currency). Operating Margin improved to 10.9% from 9.2%. EBITDA margin improved to 13.5% from 12.5% in 2017.
- Sales were up across the board – Trucks, Construction Equipment, and Boat Engines. But they were down for Buses. However, orders were up 56% - demand is good. The EV-AV revolution in buses is just getting started.
- Numerically, the biggest downer was Free Cash Flow. But it wasn’t because of poor sales or cost management. It was, in fact, because sales were too strong. Account Receivables were up. Account Payables were down. And both those variables created a massive bump in working capital needs. This is a temporary change of hands of cash – customers tend to buy on credit.
- In fact, one slide in the conference call stood out for me: the salient fact is that net truck orders in 2018 amounted to 484,000 units. Volvo’s production capacity, in contrast, is about 330,000. In 2019, backlog is already at 295,000. For 2019, they’re basically sold out! Again, demand is very strong in North America.
- In other regions, they’re seeing some slowdown in China and India. But they expect a pickup in South America. And Europe is expected to be flattish from a strong 2018.
- The most important variable in my view was Capital Expenditure – where is Management spending its cash? Fortunately, they’re spending it primarily on Electrification and Autonomous Vehicles, which was a big part of The Buylyst thesis. We’re also told that investments towards the new Modular manufacturing design has largely been done.
- A couple of new exciting products are out:
- oFully electric construction equipment is now beyond test-phase and Bronnoy of Norway has already contracted purchase of Autonomous-Electric mining equipment. This is industry-leading.
- oVolvo is testing Autonomous Buses in Singapore.
- oI had mentioned this one in one of the previous comments – but Renault Electric garbage trucks are on the road already in some cities.
- Another important point: A big part of The Buylyst Thesis was ecommerce. Management has generally been reticent about attributing sales growth to e-commerce. However, this time they were pressed a bit. They talked about it in terms of trend lines. They said that they used to assume a truck production trend line of about 250,000. But now they have to assume a trend line of about 310,000 – and most of that, they think, is an e-commerce bump.
Volvo tests an Autonomous, Electric Bus in Singapore.
The AV-EV revolution is gaining traction. Volvo has been slower to roll out Electric Buses compared to Chinese behemoths like BYD. But it seems to me that they're at least on par, if not ahead, on Autonomous Buses. I mentioned in their earnings report that they're also rolling out Autonomous construction equipment. This test with Nanyang University is a sign that this is where Volvo is spending their energy. And no surprise, in the earnings call, Management was clear that AV-EV is where they're spending their capital.
Google's AV unit, Waymo, will now sell LiDars.
I must admit the LiDars look very cool. Google's Waymo is by far the leader in Autonomous Vehicles today. It's clocked in more miles in testing than anyone else, and it's already rolling out Robotaxi services in some cities. Why it wants to sell LiDars is beyond me. And the weird thing is: they won't sell to competitors. Seems kinda childish. Also, I see Taxis being the most prolific use-case for Autonomous Vehicles. I mean, it's no fun owning your own Robo-car if you're not doing any driving.
Lithium-Ion battery prices down 85% since 2010.
Bloomberg New Energy Finance comes up with the goods quite often. This one about the state of lithium-ion batteries - the thing that's really behind the Renewable Energy revolution - doesn't disappoint. Still shocking to me is the fall in Li-Ion battery prices - 85% in just the last 9 years, and down 18% since last year. A while ago, The Buylyst had decided not to invest in Li-ion. And part of the reasoning there was (still is) a need to move beyond Lithium. This article suggests we're still a few years away from that.
Tesla releases faster electric chargers.
5 minutes for 75 miles. That's pretty good if you ask me! This is Tesla third-generation car charger and it's getting close to and "acceptable" range for most drivers. This article also pointed out something cool, and a Tesla special: Apparently Models S and X will be able to charge up even faster with a software update! That doesn't even happen on an iPhone! How cool is that?
Zuckerberg gets serious about Privacy. Yawn. FB will be the same.
There's a lot of noise about Facebook "pivoting" to a new business model etc. etc. But if you read his blog closely, he just makes general statements about Privacy, not about changing their cash-cow advertising model. This is what I got out of it: There will be a WhatsApp like encryption feature in Messaging, regardless of whether it's FB Messenger, WhatsApp or Instagram. I was hoping to read that as users we'd have an option to encrypt everything, including our web history, our posts, our interactions etc. But if that happened, FB wouldn't make money with their current model.
A nice, easy-to-read account of the Huawei drama.
BBC did a nice job of neatly laying out what the Huawei issue is, how we got here, and why it's so important. The gist is that the closeness between Huwaei and the Communist Party in China is uncomfortable. But Huawei's CEO says that the type of spying of which the company is being accused will kill its business. Hard to pick a side here - they both make sense.
Eaton sells its Lighting business.
This is a good move, and Mr. Market somewhat rewarded them for it. Eaton should focus on its core competency - help the world urbanize in a sustainable way, that's energy efficient.
Google's Deepmind wants to boost Wind Energy output.
This is like the perfect storm for The Buy List, in a positive way. If the world moves towards Renewable Energy, Smart Grids, and AI, The Buylyst should make a lot of money. It's happening slowly. This work by Google's Deepmind is a big step - if AI can reliably predict wind patterns 12 to 24 or 36 hours in advance, the intermittency problem of Wind Energy is reduced significantly. Then grid operators will know way in advance whether to turn on the switch at the dirty coal or gas power plant, because now they have a pretty good estimate of how electricity that wind farm will produce 2 days from now. Now, that's a smart grid!
Nuclear Energy 2.0 will disrupt Wind and Solar.
MIT Tech Review - a magazine I follow with passion - recently released a Bill Gates special in which they asked him to list 10 big disruptions he thinks will change our world over the next couple of decades. It's a great read. But I got a bit of jolt because he mentioned Nuclear Energy. We keep seeing grand visions of Nuclear Fission or Fusion Power in Hollywood movies but we're far from a real-life working example. It turns out China and Russia are laboring away to make Nuclear 2.0 a reality. Until then, however, the growth in Wind and Solar Power should continue. But if they come out with a workable Fission reactor, it could take over as THE ONLY power plant the world needs - one that provides cheap, abundant energy, without killing the planet. And hopefully without creating a Godzilla.
Microsoft is quietly becoming a Virtual Reality powerhouse.
This detailed article from The Verge is fantastic. It's a deep-dive into how Microsoft had to completely rethink it's VR goggles design. They're targeting factories and enterprise use-cases like construction and mining. This is smart. There's probably more money in that than in Retail use-cases like VR movies. Although, I expect the HoloLens to be seamlessly integrated with X-Box games at some point. The synergy with Azure (Microsoft Cloud) and their expertise in Operating Systems (which will beam down from Azure) puts Microsoft at a distinct advantage. Your move, Apple and Google! But the way, these new goggles look almost as thin as lab-goggles!
Volkswagen invests $1.7 billion in Ford's Autonomous Vehicle Unit.
There were murmurs for a long time. But finally, these two giants will work together. Ford's Argo AI will become the heart of the VW-Ford joint effort in Autonomous Vehicles. If you sift through the comments section here on Ford, you'll notice that I've been very excited about this partnership. Together, they can dominate the commercial vehicles space.
MacOS and iOS Apps will probably be unified. This is a good idea.
Apple needs to play to its strengths. One massive differentiator of Apple is that it has widely used desktop AND mobile operating systems. Google or Microsoft don't have both. Apple is planning on combining the the desktop and mobile architecture for Apps. As a user of both MacOS and iOS, I see a lot cross-pollination already: my iMessages show up on both my laptop and phone; I can FaceTime on my laptop...and so on. So, a lot of work has been done. Data seems to move seamlessly between my phone Apps and laptop Apps. But for developers, progress on linking MacOS and iOS will be a massive boon if they can just write one app to rule them all!
Ford investigates its own emission tests. This is not good.
This came out of nowhere. It's an unanalyzable situation. If you remember, late last year Volvo went through the same issue. It turned out that issue was overblown, financially at least. It's unanalyzable is because its hard to estimate the financial cost. That uncertainty keeps the stock depressed for a while, as we're seeing with Volvo.
Interdigital FY 2018 Results: Disappointing but Slow and Steady.
- Thesis unchanged.
- Revenue and Free Cash Flow were both much lower in 2018. The company went through a massive Accounting Rules change in 2018 – from ASC 605 to ASC 606. But even adjusting for that, 2018 was a disappointing year – below my expectations anyway.
- Revenue (according to ASC 605) was $382 million in 2018 compared to $533 million in 2017. Free Cash Flow (the way the company measures it) was $112 million in 2018 compared to $279 million in 2017.
- There are 2 main reasons for this dramatic underperformance compared to last year:
- 2018 was a transition year – some 3G and 4G licenses expired. But 5G hasn’t quite picked up yet. But we think that’s just a matter of time.
- Regarding Free Cash Flow, there were some Working Capital swings in Q4 of 2018, which lowered Free Cash Flow. This is temporary.
- In 2018, Interdigital acquired the R&D assets of Technicolor. The integration is on-going.
- One last thing is worth mentioning – Interdigital’s “exposure”, if you will, is now more than just mobile handsets. 5G opens up a whole new world of IoT devices, including Autonomous Vehicles. With the Technicolor acquisitions, Management says that digital video is now a new market.
- It’s hard to quantify the market size of these end-markets. But our bet is this: we’re assuming that Interdigital can get back to a 2017-type Free Cash Flow, given its new end-markets. This view is consistent with our views on IoT and Autonomous Vehicles.
- Numbers will be updated when the company releases its 10-K filing.
Apple and Goldman Sachs to launch a mobile credit card.
This was inevitable when you think about it - why are we carrying around rectangle pieces of plastic anymore? This is yet another cog in Apple's strategy to widen the Moat around its devices. Apple makes great devices but hardware has never come with a wide Moat. Yesterday, Samsung just released a folding phone. But software and services could have wide Moats around them.
Apple teams up with Ant Financial to make iPhones cheaper in China.
This is great news. I've been saying that they should do this in India as well - either set up a financial arm or tie up with someone else to make iPhones available via affordable monthly installment payments.
Apparently, Blockchains are hackable.
Well, there goes the one good thing that came from Cryptomania. The Buylyst view on Bitcoin isn't all that favorable. But on Blockchain, we were hopeful. Admittedly, I don't know the technical details of this but this article does a decent job of explaining it to mere mortals like us.
Daimler-Benz and BMW join hands for Autonomous and Electro-Mobility.
This is the reality in which we live - car-ownership in the traditional sense will likely decrease. As the world gets more urbanized, car-ownership will become more of a luxury item, for the traditionalist or the vane. With Uber, Lyft, Grab etc., it doesn't make sense for many people to own cars in cities. Daimler and BMW (and Ford) realize this. This line from the article sums it all up:
"As both Daimler and BMW have admitted, it's likely that cars in cities will eventually be shared-use electric machines that drive themselves and can be summoned at the touch of a smartphone."
Don't rely on P/E or other valuation ratios to select investments.
This Economist article succinctly captures the dangers of relying too much on valuation ratios to select stocks. P/E or Price-to-Earnings ratios are popular (lower the better, meaning you're paying less for the stock per unit of earnings). Another one is Dividend Yield. Passive Investing vehicles like Value Index funds will select stocks based mostly on these measures. As this article points out, this is dangerous. Many low P/E stocks tend to be failing companies or companies in structurally declining industries. This is why, at The Buylyst, we don't:
- Rely heavily on quantitative stock screens. We use them but, as a complementary tool.
- We rely heavily on having a distinct worldview - a qualitative internal compass - when we select investments.
IBM is trying hard to be Cool. It's pathetic but it seems to be working.
I just read that IBM is the favorite tech company of Generation Z employees. Yeah, I didn't expect it either. Apparently, Google and Facebook aren't exactly jiving with their values with all the privacy scandals. IBM, on the hand, doesn't have any of those problems and it is now the old underdog, trying to stay relevant among the cool kids. Maybe that's resonating with Gen Z. Incidentally, IBM's Think event this year was in San Francisco - another conspicuous attempt to be Cool.
Ford closes some plants in South America. This is good.
This is a good move. This is consistent with the point I made in Ford: Right Turn Ahead. Ford needs to chop off the unprofitable businesses. It has a a few market-leading cash cows, which should be their revenue stream. Everything else should be a logical extension of that core portfolio.
Vestas FY 2018 Earnings: Good Revenue Growth, Low Free Cash Flow.
- Generally solid results – well within Management’s 2018 guidance range. Thesis Unchanged.
- Revenue came in around the high end of guidance at EUR 10 billion. Free Cash Flow also met Management guidance, but the number is lower than I expected.
- Free Cash Flow was EUR 410 million. This compares with my Sustainable Free Cash Flow estimate of about $1 billion. The culprits were lower margins and not enough pick up in volume.
- Of course, it’s only been about a year since I estimate that Sustainable Free Cash Flow. I don’t expect Vestas to achieve a stable level of Free Cash Flow in a year. It may take 2 or 3.
- There were 2 big encouraging signs:
- Average selling prices have been stable for 5 quarters at about 0.76 million per MW. This is encouraging – it’s the main risk issue I had raised in the Catch-22 article.
- Order intake is up 27% - up in every region: Americas, Europe, Asia. Up 38% in Asia.
- Compared to last year, Management says they have a clearer revenue visibility in 2019.
- Backlog has increased. 2019 will be a backend-loaded year.
- Management expects 5-7 growth in the market in 2019.
- Services revenue keeps increasing as Installed Base increases.
- Long-term growth prospects are very positive. Bloomberg New Energy Finance estimated that by 2030, Wind Energy will make up 6 times more capacity than it did in 2017. That’s about 25-30% growth per year. By comparison, Vestas Management estimates look conservative.
- The thing to keep watching out for is Free Cash Flow. Capital Expenditure is expected to increase again to EUR 700 million in 2019. But that’s in line with expectations of higher revenue.
Zettabytes: The Data explosion has barely begun.
This report on AI and Big Data has some eye-popping stats. My favorite: The "data sphere" will expand from 33 Zettabytes (how many zeroes is that?) to 175 Zettabytes in 2025. That's insane. Another gem: Memory byte shipments will need to increase from about 2 zettabytes in 2019 to more than 5 zettabytes annually by 2025.
IBM FY 2018 Results: Luke-warm, but the bleeding seems to have stopped.
- Revenue growth was flat, as was Free Cash Flow growth. Thesis Unchanged.
- Margins improved slightly. It seems like the bleeding (declining revenues and margins) is coming to an end.
- In 2019, management expects Free Cash Flow (without deducting increases in working capital, cash interest and cash taxes) of $12 billion. That would translate to about roughly $10 billion in Free Cash Flow the way The Buylyst calculates it. That’s in line with our estimate of Sustainable Free Cash Flow.
- But 2019 numbers will be messy because of the Red Hat acquisition.
- I’ve made a note before that the strategy behind the acquisition of Red Hat makes sense. It allows IBM to be “cloud-platform-agnostic”, which means IBM applications like Watson AI can be moved around from AWS, Azure, Google Cloud etc. by clients.
- The crux of the IBM thesis is that with Cloud and AI, they can carve out a big enough market despite the competition from Amazon and Microsoft. This is a challenge, but IBM seems to be making AI more useful in boring areas like traffic management and supply-chain management.
- IBM calls these Cloud+AI services “Strategic Imperatives”. After this quarter, Strategic Imperatives grew to account for 50% of IBM’s business. This management-defined group of businesses grew by more than 10%. The rest is old businesses like Consulting, Software and Hardware which, as expected, declined.
- 60% of business is like “annuity” according to Management.
- Overall, the market was encouraged by the results because it could signal that the multi-year bleeding has stopped. But the IBM story rests on how useful Watson is and will become, and how IBM can deliver those AI capabilities via Cloud (any cloud platform). The main question that IBM needs to answer is: Why choose Watson or IBM Cloud over the alternatives?
- Valuation Details will be updated as IBM releases its 10-K.
Ford FY 2018 Results: Not good, but on the right path.
- Thesis Unchanged.
- Revenue, EBTIDA, Free Cash Flow – everything was down in 2018.
- The story laid out in Ford: Right Turn Ahead still captures what’s going on in Ford. The numbers show that if Ford pulls out of Europe, South America and Asia, it will be a more profitable company. Those are the things it should focus on in other countries as well. It can't compete in the small sedan market, even if the Mondeo and Fiesta do good business in Europe.
- North America business is strong, dominated by pickups, SUVs and Vans.
- Business everywhere else is no good. Margins are negative, especially in China.
- Ford attributes its international woes to a stale product line-up. 2019 is a big transition year where a majority of their product line-up will be refreshed. More than 75% of the line-up in China will be new by year-end.
- Ford is also investing heavily in its transition towards Electrification and Autonomy. It seems to be behind rivals on both counts. But at least It has made the commitment and is acting on it.
- An electric F-Series truck will be released in 2020. A Hybrid Explorer will be released in 2019.
- Talks with Volkswagen are ongoing – together they could become the dominant company in electrified commercial vehicles.
- 2019 is a make-or-break year for Ford. CEO Hackett says that its execution time after more than a year of planning and analysis.
- Overall, the Ford thesis hinges on these:
- It’s got a few distinct profit machines – trucks, SUVs, Vans, Mustang. That’s more than I can say for GM.
- If it can streamline its product lineup to its profit machines and to new products in its wheelhouse – trucks, vans, SUVs – Ford should become much more profitable than it is today.
- Numbers will be updated once it releases its 10-K.
The Index Funds & ETFs business - race to the bottom?
We recently proposed in our deep study of the effects of Passive Investing that it's a good idea to look at Vanguard, Blackrock and S&P Global Inc. as investment ideas. They're among the 3 biggest players in the Passive Investing industry. Vanguard is not public. Blackrock is. However, this article reminded me that Index Funds is about cost, not differentiation. It's all about low fees. It's a commodity. That means it's about scale. Has consolidation already taken place, such that fees won't go any lower? For a large part of the last 20 years, it's been a race to bottom in terms of pricing and margins. Will it keep going down that spiral?
The Gates Foundation annual letter is awesome.
Apparently agriculture accounts for 24% of greenhouse gas emissions, thereby contributing significantly to climate change. A big part of that is cows burping and farting. Also surprising in this amazing annual letter by Bill and Melinda Gates is the fact is the fact that the median age in Africa is 18; in North America it's 35!
Tesla buys a battery company, Maxwell.
The reason I bring up this story is because in the realm of electricity storage, no company seems to be doing as much as Tesla is in advancing the technology. That's because Tesla is the only major player at the key junction of Renewable Energy - in Power Generation and in Transport. We need better batteries for both. Where is the Energizer Bunny when you need him?
Time to stop destroying our oceans.
This story struck a chord. I've been asked a few times whether The Buylyst is a "socially conscious" investor. My usual reply is something to the effect of: "We try to be. It's always hard to be 100% sure. I believe that, in the long term, there is a high correlation between doing good and doing well. Ideas that make sense and are good for most people tend to survive. I would rather invest in companies that are making the world more livable and less polluted. Electrification - in Power and Transport - is a big North Star at The Buylyst...". Put another way, businesses that play a role in improving the environment will be much more sustainable (financially) over the long-term than businesses who profit from destroying it. Renewable Energy is just one avenue. Cleaning up our oceans is another. Some of the stats in this article are mind-boggling:
- Of all the plastic that's ever been produced, only 9% has been recycled.
- 83% of tap-water samples around the world have traces of microplastic. The incidence was highest in the United States, at 94%.
- 2.4 million metric tons of plastic could be entering the ocean from rivers each year.
- 8 million metric tons of land-based plastic entered the oceans each year. That's the equivalent of (in 2016) 5 grocery-size bags filled with plastic going into the ocean along every foot of coastline in the world. By 2025 those five bags will be 10.
Time to find a way to invest in this inevitable clean-up act.
It's hard being an online grocer.
This is a great article on the business of online grocery. Margins are low. Cost of storage is high. Deliver costs are high. Logistics is hard. Compared to non-perishable things like books and apparel, selling groceries online is a whole new challenge. Most people don't buy them online either, which compounds the problem because online grocers would need a minimum amount of scale to cover the huge fixed costs. In fact, this has been one of the few areas in which even the invincible Amazon has not succeeded. They're doing some cool things like Amazon Go, but it's not making a profit. Walmart is yet to turn a profit from online groceries. Peapod, as this article points out, almost declared bankruptcy before, and isn't doing all that great now either. Maybe scale is the biggest issue - more people need to buy online to make it profitable. But there's a long way to go:
"...convincing customers to order groceries online is still nearly as difficult now as it was in 1989. Twenty-two percent of apparel sales and 30 percent of computer and electronics sales happen online today, but the same can be said for only 3 percent of grocery sales..."
The Stock Buybacks debate: Senators Schumer and Sanders overreach.
Look, I'm with these guys in spirit. Companies make money, management makes money, workers make money, workers spend money, and on and on the cycle goes to raise everyone's standards of living - that's what we all want to see. Schumer and Sanders complain that big corporations are spending too much money on share buybacks than on re-investing in their business i.e. hiring more people or paying them more. I agree with them. But putting binding rules on managers dictating how they should spend shareholder capital is overreach. Maybe then, the rule should be: stock options should be given to all employees and they should vest immediately in the event of layoffs. If buybacks are made by upper management to prop up stock prices, at the cost of laying off some employees, at least those employees leave with more money than the (usually) miserly severance packages. Alternatively, put some rules around the severance package - if a company has to be "restructured", generous severance packages (say 4 months pay) are part of cost. The point is that restructurings will happen and people will be laid off. That's business. Sometimes, it's necessary. But let's make that decision hard (at least numerically) for a CEO.
The irony of cryptocurrencies.
How decentralized are they? I've argued before that the economics of cryptos don't pass the smell test. The arguments for cryptos are mainly political - about decentralization and freedom from evil bankers and so on. It turns out that they're not they decentralized either.
Try being a Digital Vegan. I challenge you. :)
I loved this series from Gizmodo. It turns out - surprise! - that cutting out Apple, Google, Amazon, Facebook and Microsoft for your life is almost impossible. First-world problems. As if it wasn't clear that they are Global Dominators, it is now. And it makes life a living hell. But there is a small group of people who've done it - with Linux laptops and flip phones. They're called Digital Vegans.
Aetna wants to pay for your Apple Watch.
This story is another step towards Apple's infiltration into our healthcare system. Biofeedback used to be the cool new thing a couple of years ago with the popularity of Fitbit. Apple is making it cool again. And its coming up with novel ways of expanding its "installed base" to which it can cross-sell other products and services.
Hints about the new Apple TV strategy. Why not just buy Roku and dominate?
Apple is going full steam ahead with its non-iPhone business. In its latest earnings call Tim Cook mentioned that we'll hear of new developments in Apple TV - including its original streaming content - later in the year. This "beyond the iPhone" ecosystem thinking was very much part of The Buylyst Apple Thesis. Things are moving in that direction. Late last year the market was fixated on iPhone sales and its inevitable plateauing. After this last earnings call a couple of days ago, Mr. Market is a little more interested in Services and Other Products. Here's the summary from the article: But put it all in one place, speed it up, and what you get is: “We are going to sell a bundle of other people’s TV shows and movies, and add our own, and make sure you can watch it anywhere you want.” Maybe Apple should just buy out Roku.
Amazon and Walmart get blindsided in India.
A new law prohibits e-commerce platforms to up-sell their own products on their sites. This is a problem for Amazon and Walmart, both of whom are on this "private label" binge. Amazon is also starting an advertising service which will showcase products that have paid Amazon to advertise. That could run into issues too. India is a big play for both these companies. Both have invested billions in trying to gain market share there. Walmart spent $16 billion acquiring Flipkart, one of the largest homegrown Indian e-commerce sites. Amazon lost that bidding war over Flipkart, but is spending billions anyway.
GE is saying the right things now. Partially.
GE reported earnings recently and Mr. Market loved it. The stock was up double-digits yesterday. The reason wasn't that GE turned around. It was that GE is making some good moves. For one, they're consolidating their Renewable Energy businesses to include Wind Turbines, Electricity Storage and Grids. But it remains to be seen what they'll do with the "old"Power Business, which makes turbines for Natural Gas Power Plants. That and lingering effects from GE Capital are the problem. New CEO Larry Culp has his work cut out.
Foreign stocks are the cheapest they've ever been compared to US stocks.
I came across this blog the other day that charted out how cheap International Stocks are compared to US Stocks. In other words, US stocks have significantly outperform international stocks. Central to the conclusion was the effect of "home bias", where local investors tend to feel "safer" when investing in their own country or they think their country is special. I think it has more to do with the boom in technology, much of which has come from the US. So, the reasons may have to do with fundamentals and the global industrial landscape rather than home bias or arrogance. Also, most big companies do business across the world. Their revenue is already diversified. It's very hard to find pure-play US companies nowadays, especially among the big ones that dominate index returns which are being used as data for studies like this. By if this guy is right, The Buy List is fairly international. I won't mind if there is some "mean reversion" when it comes to the spread between US and foreign stocks.
Growth stocks have been trouncing Value stocks.
It appears that it's been tough for Value Stock maniacs. Apparently, over the last few years Growth Stocks have significantly outpaced Value stocks, which is a departure from historical norms. I take issue with these types of sweeping statements. First, the definition of value stocks is all wrong - they take high dividend and low P/E ratios as markers. Dividends are a sign of companies that are mature (has nothing to do with value). And P/E is a flawed measure - EPS (the denominator) is a an Accounting measure which often has little in common with what really matters: Cash Flow. Secondly, I've learned from a certain Mr. Buffett that the term "Value Investing" is redundant. If there is no value in it, why would you invest? The Buylyst is sometimes accused of being a Value Investor. In reply, I'll paraphrase what Charlie Munger once said of Berkshire - At The Buylyst, we're neither growth nor value investors; our style is simple: Smart.
- Last 12 months as of December 31st 2018.
- Exchange Rate used: SEK/USD = 9.
Adobe added with a Watch Rating on January 22, 2019.
Adobe was a prime candidate in the Global Dominators List. Thesis Summary: Adobe is a cash flow machine, thanks to its industry-leading products and popular SaaS model, which has allowed it to widen the gap between competitors and itself. Management needs to keep building the Adobe ecosystem lock-in.
Xilinx: Exiting from position; rating changed to Watch.
The time has come for The Buylyst to book its first win. The Xilinx thesis is still playing out as the Data Economy keeps expanding. But the price has reached "uncomfortable" territory now, especially after today's 18% surge! Xilinx will be archived shortly. Realized Gain: 50%.
Boeing has a working prototype of an Autonomous flying machine.
This is a big story - one would imagine that Autonomous Planes would be an easier jump than Autonomous Cars. There's less traffic, and pre-determined routes. But this technology can trickle down into drones and some sort of "air taxis" in cities. Bladerunner anyone?
Apple lays off some employees from their Autonomous Car division.
Apple's doing some restructuring in Project Titan - its Autonomous Car division. They had recently hired a key executive from Tesla to run the division. So, this is par for the course. Project Titan is very secretive - but I imagine Apple focusing on software. Merging CarPlay, iOS, Siri and other additions is probably the way to do this.
Amazon debuts its self-driving delivery robot: Scout.
It's happening - slowly but surely. Amazon's Scout can roam around streets delivering smaller packages. Prime Now subscribers should be happy. This type of technology also has positive effects on Urbanization - less space wasted on vehicles for last-mile-delivery means less congestion.
Last 12 months as of September 30th, 2018. That's Adobe's fiscal year-end.
Adobe, Microsoft and SAP partner up to share data.
This effort makes sense. I'm guessing Adobe and SAP use Microsoft Azure as their main Cloud platform. Microsoft has done a good job of spearheading this Open Data Initiative. This is another effort to make Azure a leading Platform-as-a-Service. The more open a Cloud environment is, the more useful it is for client companies like Adobe and SAP.
Reinforcement Learning in AI needs to improve to teach a car to self-drive.
It appears that AI logic has yet to improve. The logic structure that trained Deepmind to beat the game Go isn't good enough for self-driving cars yet. But it's hard to predict when AI will reach that level. We humans tend to forecast in linear terms. But the very nature of AI and Neural Networks in non-linear. Things can improve very fast.
The best presentation on the Auto Industry, by the late Sergio Marchionne.
Sergio Marchionne left us with an honest, no-BS take on the Auto industry, which explains clearly why its suffering and what it needs to do to survive as car become Autonomous and Electrified. I'm glad to see that Ford - a Buylyst holding - is following at least some of this advice - the main one being "form alliances".
Cord-Cutting: 16 million US homes no longer have traditional cable or satellite TV subscriptions.
That number is up 50% from 5 years ago. This is great for consumers, and terrible for traditional Media models based on Advertising. It's not a millennial conspiracy. People want to watch what they want, when they want, on any advice they want.
Netflix now accounts for 10% of all viewing time in the US.
Even though this 10% number is self-reported, I believe it. Netflix is still producing some amazing shows that's driving subscription growth. They reported earnings this week. Mr. Market was disappointed - he wanted to see faster revenue growth. It is also true that in producing those awesome shows and movies, Netflix is spending a lot of cash. Some investors can't see how Netflix can become cash-flow positive. One possible way to do it is to charge more for their service. Incidentally, Netflix just raised prices in the US to $13/month. Most subscribers won't mind.
A Giant of Investing - John Bogle - passes away.
The founder of Vanguard and the father of Index funds passed away. He brought investing to the masses, and maybe did more for the average person in this arena than anyone else. His philosophy of investing may seem counter to The Buylyst philosophy, but it's not. The Buylyst maintains that if you want to have absolutely nothing to do with investing, indexing is the way to go. If you want to know where you're invested, The Buylyst is a great resource.
TSMC Earnings Fiscal Year 2018: Record Numbers.
- TSMC reported solid numbers for the fiscal year 2018. Thesis Unchanged.
- TSMC remains one of the true Global Dominators today. Along with Intel, it fabs a significant majority of ALL semiconductors manufactured in the world.
- 2018 revenue was great, driven by secular growth in smartphones and AI chips.
- However, management expects the first half of 2019 to be sluggish, due to a plateauing of smartphone sales, especially the high-end ones.
- Management says that many new smartphone products are due to release in the second half of 2019, which will bring numbers back on track.
- There are 2 main variables in assessing growth from smartphones: 1) Unit growth (how many new cellphones are sold) and 2) Silicon growth (how complex are smartphone semiconductors becoming). In Q1 2019, a decline in #1 may overshadow growth in #2. But over the year, #2 is expected to comfortably overshadow #1.
- CEO C.C. Wei refused to budge from his long-term revenue growth forecast of 5-10% annually. He says the long-term trends of AI and 5G are intact and have a lot of headroom to grow.
- Wei also expects growth from Autonomous Vehicles and 5G to kick in in 2020. He says they’re in the midst of working on projects with clients.
- Also encouraging to see is that production of 7-nanometer chips is in full swing and expected to keep growing. The now make up almost 10% of TSMC’s production. 7-nanometer is an important threshold, beyond which TSMC and other fabs will need to employ EUV methods to make chips. ASML, on a “Watch” rating, has a monopoly on EUV machines.
Ford and VW announce plans for Global Domination.
They finally announced it, after months of speculation in the rumor mills. This is good for both companies - it looks like they will play to their strengths and joining hands in the race towards electrification is a good idea. Electric, Autonomous, Commercial Vehicles - that's where the growth will be. And that view comes from The Buylyst worldviews on Urbanization, Retail and, well, Autonomous Vehicles.
The Auto industry is investing big in Electric Vehicles.
$300 billion, according to this analysis by Reuters. It also provides a good summary of each Auto company's investment in EVs. I can't emphasize this enough but the Auto industry has never been through such a big transformation - electrification PLUS Autonomy.
Ford cuts thousands of jobs in Europe.
This is part of a broader plan to make Ford "financially fit". I had written a worldview on Ford a couple of months ago. I had split up Ford's revenues and margins by region. That makes it pretty clear why Ford would want to downsize in Europe, or anywhere outside the US for that matter.
Apple's wearables revenue already exceeding peak iPhone revenue.
That's what Tim Cook is saying. The numbers for 2018 will come out later but if this is true, it'll should be a big boost for the stock. Recently, the stock's taken a massive beating due to concerns of a slowdown in iPhone sales.
Apple going after the Healthcare industry.
Another awesome report by CB Insights. The key takeaway for me was that Apple won't just try to infiltrate the Healthcare industry with software and a rich App Store, but also with hardware. And it won't be just wearables. When it comes to hardware, I still have to give Apple the edge over it's rivals Google and Amazon (who are also trying to get a slice of the huge healthcare market).
Apple gives us bad news; revises guidance.
Apple released a letter today revising its guidance for Q1 2019. It turns out that sales of the new iPhone releases weren't as strong as they had expected, especially in China. Mr. Market, of course, is flipping out. This is bad news but a 10% correction based on this news, especially after the 30%-ish correction since October, looks like a big overreaction. Upon parsing through the letter I see a positive and a negative. The negative is obvious: Apple has milked the iPhone cash cow as much as it could. It's time to move on. The positive news is: It's non-iPhone business is growing at 19% year-on-year. AirPods and Watches have been a big hit. But Apple needs a new, sexy product that compels people to queue up outside its stores. It can't keep iPhoning it in anymore, as I've discussed months ago.
It's important to put all this in context - the company still generates tons of cash, way more than any of its FAANG compadres. But those other guys spend a lot more on R&D and are better at giving us the impression that they're "moving fast and breaking things". That was never Apple's style but they need to move fast now.
I will update Apple's numbers and determine whether I need to change The Buylyst thesis. I suspect the changes, if any, won't be drastic.
A lot of the internet is fake. What? Nothing makes sense anymore.
This article from NY Magazine claims that a lot of the internet traffic stats we hear about are fake news - a lot of bots posing as humans. Apparently more than 40% of internet traffic are not humans. If this is true, it has massive implications on the core business models of Google and Facebook. Are they faking it?
How yooooge companies remain yoooooge: Software.
I'm not a huge fan of Harvard Business Review, but occasionally they hit the right notes. This article about how software basically widens the moat around big companies nowadays is spot on. This line captures the essence of the article: "Even if you’re not in the software industry, there’s a good chance your success hinges on your ability not just to use but also to build software." For example, I often hear people go on about Fintech. In my view, all "Fin" needs to be "Fintech". That goes for startups and for big banks. If you're financial "service" isn't heavy on tech, you're finished. The other point I'd make is that Cloud Computing has changed the game. It has enabled companies from any industry to access top-notch software packages and platforms. This sort of access allows them to build their own custom software applications, which beef up their product or service.
About GE: The best WSJ article I've read in a long time.
I did a piece on GE a couple of months ago: GE - Not So Electric. The WSJ did one a few weeks ago - I thought this was a great piece of journalism. It charts out GE's history through the lens of of big, strategic decisions by each of its CEOs - from Jack Welch to Larry Culp. The Buylyst article was more about how things stand now - from the point-of-view of a potential investor. You'll notice that GE has been on a "Watch" rating for a long time while its stock price has been on a downward spiral. Even though it presents a tremendous upside now, numerically, the rating still remains "Watch". That's because there has been a giant management shakeup and I'm just not certain of the new CEO's strategy and gameplan. Nobody is. The WSJ article sheds light no how GE got to this place.
Apple gets horrible press.
Apple's been in the news lately, mostly because its stock has tanked. But that has, in turn, brought about a slew of horrible press. This article from Gizmodo is a great little piece of hate-fest. But this one from WSJ is somewhat grounded in reality - that their India strategy (if there is one) is not working. I've been saying this for a while and I'll say it again - Apple needs to figure out some sort of a monthly installment or credit plan for its phones. Very few Indians will shell out $1,000 for a phone in one go.
Do-it-yourself investing among the super-rich.
The Economist magazine's last issue had a Briefing on the explosive growth of family offices at a time when hedge funds are falling off a cliff. The super rich take matters into their own hands and take an active role in investing. 2 things struck out at me: 1) There was no mention of Passive Investing - the super rich really want to be active, and 2) Investments in the hedge fund sector are being replaces by VC and PE style investments. A third things strikes me as smart: they invest for the long haul and they couldn't care less about violent market swings. Now if only The Buylyst can find their attention. Worth a shot.
Quant Funds are behind the violent market swings.
We all suspected it. But the WSJ article puts some numbers around it, much like the FT article last week. At The Buylyst, we're doing our own analysis, which we will publish in the next few weeks. Markets are changing. As Intelligent Investors, should we adapt?
Blockchain for Smart Cities. Makes sense.
Most of us always struggle to find uses of Blockchain outside cryptocurrencies. But the reality is that any ecosystem that will reward transparency and "tamper-proof" record-keeping will find Blockchains useful. Smart Cities, with Smart Grids and Autonomous Vehicles, would benefit from the characteristics of Blockchain. This article is a good intro.
Fed's relationship status with the market: It's complicated.
This brief history of market reactions to the Federal Reserve's interest rate moves by Ben Carson is a fantastic little lesson in macroeconomics. The key takeaways, in my view, are: 1) It's impossible to predict what the market's reactions will be and 2) The Fed has just gotten better at its job since the 70s, when there was less reliance on data and a conspicuously missing inflation target policy objective. Carson is a little less convinced about the point #2 than I am.
Added new Mental Model: Michael Mauboussin
- Mauboussin is one of the most knowledgeable, articulate and prolific thinkers in the investment arena. He's currently a Research Director at a hedge fund, and a professor at Columbia Business School.
- Common Thread: Ignore all the economic and financial theories you've been taught at school. Investors are irrational. Try to think in terms of a range of probabilities and expected values.
Passive Investing has negative side-effects.
This article in the FT is a good read. My hunch is that the massive fund inflow into Index Funds & ETFs is making the markets less efficient - in the sense that a asset prices are more correlated and move up and down based on index membership (i.e. Market Cap metrics) rather than the underlying company's business prospects. In some ways, it's a positive for Active Management. In other ways it makes the job much harder because of wilder swings that remain wilder for longer.
California requires all buses to be electric by 2040.
This story is largely symbolic, because it's California and it's already progressive. Besides, the majority of the population there drives. San Francisco may be impacted significantly, but LA is decidedly a "car city". The importance of the story lies in the fact that this is happening in many parts of the world. We always forget that Europe, China and India are importers of Oil. That's almost 3 billion people right there. China and India, in particular, are having a tough time dealing with pollution. China is already the largest market for electric buses, by far. In India, the movement hasn't picked up yet. But the intention is there. Reducing dependence on imported Oil makes economic and political sense.
China is the leader in Electric Vehicles, by far.
For all the talk of a "slowing China", there is plenty of economic activity going on. While the country's aspirations to dominate AI and Big Data may be debatable, in the EV arena, there is no doubt of their dominance. Just a few stats from this MIT Tech Review article: 1) China alone accounts for 56% of global Lithium Ion battery production and 2) China has plans for producing 3 times the amount of batteries compared to the rest of the world combined.
Micron FY 2019 Q1 earnings: Mixed
- Thesis unchanged. The rationale comes down to this: I expect ebbs and flows in the memory market, despite my expectations that AI, Big Data, Cloud, IoT, Autonomous Cars, VR/AR and 5G make up a completely different world compared to 2016. But I expect Micron to be able to sustain a Free Cash Flow level of $5 billion through these Memory market cycles (they’re now at a run-rate of about $9 billion). The market is scared that a 2016 style event will repeat, when price declines led to negative earnings and cash flow. I can’t see that happening, as I've explained here. The end-markets are different, the industry structure is different, and the management team is different. Micron trading at less than 3 times earnings, with the amount of cash it’s generating in a supposedly down-cycle, doesn’t make sense. This quarter Micron generated more than $2 billion in free cash flow.
- Micron reported its FY 2019 Q1 earnings today (remember it reports off-cycle). It missed Wall Street’s expectation on revenue but beat on earnings.
- Micron’s results were very, very good by any standards. Revenue was up 16% since this time last year, and earnings were up 21%.
- Quarter over Quarter, however, revenue was down 6% from a record 4thquarter ending August 2018. This was expected.
- First, the latter half of any year is usually their strongest. Secondly, and more importantly, pricing for both DRAM and NAND (Micron’s two broad product categories) was down quarter-over-quarter. This was also expected.
- That DRAM and NAND memory pricing has been declining, shouldn’t be a surprise to anyone. I was surprised, however, that DRAM demand was flat quarter-over-quarter. I expected a pricing decline, but I also expected an increase in demand. Management cites inventory issues as the main reason.
- NAND demand, however, grew by low-to-mid-teens, almost entirely offsetting the decline in price.
- There seems to be high DRAM inventory in the market, because all three big producers – Samsung, SK Hynix and Micron - have produced enough to satiate their demand forecasts of 20% bit-growth per year.
- Now, Micron expects DRAM demand growth to be around 16%, mostly due to CPU shortages, thanks to Intel.
- Even in NAND demand growth, Micron has reduced its forecast to 35% from 40%.
- Micron expects the inventory and CPU shortage issues to last another couple of quarters.
- As a result, Micron will reduce its Capex to about $9.5 billion – all of it dedicated to technology transition, and not to wafer capacity growth. Earlier this year, Samsung also reduced their capacity growth. In a couple of quarters, this should be a net positive for pricing, as supply growth will lag demand growth.
- About Tariffs: Micron says that by this quarter they will have mitigated 90% of the impact, should China decide to levy more tariffs.
- Mr. Market is spooked by Micron’s sober outlook, which still implies a ton of Free Cash Flow. And yet it values the company as if its sick and dying. If that’s how it values it, shouldn’t it be positively surprised that the company is making any money at all??
Hitachi in talks with ABB to buy their Power Grids business.
This news is stuck in "talks" mode, but it's a net positive for ABB depending on the price they receive. ABB wants to focus more on high value products and services like Smart Grids and EV chargers within the power business.
Global Stock valuations are at a 5 year low.
Most traders are concerned about the trade war, a slowing China economy and rising interest rates. The attitude in the markets has been mostly "sell the rally". This data suggests that the selling may have been overdone.
Does China have a head-start in AI chips?
In a word, No. But this article makes the opposite case, without tangible data to prove it. Last I checked, US companies dominate the AI-chips market. Nvidia, Xilinx, Intel, Google - these are the companies that have made significant strides in making AI semiconductors. Baidu and Alibaba have research divisions to make AI chips. But they're still mostly dependent on American chipmakers. Both happen to use Xilinx FPGAs in their Cloud datacenters. It's not easy to design and make AI hardware. Even in the US, only a handful of companies can make them. And only 2 companies in the world can build them at mass-scale in fabrication facilities: Intel and TSMC. Intel is American. TSMC is Taiwanese. Can China catch up? Sure. Does it have a head-start? No.
Ford and VW are serious about a broad alliance. This can be yoooge.
Together, these companies can dominate the Commercial Vehicle market. Combined with AV and EV technology, a Ford-VW alliance can corner this market. Most analysts and Auto manufacturers believe that the growth in the Auto industry is not in passenger cars. It's in Commercial Vehicles, especially ones that can be electrified and automated.
The Apple-Qualcomm battle gets ugly.
Qualcomm is beginning to sound like a petulant child as it goes around the world trying to block iPhone sales. It convinced a court in China to block sales in some older iPhones that allegedly infringed on Qualcomm's IP rights. The irony in that development is hilarious - China may be one of the worst offenders of IP-rights infringements. All this is happening as both countries - China and the US - are trying to gain leverage in their trade-war discussions. Now, Qualcomm is trying to do the same thing in the US. That may not work so well. The Buylyst thesis on Apple remains unchanged.
Reserve Bank of India governor suddenly resigns.
We couldn't have timed our latest worldview on India any better (or any worse?). Just as we were editing it, this news broke out. Urijit Patel, governor of the Reserve Bank of India resigned. The tension between the RBI and the top brass of India's central government has been brewing for some time. The Finance Minister - Arun Jaitley - wants the RBI to release some of its reserves to fund some of the government's fiscal policy objectives. Surprise, surprise, this tiff happens in an election season. Regardless of whether its election season or not, this is a clear case of the government overstepping its boundaries. Predictably, the Indian Rupee depreciated.
Changes to Valuation:
- Exchange Rate used for Last 12 months column and Sustainable Level column is 75 INR/USD. Earlier we had used 70 IRR/USD. Preceeding columns - 2015, 2016, 2017 still shown at 70 INR/USD.
- Numbers have been rearranged to reflect calendar years more closely. HDFC Bank reports off-cycle - their fiscal year ends on March 31st every year. In the Valuation Details page, 2015 numbers are fiscal year 2016 numbers, which are numbers ending March 31, 2016. This pattern follows through in 2016 and 2017. There is a one quarter lag, but this is the closest representation possible.
- Revenue growth assumption in Sustainable Level column has now been adjusted to 25%, down from 30% previously.
HDFC Bank Update: Thesis playing out as expected.
- HDFC Bank reported earnings on October 20th, for their fiscal-year second quarter (they report off-cycle) ending September 30th, 2018. Numbers were good.
- It was the quarter of “20s”. Most significant metrics grew by 20%+ year-over-year.
- Of note were these metrics:
- Deposits grew by 20.9% year-over-year.
- Advances grew by 24.1%
- Balance Sheet size grew by 25.3%
- Net Interest Income grew by 20.6%
- The first metric about Deposits growth was encouraging – that’s because overall deposit growth in the Indian banking sector was roughly 9% by comparison. Clearly, HDFC Bank appears to have gained market share.
- The 5thbig metric to track is the Non-performing Asset ratio. NPAs were limited to 1.3%, which is roughly in line with the last couple of years.
- The 6thimportant metric is Net Interest Margin, which clocked in at 4.3%. Again, in line with numbers we saw when we wrote our thesis.
- The other big part of The Buylyst thesis, which may explain the steadfast NPA and NIM numbers, remains intact: HDFC seems to be focused on Retail deposits, which made up 55% of their advances as of quarter-end. That’s roughly in line with their long-term trend.
- The other big development in India since The Buylyst thesis on HDFC Bank has been the deterioration of Non-Bank Finance Corporations (NBFCs), chief among them being IL&FS. We’ve covered this issue on detail here.
- HDFC Bank Management said that they did acquire some loan books from NBFCs, which would be categorized as “Wholesale” loans, not “Retail”. However, the underlying assets are mostly Housing and Retail loans. Management did not say how large “mostly” is, but they did say that about 85% of those assets are of the highest rating, based on their internal credit-rating models. Management also reiterated that they don’t expect any contagion from the NBFC failures in the country. If anything, the events are positive for incumbent banks, provided they don’t relax their lending standards as they acquire NBFC assets.
- The last significant event worth mentioning is their equity capital raise in July/August. Management reiterated that they have 3 main sources of cash – equity, debt and deposits – of which debt is the least preferred source. In India, cost of debt capital is prohibitively high. While equity raises dilute existing shareholders temporarily, they can be value-accretive if the bank finds assets to buy or loans to make. If this quarter’s numbers are any indication, that doesn’t seem to be a problem.
- Valuation details have been updated. 2 noteworthy changes:
- The INR/USD exchange rate assumption has been changed to 75, to reflect the continuing depreciation of the Rupee.
- The Last 12 months numbers now reflect the September quarter.
Ford CEO says people won't buy as many cars in the future. Thanks to AV.
This is a good interview to read if you want to understand the sport that Ford and other Auto companies must play now. The time period from when AVs were just a dream to now when it's looks very real has been short and swift. CEO Hackett describes this massive shift articulately:
"for the first time in history, you’ve got the confluence of technology that will let the vehicle drive itself, the ability for the vehicles to communicate with each other and all talk to the cloud. The cities will also communicate with the cloud, which then connects with the vehicles in ways that actually help choreograph traffic."
Nvidia AI can turn a sketch into 3-D rendering for video games and graphics.
This is a very cool technology that can have amazing effects on video games, movies and even VR down the line. When it comes to anything image-related, I suspect Nvidia will lead. Graphics is their jam.
Nvidia: Moved from "Watch" to "Buy".
Lest this looks like a sneaky move on my part, I should make it clear that I’ve been going on about this for a few weeks now since Nvidia’s stock crashed after November 15th, when it reported earnings. The thesis and the price target have remained unchanged since November 6th, 2018. As I mentioned in Foggy Bottom: The 2018 Carnage, I had decided to wait until the Trump-Xi meeting took place. Regardless of the meeting's outcome, I would have put Nvidia on The Buy List unless there was no upside left. If anything, I’ve lost a fair bit of upside since Nvidia was in the $140s. But I stand by the decision of waiting – I have more confidence in the remaining (modest) upside now. Also, whatever upside I may gain today on Nvidia, I will almost certainly lose on my next investment idea. Anyway, I’m not a trader. A single day’s move based on a single meeting is not the basis of either thesis.
Tesla's Gigafactory is awesome: A deep-dive.
The stat that stood out to me the most in this story is that Tesla's Gigafactory will account for 60% of the world's total Lithium-Ion battery production. 60%!
Volvo's Autonomous Trucks will be hauling limestone.
It's happening. Volvo is steadfast in its quest to lead the AV/EV revolution in commercial vehicles. Mining is a perfect testing ground. Distances are short. Routes are mostly pre-determined. And no random humans to worry about. These autonomous trucks will go mass-scale next year.
Father of Index Funds warns against them.
John Bogle questions the economic and social impact of Index Funds. He still likes them, but now that Passive Investing has become mainstream, it could cause problems: 1) Concentration of Stock Ownership amongst the 3 big Index Fund companies and 2) Its impact on corporate governance. The other question I struggle with is this: Is it causing correlations amongst stocks and indeed amongst asset classes to rise significantly? Just a few days ago, Deutsche Bank released a report saying that as of mid-november 90% of asset classes tracked by DB generated negative total returns - this hadn't happened since they starting tracking this metric since the beginning of the 20th century.
Micron CEO reaffirms guidance in Credit Suisse conference.
CEO Mehrotra reaffirmed Micron's guidance by saying that revenues in Q1 (ending November 29 - remember Micron has a weird reporting cycle) will come in closer to the lower end of the guidance, which is still a stupendous $8 billion. Also, he says Earnings will be closer to the higher end of their guidance. And remember, all this is in a bad pricing environment for both DRAM and NAND (especially NAND). Micron trades at a 3X multiple. For a company that generates nearly $10 billion in free cash flow, the stock price is inexplicable. Even if Free Cash Flow is $5 billion, the stock should be valued much, much higher. Mr. Market needs to believe that these amazing numbers are sustainable. 2016 is still fresh in investors' minds. But the world, the industry, and the company, have changed.
GM does a Ford. With more clarity.
You know, for all the hoopla about GM's revolutionary plan, it seems to me that they just copied Ford's strategy. However, Mary Barra did offer more clarity than Ford CEO Hackett. But the focus on SUVs, Trucks, and the AV/EV revolutions is nothing new - this was Ford's pivot earlier this year. To GM's credit, they've been more aggressive on the AV/EV front than Ford. But Ford is the leader in the car categories that GM wants to pivot to: SUVs, Trucks, Commercial Vans etc. If Ford does ink a deal with Volkswagen on commercial vehicles and trucks, of the AV/EV variety, it'll be hard for GM to compete.
Virtual Warfare: US Army to use Microsoft Hololens.
Microsoft has been in the news this week because it has beaten Apple to become the world's most valuable company, on and off. Apple may be back on top for now. The race is on. But this news story might bolster Microsoft's case. Hololens apparently beat out the much hyped company Magic Leap for this project.
Healthcare and Humanity after AI: A fascinating conversation.
This conversation by some of the stalwarts of healthcare and AI is one the best things I've read from The New York Times, or from anywhere really. Gene Editing, Social Issues, Healthcare, Emotional Wellbeing - everything will change as AI infuses itself. I'm not sure how it will all shake out. Hey, if it saves lives, I'm all for it. There is another offshoot from this page called "May A.I help you?" It's fascinating that we're closing in on something called the Turing test - when lines between human and artificial intelligence start blurring.
2018 was the worst year for investors ever, by this measure. No exaggeration.
The headline in this WSJ article is much more benign than the contents warrant. The headline is something like "No refuge for investors...". But here's the paragraph that blew my mind. "All told, 90% of the 70 asset classes tracked by Deutsche Bank are posting negative total returns in dollar terms for the year through mid-November. The previous high was in 1920, when 84% of 37 asset classes were negative. Last year, just 1% of asset classes delivered negative returns."
Some companies prefer 5G to crappy Wifi.
5G is getting serious. It appears that Audi is setting up its own 5G network because it's tired of this old thing called Wifi. I read through to find out how they're building this. It turns out they are using Ericsson equipment. Verizon used their Small Cells as well. It makes me want to do a deep-dive on Ericsson before more companies ditch Wifi for 5G.
Autonomous Vehicles have a funny side effect: Decline in Car Sales.
I think this phenomenon will play out - as cars become Autonomous and easy-to-access, especially in cities (even in cities like LA), it'll be less attractive to own a car. Vanity or a genuine interest in automobiles may be the only reasons left to be a car-owner. All the major car companies must grapple with this. This could become a disruption in their business model very fast.
TSMC could secure another big win.
Two of The Buylyst holdings may be joining hands. Multiple reports suggest that IBM is in the process of engaging TSMC to produce chips to be used in its servers.
China is not kiddin' around with Autonomous and Electro-Mobility.
No country is more serious about AVs and EVs than China. They've got the biggest EV presence in the world, by far, and they're not going to depend exclusively on American companies to figure out the AV problem. From an investment standpoint, China being serious about it means giant scale. Imagine if a country of China's size and economic power move towards AVs and EVs. The revenue potential is mind boggling.
Apple reduces XR prices in Japan.
This is another dagger into Apple's stock. Mr. Market is obsessed with Phone sales. Apple's stock has got punished since it's last earnings because there are murmurs about declining iPhone sales. combined with the fact that Apple will stop reporting unit sales. Never mind that it generates more than $50 billion in Free Cash Flow and has a brand cache that other companies can only dream of. But on the issue of price reductions, I do hope they start doing that in India. Apple selling many more phones in India is part of The Buylyst Thesis. But the big bet revolves around the Apple ecosystem.
Machine Learning says that Pop lyrics are getting more repetitive.
Really, I didn't need Machine Learning to tell me that. But maybe Pop Music artists will be more careful now, and write better songs. AI Police is here.
A cool, new flowchart to explain Artificial Intelligence.
I follow MIT Tech Review regularly - as in, everyday. In using a flowchart to explain AI, they've given The Buylyst low-down on it some stiff competition. Of course, The Buylyst angle will always be "how does this translate to returns?".
Mr. Market is spooked on rumors that Apple's iPhone sales will drop.
This has been the story of the week. Suddenly, Apple's stock is in the dog house because a couple of Apple suppliers gave hints about iPhone sales slowing down. This, combined with the fact that Apple won't be reporting unit sales numbers going forward, really spooked Mr. Market. All this is a big overreaction in my opinion. Apple's business strategy is to think beyond the iPhone - towards strengthening the ecosystem with Services as one the central pillars. The company generates tons of Free Cash Flow - more than $50 billion - a number that the likes of Amazon can only dream of.
Micron ups its game in Autonomous Vehicles.
Micron is working on products specifically for ADAS - Automotive Driver Assistance Systems. As Autonomous Vehicles go from Level 1-4 - 4 being fully autonomous - the need for memory will grow exponentially. Micron wants a big piece of this inevitable pie, which is why it's spending billions setting up a plant in Manassas, Virginia, to cater to new end-markets.
Caterpillar is going Electric. Step by Step.
Yes. The most obvious case for Electric Vehicles - slow moving gas-guzzlers that don't travel long distances - is finally gaining momentum. This move towards electrification was part of The Buylyst Caterpillar thesis.
Ford wants to deliver groceries using Autonomous Vehicles.
Ford is testing grocery delivery by Autnomous Vehicles with Walmart. Ford is serious about making AVs useful, practical and cheap. They're almost shunning the sensationalist approach that Silicon Valley likes to take. Ford's big investments in AVs gels well with what they're good at - Commercial Vehicles, Pickup Trucks and SUVs.
Waymo Autonomous Car Service is almost here.
Google's Waymo is stepping up to compete with Uber and Lyft with its Autonomous Driving system. They'll start slow, but it'll probably pick up very fast. I'm sure Uber and Lyft are working on it at double-speed as well. Ride-sharing that's Autonomous and Electric - that's where the world is going.
Nvidia stock has a rough day.
Mr. Market was very disappointed by Nvidia's earnings. Their cryptocurrency mining revenue has dried up, as was stated in The Buylyst Thesis. And Gaming, their largest segment, showed signs of slowing down. And so they had a lot of their old chips (like Pascal) in unsold inventory. That's also because they recently released their new chip - the Turning GPU. Nvidia's datacenter and AI-related businesses are doing fine - growing by double-digits year over year. I haven't been through Nvidia's earnings in detail yet, but it's unlikely that I will change The Buylyst Thesis upon digging in. Their core businesses look strong. At this point, I quite welcome Mr. Market's overreaction. Nvidia is in the Watch List, precisely for moments like this.
GE Q3 2018 Earnings: Short on details.
- GE reported earnings on October 30th. The Buylyst GE thesis is unchanged – still not ready to move GE from “Watch” to “Buy” despite the seemingly attractive Upside GE’s stock price represents.
- However, given the recent shuffle at GE – with the sudden ousting of erstwhile CEO John Flannery – a new valuation model for GE is warranted. But there is too much ambiguity about the direction of the business at this point.
- The numbers in the quarter weren’t bad – orders were up 13%, Core Revenue was up 1%. Most segments did pretty well. Power was the laggard, but what’s new there?
- Other than that, new CEO Larry Culp didn’t give us too many details. To be fair, he’s only been CEO for 30 days.
- He did say that they’re cutting dividends. Good move.
- He did say that they’re moving as fast as possible with asset dispositions. That’s good. Recently GE sold its Lighting business, which is sad because that’s how the company started. Financially, it was a good move – it’s a low margin, commodity business.
- I had written GE: Not So Electric a few weeks ago, and in it I had posited a slight change from the restructuring plan that John Flannery (ousted CEO) had laid out. I had mentioned that GE should keep its Healthcare business (Flannery wanted to divest) and get rid of its Power business (Flannery wanted to keep it).
- In the call, Larry Culp did say with regard to the Power business: “everything is on the table”.
- In other positive news, GE did generate about $1.1 billion in Free Cash Flow. The company is still making money. It’s not dying.
Added Nvidia with a Watch rating on 11/06/2018.
I went in hoping that it could be a lateral way to play the Crypto space. But the company isn't really focusing on that. Instead, they're sticking to what they do best - GPUs. Anyway, I'm glad that I dug into Nvidia. If you're invested in AI and Big Data, you should have a nuanced opinion on Nvidia.
Xilinx Q3 Earnings Results: Record Results.
- Xilinx reported its Q2 results for its Fiscal Year 2019 on October 24th. Xilinx’s Fiscal Year ends every March 31st.
- Xilinx’s revenue for the quarter was $746 million, up 19% since last year. This was a record.
- Net Income was 25% from this time last year.
- The stock shot up 15% the day it reported earnings. That’s mostly because Management raised its Revenue guidance for both the next quarter and the full Fiscal Year 2019.
- Xilinx had a great quarter in terms of innovation and positive developments. A couple of these are in the Commentary section, if you filter by Xilinx.
- Twitch can now livestream “broadcast quality” videos using Xilinx’s FPGAs.
- Samsung has incorporated Xilinx’s chips in some of its “Smart” SSDs.
- Amazon doubled its FPGA-as-as-Service instances on AWS – from 4 to 8 regions around the world.
- Xilinx launched the Alveo board along with AMD. Alveo set a world record for image processing – apparently processing 30,000 images per second, with a 2-millisecond latency.
- Xilinx’s greatest achievement this quarter was the launch of Versal, the industry’s first ACAP – Adaptive Compute Acceleration Platform (you’ll see note on it if you filter by Xilinx).
- Otherwise, revenue from 5G deployments (especially in Asia) was much higher than expected. Apparently, telecom companies are using Xilinx’s RF-SOCs (Radio Frequency System on Chip) products to deploy 5G networks.
- Xilinx’s biggest drawback is its somewhat underdeveloped software stack, which makes it harder for customers to program and use the full power of Xilinx FPGAs. They need a CUDA, Nvidia’s software stack.
Ford buys an e-scooter company.
This story, to me, says that Ford is serious about 3 things: 1) Electrification, 2) Urbanization, and 3) Commercial Vehicles. The combination of all 3 is the future of cities. Maybe Ford can pull it off. In related news, Ford and Volkswagen are thinking about becoming a dominant force in commercial vehicles. I've mentioned this in another note - that combination will be hard to beat.
AMD releases some chips for Cryptos and Blockchain.
This story is weird for 2 reasons: 1) AMD just reported a week or two ago that its Crypto revenue is drying up, and 2) they released it the day I was writing up the thesis on Nvidia, which I thought may be a lateral play on cryptocurrencies. Also interesting is that AMD really underplayed the "crypto" aspect of this, while trying to project it as a "Blockchain" thing. The truth is that complex semiconductors don't happen overnight. This was probably planned several months in advance, when crypto revenue was good.
Apple's India strategy isn't working. Yet.
This story is quite a downer for The Buylyst Thesis on Apple, which was essentially that Apple can milk the good ole iPhone for few more billion dollars before it moves on to more of a Services-type business model. I still believe that the credit system is the problem. And marketing, of course - they need to make Apple an aspirational product as it is here in the States.
Xilinx is thinking about buying Mellanox.
Xilinx stock was down a bit today on this story. At first I thought "Mellanox? Is that a Pharma company? Why Victor (Peng)? Why?". But then I read that its an equipment manufacturers for data-centers. Part of that makes sense - that it's a datacenter play - but what on earth does connectivity equipment (the type Cisco makes) have to do with FPGAs? I'll keep an eye out for Xilinx's statement.
Nvidia's fiscal year ends January 31st. So, fiscal year 2016, means last 12 months ending January 31, 2016. Since this rule only assumes 1 month in the fiscal year, the numbers on the valuation table are labeled differently. 2016 refers to Nvidia's fiscal year 2017, for example.
Sustainable Level Revenue assumptions as follows:
- Assumed 20% growth in Gaming.
- Assumed 20% growth in Professional Visualization.
- .Assumed Datacenter business doubles before it stabilizes.
- Assumed Autonomous Vehicles business doubles before it stabilizes.
- Assumed OEM and IP business declines by 50%.
- EBITDA margin improves from 39% to 42%. Compared to the trend over the last 12-24 months, that’s a modest increase.
- No benefits from Working Capital swings.
- Similar tax rate assumed.
Paraguay uses Hydro-Power for Crypto-Mining.
Here's one way to 1) try an fix the power consumption problem in Crypto-Mining, and 2) misallocate resources. On the flip side, many emerging economies don't have a sophisticated Reserve Banking system, as mentioned in "Bitcoin's merits are inflated".
Apple (finally) updates MacBook Air.
Apple's big event in Brooklyn wasn't revolutionary, but it was a much needed boost to the ancient MacBook Air. I was hoping they would release something cooler like a new TV, but we'll have to wait. I thought the most interesting thing was the new iPad Pro - it comes with a new Apple Pencil that attaches to the iPad magnetically. Why didn't Microsoft do that with the Surface? Classic.
Apple Q4 2018 (Calendar Q3) Earnings. Record Results.
- Apple beat Street expectations, both on Revenue and Earnings. The market didn’t like. But the Buylyst thesis is unchanged. It is still a giant cash machine and is likely to remain so.
- Apple’s forecast for Calendar Q4 (ending December 31st) is a new record, but that’s not good enough for Mr. Market.
- Mr. Market’s reaction is: “Apple doesn’t expect insanely high growth this Christmas season even if it’s a record forecast. Oh God, this is terrible news for the company!”. That reaction is what’s insane.
- Compared this Calendar Q3 last year, Revenue was up 20%. Earnings were up 41%.
- Service Revenue reached an all-time high of $20 billion.
- I always listen to these earnings calls through the lens of the Buylyst Thesis. The question I always try to answer is: Is the Buylyst Thesis playing out? And the thesis was mainly predicated on Apple selling more phones in India (in the short term) and moving beyond the iPhone in all markets (in the long term). It has Not Yet done either, but it is moving in the right direction:
- Apple hasn’t yet released major overhauls to its Entertainment landscape. Although it did announce a few weeks ago that it will ringfence Apple’s new content productions to Apple TV subscribers (Filter by Apple on the right to see that news feed).
- Also, Tim Cook did mention that the integration between HomePod and Apple Music is much, much better now. But Apple’s Achilles Heel has been Siri. No updates on that yet.
- Apple has released ARKit 2 this last quarter. This is a positive step ahead for Apple’s AR ambitions. Are they going to release some sort of AR/VR hardware? No mention of it.
- Apple is quietly working behind the scenes on is Autonomous Car project. But there was no mention of it by Tim Cook.
- Apple’s India strategy has taken a hit – growth was flat this quarter. But I think this is temporary. India’s currency is weaker, which makes Apple’s products very expensive there. I still maintain that it’s not the price level, but the lack of a proper credit mechanism that’s impeding sales there. Even in the US, if we all had to pay the full price of an iPhone upfront, sales would be a lot lower. I suspect, they’ll do something about this at mass-scale.
- On the flip side, Apple is seeing higher adoption of Macs in India and other developed markets. The new MacBook Air release should accelerate that.
- But overall, Services Revenue keeps increasing. This is the “New Apple” segment that will be intricately tied to Apple’s hardware products, which is their jam.
- I’m still waiting for them to release an Apple TV with an overhauled TVOS, that connects seamlessly with your iPhone, Mac, Homepod, Watch, and Apple Pay. The lines between all the operating systems – MacOS, iOS, TvOS – will keep blurring.
Microsoft has started using Xilinx chips in its datacenters.
This story from Bloomberg hasn't been confirmed but I would be surprised if it's not true. Microsoft has long used Intel's FPGA chips in its datacenters that power their Cloud business (Azure). Xilinx, a Buylyst holding, is the only other large FPGA-maker. It seems they're encroaching in on Intel's legacy territory. This is great for Xilinx.
IBM buys Red Hat in the biggest software acquisition ever.
This Wall Street Journal story captures the sentiment of the broader market about this deal: lukewarm to negative. I agree with them that IBM has been late to the Cloud party. And I agree that the Red Hat acquisition could be a desperate move. But I don't think it's a bad one. Red Hat's speciality is Containers, which means making it easier for enterprises to move virtual copies of software and applications across Cloud Platforms seamlessly. Red Hat's containers are Linux-based, which is Open Source - a characteristic that lends itself well to, well, a fluid operation like carrying volumes of code across competing platforms. This acquisitions comes days after IBM launched a Multi-Cloud and Multi-AI Dashboard. The story makes sense to me. The price, however, is up for debate.
DOJ fights for Micron. Against China.
The saga continues. The back-and-forth lawsuits about stealing IP secrets between Micron and UMC that started a few months ago (filter on the right by Micron to see Buylyst comments on it) had ignited the generally downward-sloping price path for the stock. Micron's complaints were dismissed in China. In fact, a court in China had banned certain Micron products when that initial tussle happened (those products accounted for less than 1% of Micron's revenues). It seems that now the US DOJ has got involved. They've put the alleged Chinese company that stole secrets from Micron on a sh*t list. This came around the same time when Donald Trump tweeted about his "positive" call with Xi Jinping. Maybe that's what the market liked. Micron was up 6% today.
Ford Q3 2018 Earnings: As Expected
- Ford earnings was as expected (for me). Thesis unchanged.
- Revenue increased about 3% compared to Q3 last year. But margins declined, which was expected.
- I would say the results are mixed. But Mr. Market loved it. The stock went up almost 10% yesterday!
- The story hasn’t changed. North America is strong – in terms of Revenue, Margins, and Return-on-Capital metrics. The rest of the world – not so much.
- I guess Mr. Market liked the fact that CEO Hackett gave some more details of the “Financial Fitness” plan. A larger part of the market is beginning to think that the turnaround is possible. This is what I think Mr. Market was relieved to hear:
- Restructuring expenses would be spread out over the next few years. Management is no hurry to disrupt profitable parts of the business in the name of expediency.
- Management reassured analysts that Ford’s rich dividend will be left untouched.
- On the last point, I believe them – Ford’s balance sheet is very strong. They sit on $23 billion of cash. And they are a cash-flow-positive company.
- On the strategy front, Management remained consistent with what they’ve been saying all year:
- Divest/Exit unprofitable parts of the business. Reinvest those resources in the profitable parts of the business.
- Management is very clear about what they are: the profitable parts and the unprofitable parts.
- SUVs, Commercial Vans, Pickups and the Mustang – that’s Ford’s jam. Sedans are not. And that’s not just an American phenomenon. It’s the case world-over.
- In China, Ford is going operate under a stand-alone business entity, managed by a Chinese CEO. This is a good move.
- Overall, the message was very consistent The Buylyst’s latest opinion on Ford. One of the points I had raised in the article was about their product-mix in Europe. I was especially glad to hear Management acknowledge that their business in Europe needs to tilt more towards Commercial/Utility vehicles. I’ve commented (somewhere below) before that their MoU with Volkswagen on Commercial Vehicles can be a dominant force.
- The last point I’ll make is this: Ford is in the midst of a bigger-than-usual product churn phase – many old models will be replaced by new models (like the new Ford Edge in the US, Ford Territory in China) in the next few months. I feel there is more upside to this cadence than downside.
Moved Sensata from the Watch List to the Buy List.
I had updated The Buylyst thesis on Sensata a few days ago. At that time the potential upside, based on The Buylyst estimates was still below 25%. After the market crash yesterday, Sensata now shows a 29% potential upside. Based on my positive view of the long-term fundamentals of the company, I moved it to The Buy List.
Micron rival SK Hynix reported a great quarter.
Korean Memory behemoth SK Hynix reported earnings today. The reason I mention it is because they saw their DRAM Average Selling Price go UP by 1%. This defies the Mr. Market's fear that Micron will be victim of a massive DRAM crash due to oversupply. It's still early in the game. But based on SK Hynix's earnings report, demand drivers are not slowing down. Demand - the other side of the Supply-Demand equation - is completely missing from all that doomsday chatter.
TSMC Q3 2018 Earnings Call: Solid Results.
- Solid Revenue and Earnings growth. Thesis unchanged.
- Revenue in Q3 grew by 8.1% compared to the same time last year. Earnings grew by 23%.
- They beat their own guidance for Revenue and Earnings.
- But Mr. Market penalized the stock for clocking in great numbers. Why? Because Management was “cautious” about outlook.
- I read some stories about Management being cautious about smartphone demand. I heard no such thing in the earnings call. This News organization has lost my trust, especially after that infamous China Spy Chip story that kick-started the sell-off in tech stocks. TSMC’s Management was cautious about crypto-mining, as they should be. Regarding smartphones, CEO C.C. Wei was, in fact, specifically optimistic about smartphone launches in 2019.
- The end result was that Management now expects revenue growth in the second half of the year to be around 6.5% as opposed to the previous guidance of 7-9%. Let me reiterate – Management expects TSMC’s revenue to keep growing.
- More importantly, Management reiterated its positive outlook for 2019 based on customer demand for its products. TSMC’s customers tend to sign contracts well in advance of production plans. So, I believe TSMC’s Management when they say that 2019 will see solid revenue growth.
- Mr. Market didn’t take. It behaved as though a cycle is coming to an end. And that’s really the sentiment these days – it’s been great for a few years but now the world will end.
- When it comes of the New Data Economy, there are no signs of any sort of slowdown. Some pricing cycles may ebb and flow in the short term; the keywords there are “may” and “short term”. The long-term boom is intact.
- TSMC is now the undisputed leader in semiconductor fabrication, with almost no competition in the 7 nanometer and smaller nodes, which will play a key role in the AI-5G-Cloud-AR-VR revolution. Management expects the 7nm node – also known as leading edge – to account for more than 20% of 2019 revenues.
- It has one of the most enviable client lists: Apple, AMD, Qualcomm, Nvidia, Xilinx, and even its rival Intel. None of that has changed. None of those companies will stop participating in the Grand Inflection Point. In fact, they will facilitate it, and gain massively from it.
- TSMC is one of the very few companies in the world that has a giant market share in what it does, with a wide moat, and solid profitability. And it happens to be in an industry that is about to take off.
- The stock sell-off – on earnings day and since then – is inexplicable.
Volvo AB Q3 2018 Earnings: Solid Results
- Volvo reported solid revenue and earnings growth. Thesis unchanged.
- Q3 Revenue was up 21% (including currency tailwinds) and 13% (excluding currency tailwinds).
- Adjusted Operating Income increased 48% to 10.2 billion Kroners. Most of this increase was due to margin improvements in both the Trucks and the Construction Equipment segments.
- The Buses segment was a bit a drag, but that was expected while the company refreshes its product line.
- The Penta Boat engines business keeps growing. I guess rich people keep getting richer.
- On the emissions issue, which I made a note of (last week), Management says that the costs should be limited. It was a materials degradation issue that was discovered by Volvo, as opposed to the EPA. And so, logically, fines will be limited, if at all. A Volkswagen debacle, this is not.
- Mr. Market didn’t like the results. I was befuddled. But then upon parsing Management’s comments, they said that the pace of growth in China could slow down. Here we go again – the second derivative argument.
- My take on the China infrastructure play is this: It will probably grow regardless of macroeconomic pressures. China’s modus operandi when the economy slows down is massive Keynesian expansion via government funding for infrastructure projects. Volvo should gain from that. And if the Chinese economy keeps growing, then infrastructure spending levels should remain healthy anyway.
- Volvo saw very growth in India, which is some validation for out Indian Urbanization theory.
Caterpillar Q3 2018 Earnings: Record Results
- Solid Revenue and Earnings growth. Thesis unchanged.
- Mr. Market’s reaction to Caterpillar’s Q3 earnings yesterday was perplexingly, to put it mildly. To put it in more appropriate terms, it was bonkers.
- Q3 revenues were up 18% from this time last year, with all segments clocking in growth.
- Operating Profit was up 41%.
- Adjusted Profit per share was up 47%.
- Q3 was a record in terms of profit.
- Management raised its full year 2018 guidance for Earnings per share.
- But they maintained their guidance for Adjusted Profit per share. Analysts didn’t like that. But this is just a math question. And management was clear that CAT will most likely end up at the higher end of the $11 to $12 EPS guidance range exiting 2018. What’s the problem?
- The other thing that spooked markets was the issue of higher steel costs due to tariffs. In fact, most media outlets, witnessing the irrational fear-fueled reaction to Caterpillar’s stock price, cited tariffs as the reason. This one is laughable. They failed to report that Management was very clear in saying that those cost increases will be passed on to customers via a 1-4% price increase. Management expects no blowback from this price increase whatsoever, given Caterpillar’s market-leading position.
- Management saw no signs of a slowdown in Chinese demand. And even if there was, Management didn’t seem too concerned – China makes up about 5% of CAT’s revenues.
- As I mentioned in the Volvo earnings update, in the event of a serious China slowdown I expect the Chinese government to prop up the economy through a classic Keynesian spending plan – building airports, bridges etc. That should help CAT.
- Overall, I couldn’t have asked for better results or a better outlook from Caterpillar. I must admit that the India growth story hasn’t really found its way into Caterpillar’s cash flows in a meaningfully. But I expect that will happen soon.
Micron buys out Intel's interest in a Memory joint-venture.
Micron says this deal is a continuation of its strategy to push further towards "specialized memory solutions". 3DX-Point, the product in question here, is a product designed by jointly by Micron and Intel to cater to the Big-Data economy. It's supposed to provide a combo package with advantages of both DRAM and Flash - the two major Memory constructs. I've discussed this in more detail in the AI Hardware article.
This part of a fairly long breakup with Intel on Memory projects comes at an interesting time - Intel, it seems, is realizing that it has made the mistake of being everything to everybody. Memory, I would think, would be an area where they'd decide to cede ground - it's not their base business and it never has been.
IBM Q3 2018 Earnings: Mr. Market hates this company.
- IBM’s Q3 earnings report was mixed – it missed Wall Street’s revenue estimates but beat earnings estimates. The Buylyst thesis is unchanged.
- Mr. Market punished the stock for missing revenue expectation by 2%. Remember, we’re just talking about 1 quarter.
- Mr. Market’s psychology can be summarized as: If IBM’s revenue doesn’t keep growing every quarter, it means that revenue will keep shrinking. Never mind that it generates $12 billion of Free Cash Flow – today.
- Last quarter it was Mr. Market complaining about gross margins, when IBM beat Street estimates both on Revenue and Earnings. This quarter IBM missed on revenue but beat on earnings. And gross margins improved. But now the complaint is about revenue.
- To be fair, I understand the market’s impatience with this turnaround story. Trust me, IBM is beginning to test my patience too. But if it’s grown for the past 2 quarters, and it missed revenue expectations by 2% in a given quarter, a 7-8% correction in the firm’s value looks and smells like fear-driven pseudo-analysis.
- As mentioned in The Buylyst IBM thesis, the business can be broken down into two broad buckets: their legacy business, and something called “Strategic Imperatives”.
- Strategic Imperatives is the “new IBM” – this is IBM’s pivot towards commercializing Watson AI via Cloud Computing. This is the bucket that I think will keep growing despite tough competition. I don’t believe Amazon and Google will be a duopoly in AI.
- Here’s the problem: Mr. Market fears that growth Strategic Imperatives will not be enough to compensate for the inevitable decline in IBM’s legacy business. Mr. Market is concerned that Revenue declines will be hard to turn around.
- This quarter, one of the main concerns (I imagine – I don’t know Mr. Market personally) was the decline in Cognitive Solutions revenue. This is a confusing name for a bucket of revenue that includes some Watson AI solutions but also some legacy Transaction Processing solutions. Mr. Market was spooked by this decline. Management stated that this is affected by lead times in signing deals and recognizing revenue, which should materialize into revenue in Q4. Mr. Market doesn’t buy it.
- I look at this quarter as a sign of stabilization – I believe the growth in Strategic imperatives will offset the decline in IBM’s legacy business over the long term.
- Mr. Market is obsessed with Revenue. I’m not. I’m obsessed with Cash Flows. IBM’s Management reiterated that they expect to exit 2018 with $12 billion in Free Cash Flow.
- Based on my definition of Free Cash Flow, which also deducts cash paid for interest and taxes, a $10 billion number looks like a comfortable estimate. And I think that level is sustainable.
IBM launches a Multi-Cloud, Multi-AI dashboard.
These products - IBM Multicloud and IBM AI OpenScale - make sense to me, and it should find takers. Consider these facts: 1) Only about 20% of Enterprise workloads have made it to "the cloud". 2) Most firms want to have a multi-cloud approach. IBM haters will see this product move as an acknowledgment of defeat to the big 2 Cloud Infrastructure providers - Amazon and Microsoft. Other will see this as a smart way to increase IBM's own Enterprise-focused Cloud business - the tool will run from IBM Cloud, and will be optimized for Watson, but will play nice with Google Tensorflow and AI on AWS or Azure.
Taiwan's President has strong words for China and the US.
I read the full text of the speech given by Taiwan's President. Most of it is directly about the US-China trade tensions. It affects Taiwan's economy in a big way. Specifically, for the The Buylyst, the trade direclty/war/argument is the biggest risk in the thesis. Rational heads should prevail - otherwise things could escalate out of control of both US and China.
Investment in Infrastructure is booming.
This Wall Street Journal article highlights a lot of the points made in the The Buylyst Caterpillar (and Eaton) thesis. In the developed markets - especially the US - things are reaching a breaking point. In the developing world, things were already bad, so governments are spending big bucks to make cities livable. Private Equity firms are seeing this an a big opportunity.
Volvo trucks have emission problems. Markets spooked.
I woke up to this news today, and it took the wind out of what was otherwise a good returns day. Volvo's ADR that's traded in the US was down nearly 4% for the day. Volvo's trucks apparently emit too much Nitrogen Oxide, which is regulated in the US and Europe. The company says this "could have a material impact" on costs. But no number was given. I'll wait and watch.
Sensate Price Target changed from $46.9 to $53.1. Based on the following:
- Sustainable Level Revenue increased to mid-point of Management’s 2018 guidance.
- EBITDA margin increased from 25.2% (actual number over last 12 months) to an expected level of 26%.
- Capital Expenditure assumption increased slightly.
- Working Capital needs expect to revert back to “normal” levels of roughly $90 million a year.
- Cash Paid for Interest assumed to increase slightly due to Term Loan, which is a floating-rate debt tranche.
- Free Cash Flow ends up at roughly $450 million, which is about $50 million higher than the previous estimate.
Microsoft invests in Grab - Singapore's Uber.
This story highlights Microsoft's approach to AI. With their investment in Grab comes an infusion in AI into ride-hailing and transport. "Infusion" is the key word here.. Microsoft seems to like introducing AI drip-by-drip, as opposed to big, flashy demonstrations by Google and Amazon, which are mainly meant to make you buy more things. I mentioned in The Buylyst Microsoft thesis that I'm unclear about Microsoft AI - I can't put a finger on it. Maybe that's the identity they're going for - clandestine AI that makes stuff work!
Apple's A13 chip to be manufactured by TSMC.
I think this story comes from a reliable source. TSMC has forged ahead with the 7 nanometer node while rivals Intel and GlobalFloundries deal with their own issues. In other words, TSMC seems to be dominating. However, US-China trade tensions remains the biggest risk.
Xilinx and AMD set a world record.
In the midst of the tech bloodbath this month, good news gets lost. Xilinx and AMD set a world record for AI Inferernce. This has to do with speed and accuracy of image recognition. As you can imagine, the applications are innumerable. Xilinx had a great October. Alas, the market is too panicky.
A big non-bank banking mess in India.
IL&FS - a non-bank lender for giant infrastructure projects in India - imploded last week. It sent out strong negative vibes across the Indian market. Some people likened it to Lehman 2008. For The Buylyst, this affects our thesis on HDFC in a positive way. A central part of our thesis was HDFC's discipline in NOT lending to these big, mismanaged infrastructure projects. HDFC's biggest rivals - ICICI and Axis - had IL&FS-like problems, albeit at a more manageable scale. Non-performing assets keep racking up in the Indian banking sector.
Apple gives out $1 billion of content for free.
OK. Now the scenario – this is how I imagine Apple will fight in the Entertainment arena. Both investments mentioned above are critical to this scenario:
- Apple will get rid of the Apple TV “puck” and replace it with an actual TV, with a TV Operating system.
- The TV will be premium quality, of course.
- It’ll come with a Homepod-like speaker system that acts as both the sound system and the “voice-controlled” remote.
- The new TV Operating System will give users special access to Apple’s original content, for free. So, Apple shows can be accessed only on Apple TV – not on Roku and certainly not on Chromecast.
- The TV will be controlled by an app on your iPhone, if you don’t want to use your voice. Or if you don’t have an iPhone, you gotta pony up for a cool, slick, expensive remote.
- Obviously, the operating system allows paid access to Netflix, Amazon, Hulu – the whole bunch.
- And obviously, you can still rent movies on iTunes, play your Apple Music, maybe even play Spotify.
- The end-game of this “home entertainment system” will be to create an AR/VR entertainment system. 3-D dinosaurs chasing me – that’s where this is going in 3-5 years.
Micron CEO says the Memory Industry is "structurally different".
Micron recently had its "Insights" event where their CEO talked about the industry. I feel the market is applying historical models for valuation and risk calibration that contain data from the PC-era. It's now decidedly a post-PC world with Cloud Computing, AI, VR/AR and Autonomous Cars, all of which need much memory - this is big part of The Buylyst Micron thesis. Micron's CEO keeps repeating this point, but the market doesn't take.
Who was lying? Bloomberg or Apple/Amazon/Supermicro?
This is the best analysis of the major China Spy Chip story I've seen - and I scoured through almost all available stories on the web, attached to this so-called revelation. The gist of the story is: Chances are that Bloomberg got a few things wrong.
GE gets a new CEO. Suddenly.
GE's Board showed John Flannery the door. And they brought in Larry Culp (a Board member) in charge of what may be the biggest restructuring in the country. Apparently, restructuring is Culp's jam. But I agree with many commentators in saying that I don't think Flannery was given enough time. Flannery has certainly been saying the right things, as stated in The Buylyst thesis. I think he's been doing the right things too. GE's problem is that it has a bunch of declining businesses and a bunch of top-notch business. It takes a while to dispose off the bad ones. Maybe the Board believes that Culp can do it much faster.
Musk can't stop tweeting stupid ****.
Elon's at it again. He now calls the SEC the "Shortseller Enrichment Commission". I (reluctantly) share his disdain for short-sellers. But he was wrong about tweeting "Funding Secured..." a few weeks ago. And he's wrong again. He should stick to what he does best - building things that will change our civilization.
China implanted an espionage microchip, says Bloomberg. American and Chinese companies vehemently refute the story.
This story is right out of a Hollywood movie. Bloomberg claims that Chinese assembly companies implanted a microchip in servers made by an American company called Supermicro to spy on American companies that use those servers in their datacenters. Some of those end-users are big guns like Apple and Amazon. They vehemently refute Bloomberg's claims, item by item. That's rare for companies to do. In my humble opinion, the Bloomberg story stinks of political smoke-screens here at home. I'm having a hard time believing that the Chinese government would actually expect to get away with this in the long-term. But then again, very smart people do very stupid things more than often than we'd think.
Xilinx releases the world's first Adaptive Compute Acceleration Platform (ACAP).
Xilinx is all-in on the AI revolution, and they want to among the handful of players that power this phenomenon. Xilinx released the world's first Adaptive Compute Acceleration Platform (ACAP), which has been in development for 4-5 years. Their investment and patience has finally materialized. They've given it a name - Versal. Now the question is whether the Versal will pay off. In my view, it should, as I made clear in my Xilinx Thesis. The ACAP concept (now named Versal), which is very much in their wheelhouse (FPGAs), was a big part of the buy rationale. Incidentally, the Versal is manufactured at TSMC, another Buylyst holding. My favorite part of this story is CEO Victor Peng's quote: "With the explosion of AI and big data and the decline of Moore's Law, the industry has reached a critical inflection point. Silicon design cycles can no longer keep up with the pace of innovation...". It's almost as if he took the words right out of this Buylyst worldview: The Grand Inflection Point.
Microsoft "re-Ignites" its focus on Enterprises.
Based on this summary of Microsoft's recent "Ingnite" event, Microsoft continues to carve out its kingdom - the Enterprise software space. Here are a couple of things they launched:
- Giant Surface screens for meeting rooms and presentations to be distributed in Q2 2019.
- Azure Digital Twins allows enterprises to model their real-world IoT deployments in the cloud.
Gone are the days when Apple and Microsoft were true competitors. Now, they're playing mostly different sports. This decisiveness from Microsoft is nice to see. The Buylyst Microsoft thesis very much depended on this clarity.
Tesla's Utility-Scale Battery works wonders.
There's a lot of bad news about Tesla and Elon Musk - most of it rightly so. But here's something Tesla has done that no other company has even come close to doing - building and deploying a utility-scale Electricity Storage system that has surprised even its buyers in South Australia. This is a game-changer for the Renewable Energy industry. If someone (probably Tesla) can take the baton from here, the boom in Wind and Solar energy could be round the corner. This paragraph captures it all:
"They said it couldn’t be done. Batteries can’t be that big. They can’t be built that quick. They won’t work. Ten months on from its installation, the Tesla big battery has emphatically proven its worth – faster, quicker, more accurate, more reliable and more flexible than even the market operator thought possible."
Why US public transport is so bad.
A great article in Vox about this issue that had me vexed for a long time. It comes down to the distinctly American idea of "rugged individualism". The Automobile represents that idea probably more than anything else. And half the country looks at "mass transit" as a Communist idea. I raised this issue in my article on Urbanization - American cities are designed for cars, and that poses new challenges. That type of design somehow conflicts with efficient mass transit. But New York, you have no excuse.
Vestas makes world's first 10 megawatt Wind Turbine.
This is big - literally and figuratively. To put this 10 MW number in context, many of the new natural-gas-fueled power plants being constructed in the US are have a capacity of 500-700 MW. So, with a 10 MW capacity turbine, you'd need 50-70 of those to match up. That's a lot of real estate, either on land or on sea. But it doesn't sound crazy to me. Of course, sometimes the wind doesn't blow, which means you may need even more turbines to match up to the average nat-gas power plant if you factor in "downtime". 10MW is progress, but Wind Energy still needs better battery technology to be an indisputable winner. We're getting there.
The FCC limits fees telecom companies need to pay municipalities for 5G.
In my humble opinion, this is a good move - limit the tax on innovation and infrastructure investment. Most of this debate is about the small cells that 5G networks will depend upon for stronger signals. It's the telecom companies that will need to install these things. I discussed this is some detail in my 5G article. I guess the actual "tax" that the Verizons and AT&Ts should pay for using public infrastructure is debatable. I mean, they should pay something; they can't just go around willy-nilly putting up small cells all over town. But it should be kept at a minimum. Now if only the FCC comes to its senses and accepts that Net Neutrality is a public good.
Zinc and Flow: Electricity Storage technology research is alive and well.
Two new things scientists and engineers are working on: Zinc Air batteries and Flow Batteries. The latter is about storing Solar power and could be massive in countries like India. The progress continues. I had written about this Battery Technology a few months ago - the point is that eventually we'll need to move beyond the prevailing technology of today: Lithium Ion.
Ford's costs increase due to Steel Tariffs. Bigly.
Ford's CEO Jim Hackett says that the Trump Administration's tariffs on steel. Of course, Ford isn't alone on this. All Auto companies have complained about it. But Hackett's quote about $1 billion in lost earnings due to tariffs raised a few eyebrows, including mine. I still think the story is solid. Ford's making the right investments, and they have ample to cash to do both - make those investments and ride this trade war phase.
Autonomous Vehicle startups rake in $3.5 billion so far this year.
CB Insights has some nice data on the AV startup scene. But there's a chart in there about how much traditional Auto companies are also investing. These stodgy companies now make up roughly half of the funding pool for those cool, new startups.
Alibaba bets on Quantum Computing.
Alibaba thinks that Quantum Computing is a necessary component to their business, which is a combination of e-commerce and Cloud Computing (just like Amazon). I have yet to understand what Quantum Computing is. But I do hope that as Alibaba makes these specialized semiconductor chips, Xilinx (a Buylyst holding) gains from it. Xilinx supplies Alibaba with FPGAs and System-on-Chips (SOCs) to Alibaba's Cloud Computing division. But I wonder if they're involved in this. And I wonder if TSMC is going to "fab" them.
Walmart uses IBM's Blockchain technology to track lettuce.
Walmart has found a good use for Blockchain. I have yet to dig into Blockchain, but my first impression was "Is Blockchain a solution that's trying to find a problem?" In this case, it seems to have found a problem to solve. I suspect Blockchain will find more uses (beyond cryptocurrencies). Inefficiencies in Banking would be my guess. What I like about this story is the shout out to IBM (a Buylyst holding that's treated like an ugly duckling). Walmart's blockchain-based system was developed by IBM. Incidentally, UBS now thinks IBM is a good buy.
IKEA suggests having a meeting in an Autonomous Vehicle.
This is one of those ridiculous suggestions the could become a reality sooner than we expect. I remember the (nauseating) concept of a "working lunch" in corporate America. Now that can evolve into a "moving lunch" - slightly more nauseating, literally and figuratively.
More (better) data is needed to make Autonomous Vehicles really Autonomous.
Another cool article on The Verge about a classic AI problem - I say classic half-jokingly because AI is so new in our civilization. And because this is the central point I had made in "Artificial Intelligence is Real". The point is this: More data is needed but, more importantly, better quality data is needed, which can only be collected through real-world experience. And to process all that, we need a ton of processing power and memory.
Micron Q4 2018 Earnings
- Micron reported earnings yesterday. They
beatcrushed Wall Street Estimates. But the stock took a beating in the after-market hours for 2 main reasons:
- The CFO mentioned that the US-China trade war tariffs would affect gross margins.
- Datacenters are having some trouble finding enough CPUs to keep up with demand. That affects demand for Memory, in that Datacenters won’t buy Memory without CPUs. The CPU company in question is Intel. Micron thinks this problem will last 1 or 2 quarters.
- I watched the stock chart last night while the call was going on. The stock shot up more than 5% during the first half of the call, and then shot down 7% within a minute as soon the word “tariffs” was mentioned.
- I describe Mr. Market’s reaction as complete cognitive dissonance. Its valuation of Micron is that of sick company. But then when it doesn’t grow at the insane pace (>30%) every quarter, the company gets penalized even more. A company growing as fast as Micron should be valued much, much higher.
- Anyway, the Micron’s results were fantastic. Revenue grew 8% since last quarter and was up nearly 50% as compared to fiscal year 2017.
- Gross Margins were more than 60% this quarter. And almost 59% for the year. When the CFO mentioned that gross margins are expected to be slightly lower, in the 57%-60% range in Q1, Mr. Market went crazy with a sell-off!
- Oh, and Micron generated $9.2 billion of Free Cash Flow in the fiscal year. Jeff Bezos would love that. His company is nowhere close.
- Mr. Market doesn’t seem to buy the argument that Datacenters, AI applications, 5G, VR/AR, Autonomous Cars are growth avenues for Micron, which is unlike the 2014-2016 era of commoditized memory.
- About the fears of a DRAM and NAND oversupply, the concern is now more muted since Samsung and SK Hynix (Micron’s rivals) have decided not to expand capacity.
- One more thing: The average price target of Wall Street analysts is more $75.
- Having said all this, this stock is clearly not for the faint of heart.
- This story requires a 1-2-year investment horizon.
Ford first to launch Plug-in-Hybrids in a product category it leads: Commercial Vans
Ford's product in this category - Commercial Vans - is called the Transit. It's a market leader in this category, along with Daimler Benz. If you notice on the street in the developed world, most commercial vans are either Fords or Benzs. I think it's a good category to electrify - businesses usually take a longer view and would be happy to save fuel costs in the long run, not to mention the volatility associated with oil prices. The other (sometimes overlooked) factor is the ubiquity of Vans in cities, as the dual-force of Urbanization of E-Commerce grows in tandem. Ford launches 3 types of hybrids in Germany:
- EV Auto – default setting determines how to use the energy sources
- EV Now – uses only electric power until the battery is depleted
- EV Later – system aims to maintain current level of battery charge
This is a good move, and it's in line with the new direction Ford has taken: focus on its strengths (Mustang, Vans, Trucks, SUVs), and go full steam ahead in Electrification and Autonomy.
AI could lead to the next financial crisis.
Harvard Business Review published an article on "quant delusion", which led to the financial crisis. Quant Delusion refers to the reality that quants or statisticians or data scientists tend to respect algorithms and quantity of data a little too much. Instead, Professor Blythe argues, the focus should be more on QUALITY of data. This is exactly the point I made in Artificial Intelligence is Real.
Progress in Autonomous Vehicles in Delivery and Short-Haul transport.
The Verge has a nice piece on the progress in the AV space. They see good progress in things like driverless shuttle services and driverless delivery. Both use-cases have 2 things in common: short distances, and pre-determined routes within a "geofenced" area. In other words, their routes can be easily managed. Incidentally, Ford is already delivering food in Miami!
IBM being sued for discrimination.
The law suit is about IBM firing thousands of people based on age. IBM may want to be a younger company, but if they did this just to be "one of the cool kids of the valley", then they were stupid.
Apple enters the Healthcare space. Sort of...
Apple released a watch which can monitor your heart - for irregular beats etc. Apparently, this has been blessed by the FDA. This is a legit step towards "biofeedback" - a term that's been thrown around for the last few years without much to back it up. This may change things. Otherwise, I thought the iPhone launches were "meh" except that the cheaper iPhone could have been relaeased with an eye towards India. I wanted more announcements on their TV OS and progress in Autonomous Vehicle technology. But I guess those are more Developer Conference type of announcements.
Volvo is serious about Self-Driving trucks.
Volvo showed off a prototype for cool, sleek self-driving truck, but with no cab yet. To me, the Autnomous Vehicle movement in the commercial space is pretty close to being an inevitability. Here's a line from the article that captures it more elegantly:
"Trucking is viewed by transport experts as a natural application for self-driving technology because of the relative predictability of highways compared with busy city streets."
David Tepper is "very, very long" Micron.
Some validation is nice when you're decidedly against the crowd, especially when the validation comes form an investing giant. His basic thesis that the demand side (Cloud, AI, Autonmous Cars, Virtual Reality) will outweigh pricing concerns is the essence of my thesis as well. The swings in Micron are just insane. If there was one live case-study you'd want to use to prove to the Fama-French "Efficient Market" crowd that they are nuts, Micron is it.
should must move to Renewable Energy in Power and in Mobility.
That's the message from this informative interview at the Bloomberg New Energy Finance forum in New Delhi. It makes sense - historically India's economic growth numbers have been inversely related to changes in Oil Prices. The sooner India reduces its dependence on Oil, the better it is for its economy, and for its environment.
Apple's post-iphone plans
CB Insights' "teardown" mirrors a lot of the things we talked about in Apple's new stomping grounds. So - Augmented Reality, Autnomous Car software, and Entertainment - are in the mix. But CB Insights is not as bullish on Entertainment as I am. Also, they don't talk about iPhones in India - an under-the-radar growth opportunity. But overall, great minds think alike. ;-)
If I factor in some growth assumptions into Xylem’s numbers, one can argue that I may be reaching. I would buy that argument if there wasn’t a legitimate case to assume any growth. Here are the facts:
- It deals with a problem that’s life-threatening: Water.
- Xylem’s end-markets are growing. About a third of humanity is facing severe Water issues.
- Xylem has been capturing its fair share of those end-market growth stories.
- Management has demonstrated that it can cut costs and release cash flow from better inventory management.
Now here’s where we jump into Opinion territory:
- I expect revenue from India and China to continue growing – thanks to the potent combination of urbanization and industrialization.
- I expect Management can continue to deliver on cost improvements.
- I expect Management can continue to decrease the company’s working capital needs.
The opinions above translate to these assumptions:
- Revenue grows another 20% over the next 2-3 years – mostly due to the growth in India and China – before it plateaus.
- Management expects revenue growth of 6-7% (organic) over the next 12 months. And it expects that trend to continue over the next 2-3 years.
- EBITDA margins improve to 19%, lower than Management guidance of 19.5-20%.
- Management finds another $150 million of working capital improvements, based on their “localization” strategy and better inventory management.
- a.This is roughly in line with the trend over the last 2 years.
All that culminated to a price target of about $102. The Margin of Safety is not phenomenal but considering the stability and expected sustainability of Xylem’s cash flows, it’s plenty.
Revenue jump from 2016 to 2017 due to the Sensus acquisition.
Micron share price plunges.
- Micron shares fell almost 10% yesterday. In my view, this is a massive overreaction.
- The sell-off was triggered by a couple of things:
- Murmurs about George Soros switching from Micron to AMD.
- An analyst revised Micron’s price target from $100 (coincidentally the same as mine) to $75. That’s still amounts to a massive upside from Micron’s closing price yesterday of $44.65.
- The analyst apparently revised his price target because he expects DRAM pricing to soften in the next few quarters.
- That may be true. But Micron’s CFO said yesterday that Average Selling Price over the last few months has actually increased.
- In any case, Revenue always has 2 components: Price and Volume. Even if prices go down, almost nobody believes that volume will decrease.
- The Buylyst thesis rests on these assumptions:
- Volume increases will more than offset DRAM and NAND price declines.
- Micron will successfully migrate towards more specialized “Memory Solutions” for Datacenters, Autonomous Cars, and new Edge devices like AR/VR wearables.
- The Buylyst valuation has no growth assumptions baked into it.
- The biggest risk in the Micron story is political – The China Trade War issue.
- But China is still a couple of years away from building their own Memory powerhouses.
- In other news: Micron is investing massively in new production facilities. They’ve got the cash to do it. And I think this will widen their Moat. It’ll be hard for the Chinese to catch up with them.
Ford Downgraded by Moody’s
Yesterday, Moody’s downgraded Ford’s credit rating to just above “junk bond status”. Mr. Market is concerned. “Junk Status” really means that Ford’s borrowing costs – the coupon they must pay for issuing more debt from this point on – will increase. So, Free Cash Flow, which is the most important variable at The Buylyst, decreases. Does this change The Buylyst’s valuation of Ford? Probably, but I suspect not by much.
Moody’s main contention is that Ford’s bold transition, as laid out by CEO Hackett, will cost more money. And at the same time, there is the Trade War issue while they’re already facing decreasing volumes in China and Latin America. All legitimate concerns, but I have some issues.
Having been a “junk bond analyst” for a while, I know how the Rating Agency system works. They’re in the business of pricing risk. They are not in the business of taking bets on the fortunes of a company. Their incentives are that they’d rather err on the side of caution – if they’re wrong because they said a company is risky and it didn’t turn out to be, it’s no big deal. The opposite is a problem – if they don’t downgrade and the company ends up having cash flow issues, their reputation takes a bigger hit. Although, they did escape an existential threat after their utter failure during the 2008-09 crisis in not downgrading toxic assets that put the global economy in peril.
So, I’d take the stuff coming out of Rating Agencies like Moody’s with a pinch of salt. Having said that, the short-term risks that Moody’s pointed out are legit:
- While Ford repositions itself in the market, it may lose sales in its existing product line up.
- Could they be a “day late and a dollar short” in their move towards Electro-Mobility? It’s possible.
The Ford strategy is a bold one. In fact, just days after I published The Buylyst’s thesis, CEO Hackett announced that Ford would be getting of most Sedans in their line-up, and focus on their strengths – pickup trucks, vans and the iconic Mustang – while accelerating the move towards Electro-Mobility. It almost seemed like his words came right out of my Thesis. I was happy to hear it and, more importantly, the market reacted positively. So, here’s what Ford’s doing:
- Focus on their strengths. Get rid of the weaknesses. This costs money in the short run but the long run payoff can be massive.
- Focus on Autonomous Vehicles and Electrification – this is the future. I’m glad they’re going all in. In fact, it gels very well with their focus on Commercial Vehicles. Autonomy makes much more sense for a delivery Van, for example, rather than a family car.
- Focus on India with their joint venture with Mahindra.
- In Ford’s valuation, I’ve already assumed higher Capital Expenditure costs, compared to what they’ve been spending in the last couple of years.
- I’ll probably increase my assumption for Ford’s “Debt Service Charges”.
- I really doubt my re-evaluation of Ford will change the Free Cash Flow number significantly from the $3 billion-ish level that I currently assume.
I have been meaning to update The Buylyst valuation of Ford. Because the impact won’t be drastic, it hasn’t been top priority. But I’ll get to it in the next couple of weeks.
California is on the verge of passing a rule requiring 100% of its electricity to come from carbon-free sources. This echoes a lot of The Buylyst views on Electricity, and Energy in general. That sometimes the wind doesn't blow or the sun doesn't shine, is still a problem. There is only now solution: Advances in Battery Technology. That could mean moving beyond Lithium-Ion technology. We're not there yet. But exciting things are happening - check this out.
Of all the Fortune Magazine lists, this one is the most interesting to me. A couple of solid investment ideas here. The correlation between doing good and doing well is pretty high. And if their valuation is reasonable - Bingo.
This is cool - and encouraging - as far as the Ford thesis is concerned. Apparently they have the highest number of patents for Autonomous Vehicles.
The only changes from the numbers Eaton achieved over the last 12 months are:
- Decrease in Working Capital Needs: I expect working capital needs will decrease from the level seen over the last 12 months, down to its long-term average.
- Decrease in cash taxes: I expect cash taxes to decrease as a result of the recent Tax Act in the US.
Just as I publish an investment thesis on Eaton, I see this: Google's using AI to consume less power in its data centers. I think this type of a movement - if this goes commercial - is a net-positive for a company like Eaton, which has seen good growth in its business from Data Centers. For electrical systems to be infused with AI, new products (like the sort Eaton makes) will be needed.
Truck demand is at an all-time high. Should bode well for Volvo AB.
"North American freight-haulers ordered more than 300,000 Class 8 trucks in the first seven months of this year and are on track to order a record 450,000 of the heavy-duty vehicles for the full year, according to ACT Research. That would be the largest book since 2004, when orders reached 390,000, according to analysts."
But there are bottlenecks: in the production supply chain (can't keep up with demand) and in finding enough truck drivers!
Vestas Q2 2018 Earnings: Notes
- Vestas reported second quarter 2018 earnings on August 15th – they were better than “street” expectations.
- Thesis remains unchanged because the fundamentals of the company remain intact. But my valuation has changed, albeit a small amount – my target price is now about $35 vs. my previous estimate of $38. So, there is still significant upside in my opinion.
- The basic thesis remains intact: Wind Energy becomes more economical, and that will accelerate with advances in battery technology. The increase in volume should be enough to offset a decrease in selling prices. Increases in volume may be a big assumption but I’m not alone. Most projections look like this, and that’s without factoring in any advances in Battery Technology.
- Vesta’s stock has taken a hit over the last few months. There has been a decrease in EBITDA and Free Cash Flow compared to last year. But the sell-off – a gradual and frustrating bleed of approximately 15% since I made the call early this year – is a big overreaction, in my opinion. Here’s why:
- Revenue has generally been around the same 10 billion Euros level in 2016, 2017, or over the last 12 months ending June 30th, 2018.
- The reason Revenue hasn’t grown is because Vestas’s average selling price per megawatt of Turbine-Generation capacity has decreased over the last couple of years. This is not a surprise – this is the Catch-22 of Wind Energy investments. That decrease has been generally been offset by an increase in volume, as expected.
- To be honest, I am surprised that volume hasn’t grown faster.
- EBITDA, over the last 12 months, has decreased (by 11%) compared to 2017. That’s because of some commodity cost increases and some inventory accounting methodologies, which increase Cost of Goods Sold disproportionately versus Revenue. This is a transient issue.
- Free Cash Flow has certainly taken a hit because of lower EBITDA margins but also because of a big increase in working capital.
- The increase in working capital was because of a massive inventory build-up during most of this year for a busier second-half in 2018.
- About the changes to Valuation: It is NOT a consequence of the recent sell-off in Vestas shares, or the decrease in free cash flow. I expect Free Cash Flow to climb back up to a sustainable level of around $1 billion Euros, without any growth assumption built in. The reasons for the changes in valuation are more macroeconomic in nature:
- Changed cost assumptions – higher operating costs reflected in a more conservative EBITDA margin assumption. Vestas’s costs may increase due to a rise in input costs such as steel and aluminum in a tariffed world.
- Assumed exchange rate at a conservative level of $1 per Euro. This compares to the current rate of $1.14 per Euro. Problems like Turkey and Trade Wars may keep popping up.
- On the issue of exchange rates: ADRs (American Depository Receipts) of foreign stocks have currency risk. I’m essentially “short the dollar” when I buy an ADR. If the EUR depreciates against the US Dollar, it’s a negative for me.
- There is, of course, an in-built hedge, because a lot of Vestas’s sales are in the US, which means that’s I’m “long the dollar” for that portion.
- But Vestas (or any other foreign company) may partially hedge currency risk to the best of their ability. That works against an ADR-holder like me.
- So, I should hedge currency risk on my end, separately. Since I’m inherently “short the dollar” in my ADR holding, I could buy the DXY Dollar Index to hedge some of that risk.
- Even if I do that, it’ll never be a “perfect hedge”, because currency risk within companies (my holdings) will change all the time. And I have companies like Ford (for example), which have a significant portion of revenues earned abroad.
- The point is that it’s hard to hedge out currency risk completely.
- However, I’ll be looking into a DXY-type of position over the next few weeks.
This article sheds some light on a large part of the Apple Thesis: iPhone sales in India. I agree that Apple has failed to come up with a cohesive marketing strategy there. But I still think price is the biggest barrier, not preferences. In any case, Apple will target the top 10% of the population (as measured by income). I think their marketing strategy should be based on these:
- Credit plans, in partnership with cellular service-providers.
- Market as an aspirational product - as a status symbol. But do it without looking ostentatious.
- Finally, related to #2, keep marketing the merits of an Apple ecosystem.
Xilinx Q1 2019 (Reported July 25th, 2018):
- Thesis unchanged.
- Xilinx beat Wall Street expectations both on revenue and earnings. The stock jumped significantly the day after the earnings report.
- Revenues were up 14% from this time a year ago.
- The Buylyst’s overall bet that Xilinx’s expertise in FPGAs (and now ACAP) will find takers in Cloud Datacenters and Autonomous Cars (which will essentially be mobile datacenters) seems to be playing out so far.
- 3 out of 4 revenue segments were up year-over-year. Communications was down 7%. It seems like the 5G bump hasn’t hit the numbers yet. But that’s likely to change over the next few quarters.
- The other drivers – Data Centers and Autonomous Vehicles – are materializing. Xilinx shipped 50 million ADAS (Automotive Driver Assist) units in Q1, for example. It touts some “key design wins from hyperscalers globally for accelerating applications beyond FPGA as a Service (FaaS)”. I guess those numbers will show up more in the coming quarters.
- Xilinx also reports revenue by “Core Products” and “Advanced Products”. Roughly speaking, as they moved down the nanometer-scale, their products became “advanced”. Most of their Xync system-on-chip (SOC) products are considered Advanced – overall, they make up more than 50% of the portfolio.
- Everest – Xilinx’s bold new “ACAP” product – is supposed to roll out later this year. But we didn’t get details about any ACAP deals. ACAP, by the way, stands for Adaptive Compute Acceleration Platform. Xilinx spent about 5 years developing this – based on their expertise on FPGAs – especially for a new world in which Artificial Intelligence will be ubiquitous.
- 2 other events instill more confidence in the Xilinx story:
- A deal with Daimler-Benz: “for developing a custom AI-inference platform”.
- Acquisition of DeePhi: “A Beijing-based company with industry-leading capabilities in machine learning, specializing in compression, pruning, and system-level optimizations for neural networks.”
- Another confidence-instilling move: Management raised its revenue guidance for the rest of the fiscal year (ending March 31, 2019), citing expected boosts in the Data Center and Automotive businesses.
- The new guidance reinforces the path toward The Buylyst estimate of Sustainable Free Cash Flow.
Microsoft Q4 2018 (Reported July 19th, 2018):
- Thesis unchanged.
- Microsoft beat Wall Street expectations on both Revenue and Earnings.
- Revenue in Q2 2018 was up 17% from this time last year.
- Drilling down further into the 3 main reported revenue segments:
- Productivity and Business Processes: up 13%
- Intelligent Cloud: up 23% (Azure up 89%)
- More Personal Computing: up 17%
- I was watching out for these numbers because I had made some aggressive (by Buylyst standards) assumptions in my Microsoft Thesis. They were:
- Productivity and Business Processes: up 20%
- Intelligent Cloud: up 100%
- More Personal Computing: up 20%
- My Intelligent Cloud projection stick out as aggressive. But I’m in this for the long haul – at least 2 years. Consider this: Intelligent Cloud revenue was up more than 20% from last quarter (not last year). How many quarter’s will it take for revenue to double?
- My assumption was based on the fact that most companies have not yet shifted a majority of their workload onto Cloud platforms. This will take some time, and there is still a lot of room for growth. Microsoft should be one of the prime beneficiaries of this shift.
- Of some concern: I mentioned in my Thesis that I can’t really pinpoint what makes Microsoft’s AI special. It seems to me that it’s AI is more of the “infused” variety. For example, if you use Word, you’ll notice some signs of “intelligence” creep into your workflow over time.
- Overall, The Buylyst thesis is playing out so far.
Apple Q3 2018 (reported July 31, 2018):
- Thesis unchanged.
- As you have no doubt heard by now, Apple beat street expectations on both revenue and earnings.
- Revenue was up 17%, and a lot of it was driven by higher priced iPhone X sales.
- But I was particularly happy to hear about growth in the Services and Other Products segments.
- Services revenue this quarter grew 28% compared to the same time last year.
- Other Products grew 37%.
- The reason I was happy to hear that was because the results roughly match up with my thesis. My Apple thesis is hinged on these:
- iPhone sales will see a boost from India over the next few years.
- Apple will make a big move into the Entertainment arena with some evolution of Apple TV, Homepod, iTunes and, possibly, an actual Apple TV. It’s foray into producing original content could simply be a sweetener to entice people to join the Apple ecosystem.
- The financial effect of Apple gaining in a big way in Home Entertainment will show up as increases in both its Services and its Other Products segments.
- In my valuation, I had assumed about a 30% increase in Services revenue (over revenue in the last 12 months) and a 50% increase in Other Products revenue. Based on the most recent numbers, my assumptions look reasonable. I should remind you that when I make projections for “Sustainable” numbers, I look at least 2-3 years out.
- The India thesis has yet to play out. No indications of material growth this quarter but they ain’t doing so bad. I still think they need a good credit/subsidy arrangement in India to boost sales. Credit in India is getting easier.
- About Services – Apple Music has about 50 million listeners. It looks like they’re #1 in the US now.
- Other Products grew predominantly because of the Apple Watch.
- There is something else the Tim Cook mentioned, which I thought I should have included in my writeup: He mentioned that Apple has 4 Operating Systems now:
- I think this list will expand. VR-OS maybe?
- I thought this was a simple way of listing their Core Competency – great software encased in the great hardware.
- And there are 2 other significant details that Tim Cook (CEO) mentioned, which I glossed over in my Thesis, so I’ll reiterate them here:
- Apple hired top-notch TV execs to oversee their content production. These guys are the geniuses behind Breaking Bad, The Crown etc. Apple is serious about this.
- Apple’s ARKit division is working hard at making the iPhone and the App Store ready for Augmented/Virtual Reality. Personally, I feel that if Apple nails Home Entertainment, AR/VR expertise from ARKit will truly blossom.
- I said this in the thesis, but I’ll say it again – For Home Entertainment, Apple has all the pieces. They just need to tie it all together much better to offer one awesome ecosystem that their competitors simply don’t have the capability to do.
Interdigital Q2 2018 (reported August 2, 2018):
- Thesis unchanged.
- Revenue was up 5% sequentially, but roughly flat year-over-year.
- Free Cash Flow was negligible this quarter, due to timing of cash flows related to some fixed-fee contracts.
- Most of the call was around the Technicolor acquisition – Interdigital acquired Technicolor’s video patenting rights business. Management claims that there are synergies between handset 5G licenses (which is Interdigital’s core business) and video-streaming licenses. But I’m not clear about what those specific licenses are. We’ll wait and see.
- I noticed that there were many mentions of Autonomous cars in this earnings call. That’s encouraging to hear given that 5G is pretty much a requirement for Autonomous Cars, which will essentially be mobile data-centers.
- Overall, I feel the combination of 5G, Electromobility, Smart Cities, and IoT are yet to fully show up in Interdigital’s numbers. But my valuation doesn’t assume any growth.
- Interdigital is presenting at a couple of Wall Street conferences this month. I’ll tune in.
Volvo AB Q2 2018 Earnings:
- Thesis unchanged. Volvo beat Wall Street expectations, both on revenue and earnings.
- Remember, my Volvo thesis was about capturing 3 avenues of growth: 1) E-commerce, 2) Urbanization and 3) Electrification. It seems all 3 “themes” are playing out nicely.
- The basics: Sales up 18% (Trucks up 14% and Construction Equipment up 32%, thanks to China)
- I found it particularly heartening to see that Electric Bus Sales have gone up. Volvo’s fully electric buses have secured orders in Norway and Sweden. But I think this trend will continue in other parts of the world. BYD, a Chinese company, and Daimler AG are the main competitors.
- Speaking of Volvo buses: I’ve spent some time in Barcelona, and I noticed that every “long bus” – the ones with a vestibule between two “carriages” – is a Volvo bus. I’m sure there are other first-world cities where Volvo has a big share of the Public-Bus market.
- One big city in which Volvo’s made giant strides is New York. The city plans to test Mack’s (owned by Volvo AB) Fully Electric Refuse trucks. This is big. I think this product has a bright future.
- Asia was a big contributor to growth in Construction Equipment sales. I expect the urbanization angle to continue to grow.
- The one negative this quarter was an increase in Working Capital due to inventory build-up. It appears that Truck dealers in North America (Volvo’s customers) expect big increases in demand for trucks from trucking companies and retailers (the dealers’ customers). There could be a disconnect. In any case, it’s a quarterly swing in cash flow. I’m not too worried.
ABB Q2 2018 Earnings:
- Thesis unchanged. ABB beat Wall Street expectations, both on revenue and earnings.
- My ABB Thesis was hinged on these themes: 1) The proliferation of Renewable Energy, which would require 2) A major Power Grid overhaul, and 3) The growth in the Internet of Things, especially in Robotics and Manufacturing.
- If I map those “themes” onto ABB’s Revenue segments – Power Grids, Industrial Automation, Robotics and Motion, and Electrification Products – it’s clear that all those themes are seeing growth. Orders grew by 8% overall. Total revenue grew by only 1%. But considering the Orders numbers and Orders Backlog numbers, revenue growth should pick up.
- 2 things bother me a little (but not enough to change my thesis): 1) The integration of GE’s Industrial Solutions business, which ABB acquired last year – the deal recently cleared all regulatory hurdles but the hard work lies ahead. Can ABB find enough revenue and cost synergies to justify the purchase price? 2) The sluggish pace of revenue growth – I wasn’t under any illusion that ABB will be a high-growth story. My motivation was to find a stable, well-run company that played in the right sports. ABB fits the bill, but I would have expected revenue growth to exceed a rough world-average level of GDP growth – 4-5%. But it’s only been a couple of quarters since I dug into ABB.
Ford Q2 2018 Earnings:
- Thesis unchanged. Valuation may need to be adjusted – but I don’t expect a drastic change.
- Ford reduced its Earnings guidance for 2018 because of poor Q2 sales in China and Europe, and increases in commodity costs.
- North America sales remains strong. But the fire at their Meridien plant affected sales.
- My Ford Thesis was primarily based on 3 pillars of strategy: 1) Play to their strengths and invest in what they’re good at (trucks, SUVs, Mustang etc.). 2) Divest underperforming businesses (like Sedans) and 3) Invest vigorously in Electrification. In fact, I initially started looking at Ford because of #3, after they made the announcement that they would move decisively towards electrification.
- In Q1 of this year, for which they reported results soon after I had published my thesis, this script played out almost perfectly. And even in this rough Q2, each of those pillars remain intact. Ford is committed to refocusing its product portfolio and investing heavily in electrification and autonomous vehicles. Hence, I won’t be changing my thesis.
- Since then 2 things happened:
- The Trade War: this drives a wedge through Ford’s plans in China and Europe. Indeed, sales in China were down significantly in Q2, but because of an ageing product mix. However, a toxic trade war won’t help the situation even with a new product line. Trade Wars would also drive up commodity costs.
- The fire at the Meridien Plant: Ford lost about 8 days of production this quarter. And most of the disruption was in F-150s – Ford’s best-selling product. The financial impact of this was $590 million loss in EBIT.
- My valuation may change because of the trade war issue; not because of the Meridien fire issue.
- Overall, revenue in Q2 2018 was down 2% year-over-year. But they’re up 2% on a year-to-day basis, compared to the first six months of 2017. Volume has been lower. But Ford’s average selling price has been improving, as it pivots towards trucks, SUVs and icons like Mustang. So, nothing to be alarmed about.
- Cash Flow, however, has taken a big hit in Q2. There’s a big swing in working capital, which could be temporary (I’ll have to dig in). But 2 points on cash flow:
- Ford announced that they need to spend about $11 billion in EBIT, which translates to about $7 billion in cash over the next 3-5 years on “restructuring” their portfolio. That’s about $2 billion a year.
- However, in my estimate of Sustainable Free Cash Flow, I had already assumed a significant increase in Growth Capital Expenditure tied to Electrification. I may need to bake in some more cash expenditure in those assumptions. If I do that, I’ll expect my valuation to change modestly.
IBM Q2 2018 Earnings Call:
- Thesis unchanged.
- Overall, IBM positively surprised “the street”, both on Revenue and Earnings. And so, the stock did very well yesterday. Why Earnings-per-share (EPS) is still considered important is beyond me. But I digress. In IBM’s case, EPS is quite close to Free Cash Flow, which is the most important variable.
- In my valuation of IBM, I have pegged Sustainable Free Cash Flow at roughly $10 billion. Management’s guidance for this year is roughly $12 billion. CFO Jim Kavanaugh expects the company to meet this target. That’s heartening to hear, and somewhat believable, considering that Free Cash Flow over the last 12 months is roughly $12.6 billion.
- On the positive side, their “Strategic Imperatives” (Cloud, AI, the works) bucket is growing at more than 10% year-over-year. And this is the first time that this high-growth, “new IBM” part of the business makes up more than 50% of IBM’s revenue. So, overall, the company is chugging along in the right direction.
- But my thesis that IBM has finally “found is raison d’etre” with AI-delivered-via-Cloud-for-Enterprises hasn’t yet found the sort of traction I want to see. Nevertheless, this is the first time in years the company has reported revenue growth for 3 consecutive quarters.
- Concerns around gross margins remain. In fact, most of the questions in the earnings call were about them. But I think “the street” is being to nitpicky. If gross margins fluctuate by a percent or two in a given quarter when they’re currently at 45-46%, I think they’re focusing too much on the trees instead of the forest.
- Concerns around an impending slowdown in hardware (servers for datacenters) remain. This seemed to be the second-most popular question. I share this concern. But I also wonder whether they’re applying the old paradigm – a pre-AI-via-Cloud world – that existed just 2-3 years ago. I’ve seen this inertia in Memory with Micron, and I get the same feeling here. But “the street” could be right.
- Even if they are, I expect IBM to be able to maintain a $10 billion Free Cash Flow level. If that pans out, the company is significantly undervalued today.
Exchange Rate used: INR/USD = 70.
Micron-UMC spat in China update: Statement from Micron
Micron has released a statement on the Fuzhou Court injunction on sales of certain Micron DRAM and NAND Flash products in China. It turns out, the products in question make up about 1% of Micron's revenue. As such, Micron keeps its fourth quarter and full-year revenue guidance intact. So, long story short - this particular drama wasn't expensive. However, I can't rule out the possibility that Micron (along with many other companies) could get caught up as pawns in the Trump-China trade war. I'll keep an eye out on how these political tantrums and juvenile fights pan out.
At the end of the day, Micron makes a product that the world (including many Chinese companies) wants. It makes a product for which demand far exceeds supply, which is dominated by Micron, Samsung and SK Hynix. All that materializes in the fact that Micron generates a ton of free cash flow, which I think is sustainable in a semi-rational world. Political tantrums could derail that worldview, but I suspect the tantrums will be relatively short-lived. Over the long-term, economics and common-sense usually trounce tantrums and politics.
For now, it's best to keep calm and carry on.
Micron-UMC spat in China:
- I’ll refrain from any knee-jerk reactions. Micron is still very much in The Buylyst Portfolio until the facts are clear.
- UMC (a Taiwanese company) claims to have won an injunction against sales of 26 of Micron’s products in China. China makes up about 50% of Micron’s revenues.
- Micron has yet to receive the formal injunction from the Chinese court. It is amazing that the news broke out at what would have been around midnight in China yesterday. And the news was delivered by UMC, not the court. I guess money – and espionage – never sleeps.
- Remember that Micron had sued UMC for stealing trade secrets. Then UMC countersued. And it seems like they convinced the Fuzhou Intermediate Court of the People’s Republic of China that it was Micron who infringed on patent rights.
- It’s logical to think that this is directly related to the on-going trade wars waged by the Trump Administration.
- The big risk is that this could be payback for ZTE. Although now I hear that the Trump administration has given temporary reprieve to ZTE. But then the Administration seeks to block China Mobile from the US. Could this be the “Art of the Deal”?
- Add to all this the fact that China wants in on the “Memory Party”, which is now dominated by 3 companies: Samsung, SK Hynix, and Micron. That’s 2 Koreans and 1 American company. The Chinese authorities are investigating potential “price fixing” among the 3 biggies because they are amazed that Memory prices have gone up consistently for so long. I would encourage them to read “The Grand Inflection Point”. It’s not the PC-era anymore guys.
- But this isn’t about rationality. This is about politics and winning elections, which has nothing to do with rationality. The best we can do is wait for the facts and not act on hearsay. I’ll keep posting updates on this.
Xilinx in Autonomous Cars:
I didn't find this data point earlier - apparently Xilinx has a 90% market share in LiDars (which are used to sense surrounding objects).
Micron Q3 2018 earnings – reported on June 20th after-market:
- Thesis unchanged.
- Revenue, Gross Margins, Operating Margins, and Free Cash Flow at record levels.
- I’m not going to go through a laundry list of numbers – you can read them here. But I will point out two things that surprised me: 1) Free Cash Flow and 2) The tussle with the Chinese.
- On Free Cash Flow: By my estimates, Micron generated about $2 billion in Free Cash Flow this quarter. That would mean an annualized Free Cash Flow of abut $8 billion. That compares to my estimate of Sustainable Free Cash Flow of about $5.8 billion. That’s a massive difference. But I’m sticking to my original estimate.
- On the tussle with the Chinese: This didn’t really feature in the earnings call. They are eager to get in on the Memory Party, which has been fueled by the AI-Big Data revolution. But Memory has moved from a commoditized product to more of a “solutions-based” product that involves much more capital and much more innovation than was the case in the PC-era just 3 years ago. The biggies – Micron, Samsung and SK Hynix – have ridden the wave like masterful surfer-dudes. The Chinese want in.
- This story in The New York Times came out today. It’s about Micron and the Chinese, and it’s got everything from corporate espionage to theft to government big-brother-ness. I’m sure there’s sex involved somewhere.
- It seems that a Chinese Memory company (that hasn’t started operations yet) lured a couple of Micron engineers from Taiwan. These engineers allegedly stole some Micron IP secrets. Micron sued (as did Samsung for another similar case). The Chinese courts, reluctantly, looked into it.
- The Chinese firms sued back. And, of course, they convinced Chinese authorities that there is some price-fixing in DRAM memory going on between Micron, SK Hynix and Samsung. That’s because DRAM prices, which have generally been victim to cycles of oversupply, has remained high and is still increasing. This points to an issue I brought up in my Micron Thesis.
- Many people are still stuck in the PC-era. They think Memory is still commoditized, two-dimensional, with relatively little IP. It’s just not the case anymore. We’re past the PC-era. It’s about Cloud, AI, Big Data now. And so, demand is far outpacing supply. This isn’t going to stop any time soon. And throw this into the mix: the 3 remaining players in Memory – Micron, Samsung and SK Hynix – are not playing the “revenue maximization” game anymore. They’re about profit-maximization, as they should be. The Chinese don’t want to hear any of it. They want a piece of the pie.
- This is a risk I need to keep monitoring. And it may be the only area of agreement between me and the current US administration – some unfair tactics by the Chinese in the form of state-controlled courts that favor state-controlled (or highly subsidized) firms that want to flood the market with cheap knock-offs. Of course, I don’t think starting a trade war is not the solution to this. Nor is it some sort of genius chess move. It’s politics.
Micron's Fiscal Year ends August of every year.
|Twelve Months Ended March 31, 2018|
|Segment Revenue||Growth Assumption||Sustainable Revenue|
|Productivity and Business Processes||$34,643||20%||$41,572|
|More Personal Computing||$40,285||20%||$48,342|
|Q1 2018||Annualized Q1||Sustainable Level||Notes|
|North America||30,725||122,900||147,480||Assumed a 20% increase from current Annualized Q1 run-rate|
|International||14,875||59,500||77,350||Assumed a 30% increase from current Annualized Q1 run-rate|
|AWS||5,442||21,768||87,072||Assumed a 4X increase from current Annualized Q1 run-rate|
Currency Translation: Assumed exchange rate of SEK/USD = 9 to 1 in converting financial statements.
Interdigital Q1 2018 Earnings:
- Thesis and Valuation unchanged.
- Interdigital Stock was down by 3.5% today, post-earnings, which is a perfect example of how Mr. Market is indeed the manic-depressive drunk that Warren Buffett’s guru Benjamin Graham had described.
- Revenue and EBITDA were both up year-on-year based on an apples-to-apples comparison. However, they were both down on an apples-to-oranges comparison. Cash flow from Operations was up regardless of which fruit combination you choose. Mr. Market, it seems, didn’t look beyond cosmetics.
- About apples and oranges: Accounting rules changed. Revenue Recognition rules changed from ASC 605 to ASC 606, which made Q1 2018 Revenue look lower.
- As I had written in the Interdigital Thesis (Historical Profitability section within Competitive Advantage) – for a company like Interdigital, whose revenues depend on license fees (from Apple, LG and the like), Revenue Recognition rules are important because revenues are amortized over time. In going from ASC 605 to ASC 606, the amortization rules changed. The underlying economics of the business have not. In fact, they improved. But it’s just a quarter, so I’m going to wait for the rest of the year for the economics to impress me.
Ford Q1 2018 Earnings:
- Thesis and Valuation unchanged.
- It seems that Ford beat “street” expectations both on Revenue and Earnings. That doesn’t really matter to me, because I don’t consider “street expectations” sacred. I like to joke that it’s never the company that beats or misses expectations; it’s the expectations that are wrong. What the company does are facts.
- Positives: Some more clarity on “fitness” initiatives. Most notable of those are:
- Identifying $11.5 billion in cost savings over the next 3 years. Even they achieve half of that, there is upside in Ford’s valuation.
- Shifting Capital Expenditures to high-profit vehicles like SUVs, trucks, and vans.
- And my favorite: 90% of North American vehicles in production will be SUVs, Trucks and Vans by 2020. So, that’s some clarity on the “refocusing” strategy I had mentioned in my Thesis.
- CEO Hackett specifically mentioned sedans as prime candidates for the guillotine. Let’s do it.
- Negatives: Commodity Costs still a problem. And anemic performance in International Markets and China.
- Apparently, the product line-up in China is old and in a trough. New products are being launched this year.
- I think the problem with International markets is that Ford can’t compete with the Japanese and the Koreans in the small-car market. That should be obvious from the data.
- They’re still pursuing with the Lincoln story in China. I don’t understand that. As I mentioned in my thesis, Lincoln SUVs sell well in the US, especially with the Washington Entourage crew. But it’s hard to see a mammoth like the (apparently hot-selling) Navigator weave around narrow streets that cover most of the rest of the world.
- Trucks, SUVs, Vans and the Mustang – that should be the new Ford. It seems we’re getting there.
Update: The Buylyst Portfolio is now Live. As mentioned earlier, Ford will be added after their earnings report.
- Portfolio weights: Entered into all position at equal weighting of 9.5%, for 2 reasons - 1) I don't obsess over fancy portfolio optimization or weighting models (I've done them enough in my professional life to know that they don't work as intended over the long run). I will usually go in with equal weightings depending on how many positions I have on The Buy List at any given point in time. 2) I expect to hold 10-12 positions once the portfolio is rounded out in the coming weeks. Hence the roughly 10% weighting for each position. Ford will be added at a similar weighting.
- Portfolio Table Data: The Entry Price and Entry Date you see now on The Buylyst Portfolio page correspond to what you see on The Buy List. This should not be the case. The Entry Date on the Portfolio will usually lag the Entry Date on The Buy List by 2 days. The Entry Date on The Buylyst Portfolio for the 4 positions added today should read 4/24/2018. The Entry Prices will come straight from my Brokerage Account report. All this will change soon. We're working on it.
IBM Earnings Q1 2018:
The Buylyst Thesis and Valuation are unchanged.
It seems that Mr. Market wasn’t happy with Q1 results, even though the company beat revenue and earnings expectations. I’d just like to make 4 points:
- I don’t put much stock in “street expectations”. These cause short-term blips, and penalizing or rewarding a stock based on “consensus” expectations for a single quarter is symptomatic of Mr. Market’s short-termism.
- Having said that, some of the concerns are legitimate. Operating Margins didn’t improve because of a “one-time” charge for “revitalization of our skills-base…to further align these skills to these high-value areas…”. Mr. Market, I guess, didn’t like it. They wanted all numbers – including operating margins – to point up. I don’t blame them. There is a lot of “IBM-fatigue” out there.
- The “Strategic Imperatives” bucket, touted by Management as “the new IBM” grew by 10% year-over-year. This unofficial bucket now makes up 47% of IBM’s revenue. The Buylyst thesis hinges on this “repositioning”, but based on my valuation, I didn’t pay for this potential growth. I believe I have an implicit call-option to participate in this growth – hopefully a cheap one.
- The main concerns in the market seem to be:
- The growth in “Strategic Imperatives” won’t compensate for the slow-bleed of IBM’s legacy businesses. This is a legitimate concern. I think the Management team is aware of it. The jury is still out.
- The “Hardware Cycle” – the secular ebbs and flows of mainframes/server sales – will start decelerating. Hardware makes up 10-12% of IBM Revenue. That will put pressure on revenue growth. Again, legitimate concern. But, longer term, the demand for this type of hardware that supports Cloud and AI is likely to keep increasing.
Sustainable Level Revenue Assumptions:
- Tesla will sell approximately 100,000 Model S & X cars, and about 500,000 of the lower priced models – Model 3, Y etc. That’s approximately $28 billion in revenues.
- Tesla will sell Powerwalls for approximately 500,000 homes, globally. At a rate of 2 Powerwalls per home – at $6,000 per Powerwall – that’s approximately, $6 billion in revenues.
- Tesla will sell about 2 GW of battery farms (the type it sold to South Australia late last year). In Australia, they sold about 100MW of Capacity. It seems Tesla got about $50 million for the project (I don’t have an exact number). But I think that’s too low. In my view, Tesla will be able to charge about $200/kW for these farms. At that rate, that’s an extra $4 billion in revenues.
- So, that’s a total of $40 billion of revenues – a huge cry from where they are now.
Revenue Breakdown by Business Segment (page 36 of 2017 Annual Report):
- Reoganization of Segments. Energy Connections abosrbed into Power.
- Historical numbers are of GE only, excluding GE Capital.
- Sustainable Number assumptions are of GE, excluding GE Capital, GE Transportation, GE Lighting.
- Cost assumptions are made assuming the new management team fulfills its promises of cutting costs, capital expenditdures, and working capital.
China is miles ahead in the Autonomous-and-Electric vehicle race.
For all the talk of a China slowdown, they are moving fast with tomorrow's technologies. The stats laid out in this article are mind boggling in terms of how far China is pulling ahead in the Autonomous and Electric Vehicle movement. For example, China has 5.3 changing stations per 100 kilometers compared to 0.3 in the US. The world's biggest car market is going full steam ahead towards a future with Autonomous and Electric vehicles. We should be invested accordingly.
EA stock takes a beating.
That’s because EA released Apex Legends 2 and people weren’t as enthusiastic as expected. Apex Legends – EA’s answer to Fortnite – was a big part of The Buylyst EA thesis. To me, it signaled EA’s intention to keep up with the times. The “disappointment” with Apex Legends 2 seems to be hinged on some Twitch reviews. But these are fickle. There complaints seem to be more about some server glitches as opposed to the game experience. The former is quickly fixable, and I suspect EA is on top of it. The Buylyst maintains a Buy Rating on EA, with much of the thesis hinging on the fact that EA is a one of a handful of dominant content-makers at a time when the “Netflixization” of Gaming seems imminent.
ABB to provide car charging stations for Europe’s Ionity.
This is big for ABB. Long ago, car-charging was a big part of our thesis. Ionity is the big 800-pound gorilla in Europe as far as chargin networks are concerned. It’s a joint venture between some of the biggest car companies in the world: Daimler-Benz, BMW, Ford etc.
Lyft stock shoots up on vaccine news. We’re taking profits and phasing out of our position over the next few weeks.
Our thesis on Lyft was our first real “Expectations Investing” thesis. We answered the question “what do we need to believe” in order to buy the stock. We had factored in some aggressive assumptions when we wrote the thesis. In fact, we had valued Lyft to be around $44 in October 2019. It was trading around the same point back then. However, when the markets started crashing in March 2020, we noticed an opportunity. We picked up Lyft stocks at prices ranging from $20 to $30. We hadn’t adjusted our valuation of Lyft during the pandemic because our valuations are long-term estimates. In March/April 2020, our view was that the pandemic would last a quarter. We were wrong. The stock languished for most of the year, until the last few weeks. Now on hopes of a vaccine coming soon, “recovery stocks” have a seen a bump. Lyft has shot up to almost $40. We will, therefore, be phasing out our position over the next few weeks.
Government initiatives and potential spending will be a massive tailwind for Renewable Energy Companies over the next 10 years.
Here are some projections:
The US is likely to rejoin the Paris Agreement under the Biden Administration.
Britain aims for 80% of electricity to be generated by renewables by 2030.
According to Bloomberg New Energy Finance, Wind and Solar PV to account for more than 50% of electricity generation in the world by 2050, reaching up to 80% in developed countries.
IEA says that based on current proposed policies, Offshore Wind will grow 15X in Europe over the next 2 decades.
Our Disney thesis is playing out as per script.
Disney DTC (Direct to Consumer) recently crossed 100 million subscribers. This is the fastest ramp up to 100 million in history - handily beating Netflix's record. Disney DTC is THE reason we bought into Disney in 2020.
The Wind Turbine price decline has stabilized.
We keep tracking this important metric - Average Selling Price per MW of capacity - because that was the big risk in our Vestas thesis. As per their latest presentation, ASPs have stabilized. This new price point of about 70 cents per MW looks sustainable. It also makes our lives easier - to model revenue growth. Revenue = Price X Volume. One of those variables is somewhat fixed now.
Remember WeWork? It's coming back to life.
Well, we're talking about the bonds. They were trading at distressed levels for most of 2020. But now they seem to be inching back towards par value. We wonder whether the company will get a second lease of life in a post-covid world - where the steep rise in the work-from-home population slowly moves out to a work-from-anywhere set up. Maybe that's what bondholders are thinking.
Intel’s $20 billion Fab investment helps our portfolio.
We’re invested heavily in semiconductors – TSMC, ASML, KLA, Micron, Nvidia, Lumentum and now, Qualcomm. This is our main AI & Big Data play. Not so long ago, we had held Intel for a while, until this happened. More recently, Intel got a new CEO and announced a massive $20 billion plan to build out more semiconductor fabs. Intel’s new CEO Gelsinger says that the company may finally be open to manufacturing chips for other companies. This is a big announcement. We were wondering what would happen to TSMC.
This may sound like a warning sign for TSMC, which fabs all sorts of semiconductors not named Intel or Samsung. One may think that a Xilinx or a Qualcomm may move to Intel. But Intel’s problem is that they’re competitors to other chip designers. TSMC doesn't have that problem - they're just manufacturers, not designers. Why would rivals AMD or Nvidia fab with Intel? If anything, Intel’s fab plans help our semiconductor equipment companies – KLAC and ASML. And, so far, the announcement helped their stock prices.