Saturday, July 14, 2018 3 comments ++[ CLICK TO COMMENT ]++

Sold: Monsanto (merger completed)

Have been busy, and probably not efficient with my free time, so haven't blogged much... Need to get into a rythm and dedicate more time to investing. I think I'm going to give myself to post once a week and maybe just do a roundup of things I did that week, articles I read,etc.

Anyway, the Monsanto buyout by Bayer successfully closed a month ago and I just got around to reviewing it. As with most mergers, it took a bit longer than initially forecast--this is why if you are into risk arbitrage, you should always factor in a longer closeout process which lowers your annualized return. As I remarked a while ago, m&a is getting riskier with potential USA trade war with China, and likely followed by escalating trade war with Europe, so deal breaks are likely to become more common. Already several Chinese and high technology deals ran into issues.

Overall return wasn't that spectacular but I was satisfied with it. Dividends added about 1.8% which is always a positive with delayed deals (not all deals pay dividends when deal agreed).

Price Sold: $128
Total Return: 11.5% (annualized (estimate): 11.8%)
Total Return (C$): 12.34% (annualized (estimate): 12.5%)

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Saturday, November 11, 2017 9 comments ++[ CLICK TO COMMENT ]++

A Look at Tripadvisor (TRIP) and its Two Problems

It's hard to find anything that seems cheap in the current bull market but as in any market, some stocks do sell off for various reasons. One of the ones that attracts me is Tripadvisor (TRIP*). As the chart below illustrates, the stock is trading near a 5-year low and is down about 70% from its 2014 peak (share count hasn't changed much and no major return of capital to shareholders).

(* You can also own TripAdvisor indirectly through John Malone's holding company, Liberty TripAdvisor, with ticker symbols LTRPA/LTRPB. You should evaluate this option as well. Sometimes holding companies, especially if it is well run like most Malone companies have historically been, are better; sometimes they are not (there may be additional overhead/fees for the holding company, may have worse shareholder rights (doesn't favour minority shareholders) and market generally places a holding company discount on such shares and they may be illiquid))

I remember looking briefly at TripAdvisor several years ago when it was spun out of Expedia (I was evaluating Expedia at that time--too bad I didn't buy that) and it seemed very expensive at its IPO. I think its P/E at IPO was 50+ and Price/Revenue was 10+. The market was definitely pricing TripAdvisor with expectation of very high growth rates.

Now that the stock has sold off quite a bit, is it cheap?

Well, the revenue has doubled since 2012 from $700M (roughly) to $1.5B now. But its profit has fallen from a peak $226M in 2014 to $120M last year and about $96M TTM. Profit may be temporarily depressed (depends on how you view their current problems).

TripAdvisor is attractive for a few reasons:
  • Massive moat: TripAdvisor has 390+ million unique monthly visitors. This is a massive number and very few internet companies in any industry can reach such numbers. As a customer of TripAdvisor and someone who uses the site quite often for travel, I think the switching costs are very high and I doubt too many other companies can replicate its content for travel planning.
  • Low capex, high ROE: When the company was doing well a few years ago, it had 20%+ ROE. Now it has dropped below 10% but it depends on if you think current profitability is temporary or not. The company has low capex requirement and product/service doesn't become obsolete easily.
  • Good (low to moderate) growth potential: The online travel industry is likely to become more popular over time. Although TripAdvisor may have captured most of the obvious customers, it will still grow, at a minimum I think it will grow at inflation + population growth.

Having said all that, there are two big problems with TripAdvisor...

Strong Moat, Low Profits?

First of all, I have been thinking hard about this company and researching it quite a bit and... is this one of those companies that has a strong moat but low ability to profit from it? Is it another Yelp (YELP)--a dominant restaurant/event/shop review site that has been unable to make much money. TripAdvisor has a lot of online visitors and has tried all sorts of things over the years but hasn't really made much money. As a user of TripAdvisor, I don't think they can easily increase profitability (other than go into adjacent verticals or something).

TripAdvisor vs Priceline/Expedia

Secondly, TripAdvisor appears to have little bargaining power and seems to depend heavily on two companies for almost half of its revenue. From the 2016 10K,
"We derive a substantial portion of our revenue from a relatively small number of advertising partners and rely significantly on our relationships. For example, for the year ended December 31, 2016, our two most significant advertising partners, Expedia and Priceline (and their subsidiaries), accounted for a combined 46% of total revenue."
This is actually listed under the risk factors at the front so it shouldn't be a surprise to most but it still makes me nervous. Basically, online travel agents, Expedia and Priceline, contribute almost half (46%) of their revenue.

To make matters worse, those two are sometimes direct competitors, especially in some recent direct booking services being pursued by TripAdvisor. They are probably best considered frenemies. Apparently TripAdvisor is rolling back those services (probably after Priceline and Expedia started a battle and decimated TripAdvisor).

Furthermore, if I'm not mistaken, TripAdvisor generates less than 5% of Priceline's revenue (probably the same for Expedia). This basically means that Priceline doesn't care if it loses the TripAdvisor revenue; in contrast, TripAdvisor cares very much about Priceline's payments to TripAdvisor.

If you ever studied corporate strategy or Porter's Five Forces or anything like that, you will see that TripAdvisor is in a bad competitive situation here. You just don't want to be in a situation where two entities, who are sometimes your competitors, are responsible for 46% of revenue, while they get less than 5% of their total revenue from you!

Worth Waiting and Seeing

Although the competitive/supplier/customer industry dynamic looks bad for TripAdvisor, it is still worth investigating because some of its advantages are pretty big. I really can't see too many companies (except possibly something like Facebook) being able to capture almost 400 million global travelers who use the site on a regular basis. Even companies like Amazon likely can't (Amazon doesn't have strong brand outside a few regions like North America/India/etc, or outside tech circles). I'm just not sure how well TripAdvisor can monetize its users.

TripAdvisor's heavy reliance on Expedia and Priceline is also largely due to the hotel segment. If TripAdvisor can generate revenue from other travel-related segments (attractions, airlines, train bookings, global/foreign events, etc), it can lessen its dependence. Remains to be seen what the company does.

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Sunday, October 1, 2017 0 comments ++[ CLICK TO COMMENT ]++

First Look: Chipotle Mexican Grill (CMG)

This isn't my type of company.

It isn't in my circle of competence...but I've been researching and studying the industry.

It doesn't have the valuation I like... but that depends on what one thinks is normal earnings.

What it is, is a contrarian, broken, growth stock with very good backward-looking numbers and uncertain future.


Chipotle Mexican Grill (CMG) is a restaurant chain that apparently pioneered and popularized "fast casual" dining--basically a cross between fast-food (e.g. McDonald's, KFC) and casual (eg. TGI Friday's, Chili's, Boston Pizza). The food is Mexican, prepared similar to fast-food restaurants and priced in between fast-food and casual (a burger at a fast-food place might be $4 whereas a burrito at Chipotle will be something like $6).

I don't know much about restaurants and am not really into food--sometimes I wonder if I should even be looking at this company--but from reading numerous articles, it seems that some of the things Chipotle does is somewhat unique and appears to be hard to duplicate (might write more about this and its possible moat (if any) in the future). Chipotle focuses on fresh, organic, ingredients while avoiding processed foods and attempts to prepare as much of the food in the restaurant as possible (this is not the case with fast-food restaurants). I don't know how much this matters to customers but it does appear that Chipotle is on the right side of the organic/healthy-food trend (not sure if  this is a fad or a long-term trend).

Unlike a casual dining restaurant, Chipotle is set up more like a fast-food restaurant and serves customers much faster and at slightly lower prices. Thus, it has very strong profitability and high throughput (orders per minute can be really high).

It's hard to say for sure, and I don't have any solid insight, but my guess is that Chipotle's food category (Mexican/ethnic) is probably a growth area. The US population is becoming a bit more Hispanic and I suspect there is an increasing demand for this type of food. The Mexican-type food is also something "new" and fresh and probably has room to capture market. Strictly speaking, it is nothing new--this stuff seems to be already popular in Southern US; and companies like Taco Bell have been around for decades--but compared to burgers and fries, or pizza, or sandwiches, or whatever, it looks like a different alternative, at least to me.

Why Look at This Now?

Chipotle was a high-growth stock in the mid-2000's up until a few years ago. It was flying high until e-coli sickened numerous customers in 2015 and the stock crashed and burned. Actually it has had several food-safety-related crises, including one norovirus outbreak in mid-2017, so the situation is a bit worse than it seems (it doesn't seem to be just one situation). If you believe this company cannot overcome the food safety issues--say it is systematically related to their business structure and is unfixable--then you should not look into this stock. I'm still researching this to see if they have actually instituted procedures to avoid the same problems in the future.

This is definitely a contrarian stock. The stock is trading near 5-year low and about 60% off its all-time high in 2015.

(As usual on this blog, you can click on any image to get a bigger, more legible, image.)

Pre-crisis, when earnings were not depressed, the stock used to trade at obscene multiples--something like P/E of 50! So the fact that the stock is down so much doesn't necessarily mean it will go back to what it was. I doubt growth investors will be coming back to this stock, and even if they do, they probably won't attach such high multiples.

The stock is trading at the following ratios (note: figures are rough estimates (I usually just do round numbers and sometimes computed over a period of time). Figures will change depending on what current price is, etc):

P/E: 65
Forward P/E (Wall Street analysts): 27

P/FCF: 54
Forward P/FCF around 25

P/Sales: 2.1
P/Book: 6

Earnings are depressed due to the crisis but even with optimistic forward-looking earnings, P/E and P/FCF are 25+. So it isn't exactly cheap. This is not a classic Graham value stock.

So why still investigate this stock if it seems to trade at high multiples?

Does History Repeat?

Chipotle's sales fell due to the foodborne illness crisis but appears to be recovering. However, note that store count went up quite a bit so some of the revenue increase is from that. Average store sales have declined from what they were in 2015. In any case, the fact that total revenue is sort of getting back to what it was pre-crisis, shows that customers still visit the stores and we may be seeing early stages of the recovery.

As seen above, before the crisis, the company was earning about $400M in profit or FCF (both are close), which is about 10% of sales.

Right now the profit or FCF margin is in the 3% range (based on the Morningstar figures I am looking at, FCF margin is about 3.9% and profit margin is 3.2%).

The question for potential investors is whether the company can go back to 10% profit margin. A lot of qualitative analysis needs to be carried out but I think the company may be able to achieve 7% margin.

The other question to ask, especially for growth companies that are not cheap, is whether it can reinvest profits back into the business and if so, at what rates? Basically, what is the ROE? Or strictly speaking, what is its return on incremental reinvested capital, and what percent of its earnings/free cash flow can it reinvest at those rates?

Chipotle had amazing ROE (20%+) in the past (pre-crisis). This is very good for a company with no debt (i.e. ROE not boosted by debt leverage), but like all restaurants and retailers, it does have sizeable operating lease obligations (so it is being boosted by leases--but this is common for the industry).

Furthermore, it paid no dividends and barely bought back any stock (only material purchase was recently, after the crisis). So it is able to reinvest most of the earnings back into the business. The rapidly increasing store count (pre-crisis) sort of proves that. I need to dig deeper into the SEC filings to make sure it is investing properly but at first glance, this seems like it is able to reinvest almost all its earnings.

It is very rare for a company with an ROE of 20%+ being able to reinvest most of its earnings. No wonder the stock market attached a P/E multiple of 50, or whatever, to the company in the past.

The current market cap is something like $9B so Chipotle can't continue this for very long. However, it does have room to grow and I think if its business is intact and customers desire the food then it can grow for a solid 5-10 years. Compared to established restaurant chains, it is still moderately sized. For example, McDonald's has a market cap of around $100B, while Restaurants Brands International (Canada; Tim Hortons and Burger King) is around $36B, Yum Brands (KFC) is $25B, Starbucks is like $77B, and so on. The business models of these chains are all different--many are franchised whereas Chipotle is not; food types are different; etc--so it isn't a direct comparison but nevertheless, it does sort of give an idea of the potential.

More Homework to Do

Hopefully this post gave a sense of what we are looking at and why Chipotle may be worthy of an investment. I remember briefly looking at this about an year ago when William Ackman made a big investment--his firm owns around 10% of shares--but the stock seemed expensive. It has fallen maybe 20% since then and, although the valuation is still high, it is attractive. I think there are two key things one needs to answer:

i. What caused the food safety problems and will is happen again? Chipotle has rolled out new procedures and altered some food is prepared so what is the impact of this? Costs are probably higher now that there are more food safety procedures. But has the final product been altered to the point that consumers don't value it like they used to (taste? less fresh? etc)?

ii. What is the long-term profitability and growth potential? Can it really reinvest most of its profit at, say, 15% ROE? Is it really worth paying a P/E multiple of around 20-25 for this company?

I'll be thinking about these questions. Stay Tuned...

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Wednesday, September 27, 2017 11 comments ++[ CLICK TO COMMENT ]++

Sold: Cabela's (CAB) Merger Successfully Closed

I haven't had much time to blog and the highly-valued markets are frustrating for any contrarian or anyone waiting for low valuations. I have continued to research some companies and hope to write something up soon but the valuations are not compelling. If anyone has some stock ideas I should investigate, leave a message below or email me (If I am interested in them, I'll research it and write it up).

In any case, the Cabela's (CAB) merger went through. This was a low return, short time-frame, situation and it worked out as expected although it went through a turbulent period. The stock sold off quite a bit after I bought it, possibly due to risk of the financial division sale not going through. That would have been the best time to enter this risk arbitrage position. It kind of seemed like this deal might not close and I would take a loss but fortunately it didn't turn out that way. As is usually the case with risk arbitrage, in hindsight the market always looks like it was wrong (at least for deals that close).

As I mentioned when I first took the position, I made some currency computation errors and ended up with a much larger position than I would have liked. I'm glad the deal closed given that there was a real risk of taking some big losses due to the position sizing mistake.

I'm kind of backing off risk arbitrage positions now (if I like the company being bought out, I will probably still take a position). In some sense, it sort of reminds me of what happened in 2007 when there were a lot of deals being done in late stages of a bull market at high valuations. If you are into risk arbitrage, you should be extra cautious for several reasons:

  • Market valuations are high: One can't generally tell how overvalued a market is, or if it is even in a bubble, except in hindsight. But my opinion is that the market is highly valued and possibly in a big bubble. Risk arbitrage deals are kind of dangerous right now because the buyout deals are happening at high valuations (prices will fall a lot if deal fails), and purchasers will try to weasel their way out of deals (using any legal language permitted in the deals) during bad times (such as when the stock market falls and they realize they have bought something at really high valuation, or if they can't get financing).
  • Unpredictable American presidency: The Trump administration is hard to predict and deal decisions almost seem arbitrary. I would definitely be cautious with foreign buyouts (especially from China, India, Korea, etc).
  • Currency fluctuations: Might not apply to you but if you are Canadian, you have to be careful since the C$ has appreciated against the US$ recently and possibly may continue if FedRes doesn't raise rates but BOC does. It looked like I would lose money on this deal because the US$ fell quite a bit within the last few months, but it rallied in the last few weeks so I ended up only losing about 1% on fx.
  • Risk with numerous sectors: Several industries are facing problems and it's not clear if you are taking positions in areas with potential secular declines. For instance, the retail sector has deteriorated way more than I imagined and I suspect the Cabela stock would have fallen way more than I initially estimated if the deal had broken.

Overall, satisfied with how things turned out.

Price Sold: $61.50
Total Return: 3.8% (annualized (estimate): 25%--not meaningful)
Total Return (C$): 2.8% (annualized (estimate): 18%--not meaningful)

When I was starting out and had smaller portfolio, these small returns would not be worth it but with a moderate portfolio, it can be ok.

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Sunday, September 3, 2017 2 comments ++[ CLICK TO COMMENT ]++

Warren Buffett's Timeless Investing Advice

Even if we are familiar with it or even if it seems blatantly obvious, it is always good to remind ourselves of fundamentals. Here is a short clip I ran across that captures Warren Buffett's timeless advice on his investing philosophy. Pretty much captures the key tenets of his approach: circle of competence, patience, and concentrated portfolio.

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Wednesday, July 19, 2017 1 comments ++[ CLICK TO COMMENT ]++

Purchase: Cabela's (CAB) - Risk Arbitrage Position

Cabela's (CAB) is being bought out by Bass Pro Shops (private) in a cash deal and I took a position in Cabela's. Deal is expected to close by end of Q3. The spread is around 4% and my expected return (based on my probabilities and downside) is about 2%. Not that great but if the deal closes within 3 months, then return is ok.

This deal is a bit risky since it is a buyout of a retailer that has seen declining revenue and profits in the last few quarters. The whole retail industry is getting clobbered--the street blames Amazon and emergence of online retailing but I think the core problem is a likely decline in consumer spending (consumers have too much debt and have been living outside their means for a decade or more and we may be seeing an adjustment--and Cabela's is no exception. It has been so bad that the buyout price was revised down--goes to show the risk in these arbitrage situations; good thing I didn't take a position earlier--so things are definitely not good. Offsetting the poor performance is the fact that their business is somewhat unique (outdoor/hunting/etc) compared to most retailers. In any case, this is not a company that I would like to own if the deal fails.

Since the spread is so small, this deal is not worth it for you if your holdings are in a different currency and you don't hedge; or have a US$-denominated account. US$ has been weakening recently against C$ and currency fluctuations can wipe out any gains.

After purchasing the stock, I realized that I made a mistake with portfolio sizing (didn't realize some figures were in US$--I work with C$ and US$ and have to combine multiple accounts and it can be confusing--and came to the conclusion my position size is too big). I'm going to try unloading a portion of it if the price rises a little bit.

Purchase price (CAB): $59.25

Return Expectation

Takeover price: $61.50
Purchase price: $59.25

Probability of success (my estimate): 95%
Return on success: 4%
Probability of failure (my estimate): 5%
Return on failure (my estimate): -32% (assume it drops to $40 (sort of the low over the last 5 years--not absolute low)
Expected Return: 2.0%

Buffett's Four Key Questions 
(1) How likely is it that the promised event will indeed occur?  
Deal price was revised down on April 17 2017 from $65.50 to $61.50 due to poor earnings so I think deal will close.

(2) How long will your money be tied up? 
Companies expect deal to close by Q3 2017. The only delay risk I see has to do with Cabela's requirement to sell off its bank division (they have agreement with a bank but it needs to be completed).
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?  
Low probability of anything better materializing. Cabela's is slightly better than other retailers (given its target market) but its business hasn't done too well recently so suitors likely to be limited.

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?  
Trading at a really high P/E of 22. Will suffer maybe 30% loss if deal fails. Company revenue and income have declined in the last few quarters. In fact, the deal price was revised down due to its recent performance so things are definitely not good. However, this is a somewhat unique retailer (that caters to outdoor/hunting/country lifestyle) with less competition than other retail businesses.

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