Profitable Insights into Financial Markets
With the iVC reports showing some preliminary promise, I thought it would be worthwhile to begin tracking any potential predictive ability of the grading system. It's late so it's likely I'll have to update this post with better prose after I get some sleep. See this week's pre-earnings grades below. The reports are available for sale through the shop.
I am bullish on FB because I believe the firm's strategic vision is sound and recent moves have put FB in a position to build on and maintain a competitive advantage well into the future. There are 4 keys to my thesis:
Facebook is the undisputed king of social media and still expanding.
FB has a total base of 1.2 Billion monthly active users. It's standalone acquisitions and apps have the following estimated users:
The last point regarding Whatsapp users is critical; 350 million users are active every day. This is the highest user engagement in the social networking space I am aware of.
FB's size and business model will allow it to achieve greater economies of scale. FB does not sell hardware, it does not sell phones or tv's. FB provides users users a method and platform to communicate and share experiences digitally, instantaneously, globally. I believe all of their acquisitions seek to bolster this user experience. FB sells businesses use of their platform to market and distribute digital ads, products, and services to targeted, engaged users. FB is investing actively in this area in an effort to help drive its adoption as the preferred corporate marketing platform on the web.
All this is to say their model is built on leverage. As their platform gains efficiency costs to run the core services should decline bolstering operating margins. Near term margins are likely to decline due to the recent acquisitions of Oculus and Whatsapp, which will require continued investment. However, this effect may be somewhat neutralized if FB is still growing revenues faster than expenses.
FB has just begun to monetize its ad platform.
I see evidence based on FB's revenue growth. Sequentially revenues grew at ~55% year over year with Q1FY14 revenues up ~72% compared to Q1FY13. This is incredible considering revenues are already closing in on double digit billions.
FB's platform has now garnered international credibility and support considering the Publicis deal which is estimated at $500 million. Instagram has just began monetizing its user base via ads within the last year. Whatsapp hasn't even started yet...
Furthermore, I believe the popularity of FB ads will increase due to the largely unobtrusive ad placements in newsfeeds. People love to complain about the data mining that FB has to do in order to provide its ad services but I've noticed the ads have grown more relevant and often appear similar to stories, news, or videos any one of your friends would share with you.
I believe this is a major catalyst that will lead to greater corporate adoption of the FB platform.
Whatsapp's potential value is much greater than 19 billion paid.
Ultimately a bullish bet on FB is a bullish bet on Whatsapp. It is my belief that most investors were initially stunned with the $19B purchase price especially considering Whatsapp had negligible revenues to speak of, no marketing, and a CEO and management team whose slogan is literally "no ads, no games, no gimmicks". I know because I was also stunned.
After mulling it over and modeling some scenarios the price tag seems wholly justifiable and could potentially be a bargain... First lets review the press release FB issued regarding the Whatsapp deal.
FB_Whatsapp Key Stats_Acquisition
These numbers are staggering. Using these data points as a foundation I modeled what I thought was a reasonable growth sensitivity table. (Feel free to download the model and input your own assumptions in the blue cells)
Click here for the free downloadable spreadsheet version
If FB is able to monetize Whatsapp's projected user base at the current $1 per user, the present value of those sales is ~1.1B. If we use the current industry average P/S multiple of 11x (large cap, internet information providers), then those revenues are worth an additional $12B in market cap or $5 per share. I believe this is NOT priced into the stock as FB has declined ~5% or ~$3.50 since the announcement on Feb 19, 2014. This is also aligns somewhat closely to my current DCF price target of ~$69.
The value of $42 per user implied by Whatsapp's purchase price may be bargain according to Forbes. I suggest you read the entire article as it presents an alternative bull case not being considered by the market.
CitingForbes:
...How can it be that WeChat's users are worth $231, Line's are worth $73, WhatsApp's are worth $42 and Viber's are worth $9...It turns out that an international user is only worth less than a Western user if you only sell ads. It all comes down to monetization of those users. The Asian messaging companies are vastly ahead of the North American messaging companies in terms of how they monetize...Unlike in America, where the only way we seem to monetize a consumer app is through shoving ads at us constantly, over there, WeChat and Line make money through selling stickers, games, and also buying things. For example, you can now pay for taxis and food in China through the WeChat app. In Thailand recently, Line did a group-buying flash sale which was incredibly successful. It turns out, if you aggregate the users, you can sell to them. Ads are not really part of this equation...
The mobile phone market is still growing faster than GDP:
The International Data Corporation (IDC) projects mobile smartphone growth is expected to decline from current year's estimates of ~19% to ~7% by 2018. This is straightforward as a growing industry projects as a tailwind even though growth is projected decline sequentially y/y. To me this implies increasing competition between hardware manufacturers and a bifurcation in the mobile technology industry. Incorporating this into my analysis the base case has the market growing above the commonly used 5% long term stable growth rate. This is critical for attracting continued investment flows.
This is the foundation of my thesis and as long as the evidence skews in support of this thesis I will keep looking to invest in FB.
Disclosures: I am long FB.
I'll keep this short and sweet. 3d systems is still the undisputed king of the mountain in the 3d printing industry. They generate more revenue, more gross profit, more operating profit and more net income than all their competitors. See my updated report which includes their most recent 3rd quarter results and additional analysis.
Early January 2013, I did a write-up of Chipotle Mexican Grill and my thoughts on its value and whether I would buy it at that level for a long term investment. Based on my initial analysis I concluded that CMG was expensive as a growth company due to several factors. Data trends indicated that operating margins and revenue growth (while still growing) were beginning to level off. Additionally, earnings surprise momentum showed a negative trend indicating positive earnings surprises were less frequent and of decreasing magnitude. Also, the fast-casual food segment is growing but chipotle doesn’t have a stranglehold on the Mexican food niche with competitors such as Qdoba, Del Taco, Taco Bell, Baja Fresh, among others all competing for market share with generally indistinguishable menu items. Again I concluded it was an expensive buy at the time. Let’s reexamine my thesis by analyzing the following points: Earnings growth/momentum, location growth and market share, same store sales, and Revenue, NI, Ebit growth and margins.
Income Statement growth and Margins
Comparing updated year end statement revenue, EBIT, and NI growth I find that my expectations were in line in that CMG’s “growth” phase is stabilizing towards long term sustainable growth rates. I would like to qualify my previous statement and expand on my meaning.
Year over year: CMG’s revenue changed from $2.27 billion to 2.73 billion, a 20+% increase; EBIT from 351 million to 456 million, a 30% increase, and net income from 215 million to 278 million, a 29+% increase. These are definitely in growth company territory and far above sustainable growth trends. My concern was this high level of income growth was showing signs of stabilization and in some cases decline. Let’s examine the updated growth charts.
A cursory glance at these graphs shows a clear downward trend. Again this is not alarming in absolute terms but relative to prior periods it supports my thesis of a growth company moving towards stability. Ebit and Net income growth have shown decreasing volatility. Let’s now look at margin trends.
Margins clearly aren’t growing in as explosive a fashion when examined in context of the previous decade lending support to my thesis of stabilizing financial metrics.
Location growth and same store sales
Location growth has been consistent over the last few years averaging ~16% per year. According to the 2012 10K the majority of their revenue growth is attributable to menu price increases in and 7.1% same store sales growth Yoy. That figure is down from 11.2% in 2011. Average restaurant sales increased 5% Yoy a decline from 9.4% in 2011…
Now for my favorite-
EPS growth and momentum
Now we get to the meat of the discussion. Examining quarterly EPS growth, EPS absolute value, and momentum (earnings surprise) we can see more evidence of financial stabilization and some trend decline. I believe a picture is worth a thousand words. Data is sourced from earnings.com a Thomson Reuters site.
Notice that EPS has increased rather steadily, however since Q1 2011 earnings have remained range bound…
EPS growth is showing high variability q/q and the linear trendline has a negative slope.
Here we see earnings momentum is trending downward over the last few years. Good thing Chipotle has been consistent at minimum meeting consensus estimates. The magnitude of positive surprises has also declined.
While writing this blog I came to another more practical conclusion about the strength of earnings and the stock value appreciation. The fast-casual segment of restaurants is growing at above GDP trend rates and faster than the restaurant segment as a whole. It’s arguable that the Mexican niche is the most popular outside of traditional burger joints. However, the majority of the competitors in this niche are privately owned or owned by a larger diversified conglomerates. There is only one major company that allows for investors to make a pure play on this segment and that’s CMG. There are much worse companies to invest in. Consider if you’re a Portfolio Manager looking for an investment vehicle to gain exposure to this niche, who better than CMG? It dwarfs the majority of its competitors in size and revenues while maintaining a strong balance sheet and operating in a cash business with low debt. Not only that, but If you believe the positive macroeconomic headlines, CMG stands to benefit as more people gain employment via their convenience as a lunch time venue. This would definitely help explain the market beating returns CMG has posted this year. YTD CMG has outperformed the SP500 by 11.23% and is up an overall 24%.
Here is a presentation I produced in early January, where I evaluated the value of buying Chipotle (CMG) stock as a long term investment. It is here for reference for my follow up post in which I update my thesis. Check it out. As always feedback is welcomed.
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