DuPont – Investor Exodus

Written July 29th, 2015 by

DuPont management may still have the faith that the science based strategy is right, but everyone else seems to disagree.  Trian criticized the company for bloated costs and lack of returns on its R&D spend and we have echoed that in research both before and after the Trian involvement.

The bear case is winning today and it goes as follows: DuPont management takes the proxy win as an endorsement of the strategy and the path the company has followed for the last decade.  The company continues to waste money on ineffective R&D, continues to ignore its high cost base and possibly makes further bolt on acquisitions which disappoint and destroy value.  On this basis you would expect low earnings growth and a continuation of the recent history of negative guidance following too bullish expectations based on optimism around the R&D return and the value of novel products.  On this basis the stock at best moves sideways.

This is perhaps one of the least sophisticated analyses you will see from our group, but it illustrates a point.  In the exhibit below we show the cumulative spend on R&D for the last 20 years, divided by 2014 revenues.  The R&D spend at DuPont over the last 20 years is equivalent to almost 90% of the 2014 revenue level – overshadowing everyone else on the list with 20 year history.  Obviously we are not taking into account portfolio changes, but if you then compare this data with average 20 year TSR, you can see the disconnect.

DuPont will argue that the past is not a good predictor of the future, but we, and clearly many investors, believe that it is.


The bull case is that all this could be fixed and that billions of dollars of value could be unlocked.  We would contend the following:

  • There is at least $3.0 billion of costs that could be cut out of DD without breaking up the company – the number would most likely be higher with a break-up
    • $3bn of costs – if all taken to the bottom line – would be worth $2.40 per share
  • At least $0.75bn of R&D could be abandoned with no impact on earnings
    • 35% of R&D – $0.60 per share
  • The balance of the R&D spend could be managed more effectively to generate a better return
  • Free cash can be deployed in share buyback and the company could buy back as much as 12% of the stock over the next two years including the one-time cash dividend from Chemours
  • Adding this all up gives a conservative $7.00-7.50 per share earnings number in 2018 versus current consensus of $4.50

Perhaps it would take more than 3 years to pull out all of the costs, but the opportunity is clear and this is what Trian was looking for and where the target price north of $100 per share came from.

Those selling the stock today are either convinced that the activists are not willing to have another go and/or that the DuPont board is willing to sit back and hope that a flawed strategy to date can suddenly come right.  We think neither conclusion is right. The bull case is much more believable

Eastman – The Silver Lining of the Propane Cloud

Written July 29th, 2015 by

Placing the wrong bet on propane prices may have been the best thing that could have happened to Eastman!  Eastman is a roll up story and the thesis is that as the company adds complimentary and sometimes overlapping product/technology platforms there are growth and, perhaps more importantly, cost opportunities.

Eastman is delivering on the costs and the improvement in overall operating margin drove a big earnings beat in a weak sales quarter, negatively impacted by price, volumes and currency.  Perhaps the company would have been less focused on the cost opportunity had it not been staring in the face of a major hedging headwind – nothing focuses the mind like having to overcome a major error/hurdle.

The portfolio remains confusing and complex, but the company is delivering. EMN’s well received Q2 results were highlighted by significant margin expansion in the Advanced Materials segment (9 percentage points). This improvement was notable for its magnitude but also in its demonstration that the company is beginning to derive value from its acquisitions, a condition we have previously noted would be necessary to realize the (still material) upside in the name. 50% of the Advanced Materials segment is comprised of legacy Solutia businesses (Performance Films and Interlayers), and the demand outlook here remains strong, though margins are expected to normalize at the blended 1H rate of ~17%.

That this run rate would represent just the fourth highest margin of EMN’s segments speaks to the company’s cash generative capability, and cash flow in Q2 indeed came in well above estimates. The company encouragingly offered a very shareholder-friendly view of capital allocation moving forward, favoring increased dividends and share repurchases with “large acquisitions” on hold “through 2017”, meaning investors will be paid as they wait for the still-considerable upside in the share price ($100 mid-cycle value on our model implies 23% from current levels).  This change in strategy with regard to use of cash is exactly what investors have been asking for and was highlighted in our initial work on the name.

Eastman’s ability to put up very strong earnings in the face of a major hedging headwind should significantly increase confidence in the stock, with the (re)allocation cash a further positive.  Note that EMN has a very low historic average relative multiple (to the S&P500), in absolute terms and relative to other chemical names. Restored/improved confidence could drive the relative multiple higher and our $100 per share fair value would then only be a starting point.

EMN remains one of the most attractively valued names in the Chemical space in our view.



Quick Thoughts: Everybody Hates Twitter

Written July 28th, 2015 by

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Quick Thoughts: Everybody Hates Twitter

The monomaniacal focus on MAUs does TWTR a disservice – it is a lot more like YouTube than Facebook, and no one cares about Google’s MAUs. Project Lightning and an aggressive marketing campaign to educate consumers should stimulate engagement and keep the strong ad growth going. For now, TWTR is one of the few places to buy real growth – 64% growth in the face of 8% FX headwinds – at a discount.

The trading around TWTR’s 2Q15 earnings report was quite a ride for investors. At first, the stock rose more than 5% on sales and adjusted EPS that blew past expectations that had been tamped down after the widely reviled 1Q15 results. 64% top-line growth against a stiff FX headwind is nothing to sneeze at, and the $0.07 earnings number showed significant progress toward strong future profitability, even if the company is still dealing out shares to employees at a somewhat profligate rate.

Then came the second wave. First, naysayers glommed on to the fact that MOST of TWTR’s rise in MAUs came from users accessing the service via messaging platforms on feature phones rather than the full-fledged smartphone app. Fair enough, but Facebook, which doesn’t breakdown the number of its MAUs which access it via messaging apps, spent 10% of the company acquiring WhatsApp and its now 600M users for just the same type of access. Then, parsing the numbers a bit more, a new negative theme broke free – US MAUs were static quarter to quarter. By then, the stock had given back all of the rise and then some. At the end of the conference call, when management refused to give any information about the ongoing CEO search, TWTR shares settled to down more than 10% from the close.

This 2 hour frenzy of after hours action was a bit of a microcosm of TWTR’s life as a public company – fast out of the gate with big revenue growth and strong monetization trends, but slammed for its inability to post the kind of growth in registered monthly active users that had been delivered by Facebook. This investor fixation on MAUs has been a huge burden for the company, which is undoubtedly sorry that it had emphasized the metric so much in its IPO prospectus. It turns out that there are a lot of monthly visitors coming to TWTR and reading its content without registering. In this, it is a lot more like Google, which just threw in the towel on making its anonymous YouTube and Search users log in with Google+, than it is like Facebook, which bases its entire application around requiring each visitor to sign in. Google investors are happy enough with the billion plus YouTube users, even if they don’t know exactly who all of them are.

To that end, TWTR finally has some concrete plans to start monetizing the hundreds of millions of visitors that it claims to have – Project Lightning will let users immerse themselves in events and breaking news while getting relevant advertising, without logging in. A partnership with Google will lead new users to TWTR content. New marketing programs, long overdue, will promote and explain the value of Twitter to consumers long confused about its usefulness. Basically, a light bulb has come on above the heads of TWTR management, and maybe, the issues that have plagued it in the eyes of investors may be put behind it.

Meanwhile, I think the critics have gone a bit far. The Facebook favorite MAU metric is not fully indicative of TWTR’s assets – its critical mass of key opinion makers in every imaginable field, its timeliness advantage, the hundreds of millions who are aware of the service even if they haven’t registered. 64% YoY growth in the face of an 8% currency headwind despite the disappointing user number is evidence of the value of the platform to advertisers who understand the quality of TWTR’s interest data and the effectiveness of its native formats. Over a year ago, I pointed out that TWTR’s main problems were the poor design of its consumer app and the absence of effective marketing to sell its use case to the public. Finally, Project Lightening is due in 4Q, along with a real marketing campaign and, perhaps, a Chief Marketing Officer. Maybe this time the light at the end of the tunnel is not just another train.

For our full research notes, please visit our published research site.

ABBV: A Reluctant Farewell to the HCV Bull Case

Written July 28th, 2015 by

US HCV prescription demand has begun easing, and is likely to decline. Viekira Pak has maximized its share within the ESRX contract, meaning further share gains can only come from exclusive or preferred deals which don’t yet exist, or from convincing docs who can prescribe either drug to write for Viekira Pak instead of Harvoni

We don’t see any real possibility of ABBV gaining major exclusive / preferred formulary deals ahead of next year, by which time MRK will be entering the market with a third alternative that appears slightly inferior to the GILD and ABBV regimens, but which is effective enough to gain share – as long as it’s priced aggressively, as it surely will be

Share gains for Viekira Pak on ‘inclusive’ formularies, i.e. where both Harvoni and Viekira Pak are available at similar costs to patients, almost certainly will not occur. Prescribers prefer Harvoni, something no amount of promotion is likely to change

Share is stagnating, volumes are easing and soon likely to decline, and a major entrant who will presumably compete on price is due by 1Q16. And as all of this is occurring, in the US Viekira Pak has only a 9 percent share of total prescriptions and an 11 percent share of new prescriptions – well below the 20 percent lower bound of our original estimate

We believe ABBV will soon see its peak US HCV sales quarter, if it hasn’t already. On the bright side we do believe ROW sales prospects for the broader HCV market generally are too low; ultimately we expect aggregate ROW sales for the current generation of agents to be more than 2x aggregate US sales. Unfortunately US margins are higher, US sales are more relevant to near term expectations, and a larger percentage of ROW patients carry genotypes other than those (1a, 1b) against which Viekira Pak is effective

For our full research notes, please visit our published research site

LyondellBasell – Hard To Fault

Written July 28th, 2015 by

First half oil prices were almost half the levels seen in 1H 2014, yet LYB has managed to produce 17% more net income than in the prior year.  EPS growth is greater because of the significant share buyback, which looks set to continue given high free cash flows and high cash on the balance sheet. The company produced good results in the US and better than expected results in Europe given operating limitations in Q2.

LYB could make close to $11 of EPS in 2015, and with the stock trading at 8.2x that number, it is hard to resist.  The stock has underperformed recently because of sentiment around oil, as it did in September and October of last year.  Despite the collapse in oil last year, LYB is putting up better numbers and EPS is further enhanced by the buy-back.  Furthermore, the company has again increased its dividend and now has a yield of 3.5%.  LYB’s ability to buy back 10% of its shares a year offsets the risk of possible lower oil prices and lower near-term US and European ethylene margins in our view and the TSR that LYB could generate looks much more interesting than for others in the space.

LYB’s return on capital has held up while WLK’s has fallen over the last two years (see chart) – WLK, LYB and DOW are exposed to the olefin and polyolefin markets – one of the few commodity subsectors where China does not have a surplus and where Chinese exports are not damaging global pricing.  The difference for both DOW and WLK is that they are exposed to other markets where China is a problems – chlor-alkali and PVC for WLK and chlor-alkali and epoxies for DOW (though DOW is divesting these businesses in 2015 to OLN).


Nervousness around oil has brought LYB back down to a price that looks very attractive given earnings and cash flows.  There is clearly a risk that if oil weakens further you end up fighting a more general negative sentiment, but in our view the stock offers good value here.

The secondary risk would be that the strategy changes – the share buyback stops and LYB embarks on an acquisition spree.  This is unlikely, but would be very unpopular with shareholders most of whom own the stock for the return of cash to shareholders.

Note that consensus estimates going forward do not appear to account properly for the potential share buyback, suggesting that while forward estimates might be vulnerable to lower crude prices relative to natural gas, they have upside from a lower share count.

All of the ethylene names look a bit more interesting here – WLK could increase its dividend and buy back stock, given cash flows and we think the same is possible at DOW – see recent blog.  LYB is probably the cleanest story today, notwithstanding the change of strategy risk suggested above.

Dow Chemical – Neither Fish nor Fowl

Written July 28th, 2015 by

Dow Chemical’s second quarter demonstrated a problem that has concerned investors – both passive and active – for some time.  In the face of apparently very strong US and European basic plastics margins, the company did not do that well.  It will be interesting to see what the more pure play commodity polyethylene names do in the second quarter, as we suspect that they will show a better uplift than Dow.  Dow’s integration upstream into what are labeled “performance” products or “solutions” means that more and more of the commodity base materials within Dow are consumed into next stage derivatives that do not display the same level of cyclical pricing.  Polyethylene pricing may rise, but Dow’s advanced products have much more sticky pricing and do not move as much.

Dow is not displaying the cyclical swings that it used to, and as the chart shows, while returns on capital remain low and very close to the longer-term negative trend, the volatility is more muted.


However, Dow is not really a growth story either.  Dow saw 3% volume growth in Q2 on a like for like basis (excluding business sold and its raw material business related sales/trading), which is not terrible given the state of the global economy, but it is also not a growth story.  It is certainly not enough of a growth story to support the significant R&D investment and capital investments that Dow is making.

The activist initial ideas are likely correct – the company is really two companies – a large efficient commodity chemical company and a large innovation driven growth company.  Dow may not appear to many to be a better company, or pair of companies on that basis, but it may be a much better stock.

  • Both pieces need a better focus on costs – with the commodity piece shedding the overheads associated with trying to “up-sell” and focusing on lowest cost production and highest quality
  • The growth piece needs to focus on an appropriate cost structure as well, and like DuPont needs to understand what it is getting for the R&D investment.

Right now the value investors are not getting their cyclical upside and the rest are not getting the growth.  Tactically the company has a couple of options; start moving down the path suggested, or increase TSR by significantly increasing the cash return to investors – the company has been buying back stock but its dividend remains below where it was on a per share basis before the financial crisis.

Either move would likely be positive for the stock near-term, though we may be looking at relative outperformance versus the sector rather than absolute if the commodity based sell-off continues.

SNY/REGN: Eligible Patients and Sales Potential for Praluent

Written July 26th, 2015 by

Praluent received US approval for patients with atherosclerotic cardiovascular disease (ASCVD) or HeFH who are on maximally tolerated statin doses but who need additional LDL-C lowering. There are between 8.4M and 10.6M US persons who meet these criteria, depending on whether we assume an LDL-C treatment target of 70 mg/dl (lower patient total) or 40 mg/dl (higher patient total)

As expected the label excludes persons at risk of ASCVD; the number of US persons who do not have ASCVD but who: 1) meet the ACC definition for primary prevention; and 2) are currently under active treatment but 3) above a reasonable LDL-C target is between 8.7M (70 mg/dl goal) and 10.1M (40 mg/dl goal). All together, the post-outcomes eligible US population is between 17.1M and 20.9M persons

Pricing is $933 per month at ‘list’ for all doses. However, more than 2/3rds of patients can reach goal on 75mg every two weeks; and, these patients can very easily purchase the 150mg syringe ($466.50) and divide its volume across two separate doses. As long as this trade package is readily available, this is what we expect a very large number of the 75mg every-two-week patients to do

Ahead of outcomes data (earliest is November 2016, latest is January 2018) we see US sales potential for PCSK9’s in total (both Praluent and AMGN’s Repatha) of $3.1B to $5.1B, assuming outcomes  data are available on or around January 2018. Post-outcomes, we see US sales potential for PCSK9’s in the range of $9B to $20B

For our full research notes, please visit our published research site

US Generic Inflation Pauses in 2Q15, But is Very Likely to Resume

Written July 23rd, 2015 by

The sales-weighted price at which US drug retailers acquire generics (NADAC*) has grown by more than 40 percent in just over two years. This unprecedented run of inflation is wholly explained by price increases on products with very low (pre-inflation) total national sales

In the wake of wholesaler / retailer tie-ups, US drug wholesalers control or directly influence roughly 3/4ths of US generic spending. Because the prices at which wholesalers sell price-inflated generics have grown more rapidly (~76%) than the prices wholesalers pay to generic manufacturers for these same products (~49%), wholesalers have captured the lion’s share of gains from generic inflation

Given wholesalers’ dominant role in US generic purchasing, and the extent to which wholesalers benefit from the current inflationary pattern, in all likelihood inflation should continue as long as there’s still room – i.e. as long as there remain products with very low national sales whose prices have not yet inflated

For every generic drug product with very low national sales whose price has inflated, there remain about 1.5 similar products whose prices have not meaningfully changed – meaning the available ‘substrate’ for the current inflationary pattern is only about 40% consumed

*National Average Drug Acquisition Cost

For our full research notes, please visit our published research site

Quick Thoughts: The Emperor’s New Watch

Written July 20th, 2015 by

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Quick Thoughts: The Emperor’s New Watch

The Apple Watch – Everybody has an opinion. Here is mine.

So how is the new Apple Watch doing after its first three months? Two weeks ago, market research firm Slice Intelligence roiled the waters with a report which, based on its analysis of e-mail receipts sent to its 2.5 million US panel members, suggested a 90% drop off after the first week of sales. Last week, CNN reported that the search volume for the Apple Watch, as reported by Google Trends, was a tiny fraction of that for iPhones and iPads, and even below that for the moribund iPod. Meanwhile, Wristly, a new web site launched specifically to examine the Apple Watch phenomenon, is just out with a survey of 800 self-selected members of its panel showing that they LOVE their Apple Watches to the tune of 97% satisfaction. These are the three data points that we have. Unlike most products in this internet age, the distribution of Apple Watch is closely controlled by its maker, and Apple isn’t talking.

This information drought on a relentlessly promoted new product leaves analysts uncomfortable. Analysts don’t like to look stupid, and over the past two decades no company has made more TMT analysts look more stupid than Apple. Over the past 15 years, it has blindsided the investment community with the periodic introductions of audacious new products and then again, as the consumer response to those products came harder and faster than even the most bullish voices had predicted. iMac, iPod, iPhone, iPad – these have been hero products and woe be the broker, journalist or pundit that staked their reputations on the bear side. The big screen iPhone 6, though not really a revolutionary new product concept, sold like one, taking Apple stock on another leg up as the most valuable company in the world. After all of this, when Apple so much as hints at a product, analysts take it very seriously – hence the annual hype cycle around the mythical Apple TV set and the respect paid to the potential of an Apple car in every iPhone user’s garage.

In this spirit, analysts and market pundits have been struggling for relevance on the new Apple Watch – hinted about for months, acknowledged with a vague announcement last September, and thrust into the market with a shock-and-awe marketing wave in April. Confronted with a real product with real specs but no real visibility into the actual sales, the pressure to have something to say about the product rose. An intrepid few went big early, forecasting that the Apple Watch would be a significant factor for the company in its first year – a tall order given Apple’s $200B plus in annual sales. A few others went the other way, mostly asserting skepticism over the addressable market or the learning curve rather than the quality of the product. Most hedged their bets.

In the absence of information, the prevailing hedged perspective on the Apple Watch has held that 1) the product concept is a paradigm shifting stroke of genius in the tradition of the iPod, iPhone and iPad; 2) near term demand may be muted due to consumer unfamiliarity with the use cases, a narrow library of early apps, and narrow distribution – issues also observed in the slow ramp for the iPod and iPhone; 3) the 2nd generation Apple Watch will resolve many unforeseen issues with the original model, while new apps begin to exploit the real potential of a wrist mounted computing platform; and 4) by 2017, the Watch will be another tent pole product for Apple, delivering significant contribution to the company’s top-line and bottom-line growth on its own, while also adding further advantage to the iPhone vs. rival products and thus, driving growth there as well. Ultimately, this is a faith-based argument, turning on the belief that Apple’s exemplary track record leaves it above question. It also protects the analyst from looking stupid – at least for the next year or two.

When the Slice Intelligence data point popped up on July 7, the market reacted to it, sending the stock on a three day 4% drop. Bloggers, many well respected tech market observers, were vigorous in defense, pointing out that Slice’s methodology of examining e-receipts received by its 2.5 million person US panel ignored many important segments of the Apple Watch market. A week later, the Google Trends data point hit, reported by CNN and others, right in the midst of and ignored by a NFLX/GOOG inspired tech rally that took Apple back to test its all-time highs. This week, the Wristly customer satisfaction report comforted Apple bulls, even though it carries similar methodological weaknesses as the Slice Intelligence report that had been so derided a week earlier. These data points may mean something or nothing, and Apple Fanboys are going to love and haters are going to hate.

As I sit in this same information void, I definitely lean to the skeptical side. I note a few media voices are beginning to talk more boldly about their own Apple Watch doubts. The always provocative Bob Lefsetz recently wrote a piece suggesting that Apple has lost its way in the aftermath of losing Steve Jobs, and that the Apple Watch was poorly conceived, designed and executed. You can read it here ( The Information’s Jessica Lessin wrote of feeling almost self-conscious with her Apple Watch, and her surprise at how few of the movers and shakers at Paul Allen’s Sun Valley conference wore one – she counted just 4 others, including Apple CEO Tim Cook. ( When I read these accounts, by writers that I consider thoughtful and honest, my confirmation bias kicks in and I feel my own suspicions rise. I have also been surprised at how few of my iPhone loving friends have sprung for the Watch and the fairly lukewarm praise from the ones that have. There are no real facts to support my position – or refute it – but I don’t really believe that the use cases, form factor, or price will captivate most consumers, even in a 2.0 version.

Maybe everyone is just waiting for Christmas. Maybe the market for Apple Watches is on fire in China. Maybe this is just normal, and sales will ramp steadily over the next few years the way that most analysts say that it will. Maybe – but I’m thinking probably not.

For our full research notes, please visit our published research site.

SSR Health New Product Approval Portfolios & Supporting Data Update

Written July 15th, 2015 by

Drug, biotech, and research-based spec pharma stocks tend to outperform their peers in the year or so before and after regulatory actions (‘PDUFA’ dates) on major new products, with a large portion of total risks being concentrated in the days immediately preceding and following the PDUFA date

Since November of 2011 we’ve run model portfolios consisting solely of names with pending (i.e. ‘pre-PDUFA’) or recent (i.e. ‘post-PDUFA) major-product regulatory actions, respectively. Within each broader ‘pre-‘ and ‘post-PDUFA’ portfolio are three sub-portfolios that differ only in terms of how large the new product is as a percentage of the company’s total sales forecast. E.g. the ‘1% pre-PDUFA’ portfolio consists of all names with pending regulatory decisions on products that account for at least 1% of the company’s total sales forecast, and so on for the ‘5%’ and ‘20%’ pre- and post-PDUFA portfolios. To moderate risks, all portfolios follow rules to limit long positions in the days immediately before and after regulatory actions

Since inception the 1% pre-PDUFA portfolio has produced greater annualized returns (58% v. 37%) with a lower standard deviation of annual returns (11% v. 15%) than an ‘innovator index’ of nearly the entire universe of biopharmaceutical stocks. The 5% and 20% pre-PDUFA portfolios have outperformed by even greater margins as compared to the innovator index (76% and 89% v. 37%), though at higher s.d. of returns (23% and 47% v. 15%)

We expect US real pricing power for pharmaceuticals to fade, increasing the importance of new product flow to relative performance. Thus screening for names with attractively priced new product flow is an appropriate first step to stock selection across the drug, biotech, and spec pharma sub-sectors. We offer two related tools, the first being these portfolios of names with major pending or recent regulatory actions (published monthly); the second being our Hidden Pipeline series of reports that identify undervalued phase 2 and earlier pipelines (published quarterly)

For our full research notes, please visit our published research site

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