The Power Of Positive Thinking – APD and the DD read-through

Written October 31st, 2014 by

If the previous management of Air Products had delivered a quarter that included the following, the stock would have been down meaningfully on the day:

  • A year on year decline in operating income from its core gases business
  • A write down of around a third of the value of a business acquired only two years ago
  • A suggestion that two of the (much questioned) China based on-site projects have been delayed by 2 quarters

However, the current management was able to announce exactly this and the stock closed up almost 4%, while already commanding a significant multiple premium to Praxair, which over the last 12 months has delivered growth in its gases portfolio – Exhibit.


What is going on here is “belief”.  Belief that the newly focused APD can drive down costs, allocate capital better and drive better EPS growth than it has in the past.   There were signs of this in the quarter as APD beat estimates, despite the weaker gas numbers.  Very strong results from its Materials and Equipment businesses were largely the cause, but there was also significant focus on cost allowing the company to increase margins.  We are assured that the cost focus will continue.

While we are skeptical as to whether APD can cut costs fast enough to deliver positive earnings surprises given a weaker gas business (which we think will take a couple of years to turn around) that is not the point of this short note.

The point is to highlight the power of a change in sentiment.  APD has almost a 3x multiple premium over PX on 2015 earnings, unheard of at any point in recent history.  The market believes that the change in focus at APD will deliver outsized returns and the stock has been one of the best performers in the space over the last two years.

This change of sentiment will likely take place at DuPont also.  The activist fund in DuPont has the right story in our view – just as the activist fund at APD had 18 months ago.

The issues are what will be the catalyst and when will it happen?  And the answer is simple – we do not know!  What we do know is that there will need to be a catalyst.  DuPont is resisting Trian’s suggestions and, in our view putting up weak numbers and a weak defense.  The war of words has begun.

Catalysts could be: (we are just making stuff up here)

  • A public proxy fight where Trian nominates a couple of very strong board candidates (unlikely that it will come to this)
  • DuPont continues to disappoint on the growth story – increasing shareholder pressure to act
  • A change of management at DD
  • A second activist fund taking a large stake
  • A private equity bid for the company (it is smaller than KO!)

Once the catalyst arrives the stock will stop discounting Trian’s likely failure and start discounting Trian’s likely success.  The stock could appreciate quickly.  We generated a value of $100 per share in a piece that we did on the cost opportunity at the beginning of this month.

The risk to holding the stock is that the company makes a large and poor tactical acquisition to change the game.

October 30, 2014 – TMT: Portfolio Update – Dreams, Comebacks, Skeptics and the Death Watch Redux

Written October 30th, 2014 by


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TMT: Portfolio Update – Dreams, Comebacks, Skeptics and the Death Watch Redux

Last quarter, we created a framework to assess TMT stocks, juxtaposing near-term cash flow expectations (5-year consensus cash flows) with long term expectations (post 5 year cash flows implied by residual value). Arrayed on these axes, companies fall into 4 distinct quadrants 1) High near-term/High long-term “Dream Stocks”, 2) High/Low “Skepticism Stocks”, 3)Low/High “Comeback Stocks”, and 4) Low/Low “Death Stocks”. We extended this analysis to all US-traded TMT stocks with market cap above $3B, yielding a universe of 180 names, updating it to account for recent changes in valuation. As with the original analysis, the stocks largely fall into intuitively sensible quadrants. We believe the categorization has clear implications for investment – Dream Stocks are easily forgiven for short term transgressions, Skepticism Stocks are chronically “undervalued”, Comeback Stocks must justify their valuations or rerate, and Death Stocks have potential to surprise but could be value traps.

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Quick Thoughts: FB 3Q14 – “A Significant Investment Year” or Zuckerberg’s Bezos Envy

Written October 28th, 2014 by

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-        FB delivered $0.43 in 3Q14 EPS on $3.20B in sales, topping consensus ($0.40 on $3.14B) on 59% sales growth, but spooked investors with guidance for decelerating sales and high expenses

-        User metrics were impressive for a base the size of FB. MAUs up 14% YoY, DAUs up 19% YoY, mobile MAUs up 29% to 83% of total MAUs, Asia/ROW MAUs up 19% to 63% of total.

-        FB killed it on monetization. US/Canada and Europe ad sales grew 63% YoY combined despite just 5.7% MAU growth, as ARPU grew 58% and 51% respectively. Average $/ad was up 274%!

-        Management set 4Q sales guidance for 40-47% growth, with 2015 OPEX projected up 55-75%. Dilutive WhatsApp shares are also now registered to trade. OOPS! another after-hours sell off.

Facebook delivered yet another solid quarter fueled by growth in mobile advertising, which was up a stunning 122% YoY and now stands just shy of $2B for the quarter and a $5.4B run rate. Not bad for a business that didn’t exist when the company IPOed in May 2012.  Top line revenue came in at $3.2B, handily beating the $3.12B expected. Earnings also beat with $0.43 in EPS versus the $0.40 expected. With 1.3B+ users, FB is still growing users in the double digits with Daily Average User (DAU) growth at 18.7% YoY and Monthly Average Users (MAU) up 13.7%. Faster DAU growth points to greater engagement with the ratio of daily to monthly actives growing to 64% from 61% last year. Monetization was also looking good with strong ARPU growth across all regions, but especially strong in FB’s largest markets. FB shares barely moved after the bell, but then came the earnings call. Cue the spooky Halloween music.

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Quick Thoughts: TWTR 3Q14 – It’s Always Something

Written October 27th, 2014 by

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-        TWTR posted 3Q14 results that either met or beat consensus for every reported metric, including 23% growth in users, 14% growth in timeline views, and 114% growth in revenue

-        Nonetheless, shares traded off 10%+ after hours, leading reporters to speculate the cause – 4Q sales guidance? Views per user? Whisper numbers? Decelerating QoQ MAU growth?

-        The worst number in the report was a 7% sequential jump in stock based compensation expense, which wiped away the benefit of record EBITDA margins, and then some.

-        4Q compares are relatively easy on MAUs, engagement and sales. 4Q guidance could be a low ball –3Q sales were 6% above the high end of guidance. Perhaps TWTR will answer the skeptics.

In its fourth quarter of reporting earnings as a public company, Twitter once again reported generally strong results that were either in line or beat consensus. Top line revenue was a clear beat at $361M against the $352 expected by consensus, growing 114% YoY. EBITDA came in at $68M, well above the consensus target of $54M, on operating margins that were, again, well above analyst expectations. EPS was on target at a penny, but save for some extraordinary expenses including forex and increased interest expense on a convertible note offering, it would have been $0.02.

Monthly Active Users (MAUs), 284M, were up 13M from last quarter and 52M from last year, representing YoY growth of 23%, in line or ahead of analyst projections that had been quoted in the press. Timeline views by logged in users reached 180.6B, up from 158.8B last year, growing at 14%. The company had phenomenal success monetizing mobile, with the category now representing 85% of revenue, up from 70% last quarter. The “data licensing & other” category was up 171% to $41M driven by MoPub. Its international user monetization more than doubled in value as the company now has a presence in 60 countries, and is aggressively targeting certain growth markets. BAM! The stock is trading down more than 10% after hours. What happened?

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Quick Thoughts: MSFT – Not Your Father’s Microsoft

Written October 23rd, 2014 by

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-          MSFT’s 1QFY15 were stellar – 11% YoY organic sales growth, strength in both devices/consumer and commercial businesses, and a solid EPS beat.

-          MSFT is killing it in the cloud – commercial sales up 128% YoY, likely to a $5B+ annual run rate. Commercial Windows and Server both delivered double digit growth

-          Consumer was a surprise. Xbox sales doubled YoY. Surface Pro 3 is selling at 2X the pace of Pro 2. Office 365 up 25% QoQ. Even Nokia was surprisingly strong.

-          Margins are down, but the fruits of MSFT’s significant restructuring are yet to be felt. 2015 should yield significant earnings acceleration.

Microsoft delivered another extraordinary quarter under CEO Satya Nadella showing the “mobile-first and cloud-first” strategy articulated in July is working. Top line revenue was up 25% to $23.2B, and backing out Nokia, the organic growth was a still impressive 11%. The top line figure handily beat consensus expectations of $22.0B and the bottom line was a solid beat of $0.54 in EPS against $0.49 expected. The company’s restructuring expenses also came in at the lower end of guidance with some $1.14B in write offs related to the Nokia handset business. With other traditional enterprise IT players struggling to adapt their businesses for new cloud and mobile opportunities, Microsoft has shown it’s successfully making the transition.

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October 21, 2014 – Sensors: What’s in YOUR Smartphone?

Written October 21st, 2014 by

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Sensors: What’s in YOUR Smartphone?

In the growing functionality of high end devices, the spread of basic smartphones, and the emergence of new device types – wearables, etc. – sensors are a $60.4B market that is growing at a 9.2% CAGR. We categorize them into 5 groups – physical, optical, radio, electrical and chemical – each serving specific applications and requiring particular design and manufacturing disciplines. As such, competition amongst sensor manufacturers stays within these silos. For sensor functions already well embedded into portable devices, suppliers are challenged to minimize cost, footprint and power draw, often integrating multiple functions of a type into a single solution. Emerging functions, such as gesture control or biometric ID, have drawn approaches using different sensor types, although economics and performance will eventually drive standardization. New devices are a growth market for existing sensor types, but may also create opportunity for new sensor components suited to specific applications. While we are bullish on new portable device opportunities for sensor components, we note that many longstanding sensor products are commoditized, particularly within well established traditional end markets, such as automotive and industrial automation.

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The Most Important Question to Ask on Earnings Calls – Q4 Demand!

Written October 21st, 2014 by

We have touched on the subject of inventory drawdown in Q4 in a couple of recent reports, but the more we think about the subject and refer back to history, the more we believe that this could be the most significant year-end surprise across a number of industries, but most significantly those where crude oil is a major input.

Outside the US the economic news is worse, demand growth is slowing in Europe, and in large parts of Asia and Latin America.  Local sellers and distributors will likely look to lower inventories as a consequence of expected lower offtake.  Within our Industrials and Materials universe inventories are not low in absolute terms – see exhibit, but not particularly high as a percent of revenues.


More significantly, with the almost 25% decline in Brent Crude Oil pricing since its summer peak, any international consumer of products made from crude oil or its fractions, will be expecting much lower pricing going forward.  Consequently, if historical behavior is any guide, they will drop purchased volumes immediately (this will have already happened in October) – to the minimums that contracts allow, and wait for pricing to drop.  This behavior was very pronounced among Chinese plastics importers amid the crude oil volatility of the late 1980s and 1990s, and was last seen most obviously in the early months of the GFC, when demand vanished for a quarter or two.  The second chart is a repeat from recent work which shows short periods of negative demand surprises as crude oil prices fall.


As an example, Dow Chemical’s sales in Q3 2008 were 13% higher than the prior year – in Q4 they were 25% lower than the prior year and in Q1 2009 40% lower.  This was a combination of volume and pricing – with part of the volume swing driven by destocking as crude oil prices collapsed and part was the ensuing price response both to lower crude prices and lower demand.  We are not calling for a decline this significant this time, but we do expect a negative surprise for Q4 and possibly Q1 for all chemical producers and possibly for most industrial companies with significant international business.

The counter of course is that lower crude is likely very good for economic growth – longer term things should improve and our expected demand shortfall should be no more than a one or two quarter event.

Further, there are conflicting signals in the US as international chemical pricing specifically could fall much more quickly than US domestic pricing (because the US market is very short of some chemicals today) – it could take a couple of quarters for the US to catch up.  Additionally, given the constraints on rail and road traffic in the US today, consumers of chemicals and plastics will likely be reluctant to play the inventory game because of supply delay fears – at the margin we have seen inventories creep up in the US for supply security reasons in recent months.

Quick Thoughts: AAPL – SURPRISE! AAPL beats! (actually, not a surprise)

Written October 20th, 2014 by

-          AAPL delivered 4QFY14 EPS of $1.42 on sales of $42.1B, handily beating the published consensus, on very strong sales of the iPhone 6 and 6 Plus that had been widely anticipated

-          Sales growth of 12.4% was the best since December 2012. iPhone unit sales of 39.3M were up 16.2% YoY, with ASPs up 4.3% to $6.02. iPhone is 56.2% of AAPL sales, up 340bp YoY.

-          Mac sales had a big quarter, up 18% YoY and 15.7% of total. The iPad franchise, down 14% to 12.6%. of AAPL sales, is deteriorating. iTunes grew 8% YoY, falling to 10.9% of total sales.

-          We expect another big beat in December. Increasing dependence on iPhone raises risks as high end smartphone market saturates. Strong Apple Watch sales needed to sustain growth in 2015.

Having already reported selling 10 million units during the opening weekend sales of the iPhone 6 and iPhone 6 Plus, and ongoing press commentary of the vigorous global demand for Apple’s foray into modern larger screen form factors, it would have been shocking if the company had not blown out the published consensus numbers. In that context, the fairly sleepy after-hours response to the obviously excellent results is not all that surprising.

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SSR Health New Product Approval Portfolios & Supporting Data Update

Written October 20th, 2014 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’ portfolios 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 (52% v. 31%) at a lower standard deviation annual of returns (11% v. 14%) 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 (68% and 79% v. 31%), though at higher s.d. of returns (25% and 43% v. 14%). Over the last twelve months, the 1%, 5%, and 20% pre-PDUFA portfolios have returned 43%, 66%, and 116%, respectively, versus 17% for the innovator index and 36% for the BTK, while also reducing relative risk

We expect US real pricing power for pharmaceuticals to fade, which will increase 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)

Please note: regularly included in this series of reports are detailed tables of all (major or not) pending new drug applications (NDAs) and biologics license applications (BLAs) for all US-listed drug, biotech, and research-based spec pharma companies; and, detailed tables of all phase 3 products under active development by these companies

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

Quick Thoughts – Initially Apple Pay More Disruptive Online than at Point-of-Sale

Written October 17th, 2014 by

Apple’s new iPads (iPad Air 2 and iPad Mini 3) announced today will have TouchID and hence allow for Apple Pay purchases within apps supporting the Apple Pay API (albeit not at point-of-sale since the iPads do not have NFC radios). Apple Pay becomes available in the US this Monday with the release of iOS8.1; the initial bank partners are AXP, BAC, JPM, C and WFC with a reported additional 500 banks signed up for the service since the initial announcement on September 9th and to be included over time.

A likely impact of reduced payments friction for online purchases (since using Apple Pay is easier than entering card credentials into a tablet screen) will be to close the gap between tablet traffic (at 17% of the e-commerce total) and tablet orders (at 13% of the e-commerce total); as shown in the chart below, the gap is even larger for mobile. Furthermore, Apple Pay will likely encourage consumers to shop more frequently via app than browser giving the app-provider (typically a retailer) more control over data and advantaging the app-provider in tracking digital ads and offers through to purchase. As discussed in our October 6th note, “Expect Data Partnership between Google and Visa”, the current difficulty in achieving this trackability is one reason Google reports “mobile does not monetize as well as other forms”.

Chart: Purchase Orders on Mobile and Tablets are Low Relative to Traffic


The mobile or tablet wallet is a marketing platform, not just a payment facilitator. Payments consultant, Richard Crone, noting estimates for the annual revenue potential from ads and offers at $300 per active mobile wallet user, has commented that banks would prefer to recapture this revenue from their own branded wallets. However, this is not possible with Apple Pay because its implementation through the Passbook app means that Apple controls the user experience and can shape the options for tender-steering and marketing. Banks have more flexibility on Android devices (KitKat and above) because host card emulation (whereby an Android device “emulates” a payment card by storing credentials in the cloud) allows them to control payments-branding; however, ad tech company Fluent reports that over two-thirds of mobile transactions are on iOS devices.

A specific example of Apple shaping tender-options is that PayPal is not included in Apple Pay. Indeed, as noted in our October 2nd report “The Closing Window of Opportunity to Broaden the PayPal Acceptance Brand”, we see new solutions to simplifying online checkout – including Apple Pay and Visa Checkout announced in July – as significant threats to incumbent solutions such as PayPal and Pay-with-Amazon that involve the increased acceptance costs and data-leakage risks of an intermediating payments “aggregator” that acts as merchant of record. This is not the case for Apple Pay which acts simply as a conduit, and costs the retailer no more than acceptance of the customer’s payment card.

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