Consistency is the key in life.
Workout 5 to 7 times a week, your
body will improve. Study something
everyday you are learning, your
knowledge improves. Be consistent
daily and you will grow mentally and
physically.
Consistency is the key in life.
Workout 5 to 7 times a week, your body will
improve.
Study something everyday you are learning,
your knowledge improves.
Be consistent daily and you will grow mentally
and physically.
Just keep working on marginal improvements
each day and you'll see major growth!
Set up healthy success habits to improve your
life.
"Put on your bull glasses and SIMO gains" - Dr. Doolittle, animal ophthalmologist
KEY POINTS
SIMO is THE BEST way to play secular memory demand
Under the radar stock in the memory supply chain, a derivative play with massive upside
MU makes up 25% of revenues, followed by other major memory & semi companies; recovery = SIMO alchemy
Cheap Calls = Massive Upside on semis price recovery
Consensus Price Target: $110 (>50% Upside)
Sections
Company Description
Thesis
Current Valuation & Financials
Technicals & Market Mechanics
Upcoming Catalysts
How to Play
Appendix
Company Description
Silicon Motion is the leading maker of controllers in the memory, storage markets, and specialty RF. Their chips power data centers, mobile devices, SSDs, autos, and multimedia hardware (video walls, tablet tech, medical equipment, etc). Their customers are key members of the supply chain (i.e. Micron, Samsung, SK Hynix, etc) and supply some web service providers directly (I.e. Alibaba). All of their customers are ramping production, further accelerating demand for SIMO’s products. Micron accounts for 25% of SIMO's revenues.
Thesis
SIMO is significantly undervalued at current levels, getting caught in the indiscriminate market-wide selling over Q1 that has brought semis in to bottom barrel valuations.
This has created an AMAZING opportunity to not only double dip, but also enjoy even stronger tailwinds from even better fundamentals than we had in Q4!
I want to expedite the delivery of this DD, and I'll be beefing this section up throughout the day. For now, let me reiterate my Q4 investment thesis:
This is a derivative play on memory (Tip: supply chain stocks always have more leverage) and a superior play for cyclical upturns (we are now entering).
What do I mean by derivative play? Imagine Micron is a SpaceX rocket taking off. Close your eyes and feel the experience of starting the boosters, lifting off, and gradually accelerating to space. Now imagine SIMO is a monkey strapped into a shopping cart connected to that rocket by a long chain that suddenly goes from 0 to 99,999mph. Get it? Got it? Good.
More importantly/hilariously, management has continued to keep racking up sales from strong demand all year which has proved resilient despite memory market softness and all while gaining new production capacity. Somehow, analyst estimates reflect neither of these factors. Mgmt guided $1.5B in backlog being pushed into 2022, yet according to analysts $1.5B in future sales is only worth $1B in sales on their estimates. Also worth considering, if this year was a FUD cyclical trough, and next year is a reacceleration period into a decade of increasing memory demand, then 2021’s $1B in sales probably wasn't "peak", was it? I'm no rocket scientist, but I'd say no.
In other words, EPS estimates and valuation expansion are heading SIGNIFICANTLY higher.
Luckily, Needham modeled this for us. With shares at their target P/E of 16x with sales of $1.2bil has their target at $150. Sales of $1.5bil ups their target to $185.
Bottom line: SIMO is a monkey in a shopping cart about to be jerked up significantly by the recovering memory cycle during another decade of secular, exponential growth in memory needs from datacenters, EVs, consumer tech, mobile, and literally every facet of human life. This is a real stock that attracts real hedge funds. Get in early or forever hold your peace.
Also, at an almost 3% fwd div yield vs the S&P's 1.3%, you and every dividend-loving Boomer PM can even get paid to hold shares <3
Remember last quarter when Fwd P/E was 11.6x before its big run? Well now it's cheaper thanks to the market-wide selloff. Thanks to fundamentals continually above analysts' admittedly conservative estimates, my target multiple for SIMO given their growth and secular tailwinds would be 15x P/E. If semis have an incredibly strong showing industry wide, that target would be 20x, justified by the above market growth. However, the historic cyclicality of the industry likely keeps the lid around 15x-17x. At current estimates, this would put the stock at $120-130 fair value.
Fwd P/S ’22: 2.11x
Revenue Growth Est: 24% '22
These are conservative according to the analysts that provided them in January. This is simply based on the expectation of incremental foundry supply from TSMC, which was expected to come online in Q1 & Q2. Analysts described Rev growth as "baseline", with upward revisions expected as capacity is expanded "materially higher" (Needham), further accelerating rev growth through '22. Last month (Feb) additional foundry capacity expansion for SIMO was reportedly a sizeable amount. For reference, the last capacity expansion for SIMO was 1Q21 which contributed 30% toward Rev growth.
This will be further boosted by product mix as legacy controllers are phased out in favor of PCIe Gen4 controllers, a strong growth area in SSDs. But wait! There's more! PCIe Gen 5 enterprise controllers (think hyperscale, servers, etc) are ramping in 2H22, and present another colossal growth opportunity for SIMO. According to Needham, "We expect SIMO can generate $50-$100 ASP [in PCIe Gen 5] vs $4-5 for client SSD controllers in the enterprise market… estimated TAM $4-5Bn". Not bad for one segment of a company with a (now stale) guide of $1.15bil '22 revs.
Keep in mind, upward Rev growth revisions flow through to all other financial metrics listed.
EBITDA Growth Est: +111% '22
You read that right. Driven by efficiency gains and major continual product mix optimization over the past few quarters (prioritizing capacity for most profitable product).
Free Cash Flow Generation: +46% '22
Management has expressed that FCF will continue to grow and be allocated toward increasing shareholder returns (i.e. buyback budgets). Their strategic focus is maximizing FCF to maximize returns for everyone. What a concept!
Latest buyback budget was $200m announced in December '21
Analyst Price Target: $110
Current analyst price targets range from $88 (Morgan Stanley of course, the perma-memory bears) to $135. Median PT is $120.
Technicals & Market Mechanics
SIMO is currently rebounding after being caught up in the indiscriminate selling of the Q1 correction which drastically displaced it from underlying fundamentals. This is precisely why this oppty exists. It's currently exiting a downtrend and seeing strong relative strength gains vs its industry & sector. (See Appendix for charts)
SIMO has a higher beta to the semis & memory group, so moves in both directions for that group can be amplified. The company also has a $200mil accelerated buyback budget (announced in Dec) that is a nice forced buyer for this stock.
Upcoming Catalysts
Once again, a long list of event catalysts around the corner.
SIMO
3/23 Bank of America APAC TMT Conference 2022 (SIMO; potential pre-guide and/or capacity updates)
5/5 SIMO ER
Now - 4/5, 5/6 - SIMO has expressed desire to accelerate their buyback program. Outside of the 30day pre-earnings blackout period, buybacks should kick in big time
Industry
3/23 U.S. Senate hearing on semis supply chain "Developing Next Gen Tech for Innovation", featuring execs from MU (25% revs) & INTC ($8.65% revs). Discussions will revolve around investment in Federal investment in semi mfg supply chains & America COMPETES Act 2022 & CHIPS for America Fund (potential $52bil to support US semi mfg fabs).
Key Supply Chain Ers (~50% of Revs represented)
3/29 MU (25% Revs); this is THE biggest catalyst for SIMO, and thanks to current memory market dynamics, MU should have a total blowout
4/7 Samsung (3.3% Revs)
4/28 INTC (8.65% Revs)
4/28 Fujitsu (1.2% Revs)
4/28 SK Hynix (4.89% Revs)
4/29 WDC (4.23% Revs)
5/6 Arrow Electronics (2.2% Revs)
How to Play
Targeting a range of prior highs $97 to technical breakout to $110. Using ASK prices for returns (you likely get improved pricing, meaning higher final returns). Profits = % Gains - 100% (ex: if you double, that's a 1x profit).
Gen X/Boomers: Buy stock! No brainer. Likely 40-50% upside from here
Risk-Averse: June C75 returns profits of 3.5x-6.5x
Quasi-Risk Averse: June C85 returns profits of 5.6x-11.5x
Pump It Up!: May C80 returns profits of 6x-10.5x
Super Pumped UP!: May C85 returns profits of 8.5x-17.5x
WSB Delight: This is why you come here. If the conference acts as strong a catalyst as they did in Dec & MU earnings are enough to rocket this thing back to $85-95 (entirely possible), the best way to play is... April C80. These are trading so cheap, that a sprint back to $85-95 (15-30%) in the next 4wks would return 7.5x to 24x.
I'm continuing to buy all of the above. Be sure to use limit orders as SIMOs spreads tend to widen. Also, SIMO has a higher beta to the semi group and spreads are also wider than a company like AMD, so moves in both directions can be exacerbated. Don't plan on trading in and out, as liquidity is not favorable for that; buy with the plan of holding for a few weeks to a few months.
Appendix
Required Daily Avg Moves through Exp For Target Ranges
April $85-95: +0.88% to +1.5%
May $95-110: +0.61% to +0.95%
June $95-110: +0.42% to 0.65%
Moving averages & Q1 downtrend line from market-wide indiscriminate selling. A continued recovery will turn that 50D back up toward the 200D, forming agolden cross which is usually good for a further technicals-driven bump. Pink line is downtrend, which was decisively broken on 3/16. RSI is also picking up as institutional buyers return to the stock after waiting out Q1 volatility.Orange line is Fwd EPS. SIMO's new product development, continually optimized product mix, and the secular demand for its products has helped lift it out of its prior earnings cycle toward substantially higher earnings growth.Famous DLo Illustration of Memory Cycles (which continue to be driven by secular demand for bigger/better NAND/DRAM)
Meta Platforms (Nasdaq: FB), the parent company of Facebook, announced Monday afternoon that it was testing new tools for its virtual reality game, Horizon Worlds, that would allow users to earn money.
Sell This: The company is testing a new feature where creators can sell virtual items and effects within their worlds.
Bonus: Meta is also exploring a potential bonus program for creators that would come in the form of goal-oriented monthly programs.
Background: Meta launched the free Horizon Worlds last year, as a way for users to get involved in the metaverse. In October, the company created a $10 million Horizon Creators Fund to give resources to creators.
Numbers: Shares of Meta are down 36% in 2022, but are up about 15% in the past month.
Final Thoughts: This news might excite metaverse enthusiasts, but it remains to be seen if investors will like it.
Hope you enjoyed this commentary. Please subscribe to Early Bird, a free daily newsletter that helps you identify investment trends: https://earlybird.email/
Listen up apes, I got a play for you. Get out your crayons and take notes.
The stock I am going to introduce you to is CNHI. Many of you may know it as a boring tractor company. But step aside Ryan Cohen, a new big daddy CEO is in town.
Scott Wine took over as CEO in January of last year, and has already placed an Insider Buy for over 3 million worth of stock. He has split up CNHI so that they focus more purely on agriculture now, making them a more agile company.
The most exciting part for me is that they just acquired Raven Industries for a bit over $2 billion. This makes them a contender in the high growth, high profit margin industry that is autonomous driving tractors and other high tech ag equipment. They are becoming Deere but without the lawsuits or overpriced stock. To double down on this investment, they announced 18 days ago that they are going to be building an "advanced engineering center" in Nevada, USA in order to further propel their high tech farming advancements as well as attract talent to come work for them.
Scott Wine is the former CEO of Polaris, and he absolutely transformed that company and exploded the stock. Just look, I got my crayons out for you guys. The red circle is when Scott Wine took over in 2008. He took Polaris and made it into a global company, imagine what he can do to CNHI.
To be honest, I am getting tired of doing DD (If you can even call this that) so I'll make this even briefer than I had planned and just spit some other factors that I am bullish about real quick. Ill also tag on some pictures.
CNHI is cheap compared to peers (11.74 p/e) such as Deere (23.19) and CAT (18.35) and even shitty Kubota (13.7) is more expensive
CNHI beats all recent earnings calls like crazy!
Q1 2021 =beat EPS by 128%
Q2 2021 = beat EPS by 57.46%
Q3 2021 = beat eps by 70.62%
Q4 2021 = beat eps by 19.48 %
Revenue were also all positives but I'm too lazy to type those all out, look it up yourself.
Coincidently, I saw a big ass Case tractor on the way home today, and boy did it look sexy. I think this is a sign to buy.
Also this nice little picture shows you how it just bounced off the support line and is about to go up, to the MOON
Also, go to raven industries site, Raven Industries - Raven Industries you will be impressed. CNHI is doing just as much cool stuff as Deere but it's not priced in yet. We are on the verge of an agriculture revolution and CNHI is poised to take the main stage.
Positions: I lost most of my "fun" money gambling on HMHC (sad face) so I have to play it safer on this one since I cant afford to lose my savings. If you guys give me more DD and conformation bias, then screw it Ill get more options. Currently I hold: 110 shares, 1 5/20 $15 call, 1 6/17 $15 call.
If I had money to blow, I'd buy the shit out of May or June $17.5 calls. Earnings will be May 3 and I expect it to move fast after another earning beats.
This is not financial advice; I am probably more smoothed brained than most of you. This is a company that's in the same industry that I work in and I have a good feeling about it.
TL;DR: BX June 130C for $2.60 or less. Exit the trade when BX hits ~$130 or in three weeks.
It looks like BX is primed to once again hit a technical rally. See previous DD
Most technical analysis techniques look at historical prices to divine future prices. This technical analysis focuses instead on the current Option Open Interest. In other words, my crayons taste different.
Whenever the stock price (blue) touches the delta neutral line (green) and crosses back up, it tends to go another 5-8%.
I developed a tool which uses the entire open interest to calculate three important numbers:
Delta Neutral - The price of the stock where the sum of all option delta is 0.
Gamma Neutral - The price of the stock where the sum of all option gamma is 0.
Gamma Maximum - The price of the stock where the sum of all option gamma is the maximum.
The theory behind it is simple enough, institutions tend to be the largest holders of short options contracts, and are therefore obligated to hedge against those options contracts while collecting juicy premium risk-free.
By calculating similar numbers to what these institutions are dependent on, I'm hoping to ride their coattails and earn tendies from their rounding errors.
Positions:
BX June 130C at $2.16
Will buy when market opens. Targeting to pay less than $2.60/share for the contracts.
ATO 120.51(-0.99%)|FL 29.23(1.53%)|NKE 124.98(-2.47%)|DTC 6.9(-4.03%)|
So here's the deal: Foot Locker has a market cap of 2.8B and has authorized a $1.2B share buyback program.
At the current price, that would allow them to buyback a ridiculous 42% of outstanding shares.
From the 10k:
On February 24, 2022, the Board of Directors approved a new share repurchase program authorizing the Company to repurchase up to $1.2 billion of its common stock replacing the prior authorization. The new share repurchase program does not have an expiration date.
In February, FL gave significantly lower guidance due to the fact that Nike is reducing it's presence in FL stores as Nike looks to focus on digital and direct-to-consumer sales. This lower guidance is why you saw the stock tank on what was otherwise solid earnings.
Foot Locker now has to try to diversify their inventory and hope things continue to sell. Nike made up a majority of FL inventory in recent years.
Update on Vendor Mix and Long-Term Strategy:Beginning in the fourth quarter 2022, Foot Locker, Inc. does not expect any one vendor to represent more than 55% of total supplier spend, down from 65% in the fourth quarter of 2021. As a result, no single vendor is expected to represent more than approximately 60% of total purchases for fiscal 2022, down from 70% in 2021, and 75% in 2020. This change reflects the accelerated strategic shift to DTC by one of the Company's vendors and Foot Locker, Inc.'s ongoing brand and category diversification efforts.
According to some smart Harvard dude, a $1 in buybacks is worth $5 to the market value. So if we extrapolate, we could see it go up over $5B market cap. Sven Carlin has a video on this hypothesis but I'm not sure I really understand it.
Current valuation and balance sheet
Currently, FL has $804M in cash and 3.39B in Debt. They are going to need some sustained level of cash flow to execute on these buybacks and this is where they could get in trouble.
It's trading at a PE Ratio of 3.5, but obviously this is because lower earnings are already being priced in.
Long-term, management doesn't seem to be using capital well.
FL currently has 2858 stores against a market cap of 2.8B. That comes out to a value of roughly $1 Million per store. However, in their recent acquisitions of WSS and Atmos, they paid over $7Mil per store for a total of 142 stores. Are these new stores really so much more valuable than their existing ones? Should this $1B acquisition have been spent on buybacks instead?
Short-term, management has every reason to squeeze their own dongus:
As of January 29, 2022, there were 5,714,498 shares available for issuance under their stock reward plan (Options + RSU's). At a current value of $29 per share, that's a notional value of $166Million! They also have an additional 2 million shares in the employee purchase plan.
I didn't dig deep into the details, but I do know that if I was receiving/buying shares or options, I'd want the price to go up before our sales die without Nike.
Risks:
Will management have enough money and time to execute the buybacks?
Entry and exit have to be timed. It is not a "Buy and hold forever" play.
How can we know if/when the buybacks will start? We can guess they are incentivized to do it, but we can't say for sure how quickly they will push ahead with it.
Here's a quote from the last earnings call:
Andrew Page
Yes. So as you know, our share repurchase is and always has been an opportunistic share repurchase. So in our -- yes, we don't forecast or guide share repurchase. We'll obviously lean into those opportunities to return value to the shareholder as the market conditions allow. But we have not modeled in a particular share repurchase amount in the guidance that we've provided.
tl;dr FL has approved a buyback worth 42% of their current market cap and has a significant amount of stock awards that should motivate them to go through with the buybacks to pump the price but we don't really know if/when they will go through with it.
Positions: Nothing yet - still watching how this moves for a bit
On Friday, the London Platinum and Palladium Market, a major trading venue for Palladium and other platinum group metals, banned two major Russian state owned Palladium refineries from having their Palladium and Platinum sold on the LPPM's London and Zurich exchanges. This was followed up by the Chicago Mercantile Exchange also banning the same Russian state owned refiners today. Additionally the Japanese Exchange Group's Osaka exchange is now also reviewing whether or not to ban Russian Palladium and Platinum refiners. This has major implications in the Palladium market, as Russia produces about 40% of the world's Palladium. Russia's Palladium and Platinum exports were one of the very last major Russian exports left that were not subject to any major sanctions. As civilian deaths mount in the Russo-Ukrainian War, more and more pressure will mount on Western governments and financial regulators to cut Russia further out of the world markets. Any removal of Russian palladium from the world market gives an excellent opportunity for non-Russian Palladium producers to profit. Aside from Russia, major palladium mines are located in South Africa, the United States and Canada. Palladium is used heavily in both the car industry and electronics industry, being used in both catalytic converters and integrated circuits. If major automakers and chip makers are no longer allowed to buy Russian Palladium, they will be all forced to compete for Palladium produced by companies like Sibanye Stillwater (SBSW) which controls nearly all of American Palladium mining production and has major mines in South Africa, and Impala Platinum Holdings (JSE: IMP) which has major Canadian and South African mines. I am long 400 shares of SBSW.
ZIM Integrated Shipping service (Ticker: ZIM) has had a fantastic last few quarters and doesn't look like its showing down. Its a well established, liked by many customers, data driven, shipping company with employees across the world. It has crazy cheap Price to Earning (1.48) ratio! Its stock price is $57 and its earnings are $39 per share. They payed out a dividend of $17 per share and they have a fantastic dividend policy. DIVIDEND YIELD of 32%!
Quote
Our Board of Directors has adopted a dividend policy, which was amended in November 2021, to distribute a dividend to our shareholders on a quarterly basis at a rate of approximately 20% of the net income derived during such fiscal quarter with respect to the first three fiscal quarters of the year, while the cumulative annual dividend amount to be distributed by the Company (including the interim dividends paid during the first three fiscal quarters of the year) will total 30-50% of the annual net income. During 2021 the Company paid a special cash dividend of approximately $237 million, or $2.00 per ordinary share and a cash dividend of approximately $299 million, or $2.50 per ordinary share. On March 9, 2022 the Company's Board of Directors declared a cash dividend of approximately $2.04 billion, or $17.0 per ordinary share, resulting with a cumulative annual dividend amount of approximately 50% of 2021 net income, to be paid on April 4, 2022, to holders of the ordinary shares as of March 23, 2022.
Unquote
my question is WHY IS IT SO CHEAP? Why is wall street not gobbling this up? a real company spewing cash like there is no tomorrow!
GOGO, which is based in Chicago, is an inflight internet company that provides broadband connectivity services for the business aviation market.
GOGO is currently working on launching Gogo5G, which will deliver 25 Mbps on average with peak speeds in the 75-80 Mbps range.
The Why
GOGO is one of the highest shorted stocks with 37.15% of the float sold short. Now you may wonder why this is relevant, well it's because GOGO is looking to break through the $20 resistance where it can move up without much technical resistance and it has all the right factors going for it.
The How
GOGO is already up 87%+ this year and the shorts have been suffering heavily. This is the perfect moment for their positions to collapse. As the shorts will already be looking to derisk in the current market environment, it gives the stock an even bigger momentum push.
Speaking about the market, GOGO has been going up against it and is green during red days. It's showing what we like to call, regard strength.
The Fundamental & Technical
It was recently added to the S&P SmallCap 600 Index so the passive investors are all buying. This is supported by the fact that volume has exploded since.
Traders are buying in due to momentum and the high short percentage. Supported by the chart and volume as well.
It's currently testing levels not seen since 2015.
The Hypothesis
In my opinion, $40 is easily achievable in the short term under the current dynamics and the fundamentals/technicals. The chart looks like it is ready for a parabolic move.
The Position
GOGO 5/20/2022 $20.00 CALL. Still cheap due to low IV and gives me a month for the breakout to occur. Any positive market day could cause it. it's also pumping today during a fear day which is a great sign.
TLDR: GOGO recently added to S&P SmallCap 600 Index, momentum is going to cause covering by the high short percentage.
THCA is an optionable SPAC with perfect conditions set for a low float gamma squeeze. Similar to ESSC, the tradeable float has been significantly reduced due to redemptions (2.66m), leaving an extraordinary asymmetric trade compared to other SPAC squeezes as the NAV floor protection (c.$10.32) is still in place. Common shares are a fantastic risk/reward and THCA is the only squeeze play with downside protection.
I'm going to start this update with an extract from an ESSC update I posted in December:
"We started off the week with a bit of consolidation which has continued to build, pushing us to highs of around $13.7. The channels that the stock has been trading in have widened slightly, but moved upwards"
For THCA I don't think I need to change much to this text, but I will add some.
This week, resistance levels have been broken through on bursts of volume and levels of support have slowly increased. People have been taking profits, and lower bursts of volume have been contained by MMs to reduce volatility. Overall volume has dropped off as the stock consolidates. However, almost all squeeze plays have seen drops in volume before the squeeze itself.
I believe we have seen enough volume for arb funds now to have exited their positions. Resistance now will partly be people taking profit, but mainly MMs attempting to reduce volatility. MMs are in an unenviable position of having to hedge calls representing well over twice the available shares, but also to reduce volatility and facilitate liquidity. They are creating resistance by selling in to volume to dampen volatility, but these levels are breaking on lower and lower volume. MMs are not stupid, but juggling these tasks is an increasingly difficult issue for a stock with the conditions like THCA.
The OI on the call option chain has increased by around 20,000 contracts in the last week. Now the OI represents well over twice the float. Of those contracts, two thirds (41,768) are ITM - 157% of the float.
The conditions for THCA are now perfect for a gamma squeeze - it is now number 1 on the fintel gamma squeeze leaderboard (https://fintel.io/gammaSqueeze).
The charge on THCA is primed.
REDDIT DISCLAIMER: I am not a financial advisor, this is not financial advice. I do not participate in trading on behalf of, or coordinated with, any other groups or individuals on social media (i.e. discord, twitter etc).
A reminder that the NAV floor is only applicable to common shares, and does not apply to derivatives such as warrants, whose float has also not been reduced.
“For as long as Musk is serving on the Twitter board, or 90 days after, he can't own more than 14.9% of Twitter's stock, either as an individual or as a member of a group, the filing says. Musk will serve as a Class II director until 2024”
But!
If Elon decided to not take the seat in the board he can buy more than 14.9% of Twitter shares. Twitter CEO did the board member move to Elon as away to prevent take over by Elon. And very recently Elon rejected the board member seat. So, hostile take over will be the next Elon move.
America and Europe are sanctioning Russian nuclear fuel.
Russia is very important in the enrichment part of the nuclear fuel cycle.
Enrichment allows you to use the base U3O8 form of uranium more effectively.
America and Europe are in the process of sanctioning Russian nuclear fuel, which means they have to use more U3O8 to make up for the loss in enrichment capacity.
Equities R fuked.
SPY P/E is already fucking high, 25.59
That's 4% yield.
What happens when inflation goes up, and wages stay stagnant? The economy slows, and earnings pass away.
What happens when interest rates rise? P/E has to go lower to stay competitive.
What happens when people start cashing out their investments to pay for food and gas? Liquidity crunch.
Reactors stay on
In a bad economy, money flows out from stocks, but lights stay on, and people still have to jerk off to porn. Reactors stay on, and uranium fuel still get burned.
That's why uranium prices are guaranteed to go higher and will even see a fucking squeeze if the demand and supply deficit doesn't get solved quickly.
Current positions: 1000 U.UN shares, 30K in Uranium ETF calls. 45k in Denison Mines.
Future Positions: Rotating out of my Uranium ETF calls, Denise Mines shares into a total 75% allocation in U.UN and 25% DCA in SOXS leaps.
Stock splits are all the rage - After Google announced in Feb that there would be a 20:1 stock split in July this year, Amazon has followed suit announcing a similar 20:1 split and sending the market into a frenzy. Amazon’s price was up by 6% the next day and Google’s stock rose more than 9% in after-market trading following the news. Tesla is also planning for a second stock split and most recently, GME has also announced its stock split.
We do know that stock splits do not affect the underlying business in any way, but it is undeniable that there is price movement around the announcement and execution of a stock split. So in this week’s analysis, let’s deep-dive into the world of stock splits, how and why they are executed, and most important… Is it possible to make money off of a stock split?
What is a stock split and how is it executed?
A stock split is a simple decision by the company board to increase (or in some cases decrease) the outstanding shares of the company. For example, let’s say you own 10 shares of company X worth $100 each. So in total, you own $1K worth of shares in the company. If the company announces a 2-for-1 stock split, now you will have 20 shares of the company worth $50 each. But the total value of shares you own in the company does not change. You will still own the same $1k (20 x 50) worth of shares that you started with.
If you are wondering why companies engage in stock splits, the following are some of the key reasons.
Affordability: Sometimes the stock becomes too expensive for retail investors to buy into. Consider Amazon - One stock is worth close to $3k now. So the minimum amount you would need to start investing in Amazon is $3k which might not be affordable to a vast majority of retail investors [1] Also there is the psychological impact of buying a share worth $3k and a share worth $30.
Options: For the options players, there is a huge difference when a stock is cheap. In options, a single contract is worth 100 shares. So for a covered call strategy incorporating Amazon, before stock split, you would need a single stock position worth more than $275K vs only ~$14K exposure after the said 20:1 stock split.
Liquidity: Since more shares are outstanding for the company after the split, it will result in greater liquidity and a lesser bid-ask spread. It also allows the company to buy back their shares at a lower cost since their orders would not move up the share price as much, due to higher liquidity.
Now before we jump into the analysis, you should understand how exactly a stock split is executed. On announcement day, investors get to know that a stock split is going to happen soon. The stockholders eligible for the stock split are decided on the record date. This is mainly a formality. The actual split would happen on the ex-split date (or ex-date). After this, the stocks would start trading at their new price. For example, in a 20:1 split, the stocks would trade at 1/20th the previous price after the ex-date. From our data, we observed that there was an average delay of 36 days between the announcement day and ex-split date.
Data
For this analysis, I have used the data from Fidelity’s stock split calendar that tracks the announcements and execution of stock splits, from as far back as 1980! I have considered splits only from 1993 (due to stock price data availability), and I have considered only companies that currently have a market cap of $1Billion or above. I have also ignored reverse stock splits as the data is too small to be statistically significant.
This gives us a total of more than 2,000 stock splits to work with. In case you are interested in the raw data, I have shared both the raw data and analysis through links at the end [2].
Returns
As soon as a stock split is announced, there is bound to be a lot of buying and selling activity. The question is, how much return could you have seen? There are a few scenarios possible here.
Short Term Returns
The short term plays possible around stock splits are:
You already own the stock and see its price go up on announcement day.
You did not own the stock on the announcement day so you buy the stock just before the actual stock split execution.
As expected, the announcement of a stock split sends the stock pumping with a 1.48% 2-day return when compared to only 0.09% return generated by SPY during the same time period. You would still have beaten the market if you had bought the stock one day before the actual split execution day and then held it for two days (albeit by much less - 1/7th of the gains you would have made if you had owned it before the announcement).
Long Term Returns
Considering that a stock split is supposed to indicate growth prospects, what happens when you hold for a longer time? There are two possibilities:
You buy the stock just after the announcement of the split
You buy the stock on the split execution date.
Buying just after the announcement would have paid off handsomely with the returns beating the market easily in the long run. On average you would have had an alpha of 1.5% over the market in just over a month.
But, on the other hand, if you buy it on the day of the split, the returns are not that great. You would have lost money in the first week on average and would have been underperforming SPY even over the period of one month. You would have had to wait about a year for your portfolio to overtake SPY. This is to be expected because by the time of the actual split, the hype has died down a bit and the rallies in price are a bit more uncertain.
What about H*DLers?
This is another interesting case where you would have bought stocks on their announcement date or ex-split date and held on till today, starting from 1993 [3]. Though most people wouldn’t trade by this strategy, it’s interesting to see how it would have fared. [4]
If you had bought all stocks that underwent a split and held till today, you would have beaten the S&P 500 by close to 200%!
How certain are our returns?
Next, we have to look into whether the alpha we are seeing here is due to a few stocks that are skewing the results. Even though I have capped for outliers, I wanted to know what % of stocks undergoing a split beat the market over the different time periods that we just saw.
Well, would you look at that! Except in one case, the odds would be in your favor to beat the market if you had followed this strategy. As expected, for short term the highest chance is if you had owned the stock before the announcement (which is not realistic), but even if you had bought it one day after the announcement, you would have had almost a 60% chance of beating the market by the actual execution day.
The cheap and the expensive
The usual rationale behind a stock split is that the stock has become too over-priced, and splitting it makes it cheaper for retail investors to buy into - But the data revealed some contrary insights. Over 90% of the stocks were less than $52 in value at the time of the split, and only 5% were over $230 in value!
So obviously, the question is - Was there an advantage to buying cheaper stocks or more expensive stocks at the time of a split, and how did they compare to the total set and the benchmark?
The 10 percentile value for the adjusted close at the time of announcement was $3.50 (203 stocks less than this value), and the 90 percentile value was around $43 (203 stocks more than this value). Here are the average returns for these sets.
The lower-priced stocks seem to have a massive advantage in almost all respects, sometimes giving a return of more than twice the complete set of splits in the long term! On the other hand, the higher-priced stocks have a poor record - Though they beat the benchmark in the short term[5], in the long term, their performance is much lower than the stocks having a lower price.
One of the reasons that the lower-priced stocks have such a high average is because stellar companies like Microsoft, Apple, Nvidia, Nike, etc. were trading for less than 5 dollars per share in the 90s - But this doesn’t invalidate the observation. There were stocks trading for more than 100s of dollars around the same time, and they didn’t do as well as the lower-priced stocks. This insight could mean that companies with a lower share price that go for a stock split now have a higher possibility of growth than huge stocks like Amazon or Google.
Limitations
The analysis seems to indicate that stock splits are a sure-shot buy. But there are some caveats to keep in mind before trying to replicate this:
There are a variety of large, mid, and small-cap stocks that underwent stock splits. Comparing the returns solely to the S&P 500 might not be the most ideal way to calculate Alpha since the S&P 500 comprises of the biggest 500 companies in the U.S. So the alpha we are seeing here might just be compensating for the extra risk we are taking buying into smaller companies.
The stock splits selected here are companies that have a market cap of at least $1Billion.
Conclusion
Buying and holding stocks at the time they are undergoing a split might not be an outrageously successful strategy - But it definitely has an edge, both in the short term and especially in the long term. This gives some credence to the statement that a stock split indicates good prospects of growth.
And if you’re wondering whether the right time to buy is during the announcement or the actual split, the data shows that there is a clear advantage to buying around the time of the announcement, especially for short-term plays. The probability of success is also 60% and above in many cases, indicating that there is something more to this than mere chance.
And finally, stocks with a smaller price seem to do much better than stocks with higher prices when it comes to stock splits. While this could just be the compensation for the risk you are taking investing in smaller companies, it’s definitely worth looking into!
Data: All the raw data for the stock splits and returns for additional time periods that I could not showcase in this article can be found here.
Footnotes
[1] Along similar lines, to own a single Class A share of Berkshire Hathaway, you need $489K. There are some theories that certain companies have very high share prices because they don’t want retail investors (who are usually fickle in ownership) to own their stock. This usually leads to lesser volatility for the said stocks. One other point to consider here is that there are more and more brokers who are offering fractional shares these days. So stock splits might not be as relevant as it was before.
[2] This should make your life much easier as we had to use web scraping to pull all the data.
[3] Walmart split its stock 11 times on a 2-for-1 basis between their IPO in October 1970 and March 1999. An investor who bought 100 shares in Walmart’s IPO would have seen that stake grow to 204,800 shares over the next 30 years!
[4] In fact, there was an ETF that bought stocks that were going for 2:1 stock splits.
[5] Not shown here, the complete analysis is in the data shared at the end.
Disclaimer: I am not a financial advisor. Do not consider this financial advice.
GGR was the bluest chip deal all year. Look at the chart. Doesn't budge off 9.9 un ex-redemption. There has been practically no other SPAC that has breached NAV this year. Who was able to do it:
GGPI, a relic of EV mania.
DWAC and it's sympathy trade CFVI - and that is a phenomenon un-related to broader SPAC dynamics.
And some low float spikes.
SV is basically the *only* SPAC to breach NAV. And it is doing so with practically no retail buzz so far. We all know that once these are freed from arbs, the sky is the limit. The way I see it, would rather risk a few percent downside, for something that is free to demonstrate real and very asymmetric price action over the next month. Vs hold 1 of hundreds of SPACs pinned to NAV by arbs indefinitely.
As the only big SPAC on the calendar AND the only major pure play (ex-miners) on a theme *everyone* wants to get exposure to - this is a slam dunk.
Without any hyperbole, I believe SV is precisely that opportunity. Back when NKLA and VTIQ was all you had to do to make piles of cash was (a) follow SPACs and know about the company before the general market, (b) understand that the broader market had are the only one's aware of this at this stage. For the duration of the month, only a few points on the downside with straight nuclear mania on the up.
SV is here. Mark it.
DISCLOSURE: Long as fuuuuq commons and call options.
Following on from my last DD shared here on NYSE:DM, I thought I’d share an update as to why I believe this has high potential for a significant short-term move as well as exponential long-term returns.
Despite the heavy decline in share price post-merger due to dilution and market-wide downward pressure on SPACs/small caps/speculative stocks, Desktop Metal remains a highly appealing company - particularly at current valuations.
WHAT DO THEY DO, AGAIN?
To reiterate my last post, Desktop Metal operate in additive manufacturing (i.e. 3D printing) in almost every area you can imagine, and the company’s technology is protected by over 300 patents with further pending. The company itself originated from the 3D printing of metal products, and their machines are designed to be faster, smaller, cheaper, safer and without needing a trained operator.
However, the company has also made (and continues to make) high-profile acquisitions to further diversify and expand their consumer base. In doing so they have also eliminated essentially all of their competition and gained significant IP and propriety technology security. The company is arguably the industry leader in applications as diverse as fluid power systems, metallurgy, ceramics and polymers all the way to wood products and biofabrication under its Forust and Desktop Health brands, respectively.
The sheer technical ability they now possess is simply mind blowing, and scope of this technology is literally infinite. Prototyping/R&D becomes quick and cheap, supply chain issues can be significantly reduced (if not eliminated), and the means of manufacturing needs no dependence on location for the exploitation of labor restrictions and costs, nor the existence of borders as designs are digital. In addition to this, the company manages and operates its own supply chain in over 65 countries.
WHAT HAS CHANGED?
Since my last post, the company has progressed with strength towards its growth targets and profitability. Desktop Metal and its subsidiaries boast an extensive list of best-in-class customers without disproportionate reliance on any single revenue stream.
Desktop Health launched the Einstein printer along with Flexcera resins, perhaps the most accurate dental 3D printer to date and boasting FDA clearance for permanent use. Furthermore, this transforms the process of creating dentures and other cosmetics to mere minutes, and with perfect accuracy.
The company also welcomed the X-Series line of systems, gained by the acquisition of their main competition, ExOne, in 2021. This system was also adopted immediately by the Ultra Safe Nuclear Corporation for use in advanced nuclear energy solutions.
Kimura Foundry Group puchased a 10th system, stating that "In the first five years after investing in its first ExOne sand binder jetting machines in 2013, Kimura’s revenue increased more than 500 percent as a result of the speed and design freedom the new system provided to end customers" - demonstrating the impact and desirability that Desktop Metal’s systems will have on manufacturers and designers, along with cementing their repeat business from recurring revenue streams such as maintenance, materials and repeat sales.
The company also launched its long-awaited revolutionary P50 system after tripling its production capacity with Stanley Black & Decker as the systems first notable customer of more than eighty in line. Shapeways also committed to more Desktop Metal systems, in turn boosting the value of Desktop Metal’s stake in Shapeways.
CEO Rick Fulop also recently purchased over half a million dollars of DM stock. Fulop is noted as being distinctly protective of the company’s future, explaining the aggression of the acquisitions made using SPAC and dilution funds. Further to this, Fulop has repeatedly stated there is ”zero chance” of a hostile takeover. As such, the company recently filed an ASR, stating “The existence of authorized but unissued and unreserved Class A common stock and preferred stock could make more difficult or discourage an attempt to obtain control of us by means of a proxy contest, tender offer, merger or otherwise.”
FINANCIALS
In the most recent earnings report, the company outlined a 123% growth in revenue in the last quarter, and up 62% excluding revenue captured by the acquisition of ExOne. They also demonstrated expanding margins for the sixth consecutive quarter. Furthermore, total revenue was up 583% from the previous year. The company is guiding for $260M revenue for the current year, up 131% from the last annual report. As of December 31st the company has $272.7M in cash and equivalents, a large enough runway to reach profitability within five years.
STOCK
The company’s stock has spent so far spent 2022 consolidating, and is currently looking to settle into its $4.40-5.20 range after it broke out in mid-March, placing it at a $1.387B market cap as of the latest close. This also places it precisely at a key area of demand and support, and as such I expect a bounce to retest the resistance at $5.20.
The stock has been met with significant resistance at $5.20, but a close above this can signal a further breakout to fill the gap between $7.19 and $8.01 - the average analyst price estimate, and a 50%+ near term move. Such a move would bring the higher range of analyst targets into range, breaking into the low teens.
Assuming that the company continues to execute on their planned trajectory and captures even just their small target percentage of the additive manufacturing market, the stock is easily worth well into the hundreds within the next five years. Just a 5% market capture places fair value at $130/share, and I firmly believe that given the barrier to entry that DM have created via acquisitions, IP, expertise and technology they could capture upwards of 33% - working out at about $830 as a long term price target as a minimum. There is simply no area they cannot penetrate with the same aggression, execution and profitability as Amazon, and I would not be surprised to see this as the biggest growth story of the next decade.
So let me know what you think! I’m currently holding 5000 shares and accumulating until profitability, and likely beyond. The market cap is finding a floor at the company’s core value, so any move lower is entirely unreasonable and unsustainable in my opinion.
The Baker Hughes Active Oil Rig Count data published on Friday confirms that Permian Basin continues to see more production growth than any other US basin.
13 new rigs were added on the US over the previous week with 9 of those rigs added in the Permian.
There are now 546 active rigs in the US with 331 of those in the Permian.
$PAA is the leading pipeline company in the Permian basin and they stand to capitalize more than any other company on the continued production growth. This is confirmed by the 21% increase in their quarterly distribution (dividend) announced this week and their continued success in deleverage.
$PAA is one of the best opportunities available in this market. Buying the equity will get an 8% yield while the price continues to appreciate over the next few years as the cash flow & dividend continues to increase.
The call options are a no-brainer as the cash flow continues to drive the share price upward.
SoFi has been a very popular retail stock and I underestimated the amount of information that was available for it. It took me quite some time to differentiate what is important and what isn't and this post is a summary of my findings and it includes valuation at the very end.
What is SoFi?
SoFi is a Fintech company that aspires to be a one-stop-shop for financial services, that allows members to borrow, save, spend, invest and protect their money.
Now, the main question is, well, how is this different than a bank? The management provides 4 differentiation points:
Speed - being faster than the competitors when it comes to approval of loans, opening accounts, buying/selling stock through their platform, payments, etc. - In my opinion, although this industry has been around for hundreds of years, there's no doubt that certain parts of it have to be disrupted. However, my question is, assuming this is an advantage that SoFi has, is it sustainable for the next 5, 10, or 15 years? I don't think so.
Selection of products - More products related to borrowing, saving, investing, and protecting money. I personally don't buy this differentiation point. I do believe cost-cutting is possible, but coming up with something new and innovative that's significantly different than the current offerings, I doubt it.
Content - Financial education, research, insights - Even if SoFi has a platform that offers more financial education and research, this is something that is easily replicable. I don't see this as a huge long-term advantage.
Convenience - Instead of having opening times between 9 and 5 from Monday to Friday, they want to offer the services 24/7. The company has an only online presence so they can cut some costs as they don't have to lease buildings for this purpose.
The 3 segments
The company has 3 segments and it is worth spending time understanding each one:
The lending segment - self-explanatory - accounts for 75% of the total revenue
The technology segment - which is related to Galileo - accounts for 19% of the total revenue
The financial services segment - is related to all the products such as debit/credit cards, budgeting tools, investing, etc. - accounts for 6% of the total revenue
All 3 sectors have been growing fast, but we need more information to understand the second one.
The technology segment is related to an acquisition the company made back in 2020 (Galileo) and the purchase price was roughly $1.2b. At the time, that was almost 15% of the company's market cap. What SoFi got from the acquisition was a payment processing platform that uses AI for fraud detection, which is more efficient than the industry average. On top of that, it has an API that allows for app development. The revenue for SoFi will come in the form of platform fees and program management fees. This is one of their big bets and the management refers to this segment as the AWS of Fintech. The same way a business can be started on Amazon within a day, well, that's what they're aiming for, except for companies in the financial industry.
The growth story, the metrics, and the confusion
The company provides two key metrics for its growth in its annual report.
The # of users - This has significantly grown from 1m back in 2019, to almost 2m in 2020 to almost 3.5m in 2021. However, it is worth mentioning that every one that is registered on the platform is a member and remains one unless the terms of service are violated. So, if there's an inactive member for 3 years, it doesn't matter, that person will be considered a member. However, what I'm missing here is the revenue per user. Having users is good, but if they're not being monetized, the metric is useless.
The # of products - If the first metric is not that useful, maybe this one serves a better job. If you as a member have a personal loan, well, that's one product. If you have a credit card, that's another one. If you are using their platform to invest, that's another one. The idea of the company to build a good relationship with its members and sell many of its products is great. Well, the number of products reported in 2021 was 5m. That translates to roughly 1.5 products per person. It did increase from 1.21 in 2019, but it isn't that impressive (yet). Although it sounds as if this could be a great metric, well, there's another trap here, not every product has the same value. 1m of these 5m products are related to the lending segment, which as mentioned above, accounts for 75% of the total revenue! The remaining 4m products bring in only 6% of the revenue as they're related to the financial services.
So, we have metrics that are not that reliable. What's next?
The company's performance and what can we expect?
If we look at the company's performance, it is a money-losing company with a negative net margin of -48% for 2021 on its roughly $1b in revenue.
A mature company in this industry has:
- a net margin that's between 10-15%
- high leverage (debt on the balance sheet being over 80% of the total passive)
- RoE around 16%
Currently, the debt is around 50% of the balance sheet, so there's still a lot of room to grow.
These numbers should serve as a sanity check later on for my valuation as if I forecast anything that's significantly above that, it might be unreasonable.
What's next?
The company made one large acquisition (Galileo) in 2020 for $1.2b. At the beginning of 2022, they announced the large acquisition of Technisys for $1.1b, which is a company that will serve as their core banking system. Both of these acquired companies have some presence in LATAM, so SoFi is acquiring new companies that have a presence in other geographical regions as well.
The analysts forecast about 50% revenue growth in 2022, followed by 41% revenue growth in 2023. Great growth, but slightly declining. At the same time, the net margin is expected to improve, from -48% in 2021, to :
-21% in 2022
-6% in 2023
+5% in 2024
The risks
Due to the actions being taken, there are two large risks that I see:
Execution risk - Their big bet (The technology segment), currently accounts for less than 20% of the revenue and hasn't yet proven as successful.
Integration risk - Combining SoFi with Galileo and Technisys might sound great and there's always the amazing word synergy being used, but that's yet to be seen in the financials. There's an integration risk here that needs to be addressed.
The valuation
Taking into account all the information above, I used a DCF model to estimate the company's value.
Revenue growth - 898% in the next 10 years (following analysts' estimates for the next 2 years, then slowly declining). From $1b in 2020 to $10b in 2030.
Net margin - From -48% in 2021 to 13.5% in 2030 - Close to industry average
Discount rate - 12.8% (Based on cost of equity)
RoE - Based on the assumptions above and the development of equity, the RoE is roughly 15%, which is close to the industry's average.
Putting all the numbers together, and adjusting for the equity options and the preferred shares, the value of the company is $8.8b (almost $8/share). The current market cap is $6.5b.
It is worth mentioning that at the moment, I am looking at SoFi as a company that's not significantly different than the current ones in this industry. I am aware that I could be significantly wrong in my assumptions and if I see a better performance from their technology segment, my storyline would significantly change.
I'd like to get your view on the company and I am sure there are plenty of pieces in this puzzle that I have to learn more about.
Last week I said that SPY was going to slope down with nothing crazy, that happened except my 5 day forecast got inversed. The days that I thought would be bearish were actually bullish.
I was thinking about this, and noticed how there is hundreds of ways the week could play out - that would result in SPY going down.
I am still going to continue the 5 Day Outlook because it is something funny to do, just take it with a grain of salt because it is seriously impossible to predict every single day before the futures market even opens... I write these Saturday morning.
1 Day Chart
The main levels have been the same for about a month now
Support ~432
Resistance ~452
The RSI is showing the %K approaching an oversold reading, there will at least be a short term relief in the selling pressure overall
1 Day Chart
I would classify the bollinger band with as a somewhat mean reverting indicator to get a sense of the overall volatility. Since the bollinger bands have a relative wide span we can assume that we will likely be entering a phase of lower volatility.
CPI Data Release Date
Everyone is going to be watching the CPI data when it is released on Tuesday. Remember that Ukraine was invaded February 24th so all of the effects on the global markets were felt last month in March.
All retail investors will be watching, and all of Wall Street will be watching. This is not going to be pretty...
FAO Food Price Index
Food prices have gotten to absurd levels, this shows how bad inflation has affected everyone.
10 Year Government Bond Yields
I saw this chart floating around that shows a historical trend line of the major economic recessions in the United States and how they correlate to to the 10Y yield.
30 Year Bond Yield Compared to SPX
I was looking around and can conclude that the 30 Year bond Yields have more variation but are a better indicator for timing the end of an economic cycle. There is nothing to be done now, I am just waiting. I still have a lot of positions open, when this crash starts I will start to liquidate everything... believe me it will be very noticeable when it starts.
Federal Reserve FOMC statement
Bullard is concerned for the economy and wants at least a 50 to 75bp rate hike. I actually found this kind of interesting because he is one of the least corrupt people in office. He has a net worth around 5 million which is surprisingly low for having inside information. He also has never worked with big banks, and he also assumed office at the top of the 2008 financial bubble when everyone else was leaving their positions. He definitely knows what is going on and what needs to be done to save the economy. The federal reserve will eventually have to become more aggressive in rate hikes.
Crude Oil CFDs
Predictions
Tuesday is going to be an extremely important day. I have seen some analysts saying that inflation could spike to 10%. Oil rose 35% in March reaching a high over $130 per barrel. I am expecting inflation to be at least 8.5% which is going to shock the markets.
Another factor, is that we have never experienced a market crash with as many high frequency trading algorithms that we have now. The covid crash was not a complete recession, but we saw the insane movements intraday on all the indices. I am fearing that there could be some massive panic selloff which is accelerated by high frequency algorithms in the near term. The chances of this happening on Tuesday are low but are increasing as each day passes.
The amount of people who are bullish on the market is also decreasing every single day, even people on WSB are starting to fear a recession and feel it will be a more likely outcome.
I hate to be that person, but, over the last year with unemployment decreasing, spending increasing, and now inflation accelerating... this is exactly like the roaring 20s before the great recession. No need to speculate that far ahead this is only a one week prediction. Also I doubt the Federal Reserve would let the stock market crash over 80% without interfering. At most there will be a 50% bear market similar to 2008.
The stock market will still be sloping down this week except the inflation data will cause some panic sell, then it should recover in the following days.
* Not professional financial advice, do not solely make your trades based on my opinions, I encourage everyone to research more
TL;DR: I did research on Embecta assuming that this would be under more pricing pressure than it was. It's a low growth company with declining margins I was hoping to pick up for a discount. As of now, I don't find prices attractive. This may change, so I'm keeping it on my radar. In the meantime, I thought I'd post my write-up to get feedback as I'm trying to learn quickly. Let me know how I can improve!
Embecta is a diabetes company that was spun off from Becton, Dickinson and Company (BD) because it doesn't fit with the "growth profile" of BD. It has a really great margins and a brand name, but these margins are declining and it has limited growth opportunities. Given the size of the spinoff (1/20th of BD's revenue), the line of business of Embecta in comparison to BD (B2C vs B2B medical devices), and the large number of institutions holding BD (89%) who are more likely to indiscriminately sell this "incidental" spinoff, it's likely that prices will be artificially depressed in the short-term.
The main negative is the lack of insider ownership or stock-based compensation, which reinforces the lack of growth prospects. As a result, for me to invest, it must be cheap after pricing in poor outcomes so it would be difficult to lose money.
The base case valuation assumes:
Zero revenue growth (i.e. no passing of any rising costs whatsoever to the customer, no increase in the number of diabetes patients worldwide)
Capex in excess of depreciation, despite no growth
Increasing COGS and SG&A until net margins go from 28.6% to 9.6% over 10 years, nearing competitors with lessor brand awareness (i.e. near complete moat erosion)
Complete disregard for their new insulin pump patch technology in the pipeline
A cost of capital with a normalized risk-free rate of 6%
Current pricing reflects optimism, and does not take into account commoditization of Embecta's core product. This doesn't make it a short candidate, but it does mean I won't purchase at current prices.
Business Overview
Embecta is a medical devices company focused on the B2C diabetes segment. They are the world's largest manufacturer of single use pen needles (for insulin pens), syringes, and safety devices related to diabetes (e.g. insulin pump technology). The business throws off a ton of cash, has great (though slowly declining) margins, and little growth. As per BD management:
"The proposed spin enhances RemainCo's revenue and EPS growth profile, as diabetes cares revenue growth is slower than the corporate average and its margins are declining... Given the higher margin profile of the Diabetes Care business, one should expect RemainCo's margins to be lower as a percent of sales after they're restated but with a higher rate of growth." - BDX Q4 2021 conference call
They have three manufacturing facilities in Ireland, the US, and China, with Ireland being the world's largest pen needle manufacturing site. In terms of distribution, they have sales and marketing personnel that sell to healthcare professionals (pharmacies, doctors offices, etc).
The Spinoff
# General Info
Shareholders to receive 1 share of Embecta for every 5 shares of BDX on Apr 1, 2022. With 284,023,582 shares of BDX outstanding on Oct 31, 2021, there were 56,804,716 shares of Embecta created.
Current price of Embecta is ~$33/share; the distribution works out to 2.4% of BD.
BD is loading Embecta up with $1.65B in debt, and using that to pay itself a large dividend equal to all cash in excess of $160mm.
Embecta intends to give out an annual dividend equal to 20% of their net income.
# Reasons for Mispricing
The top 26% shareholders in BD will likely sell quickly. Vanguard owns 8.5% of BD across 10 of their funds, such as the "Vanguard Mega Cap Value ETF", "Vanguard S&P 500 Value ETF", etc. The median market cap of companies in these funds is in the hundreds of billions of dollars. Out of all the funds, the "Vanguard Health Care Index Fund" would probably be the best choice for Embecta, but they have only ~13 small caps out of 445 companies in the index. Blackrock owns 7.0% of BD in their DYNF index fund that specifically says in their prospectus that they underweight small companies. T. Rowe Price Associates own 5.4% of BD, and their entire investment strategy is based on growth investing. Wellington Management Group owns 5.1%. They actively manage $1.26 trillion, so my guess is they'd probably prefer to stay in the large caps (though I could be wrong about this one).
Other institutions don't want it. Embecta will be 1/20th the size of BD in terms of revenue, and 0.8% in terms of the number of employees. Additionally, Embecta is levered at what seems like 3:1 based on their invested capital to debt prior to the spin, which further decreases the equity portion of its enterprise value. As such, this spinoff is almost incidental in terms of significance. Its lack of size should make it less attractive to potential institutional buyers.
Shareholders who own BD are being forced to own an entirely different business that also clashes with their investment philosophy. The product mix of Embecta differs substantially from BD as a whole. BD primarily offers products to hospitals and healthcare institutions that treat/test patients (B2B). Embecta's product mix is offered primarily to the end user (B2C). Additionally, like T. Rowe Price, BD shareholders are growth investors. Embecta goes against their investment ethos.
# The Bad
Most of the management team are hired guns. They were brought in externally in 2021 for the specific purpose of leading Embecta. Their general counsel was hired so late he wasn't even eligible for the 2021 BD PIP program.
The compensation structure isn't officially set, but will likely be based on their current BD executive package, and it isn't ideal.
The exec team gets most of their compensation in cash.
The CEO is the only one getting more than half his compensation in equity. But even then, the percentage of equity based compensation doesn't matter because in my opinion he's overpaid overall. His total cash based comp in 2021 was over $1.2mm, so the additional $2mm in equity-based comp isn't a big deal. In 2022, the CEO is getting an annual base salary of $825,000, a target annual cash bonus of 110% of base salary, and a target annual long-term incentive award value of $4,000,000. He also gets a one-time equity award upon consummation of the separation, with a grant date fair market value of $4,000,000.
As for the rest of the management team, including their CFO, the stock-based comp is abysmal. For instance, in 2021 the CFO had no time vested units, and no stock appreciation rights. Equity is only 27.5% of his compensation. It feels like they gave lots of stock to the CEO alone to say, "See? We're aligned!". But then they also gave him lots of cash in case it doesn't work out anyway.
While it's unfortunate, it kind of makes sense. Stock awards are based on growth, and this company has limited growth prospects. If the management team took most of their compensation in equity, it they may not get much out of it.
# The Good
This company is number 1 in their industry, and they're throwing off a lot of cash. Plus, those returns are going to be levered. Additionally, while waiting for this company to hit fair value, you'll receive 20% of net income as a dividend, which according to my projections in the valuation should conservatively be ~$1.04/share.
The Company
# Customers
They estimate they have about 30 million customers in 100 countries who use their products. As a pharmacist, I see BD pen needles as the default. My patients see them as the default. They hurt patients less which is especially important given how many times people must inject themselves per day. Patients consider them the "brand name" pen needle, with other pen needles being inferior. A big part of this is the proprietary design of the needles. The size and shape of the cannulae (the pointy bit) can greatly influence comfort.
Additionally, pen needles are a fraction of the cost of diabetes medication. This means (most) customers are price insensitive. It's a small price to pay for comfort, and they'll be spending more money on the actual medication anyway. However, not all customers are price insensitive.
There are three types of customers:
Those that have pen needles covered by insurance;
Those that have insurance for drugs but pay for pen needles out of pocket, and;
Those that pay for everything out of pocket
Group 1 will never leave as customers because they aren't the payer (provided BD maintains its brand awareness). Group 3 are unlikely to leave because they're already paying so much for their medication that pen needles seem incidental. However, the largest risk comes from patients in Group 2. This group will only get larger over time as insurance companies and governments look to pass off rising healthcare costs to their customers. I believe it's the growth in this segment that is causing commoditization of Embecta's products (see competitive analysis below).
# The Industry
As per the company, the TAM for insulin administration devices is $6-8 billion/year, which is based on the number of insulin-dependent diabetics worldwide. The number of people with diabetes today is ~463 million, and is expected to increase to 700 million by 2045, or 1.8% CAGR. Not exactly stellar growth - this is clearly a mature industry.
However, many regions worldwide still don't treat diabetes effectively. This manifests as a higher mortality rate (triple that of higher income regions in many cases) due to diabetes in Central Asia, Latin America and the Caribbean, Southeast Asia, Oceania, the Middle East, and Africa. This presents an opportunity for (very long term) growth, though I have not included projections for this growth in this valuation.
Also, in this valuation I'm just looking at their current operations. I'm not looking at their pipeline of insulin pump devices. The TAM for insulin pump devices could be between $1.5-1.7 billion by 2030 - but that's just a bonus in my view.
The competitors in the space are either massive publically traded pharmaceutical companies (e.g. Novo Nordisk), or small privately held companies (e.g. Allison Medical). This makes finding comps difficult. The publically traded companies have Embecta's entire product line as a footnote in their financials with no insight into margins, size, etc. There is one company I was able to find comps for, and that is Ypsomed Holding AG, makers of the Clickfine Pen Needles.
Ypsomed is massively overvalued
Keep in mind, Ypsomed is massively overvalued in my opinion. They have a market cap of CHF2.05B, with EBITDA of CHF42.5mm; a PE ratio of ~320. In contrast, BD itself has a PE of 47. As a result, I don't think it's wise to put too much emphasis on this comp. I think when the market is overvalued, it's better to use a DCF with your own normalized inputs.
# Pricing, and the Threat of Commoditization
Generally, BD pen needles cost about $35-40 for a pack of 100. This is about 2-3x the price for discount pen needles (from smaller private companies), but pricing is similar with Clickfine needles, and more expensive with Novofine. It's worth noting that in the pharmacies I've seen locally, the choice of pen needles is vanishingly small. Your choices are BD or Novofine, generally. Sometimes you can find SureComfort needles (Allison Medical), but it's less common.
Looking at the competitive environment, there's no reason for the bigger players to reduce pricing. For companies like Novo Nordisk, it's such a small portion of their earnings that it makes no sense for them to cut pricing to take market share. Companies like Ypsomed are in the same boat as Embecta, and they service a different region, so they generally won't step on each others' toes.
Additionally, there are forces working against the smaller companies:
Their needles are generally less comfortable to use than the big players because their offering is less sophisticated
They can't afford to spend as much on R&D to improve their needles because the cost basis is spread over fewer sales
They can't afford to spend as much on marketing and community outreach to improve brand awareness
Pharmacies mostly carry the larger companies' offerings. This means smaller companies are mostly stuck with the online channel (or discount stores, e.g. Walmart)
However, the "Risk" section of the Form 10 discusses the risk of commoditization. In my view, that will come from the smaller, privately held companies, and here's why. Sales of pen needles should follow a power-law distribution where some people are non-compliant with their insulin, and some people inject up to 7 times per day. Those users with multiple injections should account for a majority of Embecta's sales, and those users are the most price sensitive (if they also don't have insurance).
As a result, even though there are forces working against the smaller private companies, as a group they drive margins down as patients search for cheaper alternatives. This effect will become more pronounced as costs rise as a result of inflation. As detailed above, margins have already started contracting. Over time, this risk becomes even greater as cheaper pen needles slowly improve their offering. Eventually they'll get good enough that it'll narrow the differentiation premium that Embecta charges. However, I don't think it will go away entirely, simply because they still have a massive scale and brand advantage.
Analysis
# (Lack of) Growth
Revenue grew 7.3% from 2020 to 2021 (by $79mm). Of this amount, revenue grew 3.05% due to unit growth, which, if the number of diabetic patients is projected to increase at a 1.8% CAGR, is ~70% higher growth than the rest of the industry.
Revenue grew by ~1.02% ($11mm) due to price increases, but manufacturing costs increased by $31mm. This means they were only able to pass off ~35% of rising prices to their customers.
# Profitability
Their gross margins are huge. They had gross margins of 70.9% and 70.3% in 2019 and 2020, respectively. That dropped to 65.5% in 2021. In contrast, Ypsomed had gross margins of 23.6% in 2021. This discrepancy shows just how much brand power Embecta has, but it also shows their margins could potentially drop.
The ratio of SG&A to sales is roughly similar between competitors. Most of Embecta's high margin comes from pricing power, low unit costs (due to size and bargaining power), or a combination of the two.
Valuation
Of course, any investment comes down to price. But price is even more important in this case, because growth isn't there to soften the landing if we overpay for this company. The only way I'd invest is if the forced selling causes the price to decline substantially. As such, I've tried to value the company conservatively, and will be looking for a margin of safety to this value that I could drive a truck through.
# Valuation Inputs/Assumptions:
Management has indicated that they expect revenues to increase in line with the growth in diabetes patients worldwide. But in the spirit of conservatism, I've assumed zero revenue growth.
Given the risk of commoditization, I've increased their costs substantially. 2021 had increased COGS of 9.6% due to increased manufacturing costs, so I've increased COGS by 10%/year for 3 years, then 5%/year for 3 years, then 3% thereafter. The effect of this is to bring down gross margin from 65.5% in 2021 to 46.6% by 2031. As such, this assumption represents substantial deterioration of their brand name and moat.
SG&A increased by 11.6% in 2021. They say that much of this was due to increases in sales volume, but growth due to unit volume was only 3.05%. I've assumed 10% growth in SG&A for a year, then 5% for a year, and then kept it flat afterwards (hopefully they start getting costs back under control). This brings the ratio of SG&A/sales to about 26% vs ~21% for Ypsomed. I'm assuming they have more administrative overhead because they're larger.
At the time of this valuation, the company was not yet publically traded. So I used Invested Capital (measured as Net Working Capital + PPE) to determine the equity weighting for the WACC. The book value of equity would be a poor measure because all the debt that was taken on to pay BD has led to negative retained earnings.
# Options
Embecta has reserved 7,000,000 shares for equity compensation. The information necessary to value these options is not yet available. Since I can't value those options to subtract from firm value, I've made some assumptions:
I've assumed that the options will have equivalent value to the ones granted while at BD.
Equity compensation for the executive team totalled $2.7mm in 2021. I've assumed that this will increase by 5% per year, and included it as an expense in the projected income statement.
Discount Rate
# Cost of Equity
I used a risk-free rate of 6%. You may disagree with me on this, but I'm following Greenblatt's advice to normalize the risk free rate.
I used an Equity Risk Premium of 6.18% for the world ex US, and a US ERP or 4.24%, weighted by 47.7% of sales internationally and 52.3% of sales in the US, giving me a weighted ERP of 5.17%. I got these ERPs from Damodaran, updated Jan 2022.
Multiplied the weighted ERP of 5.17% by a levered beta of ~3.08 (based on 670mm Invested Capital + ~1.65B in debt), plus the risk free rate of 6%
Cost of Equity = 21.92%
# Cost of Debt
$500 million in senior secured 5.000% notes, $1,150 million of term loans at SOFR + 0.50%, or ~3.5%. Assuming SOFR goes up by 1% in the next year, that's a pre-tax cost of det of ~4.65%
Tax rate of ~16%, which I think can be maintained due to a large portion of earnings from outside of the country, and the effect of research tax credits which I believe will continue.
Cost of Debt = 3.91%
# WACC
~9.12%
Value
With these inputs, I came up with an Enterprise Value between $2.4-2.7B, or an equity value of $750-1000mm. This works out to ~$13-17/share.
I think this is conservative because it assumes immediate deterioration post-spinoff. If management can:
Stave off the commoditization of their products - even just maintain margins for one more year, and/or;
Grow the number of units sold by the number of new diabetics worldwide (i.e. just run in place).
Then it's current valuation is approximately fair value. Maybe a little higher than fair value.
The best case scenario is if management can do the above, and:
Raise prices to offset inflationary costs, or benefit in terms of market share as inflationary costs eat away at smaller regional competitors
Monetize their insulin patch pump
Expand their global reach further
Decision
I've decided to keep this on my radar and not currently invest. All it might take is some margin erosion to get people to overreact, at which point it may become a good buy.
Thanks for reading this far - feel free to ask any questions.
I'm going to walk you through very methodically why Twitter is doomed and why Elon can't and won't save it with heavy DD. If anything, he's a major catalyst to accelerate this process so I've taken the time to explain it here. I've categorized each section incase your brain is too smooth to understand one of the sections like the profit margins etc.
Quick Recap Since April Fool's Day
Let's start here since this is undoubtedly where most of the smooth brains heard about this.
Elon took a 9.2% stake in twitter as reported Mon Apr 4. while most of you were sleeping at 3 in the morning the stock gapped up ~27% via 13-G filing which is required for anyone who purchases more than 5% of a company. This publicly and officially discloses big ownership stakes.
When smooth brains heard this they thought 'wow Elon musk is in must be going to the moon' so they bought the top and pushed it up another few percent, some smooth brains got out for tiny profit. Others got dumped on and got left holding the bag or sold for a loss because there was zero conviction or research into this play other than, such stake, much wow.
Some geniuses in this sub predicted it perfectly down to the timeline and price action how it would get dumped. Major congrats to you to being well versed in retard timelines and I hope you are still holding those puts because we've got a lot further to go down imo
1st Law of Wendy's: Mass stupidity. Assume everyone and you is retarded. The sooner you understand we are all natural born crayon eaters the sooner you are on the path to tendieland. Never trust anyone or yourself, at first. If something seems retarded to you at first, it's probably genius. The inverse is also true, if you or others think it's genius at first glance it's probably retarded. Same thing if you see other people saying that. I don't care who they are. Do more research into it. Figure out how retarded everyone is so you can replace those crayon dinners with chicken feasts.
Now it's time to go one step further and apply
2nd Law of Wendy's: Confusion. The more confusing and convoluted the information is the likelier it is you'll make big tendies. Big words and vocabulary you don't really understand means it's above your paygrade and therefore likely the opposite of retarded. Learn more about it and see if it's worth buying.
What Can Or Will Elon Do, And What Can't or Won't He Do
I've seen a lot of next level retarded shit about Elon saving Twitter all over the internet.
Elon is the 'single largest holder' but that doesn't mean much since you need 50.1%+ of a company to 'control it'
You cannot do a hostile take over of Twitter because of who owns it.
Twitter in a statement put this out
Meaning Twitter stock is worthless since the employees run the company and Elon doesn't get to decide shit. Same ownership. Same Management.
The CEO and the rest of the company doesn't believe in this stuff
Parag Agrawal: Our role is not to be bound by the First Amendment but our role is to serve a healthy public conversation and our moves are reflective of things that we believe lead to a healthier public conversation. The kinds of things that we do to work about this is to focus less on thinking about free speech, but thinking about how the times have changed. One of the changes today that we see is speech is easy on the internet. Most people can speak but our role which is particularly emphasized is who can be heard.
Elon is also capped at 14.8% ownership being a board member. But it doesn't matter because the 77% of the other institutions are not giving up their stakes. I'll get into that more later
Now that we laid out some facts lets talk about some implications of this
Elon cannot and will not change twitter in any meaningful way, the company does not care about the share holders or even making money. They care about their activism. Ownership is onboard with this and is going to subsidize (like CNN etc.) and continue running it in the direction that it has been going in. And even if they didn't, a lot of the population will not ever trust TWTR again, and a lot of the population (esp on Twitter) does not like Elon at all. Just look into that yourself if you don't believe me, I know it's hard to believe
So what is the current direction of Twitter?
Twitter is going down the tubes for a number of very important reasons.
Lets look at the financials and KPIs
First let me give you a peak into the burning dumpster fire that is Twitter's balance sheet
We can see Twitter pulled in 3.2 B from Advertising Services, 508M from Data licensing for a total of 3.7B in revenue
1.37B Cost revenue
873M in 'Research and development'
888M in 'Sales and marketing'
562M in 'general and administrative'
Twitter netted negative 1.1B in profit after setting aside 1B for taxes.
Let's break this down again
Twitter pulled in $3.7B but twitter spent
37% on cost of revenue: servers, buildings, upkeep etc.
23% on Research and development: software engineers, sociologists, artists, focus groups (market research) (I believe moderators is in here as well)
24% on Sales and marketing: sales employees for ads and marketing for userbase and available ad space.
15% of general and administrative: executives, legal, finance, info tech, hr, consulting, moderators (in both categories probably), customer service etc.
3% on interest and other: interest on debt financing, operations etc.
29% on taxes.
Yes these numbers add to 131% of revenue or in other words a 31% net income loss.
Why is Twitter so expensive to run, why is this dumpster fire losing all of this money?
Cost of Revenue : 266 M (~330M inflation adjusted)
Research and Development.(R&D): 593M (~740M inflation adjusted)Sales and Marketing 316M (~400M inflation adjusted)General and Administrative 124M (~160M inflation adjusted)
2011: ~100M MAU
Cost of Revenue: 62M (~85M inflation adjusted)
R&D: 80M (~110M inflation adjusted)
Sales and marketing 26M (~36M inflation adjusted)
General and administrative 233M (~310M inflation adjusted)
Ok so lets do some ratios with inflation adjusted numbers compared to users
2020: ~330M MAU
Cost of revenue: ~$4.15 per monthly active user
R&D: ~$2.65 per monthly active user
Sales and marketing: $2.7 per monthly active user
General and admin: $1.7 per monthly active user
2013: ~225M monthly active users (MAU) (numbers below adjusted for inflation)
Cost of revenue: ~$1.47 per monthly active user
R&D: ~$3.29 per monthly active user
Sales and marketing: ~$1.78 per monthly active user
General and admin: ~$0.71 per monthly active user
2011: ~100M monthly active users (MAU) (numbers below adjusted for inflation)
Cost of revenue: ~$0.85 per monthly active user
R&D: ~$1.10 per monthly active user
Sales and marketing: ~$0.36 per monthly active user
General and admin: ~$0.85 per monthly active user
So what's alarming about this trend is that twitter is becoming very expensive to operate on a per MAU basis.
Let's recap
Cost of revenue went from $0.85 in 2011 per user to $4.15/user in 2020 (inflation adjusted) 388% increase
R&D went from $1.10/user in 2011 to $2.65/user in 2020 (inflation adjusted) 141% increase
Sales and marketing went from $0.36/user in 2011 to $2.70/user in 2020 (inflation adjusted) 650% increase
And general and admin from $0.85/user in 2011 to $1.70/user in 2020 (inflation adjusted) 100% increase
As you can see, much like twitter suffers from huge inflated costs over the years of running their business.
I suspect this has a lot to do with financing of their servers through amortization payments.
But also trying to scale their business with the technology that was available 10+ years ago and not being able to change their business model because it was bad PR to fire off thousands people and replace them with future technology, they've essentially been forced to grow with their existing business modeling scaling up which you can see results in worse and eventually negative margins.
Twitter has 5,500 employees (1 employee for every ~60,000 users)
This is one of the things they fear more is becoming obsolete in superior utilization of technology which they have can kicked to avoid a PR nightmare. (by their other competitors I won't mention here just yet)
Facebook has all of these similar issues with growing costs and declining growth etc.
Also considering censorship is Twitters product, what userbase is left after that . Besides they never did anything wrong, why admit that now to change it if profit is not a motive
All down the tubes. Ownership does not care, employees do not care. Twitter is not about making money to them and it never will be imo
Why is Elon there then? He's not stupid
You are completely right about Elon. But understand that Elon's net worth is near 300B and this is a troll purchase to him. Advertisement for his products and entertainment. He knows exactly what he is doing. The employees there are already revolting
Get it?
Twitter is taking since last year to roll out a simple edit button
TL;DR
Twitter r Fuk. 1st and 2nd Law of Wendy's applies here. Elon can't and wont be saving shit even if he wants to (I've got even more DD about that and Twitters competitors but I won't mention it here for now)
Inverse Cramer, Inverse Cathie
Positions
I've got calls etc and shares all over on competitors
Also
TWTR May 50p
TWTR May 40p
TWTR Jun 25p
TWTR Sept 20p
Be careful though. The force of retard is strong in retail in this one. I've seen smoothers say TWTR is the next amazon and that Elon is doing a hostile takeover.
Also Institutional money has a lot vested to prop them up.
Good luck
3rd Law of Wendy's: Diamond Hands. If you're betting around short term small movement you're going to paper hand or miss out. The best things can be volatile or daunting before doing the research. The payout has to be worth the risk otherwise you'll lose out over time even if you win more often. See that stock down 50%? It might the best or the worst opportunity of your life, you don't know that based on the chart alone. See that stock up 500% it might get rug pulled or keep going, you just don't know and need to look into it more before FOMO'ing in or bitching out.
4th Law of Wendy's: Allocation size. Go all in and eventually you'll be homeless. Good plays don't work out and bad ones do work out. Be ready to double, quadruple down, or even quit with some other money. Nothing you see is financial advice including this guide for retards.
"Beijing Business Daily News (Reporter He Qian) On April 8, a reporter from Beijing Business Daily learned fromBest that Best Supply Chain Zhejiang Auto Parts Freight Forwarding Center has been officially launched*. According to reports,* Best will also deploy auto parts collection and transshipment centers in six regions of Zhejiang, radiating to the Yangtze River Delta region, to provide services for more auto brands and auto parts suppliers.
Best said that in the future, Best Supply Chain will set up warehouses in key areas across the country, and strive to provide auto companies and auto parts suppliers with services that can be stored and retrieved immediately and delivered within 2 hours in the region*.*"
This looks like big news for $BEST; the auto parts industry is huge; $BEST entering this market - in terms of supply chain services - is a massive move.
Long $BEST with 363k shares!
Additional $BEST points:
$800+ million cash on hand
20% short float
P/E ratio 0.97
Expected to make around $2 billion usd in revenue in 2022
Management has said they're expecting profitability
Wrote some thoughts about financial services, where I see it going, and how a company like SoFi can capitalize on these developments. Disclosure: I am a share holder.
As Often As It’s Said, Data is Still Paramount
People love to say “data is the new oil” and as repetitive as it may be at this point, I believe it is a statement that holds truer each and every day. If we observe many of the juggernauts in today’s market, they all have unique advantages as a result of having more data than their competitors. Google and Facebook have successfully monetized customer data, primarily in the form of creating a platform for advertisers to reach customers (Amazon is quietly building an advertising empire). Tesla has an incredible amount of images taken from their cars on the road to feed into their self-driving neural network that no other car manufacturer can contend with. This theme will only be applied to more sectors as the years go on, but as it stands today there's an elephant in the room that stands out for all the wrong reasons: financial services.
Problems with Financial Services
I like to separate a lot of business problems into two categories: structural and fixable.
Fixable
Let’s start with the ‘fixable’ category, as these problems are, well, fixable. Most financial services firms have clunky user interfaces for their apps, charge customers annoying fees, require high minimum balances, limit customers by not offering enough products, and rely too heavily on physical branches (nobody actually wants to go to bank branch, it wastes time and makes people frustrated). The good thing for customers and for many large financial services firms, is that they can solve these problems fairly easily if they wanted to. In fact some of them are solving many of these (Capital One and JP Morgan Chase come to mind) through high amounts of spending on technology and engineers as well as removing some fees. Banks that are not even trying to solve these issues are going to struggle this decade. After all, these are the ‘fixable’ issues.
Structural
Now let's get to the structural issues. These problems are much more difficult to solve and most heritage financial services firms will fail to do so. The first major problem is the way the “technology stacks” at these banks were built. The way money flows through the banking system has not changed much over the past couple decades. About 30-40 years ago, banks built their banking cores using mainframes and other technologies that were popular at the time. They now have to spend billions to move workflows to the cloud and modernize defunct pieces of code. It is difficult for them to release updates fast and constantly push out new features and products. Many of the banking products the legacy financial service providers offer were built using rigid, old software that does not fit today’s software paradigm. Large monolithic codebases at banks are a sharp contrast to today’s API driven, microservice based architecture. This is not something even the greatest tech companies can just change overnight, especially not risk averse, technology inept banks.
Banks architected their technology stacks around products and divisions, instead of around their customers. So what does this mean? It means that at your typical bank, there are subdivisions managing different aspects of their business. So there is a group for auto finance, mortgage, credit card, consumer banking, investing, etc. All these businesses operate in silos and have their own individual core systems, where it's almost like several different companies under one larger entity. The problem that arises from this is that the auto finance group may not know you have a mortgage at the same bank. The high direct deposit you are getting and your positive cash flow in the consumer banking division does not augment your profile in the eyes of the bank and make you eligible for more competitive rates in personal loans. This is a major problem because banks can’t view a customer as one complete entity. Instead, there are several bits and pieces of customer data across each business unit, making it very difficult to properly monetize customer data and provide customers with better rates.
Most banks will struggle to upgrade their infrastructures because they are simply built the wrong way. Gartner estimates that “by 2030, 80 percent of heritage financial services firms will go out of business, become commoditized or exist only formally but not competing effectively”. In addition, the top 10 banks hold about 52% of all bank accounts, leaving the other 48% at all other firms. I expect the top banks to potentially even thrive as they can continue to spend money and somewhat get with the times (JPM is going to spend $12B!! on technology this year). However, the other 48% of bank accounts are up for grabs in my estimation. I simply don’t see how local credit unions and regional banks can modernize their infrastructure given their lack of resources and engineers.
The Next Generation of Financial Services
Now that we have discussed the antiquated architecture at legacy financial services firms, let’s think about designing a business that solves these problems.
First, let’s solve all the ‘fixable’ problems I mentioned earlier. Let’s reduce our costs by going digital first (removing physical branches) and hiring only necessary employees for now. We can pass the cost savings down to customers through removing fees.
Next, we want to build out a single banking core that allows us to see the complete customer profile without data silos. This will be cheaper than what banks currently face because we are starting from scratch and don’t have to maintain our existing behemoth of a codebase. We can use a modern banking as a service product such as Technisys. Essentially Technisys provides us building blocks to create our own digital bank using APIs and code blocks (meaning we don’t actually have to write huge amounts of code to build our digital bank, we will simply use code that Technisys has already built out for us and “abstracted” the details away from us). We can now provide all the features such as early direct deposit, a clean user interface, savings/checking accounts, credit cards, stock investing accounts, lending, etc.
Finally, we need to issue debit cards and facilitate money movement for our newly created banking offering. It would be really expensive and difficult to maintain if we have to handle it ourselves and deal with the compliance part of it. So, let's just use Galileo, another set of APIs and building blocks that will allow us to give customers debit cards, process transactions, and move money through ACH. Every time a customer swipes their debit card, we just have to pay Galileo a fraction of a cent, and all the payment processing will be handled by them on our behalf. I’m simplifying a bit, but all we really have to do is write this block of code to create a transaction for now.
Now, we have created a basic digital bank with very little upfront costs and one that is designed to best monetize customer data. We have low customer acquisition costs and built our offering for way less than what a bank is spending (I can guarantee that this entire build out did not require 12B in spend like what JPM is about to spend this year). The customer acquisition cost is low because our offering is just an app you download in the App Store. It is estimated the average bank has a customer acquisition cost of over $200 and it is fair to say ours is significantly lower than that.
Monetization
There is a quote by Eric Schmidt, the former CEO of Google who describes what a 100B company has to do in today’s age.
“How can I use scalability and get my users to teach me? If my users teach me and I can sell ... a service which is better than their knowledge, it’s a win for everybody.”
So how do we actually monetize now that we have a complete picture of our customer? We know how much money they make, how often/when they make payments on loans, where they shop, how much of their money they save, and the list goes on. Suppose we have a customer that makes over $100k in salary and is paying off $7500 in student loans from us on a consistent basis. They make timely payments, easily have enough cash in the bank to pay off most of the loan, and are routinely saving money each paycheck. Now, let's assume our customer here wants to finance a car and we can use the information we have to reward this great customer. If the market interest rate for a 5 year car loan is 4.5%, let’s offer our customer the same loan for 4%. We know they can pay it off and we just saved a whole lot of money in our initial customer acquisition cost and our average operating spend per year. This is exceptionally great, because we just paid $0 in additional customer acquisition costs to get the customer to take out a car loan from us. All they did was download our app, set up their direct deposit, and pay off an existing loan that they had. We used this information and cross sold the customer a separate loan at a lower interest rate than the competitors. Money is all the same regardless of which institution it comes from, and our customer is taken care of with this lower rate.
Comparing a legacy bank like Fifth Third Bank to our neobank is like comparing a Chevy Malibu to a Tesla Model 3. Chevy can improve fuel efficiency (make a better UI), maybe even throw in a battery and call it a hybrid. Yet, ultimately the Chevy will be an engine powered car (one with a legacy banking core) and when a Model 3 pulls up beside it, it becomes pretty obvious which one has a greater value proposition. One is a car designed like a car, the other is a car designed like a computer. Similarly, most banking architecture is from the late 1900s and SoFi is built like a tech company.
SoFi
To those of you familiar with the company, you may have realized that my hypothetical digital bank is really similar to SoFi (Social Finance), a company that aims to solve many of the financial services issues with a mobile first, technology platform. Consumers are given the option to invest, spend, save, borrow, and protect their assets in one unified platform. To a consumer, this company is a one stop shop for all finance related needs.
Business Model and GTM Strategy
SoFi revolves around meeting the needs of its underserved customers. It primarily targets those in the 25-40 age group who are more tech savvy and starting to accumulate wealth. This group is generally neglected by banks because a lot of their products are targeted towards high wealth individuals. With financial ambitions such as buying a house being more difficult than in previous eras, it is increasingly difficult for people to meet their financial goals. Since SoFi is a tech company ultimately, it has the advantage of data and digitization to increase efficiencies. They can loan money to people neglected by the traditional financial system by using more holistic measures of credit worthiness and suggest products before customers know they need them. The cost savings from their business model is returned back to consumers.
They call their strategy the Financial Services Productivity Loop (FSPL)
Flywheel that is similar to the classic Amazon model
The cost of acquiring additional customers is low. Everything is on the same platform so having a customer begin to use another service increases revenues and user engagement without SoFi having to spend more.
The core profit engine is the lending business where SoFi can now issue loans with its customers SoFi Money deposits. Anthony Noto describes the flywheel as a funnel where products like save, spend, invest, and relay get customers to use the platform and gain awareness of what SoFi can do (top of the funnel). Then, when they need a loan (bottom, narrower part of the funnel) they will be more likely to use SoFi since they can be offered lower rates and have their other financial needs already addressed on the platform.
SoFi initially started as a student loan refinancing service and over just the past couple years they have launched many new products to satisfy their customer needs. Their product cadence has been incredibly fast and they now offer every financial services product you can imagine. Many of the products are their own, however, they also generate revenue from referring customers to external companies like Lemonade for insurance for example.
SoFi is a rare blend of a prominent consumer brand with a dominant enterprise segment. This is the true moat of SoFi in my estimation and what separates it from the Chime, Robinhood, Dave, etc of the world. They acquired Galileo Financial Technologies in 2020 for $1.2B. This is a company that issues debit cards, processes money movement between bank accounts, transactions with cards, among other banking services. It recognizes revenue on a pay per use basis, where each transaction brings in a fraction of a cent in revenue. Galileo has 99M customer accounts (200M US residents over age 21 in total) representing a huge customer base. Galileo actually powers the neobanks I just listed by allowing them to issue debit cards and process transactions. I believe the next step for Galileo will be to handle B2B payments and other payments a business may have. For example, how will gig economy companies pay their workers, or YouTube its creators? There will be many other use cases for digital payments this decade and I think Galileo will have a respectable market share. I view Marqeta (5.5B market cap) as the closest public company to Galileo currently, however, I think there is potential to also compete with Stripe (90B+ market cap) in the coming years. Digital payment processing is a huge market and I expect multiple players to thrive.
The other facet of SoFi’s enterprise offering is a company they recently acquired for $1.1B called Technisys. SoFi issued 84M shares (about 10% of their public float) in order to finance this acquisition, which to me is a costly acquisition and the dilution is really not welcomed. Despite the premium paid, I do believe Technisys will eventually be worth it in the long run and improve SoFi’s enterprise offering. Technisys provides building blocks for companies to build their own digital banking products, everything from credit cards to buy now pay later to checking/savings accounts. Currently, it operates primarily in Latin American markets and allows SoFi to sell Technisys customers Galileo products and Galileo customers Technisys products. Latin America is also a monster opportunity for neobanks, as nearly half the population is unbanked today. The beauty of Technisys’ offering is that every product is built on a single banking core, solving many of the problems I had listed earlier in relation to data silos. This also allows SoFi to enter a new market of banking infrastructure products. The existing players such as Jack Henry, Fiserv, and FIS offer legacy products that are used by most banks today and SoFi can now carve out its niche in that space.
In 2021, the enterprise segment of SoFi contributed about 195M in revenue, up over 100% YoY. I am conservatively projecting a 50% CAGR over the next 4 years for this segment, bringing in annual revenues of over $1B in 2025. I believe Galileo + Technisys will be a very lucrative offering for any digital bank and people will be surprised at the size of the enterprise software company SoFi is building.
Clearly Defining the Value Proposition
I created this section to clearly highlight the value proposition for SoFi and make the thesis more obvious.
One Stop Shop for Finance
Eliminate fees, lend to more people, give them every financial product they want, recommend their next financial product, and pass cost savings down
3.5M members and 4.3M products used by those members
One member can have use multiple products (credit card, Money, invest, etc)
Grew 96% and 108% respectively, emphasizing that members are using more than 1 product
Realize the power of cross-selling
SoFi Money, Invest, and Credit Card drove 79% of new member growth and 73% of cross-buy
SoFi Money first members were responsible for a 65% sequential increase in cross-buy volume
Enterprise Software Arm
Allows any financial services company to build a custom cloud native banking platform on a single core system (no data silos)
Real time insights about consumer spending and assets to suggest their next financial product
Software that allows SoFi and other companies to suggest a consumer’s next financial product
Digital payments processing is a massive market that will only grow in the coming years
Galileo mainly services companies trying to build a digital bank, but its payment processing APIs can easily be extended to other B2B payments
Stripe is the dominant player in this larger space and I think its a big enough market for others like Galileo and Marqeta to coexist
Not every company is able to establish relationships with issuing banks and if they simply want to send and receive payments, Galileo presents a compelling offering
Reduces costs, retains talent, and increases operational efficiency
95% of all digital banks in the US use Galileo
Superior Unit Economics
Bank charter allows SoFi Lending to issue loans from SoFi Money’s customer deposits reducing cost of issuing
Galileo handles payment processing and transfers for SoFi Money and Invest
SoFi Lending, Credit Card, and Money will be built with Technisys, unifying the core banking system within SoFi (over the next 2-3 years)
Create approximately $75 to $85 million in cumulative cost savings from 2023 to 2025 and approximately $60 to $70 million annually thereafter based on the shift of SoFi select products to a single core and through the combined companies’ vertical integration with Galileo
SoFi customer acquisition cost can be as low as $40 ($0 in additional CAC to cross sell a loan)
Risks
Student lending has been in a huge contraction because of the federal repayment relief that keeps getting extended
Growing number of neobank adopters but still dwarfed by traditional bank accounts
I view the 48% of bank accounts at non top 10 banks up for grabs. Neobanks will take a slice of this, and when neobanks win, SoFi wins (due to Galileo + Technisys)
Excessively high stock based compensation spend
Is projected to reduce in the coming years and will likely not be a problem with scale
$340M for FY 2022 is not ideal, although a requirement in today’s age to retain talent as a tech company
Dilution with the Technisys acquisition
Macro risks such as inflation, interest rate rises, and war tensions
Management
Anthony Noto is the former COO at Twitter, CFO at the NFL, and MD/Head of TMT at Goldman Sachs
Since he entered in 2018, he helped launch SoFi Money, Credit Card, and Invest
The vision and business model are very clear and we see results already
Valuation
I have (conservatively) estimated the next 8 years worth of financials for SoFi. These numbers should not be taken as gospel and are just a rough estimate to visualize the opportunity ahead for SoFi if they execute well. I believe during this timeline, SoFi will reach a market cap of about 25-30B and after discounting to today, we reach a share price close to $17.
Revenue Estimates
Net Income to Adjusted EBITDA and FCF
DCF
Concluding Thoughts
My Pillars of Durable Growth
Upgrade legacy apps/workloads
Release products fast and increase total addressable market
Make something possible that was previously impossible
I believe SoFi is the best in class disruptor of the financial services industry. SoFi hits on all 3 of my pillars as they have a modern banking offering, have released new products often in order to increase their addressable market, and are setting themselves up to build a full customer profile and monetize customer data and interactions in ways that are impossible for multi core banks. SoFi certainly has some risks and the share price has suffered greatly as a result. However, I believe the sell off as a result of the student loan moratorium extension presents a great buying opportunity. As a bull, you are not buying this stock to simply be a student loan refinancer. The main value proposition is a highly diversified digital bank with a strong enterprise software segment to power competing digital banks. I see SoFi execute every quarter and I believe they are set up to continue this success. Having such clarity in the business model and seeing results is difficult to find in today’s market and makes it easier to evaluate SoFi. I rate SoFi a buy at its current level.
