• 006 05/16/2014

    We probably look at 175 – 200 investment opportunities annually (someone actually employs me...). Most of these are brought to us by investment banks, and some come with projections offering a range of outcomes. The best-case projection often looks like a hockey stick: historically flat or with a slight positive trend, but showing explosive growth for the projected period. In stark contrast, the worst-case projection hardly ever shows revenue declining. At worst (according to the materials provided) revenues will remain constant.

    We then take this information and develop our own scenarios to appropriately stress test various capital structures under a variety of conditions. In this process I occasionally think back to this entertaining quote from Howard Marks:

    We hear a lot about “worst-case” projections, but they often turn out not to be negative enough. I tell my father’s story of the gambler who lost regularly. One day he heard about a race with only one horse in it, so he bet the rent money. Halfway around the track, the horse jumped over the fence and ran away. Invariably things can get worse than people expect. Maybe “worst-case” means “the worst we’ve seen in the past.” But that doesn’t mean things can’t be worse in the future. In 2007, many people’s worst-case assumptions were exceeded.

    About Howard Marks: 

    “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book.”
    Warren Buffett
 



  • 005 05/13/2014

    Kerrisdale Capital posted an eye-opening piece earlier this year detailing “extremely sloppy” work published by analysts at well-known banks. The focus is on “one of the most basic inputs of equity valuation: the number of fully diluted shares of common stock.”

    Visit a basic finance website such as Yahoo Finance or Google and you’ll see 138.7 million shares for ServiceNow, leading to a market cap of about $8.1bn at the current $58 share price. You could forgive an ordinary retail investor for assuming that this information is accurate.

    However, professional investors should always be aware of the total capital structure, rather than just the number of current outstanding shares, which is one of many inputs to determine valuation. In the case of young companies, particularly in technology, analysts can’t overlook stock option grants to employees. Since tech startups tend to be short on cash and long on blue sky potential, they forgo paying higher compensation in the short-run and defer it via options. Usually this doesn’t make too much of a difference in the long run, but if a company is particularly successful, and/or its shares perform exceedingly well, the impact of options grants given to executives and early-hire employees can be dramatic.

    ServiceNow has more than 25 million outstanding in-the-money stock options, in addition to almost 5 million restricted stock units (“RSUs”) (2013 10-Q3). With the options having an average strike price of $8.12 and RSUs providing no future cash to ServiceNow’s treasury at all, these 30 million issued shares represent a tremendous dilutive overhang to the company’s share count. When these 30 million shares convert into common stock, the company will raise only ~$200 million in proceeds but be burdened with $1.75bn of newly traded common stock.

    In reality there are 169 million shares of ServiceNow, or 165.4 million using the treasury stock method, rather than the 139 million you see reported at sites such as Yahoo or Google. And it’s excusable that these free finance sites are wrong; you get what you pay for. This is why an investor should always check a company’s filings rather than simply trusting a free website’s computer-generated financial information.

     

    Given that the average exercise price for the options is $8, compared to a current share price of $58, and even the most recently granted round of options are still well in the money, it should be assumed that the vast majority of these options will turn into common stock as well. Thus, adding together the 138.7 million common shares, the 4.8 million RSUs, and 21.9 million dilutive impact from the options (using the treasury method), we arrive at 165.4 million fully diluted outstanding shares, which results in a market cap of $9.6bn.

    If you are new to accounting / finance there is a fair amount of foreign vocabulary in the passage above. The takeaway is that, according to the commentary published by Kerrisdale, analysts are reporting inaccurate fully diluted share counts for ServiceNow (NOW). This is no trivial matter as this data is used in many critical financial metrics (you will find it referenced in models on this website). You may have noticed that the discrepancy in share count above results in two significantly different figures for the company’s market capitalization.

    For the full article and a list of the institutions that reported different figures please visit the Kerrisdale Commentary page.

    About Kerrisdale Capital Management, LLC

    Kerrisdale Capital Management, LLC is a fundamentally-oriented investment manager that focuses on long-term value investments and event-driven special situations. Kerrisdale has $225 million in assets under management and is based out of New York City. 

 



  • 004 05/11/2014

    In a management presentation not too long ago I was made aware of an investment theme completely unknown to me previously: ballast water treatment. Ballast water is used by shipping vessels, such as bulk carriers or tankers, to maintain stability in transit. Larger ships can carry millions of gallons of water in their ballast tanks, which is brought on board and discharged between ports as needed. Coincidentally, a colleague of mine recently e-mailed me a copy of Janney Capital Markets Infrastructure Quarterly Newsletter, which had some data on the subject I thought was worth sharing:

    Global regulatory authorities such as the International Maritime Organization (“IMO”) and individual countries such as the United States have set standards to mandate that ships’ ballast water be treated to eliminate the spread of invasive aquatic species. On a worldwide basis, this is expected to impact both newly built ships (~1,500 per year) and the installed base of existing ships. One of the largest segments of the existing ship market comprises solutions for large bulk carriers and tankers, which must treat extremely high volumes of ballast water (1,500 to over 6,000 cubic meters per hour). Today, there are approximately 50,000 vessels with ballast tanks in excess of 1,500 cubic meters.

    In anticipation of this emerging world market, a variety of analysts have developed studies to clarify the opportunity. One of the most comprehensive was recently issued by a prominent market research firm which has estimated that ship owners will spend over $40 billion between 2013 and 2023 to comply with emerging regulations on discharging ballast water.

    The report referenced in the article, suggests that "Annual BWT Equipment Spend" will grow at a rate of 21% from 2013 - 2023. 

    On the flight back from the management presentation, I read an article in Barron's outlining a different theme (water scarcity), and found one quote in the article particularly relevant to the topic of theme investing:

    “ The problem with theme investing, however, is that some key factors that drive stock returns have nothing to do with the themes. Chief among these is valuation; the price an investor pays is easily as important to long-term returns as what he buys. The S&P Global Water index recently traded at 23 times trailing earnings, versus 18 times for the S&P 500. Investors with a thirst for water exposure must be careful not to pay too much.”

    I wanted to couple these two passages because I am consistently surprised by the variety of niche industries revealed in the quest to uncover value. It is truly fascinating to me. And once an attractive sector has been identified, one of the greatest challenges for an investor is to wait patiently for the right buying opportunity. As the legendary investor Joel Greenblatt puts it, "This is one of the hardest things to master for professional investors: coming in each day for work and doing nothing."

     

 




 



Models are:
 
A) really boring
B) pretty sweet
C) super important
D) somewhat easy
E) kind of hard
F) fun
G) all of the above

 

 


*Answers a, b, c, d, e, f and g are all correct.