• 007 05/17/2014

    JPE.com may be the coolest private equity website I’ve seen. It has one page (excluding Contact), and just lists the professional accomplishments of the man behind the fund: Bradley S. Jacbos. Turns out he has founded or co-founded four companies, all of which became multi-billion dollar entities:

    In 1997, Mr. Jacobs co-founded United Rentals, Inc. (NYSE: URI) to capitalize on the early-stage consolidation opportunities in the construction equipment rental industry in North America. Under his direction, United Rentals achieved industry leadership in just 13 months, with a brand globally recognized for its quality of operations and depth of resources.


    As chairman of United Rentals from 1997 through 2007, Mr. Jacobs' strategic vision was instrumental in helping the company attain $3.9 billion in revenues, with more than 700 branch locations, 13,000 employees, and a ranking as the 536th largest public corporation in America by Fortune magazine. During his chairmanship, United Rentals stock outperformed the S&P 500 Index by 2.2 times.

     

    In 1989, Mr. Jacobs founded United Waste Systems, Inc. During his eight years as chairman and chief executive officer, he built the company into the fifth largest solid waste management business in North America. United Waste Systems generated pre-tax margins that were among the highest in its industry. Its stock outperformed the S&P 500 Index by 5.6 times and delivered a 55% compound annual rate of return from IPO until the company was sold for $2.5 billion in 1997. At the time of sale, the company had 40 landfills, 86 collection companies and 79 transfer and recycling stations in 25 states.

     

    In 1984, Mr. Jacobs founded Hamilton Resources (UK) Ltd., a worldwide oil trading company, and served as its chairman and chief operating officer through 1989. During that time, he grew the company to annual revenues of approximately $1 billion through the execution of numerous large contracts with major oil companies and oil-producing countries and complex countertrade transactions.

     

    In 1979, Mr. Jacobs co-founded Amerex Oil Associates, Inc. and served as its chief executive until the company was sold in 1983. Mr. Jacobs led the team that grew Amerex from a concept into one of the world's largest oil brokerage firms, with an annual gross contract volume of approximately $4.7 billion and offices in Houston, London, Tokyo and New Jersey. He oversaw all aspects of the business, including brokerage activities for refined petroleum products, residual fuels and energy futures, and personally directed all brokerage operations for international and domestic crude oil.

    I came across the website while reading the 10-K for XPO Logisitics, where he is presently the Chairman and CEO. According to the filings, Jacobs Private Equity, LLC is the largest stockholder. With so much invested, it will be interesting to see what he accomplishes in this role. He is certainly not timid. In the letter to shareholders he lays out his 2014 objectives in bold type:

    “By year-end 2014, we expect to be on annual run rates of $2.75 billion in total revenue and $100 million in EBITDA. We anticipate acquiring at least another $400 million of revenue in 2014, excluding Pacer.”

    Disclosure: I have no positions in any stocks mentioned. 

 



  • 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. 

 




 



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.