IAC

IAC is a long-time favorite among growth-oriented value investors. Some investment thesis from this year listed here:

Positives are:

  • Exposure to positive surprises/fat tail given astute stewardship.
  • Net exposure has structural tailwinds (internet/online)
  • Cash provides optionality on weakness.

Negatives are:

  • Diller is nearly 80
  • some businesses within portfolio are permanently impaired
  • Need to have a view on ANGI, since it makes up so much of marketcap.

During March lows, IAC was hit particularly hard. I luckily bought 100 shares for an effective price of about $150. This was the pre-spin, so the stake has more than doubled in about 6 months.

Valuation

Post Match.com spin, the standard idea is to do a SOTP appraisal. The publicly traded pieces are relatively easy to assess. After Q2 2020, IAC has 85.1m shares out. It has

  • 421.8m shares of ANGI, or 4.96 ANGI shares/IAC share. Using current prices, this accounts for about half [$60/share] of IAC’s market value.
  • 59m shares of MGM, or 0.69 MGM shares/IAC share. Using current prices, this accounts for $16 of IAC’s market value.
  • $2.9B in cash accounts is $34/share.

Adding up these stakes gives us $111, which is nearly equal to current prices near $120. This places zero value on IAC’s host of smaller businesses.

Depending on how values the different pieces, it is not difficult to assign a number like $2.5B to these investments, or nearly $30/share.

Adding everything together, we get estimates of $130-$150/share.

Milestones

This past week Nasdaq took a breather (-6% from ATH). Many stocks (like TSLA) are still in bubble territory; I am fairly certain that in three years we will look at these pockets of insanity and wonder “what were we thinking?”.

In the midst of this mania, my personal portfolio temporarily hit the (psychologically important) $1M mark. This was the only explicit goal I set for myself, when I started this process; the only one that focused on outcome rather than process.

Little did I foresee the trajectory the portfolio would take. It started 2020 at $865k, touched $925k in Feb, before crashing down to $645k in mid-March. It passed the previous high in early August, and hit ATHs in early September. It has been quite the ride!

So what happens now? Honestly, I don’t know what happens to markets. I have been so wrong so many times (even just this year), that every atom in every cell of my body has embraced this ignorance.

What do I hope? As I’ve sold down some large positions (TCEHY, and JD in particular), my cash position has ballooned once again to 25%. I do hope for a pullback, that is obvious, and self-serving.

In March, I did buy some IAC, DIS, and CMCSA (and nibbled on BRK, MKL, and GOOG). But the V-shaped recovery meant that my usual strategy of using (richly valued) puts during times of emergency to back into positions was sub-optimal. I did buy shit, but not in size!

I am not sure if that was a “process” mistake, knowing what I knew then. The range of outcomes seemed quite wide. While a V-shaped recovery was possible, it did not seem like a high-probability bet.

In March, I was more pessimistic than most people. Today, I am more optimistic about COVID than most people. I really don’t think that the virus will dominate our lives in 2021, the way it did in 2020. I expect the worst hit industries to bounce back sooner than most people do. But don’t listen to me; what do I know.

In recent weeks, I bought some BAC and SCHW.

Buffett’s selling of WFC makes me nervous of my sizable position, but I see so much optionality – so many ways in which one or more things could finally go right – that it seems silly to bail out now.

I fully expect to regret for not paying obeisance to WEB.

Sold Tencent

I sold Tencent (TCEHY) at $72.70 today. I bought it for roughly $40 nearly two years ago. There has been a lot of drama over my period of association. Surprisingly most of it did not bother me much.

I do believe that the future is bright for Tencent, and wish it well. But in recent days, I had started getting mildly anxious. TCEHY had grown into my third largest position (behind FB and BRK) at nearly 6%. The sour tone of US-China dialogues somehow started becoming an X-factor. Trump’s messing with TikTok, could be reciprocated in unexpected ways.

I’d never fully grown comfortable with the VIE structure, but my ignorance ensured that it did not bother me as much as other more sophisticated investors. Also the stock had started trading above my estimate of fair value, which I pegged around ~$70, already a generous 40x earnings.

In the end, the combination of worsening US-China relations, a full sticker price, and general exuberance among tech stocks spurred me to dispose my shares.

While I hoped TCEHY would be a coffee-can investment, I am happy to take a 30+% CAGR on a decent-sized bet over two years, and look for greener pastures elsewhere.

UPDATE: Two days after I sold out, the share price plummetted 10% to $65 on Trump’s talk of a WeChat ban. Feels great to get lucky!

Some Valuation Updates

JD

This may have gotten a little frothy.

TTM revenues were $85B (topline growth rate ~25%). If we project same growth rate out for 5 years, revenue ~ 3x at $255B. JD has lot of moving parts, and partial ownership in spinoffs, but ignore that and apply a 2% margin (previous net margin ~ 0-2%) for an EPS of $5.1B/1.6B shares ~ $3/sh, 5 years out.

Suppose it then trades for a P/E of 30x for a fast growing business ($3*30 = $90). If we discount that back at 10%, we get a present value around $55-60. My assumptions of growth rate, profitability, and discount rate are more aggressive than normal. Risks include a price war with BABA, deterioration of US-China relations, VIE structure, dissipation of COVID bump.

With the stock price at $65+, I’ve laddered calls (still juicy) to exit my entire position (August 21 expiry) at an average price of $60.

FB/GOOG

FB has about $21/sh cash. Given quality of company and CEO alignment, 25x NTM EPS of $9.50 gives $255-$260. Plenty of cylinders still left to fire. This is currently my largest position (~11% portfolio), and is trading a tad below my estimate of fair value.

GOOG has about $165/sh cash. A 20x multiple on normalized EPS of $55, plus $300 of other bets yields a fair price around $1550-1600, right around where it is trading these days.

FRFHF/WFC

Both have been crushed this year. Fairfax is down 35% and Wells Fargo has been halved! Both have seen meaningful insider buying activity. Both Fairfax and WFC should be worth at least book, which were $420 and ~$40 at the end of March qtr.

COVID 2020

2020 has been an unsual year. It is certainly shaping up to be one of those “what did you do during those times?” moments.

At the time of writing, it is hard to believe that I am only down -14% (market down -17%) from ATH. My largish cash position has cushioned the swings, but exposure to energy and financials has cut meaningfully into that cushion.

Due to the nature of my job, summer months are fallow. I cannot put new money into my investment pot. So my primary goal is to survive and not to do anything too stupid. I’ve added a little DIS, MO, IAC, BRK, CMCSA, and MKL over the past few months, but nothing dramatic. I have puts outstanding on IAC, WBA, and DIS.

Is the worst over? Some smart people definitely think so and make persuasive arguments. On the other hand, a perennial optimist like Warren Buffett (who is privy to Bill Gates’ unfiltered thoughts on the pandemic) appears to be bearish.

Will we revisit lows, or will be break to ATHs? I have no clue. The range of possible outcomes still seems wider than most people acknowledge.

If the second wave is bad, and if it coincides with a major natural disaster, social unrest, or war, then things could get ugly! The longer it takes for us get back on our feet, the longer it will take for us to walk and get our previous stride back.

On the other hand, the possibility of a cheap and effective treatment/vaccine would be a gamechanger. Even without them, perhaps the second wave is not as bad because we have somehow learned to deal with it better (masks, social distancing et cetera). If this happens, energy, financials, and travel/hospitality stocks could snap back really fast.

One way to look like a genius is to bet the house on one of these outcomes. There are fortunes to be made (or lost). But my goal is to muddle through. To survive regardless of how the hand plays out.

 

Coronavirus

So the coronovirus pandemic is ongoing. Initially, the market shrugged it off, racing to new all time highs (3393 on the S&P).

Then, as the scale and nature of the destruction (supply chain and demand disruption) became apparent, it started to have convulsions. At one point the market corrected 15%, and there have been wild +/- 3-5% daily moves.

Today it is down about 12-13% from ATHs, but many interesting names have been hammered. Among the stocks I own, financials (led by WFC) and energy (XOM is now trading near tangible book!) have been hit especially hard. The companies that are holding on best are surprisingly Tencent and JD.

Overall, my portfolio is bleeding red. The large cash cushion (~25% at year end) has softened the blow to about 7-8%. Still, I feel like I have been punched in the gut.

Given the crazy volatility, I’ve been trying to deploy cash using puts. Part of me is fearful that I am trying to be too clever. That the market will snap back before most of my puts gets exercised; kinda like Dec 2018. But for some reason, I feel the effects of this down turn might linger.

I’ve taken the opportunity to write a lot of cash-secured puts on businesses I like. These include IAC, CMCSA, DIS, MO, and MTCH. I also put some new puts on midstream players, MMP and EPD. The implied volatility on many of these fine businesses is crazy. In a year or two, I expect all of these to survive and thrive, and shrug off any effects of the coronavirus.

I really don’t mind owning them at current prices for the long run.

I still have about 10% in uncommitted cash because I don’t think the market sell-off has been overdone. If we get a real melt-down, then I want some dry powder.

WFC Update

WFC reported earnings, and they were a mess. The fake-accounts scandal refuses to go away. They have unsuccessfully tried to clean up their act for 3+ years now.

Without a doubt the scandal has been bad for the bank. But it may have been a blessing in disguise for me. I have been building a position, since the scandal first broke out. Currently, WFC is my third largest position (after FB and BRKB) with an effective cost basis around $43. I am looking to add.

The downside, in my opinion, is well-protected. Almost everything that could go wrong in the past three years, has gone wrong. Low interest rates, check. A steady stream of other scandals, check. Regulator ire, check. Bad media, check. Leadership vacuum (for a long time), check.

So what’s the good news?

The stream of negative hits has been incessant. If a few of these factors turn, the narrative and the stock price will improve.

Despite the bad news and depressed earnings, WFC trades for a PE of less than 10. It is cheap. The juicy 4% dividend provides downside support. The new CEO looks capable and focused on the right things. His incentives are lined to make the latest quarter a kitchen-sink quarter.

Over the next 5 years, WFC will generate about 40-50% of its market cap in FCF. With their capitalization levels, and buyback policy they could retire a significant fraction of their shares. They already ate up 10+% of their shares last year. Part of me hopes the stock price languishes, so that the buyback can be carried out at attractive prices.

In 5 years, one can conservatively see an EPS of ~$7. At 12x EPS, shares could trade around $85. With the 4% dividend, a mid-teens return seems reasonable to expect, even without too many positive surprises. If litigation expenses subside, their profitability will improve further. If interest rates rise, earnings will increase. If the eyes of the media and regulators moves elsewhere, WFC will thrive. In that scenario, IRR might increase from ~15% to ~25%.

Compared with the rest of this “bubbly” market, this seems like a classic, “heads I win, tails I don’t lose too much.”

—-

Here are links to two great writeups on WFC.

  1. Saber Capital Management (July 2019) (pdf)
  2. Kyler Hasson (link)

 

2019 in Review

Here is a summary of the main action in 2019.

Big Holdings

Let me start with the six biggest positions at year end, BRK (10%), FB (9.5%), WFC (6.4%), CHTR (4.4%), GOOG (3.8%), and FFH (3.8%).

BRK started the year at $200, dropped below $190 at one point, and ended year above $220 (+10%). IV remains near $260-$270, and continues to grow. Its large cash pile provides some counter-cyclicality in case of a downturn. I expect BRK to outperform the indices next year.

FB started the year at $135, roared over $200 (~50%), before settling down near year end. My estimate of IV is $220-$230, but as CapEx declines, cash should start gushing in. This one is a monster!

WFC was the most significant addition in 2019; I added 2/3 to my original position. It started at $46, and closed the year near highs ($54). I figure IV is around $65. The dividend, and proximity to cleaning up legacy legal issues makes it an interesting position to hold.

CHTR was the biggest mover among my large positions. It rose from $285 to $470 (~65% rise) nearly monotonically, as the FCF thesis started playing out.

I added 40% to GOOG near its lows $1000 at the start of the year. It has risen ~30% over the year to $1350, still below my IV $1525. GOOG is an interesting personal example. It is perhaps the only large position where I’ve paid up for quality, and even averaged up.

FFH was essentially flat for the year. I think it is a coiled spring, and at close to book value, it is a compelling stock. I might even add here. Recent underperformance has left a bad aftertaste. Nevertheless insurance operations are improving, it provides exposure to Africa and India. If things go right it could have a 20-25% year in 2020 (IV ~ $575).

Other Extreme Performers

CFX (3.3%) was 75%+ over the year, thanks to a transition to a less cyclical business model. Codan (2.5%) is a small position but went up by another +50%; it has been one of my best picks of all time. Unfortunately, it was a tiny position at inception. JD (3.1%) and BAM (2.7%) both registered 50%+ gains in 2019.

The weakest performers were GME (0.4%) which declined by a half. ALJJ, XOM, and NOV were flat in a year, when the S&P rose 30%.

Other developments

I bought WBA (2.8%) around $50. I started building a tobacco basket (MO, BTI, IMBBY; 2% right now). OAK got taken over at $50. I sold 1/3 of my ALJJ position at $1.65.

In terms of options, I tempered my enthusiasm. Let winners run!

The juiciest stocks from an options standpoint were: GME $1200+, IBM $1200, KKR $1500, SCHW $1600, WDC $1500, WW $1000, IAC $1600.

I started the year at an 18% cash position, which is now close to 25%, as I run out of no-brainer opportunities.

Updates: CHTR and WDC

CHTR

In my last update on CHTR  in mid February this year (4Q 2018), CHTR had a FCF of ~$7B (FCF = EBITDA – CapEx) on ~235m shares out for an FCF/share of $25-$30. This amounted to a 12-13x FCF multiple.

We can run the same numbers using current (3Q 2019) results. FCF = $16B – $7.5B = $8.5B. Divided by the 226.5m shares, we get an FCF/share of $37.5/share. At current prices of $475/share, CHTR still trades at the same FCF multiple (12-13x).

The run up in price has has matched the run up in performance. However, EV/fwd.EBITDA has increased from 8.8x to 10x, while net debt/EBITDA is essentially flat near the targeted range of 4.5-4.6x.

For next year EBITDA is expected to grow by ~9%, while CapEx is expected to decline by  3-5%. Thus, FCF/share is expected to rise 12-14%. If the valuation multiple remains the same, then the stock should return the same low to mid-teen numbers (IV ~ $530). Furthermore, this should happen, regardless of what else transpires in the broader market.

WDC

During my last update, WDC was trading in the mid $30s, and things looked terrible. Since then it nearly doubled before falling hard by about 20%+ in the last few weeks.

Other than the US-China trade drama, what else has changed?

LT debt is now $9.97B (down from $10.25B last Q), TTM interest ~$475M is flat. The cycle is showing signs of bottoming. Consensus estimates (for what they are worth), have two and three years out EPS estimates at $6 and $9, respetively. A 15x peak multiple, with a 12% discount rate still suggests IV in the $90-$100, nearly double current prices.

From a technical standpoint, it currently trades around P/S (TTM) around 0.9. Historically, it has been a good idea to buy near P/S ~ 0.7-0.8 and to sell near 1.3 and over.

Options on the name are very juicy, given the short to medium term uncertainty. It may not be a bad idea to use puts opportunistically to add to my current modest (1%) position.

 

Update on McKesson

I first looked at MCK almost exactly two years ago. I used puts to enter into a position June-Dec 2018. My effective cost basis is about $124. Currently, the stock trades between $140-$150.

Over the past two years, revenue has increased from $202B to $220B. A massive buyback at attractive prices has reduced share count by over 12% (214M to 188M). The sword of a punishing opioid settlement hangs over MCK, and half the health care industry. But let’s leave that aside for now, and look at normalized earnings power.

The company guided adjusted EPS of $14.50/share for the upcoming year. This is reasonable considering 5% growth in revenues, and 1.2% net income or FCF margin [$222B * 1.05 * 0.012 = $2.8B or ~ $14.50/share]. Litigation aside, the core business is above average, and should command at least a market multiple on earnings [15-18x] giving it an enterprise value of $42-$50B. Net debt is about $5B. Let us be lazy, and just subtract that outright to yield about $37B-$45B equity value or per share appraisal of $195-$240.

Now let us turn to the litigation part. For a primer see this and this (NPR). There is a fair bit of helpful disclosure on MCK’s website. We still need some numbers. This academic paper suggests an annual cost of $80B (comparable with the SNAP program).

The settlement of drug distributors (and Teva) with two Ohio counties was $260M. MCK took a $82M charge in 2Q 2019 to reflect that.  There was some rumor that distributors had settled the nationwide case for around $18B to be paid out over 18 years. We can just add this liability (MCK’s share) to long term debt.

The present value of this for MCK is probably around $4-5B. This implies a loss of $25-$30 of value per share. Accounting for this gives us a $165-$210 target price range [say $185 point estimate]. In any case, the downside seems reasonably well-capped at current prices.