All hedge funds managers make mistakes. Even the best value managers could be prone to errors in valuation or could ignore big trends that could make their positions suffer big losses.
I think that it could be a big opportunity to buy stocks at much cheaper valuations than super-value managers did. Of course, all these stocks deserve careful research before making the purchase. For example, In the beginning of 2009, I started to see that Gurus started accumulating tech stocks, even though they were going down in price. That was the starting point for me to analyze that the technological sector was ridiculously cheap in 2009, so I started buying MSFT, AAPL, QQQ, etc. I am analyzing four stocks at this moment from well respected managers that got my attention:
Michael Price Opportunity: ITT Services (ITT, Financial)
Michael Price INCREASED his position of ITT in the last three quarters.
Industrial conglomerate ITT Industries produces defense electronics and fluid technology products that lead their markets. Although the recent boost to the defense business may not be a long-term phenomenon, ITT's burgeoning water-treatment segment and growing industrials operations should power revenue growth at the post-split water and ITT businesses.
ITT's defense products are crucial to the armed forces fighting today's asymmetric wars in Iraq and Afghanistan. For example, the firm produces a single channel radio, or SINCGARS, that provides enhanced situational awareness through instant communication between ground-based units and aerial support. The SINCGARS transmits encrypted information that improves battlefield survivability by warning soldiers about lurking hazards. Another important product, JCREW, jams the radio signal that detonates roadside bombs, which have been the single-largest cause of deaths in Iraq. ITT is also by far the leader in night vision equipment. An expanding military budget and the EDO acquisition improved ITT's defense business 13% annually, from $3.2 billion in 2004 to $5.9 billion in 2010.
I expect defense spending in the United States to ease in the coming years. The mandatory portion of the federal budget — consisting of Social Security, Medicare, and Medicaid — will increase faster than federal revenue, straining budget allocations to non-mandatory spending. Consequently, defense spending will receive a reduced budget allocation. As the government seeks ways to reduce the federal deficit, appropriations for weapons and equipment procurement are likely to come under the knife.
However, I believe (maybe Michael Price does too) that ITT's fluid technology business will benefit from secular growth trends in the water and wastewater treatment business. Exploding urban populations, increasing pollution-control norms, and a poor existing water infrastructure in many countries provide a plethora of opportunities to ITT. In the U.S., water treatment facilities are suffering from decades of underinvestment. In a recent report, the American Society of Civil Engineers graded water and wastewater treatment facilities in the U.S. a D-. As the market leader in water and wastewater pumps, ITT should benefit as municipalities increase spending to ramp up water infrastructure.
After defense operations grew to nearly half of ITT's revenue, and as the defense budget started slowing in the face of troop withdrawal from Iraq, the firm started to trade at a low-double-digit earnings multiple. To unlock value from its non-defense operations, the firm has decided to split itself into three companies, each focusing on fluid technologies, industrial operations and defense. I am in the process of creating a sum of the parts valuation model to create a thesis on what ITT's true intrinsic value is.
John Griffin Opportunity: Netflix Inc. (NFLX, Financial)
John Griffin incrementally INCREASED his position of NFLX in the last five quarters, buying big in the last quarter.
John Griffin is the president of Blue Ridge Capital, an investment partnership that he founded in 1996. Mr. Griffin was known as legendary investor Julian Robertson's right-hand man. He and a few others are named as Tiger Cubs as they worked with Julian Robertson at Tiger Funds. Mr. Griffin is adjunct professor of finance at Columbia Business School and a visiting professor at the University of Virginia. He began his career as a financial analyst for Morgan Stanley Merchant Banking Group before moving on to Tiger Management, where he became president in 1993.
Regarding Netflix, consensus analysts have a $80 fair value estimate that implies forward 2012 P/E of over 150 times. Admittedly, short-term EPS estimates are very difficult to predict given Netflix's new business model and various moving parts in the cost structure.My valuation model assumes that Netflix's total subscriber count reaches about 42 million by 2015, with about 25% coming from outside the U.S. This would imply that, by 2015, roughly 30% of U.S. TV households would be Netflix subscribers. I believe the non-U.S. business will struggle to sustain profitability over the next five years, as the company's success in Canada will be hard to replicate in other regions.
I think the transition to digital delivery levels the playing field for Netflix's competitors. Steaming content doesn't require a nationwide network of distribution centers, so barriers to entry are much lower. Several larger companies that already sell or rent digital content such as Apple and Amazon could emerge as strong competitors to Netflix.
For example, Amazon Prime offers streaming video in addition to expedited shipping for $79 annually. I view Amazon's push into tablets as a sign that it intends to invest more in digital media. Apple is the elephant in the room, as it is the most successful hardware firm of the past 25 years and its recent growth has pushed its cash balance above $70 billion dollars (over 20 times Netflix sales).
Recent moves by the management team have added near-term uncertainty to a challenging long-term road for Netflix. I thought a price increase was necessary for Netflix to invest in its streaming business as $10 per month for one DVD at a time and unlimited streaming was a good value for customers. For $10 per month, I viewed the access to deep library of DVDs as offsetting the weak streaming library, creating a strong value proposition for customers. However, such a large 60% increase for subscribers that bundle one DVD at a time and streaming was a mistake in my view. I think there is a large gap from $10 for streaming and access to DVDs versus $8 for streaming-only.
It was interesting to see how the information changed as the stock fell. When the stock was at $280, Netflix was still making $4 per share and was projected to make $6 per share in 2012. Now, it will make $3-$3.50per share in 2011 and will lose money for all of 2012, and the management team has since proven it has no idea how to keep customers happy, how to allocate its fragile capital structure, or even how to turn a profit any more.
There's always a big piece of news that causes a big drop in this stock. The fundamental story keeps getting decisively worse for Netflix, and there is no legitimate catalyst that could suddenly turn this thing around — the math just isn't there and Netflix has just admitted that to us. I would advise to be very careful in investing in this company.
Lee Ainslie Opportunity: First Solar (FSLR, Financial)
Lee Ainslie incrementally INCREASED his position of FSLR in the last two quarters, buying big in the last quarter.
Founder and CEO of Dallas-based Maverick Capital, Lee Ainslie started Maverick Capital back in 1993 with $38 million. Nowadays, the fund is worth $10 billion. He also learned from legendary great Julian Robertson at Tiger Management. Ainslie has averaged more than 13% a year since from 1995 to 2009. In the market crash of 2008, his fund lost about 30%.
At the end of 2009, First Solar was perceived by some to be vulnerable. Falling silicon prices and cost reductions by the leading crystalline silicon (c-si) companies (such as Trina and Yingli) combined to materially eat into the cost advantage First Solar has held over the rest of the industry. Consequently, many predicted it was only a matter of time before the company was overtaken by the best of the low-cost Chinese module makers.
As it turns out, this threat was exaggerated. Halfway through 2011, c-si cost leader Trina was able to produce a completed solar module for approximately $1.20-$1.25 per watt (including stock comp and shipping). Meanwhile, First Solar is producing modules for $0.75. Even if silicon costs are normalized at $45/kg, Trina's module costs would still be above $1.00. First Solar has reduced its module costs by more than 10% in each of the last two years, and I believe there is sufficient scope to allow annual reductions of 7%-10% to continue during the next few years. As a result, I project First Solar will reach a module cost per watt of $0.64 by the end of 2012, well below the $0.89 ($0.21 silicon material costs and $0.69 module processing costs) I expect Trina to be producing at.
These are the facts that Lee Ainslie analyzed too.
There are multiple reasons that First Solar can produce solar modules at cheaper costs than its competitors, and these create a cost advantage that the company can sustain for at least the next few years. The company employs a production process that uses cadmium telluride (CdTe) rather than silicon to generate electricity. Further, it custom builds and designs its manufacturing lines, and the resulting intellectual property is protected by multiple patents. Ninety percent of c-si production, conversely, uses industry-standard equipment/technology, and none of the leading Chinese module makers possess meaningful IP.
Further, crystalline silicon as a technology has limitations that likely will frustrate competitors' attempts to reach cost parity with First Solar. In the opinion of many c-si companies and other industry experts, it will be very difficult to push c-si module costs below $0.85 per watt at current conversion efficiencies (the amount of sunlight that is converted into electricity). The quandary facing c-si manufacturers is that improving conversion efficiencies requires a redesign of their production process. Each attempt at redesigning the c-si production process has seemed to yield more problems than progress (such as Suntech's Pluto cell technology). Eventually, this $0.85-per-watt barrier is likely to be broken down. But given how far c-si costs must fall and the issues the technology is already encountering, I believe First Solar has a multi-year window to be the industry's low-cost leader.
I think that it could be a big opportunity to buy stocks at much cheaper valuations than super-value managers did. Of course, all these stocks deserve careful research before making the purchase. For example, In the beginning of 2009, I started to see that Gurus started accumulating tech stocks, even though they were going down in price. That was the starting point for me to analyze that the technological sector was ridiculously cheap in 2009, so I started buying MSFT, AAPL, QQQ, etc. I am analyzing four stocks at this moment from well respected managers that got my attention:
Michael Price Opportunity: ITT Services (ITT, Financial)
Michael Price INCREASED his position of ITT in the last three quarters.
Industrial conglomerate ITT Industries produces defense electronics and fluid technology products that lead their markets. Although the recent boost to the defense business may not be a long-term phenomenon, ITT's burgeoning water-treatment segment and growing industrials operations should power revenue growth at the post-split water and ITT businesses.
ITT's defense products are crucial to the armed forces fighting today's asymmetric wars in Iraq and Afghanistan. For example, the firm produces a single channel radio, or SINCGARS, that provides enhanced situational awareness through instant communication between ground-based units and aerial support. The SINCGARS transmits encrypted information that improves battlefield survivability by warning soldiers about lurking hazards. Another important product, JCREW, jams the radio signal that detonates roadside bombs, which have been the single-largest cause of deaths in Iraq. ITT is also by far the leader in night vision equipment. An expanding military budget and the EDO acquisition improved ITT's defense business 13% annually, from $3.2 billion in 2004 to $5.9 billion in 2010.
I expect defense spending in the United States to ease in the coming years. The mandatory portion of the federal budget — consisting of Social Security, Medicare, and Medicaid — will increase faster than federal revenue, straining budget allocations to non-mandatory spending. Consequently, defense spending will receive a reduced budget allocation. As the government seeks ways to reduce the federal deficit, appropriations for weapons and equipment procurement are likely to come under the knife.
However, I believe (maybe Michael Price does too) that ITT's fluid technology business will benefit from secular growth trends in the water and wastewater treatment business. Exploding urban populations, increasing pollution-control norms, and a poor existing water infrastructure in many countries provide a plethora of opportunities to ITT. In the U.S., water treatment facilities are suffering from decades of underinvestment. In a recent report, the American Society of Civil Engineers graded water and wastewater treatment facilities in the U.S. a D-. As the market leader in water and wastewater pumps, ITT should benefit as municipalities increase spending to ramp up water infrastructure.
After defense operations grew to nearly half of ITT's revenue, and as the defense budget started slowing in the face of troop withdrawal from Iraq, the firm started to trade at a low-double-digit earnings multiple. To unlock value from its non-defense operations, the firm has decided to split itself into three companies, each focusing on fluid technologies, industrial operations and defense. I am in the process of creating a sum of the parts valuation model to create a thesis on what ITT's true intrinsic value is.
John Griffin Opportunity: Netflix Inc. (NFLX, Financial)
John Griffin incrementally INCREASED his position of NFLX in the last five quarters, buying big in the last quarter.
John Griffin is the president of Blue Ridge Capital, an investment partnership that he founded in 1996. Mr. Griffin was known as legendary investor Julian Robertson's right-hand man. He and a few others are named as Tiger Cubs as they worked with Julian Robertson at Tiger Funds. Mr. Griffin is adjunct professor of finance at Columbia Business School and a visiting professor at the University of Virginia. He began his career as a financial analyst for Morgan Stanley Merchant Banking Group before moving on to Tiger Management, where he became president in 1993.
Regarding Netflix, consensus analysts have a $80 fair value estimate that implies forward 2012 P/E of over 150 times. Admittedly, short-term EPS estimates are very difficult to predict given Netflix's new business model and various moving parts in the cost structure.My valuation model assumes that Netflix's total subscriber count reaches about 42 million by 2015, with about 25% coming from outside the U.S. This would imply that, by 2015, roughly 30% of U.S. TV households would be Netflix subscribers. I believe the non-U.S. business will struggle to sustain profitability over the next five years, as the company's success in Canada will be hard to replicate in other regions.
I think the transition to digital delivery levels the playing field for Netflix's competitors. Steaming content doesn't require a nationwide network of distribution centers, so barriers to entry are much lower. Several larger companies that already sell or rent digital content such as Apple and Amazon could emerge as strong competitors to Netflix.
For example, Amazon Prime offers streaming video in addition to expedited shipping for $79 annually. I view Amazon's push into tablets as a sign that it intends to invest more in digital media. Apple is the elephant in the room, as it is the most successful hardware firm of the past 25 years and its recent growth has pushed its cash balance above $70 billion dollars (over 20 times Netflix sales).
Recent moves by the management team have added near-term uncertainty to a challenging long-term road for Netflix. I thought a price increase was necessary for Netflix to invest in its streaming business as $10 per month for one DVD at a time and unlimited streaming was a good value for customers. For $10 per month, I viewed the access to deep library of DVDs as offsetting the weak streaming library, creating a strong value proposition for customers. However, such a large 60% increase for subscribers that bundle one DVD at a time and streaming was a mistake in my view. I think there is a large gap from $10 for streaming and access to DVDs versus $8 for streaming-only.
It was interesting to see how the information changed as the stock fell. When the stock was at $280, Netflix was still making $4 per share and was projected to make $6 per share in 2012. Now, it will make $3-$3.50per share in 2011 and will lose money for all of 2012, and the management team has since proven it has no idea how to keep customers happy, how to allocate its fragile capital structure, or even how to turn a profit any more.
There's always a big piece of news that causes a big drop in this stock. The fundamental story keeps getting decisively worse for Netflix, and there is no legitimate catalyst that could suddenly turn this thing around — the math just isn't there and Netflix has just admitted that to us. I would advise to be very careful in investing in this company.
Lee Ainslie Opportunity: First Solar (FSLR, Financial)
Lee Ainslie incrementally INCREASED his position of FSLR in the last two quarters, buying big in the last quarter.
Founder and CEO of Dallas-based Maverick Capital, Lee Ainslie started Maverick Capital back in 1993 with $38 million. Nowadays, the fund is worth $10 billion. He also learned from legendary great Julian Robertson at Tiger Management. Ainslie has averaged more than 13% a year since from 1995 to 2009. In the market crash of 2008, his fund lost about 30%.
At the end of 2009, First Solar was perceived by some to be vulnerable. Falling silicon prices and cost reductions by the leading crystalline silicon (c-si) companies (such as Trina and Yingli) combined to materially eat into the cost advantage First Solar has held over the rest of the industry. Consequently, many predicted it was only a matter of time before the company was overtaken by the best of the low-cost Chinese module makers.
As it turns out, this threat was exaggerated. Halfway through 2011, c-si cost leader Trina was able to produce a completed solar module for approximately $1.20-$1.25 per watt (including stock comp and shipping). Meanwhile, First Solar is producing modules for $0.75. Even if silicon costs are normalized at $45/kg, Trina's module costs would still be above $1.00. First Solar has reduced its module costs by more than 10% in each of the last two years, and I believe there is sufficient scope to allow annual reductions of 7%-10% to continue during the next few years. As a result, I project First Solar will reach a module cost per watt of $0.64 by the end of 2012, well below the $0.89 ($0.21 silicon material costs and $0.69 module processing costs) I expect Trina to be producing at.
These are the facts that Lee Ainslie analyzed too.
There are multiple reasons that First Solar can produce solar modules at cheaper costs than its competitors, and these create a cost advantage that the company can sustain for at least the next few years. The company employs a production process that uses cadmium telluride (CdTe) rather than silicon to generate electricity. Further, it custom builds and designs its manufacturing lines, and the resulting intellectual property is protected by multiple patents. Ninety percent of c-si production, conversely, uses industry-standard equipment/technology, and none of the leading Chinese module makers possess meaningful IP.
Further, crystalline silicon as a technology has limitations that likely will frustrate competitors' attempts to reach cost parity with First Solar. In the opinion of many c-si companies and other industry experts, it will be very difficult to push c-si module costs below $0.85 per watt at current conversion efficiencies (the amount of sunlight that is converted into electricity). The quandary facing c-si manufacturers is that improving conversion efficiencies requires a redesign of their production process. Each attempt at redesigning the c-si production process has seemed to yield more problems than progress (such as Suntech's Pluto cell technology). Eventually, this $0.85-per-watt barrier is likely to be broken down. But given how far c-si costs must fall and the issues the technology is already encountering, I believe First Solar has a multi-year window to be the industry's low-cost leader.
