Over the past several weeks, we’ve had several investment partners of Nintai question our decisions to purchase stocks with the markets at mostly all-time highs. It’s a reasonable question to ask and one we never get tired of answering. First, we believe that while markets are fairly priced at this stage, it’s important to understand every market is a sum of individual companies. Individual equities can – and probably will – trade at ranges quite distinct from market returns. We believe this makes for investment opportunities even though the markets may seem quite pricey. With that in mind, we made some changes to the Nintai Portfolio over the past few days including one sale and one new purchase.
BUY: Intuitive Surgical (ISRG, Financial)
We sold ISRG in 2012 after holding it for roughly 16 months after it ran away from us and reached a price far in excess of our estimated fair value. With 20/20 hindsight we made a relatively smart move for which we can take absolutely no credit. Since our sale, the stock returned roughly 14% versus the S&P 500 TR return of 65%. However, it should be noted we were right for the wrong reasons. In our calculations at the time we had free cash flow rising to roughly $700M by 2014. Looking at ISRG’s free cash flow, one might think we were slightly too optimistic in our projections.
| 2010 | 2011 | 2012 | 2013 | 2014 |
| $450M | $595M | $672M | $775M | $560M |
Not shown in these numbers are two important decisions by ISRG management. First, was management’s decision that the company was undervalued after share price decreases in 2013 and 2014. The second was management’s decision to aggressively purchase roughly $2B in shares through the open market utilizing free cash during this period. Shares outstanding have decreased from 41.1M at year-end 2012 to 37.7M by year-end 2014. Taking that into account, free cash flow would have nearly doubled in the years 2013 and 2014 making the numbers starting in 2010 the following:
| 2010 | 2011 | 2012 | 2013 | 2014 |
| $650M | $927M | $1.0B | $1.7B | $1.6B |
In essence, the company had generated roughly $1.6B in free cash in 2014 versus our estimate made in 2012 of $700M. Boy, did we get that wrong! When we factored in this new growth rate, we significantly increased our fair value of ISRG reflecting the value of cash and time.
This is simply one part of why we have purchased the stock. We also believe they have answered several questions we thought could greatly impact future growth. These included settlements with the FDA, clear market acceptance of robotic surgery in new therapeutic groups, and maintaining a clear dominance in the field. Utilizing our median growth model we believe the company is worth $532/share. Accordingly we added ISRG to the Nintai portfolio on Friday, May 29 at $486.34/share.
SELL: Cognizant Technology (CTSH, Financial)
Our decision to sell Cognizant is based on two reasons. First, Nintai believes the company’s base valuation is roughly $63/share. Currently trading at roughly $65/share, we would have been comfortable holding the company for the foreseeable future. Unfortunately, the company decided to take on $925M in long-term debt and $150M in short-term debt. While we completely understand the rationale for this move, this shaved roughly 6% off of our fair value estimate bringing it to roughly 10% above fair value. Combined with an internal negative financial strength rating, we believe there is simply too much risk for our investors and no reasonable case to make for an adequate return going forward. We like this space and if we could obtain a better price might have interest in Infosys (INFY, Financial) with its pristine balance sheet, high returns, and more compelling valuation.
Accordingly, we sold our entire position in CTSH on Monday, June 1 for an average price of $65.61. We first purchased the stock in November 2007 when we initiated our position at $9.11/share. Taking into account a 2:1 split in 2014, our total return was roughly 620%.
As always, we look forward to your thoughts and comments.
