Thoughts on the Twitter IPO

I confess; when Twitter (TWTR) launched I thought it was stupid. When every single television commercial and print advertisement started saying "like us on Facebook, follow us on Twitter, etc I felt like it was social media overload. Now I can hardly watch any TV program without having random hashtag phrases pop up on the screen. Like enough people are really dying to tweet about the Survivor episode they are watching. #redemption island? Please. Stop. And no, I don't care what most celebrities have to say in 140 characters. And how many times do we need to hear about a professional athlete who tweeted something insensitive and then had to issue a public apology? We have better things to do with our time. As a result, I never thought I would really "get" Twitter.

But I am slowly coming around. Not because I find Paris Hilton interesting, but because I have actually found myself searching twitter several times lately for other reasons in my daily life. I was traveling on the day of the Potbelly (PBPB) IPO but one of my clients was interested in the shares, if the price was right after it came public (it wasn't). So I am sitting in an airport terminal waiting for my flight and wanted to know how PBPB opened. Since IPOs typically don't open until an hour or so after the opening bell in New York, I had no idea when that first trade would print. But a quick search on Twitter provided that information. I no longer had to be in front of a TV tuned to CNBC to find out.

Not only that, but I also wanted to know at what price it opened. Many stock quote apps are 15-20 minutes delayed and it would take 30-60 minutes for major news outlets to write and publish a story about it. Once again, Twitter was the only way I could find out the opening price in real-time. Within minutes after that I was boarding my flight and powered down my phone. But I knew that the price was above what I felt was reasonable and I could forget about it for the rest of the day.

It turns out Twitter is very useful for non-investing information as well. Now that I have lived in the Pacific Northwest for almost 18 months, I have grown to be a huge fan of food trucks. They were everywhere in Portland (part of the culture really) and here in Seattle there aren't as many but still quite a few. In fact, there are two that serve the parking lot outside my office a few times a month. The schedules can be variable and sporadic (the food truck business is tough from a proprietor standpoint so unless you have a "can't miss" location reserved, you are likely to mix it up day-to-day or week-to-week to try and get by financially). It turns out the only way to really find out where and when a particular truck will be in a given location is through Twitter. Web site listings become quickly out of date given how much these trucks relocate and how little advance notice is typically given.

So, I am warming up to Twitter. I don't actively tweet (although links to each of my blog posts are set up to automatically go out to followers of @peridotcapital) and I don't plan to, but the service clearly has value. And as I have found, not only to celebrity junkies or tech heads. Now, does the fact that I can get Potbelly quotes and food truck location updates mean that Twitter is a sure-fire business that is worthy of your consideration at a $20 per share IPO price/$14 billion initial valuation (and likely to go higher than that even before it begins trading)? Maybe, maybe not.

I don't think there is any way to know that without a crystal ball. After all, the company will bring in about $700 million in revenue this year so investors who buy the stock are buying it for future revenue and profits, not what they are earning today (which is only about $3 per year for each of the 230 million monthly active users they have right now).

It is entirely possible the stock opens at $40 next month (I would not be surprised if the IPO price gets bumped up to $25-$28 before it is all said and done as well) and comes with a nearly $30 billion valuation. It is hard to justify that, but I am beginning to see that Twitter could play a large role in social media going forward with a larger slice of the population than I would have guessed and is likely to figure out a way to make several billion dollars monetizing the platform over time. Whether investors are willing to pay $10 billion, $20 billion, or $30 billion for that business remains to be seen.

Full Disclosure: No positions in any of the companies mentioned at the time of writing, but positions may change at any time.

Yahoo Stock No Longer Cheap After Doubling In A Year

We are less than two weeks from the one-year anniversary of my blog post entitled "Does Marissa Mayer Make Yahoo Stock A Worthwhile Bet?"that highlighted how cheap the shares were at $16 each and the answer has been a resounding "yes." Yahoo (YHOO) has now doubled in price and I think the easy money has been made. Take a look at my sum-of-the-parts valuation on the company: 

As you can see, the majority of the value in Yahoo is their 20% stake in Alibaba (slated to go public soon at a valuation of around $100 billion) and the company's core operations that Marissa Mayer is in the process of trying to turn around. The stock right now is trading right at this $32-$33 valuation. While there is additional upside if Alibaba marches even higher post-IPO and/or if Yahoo can start to grow its core business, both of those are far from assured. As a result, the stock looks fully priced based on what we know today.

Full Disclosure: Long Yahoo at the time of writing but positions may change at any time

Fossil Stock Momentum Could Falter If "Smart" Watches Are Successful In Coming Years

Shares of accessory maker Fossil Group (FOSL) have been on fire lately, capped by an 18% jump on Tuesday after a better-than-expected second quarter earnings report:

While Fossil's business is unlikely to be impacted in the next few quarters, I have to wonder what happens to this stock if the category of "smart" watches takes off in coming years. After all, during the first half of 2013 more than 75% of Fossil's revenue came from watches. We know that tech giants like Apple and Microsoft are developing smart watch products to be used as phone extension accessories. Smaller firms focused on wearable computing are also jumping into this space.

While it is too early to declare the product category a success (development could go south, or the products could bomb upon release), given that the younger generation does not really wear watches at all (they simply use their cell phone to tell time) and plenty of companies believe they can add functionality for the traditional watch wearer, it stands to reason that Fossil would suffer materially if a certain percentage of regular watches were replaced over the next few years by a wearable electronic device.

If these new product developments continue to progress, Fossil shares could be a very attractive short candidate. Given how focused Wall Street is on short term results, it does not appear that many investors have this potential catalyst on their radar. In my view it is definitely something to monitor, especially if Fossil shares continue to march higher short term even as the demographic and technology trends are moving against them in many respects over the intermediate and long term.

Full Disclosure: No position in Fossil at the time of writing, but positions may change at any time.

After Doubling, Groupon Shares Now Appear Fully Valued

After two very accurate calls on Groupon (GRPN) stock on this blog; bearish on the company's $20 per share IPO in 2011 (Numbers Behind Groupon's Business Warrant Caution), and bullish last year as the stock was being priced like trash at $4.50 (Isn't Groupon Worth Something), I should probably quit while I am ahead. But what the heck, let's try to go 3-for-3.

In the year since my last Groupon post the stock has doubled to $9 per share, giving the company an equity market value of $6 billion. At this point I believe the market has appropriately priced it, understanding that while the company's growth has come to a screeching halt, it has a sustainable business (which I argued was not the consensus view at a $3 billion market cap). The company is profitable, proving the naysayers who raised solvency concerns last year wrong, and should book about $2.5 billion in revenue this year.

It is hard to argue that the stock is worth materially more than the current price, in my view. While I still believe that high fixed-cost businesses, such as hotels and movie theaters, will continue to use Groupon to draw customers to fill unbooked rooms and empty seats, many small businesses will realize that repeated Groupon promotions aren't likely to pay off meaningfully for them. While new businesses should still consider Groupon for an awareness campaign (again, my personal view), growth from new vendors is not going to move the needle very much now that Groupon has become a multi-billion dollar company.

Today, Groupon's daily deals business is likely to succeed with only a subset of small businesses nationwide, and their Groupon Goods overstock retail offerings can certainly move volume, albeit at very low, Amazon-like profit margins. So while Groupon stock has done well lately as the doomsayers quiet down, I don't see how one arrives at a valuation much higher than $6 billion/$9 per share, and there are risks to the business longer term from a competitive perspective. A year from now, I'll try and revisit the stock again and see if I was able to go 3-for-3.

Full Disclosure: No position in GRPN at the time of writing, but positions may change at any time

Apple Shipped 14,000 iPhones Every Hour Last Quarter

Apple (AAPL) shipped 31.2 million iPhones during the second quarter. Without any context that might not mean anything. So let's give it some context. That's 342,000 phones per day and more than 14,000 every hour. What is even more remarkable is that Apple stock has gone from $700 to $400 because the company has been muddling through a gap in new product introductions.

Lots of people believe Samsung has stolen their smartphone thunder with the Galaxy S3 and S4. Some industry pundits have left them for dead, citing the typical cyclical nature of popular consumer electronic brands. While we won't know what Apple is working on exactly until after they launch new products later this year and next, this company clearly has not been passed by. Companies don't ship 14,000 phones every hour, every day, for three months straight, if they are in a death spiral.

If Apple can use the money they make on all of these phones and churn out impressive new products, the naysayers (even with the stock down around $400 per share) will likely be proven very, very wrong. That is the bet I am making with my clients' money as well as my own.

Full Disclosure: Long Apple at the time of writing, but positions may change at any time.

Netflix and Tesla: Early Signs of Froth in a Bull Market

It is quite common for a bull market to last far longer than many would have thought, and even more so after the brutal economic downturn we had in 2008-2009. Only just recently did U.S. stocks surpass the previous market top reached in 2007. Although it does not mean that a correction is definitely imminent, the current stock market rally is the longest the U.S. has ever seen without a 5% correction. Ever. Dig deeper and we can begin to see some froth in many high-flying market darlings. Fortunately, we are not anywhere near the bubble conditions of the late 1990's, when companies would see their share prices double within days just by announcing that they were launching an e-commerce web site. However, some of these charts have really taken off in recent weeks and I think it is worth mentioning, as U.S. stocks are getting quite overbought. Here are some examples:

TESLA MOTORS - TSLA - $30 to $90 in 4 months:

NETFLIX - NFLX - $50 to $250 in 8 months:

GOOGLE - GOOG - $550 to $920 in 10 months: 

You can even find some overly bullish trading activity in slow-growing, boring companies that do not have "new economy" secular trends at their backs, or those that were left for dead not too long ago:

BEST BUY - BBY - $12 to $27 in 4 months:

CLOROX - CLX - $67 to $90 in 1 year:

WALGREEN - WAG - $32 to $50 in 6 months: 

Ladies and gentlemen, we have bull market lift-off. My advice would be to pay extra-close attention to valuation in stocks you are buying and/or holding at this point in the cycle. While the P/E ratio for the broad market (16x) is not excessive (it peaked at 18x at the top of the housing/credit bubble in 2007), we are only 15-20% away from those kinds of levels. Food for thought. I remain unalarmed, but definitely cautious to some degree nonetheless, and a few more months of continued market action like this may change my mind.

Full Disclosure: No positions in any of the stocks shown in the charts above, but positions may change at any time

Qualcomm Now Hoarding More Cash Than Apple On Relative Basis

Qualcomm (QCOM), the leading provider of chipsets for wireless consumer devices, has seen its stock price underperform the S&P 500 index over the last year (see chart below), which could prompt shareholders to get more vocal about the company's sub-optimal capital allocation practices later this year. We have seen with Apple that hoarding capital can negatively impact the multiple that investors are willing to pay for a company's shares. In fact, Apple's stock has rebounded nicely in recent weeks, after the company announced it was increasing the size of its share repurchase program by 500%, from $10 billion to $60 billion.

Believe it or not, Qualcomm's cash hoard has eclipsed the $30 billion mark as of March 31st, though the company has no debt. On a relative basis, this is actually more anti-shareholder than Apple. QCOM's cash amounts to 1.4 times the company's annual revenue, 4 times annual cash flow, and more than 26 years' worth of capital expenditures. Compare that to Apple's $145 billion of cash as of March 31st, which comes to 0.85 times annual revenue, 2.5 times annual cash flow, and more than 14 years' worth of capital expenditures.

For investors interested in Qualcomm as an investment, the future will clearly be impacted by how (or if) the company's capital allocation actions change over time. Just as Apple's share price plunge from over $700 to under $400 resulted in a louder chorus from investors about the return of cash, continued underperformance by QCOM stock might just have the same impact. The company certainly does not need $30 billion of cash sitting in the bank.

Full Disclosure: Long Apple and no position in QCOM at the time of writing, but positions may change at any time

Alright Apple, Let's Tackle This Cash Issue Once And For All

I am drafting my quarterly letter to clients right now and given the poor performance of Apple (AAPL) shares during the first quarter, it is a stock I have been adding to lately on the long side, even as it has clearly negatively impacted portfolio performance so far in 2013 (down 16% vs S&P 500 up 10%). The bullish argument is quite simple; the stock trades at a discount to pretty much every other large cap technology company. The lack of momentum in their business right now is clearly hurting the stock, but the lack of a cash plan is just as important, in my view. They need to take decisive action soon, if for no other reason than it will allow them to not keep hearing about it quarter after quarter in the future.

There is an argument out there that shareholders should not care if Apple holds its cash or uses it to buyback stock or pay dividends to shareholders. It's an academic argument really, as finance textbooks insist that a $50 per share dividend will decrease the value of the stock by exactly $50, so shareholders are not better off one way or the other.

But think about this. Right now Apple is earning about 1% on $137 billion of cash (actually, the quarter just ended so they likely have closer to $150 billion as of today, although they won't report earnings for a few weeks). They have two other options for that cash; repurchase stock or pay dividends. The idea that shareholders should be indifferent to those three choices is just silly. If Apple repurchased shares, the stock would only have to rise by more than 1% per year in the future to be serving shareholders better than their current hoarding strategy (even Apple bears would likely concede that a 2% annual return is a reasonable future outcome).

The case with a dividend is a bit more complex, but still easy to understand. If Apple pays out its cash to shareholders, the shareholder would have to reinvest it themselves and earn more than 1% per year on their own in order to be in a better situation than they are now. We could easily achieve that hurdle rate. What if you own Apple in a taxable account and have to pay taxes on those dividends? Instead of beating 1% per year you would have to earn about 1.2% per year. Again, piece of cake. What if Apple had to repatriate the cash from overseas and pay income taxes on that money before paying out the dividend? Instead of needing to earn 1.2% per year, shareholders would have to earn about 2% per year investing the money themselves. Again, piece of cake.

The math: $1 of overseas cash after repatriation taxes becomes about 70 cents, and after a 15% dividend income tax, comes out to about 60 cents net to the shareholder. Apple currently earns 1-cent per year on that $1 of overseas cash (1%). In order to be better off, the shareholder would have to earn more than 1 cent on the 60 cents they receive after all taxes are paid. That equates to just a 2% annual return.

Although hedge fund manager David Einhorn took some heat for suggesting that Apple's share price multiple would increase if the cash were used in a more shareholder-friendly way, it is hard to argue that the market is giving Apple credit for its vast cash hoard right now. The stock currently trades at around $435 per share. Net cash is likely to be around $160 per share as of March 31st, so you are paying $275 for the actual business. That business will earn $40 billion (over $40 per share) this year, more than any other U.S. company.

The idea that Apple should trade at a 7 P/E simply makes no sense. There are many reasons why it does today, and the fact that they have $150 billion stashed away earning 1% per year is a major reason why. I am buying more of the stock at current levels because I am betting this cannot go on forever. Just including the cash and using a 10 P/E (in-line with other large tech stocks) on the operating earnings of the business nets you a $600 price target for the shares (38% above current levels). Even though Apple's management team has been completely dismissive so far, I still feel strongly that this is a bet worth making. And that is what I will be telling my clients in this quarter's letter.

Full Disclosure: Long Apple at the time of writing, but positions may change at any time

Would David Einhorn's Apple Preferred Stock Idea Really Create Shareholder Value?

This week hedge fund manager David Einhorn, whose investment management firm owns more than 1 million shares of Apple (AAPL) stock, publicly urged the company to take more meaningful action on its ever-rising cash hoard of $137 billion. Since management is not really taking the matter very seriously, despite the fact that every dime of that $137 billion belongs to the shareholders, Einhorn has proposed an alternative idea to unlock shareholder value; issuing preferred stock to existing shareholders, at no charge, with a 4% perpetual dividend.

His thinking revolves around the idea that Apple shares are not adequately valuing the cash on the company's balance sheet, and issuing preferred stock would actually boost shareholder value because the new stock would have a quoted value in the market that investors could actually monetize if they chose to do so. Einhorn is saying that if implemented, Apple shares post-preferred issuance would be worth more than they are today (because he does not think Apple common stock would fall by $100, the value of the preferred given out). In addition, the 4% dividend on the preferred stock would increase the company's dividend obligation by less than $4 billion per year, which would easily be covered by future free cash flow and not eat into the current $137 billion cash balance.

So does this plan have merit? I think it does, but I would agree with many who say that it is an overly complicated solution to a relatively simple problem. That said, if Apple is unwilling to take more traditional steps for the benefits of shareholders (after all, Tim Cook and his team work for us), then an idea like this is worth considering (to be fair, since a large portion of Apple's cash is overseas, repatriation tax issues complicate their possible strategies quite a bit).

Interestingly, today I read a post by Aswath Damodaran, a well known finance professor at NYU, who argues that Einhorn's idea would generate no shareholder value whatsoever. How he can make such a bold claim, to me, is quite odd. It is true that the idea right now is all theoretical, and there is not a way to know for sure how much the market would value Apple's common and preferred shares if such an issuance was implemented, but Damodaran equivocally states that value can not be created out of thin air. Here is his exact quote:

"You cannot create value out of nothing and giving preferred stock to your common stockholders is a nothing act, as far as the value of the company is concerned."

This concept is along the lines of something you are likely to find in a finance textbook. Damodaran would likely argue that a company is worth X, based on the discounted value of future expected cash flows, plan and simple, and slicing and dicing paper does nothing to change that.

I would respectively disagree for a fairly simple reason. I believe that something is worth what someone else is willing to pay. You have probably heard people say that a lot in a wide variety of contexts. For instance, if you are selling your house, just because it is appraised for "X" does not mean that is what it is "worth." It is only worth the amount that a buyer is willing to pay you for it. Which is why real estate agents value their clients' homes using "comps," which are actual sale prices for comparable homes. Original asking prices, or appraised values, are not considered because they are not "real" prices.

The same is true of stocks. At any given time a share of stock is worth the market price, plain and simple. If Apple stock is trading at $470, as it is today, that is what you can sell it for. As a shareholder, that price represents its value to you. At that moment  you can either choose to own one share of Apple or $470 in cash. No other option exists.

Now, an analyst, or portfolio manager, or finance professor can do some number-crunching and conclude that they believe Apple should be worth more than $470 per share (in fact, both Professor Damodaran and I agree that Apple is a bargain currently), but just because someone believes that to be the case does not make it true. In order for our opinions to be proved right, the market has to price the stock at that level. That is the only way we could ever actually sell our stock for a higher price.

Investing in a stock is making a bet that its market value will be higher in the future, affording us the opportunity to sell our shares and make a profit. Professor Damodaran makes the philosophical argument that price and value are not the same, but I respectfully disagree. A share of stock is only worth what someone else is willing to pay and the price someone is willing to pay is the current market price.

So, back to the case of Apple. If the company took David Einhorn's advice and gave investors $100 of preferred stock for free, for every share of Apple they owned, it is entirely possible that Apple common stock would trade above $370 (the current price less $100). We cannot prove that unless it actually happened, but it is a reasonable conclusion to draw based on Apple's earnings power ($40 per common share in trailing EPS post-preferred issuance).

In fact, if Apple common shares fetched a 10 P/E, as Einhorn projects, the stock would be $400 and shareholders would then own $500 worth of Apple securities ($400 common plus $100 preferred). Considering that they can now only get $470 for their shares, there would indeed be $30 per share of "value creation" for shareholders. Again, Apple stock is only worth what someone is willing to pay. That amount is the current price. no more and no less. For anyone to argue that no value would have been created for investors in that scenario seems illogical. Price and value are one and the same because there is no guarantee that anyone will ever be willing to pay you what you perceive the value of something to be (how frequently that occurs will determine how good of an investor you are).

I remember reading about a line delivered by Donald Trump in 2007 when asked about his net worth. Here is the exchange:

Trump: My net worth fluctuates, and it goes up and down with the markets and with attitudes and with feelings, even my own feelings, but I try.

Ceresney: Let me just understand that a little. You said your net worth goes up and down based upon your own feelings?

Trump: Yes, even my own feelings, as to where the world is, where the world is going, and that can change rapidly from day to day ...

Ceresney: When you publicly state a net worth number, what do you base that number on?

Trump: I would say it's my general attitude at the time that the question may be asked. And as I say, it varies.

In this case Trump is using the same definition of value that Professor Damodaran seems to be using. Trump says his net worth is X. That is the perceived value, which is why he thinks it can be different based on how he "feels." Of course, we know that net worth is a technical term. There is no perception involved. His net worth is the amount of money that would be left over if he were to sell all of his assets and repays all his debts. Plain and simple.

As for Apple, I am hopeful that Einhorn's public challenge of Apple's capital allocation policies kick-starts some changes at the company. There is no doubt in my mind, and many are in agreement, that the current market price of Apple is largely discounting the value of its massive $137 billion cash hoard. There is no other explanation as to why the stock current trades at a trailing P/E of only 7, especially when you compare it with other technology stocks.

Full Disclosure: Long shares of Apple at the time of writing, but positions may change at any time

Wow: Apple's Round Trip Back Below $450 Brings Trailing P/E Down To 7x

That kind of looks like a mountain landscape I would see from higher elevations out here in Oregon, but instead it is a 1-year chart of Apple (AAPL) stock. After Tuesday's solid but uninspiring fourth quarter earnings report, Apple's quick fall from perceived market darling to "just another large cap tech stock that is being passed by on the innovation front" has reached a crescendo. The magnitude of the drop from the September high of $705 now sits at -37%. Instead of $800 price objectives, some are suggesting $300 may be more fitting. How times have changed in just four months.

Apple earned $44 per share last year, giving the stock (at the current $445 quote) a trailing P/E of 10x. Free cash flow in 2012 was $47 billion, giving the stock a 9x free cash flow multiple. The P/E is actually lower if you use free cash flow instead of reported earnings. That hardly ever happens and shows you just how cheap the shares are right now. And don't forget the $137 billion ($145 per share) of cash that Apple has in the bank). Subtract out the cash position and investors are getting Apple's operations for just $300 per share ($285 billion). That equates to a trailing P/E of 6.8x and 6.1x times last year's free cash flow.

How do those numbers compare to others? The P/E is lower than Microsoft, Intel, Cisco, IBM, and Oracle. The free cash flow multiple is unheard of. Try finding any other company that trades at 6x free cash flow, in any industry!Now, I did write about a month ago that I thought Apple stock was cheap at $525 ("Apple Shares Now Nearly As Cheap As Microsoft: Which Would You Rather Have?") so it should come as no surprise that I think it's super cheap at $445. The point is, even if you think both their growth and margins have peaked, it is not easy to justify the stock being at $445 or $300 net of cash. The business would have to decline meaningfully from here for that to make sense.

Sure, it's not impossible, but is that the most likely outcome? Is it likely that Apple's share of the tablet market declines meaningfully? Is it likely that their share of the smartphone market declines meaningfully? Remember, those end markets are growing, so just maintaining current market share results in Apple's business growing, not declining from here. Is it likely that they never come out with any new products? A television? A lower cost tablet for the education market to replace expensive, heavy textbooks? A streaming radio competitor to Pandora? Something else that has not yet been rumored already (those three have)?

Yes, it is possible that nothing positive happens for Apple from here on out. That they have peaked and will graduate to "old tech" like Gateway, Dell, HP, Intel, or Microsoft. But that is what the stock is priced for right now. To me, that does not seem like the most likely outcome. And if some things start to get better, or if Apple's 80,000 employees use their $137 billion of excess cash to create something new and great again, then the current stock price might look a little silly.

There is a difference between growth rates and profit margins peaking and massive deterioration in sales and profits. The stock has broken down technically, emotions are running high, analysts are slashing their price targets, and there are no catalysts to turn things around in the short term. But all of that could change fairly quickly. And given how cheap the stock is and how much money the company continues to print each day in its stores and on its web site, I just don't think fair value on Apple is a 7 trailing P/E multiple.

But we will just have to wait and see. I am willing to wait this out and will likely selectively add to client positions in the stock.

Full Disclosure: Long shares of Apple, but positions may change at any time.