What do we got for ya this week on Value Hive? Sony and Loeb duke it out over operations. AT&T appears to have listened to Elliot management. A trader loses his shirt, and more!
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Let’s get to it!
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September 25, 2019
How’s Your History? — I’m in Charleston, SC this week. That means a lot of Civil War tourist sights to visit. Also, for those that haven’t ventured down to the Palmetto state, make time. The beaches are amazing.
This week’s bonus round question is either easy or impossible. What is the name of the Fort that was first fired on to mark the start of the Civil War? Don’t Google! Answer at the bottom.
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Investor Spotlight: Dan Loeb Gets Rejected, AT&T Listens to Elliot
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Last Wednesday, Sony (SNE) gave Loeb’s fund Third Point a critical stiff-arm/middle finger. If you’re new to the Loeb / Sony saga, here’s some backdrop:
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- Third Point built a $1.5B stake in SNE, which it announced back in April. That’s good enough for 6% of total shares outstanding.
- Loeb’s fund sent a letter to SNE management suggesting various sales and spin-offs as a way to create value.
- Shares are up 40% since April. (Loeb’s sitting on nice gains).
The decision wasn’t a close one. SNE’s board unanimously decided to keep the semiconductor business. This makes sense. SNE’s semiconductor business is a powerhouse for the company. It provides 18% of total revenue and owns over half of the image sensor market.
SNE offers other “reasons” why the company decided to keep the business:
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- SNE expects its semiconductors will play a crucial role in various growth industries. (IoT, autonomous driving, etc.)
- SNE believes it’s too expensive to run the semiconductors business as a separate entity. Management cites higher licensing fees, tax inefficiencies, etc.
Yet I think the real reason is a bit more obvious, and a lot less academic. They don’t feel like it. The stock’s up over 60% in three years (10%+ CAGR). Things aren’t terrible at SNE. The switching costs to shake things up are too high.
What Will Loeb Do Next?
Loeb could fight this with a proxy vote to get seats on the board. And if Loeb’s past is any sign of his future, things could get nasty. Loeb’s known for fighting corporate big-wigs until he gets his way.
Once again, there’s reasons why Loeb wants this semiconductor business separated. SNE has ridiculous corporate structures (like most Asian companies). Structures which Loeb believes depress shareholder value.
Sony’s involved in gaming, music/picture and semiconductors. Those don’t quite go together.
SNE trades at a mere 11x earnings despite growing profitability every year for the last five years. So while they have appreciated over 60% since April, one could make the argument that they haven’t grown enough.
I’m with ya, Loeb. Increasing profitability five out of the last five years should command a higher multiple.
AT&T (T) Listens to Elliott Management
Elliott Management’s activist story seems to be going better than Loeb’s. AT&T’s looking to rid their stake in DirecTV, an acquisition they made only four years ago. We can assume it had something to do with Elliott’s activism.
AT&T’s Plan for DirecTV
The company’s discussed two ways to separate the business:
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- Spin-off the business into a separate, public entity
- Spin-off of DirecTV with combination of Dish TV Satellite assets
Given how bad the DirecTV investment went for T shareholders, either option looks appealing.
DirecTV is a Disaster
What went wrong? Well, everything. Elliott believes T overpaid for the TV company in the first place. On top of overpaying, DirecTV’s losing customers faster than Antonio Brown’s chances of playing football.
How bad is this customer churn? Management anticipates another 1M subs gone by next quarter. In other words, DirecTV’s losing subscribers at a 1MM quarterly run-rate basis.
But it doesn’t end there.
AT&T faces a class-action lawsuit for wrongfully reporting subscriber figures to its shareholders. Not to be outdone by Wells Fargo, AT&T is also accused of creating fake DirecTV Now accounts for customers without them knowing.
Yikes.
I love spin-offs. But I don’t want to touch a DirecTV spin-off with a 10-foot pole.
One Down, One To Go
If Elliott gets their way with the spin-off, it would mark a crucial turning point for the firm’s investment. The only remaining piece of business to take care of after the spin-off? Figuring out what to do with the Time Warner stake.
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Movers and Shakers: Rogue Traders & Adam Neumann
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We’ve all had bad days in the investing world. A stock we love reports shocking negative earnings — the stock tanks — and with it, your confidence. It’s that feeling you get when a stock you love keeps diluting shareholders even though its undervalued!!!
Despite all that, nothing this week tops what one oil trader did to his firm’s money.
Who’s To Blame
Chinese trader Jack Wang of Petro-Diamond Singapore Pte had lost $320M since January. OUCH. I use the word “had” because he got canned. Not surprising.
For context, Wang’s firm expects to generate around $5.6B in trading profits for 2019. So the $320M is a drop in the bucket. Still. It begs the question.
How did he do it?
According to the report, Wang placed a plethora of “unauthorized deals disguised as hedges.”
Hedge transactions are normally created through derivative instruments such as options and futures. Gotta love that sweet, sweet leverage.
How They Found Out
Wang did what any well-respected, hard-working oil trader would do. He went to his boss, informed him of the trades and suffered the consequences.
Just kidding.
He stopped showing up at work. After a while, people became suspicious. One thing led to another. Finally, after going through Wang’s trades during the oil bust of July – August they found the unauthorized deals.
Lesson To Learn From Wang
What can we, as investors learn from Wang’s demise? Should we never engage in derivative instruments? Never flirt with futures trading? It goes beyond that. Most likely Wang tried to make up for previous losses, only to suffer more losses. Which led him to try to make up for his bigger losses, etc.
The big takeaway is to take your lumps and move on. Don’t double down if your thesis falls apart. There are plenty of opportunities in any market at any given time.
Things Aren’t Going Well For Adam Neumann
Adam Neumann reminds me of that friend your child invites out to dinner with the family. Things are great at first and your kid’s friend is respectful. But by the second time they eat out with you, they’re ordering virgin Shirley Temples and ice cream sundaes.
Masa Son Wants Neumann Out
Masa Son runs Softbank. You know, the enterprise that invested in WeWork at a $47B valuation. It’s no surprise that as of its recently quoted IPO of $27B, Son wants Neumann out of the driver’s seat.
Son wants Neumann ousted as CEO for one reason:
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- Prevent WeWork from going public
If you’re Masa Son, this makes perfect sense. Son doesn’t want a writedown of nearly $20. Who wants to take a loss like that if they don’t have to? Maybe our oil trader friend.
I can now see why Neumann cashed out when he did. Maybe this was his plan all along?
This is What We Get
Conspiracies aside, WeWork is a great example of the type of company that bubbles to the surface during peaks in the economic cycle.
When retail and institutional investors care more about narratives than profits, you get WeWork.
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Idea of The Week: Revisiting Spotify After It’s Fall
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I’m not a shareholder of Spotify (SPOT), but a disclaimer is necessary. I freaking love the product and use it every day.
With that out of the way, let’s break down this week’s Idea of The Week. The idea comes from Matthew Griffith of DA Davidson. Matt pitched this idea at ValueX Vail 2019. For those interested, you can find the entire presentation here.
Let’s break down the highlights of the bull thesis:
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- Spotify is a disruptor in a large and inefficient industry
- Spotify controls a two-sided market, creating value for listeners and music creators
- Spotify is the only competitor at scale
- Although a young, tech company, Spotify is FCF positive
It’s About The Musicians
While Spotify enjoys healthy cash flows from their growing base of listeners, that’s not their goal. The real money will come from partnering with content creators. The musicians.
Matt explains in the following chart:
Spotify’s addressable market increases considerably if their able to provide higher-value for musicians.
On top of that, the switching costs for musicians to use Spotify’s service is low. They’re already getting screwed. What’s the harm in seeing what Spotify can offer?
What The Bears Say
Many investors focus on the amount of listeners Spotify can add to their platform. But they’re missing the point. If you focus only on listeners, you overweight a critical aspect of the bear thesis: free alternatives.
These services would be stiff competition if Spotify was a one-way business.
That’s not the case.
Now there are a few major risks with Spotify, as Matt points out:
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- Inability to secure rights or control third-party content
- Unfavorable regulation changes in music
- Inability to grow outside core operating segment
Let’s take a look at price.
Flirting with All Time Lows
SPOT’s bouncing around its 2019 lows of ~$120. It still trades for ridiculously high multiples of earnings and EBITDA. But, if you look beyond traditional value metrics, the next five years could look better than its last five years.
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Resource of The Week: How To Invest in China
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I want to invest in China. I really do. Yet I can’t get myself to do it. Is it the shell companies, shady accounting practices or the CCP controlling most every public company? It’s a mixture.
Fortunately, ValueDach released a new video with Professor Dr. Ingo Beyer. Dr. Beyer works for Qilin Capital, focusing exclusively on Chinese equities.
The video touches on:
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- Why Chinese markets are interesting to invest in
- Beyer’s favorite Chinese companies
- The state of protection of shareholder’s rights in China
I want to believe. I want to have the faith of Charlie Munger in the Chinese markets. This video motivates me a little further.
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Who Won Twitter? — When In Doubt, Mention AI.
Remember where we are in the business cycle. It’s never too late to mention AI in a company’s latest earnings report.
Pro Tip: If you’re struggling with sales, mention artificial intelligence. Just say it. It’s the equivalent to saying “China” in 2017-2018.
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Bonus Round
If you guessed Fort Sumter for today’s Bonus Round question, you’d be correct. The first shots of the American Civil War fired at Fort Sumter on April 12, 1861.
That’s all I got for this week. Shoot me an email if you come across something interesting this week (mrbean@macro-ops.com).
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