2/26/16

Basket of Puts (BOX, TDOC, PSTG, APIC, CRCM)

2014 was a record year for IPOs. 275 companies went public generating proceeds of $85 billion, the most since 2000. The VC/IPO bubble 2.0 was sharply corrected in 2015 with only 170 companies going public netting $30 billion in proceeds. Average returns on 2015 IPOs as of 12/31/15 was -2.1% compared to 21.0% in 2014 and 40.8% in 2013. Despite this justified correction, a wave of unprofitable companies with unsustainable business models were able to list publicly and remain grossly overvalued.

The following companies all have several things in common. They took advantage of frothy markets and went public too early, are highly unprofitable, have meager cash reserves, and have substantial cash burn rates. Each company is trading well below their debut prices and should continue to deteriorate. I highly doubt any of these companies will be able to raise money besides secondary equity offerings, which would further dilute their share prices.

Box (BOX) is a cloud-based file sharing company focused on enterprises. It is exceedingly unprofitable  (-71% Net Income) and has declined 48% since its opening day.

TelaDoc (TDOC) is an on-demand healthcare company that allows patients to receive medical consultation via telephone or internet. While this is a novel approach, the company is also unprofitable (-74% Net Income) and has declined 49% since its opening day.

Pure Storage (PSTG) is a flash-based enterprise storage company. This particular industry is overcrowded and I expect the weaker players like PSTG to ultimately fail as the sector consolidates. Net Income is currently -76% and the lockup expires on 4/4/16. It has declined 17% since its debut.

Apigee (APIC) is an API-based software platform targeted towards enterprises. Net Income is running at -66% and it has declined 65% since its public inception.

Care.com (CRCM) is an online marketplace for babysitting, senior care, and pet care. The entire concept of this business is baffling. It is essentially using a craigslist-type website to find strangers to take care of pets or family members. While they do “vet” their caregivers, the company is currently mired in multiple lawsuits, including two wrongful death cases. Less than 2% of members actually pay for services on the website. Revenue growth is slowing at the company and their cash burn rate is astonishing. The stock has declined 75% since it went public.

Name	Ticker	IPO Proceeds (MM)	IPO Price	Current Price	TTM Revenue	TTM        Net Income	NI %	Cash (MM)	Earnings Date
Box Inc.	BOX	$175	$14	$12	$280	($198)	-71%	$215	3/9/2016
TelaDoc	TDOC	$157	$19	$14	$68	($50)	-74%	$152	3/2/2016
Pure Storage	PSTG	$425	$17	$13	$464	($353)	-76%	$573	3/2/2016
Apigee	APIC	$87	$17	$6	$73	($48)	-66%	$81	2/29/2016
Care.com	CRCM	$91	$17	$6	$147	($35)	-24%	$61	5/10/2016

It should be noted four of the five companies report earnings in the next two weeks, so I plan on getting involved prior to these releases. Shorting the majority of these stocks is not cheap and there is always the chance that they could be acquired by larger players given their distressed prices. For this reason, I am buying puts rather than purely shorting.

BOX June 17 $12 Put

TDOC July 15 $15 Put

PSTG May 20 $15 Put

CRCM July 15 $5 Put

APIC (TBD)

11/10/15

Short ESS ($222)

Overview - Essex Property Trust (ESS) is an apartment REIT based in Palo Alto, California. The company has ownership interests in 245 apartment developments strictly on the West Coast (47% Southern California, 32% Northern California, 21% Seattle Metro), in contrast to more geographically diversified REITs. The company is highly concentrated in “high end” apartments in geographies which have experienced huge growth in recent years.

Performance - Since 2009, ESS’s stock price has soared from $55 to over $220, increasing its market cap to over $14.7 billion. This has been fueled by a combination of improving real estate metrics, job market improvement, and artificially low interest rates. These variables are largely cyclical, and arguably due for reversion. While riding these tailwinds, ESS effectively “doubled down” on the West Coast by purchasing BRE last year for over $4.3 billion, probably overpay ing for a top competitor in the midst of a cyclical high.

Above $200, ESS is currently priced for perfection. Their properties are 96% occupied while experiencing tremendous rent growth. Last Friday, The Company beat Revenue, EPS, and FFO estimates, in addition to raising future guidance, yet the stock still fell. If ESS experiences any slowdown in these key metrics, the stock will certainly fall much further.

ESS has been riding the West Coast gravy train for years and a top analyst at Raymond James seems to agree that ESS is close to the top. “RJA believes that all of the good news about West Coast markets are already baked into the shares.”

Geographic Concentration - Looking closer at ESS’s properties, it’s easy to see why the company has outperformed the market over the past six years. Each of their focus areas has outpaced the national average in terms of rent growth. In San Francisco, the average apartment rent has increased 91%, Los Angeles has increased 35%, and Seattle has increased 57%. Granted these areas have experienced greater economic prosperity than the rest of the country, these growth rates are simply not sustainable. Real estate markets, like all markets, move in cycles. ESS has asymmetrically positioned itself not only to benefit from this prosperity, but also suffer from any slowdown.

Tech Bubble Spillover - San Francisco, which represents a large portion of ESS’s portfolio, has been one of the hottest real estate markets in the U.S. over the last few years. The re-emergence of the technology and venture capital markets has resulted in an influx of high-earning renters to the area. ESS has directly benefited from this external, cyclical market dynamic. Many industry experts are calling the peak, including venture capitalist Mark Suster. A few weeks ago at Venture Outlook 2016, Suster was quoted "our late-stage, privately held technology market is clearly in a bubble… we’re doomed to repeat history. Boom and bust."

The current VC cycle has been fueled by non-traditional investors in search of higher yields, given the low interest rate environment. Non-VCs led the vast majority (78%) of funding rounds in the 80 $1 billion-plus companies in the last 18 months. “When interest rates go up it's likely that non-VCs will stop investing in startups so much and focus on more traditional asset classes instead.”

An article in Marketwatch last week also weighed in on the current bubble. “Only 12 tech companies went public in the first three quarters of 2015, the lowest percentage of the overall IPO market since before the dot-com bubble formed. Nearly half of the companies that did make it to Wall Street failed to live up to their valuations, indicating that the late-stage venture investments of recent years may have been overdone.” The Marketwatch bear case was summarized with the following statement: “Wall Street just suffered its worst quarter in four years, and many tech companies’ stocks have failed to live up to their IPO prices; The next generation of hyped tech startups, while commanding jaw-dropping private valuations, has been slow to go public; and layoffs have begun at both heavily valued startups and their already-public older siblings.”

If the Technology/VC market slows, which it appears to be doing, one would expect occupancy rates and rent growth to also be affected. Jonathan Smoke, the chief economist at Realtor.com, provided the following input. “Silicon Valley is one of the markets that has the least amount of economic diversity… If tech implodes there, the housing market will feel it.”

Apartment Construction – ESS has benefited from a lag in new multifamily construction in its focus areas after the real estate crash of 2008. This supply constraint has led to excess demand and exorbitant rent increases. As with any real estate cycle, high rent prices attract new construction until the market falls back into some semblance of equilibrium. Currently, there are over 135 developments representing over 27,000 units recently completed or under construction in the San Francisco area. In Los Angeles, there are over 161 developments also representing over 27,000 units recently completed or under construction.

Raymond James’ multifamily REIT analyst Buck Horne recently addressed the issue. “Horne noted supply concerns, because new permits are up substantially in key Essex markets of San Jose, Los Angeles and Seattle; he additionally mentioned a higher cost of capital impeding accretive acquisitions moving forward.”

2015 has seen the highest level of multifamily construction starts since 1987. This will help relinquish the demand crunch and, as often is the case with ill-timed developers, eventually create an oversupply of units.

Leasing Cycle – Apartment REITs primarily deal with short term leases, which are more sensitive to economic volatility. ESS relies on a constant amount of high-earning renters to keep their occupancy levels at 96%, while also relying on rent prices to progressively increase. Any slowdown in this demographic would result in less demand, at more competitive prices.  When you couple this with the new multifamily supply due to arrive, you have a dangerous cycle on your hands. The short term leases would compound the problem in very short order.

Peer Comparison – Essex appears overvalued when compared to its peers.

ESS currently trades at 76x P/E ratio, while the overall industry average is 19x, and close competitors like AVB and EQR trade in the low 30x’s.

ESS currently trades at the highest P/FFO multiple of any major apartment REIT of 25.5x, significantly above the apartment REIT average of 20.1x.

ESS currently offers a dividend of 2.8%, also below its peers and well below the industry average of 4%.

Perhaps the most accurate way to evaluate REITs is by Net Asset Value (NAV). Apartment REITs have traded at an average discount of 7% to NAV over the last eight months. Essex currently trades at a 2% premium, significantly higher than the average and top of the peer set.

Sam Zell / EQR – Sam Zell, one of the great real estate investors and ESS competitor, seems to think we are nearing a peak, especially in the apartment space. He sold $5.3 billion worth of apartments last week to Starwood. He called the previous real estate peak by selling $39 billion worth of properties to Blackstone in 2007. By 2009, the majority of these units were underwater.

EQR is using the funds to pay a special dividend, not pursue additional acquisitions in the current market.

Anecdotes – Below are ancillary anecdotes regarding the bear case for ESS.

Rent Control – With the exorbitant rents pricing citizens out of affordable housing, cities across the West Coast are considering rent control measures. This would obviously be a worst case scenario for apartment REITs. Below is the ESS CEO weighing in: “I commented last quarter that rent control is in ongoing discussion in several West Coast cities. We continue to see plenty of media coverage concerning the pace of rent growth and its relationship to income. The city of Richmond California recently decided to pursue a rent control ordinance although details remain in draft form.”

SF real estate bubble - A recent article in Business Insider gave a telling example of the current situation: “The couple who just bought a four-unit building in what used to be a pretty scary block in the Mission — the kind of block where you wouldn't have wanted to walk around alone at night unless you had your wits about you — and is now renting the two-bedroom units out for $6,000 a month. The owners got the money for the place by selling their successful startup. Nearly all of the tenants work for startups or big tech companies.”

Conclusion – When you combine all the data points and topics above, you see a pretty compelling case that the West Coast is in a major real estate bubble. ESS is a pure play on this market that is overvalued by every available metric, compared to its peers and other asset classes. ESS is in the rare position of benefitting from multiple bubbles simultaneously. When Sam Zell checks out, I’m not far behind.

7/23/15

Short SHAK ($59.5)

The entire fast casual restaurant sector is in a bubble with Shake Shack at the pinnacle. I've been watching SHAK since its IPO and, unfortunately, have been too busy to trade and post on it. It debuted earlier this year around $40 and rose to $96 before falling to its current price (as I kicked myself the entire time). Despite the 40% correction, SHAK is still grossly overvalued.

Chipotle is the gold standard for fast casual restaurants. They have executed flawlessly to grow to almost 1,800 stores profitably and are still overvalued at current prices. Below are a few comparison metrics to show the absurdity of SHAK's valuation compared to Chipotle.

At year end, each Chipotle restaurant was valued at $12.7 million compared to $68.4 million for SHAK. SHAK restaurants are valued over 5.4x that of Chipotle, despite producing only 1.6x the revenue, less profitably. The story is the same for every possible metric, with the most ridiculous being SHAK's EV/EBITDA multiple of 234x, over 10 times Chipotle.

The argument for SHAK is centered around growth. It is growing at a rapid pace with the combination of new stores and increased same store sales. Given the valuations, you would expect SHAK to be growing 5-10x as fast as Chipotle. In reality, SHAK is expected to grow revenue 25% next year compared to Chipotle at 15%. In terms of same store sales, SHAK grew 11.7% in Q1 compared to Chipotle at 10.4%, and below Domino's at 14.5%. SHAK is growing at a similar pace to proven concepts in both metrics, yet valued substantially higher.

Bottom line, there are too many headwinds for SHAK to maintain its current price. Any slowdown in consumer spending will be first reflected in discretionary items like $15 hamburger meals. The IPO lockup expires July 29 so I would jump in prior.

1/16/15

LONG ERX ($50)

Due to multiple issues (supply, demand, geopolitical, speculation), oil is historically oversold. It will recover, it's simply a matter of timing. Both established and emerging markets need to oil to sustain growth indefinitely into the future. Technology may increase our extraction and usage efficiencies, economies may slow down periodically, but at the end of the day you have an ever growing demand for a finite resource. A 60% decline in six months is truly remarkable.

ERX is an ETF reflecting the energy industry with 3x leverage. USO is the popular play for rising oil prices, but it will not have a symmetrical return with oil. USO purchases future contracts where much of the expected rise is already priced in (Jan 2016 futures are trading for over $55). ERX is based primarily upon oil equities, but with a 3x multiplier. If this is truly the bottom for oil, ERX is the best way to play it, besides buying futures contracts directly.

Below are a few bullets to reiterate why I think we are close to the bottom.

• OPEC is manipulating the price to force out higher cost per barrel players. This is a short term attempt to raise market share. Their economies rely too heavily on oil to keep prices this low. 
• With the increased shale production, OPEC could have cut oil production by less than 2% to keep the market in equilibrium. By not cutting production even fractionally, a precipitous decline has ensued (60% decline is not a proportional response).
• Rig count is in free fall. Last week, the largest week-over-week decline since 2009 occurred, dropping to a 14 month low. This will continue as weaker players continue to take rigs offline. Less rigs means less oil extraction which leads to higher prices.
• Lower oil costs increases usage which increases demand over time.

I should have posted this yesterday since ERX is up 9% today.

8/13/14

LONG KANG ($20.7)

iKang is the largest private healthcare provider in China. Private healthcare is a relatively new and rapidly progressing segment of the Chinese market due to recent healthcare reforms. Private healthcare only represents 10% of the total Chinese market, of which iKang possesses a 12% market share. The company has received sophisticated funding over the years from large financial partners, including Merrill and Goldman. The stock went public in April and is up 38% since then.

• Exceptional Growth - Since 2010, KANG has grown Revenue at a 44% CAGR, Gross Profit at a 50% CAGR and Net Income at an 83% CAGR.
• Customers - 90% of KANG's customers are corporate clients who set up programs for employees. This is attractive since each new contract is typically large and poses little credit risk to the company.
• Chinese Healthcare Market - China is about to become the 2nd largest healthcare market in the world. It is expanding at a mind-numbing pace of 12% annually, with the private market segment growing twice as fast.
• Health Insurance Participation - 95% of Chinese citizens have health insurance, while only 85% of Americans do.
• Socioeconomics - As economic prosperity accelerates in China, so to will disposable income and healthcare demand, especially among the urban middle and upper classes (KANG's target market). The Chinese urban middle and upper classes represented 30% of total population in 2005, but will comprise 82% by 2020. 
• Demographics - The Chinese population is rapidly aging - elderly citizens represented 8.5% of the population in 2009, but are expected to comprise 18.3% by 2020. 
• Diseases and Environment - China's pollution issues continue to worsen and the health effects related to this will be an ever increasing catalyst for healthcare spending. Chronic disease cases are currently increasing at 5% annually.

All market dynamics point to an exploding Chinese healthcare industry over the next 10 years. The culmination of population growth, economic prosperity, expanding middle class, aging population, insurance participation and pollution will create a tremendous transformation/opportunity.

Foreign Investment Opportunity

Healthcare reform is currently underway in China, setting the stage for huge investment potential. China realizes they must open up their healthcare system to private markets and foreign investors. Their population is aging and becoming increasingly unhealthy. Without western processes and technology, a healthcare epidemic could loom. Up until 2012, foreign investors could only participate in the healthcare markets in minority ownership positions (30% max). This has since been relaxed and foreign investment is accelerating. TPG recently purchased one of KANG's competitors for a 50% premium over share price. 

KANG should continue to grow rapidly, organically and via acquisition, at increasing margins with economies of scale. They should easily surpass analyst expectations to our benefit and still have a small enough market cap to potentially attract PE buyout offers.

The trade is primarily betting on the Chinese healthcare market (both its growth and privatization); KANG is the best pure play. 

8/1/14

Short MCHX ($11.1)

Today's target is a low margin digital call advertiser that has risen substantially due to the overall internet bubble we are currently trapped in. Marchex is up 83% over the past year and 215% over the past two years.

• Overvalued - 300+ P/E and 45x EV/EBITDA
• Environment - Highly competitive with low barriers to entry. If the call based ad market grows substantially, major players like google would enter and MCHX would be gone.
• Flawed Business Model - MCHX relies on fees from completed sales, typically $10 - $30 per sale. As the market matures, this fee will be unsustainable and local businesses will never pay this much. The company is an unnecessary middle man. 
• Customer Concentration - Top 5 customers represent 60% of business. This gives them significant bargaining power on a business with miniscule margins already. Not to mention the fact that if a single customer from the top 5 went internal with their campaigns, results would be crushed.
• History of Cash Burn - To date, MCHX has burned through $200+ million in cash while pivoting their business model and attempting to turn an ever elusive profit. In March, they held a secondary equity offering - indicative of their continued cash  burn and equity dilution.  

MCHX could surprise with a short term earnings beat next week, but long term their fundamentals and business model will face ever stronger headwinds.

Sept 12.5 puts are a good alternative to shorting.

7/17/14

Quick thought piece to the few followers who own LO with me. This is a short term arbitrage play (3-4 week trade) that I wouldn't recommend unless you currently own the stock, given its speculative nature.

LO Sept 20 $60 Call ($1.50)

The Reynolds American (RAI) and Lorillard (LO) merger was announced two days ago. Following the release, RAI fell 6.9% and LO fell 10.5%. This unusual drop resulted from expectations of a higher purchase price

and LO divesting one of its crown jewels, Blu e-cigs. The market likely overreacted in this case. If the merger

goes through, LO shareholders will receive $67.42 based on 7/16 closing prices. RAI would have to fall to $33

to breakeven based on today's prices, given the $50.5 cash floor.

The other scenario is the merger is not approved. This could result in a number of outcomes. It could potentially stay in its current range since it would retain the Blu line. More likely, it would fall towards the mid 50's where it would be without the merger rumors. Probability  50%         Scenario #1 - Merger in current form ($67.42)                              RAI offer:                  Closing Price (7/16)      Proceeds / Share                  Cash: $50.5                 RAI: 58.14                     Cash:  $50.5                  Stock: .291 / Share      LO: 60.06                      Stock: $16.92                                                                                                      $67.42 50%         Scenario #2 - Merger does not advance. Assuming midpoint of base case ($58) & low case ($55). Expected Return: (50%*67.42) + (50%*$56.5) = $61.96 With the assumptions above, our expected return would yield an arbitrage opportunity of almost $2. While this helps our conviction, the main case for the trade in my opinion is the natural "drift" that acquisition candidates typically have during the quiet period of closing the deal and gaining regulatory approval. With little news, LO should drift towards the buyout price. Assuming a 60 day close, the Sep 20 $60 calls are probably the best way to play this. If LO pops up to $63 in a few weeks, that should yield a nice return and exit opportunity without the risk of waiting. Also, if RAI modifies the deal and offers to divest Camel, the merger approval rate would increase substantially and help our trade in the process.