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.

7/11/14 Picks

Back with a quick pick today. Hopefully everyone got in on the last two picks. LULU is up 7% and OUTR is down 23% (July puts up 573%).

The pick today is a highly unprofitable internet-related company that took advantage of frothy IPO markets to go public. It feels like the year 2000 all over again with flawed internet businesses and their owners cashing in on exuberant markets.

Short CHGG ($6.5)

• Chegg is a website focused on college students which offers textbook rentals, tutoring support, and other ancillary services.
• Chegg went public in November at $11 and has since been nearly cut in half. In the process, they have also burned through much of the cash raised via the offering. 
• Flawed Business Model: 80% of the company's revenue comes from textbook rentals. This was a great business idea in the past, competing against college bookstores, but since 2012, they go head to head against Amazon (#1 online retailer), Half.com (Ebay), and Staples (#2 online retailer). Amazon has a history of aggressively cutting prices to gain market share, which they began doing this summer. Books are a commodity product, budget-conscious students are going to search google for their title and choose the lowest price. Amazon's resources assure their title will pop up first, their pricing will be the lowest, and their shipping times will be minimal (35 distribution centers vs. 1 for CHGG). 
• Unprofitability: The company has averaged a 22% net loss in each of the past three years. In 2013, they posted revenue of $255 MM with losses of $56 MM. The more they grow, which they are doing at a progressively slower pace, the larger the losses grow.
• Industry Headwinds: College enrollment has shrunk the past two years. Less unemployment and higher wages, coupled with student debt regulations equates to less students. This trend will likely continue.
• Cash Burn: At the their current cash burn rate, they will need additional capital soon. Any follow-on equity raises will dilute the stock and debt will be expensive and covenant-heavy. This problem becomes exacerbated considering the capital intensive nature of CHGG's business: they own each book. Cash is essential to their business model and one season of poor planning would be painful, if not catastrophic.
• Expectations: Analysts expect CHGG to miraculously buck their current trend and become profitable by next year. With those expectations baked into the price, there is significant value betting on their current spiral to continue. 
• Conclusion: The current IPO lockup has expired. The CTO sold 25% of his shares a few weeks ago and I would bet more executives will follow. The IPO will allow for them to cash in their chips while they still have value. The textbook environment has transformed in the past two two years and I see this David (Chegg) vs. Goliath (Amazon, Ebay, Staples) matchup ending differently than the traditional story.
• If you can't short, OCT 7.5 puts are an alternative.

6/13/14 Picks

Long LULU ($37.4)

• LULU, the athletic apparel retailer, has been beaten down over the past year 44% due to product recalls, reduced financial projections, and management turmoil. 
• They missed earnings yesterday and fell 16% due to lowered guidance. Part of the miss was attributable to the repatriation of offshore profits, which will be used to buy back $450 million worth of shares.
• LULU has finally bottomed out and should bounce back. Their product is widely regarded as the highest quality activewear and they maintain a very loyal customer base. As much as I hate retailers in the current environment, this opportunity is an exception. Yesterday's decline provides a great entry point. 
• Valuation: LULU's P/E ratio has dropped below 20. This compares to Under Armour's 75 (with a similar growth rate) and Nike's 25. It is simply too cheap given its current growth rate. PEG ratio: LULU 1.26, UA 2.58, NKE 2.05.
• Profitability: Operating Margin: LULU 26%, UA 11%, NKE 14%. EBITDA Margin: LULU 29%, UA 13%, NKE 15%. 
• LULU is more profitable than its competitors and is still growing top and bottom line at an amazing rate. 
• Hopefully they have their issues behind them and will begin reverting back to a price range that reflects their profitability and growth prospects. 

Update from Tuesday regarding returns. We are now up in 9 of 10 positions with a 40 day return of 9.6% (unleveraged, equal weight, half long - half short). If you got involved with last week's OUTR July put, it is up 100% since Friday (not included below).

6/10/14 

Quick update on our monthly return. Assuming equal weight for each position and no leverage, 7.7% for the past month. This was generated from the same amount of longs and shorts, five each.

6/6/14 Picks

6/6/14

We are back after a two week research hiatus.

Short OUTR ($70.6)

• Outerwall is the company that owns Redbox and Coinstar.
• OUTR has grown tremendously over recent years in very profitable fashion. They literally own cash machines, but the stock has reached its peak.
• Redbox, the overnight movie rental machines outside retailers, makes up over 80% of OUTR's revenue.
• Physical movie rentals are in permanent decline, the industry has contracted 14% annually the past five years and it is accelerating.
• OUTR has deployed 40,000 of these machines across the country at an amazing pace... until this year when they took 500 out of service. Apparently they have run out of good locations which begs the question how they can possibly continue to grow as analysts predict.
• We aren't the first people to jump on this sinking ship, OUTR's current short interest is a ridiculous 37% of float, but it looks like we are timing it just right. The shares short have been cut in half in the past six months, helping to mitigate the short squeeze risk.
• So the obvious question is why the stock is up 25% in the past year and at an all time high? The stock hit its 52 week low last September ($46) after poor guidance. A few weeks later, Jana Partners bought 13.5% of the company and the stock spiked. Their goal was to unlock value, which they accomplished with hugh stock buybacks. This artificially inflated the stock all the way to $70 where it stands today.
• It appears as if Jana has accomplished its goal and is taking their money and running. In their latest 13F they reduced their position from 13.5% to 8.4%. It also looks like TPG-Axon has completely disposed of its stake in their most recent 13F.
• Short term - OUTR is headed back to its natural position (sub $50). Long Term - It has a one-way ticket on the Blockbuster bus.
• Great article and more detail on the company/trade can be found here:  http://online.wsj.com/news/articles/SB10001424052702304422704579574191322689248
• Also, there aren't many shares available to short so a good alternative is July $65 puts.

5/16/14 Weekly Picks

5/16/14

Quick note on one of last week's short picks (WWE). Turns out their network can't make up the lost Pay-Per-View revenue and the stock is down more than any stock traded today (-45%). That's what we call a Stone Cold Stunner...

Only one pick this week. This was uncovered due to long time reader Charlie Arnold's interest in the mobile payment sector.

Long MITK ($3.4)

• MITK develops mobile imaging services, primarily for financial and insurance companies.
• If anyone has deposited a check in the last few years on a banking app, they have most likely used MITK's product. MITK owns the patents on mobile check deposits and other solutions.
• Only 5% of check deposits are currently made using mobile apps, this will likely increase rapidly as more banks implement this technology and more users learn how to use it - is is the future.
• Over 2,000 banks already use their technology and all of the top ten largest banks.
• They are also in negotiations with insurance companies to file claims using your app and billing companies to take a picture of your bill and pay it automatically.
• MITK has a very small market cap and is very risky. The stock has gone from almost $8 down to $3.4 due to litigation with another company and poor profitability so far. Management is currently modifying their billing model to increase revenue and profit. Hopefully these growing pains allow for a nice entry point at a discount.
• While I usually hate unprofitable companies, there are some silver linings to MITK. 30% of their operating expenses are in Research & Development. This shows they are working hard at improving their technology and investing back into the company rather than milking it.
• At current prices, the downside is limited and the upside is exponential. They could license out their technology to any developers looking to use their image technology and it's only a matter of time before mobile deposit goes mainstream with consumers - it isn't going away.
• MITK is volatile and could swing down due to continued losses or litigation, but the upside potential seems much greater. Continued adoption among mobile users, future announcements with large corporate partners, or even being acquired by a bigger player would all result in a nice pop.

5/9/14 Weekly Picks

5/9/14

Long TRMB ($35)

• TRMB uses remote sensing technologies for various industries, mainly construction and agriculture.
• In their agriculture segment, their products increase yield by using GPS and rain sensors to tell farmers exactly where they need to water, fertilize, harvest etc. most efficiently.
• This industry is booming and will only get bigger with growing populations and limited farmland - farms have to start using technology to become more efficient and profitable.
• Company is growing quickly and very profitably.
• They missed earnings last week so it finally gives a chance to get in after a pullback.
• Farm tech is getting to be huge and they are the leader.
• Long term play

Short WWE ($17.25)

• WWE is exactly what you think, World Wresting Entertainment. Yes, they are still around and yes, people still waste money watching this.
• Stock has gone from $10 to $30 in the past year due to their online subscriptions where fans can watch current and past media on the internet.
• Instead of growing their revenue substantially, it will likely just switch fans from TV to internet and cannibalize their current base, not increase it.
• Revenue growth is flat over the past few years and they are barely profitable (600 P/E ratio).
• We missed the boat a bit here, it has already fallen from $30, but has room to fall further.
• Vince McMahon is the company, it would crash without him. Let's then consider he is 68 and has obviously been on steroids for an extended period of time. I would bet against his liver.

Short LOCK ($13)

• LOCK is lifelock, the commercials where the guy guarantees you won't have your identity stolen with their products, although the founder has had his personally stolen 13 times.
• The company has frequently been under investigation for fraud, but has weathered the storm. They are now under investigation again, and the results haven't been released yet.
• Their products don't add value, they scare consumers into buying and now other competitors (like CapitalOne) are offering similar products for free.
• We missed the boat on this one as well (down 20% YTD) but could fall further after the FTC is done with them.

5/2/14 Weekly Picks

5/2/14

Long CTRP ($45 4/29/14)

• Priceline.com of China
• Strong top and bottom line growth
• Emerging and rapidly growing Chinese middle class (target customer)
• Down 9% last month so good entry point
• Long term play

Short CSH ($45)

• Payday lender
• DOJ is investigating and likely to implement new regulations on industry
• Stock is up recently due to spinoff and good short entry point

Long INVN ($19)

• Chips for wearable devices primarily
• AAPL will likely use their chips in iWatch
• If AAPL contract is won, stock should appreciate signicantly
• Stock is expensive, near 52 week high, but fell today on poor earnings

Long SDRL ($34.5)

• Offshore driller
• 11% dividend
• 52 week low due to capacity over reaction in industry
• Mgmt assured dividend will not be decreased until 2016
• Did I mention 11% dividend?

Short CTRN ($17.2)

• Urban clothing retailer
• 52 week high for no apparent reason
• 500 P/E ratio
• Long term viability is questionable with unattractive industry and poorly run company

FSLR Long Straddle ahead of earnings on Tuesday