File this under things that make no sense whatsoever:
Beeple NFT becomes most expensive ever sold at auction after fetching over $60 million
Reader Mailbag: Merits of Shorting Tesla
Reader Question:
I am curious of your take on the benefits of shorting tiny amounts of TSLA at these levels (~$850). At +800B valuation there isn't almost any room to grow reasonably. The reward of shorting might not be very big, but neither appears to be the risk.
Many skilled short sellers often give the advice that shorting based solely on valuation is unwise. I suspect the reason is that while fundamentals do matter over the long term, in the near term, investor sentiment dictates stock movements more. The stock price action of Tesla over the last year shows this clear as day.
Accordingly, if you are early and nothing fundamentally negative occurs at TSLA for the next 6-12 months, then there is nothing stopping the stock from continuing to rise. While there are lots of positives that have already played out (S&P 500 addition, fortifying their balance sheet, etc), the list of negative catalysts is harder to pinpoint. It might be more of a lack of further positive news, which could halt the momentum, as opposed to negative news.
I think TSLA is a unique business situation, much like AMZN, in the sense that their founder and CEO is not going to constrain the company to just making cars and solar panels (just as Mr. Bezos didn’t stop at books and music). As long as that is the “story” bullish investors have at their disposal, you can almost justify any valuation, including the current near-$1 trillion level. And that is the potential problem with shorting it due to overvaluation. The bulls are not buying it because the valuation looks fair; they are buying it because they believe Elon will change the world, much like Amazon has.
Along those lines, the many comparisons of TSLA’s market cap with every other auto maker in the world (combined) are easily tossed aside as irrelevant. The same notion turned out to be right when comparing Amazon to Wal-Mart a decade ago. But what if every car company transforms their fleets to EVs over the next 20 years, won’t TSLA just be another car company? Perhaps, but what if they provide the batteries and software for the majority of the industry at that point? How much is that worth? I have no clue.
I am not trying to make the case that TSLA is a buy at current levels. I do find the valuation extreme for a manufacturing company. From 2012 through 2019 the stock fetched a year-end trailing price-to-sales ratio of anywhere between 2.5x and 9.0x. At year-end 2020 that metric was over 25x. Industrial businesses don’t earn profit margins high enough to justify that kind of valuation, but the bulls will tell me TSLA is really a software play and eventually will have the largest network of self-driving EVs on the planet. Do I have a strong conviction that they are all crazy? Not really. Amazon turned out to be a computer services company as much as a retailer, and might be adding logistics management and advertising to that list too.
I simply don’t know how we value that possibility with TSLA. Shorting Amazon on valuation has never worked in 25 years. While I am confident that Ford and GM won’t be software companies eventually, I can’t say the same for TSLA. Given this narrative and reality, it is hard to place a fair value price for the stock, and therefore, hard to know when to short and when to be long.
In your question, you state that there “isn’t almost any room to grow reasonably” from current levels. Given the above narrative, I am less confident. Can we really say with conviction that TSLA can’t double their market cap by 2028 (a 10% annual CAGR from here)? I can’t, just as I can’t say with conviction that the business is worth 5x or 10x sales instead of 25x. To your point, though, if you short a tiny amount, there is not a ton of risk. in doing so. I completely agree.
Is it going to be hard for TSLA to grow enough to justify the current valuation? Absolutely. Could the stock easily be $500 a year from now, making a short position today pay off nicely? Absolutely. But I think the more interesting question is “of all the stocks out there to be long or short, does shorting TSLA rise to make the top 10 or 20 highest conviction ideas you have with which to build a portfolio?” If so, then there is your answer. If not, then I would say why not take a pass and, as Mr. Buffett would say, put it in the too hard pile?
Another part of your question got me thinking. You wrote that “the rewards of shorting aren’t very big.” Given the unlimited loss potential of shorting stocks in general, it seems that a large potential gain could be considered a prerequisite for shorting anything, TSLA included. Something to think about, as I suspect some will agree and others won’t.
All in all, I think TSLA is emblematic of the current bull market in the tech space; one where future growth potential is valued highly and current valuations and corporate profits are not. As a contrarian, value-oriented investor, I am disheartened by that development (and I don’t think it will end well for many speculators), but we also don’t know if/when the tides will shift and by how much. Given that, I tend to think that taking a lot of pitches in the batter’s box is a fair approach, especially when there are so many easier investment options out there to take a swing at.
That said, if the equity market breaks down at some point this year, it is reasonable to think the momentum plays could lead on the downside, in which case TSLA could easily fall hundreds of dollars per share. There are arguments on both sides, for sure, so then it just comes down to how much conviction you have to ultimately decide it is worth betting on one of those potential outcomes with Tesla, versus other securities.
Reader Mailbag: Overstock, tZERO, and Crypto Hype
Reader Question:
How much is tZero contributing to OSTK's PR and balance sheets? How much actual business/revenue value are generally crypto companies generating versus stock valuation pump due to the hype around everything crypto?
It is hard to speak about crypto companies generally in terms of business value vs financial market hype because there is a such a wide range within the sector. On one hand, some companies are all hype (press releases without much in the way of products or revenue) and on the other you have some, like Overstock’s tZERO business unit, that have press releases, products, and revenue (just no profits).
There is no doubt that Overstock’s share price is being valued partly on its crypto assets. While the pandemic certainly boosted their home furnishings e-commerce business, going up against the likes of Amazon and Wayfair is a tough task (one that they have been losing) and 2021 is likely going to present tough comparisons year-over-year from a sales perspective.
As for tZERO, below is a three-year summary of the financial results Overstock has reported in their 2019 10-K annual report filing (full year 2020 results have yet to be released).
As you can see, tZERO does have some business lines generating revenue, but they are relatively small compared with OSTK’s $5 billion current equity market value. More importantly, the crypto business has been losing roughly $2 for every $1 of revenue it brings in. This is not surprising, as there are not a lot of profitable crypto businesses right now (exchanges are likely the highest margin given that trading volumes are strong, relative to actual utility of tokens more generally).
It should not be surprising then, that Overstock recently announced plans to contribute its crypto assets along with nearly $45 million of cash into a Limited Partnership managed by an external third party. You can read the details here, but essentially OSTK is funding the LP with cash (likely to cover operating losses) and taking a 99% stake as limited partner. The outside manager will be the general partner, make all operational decisions for an annual management fee of $2.5 million, and will receive a performance fee based on the sale of any assets from the partnership.
By making this move, it sure looks like OSTK has decided it does not want to continue to fund operating losses in its crypto businesses. The hiring of a third party manager with a financial incentive to sell the assets seems like a bet that it makes sense to sell while people are willing to fall all over themselves to plow money into a sector that has yet to show it can offer a return from operations (but rather, just by selling currencies to someone else for a higher price).
Perhaps most interesting is that in its deal with this new LP, Overstock has published NAVs for each of its assets within the partnership, and they total less than $200 million (less than $5 per OSTK share). The current stock price would indicate they are worth far more than that. We will have to wait and see how easy it is for them to be sold, and how much capital can be raised in the process.
Full Disclosure: The author of this post was short shares of Overstock at the time of writing, but positions may change at any time and the short position is 75% smaller today than it was at its peak during 2020
Do you have a question you would like answered on the blog? Contact me from this site or message me on Twitter (@peridotcapital)
DoorDash IPO Highlights Relative Value of Uber Shares
With the DoorDash (DASH) IPO having gone far better than anyone thought, making the stock untouchable at this point from my vantage point, the real takeaway for me is how cheap Uber Technologies (UBER) stock appears on a relative basis. According to Uber management, they expect margins in the rides business to be 50% above that of the food delivery business. This is undoubtedly due to the restaurant being the middleman for Uber Eats, with no third party involved in the legacy Uber rides division. With that in mind, consider the data below when valuing DASH and UBER, with the latter only operating in the food delivery space:
Uber 2019 “Rides” Revenue: $10.9 billion
Uber 2020 “Eats” Revenue (1/1-9/30): $2.5 billion
Current UBER equity market value at $53/share: $93 billion
DoorDash 2020 Revenue (1/1-9/30): $1.9 billion
Current DASH equity market value at $158/share: $62 billion
Based on the current business mix of both companies, how should Uber be valued relative to DASH? Is ~50% more a reasonable amount? Something to think about for sure.
Full Disclosure: Long shares of Uber at the time of writing, but positions may change at any time
Airbnb and Doordash: So Much For A More Efficient IPO Pricing Process
This week was supposed to be a coming out party for a new IPO pricing process dubbed the "hybrid auction.” Newly public companies have long complained that large first day gains for their stocks enriched institutional investors with immediate profits, with no corresponding benefit to the listing firms. Given that an IPO is often desired to raise additional growth capital, being forced to “leave money on the table” is a big disservice to these young firms.
Inefficient IPO pricing is not surprising given the actors involved. Companies are advised by investment banking firms, whose job it is to allocate stock to their large institutional clients. The incentive, then, is to keep your clients happy and instantaneous profits on day one certainly accomplishes that. While a higher IPO price would give the banks a bigger take on the total deal value, a company can only go public once. The ongoing long-term relationships the banks have with their buy side clients are far more profitable and important. As a result, the banks have little reason to price IPOs as close to market demand as possible. It is a simple conflict of interest situation.
This new “hybrid auction” idea was supposed to help with this problem. Rather than picking a price and then taking orders from investors, the new model does set an initial price indication, but it asks would-be buyers to not only submit how many shares they want to buy, but also allows them to offer the price they are willing to pay. The idea is to get a better gauge of demand by seeing just how high buyers will offer if they think a higher bid will increase their odds of getting stock.
Perhaps you can see the problem already. A buyer of an IPO wants to get the lowest price possible to maximize their potential profit. By giving buyers input into the price they end up paying, they have an incentive to keep the price low, without being insulting or risking missing out to other buyers. So, the most likely outcome is that buyers submit strong bids, maybe even a bit higher than the indicated price range, but without getting too aggressive. Therefore, the real demand is never determined, because you would be crazy to bid anywhere near the highest possible price you are willing to pay.
The results this week were therefore quite predictable (huge first day price spikes) but I think the end result was even worse than most would have guessed. DoorDash (DASH) priced at $102 and opened at $182 (+78%). The Airbnb (ABNB) deal was even worse, with an opening trade of $146, a stunning 115% above the $68 IPO price.
So what is the solution? Well, Google (GOOG) had the right idea back in 2004 when it opted for a dutch auction for its IPO. The company saw a first day price increase of just 18% because it decided to actually sell its stock to the highest bidder (what a novel concept!). A dutch auction simply sells the available stock at the highest price possible. Potential buyers submit a max buy price and a desired quantity and the IPO price is set to be the highest price such that there is a bid for every share being sold. For some odd reason, companies have not copied the Google approach. Until they do, they stand to keep leaving a ton of money on the table with nobody else to blame but themselves.
One innovation is worth mentioning as having been successful and that is the “direct listing.” Many private companies are profitable and don’t necessarily need to raise additional growth capital via an IPO. However, they still might want to be a public company in order to provide their shareholders and employees liquidity and also have a currency with which to make acquisitions. In a direct listing, the existing shares outstanding simply begin trading on the stock exchange, which opens them up to everyone. The market price is immediately known and there is no “first day pop” because no actual IPO price needs to be settled on (no new stock is being sold, so no price for a sale is needed).
The only possible downside for a direct listing is that all of the shares are dumped on the market at the same time and so it could be met with a large wave of selling early on. While not indicative of any problem at the firm, optics are important and a falling stock price will always raise questions. The solution, however, is quite simple. A rolling lock-up expiration - say, 10% of the stock each month for 10 months - would require holders to sell slowly over time to cash out, and therefore would have a minimal impact on the stock price.
So here we sit and Airbnb and DoorDash have two problems; 1) they left billions on the table, and 2) their stock prices are so high that it will be harder for them to attain the financial expectations that are embedded in the current price. Both of those are detriments to the very people they were trying to help with the IPO (their shareholders).
Is Another Mania In Overstock Stock A Chance To Short?
Overstock.com (OSTK) has long been a volatile and controversial stock, at least in part due to its founder and former CEO, Patrick Byrne. Although I don‘t short stocks very often and do so even less in client accounts (most of the assets I oversee are in retirement accounts, where shorting is not allowed), Overstock is one of those businesses that makes for an attractive short at times; a much-hyped business with relatively poor economics that loses money. Every so often it sees a huge spike in stock price, only to fall back to earth. And then the process repeats itself at some point. Here is a chart of OSTK shares from 2003 through 2019:
During the pandemic, e-commerce businesses have seen an acceleration in sales growth and stock prices have responded, with the likes of Amazon (AMZN), Etsy (ETSY), and Wayfair (W) surging. Overstock, despite being a secondary player, has once again seen its stock soar:
As I often do in situations like this, I checked to see what the borrow charge was to short OSTK (stocks with smaller floats often cannot be shorted due to a lack of available shares - or in other cases investors need to pay a fee to borrow the stock which is often high enough to negate any material gains you could earn). Interestingly, the borrow charge on OSTK right now is immaterial, so I am now short the stock. While this mania in tech-related stocks may not end anytime soon, which could spoil this particular trade (insert “the market can remain irrational longer than you can remain solvent” disclaimer here), I have little doubt that the intrinsic value of OSTK and the stock price have not moved in tandem during the last couple of months.
So how bad is the business? Well, free cash flow has been negative every year since 2015 (EBITDA negative since 2017). Revenue in 2019 was below 2015 levels. For Q1 2020, EBITDA and operating cash flow were both negative. As folks were working from home and needed to bulk up on home furnishings, OSTK saw Q2 revenue jump 109% year over year. EBITDA went from negative $20M in Q1 2020 to positive $39M in Q2 2020, as sales surged 122% quarter over quarter. This strength is likely temporary, as hard goods are typically not high frequency repeat purchases.
Overstock shares were trading for about $9 before the pandemic at the February market peak, bringing the market value gain over the last 5 months to roughly $2.5 billion. Even if Q2 2020 EBITDA was maintained in perpetuity, OSTK currently fetches a multiple of 17x EBITDA. That valuation might not seem crazy, until you consider that the brand is a second tier player, at best, and more importantly, maintaining sales at these rates over the long term is simply not reasonable. Further supporting a negative view on OSTK is the fact that the company has actively shopped the retail business to potential buyers recently and found no takers willing to offer a fair price.
Full Disclosure: Short shares of OSTK at the time of writing, but positions may change at any time
It Sure Looks Like A Bubble Is Forming Again In The Tech Sector
Apple (AAPL) stock has long been a stock market darling, but investors have generally been rational with their pricing of the shares relative to the company’s profits. At the end of each of the last 5 fiscal years, AAPL stock has garnered trailing 12-month price-to-earnings ratios of 19, 19, 17, 14, and 12, respectively (the most recent year, 2019, is listed first). Over the last few years, the market has slowly adopted the bullish thesis that Apple is more of a consumer staples company (a valuation at or above the overall market) than it is a hardware company (a valuation well below the overall market).
But something has changed as the pandemic shapes 2020 thus far. Here is the stock performance year-to-date:
Having started the year at $293 per share, Apple stock has now gained 30% so far in 2020. Has the pandemic boosted their business somehow? Obviously not. The current earnings forecast for fiscal 2020 is $12.40 per share, up mid single digits from the $11.89 they earned in fiscal 2019. The stock’s trailing P/E, assuming they do in fact earn $12.40 this year, has surged from 19 to over 30. The sentiment shift has occurred in just the last two months, despite the fact that the underlying business is essentially unchanged.
The only logical explanation to me is that momentum-driven trading action is sending popular tech stocks to the moon and another valuation bubble is likely forming. Apple’s revenue this year is projected at $264 billion, versus $260 billion in 2019 and $265 billion in 2018. Their business is simply not enjoying an acceleration of growth that would normally cause this type of P/E ratio expansion.
The scariest thing to me is that Apple actually looks cheap on the relative basis compared to other beloved tech stocks right now. For instance, Amazon stock recently crossed $3,000, attaining a market value of $1.5 trillion (joining Apple in that group). Despite the pandemic, Amazon’s earnings are actually expected to fall in 2020 due to outsize growth in expenses. Therefore, being generous and using their 2019 earnings per share of $23.01 puts Amazon’s P/E ratio at an incredulous 131.
And yes, it gets worse. You have the money-losing tech stocks that are getting multiples of revenue that exceed the earnings multiples of many leading American firms. Take DocuSign (DOCU), a leading provider of electronic signature software that is obviously seeing plenty of demand during the pandemic. For the quarter comprising February, March, and April (the height of the pandemic; their “Christmas” so to speak), DocuSign reported revenue of $297 million (up an impressive 39% year over year) and somehow managed to lose $48 million in the process. After more than tripling in price off the March lows, DocuSign’s market cap of $37.3 billion comes out to a price-to-sales ratio of above 31 (if we annualize last quarter’s results). It makes Apple at 30 times profits look darn cheap, doesn’t it?
There are plenty of other examples that most of you are aware of so I will spare you from citing more. This momentum-based market for flashy high-tech is eerily similar to 1999. Back then we were also valuing companies on sales (20-25x multiples were common) because there were no current earnings, only hopes and dreams of a bright cash cowing future. Amazingly, the revenue multiples are higher now in many cases than they were back then. And for leading firms that are making money, Cisco, Sun Microsystems, Nortel, and Intel at 80 or 100 times earnings 21 year ago does not look as egregious as the likes of Amazon or Tesla today.
I have no idea how this will play out, but having seen something similar firsthand in the 90’s, it makes me nervous. I have no intention of putting client money or my own into things trading at such sky-high prices. I will leave that to the new Robinhood crowd.
Meet Apple: The New Consumer Staples Stock
In recent years, Apple (AAPL) bulls have argued that the company is morphing from a seller of technology hardware to a software and services business, which should result in a meaningful increase in the earnings multiple of the shares. I was never really able to buy into that framework because sales of the iPhone were north of 60% of Apple's total business and services was stuck in the low double digits. Getting hardware from 90% down to 80% or even 75% of the company didn't seem like enough of a shift to warrant P/E expansion from the mid teens to the mid 20's, but plenty of folks firmly believed that Apple should have the same multiple as Starbucks or Coca Cola.
Those bulls have been waiting patiently and in recent months the value of their holdings has surged. During Apple's 2019 fiscal year (which ran from October 2018 through September 2019) the company's stock price fell from $226 to $224. In lockstep, the company's GAAP earnings per share fell by the same amount (from $11.91 to $11.89). During those 12 months, the stock's P/E ratio was (obviously) stable and it was clear that the days of P/E's in the 10-12x range were long gone. With slowing revenue and earnings and a reasonable valuation, I held no position in the shares.
Oh what a difference four months makes (evidently). Apple stock since September 30th has been on a tear, making a new high today at just shy of $320 per share. That is a gain of more than 40% in about 16 weeks. What on earth is going on? Well, the multiple expansion thesis is playing out, and fast, even though there seems to be minimal fundamental change in Apple's business.
After declining in fiscal 2019, earnings per share for the company are expected to increase in fiscal 2020, with the consensus forecast now sitting at a hair above $13 per share (10% growth). At $319 and change, Apple's forward P/E is now above 24x. When was the last time Apple's P/E was in the mid 20's? More than a decade ago! Most interesting is that Apple was much smaller and growing revenue extremely quickly back then (annual revenue growth of 47% between 2008 and 2012 thanks to the iPhone, which was released in mid 2007).
Apple shares have more than doubled over the last 12 months, despite little change in the business and hardware as a percentage of total revenue still above 80%.
Congrats to those who hoped Apple would garner a consumer staples multiple in the mid 20's a la Proctor and Gamble, McDonalds, Starbucks, or Coca Cola. I have no view on where the stock goes from here, especially since I never expected the P/E to ascend to this level. All I know is that for a stock that traded between 14x and 17x earnings between 2011 and 2017, when its organic growth was far faster, the current price implies investors are banking on a lot of good news in the coming years. So while the bar was previously set quite low for the company, due to trading at a material discount to the market, Apple's financial results will have to meet or exceed far elevated expectations to maintain a premium valuation. In a way, it signals that investors are banking on growth once again, and the dividend yield is now down to only 1%.
It will also be interesting to see how Wall Street analysts react to this latest stock price spike. Will they keep raising their targets or go to a more neutral stance? Amazingly, the average consensus price target for Apple among the 44 analysts who cover the name is $290 per share, or about 10% below the current quote. Only about half (23) have buy ratings.
While I would not short Apple unless than P/E got to nosebleed territory (say, 30+), I see little reason to own it at 24x forward earnings after a massive run. If investors value it more like a blue chip consumer brand going forward, the current price indicates that its equity returns will likely fall into that category as well.
Guess The Valuation - Inaugural Edition
As a fundamentally and valuation driven investor, I am continuously amazed at some of the equity valuations the public market bestows on growth companies, even in an age of near-zero interest rate borrowing conditions.
So for those valuation-driven readers, let me present the first of what I will simply call "guess the valuation." I present you with financial metrics and you tell me how much you think a growth investor, at most, should be willing to pay in total equity market capitalization terms.
Before the comments start coming, understand that I am fully aware that this exercise is overly simplistic and one would want to have more data before answering such a question. Humor me please to play along, and feel free to give the company below the benefit of the doubt (within reason).
Unidentified Company X
Financial results for the first 9 months of 2019
Revenue: $1 billion (+50% yoy)
Gross Profit: $600 million (+50% yoy)
R&D Expenses: $250 million (+50% yoy)
Marketing Expenses: $350 million (+35% yoy)
General/Admin Expenses: $125 million (+60% yoy)
Operating Loss: $125 million (-35% yoy)
Operating Cash Flow: $20 million (N/M)
Okay, guess the equity value assuming zero net debt on the balance sheet...
The IPO Market Has Taken The Baton From Large Cap Tech And Is Running Like Crazy
For several years until recently large cap technology companies were carrying the U.S. stock market on their backs. The nickname of FANG was even coined to describe the group, which included Facebook, Apple, Netflix, and Google. However, all of those companies saw their stock prices peak in 2018 and move in sideways fashion since, which has resulted in the S&P 500 doing the same over the last year:
With the tech sector comprising more than 30% of the S&P 500, as big tech stocks see their rapid ascents halted, so does the overall market...
However, with the economy doing well and stocks having rebounded from their Q4 2018 swoon, there are going to be pockets of strength in the market regardless. For a while it was cannabis stocks but now it appears to be the IPO market.
While the valuations are not as extreme as they were in 1998-2000 with the tech bubble, they nonetheless don't jive with the underlying financial profiles of the companies. Beyond Meat, which will wind up being among dozens of alt-meat competitors, should not be valued at $10 billion (for example). Unlike high margin tech companies like Facebook or Google, traditional businesses like food manufacturing or general merchandise retail have low margins and therefore will not result in large price-to-sales multiples over the long term.
I bring up the latter category because today's IPO winner du jour is online pet store Chewy.com (CHWY), which price its IPO at $22 per share and nearly doubled to more than $41 before 11:30am ET. At that price, CHWY's market value is $17 billion.
Chewy is growing very fast and could very well reach $5 billion in annual sales this year. That sounds great, and at a tad over 3 times annual sales, maybe the stock is not mispriced? Well, let's not forget that Chewy sells pet food online and ships it to their customers. This is not a revolutionary business model, and it certainly is not cheap to operate. Cost of goods for Chewy is above 75% and operating margins are negative. If the company decided to grow more slowly and cut marketing expenses from 10% of sales to 5% of sales, they could perhaps breakeven.
Even in a world where Chewy reaches $10 billion of sales and manages to turn a profit, the valuation should be relatively meager. General merchandise retailers like Costco, Target, Wal-Mart, and Best Buy all trade for less than 1x annual sales in the public market. This is because margins are relatively low (EBITDA less than 10% of sales) and retailers tend to trade at or below market multiples because they are simply middlemen/resellers of products that someone else makes.
Will the share of pet care continue to move in the direction of online e-commerce transactions? Almost certainly. Will Chewy be forced to price very competitively to win share from Target, Amazon, and Petco? Absolutely. Will they be able to ever make big profits by selling cat litter online and shipping it to your house? Of course not.
If Chewy trades at 1 times annual sales five years from now, it has to grow its business by28% annually during that time to be be worth today's price in 2024. For investors who buy it today and expect a 10% annual return over the next five years, Chewy would have to grow 40% per year through 2024.
So is Chewy the next big thing or just the most recent example of an overpriced new IPO? I would bet on the latter and will be paying close attention to see if high valuations persist when many recent IPO are available to short with minimal cost.
Full Disclosure: No position in Chewy at the time of writing
(Author's note added at 6/14/19 12:40p ET - Petsmart bought Chewy in 2017 for $3.35 billion, so they are sitting on a 5x return in 2 years, to give readers a sense of the valuation inflation going on here)