Not All Media Companies Are Created Equal: A Closer Look at Charter, Comcast, and Disney

A client reached out to me after reading my past post regarding the media industry landscape to point out that Comcast and Charter, while both in the business of providing video, data, and voice services to customers, are far from equal when it comes to revenue diversification.

This is a point that is certainly true. I probably should have been more specific in my prior post that my comments were meant to be focused on the TV business. With Comcast's NBC Universal acquisition about eight years ago, the company became far more than just a cable company offering triple play packages to mostly residential customers.

Along those lines, Charter is a far more one-sided investment bet than Comcast is these days, and would be more susceptible to people who are cancelling their cable service and instead opting for Netflix and/or Prime Video.

Since these companies, along with Disney, have various business segments, I thought it would be helpful to illustrate where each gets its revenue from. The answers are a bit surprising.

Below is a chart that shows the percentage of total revenue that each media company gets from various businesses. Since Disney's 2017 fiscal year is already over, I am showing data for their latest 12 months. For Comcast and Charter, only the first nine months results for 2017 are publicly available.       

In my mind, there are a few notable things about this data:

1. Disney is the most diversified of the three, as one might expect. More than 55% of their revenue comes from sources other than television.

2. 40% of Charter's subscriber revenue comes from TV packages. This is comparable to, but lower than, Comcast's non-NBCU division (44%).

3. Because of Disney's large parks/resorts segment (33% of revenue), they have less exposure to cable despite owning ESPN. Still, it is a large portion of the company at roughly 30%.

4. If you want to play increased broadband adoption and higher speeds/prices over the longer term, Charter is actually the best option, as 34% of their subscriber revenue comes from high-speed internet services. The comparable figure for Comcast is just 17% (28% if you exclude the NBCU division).

As with any publicly traded security, price should play a material role in drawing conclusions about the merits of an investment. When I look at the valuations, Charter trades at a similar level to Disney, despite having no content library or dominant consumer franchises. Comcast trades at roughly a 10-20% discount to them, even though one might expect it to trade at a premium to Charter given the diversification of their revenue stream in an uncertain and ever-changing media landscape.

As a result, my personal rankings considering valuation, revenue diversification, and franchise positioning, would be 1) Disney, 2) Comcast, 3) Charter. If I was into the paired trade strategy, long Comcast/short Charter would look interesting over a multi-year period. Of course, the big question is whether Charter will make a play for a content business, or wireless provider, or something else to expand their horizons. In that scenario, the outlook would really depend on who they bought and how much they paid, not surprisingly.

Content Providers Take Leadership Role in "Unbundling" of Cable

As we head into 2018, one of more interesting sectors among those I watch closely would have to be the media space. This year has seen a huge amount of deal activity (both discussed and completed), as well as a continued secular shift in the way content is distributed and purchased.

For years consumers and industry watchers contemplated if and how the cable bundle would come undone. The idea of paying for 100 or 200 channels, while only actually watching a dozen or so, seemed like an obvious target for disrupters, but for a long time nothing changed. The cable and satellite pay-TV providers would have been obvious candidates to initiate a change in how content is sold, which easily could have increased satisfaction scores and retention rates among consumers, but they balked at potentially bringing down their "monthly ARPU" (monthly average revenue per user). Now with so-called "cord-cutting" becoming a reality, it appears that perhaps that lack of action was a mistake.

The blossoming of Netflix shows just how much "unbundling" was the right move. It turns out that the content players have now taken a leadership role in doing away with the expensive, voluminous TV bundle. If you think about the Netflix service it really is just "a skinny bundle." Rather than pay $75 or $100 for 100-200 channels, Netflix provides enough content for consumers to be happy (I am just guessing, but perhaps 5-10 traditional cable channels worth of content library?) for $10-$12 per month. Given what industry watchers have been predicting for what seems like decades, it should not be surprising that Netflix has been a runaway success, Amazon Prime Video was created, and HBO is flourishing with its over-the-top streaming service despite more competition.

What is surprising is that the cable and satellite companies have been so slow to react. Leaders like Comcast and Charter have yet to answer with their own competing products. DirecTV did launch a $35 streaming service featuring a more limited channel line-up, so we'll give them credit for taking the plunge.

The big question is how the Comcasts and Charters of the world are going to compete as the content companies try and eliminate them as middlemen. HBO, Netflix, and Prime Video are sold direct to consumer and other content producers are now accelerating M&A activity to gain scale in content. I recently made a list of 60 top TV channels to see exactly how the concentration of ownership has been shifting lately, especially after three recent deals were announced; Discovery buying Scripps, AT&T buying Time Warner, and Disney buying much of 21st Century Fox. Assuming all of those deals close, below is the breakdown:

Disney/Fox: 12 channels

Comcast/NBC: 11 channels

Discovery/Scripps: 10 channels

AT&T/Time Warner: 8 channels

Out of 60 channels, it is entirely possible that just 4 owners will control a whopping 42, or 70% of them, within the next 12 months.

And more deals could be ahead. A remarriage of CBS and Viacom has been long-rumored and combined they own another 9 channels. A company I am invested in, AMC Networks, owns 3 channels on my list.

To me is seems pretty clear what is going on here. The infrastructure players have been slow to adapt to suit consumers' needs. The legacy content companies see Netflix and Amazon spending billions on content and realize that if they are not careful, those two companies could offer so much programming that households might no longer need to watch any of their shows. So rather than stand by and watch, they are getting bigger through M&A and will have enough selection to offer their own streaming service, cutting out the cable and satellite providers completely, while also becoming increasingly crucial for those who stick with a bigger bundle. Disney specifically is going to be in great shape given that they also have an unmatched movie collection that can be offered alongside TV programs.

If this is the internal corporate strategy, we can expect more M&A to be announced in 2018. From an investor standpoint, there are attractive opportunities outside of the profitless Netflix and e-commerce juggernaut Amazon.

AMC Networks trades at about 10x free cash flow, 8x EBITDA, and has been buying stock aggressively. In an age of scale mattering, they would seem to be a logical M&A participant. The post-merger Discovery trades at less than 10x free cash flow, has plenty of synergies to exploit with Scripps, and is internationally diversified. Their focus on non-scripted reality shows keeps production costs low and profit margins high. Disney is building a Goliath in the space and is probably the most likely candidate to create a service that can become as valued as Netflix or Prime Video in many households. At roughly 20x free cash flow and 11x EBITDA, the stock no longer trades at a premium to the market (based on ESPN viewership issues), but arguably should given their unmatched franchises.

The media space is not without investor fears, and it certainly is not a popular group for the current bull market, but there are plenty of strong, cash flow generating machines in the public markets whose share prices are quite attractive due to concerns that Netflix and Amazon will crush everyone and that young people simply don't watch TV. The financial results from these companies in recent years, even as all of this industry change has been afoot, disproves those theories. Additionally, further M&A will only serve to boost competitive positions and generate accretive returns for shareholders.

Full Disclosure: Long shares of Amazon, AMC Networks, AT&T, Discovery, Disney, and Time Warner (hedged with covered calls) at the time of writing, but positions may change at any time

A Year-End Update On Wynn Resorts

While value investing in 2017 has not been an easy task, one constant bright spot in my managed accounts this year has been casino operator Wynn Resorts (WYNN), which has been on an absolute tear.

My last update was back in May when I outlined how my conservative $150 fair value estimate was likely going to prove to be just that... too low. Since then the shares have continued their ascent, rising from $125 to $165 each. My prognosis from eight months ago ($160 by 2019) is therefore outdated.

While I have been trimming my WYNN positions as the stock has continued higher, the company continues to impress from a financial results perspective. My original $150 fair value figure was based on 15x annual free cash flow of $1 billion, which seemed to be very achievable once the company's second Macau property, Wynn Palace, opened last year.

Despite ongoing construction in the area, which has limited street access and visibility for the new resort, WYNN's numbers have been staggering, as cannibalization of their legacy property in the region (Wynn Macau) has been far less than many analysts expected. In fact, over the last 12 months for which we have reported financials (Q4 16-Q3 17), Wynn has posted operating cash flow of more than $1.5 billion. If we assume maintenance capital expenditures of $300 million annually, my $1 billion free cash flow target for the three resorts now open will prove to be be too low to the tune of $200 million or more. I would say $180 per share is probably closer to the right number for the core properties, and that assumes no future growth from those assets.

And then of course we have the Boston resort currently under construction (due to open in mid 2019), as well as phase 1 of the company's Paradise Park expansion project in Las Vegas which could be open within a year. I continue to see those two projects adding $16 per share to my valuation, which means WYNN stock could see $200 per share without being aggressive in one's underlying financial assumptions. In gaming parlance, it probably makes sense to reduce your bets but I am not getting up from the table completely just yet.

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

No Bitcoin Bubble Here: Pink Sheet Listed CRCW Market Cap Hits $10 Billion

If you were an active investor back in the late 1990's you probably remember what the climate was like during the dot-com bubble. All a company needed to do was issue a press release announcing they were going to launch a web site to sell their product online and their stock price would skyrocket. This CNET article on oldies music marketer K-Tel, which saw a 10x jump in share price in just a month back in 1998, offers a good refresher.

The current bubble in cryptocurrencies is worse, in my view, because unlike the Internet (which many will agree was the most important innovation of that generation) it is not clear that we really have any need for virtual coins, which like any collectible will see their value swing wildly based on what someone is willing to pay for them on any given day. Maybe I am just ignorant and will be proven wrong in coming years, but I don't see why a bitcoin is any different than a piece of art, a baseball card, or a beanie baby. They all have a finite supply and little or no intrinsic value.

If you need evidence of a bubble in bitcoins and the fact that the price has gone from $3 when I first heard about them in January 2012 (Featured on Season 3/Episode 13 of CBS's "The Good Wife" - streaming available for free on Amazon Prime Video) to $17,000 today is not enough, look no further than shares of The Crypto Company, an unlisted stock trading on the pink sheets under the symbol CRCW.

On November 15th, The Crypto Company announced financial results for the third quarter. There is no business here. Revenue came in at whopping $6,000 (consulting fees). Cash in the bank stood at $2.6 million, plus another $900,000 worth of cryptocurrencies.

How much is a company with a few million dollars of assets and no operating business worth? Well, the stock closed that day at $20, giving it a market value of $415 million (~20.7 million total shares outstanding).

But wait, that's not the crazy part.

Shares of CRCW have surged nearly 24,000 percent in just 30 days since then, valuing the company at $10 billion. That is a bubble, folks. 

AutoZone Three Months Later: Sentiment Shifts Dramatically Again

We are not quite three months from my last piece on AutoZone (AZO), which back in mid September was in the midst of a nasty stock price decline, and now investors seem to feel a lot better about the company's business. Of course, this is bizarre because AZO is a very large player ($11 billion of annual revenue) in a very stable industry and should therefore be mostly insulated from stock market volatility and immense shifts in short-term investor sentiment.

Below is the five-year stock price chart of AZO I shared back in September when investors were overwhelmed with negativity:

And here is an updated version that shows the last 12 months:

Why exactly a company of this size, with no material change in its business outlook could trade for as low as $497 on August 15th and as high as $763 on December 5th shows just how much the current bull market has lost a sense of rationality. That is a 53% move, for a $20 billion market cap company, in a matter of months.

So how does this happen? My guess is that the markets today are mostly driven by index funds, exchange traded funds, hedge funds, and computerized algorithms. The fundamental bottom-up investors are dwindling in numbers by the day. It is not uncommon for me to meet people who are struck by the notion that I pick individual stocks. The market has been so strong for the last nine years that indexes are now considered to be the only wise investment. It is amazing how much views shift based on where we are in the market cycle. You didn't have famous investors extolling the virtues of index funds from 2000-2008 (a nine-year period where the market had negative average annual returns), but now that the following nine years have produced +15% average annual returns, all of the sudden they are a "no-brainer" investment.

As someone who strongly believes in the cyclicality of the economy, financial markets, and investor sentiment, the AutoZone example is evidence that picking individual stocks is not silly and the markets are far from efficient. Moves like those in AZO in recent months make my job much more difficult in periods like this, when individual stock moves often make little or no sense based on fundamental research, but as long as opportunities continue to present themselves, I plan to maintain my role as an active manager of client assets. There will always be a place for index investing (for my clients it is mostly through their work retirement plan), but the ease at which it produces stellar returns will continue to ebb and flow with the market cycle.

As for AZO itself, it is hard to argue the shares are anything but fairly valued today. It will be hard for the company to grow their business (in unit terms) given the maturity of the U.S. economy and online competition, and the stock now trades for roughly 18x my estimate of normalized fee cash flow, versus just 12.5x when the shares fetched $500 each. That sounds about right to me.

Full Disclosure: Long shares of AutoZone at the time of writing (holdings have begun to be reduced recently and those trades will continue into 2018), but positions may change at any time

CenturyLink/Level 3 Merger: 1 + 1 = 1/2 ?

A year ago my local phone company, CenturyLink (CTL), announced a $34 billion deal to acquire Level 3 Communications (LVLT), one of the leading business communications carriers in the nation. The deal was widely seen as a way to preserve CTL's $2.16 per share annual dividend, coverage for which was coming under pressure as cable and streaming companies continue to take market share in the local consumer phone, video, and data markets. Combining with Level 3 would result in a larger player (competing nationally with AT&T and Verizon) with roughly 75% of revenue coming from business and wholesale customers.

Over the course of the 12 months it took for the two companies to close the deal, the consumer business continued to erode, and CTL's stock price fell from $28 to below $20 per share. Competitors like Frontier, which acquired a lot of Verizon's FIOS customers and proceeded to lose many of them, have investors fearful that the consumer business can never be repaired. Over the last month, CTL has fallen even more and today trades for $14 per share.

I happen to agree that competing with cable and streaming offerings is not a viable business model long term. CenturyLink is constantly going door to door here in Seattle peddling high speed internet. Despite general disdain for Comcast, their service is more reliable and similarly priced, so CTL really has no way of taking market share in the consumer market.

And that is why this Level 3 deal is so interesting, because the new company is 75% enterprise.  Investors and computerized algorithms treat Frontier and Windstream just like CenturyLink, even though the latter company just completed a transformational transaction that puts it in the top three corporate providers alongside AT&T and Verizon.

Perhaps the best part of the deal is the fact that Level 3 CEO Jeff Storey will take over as CEO of CenturyLink in 2019. Storey's focus on the business customer sheds light on the future direction of the company. His track record at Level 3 since joining in 2008 and being named CEO in 2013 has been superb (revenue doubled and free cash flow went from zero to over $1 billion a year). As an investor, it is refreshing to listen to him on quarterly earnings conference calls because he talks more about maximizing free cash flow per share than he does about TV and internet bundles. If there is a better CEO to integrate these two businesses, focus on the business client, and maximize cash flow for the owners of the business, I do not know of one.

CenturyLink's $2.16 per share annual dividend is on center stage as this new company begins to come together. Management has been firm in its desire to maintain the payout, but investors are looking past them. At $14 per share, the yield is a stunning 15%.On the face of things, it does appear that CTL can pay this dividend comfortably from cash flow, in addition to funding about $4 billion of annual cap-ex. Pro-forma free cash flow will likely come in around $1.5 billion in 2017. Add in $1 billion of expected cost synergies, and $600 million of annual cash tax savings (LVLT has nearly $10 billion of net operating loss carryforwards) and there is a clear path to $3 billion of annual free cash flow if management can keep the business stable (business growth offsetting consumer decline) over the next couple of years. In comparison, the current dividend amounts to about $2.3 billion annually.

It appears that Wall Street is set on painting CTL with the same brush as other regional carriers who have been unable to halt the decline in their consumer-led businesses, which has promoted repeated dividend cuts. To me, the dividend itself is relatively meaningless (stocks are valued based on profits, not dividends). Today CTL's equity is valued at roughly $15 billion, which would be 5x annual free cash flow post-synergies. Regardless of what their dividend payout ratio is, if Jeff Storey and Company can execute on the business and focus on their enterprise customers, it is reasonable to assume that CTL performs much more like a Verizon or AT&T than just another regional consumer-focused phone company.

With the stock price having been halved since the deal was announced a year ago, nobody seems to think that buying Level 3 changed CenturyLink's business outlook. And they also do not seem to care about Jeff Storey's track record of creating shareholder value (LVLT stock more tripled during his 5 years as CEO). In other words, the bar has been set immensely low.

Full Disclosure: Long shares of CTL as well as CTL debt securities at the time of writing, but positions may change at any time.

Somehow Food Companies Are No Longer Viewed as Stable, Defensive, Attractive Investments

For decades the consumer staples sector was viewed by investors as a stable and predictable cash flow generator with above-average dividend yields and below-average volatility. In particular, food companies like Kraft and Pepsi fit the bill, with brands that stood the test of time.

Lately, however, investor sentiment has shifted. While brand names continue to have loyal followers, younger consumers often prefer private label foods that come with lower prices and quality that is close enough to the branded alternative that they are more than adequate. I understand this view completely, as my family buys many store brand products from Safeway, Target, and Whole Foods.

So while the gap between store brands and global brands narrows, should food and beverage as a category be seen as no longer stable, predictable, and defensive? By the looks of the stock charts, as the tech sector powers the current bull market ever-higher, you would think that food is no longer a consumer staple. I say that because both private label and national brands are getting pummeled on Wall Street. I am baffled as to how that can be happening at the same time.

Should Kraft trade at 16x EBITDA these days? Probably not, given that they are set to cede market share over time. But there are other consumer brands that have fallen to levels that are truly cheap (as opposed to trading at a premium that may no longer be warranted).

One I like is J.M. Smucker (SJM), which has fallen from $140 to $100 over the last nine months or so. SJM owns brands such as Jif, Smucker's, Crisco, Wesson, Folgers, Pillsbury, Hungry Jack, Milk Bone, and Kibbles 'n Bits. While these brands will likely not grow market share in the future, they should continue to be cash cows for the company over the long-term. In the meantime, SJM has the scale and experience to launch brand extensions and new products that can resonate more with younger shoppers (examples being all natural, organic jam from Smucker's or Natural Balance pet food). Today SJM shares trade for 15x normalized free cash flow (which I estimate to be $7 per share) and carry a dividend yield of over 3%. They look underpriced to me.

Perhaps more interesting is the fact that the world's leading supplier of private label foods, Treehouse Foods (THS), has had one of the ugliest sell-offs lately that you will ever see from a multi-billion dollar a year category leader:

Treehouse counts each of the 50 largest food retailers as customers, with the top 10 accounting for more than half of the company's $6 billion in annual revenue. If you want to place an investment bet on private label foods increasing market share over the coming 5-10 years, THS is your stock. Needless to say, it has been quite a headache in recent months (I have been building positions in the name throughout 2017).

Treehouse's valuation makes J.M. Smucker look like nothing worth mentioning. Even after missing their own internal financial projections for most of 2017, I estimate that THS should book between $250 and $300 million of free cash flow this year. The current market value of the company is only $2.45 billion, which makes for a sub-10x free cash flow multiple. And that is for the largest private label food company out there. For comparison, over the last 10 years, THS shares have fetched an average of 16x free cash flow, which seems quite reasonable.

So we are in a weird moment in time where restaurant stocks are getting crushed (due to rising labor costs, a proliferation of home delivery services, and excess unit expansion in recent years), brand name food stocks are losing their once-premium valuations (due to private label encroachment), and the big private label supplier has seen its share price more than cut in half (due to management missteps after a large acquisition). Simply put, how can this all be rational at the same time?

Well, I am making a bet that things normalize over the longer term. I think it is fair to say that large, global food and beverage brands should no longer trade at premiums to the S&P 500, but I think any material discount is unwarranted as well. Dining out will continue to book huge sales figures overall, but profit margins are likely to permanently  compress, so valuation models need to factor in that likely reality. And as private label foods stand to gain market share over time, I cannot help but think Treehouse will fix their operational issues, grow free cash flow per share over the long-term, and once again fetch a more normal valuation (15-20x seems appropriate to me).

None of these outcomes will garner the attention from investors that an Amazon, Tesla, or a Netflix will, but if you care about valuation when investing your capital, we are talking about large multi-billion businesses that are here to stay and will generate fairly consistent profits for decades to come.

Full Disclosure: Long SJM and THS at the time of writing, but positions may change at any time

Is The CVS Health/Aetna Proposal Really Just About Amazon?

Financial journalists seem to have a pretty simple playbook these days. Most any retail-related corporate development is a direct result of Amazon (AMZN). Plain and simple. No questions asked.

Last night it was reported that CVS Health (CVS) has made a bid for health insurer Aetna (AET). Immediately the media closed the book on the strategic rationale for the deal; Amazon might soon start offering mail-order prescriptions and CVS needed to make a bold move to counter that attack.

If CVS is really most worried about Amazon stealing away its pharmacy customers, would the best counterattack to be buy the country's third largest health insurance company? Does that make sense?

It seems to me that the best competitive move to help insulate you from losing prescription share to Amazon would be to buy a last mile delivery company and use it to offer same-day or next-day prescription delivery to the home. After all, it is not like Amazon has any scale in the drug wholesale business, considering that they have yet to even enter the business to start with! And even if they do get into the business, are they really going to be able to get better pricing for drugs than CVS can, with its existing network of 10,000 retail pharmacies?

I would suggest that the CVS bid for Aetna is more about extending their corporate strategy of becoming a vertically integrated healthcare services provider. You have to remember that CVS bought Caremark, a pharmacy benefits manager, or PBM, more than a decade ago. They started Minute Clinic, the largest retail walk-in clinic chain in 2000. They acquired Omnicare, a pharmacy specializing in nursing home services, in 2015. Becoming more than just a retail pharmacy chain has long been the entire idea behind the company. It also explains why reports say that CVS and Aetna have been talking for six months (this idea was not just thrown together quickly because Amazon is applying for pharmacy licenses).

Adding a health insurer to the mix was a logical extension of that. Competitor United Health took the opposite route, as an insurance company that added Optum Health, a PBM, later on. That strategy has been wonderfully successful and I suspect that CVS and United will dominate the integrated healthcare services business for years to come.

Of course, the narrative on Wall Street has nothing to do with any of this. CVS stock is getting crushed today and United Health is up three bucks. The one-year charts make it seem like these businesses have nothing to do with each other:

To me it is simply baffling that UNH trades for 21x 2017 earnings estimates and CVS commands just 12x. If CVS really does build out a UNH-like operation, with a small retail pharmacy division, I can't fathom how that valuation gap won't narrow over time. But the investor community right now just can't get that bricks and mortar component (no matter how small it would be post-Aetna) out of their heads.

What is probably most interesting is that Amazon does not have a history of putting companies out of business when it enters new markets. Amazon started selling books online in 1994. It launched the Kindle e-reader in 2007. If any bricks and mortar retailer should have been gone by now, it would have to be Barnes and Noble. And yet they are still alive and kicking:

A lot of people thought that Best Buy was finished once Amazon started selling a huge selection of consumer electronics. After all, with thousands of reviews, great prices, and fast shipping, why bother going to a store to buy a TV or computer? And yet, here is a five-year chart of Best Buy stock:

All Best Buy had to do was offer price-matching and quick delivery to keep a lot of market share from people who like buying online. And then you will always have a subset of folks who like kicking the tires in-person and asking knowledgeable people questions about the products.

While Amazon's reach and e-commerce infrastructure will seemingly allow it to always take a certain amount of market share, it does not typically spell death for competitors. This is especially true when Amazon can't offer anything better than anyone else. Plenty of companies can offer good selection and good prices, and they are finally spending the money to handle the quick delivery too. And with physical stores, in some cases they even have a leg up on Amazon.

Jeff Bezos likes to say "your gross margin is our opportunity." By that he just means that if you mark up your prices too much, for no good reason, Amazon will undercut you and take your market share. For that to work, margins have to be high in the first place. For books and consumer electronics, gross margins aren't very high. For other areas like auto parts, where product markups are 100%, do-it-yourselfers will probably shift business away from bricks and mortar retailers and to Amazon for certain items.

In the case of pharmacies, we are not talking about huge markups, from which Amazon can really offer a significantly better deal. Sure drug prices are sky-high in many cases, but there are a lot of middlemen that split the profits. Manufacturers ship product to distributors, who stock the shelves at the pharmacies upon receiving orders, who resell to consumers. Amazon is starting from scratch and has none of those capabilities yet. If their plan is simply to buy drugs from wholesalers and ship them via Prime to their customers, there is not going to be a lot of margin to shave off in the process, nor will they be doing anything different than others.

That becomes even more true because they will not have scale at the outset to get better wholesale pricing from the suppliers. And if Amazon goes directly to the drug makers demands better prices, the drug companies will just say, "sorry, get your supply from the same places everybody else does." They are not going to voluntarily give up margin when they don't have to.

And then there is the whole issue of whether Amazon can partner up with the employers, PBMs, and insurers to get access to their customer bases. Is Wal-Mart or Target going to add Amazon to their preferred network for employer-sponsored prescriptions? If CVS buys Aetna, will they let Aetna members get their drugs through Amazon at the same prices they could through CVS retail or mail order? And what is stopping CVS from hiring drivers at $15 an hour to drive around their local neighborhood delivering prescriptions to people's homes? Does Amazon really have any competitive advantages in this space, assuming they enter it in the future?

I guess they could buy Rite Aid and Express Scripts, to add pharmacies and a PBM, but even after they spend all that money and integrate those businesses, aren't they just in the same boat as CVS and Walgreens? Sure they are players at that point, but how will they crush the competition?

This is why I am skeptical that Amazon will try to do everything, will succeed at everything, and will kill off legacy providers that have been doing this stuff for decades. When I see a powerhouse like CVS, which will only get stronger if it buys Aetna, trading at 12x earnings, with the rest of the market trading at 20x it just doesn't make a whole lot of sense. As Warren Buffett would say, "in the short term the market is a voting machine, but in the long term it is a weighing machine."

Full Disclosure: Long shares of Amazon and CVS Health at the time of writing, but positions may change at any time

Even After 30% Decline, Equifax Shares Not Cheap

It seems that data breaches are going to become the norm globally, if they have not already, so whenever a company is hit by hackers and the stock price declines as a result, I try to take a look and see if there are investment opportunities. The best example was Target several years ago, when hackers pierced the retailer's in-store credit card scanners and stole customer payment data. While the media would have had you believe people were going to abandon the chain for life, after 6-12 months (and many more hacks of other companies), it was business as usual.

Equifax (EFX) might be a different animal given that they are in the business of collecting credit data, but most corporations do not seem to be much of a match for professional hackers. So while it is easy to argue that their security should have been stronger than Target's, I am not so sure that a year from now Equifax's business will be materially harmed. It is worth watching, however, since there are other data providers corporate clients can use.

What is interesting to me is that even after large drop (in recent weeks EFX shares have fallen from the low 140's to today's $103 level), the stock is not cheap. In fact, it appears it was quite overvalued leading up to the hack disclosure, making a 30% decline less enticing for value investors.

I went back and looked at Equifax's historical valuations and found that the stock has ended the calendar year trading between 14x and 23x trailing free cash flow since 2010. I would say that 20x is a fair price for the company.  But pre-hack the shares had surged more than 20% year-to-date and fetched roughly 27x projected 2017 free cash flow. So at today's prices they still are trading at the high end of recent historical trends at ~20x.

For investors who think this hack will come and go without permanently damaging the Equifax brand, the current price is a discount from recent levels but hardly a bargain. If you are like me and would want to see how financial results come in over the next 6-12 months (to see if customers are bailing), you would want a far better price if you were going to start building a long position now. And even when you felt comfortable with the long-term prospects of the business, the current price would hardly scream "buy" at you.

The stock seems to be acting well in recent days, which suggests many are taking the bullish view. While I don't necessarily think that is the wrong move, recent history suggests the stock isn't worth the $140+ it was trading at prior to the hack.

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

AutoZone's Numbers Don't Suggest Amazon Will Replace Them Or Their Competitors

After a huge rally over the past five years, shares of auto parts retailer AutoZone (AZO) have taken a beating in recent months as investors fret over Amazon's ability to become a full service parts supplier.

What is interesting, however, is that auto parts industry observers are far less optimistic about Amazon's desire and ability to break into a business that often requires super fast delivery (far less than even two hours) and a huge selection of SKUs. Simply put, auto body shops suddenly dumping their relationship with AutoZone seems unlikely. In that case, AZO's share price slump from $800 to $500 lately is probably unjustified.

There is little doubt that non-time sensitive auto-related purchases have a place in the online world. If you want to stock up on car air fresheners or get a new license plate holder, Amazon is a good place to look. But for more specialized needs, where price is not always the most important factor (getting your car back as soon as possible is), the distribution networks powering the large national auto parts retailers should still provide certainty, comfort, and value.

To see exactly how much AutoZone's business has been impacted by Amazon, I looked back over the last 15 years to see the trend for the company's sales per retail square foot. After all, if auto part sales are moving online in a material way, the average AutoZone retail store should be seeing sales declines. This would show up in sales per square foot since a store's size is constant even if more stores are built.

Here is a graph of AutoZone's sales per square foot since 2003:

Can you see Amazon's impact in that graphic? When did they really accelerate their auto parts selection? Does it look like they are having the same chilling effect on AutoZone's business as they are on, say, JC Penney? I just don't see it.

For those expecting the impending doom of auto parts retailers like AZO, I think their death may be greatly exaggerated in Wall Street circles lately. In fact, it is notable to point out that over the last five years (when e-commerce growth has really started to disrupt traditional retailers), AutoZone's revenue has grown from $9 billion to $11 billion, leading to an increase in free cash flow from $27 to $34 per share.

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