Unilife, Or: When A “Growth” Pure-Play Isn’t A Smart Play

I come from the school of fundamental value analysis/investing. So when a client asked me to look into Unilife Corp (UNIS) a few weeks ago, naturally, my first reaction was to look at their SEC filings and financial statements. It became immediately clear (as it should to anyone who’s spent more than 60 seconds looking) that this was not a company on which one could perform a discounted cash flow (DCF) valuation or any other traditional fundamental valuation, since their financials are an absolute and utter disaster of the highest order. DCF won’t work – it’d just be adding an enormous degree of false precision/certainty to an extremely uncertain and unpredictable set of financials – and comps are only useful insofar as they not only exist, but have similar activities, capital structures, etc. Option valuation is just another exercise in futility, especially considering the firm’s financial and operating history is all over the place, making any assumptions/inputs useless.

So how then are we supposed to value this company? Continue reading

Richard Koo on Tapering

In a note this week Nomura Research Institute’s famed chief economist Richard Koo laid out his case for the Fed to start tapering as soon as possible. Most of it focused on liquidity, recent labor market improvement, benign inflation, and the current pace of economic growth through his ever insightful balance sheet recession lens. Most of these factors have been debated to their fullest extent by every research team in finance, and with industrial production and CPI as the only significant data points left before the FOMC meeting, there is little to change any views from that angle.

What stuck out to me was his “personal standpoint” argument. This is especially worth noting because he recently met with both Bernanke and Yellen to discuss monetary policy and presented his case for normalizing policy. As an aside the aforementioned presentation, which I was lucky enough to see later in the month, included one of my favorite chart’s of the year.

Since I did not see any of the usual suspects write up his most recent note I have shared the relevant section directly below.

(A)n objective view of the situation suggests that now—when forward guidance is still in effect and inflation is subdued—is the time to act in order to prevent a premature rise in interest rates under tapering. For that reason, I suspect many FOMC members are arguing that now is the time to make the announcement.

December tapering would benefit both Bernanke and Yellen
A December tapering would also be beneficial from a personal standpoint for both the current Fed chairman and his successor nominee. As the man responsible for launching quantitative easing, Mr. Bernanke would no doubt like to set a course for the normalization of monetary policy before his term expires.

I suspect he began talking about tapering in May because he wanted to at least put things in motion before his term expired at the end of January. Then, even if the US economy fell into a quantitative easing “trap” during the process of normalizing policy, he would be able to avoid the criticism that he had started QE but left the cleanup to his successor.

Decision by Bernanke would make it easier for everyone else
Ms. Yellen, meanwhile, has strong dovish credentials, and if that was the basis for her nomination by the Obama administration, I think it would be difficult for her to announce a tapering immediately after becoming Fed chair.

For the first few months, at least, it would be better for her to spend time preparing everyone psychologically for the next step given her dovish reputation in the markets and the administration. But this would delay the start of tapering and could push the Fed behind the curve, possibly leading to an undesirable rise in long-term rates.

Her job, therefore, would be made much easier if Mr. Bernanke were able to set a new course for the Fed before stepping down.

In short, if a decision has to be made in the near future, it would be easier for all concerned if Mr. Bernanke were to make it before his term expires.

Dutch again: The parameters for policy normalization have been in place for some time now, and I agree that it is both important and would be far easier for Bernanke to make the call.

Negative Ghost Rider, the pattern is full

This post is little more than a victory lap so please feel free to stop reading now.

Something strange happened yesterday. In the morning I was looking through data from the past two debt ceiling clusterfucks trying to think of an ideal way to structure a trade for a potential impasse. Having remembered that the US sovereign CDS curve had some wild fluctuations the last two times I focused on another possible flare up on the front end. This is a rather illiquid little backwater and a truly useless market for anyone actually trying to hedge risk on a treasury portfolio, but it’s a fun spot for doing some punting.

As it stood this morning 1y CDS were at 13bps with a 6bp spread on the bid ask and 5y CDS were at 24bps with a 4bp bid ask spread. Both of these levels were significantly below their (short) historic averages.

Since I can’t trade these in my PA, my desk doesn’t actively take risk in these instruments, and our clients don’t particularly care for small illiquid trades I thought I would share my thoughts on twitter.

I was happy that a number of people thought it was an interesting trade and got a few follow ups on the matter but most people just thought it was a halfway funny joke about Top Gun.

Then at the end of the day I was going through my pricing rundowns and I saw that this happened.

1y CDS had shot up by 45bps since the morning. Upon further examination I noticed that the aforementioned 1-5y spread went from 11bps to an all time record of -28bps. As shown below this is a 5.9 standard deviation event, and if you believe that derivative pricing follows a normal distribution this is something that should be seen once in every 300 million observations.*

And here’s the one day change for the curve.

I am going to run with the assumption that I just happened to have timed this recommendation perfectly, but I will hold out an inkling of hope that just maybe someone who reads my tweets banged this level and moved the market.

*If you think illiquid derivatives follow normal distribution patterns you should stay away from them, as well as any other assets that might prove too complicated for you.

The Limit of Fundamental Analysis: You

The other day, my friend Eddy Elfenbein wrote a post entitled “The Limits of Fundamental Analysis,” which made some good points (as he most always does), but in so doing, made far too broad and thus inaccurate a conclusion. The premise is (and I welcome Eddy to correct me if I’m off-base) that in some circumstances, fundamental analysis is inappropriate, such as when dealing with transformational businesses like Amazon was (is), cyclical firms, leveraged firms, firms with varying earnings quality, etc. The thing is, we can – and do (try to) – adjust for all of these things – and more – when performing a proper fundamental analysis! I’m going to attempt to show how, by making relatively small changes to a few key assumptions (sometimes even just one number will do!) in a simple DCF framework, we can grossly change not just how much we think a stock is worth, but why it’s worth that price, as well.

Fundamental analysis, by definition, involves examining the industry in which a firm competes, the regulatory/legal environment, the market for a firm’s goods/services, the goods/services themselves, the firm’s financial condition/performance, strategy, capital structure, reliability of financial statements/accounting controls, and several other factors, not only currently, but in the past and, more importantly, the future as well. Fundamental analysis isn’t just looking at a few ratios on Yahoo Finance or Finviz or whatever and concluding a company is a good (bad) investment based on valuation, liquidity, solvency, and/or other metrics. That can be the starting point for narrowing down firms which are more (less) likely to be worth investigating further, given a finite amount of time to allocate to identifying and researching ideas which we hope will help us invest wisely.

A quick tangent: If you’re not in the markets to invest, you are in the markets to gamble. This is not up for debate, it just is; if you find or fancy yourself a gambler, save the trouble and head to your closest casino where they’ll be more than happy to separate you from your presumably hard-earned money quite expeditiously (you may even get some “free” food and drink out of it). If you’re not sure whether you’re trying to invest or gamble, just put your money under your bed until you figure it out, you’ll be doing yourself a favor. If you’re interested in making good investment decisions, this is where the fun starts…

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Seeking Part-time Interns for Fall/Winter

Since I started Stone Street Advisors LLC’s internship program, I’ve largely been impressed with the talent we’ve attracted, and proud of the positions our interns have landed after working with us. Alas, as each moves on to bigger things, it comes time again to recruit two more part-time interns for the fall semester, hopefully working through winter and perhaps into spring, as well.

Unlike the vast majority of internships, everything from our recruiting process to training to responsibilities have been carefully designed & implemented to prepare you for ultra-competitive positions at the best firms in the world. Below, I’ll describe these things, and upon consideration, you are welcome to apply.
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A Few Thoughts on Domestic Inflation

Yesterday a far more talented sell sider than myself @barnejek in a discussion on the relentless rise in US real rates over the past two months sparked this post at BI and it lead to continued discussion on twitter and a few more posts about the recent fall in inflation rates. I took a few issues with it and received many questions so it’s far too much for twitter.

First and foremost the tweet makes no sense because inflation in the US has been stubbornly low for the past two decades, so unless you think it’s going lower from these current depressed, generationally low, levels saying goodbye to inflation is ridiculous. If however, that is your actual opinion please reach out in the comment section I would be thrilled to enter a swap to that effect.

Here are US benchmark real rates and their ramp up since April. I’ve been saying for the past seven months that short 5y TIPS was the best trade on the planet as they had all the overvalued characteristics of USTs but with positive carry. I still like the trade but the recent run up in the inflation expectation component of it looks overdone. As such I find it hard to see inflation going any lower from here.

Here’s the benchmark breakevens where the move has been just as staggering, the two year most notably is off 114bps.

US inflation levels are quite low. PPI leveled off last month but CPI and PCE both surprised to the downside. Luckily, this trend looks to have reversed last month.

Inflation will be supported by the recent climb in wages which were the input most severely impacted by the payroll tax increase. If I had to peg the soft inflation from the spring to one thing, that would be it.

It is important to look at wages coupled with consumer credit which was also continued to expand.

The most stable of the bunch core PCE has a good long term track record with the 5y UST, where the recent rise in yield points to upward pressure.

Last month’s CPI reading looked like a fluke to anyone who follows it.

The reading was inconsistent with the data from PriceStats (formerly the billion prices project) where prices have been rising for weeks.

Case-Shiler showing CPI should face continued pressure from rising home prices and rent equivalents.

Lastly to show just how overdone the move in short term inflation expectations has become here’s crude oil charted against the 2y breakeven. Since it factors so heavily into both consumer and producer inflation it has had a great predictive factor.

That said, my base case if for inflation rates moving significantly closer to the Fed target of 2% over the next 6-9 months.

Quick Observations on JOSB, GPS

Wednesday night (6/5/2013) I needed to track down a specific pair of jeans in my very specific size. My build notwithstanding, the closest place I could find them was in Denville, NJ Banana Republic at the Shoppes at Union Hill, a semi-kind of upscale-ish, well-polished shopping center. I have a few quick observations/comments/questions based on this one experience, in no particular order:
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FT Alphaville CFA Meme Contest Silver Medal for Dutch Book!

The Financial Times’ great Alphaville division held a semi-quasi-formal-ish CFA exam meme contest, in which our man Dutch Book participated. Result: Silver medal (although I think he should have easily won the gold with his submission!). Stone Street Advisors: Winners at the research and meme game. (non-official motto).

Here’s Dutch’s second-place submission:

#SoMuchWin

Congratulations to Dutch Book & best of luck on the exam, which he’ll no doubt ace.

–JT

When Life Kicks You In The Butt…

My friend, my mentor, and one of our SSA teammates is in a bit of a squeeze. Per his last semi public update:

“I have a stage 2heartblock which causes me to blackout when I get dehydrated. happened Saturday morning on my way to play golf. I was taken to ER and given to IV drips. Was ok yesterday, but was in bad shape this am. So I’m currently at NYU Hospital being monitored.”

If that doesn’t scare the ever loving shit out of you to he point of action, you are a sick bastard.

While GTJ has some insurance $, anyone who knows how these things work knows damn well the $1,000′s accumulate extremely fast. I’m not asking for a Billion (we’d accept most of it though) but I want everyone who follows him on twitter, and reads his posts here and elsewhere to pray or do whatever you believe in that he’s healthy asap. We, no, I am not asking for any donations, but I will consider an offer if that is the way you want to play it.

My Friend, my Mentor, and again, My Friend is in an unenviable condition. Please do whatever you can to help.

Information @ StoneStreetAdvisors dot com.

I will match any donations as well as I can; any additional monies will go into a newly established charity which will be used for similar situations; zero will come to me or my firm.

Please wish him well, if you don’t have the money.

Jordan S. Terry
Founder & Managing Director
Stone Street Advisors LLC

Put Me in Coach!

Quick Thesis: Coach, Inc. (NYSE: COH) is solid free cash flow story which many investors have overlooked as they focus on the newly public (and faster growing) Michael Kors (NYSE: KORS). The primary concern is that sales will continue to decline and the multiple contraction at Coach will not be short lived as KORS takes share. While KORS trades a premium multiple and is priced for perfection, COH has been left for dead. The stock sits 36% below its 52 week high after missing 2nd quarter earnings on slowing sales. Current multiples make COH a compelling “value” story – with a market cap of $14.4 billion and trading at 13.6x and 8.1x consensus EPS and EBITDA
estimates, respectively, the stock trades at historically low levels. Continue reading