Category Archives: Misc Portfolio

WEEKLY COMMENTARY 3/6/17- 3/12/17

WEEKLY COMMENTARY               3/6/17- 3/12/17

 

 

CURRENT POSITIONS

 

 

 

COMPANY NEWS

 

A Soriano Corp (Anscor) reported 2016 results. We recently initiated on Anscor with the key points to our thesis being:

 

  • The company has a healthy balance sheet
  • The company was in a number of highly competitive businesses, but
  • The company consistently generated a return on equity (ROE) around 10% our discount rate for all companies.
  • Despite the company’s healthy balance sheet and the consistency of the company’s ROE, Anscor trades well below its book value currently at 0.55 times its tangible book value and at 5.5 times cyclically adjusted earnings.

 

In 2016, the company maintained a healthy balance sheet with total liabilities twice the company’s cash position but less than half the amount of the company’s total securities. While the company’s businesses continue to be competitive, it was able to generate a return on tangible equity of 9.9%.

 

The company’s income before tax increased by 26% driven by strong results in all subsidiaries. Anscor’s largest subsidiary, PDPI grew its revenue by 8.3% due to a strong macroeconomic environment boosting construction activity. It was able to increase its net income by 30.7% in 2016. PDPI generated a ROE of 32%, the second year in a row over 30%. The company’s resort operations increased revenue and gross operating profit by 5.7% and 8.3%, respectively, generating a ROE of 34.0%. Anscor’s US nurse staffing business, Cirrus, grew revenue by 39% and net income by 70%. It generated a ROE of 35.9%.

 

Overall, the results reinforce our investment thesis of a company with a healthy balance sheet consistently generating a ROE close to its discount rate yet trades at a substantial discount to book.

 

 

INTERESTING LINKS

 

 

Explaining a Paradox: Why Good (Bad) Companies can be Bad (Good) Investments! (Musing on Markets)

 

In an environment where finding high quality ideas with any margin of safety is difficult value investors often stray to the idea that any high quality company is worthy of an investment regardless of the company’s valuation as holding cash due to a lack of ideas is more painful than investing in high quality companies that are overvalued. Contrary to what is often heard, Professor Damodaran describes how high quality companies can be bad investments while low quality investments can be good investments. (link)

 

 

Rethinking Conventional Wisdom: Why NOT a Value Bias? (Research Affiliates)

 

This Research Affiliates article is from August 2016 but it reinforces what pretty much any research on value states that it is a investment strategy that consistently outperforms with less volatility.  (link)

 

 

The Emerging Markets Hat Trick: Time to Throw Your Hat In? (Research Affliates)

 

While we are bottom up investors, there are a few top down investors enjoy reading with Research Affiliates being one of them. December 2016 article discusses the attractiveness of Emerging Markets equities. (link)

 

Additionally, we look at Research Affiliates expected returns for different asset classes on occasion. (link) Expected returns are not used in our investment process but we find them interesting nonetheless. We have thought about using the index expected returns as a discount rate. We view the discount rate as an opportunity cost rather than a specific cost of capital for a company. In our view, the marginal cost of capital is for a company does not relate to our acceptable level of return. There are other problems with using the marginal cost of capital as the discount rate including potential estimation errors and biases in the calculation as the marginal cost of capital changes from company to company. Rather than focusing on the marginal cost of capital of a company, we care about generating a sufficient return in each investment idea. Our current thinking is that the return on any investment in the long term equals the return on invested capital as any valuation discount or premium to the intrinsic value is insignificant over longer periods making the average return on invested capital (ROIC) a good starting point for the discount rate. According to McKinsey, from 1963-2004, the average ROIC excluding goodwill was 10%. (link) Triangulating the view that ROIC roughly matches the performance of a business over the long run is the returns of the S&P 500 geometric average from 1928-2016 is 9.53% and 1967 to 2016 is 10.09%, roughly equal to the average ROIC excluding goodwill. (link)

 

The thought of using expected returns of Emerging Markets as the discount rate makes sense as any recommendation or actively managed portfolio should outperform its index in the long run otherwise you are destroying value as an investor can just buy a low cost index of the asset class. The big problem is the expected return is very difficult to forecast accurately. Also, using expected returns leads to intrinsic values moving with the market direction rather than being the ultimate anchor for a value investor. We are using 10% as a discount rate for all investments.

 

 

Return Expectations Going Forward (Ben Carlson)

 

Ben Carlson discusses his views on forward expected returns. (link)

 

 

On the Valuation of the Indian Stock Market (Latticework)

 

Samit Vartak provides his thoughts on the current valuations in the Indian equity market. (link)

 

 

Trusting Management and the Limitations of Research (MicroCapClub)

 

Mike Schellinger writes about the limitations of research and assessing management. (link)

 

 

Where companies with a long-term view outperform their peers (McKinsey)

 

McKinsey studies the performance of companies with a long-term view and find they outperform on many measures. (link) There is a link to the full report at the bottom of the article.

 

 

Between ROIC and a hard place: The puzzle of airline economics (McKinsey)

 

McKinsey analyze the economics of the airline business through a ROIC lense with thoughts on what attributes lead to outperformance. (link)

 

 

Salvation or misleading temptation—low-cost brands of legacy airlines (McKinsey)

 

McKinsey provides a strategy for low cost airline brands under the umbrella of a full service carrier. They also discuss the differences in cost structure between the two. (link)

 

 

The economics underlying airline competition (McKinsey)

 

A short discussion on the difficulties of low cost carriers moving into long haul flights. (link)

 

 

Shipbroking and bunkering (Bruce Packard)

 

Bruce Packard compares two shipbrokers, Clarkson and Braemar. It is an excellent comparative analysis that may be useful in any investor’s process. (link)

A. Soriano Corporation 2/23/17

A. Soriano Corporation

Bloomberg Ticker:                              ANS:PM

Closing Price (2/23/17):          PHP6.34

6 Month Avg. Daily Vol. (USD mn):    0.017

Market Cap (USD mn):           156

Estimated Annualized Return:            18.0%

February 23, 2017

 

A_Soriano_Corp_Feb_23_2017_Final

 

INVESTMENT THESIS

A. Soriano Corporation (Anscor) is a Filipino investment holding company with investments in many different industries. The company has a healthy balance sheet and consistently generates a return on equity around its discount rate. Despite the healthy balance sheet and the consistency of the company’s ROE, Anscor trades well below its book value currently at 0.56 times book and at 5.46 times cyclically adjusted earnings. There is significant upside to the company’s earnings valuation (110% upside) and asset valuation (77% upside). We are taking a 2.0% starting position as the stock is very illiquid.

 

 

COMPANY DESCRIPTION

 

Anscor was incorporated on February 13, 1930. It is an investment holding company located in the Philippines. Anscor’s largest investments are Phelps Dodge International Philippines, Inc. and Seven Seas Resorts and Leisure, Inc. Other investments include Cirrus Medical Staffing, KSA Realty, Prople Limited, and Enderun College among others.

 

 

Phelps Dodge International Philippines

 

Phelps Dodge International Philippines, Inc. (PDIPI) was incorporated in 1955 and started production in 1957. Its products are primarily copper-based wires and cables including building wires, telecommunication cables, power cables, automotive wires and magnet wires. PDIPI has a technical assistance contract with General Cable Company (GCC), the second largest cable company in the world. GCC was also a shareholder in PDIPI until December 2014 when Anscor acquired GCC’s 60% shareholding for PHP3.0 billion. The Philippine wire and cable industry is comprised of both imported and domestically manufactured products. The four largest manufacturers are Phelps Dodge, American Wire and Cable Co., Inc., Columbia Wire and Cable Corp., and Philflex Cable Corp.

 

Over the past three years, PDIPI’s average return on assets of 16% is well above its discount rate pointing to potential barriers to entry within the industry. Despite the strong returns, the industry is fragmented. There are no supply side barriers to entry as copper cables are a relatively simple product to manufacture and there is no favorable access to raw materials as raw materials are commodities that can be purchased from many suppliers. There are no demand side barriers to entry as purchasing copper cables does not create habit and there are no switching costs, search costs, or network effects.  There may be some economies of scale but with gross margin at only 14%, it seems the cost structure of the business is primarily variable eliminating any real barriers to entry from economies of scale.

 

 

Seven Seas Resorts and Leisure

 

Seven Seas Resorts and Leisure, Inc. (SSRL) was incorporated on August 28, to plan, develop, operate and promote Pamalican Island as a world-class resort. The resort is named Amanpulo and started commercial operations on January 1, 1994. SSRL inventory is 103 rooms with 40 original casitas and 63 rooms in villas. SSRL is a joint venture between Anscor, Palawan Holdings, Inc., and Aboitiz & Co with Anscor owning 62% of the resort.

 

The resort’s services are offered through the worldwide Amanresort marketing group based in Singapore, accredited travel agents, reservation sources/systems, and direct selling. Amanpulo is in competition with all other small 5 star resort companies in other destinations that are generally better known than the Philippines, such as Indonesia, Thailand, and Malaysia.

 

According to reviews on Tripadvisors.com, 90% of Amanpulo’s reviews were excellent, the highest rating. It is rated as the #1 hotel in Palawan Province.

 

Until 2015, SSRL failed to earn a reasonable return on assets. The company also failed to generate any meaningful growth with revenue increasing from PHP517 million in 2011 to PHP645 million in 2016. Similar to PDIPI, there does not seem to be any barriers to entry. There are thousands of luxury resorts around the world illustrating the lack of barriers to entry within the industry. There are no supply side advantages in owning a luxury resort. There are no demand side advantages. If there are economies of scale within the industry, SSRL is a smaller resort, which would be disadvantaged.

 

 

Cirrus Medical Staffing, Inc.

 

Cirrus Medical Staffing (Cirrus) is a US-based nurse and physical therapist staffing business. It places registered nurses on contracts of twelve weeks or longer. In January 2008, Anscor acquired Cirrus. Cirrus has a preferred vendor relationship with the US’s largest home health company. Anscor owns 94% of Cirrus.

 

Similar to SSRL, Cirrus did not generate an acceptable on assets until 2015. Unlike SSRL, Cirrus has been growing its business at a rapid pace. Since 2011, service income growing by 16.7% per annum, gross profit grew by 21.3% per year, and EBITDA grew by 90% per year.

 

The nurse and physical staffing business is very fragmented and there are no supply side advantages. Potentially, there are demand side advantages in the form of switching costs. When using a staffing agency for a large number of employees as long as the staffing agent is doing a good job, the client should continue to use the agent and the agent has a bit of pricing power due to the cost of switching providers. The client can easily offset the staffing agent’s bargaining power by using multiple providers. For small clients, it seems like the potential for a demand side advantage is much smaller as it is easier to find the necessary supply of labor.  Economies of scale do not exist in the industry.

 

 

KSA Realty Corporation

 

Anscor exchanged its old building located at acquired a 11.42% stake in KSA Realty Corporation (KSA) 1990 in exchange for Paseo de Roxas in Makati. KSA develop The Enterprise Center, a two tower, grade A office building located in Makati.

 

In 2015, KSA had an occupancy rate of 96%, generating PHP992 million in revenue, and PHP1,300 million in net income including a PHP517 million revaluation gain. Despite a decrease in the occupancy rate from 2013, KSA was able to increase revenue by 20% over the past two years. KSA’s assets have been revalued twice in the past three years. There are no competitive advantages in the property business.

 

 

Enderun Colleges, Inc.

 

In October 2008, Anscor acquired 20% equity stake in Enderun Colleges, Inc. Enderun was established in 2005 by a group of business leaders, including senior executives from Hyatt Corporation in the U.S., Enderun offers a full range of bachelor’s degree and non-degree courses in hospitality management, culinary arts, and business. Enderun has close to 1,200 full time and certificate students spread almost evenly across the school’s three main degree offerings.

 

Enderun recently launched Enderun Extension, a continuing education unit that is the college’s language training and tutorial business. In 2014, Enderun launched a hotel and management consultancy unit. Several hotels and resorts are under Enderun’s management.

 

Management expects Enderun to deliver double-digit growth in the coming years.

 

Within education, there is a brand advantage at the very elite schools but Enderun does not have that advantages.

 

 

Prople Limited

 

In December 2007, Anscor acquired 20% of Prople for US$800,000. In November 2013 acquired 100% of the non-audit business of US-based Kellogg and Andelson Accountancy Corporation (K&A). Founded in 1939, K&A is a well- established accounting firm that provides tax, general accounting, and consulting services to thousands of small to medium sized companies in California and the Midwest. It operates out of five locations in Los Angeles, Woodland Hills, San Diego, Kansas City and Chennai (India). Following its acquisition of K&A, Prople now employs 373 people serving over 5,500 clients from operations located in six cities worldwide. In 2015, Prople closed K&A’s San Diego office and client attrition in the Midwest. Prior to the acquisition of K&A, Prople’s services included business process outsourcing, knowledge process outsourcing, and content services. K&A tripled the company’s revenue.

 

With the acquisition of K&A, Prople is primarily a tax, accounting, and consulting provider. Professional services, like tax and accounting, have some switching costs as the provider is embedded in the company’s operations becoming an integral part of the team. Despite the switching costs, the industry is fragmented and bargaining power of the provider can be decreased by using multiple suppliers.

 

 

AGP International Holdings Ltd.

 

AGP International (AG&P) is Southeast Asia’s leading modular fabricator of refinery and petrochemical plants, power plants, liquid natural gas facilities, mining processing, offshore platforms, and other infrastructure. AG&P has 110 years of experience serving clients like British Petroleum, Shell and Total.

 

Anscor made its first investment in AG&P in December 2011. In June 2013, Anscor subscribed to 83.9 million series C, voting preferred shares in AG&P. Series B and Series C preferred shares are convertible at the option of the holder, into class A common shares. The subscription increased Anscor’s holdings to 27%.

 

Similar to cable manufacturing there are no barriers to entry within the modular fabrication.

 

Anscor’s businesses do not appear to be competitively advantaged. The lack of barriers to entry makes industry analysis irrelevant.

 

Listed above is the company’s shareholder structure. 50.7% of the shares issued are held by a 100% owned subsidiary. Insiders own another 27.1% of shares issued, affiliates own 3.2% of shares issued, and the public own 19.0% of shares issued.

 

 

VALUATION

 

The lack of barriers to entry within Anscor’s businesses and the management team is deeply entrenched the company’s earnings power is the best method of measuring the company’s value as the earnings generated are likely to continue. Assuming average management and a lack of barriers to entry means the value of the company’s assets should be close to the company’s earnings valuation as excess returns are unlikely and cyclical adjusted earnings should be close to the company’s discount rate.

 

Given the company’s large investments in securities and associates, we use net income as the best measure of the company’s earnings and equity as the best measure of investment capital. Since 2010, Anscor has generated an average net income of PHP1,423 on an average tangible equity of PHP12,106 equating to a roughly 11.8% return on equity.

 

Given the lack of barriers to entry in Anscor’s businesses, growth does not create value and therefore is irrelevant; therefore, assuming a 10% discount rate Anscor should be trading at roughly 1.18 times tangible book value representing a 110% upside.

 

Anscor is trading on a cyclically adjusted PE of 5.46 times meaning in the absence of growth, the company’s expected annualized return in 18.3%.

 

Given the company’s ability to generate a consistent return on equity equal to the company’s discount rate, the reproduction value of the company’s assets should equal the company’s tangible book value. It is difficult to say a collection of assets are impaired if they generate a return equal to the discount rate.

 

Anscor’s fair value is between tangible book (77% upside) and 1.18 times tangible book (110% upside).

 

 

RISKS

 

A company with a dominant shareholder (A. Soriano III) brings potential corporate governance issues. Anscor only material related party transactions are key management remuneration, which averaged 8.8% of net income over the past five years. Key management remuneration is a little high but the absence of any other related party transactions and the cheap valuations means it can be overlooked.

 

Our goal with assessing macro risk is not to forecast the path of macroeconomic indicators but to eliminate risks from a poor macroeconomic position. Anscor’s business is primarily in the Philippines, a country that seems to be in very good financial health. In 2015, the country’s current account was 2.6% of GDP and its structural balance was 0.18% of GDP allowing the country to self-finance all the domestic initiatives as well as decrease the country’s debt load. The country does not have too much credit in the system with domestic credit provided by the financial sector at 59.1% at the end of 2015, which is well below the Emerging Markets average of 97.5% and the High Income countries average of 205%. Gross government debt as a percentage of GDP stood just under 35% with External Debt to GDP at 36%. The one concerning macroeconomic indicator is the level of growth in credit in the Philippines. Over the past five years, the amount of domestic credit provided by the financial sector has increased at a rate 12% per annum. When a country is growing its banking assets at this pace, there is a high probability of an increase in non-performing loans. The country’s banking system has a healthy capital balance with capital to assets at 10.6%.

 

The investment is based on Anscor’s strong financially health. If the company were to leverage its balance sheet, the attractiveness of the investment opportunity would decline.

 

The investment is also based on Anscor’s consistently generating net income around its cost of capital. If earnings in the business were to permanently decline, the investment would become much less attractive.

 

If earnings were to decline making a liquidation value a more appropriate valuation methodology, there is still 30% upside meaning there is significant downside protection.

 

If Anscor were to make expensive acquisitions, it would decrease the returns in the business through the write down of income and equity.

 

Given the nature of Anscor’s businesses, they all lack barriers to entry and therefore are at risk of increased supply depressing profitability.

 

Most of Anscor’s businesses are cyclical in nature and subject to macroeconomic risks.

 

At the end of Q3 2016, 47% of Anscor’s assets were in available for sale securities or fair value through the profit and loss investments making the company exposed to the fluctuations of the Philippines Stock Exchange.

WEEKLY COMMENTARY 2/13/17- 2/19/17

WEEKLY COMMENTARY               2/13/17- 2/19/17

 

 

CURRENT POSITIONS

 

 

 

COMPANY NEWS

 

PC Jeweller report Q3 FY17 results over the past week. Demonetization impacted the quarter’s results with the company estimating sales were affected for three to four weeks. Post-demonetization, sales started improving in December and returned to normal in January. Gross margin were stable but the decline is sales resulted in a decline in profitability. Year on year sales declined by 3.4%, the number of showrooms grew from 58 in FQ3 2016 to 68 FQ3 2017, or 17%, and total square feet increased by 8% year on year from 346,855 square feet to 374,481 square feet. Year on year, the company’s operating profit declined 13.7%. Assuming during the four weeks that demonetization affected sales there was a 50% decreased in sales, no impact from demonetization would have lead to an increase in sales by roughly 16% year on year.

 

It is tough to tell how good or bad the quarter was due to demonetization. The company continues to increase its showroom footprint and sales barely declined despite demonetization. The company estimates 75% of the jewelry industry is unorganized dampening competitive pressures.

 

PC Jeweller is one of the most profitable and fastest growing companies in the Indian jewelry industry illustrating the strength of the company’s management and focus on efficiency. Management is one of the most innovative in the industry with many initiatives not seen in the industry. The company is trying to double its showroom footprint over the next five years. Despite the company’s strengths, it trades on an EV/NOPAT of 14 times and an EV/IC of 2.6 times. We will maintain our current position size.

 

In the past week, Grendene reported Q4 2016 and full year results. For the full year 2016, net sales declined by 7.2% with domestic sales falling by 1.6% and export sales falling by 16.3%.

 

Overall volume declined by 9.3% with domestic volume declining by 8.0% and export volumes falling by 13.0%.

 

ASP increased by 4.1% with domestic ASP increasing by 7.2% and export ASP falling by 3.2%. Gross profit fell by 6.7% as cost of goods sold declined by 7.6%.

 

Operating profit declined by in 7.5%. The company’s capital intensity did not change over the year with working capital at 47.9% of sales, fixed capital at 18.9% of sales, and invested capital at 66.8% of sales.

 

Grendene’s key value drivers are illustrated above. In 2016, gross margin reached a peak level of 48.7%. Selling expenses remain near its historical average relative to sales at 24.0%. General and administrative is at its peak at 4.8% of sales. EBIT margin remained at its historical peak of 20.0%. Working capital remains slightly elevated relative to historical averages. Fixed capital as a percentage is at its highest level over the past eleven years.

 

Grendene continues to struggle with economic weakness in Brazil and in export markets. The company operational efficiency allows the company to maintain its profitability during a period of declining revenue. In 2015, the company reiterated its growth targets of revenue growth of 8-12% and net income growth of 12-15%. The company continues to believe these targets are achievable but acknowledge risks of not achieving these results are increasing due to economic weakness in Brazil and in exports markets.

 

Given the new data, we update Grendene’s earnings valuation range. Grendene illustrated its ability to maintain profitability despite a period of declining revenues and increasing competitive pressures making earnings valuation the most appropriate valuation methodology.

 

Looking at Grendene’s earnings valuation, the company reaches our target return of 15% per year under the most optimistic scenarios. We would assume perpetuity growth only under scenarios when the company operates in an industry with barriers to entry and pricing power. Within the domestic market, there are clear barriers to entry with the company and its main competitor Alpargatas having economies of scale as they occupy over 50% of the market with large fixed costs in the form of distribution and advertising. Grendene also has unique capabilities in manufacturing plastic products as it modifies its own machines and can formulate plastics that are unavailable to other footwear producers. These barriers to entry do not transfer outside of Brazil. The company is a low cost producer with only China producing exports at a lower price.

 

The question is whether the barriers to entry within Brazil translate to pricing power. The barriers to entry within the segment means very few other players could sell products at the Grendene’s and Alpargatas’ price range meaning the company’s probably do have some pricing power in Brazil. Over the past ten years, the company average selling price increased by 3.8% per annum with the domestic selling price increasing by 2.6% and export selling pricing increasing by 3.9% in USD terms so there is a strong argument for potential pricing power. We assume 2.5% pricing power in our base case scenario. The company sales have grown at 6.8% over the past ten years with growth stagnating at 4.9% over the past five years. Assuming an inability to growth operating profit above sales growth a 5% growth rate seems appropriate for our five-year forecast period. Despite the company’s ability to maintain profitability during the recent industry weakness using peak margins seems aggressive therefore average margins are more appropriate. Our base case scenario is 5% forecast period growth, 2.5% terminal growth and average operating margins leading an upside to the 2021 fair value of 60% or 9.9% annualized return. Overall, the average return over the next five years under the earnings valuation is 59% or 9.7%.

 

 

INTERESTING LINKS

 

 

How much is growth worth? (Musing on Markets)

 

Professor Damodaran breakdowns how to value growth, the key drivers of growth, and the importance of ROIC in determing whether growth is valuable or not. (link)

 

 

Narrative and Numbers: How a number cruncher learned to tell stories! (Musing on Markets)

 

Another post by Professor Damodaran explaining how narratives can be worked into your valuation to provide a better picture of how the market is valuing a company. (link) Professor Damodaran recently published a book Narrative and Numbers, which I have not read but is next on my list.

 

 

Diversification..again.. (Oddball Stocks)

 

Nate Tobik of Oddball Stocks shares his thoughts on diversification. (link) Our current thoughts on diversification and position sizing can be viewed here. (link) We have a similar thought process on the limits of one’s knowledge as an outside investor with valuation being the biggest tool to offset the limits of our knowledge.

 

 

Humility and knowledge (Oddball Stocks)

 

Related to his post on diversification, Mr. Tobik discusses how investors sometimes make the mistake of believing they know too much. (link)  We touched on a similar topic in our diversification post linked above.

 

 

Graham & Doddsville (Columbia Business School)

 

Columbia Business School put out another edition of Graham & Doddsville, which always makes for interesting reading. (link)

 

 

Buffett’s Three Categories of Returns on Capital (Base Hit Investing)

 

Base Hit Investing’s John Huber talks about how Buffett categorizes business by their return on capital and capital requirements. (link)

 

 

What Does Nevada’s $35 Billion Fund Manager Do All Day? Nothing (Wall Street Journal)

 

The Wall Street Journal profiles the Steve Edmundson, the investment chief for the Nevada Public Employees’ Retirement. (link)

 

 

Howard Marks’ Letters Sorted by Topic (Anil Kumar Tulsiram)

 

Anil Kumar Tulsiram complied all Howard Marks’ letters by topic. He has compiled other documents in the past and can be followed on Twitter @Anil_Tulsiram. (link)

 

WEEKLY COMMENTARY 2/6/17-2/12/17

WEEKLY COMMENTARY               2/6/17-2/12/17

 

 

CURRENT POSITIONS

 

 

 

COMPANY NEWS

 

After the company’s recent share price appreciation, Grendene’s estimated five-year annualized return has fallen to roughly 10% base on scenario analysis.

 

There are barriers to entry within Grendene’s Brazilian business. Within Brazil, it is a low cost operator with scale advantage due to heavy investments in advertising, product development, automation, and process improvements. It produces a low priced experienced good with a strong brand allowing for pricing power. Grendene’s exports are at the low end of the cost curve ensuring the company stays competitive in export markets but growth in exports markets will come with lower profitability due to the weakened competitive position and excess returns.

 

Owner operators with strong operational skills, an understanding of its competitive position, and who treat all stakeholders with respect run the company. It also has consistently generated stable, excess profit even during periods of industry stress and has a net cash balance sheet.

 

Given the company’s expected return, the company’s competitive position, and the strength of management, we are decreasing our position size to 2.0%. Please review our initiation (link) for a more in-depth discussion on the company.

 

 

INTERESTING LINKS

 

 

My Interview with Jason Zweig (Safal Niveshak)

 

Vishal Khandelwal interviews Jason Zweig, who provides some very good ideas on improving your investment process. (link)

 

 

The Making of a Brand (Collaboration Fund)

 

In a wonderful article, Morgan Housel of the Collaboration Fund discusses the history of brands and what a brand is. (link)

 

 

Riding a retail roll out (Phil Oakley)

 

Phil Oakley discusses the difficulty in investing in retail rollouts. (link)

 

 

January 2017 Data Update 7: Profitability, Excess Returns and Governance (Musing on Markets)

 

Professor Damodaran provides some interesting statistics on ROIC across geographies and sectors. (link)

 

 

Investing Mastery Through Deliberate Practice (MicroCap Club)

 

Chip Maloney talks about the benefits of deliberate practice and how to use deliberate practice to make you a better investor. (link)

 

 

Out with the old (Investor Chronicle)

 

Todd Wenning provides insight on when to sell your investments (link)

 

 

2 Bitter Truths of Stock Valuation…and How You Can Avoid Them (Safal Niveshak)

 

Vishal Khandelwal highlights potential mistakes in valuing companies and how to avoid them. (link)

 

 

Revlon’s restructuring plan represents the future of legacy beauty (Glossy)

 

Glossy magazine writes about the beauty business. (link)

 

 

6 smart tips for micro-cap investors (Morningstar)

 

Ian Cassel gives readers 6 tips for micro-cap investors. These are useful for all investors. (link)

 

 

HAW PAR CORPORATION (HPAR:SP)

 

 

Company Description

 

Haw Par Corporation is a corporation with two operating businesses and strategic investments. The company’s two operating businesses are healthcare and leisure. The company’s healthcare business is the owner of the Tiger Balm, a well-known topical analgesic. The company’s leisure business own and operate two aquariums: Underwater World Singapore in Sentosa and Underwater World Pattaya in Thailand. The company also has investments in property and quoted securities.

 

 

Healthcare

 

Haw Par’s healthcare business manufactures and markets Tiger Balm and Kwan Loong. Tiger Balm is a renowned ointment used worldwide to invigorate the body as well as to relieve aches and pains. Its product extensions such as Tiger Balm Medicated Plaster, Tiger Balm Joint Rub, Tiger Balm Neck and Shoulder Rub, Tiger Balm Mosquito Repellent Patch and Tiger Balm ACTIVE range cater to the lifestyle needs of a new health-conscious generation..At first glance, the company’s healthcare business looks like a very attractive business. Tiger Balm is a trusted brand that has been around for over 100 years and generates very strong profitability.

 

Over the past four years, the healthcare business has increased sales by 18.4% per year while increasing its operating margin by 4.4 percentage points per annum and asset turnover by 0.14 per annum leading to an increase in its ROA from 27.7% in 2012 to 60.9% in 2015.

 

The majority of Haw Par’s health care business revenues are in Asia, but the company is growing fastest in America.

 

The company’s strategy for the healthcare business is to drive growth from further product penetration across existing markets to widen the brand franchise for Tiger Balm. The company has launched new products in several markets. Sales of Tiger Balm’s range of traditional and new products continued to grow in most of its key markets. The healthcare business’ margins improvement is due to lower commodity prices mitigating the pressures from rising staff costs amid tight labor markets.

 

 

Leisure

 

Haw Par’s leisure business owns two aquariums, Underwater World Singapore and Underwater World Pattaya.

 

In 2012, the company’s two aquariums attracted 1.48 million visitors at an average price of SGD20.50 leading to a SGD30.3 million in sales. The company generated operating profit of SGD11.80 million and a ROA of 45.8%. In 2015, the company attracted 0.76 million visitors to its two aquariums at an average price of SGD16.85 leading to SGD12.74 million in sales. The company had operating profit of SGD0.15 million, a segment profit of SGD-4.34 million and a ROA of 1.3%.  From 2012 to 2015, the number of visitors to the company’s two aquariums declined by 20% per year and the average price per visitor declined by 6.3% per year causing a sales to drop by 25.1% per year. The high level of fixed costs in the business saw operating profit fall by 76.8% per year.

 

The decline in the leisure business was caused by a decline in tourism and stiff competition from existing and new attractions, including direct competitors within the immediate vicinity of the two aquariums.

 

The leisure business is a great business as long as you are attracting a sufficient number of visitors to your property as the business is primarily fixed costs. Unfortunately, competition can easily enter the market in your vicinity decreasing the number of visitors at your property causing a decline in sales as you drop prices to attract people and an even greater decline in operating profit due to the operating leverage in the business.

 

 

Property

 

Haw Par’s owns three properties in Singapore and one in Kuala Lumpur. Of the company’s four properties, three are office buildings and one is an industrial building.

 

At the end of 2015, the company has total letable area of 45,399 square meters with an occupancy rate of 64.6%.

 

In 2015, the property division generated sales of SGD14.33 million, operating profit of SGD8.56 and ROA of 4.0%.  The division’s occupancy rate has fallen by almost 30 percentage points from 2013 to 2015, this could be due to a weaker environment or a deterioration of the properties’ competitive position as newer properties become available. I am not a big fan of property investments, as they tend to have poor return on assets and require significant leverage to generate a return near our required rate of return of 15%. On top of the poor profitability in the business, Haw Par’s occupancy rates have been falling potentially pointing to a weaker competitive position of the company’s properties.

 

 

Investments

 

Since 2012, Haw Par’s investment business accounted for 76.7% of the assets on the company’s balance sheet. At the end of 2015, United Overseas Bank (UOB:SP) accounted for 66.4% of the company’s available for sale securities, UOL Group (UOL:SP) accounted for 13.0%, and United Industrial Corp (UIC:SP) accounted for 9.5%.  United Overseas Bank, UOL Group, and United Industrial are all related parties as Wee Cho Yaw is the Chairman of Haw Par and the three other corporations.

 

Profit before tax is dividend income. Since 2012, the investment business has generated an average dividend income of 3.2%.

 

Since 1987, United Overseas Bank’s average annualized return was 7.0%, UOL Group’s was 5.2%, and United Industrial’s was 1.2%, nowhere near an acceptable return.

 

 

Management

 

Members of management are owner operators with insiders owning roughly 60% of Haw Par.  Management is doing a great job operating Tiger Balm but the rest of the business is a capital allocation nightmare with poor investments in leisure and property along with significant cross holdings in other family businesses.

 

Management also extracts far too much value with the average remuneration to key management personnel over the past two years at 9.9% of operating income. Operating income is used rather than profit before tax as the investment income and property income are poor capital allocation decision and it would be best if that money were returned to shareholders.  Since the income generated below operating profit detracts value it is best if operating profit is used. There are related party transactions outside of key management compensation. The company has no related party transactions.

 

 

Valuation

 

The poor capital allocation and management value extraction makes the business nothing more than a deep value holding, which would require at least 50% upside using conservative assumptions to be investible. To value the company, we value the healthcare business based off a multiple of operating profit and value all other division based on liquidation value due to the poor trends see in those businesses.

 

Given the quality and growth in Haw Par’s healthcare business, we believe 15 times operating profit is a fair multiple for the business. The company’s leisure business is given no value as the number of visitors continues to decline due to newer attractions and the company’s operating leverage means the company was barely breaking even in 2015. Cash and net working capital is valued at 100% of balance sheet value. The company’s property is seeing declining occupancy rates. We conservatively assume this to be a sign of the property’s deteriorating competitive position. There are also fees associated with any liquidation therefore we value the property assets at 75% of current value. The company’s available for sale securities are assumed to be liquidated at 75% of current value, as the holdings are so large that they would have a market impact if Haw Par ever tried to sell its shares.

 

Overall, Haw Par would be interesting below SGD7.50 but only as a deep value holding given the poor capital allocation and high management salaries.

GMA Holdings/GMA Networks 2/1/2017

GMA Holdings/GMA Networks

Ticker:                                                             GMAP:PM/GMA7:PM

Closing Price (1/31/17):                                PHP5.90

6 Month Avg. Daily Vol. (USD mn):             0.56

Market Cap (USD mn):                                 421

Estimated Annualized Return:                    12.5%

Suggested Position Size:                              4.0%

February 1, 2017

GMA_Research_Report_Feb_1_2017

 

FACTOR RATINGS

 

 

 

INVESTMENT THESIS

 

GMA Network is a competitively advantaged firm enjoying economies of scale with customer captivity and regulatory barriers to entry. Unfortunately, management’s operational inefficiency is creating a drag the business’s profitability. Additionally, management pay themselves 20% of operating profit.  The company is trading on a free cash flow yield of 7.5% and should grow at least at 5.0% leading to a minimum expected annualized return of 12.5%.

 

 

COMPANY DESCRIPTION

 

 

Company History

 

GMA Network, Inc. (GMA) is a free-to-air broadcasting company engaged in television and radio broadcasting, the production of programs for domestic and international audiences, and other related businesses. The company derives the majority of its revenues from advertising related to television broadcasting. GMA Network has 47 VHF and 41 UHF TV stations throughout the Philippines with its signal reaching approximately 98% of the country’s Urban TV Households.

 

Robert La Rue Stewart founded GMA in 1950 as Republic Broadcasting System (RBS) with its flagship AM radio station DZBB operating from Escolta, Manila. RBS started broadcasting on Channel 7 in the Greater Manila Area in 1961. In 1975, Felipe L. Gozon, Menardo R. Jimenez, and Gilberto M. Duavit took over management of RBS and renamed it to GMA 7.
The original meaning of the acronym “GMA” was Greater Manila Area, referring to the initial coverage area of the station. The company changed its name to Global Media Arts. Today, its corporate name is GMA Network, Inc.

Apart from its television and radio networks, the company owns many media businesses including film production, record publishing and distribution, program acquisition and syndication, international channel operation, production design, talent development and management, marketing and promotions, audio-visual production and new media.
In addition to its presence in the Philippines, GMA’s content is distributed outside the Philippines through its subscription-based international channels distributed through multiple platforms. Its content is also on many platforms through worldwide syndication sales to broadcasters/companies in China, Southeast Asia, Africa, and Europe.

 

In February 2001, Philippines Long Distance Telephone Company (PLDT) agreed to acquire 75% interest in GMA for PHP 8.5 billion. Regulatory approval for the deal was received in August 2001. In late 2001, the relationship between the parties deteriorated and PLDT pulled out of the deal stating its debt was too much of a burden to complete the deal.

 

GMA went public in 2007. As of September 30, 2016, the company had 3,361,047,000 common shares outstanding and 7,499,507,184 preferred shares outstanding. Common shares have two classes, common shares and Philippine Deposit Receipts (PDRs). Filipinos can only hold common shares, while anyone can hold PDRs. The two are fully fungible for Filipinos. The company’s preferred shares are unlisted and convertible to common shares at a rate of 5 preferred shares to 1 common share. The public float is 24.38%.

 

FLG Management & Development Corp. is an investment vehicle of Felipe L. Gozon, the Chairman of the Board and CEO of GMA Network. Mr. Gozon is an attorney graduating from Yale Law School. Aside from GMA Network, he is a Senior Partner at the Law Firm of Belo Gozon Elma Parel Asuncion & Lucila.

 

M.A. Jimenez Enterprises and Television International Corporation are investment vehicles of Menardo Jimenez was the former President and CEO of the GMA Network. He gave up the position to brother-in-law Felipe Gozon in 2000.

 

The company’s approved dividend policy entitles holders of common shares to receive annual cash dividends equivalent to a minimum of 50% of the prior year’s net income based on the recommendation of the Board of Directors.

 

 

Business Model

 

GMA Network creates and purchases content aggregates the content into channels. Channels are transmitted to audiences directly or over the internet. GMA generates revenue primarily by selling time within programs to advertisers. Advertisers pay based on the size and type of audience. Advertising accounted for roughly 90% of revenues over the past three years. The company also generates revenue from selling content internationally and via its websites.

In 2015, over 90% of the company’s revenue was from television and radio airtime with the remaining revenues coming from content production and others. In the first six months of 2016, Channel 7/RTV accounted for 94% of television and radio airtime revenue while GMA’s news station, GNTV, accounted for 2% of television and radio airtime revenue and radio accounted for 4% of television and radio airtime revenue.

 

The costs of creating content and purchasing local or international content are fixed and are the same regardless of audience size. For GMA, production costs or content creation costs equates the cost of goods sold.

 

The production cost structure is shown above. Talent fees account for roughly half of the company’s total production costs. The next largest expense is rentals and outside services,, which has decreased as a percentage of total production costs indicating the company is slowing moving more production in-house. Overall, the company’s gross margin has averaged 55.0% over the past three years.

 

The general and administrative expenses (GAEX) required to generate revenue averaged 37.9% of revenue over the past three years with personnel costs being the largest expense accounting for 50% of total GAEX. At 12% of GAEX, facilities costs were the next largest cost and only other cost accounting for more than 10% of GAEX.

 

Over the past three years, the total amount of operating expenses were relatively stable over the past three years while revenue fluctuated potentially pointing to the vast majority of operating expenses being fixed.

 

We estimate that roughly 70% of operating expenses are fixed. We assume all production costs are fixed along with 25% of GAEX personnel expenses. The fixed portion of GAEX personnel expenses is sales staff. Additionally, all depreciation and facilities costs are assumed to be fixed. All other expenses under GAEX are assumed to be variable.

 

Since 2007, to generate one peso of revenue, GMA needs to spend 34 centavos on working capital and 40 centavos on fixed capital leading to 74 centavos of total investment. For every peso of revenue, the company generates 24.4 centavos of operating profit leading to an average ROIC of 23.3%.

 

 

INDUSTRY ANALYSIS

 

 

Industry History

 

A predecessor of ABS CBN’s, ABS introduced television to the Philippines in 1953. ABS started broadcasting DZAQ-TV3 on a four-hour-a-day schedule from six to ten in the evening. At the start, programs were American as it was cheaper to purchase international programming than produce programming locally. ABS CBN’s other predecessor CBS started in 1955. The industry continued to grow in popularity with many new television channels broadcasting until 1972 when Ferdinand Marcos placed Philippines under martial rule and took control over the media. The industry was under government control until 1986. ABS-CBN began satellite and international broadcasts in 1989. During the 1990s and 2000s, there was a proliferation of new channels and Filipino programming started to be exported to other countries. In 2009, ABS-CBN started testing digital terrestrial television and SkyCable launched the first HD television channel. In 2010, Philippines adopted the Japanese ISDB-T standard.

 

According to CASBAA, the association for the multi-channel audio-visual content creation and distribution industry across Asia, in 2010 the number of television households in the Philippines was 13.5 million. 1.5 million households subscribed to cable television and another 100,000 subscribed to direct to home (DTH) services. Metro Manila has the highest pay TV penetration rate was Metro Manila at 27% of households.

 

 

Industry Value Chain

 

 

 

Evidence of Barriers to Entry

 

We believe barriers to entry are the most significant force in determining the underlying quality and economics of a business. Barriers to entry stops competition from entering the market allowing a company to sustain excess profitability. The absence of barriers to entry allows competition to enter the market competing away all excess profitability. In practice, excess profitability can persist for a prolonged period without barriers to entry. The institutional imperative can lead to less than optimal decision by some competitors allowing other competitors to take advantage of the poor management and generate excess profits. Also, demand can outpace supply in the short term leading to an ability to take advantage of the disequilibrium through price hikes leading to excess profitability. As supply catches up with demand, usually when demand growth slows, excess profitability will be eliminated.

 

There are indicators that provide evidence of the existence of barriers to entry within an industry. The first is the number of competitors within the industry. Many competitors within an industry means competitors can freely enter the market, while a small number of competitors means entry and survival within the industry is difficult.

 

There are a number of firms competing in the Philippines television industry but the top two firms dominate the industry with almost 80% of the audience share in 2015. Since 2010, the top three firms’ average audience share was 85% pointing very high industry concentration. Over the same period, the industry’s Herfindahl Index averaged 0.30 also pointing to very high industry concentration. Only the audience share of the top three firms were used to calculate the Herfindahl Index as estimating the number and market share of smaller firms does not meaningfully change the industry’s Herfindahl Index. As illustrated by concentration ratios, the Philippines television Industry is extremely concentrated pointing to the existence of barriers to entry.

 

The next indicator we look at to determine whether barriers to entry exist is market share stability. If there are barriers to entry, market share should be stable as potential entrants find it difficult to take share from incumbents. In the absence of barriers to entry, new entrants can use many strategies to take market share from incumbents.

 

As illustrated in the table above, the average absolute share change since 2010 is 1% pointing to share stability and additional evidence that barriers to entry exist. If over a period of at least five years the absolute average share change within an industry is two percentage points or less, barriers to entry exist. If the absolute average share change exceeds five percentage points, it is unlikely that barriers to entry exist.

 

The next and probably the most important test of barriers to entry is sustained excess profits as measured by ROIC minus the cost of capital. If a company is able to generate at least 15% ROIC on a regular basis, it is strong evidence of potential barriers to entry. ROIC cannot be used in isolation as a company can generate excess profits in the short to medium term without the existence of barriers to entry. To calculate ROIC, we attempt to separate any operating performance from capital allocation decisions leading to only using net operating assets to calculate the amount of invested capital (net working capital + PP&E + other operating assets).

 

Since 2007, GMA’s ROIC averaged 23.3%, well above the 15% threshold, with the lowest ROIC of 10% in 2014. The strength of GMA’s profitability points to barriers to entry.

 

The final test to see if barriers to entry exist is looking at potential pricing power. We assess pricing power by looking at company’s gross margin. If a company has pricing power, it should be able to raise prices to cover its raw material costs leading to a stable to increasing gross margin.

 

GMA’s gross margin has declined from 61.2% in 2007 to 57.4% in 2015. Although the company’s gross margin is high, there is very little stability with a step change in 2011 with gross margin declining by 7.0%. The lack of gross margin stability points to no pricing power and a lack of barriers to entry.

 

Overall, the evidence of barriers to entry existing is strong with three of the four tests pointing to barriers to entry existing.

 

 

Barriers to Entry

 

Given the evidence pointing to the existence of barriers to entry, the next question is what are those barriers to entry? We believe there are four barriers to entry; supply advantages, demand advantages, economies of scale with some form of customer captivity, and/or government regulation.

 

Within the Philippines and globally, the Television Industry’s barriers to entry take the form of economies of scale with customer captivity, and regulatory barriers.

 

Economies of scale comes from high fixed costs associated with producing and purchasing content as viewership of content is not known at the time of producing the program. Production costs represented 41.9% of sales. The fixed cost nature of content production/purchasing allows larger companies to produce/purchase higher quality content as they can outspend competitors. There is a wide gap in audience share from the two largest competitors, ABS CBN and GMA, and all other peers allowing ABS CBN and GMA to outspend peers by a noticeably amount. In the nine months ending 2016, ABS CBN had a 44% audience share, GMA had a 34% audience share, and third place TV5 had a 7% audience share. Assuming audience share and market share equate, TV5 would have to be twice its current size to spend as much on production costs and be break even at a gross margin level. This does not account for fixed costs below the gross margin line including depreciation and amortization, facilities, and personnel related to sales of advertising space. We estimated non-production fixed costs represented an additional 13.0% of GMA’s sales.

 

Customer captivity comes from continuous programming such as news and long running television shows, such as soap operas and sitcoms. Consumers tend to watch the same news station and get addicted to television shows. Continuous programming also requires fixed infrastructure leading to the previously mentioned economies of scale.

 

Like many countries, the Philippines restricts ownership of media assets. According to Article 16, Section 11 of the Philippine Constitution   “The ownership and management of mass media shall be limited to citizens of the Philippines…”

 

Economies of scale combined with customer captivity and regulatory restrictions are very difficult barriers to entry to overcome. Audience share is stable and the industry is becoming more concentrated pointing to a stable to expanding barriers to entry while the declining ROIC points to deteriorating barriers to entry.

 

A good way of understanding the competitive advantage is determining the length of time it would take a new entrant to replicate GMA competitive position. To replicate GMA’s competitive position, any new entrant would first have to obtain regulatory licenses associated with owning and operating mass media. This requirement is restricted to Filipinos A new entrant would have to spend over PHP5.5 billion annual in content production. This content then needs to be packaged and distributed. Advertising slots also need to be sold via building a sales force. GMA’s audience share and time in the business has created relationships that are difficult to replicate. Additionally, a new entrant would need to acquire all the expertise associated with running the business. The company would also need to advertise heavily in an attempt to attract customers from rivals. Despite, the heavy spending the share stability in the industry points an inability to attract an audience. If we assume 1% share can be acquired every year, equal to the average absolute share change over the past five years, it would take 34 years to reach GMA’s current position. Assuming all share gains are taken from GMA, despite evidence of industry concentration increasing, it would take 17 years to reach GMA’s position.

 

Given the barriers to entry, it seems GMA’s competitive position within the Filipino Television industry will remain very strong. A more likely scenario is over the top takes hold or some other technology disrupts the importance of television. Overall, GMA’s barriers to entry seem to be very difficult to overcome and should be sustained for a long period.

 

 

GROWTH

 

Ad spending is linked to GDP. The table below shows ad spending as a percentage of GDP for a number of different countries at a number of stages of development.

 

For most countries ad spend as a percentage of GDP has remained relatively stable. There is little correlation between ad spend to GDP and GDP per capita so growth in ad spend to GDP should not necessarily increase as GDP per capita increases.

 

The scatter plot graph above shows the relationship across countries and years. A linear trend only has an R squared of 0.2599, while a power trend has the highest R squared of 0.4492 illustrating while there is relationship it is not strong.

 

Looking at the United States as it has the most data, ad spend as a percentage of GDP has been consistently between 1-2% over the past 100 years, as illustrated by the chart from Bloomberg Businessweek. The consistency and lack of growth in ad spend relative to GDP supports the argument that ad spend as a percentage of GDP does not increase with development.

 

Since 2007, the Philippines ad spend to GDP has remained between 0.57% and 0.75% but seemingly on an upward trend.

 

Given the evidence, it seems appropriate to assume a stable ad spend as a percentage to GDP meaning the overall advertising market will grow with GDP growth.

 

The table above shows the growth of Philippines GDP in current local currency terms over various periods along with IMF forecasts through 2021. IMF is forecasting 6.8% growth per year until 2021.

 

Given it seems ad spend will growth with GDP, the question now becomes how will the ad spend be divided among different types of media. Television accounted for 75% of total ad spend in the Philippines in 2006, 74% in 2010, 77% in 2011, 78% in 2013, and 71% in 2015. As illustrated, television has long been the dominant form of advertising in the Philippines. Outside of the Philippines, TV is far less dominant as shown in the graphic below.

 

While television is far less dominant outside of the Philippines, it still holds a leading share of ad spend as it is the easiest and most cost effective way to reach the masses. Internet advertising is growing the fastest and taking a larger piece of the pie. Television continues to gain share increasing its slice of the advertising pie from 36.8% in 2005 to 40.2% in 2013. The growth of the internet and television’s share of ad spend is coming at the expense of everything else with newspapers and magazines being the biggest losers. The resilience of television means it continues to play an important role for advertisers in reaching a mass-market audience. The internet has not been able to take the role of reaching mass markets as audiences on the internet are much more fragmented. The internet is now doing the jobs for audiences that newspapers and magazines used to do therefore is taking their share of the advertising budgets. This makes sense as newspapers and magazines audience is much more fragmented with magazines catering to niche interests while newspaper catered to local interests therefore could never garner the national audience that major television stations.

 

While internet advertising should continue to grow, the importance of television within the Philippines will allow it to maintain a large portion of the advertising market. TV may not be the best for targeting a specific audience, but it provides an opportunity to reach an audience that other media cannot reach making it a perfect venue to educate the masses about your product.

 

Within TV, GMA and ABS CBN’s maintaining roughly 80% audience share with an increasing audience share concentration in the industry have been stable with barriers to entry allowing the companies to maintain their share of TV’s advertising.

 

Overall, ad spend should remain stable as a percentage of GDP. IMF forecasts GDP growth of 6.8% until 2021. TV currently accounts for 71% of advertising within the Philippines and has oscillated in the 70-80% region over the past decade. It should continue to maintain a strong position among other mediums particularly when digital and internet advertising is taking share from other media rather than TV. Within TV, GMA and ABS CBN’s position will be difficult to overcome and could potentially further consolidate.

 

 

MANAGEMENT

 

To judge the strength of a management team we assess management’s incentives and its ability in operations, strategy, capital allocation, and corporate governance.

 

 

Incentives

 

The current chairman of the board and CEO, Felipe Gozon owns 25.3% of the company via FLG Management & Development Corp. GMA’s management team incentives seem to be aligned with minority shareholders as members of the board and management team are the largest shareholders in the company.

 

 

Operational Efficiency

 

Regardless of the existence of barriers to entry, operational efficiency is crucial. In an industry with barriers to entry, a firm can fully exploit its advantage. Without barriers to entry, operationally inefficient firms would be forced out of the industry due to persistent losses.

 

The metrics listed above are averages over the last five years in a millions of Philippine pesos per percentage point of audience share. ABS CBN is a media conglomerate with many unrelated business segments. Its most comparable business segment is its TV and Studio segment, which releases partial accounts. ABS CBN generates much higher revenue per percentage point of audience share but also spends more on the production of content leading to a slightly higher gross margin than GMA. ABS CBN’s audience share advantage was already mentioned but it also dominates the top 10 most watched programs over the past five years, with GMA only getting a Manny Pacquiao fight in 2012 and another in 2014 into the top 10 most watched programs. The audience share and domination of the top 10 programs points to superior content of ABS CBN and ability to charge higher prices than GMA.

 

Operationally, GMA’s operational expenses are much lower than ABS CBN’s on both a per percentage point of audience share and as a percentage of sales. GMA’s operating expenses per percentage of audience share are less than half of ABS CBN’s and 7.6% less as a percentage of sales.

 

GMA’s has much higher capital efficiency with net operating asset turnover of 1.35 times compared to 0.84 times for ABS CBN. The operating efficiency and capital efficiency allows GMA to be much more profitable with a return on net operating assets of 24.3% compared to 10.7%. GMA is far more operationally efficient than ABS CBN allowing it to exploit the barriers to entry within the industry.

 

The table above illustrates the key value drivers of a number of television broadcasters around the world. ABS CBN’s figures are different from the previous discussion as this is the whole company rather than just the TV and Studio business.

 

GMA outperforms on gross margin relative to its peers with only Surya Citra Media, Media Nusantara, and Television Broadcasts having a higher gross margin meaning the company is spending less than peers on content, which could be efficiency or under spending. The company has the highest spending on GAEX relative to its peers. The company could be shifting costs from gross margin to operating expenses or it could be inefficient relative to peers. The company has the second lowest operating margin of all peers, ahead of only ABS CBN.

 

The company is middle of the pack in capital efficiency with four peers being more efficient at turning over invested capital and four peers being worse at turnover invested capital.

 

Overall, GMA has the second lowest ROIC of all peers ahead of only ABS CBN. Despite performing poorly relative to peers, GMA still generates an ROIC well above the benchmark rate of 15%. It is interesting that the two Filipino companies performed so poorly on profitability as the country has one of the most favorable market structures with essentially a duopoly. GMA has a strong gross margin pointing to an ability to extract more value from its content than peers. The key driver to GMA’s profitability weakness is administrative expenses as the company pointing to weaker operational efficiency than global peers. It is also not a capital efficiency issue as the company is also middle of the pack in invested capital turnover.

 

 

Strategy

 

Evidence points to the existence of barriers to entry within the industry with GMA being a competitively advantaged firm within the industry. The company’s management team has been in place since they took ownership in 1975. During that time, they have built and maintained their competitive position, which deserves praise.

 

The current barriers to entry are economies of scale and customer captivity. Strategy should be to strengthen those barriers to entry. The company currently spends a roughly 45% of sales on production costs. The largest competitor outside of ABS CBN, TV5, has an audience share of 7% roughly 1/5th of GMA’s 34% audience share. Assuming market share and audience share are equal, TV5 needs to increase its audience share by 217% before it was able to produce the same amount and quality and reach break-even at the gross margin level. The company is spending the necessary amount on fixed costs to ensure its smaller competition has a difficult time gaining share.

 

Despite the company’s size advantage over smaller peers, GMA is competitively disadvantaged to ABS CBN. ABS CBN dominating the top 10 programs with GMA having the odd showing when it broadcasts a Manny Pacquiao fight illustrates GMA’s lack of quality programming and inability to match ABS CBN in production costs due to its smaller size. The poor quality programming impacts customer captivity, as customers are less likely to create habit with poorer quality programming.

 

 

Capital Allocation

 

We start our discussion on capital allocation by looking at the company’s financial health. If management takes on too much debt, it is taking a significant risk for minimal reward. At the end of September 2016, GMA had a net cash position of PHP1,596 million.

 

At the end of 2015, GMA Network’s short-term loans amounted to PHP1,152.97 million. 100% of debt was in USD at an interest rate of 1.73%. At the end of 2014, GMA Network had PHP1,922.96 million in USD debt at an interest rate of 1.68% and PHP300 million in PHP debts at an interest rate of 1.90%. Foreign currency debt adds risk without any additional reward, particularly when there is a marginal difference in interest rates in USD debt and PHP debt. The unnecessary risk is nothing more than currency speculation. GMA Network has sufficient cash to buffer an increase in USD relative to PHP so other than poor judgment by management the company’s FX debt is not a major concern.

 

Next, we look at the company’s balance sheet to estimate the amount of operating assets and non-operating assets. We would like to see all assets as operating assets as the non-operating assets are not part of the company’s core business and should be returned to shareholders. Since 2011, 83% of assets have been operating assets, the best of the peer group.

 

The company has not made any expensive acquisitions in the recent past. It also was willing to sell itself in 2001 to PLDT at PHP12.5 billion or 10 times EBITDA. The 2001 valuation is roughly 75% of the company’s current enterprise value.

 

The company’s approved dividend policy entitles holders of common shares to receive annual cash dividends equivalent to a minimum of 50% of the prior year’s net income based on the recommendation of the Board of Directors.

 

Other than the excess non-operating assets on the company’s balance sheet, it is doing a good job of allocating capital to fixed costs that are crucial to the company’s size advantage. The company is also doing a good job of not straying from its core competency in a quest for growth.

 

 

Corporate Governance/Value extraction

 

With most emerging market small cap companies run by owner operators, the board and management is dominated by the owner operator making benevolence crucial.

 

To assess corporate governance we start by looking at the company’s related party transactions.

 

The majority of related party transactions are legal, consulting, and retainers’ fees paid to Belo, Gozon, Elma Law, the Chairman and CEO’s law firm. These transactions are less than 1% of operating profit and seem to be reasonable. All other related party transactions are much smaller advances to associates and joint ventures. Overall, related party transactions do not point to any corporate governance issues or excess value extraction by management.

 

After related party transactions, the compensation to key management personnel is assessed to determine if wages are excessive.

 

Compensation to key management personnel averaged 20% of operating profit and 3.2% of sales, which is very high. Typically, we would want to see salaries at less than 5% of operating profit. This is a big negative as key management is already significant shareholders meaning the excessive salaries are just extracting value from minority shareholders. Management are no way creating the value extracted from salaries as the barriers to entry in the industry are so strong that pretty much anyone can run the company and generate the level of profitability the company is generating. The massive value extraction in the form of salaries is a big negative and significantly decreases the quality of the company.

 

VALUATION

 

We start by valuing GMA at its liquidation value. Liquidation value is the most appropriate valuation method for a company that is no longer viable therefore should be liquidated. Given GMA’s competitively advantaged position in a viable industry, liquidation value is not too relevant. We estimated GMA’s liquidation value to be PHP1.32 per share representing 79% downside.

 

Using a more conservative net current asset value per share, GMA’s liquidation value is PHP0.99 per share leading to a liquidation value of roughly PHP0.99 to PHP1.32 per share.

 

Next, GMA is valued at its reproduction value. Reproduction is the appropriate valuation method in an industry lacking any barriers to entry, which eliminates excess profitability leading any investment not creating any additional value. The value of any asset under this condition is the cost to recreate the assets.

 

To calculate GMA’s reproduction value, we assess what assets would need to be reproduced to reach GMA’s competitive position. We start by looking at the company’s balance sheet. The vast majority of balance sheet values are assumed a fair representation of the cost to reproduce the asset. Trade and other receivables come with bad debt that would need to be incurred to reproduce the company’s level of receivables. GMA’s bad debt provision is 7% of the company’s trade and other receivables account. We assume a new entrant would need to match the company’s level of bad debt. Additionally, a few expenses need to be recreated. Advertising and marketing are assumed to educate the population about the company’s programming therefore in the process of recreating the company’s position advertising and marketing is necessary to reach the company’s audience share. Many television programs run for more than one year forcing a new entrant to spend a multiple of GMA’s advertising and marketing expense as advertising and marketing may create value beyond one year, but to be conservative we assumed only one year of advertising would need to be recreated. Similarly, research and surveys create knowledge that is an asset to the business and not reflected on the balance sheet. This knowledge would probably take years to replicate but we assume that two years of research and survey expense would do a good job at replicating the asset. It also costs to hire personnel and talent. We assume that any new entrant would have to spend 20% of one year’s personnel expense on agent’s fees, recruiter’s fee, and building the infrastructure to hire.

 

We also assume the non-interest bearing liabilities of trade payable and other current liabilities as well as current portion of obligation for program and other rights are spontaneously created decreasing the amount of funds required to invest in the business. Overall, we estimate GMA’s reproduction value to be PHP3.79 per share or 39% downside.

 

Given the barriers to entry in the industry and GMA’s competitively advantage position, valuing the company based off its earnings is the most appropriate valuation methodology. We value GMA using a variety of earnings based valuations. The first earnings based valuation is simply FCF yield plus growth. The Philippines advertising industry is very cyclical with political advertising distorting revenue generated by firms in some years. To eliminate this cyclicality associated with political advertisements, we average GMA’s FCF over the past five years leading to a FCF yield of 7.5%. Given FCF takes into account working capital and fixed capital investment, any potential growth can be added to estimate a company’s FCF yield to estimate its total return. It seems growth of industry will mirror the GDP growth rate as ad spend as a percentage of GDP tends to be relatively stable. Television’s share of ad spend is increasing and the share within the industry is relatively stable. All evidence points to a growth rate equal to GDP or higher. The IMF forecasts that the Philippines will grow at a rate of 6.8% through 2021. If we use a growth rate of 5.0%, to add a bit of conservatism, GMA should return 12.5% per annum over the next five years.

 

The next earnings based valuation method assumes various competitive scenarios by changing key value driver assumptions used in a residual income/DCF with the output being a range of valuations. The key value driver assumptions we use for every residual income/DCF valuation is cost of capital, sales growth, operating margin, tax rate, working capital turnover, and fixed capital turnover. With our residual income/DCF valuation, we have a five-year forecast period followed by a fade to a terminal value in year 10.

 

The key value drivers that remain stable are discount rate, tax rate, working capital turnover and fixed capital turnover at the values listed above.

 

Sales growth and operating margin are the key variables that change under different scenarios. We use three states of sales growth 0%, 2.5%, and 5% into perpetuity. There are four scenarios for operating margin: 2007-2015 trough = 12.0%, current = 21.9%, 2007-2015 average = 24.0%, and 2007-2015 peak = 32.8%.

The average 2017 target price is PHP7.42 or 19% upside, while the average 2020 target price is PHP9.74 or 56% upside. The maximum downside over the next five years is 41% under the no growth and trough operating margin scenario. This scenario points to a deterioration of the competitive environment where barriers to entry are eliminated and television share of ad spend is succeeded to the internet. The maximum upside is 228% under the 5% growth and peak operating margin scenario. This scenario points television maintaining its share of total ad spend and more benign competitive environment allowing for stronger profitability. The more likely of the two scenarios is the most optimistic scenario as this was the norm prior to 2011. Our base case scenario is 2.5% perpetuity growth with average operating margins leading to 55% upside over the next five years.

 

In summary, earning base valuation is the most appropriate valuation methodology for GMA as its industry has barriers to entry and the company is competitively advantaged. FCF yield and average of all the earnings scenarios lead to 10-12.5% annualized return.

 

 

RISKS

 

We classify the risks to an investment into four main categories: financial risk, business risk, macro risk, and valuation risk. Financial risk is the risk of permanent loss of capital due to an inability to pay its debts. Business risk is the risk a permanent loss of capital due to an impairment of a company’s earning power from competition, poor management, a disruptive technology, or government regulation. Macro risk is the risk of permanent loss of capital due to macroeconomic troubles of a country. Valuation risk is the risk of permanent loss of capital from paying too much for a company.

 

 

Financial risk

 

GMA is very conservatively financed with a net cash position of PHP1,596 million and has a competitively advantaged position making the probability bankruptcy very low. The company does finance itself with USD debt rather than PHP debt making the company susceptible to any significant moves in the USDPHP exchange rate. It is not a concern as the company has sustainable earnings stream and a net cash position.

 

 

Business Risk

 

Given GMA benefits from its competitively advantaged position, the biggest risk to the company’s business is if those barriers to entry were to weaken allowing competitively disadvantaged peers to catch up with GMA. GMA’s strongest barrier to entry is economies of scale due to the large fixed costs associated with production costs. If the company’s relative size advantage were to deteriorate, the competitive environment would be come much tougher. If fixed costs were to turn variable or not be crucial to creating value, it would also weaken GMA’s competitive position.

 

The Philippines has a regulation stating that only Filipinos can own mass media companies. If this law were to change, the number of broadcasters could increase leading to a potential pricing war via declining ad rates.

 

GMA’s content seems to lower quality than ABS CBN as illustrated by ABS CBN dominating the top 10 most viewed shows in Philippines for a number of years and ABS CBN’s high revenue per percentage of audience share. If the relative weakness in content production and sourcing continues, GMA may relinquish share.

 

Cable may increase its penetration providing more options for viewers and fragmenting audience share leading to a fragmentation of advertising revenue. At the end of 2015, cable TV penetration stood at 17% of all homes with televisions up from 15% in 2012 and 11% in 2010. Cable TV penetration is well below international standards with pay TV in Asia at 54% so there is potential for increased penetration if cable operators can improve their offering.

 

The internet is changing distribution in many industries including television. The biggest threat to television broadcasters is content producers going direct to consumers or over the top (OTT). If the OTT offering is more attractive, audiences will shift their viewing habits to providers of content via the internet. We are seeing content aggregators such as Netflix and Hulu make significant inroads in the developed world. Content aggregators acquire content from content producers and sell subscriptions. These are more of a threat to cable as they are essentially performing the same job of bundling niche content and selling it to the consumer for a subscription fee. Internet penetration in the Philippines is at 43.5%. While GMA and ABS CBN are at risk, these two produce their own local content. If the content aggregators are able to disrupt the distribution part of GMA’s and ABS CBN’s business, there will always be value in their local content. These aggregators have started producing content but not niche language content.

 

The internet is taking over traditional roles that the television used to perform. News, which is continuous content that creates customer captivity, is being consumed via the internet rather than the traditional television in many parts of the world. An increasing shift of audience towards the internet will severely affect GMA’s profitability.

 

The production of content leads to a high level of fixed costs creating operating leverage. Operating leverage is a double edge sword as growth leads to greater profitability while decline in profitability leads to a greater fall in profits. If TV broadcasting as matured and is in the decline phase of its lifecycle it may not take long before profitability is eliminated.

 

 

Macro Risk

 

Our goal with assessing macro risk is not to forecast the path of macroeconomic indicators but to eliminate risks from a poor macroeconomic position.

 

GMA Network business is primarily in the Philippines, a country that seems to be in very good financial health. In 2015, the country’s current account was 2.6% of GDP and its structural balance was 0.18% of GDP allowing the country to self-finance all the domestic initiatives as well as decrease the country’s debt load. The country does not have too much credit in the system with domestic credit provided by the financial sector at 59.1% at the end of 2015, which is well below the Emerging Markets average of 97.5% and the High Income countries average of 205%. Gross government debt as a percentage of GDP stood just under 35% with External Debt to GDP at 36%. The one concerning macroeconomic indicator is the level of growth in credit in the Philippines. Over the past five years, the amount of domestic credit provided by the financial sector has increased at a rate 12% per annum. When a country is growing its banking assets at this pace, there is a high probability of an increase in non-performing loans. The country’s banking system has a healthy capital balance with capital to assets at 10.6%.

 

 

Valuation Risk

 

The key valuation risk is the assumptions used in our scenario analysis are too optimistic. We looked at GMA’s operating history back to 2007. If we reviewed 2011 to 2015 rather than 2007 to 2015, there would be a difference in valuations. Using 2011 to 2015, the average operating margin would decrease from the current 24.0% to 18.3%. The peak operating margin would decline to the current operating margin of 21.0%. We used the operating history since 2007 as the company’s profitability in the trailing twelve months ending in September 2016 returned to levels not seen before 2011.

2016 ANNUAL PERFORMANCE REVIEW AND NOT QUITE A WEEKLY COMMENTARY 12/19/16-1/8/17

2016 ANNUAL PERFORMANCE REVIEW AND NOT QUITE A WEEKLY COMMENTARY 12/19/16-1/8/17

 

 

2016 ANNUAL PERFORMANCE REVIEW

 

While the annual performance review is somewhat arbitrary, it is good to review you investment process on a regular basis to find improvements.

 

In 2016, the average local currency return of our recommendations was -3.1% with the average US dollar return not far off at -3.0%. Relative performance was -5.3% as the Emerging Market Small Cap Index as measured by iShares MSCI Emerging Market Small Cap ETF (EEMS) was up 2.3% compared to our average US dollar return of -3.0%.

 

The major drag on the performance of recommendations was Miko International and Universal Health. Universal Health saw a significant decline after its founder and majority took a loan against the company’s shares leading to forced selling in the stock. Subsequently, the company’s operational performance deteriorated drastically leading us to question the validity of the company’s initial financial statements. Miko International saw a number of independent directors resign followed by its auditor resigning due to disagreements over accounts in the company’s financial statements. It hired an auditor of last resort known to work with many Chinese frauds. We also saw poor performance at another Chinese company Honworld as management’s poor capital allocation inhibits its ability to grow without raising external funds. The poor performance of the Chinese small and mid caps leads us to question the financial statements in many Chinese small and mid cap companies. Given the inability to have any conviction, we are taking a smaller position if we invest in Chinese companies. Our other Chinese investments in Peak Sports Products and Anta Sports Products were our second and third best performing stocks in 2017 making us not totally write off investing in Chinese companies. Interestingly, the poorly performing Chinese companies all recently went public and therefore we have implemented a rule of not purchasing any stock that went public in the last three years.

 

The poor performance of Universal Health and Miko International highlighted the limits to our knowledge leading us to be less aggressive with our position sizing. Our new position sizing philosophy is 1-2% for high quality watch list stocks like Credit Analysis and Research and Anta Sports, 2.0% for deep value, 2.0% for Chinese companies, and from 2.0% to 8.0% for high quality companies depending on the strength of the business and attractiveness of returns. The goal is to get 25-35 holdings. The smaller position sizes do not match with the depth of our research. Our research was deep dive taking up to a month. The depth of research clearly required the ability to take larger position sizes as you can research only 12 ideas in a year. Assuming, half that are fully researched reach our investment standard leads to a maximum of six recommendations per year. There is no way we could ever be fully invested with our new position size philosophy, therefore, we are decreasing the depth of the research so we can hopefully one day get close to fully invested. We will focus on the crucial elements of every investment but not as much in depth. Hopefully, this will also increase the value of the blog for readers as we are trying generating more ideas by researching more companies. As mentioned, we will also be looking at high quality stocks that may be slightly more expensive than our typical investment but meets all other requirements. These will be formally placed on the watch list and placed in the portfolio at a smaller position size. Credit Analysis and Research and Anta Sports fall into this category. The hope is these positions will eventual become more attractive on valuations. The side benefit is highlighting more high quality companies.

 

Since May 2014, we have made 10 recommendations generating an average outperformance of 30.9%, with three recommendations having negative absolute performance. The average time from recommendation to sale is 459 days with four of the 10 recommendations still being held.

 

Overall, 2016 was not the best year for stock selection with underperformance of 5.3%. More importantly, we feel the mistakes made have allowed us to strength our process. Despite the bad year, our recommendations are up 30.9% since May 2014.

 

The table above illustrates position sizes at the end of each half since the end of the first half of 2014.

 

In 2016, our portfolio fell be 12.8% on the back of poor performance and large positions in Universal Health, Miko International, and Honworld. Despite the poor performance in 2016, our portfolio is up 12.3% in absolute terms since inception and 24.4% relative to EEMS, while averaging 67.9% of the portfolio in cash. The large cash position is a function of our high threshold for investment and the time required in our in depth research process. Hopefully, our shorter reports will allow us to be more efficient at finding ideas allowing us to put the cash to work.

 

While 2016 was not the best year in terms of performance, the improvements made to our process due to the mistakes made should more than make up for it in the future.

 

 

CURRENT POSITIONS

 

 

 

COMPANY NEWS

 

Mrs. Kusum Jain, a non-Executive Director, resigned from PC Jeweller’s board, with effect December 30, 2016. This is the first director resignation at PC Jeweller for some time, but it is worth monitoring in case there are additional resignations from independent directors.

 

On December 21, 2016, Zensar Technologies announced it appointed Manoj Jaiswal as Chief Financial Officer. Manoj Jaiswal was Chief Financial Officer for CEAT, another RPG Enterprises company. Before joining CEAT, Manoj had spent 17 years in Wipro in different roles.

 

Zensar also changed its auditor to Deloitte from PricewaterhouseCooper. Under Section 139(2) of the Companies Act, 2013, all listed companies and certain categories of unlisted public companies and private companies are mandated to rotate their auditors after 10 or more consecutive years.

 

On January 7, 2017, CARE announced that it was shutting down its Maldives operations after its license expired and decided not to renew. The Maldives operations were insignificant.

 

 

INTERESTING LINKS

 

 

Horsehead Holdings (Aquamarine Fund)

 

Guy Spier, a noted value investor, and portfolio manager of Aquamarine Fund looks back at his investment in Horsehead Holdings. It is a very good template for looking back and learning from your investment mistakes. (link)

 

Looking For the Easy Game (Credit Suisse)

 

Credit Suisse’s Michael Mauboussin discusses passive and active investing. (link)

 

A Bird in Hand is Worth More Than (Forecasted) Eggs in the Future (Latticework)

 

This is a very good article by Amit Wadhwaney of Moerus Capital Management discussing his investment philosophy. (link)

 

The Future of Retail 2016 (Business Insider)

 

Business Insider’s BI Intelligence unit created an interesting slide deck on the future of retail. The slide on the article illustrates the share of digital in different categories. Useful for understanding what segments of retail are most impacted by the internet. (link)

 

Patagonia’s Philosopher King (New Yorker)

 

The New Yorker wrote an article on Yvon Chouinard, the co-founder of the outdoor-apparel company Patagonia. (link)

 

The Irrationality Within Us (Scientific American)

 

Scientific American discusses our irrationality. (link)

 

Charlie Munger on the Paradox in Hold vs. Buy Decisions in Long Term Investing (Fundoo Professor)

 

Professor Sanjay Bakshi discusses Charlie Munger’s thoughts on the decision to continue to hold a stock vs. the decision to buy a stock. (link) The comment section should be read as well as there are many insightful comments. As illustrated by the changing of our positions sizes, we do not subscribe to the buy and hold regardless of valuation. By saying that you would continue to hold an asset at a particular price but you would not buy the same amount if you did not hold it, you are ascribing more value to the asset you hold, which is a bit irrational and is known as the endowment effect. Endowment effect is valuing an item you own more than an identical item you do not own. We try to look at all companies the same way, whether we hold them or not. First, a high percentage of companies can be ruled out as a potential investment due to poor financial health, poor management, or poor business quality. We may compromise on business quality if the company is a deep value investment but there is a limit on this compromise. Once companies pass the first investment hurdle, we assess the attractiveness of the company based on its business quality, management, growth outlook, and risk. Future returns are estimated based on scenarios giving a range of potential returns. If the market values a company so highly that very aggressive assumptions are required to meet the market’s expectations, we would not buy a company or hold a position. If on the other hand, if the market was valuing that same company so cheaply that the most conservative assumptions pointed to significant upside and there was sufficient business quality, we would take our maximum position of 8%. In between the two extremes is a spectrum of potential returns leading to a spectrum of position sizes between 0% and 8%. The decision of the position size is based on the attractiveness of the returns of a business not whether we hold a stock or not.

 

Valuation and Investment Analysis (Bronte Capital)

 

Bronte Capital wrote an article discussing how they do not use valuations in their investment process. (link) Again, please read the comments as there are some useful comments.  Clearly, we do not agree with Bronte Capital’s view.  We agree that valuation is difficult and does not provide a point estimate that is why ranges and scenario analysis needs to be used in the valuation process or reverse engineering a DCF or Residual Income model to find out the market’s expectations of key value driver assumptions. These market assumptions can be tested for reasonableness. We believe it is very difficult for anyone to call themselves an investor if they do not have some estimate of what is the value of potential investment. Investing requires understanding the fundamentals of the business, and the valuations of the business. Value investing requires an additional margin of safety to ensure you are not buying a business with sufficiently attractive returns. Not having an estimate of the potential returns of an investment is pure speculation. Bronte Capital focus on operational momentum to ensure the business will continue to grow for a long time. The problem is growth stocks often do not meet the growth expectations of the market and this is precisely why you should have an understanding of what type of growth the market is expecting. Within the Emerging Markets small cap universe, the MSCI Emerging Markets Small Cap Growth Index has underperformed the MSCI Emerging Markets Small Cap Value Index by 141.34% over the past 16 years or 5.66% per annum. Similar to Bronte Capital, growth investors are more concerned with growth than valuation leading to missing a big piece of the puzzle in understanding a business.

 

Value vs. Growth in Emerging Markets

 

Given the past two articles, we thought it be interesting to review the performance of various Emerging Market indices to see how each style has performed.

 

The table above illustrates the performance of MSCI Emerging Market indices across size and style biases. Indices have various inception dates so the longest time period with performance for all indices is 10 years. Over that period, the best performing index is Emerging Markets Quality index followed by Small Cap Value and the Small Cap Index. Over the past 20 years within the large and mid cap universe, value outperformed growth by 1.00% per annum. Quality seems to be the best performing index outperforming the overall index by 1.95% per annum since 06/30/1994 compared to only 0.44% per annum outperformance of value over the past 20 years, and -0.57% underperformance by growth over 20 years. There is a one and a half year difference in the long term performance figures if quality and value and growth, but given the length of the track record there would need to be a drastic underperformance of quality (roughly 35%) over that one and half years for quality’s performance to fall back to the value index’s level of performance. With some confidence, we can say quality has been the best style among the Emerging Markets large and mid cap universe.

 

Small Cap outperformed the large and mid cap index by 1.24% per annum illustrating a persistence of the size premium in Emerging Markets. Within the Emerging Markets small cap universe, value outperformed growth by 5.66% per annum over the past 16 years. The 5.66% growth translates into 141.34% additional performance over the period. There is no small cap quality index to compare the quality style.

 

Value outperforms growth in Emerging Markets with significant outperformance vs. the benchmark and growth in the Emerging Market small cap universe. Brandes Institute of Brandes Investment Partners did a study on style bias in Emerging Markets, which can be found here.

 

Alexa: Amazon’s Operating System (Stratechery)

 

Ben Thompson always writes great articles on technology therefore is a must read. We tend not to invest in technology as short product life cycles leading to disruption leading to difficulty valuing these companies. Despite the difficulties in technology, Silicon Valley and start-ups are very good at understanding all aspects of business models and therefore reading some of the best writers in the industry helps increase understanding of business models in more investable industries. In this particular article, Mr. Thompson writes the business model of operating systems. (link)

 

Tren’s Advice for Twitter (25iq)

 

Like Stratechery, 25iq is a must read. Tren Griffin works in the technology industry but is a value investor. Mr. Griffin gives his advice to Twitter. His advice is relevant for all companies. Understand your competitive advantage and continue to strengthen it while being as operationally efficient as possible. There is not much more to strategy. Understand your competitive advantage.  If it is unique advantage,  strengthen it as much as possible. If it is a shared competitive advantage, try to cooperate with competitors as much as possible to distribute fairly the benefits of the value created by the shared competitive advantage. If there are no competitive advantages, operational efficiency is the most important thing. Due to institutional imperative, which prevents firms from acting as rational as they can, operational efficiency can allow one firm to persist with excess profits for a long time. The importance to barriers to entry on strategy and profitability illustrates why the identification of competitive advantages, also known as barriers to entry, are so crucial to Reperio’s investment process. (link)

 

Amazon’s 2004 Shareholder Letter

 

Amazon’s 2004 Shareholder Letter stresses the importance of free cash flow not earnings the main metric followed by most market participants as earnings does not take into working capital and fixed capital investments required to generate additional earnings, while free cash flow accounts for the necessary investments. (link)

WEEKLY COMMENTARY 12/13/16 – 12/19/16

WEEKLY COMMENTARY 12/13/16 – 12/19/16

 

 

POSITIONING

 

 

 

 

COMPANY NEWS

 

Grendene changed its auditor from PWC to E&Y due its requirement to change its auditor every five years.

 

We were thinking about PC Jeweller and the potential evolution of the jewelry retail industry in India. When think about industry evolution in Emerging Markets, we often look to developed markets for roadmaps. Each market has idiosyncrasies but strategic logic should hold from industry to industry across geographies. For example, the retail market structure in India should eventually look like retail market structure in the US as the industry develops. Retailing is fiercely competitive in all markets with no barriers to entry therefore all industries should have many competitors with very few if any generating significant sustained excess profits.

 

Our main reference point for the following information on the US Jewelry market is Edahn Golan Diamond Research & Data’s 2015 US Jewelry State of the Market report. You can download the report here. According to the Jewelers Board of Trade, there were 21,463 specialty jewelry retailers accounting for 43% of the US jewelry and watch retail market. The vast majority of these specialty stores are independent with Signet Jewelers being the largest retailer accounting for 4.3% of overall jewelry sales in the US and 9.8% of specialty jewelry sales. Signet Jewelers had roughly 3,000 stores at the end of 2015.  Despite market development and industry maturation, the US jewelry market remains fragmented with thousands of players illustrating a lack of barriers to entry and continued competitive pressures.

 

The lack of barriers to entry puts a cap on Signet’s and Tiffany’s ability generate excess profits with their average ROIC over the last five years below 15%.

 

Looking at the United States jewelry retail industry as a roadmap leads one to believe that fragmentation will persist within the Indian jewelry retail industry.

 

Another use of the roadmap is the potential multiple the market gives a company during maturity.  Signet’s EV/IC has ranged from 1.69 in 2012 to 2.89 at the end of 2015, while Tiffany’s EV/IC ranged from 2.54 at the end of 2016 to 3.55 at the end of 2015.

 

Signet’s EV/EBIT ranged from 6.86 in 2012 to 18.94 in 2015. Tiffany’s EV/EBIT ranged from 11.84 in 2016 to 37.19 in 2014, with operating Income in 2014 was depressed. Accounting for the depressed operating income, EV/EBIT ranged from 11.84 to 14.49.

 

We have included similar analysis on Honworld (condiments) and Universal Health (pharmacies/pharmaceutical distribution) that we did in the past at the end of the weekly commentary.

 

 

INTERESTING LINKS

 

Deep Dive into China’s Apparel Market (Fung Business Intelligence)

Fung Business Intelligence freely provide a lot of good information on China. In this multi-part report, Fung Business Intelligence provides detail on China’s Apparel Market. (Part 1) (Part 2)

 

Asahi to Buy SABMiller’s Eastern European Beers in $7.8 Billion Deal (Bloomberg)

Acquisition news is always interesting as a knowledgeable player in the market puts a value on an assets based on a detailed analysis. The problem is we do not know the assumptions the acquirer is using, which are crucial, but it gives an idea of an appropriate valuation multiple in an industry. The paragraph below is from the Bloomberg article.

 

The offer values the SABMiller assets at about 15 times Ebitda of 493.8 million euros for the year ended March 2016, according to Bloomberg calculations. That compared with the median of about 11.5 times trailing twelve-month Ebitda for 9 brewery acquisitions announced worldwide in the past five years, according to data compiled by Bloomberg.

 

We extended the sample size of acquisitions back to 1999 and the median acquisition multiple was 11.7 times not far off the 11.5 times paid over the last twelve months.

 

 

 

The table below shows the upside to the 11.7 times multiple for various brewers in Emerging Markets.

 

 

 

Median Buyout EV/EBITDA Ratios Rising (PitchBook via ValueWalk)

 

The PitchBook examines the median buyout multiple for private value investors.  (link)  What we find interesting is the disconnect between what business owners are willing to pay and the valuations public market investors are willing to pay for companies.

 

 

The Undoing Project: A Friendship That Changed Our Minds (The Rational Walk)

 

The Rational Walk discusses Michael Lewis’ new book about pioneers in Behavioural Finance and how it relates to investing. (link)

 

 

The Story of How McDonald’s First Got Its Start (Smithsonian)
The story of the history of the McDonald brothers before McDonald’s became a multi-chain restaurant. (link)

 

 

What is Your Edge? (Base Hit Investing)

 

An article discussing three types of edges in investing. (link)  We view our biggest edge over other market participants is a time horizon edge as we are looking for stocks for the next three to five years.  This also brings an analytical edge as we are analyzing business from the view point of a business owner rather than trying to figure out if the company will beat next quarter’s expectations.

 

 

Buffett’s Three Categories of Returns on Capital (Base Hit Investing)

 

An older post discussing how Buffett categorizes businesses (link)

 

 

HONWORLD DEVELOPED MARKET ROADMAP

 

As mobility increases in China, cultures converge leading to a more homogenous tastes and markets.  This will take generations to play out but when it does it leads to a national market similar to many developed market like the US. The cultural convergence leads to the ability to apply fixed costs to a larger market increasing consolidation and dominance of larger players as smaller players cannot reach the minimum efficient scale required to compete.

 

The significant fixed costs in the form of advertising and distribution allows a brand to be built by larger competitors as more customers can be reached and educated. A brand is particularly important in an industry with a low priced product as the brand decreases search costs for customers leading to potential habit forming behavior. For example in the US, customers have acquired a taste for Heinz Ketchup.  When a customer goes to the store given Heinz may cost as little $2.50 a bottle and the Heinz brand represent a known and liked product that customer is not going to spend anytime even thinking about another brand given very little benefit.

In addition, retailers only have so much shelf space and are unlikely to place 15 to 20 different cooking wines on the shelf as a good number of the 15 or 20 cooking wines will not sell leading to waste shelf space.  The biggest players have a tremendous advantage as retailers now they will sell.

 

The table below shows the market structure of the five largest condiment markets in the US.

 

The US condiment industry is a great example of industry consolidation in a more developed market and a good roadmap for the Chinese Cooking Wine industry. The lowest concentration ratio among the largest five US condiment markets is the Hot Sauce market with a 52.2% four firm concentration ratio, while the highest is Ketchup with a 78.6% three firm concentration ratio. The four firm concentration ratio in the Chinese Cooking Wine segment is only 26.8% so there is potential for significant consolidation. The low four firm concentration ratio reiterates the fragmented regional nature of the market.

 

 

UNIVERSAL HEALTH DEVELOPED MARKET ROADMAP

 

Market Structure

 

The pharmaceutical retail segment in China is fragmented. According to the China Food and Drug Administration, in November 2013, there were 433,873 chain and individual drug stores in China, 10,150 more stores than 2012. There are 3,376 enterprises with multiple locations in China. Enterprises with multiple locations are more likely to manage the business for profitability and close down unprofitable stores. All though the market is fragmented, market consolidation is underway with Universal Health and Sinopharm leading the way. Retail competition comes in the form of target customer bases, business models, and product portfolios.

 

At the time of its IPO, Universal Health was the largest pharmaceutical retailer in Northeast China with 794 self operated outlets.  There is not sufficient information to get a sense of the efficiency of each store as competitors with higher revenue per store maybe a function of bigger stores, but it seems Universal Health’s may not be as efficient as competitors. This poor efficiency may be due to acquiring less efficient stores and improving operations. The pharmacy market in Northeast China has low level of concentration with a 2012 five firm concentration ratio of 44.2%.  This only tells part of the story as there could be a large number of smaller independent stores.  Universal Health has increased its estimated market share in Northeast China retail from 5.7% in 2012 to an estimated 8.8% in 2014.

 

The largest distributors in Northeast China at the time of the IPO are listed below. Universal Health is the largest private pharmaceutical distributor in Northeast China.

 

 

The largest retail pharmacy chains in China are listed below.  In 2012, the largest pharmacy operator had a 2.1% market share.  The 2012 five firm concentration ratio was 9.4%, while the ten firm concentration ratio was 16.0% indicating a very fragmented market. At the end of 2012, Universal Health’s China retail market share was 40bps.

 

The Chinese pharmaceutical distribution market is less fragmented than the retail market but still exhibits low concentration with the leading player accounting for 16.8% of the overall market.  The five firm concentration ratio is 36.5% and the ten firm concentration ratio is 44.9%. Universal Health garnered 16 bps of the total Chinese pharmaceutical distribution market.

 

While each individual country has its own idiosyncrasies leading to different development paths, the market structure of more developed markets may give a roadmap for developing countries.

 

The US pharmacy market shows moderate levels of concentration with a five firm concentration ratio of 64.4%.  There is some fragmentation but there are a significant number of small players still operating in the market.

 

According to Canada’s Office of Consumer Affairs, the Canadian pharmacy market has a 2012 four firm concentration ratio of 68.6%. The largest company is Shoppers Drug Mart with a 31.8% market share followed by Katz Group with a 16.7% market share, Jean Coutu with a 12.2% market share, and McKesson with a 7.9% market share.

 

According to the Pharmaceutical Journal, in the UK, there are 14,361 pharmacies with 4,201 independent owners, owning up to five pharmacies, operating 5,590 pharmacies and 174 multiple owners, owning six or more pharmacies, operating 8,771 pharmacies.  Large owners and supermarkets account for 52% of the overall market.

 

The US’s, Canada’s, and UK’s pharmacy market structures point to a much more consolidated market than the Chinese market but not the oligopolistic market structure you would expect if there was a significant benefit from economies of scales.  There seems to be economies of scale in purchasing but only to a point. Another reason for the fragmentation and large number of small independent operators may be that independent operators do the job for something other than profit maximization.  Just like optometrists or dentists, the ability to be your own boss and make a decent living trumps the desire to sell to a larger chain or exit when faced with a competitive disadvantage.

 

Pharmaceutical distribution markets are far more concentrated in developed countries than China with a three firm concentration ratio ranging from 43% to 85%.  Developed pharmaceutical distributors, economies of scale manifest themselves in high capital efficiency as operating margins often struggle to reach 2%.   The high fixed costs associated with upfront investments and low marginal cost for selling an additional unit leads to very high competitive rivalry among distributors and the need to utilize fixed costs as much as possible leading to greater profitability.

 

 

WEEKLY COMMENTARY November 21, 2016 – November 27, 2016

WEEKLY COMMENTARY November 21, 2016 – November 27, 2016

 position-summary-table

 

 

COMPANY NEWS

 

PC Jeweller

 

PC Jeweller reported FQ2 2017 results on November 23, 2016. During the quarter, the company opened five stores including a franchised showroom bringing the total number of showrooms to 68. The company also introduced the Inayat wedding jewelry collection and the Azva festive and wedding season collection, which is selling in 15 independent retailers.

 

Year on year, the company’s revenues grew by 30.2%, gross profit declined by 0.9%, and operating profit declined by 5.3%. Gross margin declined from 16.3% in FQ2 2016 to 12.4% in FQ2 2017. To review the company’s business, the mix between exports and domestic sales and the mix between diamond and gold jewelry sold drive gross margin.

pc-jeweller-business-model

The expected sales mix between domestic sales and export sales is roughly 67 % to 33% with domestic sales having an estimated gross margin of 16-17% while export sales have a gross margin of 6-8%. Gold jewelry sales is expected to represent 70-75% of domestic sales with a gross margin of roughly 10%, while diamond jewelry sales is expected to represent 25-30% of domestic sales with a gross margin of roughly 25-30%.

pc-jeweller-sales-mix-and-gross-margin

The table above illustrates the actual figures on a quarterly basis dating back to the quarter ending December 2012. Since FQ3 2013, domestic sales averaged 72.3% of sales while gold sales averaged 70.5% of domestic sales. Domestic sales averaged a gross margin of 16.4%, export sales averaged a gross margin of 10.6%, and the overall gross margin averaged 14.4%. Using expected figures, gross margins should range from 12.7% to 14.0%. Operating expense averaged 3.8% of sales leading to an expected operating margin range of 8.9% to 10.2%.

 

Regarding demonetization, 32% of sales are cash sales so the company expects short-term impact from demonetization.

 

Overall, the company is operating in an industry without barriers to entry as illustrated by the thousands of competitors, but management has been able to consistent excess profits when peers other than Titan have struggled to generate any excess profits. Given the ability generate excess profits during industry distress and when peers cannot gives us confidence that valuing the company on earnings is appropriate.

 

Under our pessimist case scenario, which assumes a 12.5% discount rate, no growth into perpetuity and profitability fading to the discount rate in year 10, PC Jeweller has 4.3% annualized downside over the next five years. Under our base case scenario, PC Jeweller grows at 10% for a five-year forecast period (store openings) before fading to 0% in the terminal value in year 10. Current excess profits remain over the forecast period before halving in the terminal. Excess profits persist in our base case because of the strength of management and evidence that the company can generate excess profits when competitors cannot. Under the base case, PC Jeweller’s estimated annualized return is 9.1% over the next five years. Under the optimistic case, there is no change to profitability with growth increasing to 15.0% over the forecast period and 2.5% growth in the terminal value leading to an annualized return of 16.0% over the next five years.

 

The table below illustrates our assumptions under each scenario as well as historical averages for each key value driver.

pc-jeweller-scenario-assumptions

 

The company’s management is very strong and continues to generate excess returns in a fragmented industry where competitors struggle to generate excess profits. We will maintain our 4.0% position size.

 

 

PRE-RESEARCH REPORT

 

Executive Summary

 

ABS-CBN is a Filipino media conglomerate with three business segments: TV and Studios, Pay TV Networks, and New Business. The TV and Studios business generates 73.6% of revenue and 92.1% of EBITDA. Economies of scale exist in the form of content creation and distribution creating an advantage for the largest competitors. ABS-CBN is the largest. Unfortunately, the company is operationally inefficient generating an average of roughly 10% return on net operating assets over the past three years. The company’s Pay TV Network business only generates an average return on net operating asset of 2.3% over the past three years despite having a 45% cable market share in the Philippines. New businesses are a disparate group of organizations with no strategic connection pointing to extremely poor capital allocation. The average NOPAT margin of new businesses over the past three years is -253.4%.

 

Given the inability of the company to generate a reasonable return on a competitively advantaged business and the weak capital allocation, the company is unlikely to be considered for investment unless it trade well below book value (<0.5) or at a very cheap earnings multiple (<7 preferably <5). A change in ownership or evidence of the company improving its operational efficiency and/or capital allocation would potentially warrant a change to the view. The company currently trades at over 2 times invested capital and 16.5 times NOPAT well above its fair value based on the returns generated by the business. To reach an acceptable buy price, the company’s share price would need to fall to PHP15.00 per share.

 

 

Company Description

 

ABS-CBN Corporation is the Philippines’ leading media and entertainment organization. Primarily involved in television and radio, the company has expanded owning the leading cinema and music production/distribution companies in the country as well as operating the largest cable TV service provider.

 

ABS-CBN has business interests in merchandising, licensing, mobile and online multimedia services, publishing, video and audio postproduction, overseas telecommunication services, money remittance, cargo forwarding, TV shopping services, food and restaurant services, theme park development and management, and property management.

 

 

History

 

ABS-CBN Corporation traces its roots from Bolinao Electronics Corporation (BEC), an assembler of radio transmitting equipment, established in 1946. In 1952, BEC adopted the business name Alto Broadcasting System (ABS) and began setting up the country’s first television broadcast by 1953. On September 24, 1956, Chronicle Broadcasting Network (CBN), owned by Don Eugenio Lopez Sr. of the Lopez family, was organized primarily for radio broadcasting. In 1957, Don Eugenio Lopez Sr. acquired ABS and on February 1, 1967, the operations of ABS and CBN were integrated and BEC changed its corporate name to ABS-CBN Broadcasting Corporation. On August 16, 2010, the Philippine Securities and Exchange Commission approved the change of the corporate name to ABS-CBN Corporation reflecting the company’s diversified businesses in existing and new industries. ABS-CBN achieved many firsts since it started the television industry in the country in 1953. However, with the imposition of martial law in September 1972, ABS-CBN ceased operations as the government forcibly took control. ABS-CBN resumed commercial operations in 1986 after the People Power or EDSA revolution. Despite being shut for 14 years, ABS-CBN recaptured leadership in the Philippine television and radio industries by 1988. During the 1990s and the early part of the new millennium, the company expanded and ventured into complementary businesses in cable TV, international distribution, mobile services, and magazine publishing among others.

 

 

Shareholder Structure

 

The top 20 shareholders own 98.57% of the business.

abs-cbn-shareholder-structure

 

Lopez Inc. is the largest shareholder at 55.15%. Lopez Inc. is a Filipino business conglomerate owned by the López family of Iloilo. Oscar M. López is the Chairman Emeritus and his brother Manuel M. López is the current Chairman and Chief Executive Officer of the López Group. It was first established by Eugenio Lopez, Sr. in 1928. It has holdings in many industries including media, power, energy, real estate, infrastructure, and manufacturing.

 

PCD Nominee Corporation is a wholly owned subsidiary of Philippine Central Depository. Shares are held at PCD Nominee Corporation for other shareholders.

 

 

Current Business

In 2015, ABS-CBN’s generated PHP38,278 million with 73.6% of revenue from the TV and Studio business, 21.1% from Pay TV Networks and 5.2% from new businesses.

abs-cbn-revenue-by-segment

 

In 2015, ABS-CBN generated PHP8,083 million in EBITDA. The TV and Studio business generated 92.1% of EBITDA, Pay TV Networks generated 20.7%, and new businesses generated -12.8%.

abs-cbn-ebitda-by-segment

 

As illustrated above, ABS-CBN has three business segments: TV and Studio, Pay TV Networks, and new businesses.

 

TV and Studio

 

The TV and studio segment is comprised of broadcast, global operations, film and music production, cable channels and publishing. This consists of local and global content creation and distribution through television and radio broadcasting.

 

abs-cbn-tv-and-studio-revenue

 

In 2015, free to air TV accounted for 63.4% of revenue, global operations accounted for 19.2% of revenue, with films and music, narrowcast, and others accounting for the remaining 17.4% of revenue.

 

The Free to air TV business includes content creation and distribution mainly through free TV and radio with Channel 2 and DZMM as its flagship platforms. The content created is predominantly in Filipino and is aimed at the mass Filipino audience. The company’s leading position in the Philippine television broadcasting industry is largely due to the popularity of its entertainment programs, while the news and public affairs programs have developed a reputation for the quality of news coverage that includes national, local and international events.

php-ratings-and-audience-share

 

In 2015, ABS-CBN 41.5% audience share in all of Philippines. There is significant barrier to entry in the form of economies of scale with content creation being a large fixed cost required to acquire an audience. The industry is very concentrated pointing to the existence of a barrier to entry. The top two players ABS-CBN and GMA Network have roughly an 80% market share.

 

The global business pioneered the international content distribution through Direct to Home, cable, Internet Protocol Television, mobile and online through The Filipino Channel. It is available in all territories where there is a significant market of overseas Filipinos such as the Unites States, Middle East, Europe, Australia, Canada and Asia Pacific. Other activities include international film distribution, remittance, retail, sponsorships and events. Similar to free to air, there are economies of scale in the form of content creation with much of the content created for the free to air business can be used in global operations. Distribution is another fixed cost in the global segment intensifying economies of scale. Efficient scale also comes into play, as the global market for Filipino content is not that large therefore the market cannot support many players. GMA Network also produces content for the international market.

 

The films and music business is composed of movie production, film distribution, audio recording and distribution and video and audio postproduction. Films and music needs are generally produced through ABS-CBN Film Productions Inc. (AFPI), more popularly known as Star Cinema. Other movies are co-produced with other local or international producers or are simply distributed by AFPI. Music needs are also managed by AFPI to complement the recording needs of the company’s multi-talented artists and handle music publishing and composing requirements, respectively.

 

The Narrowcast and sports business caters to the needs of specific or targeted audiences or markets not normally addressed by the broadcast business. Included in this line of business are cable programming and channel offerings such as Filipino movie channel, music channel, animé, upscale male sports content and upscale female lifestyle content. It also covers print, sports, and other niched programming via its UHF (Ultra High Frequency) channel. Narrowcast includes the following subsidiaries: Creative Programs, Inc., ABS-CBN Publishing, Inc., and Studio 23, Inc. As part of the company’s goal to elevate boxing as a sport in the country, it entered into a joint venture agreement with ALA Sports Promotions, Inc., a world class boxing organization and promotional company.

 

In the whole TV and Studio segment, economies of scale as content creation or acquiring content is a significant upfront fixed cost. Being the market leader in free to air TV with a 41.5% audience share illustrate the strong competitive position of ABS-CBN.

tv-studio-key-drivers

 

Despite the existence of economies of scale and market share leadership, ABS-CBN’s is only able to generate an average return on net operating assets of 9.9% over the past three years point to operational inefficiency.

 

 

Pay TV Networks

 

ABS-CBN owns 59.4% of Sky Cable Corporation. Sky Cable provides cable television services in Metro Manila and in certain provincial areas in the Philippines. As of December 2015, Sky Cable held a 45% market share in the Philippines. Sky Cable’s main competitor in the pay TV business is Cignal. The company also competes with other small local operators in certain cities it operates in, but no other operator has the same scale and geographic reach as Sky Cable. Given the fixed cost associated with infrastructure needed for cable coverage, size is a key competitive factor. Size also helps with bargaining power.

 

The company also provides broadband internet services through Sky Broadband. PLDT dominates the broadband industry with 65% market share.

pay-tv-network-key-value-drivers 

 

Cable television requires infrastructure, which is an upfront fixed expense. Despite its size advantage, Sky Cable is unable to generate a reasonable return pointing to operational inefficiency.

 

 

New Business

 

ABS-CBN’s new businesses include wireless telecommunications business, digital terrestrial television, theme parks and home shopping.

 

ABS-CBN mobile’s network sharing agreement with Globe Telecom enables the company to deliver content in addition to traditional telecommunication services on mobile devices. Through the network-sharing agreement, Globe provides capacity and coverage on its existing cellular mobile telephony network to ABS-CBN Convergence, Inc. (ABS-C) on a nationwide basis. The parties may also share assets such as servers, towers, and switches.

 

In February 2015, ABS-CBN commercially launched the digital terrestrial television (DTT). The company continues to invest in DTT equipment to improve clarity of signal in certain areas of Mega Manila and Central Luzon with a belief that the transition from analogue to digital will result in an increase in its audience share.

 

ABS-CBN invested in a theme park more popularly known as KidZania Manila. KidZania provides children and their parents a safe, unique, and very realistic educational environment that allows kids between the ages of four to twelve to do what comes naturally to them: role-playing by mimicking traditionally adult activities. As in the real world, children perform “jobs” and are either paid for their work (as a fireman, doctor, police officer, journalist, shopkeeper, etc.) or pay to shop or to be entertained. The indoor theme park is a city built to scale for children, complete with buildings, paved streets, vehicles, a functioning economy, and recognizable destinations in the form of “establishments” sponsored and branded by leading multinational and local brands.

 

Launced in October 2013, A CJ O Shopping Corporation is a joint venture between ABS-CBN and CJ O Shopping Corporation of Korea to provide TV home shopping in the Philippines.

new-business-key-value-drivers

 

ABS-CBN’s new businesses generate significant losses and there seems to be no strategic logic when allocating capital. New businesses are from a variety of industries where the company does not have any particular competitive advantage, which leads to the losses. The poor capital allocation will affect the ability of the company to grow its intrinsic value. Capital allocation is unlikely to change with the current management and ownership.

 

 

Valuation

 

Given the inability of the company to generate a reasonable return in a competitively advantaged business and the weak capital allocation, the company is unlikely to be considered for investment unless it trade well below book value (<0.5) or at a very cheap earnings multiple (<7 preferably <5). A change in ownership or evidence of the company improving its operational efficiency and/or capital allocation would warrant a change to the view. The company currently trades at over 2 times invested capital and 16.5 times NOPAT well above its fair value based on the returns generated by the business.

 

 

INTERESTING LINKS

 

A Dozen Things Warren Buffett and Charlie Munger Learned From See’s Candies (25iq)

A discussion about the lesson from See’s Candies (link)

 

Mental Model: Price Incentives (Greenwood Investors)

An good article by Greenwood Investors discussing discounting and brands (link)

 

Two Powerful Mental Models: Network Effects and Critical Mass (A16Z)

The title speaks for itself, an excellent essay on network effects and critical mass. (link)

 

The Reason We Underperform – Markets Have Evolved Faster Than Humans (Acquirer’s Multiple)

An article discussing potential behavioral reasons for the underperformance of fund management. (link)

 

Anatomy of a Failed Investment (Tom Macpherson- Gurufocus)

A great reminder to never be too confident of one’s views as there is only so much that one can prove to be absolute truth. Understand the counter to your argument and always remember looking for evidence confirming either side. (link)

 

Frozen Accidents: Why the Future Is So Unpredictable (Farnam Street)

The must read blog Farnam Street discusses how complexity and randomness make prediction a difficult if not impossible task. (link) We agree with the difficulty associated with forecasting and attempt to make as few forecasts as possible. Instead, we wait until the key value drivers being priced into by the market are so pessimist that there is little downside.

 

WEEKLY COMMENTARY NOV 14 2016 – NOV 20 2016

WEEKLY COMMENTARY NOV 14 2016 – NOV 20 2016

 

Company News

 position-summary-table

PC Jeweller

PC Jeweller’s share price fell by 15.1% during the week bringing the total decline to 31.7% this month as the Indian government demonetized INR500 and INR1,000 notes in an attempt to fight “black money”. On the back of the regulation, the market is speculated that gems and jewelry companies would be one of the most impacted industries as gold and jewelry is thought to be a favorite “black money” asset. The Indian jewelry industry participants speculate a potential import ban on gold is also coming.

 

After the fall in share price, PC Jeweller is now offers a 9.1% NOPAT yield causing us to increase our position to 4.0%. While the company is in an industry with no barriers to entry evident by the thousands of competitors, PC Jeweller and Titan are far more operationally efficient than competitors creating excess profits through strong management. Our initial theory on PC Jeweller’s and Titan’s excess profits was associated with weaker competition from the unorganized sector, but the continued outperformance of PC Jeweller and Titan while listed peers continue to struggle points to operational advantage over organized peers.

indian-jewelry-value-driver-comps

 

The table shows the key value drivers within the industry as well as the financial health of peers. From 2012 to 2016, PC Jeweller has the third highest gross margin with the highest operating margin. Gross margin points directly to the customers’ willingness to pay while the difference between gross margin and operating margin point to the efficiency of management in running operations. In addition to the highest operating margin, PC Jeweller also has the fastest growth in the industry. PC Jeweller has the second highest ROIC leading to the second highest value creation in the form of excess profits. PC Jeweller and Titan are the only competitors that generated any significant excess profits over the period examined. The ability to continually generate excess profits in a period of raw material constraints and weak demand points to the strength of the management teams at PC Jeweller and Titan and an ability for sustained excess profits.

 

To get to an annualized return of 15%, PC Jeweller would have to fight margin pressures through stable operating margin and capital efficiency, while growing at 10% during the forecast period fading to a 0% growth rate in perpetuity. These assumptions do not seem too aggressive given, management ability to continue to create value despite points to sustained excess profits. New store openings and franchising should provide the 10% growth with the fade to 0% growth in year ten potentially being conservative. Our big concern with the above assumptions is competitive pressures lead to ROIC contraction rather than growth. If we change our profitability assumption to marginal excess profits from superior management (ROIC = 15%, Economic Spread = 2.5%), the five year would be 10%. This profitability assumption seems much more conservative and gives us sufficient comfort that if profitability declines there is still ample upside. It seems the risk reward is balanced sufficiently to increase our position size in PC Jeweller to 4.0%. We will be increasing our position size at a price below INR375.

 

Zensar Technologies

On November 17, 2016, Zensar Technologies reported FQ2 2017 results. Revenue grew by 2.7% and operating profit declined by 9.3%. FQ2 2017 was the third straight quarter where operating profit declined as the lack of growth on the top combined with continued growth in employee benefit expense leading to margin compression. The margin compression comes with an increasing average deal size and an increasing number of customers above 1 million, Zensar are unable to grow its top line as rapidly as its employee benefit expense leading to margin contraction. The weak top line growth may be temporary as the company’s backlog is strong at USD700 million up from USD500 million in the last quarter. Zensar is now offering a NOPAT yield of 6.5% despite being a business with no competitive advantage. With very aggressive assumption of a 12.5% discount rate, stable margins and capital efficiency, 10% forecast period growth, and 5% growth into perpetuity, Zensar offers 85% upside over the next five years. Growth in perpetuity is usually only assumed for companies with sustainable competitive advantages, which seems not to be the case for Zensar. Assuming a perpetuity growth rate of 0% decreases the potential upside over the next five years to 47%. Changing the growth assumptions to a 5% growth rate over the next five years, and a 0% terminal growth rate, there is only 19% upside over the next five years. Given the lack of upside, and lack of competitive advantages, we will be selling our Zensar position at prices above INR900.

 

Other Links

 

Why Moats are Essential for Profitability (Restaurant Edition) (25iq)

A fantastic essay at 25iq discussing the importance of moats. It also discusses the amount of research needed to understand the economics of a business. (link)

 

A Narrative Narrative (Polemic’s Pains)

A good blog post discussing how the current narrative on many topics is nothing more than speculation and subject to rapid change (link)

 

Expected Return (Research Affiliates)

Research Affiliates maintains expected real returns of different asset classes including Emerging Market Equities. (link) Given our view that the discount rate is an opportunity cost it may be more appropriate to view expected returns as the discount rate rather than historical returns. The appropriate discount rate for Emerging Markets would be 7.3% expect real return. Adding an additional 2.5% for expected inflation gets to roughly 10% discount rate. Adding an additional 2.5% as a margin of error gets us to 12.5%, our current discount rate. The idea that the discount rate should be tied to expected returns needs to be flushed out, but it seems interesting.

 

Predicting the Long Term is Easier than Predicting the Short Term (Intrinsic Investing)

An interesting article discussing how it is easier to predict the long term than the short term due and why this is one of the reason investing for the long term investing outperforms short term investing. (link)

 

Value Stocks vs. Value Traps (Old School Value)

Old School Value wrote an interesting article by discussing the characteristics of Value Stock and Value Traps. (link)

 

Chris Mayers on 100-Baggers (MicroCapClub)

Chris Mayers wrote 100-Baggers, an update on Thomas Phelps 1972 book 100 to 1 in the Stock Market. In this video, he discusses the key characteristic of 100-Baggers. (link) Below are the summary points.

 

  • Start small
  • Hold for a long time
  • Prefer a low multiple
  • High returns on capital
  • Owner operators

 

Fake News (Stratechery)

A good article by Stratechery on the subject of “fake” news, Facebook’s role in the delivering the news, and the dangers of who decides what news is deemed fake. (link) The discussion of fake news is interesting with the potential to leading us down a scary path. We must not forget the masses still receive their news from a small number of news outlets creating gatekeepers who deem some information to be newsworthy and other information less newsworthy. The existing gatekeepers already create narratives and form opinions among the population.

 

How the Brain Decides Without You (Nautilus)

It may not matter what the facts are, as the brain seems to decide how the world appears based on your existing views. (link) The best way to ensure, you are not missing anything due to pre-existing biases is to seek out the other side of the argument and understand it as well as you understand your side of the argument.

 

How Headlines Change the Way We Think (New Yorker)

Tied to the previous two articles, is an older article from the New Yorker discussing how headlines change the way we think about a story (link)

Weekly Commentary 10/31/2016-11/6/2016

Weekly Commentary 10/31/2016-11/6/2016

We are starting a weekly commentary to provide more consistent updates.  It will contain the news from the companies we cover, random investment thoughts, and the top articles of the week.  Let us know what you think.

 

Company News

 

On November 2, 2016, Zensar Technologies announced the acquisition of Foolproof. Foolproof is one of Europe’s leading experience design agencies, headquartered in London with other offices in Norwich and Singapore. The company helps global brands design better digital products and services for customers based on a deep understanding of consumer behavior, their clients’ business and new technology. It has many Global500 firms amongst its clients. LTM revenue = GBP8.5 million with a mid-single digit GBP million EBITDA with expectations for continued growth rate of 10-15% post acquisition. Zensar’s digital revenue now is 30% of total revenue.

 

From a strategic standpoint, the Foolproof acquisition makes sense. Foolproof adds knowledge in a fast growing industry strengthening Zensar’s digital services business. It strengthens Zensar’s client list adding relationship with a number of Global 500 allowing Zensar to cross-sell other services. It is also a smaller bolt on acquisition making it easier to integrate into existing operations. Unfortunately, the lack of price disclosure eliminates the ability to evaluate the transaction fully.

 

We will maintain Zensar’s current 3.5% position in our model portfolio. The company is trading at roughly 6% NOPAT yield with expected growth between 5-15% over the next five years. It continues to generate strong profitability and its executing on its strategy to increase revenue from digital services. It continues to win larger and larger contracts allowing for greater profitability. Zensar’s top 60-65 clients have had a business relationship with company on average over 6 years pointing to a quality product and/or some switching costs. Most smart customers will have multiple vendors allowing the customer to eliminate bargaining power of the suppliers and eliminating their pricing power with it as multiple vendors allows for continuity in case of switching suppliers. The Indian IT services sector is based on low cost labor or price competition. There is no sustainably differentiation on knowledge as employees hold the knowledge of the organization and employees can take this knowledge to another company.

 

Why are we maintaining Zensar Technologies 3.5% position size while decreasing PC Jeweller’s position size to 2.0%? Zensar and PC Jeweller’s both offer a NOPAT yield of roughly 6.0% and both offer growth between 5-15% over the next five years. Zensar’s business seems slightly better to us. Both industry have significant competition, but Zensar’s industry generates much higher average returns on invested capital than PC Jeweller’s, due to the asset light nature of the business. The jewelry business is very working capital intensive. Additionally, Zensar has a long history of steady growth while PC Jeweller has grown rapidly; it is in a much more cyclical industry.

 

On November 3, 2016, Miko International announced the resignation of Mr. Zhu Wenxin, an Independent Director at the company with Mr. Chan Wai Wong replacing him. The resignation is the latest in a series of director resignations. Below is a list of previous resignations.

  • On June 30, 2016, Gu Jishi resigned as Executive Director being replaced by Ms. Ding Lizhen, a member of the founder’s family.
  • On March 14, 2016, Mr. Wong Heng Choon resigned as Independent Director less than a month after being appointed.
  • On February 19, 2016, Mr. Leung Wai Yip resigned as Independent Director.
  • On September 8, 2016, Mr. Ng Cheuk Him resigned as Chief Financial Officer.

 

All the resignations follow the resignation of KPMG on April 21, 2016 and appointment of HLB Hodgson Impey Cheng Limited, an auditor of last resort for many Chinese frauds. The signs of fraud are piling up.

 

On November 4, 2016, Miko announced it signed a Memorandum of Understanding to set up a Joint Venture in the factoring business, an industry far removed from the current operations, which does not make much sense. We are already in the process of selling our position in Miko International.

 

On November 4, 2016, Credit Analysis and Research (CARE) reported first half results. Revenues grew 9% and operating profit grew 20%. The company also grew its client base by 8.5% from June 2016. It also signed a Memorandum of Understanding to start a credit rating agency in Nepal. The company also designated the first “SMART CITY” credit rating. Overall, the earnings report does nothing to move the needle either way. CARE is trading on a NOPAT yield of 3.0% but it is the most profitable company in an oligopolistic industry with significant barriers to entry and a very long runway for growth requiring no capital to grow. We entered with a 2.0% position in hopes that we could increase our position size at a cheaper price. We will maintain the current position given the barriers to entry in the industry, the runway for growth, and the lack of capital required to grow.

 

 

Random Thoughts

 

A recent FT Alphaville article discussed Sanford Berstein’s shift away from valuing companies by discounting cash flows. Bernstein argued in a zero rate world the risk free rate and the over weighted average cost of capital (WACC) is so low the importance of distant cash flows in the intrinsic value is much higher. Given an inability of analysts to forecast cash flows in the distant future, this increasing importance of the terminal value places a significant weight on highly uncertain cash flows. The following exhibits from the FT article illustrate the importance of the terminal value in Berstein’s estimation. Bernstein uses a discounted cash flow model with a five-year forecast period followed by a fade to a terminal value in year 10. Bernstein’s first charts assume a 10% growth rate for the next five years followed by a fade to a terminal growth rate of 3.5% in year 10. The second chart assumes a 5% growth rate for the five-year forecast period followed by a fade to a similar terminal growth rate.

importance-of-terminal-value-ft

 

Under the scenarios mentioned, Bernstein estimates the terminal value accounts for 55% at a 10% WACC increasing to 99% for a 3.6% WACC. WACC or discount rate is one of the many factors determining the importance of terminal value in a discounted cash flow valuation. We believe Bernstein, like many other market participants, is overlooking many other crucial factors in determining the importance of terminal value. We will discuss our view on the discount rate as well as other factors overlooked by Bernstein. We will also discuss another valuation method to overcome the shortfall of increased importance of terminal values in the discounted cash flow valuation. Whenever we value companies at Reperio, we use a similar discounted cash flow model with a five-year forecast period fading to terminal assumptions in year 10.

 

In the article, Bernstein’s main concern was lower interest rates lead to a lower discount rate leading to a lower WACC. Given the value of a corporation is driven by cash flows well into the future, the main assumption in lowering a company’s WACC is interest rates will remain low for a very long period of time. The chart below is the yield on a US 1 year treasury rate since 1953 illustrating the current rate of interest is the lowest on record.

1-yr-treasury-rate

We are bottom up investors but to assume market participants will accept 64 basis points forever in compensation for lending the US government money for one year seems aggressive, particularly, when one-year interest rates were over 1600 basis points in the early 1980s.  .

 

The treasury rate is a key input into the Capital Asset Pricing Model (CAPM) used by Bernstein and many other investors in determining a company’s WACC or discount rate. CAPM like many models in economics and finance is built with assumptions completely detached from reality. The biggest flaw in the CAPM is price equals risk. When calculating the cost of equity to determine the cost of equity, beta is multiplied by the equity risk premium. Beta is the volatility in a stock relative to a stocks benchmark meaning if a company’s share price is more volatile than its benchmark, it is assumed to be a more risky investment and therefore have a higher cost of capital. Putting aside the potential errors in measure a stock beta, a volatile stock does not equate to risk for the investor. This logic would lead you to believe a private business with the exact same characteristics of a public company listed on a stock exchange is a much safer investment, as there is not daily price volatility associated with being listed. At Reperio Capital, we view permanent loss of capital as the true risk of any investment. Permanent loss of capital comes from three risks: business risk, financial risk, and valuation risk. Business risk is the permanent loss of capital due to a permanent impairment of cash flows from competition or mismanagement. Valuation risk comes from overpaying for a security. Financial risk is when a company is has significant financial leverage that may lead to bankruptcy.

 

Another significant problem with CAPM is measuring a stock’s beta. The measurement of beta lends to significant estimation errors. Using Zensar Technologies as an example, if you calculate the company’s beta on a weekly basis since its listed in July 2002, its beta is relative to the SENSEX is -1.19. If you change the time period used in calculating beta to the last 10 years, Zenar’s beta changes to 0.77 illustrating the potential issues calculating beta.

 

Instead of calculating the weighted average cost of capital, we have used a constant discount rate as we assume there is an opportunity cost associated with making any investment. We are increasing our discount rate to 12.5% discount rate (from 10%) for all companies, roughly the average annualized return generated by the MSCI Emerging Market Index since inception and slightly more than the S&P 500 average annualized return is 9.5% since inception. If we can generate 12.5% annual return elsewhere then cash flows from any potential investment should discounted at that particular rate regardless of what the cost of capital is for each individual company. A constant discount rate also eliminates some of the subjectivity in valuation.

 

Other than lower interest rates and faulty measures of risk, Bernstein’s assumptions seem very optimistic. The FT article only mentioned growth and discount rate assumptions meaning the other important value drivers of operating margin and capital efficiency must have remained constant assuming no competitive pressures over the life of the company. The vast majority of companies succumb to competitive pressures leading to a fall in profitability and/or capital efficiency eliminating any excess returns. If excess returns are eliminated, growth does not add value making it an irrelevant discounted cash flow assumption. A small number of companies can hold off competitive pressures making profitability and capital efficiency irrelevant assumptions. The FT has a great free equity screener. In its universe, there are 13,799 stocks with a market capitalization above USD100 million and a 5-year average return on investment. Of the 13,799 stocks, only 2,001 stocks or 14.5% of the universe averaged a 15% return on investment over the past five years, which a very, very crude approximation of a company with a competitive advantage illustrating the difficulty in fending off competitive pressures and maintaining excess returns. Given the vast majority of companies face competitive pressures the assumption of constant operating margin and capital efficiency and any growth in terminal cash flows is very optimistic. An example is PC Jeweller, the company is operating efficiently generating excess returns but jewelry retailing is a fiercely competitive industry with thousands of competitors with little ability to sustain differentiation. We assume a 10% growth over the first five-year forecast period with growth fading to 0% in year 10 and competition eliminating excess profits.

1-scenario-terminal-value-total-value

 

As illustrated, at a 5% discount rate, the cash flows in the terminal value account for 51.0% total value. At a 15% discount rate, cash flows in the terminal value account for 31.6%. At a 5.0% WACC, Bernstein estimated 91% of a firm’ value is in the terminal value, while our estimate is much lower at 51.0% as we are more conservative on our assumptions for the vast majority of companies. The failure to account for competition makes terminal value a much larger percentage of total value.

 

Changing our initial assumptions to view PC Jeweller as competitive advantaged with sustainable margins and capital efficiency but with no growth in the terminal value, at a 5% discount rate, the cash flows in the terminal value account for 73.6% total firm value. At a 15% discount rate cash flows in the terminal value account for 39.1% of the total firm value still well below Bernstein’s estimates.

3-scenario-terminal-value-total-value

 

Being competitively advantaged and adding terminal value growth of 3.5% similar to Bernstein’s calculations further increases the importance of the terminal value assumptions. Again, growth in the terminal value is aggressive, as the vast majority of companies do not generate excess returns. Assuming a competitive advantage and 3.5% terminal growth, at a 5% discount rate the importance of cash flows in the terminal value increases to 90.5% of total firm value, while at a 15% discount rate 46.1% of the of the total firm value is derived from the cash flows in the terminal value.

 

The assumption of permanent low interest rates, no competitive pressures, and perpetual growth are all flaws in Bernstein’s assumptions that increase the importance of terminal value in a discounted cash flow valuation and probably are over aggressive. Like Bernstein, many investors make the same mistakes in their discount cash flow assumptions, which leads to the question why? The biggest reason is institutional constraints and the focus on asset gathering rather than performance making the vast majority of investors short term oriented and trying to outperform every quarter and every year. This short-term orientation leads to focus on next quarter’s earnings and whether a company will beat earnings estimates rather than focusing on a company’s competitive environment, management, financial health and valuation. The charts below from Andrew Haldane’s Patience and Finance illustrate the short-term orientation of market participants with the average holding period of a stock on the many different stock exchanges decreasing.

nyse-lse-holding-period

other-exchange-holding-periods

 

In the US, the average holding period of equities dropped from 7 years in 1940 to 7 months in 2007. In the UK, the average holding period of equities dropped from 5 years in the mid-1960s to 7.5 months in 2007. Looking at stock exchanges around the world the average holding period of equities has dropped to under 1 year on all exchanges with the exception of the Toronto Stock Exchange and Euronext. It seems evident that equity investors have a shorter and shorter investment horizon leading to focusing on the next few quarters making the discounted cash flow a useless tool for many investors. For long-term investors, a discounted cash flow with conservative assumptions it is still very useful. Another use for a discounted cash flow is to reverse engineer the market’s expectations of key value drivers, which eliminates the need for forecasting and makes judgment of the assumptions of key value drivers, the main determinant of the margin of safety associated with an investment.

 

If the use of a discounted cash flow still concerns you, a residual income model provides the same valuation while eliminating the importance of cash flow forecasts in the distant future. At Reperio Capital Research, we also use a residual income model with a five-year forecast period followed by a fade to the terminal value in year 10, with the current invested capital as the book value and return on invested capital and the discount rate as other key inputs. Residual income = (ROIC – discount rate) * invested capital. The residual income stream is then discounted back and added to the beginning of the year’s invested capital. The theory is every company has an asset base to generated returns. The asset base comes with an opportunity cost as the money invested in the asset base can be allocated elsewhere. If the company cannot generate its discount rate, it is destroying value and the company will be valued at less than its asset base. If the company generates excess profit, it will be valued above its asset base. Revisiting PC Jeweller using a residual income valuation and the same three scenarios illustrated above, we can see the residual income valuation method relies less on the discounted cash flows from the terminal. Under a scenario of no competitive advantage, no excess returns are generated in the terminal value assumptions therefore; the terminal value adds no value. Under the scenario of a competitive advantage but no growth, at a 5% discount rate, the terminal value accounted for 57.1% of the total firm value while a 15% discount rate 14.6% of the total firm value is derived from the terminal value. Finally, under the scenario of competitive advantage and terminal value growth, at a 5% discount rate, the terminal value accounts 83.4% of the terminal value and 21.0% of the total value at a 15% discount rate.

residual-income-terminal-value

 

The residual income method does a much better job at decreasing the reliance on terminal value calculations, but provides the same valuation outcome.

 

Discounting cash flows to value companies is still a valuable for any investor with a long-term orientation. Unfortunately, a model is only as good as its inputs. In a world with increasing short term thinking, garbage in will lead to garbage out.

 

 

Other Interesting Links

 

Jim Chanos’ and Kyle Bass’ views on China (link)

 

Mittleman Brothers Q3 Letter on Valuewalk (link)

  • They talk about a potentially interesting idea within the Emerging Market Small Cap space: ABS CBN in the Philippines.
  • They also discuss other ideas First Pacific Holdings in Hong Kong and Rallye SA in France. Both are based on management track records.

 

Apple Should Buy Netflix (link)

A very interesting post at Stratechery discussing the media value chain.

 

Competitive Advantage of Owner Operators (link)

Base Hit Investing goes into detail into the advantages of owner operators.

 

Missionaries over Mercenaries (link)

Somewhat related to the previous link on owner operators.

 

Value Investing using Enterprise Multiples — Is the Premium Due to Risk and/or Mispricing? (link)

The Alpha Architect discusses the outperformance of Enterprise Multiples.

 

Update of Measuring the Moat (link)

An excellent essay on the analysis of barriers to entry