Friday, August 28, 2015

Be Careful What You Wish For

Back in the 1990's, Legg Mason's Bill Miller was synonymous with investing excellence. He ran the Legg Mason Value Trust mutual fund, and his after-fee returns beat the S&P 500 index for 15 consecutive years from 1991 through 2005. He was often mentioned in the same breath as Warren Buffett where money making prowess is concerned. Miller's investing style was utilizing a concentrated portfolio which was in vogue at the time, and he made outsized bets on young technology companies like America Online. You can't argue with his success.

Back when Bill Miller was front page news, I distinctly remember an interview with him, and he was asked what books he was reading to compliment his investing process. He replied he was very much influenced by horse handicapping and betting books. This was before the advent of High Frequency Trading and the proliferation of Quant Funds that are popular in today's investing world. I don't know what Mr. Miller's investing style or track record is in the environment of proprietary trading algorithms, but he may have changed with the times.

Last week I read a book, Smart Sports Betting by Matt Rudinitsky that stated the sports betting market is very much like the stock market. Below are quotes by the author on the parallels of the two, plus my own commentary:

  • It incorporates everything that is public knowledge. (Just like the Web bots that scour the Internet for press releases that report investing information such as earnings statistics. By the time the retail investor gets wind of the information, deep-pocket investors have already taken advantage of the price/action.)
  • It incorporates the thoughts of all professional bettors, because their money has flown into the market and given oddsmakers information on who they like. (Sounds a lot like the options market. Industry insiders know where the hot money is flowing.)
  • It incorporates the thoughts of many ridiculously complicated algorithms that professional bettors have backed up with lots of money. (This parallels with quant hedge funds.)

Statements like this are why I have almost given up investing in individual securities, and have migrated to passive investing in index funds like iShares Core S&P 500 (IVV). All is known...except when you get a flash crash like we did on Monday when the DOW dropped close to 1,100 points at the open. Although we've regained a lot of those losses after a two day rally, the sensory overloading drop spooked both retail and institutional investors.

We haven't experienced a flash crash, or whatever you want to call it, in five years. With the high frequency trading networks and quant funds commandeering the exchanges, selling begets more selling. A vicious cycle as trading triggers kicked in as each technical level was breached. If you didn't have limit orders in place before the market opened on Monday, you were out of luck for a brief period of time. Many brokerage houses shut down for the first fifteen minutes of trading from the overwhelming volume and price depreciation in both equities and ETF's. You would not have ben able to log into your brokerage accounts in some instances.

One piece of carnage on Monday was the drop in the iShares Core S&P 500 ETF, which was down almost 25% in the first few minutes of trading. This did not correlate with the overall decrease in the S&P 500. The decrease in the iShares Core S&P 500 ETF was much more severe. Although the price/action balanced out after about ten minutes, if you sold your shares at market price, you got fleeced. Although high frequency trading makes the markets much more liquid, it is times like these that it is important to always use limit orders.

Nobody really knows what caused the violent sell-off, but speculation is that it was the implosion of the Chinese markets, and the continuing decrease in the price of oil. An infusion of cash by the People's Republic of China in their native exchanges, and a short squeeze in oil have helped boost the overall indexes the past two days. In fact, at this juncture, we're up for the week, but down 6% for the month.

My personal belief is that the correction is healthy for the markets. I had limit orders in and bought a stock and an index ETF early Monday morning - Twitter (TWTR) at $23 and the iShares Core S&P 500 ETF for $188.50. Financial guru Art Cashin who is often on CNBC, stated that historically, these sharp V shaped corrections rarely last. He didn't suggest we'd test the bottom, but that there would be some backing and filling in the next two weeks. That, coupled with the fact September and October tend to be bearish months for the markets, propelled me to raise some cash to take advantage of securities at lower entry points. And yes, I will be using limit orders.

Saturday, August 22, 2015

Alibaba Bulls Get Caught Flat-Footed

Last September, Alibaba Holdings (BABA) went public at $68/share, raising approximately $10 billion for the company before expenses. It was the biggest IPO in history. Investors thought it was an ATM stock, generating gain after gain by producing earnings that "beat the street" on a consistent basis based on past performance. For a few months, that was the case, at least on price appreciation when Alibaba reached $120 in November. However, since that time, it's been a slide straight down as it trades very close to the IPO offering. The road to nowhere.

Source: Stock Charts

This is a security that was on practically every conviction buy list from the Wall Street marketing machine. In fact, it still is, and even more so as the price loses steam each passing month. According to Yahoo!Finance, 16 brokers consider the equity a strong buy, 25 a buy, and only 4 a hold. It had almost the same recommendations three months ago when it was considerably higher.

Not everyone feels as positive about Alibaba as the sell-side analysts. Master of the Universe George Soros sold 98% of his holdings in Q2, leaving him with a meager 59,000 shares. Maybe this is a lesson for the retail investor to learn, that the majority of the time, IPO's should be left to the deep-pocket traders and hedge funds. The mom and pop investor usually gets fleeced by the time shares are available to the general public. Now we're back to square one, almost a year has passed, and the company is in transition. Let's see if you think this is a good place to park some money.

Some Background

Founded in 1999, Alibaba is the largest online and mobile commerce company in the world based on Gross Merchandise Volume [GMV]. GMV is generated from three marketplaces:

  • Taobao: China's largest online shopping destination. It works a lot like Ebay. Alibaba provides the platform for merchants to set up digital storefronts, plus assists in logistics and payment processing.
  • Tmall: China's largest third-party platform for brands and retailers. Some examples are American retailers like Costco and Macy's who are now setting up shop here for exposure in the People's Republic of China.
  • Juhuasuan: China's most popular group buying marketplace.
Alibaba's companies have become synonymous with online and mobile shopping in China. As a result, the twelve months ended March 31st, 2015, these three marketplaces generated a combined GMV of $394 billion. There were 350 million active buyers and over 10 million active sellers at this time. In Internet time, a 16 year old organization is considered a fossil, but that can be good if execution is consistent. Let's look at some numbers provided by the most recent S&P Report:

2012 2013 2014 2015
Revenues in millions $3,131 $5,488 $8,579 $12,300
Earnings per ADS $0.26 $0.57 $1.63 $1.57

As you can decipher, earnings per ADS have been lumpy on a year-to-year basis. However, with almost $400 billion GMV and growing, you can see why investors became excited at the chance to invest in such a solid company, especially when there is still a large untapped market in China. Although Q1 2016 wasn't bad, it wasn't up to Wall Street standards on the revenue front, which put additional pressure on the stock. Management took the foot off the gas in Q1 because of two transitions for Alibaba. One is the transition from desktop computing to mobile. The second is the overall transition of Alibaba from a platform to an Internet conglomerate much like Amazon (AMZN) or Google (GOOG).

Transitioning to Mobile

The overall consumer transition from desktop to mobile is a fairly old phenomenon now. It was only two years ago that Facebook (FB) shares were decimated because they didn't have a concrete mobile strategy, or at least this is what Wall Street thought. Alibaba's mobile strategy appears to be panning out, and this was a problem for the analysts because it decreased desktop growth. Alibaba management takes a different tack. They believe that both mobile and desktop are synergistic because the two platforms compliment each other. The company considers it a unified platform. Mobile users tend to visit Alibaba properties more frequently, but desktop users buy higher ticker items on a more "sticky" application.

In examining the last quarter more closely, mobile GMV reached $60 billion, an increase of 125% year-over-year. This accounted for 55% of total GMV transacted on Alibaba's marketplaces. The company expects mobile GMV as a percentage of total GMV to keep growing as they improve the user experience on their mobile apps. However, as a cautionary note, the company stated improvement in mobile monetization may not always be linear. Management also said that the strength in mobile commerce demonstrates Alibaba's ability to attract mobile users with strong commercial intent on a scale that is unrivaled by any peers in China, as well as globally.

Transitioning to a Technology Juggernaut

Rodney Dangerfield once said, "I found there was only one way to look thin: hang out with fat people.". This is exactly what Alibaba is doing, hanging with the fat technology giants like Amazon and Google. All three companies have expanded their core competencies to include other areas of interest that compliment their bread and butter technologies. For Amazon, it was morphing from an online upstart in e-commerce to cornering the market in cloud computing with Amazon Web Services. Google went from king of search to inventing the Android operating system, and developing robotics just to name a few areas of expertise. Now Alibaba has joined the fray with a big push into logistics and cloud computing.

In 2013, Alibaba formed a joint venture with Cainiao Logistics, taking a 48% equity interest in the operation. According to Alibaba, they have created the largest logistics ecosystem in China. Consumers now enjoy next-day delivery services in 41 major cities, including Beijing, Shanghai, Guangzhou, Shenzhen and Hangzhou, and this will be extended to 50 cities by the end of this year. Same-day delivery of groceries has also been launched in Beijing and Shanghai, taking a page right out of the Amazon playbook.

To buttress and expand Cainiao's logistics network, Alibaba recently formed a partnership with Suning, one of China's largest electronics and home appliance retailers. Now customers in over 150 cities will be able to enjoy two-hour delivery services. Alibaba has been handling approximately 30 million packages a day, 10 times the amount of their competitors, and those numbers just got larger with Suning in the fold. In addition, Suning has brick and mortal retail outlets to enable ease and efficiency in returning big ticket items.

Aliyun, Alibaba's cloud service, is the largest cloud computing business in China. Although the company has grand plans to take it global, I would think they would have difficulty going toe-to-toe with American counterparts such as Amazon Web Services and Microsoft's Azure. Nevertheless, after years of investment, Alibaba is beginning to see positive impact in reliable, cloud service offerings. In Q2, revenue growth from cloud services was 106% year-on-year, accelerating past the 82% growth in the prior quarter. Aliyun is one of the company's core growth strategies in the coming years.

Although Alibaba has its tentacles in many other businesses, according to the Q4 2015 conference call and the Q1 2016 conference call, logistics and cloud services are the areas the company is counting on to boost customer satisfaction and sales growth. However, make no doubt about it, Alibaba has plans to compete internationally with cross-border initiatives and other offerings. Exhibit A is Alipay, a service very similar to PayPal that accounts for about 78% of e-commerce transactions on the Alibaba platform.


According to Yahoo! Finance, Price/Sales on a trailing twelve month basis is 14.5, which is high for a mature technology company. This is not an apples to apples comparison, but Amazon comes in at only 2.52, although doesn't produce earnings like Alibaba. In fact, Alibaba's earnings generation is a big selling point for investors. Wall Street is a forward looking mechanism, and we are already past Q1 of fiscal 2016 for the Chinese e-commerce behemoth. Earnings per ADS are projected to be $2.73 for the entire year. This would give us a P/E ratio of 25. Not overly exciting, but when you consider growth projections, the PEG Ratio looks much better. Next year, earnings growth is slated to come in at 27%, which would give us a PEG Ratio of just about one. That's in the wheelhouse of many traditional growth investors.


One thing potential investors should not overlook is that Alibaba is a Chinese holding company registered in the Cayman Islands. I'm not suggesting they are going to fudge the numbers, any company has the potential to do that, but they may not have as much transparency as a domestic equity. They are also under the thumb of the People's Republic of China. Last quarter sales came up a bit short because Chinese authorities suspended Alibaba's on-line lottery. The government could interfere again in other areas.

For instance, in the 2015 Q4 conference call, an analyst brought up the point that the Ministry of Commerce recently proposed that all online merchants have to have their businesses registered and issued operating licenses. Alibaba management answered the question stating it was just a proposal, and that the government is encouraging entrepreneurs to modernize. However, Alibaba's Taobao Marketplace is a huge profit generator for the company, and any decrease in profits could place addition pressure on shares, albeit for a short period of time.

Finally, there is the issue of the September 19th share lockup expiration. Sixty three percent, or 1.58 billion ordinary shares may be flooding the market in about a month, if indeed the owners want to sell. Softbank, Yahoo!, company founder Jack Ma and Alibaba Executive Vice Chairman Joseph Tsai all have major stakes that could dilute company valuation metrics if they wish to liquidate. Not highly plausible, especially by company insiders, but could put a crimp in earnings per share if acted upon.


With the Chinese stock markets imploding, the Chinese economy contracting, global stock indexes like the DOW and S&P 500 correcting, there may be a better entry point in Alibaba. That said, this stock may be a good long-term investment for people looking for Asian exposure in their portfolios. Although Alibaba wants to expand globally, I believe that is a tall order, particularly with American rivals such as Google and Amazon which may be perceived to have the better technology. However, charity begins at home. There are over a billion people in China, and Alibaba has only 350 million monthly active customers. There's plenty of room for growth in the PRC, not to mention in the adjacent geographies in the Asia/Pacific region. I'd wait until after the lockup expiration before placing an order.

Sunday, August 16, 2015

Tableau Software Takes a Standing Eight

The world has taken a few spins since "Big Data" visualization and analytics company Tableau Software (DATA) reported Q2, 2015 earnings results on July 29th. Although Tableau had an exceptional quarter, the stock failed to maintain orbit at $131/share, and has crashed to near par value at roughly $103 in the past two weeks. The primary reason for the decline is that traders bid the stock up to nosebleed valuations, and it couldn't maintain the upward trajectory based on Q2 sales and earnings.

Source: Stock Charts

I've talked ad nauseam about equities included in the Investor's Business Daily Top 50 List, and how they tend to crash and burn with even the slightest blemish in valuations in the quarter-to-quarter trading environment we're in. The recent price decline in Tableau just illustrates the point. The company graced the upper echelon of the IBD 50 until short-term traders opened the floodgates, and dumped whatever inventory they had on hand. Exhibit A is the right hand side of the above chart. The stock declined close to 20% in one day.

This is not a slight to the IBD 50. Far from it. We're currently in a market that pays up for growth, and holding periods are minimal on a historic basis. This trend will probably continue unless there is some sort of penalty for selling securities held less than a year, such as higher capital gains rates. It hasn't paid to be a value investor, or long-term investor in this market. Now with a shift of mind-set in Tableau as a short-term trade, I want to examine the last two conference calls closer to see if this could be a good buying point.

In March of 2014, I wrote my first post about Tableau. It was a hot IPO at the time, and I thought the equity was expensive, but was in a good position in regards to its technology. Since that posting, revenue valuations have been cut in half, and the company is now profitable, but it is still an expensive security. Trailing 12 month Price/Sales Ratio is currently 14. However, this hasn't stopped traders from piling on, driving the price higher. This may be attributed to impressive execution.

According to Investor's Business Daily:

"Tableau has beaten analyst estimates on earnings and revenue in each of the nine quarters for which it has filed reports since making its IPO in 2013. Revenue gains have been in the double-digit percentages."

In the investing environment we're in, a good growth stock can levitate for years. This is especially true when your computational efficiency is considered to be leading edge. Tableau's specialty of data visualization has been proclaimed pioneering by both company execs, and The Gartner Group. A ringing endorsement by The Gartner Group can go a long way in enterprise software sales. Company chief Christian Chabot noted in the 2015 Q1 Conference Call:

"Gartner is very influential, very well read. And particularly, in regions where we don't have a lot of brand recognition, it is one of our more important awareness vehicles and sources of lead flow."
If we examine some statistics from the past four years, you can see why Wall Street considers Tableau Software a top notch growth stock. Although earnings are minuscule and lumpy on a year-to-year basis, sales and a healthy R&D budget are accelerating. Some of the increase in sales may be from the inclusion in Gartner's Magic Quadrant three years running.

2014 2013 2012 2011
Revenues (in thousands) $412,616 $232,440 $127,733 $62,360
R&D (in thousands) $110,923 $60,769 $33,065 $18,387
Net Income (in thousands) $5,873 $7,076 $1,427 $3,379

If we extrapolate revenue statistics out to full year 2015, company guidance is for a range of $617 million to $627 million, up from the $600 million to $610 million from Q1. This represents an annual growth rate of approximately 52% at the high end of the range. It should be noted that Tableau, like the majority of enterprise software corporations, lands a considerable amount of large contracts at the end of the fourth quarter. Some of these sales will come from international markets, which now constitutes 25% of business. In fact, Tableau is opening a new Data Center in Paris to make further inroads in overseas opportunities.

Competition in the "Big Data" visualization niche remains fierce. Rivals such as Microsoft (MSFT), Oracle (ORCL) and IBM (IBM) have much larger coffers than Tableau, but Tableau believes they've built the better mousetrap with first mover advantage.

CEO Chabot proclaims:

"And while everyone else is saying they're kind of figuring it out and doing it, Tableau remains the gold standard, and that will remain our main source of competitive advantage."

To maintain that edge, for the past two years the company spent a great portion of its R&D efforts on Tableau's new iteration, Tableau 9.0. It was released in Q1 with version 9.1 currently distributed in beta. It's the company's biggest leap in its history from version to version on server scalability and resiliency. Its strengths versus the competition continue to be incredible ease of use, a pioneering approach to visual analytics, a self-service platform, and a product that is finely tuned with all the world's disparate data.

Tableau now has 32,000 customer accounts worldwide. The company's "Land and Expand" sales strategy is a grassroots endeavor that has paid off handsomely, in both revenues and word of mouth advertising. Once a client signs up for the service, the Tableau Software sales team helps customers upgrade and incorporate the Tableau solution into other departments within large businesses. In Q2, they signed 233 transactions greater than $100,000 as companies continue to deploy Tableau more broadly within their organizations. Q4 should be a barn burner, but that's almost six months away.

Former NFL coach Bill Parcells is known for saying, "You are what your record says you are.". At this moment, Tableau has been a great long-term investment, especially if you bought it at the IPO price of roughly $30/share. Conversely, it's been a not-so-good investment if you bought at the top, only to see traders go into damage-control after the Q2 conference call. I believe for the time being, the selling has been done.

However, the bull market that started in March 2009 is almost six and a half years old. In addition, we haven't had a 10% correction in the S&P 500 since last October (intra-day, the correction was 9.8%). Therefore, although Tableau appears to have the secret sauce, and the digeratti has put it in the top spot in its niche, based on macro conditions, I'm betting Tableau Software trades lower along with the overall market in the next three months. After all, Tableau is expensive on a price/sales metric. P/E ratios aren't really relevant with young growth least not in this market, but maybe they should be. Companies with limited earnings may be the first to be liquidated if investors get defensive.

My buy point is between $80-$90 a share. An almost 20% decline. This will be especially true if the FED raises interest rates in September.