Generals: Amazon.com High-Level Valuation Analysis

Amazon.com

Generals: High-Level Valuation Analysis

September 23, 2016


SUMMARY INFO

  • NASDAQ: AMZN
  • Recent PPS: $804.70
  • Shares Out: 490 million
  • Market Cap: $394,303
  • Net Liabilities: $5,579
  • Enterprise: $399,882

DISCUSSION

Amazon is an unbelievable business case study; and I would put the compilation of Bezos’ annual letters up there with Warren Buffett’s as 110% required reading for anyone and everyone interested in business and investing. Likewise – as in the early days of Buffett’s Berkshire Hathaway, where a masterful owner/operator was staring down decades of virtually unconstrained growth potential, A) it does not pay to bet against the stock, and B) one should have a working fair value/entry point on hand at all times for when the market begins to doubt the long-term outlook.

At the moment, however, the market is far from doubting the long-term outlook for AMZN; and I believe the expectations currently embedded in AMZN’s stock price are likely to disappoint recent shareholders for the foreseeable future. Again – I will never bet against the stock; but as a potential long-term owner I want to be cognizant of the expectations embedded in the stock price before taking a position.

This is a very short high-level look at AMZN’s valuation designed to provide context…which in my opinion is sorely lacking. In other words, too much in the way of ephemeral TAM estimates, indefensible EBITDA multiples (indefensible for lack of a better term…I mean most EBITDA multiples are just assumed, and not tied back to a DCF-backed valuation), and nonsensical definitions of free cash flow.

17M AMZN Analysis September 2016

POLL-BASED VALUATION

Yesterday I enlisted the help of “Finance Twitter” via four valuation input polls (I have my own assumptions, but wanted to gauge the distribution of expectations):

  1. AWS Fair Value: $200B, $150B, $100B
  2. Amazon Retail ‘Intrinsic’ EBIT Margin: 6%, 5%, 4%
  3. Amazon Retail 5-Year Sales CAGR: 25%, 20%, 15%
  4. Amazon Retail Terminal PE in 5 Years: 35x, 30x, 25x, 20x

On a weighted-average basis the results look as follows:

  1. AWS Fair Value: $144 billion
  2. Amazon Retail ‘Intrinsic’ EBIT Margin: 4.82%
  3. Amazon Retail 5-Year Sales CAGR: 18.3%
  4. Amazon Retail Terminal PE in 5 Years: 24.95x

Using the poll-based inputs + a 25% tax rate + an 8% discount rate + ignoring interest expense/excess cash/debt/etc, I arrive at a total fair value of $674 per share (details provided in PDF above).

While at last closing price AMZN is only 19% this poll-based fair value, I believe the AWS fair value is likely on the high side…and after discussing with some folks on Twitter yesterday, ‘intrinsic’ EBITM is likely south of 4%…

17M VALUATION

My personal fair value is approximately $558. I use a 20% Retail Sales 5-year CAGR, a 22.5x 5-year Retail terminal PE, 30% tax rate, 10% discount rate, an ‘intrinsic’ EBITM of 4%, but leave the AWS fair value the same at $144 billion.

If AWS is ‘only’ worth $100 billion today, my fair value falls to $468.

FREE CASH FLOW DISCUSSION

“Free cash flow” is, IMO, one of the most misused terms/phrases in the market. Not to be picky – but Buffett’s original definition of “FCF” (using a newspaper company as an example, I believe) was a simple series of adjustments to the income statement in order to arrive at normalized level of distributable earnings power. In other words, assuming an appropriate maintenance level of capex and normalized working capital that keeps earnings power flat in perpetuity, what can a company fully distribute to shareholders assuming no reinvestment in growth capex/working capital. That’s the pure definition of FCF, on which you base a fair value price/earnings ratio.

The next-best definition of FCF is currently distributable FCF. So for a mature company such as Pepsi that is growing at say 6% a year, assuming a 30% ROE Pepsi’s currently distributable FCF would be 80% of earnings (to generate 6% growth at a 30% ROE, Pepsi would only need to retain 20% of normalized earnings power). Currently distributable FCF is best used in a FCF yield calculation (if distributable FCF is paid out 100% as a dividend, the calculation is easy – the dividend yield).

* * * * * * * * * * * *

Jeff Bezos is (clearly) not dumb. He knows that the marketplace A) loves easily calculable metrics (because *its* lazy), and B) loves free cash flow…in all of its forms (because FCF *=* earnings power). As such, Mr. Bezos uses a highly manipulated definition of free cash flow in order to tick both boxes:

Free Cash Flow = Operating Cash Flow – Cash Capital Expenditures

Of course for good measure, he throws in FCF less principal repayments and FCF less principal repayments less assets acquired under capital leases.

Bezos’ baseline FCF definition is absurd on two fronts – and he knows it: 1) material stock comp expense is included in operating cash flow, and 2) capital lease-financed capex is reported ‘below’ the capex line. Stock comp expense is a capital markets transaction, and should be deducted from operating cash flow; and capital lease-financed capex is no different than cash capex financed via public market bond issuance.

But the market doesn’t really care because both stock comp and capital lease-financed capex are “NON CASH”. Yay.

More than anything this is simply a rant. I want Bezos to retain every single dime of ‘intrinsic’ earnings power, as the PV of AMZN’s growth opportunities is far higher than anything investors could produce themselves by reinvesting distributed cash flow back into the capital markets. Plus it’s more tax efficient. But for goodness sakes, enough with the absurd FCF definition(s).

As found in the PDF above, AMZN’s cleaned up FCF generation (‘currently distributable’ definition) looks as follows:

  • 2013: -$2.2 billion
  • 2014: -$5.5 billion
  • 2015: -$844 million
  • LTM 2Q16: -$1.1 billion

CONCLUSION(S)

In simple summary, in my opinion there is too much optimism currently priced into the stock. While the growth runway is enormous, it is very difficult to handicap the fundamental business value with a high degree of precision, and I believe those looking to enter the stock (speaking for myself) are best served to wait for when there is widespread doubt around various aspects of the business.

Hindsight is 20-20, and I didn’t take a position thus what I am about to say is next to moot…but in late 2011 I did a valuation similar analysis (at the time it was only Amazon Retail, for the most part) using a 4% ‘intrinsic’ EBITM, 25% growth rate and a 15x terminal PE and arrived at a fair value materially higher than where the stock was trading. Again, I did not take a position – but the point is that the time(s) to buy the stock is/are when it is trading materially below an easily defensible fair value estimate. 

AWS valuation and the cost of distribution to meet Prime-led demand growth are the two key areas I will be watching for doubt to begin creeping into the stock price.

US Telecom Data Pricing (and DISH…of course)

17 Mile

US Telecom Data Pricing (and DISH…of course)

September 5, 2016


DISCUSSION

(Short write-up, more akin to the note-taking found on the Scratch Notes page.)

The debate about the value of DISH’s vast spectrum holdings centers on the following dynamic: is the US telecom spectrum ‘crisis’ severe enough to push the Big 2 (Verizon and AT&T) to ‘play ball’ with DISH before DISH’s 2020 spectrum build-out deadline(s). But this dynamic misses – almost entirely – the argument Charlie Ergen has been making now for years: the true value in DISH’s spectrum holdings lies in the fact that the industry will look vastly different 5-10 years from now.

There is no spectrum crisis under the industry’s current construct. And DISH has explained ad nauseum the build-out deadline(s) are not an issue, as in a worst-case scenario they spend $3 billion to meet the minimum requirements. As such, time is likely better spent discussing future industry dynamics and how Charlie Ergen may or may not be out of his mind…

MONTHLY “TMT” BILL

For an American “DINK” (Dual Income, No Kids), a monthly “TMT” (Technology, Media, Telecom) bill could look as follows:

Verizon

  • 1 ‘Medium’ 4GB data plan: $50

Time Warner Cable

  • Internet: $70 ($65 promo normalized by $5)
  • Video: $65 ($60 promo normalized by $5)
  • Total: $135 (compare to full triple play at $130 promo…)

Streaming Services

  • Netflix: $10
  • Hulu: $10
  • HBO GO: $7.50 ($15/month used for 50% of the year)
  • Amazon Prime: $10
  • Total: $37.50

Total TMT bill: $222.50/month

(I make no attempt to depict the average US monthly TMT bill down to even the nearest ten dollars, let alone the nearest couple. Too many moving parts. But the above should at least be in the ballpark, particularly on a relative basis as shown below.)

Percentage Breakdown

  • Phone data: 22%
  • Internet: 31%
  • Video: 29%
  • Streaming: 17%

In light of the various rapidly changing industry dynamics, it’s interesting to observe the end-user experience of the current TMT landscape via the lens of the monthly bill. Two observations: 1) it is easy to see how streaming services can be considered complementary to the traditional cable bundle video product at only 17% of the monthly bill; 2) it is (yugely?) surprising that the Telecom industry gets a nearly free pass on its data pricing practices. Consider…

A 4GB Verizon plan costs $50 per month versus unlimited data from Time Warner Cable for $70, and comprises 22% of the monthly TMT bill. For a family of 4-7 people, that $70 TWC bill remains fixed and performance does not suffer; whereas the Verizon data bill would quickly escalate to the ‘Large’ plan of 8GB + 2GB/line for $70, or the ‘XL’ plan of 16GB + 2GB/line for $90.

As an outsider observer I could be wrong…but I believe this data pricing dynamic is precisely what Charlie Ergen is attacking with his spectrum strategy and referring to in comments regarding future industry structure. The traditional cable bundle more than likely will continue to bleed subscribers until Millennials reach a fuller employment rate and/or the cable companies become a bit more technologically savvy and creative on the pricing side (I believe Charter will lead this charge, FWIW); but I believe Telecom profitability is in far greater danger, as consumers begin to rethink locking themselves into a capped data plan for almost the same price as their monthly Internet bill for unlimited data + nearly-everywhere wifi.

RECENT DEVELOPMENTS

Two WSJ articles regarding recent industry data pricing moves and my notes on them:

T-Mobile, Sprint Bring Back Unlimited Data (WSJ 8.18.16)

  • T-Mobile will stop selling monthly data packages
  • Sprint dropped the price of its unlimited data plans
  • AT&T is offering unlimited data to TV subs
  • T-Mobile and Sprint lower the quality of data for all users on unlimited data plans
  • AT&T and Verizon lower speeds to 2G for those who exceed their data caps
  • New T-Mobile plan costs $70/month for 6GB, or $160 for a family of four for 24GB

T-Mobile, Sprint Unlimited Plans Are Full of Limits (WSJ 8.30.16)

“Take T-Mobile. The carrier said Monday its T-Mobile One plan is ‘a radically simple subscription to the mobile internet at one low price’ with ‘unlimited everything.’ The carrier’s website is decorated with an oversize infinity sign.”

“But the more than 450 words of fine print on T-Mobile’s site describe the caveats. Video is delivered at a lower quality, internet speeds might get throttled after using 26 gigabytes in a month, and if a device is turned into a Wi-Fi hot spot, a practice known as tethering, it could be slowed.”

“Sprint launched its “Unlimited Freedom” plan in mid-August with limits on video, music and gaming streaming. On Friday, the company added “Unlimited Freedom Premium,” which is $20 more a month and allows for higher quality streaming than the original offering.”

“For the smaller carriers, these new “unlimited” plans are also a subtle way of eventually raising prices. They start at $60 or $70 a month, and the companies say they might eventually eliminate cheaper options with limited data.”

CONCLUDING THOUGHTS

At present, the consumer is in a bit of a box from a telecom standpoint. The smartphone is now such an integral part of everyday life that everyone ‘needs’ one – thus everyone ‘needs’ a data plan. And as the second article above indicates, it is only a matter of time before the Telecom industry locks in this monopolistic position by raising the minimum monthly data charge. But capitalism should take care of this via the Cable industry’s wide open ‘wifi everywhere’ opportunity. No, the wifi coverage while on the move is not comparable to the mobile networks LTE coverage; but in buildings, there is almost no need to utilize phone data.

The Telecom industry can continue to ‘in-fill’ its coverage with small cells, convert legacy spectrum to LTE, and wait for game-changing 5G technology; but the former two options only keep up with current data usage, and 5G is several years away at minimum. As such…

…All roads continue to point to the need for significantly more mobile network capacity in order to offer the type of data plans that can compete with the Cable industry’s monopoly on high quality, unlimited data.

Special Situations: Valeant Pharmaceuticals Public “Private Equity” Restructuring

Valeant Pharmaceuticals

Special Situations: Public “Private Equity” Restructuring

August 13, 2016


SUMMARY INFO

  • Recent PPS: $24.92
  • Shares Out: 355 million
  • Market Cap: $8,847
  • Net Debt: $30,085
  • Enterprise: $38,932

DISCUSSION

***Disclosure: This is a distressed, leveraged special situation trade with only the potential to turn into a medium- to long-term investment.***

I have been involved/followed the VRX saga for the last 2+ years, and have outlined my thoughts and analysis in detail via the following write-ups:

Since ‘puking’ up the stock in the first week of November (second November write-up) I have been firmly on the sidelines, resisting the urge to even trade the stock; but as of this week I am back in – for a trade (potentially an investment) – as I believe the latest earnings report turned VRX into a trade-able (potentially investable) special situation. In summary, my working thesis is that VRX is currently akin to a private equity restructuring (i.e. the ill-fated  2007/2008 Hilton PE deal consummated just prior to the GFC and restructured back to profitability by late 2013) that happens to be taking place in the public markets. [Pershing Square has long described its activism approach as a ‘public private equity’ methodology, and happens to be involved in this situation – but that is merely ironic, as a public restructuring was far from Pershing’s original thesis for VRX.]

Before walking thru the situational review, a quick note on price action…

Price Action

The use of price action to inform fundamental analysis can be a slippery slope, as the market can quite literally do whatever it pleases in the short-term, and at extremes (think, March 2000 and March 2009 for the broad market) is by definition wrong. But within an investment ‘mosaic’ comprised of valuation, direction of fundamentals, sector/broad market backdrop, and an analysis of key holders, high-volume price action around key news items or a lack of news can be informative. My use of price action – outlined in the second November 2015 write-up attached above – allowed me to cut my losses in VRX in the first week of November 2015 when the stock declined on high volume on no news. In the November 2015 “Quick Thoughts” post cited above I said:

“Perhaps I am wrong – but after further discussion with fellow investors re biz model, the high volume annihilation to materially below $88.50 on virtually no news is greatly concerning to me.

“Perhaps the ‘short’ thesis will ultimately be proven correct; but at present, the two key drivers of VRX’s stock price liquidation are 1) an extremely concentrated ‘stuckholder’ base, and 2) uncertainty around future organic growth. It appears VRX’s business model was/is legitimate, but extremely aggressive; and when taken in the context of the extreme stock price liquidation, I believe the market is ‘telling’ us something. Maybe all is well and I just missed the home run buying opportunity I’ve been looking for down here – but I suspect the market is ‘telling’ us that the revenue base needs to be materially adjusted, and the valuation work needs to move to a more extreme downside scenario…

Fast forward to August 9, 2016 when for the first time since VRX’s trading volume broke 100 million shares in a single day (third instance since March 15, 2016) VRX’s stock price rose on volume greater than 100 million shares. The stock was up ~25% and accelerated into the close, which IMO is indicative of more than simply short covering. A brief history of VRX’s stock price movement around 100 million share days:

  • March 15, 2016: 138.95 million shares – stock falls from $69.04 to $33.51
    • Stock goes on to bottom at $26.30 on 3/31
  • June 7, 2016: 104.12 million shares – stock falls from $28.85 to $24.64
    • Stock goes on to bottom at $18.73 on 6/27
  • August 9, 2016: 105.85 million shares – stock rises from $22.45 to $28.16

Taken within the context of what I will outline below, I believe the high-volume response to what appears to be the first signs of stabilization in VRX’s earnings power is a bullish sign for trading purposes. Lots of hurdles left to clear to make VRX an investment, but 8/9 was a start.

Quick caveat: I was dead wrong in my interpretation of the late-October price action in the November 2015 “Situational Review” cited above, so I am taking my own interpretation of recent VRX events with a fat grain of salt and keeping the position on a tight leash.

Thesis Summary

  1. Large assets rarely go to $0
  2. Credit markets are relatively benign toward VRX
  3. Segment restructuring/transparency/asset sale guide precedes big restructuring push
  4. Pershing Square tripled down and is likely to fight
  5. Covenant relief catalyst toward big restructuring push
  6. Joe Papa sly like a fox?

THESIS OVERVIEW

(1) Large assets rarely go to $0. The ‘shorts’ have done unbelievable work on VRX, particularly with regard to the clearly unsustainable organic growth rates barfed up by Mike Pearson on a quarterly basis. The big reset in VRX’s sales base, IMO, proves this out. And while there is perhaps more erosion to go in the ‘core VRX’ sales base, I believe the bottom is close. Where I differ from the shorts is that VRX is a donut that generates little in the way of true cash flow. I fully agree that the non-GAAP EPS and EBITDA figures VRX guides to overstate true underlying earnings power – but A) not by much, and B) not to the extent that cash flow generation is nonexistent. For example…

In 1H16 VRX’s ‘adjusted’ EBITDA was $2,095 million, or 43.7% of sales. But after adjusting operating cash flow for working capital, interest expense and taxes, ‘cash flow statement equivalent’ EBITDA comes in at just over 300 basis points lower (as a % of sales) than the non-GAAP figure. And regarding cash flow generation: in 1H16 net debt fell by $276 million; but after adding back contingent and deferred consideration payments of $561 million and subtracting $111 million of asset sale proceeds, implied FCF to Equity generation in 1H16 totaled $725 million. Not bad for the “Enron of Pharma” thru a volatile business model transition period.

The fact of the matter is that not only is it rare that large cash flow generating assets go to $0, but it is even more rare when credit markets are wide open…barring a large exogenous event, such as wire fraud. Simplistic I know, but look at the untold number of ‘bankrupt’ E&P firms currently trading with material equity market cushion to their capital structures. Look at TSLA. Look at POST.

(2) Benign credit markets. If a bankruptcy-inducing wire fraud ruling is coming down the pike, credit markets certainly are not indicating as much. VRX’s unsecured 2025 debt currently yields less than 9% per annum to maturity, and its 5-year CDS is less than 800 basis points. While certainly elevated for the current market environment, these credit readings, IMO, are more a sign of operational uncertainty than pricing in certain default. As some folks closer to these markets have told me, there is a structural component to these ‘benign’ readings…but the CDS market is quite telling, IMO. Using CHK as a ridiculous comparison – CHK’s 5-year CDS is well over 1,000 basis points.

The credit market is not the be all, end all – but it is to be respected. If VRX bonds were currently north of 15% YTM, I would not even dream of touching the equity.

(3) Big restructuring push. In the 8/9 earnings release VRX unveiled a simplified reporting structure (initiates 3Q16) – B&L/International, Branded Rx and Run-Off – with detailed revenue growth and margin guidance thru 2018, as well as asset sale guidance. IMO, this is the direct result of VAC/Pershing involvement and precedes a big restructuring push.

(4) Pershing likely to fight. Nobody is impressed with Pershing at the moment, and likely never will be again. But I think they deserve a bit more credit for their investment acumen than zilch. They had numerous opportunities to cut their losses in VRX, ala JCP. But not only did they choose to double down financially, they sought board representation, which serves to limit their loss-cutting ability even further. I believe the probability of Pershing putting up a huge fight to save their investment is quite high…even if VRX’s ultimate destiny is a wire fraud-induced donut.

Tough to know what a restructuring push will look like in advance, but at minimum a push to break up the Company if not a sale in its entirety.

(5) Covenant relief. On the 8/9 earnings call VRX announced they are looking to obtain further covenant relief, which I believe is likely the key reason for the post-earnings call weakness in the stock, as rumors of negotiation details can whip the stock around until an official announcement. Lenders have very little incentive to push VRX into default, so obtaining relief is a high probability, IMO. Once relief is obtained, I believe the path for a big restructuring push is set.

(6) Joe Papa sly like a fox? Many cite Papa’s awkward resignation from PRGO just prior to a decline in operational performance as reason to not trust what he says at VRX. But is it perhaps more appropriate to view his exit from PRGO as masterfully timed? And thus perhaps he sees something in VRX that we on the outside do not? At minimum, something to consider.

VALUATION/DOCUMENTS

I will leave the valuation work to the PDF attached below, as I believe the above ‘investment mosaic’ is a sufficient case for at minimum a trade in what – under stabilized operating conditions – is a severely undervalued asset.

VRX 2Q16 Earnings Presentation

17M VRX Analysis August 2016

Events: Johnson Controls Deal(s) Overview

Johnson Controls

Events: Deal(s) Overview

August 7, 2016


SUMMARY INFO

Johnson Controls

  • NYSE: JCI
  • Recent PPS: $45.52
  • Shares Out: 639.71 million
  • Market Cap: $29,120
  • Debt: $7,027
  • Enterprise: $36,147
  • 2016 EV/EBITDA: 7.9x
  • 2016 PE: 11.5x

Tyco International

  • NYSE: TYC
  • Recent PPS: $45.32
  • Shares Out: 426.18 million
  • Market Cap: $19,315
  • Debt: $2,559
  • Enterprise: $21,874
  • 2016 EV/EBITDA: 13.6x
  • 2016 PE: 22x

OVERVIEW

Summary. Johnson Controls is merging with Tyco International in early September (S-4 went final 7/6/16; shareholder vote is 8/17/17) then spinning off its Automotive Experience segment (Adient) to NewCo shareholders soon after. Post-Adient (seat manufacturer), NewCo will be a diversified industrial with $31.9 billion of 2016 revenue derived from the following segments: HVAC & Controls (~45%), Fire & Security (~30%), and Power (~25%). The Companies expect $500 million of operational synergies within three years, as well as yet-to-be-quantified revenue synergies. On a combined basis (with some estimates on my end), JCI and TYC management teams project top-line growth of approximately 6.2% and EBIT growth of 11.8% thru 2020.

Adient is projected to generate $16.7 billion of revenue and $1.6 billion of EBITDA in 2016. Projected growth is ~0% thru 2020.

Capital Structure. Post TYC and Adient, NewCo will be modestly levered at 2.68x gross debt to 2016 EBITDA. Adjusting the balance sheet for TYC-related intangibles (including GW), tangible net operating assets are $19.4 billion. With an estimated $2.93 billion of 2016 NOPAT (before synergies), ROTC is approximately 15.1%. Excess OpCo cash will represent approximately 3.5% of NewCo (pre-Adient), assuming a $46 stock price.

Adient will be levered 1.85x net debt to 2016 EBITDA post-$3 billion dividend to NewCo ($3.5 billion total debt and $500 million of retained cash).

Tyco Deal Structure

JCI. Current JCI shareholders have the option of choosing $34.88 in cash, some combination of cash & NewCo stock, or all NewCo stock. With JCI currently trading above $34.88 the choice is moot. Approximately 110.8 million JCI shares will be converted into the right to receive $34.88 in cash ($6.04 pro rata to all shareholders), thus retiring the shares and leaving 528.93 million of equivalent NewCo shares, for an approximate ownership of 56.51%.

Because the cash portion is not a simple dividend, it can get a bit muddled. JCI’s current market cap of $29,120 can be broken down as follows:

  • $29,120 Market Cap = 639.71 million shares x $45.52 stock price
  • $3,864 Cash = 110.8 million ‘cash shares’ x $34.88 per share cash consideration
  • $25,256 NewCo Stake = 528.93 million ‘NewCo shares’ x $47.75 implied NewCo (pre-Adient) stock price

As such, JCI’s current stock price is comprised of: $6.04 cash + $39.48 NewCo = $45.52.

(Important for later valuation calculations – 528.93 NewCo shares are 82.7% of total JCI shares out.)

TYC. Just prior to the merger TYC will effect a reverse stock split of .955 per current TYC share, leaving 407 million of equivalent NewCo shares, for an approximate ownership of 43.49%.

Using the $47.75 NewCo price as implied above, the ‘deal value’ for TYC shareholders is $45.60 (.955 x $47.75), versus Friday’s closing price of $45.32.

NewCo. Post-TYC transaction, NewCo will have approximately 935.93 million shares outstanding and can be broken down into the following parts:

  • OpCo = Legacy JCI Industrial + Legacy TYC Industrial
  • Excess Cash = 75% of pro forma cash on hand
  • Adient

VALUATION

Adient. Before looking at NewCo’s fair value and implied PE via JCI’s stock price, a quick fair value estimate for the Adient spin.

Per the S-4, Adient will generate $1.3 billion of EBIT in 2017. And assuming $3 billion of net debt at a 5% rate and a 25% tax rate, net income is $866 million, or $.92 per NewCo share. At an 8.33x fair value PE, Adient is worth approximately $7.70 per NewCo share.

NewCo. Using the three parts as outlined above, NewCo’s fair value is comprised of:

  • OpCo: $55.44
  • Excess Cash: $1.60
  • Adient: $7.70
  • Total: $64.74

Using management projections for JCI WholeCo, JCI RemainCo and Tyco, I use a DCF model to value the NewCo operating company (see JCI Analysis under the Documents section below). (The inputs and assumptions to the DCF can be debated ad nauseum; but as the last 18 months or so in the market have proven, any and every assumption to any and everyone’s analysis can be debated to the ‘nth’ degree…so do what works for you.) But IMO the real margin of safety lies in the very low expectations embedded within JCI’s current stock price.

JCI. As stated earlier, due to the ‘cash shares’ component of JCI’s current capitalization the NewCo calculations must be multiplied by 82.7% in order to convert into a per-current-JCI-share equivalent. With that in mind, NewCo OpCo’s implied 2017 PE based on JCI’s current stock price looks as follows:

  • JCI PPS: $45.52
  • (-) JCI Deal Cash: $6.04
  • (-) Excess Cash: $1.32
  • (-) Adient: $6.37
  • Implied NewCo OpCo PPS: $31.79

NewCo OpCo will generate 2017 EPS of approximately $3.03 before synergies. Multiplied by 82.7%, the JCI-equivalent EPS figure is $2.50 for an implied 2017 PE of 12.7x.  If Adient trades for 12.5x, the implied PE falls to 11.4x; and if it 5x, the implied PE rises to 13.7x.

Using the NewCo SOTP fair value, JCI’s current fair value is $57.

DISCUSSION

This is a rather boring, seemingly under-followed restructuring/event situation, which is why I believe it could surprise to the upside in the relatively near-term. Not huge upside, but decent nonetheless. The global macro economic backdrop is stable/improving enough to take economic-related operational downside off the table in the medium-term; revenue synergies are at minimum a free option; NewCo (ex. Adient) has material balance sheet capacity, IMO (3 to 3.5x leverage would be more appropriate given the revenue/cash flow profile); buybacks could surprise to the upside in the near-term; the Battery business could be divested or spun; Adient could be a sneaky home run; and who knows…NewCo could end up receiving a take-out offer.

The biggest risk is the tax authorities stepping in to block the ‘inversion’; but I believe investing via JCI as opposed to TYL largely takes this risk off the table. On a standalone basis JCI trades for less than 12x 2016 earnings and 8x EBITDA, versus 22x and 13.6x for TYC. Shorthand yes, but JCI is materially less expensive.

More to come…

DOCUMENTS

17M JCI Analysis August 2016

Final S-4 7.6.16

Clinton Cash

Business & Politics

Clinton Cash

August 6, 2016


Ya, ya – not supposed to talk about religion and politics. But how about corruption?

Outside of abortion – which I believe from a rational, humane standpoint can be considered nothing other than outright murder of a scientifically proven LIFE form (Hillary Clinton herself says: “The unborn person doesn’t have constitutional rights.”) – I am as politically neutral as they come:

  • Gay rights – 100% a religious issue. Any and all forms of gay rights oppression should be banned at the Federal level – once and for all. If you are religious and thus believe in ‘sin’, then you should be ashamed of yourself for hypocritically denying someone the same rights you possess based on a behavior you believe is ‘wrong’…when by definition you commit a different set of wrongs every single day.
  • Planned Parenthood – Again, a religious issue. Any and all involvement by Planned Parenthood in abortion should be shut off; but the more birth control to go around the better.
  • Healthcare – The normal market forces of supply & demand do not apply to the actual implementation of care (i.e. we do not deny care based on lack of funds); as such, the Government must be involved in some way shape or form. Republicans are out of their minds to think the entire HC system should be run by the private sector. But Democrats are equally out of their minds to think the Government can actually run the system itself.
  • Taxes/Spending – Republicans’ hyper focus on tax cuts, tax cuts, tax cuts is as asinine as Democrats hyper focus on redistribution. Simplify and flatten the tax code – particularly payroll taxes; and make government spending more transparent and highly targeted (i.e. high velocity infrastructure spending via PPIP, etc.).
  • Stimulus – One of the most embarrassing moments in Republican policy history was the full-throated opposition of the globally critical $900 (?) billion stimulus package in early 2009. As Mr. Buffett liked to say at the time – by definition, when the private sector is deleveraging, the only entity available to take the other side is fiat government. That stimulus package likely saved the global economy from a Great Depression 2.0.

With that as background, and with all possible neutrality I would like to present the “Clinton Cash” documentary. It is an hour and four minutes and fifty-seven seconds long. Do yourself a favor and take the time; and if short on time, skip to minute 50…

 

This is precisely why Trump is where he is. Bash him all you want – but the Putin ‘support’, flip-flopping, ‘lack’ of policy knowledge, and crazy behavior pales in comparison to the criminal enterprise that is the Clinton Foundation/Clinton family.

I am no Trump fan. But people have died protecting our right to vote; and I simply cannot sit idly by and vote for the continuation of one of the most egregious forms of corruption one could imagine. These criminals are hiding in plain sight, and I shutter to think of the long-term ramifications of a Hillary presidency.

HRC – see you next (election) Tuesday.