Sold BIDU @ 227.50

Sold out of BIDU @ 227.50, this short term target price was decided using a comparative valuation of BIDU with MSFT.

Using the same valuation method, we found MSFT was trading at around 100% premium to its intrinsic value. Our predictable intrinsic value for BIDU is $130 (with a couple of free options in there). BIDU doesn’t quite have the global reach that MSFT does so we set our profit target at 75% premium ($227.50), rather than 100% premium.

In the medium to long term BIDU share price could very well exceed $227.50 but that’s not our alpha. There’s many more short term opportunities in the market.

bidu closing chart

Uranium Strategy Spotlight

Summary

  • Buy Uranium (or a company with Uranium exposure) at $16.67 for value
  • Hold Uranium while it trades above its 3-month moving average to capture crisis alpha if a production shortage transpires over the next 5 years

Potential Alpha

Without a price forecast or model to go with, our only potential alpha is applying the correct execution strategy and technical analysis to ongoing market developments.

Qualitative notes

  • Almost entire global Uranium demand is used for nuclear power generation (previously 50% for military use)
  • Cost of Uranium fuel over a reactor’s entire lifetime is negligible compared to the cost of constructing the reactor which means:
    • Uranium demand is relatively price inelastic and significant lag time can exist before demand imbalances are corrected
  • ~90% of current global Uranium demand is satisfied by mining
  • Uranium was typically supplied in 5-year fixed-price contracts. Given a declining market for the past 6-years, its likely that production starts to rebalance
  • The AVERAGE cost of Uranium production is $31/pound (futures currently trade at ~$20)
  • 2015 & 2016 saw the largest increase in global nuclear power production capacity in the past 25 years.
  • Forecasted growth in nuclear demand is predominantly from China
  • Japan started approving reactors for restart (there are 54 dormant reactors in Japan out of approx 450 total reactors globally)
  • Kazakhstan cut production by 10% in Feb 2017 which caused a temporary price rally

Value Strategy

Buying at a price of $10/pound gives us a 2:1 payoff if Uranium were to revert to its cost of production of approx $30/pound. Assuming $10 is therefore a hard price boundary, a slightly smarter trader might buy at $16.67, risking $6.67 to make $13.33 and retain the 2:1 payoff.

Momentum Strategy

Medium to long term trend following will be a profitable strategy if there’s a possibility of a Uranium shortage in the future. This could happen but the timeframe is uncertain (could take up to 5 years).

Sources

 

P&L: 29-July-2017

pnl-20170729.PNG

Weekly P&L -0.3k: +6.5k BIDU, -7k crpyto assets, futures trading +0.2k.

Despite facing some operational issues reducing position size we could take in BIDU, our strategy was sound and the stock is now trading at our buy price limit of $220. Looking to take BIDU off the table at $230 next week to free up capital for other high-alpha trades.

Our crypto strategy wasn’t quite segregated enough. There were originally two trades: first buy into crypto assets as a value investment during a liquidity crisis or price dip; second provide liquidity to the market during liquidity crisis with the aim of getting out within a week. After profiting from the liquidity crisis we decided to scale up our value investment but in hindsight probably should have been more patient and timed the entry a bit better.

Main reasons for holding EOS over ETH:

  • EOS product is an infrastructure solution for future users of blockchain
  • Given ICO was hot, potential for 100% upside again on breaking news (blockchain scheduled to go live in September)

 

Deutsche Bank Strategy Spotlight (DBK)

Summary

  • Buy DBK below €15 for value based on:
    • Arbitrage boundary of 25% of tangible book value assuming no cash flows and potential litigation (€6.75 per share) +
    • Intrinsic value of 10Y cash flows assuming zero growth (€5.20 per share) +
    • Absence of litigation discount (€3 per share)

Potential Alpha

DBK has returned to profitability which means that many professional analysts are likely to be using some sort of cash flow valuation method. We don’t have any alpha competing in this game on a granular level, however it could pay to be ready for some crazy price action as this stock has traded in a 20% range over the past 6 months.

Valuation

First let’s look at the intrinsic value of DBK’s future cash flows (assume these numbers are in EUROs).dbk valuation.PNG

Using 90% of the annualised MRQ revenue and the current net profit margin we calculate an intrinsic value of cash flows €5.18.

The other half of the story is the book value. There must exist some price that the majority of Wall Street will pay per €1 of tangible book value. The theory being that if DBK trades excessively cheap then the company gets a better return from a buyback than holding underperforming assets. So what’s the arbitrage boundary?

In September 2016 DBK traded as low as 25% of tangible book value (€9) during a period of time when the bank was unprofitable and in potential litigation crisis. This is our best indicator as to the arbitrage boundary.

Current tangible book value is €27 per share which puts the book value boundary at €6.75. The bank is now profitable so we add on the intrinsic value of cash flows to get approx €12. The last piece of the puzzle is the value of the discount due to the litigation crisis, which in our opinion is best deciphered using technical analysis.

dbk chart.PNG

From the above chart we depict the litigation crisis discount to be worth €3, which makes DBK a buy at €15 for value.

Crypto Strategy Update (including Tierion ICO)

TIERION STRATEGY

Tierion who is looking to raise $25m in their ICO, has received $8.2mm of Ether deposits at the pre-sale address they gave us.

tierion pre-sale

So far there has been no notice that pre-sales have been restricted or closed off, despite the public ICO scheduled to go live in a few hours. There can’t be much alpha if any in the pre-sale if its still so easy to participate.

Again we’ll participate in the public offering only if it looks to be selling out in the first 30min. Otherwise any potential reward probably doesn’t justify the 100% potential downside.

CRYPTO BIG PICTURE

ICOs seem to be the biggest focus of the crypto market at the moment. We don’t have any hard evidence to support this but if the whole world is trying to make money on ICOs, then there’s probably fewer people buying and holding the highest quality coins. Or there’s likely to be fewer people simply trend following undercapitalised coins. For this reason we see lower risk running momentum strategies on a pre-selected batch of coins than trying to pick the next hot ICO. Stay tuned for our new strategy details.

Reader Request: Baidu Strategy Spotlight (BIDU)

Summary

  • Buy BIDU for value below $130 (USDCNY FX as at 26-July)
  • Buy BIDU for momentum below $225 if price is rising on weekly basis (USDCNY FX as at 26-July)

Potential Alpha

Baidu is a high growth, medium volatility stock with a turnover of $500m per day. The high turnover means that its a suitable candidate for many relative value strategies ran at the largest investment funds. Capturing alpha on a daily timeframe is likely to be very difficult in the absence of serious game-changing news, and hence we’ll look for a weekly or monthly strategy.

Qualitative Notes

  • Chinese language internet search provider
  • Current CNY revenue of 10b USD equivalent per year, 90% of which comes from online marketing
  • Revenue growth flattened in 2016 (prev 20+% yoy) after increased regulation was imposed on search advertising, but most recent quarter has returned to a 15% yoy increase
  • Competitive advantage is the critical mass or network effect gained from having a monopoly on China advertising services (also monopoly on data analytics)
  • Operating margin is currently at 15% with likely more upside than downside:
    • COO announced change in strategy in acquisitions Baidu Nuomi and Baidu Takeout Delivery from transaction services to advertising revenue
    • Leading online video platform iQiyi to become the sole distributor of Netflix content in China reducing the capital required for original content creation
  • Partnered with Microsoft on 18-July-2017 to collaborate on autonomous driving systems

Valuation

Our valuation method is first to calculate a high-certainty terminal value per unit of revenue. Then we proceed to make an assumption as to how many years of growth the company has before reaching its mature, terminal value.

bidu valuation.PNG

We’ve assumed that the changes in business strategy will increase the profit margin from 15% to 20%.

bidu arbsheet.PNG

Strategy

For a deep value strategy the key question to answer is: how many years of growth are the majority of value investors prepared to pay for? Or another way of looking at it: what premium to intrinsic value is the monopoly position in China’s online advertising and video streaming worth? For such a liquid stock there could also exist a relative value premium assigned to it due to its inclusion in highly liquid relative value trading strategies (e.g. trading Baidu vs Google and other search engines). For pure value in a falling market however, its definitely a buy @ $110 and a buy @ $135 if the monopoly premium or relative value premium is likely to hold.

A momentum strategy is likely to be more interesting because potential upside from Baidu’s business activity may still not be fully understood. Just how valuable is having the most comprehensive database of Chinese internet user activity? How valuable is being a first mover on autonomous driving technology? If there’s value in either of these propositions it should be captured using a momentum strategy. The momentum strategy is to buy when pricing is rising on a weekly timeframe with a 10% stop loss ($175 assuming constant USDCNY exchange rate). Target is a 20% gain or more ($240 share price) which could take up to 1 year to pan out.

Chart here: https://www.tradingview.com/chart/92jSVhm4/

 

Aconex Strategy Spotlight (ACX.AX)

Summary

  • Buy for value alpha below $3.40
  • Buy for momentum alpha $below $3.70 only if price is rising

Potential Alpha

Aconex is high growth, high volatility stock with a turnover of $2.5m per day. Because of the uncertainty around future cash flows it is likely to be more difficult for discretionary investors to make perfect decisions. A daily turnover of only $2.5m also means that it probably doesn’t move the needle on annual performance for funds with >100m AUM.

Qualitative Notes

  • Leading provider of cloud based collaboration software for construction industry.
  • Current revenue of 250m, potential future target of 3.5b based on industry size estimate.
  • Revenue realised as a % of construction cost which means that 70% of forward revenue is from existing contracts and is already known.
  • 50% of revenue currently from ANZ region.
  • Competitive advantage is the strong brand created by being a global first mover.
  • Risks to further growth are potentially inefficient acquisitions. Buying horizontal competitors rather than niche vertical tech improvements could be costly to integrate.

Valuation

Our valuation method is first to calculate a high certainty terminal value per unit of revenue. Then we proceed to make an assumption as to how many years of growth the company has before reaching its mature, terminal value.

acx instrinsic value.PNG

ACX current profit margin is approx 11%. Mature software firms can have much higher profit margins such as Integrated Research with 30%. We decided to assume that 20% profit margin is easily attainable if ACX were to cut costs on expansion efforts.

acx arb matric

Strategy

Its highly likely that at least up until the next earnings release the market is going to price in 20% growth for anywhere between 2 and 5 years (current growth is >20%). To maintain a 2:1 payoff ratio, buy for value below $3.40.

If only real money is buying at $3.40 and won’t sell it until $3.97 or higher, it is profitable for fast money or trend followers to buy up to $3.70 (half the gap). Therefore buy during momentum below $3.70 (when there’s green candles).