Friday File: Earnings Thoughts and Updates

So many thoughts, so little space -- CRTO, FOSUF, LCSHF, ROIC, VTR, COR, DSEEX, NXPI, VC and more

By Travis Johnson, Stock Gumshoe, July 29, 2016

This week I’ve got a lot of thinking to catch up on — there are several stocks in our Gumshoe Universe that have reported or generated some news of late, many of which I own, and I’ve got some thoughts on a lot of them to share with you.

I started with my reaction to the Facebook (FB) quarter in a separate note earlier in the week, and I stand by that relative optimism about Facebook’s continuing long-term potential (yes, even with the news today that they might have an additional tax liability), and remain encouraged by Alphabet/Google’s (GOOG) progress as well.

And what other stocks caught the eye this week? I thought you’d never ask…

Criteo (CRTO) has gotten a fair amount of attention lately, originally because there’s been a fairly high-profile lawsuit between Criteo and a US ad tech company called Steelhouse, and now because the Facebook and Google earnings were so fantastic that everyone’s getting a little excited about online advertising in general… and perhaps sniffing around for the possibility of a wave of mergers and acquisitions that could again spur takeover rumors for the smaller players like Criteo.

The lawsuit I can’t help you with — Criteo sued Steelhouse for click fraud, and Steelhouse countered with allegations that Criteo’s clicks look suspicious and it’s slandering Steelhouse and scaring away customers. Steelhouse is well-funded, they got their largest venture funding round of $49 million back in December, but they’re a lot younger and smaller than Criteo (CRTO was founded in 2005, Steelhouse got its first funding in 2010). Presumably there’s some long tail risk there of something happening, but I’m not specifically worried about that legal fight.

Criteo is really an outlier in the ad tech space, and that really is a big part of the reason I like it. I am currently long CRTO artificially in my personal account, through options, but would also be happy to own the equity in the low $40s. This Wall Street Journal piece from last month sums up the situation pretty well when it comes to Criteo’s fundamentals and stock performance: They are often lumped in with other “ad tech” companies, but unlike almost all of them Criteo has been consistently profitable for years and has a strong and growing base of customers with whom they have a pretty deep data connection, and a revenue stream that’s based on performance (which advertisers love, of course — they’d rather pay $5 for a click if that person buys a $300 item than pay 50 cents per click for ten different people who browse but don’t buy anything). Criteo is also a buyer of some ad space on Stock Gumshoe sometimes, so I should note that as a potential source of bias (so is Google). If you’re in a space where everyone is fighting for virtual real estate and customers and you’re the one that’s most consistently profitable and growing (the others are rarely profitable, and are mostly not even growing revenue right now with the exception of Rubicon (RUBI)), then you’re simply doing something better.

Analysts think they’ll grow earnings better than 30% this year and 25% next year. Those analysts could obviously be wrong (they’ve had trouble forecasting CRTO earnings in the past), and there are real challenges — not just this lawsuit and countersuit, whatever merit they might have, but currencies (their growth is in the US and Asia, but their largest market is still Europe) and competition are always right around the corner, and they are going to have to remain integrated with Facebook and Google and on good terms with those advertising platforms to remain a viable business, which creates risk because of their vulnerability to changes in those businesses…. but that’s excellent growth for a company that’s only trading at 19 times next year’s earnings, and CRTO remains both a good growth stock and a “maybe someday” acquisition candidate… and the only one of the sometimes high-profile small “ad tech” companies that has any kind of reasonable fundamental performance when it comes to their income statement…

… but though the ad market has folks a little smiley again after Facebook and Google, we should remember that Criteo hasn’t reported yet — their second quarter numbers will come out on Wednesday next week, so don’t jump in to do anything crazy unless you’re consciously making a bet about whether the earnings will be great or lousy in relation to analyst estimates or whether they’ll say something about market conditions or the remainder of the year that makes investors crow or cringe (they’ve beaten estimates handily in the last two quarters, but trailed estimates in the two quarters before that, for whatever that’s worth).

Fosun (656.HK, FOSUF) has been an interesting story for years, as Guo Guangchang tries to build an insurance-fueled subsidiary on top of a Chinese portfolio of steel and pharmaceutical companies and emulate the early days of Berkshire Hathaway’s growth. The challenge has always been that Fosun has been far, far more aggressive than Berkshire ever was in using a lot of debt to fuel their acquisitions, and that ha come back to bite them a few times and recently put the kibosh on two of their insurance acquisitions — they canceled their acquisition offer for an Israeli insurance company and a private banking firm in Europe, and recently have pushed forward with the spinoff of their recently acquired Ironshore insurance company, largely because regulators have complained that an insurance company being controlled by a heavily indebted conglomerate presents too much risk. They have filed the registration statement for Ironshore, and will probably float a portion of the company in an IPO, but they’re likely to have a controlling stake for the foreseeable future — ideally, I expect, the IPO will be well-received and they’ll be able to get down to a minority stakeholding and get the regulators off Ironshore’s back. Ironshore has had solid results, growing book value and reporting a good combined ratio below 90 last quarter, so though insurance is a tough market now it’s probably as good a time as any to try to entice investors with their income statement.

So Fosun changed tack a little bit, no longer acquiring financial sector assets willy nilly but still certainly an acquirer. They’re now moving to acquire Gland Pharma in India from KKR, and recently bought the Wolverhampton Wanderers English soccer team. Pharma fits right into the consumer-focused “health and happiness” strategy Fosun is pursuing as plays on the domestic market in China, and China is also catching football fever in a big way and acquiring lots of European stars to play in the Chinese leagues, I imagine Fosun is hopeful that they can create a popular fan base in China for the Wolves to complement their Chinese consumer businesses (they’re not the only ones, Aston Villa was sold to a Chinese buyer not long ago). Buying the team is not a huge deal financially, the Wolves are currently relegated and aren’t in the Premier League with the likes of Manchester United so the acquisition was pretty cheap at about $60 million, but it looks like a “value” buy as much as you can say that buying a trophy asset like a professional sports team can ever be a “value.” I sold half of my Fosun shares quite a while ago when they hit a stop loss, but am happy to continue holding the rest — they generate a lot of interesting news.

I wouldn’t want to make this a particularly large position because that debt will be sitting there for a long time as a potential problem — Fosun is funded largely by relatively short-term debt, which means they have significant potential sensitivity to any debt crisis in China that makes it tough to roll over their debt (which is, of course, what sunk so many US companies during the financial crisis — short term debt is great and cheap as long as you can keep rolling it over to a new lender… when no one will lend, things can get ugly). That’s a risk, not a prediction, but China’s financial system is so controlled and unpredictable, at least to me, that it’s enough of a risk that I keep this position muted. I like management, I like China’s long term growth potential, and they have a portfolio of valuable assets around the world… but growing fast and being opportunistic has not been great for their balance sheet.

Lancashire (LRE.L, LCSHF), our British insurance firm, posted earnings recently as well — there’s a good summary here, full reports on Lancashire’s site here, but the basic takeaway is “insurance still stinks, but we’re still underwriting better than other people.”

They’ll likely pay another special dividend late this year, as they have for several years in providing an average dividend payout of better than 10%, but my expectation is that the payout will be substantially smaller this year. They’re still very profitable, but they’re not writing as much business — which means there aren’t as many profits, but there is likely to be excess capital and they tend to return excess capital to investors. Annual earnings this year are likely to be down at least 20% from last year, but will probably be in the neighborhood of 60 cents a share, and the company is saying all the right things about continuing to manage for long term success through the cycle, staying disciplined on underwriting, and using the available cheap reinsurance these days to soften the blow of disas