by Travis Johnson, Stock Gumshoe | September 27, 2019 3:46 pm
President Trump and his team have reportedly been talking about ways to “delist China” from US stock markets or otherwise put up some barriers to prevent US investors from putting money into China, which put a scare into pretty much all the US-traded Chinese stocks and ETFs… I have no idea if that’s going to go anywhere, or if it was just leaked to try to light a fire under the Chinese negotiators, but we’ll see. Trump hasn’t mentioned it in CAPITAL LETTERS on Twitter yet, and that means it’s not real… right?
I did not sell anything as a result, of course, though I don’t have very much direct China exposure at the moment anyway… given the challenge that an autocratic move (like delisting all Chinese companies form US markets) would face in our courts, I have to imagine it wouldn’t go anywhere — but this kind of sentiment shift can be a freight train when it really gets going, so you never know. That’s part of the reason I sold some of my Apple shares a little while ago, and why I’d be a little concerned about Starbucks — US brands who are counting on continuing strength in China could face a surprising amount of backlash in favor of domestic Chinese brands if this really becomes a situation where the flags of patriotism are wagged by both sides. Image is important — if it becomes “unpatriotic” to be seen walking around Beijing with an iPhone or a pair of Nikes or a Starbucks cup, don’t be surprised if Xiaomi (XIACY) and Li Ning (2331.HK) and Luckin (LK) start to do a lot better, at least for a little while. There’s no need to overreact to that possible worry, Starbucks has been building its brand in China for more than 20 years, for example, so they know their market well, and these things are never just binary events… but the risk level for China-dependent US brands is clearly rising.
It appears to me that the market is now so driven on a day-to-day basis by shifting sentiment about the Chinese trade war that everything on Wall Street seems is seen through that prism… if impeachment moves forward, will Trump get even more aggressive with China to appear strong? Will the Chinese react by selling Treasuries or further punishing Hong Kong? Good golly, I have no idea… but more importantly, investing as if I believe I know would be stupid.
And in other big news that the market can’t help but be obsessed about, the WeWork (or We Company) IPO has been postponed, and the smaller but almost-as-hyped Peloton (PTON) IPO was a bit of a flop. Good. Hopefully they won’t try again, not with this wacky and almost-doomed business model, but at least they’re going to try to change the corporate governance at the company, and maybe that will set some example for future funders. Really, the problem is the same problem you see anywhere else: Millionaires who want to be billionaires, and billionaires who want to be trillionaires, are fighting over who can grow fastest, and that is expressed in the private markets by bidding up unprofitable “hot” ideas to ludicrous valuations. Softbank and its Saudi-fueled Vision Fund are most obvious culprits thank to Masayoshi Son’s “Buy Everything!” policy (maybe I should have shorted Softbank when I was tempted back in March… but at least this means we can more comfortably ignore crazy come-ons like Ray Blanco’s pitch for Softbank shares as a way to “get in early” on the next Venture Fund or buy into the “Halo-fi” project with OneWeb.
My favorite rant this week was Josh Brown’s “Wall Street was THISCLOSE to selling you WeWork at $50 Billion”… never forget that the people who are selling you stuff care a lot more about the “selling” part than the “you” part.
Hopefully, at least, this will serve to put to sleep the idea that “getting in early” and “buying pre-IPO” is a good idea for small investors… which might mean we’ll get fewer “angel” or “venture” themed investment teaser ads.
Just kidding, of course we’re not going to see fewer of those… in fact, we see more and more each day, as investors get a little smarter about the stock market and realize that they can do a lot of research on their own, which means that publishers and promoters have to find a new, illiquid, and mysterious market to tease them with. Keep an eye out for more ridiculous investment services that recommend cryptocurrencies, non-public “angel” investments in private companies, options, and other “secret” investments (and yes, if you’ve ever been on Shark Tank, you too can rent your visage out to a newsletter publisher!)
I bet that close to 100% of those newsletters, clubs and services that talk up private companies will make money for their publishers… but I’ll be surprised if 1% of them make money for their subscribers. You probably won’t do well buying into any private company, the odds are very slim, but you’re definitely not going to get facebook-rich investing in private little companies that large venture capital firms aren’t interested in. And no, spending $1,000 on a newsletter does not get you access to the kinds of deals that Kleiner Perkins and the other big VC firms review… nor does it make you better at evaluating companies based on the extremely sketchy information that’s usually available for “private placement” or “pre-IPO” investors. Go for it if you want a new hobby, but remember that most hobbies fall into the “expense” side of your ledger, not the “income” side.
OK, phew, got that off my chest. Sorry for the rant. What’s going on this week in my Real Money Portfolio? Aside from the fact that it’s going down, that is (super sad, I know… and I’d like to lie and tell you that I’m not watching it every day, like Warren Buffett sez I shouldn’t watch, or that I know better… but, sadly, I watch these things obsessively and I know that my portfolio was down by 1.58% while the S&P 500 was down 1.68%, and that I’ve got a lot of cash in there sitting idle, just waiting to do something useful… so I can still just barely feel good about myself, and I clearly deserve a beer :)).
As usual, I’ll start with the transactions — not many this week. I stopped out of my position in Premier (PINC) earlier in the week, I won’t bore you by reposting that text here but you can see that Trade Note from Wednesday here if you like. Incidentally, I’m trying to tag every comment or post that includes a transaction in it with that “Trade Note” subject, so it’s easier for those who just want to see the posts where I take some action with my portfolio. All of those should be available on this #TradeNote topic page (articles that include a transaction on the left, comments with Trade Notes on the right).
I added to my Activision Blizzard (ATVI) position a little bit when it finally dipped some today. The lineup of new products is impressive in their core brands, including the new version of Call of Duty that’s been a huge hit in beta so far as well as the mobile version of that game, though it was seemingly the surprising popularity of the “retro” World of Warcraft release that caused the stock to pop a few weeks back. I’m keeping an eye on the growing popularity of Activision’s eSports leagues, particularly the Overwatch league that was a pioneer of “city vs. city” teams that more closely mimic other professional sports (and with teams mostly owned by other sports league owners), and they also have a Call of Duty league launching in 2020. Esports is still a small part of Activision’s current business, but the trend is clearly strong — the Philadelphia team is even building the first real “home stadium” for a US eSports team, the 3,500 seat Fusion Arena, that will sit in the same complex as the existing stadiums and arenas being used by the Philadelphia Eagles, 76ers, Phillies and Flyers.
Speaking of eSports… I expect not many of you are particularly interested in Modern Times Group (MTG-B), the small eSports company I bought shares of a while back, mostly because they really trade only in Sweden, but they did have some meaningful news earlier this month in the form of a joint-venture deal with Huya (HUYA), which is essentially a Chinese Twitch competitor (Twitch is Amazon’s platform for live streaming video games — so if you like watching Ninja play Fortnite, for example, you might watch him on Twitch… though that’s a bad example, because Ninja famously flipped last month to Microsoft’s Twitch competitor, Mixer). The deal is intended to get more Chinese gamers into the ESL gaming platforms and tournaments, partly by starting up more Chinese esports competitions — and Modern Times’ ESL is the oldest and one of the best-known international eSports event companies. The Huya deal is at an enterprise value of $425 million for ESL, which is one of MTG’s big divisions and the one that interests me most, and will bring in $30 million in cash.
The news brought a pop in the shares, though they’re still a little below where I bought in early August, and I think it’s a nice indicator of their growth potential… though it will probably not bring any immediate changes. I may end up adding a bit to that position in the near future, “joint venture for China esports expansion” has a nice ring to it, though I’m not in a rush — particularly because the big money in esports, the media rights and sponsorship potential, is emerging a bit more slowly than I expected. This is a long slow simmer, I think, not an explosion — partly because most of the people who really care about eSports don’t care at all about investing… yet.
Gold is again looking like most of us have expected, like a “flight to safety” trade… but it’s no less volatile for that, with the price gyrating up and down like crazy during the impeachment up-and-down sentiment this week. Apparently, people fly away from “safety” when the headlines sound better just as quickly as they fly to it when the headlines induce panic.
Osisko Gold Royalties (OR) dropped sharply this week on takeover news, with investors worried that they’re getting (somewhat dangerously) into the “building and operating a mine” business, which makes royalty owners nervous (that’s largely why Sandstorm’s acquisition of Hod Maden junior partner Mariana Resources was so poorly received a few years ago as well, though it is possible to make more of a straight-faced argument that Sandstorm is a passive Hod Maden participant, since it’s likely to be a cheap mine and require little up-front capital and Sandstorm is a junior and non-operating partner).
Getting away from the truly passive scares royalty investors, as do acquisitions that are dilutive of earnings power… so that seems to be the primary reason for Osisko’s weakness on the week. The company they’re buying, Barkerville (BGM.V, BGMZF), is a real company with a real project that Osisko was already invested in (the Cariboo Project in British Columbia)… though it is pretty early stage, having generated a preliminary economic analysis but not yet a feasibility study or a “start building the mine” decision.
Barkerville shareholders are essentially getting 9% of Osisko in the all-stock deal, which sounds like a lot but makes sense — Osisko was a $1.7 billion company before the announcement, Barkerville had a market cap of about $160 million — though some of that goes full circle, since Osisko already owned a third of Barkerville before this offer.
Osisko also had some “regular” news — they had their first gold pour at the Eagle mine, which is expected to generate 10,000 ounces of gold a year for at least ten years for Osisko… and that’s good news, but even at $1,500 an ounce that’s only $15 million in revenue a year. That pales in comparison with their largest royalties, particularly Canadian Malartic, so you can see why they want to add a new big cash source… and Cariboo could be that, though they’ll first have to build a mine and it will take a long time and a lot of money.
So that’s why folks are worried, I imagine. In the meantime, Canadian Malartic continues its extension work, they’re moving a road in order to expand the mine and that should extend the forecasted life of mine for another few years, to 2028 (it had already been extended from the original 2022 to 2024). So that’s at least nine more years of production from their flagship asset, along with their other royalty-producing assets, including the troubled Renard diamond project operated by Stornoway.
The diamond project is the biggest deterrent to me here, frankly, since the diamond business is in the gutter and their rescue financing might well be throwing more good money after a bad investment — which sometimes royalty companies can’t resist doing in an attempt to rescue the value of a sunk cost (the money they originally paid for that diamond royalty).
The Barkerville acquisition seems relatively appealing, as midsize mining projects go, but it’s not particularly close to production — they just filed their preliminary economic assessment for the Cariboo project, and they say they expect it to be quite profitable with gold at $1,300, with all-in costs of $912 an ounce and an 11-year mine life producing 185,000 ounces a year. I imagine that what Osisko likes is the potential to build a real mining center in British Columbia, with a lot of exploration targets on this property beyond the Cariboo mine, but none of that is going to become valuable quickly. If I knew that they could offload Cariboo to an operator for half what they paid, getting a royalty in return without having to swallow the capital costs themselves, then it would be more appealing, and maybe that’s what happens at some point in a year or two… but unless and until that happens, they have “operator risk” and “financing risk.” It is, at least, envisioned as a relatively inexpensive project, with pre=production construction estimated at C$305 million.
So I’m waffling, frankly. Renard deters me. The risk of Barkerville deters me. Some of the possible exploration targets for the Malartic mine that could go into production over the next five years or so are in the 3% royalty zone, not the 5% zone (though the current expansion is almost entirely in the 5% zone still), which is a bit of a bummer. They have more debt than most royalty companies.
But still, there are enough future growth opportunities to provide a bit of long-term optimism… and Malartic could continue to produce at a remarkable level for a long time as they keep drilling to find and prove up more deposits (and it’s already booked for another nine years now, with probably something in the 33-38,000 ounce range being Osisko’s royalty on that — which means revenue of close to $50 million a year from just this royalty (at $1,500 gold). That’s helps to make you feel a bit better about many of those risks and deterrents.
In the end, the strength of that Malartic royalty and its leverage to rising gold prices (assuming they do rise) means I’ve talked myself into adding a little bit more to this position… it’s still not my favorite gold royalty company, Sandstorm (SAND) continues to give me a lot more confidence, and if gold falls 10-20% the stock will certainly fall along with it (and likely farther and faster), but I still thing gold exposure is important and I don’t want to have all my gold eggs in the Sandstorm basket… and it strikes me that the beating the shares have taken as a result of the Barkerville news is reason to add a bit. Osisko is now the cheapest of the royalty companies, I’d argue, so although there are reasons for that (it’s at the bottom of that table because of these new risks (Renard and Barkerville) and the reliance on a single mine), there’s still something to be said for “cheapest.”
So that’s gold… and as long as we’re on crazy hyped-up fad sectors, what’s up with marijuana?
The latest marijuana banking law passed its first hurdle, providing some hope that it might even pass the Senate and get written into law. It’s hard to see that being the focus of Congress this week, but you never know, and it could get a hearing in the Senate and get signed.
That presents two possible outcomes for my favorite pot stock, the REIT Innovative Industrial Properties (IIPR): First, that the “green light” for financing pot projects and offering mortgages to pot companies will mean there’s a lot more competition for IIPR, which could bring their cap rates down for future deals (though their existing leases all have more than a decade to run); or second, that this will make the pot business much more efficient and profitable, which would be good for their operators (able to take credit cards, get regular bank loans for inventory, etc.), and that means those pot companies immediately become more stable and better credit risks, which makes IIPR’s leases less risky.
I’m guessing both of those things will happen, over time, and I’m inclined to think that this banking reform would be a net positive for the industry, and that although IIPR’s cap rate should come down as the industry matures it remains very solid and will probably stay that way. IIPR has such a low cost of capital (selling equity with a 2-3% dividend yield, only a small amount of debt at about 3%) that even seeing the cap rate come down means there’s plenty of room for a big profit… particularly if banking and financing opens up to the degree that IIPR can get the same leverage terms as other REITs, which would make up for any reduction in cap rate. Other industrial REITs are leasing out properties at cap rates in the 6-8% range, so those properties are not as cash-profitable as IIPR’s… but they’re still profitable, and the returns are not going to drop that far, that fast — it’s not like marijuana is going to immediately become as risk-free as leasing warehouses to Amazon.
So no, the banking law doesn’t change my opinion about IIPR or any other investments — it’s likely to be a net positive for pretty much everyone in the industry, and the pot stocks are all so clobbered right now that they could use some good news.
Including my latest speculation in the pot space, which comes in that “catch a falling knife” category and has been rightly painful in the week that I’ve held the shares. The anti-vaping purge has taken the juice out of KushCo (KSHB) at just the worst time for them, when they were holding off on a capital raise in order to hopefully do so in conjunction with a NASDAQ listing, and it’s not pretty.
The first truly draconian vaping ban went into effect in Massachusetts this week — the governor surprised everyone with a total ban on e-cigarettes and vaping pods for four months to give scientists time to figure out why people are getting sick, and this is not just a “save the kids” move as we’ve seen with many of the vaping bans to this point… they’re not just restricting sales in convenience stores or restricting sales of flavored Juul pods that were clearly designed to hook kids (hint for those trying to build an addicted customer base: if you use flavors like “cotton candy,” parents might notice), they’re banning the things entirely. No sales of e-cigarettes or vaping pens or whatever you want to call them, not in smoke shops or convenience stores or, and this is important, even in regulated marijuana dispensaries. Nothing.
KushCo tried to get out ahead of this anti-vaping surge last week by partnering up with some anti-counterfeit firms, and by speaking out in favor of regulations and testing for vape equipment to ensure safety… but that hasn’t had any impact yet, and it sure didn’t form the bottom for the share price as anti-vaping sentiment washed over the country all at once. Now Wal-mart is stopping sales and states everywhere trying to figure out what to do. Massachusetts really put the hammer down, but they probably won’t be the last ones to do so… and California, KushCo’s most important state, might not be far behind.
Oddly enough, KushCo probably would have been better off with an FDA ban on sales of e-cigarettes or a much tougher crackdown on sales to minors and the criminal prosecution of some of the black market suppliers. Juul may well have stopped selling cotton candy flavored nicotine pods, but that doesn’t mean they weren’t available anymore — as of last week, you could have found plenty of “Juul compatible” pods in kid-friendly flavors in lots of convenience stores in New England, and no one was really paying attention to what was in those pods… when people know that what they’re doing is not entirely healthy anyway, the idea that it might be actively unhealthy for some other reason doesn’t necessarily come to mind. Especially if you’re a teenager and are confident that you’ll never die.
Kind of reminds me of the earlier cigarette studies that showed the asbestos and jet fuel and other junk that was in those cigarettes — publicizing those was one more way to try to drive people away from smoking, but people already knew full well that they were taking a major cancer risk by smoking, and the immediacy of the added risk of those extra things that might be in their cigarettes didn’t really jump out. Now that people are actually dying from vaping and experiencing major and immediate lung problems, the question is whether that means vaping itself is much more dangerous than suspected and we just didn’t notice until the problem got big enough for doctors to start making connections… or it’s additives and black market pods that are the problem, and some waves of tainted pods in either the nicotine or the marijuana segment have caused the illnesses.
This is all a good reason to remind ourselves that risk is in the things you don’t see. Six months ago, every tobacco and marijuana company was trying desperately to get ever more into the vaping business, since that was clearly the most popular and fastest-growing part of the marijuana business and the only growing part of the tobacco business. Now, everyone wants to get as far away from vape pens as possible. Probably this moderates, since most things do, but that doesn’t mean all the companies survive or thrive.
The most overwhelming confirmation of the risk to KushCo from the vaping crisis right now comes from the firm itself: They did a surprise $30 million share offering at $1.75, without waiting to see if they could get a NASDAQ listing or get past the first vaping panic first, and that’s a real sign that they’re probably very worried about what the next few months might bring. You don’t raise capital after a 50% drop in the share price unless you’re worried that things very well might get a lot uglier. If real bans on vaping come down from several more states, particularly California, or this panic over vaping lasts for more than a couple months without some sort of “all clear” resolution, then a lot of KushCo’s customers are going to be in trouble, returning inventory if that’s allowed, and ordering a lot less vaping stuff… which is, of course, bad for their bottom line. Vaping is not their most profitable division, and it’s not the only one that is worthy of investment, but it is their largest — and most pot retailers who have been interviewed around the state following this ban indicate that at least a quarter of their revenue comes from vaping equipment. The risk also rises for Canada, which had not yet approved sales of marijuana vaping equipment and supplies but was widely expected to later this year… and if that doesn’t get put on hold, I’ll be shocked.
I liked KushCo because they’re pushing aggressively to be the leading supplier to a growing industry, but that also means they’re burning through cash… and this drop is an example of what can happen when you need to raise cash at the same time that everyone hates you. I thought the price reflected that hate to a good degree last week, but that was clearly jumping the gun.
If vaping survives as a meaningful part of the marijuana business and the health panic is forgotten a year from now, then KushCo is insanely undervalued here… if the pot world just goes cold turkey on vape pens and switches to edibles and regular ol’ smoking, then KushCo will still have a business but they’ll have massive losses and writedowns as they close their vaping business, and I don’t know where the bottom might be.
So I’m tempted to buy more, frankly, because I think this is likely to be an overreaction on the vaping stuff and it’s likely that black-market THC vape suppliers are the ones causing the illnesses (either because of unsafe pens, or because of additives), which could help KushCo and others to push back against the black market with their (probably) safer products… but that’s not “I know” or even “I’m pretty sure”… that’s just “I think”, so I’ll let this sit for a while as we get more information. If things turn out to be OK for KushCo, and vaping with approved equipment and regulated supplies is no more dangerous than smoking, and there’s a rational market for marijuana vaping after the public health world and the FDA have had their say, then KSHB is in a great position. If that happens, though, it probably won’t happen in one fell swoop, and the stock will take its time recovering, so we won’t need to pile on and try to buy it at the bottom… the valuation (in that rosier world) is very low, given their market share and their sales growth, but it will still likely take time to get back to the $3+ level, which means discretion is probably the better part of valor. I did my knife-catching attempt last week, but now I’ll just sit on this small position and watch to see what we learn about the vaping health problems. I’m sympathetic to the idea that this is a problem caused by the black market, but I’m also sympathetic to the idea that maybe vaping in general is just a lot worse for you than anyone expected… and the vaping companies and pot retailers don’t have a lot of friends in Congress, despite the optimism over the banking act, so I wouldn’t expect regulators to try hard to save their businesses at the possible expense to public health, especially because every parent in America is already mad at the e-cigarette industry anyway.
And also in the marijuana world…
Akerna (KERN) reported its quarter, the first one as a “real” public company after their merger with the MTEC blank check company, and it was pretty weak. Nobody was expecting profitability, given the expense of the merger and all the stock options they gave employees as a result, and the business is not huge, but this is a software and service company for a “hot” sector so revenue growth of 4% over last year is not particularly interesting. Yes, their “seed to sale” tracking and compliance software should be reaching a pretty interested market, given all the new legal marijuana businesses being built each day, but so far they have apparently not been able to convince enough of them (states or companies) to adopt Akerna’s software. I still have my little stub of a warrant position that I’ll keep holding while we wait to see how things develop, Akerna has some good backers and it’s possible that it will work out, but I’m not interested in making a bigger bet on the company given the lack of traction thus far. Costs and losses can be borne or explained away, but the lack of revenue growth is a strong negative signal that we’re usually better off not ignoring… you can’t grow into profitability or grow into a valuation if you’re not growing.
We’ve also seen a big fall for the highfliers in recent weeks, and that led to a question from a reader about The Trade Desk (TTD)… so let me just share my current thinking on that.
The Trade Desk is a nutty stock, to be sure, it has massive potential because of the huge size of the online advertising market… but it also trades at a remarkable valuation as they’ve invested in expanding their presence globally and tried to build the business. Even after this latest dip in the shares, it trades at 50X estimated 2021 earnings and at 15X sales…. though the incredible gross margin (78%) reminds you, if you begin to waver, of how insanely lucrative and scalable a growing software company can be if it can keep revenue growth going.
So what is one to do? Well, the question really is whether this is a panic for all the cloud stocks, or just a downturn in sentiment that will recover… and we probably won’t really get much confirmation of that, other than technical reading of the tea leaves, until the next wave of earnings is released — which for most of the overvalued cloud stocks will be in early November (TTD is likely to be November 8).
In the meantime, I don’t have any concerns about the fundamental operations at The Trade Desk (or Okta, for that matter, which is similarly overvalued), so I’ll let the stop loss point provide some sell discipline. For TTD that would be in the low $160s, for OKTA just below $90. That would be the sign, at least according to the VQ% calculations done by TradeStops.com, that those stocks have broken below prices that you might expect to see from “normal” volatility, and therefore there’s a stronger indication that the “trend” or “momentum” is really over.
That’s not a guarantee that TTD can’t trade down to $160 and then, the following week, soar back to $240… but with little fundamental basis for the stock at any price in that range, based on current financials, it’s trading on momentum and sentiment, so we need to be mindful of the .
I’m likely to be more sympathetic with TTD just because it has been consistently profitable and has consistently grown its earnings, and I do love that huge gross margin number, so this is not just a story (OKTA, on the other hand, is nowhere near profitability and is closer to being “just a story,” based entirely on revenue and customer growth, though it’s a great story so far)… but the valuation is certainly speculative and there’s no particular reason why it can’t trade down to 25-30X earnings, or worse in a truly ugly market, and that could see the shares falling below $100. I’m unwilling to sit through that magnitude of a loss for a large position if the market decides to shift from “growth” to “value” for a considerable period of time (an unknowable “if”, but certainly there are indications of that shift in the market now), so I’ll take the stop loss signal seriously if it comes, for either of these stocks. But it’s not here yet, and it might not come, so we’ll see — that’s not much more than a 10% drop from here, and that could certainly hit at any time.
It is good, however, to remember that if you’ve been holding a lot of “hot” cloud growth stocks, even if they feel like they’re different companies and you’re diversified, that sentiment tends to change for whole sectors at once, not just for single companies… here’s what the chart of TTD looks like compared to a bunch of other high-growth cloud software stocks this year (I just used a sampling of the stocks that Barron’s profiled as “possible bubble” stocks back at the end of July):
They’re mostly moving together, and TTD as a profitable one that’s growing fast but not as fast as some, is in the middle of the pack… as it will probably continue to be.
Disclosure: I own shares and/or options or warrants on Shopify, The Trade Desk, Okta, Akerna, KushCo, Innovative Industrial Properties, Starbucks, and Apple. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s trading rules.
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