Today’s article is a rerun of an article that first appeared for paying members of the site in the Friday File about two weeks ago. It has not been updated or revised, though both stocks mentioned are trading fairly close to where they were at the time this was first published.
With IPO excitement again hitting the market pretty hard over the last six months, including the crazy performance of Yandex and LInkedIn, and the increasing lust for a “someday” Facebook IPO, I thought today’s Friday File it might be a good time to take a look at this new teaser from Jon Markman.
Markman’s newsletter doesn’t often tease stocks in their ads — he’s more of a trader, so he teases us about his techniques and past performance — but I’ve written about his ideas on occasion. This time it’s sort of a mix — he tells us that he’s got the best way to trade IPO stocks, but he also teases us about two specific ideas.
So what’s his strategy?
Here’s how he introduces it in the ad:
“The Secret to Trading Hot IPOs
“Avoid the Feeding Frenzy and Make a Ton of Money…
“The stock market is catching a wicked case of IPO fever. Which means there is a ton of money to be made right now by traders like us.
“But if, and only if, you know how to play it right.
“You probably noticed the wild ride of white-hot IPO LinkedIn. As the first social networking company to go public, this much anticipated and overhyped event became a frenzy of speculation, with more LinkedIn shares traded on its first day than traded that day in Apple, Baidu, Google, Amazon, and Netflix… combined.
“While frenetic trading may have handsomely rewarded a few privileged fat cats by day’s end, it left many regular traders licking their wounds and counting their losses, as the price rose then dove in a quick and dangerous game of musical chairs — Wall Street style.”Are you getting our free Daily Update
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So that caught my interest. What, then, is his strategy?
“The Smarter, Safer Way to Big IPO Gains
“I’m Jon Markman, and I love trading IPOs for big gains. But let me repeat for you one thing I made clear well in advance to my Trader’s Advantage readers: I wouldn’t go anywhere near LinkedIn shares on day one, day two or even day ten of its trading.
“That kind of Wild West action is just way too dangerous and unpredictable.
“You see, within minutes of becoming public, the froth had made LinkedIn the most expensive shares in the U.S. on a price-to-sales basis. It was like the worst of 1999 all over again.
“Now there may very well come a time when we want to swoop in and pick up shares of LinkedIn, and if you join me at Trader’s Advantage, you’ll know exactly when to make your move.”
Hmmm. Well, I agree with him about LinkedIn, at least. So how does he trade these IPOs if he doesn’t like to get into the first-day frenzy?
“The first few days after an IPO belong to speculators trying to make a quick buck….
“And it’s after that speculative fervor subsides when the fun starts for traders like us.
“You see, this is when the share price inevitably plummets. This will surely get our attention, but it will still be too soon to make our move.
“Why? Because some of these once-hot IPOs never recover — think Pets.com and TheGlobe.com from back in the day.
“But the good ones, the ones we want to trade, will catch a second wind. And as the price begins to rise again, this time it will not be based on raw greed, but on a company’s business success.
“And this price resurgence is often accompanied by two very important things:
“First, it often comes around the time the company issues its first earnings report, very often with stellar results.
“And second, it is around this time that stock options are often issued on the best companies, giving us the chance to turbocharge our gains.”
OK, still no real disagreement — I don’t know if it’s always necessary to wait until a new company “plummets,” but that all depends on what your definition of “plummet” means. I didn’t buy Google (GOOG) at the IPO, but I did start buying it about six months later when it was lingering under $200 and the insider lockups were expiring. That wasn’t a “plummet,” but at the time GOOG did hit a plateau and dip a bit. I’ve held the shares since then, more than five years now, so I’m clearly not the same type of trader as Markman, but he does have a good point — not that the shares necessary fall from their IPO price, since Google at that time was still more than 100% up from the IPO, but that they often plateau or dip when the first enthusiasm wanes, or when they release anything like bad or disappointing news (bad news, even “slightly” bad news, usually hits IPOs much harder than established companies), or when the insiders sell huge chunks of their shares.
This is not a shocking new revelation, of course — there is a general “Street wisdom” that the 3-6 month period after an IPO is when longer-term investors should start to take notice. There are obvious exceptions, as with all “averages” and “conventional wisdom” ideas, but it is a very rare IPO that is so successful that it can withstand the first few months of trading without any substantial drops, and even the most successful of them almost never go up in a straight line.
This is all assuming, by the way, that you can’t get in on the actual initial offering of stock that you think is fundamentally fantastic — and of course, most investors can’t. In retrospect Google was one such case, though the enthusiasm on the first day was not as dramatic as they hoped due to their need to be “different” in pricing and going public (it had some soft spots in that first six months, but never came close to getting back to the $85 IPO price — and, importantly, had established itself and been profitable for three years before the IPO), and Visa would have been a spectacular buy if you got in on the offering (officially priced above the range at $44, but hit $69 that first day and closed in the high-$50s … and only traded below that point for the worst six months of the financial crisis, though, to be fair, that also came about six months after the IPO).
Trading through the rearview mirror, though extremely successful, is unprofitable — so what, then, is one to do in the present? For that we come to the two stocks that Markman actually teases in this ad (I got the ad just yesterday, by the way, so it hasn’t had a chance to get stale yet). Here’s how he gets to the specifics:
“A Feast of IPOs Are Coming Our Way
“Last week, LinkedIn captured all the headlines. Now we have Yandex, Russia’s largest Internet company with nearly three times more of the Russian search engine market share as Google.
“And over the course of the next year, you’ll have the chance to invest in a bunch of great IPOs. Companies ranging from Twitter, to Groupon, to Toys R Us, to Prada, culminating with the Superbowl of IPOs next year, when Facebook goes public.”
Markman then uses the standard list of huge gains from 2011 recommendations to claim his throne as master trader — most of them options trades on stocks like Netflix, Union Pacific, United Technologies, Apple, Qwest, IBM, Caterpillar … and what do those stocks have in common? None of them is within five years of its IPO — I’m pretty sure the youngest of those is NFLX, and they went public in 2002. At which point we clearly should have all sold our houses, auctioned off kidneys, and combed the beach with metal detectors to scrounge up cash to buy as many shares as we could … and yes, there’s that “trading in the rearview mirror” thing again. NFLX, for whatever it might be worth, also had a “soft patch” about six months after its IPO way back when, though their first real stock price collapse came a couple years later, in mid-2004.
Finally, then, the specific stocks:
“Two IPOs to Trade Now
Here are two recent IPOs that I am really excited about trading now.
“IPO Trade #1:
“The first one is an energy company you probably have never heard of. But it is a powerhouse in the exploration and development of oil and gas off the West Coast of Africa — an underdeveloped but fertile ground for huge, new resource discoveries.
“Lately, the oil assets they control have been subject to a bidding war, with Exxon reportedly offering them $4 billion, and a group led by China’s CNOOC and BP upping the bid to $5 billion.
“But instead of cashing in now, this company will take the $594 million raised through its recent IPO and use it to fully explore the oil-rich territory it controls.
“Frankly, I love to hear when IPO funds are slated to leverage business development rather than allow the company founders to buy a bigger gated mansion with a private yacht.
“And the shares of this newly public company are acting great — with the perfect chart pattern indicating the speculators have moved on (perhaps to LinkedIn) and the committed traders and investors are moving in.
“It’s time for us to pounce.”
Well, clearly Markman isn’t holding out for a multi-month waiting period after an IPO for every trade — this one has been public for two and a half weeks, they entered the market at about $18, at the top of their expected IPO range, on May 11, and the stock got a small pop on that day but, in part thanks to somewhat soft oil prices, the shares have been pretty flat since the IPO, bouncing around a few percent but mostly sticking close to the mid-$18 range, which is where the shares are right now at $18.50.
The company is Kosmos Energy (KOS), a West Africa oil story, with their major producing asset being a 23.5% stake in the Jubilee field that’s operated by Tullow (Anadarko has a stake as well, as do some other smaller partners). Jubilee is expected to be producing at a peak of 120,000 barrels a day by later this Summer, and is producing now at something like half that rate, so there is real cash flow coming — I don’t know if they’ll be profitable at this price or not, since that probably largely depends on how much money they spend drilling. They say they’ve raised enough money now for their next few years of drilling and exploration, money that is mostly aimed at making new discoveries or extending their discoveries in the two blocks where they have interests offshore Ghana, as well as some potential drilling in one of their offshore Cameroon blocks and continued seismic and evaluation work offshore Morocco. And I assume they’re keeping an eye out for acquisitions as well, though they haven’t mentioned that.
The company is not necessarily cheap based just on their share of the producing Jubilee field — after the successful IPO they now have a market cap of just under $7 billion, which is substantially higher than the value that other players have put on that particular field. Based on Anadarko’s buyout of a small partner in the same field (which valued the whole field, by inference, at about $17.5 billion) and on ExxonMobil and CNOOC attempts to take over Kosmos’ share of the field before they went public (offers ranged from $4-5 billion), the open market value of their share in that field is probably somewhere in the range of $4.5 billion-ish. That means you’re paying something like $2.5 billion for their other potential discoveries in these blocks, and for their blocks offshore Cameroon and Morocco. That might indeed be worthwhile, if you extrapolate their expertise and foresee more big discoveries from Kosmos (they did discover the Jubilee field, so that adds to the glow of their reputation), but it’s arguably not exactly dirt cheap, even with their positions in the West African deepwater fields that so many look at with great optimism.
Probably the downside of Kosmos is simply bad news, as it is with many IPOs — it’s a big company with solid oil production, and did not experience an immediate pop to the IPO that has to be “worked out” on the charts, so we wouldn’t necessarily expect the price to trend down out of apathy … but they are dependent on Tullow really increasing production as expected in Jubilee, and the performance of the share price, if we assume that oil stays steady and Tullow produces successfully, probably depends more than anything else on additional good drilling results off Ghana or, possibly, off Cameroon. Still, as long as oil prices don’t collapse you probably do get at least a bit of a foundation for the price somewhere in the low teens even if there’s weak news, since that represents the roughly $5 billion that a big oil company (including current partners Anadarko or Tullow) might pay to take over their share of Jubilee and neighboring Ghanaian exploration territory.
Kosmos is an interesting company with good and experienced management, and with good discovery history in the West African deepwater (in addition to discovering the Jubilee field, the management team here also played a role in discovering the big Equatorial Guinea offshore fields), so I don’t know how exactly Markman “sets it up” for a trade but I may keep an eye on it to see if there’s any bad news that brings it down in price but doesn’t materially impact the value of the Jubilee field. There’s also always potential for surprising big buyout offers for these kinds of assets, though it’s a bit more complicated in this case since Kosmos has substantial partners in all of its blocks — including the governments of the respective countries, who exercise some veto power over transactions — and Kosmos has already rebuffed a couple suitors. There’s a quick article about the IPO here if you’d like to get started on a little more detail, and they explain their basic portfolio and strategy here.
Oh, and per Markman’s interest, KOS does have options trading now — but very few contracts have changed hands just yet (open interest across all possible contracts, strike prices from 17.50 to 22.50 and expirations out to January 2012, is only about 50, which is absurdly low, and most contracts haven’t traded at all), so if you decide to do any options trading in KOS shares you’ll probably be the one setting the market.
So what’s Markman’s second IPO?
“IPO Trade #2:
“This second IPO is a household name with a long reach into over 100 countries throughout the globe. This company was founded way back in 1923 but subsequently went private. It only issued a new IPO earlier this year.
“I love the recent market action of these shares as they have been steadily powering higher from a quiet start despite all the back-and-forth market action of the past few months.
“With over $5 billion in revenues and an annual growth rate of 22%, this is a prime trading setup for us.”
Interesting, I hadn’t ever looked at this company as an investment before but this is the progenitor of the consumer research business, Nielsen Holdings (NLSN). Nielsen was indeed founded in 1923 by Arthur C. Nielsen as a market research business, though perhaps it’s fairer to say that Nielsen invented market research — he’s also credited with coining the phrase, “market share.” Don’t know if that’s really true. By the 1940s Nielsen was in the businesses that we more frequently associate with the name, with a new tracking device to monitor which radio stations listeners were tuned to, and in the 1950s they applied the same basic idea to television to create what are now known as the Nielsen Ratings.
The corporate history has been convoluted, with about a half-dozen different strategic and private equity owners of the company over the last 30 years, including some periods when the different businesses were split among different owners — but the latest owners were a group of private equity firms who took the company over in 2006, spun off some parts of the business (including their publishing group, which included titles like Adweek and Billboard) and revamped others (including getting back into radio monitoring after giving it up 40 years ago), and, with projections for decent profitability, took them public in February this year at $23. That valuation, assuming the analysts are right about their forecasts (this is a big, $10+ Billion company, so there are a good number of analysts making estimates), would have given them a PE based on expected 2011 earnings of about 15 — now, with the shares having climbed pretty steadily to $31, Nielsen trades at about 20X this year’s expected earnings.
I don’t know if this will end up being a great investment or not, when it comes to their business I have a hard time figuring whether or not their new media tracking and their next-generation consumer research will be able to maintain any kind of advantage in a more competitive environment (their margins are currently pretty tight), but they will probably do at least reasonably well based on the steadiness of their contracts with huge advertisers and consumer-facing firms (like Coca Cola and Procter and Gamble, for example) and on their global presence in some growing consumer economies — maybe not exciting, and you can argue about whether that’s worth a market-premium valuation, but it doesn’t necessarily get me all hot and bothered.
Beyond any assessment of their business and their expected steady-but-not-spectacular profit growth (the estimates put next year’s sales growth at less than 10% and earnings growth of 20% next year, but far less, more like 10-13%, in the next several years, so the Price/Earnings/Growth (PEG) ratio is about 1.7, which is probably above average for the S&P but certainly not outlandish — that puts it in the same valuation neighborhood as stocks like McDonald’s, Boeing, UPS, Deere, the list goes on), it’s also worth noting two things that might hurt the share price this year: debt, and insider selling.
Since Nielsen was a leveraged buyout, one way for the private equity investors to get their money’s worth was by loading the company up with debt — and that debt service was arguably why Nielsen, though they’re expected to be profitable this year, did not report a profit last year. The IPO money is apparently largely going to pay down debt, not to fund any particularly growth ambitions, so that’s a little bit less exciting — but more importantly, the IPO is also intended to set a price for the private equity backers to begin to “monetize” (ie, sell) their shares.
Which is why it’s possible that insider selling might hit this stock fairly hard in the months ahead. Unlike Kosmos, which was taken public by the company itself, Nielsen was taken public by private equity owners who would generally be expected to want to sell their shares, and they still hold a huge chunk of the company. The private equity owners of Nielsen before the IPO, names like KKR, Thomas H. Lee and Blackstone did NOT sell their shares in the IPO, though they did generate some considerable fees, so although they’ve seen their asset value increase as the shares have gone up, they haven’t actually booked much in the way of profits from their equity stake yet. No doubt they’d like to, since the current equity valuation of the company means that their initial $10 billion investment to buy the firm back in 2006 has probably almost doubled. The risk here is that private equity investors still own roughly 80% of the company, and the company will have to show some very good performance in order to prevent the eventual selling of those private equity stakes from pressuring the stock price — since these investors own so much of the company and they’re not dummies, I can’t imagine that they’ll sell it all in short order, but I’d bet that they will start a selling program pretty quick once the lockup period expires, which should be sometime in July.
I’d guess that Nielsen is one of those IPO stocks that might hit its “soft spot” or even take a considerable fall near the beginning of that lockup period in a couple months, but that’s just a guess — and it could easily, if it releases some unexpectedly great earnings, go up a fair piece from here before that happens. Their next earnings release is also around the same time as the lockup expiry, the earnings announcement is expected to come out on July 25, so mid-summer should be a good time to watch NLSN if you’re interested in the shares — I wouldn’t personally get interested in the stock until then, and I have no real reason to think I’ll be excited about them at that time, either, but I definitely don’t feel any urgency to get into the stock right now.
Of course, I don’t know exactly what Markman’s “prime trading setup” means, or even whether he thinks the shares are a good speculation at this price — the brief teaser spiel seems more optimistic about Kosmos right now than about Nielsen, and I’d agree with that assessment.. There are options available on NLSN now — one possibility would be that you could use options to speculate on the stock dipping after earnings/lockup expiration and then rebounding later in the year, by doing something like buying the November $30 calls and selling the August $30 calls against them, which would probably cost you somewhere in the neighborhood of 75 cents (hard to say, since they’re all pretty thinly traded). That’s not a recommendation, of course, it’s just one possibly way you could think about trading off of how you expect the shares to react over the next six months or so.
Full disclosure: I currently own shares of Google. I do not own shares of any other company mentioned above, and will not trade in any mentioned company for at least three days.