Trading diary 2 February 2018
This is the experiment portfolio at this point in time. The portfolio recovered the initial losses of almost 10% and is now up a few percent to $92k from the start in mid-December.
After detailing my thoughts on Criteo I received a lot of pushback from shorts and former longs. I realized I was wrong and decided to let go of the shares on the pullback. I made two primary mistakes: one was taking a large position in a company whose competitive position is vulnerable to actions by its “suppliers” – Google, Facebook and to a lesser extent Amazon. The second mistake was simply insufficient knowledge about the future impact of GDPR, and in particular the ePrivacy Directive, which could ban the sharing of customer data between publishers and the likes of Criteo. It is fine to take positions first and then investigate, but not when a company is facing a difficult test in the near term that is difficult to get a grip on.
I increased the position in Great Wall Motor as my conviction has strengthened about the company’s product pipeline. Investors are looking in the rearview mirror, and don’t realize that the hottest new vehicle releases in 2018 will come from Great Wall, rather than Geely or GAC. The sweet spot in Chinese auto is RMB 100k SUVs and to a lesser extent sub-RMB 100k sedans. Great Wall just released the 1.5T Haval H6 in November – the first update since 2012 – and representing almost 50% of revenues last year. Then we have the Haval H4, a smaller SUV right positioned right between best-sellers H2 and H6 and the H6 coupe, due for the second half of 2018. I am getting a PE ratio 5x for 2019e under an auto market steady-state scenario, which in my view underestimates the potential of the company. Founder Wei Jianjun is a Chung Mong-Koo type personality that runs his company with an iron fist – necessary to ensure cost competitiveness and quality control. JD Power IQS rankings and PP100 scores for Chinese vehicles are steadily increasing, and given auto worker wages at 1/5 of Detroit and German levels, one would think that the long-term export potential should be large. The big question mark here is whether the overextended Chinese auto cycle will hold up. I am betting that I will be able to catch the turning point, by closely watching CPCA inventory and survey data.
The short in Zhongsheng Group has not worked out as expected. The rationale for entering it was Korean vehicles taking back share from Japanese brands post the resolution of the THAAD conflict, a heavily oversupplied dealership market as well as a weaker auto market following a higher purchase tax on 1 Jan 2018. While Japanese-vehicle auto producer GAC has already taken a hit by weaker Toyota China sales, Zhongsheng has not yet been affected.
The crypto bet has started to play out in my favour. The bets have so far not made much money for the account however. Bitcoin prices started breaking down in mid-December as predicted by Sornette’s LPPL model across multiple time frames. Yet the impact on investor appetite for ICO was not as direct as I had expected. The CRIX Crypto Index raced ahead until early January and has now formed a head-and-shoulder pattern. I believe the ICO market is breaking down, yet most of the “ICO plays” such as KODK, OSTK, SRAX, XNET etc are still close to all-time highs. I expect to run out of steam slowly over the next two or three months as the ICO market contracts. Facebook and Google’s action to crack down on cryptocurrency ads will also help shrink ICO fund raising activities.
On offshore oil services, there is particular strength in the North Sea market, which is helping Standard Drilling achieve high utilization rates. Offshore driller earnings calls are optimistic. It will take 2 years for the OSV market to reach an equilibrium, but at $60+ Brent it is a high conviction call. Standard Drilling still trades at perhaps a third of what normalized vessel prices should end up at in a few years’ time. I have not added to the position but I bought some Tidewater on weakness – a stock that is equally cheap in terms of discount to long-term vessel values, but more liquid – though with a weaker management team.
Another new position is a small short in Prestige Brands Holdings. It is a roll-up of healthcare OTC products whose organic growth is hitting a wall. Accounts receivables are blowing up, growing 57% last quarter vs 20% revenue growth. The company has spent almost $2 billion in acquisitions over the past year, yet the company’s cash flow from operations has barely budged. The business model of outsourcing of R&D via acquisitions is unlikely to work in an overheated market. The company’s value-add is supposedly in marketing – but historically that has not proved to be a sustainable competitive moat. What the company has ended up with is a $2.2 billion in debt – 2.4x sales – and a market valuation of $4 million per employee. With the large accounts receivable divergence, I am betting that the growth is starting to decelerate.
With a view that we are now in a tech blow-off phase, I have kept a large position in JD.com and bought a stake in 180 Degree Capital Corp – a company that should do well in a tech blow-off. Retail is showing a strong interest in tech stocks, as evidenced by very strong ETF flows and retail brokerage trading activity. It is as if the crypto bubble has awakened animal spirits among retail investors. Despite exhaustion signals in the major indices over the last few days, the leaders such as the FANG stocks keep going higher, suggesting a potential for FOMO. The blow-off phase has lasted about 2 months and as far as I’m aware of, there has never been such a short period of speculative euphoria – it usually keeps going for five or six months at the very least. JD.com and 180 Degree Capital Corp are value plays, however, with some cushion on the downside thanks to low multiples. The former is trading at a low multiple to sales despite a very strong competitive position in Chinese e-commerce, a sector that is growing in the 30s. It enjoys a unique distribution network and a strong relationship with Tencent, who controls the WeChat platform.
The reason for buying 180 Degree Capital Corp is its CEO Kevin Rendino, former manager of a $11 billion value fund at Blackrock. He is a clever speculator. The company owns a fair number of unlisted tech companies as well as a new portfolio of listed stocks. So far, his performance has been outstanding. The stock is trading at a 30% discount to its NAV, which by the way does not include a significant amount of NOLs. The strategy of the firm is to liquidate the portfolio of unlisted stocks, and turn it into a closed end fund run by Rendino. They will then seek to raise capital through a new broker-dealer license, and take fees along the way. Given a sub-$60 million market cap and Rendino’s respectable performance at his previous employer – how big can the AUM get? Massive insider buying suggests management has faith in the company’s prospects as well. A tech melt-up is also a favourable backdrop to liquidate privately held tech companies. The NAV for unlisted assets is based on publicly traded comparables, and they gone nowhere but up over the past few months. Add to that continued positive return among public stocks in the portfolio, and you can bet that the NAV will continue to inch upwards over the next quarter or two. I could be wrong in my view of a tech stock blow-off. But at a 30% discount to NAV even against 30 Sep 2017 NAV I believe the cushion is fairly strong.
Liquidity is likely to deteriorate as we go into the second half of 2018 as ECB and BOJ stop asset buying programs. The key indicators I am looking at for a turn are junk spreads, US Dollar strength, gold/copper and margin debt. None of them signal a crash in the very near term. It is an odd period of time to invest, given the amount of retail participation and speculative excess. A long-term investors is probably best advised to stay out of the market. For this account, I will keep the gross exposure at a fairly high level and try to trade around any speculative euphoria.