Investment Activity Review - Part 1 - July 2016

In July I decided to add a few new companies to my portfolio. In this post I will review the first which has been in the news quite a bit and for me is a company I completely don’t have my head wrapped around, but based on valuation, sentiment, and potential, I thought it could be an interesting pickup.  The other is a bit more straight forward and I’ll speak more about it in a separate post. 

I also decided to buy some more stock of a company I currently own so lets get that one out of the way first.

Added to position in Potash Corporation (Ticker: POT)

During the month the company announced it was further cutting its dividend by another 60 percent. The company also reported weaker earnings as prices for potash continue to toil at low prices. Both events were not surprising and it reflected in the stock marginally falling down to the the $20 level.  So I used the opportunity to average down my costs which are now at about $22/share.

In the earnings call, management claimed that prices may be at or near a bottom and expects production and demand to pick up later in the year.  A little spin for sure. We also learned that the latest contracts signed with it’s biggest customers which reside in China and India worked out to about $220/tonne which are near all-time lows.

The potash industry is definitely in a low point of its cycle. It could get worse before it gets better. I have no idea if and when potash price will rise again. All I know is that they appear to be making making enough to cover their cost of capital in a weak market.  Eventually prices will rise and float the stock price higher but I have a feeling it will take time. A lot of people held on to the stock because of the high dividend yield but with that seeming out of play now, it could test the stock price. It will be a bumpy ride, however I’m OK to wait. Potash is a key component in agriculture. I don’t think it can easily be substituted and given more of the world population are moving up the consumption chain in terms of healthier foods, the company should benefit in the long term.

OK now to our new addition….

Opened Position in Twitter (Ticker: TWTR)

This stock and company has not got a lot of love from investors and from me. I’ve written and ironically tweeted in the past that I just don’t get how they make money on this. It’s been a head scratcher for me and yet here I am owning stock in it. How did I get here? Well I got here by the usual path which is answering the 8 questions I ask every time I look at a company.  So let’s get to it.

Question 1: What do they sell?

Here’s the formal description of the company as per Reuters:

“The Company's service is live-live commentary, live connections, live conversations. Its products and services for users include Twitter, and Periscope and Vine. Its Twitter is a platform for public self-expression and conversation in real time. Its promoted products enable its advertisers to promote their brands, products and services, and extend the conversation around their advertising campaigns. Its promoted products consist of promoted tweets, promoted accounts and promoted trends. Its Fabric platform offers modular software development kits that help developers build applications, gives them mobile analytics, the ability to generate revenue through Twitter's mobile-focused advertising exchange, MoPub. It offers subscription access to its public data feed for partners wishing to access data beyond its public application program interface (API).”

Twitter is areal-time newsfeed that you fill with your own commentary, documents, links, video clips, images that you share with people, inviting them into your own real-time existence and vice versa. The proviso? Do it in 140 characters or less. It has become the CNN of the second screen. When a live breaking news story occurs, Twitter has become a source to get information (whether it is vetted and accurate is another question) in real-time and also to communicate with people with your main screen being the TV or maybe your tablet or computer. It got traction because we all have zero attention spans and placing a 140 character limit on tweets can give you quick hits on a variety of content.

Question 2: Who do they compete with?

Twitter competes with other social media content providers like Facebook, Snapchat. It also competes with traditional content providers in the news and entertainment media. Your CNN’s and TMZ’s of the world.

Question 3: Who buys their products and services?

I’m still a bit fuzzy on the “who” is as it pertains to its client base, but I’m willing to take a shot trying to figure it out.

When it first rolled out, it was pretty much used by the young 18-34 crowd and served as a driving force in perpetuating the Millenials as narcissts motif. It still is main demographic however, over the years the reach has gone beyond young demographic to a cross-section of consumers of pop culture, news and information. Currently there are about 300 million users which pales in comparison to Facebook with its 1.5 plus billion user base and it is growing slower. The last report indicated its users grew by 3 million in the most recent quarter.  As for what they are buying, I wouldn’t say it’s about users of Twitter buying things as it is Twitter selling advertising and access to a mass market of users and providing companies tools to segment and target their value proposition.  Right now I don’t think people are buying things directly off Twitter, although I think the company would like to evolve that way.

Said another way, Twitter right now is like Facebook is at its core:  an advertsing company. It makes money selling ads and althought I didn’t believe it, it appears to be selling a lot of ads that once were running more on traditional media outlets and as advertising dollars continue to bleed away from newspapers, magazines, TV and radio, online portals will be big benefactors.

Question 4: Will they buy their product over and over again?

If there is a critical mass of people using the service then yes opportunities will be there to sell companies opportunities to access them to promote their products and services. Twitter, like all Internet businesses has to give people a reason to stick around. It needs to provide meaningful and compelling content.

If you dig a little more deeper, there seems to have been a fair amount of analysis on what attracts people to Twitter and makes them want to come back. Dr. Marion Underwood, a clinical psychologist at the University of Texas at Dallas offered an interesting observation that offers some insight into the phenomenon.

“The type of reinforcement schedule that is the most reinforcing is what’s called an intermittent schedule. So, you have a rat pushing a lever and he gets rewarded, but not in a predictable way. Many times, that animal pushes that lever and nothing comes, but every once in a while, it gets a great treat. So the rat keeps pressing and pressing and pressing even though there’s not much reinforcement coming because every once in a while, it’s just great.”

“Twitter offers these intermittent rewards that keep us coming back. Maybe you’ll check Twitter once and have a notification that someone retweeted you. That’s enough to keep you coming back a handful more times, even if nothing new and rewarding has occurred. We keep pushing the lever, hoping for something great. The concept makes complete sense for those who wind up checking Twitter multiple times each day (same goes for email, too).”

Makes sense to me and I see in my own case why I keep checking in on my account.

Question 5: Do they make money?

I honestly thought they didn’t make any money and when you look at their income statement it’s been losing money the last 3 years, yet they seem to be losing less money every year and revenue have increased 400 percent in the last 3 years. Somebody is buying their product.  When I pulled my favorite metric Economic Profit, comprising operating profits and invested capital, we find that the company has been generating returns on invested capital in the 11-18 percent range compared to it’s cost of capital of about 11 percent, so it is creating tangible wealth. It may not be crazy wealth compared to Facebook or Google but it is tangible. I was surprised to see this.

Source: Valuentum Securities

Source: Valuentum Securities

Question 6: What do they own and who do they owe money to?

They seem to have a clean balance sheet in that they don’t have a lot of Goodwill and Intangible assets and they have a manageable level of debt (Debt/Equity comes in at about 0.20). Their liquidity is extremely strong with a Current Ratio of over 10.5. They more than enough cash to pay off their debts.  They’re not going out of business anytime soon.

Question 7: How risky is their business?

There are a lot of question marks surrounding the long-term viability of their business model. At the same time there some thing going on that are very intriguing. 

Twitter faces a lot of challenges to their business model. It’s not the only service that offers a real-time chat format. Facebook and more specifically it’s offspring, WhatsApp and Instagram offer variants on the timeline format so it’s not like anyone can’t enter this space.

One of features of Twitter is it is quite unfiltered in that as much as it can be an effective source of information, it can also expose users to insane levels of harassment and trolling. As much as Twitter says they take the protection of its users seriously, many users have said otherwise and have dropped out. The company needs to project to the market that its community is a safe one.

The market also has some serious reservations of their management team led by founder Jack Dorsey. After a period where key executives were leaving the company, Dorsey who had left the company to found and manage Square came back like the Steve Jobs/prodigal son to right the ship and the company has come under harsh criticism about any lack of strategy to monetize their product in much the same spirit as Google and Facebook. One of my core elements of my investment ideology is that the company has to have solid competent management. Twitter does not project this very well. Sure it has a dynamic, eccentric, Type A founder but so far the optics have been that the management team has been dysfunctional in establishing and executing any kind of cohesive strategy.

As much as I haven’t understood Twitter’s business model, I’ve been a heavy user. I get most of my investing information and commentary through Twitter now. I get more referrals and contacts through Twitter than I do with LinkedIn or Facebook. Despite this I’ve been pretty indifferent to the stock. Then I came across a piece (via Twitter of course) by Ophir Gottlieb of CMLViz.com who outlined that the company despite being reviled by Wall Street has been very quietly tweeking its offering in terms of content, advertising/analytics offerings.

Location, location, location

According to Gottleib, “…Location tweets are critical in two ways. First, for logged in and non-logged in users alike, access to relevant information (aka tweets) will be impossibly easier. Of course, the next step is how that access makes it an innovation for advertising…Twitter's foundation is real-time communiqués and now it has added location specific targeting in real-time for advertisers and users alike…”

Going all-in on video streaming

“Since video is becoming the end all be all in advertising and video Tweets on Twitter have increased by over 50% since the beginning of 2016, the company has focused on innovation here...”

The company recently announced it is increasing the length of videos that can be posted from 30 seconds to 140 seconds. I’ve tried and from my experience you can say a lot in 140 seconds as a one of my mind maps tweets shows.

 
 

If that’s not enough, the company is going pretty hard at live streaming. It has inked deals with most of the major professional sports league to stream some level of live content. The big one is with the NFL to stream their Thursday Night games. Huge eyeballs and huge advertising opportunities. UPDATE: Since I penned this, Twitter has announced that they will be partnering with Apple to stream the games on their app via Apple TV. This “partnership” got people all giggly and wondering if this is a precursor to an eventual buy-out by Apple? (Stock popped 7 percent on the news).

Maturing the analytics

The company also appears to be taking seriously offering a more robust analytics toolset. Again from Mr. Gottleib,

“Twitter Carousel takes actual tweets to create an advertising unit. Disney, Gatorade and Volvo are already participating. The most beautiful part of Carousel is that the secret weapon is of course, simply, the tweet. It happens 500 million times a day and unlike a Facebook or Snapchat post, is in fact content....and perhaps the best part of that blog post was this little gem: "Disney pulled in Tweets from a variety of influencers on Twitter who gave their permission. " …Now with Insiders, the data analytics side of Twitter has the potential to grow substantially. Beautifully, Twitter data can only be found on Twitter. There will be no Snapchat data product or Facebook friend-voyeurism data product.”

There are a lot of wildcards, but it appears Twitter is trying to respond to them. It maybe not as fast as what Wall Street wants but they seem to be trying. 

Question 8: Is the stock cheap?

Source: Valuentum Securities

Source: Valuentum Securities

The company creating wealth and has a clean balance sheet so from a financial side, it’s seems decent. What makes this stock a speculative investment is how they will execute their strategy which has some appeal but a lot of unknowns and does the management team who has a tendency to get distracted with other projects have the chops to stay focused? The pedigree isn’t there but at current valuations and an overall sentiment that is downright nasty, taking the other side of the trade, could yield more upside if patient.

It has a solid balance sheet with manageable debt so it’s not near any level of financial distress. It appears to be at a point where they are taking the monetization thing more seriously and adopting some clear, tangible strategies to generate additional wealth and this to me was the big reason why I decided to buy in.  The brand is now entrenched in our modern lexicon much in the same level as Google, so there is an intangible value and these elements can make it quite attractive to get bought out. The stock was down in the $16 range which puts at about 40 percent discount to its estimated intrinsic value of about $28-40 range.  Putting these elements together and the fact that so many Smart Money People are trashing this stock (and by the way they were the same Smart Money People who were trashing Apple a few years back and just recently) I thought this would be a good speculative investment. So I bought a very small amount initially and would add a bit more if it should fall back in the near future.

I bought in at $16.88 and shortly after the stock popped as high as in the $18.50 level but quickly gave it back on a supposed weak earnings report even though revenues were up 20 percent (Again nothing makes Wall Street happy). They grew the user base by 3 million which wasn’t Facebooky enough according to the analysts. Yet after the pullback the stock rose back up even further and is now trading near $21 on the Apple partnership streaming deal. It won’t take much to make it go the other way. It’s going to be a rough ride with this stock, but I knew that going in however I definitely have a better comfort level the company after going through my regimen of answering the 8 questions.