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Monday, October 3, 2011
Friday, June 24, 2011
Investment Idea - Life Technologies (LIFE)
Business
Life Technologies Corp. is a “picks and shovels” type business in the biotech industry. It has three main product groups: 1) molecular systems which produce products used to prepare biological samples and analyze gene functions, 2) cell systems which produce products used to grow cells and analyze cell functions and, 3) genetic systems which produce products used to sequence and analyze DNA.
The business has several attractive characteristics. First, the company sells into diversified end markets including hospitals, commercial applications, biotech and pharma, and academic and government research laboratories. End market uses include forensic testing, molecular medicine, synthetic genomics, food safety, and animal health. Second, the majority of the revenue stream is recurring. Consumables and services make up about 80% of revenues with instruments sales contributing the remaining 20%. Third, the company sells into a diverse geographic footprint. The Americas, which includes North and South America, make up about 50% of sales, Europe 32%, Japan 10%, and Asia-Pacific the remainder 10%. Growth is positive in all markets. Emerging markets, which make up about 10% of revenues, are currently growing at about 30% per annum.
Consensus Viewpoint
The majority of sell-side analysts have included margin and top line growth into their models as evidenced by consensus estimates.
The current share price, however, does not reflect future margin improvement or growth potential. This suggests that the market is either 1) unaware or misunderstands margin and growth opportunity or, 2) is skeptical of the story. As a significant portion of revenue comes from government funded biotech research, perhaps some anticipated funding cuts are already priced into shares.
Investment Thesis
LIFE shares have two main valuation improvement levers: 1) margin improvement and, 2) growth potential.
The creation of LIFE in 2008 through the merger of Invitrogen and Applied Biosciences created an entity with large potential synergies relating to cost reduction. There are several post merger margin improvement opportunities in the areas of manufacturing productivity, supply chain efficiencies, and fixed cost leverage. Management’s goal of expanding operating margins by 230 basis point over the next two or three years seems reasonable given the large redundancies between the legacy Invitrogen and Applied Biosciences businesses. A reading of LIFE’s proxy statement reveals that part of executive compensation is directly tied to ‘synergies’ giving a direct incentive to boost profitability. Using Economic Value Added (EVA) based discounted cash flow models, margin improvements prospects do not appear to be reflected the current share price.
The company makes equipment and consumable products used in the study of genes and proteins. The end uses of these products are growing rapidly, even in slower growth developed economies. LIFE’s products are used in the fast growing fields such as forensic testing, molecular medicine, food and water safety, and synthetic biology. As an example, LIFE products were used in the recent E. coli crisis in Germany. While assuming an above average growth rate in valuation models would seem reasonable, the current price does not reflect a large growth premium. Investors are getting a low cost (or possibly free) growth call option.
Valuation
Using the concept of Earnings Power Value (as defined by Columbia professor Bruce Greenwald in his book Value Investing), we approximate the no growth value of LIFE shares to be between the mid 40’s and 60 suggesting investors are not paying much (if anything for growth) at the current market price.
Our valuation estimate assumes 5% top line growth and continued margin expansion. By 2012 the top line should be about $4 billion with 35% EBITDA margins. Using TEV/EBITDA multiple of 10x with a reduce shares outstanding count of 170 million (management has indicated share buybacks are a cash use priority) we come to an intrinsic value of $70 per share.
Life Technologies Corp. is a “picks and shovels” type business in the biotech industry. It has three main product groups: 1) molecular systems which produce products used to prepare biological samples and analyze gene functions, 2) cell systems which produce products used to grow cells and analyze cell functions and, 3) genetic systems which produce products used to sequence and analyze DNA.
The business has several attractive characteristics. First, the company sells into diversified end markets including hospitals, commercial applications, biotech and pharma, and academic and government research laboratories. End market uses include forensic testing, molecular medicine, synthetic genomics, food safety, and animal health. Second, the majority of the revenue stream is recurring. Consumables and services make up about 80% of revenues with instruments sales contributing the remaining 20%. Third, the company sells into a diverse geographic footprint. The Americas, which includes North and South America, make up about 50% of sales, Europe 32%, Japan 10%, and Asia-Pacific the remainder 10%. Growth is positive in all markets. Emerging markets, which make up about 10% of revenues, are currently growing at about 30% per annum.
Consensus Viewpoint
The majority of sell-side analysts have included margin and top line growth into their models as evidenced by consensus estimates.
The current share price, however, does not reflect future margin improvement or growth potential. This suggests that the market is either 1) unaware or misunderstands margin and growth opportunity or, 2) is skeptical of the story. As a significant portion of revenue comes from government funded biotech research, perhaps some anticipated funding cuts are already priced into shares.
Investment Thesis
LIFE shares have two main valuation improvement levers: 1) margin improvement and, 2) growth potential.
The creation of LIFE in 2008 through the merger of Invitrogen and Applied Biosciences created an entity with large potential synergies relating to cost reduction. There are several post merger margin improvement opportunities in the areas of manufacturing productivity, supply chain efficiencies, and fixed cost leverage. Management’s goal of expanding operating margins by 230 basis point over the next two or three years seems reasonable given the large redundancies between the legacy Invitrogen and Applied Biosciences businesses. A reading of LIFE’s proxy statement reveals that part of executive compensation is directly tied to ‘synergies’ giving a direct incentive to boost profitability. Using Economic Value Added (EVA) based discounted cash flow models, margin improvements prospects do not appear to be reflected the current share price.
The company makes equipment and consumable products used in the study of genes and proteins. The end uses of these products are growing rapidly, even in slower growth developed economies. LIFE’s products are used in the fast growing fields such as forensic testing, molecular medicine, food and water safety, and synthetic biology. As an example, LIFE products were used in the recent E. coli crisis in Germany. While assuming an above average growth rate in valuation models would seem reasonable, the current price does not reflect a large growth premium. Investors are getting a low cost (or possibly free) growth call option.
Valuation
Using the concept of Earnings Power Value (as defined by Columbia professor Bruce Greenwald in his book Value Investing), we approximate the no growth value of LIFE shares to be between the mid 40’s and 60 suggesting investors are not paying much (if anything for growth) at the current market price.
Our valuation estimate assumes 5% top line growth and continued margin expansion. By 2012 the top line should be about $4 billion with 35% EBITDA margins. Using TEV/EBITDA multiple of 10x with a reduce shares outstanding count of 170 million (management has indicated share buybacks are a cash use priority) we come to an intrinsic value of $70 per share.
Sunday, February 13, 2011
Risk and the Value Investor
The continued adherence to efficient market theory ironically makes the market less efficient. The reason: the data hungry models used to describe optimal portfolio asset allocation equate volatility with risk. The models are indifferent to whether assets are cheap or expensive in terms of current relative and absolute yields.
The obsession with this one dimensional measure of risk may actually work against the prudent man rule. In the aftermath of the 2008 credit crunch, many professional fiduciaries, as advised by their consultants, actually increased their allocation to bonds. They did this even as the benchmark 10 year Treasury Bond yielded 2.5% (a multiple of 40 times "earnings").
The value investor's view of risk differs from the conventional view. A value investors' definition of risk is permanent capital impairment. As Dr. Michael Burry puts it in Michael Lewis's book The Big Short "real risk is stupid investment decisions". Investment success always comes down to one thing: the price paid. Everything is a buy at one price and a sell at another. Risk always increases as the price goes up.
The obsession with this one dimensional measure of risk may actually work against the prudent man rule. In the aftermath of the 2008 credit crunch, many professional fiduciaries, as advised by their consultants, actually increased their allocation to bonds. They did this even as the benchmark 10 year Treasury Bond yielded 2.5% (a multiple of 40 times "earnings").
The value investor's view of risk differs from the conventional view. A value investors' definition of risk is permanent capital impairment. As Dr. Michael Burry puts it in Michael Lewis's book The Big Short "real risk is stupid investment decisions". Investment success always comes down to one thing: the price paid. Everything is a buy at one price and a sell at another. Risk always increases as the price goes up.
Friday, February 11, 2011
An Important Flaw of the Efficient Market Theory
"The same finance scholars who claimed that you couldn't predict future stock price movements by looking at past stock price movements were embracing the idea that future stock volatility could be predicted by looking at past stock volatility."
From The Myth of Rational Markets by Justin Fox
This theory is the cornerstone by which the consultant industry advises institutional investors. The theory, despite the above mentioned flaw in logic (and many other flaws) will be around for some time to come because 1) it provides a C.Y.A. blanket for institutional fiduciaries and 2) a lot of consultant and academic paychecks depend on it.
From The Myth of Rational Markets by Justin Fox
This theory is the cornerstone by which the consultant industry advises institutional investors. The theory, despite the above mentioned flaw in logic (and many other flaws) will be around for some time to come because 1) it provides a C.Y.A. blanket for institutional fiduciaries and 2) a lot of consultant and academic paychecks depend on it.
Thursday, February 10, 2011
Lessons Learned from Seth Klarman
Seth Klarman – Lessons Learned – From a speech at Babson College 3/29/2010
Things that never happen before happen with regularity
You don't have to make every last cent on a holding
Conservative posturing prevents you from pain
Risk is relative to the price paid
Uncertainty is not risk
Never trust in risk models
Markets are driven by behavior not physical sciences
Never take risk in cash investments
Private market value is garbage
A broad and fluid investment approach is critical
It is critical to buy on the way down
It is better to be early than too late
Financial innovation is dangerous
Ratings agencies should never be trusted
Get well paid to take liquidity risk
Public investments are mostly superior to private investments because you can average down
Beware of leverage in all its forms
Match liability and asset duration because it is never safe to assume debt can be rolled over
Financial stocks are particularly risky
Having clients with long term orientations is critical
Pay no attention to government officials that say the problem is contained
The repeated follies of others is what makes the markets inefficient
Other nuggets of wisdom:
"The essence of value investing is behavioral"
"There is no money to be made in macro-economic forecasts"
"Forecasting macro-economic measures and short-term price movements is impossible. Focus what you can control which is your process and approach. Control of your process is critical."
"Don't buy from other good value investors. Buy from panicked sellers"
Wednesday, February 9, 2011
Long Idea - OMI
Long Idea - Owens and Minor (OMI)
OMI is one of the largest hospital supply chain businesses in the United States.
Shares of OMI are cheap due to the slowdown in the hospital business caused by high unemployment (loss of insurance coverage) and budget cuts. Many sell side analysts are modeling this as a permanent condition because management can't yet quantify when a pick-up in patient volumes might start.
The current stock price suggests that the market is under-pricing future growth potential which has at least 3 levers: 1) expansion into new markets such as ambulatory care centers 2)unemployment rates falling and/or more people gaining access to health care and 3) a continued mix shift towards high margin private label supplies.
The hospital supply market is becoming a duopoly where, on a national scale, the only other large competitor to OMI is a division of Cardinal Health. This national scale creates a competitive moat. As the trend towards consolidation of hospitals and doctor practices continues, logistics managers are looking to consolidate supply chains. OMI's scale and national footprint give the business both a scope advantage and a cost advantage that is difficult to replicate. In the latest earnings conference call, management tried to communicate this growing opportunity to analysts but they were not able to quantify the near term effect on quarterly earnings. The analysts on the call were therefore more interested in talking about things they can model into their earnings forecast such as the numbers of selling days in this quarter versus the quarter a year ago.
OMI's balance sheet is very conservative (probably too conservative) with very little debt. The company just funded the remaining pension liability and terminated the defined benefit plan. The under-levered balance sheet and steady cash flows of the business might attract private equity interest. Capital IQ gives OMI a below average rating for takeover defenses.
The main catalyst for higher share prices is a pick-up in employment that drives patient volumes back to a more normalized level. Assuming this happens sometime over the next three years (caused by on or both a drop in unemployment or some version of Obamacare actually taking effect) the company could earn $2.70+ a share. A 15 multiple, would price OMI shares at $40 giving investors a 30%+ total return including the 2.4% annual dividend.
OMI is one of the largest hospital supply chain businesses in the United States.
Shares of OMI are cheap due to the slowdown in the hospital business caused by high unemployment (loss of insurance coverage) and budget cuts. Many sell side analysts are modeling this as a permanent condition because management can't yet quantify when a pick-up in patient volumes might start.
The current stock price suggests that the market is under-pricing future growth potential which has at least 3 levers: 1) expansion into new markets such as ambulatory care centers 2)unemployment rates falling and/or more people gaining access to health care and 3) a continued mix shift towards high margin private label supplies.
The hospital supply market is becoming a duopoly where, on a national scale, the only other large competitor to OMI is a division of Cardinal Health. This national scale creates a competitive moat. As the trend towards consolidation of hospitals and doctor practices continues, logistics managers are looking to consolidate supply chains. OMI's scale and national footprint give the business both a scope advantage and a cost advantage that is difficult to replicate. In the latest earnings conference call, management tried to communicate this growing opportunity to analysts but they were not able to quantify the near term effect on quarterly earnings. The analysts on the call were therefore more interested in talking about things they can model into their earnings forecast such as the numbers of selling days in this quarter versus the quarter a year ago.
OMI's balance sheet is very conservative (probably too conservative) with very little debt. The company just funded the remaining pension liability and terminated the defined benefit plan. The under-levered balance sheet and steady cash flows of the business might attract private equity interest. Capital IQ gives OMI a below average rating for takeover defenses.
The main catalyst for higher share prices is a pick-up in employment that drives patient volumes back to a more normalized level. Assuming this happens sometime over the next three years (caused by on or both a drop in unemployment or some version of Obamacare actually taking effect) the company could earn $2.70+ a share. A 15 multiple, would price OMI shares at $40 giving investors a 30%+ total return including the 2.4% annual dividend.
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