Cheaper & Less Risky...

August 13, 2017 9:13 PM


Part of what makes the stock market so lucrative, is that it often responds in unexpected ways to new data—offering outsized profits to those that take advantage of these opportunities. Take the curious case of Aimia Inc (AIM – Canada) which I wrote about previously. The bear argument at the time, was that the Aeroplan business was permanently impaired by the pending termination of a partnership with Air Canada in 2020. At the time, I made the case that as long as the Aeroplan business did not have a negative value, the rest of the company’s assets were basically worth the current enterprise value, offering plenty of downside protection along with sizable upside if Aeroplan had true value. Aeroplan could only have negative value if there was a run on the bank where redemptions rapidly spiked and forced the current deferred redemption liability to become a real liability.  Meanwhile, there would be substantial cash flow accruing to equity owners over the next three years until the partnership terminated.

Fast forward a few weeks and the second quarter earnings are out. There was indeed an increase in redemptions, $9 million, or a 1% increase in annual redemptions—in finance, this is called “immaterial.” Even better, Aeroplan is not dying. Card spend was up 3% and new card issuance in June was basically in line with prior trends. Basically, the number one fear of equity holders did not happen. All the talk of a crisis at Aeroplan was just a media echo-chamber. At the time, I was an optimist on the business, but even I was surprised at how resilient it has been. Aeroplan is growing—no one expected that.

AIM1

Why do I bring this up? When I first wrote about AIM shares, they traded for a few pennies over $2.00. Now they trade for about a dime less, yet the investment has been dramatically de-risked. If the market were intelligent, the shares would have rocketed higher to account for the dramatic reduction in risk at the company. Instead, you can buy into a de-risked version of the same investment at a lower price, as the market basically shrugged its shoulders. I added a good deal more and AIM is now one of my largest positions.

Of course, good news can sometimes be “priced in” and that accounts for the lack of price movement. However, I don’t think this is the case as management reiterated guidance of $220 million of cash flow in 2017, with sizable cost savings starting to occur in 2018. This clearly isn’t priced in at a $300 million market cap.

I always ask myself why the market gives you a gift. I think this remains a situation where most logical equity investors are Canadians who are either too lazy or too stupid to actually analyze the company beyond the fact that the partnership with Air Canada terminates in 2020.  In any case, that’s what creates this highly unusual opportunity to buy the same investment, with a much lower risk profile at a slightly lower share price. I tend to REALLY enjoy opportunities like this—they also tend to correct themselves pretty quickly once new investors figure it out.

 

Disclosure: Funds that I manage are long AIM CN

Categories: Current Investments
Positions Mentioned: AIM CN
Comments (0)

That Was SNAPtacular...

August 3, 2017 10:25 AM


Less than a month ago, I warned of SNAPageddon in SNAP Inc. (SNAP – USA) as venture capital shares unlocked and were dumped on the market. Shares of SNAP have now declined by approximately 30% since then—hence my puts increased in value by a few hundred percent.  

woohoo

While I expect earnings next week to be abysmal, followed by more share unlocks, I’m cognizant of not being greedy after a few hundred percent gain in such a quick period of time. I’m ringing the register here and exiting the trade.

On a side note, as a result of my research on Snapchat, I learned of a new chart formation, the puking ghost.

puking ghost

 

Categories: Current Investments
Positions Mentioned: none
Comments (0)

Dr. Feelgood

July 17, 2017 10:26 AM


As an investor, my preference is to find long-term macro trends and invest alongside of those trends. Unfortunately, the current market tends to overvalue the companies participating in these trends, giving me fewer opportunities to find attractive trend-based investments. However, that hasn’t stopped me from searching and occasionally finding a real interesting one.

An increasing percentage of the population is aging and this often leads to chronic pain. Treatment with various opioids has led to an addiction epidemic that shows no signs of abating. Of course, there are other methods for treating chronic pain, such as chiropractic treatment, but public acceptance of chiropractors is still in its infancy—particularly amongst people older than 50—the people who often suffer from chronic pain in the first place. I don’t want to debate if chiropractors help or not—what’s important is that many people who have tried chiropractic treatment believe that it helps and have become recurring patients.  

Unfortunately, most chiropractors are not set up to really serve their customers. Their hours and scheduling are inconvenient and rigid, costs of use are prohibitive and procuring insurance reimbursements is difficult for patients. The Joint (JYNT – USA) is a chain of Chiropractors with over 370 locations in the US, that is growing rapidly through a franchise model. The Joint is substantially cheaper at $18 a visit (when on a monthly plan) than most chiropractors, and offers walk-in appointments making it substantially more convenient for patients. This has led to explosive growth with system-wide positive comp sales of 19% in the first quarter of 2017—which is pretty much unheard of for a franchised business. Even 4-year old locations are comping positive 11%. At the same time, the number of locations has been growing at over 20% a year. You basically have two growth avenues, comparable store growth and unit growth—both occurring simultaneously.

the joint

So, why are shares cheap today? New stores are un-profitable during the first year as the customer base grows. Big cash flow doesn’t come until the third year. During 2015, the company started opening corporate stores in addition to franchise stores. Unfortunately, given the young age of most corporate locations, they’re subtracting earning power from the substantial earnings of the overall franchise business. As these corporate stores mature, they will go from losing money, to substantial profit centers and I believe the company’s value will see a very substantial re-rating.

New management has been in place for almost a year now. They have dramatically cut costs and have ceased opening corporate stores—until the existing store base matures and becomes profitable. This is predicted to happen by year end.

Unlike many of my picks, there is some risk here as cash is somewhat tight and the company expects to continue losing money for at least the next two quarters before rounding the corner and becoming profitable. However, I gain confidence in them getting to cash flow positive, as the CEO and CFO have each purchased shares in the past few weeks.

chiro 2

Playing it forward a few years, I don’t see why this business cannot get to 1,000 locations with 15% of them being company owned and the rest franchised. Based on average store economics at the existing base, you have a very profitable business as franchised businesses tend to have rather high returns on invested capital. Meanwhile, company owned stores should have great 4-wall economics.

I don’t quite know how to value The Joint today, as it is money losing, but it does seem to be at an inflection point towards earnings. With a market cap of under US $50 million, I don’t feel like I’m paying much for the existing business that would be quite profitable, if not for the money losing corporate stores. More importantly, I have a rapidly growing, high return on capital business with a huge macro tailwind behind it.

 

Disclosure: Vehicles that I manage are long JYNT

Categories: Current Investments
Positions Mentioned: JYNT
Comments (0)

SNAPageddon

July 9, 2017 10:10 PM


Back in 2000, as the tech bubble was popping, I made a fortune by shorting recent IPOs right as previously restricted shares were unlocked for sale. These companies came public with only a small percentage of the stock sold in the initial IPO in order to create scarcity and an overvalued stock price. 6 months later, a waterfall of stock would hit the market as the rest of the outstanding shares became free trading.

The restricted shares were coming from VC funds and insiders and these individuals often had cost basis measured in pennies or a tiny fraction of the current share price—meanwhile, the insiders knew deep down, that the companies were obscenely overvalued. Therefore, at their first opportunity to sell, they all hit the bid—often with reckless abandon as they were trying to beat all the other sellers out the door.

The result was that over a few weeks period, the share price would collapse. I previously wrote about how this worked at Twitter. The difference was that, at the time, the bubble in all things social media was alive and well—so Twitter shares bounced back after a proper drubbing during the unlock. I believe that the FANG bubble is now in the process of popping. This means that buyers are no longer willing to prop up silly valuations, which will create incredible opportunities as this decade’s unicorns come public and then experience unlocks—much like in the aftermath of the 2000 bubble.

Snap Inc. (SNAP – USA) is the next of these unicorns to unlock. It is also one of the most ridiculously overvalued stocks in the market today. Despite a market cap of $25 billion, it consistently loses more money each quarter. Even the most bullish analysts—the ones who dumped this IPO on the public—do not expect profits until at least 2021. They meanwhile expect losses of approximately $1 billion during the next two years, before these losses slow. This is scary as cash is rapidly dwindling due to ongoing losses and acquisitions—they’re going to need to raise additional capital soon. Even worse, growth appears to be slowing as other social sites introduce competing products. It’s one thing if you’re burning money to rapidly grow your business—it’s a very different thing if you’re having a bonfire and not even growing fast any longer.

snap unlock

In any case, the only reason the share price is where it is, is the fact that the free trading float is currently restricted. That will all change starting on July 29th when the first of 3 unlocks begins and over 1 billion shares become free trading. I suspect that these will be dumped on the market as rapidly as possible, in order to exit positions before next quarter’s bloodbath of earnings.

I do not short stocks any longer, but I occasionally buy puts when it appears like there’s a great setup. This is a crowded trade, but I’m not sure if it matters. I’m long SNAP puts with enough duration to see this waterfall of stock hit the tape. I wouldn’t be surprised if the shares trade for the mid-single digits by year-end.

 

Disclosure: Long SNAP puts (various strikes)   

Categories: Current Investments
Positions Mentioned: none
Comments (0)

Ready, AIM, Sell??

June 13, 2017 9:06 AM


I have spent much of my career looking for strong macro trends that will drive the performance of individual companies. However, over the past few years, I’ve had much more success buying overreactions to bad news, as the makeup of the market has changed and short-term thinking pervades investment decisions. Often, large fund holders sell without even understanding what the news means. Instead, they’re more concerned with showing their investors that they didn’t own a stock that’s down 80%--especially if it’s a well-known company amongst their investor base. Meanwhile, when in sell mode, future bad news is all colored bad and good news is ignored—then the indexes kick you out and more selling comes on top. It’s just a pile-on. On the flip-side, the move from down 80% to even just down 60% is a doubling of the share price and it often happens rapidly when the selling ends. With that in mind, I might as well tell you why I own so much Aimia Inc (AIM – Canada).

Aimia operates and owns loyalty programs. It’s a reasonably good business, in that their partners buy points that Aimia creates. Aimia then give those points to their loyalty members and then at some later date, those members redeem the points for rewards such as free travel or gift cards. In the interim, Aimia has “float” from the cash that’s been paid for points that have yet to be redeemed. Additionally, a healthy percentage of points are never redeemed and Aimia gets to keep that “breakage” as free profit. Over the last few years, the sector has gotten rather saturated, which has somewhat reduced the value of individual programs, but it’s still a good business—even if it is one that’s in slow decline.

aim chart

In any case, I’m not so fixated on the long-term business fundamentals, as I am on the reason that shares of Aimia declined 80% last month. On May 11, Aimia was notified by Air Canada that they would not be renewing their current relationship after it expires in 2020. Canadians, assumed that this was the end of Aimia as Aeroplan is the largest loyalty program managed by Aimia and Aeroplan with its 5 million members, ranks up there with Tim Hortons and maple syrup in the Canadian psyche. As Aeroplan was itself a spin-out from Air Canada, it was assumed by most Canadians that Air Canada was the entirety of Aimia. What these panicked shareholders have failed to understand is that Air Canada represents approximately 11% of the total points purchased at Aimia and while it is the largest redemption partner for points (loyalty members prefer airfare to other options), this spending power can be re-directed in other places where current and future redemption partners are desperate for the $600 to 700 million in spend that comes from Aeroplan. Even more ridiculously, this change with Air Canada doesn’t occur for three years. During that time, Aeroplan will earn enough to pay off all of its debt and dividend almost the entire market cap out in dividends. In fact, the company is going ex-dividend for the first of those quarterly dividends, representing 10% of the share price on Wednesday the 14th.

A lot will happen between today and June 2020 when Air Canada parts ways with Aeroplan. I think it’s likely that longer term, this is good news for Aeroplan (despite what you read in the financial press) as it diversifies Aeroplan redemption options and allows Aeroplan to direct redemptions towards higher margin options. In any case, it’s highly unlikely that I’ll still own the shares as this all plays out. For me, this is a short-term sort of trade where I’m looking for a bounce from a ridiculously oversold condition.

aeroplan

The shares trade at 1.5x current year’s cash-flow guidance and a 40% dividend yield. While there is always risk to any business—especially one in transition, this business has many other components that are doing well. Aimia has huge value in its half ownership of AeroMexico’s PLM program (likely worth about the same as the current enterprise value), along with many existing point purchasing partners for Aeroplan. I expect that point purchases will decline and redemptions will increase over the next three years as loyalty members leave the Aeroplan network. It seems likely that current guidance of $220 million in cash flow is unrealistic, but the magnitude of the miss is hard to guess at. My hunch is that the miss isn’t all that substantial, but without new guidance, it’s just easier for everyone to sell, rather than think it all through.

Basically, I don’t understand how a change that takes place in 3 years, should yield a company with a $300 million market cap if there is $556 million in cash and liquid investments, with only $450 million in debt, while the company will earn $220 million (guidance) for the next 3 years. Even if they miss the number badly, there’s still a huge margin of safety here. That is before considering the other programs outside of Aeroplan that are likely worth more than the entire enterprise value. There has been talk in the media of an increase in redemptions hitting liquidity—I’m sure that’s happening to some extent and the redemption liability is a true liability, but the increased pace of redemptions is not enough to impair the company. In summary, in a situation with limited transparency in earnings over the next few years, along with a change-over in the C-suite, most investors have chosen to sell—rather than actually evaluate the situation. Aimia is simply cheap and you get paid 40% a year to wait for others to realize this fact.

 

 

Disclosure: Funds that I manage are long Aimia (AIM – Canada)

Categories: Current Investments
Positions Mentioned: AIM CN
Comments (0)

Subscribe

Let me know when Kuppy posts a new comment. My email address is:

 (No spam, ever.)