Wednesday, 5 December 2012

A bunch of interesting Nasdaq companies (and a free lunch)

Where to find free food in the London's West End



For London-based investors the Nasdaq conference is a bi-annual ritual. Every six months the US exchange buses a clutch of its companies to London to hawk their wares to European investors. Morgan Stanley sponsor the event (usually in a swanky West-End hotel), and unlike the typical closed-door conference, its open to all.

The roster is a fascinating bunch. Its a slightly random grab-bag of small growthy names (often sending CEO or CFO) and grizzled old corporates (Microsoft are a long-standing fixture - thankfully they don't send the CEO!). It's a good intro to bigger names you always wanted to know more about, and mid-cap diamonds who rarely get airtime this side of the pond.

Anyhow, in aid of hunting down interesting companies and obtaining a free lunch (even twelve years after undergrad, there's still a dirty little part of me that believe "free food cannot be a bad thing"), I rocked along.

In no apparent order, some of the names:


The Good, the Bad and the Ugly *


Cadence

Cadence: Like playing Nethack with micron-scale transistors
A $1bn revenue software company operating in a fascinating little niche - software for designing silicon chips (with Ivy Bridge topping 1.4bn transistors, the taping out is all automated nowadays). One of those vertical app markets which gets lost in the noise around the ERP giants and cloud monsters. Two things which stood out:
  1. The sector is now a quasi-duopoly with Synopsis (which one for the team by buying out erstwhile competitor Magma). Duopoly/oligopolies are great for pricing - doubly so in a high margin industry like software.
  2. Licences are recognised ratably over the life of the a contract rather than being bunged through the P&L upfront (viz Autonomy and the wider issue of software companies pump licence numbers). This is highly unusual in an industry where high upfront licence growth = higher P/E rating = more valuable stock options. Investors benefit though as it means more visibility on sales (although the risk is people then start to ignore sales and trade the stock on bookings numbers). Apparently the reason they moved to this revenue recognition was that they got fed up with being tainted by the horrific volatility of semi industry spending (the only bit of tech where revenues can halve in a year and a company's share price can still go up!).

Windstream

Right. About ten minutes into this company's spiel alarm bells were going off BIG TIME. This company is a regional broadband provider which has gone on an M&A binge, done nine deals in since 2006 and taken revenues from $3.0bn to $6.2bn. All well and good. But over the same period cashflow per share has only gone from $1.45 to 1.48.

That screams "value destroying M&A" to me (not helped by their insistence "out acquisition strategy has not been random it's connected". Should this sort of be taken as read?). In their defence they claim cashflow has been chewed up by additional investment in Fiber-To-The-Tower but I'm not convinced. Funny how company's always insist next year's going to be better than this one.

A quick squiz at the annual report (key financials from F-33) tells me that last year this thing generated $526m of FCF and $968m of operating profit (please don't mention EBITDA. Unless you think cash for capex grows on trees). But remember that $558m of that operating profit was then chewed up by interest costs financing their M&A binge. And that's in a zero-rate environment - costs of financing can only go up from here.

Definitely got a bad feeling about this one.

Interdigital

My first real patent troll! Somewhat surprisingly CEO William Merritt didn't breath fire and brimstone across the stage or spend his time on the phone to his battery of attorneys.

To be fair I don't think these guys are a patent troll (polite term: Non-Practicing Entity) in the sense of an outfit which does no R&D, buys up patents and runs around suing people. They do conduct real R&D, but at the same time clearly do their damnedest to get it embedded into wireless standards so they can reap the benefits later (sometimes via litigation).

Taking a step back, its actually a beautiful business model. You've create a pot of past R&D and just sit back as the stupidities of the US patent system lets you run around collecting cash for doing absolutely nothing. I call it "End of Rainbow/Pot of Gold" business model. For example French TV-conglomerate (and perpetual restructurer) Technicolor has an aweseme video-patent business which mints an 80% operating margin and frequently accounts for over 100% of group profit.

The one catch is to make is sustainable you have to keep generating new patents. One funny at Interdigital - they claim they are filing 1,000 new patents a year, but only seem to have 200 engineers in the  "Innovation Lab". That sounds suspiciously low to me - the good thing is that patents take 3-5 years til they start contributing to revenue so if there's a revenue cliff it might be some time off.

Paychex

I think this picture sums up Paychex business model nicely...
On the subject of beautiful business models, I want to have this company's children. The model is really that great.

I've written before about the beauty of the software business model. Payment processing comes a close second - build a big data centre (fixed cost), throw millions of transactions through it (variable revenue), once you get to breakeven its a licence to print money. The trick Paychex have is to make the transactions they do something incredibly sticky which you have to do to pay the bills. That's exactly what they do - SME payroll.

The end result is an incredibly resilient 40%+ margin business which returns 80% of cash to shareholders and has not debt. I don't quite understand the no-debt thing as normally this sort of business (strong recurring cashflows) leverages its balance sheet to buggery in order to pump up the bottom line.

High returns often come from strong competitive moats - for Paychex they've been building the franchise for forty years, and specialising in the SME sector is a smart move because with customers only averaging $2000 /year takes longer for new entrants to gain scale and make money. This also works against them when trying to expand into new markets e.g. Germany.

You also have to pay for the quality. A back of fag packet calc puts the company on 18x FCF. But if (like me) you have a fascinating with great business models this is one.

NB ADP, their evil twin, were also presenting. Similar model, not quite as stellar margins. Interesting car dealership business on the side.

Stratasys

You say affordable... I say "heck you
you could fifty Nexus 7s for the cash!"
I saw my first running Makerbot last weekend, at the Wired pop-up store on Regent Street. It's a surprisingly slick device (especially given the original model looked like a kindergarten DIY project). I've wanted one for years - but am still waiting for the price/innovation curve to flatten out (translation: you can buy one if you want, but in 12 months there'll be another one twice as good for half the price. Why not wait). But hey, this thing can print an army of mecha dreadnoughts overnight. What's not to like about 3D printing?

Stratasys are the grungier end of 3D printing. With 40% market share they are the incumbent in a hot growth market. Guys like Makerbot grab the headlines but in real-world 3D printing these guys are the market leader - nice problem to have.

Of course the risk is that their patents have now expired, and they will need to be pretty quick on their feet to exploit new markets. I note the tagline when you search their website is "FDM, Fused Deposit Modelling, 3D Prototyping". They could clearly do with a bit of sexing-up! Also the cheapest box currently costs $9000 - they need to bring this down if they don't want to be disrupted. They claim their reseller channel is a competitive moat; I'm not sure. Also they don't seem to have a proprietary lock on consumables - that's a risk.

Other thoughts


  • EVERYONE is banging on about big data (QlikTech, Informatica, NICE, Progress, even the uber-grungy ADP). Everyone's logic runs something like 1) As a software company we deal with data (duh). 2) If we're sneaky enough about definitions we can claim any data-set is "big". 3) Therefore we are a "Big Data Play" - can we have a bigger P/E multiple please? Free apple pie if you can spot the truism...
  • Equinix still say they make 30-40% IRRs on investment. Quite quite amazing... While it lasts.
  • Guerrino De Luca the Logitech CEO is still good value entertainment. Not sure if his core PC market is though...
  • Micron were incredibly chirpy given they operate in a horrible commodity industry with no competitive moats or pricing power. Being a memory vendor is like having a job where you need to run in circles while being chased by an extremely hungry grizzly bear, hoping the time it takes dismember one of your competitors buys you some breathing space. Then again, as an extremely smart acquaintance pointed out, running a memory company also involves running in circles and pitching for balance sheet repair/refinancing every few years. So I guess they have to sound happy...


And as for that lunch...


Nice for the price...
Oh and the catering its a standard corporate hotplate buffet. Not bad actually - non-overcooked roast beef yesterday. Quite delicious herb-crusted cod today. Okay not a most egregious piece of corporate entertaining I've ever seen (I fondly remember a three hour client lunch at Nobu once which involved a brace of truffled lobsters), but perfectly adequate given the price point.

So yes there is such a thing as a free lunch.

Anyhow its always worth coming along next time the show's in town. Its always insanely difficult to hunt down the website but keep an eye on this website for next June.

* Note that along with "Acquisitions on the Agenda" (translation: "I think this company might buy something which makes the EPS go up"), "The Good, the Bad and the Ugly" is probably the most overused title for a research note. I make no claim to originality, so I make no apologies.

5 comments:

  1. how was investor attendance? what were investors most interested in? what was most talked about by investors?

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    Replies
    1. I actually thought attendance was decent. In terms of quality I ran into quite a few guys form decent buyside shops both in London and flying in from Benelux/Germany (although to be fair, also a fair number of random investment consultants, family offices or other smaller fry). Numbers for the public presentations were decent to good (although bear in mind there's lots of tricks you can do at a conf to make a small audience look bigger, e.g. stick them behind desks).

      As to what was talked about sorry I can't give a massive steer on that. As with any conference, the really interested parties would have been having it out in the 1-0-1s rather than the public presentations. Alot of the companies seemed to spend more time explaining crappy Q2/3s than talking up Q4s. I guess Paychex was the out-and-out most impressive one to me but to be fair there's already a lot in the valuation. MSFT presentation probly seen as a bit dull given all the hype around new products recently.

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  2. Love it - funny how little US tech minnows can attract global money out of Europe. This conference's attendance is a joke, as are the companies that attend. However, for light entertainment it can't be beat. Cloud, big data, mobility, convergence blah, blah, yawn. Get the tomatoes ready...

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    Replies
    1. Yes. But the wider issue is that almost any of these tech minnows would rank among the largest European tech companies. It's a sad commentary on the European sector that once you get beyond SAP, ASML, ARM and perhaps Dassault there are very few companies of size which can claim to be real global leaders.

      Note from an investment perspective I don't think the conference having smaller companies is necessarily a bad thing. Much easier to find an edge amongst smaller less well covered companies than guys like Apple which are crawled over by every man + dog. While Europe has a lack of tech companies the US is the opposite - there are a multitude of tech mid-caps which are only covered by retail brokers if they are covered at all. That's exactly the place you should be hunting for killer stories!

      Can't disagree with you on the buzzword bingo though. As I see it cloud is last year's big data, which is this year's convergence. I'm assuming that additive manufacturing is next year's big data. Although that may be mobile payments (but mobile payments might be this year's paperless office. Let's see!)

      Ta

      J

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