February 10, 2020—Tesla’s Stock Shifts into “Ludicrous Mode” as it Hits $968 Per Share. What’s the Driving Force Behind the Share Rally?
Intercontinental Exchange Makes Takeover Offer for eBay. Why Did the Market Hate this Deal?
Spotify Buys Podcast Company The Ringer. What’s the Strategic Rationale?
Value Stocks Stage Brief, Face-Ripping Rally. Is a New Cycle of Outperformance Set to Begin?
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.
Julian Klymochko: Welcome, ladies and gents, to episode 52 of the Absolute Return Podcast. I am your host, Julian Klymochko.
Michael Kesslering: And I am Michael Kesslering.
Julian Klymochko: Today is February 7, 2020. A few interesting topics to chat about this week. And it would not be complete if we didn’t discuss what’s going on with Tesla, which is just crazy, insane. Its stock shifted into ludicrous mode and it hit nearly a thousand dollars per share this week, and its market cap at one point was about 160 billion dollars. We are going to chat about what is the driving force behind this share rally.
- In M&A news. Intercontinental Exchange made a takeover offer for eBay. Why did the market hate this deal?
- Spotify bought podcast company The Ringer. What is the strategic rationale behind this podcast acquisition?
- Lastly, we are going to chat a bit about value investing. That is right. Value stocks staged a brief face-ripping rally this week. Is a new cycle of outperformance of value stocks set to begin?
Julian Klymochko: Shares in the electric carmaker Tesla or Tezzzla, as Elon Musk would call it, they more than tripled since September as market participants have just become enamoured with the stock. I was in client meetings earlier this week, and that was pretty much how every meeting started. What do you think about Tesla stock? It is crazy. Some people are thinking it’s a bubble here compared to the infamous rise in the late 90s of tech stocks such as Yahoo! And Cisco.
These went up very quickly, exponentially, which is really, what Tesla is going through right now. Back in the late 90s, Yahoo and Cisco, hit the 2000 percent appreciation mark actually much faster than Tesla, so this situation certainly is not unprecedented in terms of just wild price action. The stock, as I indicated, was sub 200 in the second half of 2019 and peaked at nine hundred and sixty dollars and change and still remains well above seven hundred dollars this week, certainly well above Elon’s 420 takeover offer, that was a year or two ago. Now there are a number of theories floating out there to explain the price action because it was really mysterious.
This big exponential face-ripping reality came out of nowhere. Year to date, the stock has just gone nuts. So there’s really four potential causes of the share rally:
Number one is there has been a ton of option buying call options. And what this does is it sets up the market makers such that they need to go out and buy the underlying stock if they’re selling call options. They need to go and buy the stock. So this is known as being short gamma, which is a technical term on the options desk, but effectively it just creates a feedback loop of more buying. And it just really amplifies the respective stock moves. So as the share price rises and market participants are speculators, are net buyers of call options and the option market maker needs to go out into the stock market and buy more stock just to be fully hedged up on that trade.
A second reason can be covering by short sellers. Now, Tesla is heavily shorted stock, which we have touched on in the past. There is $14 billion in short interest against Tesla. Now this makes it the most shorted company on the U.S. stock market. There have been a number of hedge funds that have been burned on this one.
The Financial Times talked about a European hedge fund, Odey, getting burned on their Tesla short. Greenlight was obviously short for a number of years, but I believe they have structured that just being long of put options. So not necessarily hurting as bad as one who would be short the stock. Nonetheless, it appears that short covering is not the primary consideration here, because short interest has fallen pretty dramatically from 25 percent down to 13 percent, and combating that is the notion of the outstanding convertible bonds. So as the convertible bonds rally, convertible bond arbitrageurs, they would actually go in short, more stock just to fully hedge out their position to have a delta hedge, especially when the converts are way in the money, as I’m sure there are here. So you have an increasing short selling on the convertible side, and that is perhaps, you know, meeting what’s going on the fundamental short inside.
A third reason, which I think is one of the main reasons for this tremendous stock rally. It is just outright retail speculators. Long Tesla shares, for example, on Monday, 12,000 Robinhood accounts bought stock in the company for the first time. Now, Robinhood is the notorious free stock trading app favoured by millennials. And that could be a good indication of unsophisticated investors buying the stock. In terms of trading volume. The trading volume was just off the charts for Tesla stock. Its volume over this week was triple that of Apple, but its market cap is only one-tenth the size of Apple. So some pretty significant volumes. A lot of which is just retail speculators going long the stock. The funny thing is, if you go into Google this week and type in the phrase, should I?
And then the first thing that Google will suggest is should I buy a Tesla stock, which is just kind of indicative of the current zeitgeist and the attitude in the market regarding what’s going on with Tesla. It is really top of mind with everyone.
Perhaps the last potential cause of the share rally. Some people point to fundamentals. For example, they did have a profitable Q4 in terms of, you know, whether those were robust profits. That certainly is debatable; they did get their new China factory up and running. I believe they are producing model three cars out of there. So certainly some positive news coming out. However, on the on the other side and short sellers would certainly be the first to tell you this. They have never actually been profitable on an annual basis. You look at the comparable valuations of other auto companies. GM, they’re a small fraction of where Tesla trades. Fundamental cash flow profitability basis Tesla, their net loss has averaged more than $1 billion a year for the past five years. So it’s kind of hard to justify that company’s market value increasing by three to fourfold over the past four to five months. So it’s really just been an insane rally here. Luckily, we are not short the stock, but unfortunately not long the stock. In any event, those longs certainly are having a cold one this this weekend, having a great celebration, and anyone who has been long certainly has been enjoying the ride. What are your thoughts on this crazy price action behind Tesla stock?
Michael Kesslering: Yeah, I think one thing that Tesla has been really good at is really controlling the narrative around the fact that they’re a growth stock. Now, to fight back a little against that is that they delivered one hundred twelve thousand vehicles in Q4 this year, which put them slightly above the bottom of their annual delivery range target, which was from 360,000 to 400k. So they are just above the bottom of that range. But then as well, if you look at past deliveries, their revenue in Q4 only grew 1 percent year over year, so this really isn’t this massive growth company. And the reason why you have such a large increase in deliveries, but not also an increase in revenue is because they’re really significantly lowering their average selling price, their asap’s.
Julian Klymochko: That is through the Model 3, right. The ramping up Model 3 sales.
Michael Kesslering: Yes.
Julian Klymochko: Model 3 by far their lowest price automobile.
Michael Kesslering: Yes, so when you are looking at a business, I mean, one of the fundamental factors that you would be looking at is their pricing power over time and they are constantly reducing the price. Now, this is to increase their volume. But I guess it begs the question of whether that would be a great investment over the long term and to get away from the fundamentals as well. Just looking at the volume, as you had mentioned, Julian, and putting it into context. Is that from Monday to Thursday is close, here were one hundred ninety six million shares traded, which is one hundred and thirty eight percent of their free float now…
Julian Klymochko: And these are expensive shares as well.
Michael Kesslering: Absolutely.
Julian Klymochko: Eight hundred dollars?
Michael Kesslering: Yes, at very high prices. The free float is just their shares outstanding that are not held by insiders. But to put that into context. Last week, Amazon released their earnings. Surprise, which we discussed a little bit. But during the week, they traded about 7 percent of their float. These are just massive numbers and massive volume. It really implies that they have turned over their entire shareholder base throughout the week. As well, one other note on the volume is, significant portion of their volume has been from dark pools and that has been increasing as a proportion of their overall volume, which does lead credence into the comment that you just made about Robinhood accounts as Robinhood does sell their order flow to dark pools. And so that does lead a little bit of credence into the fact that this is really just being pumped to retail investors.
Julian Klymochko: Right, you are saying much of the volume potentially went to unsophisticated retail speculators.
Michael Kesslering: Absolutely.
Julian Klymochko: Right and that makes sense from the perspective, as we indicated previously, that Tesla is a story stock. It is effectively the definition of a story stock where the price action of the shares really is completely divorced from the underlying fundamentals of the business. As you indicated, sales are up 1 to 2 percent year over year. So certainly not a growth stock, but certainly a glamour stock that definitely is top of mind. It gets front-page news. The other thing that we should discuss is the notion of the popularity, increasing popularity of ESG investing. Everyone would certainly point to Tesla in terms of ESG. Just given no use of fossil fuels in terms of fuelling their automobiles, given that they are electric. So certainly, a big favourite of ESG and that style of investing is getting a lot of flows and they’re basically forced to buyers here.
Another really interesting aspect in this whole rigmarole is Elon Musk’s compensation scheme, where the higher the stock price goes, the more he’s compensated to. I believe that in the tens of billions of dollars, the higher the stock goes. I believe a large portion of this compensation gets issued to him if the shares close above 150 billion in market cap, which it’s right around that level. Now, some people would say, well, it incentivizes him to get the share price up, which obviously other owners of the stock would appreciate. However, conversely, a sceptic like myself would be like, well, this also incentivizes him to promote the stock and potentially manipulate the stock. So that’s kind of another potential thing to consider. So just crazy action, but something that is even crazier and I know a lot of retail speculators got heavy into the options market on this one, and there were certainly some homeruns. For example, the a thousand strike option rose from 2 cents to nearly $2 quite quickly. So that’s pretty much almost a ten thousand percent gain over a short period of time. So if you’re looking for a gamble, Tesla options are certainly where the action is, It’s as mind-blowing because more Tesla calls traded this week than S&P 500 calls. So on the overall index, there is more Tesla stock options, speculators out there than just the general stock market.
Michael Kesslering: And also with the options, I think I did see as well for options with a strike price of fifteen hundred. So, you know, another double. They were trading for I think around the $3 range. So I mean as well selling those options could be very profitable as well.
Julian Klymochko: And I will reiterate what I have stated before in terms of story stocks, we never liked being involved in these long or short because in my opinion it is really just playing with fire. Nonetheless, if you are long here, congrats. Celebrate a bit. Perhaps you are taking some off the table. And if you’re short, you know, that is real tough to go through one of these squeezes and definitely painful. Nonetheless, it makes for a great story and I am sure we will be chatting about it in the future as well.
Julian Klymochko: There was a head scratcher of an M&A offer this week with the Intercontinental Exchange, which owns the New York Stock Exchange and a few other financial product exchanges. They actually announced that they made a take-over approach for e-commerce company eBay.
Now, this acquisition would exceed $30 billion. This compares ICE market cap, that is Intercontinental Exchange, they are worth 50 billion, so this is really perhaps a bet the company deal where it’s a significant size and there’s not only is huge, but it represents a huge departure from ICE’s focus on financial markets. Obviously, they started out in derivatives. They went to buy, on to buy the New York Stock Exchange. So they’re into derivatives, commodities, stocks, futures, etc…to go and buy a consumer goods exchange was certainly causing many on the Street to scratch their heads, and many thought it was very, very odd.
Some background on Intercontinental Exchange. So ICE was founded in 2000 and it’s really turned into a global exchange powerhouse really through M&A. They have had substantial consolidation strategy that has driven their growth. They bought other exchanges. Aside from the New York Stock Exchange, including London based International Petroleum Exchange in 2001; they bought the Chicago Stock Exchange in 2018, and that is really ICE’s strategy. Is to consolidate, to continue to do these deals, which have paid off tremendously for shareholders. Their stock has done incredibly well, but my thesis on ICE was like it was similar to a shark, such that a shark, if they don’t stop, if they don’t keep moving, then you know they die. Same thing with ICE. If it can no longer buy companies, then they won’t be able to grow. They won’t be able to consolidate, make these cost cuts, harvest those synergies and get its share price moving. On the financial product side, I believe they are at the point where they can no longer buy any financial product exchanges. That’s given anti-trust regulations, not just that, but the sovereign country issues. If they tried going to London, tried going to Australia or even Canada and buying up those exchanges, then the government pretty much tells them to go pound sand.
So it’s really a head scratcher of a potential acquisition, in my opinion, going from a financial products exchange to consumer products exchange. And the market probably thought something similar, at least some shareholders. What are your thoughts on this? An interesting, to say the least, potential transaction.
Michael Kesslering: Certainly very interesting. And I will say that initially I was somewhat open minded to the idea that there could be some synergies with regards to ICE and eBay and their respective platforms, that perhaps there was some technological overlap, that they would be able to realize some value creation.
But following these really initial conversations with investors. ICE saying that they’re no longer looking at these strategic opportunities with eBay, it really makes it easier to believe your way of thinking about it is that this is really just like a stretch for growth outside of their core area of expertise. If they had a lot of conviction with the idea of the value creation that they could have with this deal, a short-term 10 percent share price decline really would not cause them to walk away. Or at the very least, when they were interacting with investors, they would present an idea of the transaction and how this would work operationally. That may be able to bring some of their investor base on board, but it really just speaks to their conviction. I guess it really is a pretty good example of how investors typically are not very friendly to a really outside the box thinking. This is kind of for good reason as that is a very high risk. Which also when you mentioned this is a bet the company moment; you need to have a lot of conviction with regards to that bet the company moment. If a 10 percent decline completely sways your thinking, then you likely as a management team did not have a lot of conviction there. But one other thing that I was curious about is do you think that they leaked this potential deal on purpose?
Julian Klymochko: Yeah, I just wanted to summarize for investors what exactly happened or what I think happened. ICE had this potential eBay deal that they’re talking to eBay. They leaked to the press. Wall Street Journal published it because they wanted to see what their shareholders would think, i.e., how would our stock react? Stock did very poorly. ICE’s stock dropped almost 8 percent, eBay obviously rallied on takeover speculation, up 9 percent. Then pretty much the day after their stock got hit. They backpedalled pretty much the fastest I have ever seen. Drop the takeover proposal and said, you know, we are not going to pursue this deal. Anyway, they also made their excuse saying blamed it on the other side, saying eBay had not engaged in a meaningful way. As a result, it was not in negotiations regarding the sale of all or part of eBay. Now, after that happened, the share price partially reverted.
Still, some ICE shareholders are probably somewhat walking on eggshells here, kind of nervous. What are they going to do next? And you’ve got to think if they’re no longer able to execute their consolidation strategy in their wheelhouse, which is, you know, financial product exchanges, derivatives, stocks, etc… What is next? Cryptocurrency, going to buy Coinbase? Shoes? They could buy StockX or perhaps one of these many private share exchanges? There is lots of potential, I call them, you know, alternative assets or just, you know, odd financial exchanges. Because one thing that they do want to harvest, as well is the data. ICE is big into harvesting and selling data to financial professionals. So that could be another play, but interesting M&A strategy here, but good for them in listening to their shareholders and walking from this deal relatively quickly.
Julian Klymochko: Streaming Company Spotify announced the acquisition of Bill Simmons’ podcast company, The Ringer, which has more than 30 podcasts in its network. This company, The Ringer, is founded just in 2016. So around for less than four years, some of their podcasts ranged from an NBA chat show to one oddly devoted to rewatching of old movies.
Nonetheless, this continues Spotify’s strategy to really capitalize on the massive growth in podcasts. They are trying to pivot away a bit from streaming music. They are expanding their podcast offering. They actually acquired three podcasts companies last year, including Gimlet Media, Anchor. They acquired those for a total value of 340 million and Precast, which they acquired for about 55 million. And who knows, maybe they’d want to buy the Absolute Return podcast? I mean, we would consider selling for 55 million, and, perhaps wouldn’t we? You never know, but no outstanding offer unfortunately, from Spotify. If you are looking for the most exciting and perhaps most insightful stock market and financial podcast out there, perhaps we can talk about a deal on the Absolute Return Podcast.
Nonetheless, a few stats on the podcast industry here. Now, there is close to a million podcasts out there right now, 850,000 thousand podcasts of which there are 30 million episodes. A lot of choice out there. I know one perhaps is number one or maybe in the top 10. 51 percent of Americans have listened to a podcast.
Ninety million listened in the last month, 62 million in the last week. And really just growing like a weed, one of the big growth industries. Podcasting advertising expected to generate more than eight hundred sixty million in revenue this year and one billion by 2021. Substantial growth there, and I think an interesting analogue is the Chinese market. They are way ahead of North America in terms of monetizing podcasters. Actually, a different model there. Where I believe, podcast listeners subscribe and pay in the billions of dollars per year to get their podcasts instead of relying on the advertising revenue. And if we look just compared to total digital advertising in the US that brought in north of 100 billion. So it’s substantial growth potential for podcast advertising. And that’s perhaps, you know, some of the main reasons why Spotify is trying to grow in the podcast space. Terms of this Ringer deal were not disclosed. But if we talked about strategic rationale, Spotify seems to indicate they think they’re buying the next ESPN, in terms of sports coverage. What are your thoughts on the strategic rationale on this deal?
Michael Kesslering: Yeah, I think the strategic rationale really just comes down to the economics of the streaming business model is right now Spotify is gross margin is in the 25 percent range, implying that they are giving out 75 cents on every dollar to the artists of revenue that they’re able to get.
Whereas for Netflix, for example, they are looking at about sixty-two cents on every dollar that goes out. So it’s fundamentally a little bit worse than streaming video. But really the streaming business is just very difficult. What Spotify’s core belief is they don’t just want to be streaming music, they want to be streaming all sorts of audio, that is their main focus. It seems to be their belief that there is a lot more flexibility with podcasts when negotiating royalties with content creators. When you look at, you know, where do they go from here after they integrate The Ringer into their suite of content? Is it really would not be surprising to see Spotify make them exclusive to their own platform. Now, they have not really done this with Gimlet Media, which you had mentioned, they had purchased last year. Another option that would be kind of keeping it more of an open system would be to take big name podcasts such as the Bill Simmons podcasts, which is one of the most successful podcasts of all time, and have that open to all platforms. Where within that podcast they would provide exposure for all their new exclusive podcasts, which they would just have on the Spotify platform, which is kind of the same way that The New York Times has used The Daily. Now that they have grown the daily to become a very successful podcast. But really, it just highlights all the journalistic capabilities of The New York Times.
Julian Klymochko: Right, so they already have all that content, they just created a new medium to share it with consumers.
Michael Kesslering: Absolutely. So really just bringing people into your platform. The one other thing that I would like to point out is that The Ringer did actually have their…I think it was about 60 or 70 percent of their employees unionize over last summer. So that’ll be something interesting to follow as the integration of The Ringer goes into Spotify. One other aspect that in terms of, you know, what type of revenue The Ringer is bringing in, it was estimated that in 2018 that they brought in about 15 million dollars for their podcast revenue. We discuss the bar stool deal with Penn last week. If it is anything like that revenue stream, it is growing at a very high rate, effectively doubling year over year. So that number is likely a lot higher today.
Julian Klymochko: One thing I wanted to touch on, it is an interesting dynamic or comment on margins specifically in the streaming business being very low. And you’ve got to think of a podcast as a very high margin opportunity. You look at someone like Joe Rogan who has the most successful podcast of all time, and is minting millions of dollars off each episode likely. These things don’t cost a lot and certainly a lot cheaper than making, you know, professional sounding quality music and putting an album out there. I know from our own experience, the Absolute Return Podcast, of course, a five star rated podcast. I’ve got to be honest with you, it’s not the most expensive thing to put together, but certainly of the highest quality, wouldn’t you say?
Michael Kesslering: Absolutely. I think I heard that a high quality podcast was about ten thousand dollars per episode to produce, which is substantially higher than this ferryboat.
Julian Klymochko: But perhaps that lends credence to our skill behind the podcast. In any event, congrats to Bill Simmons on this big win here. Clearly, even though terms were not disclosed. It looks like they are getting a big paycheck on this one.
Julian Klymochko: After being beaten down for many, many years, value stocks this week state a brief face-ripping rally on Wednesday. With some value funds rallying by over 4 percent on the day. Value stocks had outperformed glamour stocks by a substantial margin over many decades. It is known as the value factor, basically, cheap or undervalued securities outperform expensive or stocks with high multiples on book value, earnings, EBITDA, cash flow, whatever it is. Cheap tends to outperform expensive. However, the last decade this has reversed. Been a very challenging decade for cheap stocks and you have had growth or glamour stocks really just crush it. Now it makes you question does this green shoot this week signify a potential turnaround of the value factor? I know many value investors have been waiting many, many years for it to turn in. The divergence between value and growth or glamour has just been getting wider and wider.
Some details on Wednesdays move: Value’s return on the day represented more than two standard deviation daily move relative to growth and the broader market goes back about 25 years. For example, a trade of being long value short momentum was up nearly 8 percent on the day. So not only did you have the performance of value, but you had momentum stocks really going the other way. That being said, it is only one data point. Really, value had been getting kicked in the teeth year to date has underperformed growth on 83 percent of the days. Certainly been a very rough ride. What are your thoughts? Is this going to be a turnaround for value investing or is it just some fake news?
Michael Kesslering: No, this is strictly my own opinion, but I really do think that this is like setting the table for a very good run for the value factor. And I mean, it’s something I mean, I know a couple of months ago you had tweeted out pounding the table on the value factor moving forward, especially small cap value as that’s been really beaten down even more than large cap value. But moving forward, I mean, in terms of an investment thesis, I’m always weary of mean reversion, but the thing about mean reversion is when it is at extremes, that is when mean reversion can work as a strategy. And what we’re seeing is just such a large extreme of value companies just being completely killed compared to growth, and I do believe that moving forward over the next five years that this is a really good setup for the value factor.
Julian Klymochko: Yeah, it is an interesting point comparing value or valuations of value stocks versus growth stocks. And I believe the divergence is now exceeds that of the tech bubble, which previously to today or this year had been the most extreme divergence of all time. And what happened after 2000 after the tech bubble burst? You had incredible outperformance from value stocks, I believe, compounding 15 percent per annum of outperformance over many years, perhaps 5 to 10 years. So certainly, I think the setup is there for value outperformance, but it is not going to be next week, next month or next quarter. This is a long-term play, as you indicated. And if you’re looking for a value fund like Accelerate Private Equity Alpha Fund is perhaps the most value of them all, isn’t it? I think our average multiple in the portfolio is less than five times EBITDA versus S&P 500 at roughly, what, 13 times. So it’s tough to find cheaper stock portfolio than ALFA, which obviously trades on the Toronto Stock Exchange. If you are interested in taking a look at interesting way of playing this potential rally in value stocks on a go forward basis. 2010’s were the decade of growth stocks, glamour stocks and maybe the 2020s will signify the re-emergence of value stocks. It will be an exciting time to watch. And let’s keep our fingers crossed.
And that’s it, folks, for episode 52 of the Absolute Return Podcast. If you enjoyed the show, please check out more episodes at absolutereturnpodcast.com. I implore you to follow us on Twitter, your handle is?
Michael Kesslering: I @M_kesslering
Julian Klymochko: And mine? You can find me on Twitter as the people’s hedge fund manager recently changed my Twitter handle, to @JulianKlymochko that is K-L-Y-M-O-C-H-K-O. That is it for us. Wish you the best of trading, speculating, investing, short selling. If you are into that and we will chat with you soon. Cheers.
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