August 31, 2020- Apple and Tesla Announce Stock Splits and Watch their Shares Soar. Is this Rational or a Speculative Fervor?
3D Printing Startup Desktop Metal Announces Combination with SPAC Trine Acquisition. What Makes this Deal Interesting?
Peter Thiel-Backed Tech Company Palantir Files for IPO. Should Investors be Buying?
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 84 of The Absolute Return Podcast I’m Julian Klymochko.
Michael Kesslering: And I’m Mike Kesslering.
Julian Klymochko: Today is Friday, August 28, 2020, winding down summer here, not too much happening. I mean, the market hasn’t been very volatile. Anyway, the VIX is down into the twenties, which is historically high. I think, you know, the average VIX is roughly fifteen, but I mean, if we go back to March when it peaked in the eighties, certainly twenty is much, much more welcomed, but a few things we want to chat about on this week’s podcast, specifically stock splits.
- Apple and Tesla in the news announcing stock splits as their shares soar. Investors pretty keen on any companies that are splitting their shares recently. Is this rational or is this just a speculative fervour, a bubble that is going to pop?
- We are going to chat about another SPAC deal, 3D printing start-up, Desktop Metal. They announced a business combination with a special purpose acquisition company Trine Acquisition. What makes this deal interesting?
- Lastly, we are going to chat about Palantir. That is right, Peter Thiel, back to tech startup. They filed for a go public transaction. Should investors be buying this one?
APPLE AND TESLA ANNOUNCE STOCK SPLITS AND WATCH THEIR SHARES SOAR
Julian Klymochko: But Mike let’s start things off on this interesting stock split anomaly that’s happening in the market. I mean, retail investors have kind of gone crazy over this where I don’t know if anyone’s too unsophisticated to believe that they’re actually going to get more value out of a share that split, like what happens is say Apple is splitting its stock four to one, Tesla’s splitting its shares five to one. So basically Apple four to one split, you got four times as many shares, but the stock price will be cut by a quarter. Right? And so the fundamental value remains the same. The value of your position should remain the same. However, the number of shares outstanding basically quadruples or quintuples in each of these cases.
So it’s a really interesting event because these stocks have absolutely ripped off this news. They announced these splits earlier this year; Apple is up 31%, Tesla up over 55% since announcing these stock splits. And what I wanted to talk about here, such that yes, splitting a stock has no fundamental effect on the position. If you have $10,000 dollars’ worth of shares previously, there is still going to be worth $10,000. You just have four times as many at one-fourth the price. However, to me, a stock split is indicative of the price momentum anomaly, which is a classic factor that has predicted power regarding future share price performance. And you see stock splits typically follow strong, recent share price performance, as we’ve seen with both Apple and Tesla, because they tend to want to split when the shares get too pricey. They are in the quadruple digit range, both of them, well at least for Apple, you know, 500 bucks a share of Tesla around $2,000 per share. And one of the thesis behind this is that a stock split makes the shares more accessible to retail investors with less money to invest. I mean, however, these days there is this new fractional ownership initiative that a lot of the discount brokerage have implemented. It really has reduced this benefit, but nonetheless, I mean, you look at companies that have split their shares over the past number of years, Apple’s done it more than once. Google, MasterCard, Visa, retail trading volumes around these events tripled historically, so that just gives you an indication of how much retail interest there is around these events. And perhaps that’s one of the recent share price, out-performance.
Got an interesting comment here from TD Ameritrade Chief Market Analyst, he stated. “We have historically seen that our retail investors use stock splits as trading opportunities, accessing popular names that may have gotten too expensive pre-split”.
So what I wanted to talk about here is like trading off of momentum. Yeah, that is a valid strategy, so you can take that into account. Certainly, we do in our multifactor strategies, both long and short. However, if you’re buying a stock split share, thinking that you’re going to get more value for nothing, that’s not how this works, you know, your value remains the same. However, as I indicated, it is the manifestation of this price momentum anomaly. So that’s something that retail investors should keep in mind and frankly, any investors should keep in mind just because you kind of see these mistakes happening on high price stocks as they split and become lower price shares. But one interesting negative development from this is a massive change to the Dow Jones Industrial Average, which is a price-weighted index. And given that Apple price will be cut basically by 75%, they need to add more to the index. So the Dow is basically going to reduce the Apple position significantly and in its place, add Salesforce, Amgen, and Honeywell. So super interesting knock on effects of this recent trend in stock splits. Mike, what are your thoughts on stock splits and what investors should do about them?
Michael Kesslering: Yeah, so I guess the really interesting part is, something that we mentioned on the podcast’s prior episodes. Is that retail volume is really starting to dominate or at least really increase its share of stock market activity, where it is now estimated during the pandemic to be at about 25% of stock market activity. Up from 10% in 2019, so as you mentioned, Julian, this is indicative of retail’s participation in these names. I know what to expect like after this stock split, but there will be increased in retail participation, which does somewhat surprise me as these are already very popular retail names with companies like Tesla and Apple doing splits. You know, you’d think there’d be a little bit of saturation and something else that you mentioned was the ability already to buy fractional shares.
I mean on Robinhood and Fidelity accounts, which make up a pretty reasonable material portion of online trading for retail, you can already buy fractional shares. So there’s really no need for an investor to need a stock split to encourage them to be more active in these names. So it really is kind of a behavioural phenomenon. And you know, I keep saying this during the COVID pandemic is, you know, we’re just seeing lots of crazy things in the market lately, and you know, the price reaction of the stocks split names is just another box to check in terms of crazy things going on in the market. Cause there is really no fundamental rationale.
Julian Klymochko: Well Mike, the only logical conclusion here is we launch a new activist fund start filing 13D on any companies with a share price above 500 bucks. Launch a campaign to get them to do five to one stock splits, and then earn 30 to 50% returns, right.
Michael Kesslering: And activists adding serious value with that proposal.
Julian Klymochko: Yeah, that is how you got the solid value creation law. I mean it beats other activist strategies as of late, sadly, but on the less interesting dynamic to see. I am sure we will see other companies jumping on this stock split bandwagon, so keep your eyes and ears open.
3D PRINTING STARTUP DESKTOP METAL ANNOUNCES COMBINATION WITH SPAC TRINE ACQUISTION
Julian Klymochko: Onto some SPAC news, private venture-capital-backed 3D printing company, Desktop Metal announced that it is going public through the special purpose acquisition company; Trine Acquisition Corp with trades under the ticker T-R-N-E. The metal 3D printing technology provider at a whopping $2.5 billion dollars. This deal would position desktop metal as a primary player in what they call additive manufacturing 2.0, this is kind of like a replay of that 3D printing boom that we saw a number of years ago. And they’re really looking to finally see this technology fulfil its true potential of disrupting manufacturing.
I mean, we have had quite a number of years of hype behind 3D printing and we really, just haven’t seen any massive effects of it. However, I do have a comment here from the CEO of Desktop Metal. His name is Ric Fulop, he said. “We are at a major reflection point in the adoption of additive manufacturing and Desktop Metal is leading the way in this transformation”. What is important here is that they are using a SPAC and we are really continuing what we have been discussing in terms of SPAC arbitrage. A lot of the times when deals are announced, there’s a so-called SPAC pop in which blank check companies, stock rallies after announcing a business combination, Trine shares are no different. They are up about 10% this week on the news. So we are long of Trine in the Accelerate Arbitrage Fund. We had previously bought the shares at a discount to net asset value.
Now they are trading at roughly 10% premium, which is obviously, you know, great for us. And I compare this sort of SPAC pop to be somewhat analogous to the IPO pop and what SPAC arbitrage is. It’s basically the monetization of the IPO pop combined with a put option that you’re paid to own because typically you can buy into a SPAC at a discount and you have a put option in terms of the redemption offered at the deal vote, unless they get no deal. Then they liquidate and you get your money back. This one once completed, I believe they are looking towards the fourth quarter to complete this deal. It will trade under the symbol DM. So Mike, what are your thoughts on this week SPAC deal?
Michael Kesslering: Yeah, it is an interesting deal. I think you make a good point in terms of there has been a lot of capital go into 3D printing, especially over the last, you know, seven years or so. I do remember when I was an intern at an insurance company during university where we were looking at some of the trends of the capital going into 3D printing and some of the trends within that. And really at that time, the focus was on creating prototypes for companies, you know, in terms of production but not really doing full-scale manufacturing. And that’s kind of continued, it’s taken a little bit longer than that many folks in the industry had predicted back about seven years ago. So it’s interesting to follow that, but in terms of the deal specifically. It does provide the company with a decent amount of growth capital, with a potential for $575 million in growth proceeds, which also includes a $275 million dollar pipe. A private investment in public equity which also you know, one of the biggest proponents of SPAC is found in the pipe financing with Chamath Palihapitiya, is in involved in that. He seems to get his hands in all sorts of SPAC companies and different financings with these but also interesting to note that this truly is growth capital for the firm where current investors are actually rolling over their equity stakes into this firm, which is interesting. It’s not an exit for these early backers.
Julian Klymochko: Which is nice to see.
Michael Kesslering: Yeah, and in terms of Leo Hendry Jr. He also noted that since their IPO, with Trine Acquisitions IPO, they actually validated a hundred companies already. So it’s kind of gives an indication into the deal flow and how strong it’s being for SPAC in terms of what they’ve been able to get their eyes on. I thought that was an interesting takeaway, but overall, another kind of splashy deal in a sexy industry for another SPAC.
Julian Klymochko: It is interesting to note, you mentioned that they are providing true growth capital here, and it is not serving as an exit strategy. There has been, you know, a number of valid criticisms on the SPAC structure, but as we talk about traditional IPOs are common criticism is that your typical IPO is just an exit for a VC or a private equity firm. They are basically done with something and looking to make money for retail investors and say pension funds, I call it, you know, kind of dumping their trash in the public markets and not using public markets, what they were invented for, and that is true for raising capital to grow a company. The great thing about a SPAC is, they have come back to, you know, truly represent what it is to go public, and that is to raise money, to grow the business. A lot of what these SPACs are doing,
so it’s nicer to see these over the traditional IPOs, which is straight, almost always a straight exit strategy for earlier backers looking to monetize their stakes. The other great thing that critics don’t mention regarding a SPAC is, it’s giving investors exposure: like non-VC investors exposure to earlier stage businesses, many pre-profitability and some even pre-revenue businesses that historically you would only find in the private market and which, you know, large venture capital firms would have access to and no one else. So that’s another really nice thing regarding SPACs is providing investors with the earlier stage venture type opportunities that historically, at least in the past sort of 20 years have not been available to public equity investors. What has happened over the past 20 years, we have had this massive boom in private equity, venture capital, so the private markets, which are dominated by very large institutional investors, and there’s so much capital that many start-ups did not need to go public until they’re very mature.
So public market investors lost out on that ability to capture that earlier stage of growth, which is, you know, you saw in Uber, that is where all the big money made and then they go public, and the stock only goes down. If you look at Lyft as well, which is one of our short positions in our absolute return hedge fund, but nonetheless, one reason that companies would stay private for longer. In addition to, massive amounts of capital, they would indicate that public market investors were overly focused on short-term results, overly focused on short-term profitability. Nearly all the companies going public through the SPAC, typically they are not profitable. Sometimes they are even pre-revenue, which just goes to show how open and keen public market investors are on these earlier stage opportunities where they don’t really care about quarterly results.
It is hard to care about quarterly results on a company like Nikola where they are not going to be manufacturing vehicles for, you know, a number of quarters out. So that’s something to keep in mind when discussing SPACs as an asset class. I think there are great things and the other great things about SPACs is that there has been a long-term trend specifically in U.S. public markets. The decline of the public company used to have like 8,000 listings and it is down to like 4,000 or something like that. SPACs are really bringing back smaller public companies, which is a great thing for stock pickers, investors, traders, quantitative investors, either long or short. If you are a short seller and you say, oh, SPACs are garbage. Well, I mean, there is a much, much larger opportunity set for you now, so that’s something to keep in mind in the SPAC world.
PETER THIEL-BACKED TECH COMPANY PALANTIR FILES FOR IPO
Julian Klymochko: Now, a company that is going public, not by a SPAC, not by an initial public offering, but they are utilizing, what is known as a direct listing. Interestingly enough is Palantir was a tech start up named from a, I don’t even know what it was, but it was something in the movie Lord Of The Rings. I think it was just like ball that predicted stuff.
Michael Kesslering: It was from the Tolkien books I believe. The future seeing rocks, or stones or something of that nature.
Julian Klymochko: Right, yeah and I think Thiel named his hedge fund after something from those books or Lord of the Rings or something of that nature, but I digress. What they do? They are a data analytics company, they are known for controversial work for the U.S. Government. They are rumoured to have helped the U.S. Government track down Osama bin Laden when they got them way back when, and the notion of direct listing. I mean, we have spoken so much about SPACs. We talked quite a bit about traditional IPOs. I think in the podcast, we have only talked about a direct listing once and that was for Spotify, wasn’t it Mike?
Michael Kesslering: Spotify, and did Slack do a direct listing as well?
Julian Klymochko: Yeah, I think you are right, but I will give you a bit of background on Palantir. So they provide governments and corporations with tools to help with everything from tracking the spread of coronavirus to finding terrorists, their goal is to become the default operating system for data across the U S government. Basically they help organizations make sense of vast amounts of data. They help gather information from like a ton of different sources, such as internet traffic, cell phone records and helping companies analyse these troves of data into something like a visual display. What is interesting is they indicated that the 2,500-employee firm holds roughly a 3% market share of what has become a 25 billion data analytics market. But let’s talk about this S-1 filing. I had a quick look at it and an S-1 filing is what a committee submits to the SEC and its public when they are looking to complete a go public transaction, basically perspectives.
Palantir has been in business for 17 years and it is still bleeding red ink. That is right, it’s never turned a profit since it was founded in 2003, for example, last year Palantir lost $576 million on $742 million in revenue. They’ve raised more than $3 billion in funding in the private markets so far and was last valued at roughly $20 billion. But I mean, despite what looks like pretty horrific financial results losing over half a billion dollars last year, this is a type of market that seemingly is rewarding growth at any cost. And I believe that the market may prefer money-losing companies ironically, to profitable entities these days, so these shares could do well. I don’t know, Mike, what do you think? Do you think it is a buy off the IPO?
Michael Kesslering: Yeah, it is kind of difficult to say here. I am, a little bit conflicted with Palantir as typically companies like this, you know, kind of a software biz assets. This is really an enterprise software company that has very high upfront costs and long-term contracts. I typically think that the market overvalues this and they really don’t acknowledge what the eventual turn of the customer base may be. But when you look out at Palantir and just to go over their business model a little bit. It is very expensive for them to acquire customers and that is because those customers are so valuable. They only have 125 customers of which 50% of those are government agencies, but they do have an extremely high revenue per customer metric, which is at $5.6 million dollars per customer, so these are very valuable customers, but it typically takes them six to nine months to close a deal.
And in that time they are spending a lot of money, especially in terms of engineers, like their actual salary, them onboarding the potential client and really backing into the client’s own infrastructure is Palantir doesn’t bring their own database completely just plug into whatever data sets the government agency has already. So with this taking six to nine months, you really do have quite a large J curve in terms of their margins, do break it up by their cohorts. The most mature segment does have over a 50% contribution margin, but then it really becomes a question of what the retention rate and the contract length can be, and really how much they can embed themselves in these organizations. Just to manage that churn, to become profitable, and when I say contribution margin, quoting that, over 50% contribution margin for their most mature segment. That is really just gross sales minus their sales and marketing expenses and doesn’t include stock-based comp, which we’ve talked before. That should be included in that, it doesn’t make any sense. That is a real expense, but as well, I guess what surprises me at first was how large the sales and marketing expense was for Palantir, which is over 50% of revenue. And I would have thought that just looking at government agencies, perhaps that marketing spend would be a lot lower despite the very valuable customers, but really a lot of that is passed through in the initial implementation as opposed to the traditional advertising that you would think of. But a very interesting company in that sense, so if they are able to have extremely long contracts and really manage that churn, then sure this could end up being a profitable company, but, you know, Julian, you make a good poin that we briefly touched on last episode, this company has been around for 17 years and they still haven’t found a way to become cash flow positive. It is not like they’re growing at a massive, massive rate at this point. It is, you know, kind of a single-digit growth company at this stage of their maturity. And so the question does become when they’re actually going to become profitable as they do eventually need to become that way, as raising capital into infinity isn’t sustainable. But you also brought up the fact that Palantir is looking at a direct listing. There are a number of high profile, especially this week. There was a number of high profile filings for both IPOs and direct listings with Asana, another software company, looking at doing a direct listing as well.
But in addition to those doing direct listings, you have Ant Financial, part of Alibaba that is looking to do a an actual traditional IPO where they’re looking to raise, I think it’s $25 billion dollars, over a $200 dollar billion valuation. So just a massive IPO there when that comes to market, as well as Snowflake. Another I believe that is a cloud data company, but very active week in terms of new listings, both direct listings, traditional IPOs, and as we discussed SPAC. It is a great time for all those new S-1 bloggers that have been making their rounds on Twitter. It has been interesting to follow
Julian Klymochko: The Equity, window is wide-open ladies and gents, but to wrap things up here, should investors be buying the Palantir IPO? I mean, this is probably one that is going to pop, on its first day of trading. However, the long-term potential of the stock that is highly uncertain because clearly they are reliant on capital markets, on funding their business, given the persistent and growing losses and red ink on their income statement. So I would stay away long-term, but you might be able to capitalize on IPO pop, if you can get an allocation. As for SPACs, I mean, we will continue to see that SPAC pop as these hot deals are announced in terms of kind of new, sexy start-ups that are going public through a business combination with a blank check company, and then stock splits. I mean, just remember no fundamental change in their position. However, a stock split is just another momentum indicator similar to looking at the 52-week high list, or what’s been doing a best on a trailing 12-month return. So that is about it folks for The Absolute Return Podcast, episode 84, hope you enjoyed it. If you did check out absolutereturnpodcast.com for more episodes, please leave us a review. Let your family, friends, co-workers know about it and check it out as well. Until next week, I mean, definitely follow us on Twitter, Mike, what is your Twitter handle?
Michael Kesslering: M_Kesslering.
Julian Klymochko: And mine is @JulianKlymochko . That wraps it up, folks. Hope you have a great week of trading and investing. We will chat with you soon, cheers.
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