April 15, 2019 –Disney announces its new Disney+ streaming service. Is this a death knell for Netflix?
Uber files for IPO. Should you buy the stock?
Saudi Aramco issues $12 billion in bonds amidst $100 billion in demand. What did the market think?
Chevron to buy Anadarko in $50 billion energy deal. Is there more to come?
FOMC minutes released. What’s the next move for the Fed?
The magazine indicator just flashed red. Time to sell everything or nah?
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: Welcome investors to Episode 9 of the Absolute Return Podcast. Today’s April 12, 2019 and as you may know from last week’s episode April 12th is the second official Brexit day. Which obviously didn’t happen. Luckily that can’s been kicked down the road to October 31st. So hopefully we don’t have to talk about that anymore. I’m your host Julian Klymochko.
Mike: And I’m Mike Kesslering.
Julian: We got a lot of cool subjects to talk about this week. Off the top Disney announced a new streaming service. We chat about what it’s all about and the effect on Netflix. Uber filed for an IPO. We talk about that company and the stock. Saudi Aramco issued 12 billion in bonds amidst a hundred billion in demand. We talk about how those bonds have been trading. Big deal in the energy space with the Chevron buying Anadarko in a 50-billion-dollar merger. Finally, some macro stuff with the FOMC minutes and the implications on interest rates. Lastly we’re going to chat about a blog post that we released this week regarding the magazine indicator.
Huge news in the media space. Today Disney announced its new Disney Plus streaming service. Now what this is it’s a Netflix competitor, online streaming service. It’s going to launch in November at only $6.99 per month, which is nearly half the price of Netflix. Some day one content: They’ll have 18 Pixar films. All Star Wars films, which is pretty huge if you’re a Star Wars fan. 250 plus hours of National Geographic content, which I love. You know I love those nature shows. 13 Walt Disney classics. 30 seasons of the Simpsons. I mean what’s not to like there? They’ll also likely look to bundle this with an ESPN streaming offering as well. We don’t really have any details on that. As I indicated this is a real big threat to Netflix here what Disney has been doing. It is licensing some of their content to Disney, sorry to Netflix. Why don’t you talk about the details behind that and the financial implications?
Mike: Yeah I guess the one aspect is that they’re actually foregoing about a hundred and fifty million in licensing revenue this fiscal year by analysts estimates for that figure.
Julian: And that’s by pulling some content from Netflix.
Mike: Yes, and so it’s actually a good example of Bob Iger not thinking just for the short term.
Julian: Bob Iger is the CEO of Disney.
Mike: Yes, and it’s a good example of just not thinking for the short-term implications as this could be a big value enhancement for the future with a bit of short-term pain.
Julian: Certainly, and some of those long-term projections that they throw, so they said by 2024 they expect to have 60 to 90 million subscribers and by that time they’ll be dumping 2 billion per year on content. So, some pretty significant content spend. Speaking of CEO Bob Iger back in February he called streaming the company’s a number one priority and so clearly this is a pretty massive move that Disney has. So far they’re just announcing the U.S. version. But internationally the plan is to roll out internationally, globally throughout 2021.
As for the stock market reaction some pretty interesting moves. Obviously bullish for Disney and bearish for Netflix. We saw Disney stock as of this afternoon up 10.4%, the biggest move in Disney in a very long time and Netflix down 4.4%. So obviously Netflix shareholders not really liking the threat of Disney. In my opinion a better service at nearly half the price. So certainly, quite the competition coming out for Netflix.
Mike: And when you mentioned the price it is at that $6.99 / month is where it’s starting out at. But I do believe that they have plenty of untapped pricing power where over time you’ll probably see that delta between Netflix and Disney plus that’ll likely decrease in the future as they do have quite a bit of pricing power. The other prospect that I wanted to bring up was Warren Buffett and Charlie Munger. They have always said you know great things about Bob Iger, that they look up to him as a as a CEO. But a little bit of history on the relationship between Buffett and Disney was Buffett when he was running his investment partnership back in the 60’s he actually bought a 5 percent stake in Disney in the late 60’s and sold it just a year later for a 50 percent return. Which looks great you know it’s a mistake of, if he had held that all the way till today that’s you know a billion dollar mistake.
Julian: Probably more than that. 5% of Disney.
Mike: Yeah absolutely and so one thing that I wanted to bring up was you know with Buffett and Munger just describing Disney and favorable terms all the time, Munger refers to Disney as an oil company that pumps money from the ground and then puts it back into the ground to pump again. What do you think the possibility of Berkshire acquiring Disney?
Julian: Well Buffett’s always quite sensitive on valuation and price. So, I’m not sure if Disney would be cheap enough. He usually likes to pay 10 times pre-tax earnings and he always says he’s searching for that elephant and they now have north of a hundred billion in cash. But who knows Disney might be a bit of a, too big of a target for Berkshire here. Would be a pretty cool acquisition if they did it. But who knows. I mean you never know on some of these things. As you know he has a trigger finger looking for a big acquisition and so I think if we see the market really sell-off and equity prices come down, he’s much more likely to do a deal. But with the market where it is, I think any sort of deal it’s kind of unlikely.
Big step for Uber this week as they filed the S1 or prospectus for their upcoming initial public offering. As everyone knows Uber is the market leader in ride-sharing. But what you may not know is they have a lot of additional businesses, including bike and scooter rentals. Obviously Uber eats, freight hauling and another sort of nascent self-driving car division. Which is where they see the future of transportation where they don’t actually need drivers anymore. Uber operates in more than 70 countries.
Some details behind the IPO, they’re reportedly raising ten billion dollars at a hundred-billion-dollar valuation. Now this is below previously rumored valuation of a hundred and twenty billion, which came down since Lyft’s IPO. Because Lyft IPO’d at 72, rallied up to about eighty bucks a share and now they’re down to sixty. So, keep that in mind. The Lyft IPO really hasn’t performed well. That’s really dialed back expectations behind this Uber IPO. Comparing that reported or rumored a hundred-billion-dollar valuation, for example they recently did a financing in the private market at 76 billion. So private investors certainly liking that uptick in valuation.
They’re expected to kick off their investor roadshow at the end of the month with pricing and listing shortly thereafter. So, we’re likely to see a public Uber in May. As for financial performance last year had revenue north of 11 billion, gross bookings of 50 billion. But a pretty massive operating loss north of negative three billion dollars. They have 91 million users. But I think growth is somewhat slowing here and the other thing of concern is that they may never earn a profit, is that what you read in the S1?
Mike: Yeah yeah going through the S1, they actually had a net income accounting profit of 997 million. But as you had mentioned have an operating loss of three point three billion in 2018 and so the difference between this is the result of five billion in other income, which is listed in their financials as divestitures and unrealized gains in investments. So those really aren’t normal course operations. So, in terms of their continuing earnings, they were likely normalizing to that yeah to the negative number. The other aspect that’s interesting is that Uber eats has really shown, the Uber has shown Uber eats as being a real center of growth for the company moving forward. But what you’re actually seeing is that it’s actually been declining quarter-over-quarter. It’s actually only has about 165 million in quarterly revenue.
Julian: So that’s a decline in growth rate?
Mike: Yes yes, actually no just declining in general from a high of 218 million in q2 down to 165 million.
Julian: So, revenues actually declined?
Mike: Yeah which is quite interesting as this is an area where there’s competitors in the space that are growing quite rapidly. It’s interesting that Uber eats hasn’t taken that the growth rate is decreasing.
Julian: Yes, there’s just so much competition in that space, it’s pretty crazy.
Mike: The other interesting aspect that Bloomberg actually pointed out was the funny distinction between market share and category position. So, they represent themselves as having less than one percent market share in the US. So, implying that they have a very long growth runway. But while also boasting that they have a sixty five percent category position in the U.S. So, it seems like they’re kind of trying to have the best of both worlds where they’re saying that they’re in a dominant duopoly where there could be pricing power, but also that there’s a massive untapped more get. Which is kind of an interesting juxtaposition there.
Julian: By the untapped market they mean people driving their own cars?
Mike: Yes yes.
Julian: Uber is going to replace that? Interesting. Make no mistake about it, this is a huge IPO 10 billion. It’ll be the largest since 2014. Which was Alibaba’s IPO that raised 25 billion. Another interesting aspect to this deal is that they’re reserving some IPO shares for drivers who complete a certain number of trips.
Wanted to just touch on ownership. So Japanese giant Softbank owns 16.3% of Uber, Saudi Arabia’s public investment fund owns roughly 5%. Another interesting fact is that Google owns 5% of Uber and competitor Lyft. So, some interesting competitive dynamics there. And founder Travis Kalanick still remains with 8.6 percent stake. So those people certainly pretty happy with some liquidity upon IPO here.
Saudi oil giant Saudi Aramco issued 12 billion dollar in bonds amidst a hundred billion in demand. So, talk about oversubscription here, not just the deal size I wanted to talk about. With respect to this bond offering, they actually disclosed some financial information behind Aramco. What’s surprising, but the scale of the numbers you can’t help but be shocked. They’re tremendously profitable. Aramco’s by far the most profitable company in the world. Talk about numbers here they have EBITDA north of 200 billion, free cash flow of 86 billion, net income north of a hundred billion. That exceeds the former or the most profitable public company Apple by a significant margin. Talking about the scale of Aramco, they pump one in eight barrels of oil globally. Which is pretty significant. So, it just shows their market share. Which is obviously massive. I wanted to talk about this bond issue in general. So, they had pretty significant demand. But what actually happened was as demand, as they go through the book and sales people indicate that it’s oversubscribed, investors will actually boost their orders to an amount more than what they have, because they want a certain amount. Say they want 10 million in bonds, but if it’s twice oversubscribed then they’ll subscribe to or they’ll order 20 million such that if they get the 50%, they’ll get their original 10 million dollar order and as you know these things can spiral out of control into a positive feedback loop. Where demand keeps growing and growing, because they think they’ll get less and less of their orders.
Mike: Yeah and to quantify that artificial demand there’s estimates that the demand was artificially inflated by about twenty to thirty percent. Which is quite interesting. The other interesting aspect is that number one was that some institutions were actually moving from this over in Saudi bonds to Aramco. But as well there and also that they were priced below their sovereign yields. Which is quite interesting.
Julian: Yes, so they had lower yields than government bonds.
Mike: A lower cost of capital than their government. Which is interesting and then the other aspect in terms of the pricing and demand of the offering is that there are many managers that are actually forced to buy the bond. So, they’re forced buyers, despite that even if they viewed it as overpriced. Because it’s going to be included in all of the major bond indices.
Julian: Looking at the order book 100 billion in demand on a 12 billion dollar deal, initially it was a 10 billion dollar deal. You would think this would be a really hot issue. But when it hit the market, it hit with a thud and actually traded down. So, a lot of that demand was artificial and somewhat illusory. Some sell-side dynamics in the pricing trying to make the deal hot, trying to get a lot of demand for it. But trading around 97, 98 cents on the dollars not down massively, but still not what you want to see on a supposedly massively oversubscribed deal.
Massive deal in the energy space with Chevron striking a deal to buy Anadarko in a 50 billion dollar transaction, 33 billion on an equity basis. Consideration is $65 per share per Anadarko share. This was a premium of 39%. The strategic rationale behind the deal, it expands Chevron’s shale drilling ambitions. Makes it a large entity almost as big as Exxon Mobil – the biggest producer aside from Aramco in the world. Together the two companies, Chevron and Anadarko will produce 3.6 million barrels per day. Clearly putting them in the top four senior super senior entities, Exxon, Chevron, Shell and BP. Got a quote from Chevron’s chairman and CEO, he stated “the combination of Anadarko premier high-quality assets with our advantage portfolio strengthens our leading position in the Permian builds on our deep water Gulf of Mexico capabilities and will grow our LNG business”.
As for the stock market reaction Anadarko shares unsurprisingly rose 32.2%. Obviously Anadarko shareholders pretty happy with this deal. Although the shares have been under pressure for quite a while. On the back of the deal Chevron shares down 5.1 percent, what are your thoughts on this one?
Mike: Yeah I actually quite liked some of the language that Chevron CEO was using that is somewhat atypical of the energy industry saying that they’re not as concerned about being the largest producer and that really it’s more for them to generate shareholder value. Which is comforting to hear from an industry that over the entire lifecycle has destroyed capital.
Julian: Yeah not just growth for growth’s sake, but really high-grading their portfolio focusing on return on capital. High returns for shareholders right?
Mike: Absolutely and then in terms of the deal dynamic, do you see any potential for an overbid just looking at you know this scale you’d think the only competitors that could over bid would be Exxon, Shell you know those types of players? Do you see any possibility of that?
Julian: I think that’s unlikely. I mean the scale of this deal is just so massive that the larger the deal you go, the less competition you have in terms of competitive acquires. Shell recently did a massive deal a number of years ago buying BG. So, they’re likely out of the picture on a big deal for a while. Exxon and BP they tend to have different strategies. So, I think this is really a nice acquisition for Chevron, fits well into their portfolio. You can never count it out, really the market isn’t pricing in an overbid. I believe when I checked the merger arbitrage spread it was roughly around seven to eight percent annualized just pricing in standard deal risks. But interesting deal and we’ll keep you apprised of any news on this one and as for the energy industry, we really needed to see some consolidation. So perhaps here it is, and I would note the assets in this deal focused in the Permian basin, which has been a really hot play and notice that there really has been no deals in Canada over the past number of years. Which shows the lack of interest from these super majors and investing in the Canadian energy sector, just due to government policies, lack of market access due to no building of pipelines. So, another interesting dynamic there.
Mike: And Chevron CEO he did try to portray that this deal was more than just about the Permian assets that for example the Mozambique LNG facility there that they have that there are other assets. But I think the true focus was the Permian assets just by the overall deal.
Julian: Certainly, it’s a very profitable oil play these days.
FOMC minutes were released this week showing that the federal reserve is unlikely to raise rates this year. So, the federal open market committee and several participants noted that the current target range for the federal funds rate was close to their estimates of its longer-run neutral level and foresaw economic growth continuing near its longer-run trend rate over the forecast period. Now we discussed the notion of neutral level of interest rates a number of episodes ago. Which is an interesting topic. Because what central bankers have been trying to do over the past number of years is quote normalize interest rate policy, whereas after the credit crisis of 08, 09 central banks around the world really took down their benchmark rates to near to zero or near zero levels. Really emergency low interest rates and they’ve been trying to get them back to so called a neutral rate. Now this neutral rate is up for debate and what seems to be happening is instead of hiking rates, central bankers have been lowering their estimate of the neutral rate. Which is a pretty interesting concept and it is having implications for rate hikes. But what’s clear from the Fed’s recent meeting is that it seems highly unlikely that they will be raising rates this year. Another interesting quote at least say several participants noted that their views of the appropriate range for the federal funds rate could shift in either direction based on incoming data and other developments. Ultimately they’re leaving themselves an escape hatch. If inflation does pick up that gives them the ability to not necessarily flip-flop but change with the data.
Mike: Yeah and it looks like that the markets are pricing in about a fifty five percent chance of a rate cut by the end of the year. They really are taking the view that there’s any possibility of a rate increase. Which makes sense given some of the political pressures that the Fed is under currently. But as well the other aspect is that the committee also approved a plan that would have the bond reduction on the balance sheet halted by September. So, do you think this is a prudent move?
Julian: Well I think the Fed is best off being flexible which clearly they are. Contrast that to Q4 of last year. When they indicated that rate hikes will be somewhat automated as with the balance sheet runoff. This would combine to create tighter financial conditions, which obviously the markets didn’t like. The S&P 500 tanked 20%. Obviously Donald Trump was not happy with the way things were going and the Fed really did a complete 180 degrees on that. On both rates and the balance sheet runoff. One thing that you mentioned is now the Fed sees likely no rate hikes this year. But the market is pricing in over a 50% chance of rate cuts this year. So, there’s a bit of a dichotomy in between what the market thinks and what the Fed thinks. So, it’ll be an interesting dynamic to follow to see ultimately who’s right.
Mike: Absolutely and I think it’ll just be a more data dependent fed as opposed to as you mentioned something that’s more algorithmic and automated.
Julian: Yeah and what’s interesting is looking at the data as the markets tanked last year, the chances of a price or the chances of an interest rate cut increased dramatically. But now with the S&P500 back near all-time highs you haven’t seen the opposite reaction you would expect the probability of rate cuts to come down. But it just hasn’t happened.
Put out a blog post this week entitled the magazine indicator just flash red, should you sell everything. Some background on the magazine indicator – the 1970’s were a tough market for stocks. Basically, just treaded water, I believe 73-74 was a pretty punishing bear market and by the end of the decade people were really just fed up with stocks. People in general. And in 1979 BusinessWeek released one of the regular publications had a title, a now infamous cover called the death of equities. Now people point to this as being the birth of the magazine indicator. But it didn’t work right away. But in a few years the market really went on a generational tear from 1982 to the year 2000. Just that bull market was crazy. It went up multiple times and many people spoke of the death of equities magazine cover as a classic contrarian indicator and by contrarian indicator we mean if too many people are thinking one way, then that’s more than priced into the market. So, you can make money by acting in a contrarian nature or opposite of the crowd.
The reason we bring this up is because last weekend baron’s magazine released their regular issue with a bull on the cover with the title “Is the bull unstoppable?” which was quite the bold, potentially flashing red, magazine indicator that would concern a number of investors. I know I saw online a few economists, market participants really giving Barron’s crap for this one. I saw economist David Rosenberg tweeted “the front cover of Barron’s, how perfect! The makings of a market top”. I also found a funny reddit thread that said “Barron’s says the bull market is unstoppable. Sell everything, sell sell sell”.
So, you have some contrarians coming out of the woodwork. But as I indicated this death of equities cover, the timing wasn’t good at all. That came out in 1979 and by mid-1982 I believe the market was at the same level. So, it’s not much of an indicator if it’s three years too early. The other thing is ultimately there are always magazine covers coming out. I’m sure there’s been a hundred bullish ones over the past ten years and some bearish ones as well and they’ve really had no indicative value whatsoever. So, I think one thing to keep in mind with these obviously you don’t want to sell everything. You don’t want to make any dramatic changes to your asset allocation. But what you do want to do is you notice these things and take it into your investment framework as a judgement of where we are in the cycle. If you start seeing a lot of very bullish behavior. I gave this example as in 1929 Joe Kennedy had his shoeshine boy give him stock tips. He so he thought that things have gone way too far and there’d be no one else left to buy stocks and so Joe Kennedy not only sold all his stocks, but he went on to short the market and made a fortune in the great crash of 1929. Obviously I’m not advising anyone to do that. Because that takes a significant amount of luck. But obviously you want to have an asset allocation that can withstand any sort of drawdowns and note that the market has been on quite the tear and the valuations are quite high.
Mike: And I think you bring up a good point in that there’s never a bad time to look at risk management in your portfolio. So, whether you actually you know take actions and are selling off your entire portfolio, I think that’s a drastic measure. But I think it’s always good to be ensuring that you’re comfortable with the risks of your current portfolio and perhaps high grading that.
Julian: Certainly, don’t make any drastic moves. You’ll want to have long-term capital allocation plans, a well-diversified portfolio. But to answer Barron’s question is the bull unstoppable? No, at some point we do have to deal with bear markets. I mean we just had one in December where the S&P500 dropped 20% and you can typically expect that once or twice per decade and occasionally a big one down 50% like we had in 2008, 2009 and at the turn of the millennium. So, keep that in mind with your asset allocation and just be comfortable with where your portfolio is at.
And that’s it for Episode 9 of the Absolute Return Podcast. You can catch us next week. Feel free to visit our website, www.Absolutereturnpodcast.com and we’ll speak with you soon, cheers.
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