Running out of Steam

Programming Note: I deleted my first 20 subscribers by accident. I do not know who I deleted but if someone mentions no longer having access to the blog, please have them contact me.

The good times are gone and it is time for moving on.

Well, at least from the gamma squeezes.

I’ve sold all the names that might have been squeezed. I have gone short a few of the most egregiously priced stocks. And I am long the largest of the large, as I will explain below.

I have not written too much since I talked about the gamma squeeze idea a month ago because really, what is the point? When what is working are stocks you were embarrassed to say you own, who wants to put up research and reasons for that ownership for all posterity to see?

Better to make some short term bets and collect dollars in the shadows, with no one the wiser.

I should not say the good times are gone. I do not really know. There is another round of stimulus checks coming, so it is possible there will be a round two of the silliness. But I really hope not. It is just so dumb.

I am actually starting to find the whole thing a bit annoying. There are so many crazily priced stocks. That these 3D printing names have gone up to such insane levels (though they finally came off thankfully) on growth that is, at least so far, very moderate, is just unfathomable to me. The same can be said for many biotech names. And of course for the EV stocks.

I was happy to see Zoom drop after every twitter shill screamed about its magnificent quarter last night. Not because I have anything against Zoom. But it seemed to signify a lessening of the euphoria in the market.

With that in mind, let’s talk about Kopin. I wrote up Kopin last fall, I wrote about it here, and I held the stock until $3.50 or a little above that. Now the stock is $9 and their quarterly results today were good. They were pretty much inline with what you’d expect given the large military contracts they announced last year that we knew they would be delivering on beginning in Q4.

On these results the stock was up another $2.50 early in the morning. I mean, holy geez. This idea that there is no limit to what something is worth as long as they beat has gone too far. Kopin is up 900% since the last quarter. So after a move like that, just because they beat the outdated analyst estimates… (the average estimate I saw was ~$9.5 million of revenue, which meant that the analysts weren’t really trying. They had clearly not updated their numbers to account for the big contracts that had been signed and so those estimates were basically meaningless). Nevertheless, the stock goes up another 25%? Come on.

When the stock was nearly $12 today Kopin was a $1 billion company. When I was looking at Kopin it was a $130 million company! That was 4 months ago? Its worth $1 billion now? Something completely game-changing must have happened right?

Not that I can see.

The biggest thing that happened is what I just said. Kopin began delivering on a couple of big military contracts. Nothing surprising. We all knew this was coming.

But what about the consumer AR/VR? Yup, no doubt about it, there is a big potential opportunity ahead in consumer AR/VR. That is what I liked about the stock in November. And yes, it maybe appears to be coming to fruition faster than anticipated. Maybe. On the call Chin Chiang Fan (the CEO) said the adoption cycle has been brought in 2-3 years.

But the numbers… I mean I did a DCF on this stock when I bought it. Those results are, quite honestly, why I didn’t hold it to these double digit nosebleed highs. I’ve played around with that model today. If you make what I think are some extremely optimistic assumptions, with many years of 40% growth and 15% FCF margins, and then you give Kopin a decent 15x FCF multiple on the terminal value 10 years from now, you get a price that is about $14. So a little higher than the high today.

Yet Chiang Fan is already explaining the reality. On the call he said gross margins are only going to be 20-30% for consumer wearables. This is not a SaaS business. So yeah, the volumes, when and if they come, will be high, but margins will be lower. I think my FCF assumption of 15% is likely too optimistic. We know one of the stumbling blocks of AR/VR is that the devices are expensive. According to MS “Apple’s flagship iPhone 11 Pro retails for $999. The Oculus Rift costs $599. The HTC Vive costs $799. And the Microsoft Hololens costs $3,000+.” This is all going to eat into hardware supplier margins if costs are going to come down.

Meanwhile there is going to be competition. Kopin is not in the Facebook Oculus product. According to BoA, Facebook is “massively investing” in the space. These small companies can get outspent and marginalized quite easily.

Finally, as Morgan Stanley pointed out in a piece a few weeks ago there is still no killer use case. A few months ago, when I was digging into Kopin, there was a lot of talk around education, virtual tours, medical procedures, and how these “stay-at-home” use cases would be the trigger for wide based adoption. But now, with a vaccine, how likely are these use cases? Are we really going to choose to go house hunting virtually when we could just drive and look at the place. Or attend virtual school? I’m not so sure.

I am not trying to diss on Kopin here. I love Kopin. I did well on it. It probably has a great future. At the right price I would buy it back. But right now the stock is pricing in a world of nothing but growth and roses. And my experience kinda says that does not happen most of the time.

So that is one and I spent a lot of time there talking about it. A couple other shorter takes. These 3D printer companies. Take Stratasys. At the top the stock had quadrupled since November. Things must really be booming right?

Well, not really. They had results Monday. The company forecast flat revenue next quarter and mid-teens growth in the second quarter.

But wait, mid-teens, that sounds good, right? Well yeah, but this is using comps of 2020, when they saw a 28% year over year revenue decline. Before 2020, when revenue was down 18% for the FY, Stratasys had 4 years of essentially flat yoy revenue.

When I look at average estimate for Stratasys, the growth horizon is about 10% growth as far as the eye can see. The company has generated some free cash flow in the past, but it will take a lot more to live up to that $1.8 billion valuation that they have now.

The main acceleration appears to be the share price. I guess we just have to believe. Things will change, the promised land will come, growth and profitability will manifest. Just like it will for all the SPACs.

One more example. Acuity Ads. I owned this stock a year and a bit ago and then kinda lost track of it. It is up a crazy amount this year, I think close to 25x. My bad. Acuity came out with their fourth quarter results today and revenue was down yoy. Down? Acuity blamed it on covid and their hospitality clients. I mean, come on. These guys are supposed to be the next TradeDesk. TradeDesk revenue was up 40% in Q4. So why is it up 25x?

There is not anything wrong with any of these companies. These are actually good companies. But we are in full-on stupidsville here. So many microcaps have gone crazy and it just isn’t a good risk/reward any more. I am not playing that game. Instead, I will look for value somewhere else (and short the insanity where it is most egregious).

With that in mind, this is my one idea right now. A world on its head coming from me:

What if you just bought the big tech stocks. Could even short some smaller one’s if you want to hedge your bet.

Here are my reasons.

For one, Facebook and Amazon have basically not participated in this entire run-up over the last 4 months. Their under-performance has been quite stark. Google has participated because they beat earnings by so much, so maybe you need to wait a bit for that one. Apple might be an alternative, but I did not get a chance to look at it as I did these 3 others.

Second, though I have some chagrin about the overexposure of Mike Green (is he on every podcast these days?) I do believe that his idea about passive investing makes sense. My earlier posts on the reinforcing nature of the S&P carry-trade (here) feed into this as well.

These factors should, over the medium term, mean that these large tech companies, which are pillars of the index, outperform. We have just had a period of crazy out-performance of small-caps. Is it so hard to believe that there could be a mean reversion?

Third, and this is the reason I like the most: these names are actually pretty cheap.

I did simple DCF models of Facebook, Amazon and Google. I followed that up with DCF models of three smaller (but not really small) tech names that I picked somewhat at random: Workday, Atlassian and ZScaler.

In my assumptions I tried to take a very conservative view for the 3 large names. I had growth moderating to the low teens rather quickly and then to 10%, and in Facebook’s case I assumed growth dropped to as low as 5% for the last few years of the 10-year period. With the smaller names I assumed much more robust growth. Workday was the lowest, I assumed their growth did come down to 10% in 10-years. I assumed Atlassian’s growth is well over 20% for each of the next 5 years, followed by a slide to 15% growth thereafter. For Zscaler I make the assumption that it continues to grow at 25% for a full 10 years running.

For all the names I used a 10% discount rate. While I am sure this is wrong, every time I read about WACC and what I should be using I just end up confused, so I decided to go with 10%. And what I really was looking for was an apples to apples comparison.

For each of Facebook, Amazon and Google I assumed a terminal value at 10x discounted FCF at the end of the 10-year period. For the smaller names I assumed 15x.

So the assumptions are all favorable to the smaller SaaS names. Yet even so, they all appear to be overvalued by 20-30%, while Facebook and Amazon are below fair-value, and Google was about 8% above.

And I am not even really trying with the smaller SaaS names. I picked the 3 above mostly because I follow them and like the companies. I’ve owned both Workday and Atlassian in the past. These are all good, free cash flow generating companies.

I am sure with a bit of work you could find much worse.

So in summary: if I were to take longs in these very large-cap names, and take shorts in some smaller tech names as a counter, I would be doing 3 things at once: I would be long passive-momentum, I would be contrarian the current market, and I would be betting on value (at least relatively)!

So I did. This market has, for whatever reason, forgotten about big-tech and decided that micro-caps are worth the moon. Maybe that will change.