Will IBM's Red Hat Acquisition Finally Move The Needle?

International Business Machines (IBM) had been trading range bound for five months from mid-April through mid-September, trading between roughly $140 and $145. Before its Q3 earnings, IBM had finally broken out to $154 with a subsequent implosion after its earnings release that fell short of expectations coupled with its announcement that it will be acquiring Red Hat (RHT) for $34 billion.

IBM’s stock is now at a 52-week low after the company missed revenue targets, notably a drop in Cognitive Solutions and server weakness implying that its revived nascent growth earlier this year will be subdued moving forward. IBM’s stock has been decimated and now trades at ~$115 per share or down over 30% from it's 52- week high of $171. IBM has had a long turn in restoring growth after posting 20+ consecutive quarters of declining revenue however IBM had posted back-to-back quarters of revenue growth as of late.

This growth has come on heels of its long-term imperatives beginning to bear fruit in emerging high-value segments that has fundamentally changed its business mix while evolving its offerings to align with new age information technology demands. The Red Hat acquisition will ostensibly augment its transition away from its dependency on legacy businesses to the future of cloud, artificial intelligence, and analytics. Continue reading "Will IBM's Red Hat Acquisition Finally Move The Needle?"

Facebook - Compelling Buy Heading Into Q3 Earnings

Facebook’s (FB) disastrous second quarter conference call erased $119 billion in market capitalization in a single session marking the worst one day drop for any large-cap company in history while the stock shed a fifth of its value. Since then, ancillary fallout emanating from its core data misuse scandal involving Cambridge Analytica continue to surface.

Security issues affecting 50 million accounts, a lawsuit alleging concealing video ad measurements and increasing EU scrutiny have continued to plague the stock since its second-quarter implosion. The original mishandling user data resulted in the stock tumbling from $195 to $152 or 22% at the time. Facebook appreciated off those data misuse lows and broke out to $220, however, this scenario ended abruptly on the heels of its Q2 earnings. Facebook issued a major guide down in growth for the next few quarters tampering growth expectations in the near term. Facebook is facing a challenging confluence of slowing revenue growth, margin compression and stagnant daily active users in the near to intermediate term.

There’s been a recent initiative that has the backing of four large institutional investors to remove Mark Zuckerberg as Facebook’s chairman in the wake of all of these security issues. Despite these headwinds, Facebook is still posting accelerating revenue growth across all geographies, expanding market penetration with Instagram’s IGTV, Facebook’s Stories and monetization efforts in Messenger and WhatsApp. Facebook is still poised to grow at a double-digit clip with the most recent growth rate coming in at 42% in Q2.

The long-term picture looks bright for Facebook, and the recent sell-off in the stock and tech cohort is a good opportunity to initiate a long position as the company contends with and addresses all the issues across its platforms (Figure 1). Facebook remains a premier large-cap growth stock and inexpensive relative to other large-cap growth stocks in its cohort heading into Q3 earnings.

Figure 1 – FANG cohort performance throughout the tech sell-off with Facebook, Amazon, Netflix, and Google all shedding ~10% of their market capitalization

Scandals and High-Level Departures

There’s been a slew of negative press regarding additional issues negatively impacting the company’s platform and inflicting further damage on its reputation. Facebook disclosed a security issue that affected 50 million accounts. Continue reading "Facebook - Compelling Buy Heading Into Q3 Earnings"

Disney: Fox Acquisition and Strong ESPN Numbers

Stock Trends Upward to New Highs

Disney (DIS) has finally broken out to new highs as the Fox (FOX) acquisition, and its streaming initiatives come into the fold. Now that the Fox acquisition is complete and its assets are being absorbed by Disney this once opaque situation now appears clear and definitive. Furthermore, Disney is divesting its 39% Sky ownership stake that it acquired via the Fox acquisition to Comcast (CMCSA). This divestiture enables Disney to reduce its debt that was required to purchase the Fox media assets and will allow more investment into its streaming services such as Hulu, ESPN Plus and its Disney branded streaming service that will directly compete with Netflix (NFLX) in 2019. The Fox acquisition brings a majority stake in Hulu (60% ownership) while its ESPN Plus launched earlier this year and has over 1 million subscribers in its early phases of being rolled out. Disney continues to dominate at the box office while posting great growth at its theme parks translating into robust and durable revenue streams. The company is evolving to meet the new age of media consumption demands of the consumer via streaming and on-demand content. To this end, shareholders are beginning to resonate with Disney’s vision for future growth and the stock has appreciated to a 52-week high as of late-breaking above the $118 level. Disney currently trades at a P/E of 14.5 while the average stock in the S&P 500 trades at ~25, representing a ~40% discount to the average stock in the index. Disney offers a compelling long-term investment opportunity given its backdrop.

ESPN Plus – Subscriber Numbers Released

ESPN Plus was launched earlier this year in April to a mixed skeptical reception among shareholders and consumers upon its debut. Due to precipitous declines in ESPN viewership via traditional cable, Disney was cornered to remediate its ESPN business and evolve to the cord cutting consumer. Recently, Disney announced a key milestone for its streaming platform, reaching over 1 million paid subscribers. ESPN is Disney’s first inroads into the streaming arena offering a package of sports which include Major League Baseball (MLB), National Hockey League (NHL), college football, soccer, boxing and UFC for $4.99 per month. Disney has kept its ESPN Plus subscriber numbers a secret and would only state that its paid subscriptions were "strong" and that growth was surpassing expectations. Continue reading "Disney: Fox Acquisition and Strong ESPN Numbers"

Financials – Conspicuously Underperforming

Underperforming Despite Tailwinds

The financial cohort has conspicuously underperformed the broader market for the majority of 2018. The group didn’t participate in the broader market performance in Q3 where the S&P 500 had its best quarter since 2013. Banks have had domestic and global economic expansion tailwinds at its back while posting accelerating revenue growth, increasing dividend payouts, engaging in a record number of share buybacks and benefiting from tax reform. Augmenting this economic backdrop is a record number of IPOs, a record number of global merger and acquisitions, rising interest rates, deregulation, and tax reform. Banks are benefiting in unique ways due to the consulting fees regarding mergers and acquisitions and trading around market volatility. All of these elements provide an ideal confluence that bodes well for the financial sector. JP Morgan (JPM), Citi (C), Wells Fargo (WFC), Goldman Sachs (GS) and Bank of America (BAC) seemed to be poised to continue to benefit from the favorable economic backdrop. Thus far in 2018 the financials have performed terribly considering the broader market performance and the aforementioned economic tailwinds. There’s negative sentiment that’s placed the financials in a holding pattern for much of 2018 over concerns of rapid interest rate increases and an inverted yield curve.

The Federal Reserve, Rising Interest Rates and Economic Strength

The Federal Reserve expects the economy to continue to strengthen and inflation to rise shortly. The economic strength coupled with the threat of inflation provides an environment that’s ripe for rising interest rates. The Federal Reserve has been very bullish on the domestic front and signaled that rate hikes will continue and may even accelerate its pace of rate hikes contingent on inflation and economic strength. There’s no question that the financials benefit from rising interest rates, and Bank of America(BAC) has one of the largest deposit bases among all banks and serves as a pure play on rising interest rates. Goldman Sachs (GS) has even branched out into consumer banking with its Marcus product so needless to say all big banks will benefit from their deposit bases.

Federal Reserve Chairman Jerome Powell stated that the unemployment rate currently stands at 3.9%, near a 50-year low while core inflation is right around 2%. Powell said that these two metrics are part of a “very good” economy that boasts “a remarkably positive outlook” from forecasters. The central bank approved a quarter point hike rate in the funds rate that now stands at 2.25%, and the committee indicated that another rate hike would happen before the end of the year. 2019 will likely see three more rate hikes and 2020 will see one rate hike before pausing to assess the delicate balance of rising rates in the midst of a strong economy while taming inflation. Continue reading "Financials – Conspicuously Underperforming"

IBB - Stealth Bull Market Unfolding

The iShares Nasdaq Biotechnology ETF (IBB) which serves as a proxy for the biotechnology cohort has finally broken out to a 52-week of $122 against its 52-week low of $100 in May. This 20%-plus appreciation over the summer has largely gone unnoticed while some individual companies have soared even higher over this same period. The biotechnology cohort has been decimated over the past 2-plus years over the drug pricing debate while serving as a political punching bag. To be fair, the entire pharmaceutical supply chain became a victim of harsh political rhetoric as share prices fell across all companies involved in this space in any capacity. The biotechnology cohort has been largely ignored in this massive bull market and appears relatively cheap in comparison to other sectors. As the confluence of abating political threats, drug pricing certainty, merger and acquisition activity and continuity of the current health care backdrop, this cohort has witnessed a stealth bull market. This uptrend is likely to have legs as valuations remain compelling and many names have become value stocks.

Furthermore, as the raging bull market continues into frothy territory, downside risks continue to mount. Bank of America is predicting an end to the current bull market run and in less certain times pharma companies will benefit. Individual names within the sector have demonstrated incredible strength as of recent such as Regeneron (REGN), Bristol Meyers (BMY), Allergan (AGN), Celgene (CELG), Johnson & Johnson (JNJ) and Amgen (AMGN).

Challenging 2016, Recovering 2017 and IBB’s Resurgence in 2018

After a banner year in 2015 for the biotech ETF, the cohort sold off in a dramatic fashion falling from $138 to $89 or a 37% decline. The healthcare sector had been faced with an uncertain and volatile political backdrop. As President Trump and other political pundits vowed to bring down drug prices and increase scrutiny over the sector, IBB found its footing and set a floor near the $89 level. The ~$90 level was tested a handful of times in 2016, and it was evident that many of these political threats were being priced-in after its sharp and sustained sell-off. This sharp decline and subsequent floor coincided with heated political rhetoric aimed at the collective cohort of healthcare and more specifically biotech companies. I strongly felt that these events were extraneous and would eventually subside without any significant impact on the underlying stocks within IBB. I felt this politically induced sell-off presented a great buying opportunity considering the ~40% decline and extraneous pressures. I had written about such opportunities throughout 2016 during the market sell-off and the Brexit, respectively (Figure 1). I felt that these were great entry points for any long-term investor that desired exposure to the biotechnology sector. Ostensibly, many of these stocks were trading at multiyear low P/E ratios and as a cohort (gauged via the IBB proxy) looked to be less sensitive to tweets/threats as IBB continued to test the ~$90 barrier throughout 2016. 2017 saw a nice recovery and posted a ~20% gain, and 2018 is shaping up to posting another double-digit annual return thus far the index is up ~14% YTD. Biotechnology remains one of the few sectors that money has yet to rotate into now that retail has caught fire.
Continue reading "IBB - Stealth Bull Market Unfolding"