Author Archives: Chris Versace, Chief Investment Officer

Key Points from this Issue: 

• Our rating on Applied Materials (AMAT) remains Buy and our price target is $70
• Our rating on LSI Industries (LYTS) remains Buy and our price target is $11
• Our rating on Paccar (PCAR) remains Buy and our price target is $85
• Our price target on Amazon shares remains $1,750, and a win, whole or partial of the pending Pentagon cloud contract would lead to a reassessment of that target.
• Our long-term price target on AXT Inc (AXTI) and Nokia (NOK) shares remain $11 and $8.50, respectively.

The benchmark 10-year Treasury bond rate went over 3% yesterday for the first time since 2014, sending stock prices down sharply in response. We saw that reverberate through the Tematica Investing Select List as the stock market continues to shoot first and ask questions later. Not surprising given that CNNMoney’s Fear & Greed Index has vacillated between Extreme Fear and Fear over the last month, and commentary thus far this earnings season is aggravating things. Last week it was United Rentals (URI) beating expectations largely due to the impact of tax reform. Yesterday it was Caterpillar (CAT), which after delivering a stellar 1Q 2018 earnings report warned that its margins may have peaked in 1Q 2018 due to rising manufacturing costs. 3M (MMM) also reduced its 2018 outlook and Lockheed Martin’s (LMT) raised outlook included almost all key metrics for the company save the closely watch operating cash flow line.

Stepping back, what we’re seeing is an earnings season that developing far from what was expected. As a reminder, the S&P 500 group of companies were expected to deliver 17%-18% EPS growth year over year in 1Q 2018 and reaffirm the outlook that would equate to at least 18% EPS growth in 2018 vs. 2017. The commentary that we’ve gotten over the last week, raises some questions about those growth expectations as the 10-year Treasury bond rate has inched up, which is likely stoking interest rate hike concerns.

This skittish mentality has hit our Applied Materials (AMAT) shares last week despite a solid earnings report from competitor Lam Research (LRCX) and the vibrant outlook for chip demand over the next several years. We saw it again in our LSI Industries (LYTS) and Paccar (PCAR) shares this week – the former getting gut-punched lower amid a sudden CEO exit, and the later despite a rip-roaring 1Q 2018 earnings report that crushed expectations. With 1Q 2018 truck orders surging to levels last seen more than a decade ago, prospects for Paccar to deliver further margin leverage look rather favorable in my view. With the underlying data pointing to a favorable nonresidential construction market and a continued truck shortage, I remain bullish on LYTS and PCAR shares, especially at current levels.

The current market environment will call for patience, but that’s in keeping with our long-term, thematic perspective. Complicating matters in the short-term is the inability of companies to step in with their share repurchase programs, which would normally help backstop share prices. Until a company reports its results and clears its quiet period window, it’s in a holding pattern with its share repurchase plan. This likely means if the current market mood persists, odds are the market will trade sidewise at best and likely lower in the near-term as investors recalibrate expectations.

As we navigate through the rest of 1Q 2018 earnings season, odds are we will get a few opportunities to improve our cost basis, and odds are LYTS shares and PCAR shares will be among them unless the data suddenly turns sharply lower. As yet there are no signs indicating that is on the horizon.

• Our rating on Applied Materials (AMAT) remains a Buy and our price target is $70
• Our rating on LSI Industries (LYTS) remains a Buy and our price target is $11
• Our rating on Paccar (PCAR) remains a Buy and our price target is $85

Amazon: A looming boost for Amazon Web Services as the Pentagon gets connected

Shares of Amazon (AMZN) have been on a tear this year, up 25% thus far this year even after yesterday’s market. That makes them the best performer on the Tematica Investing Select List over the last year as well. For those wondering if my outlook for the shares of what I affectionally call the poster child company for thematic investing remains vibrant, my response would be a firm yes!

As we learned last week in Jeff Bezos’s annual shareholder letter, Amazon has 100 million Prime members – to put that in perspective that’s 1 member out of every 3.3 people in the U.S. alone – and garnered for the eighth consecutive year the top slot in the American Customer Satisfaction Index. As Bezos discusses the achievements across Amazon’s various business lines, he gives credit to the 560,000 Amazon employees and the “2 million sellers, hundreds of thousands of authors, millions of AWS developers, and hundreds of millions of divinely discontent customers around.”

Across Amazon’s various businesses it has positioned itself not only with the thematic tailwind that is the accelerating shift toward a digital lifestyle but at nearly every turn it has looked to remove friction for its customers be they consumers, enterprise or other institutions. According to data from Statista, e-commerce sales accounted for 9.1% of total U.S. retail sales in 4Q 2017, up sharply from 4.6% in 4Q 2010. The combination of Amazon’s Prime service, which in my view was the beginning of the end for the mall and brick & mortar retail, paired with a still-expanding array of products and services has led Amazon to take consumer wallet share as it disrupts existing business models and industries. As Bezos pointed out, one of Amazons’ not so subtle strategies is to tap into consumer discontent. I see that as a different way to say, Amazon is riding the thematic tailwinds associated with our Connected Society, Disruptive Technology, Cashless Consumption and other investing themes.

What many don’t realize, however, is the secret weapon that is Amazon Web Services (AWS), the company’s cloud business that accounted for 10% of its 2017 revenue but virtually all of its operating profit for the year. I see the cloud as a disruptive force in how companies are conducting their business, and for individuals, a new method to save files of various types, and this means AWS is on the receiving end of a Disruptive Technologies tailwind.

On the one hand, enables Amazon to invest in its other initiatives while more often than not beating EPS expectations over the last several quarters. On the other, this means investors need to pay close attention to AWS and its ability to continue to grow, thwart competition and maintain if not further expand its operating margins.

This brings us to one of the larger known opportunities for AWS – in March, the Department of Defense announced it would select one cloud vendor for a multibillion-dollar cloud services contract to support its 3.4 million users, 4 million devices and some 1,700 data centers. Likely competitors for this include Microsoft (MSFT), IBM (IBM), Alphabet (GOOGL), Oracle (ORCL) and yes, AWS.

This raises the question of market share and here’s the answer. According to data from research firm Gartner, AWS has 44% percent of the public cloud market, followed by Microsoft’s Azure with 7% percent, China’s Alibaba Group with 3% and both Google and Rackspace at just over 2%. Outside those top 5, the remaining 41% of the 2017 $22 billion infrastructure as a service public cloud market was spread across a number of competitors.

For those wondering, AWS has already cracked the government cloud market with the $600 million contract it received from the CIA back in 2013, beating IBM out in the process. What makes all of this interesting is that in February, the U.S. Department of Defense awarded a $950 million cloud contract to REAN Cloud LLC, an Amazon Web Services LLC consulting partner and reseller.

While the Pentagon is not slated to make any formal announcement as to the winner of the contract until September, there is pushback on the decision to go with one vendor. Understandable as even companies like Apple (AAPL) loath to be tied to just one supplier. In this case, there is the obvious risk that just one cloud vendor for the entire Pentagon would more than likely make that vendor the world’s largest target for hackers and other digital malcontents. But there are other business reasons for the Pentagon to consider multiple vendors including competitive pricing and innovation as well as limiting complacency.

As an investor, would I like to see Amazon win the Pentagon contract? Absolutely. But given the increasing frequency of cyber-attacks and a bloating government budget, the smarter business decision looks to be having at least a few cloud vendors. As the American author, Nancy Pearcey summed up rather nicely, “Competition is a good thing, it forces us to do our best.” And let’s remember, any slice of the Pentagon contract is a win for all of these potential cloud suppliers.

• Our price target on Amazon shares remains $1,750, and a win, whole or partial of the pending Pentagon cloud contract would lead to a reassessment of that target.

AXTI and NOK: Checking the 5G news

On Friday, Ericsson (ERIC) one of the leading mobile infrastructure companies reported better-than-expected results, which contained positive comments on the North American market that reflect investments in network expansions and in 5G readiness. This bodes very well not only for our Nokia (NOK) shares but also our AXT Inc. (AXTI) ones as well. It also happens that both companies are reporting later this week – AXT after Wednesday’s market close and Nokia before the market open on Thursday.

Here’s the thing – Ericsson wasn’t the only company to paint a favorable picture for these two companies when it comes to 5G. AT&T (T) recently shared that it will expand its “5G Evolution” wireless technology to more than 140 U.S. markets, which lays the groundwork for its planned mobile 5G service launch later this year. For those that are unfamiliar with AT&T’s 5G Evolution technology, it can deliver theoretical peak speeds for capable devices of up to 400 megabits per second. By the end of 2018, AT&T targets having 5G Evolution in more than 500 markets “including major cities like Baltimore, Cleveland, Denver, Detroit, Las Vegas, New York City, Philadelphia, Seattle and Washington D.C.” Alongside that announcement, AT&T also shared it is making its LTE-LAA technology available in parts of 3 new markets, bringing the total number of markets served to 7. AT&T’s LTE-LAA technologies can deliver theoretical peak speeds for capable devices of up to 1 gigabit per second.

Again, those rollouts are paving the way for AT&T 5G service. The company has been running test trials of 5G service in preparation for deployment in 12 US markets later this year. The carrier shared its speed test results and a few other notes on Tuesday. AT&T has been testing 5G with small businesses over the last year in three separate cities: Waco, Texas; Kalamazoo, Michigan; and South Bend, Indiana. Here are some of its findings:

• Waco’s 5G speeds were 1.2Gbps from 500 feet over a 400MHz channel, with 9-12 millisecond latency. That was with “hundreds of simultaneous connected users,” according to AT&T.
• Kalamazoo had 1Gbps speeds at 900 feet in “line of sight” conditions, and no negative impact from rain or snow. AT&T noted the signals could penetrate “significant foliage, glass, and even walls” better than expected, but it’s unclear what that specifically means.
• South Bend didn’t report specific speeds but claimed “gigabit wireless speeds” in the line of sight and “some non-line of sight” conditions. To put that in perspective, my home’s Wi-Fi speed is around 100Mbps and my phone on AT&T LTE averages around 25Mbps.

Putting aside the technical mumbo-jumbo, an analogy from RF semiconductor company Skyworks Solutions (SWKS) and AXT customer drives home the data speed differential – downloading a full-length HD movie in 3G took one day, in 4G, the same file took minutes. On a 5G network, this content will be downloaded in mere seconds. Talk about the next disruptive iteration in mobile technology. Given its move to acquire Time Warner (TWX), I’d argue that AT&T has a vested interest in scaling its 5G network.

In January, AT&T shared that it plans to launch its mobile 5G network in a dozen markets in late 2018, along with a phone that will actually be able to use it. When AT&T reports its 1Q 2018 results after Wednesday’s close and then holds its annual shareholder meeting on Friday (Apr. 27), we’ll be looking for confirmation of those plans and possibly either an upsizing or pulling forward of them as well. We would view any of those scenarios as positive for our AXT and Nokia shares.

• Our long-term price target on AXT Inc (AXTI) and Nokia (NOK) shares remain $11 and $8.50, respectively. 

On Monday, I shared my view about the changing narrative that has hit the stock market as we closed the books of the first quarter of 2018 and turned the page and kicked off the second quarter of this year.  Then, just this morning, I posted a follow-up as Trump’s tit for tat on those tariffs has escalated even further, only fanning the flames of uncertainty even further. You can read those comments by clicking here.

Amid all this uncertainty and volatility, the question likely on the top of your mind is what will we do here at Tematica Investing?

What we’ve always done – be prudent investors that listen to our thematic signals as we look for solid businesses to buy at favorable prices.

As I look across the current crop of holdings on the Tematica Investing Select List, I continue to see favorable outlooks for some of more recently added positions – Rockwell Automation (ROK) and Paccar (PCAR) for example – that have come under pressure along with the market these past weeks. When the market settles out, I’ll look to take advantage of the current pain to improve our cost basis. That strategy has served us well with Costco Wholesale (COST) shares and others in the past and I’m confident it will again.

With Facebook (FB), the bevy of privacy and user data concerns were once again kicked up with the announcement that Facebook CEO Mark Zuckerberg is now scheduled to testify before Congress next week. While we removed the shares from the Select List, one of the questions we’ll need to have answered is how does the company’s moves to address these concerns impact its revenue and bottom line? For now, this means Facebook is a show me story even as it continues to benefit from monetizing Instagram and its other properties.

And then more recently President Trump has turned his Twitter focus to Amazon (AMZN), the U.S. Postal Service (USPS) and how Amazon is being “subsidized.” That noise you just heard was me shaking my head in response.

I view this deal between Amazon and the UPSP as a struggling USPS cutting a deal to help it defray costs as it contends with the headwinds associated with our Connected Society investing theme — headwinds that Amazon is primarily creating. I’m only surprised that Trump hasn’t lashed out over how incompetent the USPS has been and how poor of a deal it inked. Let’s also not forget that Trump is less than pleased with his coverage in The Washington Post, which is owned personally by Amazon’s Jeff Bezos. Nevertheless, I see this only as a short-term distraction rather than a true threat to the many, many, many thematic tailwinds Amazon is riding.

Now let’s look at a new position for the Select List…

GSV Capital: A sleeper play on Spotify and Dropbox

Amid the market pain this week, a long-awaited day has finally arrived as streaming music service Spotify (SPOT) has become a publicly traded company. This follows the recent initial public offering of cloud storage company Dropbox (DBX). The former fits in our Connected Society investing theme, while the latter sits inside our Disruptive Technologies ones. While it’s not a strict rule, I tend to avoid newly public companies until after the lockup expiration period as it clears out a potentially large wave of insider selling that weights on the shares.

There is, however, GSV Capital (GSVC), which is a public company that gives “growth equity investors access to the world’s most dynamic, VC-backed private companies.” I see it as a public company that invests in private companies and looks to monetize its portfolio of holdings through either an IPO or other strategic exits such as an acquisition, and that fits rather squarely inside our Asset Lite investing theme.

For those that may not remember this particular theme, the Asset-Lite investment theme looks to capitalize on business models that leverage investments and intellectual property to generate what are typically large returns on relatively few capital assets, such as property, plant, and equipment.

A full list of the GSV’s top 10 investments can be found here, but as of year-end, 2017 Spotify accounted for 15% of GSV’s investment portfolio, while Dropbox was 8.7%. If we aggregate the investments across GSV’s investment portfolio, we would find that roughly 35% of its portfolio is centered on cloud computing and big data, which means it has meaningful exposure to our Disruptive Technologies theme. This edges out its position in education technology (Tooling & Re-tooling) and is followed by social/mobility, marketplaces, and sustainability at roughly 18%, 11% and less than 1% of the total portfolio.

Historically when holdings in GSV’s portfolio go public, it drives the company’s overall net asset value higher especially when those going public companies have been higher in profile like Spotify and Dropbox.

On March 22, Dropbox prices its IPO at $22 per share, and out of the gate, the offering was met with strong reception as the shares closed at $29 and have closed between $29.90-$31.25 ever since. Not all that surprising given the transaction was reportedly 25 times oversubscribed. The original price talk on the offering was far lower, in the upper teens. Viewed from the perspective of our GSV shares, the Dropbox offering was a success. Moreover, with consumers and corporations as well as other entities embracing the cloud, we see a bright future ahead for Dropbox, especially as it continues to take a page out of Alphabet/Google’s (GOOGL) playbook and pile on the features. In the coming days, we should get a swath of analyst coverage and odds are favorable ratings as well as price targets, especially from the underwriters – Goldman Sachs (GS), JPMorgan (JPM) and 10 others.

As I noted above, the news of the day, however, was the Spotify IPO and the shares opened up at $165.90 before closing at $149.01, roughly a 13% move higher in its debut. Unlike the Dropbox offering that was a traditional going public transaction, Spotify opted for a direct listing, which means there were no underwriters subsequently no price talk ahead of the opening trade. That said, in the private markets, Spotify shares were said to have been trading near $132-$133 ahead of the IPO – that’s how that 13% move higher was tabulated.  And lest one think Spotify went solo on this endeavor, it was advised by Goldman Sachs, Morgan Stanley (MS) and Allen & Company. That likely means follow up research and favorable price targets.

Even if those three don’t follow through on that, which in our view is unlikely, we’ve already seen price targets in the $200-$220 range emerge from RBC Capital and MKM Partners with Guggenheim offering a $175 price target. Helping set the base for those targets, last week Spotify shared guidance for 1Q 2018 revenue to climb 22% year over year and for 2018 revenue guidance to climb 20%-30%. That sound you just heard was the air being let out of the Pandora Media (P) balloon as there is a far better play on streaming music services to be had as of today. Pandora’s only expected to grow its revenue some 3% this year.

The one wrinkle in the Spotify forecast is the company expects to deliver bottom-line losses, and while investors will likely want to own shares in the largest streaming music service globally – the Netflix (NFLX) of streaming music – over time we’re likely to see questions over when it will be profitable and deliver positive EPS crop up. That’s at least several quarters away, and the near-term focus over the next 6-12 months will be the company delivering subscriber growth. Again, similar to Netflix in its early streaming days.

When it comes to both Dropbox and Spotify, their market position in their respective businesses is enviable… so enviable in fact one has to wonder why Apple (AAPL) didn’t buy them several years ago. If Apple did, odds are iCloud and Apple Music would be very different animals today.

As I mentioned above, we look to invest in businesses that are benefitting from our thematic tailwinds. In looking at both Dropbox as well as Spotify, both are benefitting from the ongoing shift toward cloud and digital/streaming services. Both allow people access to content when they want it, where they want it and on the device of their choice. Inside GSV’s investment portfolio there are other holdings that are benefitting from our thematic tailwinds as well – Palantir, a big data analytics company, and asset lite company Lyft – both of which continue to move toward monetization events for GSV and their other investors.

Because GSV is an investment portfolio, looking at EPS and revenue is rather meaningless. Instead, the valuation methodology centers on the company’s net asset value (NAV) per share. Exiting the December quarter, the company’s net asset value stood at $9.64 per share, which means even before we include the move higher in Spotify and Dropbox shares, GSVC shares are trading at a 25% discount. Factor in the moves in both holdings and that discount is even wider, which offers compelling upside to $11, which is our price target based on post-transaction net asset value calculus. Should Spotify and Dropbox move higher, which I suspect they will over the longer-term, GSV’s NAV should move higher as well. Should other holdings go public, such as Palantir, that likely means more fuel to the NAV fire.

The bottom line on GSV Capital (GSVC)

• We are issuing a Buy rating and adding GSV Capital (GSVC) shares to the Tematica Investing Select List as an Asset Lite play with an $11 price target.