Sohu Stock Undervalued Based On Sum-Of-The-Parts Analysis


Sohu(SOHU) generated a meager 5% return over the past 12 months, vastly underperforming many other Chinese technology stocks. Yet there are two catalysts in store for Sohu in the near term and the stock’s performance may finally be able to catch up. Sum-of-the-parts analysis on Sohu’s valuation shows very favorable risk/return at current price point. In an optimistic scenario, Sohu’s stock could return over 170%.


One of the catalysts is the continued price appreciation of Changyou(CYOU), Sohu’s gaming subsidiary. On May 22, Sohu’s Chairman and CEO Charles Zhang sent Changyou’s board a proposal to privatize Changyou at the price of 42.10 per ADS. Since Sohu owns about 68.5% of Changyou, Sohu will be able to monetize the Changyou stake at a decent price, given the fact that Changyou’s stock has appreciated over 100% in the last twelve months and Zhang’s offer suggests a further 6-7% upside at the current price(June 9, 2017). However, Changyou might appreciate even more if the board actually rejects the privatization. TLBB Mobile, a mobile game developed by Changyou and distributed by Tencent, has been on fire since its May 16 debut. This game, based on AppAnnie’s data, has been consistently ranked second or third in China App Store’s daily grossing. Changyou has lifted Q2’s guidance because of TLBB Mobile’s outstanding performance. If TLBB can keep maintaining its popularity, Changyou’s will vastly exceed market’s current expectation and Changyou’s stock can go even higher. In turn, Sohu should enjoy a nice stock price boost as well.

*TLBB mobile performance since release as of June 9

The other catalyst comes from Sogou, another subsidiary of Sohu. In Jan 2017, Bloomberg reported that Sogou is targeting an IPO this year potentially valuing the company at 5 billion. Sohu controls over 50% voting rights and 36% economic interests in Sogou. Sohu’s stake in Sogou alone could be worth 1.8 billion, roughly the entire market cap of Sohu.

Sogou Input method is the most popular Chinese input tool with a 95% penetration among PC users. According to Sohu’s 2016 10-K, as of December 2016, “Sogou Mobile Keyboard remained the third largest mobile application in China in terms of daily active users.” Sogou Input is very sticky because it “uses search engine technology to capture and generate vocabularies and language models and can present the latest trends in words used by Internet users.” While typing, user can directly search typed words via Sogou’s search engine without going to a search bar. Additionally, Sogou encourages its royal users to install Sogou browser and use Sogou’s search engine embedded in the browser. After Tencent bought 40% of Sogou in 2013, Tencent granted Sogou exclusive rights to search content appeared on Tencent’s WeChat social platform.

The competition is fierce in China’s search engine market: the dominant player Baidu will use all the resources to defend its market share; Shenma Search is a subsidiary of the deep-pocketed Alibaba; Qihu 360 completed its privatization and will soon gather a big round of fresh funding through an IPO in China at high valuation. Facing formidable competitors in the Chinese search engine war, Sogou knows that it must also bulk up financially as soon as possible. In addition, the year 2017 has proved so far to be a decent year especially for U.S. tech stocks, boosting Sogou’s chance of a successful IPO in the U.S.

Sohu’s Core Business

Compared to its rising subsidiaries, Sohu’s core media business is suffering. Its online video media business suffered heavy losses and its advertising business was not profitable in 2016 either. The company sees a similar level of losses for the video business this year but believes that the segment will be profitable in 2019.


Based on sum-of-the-parts analysis (detailed in the appendix), even after factoring the expected losses from Sohu’s core business this year, the stock is still highly attractive. A conservative valuation suggests the stock could go up 40% while bull case points to a 170% return, if the catalysts play out. Sohu’s chairman holds 20% of the stock and I believe that his Changyou privatization proposal is a good way to boost Sohu’s stock.


The biggest risk for this thesis is that neither of the catalysts play out and the conglomerate discount persists. Specifically, if Changyou’s independent directors reject the going-private proposal and TLBB mobile’s revenue starts to decline rapidly, Changyou’s valuation would decline. The other concern is that Sogou might fail its IPO. However, given the risk and reward scenario, I still feel Sohu is a compelling buy at the current level.


Buying Sohu at current price is a good arbitrage trade, a bet that the gap between the underlying assets’ aggregated value and Sohu’s market cap will shrink. The catalysts for the gap to close are Sogou’s IPO and Changyou’s value appreciation. However, I personally view this strictly as a trade, not a long-term holding.


I. Sogou valuation

Comp Analysis using Baidu’s current valuation

Baidu Sogou
2016 Sales 10374.85 660.4
2014-2016 3 yr Sales CAGR 12.80% 19.57%
Net Income 1628.53 60
Diluted Shares 348.7
Price 185.75
Market Cap 64771.025
Net Cash 11755.87 303
P/S net Cash 5.11
P/E net Cash 32.55

*Based on Baidu and Sohu’s 10K. Chinese Yuan to USD exchange rate is set at 6.8:1. Sogou’s Net Cash includes 17million long-term investment of Zhihu recorded at cost.

Comp Analysis using Qihu 360’s going-private valuation

2015 Sales 1680.4
Net Income 307
Market Cap 11040.58
Net Cash 484
P/S net Cash 6.282185
P/E net Cash 34.38627

*Data from Qihu 2015 10-K

Other valuation methods:

  1. In Sep 2013, Tencent invested 448 million in Sogou for an equity stake of 36.5%, valuing Sogou at 1.22 billion. Since then, Sogou has grown nicely. Applying a 50% appreciation based on Tencent’s original valuation, I value Sogou at 1.8 billion.
  2. Aforementioned Bloomberg news reports that Sogou is seeking 5 billion valuation.

Sohu’s Sogou stake valuation:

 Sogou Valuation Sohu Stake 36%
Based on Baidu P/S 3677.62 1323.94
Based on Baidu P/E 2256.24 812.25
Tencent Valuation 1800 648
Based on QIHU P/S 4451.76 1602.63
Based on QIHU P/E 2366.18 851.82
Based on Bloomberg 5000 1800

II. Changyou Valuation

Changyou at a glance

Diluted Shares 53.4
Price 39.37
Market Cap 2102.358
Net Cash 836.4

*Stock price as of 6/09/2017

I devised two scenarios-base case and bull case-for Changyou’s 2017 P/E multiple depending on TLBB mobile is future performance. The bull case assumes that TLBB mobile can firmly sit among top five in term of grossing throughout the rest of the year while the base case assumes TLBB mobile starts losing momentum quickly somewhere in Q3.

2017 P/E Forecast Base Case Q1 Q2 Q3 Q4 Total
30 53 70.5 50 203.5
2017 P/E Forecast Bull Case Q1 Q2 Q3 Q4
30 53 88 70 241

*Q1 actual earnings and Q2 estimates are from Changyou’s filing. Q2 earnings will only include half-quarter earnings contribution from TLBB mobile

*Q3 and Q4 earnings estimates factor in full-quarter TLBB mobile revenue contribution and natural monetization erosion

Changyou’s valuation will also be based on a range of scenarios:

SOHU Stake 68.5%
Privatization 2248.14 1539.98
2016 Net Income 10X 2286.4 1566.18
2017 Net Income 10X Base Case 2871.4 1966.91
2017 Net Income 12X Bull Case 3728.4 2553.95

*Net Income valuation estimates include net cash

III. Assumption on Sohu’s loss in 2017

I estimate Sohu’s total loss this year to be similar compared to last year, with bigger losses from Sohu’s core businesses offset by growing income contribution from Sogou and Changyou. Per Sohu’s 2016 10-K, Sohu’s loss is about 224 million.

IV. Valuation on Sohu’s core businesses

Although the company is in clear decline, Sohu is still a household brand and its portals still attract a big audience. Since the core businesses are losing money, we have to estimate its value based on its revenue. As a reference point, Verizon paid about one-time sales multiple for Yahoo!’s portal business. To value Sohu’s core businesses, I use 1-time sales for the bull case and 0.5 times sale for the base case.

2016 Sohu Sales 468
1 time sales 468
0.5 times sales 234

Valuation Summary

Base Case Bull Case
Sohu Core business 234 468
Sohu Net Cash 113.5 113.5
Sohu NOL 200 200
2017 Loss -224 -224
Sogou 648 1800
CYOU 1539.9759 2553.954
Sohu SOTP Value 2511.4759 4911.454
Diluted Shares 38.8 38.8
Market Price(06/13/2017) 46.54 46.54
Market Cap 1805.752 1805.752
Upside 39.08% 171.99%

*Sohu Net Cash excludes cash, short-term investment, and long-term investment that are held in Changyou and Sogou but consolidated on Sohu’s balance sheet

*Base case valuations for Sogou and CYOU refer to the lowest valuation among different valuation methods. Bull case valuations for Sogou and CYOU refer to the highest valuation among different valuation methods.

*All data are based on Changyou and Sohu’s 10-K and latest 10-Q.

Hewlett Packard Enterprise Has Upside With Multiple Near-Term Catalysts


  • A sum-of-parts analysis shows 20% upside for Hewlett Packard Enterprise based on conservative valuation and 66% upside in a bull case.
  • Management will keep returning significant capital to shareholders through share repurchases and dividends.
  • Spun-off companies have good chances to realize synergies under new management and unlock value for shareholders.

A spin-off from the PC/Print business Hewlett Packard Inc. (NYSE:HPQ), Hewlett Packard Enterprise (NYSE:HPE) itself has two spin-offs in store this year. HPE’s management has decided to focus on the hardware side of the hybrid cloud (Enterprise Group) and divest both its consulting business (Enterprise Service) and its mature software business.

Shares of HPE have outperformed the S&P 500 by over 20% since its inception, and there are reasons to believe the coming spin-offs can propel the stock further. A sum-of-parts analysis suggests HPE shares are undervalued by at least 20% on a conservative valuation. In a more optimistic yet still quite achievable scenario, HPE stock could be worth 66% more than the current price.

HPE management agrees that its stock is still cheap and will buy back more stocks during 2017. Total return to shareholders in the forms of buybacks and dividend is expected to be about $3 billion in fiscal 2017 (about 7% of HPE’s current market cap). This return commitment is on top of the $3 billion returned to shareholders in 2016. The shareholder-friendly management also has pledged to “return significant capital to shareholders” post spin-offs in the future.

In addition, the spun out companies could further boost HPE shareholders’ return. The consulting business after the spin-off will immediately merge with Computer Science Corporation (NYSE:CSC), and the combined company might achieve much higher margins because of synergies. In its press regarding the merger, CSC estimates first-year synergies of $1 billion and a run rate of $1.5 billion after year 1, with possible more synergies subsequently. To put these synergy figures into perspective, the $1.5 billion number is about half of the combined company’s adjusted EBITDA in fiscal year ’16. If CSC’s management can achieve its synergy target of $1.5 billion run rate, the forward EV/adjusted EBITDA is at about 5, a figure that is too low for this business. Even if CSC achieves only a $1 billion run rate synergy, the forward EV/adjusted EBITDA will still be a very low number of 5.5.

In the other spin-off, HPE will separate its software business and merge it with U.K. software company Micro Focus (OTCPK:MCFUF). Micro Focus will issue new ADR shares worth 50.1% of the combined company to HPE shareholders. Micro Focus management has a proven record of acquiring mature software assets and then improving the company’s operating margins. From the investor presentation, we can see Micro Focus’ current businesses have a stunning high adjusted EBITDA margin of 46%, while the to-be-acquired HPE businesses have an adjusted EBITDA margin of 21%. Management believes it can bring HPE’s software business margin to 40%+ in 3 years and double the EBITDA of HPE’s software business.

Chances that CSC and Micro Focus shareholders will approve the respective mergers with HPE’s business are high. Shares of CSC spiked almost 50% on the day of the merger announcement, and the stock finished 2016 with almost 100% gain. Shares of Micro Focus gained 10% following its own merger announcement and are currently trading around all-time highs. Positive stock price movements in these two companies indicate that market participants view these two mergers favorably and will very likely vote for the mergers.

Furthermore, there is the H3C 49% equity interest value embedded inside HPE that might appreciate in the future. In 2015, HPQ sold 51% majority interest of H3C (HP’s server and storage business in China) to Tsinghua Unisplendour for $2.3 billion. The ownership change to Tsinghua Unisplendour could greatly benefit H3C’s sales in China. Before the ownership change, H3C, as a foreign company, had a hard time selling equipment to Chinese government entities because of national security concerns about US spying. Unisplendour is a state-owned company, and after the ownership change, H3C could finally start selling to the Chinese government. If H3C’s revenue improves in the future, the remaining 49% equity interest will improve in value as well.

One more catalyst for the company is the repatriation of offshore cash if a tax holiday occurs. Most of HP’s 13 billion cash is held overseas, and after paying for one-time cash cost associated with the spin-mergers, an assumed 10% repatriation tax would leave about $6.4 billion of onshore cash (15%+ of the company’s current market cap.) It is most likely that the leaner HPE post spin-offs, with a healthy projected cash flow, would not need to hoard all of that cash and management will return part of the cash to shareholders.

This 20% base-case upside number feels very solid. The value of the HPE software company in the base-case analysis is about 30% lower than the current market value based on Micro Focus’ share price. That means if the Micro Focus merger were to happen today (as of this writing on February 3, 2017), the base-case upside would be actually 25% instead of 20%.

In the rest of the article, I will go through a detailed sum-of-parts analysis on HPE for people who want to know how I have arrived at the aforementioned possible base-case and bull-case upsides.

Valuation Breakdown

  1. Tax-free spin-merger of Enterprise Service Business division with CSC
  2. Tax-free spin-merger of non-core software assets with Micro Focus
  3. The new HPE after the two spin-offs
  4. 49% of equity interest in H3C
  5. Assets and liabilities (pension cost, deferred tax assets, one-time separation cost)

I apply conservative metrics and assumptions to calculate each component’s value in the base-case analysis and apply more optimistic scenarios under the bull-case scenario. All figures except share prices are based on press releases, earnings calls, and analyst meetings of HPE, CSC, and Micro Focus.

Spin-merger with CSC

Let’s briefly go over terms of this deal: 1) CSC will merge with HPE’s Enterprise Services Group; 2) HPE shareholders receive approximately 50% of the new combined company; 3) Debt, pension and cash transfers between CSC and HPE (I will calculate this part in the net cash and liabilities sections).

From the slides below taken from CSC, were the merger to happen on July 1, 2016, the combined company would have $955 million cash and $8,416 million debt plus pension cost. The pro forma combined company also would have $3,273 million adjusted EBITDA without accounting for any synergy. Although CSC confidently called this $1.5 billion synergy number “very strong,” I assume it only gets $1 billion synergy run rate in the base case and assume CSC fully achieves its synergy target in the bull case. CSC CEO also commented that there could be more synergy opportunities after year 1, but I do not include any additional synergies into the calculation, just to be safe.

Keen readers might spot that the data are as of July 1st last year and wonder how the businesses of CSC and HP consulting services have fared since the merger announcement. After all, if businesses deteriorated in the more recent quarters, the forward EBITDA and valuation projections might come down. In the following quarters after July 1, CSC actually reported very encouraging results – taking the most recent half year, revenue in constant currency and adjusted EBITDA both grew over 10% (see CSC’s quarterly release here and here). Although revenue of HPE’s service business declined 2-3% during the last half year, margins actually improved by over 2.5%. Because HPE’s service business has been more or less stable and CSC has performed well, the outlook for this combined piece actually looks brighter than it was on July 1.

Base Case Bull Case
Synergy 1000 1500
Base Adj. EBITDA 3273 3273
Stock Compensation 274 274
Forward Adj. EBITDA 3999 4499
EV/EBITDA Multiple 7 8
EV 27993 35992
Net Debt + Pension 7461 7461
Market Cap 20532 28531
Value to HPE shareholders 10266 14265.5

*in millions

(Source: CSC Presentation)

Spin-Merger with Micro Focus

The terms for this deal are: 1) HPE Software will issue debt and pay HPE $2.5 billion onshore cash; 2) After the cash payment, Micro Focus will acquire HPE Software and issue new Micro Focus ADR shares tradable in the U.S. worth 50.1% of the combined company to HPE shareholders.

I consider Micro Focus as the 3G Capital of the software industry. Micro Focus management specializes in acquiring mature yet sticky software assets and optimizing margins on these assets through disciplined operations. Though maybe not so famous in the U.S., this UK-based company has rewarded its shareholders handsomely over the years. Adjusted EPS per share has been compounding at annual rate of 26% over the last 10 years. The stock has more than quadrupled within the last 5 years, and the dividend has increased 10-fold over the last 10 years. Management believes it can improve margin on 80% of HPE’s software business from 21% to over 45% within 3 years after the merger. The rest of 20% of the businesses are still growing, and I assume they will command a lower margin. Seeing Micro Focus’ past record, I have high hopes that management will repeat its past success. However, in the base-case scenario, I still assume that management could not fully achieve its goal and EBITDA margin on its mature businesses peaks at 35%. If we also assume that the other 20% of the businesses have a 30% margin in year 3, we have a blended margin of 34% and about 42% for HPE’s software business under the base case and bull case respectively. Net debt for the combined company is about $5 billion.

An interesting note here is that the base-case value is actually much lower than Micro Focus’ offer price for the HPE software assets (currently over $6 billion, based on Micro Focus’ share price). This shows that Micro Focus’ management itself is very confident of achieving its cost savings targets, and the London market agrees with management. In HPE’s Q3 conference call, HPE CEO Meg Whitman also said she herself would hold on to her Micro Focus shares after the spin-merger. However, since it is unclear what Micro Focus’ stock price will be at the time of spin-merger, a conservative fair valuation is useful in case the price drops in the future. You can also consider the gap between the base-case valuation and the market price as a hidden $2 billion upside for the base case.

Base Case Bull Case
Micro Focus Year 3 EBITDA 630.0 710.0
HPE Year 3 EBITDA margin 34.0% 42.00%
HPE Year 3 Revenue 3000 3300
HPE Year 3 EBITDA 1020 1386.0
Combined EBITDA 1650.0 2096.0
EV/EBITDA multiple 10 12
EV 16500 25152
Net Debt 5000 5000
Market Cap 11500.0 20152.0
Value to HPE shareholders in Year 3 5750.0 10076.0
Discount Rate 10% 10%
Present value to HPE shareholders 4320.1 7570.2

*in millions

(Source: Micro Focus-HPE merger presentation)

The new HPE

The remaining part of HPE will consist of its hybrid IT business, mobile and IoT business, technology services division, and financial services division. HPE forecasts 2-3% growth for the overall company and normalized free cash flow of 2.1-2.4 billion in fiscal 2017.

I do not see a very big risk of the company underachieve this low-single digit growth target, because world GPD grows at around a similar pace, and the remaining HPE will be a much more focused company that can compete more effectively. Actually, HPE does not even need to beat its competition to accomplish this growth target – it simply needs to maintain its share as the market grows.

If we assume net income and free cash flow grow at 2-3% in sync with revenue growth and a discount rate of 10%, we get an FCF multiple of 12.5-14.3.

Base Case Bull Case
Fiscal 17 free cash flow 2.1 2.4
FCF multiple 12 14
Valuation 25.2 33.6

*in billions

(Source: HPE Analyst Meeting Presentation)

H3C equity interest

This is relatively straightforward. In the base case, I assume no value appreciation for the remaining 49% interest in H3C technologies, and the bull case assumes a 100% upside. In the Q2 ’16 conference call, HPE management revealed that leading to the sale of H3C’s equity interest to Tsinghua Unisplendour, H3C’s revenue increased 50%. This is a good sign for the company under the new owner and for the equity interest value HPE still holds.

Base Case Bull Case
H3C equity interest 2.2 4.4

*in billions

Assets and liabilities

At the end of Q4 2016, HPE has gross cash of $13 billion. It will receive onshore cash from CSC and Micro Focus as part of the spin-merger deals. The company also needs to pay for some one-time separation costs associated with the spin-mergers. Here is the calculation on the cash position after the spin-mergers on the operating company level – we deduct the debt and cash owned by the financial service division. I still apply a 35% repatriation tax on the offshore cash in the base case, and I use a 10% repatriation tax in the bull case.

Readers might also point out that HPE also has around $7 billion net financing receivables that it could monetize. While this is correct, I exclude these financing receivable in the calculation because the HPE remain-co’s earnings include interests received from these financing receivables, so we do not want to double count here. Another piece of asset that some people might not be aware is HPE’s real estate. It owns a total of 18 million square feet of land, and the company’s headquarter campus situated in Palo Alto alone will fetch a very nice price during the current Silicon Valley real estate boom. Although I include none of these assets in my calculation, I do view them as bonus points that make this stock even more attractive on top of the headline upsides.

Cash calculation

Onshore Cash Offshore Cash
Q4 2016 13
FS cash -0.8
Separation Cost -4.9
Micro Focus Payment 2.5
CSC Payment 1.5
Corporate-level debt -4.6
Sub Total 4 2.7

Other major assets and liabilities

Pension Liabilities -4.23
Net pension transfer to CSC 0.6
Pension paid in 17′ with cash 2.5
Deferred Tax Assets 1.86
Sub Total 0.73

Assets and liabilities

Asset Base Case Bull Case
Other assets 0.73 0.73
Onshore cash equivalent 5.755 6.43
Total 6.485 7.16

*in billions

(Source: HPE Analyst Meeting Presentation)

Sum of the Parts

Base Case Bull Case
The CSC spin-merger 10266 14265.5
The Micro Focus spin-merger 4320.1 7570.2
The new HPE 25200 33600
49% equity interest in H3C 2,200.0 4,400.0
Other assets 6485 7160
Total Value 48471.06 66995.75
HPE Stock Price 23.5 23.5
Diluted share count 1709 1709
Market Cap 40161.5 40161.5
Upside 20.69% 66.82%

*in millions; HPE stock price as of February 3, 2017

Disclosure: I am/we are long HPE.

Market fear overblown — First Data is trading at half of peers’ valuation and could rise 50%



First Data is a company with high-margin businesses in very attractive industries but currently trades at around a half of its peers’ valuation. In this article, I will list Mr. Market’s reasons for such low valuation and elaborate on why I believe that despite some valid concerns about the company, the market has been overly bearish and the valuation gap should narrow.

Comparison against its peers

Although there are some competitors listed from First Data’s annual report including Visa, Mastercard,Fiserv,JP Morgan,Wells Fargo and etc, they are ill suited for comp analysis because these companies own other businesses that First Data lack. The companies listed below, also competitors listed from First Data’s annual report, are the best comparison candidates because they almost exclusively operate in the same segments as First Data. Among the comp peers, Vantiv resembles First Data the most because it competes on all fronts with First Data. Worldpay and Global Payments focus exclusively on merchant acquiring which is First Data in First Data’s biggest segment(I will explain all the segments later). Total System Services only competes with First Data in the smaller card processing division.


Market Cap Net Debt Adjusted TTM EBITDA Net Debt/EBITDA Forward Adjusted Earning Forward P/E


11113.91 2795.8 857 3.26 2.6 21.66


5860 1373 441.3 3.11 0.126 23.25
Global Payments


11321.2 3494 757.7 4.61 3.35 21.80
Total System Services


8713.12 3183.8 896.9 3.55 2.81 16.80
First Data


12554.7 19005 2370 8.02 1.11 11.37


Market cap, net debt, adjusted TTM EBITDA in millions. Market prices are from Oct 18th 2016. Worldpay’s market cap and debt are in British Pound. Analysts’ forward earnings estimates for Vantiv, Global Payments, Total System Services, and First Data are from and Worldpay is from Net debt and adjusted TTM EBITDA figures are based on these companies’ earnings releases and annual reports from their respective investor relations websites and further adjusted by subtracting stock compensation.


Why does the valuation gap exist?

  1. Heavy debt burden. This is definitely the biggest concern. When KKR took First Data private before the financial crisis, the private equity firm loaded First Data with debt and the deal was one of the biggest LBOs (leveraged buyout) in history. As we can see from the previous comp analysis, First Data’s peers have a much lower debt/EBITDA ratio. The market worries about First Data’s default risk.
  2. Market share loss/stale growth. Because of high interest expenses, the company could not put enough resources into important functions such as R&D and sales and struggled to maintain its competitive advantage. Innovation stopped and growth became stale while First Data’s peers enjoyed very healthy growth.
  3. High churn in small business segment. The company focused on signing up small merchants but offered very poor support and customer service. As a result, the company has been losing many customers who do not renew their contracts.
  4. Leon Cooperman insider trading case. This is very recent news. Mr. Cooperman holds shares of First Data and the stock has been suffering since the insider-trading charge against Mr. Cooperman emerged. The market is worried that Insider trading charge leads to possible liquidation and forced selling of the stock from Mr. Cooperman’s fund.

At a glance, the market does seem to have some very solid reasons to discount First Data. Many potential investors probably would turn away right because of the high debt burden. However, it is time to be a contrarian and find out if the situation is indeed as grim as the market fears. First, let us find out what kind of businesses First Data own.

GBS, GFS and NSS — What does First Data do?

Per its 2015 10-K, First Data is “the largest merchant acquirer, issuer processor, and independent network services provider in the world.” It has the following three segments:

Global Business Solutions (GBS): This largest segment mainly includes its merchant acquiring business and its cloud-based point-of-sale (POS) system Clover. For anyone needs a brief explanation on the term merchant acquiring — when customers check out either at a physical store or online with an electronic payment option (credit card/debit card/gift card/PayPal), merchant acquirer acts as the messenger that handles all the communication among the POS, the card issuing bank, and the merchant’s bank. POS takes customer’s payment information and pass this to the merchant acquirer. Then the acquirer figures out which network to use(Visa/Master/Debt/etc.) and routes the processing request to card issuer for approval. Once the issuer reaches a decision, it informs the acquirer and the acquirer relays back the message to the POS. At the end of the day, the acquirer routes many messages in the batched settlement process in which the merchant settles all the daily transactions with various payment issuers. has a more thorough explanation here. Besides the merchant acquiring business, the Clover business according to management is not yet material to earnings so I will not go into mcuh details. I only will say that this online POS business is in crowded competition against many start-ups and established players.

Global Financial Solutions (GFS): In this segment, First Data enables credit card issuers to offer financial products to their customers. First Data’s clients include some of the world’s biggest financial institutions and big-box merchants and the available services include card issuing/processing services and account support services such as generating monthly statements and posting cardholder payments. First Data charges fees under contracts and the amount of the service fee is dependent on the size of the cardholder accounts under the contract. In other words, the more cardholders are under the contract, the higher contract fee is.

Network & Security Solutions (NSS): This segment offers services that deal with payment security and fraud preventions. First Data owns STAR, one of the nation’s biggest pin-debit network. While big banks might be able to afford its own secure network, other card issuers might not want to. Instead, they turn to First Data or Vantiv who own secure networks and pay for the network usage. First Data collects revenue on transactions routed on the STAR network. Also in this segment, First Data offers services in gift card issuing and processing to merchants.

In terms of geographical breakdown, U.S. is First Data’s biggest market, contributing 5.5 billion of the company’s total 7 billion revenue in 2015. EU is a distant second with a 1 billion revenue. Asia and Latin America each contributed around 260 million.

After getting some ideas of First Data’s businesses, I want to touch on why I think First Data is a great company to own.

Secular Tailwind

Continued shift to a cash-less based society.  According to this Federal Reserve survey published in 2015, between 2003 and 2012, credit card, debit card, prepaid card and ACH usage experienced very healthy growth at the expense of checks. The report summarizes the finding as such –“cards significantly increased their share of total noncash payments, from 43 percent in 2003 to 67 percent in 2012…Checks represented nearly half (46 percent) of all noncash payments in 2003, but only 15 percent in 2012.” Moreover, this trend is not just limited to the United States but rather it is a global phenomenon.  A separate article shows that globally the number of transactions grew from 269 billion times in 2009 to 390 billion times in 2014 and cites that the Federal Reserve estimates that there will be $616.9 billion in cashless transactions in 2016, up from around $60 billion in 2010. Yet despite the explosive ten-fold increase in cashless transactions, there is still vast room for further rapid growth. This same article points out in the U.S cashless transactions are only around 45% of total transactions, much lower compared to countries such as Singapore, the Netherlands, or Sweden, where about 60% of total transactions are cashless. Germany is even lower at 33% and China, Japan, and Brazil are only in the teens. Cash still accounts for a dominating 85% on global average. These data and forecasts bode very well for the electronic payment processing industry and First Data.

Highly Capable CEO

                Past achievements demonstrate high capacity. Many people probably read about First Data’s CEO joined as co-COO from JP Morgan. But who exactly is this guy? Wikipedia has detailed business achievements of Frank Bisignano, First Data’s CEO.  In brief, he has over 20 years of experience working in different roles in various big banks including First Fidelity, Citigroup, and JPMorgan. At Citigroup, he increased the revenue for his division from an annual $4 billion to $6 billion and turned a net income loss of $400 million to profit of over $1 billion. At JPMorgan, Dimon trusted him with integrating Bear Sterns and Washington Mutual during the financial crisis. Then he became head of the Mortgage Banking unit and again turned the division’s previous year loss of 2.1 billion into income of 3.3 billion in 2012. Past successes show he is a true turn-around expert, a perfect fit for the CEO role of First Data. Right after he joined First Data, he dissuaded owner KKR from selling the GFS decision, telling KKR that he believed “I could fix it.” After 3 years, the NSS and GFS divisions have experienced healthy growth. In addition, management successfully pushed First Data’s entire debt obligation to the next decade, solving a major overhang of the company.

Attractive businesses to own

Biggest merchant acquirer in the U.S.  Even after the no growth period, First Data’s acquiring business remains as the biggest in the States. But why does size matter? Because the domestic industry has increasingly become consolidated and scale helps to battle other big merchant acquirers. Vantiv, the second biggest merchant acquirer in the U.S. right behind First Data, claims to have processed 6.18 billion dollars of transactions in 2016 Q2 and around 23 billion dollars for the whole year of 2015.  By comparison, First Data in the most recent quarter reports that it processed 22.5 billion dollars for the first half of 2016, a half year figure that’s almost as big as the full year figure of the industry’s NO.2 player. This shows that what stockholders own is not a company that has fallen completely behind the competition but rather a valuable company that is still very ahead in the game, albeit with a shrinking lead and anemic growth. The main problem in growth, according to management’s earning calls, is isolated in the SMB (Small-Medium Business) space and caused by a high SMB client attrition rate. However, on the hand, the large national clients are actually very happy with the company’s service and First Data bagged quite a few national account wins including Chick-fil-A, Cabela’s, PetSmart, and Toys “R” Us.

High margin businesses. First Data’s Global Business Solutions segment has consistently generated around 40% EBITDA margin over the years. The new management also dramatically reduced the cost basis of the other two segments so that in the most recent quarterly report the Global Financial Solutions and Network & Security Solutions divisions enjoyed 40.5% and 45.4% EBITDA margin respectively.

Fast growing and sticky GFS business: the Global Financial Solution segment, the business that supports card issuers with processing and account maintenance, in the last two quarters grew revenue 12% and 14% in constant currency year over year. A contract with customers last for years and customers are generally reluctant to switch solution providers once they become accustomed to a particular provider’s offering, making this business very sticky. I think growth in this segment could be attributed to CEO Bisignano’s leadership. Customers in this segment are mainly small and mid-size banks. And where is Bisignano from? Bank. Bisignano understands very well these customers’ need and speaks their language.

                One of the biggest debit network operators. According to the aforementioned Fed Survey, debit card usage witnessed the biggest jump in terms of transaction number, increasing three fold from 15.6 billion times in 2003 to 47 billion times in 2012. First Data’s STAR network is one of the biggest pin-debit network in the nation and naturally a big beneficiary of the on-going debit card boom.

Good International exposure. First Data’s Latin America business has been on fire. Revenue from that region grew 44% in constant currency in the latest quarter and quickly becoming a meaningful contribution to earnings. Although inflation is part of the reason to the growth, the company has been adding customers rapidly in Brazil. It also recently entered the Argentina and Columbia markets, two markets with big potential that are still in infancy stage of electronic payments.

Addressing Market Concerns

In this section, I will address the concerns listed in the beginning and explain why I believe they are overblown.

                Heavy debt burden and high default risk. None of the debt matures until 2020 at the earliest and the debt maturities span over five years with the latest debt due in 2024, a situation that should be quite manageable. Management has stated that they will use majority of the company’s free cash flow to pay down debt and according to my estimate (detailed walkthrough discussed later), the company should be able to generate over 1.2 billion free cash per year. That means from now until 2024, the company can generate about 8-9 billion free cash and nearly half the current 19 billion debt, making First Data’s Net Debt/Adjusted EBITDA around 4 times which is quite manageable and very close to its peers.

Slow growth caused by high SMB attrition. Management had to deal with myriad of problems and could not solely focus on this issue.  However, with many other priorities solved, management should have enough resources to concentrate on this problem. Management stated that this is a very persistent problem and attrition rate remains high as of the last quarter. The team continues to tackle the issue with a multi-pronged approach and things might get better in the future. Based on what Bisignano has achieved in his past positions and what he has accomplished so far in First Data, I believe he has a decent chance of solving the problem. But even if it turns out that management could not fix the issue, it still would not be the end of world for First Data. Because after all, the SMB segment is only part of the acquiring business. The company still has a very healthy acquiring business with large merchants, a fast growing GFS segment and a NSS segment growing at moderate pace.

Cooperman insider trading case. I actually think this is good news. Regardless of the outcome from the insider trading charge, the entry cost for First Data stock decreased, which is great news for potential investors. In addition, this news in no way changes the fundamentals of the company. Is the stock currently cheap enough? I think so. However, I am also cognizant of the fact that based on how the insider charge goes the stock might turn even lower. To prepare for such possibility, or blessing in disguise should I say, investors should maintain some liquidity so that they can buy more on the dip and lower their cost basis.

Future cash flow analysis and stock valuation


In the past twelve months, First Data’s three divisions GBS, GFS, and NSS have adjusted EBITDA (excluding stock compensation and one-time costs) of 1691 million, 622 million, and 668 million respectively. Revenues and EBITDA picked up in GFS and NSS this year while GBS’s growth is a mere 1%. Based on the sticky nature of the businesses, for the forward 12 months, I assign an 8% increase in forward EBITDA for the GFS division(much lower than the recent 30% jump), a 3% increase for the NSS division(again much lower than the 16% and 6% quarterly increase), and no growth in EBITDA for the GBS division, an assumption that seems achievable and conservative.

Recent segment revenue/EBITDA growth trend and forward EBITDA assumption

16 Q1 Rev increase Q/Q 16 Q1 EBITDA Q/Q 16 Q2 Rev Q/Q 16′ Q2 EBITDA Q/Q Forward EBITDA growth assumption
GBS -1% 4% -2% -1% 0%
GFS 8% 30% 12% 29% 8%
NSS 5% 16% 3% 6% 3%


16 Q1 and Q2 figures based on First Data’s 2016 Q1 and Q2 earning releases

Next, corporate cost has been stable at -140 million EBITDA per year, the same figure I use for next year’s cash flow estimate. Depreciation is around 1 billion based on last year’s figure. Interest expense based on the list of debt obligations from latest 10-Q filing and the most recent interest reduction news is estimated at 1,050 million. I use a theoretical 30% tax rate because First Data has sizeable oversea business with lower tax rate than the States. The effective tax rate, however, should be much lower because the company has 3.8 billion deferred tax assets (First Data’s 2015 10-K lists 1.1-billion deferred tax asset and a further 2.7 billion valuation allowance that is likely to reverse in the future).  2017 capital expenditure of 450 million approximates the lowered spending in the first two quarters of this year because management in earning calls has said many growth initiatives have already been put in place and capex will moderate in the future.

Forward 12-month cash flow calculation (in millions)

Corporate EBITDA -140
Stock Compensation -220
D&A -1000
Interest payment -1050
Tax 30%
Income 448.56
Income with Tax Benefits(effective 10% tax rate) 640.8
Capex 450
Near-term Cash flow 1346.7
Normalized FCF 998.56

Figures based on First Data’s past four quarter earnings releases. Normalized FCF is calculated based on income + D&A – capex and near-term cash flow is based on income with tax benefits + D&A – capex + stock compensation.


Market Cap 12143.232
Discounted current value of 3.8 billion deferred tax asset 2000
Normalized FCF 998.56
Adjust market cap/FCF 10.16


From the above calculation we can see, investors are paying about 10 times the next year normalized free cash flow for First Data, a multiple that is quite low based on the quality of the business, the management, and the prospect of the e-payment industry.


Revenue increase.  There are multiple ways for the company to increase its revenue. The most certain revenue increase comes from First Data’s large clients. The company has already won quitea few big contracts from large enterprise and these wins take typically 9 months or more to realize revenue from new clients. In addition, the company showed itself capable of expanding its relationship with large clients and cross-sell more services. However, less certain is the development on the SMB segment and the improvement might not materialize in the near future. I think the chance of a success SMB turnaround is about 50%. Moreover, there are a couple long shots such like the Clover POS business and the Gyft gift card business.

Highly leveraged capital structure will boost earnings. The biggest market concern actually is, at the same time, a blessing in disguise. First, as the company pays down interest, it creates an earning boost on the bottom line. Every billion dollars of debt paid down will give the company between 50-70 million savings on interest expenses, which translates into 35-50 million net income and a 350-500 million in market cap assuming a 10X P/E. And we have shown First Data should be able to pay down billions of debt in the future. The next point is that high debt load will actually make the net income increase look more pronounced compared to a company that is less leveraged. This is a very important yet subtle point and for those who are not familiar with this very concept there is a more detailed explanation in the appendix.

Easy net GAAP income comp in the next three quarters.  First Data’s GAAP income in the last 4 quarters was all in the red except the most recent quarter. There were a lot of one time charges, such as IPO cost and restructuring cost, taken in the earlier quarters and the interest expense was much higher than the current level. Going forward, with the much lower interest expense and cost reduction initiatives taking effect, even without a higher revenue, GAAP income comp quarter over quarter should be very easy until second quarter of 2017.


I know this is a quite long article and I appreciated if you have come this far. Much ink has been spilled so let us tie up all the points. First Data is trading at around half of its peers’ multiples based on forward earnings. We also run through a cash flow analysis and finds the stock trades around 10 times 2017 cash flow. Although its peers do deserve a premium over First Data because of lower debt level and faster growth, the market looks overly bearish on First Data’s prospect. First, First Data’s debt will not start maturing until the next decade and our cash flow analysis shows that the company will be able to pay down a lot of debt before debt maturities. Second, there is a decent chance that growth will pick up in the future. In the past, management had to spend a lot of effort on the survival of the company and, after the debt became manageable, the management can now finally concentrate on the growth phase. We already see the growth initiatives bearing fruits on the GFS and NSS segment and there is a good chance for the biggest segment GBS to grow again. Third, despite the market gain of First Data’s peers, First Data still holds many valuable assets. It is still the biggest merchant acquirer in the U.S. by a wide margin and owns one of the nation’s biggest debit network. Under the rein of Bisignano, First Data deepened and expanded many important relationships with its big financial institution and large merchant clients, an initiative that lead to new contract wins and more cross-selling. Fourth, CEO Bisignano has a very impressive background in turning around businesses in different companies and so far, he has done a fabulous job at First Data, a sign that a full turnaround of First Data is quite possible. Lastly, the industry benefits from inevitable shift to a cashless society, a trend that will also help First Data in earning growth.

Because of the above reasons, the stock deserves a better valuation. A 15-16 times forward P/E or a 15 times normalized free cash flow should be fair, implying 40% – 50% potential increase above current stock level. Even at that level, First Data will be at about 2/3 of its peers’ valuation, taking consideration of the higher debt ratio and current slower business growth compared to its competitors. But the current 10-11X forward P/E and cash flow simply feels like there is more than justifiable amount of pessimism on this stock.

Although I suggest purchasing a sizable position at current level, as the 3rd quarter earnings release approaches on Nov 7th and the Cooperman insider charge case still hangs in the air, I also suggest investors keep some dry powder in case of a further stock price drop in the near term.


Capital structure effect on earnings

Assume there are two companies with the same revenue, cost, and tax rate. The only difference is that company A does not have any debt at all but company B does.

Company A Company B
Rev 100 100
Cost 50 50
Interest 0 30
Tax 30% 30%
Net Income 35 14


Then revenue and cost increase the same amount for both companies.

Company A Company B
Rev 120 120
Cost 60 60
Interest 0 30
Tax 30% 30%
Net Income 42 21
Net Income % increase 20% 50%


We can see although both companies’ earnings increased 7, the leveraged company B’s earning increases 50% while company A’s earning only increases 20%.

Steward Information Services: Event-Driven Stock With 20%+ Upside And A Relatively Short Holding Period

Three activist funds hold significant stake in Stewart Information Services. (NYSE:STC) In this article, I explain why activists are targeting this company, how much value activists think they can realize by changing the structure of the company, and what all this means for other shareholders or potential shareholders of the company.

What went wrong with Stewart?

Stewart is the No. 3 title insurance provider in the U.S. However, its profit margin persistently and significantly lags behind its competitors due to its bloated expenses. Activist Foundation Asset Management’s presentationshowed that while the company has only a meager 4.4% pre-tax operating margin, its main competitors First American Financial (NYSE:FAF), Fidelity National Financial (NYSE:FNF), and Old Republic International (NYSE:ORI) have operating margins of 11.5%, 9.2%, and 8.0%, respectively. Despite management’s promise to improve profitability, the earning results have not met investors’ expectation.

One major factor behind the company’s underperformance is the current management itself. Previously, the company had a dual class stock structure that essentially gave control of the company to the Morris family who held the class B shares because the class B shareholders can elect 4 out of 9 board members and the company bylaw dictated that any board action required 6 votes out of the 9 members. Without class B shareholder’s consent, any corporate action wouldn’t be able to gather the required 6 votes. To make matter worse, the CEO is also a member of the Morris family. Under the protection of the class B shares’ power, the CEO could underperform without being held responsible and surely they did.

Before the activists’ campaign, this 2013 shareholders’ annual meeting filingshowed a perfect example of bloated expenses: ” For many decades, the Company has maintained and utilized a collection of antique and replica carriages for business promotion and customer entertainment purposes.” The horses are owned by the Morris family but ” the Company was responsible for the labor, maintenance, housing and operating costs of these assets(carriages).” Well, I’ve seen shareholders pick up the bills for private jets but here we are talking about carriages and horses! This is probably one of the most outrageous examples I’ve ever read.

How much value could the company be worth?

Stewart’s title insurance business essentially sells a warranty that the title of a house is free of defects when lenders make a loan, including securitization. The title insurer takes a one-time fee calculated based on the transaction price and guarantees lenders’ lien priority. If for any reason lenders’ lien positions were compromised, the insurer will have to pay for the lenders’ losses. The American Land Title Association has a very comprehensive collection of data about this industry and this excel file from its website showed market share information dated all the way back to 1989. According to their data, the whole industry’s revenue grew consistently from 3.5 billion in 1989 to 13.2 billion in 2015. Market share of the big 4 — Fidelity, First American, Stewart, and Old Republic — was over 96% in 1989 and gradually declined to 87% as of 2015. But the decline was mainly at the expense of the largest player Fidelity. First American, Stewart, and Old Republic all significantly expanded their share over this period. Stewart, specifically, grew its market share from 7.3% in 1989 to 14.8% in 2015.

These data make it clear why Stewart is valuable. First of all, the industry is growing because of the housing market. America’s population is still growing at a very healthy rate which translates into mores houses and higher housing prices, a trend in turn means higher title insurance volume and higher title insurance premium. Moreover, Stewart is the last stand-alone title insurance franchise and is based in Texas, a state which is among the fastest growing states. Second, the industry dynamics looks very stable and it doesn’t seem that any disrupting force is coming anytime soon. For any spirited disrupters, chances are they haven’t even heard of title insurance.

So this is why Stewart is very appealing for either companies that want to enter this market or rival companies that want to expand its market share. IfStewart is in the hands of better management, this would be a terrific company. The easiest way for improvement, proposed by one of the activists Foundation Asset Management in their presentation to the board, is an outright sell to its rival companies or a private equity firm. Foundation Asset Management estimates that Fidelity or First American can improve the company’s margin to north of 10% and pay a fair price of $60/share forStewart. In the other scenario that the company is acquired by Old Republic or a PE firm, the margin would be a bit lower and the acquirer should be comfortable buying Stewart’s shares at $55/share. I feel their margin assumptions under various scenarios are very achievable because again if there was cost associated with horses there is probably a lot of low-hanging fruit in cost improvement.

And just for analysis’ sake, let’s back off and think about the unlikely but possible scenario in which no company is willing to take Stewart. If activists can simply replace the management and achieve an 8% pre-tax margin, a margin that is the lowest generated among its peers, as a stand-alone company Stewart would have a net income of 112 million dollars, based onStewart’s TTM revenue of around 2 billion and a 35% tax rate. As of Sep 02,2016, the company has a market cap of 1.1 billion so a 112 million net income would put the P/E ratio at right around 10 times. Old Republic, the company with an 8% pre-tax margin and the lowest P/E among Stewart’s 3 competitors, has currently a P/E ratio of 12.6. But as Foundation pointed out earlier in their presentation, compared to Old Republic, Stewart actually has a better revenue mix between its direct and agency channels (agency charges commission and hence generates lower margin for the company) so it’s quite possible for Stewart to achieve a pre-tax margin above 8%.

History of activists’ campaign against the Morris family

If the chance of improving the company’s results is relatively high as we discussed, the key question is whether activists can gain control of the company and effect a change. I will briefly list key events happened so far from the fights between activists and the Morris family. (All information related to Foundation’s involvement mentioned below is referenced from their recentletter to the board dated July 28th,2016. )

  • Foundation invested in Stewart in 2013 and started conversation with management
  • In Feb,2014, Foundation reached a stand-still agreement with the Company and elected two board members
  • In 2015,another activist Bulldog Investors joined the fight and attempted to nominate 5 directors. The fund later on settled with management and elected one director to the board.
  • In 2015’s annual meeting,shareholders overwhelmingly approved the proposal that will dismantle the dual class structure
  • In 2016’s annual meeting, shareholders approved i)the elimination of dual class structure ii) ability to call a special meeting if the meeting proposal has more than 25% votes iii) the elimination of requirement that any corporate action needs 6 out of 9 votes iv) the elimination of fixed 9-member board size
  • On July 28,2016, Foundation wrote a letter to the board and announced intention to call for a special meeting that will replace board members Malcom Morris and Stewart Morris with its own nominees. The meeting date has not yet been set but it will be sometime this year
  • On Aug 12,2016, Starboard announced its initial 9.9% ownership of Stewart in a 13D filing.

What does this all mean for other common shareholders?

From the above brief history, it’s clear to see that things are gradually falling into pieces and activists are very close to claiming the ultimate victory. And that is a good thing for every other shareholder. Let me explain.

According to the latest filings, Foundation owns 5.6% of total Stewart shares and Bulldog Investors owns another 4.85% on top of Starboard’s 9.9%. So the 3 activists altogether own around 20.5% of the total stock. They just need a mere 4.5% percent vote from other shareholders to call the special meeting. The voting results in 2015 and 2016 showed that proposals related to corporate governance improvement mentioned above gathered over 95% of votes. The past voting results firmly indicate that common shareholders like the activists’ ideas and no one is on the management’s side. Therefore, the occurrence of shareholders’ special meeting and the replacement of the Morris members are very high probability events.

Then what happens? Once the board members shuffle, we will have 7 common shareholders elected directors on the 9-member board. What’s even more important is that 4 directors are nominated by Foundation and 1 director by Bulldog. Since any decision of the board now only requires a simple majority, with at least 5 members on their side, the activists can easily push for a sale of the company. Also these 2 nominees might be very instrumental in the eventual sale of the company down the road: one nominee Earnest Smith held various positions including Co-Chief Operating Officer of Fidelity National,Stewart’s biggest competitor and the other nominee Roslyn Payne served on the board of First American, Stewart’s second biggest competitor. We can easily see where this is going if the two nominees are elected.

And this is just Foundation’s plan for Stewart. We do not know at this point if Starboard has any plan of its own for the company. But even if the prominent Starboard simply tag along and vote with the other activists, we will very likely see some favorable voting results for all shareholders out of the special meeting in the near future.


This is an uncommon situation in which average investors can buy a stock at a level close to a famous activist’s entry point (the 13D showed that Starboard’s entry price is around $43.3/share, about 7.4% less than current price). The underlying business is very stable and desirable. The activists have a very high chance of succeeding and a sale of the company could happen as early as sometime next year. The lowest estimated sale price $55/share would generate a return of around 20% within a relatively short holding period. This is not a stock that will produce a ten bagger but the risk/reward is still quite favorable.

Disclosure: I am long STC.

Do not miss this under followed regional bank



Would you like to invest alongside with a proven management team that already has successfully sold two banks at attractive valuations? Would you like to own a promising bank that has demonstrated tremendous growth in the past few years and is poised to grow further? If these questions piqued your interest, read on.


According to the bank’s 2014 10-K filing, Franklin Financial Network(ticker symbol FSB) is a bank holding company that owns Franklin Synergy Bank located in Franklin, Tennessee. The founding team, led by Chairman and CEO Richard Herrington, found their first bank Franklin Financial Corporation (not related with this current bank) in 1988 and sold it at five times tangible book value to Fifth Third Bancorp in 2002. Then they took over a troubled Tennessee-based bank in Dec 2002, turned it around by slashing nonperforming loans to a seventh and expanded net income six times within four years, and sold this second bank at three times net tangible book value to Green Country Bancshares in May 2007. Without taking much pause, such savvy management picked the worst timing for the banking industry and started their third bank in the midst of the Great Recession. They didn’t just survive in this terrifying environment- they totally killed it. The management swiftly worked out the majority of the non-performing loans and FSB’s non-performing loans to total loans is at 0.1% at the end of 2014, a stunning figure which is about 2.5% lower than its peers. Net charge-offs even in 2009 was only at 0.26%, which is about 1% lower than its peers, and the charge-offs at the end of 2014 is around 0.


Recently, another Tennessee bank has filed for an IPO, and their filing shed some more light on Tennessee’s local banking landscape. I was able to locate most local Tennessee competitors and compare their results against Franklin Financial’s. The results are quite revealing and even further strengthened my belief that Franklin Financial has probably the best managerial talent in Tennessee. But before I talk about the comparisons, let’s answer another important question first: why Tennessee?


The state since the past few years has become very business friendly. As a result, it is benefitting from business and manufactures relocating from other places. Tennessee has been the No.1 states

for advanced industry job growth since 2013.  Fast job growth push unemployment below the national average and is around the lowest level in 15 years.  Forbes magazine ranks Tennessee’s Nashville metroplex fourth on the 2016 Best Big Cities for Jobs, only behind San Francisco, San Jose and Orlando.

branch locations

Yellow dots mark Franklin Financial’s branch locations.


Williamson County and Rutherford County, where Franklin Financial’s 11 out of 12 branches are located, have a blended median household income at $79,443 in 2014, higher than cities like San Francisco and Honolulu. Their projected population growth is at 8.4% which is on par with other high growth cities such as Houston and Dallas.  A combination of high income, robust job growth, healthy population growth makes the area very attractive to banks.

Now let’s move onto the local competitive banking landscape.

Deposit growth and branch efficiency


Deposit CAGR 2013 – 2016 Q2 Branches Total Deposit(in millions) Deposit/ Branch
First Horizon National Corp(FHN) 5.48% 152 20,630 135.7236842
Pinnacle Financial Partners(PNFN) 13.36% 44 7,293 165.75
FB Financial Corp(N/A) 8% 45 2,500 55.6
Franklin Financial(FSB) 38.83% 12 2,250 187.5

All data compiled from the listed companies’ 10-K and 10-Q reports


This table shows the publicly listed Tennessee-based banks that only conduct businesses in Tennessee. As we can see, Franklin Financial experienced a superior deposit growth compared to other banks. Although observant readers will point out that Franklin started with a much smaller base compared to its larger competitors, but what makes Franklin’s truly shine are two facts behind the already stellar numbers. First, the deposit/ branch number is highest on the list. For the same amount of deposit held, lower bank branch number means less branch costs, contributing to lower Efficiency Ratio (which we will get into in a second). Second, most of the deposit growth is from organic growth. Franklin grew its deposit base in Williamson County solely in an organic fashion and became the No.1 bank in that county in 7 years, coming on top over many other much more established national and other regional contenders. In July 2014, it acquired MidSouth Bank that exclusively operated in Rutherford County. The MidSouth Bank had $244 million deposit and 5 branches, making the deposit/branch at a much lower $50 million/branch. Franklin’s combined total deposit immediately after the MidSouth Bank acquisition stood at $992 million and after 2 years at the end of 2016 Q2 the number increased by an astounding 127%. Therefore, of the $2,250 million deposit it currently holds, $2 billion is from organic growth. The huge organic growth just shows how good Franklin’s bankers are at getting deposit against the competition. It gives me the confidence that the company is capable of acquiring banks and growing the acquired businesses if more acquisitons occur in the future.


2016 Q2 Operating metrics comparison


Net Interest Margin Efficiency Ratio Net charge offs Nonperforming asset ratio ROE ROA
First Horizon National Corp 2.92% 70.51% 0.25% 0.24% 10.00% 0.91%
Pinnacle Financial Partners 3.72% 51.90% 0.39% 0.33% 9.92% 1.33%
FB Financial Corp 4.20% 69.54% 0% 0.66% 16.00% 1.40%
FSB 3.33% 52.58% 0% 0.10% 14.48% 1.14%


All figures except FB Financial’s are from the companies respective SEC 2016 Q2 filing. FB Financial figures are adjusted based on its initial IPO filling by normalizing its tax rate.


In this table, like I mentioned before, Pinnacle and Franklin the two banks that have a much higher deposit/branch number also hold a much better Efficiency ratio. In addition, Franklin’s net charge offs and nonperforming asset ratio are the lowest among the four. ROE is the second highest right behind FB Financial. However, FB Financial’s income and ROE figures benefited greatly from its mortgage re-financing business while Franklin’s income is mostly from its lending business. If interest rate starts to rise, re-fi business will shrink while lending will become more profitable. So my forecast is that going forward in a rising interest-rate environment, Franklin will have the best ROE among the four Tennessee banks.


Lastly, let’s look at the valuation comparison. I removed FB Financial because it is not yet listed. Also, I added the median numbers for region banks in the South and banks with a similar asset size to Franklin’s. The median numbers are referenced from here. The stock prices are from Aug 26, 2016.


TTM P/E Forward P/E P/TBV
First Horizon National Corp 14.3 15.9 1.68
Pinnacle Financial Partners 20 18.6 3.15
Franklin Financial 16.3 13.2 1.89
median for southern banks 16.3 1.47
median for $1B-$5B banks 15.3 1.44


Franklin is not cheap based on average price to tangible book value but we are not paying for an average bank either. The investment is a bet on the continued healthy net income growth reflected here in a low forward P/E ratio. From 2012 to 2015, Franklin Financial’s loan quadrupled and so did its net income. Its revenue in the most recent quarter is growing at 50% year over year and net income year over year doubled. As Franklin Financial demonstrate continued fast revenue and income expansion, the market should eventually reward the bank with a premium valuation.


Future catalysts for Franklin Financial:


  1. Loan expansion. Based on management’s consistent past record, the loan volume should keep rising in the future. The company is well above the required ratio for banks to be considered well capitalized so it is allowed to leverage its balance sheet further even if it doesn’t acquire any more deposit. But I don’t believe the company will stop taking deposit in its market so the combination of deposit growth and increase in leverage will be the engine for loan volume growth.


  1. Asset mix improvement. Franklin Financial’s loans make up only about 62.4% percent of total earning assets, a figure quite low compared to average bank’s number. As lower yield assets(securities held for sale such as bonds), which generates only half of the yield as Franklin’s loans do, become a smaller part of the total portfolio, the mix will improve and net interest margin will rise.


  1. Expansion into Nashville. The company expanded into Nashville with one bank branch. It also announced acquisition of Civic Bank which consists of two branches in Nashville. I believe Franklin can repeat its previous acquisition success and take market share in Nashville.


  1. M&A. Regional banks are not as much heavily regulated as the big banks. It is almost impossible for big banks to acquire more assets due to regulatory constraint so a lot of M&A activity is happening between the smaller regional banks. Franklin’s management team sold its previous two banks valued at five times and three times tangible book value respectively. Williamson County and Rutherford County are highly desirable markets for any banks that want to grow in Tennessee and what is a better way to enter these market than buying the Franklin Financial the best franchise in these two regions? Franklin currently is in the sweet spot where it can either be an acquirer or a target. A high net tangible book value multiple is probably well deserved to buy Franklin’s well managed assets.


  1. Rise in interest rate. This is the obvious catalyst that should propel all bank stocks higher.


  1. Recovery in housing market. Franklin’s bankers are specialized in real estate lending. Residential construction loans and residential real estate loans make up about half of its loan portfolio. If the auspicious August new housing starts indicates a sustained housing market recovery by any chance, Franklin should be able to crank up even higher residential loan volumes.



Franklin Financial is managing lending risks better and growing a lot faster than the average regional banks, a sign that demonstrate management excellence. The management team already has two successes under its belt, prospered through multiple cycles, and enjoyed working together for a long history. The banking business in Tennessee should experience solid growth under the current economic expansion and job growth. Therefore, as investors of this company, we are investing in the right place at the right time with the best management who owns over 12% of the company.  This is not a typical discount to tangible book value play but I believe paying for the current premium will reap big dividend in the future.

Skechers has further room to run up



Skechers is a shoemaker that manufactures both lifestyle shoes and sports shoes. In 2010, the company developed shape-up shoes that promises of toning legs while walking. Those shoes were hot sellers back then until lawsuits broke out suing the company for injuries and false advertising.In recent years, its running shoes have enjoyed tremendous growth since Meb Keflezighi, the Skechers endorsed U.S. marathon runner, became the first American runner to win the Boston Marathon in 31 years.

Considered a big growth company in the hot athleisure space, Skechers was a darling on Wall Street during 2014-15 when its share price enjoyed a more than 400% run. However, as the company could not exceed the overly hyped expectation, its share fell precipitously, currently trading around 50% of its 2015 all-time high. With a 14 times P/E, is the stock a fallen angel to buy or a value trap to avoid?

Qualitative Analysis on Skechers

Strength: Skechers presents a unique value proposition different than most of its better-known competitors: unbeatable comfort at an attractive price point.

Skechers shoes are probably the most comfortable in the sports/athleisure category. As a person who exercises regularly, I owned quite a few pairs of sports shoes. Skechers shoes, with their memory foam cushion, are very soft to the feet. After getting used to the comfort of Skechers, when I switched back to a pair of my Nike, my feet were screaming at how hard my Nike shoes feel. Skechers’ athleisure shoes also offer superior support and comfort, making them very popular items among professionals, such as nurses, who walk a lot during the day and people who prioritize foot comfort over styles.

Skechers shoes have a different price range that its main competitors including Nike, Adidas, Under Armour and New Balance. Except the golf shoes and the GoMeb running shoes targeted at hardcore runners, most of Skechers shoes sell between $65 and $75 dollars. Although its competitors do have a selection of shoes priced in the similar range as Skechers, the majority of other brands’ shoes command a selling price between $100-130.

Challenges: current shoe designs do not impress and brand awareness is relatively low

Compared to the sleek and modern looks of its competitors’ shoes, Skechers shoes in general seem casual, laid-back and sometimes even a bit funky. Admittedly, there are customers that like the current Skechers design. However, to expand its customer base further and attract people who love the modern looks of other brands Skechers need to further improve its designs.

Another challenge Skechers facing is brand awareness. For the athleisure line, although celebrities such as Demi Lovato and Meghan Trainor have boosted the brand, internationally the brand still lacks recognition. For the sports shoes, the brand is still behind bigger shoemakers in terms of endorsements. This survey shows Skechers’ brand lags most of its competitors’ and ranks eight in 2014 among US males.  To be fair, the company recognizes this challenge and is trying to further boost its image by expanding its line of sponsored athletes such as runner Kara Goucher, , golfer Matt Kuchar .

Skechers’ Growth Catalysts:


The athleisure trend is not going away and Skechers will continue riding the wave. First, the 21st century workplace dress code will keep leaning more and more towards being casual. Tech start-ups are the early adopter of such relaxed dress code. More companies, wishing to be viewed as promising and energetic like a start-up to its current and prospect employees, have also relaxed its dress code. Even JP Morgan in June this year has expanded business casual dress code to its bankers who before were only allowed to wear suits(Athleisure is still prohibitied in the firm)  In addition, with the rise of Lululemon yoga pants people started to wear athletic wear outside of gym or yoga studios. To gym-goers, it is convenient to go in and out of gym without changing clothes. As people desire a healthier lifestyle, the athleisure wear, which is associated with being sporty and energetic, will increasingly become even more popular. Another simple reason that athleisure trend will be sticky is because of these clothes and shoes are much more comfortable than their more formal brethren are. If sneakers are acceptable who want to wear dress shoes every day?

Skechers should also benefit from the fast fashion trend. Fast fashion retailers such as H&M and Uniqlo are taking shares from the traditional clothing brands by offering customers superior quality and affordable price. The concept of fast fashion should not stop just at apparel. Once people get used to buying 10-20 dollar t-shirts they will naturally start exploring alternatives to 100 dollar plus shoes. A shift from premium shoes to value shoes will greatly benefit Skechers.


Skechers’ international operations can expand further. Compared to its competitors, Skechers is still in the early stage of international expansion. According to Nike’s  and Adidas’  annual reports, Nike currently owns 683 international stores and Adidas has a total of over 2700 stores worldwide. On the other hand ,Skechers in its 2015 annual report showed that it owns only 259 international stores and 649 stores in total.   Particularly, Nike and Adidas both view China’s sports wear market still in the infancy stage and are still investing heavily in the country. As of end of 2015, Skechers in China only has 52 stores in the mainland(another 29 in HongKong). In the fast growing Southeast Asia region and India, Skechers only has 21 stores and 30 stores respectively. There is still ample room for Skechers to expand in all of these promising international markets.

Affordable price allows Skechers to penetrate developing countries’ markets better. Compared to in developed countries, in developed countries the advantage from price difference between Skechers and its premium brand competitors should become even more pronounced. Chinese on average earns less than $10,000  and the average Indian’s purchasing power is a quarter of Chinese’s. So the 30-50 dollar difference between Skechers and its competitors is not pocket change to the average consumer in developing countries. Skechers will be able to capture international consumers who cannot afford Nike or Adidas but desires quality shoes from a foreign shoemaker and who want to trade down from higher priced shoes but had no alternatives in the past.


Running shoes sales may have peaked. Struggling with obesity and other health problems, Americans have increasingly adopted healthier lifestyles. As an integral part of healthy living, exercising is incorporated into more and more people’s routines and running is the most popular exercise. This in turn fueled a surge in running shoes sales in recent years and Skechers benefited tremendously from this trend. However, based on a WSJ article, the growth in running participation may have peaked and millennials have picked up other exercises such as indoor cycling, cross fit classes, and interval training as alternatives. Therefore, the big tailwind behind Skechers’ running shoes sales may have stopped and it is imperative for the brand to expand its line of offering and compete effectively.

The low price segment of athleisure might become more crowded. Adidas recently entered the same market segment Skechers currently occupies with Addids NEO. Adidas’ NEO shoes, priced at around $60, is an athleisure brand that maintains the looks and feels of more expensive and popular line Adidas Originals. It will not be surprising to see other established premium brands to adopt a similar strategy and enter this segment in the future.

Management Stock Ownership

One concern about Skecher’ stocks is the consistent insider selling. However, the selling mainly stems from options granted to management as bonuses and management still holds significant ownership of the company. Founder and CEO Robert Greenberg owns over 29 million shares of Skechers stock according to the latest proxy statement, making him the biggest shareholder. Combining his ownership and another roughly 5 million shares held by other Greenberg family members who are also officers of the company, the founding family currently owns over 20% of the company.

Sales Growth trend for Skechers,Nike,Adidas,Under Armour(in millions)


2013 2014 2015 TTM 3.5 yrs CAGR
Skechers 1,854 2,387 3,159 3,448 19.4%
Nike 25,313 27,799 30,601 32,376 7.28%
Adidas 19,483 17,921 18,426 20,159 0.98%
UA 2,332 3,084 3,963 4423 20.05%


NI(Net Income),Margin,ROE Comparison

2013 NI Margin 2014 NI Margin 2015 NI Margin TTM NI Margin TTM ROE
Skechers 55 2.93% 139 5.82% 232 7.34% 268 7.77% 19.69%


Nike 2,472 9.77% 2,693 9.69 3,273 10.70% 3,760 11.61% 29.58%
Adidas 1,080 5.54% 604 3.37%  691 3.75% 1,091 5.05% 16.00%
UA 162 6.96% 208 6.75% 233 5.87% 232 5.24% 10.61%



P/E and  Ebitda Comparison


TTM P/E Forward P/E P/E net Cash EV/EBITDA
Skechers 14.37 12.22 10.7 7.70
Nike 27.88 24.39 22.3 17.77
Adidas 34 32.79 35.1 16.94
UA 113.54 72.46 71.9 38.09

(All comp data from as of 08/22/2016)

From the tables above we can see, for the last three and half years, Skechers has enjoyed a high growth rate almost on par with Under Armour, improved net margin and ROE that already passed Adidas and UA. Yet the stock is trading at a huge discount compared to sports brands’ stocks and the S&P 500. Although it may be hard to assign Skechers stock with similar multiples to premium sports brands, even a 50% increase in stock price would still put the forward P/E net cash at 16 times and EV/EBITDA at 11 times.

The stock suffered a big drop after Q2 earning partly because of an order pull forward into Q1 and sales pressure caused by some sporting goods stores’ bankruptcy liquidation clearance. The management stated June is the largest domestic shipping month in history and early July sales have exceeded their model.Given the current depressed price trading near 52 weeks low and the lowered expectation going into Q3, investors should accumulate a sizable position before Q3 earning comes out.

Analysis on Sina and Weibo stocks: SINA has further room to go but arbitrage between the two is the current best bet

Sina(Ticker SINA) stock has rallied about 30% from the recent low set in May. Although a sum-of-the-parts analysis of Sina still suggests the stock is trading at significant discount to even a conservative valuation, the discount gap has rapidly shrunken. In this article, I will give an introduction of the company, lay out the valuation of SINA based on a conservative case and a bull case, list the possible catalysts and risks, and recommend on how to trade the stock.

To avoid confusion, all financial figures are in USD not Chinese RMB.

An brief introduction to SINA

The best way to think of SINA is to consider it as the Chinese Yahoo because it resembles Yahoo in many ways. First, SINA started out as a Chinese news portal website that offers different types of information, such as finance, politics, entertainment, cars, weather and etc. Second, just like Yahoo, the hot web company in the past was eclipsed by newer Chinese net companies such as Baidu and Tencent; SINA’s traffic peaked and suffered a long decline. Third, although SINA’s core business is not doing so well, it also has a very valuable asset called Weibo with close ties to – yes, you guessed it—Alibaba. I think we are in the early to middle innings of the stock’s rise just like Yahoo did couple years ago when the market finally began to recognize the company’s underlying assets and bid up the stock.

Here’s what’s different between SINA and Yahoo: Yahoo doesn’t run Alibaba but SINA does runs Weibo. From Weibo’s annual reports we can see, SINA determines Weibo’s cost basis and allocates part of SINA’s overall cost and expenses to Weibo; Weibo in turn report these costs and associated revenues to Weibo’s shareholders.


Analysis on Weibo(Ticker WB)

Weibo diluted share count: 220M

Share Price: 37.17 (as of Aug 8 2016)

Market Cap: 8.14B

Sina ownership of Weibo: 54.5%

Alibaba’s ownership of Weibo: 32%


Monthly Active Users/Daily Active Users In Millions

End of  2013 End of  2014 End of 2015 2016 Q1 2016 Q2
MAU 129.1 175.7 236 261 282
DAU 61.4 80.6 106 120 126


Weibo’s Revenue and Income in Million USDs

2013 2014 2015
Net Revenue 188.3 334.2 477.9
Costs&Expenses 246.9 356.3 440.4
Non-Operating P&L -17.7 -43.4 -3.3
Net Income -40.9 -65.5 34.2


2016 Q1 2015 Q1 2016 Q2 2015 Q2
Net Revenue 119.3 96.3 146.9 107.8
Costs&Expenses 112.1 100.8 119.6 105.5
Non-Operating P&L -0.1 -1.4 -1.03 2.23
Net Income 7.1 -3.1 24.4 4.2

Weibo, the Chinese Twitter, over  the years has experienced strong growth and actually started turning a profit last year.Admittedly, judging based on the TTM P/E ratio, the stock is ridiculously expensive. However, we have to understand that to Alibaba, or to many other companies who wants to either enter the fast-growing Chinese online media space or strengthen its existing position in this space, Weibo does, at the moment, deserves a high valuation.

Alibaba’s valuation serves as a base for Weibo’s floor price

Alibaba paid 585.8 million USDs and obtained 18% of Weibo in April 2013,valuing Weibo at 3 billion dollars. When Weibo went IPO in April 2014, it further boosted its stake to 30% buy purchasing 30 million shares at 14.45 per share, valuing it at 3.6 billion dollars. As illustrated from the revenue table above, Weibo still experienced very solid growth in 2015 and a modest growth in revenue Q/Q in 2016 Q1. The appeared slow down in 2016 Q1 revenue growth is actually due to the end of strategic agreement between Weibo and Alibaba, which leads to the next point.

End to Alibaba’s strategic agreement increases Weibo’s valuation

Between 2013 and 2015, Alibaba and Weibo had a strategic agreement in which Alibaba spent significant advertising dollars on Weibo for its e-commerce business. During that period, the revenues contributed from Alibaba accounts about 30% of Weibo’s total revenue. However, at the beginning of this year, the agreement came to an end. As a result, Alibaba only contributed 11.1 million revenue (9.3% of total revenue) in Q1 16 compared to 34.5 million (35.8%) in Q1 15. Therefore, non-Alibaba related revenue grew from 61.8 million to 108.2 million, a stunning 75.1%. In essence, Weibo has proved to Jack Ma that Weibo can prosper without Alibaba’s aid, and therefore Weibo would command a strong position in negotiation if an Ali buyout talk takes place. To other possible would-be acquirers, Weibo’s valuation should also increase because Weibo has shown it is no longer that much dependent on Alibaba.


Valuation for Weibo

Based on Alibaba’s valuation and recent revenue growth trend, we should be able to price Weibo as a whole at least around 4.5-5 billion dollars. Let us cross check Weibo’s valuation against other comparable companies.

Comparison with Momo Inc and Tencent

Weibo Momo Wechat(Tencent)
Valuation 4.5 B 2.84 B 50 B
MAU 282 M 72.3 M 762 m
MAU Trend YOY 33% increase 7.4% decrease 39% increase
Valuation per MAU 16.0 39.3 65.8

Momo’s market cap is used as Momo’s valuation. Momo is a messenger service which is well known for people looking for casual hookups or getting escort services in China. The company is serving a niche market but ,despite the Momo’s effort to expand its service into mainstream, it has been extremely hard to grab market share from Tencent.

For Wechat’s valuation, I estimated its price based on a few facts:1).the app is owned by Tencent which has about a 226B market cap 2).Tencent’s main business consists of QQ(877M MAU) and Wechat 3). Wechat is currently the undisputed champion in Chinese social network space 4). Valuation metric comparison and competitive position against other social messengers, such as Whatsapp, Line, Facebook Messenger and etc. And even if this valuation of 50B turns out to be too optimistic, Weibo’s Valuation per MAU is at around a quarter of Wechat’s, which leaves plenty margin of safety.

Bull-Case for Weibo

If we price valuation per MAU of Weibo at around 35, we reach to a valuation of around 10 B.


Analysis on rest of SINA

SINA’s ex-Weibo segment revenues

2013 2014 2015
Portal Ads 378.1 375.5 340.8
Others 98.7 58.6 62.0
Segment Income 63.5 24.5 -21.8


2016 Q1 2015 Q1 2016 Q2 2015 Q2
Portal Ads 43.7 51.2 58.1 67.8
Others 35.7 31.6 38.9 34.7
Segment Income -15.6 -22.1 -3.6 -11


Clearly, the ex-Weibo segment is in decline. However, as SINA focuses efforts on growing Weibo, it is very likely that the portal and others did not receive as much attention as they did in the past and therefore performance suffered. Recent Yahoo’s core business acquisition shows that despite the loss in popularity and revenue, portal sites still hold some importance to strategic buyers even in today’s everything-going-mobile environment. Furthermore, its portal site competitor was able to keep its portal business revenue basically flat from 2015, indicating SINA’s portal business might have room for improvement.

Assigning its ex-Weibo business a 1X sales figure, we price SINA’s other businesses at around 400 million.

Sum-Of-The-Parts Analysis of SINA


Cash and Cash Equivalent: 2.1 B

Long-term investment: 1.24 B

Portal and Others business valuation: 0.4B

54.5% Weibo Ownership Valuation: base case (4.5B-5B) 2.45B bull case(10 B) 5.45B


Convertible notes 800m, matures on Dec 1 2018, convertible at around $125 per share.

Double counting weibo’s cash 129.9M, short-term investment 266.6M and long-term investment 294M: 691M

Net Asset Value: 5.5B

SINA share count: 73.4 million diluted shares

Per share Value: base case $64-67.8 per share, bull case $104.9 per share

Current market price discount: 10-16% for base case, over 70% for bull case.


CEO’s stock purchase on margin and his big gain from past stock purchase

SINA issued 11 million new shares to its CEO Charles Chao at price of $41.49 per share, subject to a lock-up period of 6 months. News of the deal came out on June 1, 2015 and closed in November last year. Before the deal, the CEO’s stake in the company was in low single digit; after the close, Charles Chao became the biggest shareholder of the company with a 17.8% stake.  Further looking into the deal on SEC we can see that the CEO actually bought the shares with 50% of margin. Such a giagantic purchase especially with borrowed money speaks for Mr.Chao’s confidence in his own company.

Another very important thing to note is that this is not the first time Mr.Chao took a very big stake in the company. Back in 2009, then SINA management, with Mr.Chao at the helm, signed a 180M equity deal buying worth over 9% of the company. The stock then went from the 30s to all the way well over 100 within a year and a half, rewarding everyone who bought along with the CEO 100%-300% gain. For himself, Mr.Chao sold off his position and reaped enormous profit in his previous endeavor. This time, with an even bigger stake, and a very hot internet media property at his hand,  Mr.Chao will surely prop up SINA and Weibo with all his might.


How to trade:

Option 1. Establish a small position (1/3 of total committed capital for SINA) and increase the stake after a pullback

This option enables us to participate in further possible rallies towards the bull case target and leaves ample firepower left to purchase more shares should the stock fall back.

Option 2. Arbitrage the spread between SINA and Weibo by buying SINA and shorting Weibo

SINA’s Weibo ownership, valued at current stock price, is equivalent to about SINA’s whole market cap. That means SINA’s other businesses, its net cash and investments are valued at 0.  What’s more, being Weibo’s controlling majority shareholder and the actual company who operates Weibo on a daily basis, I find no basis for the market to undervalue SINA’s Weibo stake as such.  Either Weibo’s valuation has to come down or SINA’s market cap has to go up – such market inefficiency won’t last forever and arbitrage is the way to trade the inefficiency.

One share of SINA owns about 1.63 share of Weibo. Since in pure arbitrage we want to perfectly hedge ourselves the long SINA shares to short Weibo shares ratio has to be around 5:8. Currently SINA’s portion of Weibo has an implied value around 2B(SINA’s market cap minus the cash and investments, plus liabilities listed above), and current market value for this chunk of share should be at 4.47B. This is probably the best trading strategy for SINA and Weibo because the arbitrage spread is over 100%.

The spread between WB and SINA has further increased this year:


Option 3. Buy SINA options

For people who firmly believe in Weibo’s bull case or a repeat of rapid meteoric rise in SINA’s stock after CEO’s buy-in, we can purchase options with long expiration dates. In particular, the $60 strike price Mar 2017 call option and the $60 strike price Jan 2018 trade at $6 and $10 respectively. If the stock trades close to our bull case, say $100, these options will return 600% and 400% respectively.