Tag: David Shakirov

By David Shakirov

There was a time decades ago, when going to the movies was a spectacular affair. Forget cramped seats, with years-old popcorn stuck in-between its cheap, polyester cloth. Or the overpriced, low quality food offerings. Nowadays, the movie theatres themselves are normally wildly empty — industry insiders cite a capacity utilization rate in the teens %. No, this is not a piece on why, or how, Netflix became a $140B company. It is, however, a speculative tale of a theatre company trying to change an otherwise boring and slowly bleeding industry. What’s in its way? The Retirement System of Alabama, of course. That is, this article will try to explore the relationship between the RSA, a $44B pension fund, and iPic, a luxury dine-in movie theatre concept that found the wrong partner in its capital intensive crusade for selling movie-goers reclining chairs, martinis and lobster rolls.

In a 2015 interview, AMC’s CFO Craig Ramsey acknowledged that the industry is slowly suffering. He noted how movie theatres, unlike most other businesses, only operate at an 11% capacity, and how, by expanding and improving its seat offerings (and increasing the ticket prices), the number of attendees grew by close to 50%. It was years before Ramsey’s realization that Hamid Hashemi was slowly developing the luxury dine-in theatre concept. Out of this came “iPic”: a concept that rapidly decreased seats per square foot, expanded the size and comfort of each seat, increased the price 2-3x, and sold restaurant quality food and booze during the film screening. The business grew, opening locations across the nation in high end neighborhoods, throwing expensive, celebrity filled launch parties, and inviting “mixologists” and chefs to populate the kitchens. While AMC struggled with $460k of annual revenues per screen, iPic enjoyed $1.65m of per screen on its most luxurious offering

At a glance, iPic seems like a ripe growth story. Inorganically, iPic wants to grow via expansion. They operate 14 theatres, with plans for 43 by 2025, and over 250 in the long run. They also want to capture 13% of the Saudi movie market after acquiring rights to open there. Each opening is financed through a long term lease, with total debt reaching average levels of $11m/theatre. In year three, iPic sees roughly 25% unlevered free cash flow returns on a new theatre, enough to pay back debtholders, and hopefully, with scale, cover its cost of goods and corporate overhead.

Organic growth is major, as well. This year, iPic plans to revamp its movie theatres to include almost 100% high end seats (think not “premium” but “premium plus”). Why? Because it found that customers prefer the more expensive offerings 4:1 to the cheaper ones. iPic gets 60% higher ticket revenues from its already high-priced tickets, and patrons spend 80% more, on average, on food and booze (win-win). Also, it’s expanding the revenue stream to include other sources, including high end advertising revenues (given its target demographic), alternative theatre revenues (renting out theatres for gaming events, for instance), etc. Overall, it’s revenue per guest is up 25% since the beginning of 2015. Even with disruptions in its theatres (during renovations) and a slow movie market in general, iPic has seen a high teen revenue growth CAGR and a 10-12% store level EBITDA margin.

Actually, its store level numbers and gross margins looked pretty good. Its unlevered returns were not bad either (again, coming in at 25%). These were the statistics that management, on its investor presentations that have since been taken down, emphasized. What these numbers fail to highlight though, is the massive debt load of the company, and its toxic corporate overhead. These two have drawn the company deep into the red, at around -25% of revenues, bottom line. As iPic’s revenues swelled from $98m in 2015 to nearly $150m in 2018, its corporate overhead doubled, along with its “other expenses” (a line item for maintenance and miscellaneous costs). These two line items alone have continuously drawn the company into the negative, excluding the interest payments (15% of revenues) on its debt.

Maybe it’s the CEO/Founder/President/Chairman’s (all the same person) $5m pay package (with cash compensation actually increasing from 2017 to 2018 as the business bled harder and harder), or the company secretary’s $3.7 comp + equity. In total for 2018, the company cites $9.4m in relation to equity-based comp. I’m not attacking a system that incentivizes executives to perform through equity-pay, but raising the point given how much overhead the company sees (why not cut the pay in half, and given the company’s proposed and believable rapid growth, have the execs put their own cash into the stock? With the stock down 90% in one year, the equity-based incentive to operate the company efficiently did not work as planned…)

In the meanwhile, the Retirement System of Alabama (RSA) promised to fund this growing, capital intensive business. I bet they heard the same-store EBITDA and unlevered FCF pitch and drank the fruit punch. I know I did. Anyways, since 2010, the RSA has funded hundreds of millions of dollars worth of CapEx, store openings, and negative EBITs, while at the same time owning class B pre-IPO equity in the company. This has now converted into a 40% equity stake, in addition to owning all of iPic’s senior debt. Yep, the Retirement System of Alabama is practically fully in charge of a luxury dine in movie theatre concept.

The RSA, just like most investors, has likely had enough. In July of this year, the RSA has declined to allow iPic to draw $10m from its $190m credit line. Why did it need the $10m? To make an interest payment on its massive debt load to … none other than the RSA. The intention is clear. In their pre-IPO filing, iPic outlines its credit agreement with the RSA as follows:

“The remaining availability under the RSA Facility requires us to achieve certain operating targets before we may borrow.” (SEC/iPic)

Last week, iPic announced its Chapter 11 bankruptcy, likely after its operating targets were not achieved and the RSA declined to extend credit. Or, as they say in Alabama, iPic “just got too big for its britches”. After the filing, the RSA lent iPic a $16m debtor in possession loan to maintain daily operations.

The business itself seems to be growing and is profitable from a gross margin standpoint. If the RSA or management can find a way to pump the brakes on corporate overhead, there could be significant operating leverage within the firm, especially as it pushes to expand from 16 to 250 theatres.

I’ve been an iPic movie and restaurant goer myself since 2016 and the business’ value prop is crystal clear. If the company emerges from restructuring, whether or not it is owned by great state of Alabama, continues with its expansion strategy, and takes massive action to cut down its overhead, it will be an investment in my portfolio. Until then, I’ll grab my popcorn and watch from the sidelines (or one of iPic’s patent pending “pod” seats) as the drama unfolds…

—

Source for Mr. Ramsey’s interview from AMC:

https://celluloidjunkie.com/2015/01/14/daily-cinema-digest-wednesday-14-january-2015/

Other sources: SEC filings and company presentations

By David Shakirov

UPDATE 11/4/2019: As of 11/4/2019, the author recommends to sell FCAU.

Even after a capital gain of 17%, from $13.78 (5/28/19 closing price) to $16.14, today, the stock continues to trade at a compressed EBITDA multiple. Unlike its competitors, FCAU runs net cash, and will likely see margin expansion as it offers higher end vehicles like the Alfa Romeo CUV, electric Maserati, and a new three row luxury Jeep. This quarter, FCAU was able to increase adj. EBIT, even as revenues and volumes shrunk (which is even more impressive with a ~15% gross margin business).

However, two issues make the investment questionable. First, holding an auto maker late cycle can prove to be dangerous. Second, the merger between FCAU and Peugeot is a source of significant uncertainty. It becomes increasingly difficult to evaluate the synergies between the two auto makers, and the benefits of such a transaction. A sell will book a 17% gain for our readers (or 7% above the S&P 500).

\\\——————————————————————————————————————————///

In the late 2000’s the American car market was in shambles. Companies including Chrysler and General Motors were pushed into bankruptcy and provided a lifeline by the federal government. Coming out of bankruptcy in 2009, Chrysler was a financially distressed corporation trying to manufacture $20,000 vehicles during the worst financial crisis since the Great Depression — what I call a hard sell. In the meanwhile, Fiat, a small Italian car marker saw an opportunity. Sergio Marchionne, the CEO of Fiat at the time (and known to be a espresso-holic and chain smoker), began expanding his stake — 20% in 2009, to 53% in 2011, and a 100% acquisition in 2014. The result  — Fiat Chrysler Automobiles N.V. (FCA).

Following the merger, FCA’s vehicle portfolio turned to be incredibly diverse and highly valuable. It included brands like Ferrari, Maserati, and Alfa Romeo (the Italian three musketeers), Chrysler (built Detroit-tough), Jeep (the legendary off-roader), and Dodge (true American muscle). FCA continues to make vehicles from minivans to Italian sports cars. Since then, its brands have seen immense growth (Maserati volumes increased 8x, its Ram trucks saw 8 years of consecutive growth, Alfa Romeo sales up by 2.6x, Jeep sales doubled, etc). Only 10 years ago, the company was in financial ruin and faced near-death.

Its 2022 master plan was unveiled last summer (one month before its CEO, Sergio, passed away) at a sentimental event celebrating the FCA success story. Its goals (and my subsequent take) include :

• $10B investment in electric tech

  • FCA recently spent over $2B to buy emissions “credits” from Tesla to meet strict carbon-laws FOR 2020 — electrification tech is important to keep emissions low

• Partnership with Google’s Waymo and BMW’s Aptiv for autonomous driving

  • Unlike other companies, this partnership is less capital intensive. With Waymo, FCA will provide ~60,000 Chrysler minivans for testing, while it shares resources, data, and testing with BMW

• Maserati volumes double to 100,000 (double from 2018) and margins increase to 15% (13.8% in 2018)

  • Maserati is moving to compete with the German’s high end offerings, while its current demographic is both 5-10 years younger and has a 2x average income (there is both potential to tap into the high-mid income bracket, plus offer higher end options, all to longer-lasting customers than the competition)

• Ram is increasing its high end truck offerings to increase its ASP

  • The brand is seeking double digit YoY volume growth and lags by $5-10k behind competitors in ASP ($50,000 vs. $56,000 for Ford, for example). Given strong loyalty data, new high end offerings should increase revenues significantly. There is also untapped potential in the Asian markets with the Ram brand

• Expansion of Jeep as a mainstream SUV brand, with a focus on electrification

  • Historically, Jeep had an image of a tough, military off roader. Now, it sells 1 in every 17 SUVs, while it expanded production capacity by 2.4x over the last four years. With SUVs constituting most car purchases in the US, it’s natural to expand into this market. By 2022, Jeep sees industry-wide utility sales (UVs) move from 32M to 37M, and has a long term goal of 20% UV market share. It will also introduce 4 dedicated electric UV models.

• 1.75x EBIT growth, margin increase from 6.8% to 10%, cash increase from $12B to $20B

  • Growth prospects both geographically and within each FCA brand, platform and fixed cost sharing, and its increasing net cash position should improve the company’s already positive financial situation. This may result in dividend increases (current dividend yield is 4-5%).

FCA is a growth story in an otherwise lackluster, high-fixed cost industry. It currently trades at a 7x P/E (17x industry average) and is faced with little debt (0.15 debt/assets). FCAU even trades on a 0.15 PEG. In the case of a recession, the company is well positioned financially, and in terms of product offerings, to weather the tough environment. Aside from its net cash position, it also only put up 10% of its PP&E as debt collateral, and has access to a $7B credit facility (historically stable liquidity at $20B, or 2x annual SG&A + R&D). Given the economic expansion continues, however, the company has incredible growth potential — it will continue to develop its diversified product offerings and push its untapped geographical penetration in China and LatAm, for example. Its 4.5% dividends can also provide a cushion in the case of minor capital losses.

During the development of this article, I was given an opportunity to drive Alfa Romeo’s flagship sedan, the Giulia (first image) — a four door Italian rebuff of the German status quo. Why the Ramsey Alfa Romeo dealer trusted me with a $50,000 stallion is beyond the point — the vehicle drove on rails, a crystal clear step above your neighbor’s vanilla Benz. As I carved through North Jersey’s twisting and turning roads, I realized the Alfa (mind you, this is the “regular” Giulia, not the $80,000 sports version) went through near-hairpin turns at 40mph. If my anecdote is any reflection of the future, then FCA’s looks bright.

Regardless, who doesn’t want a vehicle built Detroit-tough, but with a hint of Italian love?

Recommendation: BUY at the current price of $13.78 (see updated at article header)

By David Shakirov

UPDATE (6/13/19): the author recommends selling Ferrari stock. Currently, shares trade near $160. Given Ferrari’s guidance for 2022, the stock is trading at a 30x P/E on those numbers, or a 50x+ P/E on today’s figures.  Macroeconomic headwinds may still push down its equity price in the next 12-18mo, though Ferrari NV’s underlying business will likely not be impacted as severely as most corporations.

Insight readers will book considerable capital gains: since the article’s publishing just 5 months prior, Ferrari stock has climbed 40%, or 31.2% above the S&P 500. 

\\\—————————————————————————————————///

In my last article, I spoke about Ford — an international behemoth with revenues of $150B+, low margins, distressed investor sentiment, and production numbers of over 6 million cars per year. Ferrari is also a car company, is publicly traded on the NYSE, and starts with the letter “F”. That’s where the similarities end.

Here’s why Ferrari is so interesting — unlike traditional car companies, Ferrari has immense control over its top line and customers. More specifically, Ferrari admits to limiting production of its vehicles significantly below demand to enforce an aura of exclusivity, luxury, and brand image. The latter, Ferrari admits, is crucial to its business. However, how can a publicly traded company answer to Wall Street’s insatiable appetite for GROWTH? Ferrari’s medium-term solution is to grow its product lines (sports cars, GTs, and Purosangue, or SUV) and expand its demand base significantly, while growing supply at a meager 7-8% per year. In this way, Ferrari essentially controls their top line in the short run. The longer run issue, however, is when will its production finally reach demand, forcing the company to lower prices or lose its brand image? Ferrari’s current

valuation has limited medium term upside (more on this later), but investors may be interested in three factors — high dividend potential (when the company matures in the mid-late 2020s), international growth (in EMs, China, and LatAm), and nearly universal brand value and name recognition.

The relationship between Ferrari and its customers is highly unique. Of its car sales, 65% are to existing Ferrari owners while around 30% are to owners with at least 2 Ferraris. To be “allowed” to buy one, prospective clients are often screened by their devotion to the brand through Ferrari fan-clubs, general passion for the vehicles, financial standing, and other unknown factors. Owning a used Ferrari also helps. Then, customers ate pushed to buy the entry-level variants (such as the California or Portofino). This, combined with its undersupply strategy, could position the company to weather a recession incredibly well— they control who buys the cars, and tons of clients want them! In 2008, when Ferrari was not as prominent in LatAm, EM, China, etc. and did not offer as wide of a lineup, its auto sales slumped 10% (while the luxury performance auto market shrunk in half).

It is possible that in a mild recession, Ferrari’s production may continue to rise as even recessionary demand for its prancing horse declines, given the significant gap between supply and demand.

Although Ferrari is known for its car production business, this only accounts for 72% of revenues. Another 11% is engine production for Maserati (which accounts for ~80% of Ferrari’s total engine production, with the rest for Ferrari vehicles). Another 15% percent is purely based on its brand — licensing and distribution fees from selling Ferrari merchandise (think hats, shirts, and Legos), Ferrari World Abu Dhabi, and other brand-related revenues. Capital-wise, Ferrari took advantage of low rates (bonds with 25bp coupons) and secured a number of large bond offerings (it has 1.8B Euros of debt on the balance sheet, and runs net debt). Given its high margins, ability to refinance, and strong top/bottom line growth, the debt likely does not pose a significant risk to the business.

There are other important risks, however. First, international emissions regulations are pushing Ferrari into two directions. The brand could either keep buying emissions credits (by paying “clean” companies like Tesla, given Ferrari’s twelve-cylinder gas-guzzling sports cars) or begin improving efficiency. The latter strategy, which is realistic into the future, would involve hybrid motors and electrification (both of which Ferrari is trying to avoid as to not damage its brand reputation for gas-motor sports cars). Ferrari promises that in the next 3-4 years, 60% of its lineup will encompass hybrid tech and that these models will stay true to their Italian high-performance roots. Competitive risks also exist, from brands like Lamborghini, Aston Martin, Bentley, and Rolls Royce. Most of the competition is also backed by larger auto companies (Volkswagen Group in the case of Bentley and Lamborghini, BMW for Rolls Royce, etc.), which Ferrari had until its spin off and IPO in 2014. The benefits of this include better bargaining power, platform sharing, lower costs, etc. (for example, the new Lambo SUV is on the same platform as Audi’s Q7, also owned by Volkswagen). Additionally, given that 77% of Ferrari’s sales are of its lower-end V8-engine cars (which have an MSRP of $200-300,000), competition at these price points is higher. This may further discount the value of the Ferrari brand, as clients may be inclined to purchase competitive vehicles (either for lower-price or better quality). As Ferrari increases its production numbers beyond competitors due to its publicly-traded nature, it may also lose its exclusivity and touch with customers (this may not be an issue, however, if the company expands into different categories like hybrids and SUVs).

Through a DCF, I considered three cases — a base case ($116 target) where company guidance through 2022 is generally met (see the “Key Financial Targets” table), a bear case ($97 target) which includes a recession, and a bull case ($127 target) where company guidance is generally met two years early. The base case assumes a 4.7% annual growth rate of the core vehicle business (based on the CARG of the last 5 years), a 10% annual increase in Maserati’s engine demand (based on Maserati’s growth goals), and a 3% annual increase in the sponsorship arm (conservative growth). The bull case assumes the same 4.7% growth rate (since a “bull” scenario does not mean more production, given Ferrari’s exclusivity model) of the core business, but a stronger 20% y/y growth of the Maserati engine business, and slightly higher growth for the sponsorship business (somewhat conservative 5% per annum). Finally, the bear case assumes zero growth for the core business (not a decline, however, since Ferrari’s market is quite undersupplied), a 25% decline in Maserati’s business (based on luxury auto market behavior in 2008 from competitors like Mercedes/BMW), and a 20% decline in sponsorship (given a 15% decline in retail sales in 2008).

As you can see for yourself, there is not much upside or downside in the stock. However, given that they directly control around 70% of their top line results by controlling supply, the company’s performance has little downside in a recession. The short to medium term upside, however, is weak as well. Maybe I should have written this article two years ago, when Ferrari was trading at $40 (and not $110!) and had similar fundamentals. If you already own the stock (and don’t want to realize your gains for tax purposes), or are looking to invest longer term, there are a number of reasons to stay in. First, the company promises to buy back ~10% of its market cap over the next 2-3 years, has long term growth opportunities in markets like LatAm, China (where they sold only 617 cars in 2017), and other EMs, especially if it will expand its line-up to include hybrids and SUV-like vehicles. Its incredible brand value doesn’t hurt as well, while the prospect of a cash-cow business opens up the opportunity for high dividends (which are strongly considered by management for before 2022).

Overall, Ferrari is an exciting company. Unlike most car companies, it has immense control over its customers and makes exciting products. I live only a couple miles away from Ferrari’s North American headquarters and had a chance to chat with some of their engineers. One told me that Ferrari’s engineering and designing prowess (in terms of features and reliability) has improved drastically from just 3-4 years prior. Surprisingly, only two years ago, most car journalists weren’t excited about Ferrari’s vehicles and presumed that the company was relying too much on their brand to sell their cars. As a car enthusiast, I checked out the new Portofino, 812 Superfast, and some of their future offerings — Ferrari has massively stepped up products. The auto world agrees.

And who knows, maybe by buying Ferrari stock for growth you’ll be able to purchase one of their heart-stopping, pants-dropping cars down the road. If they’ll let you, that is.

By David Shakirov

UPDATE 03/21/2019: After a rise in the stock after earnings on 03/21/2019, I recommend to unload shares at $43.50, booking a 27.5% gain. An uncertain semiconductor supply/demand dynamic and higher valuation results in a more subpar risk/reward ratio. However, the gain booked from this article is an impressive 15% above the S&P 500, for a total gain of 27.53%.

Tech stocks are no longer the loud, hard partying rock and roll band of the equity markets. Although the S&P 500 has declined 10-11% over the last three months, the technology sector is trending lower (the NASDAQ 100 is down 14% in the last 3 months). At one point a sweetheart of momentum investors, AAPL, for instance, is spurring a love-hate relationship with its shareholders with lowered transparency, demand issues, and a 30% decline in its share price. Micron (MU), however, is even more extreme.

An American chip-maker based in Idaho, Micron is in the memory-supply business, including RAM, solid state, flash drives, etc. — a key component of most electronic devices. Micron tailors memory products to customer specifications, and sells through either online or in-person sales representatives. Approximately half of its net sales stem from its ten largest customers including Oracle, GE, Google, and Cisco — major players in the cloud computing, networking, and analytics businesses. To make its memory chips, MU relies on a small number of Chinese suppliers for raw materials (including silicone, chemicals, rare-earth metals, etc.), while 88% of its orders originate outside the United States — making its business model vulnerable to tariffs, shortages, or transportation mishaps.

Since mid-2016, however, RAM prices and demand have skyrocketed, which may account for Micron’s revenue growth from $12.4B (FY2016) to $30.4B (2018).  Its stock gained strong momentum, lifting from its sub-$10 low to a high of $60 over two years as analysts cited the company as “generating increasing profits” (Benchmark) and pointed to its attractive valuation (Wells Fargo).

After underperformance in 2016, Micron’s Earnings Per Share have been steadily increasing for the past two years (grey bars), beating analyst expectations for 8 straight quarters (green figures). Source: E-Trade 

Since late-May, MU has declined almost 50% to $33 as analysts began to see cracks in RAM pricing and demand, an attack on Micron’s core business. Analysts focused on declining EBITDA given the weakness in its business environment. However, firms like Moody’s have reiterated that, for example, debt-to-EBITDA will continue to be sub-1 while RAM pricing is simply a cyclical (not structural) downturn.

The PHLX Semiconductor Index (SOX), a metric cited by MU’s 10-K as an accurate measure of the semiconductor market, has trailed 15% down from its peak in late May. Some of Micron’s largest competitors, including SK Hynix, have trailed down 35% (compared to Micron’s 50% drop). Given that these companies operate in the same memory-business, Micron seems to be hit hardest by the cyclical decline in prices.

Although it faces a more difficult than expected business environment, MU may now trade at an attractive valuation. Since 2016, it has paid down debt (from $12B to $11B) while doubling assets (from $22.5B to $43B) and nearly tripling revenues.  Its short term liquidity is not concerning (current ratio of 2.8x) while its debt profile is quite small (debt/equity of 0.14x). Operating income, a large focus for MU investors, has increased from $13.3B in 2014 to $15.8B in 2018. These metrics point to a strong balance sheet position and rising revenues/income. Investors are more focused on the cyclical decline in the memory-business, however, and not company fundamentals..

Given its healthy financials, the memory business landscape is a catalyst for the stock. M As competition between MU and its competitors (including Samsung and Chinese firms such as SK Hynix ) intensifies, fears of oversupply and hence memory price deflation emerge. Micron admits that the Chinese government’s direct investment into Chinese semiconductor companies poses a competitive (and possibly “unfair”) risk. Nevertheless, Micron has close to $7B of cash to spend on R&D — a significant moat for its competitive advantage, given it only spent $2.8B on research and development in 2018. Given the tough semiconductor/memory environment and tough competition, it may make sense for MU to increase its R&D expenses to protect itself even further. ? Demand, however, should grow as the development of virtual reality, cloud storage, and machine learning expand, as Micron provides a significant amount of product for these memory-reliant industries. Investors, however, seem more worried about cyclical changes in memory pricing, rather than long term sustained growth in demand.

Even if we modeled a 10% decrease in memory prices, a stagnant market share, poor worldwide RAM demand (15% total growth from 2018 to 2025), and flat margins, we would still expect a $45 price target on the stock (given a discounted cash flow analysis, performed by Trefis).. This case incorporates very conservative inputs. A more realistic case, however, incorporates declining memory prices, a continued trend of increasing market share (given rising R&D investments from its strong cash position) at slower rates to 40% in 2025 (from 35% in 2018), and 20% total growth in the DRAM market until 2025. This points to a price target of $60, or 80% upside from its $33 price.

Micron will be announcing earnings after the bell on December 18th. If it addresses the state of its business environment — the memory market — by either pointing to improvements in the market or MU’s adaptation to the price/demand pitfalls, investors may feel relieved. Rather than focusing on the short term cyclical pricing of memory, value investors should use MU as a cheap vehicle to profit from the expanding memory market. Micron’s stock price is like a loaded slingshot, pointed up. With little downside left after a 50% decline and a catalyst earnings call, it would be hard for a disappointing news to depress the stock even more. As the third largest player in a market that naturally expands with the growth of technology, in addition to a prime financial position and an oversold price (with an RSI of 40) investors should find peace in the $45-50 range within the next 6 months.