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Investors Big Bets in Pandora Pay Off

Posted on November 6th, 2018

Pandora Media, Inc. (P) stock has soared by nearly 70% in 2018. In the middle of September Sirius XM Holdings, Inc. (SIRI)  announced it would buy the streaming music company for $3.5 billion in an all-stock transaction.

Whale Wisdom added Pandora’s stock to the WhaleWisdom 100 Index on August 15. That was when 13F filings revealed that institutional investors were purchasing the shares of Pandora during the second quarter of 2018.  Over the past year, the WhaleWisdom 100 Index has increased by nearly 10% almost double the pace of the S&P 500.

Investors Big Bets

During the second quarter institutions increased the number of total 13F shares held by nearly 2% to 268.1 million shares. During the quarter 42 institutions started new positions in the stocks, while 65 added to existing holdings. Additionally, 52 institutions exited, while 69 reduced their stakes. Immediately following the announcement of the deal shares of Pandora rose by 26% in September. However, the steep stock market sell-off has caused both Sirius and Pandora to plunge in the following weeks, with Pandora dropping by 19% from its highs, while Sirius has fallen by 21%. The all-stock nature of the deal makes the premium Sirius is paying for Pandora a risky bet at this point for new investors.

Rumors Swirl

It would seem to be the case that many of these institutions moved into Pandora in anticipation of the company getting purchased. It also makes it highly likely that many have already started to sell their shares. Anticipation for a deal had been building for some time and widely speculated over the past two years. It was in June of 2017 that Sirius took a 20% stake in the company for $480 million. It was in December of 2016 rumors that the two company might come together started to swirl.

Facing the Competition

The idea of bringing Sirius and Pandora together would make sense, especially during an age of rising streaming media rival services such as Apple, Inc. (AAPL) and Spotify SA (SPOT). Pandora is expected to operate as a wholly owned subsidiary of Sirius. The two brands will then be able to cross-promote and drive advertising revenue additionally for the newly combined companies.

Institutional Investors, in this case, saw the potential for a deal between the two companies.  Now that deal has been announced; it should be interesting to see if these same institutions sold on the news.

Mellanox Technologies Ltd.’s (MLNX) stock has been on a bull run over the past year. The shares have more than doubled, easily beating the S&P 500’s return of 6%. The strong performance is a result of the company’s ability to gain market share with its high-speed Ethernet adaptors, switches, and cables. It has led analysts to boost their earnings and revenue outlooks for the company over the course of 2018.

Hedge Funds have taken notice of the significant earnings and revenue growth the company is reporting. During the second quarter hedge funds were aggressively increasing their positions in the stock. It was also added to the Whale Wisdom WhaleIndex 100 on August 15 and has risen 11% since the addition. Meanwhile, during that time the S&P 500 has fallen 3%, while the iShares PHLX Semiconductor Index Fund (SOXX) has dropped 7%.

Adding to Holdings

During the second quarter, hedge funds were adding to their holdings in the stock, increasing the number of total 13F shares 16% to 14.35 million shares. 19 hedge funds created new positions, while 20 funds added to existing ones. Meanwhile, only five holders exited, while 13 reduced their stakes.  The number of total institutions owning the stock increased 1%.

Strong Results

The company delivered strong second quarter results with earnings beating estimates by 15% while revenue was 2% higher than estimates. Third quarter profits were 11% higher than forecast while sales were 1% better.


Big Expectations

The strong results have prompted analysts to boost full-year earnings and revenue estimates. Now analysts estimate that earnings will more than double in 2018, up from the previous forecasts for growth of 41% at the beginning of the year. Additionally, analysts expect that earnings will grow at a  compounded annual growth rate of 43% through the year 2020 to $6.70 per share.  Revenue is projected to grow at a compounded annual growth rate of 16% through 2020 to $1.4 billion.  It makes the stock relatively cheap trading with a 2019 PE ratio of 15, and a PEG ratio of just 0.34 when considering the three-year estimated compounded earnings growth rate.

Analysts are very bullish on the name as well, and see the stock rising 21% from its current price of $88.42, to an average price target of $107.33. Of the 14 analysts that cover the stock, 79% rate it a buy or outperform, while 21% rate the shares a hold.

The strong earnings and revenue growth are driving the shares of the chip company higher. Should they continue to rise, then the stock may still have much higher to climb.

Illinois Tool Works, Inc’s (ITW) stock has increased by 58% over the past five years beating out the S&P 500’s rise of 51%. Including dividends, Illinois Tool Works has been able to climb by 76% compared to the S&P 500 Total Return Index rise of 68%.  However, the shares have fallen on hard times recently, dropping by 30% from their January 2018 highs.

Unfortunately, most of the stocks increase over the past five years has come on a rising PE ratio, also known as multiple expansion. Despite, the company posting stable revenue over the past five years,  there has been no growth.  There is a silver lining because the shares are now trading at their lowest valuation since 2015. It makes now an ideal time for new investors to start a position in the stock. Meanwhile, the heightened volatility in the market may make writing calls ideal for existing holders.

Stable Revenue but No Growth

Over the past 5-years -on a trailing-twelve-month basis,  revenue has increased by 5% to $14.8 billion through the third quarter of 2018. Analysts forecast revenue to grow by a compounded annual growth rate of 2.6% through the year 2020 to $15.5 billion. However, despite the stable revenue stream,  analysts have cut their estimates since July by 3% for 2019 and 2020. The downward revisions come after the company reported weak third-quarter results with revenue missing forecast by 3%.

Valuation Low

Analysts estimate that earnings will grow by 15% in 2018 to $7.60. However, that growth is expected to slow in 2019 and 2020 to just 6% each year. Earnings are estimated to rise to $8.12 per share in 2019 and $8.63 per share in 2020.

With the stock trading well below its previous highs, the valuation has come down considerably. Since 2015 the shares have traded with a one year forward PE ratio in a range of 13.8 to 23. Now, the stock is trading at 15.3, its lowest valuation since 2016.

When considering the company’s compounded annual earnings growth rate, the stock trades with a PEG ratio of 1.6, putting it on the upper end of reasonably valued. Additionally, when compared to its peers such as Honeywell International, Inc. (HON), Dover Corp. (DOV), and Stanley Black & Decker Inc. (SWK) the stock appears to be reasonably valued as well.

Rising Dividend, Attractive Yield

The dividend has increased by more than 138% over the past five years to a $1.00 per quarter. Meanwhile, given the sharp decline in the stock, the dividend yield has increased to 2.7%. That is nearly 90 basis points greater than the SPDR S&P 500 ETF (SPY) – a proxy for the S&P 500 index. Since 2014 the company’s dividend yield has been in a range of 1.6% to 2.7%.

Options Present Opportunities

The options in the stock are currently attractive especially given the heightened level of volatility in the stock market in recent weeks. Implied volatility levels for the options expiring on March 15, 2019, are at 28%, which is higher than the S&P 500’s level of 17% for the same expiration date. The heighten volatility levels help to make the vale one would get for writing – also known as selling,  a call option greater.

The long straddle options strategy suggests that the stock rises or falls by roughly 12% from the $125 strike price. It places the stock in a trading range of $110 to $140 by the expiration date. It makes the current $140 calls for the March expiration attractive to write. It allows the seller of the calls to collect a premium of $1.40 per contract. For example, a shareholder that owns 100 shares of the stock could sell one call contract at that strike price and collect $140, which equates to a return of about 1.1%.

Technical Weakness

The chart shows that stock is now trading well off its highs and is the midst of a sharp downtrend. It is currently sitting at a technical support level of around $121. Should it fall below that support level it could decline to $110.77 an additional decline of 11% from its current price of $124.10.  Unless the shares can rise above that downtrend and technical resistance at $136, the risk remains to the downside.  It makes writing the $140 March calls attractive.

Analysts Are Negative

Analysts have slashed their price target on the stock by 21% since the beginning of April. However, they still, forecast the shares to rise to by 13% to an average price target of $140.25. Of the 22 analysts that cover the shares,  23% have a buy or outperform rating, 73% have a hold rating, and 5% have a sell rating.

Since the company’s disappointing results some analysts have downgraded the stock and lowered their price targets. For example, Wells Fargo reduced their price target to $145 from $150, noting that revenue for the company was even weaker than expected. Additionally, Seaport Global downgraded the stock to a neutral from a buy and cut its price target to $132 from $170. The firm noted that Illinois Tool was hurt by pockets of slowing international end markets and slower international auto production.

For those that already own the stock, the best choice may be to stay the course, collect the dividend, and perhaps write call options when opportunities present themselves. For those looking to get into the stock, the shares are currently trading a low valuation both historical and versus its peers. Despite the current weakness and risk for further declines, with a long enough time frame now might still be a relatively good time to start a position, while trying to buy additional shares should the price continue to fall.

Alkermes PLC.’s (ALKS) stock has fallen by 21% in 2018 easily underperform the S&P 500 which has a gain of 4%. However, the next few weeks may prove to be pivotal for the company. The company is due to go in front of an FDA advisory panel seeking FDA approval for its depression drug.

Amazingly, the top 7 shareholders of Alkermes stock own nearly 75% of this company. What is even more interesting is that Hedge Funds were fleeing the stock during the second quarter, while a few of these vast holders were adding to their position.

Concentrated Owners

Perhaps more impressive is the shareholder list which consists of Primecap Management Co. and FMR LLC (Fidelity) owning 30% of the company. That is followed by Wellington Management Group and T.Rowe Price which own an additional 25%. The smaller three institutions hold about 21% of the shares.

During the second quarter, a few of these institutions were adding to their existing positions. For example, T. Rowe Price increased its stake by 1.7 million shares bringing its total holdings to 18.7 million shares.


Hedge Funds Bail

During the second quarter, the number of a total number of 13F  shares among hedge funds fell by 35% to 3.3 million. During that time about 15 funds created or added to their positions. Meanwhile, 21 funds reduced or closed their holdings. However, overall institutions were relatively unchanged during the quarter falling by less than 1% to 157.2 million total 13F shares.

30% Rise

Analysts see the stock rising by 30% to an average price target of $52.50. However, that price target has fallen since June by 5%. One reason analysts see the shares rising is that they forecast revenue growing by 35% through the year 2020 to $1.2 billion. Meanwhile, earnings estimates call for $1.16 per share in 2020 up from $0.09 in 2018.

Upping Estimates

The good news is that analysts have increased their earnings estimates for the company. For example, since June analysts have raised their 2019 earnings estimates by more than 34% to $0.61 from $0.46.

Perhaps these few large shareholders see something more significant in Alkermes and its future then what analysts currently forecast. It is undoubtedly attention-grabbing when some of the biggest institutional investors own such a considerable amount of one company. Perhaps, the next few weeks will shed some light on the future of the company and why these big players own such a large stake.

This past week Bill Ackman’s Pershing Square revealed at the Grant’s Fall Conference a 1.1% stake in Starbucks Corp. (SBUX). However, the hedge fund’s performance has been less than inspiring in recent years with big flops along the way.

Taking a closer look at the fund’s performance since 2006 one may have been better off investing in the S&P 500 total return index which has outperformed the billionaire investor.

Big Bets

Bill Ackman is known for taking large concentrated bets in his portfolio. Currently, WhaleWisdom values his portfolio at roughly $5.8 billion as of June 30.  In total the portfolio only holds eight stocks, not including Starbucks. With its largest position being Automatic Data Processing Inc. (ADP) at a total value of $3 billion which is a massive bet at nearly 50% of the portfolio’s asset under management.

Big Rise, Big Fall

However, that doesn’t tell the whole tale of the fund’s rise and fall. In the fourth quarter of 2005 the fund’s portfolio was valued at $365 million and by the fourth quarter of 2014, it had grown into a $16 billion behemoth. It all changed quickly when investments such as Valeant – now Bausch Health Companies Inc. (BHC), went sour reducing the fund to its current value.

Uninspiring Returns

Since the second quarter of 2006 Pershing Square has had a total return of approximately 182% compared to the S&P 500 total return index of 186%.  What may be even worse, over the past three years Pershing has an Alpha of -1.35, which is a measure of the excess value generated by the portfolio against a benchmark. Additionally, the fund has had an annualized performance over the past three years of -2.32%.

Starbucks is a Struggling Company

Given the recent string of bad luck, it doesn’t make Ackman’s investment in Starbucks a slam dunk at all. Starbucks has struggled significantly over the last few years as same-store comparables in North America have slowed considerably. As a result, analysts estimate that revenue growth for the company will slow from 10% in fiscal 2018 to just 6% in fiscal 2019. Earnings growth is expected to slow from 16% in 2018 to only 10% in 2019.

Pershing is betting that growth for the company will accelerate because at its current valuation the shares are trading at 19 times fiscal 2020 earnings estimates of $3.00 per share. However, even in the year, 2020 analysts estimate growth of 14% which gives the stock a growth adjusted PEG ratio of 1.35 making the stock fairly valued at best.

Betting that the shares of Starbucks will rise because of Pershing’s investment make it a risky gamble.