Thursday, August 17, 2017

The Cheapest FANG Stock You Never Heard Of


Tired of overthinking and overpaying for the modern growth phenomena that is FANG? Afraid the next tech wreck will wreck your portfolio? Don't want to be at the mercy of a FANG member hiccup in results at these high multiples? There are FANG support stocks that are levered to this growth beast, but about all of them are well known and suffer the same over-buzzed and over-owned problems as the Fab Four. Well if you want a new, hot performing, very under-the-radar, pick-and-shovel play for FANG that's been around for over 20 years with no debt and no dilution, keep reading. It has been growing results faster than any of the FANG members the last three years, and is currently at a 1.6 multiple on sales, a 3.9 multiple on cash flow, and a TTM PE of 4.

I speak of Network-1 Technologies, Inc. (NTIP) and they chase no subscriber base, have no cost of advertising (which is one reason you've never heard of them) and have been turning roughly half their sales into EBITDA. You see, the big players (Samsung, Google, Facebook, Apple, et al) come to them for permission to play. They are a tiny $100 million market cap David that owns a wide assortment critical patents at the heart of every Goliath Amazon and Amazon want-to-be.

The Long History Of This Company

They didn't start out doing patents. They were formed in 1990 selling "prepackaged software" as their SEC business classification stated, mainly security firewalls under the name "Network-1 Security Solutions" with the ticker NSSI, going public in 1998. They are still listed by the SEC as "prepackaged software" but they are into a whole new thing business-wise.

In April, 2004 reporting 2003 results, they stated the change in focus of the company:
Network-1 discontinued its software product offering in December 2002. In November 2003 Network-1 commenced a new business consisting of the acquisition, development, licensing and protection of its intellectual property which currently consists of a portfolio of telecommunications and data networking patents. In February 2004, the Company initiated its licensing efforts relating to its patent (U.S. Patent No. 6,218,930) covering the remote delivery of power over Ethernet cables (the "Remote Power Patent"). 
Al Gore's claim about inventing the internet comes to mind, only these guys can actually claim a facsimile of that honor. So what about this pipe dream of a tiny band of highwaymen erecting a toll booth to collect patent usage bounty from FANG?  How has this worked out in real life?


There was a 2000% rise in the stock after the business model switch. But to be fair, it was from 2003, when the dot bomb had flattened the stock to near zero. As security software peddlers, their results were consistently pathetic, typically loosing over five times their sales in loss from continuing operations.

So the math had to be impressive if they just survived, and they did. What strikes me about this chart is that, after the gleam in speculators' eyes went away in 2000, the stock went into a 15 year base, and even with results now that are what the internet speculators were dreaming of in 2000 without a dime of cash flow, the stock is just barely poking its nose out of the base with a PE of 4 with no fan far. But the base breakage is accompanied by a massive increase in volume, and the ownership appears to be extremely stronghanded as evidenced by the near zero reaction by the stock to the sharp, broad selloff of early 2016. All this suggests there is much more to come.

It's also interesting in this chart that the company seemed to know that much better things would be happening soon in 2011, when they initiated their stock buyback program, and again 2014, when they uplisted their stock from OTCBB to the NYSE.

The Genius Behind The Big Change - Corey M. Horowitz

Horowitz was Chairman of the Board starting in 1996 before becoming CEO with the new vision. The November, 2003 launch of the patent business coincides with the December, 2003 start of the role of a this legal genius as CEO. He is the guiding inspiration for spotting the key patents, working deals with the inventors to monetize their work on the big stage with royalties to the inventors and licensing revenue from the big fish. It's like Shark Tank in reverse with the sharks being in the hot seat. I say "legal genius" not because he has a law degree, but because his gang, consisting of a handful employees, has been drawing the likes of Apple, Cisco, and Google, with their armies of lawyers, into court to get patent rights squared away - and winning. Legal fees are a big expense for the company. In Bloomberg's profile of Horowitz, they allude to his talent:
Mr. Horowitz was an early stage investor in Network 1 and helped transform that company into an award-winning distributed firewall vendor prior to its being taken public in 1998 ...  In 2003, as Chairman, Mr. Horowitz supervised the winding down of operations, sale of the product suite and the development of alternative business opportunities. Since 2004, he served as the Chief Executive Officer and transformed the company into a business specializing in the licensing and enforcement of intellectual property, resulting in a 25 fold appreciation in its stock price
Horowitz puts his money where his genius is, owning roughly a third of the shares. I like it when founding individuals own this kind of interest.

You can find almost nothing written or said about this company. Jeff Marston did a nice article at Seeking Alpha back in March, "Network-1 Technologies: Catalysts On The Horizon" where he explains the patent portfolio status.  And an earlier PRO article by Tom Shaughnessy from March, 2015 "Network-1 Techologies: An Undiscovered Cash Rich Company ..." discusses the patents. In lieu of the debt or dilution you'd fear with a 'net nanocap, this outfit had, as of March, 2015, laid claim to about $12 M in share buybacks on a market cap of $56M.  That's 21% of the company grabbed by the company. They now have roughly $50 M in cash and a current ratio of 22. As Shaughnessy stated:
NTIP is a uniquely financially strong microcap company which positively differentiates it from other microcaps in the space.
Is this the same company that was losing over five times their sales and needing over $40 M in paid in capital to survive in the tech boom? I think they've made a wise change in direction.  It's not that this patent brokering thing is NTIP's invention. As Marston points out, there are others doing a similar thing: RPC Corp. (RPXC) Acacia Research Corp. (ACTG) Wi-Lan Inc. (WILN) and Marathon Patent Group Inc. (MARA). But they all have had negative or spotty results with it. They just don't seem to have the flare for this sort of thing that NTIP's Horowitz has.

The Challenging World Of Patent Litigation

How these court cases turn out is very topsy turvy and are a constant battle against the expiration of the patents. The Remote Power Patent that currently has a yearly revenue stream coming to NTIP from Cisco and others expires in 2020. But expirations don't necessarily mean no revenue. For example, there is the case of the Mirror Worlds patents. In 2013, NTIP bought some patents from this company that Apple was infringing on. This was after Mirror Worlds took Apple to court and lost. Steve Jobs realized the value of these patents, saying in a Supreme Court document:
"It may be something for our future, and we may want to secure a license ASAP".  Steve Jobs stated this after seeing a New York Times article that praised Mirror Worlds' new Scopeware product. Scopeware is Dr. Gelernter's (founder of Mirror Worlds) invention for a "document stream operating system and method".
Horowitz bought the patents and got a $25 M settlement from Apple last year even though the patent had just expired. It was more of a penalty awarded by the court for Apple's infringement in the past.
These retroactive awards can apply to patents in general. From Shaughnessy's article:
The Remote Power Patent's royalties are providing a viable stream of revenue, but they can grow. For example, there are 11 infringers who have the potential to owe back damages and future royalty payments. 
NTIP can't rest on their laurels of impressive court wins (batting 1.000 so far) because patents expire and many court wins are one time settlements. They must keep a stream of license revenue and court awards coming, and they seem to be about that with actions beginning with Google and Facebook. But the future of NTIP's revenue is far from an open and shut case. The major risk with this company is the changing legal landscape for IP (Intellectual property) litigation. No one is more aware of that than Horowitz himself.

In a 2015 interview with "The Patent Investor" Horowitz predicted the massive surge in NTIP's results the following two years, but revealed some angst over the future of this patent business model:
“In the next two years, we’re going to wind up with a lot of cash on our balance sheet and then we’ll have to decide what to do next.”
For his part, Horowitz said whether he makes additional patent portfolio purchases will depend on whether the patent market gets better.
Over the past 10 years, patent holder rights have been steadily eroded by a series of court rulings that have taken away injunctive relief, reduced damages and done away with software as a patentable subject matter. In addition, the America Invents Act also established the IPR and CBM review process to give infringers an inexpensive and time-saving tool to invalidate weak patents.
“Patent holder rights have been eviscerated over the past few years and innovation in this country’s been harmed. Ambulance chasers ruined it. I’m negative on the patent business because the game keeps changing, the rules keep changing. That’s not a business for a public company.”

What Is The Attitude Of Horowitz Now, Two Years Later?

Since that discouraging word from Horowitz, the court wins have continued for Network-1, and there seems to be debate around the pendulum swinging back to patent holder rights as conveyed in this coverage of the 2016 NPE conference, attended by Horowitz:
The prevailing mood among the CEOs set a particularly sombre tone for the rest of the event. It was by no means shared by all panelists and delegates (which this blog will follow up on tomorrow), but it did contradict the claims that the pendulum is starting to swing back to stronger patent rights in the US.

As one delegate put it: “The talk at last year’s event was about turning a corner, well it’s proving to be a pretty long corner.” The reality is that while the licensing climate might be improving for some patent owners, for many NPEs it remains very challenging. If the pendulum is moving back towards the centre, it’s not taking everyone with it.
If frivolous lawsuit squashing vs patent rights is indeed a pendulum in history, we seem to be coming off a swing to the squashing, anti-patent end, a swing in which Network-1 has managed to make big hay anyway. The America Invents Act that went into effect in 2013 is generally seen as making life harder for the small inventor. The main reason for this is that it changes patent rights from first-to-invent to first-to-file. Before 2013, if you filed for a patent, someone could come along later claiming they came up with the idea first, thoroughly prove it with documentation, and steal your patent. After 2013, a patent is yours if you filed it first. This puts a lot of pressure on inventors to file before they're ready or before they pay for attorneys, giving a big advantage to bigger companies over lone wolf inventors.

To further aggravate patent rights, the US Supreme Court ruled just this May that patent court cases must be held in the district where the alleged infringement took place. This basically scatters cases away from the knowledgeable patent "specialists" of the Eastern Texas District, where some 39% of all patent cases are held and strong patent rights can be expected.

This would all seem to hurt NTIP until you think about it a little. The 2013 Act actually makes the Network-1 portfolio safer since they deal mainly with filed patents which they have paid for. The new laws prevent any of these patents from being stolen from them. It just makes it harder for those filing. Though they have been filing some patents lately with Professor Ingemar Cox as a consultant to Network-1, they are not in the business of trying to get things filed. And when they do file, they enjoy the advantages a cash rich company has over the others. As for the case location issue, Marston discusses this in his article, "What The Recent Supreme Court Decision Means For Network-1 Technologies". He points out that Network-1 has been filing in other districts, besides Eastern Texas, and they don't file a lot of frivolous lawsuits like a "patent troll" outfit does with a shotgun approach. Network-1 takes more of a smart bomb approach, doesn't go to court with weak patents and wins in any proper court.

Despite his moaning about eroding patent holder rights cited above from 2015, Horowitz is now very bullish on his stock. He still owns 33% of the shares and had this to say in a December, 2015 interview at The IP Dealmakers Forum:
“We are buying back our stock because we think it is attractive,” Horowitz said. “I have at least one trial, maybe two trials… I’m very optimistic about the next two to three years.”
He has since launched into some new litigation. And the company's rabid confidence as expressed by its stock repurchase program, initiated with $2 M worth in late 2011, continues unabated. In June, 2015, they announced another $2 M worth of approved buybacks with Horowtiz saying:
"We are pleased to announce another increase to our repurchase program to benefit shareholders at a time when we believe our stock is undervalued," said Corey M. Horowitz, Chairman and CEO of Network-1. "This, our fourth increase of our share repurchase program, reflects our confidence in the long-term potential for Network-1 and our commitment to increasing shareholder value," he added.
But he has gotten much bolder with the buybacks since then. In June, 2017, they announced another $5 M worth approved:
"We are pleased to announce another increase to our Share Repurchase Program to benefit shareholders at a time when we believe our stock is undervalued," said Corey M. Horowitz, Chairman and CEO of Network-1. "This, our fifth increase of our Share Repurchase Program, reflects our confidence in the long-term potential for Network-1 and our commitment to increasing shareholder value," he added.
This grab is aggressive:
permitting the Company to repurchase up to $5,000,000 of shares of its common stock over the next two years (for a total authorization since inception of the program of approximately $17,000,000). To date, the Company has repurchased an aggregate of 7,104,711 shares of its common stock under the Share Repurchase Program since inception of the program in August 2011 at an average price of $1.72 per share or an aggregate cost of approximately $12,214,110 (exclusive of commissions).
All this is on a market cap of just $98 M. They have bought 7.1 M shares compared to a present mutual fund ownership of 5.7 M shares (Morningstar figures). These are all huge numbers compared to a public float of only about 14 M shares. That's ultra piggish. It's almost like you're allowed to buy a private equity company while it's being made over for public consumption. If funds become very interested, it will move the stock needle. The company has been very right with their buyback buying since 2011 when their patent results began springing to life. Now they are more aggressive then ever in these buybacks. As Shaughnessy said in his article from 2015, before the massive $5 M increase this year:
We would be hard pressed to find a microcap company of this size with a comparable repurchase program.

The Patents

I don't want to go into a detailed discussion of all the patents here. Marston and Shaughnessy cover this in their articles linked above, and there is a very nice rundown of the patents on Network-1's website with up-to-date timelines on them. They presently own 28 altogether. I will however summarize the collection. These can be grouped into four batches - Power over Ethernet, Mirror Worlds, Content Monetization, and QoS.

Power over Ethernet  More commonly known as the Remote Power Patent, this is a technique where internet flows can be safely put over standard LAN lines in a local network without harming devices not able to take signal.  It has been subject to three litigations and has contributed $100 M in revenue from over 20 licencees. It expires in 2020. This summary suggests more revenue may be due once the rest of the defendents are found guilty:
So that means Network-1 has now reached settlement and license agreements with twelve of the original sixteen defendants for the licensing of its Remote Power Patent. The remaining four defendants are Avaya Inc., AXIS Communications Inc., Hewlett-Packard Company, and Juniper Networks, Inc. The litigation is currently scheduled for trial in 2017.
The patent was invented by Boris Katzenberg, who was active in the IEEE Task Force that developed the second generation Power Over Ethernet standard.

Mirror Worlds  This small company patented "technologies that enable unified search and indexing, displaying, and archiving of documents in a computer system" resulting from work in the mid 1990s (before the internet) and were later widely used in web based systems. Mirror Worlds took Apple to court and won a $208 M verdict that was not awarded due to a procedural technicality. Per Network-1's website, "Working with Dr. Gelernter, Network-1 acquired the Mirror Worlds portfolio in May 2013. Network-1 believed that under the facts of the previous case, Apple still was obligated to pursue a fair licensing agreement. Network-1 filed a patent infringement action against Apple and Microsoft on May 23, 2013." Last year, they won a $25 M settlement from Apple and $5 from Microsoft.  On May 10, 2017, Mirror Worlds, now a wholly owned subsidiary of Network-1, announced commencement of litigation against Facebook.

The patent was invented by Professor David Gelernter. He wrote a popular book titled Mirror Worlds: or the Day Software Puts the Universe in a Shoebox in 1991. It was a look into the coming of the internet. The above Facebook announcement from marketwired.com noted just how prescient Gelernter was with his amazing book:
As reported in The Economist, "Dr. Gelernter foresaw how computers would be woven into the fabric of everyday life. In his book 'Mirror Worlds,' published in 1991, he accurately described websites, blogging, virtual reality, streaming video, tablet computers, e-books, search engines and internet telephony. More importantly, he anticipated the consequences all this would have on the nature of social interaction, describing distributed online communities that work just as Facebook and Twitter do today."
Content Monetization  Otherwise know as the Cox patents, they were "12 issued patents that relate to identifying or tagging uploaded media content and taking business actions based on the identification" as the website puts it. In 2013 Network-1 bought the patents and is filing for more based on the original patents. In 2014, they began proceedings against Google, specifically against their subsidiary, YouTube, alleging they use this technology without a license. One has to wonder how many more are using it. In June, 2016, the Patent Trial and Appeals Board upheld the patentability of 119 of the 129 claims. Another objection raised by YouTube, Covered Business Method, was reviewed and ruled in favor of Network-1 in October, 2016.

These patents were invented by Professor Ingemar Cox from the University of Copenhagen. He was at Bell Labs and NEC Research Institute, holding over 40 US patents.

QoS  Then there are some "QoS" (Quality of Service) patents they've stashed away and are holding close to the vest for now.

Conclusion

There were several IP companies present at the IP Dealmakers Forum mentioned above, and they agreed that they shouldn't be judged like most companies by quarterly results as patent cases are not a smooth ride. It is difficult, in fact pointless, to project court awards into revenue. But judging from the "near miss" $208 M judgment scuttled by a technicality in one of the cases above, there appears to be even bigger money to be made with these internet defining patents than what Network-1 has done so far. The stock is not pricing any of this in. It is a fascinating speculation with a PE of 4. Network-1 keeps making precision forays into court and bringing home the bacon to inventors and shareholders.

Sunday, June 25, 2017

What Does The Swooning Commodity Index Of 2017 Mean For Gold Miners ?

If you haven't noticed, commodities are diving badly this year:


Commodities are consumed by a healthy economy, and dives like this can come before overall downturns. Gold is a commodity that historically is thought to be correlated with the CRB Index. Commodities soared along with gold in the 1970s as capital flowed into hard assets, away from a bad economy. This is all very confusing. So does the bad CRB behavior of late bode ill for gold and the miners now?

Well, if you compare gold and the CRB index over various time frames, you see a somewhat loose correlation. Sometimes they move together, sometimes they don't. But there is one thing the CRB is correlated with much more than gold, and that's oil.


Here we see a broader two year view of the CRB and oil and they look like the very same chart. Since the 2005 massive revision to the CRB index, it mainly does whatever oil does. This oil correlation of the CRB is much tighter than with gold or anything else. The energy complex is about 40% of raw index weighting, but because of the new arithmetic averaging, and oil being much more volatile than most other index components, the CRB winds up being pretty much just the oil chart.

So the real question is "What does swooning oil mean for gold miners? If we look at the year 2001, we have a comparable period where the CRB, much less slaved to oil back then, was also diving like it is this year, and the price of gold wasn't doing much:


Even back then, they were essentially the same chart. Did the gold miners, lacking any clear guidance from the gold price, follow the horrible CRB chart back then?:


Not really. Here, the miners as represented by the HUI index, did not have a bad year with the commodity dive. The gold price ended the year about right where it started, yet the gold miners did a stunning 60% return. And oil, not gold, was probably a big reason why. Gold mines are some of the biggest energy hogs on earth and when oil goes down, gold mining profits go up. You can't be quite that simplistic as gold stocks have a way of anticipating what the prices of both their product and their inputs are going to be. The gold price was beginning its long ascent the next year in 2002 and the stocks were perhaps getting wind of that. And they seemed to be a few months ahead of oil as well. But by and large, other things being equal, gold mining has a strong inverse relation with oil.

When thinking about the energy costs of gold mining, you first consider the monster trucks, bigger than your house, that carry the ore at 0.3 mpg. This is a big part of it as this article shows, giving us this chart of the climbing diesel use for the top five gold miners:


Because the higher ore grades are mined first, the declining grades mean much more rock processed to produce the same amount of gold. This has run diesel usage to a 100% increase the last 10 years producing about the same amount of gold. But the trucking is just a part of overall energy usage. Overall, gold mining is the second most energy intensive product in the world as this British engineering report shows:

Gold is literally off the charts as the arrow points to on this log scale (9000 pound sterling/kg and 6000 Megajoules/kg) and that makes sense when you consider that, as they explain:
Gold is a precious metal which can be sold for a very high price; this means that more energy can be spent in extracting it by mining rocks containing only a small fraction of gold
So they can tolerate a whole bunch of digging and energy use. This is why gold miners typically have total energy cost run roughly a third of their total cost of operation, their biggest single expense. If gold is the second most energy intensive, what is #1? It's diamond mining with many times the energy usage of gold.

Also in the expensive quarter of the above graph is all the metals that makeup the miner's massive equipment. A big chunk of what they don't spend on energy goes to buy and maintain their monster machines. Deflation is good for gold miners. Either inflation or deflation can accompany gold miner climbs as long as currency-in-the-bank is being threatened, as I discussed here. This was the case in the 1920s and '30s when the price of everything went way down, banks failed at record rates, and the gold miners were in massive climbs, both before and after the stock market crash.

As I've written before several times, I think oil will stay moderately priced ($40-$60) for a couple years at least as the shale overcapacity is gradually worked off. Gold miners did exceedingly well in gold's run to $1900 in 2011 on $100 plus oil. If we get a next bull phase for the gold price, they could do vastly better on oil at half that price. That's exactly what happened in last year's mini run up in gold. In 2009-2011, gold climbed 110% with the HUI doing 100%. In 2016, gold climbed just 28%, but the HUI blitzed for 155%. Gold CEOs will be cheering for the "horrible" CRB charts shown above and shale will be the gold miners' new best friend.

Saturday, June 17, 2017

Fed Rate Hikes - The Best Algorithm For Predicting Gold Upside

As nearly the whole world knows, higher interest rates are gold investing's worst enemy. As Warren Buffett has explained, gold is something where we pay to dig it up, we pay to put it away, we pay people to stand around and guard it, and all the while it produces no goods, pays us no dividend or gives us any interest. Well, Warren, if you take the trouble to closely examine the history of Federal Reserve raises in interest rates and gold, you got some more 'splainin to do!

If you look at what happened in the 1970's gold bull market, you see that the more gold had to compete with interest bearing investment, the better it did. In fact, there was a very close, positive correlation between the two:



These were the most extreme US interest rates of all time running to well over 10% and dwarfing our current numbers. Yet they did not kill the gold bull back then. Indeed, they seemingly waved a red cape in its face.

The 70s rate cycle was not an isolated case in its correlation with gold.  Adam Hamilton presents a detailed history of this in his article this week. He notes:
Before today’s rate-hike cycle was born in mid-December 2015, the Fed had executed fully 11 rate-hike cycles since 1971. Those are defined as 3 or more consecutive FFR increases by the FOMC with no interrupting decreases. Our current rate-hike cycle to which the Fed added a fourth hike this week is the 12th of the modern era, certainly nothing new. So there’s a substantial rate-hike dataset to evaluate gold’s action.
He notes that the average reaction of gold during all 11 previous rate ramp-ups is a climb of 27% including the most recent cycle (2004 - 2006) where rates were aggressively quintupled and gold reacted with a 50% climb over that time. If you are an investor with the mindset that rising rates is a reason to sell or avoid gold, you need to read Adam's article. He points out that our present rate hike cycle is playing out as in the past:

If you look at the four rate raises so far in our current cycle, we see that you are hard pressed to find a guru or algo that predicts gold climbs any better. If you were a newsletter with this track record, you could sell a zillion subscriptions. Note that the arrows all fall on an ascending trend since the first one in late 2015. As the above chart shows, there is typically a decline in gold leading into a much talked about FOMC meeting where everyone has come to expect a rate increase. This weakness also lasts a couple weeks or so after the fact, then a vigorous climb ensues.

Because we have just had a rate increase June 14, that would schedule our current gold weakness into July, which also agrees with many wave counters and technical analysts who are saying July/August is going to be a major bottom. It also agrees with the simple up-trending channel in the above chart that would put a visit to the bottom at about $1220-$1240, probably in July/August. It also agrees quite nicely with my fractal argument presented here. But these rate hikes can also send gold straight into a tizzy as it did the last time in March. So waiting for a bottom could leave you chasing any new exposure you want.

But why would gold, with no interest return and even a cost of storage for physical ownership, behave in such a counter-intuitive way? Is this just to punish investors who try to think logically, Mr. Market's specialty? Hamilton makes the point that these rate changes are well telegraphed. The Fed doesn't like to roil markets, so they don't like to move unless at least 70% in the polling expect them to. So you could have a longer term fundamental working in the background pressuring gold higher while the buy-the-rumor-sell-the-news effect works in the short-term around the Fed meetings.

What could that longer term fundamental be? Well, I don't really know with any certainty. But I suspect it is the age old thing about gold being an alternative currency. Fed rate raising cycles always come after they have done some kind of financial rigging, and that always somehow lessens the soundness of the dollar. It also undermines the natural viability of the economy.

As I discussed in "Fractal And Fundamental Gurus Agreeing On A Gold Mega-Bull" gold has a long history of going into bull phases, along with the stock market, years ahead of some calamity involving dollars in the bank. This was true in the 1920s when the banks were the problem, it was true in the 1960s when a gold decoupling with the dollar and double digit inflation approaching made the dollars the problem. And it is probably true now with some kind of dollars-in-the-bank problem approaching.

You can only speculate on what the gold market may be seeing. But with the European banks on shaky ground and linked to all banks no matter how healthy, you could say it's the banks. And with the dollar's soundness continuing its decay as the world's reserve currency, you could say it's the dollars. There are plenty of problems to choose from. Let's hope the problems are fixed before they get here. But a gold hedge would be in order in the mean time.

Tuesday, June 13, 2017

The FANG Gang Is Challenging The Ascending Wedge

As we all wonder what to do with the mini "tech wreck" that is upon us, it is helpful to step back and check the big technical picture of this group. The group could be defined as big cap growth, not necessarily tech, that has produced a handful of big growth superstars. These stock climbs will sometimes produce a technical condition known as the ascending wedge, which is bearish, and typically result in a trend change, either to a stagnation period or a protracted decline.

To illustrate, let's look at a good growth stock of the recent past that can seemingly do no wrong - Tractor Supply (TSCO), the specialty "recreational farming" supply retailer. If you have ever worked on a small farm like I have, you wonder why they call this "recreational". They have somehow escaped the Amazon squash with their results, but the stock went into a wedge and was squashed anyway:

What is especially bearish is when the A/D trend (upper graph) is broken in conjunction with a wedge. In TSCO's case the trend was blasted with the monster gap down move, and you had no chance to get out ahead of the damage. When this is more gradual, the warning should be heeded.

So where is the FANG gang in relation to the ascending wedge? Not in a good place:

Here we see Netflix earnestly tracing out a wedge, but the A/D trend is intact.

Google is also wedging but with no A/D problem. But stocks often break the wedge before they break the A/D trend, as TSCO did above.

An honorary FANG stock outside of tech is ULTA, the make-up and beauty supply growth beast. It is forming a wedge and also threatening an A/D breakdown as well.

Apple isn't forming a wedge, but it hasn't had much of a chance having broken out of a big downtrend just this year. But Facebook is:

And the leader of the gang:


Amazon's wedge is the most pressuring with a break imminent.  Does all this mean the FANG move is near an end? No, because ascending wedges do break to the upside as well. A case in point is Nvidia :

And another is Dave and Buster's:

But these are the exceptions, and it takes a lot of growth horsepower to break these to the upside, especially when they are proceeding at a valuation speed limit on a basic fundamental like their cash flow:

You can see from the above numbers (from Morningstar) that it took a jump to a 60 multiple on cash flow, not to mention the 13 on sales, for Nvidia to break its wedge to the upside, a rather extreme valuation for an established growth operation. Will all of FANG make this kind of jump? It's possible, but that would be a little crazy.

The large cap growth stocks are up against something of a valuation speed limit, and also up against a trend expiration limit as well. Big trends with wedge formations typically break up before they go over five years or so, and the FANG types are in wedges pushing about four years now.

If this sector does breakup into sideways or moderate declines, it will likely be in conjunction with market leadership rotation into the other good performing but neglected areas, like the financials, especially the quality growth regional banks, materials, and the other bull market sectors.

Wednesday, May 24, 2017

Fractal And Fundamental Gurus Agreeing On A Gold Mega-Bull

Back in early February, 2016,  I floated the screwball theory about gold following a fractal replication of the prior gold bull market of 1971-1980.  Fractal factors are best corroborated by sensible fundamentals, regular technicals, and respected opinion.  But the fractal things have an uncanny way of happening with or without the more proper analysis.  The markets do tend to "misbehave" as Mandelbrot, the founding father of fractal analysis, claimed in his classic book "The (Mis) Behavior of Markets".

My article of February 14, 2016 "Gold's Bull/Bear Status" explains this fractal view, and suggested a big move up in gold was beginning.  This did indeed happen as gold went from $1100 to $1370 in just four months, a 25% rise.  We've been consolidating that move, but as I showed here, the technicals now suggest a resumption of 2016's move.

I thought I was the only one noticing the two parabola progression going on in gold's behavior, with only a fractal pattern to explain it.  But I've found somebody saying the same exact thing, but from a purely fundamental perspective.  Luke Burgess gives a fundamental explanation here .  I doubt he has ever heard of the fractal explanation, but to summarize this, from my article:


As I showed in the article, many mega bull markets around the world have exhibited this basic pattern of two parabolas separated by a big downtrend.  It shows up a lot in big bull markets, especially involving currency and/or gold.  It is this same pattern that Luke Burgess discerns from the fundamental factors alone.  He derives this chart, which he claims we are repeating in our current gold market:


Before we look at his reasoning, just who is this Luke Burgess?  According to Streetwise Reports, he serves as investment director to two high-end investment advisory services, Underground Profits and Hard Money Millionaire.  He is a weekly contributor to Wealth Daily and has written for StockHouse and Goldseek.  He is a frequent guest on "Trader's Nation", "The Bill Meyer Show", and other radio programs.  He co-edits Gold World with Greg McCoach.  He was long gold until the summer of 2011, when he sold all gold stocks.  Then in October, 2015, very near the bottom of the four year decline, he went long again.  He has been playing this gold bull like a violin, so his opinion should be considered.  And his opinion is this.  The gold bull did not end in 2011 and is "going exactly as expected.  Investors simply can't see the forest for the trees" with the biggest part of the bull market still ahead.

The above chart is from his July, 2016 Wealth Daily article. His fundamental explanation for the 1970s gold bull market involves not wars, politics, catastrophe, recessions, or stock market declines, but gold as an alternative currency.  Stage One was when Nixon closed the convertibility of the USD into gold in 1971.  The dollar index declined by 25% from 1971 to 1973.  This was accompanied by the Great Recession One, the first global recession since WWII. Few today realize that this was about as bad as 2008.  The Dow was smashed by half, and the Fed went beserk (for that day) and chopped rates.

Stage Two was where the Fed's action worked for a time, and the recession eased. Gold declined for two years.  But the Fed's policies "eventually caught up with them" (Stage Three) and the dollar sank and we descended into the inflation pit sending gold into the late '70s blitz.

Burgess sees the same story driving the gold market today saying that "Nearly the same exact scenario started in 2001 and continues to unfold before our very eyes today" with 1976 being analogous to 2017.  Starting in 2001, the dollar began a plunge, then the Great Recession in 2008.  Burgess shows a side by side dollar comparison for '71-'73 vs '01-'08 with the dollar falling 120 to 92 and 120 to 72.  This was Stage One.  The Fed went beserk again, only more so with QE this time. And for a long time, it worked and the Great Recession has eased, which is where we are today, near the end of Stage Two.  The whole process today involves way more currency debasement against a way bigger mountain of debt than in the '70s.  This may explain why the whole fractal winds up being a 2X scale up (time-wise) of what happened before.  That's what fractals are all about - same thing, different scale.

So will wreckless monetary policy catch up with the dollar and cause a gold bull, or will we get away with it this time and go peacefully into calm seas? Burgess thinks not:
"make no mistake about it...The Federal Reserve and corrupt politicians can’t save the value of the U.S. dollar or your hard-earned assets, even if they wanted to.  Take control of your own money and do what the smart money did in 1976 ... buy gold."
Burgess points out the big bankers' market for gold where they lease it out amongst themselves effecting the gold lease rate.  He says the banks control the gold price more than anyone, and when they do a shuffle with it, running up the lease rates, it often signals a major move.  Such a lease rate run up is occurring right now:


There was a run up of rates going into late 2015, in front of the big move up in the gold price in 2016.  Currently, the 12 month rate (black line) has run up to its highest level since early 2009, which was just in front of the gold price running up to the 2011 peak of $1900.  So the lease rates are signaling a major move.

Does all this mean we must suffer another Great Recession and bear market soon?  For some reason we have been conditioned to think of gold as a reverse day-to-day barometer on the economy and thus the stock market.  Short term moves can reflect this, and the financial media dote on every bit of economic data released as an explanation for gold and stock market going opposite ways.

But there is another guru, a fractal practitioner, who is saying both the US stock market and gold are soon going much higher, hand in hand.  He is David Nichols, publisher of The Fractal Market Report and, like Burgess, he has been playing the gold market like a violin for many years.  Last August, he wrote a piece where he looked at some currency challenged third world countries and points out that when a government gets too powerful and self-serving, "capital gets scared and scrambles to find any kind of home that isn't a manipulated currency, or a bank that could confiscate, or debt that will inevitably default".  Capital finds a home like stocks, even if the real economy is mediocre or even bad.  This he says, is why Argentina's overpriced stock market is soaring in defiance of real economic justification.  Sound familiar?  Nichols titled his article "The US Is Becoming Argentina" and thinks our stocks will fly for similar reasons.  A quick check of where Argentina stands among the nations, as well as the Venezuela market he mentions, shows these two at the very bottom of GDP growth with inflation rates of 40% and 741%.  This is, of course, the extreme end game.  But Nichols sees the US starting to play.

Gold, Nichols says, will be the destination of much of the capital flight.  In August, 2016, with gold at the top of its sprint last year, he said this (from the above mentioned article):
Gold is responding to the switch to tangible assets.  It's got some work left to do to put the multi-year correction in the rear-view mirror, but once that happens, the "hot money" will pour right back into gold.
Since that top last August, gold has indeed done just what he predicted it would do.  It has done many months of consolidation "work" that appears close to an end.  He says the next phase should be the hot money pouring right back into gold.

Do I agree with him about joyful days ahead for both the stock market and gold, contrary to conventional wisdom?  Well, one thing that strikes me as I look at the history of gold is that you don't have to have a lousy stock market to have a gold bull market.  You just have to have a crisis of confidence in currency.  This was true in 2001-2007.  Here you had a booming stock market and no recession - just a bad drop in the dollar and resultant climb in gold.

Investor confidence with dollars in the bank seems to be the overriding factor for what gold does.  As another example of this, consider the roaring 1920s.  Here we had a booming stock market and economy.  We also had a booming gold market as measured by the few major gold miners' stocks. The gold price was set by the government then, so the handful of big miners was the gold market. The stock market and gold miners were climbing hand in hand, but there was a growing threat to dollars in the bank:

Gold miner climb "A" saw Homestead Mining appreciate by nearly 100% from 1924 to 1929, others had similar gains - and it had nothing to do with a Great Recession or a bad stock market.  It had everything to do with waning confidence in dollars in the banks.

Note the complete void of banking problems in the above chart in the 36 year cycle after Bretton Woods.  That's because this global event put us on the gold standard.  But as the monetary safe haven it created began to come under duress in the 1960s from government dollar killing practices, a gold mining bull market ensued, even though there were no Great Recessions and the stock market was good.  The only miner index for that period was BGMI, Barron's Gold Mining Index.  Take a close look at what it did in this nonrecessionary period:
All we needed was dollar-dumb policy.  The gold market saw the handwriting on the wall far before the president had to officially close the gold "window" in August of 1971.  It was pretty much the same with the housing tom foolery of 2002-2008.

So do we absolutely have to have another Great Recession and stock bear market to go along with a booming gold bull market?  Absolutely not if history is any guide.  The bad stuff seems to happen after the gold bulls have seen it coming for years.

Wednesday, May 17, 2017

Gold Miners Are At A Technical Juncture To Watch

The gold miners have been in a limbo for months now, but that is approaching an interesting condition. To better appreciate just how interesting, it would be good to go back a couple of posts to "Will Gold Ride Again?" and read that first.

So what is gold doing now that's so interesting? The miners are replicating a breakout condition they did in early 2016. Back then, it was a breakout that ended the four year decline, now it appears to want to end a continuation pattern. This is the common consolidation pattern after a big move where the bigger trend is continued after a mostly sideways period:


Here we have the two pennant formations compared. The first was the end of the long four years of decline, then we had the sharp climb in 2016, then we have had the limbo going into 2017. If this breaks to the upside, it will have been the classic continuation pattern with a new bull leg ensuing, continuing the 2016 move. The A/D (Accumulation/Distribution) and CMF (Chaikin Money Flow) cycling is very similar. In both formations, there was a positive switch trend in place in money flow, and we are at the takeoff point in that cycling.

I've also shown what I call the MAPS divider (Moving Average Pair Separator) which is the best divider of bull and bear market I've found. This is the 140 day exponential moving average plotted with the 200 day alongside, the blue and red lines in the chart. All during the four year decline, the miner index kept below MAPS very consistently. Once the break occurred in early 2016, we had a brisk positive moving average crossover which has morphed into essentially no separation in 2017's consolidation. If the formation breaks to the downside, it will produce a negative cross and puts gold back into bear mode. If it breaks to the upside, it will keep the bull cross in place.

The forces that will move gold from here are many and complicated. If interest rates go up, the dollar is defended, the economy is OK, and gold goes down. But gold has historically gone up when rates start going up, as in the late '70s. We've had political turmoil in Britain, France, the US, and elsewhere, which should move gold up. But we had gold in bull mode before any of that came along - in the politically uneventful times.

I think the main fundamental controlling gold is probably its role as an alternative currency. That was the main concern in gold's bull market in the early 2000s as the debt/dollar situation grew worse. It was the concern after the financial crisis into the bull leg to 2011. And it is still probably the main concern.

Rick And Dave And Buster Are On The Same Beam.

If you've read my Forbes article on the new paradigm in restaurants and retail, as exemplified by Dave and Buster's, you will find what's happening at Rick's Hospitality of interest. I wrote an article on RICK back in 2013 at Seeking Alpha, and what they were about back then was certainly ahead of the curve in today's ongoing train wreck in retail. Just last week alone, Kohl's was down 9%, JC Penney was down 17%, Sears was down 12%, Macy's down 18%. The Rick's article was an exclusive and is available now with a Seeking Alpha Pro subscription. So I can't reproduce it here, but I'll comment on it.

The point of my Dave and Buster's article, as explained by Patrick Doyle of Domino's Pizza, is that if you are a restaurant or retailer looking to just serve good food or merchandise and prosper, you will probably be suffering in today's evolving environment, despite adequate offline consumer spending. "People still get out" as Doyle said. You have to also be serving up "experiential retail" as it is coming to be called. Rick's Hospitality, or Rick's Caberet as it was called before their name change, is all about just that.

Rick's is a growing restaurant/entertainment chain where the entertainment is "the most beautiful women in the world featured daily". It's a little like Hooter's but there's more fun with the girls. The dancers pay a "facilities use" fee to entertain and collect tips. They can make as much as $1000 in tips for a night's shaking of the booty. But before you dismiss them as a sleazy massage parlor that has somehow wound up a public company, be aware that no less than Forbes has not only put them on their America's 200 Best Small Companies List (they installed them at # 94) but they've also been written up at The Wall Street Journal, Fortune, Smart Money, and other places that don't normally cover massage parlors. They are simply some of the early settlers in the experiential retail frontier along with Domino's Pizza, Dave and Buster's and other's with the same idea - only their experience is a little more naughty.

And they combine naughtiness with alcohol, to make money, not trouble. In the tight margin world of competitive eateries, alcohol is everything. These beverages are market up more than anything on the menu. The study "Adding Value: Beverage Alcohol's contribution to Restaurant Sales Is Significant And Growing In Importance"  gives the numbers. Of the top 500 chains, only half deal with all the hassles of alcohol at all, and only eight are able to derive 30% or more of sales from it. Rick's is an elite player here with 40%. Alcohol at over 30% is sought after by everyone in the business.

This includes even the restaurant chain giant Darden. As I covered in my article, they are trying the new ideas too. I pointed out three comparables to Rick's:
The second sort-of comparable is Yard House Restaurants. This is a private seafood/pub combo with 44% of sales from alcohol and a focus on growth. They were snapped up by Darden (DRI) last year, who paid 1.8 times sales (compared to 0.8 for Darden itself) for Yard's 15-20% annual growth rate to add some punch to the Darden lineup.
Darden recruited them into their Specialty Restaurant Group, their SWAT team for future growth.
So the second of the quasi-RICK comps, Yard House, is also a case of blistering growth, but now available as an investment only in diluted form with DRI stock.
DRI has been performing well despite old style restaurant ("casual" dining) blues and the horrors of old style retail in general:


And so has RICK:


These charts don't look at all like most restaurant chains do nowadays.

But hasn't this been tried before - entertainment with meals? What about Buffalo Wild Wings and such? Well yes it has been tried here and there, and with great success. In my RICK article, I point out three comparables, BWLD, Yard House, and VCG. Eric Langan, CEO of Rick's has compared themselves to Buffalo in past presentations, with BWLD at 30% of sales from alcohol, Yard House is now in Darden, and VCG was merging with Rick's in mid 2010 after posting blistering growth numbers in the five years they were public! But the merger fell through, and the VCG chief bought up all the shares he didn't already own and it went private.

This new paradigm is not untested, and now several players are getting in on this new beam. And those that are able to execute geographical growth will likely be good growth stocks of the future. There is something of a store count barrier here at around the 30-50 store area where growth skills of management are severely tested, and parabolic growth ensues if they prove their skills there. I show this on a chart in the Rick's article for the history of Walgreens, Walmart, Lowe's, and Rick's. Dave and Busters is just beyond this barrier with about 80 locations, Rick's is at about 40. There will be many of the big chains trying to adapt their behemoths to the new concepts, but Rick, Dave, and Buster are growing with the right idea to begin with.






Monday, April 3, 2017

Will Gold Ride Again ?


What happened to gold the last six months could best be called being shot out of the saddle. But is it dead? If you look closely, it could be crawling back into the saddle to continue the crazy ride of 2016. Gold has been a bit schizophrenic lately, not knowing if it's a bear or a bull. Although thought of as a dog since Trump's election, it actually has outperformed all the Trump commodities YTD and has trounced the Dow by almost double so far this year - seeming determined to disguise its true identity.

Back on Feb. 14, 2016 as gold was threatening to go on a tear from its long 4 year slide, I published an article here, at TalkMarkets, and at Seeking Alpha called "Gold's Bull/Bear Status". To understand this update, you need to go back and read this. The article correctly suggested a rampage upward in gold, which is what it did throughout most of 2016. But are we still in the large scale twin parabola fractal pattern that was the premise of the article? Gold has a very strong tendency to follow fractal patterns, as do a lot of big bull markets, as I illustrated in the article.

I drew a broad sweep diagram of this twin parabola fractal over a year ago that predicted last year's gold fireworks. Where are we on that map now?


I have added the black dot to update this as of April, 2017. Despite all the short-term schizophrenia of the last few months, in the bigger picture, gold seems to still be on track to do a roughly 2x scale up of the 1970s gold bull market. If we are to replicate the previous gold bull with its downtrend in the midst of the parabolic rises, we need to replicate this:

And so far we are doing this:


The two downtrends look similar in that there is churning against the resistance early on, then a sharp resignation to the downward move well below the resistance, then a return to churning on the resistance again, which is where we're at now. MAPS is what I call Moving Average Pairs for the 140 day and 200 day EMA that I find is a good separator of bull and bear moves. If GLD does a convincing break to 125-130 soon with high volume, a second parabolic rise starts to come into play.

But it is so hard to imagine gold going into a big bull market when its natural enemy, higher interest rates, are surely on the way. We seem to be going in the direction of all of gold's natural enemies - a good stock market, a defense of the dollar, an improving global economy, and a political sea change in Washington similar to the Reagan Revolution of 1981 that accompanied the death of the previous gold bull.

But gold can be very contrary to what it's supposed to be doing. For example, you can have bull markets in both stocks and gold at the same time, as in 2002 to 2007. In 1979, the year gold went ballistic in the last bull, the Dow was actually up 4.2%. And as for interest rates, if the last gold bull market is any indication, we should anticipate ramping gold alongside ramping rates:



The price of gold is very complicated and contrary, and maybe something like the science of fractals
is the best guide to what it will do.

The lead practitioner of fractal analysis of gold that I discussed in my aforementioned article back in February, 2016, is David Nichols, who publishes the Gold Fractal Report. His short-term calls on gold are somewhat hit or miss, but for long-term moves (say over two years) his accuracy is uncanny. He correctly was saying for months in 2010, when silver and gold seemed unstoppable, that precious metals would turn into a major bear move, and he gauged the time to be February/March, 2011. Silver hit its blow-off top in April and gold closely followed with its top in August, and the great four year slide began.

What is Nichols saying for our present timeframe? In August he published an article with his call for two things - the US stockmarket and gold. In August, if you will recall, we had just suffered a brutal pair of sell-offs, one in late 2015 and the plastering of early 2016. This was before the election and few were thinking run away bull, no matter who won. Nichols bad-mouthed the bears and predicted a nice bull market in stocks:
They are expecting a repeat of 2008, with a deflationary spiral that sends assets crashing down. Many seem downright gleeful at the prospect of the market doling out a brutal punishment to those holding long positions. But that was last decade's battle. The world has moved on ...
And he had this to say about gold:
Gold is responding to the switch to tangible assets. It's got some work left to do to put the multi-year correction in the rear view mirror, but once that happens the "hot money" will pour right back into gold.
Since August, gold has indeed done some "work" just as he said, being shot out of the saddle and perhaps now clawing back to put the four year slide "in the rear view mirror" and setting the stage for gold's next run. Giddyup.


Friday, March 24, 2017

The New Paradigm In Restaurants And Retail

It's well known that the brick and mortar retailers are suffering in today's ebullient markets. The internet is changing the way we shop. And, it's changing the way we dine as well, giving a twin abysmal effect in the restaurant world. The restaurant stocks are generally flat and the big box retail stocks are falling off a cliff. People today are seeking a generous serving of digital experience with their meals as well as their merchandise.

A man with some thoughts on this digital-tom-foolery/food thing is the guiding light behind what has to be considered the most successful restaurant chain of our time. This outfit has seen its stock do over a ten fold gain the last seven years since Jim Cramer first recommended him as "bankable". I am referring to Patrick Doyle of Domino's Pizza, what Cramer has called a technology company that also happens to sell good pizzas.

From the Mad Money of 3/6/17, Jim Cramer interviewed Patrick Doyle, CEO of Domino's Pizza after they reported yet another stunning quarter from the badly suffering restaurant group. Cramer asked him about what he has dubbed the new stay-at-home economy, despite growing disposable income, and how Domino's is beating this new attitude. Doyle then relates how Domino's has used the new digital age and everyone's fascination with it to deal with what he sees as the "new" consumer, telling us that fully half of the staff at the home office of Domino's are technicians that oversee the new order options where hungry customers simply order food while on Facebook, Google, Netflix, or whatever. Cramer just shakes his head at this. As for "getting out" foot traffic, the traditional life blood of restaurants, Doyle sees a great new divide now developing in consumer-land. In his words from the interview:
I think what's happening, Jim, is there is a great convenience now ... what you're seeing is people still clearly go out, but it's got to be special. There's got to be something in a restaurant or retailer that's drawing people in, that's giving them this experience that's different than simply going in and buying ... In restaurants, if you're giving someone a really special experience, then I think you're going to continue to drive traffic into your restaurant ... I think if you've got a restaurant that's a sit-down restaurant that's not doing something really special, then I think you're going to hurt." 
Doyle noted that his company is one of the few that has gone from a majority over-the-phone to a majority digital operation. "That's not a long list" he said. Cramer responded, "It's not a long list, and you are at the top of it."

Investors tend to think of Domino's as the great leader in this march of eateries into the new digital entertainment world. But there is a much more obscure name that perhaps is even more of an example of this powerful revolution, and seems to be exactly what Patrick Doyle was talking about in the above quote. That name is Dave and Buster's. You've probably heard of them because they've been around since 1982, went public in 1995 and were taken private in 2005.

In October, 2014, they have resurfaced as a public company again with a new mission and the name Dave and Buster's Entertainment, Inc. with the Nasdaq symbol PLAY. And play is what now sets them apart - digital play. About half their typical store floor space is the latest and best digital arcade games. They renew about 10% of their games each year at a cost of about 2% of their sales. These videotronical games seem like so much foolishness to me, and I've never wasted a moment of my time with one. But I've learned to never underestimate how popular they are with everyone else and I take their investment implications quite seriously.

Dave and Buster's does the big screen TV sports thing as well, even being a corporate sponsor of the UFC. But from Buffalo Wild Wings to my neighborhood Applebee's, you see the bar/TV thing everywhere these days. It's the games that now are making Dave and Buster's "special" to those cocooned in the house, and as Doyle said above, this is drawing them out. How does all this show up in their results? Well, it has propelled them to an industry leading Average Unit Volume - and the games are why:
 (Source of all results images: Investor presentation)
 The 2% of sales going to buy the games each year is well worth it as it sends the unit volume soaring past virtually all of their competition. Soldier of Fortune at Seeking Alpha has an excellent article titled "Press PLAY On A Dave And Buster's Investment" from back in November, 2015 showing these investor presentations by the company - just about a year after PLAY began trading. The stock has gone from $37 to $60 since then. Mind you this was precisely during the big swoon in both retailer and restaurant stocks since late 2015. And this has everything in the world to do with Cramer's stay-at-home economy, a corollary to his FANG acronym (Facebook, Amazon, Netflix, Google) he invented some four years ago. Jayson Lusk, a food and agri economist has a blog where he describes the Restaurant Performance Index comparing it to food spending away from home:
Here we see the tale of woe for the eateries starting in mid 2015 - about the same time when PLAY's results went ballistic:

 

 The "spending away from home" in the previous chart appears to be stampeding away from restaurants in general and into Dave and Buster's - a clear case of highway robbery in market share. And the same could be said of Domino's, which has a TV ad out now imploring customers to not deal with them by phone anymore, even smashing, with a crane, a big box with a phone image shown on it. Deal with us by the internet, they demand in the ad.

The growth shown above remains pretty cheap with just a 2.7 multiple on the revenue and just 10.8 on the cash flow from operations, whose growth looks similar to the EBITDA cash flow. Forward PE is 24.8 per Morningstar numbers.

The results at Dave and Buster's really began peeling away from the restaurant group in 2013 while they were still a private company:



I suspect this was a prime reason for the public offering of PLAY in October, 2014. It was almost like offering a new public equity launched into a new growth story - just what IPO lovers like. And they are in the fast growth part of the curve geographically, having a fraction of the store count of most major chains, just 1.7 stores per state.



If the digital traffic draw is such a good idea, why won't everybody be immediately doing it? Well, the gradual use of about 2% of sales to refresh 10% of their games each year has produced something of a competitive moat for Dave and Buster's. Each of their stores has about 150 games. And Soldier of Fortune gives this estimate:
Any competitor wishing to enter the space at any sort of scale would be facing a massive capital outlay (I estimate $165-175 M) in order to match Dave and Buster's gaming arsenal.
And as if to play dealer's advocate to the gaming junkies, they dispense:
... a pre-loaded card that one swipes to play a given game, removing the headache associated with keeping track of the coins to play with and the paper tickets won. Importantly, this is an experience that is not easily replicated at home (or at a competitor, for that matter) - most people/restaurants don't have even one full-size arcade game, much less 150+ to choose from.
For their part, Domino's has, the last seven years or so, made the massive investment to make half their main office workforce internet technicians. It would be a stretch for any competitor to suddenly make that change.

The games habit is high margin. It produces a gross margin of 86% vs 73.4% for their food and a combined average total store gross margin for their nine chief competitors of 71.3% (2015 figures). Clearing away some bookkeeping issues and just looking at EBITDA margins:



Floor space is an item that makes the business model hard for competitors to copy. A Dave and Buster's store is something around 44,000 square foot, about what the first Walmart stores were. Even if a competitor wanted to dish out the near $200 million for the state-of-the-art games, where would they put 150 of them?

As the big box mall spaces currently being occupied by J.C. Penney, Sears, Macy's, and the like become available via hundreds of closings, something like a Dave and Buster's may snap up some of this space as they would divide it up. There isn't much competitive bidding at their store size as everything this big is looking to get out of their spaces.

In the '60s, big box was good, a mega draw. Now the big boxes are making dotcom their draw and dragging the big box as dead weight. Taking the average mall annual lease rate of $41 per square foot and applying it to a typical bigger Macy's being closed at something like 260,000 sq. ft. you have about $10.7 million a year being chopped out of a big store's profit before you even pay anyone to work there. That's bad when the per store TTM profit for Macy's is currently less than $1 million. And J.C. Penney and Sears are in much worse shape.

Moving into mall space vacated by a big box retailer isn't a new idea to Dave and Buster's. Last month, the Baltimore Business Journal reported them swooping into the space at White Marsh Mall left by a Sports Authority as that company collapses into bankruptcy. If a recent CNBC story is any indication, big floor space ventures are going to have their pick of vacancies as a historic wave of big box mall closings are on the way:
"I expect the closures to be worse, and I expect the malls to be hit more than any other shopping center type," Cushman and Wakefield's Brown said. His firm keeps a list of the major store closures announced each year. Until 2016, the highest number it had tracked was in 2010, when about 3,000 closings were announced. That number grew to 4,000 last year, and Brown predicts it will balloon to 5,000 this year. "There's no way around [it]," Brown said, referring to what he considers an inevitable drop in the occupancy rate this year. While many argue that turnover and other changes have always been a part of the retail industry, "the pace at which it's changing is more rapid than has ever been the case," Green Street's Sullivan said.
Mall owners like the big floor space "anchor" tenants,  and welcome big replacements when one closes. The many smaller tenants often have contingency clauses linked to the anchors, many times governing whether they stay or leave, and at what price. This gives an operation like Dave and Buster's some bargaining power. This mall opportunity is a two edged sword for Dave and Buster's. It affords them a fast and likely cheaper path to expansion, but it also gives their competition the same physical path to copy their business model and expand.

However, as mentioned above, Dave and Buster's has just a fraction of the store count as their main competitors, and they can more easily make a higher portion of their stores mall takeovers. And all their existing stores are already that big!  Their competitors have a great mass of stores too small to populate with games, and a big learning curve with them in new places. Dave and Buster's has 35 years of experience with the games.

They are already establishing a presence in the revolution as was noted in the 3/23/17 Investor's Business Daily article about how to "Amazon proof" your mall. Sandeep Mathrani saw a vision of the future on a trip to Dubai, where he saw malls with KidZania in them - entire kid size towns with currency and role playing. Mathrani is head of the U.S. mall giant General Growth Properties (GGP) and is bringing these new concepts here. The article echoes Patrick Doyle's "special experience" theme:
For Mathrani, KidZania is part of a shift toward "experiential retail" - away from department stores ... Other concepts have taken their place, including supermarkets like Wegmans Food Markets, entertainment hub Dave and Buster's Entertainment ..."
GGP owns 126 malls in 40 states and has gone on the offensive:
"Instead of just waiting for stores to go vacant, it has bought out leases and physical property from chains like Macy's (M), Sears Holdings (SHLD) and J.C. Penney (JCP). The company has now reclaimed more than 100 stores over the past five years, Mathrani said."
Could this mall revolution be a growth engine for PLAY? I would say yes. You could say that all this videotronical stuff is just a two year fad with the kids. But be careful. You're calling Cramer's FANG and Doyle's "new convenience" a fad, and will probably wind up looking like those that called the horseless carriage and telephone fads. I think "paradigm shift" is not too strong a description.

 

 

Sunday, March 5, 2017

Is A Major Copper Bull Being Unleashed?


When the earthquake hit in Washington last November, sliding everything to a more business friendly world, copper went on a Trump tear along with several other things. Does this have any staying power? Is there something in the world's wiring to back it up?

Jesse Moore has an excellent series of reports on copper at Seeking Alpha. He began predicting a bear-to-bull turn in copper back in March, 2016, when copper was in everyone's doghouse, including mine. He was saying that within 12-24 months the bear would be a bull. We are now 12 months from his call, and copper is stirring from its bear slumber. His first in the series was a country-by-country look at copper mining projects, and he compares his result with that of Chili's government. Why should we care about Chili's copper work? Because they are the biggest copper supply in the world, giving us about one third of the metal. The whole Chilean economy centers on copper. Then there is the International Copper Study Group (ICSG) that does a projection as well. Moore's summary:
I believe both groups have not taken proper account for delays in a startup or ramp of new mines, grade reductions in Chile, water shortages leading to unplanned shutdowns, reduced capital expenditure, and the replacement of risk taking CEOs with risk averse CEO's who have slashed budgets across the world. Copper is not iron ore, and it is not nearly as easy to find and produce. The current copper price does not support growing supplies, and it appears that some producers have begun to put their collective shovels down ... In reality, the world needs another mega-project before 2020, and we just don't have one coming. The major deposits are, for the most part, found. $3.00 will easily bring on plenty of supply, but again, my belief is it will be too late. My guess is that we start to see the shortage become obvious near the end of the first half of 2017, prices will overshoot and what we saw during the China boom won't be out of the question
"The China boom" he is talking about is what happened back in 2004, when China went ballistic building the future China - and over did it. China has been notorious for commodity hoarding to insure supply for their plans. And they did this with copper in 2004, when their Shanghai inventories did a rare thing. They rose above the LME (London Metal Exchange) inventories, the world's standard for metal storage, just in front of the crazy copper bull market that ensued back then. Moore shows on a chart that this rare occurrence has just now happened again, the first time since 2004.

 Don't Ignore China

We need to pay attention to China and Asian copper usage in general because it accounts for about 62% of total copper usage, the Americas just 14% according to the ICSG pie chart shown in Moore's article treating copper demand. So forget Trump's building ambitions, copper began its breakout before the election. We need to know what's up in China.

China's construction contracts have continued a high rate of growth despite their economic slump, as have car sales. A lot of China's recent copper interest may lie in the aluminum vs copper wiring battle. They have been using a lot of the aluminum wire, because it is a very abundant metal with stable pricing running a fraction of that for copper. But aluminum wire has its problems. It must be alloyed to make it strong enough for wiring and this makes it less conductive. Copper can be used in a more pure form, especially pure, newly mined copper as opposed to the 50% of annual copper usage that is recycled. Only about 8% of scrap is made into wiring. So copper wire places nearly all its demand on the newly mined half of supply. Aluminum is also is subject to corrosion from moisture and other things and must be replaced much more often than copper. China is considering going to all copper for its wires, and this Moore says, will make a big, abrupt difference in copper demand:
Nearly half of all China's copper consumption goes towards grid infrastructure, and China has recently been discussing abandoning aluminum wiring in favor of more expensive, but reliable, copper wire. The outcome of which could drastically effect the demand for copper over the short term
Altogether, 75% of global copper demand is for electrical wires. But a big problem with copper wire is price instability. This may explain a good bit of the stockpiling going on now in China.

Copper's Supply

On the supply side, copper mining has been suffering a pronounced decline in ore grades. In "Copper: A Bullish Decade Is Coming" Moore shows a graph for global mining revealing that copper content of ore coming out of the ground is half of what it was in 2008. The best fruit has been picked, and, unlike oil, there is no big shale bump to come to the rescue. Shale, as I have written about in other articles, is keeping oil prices moderate for at least a couple of years.

If nothing suddenly shows up like a copper shale, the projected departure of demand curve from supply curve is slated to transpire around 2019 according to mining.com and their infographic tour of copper. For 50 years, they've known about shale and the other "dreg oil" (bottom of the barrel) that would be flooded onto the market by a quantum leap to higher prices. There is no such thing for copper - just a continuous slide to more and more expensive grades of normal ore. The current labor problems of Escondida, the world's biggest copper mine and other disruptions may be bringing a looming copper deficit closer at hand. Mining.com isn't the only one projecting this timeframe. Moore includes an RBC Capital Markets chart saying the same thing.

These could be some of the reasons for "Doctor Copper Hiding in Shanghai Warehouse" as a Wall Street Journal online piece from about a year ago proclaimed, saying that, "the pickup in the price of copper isn't driven by a stronger Chinese economy." You could argue that all the price surge is from Chinese stockpiling and thus it will simply reverse when they figure they have enough. But as Jesse Moore points out, they did this same stockpiling thing in 2004, to the same level relative to the LME, after which copper did a huge climb. China probably knows the copper market better than about anyone, being much more dependent on it than any country. They seem to know that they will have to buy higher later.

So are we running out of copper? No we are not. In fact we have mined way less than half of what's in the ground and almost all of that is still in circulation! Roughly half of copper usage is recycled metal. Even for silver, the recycled portion of demand is just about one fourth. Copper is by far the most reused resource on the earth. We don't burn it up like oil. It's relatively rare and doesn't rust into oblivion like iron. It only takes 15% of the energy to recycle copper as it does to mine it. How much gets recycled and refined is a function of the copper price. How much of the low grade, expensive ore that gets dug out is also a function of the copper price. We should perhaps draw a distinction here between peak oil and peak copper. We are enjoying a reprieve from peak normal oil with shale, tar sands, and so on. This could be for years, but there isn't that much of it to be exploited compared to the normal copper that's left to be recycled and still in the ground. We are not running out of copper.

We Are Running Out Of Cheap Copper

The looming supply deficit being projected is all a matter of copper pricing. It will be about market pricing and what that will be bringing to the plate. And it will be about any sudden changes to copper demand, like a China switch away from the aluminum electrical wiring. Added mine capacity doesn't come quick or cheap. And 92% of new copper wire must be pure, newly mined copper.

This aluminum/copper wire problem in China is being further aggravated by the massive internet speed bottle neck going on now in our last mile networking. I discuss this in detail in my article "The Impending Super-Cycle In The All Glass Internet" noting that as China struggles to become a superpower, their internet speed ranks #82 in the world. As all new buildings everywhere are becoming very populated with our new web connected devices, wiring material is being pushed beyond its limits now.

The disruptive switch-over from copper hybrids to an all fiber last-mile in urban areas means a very expensive mess. So ever increasing speeds have dictated a next generation of DSL on the very old copper that's already there. This new standard known as G.fast is being deployed. It is a nice speed improvement, and often compared to broadband fiber based on lab results, but will suffer the usual shortcomings of anything imposed on copper. The fade with distance is very bad relative to fiber.  Also, there is a vast difference in the normal existing copper and what they are using in the lab for these tests. I refer you to Jim Wegat for this. He was an optics engineer for Terabeam, and when I asked him about this supposed equality of G.fast copper to fiber, he said it:
... is confusing the wiring in homes and neighborhoods with the high quality wire used in the study by Alcatel-Lucent. It is a bit like saying that a specially designed car broke the land speed record and since most Americans have cars they should be able to break the land speed record with their cars too.

If we are needing this super pure, pristine copper to handle our new last mile, the cruddy, slow aluminum is out of the question. No wonder they are wanting to tear out the aluminum.

Fiber vs Copper

If I were vice president in charge of China's building programs, I would just cut to the chase and future proof my structures with all fiber and not even mess with copper. But I suppose when you must deal with a complicated budgetary mess and calendar of progress that dictate less than ideal science, it's not as simple as that.

There is a lot of debate on the pros and cons of fiber vs copper for LAN and building cables. Copper cabling suffers from electromagnetic interference between cables, fiber is immune to electric or magnetic interference. Copper is subject to disruption from lightening and water. Fiber is immune to that. I am not an expert on all this. I will just offer what Commscope has to say per a write-up titled "Will Fiber Ever Replace Copper Cable" on their website concerning what's happening in China.

Data centers in China are averaging 40% fiber and 60% copper while the very large data centers are about 70% fiber. But with "intelligent buildings" copper still dominates in-building networks:

"This is mainly due to the high cost of fiber-to-the-desk (FTTD) system as well as fiber’s high requirements for application environment and routine maintenance. Therefore, in the market of intelligent buildings, the percentage of fiber usage is only around 30 percent, while copper cabling occupies the remaining 70 percent market share. "

The Chinese seem to be very cost sensitive, having put in a lot of the aluminum wire, and now are averse to the high cost of FTTD. And that 70% copper market share may be looking better because of a new technology they are developing called Power over Ethernet (PoE):
"...when it comes to the intelligent buildings market, copper cable is facing new opportunities brought on by the fast landing of the Power over Ethernet (PoE) application"
The extraordinary copper stockpiling pointed out by Moore that took place in 2005 and just recently in 2015 was done with little fan fare or publicity, as important as it is to investors. But in a Reuters report from 2015, cited in Moore's part two article on copper (demand) China's government gives us a glimpse of their plans for copper. China does things by five year plans, and this report covers the 2015-2020 plan with the title "UPDATE 1 - China Targets $300 bln Power Grid Spend Over 2015-2020 - Report" and cites government sources in China. That's a third of a $trillion spent on wires, a big number, but to put the numbers in perspective, the plan calls for installing transmission line length over 2015-2020 equal to more than twice the 2014 level. That's over twice the cable strung in five years than was strung in the previous one hundred. The report, in what would seem to be an understatement, said all this is “likely to provide a boost for sectors like copper.” And it also makes pretty clear the choice in the aluminum vs copper battle:
“The plan was aimed at increasing the reliability of power transmission, which would favour copper-based cables over cheaper alternative aluminium-based cables, said Yang Changhua, senior analyst at state-backed research firm Antaike.”
If you look at a historical chart of China's copper imports, as in this report, you see an interesting connection to these five year plans. Over the 5 year plan 2000-2005, copper importing was flattish going from 70 to 50 (10 thousand tons). Then after the unusual stockpiling blitz by China in 2005, when the Shanghai inventories exceeded the LME the first time, the 2005-2010 five year plan saw copper imports do a massive climb from 50 to 300. This was accompanied by a strong climb in copper from $1.43 to $4.27. In the five years since, the imports have again been flat, going from 300 to 300, with the price of copper drifting back down. In fact, if you overlay this China copper import chart with the copper price chart, you get a remarkable correlation except briefly for the 2008 financial crisis. Now, the Shanghai inventories have exceeded LME once again, and you have to wonder what's up with China's plans. Keep in mind that they probably know the copper market better than anyone.
 
So a big new wave of demand could be coming for newly mined wire grade copper. The supply projections above may have a tough time keeping up with it.

The supply would have to be accomplished with higher pricesA lot of what's going on in China probably applies to other emerging Asian countries, and that block is 62% of copper's demand. China apparently sees this as a big enough problem to justify a whole new round of stockpiling.

Another consideration with copper supply is its relation to gold. Copper is usually found wherever gold has formed, and you can't read much geology on miners without seeing "gold-copper, copper-gold" and similar terminology. The basic fact is that much copper is mined as a co-product or by-product with the vastly more lucrative gold content. If the price of gold is cutting production, a copper shortage has to run a ways before operations are being ramped up just for the copper. Thus you have to be mindful of the relative status of gold and copper bulls and bears. Right now we have gold looking bearish since late last year while a copper bull may be on its way. Almost always in history, gold and copper bulls have run in tandem. If now they are to run in opposite directions, it would be an oddity. Technically, gold is in limbo now between long-term bull and possible new bear in the $1250 area. So this bears watching. We will probably have a copper shortage if gold continues its long-term bull market, but if gold continues its retreat from last year, the copper shortage could become severe.