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Market Musings - November 16, 2017

We continue our blog series: Market Musings, Volume 1, Edition 9, giving our (hopefully not too random) thoughts on recent goings-on in the markets. Today, we present Doubling Down on VIAB, An Arb Play and Travolta's Insanely Cool Airport House.

1. Doubling Down on Viacom - Viacom (ticker VIAB) announced Q4 (Sept) FY2017 earnings (see earnings release here) and the market had a minor hissy fit, sending the shares down as much as 9.4% in early trading:

Yet, despite the negative reaction by traders, the results in the quarter were actually quite good, with revenues up 3%, operating income up 112%, diluted EPS up 165% and diluted adjusted EPS up 12%, in each case versus the prior year quarter:

Moreover, net debt has been reduced to $9.7B at September 30, 2017 from $11.5B as of the end of FY2016, representing significant progress in deleveraging the company's balance sheet:

All other things being equal, with earnings up and leverage down versus the prior year, one would expect VIAB's stock price to be higher than it was 12 months ago--yet, it is way, way down. And certainly one would have expected shares to rise at least today in response to the positive earnings and balance sheet news, right? Nope. VIAB now trades at just 5.1X and 6.3X LTM GAAP EPS and adjusted EPS, respectively, the latter of which represents a massive earnings yield of 16%. The market now treats VIAB equity the same way it would treat the bonds of, for example, a distressed E&P producer closing in on bankruptcy(!)

So why the knee-jerk selloff today? Well, the market (in its infinite wisdom) remains transfixed on and bewitched by the cord-cutting phenomenon. Once one of these "tectonic shifts" in the marketplace takes hold of investors' imaginations, inevitably they carry the shift and its consequences to absurd lengths, marking down quality companies (such as VIAB) that are supposedly the (permanent) victims of the shift to obscenely low valuations and marking up the supposed (permanent) beneficiaries of the shift (such as NFLX) to insanely high valuations. This same scenario has played out in recent years with respect to vehicle electrification, where TSLA is given a ridiculously high valuation and GM receives a corresponding ridiculously low valuation in the market--despite the fact that GM is much more likely to become a successful and profitable mass producer of EVs than TSLA (in our opinion).

Cleary, as we have stated in the past, what the wise man (or woman) does in the beginning, the fool (usually a man, BTW) does in the end. Buying TSLA at $28/share or NFLX at $15/share four or five years ago was obviously a wise move, because the market had not yet priced in the gains likely to accrue to both TSLA and NFLX from the aforementioned tectonic shifts. But is buying shares at $315/share or $196/share, respectively (i.e., today's prices), really so intelligent? How much of the supposed future success of these two companies could possibly fail to be priced in at currently prevailing prices? Conversely, while selling VIAB at $80/share a few years ago was clearly prescient, as cord-cutting was just then ramping up, is selling it at $23/share this morning really a smart move when the effect of the trend should already be priced (if not vastly overpriced) in to the stock? We have taken the other sides of these trades, going against the herd, today doubling our VIAB position at $23.10/share and increasing our TSLA and NFLX shorts correspondingly. While it is admittedly lonely venturing outside the warmth of the herd, doing so is a bit less uncomfortable when the herd is mindlessly galloping off of a cliff en masse.

2. An Arb Play - Ocera Therapeutics (ticker OCRX) announced on November 2nd that it is being bought by Mallinkrodt Plc (ticker MNK) for $1.52/share in cash plus up to $2.58/share via a Contingent Value Right, or CVR (full PR linked here):

While the CVR could potentially be worth up to $2.58/share, OCRX is currently trading at just $0.24/share above the cash value of the merger, so the market is assigning less than a 10% probability that investors see the full $2.58. Granted, most CVRs in pharma buyouts are long-shots (granting a CVR is another way of an acquirer saying to the target, "We think the asset subject to the CVR is probably worthless, but just in case it's not we'll give your shareholders a chance at any upside with respect to it"). Below is the stock chart for OCRX for the past year, showing that shares were at just $1 prior to the buyout annoucement, so OCRX holders are receiving a large premium over the unaffected price:

Since the market cap for OCRX at ~$47MM is so tiny in comparison to the acquirer MNK's market cap of $2.08B (less than 5% of MNK's), there are thus two ways to win in this merger arb play: First, if the CVR unexpectedly pays off bigly, and, second, if another acquirer were to show up and start a bidding war for OCRX. Granted, neither outcome is likely (and admittedly we have no idea who much the CVR will actually be worth), however one should include at least some value for each potentiality in any expected value calculation for OCRX. The question is whether these two options are worth just $0.24/share.

3. Travolta's Insanely Cool Airplane House - On a subject only tangentially to investing (in the sense that if one becomes really adept at the craft, one could afford something like this), we chanced upon a story about John Travolta's house we'd thought we'd share. Now, say what you want about Mr. Travolta's movies (link) or even his hair (both facial and up on top - link), but we must admit the man possesses an insanely cool house, according to the following online story (see full article here):

Yeah, forget about a two-car garage, the man possesses a two-jet garage/hangar! The house (located in Ocala, FL) is part of a residential airport complex, so he can taxi his planes straight from house to runway. Pretty darn sweet--and convenient. Here's a view from inside the crib (yes, that's the smaller jet of the two):

Apparently, Travolta has always been a flight aficionado, including being an ambassador-at-large for Australian airline Quantas. You go, John (and please expect our unannounced visit sometime this coming January or February)!

DISCLOSURE: Long VIAB and GM, short NFLX and TSLA, no positions in other stocks mentioned.

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