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Market Musings - November 18, 2017

We continue our blog series: Market Musings, Volume 1, Edition 10, giving our (hopefully not too random) thoughts on recent goings-on in the markets. Today, we present Tesla's Truck Unveiling and Two Short Possibilities.

1. Tesla's Truck Unveiling - The big news since our last edition of Market Musings was the unveiling by Tesla (ticker TSLA) of its electric truck, regarding which founder Elon Musk tweeted in advance:

Well, that must be some truck then! We confess we didn't even watch the webcast (too late on the East Coast--it can still be seen here, though), but read about it yesterday morning. Apparently, as with most of Musk's promises, the truck specs and production timeline must be taken with a few grains of salt, since Musk has the unfortunate habit of making "mind-blowing" promises about TSLA's products which often don't come to fruition. For example, see the following from this past July regarding the Model 3 sedan:

So according to Musk, Tesla was supposed to produce 1.5K Model 3s in September and 20K Model 3s next month. September's actual production? Just a couple hundred (source).

At the beginning of this month, Tesla admitted that it is still nowhere close to Musk's predicted timeline and that the 5,000 per week Model 3 runrate originally scheduled for December might now be delayed to March 2018 (see Q4 2017 earnings release here). We find that Musk cries wolf quite often. One of his main motivations for constant grandiose promises seems to be that TSLA is starved for capital and thus needs its stock price as high as possible, in the event the company decides to issue equity to fund ongoing cash burn. Yet every time he fails to follow through on a promise, his credibility erodes further (and the less the stock price is propped up). Market participants are beginning to realize that--to put it bluntly--Musk is quite often completely full of it. While TSLA shares got an initial bump up in the AM yesterday, the effect largely dissipated by day's end:

2. Two Short Possibilities - With stock prices close to all-time highs, finding good longs is increasingly difficult. On the flip side, though, now that valuations have become so stretched, short opportunities should be plentiful (at least in theory). We view shorts as insurance against a market decline. In the earlier stages of a bull market, recent market declines are still so vivid in investors' minds that this insurance is priced at sky-high levels (i.e., valuations generally are depressed). However, once a bull market has run for a considerable period (we haven't been in a bear market since 2011 and haven't seen a 10% correction since early 2016), this insurance becomes quite cheap indeed. And the best time to buy insurance is when it's cheap. Thus we present below two interesting short opportunities.

A. OLED Short - Universal Display Corporation (ticker OLED) has enjoyed a meteoric rise in its share price recently, up about 270% in just the past 13 months:

Much of this rise appears to be due to the fact that the iPhone X has an OLED display and Universal Display could be poised to benefit:

Interestingly, the Street Sweeper website has run a series of articles over the past few years touting Universal Display as a good short (see here and here). To say they were "early" on this short is a bit of understatement. The crux of the Street Sweeper's argument seems to be that OLED's key patents expire at the end of this year. Obviously, based on the stock price, investors don't have any such worries, as OLED now trades at a TTM P/E of 85X and a forward (2018) P/E of 58X (in each case using suspect "non-GAAP earnings"--GAAP P/E multiples would obviously be higher). Below are current analyst expectations for the company (source here):

So even if the patent expiration issues can be overcome, OLED still appears extremely expensive (and note that analysts are not exactly the most pessimistic sort of people, so the above 2018 estimates could prove too optimistic). What about company insiders--are they buying shares on the open market (which would be an indication of undervaluation)? Uh, no...

A whole lotta selling going on (source here). Thus, OLED looks on the surface like a good short (and cheap insurance), pending further review of the patent question. To be continued...

B. LGND Short - Ligand Pharmaceuticals (ticker LGND) has also enjoyed a massive share price rise, with its stock up 1450% over the past seven years:

The company licenses its pharmaceutical technology to other pharma companies. In addition, it is developing its own drug pipeline. Shares now trade at a multiple 44X TTM and 37X forward (2018) non-GAAP earnings (source here):

The aforementioned multiples seem oddly inflated given the pricing pressure that has negatively impacted the pharma sector (both specialty and generic) over the past two years. For example, witness LGND's share performance versus a sampling of large pharma companies since mid-2015, all of which are basically flat to down huge (source here):

How about insiders at the company? Predictably, they have been sellers at recent prices (source here):

We really don't understand the market valuation of LGND at all. The company touts its "shots on goal" business model as giving investors all of the upside of investing in the pharma industry with little of the risk inherent in drug development. Management touts the fact that LGND's licensing partners fund the trials necessary for FDA approval (giving LGND a virtually "free option" on such approval--if you ignore the cost to LGND of originally acquiring its licensed IP, that is), yet they conveniently omit the fact that these partners also get the vast majority of the economic upside if a drug gets approved. For example, below is a slide from their 2017 investor day presentation from a few days ago (see full presentation here):

Color us skeptical. The old saws "There's no such thing as a free lunch" and "If it sounds too good to be true, it probably is" spring to mind when we ponder LGND management's investment pitch. Given the stretched valuation of the company's stock, as well as ongoing drug pricing pressures domestically, we think shorting LGND could be cheap market insurance indeed. To be continued...

DISCLOSURE: Short TSLA, no positions in other stocks mentioned.

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