Thoughts #35: Private vs Public Investments

Investment ideas can come from everywhere but it is important to understand that public and private investments are as different as apples and oranges. Investment ideas from personal connections, private companies and structured schemes come to us. It is very tempting to put money to work thinking that we are getting good risk reward. But we must be very discerning.

Personal and private investments cannot be compared to what is publicly listed or backed by a reputable government (e.g. US or Singapore) or large institutions. For example, we see a private investment which shows 20% annual return on paper. We cannot say that this is better than buying DBS, which can only generate 10% annual return (of which 4% is dividend).

There are a few important reasons:

• DBS is the largest bank in Singapore and the 25th largest bank in the world. There is very low probability it would actually go bust.
• DBS is publicly listed and its accounts are audited by top accounting firms. It means the numbers are real. The cash on the balance sheet is real.
• DBS is liquid, you can sell any time and take the money out if you need it.

In contrast, for a startup setup by your friend, or even and big private investment led by a Temasek linked company in which you have an angle to participte, none of the above matters. The considerations becomes:

• Can I trust the person executing the investment. What if he calls it a day at his startup or at Temasek, move on to do something else? What happens to the money committed?
• Who audited the numbers? Can I trust the cash was used the way it was intended?
• How long is this amount locked up for? What if I need the money some time in the future.

The answers are complex. For the first question, would almost certainly be dunno. Even if you have 100% trust, shit happens. What if the friend gets hit by a bus. Or the lawyer who did the work ran away with the money? With DBS stock, such risks are all averted.

So in order to make a good decision, we need to apply the right discount, we probably have to calculate the expected return here. So for DBS stock, the expected return is the same as the above because the probability that DBS will go bust is near zero and we can take the money out any time i.e. expected return is 10%pa.

But for the private investment, if the probability of default is not zero. For a Temasek led private investment, it could be 30% default probability. For your friend's startup, it could be 70%. So using those no.s, the expected returns drop to 14%pa and 6%pa respectively. Then we need to think about the liquidity needs. If it is locked for 10 years, then I cannot put like 10-20% of the portfolio or something big, like six figures. Who knows when I need that money?

Hyflux

Case in point, Hyflux. It was publicly listed. Strong links to Singapore government and Singapore Inc. Yet, it went bust. Thousands of convertible bondholders lost their shirts. Equityholders know their risks, we buy equity knowing it might go zero but we get the enjoy the upside, if any. But bondholders have no upside. We bought thinking we can enjoy 6%. Yet, it went to zero. So even listed entities are not foolproof. Shouldn't we ask more questions?

 

Full post on 8percentpa.substack.com

Huat Ah!

Market review: 2024-2025

2023 came and past. There was no recession, the Russian-Ukraine war continued and more conflict happened in other parts of the world. Israel-Hamas. We may have Trump as the most powerful man on the planet facing off three dictators: Putin, Xi and Kim. How fun.

Meanwhile stock markets continue to make new highs (except China). The Nikkei broke past its peak of 39,000, last achieved in 1989. This was the year Taylor Swift, the first billionaire singer who helped Singapore gain more hatred from our neighbours, was born. At 35, her age is also slightly higher than the median and average age of all the humans on planet Earth. 

My point, is that it's been a while since Japan was on investors' mind and just when Nikkei tried to come back, India took centre-stage limelight again with Modi promising more and the India stock market hit all time high as well. Yeah, the world is crazy.

So what should we expect for the rest of 2024 and 2025?

I believe what goes up must come down. Valuations are stretched but not crazy. The last time Nikkei hit 39,000, it was trading at 60x PE. Today it's 16x. The PE for the US market is expensive but not at its most expensive when we look at its history, as exemplified by the famous Case-Shiller PE ratio chart below.

Case Shiller PE 50 Year Chart

The last bubble was with the Nasdaq and it is worth examining at that as well. The Nasdaq was trading at >100x PE back in 2000. While it has way surpassed that peak of c.5,000 at >17,000 today, the PE ratio is c.30x. So, just looking at PE valuations, we can always argue, things are not super crazy. But every bubble is different. It can go way higher and break the previous PE record high. 

This could be generative A.I. sucking in even more money which means the Magnificent Seven (Nvidia, Alphabet/Google, Meta / Facebook, Tesla, Amazon, Microsoft and Apple), the GRANOLAS in Europe (GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, Loreal, LVMH, AstraZeneca, SAP and Sanofi) and the Seven Samurais (Tokyo Electron, Mitsubishi Corp, Toyota, Nintendo, Fast Retailing, Sony and MUFG) continue to go up. While the rest of the market stagnates.

Or things can just collapse should the weakest link break. It could be another Silicon Valley Bank, it could be China, or Tesla. The risks are not being highlighted today but with interest rates this high, by right, investors should be favoring stocks with lower PE or higher earnings yield. Yet, we are seeing the opposite.

As fundamental investors, we always have to be mindful of valuations. I would advocate we look at the specific companies closely and make sure valuations are cheap. We should also keep comparing earnings yield to T bills. If we can get 3-5% on T bills, we must think hard about buying stocks at less than 3% earnings yield or 33x PE. Singapore 6 month T bills are still giving 3.7% and US ones are even higher at 4-5%.

US T bills from Google

As to fundamental analysis, I believe A.I. will change the game. It is still unclear how. One scenario might be that retail investors might be better served, since we can simply ask chatGPT to do the analysis in the near future. Or it might also be the case that no one beats the market anymore. So we just buy the index which is generating return by A.I. investing for us.

Before that future happens though, we have Substack today (mine is 8percentpa.substack.com). I believe Substack is becoming an important growing eco-system for independent writers who could write as well as professional analysts perhaps with the help of chatGPT. Their analysis are in-depth, informative and much better than Youtube videos (e.g. Roaring Kitty). The following would be a list of posts on both new names and names that I follow.

Just a few posts from other Substacks:

https://eaglepointcapital.substack.com/p/verisign-a-capital-light-compounder

https://buybackcapital.substack.com/p/the-issue-no-4-vrsn

https://hightechinvesting.substack.com/p/warner-bros-discovery-stock-catching

https://pricepoint.substack.com/p/price-point-040-lets-take-a-look

https://theartofhittingbombs.substack.com/p/company-deep-dive-no-5-adobe

https://cloud.substack.com/p/the-5-ways-ai-will-transform-creativity

Huat Ah!

Thoughts #34: A.I. vs Human Portfolio Manager

Portfolio Management has never been easy. 80% of portfolio managers cannot beat the benchmark. Would it be the case that this becomes 99-100%? There could be a few scenarios:

1. A.I. beats everyone -> all portfolio managers cannot beat the benchmark

2. A.I. plus the best portfolio managers beats everyone, including A.I. These hybrid A.I. + best human portfolio managers make up the best 1%.

3. A.I. competes with A.I. and only the best A.I. beats everything else. 

The chart below shows humans don't really stand a chance...

Huat Ah!

Please support us on 8percentpa.substack.com too!

QYLP: Global X Nasdaq 100 Covered Call ETF

Covered call ETFs are relatively new and literature on the internet provide little insights on how such an asset is good for investors. Hence, this post hopes to add knowledge to whoever is interested. First we need to cover the following sub-topics to understand this idea better. 

1. What is a covered call ETF?
2. Why buy on the London Stock Exchange or LSE?
3. What is the thesis?
4. What are the risks?

First up, a covered call is an option which allows the seller to sell a stock which he or she owns, usually at a higher fixed price vs today some time in the future. This allows the seller to receive a premium from the buyer. Call options give the buyer the right to buy a stock at a certain price (i.e. the seller has the obligation to sell at that same price)

There is also something known as a naked call, when the seller doesn’t own the stock. But that is a topic for another day. Today, let’s discuss the thinking for the buyer and seller of call options:

The call option buyer thinks it is good bargain to buy a stock at a certain higher price but doesn’t want to pay up for it. So he wants to only buy the right (i.e. the call option) which is much cheaper. In a way, call options provide stock buyers leverage. He is bullish on the stock.

The call option seller (i.e. us) is obliged to sell at this higher price, but in return, receives a premium. He doesn’t want to sell the stock now but at a certain higher price, he is okay to sell. On top of that, he receives a premium and is therefore even happier. In a way, the seller is bearish but not bearish enough to sell today.

Covered call ETFs

Now that we have covered covered calls. We can go on to how it works for an ETF. So extrapolating form the above, the Nasdaq 100 covered call ETF will own the 100 Nasdaq stocks but sell covered calls on them. In the US, this goes by the ticker QYLD and in UK, the author would be buying QYLP which is part of the group of ETFs listed in 2022 with the same manager Global X but this particular ticker is denominated in pounds. The reasons shall be discussed in the next section. 

This ETF essentially owns names of the Nasdaq and sells covered calls on them to generate returns. The list of names, which are publicized regularly and differs in weightage vs the index, are as follows:

The US listed entity has a much longer history and we can see from the below that the track record is not far from the index return assuming that all proceeds are reinvested. Since inception (which was 2013), the ETF has returned 7.4% while the index returned 8.3%.

Yes the ETF return is actually lower than the index, so shouldn't we buy the index? This too shall be discussed below in the thesis section. For now, let's call that covered call provides premium to the owner and is less volatile than the index. Covered call ETFs generate very high dividend and this particular one, QYLP has provided 11-12% dividend since inception (which was 2022 on the London Stock Exchange).

This is a good segue to go into the next section.

Why the London Stock Exchange (LSE)?

The reason is that UK has no withholding tax. So the 11-12% goes directly into investors' pockets. If we have bought the US listed one, 30% would be taken away by taxes which makes it less interesting. The author has chosen the GBP denominated one because of future currency needs but most investors should just use USD, which is the default currency and that means less complications.

The dividends come monthly and has been very beneficial for many retirees. Some people have invested in covered call ETFs for decades and benefit from the monthly income. Notable ones include DIVO and JEPI which interested readers can also dig into from the link below.

https://moneyguynow.com/best-covered-call-etfs/

Thesis and Risks

Okay, let's discuss the main topic. Thesis and risks. Why buy such a complicated instrument when we can buy the index. The answer is that in other times other than 2024, you should probably buy the index. Index buying has been proven to be the easiest way to compound returns and dollar cost averaging into index buying will create good wealth over time. The index of choice will be the S&P500 which has returned c.11%pa over the last 10 years and more than 10%pa over the last century.

So why bother with covered call ETF on the Nasdaq? 

Here's why:

1. We don't want to miss out on the tech and Gen AI bubble.
2. The regular income is good.
3. Covered call ETFs will outperform if the market is flat or if it goes down.

There is real upside risk that we are at in the middle of yet another tech bubble which is driven by the Magnificent Seven, Generative AI and perhaps cryptocurrency (again!). Yes these names have rallied a lot but it seemed that we are not in the final legs of any huge bubble. It could go up a lot more from here and we stand to miss all the upside from here.

If you owned Nvidia when it was below $100 and has rode the stock up, then good for you and perhaps this idea is not for you. But for most of us, this might be a good way to participate without taking on all the risk. The covered call ETF owns the underlying names and will go up as long as the index goes up. It also provides regular income. However, it will underperform the index over the long run due to higher expenses, 

This brings us to the second point which is the monthly dividend. Covered call ETFs provide regular income which is very attractive for people who require this. As mentioned, for QYLP listed on LSE, this is 11-12%pa which is very significant. 

The last point is simply a reiteration that we are hedging ourselves should this bubble scenario not play out. If Nasdaq collapses, then we are saved by the dividends and should outperform, at which point, we should then actually buy the index like QQQ or SOXX. 

Let's talk about the risks!

The full post is on 8percentpa.substack.com

References:

https://globalxetfs.eu/funds/qyld/

https://www.globalxetfs.com/funds/qyld/

[Globe Newswire] - YY Group Announces Strategic Entry Into Vietnam’s Booming Labour Market Within the Dynamic Hospitality Industry

This is a collaboration post with Globe Newswire which provides earnings update and salient financial news globally.

SINGAPORE, May 02, 2024 (GLOBE NEWSWIRE) -- YY Group Holding Limited (NASDAQ: YYGH) (“YY Group”, “YYGH”, or the “Company”), a data and technology-driven company that specializes in creating enterprise intelligent labor matching services and smart cleaning solutions, is pleased to announce its entry into Vietnam’s thriving hospitality industry, which is worth USD $5.16 billion in 2024. This underscores YY Group’s commitment to supplying skilled manpower to meet the growing demands of Vietnam’s dynamic hospitality sector.

Following its successful entry into the Malaysian market last year, YY Group is leveraging its sophisticated technology and scalable digital platform to penetrate the growing hospitality sector in Vietnam. With a robust presence in Singapore, YYGH currently supplies skilled manpower to major hotels such as Ritz-Carlton, Hilton, and Shangri-La Hotels and Resorts. Building on this success, YYGH aims to adopt the same innovative approach in Vietnam, tapping into the growing demand for high-quality hospitality staff in the region.

The YY Circle Super App (YY App) is a one-stop intelligent manpower outsourcing platform that simplifies and streamlines the staffing process for customers across diverse industries, including luxury hotels, food and beverage outlets, clubs, and retail outlets. YY App, as an online marketplace for manpower outsourcing has recorded approximately 400,000 downloads and 150,000 total active users as of June 30, 2024. The YY App has proven its effectiveness in connecting businesses with qualified talents.

Vietnam, known for its vibrant tourism industry and bustling hospitality sector, represents a significant growth opportunity for YYGH. Vietnam National Administration of Tourism predicted that by 2025, the number of international tourists would climb to 32 million and domestic tourists would reach 110 million. According to Mordor Intelligence, the market size of hospitality industry in Vietnam is projected to reach USD $9.91 billion by 2029, with a compound annual growth rate (CAGR) of 13.94% from USD $5.16 billion in 2024. With a sizable addressable market and a robust CAGR, Vietnam offers immense potential for YY Group to establish a strong presence and deliver innovative manpower solutions tailored to the needs of the hospitality industry.

“We are thrilled to bring YYGH’s innovative solutions to the vibrant hospitality market in Vietnam. With our proven track record and advanced technology, we are confident in our ability to drive positive change and deliver exceptional value and quality talents to our clients in Vietnam and beyond,” said Mike Fu, Founder and Chief Executive Officer of YY Group.

About YY Group Holding Limited

YY Group Holding Limited is a Singapore-based company dedicated to redefining digital interactions and creating impactful connections in the ever-evolving digital landscape. Rooted in innovation and a commitment to user-centric experiences, YY Circle leverages sophisticated technology to foster engagement, collaboration, and community building.

For more information on the Company, please log on to https://yygroupholding.com/

UK Dividend List

This post is also available on 8percentpa.substack.com.

The world is moving into a new high interest rate environment and as investors, we should be demanding higher dividends. Today we are looking at UK's dividend plays. The UK is one of the few countries in the world with no withholding tax on dividends. The other is Singapore. Today, we shall take a look at what are the good UK dividend stocks using our favorite poems screen.

The usual poems screen with idiosyncratic cut-offs like 8.5% ROE 

As per previous years, we have used the above screen with ROEs, ROAs and Operating Margins driving the screen. The UK list this year generated 20 odd names. Many of which had been discussed here: Reckitt, Diageo, BHP amongst others. They are still here because they have not outperformed. The market has been very focused on the Magnificent Seven and similar stocks such that the rest of the good old names are forgotten. We believe the above names are compounders and the investment theses described are still intact.

Good UK names

The other top names are also worth mentioning. Unilever and its closest rival Nestle have also been good compounders currently trading at reasonable valuations. Rio Tinto is similarly another version of BHP. We all remember BP and Deepwater Horizon. Amazingly, it rebounded 2x from there, collapsed near those lows during the pandemic and is now almost at all time high! It appears on this screen because cyclical names like oil majors have good ROEs at the peak. So this is not a call to buy BP. 

BP's share price

The flavor on fossil fuel names have also changed with Greta Thunberg and her environmentalist gang shaming our generation and companies destroying the planet. Stocks like BP and miners are unable to command good premiums and hence the high dividend. The other name that falls into the same category is Imperial Brands (formerly known as Imperial Tobacco).

Burberry looks really interesting with its share price almost halving in a couple of months. It is very rare to see a luxury name on such lists. We have done the due diligence so there are no good analysis why the stock tanked and whether it is a good buy today. It does look reasonable on 14.7x PER, 6.8x EV/EBITDA and free cashflow c.7%. If it gets cheaper, LVMH will snap it up in a snap!

Burberry's share price

That said, works need to be done. This author had never bought well buying something on three sentences of analysis. But perhaps some readers have the luck and if you do make money please report back!

Huat Ah!

WBD Update - Full Post on Substack!

Full Post:

https://8percentpa.substack.com/p/update-on-warner-bro-discovery-media

We have discussed Warner Brothers Discovery (WBD) and deemed it as an interesting and cheap alternative to Disney. Share price has collapsed on the back of its heavy debt and poor earnings performance in 2023. The company is still losing money at the net income level for the past few quarters and looks like it could continue and even if it somehow breaks even, net income level will be low. As such, the stock is best valued using FCF. Here's a look at its full year 2022 results:

WBD was created in 2022 with the merger of Warner Media, which was spun out of AT&T, and Discovery. The current entity is an entertainment IP franchise powerhouse and a global media giant that operates cable TV networks with both premium entertainment and low cost family-friendly content as well as non-fiction science and lifestyle programming.

More interestingly, WBD is now home to iconic franchises like Game of Thrones, Harry Potter, Friends, Batman, Superman & the DC Justice League universe and Looney Tunes amongst others. It also houses distinguished media brands such as CNN, HBO, Cinemax, Discovery and Cartoon Network that most of us would be familiar with. As such, CEO David Zaslav estimated that WBD has 35% market share of the best content on Earth.

The investment thesis is therefore about owning such an entertainment content juggernaut which also generates tremendous amount of free cashflow at an attractive entry price today.

Let’s look at the simple financials which we skipped in the initial discussion.

Simple financials (Dec 2025 estimate, USD)

• Sales: 42.5bn
• EBITDA: 10.8bn, EBIT: 3.1bn
• Net income: -0.2bn, FCF: 5.8bn
• Current Debt: 40.0bn, Mkt Cap 21.0bn
• ROE 16%, ROIC 9% in 2019, currently negative
• EV/EBITDA 5.8x (Dec 25), PER currently negative
• Past EBIT margins: 10-25%, 0% in Dec 23 and 7% in Dec 24
• FCF yield >20%

While net income is negative, the company has been generating positive free cashflow. The slide from the full year earnings deck above showed how FCF ended at a spectacular USD6.2bn. Analysts are estimating that EBITDA and FCF would be sustained into 2024 and 2025.

Management has listed other key objectives above. While the targets were ambitious, WBD is led by a management with strong track record and we are seeing good progress. EBITDA has grown with the losses in DTC business segment gone now and 2023’s FCF has well exceeded its original target of USD4.5bn. WBD has been laser focused on FCF. If we count from its days when it was still just Discovery Ltd (i.e. since 2012), the firm has generated USD27bn in FCF cumulatively which is more than its market cap today!

1. Business Segment Updates

In the initiation, we did not discuss the segments in detail. WBD has three business segments: Studios, Network and DTC.

Studios create the core IP content and oversee the release of such content into films, TV programs, streaming services and the distribution of related consumer products, themed experience licensing and gaming. It is the engine of the WBD franchise but the segmentation sees it contributing to just 20-30% of EBITDA with EBITDA margins of 17-18%.

Networks consists of the US and international TV networks. This business is in secular decline with the disruption of Netflix and streaming. It is also the reason for the weak share price and therefore the attractive valuation. Analysts estimate that the business is declining c.5% annually. However, Networks is the main earnings generator today (c.90% of EBITDA) with EBITDA margins of >40%.

DTC which stands for Direct-to-Consumer is WBD’s premium pay TV and streaming service but is significantly weaker than Netflix or Disney at just single digit market share. In 2023, revenue grew 40%YoY reaching USD10.2bn (table below). But more importantly, EBITDA also just broke even.

Full Post:

https://8percentpa.substack.com/p/update-on-warner-bro-discovery-media

Finance Acronyms

After doing this for twenty years, I find it sometimes amazing that we can have so many acronyms. It must also be frustrating and confusing for people not in tuned with them. This is an attempt to put down a non-exhaustive list for everyone since I use them a lot myself and will direct new readers here in the future.

AML = Anti-money laundering

ALM = Asset Liability Management

BRICs = Brazil, Russia, India and China which led the growth in emerging market economies

BS = Balance Sheet

Capex = Capital Expenditure

CF = Cashflow (from CF statement

COGS = Cost of Goods Sold

DE Ratio = Debt-to-Equity Ratio

DM = Developed Markets

DVD = Dividend

EBIT = Earnings before interest and tax

EBITDA = Earnings before interest and tax, depreciation and amortization

EM = Emerging Markets

ESG = Environment, Social and Governance

EV = Enterprise Value

FAANGs = Refers to the Facebook, Apple, Amazon, Netflix and Google but that has now evolved in the Magnificent Seven: Microsoft, Apple, Nvidia, Amazon, Alphabet, Meta and Tesla

FCF = Free Cashflow

FOMO = Fear of Missing Out

FX or Forex = Foreign Exchange

FY = Financial Year or Fiscal Year

GFC = Great Financial Crisis of 2008-2009

GIGO = Garbage In Garbage Out

HHI = Herfindahl-Hirschman Index, common measure of market concentration

IRR = Internal Rate of Return, an important return calculation methodology in the PE world

IV = Intrinsic Value

LIFO = Last In First Out, one of the accounting terms

MOS = Margin of Safety

NAV = Net Asset Value, often used used in conjunction with IRR calculation.

NI = Net Income

OP = Operating Profits which is similar to EBIT

OPEX = Operating Expenses

PBR = Price-to-Book Ratio

PE = Private Equity

PER = Price Earnings Ratio

PL = Profit and Loss Statement

RE = Real Estate

ROE = Return on Equity

ROIC = Return on Invested Capital

SGA = Sales, General and Administrative Expenses

TMT = Tech, Media and Technology, often used to described the 1999-2000 IT bubble, a.k.a. the TMT bubble

That's all for now, but this will be updated as new acronyms come along.

Huat Ah!

Fortinet - Cybersecurity Play

It was reported that Singapore lost >SGD500m to cybercrime in 2023. Imagine, our small country of a few million people, losing that much. What would that number be in China, US and Europe? Based on population sizes, it could be 300x more ((China’s 1.3bn + US’ 300m + Europe’s 500m) / Singapore’s 6m = 300). That’s USD150bn!

The company we are discussing today is one of the cybersecurity play listed in the US. Recently, the firm published some good quarterly investment materials and we shall be highlighting many of the key slides here starting the one on Total Addressable Market. The company estimates that its TAM is currently USD125bn but will grow to USD200bn by 2027.

Cybersecurity is big business!

Next, let’s take a look at the simple financials. It is also worth noting that the company has generated high teens growth to sometimes 30% YoY growth for more than 10 years. 

Simple financials (Dec 2024 estimate, USD)

• Sales: 5.5bn
• EBITDA: 1.7bn, EBIT 1.5bn
• Net income: 1.2bn, FCF: 1.7bn
• Debt: -1.0bn (net cash), Mkt Cap 38.7bn

Ratios

• ROE >100%, ROIC 70%
• EV/EBITDA 21.7x (Dec 24), PER 29.9x (Dec 24)
• Past margins: OPM 15-20%
• FCF yield 4-5% (4.4% based on no.s here)

As one the leaders in the cybersecurity space, the company has also enjoyed stable high margins, extraordinarily high ROICs and good Free Cashflow. Due to its recent earnings weakness, shared price collapsed, presenting an opportunity for us to buy. That said, it is still not cheap with PER at close to 30x based on consensus no.s although it looks better with c.5% FCF yield.

1. Fundamentals

Cybersecurity is a megatrend with hackers being way more sophisticated vs 20 years ago and companies and individuals needing more software and solutions to protect themselves. The company has projected market growth to be c.12% but its own revenue has grown close to 20% over the last 15 years.

The company has implemented its own rule of 40 stating that revenue growth and operating margins should exceed 40 in any given year. As we can see, it has comfortably achieved this over the last 5 years. Management is also focused on Free Cashflow and it started generating billion dollar FCF in 2021 and looks like it should hit USD2bn this year.

The company we are discussing today is Fortinet (FTNT US) and we have the following investment thesis:

Fortinet is a leader in network security and is a key beneficiary of the ever-growing cybersecurity megatrend. It is a differentiated player in its space with unique technology which has allowed the firm to build a strong and diversified customer base across geographies. It also boasts higher margins and stronger FCF growth vs its peers.

Fortinet is a network security specialist with 70% of revenue coming from its security network business. The firm is the only cybersecurity vendor with its own SPU or security processing unit with application specific design multi-core processor that has supported generations of secure infrastructure with every iteration. Its main product FortiGate Firewall has 20 years of track record and helped the firm expanded its business portfolio to encompass more recurring revenue and value added services such as SASE*.

Today, Fortinet has an another 20% of revenue coming for universal SASE and 10% from security operations. While its business is entirely related to network security, Fortinet has diversified its business across customer types, geographies and industries. The following charts provide the breakdowns showing how its businesses are evenly split.

*SASE or Secured Access Service Edge, extends networking and security capabilities allowing work-from-anywhere and remote workers, to take advantage of firewall as a service, secure web gateway and zero-trust network access and a medley of threat detection functions. 

Positives

Continuing increase in penetration of secured networks: Networking used to be simple installations. We only needed LAN cables but with the advent of cloud and increased cybersecurity threats, network has become increasing complicated and needed to be secured. Starting from a few years ago, secured network installation picked up globally and penetration stands at 40% of all networks today. This is expected to grow to more than 52% in 2030 i.e. more than half of all networks are secured networks. Fortinet stands to benefit from this trend as the leading player in the field.

High recurring gross profits: The nature of the cybersecurity business calls for monitoring, service and support. As such, c.65% of Fortinet’s gross profits comes from service and such high recurring gross profits look set to grow as we can see from the chart below:

As its installed base grows, cost is spread across to a bigger revenue pie and use cases are learnt and reapplied to solve similar problems with other clients. The strengthens Fortinet’s moat and widen the knowledge gap between the company and its smaller competitors. We shall revisit this point later.

Strong shareholder returns via share buybacks: Fortinet’s business is highly FCF generative and it has spent a significant sum in share buyback over the years, repurchasing 214m shares (c.20% of outstanding shares) for USD5.8bn. Fortinet’s current buyback until Jan 2024 will be accretive at current valuation and providing further downside support for share price.

Risks

High growth markets are naturally highly competitive and cybersecurity is no different. Fortinet needs to compete with its bigger and more prominent peer - Palo Alto Networks alongside a slew of US and global competitors. It is unclear if the firm can maintain its high margins indefinitely.

At the same time, behemoths like Microsoft, Google and Apple would also be keen to enter this space given its importance to their core business. These are trillion dollar companies that have all the resources to compete. Fortinent’s own slide below illustrates the risk we are discussing well.

Mitigating factor: Fortinet has USD5bn of revenue in its space, second only to Palo Alto (as shown above) and should be strong enough to compete against the peers listed above. On the other hand, if Google or Microsoft is looking for something to acquire in cybersecurity, then Fortinet will also be interesting as a target. So as long as management continues to execute well, earnings and share price should do okay.

Management

Fortinet is founded in 2000 by two brothers: Ken Xie (60) and Michael Xie (54) and together they still own c.20% of the company. Ken is Chairman and CEO while Michael is President and CTO. Needless to say, Fortinet will not be here today without them and while the management team is professional and strong, Ken and Michael will be instrumental to Forinet’s continuing growth.

2. Technicals

The following chart shows how Fortinet has traded over the last 5 years. Recall that Mar 2020 was an important point in time for many stocks as it reflected maximum fear at the height of the pandemic but looking at Fortinet’s stock price, it is probably not relevant and we see a stronger support near today’s share price of USD52.

Without looking at valuations (just pure technicals), the risk reward seemed to suggest USD50 at the downside and USD80 on the upside, as marked by its historical high. But if we want to be more conservative, the next support at USD30 marked around 2020-21 could be used. The math would then be 40% downside (USD 52, today’s share price / USD30 support) vs 60% upside (USD80, historical high/52, today’s share price).

To be clear, this is a first-cut rudimentary exercise using just technicals and we shall revisit this later with valuations which is more reliable.

The other important point to note with technicals is the drawdown. As we can see, drawdowns have been treacherous at close 50% twice just looking at the last 2 years. As our past investments have shown, it is not inconceivable that share prices plunge 50% even when our analysis shows everything is cheap. Just look at Idea #11 - Bayer!

So, I would caution that we size slowly with Fortinet given its business nature, share price volatility and high valuation.

3. Valuation

As a cybersecurity play, Fortinet does not come cheap and our usual valuation table below shows marginal upside. To recap, earnings are represented by Free Cashflow, EBITDA and Net Income.After ascribing the respective high multiples (20-25x) and adjusting for cash on its balance sheet, we are just getting USD54-61 which is quite far away from its historical high share price of USD80.

Compared to its peers (table below), Fortinet trades at a slight discount but it’s still not cheap. Again, this is a name that we should size small initially to adjust for its high valuation. If share price declines and valuation becomes reasonable, Fortinet could also become a take out candidate. As mentioned, megacaps like Google, Microsoft or even its peers might be keen to acquire Fortinet should it trade cheaply.

Intrinsic Value 

 There are two ways to think about Fortinet’s intrinsic value. We can take the average of the three intrinsic values, that gives us USD57 or c.10% upside. Or we can use the FCF IV of USD61 which has 19% upside. Personally I think the latter better reflects the cybersecurity growth opportunity. 

Now that we have the valuation numbers, let’s do the risk reward analysis again. On the downside, if we take down the valuation multiples by 5 turns across the three metric, we get -4 to -19% downside. As mentioned, the upside would be 19%. This shows that risk reward is just balanced. Not asymmetrical with a lot of upside and little downside but I would say that’s good enough.

Putting everything together, I would be initiating a small position at current share price of USD51. 

Huat Ah!

This post does not constitute investment advice and should not be deemed to be an offer to buy or sell or a solicitation of an offer to buy or sell any securities or other financial instruments.

[Globe Newswire] Fluence Expands Presence in Asia-Pacific Region, Opens Local Office in Taiwan

This is a collaboration post with Globe Newswire which provides earnings update and salient financial news globally. 

TAIPEI, Taiwan, March 15, 2024 (GLOBE NEWSWIRE) -- Fluence Energy, Inc. (“Fluence”) (NASDAQ: FLNC), a leading global provider of energy storage products, services, and optimization software for renewables and storage, has expanded its presence in the Asia-Pacific region, opening a local office in Taiwan to further engage in the country's energy storage market. According to the Energy Administration, Ministry of Economic Affairs, by the end of 2023, Taiwan's cumulative installed renewable energy capacity had reached 17,916 MW, an increase of 150% from 2019. This consistent year-over-year growth in renewables to meet the country’s ambitious clean energy targets is positioning Taiwan as a prime regional market for energy storage.

“We are proud to announce our expansion in Taiwan, a key market for energy storage in the Asia-Pacific region. Having already successfully collaborated with local partners to complete 10 storage projects in Taiwan, this expansion underscores our long-term commitment to the region,” said Jan Teichmann, SVP & President APAC at Fluence. “Harnessing our cutting-edge energy storage technology and leveraging our extensive field experience, we are committed to enhancing the reliability and stability of Taiwan's power grid. Together with our customers, we aim to accelerate the pace of the energy transition, contributing to a more sustainable and resilient future for the region.”

To date, Fluence has been selected to deliver over 2 GW energy storage projects within the Asia-Pacific region to help enhance grid stability and promote the region’s clean energy transition. Globally, Fluence has deployed and contracted 8.7 GW of energy storage projects.

About Fluence

Fluence Energy, Inc. (Nasdaq: FLNC) is a global market leader in energy storage products and services, and optimization software for renewables and storage. With a presence in 47 markets globally, Fluence provides an ecosystem of offerings to drive the clean energy transition, including modular, scalable energy storage products, comprehensive service offerings, and the Fluence IQ Platform, which delivers AI-enabled digital applications for managing and optimizing renewables and storage from any provider. The company is transforming the way we power our world by helping customers create more resilient and sustainable electric grids.

Full article:

https://www.globenewswire.com/news-release/2024/03/15/2846779/0/en/Fluence-Expands-Presence-in-Asia-Pacific-Region-Opens-Local-Office-in-Taiwan.html