Author: Kris Tuttle
Covestor model: Soundview Technology
Disclosure: Long ADBE
Over the course of April, we filled out our portfolio and eliminated our 14% placeholder position in the PowerShares QQQ Trust Series 1 (QQQ). Our new positions include: Adobe (ADBE). We have been waiting for the right moment to buy Adobe over the past year or so.
The shift to “mobile first” development and rejection of Adobe Flash in favor of HTML and other toolsets have knocked the company for a loop. However, as we expected, Adobe has been remaking its strategy and will soon be shipping the next version of its flagship product Creative Suite 6. This will be the first version available as a Software as a Service, or SaaS, offering hosted on the cloud. There is still some debate in the market as to what extent the monthly subscription option might cannibalize their core software and upgrade business, but we see that as a distraction.
Fundamentally Adobe has fended off any and all realistic competition for serious digital development projects. We actually expect the SaaS option to finally entice reluctant customers to move off older versions like CS3 and CS4. A casual user isn’t going to pay several hundred or more than $1000 to upgrade to a new version. So the monthly option is perfect for them.
It’s possible that some who might purchase could opt for the SaaS version but since this is generally “higher multiple” business from an investment standpoint, we are not concerned about the potential mix shift. Finally, Adobe shares at current prices are well below our intrinsic value (IV) estimate of $50.
Qualcomm (QCOM) is another well-known name in the mobile space. The company has been executing extremely well and is one of those unassailable players in mobile infrastructure. With our analysis complete and a long-term IV of $100, the shares justified an initial position.
Then there is Enphase Energy (ENPH). Enphase makes inverter technology which is needed to take the DC from solar cells and panels and create AC for use. Solar has been a frustrating area for most investors. It’s a great secular growth story and the technology is steadily improving. Yet unit prices decline faster than volume can ramp up. Coupled with high capital costs and shifting regulatory factors there have been few attractive ways to invest.
Traditionally these inverters are large, centralized and somewhat mysterious pieces of equipment. In fact knowing how to design and install a system is made difficult mostly due to the need for special engineering around the inverter. Enphase has come up with “micro-inverters” which are small enough to attach to individual panels and perform the conversion at the source.
The company has proven an ability to scale revenue and profit with units. The company recently completed an IPO in a market that is still hostile to solar and unfriendly to alternative energy plays. Offerings by Enerkem, Luca Technologies and BrightSource all were withdrawn. The Enphase deal priced at the low end ($6) of the revised downward range (originally $10 to $12 per share.) Our IV of $12 allowed us to finally include a play on solar that fits our investment profile and offers substantial upside.
In terms of our investment process, we made one change in April. Typically we use the current year estimate for IV in our decision process. However for “core” positions we decided that an extra year helps to make better decisions that are consistent with our long-term approach. By having an IV for both 2012 and 2013, we can make better decisions.
We don’t try to analyze the economy or markets in general but we can say that many potential positions in April didn’t make the cut because those stocks are trading at or above our IV estimates, in many cases even the ones we have for 2013. There’s evidence of investors getting carried away in some niche areas and with a few stocks but our IV process keeps doing the job for us.
We’ve been adding all these names to our database of companies organized by theme so that if opportunities develop in some of these stocks we will be prepared. We may also look for shorts in this market starting in May. There are some technology trends we see ending and there may be cases where that isn’t reflected in some of the stocks of companies positioned in those areas.
Even though we will own large well-known names if the technology trends and potential returns justify it, we will do the work on very small companies that are largely unknown to investors even though they are tapping into key trends we follow. One of those names is Cinedigm Digital (CIDM) which we have followed for over two years and owned since late 2011.
When we first checked out Cinedigm, they had a decent business helping theaters to convert to digital and 3D technologies. The company’s long-time CEO was a good guy and a don of the industry niche. The business though was a little boring and not growing much. Underneath it all, though, was a position in software that put the company at the heart of what would be an important transition to “all digital” for the cinema industry. But it wasn’t clear to what degree this position would be leveraged and brought to the surface.
It didn’t take long for some changes to sharpen our focus on the company. The long-time CEO resigned and the company set out to hire a new one. At the beginning of 2011, an industry heavyweight, Chris McGurk, with a strong background in filmed entertainment content came on board. This was a classic case of a big vision in a small company and we saw a flurry of events in 2011 as the company shed non-core businesses and accelerated their growth and profitability.
Wall Street noticed at first and the shares moved from $1.50 to more than $2.00. (As of May 1, the stock has fallen back closer to $1.50 per share.) While everyone was in agreement that the management team was making material improvements, the company was still lacking a convincing alternative content strategy. Knowing the McGurk as we do, we were sure it would happen over time and took advantage of the company’s lower share prices in fourth quarter of 2011.
Recently Cinedigm completed a small ($10 million) equity offering and acquired a company called New Video. We see this as a huge catalyst for growth and strategic value that so far is unappreciated by most investors. New Video is responsible for a big chunk of the content in places like iTunes, Netflix (NFLX) and Amazon (AMZN). They finally give Cinedigm the critical mass they need in content.
At the same time the company has been investing heavily in their software and building the team to drive it. In many ways they have a captive market for their software which enables cinemas to program content and for content owners to track and manage rights and revenue. This software will also be a core element of what enables the company to deliver new content distribution business models where cinemas are able to participate in downstream revenues.
It’s going to take time for the Cinedigm story to unfold and it still presents challenges to investors who often won’t take the time to look through an unusual balance sheet or believe in a new business model. But we see reward that is greater than the risk here with an IV of $6 versus the current $1.50 share price. We may realize it in 2013 or 2014, but when we do it will be a substantial return for the portfolio.
We will be in NYC in May 21 and 22 attending TechCrunch Disrupt, which gives us an opportunity to see a great deal of the latest technology innovations in one place. We’re hoping that the trip provides enough research to support idea or two with the appreciation potential to make it into the portfolio.
