KeyStone’s Stock Talk Podcast Episode 121
This week we kick off with a brief discussion on SPACs. With everyone from hedge fund manager Bill Ackman and Oakland Athletics general manger Billy Beane to former Trump economic adviser Gary Cohn, former U.S. House Speaker Paul Ryan and LinkedIn co-founder Reid Hoffman, backing SPACs. And, Virgin Galactic, DraftKings and Nikola Motor Co. all going public through a SPAC. The SPAC has come mainstream. We let you now what they are and if they are a unique opportunity. Our first Your Stock, Our Take is on Netflix Inc. (NFLX: NASDAQ), the largest video streaming company in the world. A listener asks us how the shutdown with more people were staying at home and watching video, has impacted Netflix and whether we would buy the company at the current price? Our second YSOT was sent in from a listener on ParkLawn Corp. (PLC: TSX), one of the largest providers of deathcare products and services in North America with operations in 5 Canadian provinces and 15 U.S. states. The listener notes ParkLawn has continued to make acquisitions during the pandemic and whether it is a long-term growth opportunity.
Ask us Anything
Can you explain to me what SPACs are? I have been hearing the term thrown around in US markets a lot lately – what are they and are they an opportunity?
- Karl.
The Year of the SPAC?
Well Karl, your question is on point. Aside from a global pandemic, shutdown, and racial unrest worldwide, 2020 would have been known as the year of the SPAC.
In recent months, everyone from hedge fund manager Bill Ackman, Oakland Athletics general manger Billy Beane, former Trump economic adviser Gary Cohn, former U.S. House Speaker Paul Ryan and LinkedIn co-founder Reid Hoffman, have backed SPACs. Virgin Galactic, DraftKings and Nikola Motor Co. all went public through a SPAC. The SPAC has come mainstream. But what is a SPAC.
What is a SPAC?
SPAC is an acronym for Special Purpose Acquisition Company.
Also known as “blank check companies, SPACs are set up with no commercial operations and strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company. SPACs have been around since the 1980s. In recent years, they have gone mainstream, attracting big-name underwriters and investors and raised a record amount of IPO money in 2019.
The 2019 record will be eclipse in 2020, as 82 special purpose acquisition corporations had gone public by mid September raising a record $31 billion – with more are on the way.
While in the past they could be classified strictly as buyer beware, the reputation of SPACs has improved over the decades as governance practices have also improved and made them more shareholder-friendly. For example, shareholders are now able to vote either in favor of or against a deal or acquisition proposed by the SPAC and still ask for their cash back.
Notable SPACs of 2020
Pershing Square Tontine Holdings
- IPO Price: $20
- Capital Raised: $4 billion
Churchill Capital Corp. III
- IPO Price: $10
- Capital Raised: $1 billion
Therapeutics Acquisition
- IPO Price: $10
- Capital Raised: $118 million
Performance of SPACs
In the end, it all comes down to performance. As of mid September 2020 – of the 223 SPAC IPOs conducted from the start of 2015 through July, 89 have completed mergers and taken a company public, offering the chance to examine their performance, according to a report from Renaissance Capital, a provider of IPO ETFs and institutional research. Of those 89, the common shares have delivered an average loss of 18.8% and a median return of minus 36.1%. That compares with the average after-market return from traditional IPOs of 37.2% since 2015.
As of July 24th, 2020, only 26 of the SPACs in that group had positive returns, the study found.
The recent crop of SPAC mergers has performed better than the broader group, the report found. The common shares of the 21 SPAC mergers completed in the period from Jan. 1 of this year to July are averaging a return of 13.1% from their offer price, but that’s mostly due to the two highest performers — DraftKings and Nikola. Without those two, the SPACs produced better returns than in the period going back to 2015, but are still a negative 10.5%. That compares with the 2020 IPO market’s average aftermarket positive return of 6.5%.
Each deal should be looked at on its own merits, but on average, the performance has not been strong over the past 5 years, in a good market. And the better performance year-to-date in 2020, appears to be driven by a few very high profile names, which we would argue are trading at astronomically inflated numbers based on current cash flow.
Why SPACs?
Within the venture capital community there has been general dissatisfaction with the traditional IPO process. Essentially, founders believed they were not getting control of the pricing process.
That’s led to conversations about going the direct listing route, and now the SPAC route.
From an investor perspective, a SPAC waiting to make an acquisition is essentially a shell with no business. Therefore, there is no revenue or cash flow to analyze and no way to put a valuation on the stock. Essentially, it is a bet on the management’s ability to deploy the capital accretively and grow shareholder value over the long-term. You are making a very speculative bet. There is no guarantee the capital will ever be deployed at all or deployed to create value.
Each SPAC and the potential subsequent acquisition should be analyzed and valued on its own merits, but the historical track record and lack of tangible cash flow to analyze makes SPACs very speculative investments generally speaking. Great for a founder going public while they are hot, not as great historically for investors.
Your Stock, Our Take
Can you give me your views on Netflix? During the shutdown more people were staying at home and watching video. How has this impacted Netflix and would you buy the company at the current price?
Kyle – via email.
Your Stock, Our Take
Netflix Inc. (NFLX: NASDAQ)
Current Price: $555
Market Cap: $245 billion
What does the company do?
Netflix is the largest video streaming company in the world with 193 million paid memberships in over 190 countries.
Key Points:
- Netflix has been a huge beneficiary of the Covid-19 shutdown.
- The company’s stock price is up 70% since the start of the year.
- During the first 2 quarters of 2020, the company has added nearly 26 million paid subscribers compared to 12 million net new subscribers during the same period of 2019.
- Netflix operates in nearly every country in the world with the exception of China.
- The size of the global video streaming market was estimated to be about US$44 billion in 2019 (according to Statistica) which gives Netflix a market share of around 45%.
- There are two key risks facing the company right now that we would be focused on.
- The company has generated excellent success financially, but there are two key risks facing the company right now.
- The first is competition which leads to concerns about Netflix losing market share even as they continue to grow revenue.
- There are 3 big streaming players that operate in China but the biggest competition to Netflix comes from Amazon Prime, Hulu and mostly recently Disney+.
- Amazon Prime has been growing quickly and now has an estimated 150 million global subscribers. Disney+ is a newer entry to the streaming market but currently has close to 55 million subscribers and is building momentum.
- The second risk is increasing costs and the company has been forced to create more and more of its own content as opposed to licensing new content. We have yet to see these increased costs show up in the operating margins.
Recent Financial Performance
- Financially, the company looks to be in a strong position.
- Q2 revenue grew 24% and earnings per share grew 165% to $1.59.
- Revenue last year grew 28% and earnings per share grew 53% to $4.26.
- The company trades at a valuation multiple of 90 times trailing earnings.
- Management did state in its guidance that growth is expected to slow through the second half of 2020.
Conclusion
In summary, Netflix is a great growth business but it is not a stock that would be well suited to KeyStone’s research. This largely comes down to valuation. At 90 times earnings the stock is expensive. We don’t mind paying higher valuations for the best companies but there are some concerns that growth with Netflix is going to start to slow. Management is expecting a slowdown in growth for the balance of 2020 and more competition is also a factor. Certainly, if earnings growth continues at 50%+ per year then the company can justify 90 times earnings multiple. Our concern is the potential risk that earnings growth will slow and the market will readjust the valuation. I think that if price and valuation are not a restraint, the there are other interesting companies that investors could consider, including Amazon which has streaming, ecommerce and cloud computing.
Your Stock Our Take
Braden via Email
ParkLawn Solutions (PLC:TSX) is a death care company that operates funeral homes in Canada and the US that have been acquiring through the pandemic as well. Do you have an opinion on them?
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ParkLawn Corp. (PLC: TSX)
Current Price: $28
Market Cap: $825 Million
Yield: 1.6%
What does the company do?
ParkLawn is one of the largest providers of deathcare products and services in North America with operations in 5 Canadian provinces and 15 U.S. states. The company and its subsidiaries operate 114 cemeteries, 109 funeral homes (including 21 on-sites, where a funeral home is located on a cemetery) and 39 crematoria businesses, each of which service different areas and provide a different combination of product and services.
As Braden mentioned the company has been acquiring businesses through the COVID-19 pandemic. With the following acquisitions:
- October 1st, 2020 – Acquired the assets of Bowers Funeral Service Ltd – a three-location funeral home business in Salmon Arm.
- January 31st, 2020 – Acquired Family Legacy LLC.
- Approximately US$20 million in annual revenue and EBITDA of US$5.5 million.
Recent Financial Results: (Q2, 2020)
- Revenues were up 44.6% to $84.7 million, compared to the same period last year.
- Adjusted EBITDA increased to $19.5 million, an increase of 50% from $13.0 million in Q2, 2019.
- Adjusted EPS came in at $0.295, compared to $0.19 in Q2 of 2019.
With trailing twelve month adjusted EBITDA of approximately $65 million, ParkLawn is trading at an EV/adj. EBITDA multiple of ~16x. Which appears reasonable considering the company’s decent historical growth.
As at June 30th, 2020, the company had a D/E ratio of 0.42 and a net debt to EBITDA multiple of ~3x. Considering the company’s positive cash flow I believe that this debt balance is sustainable. Just as a note, in the summer of 2020, the company closed a debenture raise of $86 million, which they stated would be used to pay down its credit facility. And in August management said that including its $34 million cash on hand they have an additional $175 million in liquidity to pursue growth objectives.
Our Take:
I like Park Lawn as a company, because of the businesses’ defensive nature, decent growth, relatively attractive valuation and it pays a slight yield on top of it all.
I believe that the company’s debt balance is sustainable, but its definitely something to keep an eye on as to how far they extend this balance and their net debt-to-EBITDA multiple. On top of that, I wish the company would provide more details in regard to their acquisitions so we could gauge how good of a price they are receiving and whether the businesses will be accretive on day one.
I must say that it is not a stock that KeyStone has under coverage, but all in all, I think for an investor wanting to hold a defensive business that is growing – it could certainly be a good option.
