Model Volatility Continues as Mid Cap Gains Favro

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Northlake’s Market Cap model shifted back to Mid Cap after a brief, one month stop at large cap in November. As a result of the new signal, client positions in the Russell 2000 (IWM) were sold and the proceeds were reinvested in the S&P 400 mid Cap (MDY). There was no change to the Style model, which continues to recommend Growth over Value. Client holdings in the Russell 1000 Growth (IWF) will be held for at least another month.

Over much of this year I have mentioned that the models have been giving borderline recommendations and performance variance among the market cap and value themes has been low. The December swap from small cap to mid cap is another example as it took only a shift in one of the technical indicators measuring market breadth to cause the Market Cap model’s recommendation to shift. Overall, both models are reflecting a steadily trending market and sluggish but consistent growth in the domestic economy. This environment does not lead to a lot of variance among stocks whether it be Northlake’s themes or specific sectors or industries.

The one month stop at small cap did prove profitable as IWM gained almost 4% ahead of the 3% gain for the S&P 500 and a gain of only 1% for MDY. In the Style category, both growth and value kept up with the broad market and gained 3% for the month.

Results for both models on a year to date basis are very closely tracking the benchmark S&P 500. Given that both models have had their signals bounce around, this is indicative of the market environment mentioned above where a rising tide has lifted all boats about equally.

MDY and IWF are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov.

Liberty Media Simplifies, Starz Hunts Hits

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Liberty Media (LMCA) and its former subsidiary Starz (STRZA) reported earnings last week. LMCA is an asset play where value is created through its ownership of significant stakes in other public companies, including a majority interest in Sirius XM Satellite Radio and 25-30% stakes in Live Nation Entertainment (LYV) and Charter Communications (CHTR). LMCA also owns a variety of other investments generally connected to media and communications. Given LMCA does not operate an actual business, the earnings reports are usually just a chance to hear management thinking on strategies for enhancing the net asset value of the company’s portfolio. Given the steallar tracke record of LMCA’s controlling shareholder, John Malone, and his top lieutenant, Greg Maffei, I always look forward to the conference calls.

On the latest call, it became apparent that for now, LMCA has simplified its investment portfolio and balance sheet including building some liquidity for possible future investments. A recent transaction with Comcast was critical in this regard and included a buyback of about 5% of the outstanding shares. With a simpler profile, LMCA shares have closed the discount to net asset value to under 10%. This leaves the shares more directly connected to performance of SIRI, LYV, and CHTR. All three are in good shape fundamentally with significant upside in their own shares over the next year. Most of the speculation now revolves around CHTR as John Malone has made clear he wants to use CHTR as a vehicle to consolidate the non-Comcast cable industry in the United States. LMCA is likely to create extra value for itself by acting as a financier for any large merger involving CHTR. If SIRI, LYVV, and CHTR all perform as I hope, I can see LMCA shares trading up to $180+ before any incremental value is made by the Malone/Maffei deal making. LMCA remains an excellent investment.

Starz has now been independent for several quarters. The most recent results were mixed with decent subscriber growth and financial upside driven by the company’s content distribution business. The core business is the operation of the Starz and Encore pay TV channels. Starz is attempting to duplicate the success of HBO and Showtime in original programming. This would drive subscriptions and allow further financial upside through ownership of successful shows that are sold in digital and DVD form around the world. STRZA faces some pressure to find hit shows quickly as the company will lose its access to Disney movies after 2016. As STRZA rolls out new shows, a few of which are showing potential, the company has been aggressively buying its stock using the company’s high free cash flow and debt free balance sheet. STRZA would be a good acquisition for larger entertainment conglomerate but that has been the case for a couple of years since Liberty Media first made its interest in selling STRZA public. I think it is worth the wait to see if the company is sold or hit shows are developed that build value for investors. Upside is hard to determine but if the shares attained a premium valuation to peer entertainment companies, which the shares may not deserve absent a buyout, a target of $35-40 in 2014 is plausible.

LMCA and STRZA are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. LMCA and STRZA are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Liberty Global Set to Accelerate Growth in 2014

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Liberty Global (LBTYK) reported results that matched Wall Street expectations with rebased revenue and EBITDA growth of 3%. New subscriber growth surprised meaningfully to the upside following last quarter’s disappointing growth. Investors have been worried about the second half of 2013 growth due to tough competition in Netherlands and England and last quarter’s modest slowing in Germany. LBYTK shares moved sharply highly following the report, recovering much of their recent losses.

It appears there is one more tough quarter ahead in Netherlands and England before growth accelerates companywide in 2014. Liberty investors also have to deal with a high level of acquisition rumors that raise concerns about balance sheet leverage and the sustainability of share repurchase activity. History suggests a high level of trust in LBTYK management is warranted and patience with the shares recent consolidation will be well rewarded. Free cash flow per share north of $12 in 2017 is not a stretch and if that target is evident as we move through 2014 the shares should trade toward $100, providing 30% upside.

German, Switzerland, Belgium, and Chile drove growth for LBTYK in the latest quarter with revenue and EBITDA rising high single digits in all three markets. These markets also led the way in subscriber growth. Virgin Media grew very low single digits in England although this was better than feared given the highly competitive environment there due to aggressive sports promotions from BT. Virgin faces tough comp in the fourth quarter but management doubled merger synergies which should begin to accelerate growth in early 2014. Netherlands was the gig drag in the quarter with EBITDA falling 10%. Netherlands did see better than expected subscriber metrics, a sign that the bottom may be set in 2H13. KPN, the local telco has been very aggressive with uneconomic promotions and now that the company is going to remain independent rather than selling to Mexican telco behemoth America Movil, there is some hope that competitive intensity eases in 2014.

On the acquisition front, the latest rumors concern a bid for the portion of Dutch cable company Ziggo, of which LBTYK already owns more than 25%. A merger between the two largest cable companies in Netherlands would offer significant synergies and economies of scale.

LBTYK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. LBTYK is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Qualcomm Guidance Raises Questions

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Qualcomm (QCOM) reported 4Q13 results mostly in line with expectations. However, guidance for 2014 indicated slower growth in units and a slight decrease in average selling prices. The guidance led analysts to reduce their outlook for revenues and operating income for 2014. However, QCOM’s commitment to large share repurchases leaves earnings estimates unchanged at a little over $5.
Two issues are leading management to be cautious. First, QCOM is increasingly reliant on just Samsung and Apple, which dominate high end smartphones and use their buying power to keep QCOM pricing and margins in check. Second, QCOM’s strength at the high end leaves it underexposed to the booming market for low end smartphones, particularly in China.
I believe the cautious outlook warrants a reevaluation of the upside in QCOM’s shares. The company has an analyst meeting later this month which should provide greater clarity on the 2014 and longer term outlook. I think the shares are worth holding for now as management is very good and is likely to reassure investors at the meeting. In addition, the shares are not expensive. At less than 14 times forward earnings estimates without considering the company’s large cash balance. The shares have bounced off their post-earnings lows. I think that stability indicates underlying support for the bull thesis and keeps risk in check heading into the analyst meeting. As a result, I am comfortable continuing to own the shares while looking for further detail on the 2014 outlook and what it means for long-term growth. Lower expectations might be a good thing for QCOM shares after a long period as a Wall Street favorite.
QCOM is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. QCOM is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

CBS Lacks Usual Upside But Upside Intact

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CBS reported solid but unspectacular third quarter 2013 results. EPS matched Wall Street consensus of 76 cents, up from 64 cents a year ago. Revenue grew 11% but EBITDA was up only 4%. Revenue was a little ahead of estimates, while EBITDA fell slightly short. Unlike many recent quarters, CBS did not show an upside earnings surprise. CBS shares retreated following the report although the decline came amid a large sell-off in media stocks on a very poor day for the market.
CBS shares have performed exceptionally well and the bar was set very high for this quarter’s earnings report. High expectations probably had more to do with the pullback in the shares than the results. This has an issue throughout the media stock universe this quarter. At Northlake, we are focused on the fundamental operating prospects of a company’s business. In this regard, we find CBS remains well positioned with a less cyclical business mix and higher margins driving consistent return of capital to shareholders. A target in the upper $60s based on 20 times 2014 earnings estimates provides 20% upside and strongly supports continuing to own the shares.
The third and fourth quarters face difficult comparisons due to heavy political advertising in 2012, particularly at local TV stations. CBS also faces higher spending on programming as successful original programming is more critical than ever to sustain advertising growth and lock in higher retransmission fees. Fortunately, current ad trends remain strong at the local TV stations and national TV networks, with auto, communications, and other major categories picking up the slack from political.
In the third quarter, CBS did pull forward some revenue that probably overstated the results relative to expectations. In turn, fourth quarter estimates fell slightly. This may keep upside in the shares in check until further evidence of advertising gains appears or investors turn their attention to what is shaping up as a very strong 2014 with a return of political advertising, the spin-off of the Outdoor business, and another massive accelerated share repurchase. As long as U.S. economic growth remains sluggish but positive momentum, I think the upside in 2014 at CBS is worth waiting for.
CBS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. CBS is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Discovery Finds Love After Strong Quarter

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After a couple of quarters where Discovery Communications (DISCK) did not quite meet the high expectations the company has rightly created for itself, third quarter 2013 results hit the mark. Domestic advertising and affiliate growth were ahead of expectations. International growth was a little light but clear indications that the company’s acquisitions in Europe are working well was evident. Management confirmed 2013 guidance despite a one-time hit to expenses in the fourth quarter. Commentary surrounding 2014 was positive amid some concern that growth was set to slow.
DISCK earnings growth will be supplemented by its very healthy balance sheet and high free cash flow. Share purchases continue at a high pace despite the capital the company committed to its European acquisitions. It seems as though 2014 will be spent consolidating recent acquisitions, freeing 100% of free cash flow to be dedicated share repurchase.
The key risk to renewed positive sentiment on DISCK shares (up 5% in a flat market after the report) is any weakness in ratings for its domestic TV networks. Ratings can be volatile across large portfolio of networks like those owned by Discovery (Discovery Channel, TLC, Animal Planet, ID, OWN, and many more).
DISCK shares have lagged the market and peer media companies since early March. This was partially due to the last two quarters not meeting sky high expectations. With the tock going sideways and growth continuing, the premium multiple assigned DISCK shares had a chance to moderate. The strong third quarter and promising outlook suggests the shares can again lead the industry, reflecting the company’s superior growth profile. A move over $100 is possible with earnings heading to $4 next year and $5 in 2015.
DISCK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. DISCK is a new long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Small Cap and Growth Favored for November

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Northlake’s Market Cap model shifted from Mid Cap to Small Cap for November. As a result, client positions in the S&P 400 Mid Cap (MDY) have been swapped into the Russell 2000 (IWM). There was not change in the Style model, which is recommending Growth for the second consecutive month after a long run at value.
To be honest, I am a little wary of a shift to small cap after huge outperformance for this segment so far this year. The Russell 2000 is up 28% this year, ahead of the 23% gain in the S&P 500. October was the first month in a while where small cap lagged most of the other major averages. However, if you are going to use a model you cannot second guess it. The whole point of using models is to impose discipline. Furthermore, there are reasons to believe small cap can continue to lead, especially if the market follows its normal seasonality and rallies into year end. Northlake’s model is picking up the excellent breadth on this rally and a sustained high level of bullish sentiment that occurred after a period of bearish sentiment. These technical factors plus continued growth in the economy historically have favored small caps.
The new signal is a weak one, just barely over the line from mid cap. Ultimately, I think the big call until yearend is small or mid cap vs. large cap. Small and mid cap tend to correlate more highly with each other than either does with large cap.
The new growth signal initiated in October looks a little stronger this month. Growth is favored due to trend indicators, recent action in foreign exchange markets, and attractive relative valuation of growth stocks vs. value stocks.
Last month, the mid cap signal outperformed small cap but slightly lagged large cap. Growth and value produced almost identical returns in October, each matching the S&P 500. So far this year, the Style model has matched the S&P 500, while the Market Cap model slightly trails the benchmark.
IWF and IWM are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov.

Comcast Continues Excellent Performance

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Comcast (CMCSK) reported mixed results relative to consensus expectations but growth remains vibrant and the outlook is excellent. Financial results were good with mid-single digit revenue growth and modest margin expansion leading to high single digit growth in operating cash flow. There was modest disappointment with subscriber counts at cable but nothing outside the margin of error. NBC Universal continues to show a strong turnaround with a significant potential if the improved ratings at the NBC network hold through spring.
Comcast’s financial profile is superb and offers promise for significant boost to shareholder returns in early 2014. The company is ahead of schedule in reaching its targeted debt levels. This should mean a big boost to the share repurchase plan and dividend is coming early next year. There is also the possibility that Comcast increases its debt level modestly to further juice return of capital to shareholders. Management seems 100% committed to its debt targets but by any measure there is room for more debt given the stability of the financial model.
Management may be waiting on rumored industry consolidation in cable as the company has some capacity to add subscribers without violating government ownership limits. Scale truly matters in cable as Comcast has shown by outperforming the industry significantly over the past year. Industry pioneer John Malone is leading the charge for more industry consolidation, something that can benefit Comcast in two ways. First, it reveals the value in the cable business, which Comcast’s trading multiples arguably do not reflect. Second, participating in consolidation could allow Comcast to gain even more economies of scale and further improve the financial model.
A slight expansion in the multiple applied to Comcast’s cable business along with an industry average valuation for NBC Universal would lead to Comcast shares approaching $60. With business trends stable and financial strength unparalleled in the media industry, Comcast shares are worth owning.
CMCSK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. CMCSK is a new long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Another Solid Quarter and Guidance As Apple Ripens Again

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Apple reported better than expected earnings for the second consecutive quarter. Guidance for the December quarter was confusing but ultimately better than Wall Street expectations. This sets the stage for a continued recovery in Apple shares into year end. Datapoints on product sell through for the new iPhones and iPads and a possible deal with China Mobile for iPhone distribution are catalysts most likely to move the shares.
The biggest risk relates to the outlook for the March quarter. The timing of the rollout of iPhones this year on a geographic basis may pull some demand into the December quarter that was in the March quarter last year. In particular, China shipped in the March quarter in last year’s product cycle.
Thinking longer term the two big issues remain whether Apple needs a truly low cost iPhone and where gross margins end up. The new iPhones and iPads appear to support gross margins but many analysts feel that Apple has saturated the high end of the smartphone market and can no longer grow consistently without a low-priced phone. Furthermore, there is a worry that if Android gains too much market share, Apple’s big advantage with app developers will be lost and the network effect that drives Apple’s business model will suffer.
For now, I think it makes sense to continue to show patience. After a year of declining earnings, Apple appears poised to show growth in the December quarter. Comparisons are much easier in the March and June quarters as those are the periods during which gross margins were declining sharply from peak levels in 2012.
A return to growth should allow some multiple expansion for Apple shares. At 12 times the 2014 consensus estimate of $47, the shares would trade at $564 giving no credit to $143 cash per share on the balance sheet as of September 30th. One more good quarter and decent guidance for the March quarter and the shares could reach well north of $600 within three months.
Clearly this is a bullish case and risk exists that products do not sell well enough to meet earnings estimates. However, two straight above average quarters, well-reviewed new products, early indications that sales are good, and a better product mix that helps margins, suggest near-term optimism is warranted. For Northlake clients, that is good enough. If the stock works to $600 and above, we can worry about the long-term issues.
AAPL is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. AAPL is a new long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Google Finally Provides Upside That Triggers Shares

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Google (GOOG) finally reported a quarter that surpassed Wall Street estimates and satisfied investors. The stock had worked higher over the last few years despite never quite satisfying Wall Street. A bull market and solid core growth search carried the stock but it lacked the momentum of other high flyers with which it is often compared. Linked In, Netflix, and Facebook all produced stock gains well ahead of GOOG.
I continually stuck with GOOG for Northlake clients because I found the consistent 20% growth in the core online advertising business to be undervalued by investors. The stock was stuck between $850 and $900 from May until this month’s earnings report. Facebook, LinkedIn, Netflix, and Priceline rose between 30% and 100% over the same time frame. Despite what I thought was steady progress for GOOG on the earnings and business development front, it had become clear that the company needed to beat the street to free the stock to realize the potential I thought existed.
Well, that finally happened with the third quarter report. GOOG beat estimates. Most importantly, revenue trends remained at the 20% plus level for the core but margins showed upside to street expectations. If there was one thing that had been troubling GOOG shares, it was steady deterioration in operating margins as the company diversified and transitioned its business model to a mobile world. Upside in the third quarter margins excites investors and is leading to multiple expansion. The shares moved from $890 just prior to the report to the current $1,028 which is right at an all-time high.
Looking ahead, GOOG shares are trading about 20 times Wall Street estimates for 2014, which call for 18% growth. The company has about $43 billion in cash net of debt, representing about $130 in cash per share. I think the company deserves some credit for the cash, so you could argue the 20 P-E overstates the value by 1-2 multiple points.
I think the shares can rise another 20-30% if the GOOG shows that it can more regularly beat earnings estimates. The company is very hard to model and management provides limited guidance and really does not seem to care that much about quarterly results. GOOG truly does seem to be run for the lng-term.
If GOOG hits 2014 estimates for $52 in earnings I think the multiple can expand slightly driving the shares to $1,200 or up another 20%. There are very few megacap stocks grow anywhere near 20%, high single digits is good for most large cap blue chips.
If the company can string together a few better than expected quarters, Wall Street will start looking toward 2014 EPS of $54 or $55 and apply a higher multiple as fears about margins recede. This would put a bull case for the stock closer to $1,400 based on a 24 multiple and credit for the cash.
As long as GOOG sustains core growth near 20% and shows discipline on operating expenses, I think the shares will have enough upside to justify them as a core holding in Northlake client portfolios.
GOOG is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. GOOG is a new long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.