Tag Archives: ideas

Open Letter To Norway’s Sovereign Wealth Fund: Target Lions Gate Entertainment

Norway’s Sovereign Wealth Fund’s CEO Yngve Slyngstad recently told the Financial Times that the fund is looking to restructure compensations plans at certain companies in its portfolio. “We have so far looked at this in a way that has focused on pay structures rather than pay levels…We think, due to the way the issue of executive remuneration has developed, that we will have to look at what an appropriate level of executive remuneration is as well.” As the fund looks for a company it can target, we offer a candidate: Lions Gate Entertainment (NYSE: LGF ). How Reforming Executive Compensation Creates Value For Investors We applaud the fund for looking at both the structure and the size of executive compensation packages. Many of the fund’s 9,000 holdings overpay their executives for hitting targets that don’t create shareholder value. Over the past several months, we’ve written a number of articles about the risks that excessive and misaligned executive compensation plans pose to investors. We’ve dissected examples of poor compensation plans leading to significant shareholder value destruction, from Valeant (NYSE: VRX ) to Men’s Wearhouse (NYSE: TLRD ). When boards of directors pay executives based on misleading and easily manipulated performance metrics, they harm investors in two ways. Immediate wasted money: the compensation going to executives, in the form of cash or equity, decreases the amount of cash flows available to investors. Long-term value destruction: poorly designed compensation plans incentivize behavior that leads to poor operational and strategic decisions with respect to the long-term interests of shareholders. For more evidence of the outsized impact of compensation plans on a business, look no further than Home Depot (NYSE: HD ). From 2001-2006, CEO Robert Nardelli earned $240 million in compensation. For comparison, his counterpart at Lowe’s (NYSE: LOW ) made around $30 million over that same time, about 1/8th of Nardelli’s compensation despite Lowe’s being between 1/4th to 1/3rd Home Depot’s size. In addition, Nardelli’s compensation was heavily tied to EPS-which he boosted by buying back billions of dollars of shares every year-and sales growth, which he accomplished by investing heavily in the company’s low margin, low return on invested capital ( ROIC ) wholesale business. These moves helped Nardelli’s bonus, but they created little value for investors. During Nardelli’s tenure, Home Depot’s stock was essentially flat. In the midst of a bull market and a housing bubble, Home Depot delivered almost no returns to shareholders! In 2006, activist Ralph Whitworth took a 1.2% stake in Home Depot and began agitating for a change to the company’s executive compensation practices. He was able to force Nardelli out, significantly reduce CEO pay to less than $10 million a year, and institute a compensation plan with long-term incentives for increasing ROIC. Figure 1: Stock Prices Move In Line With Return On Invested Capital Click to enlarge Sources: New Constructs, LLC and company filings Figure 1 shows how Home Depot significantly underperformed Lowe’s stock during Nardelli’s tenure. It also shows how it significantly outperformed after Whitworth’s reforms, gaining more than 200%. This link between stock prices and ROIC is intuitive and well-known among more diligent investors. Increasing ROIC is the best way to create long-term value for shareholders . Linking executive compensation to ROIC has helped companies such as AutoZone (NYSE: AZO ) outperform the market for many years. Don’t just take our word for it either. S&P Capital IQ recently released a study showing a significant statistical link between ROIC improvement and outperformance. Finding A Target: Lions Gate Entertainment Lions Gate turned heads when it handed CEO Jon Feltheimer over $60 million in equity awards as part of a new five-year contract. The board lauded the company’s strong performance in 2014 as justification for the large stock award, but our numbers show that ROIC actually fell from 12.1% to 11.1% that year. As Figure 2 shows, the problem goes far beyond just 2014. Over the past five years, Lions Gate has spent a larger portion of its enterprise value on executive compensation than any of the companies in its self-identified peer group for which we have five years of data. Figure 2: High Executive Compensation + Poor Return On Invested Capital = Bad News For Investors Click to enlarge Sources: New Constructs, LLC and company filings. “TTM” = Trailing Twelve Months. Figure 2 also shows that Lions Gate’s ROIC has dropped to just 2.3%, putting it near the bottom of its peer group. That’s due in part to disappointing results from several films this year. It also reflects a compensation plan that does a poor job aligning executive incentives with shareholder interests. Both annual and long-term incentive bonuses are tied to a non-GAAP metric called “adjusted EBITDA.” This metric does a poor job of measuring shareholder value creation for several reasons: Excluding depreciation and amortization means that executives are not held accountable for capital allocation. They can boost adjusted EBITDA by investing heavily in low return projects and excluding the costs. Adjusted EBITDA excludes stock-based compensation, which is a real expense and should be accounted for. Since executives are largely paid in stock, they get to largely exclude their own compensation when calculating profitability. Adjusted EBITDA makes a number of adjustments for purchase accounting, start-up losses, and backstopped expenses. These are real costs, and executives have a high degree of discretion when it comes to calculating these numbers so they can hit their targets. Tying executive compensation to such a flawed metric is a recipe for low ROIC and significant shareholder dilution. Sure enough, going back to 2005 Lions Gate has earned an ROIC below its cost of capital ( WACC ) in every year except 2013-2015, when it was buoyed by the success of the (now-ended) Hunger Games franchise. Over that time, its share count increased by 47%. Succeeding through creating original content is tough. It’s even tougher when management is not a responsible steward of capital. It should come as no surprise that the most successful company in the industry, Disney (NYSE: DIS ), is also one of the few that links executive compensation directly to ROIC. If Lions Gate wants to have any hope of creating long-term value for shareholders, it needs to cut back on executive compensation and better align compensation incentives with investors’ best interests. Norway’s Sovereign Wealth Fund should consider Lions Gate as its first target in its campaign against excessive executive compensation. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Best And Worst Q2’16: Telecom Services ETFs, Mutual Funds And Key Holdings

The Telecom Services sector ranks eighth out of the ten sectors as detailed in our Q2’16 Sector Ratings for ETFs and Mutual Funds report. Last quarter , the Telecom Services sector ranked eighth as well. It gets our Dangerous rating, which is based on aggregation of ratings of six ETFs and 15 mutual funds in the Telecom Services sector. See a recap of our Q1’16 Sector Ratings here . Figure 1 ranks from best to worst the five Telecom Services ETFs that meet our liquidity standards and Figure 2 shows the five best and worst rated Telecom Services mutual funds. Not all Telecom Services sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 24 to 59). This variation creates drastically different investment implications and, therefore, ratings. Investors should not buy any Telecom Services ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off. Figure 1: ETFs with the Best & Worst Ratings – Top 5 Click to enlarge Sources: New Constructs, LLC and company filings Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 Click to enlarge * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Five funds are excluded from Figure 2 because their total net assets are below $100 million and do not meet our liquidity minimums. State Street SPDR S&P Telecom ETF (NYSEARCA: XTL ) is the top-rated Telecom Services ETF and Fidelity Select Wireless Portfolio (MUTF: FWRLX ) is the top-rated Telecom Services mutual fund. Both earn a Neutral rating. iShares Global Telecom ETF (NYSEARCA: IXP ) is the worst rated Telecom Services ETF and Fidelity Advisor Telecommunications Fund (MUTF: FTUAX ) is the worst rated Telecom Services mutual fund. IXP earns a Dangerous rating and FTUAX earns a Very Dangerous rating. 45 stocks of the 3000+ we cover are classified as Telecom Services stocks, but due to style drift, Telecom Services ETFs and mutual funds hold 59 stocks. Atlantic Tele-Network (NASDAQ: ATNI ) is one of our favorite stocks held by Telecom Services ETFs and mutual funds and earns an Attractive rating. Over the past five years, Atlantic Tele-Network has grown after-tax profit ( NOPAT ) by 13% compounded annually. The company has improved its return on invested capital ( ROIC ) from 5% in 2010 to 10% in 2015 while NOPAT margins have increased from 5% to 17% over the same time period. This impressive fundamental growth could help explain why ATNI is up over 90% over the past five years. However, shares remain undervalued. At its current price of $73/share, ATNI has a price-to-economic book value ( PEBV ) ratio of 1.1. This ratio means that the market expects ATNI’s to grow its NOPAT by only 10% over its remaining life. If Atlantic Tele-Network can grow NOPAT by just 10% compounded annually for the next five years , the stock is worth $98/share today – a 36% upside. CenturyLink (NYSE: CTL ) is one of our least favorite stocks held by FTUAX and earns a Dangerous rating. CenturyLink was placed in the Danger Zone in February 2015 . CTL at one point was down over 40% since the Danger Zone was published, but has since rebounded and has become significantly overvalued again. Over the past decade, CenturyLink’s economic earnings have declined from -$152 million to -$1.2 billion. In fact, the company has never generated positive economic earnings in any year of our model, which dates back to 1998. The company’s ROIC peaked in 2009 at 7% and has since fallen to a bottom-quintile 4%. Despite the deterioration of CenturyLink’s business, the stock is priced for impressive profit growth. To justify its current price of $33/share, CTL must grow NOPAT by 8% compounded annually for the next 11 years . Given the decline in CTL’s operations, this expectation seems overly optimistic. Figures 3 and 4 show the rating landscape of all Telecom Services ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst ETFs Click to enlarge Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds Click to enlarge Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Hitting A Home Run With Our SPY Put Spread

We have another home run here, a 13.02% profit in only 6 trading days. Friday the 13th seems as good a day as any to take a profit. Also, we are realizing 87.17%of the maximum potential profit in the S&P 500 SPDR’s (NYSEARCA: SPY ) May , 2016 $210-$213 in-the-money vertical bear put spread. In the highly unlikely event that we have a major rally in stocks next week, we now have new dry powder to play with, having cut our net short position in the from 40% to 20%. If you have the ProShares Short S&P 500 Short Fund ETF (NYSEARCA: SH ) (click here for the prospectus here ), or the ProShares Ultra Short S&P 500 Short Fund 2X ETF (NYSEARCA: SDS ) (click here for the prospectus here ), keep them. We are going lower. This trade takes our performance up to a blockbuster 10.37% so far in May, and 11.58% since the beginning of 2016. These are numbers almost anyone would kill for. I never bought this week’s rally in the Dow Average for two seconds. No volume, no news, and no cross asset class confirmations meant it was not to be believed. It was just another opportunity for the high frequency traders to pick the pockets of hedge funds by squeezing them out of their shorts, which they have been doing on a weekly basis all year. That conviction allowed me to hang on to my aggressive 40% net short position, until now. This takes my Trade Alert performance to a new all time high of over 203.26%. Better yet, WE ARE POISED TO MAKE AS MUCH AS A 14% PROFIT BY THE END OF NEXT WEEK WITH OUR REMAINING POSITIONS! To remind you of why we are short the S&P 500 in a major way, let me refresh your memories. It’s all about the strong dollar. A robust buck diminishes the foreign earnings of the big American multinationals, major components of the S&P 500. I think it is much more likely that stocks grind down in coming weeks to first retest the unchanged on 2016 level at $2,043, and then the 200-day moving average at $2,012. Share prices are anything but inspirational here. Price earnings multiples are at all time highs at 19X. The calendar is hugely negative. Soggy and heavily financially engineered Q1 earnings reports came and went. Huge hedge fund shorts have been covered with large losses, and no one is in a rush to jump back into the short side. Oh, and the is bumping up against granite like two year resistance at $2014 that will take months to break through in the best case. Did I mention that US equity mutual funds have been net sellers of stock since 2014? This position is also a hedge against what I call “The Dreaded Flat Line of Death” Scenario. This is where the market doesn’t move at all over a prolonged period of time and no one makes any money at all, except us. If I am right on all of this May will come in as the most profitable month for the Mad Hedge Fund Trader Trade Alert Service in more than a year. For new subscribers, your timing is perfect! To see how to enter this trade in your online platform, please look at the order ticket below, which I pulled off of optionshouse . The best execution can be had by placing your bid for the entire spread in the middle market and waiting for the market to come to you. The difference between the bid and the offer on these deep in-the-money spread trades can be enormous. Don’t execute the legs individually or you will end up losing much of your profit. Spread pricing can be very volatile on expiration months farther out. Here are the specific trades you need to execute this position: Sell 37 May, 2016 $213 puts at………….….……$8.40 Buy to cover short 37 May, 2016 $210 puts at…..$5.45 Net Cost:…………………………………………………..$2.95 Potential Profit: $2.95 – $2.61 = $0.34 (37 X 100 X $0.34) = $1,258 or 13.02% profit in 6 trading days. Time for Some Downside Protection Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.