Year: 2017

A Valuation Framework for Bitcoin

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There is no new thing under the sun.

– The Bible

Disclosure first: This piece might be sacrilegious to many value investors. In Nov 2013 (yes, the last Bitcoin “bubble”), I put a small percent of my net worth then into Bitcoin. I have been holding and plan to hold them until it reaches my estimated value (showed below). Please do NOT see this piece as a defense to Bitcoin critics or as investment advices (In fact, I am always ready to change my view, however I just didn’t come across convincing counter-arguments. Or put it differently, I’ve been most of the critics’ place and held similar suspicion before but changed later). I see this piece as an alternative thinking framework to a potential significant invention in human history, and I welcome any sort of comments/feedbacks/critiques.

A few lemmas I want to establish before going further:

  1. The universe we live in consists of two and only two elements: energy and information. (mass, or material, could be unified to energy by Einstein’s famous equation: E = MC^2)
  2. Bitcoin’s value is binary (i.e. it should either 0 or something very large, there is no middle ground)
  3. If “intrinsic value” is defined as “present value of expected cash flow from a value producing asset”, Bitcoin (as well as all kinds of money) has NO intrinsic value.
  4. Global governments as a whole, is not as prudent and resposible as developed counties’.
  5. I have been wrong and could be wrong on Bitcoin

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YY – an Under-Followed Chinese TMT Play with Margin of Safety

taovalue China, Investing, Technology , , , , , , , ,

YY is a Chinese video live streaming + social networking business with two main operational segments, YY Live (the general entertainment content streaming, a loose equivalent of Periscope) and Huya (Gaming content streaming, an equivalent of Twitch). Its share has risen 135% YTD and valuation moved from a dirt cheap 11 trailing P/E by 2016 to a less cheap trailing 16 P/E (still cheap compared to other Chinese Tech peers), so why I am still interested in this name?

In short, a debt-free cash-gushing main business poised to take more market share as the general entertainment streaming market start to mature and consolidate, plus a fast growing gaming/e-sports streaming platform close to turn profitable and filing IPO in a favorable secular tailwind should warrant a market average valuation.  In addition, I noticed both platforms achieved market leading positions without promotion and successfully fended off competitors who tried to copy their business model. Add to it, YY has a deep-thinking founder-CEO with some track records of continuous innovation in fast changing market environment. All in all, this is something I think should be priced at a premium to market. My neutral assumption based valuation shows there still could be 29% upside, and a conservative assumption based valuation shows 0% downside. (optimistic assumption indicates 90% upside, but I don’t have to count on it)

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Incentive System Evaluation – a Case Study of Coty

taovalue Business, Corporate Governance , , ,

Coty is a new position last quarter. As mentioned in my Q3 letter, I think the “system” factor of Coty is very impressive. As an effort to document my own learning as well as knowledge sharing, I here formalize my notes. It’s not intended as a support for my judgement, rather I think it would be beneficial in general for anyone who involves in a principal-agent situation (e.g. board of directors, entrepreneurs, etc.) for designing or assessing incentive systems.

Investing community generally agree that a management with owner mindset is preferred. But how exactly could one evaluate “owner mindset”? One way is to talk to the management in person and make assessment qualitatively, however that’s not possible for all shareholders. CEOs typically are also very good at marketing themselves, which adds another layer of uncertainty. These are the reasons why some investors prefer founder CEOs, who are inherently owners.

Coty’s incentive system has following uncommon designs based on a heavy ownership philosophy.

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Book Notes – Big Money Thinks Small (by Joel Tillinghast)

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Joel Tillinghast is a tenured Fidelity portfolio manager for its Low-Priced fund, however his name was known by few, including me, until recently. Tillinghast recently published his first book – Big Money Thinks Small last month, and was featured in a Barron’s interview in 08/12/2017 (Link here). When I first saw his interview, I found this manager interesting for his ability to consistently beat his benchmark, Russell 2000, for years with 100+ holdings. This diversified approach is very different than the “traditional” school of value investing, who advocates concentrated bets. Another impressive trait of Tillinghast’s fund is the extreme low turnover – only 9% a year. This means he on average holds each position for over 10 years!

For the sake of these special traits, I decide to pick up his book and try to see if there is anything I could learn from him.

BigMoneyThinksSmall

Overall, I think it is a valuable book, especially for someone had some investing experiences and is eager for historical investing case studies. Here are my key thoughts/lessons:

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Great Oriental Investors – Shoucheng Zhang, a Quantum Polymath (Award Winning Physicist and VC Investor at once)

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As I mentioned in my first investor letter, my investing philosophy had deep roots in oriental philosophies. For this reason, I always find those investors who are able to master both eastern and western mental models extremely intriguing. On surface, lots of eastern mental models & philosophies resonate with well-known western principles already, but I also believe they have more unrecognized value to investing practices. I am planning to start a series to document all investors that fits this category, to document my lessons learned from them and to share with my readers their insights (many of which aren’t available in English media).

 

The first one is Shoucheng Zhang (Wikipedia Link). Zhang is an ingenious physicist, to say the least. He got admitted by one of the top universities in China purely by self-study after the Culture Revolution ended in 1978 when he was only 15, then went abroad and finished his PhD by 24. His best known finding is probably topological insulators, for which he was awarded a Dirac Medal in 2012. His work was estimated by Thompson Reuters to be able to win Nobel Prize in 2014 (Link). Zhang is also a tech VC investor. He is said to be one of the early investors of VMWare (as he’s a neighbor of the co-founder Mendel Rosenblum who is also a Stanford professor) and made hundred bagger on it. He officially started his profession investing career in 2013 by founding Danhua Capital (website link), an early/growth stage VC focusing on disruptive technologies.

 

Like Charlie Munger, Zhang also see Benjamin Franklin as an archetype. Zhang mentioned that he struggled at a young age on whether he should aspire to be a scientist or an entrepreneur, until he realized he really could be both after reading about Franklin, one of the greatest polymaths in history. Not surprisingly, he is also a fan of multi-disciplinary mental models. As a theoretical physicist, his application of quantum physics principles to investing (and life) is the most interesting insights among other thing. Additionally, contradicting to stereotype of physicists, he seems to have strong interests in Aesthetics.

 

Zhang’s key philosophy can be summarized by a quote he constantly mentioned in multiple interviews: “Complexity out of Simplicity” or “First Principle”. Before moving on, I think it would be beneficial to expand on the “First Principle” (Wikipedia link) as it initially appeared foreign to me. My understanding is that first principle is a thing/principle/notion which is in its most fundamental form and is self-evident without proof or deduction.  That is where you want to start your learning/thinking process.

 

Some of my favorite thoughts of Zhang (paraphrased) are below:

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All About Moats – Book Notes of Pat Dorsey’s Two Books

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If you haven’t heard of Pat Dorsey, here is a quick intro for you: He started his career at Morningstar as a sell side analyst, moved up to the head of the reach team in a few year and stayed there for about a decade. After leaving Morningstar, he started his own firm Dorsey Asset Management in 2014. Although his track record as a fund manager is yet to be tested, I found his books very insightful, especially for firm’s economic moat/competitiveness study.

 

Dorsey is the author of below two books:

Image result for The Five Rules for Successful Stock InvestingImage result for The Little Book that Builds Wealth

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“Sun Tzu’s Five Factors” Business Analysis Framework

taovalue Investing, Investment Process, Philosophy , , ,

[I recently finished my first quarterly letter to my investors, who are some close family members and friends. Below is an excerpt from the investment process section, where I spent most of the time explaining my unique (at least I think) business analysis framework, which is a combination of Sun Tzu‘s Five Factors (based on the Art of War) & checklist method.]

 

Investment Approach – The Process

I will start with where I spend my resources and our capital to. It’s mainly 3 investment themes: special situations, distressed assets and great operations at reasonable price. The core idea of all three is “buy low sell high”, however the way of analysis for each is somewhat different.

  • In special situations category, I look for entities undergoing some type of corporate event that might lead to a mismatch of value and price (e.g. depressed prices due to forced sells, or under-appreciated prospect that could increase the value). Examples of special situation investments include, but are not limited to, spinoffs, corporate restructurings, mergers, liquidations, and rights
  • In distressed assets category, I look for asset that is priced well below its value due to unfavorable developments. a.k.a. “There is always a price to make a crappy business an attractive investment.” Since the risky nature of distressed assets, heavy analysis is performed on balance sheet and solvency side. It also is the most time consuming from tracking perspective as any new development and disclosure could significantly change the value evaluation outcome. I typically size ideas in this category conservatively. Examples of distressed assets investment include, but are not limited to, cigar butts, scandals and high yield corporate debts.
  • In great operations at reasonable price category, I look for, as the name itself says, great operating businesses at reasonable price. This is what Buffett does for the late part of his career, and examples include well known Berkshire Hathaway’s holdings of Coca Cola, American Express and Wells Fargo, etc. The return of this category comes not from the price/value mismatch in current day per se, rather from the compounding growth of the value in future. Thus, my research spent on this category is mainly on the industry, business model and moat of the business, which drive the value compounding ability of an entity.

Next, I will talk about the process of how I approach analyzing an opportunity. I usually start with the business itself, trying to understand the business model, industry landscape & whether there is moat around the business. Then I will move on to balance sheet, to get an idea of what assets it has, last to its profitability (i.e. income statement). There are well documented metrics and valuation methods for analyzing the latter two, but the first (also the most important, in my opinion) item – business analysis – may worth more elaboration.

I use a self-developed “Sun Tzu’s 5 factors” method to analyze businesses. Sun Tzu’s classical military treatise, The Art of War, starts with the 5 most important factors affecting wars: Tao/Dao (道), Meteorology (天), Topography (地), Commander (将), System (法).

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Chinese ADR “Go-Private” Deals Overview-  A Changyou Buyout Inspired Study

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On 5/22/2017, Changyou [CYOU] received a preliminary non-binding offer from its chairman Dr. Charles Zhang, who is also the CEO and Chairman of Changyou’s parent company Sohu, to take the company private with and offer of $42.10 per ADS. The offer letter can be seen here: http://ir.changyou.com/05_22_2017.shtml. It is interesting that it is Charles Zhang, the person, not the parent company Sohu, to make the acquisition.

As a current CYOU shareholder, I think it’s a OK deal despite I had higher expectation of the turnaround execution which just started to show some positive signs. As of 5/31/2017, there is still about 8% spread between the close price of $38.9 and offer price $42.1. If the deal could be closed timely, it would be a good risk arbitrage opportunity.

Inspired by this event, below I did a general study of all the Chinese ADR “go-private” deals in past few years. I’m keen to get answers to these 3 questions (which could help me evaluate upcoming similar deals’ risk/reward):

  1. How much percent of these deals fell through?
  2. What are the characteristics of the failed deals? (does CYOU have any of these traits?)
  3. How long do they usually take to close?

 

History of Chinese ADR Privatization Deals

Let’s begin with a rough understanding of a typical ADR privatization process. Credit to a Credit Suisse’s study [link here], here is a great chart showing the 6 milestones of such a process.

CPD_GoPrivateDealProcess

It is also important to understand the main incentive of such privatization deals, specifically for these US listed Chinese companies. Like most of the PE backed LBO deals, Chinese ADR privatization deals also target for a relist for higher valuation. However the difference is that, rather than streamlining and growing the businesses for a few year in private arms (in LBO cases), the Chinese ADR companies could seek a faster re-valuation by relisting the firm to its home market (which offered richer valuation, especially back in 2015 before the crash). This also explained why there were so many proposed deals announced in 2015.

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