MorningWord 1/12/15: Picking On Stock Pickers

by Dan January 12, 2015 9:29 am • Commentary

Interesting read on the last night titled “Hedge Funds Take Cautious Line on Stocks” suggesting that a sharp decline in the use of leverage by large hedge funds, coupled with their under-performance in 2014 are evidence of declining confidence in the stock market’s ability to rally, or at least the difficulty for stockpickers to outperform the broad market.

At one point in mid 2014 I remember famed activist investor Carl Icahn making comment on CNBC that he is seeing fewer and fewer suitable targets for his style of investing.  At the time I thought it was pretty interesting especially given the fact that two of his most high profile picks to click were mega-cap tech stocks, Apple (AAPL) & eBay (EBAY), suggesting safety in size and balance sheet.  Icahn had some sub $10 billion targets in 2014 like Family Dollar (FDO) and Hertz (HTZ), but many of his single digit billion market cap holdings took a beating in 2014, like Herbalife (HLF), Nuance Communication (NUAN) and Transocean (RIG), all down between 30 and 60% from their 52 week highs.  As it relates to Mr. Icahn though, I think it is important to note that his more than 40% gains in his AAPL holdings likely more than made up for the above losses.  Intent wasn’t to pick on Icahn’s misses of late, the guy has been on fire, and who am I to judge.

In this morning’s Notable Options Activity post, I highlighted a large, bearish trade in NUAN that caught my eye, as it appears at least one holder is looking for some near term protection:

NUAN – total options volume ran 6x avg daily volume, with more than half the volume coming in one trade. When the stock was $13.65 (also a new 52 week low) a trader paid .35 for 20,000 Feb 13 puts to open.  These puts are likely dollar cheap protection for a long, or a fairly reasonable vol purchase into the company’s fiscal Q1 results that should fall in Feb expiration. Implied vol should rise into the mid to high 40s prior to results:

NUAN 1yr chart of 30 day at the money IV from Bloomberg

To be fair I am not sure what Mr. Icahn’s objective is with his 60 million shares, or about 19% of the shares outstanding. But the stock’s precipitous decline and drop in cash on balance sheet (cut in half since the end of fiscal 2012) is causing the stock’s leverage ratio to look a tad high ( $4.4 billion market cap, $588 in cash and $2.1 billion in debt).  The stock is cheap at 12x expected 2015 earnings, if you believe those estimates, but low single digit sales growth ain’t gonna get it done, and I am not sure what the end game is.  If the jig is up for stockpicking, stocks like NUAN are not the sort of names you want to step into at this stage of the game.

Speaking of activists, On Friday’s Options Action on CNBC my friends Mike Khouw and Carter expressed a bearish trade idea in QCOM. I agreed with that though process (read here) but also think that on on the next gap lower this stock could be on an activist’s radar:

I have taken a couple shots on the long side in QCOM in the last year, the most recent back in November (read here).  The thought process was fairly simple, the stock is cheap, estimates have come done a lot over the last year few quarters, the company has the potential to buy back a ton of stock, with 26% of their market cap in cash with no debt, they pay a dividend that yields 2.25% and they have a near monopoly on smartphone chips.  In this easy money environment, I am shocked the company has not been targeted by activist investors forcing them to lever up and buyback a lot of stock.  Additionally, it is my view that the company should merge with computer and server chip behemoth Intel (INTC) as their efforts in mobile chips have yielded billions of dollars in losses and will likely never catch QCOM.  But I guess that is pie in the sky sort of stuff, the likelihood of a merger is low, and playing for activist involvement doesn’t sound much like an investment strategy. So I am with Mike and Carter, one more gap back towards the 52 week lows in the highs $60s could be the spot to step in on the long side.

In sum, who knows what 2015 will bring. But most stock pickers will tell you that 2014 was NOT easy. But to be fair when is it??