Monthly Archives: October 2016

One Direction

Goldman Sachs says “we have more potential for shocks right now”. Deutsche Bank and Bank of America Merrill Lynch predict a pick-up in volatility to hit equities. The ever positive Albert Edwards of Socgen points to a recent IMF report on debt and trashes the Fed with the quip “these dudes will never identify an asset bubble at least before the event!

In the IMF report referenced above, and other reports published by the IMF this month, there is some interesting analysis and a sample of the accompanying graphs are reproduced below.

All of these graphs show trends going inexorably in one direction. Add in dollops of (not unrelated) political risk particularly in the UK and across Europe, and that direction looks like trouble ahead.

click to enlargeimf-gross-global-debt-as-of-gdp

click to enlargeimf-private-debt-during-deleveraging-periods

click to enlargeimf-decomposition-of-equity-valuations-october-2016

click to enlargeimf-global-real-rates

click to enlargeimf-report-sovereign-bond-yields-and-term-premiums

click to enlargeimf-report-banking-sector

click to enlargeimf-report-pension-deficits

Trinity Meltdown

In May last year I posted on an undisciplined investment, Trinity Biotech (TRIB), which I bought at $21 per share and, after ignoring some basic investing rules, didn’t sell until it hit $16. I had thought that the underlying metrics of TRIB existing business would improve, with a big upside potential with the FDA approval of its Meritas Troponin Point-of-Care test (as outlined in this post). Since last year, I have kept an eye on the firm as their operating results continued to be uninspiring, as per the graph below.

click to enlargetrinity-biotech-2011-to-q22016-revenue-operating-profit

I continued to monitor the firm from afar to see how the FDA approval was progressing, for curiosity sake more than anything else (the investment case was similar a coin toss given the operating results and I have, thankfully, grown out of such gambles). The timing of any final approval was dependent upon FDA queries but Q4 was been talked of as a possible time for a final FDA decision.

It has therefore come as a considerable shock to all stakeholders, and a 50% collapse in the share price, when TRIB announced early on Tuesday that it has withdrawn its FDA application for the Troponin test on the advice of the FDA itself. Analysts representing investors vented their anger at the company’s management on the conference call on the news (worth a listen if you are so inclined).

I genuinely felt sorry for management as they tried to explain the “devastating news” about how they could have got the FDA approval so wrong. Although the FDA would not go into the gritty details on a 30 minute call communicating the news to management behind their “minded to refuse” position, TRIB’s management were restrained in expressing their (obviously very disappointed) view that the FDA had moved the goal posts in their assessment criteria. The FDA will give TRIB more detail on their decision over the coming months (strangely only on the condition that TRIB withdrew their application).

Management expressed their view, based upon the information from the FDA call, that any new application was unlikely given the large R&D expenses needed to address the issues raised and announced they would shutter the programme, reducing their annual capitalised expenses from $9 million to $1.5 million including the closure of their Swedish facility. Given they capitalise most of these expenses, the impact will primarily be on cash-flow rather than on the P&L (they may manage to be cash-flow neutral on a pro-forma basis).  Insight into future operating results and what the balance sheet will look like after the write-offs needed on this withdrawal may come with the Q3 results.

At a share price of approx $6.50, TRIB indicated that their Board would likely instigate a large buy-back programme after the early release of their Q3 results (likely due by mid October). With $85 million of cash left from their $100 million convertible debt, TRIB has the firepower if it can get to positive cash-flow on an operating basis in the near term. Analysts were very blunt in their reaction, stating that management now had a major credibility issue and that a sale of the firm should now be the priority.

All in all, a sad day for TRIB, its employees and its future prospects. And, of course, for its shareholders.

Restrict the Renters?

It is no surprise that the populist revolt against globalisation in many developed countries is causing concern amongst the so called elite. The philosophy of the Economist magazine is based upon its founder’s opposition to the protectionist Corn Laws in 1843. It is therefore predictable that they would mount a strong argument for the benefits of free trade in their latest addition, citing multiple research sources. The Economist concludes that “a three pronged agenda of demand management, active labour-market policies and boosting competition would go a long way to tackling the problems that are unfairly laid at the door of globalisation”.

One of the studies referenced in the Economist articles which catch my eye is that by Jason Furman of the Council of Economic Advisors in the US. The graph below from Furman’s report shows the growth in return on invested capital (excluding goodwill)  of US publically quoted firms and the stunning divergence of those in the top 75th and 90th percentiles.

click to enlargereturn-on-invested-capital-us-nonfinancial-public-firms

These top firms, primarily in the technology sector, have increased their return on invested capital (ROIC) from 3 times the median in the 1990s to 8 times today, dramatically demonstrating their ability to generate economic rent in the digitized world we now live in.

Furman’s report includes the following paragraph:

“Traditionally, price fixing and collusion could be detected in the communications between businesses. The task of detecting undesirable price behaviour becomes more difficult with the use of increasingly complex algorithms for setting prices. This type of algorithmic price setting can lead to undesirable price behaviour, sometimes even unintentionally. The use of advanced machine learning algorithms to set prices and adapt product functionality would further increase opacity. Competition policy in the digital age brings with it new challenges for policymakers.”

IT firms have the highest operating margins of any sector in the S&P500, as can be seen below.

click to enlargesp-500-operating-profit-margins-by-sector

And the increasing size of these technology firms have contributed materially to the increase in the overall operating margin of the S&P500, as can also be seen below. These expanding margins are a big factor in the rise of the equity market since 2009.

click to enlargesp-500-historical-operating-profit-margins

It is somewhat ironic that one of the actions which may be needed to show the benefits of free trade and globalisation to citizens in the developed world is coherent policies to restrict the power of economic rent generating technology giants so prevalent in our world today…