Wednesday, 14 July 2021 07:53

Retail investors guide to IPO's

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Every month, Mark Draper (GEM Capital) writes an article about investing for the Australian Financial Review.  

This  month he writes about how retail investors should think about IPO's (initial public offerings or floats).  This article appeared in the AFR during July 2021.

 

Every retail investor dreams about doubling their money on day one of a hot IPO (initial public offering).  But Myer, Dick Smith and Nuix demonstrate that not all IPO’s turn out to be profitable.  With the likelihood of a flood of IPO’s in the second half of the year, investors should dust off the IPO playbook to ensure they don’t end up owning the next Dick Smith.

Hugh Dive (Chief Investment Officer, Atlas Funds Management) believes that the most important question for an investor to ask is who is the vendor and why are they selling.  Historically investors tend to do well where the IPO is a spin-off from a large company exiting a line of business, or the vendors are using the proceeds to expand their business.  IPOs, where the owners are looking solely to exit the business entirely (such as in the 2009 Myer IPO), tend to see poor outcomes for investors.

Investors also need to understand whether the vendor will continue to own any shares post IPO and ‘have skin in the game’ and for how long.  While continued vendor ownership doesn’t guarantee success, it does result in some alignment of interests with new shareholders at least in the short term.

Vince Pezzullo (Deputy Head of Equities, Perpetual) firmly believes that any IPO candidate must fit in with the investor’s usual investment strategy.  Retail investors in the past have been guilty of chasing a quick trading profit via IPO’s, often deviating from the types of investments they would usually make.  

Matt Williams (Portfolio Manager, Airlie Funds Management) agrees and says that while it might sound simple, the IPO has to be a good business with good prospects.  Some ingredients to determine whether the IPO is a good business would include the level of recurring earnings, debt levels and whether the industry sector has a favourable outlook.

The difficulty facing retail investors wishing to participate in IPO’s is access to information.  IPO investors are confronted with the task of understanding a new company with limited and often misleading financial data often referred to as pro-forma accounting within a brief marketing period.  Some of the accounting tricks that IPO’s have used in the past include amortising expenses so costs are transferred from the profit and loss account to the balance sheet, writing down of inventory pre IPO to artificially boost profitability post IPO, and cutting regular maintenance expenditure to boost profit.  Investors would be wise to read the cash flow statements and balance sheet positions in the prospectus to look for red flags.

The prospectus is generally considered an unfriendly document to retail investors due to its length and complexity.  Williams says that before investing in an IPO it is critical investors do their homework so they know what they are buying.  This involves reading the prospectus, particularly the ‘bad stuff’ including the Key Risks section.  Usually in the key risks section there is information showing the sensitivities to profitability should certain conditions change such as interest rates, currency, input costs etc.  Williams believes this is critical in assisting the investor make a decision on what to do next after the IPO lists.

If an investor can get comfortable with the quality of the IPO on offer, Pezzullo then suggests looking at whether the price is attractive.  Assessing the IPO price compared to other listed companies in the IPO’s peer group would be a useful measure of this.

Dive says there is a fundamental informational imbalance between the seller and the buyer of the IPO.  The seller knows the business intimately and is choosing the time to sell their stake in the business to be IPO’d at the time when conditions are most favourable to the seller.

Dive advises to ignore the hype around recent IPO success stories and look at every IPO from the initial position that the seller is trying to trick you into buying something that they are selling and then slowly work backwards towards a position of trust.

Finally, Warren Buffett says about IPO’s "It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller to a less-knowledgeable buyer."  When it comes to IPO’s - Buyer beware!

 

Thursday, 13 May 2021 07:57

Telstra - value emerging for shareholders

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In the last 5 years Telstra shareholders have had little to cheer about as they have watched the NBN punch a hole in earnings, resulting in a share price slide and dividend cuts.  That is now changing.

In the recent profit result, not only did Telstra forecast earnings growth for the first time in 5 years, but also outlined a timetable to change its legal structure by splitting the company into 4 parts.

The proposed legal structure within the Telstra Group, expected to be completed by December 2021, includes:

  • InfraCo Fixed, which would own and operate Telstra’s passive or physical infrastructure assets: the ducts, fibre, data centres, and exchanges that underpin Telstra’s fixed telecommunications network.
  • InfraCo Towers, which would own and operate Telstra’s passive or physical mobile tower assets, which Telstra is looking to monetise given the strong demand and compelling valuations for this type of high-quality infrastructure.
  • ServeCo, which would continue to focus on creating innovative products and services, supporting customers and delivering the best possible customer experience. ServeCo would own the active parts of the network, including the radio access network and spectrum assets to ensure Telstra continues to maintain its industry leading mobile coverage and network superiority.
  • International, will be established under a separate subsidiary within Telstra Group and includes subsea cables

 

After being negative on Telstra for years, Gaurav Sodhi (Analyst, Intelligent Investor) believes the new structure is a good move.  He says that there are a lot of assets within Telstra that aren’t being adequately valued.  Separating them will recognise the value of infrastructure style assets that can generate stable, recurring revenues, resulting in a far higher valuation than the present share price.  Sodhi’s sell trigger of $5 on Telstra provides some guidance on the value he sees.

The Towers business carries a modest asset value of just $300m on Telstra’s balance sheet after heavy depreciation.  Once towers are in place and connected to the fibre backhaul, they are expensive to replicate and therefore extremely valuable.

Experience overseas shows that Telstra is following a well trodden path as it seeks to increase shareholder value.  Will Granger (Analyst, Airlie Funds Management) says that mobile tower companies can trade at EBITDA multiples (earnings before interest, tax, depreciation, amortisation) ranging between 21-27 times earnings.  Telstra by comparison currently trades on an EBITDA multiple of around 8 times.  Granger believes through a partial or full sell down of these assets, Telstra can realise this valuation arbitrage and increase shareholder returns.

Gaurav supports this view by referencing American Tower which is listed in the US.  It is the largest tower business in the world which bought AT&T’s long distance phone lines years ago and used them to host mobile infrastructure and are today valued at over US$100bn.  American Tower trades at over 20 times EBITDA while AT&T trades at just 7 times.

Granger adds that Vodafone spun off its mobile tower assets in March of this year on an EBITDA multiple of around 20 times.

Granger sees few downsides for the proposed restructure other than Telstra risking their network advantage if the mobile towers separation is not properly structured.

Sodhi agrees and said that American Tower and Crown Castle have been so successful because they host multiple networks from a single piece of infrastructure.  They have been able to scale nicely.  For Telstra’s tower businesses to do the same, Telstra would have to allow other networks access to those sites.

There is a clear trade off here.  In order to maximise the value of its infrastructure, Telstra needs to allow other networks access to it.  If it does that, it risks its network superiority.  Sodhi believes that Telstra is likely to opt for a lower value for its infrastructure to protect its network superiority.

The ACCC is another risk to this restructure.  Sodhi says that while its been hard to predict the reaction of the ACCC in recent years, he doesn’t believe there would be too many objections.  A split of the towers and infrastructure assets potentially opens the door to other networks also utilising those assets which could even the playing field.

Telstra has been a serial underperformer over the past 5 years, but investors must be forward looking and responsive to new information.  The split is new and its happening this year, and investors may do well to reconsider Telstra.

 

 

This article was written by Mark Draper and appeared in the Australian Financial Review during the month of April 2021.

Bell Potter have produced a special report on developments of COVID-19 focussing on the virus itself with particular reference to Europe and the US.

The report looks at infection rates and death rates, comparing the first and second waves.

The analysis considers the likelihood of reaching herd immunity.  Complete with statistics and graphs the report is designed to assist investors reach their own conclusions about what may be in store for the world with COVID-19.

Download your copy of the report by clicking on the report below.

 

Friday, 04 September 2020 09:05

Best of the Best - August 2020

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The Investment Team at Montgomery Investments have produced their bi-monthly "Best of the Best" report.

This edition focuses on:

- Why it's time to focus on quality businesses

- Optum - Hidden GEM in US Healthcare

- Nanosonics has a long runway for growth

- Three reasons we continue to like Woolworths

 

Download your copy of the report by clicking on the report below.

 

Friday, 04 September 2020 08:56

What we learned from reporting season

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The only thing certain about the future right now is that the future is uncertain.  So as we complete one of the strangest company reporting seasons we have ever seen, investors should reflect on the company profit announcements to see what they can learn about what may lie ahead 

Matt Williams (Portfolio Manager, Airlie Funds Management) says that while overall profits were down 20% compared to the previous year, the dire predictions in late March proved to be too bearish and there are now more profit upgrades than downgrades.  He said “The economy has strongly outperformed the accepted bearish scenarios of late March, retailers have produced phenomenal numbers”.

“The COVID-19 pandemic has not been uniformly bad for all Australian companies.  Travel related companies and listed property trusts with shopping centre assets have had a tough 6 months, while electrical retailer JB Hifi, hardware and office retailer Wesfarmers, AfterPay and Domino’s Pizza all saw record revenue over the past 6 months, benefitting from consumers being quarantined at home” according to Hugh Dive (Senior Portfolio Manager, Atlas Funds Management).

Nathan Bell (Head of Research & Portfolio Management, Investsmart) picked up on the travel sector which saw airlines and travel retailers at the epicentre of the COVID-19 storm.  “You could hear the desperation in Alan Joyce’s voice as he pleaded for state borders to reopen after announcing a $4bn loss”.  Bell also highlighted the almost 100% drop in passenger numbers since COVID-19 emerged for listed Sydney and Auckland airports.  He is of the view that leisure travel ultimately recovers and even if business travel only recovers to 70% of past highs due to a permanent shift to online meetings, both airports represent good value at current prices.  “People are once again going on holidays in the northern hemisphere, which is another good omen for this pair of airports.  Vietnam, Taiwan and Korea recently reopened their domestic borders and passenger numbers are now 10 – 20% above 2019 levels, suggesting pent up demand” he adds in support of the investment case for a rebound in airports.

Food and alcohol retailers (such as Woolworths and Coles) reported solid results as they benefitted from changing consumer purchase patterns, but they now trade at huge valuations.  Their valuations suggest future returns are likely to be far more muted if not negative should the impact of Job Keeper payments and people raiding their super funds wear off.

Dive points to the fact that “cash flows from the government were a significant feature of the August results season, albeit one that was understandably not highlighted by management when they presented their results.  JobKeeper and higher JobSeeker payments have helped companies such as JB Hifi and Afterpay as cash flows from the Government have supported retail sales despite the significant rise in unemployment”.  Investors would be wise to resist extrapolating the impact of these Government payments over the past 6 months into the future.

While the Telco sector reported earnings hits from lower global roaming charges and reduced retail sales during lockdowns, the 5G networks will cover the majority of the population in the next 12 months which represents revenue growth opportunities.  More rational mobile pricing should also help the Telco’s.

Banks reported much lower profits due to a mix of low credit growth, low interest squeezing margins and increasing bad debts.  Bell says of the banks “the bull case for Australia’s largest banks rests on them trading at large premiums to book value despite reporting single digit return on equity figures.  If this happens, Australia will be the exception to the rest of the world.  We don’t see why Australian banks are an exception as more people deleverage in the years ahead and property investors look beyond property for large capital gains”.  Ultimately the loan repayment deferrals will also need to be bought to account as well.

Williams said that in his discussions with company management, the key themes about the future were:

-       What happens at the end of the Government stimulus where retailers would appear most exposed.  

-       Opening up of state borders

-       Economic reform

With around 70% of companies either not issuing future earnings guidance or withdrawing earnings guidance, coupled with some market sectors trading on extremely high valuations, the job of assessing investment value is difficult.  The best opportunities ahead are less likely to be found in this years’ reporting season stars.  

 

This article was published in the Australian Financial Review during the month of September 2020.

Monday, 10 August 2020 14:03

Sustainable returns from Telco sector

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Telecommunication companies (Telcos) have been central to many of our activities during the COVID-19 crisis, ranging from virtual wine tasting nights with friends, working from home, Netflix binges or simply ringing family.

In recent years Telco’s have been challenging for investors with falling margins from mobiles and the NBN crushing broadband margins.  The worst of this may be behind the sector now and investors are now presented with an investment opportunity that may be COVID-19 proof.

An investment into a Telco company typically involves two main segments, infrastructure and retail/business operations which includes broadband, mobiles and services. .  

In Australia the three major players are Telstra, Optus and TPG which recently merged with Vodafone.  Telstra and TPG are listed on the ASX.

According to Andrew Peros (Deputy Head of Research, Ausbil) “infrastructure is probably the most attractive on the assumption that it can be successfully separated from the retail assets.  Telecommunications infrastructure provides a long term steady cash flow which is highly valued by the market.  Unfortunately, in Australia, there are no pure play communication tower investments.  Telstra’s communications infrastructure are currently part of the overall business and have not yet been demerged as a separate business, similarly with TPG’s cable infrastructure”

That may be about to change following a restructure announced last year which resulted in Telstra splitting its infrastructure assets into a separate business segment called InfraCo.  InfraCo consists of exchanges, ducts, data centres, subsea cables, fibre and 8,000 towers that host networking equipment.

Towers and other parts of InfraCo currently generate revenue from servicing Telstra alone.  If this division were separated from Telstra, these assets could increase revenue by servicing other Telcos.  A tower that currently services only Telstra could service all three mobile networks.  Competitors would have to supply their own networking gear, but the infrastructure owner could earn three times as much revenue. Mobile network towers are a natural monopoly and it makes little sense to duplicate a network once it has been constructed.  We don’t duplicate water pipes or electricity wires and the same can apply to mobile towers. This is an important opportunity for investors to grasp.

Annabel Riggs (Telco Analyst, Airlie Funds Management) is “attracted to the mobiles market, with the sector transitioning into a more rational pricing environment after a period of intense competition between network operators.  We are beginning to see evidence of a more rational market with Telstra lifting prices a couple of weeks ago across its post paid mobile plans.  This is positive for earnings and returns.”

5G is the next battle ground for the Telco’s.  Riggs believes that “network operators will selectively compete with the NBN in some areas by using a fixed wireless product.  The margins and returns on this product work if the customers are relatively low usage.  We have seen in New Zealand that about 20% of their broadband base is now on Fixed Wireless and bypassing their own version of the NBN.”

Peros adds “telcos are likely to hesitate on fixed wireless if competition between operators is expected to lower returns on capital, and there is a risk in Government support firming to protect the value of the NBN.”

Government regulation would seem one of the key risks to investing in the Telco sector.  The relatively high access costs the NBN charges the telco resellers for broadband is a good example.  Riggs points out that the NBN has improved its pricing model however the total cost of accessing the NBN for telcos is still much higher than the copper network.  The higher access costs to the NBN has put huge pressure on earnings of the telco sector.

The decision to ban Huawei from providing 5G equipment in Australia was another big decision.  Huawei was a lower cost equipment provider which will ultimately increase expenditure for TPG which was planning their 5G build around Huawei equipment.

Peros flags the economies of scale in a geographically large country with a small population as another important risk.  

Investors should also pay attention to some interesting new entrants.  Riggs points to Uniti Group who has recently acquired Opticom as having an interesting opportunity to challenge the large players in the fibre market.  Peros likes NextDC which owns data centres which will benefit from the increased demand for data now that a greater proportion of the workforce are working from home.

It would seem that Telco’s revenues are largely COVID-19 proof, but the growth story could come from the demerging of infrastructure and new entrants.

This article was published in the Australian Financial Review online on Monday 3rd August 2020

Note:  Mark Draper, Shannon Corcoran and their entities own shares in TPG and Telstra.

The investment team at Montgomery Investments have put together another informative report that covers various aspects of the current investment landscape.

In this report the team looks at:

- Is it time to get back in

- How should you think about cash?

- Looking through market volatility for opportunity

- 4 criteria to consider before buying shares in this market

 

To download your copy of this report, click on the report below.

 

Thursday, 16 April 2020 09:14

COVID-19: Demystifying this Frightening Disease

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The COVID-19 (coronavirus) pandemic has shaken the global population to its core. The personal toll is enormous, and the fear, immense. In this special feature I will explain what the virus is, what makes it unique and the progress that has been made in developing a treatment and vaccine. The collaboration between pharma, biotech and medtech companies, as well as researchers has been astounding and gives me great confidence that we will win this fight.

Within a very short period of time, the world has shifted its focus to a virus that measures roughly 50-200 nanometres1. Suddenly, we have all become familiar with scientific terms such as viral spread, PCR testing capacity, antibodies, viral shedding and many more. Economists have become epidemiologists hoping to model the outbreak, while we have also witnessed the limitations of many healthcare systems.

Viruses are a part of life. There are plant viruses, animal viruses and viruses that infect bacteria. Over time, outbreaks occur and can be devastating. Polio was an example of a seasonal, frightening viral epidemic in the 1940s and 1950s that was eventually eliminated by vaccination. There is no reason to believe that we will not be successful combating SARS-CoV-2, the new coronavirus.

SARS-CoV-2 is a member of the Coronaviridae family, a rather large clan with two subfamilies (Coronavirinae and Torovirinae) that can infect humans as well as animals. These subfamilies have several members and there are four coronaviruses that we have all most likely had exposure to. They cause mild symptoms, such as the common cold and require no diagnostic testing. However, occasionally we see a coronavirus that causes very unpleasant diseases, such as SARS (2002/2003), MERS (2012/2015) and now COVID-19.

This latest virus outbreak will change our view about this viral family, vaccination, pandemic preparedness and antiviral therapeutics. It is highly plausible that we may require vaccination against this culprit with additional booster shots annually. Given what we are seeing today, this new coronavirus is here to stay.

Viruses are simple but sophisticated creatures. They have an outer shell and sometimes an inner one as well. Inside, is the viral genome, often with some viral functional proteins attached to it. The outer shell tends to have family-specific characteristics that determine which and how the virus infects its host. Coronaviruses like respiratory and gastrointestinal tracts. So-called spike proteins that sit on the outer shell of the virus have a high affinity for proteins localised in our throat, lungs and gut. It is this outer shell that disintegrates when it contacts soap, hence the reason why washing our hands is so crucial. Similarly, we as the host, are crucial for the survival of the virus. Viruses cannot replicate by themselves, they need the host’s ‘machinery’ to multiply. Viruses are masters at exploiting the host’s machinery and they know how to adapt, so it is essential we deny them any opportunity to find another host by practising social distancing. Some viruses are very clever, they have worked out that causing mild disease is better as the host keeps socialising, which guarantees survival of the virus, while the more aggressive (not so clever) viruses cause devastating diseases and hence eliminate themselves quickly. SARS-CoV-2 falls into the sophisticated category as it replicates in the upper respiratory tract (e.g. throat), causing mild symptoms vs. its cousin SARS-CoV that settles deep in the lungs. Transmission from the throat is much easier and hence requires drastic actions to slow it down and stop its spread. Scientists are closing in on this virus a lot faster than we have ever seen before.

What we learnt from HIV

Thanks to the advanced scientific tools we use today in the laboratory, we have been able to identify and study SARS-CoV-2 and its lifecycle at a rapid speed. It is worthwhile revisiting the AIDS/HIV epidemic in the 1980s to understand how far we have come. In 1981, the US Centres for Disease Control and Prevention (CDC) started to see patients with diseases that occurred due to a malfunctioning immune system. However, nobody knew what was causing this immune deficiency. A year later, the disease was called AIDS (Acquired Immune Deficiency Syndrome). In 1983, French scientists postulated that a retrovirus could be the cause of AIDS, which was confirmed by US scientists the following year. In 1985, the US Food and Drug Administration (FDA) approved the first commercial HIV blood test that detected antibodies in a patient’s blood. A molecular test, similar to what is being used today to detect SARS-CoV-2, was only available for HIV in the mid-1990s. The first antiviral drug was approved in 1987. Compare this timetable to the current pandemic. Late last year, news emerged from China about a respiratory disease that did not test positive for any known respiratory pathogen. It quickly emerged that it was due to a new coronavirus. The genome of the virus was rapidly sequenced and distributed to scientists globally and molecular tests were established. Biotechs and pharmaceutical (pharma) companies quickly looked inside their drug cabinets for potential therapies as well as how their technologies could be applied to make specific drugs and vaccines for this new virus. It has been a phenomenal global effort. Currently, we are awaiting clinical trial data for the first repurposed antiviral therapy (Gilead Science’s Remdesivir, which was originally developed to treat Ebola), while the first vaccine is also already being tested in humans. It may feel like a long time but it has only been months.

The virus itself is being studied intensely by several groups around the world. The spike proteins that make up the outer shell have been analysed and scientists have elucidated the structure of one of the viral functional proteins called protease, which is immensely important, as it will allow scientists to develop anti-protease inhibitors, which were crucial in treating HIV.

Scientists are simultaneously studying the immune system’s response to the virus and have identified Interleukin-6 (IL-6) as a key mediator, hence Roche’s IL-6 Antibody Actemra is being used to treat COVID-19 in some hospitals, while clinical trials are ongoing. Meanwhile, Sanofi/Regeneron’s IL-6 antibody has also just entered clinical trials for COVID-19.

We know from previous viral outbreaks that patients who have recovered from a virus will have produced antibodies that neutralise the virus, so Japanese pharmaceutical company, Takeda has started collecting plasma from patients who have recovered from COVID-19 to give to patients currently suffering from the disease. CSL has recently joined Takeda to work together on such a plasma-derived product.

Regeneron, a US biotech, is using its antibody engineering capability to find antibodies that target the virus. Those antibodies should move into human testing later this year. Alnylam and Vir Biotechnology are working on a long-acting small interfering RNA (siRNA) therapeutics targeting the virus. Vir is also working on antibodies with GSK.

The ability to explore and investigate so many different drug modalities was not possible during other viral outbreaks as we did not have the technological capability.

Global collaboration

There has been a lot of debate about the lack of testing capacity, but overall, the scientific community, including biotechs, pharma and medtechs, have all shown great leadership in this pandemic. The collaboration and sheer speed in detecting the virus and developing a treatment have been unprecedented. Not that long ago, pharma and biotechs were in the political crossfire regarding high drug prices. In this pandemic, the industry has the opportunity to set the record straight and show their full capabilities. In years to come, this industry, along with the medical profession, will be viewed through a very different lens.

Vaccines, the holy grail to combat infectious diseases, are also experiencing immense activity by traditional vaccine companies and also by biotechs who use new transformative technologies, such as messenger ribonucleic acid (mRNA).

The concept of a vaccine is simple. A venture capitalist recently described it in the easiest possible way; likening a vaccine to sending a “wanted criminal dossier” to the immune system, that shows the immune cells what to look out for and prepare to capture the ‘criminal’. Sometimes, the immune cells are able to see the picture of the criminal just once to ensure the immune cells can fight off the criminal, other times, they need to be reminded again i.e. get a booster.

The criminal dossier can come in different forms. It can be very detailed (a weakened form of the virus) or it may only have some very poignant features of the criminal (parts of the virus that are very immunogenic).

It takes time for laboratories to make a virus that replicates the criminal dossier. Firstly, scientists need to figure out how best to make it, or which part of the virus they should focus on. Manufacturing then has to be scaled up, which all requires a significant amount of money. The vaccine then needs to be tested at length and many millions/billions of dosages have to be manufactured. Today, four companies dominate the vaccine industry (GSK, Pfizer, Sanofi, Merck) with Australian company, CSL a distant fifth and Johnson & Johnson always keen to participate.

The potential long lead times and significant upfront costs have, however, not deterred Sanofi and Johnson & Johnson from applying their more traditional vaccine-making approach. Both companies are actively working on the criminal dossier and Johnson & Johnson is due to start trials later this year.

Platinum has followed the vaccine space for more than a decade and we have long hoped that technology advances would one day change the way vaccines are made. Using cell lines (where a permanently established cell culture multiplies indefinitely) has been one significant step along this path, but overall, the vaccine industry has remained a tight oligopoly.

In recent years, the potential to use mRNA as a therapeutic treatment and as a vaccine has emerged. We have been following the progress closely and invested in two companies in this space, Moderna and BioNTech, some time ago. The pandemic has placed mRNA and both companies firmly in the global spotlight. US-based Moderna was able to start clinical trials within 63 days of receiving the genomic sequence of the new virus. BioNTech has been slightly slower, but recently expanded its partnership with Pfizer and also entered a partnership with Chinese company, Fosun to develop its vaccine candidate. Curevac, another privately- owned German mRNA biotech backed by SAP co-founder Dietmar Hopp, is also busy developing a vaccine, while Sanofi recently expanded its alliance with biotech, Translate Bio.

Using mRNA for vaccine development is quite an elegant approach and Moderna and BioNTech have invested considerable effort in designing and selecting the best possible mRNA molecule for a respective protein of interest. It remains to be seen if it works, however, both companies have received support from the Bill and Melinda Gates Foundation and have large partners for various pipeline products. Some established vaccine makers are sceptical, but Moderna has been the first to take their mRNA to the clinic.

mRNA explained

mRNA is a molecule that functions naturally in our bodies as an intermediary between our genes and our proteins. It is the blueprint for our proteins and essentially a copy of the gene encoding the protein. If designed and delivered correctly, cells will recognise the mRNA and start making the protein. For vaccines and therapeutics alike, the mRNA can be quickly designed (by the right team of scientists) in the lab once the scientists know which is the correct viral particle to make. Usually, several mRNAs are made and scientists quickly assess which one is the most suitable. Manufacturing these chemical molecules (or information molecules, as Moderna calls them) can be done with a much smaller manufacturing footprint and also at a fraction of the cost of making traditional vaccines or protein therapeutics, as it is not a protein, it is the information to make the end product. In the end, the 'active’ product, the vaccine or the therapeutic protein, is made by the person who receives the mRNA injection. Humans essentially function as the manufacturing site for the mRNA vaccine.

We are convinced that these multiple vaccine efforts (traditional and modern) will result in a product, potentially as a first-generation product that will give companies time to refine their efforts and develop the next generation of longer-lasting vaccines.

A global logistical exercise

Apart from the scientific approach that is being undertaken to combat the virus, this pandemic is also witnessing large- scale crisis planning and management in different countries.

Molecular testing has been a key pillar in managing the viral spread. It is clear, however, that the supply of these tests cannot fulfil demand. Each country has taken slightly different approaches to testing. Some countries are actively looking for asymptomatic infected individuals, while others are struggling to keep on top of the symptomatic patients. Testing guidelines will undoubtedly change over time and serological testing, whereby a test determines antiviral antibodies in a patient's blood, will complement molecular testing in the future.

In a pandemic, facts determine your management plan and as the facts change so should the plan. Many people worry when plans change, but in the crisis we are experiencing today, it is paramount that countries adjust their plans to address the changing dynamics.

Our knowledge of the SARS-CoV-2 virus and the COVID-19 disease has rapidly grown and changed as physicians in different countries gained first-hand experience. Throughout this pandemic we have drawn on a number of sources, including the New England Journal of Medicine (NJEM), a weekly medical journal published by the Massachusetts Medical Society, Dr Anthony Fauci, one of the lead members of the White House Coronavirus Task Force in the US, the German federal government agency and research institute, Robert Koch Institute, along with a German virologist Professor Drosten (coronavirus specialist) and several of his colleagues.

These learnings and the exchange of these experiences is vital to form response plans. One of the key learnings in recent months has been the fact that this coronavirus can spread very quickly. This is due to its preference for residing in the upper respiratory tract, as highlighted above. This means it often causes milder symptoms that can go undetected. The biggest challenge is to break this rapid spread and protect vulnerable individuals. In an ideal world, everyone would be tested. A swab kit would arrive in your mailbox (similar to the bowel cancer test kit), you would take a swab, it would be collected by a courier and the results emailed to you in a matter of hours. What would be even better though, would be a molecular test that people can do themselves at home. This would quickly identify who is infected and who needs to self-isolate.  Unfortunately, these tests are not available to us today, so the next best option is what is currently being practised in many countries; quarantine, social distancing, drive-thorugh testing facilities, and tracing potential infections practively.  Sophisticated piont of care testing that could be done at home or at the local medical centre is emerging rapidly, with companies such as Roche, Qiagen (soon to be part of Thermo Fisher) and Cepheid (now part of Danaher), key platers developing this technology.

At the core of this pandemic, due to the rapid spread of the virus, is the ICU capacity of hospitals. In the current phase of the pandemic, the focus hence needs to be on ensuring we have enough ICU beds and ventilators. Globally, we are seeing different ICU capacities and thankfully we are seeing a move to central ICU bed co-ordination. Germany, for example, is moving to real-time monitoring of its ICU beds as well as transporting patients from neighbouring countries. All hospitals have to work together, which has been a challenge, particularly in the US. We have learned from Italy’s experience that it is important to have COVID-19 treatment centres protecting non-COVID-19 patients. This pandemic is as much a logistical and planning exercise as it is a scientific endeavour. It will highlight very quickly the shortcomings of our healthcare system along with our past desire to be as supply chain efficient as possible.

However, there will be a next phase to this pandemic, and that will be when we start to return to our offices and gradually begin to socialise again.

During the next phase it will be about recovered patients and keeping on top of regional outbreaks and next-generation diagnostic tests that identify antibodies to the virus. Many of these tests are currently receiving media coverage, however, I would caution that these tests are not yet ready to be used widely. The potential for false negatives is not a risk we want to take currently; it takes days to develop antibodies and hence molecular tests remain the best approach to detect an infection early.

However, the presence of anti-SARS-CoV-2 antibodies in the blood means the person has been infected sometime in the past and hence are now regarded as being immune, which will be important when we are ready to return to work. In Germany, for example, the debate is currently about issuing “immunity certificates” for those who show positive antibody titres in their blood. It is still unclear, however, how long this immunity will last. In the months to come, detection of the virus and our immunity will remain paramount until we have therapeutic options and a vaccine.

At Platinum, we have long believed that diagnostic tests will become a key pillar of healthcare, be that in oncology, inflammatory diseases or infectious diseases. The aim in healthcare should be prevention, which requires tools to detect changes in our body early with precision. This is the same with the current virus, if we can detect it quickly, we can prevent it spreading. This pandemic challenge has placed the healthcare industry squarely in people’s minds. It has shown how limited our arsenal of antiviral therapies is and highlighted how our approach to vaccine development has to be overhauled. In the world we are living today, with all the digital factory technology that is available, manufacturing vaccines strikes us as 'old style’. Given we have seen several coronavirus outbreaks in the last 18 years, it is more likely than not, that this coronavirus family will continue to cause us harm and hence having a vaccine, or possibly an annual coronavirus vaccination booster would be worthwhile investing in. We are firm believers that current events will change healthcare systems and most importantly, will highlight what a vital role biotechs play today.

The biotech industry is relentless in its search for new technologies and new therapeutics. Bankruptcies are rare and failure does not demotivate them, to the contrary, it motivates them.

For now, as Germany’s chancellor Angela Merkel recently said, the best therapy we have for SARS-CoV-2 is to stay at home.

 

This article has been reproduced with permission from Platinum Asset Management.  The article is written by Dr Bianca Ogden (Healthcare Portfolio Manager Platinum Asset Management).  

Dr Bianca Ogden, MBio (Tübingen), PhD (University College London), has been the portfolio manager for the Platinum International Health Care Fund since 2007 and leads the healthcare sector team. Molecular biology was Bianca’s first love before she discovered the joys and challenges of investing. After spending some time at Swiss pharmaceuticals company Novartis researching new HIV drugs (one of which has been approved and is in use today), Bianca went on to complete a PhD at UCL, investigating Kaposi’s sarcoma-associated herpesvirus. She then migrated to Australia and joined Johnson & Johnson as a molecular biologist, researching new drug targets in oncology. Bianca embarked on a career change and joined Platinum as an investment analyst in 2003. Her rich knowledge base in molecular biology and first-hand insights into the pharmaceutical and biotech industry give her a unique ability to delve deeply into the fundamentals of healthcare companies and identify those with a solid foundation in scientific research.

 

Wednesday, 01 April 2020 13:23

Alibaba - why the smart money likes it

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Chinese CurrencyWith the Chinese middle class population forecast to double to over 600 million over the next 5 years, which in turn increases consumer spending, it is not difficult to see why the ‘smart’ money is investing in Alibaba, one of China’s largest companies that is likened to Amazon, eBay, Paypal and Google all rolled into one.

Alibaba was founded during the 1990’s by Jack Ma who realised at that time China lacked technology in the business world.  Alibaba, now one of China’s largest companies, listed in 2014, and today is highly profitable with a market capitalisation of over US$580bn.  This is about 6 times larger than Australia’s largest company CSL.

Alasdair McHugh (Product Specialist Baillie Gifford) is attracted to Alibaba due to their very strong position in ecommerce transactions in China where their market share is over 60% by gross merchandise value and likely to rise further.  He also likes the fact that the original co-founder and visionary Jack Ma is still involved in the business.  

According to the China Ministry of Commerce, total retail sales across China increased 8% in calendar 2019, for a total of RMB 41 trillion (AUD $9 trillion).  Consumption contributed over half of China’s economic growth.  Online retail sales for the year was RMB 8.5 trillion (AUD $1.87 trillion) up 19.5% from the year before.  It is clear that consumption is now a major driver of economic growth in China, and online retail is an important driver of consumption growth. Alibaba’s dominant position means it is well placed to capture this growth.

The scale of the opportunity is extraordinary and underestimated by certain investors, particularly some from the west who still consider China as a risky emerging market.  But McHugh suggests that those who still treat China as an emerging market are overlooking the fact that the addressable market for Chinese consumer spending is 1.3 billion people.  

Illustrating this point was the recent ‘Singles Day’ held in November 2019 where another record was broken with total sales of RMB 268.4bn (approx. AUD $59.2bn).  Almost 1.3 billion packages were delivered by Alibaba from ‘Singles Day’ orders and of those 960 million were delivered within one week.  This is equivalent to 2.3 times the combined online sales of Black Friday and Cyber Monday in the US.  It reflects the strength of Alibaba’s digital economy and of Chinese consumers consumption power.

Joe Lai (Portfolio Manager Platinum Asset Management) says that “mobile monthly average users on Alibaba’s retail marketplaces in China reached 824 million in December 2019, an increase of 39 million from the previous quarter”.  

Beyond the ecommerce business, Alibaba operates the largest cloud computing business in China, Alibaba Cloud.  Many believe that this business can ultimately become the largest division within the company despite it presently representing less than 10% of overall revenue.  Revenue from Alibaba Cloud grew by 62% over the year to December 2019.

A fascinating aspect of Alibaba’s recent quarterly earnings update related to the company’s involvement in procuring and delivering 40 million units of medical supplies worth around AUD$100 million to Wuhan which has been impacted by Covid-19.  This shows a company that is so much more than an online retailer. 

Lai points out that “The Alibaba ecosystem keeps delivering new sources of value to shareholders.  Amid the Covid-19 lock down in China, Alibaba’s new enterprise communication app, DingTalk, has achieved new prominence.  Alibaba introduced a new digital health check in feature on DingTalk, which as at February 2020, had recorded more than 150 million daily health check ins.”

While currently investors are obsessing over Covid-19, Alibaba management said “17 years ago, the ecommerce business experienced tremendous growth after SARS.  We believe the adversity will be followed by changes in behaviour among consumers and enterprises and bring ensuing opportunities.  We have observed more and more consumers getting comfortable with taking care of their daily living needs and working requirements through digital means.” 

With the huge growth in China’s middle class and online commerce in coming years, combined with Alibaba’s dominance across retail, financial and computing businesses it’s clear to see why the company is in Platinum and Baillie Gifford portfolios.  Investors can of course buy Alibaba directly either on the Hong Kong or US exchange and can also gain access to it through managed global funds.

 

This article appeared in the Australian Financial Review during March 2020 - written by Mark Draper GEM Capital

Wednesday, 01 April 2020 13:04

Solvency and Debt in time of crisis

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This article was written by Hugh Dive - Atlas Funds Management and he has generously authorised its reproduction ..... Thanks Hugh!

 

Alongside the worldwide devastation as healthcare systems struggle to cope and deaths are well into the tens of thousands, the COVID-19 crisis is having a chilling impact on Australian corporates. Many companies are removing profit guidance given less than a month ago, cancelling dividends, raising debt, and in the last five days attempting to raise capital. Eleven years ago during the GFC many companies raised equity, often at deep discounts to their share price, as nervous bankers put pressure on management to shore up weakened balance sheets. In some situations, companies were forced to raise equity as their bankers were unable to refinance loans that had become due in a frozen credit market. 
 
In this week’s piece we are going to look at the various debt measures that we examine to assess a company’s solvency. These measures provide insight into whether management will be forced to raise equity during times of stress.

Gearing


Gearing is the most commonly discussed measure of a company’s debt. It indicates the degree to which a company’s business is supported by equity contributed by shareholders, as opposed to debt from banks and bondholders. Gearing is measured by dividing net debt by total equity (assets plus liabilities).  During times of buoyant business conditions, companies with a high level of gearing generally deliver higher returns to investors. However, when the tide turns, highly geared companies have a riskier financial structure and have an increased chance of going into administration or having to raise equity to retire debt.

Most companies on the ASX have a gearing ratio between 25% and 35%. However, the level of gearing needs to be assessed in the context of the industry in which the company operates.  Utilities such as Spark Infrastructure with regulated revenues can “safely” have a higher level of gearing than a highly cyclical stock such as Myer or Qantas. The latter two have more variable earnings and thus a variable ability to meet interest payments.

The key weakness in using gearing alone to measure a company’s solvency is that it assumes that the company’s assets can be realised for close to what they are valued on the balance sheet. The shortcomings of this approach are especially apparent for companies with a large proportion of intangible assets on their balance sheet, such as goodwill stemming from acquiring other businesses at prices above their net asset backing. In 2019 AMP’s gearing increased rapidly after the financial services company wrote down the asset value of its troubled wealth management and life divisions by $2.5 billion. Shortly after writing down the value of its assets, the highly geared AMP both cancelled its dividend and conducted a $650 million equity raising at a 16% discount to the share price at the time.

Companies such as Medibank PrivateJanus Henderson and A2Milk are in the fortunate position in 2020 of having no net debt on their balance sheet. As a result, each has a negative gearing ratio and is facing no anxious discussions with their bankers. By contrast AMP, Pact and OohMedia (which raised $167 million last week) all have high levels of gearing.
 

Short-Term Solvency


Short-term solvency ratios, such as the current ratio, are used to judge the ability of a company to meet their short-term obligations. The current ratio divides a company’s current assets by their current liabilities (i.e. liabilities due within the next 12 months). Firms can get into financial difficulties despite long term profitability or an impressive asset base if they can’t cover their near-term obligations. A current ratio of less than one would indicate that a company is likely to have trouble remaining solvent over the next year, as it has less than a dollar of assets quickly convertible into cash for every dollar they owe. A weakness in using this measure to assess the solvency of a company is that the current ratio does not account for the composition of current assets which include items such as inventory. For example, winemaker Treasury Wine reports a robust current ratio. However, a large proportion of current assets are inventories of wine which may be challenging to convert into cash at the stated value during times of distress (panic buying of wine notwithstanding).

A further limitation of the current ratio in assessing a company’s financial position is that some companies such the ASX, Coles and Transurban which have minimal inventories or receivables on their balance sheet. This occurs as they collection payment immediately from their customers, but pay their creditors 30 or 60 days after being invoiced. These companies will tend to report current ratios of close to 1. Alone, this figure would indicate that these companies may be in distress. Indeed Coles has a current ratio below 1, which far from being alarming is due to the nature of the grocery business. Suppliers such as Kellogg’s and Coke are paid on terms between 60 and 120 days after they deliver their goods which creates a large current payables balance, while the receivables balance is small when customers pay for their cornflakes or Diet Coke via direct debit. This favourable mismatch between getting paid and paying their suppliers allows Coles and Woolworths to report an alarming current ratio that is effectively a loan from their suppliers to fund the grocers’ working capital.
 

Interest Cover


A debt measure that we look at more closely than gearing is interest cover, as this measures cash flow strength rather than asset backing. Interest cover is calculated by dividing a company’s EBIT (earnings before interest and taxes) by their interest cost. The higher the multiple, the better. If a company has a low-interest cover ratio, this may indicate that the business might struggle to pay the interest bill on its debt.

Before the GFC, I had invested in a company that had significant asset backing held in the form of land and timber. Using gearing as a debt measure alone, Gunns appeared to be in a robust financial position. However, interest cover told a different story. The combination of a rising AUD (which cut demand for its woodchips) and weak economic conditions resulted in Gunns having trouble servicing their debts despite their asset backing, and the company ended up in administration.

As interest rates have trended downwards over the past decade, it has become easier for companies to pay their declining interest bills, so in general, the interest cover ratio for corporate Australia has increased. Across the ASX companies such as JB Hi-Fi, Goodman Group, Wesfarmers and RIO Tinto all have an interest cover of greater than ten times. At the other end of the spectrum Nufarm, Viva Energy, Boral and Vocus all finished 2020 with interest cover ratios less than three times, which is likely to result in some worried discussions with their bankers. Nufarm has since sold its South American crop protection business with the proceeds going to pay down debt.  
 

Tenor of Debt


A very harsh lesson learned on debt during the GFC was not on the absolute size of the debts owed by a company, but the time to maturity – known as the tenor of the debt. The management of many ASX-listed companies sought to reduce their interest costs by borrowing on the short-term market and refinancing these debts as they came due. While this created a mismatch between owning long-dated assets that were refinanced yearly, it was done under the assumption that credit markets would always be open to finance debt cheaply. This strategy worked well until global credit markets seized up in 2008 and a range of companies such as RAMS and Centro struggled to refinance debts as they came due.

When looking at a company’s solvency during times of market stress, one of the critical items to look at is the spread of a when a company’s debt is due. If the company’s debt is not due for many years, management teams may not be forced by their bankers into conducting dilutive capital raisings during a period of difficult economic times. In the ASX over the next year Seven West Media, Downer and Southern Cross Media all have significant levels of debt to refinance, which may prove challenging in the current environment.

After the GFC many of the larger ASX-listed companies have sought to limit refinancing risks by issuing long-dated bonds in the USA and Europe. Toll road companyTransurban does carry a large amount of debt, but as you can see from the table below, the maturities of these debts are spread over the twenty years with an average debt to maturity of 8.4 years.

Similarly, at the smaller end of the market, the supermarket landlord SCA Property has minimal debt due over the next three years after issuing long-dated bonds in the USA. While COVID-19 is disrupting SCA Property’s business in March 2020, this spread of debt maturities positions this property trust better to ride out the current storm.


 

Covenants


Covenants refer to restrictions placed by lenders on a borrower’s activities and are contained in the terms and conditions in loan documents. These are either affirmative covenants that ask the borrower to do certain things such as pay interest and principal, or negative covenants requiring the borrower not to take on more debt above a certain level – for example; gearing must stay below 60% or an interest cover above three times. For investors, covenants can be difficult to monitor since, while companies reveal the maturity, currency and interest rate of their debts in the back of the annual report, disclosure on debt covenants is generally relatively weak.

Debt covenants were something that received little attention before the GFC when a covenant linked to Babcock & Brown’s market capitalisation triggered the collapse of the company. In June 2008, Babcock & Brown’s share price fell such that the company’s market capitalisation fell below $2.5 billion, and this triggered a covenant on the company’s debt that allowed its lenders to call in the loan.  After this experience, very few borrowers will include a market capitalisation covenant in their debt, as this leaves the company vulnerable to an attack by short-sellers. More recently in 2019 when Blue Sky Alternatives breached covenants, bondholders called in the receivers to protect their loan.

In 2020 amid the COVID-19 crisis, debt covenants are once again in the minds of investors, particularly in the hard-hit media and listed property sector. In the media sector, a fall in TV advertising revenue of 10% is likely to trigger Seven West Media’s debt covenant of 4 times EV/EBITDA (enterprise value divided by earnings before interest, depreciation and tax).

In listed property, the embattled shopping centre trusts have more breathing room, as they entered 2020 with a lower level of debt. The key covenants for Scentre are gearing (less than 65%) and interest cover (higher than 1.5 times). For the gearing covenant to be breached, the independent valuation of Scentre’s assets would have to fall by 60% from December 2019; for the interest cover to be breached, earnings would have to fall by 60% assuming no change to Scentre’s cost of debt.
 

Hedging


In the context of debt, hedging refers to the addition of derivatives to limit the impact of movements in either interest rates or the currency in which the debt is denominated. Many Australian companies borrow in Euros, US dollars and yen – both to take advantage of the lower interest rates in these markets, but more importantly to borrow money for a longer-term.  In 2020 the Australian dollar has fallen 12% against both the Euro and the US Dollar.

Companies that have significant un-hedged debt – such as building materials company Boral – will see their interest costs increase, especially if the company does not have enough foreign earnings to service their debt. This situation occurred in 2010 for Boral and required a dilutive $490 million to keep the company within their debt covenants. In December 2019 Boral’s debt was A$2.8 billion, but currency movements over the past 90 days have added $340 million to the struggling building materials company’s debt pile.

Our take

The upcoming year  will be tough for Australia’s companies as the sudden step change in demand is very different to the falls in 1987,1991,2000 or 2008/09. While demand for goods and services fell during these previous times of stress, some companies are now facing a government mandated shut-down in their businesses.

On a more positive note businesses are also likely to find more sympathetic bankers in 2020 than they faced in previous recessions, as well as massive government support. During the GFC,  the banks themselves were not well placed to help businesses, as issues with the global banking sector were at the heart of the crisis. The banks were de-levering their own balance sheets, while struggling to explain collapsed credit markets and the problems created by complex financial instruments to hostile politicians. Given that the shutdowns from COVID-19 are a temporary state of affairs and in light of the massive fiscal stimulus, we would expect the banks to give many struggling firms a degree of leeway over the next year.

 

 

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