Stock Analyst Program Winter 2013

1. Stock Analyst ProgramWinter 2013 Zeeshan Maqsood MIC VP Portfolio Zeeshan.maqsood@mail.mcgill.ca Ivan Di MIC VP Portfolio Minghui.di@mail.mcgill.ca February 1st, 2013

2. Executive Summary Stock Analyst Program 2013 • Short Selling Mechanics • Picking Good Targets • Examples

3. Short Selling Mechanics

4. What is Short Selling Stock Analyst Program 2013 • Why? Ability to benefit from stock price decline • Profit/loss of short-seller: [Initial price – selling price] – trading commission – dividend payment Source: http://www.invest2success.com/

5. Particularities of Short Selling • Short selling is not simply the opposite of long positions from a risk and return perspective. • Unlimited losses: 100% vs. unlimited loss; as trade plays out, less capital allocated • Stock Loan: Can be called, if tough to find loan can be very expensive • Short Squeeze: Positive news triggers margins calls and creates self-reinforcing cycles of forced buying back. Stock Analyst Program 2013

6. A Famous Short Squeeze Stock Analyst Program 2013 • The number of short sold shares may even exceed those in circulation • Porsche/VW example • Porsche buildings stake in VW • VW overvalued, HF short it • Porsche announce they had increased their control of VW to 74% leaving only 6% of the stock as free float (due to derivatives) • 13% of float was sold short • Stock went from 200euros to over 1000 euros, briefly making VW the world’s most valuable company. • See http://www.economist.com/node/12523898

7. Picking Good Targets

8. Idea Generation Stock Analyst Program 2013 • How to find ideas?  Fundamental analysis, same as long! • Reading 100's of financial statements • Hot sector, with a companies multiple that’s too expensive • Terminal shorts: • Stock prices overvalued by at least two times (valuation) • Fundamental company problems (business/strategy) • Weak financial conditions (financial analysis) • Weak or crooked management (red flags analysis) • Want at least a 50% decline in price (margin of safety)

9. Red Flags Stock Analyst Program 2013 • Declining cash flows • Serial chargers • Serial acquirers • Change of CFO or auditor • Bills aren’t getting paid

10. Declining cash flows Stock Analyst Program 2013 • Increasing net earnings, declining cash flows • Rationale: CF harder to manipulate (non-cash & NWC) • Example: Lucent 1999-1997 • Easy credit to anyone • Piling up inventory • Net earnings boosted by one-time gains in pension plan

11. Serial… Stock Analyst Program 2013 • Serial chargers • Frequent one-time charges • Big baths (future charges written off now) • Often they try that we ignore and economic loss/weak accounting? • Serial acquirers • Try to mask declining results in core business? • Risk of bigger nasty acquisitions Back in FY 2009… Jean Coutu ROE: 33% Shoppers ROE: 15% Walgreens ROE: 16% Source: BCG

12. Bills not getting paid… Stock Analyst Program 2013 • Bills aren’t getting paid… • Loose credit terms to grow sales faster  Risk of never getting paid • Reasonable allowance for doubtful accounts? • A/R as % of sales • How fast does A/R increase relative to sales? The two should roughly track each other. If sales increase by 15% YoY, but A/R increases by 25% YoY, the company is booking sales faster than it’s receiving cash from its customers. Source: BCG

13. CFO & Auditor Turnover… Stock Analyst Program 2013 • Change of CFO or auditor • No justification  Potential for fraud • Bloomberg function RSKC<GO> Source: BCG

14. Bloomberg: RSKC Stock Analyst Program 2013 3 4 1 5 2 Altman’s Z Score (predicting bankruptcy ): <1.1 Bankruptcy zone, >2.60 safety zone Source: BCG

15. Examples

16. Green Mountain Coffee Roasters (Einhorn) Stock Analyst Program 2013 • Short thesis (October 17, 2011) • http://online.wsj.com/public/resources/documents/EinhornGMCRpresentation_Oct2011_VIC.pdf

17. China Media Express (Muddy Waters) Stock Analyst Program 2013 • “China’s largest television advertising operator on inter-city and airport express buses.”  Sexy Chinese growth story (Beware of THEME stocks) • Reverse takeover (avoids most regulations) • Incredible growth with low capital (unbelievable ROIC) • Bulls arguments: • Neat industry • Very cheap (low single digit P/E) • Large cash balance • Deloitte as an auditor • North American PE firm made investment Source: BCG

18. China Media Express (Muddy Waters) Stock Analyst Program 2013 • Short thesis involved heavy ground work: • <1/2 of buses it claims to have • Most buses don’t play content • Management lying on agreements • Unknown in the industry (customers, competitors) • Audience has very low buying power • Management tries to keep share price high and sell shares to pocket profit • See report http://www.muddywatersresearch.com/wp-content/uploads/2011/02/CCME_MW_020311.pdf Source: BCG

19. CCME Stock Analyst Program 2013 Source: BCG

20. Netflix (Whitney Tilson) Stock Analyst Program 2013 • Short thesis (December 16, 2010) • Main short thesis here is valuation: 63.1x the high end of the company’s EPS guidance for the full year 2010 • Switching business model: • Streaming business was a less profitable one than its DVD-by-mail operation • Increasing competition in streaming • Weak streaming content, increasingly expensive licensing deals • Bandwidth challenges • Growing disparities between cash & accrual accounting (amortization of content) • CFO Resignation • See entire thesis: http://www.marketfolly.com/2010/12/why-whitney-tilson-is-short-netflix.html Source: BCG

21. Netflix Stock Analyst Program 2013 Source: BCG