Monthly Archives: November 2012

Wexboy’s letter to Argo

Argo Group has the questionable honor of being the worst performing stock that I bought and have blogged about: it’s down ~33% since the beginning of the year. Fellow blogger and Argo owner Wexboy decided to not stand idle at the sidelines, and send a letter to Argo to urge management to take action. If you are a shareholder you should check it out.

I don’t fully agree with all suggestions, but buying back shares when the company has 20.9p/share in cash and investments while it is trading below 10p/share is something I absolutely want to see! Better disclosure on what’s exactly inside the Argo fund is also a good suggestion since it is such a huge part of Argo’s balance sheet. I don’t think management needs to be urged to increase AUM. I’am sure that they know this, and will try to do this if they can since it’s already in their best interest to do so. The launch of a new emerging market fund earlier this month is a good sign in this direction. I also don’t really care about promotional investor relations activities. Influencing the share price of the company is in my opinion not managements job. They just need to run the company, and if they are doing a good job the market will take care of the share price.


Long Argo Group

Zynga, an unexpected value stock?

If you would have told me a year ago that I would consider investing in Zynga I would have declared you crazy. Valuation wise a lot has changed since then, and the company is actually close to becoming a net-net. On the balance sheet we find  $1.55B net in cash, cash equivalents and securities while Zynga has a $1.66B market capitalization. Not only does Zynga own a significant amount of cash, they also bought new headquarters this year that are worth a cool $272M. This basically means that you are getting the Zynga operating business for free these days. You don’t have to believe in a ‘the sky is the limit web 2.0-story’ anymore to consider an investment, but you do need to believe that it is a viable business.

To get an idea of the historic earnings power of the business I have created the table below with some key data of the performance of Zynga since the inception of the company.

Zynga has shown explosive revenue growth the past years, but seems to have hit a brick wall this year. Unfortunately the company never really managed to show impressive GAAP earnings with the exception of 2010. Fortunately for the company a lot of the expenses booked are non-cash items, and Adjusted EBITDA paints a different picture.

This absolutely doesn’t mean that we can conclude that Zynga has at it’s core a profitable business. One of the biggest costs that is excluded when looking at Adjusted EBITDA is stock based compensation, and this is a huge part of the pay that Zynga employees receive. If you need to pay a bunch of nerds to create games paying them $100,000 a year in cash or $100,000 in stock doesn’t make a huge difference: both costs are just as real, and if your stock drops big time you can bet that your programmers still want to receive roughly the same pay next year. So the GAAP numbers are a more or less reasonable approximation of Zynga’s profitability.

One thing where the GAAP numbers are a bit misleading is in my opinion with regards to revenue recognition. In a sense Zynga’s accounting is conservative: they don’t recognize income as soon as they sell virtual goods, but recognize the income over the duration of the lifetime of the item. I think the more aggressive approach would reflect reality better than the ‘conservative approach’. As soon as you have sold a customer some crap virtual item in Farmville you have the money in your pocket, and you don’t have to spend significant resources to deliver the service the customer paid for. Sure, you need to keep your servers online, but that’s just a small fraction of the cost of the good. Game development and advertising is where most of the money is disappearing.

Currently the delayed recognition of revenue is actually making the Zynga numbers look better than they are since bookings are down the last quarter, but earnings aren’t dropping as fast since they have deferred revenue from previous quarters. In the table above you can see how deferred revenue dropped from 480M at the end of 2011 to 390M right now.


From an asset point of view Zynga looks potentially interesting, and that is extremely rare for a software company since they are generally asset light. Unfortunately it seems to be questionable if the Zynga business model is sustainable. Looking at the historical earnings you get the idea that there are simply not enough paying customers for the average Zynga game to recoup the significant costs needed to create and run a game. And given the trend in revenues betting on growth and increasing economies of scale seems quite optimistic.

So Zynga is still not a stock I would invest in, but at the same time I wouldn’t be surprised if an investment at the current price would turn out favorable. The company has announced to cut 5% of their staff, rationalize their offering of online games and to buy back $200M of shares. If they manage to get their cost structure under control and not to do more stupid stuff with their cash like the disastrous OMGPOP acquisition it could work out alright.



Covered my Vivus short

Vivus has been dropping like a stone the past few weeks, and today the stock moved down even further when the company disclosed during it’s quarterly conference call that just 3504 patients are on Qsymia to date and that about 30 percent of prescriptions are abandoned due to cash outlay. With the stock down more than 50% since I initiated my short this seemed like a good moment to close my position.

While the result of my Vivus short has been favorable it’s still a bit too early to tell if the original thesis was correct. The dropping share price the past few weeks had nothing to do with potential patent issues, but everything with disappointing sale numbers and a decision from the EU to disallow Qsymia on the European market. This last point was certainly not part of the original short case, and it’s a bit too early to tell what’s exactly the cause of the disappointing sale numbers. If the short case was correct this should be because Qsymia is just a combination of two cheap generic drugs and that patients and/or doctors prefer this option. If the low number of sales are because the US population is for example not interested in an anti-obesity drugs I just got lucky.


No position in VVUS anymore

China Mass Media transaction completed

The going private transaction of China Mass Media went without any problems. The merger was approved on October 31 and the payment for my shares should follow soon. The absolute return on this position is just 4%, but since it was completed after just ~1.5 months the annualized return is roughly 35% (depends a bit on when I’m paid). That’s pretty solid.

Hopefully we will see a similar fast deal completion with my other Chinese going private position (China Nuokang Bio-Pharmaceutical) that is scheduled to be completed in Q1 2013.