Some research discards – PDII

PDI, Inc. (Nasdaq: PDII) is a contract pharmaceutical marketing corporation. They managed to make it past my initial screen and I did some subsequent research. On initial glance, it does appear to be relatively cheap from a valuation perspective (revenues in relation to enterprise value is quite inexpensive), but the corporation suffers from significant customer concentration and they are strategically diversifying into partnering with diagnostic companies which creates a different element of investment risk – and valuing these risks from an external investor perspective adds even further complexity.

I generally do not like customer concentration and will pass on this, but will leave this for more enterprising readers out there to figure out if there is value here – my hunch is that the computer traders out there are looking at the low enterprise value in relation to other valuation metrics ($24 million vs. $75 million market cap, and $150 million revenues over the past 12 months), but are not paying enough attention on tangible book ($2.27/share) which means the downside risk is a bit lower (clarification, added December 24, 2013: downside risk referring to a lower price floor) than one would intuitively think.

In other words, without projecting some future external factors out there that would lead to ‘big pharma’ engaging firms such as these, or any intuition that these investments in diagnostics will succeed (there is no way of knowing), PDII is a pass on my books.

Blackberry Q3-2014

It looks like sentiment reached its maximum in mid-December; also just after the earnings release the lowest trade after-hours was at $5.70/share. Clearly the market over-discounted the negative aspect of this quarterly result despite the fact the company’s revenues were well below consensus.

It still remains an interesting business case, whether their existing businesses are viable after shutting down their consumer end. I think their QNX segment has value, but how much is another question. I generally believe their BBM technology is over-hyped and is going to become a “me-too” type product even when ported to other consumer platforms (Android and iOS). It reminds me of what happened to OS/2 when they successfully were able to have Windows 3.1 applications run within the OS/2 operating system – why bother when you can just have Windows 3.1 and not have to mess around other operating systems?

Anyhow, no positions and I will not be taking one. Too many eyeballs are on Blackberry and a lot of those eyeballs are connected to brains a lot smarter than I am.

General comments on the market

I have not written too much lately, but the short-term research focus continues on stocks that are generally trading at 52 week lows. If you are into gold mining companies, let me tell you, there is no shortage of research to be conducted.

Fortunately, I do not focus on the gold mining industry and can let other intelligent people harvest opportunities in that category. One would think, however, that large-scale entities like Barrick (TSX: ABX) and Kinross (TSX: K) would have some sort of value, given that they are trading at lows they haven’t seen in a decade. That said, just because a large corporation has traded at a certain level in the past doesn’t mean they will continue trading at that value forever – the market is full of survivor bias, which is why you don’t see Polaroid or Kodak trading anymore.

There is another focus which I have been slowly shifting my attention to, and this is territory that is generally unexplored for me: international stocks, beyond those in English-speaking jurisdictions. My natural investment aversion to non-English speaking jurisdictions is colliding against the general belief that there seemingly are entities trading out there that are at relatively cheap valuations. I can easily see right now, however, that I am the person around the poker table that everybody wants to take a dollar out of, so I am very wary treading into this direction.

I did find a particular investment candidate in the early part of the quarter which I pounced on with two feet and this unexpectedly has boosted the performance of the portfolio considerably and I hope to find others. I might write a report on this one after year-end.

Timing Blackberry

Blackberry is going to be an interesting business case as they are clearly not going down without a fight.

They are going to report quarterly results on December 20, 2013. I would expect these results to be very sub-optimal simply because if there was some signs of revenue stabilization it is much more likely that they would have found partners in the proposed buyout at US$9/share. Since there were multiple parties out there that were looking at the internals of Blackberry during October and would have received full visibility in two of three months of the fiscal cycle, I very much believe that revenues will be well below the $1.58 billion consensus estimate that I see on Yahoo at the moment.

In addition, with the new CEO cleaning house at the upper management level, it is going to take at least three to six months for them to realign the company and apply resources to the appropriate strategic priorities the company needs to focus on to get back to a profitable setting. However, the fact that he is cleaning house is a positive signal even though you will not be seeing the results of such actions for at least half a year.

That said, with the expectations in the stock market, I would expect rock bottom to be hit at the end of the year. Not only will they likely produce a lower-than-low expectations quarter, but you will also have the avalanche of tax loss selling and portfolio window dressing – which portfolio manager out there except for Prem Watsa would want to see this dog in their portfolio at year-end?

The sentiment regarding this upcoming quarter is quite bad. The question is how much the market has already baked in an upcoming bad quarter. Have they over-discounted?

DISCLOSURE: A friend of mine who I consider to be quite tech savvy, who already owns a Samsung smartphone with one of those giant screens, recently bought a Blackberry Q10. He suffers from a “can’t type on a touchscreen if it could save my life” syndrome. I share the same syndrome and am actually in the market looking for a usable phone with an actual physical keyboard. Other than that, no positions.

When will Bitcoins peak?

Bitcoins are once again making headlines, for exceeding US$1,000 per Bitcoin on various exchanges.

I wrote about them back in 2011 when they were trading at around US$20 a piece. The analysis is really still the same.

The debate here should not be whether Bitcoins are useful as a currency or not, but the lesson here is strictly one in economics – people see value in very strange things, and when people do see value, there will be markets created. In this case, the product is a currency that is only valuable because of its rarity and difficulty of generation, and is not too different than trading artwork or collectibles which have similar appeal.

More people are seeing something valuable in something very odd and this is apparently spreading world-wide to anybody with a computer.

As for answering the question as to what Bitcoin’s peak is, I do not know for sure. This reminds me of when I asked myself when the dot-com bubble is going to burst, or how far the US stock market was going to plunge in late 2008/early 2009.

There are a few headwinds I see for Bitcoin, and they generally deal with hitting the law of large numbers.

The first deals with liquidity.

There are 12 million Bitcoins outstanding, but the reported liquidity is quite thin. Right now if you wanted to liquidate 5,000 Bitcoins and raise a cool $5 million, according to the liquidity chart you would move things about 13% if you wanted to hit the bid with everything you have. Obviously you would want to fragment the order and leak it out over a period of time over multiple exchanges, but I would suspect that there are some component of technical traders that are simply out there to scalp dollars and not actually give a hoot about the currency.

The reported market cap of Bitcoin is about $11 to 12 billion and when looking at a typical equity trading with the equivalent capitalization, Bitcoin’s liquidity is nowhere close.  How many dollars can you actually extract out of the market if you had 100,000 Bitcoins and wanted to liquidate in a timely manner?

Another issue deals with the ability to control the blockchain (the accounting equivalent of the general ledger, with the notable exception that the blockchain contains ALL information of transactions since the history of Bitcoin).  Without getting into a lot of technical details, there are collusion opportunities to corrupt the blockchain if you control a majority of Bitcoin miners.  Bitcoin mining has become a very specialized art and to effectively compete in mining, you need to own arrays of specialized devices for the purposes of mining Bitcoins.  Since the difficulty of Bitcoin mining increases as a function of both time and the amount of computational power on the Bitcoin network, there has been a technological arms race, with the following result:

Please observe the y-axis is logarithmic – mining Bitcoins has been over a hundred times more difficult than it was at the start of the year.  This is like your typical 10MBps residential high-speed internet connection scaling down to twice the speed of a dial-up modem.

The technology to do the proper calculations are application-specific integrated circuits (ASICs) that have their sole purpose in life to mine Bitcoins, but as these are permeating the Bitcoin marketplace, there are limited opportunities for exponential improvement to Bitcoin hash rates through technological innovation – most performance improvement from this point is going to be linear as more machines get added to the cluster networks that are solely dedicated to Bitcoin mining.

I note with amusement the announcement that somebody is producing a 20nm process ASIC rig that can do some insanely high hash rate, but this will be the end of the line: 20nm semiconductor processing is the peak of the current technology limit – even Intel is still working on perfecting the 14nm process.  Even then, the company has already announced the product (which apparently will be shipped in Q2-2014) will be at the threshold of the limits that a typical household power supply can handle.

So when you get into industrial-level operations to run arrays of computer hardware solely for the purpose of mining Bitcoins, some group is going to consolidate a majority of miners and be able to corrupt the network.  With billions of dollars of market capitalization, it is getting to the point where that group is probably thinking about implementing some scheme to control the blockchain.

The blockchain concept also creates a scaling issue as eventually it becomes impractical for it to be maintained by distributed “retail” computers – “institutional” resources are increasingly employed to maintain the blockchain as they will be the only ones to have sufficient computational muscle to be relevant.

When will this blow up?  I’m not sure, but I’m reasonably sure we’re within an order of magnitude (i.e. not higher than US$10,000/Bitcoin) just because of the law of large numbers – liquidity (the quantity of dollars Bitcoin is able to extract from others) and blockchain dynamics.

The current phase in Bitcoin is still adding people with money into the system, which is required for the scheme to continue, but those that have caught onto the scheme earlier will presumably be continuing to diversify their Bitcoin holdings into harder currency.

When reading Reddit’s Bitcoin chatter, I see a lot of financial illiteracy out there, which doesn’t bode well for those that have high hopes for Bitcoin.

I do not own any Bitcoins, nor will I, but I am watching this with curiosity.  It is indeed is fascinating to watch non-financial people get involved in what is inherently a financial specialty product with a touch of well-designed technology sprinkled in.  Whoever conceived of this did their homework and never would have guessed the technology arms race that has developed as a result.