Research Notes: Friday Insanity
Looking back to Friday's trading session plus updates on our recent calls.
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Author’s Note: Research Notes is usually published mid-week, but we moved it up this week for reasons that will become immediately clear.
Here’s a list of things that happened in the market on Friday:
WeTrade Group (WETG), a Chinese company that supposedly is developing a “social e-commerce platform” which is also an “international cloud-based intelligence system” and a “micro-business cloud intelligence system”, rose as much as 176% during the session, and closed up 13% for the day and 416% since its July 19 IPO. The Friday gains appear due to a partnership with China’s Jiqing Bio, in which WeTrade will exclusively sell Jiqing’s test kits for monkeypox. Jiqing does not appear to have received any approval for its kits; WeTrade generated $14 million in revenue in 2021, ~one-third of it to a related party. WETG now has a market cap clearing $4 billion.
Hong Kong-based underwriter Magic Empire Global Limited (MEGL) went public at $4. The stock opened at $50 and closed at $97. It appears likely that “investors” were trying to catch the “next” AMTD Digital (HKD), which at one point on Tuesday had a market capitalization of $310 billion. (Three hundred and ten billion, not three point one billion.)
Door-lock maker Intelligent Living Application Group (ILAG), also based in Hong Kong, saw its shares gain 64%. Volume during the session was 3.5x the number of shares outstanding, and ~13x the 5.06 million shares floated during the company’s IPO last month.
Redbox Entertainment (RDBX) rallied 27% to close at $5.02. Redbox has agreed to sell itself to ‘Chicken Soup for the Soul Entertainment’ (CSSE) for stock consideration worth roughly $1 per RDBX share. Traders are trying for a “short squeeze” despite the fact that Redbox’s float is incredibly thin: about 2 million shares. The float is thin because Redbox was a ridiculous piece of junk that went public via the SPAC (special purpose acquisition company) route, and unsurprisingly saw 89% of its pre-merger SPAC shares redeemed. RDBX bulls are positing that a global financial conspiracy is being abetted by the company’s own shareholders in order to protect a short position with a total notional value of about $10 million.
AMC Entertainment (AMC) stock gained 19% after its second quarter earnings were issued after the bell on Thursday. Relative to Q2 2019 performance, AMC’s revenue was down 23%, and Adjusted EBITDA 55%. Yet its bulls — many of whom predict the MOASS (Mother Of All Short Squeezes) — cheered the company’s issuance of preferred stock, which will have the ticker ‘APE’. That preferred stock in fact is simply an end run around the fact that AMC shareholders won’t authorize an increase in shares because they are convinced that billions of “synthetic” shares of the stock exist.
In its Q2 earnings report after the close Thursday, Beyond Meat (BYND) posted negative gross margins and cut full-year revenue guidance. The stock gained 22% on Friday. Its market capitalization sits above $2.4 billion. Beyond Meat’s zero-coupon convertible matures in 2027 and last traded at 41.5 for a yield-to-maturity over 23%.
Coinbase (COIN) rallied 4.7%, closing a four-day rally in which the stock gained 53% and the company added ~$7 billion in market capitalization. The only catalyst was an agreement with BlackRock (BLK), which agreed to partner with Coinbase in providing Bitcoin trading to institutional clients. Existing institutional revenues for Coinbase are exceptionally low-margin, and profits will likely be further pressured assuming BlackRock gets a piece.
This all happened in a single day — a Friday, no less — in August 2022. Not October 2020, or February 2021.
The All Clear Echo
In an excellent Twitter thread on Thursday, Paulo Macro (presumably a pseudonym) highlighted what he called the “All Clear Echo”. He pointed to something I honestly had forgotten: in both 2000 and 2008, markets bounced sharply after the point (that in retrospect) looked like a clear top. In 2000, in particular, the March 2000 top was followed by a face-ripping rally in bubble stocks during the third quarter.
That history informed this prediction:
Paulo Macro @PauloMacroUpdate on equities as I am getting flooded if I am still constructive. Yes. No hedges since June opex. Been clear on that and if my views change I would post. Ponzi and crypto longs saving me while a collection of oil/cu/U/silv/wheat longs do a Marcellus Wallace on my PNL. 1/
The entire thread is worth reading, but Paulo’s theory (and the following day’s trading) combine to create one key question: have we yet reached Max Stupid?
Paulo argues, perhaps tongue-in-cheek, that Max Stupid would be reached when Tesla (TSLA) became the world’s most valuable company1. But if history repeats, it would at least seem that we’re knocking on the door of Max Stupid. At least, if Friday wasn’t Max Stupid, it’s terrifying to think what might be.
The Bear Market Rally
Paulo’s argument dovetails with an argument made on my very first post, at the end of March:
…what many of us — again, myself included — have not quite appreciated is the unbelievable amount of stupidity that has dominated this market, particularly over the last 25 months.
Where I went wrong was not pushing enough on that thesis as the market tumbled toward May lows — and not seeing the voraciousness of the bear market rally that followed. That rally looks like it’s been driven by positioning, with both institutional and retail investors looking to make up for the early-year losses.
I’m increasingly convinced that this indeed is a bear market rally. Friday’s action (in every sense of the word) strengthens that belief.
In the meantime, however, it’s admittedly somewhat difficult to have conviction. One response to Friday’s moves, and the huge gains in speculative stocks, is to simply short the bounce. But a lot of shorts last Monday and Tuesday got run over on Thursday and Friday. The converse strategy — long garbage, perhaps dressed up as long volatility — has its own risks (and, to be honest, isn’t a strategy with which I’m experienced or even comfortable).
We’ve tried to thread the needle, focus on defensive-ish names and pay close attention to position sizing. We’ve kept an eye on the long-term while acknowledging short-term realities. That strategy has had decent results overall (our average call remains +2% in a market still down 9%). Although we’ve had some disappointing results of late. Given the size of this rally, that short-term weakness isn’t terribly surprising. In that context, some updates on recent picks:
Texas Roadhouse (TXRH)
TXRH is a good example of how we’ve misread the broader market environment. Nothing really has changed in the five weeks since publication. Q2 earnings look about in line with our expectations. Same-restaurant sales guided positive and the outlook for inflation, net/net, is essentially unchanged.
What has changed is the market’s attitude toward the stock:
TXRH — a chain restaurant operator — is now down just 1% year-to-date. From here, it looks like a perfect distillation of the market’s willingness to look past still-present risks.
Brunswick Corporation (BC) and OneWater Marine (ONEW)
Our bear thesis on boating stocks, including industry leader Brunswick, dwelt on a similar theme: that the cycle inevitably was going to turn.
It hasn’t done so yet, at least per the numbers so far. Brunswick moved up the low end of full-year guidance for both revenue and EPS. OneWater raised its Adjusted EBITDA guidance for the year.
In both cases, the macro environment appears favorable enough to keep near-term momentum going. The long-term thesis — that demand pull-forward will hit the industry for years to come — might now become a 2023 story. I’m personally not pulling out of my short in ONEW yet, but adding to the short or trying to scalp this rally elsewhere in the space might not be wise.
Kulicke & Soffa (KLIC)
Heading into fiscal Q3 results, the bear case we laid out for KLIC was that the cycle would turn, and profits would head back toward FY19 levels, suggesting sharp downside in the stock. The bull case — one detailed by management as well — was that technological advancements and new markets, notably in advanced packaging, meant this was not the same cyclical semicap it had always been.
The Q3 report seemed to support the bear case. Kulicke & Soffa guided for revenue to decline 25% sequentially, with non-GAAP EPS dropping by more than half even with the benefit of significant share buybacks in recent months.
The Q3 call, however, went to the bulls. K&S gave preliminary guidance for fiscal 2023, projecting that the average quarterly run rate would about match Q4 FY22 results. In other words, the initial outlook is for $3.50-plus next year — and management, as they had earlier in the year, predicted that the company would then grow off that level.
The question therefore is whether management is right. Some skepticism is warranted. But to be fair, K&S historically has been reasonably honest about cycle turns. The company has a seven-decade history of managing those turns after all.
But at the same time, guidance still suggests that K&S has transformed itself in a matter of years: the four-year adjusted EPS average from FY16 to FY19 was $1.28. K&S is saying that adjusted net income will rise roughly 2.5x in seven years (buybacks are increasing EPS as well), and just happen to do so during an unprecedented amount of falling demand in the core market it dominates. Near-term, the company is projecting that revenue is going to decline 25% q/q — and then suddenly stabilize.
From most other companies, that kind of guidance would be seen as laughable. The fact that the market gives it some respect says a lot about the company’s history. But it also doesn’t, on its own, counteract the short case.
That (still-unofficial) guidance implies a roughly 10x multiple to FY23 earnings — a multiple not out of line against the stock’s past valuation. The market still is pricing in a transformation here, and it still seems reasonable to take the other side of that bet, at least at the right time.
As of this writing, Vince Martin is short ONEW and TSLA.
Tickers mentioned: WETG TXRH ONEW KLIC
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