Brian Gaynor: Kids can be your best investment guide

11 Mar, 2017

Categories: Brian Gaynor, Market Commentary, News

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This article originally appeared in the NZ Herald.

One of the best pieces of investment advice is to listen to your partner and children.

This was clearly evident during the Snapchat IPO as one of the company’s external pre-IPO shareholders made a killing because his daughter was engrossed in the social media app.

Peter Lynch, the legendary manager of the US based Fidelity Magellan Fund, listened carefully to his wife Carolyn. In his book “One up on Wall Street”, Lynch included a section called “The Power of Common Knowledge” where he described his investment in Hanes, the L’eggs pantyhose company.

Hanes sold pantyhose in colourful plastic eggs near supermarket checkout counters. The logic behind this was that women visited a supermarket twice a week while they only visited department stores once every six weeks, where pantyhose was traditionally sold.

Lynch wrote: “Carolyn didn’t need to be a textile analyst to realise that L’eggs was a superior product.

All she had to do was buy a pair and try them on. These stocking had what they also call a heavier denier, which made them less likely to develop a run than the normal stockings. They also fit very well, but the main attraction was convenience. You could pick up L’eggs right next to the bubble gum and razor blades, and without having to make a special trip to the department store”.

Fidelity portfolio managers bought the stock after Lynch decided it was a winner following his wife’s advice. L’eggs was one of the 1970s most successful consumer products and Hanes share price soared more than six fold before it was acquired by Consolidated Foods.

Lynch’s best selling book goes on to describe how a number of other successful investments were suggested to him by his late wife while many investors follow poor advice by Wall Street analysts.

Snapchat was launched in 2011 by three Stanford University students, Evan Spiegel, Bobby Murphy and Reggie Brown. The company is based a stone’s throw from the ultra cool Venice Beach, just north of Los Angles Airport.

The social media app was developed as an efficient and fast way to send and receive photos on smartphones. According to the IPO offer document: “Every Snap was deleted from our servers by default after it was viewed, and a copy was saved only if the sender or recipient took a screenshot or otherwise saved it. Since the beginning, many people have used Snapchat primarily to send ‘selfies’, digital self-portraits captured and shared using our camera. We think this is because deletion by default makes our users feel comfortable sending photos of themselves even when they don’t look pretty or perfect”.

The IPO documents revealed that Brown filed a lawsuit in 2013 claiming that he was unfairly dumped from the company and was entitled to one-third ownership. The suit was settled for US$157.5 million (NZ$228m) but Brown received no equity as part of the agreement.

Snap Inc, the owner of Snapchat, listed on the New York Stock Exchange on March 2 following the sale of 230m shares to the public at US$17 each. The issue raised US$3.91 billion for the company and existing shareholders and the 230m shares represent 19.9 per cent of the company after the IPO.

The stock has been on a rollercoaster ride since listing with its share price rising rapidly on the first two days, falling the next two and then rising on Wednesday but easing on Thursday. More than 600 million shares have been traded in the first six days with the shares hitting a high of US$29.44 on the second day and closing at US$22.71 on Thursday. The total value of Snap Inc. shares traded since listing exceeded the total value of all shares traded on the NZX over the past six months.

The latest share price of US$22.71 represents a gain of 33.6 per cent from the IPO price and the company now has a sharemarket value of US$27.3b (NZ$39.6).

The big winners from the IPO are the two co-founders, 26 year old Spiegel, who is the chief executive officer, and 28 year old Murphy, the chief technology officer. Spiegel and Murphy own nearly 20 per cent of the company each and their Snap Inc holdings were worth US$5.2b (NZ$7.5b) each at Thursday’s closing price. In addition, they have almost total control of the company as the Common A shares issued to the public have no voting rights.

Spiegel’s girl friend is the Australian model Miranda Kerr, who was previously married to English actor Orlando Bloom.

One of the big media stories is how San Francisco based Lightspeed Venture Partners invested just US$8.5m in Snap Inc and sold US$74m worth of shares through the IPO. Its remaining shares are worth nearly US$2b according to the Australian Financial Review.

Lightspeed partner Barry Eggers writes how he came home from work one day and saw his daughter Natalie and her high school friends absorbed in their phones and laughing.

He asked what they were doing and she replied; “Dad, have you seen this app? It’s called Snapchat. You take pictures, send them to your friends, and they disappear in 10 seconds”.

Eggars told one of his Lightspeed partners, Australian Jeremy Liew, to look at the company and the rest, as they say, is history. The Australian media has been beating up the story this week because of Liew’s connection with Lightspeed and Kerr’s romance with Spiegel.

Snapchat now has 158m daily active users, 70 per cent of whom are women.

But – and it is a big but – Snap Inc, generated revenue of only US$404m in the 2016 calendar year and had a net loss of US$515m.

The key to the company’s future success is advertising revenue, which remains low but is growing rapidly. For example, total revenue has grown from just US$3.9m in the first quarter of 2015 to US$128.2m and US$165.7m for the last two quarters of 2016 respectively.

US investors are patient as far as its high profile social media companies are concerned but this patience doesn’t last forever.

For example, Twitter has had a negative one year sharemarket return of 13.8 per cent and its share price has plunged from a post-listing high of US$74.73 to US$15.22. The company has a market value of US$11.0b and reported a net loss of US$457m, on revenue of US$2,530m, for the December 2016 year.

On the other hand, Facebook’s share price closed on an all-time high of US$138.24 on Thursday. The company has a sharemarket value of US$398b and reported net earnings of US$10.2b for the 2016 calendar year on revenue of US$27.6b.

This brings us back to Peter Lynch and the importance of investment timing. Thanks to his wife, Lynch got it right with Hanes and L’eggs while Lightspeed hit the Snapchat jackpot because of the daughter of one of the company’s partners.

However, Lynch tells the story of an investor who relied heavily on Wall Street analysts and rejected his wife’s recommendation to invest in The Limited, a department store owner, after it listed on the NYSE in 1977. The company’s share price soared 100 fold after it it purchased the Victoria’s Secrets brand and 25 Abercrombie & Fitch stores.

Ten years later Lynch’s investor spotted The Limited on a broker’s buy list and decided to buy at an all time high of US$50 a share even though his wife told him the merchandise was overpriced and she didn’t shop there anymore.

The Limited’s share price quickly fell to US$16 when the investor sold out to limit his losses. The company is now in private equity ownership.

Only time will tell whether Snap’s IPO price will be a repeat of Lynch’s Hanes or his investor’s purchase of The Limited shares.

 

Brian Gaynor

Head of Investments

Disclosure of interest: Milford Funds Ltd. holds shares in Facebook on behalf of clients.

Disclaimer: This article originally appeared in the NZ Herald and is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so should not be viewed as investment or financial advice. If you require financial advice we recommend that you speak to an Authorised Financial Adviser.

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