The major market indexes have been retracing their steps back to their late-October lows. With the trend down, it should come as no surprise that most of our stocks lost ground over the last five trading days, too.
This continues to look like a bottoming process, during which we get a lot of fake signals both to the upside and the downside. It’s the kind of market that can lead to a lot of bad trades if you’re trying to move in and out of stocks (and small caps in particular) based on what appear to be the emergence of trends. It’s really just a sloppy mess, and frankly I think the less trading you do the better.
Another subject on the minds of some small cap investors is the Russell 2000 “death cross” signal, which happens when the 50-day moving average line falls below the 200-day moving average line (it just occurred). Some say this signal suggests bad things are on the horizon. Looking back over the last decade the signal has occurred five times, and in only one case (2015 - 2016) did the Russell 2000 fall significantly lower afterward.
I wouldn’t make too much of a fuss about this signal. In my opinion it’s just telling us that the market is trending down (we don’t need an ominous sounding technical term to tell us that!). But it has limited predictive accuracy (just 20% over the last decade).
With the market bouncing around investors often spend more energy thinking about stock prices than about businesses. Stock price matters. But I’d argue that business strength matters more. It drives a stock’s price over the long haul.
Good businesses have inherent value. Yes, value can be subjective. And it changes with sentiment and market forces. But over time that inherent value will usually bubble back up to the surface.
We’ve seen compelling examples of the emergence of value recently as several transactions have been announced at attractive prices. Most have been in the cloud software space, but a few in health care too.
The most pertinent one to us is the deal I wrote about earlier this week. Vista Equity Partners is acquiring portfolio-holding Apptio (APTI) for $1.94 billion, or 38 a share. That price represented a 50% premium to Apptio’s prior-day closing price, and means we locked in a nearly 70% gain.
It also implies Vista paid a nice premium in terms of valuation. The transaction implies a multiple of 7.5-times on an enterprise-value-to-forward-twelve-month-sales (EV/FTM) basis. According to JP Morgan, this multiple is toward the high end of nine other deals closed in 2018, including:
1. SAP buys Callidus
2. Salesforece.com buys Mulesoft
3. Microsoft buys GitHub
4. IBM buys Red Hat
5. Adobe buys Marketo
6. Adobe buys Magento
7. Workday buys Adaptive Insights
8. Twilio buys SendGrid
9. SAP buys Qualtrics
Only time will tell if these deals were completed at good prices or not. What we can say with confidence right now is that there appears to be plenty of appetite to get deals done. And any one of our cloud software stocks could be next.
We also saw a deal this week with Arena Pharmaceuticals (ARNA), which has agreed to out-license its ralinepag asset to United Therapeutics (UTHR) for up to $1.2 billion. Ralinepag is being investigated for the treatment of pulmonary arterial hypertension (PAH). I’ll talk about that deal below, but for now, the message is simply that the appetite for deals is out there—if the asset/business has value.
As I’ve stated several times, I continue to see this as a normal, albeit significant, market correction (not unlike the one in 2015 that preceded a mini-bear market). If we focus on the right things we will come out the other side just fine.
There is one rating change this week and one action:
Goosehead Insurance (GSHD) – Moves to Hold
IntriCon (IIN) – Sell another quarter, Hold Half
Updates
Altair Engineering (ALTR) reported last Thursday and missed by a fraction on revenue due to deal timing and foreign exchange, while EPS beat by a penny. The Datawatch (DWCH) acquisition is also a major question on the minds of investors and one that I think has potential (despite the challenges), provided Altair executes well (it has done well in the past with acquisitions). I moved the stock back to Buy last Friday since I think the majority of selling is behind us. On the other hand, this could just be another plateau, or head-fake small uptrend, before another leg down. We’ll just keep an eye on it. It seems like a good value here. BUY.
AppFolio (APPF) is still a good company that trades at a premium (EV/FTM sales ratio is 10.2). The stock price is essentially unchanged over both the last one and three-week periods. Nothing new here. Keep Holding. HOLD.
Apptio (APTI) announced a deal earlier this week to be taken private by Vista Equity Partners at 38 a share, or $1.94 billion. That represented a 50% premium to the stock price on the previous day’s close. I sent out a Special Bulletin advising you sell the stock on Monday, and shares are unchanged since then. We booked a gain of 69% over a holding period of around 11 months. My only regret is that we can’t keep holding the stock and see where it goes! SOLD.
Arena Pharmaceuticals (ARNA) announced on Thursday that it would out-license its ralinepag asset to United Therapeutics (UTHR) for up to $1.2 billion. Ralinepag is being investigated for the treatment of pulmonary arterial hypertension (PAH), and this announcement drove the stock up over 20% yesterday. United is a logical partner for ralinepag since it also has Orenitram, the only FDA-approved prostacyclin analogue in a tablet to treat PAH. This deal can be taken as a partial admission that ralinepag is likely a more valuable asset. Because United already is in the PAH market, it’s also reasonable to conclude they’re a very good partner for Arena. Given the potential royalties, a good partner is important. IP protection should extend until around 2035.
As part of the deal, Arena gets a $800 million upfront payment (equal to roughly half its market cap earlier in the week), a $400 milestone payment, and tiered low double-digit royalties on global sales. One piece of the milestone payment ($250 million) is for US approval of an inhaled version of ralinepag, while the remaining $150 million is for approval of oral ralinepag in Japan, France, Italy, the UK, Spain or Germany.
On the conference call management stated that this transaction takes the financial pressure off the company and essentially gives it a “slush fund” to move etrasimod (higher peak sales potential than ralinepag due to number of possible indications) and olorinab (as well as other early-stage assets) through the pipeline. Not only does Arena get a chunk of change, it’s also relieved of some R&D spending during the most expensive part of drug development.
Overall, this seems like a good deal and it’s nice to see Arena ringing the cash register at a time when investors were likely getting weary of the story given the extended time to market for its first treatment. This doesn’t change that (etrasimod isn’t likely to get the market until 2022) but it should take some pressure off and illustrate the value in the company. Keeping at Buy. Average in. BUY.
AxoGen (AXGN) retraced its steps back to its October low this week. That’s not particularly concerning given the broad-market trend. Let’s look for the stock to hold up here and, with a little luck, get a bump from next Monday’s Analyst Day. I’ll update you on the highlights from that event. HOLD.
Bottomline Technologies (EPAY) was beaten down last week after reporting an unremarkable quarter (nothing awesome, nothing awful). I’ve kept it a buy since I think the selloff is overdone. Shares have come back a little on decent volume and have held above their 200-day moving average line. These are decent indications that investors are stepping in to grab shares. Keeping at Buy. BUY.
Chefs’ Warehouse (CHEF) is trading near its recent high and is among the strongest in our portfolio. This is more of a growth and value stock than a pure growth stock, which makes it a good match for this market environment. Keeping at Buy, but continue to average in on pullbacks. BUY.
Everbridge (EVBG) reported last Monday night and following a nice pop shares pulled back to near their October low on Wednesday (they rallied almost 8% yesterday). I think there’s tons of potential with the stock and it’s already proven to be one of the stronger small cap SaaS stocks during this correction. But trading at 9.6-times FTM sales, it’s not cheap. This dynamic (great growth, great story, resilient, but expensive) is likely driving some of the erratic trading action. You can nibble on a few shares here if you feel light on your position. If you’re already loaded up, it’s a Hold. HOLD.
Goosehead Insurance (GSHD) rallied up to its September high in late-November but is now down eight sessions in a row and has broken below a support zone in the 24 - 26 area that had held since the beginning of June. Recall that the IPO lockup expiration date was a few weeks back and it’s possible that some insiders are looking at the broad market’s trend and thinking its good to lighten up a bit. Volume has been higher than normal, which isn’t surprising given the lock up expiration. There’s nothing wrong with the business, but the stock is clearly not doing well. Bottom line—the depth of this correction means we need to move Goosehead to Hold and watch it closely. HOLD.
IntriCon (IIN) is another situation where the business appears just fine but the stock is weak. Shares broke below their 200-day moving average early in the week, which was also prior price support (and about where we got into the name) from back in June. We’ve taken partial profits (sold one quarter of our original shares), so this retreat hasn’t been all pain, but there’s no doubt this has gone longer and deeper than I expected. Let’s average out a little more by selling another quarter position. Hold your other half. Sell A 1/4, Hold 1/2.
Q2 Holdings (QTWO) hasn’t done anything remarkable over the last week and there haven’t been any big news events, other than an announced integration with DocuSign’s (DOCU) Centrix Dispute Tracking System interface, which will help streamline dispute resolution for financial institutions by automating electronic signatures on any dispute form. The stock has been knocking around for the last three weeks and is essentially unchanged over that timeframe. Keep Holding. HOLD.
Rapid7 (RPD) is back near its October low after giving up its earnings-driven rally. The story is still good here we just need a more supportive market to get the stock going again. Keep Holding. HOLD.
Repligen (RGEN) is our newest addition and we’re still sitting on our initial position (a half position). Shares have pulled back a little, but not nearly enough to warrant buying more. Repligen designs and sells bioprocessing technologies that make it more efficient to manufacture biologic drugs. This is a booming market and the company’s recent quarter, and the stock’s reaction, illustrated how high demand for exposure is among the investment community. No change in the story this week. Just keep averaging in. BUY 1/2.
Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.
