Coho Capital has been doing much better than many of the hedge funds we cover. While overall hedge fund data from sources like Eurekahedge has pointed to lackluster or nonexistent gains for most funds, Coho gained 14.2% in the first half of the year, significantly outperforming the S&P 500’s 2.7% increase during the same timeframe.
ValueWalk obtained the firm’s second-quarter letter, in which Managing Partner Jake Rosser covered two of their key positions: Walt Disney and Facebook.
Seth Klarman: Investors Always Need A Strategy To Guide Them
"Many investors lack a strategy that equips them to deal with a rise in volatility and declining markets," Seth Klarman told his audience in a speech at MIT in 2012. Q3 2020 hedge fund letters, conferences and more Klarman was talking about the benefits of having a strategy, such as value investing, to provide a Read More
Coho Capital’s biggest position is Facebook
In the Q2 Coho Capital letter, Rosser revealed that Facebook is the firm’s largest position. They decided to capitalize on the pullback in Facebook stock following the Cambridge Analytica data scandal. The social networking company was already one of Coho’s biggest positions when Rosser and his team decided to add to their position.
Facebook stock plunged 18% in only two weeks earlier this year, but after assessing the situation, Coho Capital decided that the long-term impact probably wouldn't amount to much. The firm ended up doubling its stake in Facebook stock after the Cambridge Analytica news was revealed in March.
Then the shares plunged another 23% in July after the company slashed its revenue outlook and increased its expenses to improve user privacy. Even though Facebook was Coho Capital's biggest position in July, they added increased their stake by another 50% following the July pullback.
Rosser remains confident Facebook stock will eventually reward Coho. He believes Instagram, WhatsApp, Messenger and the other non-Facebook properties are still "early in their monetization cycles," so he eventually expects them to contribute much more revenue to the company than the core Facebook platform in the coming years.
Digital advertising and non-Facebook properties
He noted that the digital ad market remains strong as consumers spend less time watching TV, which has caused a decline in TV ad spend. Facebook is widely seen as a key beneficiary of this trend as TV ad dollars are being shifted to digital advertising.
The Coho team sees the non-Facebook properties as important pieces of the whole with each reinforcing the others and "creating an advertising eco-system." Each property enhances the company's data collection while providing multiple formats for advertisers to choose from when serving up their ads.
Eventually, they see Instagram as being "the most valuable driver" of Facebook stock. In addition to rapid user growth, the photo-sharing platform is also benefiting from increased engagement among its users. Rosser explained that Instagram is also much better-suited for serving up video ads, so they expect Instagram Stories to eventually enjoy higher monetization levels than the core Facebook property.
Instagram also benefits from the growth in online shopping, and as the social network adds more and more features aimed at e-commerce, Rosser expects a significant increase in digital purchases made through it. He even finds it "conceivable" that the photo-sharing network will one day "become the largest online mall in the world."
Ignoring the "chatter" around Facebook stock
Rosser pointed out that most news headlines focus on the core social network rather than its non-Facebook properties, and as a result, talk about its stock generally does the same. As a result, he feels it's a good idea to "ignore the chatter" about Facebook stock because any downside in engagement on the main platform can be more than made up for by the non-Facebook properties.
In Facebook, he sees a "sizable gap between future cash flows and anticipation of those cash flows. He values core Facebook and Instagram at 18 times forward earnings, which puts it in line with the S&P 500's forward earnings multiple.
"Not bad for a 30% grower with 35% operating margins..." he wrote. "You get the optionality of future monetization of Facebook's messaging apps and home-run potential with Instagram for free."
The Coho Capital team likes the set-up in Facebook stock and sees their downside as "well-protected."
The deal with Disney
In his commentary on Walt Disney, Rosser highlighted the nostalgia offered by the House of Mouse and all its brands. He explained that Disney has created a cycle of "self-reinforcing demand," which has enabled it to increase ticket prices for its theme parks dramatically. The Disney brand also spans multiple generations and global regions, and Brand Finance values it at $33 billion, which makes it the world's most valuable brand.
Rosser describes Disney's content library as "its crown jewel," noting the company's long track record of success, not only in releasing popular content, but also in acquiring it through asset purchases such as Pixar, Marvel Studios and Fox. The Fox acquisition brings with it control over streaming platform Hulu, which will play a pivotal role in the development of Disney's streaming strategy.
"Patient" Disney shareholders to be rewarded
Coho Capital management thinks it's "crazy" that Walt Disney stock has been range-bound over the last three years because the company's "brand library and content engine are unparalleled among media companies." Rosser noted that despite its premium content and evolving business model, Disney continues to trade at a multiple that's in line with those of traditional media companies like Discovery.
He pointed out that Disney shares have been pressured by concerns about ESPN's pricing power and "near-term earnings dilution from its shift toward a digital future." However, he feels much of the weight on Disney stock has been the company's exposure to "the vagaries of a hit-driven business model," even though the company has been extremely successful when it comes to releasing hit content.
Stock multiple for "Disney as a Service"?
Rosser thinks that eventually, Walt Disney's multiple will expand to get in line with those of media companies with a digital-first business model and recurring revenue streams. He pointed out that software-as-a-service companies tend to have multiples of six to 12 times on a price/ sales basis. He doesn't expect Disney's multiple to go that high because the company has much more in capital expenditures each year, but he does expect it to expand from where it currently is.
To estimate what the stock's multiple could be under what he describes as a "Disney as a Service" model, he compared it to Vail Resorts. He sees Vail as comparable because it is also a "consumer experience focused company," although the lack of content doesn't make it a perfect comparable. Rosser estimates Vail's price/ to sales multiple at 5.8 times, compared to Disney's multiple of 2.8 times, "suggesting plenty of upside once the Market confers a subscription multiple on Disney," he declared.
The Coho Capital managing partner also spoke highly of Disney's focus on "widening its moat over time rather than winning the quarterly earnings race." The Coho team tends to favor companies which essentially ignore Wall Street in favor of simply building their business.