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Southwest Airlines, Clover Health, SPACs, Opendoor, Spotify and Roku

Southwest Airlines asks employees to take pay cuts, Clover Health is going public by SPAC and Opendoor provides a look at its financials.
(By Carlos Yudica)
(By Carlos Yudica)
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Good morning! Today’s word count is 2,375 words, or a 12-minute read. Let’s get to it:

Market Summary (12:10 pm ET): U.S. stocks are flat today despite Fed Chairman Jerome Powell’s warning of “Tragic” risk to the economy from a potential lack of fiscal support.

  • S&P 500:  $3,404.60 (-0.12%)
  • Nasdaq: $11,284.34 (-0.41%)
  • Bitcoin: $10,715.15 (-0.35%)
  • U.S. 10-Year: 0.776%

Justin Oh’s Quick Read

Tao H. had a great comment on our YouTube live stream about how Roku ($ROKU) has faster growth than Spotify ($SPOT), so is it actually more expensive? Let’s take a look. 

Roku sells connected TV devices and is the market leader with a 35-40 percent share with over 43 million installed units. I love their strategy of selling their devices at low margins and within cheap TVs to grow their installed base. It’s easy to see why people are watching on Roku over the $200 Apple TV. Only 30 percent of its revenue comes from devices, and the majority of the business is high-margin media through advertising, subscription and transactional revenue on the platform. They are seen as the “Switzerland” of streaming video between Amazon, Apple and Google. Given their momentum and the shift to streaming, they are expected to grow revenues by 30 percent and gross profit by 35 percent annually over the next 3-5 years. Our biggest concern is that, with all eyes on streaming, platform competition and negotiations with content providers will get extra tough (as seen with Roku’s hiccups with NBC’s Peacock and HBO Max).

Spotify sells music streaming on their app, supported by advertising and subscription revenue. In a way, it is also the “Switzerland” of music streaming and holds the top market share of over 35 percent. It’s expected to grow revenues by 20 percent and gross profit by 25 percent annually over the next 3-5 years. I am more confident in Spotify’s growth because of how the music industry compares with the motion picture one. Music content creation is much more dispersed and labels and individuals control popular music. There really isn’t a path for the music platforms to create in-house music content, whereas Netflix, Amazon, HBO, Apple, Disney, etc. are all trying to develop in-house video content. For music streaming, user experience and platform supremacy are more important, but content is much more critical for video streaming.

At $208 per share, $ROKU trades at 19x estimated 2022 gross profit. At $254 per share, $SPOT trades at 12.7x gross profit. So, $ROKU is trading at a 50 percent valuation premium to $SPOT and expected to grow profits 40 percent faster. That being said, after reading more about the company, Roku has a lot of growth runway ahead and the potential to leverage their installed base into a high-value advertising platform. If you believe that people will continue to shift towards streaming video and music, both of these growth stocks look to be great long-term holds. Still, with a much higher valuation, $ROKU will be more susceptible to harder stock price drops if they encounter hiccups in business performance. All things considered, I prefer both of these stocks to Apple.

Southwest Asks Employees to Accept Pay Cuts to Avoid Furloughs

Amid the airline industry’s pandemic-driven struggles, Southwest Airlines is attempting to take a different approach than its competitors. To prevent furloughs and layoffs through the end of the year, Southwest is asking its labor unions to accept pay cuts for the first time, WSJ reports.

Covid-19 has battered the airline industry, with government restrictions and overall virus concerns severely limiting travel. Demand is still 70 percent below last year’s levels, and airlines are having a hard time retaining employees while “bleeding cash.”

  • Airlines received a $25 billion bailout earlier this year, which barred them from laying off employees before Oct.1, but hopes of a follow up have faded.
  • After the layoff moratorium expired, United Airlines and American Airlines cut a combined 32,000 jobs.
  • Delta had some success mitigating forced cuts with early retirement deals and hours reductions.

New Territory: Southwest has never cut jobs or furloughed employees, but CEO Gary Kelly warned of the possibility without new federal aid.

  • Kelly has taken reduced pay since March and will forgo his salary for the rest of the year.
  • He also said Southwest’s quarter losses could be “in the billions” until there’s an effective vaccine widely available.

The unions are open to discussion, but skeptical that concessions on their end would boost the bottom line.

  • Pilots’ union: “Agreeing to discussions is very different than agreeing to concessions.”
  • John Samuelsen of the Transport Workers Union: “It’s a slippery slope, and we have no intention of sliding down it.”

In the meantime: Kelly agreed to take no salary through 2021, and nonunion employees will have pay reduced by 10 percent.

  • He does think Congress will reach another pandemic relief deal, including an airline provision, which would reverse any agreed-upon reductions.

Justin Oh:

I haven’t liked airline stocks since the start of Covid-19 and are still not fans of a near-term “recovery” play. Although if you’ve followed A Couple Cents for a while, you would have outperformed from our recommendation in May that Southwest ($LUV) was by far the best airline to invest in. Business travel, which accounts for half of the industry’s profits, is still on complete hold for the foreseeable future, and we are in a seemingly unending state of pseudo-quarantine. Even with a vaccine by early 2021, I believe that we are in for a slow and steady recovery in air traffic volumes over two years. Unless the government offers billions in free money, the airlines will have racked up so much debt that many will have to go through Chapter 11 bankruptcy. Again, I don’t love the airline space. But it would undoubtedly be Southwest ($LUV) if I were to buy one.

Chamath Palihapitiya is Taking Clover Health Public in a Multi-Billion SPAC Deal

Clover Health, a medical insurance start-up, is going public in a $3.7 billion deal with Chamath Palihapitiya’s SPAC Social Capital Hedosophia Holdings Corp. III, CNBC reports.

Clover who? Clover Health, founded in 2013, sells Medicare Advantage in the U.S. and boasts more than 57,000 members across seven states.

  • According to the Clover Health website, the company uses “patient-centered analytics and a dedicated care management team to identify potential risks a member may face and directly provide preventive care.”
  • Alphabet’s venture arm GV invested in the company back in 2017.

The Details: Clover will receive $1.2 billion in cash proceeds from the deal, $400 million of which are coming from a Palihapitiya-led private investment.

  • The new funds provide “significant capital” for Clover to “scale and improve health outcomes for seniors across the United States,” according to a company statement.

The “Year of the SPAC” continues: We’re now up to $48.5 billion in gross proceeds from 127 SPAC IPOs in 2020, according to SPACInsider.com.

  • SPACs have emerged as a more-certain, time-efficient alternative for companies to go public. 
  • Palihapitiya, who last month said the SPAC boom is healthy for the overall market, took Virgin Galatic public by SPAC last year and announced a $4.8 billion SPAC deal with Opendoor three weeks ago.

Clover’s Outlook: “This is one of the most straightforward investments I’ve ever made,” Palihapitiya said.

  • He also said Clover will have overall profitability by 2023.

Justin Oh:

At Medalogix, we’ve worked with Clover ($IPOC) and probably will in the future, so I’ll be holding off on any personal recommendation of the stock, but here’s some context.

I believe that Medicare Advantage (MA) is the best compromise at being the future of healthcare in America. Essentially the government pays for healthcare for those 65 and older through Medicare but is increasingly giving the funds to be managed by private managed care insurance providers like Clover, Humana, United, etc. This is paid for by the taxpayer and managed by the private sector, driving innovation and efficiency. If we get “Medicare For All,” that probably just expands the Medicare and MA markets and kills Commercial insurance.

Clover is seen as a newcomer to the industry with incredible growth off of a small base. They tout lower co-pays for patients and faster reimbursements for physicians driven by a streamlined technology. Clover is still unprofitable, which is probably why it needs this SPAC capital. Still, it’s in a very positive industry and is seeing encouraging trends in member growth and profitability margins.

At $11.00 per share, $IPOC is trading at 14.8x 2023 estimated Gross Profit, which is expected to grow at 40 percent annually. This is quite a large premium to its large peers. For reference, Humana and Centene have been growing revenues by 15 percent and 25 percent, respectively. And Humana ($HUM), United ($UNH), and Centene ($CNC) are trading at 11x, 11x, and 7x 2022 EBITDA, respectively.

Opendoor, Seeking SPAC Merger, Lays Out Financial Picture

As Opendoor seeks shareholder approval to merge with Chamath Palihapitiya’s SPAC, the instant home buying company released its financial prospectus, The Information reports. The books don’t paint a pretty picture, revealing revenue drops alongside significant losses.

How bad is it? Opendoor’s revenue decreased by 12 percent in the first half of 2020 compared to the same period last year. The outbreak of Covid-19 resulted in a slower housing market. The company said it expected the decline to run through the early part of 2021.

Opendoor trimmed its losses by cutting 35 percent of its staff in May. It lost $118 million in the first half, but that was actually a 25 percent improvement over the same period last year.

  • The company also increased its cash, cash equivalents and marketable securities by roughly 25 percent to $560 million as of June 30.

A Closer Look: Opendoor collects 6 percent to 8 percent commission on each sale but reports the full price of homes it sells as revenue. Under those guidelines, it earns a razor-thin margin.

  • Opendoor sees adjacent services such as home loans and title insurance as profit-generating streams. But as of right now, they have yet to contribute meaningful revenue.
  • It also adjusts its EBITDA to exclude property costs, or interest payments on debt taken to finance the homes, which will “increase as revenue increases.”

Justin Oh:

I’m not that scared long-term by the 12 percent drop in revenues and 3 percent drop in gross profit as the headlines might suggest. Housing inventory has been significantly constrained during Covid-19, as sellers are unwilling to list their homes during the pandemic. The company is still heavily money-losing, and the core business model is very low-margin on a heavy capital investment. iBuyers will need to rely heavily on cheap debt to make the business work on a Return-on-Equity basis. And at $17.10 per share, $IPOB values OpenDoor at 10.4x 2023 estimated Gross Profit, which is equal to Redfin’s (RDFN) valuation and more expensive than Zillow’s ($Z) 9.4x estimated 2023 Gross Profit. 

I would prefer an iBuyer company that offers a security tech solution and monitoring service that does the following for a 1 percent fee: 1) lists the property at a suggested price 2) sends in cleaners and stagers 3) allows for tech-enabled, monitored, self-guided tours and 4) handles the seller’s offer and closing process. That way, they can quickly grow into handling all listings without having actually to own properties and take the flipping risk. Do any VC’s want to fund my better iBuyer company?

What’s Going On

Meat The Guidelines: “Another wave of coronavirus-driven closures of meatpacking plants is unlikely because worker testing and safety practices have improved since the spring. JBS and other major meat companies have installed automated temperature checkpoints, distributed safety gear to plant workers and installed partitions between some work stations to catch Covid-19 symptoms and prevent its spread in plants. Those moves came as thousands of employee infections in March and April forced JBS, Tyson Foods, Cargill and other meat companies to temporarily close plants to stem outbreaks.”

Trade On Me: “The U.S. trade deficit widened in August to the largest since 2006 as the nation imported a record amount of consumer goods amid a pickup in demand ahead of the holiday shopping season. The overall gap in trade in goods and services expanded to $67.1 billion in August from a revised $63.4 billion in July. The median estimate in a Bloomberg survey of economists had called for a widening to $66.2 billion. The positive balance on services dropped to $16.8 billion.”

Raising News: Venture capital firm Greycroft Partners netted $680 million to “find the next Bumble or Venmo,” accounts payable platform Tipalti collected $150 million to bring the company’s valuation to more than $2 billion, contact-center service Dialpad grabbed $100 million in Series E funding, high tech bug colony startup Ÿnsect added $224 million in equity and debt, social product recommendation app Picker pulled in €1.3 million and Uni, an Indian startup from PayU co-founder Nitin Gupta, raised $18.5 million without even having a product yet.

Boy Band Mania: “South Korean retail investors ponied up over $50 billion as they sought to lay their hands on shares in Big Hit Entertainment, the management label of K-pop sensation BTS – more than 600 times the value of shares on offer.”

Swedish Slumpbuster: “Retail sales at IKEA, the world’s biggest furniture group, shrank 4% in the year to the end of August as demand recovered quickly from a slump caused by COVID-19.”

Get On The Green Train: “The newly-listed Siemens Energy has signed a memorandum of understanding with Siemens Mobility to ‘jointly develop and offer hydrogen systems for trains.’”

Crypto Growth: “Mobile cryptocurrency wallet BRD announced today that it now has more than six million users worldwide, thanks to strong growth in India and Latin America…the company expects to reach 10 million users by early 2021.”

Shrinking Land: “U.S. job openings declined in August for the first time in four months, pointing to a moderation in pace of hiring as the pandemic drags on.”

Unique Opportunity: “Asia’s top clothing retailer, [Uniqlo], is betting it can emerge from the coronavirus storm in a better position than Western rivals, in part by focusing on China and continuing to build physical stores.”

The Next Siri: “A former Apple engineer who worked on Siri has launched a new startup, [Brighten.ai], that aims to compete with conversational AI giants like Amazon and Google.”

A Couple Cents Featured

Cineworld, the world’s second-largest movie theater chain, is shutting down, again. Justin Oh discusses the outlook of the movie theater industry.
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