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UA – Growth vs. ROIC Decision Tree

Takeaway: We think UA is hitting the point where it needs to pick between growth and ROIC. In a tape that rewards growth, returns likely coming down.

Few people would argue that UA is a tremendous story by almost any measure. Overcoming significant odds, it has drawn a line in the sand as the #2 Athletic brand in the US, it broke through the $3bn revenue mark faster than any Athletic brand in history (including Nike), it (Plank & Co) created $13.9bn in value for shareholders in just the past 3-years alone off of just a $5bn base, and now stands as one of the only companies with $3bn revenue base that is covered and owned by large-cap managers. #impressive. But the downside for UA is that when it is hovering at over 70x earnings with just 7% of the float short, it leaves extremely little room for error.


The good news is that UA has gotten extremely good at setting and managing quarterly expectations – even better than Nike, we’d argue (and guide/print numbers would support that), which says a lot. The punchline there is that the risk of UA missing numbers in 2015 is pretty low, at least how we’re doing the math.


The bad news is that the primary growth elements at UA are becoming more complex, more expensive, and more capital intensive – with what we think is a lengthier duration on payback. Again, when we consider UA’s multiple and lack of room for error in the model, we’d consider these factors ‘errors’, for lack of a better term.  We’d love to own this name given the growth algorithm, but we simply don’t think that the risk-adjusted long-term upside offsets the severe pain of growth slowing, margins falling, returns declining (which is a near certainty), or market style-factors falling out of favor – even for a quarter.


Here are some things we’re referring to:

1) First off, let’s call a spade a spade…capex is going up this year – a lot. It should clock in at $330-$340mm, up from $141mm in 2014. That’s a 140% increase in capital spending – one of the biggest increases we’ve ever seen in this space. We’re not saying UA should not spend it. The fact of the matter is that the company probably should. We fundamentally believe that you need to spend money to make money (assuming it is well spent). But UA has proven to be a good steward of capital over time, and we don’t expect that to change. But with this level of spending, we need to see the company put up 27% growth in earnings this year, versus the Street’s expectation for 15% growth, in order to prevent dilution in ROIC.


2) Connected Fitness As a Business Driver. We struggle with this one. We understand the importance of assets like MapMyRun, Endomondo, and MyFitnessPal. But we don’t see how they are monetized. It doesn’t sound like the company does either, without significant capital spend. Is it possible that UA has a vision for how the different apps will be merged and integrated in a complimentary way years down the road? For sure. But ultimately it needs to drive consumers to the UA brand in a commercial way.  Nike has been struggling with this for years in its digital businesses – most notably Nike+. And let’s not forget that Nike already has a seamless benefit of a digital platform that synchs perfectly with its product. We’re not saying that Nike will beat UA in this arena – this game is wide open. But if UA wants to play it’s going to have to spend.


3) SAP: A big part of the increase in capital spending is SAP-related. If there’s one thing we know about SAP, it is NEVER a 1-year spend, nor is it 2, 3 or even 4. The only companies who successfully implement SAP spend not only for the software (capex), but also for the service component (SG&A) as SAP staff immerse themselves in the company.  UA said repeatedly that it has a ‘partnership with SAP.’  We need to get more color from the company on that one. That sounds to us like someone saying ‘I have a partnership with iOS8’. Unless there’s a profit sharing component (which is possible, by the way), this sounds more like a complex customer agreement.


4) Athlete Endorsements are Headed Higher.  There was an unusual amount of real estate on the call dedicated to Jordan Spieth, Stephan Curry, Lindsay Vonn and Tom Brady. We understand that these athletes are winning, and it’s the job of the CEOs to be promotional regarding their assets. Heck, if I were in Plank’s position and had just notched some high-profile victories with athletes I pushed for from a business/endorsement perspective, I’d be just as loud. But what if these athletes lose? 

What if Jordan Spieth is not ‘the new face of US Golf’?  We’ve already seen the cost of endorsements head higher, and that before Nike lost some high profile events (starting with World Cup). UA and Nike duked it out over Kevin Durant, and Nike won by retaining him. Then Durant lost half his season to injury. The Masters was a shot in the jaw to Nike, who had a major Rory/Tiger campaign leading up to the event. Heck, Nike was sweating it out at the potential for Duke (Nike) to lose to Wisconsin (Adidas) in the NCAA finals. The sports marketing folks at Nike are nervous…and they should be. We think it’s going to go on a buying spree, which puts pressure on everyone. UA will play the game, and they’ll drive up prices for Nike. Nike will do the same for UA. Don’t forget about AdiBok, who is bowing out of its NBA deal to focus more in specific athletes. 

Let’s put real numbers behind it. Last year Nike had $4.7bn in athletic sponsorship obligations sitting on (actually, off) its books. UA was at $393mm. Nike’s total obligations changed last year by $1.1bn. In other words, Nike’s endorsement purse changed last year by more than UA has in total. Again, this is not a nit-pick on UA, but stating the simple facts that the cost of growth is critical to consider with a stock trading at 70x earnings – no matter how good the story might be.

What Is The "Pain Trade"?

Takeaway: Pain Trade in US Stocks = #on

Pain Trade  is the one that the largest % of market participants are not positioned for.

What Is The "Pain Trade"? - z 99


One very important way to listen to where the crowd is positioned is in futures and options contract terms. Before yesterday’s (and this morning’s pre-market futures) ramp, here’s where non-Commercial CFTC futures/options NET positioning stood:


  1. SP500 (Index + Emini) net SHORT position of -40,978
  2. The 3 month avg net position = +13,092 (net LONG)
  3. The 6 month avg net position = +31,930 (net LONG)

Click to enlarge.

What Is The "Pain Trade"? - 04.21.15 chart

Keith's Macro Notebook 4/21: Yen | Europe | S&P 500

Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.

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P: Thoughts into the Print (1Q15)

Takeaway: 1Q15 is shaping us as a mixed bag, but may be P's best print this year. The setup gets progressively worse from here.


  1. 1Q15 = MIXED BAG: We’re expecting upside to revenues on light 1Q15 guidance and corresponding consensus estimates.  However, we’re expecting user metrics to disappoint on heightened expectations following P’s accelerating user growth off a depressed comp.  We definitively can’t say what is more important for the stock this quarter, but historically P needs to win on both fronts to appease the street.
  2. SETUP GETS WORSE FROM HERE: After 1Q15, the setup deteriorates through the year.  We suspect revenues could disappoint in 2H with consensus calling for accelerating ad revenue growth through 2015.  Further, as we move through 2015, the prospect for declining users grows, and the overhang from Web IV will intensify. 
  3. WHAT WE’RE KEYING IN ON: Listener Hours. Web IV is all that really matters now, and we expect P will lose the one debate that it can’t on royalty rates (bifurcated structure).  Given the potentially significant increase in rates, the more hours P enter 2016 with, the more bearish we become (as perverse as that sounds).  The situation would be far too sensitive to just apply a simple listener cap, and hope it would suffice (see table below).  P would need to take more drastic steps to reign in content costs



Management issued particularly light 1Q15 revenue guidance, implying nearly 10 percentage points of deceleration in y/y revenue growth from 4Q14 to 1Q15 (from 33% to 24% at the midpoint of guidance).  We’re expecting 29% revenue growth (vs. consensus of 25%) given continuing strength in local advertising and the embedded y/y tailwind on its higher-ARPU subscription product from the 25-33% price increase late in 1Q14. 


However, we are expecting user growth to disappoint.  We believe consensus is putting too much stock into P’s 4Q14 acceleration, which came off a particularly weak comp.  In 4Q13, P experienced its worst deceleration in y/y active listener growth in its reported history following its redesigned ad feed late in 3Q13 (switched from single to double ad feed, and increased max ad load from 4 to 6).  The other thing to consider is that the first quarter is seasonally slower.  We don't believe P can sustain +80M active users that the street is expecting. 


P: Thoughts into the Print (1Q15) - P   User growth detail 4Q14  



1Q15 may be P's best release of the year.  We’re expecting revenues could disappoint in 2H with consensus calling for accelerating ad revenue growth through 2015; a situation that essentially requires accelerating growth in P's two competing growth drivers (Ad-Supported Listener Hours and Advertising RPMs). 


P: Thoughts into the Print (1Q15) - P   2H15 Ad rev scen


But the two more important headwinds are Web IV and Active User growth.  We expect Web IV to increasingly dominate the story as we draw closer to the CRB decision (expected by Dec 15th).  We also expect active users to decline on a y/y basis in 2H15.


Regarding users, we estimate that P’s remaining TAM isn’t large enough to offset its heightened churn issues for much longer, and as we move closer to year end, penetrating what remains of P’s TAM (mostly older) will become more challenging.  For more detail, see the note below.


P: New Best Idea (Short)

12/22/14 03:56 PM EST

[click here



Listener Hours.  Our focus moving forward is Web IV.  We’re expecting P to lose the one debate that it can’t on royalty rates (different rates for ad-supported vs. subscription music).  If that winds up being the case, P could see a crippling increase in ad-supported royalty rates, and the more listener hours P enters 2016 with, the greater the profitability squeeze that would occur. 


P: Thoughts into the Print (1Q15) - P   Web IV scen P sub rates 3 


The obvious question is why we’re considering revenue as a secondary read.  The reason is that P’s revenue growth has been largely driven by a ramping investment in it’s a salesforce, with S&M expenses growing as a percentage of annual revenue since 2012.  If Web IV goes against P, its ability to continue investing in its salesforce would be limited at best, if not entirely dependent on managing its listener hours. 


In short, the best case scenario for P would be if user/hour growth decelerates as we expect this year.  If not, the situation would be far too sensitive, and P would have limited wiggle room to get this right (see table above).  P would not have the luxury of applying a simple listener cap, and hoping everything turns out ok.  P would need to take more drastic steps in 2016 to reign in content costs.  



Let us know if you have any questions, or would like to discuss in more detail.  For Web IV supporting analysis, see links below.  


Hesham Shaaban, CFA






P: Losing the Critical Debate?

04/08/15 08:53 AM EDT

[click here]


P: Worst-Case Scenario? (Web IV)

03/23/15 09:30 AM EDT

[click here]


P: Webcaster IV = Powder Keg

01/13/15 02:49 PM EST

[click here]

REPLAY | Q&A With Hedgeye Healthcare Sector Head Tom Tobin $HCA $MDSO $ATHN

Hedgeye's Healthcare Sector Head Tom Tobin and Analyst Andrew Freedman hosted a live Q&A session today discussing new developments for HCA, MDSO and ATHN.


Watch the replay below to learn about their new MDSO tracker, a web-based program that generates a comprehensive list of customers. 


21 Fearless Stanley Cup Playoffs Predictions From Hedgeye


Who's going to bring home Lord Stanley's chalice? The New York Rangers? Montreal Canadians? Nashville Predators? With the playoffs in full swing, Hedgeye employees reveal who they like to win the Stanley Cup.