TheChek News Flow

It Will SUNE Be Over: Axiom Says SunEdison "Credit Event Appears More Likely", Sees Price Dropping To $2/Share

We add APPL to the Conviction Buy List. Shares are trading at a CY16 P/E of 11X (10.5X on GSe), a 30% discount to the S&P 500 multiple of 16X despite a 9% EPS CAGR in FY15-17 (GSe 14%) as the market views it as a “hardware” stock – a transactional model with limited recurring revenues and with visibility that extends only to the next product cycle. We expect that over the next year, the focus will shift from unit growth (which is slowing given a maturing smartphone market) to installed base monetization and recurring revenues (“Apple-as-a- Service”). Apple’s model has already tilted that way with its new iPhone 6s installment plans, and we see the upcoming TV service as a powerful next step.

With an estimated installed base of 500mn loyal iPhone users, we see a significant multi-year opportunity for Apple to increase monetization through  (1) increased attach of services such as TV, Music, and Pay, and  (2) increased attach of additional hardware such as Mac, iPad and Watch. The size and quality of the iPhone installed base is the glue behind this virtuous cycle, as it is very loyal (estimated churn <10%) and monetizable (80% higher app store sales than Google). In a recurring revenue framework, we have constructed an average revenue per user (ARPU) metric that captures the installment plan pricing of the iPhone ($32/month), assumed installment plans for the other hardware products, and services (e.g. Music at $10/mo, TV at $40/mo). We calculate a current ARPU of $42/mo per iPhone user, pro rata for the current adoption rates of Mac, iPad, Watch, and services. The theoretical ARPU (assuming every iPhone user has all other Apple hardware products and services) is $153/mo, implying significant growth as the adoption of Apple hardware and services increases within the user base.

Our 12-month $163 price target is based on 15X our CY16E EPS of $10.71.

Product cycle execution, end demand, and a slower pace of innovation.

- UK yield curve is too flat

- Gap between market and economists forcasts for rate rises tends to widen when risky assets do poorly

- Surveys can offer better guide to rate moves than BoE inflation forecasts

- Sees problem with focusing too obsessively on particular date for rate lift off

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Add one more name to the chorus of doom. Earlier this week, Andrew Tyrie, the Conservative MP and chairman of the Treasury Select Committee, wrote to Mark Carney, the Governor of the Bank of England, to express his concern about bond market liquidity – or, more precisely, the lack thereof.

He’s far from the only worrier. In April, Jamie Dimon, the chief executive of JP Morgan Chase, devoted three pages of his annual shareholder letter to the subject, writing that dislocations in the US government bond and currency markets were a “warning shot across the bow”. These include the so-called “flash rally” in October last year when 10-year US Treasury yields fell by 29bps in just over an hour (it was a rally because prices rise as yields fall) and the Swiss franc spiking 28pc against the euro in 20 minutes at the beginning of this year.

In May, Nouriel Roubini, the US economist made famous for predicting the US housing problems that led to the financial crisis, wrote about “the liquidity timebomb”. In June, Stephen Schwarzman, the chief executive of private equity firm Blackstone, penned a comment piece for The Wall Street Journal on bond market liquidity entitled: “How the next financial crisis will happen”.

Why has what sounds like a pretty niche subject got so many knickers in such a collective twist?

Every market is a tug-of-war between buyers and sellers. Liquidity is a gauge of both the size of the market (the number of buyers and sellers) and its depth (the number of buyers and sellers of both small and large amounts of securities). Why is the depth of the market important? Because if you want to sell £10,000 of government bonds you’re sure to find plenty of willing buyers but if you want to sell £100m-worth, it might be a touch harder.

If there isn’t a buyer, supply could momentarily outweigh demand and the price will start to fall before you get a chance to execute the trade. This is called market impact. The less liquidity there is, the greater an impact large trades will have. If lots of people are all trying to sell lots of stuff at once, things could get very messy.

There are plenty of possible reasons why liquidity might be evaporating. For one thing, there has been a huge increase in the amount of bond trading being conducted electronically and this method of dealing is now responsible for about half of all turnover in the US. This has attracted the attention of high-frequency firms who help provide liquidity and lower transaction costs but only really for small trades, creating the illusion of liquidity, which, like a mirage, just isn't there when you reach for it.

Those looking to pull off a bigger trade require the services of a bank, which will, for a fee, act as a market maker – putting buyers together with sellers. If it can’t, the bank may buy the securities itself on the assumption that it will be able to find a buyer at a later date. In this way banks can smooth out any temporary mismatches in the market.

Or they did. Since the financial crisis, global financial regulators have rightly been attempting to make banks safer. They have done this by, for example, banning proprietary trading, making it harder to lend government bonds in the repo market and, most importantly, forcing banks to deleverage.

One of the upshots is that it is now much more expensive for banks to hold securities on their own books and therefore provide liquidity in the market. Deutsche Bank recently noted that the amount of outstanding corporate bonds has doubled since 2001 but dealer inventories of these securities have fallen 90pc over the same period.

This could be a problem. The world is awash with debt. With central banks increasing their balance sheets through quantitative easing, simultaneously pushing down interest rates and taking huge chunks of the market out of circulation, investors have had to stray beyond developed market government bonds in search of yield.

Companies and emerging market countries have been happy to oblige. Since 2004, the stock of emerging market, non-financial corporate debt, for example, has more than quadrupled to $18 trillion, according to the International Monetary Fund. And this is increasingly being gobbled up by flighty retail investors – in 1990 mutual funds held around 4pc of all corporate bonds in circulation; today they hold more than 20pc.

This whole process could be about to go into reverse as central banks look to end the unprecedented period of loose monetary policy. As interest rates rise, the prices of many bonds will fall. How quickly is anyone’s guess. But, according to the worriers, a lack of liquidity could hasten the sell-off, turning a correction into a rout.

It is worth pausing here to ask whether there is a certain amount of self-interest behind the warning from banks. Is this just a more creative way for them to chafe against demands that they hold more capital? And would they really throw themselves in front of falling prices for the greater good when the crunch came? Liquidity had a habit of mysteriously disappearing during previous crises, even before the new rules were in place. Indeed, would we want banks to be making markets during a crash? If they bought bonds as prices fell, they’d end up sitting on huge losses.

That said, even though banks may have stood back for a while as markets fell in the past, they were usually the first buyers back in, ensuring that prices didn’t overshoot. That’s not to be sniffed at. Also worth noting: it’s not just banks that are issuing these warnings.

Regardless, there’s little appetite among regulators to row back on capital rules. So liquidity may need to come from somewhere else. One theory is that fund managers should try to trade directly with each other (although the fate of Bondcube, an online marketplace which tried to facilitate such transactions but went bust in July after only three months because investors couldn’t agree on prices without the involvement of a broker, doesn’t bode well).

Or perhaps the amount of liquidity available before the crisis was the aberration and we now need to reset our expectations. Banks have been made less risky. But, as Bill Gross, the famous bond investor, said earlier year, that risk hasn’t been eliminated – it’s just moved elsewhere in the system.

The question is: where? And the worry is that nobody appears to know for sure.