3 Great Picks from Fir Tree Partners

Laura is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In this article I analyze Fir Tree Partners portfolio. Fir Tree Partners is a New York City based privately owned investment hedge fund founded by Jeffrey Tannenbaum in 1994. The fund has been averaging a healthy return of 28% annually since its inception, beating the S&P 500 index by over 18%. Today, the firm manages over seven billion dollars on behalf of major endowments, foundations, pension funds (private and public) and other institutional and individual investors. One of the questions Fir Tree asks about a possible investment is “Why is it mispriced?” Jeff Tannenbaum (Fir Tree’s founder) explains that if you don’t have a strong reason, there’s a good chance that it isn’t mispriced. (Source: Hedge Fund Letters.com).

I think it is important to study what top hedge fund holds in their portfolios. Let’s review Fir Tree's current holdings:

Equinix: Big Data Trend

Equinix (NASDAQ: EQIX) represents 8.14% of Fir Tree's portfolio. The fund increased that position in the last quarter by 5%. Fir Tree seems to be bullish on EQIX prospects related to the growth of data and connectivity. I like the fact that prominent Hedge Fund managers such as Daniel Loeb, John Griffin, Andreas Halvorsen and Steve Mandel also are bullish on this company. Let's analyze why they like EQIX:

As EQIX management converted the company's structure to a REIT, Equinix should catch-up to a "REIT like" valuation . Comparable data-center REITs trade at dramatically higher multiples, and accordingly, several institutional investors have begun to revalue Equinix's shares to close that gap. I think that Equinix offers meaningful long term upside in the shares, through both further valuation expansion and continued growth.

Equinix has a great business model that is expected to keep growing. Data centers are subject to a positive feedback loop derived from a link between a large customer base and desirability of services. This is called "network effects". Since data centers can allow customers to directly connect within the facility, a broader customer base actually increases the utility of the data center. For example, if I were Bloomberg or Yahoo Finance (or any financial company that needs super fast data feeds), I want to get my news feeds from the NASDAQ and the New York Stock Exchange very close to me so I have the prices immediately.  By putting the servers right next to those of Nasdaq and NYSE, I can get those prices and send them out to all of my customers in a prompt and reliable way. In other words,  Bloomberg needs to have their servers right next to the servers of these other companies, and that is Equinix expertise. An identical facility charging identical rates would not be able to compete with an already established facility with a critical mass of customers. This "Network Effect" creates a strong positive feedback loop in which enhanced profitability promotes exclusivity which in turn promotes profitability

As the largest provider of data centers, Equinix is has achieved critical mass of consumers. It has a Data Center monopoly in Tokyo and is also expanding to other Asian emerging economies.

Equinix business is expected to keep growing as demand for the internet and connectivity will continue to grow. Currently, the company is growing 25-30% EBITDA compared to Industry Median growth of 6%. As the largest and only global provider of network dense colocation services, I believe Equinix remains well positioned to sustain healthy growth. Fir Tree surely thinks the same.

In the last report, Equinix gave solid 4Q12 results which reflected a continued healthy growth outlook for Equinix and the broader network dense colocation sector. Top line growth trends remain positive across geographies and verticals with the majority of key metrics trending positively. The company's margin performance was slightly better-than-expected reflecting a continued focus on driving profitable growth.

I also think that the fact that EQIX will convert to a REIT could support shares as much of its costly current taxation could be forgone as the conversion materializes. Additionally, the usage of FFO as an earnings metric would provide transparency to Equinix's results.

In terms of valuation, an investor should value Equinix as a REIT and focus on cash flows. EQIX management guided cash flows of $600-$620 Million for FY13 which translates to a P/E of 17x, close to the Data Center average multiple of 18.5x.  I think the shares are reasonably valued but I will wait for a general market correction and look to buy EQIX in the range between $180 and $190.

Sum of the Parts opportunity

Fir Tree also holds Williams Companies (NYSE: WMB). This company operates pipelines, which is a good business model as it is an inevitable service which has benefits of scale and favorable competitive environment as pipelines take time to build. In addition, Williams in a low cost provider.

At a Value Investing Congress Presentation in 2011, value investor Adam Weiss explained that WMB could get to $50 (42% upside from current prices) driven by a continued dividend raise and the discovery of hidden asset by Street.  In terms of valuation, he analyzed WMB using a sum of the parts model (source marketfolly):

1. Infrastructure assets. Dividend of $1.14-1.37, 1.2x coverage, gets $25 stock based on 4.5% yield, similar to KMI or OKE comps. Upside case 4% yield is $30.

2. E&P business: $9.00 floor share, based on NAV comps- CHK, et al. $1.24 per proven mcf, 25% below peers.

3. Hidden asset. Canadian Midstream business, oil sands gas processor. Based on 4.5x EBITDA get $3.00 base case, upside based on dividends, 0.40 div, 4.5-5.0% yield, get $6-8 per share in bull case.

4. Balance sheet value/ cap structure optimization. Either M&A or buyback, get $2-3 per share.

The best stock in the whole technology sector

Fir Tree is bullish on Google (NASDAQ: GOOG). I think it is the best stock to focus in the whole technology sector.

I am optimistic on the company's future positioning and ability to achieve the street mid-teens revenue and growth forecasts, particularly within the context of the disruptive nature of smartphones and tablet adoption.

Google profitability metrics speak for themselves:

  • Operating margin of 25.4% compared to the Industry Median of 4.5%
  • Net margin of 21.4% compared to the Industry Median of 2.95%
  • ROE of 15% with no debt
  • ROC of 110.4%: outstanding (metric that Greenberg seems to look for very carefuly)
  • Average Revenue Growth of 20% compared to Industry Median of 8%
  • EPS Growth of 12.3%
  • Operating Cash Flow converts almost everything to Free Cash Flow

Credit Suisse recently listed 5 attributes on why they like Google:

(1) Google can sustain five-year revenue CAGR of 16% even amidst the increased access to its services via smartphones and tablets.
(2) In an increasingly mobile environment, traffic acquisition cost will have a muted impact on Google’s margin structure.
(3) Google remains in prime position to benefit from the incremental search ad budgets on mobile – we expect smartphone revenue CAGR of 39%.
(4) Despite shifting engagement to mobile, PC search revenue can be sustained.
(5) We expect user behavior on tablet to be similar to that that of the PC, with revenue increasing at 56% CAGR due to increased adoption.

laurapaur2013 has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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