The Top 3 New Buys of Soros Fund Management

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

Tracking the movement of a billionaire hedge fund manager like George Soros can provide an investing opportunity. His Soros Fund management has a total value of $8.5 billion and is known for generating returns from short-term volatility. According to the recent 13F filings of Soros Fund Management, its top three new buys were MeadWestvaco (NYSE: MWV), Brocade Communication (NASDAQ: BRCD), and Red Hat (NYSE: RHT). Let’s analyze these companies on fundamental grounds and see if there exists any investing opportunity.

OpenStack a growing opportunity

Red Hat is continuously making efforts to commercialize its services from the OpenStack platform. OpenStack is an open source software platform for cloud computing and data centers. Red Hat started its OpenStack infrastructure as a service platform called RDO in April 2013. It started this program with around 20 strategic partners. Red Hat will launch commercial subscription-based OpenStack distribution RDO in July 2013. It is expected that this program will be able to attract around 100 initial customers by the end of June.

Although, there are many vendors in the OpenStack platform, Red Hat’s strong market position will help it to tap this growing opportunity. It is the top software code contributor in OpenStack’s latest version, "Grizzly," which suggests the level of efforts it is making to tap this opportunity. Red Hat’s traditional partners like Cisco (NASDAQ: CSCO) and Intel are also focusing on OpenStack; this will help Red Hat to expand the RDO platform to their customers. Cisco is the early adopter of Red Hat’s RDO initiative and is receiving strong interest for OpenStack from its customers.

Red Hat will club OpenStack with its current cloud solutions like RHEV virtualization products CloudForms IaaS, OpenShift, and ManageIQ. The company is also looking to become a leading certification partner in the same way it did for the open source Linux. Overall, it is expected that this OpenStack platform will generate around $480 million in revenue in 2015. This in turn will be an additional 30% revenue for Red Hat.

However, in the short run, investors are worried that the company will experience some slowdown in its billing growth rate. After the end of fourth-quarter 2013, it had a billing growth rate of 9% that was down from 20%, which it had in the prior three quarters. However, this slowdown was because some of its customers opted to pay quarterly in comparison to upfront payment. This change in payment pattern also affected its total backlog, which was up 19% year over year after the fourth quarter and will help it to post continuous revenue in the coming quarters.

Rising SDN threat and completion

Brocade’s second-quarter results came in line with its pre-announcement of weaker results. In the second quarter, it reported storage area networking, or SAN, revenue of $319 million, showing a decline of 7% year over year. This decline was due to softness in the storage market and weaker revenue from its original equipment manufacturer, or OEM, partners.

Brocade’s storage business contributes around 70% of total revenue. Going forward, it is expected to face issues because of cautious spending by customers in the storage market. The growing adoption of cloud-based storage services will also become a headwind for the company because it reduces the requirement of these networking products.

With the emergence of software defined networking, or SDN, storage solutions, Brocade is further going to face issues. According to IDC, SDN will become a key technology for data centers, and it expects that SDN revenue will reach $3.6 billion by 2017, up from $360 million in 2013. As these SDN storage solutions do not require traditional SAN networking products, this trend will become a headwind for its SAN solutions.

Additionally, Cisco’s entry in the 16-gigabit fibre channel platform will remove Brocade’s monopoly in this product segment. Because of this monopoly, this product category contributed 50% of total SAN revenue in the second quarter. It is expected that Cisco will aggressively push its 16-gigabit products; this will force Brocade to reduce its margin on these products.

The company is now refocusing on SAN for data centers, SDN technologies, and Ethernet fabrics for data centers. This will help it to reduce its investment in other areas. It is expected that this strategy will help the company to reduce its cost by $100 million by 2014.

Overall, in the short run, Brocade will continue to experience a decline in its revenue from the structural weakness, but in the long term its focus on SAN, SDN, and Ethernet will help it improve profitability. I will recommend holding this stock for now and waiting for signs of successful implementation of its strategy before taking any new position.

Packaging business focus is the key

MeadWestvaco reported weak first-quarter results, with gross margin of 17.6%, down from 21.2% a year ago. This was largely because of higher raw material costs and a longer planned outage of its production facility that alone reduced gross margin by 1%. The company experienced a decline in all business except for its community development and land management business. In the land management business, a higher land pricing environment helped MeadWestvaco to report profit of $16 million, which was up 14% year over year.

Going forward, MeadWestvaco will increase its focus on its packaging business, which currently generates 85% of its revenue. The company is making significant investments in emerging countries like Brazil. In Brazil, it is currently undergoing a $500 million expansion plan of the Rigesa containerboard production facility for its industrial segment. Rigesa’s new containerboard machine started production in August 2012, and the company is continuously increasing the production at its new Tres Barras plant. With the growing Brazilian economy, it is expected that this investment will increase its revenue in the industrial segment by 50%. This will also increase its operating income by more than 100% in the industrial segment in the next two years, driven by volume expansion and better cost management. However, in the first quarter, the industrial segment declined because of higher startup costs related to this expansion.

On the other hand, the company is looking to exit from the beauty and healthcare folding carton business in Europe and Brazil. This divestment will help it to improve its operating income, as this segment is becoming a drag to its income. It is estimated that this division incurred losses of around $10 million in 2012.

In addition to this, the company has announced a cost reduction program. Under this program, MeadWestvaco will decrease overhead cost by $65 million annually by 2014. It is expected that in 2013 the company will generate savings of around $30 million through lower sales general and administrative, or SG&A, expenses.

Conclusion:

Red Hat will continue its efforts to commercialize the OpenStack platform. Its leading code provider image will help it to differentiate itself from other vendors.

MeadWestvaco’s increased focus on its packaging business will help in the future with increased focus on emerging countries like Brazil.

I recommend buying these stocks for the long term.

On the other hand, Brocade will continue to face weakness in its SAN products and services. However, it has increased its focus on SAN for data centers, SDN technologies, and Ethernet fabrics. Hence, I recommend holding this stock for now and waiting for a sign of the success of its strategy.

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Madhu Dube has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. 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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