Note: A Fourth Ten Bagger Has Emerged! Read about it here.
Yesterday was a rather monumental day in my investing life—I finally caught a 10-bagger. A 10-bagger is any investment that rises 10-times over (or an increase of 900%). My initial purchase of Netflix (NFLX) in 2010 is now up 1,004% and (hopefully) still climbing. At the time, Netflix was just your run-of-the-mill red envelope DVD mailing company. Few of us foresaw the potential of streaming, but many of us believed in the leadership and vision of the company and the need for disruption in an industry where nearly every end user was either, a.) unhappy with their service, or b.) felt they were overpaying for what they were using. Netflix, a highly consumer-oriented company, became the trailblazer in over-the-top broadband media delivery. Using a low-cost, all-you-can-eat style, Netflix went ahead and solved both of those consumer problems of service and price.
I’m here today to help you find the next 10-bagger, which is no easy task. There is nary a company around that is “undervalued” by 900%, so you must have a bit of faith in the “what if” scenarios of a company and a firm belief in the vision of a company’s leaders. I’m going to give you three investments that I believe could be 10-baggers in a decade or less.
Netflix (NFLX) – Let’s start with a contentious option. Netflix is already insanely overvalued on an earnings basis (P/E of 123), however, Netflix is still in a period of extreme growth. Domestic subscribers are rising at 16% year-over-year and international subs at 65% year-over-year. Heavy reinvestment into more international markets has resulted in an earnings story that is intentionally depressed. Netflix is playing from Amazon’s deck: build a broad and fanatical user base, then monetize. Netflix just expanded to New Zealand and Australia last month, Japan comes up later this year, China next year, and Netflix’ plan for their full global expansion (~200 countries) is expected to be complete in 2017.
Netflix is currently valued at $34B; could they become a $340B company? I think so. Netflix is targeting a U.S. saturation of 60-90M subscriptions. Hitting that midpoint would mean roughly 80-90% of broadband users or two-thirds of all households. I think getting there in ten years is nearly a given. Current growth would get them to 75M U.S. subs in just four years (from 41.4M) today. I’m hoping that U.S. plan prices in ten years would average $14/mo, up from just over $8 today. A lot of levers can drive that increase; inflation alone will tack on $3/mo, multi-stream bundling and the introduction of premium services (like 4k streaming, some live feeds) could also tack on another couple bucks.
On the international side, penetration certainly won’t hit U.S. levels, but it doesn’t need to. Reed Hastings, the CEO, believes that international will eventually account for 80% of revenues, which would equate to roughly 300M subs, or 29% annual subscriber growth for ten years from today’s levels. That’s a heady number, given that would be 55% of all international broadband households (or 80% if you don’t include China). Although, broadband is growing very quickly in developing markets (mid-teens growth annually) and the rise and speed of mobile internet (untethering Netflix from the need for broadband) is a potential benefactor. Imagine the possibilities of subscriptions if Netflix offered a “mobile only” streaming option for $4.99/mo—how do you think that would be received in mobile-heavy, broadband-light regions like China, India, or developed Africa? This also cuts out the pesky middleman known as the “cable companies.”
If Netflix can garner $12/mo from 300M international subs in 2025, we’d be looking at global revenue of $5.6B. Consolidated contribution (operating) margin may be around 35% (Hastings is targeting 40% domestic margins by 2020). Knock off a little for Uncle Sam, and net profits would be $16.5B, at a 20 P/E, we get to a $330B company. This could certainly NOT happen, but when people like Marc Andreessen are talking about Netflix having 1 Billion subscribers by 2020 (much more than my estimate of 375M by 2025), I think I could at least be in the ballpark—and in the game of spotting 10-baggers, “in the ballpark” is all you need.
Tesla Motors (TSLA) – Elon Musk, CEO of Tesla and Chairman of SolarCity, will be written about in history books. People liken him as “the next Steve Jobs,” but I think that sells Musk far short of his proven capabilities. Steve Jobs was a savvy operator, a ruthless businessman, a focused and driven leader, and an innovator and visionary in consumer electronics.
Musk, on the other hand, is a purebred genius. The man founded and sold a little company called Paypal which brought internet-based payments to the mainstream, launched the first successful car company since Ford, and has commercialized space flight with his company SpaceX. Oh, and over the weekend and with a few pizzas, he went ahead and invented a fifth form of transportation, the Hyperloop. Did I mention he was only 43 years old? Musk will be written about alongside the likes of Leonardo da Vinci, Aristotle, and Thomas Edison. The man-crush is strong in this one. Never before has a premier knowledge of physics, computing, engineering and a business know-how to make it all profitable ever existed in one man’s brain. I am privileged to invest alongside him in his company, Tesla, which is improving the world and is poised to deliver immense profits for many years.
Recently, Musk stated that Tesla could be a $700B company within ten years. This would represent a 27-bagger from today’s levels. Musk, who knows far more than me, said that fleet-wide sales could increase 50% annually over the next decade. That would give you revenues of about $350B in 2025, Musk thinks they can operate at a 10% net margin (which is rich for a car company, but quite reasonable for a tech company—which is what Tesla really is), yielding $35B in annual profits. Apply a 20x earnings multiple and you’ve got a $700B company. Musk acknowledged that these are back-of-the-envelope calculations, but he finished this with saying “I’m not saying they’re true or that they will occur, but I bet that they do occur.” Most analysts scoffed at this notion, dismissing it as glassy-eyed CEO-speak, but they’d be remiss to do so. Why? Look at Musk’s track record. The man doesn’t fail, or at least he will put his whole fortune on the line (as he did twice with SpaceX) to avoid failure.
Frankly, I find it hard to see why every person alive doesn’t put at least a little bit of money in Tesla. Just a few hundred bucks. I mean, why not? We’re talking about a nascent pure play on electric cars run by what is likely the smartest person on earth. Might they fail and become commoditized as General Motors, Ford, Nissan, and Toyota start selling their own electric vehicles? Maybe. However, what if they finally crack the code on self-driving vehicles (which is already starting in the Model S line this summer with an auto-pilot software upgrade)? The Model S has been named by Consumer Reports as the best car of 2014 and 2015—that’s of ANY car, not just electric cars. The National Highway Traffic Safety Commission gave the Model S the best safety rating of any car ever. Are you hearing this? What if Tesla leverages that same Model S technology to the Model III, to a minivan, to a compact, and to a pick-up truck? What if the Model X Crossover SUV (launching next Spring) has a huge reception and sells like hotcakes, just as the Model S has? What if Tesla’s gigafactory—which will produce more than half the world’s lithium-ion batteries by 2020—is successful at home-based power storage, finally filling a huge gap in the adoption of solar? What is Tesla decides to start advertising its own products (which it has never done)?
Here lies the rub. Tesla is the kind of company where you only need to invest a little. If they fail, a little is all that you’ll lose. If they succeed, a little is all that you’ll need.
Many people are hesitant to invest to companies they don’t know or use. The thinking is counter to Peter Lynch’s mantra, “invest in what you know.” There’s a belief that if the business isn’t as tangible to the investor, that increases risk. However, I’m here to tell you that Bank of Internet is absolutely killing it, and at just a $1.4B market cap, Bank of Internet is my strongest recommendation out of all three of these to 10-bag your money by 2025.
Banks are notoriously hard to value and understand. I worked for JPMorgan, and even I had an impossible time deciphering its income statement. But, BOFI is a whole
different simpler game. Bank of Internet is your basic Bailey Building and Loan. It’s not like an investment bank providing M&A services or underwriting IPOs. It doesn’t trade or broker or advise. It doesn’t manage assets or create and sell structured products and funds. Nope, Bank of Internet does what “banks” have done since Rome was the world’s capital: it borrows and lends.
In the game of traditional banking, the measure of success of borrowing and lending depend only on a few things: the interest rate you borrow at, the interest rate you lend at, the quality of your loans, and the overhead of the bank.
At this core level, understanding a bank is very easy. The goal of a successful bank is simple:
- Obtain as many deposits as possible at as low of a cost as possible. Checking accounts are better than money markets. Money markets are better than CDs. CDs are better than bonds. Etc.
- Take that money and lend it at as high of rates as possible while minimizing write-offs. Better borrower credit means lower loan rates, but fewer delinquencies and write-offs. Jumbo mortgages mean higher interest than small mortgages, but come with higher risk of default.
- Limit overhead. As measured by a bank’s “efficiency ratio” this is a measure of how lean a bank operates. It’s calculated by taking non-interest expenses and dividing by revenues. Marble lobbies, big bonuses, and corporate jets mean high costs so a high efficiency ratio. It’s counterintuitive, but a lower efficiency ratio is better.
There’s a lot more that goes into this, of course. Interest rate risk, leverage, fee generation, value-to-loan ratios, and a lot more. However, if you do 1, 2, and 3 correctly, most of the rest falls into place.
So, how does BOFI do on 1, 2, and 3?
- As far as growing deposits, BOFI is killing it. It has grown its deposit base by 40% annually over the last three years. That is mostly organic growth, although they did purchase one deposit base of $125M from Union Federal last December. That amounts to about 3% of their deposit base, and BOFI paid no premium for it. BOFI has already agreed to acquire about $500M in H&R Block prepaid deposits at no premium, and this deal is expected to receive regulatory approval this spring—this alone will increase deposits by another 12%. Regarding the cost of deposits, BOFI does poorly—but I think that’s a good thing in some regard. BOFI’s interest expense as a percentage of demand deposits is .88%, which is significantly higher than the national average of .47%. Why is this so high? Well, where else can you get 1.25% APY on your checking account? BOFI’s forte is offering compelling retail products to retail banking customers. This is certainly a cause for BOFI’s astounding deposit growth rate, but can BOFI absorb this cost?
- To quickly answer that last question, yes, they can. BOFI’s interest on assets (loans) is 4.99%, which is nearly a full point higher than the 4.03% industry average. A bank’s profit lies in what is referred to as “the spread,” which is the difference in the cost of lending versus the cost of borrowing. BOFI’s spread (also called net interest margin) is 4.09% compared to 3.59% for the industry. This would be problematic if BOFI sacrificed loan quality to achieve this high spread, but they aren’t sacrificing quality at all. I’m not sure what they’re drinking in that loan origination department, but over the last two years, BOFI’s net charge-offs (loans removed from balance sheet due to inability to collect) has run just 0.0338%, compared to the national average of .2475%. BOFI maintains a loan loss provision on its balance sheet that is comparable with industry norms (about a quarter percent), but they’ve shown little need the use that provision.
- So in addition to stellar loan origination practices and an industry leading interest spread, BOFI is also, without hyperbole, the most efficient bank in the United States. It runs a tight shop, with an efficiency ratio of 31.06%, compared to 67.57% for the national average. Wells Fargo, often thought of as the “gold standard” of big bank efficiency, runs an efficiency ratio in the mid-50’s. Even other “lean” banks like Ally Financial (high 40’s) or Internet Bancorp (high 70’s) don’t even come close to matching BOFI’s efficiency. This translates into an ROE of over 19% (industry average of 7.3%) and a ROA of 1.64% (twice the industry average of .86%).
So, in summary…we have a bank that offers some of the best products in retail banking. It is extremely lean in operations, with nary a single brick-and-mortar location. It’s growing its deposit base by leaps and bounds organically while also seeking out tuck-in acquisition opportunities. BOFI has a return on assets and equity that blow away competition. Even with the great checking and savings accounts rates BOFI offers, it still sports an industry-leading interest spread and uber-low loan charge-offs. This is a culture of what a new bank looks like. The Millennial generation is more comfortable doing business and banking online than any other group before it. BOFI offers core services of checking, savings, CDs, and Home and multi-family loans. That’s all it does; nothing else. But, those things that it does do, it does extremely well. To reach a $14B market cap (ten times today’s size) is really only a matter of time. BOFI would need 25% loan growth annually for ten years to get to an asset level that would yield $700M in profit (at current ROA)—a 20x P/E would be a $14B market cap. Being that they’ve outpaced this significantly through entirely organic growth and in a very low interest rate environment, I think this is very doable. But, even if they don’t accomplish this feat, I think strong returns are highly likely for many years to come.
In the game of investing, every portfolio needs a little speculative money. It makes investing fun and exciting. These three companies, I feel, have the potential to be huge winners over the medium term. It’s possible they fail, however unlikely, but that is the risk you take. These aren’t investments like Johnson & Johnson or Pepsi. These aren’t investments to put your kids college education money in. These are investments where $1,000 today might buy you a new car in a decade These are investments you can brag about at parties, “Yah, Bank of Internet, I bought them at $90. They hit $1,000 today.” Understand the risks, but believe in the potential.