We’ve got a lot to get to in this edition of Tematica Pro so we’re going to keep the introductory chit-chat to a minimum and get right to it as we double-down on one position, add a new one and put a new short position candidate on the board. Here we go…

Scaling into McCormick calls

A few weeks ago we added the McCormick (MKC) December $95 calls (MKC161216C00095000) to our Tematica Pro ahead of what we suspected would be another dividend increase by this spice and extract juggernaut. As suspected, last week McCormick boosted its quarterly dividend to $0.47 per share from the prior $0.43 per share. The initial reaction saw the shares trading off and this pressured our call significantly. As the market has digested the news, Bank of America/Merrill Lynch initiated coverage on the shares with a Buy rating and a $100 price target. The basis for that recommendation not only confirmed our longer-term thesis on the shares, but it led to a rebound in the shares.

• With roughly two weeks to go until our MKC calls expire, we’re doubling down on the position as the shares are just a few points away from our $95 strike price. 

 

Adding Facebook calls to our holdings

Right after Thanksgiving we added Facebook (FB) shares to the Tematica Selection Investment List given the prospects for the company to further monetize its subscribers base across its various social media properties. Over the last few weeks, Facebook shares have traded off, even though there have been more data points to support the accelerating shift to digital advertising.

Advertising agency Zenith Optimedia predicts global advertising expenditure on social media will account for 20 percent of all internet advertising in 2019, hitting $50 billion and coming in just one percent smaller than newspaper ads. By 2020, Zenith expects social media to comfortably overtake newspapers by 2020.

To take advantage of the recent pullback in Facebook shares:

• We’re adding the Facebook (FB) February $120 calls (FB170217C00120000) that closed last night at $4.70.
• We would buy the calls up to $5.00.
• We’ll set a protective stop loss at $3.80.

 

One to Watch:
A Potential Short Position in Plantronics (PLT)

When looking at short positions, it’s best to sharpen your pencils once, twice and maybe even three times and be ready to pounce when the opportunity is right. Keeping that in mind, below is our first look at Plantronics (PLT), a name we’ve seen rise 30 percent since the summer, but one that is facing some significant headwinds in the future. While we aren’t making a move right now, we’re placing it on the Contender List.  Below is our detailed analysis of the position we want to share now so we’re all on the same page when the timing is right.

Arising tide can lift many boats and the last several weeks in the US stock market have done just that. Some companies are benefitting from the what is being called either the “Trump Bump” or the “Trump Trade” that has led to a market rotation into infrastructure and construction-related companies as well as financials, while moving out of technology stocks like Facebook (FB), Amazon (AMZN), and Alphabet (GOOGL) to name a few. What we’ve mostly seen is, in particular, the small cap heavy Russell 2000 Index has climbed more than 16 percent over the last month and that index has lifted many individual stocks along the way.

As Tematica’s Chief Investment Officer Chris Versace and Chief Macro Strategist Lenore Hawkins point out in their book Cocktail Investing: Distilling Everyday Noise into Clear Investment Signals for Better Returns, in addition to those thematic factors that drive and shape a company’s industry and its competitive position, investors need to be aware of other issues that could spell trouble for a company’s business, its shares or both. One example is regulatory mandates that can alter demand dynamics or shift the playing field. Another is legal action, such as antitrust lawsuits and securities law violations, that can lead to uncertainty overhangs, sanctions and other fallout that could weigh on a company’s credibility and business prospects.

Headset company Plantronics is an example of the latter issues, as it is facing an investigation over potential securities law violations and an antitrust lawsuit brought against it by competitor GN Netcom. The potential securities law violation investigation is examining “whether a series of statements by Plantronics regarding its business, its prospects and its operations were materially false and misleading at the time they were made.”  GN Netcom’s antitrust lawsuit accused Plantronics of preventing its distributors from selling competing products to large call centers.

Either one of these would lead to an air of uncertainty, but the combination of the two weighed on Plantronics shares during the middle of 2016, but as the late summer stock market melt gave way to the Trump Bump, Plantronics shares soared more than 30 percent from their late June low.

Quite the move, considering the lawsuit revealed that Donald Houston, senior vice president of sales at Plantronics, “was instructing employees who worked under him to delete e-mails that were clearly relevant and responsive to pending discovery having to do with the distributors that are at issue in this case.”

To be fair, Plantronics did make some moves to address the situation. Plantronics set aside $5 million in anticipation of a court sanction for spoliation of evidence.  Also, Plantronics President and Chief Executive Officer Ken Kannappan retired and was replaced.

During the September 2016 quarter, however, US District Judge Leonard Stark sanctioned the company $3 million plus attorney’s fees for intentionally destroying evidence.  In his decision to sanction the company, Judge Stark wrote “…Plantronics’ high degree of fault, its bad-faith intent to deprive GN of responsive documents, and the prejudice it has caused to GN’s case — along with the difficulties it has created for GN in ‘getting to the bottom of the deletion story’ and its (at times) unwillingness to acknowledge wrongdoing — further merit punitive monetary sanctions.”

Judge Stark also suggested that a reasonable jury could consider that the intentional destruction of evidence, including as many as 90,000 emails evidence in their deliberations could be an indication of more wrongdoing: “Even the instruction from Mr. Houston to delete emails may be viewed by a reasonable jury as part of a massive cover-up to hide antitrust violations Plantronics knew it was guilty of, or, alternatively, as merely a misguided fear that innocuous, pro-competitive conduct might be misunderstood by a competitor (and ultimately a fact finder) to be improper.”

In a report compiled by Gibson Dunn & Crutcher’s Gareth Evans and Jennifer Rearden that cited Jude Starks’ views in the Plantronics case, Evans commented that “you’re only going to get the most serious sanctions where there’s this very extreme behavior, destroying documents with the intent to deprive the other side of them in the litigation.” Evans went on to add, “that in such circumstances, the consequences are likely to be severe.”

In a July 2016 press release, Plantronics said, “that the underlying antitrust action is without merit and intends to defend itself vigorously.” As expected, and noted in its most recent 10-Q filing, Plantronics said it may appeal the ruling and maintained that the underlying case was without merit. Thumbing through that same 10-Q, however, it was revealed that Plantronics is, “not accruing any financial damages related to the underlying antitrust case” because it sees the “antitrust action is without merit.” Even so, it still acknowledges if the antitrust suit prevails it could be required “to pay substantial damages, which would have a material adverse effect” on the company’s financial position. Exiting the September quarter, Plantronics’ balance sheet had $422 million in cash and total debt of $490.3 million and the trial of the underlying antitrust case is currently scheduled to commence in October 2017.

Compounding the problem is the potential loss of government contracts. Plantronics sells products to various government agencies as a General Services Administration (GSA) contractor.  Though the company maintains that these sales do not comprise a significant portion of its net revenue, it did warn that declining government spending could reduce their revenue. Given the campaign promise to rebuild the US military by now President-elect Trump, Plantronics may not face any danger from declining government spending. Instead, it could face suspension or disbarment from the GSA schedule, which would render Plantronics ineligible for any government contracts.  Two causes for suspension or disbarment include the destruction of records and violation of antitrust statutes.  In other words, the plot thickens.

We also have Apple (AAPL) looking to make serious inroads into the headset markets with its soon-to-be-released Air Pods as well as updates to its Beats line of Bluetooth headset products. While those products may not impact the enterprise market for Plantronics’ products, they along with the competitive response that is likely to ensue could pressure Plantronics’ Consumer business. Over the last two quarters that Consumer business accounted for just under 30% of Plantronics’ overall revenue.

Put it all into our cocktail shaker, stir and pour, we find ourselves looking past the recent and pronounced rise in the shares to several uncertainties that raise serious questions about the company’s outlook. Keep in mind, that after the “Trump Trade” rally, Plantronics shares are bumping up their 52-week high, which suggests the outlook could be irrationally exuberant.

• With the market likely to melt higher between now and the end of 2016, we’ll look to revisit Plantronics shares with a negative disposition if and when they enter overbought territory. 
• For now, we’ll sit on the sidelines, but with our homework done, we’ll be ready to pounce when the timing is right.