gm7 10.20.2015

General Meeting #710.20.2015University Securities Investment Teamtexasusit.org

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Agenda• General Announcements• Market Update

• Kajal Dayal• Portfolio Update

• Cliffe Kim• Lecture: High Frequency Trading

• Grant Kjeldsen• Stock Pitch: Baxter International (BAX)

• Connor Ruddick, Austin Partridge, Karna Venkatraj, Phoebe Lin

• Kendra Zhi, Paul Gilmore

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Recruiting

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General Announcements

10/20/15

• First TWO meetings are free!• Analyst Groups: CLOSED• Email vicepresident@usiteam.org for WSJ log-in

information• UCF Workshop: Options Theory III

• Thursday – CBA 4.328, 7-8pm

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Social

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USIT Social! • The Picnic • Hula Hut• Abel’s on the Lake • Friday, October 16th • Saturday, October 17th • 7pm – 9pm• 8pm – 10pm

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Not at all related….

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• Advertising and Social Chair

• Board Position Now Open!!• Membership Chair• If interested, email resume to

president@usiteam.org with subject line “Membership Chair Application”

• Interviews will be sometime next week

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Upgrade Capital

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Code in Finance

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Recruiting• Investment Banking Interviews• Feel free to reach out to SCG members

for help preparing• miguelperez32013@utexas.edu

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Market UpdateKajal Dayal

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Bernie & Hillz Show• Hillary: Give regulators authority to go after big

banks

• Sanders: “I am the only candidate running who’s not a billionaire and doesn’t have substantial sums of money coming from a super-PAC”

• “shadow banking”?

• “I trust Sanders like I trust a North Korean Chef with my Labrador”

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Walmart• Largest Retailer in the World ($188B)• 10% drop $21 billion loss• Top 10 shareholders $14.7 billion

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• Increased pay to $10/hr.

• Slowing down store expansions

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Theranos• $9 billion healthcare startup• One of the hottest yet most secretive

companies• CEO Elizabeth Holmes: youngest self

made billionaire female CEO • Recently called out for using “traditional

machines”• Transparency…….

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Deutsche Bank• Largest German Bank• Libor rigging $2.5 billion fine• Approx. 1 Quarter’s worth of earnings for

DB• Worst valued stock among global leaders• Rev. from FI & currencies dropped 30%

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• Co- CEO John Cryan stepping in to restructure• Scrap dividends & cut 8,000 jobs

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In other news• the US killed the leader of a terror group

linked to al-Qaeda• Boss of an al-Qaeda “super group” HQ in

Syria

• Obama slowing down the withdrawal of troops from Afghanistan

• 100,000 troops meant to come home in 2016• Now deferred to 2017

• Why?

Chinese GDP … Growth?• exports and imports• Production • Factories have seen 43 consecutive

months of falling prices

• Retail sales and services = GDP Growth Rate of 6.9%

Interesting…..

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Better Factors for GDP estimate• Railway cargo volumes• Electricity consumption• Loans disbursed by banks

• History discontinuing statistics• “Gini coefficient”

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And of course….

• ALCOA Inc. (AA) fell another 6.71%

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Portfolio UpdateCliffe Kim

Portfolio Performance

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USIT Portfolio Current Value: $ 11,899.915d Performance Index Comparison

+0.15%

+1.46%

+1.28%

+1.71%

500

2000

Name Price 5d Chg ($ · %) Mkt Value Total Chg ($ · %) 52wk Low 52wk High

AAL American Airlines 44.79 17.94 · 3.18% 582.77 132.86 · 29.56% 34.00 56.20

AAPL Apple 113.77 41.58 · 1.77% 2389.17 930.84 · 63.83% 92.00 134.54

ACC American Campus 39.40 18.80 · 5.01% 394.00 35.70 · 9.96% 32.12 45.38

AGX Argan 36.02 26.25 · 2.13% 1260.70 501.20 · 65.99% 29.63 42.50

BABA Alibaba Group 71.79 10.60 · 3.04% 358.95 -48.75 · -11.96% 57.20 120

BBRY BlackBerry 7.20 3.00 · 0.42% 720.00 -317.00 · -30.57% 5.96 12.63

FNMA Fannie Mae 2.37 -34.32 · -9.20% 338.91 -180.18 · -34.71% 1.97 3.51

GENC Gencor 9.77 -2.35 · -0.51% 459.19 -39.95 · -8.00% 8.90 10.17

GILD Gilead Sciences 101.66 17.35 · 3.53% 508.30 -4.70 · -0.92% 85.95 123.37

AJRD Aerojet Rocketdyne 16.66 -29.50 · -3.42% 833.00 -18.00 · -2.12% 15.75 24.35

IDT IDT Corporation 13.43 -60.75 · -5.69% 1007.25 -344.25 · -25.47% 12.57 23.24

MUSA Murphy USA 55.83 8.85 · 1.07% 837.45 247.95 · 42.06% 47.73 73.97

PTC PTC Inc. 34.83 1.50 · 0.43% 348.30 10.20 · 3.02% 30.53 42.75

RNET RigNet 30.73 6.70 · 2.23% 307.30 -146.90 · -32.34% 23.37 47.37

SLCA U.S. Silica 16.51 -11.10 · -4.29% 247.65 -179.85 · -42.07% 13.48 52.90

SWKH SWK Holdings 13.90 8.00 · 1.46% 550.00 102.00 · 22.77% 11.70 45.00

TRN Trinity Industries 26.88 -2.60 · -0.74% 349.44 -49.66 · -12.44% 21.78 37.52

HLT Hilton Worldwide Holdings 24.91 -1.53 · -0.36% 423.47 -14.96 · -3.41% 20.93 31.60

Fannie Mae (FNMA)• Fannie Mae, or the Federal National

Mortgage Association, buys mortgages and repackages them for sale

• 5d Change: -9.20%

• Government Sponsored Enterprise(GSE). Founded by FDR after the Great Depression

• Along with Freddie Mac, plays a key role in making housing affordable to middle and low income families

• 50% of all U.S. mortgages

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Sidetrack: How to Name a Lending Company

Friendly, Neighborly, Southern Name

Initials Actual Name

Fannie Mae FNMA Fed. National Mortgage Assc.

Freddie Mac FHLMC Fed. Home Loan Mortgage Corp.

Ginnie Mae GNMA Gov. National Mortgage Assc.

Sallie Mae SLMA Student Loan Marketing Assc.

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Loan:$200,000

Mortgage:Monthly $1,000over 30 years

MBS: Mortgage Backed SecuritiesMultiple mortgages pooled to spread riskMonthly Interest Payments

Investors

Fannie Mae (FNMA)• Competition with private banks in 2000s led

to decrease in underwriting standards• Saw fantastic losses when housing market

crashed

• Treasury currently holds $117.1 billion in Fannie Mae (80%), after 2008 bailout

• Fannie Mae has paid $239 billion

• Treasury takes all dividends of Fannie Mae• This makes a lot of bankers and investors angry• Lawsuit against government

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“None of us should be misled by the increasingly noisy chorus of advocates of recap and release”

Michael Stegman (White House housing adviser )

Conclusion• No major change with Fannie Mae until

next President or Congress

• Share Prices will likely stay low until then

Unless lawsuit ends before legislation is passed

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Introduction to High Level Physics

by Grant Kjeldsen

Introduction to High Frequency Trading

by Grant Kjeldsen

Physics (Frequency vs Amplitude)

Definition of HFT

“A program trading platform that uses powerful computers to transact a large number of orders at very

fast speeds.”

As of 2012, it is estimated more than 50% of exchange volume comes from HFT orders.

HFT center is effectively a bunch of computers in a room being monitored by more computers.

HFT Center

The goal of an HFT Center is to have low latency to ensure better trades.

• Latency - The time that elapses from the moment a signal is sent to its receipt.

HFT Terminology: Latency

• Latency - The time that elapses from the moment a signal is sent to its receipt.

HFT Terminology: Latency

2 milliseconds

HFT Terminology: Latency

Best: 126 microseconds

Average: 30 milliseconds

>10 milliseconds

• Co-location - Locating computers owned by HFT firms and proprietary traders in the same premises where an exchange’s computer servers are housed.

HFT Terminology: Co-location

(NYSE Euronext data center)

• Pinging - Refers to the tactic of entering small marketable orders – usually for 100 shares – in order to learn about large hidden orders in dark pools or exchanges.

HFT Terminology: Pinging

• Slow market arbitrage (latency arbitrage) – where a high-frequency trader arbitrages minute price differences of stocks between various exchanges.

HFT Terminology: Predatory Trading

• Arbitrage – The simultaneous purchase and sale of an asset in order to profit from a difference in the price

• Electronic front running - a HFT firm racing ahead of a large client order on an exchange, scooping up all the shares on offer at various other exchanges (if it is a buy order) or hitting all the bids (if it is a sell order), and then turning around and selling them to (or buying them from) the client and pocketing the difference.

HFT Terminology: Predatory Trading

HFT

• Rebate arbitrage - a HFT activity that attempts to capture liquidity rebates offered by exchanges without really contributing to liquidity

HFT Terminology: Predatory Trading

HFT

SLP Rebate

Why so Popular?

Exchanges began to offer incentives for companies to add liquidity to the market.

From $0.0015 in 2009 to $0.0032 in 2012 the SLP rebate has continued climbing.

• Supplemental Liquidity Provider - Market participants that use sophisticated high-speed computers and algorithms to create high volume on exchanges in order to add liquidity to the markets.

SLP Rebate

“Hi I’m Dick Fuld, the most hated man in America.”

• Point of Presence - The point at which traders connect to an exchange.

HFT Terminology: Point of Presence

• SIP - The technology used to collect quote and trade data from different exchanges, collate and consolidate that data, and continuously disseminate real-time price quotes and trades for all stocks

HFT Terminology: Securities Information Processor (SIP)

• Matching Engine - The software algorithm that forms the nucleus of an exchange’s trading system, continuously matching buy and sell orders, a function previously performed by specialists on the trading floor

HFT Terminology: Matching Engine

• Smart Router - Technology that determines to which exchanges orders or trades are sent

HFT Terminology: Smart Routers

• Flash Trading - A type of HFT trading wherein an exchange will “flash” information about buy and sell orders from market participants to HFT firms for a few fractions of a second before the information is made available to the public.

HFT Terminology: Flash Trading

You’re Ready to Start HFT, right?

Stock Pitch: Baxter International (BAX)Pitch Team: Connor Ruddick, Austin Partridge, Karna Venkatraj, Phoebe Lin, Kendra Zhi, Paul Gilmore

Baxter International Inc. (NYSE:BAX)Position: LONGPrice Target: $40.11 (17.1% Discount)

Paul Gilmore | Phoebe Lin | Austin Partridge | Connor Ruddick | Karna Venkatraj | Kendra Zhi

T H E S I S V A L U A T I ONC O M P A N Y R I S K SI N D U S T R Y

Investment Thesis

59

Main factors driving value

1

2

3

Market undervalues new dialysis system recently approved by FDABaxalta spinoff will allow Baxter to focus on core competencies Revenue growth from more than 50 product launches over next 10 years

T H E S I S V A L U A T I ONC O M P A N Y R I S K SI N D U S T R Y

6/1/2015 7/1/2015 8/1/2015 9/1/2015 10/1/2015$32

$34

$36

$38

$40

$42

$44

Price History

60

Major events and resulting share priceBaxaltaSpinoff

Shire $30.6B Baxalta

Bid

FDA Clearance of AMIA

APD

T H E S I S V A L U A T I ONC O M PA N Y R I S K SI N D U S T R Y

Company Overview

Founded in 1931 66,000 employees Provides products for people with chronic and

acute medical conditions Hemophilia, immune disorders, infectious diseases,

kidney disease, and trauma

61

Leader in healthcare equipment and pharmaceutical industry

Hospital Products Renal Products

2 Main Components

T H E S I S V A L U A T I ONC O M PA N Y R I S K SI N D U S T R Y

Company Overview

62

Leader in healthcare equipment and pharmaceutical industry

T H E S I S V A L U A T I ONC O M PA N Y R I S K SI N D U S T R Y

Company Overview

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Leader in healthcare equipment and pharmaceutical industry

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Revenue Breakdown

64

2014 sales by business segment and region

T H E S I S V A L U A T I ONC O M PA N Y R I S K SI N D U S T R Y

Sales Growth

65

Expected sales growth by market

T H E S I S V A L U A T I ONC O M PA N Y R I S K SI N D U S T R Y

Baxalta Spinoff

66

Product revenue by business unit

BioScienceBaxalta

Medical ProductsBaxter

$3,728$2,224

$747

Hemophilia BioTherapeuticsBioSurgery

$4,172

$3,222

$1,574

$1,004

RenalFluid Systems

T H E S I S V A L U A T I ONC O M PA N Y R I S K SI N D U S T R Y

Baxalta Spinoff

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Product revenue by business unit

2014 Revenue by Geography

UnitedStates

Established Markets

Emerging Markets

$6B

7 Regulatory Approvals

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Future Prospects

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Additional expansion and product launches

T H E S I S V A L U A T I ONC O M PA N Y R I S K SI N D U S T R Y

Recent FDA Approval

69

AMIA Automated Peritoneal Dialysis System With SHARESOURCE Connectivity Platform

Only dialysis machine in U.S. that incorporates patient-centric features

Market disruptor for dialysis medication delivery Allows easy access to patient historical treatment

data FeaturesVoice Guidance Touchscreen

Control Panel

SHARESOURCE Two-way

Connectivity Platform

T H E S I S V A L U A T I ONC O M P A N Y R I S K SI N D U S T R

Y

Industry Overview

70

Major trends in the health care industry

Health care reform increased access to

prescription drugs by 32 million people.

Shifting to an older population

Emerging Markets increase demand for specialized

pharma

T H E S I S V A L U A T I ONC O M P A N Y R I S K SI N D U S T R

Y

High startup costs Patents and

intellectual property

Human capital in R&D

FDA patented approval

Improvements have few substitutions

Competing products with variations on existing tech present a high threat

Multitude of suppliers limiting influence

Sales concentrate in handful of large players Decreased the bargaining power of suppliers

Importance of patents

Superior technology can dictate price and supply

Industry Analysis

71

Porter’s Five Forces AnalysisBargaining Power of

Buyers (Low)Bargaining Power of

Suppliers (Low)

Barriers to Entry (High) Threat of Substitutes (Moderate)

Intensity of Rivalry

(High) Established firms compete on:

Innovation FDA

approval Contracts Price Production

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Y

Market Share

72

Relative market share vs competitors

74%

22%

4%

Baxter Pall Corp Other

Medical Delivery Market Share

Renal Pharma Market Share

53%43%

4%

Baxter Becton Dickson & Co.

T H E S I S V A L U A T I ONC O M P A N Y R I S K SI N D U S T R Y

Risks & Mitigations

73

Potential risks and mitigating factors

Risk of FDA approval

Shared by all firms in industry

Will not specifically hurt Baxter

High Competition

FDA Approval

High barriers to entry and added value to new products

Reduce threat of substitute goods

Product Recalls

Recalls happen regularly and are common in operations

Should not have any unexpected negative impacts

T H E S I S V A L U A T IO NC O M P A N Y R I S K SI N D U S T R Y

Public Company Comparables

74

Valuation relative to comparable firms

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Public Company Comparables

75

Valuation relative to comparable firms

T H E S I S V A L U A T IO NC O M P A N Y R I S K SI N D U S T R Y

Discounted Cash Flow

76

Intrinsic valuation of the company’s future cash flows

Baxter International Inc. (NYSE:BAX)Discounted Cash Flow (in millions) Historical

2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020ERevenue 12,843.0 13,893.0 13,936.0 14,967.0 16,671.0 16,026.7 16,828.0 17,501.2 18,026.2 18,386.7 18,570.6

Growth % 8.2% 0.3% 7.4% 11.4% -3.9% 5.0% 4.0% 3.0% 2.0% 1.0%COGS 5,772.0 6,163.0 6,146.0 6,669.0 7,636.0 7,267.9 7,623.1 7,928.0 8,165.9 8,329.2 8,412.5

% Revenue 44.9% 44.4% 44.1% 44.6% 45.8% 45.3% 45.3% 45.3% 45.3% 45.3% 45.3%Gross Margin 7,071.0 7,730.0 7,790.0 8,298.0 9,035.0 8,758.8 9,204.9 9,573.1 9,860.3 10,057.5 10,158.1

Operating Expenses 2,754.0 3,057.0 3,044.0 3,308.0 3,780.0 3,763.0 4,038.7 4,200.3 4,326.3 4,412.8 4,456.9 % Revenue 21.4% 22.0% 21.8% 22.1% 22.7% 23.5% 24.0% 24.0% 24.0% 24.0% 24.0%

Operating Income 4,317.0 4,673.0 4,746.0 4,990.0 5,255.0 4,995.8 5,166.2 5,372.9 5,534.0 5,644.7 5,701.2

R&D 881.0 946.0 940.0 1,016.0 1,164.0 1,175.9 1,346.2 1,400.1 1,442.1 1,470.9 1,485.6 % Revenue 6.9% 6.8% 6.7% 6.8% 7.0% 7.3% 8.0% 8.0% 8.0% 8.0% 8.0%

EBITDA 3,436.0 3,727.0 3,806.0 3,974.0 4,091.0 3,819.9 3,820.0 3,972.8 4,091.9 4,173.8 4,215.5

Depreciation and Amortization 606.0 589.0 611.0 694.0 820.0 819.5 841.4 875.1 901.3 919.3 928.5 % Revenue 4.7% 4.2% 4.4% 4.6% 4.9% 5.1% 5.0% 5.0% 5.0% 5.0% 5.0%

EBIT 2,830.0 3,138.0 3,195.0 3,280.0 3,271.0 3,000.4 2,978.6 3,097.7 3,190.6 3,254.5 3,287.0

Taxes @ 21.5% 608.5 674.7 686.9 705.2 703.3 645.1 640.4 666.0 686.0 699.7 706.7 NOPAT 2,221.6 2,463.3 2,508.1 2,574.8 2,567.7 2,355.3 2,338.2 2,431.7 2,504.7 2,554.7 2,580.3

Add: D&A 606.0 589.0 611.0 694.0 820.0 819.5 841.4 875.1 901.3 919.3 928.5 Less: CapEx 963.0 960.0 1,161.0 1,525.0 1,898.0 1,858.0 1,851.1 1,750.1 1,802.6 1,838.7 1,857.1

% Revenue 7.5% 6.9% 8.3% 10.2% 11.4% 11.6% 11.0% 10.0% 10.0% 10.0% 10.0%Less: Change NWC (420.0) 47.0 247.0 1,797.0 (296.0) 17.4 40.0 35.5 27.7 19.0 9.7 Unlevered FCF 2,284.6 2,045.3 1,711.1 (53.2) 1,785.7 1,299.4 1,288.5 1,521.1 1,575.6 1,616.4 1,642.1

WACC 3.5% Discount Period 0.25 1.25 2.25 3.25 4.25 5.25Present Value of Cash Flows 1,288.4 1,234.6 1,408.5 1,410.0 1,397.8 1,372.3

Projected

T H E S I S V A L U A T IO NC O M P A N Y R I S K SI N D U S T R Y

Discounted Cash Flow

77

Intrinsic valuation of the company’s future cash flowsEnterprise Value Equity Value

PV of FCFF 8,111.6 Enterprise Value 29,602.3 Less: Total Debt 14,230.0

Terminal Value Less: Preferred Stock - Terminal Year EBITDA 4,215.5 Less: Minority Interest 33.0 Exit Multiple 6.1x Plus: Cash & Cash Eq. 6,680.0

Terminal Value 25,714.7 Discount Factor 0.84 Equity Value 22,019.3$ PV of Terminal Value 21,490.8 Diluted Shares Out. 549

% of EV 72.6% Implied Share Price 40.11$ Current Share Price 34.26$

Enterprise Value 29,602.3$ Implied Discount 17.1%

Exit Multiple5.1x 5.6x 6.1x 6.6x 7.1x

2.5% 8.7% 19.6% 30.6% 41.5% 52.5%3.0% 5.5% 16.1% 26.8% 37.5% 48.2%3.5% 2.4% 12.8% 23.2% 33.6% 44.0%4.0% -0.7% 9.5% 19.6% 29.8% 39.9%4.5% -3.6% 6.3% 16.2% 26.1% 36.0%

WAC

C

T H E S I S V A L U A T I ONC O M P A N Y R I S K SI N D U S T R Y

Summary

78

1

2

3

FDA approval of new dialysis system has been undervalued by the marketNegative sentiment of Baxalta spinoff overshadows approvalsNew product launches will continue strong revenue growth

Q&A

Vote: texasusit.org/portfolioVoting opens after DCF Analysis