John Overdeck and David Siegel are the names behind one of the world’s largest global quant funds- the New York-based Two Sigma Investments LP. The fund has experienced a rapid explosion from just $6 billion in 2011 to $50 billion today due to its highly successful computer-powered investment strategies. As a result it is worth keeping a close eye on the fund’s latest trades- as revealed by forms filed with Two Sigma with the SEC. In the last quarter, the fund exited Valeant Pharmaceuticals International, Inc. (NYSE:VRX) but initiated a new position in another struggling debt-laden pharma giant, Teva Pharmaceutical Industries Limited (NYSE:TEVA).
The fund was set up in 2001 by computer scientist David Siegel and mathematician John Overdeck. Both Siegel and Shaw previously held senior positions at another large hedge fund – DE Shaw Group run by internationally renowned computer scientist David Shaw. Now Two Signma is recognized as one of world’s most established quant funds. The fund ensures that it stays ahead of the pack by recruiting most of its 1,200 employees from mathematics and computer sciences backgrounds rather than the typical finance industry. Famously this includes a Japanese backgammon tournament winner and the “world’s first open-source software artist”, according to the Financial Times.
Two Sigma has also closed its main fund to outside investors and is instead growing a number of hybrid vehicles. Indeed, the fund has four specialized trading divisions including Two Sigma Securities LLC is a high frequency broker-dealer and Two Sigma Ventures which invests in AI, machine learning and data science. However the fund’s overarching principle remains the same. It is neatly expressed by Two Sigma here: “We’re not your typical investment manager. We follow principles of technology and innovation as much as principles of investment management. Fields like machine learning and distributed computing guide us. Since 2001, we’ve searched for ways that these kinds of technologies can make us better at what we do. We never stop researching and developing.”
The fund’s unique approach is reflected in various offbeat initiatives. For example, in 2016 the fund ran an artificial intelligence challenge called Halite. Halite is a programming game inviting coding enthusiasts to build smart bots whose goal is to gain control of a virtual grid. Similarly in March 2017 the fund ran a competition on Kaggle to code a trading algorithm.
Now we have a basic understanding of the fund and its founders, let’s dive in and take a closer look at two of the fund’s most intriguing stock moves:
In the third quarter, Overdeck and Siegel seem to have lost faith in the fortunes of Valeant Pharmaceuticals. They sold off their entire Valeant position of 712,674 shares worth $10,212,618.
No doubt top Mizuho analyst- and longtime VRX skeptic- Irina Rifkind Koffler would approve of the fund’s latest move. She has just released a report reiterating her Sell rating on VRX. However, she does ramp up her price target to $10 from $7 previously- which still represents significant downside from the current share. (To watch Koffler’s track record, click here)
According to Koffler, the stock’s current valuation cannot be justified. “We were going to upgrade VRX but the stock ran away from us” explains Koffler. Indeed, VRX shares have soared in the last three months from just $13.79 to $19.71.
And it’s not just the share prices that are making Koffler cautious. She says: ‘Valeant deftly refinanced its debt, but we expect a negative stock reaction to 2018 guidance and worry about a dilutive financing event after the recent run up.’ She says the credit market is anticipating a dilutive equity event to further de-lever the business and that as a result she “sees additional downside risk to shares.” The possibility of VRX doing something dilutive overshadows the company’s performance this year. Indeed, Koffler believes that the company is on track to meet 2017 guidance and even beat 4th quarter consensus estimates due to momentum in gastrointestinal unit Salix.
In fact, Koffler even takes a positive tone on VRX when she says: “We have to credit mgmt. for maximal effort to turn the stock and quarterly performance around appropriately using all of the levers at its disposal.” But at the same time, she believes VRX will struggle to address the 2020 debt maturities given the current drug pipeline at its disposal. She sees the recent refinancing as an ‘admission’ of this troubling fact. While eye division Bausch + Lomb may be growing, she expects Branded Rx and Diversified segments to continue to decline. Salix could also experience pressure especially if Uceris and Apriso go generic while psoriasis treatment Siliq remains ‘unimpressive’. As for the price target increase, Koffler explains that after consulting a lawyer she has lowered her litigation reserve for VRX by $1 billion.
Note that this analyst has a strong track record on TipRanks- and even her record on VRX stock specifically is better than many of her loss-making peers. Across her 58 Valeant ratings Koffler has achieved a 52% success rate and 1.1% average return.
Overall, the Street has a relatively pessimistic outlook towards VRX with a Moderate Buy analyst consensus rating. Indeed, in the last three months, the stock has received just 1 buy rating, versus 6 hold ratings and 4 sell ratings. The average price target from these analysts comes out at $15.56, indicating potential downside of over 21% from the current share price.
Teva Pharmaceutical Industries
Overdeck and Siegel initiated a surprise position in Israeli pharma giant TEVA in the third quarter. The fund snapped up 98,732 TEVA shares worth $1,738,000.
Luckily for the fund, shares are rising after hitting rock bottom at $10.85. Now shares are trading up at $18.60. In fact, shares have just leapt by 10% following an announcement that the company plans to cut 25% of its workforce. This tougher-than-expected cost cutting measure will see the company fire 10,000 workers- leading to protest strikes across Teva factories. Teva also plans to suspend its famous dividend payment as it works to get back on track. Shares plunged earlier this year after disastrous second-quarter results. The company has failed to recover after saddling itself with debt on the back of its foolish $40 billion acquisition of acquisition of Actavis Generics.
Now Teva says that these new measures will ultimately cut $3 billion from its annual operating costs. Currently Teva experiences about $16.1 billion in costs to produce $23.4 billion in annual revenues. The cost cuts could therefore improve the company’s operating profit margin by about 1860 basis points from about 2019.
Oppenheimer analyst Derek Archila says the move will help Teva improve its pricing power when faced with major pharmacy chains like CVS, Walgreens, and Walmart. Archila now predicts that Teva will earn $3.29 per share in 2018 (up $0.57 from previous estimates) and $4.37 in 2019 (up $1.64) — with these profit improvements rapidly moderating after 2019.
However, the crucial point is that the underlying Teva picture looks just as unappetizing as before the cuts. This includes “generic competition to its 40mg Copaxone,” “continued pricing pressure in US generics” alongside “g-Concerta erosion.” Plus, cost cutting carries its own risks, especially to new product development. Cutting research and development funds makes it less likely that new revenue-generating products will be developed. At the same time, Teva plans to discontinue certain products which could also create a drag on revenue says Archila.
With the stock’s future so uncertain it makes sense that the market is currently sidelined on TEVA. Indeed, we can see that the stock has a firm Hold analyst consensus rating on TipRanks. This breaks down into 13 hold ratings and only 3 buy ratings and 2 sell ratings. These analysts are predicting (on average) that the stock will sink back 6% to $17.50.