Value Line Institutional Services


August 2017


Growth & Income Investment

CONE Midstream Partners LP (CNNX)

By Jeremy Butler, Editorial Analyst

CONE Midstream Partners LP (CNNX) is a master limited partnership, commonly referred to as an MLP (details below). It was formed in May, 2014 by CONSOL Energy (CNX) and Noble Energy (NBL). CONSOL and Noble are CONE’s sponsors, meaning that they created CONE to service their oil and gas production needs in the Marcellus Shale fields of Pennsylvania and West Virginia. Essentially, CONE (as well as other pipeline MLPs) are tax-advantaged oil and gas transporting, processing, and distribution companies. CONE acquires the assets that Noble and CONSOL use to operate in the Marcellus. These assets include natural gas gathering, drilling, and collecting facilities, as well as transportation equipment and pipelines. In return, CONE receives a fee from the sponsors based on how much gas it processes. The fee also varies depending on which type of gas is being processed. The fee is typically renegotiated every few years, and the price of gas factors into these discussions. These fees are currently responsible for all of CONE’s revenues.

In September, 2014, CONE Midstream Partners LP closed its initial public offering of 20.13 million units at $22.00 a unit. These units are listed on the NYSE under the ticker CNNX. The MLP has about 100 employees and is headquartered in Canonsburg, PA.

How Does A Master Limited Partnership Work?
There are three main parties involved in an MLP. The first is the sponsor (Noble and CONSOL), which creates the MLP. The second is the general partner (CONE Midstream GP LLC), which is separate from the sponsor and makes the managerial decisions. The third is the limited partner (or partners), which contributes funds to the MLP. In this case, the limited partners are the public unitholders.

MLPs do not usually pay state or federal corporate income taxes. Instead, the general partnership typically chooses to have the MLP pay out all of its distributable income to unitholders (usually, earnings plus depreciation, depletion, and amortization, along with other noncash charges, minus maintenance expenses, capital spending, and payouts to the general partner) less a small portion retained to fund growth. MLPs own storage, processing, and transportation assets and charge customers fees for usage. They do not typically take title to hydrocarbons, nor do their fees usually depend directly on volatile energy prices.

The fact that MLPs generally pay no corporate income taxes is a major reason sponsors set them up. Consequently, the tax responsibility lies with the unitholder. (Please note that MLPs present unique tax implications for investors; potential unitholders should consult a tax accountant before purchasing.) To sum up, in CONE’s case, the sponsors (CNX and NBL) pay CONE processing fees, which are used by CONE to help pay for the assets it acquires to service its sponsors, run its business, generate cash flow, and pay its unitholders.

Investment Thesis
CONE is an oil and gas MLP. Its sponsors’ production is predominantly natural-gas weighted, rather than oil weighted. CONE, therefore, relies indirectly on the price of natural gas for its long-term livelihood, as higher prices encourage the sponsor to produce more natural gas. And the more gas that CONE processes, the more revenue it collects. Due to the decline in natural gas (and oil) prices, CONE’s sponsors have been forced to cut costs and dramatically improve their operating efficiencies. As a result, they have developed very high operating leverage. This means that it would only take a small rise in natural gas prices for CONSOL and Noble’s profits to rise significantly by producing more gas. Moreover, the chance of an increase in demand for cleaner-burning natural gas is higher than that for oil, in our view. Higher demand for natural gas usually means a rise in natural gas prices, translating into better profits for the sponsors and subsequently higher negotiated long-term fees (revenues) to CONE, which would presumably lead to a higher stock price. Even if natural gas prices remain where they are, or even decline, CONE would still receive the guaranteed rates it negotiated with its sponsors (though production could slow). As such, the dividend yield on CONE units should remain strong. The recent yield was above 5%. 

Although CONE’s sponsors currently account for all its revenues, it can seek to supplement its profitability and growth potential by performing services for unrelated third parties in the future, potentially enhancing its earnings and dividend payout.

Strong Operating Fundamentals
Since the company went public in 2014, annual revenues have risen from $130 million in that year to $239 million in 2016. They will likely reach $265 million this year. Over the same three years, share net has risen from $0.26 to $1.58. Earnings will likely reach $1.80 this year and $2.00 in 2018. Meantime, the annual dividend per share has increased from zero in 2014 to $1.00 in 2016; the payout is on track to reach $1.16 in 2017. As of March 31st, the long-term debt-to-total capital ratio stood at 31%.

CONE stock performed very well in 2016, rising from a low of $7.55 per share in February to a high of $24.20 in December. After climbing a bit more in early 2017, the price got somewhat extended and subsequently pulled back. As a result, we think the recent quotation provides potential investors with a good entry point to participate in what we expect will be favorable future capital gains. Moreover, the attractive dividend yield is a big supplement to any potential capital gains and greatly enhances the issue’s total return potential. The fact that CONE receives a guaranteed rate from its sponsors, and that it has the ability to acquire further business from third parties, provides investors with a level of comfort. That said, this entity’s fortunes ultimately depend on the price of natural gas (as well as oil, to a minor extent). Although we don’t expect the price of these commodities to fall drastically for any extended period of time, their upward potential isn’t well defined.


At the time of the above article’s writing, the author did not have positions in any of the companies mentioned.


Long-Term Investment

Vuzix Corporation (VUZI)

By Kevin Downing, Editorial Analyst

Vuzix Corporation (VUZI) designs, manufactures, and markets “wearable display devices” (also known as smart glasses) for consumers and enterprises worldwide. These devices are worn like eyeglasses and feature built-in video screens that allow users to view and interact with video and digital content (movies, video games, computer data, the Internet, etc.). In fact, the company’s products offer much of the same functionality as smartphones, but are wearable and can “augment reality” by superimposing virtual 3D objects and information onto peoples’ real-world views. Vuzix’s devices include cameras, sensors, and computer chips to enable interaction with the aforementioned digital content. Its smart glasses connect to the Internet via Wi-Fi or through a smartphone with Bluetooth. They can also work offline with custom software or third-party applications that don’t need access to the Internet.

The technology is still in its infancy, which helps explain Vuzix’s small market capitalization and a consensus Wall Street revenue estimate of only $9 million this year. However, the average revenue estimate for 2018 suggests 200% year-over-year growth, as manufacturing capabilities and volumes are expected to rise substantially in the second half of 2018. Moreover, the 19.7% ownership stake taken by tech giant Intel (INTC) is a confidence-builder. Recent usability and functionality breakthroughs achieved by the company’s current generation of products, coupled with an increasingly favorable positioning within the competitive landscape, have increased our confidence that long-awaited revenue growth will commence within 12 months. Too, we believe that VUZI’s devices are sufficiently differentiated from Google’s failed Google Glass product, and think the company’s efforts to target the enterprise market will help it succeed.

The market Vuzix operates in could potentially grow to be quite large. ABI Research expects augmented reality (AR) and virtual reality (VR) device sales to reach upwards of $120 billion by 2020, with the majority coming from the AR side. To put this in perspective, revenue from Samsung and Apple mobile devices reached $240 billion in 2016. Moreover, fellow researcher IDC has forecast $49 billion in AR headset sales by 2021, which would be around ten times current levels. That outfit cites falling prices and the ability of devices to work without connecting to a PC or mobile device as drivers, both of which are functions that VUZI already offers. IDC also expects the AR/VR market to have a 40% consumer/60% enterprise customer mix, versus around an 80% consumer/20% enterprise split now.

We believe rising demand for smart glasses in the enterprise space will be the primary driver of near and long-term revenue growth for this company. The M300 product addresses this customer group and looks promising because of its sturdy form and efficiency-improving functionality. The company says that Fortune 500 customers are reporting 32%-33% productivity improvements owing to the headset (when combined with value-added software from third parties and resellers). A lot of that likely stems from improvements in the speed and quality of training processes. The technology allows workers to learn by following virtual graphics that depict step-by-step instructions for things like complex machine assembly and heavy vehicle maintenance. Too, video and audio systems inside an employee’s headset can give supervisors access to their viewpoint, and ultimately help provide instruction to quickly fix problems. This limits machine downtime and helps save money.

Meanwhile, the “intelligent wayfinding” and light guiding technology appears capable of nearly eliminating human error in the warehousing industry. This involves workers with headsets being guided directly to the location of specific parts and items, which are then highlighted. Vuzix’s enterprise solutions also appear well suited for operators of construction equipment, package delivery companies, food inspection, and healthcare organizations, to name a few. The company has several leading enterprise customers already using its technology, such as John Deere, Amazon, Pfizer, Dell, etc. In February, VUZI signed an agreement to build a customized line of smart glasses for Toshiba.

Part of the reason Vuzix has received a lot of attention in the enterprise space of late is the rugged, ergonomic design of its offerings. Management recently called Microsoft’s competing HoloLens “a tremendous and powerful product,” but criticized its wearability, saying its weight and design would reduce performance and cause people to take them off. The $3,500 price tag for the Microsoft device is also significantly more expensive than VUZI’s M300 offering at $1,499. The company will also have to compete with products from ODG with its R9 and a much-hyped (but frequently delayed) product from Magic Leap. In general, Vuzix appears more focused than some of its competitors on offering good value instead of a somewhat more immersive experience at a higher price point, which should play well to potential enterprise customers.

Vuzix’s consumer product, the Blade 3000, is arguably the most esthetically pleasing pair of smart glasses on the market today, as they are nearly undistinguishable from a normal pair of sunglasses. This contrasts with Google’s Glass device, which failed after receiving a lot of criticism for looking awkward and unfashionable. Before becoming more optimistic about the consumer business, we would like to see Vuzix’s price points come down further, an even more discreet/conventional form factor, some co-branding, and an expanded AR application ecosystem. However, we think the advancements of the Blade 3000 make widespread adoption a more realistic goal for the company. The device is expected to be released in late 2017/early 2018, and may well be at a sub-$1000 price point by this time next year.


The uses for Vuzix’s enterprise products should prove to be compelling for participants in a variety of industries. The company’s technology allows customers to save time, enhance workers’ performance, and improve regulatory compliance. We think VUZI’s solutions are well positioned to capture a respectable share of this budding enterprise market. Still, the relatively small size of the company and its revenue base make near-term results vulnerable to inconsistencies (second-quarter earnings are due in mid-August). We think it will likely take further development and time to appeal to the mass consumer market, but we are optimistic about the underlying demand trends there. Moreover, the fact that chipmaker Intel backs Vuzix (it owns a 20% stake) should help it compete against its larger rivals. Although the young, unproven nature of these products likely won’t appeal to more-conservative investors, patient accounts with a long-term focus may find these small-cap shares worthy of further consideration.


At the time of the above article’s writing, the author did not have positions in any of the companies mentioned.



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