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Wednesday, December 8, 2010

Pershing Square Presentation

Attached please find a recent presentation from Pershing Square. It is interesting although there are no real gems here. That being said for those who haven't realized that now (a time when mortgages are incredibly cheap) should consider levering up to purchase a house - it may be of use.


Pershing Square_How to Make a Fortune_12!6!10

Latest from Hugh Hendry

Attached please find the latest from Hugh Hendry. It is fairly interesting and quite colorful. Enjoy.

Ecclectica Fund - 12-1-10

Thursday, November 4, 2010

EDCI and the tale of approx $100 free.

his is an idea for a personal account only with a very short time frame. The ticker is EDCI.

Basically the trade has to be made today. The company is doing a go private and they are conducting a 1,400 to 1 reverse split then another forward split. The goal of this is to shake out all holders with less than 1,400 shares bringing their total number of shareholders below 300 which relieves them of reporting status. They will be purchasing all shares from holders with less than 1,400 shares for $3.44 vs. a current price of $3.35. This 2.7% spread is pretty paltry, but when annualized with the estimated 1 month it will take to receive the cash it’s a not too shabby IRR of 38%.

Basically per trade it’s around $100 free money (net of trading fees).

EDCI Holdings, Inc. (“EDCI”), the majority shareholder of Entertainment Distribution Company, LLC (“EDC”), a European provider of supply chain services to the optical disc market, is a company engaged in a final Plan of Complete Liquidation and Dissolution. EDCI provides supply chain services to the world’s best-known music, movies and gaming companies. EDC’s mandate is to be the pre-eminent independent and autonomous supply chain service provider to the entertainment industry and the retailers who deal directly with consumers.

The Plan of Dissolution was approved by EDCI’s shareholders at a Special Meeting held on January 7, 2010. Accordingly, EDCI commenced the voluntary dissolution, liquidation and winding up of the Company in accordance with Delaware law. On November 3rd the Company announced that, based on current voting results indicating more than a majority of EDCI’s outstanding stock had been voted in favor of the Split Transaction, it had filed a Form 25, Notification of Removal from Listing and/or Registration under Section 12(b) of the Securities Exchange Act (the “Exchange Act”), with the SEC and NASDAQ. EDCI expects its common stock will be quoted in the over-the-counter market on the Pink Sheets beginning November 4, 2010. On or about the effective date of the NASDAQ delisting, which is expect to be November 13, 2010, the Company intends to file a Form 15, Notice of Termination of Registration or Suspension of Duty to File, with the SEC to terminate its reporting obligations under the Exchange Act.

So basically you have a quick time to be a shareholder of record as of November 13 then you get the quick proceeds.

Monday, November 1, 2010

Greenlight Capital Q3 2010 Letter

See the latest and greatest from David Einhorn. Enjoy. Unfortunately I can not embed it here so I to view the letter please follow the link.


Monday, October 25, 2010

Graham & Doddsville Fall 2010

The latest from the fine students at Columbia. For those of you who don't read this I recommend starting. They do a good job of getting good interviews and the ideas that come out (2 per issue) are decent enough. Another good resource that a prudent investor would be foolish to not take advantage of.


Graham & Doddsville Fall 2010

Friday, October 8, 2010

Liberty Acquisition Warrants

This situation has three components to it:

1) Grupo Prisa (PRS.MC), which closed (10/7) at 1.68 euros, or $2.335 (at EUR to USD of 1.39:1)
2) Liberty warrants (LIAWS), $1.63
3) Liberty stock (LIA), $10.29

First some background:

Grupo Prisa was founded in 1972, as the editorial company of daily newspaper El País. Prisa's activities are classified under generalist press (El País), specialized press, radio (11%), educational publishing (17%), and television (18% Telecinco and 56% Digital+). Post recent transactions to reduce the group's debt pile, we think the group's most important assets are its holding in Digital+ and then Santillana, its educational publishing business. As such, it is less of an advertising play than historically.

Liberty Acquisition Holdings Corp. is a publicly traded company formed for the purpose of effecting a business combination with one or more operating businesses. Liberty completed its initial public offering of 103,500,000 units at $10.00 per unit in December 2007. Each unit was comprised of one share of common stock and one half (1/2) of one warrant to purchase a share of its common stock.

Prisa initially announced in March 2010 that they had reached an agreement with Liberty Acquisition Holdings in which Prisa would buy 100% of Liberty through an exchange of shares Prisa shares valued for a total consideration of €660m - implying that Liberty obtained a >50% stake in Prisa and the Prisa controlling shareholders would have been diluted to c30% (but according to the agreement would not lose control). Since then the deal has been amended twice. Below is the most recent iteration:

Prisa’s syndicate of banks had agreed to extend its current bridge loan (€1.9bn) to May 2013 if certain conditions were met; of which the most important, in our view, was a capital injection of at least €450m. The Liberty transaction assures a US$870m injection (€680m). Prisa announced on August 4, 2010 a revised structure to the Liberty deal
(initially announced in May 2010) that practically assures that the deal is approved.
In summary, in exchange for the US$870m cash, Prisa shall:
1) LIA shares: Issue 1.5 ordinary shares; 3.0 non-voting convertible shares (NVCS) and $0.50 cash for each LIBERTY share.
— For the NVCS, there is mandatory conversion in 3.5 years (Each NVCS converts to 1.33 shares of common stock for common prices below €1.50, 1.0 share for stock prices above €2.00, and a conversion ratio of [2.33 – (2 * Stock Price)/3)] for stock prices in between €1.50 and €2.00); they receive €0.175 minimum dividend per annum
2) LIA warrants: Issue 0.45 ordinary shares and $0.90 cash for each LIBERTY warrant

I am advocating a purchase of the warrant. Based on Prisa’s 10/8 close and the EUR/USD conversion rate at that time each LIA warrant receives:

$0.90 + (0.45 x (€1.68 x 1.39 (conversion rate))) = $1.95 vs. a current share price of $1.63. The current spread implies a profit of 20% - this can be increased should the underlying security (Prisa) move up in value.

The main risk to the warrants is if the deal falls through. The risk of the deal falling through is limited, as Prisa has secured US$500m interest and the deal terms are attractive to Liberty shareholders. In order for the deal to be approved, at least 70% of Liberty shareholders (excluding Sponsors) need to give their approval. With the secured US$500m only another 20% of shareholders need to give their consent.
The approval of the deal should enable Prisa to refinance its Balance Sheet and management (with the help of the Liberty management) to focus on its operating
business. Additionally free-float and disclosure should also increase – this last point is key as Prisa has been mired by a single dominant family owner who many believed was more interested in empire building than in maximizing shareholder value.

While the transaction does reduce the level of debt (through asset sales which are contingent upon the merger plus the large cash influx from LIA) the pro-forma entity will remain highly levered. A slide presentation has been provided that estimates net debt declines from €4.75 billion to €3.25 billion, equivalent to 5.2 times TTM EBITDA.
It can be seen here:

It also gives a good overview and a recommend reading it.

On a total enterprise value basis it will trade around 7x EV/EBITDA not a screaming buy but fairly valued and its leaves room for upside as operational efficiencies and deleveraging occurs.

Overall you have a chance to lock in a good return – you could hedge if you wanted but I think Prisa’s stock is interesting enough that I would rather have the beta risk. I was going to expound more on this here but its late – just know that Prisa is a force to be reckoned with on the Spanish-language media scene. The conglomerate operates in newspaper and book publishing, radio broadcasting, and pay TV services in Spain and Latin America. They will benefit as ad rates and consumption returns to normal in Europe.

Complete Notes from Ira Sohn Research Conference West

Thanks to BTIG please find the complete notes to the Ira Sohn Research Conference West. Nothing earth shattering but some interesting ideas nonetheless.


John H. Burbank III, Passport Capital.
Burbank’s presentation was titled the “Math of Democracy.” Burbank noted the progressive blow-ups in the U.S. economy over the past decade. First, equities, then credit and potentially today politically. As a result of the increasing sovereign risk of the United States, Burbank believes that from an investment perspective the U.S. should be viewed as an Emerging Market. In the current environment Washington D.C. has become a key area of his research focus, with frequent visits to stay on top of developments. For Burbank, who describes himself as apolitical, this has been a notable transition. He warns that we are caught investing in 2 year political cycles, very similar to the way one would study the political cycle and sovereign risk of an Emerging Market. Burbank noted that market prices do not tell you as much as investors believe them to, instead prices generally reflect the aspect and conditions of liquidity.

Burbank noted that in 2025 entitlements and spending in the U.S. budget are predicted to surpass revenues. He then asserted the market will not let it get to that point and the markets will react sooner, potentially in the next two years to prevent that occurrence. He then explained there are 6x as many lawyers in the House of Representatives than there are MBA’s and in the Senate there are 8x as many lawyers as MBA’s. His description was it appears Congress is filled with many arguers and policy people and not too many business people.

Burbank advised that there is hope that the composure Washington D.C. can change, additionally there is also the potential for it to change quickly. He noted the public should be looking for good candidates with traits like business experience, financial acumen and courage. Burbank then described the $115,000 investment. He explained that $115,000 is the largest amount of political donations that an individual can make for an election cycle. Of that $42,700 can go directly to candidates. Burbank then broke down the spending for the last congressional election. There was $1.238 Billion spent, which if divided by the maximum $42,700 a person can spend, then 28,994 people could have funded the entire election if all gave the maximum contribution. Burbank stated this potential for small numbers of people to exert influence in past elections made him hopeful that as more Americans became disappointed, they will become more active participants in the political process thus shifting the direction of the country.

After November’s election, he expects gridlock in Washington. Burbank expects gridlock to be a positive in the short term. Although current problems won’t be fixed, new problems won’t be created. Uncertainty should come down as should volatility, both move should be beneficial to markets.

As far as the future is concerned, Burbank believes the U.S. is at an inflection point where we must choose to head in the direction of either Argentina or Germany. The developed world must now be broken down into two categories: the Solvent and the Indebted. The solvent consist of New Zealand, Canada, Australia, Switzerland, Singapore and Hong Kong (NEW CASSH). Then there is “Big Debt” consisting of the U.S., Japan, U.K., Italy, France and Spain. There has been a decade long uptrend of the performance of being long New Cassh currencies versus being short Big Debt currencies. There was a correction in the ascension during a flight to quality bid during the crisis. The uptrend has since resumed hitting new highs and Burbank expects the trend to last another decade.

Barry Rosenstein, JANA Partners.
Rosenstein discussed the improving environment for activist investors in today’s market. Activist investing is meant to create a referendum on the best ideas for value creation. The opportunity set for activism is better than it has been for a long time. Today, boards of directors look for common ground. Staggered boards and shareholder rights plans have been a decade long downtrend. In the past credible industry operators would not work with activists, this has changed. The legal environment continues to push further in the direction of shareholder rights. Corporate cash is at record levels and corporate valuations are very attractive. Private equity has $500 Billion on the sidelines, $250 Billion of which needs to be used in the next 5 years or it must be returned.

Rosenstein likes the Netherlands based global transport company TNT (TNT NA). The company has a €7.5 Billion market capitalization and trades 6x EBITDA and 11x earnings. The company has an 18% market share in Europe. €1 Billion of revenues comes from rapidly growing businesses. The company’s Express business is highly strategic. It would be attractive to FedEx, because FedEx only has a 2% market share in Europe. It would also be attractive to UPS to prevent FedEx from acquiring it. It trades with a conglomerate discount, during the past 3 years it traded at an average of 10x earnings, a significant discount to its competitors. He expects the company to break up in the next 6-9 months, but even as a stand alone, he thinks it will go to €27 from today’s price of €20.

Rosenstein also likes Charles River Labs (CRL). The company has a $2.3 Billion enterprise value and trades 10.8x after tax earnings. The company consistently has 30%+ margins and the revenue base is sticky. In 2008 preclinical spending in the pharma industry dropped and big pharma mergers hurt business. The company raised prices in 2009 and still gained market share. The company has a $500 million buyback program. Rosenstein says it is trading at a trough valuation on trough earnings. His price target is $46 versus the current price of $32. He also believes it has a breakup value above $50.

Brian Zied, Charter Bridge Capital Management.
Zied likes Sirius XM Radio (SIRI). Sirius and XMSR merged in 2008 and have 130 channels. The company has just under 20 million subscribers, 7 million retail subscribers and 12-13 million automotive. 60% of new cars sold today have built in satellite radios. 46% of those convert to become paid subscribers. The company has a low churn. It was only 1.8% last quarter. Zied analogizes the industry to the early stages of pay television rollout, now there are 100 million pay TV households in this country. There are 240 million cars on the road today and only 12-13 million have satellite radios. Depending upon the SAAR you use (current is 11.73 million) then 6-9 million cars are hitting the road every year with a factory installed radio. Auto sales rebounding will also help. Subscriber conversion and customer acquisition rates are improving.

Major capital expenditures are complete, thus most costs are fixed. For every incremental revenue dollar, sixty cents goes to the bottom line. Zied uses a conservative 10% subscriber growth, which he gets by multiplying the car conversion rates by SAAR and then accounting for the churn rate. SIRI is a $7.5 billion company with minimal sponsorship. John Malone is a significant shareholder. Today, fixed costs as a percentage of sales is 45%, in 2015 Zied believes it will be 30%. The company has $8 billion of net operating losses. The Net Present Value of them is $2 Billion. If Malone’s Liberty were to acquire SIRE, the NPV on the NOLs would be $3 Billion to them.
The company is levered, but Zied expects them to pay off debt sooner rather than later. There are also no major maturities until 2013. Although the company looks expensive on an EBITDA basis (10x), that is not the proper way to evaluate the company because the company does not have to pay taxes. Instead, it should be measured by the 14% free cash flow yield.

Mitch Julis, Canyon Partners.
Julis believes focusing upon the balance sheet evolution of a company is important. As balance sheet changes occur, they change the range of opportunities ahead for a company. Canyon practices value investing from a total return perspective as opposed to margin of safety. He noted equilibrium is the exception not the rule. Julis believes investments need both staying power and earnings power in order to build real wealth over time. When making investments, it is important to avoid focusing on the label of an instrument and instead focus on the underlying characteristics. You have to examine the bundles of rights in their entirety. Julis talked about the transition from Leveraged Buyout to Leveraged Die-out of Tribune company. Although he did not recommend them as an investment, Julis discussed the scenarios where the bond holders and term loan holders could see different levels of recoveries.

Jeffrey W. Ubben, ValueAct Capital.
ValuAct builds relationships with the companies it invests in, it is often invited to join the Board. They focus on the quality of the business. Ubben believes industry structure is important, in a 3 player industry there is often room for the number 2 or 3 player to make advances with the right changes. He looks for traits such as an oligopolistic industry and intellectual property, among other things. Industrires in transition often create opportunities when an industry matures. Often the business model is still in the growth phase mismatched with the environment, thus hurting share price and creating the opportunity for correcting course. An industry in transition today is Pharma. ValuAct saw its opportunity in Valiant Pharmaceuticals and acquired 20% of the company. Just last month, the company closed a deal with Biovail. Biovail became the acquirer because it allows the company to adopt Biovail’s tax regime. Valiant (VRX CN, VRX) was a turnaround story for ValueAct. ValuAct saw revenue diversity and customer opportunities in Valiant. They then hired Mike Pearson as CEO and the business model was transformed from focusing less on R&D and more on partnering with other drug developers and focusing on branded generics. The company dropped CapEx to $15 million per year and delivered $2.50 per share in Free Cash Flow. The impetus for the Biovail deal was that Biovail offered the same opportunity to restructure the business model in the same fashion and replicate the current success.

Robert M. Rosner, Buena Vista Fund Management.
Buena Vista focuses on Non-Japan Asia. Rosner likes Taiwan Semiconductor (2330 TT, TSM) the world’s largest foundry. The company has a $50 billion market cap and $11 Billion in revenues. He calls it a $50 Billion investment orphan. The company has been profitable every year since it came public in 1994. It has a 5% Free Cash Flow Yield. TSMC’s cash and equivalents more than double its total liabilities. Rosner explained how the CapEx in the Semi industry has transitioned from the pre-bubble to the post-bubble environment, form out of control to consistent and responsible. Rosner also pointed out the high level of asset turns and their importance. As long as the dominant player does not overcharge for their services, new competition has trouble entering the market because they cannot get up to scale quickly enough to survive. TSMC has 70% market share in advanced semi R&D giving it a strong competitive advantage.
John B. Taylor, Stanford University (The Taylor Rule).
Taylor talked about lessons learned from the financial crisis: what were the causes, why is it prolonged, why did it worsen and why is the recovery so slow. The common denominator in all aspects was government interference. During the Great Moderation, the Fed followed a rules based approach (Taylor Rule). In 2003-2005, the Fed abandoned this approach and created monetary excesses via an artificially low Fed Funds rate. The Great Deviation was taking the path that deviated from the rules based approach. He also notes that the stimulus did little good, having little to no effect on consumer spending. He concluded by highlighting what occurred in 3 month Libor-OIS in the pre-panic, panic and post panic phases of the crisis. He noted that the Libor- OIS spread only peaked when the public finally heard what the actual TARP policy was going to be - capital infusions for the banks. The policy confusion about the program before that created additional fear in the market place. Taylor believes we need to return to rules based policy and keep taxes low.

Christopher Chabris, Co-author The Invisible Gorilla.
Chabris is a cognitive psychologist and focuses on how humans have illusions about their own abilities and we often don’t recognize our lack of self awareness. He discussed inattentional blindness or the illusion of attention. He also discussed change blindness. Essentially, we can miss very important changes within mundane tasks. He also discussed the illusion of memory, in that we are often very imprecise in how we remember certain things. Chabris explained the illusion of confidence, where those who are unskilled are unaware of it and believe themselves to be much better at a task than they are. Similarly, those who are very skilled tend to believe they are better at a task than they are, but only by a very small margin.

Richard Farber, Kayne Anderson.
Farber started by discussing America’s key strengths: a powerful military, the higher education system, the patent system and Coal. Of the nearly $1 Trillion in coal reserves in the world, the U.S. has $260 Billion. That is 25%-30%, that compares to China’s 12% and Australia’s 8%. 6.5 billion tons of coal will be produced this year, half of it will be in China. The U.S. produces 3.8 tons of coal per person per year. 45%-50% of the electricity generated in the U.S. comes from coal. There are 250 years of recoverable coal reserves in the world as compared to 65 years of NatGas and 45 years of Oil. There are 3.6 billion people in the world who have no access to electricity. Farber likes the different aspects of the capital structure of Patriot Coal (PCX). It has a $1.3 billion enterprise value, $450 million in debt and $250 million in cash. The company has 1.8 billion tons of proven reserves and will extract 30-31 million tons this year. There is an 8.25% senior note maturing in 2018 that is attractive for fixed income investors. There is a 3.25% busted convert trading at a 7.5% yield to maturity. Farber believes the company will do $350-$450 million in EBITDA in 2012. Putting a modest 5x multiple on where he expects EBITDA to be, he believe the stock could double in the next 2-3 years.

Arthur Patterson, Accel Partners.
Patterson noted that IPO cycles traditionally peak every 15 years, 1969, 1983, 1999, 2014? From 1995 through 2000 there were 3000 ipos. Over the past 3 years there have been less than 150. There are still positive technological advances being driven by Moore’s law, decreasing storage costs, mobile broadband and other technologies. There has probably been a 10 fold productivity increase in the past 10 years. Due to the hostile public environment there is a pent up ipo supply. Convergent synergistic technologies continue to fuel one another. End markets continue to expand as they have done historically. Many companies are poised for growth in the current cycle. He does expect the current cycle to be milder than recent cycles. Patterson advocates IT businesses as investments because they are less capital intensive. Health Care and Cleantech have interesting opportunities, but are subject to additional regulations and can be capital intensive.

Kathryn A. Hall, Hall Capital Partners.
Hall builds global multi-asset class portfolios for families, endowments and private pensions. Her firm has $19 Billion in assets under managements. Themes dominating the tape today are macro uncertainties, government responses, high risk premiums and a burgeoning bond bubble as investors seek safety. Too often investors mistake price volatility with economic volatility. Additionally, quant trading is adding to the price volatility.

Hall believes in what she calls “First Principles” of investing. True diversification is important, that includes diversifying economic drivers and duration. An investors liquidity pool should be sized appropriately and everyone’s proper size is different. Investors should seek to take advantage of other peoples prejudices and pain. Be willing to seize an opportunity in markets where others are unwilling due to a complexity or lack of liquidity. She advocates looking for global exposure, particularly for equities. She also notes investors should not ignore inflation risk.

Thomas A. Russo, Gardner Russo & Gardner.
Russo talked about the ability to “do nothing well” and the “ability to suffer.” He described looking for companies that throw off bond like cash flow like a bond, but has the ability to reinvest it to grow their business (doing nothing well). He recalled some important wisdom Warren Buffett imparted when Russo was in business school.
“You only get 20 or so good investments in life so select them well.”
“Government is your partner in every investment (because you pay taxes), so take advantage of tax deferments.”
“Reduce agency costs (make sure the correct corporate culture).

When Russo explained the capacity to suffer, he talks about the ability to endure pain and setbacks for the purposes of investing in the future. Not only the ability to do it as an investor, but to also to find companies that were willing to endure the pain of upfront investment for the long term gain. He does not like companies that manage for the short term. When companies take the opportunity to invest for the long term and it hurts the share price, it provides the opportunity for the investor to buy at good prices. Most companies have trouble taking the short term suffering because management then faces control risk. He noticed that family owned companies often have a better capacity to withstand this control risk. The companies that he own that pursue this corporate culture are Nestle, Pernod-Ricard and SAB Miller. Nestle took the opportunity of the Russian debt crisis to invest in the country as others pulled out. SAB Miller has huge opportunities in Sub Saharan Africa (where GDP grows 10% per year) where the majority of beer is locally brewed and has a 40% market share in India. Pernod-Ricard took advantage of the largest international spirits distributer leaving China in 2000, to invest and lose in the short term for the long term gain. Now it is the number one international spirits company in China and it only has a fraction of the overall spirits market.

Friday, August 27, 2010

Owl Creek Q2 2010 Letter

In a similar light to my past post, I came across another quarterly letter that I thought was worth reading. Owl Creek is a macro hedge fund and they do a good job of explaining their thinking. Enjoy.

Owl Creek - 8-17-10

Pershing Square Q2 2010 Letter

Here is Pershing Square's Q2 2010 letter. In it, among other things, they discuss their position in BP CDS (basically a bet the company will have hard times ahead). I felt this would be good for readers to see the counter point to my original BP trade posted a while back. Enjoy.

Pershing Square - 8-26-10

Tuesday, August 24, 2010


With all the chatter about the upcoming GM IPO. I thought now would be a good time to post up a recent idea I read on investing in GM Bonds. It does a good job of walking through the framework of how to evaluate distressed debt and shows how powerful catalyst investing can be. Enjoy:

The distressed market is often inefficient due to the complicated nature of the product, lack of information and illiquid trading. In some cases, this allows for significant arbitrage, and an investment in the bonds of Motors Liquidation Company (“MLC”), the former General Motors, allows for just such an opportunity. Understanding a couple of key distressed concepts – namely accrued interest and how foreign currency is treated in bankruptcy – reveals that one can generate a gross return of 11% (less borrowing cost) and an IRR of over 20% based on current market levels by establishing a long / short position in the bonds of MLC. Specifically, we advocate a long position in the Euro Notes and a short position in the Dollar Notes at a ratio of 1.000:1.123 in terms of capital invested, which results in a neutral position on a claim basis, and given that both the long and short sides of the trade involve the same claim in bankruptcy, we believe this return involves no real fundamental risk.

Situation Overview:
The former General Motors filed for bankruptcy in June 2009. The governments of the United States and Canada sponsored an asset sale of the company in bankruptcy under Section 363 of the bankruptcy code by capitalizing a new company to purchase most of the assets. This “new” General Motors is currently private, with the equity owned by the US and Canadian governments, an employee benefit trust and MLC. When the 363 sale was completed, the “old” General Motors was renamed Motors Liquidation Company and is being wound down over time as part of the bankruptcy estate. The unsecured claims at MLC are set to receive common stock and warrants of the new General Motors, and it is this value of new GM equity that comprises the vast majority of MLC’s value and will determine the price of the bonds.

Bond Valuation and Trade Details:
The proposed trade requires the purchase of Euro Notes (offered at 34.50%) and the short sale of Dollar Notes (bid at 31.50%). Despite the optically higher price of the Euro Notes, they are cheaper than the Dollar Notes by 11% on a claim basis. The reason for this is two-fold:
• The pre-petition accrued interest, which is part of the bankruptcy claim, is much higher in the Euro Note than in the Dollar Note. Since these bonds trade flat (i.e. without accrued interest), the buyer does not pay for accrued interest as with a current-pay bond, but bond prices should generally reflect this. In this case, part of the arbitrage is that the difference in accrued interest is not fully accounted for in the prices of these bonds. Euro-denominated bonds generally pay interest annually, as opposed to the domestic market, where the convention is to pay interest semi-annually, as is the case with each of these bonds. The last interest payment made on the Euro Note was on July 5, 2008, and there are ~7.58 points of pre-petition accrued interest in that note (8.375% coupon * 326 days from last payment to bankruptcy filing / 360 days used for bond year). However, since the Dollar Note last paid interest on January 15, 2009, the pre-petition accrued interest is only ~3.16 points (8.375% coupon * 136 days from last payment to bankruptcy filing / 360 days used for bond year).
• A weaker Euro has benefited the Euro Notes since a claim denominated in foreign currency is fixed at $1.4159 / Euro (exchange rate as of the date of filing, pursuant to section 502(b) of the U.S. Bankruptcy Code) but the notes are bought at the current exchange rate ($1.2000 / Euro).

Each Euro Note (face value of €1,000) is bought for $414 (€1,000 face value * 34.50% price * 1.200 current USD / EUR exchange rate), and what is purchased is a claim of $1,523 (€1,000 face value * 1.0758 to account for pre-petition accrued interest * 1.4159 USD / EUR exchange rate at time of filing). Therefore, the claim-adjusted price is 27.2% via purchase of the Euro Note.

Each Dollar Note (face value of $1,000) is bought for $315 ($1,000 face value * 31.50% price), and what is purchased is a claim of $1,032 ($1,000 face value * 1.0316 to account for pre-petition accrued interest). Therefore, the claim-adjusted price is 30.5% via purchase of the Dollar Note.

By investing the amount of dollars required to be neutral on a claim basis (a capital invested ratio of short $1.123 in Dollar Notes for each $1.000 purchased of Euro Notes), one will collect the difference in spread when the bonds are cancelled and new securities are issued. As an example, in conducting a short sale of $1,000 worth of claim via the Dollar Note, $305 in proceeds would be collected ($1000 * 30.5% claim-adjusted price). In order to satisfy the $1,000 of claim being borrowed, an investment in the Euro Notes of $272 ($1000 * 27.2% claim-adjusted price) is required. The difference of $33 would then be left over once the borrowed position on the Dollar Notes is covered using the claim proceeds from the Euro Notes.


While we do not believe there is fundamental risk associated with this position, there are several risks to be aware of:

• Availability of borrow on the Dollar Notes
o There is currently ample borrow on the Dollar Notes – it is a $3 billion issue and generally the most liquid of the MLC bonds that trade. However, there is always the risk that the borrow might become unavailable in the future, and a short position may be called. If this occurs, and the other side of the trade (long Euro Notes) needs to be closed, it may be at an unattractive level. The borrow rate on the bonds is currently 2% per annum (or 1% over our estimated holding period).
• Timing and form of securities
o There is no definitive end date for the trade, as it requires a distribution of value based on claims in order to close. This will occur when the equity of new GM is distributed from MLC to the bondholders and other unsecured claimants. Press reports indicate that new GM will likely try and file for an IPO in early Q4 2010, although there may not be a full distribution at that time as MLC may hold back some value until it is wound down. We assume a scenario where 70-80% of the stock is distributed immediately, with the remaining stock to be distributed at a later date. There is a chance that the bonds could remain outstanding after this distribution, and so the trade may not fully close, but MLC is incentivized to wind down and claimants could instead receive new equity in a liquidating trust. This has been done in previous bankruptcies and could collapse the proposed trade even without a full distribution of new GM shares. We believe a full collapse of the trade before year-end is the most likely outcome.
• Mark to market risk on Euro Notes
o Holding the trade to completion should not result in any foreign currency issues, but in the interim there is risk that the price of the Euro Notes does not reflect the change in the value of the Euro (which has been very volatile and may continue to be so). This may result in some interim mark-to-market fluctuations, but should not be material over time.

Alternative Trade:
Depending on the viewpoint one has on new GM stock, the trade can be set up in a different ratio to create “free” shares in the new GM when the long and short ends of the trade collapse and new securities are issued. This can be accomplished by investing the same amount of dollars on each side of the trade (a capital invested ratio of short $1.000 in Dollar Notes for each $1.000 purchased of Euro Notes). As an example, investing $1,000 in Euro Notes buys $3,679 of claim value ($1,000 invested / 27.2% claim-adjusted price), while shorting $1,000 in Dollar Notes results in being short $3,275 of claim value ($1,000 invested / 30.50% claim-adjusted price). The difference, $404, is what would be kept in claim value once the trade closes and the GM stock is received, and at a market price of 27% (based on the price paid for the claim), is worth $110 against $1,000 invested in the long position.

While we believe that we are creating GM equity cheaply based on current bond prices, as we believe there is 50% upside from current levels, we acknowledge that the investment is speculative and may not be for everyone. The trade also requires significant capital to be put to work on a gross basis. However, investing in the equity theoretically removes the timing risk involved in the trade – to the extent that the trade takes longer than expected, the company should continue to accrue equity value as the operations are improving at a very fast rate. This is offset by the fundamental risks associated with owning the equity, rather than receiving cash. We have included a very brief valuation discussion on the new GM for those interested.

New GM Valuation:
The main source of value at GM is its auto manufacturing operations. With a streamlined focus on four brands (Buick, Cadillac, Chevrolet and GMC), an improved cost structure and positive outlook on vehicle sales, we estimate GM will generate $13 billion of EBITDA in 2011. We gain comfort in this estimate not only from our top-down model but also based on projections from GM’s financial advisor and recent performance. In May 2009, Evercore estimated that GM would be able to achieve $13 billion in EBITDA in 2012, but since that time, results have been much stronger than anticipated, so we do not consider achieving those results a year ahead of schedule to be significantly optimistic (disclosure statement projections, especially recently, have also historically proven to be conservative). Moreover, GM generated $3 billion of EBITDA in Q1 2010, so on a run-rate basis is already tracking close to our 2011 estimate a year ahead of schedule, and this was achieved with European operations being a drag on earnings.

We value GM on a sum-of-parts basis and use the valuation of Ford as a blueprint. While Ford is a better-run company with a stronger lineup over the next few years, we believe that GM has significant cost-cutting opportunities (particularly in Europe) and top-line projections also have more upside, so a similar multiple to Ford on our projections is warranted. Additionally, there will be some technical support for GM shares upon issuance, as it will likely be added to major indices.

• GM’s core OEM operations are worth $65 billion, based on a 5x multiple on 2011 EBITDA. This multiple is in line with Ford, after adjusting for that company’s non-core assets in a similar sum-of-parts methodology (Toyota also trades at a similar multiple based on consensus estimates).
• JV interests in Asian operations generated over $500 mm in net income in the second half of 2009 and over $400 mm in Q1 2010 – these results are not consolidated in GM’s income statement and so are not included in its reported EBITDA. Assuming that on a full-year basis these operations can contribute $1.6 billion in net income (based on Q1 2010 run-rate) and applying a 12.5x P/E multiple indicates $20 billion of value
• GM owns an equity stake in Delphi. While information on Delphi’s performance is private, we know that GM invested $2.8 billion in cash in November 2009 to purchase Delphi equity, and value the stake at the purchase price.
• GM also has a stake in both the common and preferred equity of Ally Financial (formerly GMAC). As of March 31, 2010, GM estimated the fair value of the common stock to be $1.093 billion and the preferred to be $1.002 billion, for a total value of $2.1 billion.
• GM was overcapitalized given the difficulty in obtaining financing in the markets, and thus has a strong balance sheet. As of March 31, 2010, the company had cash and investments of $23.5 billion, as well as restricted cash related to the US Treasury credit agreement of $11.3 billion (since the loans were repaid in April 2010 these funds are no longer subject to restriction, and so should be included on a pro forma basis as available cash), for a total of $34.7 billion. This amount excludes ~$1.5 billion of other restricted cash, much of which is related to a Canadian health care trust. With respect to debt, the company shows total debt of $14.2 billion as of March 31, 2010, but we believe this includes a discount of $1.6 billion and have added that amount to the balance (this was included in disclosures in the 10-K for the period ended December 31, 2009 and we have no reason to believe this number has changed). Additionally, the company had $9 billion of preferred stock. In aggregate, the company has a net cash position of $10 billion (while some debt was repaid after the reporting period, this will not change the net debt figure).
• New GM has significant underfunded pension and OPEB liabilities – as of December 31, 2009, these broke down as follows:
o $17.1 billion in underfunded U.S. pension
o $10.3 billion in underfunded non-U.S. pension
o $5.8 billion in underfunded U.S. OPEB
o $3.8 billion in underfunded non-U.S. OPEB
We do not believe that General Motors will end up being liable for this entire amount, particularly with respect to some non-U.S. and/or OPEB liabilities. Additionally, were the amounts to be paid off, the company would generate a massive deferred tax asset. Our base case conservatively assumes the entire liability is paid and discounts both the U.S. and non-U.S. amounts by 35% to account for the value of the tax shield. This results in a total liability of $24 billion.

Adding up these numbers gets to a total equity value of $75.8 billion. Based on an estimated $37 billion in unsecured claims (this is the amount estimated in the company’s SEC filings, although its monthly operating reports filed with the bankruptcy courts show liabilities subject to compromise of $32.2 billion), MLC is entitled to 52.9 million shares of new GM stock, as well as two series of warrants to purchase 45.5 million shares at implied equity values of $15 billion and $20 billion, respectively. Using the treasury method (the warrants are well in-the-money and so we ignore option value), MLC will own 115.9 million shares of new GM at an implied share price (based on total equity value of $75.8 billion) of $134, resulting in total value of $15.4 billion. Based on a total claims pool of $37 billion, this implies a recovery of 41.7%, against the current claim-adjusted price of the Euro Notes of 27.2%. In May 2009, Evercore estimated a recovery of 26.5% - however, they assumed cash at GM would be $15.3 billion, while the company has nearly $20 billion more than that. This would imply a recovery of 37.3%, holding all else equal, and performance has also been better than expected in the year since that analysis was done. While there is a wide range of opinions on what the ultimate recovery will be worth, we note that Street estimates have recovery values as high as 47 to 50%.

Friday, July 16, 2010

Additional Thoughts on BP

I felt a nice compliment to the T2 Presentation might be an explanation of a trade that I beleive could yield a nice return. Would love any feedback.

Now that BP has put the cap on the well its all gravy from here. Well....maybe not but the good news is this idea doesn't really depend on stellar out-performance. I am recommending a 1X1 vertical call spread. I would advise using the 1/20/2012 Calls at strikes of 42.5 and 45 (to avoid confusion I am advocating buying the 42.50s and selling the 45s at a 1:1 ratio). Based on midpoint pricing as of close on 7/15/10 the 42.50s trade at 6.90 and the 45s are at 6.13 this represents a $0.77 spread. So using simple math if at anytime up until 1/20/2012 BP's equity goes to 45 or above the position will have an intrinsic value of $2.50/share versus a cost of $0.77 or a nice profit of 3.25x invested capital. For frame of reference BP's equity closed trading today at $38.92. That means we have the potential to make 3.25x our money if the stock just goes up by 15.6% by 1/20/2012 - sounds like a pretty manageable gap to me.

Now for the nitty-gritty. Obviously BP will have to pay substantial sums for the damage they have caused to the Gulf Coast. Given our populist president and the current business hating environment I imagine these fees will be quite large. The ultimate cost to BP is impossible to know currently. The 1989 Exxon Valdez spill of 250 kbls cost Exxon US$3.8 bn. Assuming that a spill of similar size in the GoM could today cost $10 bn, allowing for inflation and the greater impact of this spill (a more highly populated and more economically relevant area). However, this estimate is subject to great uncertainty, as there is no useful recent comparison for a spill of this size in such a populated area. To be conservative we assume that BP (as an operator) bears 100% of the clean-up and legal costs, despite owning only 65% of the license. However, this is another key area of uncertainty; we do not know yet the exact reasons for the failures that led to the spill and which company might be responsible for it.

Just for fun lets make some nice round estimates on what the spill could ultimately cost. At $40,000 per barrel spilt, or $10 bn per 250 kbls (backed into by inflating Exxon’s US$3.8 bn costs relating to the Valdez spill in 1989 by 5% pa). Then a apply this cost to the total number of barrels spilt, and do not adjust for those barrels
that have been dispersed or evaporated, which could be as much as 50% of the total
volume. We also attribute 100% of this cost to BP, as the operator of the license, although it owns only a 65% stake in the block (and bless BP's heart they have been sending bills to their partners as incurred - payment of such bills is another topic all together). Lets be draconian, the well leaked for 85 days, lets assume the well leaked all in 1.65mbls (about 19kbls per day while there have been a number of outliers on estimates out there I decided to shoot the middle on this one). We then take that number multiplied by our $40,000 per barrel split to arrive at a total cost of $66B. Quite a staggering sum. However even using this amount the stock the stock would trade on an EV/DACF of 5.5x in 2010E and 4.5x in 2011E.

How would BP pay for this: BP has announced an intention to raise $10bn from non-core asset divestments over the next 12-months. This compares to BP's 'normal course' level of non-core divestments of $3-4bn per annum. There is an overhang of unsold refineries on the market - we count at least 25 with a capacity of 2.9 million bopd. So, we doubt BP will seek to compete in that oversupplied asset market. Retail asset divestments are always an option – given the damage to BP’s brand, it is possible that a buyer may see greater value by rebranding some outlets. Excluding Russia, BP has 22,400 retail sites. An exit from specialty (acetyls and aromatics) chemicals is possible – given capital employed of $5-6bn, this could be a useful ticket which would complete BP's exit from the chemicals segment following the sale of Innovene. Upstream, we sense that it more a buyer’s market for gas oriented assets and we doubt BP will U-turn following its recent build up in the US gas shale ($3.7bn acquisitions in H2 2008). This leaves oil biased upstream assets. We doubt BP will want to sell growth oriented (undeveloped) assets; we suspect it should rather sell more mature producing positions which are more straightforward to value and for which there is a relatively buoyant market. Such assets could include pieces in the UK North Sea, the Lower 48 (onshore USA), Canada and perhaps Colombia. We very much doubt BP will look to reduce its exposure to Angola or TNK-BP given their resource depth and long term growth potential. BP has three listed investments which have an aggregate market value of approximately $2.6bn that it might consider selling – a 1.3% stake in Rosneft (market value $880m), a 20% stake in China Aviation Oil Singapore (market value $150m) and a 71% stake in Castrol India (market value $1,600m). Aside from just the raw cashflow producing power of BP there are a number of avenues for additional cash.

There is a lot more I could talk about on the company and its cash producing prospects but I will leave that to the reader to discover.

While the dynamics may be unappealing to some - 100% loss versus 325% upside. I personally find a 3:1 trade with reasonable safety and a long life quite appealing.

T2 Partners Presentation on InBev, Microsoft, and BP - Enjoy

T2 Presentation 07-12-10

Wednesday, June 16, 2010

Passport Capital Q1 2010 Letter

Below is Passport Capital's Q1 2010 letter. John Burbank is always worth a read (just look at that CAGR since inception!). They do a good job of giving readers insight into how one of the most successful recent macro funds operate. Enjoy:

Passport Capital Q1 2010 Letter

Monday, June 7, 2010

Update of RAFI

For those of you still following the story, RAFI filed some additional documents with the SEC per their comments. Its a fairness opinion and it suggests a fair value of slightly north of $6. Hopefully this will be the last of the comments and we can move forward with the distribution. The presentation does do a good job of explaining what the company does. Enjoy:

Pershing Square's Presentation at Ira Sohn - GGP

Pershing Square_GGP Part II_5!26!10

Friday, May 28, 2010

Easy Money, Hard Truths

David Einhorn - the manager of Greenlight Capital, recently wrote an OpEd piece for the NYT (it was a reproduction of his speech at the Ira Sohn conference). It is worth a read. Really makes me question the investment merits of TIPS and reinforces my interest in natural resources like Timber and Gold. Without further ado, here is the article:

"Are you worried that we are passing our debt on to future generations? Well, you need not worry.

Before this recession it appeared that absent action, the government’s long-term commitments would become a problem in a few decades. I believe the government response to the recession has created budgetary stress sufficient to bring about the crisis much sooner. Our generation — not our grandchildren’s — will have to deal with the consequences.

According to the Bank for International Settlements, the United States’ structural deficit — the amount of our deficit adjusted for the economic cycle — has increased from 3.1 percent of gross domestic product in 2007 to 9.2 percent in 2010. This does not take into account the very large liabilities the government has taken on by socializing losses in the housing market. We have not seen the bills for bailing out Fannie Mae and Freddie Mac and even more so the Federal Housing Administration, which is issuing government-guaranteed loans to non-creditworthy borrowers on terms easier than anything offered during the housing bubble. Government accounting is done on a cash basis, so promises to pay in the future — whether Social Security benefits or loan guarantees — do not count in the budget until the money goes out the door.

A good percentage of the structural increase in the deficit is because last year’s “stimulus” was not stimulus in the traditional sense. Rather than a one-time injection of spending to replace a cyclical reduction in private demand, the vast majority of the stimulus has been a permanent increase in the base level of government spending — including spending on federal jobs. How different is the government today from what General Motors was a decade ago? Government employees are expensive and difficult to fire. Bloomberg News reported that from the last peak businesses have let go 8.5 million people, or 7.4 percent of the work force, while local governments have cut only 141,000 workers, or less than 1 percent.

Public sector jobs used to offer greater job security but lower pay. Not anymore. In 2008, according to the Cato Institute, the average federal civilian salary with benefits was $119,982, compared with $59,909 for the average private sector worker; the disparity has grown enormously over the last decade.

The question we need to ask is this: If we don’t change direction, how long can we travel down this path without having a crisis? The answer lies in two critical issues. First, how long will the capital markets continue to finance government borrowings that may be refinanced but never repaid on reasonable terms? And second, to what extent can obligations that are not financed through traditional fiscal means be satisfied through central bank monetization of debts — that is, by the printing of money?

The recent United States credit crisis was attributable in large measure to capital requirements and risk models that incorrectly assumed AAA-rated securities were exempt from default risk. We learned the hard way that when the market ignores credit risk, the behavior of borrowers and lenders becomes distorted.

It was once unthinkable that “risk-free” institutions could fail — so unthinkable that the chief executives of the companies that recently did fail probably didn’t realize when they crossed the line from highly creditworthy to eventually insolvent. Surely, had they seen the line, they would, to a man, have stopped on the solvent side.

Our government leaders are faced with the same risk today. At what level of government debt and future commitments does government default go from being unthinkable to inevitable, and how does our government think about that risk?

I recently posed this question to one of the president’s senior economic advisers. He answered that the government is different from financial institutions because it can print money, and statistically the United States is not as bad off as some other countries. For an investor, these responses do not inspire confidence.

He went on to say that the government needs to focus on jobs now, because without an economic recovery, the rest does not matter. It’s a valid point, but an insufficient excuse for holding off on addressing the long-term structural deficit. If we are going to spend more now, it is imperative that we lay out a credible plan to avoid falling into a debt trap. Even using the administration’s optimistic 10-year forecast, it is clear that we will have problematic deficits for the next decade, which ends just as our commitments to baby boomers accelerate.

Modern Keynesianism works great until it doesn’t. No one really knows where the line is. One obvious lesson from the economic crisis is that we should get rid of the official credit ratings that inspire false confidence and, worse, are pro-cyclical, aggravating slowdowns and inflating booms. Congress has a rare opportunity in the current regulatory reform effort to eliminate the rating system. For now, it does not appear interested in taking sufficiently aggressive action. The big banks and bond buyers have told Congress they want to continue the current system.

As William Gross, the managing director of the bond management company Pimco, put it in his last newsletter, “Firms such as Pimco with large credit staffs of their own can bypass, anticipate and front run all three [rating agencies], benefiting from their timidity and lack of common sense.”

Given how sophisticated bond buyers use the credit rating system to take advantage of more passive market participants, it is no wonder they stress the continued need to preserve the status quo.

It would be better to have each investor individually assess credit-seeking entities. Certainly, the creditworthiness of governments should not be determined by a couple of rating agency committees.

Consider this: When Treasury Secretary Timothy Geithner promises that the United States will never lose its AAA rating, he chooses to become dependent on the whims of the Standard & Poor’s ratings committee rather than the diverse views of the many participants in the capital markets. It is not hard to imagine a crisis where just as the Treasury secretary seeks buyers of government debt in the face of deteriorating market confidence, a rating agency issues an untimely downgrade, setting off a rush of sales by existing bondholders. This has been the experience of many troubled corporations, where downgrades served as the coup de grâce.

The current upset in the European sovereign debt market is a prequel to what might happen here. Banks can hold government debt with a so-called zero-risk weighting, which means zero capital requirements. As a result, European banks stocked up on Greek debt, and sold sovereign credit default swaps, and now need to be bailed out to avoid another banking crisis.

As we saw first in Dubai and now in Greece, it appears that governments’ response to the failure of Lehman Brothers is to use any means necessary to avoid another Lehman-like event. This policy transfers risk from the weak to the strong — or at least the less weak — setting up the possibility of the crisis ultimately spreading from the “too small to fails,” like Greece, to “too big to bails,” like members of the Group of 7 industrialized nations.

We should have learned by now that each credit — no matter how unthinkable its failure would be — has risk and requires capital. Just as trivial capital charges encouraged lenders and borrowers to overdo it with AAA-rated collateral debt obligations, the same flawed structure in the government debt market encourages and therefore practically ensures a repeat of this behavior — leading to an even larger crisis.

I don’t believe a United States debt default is inevitable. On the other hand, I don’t see the political will to steer the country away from crisis. If we wait until the markets force action, as they have in Greece, we might find ourselves negotiating austerity programs with foreign creditors.

Some believe this could be avoided by printing money. Despite the promises by the Federal Reserve chairman, Ben Bernanke, not to print money or “monetize” the debt, when push comes to shove, there is a good chance the Fed will do so, at least to the point where significant inflation shows up even in government statistics.

That the recent round of money printing has not led to headline inflation may give central bankers the confidence that they can pursue this course without inflationary consequences. However, printing money can go only so far without creating inflation.

Government statistics are about the last place one should look to find inflation, as they are designed to not show much. Over the last 35 years the government has changed the way it calculates inflation several times. According to the Web site Shadow Government Statistics, using the pre-1980 method, the Consumer Price Index would be over 9 percent, compared with about 2 percent in the official statistics today.

While the truth probably lies somewhere in the middle, this doesn’t even take into account inflation we ignore by using a basket of goods that don’t match the real-world cost of living. (For example, health care costs are one-sixth of G.D.P. but only one-sixteenth of the price index, and rising income and payroll taxes do not count as inflation at all.)

Why does the government understate rising costs? Low official inflation benefits the government by reducing inflation-indexed payments, including Social Security. Lower official inflation means higher reported real G.D.P., higher reported real income and higher reported productivity.

Subdued reported inflation also enables the Fed to rationalize easy money. The Fed wants to have low interest rates to fight unemployment, which, in a new version of the trickle-down theory, it believes can be addressed through higher stock prices. The Fed hopes that by denying savers an adequate return in risk-free assets like savings deposits, it will force them to speculate in stocks and other “risky assets.” This speculation drives stock prices higher, which creates a “wealth effect” when the lucky speculators spend some of their gains on goods and services. The purchases increase aggregate demand and lead to job creation.

Easy money also aids the banks, helping them earn back their still unacknowledged losses. This has the perverse effect of discouraging banks from making new loans. If banks can lend to the government, with no capital charge and no perceived risk and earn an adequate spread, then they have little incentive to lend to small businesses or consumers. (For this reason, higher short-term rates could very well stimulate additional lending to the private sector.)

Easy money also helps the fiscal position of the government. Lower borrowing costs mean lower deficits. In effect, negative real interest rates are indirect debt monetization. Allowing borrowers, including the government, to get addicted to unsustainably low rates creates enormous solvency risks when rates eventually rise.

While one can debate where we are in the recovery, one thing is clear — the worst of the last crisis has passed. Nominal G.D.P. growth is running in the mid-single digits. The emergency has passed and yet the Fed continues with an emergency zero-interest rate policy. Perhaps easy money is still appropriate — but a zero-rate policy creates enormous distortions in incentives and increases the likelihood of a significant crisis later. It was not lost on the market that during this month’s sell-off, with rates around zero, there is no room for further cuts should the economy roll over.

EASY money has negative consequences in addition to the risk of inflation and devaluing the dollar. It can also feed asset bubbles. In recent years, we have gone from one bubble and bailout to the next. Each bailout has rewarded those who acted imprudently. This has encouraged additional risky behavior, feeding the creation of new, larger bubbles.

The Fed bailed out the equity markets after the crash of 1987, which fed a boom ending with the Mexican crisis and bailout. That Treasury-financed bailout started a bubble in emerging market debt, which ended with the Asian currency crisis and Russian default. The resulting organized rescue of Long-Term Capital Management’s counterparties spurred the Internet bubble. After that popped, the rescue led to the housing and credit bubble. The deflationary aspects of that bubble popping created a bubble in sovereign debt, despite the fiscal strains created by the bailouts. The Greek crisis may be the first sign of the sovereign debt bubble bursting.

Though we don’t know what’s going to happen next, the good news for our grandchildren is that we will have to face our own debts. If we realize that our own future is at risk, we might be more serious about changing course. If we don’t, Mr. Geithner and others might regret having never said never about America’s rating.

David Einhorn is the president of Greenlight Capital, a hedge fund, and the author of “Fooling Some of the People All of the Time.” Investment accounts managed by Greenlight may have a position (long or short) in the securities discussed in this article."

Tuesday, May 18, 2010

Regency Affiliates, Inc.

Regency Affiliates, Inc. (RAFI) is a publicly traded, they are the parent company of several subsidiary business operations. This play on this name is a take private that has already been approved by shareholders and the board and is currently awaiting comments (if any) from the SEC. The deal is as follows:

They will be doing a 1-for-100 reverse stock split immediately followed by a 100-for-1 forward stock split. The purpose of the split / re-split is to reduce the shareholder count below 300. Under SEC rules, a company with a class of securities registered under the Securities Exchange Act of 1934 may choose to terminate its registration if certain conditions are met - one such condition is if the securities have fewer than 300 record holders. By de-registering they will be able to avoid costly SEC listing requirements. Stockholders owning fewer than 100 shares of common stock immediately before the reverse stock split will no longer own such shares after the effective time and, in lieu thereof, will receive from RAFI $6.00 in cash, without interest, for each of such shares of common stock.

Based on this and today's closing price, investors can make a quick 43% return (non-annualized and excluding trading fees). Based on my discussions with the GC and with a couple of corporate lawyers the only risk is if the SEC comments on the transaction, thus stalling the process. The transaction was submitted to the SEC when they filed their proxy on March 1, 2010. The SEC than has (again according to the GC and confirmed by others) 60 days to review the transaction and if no comment is made the stock will split and repurchase will commence.

It almost doesn't matter what RAFI does but for those who care:
RAFI is more than 50 years old. It was reorganized in 1987 to be the successor to Transcontinental Oil Corporation, which existed since 1947. RAFI owns a partnership interest in the Security Land and Development Company Limited Partnership. The Partnership owns a two story office building and a connected six story office tower occupied by the United States Social Security Administration Office of Disability and International Operations under a fifteen year lease, expiring in 2018. On April 30, 2004, RAFI, through a newly-formed, wholly-owned subsidiary called Regency Power Corporation, acquired a 50% membership interest in MESC Capital, LLC, from DTE Mobile, LLC. MESC Capital was formed to acquire all of the membership interests in Mobile Energy Services Company, LLC. Mobile Energy owns an on-site energy facility that supplies steam and electricity to a Kimberly-Clark tissue mill in Mobile, Alabama. RAFI owns, through it 75% owned subsidiary, 80% of National Resource Development Corporation which has as its principal asset approximately 70 million + short tons of previously quarried and stockpiled rock located at the site of the Groveland Mine in Dickinson County, Michigan.

As of the most recent 10-Q (9/30/09) RAFI has approximately $7m in cash and marketable securities vs. $0 in debt.

So to reiterate the simplicity of this thesis - buy 99 shares (use limit orders so you don't get bad pricing due to the illiquidity) then sit and wait and receive $6 per share or approx 43% return in less than a month or so (annualize if you want but the number is satisfactory enough in its un-annualized state). Assuming you can get closing pricing your profit potential is ~ $180 before commissions so around $170 ex commissions. It is true you won't profit greatly from this trade, but at least its enough of a profit to go out to eat....maybe there is such a thing as a free lunch...

Target: $6.00 Current Price: $4.19

Great Northern Iron Ore Properties

reat Northern Iron Ore Properties (the "Trust") is a conventional nonvoting trust organized in 1906 by James J. Hill. He was the CEO of the Great Northern Railway and was a railroad tycoon back in the late 1800s and due to the size of the size of this region and the economic dominance exerted by his lines, Hill became known during his lifetime as The Empire Builder. Hill set up a trust to provide income for his youngest heirs. The beneficiaries were 18 children who at the inception of the trust were less than six years old.

The terms of the Great Northern Iron Ore Properties Trust Agreement, created December 7, 1906, state that the Trust shall continue for twenty years after the death of the last survivor of eighteen persons named in the Trust Agreement. The last survivor of these eighteen persons died on April 6, 1995. Accordingly, the Trust terminates twenty years from April 6, 1995, that being April 6, 2015.

The Trust owns interests in fee, both mineral and non-mineral lands, on the Mesabi Iron Range in northeastern Minnesota. The Trust's properties, which span two counties (St. Louis and Itasca) in northeastern Minnesota, extend from Hoyt Lakes on the east end of the Mesabi Iron Range to Grand Rapids on the west end of the Mesabi Iron Range. Many of these properties are leased to steel and mining companies that mine the mineral lands for taconite iron ore. The Trust has no subsidiaries.

The primary purposes of the Trust are to lease its mineral interests on the Mesabi Iron Range in northeastern Minnesota to the major steel and taconite producers, collect royalties from the extraction of taconite ore by the producers, and provide a return to the shareholders, while at the same time balancing the interests of the certificate holders with those of the reversioner -- Glacier Park Company, a wholly owned subsidiary of ConocoPhillips.

Deriving its royalty income from Taconite, as one would expect the Trust's distributions are highly correlated to the price of steel. Seeing how the trust has been operating for over 100 years it seems logical that additional discovers of Taconite are highly unlikely.

At the end of the Trust, the shares in the Trust will cease to trade on the New York Stock Exchange and thereafter will represent only the right to receive certain distributions payable to the certificate holders of record at the time of the termination of the Trust. Upon termination, the Trust is obligated to distribute ratably to shareholders the net monies remaining in the hands of the Trustees (after paying and providing for all expenses and obligations of the Trust), plus the balance in the Principal Charges account (the balance in this account consists of attorneys’ fees and expenses of counsel for adverse parties pursuant to the Court Order in connection with litigation commenced in 1972 relating to the Trustees’ powers and duties under the Trust Agreement and the costs of homes and surface lands acquired in accordance with provisions of a lease with U.S. Steel Corporation, net of an allowance to amortize the cost of the land based on actual shipments of taconite and net of a credit for disposition of tangible assets). All other Trust property (most notably the Trust’s mineral properties and the active leases) must be conveyed and transferred to the Glacier Park Company, a wholly owned subsidiary of Conoco Phillips.

This termination payment is currently (as of 12/31/09 which is the last estimate) at $8.53/share (for frame of reference it was: $8.20 in 2008, $8.78 in 2007, $8.80 in 2006, and $10.53 in 2005).

Over the past 12 months the company has declared $8.20 in annual dividends (with the last dividend being paid on April 30, 2010) which makes for some intimidating - an 8.8% trailing dividend yield.

The bet quite simply is that the Trust's accumulated dividends from here until April 6, 2015 plus the termination payment will total less than the current stock price.

Without going into great detail (which I highly recommend readers build out their own models as they can see how sensitive the Trust is to steel prices), lets assume that steel prices are back to the wild days of 2008 and the Trust's payments rise accordingly to their 2008 highs - which was $11.70/share. If we take this and multiple it by 20 payments (20 quarters to April 6, 2015 - assuming the April 30, 2015 dividend is paid on April 6, 2015) it results in total distributions of $58.5/share. We then add in the termination payment which should be around $9. This results in total payments to shareholders of $67.5/share. So in the absolute worst case (assuming steel at prices 50% higher than today) you can still expect a 9.2% IRR, if steel prices remain in a more normalized range it is a fairly attractive high double digit IRR, which could be accelerated should the shares trade closer to intrinsic value more rapidly than I am assuming.

Only negative is the cost the short - this is one reason why it may be worth sitting on the sidelines and selling into the rallies. Overall it is a fairly simple idea that should produce adequate returns.

Variant View:
There is no variant opinion, this stock has zero coverage. But the real keys to focus on in my mind are:

Higher steel prices leading to larger distributions
Some additional discovery of Taconite that can meaningfully increase their royalty stream (highly unlikely as described above)
Something funky that makes the distribution from the Principal Charges Account meaningfully higher (not even sure if this is possible).

Target: $67.50 by expiration, current price: $91.42

Updates - New Directions

Much has happened since my last post. In an effort to better align this forum with my current interests I will be shifting the format from Global Macro calls to more classical stock picking. User feedback will be greatly appreciated so if you have any thoughts or suggestions please let me know. Thanks.