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Thursday, May 26, 2011

Complete Notes from Ira Sohn Research Conference

Below find a complete set of note from the Ira Sohn Research Conference. They are a bit long but its worth reading through. Enjoy.

Erez Kalir, Sabretooth Capital - Economic Death as a Special Situation

Sabretooth Capital likes to focus on binary events with extreme divergence in potential outcomes. When companies are on the verge of economic death small changes in the outcome can produce large changes in expected values. To that end Erez believes MBIA equity and credit have both been left for dead. Trading at 0.3x adjusted book value the market is overestimating MBIA’s death. The three main issues the market has with MBIA are 1) litigation risk - there are a myriad of lawsuits attempting to undo the split of the good and bad assets at MBIA. Should these lawsuits be successful it could force MBIA into receivership. Erez believes that these lawsuits are likely to fail and even if they were not, no one is incented to force MBIA into receivership (trickle down effect it would have). 2) Legacy structured product risk - If MBIA wins the litigation it won’t matter, as these assets would stay apart from the company. However if you take into account the difference between present value and future value of these assets the exposure drops dramatically and MBIA should be able to absorb any losses from these assets. In addition, the company has litigation against the large banks that should they win, the amounts would help buffer any losses from their legacy-structured products. 3) Muni market risk - while the muni market is at risk of downgrades and losses the makeup of MBIA’s muni book should allow it to weather the storm. Depending on the range of outcomes MBIA’s book value can be $5.21 - $20.58, offering significant upside from current levels. Argentina’s E&P sector is another example of an opportunity Sabretooth is involved in. Argentina’s sovereign credit spreads are too high at current levels given the improvement in economic conditions and policy in the region (country is still suffering from the stigma of having defaulted on its debt). Erez believes the E&P sector is the best way to play an economic rebound in Argentina. Argentina has proven fields and good energy infrastructure. In addition the company is benefiting from Chinese investment. Argentina has also become a net energy importer for the first time requiring significant investment in energy to become self-sustaining again. The stocks he advocates are CWV CN, BOE CN, MVN CN, RPT CN and YPF. Finally Erez touched on the debt crisis and offered his own hedge for a doomsday scenario (he believes the US can’t grow its way out of our problems and that when interest rates are higher than GDP growth rate it spells trouble). Buying gold won’t work because is subject to government confiscation. Shorting treasuries is dangerous because you are subject to price control risk. Buying Buffett type stocks with good brands and pricing power won’t protect from a flight from all financial assets. According to Erez, buying international farmland is the best hedge as it is a replenishing asset that is a less obvious target for government seizure and plays on secular growth themes.

Dinkar Singh, TPG-Axon

The common theme of Dinkar’s presentation was to bet on stocks that will succeed when margins and valuations have little or no room to go up. 1) Orkla (ORK NO) provides 30%-60% upside from current levels. The company is Norway’s premier consumer staples franchise that is going through a restructuring. The company has a 40% stake in Renewable Energy that is 6%-7% of its enterprise value (was much higher before the fundamentals of the business went south). ORK current trades at 9x-10x EPS and 1x book value, in addition the company has a 5% dividend yield. The 22% shareholder was sick of the underperformance of the company and currently has two members on the company’s Board. Its possible the company splits up into two segments or (more likely according to Dinkar) the company increases its current dividend and declares a special dividend to shareholders (the company is over capitalized currently). Dinkar believes these actions could cause the stock to trade between EUR 65-79. 2) Asian stocks have been significantly lagging the rest of the market over the last six months. Chinese P/E ratios are now below those of the S&P (vs. inline six moths ago). A good example of an Asian growth stock on sale is Zhongpin (HOGS), a Chinese pork processing company. The company is part of a consolidating industry (50%-80% of capacity is coming out of the market by 2015. The company should be able to grow EPS by 20%-30% over the next several years and currently trades at 7x EPS (5x 2013 estimates). 3) Sprint Nextel has both low margins and a low valuation providing opportunity. The company should benefit from lower churn (a result of improved customer service), a network sharing agreement, improved CLWR economics, and potential asset divestitures should the AT&T/T-Mobile merger be approved by regulators. In addition Sprint’s network makes it an attractive acquisition candidate for CTL, AMX or CMCSK. The company currently trades at 5x EBITDA and an 18% FCF yield. Should it trade at a more reasonable 6x-7.5x EBITDA range it implies a value of $8.34-$13.83 per share. While network investments will reduce FCF over the next two years, the T/T-Mobile deal get blocked, or Sprint finds itself in a position where it has to buy CLWR all represent significant risks to the Buy thesis, Dinkar believes that underappreciated ARPU growth and trough margins will offset those risks.

Jeff Aronson, Centerbridge Partners - CIT Group, An Event Waiting to Happen

While Centerbridge rarely buys equity in their reorg plays, CIT is a value that is too good to pass up and they are still buying stock. CIT has a great mix of assets: $9b of corporate finance, $14b of transportation finance, $6b of vendor finance, $3b of trade finance, $8b of legacy consumer finance (student loans) and $12b of cash on hand. CIT has $45 of GAAP book value, $7 of a deferred tax asset (NOLs) and $7 of revaluation from Fresh Start Accounting ($59 intrinsic book value). When the company came out of bankruptcy it had to market its balance sheet to market using 2009 values ($0.89 on the dollar vs. par for most banks). Marking these assets to current market would increase book equity by $1.4b. The company has built in earnings growth with 8% asset yield vs. 7% cost of funding (banks cost of funding is 1%). As the cost of funding normalizes Net Interest Margins will improve. There are two events that could unlock value at CIT. 1) CIT uses its $12b in cash to buy a bank. Using Valley National as an example it could increase CIT’s value to $64 per share. 2) CIT could be a target for a larger bank (WFC, USB, HSBC, TD Bank) and could command $65 in a takeout ($1.75 in 2012 EPS, plus $3 in cost of fund savings and including another $1 in operational synergies (25% expense reduction) yields EPS of nearly $5.80. At a 10x multiple that is $58 plus the $7 of NOL’s gets a total value in a takeout of $65 per share). At 0.7x intrinsive book value and with an improving regulatory environment and cost of funding normalization, CIT is misunderstood by the market.

Robert Howard, KKR Equity Strategies

KKR Equity Strategies looks for misunderstood equities that fly under the radar. Wabco (WBC) makes components that enhance vehicle safety and emissions. The company should benefit from three secular growth drivers: 1) US & European truck recovery, 2) tightening safety and emissions standards and 3) emerging markets growth. WBC has 60% exposure to Western Europe where content/vehicle is $3,000. The company also has 60% market share in China and India where content/vehicle is $300. The company has 22% ROIC and 27% EBITDA margins and trades in line with its peer group in spite of its secular growth trends. Should the company trade at a premium to the group the 2013 valuation would be in excess of $100. In addition the CEO has $200m of economic exposure with stock and options, incentivizing him to see the share price appreciate. HSNI (parent of the Home Shopping Channel) could see 40% upside from three main factors: 1) trading at 5.7x EBITDA, HSNI trades well below the retail universe. A 7x retail multiple would provide 20% upside from current levels. 2) At1.2x gross debt: EBITDA, HSNI is overcapitalized. Paying out a $950m special dividend and assuming 13x retail EPS multiple would give the stock 40% upside from current levels. 3) HSNI’s margins are well below those of QVC and should those two companies consolidate it would mean significant margin appreciation. HSNI is 32% owned by QVC’s parent, LINTA.

Phil Falcone, Harbinger Capital Partners

After a brief description of Lightsquared (59 MHZ of mobile spectrum, a 4G LTE terrestrial network with a satellite overlay) Phil presented one of their largest holdings, Crosstex Energy (XTXI). XTXI is a publicly traded GP in a C-Corp asset structure. XTXI owns 100% of the GP and subsequent distribution rights of XTEX as well as 32% of the XTEX LP. XTEX is a natural gas and NGL gathering, processing and pipeline company in North Texas and Louisiana. XTEX is expected to have 30% distribution growth, which in turn should increase XTXI’s distribution at a 3x higher rate. Should the current $0.36 distribution double (which could happen as EBITDA is forecast to increase from $200m to $230m in 2011) it would imply a near $20 share price, vs. the current $10 level.

Jim Chanos, Kynikos Associates - Does Solar + Wind = Hot Air?

While there is a definite need for new sources of power both wind and solar alternatives currently cannot handle the base load power needs and require backups. Wind projects require massive subsidies to be built. Wind is 50% more expensive than natural gas while Solar is 4x more expensive. In addition these new industries do not create real job growth as they only supply temporary installation jobs and are not totally environmentally friendly. Chanos offered two short candidates Vestas and First Solar. Vestas (VWS DC) is a wind company in Denmark (Denmark gets 20% of its power from wind). The company has seen installations decline and recently changed their auditors and accounting policies to push forward revenue and push back costs. The company burned $600m of cash over the last six months and the order backlog was down 3.5% over that same time. Chanos thinks it’s a matter of time before financial strain and increased competition push this company to the brink. The Solar industry is facing installation declines of 40%-90% and relentless capacity growth from China (forecast to increase 30%-50% in the next several years). FSLR has these secular headwinds, in addition to an outdated technology (thin film). The company also recently had a quality control problem and is forecast to have a $1b FCF deficit this year. While the balance sheet continues to deteriorate the founding management team has stepped down and sold most of their shares. The new management team has limited industry experience and will have a tough time navigating the operation and industry issues the company is facing.

Michael Price, MFP - Ira Sohn Stock Picking Contest Winner

Before announcing the winner of the Ira Sohn Stock Picking Contest, Michael told the audience that the financial sell off was overdone and that he liked C, BAC and in particular GS. He believed the banks today present a similar opportunity to Chase in 1994, good risk reward in a post deflation environment. They also like CIT, ITT (splitting up), JCP (underlying real estate value) and Beckton Dickinson. The four finalists for the stock-picking contest were GM, GME, CDNS and the winner BPI (Bridgepoint Education, presented by an Indiana University Senior). BPI has been lumped in with the other for profit colleges (Steve Eisman pitched them as shorts last year). The company currently trades at 2.6x EBITDA, has a 20% FCF yield, and 22% of its market cap is cash. The company has shown consistent earnings growth and better student statistics than its peers. At 7x EBIT it would imply a $47 stock price. In addition once the company completes its current share buyback program, 73% of the float will be short (borrow costs is currently 12% and will probably increase post the buyback).

Steve Feinberg, Cerberus Capital Management

Cerberus believes Residential Mortgage Backed Securities (RMBS) provide a good investment opportunity. Home prices are down 30%, $500b of equity is underwater and good borrowers don’t want leverage. In addition the way securities are valued has changed. It used to be that as interest rates went down pre-payments went up and RMBS were priced accordingly. Now the underlying credit is becoming more important. FICO scores are becoming less important, while the loan size and loss ratio’s are more important. While the market has recovered somewhat the large supply of RMBS, regulatory environment and market uncertainties still provide good opportunities.

Peter May, Trian Fund Management

Peter pitched TIF as Trian’s stock of choice (Peter is on the Board of TIF). While TIF stock has done well the stock has room for more upside given its great brand and improving fundamentals. The company will benefit from three key factors: 1) new store growth (and new store designs) 2) same store sales growth driven by new products like watches and handbags and 3) vertical integration (investments in African diamond supply as well as in-house cutting, polishing and manufacturing operations. The company has strong FCF generation and the Board authorized a $400m share repurchase program in January. Despite having 233 stores today vs. 167 five years ago, improved margins and ROE TIF trades at a lower multiple today 17.5x 2012 EPS than it did five years ago (22x). Applying the same 22x multiple to current number would yield a share price in excess of $100. In addition Bulgari (perhaps TIF’s chief competitor) sold for 30x EPS to LVMH.

Steve Eisman, Frontpoint Partners- Are US Financials Dead Forever?

While bank capital ratios are at historical highs and loan: deposit ratios are very strong, loan growth has yet to return to normal. The industry is also plagued by regulatory uncertainty, Basel III, the Volcker Rule, capital requirements and mortgage scandals. When banks were rallying in 2009-2010 the thesis was that by 2012 credit costs would normalize, the Fed will raise rates and loan growth would return to normal. That thesis has clearly not played out. The sell off in banks has weighed on the rest of the financial sector and Steve believes that the P&C insurance business provides a good source of value. The history of the industry is to become over capitalized, lose pricing power, multiples de-rate and companies deplete their reserves and buyback stock. It takes large losses to return pricing power and turn the cycle (this happened after 9/11). Once pricing turns it tends to rise for a sustained period of time. In the last 15 months there have been $85b of losses and we are heading into what is predicted to be another bad hurricane season. On average the P&C companies are trading at 93% of book value. Pricing this year will rise 5%-10% vs. a forecasted 5%-10% decline. The best ways to play this theme are insurance brokers like MMC, AON and WSH or Bermuda P&C companies like RNR, RE, PTP and PRE.

Jeff Gundlach, DoubleLine

Jeff believes that a key to investing is accounting for policy and behavioral change. In 1940 debt was 10x tax receipts and we find ourselves in a similar situation today. The fix in 1940 was to raise taxes, but we don’t have that option today. Jeff believes that we will have persistent weakness in housing with loss severities continuing to rise (by way of example he thinks the 2007 ABX index is worth near zero in total vs. trading at $0.40 on the dollar now). In addition while there is a political will to raise taxes there is no desire to decrease spending. The problem with decreasing spending is GDP won’t grow and we can’t earn our way out of the problem. Jeff advocates a diversified portfolio including natural gas (its cheap and not going lower), dollars (2008 showed what happens when there is a flight to the dollar), gem stones instead of gold (they are cheaper and you can actually physically carry them), artwork and a hedged bond portfolio (he showed an example portfolio of GNMA and RMBS securities with a 14% yield and 6.2 year duration).

Dr. Marc Faber, The Gloom Boom & Doom Report

Dr. Faber reviewed how the US got to this point (low interest rates during an economic growth cycle fueled the housing bubble) and took many shots at Chairman Bernanke in the process. Monetary policy caused the credit excess, but now the only thing the Fed can do is print money to fight its way out. The problem is the Fed can’t control where the dollars are down. In a depression tax revenues are down and interest payments go up and the US is headed for a similar fate. Dr. Faber urged the audience to diversify into gold, other commodities and hard assets like real estate as hedges for a potential depression.

Bill Ackman, Pershing Square - Family Dollar Stores

Pershing Square has acquired 8.4m shares of FDO at pricing ranging between $43-$54 per share (they started buying in February and were buying stock up until the conference presentation. FDO offers consumers WMT pricing in a more convenient format. The company has a 20% ROIC and very good growth prospects through new store builds and store remodeling. Pershing estimates that new stores offer 35%-55% returns while store remodeling offer 30%-40% returns on capital. As of six years ago Dollar General and Family Dollar had very similar businesses and fundamental characteristics. When KKR took over DG, they began to massively outperform FDO and now have higher sales and margin growth. Trian Partners seized on this opportunity and offered to buy the company between $55-$60 per share. After they were rebuffed they implored management to close the fundamental gap between FDO and DG. FDO trades at the same multiple as DG, but has all the margin upside. Pershing believes that FDO would trade at $70-$90 per share, depending how successful they are in closing the margin gap with DG (assuming a 15x EPS multiple). A $1.5b leverage buyback scenario, coupled with margin improvement would yield a $70 value, an LBO could get $75-$80 and a strategic deal could yield a range of $68-$92 (depending on synergies). In short, FDO is cheap anyway they slice it.

Joel Greenblatt, Gotham Asset Management

Joel and his partners have created a Value Weighted Index approach to investing. Over the last 20 years the S&P has returned 9% (its a market cap weighted index). The equal weight index has returned 11.8%, the FTSE RAFI index (weighted by economic impact) has returned 12.2% and Greenblatt’s VWI (cheap stocks) has returned 16.1%. Based on Greenblatt’s analysis the Russell 2000 is cheaply priced today on a trailing FCF yield basis. ROIC is higher today than 20 years ago and the cost to create an incremental dollar of sales is much lower today ($0.35 vs. $0.55) 20 years ago. Some stocks that screen well for FCF characteristics are JWN, WLP, CVH, AGF, MET, HUM, GME, WAG, MRK, ABT, MHP, INTC, BBBY and WSM.

Mark Hart, Corriente Advisors

China has been the recipient of unprecedented foreign exchange in flows, but they are besieged by a misallocation of capital. Mark expressed three main reasons why China is a bubble and the RMB is a short. 1) China is a credit-fueled bubble. Bank lending is 125% of GDP and Chinese M2 is higher than that of the US. Fixed asset investment is 60% of GDP. By way of comparison before the 1997 Asian crisis, fixed asset investment was 45% of GDP. Somehow while bank assets have increased dramatically, non-performing loans have gone down. The reality is that 50% of loans can’t be serviced out of cash flows and are paid off through property sales and even further borrowings. A 12% loss ration would wipe out the entire Chinese banking system. In response to these heightened concerns, the PBOC has begun to tighten policy (increased reserve and deposit ratios). 2) FX reserves are assets with liabilities, not savings. The simple fact is that China is under-reserved in the event there is a crisis. FX reserves are only 25% of M2. During the Asian crisis all of those countries de-valued their currencies, if that were to happen in China where would the money come from to pay off all the reserves leaving the country? 3) Devaluation is the path of least resistance for the RMB. Upward pressure over the last 10 years and consistent analysis that says the RMB is undervalued have led to the misconception that the currency has nowhere to go but up. In a prolonged slowdown capital flight is likely and the main response from the PBOC will be to devalue the currency. Corriente is long puts on the RMB. You can buy a one-year ATM put for 3.8% vol vs. 18% vol in October 2008. You can also buy 7.50 RMB strike put for 25bps, an over 100% potential return in the event of devaluation.

David Einhorn, Greenlight Capital - Two Longs: Two Different Types of Overhangs

After a brief reminder that he likes gold, David Einhorn offered two long ideas. The first is Delta Lloyd (DL NA). The company is a Dutch insurance company with EUR24 of book value (trading at 70% of book); a 6% dividend yield and a EUR32 embedded value. The company has a strong balance sheet and focuses on long-term pension business. The company has a very solid investment portfolio (returned 5.5% last year) and was the only Dutch insurer that did not require a State bailout. With flat portfolio growth the company would earn EUR2.55 this year, implying a current valuation of 5x EPS. The reason the stock trades at a discount is that Aviva owns 43% of the company after selling down earlier this year (EUR16 secondary offering). Greenlight has told Aviva they want to buy the stake or help place it at least at current market prices, but so far they have been rebuffed. Once the overhang dissipates the stock should appreciate significantly. Microsoft was a stock that Einhorn pitched in 2006 and he was back pitching it again this year. Since 2006 MSFT has seen revenues, and EPS increase significantly. The significant blemishes have been the increased search spending without results and missing out on the mobile software opportunity. MSFT is the leading cloud company with $5b in estimated revenues. While EPS and dividends have doubled since 2006, the PE has been cut in half from 16x to 7x today. The reason this has happened is terrible capital allocation and wasted R&D investment (in some instances MSFT is stifling growth that might interfere with Windows in anyway and losing management talent in the process). CEO Steve Ballmer is trying to buy his way out of tactical errors and it is not working. Why won’t MSFT create a windows platform for the iPhone? Why is MSFT wasting money on Bing investments when they can contribute Bing to Facebook for a stake in the company and gain much needed traffic, while Facebook gains search capabilities? Einhorn believes that MSFT will not return to its appropriate multiple until Ballmer is removed as CEO.

Eike Batista, EBX Companies

Eike Batista has built an empire on what he calls “idiot proof assets”. From 1980-2000 he opened nearly 10 mines that created $20b of wealth. His current conglomerate controls major commodity deposits that are among the lowest cost producers in the word. CCX has $480b of coal value, AUX has $7.5b of gold value, MMX has $480b of iron ore value, OGX has $1.325 trillion of oil value ($18/boe cost and $25b in estimated EBITDA by 2019). He is building the third largest port in the world and the largest shipyard in the America. Batista’s goal is to surpass Carlos Slim as richest man in the world and he is doing it by building out these “idiot proof assets”.

Carl Icahn, Icahn & Company

Ichan has made a fortune by studying natural stupidity. Activism works because most Boards in the US are too collegial and incompetent. You have to be willing to go to war and when you win not micromanage your investment. In those instances you are not a distraction and you can work with management to improve performance. Icahn also wanted to set the record straight on why he closed his fund. In 2008 he refused to put up gates and paid out anyone who wanted to liquidate. Because he had the cash he was not forced to liquidate any position. Icahn believes there is another 2008 coming and he didn’t want to deal with that again so he closed the fund. Not surprisingly, Icahn’s favorite investment is IEP. IEP has over $3b in cash and very good portfolio companies (including Federal Mogul with $670m of EBITDA last year). Icahn plans on using IEP as his investment vehicle going forward and given the right valuation would not be afraid to issue equity to acquire companies.

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