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Thursday, May 9, 2013

Summary of Ira Sohn Conference

Below please find a detailed summary of the presentations given at the Ira Sohn Investment Research conference courtesy of BTIG.


Paul SingerElliott Management Corporation

Mr. Singer’s presentation focused on macroeconomics. He argued that the developed world consists of a group of “legacy countries” which are insolvent over the long term and which lack the political will to directly address this insolvency. The controversy over the Rogoff/Reinhart thesis is trivial: true sovereign indebtedness is not merely contractual but legislative – entitlement programs are effectively debt, and therefore the true debt multiple of GDP is not 0.9x or 1.1x. It is 5x in most of the West and 8x in Japan.

In his view, the common description of “growth” is not true growth. When one country changes its tax policy, or trade balance policy, or its wage laws in order to siphon value from other countries’ economies, this is rarely creative of value and more like a zero sum game. Alternately, when governments use monetary policy to create an artificial stimulus, it is not a long term strategy for growth. True growth comes from entrepreneurship and innovation, and these are disincentivized in an economy where confidence is undermined by policies that erode the long term stability of economies. There is no safe haven for capital.
Mr. Singer argued that holders of long term debt own overpriced instruments whose value is especially distorted by the entitlements and fiscally irresponsible stimulus policies he criticized.

Kyle BassHayman Capital Management

Mr. Bass offered two investment ideas. First, he advocated purchasing both the equity and the SPMD bank debt of newly combined DXM. The merger will create synergies that will help fund the company’s transition from its old model of print directories to its emerging identity as a provider of digital management services to small businesses. Annual EBITDA will stabilize at approximately $700mm. The debt is well-covered and will benefit from the strong cash flow sweep provisions in the credit agreements. The equity is a call option on the success of the transition. Moreover, a successful transition will change the multiple from the less than 4x expected of legacy print businesses to the more than 5x multiple of digital businesses. This would imply a 3x increase in current share price to as much as 10x.

Second, he argued that Japanese sovereign debt should be sold. Japan’s recent parade of finance ministers demonstrates the inconsistency and instability of Japan’s central bank: indebtedness continues to expand at an alarming pace, and the solutions offered for plugging the financing gap in Japan’s budgets are poorly communicated and unreliably disclosed. Japan begins with a desired number and then manufactures data to achieve it. Debt projected to be issued to support entitlement payments increased by 9% for five years, and then declined 8% in the subsequent 2012 budget – because that budget assumed tax reforms that had not yet been implemented. Japan will issue as much as Y54T in new debt this year, Japan’s debt is now 24x tax revenue.

Li LuHimalaya Capital

Mr. Lu advocated investing in the preferred securities of large Korean corporations. Korean preferreds trade at a sharp discount to the common shares of the issuing firms, often by as much as 65% or more. Issuers do not even consistently include them as equity or as contractual debt in their domestic security filings – and they are legally equity, effectively nonvoting shares with only a change of control veto. The situation is akin to the valuation of employee options and their accounting treatment in the US decades ago, where these instruments were invisible and assigned no value by the market – despite their clear measurable value.
Investing in Korean preferreds allows the buyer to purchase shares in high quality companies with large market capitalizations at a deep discount to intrinsic value. Firms like Samsung and Hyundai, among others, have substantial preferred offerings.

Keith MeisterCorvex

Mr. Meister focuses on good companies in transition that Corvex can positively influence, companies that have a favorable macro environment with real growth. He argued that infrastructure assets have an attractive risk/reward profile. He identified both TWTC and LVLT as attractive stocks, because they are alternative carriers that control valuable infrastructure in a consolidating industry.

TWTC equity is much like a bond. It is underlevered, executes well and has a low beta because it has reliable organic growth and dependable cash flow. It is steadily growing market share in its space, has a clean balance sheet and is an attractive target for strategics. In the meantime it will continue to expand its multiple.

LVLT is a call option: it has historically been overlevered, has had execution issues and a high beta – now it is under new management and is improving operationally. LVLT has $40B of real estate and $8.5B of NOLs that it can monetize as it goes free cash flow positive. They have been able to refinance their debt in this current environment and will achieve $130mm in annual interest savings.

William AckmanPershing Square Capital Management

Mr. Ackman presented a case for investing in the common equity of Procter & Gamble. First he emphasized the strong inherent value of the firm: P&G owns well-regarded global brands with enduring reputations for quality and consistency, its products are ubiquitous and inexpensive in developed markets, while aspirational but also affordable in developing ones. PG is the dominant player in almost every one of its core products.
PG trades at a discount to its long term value because of operational inefficiencies that are fixable. Once solved, earnings can grow from $4 to $6 per share and get to $125 per share. To get there, two issues in particular need to be addressed: gross margins and SG&A costs. Improving each metric by 100 to 300 basis points to get in line with peers who do not have PG’s scale advantages would create enormous value. $10B in savings can be achieved over the next 3 years. PG’s management has been distracted (CEO McDonald spends 25% of his time attending to his 21 external board memberships), but has promised improvement and its own accountability for improvements. This will allow activists to extract value.

Stanley Druckenmillerindependent investor

Mr. Druckenmiller’s presentation was thematic and focused on macroeconomics every bit as much as Mr. Singer’s. While he agreed with the first round of quantitative easing as an emergency measure – it was an unpleasant expedient to avoid even moe unpleasant consequences – its continued application is offensive and damaging. However, there appears to be no end in sight and those preparing for interest rates to recover over the short term really don’t have any visibility. In contrast to Mr. Bass’s view, Japan will also be able to use its massive QE program (proportionally much larger to the US’s program) to drive up Japanese assets over the next six quarters or so, and it may spur a secular bull market in Japanese equities that have been in a bear cycle for more than two decades.

On the topic of supercycles, the supercycle in commodities was driven almost solely by China absorbing approximately 50% of volumes in a broad portfolio of commodities over the span of more than a decade. China i now transitioning its economy from investment (50% of GDP for some time) to consumption. This is why commodities are in decline even as currenies are being effectively devalued – the commodity cycle is now unrepeatable and in every category production capacity is oversupplied. The Australian dollar, dependent upon the commodity supercycle, is overvalued and should be sold. He thought GOOG was likely the best play on data, since it has exposure to mobile upside and not to Chinese commodity risk.

Mitchell JulisCanyon Partners

Mr. Julis began his presentation by outlining his investment approach. He identifies opportunities that provide return of capital as well as return on capital: risk management involves taking money off the table and therefore investments that return capital are particularly attractive. He described once such opportunity: investing in the equity of Clear Channel Outdoor. He emphasized both the fundamental and structural aspects of the story.

Fundamentally, outdoor advertising is a growing business with good margins that is not capital intensive. It has recurring revenue streams with strong visibility and solid market position. The company trades at a discount to its peers and therefore looks attractive on a relative value basis. This is where the return on capital would be realized.

The discount to its value is caused not by any inherent flaws in the company relative to its peers, but by its position in a more complex capital structure. It is the publicly traded stub equity of a subsidiary in the larger Clear Channel business. The parent is highly levered as part of a larger LBO, and CCO provides positive cash flow that the parent uses to service its debt. By improving the position of its parent, it has the opportunity to recapture that value as it strengthens the larger capital structure. This provides the return of capital.

Steven EismanEmrys Partners

Mr. Eisman is constructive on US homebuilders and on housing in general, arguing that prices would need to rise 22% from here to return to historical averages. Shadow inventory has declined as financial buyers have entered the market. Last year’s recovery in housing was about volumes, this year it is about price. He favors homebuilders who own land and who have stable balance sheets, preeminently LEN, SPF and PHM. He also likes associated names, including American Woodmark and Fortune Brands and singled out Forestar in particular as being particularly rich in attractive land assets.

In financials, banks are tough due to declining loan creation and poor net interest margins exacerbated by Fed policy. He likes CLNY, specifically their home refurbishment and rental subsidiary which he believes has an attractive cost structure and will produce sizable cash flow. He also believes OCN is an undervalued company because of its specialty finance label. He believes it benefits as a servicer from the structure of loan modifications that put it at the top of the cash flow waterfall, derisking and stabilizing their cash flows.

Finally, he believes that the Canadian housing market’s growth and asset prices have not been organic recently, that loans have not been funded by deposits but by the CMHC, Canada’s Fannie Mae, to the point where CMHC’s balance sheet is now almost as large as Canada’s sovereign debt. Canadian banks are effectively socializing bad debt and they are overvalued as a result. Among Canadian financials, Home Capital Group especially should be sold. It has $15B of mortgages, of which almost $9B are subprime of relatively recent vintage. They trade at twice their book value and have an equity cushion of only $1B.

David StemermanConatus Capital Management

Mr. Stemerman presented a short thesis on Africa Bank. The thesis is premised on the larger backdrop of the South African economy, its recent explosion in unsecured consumer credit, and Africa Bank’s specific position in that marketplace. His argument is that South Africa has progressed through the initial stages of an unsupportable credit expansion - and like the US mortgage crisis has gone from easy availability of credit to good borrowers down the credit quality curve. The South African government has imposed guidelines for interest payments not to exceed a borrower’s net income, but two phenomena similar to the US mortgage crisis have emerged: questionable documentation and increasingly complicated borrowing structures – including interest free loans.

Africa Bank is the name most exposed to this dangerous environment. It has high lvels of nonperforming loans, operates at the lower end of the credit curve and its own capital base is derived from sources that only comprise 5% in cash deposits. The other 95% of the balance sheet’s financing comes from wholesale sources. Africa Bank has extremely risking assets financed by extremely risky capital sources.

James ChanosKynikos Associates

Mr. Chanos argued that the HDD manufacturers are overvalued and selected STX as a particularly attractive short. He identified a number of factors that make STX look cosmetically better than it actually is. First, he cited some issues in valuation in the larger industry: the HDD manufacturers sell into the larger PC market which is shrinking. Their recent comparative recovery was based on the destruction of capacity in Thailand by natural disasters which enforced external discipline – that effect is evaporating. In the meantime, HDD firms trade at higher valuations that PC makers, which is illogical – especially when we consider that the cloud is making storage more efficient and fewer drives are needed to consolidate data even as data grows enormously (the combined digital photos and videos on YouTube and FB require only 6mm HDDs).

STX is particularly overvalued, and its management knows it because they have been aggressively liquidating their own shares, and their CTO just left the firm with no external notice. STX has accounting issues: they pay no taxes in any jurisdiction, yet they continue to book sizable tax assets onto their balance sheets. STX’s cash flows are not sustainable and their end markets are progressively declining as they attempt to consolidate (they bought Samsung’s HDD assets at 0.5x sales, which indicates long term value of the HDD sector).

Tor Olav TroimFredriksen Group

Mr. Troim’s group effectively takes a private equity approach to its portfolio of companies, although many of them are actually publicly traded. The portfolio company he selected for his investment recommendation was Seadrill.

He highlights Seadrill for several reasons: market opportunity, asset costs, return on assets and cash flow. Energy prices, alone among commodities, remain stable because they are supported by recurring demand. The cost of extracting resource is growing because declne rates are increasing (28% on average) and geographies are becoming more challenging. Seadrill’s ultradeep offshore drilling business is attractive to producers because it offers access to plays with high discovery potential. Producers are willing to pay rates that cover the cost of SDRL’s assets in five or six years, and the assets have a 30 year life – this is because SDRL helps them ramp up quickly enough to save a year or more of PV.

SDRL is able to build these assets relatively cheaply because shipyards that ramped up capacity during the boom are hungry for contracts and SDRL is large enough (more than 40 vessels in portfolio) to get good terms. The business still has relatively high barriers to entry ($600mm per vessel build). There will be growth because high decline rates multiply the number of needed wells, which gives SDRL operating leverage.

Jonathan JacobsonHighfields Capital Management

Mr. Jacobson argued that the market is trading higher on an “illusion of yield” and he stated that this phase of the secular bull market is unique in that share price appreciation has been led by defensives, not growth stories. He believes that this is because investors are seeking better yields in equities because of low debt yields, but that they are mistaking melting ice cubes and companies dependent on capital raises for true dependable dividend payers.

AT&T is unattractive because it is a melting ice cube, wireless is eroding its core business, capital expenditures will continue to increase and it is spending all of its free cash flow on share repurchases as its assets decline. Linn Energy is likewise shaky because 50% of its cash flows come from hedging activity rather than organic growth – it depends on capital markets staying open to fund itself.

However, DLR is particularly egregious and should be shorted, it is worth only $20. DLR is structured as a REiT but it is not really a REIT. REIT investors buy traditional REITs because of low capital investment costs, high barriers to entry (location is key) and rents that grow faster than inflation. DLR says its recurring capex is only $21mm, but it spends many multiples of that upgrading equipment every year. Its business has no barriers to entry, its rental revenues decrease each year and it requires high capital investment to remain competitive. Its accounting is questionable.

Clifton RobbinsBlue Harbour Group

Mr. Robbins prefaced his recommendations with a larger perspective on the M&A marketplace. We are in the middle of a perfect storm for acquisitions: companies have large cash holdings, rates are low, the environment remains accomodative, refinancing makes most deals accretive for strategics, there is significant unfunded private equity capital and the quality of companies’ boards has improved.

Mr. Robbins advocating buying two equities. He likes CACI and believes it is cheap because it is associated with the defense complex, which implies sequestration pressure and high capital intensity. CACI’s strong defense portfolio is actually stable and growing, is a software business with good margins and low capital intensity which has other businesses that are equally attractive , cybersecurity, etc. It should trade 7x forward EBITDA, or 13.5x free cash flow, which would value the firm between $70 and $88 per share.
The second equity Mr. Robbins advocated was AKAM. It is the largest content delivery provider in the world, six times the size of its closest competitors, with its network touching between 15 and 30% of global internet traffic. AKAM specializes in delivering video, which will comprise 90% of internet traffic by 2015.

The addressable market in the space by 2016 will be approximately $12B, AKAM already has $1.5B in revenues and should capture a large share of that forward market. Gross margins are increasing and are already close to 23% today. AKAM has competitors, but one of the companies it competes with – Amazon – also uses its technology. The compound annual growth rate of AKAM’s EBITDA will be 13% and the base case for the share’s upside is 42% or $64. The company has a very clean balance sheet, with $1B in cash that is held in the US – not overseas like the cash of so many technology firms – and has strong recurring revenues with zero leverage.

Simeon McMillanColumbia Business School

This year’s award winner picked TRBAA as his investment, he recommends buying the shares. He believes that TRBAA is valuable on a sum of the parts basis and that a number of complicating factors have obscured the firm’s true value. Among the complicating factors: TRBAA’s recent reorganization, the complexity of its portfolio of assets, its lack of recent audited financials, its lack of an exchange listing and lack of broad analyst coverage. These factors cause TRBAA to trade at a discount to its potential value.

The publishing assets have many eager bidders and they could be valued at 5.5x EBIITDA. The real estate associated with those assets could be worth between $450 and $550mm. The WGN superstation asset, if converted into a cable channel on a par with its peers among the former superstations could almost double its revenue per sub from $0.22 to $0.40 or higher. The broadcast assets are more valuable than the market assumes because of persistently strong CPMs and could be worth $37 per share alone. The Food Network stake will find a ready buyer in TRBAA’s partner Scripps, and this is worth upwards of $20 per share. The aggregated sum of the parts value has a downside of $59 and an upside valuation of $115.

Jeffrey GundlachDoubleLine

Mr. Gundlach’s presentation, similar to Mr. Singer’s and Mr. Druckenmiller’s, was thematic and used the history of the capital markets and the larger economy to illustrate his analysis of the current market environment. The core theme was communication: the distinction between what policymakers express – or avoid expressing – verbally, versus what their actions really signal. Janet Yellen’s statement that “the explanation is the policy” is the essence of the problem.

When Cyprus seized depositor’s holdings in the midst of its banking crisis, it is not surprising that gold did not surge but continued in its bearish pattern. During the Great Depression, gold was effectively confiscated by the federal government. If bank deposits are not safe, no asset is safe. QE will continue indefinitely, because if rates rise to their pre-Greenspan average of 6%, at current rates of borrowing, service on US debt will reach $1.6T. QE is not a put on stocks, it is a put on treasuries and will destroy retirement accounts. However, if you want to play QE as an upside to equities, buy the Nikkei.

Chipotle should be sold. It is trading on too high of a P/E multiple (40x), betting on discretionary plays is risky in this environment, growth for the company will slow and the barriers to entry for iis offering are extremely low (Mr. Gundlach visually referenced the growing food truck trend).

David EinhornGreenlight Capital Inc.

Mr. Einhorn is short steels and iron ore. He recommends buying OIS shares because he believes a REIT conversion of its portfolio of oil field and mining accomodation assets would unlock enormous value. The core of his thesis is that OIS trades at an EBITDA multiple of 6.9x, and that separating the REITable assets would allow them to trade at 16x or more of their adjusted FFO.

He went through the companies existing business lines in a sum of the parts breakdown, isolating each asset and assigning to each piece an EBITDA multiple that he believed was conservative, reassembling the non-REIT assets into an entity that he assigned a 7.1x multiple on the basis of conservative assumptions. This underlines that the other assets are not trading above their true multiple because of association with the accomodation business.

The accomodation business is attractive not only because of its high margins and its ability to be organized into a REIT and levered, it is attractive because of secular trends in mining and energy exploration as well – increasingly extreme geographies are part of these businesses and OIS’ integrated solution has many new opportunities. Using 16x AFFO multiples or a 4% yield on projected dividends for the REIT, OIS is worth approximately $155 per share.

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